1 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A ANNUAL REPORT PURSUANT to SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (as amended) For the period ended January 27, 1996. Commission File Number 0-21910 KIDS MART, INC. (F/K/A FROST HANNA ACQUISITION GROUP, INC.) (Exact name of registrant as specified in its charter) Florida 65-0406710 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 801 Sentous Avenue, City of Industry, California 91748 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (818) 854-3166 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title of each class ------------------- Common Stock, par value $0.0001 per share 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. [ ] Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] AS OF SEPTEMBER 4, 1996, THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE ISSUER BASED ON THE AVERAGE BID AND ASK PRICES OF $1.50 AND $2.75, RESPECTIVELY, OF SUCH COMMON STOCK IS $6,916,161 BASED UPON AN AVERAGE PRICE OF $2.125 MULTIPLIED BY 3,254,664 SHARES OF COMMON STOCK OUTSTANDING ON SUCH DATE HELD BY NON-AFFILIATES. AS OF SEPTEMBER 4, 1996, THE ISSUER HAD A TOTAL OF 4,943,000 SHARES OF COMMON STOCK, PAR VALUE $0.0001 PER SHARE, OUTSTANDING. DOCUMENTS INCORPORATED BY REFERENCE: None.

2 The Registrant hereby amends its Annual Report on Form 10-K for the fiscal year ended January 27, 1996 in its entirety as follows: KIDS MART, INC. 10-K/A TABLE OF CONTENTS <TABLE> <CAPTION> Page <S> <C> PART I Item 1. Business 1 Item 2. Properties 7 Item 3. Legal Proceedings 9 Item 4. Submission of Matters to a Vote of Security-Holders 10 PART II Item 5. Market for Common Equity and Related Stockholder Matters 11 Item 6. Selected Financial Data 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 8. Financial Statements 16 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 16 PART III Item 10. Directors and Executive Officers 17 Item 11. Executive Compensation 18 Item 12. Security Ownership of Certain Beneficial Owners and Management 19 Item 13. Certain Relationships and Related Transactions 20 Item 14. Exhibits and Reports on Form 8-K 20 SIGNATURES 21 FINANCIAL STATEMENTS F-1 EXHIBITS </TABLE>

3 PART I ITEM 1. BUSINESS INTRODUCTION INTRODUCTORY NOTE. This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. See "--Private Securities Litigation Reform Act." THE COMPANY. Kids Mart, Inc. (together with its subsidiaries, the "Company"), a Florida corporation, is a value oriented chain of children's specialty apparel stores generally located in strip shopping centers. At January 27, 1996, it operated 296 children's apparel stores in 20 states under the names Little Folks (14 stores) and Kids Mart (282 stores). See "--Recent Developments --Store Closure Plan" for information regarding the closure of approximately 100 of the Company's stores during the third quarter of fiscal year 1996. The Company (then known as Frost Hanna Acquisition Group, Inc.) was formed in April 1993 to serve as a vehicle to effect a merger, exchange of capital stock, asset acquisition or other similar business combination with an operating business. In September 1993, the Company consummated an initial public offering of its equity securities from which it derived net proceeds of approximately $6.6 million. Approximately $5.7 million (representing approximately 80% of proceeds from the initial public offering, inclusive of interest earned thereon) was held in escrow, pending the consummation of the Acquisition (as hereinafter defined) described below and was released to the Company upon consummation of the Merger (as hereinafter defined) also described below. LFS Acquisition Corp. ("LFS") purchased the Little Folks and Kids Mart business from Woolworth Corporation and Kinney Shoe Corporation (collectively "Woolworth") in May 1995 (the "Acquisition"). On January 3, 1996, the Company merged with LFS. See "--Organization, Acquisition and Merger." In January 1996, the Company changed its fiscal year from a calendar basis ending on December 31 to a 52/53 week fiscal year ending on the Saturday nearest January 31 and changed its name to Kids Mart, Inc. See "--Organization, Acquisition and Merger" and "Item 3. Legal Proceedings." RECENT DEVELOPMENTS CONTINUING LOSSES AND CASH FLOW CONSTRAINTS. The Company has experienced substantial losses and cash flow constraints since the Acquisition. Net losses were $5.7 million for the eight months ended January 27, 1996, and $8.6 million for the six months ended July 27, 1996 (unaudited). No assurance can be given as to when, if ever, the Company will become profitable. See "--Private Securities Litigation Reform Act." The Company has experienced difficulties in obtaining adequate credit support from its factors. As a result, the Company has been required to operate on shortened payment terms from its vendors, creating significant cash flow constraints. Through early May 1996, the Company had been able to obtain sufficient merchandise to satisfy its requirements. However, during late May, June, July and August 1996, the Company was unable to obtain adequate credit support to achieve its planned level of inventory purchases, which severely impacted its 1996 back-to-school season. The Company relies heavily on inventory purchased during these months to generate sales during the back-to-school season in August and September. The Company's failure to achieve adequate sales levels in the 1996 back-to-school and holiday seasons would have a material adverse effect on its business. The Company's recurring losses, cash flow constraints, and anticipated loan covenant violations (see "--Other Developments") raise substantial doubt about its ability to continue as a going concern. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and "Item 14. Financial Statements." The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to successfully renegotiate its loan covenants, to obtain additional financing or equity as may be required, and ultimately, to attain profitable operations. In the event that the Company is not successful in, among other things, arranging interim and permanent financing such that the Company will be able to purchase inventory for the 1996 holiday season and thereafter, and attain credit support from its factors, 1

4 it will consider alternate means of continuing the business including further expense reductions, negotiations with landlords and vendors to reach agreement on delaying payments, closing additional stores, as well as any other options available to the Company. In the event these efforts are unsuccessful, as a last resort, the Company may consider the possible filing of a petition for reorganization under Chapter 11 of the Federal bankruptcy laws. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." STORE CLOSURE PLAN. In response to the Company's going concern issues, management implemented a store closure plan (the "Store Closure Plan") during the third quarter of fiscal year 1996 that immediately closed approximately 100 stores (the "Closed Stores") and reduced staff at its distribution center and administrative offices. The Store Closure Plan will require, during the third quarter of fiscal year 1996, an estimated charge to operations of approximately $5.4 million, principally related to store rent liability, closing costs, and separation pay. See "--Personnel." The Company has received the consent of Foothill Capital Corporation ("Foothill"), the Company's principal lender, to the Store Closure Plan. Management based its decision on which stores to close by reviewing each store's performance for the twelve-month period from the Acquisition through May 31, 1996, with respect to sales, gross margins, occupancy costs, and store contribution. The worst performing stores were identified for closure. Certain other Closed Stores were determined based on geographic or other market and cost considerations. The aggregate rent liability for the Closed Stores is approximately $13.2 million and the average remaining lease term is approximately 30 months. In connection with the Store Closure Plan, the Company will undertake to negotiate with the various landlords the outstanding lease liability of the Closed Stores. There can be no assurance that such negotiations will be successful. Failure to reach acceptable agreements with these landlords would have a material adverse effect on the Company. The Company transferred the remaining inventory from the Closed Stores to the remaining open stores. Prior to the Store Closure Plan, average store retail inventory was approximately $78.3 thousand, which was $25.7 thousand below planned retail store inventory for September 1996. The inventory consolidation brought the average retail store inventory up to approximately $112.1 thousand. However, there can be no assurance that the increased inventory levels will improve the Company's sales and operating results or that the Company's inventory levels will not drop below acceptable levels in the future. In connection with the Store Closure Plan, the Company reduced staff at its distribution center and administrative offices, with a corresponding annualized reduction in payroll and benefits expense of approximately $1.4 million. There are a number of risks associated with the Store Closure Plan, including, but not limited to, the inability of the Company to successfully negotiate favorable terms with respect to the lease terminations, the inability of the Company to generate adequate revenues to cover expenses and generate profits, and the possibility that due to the staff reductions and store closings, the Company may not be able to attract or retain qualified personnel. In addition to the Store Closure Plan, since May 1995, management has taken the following steps to improve the Company's operations: - implemented a coordinated merchandising plan with a discernible style and fashion; - increased the percentage to total inventory of higher margin private label merchandising; - reduced its work force; - identified and closed unprofitable stores (37 were closed during the eight months ended January 27, 1996, and an additional 14 were closed by July 27, 1996); - renegotiated certain store leases; - instituted a markdown strategy to support the Company's inventory turnover goals; - targeted marketing efforts to "Preferred Customer" cardholders; - added a limited number of unique toys and stuffed animals to most of its stores; and - improved customer service to create a friendly, neighborhood store atmosphere 2

5 INTERIM FINANCING. The Company requires immediate financing to purchase inventory for the 1996 holiday sales season. Failure to achieve adequate sales levels in the 1996 holiday season would have a material adverse effect on the Company's business. Management has held discussions with financial advisors and potential investors with respect to interim financing through short-term subordinated debt, equity investment, or debt restructuring. The Company has raised approximately $0.9 million through a sale/leaseback transaction and conversion of a vendor account payable to shares of the Company's common stock, par value $.0001 per share, (the "Common Stock"). See "--Other Developments." However, the Company has not yet entered into any agreements with respect to additional interim financing, and accordingly, there can be no assurance that the Company can obtain such financing, that such financing would be timely, or that such financing, if obtained, would be sufficient to enable the Company to continue as a going concern for a reasonable period of time. PERMANENT FINANCING. The Company also requires substantial long-term investment so that it can meet its obligations and sustain operations. Toward this end, the Company has entered into an engagement letter with a financial advisor and placement agent with respect to a proposed $10 million to $15 million private placement of the Company's securities. The placement agent's obligations under the engagement letter are subject to a number of qualifications, including, but not limited to, the placement agent's successful completion of its due diligence review and the successful negotiation of a definitive placement agent agreement. There can be no assurance that such private placement will be consummated, that it would be on terms favorable to the Company or that it would be sufficient to enable the Company to continue as a going concern for a reasonable period of time. OTHER DEVELOPMENTS. The Company anticipates violation of certain of its loan covenants under its credit facility with Foothill during the remainder of fiscal year 1996. The Company is currently in negotiations with Foothill to waive or amend these covenants. There can be no assurance that Foothill will waive or amend the covenants or that the Company will not violate other covenants in the future. If the Company does violate any such covenants, there can be no assurance that Foothill will not declare the Company in default under the credit facility and seek to exercise its remedies under the credit facility, including foreclosure of the Company's assets. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company has arranged an overdraft facility for up to $2.0 million with Foothill during the period from June 10, 1996 to February 15, 1997. In conjunction with arranging the overdraft facility, the Company's credit facility was amended to require the Company to raise at least $2.0 million in subordinated debt or common stock equity on or before September 30, 1996, or to have substantially completed a private placement of the Company's securities by that date (the "Covenant"). As of September 16, 1996, the Company has raised approximately $0.9 million of the $2.0 million needed through the transactions discussed below. On July 24, 1996, the Company entered into a sale/leaseback transaction whereby it sold certain equipment to a leasing company for $0.3 million, and leased it back under an operating lease for 24 months. As consideration for this transaction, the Company issued a warrant to the leasing company to purchase 50,000 shares of Common Stock at $7 per share. On September 11, 1996, the Company entered into an agreement pursuant to which one of its vendors converted $0.65 million of amounts due to the vendor to 433,333 shares of Common Stock. In exchange, the Company will use its best efforts to purchase annually a minimum of $10 million of merchandise inventories, as defined, from this vendor. Further, the vendor shall have the right to have its nominee installed as a director to the Company's Board of Directors within three months of execution of the agreement. Thereafter, unless the vendor has reduced its investment in the Company by more than 50% the Company shall nominate said nominee to the Board of Directors to be voted upon by the shareholders of the Company at each annual meeting. There can be no assurance that the Company will raise the additional $1.1 million necessary to avoid a violation of the Covenant, that the Company will not violate other covenants under its credit facility, or that if a violation occurs, that Foothill will not declare the Company in default and seek to exercise its remedies under the credit facility, including foreclosure of the Company's assets. PRIVATE SECURITIES LITIGATION REFORM ACT. The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in "Item 1. Business --Recent Developments" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and in other parts of this Form 10-K and other materials filed or to be filed by the Company with the Securities and Exchange Commission contains statements that are forward-looking, such as statements relating to the 3

6 Company's Store Closure Plan, statements relating to the Company's need for additional financing and statements regarding the Company's anticipated potential loan covenant violations, among others. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future, and accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, the risk of continuing losses and cash flow constraints despite the Company's efforts to improve operations, including the Store Closure Plan, the inability to obtain interim financing or permanent financing such that the Company will be able to purchase inventory for the 1996 holiday season and thereafter, and attain credit support from its factors, failure to negotiate acceptable payment terms with vendors and landlords, and failure to negotiate waivers or amendments to loan covenants. BUSINESS MERCHANDISING. The Company positions itself in the market by offering children's fashions with a coordinated and stylish look at moderate prices. It accomplishes this by consistently offering customers value at a reasonable price and utilizing its position as a large retailer in the children's specialty store apparel market. The Company seeks store sites that are highly visible, well-signed and provide easy customer access. The Company favors locations in strip centers with established anchor tenants next to heavily trafficked roads and within convenient reach of its customer base. Management prefers strip center locations over mall locations because occupancy costs are less expensive, and these locations match its core customer's shopping needs. The Company's stores carry a full range of clothing and accessories for children from infants to 11 years of age, including pants, jeans, tops, skirts, dresses, coveralls, sweaters, shorts, socks, belts, hats, outerwear, backpacks, sunglasses and many other items carried both on a seasonal and year-round basis. Management has increased inventory levels for infant merchandise because this category typically generates higher gross margins. Currently, approximately 32% of the merchandise sold by the Company is private label, primarily under the Way Cool, U BET and Bebe Terrifique labels. The Company plans to gradually increase the percentage of private label merchandise to 65% over the next three years, if warranted. This emphasis on private label merchandise should result in better gross profit margins, better direct sourcing from manufacturers and better control over styles, fabrics and colors. The use of private label merchandise, however, brings with it the associated burdens of quality control and unfavorable delivery schedules. The Company monitors both these issues closely. The Company currently has a product development department that is responsible for working with manufacturers, both domestic and overseas, to design merchandise to be sold under the Company's private labels. The Company offers a small selection of creative toys and unique stuffed animals. These toys are designed for newborn children to 11 year olds. Presently the Company is generating approximately one-half of toy sales from impulse items under $5 each, and the remainder from more expensive toys primarily carried during the fourth quarter. The success of the Company's merchandising strategy will be dependent on its ability to generate sufficient cash flow to sustain operations. See "--Recent Developments." 4

7 MARKETING AND ADVERTISING. The Company maintains a "Preferred Card" program that had approximately 607,000 card holders as of January 27, 1996. Of these, approximately 498,000 holders had shopped at one or more of the Company's stores during the past 18 months. Sales of the card, which can be purchased on a yearly basis for $6 per card, resulted in revenue of $2.3 million for the eight months ended January 27, 1996. Purchase of the card entitles the holder to a 10% discount on all regular price purchases and other special privileges. The Company maintains a data base that includes demographic and purchasing data on these cardholders. The Company conducts periodic targeted marketing campaigns utilizing this list. The Company historically spent significant amounts of its advertising dollars on national programs. Current management has reduced national advertising in favor of local and point of purchase programs which it believes are more effective and less costly. The Company operates an in-house advertising and marketing department with a staff of five. The department creates all of the Company's printed materials, including mailers, newspaper advertisements, and in-store displays. The Company's marketing strategy is aimed at attracting customers to the store by stressing promotional pricing, value, and fashion. Many of the Company's sales are at the beginning of the important selling seasons, including Christmas, back-to-school, and spring and summer. The Company's stores feature wall and selling-floor displays that coordinate merchandise in order to promote multiple sales. MARKET. The Company's largest market is California where it maintained 43% of its stores and derived approximately 45% of its revenue during the eight months ended January 27, 1996. Sales of apparel and accessories represented 87% and 13% of the Company's revenue, respectively during the eight months ended January 27, 1996. After giving effect to the Store Closure Plan, the Company's largest market remained California where 52% of its stores are located. See "--Recent Developments." PRODUCT SOURCING AND MANUFACTURING. The Company has no in-house manufacturing capability. Approximately 32% of the Company's merchandise is currently manufactured to its private label specifications by independent factories located in the United States and throughout the world. The Company utilizes a buying agent in Hong Kong to coordinate overseas production. Approximately 35% of the Company's private label capacity is produced by fewer than 30 manufacturers. On September 11, 1996, the Company entered into an agreement with one of its vendors to use its best efforts to purchase annually a minimum of $10 million of merchandise inventory, as defined, from this vendor. As part of the agreement, the vendor has converted $0.65 million of amounts owed to it by the Company into 433,333 shares of Common Stock. See "Recent Developments --Other Developments." TRADEMARKS AND PRIVATE LABELS. The Company owns the right to the following trademarks: Bebe Terrifique, Kids Mart, Kidsmart (pending), Little Folk, Little Folks, Little Folk Shop, Little Folk Shops, Way Cool, U Bet and others. RESTRICTION ON IMPORTS. The Company's operations are subject to the customary risks of doing business abroad, including fluctuations in the value of currencies, customs duties and related fees, import controls and trade barriers (including quotas), restrictions on the transfer of funds, work stoppages and political instability in certain parts of the world. However, the Company believes that it has reduced these risks by diversifying its offshore purchases among various countries and factories. These risks have not had a material adverse impact upon the Company's operations to date. Imports into the United States are also affected by the cost of transportation, the imposition of import duties and increased competition for greater production abroad. The countries from which the Company's products are imported may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duty or tariff levels, which could affect the Company's operations and its ability to import products at current or increased levels. The Company cannot predict the likelihood or frequency of any such events occurring. The Company's imported products are subject to United States customs duties and, in the ordinary course of its business, the Company may be subject to claims for duties and other charges. WAREHOUSING AND DISTRIBUTION. The Company leases a warehouse and distribution center, approximately 118,500 square feet, located in City of Industry, California. Management believes that the warehouse has current capacity to serve as many as 500 stores and is therefore sufficient for the Company's needs. The facility also contains the Company's executive, administrative and buying offices. 5

8 Merchandise purchased by the Company is received at this facility and prepared for distribution to its stores. The functions performed at the facility include quality control inspection, ticketing, packing and shipping. The facility's automated sorting system ensures the proper flow of merchandise from receipt to shipment. Shipments to each store are made by trucks operated principally by common carriers. The Company ships to stores two to five times per week, depending on seasonal volume. PERSONNEL. At January 27, 1996, the Company had 831 full-time equivalent employees comprised of 148 full-time employees in the administrative offices and distribution center, 21 full-time field supervision personnel, and 661 full-time and 1,223 part-time employees at the stores. After giving effect to the Stores Closure Plan and staff reductions, the Company will have approximately: 511 full-time equivalent employees comprised of 136 employees in the administrative offices and distribution center, 11 full-time field supervision personnel, and 364 full-time and 728 part-time employees at the stores. See "--Recent Developments." TRANSITIONAL SERVICES. The Company receives information systems, accounting and administrative services from Woolworth pursuant to the terms of a transition service agreement (the "Service Agreement"). In return, the Company pays certain fees to Woolworth. The initial term of the Service Agreement expired on May 31, 1996. In connection with a settlement reached under a Mutual Release and Settlement Agreement (the "Settlement Agreement"), the Service Agreement was extended to October 26, 1996, at which time the Service Agreement can be extended on a month-to-month basis unless terminated by either party upon a 30-day notice. See "--Organization, Acquisition and Merger" and "Item 3. Legal Proceedings." The Company is currently upgrading its management information systems. These systems will offer greater functionality and flexibility than systems currently available to the Company under the Service Agreement with Woolworth. Implementation of these systems is a high priority of management. Management had originally estimated that the cost of this upgrade would be up to $5.5 million, which includes financial and merchandise system software, main system hardware, and POS (point-of-sale) hardware and software. As a result of the Store Closure Plan, the POS hardware requirements have been reduced, and the estimated cost of the upgrade is approximately $4.1 million. Approximately $0.9 million of systems upgrade costs had been incurred as of July 27, 1996. The Company has entered into an operating lease agreement for a significant portion of this equipment and will fund the remaining portion from internally generated sources of funds or additional financing. The Company may not establish its own systems by the expiration date of the Service Agreement and may incur significant expenses in excess of the budgeted amounts in developing such systems. IMPACT OF COMPETITION. All aspects of the children's apparel specialty retail industry are highly competitive. The Company competes with a number and variety of retailers, mass merchandisers and warehouse clubs, including several national chains, some of which have greater financial and marketing resources than the Company. The principal competitors of the Company include Baby Gap/Gap Kids, Gymboree, Kids "R" Us, Children's Place, Little Things, Mervyns, Wal-Mart, J.C. Penney, Ross Stores, Target, Venture and Marshall's. Competition exists primarily in the areas of price, product selection and service. Competitive factors could require price reductions or increases in expenditures for marketing and customer service that could adversely affect the Company's operating results. SEASONALITY. The Company has historically experienced and expects to continue to experience seasonal fluctuations in its sales and operating results. A disproportionate amount of the Company's sales and operating income are realized during the months of August, September, November and December. The Company has also experienced periods of increased sales activity in early spring and early fall. Furthermore, sales and operating results are generally weakest during the second quarter. Because of the seasonality of the Company's business, results for any quarter are not necessarily indicative of results that may be achieved for a full fiscal year. ORGANIZATION, ACQUISITION AND MERGER The Company was formed in April 1993 to serve as a vehicle to effect a merger, exchange of capital stock, asset acquisition or other similar business combination with an operating business. In September 1993, the Company consummated an initial public offering of its equity securities from which it derived net proceeds of approximately $6.6 million. Approximately $5.7 million (representing approximately 80% of proceeds from the initial public offering, inclusive of interest earned thereon) was held in escrow, pending the consummation of the Acquisition described below and was released to the Company upon consummation of the Merger also described below. 6

9 On January 3, 1996, pursuant to an Agreement and Plan of Merger and Reorganization (the "Merger Agreement"), dated May 31, 1995, FH Sub Delaware, Inc., a Delaware corporation and wholly-owned subsidiary of the Company merged with and into LFS (the "Merger"). As a result of the Merger, LFS became a wholly owned subsidiary of the Company. Thereupon, the Company issued an aggregate of 2,678,000 shares (the "Shares") of Common Stock to the owners of all the issued and outstanding shares of capital stock of LFS. The Shares constituted approximately 54% of the outstanding shares of Common Stock of the Company. Additional shares of Common Stock issuable upon the exercise of certain warrants are held by a) the underwriter of the Company's initial public offering (110,000 shares) and b) the initial LFS investors (1,094,300 shares). Assuming full exercise of all of the outstanding warrants to purchase shares of the Company's Common Stock, the former LFS security holders would own approximately 61.4% of the outstanding shares of the Company's Common Stock. Since the former LFS investors own the controlling interest of the Company's Common Stock, the Merger has been accounted for as a "reverse acquisition" as if LFS recapitalized its ownership interest and then acquired the Company under the purchase method of accounting by the issuance of 2,265,000 shares of its Common Stock. These 2,265,000 shares were valued at $6.2 million which represented the estimated fair market value of the Company's net assets acquired at the date of the Merger. For purposes of the Merger, LFS is the "accounting acquirer" and the Company is the "legal acquirer." LFS was formed on May 26, 1995, for the purpose of acquiring the Holtzman's Little Folk Shop, Inc. ("Holtzman's") business from Woolworth. On May 31, 1995, LFS acquired all of the outstanding shares of capital stock of Holtzman's from Woolworth and certain of Holtzman's operating assets and liabilities from Kinney Shoe Corporation, a wholly owned subsidiary of Woolworth ("Kinney"). Prior to this transaction, Holtzman's had transferred certain of its assets and liabilities to Kinney. The preliminary purchase price of the Acquisition was $21.0 million, which was financed with a $5.0 million promissory note to Woolworth, $4.3 million of current liabilities to Woolworth, a borrowing of $4.4 million under the Company's revolving credit facility, $4.3 million of short-term bridge loans advanced by a group of private lenders, including Woolworth, and $3.0 million of cash on hand. Subsequent to the Acquisition, disagreements arose between LFS and Woolworth regarding the determination of the final purchase price of Holtzman's net assets at May 31, 1995. Such disagreements resulted in LFS filing a lawsuit against Woolworth, and a cross-complaint filed by Woolworth against LFS. On May 30, 1996, the Company and Woolworth reached a settlement under the Settlement Agreement. Pursuant to the Settlement Agreement, Woolworth agreed to release to the Company $1.7 million placed in escrow at the closing of the Acquisition, cancel the $9.3 million of Company debt and liabilities incurred in connection with the Acquisition, and also cancel $4.4 million of other amounts advanced by Woolworth on behalf of the Company during the eight months ended January 27, 1996. In exchange, the Company issued one million shares of Series A convertible nonvoting preferred stock to Woolworth. The adjusted purchase price for the Acquisition was $11.1 million. See "Item 3. Legal Proceedings." ITEM 2. PROPERTIES At January 27, 1996, the Company operated 296 stores in 20 states, consisting of 14 Little Folks Stores and 282 Kids Mart stores. Stores that are located in strip shopping centers are open eleven hours each day, Monday through Saturday, and seven hours on Sunday; stores located in enclosed malls conform to mall hours. Store hours are longer during the Christmas holiday season and during back-to-school programs. After giving effect to the Store Closure Plan, the Company will operate approximately 182 stores in 18 states consisting of approximately 11 Little Folks Stores and approximately 171 Kids Mart Stores. The Company's stores range in size from 1,800 to 6,000 square feet, averaging approximately 2,600 square feet and are designed to maximize selling space. The Company seeks store sites which are highly visible, well-signed and provide easy customer access. The Company has favored locations in strip centers with established anchor tenants next to heavily trafficked roads and within convenient reach of its customer base. Management prefers strip locations over mall locations because 7

10 occupancy costs are less expensive, strip center leases are typically more favorable than mall leases, and these locations match its core customer's shopping needs. The table below sets forth the location of the Little Folks and Kids Mart stores by state: <TABLE> <CAPTION> CLOSED STORES AND OTHER CLOSED STORES (a) ---------------------------------------- NUMBER OF STORES LITTLE FOLK KIDS MART ADJUSTED STATE AT JANUARY 27, 1996 STORES STORES STORE COUNT ------------------------------------------------ ---------------------------------------- <S> <C> <C> <C> <C> California 127 (2) (30) 95 Texas 31 (12) 19 Illinois 24 (18) 6 Ohio 18 (12) 6 Florida 17 (5) 12 Louisiana 12 (2) 10 Maryland 10 (1) (6) 3 Michigan 9 (4) 5 Arizona 8 (4) 4 Missouri 6 (2) 4 Virginia 6 (2) 4 Indiana 5 (3) 2 Utah 4 (1) 3 Washington 4 (3) 1 Nevada 3 (2) 1 New Mexico 3 3 Oklahoma 3 (1) 2 Oregon 3 (1) 2 Wisconsin 2 (2) -- Kentucky 1 (1) -- ------------------------------------------------ ---------------------------------------- Total 296 (3) (111) 182 ================================================ ======================================== </TABLE> (a) 97 stores have been closed with respect to the Store Closure Plan; 17 additional stores have been closed since January 27, 1996. Up to 10 additional stores may be closed with respect to the Store Closure Plan pending review of such stores by management. The following table sets forth the types and number of store leases to which the Company is a party as of the date of this filing giving effect to the Closed Stores and other closed stores. <TABLE> <CAPTION> No. of Leases Closed Stores & Adjusted Type of lease at January 27, 1996 other closed stores (a) lease count ------------------------------------------------------------------------------------------------ <S> <C> <C> <C> Short-Term (12 months or less) 39 (13) 26 Month-to-Month 57 (22) 35 Long-Term 200 (79) 121 ------------------------------------------------------------------------------------------------ TOTAL 296 (114) 182 ================================================================================================ </TABLE> (a) 97 stores have been closed with respect to the Store Closure Plan; 17 additional stores have been closed since January 27, 1996. Up to 10 additional stores may be closed with respect to the Store Closure Plan pending review of such stores by management. Lease payments for the six months ended July 27, 1996 were $5.8 million, which included approximately $1.8 million for the Closed Stores. The aggregate rent liability for the Closed Stores is approximately $13.2 million 8

11 and the average remaining lease term is approximately 30 months. In connection with the Store Closure Plan, the Company will undertake to negotiate with the various landlords the outstanding lease liability of the Closed Stores. There can be no assurance that such negotiations will be successful. Failure to reach acceptable agreements with these landlords would have a material adverse effect on the Company's business. The Company leases a warehouse and distribution center, approximately 118,500 square feet, located in City of Industry, California. Management believes that the warehouse has current capacity to serve as many as 500 stores and is therefore sufficient for the Company's needs. The facility also contains the Company's executive, administrative and buying offices. Lease payments for the eight months ended January 27, 1996 were $8.3 million, which included approximately $1.1 million of rent for 37 unprofitable stores closed during the eight months ended January 27, 1996. Since the date of the Acquisition, the Company has successfully renegotiated leases on 81 stores and the distribution center, and intends to renegotiate the leases on the remaining stores during the next 12 months. However, there is no assurance that the Company will be successful in its effort to renegotiate the remaining leases or that if it is successful, that the new leases will be on terms more beneficial to the Company. Within the context of the lease renegotiations described above, with respect to the stores currently operating on month-to-month or short term leases, the Company will attempt to secure longer term leases on terms favorable to the Company, for those stores which fit the Company's performance requirements. In the event landlords representing these centers refuse to extend terms on these leases, the Company would experience a significant reduction in sales volume with a resulting negative impact on earnings. During the eight months ended January 27, 1996, the Company closed 37 unprofitable stores, nine of which had lease terms remaining when the Company ceased store operations. The remaining lease terms on these stores varied from less than six months to over three years. As of January 27, 1996, the total rent liability associated with these leases was $0.5 million. Based on favorable negotiations with the landlord at one of the stores, the Company recorded a provision as of January 27, 1996, of $0.4 million to reflect the impact of these closures. As of July 27, 1996, three of the nine stores' leases had been terminated. The six remaining stores have a total rent liability of $0.2 million, which approximates the remaining accrued balance. The Company is attempting to negotiate favorable terms with the other landlords but it is possible that because the Company has ceased operations in these nine locations, the individual landlords may declare the Company in default under the terms of these leases. See "Recent Developments." ITEM 3. LEGAL PROCEEDINGS On December 5, 1995, LFS filed a complaint against Woolworth in Superior Court for the County of Los Angeles. The complaint alleged fraud, negligent misrepresentation, and breach of contract in connection with the Acquisition. LFS contended that before the Acquisition, Woolworth conducted extended clearance sales which damaged the Company's consumer base, failed to disclose to LFS the financial impact resulting from inventory markdowns and purchased excess inventory which LFS acquired in the Acquisition. In addition, LFS claimed that Woolworth breached the Service Agreement. Woolworth filed a general denial of all of the material allegations of the complaint and served a cross-complaint against LFS. Woolworth sought recovery of a minimum of $5.6 million for payroll taxes, sales and use taxes, customs duties and other taxes, charges and expenses paid by Woolworth on behalf of LFS. LFS filed a general denial to this cross-complaint and asserted several affirmative defenses. On May 30, 1996, the Company and Woolworth entered into the Settlement Agreement. Pursuant to the Settlement Agreement, Woolworth agreed to release to the Company $1.7 million placed in escrow at the closing of the Acquisition, cancel the $9.3 million of Company debt and liabilities incurred in connection with the Acquisition, and also cancel $4.4 million of other amounts advanced by Woolworth on behalf of the Company during the eight months ended January 27, 1996. In exchange, the Company issued one million shares of Series A convertible nonvoting preferred stock to Woolworth. These shares were valued at $3.5 million, representing their fair market value at the date of issuance. The Company has reflected the impact of the Settlement Agreement on its consolidated financial statements as of May 31, 1995, the date of the Acquisition. 9

12 Woolworth has refused to pay the Company $0.5 million for amounts collected on behalf of the Company under the terms of the Service Agreement. In its consolidated balance sheet as of January 27, 1996, the Company reported a receivable from Woolworth for $0.5 million, which it has deducted from payments owed to Woolworth under the terms of the Service Agreement. If it is determined that the Company must release Woolworth from the $0.5 million liability, there could be a material adverse impact on the Company's results of operations and cash flows. The Company has not recorded a loss provision in its consolidated financial statements for the eight months ended January 27, 1996, based upon management's belief that the possibility of such loss is remote. The Company has been notified that certain stores that it leases in California have materials containing asbestos. The asbestos material is generally in trace quantities, and no remediation is expected to be required on the understanding that such material is properly secured. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On January 3, 1996, the Company held a special meeting of stockholders. At that meeting the stockholders voted on the proposals described below. The results of the stockholder vote on each proposal is set forth after such description. 1. To approve the Merger, including an amendment to the Articles of Incorporation of the Company to change the Company's name to "Little Folks Shops, Inc." FOR: 1,342,100 shares. AGAINST: 9,900 shares. ABSTAIN: 3,200 shares. 2. To approve and adopt the Company's Restated Articles of Incorporation. FOR: 1,316,750 shares. AGAINST: 25,200 shares. ABSTAIN: 13,250 shares. 3. To approve and adopt the 1995 Frost Hanna Acquisition Group, Inc. Stock Option Plan. FOR: 1,300,016 shares. AGAINST: 42,234 shares. ABSTAIN: 12,950 shares. 10

13 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The principal market in which the Company's Common Stock, is traded is the over-the-counter market under the symbol KIDM. The Common Stock commenced trading on September 7, 1993. The following table shows the reported low bid and high bid quotations per share of Common Stock for the periods indicated. The high and low bid prices for the periods indicated are inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. These quotations have been obtained from the OTC Bulletin Board. <TABLE> <CAPTION> Low Bid High Bid <S> <C> <C> Year ended December 31, 1994 First quarter $7.375 $ 8.25 Second quarter 6.75 8.25 Third quarter 5.50 7.25 Fourth quarter 4.50 6.50 Year ended December 31, 1995 First quarter 3.00 5.25 Second quarter 5.00 7.00 Third quarter 4.75 7.50 Fourth quarter 3.375 6.25 Interim period (due to change in fiscal year end) January 1, 1996 through January 27, 1996 4.375 5.125 Year ending February 3, 1997 First quarter 3.88 4.40 Second quarter 2.00 6.125 Third quarter (through September 4, 1996) 0.50 2.75 </TABLE> On September 4, 1996, the closing bid and ask prices of the Common Stock were $2.00 and $2.75, respectively. On September 5, 1996, there were 87 recorded holders of Common Stock, inclusive of those brokerage firms and/or clearing houses holding shares of Common Stock for their clientele (with each such brokerage house and/or clearing house being considered as one holder). The Company has not declared or paid any cash dividends on its Common Stock and does not intend to declare or pay any cash dividends in the foreseeable future. The payment of dividends, if any, is within the discretion of the Board of Directors and will depend on the Company's earnings, if any, its capital requirements and financial condition and such other factors as the Board of Directors may consider. Under the Company's lending arrangements, the Company will not be permitted to declare any dividends without the lender's prior consent. 11

14 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes selected consolidated financial data as of and for the eight months ended January 27, 1996, and should be read in conjunction with the audited consolidated financial statements included elsewhere in this report. The table also sets forth summarized unaudited consolidated financial data as of and for the six months ended July 27, 1996. <TABLE> <CAPTION> January 27, July 27, INCOME STATEMENT DATA 1996 1996 ----------------------------------------------------------------------------------------------------- (in thousands, except for per share amounts) (eight months ended) (six months ended) (unaudited) <S> <C> <C> Net sales $87,698 $47,370 Gross profit $34,402 $17,708 Loss from operations $(4,212) $(7,775) Net loss $(5,696) $(8,563) Net loss per common share $ (1.15) $ (1.73) Dividends per common share None None Average shares 4,943 4,943 ===================================================================================================== <CAPTION> BALANCE SHEET DATA ----------------------------------------------------------------------------------------------------- (in thousands) (at fiscal year end) (six months ended) (unaudited) <S> <C> <C> Working capital (deficiency) $ 1,010 $(7,883) Total assets $27,609 $23,374 Borrowings under credit facility $ 8,849 $ 9,422 Redeemable common stock $ 50 $ 50 Stockholders' equity (deficiency) $ 7,087 $(1,470) ===================================================================================================== </TABLE> ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PRIVATE SECURITIES LITIGATION REFORM ACT. This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and the Company intends that such forward-looking statements be subject to the safe harbors created thereby. See "Item 1. Business --Private Securities Litigation Reform Act." OVERVIEW. The following discussion presents information about the financial condition, liquidity and capital resources, and results of operations of the Company as of and for the eight months ended January 27, 1996. This information should be read in conjunction with the audited consolidated financial statements of the Company and the notes thereto. Information presented as of and for the six months ended July 27, 1996 is unaudited. See "Item 1. Business --Recent Developments." The Company reported a net loss of $5.7 million for the eight months ended January 27, 1996. The net loss reflected $1.0 million of goodwill impairment write-off related to the Acquisition, and a charge against cost of sales for $1.2 million for markdown reserves. Also 37 unprofitable stores were closed during the eight months ended January 27, 1996. Net sales for the eight months ended January 27, 1996 were $87.7 million. The Company has continued to experience operating losses and cash flow constraints subsequent to January 27, 1996. Unaudited net losses were $8.6 million for the six months ended July 27, 1996, unaudited current liabilities exceeded unaudited current assets by $7.9 million, and the Company has an unaudited stockholders' deficiency of $1.5 million, respectively, as of July 27, 1996. The Company also anticipates violation of certain of its loan covenants under its credit facility for the remainder of fiscal year 1996. These conditions have raised substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time. In response to the Company's going concern issues, management implemented the Store Closure Plan during the third quarter of fiscal year 1996 that immediately closed the Closed Stores and reduced staff at its distribution center and 12

15 administrative offices. The Store Closure Plan will require, during the third quarter of fiscal year 1996, an estimated charge to operations of approximately $5.4 million, principally related to store rent liability, closing costs, and separation pay. The Company has received the consent of Foothill, the Company's principal lender, to the Store Closure Plan. FINANCIAL CONDITION. The Company's working capital was $1.0 million as of January 27, 1996, and a deficiency of $(7.9) million as of July 27, 1996 (unaudited). Its current ratio and debt-to-equity ratios were 1.05 and 3.54, respectively, at January 27, 1996, and 0.68 and (7.35), respectively, at July 27, 1996 (unaudited). On the Acquisition date of May 31, 1995, average store inventory at retail was approximately $152.2 thousand. New management's 1996 plan called for average store inventory of approximately $135.3 thousand for May. This average store inventory surplus aggregated approximately $5.6 million in excess inventory at the date of the Acquisition. Woolworth also had significant merchandise inventory orders outstanding at the Acquisition. Management canceled approximately $30 million at retail of these orders. Despite these order cancellations, merchandise purchases during June, July and August 1995, were approximately $62.5 million, as compared to the 1996 plan for merchandise purchases of approximately $44.2 million for the same three months during 1996. The excessive levels of inventory and merchandise purchases as of the Acquisition and immediately following it resulted in high levels of aged inventory at January 27, 1996. Aged inventory (that is, merchandise on-hand greater than nine months) was 10.9% of total inventory at January 27, 1996. The Company recorded purchase accounting adjustments to the beginning inventory balance and inventory markdown reserves against the year-end inventory balance for approximately $22.1 million, at retail, during the eight months ended January 27, 1996. Pursuant to the Store Closure Plan, the Company transferred the remaining inventory from the Closed Stores to the remaining open stores. Prior to the Store Closure Plan, average store retail inventory was approximately $78.3 thousand, which was $25.7 thousand below planned retail store inventory for September 1996. The inventory consolidation brought the average retail store inventory up to approximately $112.1 thousand. However, there can be no assurance that the increased inventory levels will improve the Company's sales and operating results or that the Company's inventory levels will not drop below acceptable levels in the future. Woolworth has refused to pay the Company $0.5 million for amounts collected on behalf of the Company under the terms of the Service Agreement. In its consolidated balance sheet as of January 27, 1996, the Company reported a receivable from Woolworth for $0.5 million, which it has deducted from payments owed to Woolworth under the terms of the Service Agreement. If it is determined that the Company must release Woolworth from the $0.5 million liability, there could be a material adverse impact on the Company's results of operations and cash flows. The Company has not recorded a loss provision in its consolidated financial statements for the eight months ended January 27, 1996, based upon management's belief that the possibility of such loss is remote. LIQUIDITY AND CAPITAL RESOURCES. The Company's cash requirements are primarily related to the need to purchase and pay for inventory prior to its sales, lease payments for store rent, the costs associated with computer system hardware and software installation, and the funding of normal operating expenses. The Company's cash requirements fluctuate based on the seasonality of its sales and the required build up of inventory in advance of peak sale periods. The Company funds its operations from retail sales; it does not offer its customers credit terms. The Company is party to a revolving credit facility with Foothill for up to $20 million for working capital advances, of which as much as $10 million can be used for obligations under letters of credit. Aggregate borrowings are limited to the lesser of $20 million or specified percentages of eligible merchandise inventories, as defined. All loans made pursuant to the credit facility are secured by substantially all of the Company's assets and bear interest at a reference rate plus 2 percent. The credit facility expires on May 31, 1999, and can then be renewed for successive one-year periods unless terminated by either party pursuant to the terms of such agreement. The credit facility contains various restrictions concerning the Company's ability to assume additional indebtedness and specifies limits on capital expenditures. The credit facility also contains various covenants that require the Company to maintain certain minimum levels of working capital and tangible net worth, as defined, and to maintain certain minimum financial ratios, among others. 13

16 At January 27, 1996, the Company had drawn down approximately $8.8 million at 9.75% under the credit facility and had approximately $1.1 million of remaining availability. The Company's average interest rate on borrowings under its credit facility was 11.37% during the eight months ended January 27, 1996. Following the date of the Acquisition, the Company experienced substantial losses in connection with inventory writedowns recorded prior to the Settlement Agreement adjustments, which resulted in a violation of certain covenants under its credit facility as of January 27, 1996. Subsequent to January 27, 1996, the Company has experienced losses and cash flow constraints that resulted in uncertainty regarding the Company's ability to continue as a going concern. As a result, the Company's auditors have included an emphasis paragraph regarding the uncertainty of the Company's ability to continue as a going concern in their report on the Company's audited consolidated financial statements as of and for the eight months ended January 27, 1996. The going concern qualification was a violation of one of the credit facility covenants as of January 27, 1996. However, the Company obtained waivers of the first covenant violation through April 1996, and of the second violation on September 4, 1996. The Company also anticipates potential violation of certain other covenants for the remainder of fiscal year 1996. During April and June 1996, the Company amended its revolving credit facility with Foothill. These amendments modified certain covenants, extended the term of the agreement from May 31, 1998 to May 31, 1999, and granted the Company additional borrowings for up to $2.0 million during the period from June 10, 1996 to February 15, 1997. In conjunction with arranging the overdraft facility, the Company's credit facility was amended to require the Company to raise at least $2.0 million in subordinated debt or common stock equity on or before September 30, 1996, or to have substantially completed a private placement of the Company's securities by that date (the "Covenant"). To date, the Company has raised $0.9 million of the $2.0 million needed. There can be no assurance that the Company will raise the additional $1.1 million necessary to avoid a violation of the Covenant, that the Company will not violate other covenants under its credit facility, or that if a violation occurs, that Foothill will not declare the Company in default and seek to exercise its remedies under the credit facility, including foreclosure of the Company's assets. The Company must also achieve certain performance criteria. The Company issued to Foothill warrants to purchase 100,000 shares of Common Stock at $6 per share as consideration for these amendments. As of July 27, 1996, approximately $7.9 million was outstanding at 10.25% under the credit facility. There was no credit available as of that date. Further, the Company had borrowed $1.5 million and had $0.5 million available under its overdraft facility. The Company has experienced difficulties in obtaining adequate credit support from its factors. As a result, the Company has been required to operate on shortened payment terms from its vendors, creating significant cash flow constraints. Through early May 1996, the Company had been able to obtain sufficient merchandise to satisfy its requirements. However, during late May, June, July and August 1996, the Company was unable to obtain adequate credit support to achieve its planned level of inventory purchases, which severely impacted its 1996 back-to-school season. The Company relies heavily on inventory purchased during these months to generate sales during the back-to-school season in August and September. The Company's failure to achieve adequate sales levels in the 1996 back-to-school and holiday seasons would have a material adverse effect on its business. The Company's recurring losses, cash flow constraints, and anticipated loan covenant violations (see "Item 1. Business --Other Developments") raise substantial doubt about its ability to continue as a going concern. See "Item 14. --Financial Statements." The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to successfully renegotiate its loan covenants, to obtain additional financing or equity as may be required, and ultimately, to attain profitable operations. In the event that the Company is not successful in, among other things, arranging interim and permanent financing such that the Company will be able to purchase inventory for the 1996 holiday season and thereafter, and attain credit support from its factors, it will consider alternate means of continuing the business including further expense reductions, negotiations with landlords and vendors to reach agreement on delaying payments, closing additional stores, as well as any other options available to the Company. In the event these efforts are unsuccessful, as a last resort, the Company may consider the possible filing of a petition for reorganization under Chapter 11 of the Federal bankruptcy laws. The Company requires immediate financing to purchase inventory for the 1996 holiday sales season. Failure to achieve adequate sales levels in the 1996 holiday season would have a material adverse effect on the Company's business. Management has held discussions with financial advisors and potential investors with respect to interim financing through short-term subordinated debt, equity investment, or debt restructuring. The Company has raised approximately $0.9 million through a sale/leaseback transaction and conversion of a vendor account payable to shares of Common Stock. See "Item 1. Business --Other Developments." However, the Company has not yet entered into any agreements with respect to additional interim financing, and accordingly, there can be no assurance that the Company can obtain 14

17 such financing, that such financing would be timely, or that such financing, if obtained, would be sufficient to enable the Company to continue as a going concern for a reasonable period of time. The Company also requires substantial long-term investment so that it can meet its obligations and sustain operations. Toward this end, the Company has entered into an engagement letter with a financial advisor and placement agent with respect to a proposed $10 million to $15 million private placement of the Company's securities. The placement agent's obligations under the engagement letter are subject to a number of qualifications, including, but not limited to, the placement agent's successful completion of its due diligence review and the successful negotiation of a definitive placement agent agreement. There can be no assurance that such private placement will be consummated, that it would be on terms favorable to the Company or that it would be sufficient to enable the Company to continue as a going concern for a reasonable period of time. RESULTS OF OPERATIONS. The Company reported a net loss of $5.7 million on net sales of $87.7 million for the eight months ended January 27, 1996. The Company operated 296 stores at January 27, 1996. The Company reported an unaudited net loss of $8.6 million on unaudited net sales of $47.4 million for the six months ended July 27, 1996. After giving effect to the Store Closure Plan, the Company will operate approximately 182 stores. Selling, general and administrative expenses were $36.1 million for the eight months ended January 27, 1996, and included $1.4 million of charges related to the Service Agreement. Selling, general and administrative expenses were $24.5 million, unaudited, for the six months ended July 27, 1996. Depreciation and amortization was $1.5 million for the eight months ended January 27, 1996. The Company also recorded a charge for goodwill impairment for approximately $1.0 million. Depreciation and amortization was $1.0 million, unaudited, for the six months ended July 27, 1996. Interest expense was $1.5 million for the eight months ended January 27, 1996. Interest expense included approximately $0.6 million of interest payments on the Acquisition debt. Interest expense was $0.8 million, unaudited, for the six months ended July 27, 1996. In response to the Company's going concern issues, management implemented the Store Closure Plan during the third quarter of fiscal year 1996 that immediately closed the Closed Stores and reduced staff at its distribution center and administrative offices. The Store Closure Plan will require, during the third quarter of fiscal year 1996, an estimated charge to operations of approximately $5.4 million, principally related to store rent liability, closing costs, and separation pay. The Company has received the consent of Foothill, the Company's principal lender, to the Store Closure Plan. See "Item 1. Business --Recent Developments." Management based its decision on which stores to close by reviewing each store's performance for the twelve-month period from the Acquisition through May 31, 1996, with respect to sales, gross margins, occupancy costs, and store contribution. The worst performing stores were identified for closure. Certain other Closed Stores were determined based on geographic or other market and cost considerations. The aggregate rent liability for the Closed Stores is approximately $13.2 million and the average remaining lease term is approximately 30 months. In connection with the Store Closure Plan, the Company will undertake to negotiate with the various landlords the outstanding lease liability of the Closed Stores. There can be no assurance that such negotiations will be successful. Failure to reach acceptable agreements with these landlords would have a material adverse effect on the Company's business. The Company transferred the remaining inventory from the Closed Stores to the remaining open stores. Prior to the Store Closure Plan, average store retail inventory was approximately $78.3 thousand, which was $25.7 thousand below planned retail store inventory for September 1996. The inventory consolidation brought the average retail store inventory up to approximately $112.1 thousand. However, there can be no assurance that the increased inventory levels will improve the Company's sales and operating results or that the Company's inventory levels will not drop below acceptable levels in the future. 15

18 In connection with the Store Closure Plan, the Company reduced staff at its distribution center and administrative offices, with a corresponding annualized reduction in payroll and benefits expense of approximately $1.4 million. There are a number of risks associated with the Store Closure Plan, including, but not limited to, the inability of the Company to successfully negotiate favorable terms with respect to the lease terminations, the inability of the Company to generate adequate revenues to cover expenses and generate profits, and the possibility that due to the staff reductions and store closings, the Company may not be able to attract or retain qualified personnel. See "Item 1. Business --Recent Developments." ITEM 8. FINANCIAL STATEMENTS The consolidated balance sheet as of January 27, 1996, and consolidated statements of operations, stockholders' equity, and cash flows for the eight months ended January 27, 1996 are set forth in the pages indicated in Item 14. Balance sheets for Holtzman's as of January 29, 1994 and January 28, 1995, and statements of operations, stockholders' equity, and cash flows for the fiscal years ended January 30, 1993, January 29, 1994, and January 28, 1995, and the four months ended May 31, 1995, (the "Disputed Financial Statements") have not been reported. Preparation and delivery of the Disputed Financial Statements was an issue in the Company's dispute with Woolworth described in "Item 3. Legal Proceedings." Currently, Woolworth is preparing and its certified public accountants, KPMG Peat Marwick, LLP, are auditing the Disputed Financial Statements, which have not been completed as of the date of this filing. When the Company receives the Disputed Financial Statements from Woolworth, the Company intends to include them in an amendment to the Company's Annual Report on Form 10-K for the fiscal year ended January 27, 1996. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE In connection with the Merger, Deloitte & Touche LLP ("Deloitte") was appointed as the independent auditors of the Company replacing Arthur Andersen, LLP ("Arthur Andersen"). During the Company's fiscal years ended December 31, 1995, and December 31, 1994, and the interim period preceding the change in accountants, there were no disagreements with Arthur Andersen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures which disagreements, if not resolved to the satisfaction of Arthur Andersen, would have caused Arthur Andersen to make reference to the subject matter of the disagreements in connection with its reports. The Company has authorized Arthur Andersen to respond fully to the inquiries of Deloitte or any other successor accountant concerning the subject matter described above. 16

19 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS EXECUTIVE OFFICERS AND DIRECTORS. Pursuant to the Merger Agreement the persons identified below were appointed to the Board of Directors of the Company on January 3, 1996, to serve until their successors are duly elected and qualified. Set forth below is certain information concerning each person who is presently an executive officer or director of the Company. <TABLE> <CAPTION> Name Age Position ----------------------------------------------------------------------- <S> <C> <C> Bernard Tessler 46 Chairman of the Board, President, Chief Executive Officer Robert S. Kelleher 47 Vice President, Chief Financial Officer, Chief Operating Officer Jeffrey Koffman 31 Director Eric M. Specter 38 Director Stephen L. Pistner 64 Director Donald S. Rosenberg 62 Director </TABLE> Bernard Tessler has been Director, Chairman, President and Chief Executive Officer of the Company since January 3, 1996. From 1991 to 1993, Mr. Tessler was Vice President-General Merchandise Manager (Children's Apparel, Sporting Goods, Seasonal, "Crafts and More") of Ames Department Stores Inc. ("Ames"). Mr. Tessler was responsible for the $700 million children's division of Ames. From 1987 to 1991, Mr. Tessler was President and Chief Executive Officer of Children's Creative Workshop, Ltd., a publicly held consulting firm, where he worked with diverse retailers in developing new children's and toy store concepts. From 1983 to 1987, Mr. Tessler was Chairman of the Board and President of Enchanted Village Stores, Inc., a publicly held company with 23 children's toy stores. Robert Kelleher joined the Company on July 3, 1995, as Chief Administrative Officer and Chief Financial Officer. Mr. Kelleher has been appointed Chief Operating Officer of the Company effective April 1, 1996; he will continue to hold the position of Chief Financial Officer. Prior to joining the Company, Mr. Kelleher was employed from 1980 to 1995 by Contempo Casuals, Inc., a subsidiary of the Neiman Marcus Group. Contempo Casuals was a chain of over 240 junior women's apparel specialty stores. Since 1993, Mr. Kelleher held the position of President and Chief Operating Officer of Contempo Casuals, Inc.; prior to that he was Executive Vice President and Chief Financial Officer. Jeffrey Koffman served as a financial analyst with Security Pacific from 1987 to 1989. In 1989, Mr. Koffman became Vice President of Pilgrim Industries and in 1990, he became the President of that company. From 1994 to present, Mr. Koffman has served in the capacities of Executive Vice President of Tech Aerofoam Products and Executive Vice President, and more recently, President of Apparel America, Inc. Eric M. Specter has been Vice President and Chief Financial Officer of Charming Shoppes, Inc. since December 1995 and, prior to that time he served as Vice President Corporate Controller since 1985 and has been employed by that company since 1983. Prior to that he was an associate in the accounting firm of Touche Ross & Company. Stephen L. Pistner currently operates the consulting firm of Pistner and Associates. From April 1990 to December 1992, Mr. Pistner was Chairman of the Board and Chief Executive Officer of Ames Department Stores, Inc. From 1981 to 1985, Mr. Pistner was Chairman and Chief Executive Officer of Montgomery Ward and Company, and later served as Chairman of McCrory Corporation. Donald S. Rosenberg is an attorney and a partner in Rosenberg, Reisman & Stein, Miami, Florida, where he has worked since 1956. Mr. Rosenberg is a member of the Board of Directors of the Skylake State Bank and Chairman of its Audit Committee. He serves as a member of the Board of Trustees, Executive Committee, Finance 17

20 Committee and Investment Committee of Barry University, Miami, Florida and is a member of the Board of Trustees of the Zoological Society of Florida. Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Company during the fiscal year ended January 27, 1996, and Form 5 and amendments thereto furnished to the Company with respect to the fiscal year ended January 27, 1996, and certain representations made to the Company, no person required to file such forms failed to do so on a timely basis, as disclosed in such Forms, during the fiscal year ended January 27, 1996, or prior years. ITEM 11. EXECUTIVE COMPENSATION The following summary compensation table sets forth information concerning compensation for services in all capacities awarded to, earned by or paid to the Chief Executive Officer and the Company's most highly paid executive officer. <TABLE> <CAPTION> ------------------------------------------------------------------------------------------------------------------------------------ Long-term Annual Compensation Compensation Awards Payouts ------------------- ------------ ---------------------------- ------------ Other Annual Restricted Options/SARS All Other Name and Principal Position Year Salary Bonus Compensation Stock Awards (# of shares) LTIP Payouts Compensation --------------------------- ---- ------ ----- ------------ ------------ ------------- ------------ ------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> Bernard Tessler, CEO 1995 $300,000 $-- $-- $-- $-- $-- $168,375 * Robert Kelleher, CFO/COO 1995 $245,000 $-- $-- $-- $-- $-- $ 3,600 ** ------------------------------------------------------------------------------------------------------------------------------------ </TABLE> * Pursuant to an agreement with the Company (then LFS), Mr. Tessler received short-term advances in the amount of $19,313 to cover expenses related to his relocation to California on behalf of the Company. In addition, Mr. Tessler received compensation in respect of the fiscal year ended January 27, 1996, in the amount of $49,062, representing housing allowance and car allowance, and $100,000 of compensation related to the Acquisition. ** Car allowance. COMPENSATION OF DIRECTORS. Directors of the Company receive no compensation for their services as directors; however, they will be entitled to receive stock options under the Company's Stock Option Plan and may receive monetary compensation in the future. EMPLOYMENT ARRANGEMENTS. The Company (then LFS) entered into an employment agreement, dated as of May 31, 1995, with Bernard Tessler, pursuant to which the Company has agreed to employ Mr. Tessler as President and Chief Executive Officer for a term which commenced on May 31, 1995, and will continue through May 31, 1999, unless sooner terminated in accordance with its terms. Thereafter, Mr. Tessler's employment with the Company would continue until terminated by the Company upon not less than one year's notice. For compensation for his services, Mr. Tessler will receive, among other things, an annual salary of $300,000 and any bonus to which he will be entitled under the Company's Management Incentive Plan (see below). If Mr. Tessler's employment with the Company is terminated without cause by the Company or by Mr. Tessler for good reason, Mr. Tessler will be entitled, among other things, to a termination payment equal to the greater of (i) the balance due under the remainder of the term of the employment agreement or (ii) one year's compensation. Mr. Tessler is also entitled to a $5,000 per month housing allowance. Mr. Tessler is prohibited from competing with the Company for a period of one year following termination. MANAGEMENT INCENTIVE PLAN. The Company is in the process of instituting a performance based incentive award program. While specific details of the plan have not been finalized, achievement of profitability targets will be a primary factor in determining bonus compensation. It is contemplated that a substantial number of employees will participate in this plan. 1995 STOCK OPTION PLAN. The stockholders of the Company approved the adoption of the 1995 Stock Option Plan at a meeting on January 3, 1996. No grants were made pursuant to such plan in the year ended December 31, 1995. Members of the Board of Directors who are not employees of the Company, are automatically entitled to receive options to purchase 2,000 shares for each year they serve on the Board. 18

21 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information as of September 5, 1996, based on information obtained from the persons named below, with respect to the beneficial ownership of shares of Common Stock by (i) each person known by the Company to be the owner of more than 5% of its outstanding shares of Common Stock, (ii) each director and (iii) all executive officers and directors as a group: <TABLE> <CAPTION> Amount and Nature of Name of Beneficial Owner (1) Beneficial Ownership (2) Percent of Common Stock ------------------------------------------------------------------------------------- <S> <C> <C> CSHC, Inc. (3) 783,040 15.8% 450 Winks Lane Philadelphia, PA 19020 Donald S. Rosenberg (4) 22,500 0.5% 1 S.E. 3rd Avenue Suite 2600 Miami, FL 33131 Bernard Tessler 773,025 15.6% 801 Sentous Avenue City of Industry, CA 91748 Jeffrey Koffman (5) 109,771 2.2% 150 E. 52nd Street New York, NY 10022 Robert S. Kelleher (6) * * Eric M. Specter (6) * * Stephen L. Pistner (6) * * 801 Sentous Avenue City of Industry, CA 91748 All executive officers and directors as a group (6 persons) 1,688,336 34.2% </TABLE> -------------- (1) Unless otherwise noted, all persons named in the table have sole voting and investment power with respect to all shares of Common Stock beneficially owned by them. No persons named in the table are acting as nominees for any persons or are otherwise under the control of any person or group of persons. (2) Excludes Common Stock issuable upon exercise of outstanding warrants. If such warrants were exercised, the percentage of ownership of all outstanding Common Stock would be as follows: CSHC, Inc., 12.7%, Donald S. Rosenberg, 0.4%, Bernard Tessler, 16.7%, Jeffrey Koffman, 2.6%, and all executive officers and directors as a group, 32.4%. (3) CSHC, Inc. is controlled by Charming Shoppes, Inc. of which Mr. Eric M. Specter, a director of the Company, is a Vice President and Chief Financial Officer. Mr. Specter disclaims beneficial ownership of these shares. (4) Members of Mr. Rosenberg's immediate family own 218,000 additional shares of Common Stock. Mr. Rosenberg, a director of the Company, disclaims beneficial ownership of such shares. (5) Members of the Koffman family or entities controlled by the Koffman family own an additional aggregate 582,331 shares of Common Stock. Mr. Jeffrey Koffman, a director of the Company, disclaims beneficial interest in these shares. (6) Messrs. Pistner and Specter, directors of the Company, and Mr. Kelleher, an executive officer of the Company do not beneficially own shares of Common Stock. 19

22 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Between December 1993 and January 1996, the Company maintained its executive offices in approximately 1,100 square feet of office space located at 7700 West Camino Real, Suite 222, Boca Raton, Florida 33431. The Company leased this space from an unaffiliated third party for approximately $1,260 per month. In January 1994, an affiliate of the Company ("FHM") agreed to sublease from the Company approximately one half of such office space for approximately $630 per month. Upon consummation of the Merger, the Company assigned to FHM, and FHM assumed, the Company's obligations under the lease. Mr. Jeffrey Koffman, a director of the Company, acted as a consultant to the Company for which he was paid $4,166 per month from June 1, 1995 until May 31, 1996. Rosenberg, Reisman & Stein, a law firm of which Donald S. Rosenberg, a director of the Company, is a partner, has represented the Company in certain legal matters for which he was paid $54,829 from May 31, 1995, to December 31, 1995. From December 31, 1995, to January 27, 1996, Rosenberg, Reisman & Stein has been paid $2,053. Rosenberg, Reisman & Stein may continue to provide legal services to the Company in the future. The Company purchases merchandise from apparel manufacturers owned by members of the Koffman family. These purchases amounted to $36,882 for the eight months ended January 27, 1996. ITEM 14. EXHIBITS, LIST AND REPORTS ON FORM 8-K <TABLE> <CAPTION> (a) Financial Statements <S> <C> Report of Management F-1 Independent Auditors' Report F-2 Consolidated Balance Sheet F-4 Consolidated Statement of Operations F-5 Consolidated Statement of Stockholders' Equity F-6 Consolidated Statement of Cash Flows F-7 Notes to Consolidated Financial Statements F-8 </TABLE> The registrant is not required to file supplemental schedules to its consolidated financial statements. (b) Exhibits (c) Reports on Form 8-K. The Company filed a current report on Form 8-K dated January 8, 1996, relating to the Merger, a change in certifying accountants and the change in the Company's fiscal year end. The Company filed a current report on Form 8-K dated May 31, 1996, relating to the settlement of its litigation against Woolworth Corporation and Kinney Shoe Corporation. The Company filed a current report on Form 8-K dated September 6, 1996, relating to the engagement letter with a financial advisor and placement agent with respect to a proposed $10 million to $15 million private placement of the Company's securities. 20

23 SIGNATURES In accordance with 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. KIDS MART, INC. By /s/ BERNARD TESSLER ----------------------- Bernard Tessler, Chief Executive Officer Date: September 16, 1996 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated: <TABLE> <CAPTION> Signature Title Date --------------------------------------- ---------------------------------------- ------------------ <S> <C> <C> /s/ BERNARD TESSLER Chairman, Chief Executive Officer, September 16, 1996 --------------------------------------- and Director Bernard Tessler /s/ ROBERT S. KELLEHER Vice President, Chief Operating Officer, September 16, 1996 --------------------------------------- and Chief Financial Officer Robert S. Kelleher /s/ JEFFREY KOFFMAN Director September 16, 1996 --------------------------------------- Jeffrey Koffman /s/ STEPHEN L. PISTNER Director September 16, 1996 --------------------------------------- Stephen L. Pistner /s/ ERIC M. SPECTER Director September 16, 1996 --------------------------------------- Eric M. Specter /s/ DONALD S. ROSENBERG Director September 16, 1996 --------------------------------------- Donald S. Rosenberg </TABLE> 21

24 INDEX TO EXHIBITS <TABLE> <CAPTION> Sequentially Exhibit Numbered Number Description of Exhibit Page ------ ---------------------- ---- <S> <C> <C> 2.1 Agreement and Plan of Merger and Reorganization dated May 31 1995, by and between the Company and LFS Acquisition Corp. (incorporated by reference to Exhibit A-1 to the Company's Proxy Statement dated December 14, 1995). 3.1 Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form SB-2, File No. 33-63736-A, filed with the Securities and Exchange Commission on July 2, 1993). 3.2 Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit C-1 to the Company's Proxy Statement dated December 14, 1995). 3.3 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form SB-2, File No. 33-63736-A, filed with the Securities and Exchange Commission on July 2, 1993). 9 Stockholders' Agreement, dated May 30, 1995, among LFS Acquisition Corp., Bernard Tessler, Sentani Trading Ltd., Jeffrey Koffman, Allison Koffman, Jack Koffman, Janice Payson, Barbara Koffman, Tech Aerofoam, Inc., David Koffman, Ruthanne Koffman, Whitehorn, Inc., Financo, Inc. and Marvin Traub (incorporated by reference to Exhibit 9 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995). 10.1 1995 Stock Option Plan of the Company (incorporated by reference to Exhibit B-1 to the Company's Proxy Statement dated December 14, 1995). 10.2 Employment Agreement between LFS Acquisition Corp. and Bernard Tessler dated May 31, 1995, (incorporated by reference to Exhibit 10.2 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995). 10.3 Transitional Services Agreement between LFS Acquisition Corp. and Woolworth Corporation dated as of May 31, 1995 (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995). 10.4 Settlement Agreement between LFS Acquisition Corp. and Woolworth Corporation and Kinney Shoe Corporation dated as of May 30, 1996. 10.5 Loan and Security Agreement by and between LFS Acquisition Corp. and Foothill Capital Corporation dated as of May 31, 1995, and amendments thereto. 10.6 Sale/leaseback agreement between Kids Mart, Inc. and Computer Sales International, Inc. dated as of July 24, 1996. 10.7 Agreement between Kids Mart, Inc. and Be Bop Clothing, Inc. dated September 11, 1996. 10.8 Exchange Agreement and Investment representation Agreement between Kids Mart, Inc. and Be Bop Clothing, Inc. dated September 11, 1996. 27 Financial Data Schedule </TABLE> 22

25 REPORT OF MANAGEMENT The management of the Company is responsible for the preparation, integrity, and objectivity of the data included in this report. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles. The consolidated financial statements are audited by independent auditors, through the application of generally accepted auditing standards. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded against loss, that the financial records reflect fairly the transactions of the Company, and that established policies and procedures are followed. The concept of reasonable assurance is based on the recognition that the cost of a system of internal accounting controls must be related to the benefits derived. The Audit Committee, composed of two members of the Company's Board of Directors who are not employees of the Company, meet with representatives of management and the independent auditors to monitor the functioning of the accounting and control systems, and to review the results of auditing activities. The Audit Committee also recommends independent auditors for appointment by the Board. The independent auditors have full and free access to the Audit Committee. /s/ BERNARD TESSLER /s/ ROBERT S. KELLEHER ------------------------ --------------------------- Bernard Tessler Robert S. Kelleher Chairman, President and Vice President, Chief Executive Officer Chief Operating Officer and Chief Financial Officer F-1

26 INDEPENDENT AUDITORS' REPORT To the Board of Directors of Kids Mart, Inc.: We have audited the accompanying consolidated balance sheet of Kids Mart, Inc. (the "Company") and subsidiaries as of January 27, 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for the eight months ended January 27, 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 audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. As discussed in Note 2 of the notes to the consolidated financial statements, on January 3, 1996, the Company consummated a transaction to acquire substantially all the assets and assume all the liabilities of LFS Acquisition Corp. ("LFS"). After the acquisition, the original stockholders of LFS hold approximately 54% of the voting power of the Company stock. The acquisition has been accounted for as a reverse acquisition of the Company by LFS. As discussed in Note 3 of the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be disposed of," as of January 27, 1996. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and its subsidiaries at January 27, 1996, and the results of their operations and their cash flows for the eight months ended January 27, 1996 in conformity with generally accepted accounting principles. F-2

27 The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company's recurring losses raise substantial doubts about its ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1. The Consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Deloitte & Touche LLP Los Angeles, California June 17, 1996 (July 24, 1996, September 11, 1996, and September 13, 1996 as to paragraph one, two, and three, respectively, of Note 15) F-3

28 KIDS MART, INC. CONSOLIDATED BALANCE SHEET JANUARY 27, 1996 (In thousands, except share and par value amounts) <TABLE> <CAPTION> ASSETS (NOTE 8) <S> <C> CURRENT ASSETS: Cash $ 502 Receivable from Woolworth Corporation (Note 2) 1,670 Merchandise inventories (Note 4) 17,144 Prepaid expenses and other current assets 1,888 ------- Total current assets 21,204 Property and equipment, net (Note 5) 6,106 Deferred financing costs, net of accumulated amortization of $85 299 ------- Total $27,609 ======= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Borrowings under credit facility (Note 8) $ 8,849 Accounts payable 5,562 Accrued expenses and other current liabilities (Note 7) 4,546 Deferred revenue 1,237 ------- Total current liabilities 20,194 ------- Deferred rent 278 ------- Redeemable common stock (Note 9) 50 ------- Commitments and contingencies (Notes 8, 12, 14 and 15) STOCKHOLDERS' EQUITY (Notes 10, 14, and 15): Preferred stock, par value $.0001 per share; 100,000,000 shares authorized; 1,000,000 issued and outstanding; liquidation preference of $10,000,000 Common stock, $.0001 par value; 100,000,000 shares authorized; 4,943,000 shares issued and outstanding Additional paid-in capital 12,783 Accumulated deficit (5,696) ------- Total stockholders' equity 7,087 ------- Total $27,609 ======= </TABLE> See accompanying notes to consolidated financial statements. F-4

29 KIDS MART, INC. CONSOLIDATED STATEMENT OF OPERATIONS EIGHT MONTHS ENDED JANUARY 27, 1996 (In thousands, except per share amounts) <TABLE> <S> <C> Net sales $87,698 Cost of sales 53,296 ------- Gross profit 34,402 Selling, general and administrative expenses (Note 13) 36,128 Goodwill impairment (Note 2) 979 Depreciation and amortization 1,507 ------- Loss from operations (4,212) Interest expense (Notes 6, 8 and 13) 1,484 ------- NET LOSS $(5,696) ======= PER SHARE DATA: Average shares outstanding 4,943 ======= Net loss per common share $(1.15) ======= Dividends per common share None ======= </TABLE> See accompanying notes to consolidated financial statements. F-5

30 KIDS MART, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY EIGHT MONTHS ENDED JANUARY 27, 1996 (In thousands, except for number of shares) <TABLE> <CAPTION> CLASS A CLASS B COMMON STOCK PREFERRED STOCK PREFERRED STOCK ------------------- ----------------- ------------------ SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT <S> <C> <C> <C> <C> <C> <C> BALANCE, MAY 31, 1995 1,400,626 $ 14 81.7 $ - 854,560 $ 9 Issuance of Series B preferred stock 320,000 3 Redemption of Series A preferred stock (81.7) Exercise of Warrants C (Note 10) 102,814 1 Acquisition of Frost Hanna Acquisition Group, Inc. (Note 2) 3,439,560 (15) (1,174,560) (12) Issuance of Series A nonvoting Convertible Preferred Stock (Notes 2 and 10) Net loss --------- ---- ----- ---- ---------- ---- BALANCE, JANUARY 27, 1996 4,943,000 $ - - $ - - $ - ========= ==== ===== ==== ========== ==== </TABLE> <TABLE> <CAPTION> SERIES A PREFERRED STOCK ADDITIONAL --------------------- PAID-IN ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT TOTAL <S> <C> <C> <C> <C> <C> BALANCE, MAY 31, 1995 $ 2,977 $ 3,000 Issuance of Series B preferred stock 817 820 Redemption of Series A preferred stock (820) (820) Exercise of Warrants C (Note 10) 616 617 Acquisition of Frost Hanna Acquisition Group, Inc. (Note 2) 5,693 5,666 Issuance of Series A nonvoting Convertible Preferred Stock (Notes 2 and 10) 1,000,000 $ - 3,500 3,500 Net loss $(5,696) (5,696) --------- ---- ------- ------- ------- BALANCE, JANUARY 27, 1996 1,000,000 $ - $12,783 $(5,696) $ 7,087 ========= ==== ======= ======= ======= </TABLE> See accompanying notes to consolidated financial statements. F-6

31 KIDS MART, INC. CONSOLIDATED STATEMENT OF CASH FLOWS EIGHT MONTHS ENDED JANUARY 27, 1996 (In thousands) <TABLE> <CAPTION> CASH FLOWS FROM OPERATING ACTIVITIES: <S> <C> Net loss $(5,696) Adjustments to reconcile net loss to net cash used in operating activities: Goodwill impairment 979 Depreciation and amortization 1,592 Changes in operating assets and liabilities, net of effect of acquisition of Frost Hanna Acquisition Group, Inc.: Receivable from Woolworth Corporation 4,130 Merchandise inventories (3,907) Prepaid expenses and other current assets (1,211) Accounts payable (859) Accrued expenses and other current liabilities 2,154 Deferred revenue (536) Deferred rent 278 ------- Net cash used in operating activities (3,076) ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (1,166) Net cash acquired in acquisition of Frost Hanna Acquisition Group, Inc. 6,199 ------- Net cash provided by investing activities 5,033 ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings under credit facility 2,740 Net proceeds from issuance of Class B preferred stock 820 Redemption of Class A preferred stock (820) Transaction fees incurred in acquisition of Frost Hanna Acquisition Group, Inc. (562) Increase in deferred financing costs (60) Exercise of Warrant C (Note 10) 617 Repayment of bridge loans (4,250) ------- Net cash used in financing activities (1,515) ------- NET INCREASE IN CASH 442 CASH, BEGINNING OF PERIOD 60 ------- CASH, END OF PERIOD $ 502 ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 1,405 Income taxes paid $ - </TABLE> See accompanying notes to consolidated financial statements. F-7

32 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements, during the eight months ended January 27, 1996, Kids Mart, Inc. incurred net losses of $5,696. Additionally, subsequent to January 27, 1996, Kids Mart, Inc. continued to experience operating losses and anticipates violation with certain other covenants during the remainder of fiscal 1996 (see Note 8). These factors among others may indicate that Kids Mart, Inc. will be unable to continue as a going concern for a reasonable period of time. In response to these conditions, Kids Mart, Inc. has taken steps to reduce expenses and increase liquidity. Kids Mart, Inc. has, among other things, increased the percentage of higher margin private label merchandise and closed 37 stores during the eight months ended January 27, 1996. In addition, subsequent to January 27, 1996, Kids Mart, Inc. closed 17 stores, reduced its work force, renegotiated certain of its store leases, entered into a sale/leaseback transaction (see Note 15), entered into an agreement with a vendor to convert amounts payable to this vendor to common stock (see Note 15), implemented a store closure plan (the "Store Closure Plan") whereby it identified approximately 100 stores for closure (see Note 15), is renegotiating its loan covenants with its lender (see Note 8), and is exploring various interim and permanent financing opportunities with two financial advisors. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classifications of liabilities that might be necessary should Kids Mart, Inc. be unable to continue as a going concern. Kids Mart, Inc.'s continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to successfully negotiate its loan covenants with its lender and payments terms with its vendors and landlords, to obtain additional financing or equity as may be required, and ultimately, to attain profitable operations. Management is continuing its efforts to obtain additional funds so that Kids Mart, Inc. can meet its obligations and sustain operations (see Note 15). 2. ORGANIZATION OF THE BUSINESS On January 3, 1996, pursuant to an Agreement and Plan of Merger and Reorganization (the "Merger Agreement"), dated May 31, 1995, FH Sub Delaware, Inc., a Delaware corporation and wholly owned subsidiary of Frost Hanna Acquisition Group, Inc., a Florida corporation in the development stage, ("FH") merged with and into LFS Acquisition Corp. ("LFS") (the "Merger"). As a result of the Merger, LFS became a wholly owned subsidiary of FH. In exchange, FH issued an aggregate of 2,678,000 shares (the "Shares") of its common stock to the owners of all the issued and outstanding shares of capital stock of LFS. The Shares constituted approximately 54% of the outstanding shares of common stock of FH without giving effect to the issuance of 1,204,300 shares of FH's common stock issuable upon the exercise of certain warrants held by a) the underwriter of FH's initial public offering (110,000 shares) and b) the initial LFS investors (1,094,300 shares) (see Note 10). Assuming full exercise of all of the outstanding warrants to purchase shares of FH's common stock, the former LFS security holders would own approximately 61.4% of the outstanding shares of FH's common stock. Since the former LFS investors would own the controlling interest of FH's common stock, the Merger has been accounted for as a "reverse acquisition" as if LFS recapitalized its ownership interest and then acquired FH under the purchase method of accounting by the issuance of 2,265,000 shares of its common stock (the "FH Shares"). The FH Shares were valued at $6,199 which represented the estimated fair market value of FH's net assets acquired at the date of the Merger. Under such a transaction, LFS is the "accounting acquirer" and FH is the "legal acquirer". Because LFS is the "accounting acquirer", the consolidated financial statements presented are those of LFS, not FH. F-8

33 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) FH was formed on April 2, 1993 to seek to effect a merger, exchange of capital stock, asset acquisition or similar business combination with an acquired business and completed a public offering of 1,265,000 shares of its common stock in September 1993. Through January 3, 1996, FH was in the development stage. The operating results reflected in the accompanying consolidated financial statements do not include FH's operating activities prior to January 3, 1996, the date of the Merger, as the amounts are not significant. Concurrent with the Merger, FH changed its fiscal year from the year ending December 31 to the 52/53-week period ending on the Saturday nearest January 31 and changed its name to Little Folks Shops, Inc. On January 23, 1996, the name was changed to Kids Mart, Inc. (the "Company"). LFS, a Delaware corporation, (hereafter, also referred to as the Company), was formed on May 26, 1995 for the purpose of acquiring the Holtzman's Little Folk Shop, Inc. ("Holtzman's") business from Woolworth Corporation ("Woolworth"). On May 31, 1995 the Company acquired all the outstanding shares of capital stock of Holtzman's from Woolworth and certain of Holtzman's operating assets and liabilities from Kinney Shoe Corporation, a wholly owned subsidiary of Woolworth ("Kinney") (the "Acquisition"). Prior to this transaction, Holtzman's had transferred certain of its assets and liabilities to Kinney. The preliminary purchase price of the Acquisition was $22,820 ($20,970 to Woolworth plus $1,850 in transaction fees) and included $11,670 in cash (of which $1,670 was placed into an escrow account) and $9,300 in current and long-term debt. This purchase price, excluding transaction fees, increased from an originally agreed upon estimated purchase price of $16,670 due to opening balance sheet adjustments of approximately $4,300 (principally inventory, other assets and accrued liabilities). The purchase price was subject to adjustment based on the final book value of Holtzman's at May 31, 1995, as defined. Subsequent to the Acquisition, disagreements arose between the Company and Woolworth regarding the determination of the final purchase price of Holtzman's net assets at May 31, 1995. Such disagreements resulted in the filing of a complaint by the Company against Woolworth and Kinney with Woolworth filing a counter complaint. On May 30, 1996, the Company and Woolworth and Kinney reached a settlement under a Mutual Release and Settlement Agreement (the "Settlement Agreement") whereby Woolworth agreed to 1) release the cash of $1,670 held in escrow to the Company, 2) cancel the $9,300 of debt incurred in connection with the Acquisition and also cancel approximately $4,415 of other amounts paid by Woolworth on behalf of the Company during the eight months ended January 27, 1996. In exchange, the Company issued 1,000,000 shares of its Series A convertible nonvoting preferred stock to Woolworth (see Note 10). These shares were valued at $3,500, which represented their fair market value at the date of issuance. F-9

34 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) The Company has accounted for the Acquisition under the purchase method of accounting and, accordingly, recorded the assets and liabilities acquired at their fair values. The excess purchase price over net assets acquired is computed as follows: <TABLE> <S> <C> Purchase price: Cash paid by the Company, net of canceled advances of $4,415 $ 5,585 Issuance of 1,000,000 shares of Series A convertible preferred stock 3,500 Fees incurred in connection with the Acquisition 2,039 ------- Total 11,124 ------- Fair value of net assets acquired: Current assets 13,610 Property and equipment 6,413 Liabilities (9,912) ------- Total 10,111 ------- Excess of purchase price over net assets acquired $ 1,013 ======= </TABLE> 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES General - The Company, a retailer of infant and children apparel and toys, operates 296 stores in 20 states. Basis of Consolidation - The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Fiscal Year - The Company's fiscal year is the 52/53-week period ending on the Saturday nearest January 31. Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Merchandise Inventories - Merchandise inventories consist principally of finished goods purchased from domestic and foreign vendors. Inventories are carried at the lower of cost (determined by the retail inventory method), or market. Certain costs of buying, warehousing and distribution are included in inventory. Property and Equipment - Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of their useful lives or the related lease terms. Useful lives range from three to ten years. Deferred Financing Costs - Deferred financing costs are amortized using the straight-line method over the terms of the related debt agreement. F-10

35 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) Excess of Purchase Price Over Net Assets Acquired - Excess purchase price over net assets acquired is amortized over its estimated useful life of 20 years. Amortization expense during the eight months ended January 27, 1996, amounted to $34 (see Impairment of Long-Lived Assets, below). Deferred Revenue - The Company offers for sale a preferred customer card which entitles the holder to a one-year 10% discount from the retail price of its regularly priced merchandise. The proceeds from card sales, net of related direct costs, are amortized into income over a 12-month period. Deferred Rent - Leases with free rent periods and/or scheduled specific rent increases are recognized on a straight-line basis over the lease term. Income Taxes - Deferred income taxes reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, based on the income tax rates expected to be in effect when the temporary differences are expected to reverse. Net Loss per Common Share - Net loss per common share is based on the weighted average number of common shares and common stock equivalents outstanding. Common stock equivalents represent shares issuable upon assumed exercise of warrants and conversion of preferred stock, which would have a dilutive effect when there are earnings. Impairment of Long-Lived Assets - In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which the Company is required to adopt effective with the fiscal year beginning January 28, 1996. SFAS No. 121 standardizes the accounting practices for the recognition and measurement of impairment losses on certain long-lived assets. The Company elected early adoption of SFAS No. 121 and, accordingly, wrote off the value of the excess purchase price over net assets acquired amounting to $979 at January 27, 1996, based on the projections of future cash flow. Accounting for Stock-Based Compensation - The Company currently accounts for its stock-based compensation plans using the provision of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). In 1995, the FASB issued SFAS No. 123 "Accounting for Stock-Based Compensation". Under the provisions of SFAS No. 123, companies can elect to account for stock-based compensation plans using a fair-value based method or continue using the intrinsic value method prescribed in APB No. 25. SFAS No. 123 requires that companies electing to continue using APB No. 25 must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting had been applied. The Company will include the necessary disclosures in its 1996 consolidated financial statements. As the Company anticipates continuing to account for stock-based compensation using the intrinsic value method, SFAS No. 123 will not have an impact on the Company's consolidated financial statements. Fair Value of Financial Instruments - The carrying value of financial assets and liabilities approximates fair value due to the short maturity of these items. The carrying amount of debt issued pursuant to the Company's credit facility approximates fair value because the interest rate changes with market interest rates. F-11

36 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) 4. MERCHANDISE INVENTORIES At January 27, 1996, the Company recorded a $1,164 markdown reserve in connection with the reduction of merchandise retail prices subsequent to January 27, 1996. In the opinion of management, this charge was necessary to clear various categories of aged inventories and provide space for fresh and more competitive merchandise. 5. PROPERTY AND EQUIPMENT Property and equipment at January 27, 1996 consist of the following: <TABLE> <S> <C> Furniture, fixtures and equipment $5,212 Leasehold improvements 2,367 ------ Total 7,579 Less accumulated depreciation and amortization 1,473 ------ Property and equipment, net $6,106 ====== </TABLE> 6. BRIDGE LOANS In connection with the Acquisition (see Note 2), the Company obtained an aggregate of $4,250 of 10% bridge loans from a group of private lenders, as well as Woolworth. The bridge loans were repaid on January 3, 1996. In consideration for providing the bridge loans, each of the lenders, with the exception of Woolworth, was granted one warrant to purchase a share of common stock of the Company for a purchase price of $6.00 per share for each $5.00 of bridge loans made (see Note 10). 7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES Accrued expenses and other current liabilities consist of the following at January 27, 1996: <TABLE> <S> <C> Accrued payroll and related expenses $1,114 Accrued advertising expenses 810 Accrued sales taxes 603 Other accrued expenses 2,019 ------ Total $4,546 ====== </TABLE> 8. CREDIT FACILITY The Company has a credit facility with a financial institution under which $20,000 is available for working capital advances and $10,000 is available for the issuance of letters of credit. Aggregate borrowings are limited to the lesser of $20,000 or specified percentages of eligible merchandise inventories, as defined. At January 27, 1996, the Company had outstanding revolving advances of $8,849 and letters of credit of $4,893. Additional borrowings available under the facility amounted to $1,148 at January 27, 1996. F-12

37 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) Advances under the credit facility, which bear interest at a reference rate plus 2% (9.75% at January 27, 1996), are collateralized by substantially all the assets of the Company. The credit facility shall continue in effect until May 31, 1998, at which time it can automatically be renewed for successive one-year periods thereafter, unless sooner terminated pursuant to the terms of the agreement. On April 15, 1996 and June 10, 1996, the credit facility was amended to modify certain of its covenants, extend its term to May 31, 1999 and grant the Company $2,000 of additional borrowings available from June 10, 1996 to February 15, 1997. In exchange, warrants to purchase 100,000 shares of the Company's common stock were issued to the financial institution on June 14, 1996 (see "Financial Institution Warrants" at Note 10). Loan covenants in connection with the credit facility include the maintenance of certain financial ratios and other restrictions, including the Company's successful completion of a private placement of the Company's securities by September 30, 1996, or successfully raising at least $2,000 in subordinated debt or common stock equity by that date. At January 27, 1996, the Company was in violation of one of these covenants, and anticipates violation with certain other covenants during the remainder of fiscal 1996, and accordingly, has reclassified the amounts due under the credit facility as of January 27, 1996 to a current liability. The Company is currently in negotiations with the financial institution to waive or amend these covenants. 9. REDEEMABLE COMMON STOCK In connection with the Merger Agreement (see Note 2), certain public stockholders of FH representing 9,900 shares of the Company's common stock, voted against the Merger. Accordingly, as required per an agreement with these stockholders to redeem their common stock shares held, the Company reclassified the redemption value of 9,900 shares, which voted against the Merger, to "redeemable common stock" in the accompanying consolidated balance sheet. However, to the Company's knowledge, none of these stockholders took the steps needed to exercise the redemption rights and, therefore the Company may not have any obligation to redeem these shares 10. STOCKHOLDERS' EQUITY PREFERRED STOCK - The Company has authorized the issuance of 100,000,000 shares of $.0001 par value preferred stock, including 1,000,000 shares of $.0001 par value Series A Convertible Preferred Stock (the "Convertible Preferred Stock"). In connection with the Settlement Agreement, the Company issued all shares of the Convertible Preferred Stock to Woolworth (see Note 2). The Convertible Preferred Stock have a liquidation preference of $10.00 per share and are redeemable, at the Company's option, at a redemption price of $10.00 per share. Each share is convertible into one share of common stock subject to adjustment for dilution. The Convertible Preferred Stock are nonvoting. However, their holders can vote, as a single class, to approve certain modifications to among other things, the Articles of Incorporation. Upon the declaration of dividends to common stockholders, the Company is required to declare dividends on the Convertible Preferred Stock in an amount equal to the per share amount distributable with respect to the number of shares of common stock into which such shares of Convertible Preferred Stock is convertible on the common stockholder dividend declaration date. WARRANTS - The Company has the following warrants outstanding at January 27, 1996 related to the issuance of common stock: Underwriter's Warrant - In connection with FH's initial public offering in September 1993, FH sold to the managing underwriter for $.1, warrants to purchase 110,000 shares of common stock at $6.60 per share. F-13

38 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) The right to exercise these warrants is for the four-year period commencing on September 2, 1994. These warrants are not redeemable. Warrant A - Represents the aggregate right to purchase 494,300 shares of common stock (including the right to purchase 35,590 shares as exercised under Warrant C) at $6.00 per share. The right to exercise these warrants is for the five-year period that begins at the earlier of a) the first fiscal year reflecting net income of at least $.75 per share (undiluted) or b) December 31, 2004. Warrant B - Represents the aggregate right to purchase 600,000 shares of common stock at $6.00 per share. These warrants expire on May 31, 2000. Financial Institution Warrant - In connection with the amendment of the credit facility (see Note 8), the Company issued to the financial institution warrants to purchase 100,000 shares of common stock at $6.00 per share. These warrants expire on June 14, 2001. Prior to the merger, LFS had certain warrants outstanding (Warrant C) which represented the right to purchase for $1.00 at a time immediately preceding the consummation of the Merger (i) 102,814 shares of common stock of the Company, and (ii) such Warrant A securities representing the right to purchase 35,590 (see Warrant A above) shares of common stock. In connection with the exercise of Warrant C on January 2, 1996, the Company issued 102,814 shares of LFS common stock and recorded compensation expense of $617 representing the difference between the market price of $6.00 per share and the exercise price of $1.00 for Warrant. 11. INCOME TAXES At January 27, 1996, deferred tax assets and liabilities were comprised of the following: <TABLE> <CAPTION> CURRENT NONCURRENT TOTAL <S> <C> <C> <C> Deferred tax assets: Net operating loss carryforwards $ 1,640 $ 1,640 Deferred revenue $ 495 495 Inventory capitalization 400 400 Other 393 393 ------ ------- ------- Total 1,288 1,640 2,928 Deferred tax liability Accelerated deductions (641) (641) ------ ------- ------- Net deferred tax assets 647 1,640 2,287 Less: valuation allowance (647) (1,640) (2,287) ------ ------- ------- Net amount recorded $ - $ - $ - ====== ======= ======= </TABLE> The Company has recorded a valuation allowance to reduce the net deferred income asset to zero. The Company has federal net operating loss carryforwards available for income tax purposes of approximately $4,103 that expire in 2010. F-14

39 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) 12. COMMITMENTS AND CONTINGENCIES The Company has been notified that certain stores in California have materials containing asbestos. The asbestos material is generally in trace quantities, and no remediation is expected to be required on the understanding that such material is property secured. The Company is a party to various other legal proceedings incidental to its business. In the opinion of management, the ultimate resolution of these matters would not have a material effect on the Company's consolidated financial statements. The Company has an employment agreement with its President that expires on May 31, 1999 and requires a yearly salary of $300. The Company has noncancelable operating leases, primarily for retail stores, that expire at various dates through 2004. These leases generally contain renewal options for periods ranging from one to three years and require the Company to pay costs such as real estate taxes, maintenance and/or additional rents based on a percentage of sales. Net rental expense for all operating leases during the eight months ended January 27, 1996 was $8,330. Future minimum lease payments under operating leases at January 27, 1996 are as follows: <TABLE> <CAPTION> YEAR ENDING JANUARY <S> <C> 1997 $ 9,185 1998 7,548 1999 6,448 2000 5,153 2001 3,759 Thereafter 3,375 ------- Total $35,468 ======= </TABLE> On June 17, 1996, the Company entered into an operating lease agreement for a point-of-sale system. Under the provisions of this lease agreement, the Company is required to make monthly payments commencing with the first store installation and increasing to $62.3 based upon 282 stores. Monthly payments will be reduced in the event of store closures. The term of the agreement is five years. 13. TRANSACTIONS WITH WOOLWORTH The Company receives information systems, accounting and administrative services from Woolworth pursuant to the terms of a transition service agreement (the "Service Agreement"). In return, the Company pays certain fees to Woolworth. These fees amounted to approximately $1,440 during the eight months ended January 27, 1996. The initial term of the Service Agreement expired on May 31, 1996. In connection with the Settlement Agreement (see Note 2), the Service Agreement was extended to September 28, 1996, at which time, the Service Agreement can continue on a month-to-month basis unless terminated by either party upon a 30-day notice. Interest expense paid to Woolworth in connection with debt incurred with the Acquisition (see Note 2) and the bridge loans (see Note 6) amounted to $372 during the eight months ended January 27, 1996. F-15

40 KIDS MART, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EIGHT MONTHS ENDED JANUARY 27, 1996 (Dollar amounts in thousands, except per share amounts) 14. STOCK OPTION PLAN On January 3, 1996, the stockholders of the Company approved the 1995 Stock Option Plan (the "Plan"). Under the Plan, 600,000 shares of common stock have been reserved for issuance to eligible employees, directors, consultants and advisors, subject to certain limitations, as defined in the Plan. Incentive stock options may be granted at prices not less than 100% (110% for individuals controlling more than 10% of the Company's total combined capital stock) at the date of the grant, and expire within 10 years from the date of the grant (5 years for individuals controlling more than 10% of the Company's total combined capital stock). Nonstatutory stock options may be granted at prices not less than 100% of the fair market value at the date of the grant and expire within 10 years of the date the grant. The Plan provides for an automatic grant of nonstatutory stock options to acquire 2,000 shares of the Company's common stock to non-employee directors (other than designees of Woolworth) each year on the day following the Company's annual meeting of stockholders. No options were granted during the eight months ended January 27, 1996. 15. SUBSEQUENT EVENTS On July 24, 1996, the Company entered into a sale/leaseback transaction whereby it sold certain equipment to a leasing company for $288. The Company leased back such equipment under an operating lease which provides for 24 monthly payments of $10 each. The Company issued a warrant to the leasing company to purchase 50,000 shares of the Company's common stock at $7.00 per share. On September 11, 1996, the Company entered into an agreement with a vendor whereby the vendor agreed to convert $650 of amounts due from the Company to 433,333 shares of common stock. In exchange, the Company agreed to use its best efforts to purchase annually a minimum of $10,000 of merchandise inventories, as defined, from the vendor. On September 13, 1996, the Company's Board of Directors approved the Store Closure Plan under which the Company will immediately reduce its workforce at its distribution center and administrative offices and close approximately 100 stores. The Company estimates that its lease termination costs, property and equipment write-off and other closing costs in connection with the Store Closure Plan will be approximately $5,366, which will be recorded as a charge to operations the third quarter ending October 26, 1996. * * * * * * F-16

1 EXHIBIT 10.4 MUTUAL RELEASE AND SETTLEMENT AGREEMENT This Mutual Release and Settlement Agreement (this "Settlement Agreement") is made and entered into this 30th day of May, 1996 by and among Plaintiff LFS Acquisition Corp., a Delaware corporation and successor in interest to LFS Acquisition Corp., a California corporation, and its parent, Kids Mart, Inc., a Florida corporation (individually, each a "Plaintiff" and collectively, "LFS"), Defendants Woolworth Corporation and Kinney Shoe Corporation, each a New York corporation (individually, each a "Defendant" and collectively, "Woolworth") and Jack Koffman. This Settlement Agreement is made and entered into with reference to the following facts and circumstances: WHEREAS, LFS Acquisition Corp. and Woolworth are parties to a Purchase Agreement dated February 3, 1995, as may have been amended (the "Purchase Agreement"), under which LFS Acquisition Corp. agreed to purchase the business and assets of the Kids Mart/Little Folk Division from Kinney Shoe Corporation, and the stock of Holtzman's Little Folk Shop Inc. (collectively, "Kids Mart") from Woolworth Corporation, and Woolworth agreed to sell the same to LFS Acquisition Corp.; and WHEREAS, on or about May 31, 1995, the closing contemplated by the Purchase Agreement occurred; and WHEREAS, the initial purchase price (the "Purchase Price") for Kids Mart was approximately $18.4 million with a purchase price adjustment of $1.75 million, resulting in an adjusted purchase price of $16.67 million (of which 10% was held in escrow), of which adjusted purchase price the sum of $5,001,382 was paid by a Promissory Note from LFS Acquisition Corp. to Woolworth Corporation dated May 31, 1995 (the "Woolworth Note"); and

2 WHEREAS, on or about May 31, 1995, LFS Acquisition Corp. deposited $1.67 million of the purchase price for Kids Mart into an escrow account with Kaye, Scholer, Fierman, Hays & Handler, LLP the escrow agent (the "Escrow Agent") pursuant to the Escrow Agreement (the "Escrow Agreement") dated May 31, 1995 by and among LFS Acquisition Corp., Woolworth and the Escrow Agent (the "Escrow Agreement"); and WHEREAS, LFS Acquisition Corp. and Woolworth Corporation entered into a Transitional Services Agreement dated May 31, 1995 (the "Service Agreement") under which Woolworth Corporation agreed to perform certain services for LFS Acquisition Corp., and during the course of which Woolworth Corporation asserts it has paid for state sales and payroll taxes and other amounts on behalf of LFS Acquisition Corp. in an amount in excess of $4.4 million (the "Advances"); which Advances remain unpaid; and on April 30, 1996 Woolworth Corporation gave notice of termination of the Service Agreement; and WHEREAS, Woolworth asserts that LFS Acquisition Corp. owes Woolworth $4,297,649 in adjustments to the Purchase Price and has asserted that it may seek impartial resolution of the final purchase price adjustment pursuant to the Purchase Agreement; and WHEREAS, in December 1995, LFS Acquisition Corp. and Jack Koffman ("Koffman") filed a complaint (the "Complaint") in California Superior Court for the County of Los Angeles entitled LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., Case No. BC140222 (the "Action") asserting causes of action for fraud, negligent misrepresentation, and breach of contract; and WHEREAS, Woolworth denied the material allegations of the Complaint and, on January 23, 1996, cross-complained against LFS Acquisition Corp., asserting causes of action for 2

3 money paid on behalf of another, account stated, breach of contract, and unjust enrichment; and LFS Acquisition Corp. has denied those allegations; and WHEREAS, on January 3, 1996, FH Sub Delaware, Inc., a wholly-owned subsidiary of Frost Hanna Acquisition Group, Inc., merged with and into LFS Acquisition Corp., with LFS Acquisition Corp. surviving and becoming a wholly-owned subsidiary of Frost Hanna Acquisition Group, Inc., which on January 3, 1996 changed its name to Little Folk Shops, Inc. and which, on January 23, 1996, changed its name to Kids Mart, Inc.; and WHEREAS, the parties now desire to resolve these disputes without the burden and expense of protracted litigation; and WHEREAS, in furtherance of such resolution, Woolworth Corporation and Kids Mart, Inc. are concurrently herewith entering into a Stock Acquisition Agreement of even date (the "Stock Agreement") pursuant to which it is contemplated that Kids Mart, Inc. will issue to Woolworth Corporation 1,000,000 shares of a newly-designated Series A Convertible Preferred Stock (the "Preferred Stock"). NOW, THEREFORE, in consideration of the mutual covenants and agreements contained in this Settlement Agreement, the parties have agreed as follows: 1. Woolworth Note. At the closing of the transactions contemplated by the Stock Agreement (the "Closing"), Woolworth Corporation shall deliver to LFS for cancellation the original Woolworth Note, with such delivery to be deemed the release by Woolworth of all amounts (including principal, interest, costs and fees) owed thereunder. 2. Amounts In Escrow. At the Closing, LFS Acquisition Corp. and Woolworth shall execute and deliver the notice, in the form attached as Exhibit "A" hereto, to the 3

4 Escrow Agent, directing the Escrow Agent forthwith to pay to LFS all funds held in the escrow account established by the Escrow Agreement, including principal and any earnings thereon. 3. Issuance of Preferred Stock. Within five (5) business days after the Closing, Kids Mart, Inc. in consideration of the transactions contemplated by this Settlement Agreement, including among other things, Woolworth's cancellation of the Woolworth Note and the satisfaction of the Advances shall issue to Woolworth Corporation, in accordance with the terms of the Stock Agreement, the Preferred Stock. 4. Transitional Services Agreement. The Service Agreement between Woolworth Corporation and LFS Acquisition Corp. is and remains in full force and effect, and shall be, and hereby is, extended under the following terms and conditions: Woolworth Corporation shall continue to provide MIS Services, Office Services, Retail Accounting Services, Store Audit Services, Store Repair Services, and Store Cash Management Services, as those terms are defined in the Service Agreement, for all periods through the period ended September 28, 1996. LFS Acquisition Corp. agrees to pay for these services at the respective following rates from June 1, 1996 until termination of such services: a. MIS Services: .91% of the actual sales by LFS during the month in which such MIS Services are provided (less $9,450 per month). b. Office Services: $15,300 per month. c. Retail Accounting Services: $40,700 per month (as reduced from time to time due to reduction in use and scope of services). d. Store Cash Management Services: $1,650 per month. 4

5 e. Store Repair Services: Cost of repairs and maintenance plus a 20% service charge. f. Store Audit Services: $475 per store. As part of the MIS Services, Woolworth will also support the connection of LFS' AS/400 to the Woolworth system for the transfer of data files between Woolworth and LFS. Further, Woolworth shall continue to send data (POS Polling) to and receive data (POS Polling) from LFS stores until April 1, 1997. Data required for the stores would be prepared and transmitted to Woolworth from LFS and data received from the stores would be de-compressed and transmitted from Woolworth to LFS. LFS may, upon thirty (30) days' written notice to Woolworth, terminate the POS Polling and any charges for this service. Woolworth shall, in connection with all services to be rendered hereunder, timely provide LFS with normal month-end closing reports. For the Additional Services related to the MIS Services (as defined in the Service Agreement) described in this paragraph, and any additional such developmental services, LFS agrees to pay Woolworth Corporation the following additional fees: a. As long as Woolworth Corporation continues to provide the other MIS Services described above (and to receive the .91% based fee therefor), $60 per hour for such Additional Services; and b. At such time as Woolworth Corporation no longer provides the other MIS Services (and does not receive the .91% based fee therefor), $1.00 per store per polling or promotional file download and $3.00 per store per PLU (price look-up) download, including communication expense; $25.00 per incident for help desk calls; 5

6 and, unless otherwise agreed, $60 per hour for any Additional Services related to the MIS Services. Notwithstanding the contemplated termination of services after the period ended September 28, 1996 and after April 1, 1997, as the case may be, it is understood and agreed that, in accordance with Section 3.1 of the Service Agreement, such services shall continue to be provided thereafter on a month-to-month basis (for the described fees) unless and until either Woolworth Corporation or LFS Acquisition Corp. terminates any one or more of such services upon thirty (30) days' notice. Notwithstanding anything in the Service Agreement to the contrary, LFS agrees and acknowledges that (i) the total liability of Woolworth Corporation (and its directors, officers, employees, agents and representatives) arising out of or in connection with any breach by Woolworth Corporation of, or any acts or omissions by Woolworth Corporation in performing its obligations under, the provisions of the Service Agreement and/or the provisions of this Paragraph 4, in each case from and after the date of this Settlement Agreement, shall not exceed, regardless of the form of action, whether in contract or in tort, including negligence, the aggregate fees actually paid to Woolworth Corporation pursuant to this Paragraph 4 for such period, except to the extent such claims arise from the willful misconduct or bad faith of Woolworth Corporation, and (ii) none of Woolworth Corporation or its directors, officers, employees, agents or representatives will be liable to LFS for incidental, special, exemplary or consequential damages, even if previously advised of the possibility thereof, including, but not limited to, lost business revenue, failure to realize expected savings or other commercial or 6

7 economic loss of any kind, except to the extent such claims arise from the willful misconduct or bad faith of Woolworth Corporation. Woolworth Corporation will use its reasonable best efforts to provide timely support in any translation of data in files for transmittal to LFS Acquisition Corp. 5. Financial Statements. Woolworth Corporation will use its reasonable best efforts to cause KPMG Peat Marwick LLP ("KPMG") to perform an audit (the "Stub Audit") of the balance sheet of Holtzman's Little Folk Shop, Inc. ("Holtzman's") as of May 31, 1995, and the related statements of operations, stockholders' equity and cash flows for the period January 29, 1995 through May 31, 1995. At the Closing (if KPMG has given reasonable written assurances to LFS that it will perform such work) LFS will pay KPMG (i) $22,500 for past due professional fees; and (ii) $100,000 (the "Preliminary Payment") for fees incurred or to be incurred by KPMG for conduct of the Stub Audit and preparation of the Draft Audit Materials and the Final Audit Materials, each as defined below. At the conclusion of the Stub Audit, Woolworth Corporation will use its reasonable best efforts (A) to deliver to Kids Mart, Inc. drafts of the following materials (the "Draft Financial Statements"): (i) draft audited financial statements for the "stub period" ended May 31, 1995 (the "Stub Financials") and (ii) draft adjustments, if any, suggested by the Stub Audit to the previously audited financial statements of Holtzman's for the two years ended January 28, 1995 (the "Historical Financials") and (B) to cause KPMG to deliver to Kids Mart Inc. a draft audit opinion and a draft auditor's consent with respect to (x) the draft Stub Financials and (y) the Historical Financials (as they may be adjusted) (such opinions and consents, the "Draft Audit Materials"). 7

8 Each of Woolworth Corporation and Kids Mart, Inc. will use its respective reasonable best efforts to cause KPMG and Kids Mart, Inc's. auditors, Deloitte & Touche ("Deloitte"), as well as the respective managements of Woolworth Corporation and Kids Mart, Inc., to work together and cooperate in resolving any disagreements that may arise with respect to the Draft Financial Statements or the Draft Audit Materials. If all such disagreements are resolved, or if none exist, then (i) Woolworth Corporation will use its reasonable best efforts (A) to revise, if necessary, and finalize the Draft Financial Statements and deliver to Kids Mart, Inc. the following materials (the "Final Financial Statements"): (x) the Stub Financials and (y) the Historical Financials, if revised and (B) to cause KPMG to deliver to Kids Mart, Inc. an audit opinion and auditor's consent with respect to the Stub Financials and the Historical Financials (as they may be adjusted) for use in connection with periodic reporting requirements under the Securities Exchange Act of 1934, as amended (the "1934 Act") (such opinion and consent, the "Final Audit Materials"), and (ii) Kids Mart, Inc. (x) will use its reasonable best efforts to cause (A) Deloitte to deliver a "material events," successor auditor letter to KPMG substantially to the effect that nothing has come to Deloitte's attention in its audit work for the eight month period ended January 27, 1996 that would have a material effect on the financial statements of Holtzman's for any period prior to June 1, 1995 or that causes Deloitte to believe that any such financial statements are incomplete or misleading in any material respect and (B) the respective managements of Kids Mart, Inc. and LFS Acquisition Corp. to deliver similar letters that also correct or retract (if, and to the extent, applicable) their prior statements with respect to such financial statements in the 1934 Act filings of Kids Mart, Inc. and in the pleadings in the Action and (y) will (A) deliver to KPMG, with respect to all audits conducted and audit opinions 8

9 prepared by KPMG with respect to Holtzman's, including the Stub Audit and the Final Audit Materials, a release of KPMG and its affiliated and related persons substantially similar in form to the release contained in Paragraph 7 of this Settlement Agreement and (B) use its reasonable best efforts to deliver to KPMG similar releases from the individuals identified in the last paragraph of said Paragraph 7. It is understood that the respective deliveries contemplated by clauses (i) and (ii) of this paragraph are conditioned upon each other and intended to occur simultaneously. If the Final Audit Materials are delivered, LFS also agrees to pay KPMG reasonable and customary fees not to exceed $10,000 for the performance of standard auditing procedures with respect to the delivery of the auditor's consent included therein. If at any time subsequent to delivery of the Final Audit Materials, Kids Mart, Inc. requests KPMG to provide an additional consent with respect to the use of the Final Audit Materials in any filing by Kids Mart, Inc. under the Securities Act of 1933, as amended, it is understood that nothing in this Paragraph 5 shall obligate KPMG to deliver such consent, and KPMG may condition the delivery of such consent upon such lawful terms and conditions as it deems necessary or appropriate. If KPMG fails to provide reasonable written assurance of its undertaking to perform the Stub Audit, or if any material disagreements with respect to the Draft Audit Materials occur such that the deliveries contemplated by the second preceding paragraph above are no longer feasible, or if the Final Audit Materials and all other deliveries contemplated above do not occur within three months of the Closing, then Woolworth Corporation agrees to engage an independent accounting firm reasonably acceptable to Kids Mart, Inc. (the "Independent Accountant") to perform an audit of the balance sheets of Holtzman's as of January 29, 1994, 9

10 January 28, 1995 and May 31, 1995, and the related statements of operations, stockholders' equity and cash flows for the years ended January 29, 1994 and January 28, 1995 and the period of January 29, 1995 to May 31, 1995 (the "Second Audits"), for the purpose of inclusion in the amended Form 10-K of Kids Mart, Inc. for the year ended January 27, 1996 and with the understanding that the Independent Accountant's work papers shall reasonably be made available to LFS and Deloitte. Woolworth Corporation will also engage the Independent Accountant to make a separate statement at the end of its audit process if, in the view of the Independent Accountant, the Stub Financials and the Historical Financials included in the Draft Financial Statements were not accurate in all material respects or were otherwise materially misleading, in each case, as they relate to Holtzman on a stand alone basis, it being understood that specific expense categories for corporate allocations will be identified to LFS and the basis of presentation in the Draft Financial Statements and the Final Financial Statements with resepct to such allocations shall not be considered inaccurate or misleading by the Independent Accountant if they are consistent with the basis described in the Note 1(b) of the Historical Financials. If the Independent Accountant makes such a statement, it is agreed that LFS will reimburse Woolworth Corporation for 25% of all fees and costs of the Independent Accountant in connection with the Second Audits, up to a maximum reimbursement by LFS (exclusive of the Preliminary Payment) of $100,000. If the Accountant does not make such a statement, it is agreed that LFS will reimburse Woolworth Corporation for 75% of all fees and costs of the Accountant in connection with the Second Audits, up to a maximum reimbursement by LFS (inclusive of the Preliminary Payment) of $300,000. 10

11 In addition, if at any subsequent time Kids Mart, Inc. requests the Independent Accountant to provide consents with respect to any of the financial statements included in the Second Audits for use in any other federal and/or state reporting or financial filings by Kids Mart, Inc., Woolworth Corporation will use its reasonable best efforts to cause the Independent Accountant to so provide such consents, provided that LFS agrees to reimburse Woolworth Corporation and/or the Independent Accountant, as the case may be, for all customary and reasonable fees incurred in connection with the performance of standard auditing procedures with respect to delivery of such consents. Each of Woolworth and LFS agrees to cooperate reasonably with each other and their respective accountants in order to facilitate the performance and timely conduct of all audits and other actions contemplated by this Paragraph 5. 6. Dismissal of Action. At the Closing, counsel for LFS, Koffman, and Woolworth shall execute a stipulation of dismissal with prejudice of the Action, including the Complaint and Woolworth's cross-claim, in the form annexed as Exhibit "B" hereto, the filing of which the parties hereto shall forthwith jointly cause to be completed. 7. Kids Mart, Inc., LFS Acquisition Corp. and Jack Koffman's Release of Woolworth Corporation and Kinney Shoe Corporation. Effective at the time of the Closing, each of Kids Mart, Inc. and LFS Acquisition Corp., on behalf of itself, its subsidiaries and any person or entity claiming through (derivatively or otherwise) or otherwise asserting or obtaining rights through, from or on behalf of it, and Koffman, on behalf of himself and any person or entity claiming through or otherwise asserting or obtaining rights through, from or on behalf of him (collectively, the "LFS Releasing Parties"), hereby permanently and irrevocably discharges 11

12 each of Woolworth Corporation, Kinney Shoe Corporation, the respective subsidiaries, affiliates, successors, predecessors and assigns of Woolworth Corporation and Kinney Shoe Corporation, and the respective present and former shareholders, officers, directors, general and limited partners, employees, agents, representatives, attorneys, and parents of Woolworth Corporation, Kinney Shoe Corporation and such other persons and entities, from, and settles and compromises, all liabilities, debts, liens, claims, suits, actions, causes of action, or rights to relief, whether anticipated or unanticipated, known or unknown, of every kind, nature and description relating directly or indirectly in any way to the subject matter of the Purchase Agreement or the Action, whether arising out of any federal law (including, without limitation, the federal securities laws), state or local law or other law, whether asserted as complaints, demands, cross-claims, third-party claims or otherwise, including but not limited to those that any LFS Releasing Party now has or may ever have arising out of: a. LFS Acquisition Corp.'s acquisition of Kids Mart from Woolworth under the Purchase Agreement and said Purchase Agreement; b. Any transaction taking place before the date of this Settlement Agreement and any and all claims relating thereto; c. The Woolworth Note and any other note obligations between either or both Plaintiffs, on the one hand, and either or both Defendants, on the other hand, entered, made, or outstanding before the date of this Settlement Agreement; and d. Services performed before the date of this Settlement Agreement by Woolworth Corporation under the Service Agreement. 12

13 LFS Acquisition Corp. agrees that no later than five (5) business days following the Closing, it shall deliver to Woolworth Corporation releases from Richard B. Frost, Mark J. Hanna, Donald H. Baxter, Marshall E. Rosenberg and Bernard E. Tessler, in their respective individual capacities, providing for the permanent and irrevocable discharge to Woolworth Corporation, Kinney Shoe Corporation, and the other releases identified in the immediately preceding paragraph of this Paragraph 7 to the extent set forth therein. In addition, and without in any way limiting the nature, effect, extent and scope of the releases contained in this Paragraph 7, nothing contained in this Paragraph 7 shall be deemed to affect the right of any LFS Releasing Party to join or implead any of the released parties, for the purpose of seeking appropriate apportionment of liability or contribution in accordance with applicable law, as parties to any litigation or proceeding that may be commenced by any party that is not, and is not controlled by or acting in concert with, any LFS Releasing Party against any of the LFS Releasing Parties relating directly or indirectly to the subject matter of the Purchase Agreement or the Action or any other matter the subject of the release contained in this Paragraph 7. 8. Surviving Woolworth Obligations. Notwithstanding the releases provided for in Paragraph 7 of this Settlement Agreement, it is understood and agreed that the obligations and agreements of Woolworth contained in Sections 8.4, 8.7, 8.8, 8.10, 8.13, 8.16, 8.18, 9.3(e), 9.3(f), 9.3(g), 9.4, 10.1(a)(i) (but only with respect to a misrepresentation in a Woolworth Continuing Representation (as hereinafter defined)), 10.1(a)(ii) through (xii) (other than a condition constituting a failure to comply with, or a violation of, any anti-fraud provision of any federal or state securities law), 10.2, 10.3 and Article XII of the Purchase Agreement shall 13

14 survive and continue in full force and effect in accordance with their terms. For purposes hereof, the term "Woolworth Continuing Representations" shall mean the representations and warranties of Woolworth made in Sections 6.1, 6.2, 6.3, 6.4 (other than clause (a)(iii) thereof), 6.5, 6.6, 6.8, 6.9, 6.10, 6.11, 6.12, 6.13, 6.14, 6.15, 6.17, 6.18, 6.19, 6.20, 6.21 (other than a condition constituting a failure to comply with, or a violation of, any anti-fraud provision of any federal or state securities law), 6.22, 6.23, 6.24, 6.25, 6.26, 6.27, 6.28, 6.29 and 6.31 of the Purchase Agreement. Notwithstanding the immediately preceding two sentences, it is understood and agreed that the releases in Paragraph 7 with respect to the Action are intended to be absolute, and nothing in this Paragraph 8 is intended to or shall form or preserve the basis of a claim, right or cause of action by or on behalf of either Plaintiff under the Purchase Agreement that (i) was asserted in the Action or that reasonably could have been asserted in the Action or (ii) is known to either Plaintiff as of the date of this Settlement Agreement. 9. Woolworth's Release of LFS, Holtzman's Little Folk Shop, Inc. and Koffman. Effective at the time of Closing, each of Woolworth Corporation and Kinney Shoe Corporation, on behalf of itself, its subsidiaries and any person or entity claiming through (derivatively or otherwise) or otherwise asserting or obtaining rights through, from or on behalf of it (collectively the "Woolworth Releasing Parties"), hereby permanently and irrevocably discharges each of Kids Mart, Inc., LFS Acquisition Corp., Holtzman's Little Folk Shop, Inc., Koffman, the respective subsidiaries, affiliates, successors, predecessors, and assigns of Kids Mart, Inc., LFS Acquisition Corp., Holtzman's Little Folk Shop, Inc. and Koffman, and the respective present and former shareholders, officers, directors, general and limited partners, employees, agents, representatives, attorneys, and parents of Kids Mart, Inc., LFS Acquisition 14

15 Corp., Holtzman's Little Folk Shop, Inc. and Koffman and such other persons and entities from all liabilities, debts, liens, claims, suits, actions, causes of action, or rights to relief, whether anticipated or unanticipated, known or unknown, of every kind, nature and description relating directly or indirectly to the subject matter of the Purchase Agreement or the Action, whether arising out of any federal law (including, without limitation, the federal securities laws), state or local law or other laws, whether asserted as complaints, demands, cross-claims, third-party claims or otherwise, including but not limited to those that any Woolworth Releasing Party now has or may ever have arising out of: a. LFS Acquisition Corp.'s acquisition of Kids Mart from Woolworth under the Purchase Agreement and said Purchase Agreement; b. Any transaction taking place before the date of this Settlement Agreement (including the Advances) and any and all claims relating thereto; c. The Woolworth Note and any other note obligations between either or both Plaintiffs on the one hand and either or both Defendants on the other hand, entered, made, or outstanding before the date of this Settlement Agreement; and d. Services performed before the date of this Settlement Agreement by Woolworth Corporation under the Service Agreement. In addition, and without in any way limiting the nature, effect, extent and scope of the releases contained in this Paragraph 9, nothing contained in this Paragraph 9 shall be deemed to affect the right of any Woolworth Releasing Party to join or implead any of the released 15

16 parties, for the purpose of seeking appropriate apportionment of liability or contribution in accordance with applicable law, as parties to any litigation or proceeding that may be commenced by any party that is not, and is not controlled by or acting in concert with, any Woolworth Releasing Party against any of the Woolworth Releasing Parties relating directly or indirectly to the subject matter of the Purchase Agreement or the Action or any other matter the subject of the release contained in this Paragraph 9. 10. Surviving LFS Obligations. Notwithstanding the releases provided for in Paragraph 9 of this Settlement Agreement, it is understood and agreed that the obligations and agreements of LFS Acquisition Corp. contained in Sections 8.4, 8.7, 8.8, 8.10, 8.13, 8.16, 8.18, 8.20 (added by amendment), 9.2, 9.3, 9.4, 10.1(b), 10.1(c), 10.2, 10.3 and Article XII of the Purchase Agreement shall survive and continue in full force and effect in accordance with their terms. Notwithstanding the immediately preceding sentence, it is understood and agreed that the releases in Paragraph 9 with respect to the Defendants' cross-claims in the Action are intended to be absolute, and nothing in this Paragraph 10 is intended to or shall form or preserve the basis of a claim, right or cause of action by or on behalf of either Defendant under the Purchase Agreement that (i) was asserted as a cross-claim in the Action or that reasonably could have been asserted as a cross-claim in the Action or (ii) is known to either Defendant as of the date of this Settlement Agreement. Notwithstanding the foregoing, and notwithstanding the releases provided for in Paragraph 9 of this Settlement Agreement, it is understood and agreed by LFS that Woolworth Corporation retains the right to receive payment, and LFS hereby agrees to pay, (x) on account of the invoices attached hereto as Exhibit "C" aggregating $306,104.45 and (y) for 16

17 any services provided under the Service Agreement with respect to periods after April 30, 1996 and not heretofore paid by LFS. 11. Representations and Warranties of LFS. LFS represents and warrants that (i) LFS Acquisition Corp. is not aware of any currently existing default (other than certain immaterial reporting requirements) under its loan and security agreement, dated May 31, 1995, with Foothill Capital Corporation, (ii) LFS is not aware of any material liability to Woolworth Corporation or any of its subsidiaries which has not been disclosed in writing to Woolworth Corporation prior to the Closing, (iii) LFS has no present intention to file, or permit any subsidiary to file, a petition for relief under title 11 of the United States Code, (iv) after giving effect to the transactions contemplated hereby and the results thereof, and as at the effective date of this Settlement Agreement, each of Kids Mart, Inc. and LFS Acquisition Corp. (x) has assets in excess of its liabilities, at a fair valuation, (y) will be able to pay its debts as they mature and (z) will have capital sufficient with which to conduct its business and (v) each of LFS Acquisition Corp. and Kids Mart, Inc. has determined, in the exercise of its business judgment, that its execution and performance of this Settlement Agreement are in the best interests of itself, its shareholders, and its creditors. 12. Section 1542 Waiver. Each of the parties acknowledges and warrants that its signing representatives have read and understand the provisions of California Civil Code Section 1542, which states as follows: "A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF 17

18 EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." Each of these parties expressly, voluntarily, and knowingly waives any and all rights it may have under Civil Code Section 1542 and under any other statutes or common law principles of similar effect. 13. Non-Admission of Liability. Each of the parties has denied and continues to deny all claims, allegations, and contentions of liability alleged by the other parties. Nothing in this Settlement Agreement and nothing about the fact that the Action was settled shall be construed as an admission by any of the parties of any fault, wrongdoing, or liability whatsoever. 14. Subsequent Litigation; Indemnity. a. Each of LFS Acquisition Corp. and Kids Mart, Inc., jointly and severally, hereby agrees to indemnify and hold harmless Woolworth Corporation, its subsidiaries and affiliates, and any present or former shareholder, director, officer, agent, employee or attorney of Woolworth Corporation or any of its subsidiaries or affiliates (any of the foregoing, an "Indemnified Person"), to the full extent lawful, from and against any losses, expenses (including reasonable attorney's fees), claims or proceedings, including shareholder actions (hereinafter collectively referred to as "losses") related to or arising out of the negotiation, execution and/or implementation of the Settlement Agreement. 18

19 b. Kids Mart, Inc. or LFS Acquisition Corp. shall be entitled to assume the defense of any action for which indemnification is sought under paragraph a. above with counsel of its choice at its expense (in which case it shall not thereafter be responsible for the fees and expenses of any separate counsel retained by an Indemnified Person except as set forth below), provided, however, that such counsel shall be reasonably satisfactory to Woolworth Corporation. Notwithstanding an election by Kids Mart, Inc. or LFS Acquisition Corp. to assume the defense of such action, each Indemnified Person shall have the right to employ separate counsel and to participate in the defense of such action at its own cost. 15. Costs and Attorneys' Fees. Each of the parties agrees to bear its own attorneys' fees and costs incurred in connection with the Action and this Settlement Agreement, through and including the date of the Closing. 16. Tax Assistance. LFS agrees, without cost or further obligation, to identify to Woolworth tax positions that LFS believes may be beneficial or advantageous for Woolworth to utilize or apply in connection with Woolworth's prior operation of Kids Mart, Inc. stores and the Purchase Agreement. 17. Applicable Law. The parties intend and agree that this Settlement Agreement shall be subject to, governed by, and enforced and construed pursuant to the internal law of the State of California (without regard to principles of conflicts of laws). 19

20 18. Independent Counsel. Each of the parties represents and warrants that, in connection with the negotiation and execution of this Settlement Agreement, it has been represented by independent counsel and financial advisors of its own choosing, that it has not relied upon the advice or counsel of any other party's independent counsel or financial advisor in the negotiation or drafting of this Settlement Agreement, that it has executed this Settlement Agreement after receiving the advice of such independent counsel and financial advisors, that its representative has read and understands the provisions and terms of this Settlement Agreement, and that it has had an adequate opportunity to conduct an independent investigation of all facts and circumstances with respect to all matters that are the subject of this Settlement Agreement. Woolworth acknowledges that it received and reviewed the Form 10-K of Kids Mart, Inc. for the period ended January 27, 1996, filed with the Securities and Exchange Commission. 19. Non-Assignment of Claims. Each of the parties warrants and represents that it has not assigned or transferred or purported to assign or transfer, voluntarily, involuntarily, or by operation of law, any claim, cause of action, or matter released pursuant to this Settlement Agreement, or any part or portion thereof, to any person or entity not a party to this Settlement Agreement. Each of the parties agrees to indemnify all other parties and hold them harmless from any claims, demands, damages, debts, liabilities, accounts, obligations, costs, expenses, liens, actions, or causes of action (including the payment of attorneys' fees and costs actually incurred, whether or not litigation is commenced) based upon, in connection with, or arising out of any such assignment or transfer or purported assignment or transfer of such a claim, cause of action, or matter released pursuant to this Settlement Agreement. 20

21 20. All Terms In Writing. Each of the parties acknowledges that this Settlement Agreement together with the Stock Agreement (including the respective exhibits thereto and documents and instruments to be delivered pursuant thereto) contains all of the terms and conditions agreed upon by the parties concerning the settlement of the Action, and that this Settlement Agreement together with the Stock Agreement supersedes all prior negotiations, proposed agreements, and agreements concerning this settlement and release. Each of the parties acknowledges that no party or representative, agent, or attorney for a party has made any representation or warranty to influence the execution of this Settlement Agreement that is not expressly contained in this Settlement Agreement or the Stock Agreement. Each of the parties acknowledges that it has not executed this Settlement Agreement in reliance upon any representation or warranty not contained in this Settlement Agreement or the Stock Agreement. This Settlement Agreement shall not be modified or changed except by a written instrument signed by Kids Mart, Inc. and Woolworth Corporation. 21. Successors. This Settlement Agreement is binding upon and shall inure to the benefit of the parties and their respective successors, assigns, heirs, trustees, and personal representatives. 22. Execution in Counterparts. This Settlement Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which together shall be deemed to be one and the same instrument. 23. Joint Drafting. The parties have jointly drafted this Settlement Agreement and this Settlement Agreement shall not be interpreted against or in favor of any of the parties on the ground that any of the parties participated in the drafting of the Settlement Agreement. 21

22 24. Authority to Execute. Each of the parties represents and warrants that the person executing the Settlement Agreement on its behalf is a representative duly authorized to bind it and empowered to enter into the Settlement Agreement on its behalf. 25. Notice. All notices, requests, demands, consents, and other communications required or permitted to be given or made hereunder shall be in writing and shall be deemed to have been duly given if delivered by hand or telecopier, or if mailed, certified or registered first class mail, postage prepaid, return receipt requested, to: a. as to LFS and Koffman, to Kids Mart, Inc., 801 S. Sentous Avenue, City of Industry, California 91748, Attn: Bernard Tessler, CEO, Fax No. 818-854-3832, with copy to Kaye, Scholer, Fierman, Hays & Handler, LLP, 425 Park Avenue, New York, New York 10022, Attn: Mitchel H. Perkiel, Esq., Fax No. 212-836-7157; and b. as to Woolworth, to Woolworth Corporation, 233 Broadway, New York, New York 10279, Attn: General Counsel, Fax No. 212-553-2152; with copy to Skadden, Arps, Slate, Meagher & Flom, 919 Third Ave., New York, New York 10022, Attn: Peter J. Neckles, Esq., Fax No. 212-735-2000. 22

23 THE UNDERSIGNED ACKNOWLEDGE THAT THEY HAVE READ THIS SETTLEMENT AGREEMENT IN ITS ENTIRETY AND FULLY UNDERSTAND ITS TERMS. The undersigned LFS Acquisition Corp. agrees to the terms of this Settlement Agreement in LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., California Superior Court for the County of Los Angeles, Case Number BC140222. LFS ACQUISITION CORP. Dated: By: -------- ------------------------------- Name: ----------------------------- Signature: ------------------------ Title: ---------------------------- The undersigned Kids Mart, Inc. agrees to the terms of this Settlement Agreement in LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., California Superior Court for the County of Los Angeles, Case Number BC140222. KIDS MART, INC. Dated: By: -------- ------------------------------- Name: ----------------------------- Signature: ------------------------ Title: ---------------------------- 23

24 The undersigned Jack Koffman agrees to the terms of this Settlement Agreement in LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., California Superior Court for the County of Los Angeles, Case Number BC140222. JACK KOFFMAN Dated: By: -------- ------------------------------- Name: ----------------------------- Signature: ------------------------ Title: ---------------------------- The undersigned Woolworth Corporation agrees to the terms of this Settlement Agreement in LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., California Superior Court for the County of Los Angeles, Case Number BC140222. WOOLWORTH CORPORATION Dated: By: -------- ------------------------------- Name: ----------------------------- Signature: ------------------------ Title: ---------------------------- 24

25 The undersigned Kinney Shoe Corporation agrees to the terms of this Settlement Agreement in LFS Acquisition Corp., et al. v. Woolworth Corporation, et al., California Superior Court for the County of Los Angeles, Case Number BC140222. KINNEY SHOE CORPORATION Dated: By: -------- ------------------------------- Name: ----------------------------- Signature: ------------------------ Title: ---------------------------- 25

26 Exhibit A NOTICE TO ESCROW AGENT Kaye, Scholer, Fierman, Hays & Handler, as Escrow Agent ("Escrow Agent") under the Escrow Agreement dated May 31, 1995, by and among LFS Acquisition Corp., Kinney Shoe corporation, Woolworth Corporation and the Escrow Agent (the "Escrow Agreement") 425 Park Avenue New York, New York 10022 Attn: Alan Capilupi, Controller Roger Berg, Esq. Dear Sirs: You are hereby instructed and directed to pay, by wire transfer, the Escrow Fund (as defined in the Escrow Agreement) to the following: Payee: Foothill Capital Corporation Bank Name: Chemical Bank ABA#: 021000128 Account Name: Little Folk Shop or Kids Mart Account Number: 323-266193 Very truly yours, LFS ACQUISITION CORP. By: _______________________________ KINNEY SHOE CORPORATION By: _______________________________ WOOLWORTH CORPORATION By: _______________________________

1 EXHIBIT 10.5 ================================================================================ LOAN AND SECURITY AGREEMENT BY AND BETWEEN LFS ACQUISITION CORP. AND FOOTHILL CAPITAL CORPORATION DATED AS OF MAY 31, 1995 ================================================================================

2 TABLE OF CONTENTS <TABLE> <CAPTION> Page <S> <C> <C> 1. DEFINITIONS AND CONSTRUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.2 Accounting Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.3 Code . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.4 Construction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1.5 Schedules and Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2. LOAN AND TERMS OF PAYMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.1 Revolving Advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 2.2 Letters of Credit and Letter of Credit Guarantees . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 2.3 Intentionally Omitted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 2.4 Overadvances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2.5 Interest: Rates, Payments, and Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2.6 Crediting Payments; Application of Collections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 2.7 Statements of Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 2.8 Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3. CONDITIONS; TERM OF AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3.1 Conditions Precedent to Initial Advance, L/C, or L/C Guaranty, and Conditions Subsequent . . . . . . . . . 15 3.2 Conditions Precedent to All Advances, L/Cs, or L/C Guarantees . . . . . . . . . . . . . . . . . . . . . . 17 3.3 Term; Automatic Renewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.4 Effect of Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.5 Early Termination by Borrower . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 3.6 Termination Upon Event of Default . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4. CREATION OF SECURITY INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.1 Grant of Security Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.2 Negotiable Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.3 Collection of Accounts, General Intangibles, Negotiable Collateral . . . . . . . . . . . . . . . . . . . . 19 4.4 Delivery of Additional Documentation Required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.5 Power of Attorney . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.6 Right to Inspect . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 5. REPRESENTATIONS AND WARRANTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.1 No Prior Encumbrances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.2 Intentionally Omitted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.3 Eligible Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 </TABLE> -i-

3 <TABLE> <S> <C> <C> 5.4 Location of Inventory and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.5 Inventory Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.6 Location of Chief Executive Office; FEIN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.7 Due Organization and Qualification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.8 Due Authorization; No Conflict . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.9 Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 5.10 No Material Adverse Change in Financial Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 5.11 Solvency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 5.12 Employee Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 5.13 Environmental Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 5.14 Reliance by Foothill; Cumulative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 6. AFFIRMATIVE COVENANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 6.1 Accounting System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 6.2 Collateral Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.3 Schedules of Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.4 Financial Statements, Reports, Certificates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 6.5 Tax Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 6.6 Guarantor Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 6.7 Designation of Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 6.8 Store Openings and Closings and Rent Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 6.9 Title to Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 6.10 Maintenance of Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 6.11 Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 6.12 Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 6.13 Financial Covenants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 6.14 No Setoffs or Counterclaims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 6.15 Location of Inventory and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 6.16 Compliance with Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 6.17 Employee Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 7. NEGATIVE COVENANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 7.1 Indebtedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 7.2 Liens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 7.3 Restrictions on Fundamental Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 7.4 Extraordinary Transactions and Disposal of Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.5 Change Name . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.6 Guarantee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.7 Restructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.8 Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.9 Change of Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.10 Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.11 Consignments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 </TABLE> -ii-

4 <TABLE> <S> <C> <C> 7.12 Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7.13 Accounting Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.14 Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.15 Transactions with Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.16 Suspension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.17 Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.18 Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 7.19 Change in Location of Chief Executive Office; Inventory and Equipment with Bailees . . . . . . . . . . . . 31 8. EVENTS OF DEFAULT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 9. FOOTHILL'S RIGHTS AND REMEDIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 9.1 Rights and Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 9.2 Remedies Cumulative . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 10. TAXES AND EXPENSES REGARDING THE COLLATERAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 11. WAIVERS; INDEMNIFICATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 11.1 Demand; Protest; etc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 11.2 Foothill's Liability for Collateral . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 11.3 Indemnification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 12. NOTICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 13. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 14. DESTRUCTION OF BORROWER'S DOCUMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15. GENERAL PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.1 Effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.2 Successors and Assigns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.3 Section Headings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.4 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.5 Severability of Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.6 Amendments in Writing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 15.7 Counterparts; Telefacsimile Execution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 15.8 Revival and Reinstatement of Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 15.9 Integration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 </TABLE> -iii-

5 SCHEDULES Schedule E-1 Eligible Inventory Schedule P-1 Permitted Liens Schedule 5.9 Litigation Schedule 6.15 Location of Inventory and Equipment -iv-

6 LOAN AND SECURITY AGREEMENT This LOAN AND SECURITY AGREEMENT, is entered into as of May 31, 1995, 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 LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), with its chief executive office located at 801 Sentous Avenue, City of Industry, California 91784. 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 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. "Affiliate" means, as applied to any Person, any other Person directly or indirectly controlling, controlled by, or under common control with, that Person. For purposes of this definition, "control" as applied to any Person means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of that Person, whether through the ownership of voting securities, by contract, or otherwise. "Agreement" means this Loan and Security Agreement and any written extensions, riders supplements, notes, amendments, or modifications to or in connection with this Loan and Security Agreement. "Authorized Officer" means any officer of Borrower. "Average Unused Portion of Maximum Amount" means (a) the Maximum Amount; less (b) the sum of: (i) the average Daily Balance of advances made by Foothill under Section 2.1 that were outstanding during the immediately preceding month; plus (ii) the average Daily Balance of the undrawn standby L/Cs and L/C Guarantees (and in the case of commercial L/Cs and L/C Guarantees, fifty percent (50%) of the average Daily Balance of the undrawn L/Cs and L/C Guarantees) issued by Foothill under Section 2.2 that were outstanding during the immediately preceding month. -1-

7 Bankruptcy Code" means the United States Bankruptcy Code (11 U.S.C. Section 101 et seq.), as amended, and any successor statute. "Borrower" has the meaning set forth in the preamble to this Agreement. "Borrower's Cost" means Borrower's landed cost of Inventory, as determined by Borrower based upon a calculation reasonably acceptable to Foothill. "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, disc or tape files, printouts, runs, or other computer prepared information. "Borrowing Base" has the meaning set forth in Section 2.1. "Business Day" means any day which 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 thirty percent (30%) of the total voting power of all classes of stock then outstanding of Borrower normally entitled to vote in the election of directors. "Closing Date" means the date of the initial advance or the date of the initial issuance of an L/C or an L/C Guaranty, whichever occurs first. "Code" means the California Uniform Commercial Code. "Collateral" means each of the following: the Accounts; Borrower's Books; the Equipment; the General Intangibles; the Inventory; the Negotiable Collateral; any money, or other assets of Borrower which now or hereafter come into the possession, custody, or control of Foothill; and 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, Inventory, Negotiable Collateral, 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. -2-

8 "Consolidated Current Assets" means, as of any date of determination, the aggregate amount of all current assets of Borrower and its subsidiaries calculated on a consolidated basis that would, in accordance with GAAP, be classified on a balance sheet as current assets. "Consolidated Current Liabilities" means, as of any date of determination, the aggregate amount of all current liabilities of Borrower and its subsidiaries, calculated on a consolidated basis that would, in accordance with GAAP, be classified on a balance sheet as current liabilities. For purposes of this definition, all advances outstanding under this Agreement shall be deemed to be current liabilities without regard to whether they would be deemed to be so under GAAP. "Daily Balance" means the amount of an Obligation owed at the end of a given day. "Early Termination Premium" has the meaning set forth in Section 3.5. "Eligible Inventory" means Inventory consisting of first quality finished goods (not defective goods or "seconds") held for sale in the ordinary course of Borrower's business (net of all capitalized distribution center costs and net of shrinkage reserves which may be adjusted by Foothill from time to time in its reasonable discretion based upon historical shrinkage levels), that is acceptable to Foothill in all respects, that is located at Borrower's premises identified on Schedule E-1 or that is in transit to Borrower if: (a) title to such Inventory has been transferred to Borrower and the Inventory is in route to Borrower via a third party carrier, (b) the Inventory is insured to Foothill's satisfaction and (c) documentation regarding such Inventory is acceptable to Foothill, and such Inventory strictly complies with all of Borrower's representations and warranties to Foothill. If Eligible Inventory is in transit to Borrower and has been acquired pursuant to a Foothill L/C or L/C Guarantee, the L/C or L/C Guarantee must have been drawn upon. Eligible Inventory shall not include slow moving Inventory (meaning Inventory held by Borrower in excess of one (1) year at any time during the first twelve (12) months following the Closing Date, and thereafter meaning Inventory at any time held by Borrower for more than six (6) months) or obsolete items, restrictive or custom items, raw materials, work-in-process, components that are not part of finished goods, spare parts, packaging and shipping materials, supplies used or consumed in Borrower's business, Inventory subject to a security interest or lien in favor of any third Person, bill and hold goods, Inventory that is not subject to Foothill's perfected security interests, and Inventory acquired on consignment. "Equipment" means all of Borrower's present and hereafter acquired machinery, machine tools, motors, equipment, furniture, furnishings, fixtures, leasehold improvements, vehicles (including motor vehicles and trailers), tools, parts, dies, jigs, goods (other than consumer goods, farm products, or Inventory), wherever located, and any interest of Borrower in any of the foregoing, and all attachments, accessories; accessions, replacements, substitutions, additions, and improvements to any of the foregoing, wherever located. -3-

9 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, or any predecessor, successor, or superseding laws of the United States of America, together with all regulations promulgated thereunder. "ERISA Affiliate" means any trade or business (whether or not incorporated) which, within the meaning of Section 414 of the IRC, is: (i) under common control with Borrower; (ii) treated, together with Borrower, as a single employer; (iii) treated as a member of an affiliated service group of which Borrower is also treated as a member; or (iv) is otherwise aggregated with the Borrower for purposes of the employee benefits requirements listed in IRC Section 414(m)(4). "ERISA Event" means any one or more of the following: (i) a Reportable Event with respect to a Qualified Plan or a Multiemployer Plan; (ii) a Prohibited Transaction with respect to any Plan; (iii) a complete or partial withdrawal by Borrower or any ERISA Affiliate from a Multiemployer Plan; (iv) the complete or partial withdrawal of Borrower or an ERISA Affiliate from a Qualified Plan during a plan year in which it was, or was treated as, a "substantial employer" as defined in Section 4001(a)(2) of ERISA; (v) a failure to make full payment when due of all amounts which, under the provisions of any Plan or applicable law, Borrower or any ERISA Affiliate is required to make; (vi) the filing of a notice of intent to terminate, or the treatment of a plan amendment as a termination, under Sections 4041 or 4041A of ERISA; (vii) an event or condition which might reasonably be expected to constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Qualified Plan or Multiemployer Plan; (viii) the imposition of any liability under Title IV of ERISA, other than PBGC premiums due but not delinquent under Section 4007 of ERISA, upon Borrower or any ERISA Affiliate; and (ix) a violation of the applicable requirements of Sections 404 or 405 of ERISA, or the exclusive benefit rule under Section 403(c) of ERISA, by any fiduciary or disqualified person with respect to any Plan for which Borrower or any ERISA Affiliate may be directly or indirectly liable. "Event of Default" has the meaning set forth in Section 8. "Excess Cash Flow" means an amount equal to one half (50%) of the amount of Borrower's net income, plus depreciation, minus Borrower's capital expenditures and required principal payments on Indebtedness, for the following fiscal years in excess of the Base Amount set forth below for each such year: <TABLE> <CAPTION> Fiscal Year Ending Base Amount <S> <C> January 31, 1996 $1,500,000 January 31, 1997 $4,000,000 January 31, 1998 $6,000,000 </TABLE> "FEIN" means Federal Employer Identification Number. -4-

10 "Foothill" has the meaning set forth in the preamble to this Agreement. "Foothill Expenses" means all: costs or expenses (including taxes, photocopying, notarization, telecommunication and insurance premiums) required to be paid by Borrower under any of the Loan Documents that are paid or advanced by Foothill to third Persons; documentation, filing, recording, publication, appraisal (including periodic Collateral appraisals), and search fees assessed, paid, or incurred by Foothill in connection with Foothill's transactions with Borrower; 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; 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. "Frost Hanna" means Frost Hanna Acquisition Group, Inc., a Florida corporation. "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, infringements, claims, computer programs, computer discs, computer tapes, literature, reports, catalogs, deposit accounts, insurance premium rebates, tax refunds, and tax refund claims), other than goods and Accounts. "Hazardous Materials" means all or any of the following: (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 -5-

11 substances or explosives or any radioactive materials; and (d) asbestos in any form or electrical equipment which contains any oil or dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty (50) parts per million. "Holtzman" means Holtzman's Little Folk Shop, Inc., a California corporation. "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, letter of credit guaranties, bankers acceptances, interest rate swaps, controlled disbursement accounts, or other financial products; (c) all obligations under capitalized leases; (d) all obligations or liabilities of others secured by a lien or security interest on any property or asset of Borrower, irrespective of whether such obligation or liability is assumed; (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; and (f) all obligations of Borrower to Woolworth evidenced by the Promissory Note issued by Borrower to Woolworth pursuant to the Purchase Agreement, but excluding any obligations thereunder payable solely from Borrower's excess cash flow. "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, including assignments for the benefit of creditors, formal or informal moratoria, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other similar relief. "Inventory" means all present and future inventory in which Borrower has any interest, including goods held for sale and all of Borrower's present and future raw materials, work in process, finished goods, and packing and shipping materials, wherever located, and any documents of title representing any of the above. "IRC" means the Internal Revenue Code of 1986, as amended, and the regulations thereunder. "Kinney" means Kinney Shoe Corporation, a New York corporation. "L/C" has the meaning set forth in Section 2.2(a). "L/C Guaranty" has the meaning set forth in Section 2.2(a). "Loan Documents" means this Agreement, the Lock Box Agreements, the Holtzman Continuing Guaranty and Security Agreement (Trademarks), subordination agreements with other holders of Indebtedness, any note or notes executed by Borrower and payable to -6-

12 Foothill, and any other agreement entered into by the parties hereto in connection with this Agreement. "Lock Box" has the meaning provided in the respective Lock Box Agreements. "Lock Box Agreements" means those certain Blocked Depository Account Agreements, in form and substance satisfactory to Foothill, each of which is among Borrower, Foothill, and one of the Lock Box Banks. "Lock Box Banks" means First Interstate Bank of California. "Maximum Amount" has the meaning set forth in Section 2.1. "Multiemployer Plan" means a multiemployer plan as defined in Sections 3(37) or 4001(a)(3) of ERISA or Section 414 of the IRC in which employees of Borrower or an ERISA Affiliate participate or to which Borrower or any ERISA Affiliate contribute or are required to contribute. "Negotiable Collateral" means all of Borrower's present and future letters of credit, notes, drafts, instruments, certificated and uncertificated securities (including the shares of stock of subsidiaries of Borrower), documents, personal property leases (wherein Borrower is the lessor) and chattel paper. "Obligations" means all loans, advances, debts, principal, interest (including any interest that, but for the provisions of the Bankruptcy Code, would have accrued), contingent reimbursement obligations owing to Foothill under any outstanding L/Cs or L/C Guarantees, premiums, liabilities (including all amounts charged to Borrower's loan account pursuant to any agreement authorizing Foothill to charge Borrower's loan account), obligations, fees (including Early Termination Premiums), guaranties, covenants, and duties owing by Borrower to Foothill of any kind and description (whether pursuant to or evidenced by the Loan Documents, by any note or other instrument, 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. "Overadvance" has the meaning set forth in Section 2.4. "PBGC" means the Pension Benefit Guaranty Corporation as defined in Title IV of ERISA, or any successor thereto. -7-

13 "Permitted Liens" means: (a) liens and security interests held by Foothill; (b) liens for unpaid taxes that are not yet due and payable; (c) liens and security interests set forth on Schedule P-1 attached hereto; (d) purchase money security interests and liens of lessors under leases to the extent that the acquisition or lease of the underlying asset was permitted under Section 7.10, and so long as the security interest or lien only secures the purchase price of the asset; (e) easements, rights of way, reservations, covenants, conditions, restrictions, zoning variances, and other similar encumbrances that do not materially interfere with the use or value of the property subject thereto; (f) obligations and duties as lessee under any lease existing on the date of this Agreement; and (g) mechanics', materialmen's, warehousemen's, or similar liens. "Person" means and includes natural persons, corporations, limited partnerships, general 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 an employee benefit plan (as defined in Section 3(3) of ERISA) which Borrower or any ERISA Affiliate sponsors or maintains or to which Borrower or any ERISA Affiliate makes, is making, or is obligated to make contributions, including any Multiemployer Plan or Qualified Plan. "Prohibited Transaction" means any transaction described in Section 406 of ERISA, which is not exempt by reason of Section 408 of ERISA, and any transaction described in Section 4975(c) of the IRC which is not exempt by reason of Section 4975(c) of the IRC. "Purchase Agreement" means that certain Purchase Agreement, dated as of February 3, 1995, among Borrower, Kinney and Woolworth, as amended from time to time. "Qualified Plan" means a pension plan (as defined in Section 3(2) of ERISA) intended to be tax-qualified under Section 401(a) of the IRC which Borrower or any ERISA Affiliate sponsors, maintains, or to which any such person makes, is making, or is obligated to make, contributions, or, in the case of a multiple-employer plan (as described in Section 4064(a) of ERISA), has made contributions at any time during the immediately preceding period covering at least five (5) plan years, but excluding any Multiemployer Plan. "Reference Rate" means the highest of the variable rates of interest, per annum, most recently announced by (a) Bank of America, N.T. & S.A., (b) Mellon Bank, N.A., or (c) Citibank, N.A., or any successor to any of the foregoing institutions, as its "prime rate" or "reference rate," as the case may be, irrespective of whether such announced rate is the best rate available from such financial institution. "Renewal Date" has the meaning set forth in Section 3.3. -8-

14 "Reportable Event" means any event described in Section 4043 (other than Subsections (b)(7) and (b)(9)) of ERISA. "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, and (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. 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. "Subordinated Indebtedness" means Indebtedness in the aggregate principal amount of Four Million Two Hundred Fifty Thousand Dollars ($4,250,000), evidenced by various Bridge-Notes, of even date herewith, in which Borrower is the maker. "Tangible Net Worth" means, as of the date any determination thereof is to be; made, the difference of: (a) Borrower's total stockholder's equity plus Subordinated Indebtedness and Indebtedness to Woolworth pursuant to the Purchase Agreement; minus (b) the sum of: (i) all intangible assets of Borrower; (ii) all of Borrower's prepaid expenses; and (iii) all amounts due to Borrower from Affiliates, calculated on a consolidated basis. "Unfunded Benefit Liability" means the excess of a Plan's benefit liabilities (as defined in Section 4001(a)(16) of ERISA) over the current value of such Plan's assets, determined in accordance with the assumptions used by the Plan's actuaries for funding the Plan pursuant to Section 412 of the IRC for the applicable plan year. "Voidable Transfer" has the meaning set forth in Section 15.8. "Woolworth" means Woolworth Corporation, a New York corporation. "Working Capital" means the result of subtracting Consolidated Current Liabilities from Consolidated Current Assets. 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. -9-

15 1.3 CODE. Any terms used in this Agreement which 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, and the term "including" is not limiting. 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. 2. LOAN AND TERMS OF PAYMENT. 2.1 REVOLVING ADVANCES. (a) Subject to the terms and conditions of this Agreement, Foothill agrees to make revolving advances to Borrower in an amount not to exceed the Borrowing Base. For purposes of this Agreement, "Borrowing Base" shall mean an amount equal to: (1) During the months of January through April and July, August and December of each year, the lower of: thirty percent (30%) of the retail selling price of Eligible Inventory or sixty percent (60%) of Borrower's Cost of Eligible Inventory, and (2) During the months of September through November and May and June of each year, the lower of: thirty five percent (35%) of the retail selling price of Eligible Inventory, or sixty five percent (65%) of Borrower's Cost of Eligible Inventory. (b) Anything to the contrary in Section 2.1 (a) above notwithstanding, Foothill may reduce its advance rates based upon Eligible Inventory without declaring an Event of Default if it determines, in its reasonable discretion, that there is a material impairment of the prospect of repayment of all or any portion of the Obligations or a material impairment of the value or priority of Foothill's security interests in the Collateral. (c) Foothill shall have no obligation to make advances hereunder to the extent they would cause the outstanding Obligations to exceed Twenty Million Dollars ($20,000,000) ("Maximum Amount"). -10-

16 (d) Foothill is authorized to make advances under this Agreement based upon telephonic or other instructions received from anyone purporting to be an Authorized Officer of Borrower, or without instructions if pursuant to Section 2.5(d). Borrower agrees to establish and maintain a single designated deposit account 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 such designated deposit account. 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 LETTERS OF CREDIT AND LETTER OF CREDIT GUARANTEES. (a) Subject to the terms and conditions of this Agreement, Foothill agrees to issue commercial or standby letters of credit for the account of Borrower (each, an "L/C") or to issue standby letters of credit or guarantees of payment (each such letter of credit or guaranty, an "L/C Guaranty") with respect to commercial or standby letters of credit issued by another Person for the account of Borrower. The aggregate face amount of such L/Cs, and L/C Guarantees cannot exceed Ten Million Dollars ($ 10,000,000), and the aggregate face amount of standby L/Cs and L/C Guarantees plus fifty percent (50%) of the aggregate face amount of commercial L/Cs or L/C Guarantees (which require delivery of finished Inventory as a drawing condition) cannot exceed the Borrowing Base less the amount of advances outstanding pursuant to Section 2.1. Borrower expressly understands and agrees that Foothill shall have no obligation to arrange for the issuance by other financial institutions of letters of credit that are to be the subject of L/C Guarantees. Borrower and Foothill acknowledge and agree that certain of the letters of credit that are to be the subject of L/C Guarantees may be outstanding on the Closing Date. Each such L/C (including those that are the subject of L/C Guarantees) shall have an expiry date no later than thirty (30) days prior to the date on which this Agreement is scheduled to terminate under Section 3.3 (without regard to any potential renewal term) and all such L/Cs and L/C Guarantees shall be in form and substance acceptable to Foothill in its sole discretion. Foothill shall not have any obligation to issue L/Cs or L/C Guarantees to the extent that the face amount of all outstanding L/Cs and L/C Guarantees, plus the amount of advances outstanding pursuant to Section 2.1, would exceed the Maximum Amount. The L/Cs and the L/C Guarantees issued under this Section 2.2 shall be used by Borrower, consistent with this Agreement, for its general working capital purposes or to support its obligations with respect to workers' compensation premiums or other similar obligations. If Foothill is obligated to advance funds under an L/C or L/C Guaranty, the amount so advanced immediately shall be deemed to be an advance made by Foothill to Borrower pursuant to Section 2.1 and, thereafter, shall bear interest at the rates then applicable under Section 2.5. (b) Borrower hereby agrees to indemnify, save, defend, and hold Foothill harmless from any loss, cost, expense, or liability, including payments made by Foothill, expenses, and reasonable attorneys fees incurred by Foothill arising out of or in connection with any L/Cs or L/C Guarantees except where such loss, cost, expense or liability results from -11-

17 Foothill's gross negligence or willful misconduct, as determined by a final, non-appealable order of a court of competent jurisdiction. Borrower agrees to be bound by the issuing bank's regulations and interpretations of any letters of credit guaranteed by Foothill and opened to or for Borrower's account or by Foothill's interpretations of any L/C issued by Foothill to or for Borrower's account, even though this interpretation may be different from Borrower's own, and Borrower understands and agrees that Foothill shall not be liable for any error, negligence, or mistakes, whether of omission or commission, in following Borrower's instructions or those contained in the L/Cs or any modifications, amendments, or supplements thereto. Borrower understands that the L/C Guarantees may require Foothill to indemnify the issuing bank for certain costs or liabilities arising out of claims by Borrower against such issuing bank. Borrower hereby agrees to indemnify, save, defend, and hold Foothill harmless with respect to any loss, cost, expense (including attorneys fees), or liability incurred by Foothill under any L/C Guaranty as a result of Foothill's indemnification of any such issuing bank. (c) Borrower hereby authorizes and directs any bank that issues a letter of credit guaranteed by Foothill to deliver to Foothill all instruments, documents; and other writings and property received by the issuing bank pursuant to the letter of credit, and to accept and rely upon Foothill's instructions and agreements with respect to all matters arising in connection with the letter of credit and the related application. Borrower may or may not be the "applicant" or "account party' with respect to such letter of credit. (d) Any and all service charges, commissions, fees (including an annual fee in the amount of not less than one percent (1%) per annum), and third party costs incurred by Foothill relating to the L/Cs guaranteed by Foothill shall be considered Foothill Expenses for purposes of this Agreement and immediately shall be reimbursable by Borrower to Foothill. On the first day of each month, Borrower will pay Foothill a fee equal to one percent (1.0%) per annum times the actual Daily Balance of the undrawn L/Cs and L/C Guarantees that were outstanding during the immediately preceding month. Service charges, commissions, fees, and third party costs may be charged to Borrower's loan account at the time the service is rendered or the cost is incurred. (e) Immediately upon the termination of this Agreement, Borrower agrees to either: (i) provide cash collateral to be held by Foothill in an amount equal to the maximum amount of Foothill's obligations under L/Cs plus the maximum amount of Foothill's obligations to any Person under outstanding L/C Guarantees, or (ii) cause to be delivered to Foothill releases of all of (Foothill's obligations under its outstanding L/Cs and L/C Guarantees. At Foothill's discretion, any proceeds of Collateral received by Foothill after the occurrence and during the continuation of an Event of Default may be held as the cash collateral required by this Section 2.2(e). All cash collateral held by Foothill shall be placed in an interest bearing account and shall be returned to Borrower by Foothill when the L/Cs and L/C Guarantees are no longer outstanding. 2.3 INTENTIONALLY OMITTED. -12-

18 2.4 OVERADVANCES. If, at any time or for any reason, the amount of Obligations owed by Borrower to Foothill pursuant to Sections 2.1 and 2-2 is greater than either the dollar or percentage limitations set forth in Sections 2.1 or 2.2 (an "Overadvance"), Borrower immediately shall pay to Foothill, in cash, the amount of such excess to be used by Foothill first, to repay noncontingent Obligations and, thereafter, to be held by Foothill as cash collateral to secure Borrower's obligation to repay Foothill for all amounts paid pursuant to L/Cs or L/C Guarantees which cash collateral shall be returned to Borrower by Foothill when the L/Cs and L/C Guarantees are no longer outstanding. 2.5 INTEREST: RATES, PAYMENTS, AND CALCULATIONS. (a) Interest Rate. All Obligations, except for undrawn L/Cs and L/C Guarantees, shall bear interest, on the actual Daily Balance, at a per annum rate of one and one-quarter (1.25) percentage points above the Reference Rate. (b) Default Rate. All Obligations, except for undrawn L/Cs and L/C Guarantees, shall bear interest, from and after the occurrence and during the continuance of an Event of Default, at a per annum rate equal to four and one-quarter (4.25) percentage points above the Reference Rate. From and after the occurrence and during the continuance of an Event of Default, the fee provided in Section 2.2(d) shall be increased to a fee equal to four percent (4.0%) per annum times the actual Daily Balance of the undrawn L/Cs and L/C Guarantees that were outstanding during the immediately preceding month. (c) Minimum Interest. In no event shall the rate of interest chargeable hereunder be less than seven and one-quarter percent (7.25%) per annum. 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. (d) Payments. Interest hereunder shall be due and payable on the first day of each month during the term hereof. Borrower hereby authorizes Foothill, at its option, without prior notice to Borrower, to charge such interest, all Foothill Expenses (as and when incurred), and all installments or other payments due under any note or other Loan Document to Borrower's loan account, which amounts shall thereafter accrue interest at the rate then applicable hereunder. Any interest not paid when due shall be compounded by becoming a part of the Obligations, and such interest shall thereafter accrue interest at the rate then applicable hereunder. (e) Computation. The Reference Rate as of this date is nine percent (9.0%) 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. The rates of interest charged hereunder shall be based upon the average Reference Rate in effect during the month. All interest and fees -13-

19 chargeable under the Loan Documents shall be computed on the basis of a three hundred sixty (360) day year for the actual number of days elapsed. (f) 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 this Agreement, intend to legally 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. 2.6 CREDITING PAYMENTS; APPLICATION OF COLLECTIONS. The receipt of any wire transfer of funds, check, or other item of payment by Foothill (whether from transfers to Foothill by the Lock Box Banks pursuant to the Lock Box Agreements or otherwise) immediately shall be applied to provisionally reduce the Obligations, but shall not be considered a payment on account unless such wire transfer is of immediately available federal funds and is made to the appropriate deposit account of Foothill or unless and until such check or other item of payment is honored when presented for payment. From and after the Closing Date, Foothill shall be entitled to charge Borrower for one (1) Business Day of 'clearance' at the applicable rates set forth in Sections 2.5(a) and 2.5(b) (applicable to advances under Section 2.1) on all collections, checks, wire transfers, or other items of payment that are received by Foothill (regardless of whether forwarded by the Lock Box Banks to Foothill, whether provisionally applied to reduce the Obligations, or otherwise). This across-the-board one (1) Business Day clearance charge on all receipts is acknowledged by the parties to constitute an integral aspect of the pricing of Foothill's facility to Borrower, and shall apply irrespective of the characterization of whether receipts are owned by Borrower or Foothill, and irrespective of the level of Borrower's Obligations to Foothill. Should any check or item of payment 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 wire transfer, check, or other item of payment shall be deemed received by Foothill only if it is received into Foothill's Operating Account (as such account is identified in the Lock Box Agreements) on or before 11:00 a.m. Los Angeles time. If any wire transfer, check, or other item of payment is received into Foothill's Operating Account (as such account is identified in the Lock Box Agreements) after 11:00 a.m. Los Angeles time it shall be deemed to have been received by Foothill as of the opening of business on the immediately following Business Day. 2.7 STATEMENTS OF OBLIGATIONS. Foothill shall render statements to Borrower of the Obligations, including principal, interest, fees, and including an itemization of all charges and expenses constituting Foothill Expenses owing, and such statements shall be conclusively -14-

20 presumed to be correct and accurate and constitute an account stated between Borrower and Foothill unless, within thirty (30) days after receipt thereof by Borrower, Borrower shall deliver to Foothill by telefacsimile, recognized overnight courier service, or registered or certified mail at its address specified in Section 12, written objection thereto describing the error or errors contained in any such statements. 2.8 FEES. Borrower shall pay to Foothill the following fees: (a) Closing Fee. A one time closing fee of Two Hundred Thousand Dollars ($200,000) which is earned, in full, on the Closing Date and is due and payable by Borrower to Foothill in connection with this Agreement on the Closing Date; (b) Unused Line Fee. On the first day of each month during the term of this Agreement, a fee in an amount equal to three eighths of one percent (.375%) per annum times the Average Unused Portion of the Maximum Amount; (c) Financial Examination, Documentation, and Appraisal Fees. Foothill's customary fee of Six Hundred Fifty Dollars ($650) per day per examiner, plus out-of-pocket expenses for each financial analysis and examination of Borrower performed by Foothill or its agents; Foothill's customary appraisal fee of One Thousand Five Hundred Dollars ($1,500) per day per appraiser, plus out-of-pocket expenses for each appraisal of the Collateral performed by Foothill or its agents. Prior to the occurrence of an Event of Default or Foothill deeming itself insecure, financial examinations will not be conducted more frequently than quarterly; and (d) Servicing Fee. On the first day of each month during the term of this Agreement, and thereafter so long as any Obligations are outstanding, a servicing fee in an amount equal to Four Thousand Dollars ($4,000) per month. 3. CONDITIONS; TERM OF AGREEMENT. 3.1 CONDITIONS PRECEDENT TO INITIAL ADVANCE, L/C, OR L/C GUARANTY, AND CONDITIONS SUBSEQUENT. The obligation of Foothill to make the initial advance or to provide the initial L/C or L/C Guaranty 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) the Closing Date shall occur on or before June 30, 1995; (b) Borrower shall have consummated the acquisition that is the subject of the Purchase Agreement; (c) Intentionally Omitted -15-

21 (d) Foothill shall have received each of the following documents, duly executed, and each such document shall be in full force and effect: i) Borrower hereby agrees to execute and deliver the Lock Box Agreements upon Foothill's request; ii) a Continuing Guaranty of the Obligations from Holtzman; iii) a Security Agreement (Trademarks) from Holtzman; and iv) a letter from Woolworth regarding its promissory note and Transitional Services, as defined in the Purchase Agreement. (e) Foothill shall have received a certificate from the Secretary of Borrower attesting to the resolutions of Borrower's Board of Directors authorizing its execution and delivery of this Agreement and the other Loan Documents to which Borrower is a party and authorizing specific officers of Borrower to execute same; (f) Foothill shall have received copies of Borrower's By-laws and Certificate of Incorporation, as amended, modified, or supplemented to the Closing Date, certified by the Secretary of Borrower; (g) Foothill shall have received a certificate of corporate status with respect to Borrower, dated within ten (10) days of the Closing Date, by the Secretary of State of the state of incorporation of Borrower, which certificate shall indicate that Borrower is in good standing in such state; (h) Borrower shall deliver to Foothill, within thirty (30) days of the Closing Date, certificates of corporate status with respect to Borrower, such certificates to be issued by the Secretary of State of the states in which its failure to be duly qualified or licensed would have a material adverse effect on the financial condition or properties and assets of Borrower, which certificates shall indicate that Borrower is in good standing; (i) Foothill shall have received the certified copies of the policies of insurance, together with the endorsements thereto, as are required by Section 6.12 hereof, the form and substance of which shall be satisfactory to Foothill and its counsel; (j) Foothill shall have received duly executed certificates of title with respect to that portion of the Collateral that is subject to certificates of title; (k) Foothill shall have received landlord waivers from the lessor of Borrower's distribution center in City of Industry, California; -16-

22 (l) Borrower shall have not less than One Million Five Hundred Thousand Dollars ($1,500,000) of cash or unused borrowing availability under this Agreement after payment of monies required to the paid on the Closing Date, net of any delinquencies on material obligations; (m) Borrower shall have not less than Three Million Dollars ($3,000,000) of Common Stock and Preferred Stock issued for cash, plus Subordinated Indebtedness in the principal amount of not less than Four Million Two Hundred Fifty Thousand Dollars ($4,250,000); (n) Foothill shall have received an opinion of Borrower's counsel in form and substance satisfactory to Foothill in its sole discretion; and (o) all other documents and legal matters in connection with the transactions contemplated by this Agreement shall have been delivered or executed or recorded and shall be in form and substance satisfactory to Foothill and its counsel. The following conditions must be satisfied by Borrower after the Closing Date: (a) Borrower shall use its best efforts to obtain landlord waivers for all locations in states in which landlords have rights of distraint for rent that would have priority over Foothill's security interest in any of the Collateral; and (b) Within twelve (12) months of the Closing Date, Borrower shall merge or consolidate with Frost Hanna, or Frost Hanna shall acquire all of Borrower's outstanding capital stock or assets in a transaction that is not taxable to Borrower, and immediately prior to such transaction, Frost Hanna's net worth shall be not less than Six Million Dollars ($6,000,000); and (c) Within sixty (60) days of the Closing Date, the Lock Box shall be in effect and Woolworth shall no longer have access to proceeds of store sales. 3.2 CONDITIONS PRECEDENT TO ALL ADVANCES, L/CS, OR L/C GUARANTEES. The following shall be conditions precedent to all advances, L/Cs, or L/C Guarantees 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, L/C, or L/C Guaranty, 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 -17-

23 date of such advance, L/C, or L/C Guaranty, nor shall either result from the making of the advance; and (c) no injunction, writ, restraining order, or other order of any nature prohibiting, directly or indirectly, the making of such advance or the issuance of such L/C or L/C Guaranty shall have been issued and remain in force by any governmental authority against Borrower, Foothill, or any of their Affiliates. 3.3 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 three (3) years from the Closing Date and automatically shall be renewed for successive one (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 anniversary of the Renewal Date by giving the other party at least sixty (60) days prior written notice by telefacsimile, recognized overnight courier service, or registered or certified mail, return receipt requested. 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. 3.4 EFFECT OF TERMINATION. On the date of termination, all Obligations(including contingent reimbursement obligations under any outstanding L/Cs or L/C Guarantees) 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 advances hereunder is terminated. If Borrower has sent a notice of termination pursuant to the provisions of Section 3.3, but fails to pay all Obligations 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 one (1) year. 3.5 EARLY TERMINATION BY BORROWER. The provisions of Section 3.3 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 sixty (60) days prior written notice to Foothill, to terminate this Agreement by paying to Foothill, in cash, the Obligations (including an amount equal to the full amount of the L/Cs or L/C Guarantees), together with a premium (the "Early Termination Premium") in an amount equal to (a) three percent (3.0%) of the Maximum Amount during the first year after the Closing Date, (b) two percent (2.0%) of the Maximum Amount during the second year after the Closing Date, and (c) one percent of the Maximum Amount during the third year after the Closing Date; provided, however, if Borrower terminates this Agreement as the result of Foothill's material breach hereunder, no Early Termination Premium need be paid. -18-

24 3.6 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 3.6 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 this Agreement or any other Loan Document to the contrary notwithstanding, and other than sales of Inventory to buyers in the ordinary course of business and sales of Equipment in the aggregate amount of up of Fifty Thousand Dollars ($50,000) in any fiscal year, 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 shall, immediately upon the request of Foothill, endorse and assign such Negotiable Collateral to Foothill and deliver physical possession of such Negotiable Collateral to Foothill. 4.3 COLLECTION OF ACCOUNTS, GENERAL INTANGIBLES, NEGOTIABLE COLLATERAL. Foothill, Borrower, and the Lock Box Banks shall enter into the Lock Box Agreements, in form and substance satisfactory to Foothill in its sole discretion, pursuant to which all of Borrower's cash receipts, checks, and other items of payment (including, insurance proceeds, proceeds of cash sales, rental proceeds, and tax refunds) will be forwarded to Foothill on a daily basis. At any time, Foothill or Foothill's designee may: (a) at any time that an Event of Default has occurred and is continuing or Foothill deems itself insecure (in accordance with Section 1208 of the Code), 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 Borrower's loan account. Borrower agrees that it will hold in trust for Foothill, as Foothill's trustee, any cash receipts, checks, and other items of payment (including, insurance proceeds, proceeds of cash sales, rental proceeds, and tax refunds) that it receives and immediately will deliver said cash receipts, checks, and other items of payment to Foothill in their original form as received by Borrower. -19-

25 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, chattel mortgages, 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 may reasonably 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. 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 (in accordance with Section 1208 of the Code), 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 checks, notices, acceptances, money orders, drafts, or other item of payment or security that may come into Foothill's possession; (e) at any time that an Event of Default has occurred and is continuing or Foothill deems itself insecure (in accordance with Section 1208 of the Code), 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 (in accordance with Section 1208 of the Code), 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 (in accordance with Section 1208 of the Code), settle and adjust disputes and claims respecting the Accounts directly with Account Debtors, for amounts and upon terms which Foothill determines to be reasonable, and Foothill may cause to be executed and delivered any documents and releases which 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, during normal business hours, 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. -20-

26 5. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Foothill as follows: 5.1 NO PRIOR ENCUMBRANCES. Borrower has good and marketable title to the Collateral, free and clear of liens, claims, security interests, or encumbrances, except for Permitted Liens. 5.2 INTENTIONALLY OMITTED. 5.3 ELIGIBLE INVENTORY. All Eligible Inventory is now and at all times hereafter shall be of good and merchantable quality, free from defects. 5.4 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 6.15, in transit, or as otherwise permitted by Section 6.15. 5.5 INVENTORY RECORDS. Borrower now keeps, and hereafter at all times shall keep, correct and accurate records itemizing and describing the kind, type, quality, and quantity of the Inventory, and Borrower's cost therefor in accordance with the retail method of accounting. 5.6 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 11-3264797. 5.7 DUE ORGANIZATION AND QUALIFICATION. Borrower is duly organized and existing and in good standing under the laws of the state of its incorporation and, within ten (10) days of the date hereof, will be qualified and licensed to do business in, and in good standing in, any state where the failure to be so licensed or qualified could reasonably be expected to have a material adverse effect on the business, operations, condition (financial or otherwise), finances, or prospects of Borrower or on the value of the Collateral to Foothill. 5.8 DUE AUTHORIZATION; NO CONFLICT. The execution, delivery, and performance of the Loan Documents are within Borrower's corporate powers, have been duly authorized, and are not in conflict with nor constitute a breach of any provision contained in Borrower's Articles of Incorporation, or By-laws, nor will they constitute an event of default under any material agreement to which Borrower is a party or by which its properties or assets may be bound. 5.9 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, -21-

27 complaints, actions, or prosecutions involving Borrower or any guarantor of the Obligations; except for: (a) ongoing collection matters in which Borrower is the plaintiff; (b) matters disclosed on Schedule 5.9; and (c) matters arising after the date hereof that, if decided adversely to Borrower, would not materially impair the prospect of repayment of the Obligations or materially impair the value or priority of Foothill's security interests in the Collateral. 5.10 NO MATERIAL ADVERSE CHANGE IN FINANCIAL CONDITION. 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 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, except that Borrower's fiscal year 1995 financial statements do not include the type of notes that would customarily be included in a financial statement prepared in accordance with GAAP, and interim financial statements do not reflect normal, non-material, year-end audit adjustments. There has not been a material adverse change in the financial condition of Borrower (or such guarantor, as applicable) since the date of the latest financial statements submitted to Foothill on or before the Closing Date. 5.11 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. Borrower is not engaged in a business or transaction, and is not about to engage in business or a transaction, for which Borrower's properties and assets would constitute unreasonably small capital after giving due consideration to the prevailing practices the industry in which Borrower is engaged. 5.12 EMPLOYEE BENEFITS. Each Plan is in compliance in all material respects with the applicable provisions of ERISA and the IRC. Each Qualified Plan and Multiemployer Plan has been determined by the Internal Revenue Service to qualify under Section 401 of the IRC, and the trusts created thereunder have been determined to be exempt from tax under Section 501 of the IRC, and, to the best knowledge of Borrower, nothing has occurred that would cause the loss of such qualification or tax-exempt status. There are no outstanding liabilities under Tide IV of ERISA with respect to any Plan maintained or sponsored by Borrower or any ERISA Affiliate, nor with respect to any Plan to which Borrower or any ERISA Affiliate contributes or is obligated to contribute which could reasonably be expected to have a material adverse effect on the financial condition of Borrower. No Plan subject to Title IV of ERISA has any Unfunded Benefit Liability which could reasonably be expected to have a material adverse effect on the financial condition of Borrower. Neither Borrower nor any ERISA Affiliate has transferred any Unfunded Benefit Liability to a person other than Borrower or an ERISA Affiliate or has otherwise engaged in a transaction that could be subject to Sections 4069 or 4212(c) of ERISA which could reasonably be expected to have a material adverse effect on the financial condition of Borrower. Neither Borrower nor any ERISA Affiliate has incurred nor reasonably expects to incur (x) any liability (and no event has occurred which, with the giving of notice under Section 4219 of ERISA, would result in such liability) under Sections 4201 or 4243 of ERISA with respect to a Multiemployer -22-

28 Plan, or (y) any liability under Title IV of ERISA (other than premiums due but not delinquent under Section 4007 of ERISA) with respect to a Plan, which could, in either event, reasonably be expected to have a material adverse effect on the financial condition of Borrower. No application for a funding waiver or an extension of any amortization period pursuant to Section 412 of the IRC has been made with respect to any Plan. No ERISA Event has occurred or is reasonably expected to occur with respect to any Plan which could reasonably be expected to have a material adverse effect on the financial condition of Borrower. Borrower and each ERISA Affiliate have complied in all material respects with the notice and continuation coverage requirements of Section 4980B of the IRC. 5.13 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 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; provided, however that the Borrower has been advised by certain landlords of its retail stores that such stores contain asbestos. 5.14 RELIANCE BY FOOTHILL; CUMULATIVE. Each warranty and representation contained in this Agreement automatically shall be deemed repeated with each advance or issuance of an L/C or L/C Guaranty and shall be conclusively presumed to have been relied on by Foothill regardless of any investigation made or information possessed by Foothill. The warranties and representations set forth herein shall be cumulative and in addition to any and all other warranties and representations that Borrower now or hereafter shall give, or cause to be given, to Foothill. 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. Borrower shall maintain a standard and modern system of accounting in accordance with GAAP with ledger and account cards or computer tapes, discs, printouts, and records pertaining to the Collateral which contain information as from time to time may reasonably be requested by Foothill. Borrower also shall keep proper books of account showing all sales, claims, and allowances on its Inventory. -23-

29 6.2 COLLATERAL REPORTS. Borrower shall deliver to Foothill, no later than the fifteen (15th) day of each month during the term of this Agreement, a detailed aging, by total, of the Accounts, a reconciliation statement, and a summary aging, by vendor, of all accounts payable and any book overdraft. Borrower shall deliver to Foothill, as Foothill may from time to time require, copies of collection reports, sales journals, invoices, original delivery receipts, customer's purchase orders, shipping instructions, bills of lading, and other documentation respecting shipment arrangements. Absent such a request by Foothill, copies of all such documentation shall be held by Borrower as custodian for Foothill. 6.3 SCHEDULES OF ACCOUNTS. With such regularity as Foothill shall require, Borrower shall provide Foothill with schedules describing all Accounts. Foothill's failure to request such schedules or Borrower's failure to execute and deliver such schedules shall not affect or limit Foothill's security interests or other rights in and to the Accounts. 6.4 FINANCIAL STATEMENTS, REPORTS, CERTIFICATES. Borrower agrees to deliver to Foothill: (a) as soon as available, but in any event within thirty (30) days after the end of each month during each of Borrower's fiscal years (and forty-five (45) days after the end of each fiscal quarter), a company prepared balance sheet, income statement, and cash flow statement covering Borrower's operations during such period; and (b) as soon as available, but in any event within ninety (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, 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 event or condition constituting an Event of Default, or that would, with the passage of time or the giving of notice, constitute an Event of Default. Such audited financial statements shall include a balance sheet, profit and loss statement, and cash flow statement, 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 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 Securities and Exchange Commission, 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 Collateral and financial condition of Borrower. Each month, together with the financial statements provided pursuant to Section 6.4(a), Borrower shall deliver to Foothill a certificate signed by its chief financial officer or chief executive officer to the effect that: (i) all reports, statements, or computer prepared -24-

30 information of any kind or nature delivered or caused to be delivered to Foothill hereunder have been prepared in accordance with GAAP and fairly present the financial condition of Borrower; (ii) Borrower is in timely compliance with all of its covenants and agreements hereunder; (iii) 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); and (iv) on the date of delivery of such certificate to Foothill there does not exist any condition or event that constitutes an Event of Default (or, in each case, 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 (other than attorneys) 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 and financial condition. 6.5 TAX RETURNS. Borrower agrees to deliver to Foothill copies of each of Borrower's future federal income tax returns, and any amendments thereto, within thirty (30) days of the filing thereof with the Internal Revenue Service. 6.6 GUARANTOR REPORTS. Borrower agrees to cause any guarantor of any of the Obligations to deliver its annual financial statements at the time when Borrower provides its audited financial statements to Foothill and copies of all federal income tax returns as soon as the same are available and in any event no later than thirty (30) days after the same are required to be filed by law. 6.7 DESIGNATION OF INVENTORY. Borrower shall now and from time to time hereafter, but not less frequently than weekly, execute and deliver to Foothill a designation of Inventory specifying the retail selling price of Borrower's Inventory and Borrower's Cost, and an aging of Borrower's Inventory and further specifying such other information as Foothill may reasonably request. Borrower will not include Inventory in transit in its Inventory reports until such Inventory has been paid for by draws under applicable letters of credit or has been acquired by Borrower without letter of credit financing. 6.8 STORE OPENINGS AND CLOSINGS AND RENT REPORTS. Borrower shall give Foothill reasonable prior notice of new store openings and closing of its stores. Except where Borrower is disputing its rent obligation in good faith, Borrower shall make timely payment of all rents on real property leases where Borrower is the lessee within applicable grace periods, and -25-

31 shall provide Foothill with a monthly report specifying the status of such payments. In the event that Borrower becomes delinquent in its rent payments, then Foothill can establish reserves against the Borrowing Base for the amount of any landlord liens arising from such delinquency. 6.9 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. 6.10 MAINTENANCE OF EQUIPMENT. Borrower shall keep and 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. Borrower shall not, knowingly or willingly, permit any item of Equipment to become a fixture to real estate or an accession to other property, and the Equipment is now and shall at all times remain personal property. 6.11 TAXES. Except where the assessment or tax is being disputed by Borrower in good faith, 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 have been paid, and shall hereafter be paid in full, before delinquency or before the expiration of any extension period. Borrower shall make due and timely payment or deposit of all federal, state, and local taxes, assessments, or contributions required of it by law, 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. 6.12 INSURANCE. (a) Borrower, at its expense, shall 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. (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 such policies of insurance (except those of public liability and property damage) shall contain a 438BFU lender's loss payable endorsement, or an equivalent endorsement in a form satisfactory to Foothill, showing Foothill as sole loss payee thereof, and shall contain a waiver of warranties, and shall specify that the insurer must give at least ten (10) days prior written notice to Foothill before canceling its policy for any reason. Borrower shall deliver to Foothill certified copies of such -26-

32 policies of insurance and evidence of the payment of all premiums therefor. All proceeds payable under any such policy relating to Collateral shall be payable to Foothill to be applied on account of the Obligations. 6.13 FINANCIAL COVENANTS. Borrower shall maintain: (a) Current Ratio. A ratio of Consolidated Current Assets divided by Consolidated Current Liabilities of at least eighty five one hundredths to one (0.85:1.0), measured on a fiscal quarter-end basis; (b) Total Liabilities to Tangible Net Worth Ratio. A ratio of Borrower's total liabilities (other than the Subordinated Indebtedness and Indebtedness to Woolworth pursuant to the Purchase Agreement) divided by Tangible Net Worth of not more than four and eight tenths to one (4.8:1.0), measured on a fiscal quarter-end basis at all times prior to Borrower's combination with Frost Hanna, and a ratio of not more than three and four tenths to one (3.4:1.0) thereafter; (c) Tangible Net Worth. Tangible Net Worth of at least Three Million Two Hundred Thousand Dollars ($3,200,000), measured on a fiscal quarter-end basis at all times prior to Borrower's combination with Frost Hanna, and at least Five Million Nine Hundred Thousand Dollars ($5,900,000) thereafter; and (d) Working Capital. Working Capital of not less than negative Four Million Three Hundred Thousand Dollars (-$4,300,000), measured on a fiscal quarter-end basis at all times prior to Borrower's combination with Frost Hanna, and not less than a negative Two Million Nine Hundred Thousand Dollars (-$2,900,000) thereafter. 6.14 NO SETOFFS OR COUNTERCLAIMS. All payments hereunder and under the other Loan Documents made by or on behalf of Borrower shall be made 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. 6.15 LOCATION OF INVENTORY AND EQUIPMENT. Borrower shall keep the Inventory and Equipment only at the locations identified on Schedule 6.15; provided, however, that Borrower may amend Schedule 6.15 so long as such amendment occurs by written notice to Foothill not less than thirty (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 landlord's waiver in form and substance satisfactory to Foothill. -27-

33 6.16 COMPLIANCE WITH LAWS. Borrower shall 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 have and could not reasonably be expected to have a material adverse effect on the business, operations, condition (financial or otherwise), finances, or prospects of Borrower or on the value of the Collateral to Foothill. 6.17 EMPLOYEE BENEFITS. (a) Borrower shall deliver to Foothill a written statement by the chief financial officer or chief executive officer of Borrower specifying the nature of any of the following events and the actions which Borrower proposes to take with respect thereto promptly, and in any event within ten (10) days of becoming aware of any of them, and when known, any action taken or threatened by the Internal Revenue Service, PBGC, Department of Labor, or other party with respect thereto: (i) an ERISA Event with respect to any Plan; (ii) the incurrence of an obligation to pay additional premium to the PBGC under Section 4006(a)(3)(E) of ERISA with respect to any Plan; and (iii) any lien on the assets of Borrower arising in connection with any Plan. (b) Borrower shall also promptly furnish to Foothill copies prepared or received by Borrower or an ERISA Affiliate of: (i) at the request of Foothill, each annual report (Internal Revenue Service Form 5500 series) and all accompanying schedules, actuarial reports, financial information concerning the financial status of each Plan, and schedules showing the amounts contributed to each Plan by or on behalf of Borrower or its ERISA Affiliates for the most recent three (3) plan years; (ii) all notices of intent to terminate or to have a trustee appointed to administer any Plan; (iii) all written demands by the PBGC under Subtitle D of Title IV of ERISA; (iv) all notices required to be sent to employees or to the PBGC under Section 302 of ERISA or Section 412 of the IRC; (v) all written notices received with respect to a Multiemployer Plan concerning (x) the imposition or amount of withdrawal liability pursuant to Section 4202 of ERISA, (y) a termination described in Section 4041A of ERISA, or (z) a reorganization or insolvency described in Subtitle E of Title IV of ERISA; (vi) the adoption of any new Plan that is subject to Title IV of ERISA or Section 412 of the IRC by Borrower or any ERISA Affiliate; (vii) the adoption of any amendment to any Plan that is subject to Title IV of ERISA or Section 412 of the IRC, if such amendment results in a material increase in benefits or Unfunded Benefit Liability; or (viii) the commencement of contributions by Borrower or any ERISA Affiliate to any Plan that is subject to Title IV of ERISA or Section 412 of the IRC. 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: -28-

34 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 the latest financial statements of Borrower submitted to Foothill on or prior to the Closing Date; (c) Indebtedness secured by Permitted Liens; (d) Indebtedness owed to Woolworth pursuant to the Purchase Agreement; (e) Indebtedness incurred for remodeling of stores; (f) The Subordinated Indebtedness; and (g) refinancings, renewals, or extensions of Indebtedness permitted under clauses (b), (c), (e) and (f) 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 secure only those assets or property that secured the original Indebtedness). 7.3 RESTRICTIONS ON FUNDAMENTAL CHANGES. Except for a merger or consolidation with Frost Hanna, or the acquisition of Borrower's outstanding capital stock or assets by Frost Hanna in a transaction that is tax free to Borrower, enter into any acquisition, merger, consolidation, reorganization, or recapitalization, or reclassify its capital 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 business, property, or assets, whether now owned or hereafter -29-

35 acquired, or acquire by purchase or otherwise all or substantially all of the properties, assets, stock, or other evidence of beneficial ownership of any Person. 7.4 EXTRAORDINARY TRANSACTIONS AND DISPOSAL OF ASSETS. Enter into any transaction not in the ordinary and usual course of Borrower's business, including the sale, lease, or other disposition of, moving, relocation, or transfer, whether by sale or otherwise, of any of Borrower's properties or assets (other than sales of Inventory to buyers in the ordinary course of Borrower's business as currently conducted). 7.5 CHANGE NAME. Change Borrower's name without giving Foothill at least thirty (30) days prior written notice, or change its FEIN, business structure, or identity, or add any new fictitious name. 7.6 GUARANTEE. Guarantee or otherwise become in any way liable with respect to the obligations of any third Person except by endorsement or instruments or items of payment for deposit to the account of Borrower or which are transmitted or turned over to Foothill. 7.7 RESTRUCTURE. Except for a merger or consolidation with Frost Hanna, make any change in the principal nature of Borrower's business operations, or the date of its fiscal year. 7.8 PREPAYMENTS AND AMENDMENTS. Prepay any Indebtedness owing to any third Person, except: (a) in connection with a refinancing permitted by Section 7.1(d), (b) repayment of the Subordinated Indebtedness from proceeds of an equity investment, or (c) payments to Woolworth, in accordance with the Purchase Agreement, from Excess Cash Flow, as determined based upon Borrower's year end audited financial statements; or amend any of the terms of the Subordinated Indebtedness. 7.9 CHANGE OF CONTROL. Cause, permit, or suffer, directly or indirectly, any Change of Control except for a merger or consolidation with, or sale of Borrower's outstanding capital stock to Frost Hanna. 7.10 CAPITAL EXPENDITURES. Make any capital expenditure, or any commitment therefor, where the aggregate amount of such capital expenditures, made or committed for in the fiscal year ending January 31, 1996, is in excess of Two Million Five Hundred Thousand Dollars ($2,500,000), or in any subsequent fiscal years is in excess of Three Million Five Hundred Thousand Dollars ($3,500,000). 7.11 CONSIGNMENTS. Consign any Inventory or sell any Inventory on bill and hold, sale or return, sale on approval, or other conditional terms of sale. 7.12 DISTRIBUTIONS. Make any distribution or declare or pay any dividends (in cash or in stock) on, or purchase, acquire, redeem, or retire any of Borrower's capital stock, of any class, whether now or hereafter outstanding. -30-

36 7.13 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 Agreement, and agrees that Foothill may contact directly any such accounting firm or service bureau in order to obtain such information if it is not provided to Foothill by Borrower promptly after a request by Foothill. 7.14 INVESTMENTS. Directly or indirectly make or acquire any beneficial interest in (including stock, partnership interest, or other securities of), or (except for employee loans and advances in an aggregate amount outstanding at any one time not to exceed One Hundred Thousand Dollars ($100,000)) make any loan, advance, or capital contribution to, any Person. 7.15 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, and that are no less favorable to Borrower than would be obtained in arm's length transaction with a non-affiliate. 7.16 SUSPENSION. Suspend or go out of a substantial portion of its business. 7.17 COMPENSATION. Increase the annual fee or per-meeting fees paid to directors during any year by more than fifteen percent (15%) over the prior year; pay or accrue total cash compensation, during any year, to officers and senior management employees in an aggregate amount in excess of the amount set forth in the schedule provided to Foothill by Borrower for Borrower's current fiscal year, or in excess of one hundred fifteen percent (115%) of that paid or accrued in the prior year for all subsequent fiscal years. 7.18 USE OF PROCEEDS. Use the proceeds of the advances made hereunder for any purpose other than: (a) on the Closing Date, to pay or portion of the purchase price to Kinney and Woolworth pursuant to the Purchase Agreement; (b) to pay transactional fees, costs and expenses incurred in connection with this Agreement; and (c) thereafter, consistent with the terms and conditions hereof, for its lawful and permitted corporate purposes. 7.19 CHANGE IN LOCATION OF CHIEF EXECUTIVE OFFICE; INVENTORY AND EQUIPMENT WITH BAILEES. Borrower covenants and agrees that it will not, without thirty (30) days prior written notification to Foothill, relocate its chief executive office to a new location 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 landlord's waiver in form and substance satisfactory to Foothill. The -31-

37 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. 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); 8.2 If Borrower fails or neglects to perform, keep, or observe any term, provision, condition, covenant, or agreement contained in this Agreement, in any of the Loan Documents, or in any other present or future agreement between Borrower and Foothill; provided, however, that Borrower's failure or neglect to comply with Sections 6.2 through 6.7, Sections 6.9, 6.11, and 6.17 shall not constitute an Event of Default hereunder unless such failure or neglect continues for ten (10) days or more; 8.3 If there is a material impairment of the prospect of repayment of any portion of the Obligations owing to Foothill or a material impairment of the value or priority of Foothill's security interests in the Collateral; 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 forty-five (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 make additional advances or issue additional L/Cs or L/C Guarantees 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 of entered therein; -32-

38 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; 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 and the aggregate amount of such liens exceeds One Hundred Thousand Dollars ($100,000) at any one time, which amount shall be fully reserved under the Foothill credit facilities; 8.9 If a judgment or other claim becomes a lien or encumbrance upon any material portion of Borrower's properties or assets and the same is not satisfied or released within thirty (30) days thereafter; 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 third Persons either accelerate the maturity of Borrower's obligations thereunder or such default results in a right by such third Persons, irrespective of whether exercised, to accelerate the maturity of Borrower's obligations thereunder, which right continues for more than thirty (30) days; 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; 8.13 If the obligation of any guarantor 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; or 8.14 If (a) with respect to any Plan, there shall occur any of the following which could reasonably be expected to have a material adverse effect on the financial condition of Borrower: (i) the violation of any of the provisions of ERISA; (ii) the loss by a Plan intended to be a Qualified Plan of its qualification under Section 401(a) of the IRC; (iii) the incurrence of liability under Title IV of ERISA, (iv) a failure to make full payment when due of all amounts which, under the provisions of any Plan or applicable law, Borrower or any ERISA Affiliate is required to make; (v) the filing of a notice of intent to terminate a Plan under Sections 4041 or -33-

39 4041A of ERISA, (vi) a complete or partial withdrawal of Borrower or an ERISA Affiliate from any Plan; (vii) the receipt of a notice by the plan administrator of a Plan that the PBGC has instituted proceedings to terminate such Plan or appoint a trustee to administer such Plan; (viii) a commencement or increase of contributions to, or the adoption of or the amendment of, a Plan; and (ix) the assessment against Borrower or any ERISA Affiliate of a tax under Section 4980B of the IRC; or (b) the Unfunded Benefit Liability of all of the Plans of Borrower and its ERISA Affiliates shall, in the aggregate, exceed One Hundred Dollars ($100). 9. FOOTHILL'S RIGHTS AND REMEDIES. 9.1 RIGHTS AND REMEDIES. Upon the occurrence 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; (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) Intentionally Omitted. (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 premises, Borrower hereby grants Foothill a license to enter into possession of such premises and -34-

40 to occupy the same, without charge, for up to one hundred twenty (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 Lock Boxes), or (ii) indebtedness at any time owing to or for the credit or the account of Borrower held by Foothill; (h) Hold, as cash collateral, any and all balances and deposits of Borrower held by Foothill, and any amounts received in the Lock Boxes, 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 five (5) days before the date fixed for the sale, or at least five (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; -35-

41 (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 five (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 (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 REGARDING THE COLLATERAL. If Borrower fails to pay any monies (whether taxes, rents, assessments, insurance, premiums, or otherwise) 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 have a material adverse effect on Foothill's interests in the Collateral, even if Borrower is disputing such payment obligation in good faith, 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 6.12, 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, security interest, encumbrance, 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 owning. 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, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees at any tune held by Foothill on which Borrower may in any way be liable. -36-

42 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 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 agrees to defend, indemnify, save, and hold Foothill and its officers, employees, and agents harmless against: (a) all obligations, demands, claims, and liabilities claimed or asserted by any other Person arising out of or relating to the transactions contemplated by this Agreement or any other Loan Document, and (b) all losses (including attorneys fees and disbursements) in any way suffered, incurred, or paid by Foothill as a result of or in any way arising out of, following, or consequential to the transactions contemplated by this Agreement or any other Loan Document, but excluding any such obligations, demands, claims, liabilities and losses directly caused or incurred by reason of the gross negligence or willful misconduct of the Person otherwise to be indemnified and held harmless under this Section 11.3, as determined by a final, non-appealable order of a court of competent jurisdiction. This provision shall survive the termination of this Agreement. 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, or by recognized overnight courier service, or by telefacsimile, to Borrower or to Foothill, as the case may be, at its address set forth below: If to Borrower: LFS ACQUISITION CORP. 801 Sentous Avenue City of Industry, California 91784 Attn.: Bernard Tessier, Chief Executive Officer Telefacsimile No. (818) 854-3127 If to Foothill: FOOTHILL CAPITAL CORPORATION 11111 Santa Monica Boulevard Suite 1500 Los Angeles, California 90025-3333 Attn.: Business Finance Division Manager Telefacsimile No. (310) 479-2690 -37-

43 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 three (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 transmitted by telefacsimile or other similar method set forth above. 13. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER. THE VALIDITY OF THIS AGREEMENT, ITS CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT, AND THE RIGHTS OF THE PARTIES HERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR RELATED HERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA, WITHOUT GIVING EFFECT TO ITS CONFLICT OF LAWS PRINCIPLES. THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS AGREEMENT 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 BELIEVES THAT LEGAL OR EQUITABLE PROCEEDINGS ARE REQUIRED TO PROTECT OR ENFORCE ITS RIGHTS HEREUNDER 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. BORROWER AND FOOTHILL REPRESENT THAT EACH 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. -38-

44 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 four (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 Obligations unless such consent specifically provides that Borrower shall be released. 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 shall thereafter 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. -39-

45 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 a manually executed counterpart of this Agreement. Any party delivering an executed counterpart of this Agreement by telefacsimile also shall deliver a manually executed counterpart of this Agreement but the failure to deliver a manually 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 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, reflect the entire understanding of the parties with respect to the transactions contemplated hereby -40-

46 and shall not be contradicted or qualified by any other agreement, oral or written, before the date hereof. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed and delivered. FOOTHILL CAPITAL CORPORATION, a California corporation By /s/ PATRICIA McLOUGHLIN --------------------------------- Patricia McLoughlin, Vice President LFS ACQUISITION CORP. a Delaware corporation By /s/ BERNARD TESSLER --------------------------------- Bernard Tessler, President -41-

47 SCHEDULE 5.9 LITIGATION NONE

48 SCHEDULE P-1 PERMITTED LIENS NONE

49 SCHEDULE E-1 ELIGIBLE INVENTORY AND SCHEDULE 6.15 LOCATION OF INVENTORY AND EQUIPMENT <TABLE> <CAPTION> ZIP RM DM STORE #3 CENTER ADDRESS CITY STATE CODE TELEPHONE <S> <C> <C> <C> <C> <C> <C> <C> <C> 52 333 12025 Atlantic Square 2130 S. Atlantic Blvd. Monterey Park CA 91754 (213) 721-2766 52 334 12026 Music Plus Plaza 9160 Foothill Blvd. Rancho Cucamonga CA 91730 (909) 989-9444 52 333 12027 Five Points 11964 Garvey Ave. El Monte CA 91732 (818) 444-0489 51 326 12029 Sycamore Square 2837 Cochran, E Simi Valley CA 93065 (805) 581-1062 52 333 12031 Foothill Shopping Center 868 Alosta Ave. Azusa CA 91702 (818) 334-7504 52 334 12035 Wild West Center 854 Jackman St. El Cajon CA 92020 (619) 447-2559 51 326 12038 Reseda Shopping Center 18207 Sherman Way Reseda CA 91335 (818) 708-3803 52 339 12041 Park Plaza Center 862 N. Western Ave. San Pedro CA 90732 (310) 831-3330 51 326 12042 Northridge Plaza 8750 Corbin Avenue Northridge CA 91324 (818) 886-1255 52 339 12043 Lakewood Plaza 6269 E. Spring St. Long Beach CA 90808 (310) 421-6126 52 337 12044 Lake Forest 23819 El Toro Rd., #8 Lake Forest CA 92630 (714) 855-8244 51 337 12045 Encinitas Village 111 N. El Camino Real Encinitas CA 92024 (619) 942-9811 51 326 12046 Park Oaks Center 1754-A Moorpark Rd. Thousand Oaks CA 91360 (805) 497-0677 52 336 12047 Chino Towne Center 12131 Central Ave. Chino CA 91710 (909) 627-0290 52 332 12048 Foothill/Rosemead 3615 Foothill Blvd. Pasadena CA 91107 (818) 351-0777 52 334 12049 Central City Mall 677 2nd St. San Bernardino CA 91408 (909) 889-6285 52 333 12053 North Downey 9216 Lakewood Blvd. Downey CA 90240 (310) 861-1828 52 336 12054 Brookhurst Center 929 S. Brookhurst Anaheim CA 92804 (714) 533-7611 52 332 12055 Cornell Plaza 1121 San Fernando Rd. Burbank CA 91504 (818) 848-6314 52 336 12056 Arlington Square 4060 Madison Ave. Riverside CA 92504 (909) 688-3203 52 336 12059 Chapman/Main 1421 West Chapman Ave. Orange CA 92668 (714) 978-7119 52 337 12060 La Mesa Springs 8036 La Mesa Blvd. La Mesa CA 92041 (619) 462-7388 52 337 12061 Clairmont Square 4735 Clairmont Sq., A San Diego CA 92117 (619) 270-4253 52 333 12062 Alhambra Valley Center 904 E. Valley Blvd. Alhambra CA 91801 (818) 289-8684 52 332 12063 Granary Square Center 25870 McBean Parkway Valencia CA 91355 (805) 255-8096 52 337 12064 El Camino N. Center 2455-K Vista Way Oceanside CA 92054 (619) 439-0966 52 339 12066 Carson/Main Center 166 E. Carson St. Carson CA 90745 (310) 549-3105 51 326 12067 Santa Maria Plaza 230 E. Betteravia Rd., M Santa Maria CA 93454 (805) 928-7331 52 336 12068 Norwalk Town Center 11713 Rosecrans Ave. Norwalk CA 90650 (310) 929-6322 52 339 12070 Culver City 3872 Midway Culver City CA 90230 (310) 837-8040 51 326 12072 Telephone Road 4744 Telephone Rd., #6 Ventura CA 93003 (805) 644-5909 52 334 12074 Hemet Valley 3485 W. Florida Ave. Hemet CA 92543 (909) 929-3335 52 336 12075 Fullerton 3208 E. Yorba Linda Blvd. Fullerton CA 92631 (714) 996-9072 52 332 12079 Eagle Rock Plaza 2700 Colorado Blvd. Los Angeles CA 90041 (213) 259-8545 51 321 12084 Silver Creek 1783 E. Capitol Expressway San Jose CA 95121 (408) 274-6593 51 324 12085 Vineyard Center 740 W. Kettleman Lane Lodi CA 95240 (209) 368-5023 51 324 12086 Mineral King 4239 Mineral King Hwy. Visalia CA 90321 (209) 739-1351 51 324 12087 College Square 967 N. March Lane Stockton CA 95207 (209) 951-7224 51 324 12088 Stockdale Village 5550 Stockdale Hwy. Bakersfield CA 93309 (805) 322-0221 51 322 12089 Santa Rosa 3575 Industrial Dr. Santa Rosa CA 95401 (707) 526-7848 51 321 12092 Westgate Mall 1600 Saratoga Ave., #505 San Jose CA 95129 (408) 374-2213 51 323 12093 Crestview Village 4754 Manzanita Ave. Carmichael CA 95608 (916) 972-7631 51 324 12094 Mervyn's Center 2801 McHenry Blvd. Modesto CA 95350 (209) 524-4680 51 321 12095 Westlake Mall 37 Westlake Mall Daly City CA 94015 (415) 755-1555 51 321 12097 Northridge Center 1376 Northridge Center Salinas CA 93906 (408) 449-9401 51 322 12099 Dublin Place 6948 Amador Plaza Road Dublin CA 94566 (510) 829-5767 51 324 12102 Olivewood Center 1366 W. Olive Ave. Merced CA 95340 (209) 722-5159 51 326 12103 Madonna Plaza 269 Madonna Road San Luis Obispo CA 93405 (805) 543-8511 51 322 12104 Fairmont Square 15081 E. 14th St. San Leandro CA 94578 (510) 481-8033 51 327 12105 Deer Valley 4155 W. Tunderbird Rd. Phoenix AZ 85023 (602) 938-4129 51 322 12107 Raley's Shopping Center 708-C Onstott Blvd. Yuba City CA 95991 (916) 673-0117 51 322 12108 Pinole Vista 1502 N. Fitzgerald Ave. Pinole CA 94564 (510) 222-1058 51 321 12110 Princeton Plaza 1375 Blossom Hill Rd., #46 San Jose CA 95118 (408) 266-9300 51 326 12112 Five Points Shopping Ct. 3963 State Street Santa Barbara CA 93105 (805) 964-8456 </TABLE>

50 <TABLE> <CAPTION> ZIP RM DM STORE # CENTER ADDRESS CITY STATE CODE TELEPHONE -- -- ------- ------ ------- ---- ----- ---- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> 52 337 12113 Loma Square Center 3333 Rosecrans Ave. San Diego CA 92110 (619)222-7808 51 327 12114 Loma Vista Center 4620 Meadow Land, #83 Las Vegas NV 89107 (702)870-8883 51 327 12115 Westridge 7611 W. Thomas Rd., #37 Phoenix AZ 85033 (602)849-5707 53 341 12116 Richland Pointe 5217 Rufe Snow Drive N. Richland Hill TX 76118 (817)485-2523 53 341 12118 Mervyn's Plaza 3725 W. Camp Wisdom Rd. Dallas TX 75237 (214)298-6692 53 341 12125 Market East 1515 N. Towneast, #147 Mesquite TX 75150 (214)279-9265 53 347 12130 Steeplechase Mall 10805 Jones Road Houston TX 77065 (713)955-5375 53 347 12132 North Oaks Center 4603-C FM 1960, West Houston TX 77069 (713)580-2933 51 323 12137 Southgate Plaza 4204 Florin Road Sacramento CA 95823 (916)424-9930 51 322 12138 Grape Yard Center 3222 Jefferson St. Napa CA 94558 (707)253-8259 53 347 12139 Spencer Square 3614 Spencer Highway Pasadena TX 77504 (713)946-4140 53 343 12140 Walzam Plaza Ct. 5350 Walzam Plaza San Antonio TX 78218 (210)656-8956 53 343 12141 Valley View Ct. 8507-A Blanco Road San Antonio TX 78216 (210)377-1058 51 327 12144 Flagstaff Mall 4650 N. Highway 89, #C-16 Flagstaff AZ 86004 (602)526-2321 53 347 12145 Palmer Plaza 3448 Palmer Highway Texas City TX 77590 (409)945-6364 53 346 12147 Town West 2315 Richmond Rd., #3 Texarkana TX 75503 (903)838-7695 53 347 12149 Culpepper Plaza 1663 Texas Ave., South College Station TX 77840 (409)764-8738 53 343 12152 Northwood Plaza 2900 W. Anderson Ln., #16 Austin TX 78704 (512)458-3002 53 343 12153 Brodie Oaks 4220 S. Lamar Blvd., #400 Austin TX 78704 (512)447-9447 53 347 12156 Deerbrook/Commons 9606 FM 1960 Bypass Humble TX 77338 (713)540-1844 53 347 12157 Greens Crossroads 225 W. Greens Rd. Houston TX 77067 (713)875-3408 52 334 12159 El Centro Center 1116 N. Imperial Ave. El Centro CA 92243 (619)353-3715 51 322 12160 Park Lane Center 274 E. Plumb Lane Reno NV 89502 (702)826-2821 53 347 12161 Galveston Plaza 2725 61st Street Galveston TX 77553 (409)744-0928 51 323 12163 Roseville Square 1101 Roseville Square Roseville CA 95678 (916)783-4072 53 341 12167 Richland Plaza 1328 E. Beltine Road Richardson TX 75081 (214)234-3039 53 347 12169 Northeast Square 18-C Uvalde Street Houston TX 77015 (713)453-3478 52 333 12172 Citrus Plaza 217 N. Citrus St., #8 West Covina CA 91791 (818)915-3919 52 333 12173 Mart of Montebello 876 W. Beverly Blvd. Montebello CA 90640 (213)721-7743 53 346 12175 North Park Plaza 5892-D Eastex Freeway Beaumont TX 77708 (409)892-2340 51 323 12177 Sunrise Mall 6165 Sunrise Mall Citrus Heights CA 95610 (916)729-0942 51 321 12178LF Serramonte Mall #8C Serramonte Center Daly City CA 94015 (415)755-3224 51 321 12179LF Eastridge Mall 153-A Eastridge Mall San Jose CA 95148 (408)238-7500 53 341 12180 French Quarter 4500 S. Broadway Tyler TX 75703 (903)561-7835 53 343 12181 Interstate 2300 Bell, #2 Amarillo TX 79106 (806)359-6950 53 347 12182 Gulfway Shopping Center 1420 Airline Drive Corpus Christi TX 78412 (512)991-5390 53 343 12183 South Plains Mall 6002 Slide Road, #813 Lubbock TX 79464 (806)793-5348 53 346 12184 South Gate 2940 Ryan Street Lake Charles LA 70601 (318)433-5745 53 343 12186 Cielo Vista Mall 8401 Gateway W. Blvd., F-4 El Paso TX 79925 (915)772-8211 52 332 12187 La Canada 2196 W. Footill Blvd. La Canada CA 91011 (818)249-9011 51 322 12190 Redding Fashion Plaza 1611 Hilltop Drive, G Redding CA 96001 (916)221-2871 52 332 12191 Barnsdall Square 1625 N. Vermont Hollywood CA 90027 (213)666-7196 53 336 12192 The City Mall 16 City Blvd., East, #110 Orange CA 92668 (714)634-4164 52 337 12193 Plaza Bonita 3030 Plaza Bonita Rd., #1160 National City CA 92050 (619)475-2775 52 336 12194LF Buena Park Mall 8393 On the Mall, #32 Buena Park CA 90620 (714)952-0475 53 343 12195 One Energy Square 3314 Andrews Highway Odessa TX 79762 (915)362-4750 51 326 12196 Topanga Plaza 6600 Topanga Cyn., #13A Canoga Park CA 91303 (818)702-9637 53 347 12200 Amigoland Mall 301 Mexico Blvd., Suite E-13 Brownsville TX 78520 (210)546-6743 53 343 12201 Killeen Mall 2100 S. SW Young Dr., #1312 Killeen TX 76541 (817)690-2337 53 343 12203 Midland Park Mall 4511 N. Midkiff, #C-37 Midland TX 79705 (915)697-0233 53 341 12205 Park Central Center 3226-A S. Clack Abilene TX 79606 (915)695-8361 51 322 12206 South Shore Center 2202 Shore Center, Suite E Alameda CA 94501 (510)523-2133 52 337 12207LF Chula Vista Shopping Ct 555 Broadway, #108 Chula Vista CA 91910 (619)425-4002 53 341 12209 Wichita Square 3614 Callfield Wichita Falls TX 76308 (817)691-7632 53 341 12210 Regency Square 1834 N.W. 52nd Street Lawton OK 73505 (405)355-8445 53 341 12211 Walnut Square 2209 S.W. 74th St., #301 Oklahoma City OK 73159 (405)685-6082 52 339 12212 Ladera Center 5375 W. Centinela Blvd. Los Angeles CA 90045 (310)568-8240 51 324 12214 Clovis Towne Center 130 W. Shaw Ave., #102 Clovis CA 93612 (209)298-8181 53 341 12216 Centre of America 1331 W. Memorial Rd. Oklahoma City OK 73114 (405)755-6082 51 327 12218 Valley Fair Mall 3601 S. 2700 West West Valley City UT 84119 (801)968-5664 53 343 12219 Mesilla Valley Mall 700 S. Tellshore, #1008 Las Cruces NM 88001 (505)522-0142 54 354 12221 Oaks Shopping Center 1533 Lee Street Des Plaines IL 60018 (708)297-7239 54 352 12222 Downers Park Plaza 7319 Lemont Road Downers Grove IL 60516 (708)852-7496 54 354 12223 Springbrook Shopping Ct 160 E. Lake St., S.E., #13 Bloomingdale IL 60108 (708)351-1045 54 354 12224 Meadows Town Mall 1400 E. Gulf Rd., #260 Rolling Meadows IL 60008 (708)593-4249 53 346 12225 Eastgate Center 3134 Louisville Ave. Monroe LA 71201 (318)323-2439 53 346 12226 East Lake Plaza 9851(A-2) E-10 Service Rd. New Orleans LA 70127 (504)243-0328 53 346 12228 Cortana Square 9536 Cortana Plaza Baton Rouge LA 70815 (504)926-3218 53 346 12229 Ambassador Row Courtyard 3603-F Ambassador Caffery Lafayette LA 70503 (318)988-4505 53 343 12230 Ross Plaza 4770 Montgomery, NE #8-10 Albuquerque NM 87110 (505)888-0601 </TABLE>

51 <TABLE> <CAPTION> ZIP RM DM STORE #3 CENTER ADDRESS CITY STATE CODE TELEPHONE <S> <C> <C> <C> <C> <C> <C> <C> <C> 53 343 12231 Rio West Mall 1430 W. I-40 Frontage #158 Gallup NM 87301 (505) 722-9153 51 321 12233 Milpitas Towne Center 551 E. Calaveras Blvd. Milpitas CA 95035 (408) 946-8354 52 333 12234 Commerce Center 502 E. Whittier Blvd. Commerce CA 90022 (213) 728-3600 52 334 12236 Rialto Value Center 1517 S. Riverside Ave. Rialto CA 92376 (909) 877-6626 52 339 12238 Cypress Fashion Plaza 6876 Katella Avenue Cypress CA 90630 (714) 892-9894 52 333 12239 La Cienega 1837 S. La Cienega Blvd. Los Angeles CA 90035 (310) 837-8858 52 336 12240 Santa Fe Springs Mall 13350 Telegraph Rd. #94 Santa Fe Springs CA 90670 (310) 944-6932 54 352 12241 North Ridge Plaza 1330 North Larkin Joliet IL 60431 (815) 725-1193 54 353 12246 Marketplace of Matteson 4158 W. 211th St., Sp. #32-B Matteson IL 60443 (708) 481-7676 54 352 12247 Waukegan Plaza 1305 N. Lewis Avenue Waukegan IL 60085 (708) 249-1773 51 324 12248 Selma Plaza 2829 Whitson Selma CA 93662 (209) 896-2737 51 327 12250 Canyon Center 2071 E. 9400 South, #3 Sandy UT 84092 (801) 943-2215 51 327 12252 Layton Hills Mall 1076 Layton Hills Mall Layton UT 84041 (801) 546-4343 54 353 12254 Lake View Center 15798 La Grange Rd. Orland Park IL 60462 (708) 460-4913 54 352 12257 Brookfield Fashion Center 16900-K W. Bluemound Rd. #240 Brookfield WI 53005 (414) 797-9688 52 336 12259 Mall of Orange 2374 N. Orange Mall Orange CA 92665 (714) 637-3940 52 339 12260 Atlantic & Elizabeth 7910-E S. Atlantic Blvd. Cudahy CA 90201 (213) 560-9827 54 354 12262 Postal Center 2908 N. Ashland Blvd. Chicago IL 60657 (312) 248-1132 54 354 12263 N. Riverside Park Plaza 7345 W. 25th Street N. Riverside IL 60546 (708) 442-0828 54 352 12266 Fox River Mall 4301 W. Wisconsin, Sp. #838 Appleton WI 54915 (414) 730-8880 54 352 12267 Forest Plaza 6211 E. State St., #87 Rockford IL 61008 (815) 397-2508 54 354 12270 Cermark Court Shopping Ct. 2539 W. Cermak Chicago IL 60608 (312) 523-0537 54 355 12273 Westland Crossings 34758 Warren Road Westland MI 48185 (810) 525-1144 54 355 12275 Gratiot Center 31902 Gratiot Avenue Roseville MI 48066 (810) 293-4900 54 355 12277 Southgate Crossing Center 14870 Dix-Toledo Road Southgate MI 48192 (810) 282-1428 51 324 12281 Turlock Towne Center 665-2C N. Golden State, #2C Turlock CA 95380 (209) 632-7248 52 339 12282 Paramount Towne Center 16260 Paramount, Bldg E Paramount CA 90723 (310) 633-8551 51 324 12284 Heritage Place 204 E. Cross Street Tulare CA 93274 (209) 685-8526 52 332 12285 Gateway Center 1773-P E. Palmdale Blvd. Palmdale CA 93550 (805) 273-7268 52 339 12286 Hawaiian Gardens 12100 Carson Street Hawaiian Gardens CA 90716 (310) 429-4860 51 327 12287 Mervyn's Plaza 2978 N. Alma School Rd. Chandler AZ 85224 (602) 732-9616 54 352 12290 Westgate Mall 442 Westgate Mall Madison WI 53711 (608) 274-2440 54 352 12292 Oakwood Mall 4800 Golf Rd., Sp. #424 Eau Claire WI 54701 (715) 834-1061 54 354 12294 Melrose Crossings Center 1937 N. Mannheim Road Melrose Park IL 60160 (708) 343-5111 54 355 12295 North Towne Mall 343 New Town Sq. Dr., E-10 Toledo OH 43612 (419) 478-3201 54 353 12301 Speedway Shopping Center 5662-B Crawfordsville Rd. Speedway IN 46224 (317) 244-1400 51 323 12302 County Fair Mall 1264 E. Gibson Rd., SE #G-175 Woodland CA 95695 (916) 661-6804 53 346 12303 Carrollton Central Plaza 3844 Dublin Street New Orleans LA 70118 (504) 488-4571 53 346 12304 Westgate Center 8847 Veterans Memorial Blvd. Metaine LA 70003 (504) 466-2235 53 346 12305 Elmwood Center 1200 S. Clearview, #1150 Harahan LA 70123 (504) 734-5925 54 355 12306 Fashion Corners 4375 Bay Road Saginaw MI 48603 (517) 790-7278 52 332 12308 Santa Anita Fashion Mall 256 Santa Anita Fash Park Arcadia CA 91006 (818) 447-6456 54 356 12310 Euclid/Superior 13501 Euclid Avenue East Cleveland OH 44122 (216) 761-3700 54 356 12311 Kamms Plaza 3760 Rocky River Drive West Cleveland OH 44111 (216) 251-7908 54 356 12312 Southgate Center 21200 Libby Road Maple Heights OH 44137 (216) 663-1022 54 356 12313 Pleasant Valley Center 7534 Broadview Road Parma OH 44134 (216) 842-0664 54 356 12315 Southland Center 6865-D Southland Drive Middleburg Hts. OH 44130 (216) 684-6564 51 326 12316LF Panorama Mall #35 Panorama Mall Panorama City CA 91402 (818) 891-4404 54 353 12318 Greenwood Place 7685 S. Shelby St. Indianapolis IN 46227 (317) 887-6676 54 354 12319 Riverside Square 3145 S. Ashland Ave., #115 Chicago IL 60608 (312) 254-3892 54 354 12320 Scottsdale Shopping Center 7929 S. Cicero Avenue Chicago IL 60652 (312) 581-0024 54 353 12321 Salem Square 5555 S. Brainard Ave. Countryside IL 60525 (708) 352-8247 52 336 12324LF Lakewood Center 46 Lakewood Ct. Mall, #1101 Lakewood CA 90712 (310) 531-3459 52 332 12330LF Glendale Galleria 2223 Glendale Galleria Glendale CA 90210 (818) 241-6561 54 354 12333 Kedzie Plaza 4758 S. Kedzie Chicago IL 60632 (312) 523-1594 54 355 12334 The Heights 26434 Ford Road Dearborn Heights MI 48127 (810) 274-5426 54 356 12339 Plaza at Chapel Hill 462 Howe Avenue Cuyahoga Falls OH 44221 (216) 922-0943 54 356 12340 West Market Plaza 3893 Medina Road Akron OH 44313 (216) 666-2094 54 355 12341 Cross Pointe Center 101 E. Alex-Bel Rd., #156 Centerville OH 45459 (513) 436 4715 54 356 12342 Solon Square 33431 Aurora Road Solon OH 44139 (216) 248-5541 54 356 12343 Ridge Park Square 4778 Ridge Road Brooklyn OH 44144 (216) 749-4060 54 354 12344 Western Hills Plaza 6180-D Glenway Avenue Cincinnati OH 45211 (513) 481-6565 54 354 12345 Hyde Park Plaza 3880 Paxton Rd., Suite 1 Cincinnati OH 45209 (513) 321-8311 54 354 12346 Blue Ash Plaza 4130 Hunt Road Cincinnati OH 45236 (513) 791-0830 54 355 12348 Spring Meadows 1482 Spring Meadow Drive Holland OH 43528 (419) 866-5690 54 355 12349 Bel-Air Center 8800 E. Eight Mile Road Detroit MI 48234 (810) 893-7887 52 337 12350 Bristol Place 3378 S. Bristol Street Santa Ana CA 92704 (714) 545-8204 51 327 12352 Nellis Crossing 1256 Nellis Blvd., #E-125 Las Vegas NV 89104 (702) 459-8116 51 324 12353 Porterville Town 866 W. Henderson Avenue Porterville CA 93257 (209) 784-1136 51 326 12354 Central Plaza 830 Arneill Road Camarillo CA 93010 (805) 388-3828 </TABLE>

52 <TABLE> <CAPTION> ZIP RM DM STORE # CENTER ADDRESS CITY STATE CODE TELEPHONE -- -- ------- ------ ------- ---- ----- ---- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> 52 337 12472 Plaza Del Obispo 31878 Del Obispo, #112 San Juan Capistrano CA 92675 (714) 240-0942 52 334 12473 Rancho Calif. Town Center 29720 Rancho Calif. Rd. 3B Temecula CA 92591 (909) 699-5181 51 327 12474 Park Mall 5870 E. Broadway, #850 Tucson AZ 85711 (602) 745-0595 54 350 12477 Laurel Centre 14776 Baltimore Wash. Blvd. Laurel MD 20707 (301) 604-6776 53 347 12478 Shannon Mall 313 Shannon Sq. Park Mall Union City GA 30291 (404) 969-0626 54 353 12479 The Parkway 2103 N. Veterans Pkwy, #322 Bloomington IL 61704 (309) 664-0844 54 354 12480 Westview Center 1050A Barrington Road Streamwood IL 60107 (708) 837-4736 52 339 12483 Baldwin Hills Crens Plaza 3650 W. Martin Luther King Los Angeles CA 90008 (213) 294-4034 52 336 12484 Whittwood Mall 15612 Whittwood Lane Whittier CA 90603 (310) 947-5697 52 333 12485 Baldwin Park 14547 Ramona Blvd., #813 Baldwin Park CA 91706 (818) 814-0096 51 321 12486 Cochrane Plaza 128 Cochrane Plaza Morgan Hill CA 95037 (408) 778-2668 53 346 12488 Southland Mall 3038 W. Park Ave., #F13 Houma LA 70364 (504) 868-2287 53 345 12489 Mall of America 7795 W. Flagler St., #21 Miami FL 33144 (305) 267-5052 53 348 12491 Heritage Place 12559 Olive Blvd. Creve Coeur MO 63141 (314) 469-1544 54 350 12492 Montgomery 18280 Contour Rd., #6 Gaithersburg MD 20879 (301) 948-5780 54 350 12493 Landover Mall 2205 Bright Seat Road, A-1 Landover MD 20785 (301) 322-7407 54 356 12494 Reisterstown Rd. 6748 Reistertown Rd. Baltimore MD 21215 (410) 358-6419 54 350 12495 Iverson Mall 3791 Branch Ave. Hillcrest MD 20748 (301) 423-7617 53 348 12496 Lakeland Square 3800 N. Highway, 98, #126 Lakelarnd FL 33809 (813) 853-2041 53 346 12497 Belle Promenade 1701 Barataria Blvd., #168 Marrero LA 70072 (504) 348-8901 53 347 12498 Southlake Mall 2305 Southlake Mall Morrow GA 30260 (404) 960-8322 52 339 12499 Fox Hills Mall 366 Fox Hills Mall Culver City CA 90230 (310) 397-3299 54 352 12503 Gurnee Mills 6170 Grand Avenue Gurnee IL 60031 (708) 855-1801 51 327 12507LF Metro Center 9657-A Metro Parkway West Phoenix AZ 85051 (602) 861-1133 52 334 12509 Terra Vista Town Center 10582 Foothill Blvd., #190 Rancho Cucamonga CA 91730 (909) 948-1783 52 334 12510 Escondido 1272 G. Auto Parkway Escondido CA 92025 (619) 738-8277 53 346 12511 Pierre Bossier 2950 E. Texas Rd., #106 Bossier City LA 71111 (318) 747-6721 54 350 12512 The Center at Salisbury 2300 N. Salisbury Rd., #J121 Salisbury MD 21801 (410) 548-5602 54 350 12513 Federal Plaza 12268 Rockville Pike Ste. H Rockville MD 20852 (301) 816-0240 54 356 12514 Eastwood Plaza 5555 Youngstown Warren, #402 Niles OH 44446 (216) 652-6756 53 348 12515 Overland Plaza 9122 Overland Plaza Overland MO 63114 (314) 427-2112 54 353 12516 Northfield Square 1600 N. State Route 50, #708 Bourbonnais IL 60914 (815) 939-9777 51 327 12517 University Mall E-83 University Mall Orem UT 84058 (801) 225-4426 52 337 12518 Fountain Valley 18309 Brookhurst St., #4 Fountain Valley CA 92708 (714) 964-2045 52 332 12519 Huntington Oaks 518 Huntington Drive Monrovia CA 91016 (818) 358-4588 54 353 12521 Rivercrest Centre 4839 W. Cal Sag Crestwood IL 90445 (708) 489-5750 53 345 12523 Melbourne 1700 W. New Haven Ave., #741 Melbourne FL 32910 (407) 729-8147 53 345 12524 Westchester Shopping Ct 8459 S.W. 24th St. Miami FL 33155 (305) 264-0975 53 345 12525 Sawgrass Mills 12801 W. Sunrise Bl., #281 Sunrise FL 33323 (305) 846-9041 53 345 12526 Pembroke Commons 508 University Drive Pembroke FL 33024 (305) 435-1476 54 353 12527 Woodmar Shopping Center 6606-17B Indianapolis Blvd. Hammond IN 46320 (219) 844-4001 54 355 12528 Southland Mall 23000 Eureka Rd., #E-16 Taylor MI 48180 (810) 374-5960 52 332 12530 Plaza Pasadena 128 The Plaza Pasadena Pasadena CA 91101 (818) 564-1728 52 337 12531 Plaza De La Paz 27281 La Paz Rd., Suite P Laguna Niguel CA 92656 (714) 831-8837 52 336 12532 Corona Hills 340 McKinley St., #101 Corona CA 91719 (909) 272-6607 52 336 12533 Chino 4200 Chino Hills Pkwy, #670 Chino Hills CA 91709 (909) 393-7427 54 355 12534 Northland Mall 21500 N. Western Hwy., E24 Southfield MI 48075 (810) 443-5722 53 345 12538 Westland 3800 W. 18th Ave., #120 Hialeah FL 33012 (305) 828-6394 53 346 12540 Alexandria Mall 3437 Masonic Dr., #1566 Alexandria LA 71301 (318) 473-4303 54 353 12541 Village Park 1950-B Greyhound Pass Carmel IN 46032 (317) 846-7230 54 356 12542 Eastpoint Mall 7833 Eastpoint Mall Baltimore MD 94611 (410) 288-5298 54 356 12543 Annapolis Harbor Center 2528 Soloms Island Rd. Annapolis MD 21401 (410) 224-0766 51 322 12544 Rockridge Center 5110 Broadway Oakland CA 94611 (510) 601-0151 52 336 12545 Lake Elsinore Town Center 32295 Mission Trail Road Lake Elsinore CA 92330 (909) 245-5275 54 350 12546 Chesapeake Square 4200 Portsmouth Blvd. Chesapeake VA 23321 (804) 465-8086 54 350 12547 Coliseum Mall 1800 W. Mercury Blvd., #A4 Hampton VA 23666 (804) 825-0827 52 334 12548 Mall of Victorville 14400 Bear Valley Road Victorville CA 92392 (619) 955-6325 52 333 12549 Plaza at West Covina 1200 W. Covina Pkwy, #514 West Covina CA 91790 (818) 962-7108 52 333 12550 La Verne Towne Center 2418-C Foothill Blvd. La Verne CA 91750 (909) 596-5596 54 355 12551 Redford Plaza 9335 Telegraph Road Redford MI 48239 (810) 537-6328 51 326 12552 Santa Maria Town Center 115 Town Center East Santa Maria CA 93454 (805) 928-7471 51 326 12553 Esplanade Mall 183 Esplanade Mall Oxnard CA 93030 (805) 485-4229 51 324 12554 Hanford Mall 1675 W. Lacey Blvd., #H5 Hanford CA 93230 (209) 584-1173 54 350 12555 Potomac Mills 2700 Potomac Mills Cir. #148 Prince VA 22193 (703) 491-6327 52 334 12556 Moreno Valley Mall 22500 Towngate Circle, #2205 Moreno Valley CA 92553 (909) 653-7697 51 321 12557 Mervyn's Plaza 2064 El Camino Real Santa Clara CA 95051 (408) 261-9480 51 356 12562 Marley Station 7900 Gov. Ritchie Hwy. #19 Glen Burnie MD 21061 </TABLE> 331 TOTAL STORES Distribution Center HQ Property City of Industry, CA

53 <TABLE> <CAPTION> ZIP RM DM STORE # CENTER ADDRESS CITY STATE CODE TELEPHONE -- -- ------- ------ ------- ---- ----- ---- --------- <S> <C> <C> <C> <C> <C> <C> <C> <C> 52 332 12355 Canyon Country 19188 Soledad Canyon Road Canyon Country CA 91351 (805)252-5212 54 353 12357 Applewood Village 1908 Applewood Center Drive Anderson IN 46015 (317)644-0249 52 333 12358 San Dimas Plaza 957 West Arrow Highway San Dimas CA 91773 (909)592-9757 54 353 12362 Northgate Mall 2800 N. Waters St., #75 Decatur IL 62526 (217)877-3953 54 353 12364 Market View 13 Market View Champaign IL 61820 (217)359-8240 54 355 12366 Salem 5465 Salem Pike Dayton OH 45426 (513)854-1387 54 356 12367 Oak Park Center 2474 Lincoln Way East Massillon OH 44646 (216)837-2121 51 323 12368 Elkhorn Center 4341 Elkhorn Blvd. N. Sacramento CA 95842 (916)344-6873 53 343 12369 Old Mill Place 7040 Bandera Road San Antonio TX 78238 (210)680-4377 51 323 12373 Factoria Square 4086 128th Ave., SE, H-16 Bellevue WA 98006 (206)562-1495 51 327 12375 Santa Cruz Plaza 3720 South 16th Avenue Tucson AZ 85713 (602)624-3479 52 337 12376 Crossroads 3800 Barrance Parkway, J Irvine CA 92714 (714)551-3590 52 337 12378 Garden Grove Pavillion 12093 S. Brookhurst St. Garden Grove CA 92640 (714)534-1379 52 334 12379 Twin Peaks Plaza 14761 Pomerado Road Poway CA 92064 (619)486-3312 54 352 12381 Regency Point 2310 S. Greenbay Rd., #F Racine WI 53406 (414)554-6067 54 353 12382 Commons of Chicago 247 Commons Drive Chicago Ridge IL 60415 (708)636-1344 54 352 12384 Danada Square 86 Danada Square West Wheaton IL 60187 (708)668-2009 53 341 12386 Woodland Hills 7021 S. Memorial Drive Tulsa OK 74133 (918)250-1957 54 354 12388 Florence Square 7733-A Mall Road Florence KY 41042 (606)283-9499 54 355 12389 Livonia Plaza 30951 5 Mile Road, #86 Livonia MI 48150 (810)427-3690 54 355 12390 Commerce Towne 3050 Union Lake Road, #3D Commerce MI 48382 (810)363-0488 53 348 12393 Central Plaza 15305 Manchester Road Ballwin MO 63011 (314)394-4755 53 348 12394 Dierberg's Clocktower 11238 W. Florissant Road Florissant MO 63033 (314)838-6053 53 345 12396 University 417 S. Semoran Blvd. Winter Park FL 32792 (407)657-1787 53 345 12397 Skyview Plaza 7671 S. Orange Blossom Trl. Orlando FL 32809 (407)855-0351 53 345 12401 Crossroads 3922 Northlake Blvd. Palm Beach FL 33403 (407)694-8627 53 345 12402 Deerfield Mall 3828 W. Hillsboro Blvd. Deerfield FL 33442 (305)427-8778 53 348 12404 Cypress Point 25865 E. US Hwy. 19, N Clearwater FL 34623 (813)791-8817 51 323 12407 Gresham Town Fair 610 N.W. Eastman Parkway Gresham OR 97030 (503)669-0252 51 323 12408 Clackamas 8946 Sunnyside Road Clackamas OR 97015 (503)652-9043 51 323 12412 Greentree Square 505 S.E. Everett Mall Way Everett WA 98204 (206)353-7259 51 323 12413 Century Square 32041 Pacific Hwy. South Federal Way WA 98003 (206)839-6306 53 345 12414 Colonial 4652 E. Colonial Drive Orlando FL 32803 (407)898-6973 53 345 12415 TJ Maxx Plaza 7364 S.W. 117th Avenue Kendall FL 33183 (305)595-0845 53 348 12416 Rengency Square 2452 W. Brandon Blvd. Brandon FL 33511 (813)654-3996 53 348 12417 Largo Mall 10500 Ulmerton Rd., #620 Largo FL 34641 (813)586-4699 53 348 12418 Crossroads Center 38 Crossroads Center Fairview Heights IL 62208 (618)397-8908 53 348 12419 Hampton Village 34 Hampton Village Center St. Louis MO 63109 (314)481-9143 53 341 12420 Arlington Park 3701 S. Cooper, #151 Arlington TX 76015 (817)784-8705 53 347 12421 Baybrook Square 1273 W. Bay Area Blvd. Webster TX 77598 (713)332-2867 52 334 12422 Tri-City Center 1458 Industrial Park, #A1 Redlands CA 92374 (909)792-5783 52 339 12424 Hawthorne 12036 Hawthorne Plaza, #U3 Hawthorne CA 90250 (310)978-0756 51 322 12425 Factory Nut Tree 311-J Nut Tree Rd. Vacaville CA 95687 (707)446-9643 53 348 12431 Crosswinds Center 2056 66th St., N #139 St. Petersburg FL 33710 (813)343-6675 53 345 12432 IntraCoastal Mall 3745 N.E. 163rd Street North Miami FL 33160 (305)949-1065 54 356 12433 Boardman Plaza #35 Boardman/Centerfield Rd. Youngstown OH 44512 (216)726-5685 51 323 12435 Bellis Fair Mall 1 Bellis Fair Pkwy, #118 Bellingham WA 98226 (206)647-9492 52 332 12436 Kinney Cut-Down 13711 Foothill Blvd. Sylmar CA 91342 (818)362-0511 51 321 12437 Sunnyvale Town 1175 Town Center Lane Sunnyvale CA 94086 (408)733-3317 52 332 12439 Kinney Cut-Down 12512 N. Victory Blvd. North Hollywood CA 91606 (818)508-6109 51 322 12443 Navato Fair 922 Diablo Avenue Novato CA 94945 (415)892-2213 52 334 12444 Midtown Square 16930-G Main Street Hesperia CA 92345 (619)949-8224 52 334 12445 Mission Gorge 9720 Mission Gorge Rd., A&B Santee CA 92071 (619)562-5381 51 324 12447 Valley Plaza 2701 Ming Avenue, #64 Bakersfield CA 93304 (805)832-4048 54 350 12448 Plaza at Landmark 6204 Little River Turn Pike Alexandria VA 22312 (703)354-8663 54 350 12449 Fair City Mall 9662 Main Street Fairfax VA 22031 (703)239-8830 53 348 12451 South County Mall 424 S. County Center Way St. Louis MO 63129 (314)894-3406 52 333 12452LF Montebello Town Center 2011 Montebello Town Center Montebello CA 90640 (213)888-1370 51 321 12453LF Oakridge Mall 110 Oakridge Mall San Jose CA 95123 (408)281-4082 52 337 12454LF Laguna Hills Mall 24155 Laguna Hills Mall #1750 Laguna Hills CA 92653 (714)586-4829 54 350 12455 Forest Village 3393 Donnel Drive Forestville MD 20747 (301)967-1883 54 350 12456 Westgate Plaza 8085 Sudley Road Manassas VA 22110 (703)368-3692 53 348 12457 Fashion Square 3657 W. Waters Avenue Tampa FL 33614 (813)935-6686 53 347 12459 King's Market 1425 Market Blvd., #560 Roswell GA 30076 (404)641-1129 53 343 12460 Market Center 11130 Lomas Blvd., N.E. #F4 Albuquerque NM 87112 (505)291-8794 51 327 12461 Scottsdale 8980 E. Indian Bend Rd., #D4 Scottsdale AZ 85250 (602)998-8410 51 323 12463 Sunset Esplanade 2322 Tualation Valley Hwy. Hillsboro OR 97123 (503)640-6907 54 352 12464 Machesney Park 8750 N. 2nd Street Rockford IL 61111 (815)633-4955 51 321 12465LF New Park Mall 1213 New Park Mall Newark CA 94560 (510)796-3669 52 339 12469 Carson Mall 283 Carson Mall Carson CA 90746 (310)715-2516 </TABLE>

54 VIA FEDERAL EXPRESS FOOTHILL. November 9, 1995 Mr. Bernie Tessler President C/O Little Folk Shop, Inc. 801 Sentous Avenue City of Industry, CA 91748 Re: AMENDMENT NO. ONE TO THE LOAN AND SECURITY AGREEMENT ("AMENDMENT") Dear Mr. Tessler: Enclosed please find two (2) execution copies of the above referenced Amendment to be signed on behalf of LFS Acquisition Corp., and reaffirmed by Mr. Bernard Tessler. Please return one (1) fully executed Amendment via Federal Express to my attention and retain the remaining with your records. If you have any questions, please give me a call at (310) 996-7144. Sincerely, FOOTHILL CAPITAL CORPORATION /s/ MICHELLE L. MARTINEZ ---------------------------- Michelle L. Martinez Loan Security Administrator /mm Enclosures Foothill Capital Corporation / 310-996-7000 11111 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025-3333 A NORWEST COMPANY

55 AMENDMENT NO. ONE TO THE LOAN AND SECURITY AGREEMENT LFS ACQUISITION CORP. This Amendment No. One To The Loan And Security Agreement (the "Amendment") is entered into as of the 8th day of November, 1995, by and between LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), whose chief executive office is located at 801 Sentous Avenue, City of Industry, California 91748 and 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, in light of the following facts: FACTS FACT ONE: Foothill and Borrower have previously entered into that certain Loan And Security Agreement, dated May 31, 1995 (the "Agreement"). FACT TWO: Foothill and Borrower desire to further amend the Agreement as provided herein. Terms defined in the Agreement which are used herein shall have the same meanings as set forth in the Agreement, unless otherwise specified. NOW, THEREFORE, Foothill and Borrower hereby modify and amend the Agreement as follows: 1. Notwithstanding anything to the contrary contained in Section 2.1 (a)(1) and Section 2.1 (a)(2) of the Agreement, Borrower's cost of Eligible Inventory shall be (i) sixty five percent (65%) from December 1, 1995 through December 10, 1995, (ii) sixty four percent (64%) from December 11, 1995 through December 17, 1995, (iii) sixty three percent (63%) from December 18, 1995 through December 24, 1995, and (iv) sixty two percent (62%) from December 25, 1995 through December 30, 1995. On December 31, 1995, said Eligible Inventory shall revert to the original terms of the Agreement. 2. Notwithstanding anything to the contrary contained in Section 2.1(c) of the Agreement, the "Maximum Amount" for purposes of the Agreement shall be at Twenty Three Million Dollars ($23,000,000) from November 2, 1995 through December 31, 1995. On January 1, 1996, the Maximum Amount shall revert to the original term of the Agreement. 1

56 3. Foothill shall charge Borrower's loan account a fee in the amount of $50,350 upon execution and delivery to Foothill of this Amendment. Said fee shall be fully-earned, non-refundable, and due and payable on the date Borrower's loan account is charged. 4. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provisions of this Amendment shall govern. In all other respects, the Agreement, as supplemented, amended and modified, shall remain in fun force and effect. IN WITNESS WHEREOF, Borrower and Foothill have executed this Amendment as of the day and year first written above. FOOTHILL CAPITAL CORPORATION LFS ACQUISITION CORP. a California corporation a Delaware corporation By /s/ LISA M. GONZALES By /s/ BERNARD TESSLER, PRESIDENT ------------------------------ ------------------------------ Lisa M. Gonzales Bernard Tessler Its Assistant Vice President Its President ----------------------------- ----------------------------- ------------------------------------------------------------------------------ By its acceptance below this ___ day of November, 1995, the undersigned guarantor hereby reaffirms its Continuing Guaranty dated May 31, 1995 and consents to the above-stated terms. HOLTZMAN'S LITTLE FOLK SHOP, INC. a California corporation By /s/ BERNARD TESSLER, PRESIDENT ------------------------------ Bernard Tessler Its President ----------------------------- 2

57 VIA FEDERAL EXPRESS FOOTHILL. February 21, 1995 Mr. Bernie Tessler President C/O Little Folk Shop, Inc. 801 Sentous Avenue City of Industry, CA 91748 Re: LFS ACQUISITION CORP. Dear Mr. Tessler: Enclosed please find an executed copy of Amendment No. Two to the Loan And Security Agreement regarding the above referenced company for your records. If you have any questions regarding the enclosed, please feel free to call me at (310) 996-7144. Sincerely, FOOTHILL CAPITAL CORPORATION /s/ MICHELLE L. MARTINEZ ---------------------------- Michelle L. Martinez Loan Security Administrator /mm Enclosures cc: Robert C. Colton, Esq. Foothill Capital Corporation / 310-996-7000 11111 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025-3333 A NORWEST COMPANY

58 AMENDMENT NUMBER TWO TO LOAN AND SECURITY AGREEMENT This Amendment Number Two to Loan and Security Agreement ("Amendment") is entered into as of February 1, 1996, by and between FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"), and LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), in light of the following: A. Borrower and Foothill have previously entered into that certain Loan and Security Agreement, dated as of May 31, 1995 (as amended, the "Agreement"). B. Borrower and Foothill desire to amend the Agreement as provided for and on the conditions herein. NOW, THEREFORE, Borrower and Foothill hereby amend and supplement the Agreement as follows: 1. DEFINITIONS. All initially capitalized terms used in this Amendment shall have the meanings given to them in the Agreement unless specifically defined herein. 2. AMENDMENTS. (a) The definition of Reference Rate in Section 1.1 of the Agreement is amended as follows: "Reference Rate" means the variable rate of interest, per annum, most recently announced by Norwest Bank Minnesota, National Association, or any successor to the foregoing institution as its "prime rate" or "reference rate" as the case may be, irrespective of whether such announced rate is the best rate available from such financial institution. (b) Section 2.1(a)(1) of the Agreement is amended as follows, but only for the periods of February 1, 1996 through April 30, 1996 and July 1, 1996 through August 31, 1996 or on such earlier date as Borrower has elected in writing to terminate the amendment to such section; (1) During the months of February through April of 1996, and July and August of 1996, the lower of: thirty five percent (35%) of the retail selling price of Eligible Inventory or sixty five percent (65%) of Borrower's cost of Eligible Inventory, and 1

59 (c) The second sentence of Section 2.2(d) of the Agreement is amended as follows: On the first day of each month, Borrower will pay Foothill a fee equal to two percent (2%) per annum times the actual Daily Balance of the undrawn L/Cs and L/C Guarantees that were outstanding during the immediately preceding month. (d) Section 2.5(a) and (b) are amended to read as follows: (a) Interest Rate. All Obligations, except for undrawn L/Cs and L/C Guarantees, shall bear interest, on the actual Daily Balance, at a per annum rate of two (2) percentage points above the Reference Rate. (b) Default Rate. All Obligations, except for undrawn L/Cs and L/C Guarantees, shall bear interest, from any after the occurrence and during the continuance of an Event of Default, at a per annum rate equal to five (5) percentage points above the Reference Rate. From and after the occurrence and during the continuance of an Event of Default, the fee provided in Section 2.2(d) shall be increased to a fee equal to five percent (5%) per annum times the actual Daily Balance of the undrawn L/Cs and L/C Guarantees that were outstanding during the immediately preceding month. (e) The second sentence of Section 2.6 is amended as follows: From and after February 1, 1996, Foothill shall be entitled to charge Borrower for two (2) Business Days of clearance at the applicable rates set forth in Sections 2.5(a) and 2.5(b) (applicable to advances under Section 2.1) on all collections, checks, wire transfers or other items of payment that are received by Foothill (regardless of whether forwarded by the Lock Box Banks to Foothill, whether provisionally applied to reduce the Obligations, or otherwise). (f) Section 6.13 of the Agreement is hereby amended as follows, but only for the quarters ending January 31, 1996, April 30, 1996 and July 31, 1996: 6.13 FINANCIAL COVENANTS. Borrower shall remain: (a) Current Ratio. A ratio of Consolidated Current Assets divided by Consolidated Current Liabilities of at least the following, measured on a fiscal quarter-end basis: (1) eighty five one hundredths to one (0.85:1.0) as of January 31, 1996; 2

60 (2) eighty one hundredths to one (0.80:1.0) as of April 30, 1996 and July 31, 1996; (b) Total Liabilities to Tangible Net Worth Ratio. A ratio of Borrower's total liabilities (other than the Subordinated Indebtedness and Indebtedness to Woolworth pursuant to the Purchase Agreement) divided by Tangible Net Worth of not more than one of the following, measured on a fiscal quarter-end basis: (1) fifteen to one (15:1.0) as of January 31, 1996; (2) twenty five to one (25:1.0) as of April 30, 1996; (3) fifty five to one (55:1.0) as of July 31, 1996. (c) Tangible Net Worth. A Tangible Net Worth measured on a fiscal quarter-end basis of not less than the following: (1) Two Million Seven Hundred Fifty Thousand Dollars ($2,750,000) as of January 31, 1996; (2) One Million Two Hundred Fifty Thousand Dollars ($1,250,000) as of April 30, 1996; (3) Two Hundred Fifty Thousand Dollars ($250,000) as of July 31, 1996; and (d) Working Capital. Working Capital of not less than the following negative amounts, measured on a fiscal quarter-end basis: (1) Two Million Five Hundred Thousand Dollars (-$2,500,000) as of January 31, 1996; (2) Four Million Five Hundred Thousand Dollars (-$4,500,000) as of April 30, 1996; (3) Five Million Dollars (-$5,000,000) as of July 31, 1996. For purpose of calculating the financial covenants contained in this Section 6.13, Two Million Two Hundred Thousand Dollars ($2,200,000) of Borrower's Consolidated Current Liabilities owed to Woolworth shall be excluded through July 31, 1996 unless one of the following events occurs during such period: (a) Borrower shall have settled its litigation with Woolworth, or (b) Borrower's parent, Kids Mart, Inc. (formerly Frost Hanna), shall have issued additional equity securities in either a public or private transaction. Upon consummation of either one or both of the events set forth in (a) or (b) above, whether prior to, on or after July 31, 1996, Foothill and Borrower shall 3

61 amend this Section 6.13 to give effect to such event in the same manner that they utilized in establishing the covenants in Amendment Number One to Loan and Security Agreement dated as of February 1, 1996. 3. REPRESENTATIONS AND WARRANTIES. Borrower hereby affirms to Foothill that all of Borrower's representations and warranties set forth in the Agreement are true, complete and accurate in all respects of the date hereof. 4. NO DEFAULTS. Borrower hereby affirms to Foothill that no Event of Default has occurred and is continuing as of the date hereof. 5. CONDITION PRECEDENT. The effectiveness of this Amendment is expressly conditioned upon the following: (a) Payment by Borrower to Foothill of an amendment fee in the aggregate amount of Ninety Thousand Dollars ($90,000). The amendment fee shall be charged to Borrower's loan account pursuant to Section 2.5(d) of the Agreement and shall be payable on the first day of each month as follows: (1) $15,000 each for the months of February through April, 1996, (2) $20,000 for the month of July, 1996, if Section 2(b) of this Amendment remains in effect on the first day of such month, and (3) $25,000 for the month of August, 1996, if Section 2(b) of this Amendment remains in effect on the first day of such month; and (b) Receipt by Foothill of an executed copy of this Amendment. 6. COSTS AND EXPENSES. Borrower shall pay to Foothill all of Foothill's out-of-pocket costs and expenses (including, without limitation, the fees and expenses of its counsel) arising in connection with the preparation, execution, and delivery of this Amendment and all related documents. 7. LIMITED EFFECT. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provision of this Agreement shall govern. In all other respects, the Agreement, as amended and supplemented hereby, shall remain in full force and effect. 8. COUNTERPARTS: EFFECTIVENESS. This Amendment may be executed in any number of counterparts and by different parties on separate counterparts each of which when so executed and delivered shall be deemed to be an original. All such 4

62 counterparts, taken together, shall constitute but one and the same Amendment. This Amendment shall become effective upon the execution of a counterpart of this Amendment by each of the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first set forth above. FOOTHILL CAPITAL CORPORATION, a California corporation By: /s/ MARTIN VALENCIA ------------------------------------ Title: Assistant Vice President -------------------------------- LFS ACQUISITION CORP., a Delaware corporation By: /s/ BERNARD TESSLER ------------------------------------ Bernard Tessler, President 5

63 The undersigned has executed a Continuing Guaranty in favor of Foothill Capital Corporation ("Foothill") respecting the obligations of LFS ACQUISITION CORP. ("Borrower") owing to Foothill. The undersigned acknowledges the terms of the above Amendment and reaffirms and agrees that: its Continuing Guaranty remains in full force and effect; nothing in such Continuing Guaranty obligates Foothill to notify the undersigned of any changes in the financial accommodations made available to Borrower or to seek reaffirmations of the Continuing Guaranty; and no requirement to so notify the undersigned or to seek reaffirmations in the future shall be implied by the execution of this reaffirmation. HOLTZMAN'S LITTLE FOLK SHOP, INC., a California corporation By: /s/ BERNARD TESSLER ------------------------------------- Bernard Tessler, President 6

64 VIA FEDERAL EXPRESS April 11, 1996 FOOTHILL. LFS Acquisition Corp. 801 Sentous Avenue City of Industry, CA 91748 Attn: Bernie Tessler Re: LFS ACQUISITION CORP. Gentlemen: Reference is hereby made to that certain Loan And Security Agreement by and between Foothill Capital Corporation ("Foothill") and LFS Acquisition Corp. ("Borrower") dated as of May 31, 1995 (as amended and supplemented, "the Agreement"). Borrower has informed Foothill that it was not in compliance with Sections 6.13(a), (b), (c) and (d) of the Agreement for its fiscal quarter ended January 31, 1996 and has requested that Foothill waive compliance of said Sections. Section 6.13(a) of the Agreement states that Borrower shall maintain a ratio of Consolidated Current Assets divided by Consolidated Current Liabilities of at least eighty five one hundredths to one (0.85:1.0) as of January 31, 1996. Section 6.13(b) of the Agreement requires that Borrower shall maintain a ratio of Borrower's total liabilities to Tangible Net Worth of not more than fifteen to one (15:1.0) as of January 31, 1996. Section 6.13(c) of the Agreement stipulates that Borrower shall maintain a Tangible Net Worth of not less than Two Million Seven Hundred Fifty Thousand Dollars ($2,750,0000) as of January 31, 1996. Section 6.13(d) of the Agreement mandates that Borrower shall maintain a Working Capital of not less than the negative amount of Two Million Five Hundred Thousand Dollars (-$2,500,000) as of January 31, 1996. Foothill hereby agrees to waive Borrower's compliance as stated above for Sections 6.13(a), (b), (c) and (d) of the Agreement for Borrower's fiscal quarter ended January 31, 1996 only. Foothill Capital Corporation / 310-996-7000 11111 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025-3333 A NORWEST COMPANY

65 LFS Acquisition Corp. April 11, 1996 Page Two Foothill shall charge Borrower's loan account a fee in the amount of $4,000. Said fee shall be fully-earned, non-refundable, and due and payable on the date Borrower's loan account is charged. Foothill's waiver is effective only to the extent specifically stated above and does not effect or diminish Foothill's rights hereafter to require strict performance by Borrower of each provision of the Agreement. Foothill's rights and remedies under the Agreement continue in full force and effect and the consequences of any act or failure to act on the part of Borrower which would constitute an Event of Default, as defined in the Agreement and to which Foothill has not herein specifically consented are not waived. Sincerely, FOOTHILL CAPITAL CORPORATION By /s/ MARTIN VALENCIA ---------------------------- Martin Valencia Its Assistant Vice President ---------------------------- Foothill Capital Corporation / 310-996-7000 11111 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025-3333 A NORWEST COMPANY

66 AMENDMENT NUMBER THREE TO LOAN AND SECURITY AGREEMENT This Amendment Number Three to Loan and Security Agreement ("Amendment") is entered into as of April 15, 1996, by and between FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"), and LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), in light of the following: A. Borrower and Foothill have previously entered into that certain Loan and Security Agreement, dated as of May 31, 1995 (as amended, the "Agreement"). B. Borrower and Foothill desire to further amend the Agreement as provided for and on the conditions herein. NOW, THEREFORE, Borrower and Foothill hereby amend and supplement the Agreement as follows: 1. DEFINITIONS. All initially capitalized terms used in this Amendment shall have the meanings given to them in the Agreement unless specifically defined herein. 2. AMENDMENTS. Section 6.13 of the Agreement is hereby amended in its entirety as follows: 6.13 FINANCIAL COVENANTS. Borrower shall maintain: (a) Current Ratio. A ratio of Consolidated Current Assets divided by Consolidated Current Liabilities of at least the following, measured on a fiscal quarter-end basis: .55:1.00; (b) Tangible Net Worth. A Tangible Net Worth measured on a fiscal quarter-end basis of not less than the following negative amounts: (1) -$4,500,000 as of April 30, 1996; (2) -$6,000,000 as of July 31, 1996; and (3) -$5,000,000 for all subsequent fiscal quarters. (c) Working Capital. Working Capital of not less than the following negative amounts, measured on a fiscal quarter-end basis: 1

67 (1) -$10,000,000 as of April 30, 1996; (2) -$11,500,000 as of July 31, 1996; (3) -$10,500,000 as of October 31, 1996; (4) -$9,750,000 for all subsequent fiscal quarters. For purpose of calculating the financial covenants contained in this Section 6.13, Two Million Two Hundred Thousand Dollars (2,200,000) of Borrower's Consolidated Current Liabilities owed to Woolworth shall be excluded through April 30, 1997 unless one of the following events occurs during such period: (a) Borrower shall have settled its litigation with Woolworth, or (b) Borrower's parent, Kids Mart, Inc. (formerly Frost Hanna), shall have issued additional equity securities in either a public or private transaction. Upon consummation of either one or both of the events set forth in (a) or (b) above, whether prior to, on or after April 30, 1997, Foothill and Borrower shall amend this Section 6.13 to give effect to such event in the same manner that they utilized in establishing the covenants in Amendment Number One to Loan and Security Agreement dated as of February 1, 1996. 3. REPRESENTATIONS AND WARRANTIES. Borrower hereby affirms to Foothill that all of Borrower's representations and warranties set forth in the Agreement are true, complete and accurate in all respects as of the date hereof. 4. NO DEFAULTS. Borrower hereby affirms to foothill that no Event of Default has occurred and is continuing as of the date hereof. 5. CONDITION PRECEDENT. The effectiveness of this Amendment is expressly conditioned upon the following: (a) Payment by Borrower to Foothill of an amendment fee in the aggregate amount of Fifty Thousand Dollars ($50,000). The amendment fee shall be charged to Borrower's loan account pursuant to Section 2.5(d) of the Agreement and shall be payable on the date hereof. (b) Receipt by Foothill of an executed copy of this Agreement. 6. COSTS AND EXPENSES. Borrower shall pay to Foothill all of Foothill's out-of-pocket costs and expenses (including, without limitation, the fees and expenses of its counsel) arising in connection with the preparation, execution, and delivery of this Amendment and all related documents. 7. LIMITED EFFECT. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provisions of the Amendment shall govern. In all other respects, the Agreement as amended and supplemented hereby, shall remain in full force and effect. 2

68 8. COUNTERPARTS; EFFECTIVENESS. This Amendment may be executed in any number of counterparts and by different parties on separate counterparts, each of which when so executed and delivered shall be deemed to be an original. All such counterparts, taken together, shall constitute but one and the same Amendment. This Amendment shall become effective upon the execution of a counterpart of this Amendment by each of the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first set forth above. FOOTHILL CAPITAL CORPORATION, a California corporation By: /s/ MARTIN VALENCIA ------------------------------------ Title: Assistant Vice President -------------------------------- LFS ACQUISITION CORP., a Delaware corporation By: /s/ BERNARD TESSLER ------------------------------------ Bernard Tessler, President 3

69 The undersigned has executed a Continuing Guaranty in favor of Foothill Capital Corporation ("Foothill") respecting the obligations of LFS ACQUISITION CORP. ("Borrower") owing to Foothill. The undersigned acknowledges the terms of the above Amendment and reaffirms and agrees that: its Continuing Guaranty remains in full force and effect; nothing in such Continuing Guaranty obligates Foothill to notify the undersigned of any changes in the financial accommodations made available to Borrower or to seek reaffirmations of the Continuing Guaranty; and no requirement to so notify the undersigned or to seek reaffirmations in the future shall be implied by the execution of this reaffirmation. HOLTZMAN'S LITTLE FOLK SHOP, INC., a California corporation By: /s/ BERNARD TESSLER ------------------------------------- Bernard Tessler, President 4

70 AMENDMENT NUMBER FOUR TO LOAN AND SECURITY AGREEMENT This Amendment Number Four to Loan and Security Agreement ("Amendment") is entered into as of June 10, 1996, by and between FOOTHILL CAPITAL CORPORATION, a California corporation ("Foothill"), and LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), in light of the following: A. Borrower and Foothill have previously entered into that certain Loan and Security Agreement, dated as of May 31, 1996 (as amended, the "Agreement"). B. Borrower and Foothill desire to further amend the Agreement as provided for and on the conditions herein. NOW, THEREFORE, Borrower and Foothill hereby amend and supplement the Agreement as follows: 1. DEFINITIONS. All initially capitalized terms used in this Amendment shall have the meanings given to them in the Agreement unless specifically defined herein. 2. AMENDMENTS. (a) The final sentence of the definition of "Eligible Inventory" is hereby amended as follows: "Eligible Inventory shall not include obsolete items, restrictive or custom items, raw materials, work-in-process, components that are not part of finished goods, spare parts, packaging and shipping materials, supplies used or consumed in Borrower's business, Inventory subject to a security interest or lien in favor of any third Person, bill and hold goods, Inventory that is not subject to Foothill's perfected security interests, Inventory acquired on consignment, and slow moving Inventory which means Inventory held by Borrower in excess of the number of months for the periods set forth below: Number of Months ---------------- Prior to June 15, 1996 12 months June 15, 1996 through July 14, 1996 11 months July 16, 1996 through August 14, 1996 10 months August 15, 1996 through September 14, 1996 9 months 1

71 September 15, 1996 through October 14, 1996 8 months October 15, 1996 through November 14, 1996 7 months November 15, 1996 and at all times thereafter 6 months." (b) Section 2.1(a) of the Agreement is amended additional to the Borrowing Base an additional amount of $2,000,000 (the "Overadvance") from June 10, 1996 through February 1, 1997. Thereafter, the Borrowing Base shall not include any portion of the Overadvance. (c) The first sentence of Section 3.3 of the Agreement is hereby amended in its entirety to read as follows: "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 May 31, 1999 (the "Renewal Date") and automatically shall be renewed for successive one-year periods thereafter, unless sooner terminated pursuant to the terms hereof." (d) Section 3.5 of the Agreement is amended in its entirety to read as follows: "3.5 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 sixty days prior written notice to Foothill, to terminate this Agreement by paying to Foothill, in cash, the Obligations (including an amount equal to the full amount of the L/Cs or L/C Guarantees), together with a premium (the "Early Termination Premium") in an amount equal to (a) 3% of the Maximum Amount prior to June 1, 1997 (b) 2% of the Maximum Amount from June 1, 1998 until May 31, 1999; provided, however, if Borrower terminates this Agreement as the result of Foothill's material breach hereunder, no Early Termination Premium need be paid." (e) The following additional sections are added to the Agreement: "6.18 SUPPLIER TERMS. At all times on or after August 31, 1996, Borrower shall receive payment terms from its major suppliers and factors which will average not less than 30 days from invoice date." 2

72 "6.19 ADDITIONAL EQUITY. On or before September 30, 1996, Borrower shall have received proceeds from a private placement by Kids Mart, Inc. of equity securities for an amount of not less than $2,000,000 or shall have substantially completed such private placement." "6.20 COMPLIANCE WITH FINANCIAL PROJECTIONS. For the periods June 1996 through January 1997, Borrower must be within at least 85% of its financial projections for net revenues; earnings before interest, taxes, depreciation and amortization; and net income. For purposes of this Section 6.20, Borrower's projections shall be those projections most recently delivered by Borrower to Foothill prior to June 10, 1996." 3. REPRESENTATIONS AND WARRANTIES. Borrower hereby affirms to Foothill that all of Borrower's representations and warranties set forth in the Agreement are true, complete and accurate in all respects as of the date hereof. 4. NO DEFAULTS. Borrower hereby affirms to Foothill that no Event of Default has occurred and is continuing as of the date hereof. 5. CONDITION PRECEDENT. The effectiveness of this Amendment is expressly conditioned upon the following: (a) Receipt by Foothill of an executed copy of this Amendment. (b) Receipt by Foothill of a five year Warrant to purchase 100,000 shares of Common Stock of Borrower's parent, Kids Mart, Inc., a Florida corporation, in the form attached hereto. 6. FEES, COSTS AND EXPENSES. Borrower shall pay to Foothill: (a) all of Foothill's out-of-pocket costs and expenses (including, without limitation, the fees and expenses of its counsel) arising in connection with the preparation, execution, and delivery of this Amendment and all related documents, and (b) the following fees for this Amendment and the Overadvance: (1) $15,000 per month for the months of June 1996 through January 1997 which fee is payable on the first day of each month in advance; and (2) $7,500 for each month that any portion of the Overadvance is outstanding (and an additional $7,500 for each month in which the Overadvance exceeds $1,000,000 on any day), which fees are payable on the first day of each month in arrears. 7. LIMITED EFFECT. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provisions of this Amendment shall govern. In all other respects, the Agreement, as amended and supplemented hereby, shall remain in full force and effect. 8. COUNTERPARTS; EFFECTIVENESS. This Amendment may be executed in any number of counterparts and by different parties on separate counterparts, each of which when so executed and delivered shall be deemed to be an original. All such 3

73 counterparts, taken together, shall constitute but one and the same Amendment. This Amendment shall become effective upon the execution of a counterpart of this Amendment by each of the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of the date first set forth above. FOOTHILL CAPITAL CORPORATION, a California corporation By: /s/ MARTIN VALENCIA ------------------------------------ Title: Assistant Vice President -------------------------------- LFS ACQUISITION CORP., a Delaware corporation By: /s/ BERNARD TESSLER ------------------------------------ Bernard Tessler, President 4

74 The undersigned has executed a Continuing Guaranty in favor of Foothill Capital Corporation ("Foothill") respecting the obligations of LFS ACQUISITION CORP. ("Borrower") owing to Foothill. The undersigned acknowledges the terms of the above Amendment and reaffirms and agrees that: its Continuing Guaranty remains in full force and effect; nothing in such Continuing Guaranty obligates Foothill to notify the undersigned of any changes in the financial accommodations made available to Borrower or to seek reaffirmations of the Continuing Guaranty; and no requirement to so notify the undersigned or to seek reaffirmations in the future shall be implied by the execution of this reaffirmation. HOLTZMAN'S LITTLE FOLK SHOP, INC., a California corporation By: /s/ BERNARD TESSLER ------------------------------------- Bernard Tessler, President 5

75 AMENDMENT NO. FIVE TO THE LOAN AND SECURITY AGREEMENT LFS ACQUISITION CORP. This Amendment No. Five To The Loan And Security Agreement (the "Amendment") is entered into as of the 19th day of July, 1996, by and between LFS ACQUISITION CORP., a Delaware corporation ("Borrower"), whose chief executive office is located at 801 Sentous Avenue, City of Industry, California 91748 and 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, in light of the following facts: FACTS FACT ONE: Foothill and Borrower have previously entered into that certain Loan And Security Agreement, dated May 31, 1995 (as amended and supplemented, the "Agreement"). FACT TWO: Foothill and Borrower desire to further amend the Agreement as provided herein. Terms defined in the Agreement which are used herein shall have the same meanings as set forth in the Agreement, unless otherwise specified. NOW, THEREFORE, Foothill and Borrower hereby modify and amend the Agreement as follows: 1. Section 2.1(a) of the Agreement is hereby amended to extend the $2,000,000 Overadvance period from June 10, 1996 through February 15, 1997. Thereafter, the Borrowing Base shall not include any portion of the Overadvance. 2. Foothill shall charge Borrower's loan account a fee in the amount of $250.00 upon execution and delivery to Foothill of this Amendment. Said fee shall be fully-earned, non-refundable, and due and payable on the date Borrower's loan account is charged. 3. In the event of a conflict between the terms and provisions of this Amendment and the terms and provisions of the Agreement, the terms and provisions of this Amendment shall govern. In all other respects, the Agreement, as supplemented, amended and modified, shall remain in full force and effect. 1

76 IN WITNESS WHEREOF, Borrower and Foothill have executed this Amendment as of the day and year first written above. FOOTHILL CAPITAL CORPORATION LFS ACQUISITION CORP. a California corporation a Delaware corporation By /s/ MARTIN VALENCIA By /s/ BERNARD TESSLER ------------------------------ ------------------------------ Martin P. Valencia Bernard Tessler Its Assistant Vice President Its President ----------------------------- ----------------------------- ------------------------------------------------------------------------------- By its acceptance below this 24 day of July, 1996, the undersigned guarantor hereby reaffirms its Continuing Guaranty dated May 31, 1995 and consents to the above-stated terms. HOLTZMAN'S LITTLE FOLK SHOP, INC. a California corporation By /s/ BERNARD TESSLER ------------------------------ Bernard Tessler Its President ----------------------------- 2

1 Exhibit 10.6 [CSI LOGO] MASTER LEASE AGREEMENT NUMBER 143050 COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard MAILING ADDRESS: St. Louis, Missouri 63141 Post Office Box 16264 (314) 997-7010 St. Louis, MO 63105 In California: CSI Leasing Inc. In Florida: CSI Computer Sales, Inc. MASTER LEASE AGREEMENT dated as of July 24, 1996 by and between COMPUTER SALES INTERNATIONAL, INC. (hereinafter called "Lessor") having its principal office and place of business at 10845 Olive Boulevard, St. Louis, Missouri 63141, and KIDS MART, INC. ---------------------------------------------------------------------------- (hereinafter called "Lessee") having its principal office and place of business at 801 Sentous Avenue, City of Industry, California 91748 IN CONSIDERATION of the mutual agreements hereinafter set forth and the payment of rent as herein provided for, the parties hereto agree as follows: 1. LEASE AGREEMENT Lessor hereby leases to Lessee and Lessee hereby leases from Lessor all of the equipment and other tangible personal property described in each of the Equipment Schedules which are executed from time to time by Lessor and Lessee pursuant to this Master Lease. Each Equipment Schedule shall constitute a separate lease on the terms and conditions stated therein and, to the extent not inconsistent with the Equipment Schedule, on the terms and conditions stated in the Master Lease which shall be incorporated by reference in the Equipment Schedule. The term "Equipment" as used herein shall mean, with respect to any Equipment Schedule, the Equipment described therein. The term "Unit" as used herein shall mean an individual machine on an Equipment Schedule or an individual feature when such feature is leased separately from a machine. The term of this Master Lease shall begin on the date set forth above and shall continue in effect so long as any Equipment Schedule entered into pursuant to this Master Lease remains in effect. 2. TERM 2.1 COMMENCEMENT DATE: The commencement date ("Commencement Date") for each Unit of Equipment will be the date on which such Unit is installed by the manufacturer or other installer, except that, in the event there is a delay in the installation of a Unit and such delay is attributable to Lessee, then the Commencement Date for such Unit shall be five (5) working days following the date upon which Lessee has been given notice that such Unit is available for installation. If requested by Lessor, Lessee will promptly execute and deliver to Lessor a certificate confirming the Commencement Date(s). 2.2 INITIAL TERM: The "Initial Term" of an Equipment Schedule shall mean the period beginning on the Commencement Date of the Unit having the latest Commencement Date of the Units on such Equipment Schedule if such Commencement Date is the first day of a month, and otherwise, the Initial Term shall begin on the first day of the month immediately following the month in which such latest Commencement Date falls. The Initial Term of an Equipment Schedule shall continue for the number of months specified therein and shall automatically be extended for successive four month periods thereafter at the same Monthly Rental unless and until terminated by either party giving the other party not less than 120 days prior written notice. Any termination (i) must relate to all of the Equipment described on the Equipment Schedule to which the notice applies, (ii) will be effective only on the last day of the Initial Term or on the last day of any successive four month period, (iii) will be effective only if Lessee returns all of the Equipment to Lessor in accordance with the terms of the Equipment Schedule by the day after the scheduled termination date, and (iv) may not be unilaterally revoked. 3. MONTHLY RENTAL Lessee shall pay to Lessor the monthly rental ("Monthly Rental") for each Unit as set forth in the relevant Equipment Schedule. The Monthly Rental shall be payable at the above mailing address of Lessor or at such other place as Lessor may from time to time designate in a written notice to Lessee. The Monthly Rental for each Unit shall commence on the Commencement Date of such Unit and shall be due and payable in advance and without demand on the first day of each month thereafter during the term of this Lease. If the Commencement Date for a Unit is a day other than the first day of a month, Daily Rental shall be payable ("Daily Rental" shall equal one-thirtieth of the Monthly Rental for such Unit) for each day from, and including, the Commencement Date to, but not including, the first day of the Initial Term, and such total Daily Rental amount shall be due and payable on the first day of the Initial Term. 4. WARRANTIES 4.1 AFFIRMATIVE WARRANTIES: Lessor represents and warrants that: (a) The Equipment shall be eligible for the manufacturer's standard prime shift maintenance contract upon installation, provided Lessee requests such coverage in writing prior to installation of the Equipment. (b) During the term of this Master Lease, if no Event of Default has occurred, Lessee's quiet enjoyment and peaceable possession of the Equipment shall not be interrupted by Lessor or anyone claiming solely through or under Lessor. 4.2 DISCLAIMER OF WARRANTIES: THE AFFIRMATIVE WARRANTIES SET FORTH ABOVE ARE IN LIEU OF ALL OTHER WARRANTIES OF LESSOR. LESSOR MAKES NO OTHER WARRANTIES, EXPRESS OR IMPLIED, AS TO ANY MATTER WHATSOEVER, INCLUDING, WITHOUT LIMITATION, THE DESIGN OR CONDITION OF THE EQUIPMENT, ITS MERCHANTABILITY, FITNESS, CAPACITY OR SUITABILITY FOR Page No. 1 of 6

2 ANY PARTICULAR PURPOSE, THE QUALITY OF THE MATERIAL OR WORKMANSHIP OF THE EQUIPMENT, OR CONFORMITY OF THE EQUIPMENT TO THE PROVISIONS AND SPECIFICATIONS OF ANY PURCHASE ORDER OR ORDERS RELATING THERETO. Without limiting the generality of the foregoing, Lessor shall not be liable to Lessee for any liability, claim, loss, damage or expense of any kind or nature [including strict liability in tort] caused directly or indirectly by the Equipment, any inadequacy thereof for any purpose, any deficiency or defect therein, whether known or unknown to Lessor. In any event, Lessor shall not be liable to Lessee for any loss of business or any other incidental or consequential loss or damage resulting from any cause whatsoever. 4.3 ASSIGNMENT OF WARRANTIES: Lessor hereby assigns to Lessee any and all manufacturer's warranties, if assignable, and any other such rights that are assignable as Lessor may have against the manufacturer of the Equipment provided, however, that Lessee's sole remedy for the breach of any such warranty or right shall be against the manufacturer and not Lessor. 4.4 SELECTION: Lessee acknowledges, represents and warrants that it has made the selection of the Equipment based on its own judgment and expressly disclaims any reliance upon statements made by the Lessor. The Equipment is being leased for commercial or business purposes only, and will not be used for consumer, personal, home, or family purposes. 5. NET LEASE Each Equipment Schedule constitutes a net lease. Lessee shall be solely responsible for all costs and expenses of every nature arising out of the possession, use, and operation of the Equipment. Lessee's obligation to pay the Monthly Rental and all other sums due hereunder shall be absolute and unconditional and shall not be subject to any setoff, abatement, counterclaim, recoupment, defense, cancellation, repudiation, rejection of Equipment, revocation of acceptance of Equipment or any other right that Lessee may have against Lessor. Except as expressly provided for herein, neither this Master Lease, nor any Equipment Schedule, shall terminate nor shall the obligations of Lessee be affected by reason of any defect in, damage to, or any loss or destruction of the Equipment or any Unit from any cause whatsoever, or the interference with the use thereof by any private person, corporation, or governmental authority or as a result of any war, riot, insurrection or Act of God. It is the express intention of Lessor and Lessee that all Monthly Rental payable by Lessee under each Equipment Schedule shall be, and continue to be, payable in all events throughout the term thereof. 6. TAXES 6.1 PAYMENT OF TAXES: Lessee covenants and agrees to pay to the appropriate taxing authority, and discharge before the same become delinquent, all taxes, fees, or other charges of any nature whatsoever, without pro-ration, together with any related interest or penalties ["Impositions"] now or hereafter imposed, assessed or payable during the term of the relevant Equipment Schedule including any extension thereof (or an imposition relating to a record date or status date that fell within the term of the relevant Equipment Schedule including any extension thereof or is otherwise associated with Lessee's leasing, possession or use of the Equipment) against Lessor, Lessee or the Equipment by any federal, state, county or local government or taxing authority upon or with respect to [i] the Equipment or any Unit, [ii] upon the leasing, ordering, purchase, sale, ownership, use, operation, return or other disposition thereof, [iii] the Monthly Rental or any other sums due hereunder with respect to any Equipment Schedule, or [iv] the leasing of the Equipment [excepting only federal, state and local taxes measured by the net income of Lessor or any franchise tax upon Lessor measured by Lessor's capital, capital stock or net worth]. Because the payment due date or reimbursement date for an imposition may occur after the expiration or termination of the term of the relevant Equipment Schedule, it is understood and agreed that Lessee's liability for such impositions shall survive the expiration or termination of the term of the relevant Equipment Schedule. 6.2 BILLING: Lessee shall, to the extent permitted by law, cause all impositions to be billed to Lessee. Lessee shall, at its expense, timely file all forms and returns and timely do all things required to be done in connection with the levy, assessment and payment of any impositions, and Lessor hereby appoints Lessee as Lessor's attorney-in-fact where necessary for such purposes. Lessee shall submit written evidence to Lessor of the payment of all impositions required to be paid by Lessee hereunder promptly after such payment. Notwithstanding the foregoing, Lessor, in its sole discretion, may pay any imposition itself or file any forms or returns with respect thereto. If Lessor pays any imposition, Lessee shall, when billed, reimburse Lessor for such payment. 6.3 CONTEST: Lessee may contest any imposition by appropriate legal proceedings provided the nonpayment of such imposition thereof, or such proceedings, will not, in the opinion of counsel for Lessor, adversely affect the title, property interest or rights of Lessor in the Equipment and provided further that, if requested by Lessor, Lessee has given to Lessor security, sufficient in form and amount, in Lessor's reasonable judgment, to fully satisfy the amount of the contested imposition. 7. DELIVERY AND RETURN Lessor shall arrange for delivery, and Lessee shall pay, when billed, all delivery expenses [including, without limitation, transportation costs and the cost of in-transit insurance] associated with the delivery of each Unit from its previous location to the location specified in the relevant Equipment Schedule. Lessee shall inspect each Unit upon delivery, identify any observable damage prior to accepting delivery, and note any such damage on the bill of lading. Costs of repair which are not recoverable from the carrier because of Lessee's failure to properly inspect for observable damage shall be borne and promptly paid by Lessee. Lessee shall provide a suitable place for installation of the Equipment with all appropriate facilities as specified by the manufacturer. Lessor shall arrange and Lessee shall pay for the installation of each Unit [if Lessee wishes to have the Equipment installed by an installer other than the manufacturer or some other party approved in writing by Lessor, then Lessee shall accept the Equipment "as is" and Lessor's warranty set forth in Paragraph 4.1 (a) shall not apply]. Upon the termination of Lessee's right to possession of any Unit [by expiration of the term of the relevant Equipment Schedule or otherwise], Lessee shall, in accordance with Lessor's instructions and at Lessee's expense [including without limitation transportation costs and costs of in-transit insurance] return the Unit to such location within the Continental United States as shall be designated by Lessor. Lessee shall reimburse Lessor for all expenses paid by Lessor associated with return of the Unit when billed. Lessee shall return each Unit in the same operating order, repair, condition and appearance as when received, excepting only normal wear and tear, and with all engineering changes prescribed by the manufacturer prior to the termination of Lessee's right of possession incorporated in the Unit. Lessee, at its expense, shall make any repairs necessary in order to certify the Equipment as eligible for the manufacturer's prime shift maintenance contract upon its return and shall have the Unit certified as eligible for the same. At the time the Equipment is returned, Lessee shall provide a letter from the manufacturer certifying such maintenance eligibility. 8. CARE OF EQUIPMENT 8.1 USE AND MAINTENANCE: Lessee shall, at its expense, maintain the Equipment in good operating order, repair, and condition. Lessee shall not use the Equipment for any purpose other than that for which it was designed. Prior to the delivery date and before any action is taken to install the Equipment, Lessee shall make a written request to the manufacturer for continued coverage of the Equipment under one of the manufacturer's standard maintenance agreements, and shall, at its expense, enter into and maintain in force such maintenance agreement for each Unit and provide Lessor with a copy of such agreement. IF LESSEE FAILS TO MAKE THE PROPER WRITTEN REQUEST TO THE MANUFACTURER FOR COVERAGE UNDER ONE OF THE MANUFACTURER'S STANDARD MAINTENANCE Page No. 2 of 6

3 AGREEMENTS, THEN LESSEE SHALL ACCEPT THE EQUIPMENT "AS IS" AND LESSOR'S WARRANTY SET FORTH IN PARAGRAPH 4.1(A) SHALL NOT APPLY. In no event, however, shall Lessee be required to enter into such a contract for any Unit so long as that Unit is under a manufacturer's warranty which provides substantially similar coverage. 8.2 ALTERATIONS AND ATTACHMENTS: With the prior written consent of the Lessor, Lessee may, at its expense, make alterations or add attachments to the Equipment which are removable and which do not interfere with the normal and satisfactory operation or maintenance of the Equipment or Lessee's ability to obtain the maintenance contract required in Section 8.1 above. Upon the termination of Lessee's right to possession of any Unit, any alterations or attachments to such Unit shall become the property of Lessor unless removed at Lessee's expense prior to such termination. Lessor shall have the right, following termination of Lessee's right to possession of any Unit, to remove any attachments or alterations made by Lessee to such Unit and dispose of the same without any liability therefor to Lessee and Lessee shall pay the costs of such removal when billed. 8.3 INSPECTION: Lessee shall make the Equipment available to Lessor, Secured Party (hereinafter defined) and Assignee (hereinafter defined) or the designees of any of them during normal working hours for inspection or for any other reasonable purpose. 9. LOSS OR DAMAGE 9.1 RISK OF LOSS: Lessee shall be responsible for and hereby assumes the entire risk of the Equipment being lost, damaged, destroyed, stolen, or otherwise rendered unfit or unavailable for use from the date of delivery to Lessee to the date of return to Lessor. 9.2 OCCURRENCE OF LOSS: If any Unit is lost, damaged, destroyed, stolen, or otherwise rendered unfit for use, Lessee shall give to Lessor immediate notice thereof, and this Master Lease and the applicable Equipment Schedule shall continue in full force and effect without any abatement in the Monthly Rental. Lessee shall determine within fifteen (15) days after the date of the occurrence of damage whether such Unit can be repaired. In the event Lessee determines that such Unit can be repaired, Lessee, at its expense, shall cause such Unit to be promptly repaired. If a Unit is lost, destroyed or stolen or if Lessee determines that a damaged Unit cannot be repaired, Lessee shall, at Lessor's direction, within thirty (30) days of such event either replace the Unit with an identical Unit, the title to which shall thereupon vest in Lessor and which thereafter shall be considered the Unit subject to the Equipment Schedule with no abatement in the Monthly Rental or, in Lessor's sole discretion, pay to Lessor an amount equal to the Stipulated Loss Value of the Unit determined as of the date of payment in accordance with the Stipulated Loss Value Schedule attached to the applicable Equipment Schedule together with all unpaid Monthly Rental which is due and payable through the date of payment. Upon such payment, Lessee's obligation to pay further Monthly Rental for such Unit shall cease. 10. INSURANCE 10.1 PROPERTY INSURANCE: Throughout the term of each Equipment Schedule, Lessee shall, at its expense, maintain in full force and effect "all risk" extended coverage, fire and casualty insurance for the Equipment. Such insurance shall provide for coverage in an amount equal to the greater of the Stipulated Loss Value or the replacement cost of the Equipment at the time of loss. Lessor shall be named as the Loss Payee on such policy. In addition, the policy shall, by means of a standard mortgage clause, name the Secured Party and Assignee as additional insureds and loss payees as their interest shall appear. Such policy shall provide that it may not be canceled or materially altered unless thirty (30) days prior written notice is given to all parties named therein. Upon Lessor's written request, Lessee shall provide Lessor with a Certificate of Insurance evidencing such insurance coverage. If, within two weeks after Lessee's receipt of such request, Lessee has not provided Lessor with a satisfactory Certificate, then Lessor may, at Lessor's option, obtain such insurance until Lessee provides the Certificate, and Lessee shall reimburse Lessor for the cost of such insurance when billed. 10.2 LIABILITY INSURANCE: During the term of this Master Lease, Lessee, at its expense, shall maintain reasonable, commercial general liability and property damage insurance with respect to the use, possession and operation of the Equipment in an amount not less than one million dollars for each occurrence. 11. INDEMNIFICATION Lessee shall and does hereby indemnify and hold Lessor, any Assignee, and any Secured Party, harmless from and against any and all claims, costs, reasonable attorneys' fees, expenses, damages, and liabilities (including those resulting from the application of strict liability doctrines or statutes) arising out of Lessee's selection, possession, leasing, operation, control, use, maintenance, delivery, or return of the Equipment. Notwithstanding the foregoing, Lessee shall not be required to indemnify a party for any claim resulting from acts of that party which constitute willful misconduct or gross negligence. 12. ASSIGNMENT, SUBLEASE OR RELOCATION BY LESSEE UPON AT LEAST THIRTY (30) DAYS PRIOR WRITTEN NOTICE TO LESSOR, LESSEE MAY ASSIGN OR SUBLEASE A UNIT TO ANY PARTY, OR RELOCATE A UNIT TO ANY LOCATION, WITHIN ANY STATE OF THE CONTINENTAL UNITED STATES, PROVIDED THAT LESSOR, ASSIGNEE, AND SECURED PARTY, IN SUCH PARTIES' SOLE DISCRETION, SHALL HAVE APPROVED SUCH ASSIGNEE, SUBLESSEE, OR LOCATION, AND PROVIDED FURTHER THAT (i) ALL COSTS OF ANY NATURE WHATSOEVER (INCLUDING ANY ADDITIONAL IMPOSITIONS AND ANY ADDITIONAL EXPENSES ASSOCIATED WITH FILING NEW PRECAUTIONARY UNIFORM COMMERCIAL CODE FINANCING STATEMENTS) RESULTING FROM ANY RELOCATION, ASSIGNMENT OR SUBLEASE SHALL BE BORNE BY LESSEE; (ii) ANY ASSIGNMENT OR SUBLEASE SHALL BE MADE EXPRESSLY SUBJECT AND SUBORDINATE TO THE TERMS OF THIS LEASE; AND (iii) LESSEE SHALL ASSIGN ITS RIGHTS UNDER SUCH ASSIGNMENT OR SUBLEASE TO LESSOR, ASSIGNEE, OR SECURED PARTY AS ADDITIONAL COLLATERAL AND SECURITY FOR LESSEE'S OBLIGATIONS HEREUNDER. In the event of a relocation, assignment, or sublease, Lessee and its assignee or its sublessee shall cooperate with Lessor in taking all reasonable measures to protect the title of Lessor or Assignee and the interest of any Secured Party to and in the Equipment. No relocation, assignment, or sublease shall relieve Lessee of its primary obligations under the relevant Equipment Schedule and this Master Lease. 13. ASSIGNMENT BY LESSOR Lessor shall have the right to assign as security its interest or grant a security interest in any or all of the Equipment Schedules which may from time to time be executed and the Units described in any such Equipment Schedules to a security assignee ("Secured Party"). Lessor shall also have the right to sell or otherwise dispose of any or all of the Units described in any Equipment Schedule, subject to the prior right of Lessee in such Units, and to assign its interest as Lessor under such Equipment Schedule, to any assignee ("Assignee"). Any such assignment shall not in any way release Computer Sales International, Inc. from liability for performance of the Lessor's obligations hereunder. Lessee acknowledges that any assignment by Lessor will not materially change Lessee's duties or obligations under the Equipment Schedule nor materially increase the burden or risk imposed on Lessee. Lessee hereby consents to and shall acknowledge such assignment or assignments as shall be designated by written notice to Lessee by Lessor. Lessee further covenants and agree that: (a) Any such Secured Party or Assignee shall have and be entitled to exercise any and all discretions, rights and powers of Lessor under the Equipment Schedule in which it has an interest, provided that a Secured Party or Assignee shall not be obligated to perform any of the obligations of Lessor other than Lessor's obligations under Paragraph 4.1(b). (b) Lessee shall pay directly to the Secured Party or Assignee all Monthly Rental and all other sums due upon receipt of notice of any assignment and of instructions to do so; and Page No. 3 of 6

4 (c) After an assignment to a Secured Party or Assignee, Lessee's obligations hereunder including its obligation to pay the Monthly Rental and any and all other amounts payable under the Equipment Schedule by Lessee shall be absolute and unconditional and shall not be subject to any abatement, reduction, recoupment, defense, setoff, or counterclaim available to Lessee against Lessor for any reason whatsoever. (d) Only one executed counterpart of any Equipment Schedule shall be marked "Original"; any other executed counterparts shall be marked "Non-original" or "Copy". No security interest in any Equipment Schedule may be created through the transfer and possession of any counterpart other than the "Original", nor shall any sale, assignment or transfer of any interest in an Equipment Schedule be effective or be binding upon Lessee through the transfer and possession of any counterpart other than the "Original". 14. EVENTS OF DEFAULT The occurrence of any one or more of the following events ("Events of Default") shall constitute a default under the relevant Equipment Schedule: (a) Lessee fails to pay the Monthly Rental, or any other amount due hereunder, on or before the date the same is due and such failure continues for a period of ten (10) days after receipt of written notice thereof from Lessor; (b) any financial statements or information or any other representation or warranty given to Lessor proves to have been materially false or misleading as of the date it was given by or on behalf of Lessee; (c) Lessee fails to observe or perform any other material term, condition, obligation, agreement or covenant set forth herein, and such failure continues for a period of ten (10) days after receipt of written notice thereof from Lessor; (d) Lessee assigns or attempts to assign this Master Lease or any Equipment Schedule, or removes, transfers, encumbers, sublets or parts with possession of any Unit, attempts to do any of the foregoing, or suffers or permits any of the foregoing to occur except as expressly permitted herein; (e) Lessee ceases doing business as a going concern, or it or its shareholders take any action looking to its dissolution or liquidation; (f) the entry of an order for relief under the United States federal bankruptcy laws or the entry of any other decree or order by a court having jurisdiction in the premises adjudging the Lessee a bankrupt or insolvent, or approving as properly filed a petition seeking reorganization, arrangement, adjustment or composition of or in respect of the Lessee under the United States federal bankruptcy laws or any other applicable federal or state law, or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator (or other similar official) of the Lessee or of any substantial part of its property, or the ordering, the winding up or liquidation of its affairs, and the continuance of any such decree or order unstayed and in effect for a period of 60 consecutive days; (g) the commencement by the Lessee of a voluntary case under the United States federal bankruptcy laws, or the institution by the Lessee of proceedings to be adjudicated a bankrupt or insolvent, or the consent by it to the institution of bankruptcy or insolvency proceedings against it, or the filing by it of a petition or answer or consent seeking reorganization, an arrangement with creditors or an order for relief under the United States federal bankruptcy laws or any other applicable federal or state law, or the consent by it to the filing of any such petition or to the appointment of a receiver, liquidator, assignee, trustee, custodian, sequestrator (or other similar official of the Lessee or of any substantial part of its property, or the making by it of an assignment for the benefit of creditors, or the admission by it in writing of its inability to pay its debts as they become due, or, to the knowledge of the Lessor, the taking of corporate action by the Lessee in furtherance of any such action. 15. REMEDIES 15.1 EXPRESS REMEDIES: If an Event of Default occurs, Lessor may, at is option, do any or all of the following: (a) proceed by appropriate court action or actions either at law or in equity to enforce performance by Lessee of the relevant Equipment Schedule, and the covenants and terms of this Master Lease to the extent it pertains to such Equipment Schedule, and to recover from Lessee any and all damages or expenses, including reasonable attorneys' fees, which Lessor shall have sustained or incurred by reason of the Event of Default or on account of Lessor's enforcement of its remedies hereunder, or (b) by notice to Lessee, declare immediately due and payable all monies to be paid by Lessee during the Initial Term (or any extended term then in effect) of the Equipment Schedule, as liquidated damages, and not as a penalty, and Lessor shall have the right, to the extent permitted by law, to (i) recover all monies so declared due and payable, discounted to the date of payment at the rate of 4% per annum, or one-half of the then-prevailing prime interest rate charged by principal New York banks, whichever is less, as liquidated damages, and not as a penalty; (ii) recover all other amounts which are due or which become due under the Equipment Schedule; (iii) terminate Lessee's right to possession (but not Lessee's obligation under this Lease) and to retake immediate possession of the Equipment without any process of law and for such purpose Lessor may enter upon premises where the Equipment may be located and may remove the same therefrom without notice, and without being liable to Lessee therefor, except that Lessor shall be liable for damages resulting from the negligence of Lessor, Lessor's assignee or their respective agents and representatives in any such entry or repossession; (iv) recover all expenses, including reasonable attorneys' fees, which Lessor shall have incurred or may incur by reason of the Event of Default on account of Lessor's endorsement of its remedies hereunder; and (v) pursue any other remedy permitted by law or equity. The possibility of a re-lease or resale under Paragraph 15.2 shall not excuse prompt payment in full by Lessee under this Paragraph 15.1. 15.2 RE-LEASE OR RESALE: Lessor shall made a reasonable, good faith effort to retake possession of the Equipment and, if Lessor succeeds in retaking possession of any Unit, Lessor shall sell or lease each Unit with the privilege of becoming the purchaser thereof, at public of private sale, for cash or on credit. Lessee's share of the proceeds of any such sale or lease ("Lessee's Share") shall be the lesser of (x), the amount by which the Re-Lease Proceeds or the Resale Proceeds of such Unit exceed the Remarketing Costs of such Unit, and (y), the amount payable by Lessee to Lessor pursuant to Paragraph 15.1 (b)(i) above with respect to such Unit. Lessor shall credit Lessee's Share against all amounts owed by Lessee to Lessor under Paragraph 15.1 or otherwise and the remainder of Lessee's share, if any, shall be paid to Lessee. EXCEPT AS SET FORTH IN THIS PARAGRAPH, LESSEE HEREBY WAIVES ANY RIGHTS NOW OR HEREAFTER CONFERRED BY STATUTE OR OTHERWISE WHICH MAY REQUIRE LESSOR TO MITIGATE ITS DAMAGES OR MODIFY OR LIMIT ANY OF LESSOR'S RIGHTS OR REMEDIES STATED HEREIN. In applying this provision, the following definitions shall apply: (a) The "Re-Lease Proceeds" of a Unit shall mean the present value (discounted to the date of payment using the interest rate at which Lessor has non-recourse financing or a non-recourse financing commitment with respect to the re-lease) of the monthly rental payments for the Unit under a re-lease to a third party, taking into account only those monthly rental payments under the re-lease which are payable on or before the last day of the Initial Term or the last day of any extended term then in effect with respect to the Unit under the Equipment Schedule. If the re-lease is not financeable, the Re-Lease Proceeds shall be the monthly rental payments for such period as received. (b) The term "Resale Proceeds" of a Unit shall mean the amount by which the proceeds of any sale of the Unit exceed the Lessor's estimate of the fair market value of the Unit at the end of the Initial Term or at the end of any extended term then in effect with respect to the Unit under this Master Lease. (c) The term "Remarketing Costs" of a Unit shall mean all expenses incurred directly or indirectly by Lessor in re-leasing or selling the Unit and in obtaining a financing commitment in the case of a re-lease of a Unit, including, without limitation, reasonable fees and commissions (including a reasonable fee to Lessor) incurred in locating a buyer, a subsequent lessee or a financing Page No. 4 of 6

5 commitment, attorneys' fees, the cost of recovering the Unit from the Lessee and transportation, installation, refurbishing, reconditioning and storage charges. 15.3 NO WAIVER: The waiver by Lessor of any breach of any obligation of Lessee shall not be deemed a waiver of a breach of any other obligation or of any subsequent breach of the same or any other obligation. The subsequent acceptance of rental payments hereunder by Lessor shall not be deemed a waiver of any prior existing breach by Lessee regardless of Lessor's knowledge of such prior existing breach at the time of acceptance of such rental payments. 15.4 CUMULATION: To the extent permitted by law, the above remedies shall be deemed cumulative and may be exercised successively or concurrently. 16. PERFORMANCE AND EXECUTION Lessee represents and warrants to Lessor (i) that the execution and performance of this Master Lease and each Equipment Schedule have been duly authorized by Lessee and that upon execution by Lessee and Lessor this Master Lease and each Equipment Schedule will constitute a valid obligation binding upon, and enforceable against, Lessee in accordance with the terms of the Master Lease and each Equipment Schedule; (ii) that neither the execution of this Master Lease or any Equipment Schedule nor the due performance thereof by Lessee will result in any breach of, or constitute any default under or violation of, Lessee's certificate or articles of incorporation, Lessee's by-laws or any agreement to which Lessee is a party or by which any interest of Lessee may be affected; (iii) that Lessee is in good standing in its state of incorporation and in the states where any Unit is to be located; (iv) the persons executing this Master Lease and each Equipment Schedule on behalf of Lessee have been duly authorized to do so; and (v) that any and all financial statements and other information with respect to Lessee heretofore furnished by Lessee to Lessor in connection with negotiations concerning one or more Equipment Schedules were, when furnished, and remain at the time of execution of any Equipment Schedule, true and without any misleading omissions, excepting any changes which have been disclosed in a written notice to Lessor. 17. ADDITIONAL DOCUMENTATION Lessee shall promptly deliver to Lessor the documentation listed below which may from time to time be requested by Lessor. If such a request is made prior to the delivery of any Unit, receipt of such documentation shall be a condition precedent to Lessor's obligation to deliver such Unit: (a) financial information including, without limitation, a copy of Lessee's balance sheet and income statement for Lessee's three prior fiscal years, certified by independent certified public accountants and such other current financial information representing the financial condition and operations of Lessee as Lessor may from time to time reasonably request; (b) a certificate of the resolutions of the Board of Directors of Lessee duly authorizing or ratifying this Master Lease or any Equipment Schedule executed hereunder; (c) a certificate of incumbency setting forth names and signatures of those persons authorized to execute this Master Lease or any Equipment Schedule on behalf of Lessee; (d) landlord's and/or mortgagee's waiver, in form and substance satisfactory to any Assignee or Secured Party, from any landlord or mortgagee of any premises upon which any Unit is located; (e) an opinion of counsel for Lessee as to the matters set forth in Paragraph 16. (i through iv) above, and as to such other matters as Lessor may reasonably request; and (f) such document confirming the execution of the Lease necessary or desirable to effect an assignment, to perfect an interest of Lessor, a Secured Party or Assignee, or for such other purpose relating to the Master Lease and/or any Equipment Schedule or to an assignment as Lessor may reasonably request. Lessee hereby appoints Lessor as Lessee's agent to prepare, execute and file in Lessee's name precautionary Uniform Commercial Code financing statements in connection with each Equipment Schedule showing the interest of Lessor, and any Assignee or Secured Party in the Equipment as appropriate. 18. GENERAL 18.1 TITLE: This Master Lease is intended to be a true lease and not a lease intended as security or lease in the nature of a security interest. Lessee shall, at its expense, protect and defend Lessor's title to the Equipment and the interest of any Assignee or Secured Party against all persons claiming against or through Lessee. Lessee shall keep and maintain the Equipment and this Master Lease free and clear of all liens and encumbrances (other than those placed on the same by Lessor and the liens for current taxes not yet payable). 18.2 FIXTURES: Lessee will not affix any Unit of the Equipment to any real property if, as a result thereof, the Unit will become a fixture under applicable law. 18.3 ENTIRE AGREEMENT: This Agreement (together with all schedules and attachments hereto) constitutes the entire agreement between Lessor and Lessee, and no provision hereof may be amended or modified except in writing signed by Lessor and Lessee. NO PROVISION OF THIS AGREEMENT MAY BE WAIVED EXCEPT IN WRITING SIGNED BY THE PARTY FROM WHOM SUCH WAIVER IS SOUGHT, AND ANY SUCH WAIVER SHALL BE EFFECTIVE ONLY IN THE SPECIFIC INSTANCE AND FOR THE SPECIFIC PURPOSE GIVEN. LESSEE'S INITIALS: BS ------ 18.4 NOTICES: All notices hereunder shall be in writing and shall be delivered in person or sent by registered or certified mail, to the address of the party contained herein, and shall be deemed received three (3) days after deposit in the United States mail with postage prepaid. Either party may change its address for notice purposes by notifying the other party in the manner aforesaid of such change. Lessee shall also send copies of all notices sent to Lessor, to Secured Party, or Assignee (if any). 18.5 SEVERABILITY: Any provision hereof prohibited by, or unlawful or unenforceable under, any applicable law of any jurisdiction shall be ineffective as to such jurisdiction without invalidating the remaining provisions of this Agreement provided, however, that where the provisions of any such applicable law may be waived, they are hereby waived by Lessee and Lessor to the full extent permitted by law. 18.6 GOVERNING LAW: THIS MASTER LEASE AND ALL EQUIPMENT SCHEDULES AND ANY OTHER INSTRUMENT EXECUTED IN CONNECTION HEREWITH SHALL BE GOVERNED BY, AND CONSTRUED AND INTERPRETED UNDER, THE LAWS OF THE STATE OF MISSOURI, WITHOUT GIVING EFFECT TO PRINCIPLES OF CONFLICTS OR CHOICE OF LAW. NO RIGHTS OR REMEDIES REFERRED TO IN ARTICLE 2A OF THE UNIFORM COMMERCIAL CODE WILL BE CONFERRED ON LESSEE UNLESS EXPRESSLY GRANTED IN THIS MASTER LEASE OR AN EQUIPMENT SCHEDULE. This Master Lease and Equipment Schedules are subject to acceptance by Lessor at its home office. 18.7 PERFORMANCE OF LESSEE'S OBLIGATIONS: If Lessee shall fail to make any payment or perform any act required by this Master Lease or any Equipment Schedule, Lessor may at Lessee's expense, but shall not be obligated to, make such payment or perform such act without notice to or demand upon Lessee and without waiving or releasing any obligation or default. Lessee shall, when billed, reimburse Lessor for any expense incurred hereunder by Lessor in performing Lessee's obligations. LESSEE MAY NOT ASSIGN ITS RIGHTS OR OBLIGATIONS, EXCEPT AS SPECIFICALLY PROVIDED IN PARAGRAPH 12 OF THIS MASTER LEASE. 18.8 SURVIVAL: All representations, warranties, indemnities, and covenants contained in this Master Lease and in any Equipment Schedule, which by their nature would continue beyond the termination, cancellation or expiration of the Lease, including, by way of illustration only and not limitation, those in Paragraph 6, 10, 11 and 18, shall continue in full force and effect and shall survive Page No. 5 of 6

6 notwithstanding the full payment of all amounts due hereunder or the termination of Lessee's right to possession of any Unit. 18.9 HEADINGS: Headings and captions are for convenience of reference only and shall not be construed as part of the Lease. 18.10 OVERDUE PAYMENTS: Any Monthly Rental due Lessor under this Master Lease, if not paid by the fifth day of the month in which payment became due, shall accrue interest until paid at a rate equal to one and one-half percent per month, or the maximum rate permissible by law, whichever is lower. Any other amounts payable to Lessor by Lessee under this Master Lease are due and payable within fifteen (15) days after the billing date, and, if not paid on or before such due date, shall accrue interest from the due date until paid at a rate equal to one and one-half percent per month, or the maximum rate permitted by law, whichever is lower. 18.11 CONSENT OR APPROVAL: With respect to any provision herein which calls for the consent or approval of a party, such consent or approval shall not be unreasonably withheld. 18.12 SUBSTITUTION OF EQUIPMENT: If, at any time during the term of an Equipment Schedule, Lessor's right to lease the Equipment expires, Lessor shall promptly provide indentical substitute Equipment, and all expenses of such substitution, including deinstallation, installation and transportation expenses, shall be borne by Lessor. 18.13 DELIVERY FOR EXAMINATION: Submission of the form of this Master Lease for examination shall not bind Lessor in any manner, and no obligations shall arise until this instrument is signed by both Lessor and Lessee. 18.14 TERMS IN EQUIPMENT SCHEDULES: If the provisions of any Equipment Schedule are inconsistent with the provisions of this Master Lease, then the provisions of such Equipment Schedule shall control. LESSOR: LESSEE: COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. BY: /s/ E. William Gillula BY: /s/ Bradley H. Sell -------------------------------- --------------------------------- E. William Gillula Bradley H. Sell TITLE: Executive Vice President TITLE: Vice President/Controller ------------------------------ ------------------------------ DATE: August 1, 1996 DATE: July 26, 1996 ------------------------------- ------------------------------- (Please initial page 5, section 18.3)

7 ADDENDUM ONE TO MASTER LEASE AGREEMENT NO. 143050 This Addendum One to Master Lease Agreement No. 143050 (the "Lease") is dated as of July 24, 1996, and is entered into by and between COMPUTER SALES INTERNATIONAL, INC. ("Lessor") and KIDS MART, INC. ("Lessee"). Notwithstanding anything to the contrary contained in the Lease between the parties hereto, dated on even date herewith, and in consideration of the mutual promises, covenants, and conditions contained in the Lease and contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows: 1. CONTROLLING TERMS: This Addendum One shall become a part of the Lease and shall be read together with the Lease as one single document. To the extent that there shall be any conflict as between the terms and provisions contained in the Lease and those contained herein, the terms and provisions set forth herein shall control. 2. SECTION 11 INDEMNIFICATION: Add the following paragraph to the end of the section: Lessor shall indemnify Lessee from and against any and all claims, costs, reasonable attorneys' fees, expenses, damages and liabilities arising out of the negligence or intentional misconduct of Lessor or its employees or agents, or arising out of Lessor's breach of its obligations under this Lease. 3. SECTION 14 EVENTS OF DEFAULT: In subsection (c), insert "material" before "term." IN WITNESS WHEREOF, the parties hereto have executed this Addendum One to Master Lease No. 143050, as of the date set forth below. COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. BY: /s/ E. William Gillula BY: /s/ Bradley H. Sell ----------------------------- ----------------------------- E. William Gillula Bradley H. Sell TITLE: Executive Vice President TITLE: Vice President/Controller --------------------------- --------------------------- DATE: August 1, 1996 DATE: July 30, 1996 -------------------------- --------------------------- HRA/LA

8 ADDENDUM ONE TO MASTER LEASE AGREEMENT NO. 143050 This Addendum One to Master Lease Agreement No. 143050 (the "Lease") is dated as of July 24, 1996, and is entered into by and between COMPUTER SALES INTERNATIONAL, INC. ("Lessor") and KIDS MART, INC. ("Lessee"). Notwithstanding anything to the contrary contained in the Lease between the parties hereto, dated on even date herewith, and in consideration of the mutual promises, covenants, and conditions contained in the Lease and contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows: 1. CONTROLLING TERMS: This Addendum One shall become a part of the Lease and shall be read together with the Lease as one single document. To the extent that there shall be any conflict as between the terms and provisions contained in the Lease and those contained herein, the terms and provisions set forth herein shall control. 2. SECTION 11 INDEMNIFICATION: Add the following paragraph to the end of the section: Lessor shall indemnify Lessee from and against any and all claims, costs, reasonable attorneys' fees, expenses, damages and liabilities arising out of the negligence or intentional misconduct of Lessor or its employees or agents, or arising out of Lessor's breach of its obligations under this Lease. 3. SECTION 14 EVENTS OF DEFAULT: In subsection (c), insert "material" before "term." IN WITNESS WHEREOF, the parties hereto have executed this Addendum One to Master Lease No. 143050, as of the date set forth below. COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. BY: /s/ E. William Gillula BY: /s/ Bradley H. Sell ----------------------------- ----------------------------- E. William Gillula Bradley H. Sell TITLE: Executive Vice President TITLE: Vice President/Controller --------------------------- --------------------------- DATE: August 1, 1996 DATE: July 29, 1996 -------------------------- --------------------------- HRA/LA

9 ADDENDUM ONE TO MASTER LEASE AGREEMENT NO. 143050 This Addendum One to Master Lease Agreement No. 143050 (the "Lease") is dated as of July 24, 1996, and is entered into by and between COMPUTER SALES INTERNATIONAL, INC. ("Lessor") and KIDS MART, INC. ("Lessee"). Notwithstanding anything to the contrary contained in the Lease between the parties hereto, dated on even date herewith, and in consideration of the mutual promises, covenants, and conditions contained in the Lease and contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows: 1. CONTROLLING TERMS: This Addendum One shall become a part of the Lease and shall be read together with the Lease as one single document. To the extent that there shall be any conflict as between the terms and provisions contained in the Lease and those contained herein, the terms and provisions set forth herein shall control. 2. SECTION 11 INDEMNIFICATION: Add the following paragraph to the end of the section: Lessor shall indemnify Lessee from and against any and all claims, costs, reasonable attorneys' fees, expenses, damages and liabilities arising out of the negligence or intentional misconduct of Lessor or its employees or agents, or arising out of Lessor's breach of its obligations under this Lease. 3. SECTION 14 EVENTS OF DEFAULT: In subsection (c), insert "material" before "term." IN WITNESS WHEREOF, the parties hereto have executed this Addendum One to Master Lease No. 143050, as of the date set forth below. COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. BY: /s/ E. William Gillula BY: /s/ Bradley H. Sell ----------------------------- ----------------------------- E. William Gillula Bradley H. Sell TITLE: Executive Vice President TITLE: Vice President/Controller --------------------------- --------------------------- DATE: August 1, 1996 DATE: July 29, 1996 -------------------------- --------------------------- HRA/LA

10 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. [CSI LOGO] ------------------------------------------------------------------------------ COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard MAILING ADDRESS: St. Louis, Missouri 63141 Post Office Box 16264 (314) 997-7010 St. Louis, MO 63105 EQUIPMENT SCHEDULE NO. ONE Dated as of July 24, 1996 LESSOR: LESSEE: KIDS MART, INC. 801 Sentous Avenue COMPUTER SALES INTERNATIONAL, INC. City of Industry, California 91748 Lessor and Lessee named above hereby agree that, except as modified or superseded by this Equipment Schedule or any Addenda hereto, all of the terms and conditions of the MASTER LEASE AGREEMENT NO. 143050 dated July 24, 1996, are hereby incorporated herein and made a part hereof: 1. EQUIPMENT: FEATURE MONTHLY MACHINE (QUANTITY NEW/ RENTAL QTY TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED PER UNIT _____________________________________________________________________________ Exhibit "A" (Listing of Equipment) is incorporated herein by this reference. /X/ (check box if applicable) ----------------------------------------------------------------------------- EQUIPMENT LOCATION: 801 Sentous Avenue City of Industry, California 91748 ----------------------------------------------------------------------------- 2. Monthly Rental for all Units: MONTH 1 - $31,458.00; MONTHS 2 THROUGH 22 - $10,486.00; MONTHS 23 AND 24 - $0.00 3. Initial Term: TWENTY-FOUR (24) MONTHS 4. Anticipated Installation Date: ALREADY INSTALLED AND ACCEPTED 5. Addendum One hereto is incorporated herein by this reference. /X/ (check box if applicable) 6. A photocopy of this Equipment Schedule, and any exhibits or addenda hereto, may be filed as a precautionary Uniform Commercial Code Financing Statement to evidence Lessor's interest in the Equipment. 7. At Lessor's option, this Equipment Schedule shall not be effective unless signed by Lessee and returned to Lessor on or before JULY 31, 1996. COMPUTER SALES INTERNATIONAL, INC. LESSEE: KIDS MART, INC. By: /s/ E. William Gillula By: /s/ Bradley H. Sell -------------------------------- --------------------------------- E. William Gillula Bradley H. Sell Title: Executive Vice President Title: Vice President/Controller ----------------------------- ------------------------------ Date: August 1, 1996 Date: July 26, 1996 ----------------------------- ------------------------------ HRA/LA

11 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. EXHIBIT "A" KIDS MART, INC. EQUIPMENT SCHEDULE NO. ONE, MASTER LEASE NO. 143050 $10,486.00 <TABLE> <CAPTION> FEATURE MONTHLY MACHINE (QUANTITY NEW/ RENTAL PER QTY. TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED UNIT ---- ---------- --------- ----------- -------- ---- ---------- <S> <C> <C> <C> <C> <C> <C> 1 IBM 3490-E01 DESKTOP TAPE SUBSYSTEM 13-B4569 USED $860.00 1 IBM 9406-510 AS 400 100511M USED $9,626.00 0044(1) DEVICE PARITY PROTECTION 0078(1) 3490-E01 FIELD MERGE STAND ALONE 0090(1) LOAD PER CANADA 2144(1) 30.0 RPR PROCESSOR 2612(1) EIA 232/V.24 ONE LINE ADPT 2617(2) ETHERNET LAN (IEEE 802.3 CSMA/CD) 2960(1) 120V, 15A 6FT LINECORD 5014(1) QUICK SHIP 5052(1) STORAGE EXPANSION - KITTYHAWK BASE 5504(1) 1/2" TAPE CART ALT IPL SPECIFY FOR 3490 EXX 5520(1) COMPLETE SYSTEM ORDER 5540(1) WSC-T TWIN-AS CABLE 6380(1) FIELD REMOVABLE MEDIA 6501(1) SCSI-P CABLE (RED HEAD V2R3 FEATURE) 6512(1) DISK UNIT CONTROLLER FOR RAID 6606(1) RESTORE DEVICES FOR CENTURY MODELS 6607(13) RESTORE DEVICES FOR CENTURY MODELS 7255(2) OPTIONAL BASE 256MB MS </TABLE> Initialed by : Lessor L ----- Lessee BS ----- Page No. 1 of 1

12 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. ADDENDUM ONE TO EQUIPMENT SCHEDULE NO. ONE MASTER LEASE AGREEMENT NO. 143050 This Addendum One to "Equipment Schedule One, Master Lease Agreement No. 143050" (the "Lease"), is dated as of July 24, 1996, and is entered into, by and between COMPUTER SALES INTERNATIONAL, INC. ("Lessor") and KIDS MART, INC. ("Lessee"). Notwithstanding anything to the contrary contained in the Lease between the parties hereto, dated on even date herewith and with respect to certain computer equipment (the "Equipment"), and in consideration of the mutual promises, covenants, and conditions in the Lease and contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows: 1. CONTROLLING TERMS: This Addendum One shall become a part of the Lease and shall be read together with the Lease as one single document. To the extent that there shall be any conflicts as between the terms and provisions contained in the Lease and those contained herein, the terms and provisions set forth herein shall control. 2. LESSOR'S PURCHASE OF EQUIPMENT: a) The Equipment is installed at Lessee's location and is unconditionally accepted by Lessee for lease hereunder. b) Lessor will buy the Equipment directly from Lessee pursuant to Purchase Agreement No. 143051 entered into contemporaneously herewith. c) Lessor's performance under this Lease is conditioned on Lessee selling the Equipment to Lessor at a price not to exceed $265,220.00. 3. COMMENCEMENT DATE: The Commencement Date is the date Lessor buys the Equipment from Lessee. 4. CALIFORNIA SALES TAX: Lessee represents and warrants that it has paid all California sales tax with respect to its purchase of the Equipment and that Lessee's first functional use of the Equipment occurred within the 90 days prior to the Commencement Date. Lessee shall provide to Lessor satisfactory proof of payment of such taxes. Accordingly, the parties understand that there will be no California sales tax due with respect to Monthly Rental under this Lease; however, if such tax is assessed or payable for any reason, then Lessee shall be responsible for payment of all amounts due (including interest and penalties, if any.). 5. LESSOR CONTINGENCY: Lessor's performance under this Lease is conditioned on Lessee issuing to Lessor a warrant for 50,000 shares of common stock of Lessee at a strike price of $7.00 per share and a duration of five (5) years from execution. Lessee will provide the warrant to Lessor prior to the Commencement Date. IN WITNESS WHEREOF, the parties hereto have executed this Addendum One to Equipment Schedule No. One, Master Lease No. 143050, as of the date set forth below. COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. By: /s/ E. William Gillula By: /s/ Bradley H. Sell --------------------------- ---------------------------- E. William Gillula Bradley H. Sell Title: Executive Vice President Title: Vice President/Controller ---------------------------- --------------------------- Date: August 1, 1996 Date: July 26, 1996 ---------------------------- --------------------------- HRA/LA

13 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. [CSI LOGO] -------------------------------------------------------------------------------- COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard St. Louis, Missouri 63141 (314)997-7010 LESSEE: KIDS MART, INC. STIPULATED LOSS VALUE SCHEDULE TO EQUIPMENT SCHEDULE NUMBER: ONE MASTER LEASE AGREEMENT NUMBER: 143050 BASE VALUE: $265,220.00 <TABLE> <CAPTION> STIPULATED STIPULATED MONTHLY LOSS VALUE MONTHLY LOSS VALUE PAYMENTS (PERCENT OF PAYMENTS (PERCENT OF MADE BASE VALUE) MADE BASE VALUE) ------------------------------------------------------------------- <S> <C> <C> <C> 0 110.0% 13 90.1% 1 108.5 14 88.6 2 106.9 15 87.1 3 105.4 16 85.6 4 103.9 17 84.0 5 102.4 18 82.5 6 100.8 19 81.0 7 99.3 20 79.4 8 97.8 21 77.9 9 96.3 22 76.4 10 94.7 23 74.9 11 93.2 24 and thereafter 73.3 12 91.7 </TABLE> In the event of a loss of less than all of the Equipment listed on the above Equipment Schedule, the Stipulated Loss Value shall be allocated to the Units lost in the same proportion as the Monthly Rental per Unit for the lost Units bears to the Monthly Rental for all Units listed on the Equipment Schedule. Initialed by Lessor: INITIALS ILLEGIBLE --------- Lessee: INITIALS ILLEGIBLE --------- HRA/LA

14 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. [CSI LOGO] ------------------------------------------------------------------------------ COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard MAILING ADDRESS: St. Louis, Missouri 63141 Post Office Box 162624 (314) 997-7010 St. Louis, MO 63105 EQUIPMENT SCHEDULE NO. TWO DATED AS OF JULY 24, 1996 LESSOR: LESSEE: KIDS MART, INC. 801 Sentous Avenue COMPUTER SALES INTERNATIONAL, INC. City of Industry, California 91748 Lessor and Lessee named above hereby agree that, except as modified or superseded by this Equipment Schedule or any Addenda hereto, all of the terms and conditions of the MASTER LEASE AGREEMENT NO. 143050 dated July 24, 1996, are hereby incorporated herein and made a part hereof: 1. EQUIPMENT: MONTHLY FEATURE LEASE RATE MACHINE (QUANTITY NEW/ FACTOR QTY TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED PER UNIT _____________________________________________________________________________ Exhibit "A" (Listing of Equipment) is incorporated herein by this reference. /X/ (check box if applicable) ----------------------------------------------------------------------------- EQUIPMENT LOCATION: 801 Sentous Avenue City of Industry, California 91748 ----------------------------------------------------------------------------- 2. Monthly Lease Rate Factor for all Units: SEE ADDENDUM ONE 3. Initial Term: TWENTY-FOUR (24) MONTHS 4. Anticipated Installation Date: JULY 1, 1996 THROUGH OCTOBER 31, 1996 5. Addendum One hereto is incorporated herein by this reference. /X/ (check box if applicable) 6. A photocopy of this Equipment Schedule, and any exhibits or addenda hereto, may be filed as a precautionary Uniform Commercial Code Financing Statement to evidence Lessor's interest in the Equipment. 7. At Lessor's option, this Equipment Schedule shall not be effective unless signed by Lessee and returned to Lessor on or before JULY 31, 1996. COMPUTER SALES INTERNATIONAL, INC. LESSEE: KIDS MART, INC. By: /s/ E. William Gillula By: /s/ Bradley H. Sell -------------------------------- --------------------------------- E. William Gillula Bradley H. Sell Title: Executive Vice President Title: Vice President/Controller ----------------------------- ------------------------------ Date: August 1, 1996 Date: July 26, 1996 ----------------------------- ------------------------------ HRA/LA

15 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. EXHIBIT "A" KIDS MART, INC. EQUIPMENT SCHEDULE NO. TWO, MASTER LEASE NO. 143050 <TABLE> <CAPTION> MONTHLY FEATURE LEASE RATE MACHINE (QUANTITY NEW/ FACTOR QTY. TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED PER UNIT ------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> * COMPAQ PENTIUM DESKTOP PC NEW .03908 TIMES UNIT COST * COMPAQ PENTIUM SERVER NEW .03908 TIMES UNIT COST * HP LASERJET PRINTER NEW .03908 TIMES UNIT COST * MISCELLANEOUS HARDWARE NEW .04689 TIMES UNIT COST </TABLE> <TABLE> <CAPTION> FEATURE MONTHLY MACHINE (QUANTITY NEW/ RENTAL QTY. TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED PER UNIT ------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> **11 COMPAQ 151N 150 COLOR MONITOR 603BCO5AH582, USED $16.00 603BC05AH890, 603BC05AH474, 603BC05AF200, 612BC05AH450, 612BC05AH457, 612BC05AH451, 612BC05AI986, 612BC05AJ004, 612BC05AJ007, 612BC05AI994 **10 COMPAQ 5100E PROLINEA PC A616HTC2H155, USED $72.00 A616HTC2H666, A616HTC2H763, A616HTC2H709, A614HTC2D190, A616HTC2J107, A616HTC2J135, A616HTC2J133, A603HTB3H035, A603HTB3H036 (2) KINGSTON 4MB NON-PARITY F/CQ PRO E SERIES (1) INTEL (10) ETHEREXPRESS LAN 16TP 8/16 BIT ADP </TABLE> Initialed by: Lessor INITS ILLEGIBLE --------------- Lessee INITS ILLEGIBLE Page No. 1 of 1 ---------------

16 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. ADDENDUM ONE TO EQUIPMENT SCHEDULE NO. TWO MASTER LEASE AGREEMENT NO. 143050 This Addendum One to "Equipment Schedule Two, Master Lease Agreement No. 143050" (the "Lease"), is dated as of July 24, 1996, and is entered into, by and between COMPUTER SALES INTERNATIONAL, INC. ("Lessor") and KIDS MART, INC. ("Lessee"). Notwithstanding anything to the contrary contained in the Lease between the parties hereto, dated on even date herewith and with respect to certain computer equipment (the "Equipment"), and in consideration of the mutual promises, covenants, and conditions in the Lease and contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto covenant and agree as follows: 1. CONTROLLING TERMS: This Addendum One shall become a part of the Lease and shall be read together with the Lease as one single document. To the extent that there shall be any conflicts as between the terms and provisions contained in the Lease and those contained herein, the terms and provisions set forth herein shall control. 2. LESSOR'S PURCHASE OF EQUIPMENT: (a) Lessor shall purchase the Equipment designated with one asterisk (the "New Equipment") directly from Entex Information Services, Inc. ("Entex") and other vendors designated by Lessee. (b) The Equipment designated with two asterisks (the "Lessee Equipment") is already installed at Lessee's location and is unconditionally accepted by Lessee for lease hereunder. Lessor shall purchase the Lessee Equipment directly from Lessee pursuant to Purchase Agreement No. 143059 entered into contemporaneously herewith. The purchase price of the Lessee Equipment will not exceed $22,880.00. The Commencement Date of the Lessee Equipment is the date Lessor buys the Lessee Equipment from Lessee. (c) Total Equipment cost is not to exceed $200,000.00. If Lessee wants this Lease to cover Equipment which has a cost greater than $200,000.00, Lessor, in its sole discretion, may pay the additional cost. (d) Lessor is not liable for any failure or delay in delivery caused by Entex or any other party or condition not within Lessor's control. *3. QUANTITIES; MONTHLY RENTAL: (a) In addition to the Lessee Equipment, this Equipment Schedule covers all Units of New Equipment listed that are installed at Lessee's facilities between July 1, 1996 and October 31, 1996, inclusive. At this time, Lessee is unable to specify exactly how many Units will be installed; therefore, the "quantity" column has been left blank. As Lessee determines the quantities of New Equipment it requires, Lessee shall have the vendor send to Lessor invoices which will reference this Lease and which will specify machine type(s), quantities, equipment location(s), sales price, serial number(s) and installation date(s) of the Units ordered by Lessee. Upon receipt of each properly prepared invoice, Lessor shall remit the sales price to the vendor. (b) Monthly Rental per Unit for the New Equipment will equal the "Monthly Lease Rate Factor" for that Unit, which is specified in the Equipment Schedule or on Exhibit "A", multiplied by the Unit's cost. On November 1, 1996, or as soon thereafter as is reasonably practicable, Lessee shall execute a Certificate of Acceptance for all installed Equipment, which Certificate verifies the actual quantities of machines; and the Monthly Rental per Unit and the total Monthly Rental for the Equipment Schedule, both of which will be expressed as dollar amounts.

17 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. 4. INITIAL TERM: The twenty-four (24) month Initial Term shall start on November 1, 1996, and expire on October 31, 1998. Lessee shall pay to Lessor Daily Rental as set forth in Section 3 of the Master Lease, for each Unit of Equipment for each day from, and including, its installation date (or, for Lessee Equipment, its Commencement Date) through, but not including, November 1, 1996. Daily Rental shall be due in a lump sum on November 1, 1996. 5. STIPULATED LOSS VALUE: Because the actual quantities of Equipment are unknown at this time, specific dollar amounts cannot be listed on the Stipulated Loss Value Schedule. Instead, "vendor list price/Lessor purchase price" has been specified so that, at the time of a loss, the Stipulated Loss Value shall be equal to the present vendor list price for the Unit times the applicable percentage, or in the case of Lessee Equipment, equal to Lessor's purchase price for the Unit times the applicable percentage. The parties agree, however, that on November 1, 1996, or as soon thereafter as reasonably practicable, a new Stipulated Loss Value Schedule specifying a dollar amount Base Value shall be executed. 6. CALIFORNIA SALES TAX: Lessee represents and warrants that it has paid all California sales tax with respect to its purchase of the Lessee Equipment and that Lessee's first functional use of the Lessee Equipment occurred within the 90 days prior to its Commencement Date. Lessee shall provide to Lessor satisfactory proof of payment of such taxes. Accordingly, the parties understand that there will be no California sales tax due with respect to Monthly Rental for the Lessee Equipment under this Lease; however, if such tax is assessed or payable for any reason, then Lessee be responsible for payment of all amounts due (including interest and penalties, if any.). 7. LESSOR CONTINGENCY: Lessor's performance under this Lease is conditioned on Lessee's execution and performance under Equipment Schedule One between the parties. IN WITNESS WHEREOF, the parties hereto have executed this Addendum One to Equipment Schedule No. Two, Master Lease No. 143050, as of the date set forth below. COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. By: /s/ E. William Gillula By: /s/ Bradley H. Sell -------------------------------- -------------------------------- E. William Gillula Bradley H. Sell Title: Executive Vice President Title: Vice President/Controller ----------------------------- ----------------------------- Date: August 1, 1996 Date: July 26, 1996 ------------------------------ ------------------------------

18 NON-ORIGINAL No security interest in an Equipment Schedule may be created or perfected by possession of this copy. [CSI LOGO] -------------------------------------------------------------------------------- COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard St. Louis, Missouri 63141 (314)997-7010 LESSEE: KIDS MART, INC. STIPULATED LOSS VALUE SCHEDULE TO EQUIPMENT SCHEDULE NUMBER: TWO MASTER LEASE AGREEMENT NUMBER: 143050 BASE VALUE: Vendor List Price/Lessor Purchase Price <TABLE> <CAPTION> STIPULATED STIPULATED MONTHLY LOSS VALUE MONTHLY LOSS VALUE PAYMENTS (PERCENT OF PAYMENTS (PERCENT OF MADE BASE VALUE) MADE BASE VALUE) ------------------------------------------------------------------- <S> <C> <C> <C> 0 110.0% 13 90.1% 1 108.5 14 88.6 2 106.9 15 87.1 3 105.4 16 85.6 4 103.9 17 84.0 5 102.4 18 82.5 6 100.8 19 81.0 7 99.3 20 79.4 8 97.8 21 77.9 9 96.3 22 76.4 10 94.7 23 74.9 11 93.2 24 and thereafter 73.3 12 91.7 </TABLE> In the event of a loss of less than all of the Equipment listed on the above Equipment Schedule, the Stipulated Loss Value shall be allocated to the Units lost in the same proportion as the Monthly Rental per Unit for the lost Units bears to the Monthly Rental for all Units listed on the Equipment Schedule. Initialed by Lessor: INITIALS ILLEGIBLE --------- Lessee: INITIALS ILLEGIBLE --------- HRA/LA

19 [CSI LOGO] PURCHASE AGREEMENT NUMBER: 143059 -------------------------------------------------------------------------------- COMPUTER SALES INTERNATIONAL, INC. 10845 Olive Boulevard MAILING ADDRESS: St. Louis, Missouri 63141 Post Office Box 16264 (314)997-7010 St. Louis, MO 63105 PURCHASE AGREEMENT Dated JULY 24, 1996 This Agreement is between COMPUTER SALES INTERNATIONAL, INC. (the "Buyer") and KIDS MART, INC. which has its principal place of business at 801 SENTOUS AVENUE, CITY OF INDUSTRY, CALIFORNIA 91748 (the "Seller"). 1. EQUIPMENT: Seller agrees to sell and Buyer, by its written acceptance, agrees to buy the following Equipment (the "Equipment") on the terms and conditions contained in this Agreement: -------------------------------------------------------------------------------- FEATURE MACHINE (QTY. NEW/ UNIT QTY. TYPE/MODEL PER UNIT) DESCRIPTION SERIAL# USED PRICE -------------------------------------------------------------------------------- SEE EXHIBIT "A" ATTACHED HERETO FOR A LISTING OF EQUIPMENT BUYER WILL LEASE THE EQUIPMENT BACK TO SELLER UNDER EQUIPMENT SCHEDULE NO. TWO TO MASTER LEASE AGREEMENT NO. 143050 BETWEEN THE PARTIES. ------------------------------------------------------------------------------- 2. DELIVERY: Seller shall deliver and Buyer shall accept delivery of each Unit of the Equipment at 801 SENTOUS AVENUE, CITY OF INDUSTRY, CALIFORNIA 91748; on a mutually acceptable date no later than AUGUST 5, 1996. (Under Equipment Schedule No. Two, the Equipment will remain at Seller's location.) 3. SALES PRICE: The aggregate sales price of the Equipment is $22,880.00, which Buyer will pay to Seller by the delivery date of the Equipment, provided all serial numbers for the Equipment have been given to Buyer and all liens on the Equipment have been released. Buyer is buying the Equipment for resale and its sales tax number is SS-OHA-30-631191 in the state of California. 4. WARRANTIES: A. Seller warrants to Buyer: (i)Seller, at the time of delivery of the Equipment, is the lawful owner of the Equipment free and clear of all liens and encumbrances of every kind and manner. Seller shall supply Buyer with a Bill of Sale evidencing title and warranty, and Seller shall supply Buyer with a copy of its Bill of Sale from Entex Information Services, Inc.; and (ii)Seller, at the time of delivery, has the full right, power and authority to sell the Equipment; and (iii)The Equipment has been under a manufacturer's maintenance agreement and at the time of delivery the Equipment is in good working order and eligible (according to the manufacturer's normal policies) for the manufacturer's standard maintenance contract. On Buyer's request, Seller shall supply Buyer with a letter from the manufacturer regarding eligibility of the Equipment for a maintenance contract. B. THE EXPRESS WARRANTIES ABOVE ARE IN LIEU OF ANY AND ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. SELLER MAKES NO WARRANTY AS TO THE CONDITION OF THE EQUIPMENT EXCEPT AS SPECIFICALLY SET FORTH IN THIS SECTION. 5. TAXES: Buyer shall pay all sales and use taxes levied or based on the sales price, this Agreement, or the Equipment. Personal property taxes assessable on a Unit prior to the delivery date will be paid by Seller. Page No. 1 of 2

20 6. DISABILITY: If Seller is unable to timely perform its obligations under this Agreement due to any cause, Buyer may terminate this Agreement in whole or in part and on termination Seller shall refund to Buyer all monies paid to it by Buyer on this Agreement. 7. MISCELLANEOUS: A. ENTIRE AGREEMENT: This Agreement is the entire agreement between Seller and Buyer with respect to the purchase and sale of the Equipment. No representation or statement not contained in this Agreement will be binding on Seller or Buyer as a warranty or otherwise, unless in writing and executed by the party to be bound. B. BINDING EFFECT: This Agreement is binding on and inures to the benefit of the parties to this Agreement and their respective successors in interest and permitted assigns. C. NOTICES: Any notice relating to this Agreement must be in writing and sent by electronic facsimile transmission, by overnight courier service or by registered or certified mail, postage prepaid, addressed to the party for which it is intended at the address set forth in the beginning of this Agreement or to such other address as either party indicates in writing. Notice is effective on the earlier of receipt or three days from the date of mailing. D. GOVERNING LAW: This Agreement, including all matters of construction, validity, performance and enforcement, is governed by the laws of the State of Missouri, without giving effect to principles of conflicts or choice of law. E. OTHER EQUIPMENT: All form stands, logic manuals, diagnostics, test decks, cables, terminators, special RPQ devices permanently attached or removable on one or more ends, associated cables, maintenance documentation, tools, IR log(s), kick plates, covers and the like, which are required to attach and install the Equipment will be included as part of the Equipment and will be delivered to Buyer by Seller at no additional charge. Seller shall either replace or pay the replacement costs of any missing items. F. ACCEPTANCE: This Agreement is subject to acceptance by Buyer at its home office. G. SEVERABILITY: Any provision of this Agreement prohibited by, or unlawful or unenforceable under, any applicable law of any jurisdiction will be ineffective as to that jurisdiction without invalidating the remaining provisions of this Agreement, but where the provisions of applicable law may be waived, they are waived to the full extent permitted by law. H. SURVIVAL: All representations, warranties, and covenants contained in this Agreement continue in full force and effect and survive the purchase of the Equipment. I. CORPORATE AUTHORITY: The parties covenant and warrant that the persons executing this Agreement on their behalf are duly authorized to execute this Agreement, and this Agreement constitutes a valid and binding obligation of the parties. J. EQUAL OPPORTUNITY COMPLIANCE: The Equal Employment Opportunity Clause in Section 202 of Executive Order 11246, as amended, relative to equal employment opportunity and the implementing rules and regulations of the Office of Federal Contracts Compliance Programs are incorporated in this Agreement by specific reference. On request, Seller shall furnish Buyer certificates of compliance with orders and regulation. The parties have executed this Agreement on the date written below. At Buyer's option, this Agreement is not effective unless signed by Seller and returned to Buyer by JULY 31, 1996. BUYER: SELLER: COMPUTER SALES INTERNATIONAL, INC. KIDS MART, INC. By: /s/ E. William Gillula By: /s/ Bradley H. Sell ------------------------------- ----------------------------- E. William Gillula Bradley H. Sell Title: Executive Vice President Title: Vice President/Controller --------------------------- -------------------------- Date: August 1, 1996 Date: July 26, 1996 --------------------------- -------------------------- Page No. 2 of 2

21 EXHIBIT "A" KIDS MART, INC. PURCHASE AGREEMENT NO. 143059 <TABLE> <CAPTION> FEATURE MACHINE (QUANTITY NEW/ QTY. TYPE/MODEL PER UNIT) DESCRIPTION SERIAL # USED ------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> 11 COMPAQ 15IN 150 COLOR MONITOR 603BC05AH582, USED 603BC05AH890, 603BC05AH474, 603BC05AF200, 612BC05AH450, 612BC05AH457, 612BC05AH451, 612BC05AI986, 612BC05AJ004, 612BC05AJ007, 612BC05AI994 10 COMPAQ 5100e PROLINEA PC A616HTC2H155, USED A616HTC2H666, A616HTC2H763, A616HTC2H709, A614HTC2D190, A616HTC2J107, A616HTC2J135, A616HTC2J133, A603HTB3H035, A603HTB3H036 (2) KINGSTON 4MB NON-PARITY F/CQ (1) INTEL (10) ETHEREXPRESS LAN 16TP 8/16 BIT ADP </TABLE> Page No. 1 of 1

1 EXHIBIT 10.7 ALL SECTIONS MARKED WITH TWO ASTERISKS ("* *") REFLECT PORTIONS WHICH HAVE BEEN REDACTED AND WILL BE FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION BY KIDS MART, INC. AS PART OF A REQUEST FOR CONFIDENTIAL TREATMENT. AGREEMENT Michael A. Harb BE BOP CLOTHING, INC. 5833 Avalon Blvd. Los Angeles, CA 90003 Dear Mr. Harb: SECTION 1 The parties to this Agreement are Be Bop Clothing, Inc., a California corporation and Kids Mart, Inc., a Florida corporation. This Agreement is also contingent upon the parties executing an Exchange Agreement and Investment Representation Agreement. Pursuant to that contingency and also in exchange for the following agreed upon consideration, the parties agree as follows: SECTION 2 Currently, there exists an open Accounts Receivable owed to Be Bop Clothing, Inc. in the sum of Five Hundred Eighty Six Thousand Four Hundred Twenty-three Dollars and Thirteen Cents ($586,423.13). It is anticipated that an additional Sixty Three Thousand Five Hundred Six Dollars and Eighty Seven Cents ($63,576.87) of merchandise will be shipped to Kids Mart, Inc. to comprise a total "investment" of Six Hundred Fifty Thousand Dollars ($650,000.00). That amount will be the total "investment" by Be Bop Clothing, Inc., which will then be given non-registered Common Stock of Kids Mart, Inc. at a price per share (with respect to the Exchange Agreement) of One Dollar and Fifty Cents ($1.50). The Common Stock of Kids Mart, Inc. is currently quoted on the OTC Bulletin Board. SECTION 3 As long as Be Bop Clothing, Inc. does not reduce its investment in Kids Mart, Inc. as set forth in Section 2 above, Kids Mart, Inc. will use its best efforts to maintain Ten Million Dollars ($10,000,000) in annual sales from Be Bop Clothing, Inc. beginning January 1, 1997, as per the attached "Volume Breakdown and Mark-up Goal" which is hereby incorporated by reference and made a part of this Agreement. Until Kids Mart, Inc. receives factor support, the terms of payment for the Ten Million Dollars annual sales will be based upon mutual agreement between Be Bop Clothing, Inc. and Kids Mart, Inc., for each purchase order. If the parties are unable to agree upon mutually agreeable terms, either party has the option to cancel this agreement upon thirty (30) days written notice. However, until Kids Mart, Inc. receives factor support, Kids Mart, Inc. agrees to net 45 day terms. At the time Kids Mart, Inc. receives factor support, Be Bop Clothing, Inc. will grant Kids Mart, Inc. net sixty (60) day terms. Should Kids Mart, Inc. not be prompt in paying said accounts on these terms, said failure would constitute a breach of this Agreement.

2 SECTION 4 Kids Mart, Inc. agrees that a senior executive officer and primary shareholder of Be Bop Clothing, Inc. will be installed on the Board of Directors of Kids Mart, Inc. within three (3) months of the execution of this Agreement to serve until the next Annual Meeting of Shareholders. Thereafter, unless Be Bop Clothing, Inc. has reduced its above-stated investment by more than Fifty Percent (50%), Kids Mart, Inc. shall nominate said senior executive officer of Be Bop Clothing, Inc. to the Board of Directors to be voted upon by the shareholders at each annual meeting. SECTION 5 Modification. Neither this Agreement nor any provision hereof shall be modified, discharged or terminated except by an instrument in writing signed by the party against whom any waiver, change, discharge or termination is sought. SECTION 6 Notices. Any notice, demand or other communication which any party hereto may be required, or may elect, to give to anyone interested hereunder shall be sufficiently given if (a) deposited, a postage prepaid, in a United States mail letter box, registered or certified mail, return receipt requested, addressed to such address as may be given herein or (b) delivered personally at such address. SECTION 7 Binding Effect. Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the parties and their heirs, executors, administrators, successors, legal representatives and permitted assigns. If the undersigned is more than one person, the obligations of the undersigned shall be joint and several and the agreements, representations, warranties and acknowledgments herein contained shall be deemed to be made by and be binding upon each such person and his heirs, executors, administrators and successors. SECTION 8 Partial Agreement. This instrument contains the partial agreement of the parties, and there are no representations, covenants or other agreements except the Exchange Agreement and Investment Representation Agreement referenced herein. SECTION 9 Assignability. This Agreement is not transferable or assignable by the parties unless agreed to in writing by all said parties. 2

3 SECTION 10 Applicable Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California applicable to contracts made and to be performed entirely within such state. SECTION 11 Gender. All pronouns contained herein and any variations thereof shall be deemed to refer to the masculine, feminine or neuter, singular or plural, as the identity of the parties hereto may require. SECTION 12 Counterparts. This Agreement may be executed through the use of separate signature pages or in any number of counterparts, and each of such counterparts shall, for all purposes, constitute one agreement binding on all the parties, notwithstanding that all parties are not signatories to the same counterpart. IN WITNESS WHEREOF, the parties have executed this Agreement on this 11th day of September, 1996. BE BOP CLOTHING INCORPORATED KIDS MART, INC. By: /s/ Marcus Sphatt By: /s/ Bernard Tessler ---------------------------- ---------------------------- Marcus Sphatt Bernard Tessler Vice President President By: /s/ Michael Harb ---------------------------- Michael Harb Chief Executive Officer

4 * * ADDENDUM TO AGREEMENT

1 EXHIBIT 10.8 KIDS MART, INC. (A FLORIDA CORPORATION) EXCHANGE AGREEMENT AND INVESTMENT REPRESENTATION AGREEMENT Bernard Tessler Kids Mart, Inc. 801 Sentous Avenue City of Industry, CA 91748 Dear Mr. Tessler: SECTION 1 1.1 SUBSCRIPTION. The undersigned hereby subscribes for and agrees to purchase 433,333 shares of Common Stock (Par Value $.0001 per share) (the "Securities") issued by Kids Mart, Inc. (the "Company"), a corporation organized under the laws of the State of Florida, at a price of $1.50 per share, on the terms and conditions described herein. Although the Securities are unregistered and may not be sold unless registered under federal and state securities laws, or an exemption from registration is applicable, the Common Stock of the Company is quoted on the OTC Bulletin Board. 1.2 PURCHASE The undersigned tenders trade payables due from the Company to the undersigned in the amount of $650,000 in full payment of the purchase price of the Securities. Upon execution and delivery of this Agreement, acceptance by the Company, and delivery of the Securities such $650,000 of trade payables shall be converted into payment of the purchase price of the Securities and shall no longer be considered due and owing to the undersigned. 1.3 ACCEPTANCE OR REJECTION OF SUBSCRIPTION. (a) The undersigned understands and agrees that the Management of the Company reserves the right to reject this subscription for the purchase of Securities, in whole or in part, if in its judgement it deems such action in the best interests of the Company. (b) In the event the undersigned's subscription is accepted, Management shall accept the undersigned's tender by executing this subscription agreement.

2 Section 2 2.1. Investor Representations and Warranties. The undersigned hereby acknowledges, represents and warrants to, and agrees with, Management of the Company as follows: (a) The undersigned is investing in the Securities for its own account, for investment purposes only, and not with a view to or for the resale, distribution or fractionalization thereof, in whole or in part, and no other person has a direct or indirect beneficial interest in the Securities. (b) The undersigned has reviewed the opinion of counsel to the Company pertaining to the offer and sale of the Securities contemplated herein and acknowledges its understanding that the offering and sale of the Securities is intended to be exempt from registration under the Securities Act of 1933, as amended (the "Act"), by virtue of Section 4(2) of the Act and exempt from qualification under the California Corporate Securities Law of 1968, as amended, by virtue of Section 25102 (f). In furtherance thereof, the undersigned represents and warrants to and agrees with the Management of the Company as follows: (i) The undersigned has the financial ability to bear the economic risk of its investment in the Securities (including its possible loss), has adequate means of providing for its current needs and personal contingencies and has no need for liquidity with respect to its investment in the Securities. (ii) The undersigned has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of an investment in the Securities and has obtained, in its judgment, sufficient information from the Company to evaluate the merits and risks of an investment in the Securities. (c) The undersigned: (i) has been provided an opportunity to obtain any information concerning the Company and all other information to the extent the Company possesses such information or can acquire it without unreasonable effort or expense; (ii) has been given the opportunity to ask questions of, and receive answers from the Management of the Company concerning all matters pertaining to this investment, and has been given the opportunity to obtain such additional information necessary in order to evaluate the merits and risks of an investment in the Securities to the extent the Company possesses such information or can acquire it without unreasonable effort or expense; and

3 (iii) has determined that the Securities are a suitable investment for it and that at this time it could bear a complete loss of its investment; (d) In making the decision to purchase the Securities herein subscribed for, the undersigned has relied solely upon independent investigations made by it. The undersigned is not relying on the Company with respect to tax and other economic considerations involved in this investment. (e) In addition to the Risk Factors set forth in this Agreement, the undersigned specifically acknowledges its awareness that the Company's financial position continues to deteriorate. Consequently, investment in the Company at this time is extremely speculative and the undersigned acknowledges the distinct possibility that the undersigned may lose the entire investment. THIS INVESTMENT SHOULD BE CONSIDERED RESCUE FINANCING OF THE MOST SPECULATIVE NATURE. (f) The undersigned is an "accredited investor" as such term is defined in Regulation D promulgated by the Securities and Exchange Commission under the Securities Act of 1934, as amended. The undersigned falls within item 10 set forth on the copy of such definition attached hereto as Annex A. (g) The undersigned represents, warrants and agrees that it will not sell or otherwise transfer the Securities without registration under the Securities Act or an exemption therefrom, and fully understands and agrees that is must bear the economic risk of its investment for an indefinite period of time because, among other reasons, the Securities have not been registered under the Act or under the securities laws of certain states and, therefore, cannot be resold, pledged, assigned or otherwise disposed of unless it is subsequently registered under the Act and under applicable securities laws of such states or an exemption from such registration is available. The undersigned understands that the Company is under no obligation to register the Securities on its behalf or to assist it in complying with any exemption from such registration under the Act, except as set forth in Section 4, hereto. The undersigned also understands that sales or transfers of the Securities are further restricted by provisions of the applicable state securities laws. 2.2. Investor Awareness. The undersigned acknowledges, represents, agrees and is aware that: (a) no Federal or state agency has passed upon the securities or made any findings or determination as to the fairness of this investment;

4 (b) an investment in the Company is an illiquid investment and the undersigned must bear the economic risk of its investment for an indefinite period of time; (c) the Management of the Company may be indemnified by the Company against liabilities sustained by it by reason of its serving as the Management of the Company; (d) the Management of the Company is relying upon the representations, warranties, agreements, undertakings and acknowledgments made by the undersigned in this Agreement in determining the undersigned's suitability as a purchaser of the Securities as an "accredited investor" as set forth above. In addition, the undersigned undertakes to notify the Company immediately of any change in any representation, warranty or other information relating to the undersigned set forth herein. (e) The purchase and sale of any investment in the Company involves a high degree of risk and such risk may be increased in the case of circumstances beyond the control of Management of the Company. This investment is not recommended for those who cannot withstand the loss of their entire investment; (f) the success of the Company will be particularly dependent upon the efforts of its Management. If the Company's officers and directors die or become disabled, or otherwise terminate their relationship with the Company, the Company would be materially adversely affected. There is no assurance that the net worth of the Company's Management will be sufficient to enable it to perform any financial obligations which the Company's Management may have to the Company. Neither the Company's Management nor anyone else, including the undersigned, has agreed to fund any deficits or agreed to lend money to the company; (g) Because of its minority interest in the Company, except as permitted by general shareholder rights, a holder of the Securities will have no right to participate in management of the Company or in the conduct of its business except as permitted by general shareholder rights and unless a representative of the undersigned serves as a member of the Board of Directors. Section 3 3.1 Risk Factors. The undersigned has carefully considered and evaluated the following risk factors. The risks set forth below do not purport to be a complete description of all risks which may exist with respect to an investment in the Securities, but is merely illustrative of the types of risks which an investor should consider before deciding to invest.

5 (a) Hazardous Materials. The Company has been notified that certain stores in California have materials containing asbestos. The asbestos material is generally in trace quantities, and no remediation is expected to be required on the understanding that such material is properly secured. However, should remediation be required, no assurance can be given as to the effect this would have on the Company, although it could have a material adverse effect. (b) Closed Stores; Rent Liability. The Company has ceased operations in nine previously unprofitable stores. The remaining term of the leases on eight of these stores vary from less than six months to over three years. As of January 27, 1996 the total rent liability associated with these leases was approximately $0.4 million. The Company is attempting to negotiate favorable terms with the various landlords. However, the Company may incur a significant rent liability in connection with these leases. (c) Credit Restraints. The Company is having difficulty securing adequate terms from its suppliers. It has been required to pay for inventory on significantly shortened terms. Support among the factors has been on a severely limited basis. The Company has not been able to obtain merchandise at planned levels. These restrictions may adversely impact the Company's ability to continue to procure adequate levels of merchandise, especially for the back-to-school and Christmas seasons. (d) Cash Flow Constraints. The Company is experiencing acute cash flow constraints. Two factors have contributed to these constraints; 1) heavy liquidation sales at all stores prior to and following the acquisition of the company's business; and 2) shortened inventory payment terms. There can be no assurance that the Company will not continue to incur substantial markdowns and impaired cash flows. (e) Net Losses and Accumulated Deficit. The Company has experienced substantial losses since its acquisition of the Little Folks/Kids Mart business. No assurance can be given as to when, if ever, the Company can become profitable. (f) Dependent on Woolworth. The Company receives information systems, accounting and administrative services from Woolworth pursuant to the terms of a transition service agreement (the "Service Agreement"). In return, the Company pays certain fees to Woolworth. The initial term of the Service Agreement expired on May 31, 1996. In connection with the Settlement Agreement, the Service Agreement was extended to September 28, 1996. The Company may not establish it own systems by the expiration date and may incur significant expenses in developing such systems. (g) Adverse Retail Industry Conditions. The retail industry generally has recently suffered through a period of

6 sluggish sales and significant price competition. The Company continues to struggle through difficult market and industry condition over which it has no control. No assurance can be given that such adverse market conditions will not continue, nor can the Company predict what effect such conditions may have on the near or long term prospects of the Company. (h) Absence of Market; Transferability and Liquidity of Investment. While the Common Stock of the Company is currently quoted on the OTC bulletin Board, no established trading market has developed and there can be no assurance that an established trading market will develop, or if developed, that it will be maintained. Further, as noted a above, the issuance of the Securities has not been registered under the Securities Act and, accordingly, the undersigned may not dispose of its Surities unless such disposition has been validly registered with the SEC under the Securities Act or such disposition is, in the opinion of counsel to the Company, exempt from such registration. (i) Offering Price. The offering price of the Securities has been aribtrarily determined by the Company. Accordingly, the offering price of the Securities may not be any indication of the value of the Securities. (j) Risk of Dilution; Need for Additional Financing. Based on internal financial forecasts, the Company believes that the proceeds from this transaction will not be sufficient to fund the Company's operation and capital expenditures during the next six months. The Company will need additional capital and there can be no assurance that the Company will be able to obtain such additional capital. The Company's cash requirements may vary materially from those planned currently due to general economic, competitive or other factors. Adequate funds to meet that company's working capital requirements, whether obtained through financial markets, additional equity offerings or from the resources, may not be available to the Company when required or may not be on terms acceptable to the Company. Any such additional financing may result in significant dissolution to existing stockholders, or the issuance of securities with rights superior to those of the Securities. If such financing is not available, the Company may be required to modify its business plans or reduce or cease certain or all of its operation, or file a petition for reorganization under Chapter 11 of the Federal bankruptcy laws. (k) Dividend Policy. Since its inception, the Company has not paid any dividends on its Common Stock The Company intends to retain future earnings, if any, to provide funds for working capital, operations and/or expansion of its business, and accordingly, does not anticipate paying any cash dividends on the Stock in the foreseeable future. Furthermore, the Company's revolving credit line contains convenants restricting declaration or payment of dividends.

7 (1) Competition. All aspects of the children's apparel specialty retail industry are highly competitive. The Company competes with a number and variety of retailers, mass merchandisers and warehouse clubs, including several national chains, some of which have greater financial and marketing resources than the Company. Competition exists primarily in the areas of price, product selection and service. competitive factors could require price reductions or increases in expenditures for marketing and customer service that could adversely affect the Company's operating results. (m) Dependence on Key Personnel. The Company is highly dependent on the members of its management team. The future success of the Company depends in part on its ability to attract and retain highly qualified personnel. The Company faces intense competition for such highly qualified personnel. There can be no assurance that the Company will be able to hire sufficient qualified personnel on a timely basis or retain such personnel. (n) Dependence on Key Suppliers. The Company has no in-house manufacturing capability. Approximately 35% of the Company's merchandise is currently manufactured to its private label specifications by independent factories located in the United States and throughout the world. The Company utilizes a buying agent in Hong Kong. the Company has no long-term contracts with its private label manufacturing sources and competes with other companies for production facilities and import quota capacity. Approximately 35% of its private label merchandise is produced by fewer than 30 manufacturers. The use of private label merchandise brings with it the associated burdens of quality control and favorable delivery schedules. There can be no assurance that the Company will be able to maintain relationships with its suppliers or at acceptable costs and terms. (o) Restrictions on Imports. The Company's operations are subject to the customary risks of doing business abroad, including fluctuation in the value of currencies, customs duties and related fees, import controls and trade barriers (including quotas), restrictions on the transfer of funds, work stoppages and in certain parts of the world, political instability. The Company believes that it has reduced these risks by diversifying its offshore purchases among various countries and factories. These factors have not had a material adverse impact upon the Company's operations to date. Imports into the United States are also affected by the cost of transportation, the imposition of import duties and increased competition for greater production abroad. The countries from which the company's products are imported may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duty or tariff levels, which could affect the Company's operations and its ability to import products at current or increased levels. The Company cannot predict the likelihood or frequency of any such events occurring. The Company's

8 imported products are subject to United States customs duties and, in the ordinary course of its business, the Company may, from time to time, be subject to claims for duties and other charges. Section 4 Registration Rights; Etc. 4.1. Certain Definitions. As used in this Section 4, the following terms shall have the following respective meanings: "Commission" shall mean the Securities and Exchange Commission or any other federal agency at the time administering the Act. "Registrable Securities" shall mean the Securities covered hereby. The terms "register", "registered" and "registration" shall refer to a registration effected by preparing and filing a registration statement in compliance with the Act and applicable rules and regulations thereunder, and the effectiveness of such registration statement. "Registration Expenses" shall mean all expenses incurred by the Company in compliance with Section 4.2 hereof other than Selling Expenses, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for the Company, blue sky fees and expenses, and the expense of any special audits incident to or required by any such registration (but excluding the compensation of regular employees of the Company, which shall be paid in any event by the Company). "Selling Expenses" shall mean all underwriting discounts and selling commissions applicable to the sale of Registrable Securities, all fees and disbursements of counsel for any Holder and any blue sky fees and expenses excluded from the definition of "Registration Expenses". "Holder" shall mean any holder of outstanding Shares or Registrable Securities which (except for purposes of determining "Holders" under Section 4.6 hereof) have not been sold to the public. "Other Shareholders" shall mean holders of securities of the Company who are entitled by contract with the Company to have securities included in a registration of the Company's securities. 4.2. Company Registration. (a) Notice of Registration. If the Company shall determine to register any of its securities either for its own account or the account of a security holder or holders exercising their respective demand registration rights, other than a

9 registration relating solely to employee benefit plans, or a registration relating solely to a Commission Rule 145 transaction, or a registration on any registration form which does not permit secondary sales, the Company will: (i) promptly give to each Holder written notice thereof (which shall include a list of the jurisdictions in which the Company intends to attempt to qualify such securities under the applicable blue sky or other state securities laws); and (ii) include in such registration (and any related qualification under blue sky laws or other compliance), and in any underwriting involved therein, all the Registrable Securities specified in a written request or requests, made by any Holder within fifteen (15) days after receipt of the written notice from the Company described in clause (i) above, except as set forth in Section 4.2(b) below. (b) Underwriting. If the registration of which the Company gives notice is for a registered public offering involving an underwriting, the Company shall so advise the Holders as part of the written notice given pursuant to Section 4.2(a)(i). In such event, the right of any Holder to registration pursuant to Section 4.2 shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall (together with the Company, directors and officers and the Other Shareholders distributing their securities through such underwriting) enter into an underwriting agreement in customary form with the underwriter or underwriters selected for underwriting by the Company. Notwithstanding any other provision of this Section 4.2, if the underwriter determines that marketing factors require a limitation on the number of shares to be underwritten, the underwriter may (subject to the allocation priority set forth below) exclude from such registration and underwriting some of the Registrable Securities which would otherwise be underwritten pursuant hereto provided, however, that in no event shall the Registrable Securities underwritten pursuant hereto constitute less than one-third of such offering. The Company shall so advise all holders of securities requesting registration, and the number of shares of securities that are entitled to be included in the registration and underwriting shall be allocated in the following manner. The number of shares that may be included in the registration and underwriting on behalf of such Holders, directors and officers and Other Shareholders shall be allocated among such Holders, directors and officers and other Shareholders in proportion, as nearly as practicable, to the respective amounts of Registrable Securities and other securities

10 which they had requested to be included in such registration at the time of filing the registration statement. If any Holder of Registrable Securities or any officer, director or Other Shareholder disapproves of the terms of any such underwriting, such person may elect to withdraw therefrom by written notice to the Company and the underwriter. Any Registrable Securities or other securities excluded or withdrawn from such underwriting shall be withdrawn from such registration. 4.3 Expenses of Registration. The Company shall bear all Registration Expenses incurred in connection with any registration, qualification and compliance by the Company pursuant to Section 4.2 hereof. All Selling Expenses shall be borne by the holders of the securities so registered pro rata on the basis of the number of their shares so registered. 4.4 Registration Procedures. In the case of each registration effected by the Company pursuant to this Section 4, the Company will keep each Holder advised in writing as to the initiation of each registration and as to the completion thereof. The Company will, at its expense: (a) keep such registration effective for a period of one hundred twenty (120) days or until the Holder or Holders have completed the distribution described in the registration statement relating thereto, whichever first occurs; (b) furnish such number of prospectuses and other documents incident thereto as a Holder from time to time may reasonably request; and (c) use its best efforts to register or qualify the Registrable Securities under the securities laws or blue-sky laws of such jurisdictions as any Holder may request; provided, however, that the Company shall not be obligated to register or qualify such Registrable Securities in any particular jurisdiction in which the Company would be required to execute a general consent to service of process in order to effect such registration, qualification or compliance unless the Company is already subject to service in such jurisdiction and except as may be required by the Securities Act or applicable rules or regulations thereunder. 4.5 Indemnification. (a) The Company, with respect to each registration, qualification and compliance effected pursuant to this Section 4, will indemnify and hold harmless each Holder, each of its officers, directors and partners, and each party controlling such Holder, and each underwriter, if any, and each party who controls any underwriter, against all claims, losses, damages and liabilities (or

11 actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any prospectus, offering circular or other document (including any related registration statement, notification or the like) incident to any such registration, qualification or compliance, or based on any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or any violation by the Company of the Securities Act or any rule or regulation thereunder applicable to the Company and relating to action or inaction required of the Company in connection with any such registration, qualification or compliance, and will reimburse each such Holder, each of its officers, directors and partners, and each party controlling such Holder, each such underwriter and each party who controls any such underwriter, for any legal and any other expenses incurred in connection with investigating or defending any such claim, loss, damage, liability or action, provided that the Company will not be liable in any such case to the extent that any such claim, loss, damage, liability or expense arises out of or is based on any untrue statement or omission based solely upon written information furnished to the Company by such Holder or underwriter, as the case may be, and stated to be specifically for use therein. (b) Each Holder and Other Shareholder will, if Registrable Securities held by such person are included in the securities as to which such registration, qualification or compliance is being effected, indemnify and hold harmless the Company, each of its directors and officers and each underwriter, if any, of the Company's securities covered by such a registration statement, each party who controls the Company or such underwriter, each other such Holder and Other Shareholder and each of their respective officers, directors and partners, and each party controlling such Holder or Other Shareholder, against all claims, losses, damages and liabilities (or actions in respect thereof) arising out of or based on any untrue statement (or alleged untrue statement) of a material fact contained in any such registration statement, prospectus, offering circular or other document, or any omission (or alleged omission) to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, and will reimburse the Company and such Holders, Other Shareholders, directors, officers, partners, parties, underwriters or control persons for any legal or any other expenses reasonably incurred in connection with investigating or defending any such claim, loss, damage, liability or action, in each case to the extent, but only to the extent, that such untrue statement (or alleged untrue statement ) or omission (or alleged omission) is made in such registration statement, prospectus, offering circular or other document solely in reliance upon and in conformity with written information furnished to the Company by such Holder or Other Shareholder and stated to be specifically for use therein; provided, however, that the obligations of such Holders and Other Shareholders hereunder shall be limited to an amount equal to the proceeds to

12 each such Holder or Other Shareholder of securities sold as contemplated herein. (c) Each party entitled to indemnification under this Section 4.5 (the "Indemnified Party") shall give notice to the party required to provide indemnification (the "Indemnifying Party") promptly after such Indemnified Party has actual knowledge of any claim as to which indemnity may be sought, and shall permit the Indemnifying Party to assume the defense of any such claim or any litigation resulting therefrom, provided that counsel for the Indemnifying Party, who shall conduct the defense of such claim or any litigation resulting therefrom, shall be approved by the Indemnified Party (whose approval shall not unreasonably be withheld), and the Indemnified Party may participate in such defense at such party's expense (unless the Indemnified Party shall have been advised by counsel that actual or potential differing interests or defenses exist or may exist between the Indemnifying Party and the Indemnified Party, in which case such expense shall be paid by the Indemnifying Party), and provided further that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under this Section 4. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. 4.6 Information by Holder. Each Holder of Registrable Securities, and each Other Shareholder holding securities included in any registration, shall furnish to the Company such information regarding such Holder or Other Shareholder as the Company may reasonably request in writing and as shall be reasonably required in connection with any registration, qualification or compliance referred to in this Section 4. 4.7 Rule 144 Reporting. With a view to making available the benefits of certain rules and regulations of the Commission which may permit the sale of the Registrable Securities to the public without registration, the Company agrees to: (a) Make and keep public information available, as those terms are understood and defined in Rule 144 under the Securities Act, at all time from and after ninety (90) days following the effective date of the first registration under the Securities Act filed by the Company for an offering of its securities to the general public; (b) Use its best efforts to file with the Commission in a timely manner all reports and other documents required of the Company under the Securities Act and the Securities Exchange Act of

13 1934, as amended, at any time after it has become subject to such reporting requirements; and (c) So long as the Holder owns any Registrable Securities, furnish to the Holder forthwith upon request a written statement by the Company as to its compliance with the reporting requirements of Rule 144 (at any time from and after ninety (90) days following the effective date of the first registration statement in connection with an offering of its Securities to the general public), and of the Securities Act and the Securities Exchange Act of 1934, as amended (at any time after it has become subject to such reporting requirements), a copy of the most recent annual or quarterly report of the Company, and such other reports and documents so filed as the Holder may reasonably request in availing itself of any rule or regulation of the Commission allowing the Holder to sell any such securities without registration. Section 5 5.1 Indemnity. The undersigned hereby agrees to indemnify and hold harmless the Company, its officers and directors, and each other person, if any, against any and all loss, liability, claim, damage and expense whatsoever resulting directly from any material false representation or material breach of warranty by the undersigned contained herein. 5.2 Modification. Neither this Agreement nor any provision hereof shall be modified, discharged or terminated except by an instrument in writing signed by the party against whom any waiver, change, discharge or termination is sought. 5.3 Notices. Any notice, demand or other communication which any party hereto may be required, or may elect, to give to anyone interested hereunder shall be sufficiently given if (a) deposited, postage prepaid, in a United States mail letter box, registered or certified mail, return receipt requested, addressed to such address as may be given herein or (b) delivered personally at such address. 5.4 Binding Effect. Except as otherwise provided herein, this Agreement shall be binding upon and inure to the benefit of the parties and their heirs, executors, administrators, successors, legal representatives and permitted assigns. If the undersigned is more than one person, the obligations of the undersigned shall be joint and several and the agreements, representations, warranties and acknowledgements herein contained shall be deemed to be made by and be binding upon each such person and his heirs, executors, administrators and successors. 5.5 Entire Agreement. This instrument contains the entire agreement of the parties, and there are no representations,

14 covenants or other agreements except as stated or referred to herein. 5.6. Assignability. This Agreement is not transferable or assignable by the undersigned. 5.7 Applicable Law. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of California applicable to contracts made and to be performed entirely within such state. (b) The undersigned is a California resident and the offer and issue of the Securities has been made in California. 5.8. Gender. All pronouns contained herein and any variations thereof shall be deemed to refer to the masculine, feminine or neuter, singular or plural, as the identity of the parties hereto may require. 5.9. Counterparts. This Agreement may be executed through the use of separate signature pages or in any number of counterparts, and each of such counterparts shall, for all purposes, constitute one agreement binding on all the parties, notwithstanding that all parties are not signatories to the same counterpart. IN WITNESS WHEREOF, the undersigned has executed this Exchange Agreement and Investment Representation Agreement on this 11th day of September 1996. BE BOP CLOTHING, INCORPORATED By: /s/ Michael Harb By: /s/ Marcus Sphatt ------------------------------- --------------------------------- Michael Harb Marcus Sphatt, Vice President Chief Executive Officer * * * * * * Subscription accepted as of the 11th day of September 1996. KIDS MART, INC. By: /s/ Bernard Tessler, President ------------------------------- Bernard Tessler, President

15 ANNEX A Effective April 19, 1989, the following are "accredited investors" within the meaning of Rule 501(a) of Regulation D under the Securities Act of 1933 (the "Securities Act"): 1. An individual whose net worth, together with that of his spouse, exceeds $1,000,000. 2. An individual who had individual income in excess of $200,000 in each of the two most recent years or joint income with that individual's spouse in excess of $300,000 in each of those years and who reasonably expects to reach the same income level this year. 3. A bank as defined in Section 3(a)(2) of the Securities Act, or a savings and loan association or other institution as defined in Section 3(a)(5)(A) of the Securities Act whether acting in its individual capacity or fiduciary capacity. 4. A broker or dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934. 5. An insurance company as defined in Section 2(13) of the Securities Act. 6. An investment company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) of that Act. 7. A Small Business Investment Company licensed by the U.S. Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958. 8. An employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974, if: a. the decision to invest in the entity is made by a plan fiduciary, as defined in Section 3(21) of such Act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or b. the plan has total assets in excess of $5,000,000, or c. the plan is a self-directed plan with investment decisions made solely by persons who are accredited investors.

16 9. A private business development company as defined in Section 202(a)(22) of the Investment Advisers Act of 1940. 10. A charitable organization described in Section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust or partnership, not formed with the specific purpose of acquiring the securities, with total assets in excess of 5,000,000. 11. A trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities, whose purchase is directed by a sophisticated person as described in Rule 506(b)(2)(ii) of the Securities Act. 12. Any director, executive officer or general partner of the issuer of the securities being offered or sold, or any director, executive officer or general partner of a general partner of that issuer. 13. A plan established and maintained by a state, its political subdivisions or any agency or instrumentality of a state or its political subdivisions for the benefit of its employees with total assets in excess of $5,000,000. 14. An entity in which all of the equity owners are accredited investors.

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