Document:

Exhibit 10.01

                              SETTLEMENT AGREEMENT

1. Parties: This is a Settlement Agreement (this "Agreement") by and among
EDWARD MIKE DAVIS, an individual (hereinafter "EMD"), MID-POWER SERVICE
CORPORATION, a Nevada corporation (hereinafter "MPSC"), MID-POWER RESOURCE
CORPORATION, a Nevada corporation (hereinafter "MPRC") (MPSC and MPRC are
collectively referred to as "Mid-Power").

2. Recitals: This Agreement is made with reference to the following facts:

         2.1 EMD and Mid-Power entered into that certain Acquisition Agreement
and Plan of Merger on or about the 13th day of June 2002 (the
"Acquisition/Plan"). Pursuant to the Acquisition/Plan EMD transferred certain
interests in oil and gas prospects in the Clear Creek Federal Unit (the "CCU")
located in Carbon and Emery Counties, Utah. In the course of that transaction,
EMD retained certain interests in the CCU as follows:

         a. an overriding royalty of approximately 7.8% (the "CCU Override");

         b. certain deep drilling rights (the "CCU Deep Rights"); and

         c. a 14.23199056% working interest (based on a 70% net revenue interest
in the entire Clear Creek Unit, equating to a 10% net revenue interest) in the
Anschutz Oman 2-20 Well and the Utah Fuel #8 Well located in the NW1/4NE1/4 of
Section 20 and the NE1/4NW1/4 of Section 19, Township 13 South, Range 7 East,
SLA, respectively, that were subject to a potential claim by Thomas Kelly (the
"Potential Kelly Interests").

(these interests collectively referred to as the "Retained CCU Interests")

         2.2 EMD and Mid-Power entered into that certain Venture Agreement on or
about the 24th day of September, 2002, as amended, covering all of Township 3
South, Ranges 48, 49, 50 and 51 West, Township 4 South, Ranges 49 and 50 West
and the Otis No. 2 prospect, Township 2 North Range 50 West, all located in
Washington County, Colorado (except Township 3 South, Range 48, which is located
in Yuma County, Colorado) plus any areas of mutual interest ("AMI") (the
"Colorado Venture").

         2.3 EMD and Mid-Power entered into that certain Venture Agreement on or
about the 24th day of September, 2002, covering all of Township 14 North, Ranges
61 and 62 West, Township 15 North, Ranges 61 and 62 West, all in Laramie County,
Wyoming (being acquired from Kachina Energy, David L. Kunovic, Cheryl L. Kunovic
and/or Lipizzan Petroleum Corporation), plus any AMI's (the "Wyoming Venture").

         2.4 EMD and Mid-Power entered into that certain Venture Agreement on or
about the 1st day of August, 2002 covering prospects within the Otis Creek
Prospect, Richland County, Montana covering sections 11 and 14, Township 26
North, Range 50 East (the "Montana Venture").

         2.5 EMD and Mid-Power entered into that certain Agreement on or about
August 22, 2002, as amended, covering a prospect, namely the Larson-Newporte
Proposal, located in Renville County, North Dakota, Section 9 NE SW, namely
EM-Larson 9-11R, Township 163 North, Range 87 West, Renville County, North
Dakota (the "North Dakota Prospect").

         2.6 EMD and Mid-Power entered into that certain Venture Agreement on or
about the 10th day of May, 2002, covering prospects within the Arbuckle Gas
Field in Colusa County, California (the "Arbuckle Prospects").

         2.7 EMD and Mid-Power entered into that certain Letter Agreement on or
about the 1st day of August, 2002, covering the Petrogulf Farmout known as the
Lakeside Prospect in Cameron Parish, Louisiana (the "Lakeside Agreement").

         2.8 EMD and Mid-Power from time to time entered into other venture
agreements for other prospects and other agreements. It is the intent of the
parties that this settlement shall resolve and terminate any and all agreements
and or ventures regardless of the nature between the parties. Any and all other
agreements and or venture's between the parties, regardless of the nature not
specifically set forth above shall be collectively referred to for purposes of
this Agreement as the "Other Agreements".

         2.9 EMD holds 17,125,365 shares of restricted common stock of Mid-Power
(the "Stock").

         2.10 Under the Acquisition/Plan, a certain $10 million Promissory Note
with interest, payable by Mid-Power to EMD was delivered (the "Note") which Note
was backed by a Confession of Judgment (the "Judgment").

         2.11 On or about January 24, 2003, both MPSC and MPRC filed Petitions
under Chapter 11 of the United States Bankruptcy Code (collectively the
"Bankruptcy Case") in the United States Bankruptcy Court for the District of
Nevada ("Bankruptcy Court"). Mid-Power is debtor-in-possession in the Bankruptcy
Case.

         2.12 On or about January 17, 2003, Thomas Kelly filed suit against EMD
and MPRC with respect to the Potential Kelly Interests (the "Kelly Lawsuit").

         2.13 On February 28, 2003, the Parties hereto appeared at a settlement
conference in front of the Honorable Gregg W. Zive. The parties were each
represented by Counsel. Edward Mike Davis appeared on his own behalf, and
Mid-Power was represented by James W. Scott. Both Edward Mike Davis and James w.
Scott represented that they possessed authority to bind the parties to the
settlement terms set forth herein.

         2.14 It is understood by and between the parties hereto that this
Agreement is being entered into as a settlement of disputed claims. Nothing
herein is to be construed as any admission of liability on the part of any party
to this Agreement nor is it to be construed as an admission of the truth of any
allegation in any court document filed by any party to this Agreement in any
legal proceeding relating to the disputes discussed herein.

         2.15 The recitals contained herein are an integral part of this
agreement and are incorporated into the body of this Agreement by reference as
if fully set forth herein.

3. Cooperation Covenant: The parties hereto shall fully cooperate and deliver
all documents necessary to effect this settlement in as timely a fashion as
reasonable between the parties.

4. Representations And Warranties Of MPSC And MPRC :

MPSC and MPRC represent and warrant to EMD as follows:

         4.1 Organization. MPSC and MPRC are corporations duly organized,
validly existing and in good standing under the laws of the State of Nevada.

         4.2 Authority Relative to this Agreement. MPSC and MPRC each have full
power (legal and otherwise) and authority to execute and deliver this Agreement
and to consummate the transactions contemplated hereby. Before the Closing
(defined later), the Board of Directors of MPSC and MPRC each will have duly and
validly authorized the consummation of the transactions contemplated hereby. No
other proceedings on the part of MPSC and MPRC are necessary to authorize this
Agreement or to consummate the transactions contemplated hereby other than
Bankruptcy Court approval in the Bankruptcy Case. This Agreement has been duly
and validly executed and delivered by MPSC and MPRC and, assuming due and valid
execution by EMD, constitutes a valid and binding agreement of Mid-Power,
enforceable against Mid-Power in accordance with its terms.

         4.3 Conflicts. etc. Neither the execution, delivery nor performance of
this Agreement by Mid-Power will (a) conflict with, or result in a breach of, or
constitute a default under, or result in violation of, any agreement or
instrument to which Mid-Power is a party or by which the property of Mid-Power
is bound or (b) result in the violation of any applicable law or order,
judgment, writ, injunction, decree or award of any court, administrative agency
or governmental authority.

         4.4 Mid-Power warrants that they have not transferred, assigned,
conveyed, hypothecated or in any way attempted to transfer, assign, conveyor
hypothecate any interest in the Colorado Venture, the Wyoming Venture, the North
Dakota Venture, the Montana Venture or the Arbuckle Prospects.

         4.5 Legal Action. No lawsuit or other proceeding, other than the
lawsuit set forth in 7.2 (i), has been filed or commenced by MPRC and/or MPSC
against EMD relating to the disputes set forth herein.

         4.6 Recitals. The recitals contained in this agreement are all true and
accurate to the best of Mid-Power's knowledge.

5. Representations and Warranties of EMD:

         5.1 Conflicts. etc. Neither the execution, delivery nor performance of
this Agreement by EMD will (a) conflict with, or result in a breach of, or
constitute a default under, or result in violation of, any agreement or
instrument to which EMD is a party or by which the property of EMD is bound or
(b) result in the violation of any applicable law or order, judgment, writ,
injunction, decree or award of any court, administrative agency or governmental
authority.

         5.2 Ownership. EMD has good and marketable title to the Stock except
for the options granted by EMD listed in Section 6.2(ii)(b), the Note and the
Judgment, free and clear of any charge, claim, condition, equitable interest,
lien, option, pledge, security interest, right of first refusal, or restriction
of any kind, including any restriction on use, voting, transfer, receipt of
income, or exercise of any other attribute of ownership.

         5.3 Authority Relative To This Agreement. This Agreement constitutes a
valid and binding agreement of EMD enforceable against him in accordance with
its terms.

         5.4 Legal Action. No lawsuit or other proceeding other than those set
forth in 7.2 (ii) and (iii) have been filed or commenced by EMD against MPRC
and/or MPSC.

         5.5 Recitals. The recitals contained in this agreement are all true and
accurate to the best of EMD's knowledge.

6. Closing Conditions:

         6.1 The parties hereto understand and acknowledge the closing of this
settlement is contingent upon the approval of the Bankruptcy Court in the
Bankruptcy Case. Mid-Power shall petition the Court for such approval as soon as
possible, and in any case shall request that Mid-Power's request for approval of
this settlement be heard by the Bankruptcy Court on shortened time. The parties
hereto will both work in good faith to secure such approval.

         6.2 The parties agree that at the closing which shall take place within
72 hours after approval of this settlement by the Bankruptcy Court at a time and
place mutually agreeable to the parties (the "Closing") they shall perform as
follows:

         (i) EMD shall:

         (a) Deliver to Mid-Power the Stock duly endorsed.

         (b) Deliver the Note, which includes all accrued interest, fees and
charges, marked canceled and the Judgment, marked cancelled.

         (c) This Section 6.2(i)(c) shall cancel any right to any assignment
which EMD was to receive pursuant to the Lakeside Agreement and disclaims any
interest whatsoever in the Lakeside Prospect. Such cancellation to be effected
by EMD's signature to this Agreement and become effective at Closing.

         (d) EMD shall take the following action with respect to the Retained
CCU Interests:

The CCU Override shall be divided with a 3% overriding royalty to be assigned by
EMD to Joy S. Bell and the remaining overriding royalty being assigned to
Mid-Power by execution of two originals (one for Carbon County, Utah and one for
Emery County, Utah) of the Assignment attached hereto as Exhibit A and
incorporated herein by reference.

EMD shall retain the CCU Deep Rights.

EMD shall assign so much of the Potential Kelly Interests as is not obtained by
Thomas Kelly in the course of the Kelly Lawsuit to Mid-Power by execution of the
Conditional Assignment attached hereto as Exhibit B and incorporated herein by
reference.

         (e) Deliver a mutual release in favor of Mark T. Davis, Kenneth Emter,
Gary G. Lowley, Ph.D., Michael T. Maloney, and James W. Scott executed by EMD
individually and on behalf of, Edward Mike Davis, L.L.C.; Edward Mike Davis,
Inc.; Bear Oil And Gas, Inc.; Elk Oil And Gas, Inc.; and Spottie, Inc. the form
of which release is attached hereto as Exhibit C and incorporated herein by
reference.

         (ii) Mid-Power shall:

         (a) By executing this Agreement, this Section 6.2(ii)(a) shall
terminate Mid-Power's past, current or future rights of any kind whatsoever in
the Colorado Venture, the Wyoming Venture, the North Dakota Venture, the Montana
Venture and Other Agreements and relinquish Mid-Power's rights to all funds
currently held in escrow by EMD.

         (b) Issue options for 1,000,000 shares of Mid-Power's common stock at a
price of Two Dollars and no cents ($2.00) per share. Each option will be valid
until December 31, 2004 at 11:59.59 p.m. Pacific Time. The options will be
issued to following recipients:

Option Holder                                    Number of Shares
-------------                                    ----------------
Phyllis J. McGuire                                   500,000
Joy S. Bell                                          100,000
Harold D. Hein                                       275 000
Emilio R. Giuliani, M.D.                              50,000
William J. Oskilanec                                  50,000
O.D. Chamberlain, Jr.                                 25 000
                                                   ---------
Total                                              1,000,000
                                                   =========

         (c) By execution of this Agreement and effective upon Closing,
ownership of ownership of one (1) 310 KW generator and one (1) 265 KW generator,
each with a gas Waukesha engine in a house currently located at Hams Well
Service, Highway 83 South, Westhope, North Dakota shall be solely vested in EMD.

         (d) By execution of this agreement and effective upon Closing,
ownership of one H-40 Ideco Work-Over Rig (the "Rig") and approximately 6,000
feet of 2 7/8" N-80 EUE tubing currently located at Ross Well Service, 4111 West
1250 South, Roosevelt, Utah shall be solely vested in EMD. EMD acknowledges that
the Rig may be subject to certain recorded liens and agrees to take ownership of
the Rig as is, where is.

         (e) Mid-Power shall pay to EMD the sum of $17,500 or so much of the sum
that has not been released by the United States Bureau of land Management
("BLM") related to deposits for bonds which have not been released on the CCU.
EMD, upon such payment shall assign to Mid-Power his rights to the funds not
released by the BLM.

         (f) Execute a form acceptable to Southwest Gas in Las Vegas, Nevada
("SWG") to disclaim any and all interest in funds of approximately $1,500 posted
in a bond with SWG by EMD personally in the name of Red Star, Inc. for the
benefit of Dryclean Express prior to the merger of Red Star and MPRC.

         (g) This Section 6.2(i)(g) shall be effective, as of February 28, 2003
as an assignment of all of Mid-Power's currently existing interests and rights
in the Prospects (mineral leases and gas prospects in the Arbuckle gas field in
Townships 13 & 14 N, Range 2W MDB&M (Mt. Diablo Basin Meridian), Colusa County,
California), including, but not limited to, the Lohman 2A-14 Well, in which
Mid-Power has a 50% working interest that is equivalent to a forty (40%) percent
net revenue interest (the "40% Interest"); Mid-Power makes no representation or
warranty as to title except that Mid-Power has made no prior assignment of the
40% Interest. The form of assignment is attached hereto as Exhibit D and
incorporated herein by reference. EMD will pay to Mid-Power forthwith, upon
receipt thereof from Petrogulf Corporation the proceeds attributable to the 40%
interest for the months of January and February 2003 and all months prior to
January 2003 less operational expenses paid during said months to the extent
that such proceeds have not been distributed prior to the execution of this
Agreement.

         (h) Deliver a mutual release in favor of EMD and executed by Mark T.
Davis, Kenneth Emter, Gary G. Lowley, Ph.D., Michael T. Maloney, and James W.
Scott the form of which release is attached hereto as Exhibit C and incorporated
herein by reference.

7. Releases and Dismissal of Legal Proceedings:

         7.1 In consideration of good and valuable consideration, the parties to
this Agreement hereby remise, release, acquit, satisfy and forever discharge
each other from all manner of action and actions, cause and causes of action,
suits, debts, dues, sums of money, accounts, reckonings, bonds, bills,
specialties, covenants, contracts, controversies, agreements, promises,
variances, trespasses, liens, damages, judgments, executions, claims and demand
whatsoever, in law or in equity, which either party ever had, now has, or which
any personal representatives, successor, heir or assign of either party,
hereafter can, shall or may have, against each other, for, upon or by reason of
any matter, cause or thing whatsoever, from the beginning of the world up to and
including the date of this Agreement, whether known or unknown, liquidated or
unliquidated, contingent or noncontingent, except for the obligations to be
performed pursuant to Section 6 hereof.

         7.2 At the time of Closing described above, the parties will deliver to
each other and execute documentation necessary to dismiss with prejudice the
following legal proceedings:

         (i) The lawsuit filed by MPSC and MPRC against EMD in the Eighth
Judicial District Court, Clark County, Nevada, case number A460833. The
documents dismissing this suit shall contain a stipulation for the dissolution
of the Stipulated Temporary Restraining Order entered by the Court on January 3,
2003 and for return of the security posted by MPSC and MPRC as security for that
Order.

         (ii) The lawsuit filed by EMD against MPRC in the District Court of
Washington County, Colorado, case number 2002 CV34.

         (iii) The lawsuit filed by EMD against MPRC in the First Judicial
District Court, Laramie County, Wyoming, case number 161-243.

Following the Closing, the parties shall cause the above-referenced dismissals
to be filed with the appropriate courts.

8. Indemnification:

         8.1 Indemnification of EMD

         (a) Agreement to Indemnify. Mid-Power hereby agrees to indemnify,
defend and hold harmless EMD, his heirs, successors and assigns (each an "EMD
Indemnified Party") from and against all demands, claims, actions, causes of
action, inquiries, investigations, assessments, losses, damages, liabilities,
costs and expenses, including, without limitation, interest, penalties and
reasonable attorneys' fees and expenses (collectively, "Damages"), directly
asserted against, resulting to, imposed upon or incurred by an EMD Indemnified
Party at any time after the date hereof, solely by reason of: (i) consulting
services provided by EMD to Mid-Power pursuant to the terms of that certain
consulting Agreement dated June 13, 2002 providing for such consulting services;
(ii) his ownership of the Stock, solely in EMD's role as a shareholder; and
(iii) the Lakeside Agreement and Lakeside Prospect; (collectively and each of
them, the "Mid-Power Claims").

         (b) Conditions of Indemnification. The obligations and liabilities of
Mid-Power under Section 8.1 with respect to the Mid-Power Claims made by third
parties shall be subject to the following terms and conditions:

         (i) The EMD Indemnified Party, will give Mid-Power reasonable notice of
any such Mid-Power Claim, and Mid-Power will assume the defense thereof by
representatives chosen by it and reasonably satisfactory to the EMD Indemnified
Party.

         (ii) If Mid-Power, within a reasonable time after notice of any such
Mid-Power Claim, fails to assume the defense thereof, the EMD Indemnified Party
shall (upon further notice to Mid-Power) have the right to undertake the
defense, compromise or settlement of such Mid-Power Claim on behalf of and for
the account and risk of Mid-Power, subject to the right of Mid-Power to assume
the defense of such Mid-Power Claim at any time prior to the settlement,
compromise or final determination thereof.

         (iii) Anything in this Section 8.1 to the contrary notwithstanding, (A)
if there is a reasonable probability that a Mid-Power Claim may materially and
adversely affect the EMD Indemnified Party other than as a result of money
damages or other money payments, the EMD Indemnified Party shall also have the
right to defend with respect to non-monetary claims, at the cost and expense of
Mid-Power, to compromise or settle such Claim with the consent of Mid-Power; and
(B) Mid-Power shall not, without the written consent of the EMD Indemnified
Party, settle or compromise any such Mid-Power Claim or consent to the entry of
any judgment which does not include as an unconditional term thereof the giving
by the claimant or the plaintiff to the EMD Indemnified Party a release from all
liability in respect of such Mid-Power Claim. EMD Indemnified Party shall not
unreasonably withhold consent under this Section 8.1(b)(iii)(B).

         8.2 Indemnification of MPSC and MPRC

         (a) Agreement to Indemnify. EMD hereby agrees to indemnify, defend and
hold harmless MPSC and MPRC, their successors and assigns (each a "Mid-Power
Indemnified Party") from and against all demands, claims, actions, causes of
action, inquiries, investigations, assessments, losses, damages, liabilities,
costs and expenses, including, without limitation, interest, penalties and
reasonable attorneys' fees and expenses (collectively, "Damages"), directly
asserted against, resulting to, imposed upon or incurred by a Mid-Power
Indemnified Party at any time after the date hereof, solely by reason of the
Arbuckle Prospects, the Colorado Venture and/or the Wyoming Venture (the "EMD
Claims").

         (b) Conditions of Indemnification. The obligations and liabilities of
EMD under Section 8.2 with respect to the EMD Claims made by third parties shall
be subject to the following terms and conditions:

         (i) The Mid-Power Indemnified Party will give EMD reasonable notice of
any such EMD Claim, and EMD will assume the defense thereof by representatives
chosen by him and reasonably satisfactory to the Mid-Power Indemnified Party.

         (ii) If EMD, within a reasonable time after notice of any such EMD
Claim, fails to assume the defense thereof, the Mid-Power Indemnified Party
shall (upon further notice to EMD) have the right to undertake the defense,
compromise or settlement of such EMD Claim on behalf of and for the account and
risk of EMD, subject to the right of EMD to assume the defense of such EMD Claim
at any time prior to the settlement, compromise or final determination thereof.

         (iii) Anything in this Section 8.2 to the contrary notwithstanding, (A)
if there is a reasonable probability that an EMD Claim may materially and
adversely affect the Mid-Power Indemnified Party other than as a result of money
damages or other money payments, the Mid-Power Indemnified Party shall also have
the right to defend with respect to non-monetary claims, at the cost and expense
of EMD, to compromise or settle such EMD Claim with the consent of EMD; and (B)
EMD shall not, without the written consent of the Mid-Power Indemnified Party,
settle or compromise any EMD Claim or consent to the entry of any judgment which
does not include as an unconditional term thereof the giving by the claimant or
the plaintiff to the Mid-Power Indemnified Party a release from all liability in
respect of such EMD Claim. Mid-Power Indemnified Party shall not unreasonably
withhold consent under this Section 8.2(b)(iii)(B).

9. Successors and Assigns: This Agreement shall inure to the benefit of and
shall be binding upon the successors, heirs, legal representatives and/or
assigns of the parties hereto, and each of them, and shall survive any dismissal
or other disposition of the Bankruptcy Case.

10. Integration: This Agreement constitutes a single, written contract
expressing the entire Agreement of the parties hereto relative to the subject
matter hereof. No covenants, Agreements, representations, or warranties of any
kind whatsoever have been made by any party hereto, except as specifically set
forth in this Agreement. All prior discussion and negotiations have been and are
merged and integrated into, and are superseded by this Agreement.

11. Severability: In the event that any provision of this Agreement should be
held to be void, voidable or unenforceable, the remaining portions hereof shall
remain in full force and effect as each provision is an independent covenant and
not a condition precedent to the effectiveness of any other provision herein.

12. Governing Law: Venue: This Agreement shall be governed by the laws of the
State of Nevada (regardless of the laws that might otherwise govern under
applicable Nevada principles of conflicts of law) as to all matters, including
but not limited to matters of validity, construction, effect, performance and
remedies. The parties hereto agree that all actions or proceedings arising in
connection with this Agreement shall be initiated and tried exclusively in the
state and federal courts located in Clark County, Nevada.

13. Survival of Warranties. Representations and Other Items: The provisions of
Sections 4, 5, 6, 7 and 8 of this Agreement shall survive for the period
indicated therein or, if no period is indicated, forever until satisfied.

14. General Provisions:

         14.1 The parties hereto have each received or have had the opportunity
to receive independent legal advice from attorneys of their choice with respect
to the advisability of making the settlement and release provided herein, and
with respect to the advisability of executing this Agreement

         14.2 Except as expressly stated in this Agreement, no party hereto has
made any statement or representation to any other party regarding any fact
relied upon by any other party in entering into, this Agreement, and each party
specifically does not rely upon any statement, representation, or promise of any
other party in executing this Agreement, or in making the settlement provided
for herein, except as expressly stated in this Agreement.

         14.3 Each party has made such investigation of the facts pertaining to
this Agreement, and all of the matters pertaining thereto, as they deem
necessary.

         14.4 The terms of this Agreement are contractual, not a mere recital,
and are the result of negotiation among all the parties.

         14.5 This Agreement has been carefully read by, the contents hereof are
known and understood by, and it is signed freely by, each person executing this
Agreement; and each person executing this Agreement in a representative capacity
is empowered to do so.

         14.6 Each party hereto agrees that such party will not take any action
which would interfere with the performance of this Agreement by any of the
parties hereto or which would adversely affect any of the rights provided for
herein.

         14.7 This Agreement may be signed in any number of counterparts with
the same effect as if the signatures to each counterpart were upon a single
instrument, and all such counterparts together shall be deemed to constitute an
original and the same instrument. Faxed signatures shall be deemed to be the
same as original signatures.

IN WITNESS WHEREOF, the parties hereto have approved and executed six (6) copies
of this Agreement on the dates set forth opposite their respective signatures.

/s/ Edward Mike Davis                                   March 15, 2003
------------------------------------                  -----------------
EDWARD MIKE DAVIS, an individual                             DATE

MID-POWER SERVICE CORPORATION,
a Nevada corporation

/s/ James W. Scott                                      March 18, 2003
------------------------------------                  -----------------
JAMES W. Scott. President                                     DATE

MID-POWER RESOURCE CORPORATION,
a Nevada corporation

/s/ James W. Scott                                      March 18, 2003
------------------------------------                  -----------------
JAMES W. SCOTT, President                                     DATEQuickLinks
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Exhibit 10.1    
  

        
March 25, 2003 

FAO, Inc.

2520 Renaissance Boulevard

King of Prussia, PA 19406 

Attention:
Mr. Raymond Springer 

Dear
Mr. Springer: 

        1. COMMITMENT  

        We are pleased to advise you of the several commitments of Fleet Retail Finance Inc. ("FRF") and Back Bay
Capital Funding LLC ("Back Bay"), subject to the terms and conditions hereof, respectively to provide a senior secured revolving credit facility in the
amount of $67,000,000 (the "Revolving Credit Facility") and a senior secured term loan facility in the amount of $10,000,000 (the
"Term Loan" and together with the Revolving Credit Facility, the "Facilities") in favor of
FAO, Inc. ("FAO") and its subsidiaries (collectively, the "Borrower"), all as contemplated on the
Summaries of Terms and Conditions (the "Term Sheets") annexed to this letter as EXHIBIT A (with respect
to the Revolving Credit Facility) and EXHIBIT B (with respect to the Term Loan). The commitment of FRF hereunder shall be limited to the Revolving
Credit Facility and the commitment of Back Bay hereunder shall be limited to the Term Loan. 

        2. AGENT  

        Fleet Retail Finance Inc. will act as Administrative Agent and Collateral Agent (and is referred to herein in such capacities as the
"Agent") for itself and the other lenders (the "Revolving Credit
Lenders") which fund the Revolving Credit Facility and for Back Bay as lender for the Term Loan. The Revolving Credit Lenders and Back Bay are referred to herein collectively
as the "Lenders". 

        3. SYNDICATION  

        FRF will act as the exclusive syndication manager for the Revolving Credit Facility and, in such capacity, will perform the duties and exercise the authority
customarily associated with such role. No additional agents, arrangers or syndication managers will be appointed with respect to the arrangement and syndication of the Revolving Credit Facility. FRF
will provide the full amount of the Revolving Credit Facility but intends to syndicate the Revolving Credit Facility among a group of financial institutions arranged by FRF. FRF, in its sole
discretion, but in consultation with the Borrower, will manage all aspects of the syndication of the Revolving Credit Facility, including the selection of lenders, the determination of when to
approach potential lenders, the title and roles given various lenders in the syndicate, and the final allocation of the commitments among the lenders. FRF shall, in all events, have the final say
concerning all aspects of the syndication. FRF shall be released from a portion of its commitment hereunder in an aggregate amount equal to the commitment of those Lenders which commit and subscribe
to the syndicate assembled by FRF. 

        The
Borrower will assist FRF in achieving a timely syndication, such assistance to include, among other things, (a) direct contact during the syndication between the Borrower's
senior officers, representatives and advisors, on the one hand, and prospective lenders, on the other hand, at such times and places as FRF may reasonably request; (b) providing FRF and Back
Bay with all such financial and other information in the Borrower's possession with respect to the Borrower and the transactions contemplated by this letter, including but not limited to financial
projections and forecasts relating to the foregoing which FRF and Back Bay reasonably may request from time to time; and (c) assistance in the preparation of a confidential information
memorandum and other marketing materials to be used in connection with the syndication. You expressly permit FRF and Back Bay to distribute any and all documents and information relating to the
transactions contemplated hereby and received from you or any other source to any potential Lender, participant or assignee, on a 

 

confidential basis reasonably satisfactory to the Borrower and to permit FRF and Back Bay to publicize information in respect of the Facilities (including FRF's and Back Bay's roles in the
structuring and financing thereof) subject to your prior reasonable approval of the form and content thereof. 

        The
Borrower acknowledges that the Agent, FRF and Back Bay, in consultation with the Borrower, may change the pricing, structure and any other terms of the Facilities if the Agent, FRF
and Back Bay determine that such changes are advisable in order to ensure a successful syndication or an optimal credit structure for the Facilities. 

        4. CONDITIONS  

        The commitments of FRF, Back Bay and the Agent, as expressed in this letter, are subject to those conditions set forth on the Term Sheets. 

        5. INDEMNIFICATION  

        Whether or not the credit facilities contemplated hereby are established, the Borrower agrees to indemnify and hold harmless FRF, Back Bay, the Lenders, the
Agent, any participants, and their respective directors, officers, employees, affiliates, agents, attorneys, accountants, consultants and each other entity, if any, who controls any of the foregoing,
and to hold such persons and entities (each, an "Indemnified Person") harmless from and against all losses, claims, damages, liabilities and expenses,
joint or several, to which any such person or entity may become subject arising out of or in connection with this letter, the Term Sheets, the Facilities, the use of proceeds of the extensions of
credit thereunder or any related transaction or any claim, litigation, investigation or proceeding relating to any of the foregoing, regardless of whether any of such Indemnified Persons is a party
thereto, and to reimburse each Indemnified Person upon demand for any reasonable legal or other expenses incurred in connection with investigating or defending any of the foregoing;  provided, however,
the foregoing indemnification shall not be available, as to any Indemnified Person, on account of or in respect to any claim as to
which there is a final determination made in a judicial proceeding (in which the Agent, FRF, Back Bay and such Indemnified Party have had an opportunity to be heard), which determination includes a
specific finding that the person seeking indemnification pursuant hereto had acted in a grossly negligent manner or in bad faith. 

        If
for any reason the foregoing indemnification is unavailable to any Indemnified Person or insufficient to hold it harmless, then the Borrower shall contribute to the amount paid or
payable by such Indemnified Person as a result of such loss, claim, damage or liability to the maximum amount legally permissible. The Borrower also agrees that neither any Indemnified Person, nor any
of their respective affiliates, partners, directors, agents, employees or controlling persons, shall have any liability to the Borrower, any person asserting claims on behalf or in right of the
Borrower or any other person in connection with or as a result of either this arrangement or any matter referred to herein or in the loan documentation except to the extent that there is a final
determination made in a judicial proceeding (in which the Agent, FRF, Back Bay and such Indemnified Party have had an opportunity to be heard), which determination includes a specific finding that the
losses, claims, damages, liabilities or expenses incurred by the Borrower resulted from the gross negligence or bad faith of such Indemnified Person. 

        No
Indemnified Person shall be liable for any indirect, special, punitive, or consequential damages in connection with or arising out of this letter or the transactions contemplated
hereby. This indemnification shall survive any closing of the Facilities. 

        6. REIMBURSEMENT  

        The Borrower shall reimburse FRF, Back Bay and the Agent from time to time on demand for reasonable out-of-pocket expenses (including, but
not limited to, reasonable expenses of due diligence investigation, reasonable syndication expenses, reasonable travel expenses and reasonable fees, 

2

 

disbursements and charges of its counsel), in each instance incurred in connection with the Facilities and the preparation of this letter, the Term Sheets and the definitive documentation for the
Facilities, whether or not the transactions are closed. 

        In
accordance with the Term Sheets, FRF has received a due diligence deposit of $125,000 and Back Bay has received a due diligence deposit of $85,000 (collectively, the
"Work Fee"). If the Facilities are so established, then the Work Fee shall be accounted for by FRF and Back Bay and any excess amounts shall be returned
to the Borrower; provided, however, the Borrower shall remain obligated to reimburse the Agent, FRF and Back Bay for any legal fees and expenses
reasonably incurred in connection with the transactions contemplated by this letter whether or not the Facilities are closed and whether or not the Work Fee is sufficient for such purpose. If the
Facilities are not so established then the Work Fee may be retained by FRF and Back Bay as additional compensation for FRF's and Back Bay's lost opportunity costs. The Work Fee shall be in addition to
the obligations of the Borrower to reimburse the Agent, FRF and Back Bay for the expenses to be reimbursed by the Borrower as herein provided. 

        7. CLOSING  

        This letter shall terminate unless accepted by the Borrower on or before 5:00 p.m. (Boston time) on March 28, 2003 by signing below and returning
this letter, so signed to the Agent, together with that portion of the Commitment Fees due to FRF and Back Bay upon the acceptance hereof, as more specifically provided in the Term Sheets. 

        If
this letter is so accepted, then, subject to the terms and conditions of this letter, FRF would be obligated to establish the Revolving Credit Facility and Back Bay would be obligated
to provide the Term Loan if all conditions precedent thereto are satisfied (as reasonably determined by the FRF, the Agent and Back Bay) on or before April 30, 2003. The closing, in such event,
would take place in Boston, Massachusetts at the offices of the Agent's counsel. 

        The
Borrower, with its acceptance of this letter, shall be deemed to have authorized the Agent and its counsel to file financing statements in form prepared by the Agent's counsel and in
accordance with the Term Sheets with a view towards the filing of such financing statements prior to the anticipated
closing date. If the Facilities are not so established, the Agent shall promptly terminate all filed financing statements. 

        This
letter does not constitute an unconditional commitment to lend. Such a commitment will exist only following: execution and delivery of definitive loan documents (each in form
satisfactory to the Agent, FRF and Back Bay); the recordation of such instruments and documents as the Agent, FRF and Back Bay reasonably determine to be appropriate under the circumstances; and the
satisfaction of all conditions precedent referenced herein, in the Term Sheets, or in any of the definitive loan documents. 

        8. NONTRANSFERABILITY OF COMMITMENT  

        The identity of the Borrower is of material importance to the Agent, FRF and Back Bay. Consequently, this commitment may not be assigned or transferred by the
Borrower (it being understood that a change of control of the Borrower shall not be considered an assignment or transfer). FRF and Back Bay may assign its obligations (a) under this commitment
to any present or future affiliate of FRF, Back Bay or the Agent, (b) in connection with the syndication contemplated hereby or (c) after the closing of the Facilities, in accordance
with the loan documentation. 

        9. NON-DISCLOSURE OF COMMITMENT; EXCLUSIVE DEALINGS  

        The Borrower shall maintain as confidential the terms and conditions of this letter and the Term Sheets and the terms, conditions, provisions and documentation of
the Facilities. Without limiting the foregoing, this letter and the Term Sheets may not be disclosed to any persons other than the 

3

 

employees and affiliates of the Borrower and its accountants, financial advisors, existing lenders, creditors committee and counsel or as may be required by law without the prior written consent of
FRF, Back Bay and the Agent. Further, none of the foregoing may discuss the pricing or other terms contained herein with any person not entitled to receive a copy hereof. The failure to comply with
the foregoing provisions shall automatically terminate any and all obligations of FRF, Back Bay and the Agent with respect to the financing contemplated hereunder. 

        By
executing this letter where indicated below, the Borrower covenants that, from and after the date of this letter and until the consummation of the transactions contemplated herein or
the expiry of FRF's and Back Bay's obligations hereunder, the Borrower (and its officers, directors, employees, agents and representatives) (a) shall not directly or indirectly solicit,
initiate, encourage, facilitate, or discuss any submission, proposal, or offer from, or any effort or attempt by, any other person, entity, or group relating to the financing of the Borrower or any of
its affiliates, and (b) shall provide the Agent with immediate written notice (with reasonable detail of the facts and circumstances relating thereto) of any submission, proposal, or offer, of
any request for information, related directly or indirectly to any such financing of the Borrower or any of its affiliates. 

        10. GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL  

        This letter is a contract under the laws of the State of New York and shall pursuant to New York General Obligations Law §5-1401, be
construed in accordance with and be governed by the laws of the State of New York. 

        The
Borrower agrees that any legal action, proceeding, case, or controversy against the Borrower with respect to this letter or the Facilities may be brought in the Courts of the State
of New York or any federal court sitting therein, as the Agent, FRF or Back Bay, as applicable, may elect in its sole discretion. By acceptance of this letter, the Borrower for itself and in respect
of its property, accepts, submits, and consents generally and unconditionally, to the jurisdiction of the aforesaid courts. The Borrower Waives any
objection based on forum non conveniens and any objection to venue of any action or proceeding instituted under or with respect to this letter or the
Facilities and consents to the granting of such legal or equitable remedy as is deemed appropriate by the relevant Court. The Borrower further agrees that any action commenced by the Borrower
asserting any claim or counterclaim arising under or in connection with this letter or the Facilities shall be brought solely in the Courts of the State of New York or any federal court sitting
therein, and that such Courts shall have exclusive jurisdiction with respect to any action. 

        The
Borrower, the Agent, FRF and Back Bay make each of the following waivers knowingly, voluntarily, and intentionally, and each understands that the Agent, FRF and Back Bay, in
providing this letter, and the Borrower, are each relying on such waivers. 

        THE
BORROWER, THE AGENT, FRF AND BACK BAY EACH WAIVE THE FOLLOWING: 

THE
RIGHT TO A JURY IN ANY TRIAL OF ANY CASE OR CONTROVERSY IN WHICH THE BORROWER, THE AGENT, FRF OR BACK BAY IS OR BECOMES A PARTY (WHETHER SUCH CASE OR CONTROVERSY IS INITIATED BY OR AGAINST THE
BORROWER, THE AGENT, FRF AND/OR BACK BAY OR IN WHICH THE BORROWER, THE AGENT, FRF OR BACK BAY, IS JOINED AS A PARTY LITIGANT), WHICH CASE OR CONTROVERSY ARISES OUT OF OR IS IN RESPECT OF, ANY
RELATIONSHIP AMONGST OR BETWEEN THE BORROWER OR ANY OTHER PERSON AND THE AGENT, FRF OR BACK BAY. 

[Remainder of page Intentionally Blank] 

4

 

        If
the foregoing is in accordance with your understanding of our agreement, please sign this letter in the space indicated below and return it to the Agent. 

	 	 	Very truly yours,
	

 	
 	

FLEET RETAIL FINANCE INC.,

individually and as Agent
	

 	
 	

By:	
 	

 
	 	 	 	 	

	 	 	Title:
	

 	
 	

BACK BAY CAPITAL FUNDING, LLC
	

 	
 	

By:	
 	

 
	 	 	 	 	

	 	 	Title:

The foregoing is agreed to: 

FAO, INC.

By:
                                         
                

            Title:

            Dated: 

5

 
 

Exhibit A    
  

 
 

FAO, Inc.—Emergence
  Summary of Terms and Conditions
  For Senior Revolving Credit Facility
  March 25, 2003    
  

	Borrowers:	 	FAO, Inc. and its subsidiaries (collectively, the "Borrower" or the "Company")
	

Agent:	
 	

Fleet Retail Finance Inc. ("FRF" or the "Agent")
	

Lenders:	
 	

Fleet Retail Finance Inc. and a group of financial institutions to be arranged by the Agent, in its sole discretion
	

Credit Facilities:	
 	

The revolving credit facility (the "Revolver Facility") shall consist of a revolving line of credit in the maximum principal amount of $67,000,000 with a sub-limit of $15,000,000 for documentary and standby letters of credit. This revolving line will
be provided in combination with a fully funded tranche B term facility in an amount of no less than $10,000,000 to be provided by Back Bay Capital Funding LLC ("Back Bay"), as outlined in the Term Sheet of even date herewith (the "Term Facility").
Each of which will be subject to acceptable documentation, inclusive of an intercreditior agreement satisfactory to FRF. The combined facilities will total $77,000,000.
	

Purpose:	
 	

Borrowing under the Revolver Facility will be used to fund working capital and inventory purchases in accordance with the Company's budget and business plan and to fund the Company's emergence upon confirmation of a reorganization plan (the "Plan")
by the Bankruptcy Court.
	

Maturity:	
 	

Three (3) years from the closing date, but at all times coterminous with the Term Facility.
	

Security:	
 	

The Revolver Facility shall have a perfected first lien on all presently owned and hereafter acquired assets of the Borrower subject to a second lien by Back Bay and permitted liens as set forth in the final documentation (including first liens on
equipment, and with respect to equipment liens not existing as of the closing, such liens shall be subject to intercreditor terms and conditions acceptable to FRF, as Agent).
	

Commitment Fee:	
 	

As set forth on Schedule I.
	

Borrowing Options:	
 	

Borrowings under the Revolver Facility shall be at the Fleet Bank Base Rate ("Base Rate Loan") plus the Applicable Margin as indicated below or the Eurodollar Rate plus the Applicable Margin as indicated below ("Eurodollar Rate Loan"). Eurodollar
Rates will be quoted for 1, 2, 3 and 6 months. Base Rate Loans shall require one business day's advance notice. Eurodollar Rate Loans shall require three business days' advance notice.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

 

	

 	
 	

Interest on Base Rate loans will be due and payable monthly in arrears. Interest on Eurodollar Rate Loans will be payable at the end of each applicable interest period or quarterly in arrears, whichever is earlier. All interest on Base Rate Loans and
Unused Fee and other fee calculations shall be based on a 365/366-day year and actual days elapsed. All interest on Eurodollar Rate Loans shall be based on a 360-day year and actual days elapsed.
	

Applicable Margin:	
 	

 	
 	
Level	
 	
Excess

Availability	
 	
Eurodollar

Margin	
 	
Base Rate

Margin	
 	

 
	 	 	 	 	
	 	
	 	
	 	
	 	 
	

 	
 	

 	
 	

I	
 	

TBD	
 	

2.00%	
 	

        0%	
 	

 
	

 	
 	

 	
 	

II	
 	

TBD	
 	

2.25%	
 	

    0.25%	
 	

 
	

 	
 	

 	
 	

III	
 	

TBD	
 	

2.50%	
 	

    0.50%	
 	

 
	

 	
 	

 	
 	

Level II (the starting point) will be in effect for the first year of the commitment, unless excess availability falls into Level III. Thereafter, any upward or downward pricing adjustments will be made quarterly based upon the average excess
availability for the prior quarter.	
 	

 
	

 	
 	

 	
 	

As used herein, "Excess Availability" shall be the amount by which the lesser of (i) the Borrowing Base and (ii) the Maximum Commitment exceeds the loans and letters of credit outstanding under
the Facility.	
 	

 
	

Default Rate Pricing:	
 	

2% above the applicable margin.
	

L/C Issuing Bank:	
 	

Fleet National Bank
	

Letters of Credit:	
 	

Standby and Documentary Letters of Credit shall be priced at the Applicable Margin for Eurodollar Rate Loans per annum, payable on the total face amount of each outstanding letter of credit quarterly in advance.
	

Unused Fee:	
 	

Three eighths of one percent (0.375%) on the average unused portion of the Revolver Facility.
	

Borrowing Base/

Advance Rates:	
 	

Advances under the Revolver Facility will be subject to a borrowing base (the "Borrowing Base") to be calculated daily and determined by the following formula:
	

 	
 	

Advances against the cost value of the Company's Eligible Inventory and Eligible Letter of Credit Inventory shall not exceed 85.0% of the appraised liquidation value of inventory.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

2

 

	

 	
 	
Plus
	

 	
 	

85.0% of Eligible Credit Card Receivables
	

 	
 	
Minus
	

 	
 	

applicable reserves.
	

 	
 	
Eligible Inventory shall consist of stock ledger inventory at cost less any capitalized costs (exclusive of usual and customary freight), and shall exclude the following: Inventory that
cannot be sold, including non-merchandise categories (labels, bags, packaging, etc.), inventory in foreign locations (except for inventory supported by eligible letters of credit whose initial term does not exceed 60 days) and samples.
Additionally, eligible inventory will specifically exclude (i) damaged goods, return to vendor merchandise, packaways, consignment inventory and such other similar categories to be determined based on due diligence, and (ii) third party
locations not under the Borrower's control unless appropriate waivers are obtained.
	

 	
 	
Eligible Credit Card Receivables shall consist of amounts payable from nationally recognized credit card processors, payable within 3-to-5 business days, on a non-recourse basis.
	

 	
 	

The actual reserves and final advance rates will be determined based upon the results of due diligence, which will include a third party appraisal of the net liquidation (GOB) value of inventory, and a commercial finance examination, which will be
shared by and coordinated with FRF.
	

Prepayment Fee:	
 	

If the Company terminates the Revolver Facility and repays the loan prior to maturity with funds borrowed from sources other than FRF, Fleet Boston, NA or any of its affiliates, the company will pay an early termination fee equal to 2.0% of the
maximum commitment if terminated in the first year of the facility and 1% if terminated in the second or third year of the facility. Except, there shall be no prepayment fee if the Company refinances the Revolver Facility within 90 days of
maturity of the Revolver Facility.
	

Financial Covenants:	
 	

Financial Covenants to include but not be limited to:
	

 	
 	

•	
 	

Minimum excess borrowing availability at all times must exceed the greater of $4.0 million or 7.5% of the Borrowing Base.
	

 	
 	

•	
 	

Maximum annual capital expenditures to be determined in the course of due diligence.
	

 	
 	

•	
 	

Minimum ratio of Accounts Payable to Inventory to be determined.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

3

 

	

 	
 	

•	
 	

Minimum EBITDA to be determined.
	

Cash Concentration Account:	
 	

Fleet National Bank shall remain throughout the term of the Revolver Facility the concentration bank for all of the Borrowers' cash management. The Borrowers' disbursement account may be at Fleet National Bank or another bank acceptable to FRF
subject to a control agreement satisfactory to FRF. All credit card collections will be transferred directly to FRF and subject to direction letters with the credit card issuers. All collections and proceeds from asset sales (other than credit card
collections) will be transferred to concentration accounts with institutions which have entered into control agreements satisfactory to FRF and such amounts will on a regular basis be transferred to the Fleet concentration bank. Proceeds will be
applied on a daily basis to reduce borrowings under the Revolver Facility on the business day immediately following receipt.
	

Conditions Precedent:	
 	

Closing shall be conditioned upon satisfaction of the following conditions precedent and other conditions customary to transactions of this type, or reasonably required by the Agent.
	

 	
 	

1.    FRF shall have received a copy of the Plan and the final terms of any Plan to be consummated and the order of the Bankruptcy Court approving such Plan (the "Confirmation Order") shall be reasonably satisfactory to FRF. All
material conditions precedent to confirmation, as defined in the Plan, shall have been met (or the waiver thereof shall have been consented to by FRF). The confirmation order shall not have been reversed, modified, amended, or stayed and, unless
otherwise agreed by FRF, all appeal periods relating to the confirmation order shall have expired, and no appeals from the confirmation order shall be outstanding. Except as consented to by FRF, the Bankruptcy Court's retention of jurisdiction under
the confirmation order shall not govern the enforcement of the loan and security documents for the Revolver or any rights or remedies relating thereto. The capital structure of the Borrower after giving effect to the Plan shall be reasonably
satisfactory to FRF in all respects and shall include evidence of a successful equity private placement generating not less than $25,000,000 of new cash equity (net of costs) and available to fund the Plan and for ongoing operations. Further, the
terms of indebtedness (if any) and capital stock issued under the Plan shall be reasonably satisfactory to FRF in all respects.
	

 	
 	

2.    Funding of the Term Facility.
	

 	
 	

3.    Minimum day one opening excess availability under the Revolver Facility (after giving effect to the funding of the Term Facility and the Minimum Excess Availability Covenant) shall be equal to or greater than $14,000,000.
All post petition accounts payable and taxes shall be paid current; excluding good faith disputes and "liabilities subject to compromise".
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

4

 

	

 	
 	

4.    All necessary consents and approvals to the Revolver Facility shall have been obtained.
	

 	
 	

5.    Satisfactory completion of due diligence, including without limitation, a commercial finance examination and collateral examinations.
	

 	
 	

6.    Usual and customary financial reporting requirements, including monthly stock ledger by department, certain asset based reporting requirements and monthly business plan for 12 consecutive months from date of projected
closing.
	

 	
 	

7.    Preparation, execution and delivery of definitive documentation (the "Definitive Documentation") satisfactory to the Agent (including a certified Borrowing Base certificate and reasonably appropriate security
documentation).
	

 	
 	

8.    Satisfactory inter-creditor or agency agreement provisions between the Lender and (a) the agent for the Senior Credit Facility, (b) Saks and (c) any other debt of the Borrower as part of the plan.
	

 	
 	

9.    Liens on all of the Borrower's collateral shall have been filed and otherwise perfected to the satisfaction of the Agent.
	

 	
 	

10.    Legal opinions of counsel to the Company reasonably satisfactory in form and substance to FRF, including, without limitation, with respect to the enforceability and perfection of FRF's security interests.
	

 	
 	

11.    No material misstatements in the materials furnished to FRF for its review prior to closing, or in representations or warranties made in the final documentation. FRF must be satisfied that any financial statements and
projections delivered to it fairly present the business and financial condition of the Company and its subsidiaries, and that there has been no material adverse change in the assets, business, financial condition, income or prospects of the Company
since the date of the most recent financial information delivered to FRF.
	

 	
 	

12.    The absence of any litigation or other proceeding the result of which might have a material adverse effect on the Company (excluding the current Chapter 11 proceeding).
	

 	
 	

13.    Absence of any material adverse change in the condition (financial or otherwise), operations, assets, income and/or prospects of the Company.
	

 	
 	

14.    The proposed financing is subject to the condition that no material changes in governmental regulations or policies affecting the Company or FRF occur prior to Closing.
	

 	
 	

15.    The absence of any default of any material contract or agreement of the Company.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

5

 

	

 	
 	

16.    The Bankruptcy Court shall have entered an order allowing the Company to emerge from bankruptcy protection.
	

 	
 	

17.    There shall not have occurred any disruption or material adverse change in the financial or capital markets in general that would, in the opinion of the Agent, have a material adverse effect on the market for loan
syndications or in the markets for equity securities in particular, or adversely affecting the syndication.
	

Documentation:	
 	

The Revolver will be subject to the negotiation, execution of an acceptable credit agreement and related security agreements, guarantees, and any other documents as shall be requested by FRF. Such credit agreement will contain representations, and
warranties, conditions precedent, covenants, events of default and other provisions appropriate for transactions of this size, type and purpose and shall be acceptable to FRF and its counsel in every respect.
	

Expenses and Indemnification:	
 	

The Company will pay FRF's reasonable legal and other out-of-pocket expenses incurred in connection with the negotiation, preparation and execution of the documentation, regardless of whether the Revolver Facility should close. Documentation shall
contain enforcement expense and indemnification provisions for the benefit of FRF customary for a transaction of this size, type and purpose.
	

Governing Law:	
 	

State of New York.

6

 
  
 

    Schedule I    
  

	Commitment Fee:	 	0.80% of the total commitment. 30% of the Commitment Fee ($160,800) shall be due and payable on the Borrowers acceptance of the commitment letter (the "Commitment Acceptance Fee") with the remainder due at Closing;
provided, however, the Borrowers can instruct FRF to apply up to $75,000 of the Work Fee previously paid by the Borrowers to FRF as partial payment of the
Commitment Acceptance Fee with the remainder due in cash. The Commitment Fee shall be non-refundable upon pay.

7

[BackBay Capital LOGO]  

  
 

    Exhibit B    
  

 
 

FAO, Inc.—Emergence
  Summary of Terms and Conditions
  For Term Loan Credit Facility
  March 25, 2003    
  

	Borrowers:	 	FAO, Inc. and its subsidiaries (collectively, the "Borrower" or the "Company").
	

Lender:	
 	

Back Bay Capital Funding LLC ("Back Bay").
	

Credit Facility:	
 	

$10,000,000 term loan to be fully funded at closing (the "Credit Facility"), and structured on a first in/last out basis as part of a $67,000,000 senior credit facility to be agented by Fleet Retail Finance Inc. ("FRF"), (the "Senior Credit
Facility"). Total facility size will be $77,000,000.
	

Purpose:	
 	

For working capital and general corporate purposes, all in accordance with the Borrower's bankruptcy court approved confirmation of emergence plan of reorganization (the "Plan").
	

Maturity:	
 	

Three (3) years from the closing date, but at all times coterminous with the Senior Credit Facility.
	

Security:	
 	

The Credit Facility will be secured by a 2nd security position on all of the Borrowers' assets, capital stock of the Borrower and each of its subsidiaries; subject only to a 1st security position in favor of the Senior Credit
Facility and liens permitted under the Senior Credit Facility (including first liens on equipment, and with respect to equipment liens not existing as of the closing, such liens shall be subject to intercreditor terms and conditions acceptable to FRF,
 as Agent).
	

Borrowing Base:	
 	

At no time shall outstanding amounts under the Senior Credit Facility plus outstanding amounts under the Credit Facility exceed 95% of the current appraised liquidation (GOB) value of Eligible Inventory from November 1st through
August 14th, and 102.5% of the current appraised liquidation (GOB) value of Eligible Inventory from August 15th through October 31st; plus, 85% of eligible
credit card receivables; minus, applicable reserves.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

 

	

 	
 	
Eligible Inventory shall consist of stock ledger inventory at cost less any capitalized costs (exclusive of usual and customary freight), and shall exclude the following: Inventory that
cannot be sold, including non-merchandise categories (labels, bags, packaging, etc.), inventory in foreign locations (except for inventory supported by eligible letters of credit whose initial term does not exceed 60 days) and samples.
Additionally, eligible inventory will specifically exclude (i) damaged goods, return to vendor merchandise, packaways, consignment inventory and such other similar categories to be determined based on due diligence, and (ii) third party
locations not under the Borrower's control unless appropriate waivers are obtained.
	

 	
 	
Eligible Credit Card Receivables shall consist of amounts payable from nationally recognized credit card processors, payable within 3-to-5 business days, on a non-recourse basis.
	

 	
 	

The actual reserves and final advance rates will be determined based upon the results of due diligence, which will include a third party appraisal of the net liquidation (GOB) value of inventory, and a commercial finance examination, which will be
shared by and coordinated with FRF.
	

Commitment Fee:	
 	

As set forth on Schedule I.
	

Current Pay Interest:	
 	

From the closing through the first anniversary date of closing, 13.00% per annum, payable monthly in arrears. Thereafter, interest shall accrue at a rate equivalent to Fleet Bank's prime lending rate plus 8.75% per annum adjusted quarterly, payable
monthly in arrears.
	

PIK (Payment in Kind) Interest:	
 	

2.50% per annum accruing, to be capitalized and added to both the principal balance of the Credit Facility and the maximum commitment amount, on the first day of each calendar month, and payable upon maturity.
	

Monitoring Fee:	
 	

As set forth on Schedule I.
	

Early Termination Fee:	
 	

The greater of (i) yield revenue due within the 1st fifteen (15) months following the closing (Commitment Fee, Current Pay Interest, PIK Interest) less actual payments of Commitment Fee, Current Pay Interest, PIK Interest
(Partial pre-payments will be applied to the preceding formula on a pro-rata basis); or (ii) 1.00% of the amount pre-paid. If the Credit Facility is repaid as a result of a refinancing effort that takes place after the close of the 33rd month
following the initial loan closing, the Early Termination Fee shall be waived.
	

Amortization:	
 	

None
	

Financial Covenants:	
 	

•	
 	

Minimum excess availability at all times, equal to the greater of (i) $4,000,000 or (ii) 7.50% of the Borrowing Base;
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

2

 

	

 	
 	

•	
 	

Maximum annual capital expenditures (threshold amounts t/b/d);
	

 	
 	

•	
 	

Minimum ratio of Accounts Payable to Inventory (threshold ratio amount to be determined);
	

 	
 	

•	
 	

Minimum EBITDA (threshold amounts to be determined).
	

Conditions Precedent:	
 	

Closing shall be conditioned upon satisfaction of the following conditions precedent and other conditions customary to transactions of this type, or reasonably required by the Lender.
	

 	
 	

1.	
 	

The final terms of any Plan to be consummated and the order of the Bankruptcy Court approving such Plan (the "Confirmation Order") shall be reasonably satisfactory to the Lender. All material conditions precedent to confirmation, as defined in the
Plan, shall have been met (or the waiver thereof shall have been consented to by the Lender). The confirmation order shall not have been reversed, modified, amended, or stayed and, unless otherwise agreed by the Lender, all appeal periods relating to
the confirmation order shall have expired, and no appeals from the confirmation order shall be outstanding. Except as consented to by the Lender, the Bankruptcy Court's retention of jurisdiction under the confirmation order shall not govern the
enforcement of the loan and security documents for the Facility or any rights or remedies relating thereto. The capital structure of the Borrower after giving effect to the Plan shall be reasonably satisfactory to the Lender in all respects and shall
include evidence of a successful equity private placement generating not less than $25,000,000 of new cash equity (net of costs) and available to fund the Plan and for ongoing operations. Further, the terms of indebtedness (if any) and capital stock
issued under the Plan shall be reasonably satisfactory to the Lender in all respects.
	

 	
 	

2.	
 	

Minimum excess availability under the Senior Credit Facility at closing, after giving effect to the funding of the Credit Facility and the Minimum Excess Availability Covenant, shall be equal to or greater than $14,000,000. All post petition accounts
payable and taxes shall be paid current; excluding good faith disputes.
	

 	
 	

3.	
 	

Liens on all of the Borrower's collateral shall have been filed and otherwise perfected to the satisfaction of the Lender.
	

 	
 	

4.	
 	

Satisfactory completion of due diligence, including, without limitation, completion of a commercial finance examination.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

3

 

	

 	
 	

5.	
 	

All necessary consents and approvals to the financing shall all have been obtained.
	

 	
 	

6.	
 	

Receipt by the Lender of financial projections and the Plan, which shall be satisfactory to the Lender in both form and substance.
	

 	
 	

7.	
 	

Completion of legal due diligence investigation by the Lender's counsel, with results satisfactory to the Lender and its counsel.
	

 	
 	

8.	
 	

Preparation, execution and delivery of definitive documentation satisfactory to the Lender. Documentation shall contain representations, covenants, events of default, expense reimbursement, and indemnification provisions for the benefit of the Lender
customary for transactions of this size, type, and purpose.
	

 	
 	

9.	
 	

Satisfactory (a) inter-creditor or agency agreement provisions with any other debt of the Borrower as part of the plan and (b) collateral agency agreements with Saks.
	

 	
 	

10.	
 	

The Lender shall have received (i) reasonable and customary opinions of counsel to the Borrower as to the transactions contemplated hereby which opinions are satisfactory to the Lender and (ii) such corporate resolutions, certificates and
other documents as the Lender shall reasonably request. With respect to the form and scope of the opinion of Borrower's counsel, the Lender shall rely upon the requirements as determined by counsel to FRF, as Agent to the lenders under the Senior
Credit Facility.
	

 	
 	

11.	
 	

No material misstatements in the materials furnished to the Lender for its review prior to closing, or in representations or warranties made in the final documentation. The Lender must be satisfied that any financial statements and projections
delivered to it fairly present the business and financial condition of the Borrower; and that there has been no material adverse change in the assets, business, financial condition, income or prospects of the Borrower since the date of the most
recent financial information delivered to the Lender.
	

 	
 	

12.	
 	

The absence of any litigation or other proceeding the result of which might have a material adverse effect on the Borrower (excluding the current Chapter 11 proceedings).
	

 	
 	

13.	
 	

The absence of any default of any material contract or agreement of the Borrower or any of its subsidiaries.
	
 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 	
 	

 

4

 

	

 	
 	

14.	
 	

The proposed financing is subject to the condition that no material changes in governmental regulations or policies affecting the Borrower or Lender involved in this transaction occur prior to the closing date.
	

Expenses:	
 	

Legal, appraisal, commercial finance examination (field audit), and any other out of pocket expenses of the Lender will be paid by the Borrower.
	

Governing Law:	
 	

State of New York.

5

 
  
 

    Schedule I    
  

	Commitment Fee:	 	3.00% of the total commitment. $75,000 of the Commitment Fee shall be due and payable on the Borrowers acceptance of the commitment letter (the "Commitment Acceptance Fee") with the remainder due at Closing; provided, however, the Borrowers can instruct Back Bay to apply up to $50,000 of the Work Fee previously paid by the Borrowers to Back Bay as partial payment of the
Commitment Acceptance Fee with the remainder due in cash. The Commitment Fee shall be non-refundable upon pay.
	

Monitoring Fee:	
 	

$25,000 payable at closing and on the 1st and 2nd anniversary dates of the closing.

6

QuickLinks

Exhibit 10.1

Exhibit A

FAO, Inc.—Emergence Summary of Terms and Conditions For Senior Revolving Credit Facility March 25, 2003

Schedule I

Exhibit B

FAO, Inc.—Emergence Summary of Terms and Conditions For Term Loan Credit Facility March 25, 2003

Schedule I

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