<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 23, 1997
REGISTRATION NO. 333-10491
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
POST-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
GUITAR CENTER, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 5733 95-4600862
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification Number)
incorporation or organization)
</TABLE>
------------------------
5155 CLARETON DRIVE
AGOURA HILLS, CALIFORNIA 91301
(818) 735-8800
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
------------------------
BRUCE ROSS
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
GUITAR CENTER, INC.
5155 CLARETON DRIVE
AGOURA HILLS, CALIFORNIA 91301
(818) 735-8800
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------
COPIES TO:
Anthony J. Richmond
Latham & Watkins
633 West Fifth Street, Suite 4000
Los Angeles, California 90071
(213) 485-1234
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended (the "Securities Act"), check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the
same offering. / /
- --------------
If this Form is a post-effective amendment filed pursuant to Rule 462(b)
under the Securities Act, check the following box
and list the Securities Act registration statement of the earlier effective
registration statement for the same
offering. / /
- --------------
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. / /
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
$66,667,000
[LOGO]
GUITAR CENTER, INC.
11% SENIOR NOTES DUE 2006
------------------
The 11% Senior Notes due 2006 (the "Notes") were issued by Guitar Center,
Inc. ("Guitar Center" or the "Company") pursuant to an Indenture (as defined
herein). As of the date of this Prospectus, there are $66,667,000 aggregate
principal amount of Notes outstanding. The Notes are general, unsecured
obligations of the Company. The Notes rank senior in right of payment to all
subordinated indebtedness of the Company and PARI PASSU in right of payment with
all other senior indebtedness of the Company, including the Company's
outstanding indebtedness under the 1996 Credit Facility (as defined herein), as
in place on the date hereof. The 1996 Credit Facility, upon the occurrence of
certain events, will be secured by substantially all of the assets of the
Company. The Company may borrow up to $25,000,000 under the 1996 Credit
Facility, as in place on the date hereof, and could borrow additional amounts if
and when it enters into a secured successor bank facility which it is currently
negotiating. See "Description of the 1996 Credit Facility." As of the date of
this Prospectus, the Company has no outstanding Indebtedness (as defined herein)
other than the Notes.
The Notes mature on July 1, 2006. Interest on the Notes is payable in cash
semi-annually on January 1 and July 1 of each year. The Company is not required
to make any mandatory redemption or sinking fund payment with respect to the
Notes prior to maturity. The Notes are redeemable at the option of the Company,
in whole or in part, on or after July 1, 2001, at the redemption prices set
forth herein, plus accrued and unpaid interest, if any, to the date of
redemption. Upon a Change of Control (as defined herein), the Company is
required to make an irrevocable and unconditional offer to repurchase all
outstanding Notes at 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest, if any, to the date of repurchase. See "Description
of Notes."
This Prospectus may be used by Chase Securities Inc. ("Chase Securities"),
in connection with offers and sales related to market-making transactions in the
Notes. Chase Securities may act as principal or agent in such transactions. Such
sales will be made at prices related to prevailing market prices at the time of
sale. See "Plan of Distribution."
SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR CERTAIN CONSIDERATIONS RELEVANT
TO AN INVESTMENT IN THE NOTES.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
The date of this Prospectus is April 23, 1997.
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") in Washington, D.C. a Registration Statement on Form S-1, File No.
333-10491 (as amended, the "Registration Statement") under the Securities Act of
1933, as amended (the "Securuties Act") with respect to the Notes offered
hereby. This Prospectus does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto. For further
information with respect to the Company and the Notes, reference is hereby made
to such Registration Statement and the exhibits and schedules thereto.
Statements contained in this Prospectus as to the contents of any contract or
other document are not necessarily complete and in each instance, reference is
made to the copy of such contract or documents filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. The Registration Statement, including the exhibits and schedules
thereto, may be inspected and copied at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Washington,
D.C. 20549 and at certain regional offices of the Commission located at 75 Park
Place, 14th Floor, New York, New York 10007 and Northwest Atrium Center, 500
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials
can be obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., Room 1025, Washington, D.C. 20549, at prescribed rates. The
Commission maintains a World Wide Web site at http://www.sec.gov that contains
reports, proxy and information statements and other information regarding
registrants that filed electronically with the Commission. The Company is
currently subject to the informational requirements of the Exchange Act of 1934,
as amended (the "Exchange Act") and, in accordance therewith, files reports,
proxy and information statements with the Commission. The Company is required by
the terms of the Indenture to furnish to the applicable trustee or transfer
agent and the holder(s) of the Notes annual reports containing consolidated
financial statements audited by its independent certified public accounts, with
quarterly reports containing unaudited condensed consolidated financial
statements for each of the first three quarters of each fiscal year and with
current reports on Form 8-K.
2
<PAGE>
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION, INCLUDING "RISK FACTORS" AND
THE COMPANY'S FINANCIAL STATEMENTS AND NOTES THERETO, APPEARING ELSEWHERE IN
THIS PROSPECTUS. EXCEPT WHERE OTHERWISE SPECIFIED, THE INFORMATION IN THIS
PROSPECTUS GIVES EFFECT TO THE FOLLOWING EVENTS: (I) A 100-TO-1 STOCK SPLIT
EFFECTUATED ON JUNE 5, 1996; (II) THE REINCORPORATION OF THE COMPANY FROM A
CALIFORNIA TO A DELAWARE CORPORATION, EFFECTUATED ON OCTOBER 11, 1996; (III) A
2.582-TO-1 STOCK SPLIT EFFECTUATED ON JANUARY 15, 1997; AND (IV) THE MANDATORY
CONVERSION OF EACH OUTSTANDING SHARE OF 8% JUNIOR PREFERRED STOCK, $.01 PAR
VALUE (THE "JUNIOR PREFERRED STOCK"), OF THE COMPANY INTO 6.667 SHARES OF COMMON
STOCK, $.01 PAR VALUE PER SHARE ("COMMON STOCK"), OF THE COMPANY UPON
CONSUMMATION OF THE COMPANY'S INITIAL PUBLIC OFFERING ON MARCH 19, 1997.
MARKET-MAKING PROSPECTUS
This Prospectus may be used by Chase Securities in connection with offers
and sales related to transactions that stabilize, maintain or otherwise affect
the price of the Notes offered hereby. Chase Securities may act as principal or
agent in such transactions. Such sales will be made at prices related to
prevailing market prices at the time of sale. See "Plan of Distribution."
THE COMPANY
Guitar Center is a leading retailer of guitars, amplifiers, percussion
instruments, keyboards and pro audio and recording equipment with 28 stores
operating in 15 major U.S. markets as of December 31, 1996, including, among
others, areas in or near Los Angeles, San Francisco, Chicago, Miami, Houston,
Dallas, Detroit, Boston and Minneapolis. From fiscal 1992 through fiscal 1996,
the Company's net sales and operating income before deferred compensation
expense grew at compound annual rates of 25.6% and 43.0%, respectively. This
growth was principally the result of strong and consistent comparable store
sales growth, averaging 14.8% per year over such five-year period, and the
opening of 13 new stores.
Guitar Center offers a unique retail concept in the music products industry,
combining an interactive, hands-on shopping experience with superior customer
service and a broad selection of brand name, high-quality products at guaranteed
low prices. The Company creates an entertaining and exciting atmosphere in its
stores with bold and dramatic merchandise presentations, highlighted by bright,
multi-colored lighting, high ceilings, music and videos. Management believes
that approximately 80% of the Company's sales are to professional and aspiring
musicians who generally view the purchase of music products as a career
necessity. These sophisticated customers rely upon the Company's knowledgeable
and highly trained salespeople to answer technical questions and to assist in
product demonstrations.
The Guitar Center prototype store generally ranges in size from 12,000 to
15,000 square feet (as compared to a typical music products retail store which
averages approximately 3,200 square feet) and is designed to encourage customers
to hold and play instruments. Each store carries an average of 7,000 core stock
keeping units ("SKUs"), which management believes is significantly greater than
a typical music products retail store, and is organized into five departments,
each focused on one product category. These departments cater to a musician's
specific product needs and are staffed by specialized salespeople, many of whom
are practicing musicians. Management believes this retail concept differentiates
the Company from its competitors and encourages repeat business.
Guitar Center stores historically have generated strong and stable operating
results. All of the Company's stores, after being open for at least twelve
months, have had positive store-level operating income in each of the past five
fiscal years.
3
<PAGE>
The following summarizes certain key operating statistics of a Guitar Center
store and is based upon the 21 stores operated by the Company for the full year
ended December 31, 1996:
<TABLE>
<S> <C>
Average 1996 net sales per square foot......................... $ 707
Average 1996 net sales per store............................... 9,148,000
Average 1996 store-level operating income (1).................. 1,402,000
Average 1996 store-level operating income margin (1)........... 15.3%
</TABLE>
- ------------------------
(1) Store-level operating income includes individual store revenue and expenses
plus allocated rebates, cash discounts and purchasing department salaries
(based upon individual store sales).
The United States retail market for music products in 1995 was estimated in
a study by MUSIC TRADES magazine to be approximately $5.5 billion in net sales,
representing a five-year compound annual growth rate of 7.9%. Products currently
offered by Guitar Center include categories of products which account for
approximately $4.0 billion of this market, representing a five-year compound
annual growth rate of 8.6%. The industry is highly fragmented with the nation's
leading five music products retailers (as measured by the number of stores
operated by such retailers) accounting for approximately 8.4% of the industry's
estimated net sales in 1995. Furthermore, approximately 90% of the industry's
estimated 8,200 retailers operate only one or two stores. The Company believes
that it benefits from several advantages relative to smaller competitors,
including volume purchasing discounts, centralized operations and financial
controls, advertising economies and the ability to offer an extremely broad and
deep selection of merchandise.
For the fiscal years ended December 31, 1994, 1995 and 1996, the Company
recorded net income (loss) of $8.8 million, $10.9 million and ($72.4) million,
respectively. The results for 1996 reflect $11.6 million for transaction costs
and financing fees incurred in connection with the Recapitalization (as defined
herein) and non-recurring deferred compensation expense of $71.8 million,
substantially all of which related to the Recapitalization.
BUSINESS STRATEGY
EXPANSION STRATEGY. Guitar Center's expansion strategy is to continue to
increase its market share in existing markets and to penetrate strategically
selected new markets. The Company plans to continue pursuing its strategy of
clustering stores in major markets to take advantage of operating and
advertising efficiencies and to enhance awareness of the Guitar Center name in
new markets. The Company opened seven stores in fiscal 1996, and currently
anticipates opening or acquiring approximately eight stores in each of fiscal
1997 and 1998. In the first four months of 1997, the Company opened three new
stores and acquired two existing stores from a third party. In preparation for
this expansion, management has dedicated substantial resources over the past
several years to building the infrastructure and management information systems
necessary to support a large national chain. In addition, the Company believes
that it has developed a methodology for targeting prospective store sites which
includes analyzing demographic and psychographic characteristics of potential
store locations. Management also believes that there may be attractive
opportunities to expand by selectively acquiring existing music products
retailers.
EXTENSIVE SELECTION OF MERCHANDISE. Guitar Center offers an extensive
selection of brand name music products complemented by lesser known, hard to
find items and unique vintage equipment. The average 7,000 core SKUs offered
through each Guitar Center store provide a breadth and depth of in-stock items
which management believes is not available from traditional music products
retailers.
HIGHLY INTERACTIVE, MUSICIAN-FRIENDLY STORE CONCEPT. Each Guitar Center
store contains creative instrument presentations and colorful, interactive
displays which encourage the customer to hold and play instruments as well as to
participate in product demonstrations. In addition, private sound-controlled
rooms enhance a customer's listening experience while testing various
instruments.
4
<PAGE>
EXCEPTIONAL CUSTOMER SERVICE. The Company conducts extensive training
programs for its salespeople, who specialize in one of the Company's five
product categories. Many of the Company's salespeople are also musicians. With
the advances in technology and continuous new product introductions in the music
products industry, customers increasingly rely on qualified salespeople to offer
expert advice and assist in product demonstrations. Management believes that its
emphasis on training and customer service distinguishes the Company within the
industry and is a critical part of Guitar Center's success.
INNOVATIVE PROMOTIONAL AND MARKETING PROGRAMS. Guitar Center sponsors
innovative promotional and marketing events which include in-store
demonstrations, famous artist appearances and weekend themed sales events
designed to create significant store traffic and exposure. In addition, the
Company's special grand opening activities in new markets are designed to
generate consumer awareness for each new store. Management believes that these
events help the Company build a loyal customer base and encourage repeat
business. Since its inception, the Company has compiled a unique, proprietary
database containing information on more than one million customers. This
database enables Guitar Center to advertise to select target customers based on
historical buying patterns.
GUARANTEED LOW PRICES. Guitar Center endeavors to be the low price leader
in each of its markets which is underscored by a 30-day low price guarantee. The
Company's size permits it to take advantage of volume discounts for large orders
and other vendor supported programs. Although prices are usually determined on a
regional basis, store managers are trained and authorized to adjust prices in
response to local market conditions.
EXPERIENCED AND MOTIVATED MANAGEMENT TEAM. The executive officers and key
managers have an average of 11 years with the Company. In addition, as of the
date of this Prospectus, executive officers and key managers beneficially own
approximately 17.8% of the Company's outstanding Common Stock.
THE RECAPITALIZATION
On June 5, 1996, the Company consummated a series of transactions to effect
a recapitalization of the Company (the "Recapitalization") in order to transfer
ownership of the Company from its sole stockholder, the Scherr Living Trust (the
"Scherr Trust"), to members of management, Chase Venture Capital Associates,
L.P. ("Chase Ventures") and an affiliated entity, Wells Fargo Small Business
Investment Company, Inc. ("Wells Fargo") and Weston Presidio Capital II, L.P.
("Weston Presidio"). Chase Ventures, Wells Fargo and Weston Presidio are
collectively referred to herein as the "Investors." See "The Recapitalization
and Related Transactions."
THE INITIAL PUBLIC OFFERING
On March 19, 1997, the Company completed an initial public offering (the
"Offering") of Common Stock pursuant to which it sold 6,750,000 shares of Common
Stock and received approximately $94.1 million in net cash proceeds (before
deducting expenses associated with the Offering). On April 15, 1997, the Company
sold an additional 1,012,500 shares of Common Stock and received an additional
$14.1 million in net cash proceeds (before deducting expenses associated with
the Offering) upon the underwriters' exercise in full of their over-allotment
option. Upon consummation of the Offering, the Company converted 100% of the
outstanding shares of its Junior Preferred Stock into shares of Common Stock at
a ratio of 6.667 shares of Common Stock to each share of Junior Preferred Stock
(the "Junior Preferred Stock Conversion"). Approximately $22.9 million of the
net proceeds from the Offering was used to redeem, at a premium of 3%, all of
the outstanding shares of the Company's 14% Senior Preferred Stock, $.01 par
value per share (the "Senior Preferred Stock"); approximately $9.7 million of
such proceeds was used to repay all amounts then-outstanding under the 1996
Credit Facility; approximately $18.4 million of such proceeds was used to redeem
approximately 1,317,000 shares of Common Stock in the Management Tax Redemption
(as defined herein); and approximately $37.9 million of such proceeds was used
to redeem, at a premium of 10%, an aggregate of approximately $33.3 million
principal amount of Notes on April 19, 1997 and to pay all accrued and unpaid
interest with respect to the Notes called for redemption. The balance of the net
proceeds was retained for general corporate purposes, including the acquisition
of two musical instruments stores in the Atlanta, Georgia market in April 1997.
5
<PAGE>
RECENT DEVELOPMENTS
On April 16, 1997, the Company acquired all of the outstanding capital stock
of Rhythm City, Inc. ("Rhythm City"), the operator of two musical instrument
stores in the Atlanta, Georgia market for $10.3 million in cash, subject to
adjustment based on the actual level of working capital on such date and other
matters. The purchase price included the acquisition of the building and
improvements of the flagship Rhythm City store in Atlanta. All of the debt and
other liabilities of Rhythm City were either repaid or assumed by the sellers
prior to closing.
STATUS OF THE OFFERING OF THE NOTES
In December 1996, the Company completed an exchange offer pursuant to which
$100 million aggregate principal amount of Notes was issued in exchange for an
equal amount of then-outstanding, unregistered 11% Senior Notes due 2006 of the
Company (the "Old Notes"). The Notes are substantially identical to the Old
Notes, except that the Notes are not restricted securities for federal
securities law purposes. The Company did not receive any proceeds from such
exchange offer.
In March 1997, the Company completed its Offering of Common Stock.
Immediately following the Offering, the Company called for redemption, at a
premium of 10%, an aggregate of $33,333,000 of Notes. The Company used
approximately $37.9 million of the net proceeds from the Offering to redeem such
Notes on April 19, 1997 and to pay all accrued and unpaid interest with respect
to the Notes called for redemption. As of the date of this Prospectus, there are
$66.7 million aggregate principal amount of Notes outstanding. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
THE NOTES
<TABLE>
<S> <C>
SECURITIES OFFERED..................... $66,667,000 million aggregate principal amount of
11% Senior Notes due 2006.
MATURITY............................... July 1, 2006.
INTEREST PAYMENT DATES................. January 1 and July 1.
OPTIONAL REDEMPTION.................... The Notes are redeemable at the option of the
Company, in whole or in part, on or after July 1,
2001, at the redemption prices set forth herein,
plus accrued and unpaid interest, if any, to the
date of redemption. See "Description of Notes --
Optional Redemption."
SINKING FUND........................... None.
RANKING................................ The Notes are general, unsecured obligations of the
Company. The Notes rank senior in right of payment
to all subordinate indebtedness of the Company, and
PARI PASSU in right of payment with all other
senior indebtedness of the Company, including the
Company's outstanding indebtedness under the 1996
Credit Facility. The 1996 Credit Facility, upon the
occurrence of certain events, will be secured by
substantially all of the assets of the Company. See
"Description of the 1996 Credit Facility." The
Company may borrow up to $25 million under the 1996
Credit Facility, as in place on the date hereof,
and could borrow additional amounts if and when it
enters into a secured successor bank facility which
it is currently negotiating. See "Management's
Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital
Resources." As of the date of this Prospectus, the
Company had no outstanding indebtedness, other than
the Notes.
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
CHANGE OF CONTROL OFFER................ Upon a Change of Control (as defined herein), the
Company will be required to make an irrevocable and
unconditional offer to repurchase all outstanding
Notes at 101% of the aggregate principal amount
thereof, plus accrued and unpaid interest, if any,
to the date of repurchase. A Change of Control will
not result from a sale of the Company or
substantially all of the Company's assets to a
person or group of persons who are Investors (as
defined herein) and the Holders (as defined herein)
would not receive the benefit of this provision in
the event of such a transaction. See "Description
of Notes -- Certain Covenants -- Repurchase of
Notes at the Option of the Holder Upon a Change of
Control."
CERTAIN COVENANTS...................... The Indenture contains certain covenants with
respect to the Company that, among other things,
limit the ability of the Company and any
subsidiaries of the Company to (i) incur additional
Indebtedness and issue Disqualified Capital Stock
(as defined herein); (ii) pay dividends or make
other distributions and certain investments; (iii)
create certain liens; (iv) sell certain assets; (v)
enter into certain transactions with affiliates; or
(vi) enter into certain mergers or consolidations
involving the Company. See "Description of Notes --
Certain Covenants."
</TABLE>
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered by Holders prior to purchasing any Notes.
FORWARD LOOKING STATEMENTS
Information contained in this Prospectus includes "forward-looking
statements" that are based largely on the Company's current expectations and are
subject to a number of risks and uncertainties. Forward-looking statements can
be identified by the use of forward-looking terminology such as "may," "will,"
"should," "expect," "anticipate," "estimate," "continue," "plans," "intends" or
other similar terminology. See "Risk Factors."
The Company is a Delaware corporation with its principal executive offices
located at 5155 Clareton Drive, Agoura Hills, California 91301, and its
telephone number is (818) 735-8800.
7
<PAGE>
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL DATA
The financial data for the fiscal year ended October 31, 1992, the two
months ended December 31, 1992 and the fiscal years ended December 31, 1993,
1994, 1995 and 1996 has been derived from the audited financial statements of
the Company. The PRO FORMA financial data set forth below is not necessarily
indicative of the results that would have been achieved or that may be achieved
in the future. The summary historical and PRO FORMA financial data should be
read in conjunction with "The Recapitalization and Related Transactions,"
"Selected Historical Financial Data," "Unaudited Pro Forma Condensed Financial
Data," "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the financial statements of the Company and the notes thereto
included elsewhere herein.
<TABLE>
<CAPTION>
FISCAL
YEAR
ENDED TWO MONTHS FISCAL YEAR
OCTOBER ENDED ENDED
31, DECEMBER 31, DECEMBER 31,
------- ------------ -------------------------------------
1992 1992 1993 1994 1995 1996
------- ------------ ------- -------- -------- --------
(IN THOUSANDS, EXCEPT STORE AND
INVENTORY OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales....................................... $85,592 $18,726 $97,305 $129,039 $170,671 $213,294
Gross profit.................................... 25,472 5,393 28,778 36,764 47,256 60,072
Selling, general and administrative expenses.... 20,998 3,547 21,889 26,143 32,664 41,345
Deferred compensation expense (1)............... -- 373 1,390 1,259 3,087 71,760
Operating income (loss)......................... 4,474 1,473 5,499 9,362 11,505 (53,033)
Non recurring transaction expense............... -- -- -- -- -- (6,942)
Net income (loss)............................... 3,987 1,385 5,105 8,829 10,857 (72,409)
PRO FORMA FOR INCOME TAX PROVISION: (2)
Historical income (loss) before provision for
income taxes................................... $4,076 $ 1,424 $ 5,251 $ 9,155 $ 11,202 $(72,270)
Pro forma provision for income taxes............ 1,753 773 2,856 4,478 6,144 --
------- ------------ ------- -------- -------- --------
Pro forma net income (loss)..................... $2,323 $ 651 $ 2,395 $ 4,677 $ 5,058 $(72,270)
------- ------------ ------- -------- -------- --------
------- ------------ ------- -------- -------- --------
OPERATING DATA:
Net sales per gross square foot (3)............. $ 429 -- $ 478 $ 546 $ 661 $ 707
Stores open at end of period.................... 15 15 17 20 21 28
Net sales growth................................ 14.3% 18.7% 13.7% 32.6% 32.3% 25.0%
Increase in comparable store sales (4).......... 11.5% 18.7% 11.4% 17.3% 23.4% 10.2%
Inventory turns................................. 3.3x 3.4x 3.1x 3.4x 3.7x 3.4x
Ratio of earnings to fixed charges (5).......... 5.8x 13.8x 9.1x 11.6x 11.7x --
Capital expenditures............................ $ 445 $ 966 $ 2,618 $ 3,277 $ 3,432 $ 6,133
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31, 1996
------------------
(IN THOUSANDS)
<S> <C>
PRO FORMA DATA: (6)
Net sales................................................................................ $ 213,294
Operating income......................................................................... 19,159
Net income............................................................................... 6,456
</TABLE>
FOOTNOTES APPEAR ON FOLLOWING PAGE.
8
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
------------------------------
HISTORICAL AS ADJUSTED (7)
----------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................ $ 47 $ 25,912
Net working capital...................................... 27,436 56,837
Total assets............................................. 74,849 99,591
Total long term and revolving debt (including current
maturities)............................................. 103,536 66,667
Senior preferred stock................................... 15,186 --
Junior preferred stock................................... 138,610 --
Warrants................................................. 6,500 6,500
Stockholders' equity (deficit)........................... (68,815) 7,982
</TABLE>
- ------------------------------
(1) For 1996, the Company recorded a non-recurring deferred compensation
expense of $71.8 million, of which $69.9 million related to the
cancellation and exchange of management stock options pursuant to the
Recapitalization and $1.9 million related to a non-cash charge resulting
from the grant of stock options to management by the Investors. The Company
has not, and will not, incur any obligation in connection with such grant
of options by the Investors. See "The Recapitalization and Related
Transactions" and "Certain Transactions -- Options Granted by the Investors
to Certain Members of Management."
(2) Pro forma provision for income taxes reflects the estimated statutory
provision of 43% for income taxes assuming the Company was a "C"
corporation.
(3) Net sales per gross square foot does not include new stores opened during
the reporting period. Information for the two months ended December 31,
1992 is not meaningful.
(4) Compares net sales for the comparable periods, excluding net sales
attributable to stores not open for 14 months.
(5) For the purposes of calculating the ratio of earnings to fixed charges,
"earnings" represents income before provision for income taxes and fixed
charges. "Fixed charges" consist of interest expense, amortization of debt
financing costs and one third of lease expense, which management believes
is representative of the interest components of lease expense. Earnings
were insufficient to cover fixed charges by $72.3 million for the year
ended December 31, 1996.
(6) The pro forma data reflect adjustments as if the Recapitalization, the
Junior Preferred Stock Conversion, the sale of the Notes, the Offering and
the application of the net proceeds therefrom to redeem all of the shares
of Senior Preferred Stock, approximately $33.3 million aggregate principal
amount of the Notes and certain shares of Common Stock in the Management
Tax Redemption had been consummated and were effective as of January 1,
1996.
(7) The pro forma balance sheet data give effect to the Junior Preferred Stock
Conversion, the Offering and the application of the net proceeds therefrom
to redeem all of the shares of Senior Preferred Stock, approximately $33.3
million aggregate principal amount of the Notes and certain shares of
Common Stock in the Management Tax Redemption, as if such transactions had
been consummated and were effective on such date.
9
<PAGE>
RISK FACTORS
PRIOR TO MAKING AN INVESTMENT DECISION, PROSPECTIVE INVESTORS SHOULD
CAREFULLY CONSIDER THE FOLLOWING SPECIFIC INVESTMENT CONSIDERATIONS. SEE
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND "BUSINESS" FOR A DESCRIPTION OF OTHER FACTORS AFFECTING THE
BUSINESS OF THE COMPANY.
AGGRESSIVE GROWTH STRATEGY
The Company intends to pursue an aggressive growth strategy by opening
additional stores in new and existing markets. The Company, which operated 28
stores as of December 31, 1996, opened seven stores in fiscal 1996 and expects
to open or acquire approximately eight stores in each of fiscal 1997 and fiscal
1998, which represents significant increases in the number of stores previously
opened and operated by the Company. In the first four months of 1997, the
Company opened three new stores and acquired two existing stores from a third
party. Although historically the Company has opened new stores and expanded or
relocated existing stores, prior to 1996 the Company had not opened more than
four new stores for any twelve-month period for the prior three fiscal years.
See "Business -- Properties." The Company's expansion plan is dependent upon a
number of factors, including the identification of suitable sites, the
negotiation of acceptable leases for such sites, the hiring, training and
retention of skilled personnel, the availability of adequate management and
financial resources, the adaptation of its distribution and other operational
and management information systems to such sites, the ability and willingness of
the Company's vendors to supply its needs on a timely basis and other factors,
some of which are beyond the control of the Company. There can be no assurance
that the Company will be successful in opening such new stores on schedule, if
at all, or that such newly opened stores will achieve sales and profitability
levels comparable to existing stores, if they are profitable at all, or that the
Company will improve its overall market position and profitability as a result
therefrom.
The Company's expansion strategy includes clustering stores in each of its
markets which has, in certain instances, resulted in some transfer of sales from
existing stores to new locations. There can be no assurance that the opening of
one or more new stores in a market area containing an existing store or stores
will not reduce the sales and profitability level of any of the stores in such
market area. In addition, the Company's expansion into new markets has in
certain circumstances presented competitive and merchandising challenges that
are different from those currently encountered by the Company in its existing
markets. These challenges include the effective management of stores that are in
distant locations and the incurrence of significant start-up costs, including
costs related to promotions and advertising. Although the Company is continually
evaluating the adequacy of its existing systems and procedures, including store
management, financial controls and management information systems in connection
with the Company's planned expansion, there can be no assurance that the Company
will adequately anticipate all of the changing demands which its expanding
operations will impose on such systems. The failure by the Company to identify
and respond to such demands may have an adverse effect on the Company's results
of operations, financial condition, business and prospects.
The Company also believes that there may be attractive opportunities to
expand by selectively acquiring existing music product retailers. For example,
in April 1997 the Company consummated the acquisition of a music products
retailer operating two stores in the Atlanta, Georgia market. See "Summary --
Recent Developments." The Company, in the ordinary course of business, regularly
evaluates and enters into negotiations relating to potential acquisition
candidates in new and existing market areas. Any such transactions may involve
the payment by the Company of cash or securities (including equity securities),
or a combination thereof. There can be no assurance that the Company will be
able to identify suitable acquisition candidates available for sale at
reasonable prices or consummate additional acquisitions. Further, acquisitions
may involve a number of special risks, including diversion of management's
attention, the inability to integrate successfully any acquired business, the
incurrence of legal liabilities and unanticipated events or circumstances, some
or all of which could have a material adverse effect on the Company's results of
operations, financial condition, business and prospects. See "Business."
DEPENDENCE ON SUPPLIERS
The Company's business and its expansion plans are dependent to a
significant degree upon its suppliers. As it believes is customary in the
industry, the Company does not have any long-term supply
10
<PAGE>
contracts with its suppliers. The loss of certain key vendors or the failure to
establish and maintain relationships with brand name vendors could have a
material adverse effect on the Company's business. The Company believes it
currently has adequate supply sources; however, there can be no assurance,
especially given the Company's expansion plans, that the Company will be able to
acquire sufficient quantities and an appropriate mix of such merchandise at
acceptable prices or at all. Specifically, the establishment of additional
stores in existing markets and the penetration of new markets is dependent to a
significant extent on the willingness of vendors to supply those additional
retail stores, of which there can be no assurance. As the Company continues to
expand, the inability or unwillingness of a supplier to supply some or all of
its merchandise to the Company in one or more markets could have a material
adverse effect on the Company's results of operations, financial condition,
business and prospects.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS
Historically, the Company's sales growth has resulted in large part from
comparable store sales growth. There can be no assurance that such growth will
continue. A variety of factors affect the Company's comparable store sales
results including, among others, competition, economic conditions, consumer
trends, retail sales, music trends, changes in the Company's merchandise mix,
distribution of products, transfer of sales to new locations, timing of
promotional events and the Company's ability to execute its business strategy
efficiently, including its strategy of clustering stores in certain markets. The
Company's quarterly comparable store sales (net sales for comparable periods,
excluding net sales attributable to stores not open for 14 months) results have
fluctuated significantly in the past. The Company's comparable store sales
growth was 24.4%, 30.1%, 25.5% and 16.3% in the first, second, third and fourth
quarters of fiscal 1995, respectively, and 14.5%, 9.3%, 7.6% and 10.1% in the
first, second, third and fourth quarters of fiscal 1996, respectively. The
Company does not expect comparable store sales to continue to increase at
historical rates, and there can be no assurance that comparable store sales will
not decrease in the future. As is the case with many specialty retailers, the
Company's comparable store sales results could cause the market price of the
Common Stock and the Notes to fluctuate substantially. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON KEY PERSONNEL
The Company believes that its continued success depends to a significant
extent on the services of Larry Thomas, its President and Chief Executive
Officer, and Marty Albertson, its Executive Vice President and Chief Operating
Officer, as well as on its ability to attract and retain additional key
personnel with the skills and expertise necessary to manage its existing
business and effectuate its planned growth. The loss or unavailability of the
services of one or both of these individuals or other key personnel could have a
material adverse effect on the Company. In June 1996, in connection with the
Recapitalization, the Company entered into a five-year employment agreement with
each of Messrs. Thomas and Albertson. The Company currently carries key man
insurance on the lives of Messrs. Thomas and Albertson in the amounts of $5.0
million and $3.5 million, respectively. See "Management." Historically, when
filling its senior operations, sales and store management positions, the Company
has generally followed a policy of "promotion from within." The success of the
Company's growth strategy will also depend on its ability to promote existing
well-trained store personnel to senior management and to retain such employees,
as well as on its ability to attract and retain new employees who have the skill
and expertise to manage the Company's business. Any inability to hire, retain
and promote such personnel could have a material adverse effect on the Company's
results of operations, financial condition, business and prospects. See
"Business -- Customer Service" and "Management."
COMPETITION
The retail market for musical instruments is fragmented and highly
competitive. The Company competes with many different types of retailers who
sell many or most of the items sold by the Company, including other specialty
retailers and catalogue retailers. The Company's expansion into new markets in
which its competitors are already established, competitors' expansion into
markets in which the Company is currently operating, the adoption by competitors
of innovative store formats and retail sales methods or the entry into the
Company's markets by competitors with substantial financial or other resources
may have a material adverse effect on the Company's results of operations,
financial condition, business and prospects. See "Business -- Competition."
11
<PAGE>
POTENTIAL CONSEQUENCES OF SIGNIFICANT LEVERAGE; RECENT LOSS
The Company has significant financial leverage. On a PRO FORMA basis after
giving effect to the Offering and the application of the net proceeds therefrom,
as of December 31, 1996, the Company would have had approximately $66.7 million
of outstanding long-term indebtedness, its ratio of total long-term debt to
total capitalization would have been approximately 89% and it would have had a
stockholders' equity of approximately $8.0 million. See "Capitalization" and
"Unaudited Pro Forma Condensed Financial Data."
The degree to which the Company is leveraged could have important
consequences to the holders of the Notes, including the following: (i) the
Company may not generate sufficient cash to service its debt obligations,
including obligations under the Notes; (ii) the Company's ability to obtain
financing for future working capital needs or other purposes may be limited;
(iii) a significant portion of the Company's cash flow from operations will be
dedicated to debt service, thereby reducing funds available for operations; and
(iv) the substantial indebtedness and the restrictive covenants to which the
Company is subject under the terms of its indebtedness, including the terms of
the 1996 Credit Facility and the Indenture, may make the Company more vulnerable
to economic downturns, may hinder its ability to execute its growth strategy,
may reduce its flexibility to respond to changing business conditions and
opportunities and may limit its ability to withstand competitive pressures. See
"Description of Notes."
The Company's ability to generate sufficient cash to meet its debt service
obligations will depend on future operating performance, which will be subject,
in part, to factors beyond its control, including prevailing economic conditions
and financial, business and other factors. While the Company believes that cash
flow from operations will be adequate to meet its debt service obligations,
there can be no assurance that the Company will generate cash in sufficient
amounts to meet such obligations. In the event the Company's operating cash flow
is not sufficient to fund the Company's expenditures or to service its debt,
including the Notes, the Company may be required to raise additional financing
through equity offerings, the refinancing of all or part of its indebtedness,
including the Notes, or sales of its assets. There can be no assurance that the
Company will be able to obtain any such additional financing or effect
satisfactory refinancings or asset sales on favorable terms, if at all. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
For the year ended December 31, 1996, the Company had a net loss of $72.4
million. The results for such period reflect non-recurring deferred compensation
expense of $71.8 million and $11.6 million for transaction costs and financing
fees incurred in connection with the Recapitalization. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Fiscal 1996 Compared to Fiscal 1995."
FRAUDULENT TRANSFER CONSIDERATIONS
The obligations of the Company under the indebtedness represented by the
Notes may be subject to review under relevant federal and state fraudulent
transfer laws, as well as other similar laws regarding creditors rights
generally or distributions to stockholders, if a bankruptcy case or a lawsuit
(including circumstances not involving bankruptcy) is commenced by or on behalf
of any unpaid creditor or a representative of the Company's creditors, such as a
trustee in bankruptcy or the Company as debtor in possession. If a court, in
such a lawsuit, were to find that the Company incurred the indebtedness
represented by the Bridge Facility (as defined below) or the Notes (i) with the
intent to hinder, delay or defraud present or future creditors or contemplated
insolvency with a design to prefer one or more creditors to the exclusion in
whole or in part of others; or (ii) received less than a reasonably equivalent
value or fair consideration for any such indebtedness and, at the time of such
incurrence (a) was insolvent; (b) was rendered insolvent by reason of such
incurrence; (c) was engaged or about to engage in a business or transaction for
which its remaining assets constituted unreasonably small capital to carry on
its business; or (d) intended to incur, or believed or reasonably should have
believed that it would incur, debts beyond its ability to pay such debts as they
matured, such court could void the obligations under the Notes, direct the
return on any amounts paid thereunder to the Company or to a fund for the
benefit of its creditors, subordinate such obligations to all other indebtedness
of the relevant obligor or take other action detrimental to the holders of the
Notes.
12
<PAGE>
The measure of insolvency for purposes of the foregoing will vary depending
upon the law of the jurisdiction that is being applied. Generally, however, a
company would be considered insolvent if either (i) the sum of its debts
(including contingent or unliquidated debts) is greater than all of its property
at a fair valuation; or (ii) if the then fair saleable value of its assets is
less than the amount that is required to pay its probable liability on its
existing debts (including contingent or unliquidated debts) as they become
absolute and matured.
A court would likely conclude that the Company did not receive reasonably
equivalent value or fair consideration for incurring its obligation under the
Notes to the extent that the proceeds of the Notes were used to refinance the
Bridge Facility and the Bridge Facility was used to repurchase stock of the
Company from any of its stockholders. The Company, however, believes that it was
at the time of the Recapitalization and is now solvent and that it had at the
time of the Recapitalization and now has sufficient capital to carry on its
business and that it believed at the time of the Recapitalization and now
believes that it was and will be able to pay its debts as they mature. There can
be no assurance, however, that a court would reach the same conclusion.
CONCENTRATION OF OPERATIONS IN CALIFORNIA
As of December 31, 1996, 13 of the Company's stores were located in
California and generated 55.9% and 52.8% of the Company's net sales for fiscal
1995 and 1996, respectively. Although the Company has opened and acquired stores
in other areas in the United States, a significant percentage of the Company's
net sales is likely to remain concentrated in California for the foreseeable
future. Consequently, the Company's results of operations and financial
condition are heavily dependent upon general consumer trends and other general
economic conditions in California and are subject to other regional risks,
including the risk of seismic activity. The Company does not maintain earthquake
insurance. See "Business -- Properties."
IMPACT OF ECONOMIC CONDITIONS ON INDUSTRY RESULTS; CHANGING CONSUMER PREFERENCES
The Company's business is sensitive to consumer spending patterns, which in
turn are subject to, among other things, prevailing economic conditions. There
can be no assurance that consumer spending will not be affected by economic
conditions, thereby impacting the Company's growth, net sales and profitability.
A deterioration in economic conditions in one or more of the markets in which
the Company's stores are concentrated could have a material adverse effect on
the Company's results of operations, business and prospects. Although the
Company attempts to stay abreast of consumer preferences for musical products
and accessories historically offered for sale by the Company, any sustained
failure by the Company to identify and respond to such trends would have a
material adverse effect on the Company's results of operations, financial
condition, business and prospects.
LIMITED TRADING MARKET FOR THE NOTES
The Notes are not listed on any national securities exchange and are not
admitted to trading on the National Association of Securities Dealers Automated
Quotation System. The Company has been advised by Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ") and Chase Securities that they presently intend
to make a market in the Notes. However, DLJ and Chase Securities are not
obligated to do so and any market-making activities with respect to the Notes
may be discontinued at any time without notice. If a trading market does not
develop or is not maintained, holders of the Notes may experience difficulty in
reselling the Notes or may be unable to sell them at all. If a market for the
Notes develops, any such market may be discontinued at any time. If a public
trading market develops for the Notes, future trading prices of the Notes will
depend on many factors, including, among other things, prevailing interest
rates, the Company's results of operations and the market for similar
securities. Depending on prevailing interest rates, the market for similar
securities and other factors, including the financial condition of the Company,
the Notes may trade at a discount from their principal amount.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
This Prospectus contains certain forward-looking statements, relating to,
among other things, future results of operations, growth plans, sales, gross
margin and expense trends, capital requirements and general industry and
business conditions applicable to the Company. These forward-looking statements
are based largely on the Company's current expectations and are subject to a
number of risks and uncertainties. Actual results could differ materially from
these forward-looking statements. In addition to the other risks described
elsewhere in this "Risk Factors" discussion, important factors to consider in
13
<PAGE>
evaluating such forward-looking statements include changes in external
competitive market factors, changes in the Company's business strategy or an
inability to execute its strategy due to unanticipated changes in the music
products industry or the economy in general, the emergence of new or growing
specialty retailers of music products and various other competitive factors that
may prevent the Company from competing successfully in existing or future
markets. In light of these risks and uncertainties, there can be no assurance
that the forward-looking statements contained in this Prospectus will in fact be
realized.
14
<PAGE>
THE RECAPITALIZATION AND RELATED TRANSACTIONS
On June 5, 1996, Guitar Center consummated a series of transactions to
effect a Recapitalization of the Company in order to transfer ownership of the
Company from its sole stockholder, the Scherr Trust, to members of management
and the Investors. The Recapitalization included the following transactions: (i)
members of the Company's management purchased 1,291,000 shares of Common Stock
for $0.5 million in cash; (ii) members of the Company's management received
495,000 shares of Junior Preferred Stock, with an aggregate liquidation
preference of $49.5 million, in exchange for cancellation of outstanding options
exercisable for 127,809,000 shares of Common Stock; (iii) the Scherr Trust
received 198,000 shares of Junior Preferred Stock, with an aggregate liquidation
preference of $19.8 million, in exchange for 51,123,600 shares of Common Stock;
(iv) the Investors purchased 1,807,400 shares of Common Stock and 693,000 shares
of Junior Preferred Stock for $70.0 million in cash; (v) the DLJ Investors (as
defined herein) purchased 800,000 shares of Senior Preferred Stock, with an
aggregate liquidation value of $20.0 million, and warrants (the "Warrants") to
purchase 190,252 shares of Common Stock and 72,947 shares of Junior Preferred
Stock, for an aggregate purchase price of $20.0 million in cash; (vi) GCMC
Funding, Inc. ("DLJ Bridge") purchased $51.0 million aggregate principal amount
of senior unsecured increasing rate notes for cash and Chemical Bank, a
predecessor of The Chase Manhattan Bank ("Chemical"), loaned $49.0 million to
the Company (together, the "Bridge Facility"); (vii) the Company repurchased
309,840,000 shares of Common Stock from the Scherr Trust for approximately
$113.1 million in cash; (viii) the Company cancelled options to purchase
82,384,907 shares of Common Stock held by certain members of management in
exchange for approximately $27.9 million in cash; and (ix) the Company cancelled
its revolving credit facility (the "Old Credit Facility") upon repaying in cash
the approximately $35.9 million outstanding pursuant thereto. Transaction costs
and financing fees incurred by the Company to effect the Recapitalization and
the Bridge Facility aggregated approximately $11.6 million. See "Certain
Transactions."
In connection with the Recapitalization, the Company granted options for the
purchase of 43,344 units (a unit consisting of 2.582 shares of Common Stock,
after giving effect to the stock splits described in this paragraph, and
99/100ths of a share of Junior Preferred Stock (each, a "Unit")) at an exercise
price of $100 per Unit to each of Larry Thomas, its President and Chief
Executive Officer, and Marty Albertson, its Executive Vice President and Chief
Operating Officer and adopted the 1996 Plan (as defined herein) for the benefit
of the Company's key employees. See "Management -- Management Stock Option
Agreements; -- 1996 Performance Stock Option Plan." Upon consummation of the
Recapitalization, management, the Investors, and the Scherr Trust owned
approximately 35.7%, 50.0%, and 14.3%, respectively, of the issued and
outstanding Common Stock of the Company. Immediately following the
Recapitalization, the Company effected a 100-to-1 stock split. On October 11,
1996, the Company reincorporated from a California corporation to a Delaware
corporation and changed the par value of its Common Stock, Senior Preferred
Stock and Junior Preferred Stock. On January 15, 1997, the Company effectuated a
2.582-to-1 stock split. Upon the consummation of the Offering, each share of
Junior Preferred Stock was automatically converted into 6.667 shares of Common
Stock, and all outstanding shares of Senior Preferred Stock were redeemed, at a
premium, with a portion of the net proceeds from the Offering. As of the date of
this Prospectus, the Company's executive officers and key managers, the
Investors and the Scherr Trust (and affiliated family trusts) beneficially own
approximately 17.8%, 30.6% and 8.8%, respectively, of the outstanding shares of
Common Stock. See "Principal Stockholders."
Upon the effectiveness of the Recapitalization, the Company entered into a
$25 million revolving credit facility (the "1996 Credit Facility") with Wells
Fargo Bank, N.A. ("Wells Fargo Bank"). See "Description of the 1996 Credit
Facility." On July 2, 1996 the Company issued in a private placement an
aggregate of $100 million of Old Notes to DLJ and Chase Securities, as the
Initial Purchasers. The proceeds of the offering of the Old Notes were applied
to the retirement of the Bridge Facility. The Old Notes were resold by the
Initial Purchasers pursuant to Rule 144A under the Securities Act ("Rule 144A")
and were later exchanged for the Notes in an exchange offer registered under the
Securities Act which was consummated in December 1996. The Notes are
substantially identical to the Old Notes (except that the Notes are not
restricted securities for federal securities law purposes). Approximately $33.3
million principal amount of the Notes were redeemed, at a premium, on April 19,
1997 with a portion of the net proceeds from the Offering. See "Description of
Notes."
15
<PAGE>
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of any Notes in any
market-making transaction in connection with which this Propsectus may be
delivered.
CAPITALIZATION
The following table sets forth the actual capitalization of the Company as
of December 31, 1996 and the as adjusted capitalization of the Company at that
date after giving effect to the Offering and the application of a portion of the
net proceeds therefrom. This table should be read in conjunction with "The
Recapitalization and Related Transactions," "Unaudited Pro Forma Condensed
Financial Data," "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements of the Company and the
notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
--------------------------
ACTUAL AS ADJUSTED
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt (including current portion)
Notes............................................................................... $ 100,000 $ 66,667
1996 credit facility................................................................ 3,536 --
------------ ------------
Total long-term debt.............................................................. 103,536 66,667
------------ ------------
Senior preferred stock................................................................ 15,186 --
Stockholders' equity (deficit)
Junior preferred stock (1).......................................................... 138,610 --
Warrants............................................................................ 6,500 6,500
Common stock 55,000,000 shares, $.01 par value, authorized; 3,622,804 shares
outstanding, actual; 19,329,079 shares outstanding, as
adjusted (1)....................................................................... 36 193
Additional paid-in capital.......................................................... (6,966) 220,548
Retained earnings (deficit)......................................................... (206,995) (219,259)
------------ ------------
Total stockholders' equity (deficit).............................................. (68,815) 7,982
------------ ------------
Total capitalization............................................................ $ 49,907 $ 74,649
------------ ------------
------------ ------------
</TABLE>
- ------------------------
(1) Under the terms of the Junior Preferred Stock, upon the consummation of the
Offering each share of Junior Preferred Stock was converted automatically
into 6.667 shares of Common Stock. Also excludes shares issuable upon the
exercise of outstanding employee stock options and outstanding Warrants.
16
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
The selected financial data for the fiscal year ended October 31, 1992, the
two months ended December 31, 1992 and the fiscal years ended December 31, 1993,
1994, 1995 and 1996 has been derived from the audited financial statements of
the Company. The selected PRO FORMA financial data set forth below is not
necessarily indicative of the results that would have been achieved or that may
be achieved in the future. The selected historical and PRO FORMA financial data
should be read in conjunction with "The Recapitalization and Related
Transactions," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the financial statements of the Company and the notes
thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
TWO
FISCAL YEAR MONTHS
ENDED ENDED FISCAL YEAR ENDED DECEMBER 31,
OCTOBER 31, DECEMBER 31, ------------------------------------------
1992 1992 1993 1994 1995 1996
--------------- --------------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT STORE AND INVENTORY OPERATING DATA)
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net sales............................................ $ 85,592 $ 18,726 $ 97,305 $ 129,039 $ 170,671 $ 213,294
Cost of goods sold (1)............................... 60,120 13,333 68,527 92,275 123,415 153,222
--------------- --------------- --------- --------- --------- ---------
Gross profit....................................... $ 25,472 $ 5,393 $ 28,778 $ 36,764 $ 47,256 $ 60,072
Selling, general and administrative expenses......... 20,998 3,547 21,889 26,143 32,664 41,345
Deferred compensation expense (2).................... -- 373 1,390 1,259 3,087 71,760
--------------- --------------- --------- --------- --------- ---------
Operating income (loss).............................. $ 4,474 $ 1,473 $ 5,499 $ 9,362 $ 11,505 $ (53,033)
--------------- --------------- --------- --------- --------- ---------
Other (expense) income
Interest expense, net.............................. (457) (49) (271) (252) (368) (12,169)
Transaction expense and other expenses............. 59 -- 23 45 65 (7,068)
--------------- --------------- --------- --------- --------- ---------
$ (398) $ (49) $ (248) $ (207) $ (303) $ (19,237)
--------------- --------------- --------- --------- --------- ---------
Income (loss) before provision for income taxes...... 4,076 1,424 5,251 9,155 11,202 (72,270)
Provision for income taxes........................... 89 39 146 326 345 139
--------------- --------------- --------- --------- --------- ---------
Net income (loss).................................... $ 3,987 $ 1,385 $ 5,105 $ 8,829 $ 10,857 $ (72,409)
--------------- --------------- --------- --------- --------- ---------
--------------- --------------- --------- --------- --------- ---------
PRO FORMA FOR INCOME TAX PROVISION (3):
Historical income (loss) before provision for income
taxes............................................... $ 4,076 $ 1,424 $ 5,251 $ 9,155 $ 11,202 $ (72,270)
Pro forma provision for income taxes................. 1,753 773 2,856 4,478 6,144 --
--------------- --------------- --------- --------- --------- ---------
Pro forma net income (loss).......................... $ 2,323 $ 651 $ 2,395 $ 4,677 $ 5,058 $ (72,270)
--------------- --------------- --------- --------- --------- ---------
--------------- --------------- --------- --------- --------- ---------
OPERATING DATA:
Net sales per gross square foot (4).................. $ 429 -- $ 478 $ 546 $ 661 $ 707
Net sales growth..................................... 14.3% 18.7% 13.7% 32.6% 32.3% 25.0%
Increase in comparable store sales (5)............... 11.5% 18.7% 11.4% 17.3% 23.4% 10.2%
Stores open at end of period......................... 15 15 17 20 21 28
Inventory turns...................................... 3.3x 3.4x 3.1x 3.4x 3.7x 3.4x
Ratio of earnings to fixed charges(6)................ 5.8x 13.8x 9.1x 11.6x 11.7x --
Capital expenditures................................. $ 445 $ 966 $ 2,618 $ 3,277 $ 3,432 $ 6,133
BALANCE SHEET DATA:
Net working capital.................................. $ 11,923 $ 12,679 $ 10,243 $ 11,468 $ 6,002 $ 27,436
Property, plant and equipment, net................... 7,888 8,677 10,066 11,642 13,276 14,966
Total assets......................................... 32,082 34,978 37,602 46,900 49,618 74,849
Total long term and revolving debt (including current
debt)............................................... 6,103 5,001 3,400 825 -- 103,536
Senior preferred stock............................... -- -- -- -- -- 15,186
Junior preferred stock............................... -- -- -- -- -- 138,610
Stockholders' equity (deficit)....................... 16,612 17,997 18,484 23,424 19,763 (68,815)
</TABLE>
FOOTNOTES APPEAR ON FOLLOWING PAGE.
17
<PAGE>
FOOTNOTES TO TABLE ON PREVIOUS PAGE.
- ----------------------------------
(1) Cost of goods sold includes buying and occupancy costs.
(2) For the fiscal year 1996, the Company recorded a non-recurring deferred
compensation expense of $71.8 million, of which $69.9 million related to the
cancellation and exchange of management stock options pursuant to the
Recapitalization and $1.9 million related to a non-cash charge resulting
from the grant of stock options to management by the Investors. The Company
has not, and will not, incur any obligation in connection with such grant of
options by the Investors. See "The Recapitalization and Related
Transactions" and "Certain Transactions -- Options Granted by the Investors
to Certain Members of Management."
(3) Pro forma provision for income taxes reflects the estimated statutory
provision for income taxes assuming the Company was a "C" corporation.
(4) Net sales per gross square foot does not include new stores opened during
the reporting period. Information for the two month period ended December
31, 1992 is not meaningful.
(5) Compares net sales for the comparable periods, excluding net sales
attributable to stores not open for 14 months.
(6) For the purpose of calculating the ratio of earnings to fixed charges,
"earnings" represents income before provision for income taxes and fixed
charges. "Fixed charges" consist of interest expense, amortization of debt
financing costs, and one third of lease expense, which management believes
is representative of the interest components of lease expense. Earnings were
insufficient to cover fixed charges by $72.3 million for the year ended
December 31, 1996.
18
<PAGE>
UNAUDITED PRO FORMA CONDENSED FINANCIAL DATA
The following unaudited PRO FORMA condensed financial data (the "Pro Forma
Financial Data") have been prepared by the Company's management from the
financial statements of the Company and the notes thereto included elsewhere in
this Prospectus. The unaudited PRO FORMA condensed statements of operations for
the fiscal year ended December 31, 1996 reflects adjustments as if the
Recapitalization, the Junior Preferred Stock Conversion, the sale of the Notes,
the Offering and the application of a portion of the estimated net proceeds
therefrom to redeem all outstanding shares of Senior Preferred Stock, a portion
of the Notes and certain shares of Common Stock in the Management Tax Redemption
and to repay amounts outstanding under the 1996 Credit Facility had been
consummated and were effective as of January 1, 1996. The unaudited PRO FORMA
condensed balance sheet as of December 31, 1996 gives effect to the Junior
Preferred Stock Conversion and the application of the estimated net proceeds of
the Offering as if they had occurred on such date.
The financial effects of the Recapitalization and the Offering as presented
in the Pro Forma Financial Data are not necessarily indicative of either the
Company's financial position or the results of its operations which would have
been obtained had the Recapitalization and the Offering actually occurred on the
dates described above, nor are they necessarily indicative of the results of
future operations. The Pro Forma Financial Data should be read in conjunction
with the notes thereto, which are an integral part thereof, the financial
statements of the Company and the notes thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
UNAUDITED PRO FORMA CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
PRO FORMA
ADJUSTMENTS PRO FORMA FOR THE
RELATED TO THE FOR THE ADJUSTMENTS RECAPITALIZATION,
RECAPITALIZATION RECAPITALIZATION RELATED THE SALE OF THE
AND THE SALE OF AND THE SALE OF TO THE NOTES
HISTORICAL THE NOTES THE NOTES OFFERING AND THE OFFERING
----------- ----------------- ----------------- ------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales............................. $ 213,294 $ -- $ 213,294 $ -- $ 213,294
Cost of sales, buying, and
occupancy............................ 153,222 -- 153,222 -- 153,222
----------- -------- ----------------- ------------- -----------------
Gross profit.......................... $ 60,072 $ -- $ 60,072 $ -- $ 60,072
Operating expenses.................... 41,345 (432)(1) 40,913 -- 40,913
Deferred compensation expense......... 71,760 (71,760)(2) -- -- --
----------- -------- ----------------- ------------- -----------------
Operating income...................... $ (53,033) $ 72,192 $ 19,159 $ -- $ 19,159
Other (expenses) income:
Interest expense.................... (12,177) 671(3) (11,506) 3,792(4) (7,714)
Transaction expenses................ (6,942) 6,942(5) -- -- --
Interest income..................... 8 -- 8 -- 8
Other............................... (126) -- (126) -- (126)
----------- -------- ----------------- ------------- -----------------
$ (19,237) $ 7,613 $ (11,624) $ 3,792 $ (7,832)
----------- -------- ----------------- ------------- -----------------
Income (loss) before provision for
income taxes......................... (72,270) 79,805 7,535 3,792 11,327
Provision for income taxes............ 139 3,101(6) 3,240 1,631(6) 4,871
----------- -------- ----------------- ------------- -----------------
Net income (loss)..................... $ (72,409) $ 76,704 $ 4,295 $ 2,161 $ 6,456
Preferred stock dividends............. (7,951) (6,083)(7) (14,034) 14,034(8) --
----------- -------- ----------------- ------------- -----------------
Net income (loss) available for common
stockholders......................... $ (80,360) $ 70,621 $ (9,739) $ 16,195 $ 6,456
----------- -------- ----------------- ------------- -----------------
----------- -------- ----------------- ------------- -----------------
PRO FORMA
Historical income (loss) available to
common stockholders before provision
for income taxes..................... $ (80,221)
Pro forma provision for income taxes
(9).................................. --
-----------
Pro forma net income (loss) available
to common stockholders............... $ (80,221)
-----------
-----------
</TABLE>
See accompanying notes to the unaudited pro forma condensed statements of
operations.
19
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED STATEMENTS OF OPERATIONS
(1) Represents a reduction in (i) compensation expense historically paid to
Raymond Scherr, the former Chairman of the Board; and (ii) bonuses paid to
certain key executives based upon new bonus plans adopted as part of the
Recapitalization and a non-recurring charge associated with options granted
to management by the Investors.
(2) Represents the elimination of deferred stock compensation expense associated
with the management stock options which were partially redeemed and
partially exchanged for Junior Preferred Stock as part of the
Recapitalization.
(3) The interest expense adjustment is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
---------------
<S> <C>
Historical interest expense............................................................... $ 12,177
Assumed interest expense on new credit facility for working capital purposes.............. (131)
Cash interest expense on the Notes at an interest rate of 11%............................. (11,000)
---------------
Total cash interest expense adjustment.................................................... $ 1,046
Amortization of deferred financing fees
on the Notes............................................................................. (375)
---------------
Total interest expense adjustment......................................................... $ 671
---------------
---------------
</TABLE>
(4) The interest expense adjustment relating to the Offering is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
---------------
<S> <C>
Interest expense relating to borrowings under Notes repaid................................ $ 3,667
Amortization of deferred financing fees under Notes repaid................................ 125
-------
Interest expense adjustment............................................................... $ 3,792
-------
-------
</TABLE>
(5) Represents the elimination of non-recurring transaction expenses which are
directly attributable to the Recapitalization.
(6) Reflects the estimated statutory provision for income taxes assuming the
Company was a "C" corporation, and the increase in net expenses as a result
of the adjustments described in notes (1), (2), (3), (4) and (5) above. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Income Taxes."
(7) Represents accrued dividends on the Senior Preferred Stock and the Junior
Preferred Stock.
(8) Preferred stock dividends include the difference between the liquidation
value of the Senior Preferred Stock and the financial statement value for
all periods presented. For pro forma financial statement purposes, the
Senior Preferred Stock is assumed to be redeemed during the period and the
Junior Preferred Stock is assumed to be converted into Common Stock.
(9) The Company was an "S" Corporation prior to the consummation of the
Recapitalization on June 5, 1996. The pro forma statement of operations
information reflects adjustments to historical net income (loss) as if the
Company had elected "C" Corporation status for income tax purposes.
20
<PAGE>
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET DATA
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1996
--------------------------------------------
ADJUSTMENTS
RELATED TO THE PRO FORMA
ACTUAL OFFERING FOR THE OFFERING
--------- -------------- ----------------
(IN THOUSANDS)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 47 $ 25,865 $ 25,912
Accounts receivable........................................... 4,062 -- 4,062
Inventories................................................... 49,705 -- 49,705
Prepaid expenses and other current assets..................... 1,455 -- 1,455
--------- -------------- ----------------
Total current assets........................................ $ 55,269 $ 25,865 $ 81,134
Property and equipment, net..................................... 14,966 -- 14,966
Other assets.................................................... 4,614 (1,123)(1) 3,491
--------- -------------- ----------------
Total assets.............................................. $ 74,849 $ 24,742 $ 99,591
--------- -------------- ----------------
--------- -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.............................................. $ 14,005 $ -- $ 14,005
Accrued expenses and other current liabilities................ 10,292 -- 10,292
Revolving line of credit...................................... 3,536 (3,536)(2) --
--------- -------------- ----------------
Total current liabilities................................... $ 27,833 $ (3,536) $ 24,297
Long term debt.................................................. 100,000 (33,333)(1) 66,667
Long term liabilities........................................... 645 -- 645
--------- -------------- ----------------
Total liabilities........................................... $ 128,478 $ (36,869) $ 91,609
--------- -------------- ----------------
Senior preferred stock.......................................... 15,186 (15,186)(4) --
Stockholders' equity (deficit):
Junior preferred stock........................................ 138,610 (138,610)(7) --
Warrants...................................................... 6,500 -- 6,500
Common stock.................................................. 36 157(5) 193
Additional paid in capital.................................... (6,966) 227,514(6) 220,548
Retained deficit.............................................. (206,995) (12,264)(8) (219,259)
--------- -------------- ----------------
Total stockholders' equity (deficit)........................ $ (68,815) $ 76,797 $ 7,982
--------- -------------- ----------------
Total liabilities and stockholders' equity (deficit)...... $ 74,849 $ 24,742 $ 99,591
--------- -------------- ----------------
--------- -------------- ----------------
</TABLE>
See accompanying notes to unaudited pro forma condensed balance sheet data.
21
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED BALANCE SHEET DATA
(1) Represents the 10% premium paid to redeem approximately $33.3 million
principal amount of Notes. Such redemption resulted in the proportionate
reduction of long-term debt and the related unamortized financing costs and
accrued interest.
(2) Represents the application of a portion of the net proceeds of the Offering
to repay the line of credit under the 1996 Credit Facility.
(3) Represents payroll taxes to be paid by the Company upon conversion of
management's Junior Preferred Stock to Common Stock.
(4) Represents the application of a portion of the net proceeds of the Offering
to redeem the Senior Preferred Stock.
(5) Represents the adjustments to Common Stock as follows:
<TABLE>
<CAPTION>
Net proceeds from the Offering................................... $ 78
<S> <C>
Conversion of Junior Preferred Stock............................. 92(7)
Redemption of Common Stock....................................... (13)(12)
---------
$ 157
---------
---------
</TABLE>
(6) Represents adjustments to Additional Paid in Capital as follows:
<TABLE>
<CAPTION>
Net proceeds from the Offering................................... $ 107,400
<S> <C>
Conversion of Junior Preferred Stock............................. 138,529(7)
Redemption of Common Stock....................................... (18,415)(12)
---------
$ 227,514
---------
---------
</TABLE>
(7) Represents the conversion of the Junior Preferred Stock to Common Stock in
conjunction with this Offering.
(8) Represents the adjustments to retained earnings as follows:
<TABLE>
<CAPTION>
Premium on redemption of Preferred Stock......................... $ (648)(11)
<S> <C>
Premium on redemption of 33.3% of the Notes...................... (3,333)(9)
Write-off of a portion of deferred financing costs on Notes...... (1,123)(1)
Dividend on Senior Preferred Stock............................... (6,416)(10)
Payroll taxes.................................................... (744)(3)
---------
$ (12,264)
---------
---------
</TABLE>
(9) Represents the 10% premium paid to redeem a portion of the Notes.
(10)Represents the difference between the amount of the Senior Preferred Stock
as reported on the Financial Statements to be redeemed and its liquidation
value.
(11)Represents the 3% premium paid to redeem the Senior Preferred Stock.
(12)Represents the redemption of shares of Common Stock pursuant to the
Management Tax Redemption.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Guitar Center operated 28 stores in 15 major markets as of December 31,
1996. From 1992 to 1996, Guitar Center's net sales and operating income before
deferred compensation expense grew at compound annual growth rates of 25.6% and
43.0%, respectively, principally due to comparable store sales growth averaging
14.8% per year and the opening of new stores. Guitar Center achieved comparable
store net sales growth of 17.3%, 23.4% and 10.2% for the fiscal years ended
December 31, 1994, 1995 and 1996, respectively. These increases were primarily
attributable to increases in unit sales rather than increases in prices or
changes in product mix. Management believes such volume increases are the result
of the continued success of the Company's implementation of its business
strategy, continued strong growth in the music products industry and increasing
consumer awareness of the Guitar Center name. The Company does not expect
comparable store sales to continue to increase at historical rates.
The Company opened seven stores in fiscal 1996 and presently expects to open
or acquire approximately eight stores in each of fiscal 1997 and 1998. In
preparation for these additional stores, management has dedicated a substantial
amount of resources over the past several years to building the infrastructure
necessary to support a large, national chain. For example, the Company spent
$2.9 million from January 1, 1993 to December 31, 1995 on system upgrades to
support the storewide integration of a state-of-the-art management information
system. The Company has also established centralized operating and financial
controls and has implemented an extensive training program to ensure a high
level of customer service in its stores. Management believes that the
infrastructure is in place to support its needs for the immediately foreseeable
future, including its present expansion plans as described herein.
Guitar Center's expansion strategy includes opening or acquiring additional
stores in certain of its existing markets and entering new markets. As part of
its store expansion strategy, the Company opened five stores during a 14-month
period from October 1993 through November 1994. Additionally, the Company opened
one store in December 1995, seven stores in 1996 and opened three new stores and
acquired two existing stores from a third party during the first four months of
1997. The Company will continue to pursue its strategy of clustering stores in
major markets to take advantage of operating and advertising efficiencies and to
build awareness of the Guitar Center name in new markets. In some markets where
the Company has pursued its clustering strategy, there has been some transfer of
sales from certain existing stores to new locations. Generally, however, mature
stores have demonstrated net sales growth rates consistent with the Company
average. As the Company enters new markets, management expects that it will
initially incur higher administrative and advertising costs per store than it
currently experiences in established markets.
The following table sets forth certain historical income statement data as a
percentage of net sales:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED
DECEMBER 31,
----------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net sales......................................................................... 100.0% 100.0% 100.0%
Gross profit...................................................................... 28.5 27.7 28.2
Selling, general and administrative expenses...................................... 20.3 19.2 19.4
---------- ---------- ----------
Operating income before deferred compensation expense............................. 8.2 8.5 8.8
Deferred compensation expense..................................................... 0.9 1.8 33.7
---------- ---------- ----------
Operating income (loss)........................................................... 7.3 6.7 (24.9)
Interest expense, net............................................................. 0.2 0.1 5.7
Transaction expenses and other.................................................... -- -- 3.3
---------- ---------- ----------
Income (loss) before income taxes................................................. 7.1 6.6 (33.9)
Income taxes...................................................................... 0.3 0.2 --
---------- ---------- ----------
Net income (loss)................................................................. 6.8% 6.4% (33.9)%
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
23
<PAGE>
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales for the year ended December 31, 1996 increased 25.0% to $213.3
million from $170.7 million in fiscal 1995. This growth was attributable to an
increase of $25.6 million in new store net sales, accounting for 60.1% of such
increase. In addition, comparable store net sales increased 10.2%, or $17.0
million, accounting for 39.9% of such increase. The increase in comparable net
store sales was primarily attributable to increases in unit sales rather than
increases in prices or changes in the mix of sales between the product
categories. Such volume increases were primarily the result of the continued
success of the Company's implementation of its business strategy, continued
strong growth in the music products industry and increasing consumer awareness
of Guitar Center stores.
Gross profit for fiscal 1996 compared to fiscal 1995 increased 27.1% to
$60.1 million from $47.3 million in fiscal 1995. Gross profit as a percentage of
net sales ("gross margin") for fiscal 1996 increased to 28.2% from 27.7% in
fiscal 1995. This increase in gross margin was primarily the result of the
introduction and sales of higher margin high-technology pro audio and recording
equipment.
Selling, general and administrative expenses for fiscal 1996 increased 26.6%
to $41.3 million from $32.7 million in fiscal 1995. As a percentage of net
sales, selling, general and administrative expenses for fiscal 1996 increased to
19.4% from 19.2% in fiscal 1995. This change reflects an increase in the number
of store employees in anticipation of continued comparable store sales growth,
as well as the incremental cost of staffing newly opened stores prior to sales
reaching mature levels. During fiscal 1996, seven new stores commenced operation
and were open an average of four and a half months. In addition, the increase
reflects increases in corporate personnel and management information systems
expenses associated with the Company's continuing expansion.
Deferred compensation expense for fiscal 1996 increased to $71.8 million
from $3.1 million in fiscal 1995. The deferred compensation expense resulted
from a $69.9 million charge related to the purchase and exchange of management
stock options and the cancellation of the Company's prior stock option program
and a $1.9 million non-cash charge related to stock options granted by the
Investors to certain members of management. These expenses are non-recurring.
The Company has not, and will not, incur any obligation in connection with such
grant of options by the Investors. See "The Recapitalization and Related
Transactions" and "Certain Transactions -- Options Granted by the Investors to
Certain Members of Management."
The operating loss for fiscal 1996 was $53.0 million compared to operating
income of $11.5 million in fiscal 1995. Operating income before deferred
compensation expense increased 28.1% to $18.7 million from $14.6 million over
the comparable period. As a percentage of net sales, operating income before
deferred compensation expense for fiscal 1996 increased to 8.8% from 8.5% in the
prior year.
Interest expense, net for fiscal 1996 increased to $12.2 million from $0.4
million in fiscal 1995. This increase was attributable to the write-off of
financing fees of $4.7 million and interest of $7.5 million on outstanding
borrowings during the seven months following the Recapitalization.
Nonrecurring transaction expenses of $6.9 million related to the
Recapitalization were expensed in fiscal 1996.
Net income (loss) for fiscal 1996 decreased to ($72.4) million from $10.9
million in fiscal 1995.
FISCAL 1995 COMPARED TO FISCAL 1994
Net sales for the year ended December 31, 1995 increased 32.3% to $170.7
million from $129.0 million in fiscal 1994. This growth was attributable to an
increase of 23.4% in comparable store net sales which contributed $28.4 million,
or 68.1% of the increase. In addition, $13.3 million was contributed from new
store sales which accounted for 31.9% of the increase. The increase in
comparable store net sales was primarily attributable to increases in unit sales
rather than increases in prices or changes in the mix of products sold. Such
volume increases were primarily the result of the continued implementation of
the Company's business strategy, continued strong growth in the music products
industry and increasing consumer awareness of Guitar Center stores.
24
<PAGE>
Gross profit for fiscal 1995 increased 28.5% to $47.3 million from $36.8
million in fiscal 1994. Gross margin for fiscal 1995 decreased to 27.7% from
28.5% in fiscal 1994. This decrease in gross margin was primarily the result of
(i) an increase in the proportion of total net sales attributable to lower
margin pro-audio and recording equipment and (ii) the continuation of a sales
program which emphasized volume increases, customer service and market share
over gross margin.
Selling, general and administrative expenses for fiscal 1995 increased 24.9%
to $32.7 million from $26.1 million in fiscal 1994. As a percentage of net
sales, selling, general and administrative expenses for fiscal 1995 decreased to
19.2% from 20.3% in fiscal 1994 reflecting the leveraging of fixed expenses over
greater store net sales.
Deferred compensation expense for fiscal 1995 increased 145.2% to $3.1
million from $1.3 million in fiscal 1994. Deferred compensation relates to
non-cash expenses associated with the Company's prior stock option program.
Operating income after deferred compensation for fiscal 1995 increased 22.9%
to $11.5 million from $9.4 million for fiscal 1994. Operating income before
deferred compensation increased 37.4% to $14.6 million from $10.6 million over
the comparable period. As a percentage of net sales, operating income before
deferred compensation for fiscal 1995 increased to 8.5% from 8.2% for fiscal
1994. This increase was primarily attributable to the decrease in selling,
general and administrative expenses as a percentage of net sales, offset by the
decrease in gross margin.
Interest expense, net for fiscal 1995 increased 46.0% to $0.4 million from
$0.3 million for fiscal 1994. This increase was attributable to increased
borrowings to fund distributions to the Company's former sole stockholder.
Net income for fiscal 1995 increased 23.0% to $10.9 million from $8.8
million for fiscal 1994.
FISCAL 1994 COMPARED TO FISCAL 1993
Net sales for fiscal 1994 increased 32.6% to $129.0 million from $97.3
million in fiscal 1993. This growth was attributable to an increase of 17.3% in
comparable store sales which contributed $15.9 million, or 50% of the increase.
In addition, $15.8 million was contributed from new store sales which accounted
for 50% of the increase. The increase in comparable store sales was primarily
attributable to increases in unit sales rather than increases in prices or the
mix of products sold. Such volume increases were primarily the result of the
implementation of the Company's business strategy, continued strong growth in
the music products industry and increasing consumer awareness of Guitar Center
stores.
Gross profit for fiscal 1994 increased 27.7% to $36.8 million from $28.8
million in fiscal 1993. Gross margin for fiscal 1994 decreased to 28.5% from
29.6% in fiscal 1993. This decrease in gross margin was primarily the result of
(i) an increase in the percentage of total net sales attributable to lower
margin pro-audio and recording equipment and (ii) the implementation of a sales
program which emphasized volume increases, customer service and market share
over gross margin.
Selling, general and administrative expenses for fiscal 1994 increased 19.4%
to $26.1 million from $21.9 million in fiscal 1993. As a percentage of net
sales, selling, general and administrative expenses for fiscal 1994 decreased to
20.3% from 22.5% in fiscal 1993, reflecting the leveraging of fixed expenses
over greater store net sales.
Deferred compensation expense for fiscal 1994 decreased 9.4% to $1.3 million
from $1.4 million in fiscal 1993. Deferred compensation relates to non-cash
expenses associated with the Company's prior stock option program.
Operating income after deferred compensation for fiscal 1994 increased 70.2%
to $9.4 million from $5.5 million for fiscal 1993. Operating income before
deferred compensation increased 54.2% to $10.6 million from $6.9 million over
the comparable period. As a percentage of net sales, operating income before
deferred compensation for fiscal 1994 increased to 8.2% from 7.1% for fiscal
1993. This increase was primarily attributable to the decrease in selling,
general and administrative expenses as a percentage of net sales, offset by the
decrease in gross profit as a percentage of net sales.
25
<PAGE>
Interest expense, net for fiscal 1994 remained unchanged at $0.3 million
from fiscal 1993.
Net income for fiscal 1994 increased 72.9% to $8.8 million from $5.1 million
for fiscal 1993.
LIQUIDITY AND CAPITAL RESOURCES
On March 19, 1997, the Company completed the Offering pursuant to which it
sold 6,750,000 shares of Common Stock and received approximately $94.1 million
in net cash proceeds (before deducting expenses associated with the Offering).
On April 15, 1997, the Company sold an additional 1,012,500 shares of Common
Stock and received an additional $14.1 million in net cash proceeds upon the
underwriters' exercise in full of their over-allotment option. Approximately
$22.9 million of the net proceeds from the Offering was used to redeem, at a
premium, all of the Company's outstanding Senior Preferred Stock. As a result,
the Company will report a dividend for the first quarter of 1997 in an amount
equal to the difference between the financial statement value of the Senior
Preferred Stock and the face amount thereof, plus the aggregate amount of the
premium paid on the Senior Preferred Stock. Immediately following the Offering,
the Company called for redemption, at a premium, an aggregate of approximately
$33.3 million of Notes. Approximately $37.9 million of the net proceeds from the
Offering were used to redeem such Notes on April 19, 1997 and to pay all accrued
and unpaid interest with respect to the Notes called for redemption.
Accordingly, the Company anticipates that an extraordinary charge to operations
will be incurred equal to the aggregate amount of the premium paid on the Notes
called for redemption plus the write-off of one-third of the unamortized
deferred financing fees associated with the issuance of such Notes.
Approximately $9.7 million of the net proceeds from the Offering was used to
repay all amounts outstanding under the 1996 Credit Facility. Approximately
$18.4 million of the net proceeds from the Offering was used to redeem
approximately 1,317,000 shares of Common Stock in the Management Tax Redemption.
The balance of the net proceeds were retained for general corporate purposes,
including the acquisition of two musical instruments stores in the Atlanta,
Georgia market in April 1997.
Guitar Center's need for liquidity will arise primarily from interest
payable on its indebtedness and the funding of the Company's capital expenditure
and working capital requirements, as well as possible acquisitions. The Company
has historically financed its operations through internally generated funds and
borrowings under its credit facilities. The Company has no mandatory payments of
principal on the Notes prior to their final maturity in 2006. The Company
presently has no amounts outstanding under its 1996 Credit Facility. The
interest rate under the 1996 Credit Facility as of the date of this Prospectus
was 9.75% on prime rate based borrowings and 8.40% on Eurodollar rate based
borrowings. The agreement underlying the 1996 Credit Facility expires June 1,
2001 and includes certain restrictive covenants which, among other things,
require the Company to maintain certain financial ratios. The Company was in
compliance with respect to all such requirements as of December 31, 1996. The
Company may borrow up to $25 million under the 1996 Credit Facility, as in place
on the date hereof. The Company is currently negotiating a secured successor
bank facility to replace the 1996 Credit Facility, although no agreement has
been reached as of the date of this Prospectus. If and when the Company enters
into such a successor facility, it presently expects that such facility would
permit borrowings in excess of the $25 million of borrowings permitted under the
1996 Credit Facility.
For fiscal 1996, cash used in operating activities was $44.9 million. During
fiscal 1995, cash provided by operating activities was $16.4 million. Cash
provided by financing activities was $49.3 million for fiscal 1996, which
includes the effects of the Recapitalization. Cash used in financing activities
during fiscal 1995 was $15.3 million which consisted primarily of distributions
to the Company's former sole stockholder of $14.5 million.
Capital expenditures totaled $6.1 million for fiscal 1996. The Company's
capital expenditures related to the opening of new stores, management
information systems and store remodels.
The Company intends to pursue an aggressive growth strategy by opening
additional stores in new and existing markets. Each new store typically has
required approximately $1.5 million for gross inventory. Historically, the
Company's cost of capital improvements for an average new store has been
approximately $450,000, consisting of leasehold improvements, fixtures and
equipment. Pre-opening
26
<PAGE>
costs for new stores have averaged approximately $110,000 per new store, the
majority of which are expensed and the remaining portion of which are
capitalized and amortized over a twelve-month period. Nominal pre-opening costs
are incurred for the stores that are relocated.
The Company also believes that there may be attractive opportunities to
expand by selectively acquiring existing music product retailers. For example,
in April 1997 the Company consummated the acquisition of a music products
retailer operating two stores in the Atlanta, Georgia market. See "Summary --
Recent Developments." The Company, in the ordinary course of business, regularly
evaluates and enters into negotiations relating to potential acquisition
candidates in new and existing market areas. Any such transactions may involve
the payment by the Company of cash or securities (including equity securities),
or a combination thereof. There can be no assurance that the Company will be
able to identify suitable acquisition candidates available for sale at
reasonable prices or consummate additional acquisitions.
Management believes that the Company has adequate capital resources and
liquidity to meet its borrowing obligations, fund all required capital
expenditures and pursue its business strategy for at least the next twelve
months, including its present plans for expansion as described elsewhere herein.
The Company's capital resources and liquidity are expected to be provided by the
Company's cash flow from operations and borrowings under the 1996 Credit
Facility, or a replacement facility (if implemented). Depending on market
conditions, the Company may also incur additional indebtedness or issue equity
securities. There can be no assurance that such additional capital, if and when
required, will be available on terms acceptable to the Company, if at all.
In December 1996, Chase Ventures, Wells Fargo and Weston Presidio granted
options (the "Investor Options") to purchase an aggregate of 277,194 shares of
Common Stock at a purchase price of $4.33 per share to certain officers and key
managers of the Company. Under generally accepted accounting principles, the
Company recorded a non-cash, non-recurring compensation charge of approximately
$1.9 million in the fourth quarter of 1996 with an offsetting increase to
stockholders' equity. The Company is not a party to this agreement and has not,
and will not, incur any obligation in connection with such options. See "Certain
Transactions -- Options Granted by the Investors to Certain Members of
Management."
INCOME TAXES
The Company operated as an "S" corporation for all reported periods prior to
the closing of the Recapitalization on June 5, 1996. Accordingly, federal taxes
were paid at the stockholder level and the Company paid minimal state income
taxes. Upon consummation of the Recapitalization, the Company eliminated its "S"
corporation status and, accordingly, became subject to federal, state and local
income taxes. The Company anticipates that the impact of the termination of the
"S" corporation and the election of the "C" corporation status on its future
operations will be that additional federal and state income taxes will have to
be provided and charged to the statement of operations. The Company believes,
however, that the cash impact to the Company will be reduced as the Company will
no longer make distributions to its former sole stockholder. See "Unaudited Pro
Forma Condensed Statements of Operations."
As a result of the $72.4 million loss incurred in fiscal 1996, the Company
has a tax net operating loss carryforward for federal income tax purposes
aggregating $64.2 million, which will expire if unused in 2011. As of December
31, 1996, the Company had fully reserved the related deferred tax asset of $22.5
million.
SEASONALITY
The Company's results are not highly seasonal, although, as with most
retailers, sales in the fourth quarter are typically higher than in other
quarters.
INFLATION
The Company believes that the relatively moderate rates of inflation
experienced in recent years have not had a significant impact on its nets sales
or profitability.
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FORWARD-LOOKING STATEMENTS
This Prospectus contains certain forward-looking statements relating to,
among other things, future results of operations, growth plans, sales, gross
margin and expense trends, capital requirements and general industry and
business conditions applicable to the Company. These forward-looking statements
are based largely on the Company's current expectations and are subject to a
number of risks and uncertainties. Actual results could differ materially from
these forward-looking statements. Important factors to consider in evaluating
such forward-looking statements include changes in external competitive market
factors, change in the Company's business strategy or an inability to execute
its strategy due to unanticipated changes in the music products industry or the
economy in general, the emergence of new or growing specialty retailers of music
products and various competitive factors that may prevent the Company from
competing successfully in existing or future markets. In light of these risks
and uncertainties, many of which are described in greater detail in "Risk
Factors," there can be no assurance that the forward-looking statements
contained in this Prospectus will in fact be realized. See "Risk Factors."
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BUSINESS
COMPANY HISTORY
Guitar Center was founded in 1964 in Hollywood, California. In 1972, the
Company opened its second store in San Francisco to capitalize on the emerging
San Francisco rock 'n roll scene. By this time, Guitar Center's inventory had
been expanded to include drums, keyboards, accessories and pro audio and
recording equipment. Throughout the 1980s, Guitar Center expanded by opening
nine stores in five major markets including Chicago, Dallas and Minneapolis.
Since 1990, the Company has continued its new store expansion and has focused on
building the infrastructure necessary to manage the Company's strategically
planned growth. Current executive officers and key managers have been with the
Company for an average of 11 years and two of such executive officers (the
Company's President and Chief Executive Officer and the Company's Executive Vice
President and Chief Operating Officer) effectively assumed full operating
control in 1992. Since then, management has focused on developing and realizing
its long-term goal of expanding its position as the leading music products
retailer throughout the United States.
Guitar Center's flagship Hollywood store currently is one of the nation's
largest and best-known retail stores of its kind with approximately 30,600
square feet of retail space. The Hollywood store features one of the largest
used and vintage guitar collections in the United States, attracting buyers and
collectors from around the world. In front of the Hollywood store is the Rock
Walk which memorializes over 70 famous musicians and music pioneers. The Rock
Walk attracts several tour buses daily and has helped to create international
recognition of the Guitar Center name.
BUSINESS
The Company operated 28 stores in 15 major U.S. markets as of December 31,
1996, including, among others, areas in or near Los Angeles, San Francisco,
Chicago, Miami, Houston, Dallas, Detroit, Boston and Minneapolis. From fiscal
1992 through fiscal 1996, the Company's net sales and operating income before
deferred compensation expense grew at compound annual growth rates of 25.6% and
43.0%, respectively. This growth was principally the result of strong and
consistent comparable store sales growth, averaging 14.8% per year over such
five-year period, and the opening of 13 new stores. Comparable store sales
(stores opened for at least 14 months) for fiscal 1992, 1993, 1994, 1995 and
1996 were $85.6 million, $95.4 million, $113.2 million, $157.5 million and
$187.7 million, respectively.
Guitar Center offers a unique retail concept in the music products industry,
combining an interactive, hands-on shopping experience with superior customer
service and a broad selection of brand name, high-quality products at guaranteed
low prices. The Company creates an entertaining and exciting atmosphere in its
stores with bold and dramatic merchandise presentations, highlighted by bright,
multi-colored lighting, high ceilings, music and videos. Management believes
that approximately 80% of the Company's sales are to professional and aspiring
musicians who generally view the purchase of music products as a career
necessity. These sophisticated customers rely upon the Company's knowledgeable
and highly trained salespeople to answer technical questions and to assist in
product demonstrations.
The Guitar Center prototype store generally ranges in size from 12,000 to
15,000 square feet (as compared to a typical music products retail store which
averages approximately 3,200 square feet) and is designed to encourage customers
to hold and play instruments. Each store carries an average of 7,000 core SKUs,
which management believes is significantly greater than a typical music products
retail store, and is organized into five departments, each focused on one
product category. These departments cater to a musician's specific product needs
and are staffed by specialized salespeople, many of whom are practicing
musicians. Management believes this retail concept differentiates the Company
from its competitors and encourages repeat business.
Guitar Center stores historically have generated strong and stable operating
results. All of the Company's stores, after being open for at least twelve
months, have had positive store-level operating income in each of the past five
fiscal years.
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The following summarizes certain key operating statistics of a Guitar Center
store and is based upon the 21 stores operated by the Company for the full year
ended December 31, 1996:
<TABLE>
<S> <C>
Average 1996 net sales per square foot......................... $ 707
Average 1996 net sales per store............................... 9,148,000
Average 1996 store-level operating income (1).................. 1,402,000
Average 1996 store-level operating income margin (1)........... 15.3%
</TABLE>
- ------------------------
(1) Store-level operating income includes individual store revenue and expenses
plus allocated rebates, cash discounts and purchasing department salaries
(based upon individual store sales).
Management is highly committed to the success of Guitar Center. As of the
date of this Prospectus, executive officers and key managers beneficially own
approximately 17.8% of the Company's outstanding Common Stock. The Company's
growth strategy is to continue to increase its presence in its existing markets
and to open or acquire new stores in strategically selected markets. The Company
will continue to pursue its strategy of clustering stores in major markets to
take advantage of operating and advertising efficiencies and to build awareness
of the Guitar Center name in new markets. The Company opened a total of seven
stores in fiscal 1996, and presently expects to open or acquire approximately
eight stores in each of fiscal 1997 and fiscal 1998. The Company has committed
substantial resources to building a corporate infrastructure and management
information systems that it believes can support the Company's needs, including
its expansion plans, for the foreseeable future.
For fiscal years ended December 31, 1993, 1994, 1995 and 1996, the Company
had net income (loss) of $5.1 million, $8.8 million, $10.9 million and ($72.4)
million, respectively. The results for fiscal 1996 reflect $11.6 million for
transaction costs and financing fees incurred in connection with the
Recapitalization and non-recurring deferred compensation expense of $71.8
million, substantially all of which related to the Recapitalization.
INDUSTRY OVERVIEW
The United States retail market for music products in 1995 was estimated in
a study by MUSIC TRADES magazine to be approximately $5.5 billion in net sales,
representing a five year compound annual growth rate of 7.9%. The broadly
defined music products market, according to the National Association of Music
Merchants ("NAMM"), includes retail sales of string and fretted instruments,
sound reinforcement and recording equipment, drums, keyboards, print music,
pianos, organs and school band and orchestral instruments. Products currently
offered by Guitar Center include categories of products which account for
approximately $4.0 billion of this market, representing a five-year compound
annual growth rate of 8.6%. The music products market as currently defined by
NAMM, however, does not include the significant used and vintage product
markets, or the computer software or apparel market in which the Company
actively participates. According to findings by a Gallup Survey, as reported by
NAMM, there were 62 million amateur musicians in the United States in 1994, with
62% of households characterized as "player households," in which someone plays
or has played a musical instrument.
The industry is highly fragmented with the nation's leading five music
products retailers, as measured by the number of stores operated by such
retailers (I.E, the Company, Sam Ash Music Corp, Brook Mays/C&S/H&H, Fletcher
Music Center and Musicians Friend, Inc.), accounting for approximately 8.4% of
the industry's estimated $5.5 billion in net sales in 1995. Furthermore, ninety
percent of the industry's estimated 8,200 retailers operate only one or two
stores. A typical music products store averages approximately 3,200 square feet
and generates an average of approximately $0.6 million in annual net sales. In
contrast, a Guitar Center store generally averages between 12,000 and 15,000
square feet and in 1996 generated an average of approximately $8.3 million in
annual net sales for stores open the full year (excluding the Company's
Hollywood store).
Over the past ten years, technological advances in the industry have
resulted in dramatic changes to the nature of music-related products.
Manufacturers have combined computers and micro-processor technologies with
musical equipment to create a new generation of products capable of high grade
sound processing and reproduction. Products featuring this technology are
available in a variety of
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forms and have broad applications across most of the Company's music product
categories. Most importantly, rapid technological advances have resulted in the
continued introduction of higher quality products offered at lower prices. For
example, today an individual consumer can more affordably create a home
recording studio which interacts with personal computers and is capable of
producing high-quality digital recordings. Until recently, this type of powerful
sound processing capability was prohibitively expensive and was typically
purchased only by professional sound recording studios.
BUSINESS STRATEGY
Management's goal is to continue to expand Guitar Center's position as the
leading music products retailer throughout the United States. The principal
elements of the Company's business strategy are as follows:
EXPANSION STRATEGY. Guitar Center's expansion strategy is to continue
to increase its market share in existing markets and to penetrate
strategically selected markets. The Company opened a total of seven stores
in fiscal 1996, and currently anticipates opening approximately eight stores
in each of fiscal 1997 and fiscal 1998. In the first four months of 1997,
the Company opened three new stores and acquired two existing stores. In
preparation for this expansion, management has dedicated a substantial
amount of its resources over the past several years to building the
infrastructure necessary to support a large national chain. In addition, the
Company believes it has developed a methodology for targeting prospective
store sites which includes analyzing demographic and psychographic
characteristics of a potential store location. See "-- Site Selection."
Management also believes there may be attractive opportunities to expand by
selectively acquiring existing music products retailers.
EXTENSIVE SELECTION OF MERCHANDISE. Guitar Center offers an extensive
selection of brand name music products complemented by lesser known, hard to
find items and unique, vintage equipment. The average 7,000 core SKUs
offered through each Guitar Center store provide a breadth and depth of
in-stock items which management believes is not available from traditional
music products retailers, such as the two stores in the Atlanta market
acquired in April 1997.
HIGHLY INTERACTIVE, MUSICIAN-FRIENDLY STORE CONCEPT. The purchase of
musical instruments is a highly personal decision for musicians. Management
therefore believes that a large part of the Company's success is
attributable to its creative instrument presentations and colorful,
interactive displays which encourage the customer to hold and play
instruments as well as to participate in product demonstrations. Each store
also provides private sound-controlled rooms to enhance a customer's
listening experience while testing various instruments.
EXCEPTIONAL CUSTOMER SERVICE. Exceptional customer service is
fundamental to the Company's operating strategy. Accordingly, the Company
conducts extensive training programs for its salespeople, who specialize in
one of the Company's five product categories. Many of the Company's
salespeople are also musicians. With the advances in technology and
continuous new product introductions in the music products industry,
customers increasingly rely on qualified salespeople to offer expert advice
and assist in product demonstrations. Management believes that its emphasis
on training and customer service distinguishes the Company within the
industry and is a critical part of Guitar Center's success.
INNOVATIVE PROMOTIONAL AND MARKETING PROGRAMS. Guitar Center sponsors
innovative promotional and marketing events which include in-store
demonstrations, famous artist appearances and weekend themed sales events
designed to create significant store traffic and exposure. In addition, the
Company's special grand opening activities in new markets are designed to
generate consumer awareness for each new store. Management believes these
events help the Company to build a loyal customer base and to encourage
repeat business. Since its inception, the Company has compiled a unique,
proprietary database containing information on more than one million
customers. This database enables Guitar Center to advertise to select target
customers based on historical buying patterns. The Company believes the
typical music products retailer does not have the resources to support
large-scale promotional events or an extensive advertising program.
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GUARANTEED LOW PRICES. Guitar Center endeavors to be the low price
leader in each of its markets, as underscored by its 30-day low price
guarantee. The Company's size permits it to take advantage of volume
discounts for large orders and other vendor supported programs. Although
prices are usually determined on a regional basis, store managers are
trained and authorized to adjust prices in response to local market
conditions.
EXPERIENCED AND MOTIVATED MANAGEMENT TEAM. The executive officers and
key managers have an average of 11 years with the Company. In addition, as
of the date of this Prospectus, executive officers and key managers
beneficially own approximately 17.8% of the Company's outstanding Common
Stock. See "Management" and "Principal Stockholders."
MERCHANDISING
Guitar Center's merchandising concept differentiates the Company from most
of its competitors. The Company creates an entertaining and exciting atmosphere
in its stores with bold and dramatic merchandise presentations, highlighted by
bright, multi-colored lighting, high ceilings, music and videos. The Company
offers its merchandise at guaranteed low prices and utilizes aggressive
marketing and advertising to attract new customers and maintain existing
customer loyalty. The principal elements of the Company's merchandising
philosophy are as follows:
EXTENSIVE SELECTION OF MERCHANDISE. The Company seeks to maintain a broad
customer appeal by offering high-quality merchandise at multiple price points to
serve musicians ranging from the casual hobbyist to the serious professional
performer. Guitar Center offers five primary product categories: guitars,
amplifiers, percussion instruments, keyboards and pro audio and recording
equipment.
GUITARS. The Company believes that Guitar Center's electric, acoustic
and bass guitar selections are among the deepest and broadest in the
industry. Each store features for sale 300 to 500 guitars on the "guitar
wall" and also displays many autographed instruments from world-renowned
musicians. Major manufacturers, including Fender, Gibson, Taylor, Martin,
Ovation and Ibanez, are well represented in popular models and colors. The
Company believes it has one of the largest selections of custom,
one-of-a-kind and used/vintage guitars of any retailer. Prices range from
$175 for entry-level guitars to over $50,000 for special vintage guitars. In
addition, the Company has recently expanded its line of string instruments
to include banjos, mandolins and dobros, among others. The Company also
offers an extensive selection of guitar sound processing units and products
which allow the guitar to interface with a personal computer. The
introduction of such equipment has enabled the Company to serve crossover
demand from the traditional guitarist into new computer-related sound
products.
AMPLIFIERS. The Company offers an extensive selection of electric and
bass guitar amplifiers and in addition carries a broad selection of boutique
and vintage amplifiers with prices ranging from $50 to $3,000. Guitar Center
represents most manufacturers, including Marshall, Fender, Crate, Ampeg and
Roland.
PERCUSSION INSTRUMENTS. The Company believes that Guitar Center is
one of the largest retailers of percussion products in the United States.
The Company's offerings range from basic drum kits to free standing African
congos and bongos and other rhythmic and electronic percussion products with
prices ranging from $10 to $10,000. The Company also has a large selection
of vintage and used percussion instruments. Name brands include Drum
Workshop, Remo, Sabian, Pearl, Yamaha, Premier, Tama and Zildjian. The
Company carries an extensive selection of digital drum kits and hand held
digital drum units. The digital units produce a variety of high quality
life-like drum sounds and have broad appeal to musicians.
KEYBOARDS. Guitar Center carries a wide selection of keyboard
products and computer peripheral and software packages with prices ranging
from $150 to $5,000. The Company offers an extensive selection of software
for the professional, hobbyist, studio engineer and the post production
market enthusiast. The product line covers a broad range of manufacturers
including Roland,
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Korg, Emu and Ensoniq. The Company also maintains a broad selection of
computer related accessories, including sound cards, sound libraries and
composition, sequence and recording software.
PRO AUDIO AND RECORDING EQUIPMENT. Guitar Center's pro audio and
recording equipment division offers products ranging in price from $100 to
$25,000 for musicians at every level, from the casual hobbyist to the
professional recording engineer. Guitar Center's products range from
recording tape to state-of-the-art digital recorders. The Company believes
it also carries one of the largest pro audio assortment of professional
stage audio equipment for small traveling bands, private clubs and large
touring professional bands. The Company's major brand name manufacturers
include JBL, Panasonic, Sony, Mackie, Tascam and Alesis.
BROAD USED MERCHANDISE SELECTION. Guitar Center offers an extensive
selection of used merchandise, the majority of which derives from instruments
traded in or sold to Guitar Center by customers. The Company believes that its
trade-in policy assists in attracting sales by providing musicians an
alternative form of payment and the convenience of selling an old instrument and
purchasing a new one at a single location. Used products are bought and priced
to sell by store managers who are well trained and knowledgeable in the used
musical instrument market.
GUARANTEED LOW PRICES. Guitar Center endeavors to be the price leader in
each of the markets it serves. The Company is one of the leading retailers in
each of its product categories and its size permits it to take advantage of
volume discounts for large orders and other vendor supported programs. To
maintain this strategy of guaranteed low prices, the Company routinely monitors
prices in each of its markets to assure that its prices remain competitive.
Although prices are typically determined on a regional basis, store managers are
trained and authorized to adjust prices in response to local market conditions.
The Company underscores its low price guarantee by providing a cash refund of
the price difference if an identical item is advertised by a competitor at a
lower price within thirty days of the customer's purchase.
DIRECT MARKETING, ADVERTISING AND PROMOTION. The Company's advertising and
promotion strategy is designed to enhance the Guitar Center name and increase
consumer awareness and loyalty. The advertising and promotional campaigns are
developed around "events" designed to attract significant store traffic and
exposure. Guitar Center regularly plans large promotional events including the
Green Tag Sale in March, the Anniversary Sale in August, the Blues Fest in
October and the Guitar-a-thon in December. The Company believes that its special
events have a broad reach as many of them have occurred annually during the past
twenty years. These events are often coordinated with product demonstrations,
interactive displays, clinics and in-store artist appearances.
As Guitar Center enters new markets, it initiates an advertising program,
including mail and radio promotions and other special grand opening activities
designed to accelerate sales volume for each new store. Radio advertising plays
a significant part in the Company's store-opening campaign to generate
excitement and create customer awareness.
Guitar Center maintains a unique and proprietary database containing
information on over one million customers. The Company believes that this
database assists in generating repeat business by targeting customers based on
their purchasing history and by permitting Guitar Center to establish and
maintain personal relationships with its customers.
CUSTOMER SERVICE
Exceptional customer service is fundamental to the Company's operating
strategy. With the rapid changes in technology and continuous new product
introductions, customers depend on salespeople to offer expert advice and to
assist with product demonstrations. Guitar Center believes that its well trained
and highly knowledgeable salesforce differentiates it from its competitors and
is critical to maintaining customer confidence and loyalty. The Company's
employees are typically musicians who are selected and trained to understand the
needs of their customers. Salespeople specialize in one of the Company's five
product categories and begin training on their first day of employment. Sales
and
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management training programs are implemented on an ongoing basis to maintain and
continually improve the level of customer service and sales support in the
stores. Based on examination results, an employee is given a rating which
determines his or her salary and level of responsibility. Guitar Center believes
that its employee testing program impresses upon its salespeople a sense of
professionalism and reduces employee turnover by providing salespeople with the
opportunity to increase their salary by advancing through the certification
program. The Company believes that due to its emphasis on training, it is able
to attract and retain well-qualified, highly motivated salespeople committed to
providing superior customer service. In addition, each salesperson in the
keyboards and pro audio and recording departments is certified by a technical
advisory board after satisfactory completion of an extensive training program.
The Company's customer base consists of (i) the professional or aspiring
musician who makes or hopes to make a living through music and (ii) the amateur
musician or hobbyist who views music as recreation. Management estimates that
professional and aspiring musicians, who view the purchase of musical products
as a career necessity, represent approximately 65% of the Company's customer
base, and account for approximately 80% of the Company's sales. These customers
make frequent visits to a store and develop relationships with the salesforce.
Guitar Center generates repeat business and is successful in utilizing its
unique and proprietary database to market selectively to these customers based
on past buying patterns. In addition, Guitar Center services touring
professionals, providing customized products for musical artists.
STORE OPERATIONS
To facilitate its strategy of accelerated but controlled growth, Guitar
Center has centralized many key aspects of its operations, including the
development of policies and procedures, accounting systems, training programs,
store layouts, purchasing and replenishment, advertising and pricing. Such
centralization effectively utilizes the experience and resources of the
Company's headquarters staff to establish a high level of consistency throughout
all of the Guitar Center stores.
The Company's store operations are led by its Chief Operating Officer and
five regional store managers with each regional manager responsible for
approximately four to eight stores. Store management is comprised of a store
manager, a sales manager, an operations manager, two assistant store managers
and five department managers. Each store also has a warehouse manager and a
sales staff that ranges from 20 to 40 employees.
The Company ensures that store managers are well-trained and experienced
individuals who will maintain the Guitar Center store concept and philosophy.
Each manager completes an extensive training program which instills the values
of operating as a business owner, and only experienced store employees are
promoted to the position of store manager. As a result of this strategy, the
average tenure of the store managers is approximately seven years. The Company
seeks to encourage responsiveness and entrepreneurship at each store by
providing store managers with a relatively high degree of autonomy relating to
operations, personnel and merchandising. Managers play an integral role in the
selection and presentation of merchandise, as well as the promotion of the
Guitar Center reputation.
The Company views its employees as long-term members of the Guitar Center
team. The Company encourages employee development by providing the salesforce
with extensive training and the opportunity to increase both compensation and
responsibility level through increased product knowledge and performance. The
Company's aggressive growth strategy provides employees with the opportunity to
move into operations, sales and store management positions, which management
believes is not available at most other music retailers. As the Company opens
new stores, key in-store management positions are primarily filled by the
qualified and experienced employees from existing stores. By adopting a
"promotion from within" strategy, Guitar Center maintains a well trained, loyal,
and enthusiastic salesforce that is motivated by the Company's strong
opportunities for advancement. Both Larry Thomas and Marty Albertson, the
Company's Chief Executive Officer and Chief Operating Officer, respectively,
began their careers as salespersons at Guitar Center.
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PURCHASING, DISTRIBUTION AND INVENTORY CONTROL
PURCHASING. Guitar Center believes it has excellent relationships with its
vendors and, as one of the industry's largest volume purchasers, is able to
receive priority shipping and access to its vendors' premium products on
favorable terms. The Company maintains a centralized buying group comprised of
merchandise managers, buyers and planners. Merchandise managers and buyers are
responsible for the selection and development of product assortments and the
negotiation of prices and terms. The Company uses a proprietary merchandise
replenishment system which automatically analyzes and forecasts sales trends for
each SKU using various statistical models, supporting the buyers by predicting
each store's merchandise requirements. This has resulted in limited "out of
stock" positions.
The Company's business and its expansion plans are dependent to a
significant degree upon its vendors. Specifically, the establishment of
additional stores in existing markets and the penetration of new markets is
dependent to a significant extent on the willingness of vendors to supply those
additional retail stores of which there can be no assurance. As it believes is
customary in the industry, the Company does not have any long-term supply
contracts with its vendors. See "Risk Factors -- Dependence on Suppliers."
DISTRIBUTION. Guitar Center products are typically shipped direct from the
manufacturer to individual stores, minimizing handling costs and reducing
freight expense. Management continues to evaluate the cost effectiveness of
operating a distribution center in comparison to a direct ship program and
believes it can implement its growth strategy without a central distribution
center.
INVENTORY CONTROL. Management has invested significant time and resources
in its inventory control systems and believes it has one of the most
sophisticated systems in the music products retail industry. Management believes
the vast majority of music product retailers do not use a computerized inventory
management system. Guitar Center performs cycle inventory counts daily, both to
measure shrinkage and to update the perpetual inventory on a store-by-store
basis. The Company's shrinkage level has historically been very low which
management attributes to its highly sophisticated system controls and strong
corporate culture.
SITE SELECTION
The Company believes it has developed a unique and, what historically has
been, a highly effective selection criteria to identify prospective store sites.
In evaluating the suitability of a particular location, the Company concentrates
on the demographics of its target customer as well as traffic patterns and
specific site characteristics such as visibility, accessibility, traffic volume,
shopping patterns and availability of adequate parking. Stores are typically
located in free-standing locations to maximize their outside exposure and
signage. Due to the fact that the Company's vendors drop ship merchandise
directly to the stores, the Company's expansion plans are dependent more on the
characteristics of the individual store site than any logistical constraints
that would be imposed by a central distribution facility. See "-- Store
Locations."
MANAGEMENT INFORMATION SYSTEMS
Guitar Center has invested significant resources in management information
systems that provide real-time information both by store and by SKU. The systems
have been designed to integrate all major aspects of the Company's business
including sales, gross margins, inventory levels, purchase order management,
automated replenishment and merchandise planning. Guitar Center's highly
sophisticated management information systems provide the Company with the
ability to monitor all critical aspects of store activity on a real-time basis.
Guitar Center's system capabilities include inter-store transactions, vendor
analysis, serial number tracking, inventory analysis and commission sales
reporting. Guitar Center believes that the systems it has developed will enable
the Company to continue to improve customer service and operational efficiency
and support the Company's needs for the immediately foreseeable future.
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COMPETITION
The retail market for musical instruments is highly fragmented with the
nation's leading five music products retailers accounting for approximately 8.4%
of the industry's net sales in 1995. The Company's largest competitor, Sam Ash,
operates ten stores in the New York City area and two stores in the South
Florida area. The Company currently has no stores in the New York City area. The
Company competes with many different types of retail stores, primarily specialty
retailers and music product catalogue retailers.
Guitar Center believes that the ability to compete successfully in its
markets is determined by several factors, including breadth and quality of
product selection, pricing, effective merchandise presentation, customer
service, store location and proprietary database marketing programs. Customer
satisfaction is paramount to Guitar Center's operating strategy and the Company
believes that providing knowledgeable and friendly customer service gives it a
competitive advantage. The store environment is designed to be an entertaining
and exciting environment in which to shop. In an effort to exceed customer
expectations, Guitar Center stores provide a number of services not generally
offered by most competitors, including the ability to hold and use merchandise,
product demonstrations and extensive product selection. Salespeople are highly
trained and specialize in one of the Company's five product areas. Salespeople
are certified by an outside technical advisory board, based on extensive
training and product knowledge testing. The Company believes that this
certification process has increased the professionalism of its employees while
reducing turnover. Customers are encouraged to help themselves to the displayed
instruments or to seek the assistance of the professional salespeople.
Certain factors, however, could materially and adversely affect the
Company's ability to compete successfully in its markets, including, among
others, the expansion by the Company into new markets in which its competitors
are already established, competitors' expansion into markets in which the
Company is currently operating, the adoption by competitors of innovative store
formats and retail sales methods or the entry into the Company's market by
competitors with substantial financial or other resources. See "Risk Factors --
Aggressive Growth Strategy; -- Competition."
EMPLOYEES
As of December 31, 1996, Guitar Center employed approximately 1,010 people,
of whom approximately 480 were hourly employees and approximately 530 were
salaried. To date, the Company has been able to recruit qualified personnel to
manage or staff its stores. None of the Company's employees are covered by a
collective bargaining agreement. Management believes that the Company enjoys
good employee relations.
PROPERTIES
As of December 31, 1996, Guitar Center leased all but five of its stores and
presently intends to lease all new locations. The terms of the store leases are
generally for 10 years and typically allow the Company to renew for two
additional five-year terms. Most of the leases require the Company to pay
property tax, utilities, normal repairs, common area maintenance and insurance
expenses. Guitar Center leases its corporate offices of approximately 20,000
square feet, which are located at 5155 Clareton Drive, Agoura Hills, California
91301. Due to the Company's expansion which has included the hiring of new
corporate and administrative personnel, the Company is currently evaluating
whether to lease additional space in a nearby location. The Company believes
that sufficient additional space is available on reasonable terms.
In April 1997, the Company consummated the acquisition of a music products
retailer operating two stores in the Atlanta, Georgia market, one of which is
owned and the other of which is leased. See "Summary -- Recent Developments."
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STORE LOCATIONS
The table below sets forth certain information concerning Guitar Center
stores, as of the date of this Prospectus:
<TABLE>
<CAPTION>
APPROXIMATE
YEAR GROSS SQUARE
STORE OPENED FEET LEASE/OWN
- ------------------------------------------------------------------- --------- -------------- -----------
<S> <C> <C> <C>
ARIZONA
Phoenix.......................................................... (1) 13,900 Lease
Tempe............................................................ 1997 12,500 Lease
SOUTHERN CALIFORNIA
Hollywood........................................................ 1964 30,600 Own
San Diego........................................................ 1973 13,500 Own
Fountain Valley.................................................. 1980 13,700 Lease
Sherman Oaks..................................................... 1982 10,900 Own (2)
Covina........................................................... 1985 15,400 Lease
Lawndale......................................................... 1985 15,700 Lease
San Bernardino................................................... 1993 9,500 Lease
Brea............................................................. 1995 14,900 Lease
San Marcos....................................................... 1996 14,900 Lease
NORTHERN CALIFORNIA
San Francisco.................................................... 1972 11,900 Lease
San Jose......................................................... 1978 14,200 Own
El Cerrito....................................................... 1983 21,300(3) Lease
Pleasant Hill.................................................... 1996 11,300 Lease
FLORIDA
North Miami area................................................. 1996 22,300 Lease
South Miami area................................................. 1996 14,700 Lease
GEORGIA
Atlanta.......................................................... (4) 19,200 Own
Smyrna........................................................... (4) 8,500 Lease
ILLINOIS
South Chicago.................................................... 1979 11,300 Lease
North Chicago.................................................... 1981 10,400 Lease
Central Chicago.................................................. 1988 8,700 Own
Villa Park....................................................... 1996 15,000 Lease
MASSACHUSETTS
Boston........................................................... 1994 12,600 Lease
Danvers.......................................................... 1996 14,600 Lease
Natick........................................................... 1997 15,500 Lease
MICHIGAN
Detroit.......................................................... 1994 10,100 Lease
Southfield....................................................... 1996 13,600 Lease
MINNESOTA
Twin Cities...................................................... 1988 9,500 Lease
OHIO
Cleveland........................................................ 1997 15,800 Lease
TEXAS
Dallas........................................................... 1989 12,700 Lease
Arlington........................................................ 1991 9,700 Lease
South Houston.................................................... 1993 14,700 Lease
North Houston.................................................... 1994 10,300 Lease
WASHINGTON
Seattle.......................................................... (1) 20,800 Lease
</TABLE>
- ------------------------------
(1) Presently expected to open in the first half of 1997.
(2) The Company presently expects to relocate the store it operates in Sherman
Oaks from a location it owns to a new leased location.
(3) Of the 21,300 square feet, approximately 10,000 square feet consist of a
basement and warehouse space.
(4) Acquired effective as of April 16, 1997.
SERVICE MARKS
The Company has registered the GUITAR CENTER and ROCK WALK service marks
with the United States Patent and Trademark Office. The Company believes that
these service marks have become important components in its merchandising and
marketing strategy. The loss of the GUITAR CENTER service mark could have a
material adverse effect on the Company's business.
37
<PAGE>
LEGAL PROCEEDINGS
Guitar Center is not a party to any legal proceedings other than various
claims and lawsuits arising in the normal course of its business which, in the
opinion of the Company's management, are not individually or collectively
material to its business.
38
<PAGE>
MANAGEMENT
The executive officers, directors and key managers of the Company are as
follows:
<TABLE>
<CAPTION>
YEARS OF SERVICE
NAME AGE POSITION WITH THE COMPANY
- ---------------------- --- ------------------------------------------------ -------------------
<S> <C> <C> <C>
EXECUTIVE OFFICERS AND
DIRECTORS
Larry Thomas.......... 47 President, Chief Executive Officer and Director 19
Marty Albertson....... 43 Executive Vice President, Chief Operating 17
Officer and Director
Bruce Ross............ 48 Vice President, Chief Financial Officer and 3
Secretary
Barry Soosman......... 37 Vice President of Corporate Development and 1
General Counsel
Raymond Scherr........ 48 Director --
David Ferguson(1)..... 41 Director --
Jeffrey Walker(2)..... 41 Director --
Michael Lazarus(1).... 41 Director --
Steven Burge(2)....... 40 Director --
KEY MANAGERS
Dave DiMartino........ 42 Vice President -- Store Development 24
Richard Pidanick...... 44 Vice President -- Southern California Regional 13
Manager
Rodney Barger......... 46 Vice President -- Merchandising 16
David Angress......... 47 Vice President -- Merchandising 1
Greg Bennett.......... 45 Vice President -- Merchandising --
Andrew Heyneman....... 35 Vice President -- Marketing 13
William McGarry....... 43 Vice President -- Store Administration 16
Mark Laughlin......... 37 Vice President -- Information Services 6
</TABLE>
- ------------------------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
The principal occupations and positions for the past five years, and in
certain cases prior years, of the executive officers, directors and key
personnel named above are as follows:
LARRY THOMAS has been with Guitar Center since 1977. He has served as a
director since 1984 and has been the Company's President and Chief Executive
Officer since 1992. After working for a year as a salesperson in the San
Francisco, California store, Mr. Thomas became the store's manager. In 1980, Mr.
Thomas became the San Francisco area regional manager. After serving as a
regional manager in California and Illinois for four years, Mr. Thomas assumed
the role of Corporate General Manager and Chief Operating Officer. Mr. Thomas is
currently a member of the Los Angeles Chapter of the Young Presidents'
Organization and is a former board member of NAMM.
MARTY ALBERTSON has served as Executive Vice President and Chief Operating
Officer since 1990. Mr. Albertson was elected as a director upon consummation of
the Recapitalization. Mr. Albertson joined the Company as a salesperson in 1979
and has held various positions of increasing responsibility with
39
<PAGE>
the Company since such time. In 1980, he served as the Company's Advertising
Director. In 1984, he became the Company's National Sales Manager. Thereafter,
in 1985, Mr. Albertson became Vice President of Corporate Development, and then
became the Vice President of Sales and Marketing in 1987.
BRUCE ROSS joined the Company in July 1994 as Chief Financial Officer. Prior
to joining the Company, Mr. Ross was Chief Financial Officer of Fred Hayman
Beverly Hills, Inc., a retailer of high end fashion clothing on Rodeo Drive in
California and a wholesaler of men's and women's fragrances. From 1982 to 1990,
Mr. Ross was employed by Hanimex Vivitar Corporation, a worldwide manufacturer
and distributor of photographic products. Mr. Ross served in various capacities
with Hanimex Vivitar in Australia, the United States and Europe. While working
for Hanimex Vivitar in the United States, Mr. Ross was promoted to the position
of Chief Financial Officer in 1986 and Chief Executive Officer for North America
in 1988. Mr. Ross graduated from the University of New South Wales (Australia)
with a degree in Commerce and is an associate of the Institute of Chartered
Accountants.
BARRY SOOSMAN joined the Company in July 1996 as Vice President of Corporate
Development and General Counsel. Mr. Soosman has been a practicing attorney for
twelve years specializing in real estate, commercial and corporate law. Since
1992 and prior to joining the Company, Mr. Soosman had been the outside general
counsel to the Company. Mr. Soosman earned a Bachelor of Science degree in
Business Administration (corporate finance and real estate valuation) with
honors and a Juris Doctorate degree at the University of Southern California. In
June 1996 Mr. Soosman became of counsel to the law firm of Buchalter, Nemer,
Fields & Younger, a Professional Corporation. Mr. Soosman is a former Adjunct
Professor at Southwestern School of Law.
RAYMOND SCHERR became a director in 1978 and served as the Chairman of the
Board from 1990 until consummation of the Recapitalization. Mr. Scherr joined
the Company in 1975 as a salesperson in the Company's San Francisco, California
store. From 1981 through 1992 Mr. Scherr was also the Company's President and
Chief Executive Officer.
DAVID FERGUSON is a general partner of Chase Capital Partners, the sole
general partner of Chase Ventures and an affiliate of Chase Securities. He
became a director of the Company upon consummation of the Recapitalization.
Prior to joining Chase Capital, Mr. Ferguson was a member of the mergers and
acquisitions groups of Bankers Trust New York Corporation and Prudential
Securities, Inc. Mr. Ferguson currently serves as a director of Thompson PBE,
Inc. and Wild Oats Markets, Inc. and various privately held companies. Mr.
Ferguson received a Bachelor of Arts degree from Loyola College in Baltimore,
Maryland and an M.B.A. degree from The Wharton School of the University of
Pennsylvania. Mr. Ferguson is a certified public accountant.
JEFFREY WALKER is the managing general partner of Chase Capital Partners,
and a senior managing director and member of the Policy Council of The Chase
Manhattan Corporation. He became a director of the Company in 1996. Prior to
co-founding Chase Capital Partners in 1984, Mr. Walker worked in the Investment
Banking and Finance Divisions of Chemical Bank and the Audit and Consulting
Divisions of Arthur Young & Co. Mr. Walker is a Certified Public Accountant and
a Certified Management Accountant. Mr. Walker received a Bachelor of Science
degree from the University of Virginia and an M.B.A. degree from the Harvard
Business School. Mr. Walker currently serves as a director of various privately
held companies and was Vice Chairman of the National Association of Small
Business Investment Companies.
MICHAEL LAZARUS is a general partner of Weston Presidio Capital Management
II, L.P., a venture capital firm and the sole general partner of Weston
Presidio. From 1986 to 1991, he served as Managing Director and Director of the
Private Placement Department of Montgomery Securities. He became a director of
the Company upon consummation of the Recapitalization. Mr. Lazarus is currently
on the Board of Directors of Just For Feet, Inc. and various privately held
companies.
STEVEN BURGE is a Managing Director of Wells Fargo. He became a director of
the Company upon consummation of the Recapitalization. From 1987 through 1995,
Mr. Burge was a Managing General
40
<PAGE>
Partner of Wedbush Capital Partners, a private investment fund, and was an
executive in the Corporate Finance Department of Wedbush Morgan Securities, a
regional investment banking firm. Prior to joining Wedbush Morgan Securities,
Mr. Burge held various positions with Wells Fargo Bank.
DAVE DIMARTINO joined the Company in 1972. In 1983, Mr. DiMartino became the
manager of Guitar Center's flagship Hollywood, California store. In 1988, Mr.
DiMartino became Vice President -- Store Development. In 1992, he became West
Coast Regional Manager responsible for all of the Company's West Coast stores.
In 1995, he reassumed the position of Vice President -- Store Development.
RICHARD PIDANICK joined the Company in 1983 as a salesperson. Mr. Pidanick
was promoted to store manager in 1984, after working in a variety of capacities
and locations for Guitar Center. Mr. Pidanick was promoted in 1990 to District
Manager of the Mid-West and was appointed as the Vice President -- Southern
California Regional Manager in 1996.
RODNEY BARGER joined the Company in 1980 as a salesperson. Mr. Barger was
promoted to a store manager in 1981. In 1989, Mr. Barger was promoted to Western
Regional Sales Manager and then to the corporate office in the position of
Purchasing Director. In 1996, Mr. Barger was promoted to Vice President --
Merchandising, Vintage and Used Products.
DAVID ANGRESS joined the Company in January 1996 as Vice President --
Merchandising. Prior to joining the Company, Mr. Angress was Vice President of
Harman Pro., North America where he was responsible for North American marketing
and sales for such brands as JBL, Soundcraft, AKG and worldwide marketing
manager of dbx and Orban. Prior thereto, Mr. Angress was the Vice President and
General Manager of Sound Genesis, a retailer of professional audio equipment.
Mr. Angress has over 20 years of music retailing experience.
GREG BENNETT joined the Company in September 1996 as Vice President --
Merchandising. Prior to joining the Company, Mr. Bennett was Director of
Marketing at Washburn International, where he was responsible for the marketing
services for Washburn Guitars, Sound Tech and Oscar Schmidt. Prior thereto, Mr.
Bennett was Marketing Director of Gibson Guitars. Mr. Bennett has over 20 years
of experience in the music industry.
ANDREW HEYNEMAN joined the Company in 1983. He has served in a variety of
positions with Guitar Center ranging from salesperson to department manager. In
July 1985, Mr. Heyneman was appointed store manager and later promoted to the
corporate office as an advertising director in 1989. In 1996, Mr. Heyneman was
promoted to Vice President -- Marketing.
WILLIAM MCGARRY joined the Company in 1980 as a salesperson. In 1981 he was
promoted to a store manager. In 1985 Mr. McGarry was promoted to Midwest
District Manager. Mr. McGarry became the Company's first Director of Store
Administration in 1986 and was promoted to Vice President -- Store
Administration in 1996.
MARK LAUGHLIN joined the Company in 1991 as Director of Information
Services. In 1997, he was promoted to Vice President -- Information Services.
Prior to joining Guitar Center, Mr. Laughlin was an Information Services manager
for Clothestime, and originally began his career in accounting at Arthur
Andersen & Co.
BOARD OF DIRECTORS
As of the date of this Prospectus, the Board consists of seven persons with
two vacancies. The Certificate of Incorporation and Bylaws provide that
directors shall be elected by a plurality vote, with no cumulative voting, at
each annual meeting of stockholders. Each elected director shall hold office
until his resignation or removal and until his successor shall have been duly
elected and qualified. In connection with the Recapitalization, the Company
agreed that, following the Offering and so long as Mr. Scherr and certain
related entities own 5% or more of the Common Stock on a fully diluted basis,
the Company would nominate or cause the nomination of Mr. Scherr to the Board
(and include Mr. Scherr in any proxy statement and related materials used in
connection with an election of directors) and otherwise use its best efforts to
cause his election at each annual meeting or special meeting relating to the
election of directors of the Company. See "-- Scherr Board Representation
Letter."
41
<PAGE>
COMMITTEES OF THE BOARD OF DIRECTORS
The Board has two standing committees, the Audit Committee and the
Compensation Committee. The Audit Committee has responsibility for reviewing and
making recommendations regarding the Company's employment of independent
accountants, the annual audit of the Company's financial statements, and the
Company's internal controls, accounting practices and policies. The members of
the Audit Committee are Jeffrey Walker and Steven Burge. The Compensation
Committee has responsibility for determining the nature and amount of
compensation of the management of the Company and for administering the
Company's employee benefit plans (including the 1996 Plan and the 1997 Plan (as
defined herein)). The members of the Compensation Committee are David Ferguson
and Michael Lazarus.
DIRECTOR COMPENSATION
Each member of the Board who is not a full-time employee is paid $3,000 for
attendance at each meeting of the Board and $1,000 for attendance at each
meeting of a committee of the Board, and all directors are reimbursed for
reasonable out-of-pocket expenses arising from attendance at any Board or
committee meetings or otherwise related to Company business. The 1997 Plan also
provides for the grant of options to certain non-employee directors.
Specifically, each non-employee director initially elected to the Board after
the Offering automatically will be granted an option to purchase 15,000 shares
of Common Stock on the date of such initial election, and each non-employee
director automatically will be granted an option to purchase 5,000 shares of
Common Stock on the date of each annual meeting of stockholders at which such
director is re-elected to the Board, provided such annual meetings is not less
than 120 days after initial appointment to the Board. All options granted to
non-employee directors will have a per share exercise price equal to fair market
value of a share of Common Stock on the date of grant. See "-- 1997 Equity
Participation Plan."
42
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company to its
Chief Executive Officer and each of the four other highest paid executive
officers of the Company (collectively, including the Chief Executive Officer,
the "Named Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION ($) -----------------
------------------------------------------- SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS COMPENSATION ($)(1) OPTIONS/SAR#(2) COMPENSATION ($)(3)
- ------------------------ --------- ---------- --------- -------------------- ----------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Larry Thomas............ 1996 $ 500,000 -- $ 10,660,728(4) 397,985 $ 11,250
President and Chief 1995 500,000 $ 285,715 -- -- 25,645
Executive Officer
Marty Albertson......... 1996 $ 375,000 -- $ 7,107,146(4) 397,985 $ 11,250
Executive Vice 1995 375,000 $ 214,285 -- -- 25,645
President and Chief
Operating Officer
Bruce Ross.............. 1996 $ 195,000 $ 58,500 -- 79,599 $ 11,250
Vice President and 1995 180,000 48,060 -- -- --
Chief Financial Officer
Barry Soosman........... 1996 $ 112,500 $ 10,000 -- 79,599 --
Vice President of 1995 -- -- -- -- --
Corporate Development
and General Counsel
Raymond Scherr (5)...... 1996 $ 529,885 -- -- -- $ 11,250
Chairman and Operator 1995 1,000,000 -- -- -- 25,645
of Rock Walk, a
division of the Company
</TABLE>
- ------------------------------
(1) Excludes perquisites and other personal benefits, securities or property
aggregating less than $50,000 or 10% of the total annual salary and bonus
reported for each Named Officer.
(2) The securities underlying the options are shares of Common Stock. For a
description of terms pertaining to such options and other information
relating thereto, see "-- Employment Agreements; -- Management Stock Option
Agreements; -- 1996 Performance Stock Option Plan."
(3) All other compensation consists of contributions made by the Company to its
profit sharing plan on behalf of each Named Officer.
(4) Other annual compensation consists of cash compensation received by such
Named Officer in connection with the Recapitalization and related
transactions. Excludes restricted shares of Junior Preferred Stock received
by such Named Officer upon the cancellation of employee stock options in
connection with the Recapitalization that were converted into Common Stock
in connection with the Offering. See "The Recapitalization and Related
Transactions" and "Description of Capital Stock -- Preferred Stock --
Junior Preferred Stock."
(5) Resigned as the Chairman of the Board effective with the completion of the
Recapitalization.
During the periods indicated above, none of the Named Officers received any
awards under any long-term incentive plan, and the Company does not have a
pension plan.
EMPLOYMENT AGREEMENTS
Upon consummation of the Recapitalization, the Company entered into a
five-year employment agreement with each of Larry Thomas and Marty Albertson, a
three-year employment agreement with Bruce Ross and a three and one-half year
employment agreement with Barry Soosman (collectively, as amended to date, the
"Employment Agreements"). The Employment Agreements provide Messrs. Thomas,
Albertson, Ross and Soosman (each a "Senior Officer" and collectively, the
"Senior Officers") with base salaries of $500,000, $375,000, $195,000 and
$225,000, respectively. Each Senior Officer is entitled to participate in all
insurance and benefit plans generally available to executives of the
43
<PAGE>
Company. In addition to their base salary, Messrs. Thomas and Albertson will be
paid an annual bonus equal to 57.14% and 42.86%, respectively, of a bonus pool
determined at the end of each year, not to exceed $900,000. The amount of the
bonus pool with respect to any fiscal year will be a percentage ranging from 10%
to 30% of the excess of the Company's actual earnings before interest expense,
tax expense, depreciation expense and amortization expense ("EBITDA") over the
Company's target EBITDA (as determined by the Board). Messrs. Ross and Soosman
will receive annual bonuses at the discretion of the Board. Pursuant to their
employment agreements, each of Messrs. Ross and Soosman have been granted
options under the Company's 1996 Plan to purchase 79,599 shares of Common Stock
at an exercise price of $10.89 per share. Of such options, one-half vest at the
end of five years subject to acceleration upon the attainment of certain
performance events and one-half vest ratably over a three-year period.
Under the terms of each Employment Agreement, if a Senior Officer is
terminated without cause or resigns with reasonable justification, such Senior
Officer will be entitled to receive his base salary, annual cash bonus (equal to
the last annual bonus he received prior to termination) and continuation of his
benefits through the term of the agreement. With certain exceptions, if a Senior
Officer is terminated without cause, all stock options held by such Senior
Officer will immediately vest. If a Senior Officer's employment is terminated
for any other reason, he will be entitled only to his accrued base salary
through the date of termination.
Upon consummation of the Recapitalization, the Company entered into a
three-year employment agreement with Mr. Scherr pursuant to which Mr. Scherr
will serve as the chairman and operator of Rock Walk, a division of the Company.
Mr. Scherr's duties will be of a part-time nature, and he will devote only such
time to his duties as he determines in good faith are required. Mr. Scherr will
receive $100,000 per year, which will be allocated among his salary and expense
allowance, as Mr. Scherr determines. Mr. Scherr will be entitled to participate
in all employee medical benefit programs available generally to employees of the
Company. If Mr. Scherr's employment is terminated by the Company without cause,
he will be entitled to receive as severance the cash equivalent of his
compensation package ($100,000) for the remainder of the term of the agreement,
not to exceed $300,000, and continuation of his medical benefits until age
63 1/2. After his employment agreement expires, Mr. Scherr will continue to be
entitled to medical benefits until age 63 1/2. If Mr. Scherr's employment is
terminated by the Company for cause or upon Mr. Scherr's death, he or his estate
will be entitled to receive his compensation to the extent such amount has
accrued through the date of termination.
MANAGEMENT STOCK OPTION AGREEMENTS
In connection with the Recapitalization, the Company granted options (each,
a "Management Option") to each of Messrs. Thomas and Albertson to purchase
397,985 shares of Common Stock at an exercise price of $10.89 per share pursuant
to stock option agreements (the "Management Stock Option Agreements"). Unless
terminated or accelerated, each Management Option will vest in three equal
installments in 2003, 2004 and 2005 and will terminate upon the first to occur
of: (i) June 5, 2005; (ii) the consummation of a Company Sale (as defined in the
Management Stock Option Agreements); or (iii) the termination, either
voluntarily or for cause, of the employment of such executive officer with the
Company. The vesting of each Management Option will be accelerated: (a) if there
is a "Significant Public Float" of the Common Stock (as defined) and if the
Company's "Calculated Corporate Value" (which, in general, equals the market
value of the fully diluted shares of Common Stock based on the closing sales
price of the Common Stock on a national exchange or the Nasdaq National Market)
exceeds approximately $280 million, subject to adjustment; (b) if there is a
Company Sale and the consideration paid for the Company exceeds certain target
values set forth in the Management Stock Option Agreements; or (c) if the
executive officer's employment is terminated by the Company without cause or by
such executive officer with reasonable justification. The Company intends to
file a registration statement on Form S-8 under the Securities Act to register
the shares of Common Stock issuable upon exercise of such options.
44
<PAGE>
OTHER OPTION ARRANGEMENTS
Chase Ventures, Wells Fargo and Weston Presidio granted options (the
"Investor Options") to purchase an aggregate of 277,194 shares of Common Stock
at a purchase price of $4.33 per share to certain officers and key managers of
the Company. Each grant of an Investor Option is, to the extent possible, deemed
to be granted by each Investor to each member of management in the same ratio as
granted by each Investor (I.E., 75.00% by Chase Ventures, 14.29% by Wells Fargo
and 10.71% by Weston Presidio). Included in the Investor Options are options to
purchase 109,722 shares of Common Stock that were granted to each of Messrs.
Thomas and Albertson and 3,850 shares of Common Stock that were granted to each
of Messrs. Ross and Soosman. The Investor Options were granted in December 1996,
are presently exercisable and will expire on December 30, 2001. The Company is
not a party to this agreement and has not, and will not, incur any obligation in
connection with such options. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources" and "Certain Transactions -- Options Granted by the Investors to
Certain Members of Management."
1996 PERFORMANCE STOCK OPTION PLAN
The Company's 1996 Performance Stock Option Plan was adopted by the Board of
Directors and approved by its sole stockholder on June 3, 1996 and became
effective on that date. The Board of Directors and the stockholders approved an
Amended and Restated 1996 Performance Stock Option Plan in October 1996 (as
amended to date, the "1996 Plan"). The principal purposes of the 1996 Plan are
to provide incentives for officers, employees and consultants of the Company and
its subsidiaries through granting of options, thereby stimulating their personal
and active interest in the Company's development and financial success, and
inducing them to remain in the Company's employ. No further grants of options
will be made under the 1996 Plan.
The principal features of the 1996 Plan are summarized below, but the
summary is qualified in its entirety by reference to the 1996 Plan, which is
filed as an exhibit to the Registration Statement of which this Prospectus is a
part.
GENERAL NATURE OF THE PLAN. Options issued under the 1996 Plan may be
either incentive stock options ("Incentive Options") intended to qualify as such
under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"),
or non-qualified stock options ("Non-qualified options"). As of the date of this
Prospectus, the Company has outstanding under the 1996 Plan options to purchase
713,782 shares of Common Stock, at an exercise price of $10.89 per share. The
1996 Plan is administered by the Compensation Committee.
ELIGIBILITY. Options may be granted under the 1996 Plan to employees of and
consultants to the Company, or any of its subsidiaries (other than Larry Thomas,
Marty Albertson, or any other person serving on the Compensation Committee). No
options may be granted to any one person in any one taxable year in excess of
25% of the options issued or issuable under the 1996 Plan. Incentive Options may
not be granted to an employee who owns (as described in Sections 422(b)(6) and
425(d) of the Code) stock possessing more than 10% of the aggregate voting power
of the Company unless the option price is fixed at least than 110% of the fair
market value (as determined according to the 1996 Plan) of the stock on the
grant date and the options are not exercisable later than five years following
the grant date.
GRANT OF OPTIONS. Options may be granted under the 1996 Plan at any time,
from time to time, prior to the termination of the 1996 Plan. Each option grant
will be set forth in a separate agreement with the person receiving the grant
and will indicate the type, terms and conditions of the option grant.
VESTING. Options are deemed granted on the date the Compensation Committee
approves the grants. However, in the case of Incentive Options, the grant date
may not be earlier than the date the optionee becomes an employee of the Company
or one of its subsidiaries. The Compensation Committee shall determine whether
and to what extent any options are also subject to time vesting based on the
optionee's continued service. The 1996 Plan generally provides for acceleration
of time vesting upon a
45
<PAGE>
sale of the Company or termination of the optionee's relationship with the
Company without cause (as defined in the 1996 Plan), by the optionee with
reasonable justification (as defined in the 1996 Plan) or upon death.
OPTION PRICE AND EXERCISE. An option is exercisable at such times as are
determined on the grant date by the Compensation Committee. The purchase price
for shares to be issued to an optionee upon exercise of an option shall be the
fair market value of a share of Common Stock on the grant date (or such lesser
amount approved by the Board, but not less than 85% of the fair market value of
a share of Common Stock).
EXPIRATION, TERMINATION, REVOCATION, TRANSFER OF OPTIONS AND
AMENDMENTS. Options granted under the 1996 Plan are not assignable except by
will or by the laws of descent and distribution. The Compensation Committee,
with the Board's approval, may amend or modify the 1996 Plan in any respect,
PROVIDED HOWEVER, that approval of the holders of a majority of Common Stock
must be obtained if required by law or for compliance with federal securities
laws or the Code.
REGISTRATION STATEMENT ON FORM S-8. The Company intends to file a
registration statement on Form S-8 under the Securities Act to register the
shares of Common Stock issuable under the 1996 Plan.
OPTION GRANTS IN 1996; AGGREGATE OPTION EXERCISES IN 1996; 1996 YEAR-END OPTION
VALUES
In 1996, the Company granted to certain directors, officers and employees of
the Company (including Messrs. Ross and Soosman) options to purchase 554,584
shares of Common Stock at a purchase price of $10.89 per share under the 1996
Plan and, pursuant to separate arrangements, granted to each of Messrs. Thomas
and Albertson options to purchase 397,985 shares of Common Stock at a purchase
price of $10.89 per share. Pursuant to the requirements of their respective
employment agreements, the Company has also granted to each of Messrs. Ross and
Soosman options to purchase an additional 79,599 shares of Common Stock at a
purchase price of $10.89 per share under the 1996 Plan. See "-- Director
Compensation," "-- Employment Agreements," "-- Management Stock Option
Agreements," "-- 1996 Performance Stock Option Plan" and "-- 1997 Equity
Participation Plan."
Set forth below is a table describing the options granted by the Company to
each of the Named Officers during the year ended December 31, 1996:
<TABLE>
<CAPTION>
INDIVIDUAL OPTION GRANTS IN 1996
-----------------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL
NUMBER OF PERCENT OF RATES OF STOCK
SECURITIES TOTAL OPTIONS/ PRICE APPRECIATION
UNDERLYING SARS GRANTED TO EXERCISE OR FOR OPTION TERM (2)
OPTIONS/SARS EMPLOYEES IN BASE PRICE EXPIRATION ----------------------------
NAME GRANTED (#)(1) FISCAL YEAR ($/ SHARE) DATE 5% ($) 10% ($)
- ------------------------- -------------- --------------- ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Larry Thomas............. 397,985 29.5% $ 10.89 2006 $ 2,725,880 $ 6,907,917
Marty Albertson.......... 397,985 29.5 10.89 2006 2,725,880 6,907,917
Bruce Ross............... 79,599 5.9 10.89 2006 545,189 1,381,615
Barry Soosman............ 79,599 5.9 10.89 2006 545,189 1,381,615
Raymond Scherr........... -- -- -- -- -- --
</TABLE>
- ------------------------
(1) The securities underlying the options are shares of Common Stock. No SARs
were granted in fiscal 1996. For a description of terms pertaining to such
options and other information relating thereto, see "-- Employment
Agreements; -- Management Stock Option Agreements; -- 1996 Performance Stock
Option Plan."
(2) The potential realizable value assumes a rate of annual compound stock price
appreciation of 5% and 10% from the date the option was granted over the
full option term. These assumed annual
46
<PAGE>
compound rates of stock price appreciation are mandated by the rules of the
Securities and Exchange Commission and do not represent the Company's
estimate or projection of future Common Stock prices.
The following table sets forth, on an aggregated basis, information
regarding securities underlying unexercised options during the year ended
December 31, 1996 by the Named Officers:
<TABLE>
<CAPTION>
OPTION VALUES AT DECEMBER 31, 1996
--------------------------------------------------------------
NUMBER OF VALUE OF
SECURITIES UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR-END (1)(#) FISCAL YEAR-END ($)
----------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------------- ------------- -------------- ------------- ----------------
<S> <C> <C> <C> <C>
Larry Thomas..................................... -- 397,985(2) -- $ 1,635,718(2)
Marty Albertson.................................. -- 397,985(2) -- 1,635,718(2)
Bruce Ross....................................... -- 79,599 -- 327,152
Barry Soosman.................................... -- 79,599 -- 327,152
Raymond Scherr................................... -- -- -- --
</TABLE>
- ------------------------
(1) The securities underlying the options are shares of Common Stock. For a
description of terms pertaining to such options and other information
relating thereto, see "-- Employment Agreements; -- Management Stock Option
Agreements; -- 1996 Performance Stock Option Plan."
(2) The options granted to Messrs. Thomas and Albertson are subject to future
vesting which may be accelerated upon the attainment by the Company of
certain performance hurdles based on market capitalization and other
factors. See " -- Management Stock Option Agreements."
1997 EQUITY PARTICIPATION PLAN
The Company's 1997 Equity Participation Plan (the "1997 Plan") was adopted
by the Board of Directors and approved by the stockholders in January 1997. The
principal purposes of the 1997 Plan are to provide incentives for officers,
employees and consultants of the Company and its subsidiaries through granting
of options, restricted stock, stock appreciation rights, dividend equivalent
performance awards and deferred stock awards (collectively, "Awards"), thereby
stimulating their personal and active interest in the Company's development and
financial success, and inducing them to remain in the Company's employ. In
addition to Awards made to officers, employees or consultants, the 1997 Plan
permits the granting of options ("Director Options") to the Company's
non-employee directors.
Under the 1997 Plan, not more than 875,000 shares of Common Stock (or the
equivalent in other equity securities) are authorized for issuance upon exercise
of options, stock appreciation rights ("SARs") and other Awards, or upon vesting
of restricted or deferred stock awards. Furthermore, the maximum number of
shares which may be subject to options or stock appreciation rights granted
under the 1997 Plan to any individual in any calendar year cannot exceed
150,000. As of the date of this Prospectus, no options have been granted under
the 1997 Plan.
The principal features of the 1997 Plan are summarized below, but this
summary is qualified in its entirety by reference to the 1997 Plan, which is
filed as an exhibit to the registration statement of which this Prospectus is a
part.
ADMINISTRATION. The Compensation Committee will administer the 1997 Plan
with respect to grants to employees or consultants of the Company and the full
Board will administer the 1997 Plan with respect to Director Options. The
Compensation Committee will consist of at least two members of the Board, each
of whom is a "non-employee director" for purposes of Rule 16b-3 ("Rule 16b-3")
under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and,
with respect to options and SAR's which are intended to constitute
performance-based compensation under Section 162(m) of the Code ("Section
162(m)"), an "outside director" for the purposes of Section 162(m). Subject to
the terms
47
<PAGE>
and conditions of the 1997 Plan, the Board or Compensation Committee has the
authority to select the persons to whom Awards are to be made, to determine the
number of shares to be subject thereto and the terms and conditions thereof, and
to make all other determinations and to take all other actions necessary or
advisable for the administration of the 1997 Plan. Similarly, the Board has
discretion to determine the terms and conditions of Director Options and to
interpret and administer the 1997 Plan with respect to Director Options. The
Compensation Committee (and the Board) are also authorized to adopt, amend and
rescind rules relating to the administration of the 1997 Plan.
ELIGIBILITY. Options, SARs, restricted stock and other Awards under the
1997 Plan may be granted to individuals who are then officers or other employees
of the Company or any of its present or future subsidiaries based upon the
determination of the Compensation Committee. Such Awards also may be granted to
consultants of the Company selected by the Board or Compensation Committee for
participation in the 1997 Plan. Non-employee directors of the Company may be
granted NQSOs (as defined herein) by the Board.
GRANT OF AWARDS. The 1997 Plan provides that the Compensation Committee may
grant or issue stock options, SARs, restricted stock, deferred stock, dividend
equivalents, performance awards, stock payments and other stock related
benefits, or any combination thereof. Each Award will be set forth in a separate
agreement with the person receiving the Award and will indicate the type, terms
and conditions of the Award as determined by the Compensation Committee.
NONQUALIFIED STOCK OPTIONS ("NQSOS") will provide for the right to
purchase Common Stock at a price not less than the fair market value on the date
of grant, and usually will become exercisable (in the discretion of the Board or
Compensation Committee) in one or more installments after the grant date,
subject to the participant's agreement to continue in the employ of the Company
for at least one year (or shorter period as fixed in a written agreement) and/or
subject to the satisfaction of individual or Company performance targets
established by the Board or Compensation Committee. NQSOs may be granted for up
to a ten-year term specified by the Board or Compensation Committee and the
exercise price thereof must be not less than the fair market value of the
underlying Common Stock on the date of grant. The Compensation Committee may
extend the term of any outstanding option in connection with any termination of
employment or consultancy of the optionee or amend any condition or term of such
option relating to such termination. Notwithstanding the foregoing, options may
not be repriced after issuance.
INCENTIVE STOCK OPTIONS ("ISOS"), will be designed to comply with the
provisions of the Code and will be subject to certain restrictions contained in
the Code. Among such restrictions, ISOs must have an exercise price not less
than the fair market value of a share of Common Stock on the date of grant, may
only be granted to employees, must expire within a specified period of time
following the Optionee's termination of employment, and must be exercised within
the ten years after the date of grant; but such options may be subsequently
modified to disqualify them from treatment as ISOs. In the case of an ISO
granted to an individual who owns (or is deemed to own) at least 10% of the
total combined voting power of all classes of stock of the Company, the 1997
Plan provides that the exercise price must be at least 110% of the fair market
value of a share of Common Stock on the date of grant and the ISO must expire no
later than the fifth anniversary of the date of its grant. Any option granted
may be modified by the Compensation Committee to disqualify such option from ISO
treatment.
RESTRICTED STOCK may be sold to participants and made subject to such
restrictions as may be determined by the Board or Compensation Committee.
Restricted stock, typically, may be repurchased by the Company at the original
purchase price if the conditions or restrictions are not met. In addition, under
certain circumstances, the Company may repurchase the restricted stock upon
termination of employment at a cash price equal to the price paid by the
grantee. In general, restricted stock may not be sold, or otherwise transferred
or hypothecated, until restrictions are removed or expire. Purchasers of
restricted stock, unlike recipients of options, will have voting rights and will
receive dividends prior to the time when the restrictions lapse.
48
<PAGE>
DEFERRED STOCK may be awarded to participants, typically without payment
of consideration, but subject to vesting conditions based on continued
employment or on performance criteria established by the Board or Compensation
Committee. Like restricted stock, deferred stock may not be sold, or otherwise
transferred or hypothecated, until vesting conditions are removed or expire.
Unlike restricted stock, deferred stock will not be issued until the deferred
stock award has vested, and recipients of deferred stock generally will have no
voting or dividend rights prior to the time when vesting conditions are
satisfied.
STOCK APPRECIATION RIGHTS may be granted in connection with stock
options or other Awards, or separately. SARs granted by the Board or
Compensation Committee in connection with stock options or other awards
typically will provide for payments to the holder based upon increases in the
price of Common Stock over the exercise price of the related option or other
Awards, but alternatively may be based upon criteria such as book value. Except
as required by Section 162(m) with respect to an SAR intended to qualify as
performance-based compensation as described in Section 162(m), there are no
restrictions specified in the 1997 Plan on the exercise of SARs or the amount of
gain realizable therefrom, although restrictions may be imposed by the Board or
Compensation Committee in the SAR agreements. The Board or Compensation
Committee may elect to pay SARs in cash or in Common Stock or in a combination
of both.
DIVIDEND EQUIVALENTS represent the value of the dividends per share, if
any, paid by the Company, calculated with reference to the number of shares
covered by the stock options, SARs or other Awards held by the participant.
Dividend equivalents will be converted into cash or additional shares of Common
Stock as determined by the Compensation Committee.
PERFORMANCE AWARDS may be granted by the Board or Compensation Committee
on an individual or group basis. Generally, these Awards will be based upon
specific performance targets and may be paid in cash or in Common Stock or in a
combination of both. Performance Awards may include "phantom" stock Awards that
provide for payments based upon increases in the price of the Company's Common
Stock over a predetermined period.
STOCK PAYMENTS may be authorized by the Board or Compensation Committee
in the form of shares of Common Stock or an option or other right to purchase
Common Stock as part of a deferred compensation arrangement in lieu of all or
any part of compensation, including bonuses, that would otherwise be payable in
cash to the key employee or consultant. Such payments will be determined by the
Compensation Committee based on specific performance criteria.
Generally, in addition to the payment of any purchase price as
consideration for the issuance of an Award, the grantee must agree to remain in
the employ of or to consult for, the Company for at least one year after such
Award is issued. In addition, under the terms of the 1997 Plan Awards are
exercisable or payable only while the grantee is an employee or consultant of
the Company. However, under certain conditions, the Committee may determine that
any such award may be exercisable or paid subsequent to termination of
employment.
DIRECTOR OPTIONS will be granted to the Company's non-employee directors
under the 1997 Plan at a per share price not less than the fair market value of
a share of Common Stock on the date of grant. Following the consummation of the
Offering, (i) a person who is initially elected to the Board and who is a
non-employee director at the time of such initial election automatically will be
granted a Director Option to purchase 15,000 shares of Common Stock on the date
of such initial election, and (ii) a person who is re-elected to the Board and
who is a non-employee director at the time of such re-election automatically
shall be granted a Director Option to purchase 5,000 shares of Common Stock on
the date of each annual meeting of stockholders at which such director is
re-elected to the Board. Notwithstanding the foregoing, (A) no grant shall be
made to a non-employee director pursuant to the foregoing clause (i) if: (x) an
affiliate of such non-employee director served on the Board within the
twelve-month period prior to the initial election of such non-employee director
or (y) such non-employee director is an employee of the Company who subsequently
retires from the Company and remains on the Board, and (B) no grant shall be
made to a non-employee director pursuant to the foregoing clause (ii) if such
non-employee
49
<PAGE>
director was initially elected to the Board within 120 days of such annual
meeting of stockholders. Director Options granted to non-employee directors will
vest over a three-year period. Although the Board presently has an intention to
grant only Director Options to non-employee directors, the Board may grant other
stock options or Awards to non-employee directors in accordance with the
provisions of the 1997 Plan.
The 1997 Plan may be amended, suspended or terminated at any time by the
Board or the Compensation Committee. However, the maximum number of shares that
may be sold or issued under the 1997 Plan may not be increased without approval
of the Company's stockholders.
SECURITIES LAWS AND FEDERAL INCOME TAXES
SECURITIES LAWS. The 1997 Plan is intended to conform to the extent
necessary with all provisions of the Securities Act and the Exchange Act and any
and all regulations and rules promulgated by the Securities and Exchange
Commission thereunder, including without limitation Rule 16b-3. The 1997 Plan
will be administered, and options will be granted and may be exercised, only in
such a manner as to conform to such laws, rules and regulations. To the extent
permitted by applicable law, the 1997 Plan and options granted thereunder shall
be deemed amended to the extent necessary to conform to such laws, rules and
regulations.
GENERAL FEDERAL TAX CONSEQUENCES. Under current federal laws, in
general, recipients of awards and grants of nonqualified stock options, stock
appreciation rights, restricted stock, deferred stock, dividend equivalents,
performance awards and stock payments under the 1997 Plan are taxable under
Section 83 of the Code upon their receipt of Common Stock or cash with respect
to such awards or grants and, subject to Section 162(m), the Company will be
entitled to an income tax deduction with respect to the amounts taxable to such
recipients. Under Sections 421 and 422 of the Code, recipients of ISOs are
generally not taxable on their receipt of Common Stock upon their exercises of
ISOs if the ISOs and option stock are held for certain minimum holding periods
and, in such event, the Company is not entitled to income tax deductions with
respect to such exercises. Participants in the 1997 Plan will be provided with
additional information regarding the tax consequences relating to the various
types of awards and grants under the plan.
SECTION 162(m) LIMITATION. In general, under Section 162(m), income tax
deductions of publicly-held corporations may be limited to the extent total
compensation (including base salary, annual bonus, stock option exercises and
non-qualified benefits paid) for certain executive officers exceeds $1 million
(less the amount of any "excess parachute payments" as defined in Section 280G
of the Code) in any one year. However, under Section 162(m), the deduction limit
does not apply to certain "performance-based compensation" established by an
independent compensation committee which is adequately disclosed to, and
approved by, stockholders. In particular, stock options and SARs will satisfy
the "performance-based compensation" exception if the awards are made by a
qualifying compensation committee, the plan sets the maximum number of shares
that can be granted to any person within a specified period and the compensation
is based solely on an increase in the stock price after the grant date (I.E.,
the option exercise price is equal to or greater than the fair market value of
the stock subject to the award on the grant date). Under a Section 162(m)
transition rule for compensation plans of corporations which are privately held
and which become publicly held in an initial public offering, the 1997 Plan will
not be subject to Section 162(m) until the earlier of (i) a material
modification of the 1997 Plan; (ii) the issuance of all employer stock and other
compensation that has been allocated under the 1997 Plan; or (iii) the first
meeting of stockholders at which directors are to be elected that occurs after
December 31, 1999 (the "Transition Date"). After the Transition Date, rights or
awards granted under the 1997 Plan, other than options and SARs, will not
qualify as "performance-based compensation" for purposes of Section 162(m)
unless such rights or awards are granted or vest upon preestablished objective
performance goals, the material terms of which are disclosed to and approved by
the stockholders of the Company. Thus, the Company expects that such other
rights or awards under the 1997 Plan will not constitute "performance-based
compensation" for purposes of Section 162(m).
The Company has attempted to structure the 1997 Plan in such a manner that,
after the Transition Date, subject to obtaining stockholder approval for the
1997 Plan, the remuneration attributable to stock
50
<PAGE>
options and SARs which meet the other requirements of Section 162(m) will not be
subject to the $1 million limitation. The Company has not, however, requested a
ruling from the IRS or an opinion of counsel regarding this issue.
REGISTRATION STATEMENT ON FORM S-8. The Company intends to file a
registration statement on Form S-8 under the Securities Act to register the
shares of Common Stock reserved for issuance under the 1997 Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to the Recapitalization, the Company did not have a compensation
committee. In fiscal 1995, compensation decisions for executive officers and
senior management were made by Messrs. Scherr and Thomas. Following the
Recapitalization, Messrs. Thomas, Albertson, Ferguson and Lazarus served on the
Compensation Committee. Upon consummation of the Offering, Messrs. Thomas and
Albertson resigned from the Compensation Committee. In April 1996, the Company
made a personal loan to Larry Thomas, the Company's President, of $1 million at
an annual interest rate of 8.0% to assist Mr. Thomas's purchase of a personal
residence. The loan, excluding accrued interest of $10,000 (which was forgiven),
was repaid concurrently with the Recapitalization.
51
<PAGE>
PRINCIPAL STOCKHOLDERS
The information in the following table sets forth the ownership of the
Common Stock, as of the date of this Prospectus, by (i) each person who, to the
knowledge of the Company, beneficially owns more than 5% of the outstanding
shares of Common Stock; (ii) each Named Officer; (iii) each director of the
Company; and (iv) all directors and executive officers of the Company, as a
group. As of the date of this Prospectus, the Company had 19,329,079 shares of
Common Stock outstanding and, to the knowledge of the Company, there were 45
record holders of Common Stock. The Company believes that the number of
beneficial holders is significantly in excess of this amount.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP (1)
------------------------
NUMBER OF
NAME AND ADDRESS (2) SHARES PERCENT
- ------------------------------------------------------------------------------------------ ----------- -----------
<S> <C> <C>
Chase Venture Capital Associates, L.P. (3)................................................ 4,381,265 22.7%
380 Madison Avenue, 12th Floor
New York, NY 10017
Raymond Scherr (4)........................................................................ 1,710,148 8.8
David Ferguson (5)........................................................................ -- --
Jeffrey Walker (5)........................................................................ -- --
Michael Lazarus (6)....................................................................... -- --
Steven Burge (7).......................................................................... -- --
Larry Thomas (8).......................................................................... 1,384,816 7.2
Marty Albertson (9)....................................................................... 927,637 4.8
Bruce Ross (10)........................................................................... 30,383 *
Barry Soosman (11)........................................................................ 76,293 *
All Executive Officers and Directors as a group (9 persons) (5)-(12)...................... 4,076,211 21.1
</TABLE>
- ------------------------
* Represents less than 1% of the issued and outstanding shares.
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock subject
to options and warrants which are currently exercisable, or will become
exercisable within 60 days of the date of this Prospectus, are deemed
outstanding for computing the percentage of the person or entity holding
such securities but are not outstanding for computing the percentage of any
other person or entity. Except as indicated by footnote, and subject to the
community property laws where applicable, to the knowledge of the Company,
the persons named in the table above have sole voting and investment power
with respect to all shares of Common Stock shown as beneficially owned by
them.
(2) Unless otherwise indicated, the address for each person is the Company's
address at 5155 Clareton Drive, Agoura Hills, CA 91362.
(3) Excludes Investor Options granted by Chase Ventures to certain members of
management for the purchase of 207,899 shares of Common Stock, respectively.
See "Certain Transactions -- Options Granted by the Investors to Certain
Members of Management."
(4) Represents: (i) 1,150,046 of shares of Common Stock held by the Scherr Trust
for which Mr. Scherr and his spouse serve as co-trustees and share voting
and investment control over such shares of Common Stock; (ii) 275,460 shares
of Common Stock held in trust for the benefit of Mr. Scherr and his son for
which Mr. Scherr's brother serves as trustee and exercises voting and
investment control; (iii) 275,460 shares of Common Stock held in trust for
the benefit of Mr. Scherr's spouse and daughter for which Mr. Scherr's
brother serves as trustee and exercises voting and investment control; and
(iv) 9,182 shares of Common Stock held by Mr. Scherr's brother. The address
of each
52
<PAGE>
such person is 1096 Lakeview Canyon, Westlake Village, CA 91362. Mr. Ray
Scherr disclaims beneficial ownership of the shares held in trust for the
benefit of his wife and daughter and held by David Scherr.
(5) Neither Mr. Walker nor Mr. Ferguson own any Common Stock. Messrs. Walker and
Ferguson are the Managing General Partner and a General Partner,
respectively, of Chase Capital Partners, a New York general partnership, and
the sole general partner of Chase Ventures and an affiliate of Chase
Securities. Each of Messrs. Walker and Ferguson disclaims beneficial
ownership of the shares owned by Chase Ventures except to the extent of his
pecuniary interest therein. The address for Mr. Walker is c/o Chase Capital
Partners, 380 Madison Avenue, 12th Floor, New York, New York 10017, and the
address for Mr. Ferguson is c/o Chase Capital Partners, 840 Apollo Street,
Suite 223, El Segundo, California 90245.
(6) Mr. Lazarus does not directly own any Common Stock. However, as a general
partner of Weston Presidio Management II, L.P., the sole general partner of
Weston Presidio, he may be deemed to share voting and investment control
over the 658,966 shares of Common Stock held by Weston Presidio and over the
additional 29,684 shares of Common Stock owned by Weston Presidio that are
subject to Investor Options. See "Certain Transactions -- Options Granted by
the Investors to Certain Members of Management." Mr. Lazarus disclaims
beneficial ownership of the shares held by Weston Presidio, except to the
extent of his pecuniary interest therein. The address for Mr. Lazarus is c/o
Weston Presidio, 343 Sansome Street, Suite 1210, San Francisco, California
94111.
(7) Mr. Burge does not own any Common Stock. However, as a managing director of
Wells Fargo, he may be deemed to share voting or investment control over the
878,589 shares of Common Stock owned by Wells Fargo and over the additional
39,611 shares of Common Stock owned by Wells Fargo that are subject to
Investor Options. See "Certain Transactions -- Options Granted by the
Investors to Certain Members of Management." Mr. Burge disclaims beneficial
ownership of the shares held by Wells Fargo, except to the extent of his
pecuniary interest therein. The address for Mr. Burge is c/o Wells Fargo
Equity Capital, 333 South Grand Avenue, Suite 1200, Los Angeles, California
90071.
(8) Represents: (i) 1,275,094 shares of Common Stock held by a trust for the
benefit of Mr. Thomas and his spouse for which Mr. Thomas and his spouse
serve as co-trustees; and (ii) 109,722 shares of Common Stock issuable upon
the exercise of an Investor Option granted to Mr. Thomas by the Investors.
See "Certain Transactions -- Options Granted by the Investors to Certain
Members of Management."
(9) Represents: (i) 711,717 shares of Common Stock held by a trust for the
benefit of Mr. Albertson and his spouse for which Mr. Albertson and his
spouse serve as co-trustees; (ii) 53,099 shares of Common Stock held in
trust for the benefit of Mr. Albertson and one of his children for which Mr.
Albertson serves as trustee; (iii) 53,099 shares of Common Stock held in
trust for the benefit of Mr. Albertson's spouse and one of his children for
which Mr. Albertson serves as trustee; and (iv) 109,722 shares of Common
Stock issuable upon the exercise of an Investor Option granted to Mr.
Albertson by the Investors. See "Certain Transactions -- Options Granted by
the Investors to Certain Members of Management."
(10)Includes 3,850 shares of Common Stock issuable upon the exercise of an
Investor Option granted to Mr. Ross by the Investors. See "Certain
Transactions -- Options Granted by the Investors to Certain Members of
Management."
(11)Includes: (i) 45,910 shares of Common Stock held by the Soosman Family Trust
with respect to which Mr. Soosman and his spouse serve as co-trustees and
share voting and investment control; and (ii) 3,850 shares of Common Stock
issuable upon the exercise of an Investor Option granted to Mr. Soosman by
the Investors. See "Certain Transactions -- Options Granted by the Investors
to Certain Members of Management."
53
<PAGE>
CERTAIN TRANSACTIONS
MANAGEMENT TRANSACTIONS
In April 1996, the Company made a personal loan to Larry Thomas, the
Company's President, of $1.0 million at an annual interest rate of 8.0% to
assist Mr. Thomas's purchase of a personal residence. The loan, excluding
accrued interest of $10,000 (which was forgiven), was repaid concurrently with
the Recapitalization.
On February 15, 1996, the Company entered into sale-leaseback transactions
with Raymond Scherr relating to the Company's Arlington, Texas store and North
Chicago, Illinois store. The Arlington, Texas store was sold by the Company to
Mr. Scherr for $935,000. The North Chicago, Illinois store was sold by the
Company to Mr. Scherr for $820,000. The Company leases the Arlington, Texas
store and North Chicago, Illinois store from Mr. Scherr for $7,687 and $8,570
per month, respectively. In August 1995, Mr. Scherr purchased the South Chicago,
Illinois store from the Company's profit sharing plan for $500,000. The Company
leases this store from Mr. Scherr for $8,250 per month. The Company leases its
Covina, California store from Mr. Scherr for $9,900 per month. All of the leases
are on a triple net basis pursuant to which the Company pays rent, as well as
expenses relating to taxes, insurance and maintenance. Management believes that
the terms of these leases are on the same or similar terms that would be
available from an unaffiliated third party in an arm's length negotiation.
The Company paid the law firm of Soosman & Associates, of which Barry
Soosman was a partner, $70,000, $120,000 and $160,000 for legal fees in 1994,
1995 and 1996, respectively.
RECAPITALIZATION AND TRANSACTIONS WITH MANAGEMENT
On June 5, 1996, the Company consummated a series of transactions to effect
the Recapitalization pursuant to which control of the Company was transferred
from its sole stockholder, the Scherr Trust, to members of management (including
Messrs. Thomas and Albertson) and the Investors. The terms of the
Recapitalization, including the basis of the purchase price for shares of Common
Stock and the number of shares of Junior Preferred Stock issued to Messrs.
Thomas and Albertson and the Scherr Trust, was determined as a result of
arms-length negotiations with the Investors.
In connection with the Recapitalization, Larry Thomas (i) purchased 493,376
shares of Common Stock at a purchase price of $1.00 per share in cash; (ii)
purchased 189,171.92 shares of Junior Preferred Stock (with an initial
liquidation value of $100 per share) in exchange for the cancellation of options
to acquire 48,844,190 shares of Common Stock; and (iii) received $10.6 million
in cash upon the cancellation of options for the purchase of 31,484,670 shares
of Common Stock. The options exchanged had a weighted average exercise price of
$0.003 per share.
In connection with the Recapitalization, Marty Albertson (i) purchased
328,916 shares of Common Stock at a purchase price of $1.00 per share in cash;
(ii) purchased 126,114.41 shares of Junior Preferred Stock (with an initial
liquidation value of $100 per share) in exchange for the cancellation of options
to acquire 32,562,741 shares of Common Stock; (iii) received $7.1 million in
cash upon the cancellation of options for the purchase of 20,989,747 shares of
Common Stock. The options exchanged had a weighted average exercise price of
$0.003 per share.
In connection with the Recapitalization, the Company repurchased 309,840,000
shares of Common Stock from the Scherr Trust for approximately $113.1 million in
cash. The Scherr Trust also exchanged 51,123,600 shares of Common Stock for
198,000 shares of Junior Preferred Stock (with an initial liquidation value of
$19.8 million) and retained 516,400 shares of Common Stock.
In connection with the Recapitalization, the Company granted options to each
of Messrs. Thomas and Albertson to purchase 397,985 shares of Common Stock at an
exercise price of $10.89 per share pursuant to the Management Stock Option
Agreements. All such options granted to Messrs. Thomas and Albertson are subject
to future vesting which may be accelerated upon the attainment by the Company of
certain performance hurdles based on market capitalization and other factors.
See "Management -- Management Stock Option Agreements." Following the
consummation of the Offering, the Company intends to file a registration
statement on Form S-8 under the Securities Act to register the issuance of
Common Stock upon exercise of such options.
54
<PAGE>
The Company granted certain registration rights to Messrs. Thomas and
Albertson and the Scherr Trust. See "-- Registration Rights."
TRANSACTIONS WITH THE INVESTORS
In connection with the Recapitalization, the Investors purchased the
following equity securities of the Company for an aggregate purchase price of
$70.0 million in cash: (i) Chase Ventures and an affiliate purchased 1,355,550
shares of Common Stock and 519,750 shares of Junior Preferred Stock; (ii) Wells
Fargo purchased 258,200 shares of Common Stock and 99,000 shares of Junior
Preferred Stock; and (iii) Weston Presidio purchased 193,650 shares of Common
Stock and 74,250 shares of Junior Preferred Stock.
Chase Ventures is an affiliate of Chase Securities. Jeffrey Walker, a
director of the Company, is the managing general partner of Chase Capital
Partners, the general partner of Chase Ventures. David Ferguson, a director of
the Company, is a general partner of Chase Capital Partners. Messrs. Walker and
Ferguson have equity interests in Chase Capital Partners. Mr. Burge, a director
of the Company, is a managing director of Wells Fargo. Wells Fargo is an
indirect wholly owned subsidiary of Wells Fargo & Co., the parent company of
Wells Fargo. Mr. Burge does not have an equity interest in Wells Fargo or Wells
Fargo & Co. Michael Lazarus, a director of the Company, is a general partner of
Weston Presidio Capital Management II, L.P. and has an equity interest therein.
Weston Presidio Capital Management II, L.P. is the sole general partner of
Weston Presidio.
In connection with the Recapitalization, the Scherr Trust and stockholders
holding management positions (the "Management Stockholders") have agreed to
indemnify the Investors and the DLJ Investors for losses incurred in connection
with any misrepresentations or breaches of warranty by the Company or its
affiliates. The Investors and the DLJ Investors (as defined herein) have agreed
to indemnify the Company in substantially the same manner, with the indemnified
amount limited to each Investor's ratable share of such losses.
TRANSACTIONS WITH AFFILIATES OF CHASE SECURITIES
In connection with the Recapitalization, the Company entered into the Bridge
Facility with DLJ Bridge and Chemical, an affiliate of Chase Securities,
pursuant to which DLJ Bridge purchased for cash $51.0 million of notes of the
Company bearing interest at 12.75% per annum and Chemical loaned $49.0 million
in cash to the Company with interest payable at 12.75% per annum. The Company
applied the net proceeds of the private placement of the Old Notes, for which
Chase Securities acted as an Initial Purchaser, to the retirement of the Bridge
Facility. Chase Securities also acted as an underwriter in the Offering. In
connection with such transactions, Chemical and Chase Securities received
customary fees.
1996 CREDIT FACILITY
Effective with the Recapitalization, Wells Fargo, an affiliate of Wells
Fargo Bank, purchased approximately 7.14% of the then outstanding Common Stock.
See "Principal and Selling Stockholders." Wells Fargo Bank is acting as lender
under the 1996 Credit Facility and is being paid customary fees therefor. See
"Description of the 1996 Credit Facility."
REGISTRATION RIGHTS
The Company granted to the Investors and certain members of management,
including Messrs. Thomas and Albertson and the Scherr Trust, the right to cause
the Company to register such holders' shares of equity securities at any time
upon the request of holders of at least 60.0% of the equity securities held by
such holders in accordance with the requirements of the Securities Act and
subject to the Company's right to delay its obligations upon the occurrence of
specified events. In addition, all of such holders have the right to include
their shares of equity securities in any registration of equity securities
effected by the Company, subject to certain limitations. The Company has agreed
to pay all costs associated with any such registrations, except for
underwriters' discounts and commissions.
TAX INDEMNIFICATION AGREEMENT
In connection with the Recapitalization, the Company entered into a tax
indemnification agreement (the "Tax Indemnification Agreement") with Raymond
Scherr pursuant to which the Company has agreed to indemnify Raymond Scherr for
any loss, damage or liability and all expenses incurred,
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suffered, sustained or required to be paid by the Scherr Trust in the event that
certain specified aspects of the Recapitalization are not treated for tax
purposes in the manner contemplated by the Recapitalization and related
transactions. The Management Stockholders have individually agreed to reimburse
the Company on a pro rata basis for any amounts paid to Mr. Scherr by the
Company as required by the Tax Indemnification Agreement; provided, however,
that the aggregate amount reimbursed by the Management Stockholders may not
exceed $5 million.
SUBCHAPTER S DISTRIBUTIONS
The Company elected to be taxed as a "S" corporation from 1988 until
immediately prior to the consummation of the Recapitalization. The Scherr Trust,
as the sole stockholder, received for 1994, 1995 and 1996 aggregate "S"
corporation distributions of $3.9 million, $14.5 million and $29.8 million,
respectively.
SCHERR BOARD REPRESENTATION LETTER
On June 5, 1996, the Company entered into an agreement with Raymond Scherr
(the "Scherr Board Representation Letter") in which the Company agreed that
subsequent to the termination of the Stockholders Agreement by reason of a
Qualified Public Offering and so long as Mr. Scherr and certain related entities
own 5% or more of the Common Stock on a fully diluted basis, the Company will
nominate or cause the nomination of Mr. Scherr to the Board of Directors (and
include Scherr in any proxy statement and related materials used in connection
with an election of directors) and otherwise use its best efforts to cause his
election at each annual meeting or special meeting relating to the election of
directors of the Company. The Company's obligations under this agreement will
terminate if Mr. Scherr suffers a disability or commits certain acts (as
described in the agreement). The Offering constituted a Qualified Public
Offering for purposes of the Scherr Board Representation Letter.
MANAGEMENT TAX REDEMPTION
In connection with the conversion of management's shares of Junior Preferred
Stock upon completion of the Offering, a significant amount of non-cash income
was deemed to have been earned by certain employees of the Company who are also
stockholders of the Company (including Larry Thomas and Marty Albertson) for
federal and state income tax purposes whether or not such employees received any
cash with respect to the underlying stock. In February 1997, the Company agreed
to redeem (the "Management Tax Redemption") approximately 1,317,000 shares of
Common Stock, at a price equal to the initial public offering price in the
Offering less the net underwriting discount, to provide sufficient cash to such
employees to finance a portion of such federal and state income tax obligations.
Pursuant to the terms of such agreement, the Company used approximately $18.4
million of the proceeds from the Offering to redeem for cash such shares of
Common Stock (of which approximately $6.7 million and $4.5 million were paid to
Messrs. Thomas and Albertson, respectively).
OPTIONS GRANTED BY THE INVESTORS TO CERTAIN MEMBERS OF MANAGEMENT
Chase Ventures, Wells Fargo and Weston Presidio granted Investor Options to
purchase an aggregate of 277,194 shares of Common Stock at a purchase price of
$4.33 per share to certain officers and key managers of the Company. Each grant
of an Investor Option is, to the extent possible, deemed to be granted by each
Investor to each member of management in the same ratio as granted by each
Investor (i.e., 75.00% by Chase Ventures, 14.29% by Wells Fargo and 10.71% by
Weston Presidio). Included in the Investor Options are options to purchase
109,722 shares of Common Stock that were granted to each of Messrs. Thomas and
Albertson and 3,850 shares of Common Stock that were granted to each of Messrs.
Ross and Soosman. The Investor Options were granted in December 1996, are
presently exercisable and will expire on December 30, 2001. This Company is not
a party to this agreement and has not, and will not, incur any obligation in
connection with such Investor Options. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Liquidity and Captial
Resources."
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DESCRIPTION OF NOTES
Set forth below is a summary of certain provisions of the Notes. The Notes
were issued pursuant to an indenture (the "Indenture"), dated as of July 2,
1996, by and between the Company and U.S. Trust Company of California, N.A., as
trustee (the "Trustee"). The following summaries of certain provisions of the
Notes and the Indenture are summaries only, do not purport to be complete and
are qualified in their entirety by reference to all of the provisions of the
Notes and the Indenture. Capitalized terms used herein and not otherwise defined
shall have the meanings assigned to them in the Indenture. Wherever particular
provisions of the Indenture are referred to in this summary, such provisions are
incorporated by reference as a part of the statements made and such statements
are qualified in their entirety by such reference. The Indenture is filed as an
exhibit to the Registration Statement of which this Prospectus is a part.
GENERAL
The Notes are senior, unsecured, general obligations of the Company. As of
the date of this Prospectus, there are $66,667,000 aggregate principal amount of
Notes outstanding. The Notes are issuable only in fully registered form, without
coupons, in denominations of $1,000 and integral multiples thereof.
The Notes mature on July 1, 2006. The Notes bear interest at the rate per
annum stated on the cover page hereof from the date of issuance or from the most
recent Interest Payment Date to which interest has been paid or provided for,
payable semi-annually on January 1 and July 1 of each year, commencing January
1, 1997, to the Persons in whose names such Notes are registered at the close of
business on the December 15 or June 15 immediately preceding such Interest
Payment Date. Interest is calculated on the basis of a 360-day year consisting
of twelve 30-day months.
Principal of, premium, if any, and interest on the Notes are payable, and
the Notes may be presented for registration of transfer or exchange, at the
office or agency of the Company maintained for such purpose, which office or
agency shall be maintained in the Borough of Manhattan, The City of New York. At
the option of the Company, payment of interest may be made by check mailed to
the Holders of the Notes at the addresses set forth upon the registry books of
the Company. No service charge will be made for any registration of transfer or
exchange of Notes, but the Company may require payment of a sum sufficient to
cover any tax or other governmental charge payable in connection therewith.
Until otherwise designated by the Company, the Company's office or agency will
be the corporate trust office of the Trustee presently located at the office of
the Trustee in the Borough of Manhattan, The City of New York.
OPTIONAL REDEMPTION
The Company does not have the right to redeem any Notes prior to July 1,
2001 (other than out of the Net Cash Proceeds of an Initial Public Equity
Offering, as described in the following paragraph). The Notes are redeemable for
cash at the option of the Company, in whole or in part, at any time on or after
July 1, 2001, upon not less than 30 days nor more than 60 days notice to each
Holder of Notes, at the following redemption prices (expressed as percentages of
the principal amount) if redeemed during the 12-month period commencing July 1
of the years indicated below, in each case (subject to the right of Holders of
record on a Record Date to receive interest due on an Interest Payment Date that
is on or prior to such Redemption Date) together with accrued and unpaid
interest thereon to the Redemption Date:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- ---------------------------------------------------------------------- ------------
<S> <C>
2001.................................................................. 105.500%
2002.................................................................. 103.667%
2003.................................................................. 101.833%
2004 and thereafter................................................... 100.000%
</TABLE>
Notwithstanding the foregoing, prior to July 1, 1999, upon an Initial Public
Equity Offering for cash, up to 33 1/3% of the original $100 million aggregate
principal amount of the Notes may be redeemed at the option of the Company
within 60 days of such Initial Public Equity Offering, on not less than 30 days,
but
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not more than 60 days, notice to each Holder of the Notes to be redeemed, with
cash from the Net Cash Proceeds of such Initial Public Equity Offering, at 110%
of principal amount (subject to the right of Holders of record on a Record Date
to receive interest due on an Interest Payment Date that is on or prior to such
Redemption Date), together with accrued and unpaid interest to the date of
redemption; PROVIDED, HOWEVER, that immediately following such redemption not
less than 66 2/3% of the original $100 million aggregate principal amount of the
Notes remains outstanding. Pursuant to this provision, the Company redeemed
$33,333,000 aggregate principal amount of Notes on April 19, 1997. As of the
date of this Prospectus, there are $66,667,000 aggregate principal amount of
Notes outstanding.
In the case of a partial redemption, the Trustee shall select the Notes or
portions thereof for redemption on a PRO RATA basis, by lot or in such other
manner it deems appropriate and fair. The Notes may be redeemed in part in
multiples of $1,000 only.
The Notes do not have the benefit of any sinking fund.
Notice of any redemption will be sent, by first-class mail, at least 30 days
and not more than 60 days prior to the date fixed for redemption to the Holder
of each Note to be redeemed to such Holder's last address as then shown upon the
registry books of the Registrar. Any notice which relates to a Note to be
redeemed in part only must state the portion of the principal amount equal to
the unredeemed portion thereof and must state that on and after the date of
redemption, upon surrender of such Note, a new Note or Notes in a principal
amount equal to the unredeemed portion thereof will be issued. On and after the
date of redemption, interest will cease to accrue on the Notes or portions
thereof called for redemption, unless the Company defaults in the payment
thereof.
CERTAIN COVENANTS
REPURCHASE OF NOTES AT THE OPTION OF THE HOLDER UPON A CHANGE OF CONTROL
The Indenture provides that in the event that a Change of Control has
occurred, each Holder of Notes will have the right, at such Holder's option,
pursuant to an irrevocable and unconditional offer by the Company (the "Change
of Control Offer"), to require the Company to repurchase all or any part of such
Holder's Notes (PROVIDED that the principal amount of such Notes must be $1,000
or an integral multiple thereof) on a date (the "Change of Control Purchase
Date") that is no later than 35 Business Days after the occurrence of such
Change of Control, at a cash price (the "Change of Control Purchase Price")
equal to 101% of the principal amount thereof, together with (subject to the
right of Holders of record on a Record Date to receive interest due on an
Interest Payment Date that is on or prior to such repurchase date) accrued and
unpaid interest to the Change of Control Purchase Date. The Change of Control
Offer shall be made within 10 Business Days following a Change of Control and
shall remain open for 20 Business Days following its commencement (the "Change
of Control Offer Period"). Upon expiration of the Change of Control Offer
Period, the Company promptly shall purchase all Notes properly tendered in
response to the Change of Control Offer.
As used herein, a "Change of Control" means such time as: (a) a "person" or
"group" (within the meaning of Sections 13(d) and 14(d)(2) of the Exchange Act
of 1934, as amended), other than any person or group comprised solely of the
Investors, has become the beneficial owner, by way of purchase, merger,
consolidation or otherwise, of 35% or more of the voting power of all classes of
voting securities of the Company and such person or group has become the
beneficial owner of a greater percentage of the voting power of all classes of
voting securities of the Company than that then held by the Investors; or (b) a
sale or transfer of all or substantially all of the assets of the Company to any
person or group (other than any group consisting solely of the Investors or
their Affiliates) has been consummated; or (c) during any period of two
consecutive years, individuals who at the beginning of such period constituted
the Board of Directors of the Company (together with any new directors whose
election was approved by a vote of a majority of the directors then still in
office, who either were directors at the beginning of such period or whose
election or nomination for the election was previously so approved) cease for
any reason to constitute a majority of the directors of the Company, as the case
may
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be, then in office, other than as a result of election and removal of directors
pursuant to the terms of the Senior Preferred Stock as in effect on the Issue
Date or the Stockholders Agreement as in effect on the Issue Date governing the
election and removal of directors.
As used herein, "Investors" means (i) Chase Venture Capital Associates,
L.P., CB Capital Investors, Inc., Weston Presidio Capital II, L.P., Wells Fargo
Small Business Investment Company, Inc. and any Person controlled by or under
common control with any of the foregoing but not Persons controlling any of the
foregoing, other than those Persons controlling the Investors as of the date the
shares of Senior Preferred Stock are first issued and (ii) the holders of the
Company's Common Stock (including Larry Thomas, Marty Albertson and the Scherr
Trust) who are party to the Stockholders Agreement as in effect on June 5, 1996,
members of their immediate families and trusts for their sole benefit.
A transaction in which the Company is sold or its assets are transferred to
any person or group of persons who is or are Investors will not constitute a
Change of Control, thus Holders would not receive the benefit of the Change of
Control provisions in the event of such transaction. On or before the Change of
Control Purchase Date, the Company will (i) accept for payment Notes or portions
thereof properly tendered pursuant to the Change of Control Offer, (ii) deposit
with the Paying Agent cash sufficient to pay the Change of Control Purchase
Price (together with accrued and unpaid interest) of all Notes so tendered and
(iii) deliver to the Trustee Notes so accepted together with an Officers'
Certificate listing the Notes or portions thereof being purchased by the
Company. The Paying Agent promptly will pay the Holders of Notes so accepted an
amount equal to the Change of Control Purchase Price (together with accrued and
unpaid interest), and the Trustee promptly will authenticate and deliver to such
Holders a new Note equal in principal amount to any unpurchased portion of the
Note surrendered; PROVIDED, that each such new Note will be in a principal
amount of $1,000 or an integral multiple thereof. Any Notes not so accepted will
be delivered promptly by the Company to the Holder thereof. The Company publicly
will announce the results of the Change of Control Offer on or as soon as
practicable after the Change of Control Purchase Date. Any Note (or a portion
thereof) accepted for payment pursuant to the Change of Control Offer (and duly
paid on the Change of Control Purchase Date) will cease to accrue interest after
the Change of Control Purchase Date. There can be no assurance that the Company
would have available sufficient funds to repurchase the Notes in the event of a
Change of Control.
The Change of Control purchase feature of the Notes may make more difficult
or discourage a takeover of the Company, and, thus, the removal of incumbent
management. The Change of Control purchase feature resulted from negotiations
between the Company and the Initial Purchasers.
The phrase "all or substantially all" of the assets of the Company will
likely be interpreted under applicable state law and will be dependent upon
particular facts and circumstances. As a result, there may be a degree of
uncertainty in ascertaining whether a sale or transfer of "all or substantially
all" of the assets of the Company has occurred.
Any Change of Control Offer will be made in compliance with all applicable
laws, rules and regulations, including, if applicable, Regulation 14E under the
Exchange Act and the rules and regulations promulgated thereunder and all other
applicable federal and state securities laws.
LIMITATION ON INCURRENCE OF ADDITIONAL INDEBTEDNESS AND DISQUALIFIED CAPITAL
STOCK
The Indenture provides that, except as set forth below in this covenant, the
Company will not, and will not permit any of its Subsidiaries to, directly or
indirectly, issue, assume, guaranty, incur, become directly or indirectly liable
with respect to (including as a result of an Acquisition), or otherwise become
responsible for, contingently or otherwise (individually and collectively, to
"incur" or, as appropriate, an "incurrence"), any Indebtedness or any
Disqualified Capital Stock (including Acquired Indebtedness), other than
Permitted Indebtedness.
Notwithstanding the foregoing, if (i) no Default or Event of Default shall
have occurred and be continuing at the time of, or would occur after giving
effect on a PRO FORMA basis to, such incurrence of Indebtedness or Disqualified
Capital Stock and (ii) on the date of such incurrence (the "Incurrence
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Date"), the Consolidated Coverage Ratio of the Company for the Reference Period
immediately preceding the Incurrence Date, after giving effect on a PRO FORMA
basis to such incurrence of such Indebtedness or Disqualified Capital Stock and,
to the extent set forth in the definition of Consolidated Coverage Ratio, the
use of proceeds thereof, would be at least (x) 2.0 to 1, if such incurrence
occurs on or before June 30, 1997, or (y) 2.25 to 1, if such incurrence occurs
at any time thereafter (the "Debt Incurrence Ratio"), then the Company may incur
such Indebtedness or Disqualified Capital Stock.
Indebtedness or Disqualified Capital Stock of any Person which is
outstanding at the time such Person becomes a Subsidiary of the Company
(including upon designation of any subsidiary or other Person as a Subsidiary)
or is merged with or into or consolidated with the Company or a Subsidiary of
the Company shall be deemed to have been incurred at the time such Person
becomes such a Subsidiary of the Company or is merged with or into or
consolidated with the Company or a Subsidiary of the Company, as applicable.
LIMITATION ON RESTRICTED PAYMENTS
The Indenture provides that the Company and its Subsidiaries will not, and
will not permit any of their Subsidiaries to, directly or indirectly, make any
Restricted Payment if, after giving effect to such Restricted Payment on a PRO
FORMA basis, (1) a Default or an Event of Default would have occurred and be
continuing, (2) the Company is not permitted to incur at least $1.00 of
additional Indebtedness pursuant to the Debt Incurrence Ratio in the covenant
"Limitation on Incurrence of Additional Indebtedness and Disqualified Capital
Stock," or (3) the aggregate amount of all Restricted Payments made by the
Company and its Subsidiaries, including after giving effect to such proposed
Restricted Payment, from and after the Issue Date, would exceed the sum of (a)
50% of the aggregate Consolidated Net Income of the Company for the period
(taken as one accounting period), commencing on the first day of the first full
fiscal quarter commencing after the Issue Date, to and including the last day of
the fiscal quarter ended immediately prior to the date of each such calculation
(or, in the event Consolidated Net Income for such period is a deficit, then
minus 100% of such deficit), plus (b) 100% of the aggregate Net Cash Proceeds
received by the Company from the sale of its Qualified Capital Stock (other than
(i) to a subsidiary of the Company and (ii) to the extent applied in connection
with a Qualified Exchange), after the Issue Date.
Failure to satisfy the foregoing clauses (2) and (3) of the immediately
preceding paragraph, however, will not prohibit (v) Restricted Investments,
PROVIDED that, after giving PRO FORMA effect to any such Investment, the
aggregate amount of all such Investments made on or after the Issue Date that
are outstanding (after giving effect to the amount (as such amount is determined
by the Board of Directors reasonably and in good faith) of any such Investments
(whether made originally in the form of property or cash) returned to the
Company or the Subsidiary that made such prior Investment, without restriction,
in cash, except to the extent that the effect of such return increased
Consolidated Net Income of the Company, on or prior to the date of any such
calculation) at any time does not exceed $5 million, and failure to satisfy the
foregoing clauses (1), (2) and (3) of the immediately preceding paragraph will
not prohibit (w) a Qualified Exchange, (x) the payment of any dividend on
Capital Stock within 60 days after the date of its declaration if such dividend
could have been made on the date of such declaration in compliance with the
foregoing provisions, (y) the repurchase, redemption, or other acquisition or
retirement for value of any Equity Interests of the Company held by any member
of the Company's management pursuant to any management equity subscription
agreement, restricted stock agreement, stockholders agreement, stock option
agreement or other similar agreement, PROVIDED that, in the case of this clause
(y), the aggregate net consideration paid for all such Equity Interests so
reacquired shall not exceed $1.0 million, or (z) the issuance of dividends on
the Senior Preferred Stock in shares of Senior Preferred Stock or accretion to
the liquidation value thereof pursuant to the terms of the instrument governing
the Senior Preferred Stock as such instrument was in effect on the Issue Date.
The full amount of any Restricted Payment made pursuant to the foregoing clauses
(v), (x) (except to the extent also covered by clause (z)) and (y), but not
pursuant to clause (w) or (z), of the immediately preceding sentence, however,
will be deducted in the calculation of the aggregate amount of Restricted
Payments available to be made referred to in clause (3) of the immediately
preceding paragraph.
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LIMITATION ON DIVIDENDS AND OTHER PAYMENT RESTRICTIONS AFFECTING
SUBSIDIARIES
The Indenture provides that the Company and its Subsidiaries will not, and
will not permit any of their Subsidiaries to, directly or indirectly, create,
assume or suffer to exist any consensual restriction on the ability of any
Subsidiary of the Company to pay dividends or make other distributions to or on
behalf of, or to pay any obligation to or on behalf of, or otherwise to transfer
assets or property to or on behalf of, or make or pay loans or advances to or on
behalf of, the Company or any Subsidiary of the Company, except (a) restrictions
imposed by the Notes or the Indenture, (b) restrictions imposed by applicable
law and regulation, (c) existing restrictions under Existing Indebtedness
(assuming retirement of the Bridge Facility), (d) restrictions under any
Acquired Indebtedness not incurred in violation of the Indenture or any
agreement relating to any property, asset, or business acquired by the Company
or any of its Subsidiaries, which restrictions in each case existed at the time
of acquisition, were not put in place in connection with or in anticipation of
such acquisition and are not applicable to any Person, other than the Person
acquired, or to any property, asset or business, other than the property, assets
and business so acquired, (e) any such restriction or requirement imposed by
Indebtedness incurred under paragraph (e) of the definition of "Permitted
Indebtedness," PROVIDED such restriction or requirement is no more restrictive
than that imposed by the Credit Agreement as of the Issue Date, (f) restrictions
with respect solely to a Subsidiary of the Company imposed pursuant to a binding
agreement which has been entered into for the sale or disposition of all or
substantially all of the Equity Interests or assets of such Subsidiary, PROVIDED
such restrictions apply solely to the Equity Interests or assets of such
Subsidiary which are being sold or disposed of, (g) restrictions on transfer
contained in Purchase Money Indebtedness incurred pursuant to paragraph (c) of
the definition of "Permitted Indebtedness," PROVIDED such restrictions relate
only to the transfer of the property acquired with the proceeds of such Purchase
Money Indebtedness, and (h) in connection with and pursuant to permitted
Refinancings, replacements of restrictions imposed pursuant to clause (a), (c),
(d) or (g) of this paragraph that are not more restrictive than those being
replaced and do not apply to any other Person or assets than those that would
have been covered by the restrictions in the Indebtedness so refinanced.
Notwithstanding the foregoing, customary provisions restricting subletting
or assignment of any lease entered into in the ordinary course of business,
consistent with industry practice shall in and of themselves not be considered
restrictions on the ability of the applicable Subsidiary to transfer such
agreement or assets, as the case may be.
LIMITATION ON LIENS SECURING INDEBTEDNESS
The Company will not, and will not permit any Subsidiary to, create, incur,
assume or suffer to exist any Lien of any kind, other than Permitted Liens, upon
any of their respective assets now owned or acquired on or after the Issue Date
or upon any income or profits therefrom.
LIMITATION ON SALE OF ASSETS AND SUBSIDIARY STOCK
The Indenture provides that the Company will not, and will not permit any of
its Subsidiaries to, in one transaction or a series of related transactions
(that has or have, when taken together with all other such transactions over the
preceding 12-months, an aggregate fair market value in excess of $250,000 or for
aggregate net proceeds in excess of $250,000), convey, sell, transfer, assign,
or otherwise dispose of, directly or indirectly, any of their respective
property, businesses, or assets, including by merger or consolidation (in the
case of a Subsidiary of the Company), and including any sale or other transfer
or issuance of any Equity Interests of any Subsidiary of the Company, whether by
the Company or a Subsidiary of either or through the issuance, sale or transfer
of Equity Interests by a Subsidiary of the Company (an "Asset Sale"), unless
(1)(a) within 365 days after the date of such Asset Sale, the Net Cash Proceeds
therefrom (the "Asset Sale Offer Amount") are applied (i) to the optional
redemption of the Notes in accordance with the terms of the Indenture, (ii) to
the repurchase of the Notes pursuant to an irrevocable and unconditional cash
offer (the "Asset Sale Offer") to repurchase the Notes at a purchase price (the
"Asset Sale Offer Price") of 101% of principal amount, plus accrued and unpaid
interest to the date of payment, (iii) to the repayment of amounts outstanding
pursuant to the terms of the Credit Agreement (PROVIDED that upon such
application, the availability of amounts that the Company or its Subsidiaries
may be liable for pursuant thereto shall be permanently reduced by a
corresponding
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amount), or (iv) to the repayment of Purchase Money Indebtedness secured by the
assets which are the subject of such Asset Sale, or (b) within 365 days
following such Asset Sale, the Asset Sale Offer Amount is invested in assets and
property (other than notes, bonds, obligations and securities of Persons other
than subsidiaries, which are received as a result of transactions effected in
compliance with the "Limitations on Restricted Payments" covenant) which in the
good faith reasonable judgment of the Board will immediately constitute or be a
part of a Related Business of the Company or such Subsidiary (if it continues to
be a Subsidiary) immediately following such transaction, (2) at least 75% of the
consideration for such Asset Sale or series of related Asset Sales consists of
cash or Cash Equivalents, (3) no Default or Event of Default shall have occurred
and be continuing at the time of, or would occur after giving effect, on a PRO
FORMA basis, to, such Asset Sale, and (4) the Board of Directors of the Company
determines in good faith that the Company or such Subsidiary, as applicable,
receives fair market value for such Asset Sale.
The Indenture provides that an acquisition of the Notes pursuant to an Asset
Sale Offer may be deferred until the accumulated Net Cash Proceeds from Asset
Sales not applied to the uses set forth in clauses (1)(a) or (1)(b) above (the
"Excess Proceeds") exceeds $5 million and that each Asset Sale Offer shall
remain open for 20 Business Days following its commencement (the "Asset Sale
Offer Period"). Upon expiration of the Asset Sale Offer Period, the Company
shall apply the Asset Sale Offer Amount, plus an amount equal to accrued and
unpaid interest, to the purchase of all Notes properly tendered (on a PRO RATA
basis if the Asset Sale Offer Amount is insufficient to purchase all Notes so
tendered) at the Asset Sale Offer Price (together with accrued and unpaid
interest). To the extent that the aggregate amount of Notes tendered pursuant to
an Asset Sale Offer is less than the Asset Sale Offer Amount, the Company may
use any remaining Net Cash Proceeds for general corporate purposes as otherwise
permitted by the Indenture and following the consummation of each Asset Sale
Offer in compliance therewith the Excess Proceeds amount shall be reset to zero.
For purposes of (2) above, total consideration received means the total
consideration received for such Asset Sales, minus the amount of (a) non-
subordinated debt secured by the assets that were the subject of the Asset Sale
and assumed by a transferee, which assumption permanently reduces the amount of
Indebtedness outstanding on the Issue Date or permitted pursuant to paragraph
(c), (e) or (g) of the definition of "Permitted Indebtedness" (including that in
the case of a revolver or similar arrangement that makes credit available, such
commitment is permanently reduced by such amount), (b) Purchase Money
Indebtedness secured solely by the assets sold and assumed by a transferee and
(c) property that within 30 days of such Asset Sale is converted into cash or
Cash Equivalents and then applied in accordance with the terms of this covenant.
Notwithstanding the foregoing provisions:
(i)
the Company and its Subsidiaries may, in the ordinary course of
business, convey, sell, transfer, assign or otherwise dispose of
inventory acquired and held for resale in the ordinary course of business
and consistent with past practice;
(ii)
the Company and its Subsidiaries may convey, sell, transfer, assign
or otherwise dispose of assets pursuant to and in accordance with the
limitation on mergers, sales or consolidations provisions in the Indenture;
(iii)
the Company and its Subsidiaries may sell or dispose of damaged, worn
out or other obsolete (to the Company or such Subsidiaries) real or
personal property in the ordinary course of business and consistent with
past practice so long as such property is no longer necessary for the proper
conduct of the business of the Company or such Subsidiary, as applicable;
(iv)
the Company or any Subsidiary may, for fair market value (as
determined reasonably and in good faith by the Board of Directors),
convey, sell, transfer, assign or otherwise dispose of assets to the Company
or any of its Subsidiaries; and
(v)
cash and Cash Equivalents may be exchanged or sold for or in
consideration of cash or Cash Equivalents.
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All Net Cash Proceeds from an Event of Loss shall be invested or applied
otherwise as set forth in clause 1(a) or 1(b) of the first paragraph of this
covenant, all within the period and as otherwise provided above in clause 1(a)
or 1(b) of the first paragraph of this covenant.
Any Asset Sale Offer shall be made in compliance with all applicable laws,
rules, and regulations, including, if applicable, Regulation 14E of the Exchange
Act and the rules and regulations promulgated thereunder and all other
applicable federal and state securities laws.
LIMITATION ON TRANSACTIONS WITH AFFILIATES
The Indenture provides that neither the Company nor any of its Subsidiaries
will be permitted on or after the Issue Date to, directly or indirectly, enter
into or suffer to exist any contract, agreement, arrangement or transaction with
any Affiliate (an "Affiliate Transaction"), or any series of related Affiliate
Transactions (other than Exempted Affiliate Transactions), unless it is
determined that the terms of such Affiliate Transaction (or Affiliate
Transactions) are fair and reasonable to the Company, and no less favorable to
the Company than could have been obtained in an arm's length transaction with a
non-Affiliate.
Without limiting the foregoing, in connection with any Affiliate Transaction
or any series of related Affiliate Transactions (other than Exempted Affiliate
Transactions) (i) involving value to either party in excess of $1.0 million, the
Company must address and deliver an Officers' Certificate to the Trustee
certifying that (x) the terms of such Affiliate Transaction (or Affiliate
Transactions) are fair and reasonable to the Company, and no less favorable to
the Company than could have been obtained in an arm's length transaction with a
non-Affiliate and (y) such Affiliate Transaction (or Affiliate Transactions) has
been approved by a majority of the members of the Board of Directors that are
disinterested in such transaction and (ii) involving value to either party in
excess of $5.0 million, the Company must, prior to the consummation thereof, in
addition to the Officers' Certificate delivered to the Trustee pursuant to
clause (i) of this paragraph, obtain a written favorable opinion as to the
fairness of such transaction to the Company from a financial point of view from
an independent investment banking firm or valuation firm of national reputation
for being knowledgeable with respect to such matters, PROVIDED that this clause
(ii) shall not apply to transactions between the Company or any of its
Subsidiaries and any Affiliate thereof that is an investment or commercial bank
of national reputation with capital and surplus of at least $500 million, in
connection with the rendering by such Affiliate to the Company or such
Subsidiary of investment or commercial banking (including lending) services.
LIMITATION ON MERGER, SALE OR CONSOLIDATION
The Indenture provides that the Company will not, directly or indirectly,
consolidate with or merge with or into another Person or sell, lease, convey or
transfer all or substantially all of its assets (computed on a consolidated
basis), whether in a single transaction or a series of related transactions, to
another Person or group of affiliated Persons, or adopt a plan of liquidation,
unless (i) either (a) the Company is the continuing entity or (b) the resulting,
surviving or transferee entity or, in the case of a plan of liquidation, the
entity which receives the greatest value from such plan of liquidation is a
corporation organized under the laws of the United States, any state thereof or
the District of Columbia and expressly assumes by supplemental indenture all of
the obligations of the Company in connection with the Notes and the Indenture;
(ii) no Default or Event of Default shall exist or would occur immediately after
giving effect on a PRO FORMA basis to such transaction; (iii) immediately after
giving effect to such transaction on a PRO FORMA basis, the Consolidated Net
Worth of the consolidated surviving or transferee entity or, in the case of a
plan of liquidation, the entity which receives the greatest value from such plan
of liquidation is at least equal to the Consolidated Net Worth of the Company
immediately prior to such transaction; (iv) immediately after giving effect to
such transaction on a PRO FORMA basis, the consolidated resulting, surviving or
transferee entity or, in the case of a plan of liquidation, the entity which
receives the greatest value from such plan of liquidation would immediately
thereafter be permitted to incur at least $1.00 of additional Indebtedness
pursuant to the Debt Incurrence Ratio set forth in the covenant "Limitation on
Incurrence of Additional Indebtedness and Disqualified Capital Stock"; and (v)
the Company has delivered to the Trustee an Officers' Certificate and an opinion
of counsel, each stating that such consolidation, merger or transfer and, if a
supplemental indenture is required, such supplemental
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indenture, complies with the Indenture and that all conditions precedent therein
relating to such transaction have been satisfied. The provisions of clause (iv)
will not prevent the merger of the Company with or into another Person solely
for the purpose of changing the jurisdiction of incorporation of the Company.
Upon any consolidation or merger or any transfer of all or substantially all
of the assets of the Company or consummation of a plan of liquidation in
accordance with the foregoing, the successor corporation formed by such
consolidation or into which the Company is merged or to which such transfer is
made or, in the case of a plan of liquidation, the entity which receives the
greatest value from such plan of liquidation shall succeed to, and be
substituted for, and may exercise every right and power of, the Company under
the Indenture with the same effect as if such successor corporation had been
named therein as the Company, and, except in the case of a transfer of all or
substantially all of the assets of the Company and its Subsidiaries as a result
primarily of the lease to any party thereof, the Company shall be released from
the obligations under the Notes and the Indenture except with respect to any
obligations that arise from, or are related to, such transaction.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise) of all or substantially all of the properties and assets of one or
more Subsidiaries, the Company's interest in which constitutes all or
substantially all of the properties and assets of the Company, shall be deemed
to be the transfer of all or substantially all of the properties and assets of
the Company.
LIMITATION ON LINES OF BUSINESS
The Indenture provides that neither the Company nor any of its Subsidiaries
or Unrestricted Subsidiaries will directly or indirectly engage to any
substantial extent in any line or lines of business activity other than that
which, in the reasonable good faith judgment of the Board of Directors of the
Company, is a Related Business.
RESTRICTION ON SALE AND ISSUANCE OF SUBSIDIARY STOCK
The Indenture provides that the Company will not sell, and will not permit
any of its Subsidiaries to issue or sell, any Equity Interests of any Subsidiary
of the Company to any Person other than the Company or a Wholly Owned Subsidiary
of the Company, except for Equity Interests with no preferences or special
rights or privileges and with no redemption or prepayment provisions.
LIMITATION ON STATUS AS INVESTMENT COMPANY
The Indenture prohibits the Company and its Subsidiaries from being required
to register as an "investment company" (as that term is defined in the
Investment Company Act of 1940, as amended), or from otherwise becoming subject
to regulation under the Investment Company Act.
REPORTS
The Indenture provides that whether or not the Company is subject to the
reporting requirements of Section 13 or 15(d) of the Exchange Act, the Company
shall deliver to the Trustee and to each Holder within 15 days after it is or
would have been (if it were subject to such reporting obligations) required to
file such with the Commission, annual and quarterly financial statements
substantially equivalent to financial statements that would have been included
in reports filed with the Commission, if the Company were subject to the
requirements of Section 13 or 15(d) of the Exchange Act, including, with respect
to annual information only, a report thereon by the Company's certified
independent public accountants as such would be required in such reports to the
Commission, and, in each case, together with a management's discussion and
analysis of financial condition and results of operations which would be so
required and, to the extent permitted by the Exchange Act or the Commission (if
it were subject to such reporting obligations), file with the Commission the
annual, quarterly and other reports which it is or would have been required to
file with the Commission.
EVENTS OF DEFAULT AND REMEDIES
The Indenture defines an Event of Default as (i) the failure by the Company
to pay any installment of interest on the Notes as and when the same becomes due
and payable and the continuance of any such failure for 30 days, (ii) the
failure by the Company to pay all or any part of the principal, or premium, if
any, on the Notes when and as the same becomes due and payable at maturity,
redemption, by acceleration
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or otherwise, including, without limitation, payment of the Change of Control
Purchase Price or the Asset Sale Offer Price, or otherwise, (iii) the failure by
the Company or any Subsidiary to observe or perform any other covenant or
agreement contained in the Notes or the Indenture and, subject to certain
exceptions, the continuance of such failure for a period of 60 days after
written notice is given to the Company by the Trustee or to the Company and the
Trustee by the Holders of at least 25% in aggregate principal amount of the
Notes outstanding, (iv) certain events of bankruptcy, insolvency or
reorganization in respect of the Company or any of its Subsidiaries, (v) a
default in any issue of Indebtedness of the Company or any of its Subsidiaries
with an aggregate principal amount in excess of $5 million, which default (a) is
caused by failure to pay principal of, or premium, if any, or interest on such
Indebtedness prior to the expiration of the grace period provided therein on the
date of such default, or (b) results in the acceleration of payment of such
Indebtedness prior to its express maturity and (vi) final unsatisfied judgments
not covered by insurance aggregating in excess of $5 million, at any one time
rendered against the Company or any of its Subsidiaries and not stayed, bonded
or discharged within 60 days. The Indenture provides that if a Default occurs
and is continuing, the Trustee must, within 90 days after the occurrence of such
default, give to the Holders notice of such default; PROVIDED, that the Trustee
may withhold from Holders of the Notes notice of any continuing Default or Event
of Default (except a Default or Event of Default relating to the payment of
principal or interest) if it determines that withholding notice is in their
interest.
If an Event of Default occurs and is continuing (other than an Event of
Default specified in clause (iv), above, relating to the Company or any
Subsidiary), then in every such case, unless the principal of all of the Notes
shall have already become due and payable, either the Trustee or the Holders of
25% in aggregate principal amount of the Notes then outstanding, by notice in
writing to the Company (and to the Trustee if given by Holders) (an
"Acceleration Notice"), may declare all principal, premium, if any, and accrued
and unpaid interest thereon to be due and payable immediately. If an Event of
Default specified in clause (iv), above, relating to the Company or any
Subsidiary occurs, all principal and accrued interest thereon will be
immediately due and payable on all outstanding Notes without any declaration or
other act on the part of the Trustee or the Holders. The Holders of a majority
in aggregate principal amount of Notes generally are authorized to rescind such
acceleration if all existing Events of Default, other than the non-payment of
the principal of, premium, if any, and interest on the Notes which have become
due solely as a result of such acceleration have been cured or waived.
Prior to the declaration of acceleration of the maturity of the Notes, the
Holders of a majority in aggregate principal amount of the Notes at the time
outstanding may waive on behalf of all the Holders any default, except a default
in the payment of principal of or interest on any Note not yet cured or a
default with respect to any covenant or provision which cannot be modified or
amended without the consent of the Holder of each outstanding Note affected.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, the Trustee will be under no obligation to exercise any of its rights
or powers under the Indenture at the request, order or direction of any of the
Holders, unless such Holders have offered to the Trustee reasonable security or
indemnity. Subject to all provisions of the Indenture and applicable law, the
Holders of a majority in aggregate principal amount of the Notes at the time
outstanding will have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Trustee, or exercising
any trust or power conferred on the Trustee.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Indenture provides that the Company may, at its option and at any time
within one year of the Stated Maturity of the Notes, elect to have its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance"). Such Legal Defeasance means that the Company shall be deemed to
have paid and discharged the entire indebtedness represented by, and the
Indenture shall cease to be of further effect as to, all outstanding Notes,
except as to (i) rights of Holders to receive payments in respect of the
principal of, premium, if any, and interest on such Notes when such payments are
due from the trust funds; (ii) the Company's obligations with respect to such
Notes concerning issuing temporary Notes, registration of Notes, mutilated,
destroyed, lost or stolen Notes, and the maintenance of an office or agency for
payment and money for security payments held in trust; (iii) the rights, powers,
trust, duties, and immunities of the Trustee, and the Company's obligations in
connection therewith; and
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(iv) the Legal Defeasance provisions of the Indenture. In addition, the Company
may, at its option and at any time, elect to have its obligations released with
respect to certain covenants that are described in the Indenture ("Covenant
Defeasance") and thereafter any omission to comply with such obligations shall
not constitute a Default or Event of Default with respect to the Notes. In the
event Covenant Defeasance occurs, certain events (not including non-payment,
bankruptcy, receivership, rehabilitation and insolvency events) described under
"Events of Default" will no longer constitute an Event of Default with respect
to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit of
the Holders of the Notes, U.S. legal tender, noncallable U.S. government
securities or a combination thereof, in such amounts as will be sufficient, in
the opinion of a nationally recognized firm of independent public accountants,
to pay the principal of, premium, if any, and interest on such Notes on the
stated date for payment thereof or on the redemption date of such principal or
installment of principal of, premium, if any, or interest on such Notes, and the
Holders of Notes must have a valid, perfected, exclusive security interest in
such trust; (ii) in the case of the Legal Defeasance, the Company shall have
delivered to the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that (A) the Company has received from, or
there has been published by the Internal Revenue Service, a ruling or (B) since
the date of the Indenture, there has been a change in the applicable federal
income tax law, in either case to the effect that, and based thereon such
opinion of counsel shall confirm that, the Holders of such Notes will not
recognize income, gain or loss for federal income tax purposes as a result of
such Legal Defeasance and will be subject to federal income tax on the same
amounts, in the same manner and at the same times as would have been the case if
such Legal Defeasance had not occurred; (iii) in the case of Covenant
Defeasance, the Company shall have delivered to the Trustee an opinion of
counsel in the United States reasonably acceptable to such Trustee confirming
that the Holders of such Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such Covenant Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at the
same times as would have been the case if such Covenant Defeasance had not
occurred; (iv) no Default or Event of Default shall have occurred and be
continuing on the date of such deposit or, insofar as Events of Default from
bankruptcy or insolvency events are concerned, at any time in the period ending
on the 91st day after the date of deposit; (v) such Legal Defeasance or Covenant
Defeasance shall not result in a breach or violation of, or constitute a default
under the Indenture or any other material agreement or instrument to which the
Company or any of its Subsidiaries is a party or by which the Company or any of
its Subsidiaries is bound; (vi) the Company shall have delivered to the Trustee
an Officers' Certificate stating that the deposit was not made by the Company
with the intent of preferring the Holders of such Notes over any other creditors
of the Company or with the intent of defeating, hindering, delaying or
defrauding any other creditors of the Company or others; and (vii) the Company
shall have delivered to the Trustee an Officers' Certificate and an opinion of
counsel, each stating that the conditions precedent provided for in, in the case
of the Officers' Certificate, (i) through (vi) and, in the case of the opinion
of counsel, clauses (i) (with respect to the validity and perfection of the
security interest), (ii), (iii) and (v) of this paragraph have been complied
with.
If the funds deposited with the Trustee to effect Legal Defeasance or
Covenant Defeasance are insufficient to pay the principal of, premium, if any,
and interest on the Notes when due, then the obligations of the Company under
the Indenture will be revived and no such defeasance will be deemed to have
occurred.
AMENDMENTS AND SUPPLEMENTS
The Indenture contains provisions permitting the Company and the Trustee to
enter into a supplemental indenture for certain limited purposes without the
consent of the Holders. With the consent of the Holders of not less than a
majority in aggregate principal amount of the Notes at the time outstanding, the
Company and the Trustee are permitted to amend or supplement the Indenture or
any supplemental indenture or modify the rights of the Holders; PROVIDED, that
no such modification may, without the consent of each Holder affected thereby:
(i) change the Stated Maturity of any Note, or reduce the principal amount
thereof or the rate (or extend the time for payment) of interest thereon or any
premium
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payable upon the redemption thereof, or change the place of payment where, or
the coin or currency in which, any Note or any premium or the interest thereon
is payable, or impair the right to institute suit for the enforcement of any
such payment on or after the Stated Maturity thereof (or, in the case of
redemption, on or after the Redemption Date), or reduce the Change of Control
Purchase Price or the Asset Sale Offer Price or alter the provisions (including
the defined terms used therein) regarding the right of the Company to redeem the
Notes or the provisions (including the defined terms used therein) of the
"Repurchase of Notes at the Option of the Holder Upon a Change of Control"
covenant in a manner adverse to the Holders, or (ii) reduce the percentage in
principal amount of the outstanding Notes, the consent of whose Holders is
required for any such amendment, supplemental indenture or waiver provided for
in the Indenture, or (iii) modify any of the waiver provisions, except to
increase any required percentage or to provide that certain other provisions of
the Indenture cannot be modified or waived without the consent of the Holder of
each outstanding Note affected thereby, or (iv) cause the Notes to become
subordinate in right of payment to any other Indebtedness.
NO PERSONAL LIABILITY OF PARTNERS, STOCKHOLDERS, OFFICERS, DIRECTORS
The Indenture provides that no direct or indirect stockholder, employee,
officer or director, as such, past, present or future of the Company or any
successor entity shall have any personal liability in respect of the obligations
of the Company under the Indenture or the Notes by reason of his or its status
as such stockholder, employee, officer or director.
CERTAIN DEFINITIONS
"ACQUIRED INDEBTEDNESS" means Indebtedness or Disqualified Capital Stock of
any Person existing at the time such Person becomes a Subsidiary of the Company,
including by designation, or is merged or consolidated into or with or otherwise
acquired by the Company or one of its Subsidiaries.
"ACQUISITION" means the purchase or other acquisition of any Person or
substantially all the assets of any Person by any other Person, whether by
purchase, merger, consolidation, or other transfer, and whether or not for
consideration.
"AFFILIATE" means any Person directly or indirectly controlling or
controlled by or under direct or indirect common control with the Company. For
purposes of this definition, the term "control" means the power to direct the
management and policies of a Person, directly or through one or more
intermediaries, whether through the ownership of voting securities, by contract,
or otherwise, PROVIDED that, with respect to ownership of the Company and its
Subsidiaries, a beneficial owner of 10% or more of the total voting power
normally entitled to vote in the election of directors, managers or trustees, as
applicable, shall for such purposes be deemed to constitute control.
"ANCILLARY DOCUMENTS" means the amendment to the Company's Articles of
Incorporation creating the Junior Preferred Stock, the Restricted Stock
Agreements, the Shareholders Agreement, the Shareholder Registration Rights
Agreement, the Employment Agreements, the Management Stock Option Agreements and
the Plan.
"AVERAGE LIFE" means, as of the date of determination, with respect to any
security or instrument, the quotient obtained by dividing (i) the sum of (a) the
product of the number of years from the date of determination to the date or
dates of each successive scheduled principal (or redemption) payment of such
security or instrument and (b) the amount of each such respective principal (or
redemption) payment by (ii) the sum of all such principal (or redemption)
payments.
"BENEFICIAL OWNER" or "BENEFICIAL OWNER" has the meaning attributed to it in
Rules 13d-3 and 13d-5 under the Exchange Act (as in effect on the Issue Date),
whether or not applicable, except that a "Person" shall be deemed to have
"beneficial ownership" of all shares that any such Person has the right to
acquire, whether such right is exercisable immediately or only after the passage
of time.
"BORROWING BASE" means at any time the sum of (i) 75% of Eligible
Receivables, plus (ii) 65% of Eligible Inventory.
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"BUSINESS DAY" means each Monday, Tuesday, Wednesday, Thursday and Friday
which is not a day on which banking institutions in New York, New York are
authorized or obligated by law or executive order to close.
"CAPITAL STOCK" means, with respect to any corporation, any and all shares,
interests, rights to purchase (other than convertible or exchangeable
Indebtedness), warrants, options, participations or other equivalents of or
interests (however designated) in stock issued by that corporation.
"CAPITALIZED LEASE OBLIGATION" means rental or other payment obligations
under a lease of real or personal property that are required to be capitalized
for financial reporting purposes in accordance with GAAP, and the amount of
Indebtedness represented by such obligations shall be the capitalized amount of
such obligations, as determined in accordance with GAAP.
"CASH EQUIVALENT" means (i) securities issued or directly and fully
guaranteed or insured by the United States of America or any agency or
instrumentality thereof (PROVIDED that the full faith and credit of the United
States of America is pledged in support thereof), (ii) time deposits and
certificates of deposit and commercial paper issued by the parent corporation of
any domestic commercial bank of recognized standing having capital and surplus
in excess of $500 million and commercial paper issued by others rated at least
A-2 or the equivalent thereof by Standard & Poor's Corporation or at least P-2
or the equivalent thereof by Moody's Investors Service, Inc. and in each case
maturing within one year after the date of acquisition and (iii) investments in
money market accounts substantially all of whose assets comprise securities of
the types described in clauses (i) and (ii) above.
"CONSOLIDATED COVERAGE RATIO" of any Person as of the date of the
transaction giving rise to the need to calculate the Consolidated Coverage Ratio
(the "Transaction Date") means the ratio, on a PRO FORMA basis, of (a) the
aggregate amount of Consolidated EBITDA of such Person attributable to
continuing operations and businesses (exclusive of amounts attributable to
operations and businesses permanently discontinued or disposed of) for the
Reference Period to (b) the aggregate Consolidated Fixed Charges of such Person
(exclusive of amounts attributable to operations and businesses permanently
discontinued or disposed of, but only to the extent that the obligations giving
rise to such Consolidated Fixed Charges would no longer be obligations
contributing to such Person's Consolidated Fixed Charges subsequent to the
Transaction Date) during the Reference Period; PROVIDED that for purposes of
this definition, (i) Acquisitions which occurred during the Reference Period or
subsequent to the Reference Period and on or prior to the Transaction Date shall
be assumed to have occurred on the first day of the Reference Period, (ii)
transactions giving rise to the need to calculate the Consolidated Coverage
Ratio shall be assumed to have occurred on the first day of the Reference
Period, (iii) the incurrence of any Indebtedness or issuance of any Disqualified
Capital Stock during the Reference Period or subsequent to the Reference Period
and on or prior to the Transaction Date (and the application of the proceeds
therefrom to the extent used to refinance or retire other Indebtedness) shall be
assumed to have occurred on the first day of such Reference Period, and (iv) the
Consolidated Fixed Charges of such Person attributable to interest on any
Indebtedness or dividends on any Disqualified Capital Stock bearing a floating
interest (or dividend) rate shall be computed on a PRO FORMA basis as if the
average rate in effect from the beginning of the Reference Period to the
Transaction Date had been the applicable rate for the entire period, unless such
Person or any of its Subsidiaries is a party to an Interest Swap or Hedging
Obligation (which shall remain in effect for the 12-month period immediately
following the Transaction Date) that either (i) has the effect of fixing the
interest rate on the date of computation, in which case such fixed rate (whether
higher or lower) shall be used or (ii) has the effect of capping the interest
rate on the date of computation, in which case such capped rate (if lower) shall
be used.
"CONSOLIDATED EBITDA" means, with respect to any Person, for any period, the
Consolidated Net Income of such Person for such period adjusted to add thereto
(to the extent deducted from net revenues in determining Consolidated Net
Income), without duplication, the sum of (i) Consolidated Income Tax Expense,
(ii) Consolidated Depreciation and Amortization Expense, PROVIDED that
Consolidated Depreciation and Amortization Expense of a Subsidiary that is not a
Wholly Owned Subsidiary shall only proportionately be added to the extent of the
proportionate equity interest of the Company in
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such Subsidiary, (iii) Consolidated Fixed Charges, (iv) all other non-cash
charges, less the amount of all cash payments made by such Person or any of its
Subsidiaries during such period to the extent such payments relate to non-cash
charges that were added back in determining Consolidated EBITDA for such period
or any prior period, and (v) for periods including and prior to June 5, 1996,
salary paid to Raymond Scherr as Chairman of the Company (to the extent such
salary reduced Consolidated Net Income).
"CONSOLIDATED FIXED CHARGES" of any Person means, for any period, the
aggregate amount (without duplication and determined in each case in accordance
with GAAP) of (a) interest expensed or capitalized, paid, accrued, or scheduled
to be paid or accrued (including, in accordance with the following sentence,
interest attributable to Capitalized Lease Obligations) of such Person and its
Consolidated Subsidiaries during such period, including (i) original issue
discount and non-cash interest payments or accruals on any Indebtedness, (ii)
the interest portion of all deferred payment obligations, and (iii) all
commissions, discounts and other fees and charges owed with respect to bankers'
acceptances and letters of credit financings and currency and Interest Swap and
Hedging Obligations, in each case to the extent attributable to such period, and
(b) the amount of cash dividends paid or scheduled to be paid by such Person or
any of its Consolidated Subsidiaries in respect of Preferred Stock (other than
by Subsidiaries of such Person to such Person or such Person's Wholly Owned
Subsidiaries). For purposes of this definition, (x) interest on a Capitalized
Lease Obligation shall be deemed to accrue at an interest rate reasonably
determined by the Company to be the rate of interest implicit in such
Capitalized Lease Obligation in accordance with GAAP and (y) interest expense
attributable to any Indebtedness represented by the guaranty by such Person or a
Subsidiary of such Person of an obligation of another Person shall be deemed to
be the interest expense attributable to the Indebtedness guaranteed.
"CONSOLIDATED NET INCOME" means, with respect to any Person for any period,
the net income (or loss) of such Person and its Consolidated Subsidiaries
(determined on a consolidated basis in accordance with GAAP), plus, without
duplication and only to the extent not already included in net income, cash
dividends received by the Company from Unrestricted Subsidiaries (not in excess
of the Company's or such Subsidiary's proportionate share of the equity interest
therein) for such period, adjusted to exclude (only to the extent included in
computing such net income (or loss) and without duplication): (a) all gains and
losses which are either extraordinary (as determined in accordance with GAAP) or
are either unusual or nonrecurring (including any gain or loss from the sale or
other disposition of assets outside the ordinary course of business or from the
issuance or sale of any Capital Stock), (b) the net income, if positive, of any
Person, other than a Wholly Owned Subsidiary, in which such Person or any of its
Consolidated Subsidiaries has an interest, except to the extent of the amount of
any dividends or distributions actually paid in cash to such Person or a Wholly
Owned Subsidiary of such Person during such period, but in any case not in
excess of such Person's PRO RATA share of such Person's net income for such
period, (c) the net income or loss of any Person acquired in a pooling of
interests transaction for any period prior to the date of such acquisition, (d)
the net income, if positive, of any of such Person's Consolidated Subsidiaries
to the extent that the declaration or payment of dividends or similar
distributions is not at the time permitted by operation of the terms of its
charter or bylaws or any other agreement, instrument, judgment, decree, order,
statute, rule or governmental regulation applicable to such Consolidated
Subsidiary, and (e) the effect of non-cash charges resulting solely from the
issuance and/or lapse of substantial risk of forfeiture of Junior Preferred
Stock issued to members of the Company's management in connection with and at
the time of the Recapitalization.
"CONSOLIDATED NET WORTH" of any Person at any date means the aggregate
consolidated stockholders' equity of such Person (plus amounts of equity
attributable to preferred stock of such Person) and its Consolidated
Subsidiaries, as would be shown on the consolidated balance sheet of such Person
prepared in accordance with GAAP, adjusted to exclude (to the extent included in
calculating such equity), (a) the amount of any such stockholders' equity
attributable to Disqualified Capital Stock or treasury stock of such Person and
its Consolidated Subsidiaries, and (b) amounts included in such stockholders'
equity resulting from upward revaluations and other write-ups in the book value
of assets of such Person or a Consolidated Subsidiary of such Person subsequent
to the Issue Date.
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"CONSOLIDATED SUBSIDIARY" means, for any Person, each Subsidiary of such
Person (whether now existing or hereafter created or acquired) the financial
statements of which are consolidated for financial statement reporting purposes
with the financial statements of such Person in accordance with GAAP.
"CREDIT AGREEMENT" means the Credit Agreement, dated as of June 5, 1996,
between the Company and Wells Fargo Bank, N.A., and all refundings,
refinancings, amendments, modifications, replacements (solely with institutional
lenders of national reputation) and supplements thereto.
"DISQUALIFIED CAPITAL STOCK" means (a), except as set forth in (b), with
respect to any Person, any Equity Interest of such Person that, by its terms or
by the terms of any security into which it is convertible, exercisable or
exchangeable, is, or upon the happening of an event or the passage of time would
be, required to be redeemed or repurchased (including at the option of the
Holder thereof) by such Person or any of its Subsidiaries, in whole or in part,
on or prior to the Stated Maturity of the Notes and (b) with respect to any
Subsidiary of such Person (including with respect to any Subsidiary of the
Company), any Equity Interest other than any common equity with no preference,
privileges, or redemption or repayment provisions.
"ELIGIBLE INVENTORY" means the book value of all inventory owned by the
Company and its Subsidiaries as would be reportable on a consolidated balance
sheet prepared in accordance with GAAP .
"ELIGIBLE RECEIVABLES" means the face amount of all accounts receivable
owned by the Company and its Subsidiaries as would be reportable on a
consolidated balance sheet in compliance with GAAP.
"EQUITY INTEREST" of any Person means any shares, interests, warrants,
options, participations or other equivalents (however designated) in such
Person's equity, and shall in any event include any Capital Stock issued by, or
partnership interests in, such Person.
"EVENT OF LOSS" means, with respect to any property or asset, any (i) loss,
destruction or damage of such property or asset or (ii) any condemnation,
seizure or taking, by exercise of the power of eminent domain or otherwise, of
such property or asset, or confiscation or requisition of the use of such
property or asset.
"EXEMPTED AFFILIATE TRANSACTION" means (i) compensation paid to officers and
directors of the Company pursuant to the Ancillary Documents as in effect on the
date the shares of Senior Preferred Stock were first issued, (ii) any loans or
advances by the Company to employees of the Company or a subsidiary of the
Company in the ordinary course of business and in furtherance of the Company's
business, in an aggregate amount not to exceed $1 million at any one time
outstanding, (iii) transactions expressly contemplated by the Transaction
Documents (including, without limitation, the repurchase of shares of Junior
Preferred Stock and Common Stock held by employees), (iv) transactions with
employees of the Company (including but not limited to compensation arrangements
or loans and advances not referred to in clause (i) or (ii) that have been
approved by the Board of Directors, including a majority of the disinterested
directors, as being in the best interests of the Company) and (v) transactions
between or among the Company and one or more of its Wholly Owned Subsidiares and
between or among the Company's Wholly Owned Subsidiaries.
"EXISTING INDEBTEDNESS" means Indebtedness of the Company outstanding on the
Issue Date after giving effect to the redemption of the Bridge Facility.
"GAAP" means United States generally accepted accounting principles set
forth in the opinions and pronouncements of the Accounting Principles Board of
the American Institute of Certified Public Accountants and statements and
pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as approved by a significant segment of the
accounting profession as in effect on the Issue Date.
"INDEBTEDNESS" of any Person means, without duplication, (a) all liabilities
and obligations, contingent or otherwise, of such any Person, (i) in respect of
borrowed money (whether or not the recourse of the lender is to the whole of the
assets of such Person or only to a portion thereof), (ii) evidenced by bonds,
notes, debentures or similar instruments, (iii) representing the balance
deferred and unpaid of
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the purchase price of any property or services, except (other than accounts
payable or other obligations to trade creditors (not the result of borrowed
money) which have remained unpaid for greater than 90 days past their original
due date) those incurred in the ordinary course of its business that would
constitute ordinarily a trade payable (including trade payables due within 12
months representing special terms offered by vendors in connection with new
store openings, "special buy" situations or promotional situations) to trade
creditors (which in no event provide for payment more than 12 months after
delivery of goods or provision of services), (iv) evidenced by bankers'
acceptances or similar instruments issued or accepted by banks, (v) relating to
any Capitalized Lease Obligation, or (vi) evidenced by a letter of credit or a
reimbursement obligation of such Person with respect to any letter of credit;
(b) all net obligations of such Person under Interest Swap and Hedging
Obligations; (c) all liabilities and obligations of others of the kind described
in the preceding clause (a) or (b) that such Person has guaranteed or that is
otherwise its legal liability, or which are secured by any assets or property
(limited, in such case, to the lesser of the amount of such Indebtedness or the
fair market value of such assets or property) of such Person, and all
obligations to purchase, redeem or acquire any Equity Interests; (d) any and all
deferrals, renewals, extensions, refinancing and refundings (whether direct or
indirect) of, or amendments, modifications or supplements to, any liability of
the kind described in any of the preceding clauses (a), (b) or (c), or this
clause (d), whether or not between or among the same parties; and (e) all
Disqualified Capital Stock of such Person (measured at the greater of its
voluntary or involuntary maximum fixed repurchase price plus accrued and unpaid
dividends). For purposes hereof, the "maximum fixed repurchase price" of any
Disqualified Capital Stock which does not have a fixed repurchase price shall be
calculated in accordance with the terms of such Disqualified Capital Stock as if
such Disqualified Capital Stock were purchased on any date on which Indebtedness
shall be required to be determined pursuant to the Indenture, and if such price
is based upon, or measured by, the fair market value of such Disqualified
Capital Stock, such fair market value to be determined in good faith by the
board of directors of the issuer (or managing general partner of the issuer) of
such Disqualified Capital Stock.
"INITIAL PUBLIC EQUITY OFFERING" means an initial underwritten offering of
Common Stock of the Company pursuant to an effective registration statement
under the Securities Act as a consequence of which the Common Stock of the
Company is listed on a national securities exchange or quoted on the national
market system of NASDAQ.
"INTEREST SWAP AND HEDGING OBLIGATION" means any obligation of any Person
pursuant to any interest rate swap agreement, interest rate cap agreement,
interest rate collar agreement, interest rate exchange agreement, currency
exchange agreement or any other agreement or arrangement designed to protect
against fluctuations in interest rates or currency values, including, without
limitation, any arrangement whereby, directly or indirectly, such Person is
entitled to receive from time to time periodic payments calculated by applying
either a fixed or floating rate of interest on a stated notional amount in
exchange for periodic payments made by such Person calculated by applying a
fixed or floating rate of interest on the same notional amount.
"INVESTMENT" by any Person in any other Person means (without duplication)
(a) the acquisition (whether by purchase, merger, consolidation or otherwise) by
such Person (whether for cash, property, services, securities or otherwise) of
capital stock, bonds, notes, debentures, partnership or other ownership
interests or other securities, including any options or warrants, of such other
Person or any agreement to make any such acquisition; (b) the making by such
Person of any deposit with, or advance, loan or other extension of credit to,
such other Person (including the purchase of property from another Person
subject to an understanding or agreement, contingent or otherwise, to resell
such property to such other Person) or any commitment to make any such advance,
loan or extension (but excluding accounts receivable or deposits arising in the
ordinary course of business); (c) other than guarantees of Indebtedness of the
Company to the extent permitted by the covenant "Limitation on Incurrence of
Additional Indebtedness and Disqualified Capital Stock," the entering into by
such Person of any guarantee of, or other credit support or contingent
obligation with respect to, Indebtedness or other liability of such other
Person; (d) the making of any capital contribution by such Person to such
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other Person; and (e) the designation by the Board of Directors of the Company
of any person to be an Unrestricted Subsidiary. The Company shall be deemed to
make an Investment in an amount equal to the fair market value (as reasonably
determined in good faith by the Board of Directors) of the net assets of any
Subsidiary (or, if neither the Company nor any of its Subsidiaries has
theretofore made an Investment in such Subsidiary, in an amount equal to the
Investments being made), at the time that such subsidiary is designated an
Unrestricted Subsidiary, and any property transferred to an Unrestricted
Subsidiary from the Company or a Subsidiary shall be deemed an Investment valued
at its fair market value (as reasonably determined in good faith by the Board of
Directors) at the time of such transfer.
"ISSUE DATE" means the date of first issuance of the Notes under the
Indenture.
"LIEN" means any mortgage, charge, pledge, lien (statutory or otherwise),
privilege, security interest, hypothecation or other encumbrance upon or with
respect to any property of any kind, real or personal, movable or immovable, now
owned or hereafter acquired (excluding any option, warrant, right to purchase or
other similar right with respect to Qualified Capital Stock).
"NET CASH PROCEEDS" means the aggregate amount of cash or Cash Equivalents
received by the Company in the case of a sale of Qualified Capital Stock and by
the Company and its Subsidiaries in respect of an Asset Sale plus, in the case
of an issuance of Qualified Capital Stock upon any exercise, exchange or
conversion of securities (including options, warrants, rights and convertible or
exchangeable debt) of the Company that were issued for cash on or after the
Issue Date, the amount of cash originally received by the Company upon the
issuance of such securities (including options, warrants, rights and convertible
or exchangeable debt) less, in each case, the sum of all payments, fees,
commissions and (in the case of Asset Sales, reasonable and customary) expenses
(including, without limitation, the fees and expenses of legal counsel and
investment banking fees and expenses) incurred in connection with such Asset
Sale or sale of Qualified Capital Stock, and, in the case of an Asset Sale only,
less (i) the amount (estimated reasonably and in good faith by the Company) of
income, franchise, sales and other applicable taxes required to be paid by the
Company or any of its Subsidiaries in connection with such Asset Sale and (ii)
appropriate amounts provided by the seller as a reserve, in accordance with
GAAP, against (a) any liabilities associated with the property or assets
disposed of in such Asset Sale, and (b) the after-tax cost of any
indemnification payments (fixed and contingent) attributable to the seller's
indemnities to the purchaser undertaken by the Company or any of its
Subsidiaries in connection with such Asset Sale (but excluding any payments,
which by the terms of the indemnities will not be made prior to the Stated
Maturity of the Notes).
"PERMITTED INDEBTEDNESS" means any of the following:
(a) Indebtedness incurred by the Company to any Wholly Owned Subsidiary,
and any Wholly Owned Subsidiary may incur Indebtedness to any other
Wholly Owned Subsidiary or to the Company; PROVIDED that, in the case of
Indebtedness of the Company, such obligations shall be unsecured and
subordinated in all respects to the Company's obligations pursuant to the
Notes and the date of any event that causes such Subsidiary no longer to be
a Wholly Owned Subsidiary shall be an Incurrence Date;
(b) Indebtedness incurred by the Company evidenced by the Notes and
represented by the Indenture up to the amounts specified therein as
of the date thereof;
(c) Purchase Money Indebtedness (including any Indebtedness issued to
refinance, replace or refund such Indebtedness so long as such
Indebtedness is secured only by the assets that secured the Indebtedness so
refinanced, replaced or refunded on a non-recourse basis) incurred by the
Company and its Subsidiaries on or after the Issue Date, PROVIDED that (i)
the aggregate amount of such Indebtedness incurred on or after the Issue
Date and outstanding at any time pursuant to this paragraph (c) (including
Indebtedness issued so to refinance, replace or refund) shall not exceed $5
million, and (ii) in each case, such Indebtedness when incurred shall not
constitute less than 50% nor more than 100% of the cost (determined in
accordance with GAAP) to the Company of the property so purchased or leased;
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(d) Refinancing Indebtedness incurred by the Company with respect to any
Indebtedness or Disqualified Capital Stock, as applicable, incurred
as permitted by the Debt Incurrence Ratio contained in the "Limitation on
Incurrence of Additional Indebtedness and Disqualified Capital Stock"
covenant or as described in clause (b) of this definition or described in
this clause (d) or Existing Indebtedness (after giving effect to the
repayment of the Bridge Facility);
(e) Indebtedness incurred pursuant to the Credit Agreement (including any
Indebtedness issued to refinance, refund or replace such
Indebtedness); provided that, after giving effect to any such incurrence,
the aggregate principal amount of such Indebtedness then outstanding does
not exceed the greater of (i) $25 million and (ii) the Borrowing Base, which
such amount (in the case of (i) or (ii)) shall be reduced by the amount of
any Indebtedness outstanding pursuant to the Credit Agreement retired with
Net Cash Proceeds from any Asset Sale or assumed by a transferee in an Asset
Sale;
(f) Disqualified Capital Stock issued as in-kind dividends on the Senior
Preferred Stock or accretion to the liquidation value thereof
pursuant to the instrument governing the terms of such capital stock as such
instrument was in effect on the Issue Date; and
(g) unsecured Indebtedness incurred by the Company (in addition to
Indebtedness permitted by any other clause of this paragraph) in an
aggregate amount outstanding at any time (including any Indebtedness issued
to refinance, replace, or refund such Indebtedness) of up to $10 million.
"PERMITTED INVESTMENT" means Investments in (a) any of the Notes; (b) Cash
Equivalents; and (c) intercompany indebtedness to the extent permitted under
clause (a) of the definition of "Permitted Indebtedness."
"PERMITTED LIEN" means (a) Liens existing on the Issue Date; (b) Liens
imposed by governmental authorities for taxes, assessments or other charges not
yet subject to penalty or which are being contested in good faith and by
appropriate proceedings, if adequate reserves with respect thereto are
maintained on the books of the Company in accordance with GAAP; (c) statutory
liens of carriers, warehousemen, mechanics, materialmen, landlords, repairmen or
other like Liens arising by operation of law in the ordinary course of business,
PROVIDED that (i) the underlying obligations are not overdue for a period of
more than 30 days, or (ii) such Liens are being contested in good faith and by
appropriate proceedings and adequate reserves with respect thereto are
maintained on the books of the Company in accordance with GAAP; (d) Liens
securing the performance of bids, trade contracts (other than borrowed money),
leases, statutory obligations, surety and appeal bonds, performance bonds,
deposits in connection with the purchase of real property, and other obligations
of a like nature incurred in the ordinary course of business; (e) easements,
rights-of-way, zoning, similar restrictions and other similar encumbrances or
title defects which, singly or in the aggregate, do not in any case materially
detract from the value of the property subject thereto (as such property is used
by the Company or any of its Subsidiaries) or interfere with the ordinary
conduct of the business of the Company or any of its Subsidiaries; (f) Liens
arising by operation of law in connection with judgments, only to the extent,
for an amount and for a period not resulting in an Event of Default with respect
thereto; (g) pledges or deposits made in the ordinary course of business in
connection with workers' compensation, unemployment insurance and other types of
social security legislation; (h) Liens securing the Notes; (i) Liens securing
Indebtedness of a Person existing at the time such Person becomes a Subsidiary
or is merged with or into the Company or a Subsidiary or Liens securing
Indebtedness incurred in connection with an Acquisition, PROVIDED that such
Liens were in existence prior to the date of such acquisition, merger or
consolidation, were not incurred in anticipation thereof, and do not extend to
any property or assets other than property or assets acquired in such
transaction; (j) Liens arising from Purchase Money Indebtedness permitted to be
incurred under clause (c) of the definition of "Permitted Indebtedness,"
PROVIDED such Liens relate only to the property which is subject to such
Purchase Money Indebtedness and PROVIDED, FURTHER, that cross-collateralization,
creation of "collateral pools" or similar arrangements involving solely Purchase
Money Indebtedness and the assets serving as collateral therefor shall be
Permitted Liens; (k) leases or subleases granted to other Persons in the
ordinary course of business not
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materially interfering with the conduct of the business of the Company or any of
its Subsidiaries or materially detracting from the value of the relative assets
of the Company or any Subsidiary; (l) Liens arising from precautionary Uniform
Commercial Code financing statement filings regarding operating leases entered
into by the Company or any of its Subsidiaries in the ordinary course of
business; (m) Liens securing Refinancing Indebtedness incurred to refinance any
Indebtedness that was previously so secured in a manner no more adverse to the
Holders of the Notes than the terms of the Liens securing such refinanced
Indebtedness (provided that any Refinancing Indebtedness with respect to the
Credit Agreement need not have any limitation on when such Liens are granted or
perfected), PROVIDED that the Indebtedness secured is not increased, except to
finance accrued interest and the expenses of such refinancing, and the lien is
not extended to any additional assets or property; (n) Liens in favor of the
Company only; and (o) Liens imposed pursuant to the terms of the Credit
Agreement.
"PURCHASE MONEY INDEBTEDNESS" means any Indebtedness of such Person to any
seller or other Person (i) incurred solely to finance the acquisition (including
in the case of a Capitalized Lease Obligation only, the lease) of any real or
personal tangible property which, in the reasonable good faith judgment of the
Board of Directors of the Company, is directly related to a Related Business of
the Company, (ii) which is incurred within 90 days of such acquisition, and
(iii) is secured only by assets so financed.
"QUALIFIED CAPITAL STOCK" means any Capital Stock of the Company that is not
Disqualified Capital Stock.
"QUALIFIED EXCHANGE" means any legal defeasance, redemption, retirement,
repurchase or other acquisition of Equity Interests or Indebtedness of the
Company with the Net Cash Proceeds received by the Company from the
substantially concurrent sale of Qualified Capital Stock or any exchange of
Qualified Capital Stock for any Capital Stock or Indebtedness.
"REFERENCE PERIOD" with regard to any period means the four full fiscal
quarters (or such lesser period during which such Person has been in existence)
ended immediately preceding any date upon which any determination is to be made
pursuant to the terms of the Notes or the Indenture.
"REFINANCING INDEBTEDNESS" means Indebtedness or Disqualified Capital Stock
(a) issued in exchange for, or the proceeds from the issuance and sale of which
are used substantially concurrently to repay, redeem, defease, refund,
refinance, discharge or otherwise retire for value, in whole or in part, or (b)
constituting an amendment, modification or supplement to, or a deferral or
renewal of ((a) and (b) above are, collectively, a "Refinancing"), any
Indebtedness or Disqualified Capital Stock in a principal amount or, in the case
of Disqualified Capital Stock, liquidation preference, not to exceed (after
deduction of reasonable and customary fees and expenses incurred in connection
with the Refinancing) the lesser of (i) the principal amount or, in the case of
Disqualified Capital Stock, liquidation preference including accrued dividends
thereon, of the Indebtedness or Disqualified Capital Stock so Refinanced and
(ii) if such Indebtedness being Refinanced was issued with an original issue
discount, the accreted value thereof (as determined in accordance with GAAP) at
the time of such Refinancing; PROVIDED that (A) Refinancing Indebtedness
incurred by any Subsidiary of the Company shall only be used to Refinance
outstanding Indebtedness or Disqualified Capital Stock of such Subsidiary, (B)
Refinancing Indebtedness shall (x) not have an Average Life shorter than the
Indebtedness or Disqualified Capital Stock to be so refinanced at the time of
such Refinancing and (y) in all respects, be no less subordinated or junior, if
applicable, to the rights of Holders of the Notes than was the Indebtedness or
Disqualified Capital Stock to be refinanced and (C) Refinancing Indebtedness
shall have a final stated maturity or redemption date, as applicable, no earlier
than the final stated maturity or redemption date, as applicable, of the
Indebtedness or Disqualified Capital Stock to be so refinanced.
"RELATED BUSINESS" means the business conducted (or proposed to be
conducted) by the Company and its Subsidiaries as of the Issue Date and any and
all businesses that in the good faith judgment of the Board of Directors of the
Company are materially related businesses.
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"RESTRICTED INVESTMENT" means, in one or a series of related transactions,
any Investment, other than investments in Permitted Investments.
"RESTRICTED PAYMENT" means, with respect to any Person, (a) the declaration
or payment of any dividend or other distribution in respect of Equity Interests
of such Person or any parent or Subsidiary of such Person, (b) any payment on
account of the purchase, redemption or other acquisition or retirement for value
of Equity Interests of such Person or any Subsidiary or parent of such Person,
(c) other than with the proceeds from the substantially concurrent sale of, or
in exchange for, Refinancing Indebtedness, any purchase, redemption, or other
acquisition or retirement for value of, any payment in respect of any amendment
of the terms of or any defeasance of, any Subordinated Indebtedness, directly or
indirectly, by such Person or a parent or Subsidiary of such Person prior to the
scheduled maturity, any scheduled repayment of principal, or scheduled sinking
fund payment, as the case may be, of such Indebtedness and (d) any Restricted
Investment by such Person; PROVIDED, HOWEVER, that the term "Restricted Payment"
does not include (i) any dividend, distribution or other payment on or with
respect to Capital Stock of an issuer to the extent payable solely in shares of
Qualified Capital Stock of such issuer; or (ii) any dividend, distribution or
other payment to the Company by any of its Subsidiaries.
"STATED MATURITY," when used with respect to any Note, means July 1, 2006.
"STOCKHOLDERS AGREEMENT" means the agreement dated as of June 5, 1996, among
the Company and the stockholders listed on the various schedules thereto, as in
effect on the Issue Date.
"SUBORDINATED INDEBTEDNESS" means Indebtedness of the Company that is
subordinated in right of payment to the Notes in any respect.
"SUBSIDIARY," with respect to any Person, means (i) a corporation a majority
of whose Capital Stock with voting power, under ordinary circumstances, to elect
directors is at the time, directly or indirectly, owned by such Person, by such
Person and one or more Subsidiaries of such Person or by one or more
Subsidiaries of such Person, (ii) any other Person (other than a corporation) in
which such Person, one or more Subsidiaries of such Person, or such Person and
one or more Subsidiaries of such Person, directly or indirectly, at the date of
determination thereof has at least majority ownership interest, or (iii) a
partnership in which such Person or a Subsidiary of such Person is, at the time,
a general partner. Notwithstanding the foregoing, an Unrestricted Subsidiary
shall not be a Subsidiary of the Company or of any Subsidiary of the Company.
Unless the context requires otherwise, Subsidiary means each direct and indirect
Subsidiary of the Company.
"TRANSACTION DOCUMENTS" means the Investor Agreement, the Bridge Financing
Agreement, the Securities Purchase Agreement, the Registration Agreement, the
Tax Indemnification Agreement, and the Ancillary Documents, in each case as such
documents are in effect on the date shares of Senior Preferred Stock are first
issued.
"UNRESTRICTED SUBSIDIARY" means any subsidiary of the Company that does not
own any Capital Stock of, or own or hold any Lien on any property of, the
Company or any other Subsidiary of the Company and that, at the time of
determination, shall be an Unrestricted Subsidiary (as designated by the Board
of Directors of the Company); PROVIDED that (i) such subsidiary shall not
engage, to any substantial extent, in any line or lines of business activity
other than a Related Business, (ii) neither immediately prior thereto nor after
giving PRO FORMA effect to such designation would there exist a Default or Event
of Default and (iii) any Investment therein shall not be prohibited by the
"Limitation on Restricted Payments" covenant. The Board of Directors of the
Company may designate any Unrestricted Subsidiary to be a Subsidiary, PROVIDED
that (i) no Default or Event of Default is existing or will occur as a
consequence thereof and (ii) immediately after giving effect to such
designation, on a PRO FORMA basis, the Company could incur at least $1.00 of
Indebtedness pursuant to the Debt Incurrence Ratio in the covenant "Limitation
on Incurrence of Additional Indebtedness and Disqualified Capital Stock." Each
such designation shall be evidenced by filing with the Trustee a certified copy
of the resolution giving effect to such designation and an Officers' Certificate
certifying that such designation complied with the foregoing conditions.
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"WHOLLY OWNED SUBSIDIARY" means a Subsidiary all the Equity Interests of
which are owned by the Company or one or more Wholly Owned Subsidiaries of the
Company.
BOOK-ENTRY, DELIVERY AND FORM
Except as set forth below, the Notes have been issued in the form of one or
more registered Notes in global form (the "Global Notes"). Each Global Note has
been deposited with, or on behalf of, The Depository Trust Company (the
"Depositary") and registered in the name of Cede & Co., as nominee of the
Depositary.
The Depositary is (i) a limited-purpose trust company organized under the
New York Banking Law; (ii) a member of the Federal Reserve System; (iii) a
"clearing corporation" within the meaning of the New York Uniform Commercial
Code; and (iv) a "clearing agency" registered pursuant to Section 17A of the
Exchange Act. The Depositary holds securities that its participating
organizations (collectively, the "Participants") deposit with the Depositary.
The Depositary also facilitates the settlement of transactions in such
securities between Participants, such as transfers and pledges in deposited
securities through electronic computerized book-entry changes in accounts of its
Participants, thereby eliminating the need for physical movement of securities
certificates. The Depositary's Participants include securities brokers and
dealers (including the Initial Purchasers), banks and trust companies, clearing
corporations and certain other organizations. The Depositary is owned by a
number of its Participants and by the New York Stock Exchange, Inc., the
American Stock Exchange, Inc. and the National Association of Securities
Dealers, Inc. Access to the Depositary's system is also available to other
entities such as banks, brokers, dealers and trust companies (collectively, the
"Indirect Participants") that clear through or maintain a custodial relationship
with a Participant, either directly or indirectly. The rules applicable to the
Depositary and its Participants are on file with the SEC. QIBs may elect to hold
Notes purchased by them through the Depositary. QIBs who are not Participants
may beneficially own securities held by or on behalf of the Depositary only
through Participants or Indirect Participants. Persons who are not QIBs may not
hold Notes through the Depositary.
The Company expects that pursuant to procedures established by the
Depositary, upon deposit of the Global Note, the Depositary will credit the
accounts of Participants with an interest in the Global Note, and ownership of
the Notes evidenced by the Global Note will be shown on, and the transfer of
ownership thereof will be effected only through, records maintained by the
Depositary (with respect to the interests of Participants), the Participants and
the Indirect Participants. The laws of some states require that certain persons
take physical delivery in definitive form of securities that they own and that
security interests in negotiable instruments can only be perfected by delivery
of certificates representing the instruments. Consequently, the ability to
transfer Notes or to pledge the Notes as collateral will be limited to such
extent. For certain other restrictions on the transferability of the Notes, see
"Notice to Investors."
So long as the Depositary or its nominee is the registered owner of a Global
Note, the Depositary or such nominee, as the case may be, will be considered the
sole owner or holder of the Notes represented by the Global Note for all
purposes under the Indenture. Except as provided below, owners of beneficial
interests in a Global Note will not be entitled to have Notes represented by
such Global Note registered in their names, will not receive or be entitled to
receive physical delivery of Certificated Securities, and will not be considered
the owners or holders thereof under the Indenture for any purpose, including
with respect to the giving of any directions, instructions or approvals to the
Trustee thereunder. As a result, the ability of a person having a beneficial
interest in Notes represented by a Global Note to pledge such interest to
persons or entities that do not participate in the Depositary's system, or to
otherwise take actions with respect to such interest, may be affected by the
lack of a physical certificate evidencing such interest.
Accordingly, each Holder owning a beneficial interest in a Global Note must
rely on the procedures of the Depositary and, if such Holder is not a
Participant or an Indirect Participant, on the procedures of the Participant
through which such Holder owns its interest, to exercise any rights of a holder
under the Indenture or such Global Note. The Company understands that under
existing industry practice, in the event the Company requests any action of
Holders of Notes or a Holder that is an owner of a beneficial
76
<PAGE>
interest in a Global Note desires to take any action that the Depositary, as the
holder of such Global Note, is entitled to take, the Depositary would authorize
the Participants to take such action and the Participants would authorize
Holders owning through such Participants to take such action or would otherwise
act upon the instructions of such Holders. Neither the Company nor the Trustee
will have any responsibility or liability for any aspect of the records relating
to or payments made on account of Notes by the Depositary, or for maintaining,
supervising or reviewing any records of the Depositary relating to such Notes.
Payments with respect to the principal of, premium, if any, and interest on
any Notes represented by a Global Note registered in the name of the Depositary
or its nominee on the applicable record date will be payable by the Trustee to
or at the direction of the Depositary or its nominee in its capacity as the
registered holder of the Global Note representing such Notes under the
Indenture. Under the terms of the Indenture, the Company and the Trustee may
treat the persons in whose names the Notes, including the Global Notes, are
registered as the owners thereof for the purpose of receiving such payments and
for any and all other purposes whatsoever. Consequently, neither the Company nor
the Trustee has or will have any responsibility or liability for the payment of
such amounts to beneficial owners of Notes (including principal, premium, if
any, and interest), or to immediately credit the accounts of the relevant
Participants with such payment, in amounts proportionate to their respective
holdings in principal amount of beneficial interest in the Global Note as shown
on the records of the Depositary. Payments by the Participants and the Indirect
Participants to the beneficial owners of Notes will be governed by standing
instructions and customary practice and will be the responsibility of the
Participants or the Indirect Participants.
CERTIFICATED SECURITIES
If (i) the Company notifies the Trustee in writing that the Depositary is no
longer willing or able to act as a depository and the Company is unable to
locate a qualified successor within 90 days; or (ii) the Company, at its option,
notifies the Trustee in writing that it elects to cause the issuance of Notes in
definitive form under the Indenture, then, upon surrender by the Depositary of
its Global Note, Certificated Securities will be issued to each person that the
Depositary identifies as the beneficial owner of the Notes represented by the
Global Note. In addition, subject to certain conditions, any person having a
beneficial interest in a Global Note may, upon request to the Trustee, exchange
such beneficial interest for Certificated Securities. Upon any such issuance,
the Trustee is required to register such Certificated Securities in the name of
such person or persons (or the nominee of any thereof), and cause the same to be
delivered thereto.
Neither the Company nor the Trustee shall be liable for any delay by the
Depositary or any Participant or Indirect Participant in identifying the
beneficial owners of the related Notes and the Company and the Trustee may
conclusively rely on, and shall be protected in relying on, instructions from
the Depositary for all purposes (including with respect to the registration and
delivery, and the respective principal amounts, of the Notes to be issued).
The information in this section concerning the Depositary and the
Depositary's book-entry system has been obtained from sources that the Company
believes to be reliable. The Company will have no responsibility for the
performance by the Depositary or its Participants of their respective
obligations as described hereunder or under the rules and procedures governing
their respective operations.
SAME-DAY FUNDS SETTLEMENT AND PAYMENT
The Indenture requires that payments in respect of the Notes represented by
the Global Note (including principal, premium, if any, interest and liquidated
damages, if any) be made by wire transfer of immediately available funds to the
accounts specified by the Depositary. With respect to Notes represented by
Certificated Securities, the Company will make all payments of principal,
premium, if any, interest and liquidated damages, if any, by wire transfer of
immediately available funds to the accounts specified by the holders thereof or,
if no such account is specified, by mailing a check to each such holder's
registered address. Secondary trading in long-term notes and debentures of
corporate issuers is generally settled in clearing-house or next-day funds. In
contrast, the Notes represented by the Global Note are expected to trade in the
Depositary's Same-Day Funds Settlement System, and any permitted
77
<PAGE>
secondary market trading activity in such Notes will, therefore, be required by
the Depositary to be settled in immediately available funds. The Company expects
that secondary trading in the Certificated Securities will also be settled in
immediately available funds. No assurance can be given as to the effect, if any,
of settlement in immediately available funds on trading activity in the Notes.
78
<PAGE>
DESCRIPTION OF THE 1996 CREDIT FACILITY
GENERAL. The Company has entered into the 1996 Credit Facility with Wells
Fargo Bank. The 1996 Credit Facility provides for a $25 million revolving credit
facility, including a sub-limit for letters of credit of $10 million, and
expires on June 1, 2001. This summary of the 1996 Credit Facility is qualified
in its entirety by reference to the 1996 Credit Facility which is filed as an
exhibit to the Registration Statement of which this Prospectus is a part.
Capitalized terms used in this description that are not defined herein have the
meaning given to such terms in the 1996 Credit Facility. The Company is
currently negotiating a new secured bank facility to replace the 1996 Credit
Facility, although no agreement has been reached as of the date of this
Prospectus. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
AVAILABILITY. Borrowings under the 1996 Credit Facility are subject to a
borrowing base limit equal to 80% of Eligible Receivables plus 70% of Eligible
Inventory minus, at all times prior to the occurrence of the Collateral
Perfection Date, Trade Payables.
SECURITY. Indebtedness of the Company under the 1996 Credit Facility is
currently unsecured. Upon the occurrence of certain events including (i) an
Event of Default or (ii) the failure by the Company to maintain certain ratios,
at the option of Wells Fargo Bank, the 1996 Credit Facility will be secured by a
security interest in certain assets and properties of the Company, including
accounts receivable, inventory, trademarks, copyrights, patents and general
intangibles, and all products and proceeds of any of the foregoing.
INTEREST. Indebtedness under the 1996 Credit Facility bears interest at a
rate based (at the Company's option) upon (i) in the case of Prime Rate Loans,
the Prime Rate plus a maximum margin of 1.50% (subject to reduction depending on
the ratio of Funded Debt to EBITDA); and (ii) in the case of Eurodollar Rate
Loans, the Eurodollar Rate for one, two, three, six, nine or twelve months, plus
a maximum margin of 3.00% (subject to reduction depending on the ratio of Funded
Debt to EBITDA).
MATURITY. The 1996 Credit Facility will mature on June 1, 2001. Loans made
pursuant to the 1996 Credit Facility may be borrowed, repaid and reborrowed from
time to time until such maturity date, subject to the satisfaction of certain
conditions on the date of any such borrowing.
REVOLVING CREDIT FACILITY FEES. The Company is required to pay Wells Fargo
Bank a facility fee of $250,000, of which $100,000 was paid and $50,000 is
payable at the end of each fiscal year of the Company, PROVIDED that upon
termination or cancellation of the 1996 Credit Facility, the Company must pay in
full the outstanding balance of the $250,000 facility fee. In addition, the
Company has agreed to pay to Wells Fargo Bank promptly upon demand, a fee of
$25,000 in consideration for Wells Fargo Bank agreeing to allow the Company to
use the proceeds of Revolving Loans to make loans to senior management in
respect of certain personal income tax liabilities. The Company is also required
to pay to Wells Fargo Bank a commitment fee based on the average daily unused
portion of the committed undrawn amount of the 1996 Credit Facility during the
preceding quarter equal to a maximum of 0.375% per annum (subject to reduction
depending on the ratio of Funded Debt to EBITDA), payable in arrears on a
quarterly basis. In addition to a normal issuance fee for each letter of credit
issued, the Company is required to pay to Wells Fargo Bank a letter of credit
fee based on the aggregate unpaid face amount of outstanding letters of credit
equal to a maximum of 3.00% (subject to reduction depending on the ratio of
Funded Debt to EBITDA), payable in arrears on a quarterly basis.
CONDITIONS TO EXTENSIONS OF CREDIT. The obligation of Wells Fargo Bank to
make loans or extend letters of credit is subject to the satisfaction of certain
conditions including, but not limited to, the absence of a default or event of
default under the 1996 Credit Facility, all representations and warranties under
the 1996 Credit Facility being true and correct in all material respects, and
that there has been no material adverse change in the Company's properties or
business.
COVENANTS. The 1996 Credit Facility requires the Company to meet certain
financial tests, including a maximum Funded Debt to EBITDA ratio, a minimum Debt
Service Coverage Ratio, a minimum level of profit, a minimum quarterly increase
in Tangible Net Worth and a minimum EBITDA. The 1996 Credit
79
<PAGE>
Facility also contains covenants which, among other things, limit: (i) the
incurrence of additional indebtedness; (ii) the nature of the business of the
Company; (iii) leases of assets; (iv) ownership of subsidiaries; (v) dividends;
(vi) capital expenditures; (vii) transactions with affiliates; (viii) asset
sales; (ix) acquisitions, mergers and consolidations; (x) loans and investments;
(xi) liens and encumbrances; and (xii) other matters customarily restricted in
loan agreements. The 1996 Credit Facility also contains additional covenants
which require the Company to maintain its existence and rights and franchises,
to maintain its properties, to maintain insurance on such properties, to provide
certain information to Wells Fargo Bank, including financial statements, notices
and reports and to permit inspections of the books and records of the Company
and its subsidiaries, to comply with applicable laws, including environmental
laws and ERISA, to pay taxes and contractual obligations and to use the proceeds
of the Revolving Loans to finance in part the Recapitalization, and for working
capital and other general corporate purpose.
EVENTS OF DEFAULT. Events of Default under the 1996 Credit Facility include
payment defaults, breach of representations, warranties and covenants (subject
to certain cure periods), cross-default to other indebtedness in excess of $2
million, dissolution of the Company, a material adverse change in the Company's
properties or business, certain events of bankruptcy and insolvency, breach of
ERISA covenants, judgment defaults in excess of $2 million and the occurrence of
a Change of Control.
INDEMNIFICATION. Under the 1996 Credit Facility, the Company has agreed to
indemnify Wells Fargo Bank and related persons from and against any and all
Losses (including, without limitation, the reasonable fees and disbursements of
counsel) that may be incurred by or asserted against any such indemnified party
(a) in any way relating to the Loan Documents, the Recapitalization, or the use
or intended use of the proceeds of the 1996 Credit Facility; (b) in connection
with any investigation, litigation or other proceeding relating to the
foregoing; or (c) in any way relating to or arising out of any Environmental
Claims; PROVIDED, HOWEVER, that the Company is not liable for any such Losses
resulting from such indemnified party's own gross negligence or willful
misconduct.
80
<PAGE>
PLAN OF DISTRIBUTION
This Prospectus may be used by Chase Securities in connection with offers
and sales related to market-making transactions in the Notes. Chase Securities
may act as principal or agent in such transactions. Such sales will be made at
prices related to prevailing market prices at the time of sale. The Company will
not receive any of the proceeds of such sales. Chase Securities has no
obligation to make a market in the Notes and may discontinue its market-making
activities at any time without notice, at its sole discretion. The Company has
agreed to indemnify Chase Securities against certain liabilities, including
liabilities under the Securities Act, and to contribute to payments which Chase
Securities might be required to make in respect thereof.
Chase Securities and its affiliates have in the past provided, and may in
the future provide, investment banking services and general financing and
banking services to the Company and its affiliates. An affiliate of Chase
Securites beneficially owns 4,381,265 shares of Common Stock (net of certain
options granted to certain members of the Company's management). See "Principal
Stockholders."
LEGAL MATTERS
The validity of the Notes offered hereby was passed upon by Buchalter,
Nemer, Fields & Younger, a Professional Corporation.
EXPERTS
The financial statements and schedule of Guitar Center, Inc. as of December
31, 1996 and for the year then ended have been included herein and in the
registration statement in reliance upon the report of KPMG Peat Marwick LLP,
independent certified public accountants, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.
The financial statements of Guitar Center, Inc. at December 31, 1995 and for
the two years ended December 31, 1995, appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their report thereon appearing elsewhere herein, and
are included in reliance upon such report given upon the authority of such firm
as experts in accounting and auditing.
In connection with the Recapitalization, Ernst & Young LLP was replaced on
July 24, 1996 by KPMG Peat Marwick LLP as the Company's independent certified
public accountants. The decision to change accountants was approved by the
Company's Board of Directors. The reports of Ernst & Young LLP on the Company's
financial statements for the past two fiscal years did not contain an adverse
opinion or a disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principles. In connection with the audits
of the Company's financial statements for each of the two fiscal years ended
December 31, 1995, and the subsequent interim period ended June 30, 1996, there
were no disagreements with Ernst & Young LLP on any matters of accounting
principles or practices, financial statement disclosure or auditing scope and
procedures which, if not resolved to the satisfaction of Ernst & Young LLP,
would have caused Ernst & Young LLP to make reference to the matter in their
report.
81
<PAGE>
GUITAR CENTER, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors (KPMG Peat Marwick LLP).................... F-2
Report of Independent Auditors (Ernst & Young LLP)........................ F-3
Balance Sheets as of December 31, 1995 and 1996........................... F-4
Statements of Operations for the years ended December 31, 1994, 1995 and
1996..................................................................... F-5
Statements of Stockholders' Equity (Deficit) for the years ended December
31, 1994, 1995 and 1996.................................................. F-6
Statements of Cash Flows for the years ended December 31, 1994, 1995 and
1996..................................................................... F-7
Notes to Financial Statements............................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Guitar Center, Inc.:
We have audited the accompanying balance sheet of Guitar Center, Inc. as of
December 31, 1996 and the related statements of operations, stockholders' equity
(deficit) and cash flows for the year then ended. In connection with our audits
of the financial statements, we also have audited the financial statement
schedule as listed in the accompanying index. These financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
the financial statement schedule 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.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Guitar Center, Inc. as of
December 31, 1996 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, present fairly,
in all material respects, the information set forth therein.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 10, 1997, except as
to notes 13 and 14 which are as
of April 16, 1997
F-2
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
Guitar Center, Inc. ("Guitar Center" or the "Company") operates a chain of
retail stores which sell high quality musical instruments primarily guitars,
keyboard, percussion and pro-audio equipment. At December 31, 1996, the Company
operated 28 stores in major cities throughout the United States with
approximately 50% of the stores located in California.
The financial statements give effect to the reincorporation of the Company
from a California to a Delaware corporation on October 11, 1996 and a 2.582-to-1
stock split effectuated on January 15, 1997.
RECAPITALIZATION
On June 5, 1996, Guitar Center consummated a series of transactions to
effect the recapitalization of the Company (the "Recapitalization"). Members of
management purchased 1,291,000 shares of the Company's Common Stock for $0.5
million cash and received 495,000 shares of 8% Junior Preferred Stock in
exchange for the cancellation of outstanding options exercisable for Common
Stock. The Company's former sole stockholder received 198,000 shares of Junior
Preferred Stock in exchange for Common Stock. New investors purchased 1,807,400
shares of Common Stock and 693,000 shares of Junior Preferred Stock for $70.0
million cash, and 800,000 shares of 14% Senior Preferred Stock and Warrants for
an aggregate $20 million cash. The Warrants are exchangeable for 190,252 shares
of Common Stock and 72,947 shares of Junior Preferred Stock. The Company
repurchased shares of Common Stock from the former sole stockholder for $113.1
million cash, and canceled certain options for Common Stock held by management
in exchange for $27.9 million cash. For financial statement purposes, the
Company recorded a charge to operations in the amount of $69.9 million (net of
$7.9 million which the Company had previously accrued) related to the
cancellation and exchange of the management stock options.
In part to fund the Recapitalization transaction and to repay the $35.9
million outstanding under its Old Credit Facility, the Company borrowed $100
million under an increasing rate Bridge Facility. The Bridge Facility was repaid
on July 2, 1996 with the proceeds of the Company's 11% Senior Notes due 2006
(the "Senior Notes") and cash on hand.
In connection with the Recapitalization, the Company incurred transaction
costs and financing fees of approximately $11.6 million, which consists of $6.9
million of sellers transaction costs and $4.7 million in fees paid to finance
the Bridge Facility. These amounts have been charged to transaction expenses and
interest expense, net, respectively, in the 1996 statement of operations. In
addition, on July 2, 1996, in connection with the sale of the Notes,
approximately $3.6 million was paid and capitalized as an other asset and will
be amortized over the term of the related debt.
INVENTORIES
Inventories, including used merchandise and vintage guitars, are valued at
the lower of cost or market using the first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets;
generally five years for furniture and fixtures, computer equipment and
vehicles, 15 years for buildings and 15 years or the life of the lease,
whichever is less, for leasehold improvements. Maintenance and repair costs are
expensed as they are incurred, while renewals and betterments are capitalized.
F-8
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STORE PREOPENING COSTS
Effective January 1, 1996, the Company elected to capitalize certain
preopening costs and amortize the balance over 12 months. Previously, preopening
costs were charged to expense as incurred. The change was not material to any
previous periods presented.
ADVERTISING COSTS
The Company expenses the costs of advertising as incurred. Advertising
expense included in the statements of operations for the years ended December
31, 1994, 1995 and 1996, is $4,236,000, $4,128,000 and $5,717,000, respectively.
MERCHANDISE ADVANCES
Merchandise advances represent primarily layaway deposits which are recorded
as a liability pending consummation of the sale when the full purchase price is
received from the customer and outstanding gift certificates which are recorded
as a liability until redemption by the customer.
REVENUE RECOGNITION
Revenue is recognized at the time of sale, net of a provision for estimated
returns.
INCOME TAXES
In connection with the Recapitalization, the Company terminated its S
Corporation election and converted to a C Corporation for income tax purposes.
The Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under the asset
and liability method of SFAS 109, deferred income tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Under SFAS 109,
the effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the
scheduled reversals of deferred tax liabilities, projected future taxable
income, and tax planning strategies in making this assessment. Management
determined that a substantial valuation allowance was necessary as of December
31, 1996 due to the increased leverage of the Company on that date and its
effect on future taxable income.
Prior to the Recapitalization, the Company had elected to be taxed as a
Subchapter S corporation. This election generally requires the individual
stockholder rather than the Company to pay federal income taxes on the Company's
earnings.
California, and certain other states in which the Company does business,
impose a minimum tax on Subchapter S corporate income, which is reflected as
income taxes on the statements of operations.
GOODWILL
Goodwill represents the excess of the purchase price over the fair value of
the net assets acquired resulting from a business combination and is being
amortized on a straight-line basis over 40 years.
F-9
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RENT EXPENSE
The Company leases certain store locations under operating leases that
provide for annual payments that increase over the life of the leases. The
aggregate of the minimum annual payments are expensed on a straight-line basis
over the term of the related lease without consideration of renewal option
periods. The amount by which straight-line rent expense exceeds actual lease
payment requirements in the early years of the leases is accrued as deferred
minimum rent and reduced in later years when the actual cash payment
requirements exceed the straight-line expense.
CONCENTRATION OF CREDIT RISK
The Company's deposits are with various high quality financial institutions.
Customer purchases are transacted using generally cash or credit cards. In
certain instances, the Company grants credit for larger purchases, generally to
professional musicians, under normal trade terms. Trade accounts receivable were
approximately $212,000 and $409,000 at December 31, 1995 and 1996, respectively.
Credit losses have historically been within management's expectations.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
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.
CASH AND CASH EQUIVALENTS
For the purposes of balance sheet classification and the statement of cash
flows, the Company considers all highly liquid investments that are both readily
convertible into cash and mature within 90 days of their date of purchase to be
cash equivalents.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company adopted the provisions of SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, on
January 1, 1996. This Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell. Adoption of this Statement did not have a material impact on the Company's
financial position, results of operations or liquidity.
STOCK OPTION PLANS
Prior to January 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
January 1, 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share
F-10
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
disclosures for employee stock option grants made in 1995 and future years as if
the fair-value-based method defined in SFAS No. 123 had been applied. The
Company has elected to continue to apply the provisions of APB Opinion No. 25
and provide the pro forma disclosure provisions of SFAS No. 123.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of the Company's financial instruments, which
principally include cash, accounts receivable, accounts payable and accrued
expenses, approximates fair value due to the relatively short maturity of such
instruments.
The fair value of the Company's short term instrument reflects the fair
value based upon current rates available to the Company for similar debt. The
fair value of the Company's long term debt instrument is $110 million, based on
quoted market prices.
2. INVENTORIES
The major classes of inventories are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Major goods...................................................................... $ 19,597 $ 32,758
Associated accessories........................................................... 5,952 9,057
Vintage guitars.................................................................. 2,072 2,569
Used merchandise................................................................. 1,940 2,439
General accessories.............................................................. 1,720 2,882
--------- ---------
$ 31,281 $ 49,705
--------- ---------
--------- ---------
</TABLE>
Major goods includes the major product lines including stringed merchandise,
percussion, keyboards and pro-audio equipment. Associated accessories are
comprised of accessories to major goods. General accessories includes other
merchandise such as apparel, cables and books.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Land............................................................................. $ 2,881 $ 2,283
Buildings........................................................................ 9,075 7,693
Transportation equipment......................................................... 494 467
Furniture and fixtures........................................................... 5,838 8,161
Leasehold improvements........................................................... 2,416 6,440
Construction in progress......................................................... 1,201 185
--------- ---------
21,905 25,229
Less accumulated depreciation.................................................... 8,629 10,263
--------- ---------
$ 13,276 $ 14,966
--------- ---------
--------- ---------
</TABLE>
F-11
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. LONG-TERM DEBT
In connection with the Recapitalization, the Company borrowed $100 million
under increasing rate notes (the "Bridge Facility"). Financing fees of $4.7
million were paid and charged to the statement of operations during June 1996.
On July 2, 1996, the Bridge Facility was repaid with the proceeds from the sale
of the Senior Notes and cash on hand. The Senior Notes are unsecured and pay
interest on a semi-annual basis.
The Senior Notes are not entitled to the benefit of a sinking fund. The
Senior Notes may be redeemed, in whole or in part, at the option of the Company,
at any time after July 1, 2001 at prices declining from 105.5% to 100.0% of the
principal amount redeemed, plus accrued and unpaid interest. In addition, the
Company, may, at its option and subject to certain conditions, redeem up to
33 1/3% of the original aggregate principal amount of Senior Notes, at a
redemption price of 110% of the principal amount thereof in connection with an
initial public offering of Common Stock. The holders of the Senior Notes have
the right to require the Company to repurchase their Senior Notes at 101% of the
principal amount thereof, plus accrued and unpaid interest, upon the occurrence
of a change of control, as defined.
In June 1996, the Company entered into a $25 million unsecured revolving
line of credit. The line expires in June 2001. The revolving line of credit
bears interest at various rates based on the prime lending rate (8.25% at
December 31, 1996) plus 1.5% or the Eurodollar rate (5.5% at December 31, 1996)
plus 3.0%. A fee of 0.375% is assessed on the unused portion of the facility
with interest due monthly. At December 31, 1996, the Company had $3.5 million
outstanding under the revolving line of credit and $300,000 outstanding on
standby letters of credit. The Company had available borrowings under the line
of credit of $21.2 million at December 31, 1996.
Under certain conditions, the line of credit will convert to a secured
credit facility. Under the terms of the term loan and revolving line of credit
agreements, the Company is subject to various financial and other covenants. The
Company was in compliance with or had appropriate waivers for such covenants at
December 31, 1996. In addition, the Senior Notes and line of credit restrict the
payment of cash dividends.
5. LEASE COMMITMENTS AND RELATED PARTY TRANSACTIONS
The Company leases its office and several retail store facilities under
various operating leases which expire at varying dates through June 2006.
Generally, the agreements contain provisions which require the Company to pay
for normal repairs and maintenance, property taxes and insurance.
Through October 17, 1995, the Company leased from its Profit Sharing Plan
two properties at a total monthly rental of $19,988. On October 17, 1995, the
leases with the Company were cancelled for fees totaling $227,000. One of the
properties was then purchased by the Company for $500,000, a price determined by
an independent fiduciary. The other property was re-leased by the Company
through 2005 from a related party at a monthly rental of $8,250. The Company
leases three additional properties through 2006 from a related party at monthly
rentals aggregating $26,200. The total rent expense recorded for related party
leases totaled $238,000, $292,000 and $364,000 in 1994, 1995 and 1996,
respectively.
F-12
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. LEASE COMMITMENTS AND RELATED PARTY TRANSACTIONS (CONTINUED)
The total minimum rental commitment at December 31, 1996, under operating
leases, is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31 AMOUNT
- -------------------------------------------------------------------- --------------
<S> <C>
(IN THOUSANDS)
1997................................................................ $ 3,281
1998................................................................ 3,238
1999................................................................ 3,161
2000................................................................ 3,147
2001................................................................ 3,110
Thereafter.......................................................... 13,950
--------------
$ 29,887
--------------
--------------
</TABLE>
The total rental expense included in the statements of operations for the
years ended December 31, 1994, 1995 and 1996 is $1,804,000, $1,985,000 and
$2,856,000, respectively.
6. PROFIT SHARING PLAN
The Company has a Profit Sharing Plan (the "Plan") which covers
substantially all employees who meet a minimum employment requirement. The
Company's board of directors can elect to contribute up to 15% of the
participants' compensation for any plan year, subject to a maximum of $30,000
per participant. During the Plan years ended October 31, 1994, 1995 and 1996,
the Company declared total contributions of $1,003,000, $1,272,000 and $654,000,
respectively, which is included in accrued liabilities. In addition, $195,000 of
assets, included in the Plan, which had been forfeited by terminated employees,
was reallocated to participants.
7. STOCK OPTION PLANS
1996 PERFORMANCE STOCK OPTION PLAN
In June 1996, the Company adopted the 1996 Performance Stock Option Plan (as
amended, the "1996 Plan"), which provides for the granting of options to
purchase units (each unit (a "Unit")consisting of 2.582 shares of Common Stock
and 99/100 of a share of Junior Preferred Stock) at an aggregate weighted
average exercise price of $100.00 per unit. As of December 31, 1996, the Company
had issued options to purchase 60,399 Units under the 1996 Plan. Upon conversion
of the Junior Preferred Stock, an option to purchase a Unit will become an
option to purchase 9.182 shares of Common Stock at an exercise price of $10.89
per share. The options vest ratably over three years. The 1996 Plan will be
frozen upon the consummation of the Offering.
MANAGEMENT STOCK OPTION AGREEMENTS
In June 1996, the Company granted options to certain officers to purchase
86,688 Units at an exercise price of $100 per Unit. The options vest in three
equal installments commencing 2003, 2004, and 2005 and will terminate upon the
certain events. The agreements contain provisions to accelerate the vesting
period, including the achievement of a certain targeted "Calculated Corporate
Value", as defined.
1997 EQUITY PARTICIPATION PLAN
In January of 1997, the Company and its stockholders adopted the 1997 Equity
Participation Plan (the "1997 Plan"). Under the 1997 Plan, the Company may grant
options to purchase up to 875,000 shares of Common Stock, $.01 par value
("Common Stock"); provided, however, that grants to any one individual may not
exceed 150,000 shares of Common Stock in any calendar year. As of December 31,
1996, no options had been granted under the 1997 Plan.
F-13
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. STOCK OPTION PLANS (CONTINUED)
OTHER OPTION ARRANGEMENTS
In December 1996, the Company's institutional investors granted options to
certain officers and key managers of the Company to purchase 30,188.68 Units
held by such investors at a purchase price of $39.75 per Unit. The Company is
not a party to this agreement and has not, and will not, incur any obligation in
connection with such options. Under generally accepted accounting principles,
the Company recorded a charge to the statement of operations in the amount of
$1.9 million, with a corresponding increase to additional paid in capital.
The Company applies APB Opinion No. 25 in accounting for its plans. Had the
Company determined compensation cost based upon the fair value at the grant date
for its stock options under SFAS No. 123 using the Black Scholes option pricing
model with the following weighted average assumptions: 1996 - expected dividend
yield 0%, volatility 0%, risk free interest rate of 7.00%, and expected life of
10 years. The Company's net loss for the year ended December 31, 1996 would have
been increased from $72.4 million to a pro forma loss of $73.2 million.
Pro forma net loss reflects only options granted in 1996. Therefore, the
full impact of calculating compensation cost for stock options under SFAS No.
123 is not reflected in the pro forma net income amounts presented above because
compensation cost is reflected over the options' vesting period of 3 to 10 years
and compensation cost for options granted prior to January 1, 1996 is not
considered.
At December 31, 1996, all the outstanding stock options had an exercise
price of $100 per Unit and a remaining contractual life of 10 years.
At December 31, 1996, no options were exercisable.
TERMINATED PLAN
Prior to the Recapitalization, the Company had granted to certain members of
management options to purchase 81,407,400 of common stock of the Company at
prices ranging from $.0005 to $0.11 per share. Upon consummation of the
Recapitalization, these options were exchanged for cash and securities with
management and canceled. For financial statement purposes, the Company recorded
a charge of approximately $69.9 million (net of the $7.9 million previously
accrued as deferred compensation) in the statement of operations.
8. INCOME TAXES
The pro forma unaudited income tax adjustments presented represent income
taxes which would have been reported had the Company been subject to Federal and
State income taxes as a C Corporation. The historical pro forma provisions for
income taxes were as follows:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Historical income taxes............................................................ $ 326 $ 345 139
--------- --------- ---------
Pro forma adjustments (unaudited):
Federal.......................................................................... 3,645 5,001 --
California....................................................................... 507 798 (139)
--------- --------- ---------
Total pro forma adjustments.................................................... 4,152 5,799 (139)
--------- --------- ---------
Total pro forma provision for income taxes..................................... $ 4,478 $ 6,144 $ --
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-14
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Pro forma income tax expense differs from the statutory tax rate of 35% as
applied to earnings before income taxes, as follows:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ----------
<S> <C> <C> <C>
(IN THOUSANDS)
Expected income tax expense (benefit)............................................ $ 3,204 $ 3,921 (25,295)
State income taxes, net of federal benefit....................................... 541 743 (3,650)
Non deductible deferred compensation............................................. 441 1,080 --
Non deductible transaction costs................................................. -- -- 3,281
Benefit not recorded due to net carryforward position............................ -- -- 25,379
Other............................................................................ 292 400 285
--------- --------- ----------
$ 4,478 $ 6,144 --
--------- --------- ----------
--------- --------- ----------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are presented below:
<TABLE>
<CAPTION>
1996
--------------
<S> <C>
(IN THOUSANDS)
Deferred tax assets:
Federal net operating loss carryforward............................................... $ 22,483
State net operating loss carryforwards................................................ 1,622
Deferred compensation................................................................. 772
Accrued liabilities................................................................... 648
Inventory reserves.................................................................... 336
--------------
Total gross deferred tax assets......................................................... 25,861
--------------
Deferred tax liabilites
Depreciation.......................................................................... 140
Other................................................................................. 342
--------------
Total gross deferred liabilities........................................................ 482
--------------
Deferred tax assets net of deferred tax liabilities..................................... 25,379
--------------
Less valuation allowance................................................................ 25,379
--------------
Net deferred tax assets................................................................. --
--------------
--------------
</TABLE>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. In order to fully realize
the deferred tax asset, the Company will need to generate future taxable income
of approximately $64 million prior to the expiration of the net operating loss
carry forwards in 2011.
F-15
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
In connection with the Recapitalization, the Company entered into a tax
indemnification agreement with its former sole stockholder pursuant to which the
Company has agreed to indemnify such stockholder for any loss, damage, or
liability and all expenses incurred, suffered, sustained or required to be paid
by such stockholder in the event that certain specified aspects of the
Recapitalization are not treated for tax purposes in the manner contemplated by
the Recapitalization and related transactions.
9. OTHER FINANCIAL INFORMATION
Accrued Expenses
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1995 1996
------------- -------------
(IN THOUSANDS)
<S> <C> <C>
Wages, salaries and benefits........................................................ $ 2,218 $ 2,161
Sales tax payable................................................................... 1,666 2,011
Profit sharing accrual.............................................................. 1,272 786
Other............................................................................... 1,905 2,933
------------- -------------
$ 7,061 $ 7,891
------------- -------------
------------- -------------
</TABLE>
10. PREFERRED STOCK
REDEEMABLE SENIOR PREFERRED STOCK AND WARRANTS
In connection with the recapitalization, the Company issued 800,000 shares
of 14% Senior Preferred Stock ("Senior Preferred Stock") with an initial
aggregate liquidation value of $20.0 million.
Dividends on the Senior Preferred Stock accrue at a rate of 14%. Such
dividends are payable quarterly on each of March 15, June 15, September 15 and
December 15, beginning June 15, 1996. On or prior to June 15, 2002, dividends
shall not be payable in cash to holders, but shall, whether or not declared,
accrete to the liquidation value of the Senior Preferred Stock compounded on
each dividend payment date. Under certain circumstances the holders can elect to
receive additional shares of the Senior Preferred stock in lieu of accreting to
the liquidation value.
OPTIONAL REDEMPTION
The Company may, at its option, to the extent that funds are legally
available for such payment, redeem, prior to June 15, 1999, in whole or in part,
shares of Senior Preferred Stock at a redemption price equal to 103% of the
liquidation value thereof if such redemption shall occur before June 15, 1997,
or 106% of the liquidation value thereof if the redemption occurs on or after
June 15, 1997 to and including June 15,1999, without interest, PROVIDED,
HOWEVER, that an initial public offering shall have occurred and the aggregate
redemption price of the Senior Preferred Stock does not exceed the net proceeds
received by the Company in the initial public offering. In January 1997, the
Company and holders of all outstanding shares of Senior Preferred Stock entered
into an agreement pursuant to which the Company will redeem all outstanding
shares of Senior Preferred Stock at 103% of the liquidation value thereof
simultaneously with the consummation of the Offering.
F-16
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. PREFERRED STOCK (CONTINUED)
The Senior Preferred Stock is redeemable, on or after June 15,1999, at the
option of the company at a price equal to a percentage of the liquidation value
as follows:
<TABLE>
<CAPTION>
PERCENTAGE OF
YEAR BEGINNING JUNE 15, LIQUIDATION VALUE
----------- -------------------
<S> <C>
1999.............................. 110%
2000.............................. 108
2001.............................. 106
2002.............................. 104
2003.............................. 102
2004 and thereafter............... 100
</TABLE>
The Senior Preferred stock is mandatorially redeemable on June 15, 2008 at a
redemption price equal to the aggregate liquidation value plus all accrued and
unpaid cash dividends.
Holders of the Senior Preferred Stock have no voting rights with respect to
any matters except as provided by law or as set forth in the Senior Preferred
Stock Certificate of Determination. Such Certificate of Determination provides
that in the event that (i) dividends on the Senior Preferred Stock are in
arrears and unpaid for six consecutive quarterly periods after June 15, 2002;
(ii) for any reason (including the reason that funds are not legally available
for redemption), the Company shall have failed to discharge any mandatory
redemption obligation; or (iii) the Company shall have failed to provide a
notice within the time period required by a redemption pursuant to a Change of
Control (each of the foregoing, a "Voting Trigger"), the Board will be increased
by two directors and the holders of the Senior Preferred Stock, together with
the holders of shares of every other series of preferred stock of the Company
with like rights to vote for the election of two additional directors, voting as
a class, will be entitled to elect two directors to the expanded Board of
Directors. Such voting rights will continue until the Company shall have
fulfilled its obligations that gave rise to a Voting Trigger.
The Senior Preferred Stock with respect to dividend rights and rights on
liquidation, winding up and dissolution, ranks Senior to Junior Preferred Stock
and the Common Stock.
In connection with the issuance of the Senior Preferred Stock the holders
received detachable warrants (in addition to the Senior Preferred Stock) for the
aggregate $20.0 million paid. The warrants are exchangeable for 73,684 Units (or
190,252 shares of Common Stock and 72,947 shares of Junior Preferred Stock).
The market value of the warrants at issuance was deemed to be $6.5 million
with the Senior Preferred Stock valued at $13.5 million. The warrants are
exercisable at a price of $0.01 per Unit. The Senior Preferred stock will
accrete to its redemption value ($20.0 million) using the effective interest
method through its mandatory redemption date of June 15, 2008. The carrying
amount of the Senior Preferred Stock will be adjusted periodically for both the
above noted accretion as well as by amounts representing dividends not currently
declared or paid, but which will be payable under the mandatory redemption
features.
JUNIOR PREFERRED STOCK
The Company has authorized the issuance of up to 1,500,000 shares of 8%
Junior Preferred Stock, $.01 par value ("Junior Preferred Stock").
In connection with the Recapitalization 1,386,000 shares of Junior Preferred
Stock were issued. Each outstanding share of Junior Preferred Stock has a
liquidation preference of $100.00. Dividends accrue at a rate of 8% per annum on
the sum of the liquidation preference plus accumulated but unpaid dividends
thereon.
F-17
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. PREFERRED STOCK (CONTINUED)
The Junior Preferred Stock ranks junior to the Senior Preferred Stock and
senior to the Common Stock, with respect to dividend rights and rights on
liquidation.
The Company may be required to mandatorily redeem all or a portion of the
Junior Preferred Stock under certain conditions. Specifically, the company would
be required to redeem within 45 days of an initial public offering (IPO)
resulting in a market capitalization of more than $500 million, at a redemption
price per share equal to 100% of the liquidation value plus all accrued and
unpaid cash dividends as follows:
(i)
If the IPO results in a market capitalization of the Company of less
than $750 million but more than or equal to $500 million, the Company
shall redeem up to 25% of the outstanding shares of Junior Preferred Stock
held by each holder of such shares who requests redemption;
(ii)
If the IPO results in a market capitalization of the Company of less
than $1 billion but more than or equal to $750 million, the Company
shall redeem up to 50% of the outstanding shares of Junior Preferred Stock
held by each holder of such shares who request redemption; and
(iii)
If the IPO results in a market capitalization of the Company of more
than or equal to $1 billion, the Company shall redeem up to 100% of
the outstanding shares of Junior Preferred Stock held by each holder of such
shares who requests redemption.
In the event the Company intends to consummate an IPO, the holders of sixty
percent (60%) of the outstanding Junior Preferred Stock may require the Company
to convert on a PRO RATA basis all or any portion of the outstanding Junior
Preferred Stock into shares of Common Stock, such conversion to occur
automatically upon the closing of an IPO. In January 1997, the Company and
holders of the requisite number of shares of Junior Preferred Stock entered into
an agreement pursuant to which each outstanding share of Junior Preferred Stock
will be converted into 6.667 shares of Common Stock upon consummation of the
Offering.
Accumulated but unpaid dividends on the Junior and Senior Preferred Stock
aggregated $7,951,000 as of December 31, 1996.
11. SALE-LEASEBACK TRANSACTIONS
On February 15, 1996, the Company entered into two sale-leaseback
transactions with a related party-in-interest. The combined sale amount for the
two properties was $1,753,000 resulting in a $3,587 net gain for the Company.
The two properties are leased back from the related party-in-interest through
2006 for a combined monthly rental of $16,258.
12. PRO FORMA DATA (UNAUDITED)
Prior to June 5, 1996, the Company elected to be treated as an S Corporation
for federal and state income tax purposes. Pro forma information has been
provided to reflect the estimated statutory provision for income taxes assuming
the Company has been taxed as a C corporation. See note 8.
Pro forma net earnings per share has been computed by dividing pro forma net
earnings (loss) by the weighted average number of shares outstanding during the
period. The pro forma net earnings (loss) per share gives effect to: (i) the
issuance of Common Stock sold in the Offering, including the underwriters' full
over-allotment option, the issuance of Common Stock upon the conversion of all
outstanding shares of Junior Preferred Stock in connection with the Offering,
the issuance of Common Stock upon the exercise of outstanding warrants and
common stock equivalents and (ii) the redemption of Common Stock from certain
members of the Company's management upon consummation of the Offering.
F-18
<PAGE>
GUITAR CENTER, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
13. OFFERING (UNAUDITED)
On March 19, 1997, the Company completed an initial public offering (the
"Offering") of Common Stock pursuant to which it sold 6,750,000 shares of Common
Stock and received approximately $94.1 million in net cash proceeds (before
deducting expenses associated with the Offering). On April 15, 1997 the Company
sold an additional 1,012,500 shares of Common Stock and received an additional
$14.1 million in net cash proceeds (before deducting expenses associated with
the Offering) upon the underwriters' exercise in full of their over-allotment
option. Upon consummation of the Offering, the outstanding shares of Junior
Preferred Stock were mandatorily converted into shares of Common Stock at a
ratio of 6.667 shares of Common Stock to each share of Junior Preferred Stock.
No accrued and unpaid dividends were paid on any shares of Junior Preferred
Stock. Approximately $22.9 million of the net proceeds from the Offering was
used to redeem, at a premium of 3%, all of the outstanding shares of Senior
Preferred Stock. As a result, a charge to dividends will be incurred by the
Company in the first quarter of 1997 for the difference between the financial
statement value of the Senior Preferred Stock and the face amount thereof, plus
the premium paid on the Senior Preferred Stock. Approximately $9.7 million of
the net proceeds from the Offering was used to repay all amounts outstanding
under the 1996 Credit Facility. In addition, the Company used approximately
$18.4 million of the net proceeds from the Offering to redeem approximately
1,317,000 shares of Common Stock. Immediately following the Offering, the
Company called for redemption, at a premium of 10%, an aggregate of $33.3
million of Senior Notes. The Company used approximately $37.9 million of the net
proceeds from the Offering to redeem such Senior Notes on April 19, 1997 and to
pay all accrued and unpaid interest with respect to the Senior Notes called for
redemption. Accordingly, the Company anticipates that an extraordinary charge to
operations will be incurred equal to the premium paid on the Senior Notes called
for redemption plus the write-off of one-third of the unamortized deferred
financing fees associated with the issuance of such Senior Notes. The balance of
the net proceeds was retained for general corporate purposes, including the
acquisition of two musical instruments stores in the Atlanta, Georgia market in
April 1997.
If the Offering had been consummated on January 1, 1996, supplemental
earnings per share for the year ended December 31, 1996 would be calculated as
follows:
<TABLE>
<S> <C>
Earnings (loss) per common share per financial statements................ $ (72,409)
Reduction of interest assumed repaid................................... (4,619)
Reduction of Junior and Senior Preferred Dividends..................... (7,951)
---------
Supplemental earnings (loss)............................................. (59,839)
---------
---------
Supplemental earnings (loss) per share................................... $ (2.93)
---------
---------
Weighted average shares used in calculation.............................. 20,420
</TABLE>
14. SUBSEQUENT EVENTS (UNAUDITED)
On April 16, 1997, the Company acquired all of the outstanding capital stock
of Rhythm City, Inc. ("Rhythm City"), the operator of two musical instrument
stores in the Atlanta, Georgia market for $10.3 million in cash, subject to
adjustment based on the actual level of working capital on such date and other
matters. The purchase price included the acquisition of the building and
improvements of the flagship Rhythm City store in Atlanta. All of the debt and
other liabilities of Rhythm City were either paid or assumed by the sellers
prior to closing.
F-19
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESPEOPLE OR OTHER PERSON IS AUTHORIZED IN CONNECTION WITH ANY
OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT
CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION
OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE SECURITIES OFFERED HEREBY, NOR
DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF
THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO SUCH PERSON. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY
CIRCUMSTANCE CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Additional Information.................................................. 2
Summary................................................................. 3
Risk Factors............................................................ 10
The Recapitalization and Related Transactions........................... 15
Use of Proceeds......................................................... 16
Capitalization.......................................................... 16
Selected Historical Financial Data...................................... 17
Unaudited Pro Forma Condensed Financial Data............................ 19
Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................... 23
Business................................................................ 29
Management.............................................................. 39
Principal Stockholders.................................................. 52
Certain Transactions.................................................... 54
Description of Notes.................................................... 57
Description of the 1996 Credit Facility................................. 79
Plan of Distribution.................................................... 81
Legal Matters........................................................... 81
Experts................................................................. 81
Index to Financial Statements........................................... F-1
</TABLE>
[LOGO]
GUITAR CENTER, INC.
$66,667,000
11% SENIOR NOTES DUE 2006
-----------------
PROSPECTUS
-----------------
APRIL 23, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The estimated expenses in connection with the offering of the Notes are as
follows:
<TABLE>
<CAPTION>
EXPENSE AMOUNT
- -------------------------------------------------------------------------------- ------------
<S> <C>
The Commission's Registration Fee............................................... $ 34,483
Printing Expenses............................................................... 63,000
Legal Fees and Expenses......................................................... 100,000
Accounting Fees and Expenses.................................................... 85,000
Miscellaneous Expenses.......................................................... 22,000
------------
Total....................................................................... $ 304,483
------------
------------
</TABLE>
ITEM 14. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
The Certificate of Incorporation of Guitar Center, Inc. (the "Company"),
provides that, to the extent permitted by the Delaware General Corporation Law,
a director or officer shall not be personally liable to the Company or its
stockholders for monetary damages arising from a breach of their fiduciary
duties to the Company and its stockholders, to the extent permitted by the
Delaware General Corporation Law. Such limitation of liability does not affect
the availability of equitable remedies such as injunctive relief or rescission.
The Company's Amended and Restated Bylaws, as in effect immediately
following the consummation of the Offering (the "Bylaws"), provide that the
Company shall indemnify its directors and officers to the fullest extent
permitted by applicable law. The Company has entered into indemnification
agreements with its directors and executive officers containing provisions which
are in some respects broader than the specific indemnification provisions
contained in the Delaware General Corporation Law. Such agreements require the
Company, among other things, (i) to indemnify its officers and directors against
certain liabilities that may arise by reason of their status or service as
directors or officers provided such persons acted in good faith and in a manner
reasonably believed to be in the best interests of the Company and, with respect
to any criminal action, had no cause to believe their conduct was unlawful; (ii)
to advance the expenses actually and reasonable incurred by its officers and
directors as a result of any proceeding against them as to which they could be
indemnified; and (iii) to obtain directors' and officers' insurance if available
on reasonable terms. There is no action or proceeding pending or, to the
knowledge of the Company, threatened which may result in a claim for
indemnification by any director, officer, employee or agent of the Company.
Policies of insurance may be obtained and maintained by the Company under
which its directors and officers will be insured, within the limits and subject
to the limitations of the policies, against certain expenses in connection with
the defense of, and certain liabilities which might be imposed as a result of,
actions, suits or proceedings to which they are parties by reason of being or
having been such directors or officers.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
All capitalized terms not otherwise defined herein, shall have the meanings
ascribed to such terms in Part I of this Registration Statement. Unless
otherwise indicated herein, share and Unit numbers do not give effect to the
2.582-to-1 stock split effectuated by the Company on January 15, 1997 or to the
Junior Preferred Stock Conversion.
In June 1996, Guitar Center Management Company, Inc. (the "Predecessor")
effected a Recapitalization in order to transfer ownership of the Predecessor
from its sole stockholder, the Scherr Trust, to members of management and the
Investors. The Recapitalization included the following transactions: (i) members
of the Predecessor's management purchased 500,000 shares of the Predecessor's
common stock, no par value ("Predecessor Common Stock"), for $0.5 million in
cash; (ii) members of the Predecessor's management received 495,000 shares of
junior preferred stock, no par value ("Predecessor Junior Preferred
II-1
<PAGE>
Stock"), with an aggregate liquidation preference of $49.5 million, in exchange
for cancellation of outstanding options exercisable for 49,500,000 shares of
Predecessor Common Stock; (iii) the Scherr Trust received 198,000 shares of
Predecessor Junior Preferred Stock, with an aggregate liquidation preference of
$19.8 million, in exchange for 19,800,000 shares of Predecessor Common Stock;
(iv) the Investors purchased 700,000 shares of Predecessor Common Stock and
693,000 shares of Predecessor Junior Preferred Stock for $70.0 million in cash;
(v) the DLJ Investors purchased 800,000 shares of 14% senior preferred stock, no
par value (the "Predecessor Senior Preferred Stock"), with an aggregate
liquidation value of $20.0 million, and warrants (the "Predecessor Warrants") to
purchase 73,684 shares of Predecessor Common Stock and 72,947 shares of
Predecessor Junior Preferred Stock, for an aggregate purchase price of $20.0
million in cash; (vi) DLJ Bridge purchased $51.0 million aggregate principal
amount of unsecured increasing rate notes for cash. All shares numbers in this
paragraph give effect to a 100 to 1 stock split effected by the Predecessor on
June 5, 1996. Such transactions were exempt from registration by virtue of
Section 3(a)(9) or Section 4(2) of the Securities Act.
In June 1996, the Predecessor granted to certain employees options to
purchase an aggregate of 60,399 Units (a unit consisting of one share of
Predecessor Common Stock and 99/100ths of a share of Predecessor Junior
Preferred Stock (each a "Predecessor Unit")) pursuant to its 1996 Plan. Such
transactions were exempt by virtue of Section 4(2) of and Rule 701 under the
Securities Act. In June 1996, the Predecessor granted options to purchase 43,344
Predecessor Units to each of Messrs. Larry Thomas and Marty Albertson, executive
officers of the Predecessor. Such transactions were exempt by virtue of Section
4(2) of the Securities Act. The Company expects to file a Registration Statement
on Form S-8 to register the shares issuable upon exercise of such options.
In July 1996, the Company sold $100 million aggregate principal amount of
11% senior notes due 2006 ("Senior Notes") to DLJ and Chase Securities. Such
transaction was exempt by virtue of Section 4(2) of the Securities Act. DLJ and
Chase Securities resold an aggregate of $100 million principal amount of Senior
Notes to "Qualified Institutional Investors" (within the meaning of Rule 144A
under the Securities Act) in transactions meeting the requirements of Rule 144A.
The Company was incorporated in Delaware in October 1996. Pursuant to an
agreement and plan of merger, the Predecessor merged with and into the Company
in October 1996 and each share of Predecessor Common Stock, each share of
Predecessor Junior Preferred Stock, each share of Predecessor Senior Preferred
Stock, each Warrant to purchase Predecessor Common Stock and Predecessor Junior
Preferred Stock, and each employee option to purchase Predecessor Units were
converted into one share of Common Stock, $.01 par value of the Company ("Common
Stock"), one share of Junior Preferred Stock, $.01 par value of the Company
("Junior Preferred Stock"), one share of Senior Preferred Stock, $.01 par value
of the Company, a Warrant to purchase Common Stock and Junior Preferred Stock
and an employee option to purchase units of the Registrant (each unit consisting
of one share of Common Stock and 99/100ths of a share of Junior Preferred Stock
(each, a "Unit")), respectively. Such transaction is exempt by virtue of Section
4(2) of and Rule 145 under the Securities Act.
In February 1996, certain employees of the Company purchased 3,100 Units for
an aggregate purchase price of approximately $0.3 million pursuant to a
Supplemental Employee Stock Purchase Plan of the Company. Such transactions were
exempt by virtue of Section 4(2) of the Rules 505 and 506 under the Securities
Act.
In January 1997, the Company granted options to purchase an aggregate of
17,338 Units to two executive officers of the Company, pursuant to its 1996 Plan
and the terms of their employment agreements. Such transactions were exempt by
virtue of Section 4(2) of the Securities Act. The Company expects to file a
registration statement on Form S-8 to register the shares issuable upon exercise
of such options.
Upon consummation of the Company's initial public offering in March 1997,
all outstanding shares of Junior Preferred Stock were automatically converted
into Common Stock at a ratio of 6.667 shares of Common Stock for each share of
Junior Preferred Stock. Such transaction was exempt by virtue of Section 3(a)(9)
of the Securities Act.
II-2
<PAGE>
ITEM 16. EXHIBITS.
(a) Exhibits. See Exhibit Index
(b) Financial Statements Schedules:
II. Valuation and Qualifying Accounts...................................S-1
All other schedules are omitted because the required information is not
present in amounts sufficient to require submission of the schedule pursuant to
the applicable accounting regulations of the Securities and Exchange Commission
or because the information required is included in the financial statements or
notes thereto.
ITEM 17. UNDERTAKINGS.
Insofar as indemnification for liabilities arising out the Securities Act of
1933, as amended (the "Securities Act"), may be permitted to directors, officers
and controlling persons of the registrant pursuant to the foregoing provisions,
or otherwise, the registrant has been advised that, in the opinion of the
Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a directors, officer
or controlling person of the registrant in the successful defense in any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will by governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1)
For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4)
or 497(h) under the Securities Act shall by deemed to be a part of this
registration statement as of the time it was declared effective.
(2)
For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial BONA FIDE offering thereof.
The undersigned registrant hereby undertakes to provide the Underwriters at
the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
II-3
<PAGE>
SIGNATURES AND POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Post-Effective Amendment No. 1 to Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Los Angeles, State of California on this 18th day of
April, 1997.
GUITAR CENTER, INC.
By: /s/ LARRY THOMAS
------------------------------------------
Name: Larry Thomas
Title: PRESIDENT AND CHIEF EXECUTIVE
OFFICER
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Post-Effective Amendment No. 1 to Registration Statement has been signed by the
following persons in the capacities indicated on the dates indicated.
<TABLE>
<C> <S> <C>
NAME TITLE DATE
- ------------------------------------------------------ ----------------------------------- --------------------
/s/ LARRY THOMAS President, Chief Executive Officer
------------------------------------------- and Director (Principal Executive April 18, 1997
Larry Thomas Officer)
/s/ BRUCE ROSS Vice President, Chief Financial
------------------------------------------- Officer and Secretary (Principal April 18, 1997
Bruce Ross Financial and Accounting Officer)
/s/ MARTY ALBERTSON
------------------------------------------- Executive Vice President, Chief April 18, 1997
Marty Albertson Operating Officer and Director
/s/ RAYMOND SCHERR
------------------------------------------- Director April 18, 1997
Raymond Scherr
*/s/ DAVID FERGUSON
------------------------------------------- Director April 18, 1997
David Ferguson
/s/ JEFFREY WALKER
------------------------------------------- Director April 18, 1997
Jeffrey Walker
*/s/ MICHAEL LAZARUS
------------------------------------------- Director April 18, 1997
Michael Lazarus
/s/ STEVEN BURGE
------------------------------------------- Director April 18, 1997
Steven Burge
*By: /s/ BRUCE ROSS
-------------------------------------------
Bruce Ross April 18, 1997
ATTORNEY-IN-FACT
</TABLE>
II-4
<PAGE>
SCHEDULE II
GUITAR CENTER, INC.
VALUATION AND QUALIFYING ACCOUNTS
YEAR ENDED DECEMBER 31, 1996
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT ADDITIONS DEDUCTIONS BALANCE
BEGINNING CHARGED TO FROM AT END
OF YEAR OPERATIONS ALLOWANCE OTHER OF YEAR
----------- ----------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C>
December 31, 1996
Allowance for doubtful receivables................... $ 200 -- $ (50) -- $ 150
Allowance for obsolesence & damaged goods............ $ 100 $ 500 -- -- $ 600
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
- ----------- ------------------------------------------------------------------------------------------------- ---------
<C> <S> <C>
3.1 The Company's Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.5 of
the Company's Registration Statement No. 333-20931)
3.2 The Company's Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.7 of the
Company's Registration Statement No. 333-20931)
4.1 Indenture dated as of July 2, 1996 by and between the Company and U.S. Trust Company of
California as trustee (previously filed as Exhibit 4.1 of the Company's Registration Statement
No. 333-10491)
4.2 Form of Restricted Stock Agreements dated as of May 1, 1996 between the Company and certain
members of management (previously filed as Exhibit 4.2 of the Company's Registration Statement
No. 333-10491)
4.3 Warrants (1-4) dated June 5, 1996 for the purchase of shares of Common Stock and Junior Preferred
Stock issued to certain investors (previously filed as Exhibit 4.3 of the Company's Registration
Statement No. 333-10491)
4.4 Form of Stock Certificate (Incorporated by reference to Exhibit 4.4 of the Company's Registration
Statement No. 333-20931)
5.1 Opinion of Buchalter, Nemer, Fields & Younger, a Professional Corporation, relating to the
validity of the Notes (previously filed as Exhibit 5.1 of the Company's Registration Statement
No. 333-10491)
10.1 Recapitalization Agreement dated May 1, 1996 by and among the Company and the stockholders named
therein (previously filed as Exhibit 10.1 of the Company's Registration Statement No. 333-10491)
10.2 Registration Rights Agreement dated June 5, 1996 among the Company and the stockholders named
therein (previously filed as Exhibit 10.2 of the Company's Registration Statement No. 333-10491)
10.3 Tax Indemnification Agreement dated as of May 1, 1996 by and among the Company, Ray Scherr, and
the individuals identified on the signature pages thereto (previously filed as Exhibit 10.3 of
the Company's Registration Statement No. 333-10491)
10.4 Employment Agreement dated June 5, 1996 between the Company and Lawrence Thomas (previously filed
as Exhibit 10.5 of the Company's Registration Statement No. 333-10491)
10.5 The Company's Amended and Restated 1996 Performance Stock Option Plan (Incorporated by reference
to Exhibit 10.5 of the Company's Registration Statement No. 333-20931)
10.6 Employment Agreement dated June 5, 1996 between the Company and Marty Albertson (previously filed
as Exhibit 10.6 of the Company's Registration Statement No. 333-10491)
10.7 Employment Agreement dated June 5, 1996 between the Company and Bruce Ross, as amended
(Incorporated by reference to Exhibit 10.7 of the Company's Registration Statement No. 333-20931)
10.8 Employment Agreement dated June 5, 1996 between the Company and Raymond Scherr (previously filed
as Exhibit 10.8 of the Company's Registration Statement No. 333-10491)
10.9 Employment Agreement dated June 5, 1996 between the Company and Barry Soosman, as amended
(Incorporated by reference to Exhibit 10.9 of the Company's Registration Statement No. 333-20931)
10.10 Securities Purchase Agreement dated June 5, 1996 by and among the Company and the parties named
therein (previously filed as Exhibit 10.10 of the Company's Registration Statement No. 333-10491)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
- ----------- ------------------------------------------------------------------------------------------------- ---------
<C> <S> <C>
10.11 Form of Indemnification Agreement between the Company and each of its directors and executive
officers (Incorporated by reference to Exhibit 10.11 of the Company's Registration Statement No.
333-20931)
10.12 Credit Agreement dated June 5, 1996 between the Company and Wells Fargo Bank, N.A. (previously
filed as Exhibit 10.12 of the Company's Registration Statement No. 333-10491)
10.13 Revolving Promissory Note dated June 5, 1996 issued by the Company in favor of Wells Fargo Bank,
N.A. in the principal amount of $25,000,000 (previously filed as Exhibit 10.13 of the Company's
Registration Statement No. 333-10491)
10.14 Security Agreement dated June 5, 1996 between the Company and Wells Fargo, N.A. (previously filed
as Exhibit 10.14 of the Company's Registration Statement No. 333-10491)
10.15 Registration Rights Agreement dated July 2, 1996 by and among the Company, Chase Securities Inc.
and Donaldson, Lufkin & Jenrette Securities Corporation (previously filed as Exhibit 10.15 of the
Company's Registration Statement No. 333-10491)
10.16 Management Stock Option Agreement dated June 5, 1996 by and between the Company and Lawrence
Thomas (previously filed as Exhibit 10.16 of the Company's Registration Statement No. 333-10491)
10.17 Management Stock Option Agreement dated June 5, 1996 by and between the Company and Marty
Albertson (previously filed as Exhibit 10.17 of the Company's Registration Statement on No.
333-10491)
10.18 Registration Agreement dated June 5, 1996 among the Company and the parties named therein
(previously filed as Exhibit 10.11 contained in Registration Statement No. 333-10491)
10.19 Stockholders Agreement dated June 5, 1996 among the Company, and the investors listed therein
(previously filed as Exhibit 10.19 of the Company's Registration Statement No. 333-10491)
10.20 Purchase Agreement and Escrow Instructions dated February 15, 1996 by and between the Company and
G.C. Realty LLC (Arlington, Texas) (Incorporated by reference to Exhibit 10.20 of the Company's
Registration Statement No. 333-20931)
10.21 Purchase Agreement and Escrow Instructions dated February 15, 1996 by and between the Company and
G.C. Realty LLC (North Chicago, Illinois) (Incorporated by reference to Exhibit 10.21 of the
Company's Registration Statement No. 333-20931)
10.22 Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated August 11, 1995 by and
between Raymond I. Scherr and Guitar Center Management Company, Inc., Profit Sharing Plan (South
Chicago, Illinois) (Incorporated by reference to Exhibit 10.22 of the Company's Registration
Statement No. 333-20931)
10.23 Lease dated August 31, 1995 by and between G.C. Realty LLC and the Company (Covina, California)
(Incorporated by reference to Exhibit 10.23 of the Company's Registration Statement No.
333-20931)
10.24 Amendment No. 1 to Amended and Restated 1996 Performance Stock Option Plan (Incorporated by
reference to Exhibit 10.24 of the Company's Registration Statement No. 333-20931)
10.25 Form of Employee Stock Purchase Plan Agreement (Incorporated by reference to Exhibit 10.25 of the
Company's Registration Statement No. 333-20931)
10.26 1997 Equity Participation Plan (Incorporated by reference to Exhibit 10.26 of the Company's
Registration Statement No. 333-20931)
10.27 Stockholders Consent dated as of January 24, 1997 by and among the Company and certain of its
stockholders (Incorporated by reference to Exhibit 10.27 of the Company's Registration Statement
No. 333-20931)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION PAGE
- ----------- ------------------------------------------------------------------------------------------------- ---------
<C> <S> <C>
10.28 Modification to Amended and Restated 1996 Performance Stock Option Plan (Incorporated by
reference to Exhibit 10.28 of the Company's Registration Statement No. 333-20931)
10.29 Management Stock Repurchase Agreement (Incorporated by reference to Exhibit 10.29 of the
Company's Registration Statement No. 333-20931)
10.30 Amendment No. 2 to the Amended and Restated 1996 Performance Stock Option Plan (Incorporated by
reference to Exhibit 10.30 of the Company's Registration Statement No. 333-20931)
10.31 Amendment No. 1 to Management Stock Option Agreement dated as of October 15, 1996 between the
Company and Larry Thomas (previously filed as Exhibit 10.21 contained in Registration Statement
No. 333-10491)
10.32 Amendment No. 1 to Management Stock Option Agreement dated as of October 15, 1996 between the
Company and Marty Albertson (previously filed as Exhibit 10.22 contained in Registration
Statement No. 333-10491)
10.33 Notice of Redemption of $33,333,000 aggregate principal amount of 11% Senior Notes due 2006
(Incorporated by reference to Exhibit 10.33 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1996)
10.34 Board Representation Agreement dated June 5, 1996 (Incorporated by reference to Exhibit 10.35 of
the Company's Annual Report on Form 10-K for the year ended December 31, 1996)
10.35 First Supplemental Indenture dated as of November 1, 1996 by and between Guitar Center Management
Company, Inc. (the Company's predecessor), the Company and U.S. Trust Company of California, as
trustee
12.1 Ratio of Earnings to Fixed Charges (Incorporated by reference to Exhibit 12.1 of the Company's
Annual Report on Form 10-K for the year ended December 31, 1996)
16.1 Consent of Ernst & Young LLP
23.1 Consent of KPMG Peat Marwick LLP, the Company's independent auditors
23.2 Consent of Ernst & Young LLP
23.3 Consent of Buchalter, Nemer, Fields & Younger, a Professional Corporation (included in Exhibit
5.1)
24.1 Power of Attorney (previously filed as Exhibit 24.1 contained in Registration Statement No.
333-10491)
25.1 Form T-1 Statement of Eligibility of Trustee (previously filed as Exhibit 25.1 to the Company's
Registration Statement No. 333-10491)
27.1 Financial Data Schedule (Incorporated by reference to Exhibit 27.1 of the Company's Registration
Statement on Form S-1 (Registration No. 333-20931))
</TABLE>
<PAGE>
EXHIBIT 10.35
FIRST SUPPLEMENTAL INDENTURE
BY AND AMONG
GUITAR CENTER MANAGEMENT COMPANY, INC.
GUITAR CENTER, INC.
AND
U.S. TRUST COMPANY OF CALIFORNIA, N.A.
AS TRUSTEE
$100,000,000
DATED: AS OF NOVEMBER 1, 1996
11% SENIOR NOTES DUE 2006
<PAGE>
THIS FIRST SUPPLEMENTAL INDENTURE, dated as of November 1, 1996, is
made and entered into by and between GUITAR CENTER MANAGEMENT COMPANY, INC., a
California corporation ("GC-California"), GUITAR CENTER, INC., Delaware
corporation ("GC-Delaware"), and U.S. TRUST COMPANY OF CALIFORNIA, N.A. (the
"Trustee").
RECITALS:
WHEREAS, GC-California and the Trustee have heretofore entered into an
Indenture, dated as of July 2, 1996 (the "Indenture"), relating to the issuance
of $100,000,000 11% senior notes due 2006 (the "Securities");
WHEREAS, GC-California proposes to merge with and into GC-Delaware in
order to reincorporate from California to Delaware pursuant to the terms and
conditions set forth in the Merger Agreement between GC-California and
GC-Delaware, dated as of November 1, 1996;
WHEREAS, the respective Boards of Directors and stockholders of GC-
California and GC-Delaware have approved such merger;
WHEREAS, Section 5.1 of Article Five of the Indenture provides in
pertinent part that GC-California shall not merge with or into any other
corporation unless the person (if other than GC-California) into which
GC-California is merged shall be a corporation organized and existing under the
laws of any state of the United States and shall expressly assume, by an
indenture supplemental to the Indenture, executed and delivered to the Trustee,
in a form satisfactory to the Trustee, all the obligations of GC-California
under the Securities and the Indenture;
2
<PAGE>
WHEREAS, GC-California and GC-Delaware are providing this First
Supplemental Indenture in satisfaction of the requirements of Section 5.1 of
Article Five of the Indenture;
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS:
SECTION 1. ASSUMPTION OF OBLIGATIONS. GC-Delaware hereby assumes
each and all of the obligations of GC-California, whether presently existing or
hereafter arising, under the Securities and the Indenture pursuant to Section
5.1 of Article Five of the Indenture and agrees to be bound by each and all of
the terms and conditions of the Indenture.
SECTION 2. AMENDMENT TO INDENTURE. All references in the
Indenture to "the Company" are hereby amended to refer to GC-Delaware whenever
and wherever used in the Indenture. Except for such amendments, the Indenture
remains in full force and effect.
SECTION 3. COUNTERPARTS. This First Supplemental Indenture may
be executed in several counterparts, each of which shall be an original and all
of which shall constitute but one and the same agreement.
3
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this First
Supplemental Indenture to be duly executed.
Dated: October 28, 1996 GUITAR CENTER MANAGEMENT COMPANY, INC.,
a California corporation
Attest: /s/ BRUCE L. ROSS By: /s/ MARTY ALBERTSON
------------------ -----------------------------------------
Title: Chief Operating Officer
--------------------------------------
Dated: October 28, 1996 GUITAR CENTER, INC.,
a Delaware corporation
Attest: /s/ BRUCE L. ROSS By: /s/ MARTY ALBERTSON
------------------ -----------------------------------------
Title: Chief Operating Officer
--------------------------------------
Dated: October 28, 1996 U.S. TRUST COMPANY OF CALIFORNIA,
N.A., as Trustee
Attest: /s/ AGNES P. OBANDO By: /s/ SANDEE PARKS
------------------ -----------------------------------------
Title: Vice President
--------------------------------------
4
<PAGE>
STATE OF CALIFORNIA )
) ss.
COUNTY OF LOS ANGELES )
On October 28, 1996, before me, the undersigned, a Notary Public in
and for said State, personally appeared Marty Albertson, known to me to be the
C.O.O. of GUITAR CENTER MANAGEMENT COMPANY, INC. the corporation that executed
the within instrument, known to me to be the person who executed the within
instrument on behalf of such corporation, and acknowledged to me that such
corporation executed the within instrument pursuant to its bylaws or a
resolution of its board of Directors.
WITNESS my hand and official seal.
[SEAL] /s/ LESLIE GEDDRY
---------------------------------
Notary Public in and for said
County and State
STATE OF CALIFORNIA )
) ss.
COUNTY OF LOS ANGELES )
On October 28, 1996, before me, the undersigned, a Notary Public in
and for said State, personally appeared Marty Albertson known to me to be the
C.O.O. of GUITAR CENTER, INC. the corporation that executed the within
instrument, known to me to be the person who executed the within instrument on
behalf of such corporation, and acknowledged to me that such corporation
executed the within instrument pursuant to its bylaws or a resolution of its
board of Directors.
WITNESS my hand and official seal.
[SEAL] /s/ LESLIE GEDDREY
--------------------------------
Notary Public in and for said
County and State
5
<PAGE>
STATE OF CALIFORNIA )
) ss.
COUNTY OF LOS ANGELES )
On November 8, 1996, before me, the undersigned, a Notary Public in
and for said State, personally appeared Sandee Parks, known to me to be the
___________ of U.S. TRUST COMPANY OF CALIFORNIA, N.A. the corporation that
executed the within instrument, known to me to be the person who executed the
within instrument on behalf of such corporation, and acknowledged to me that
such corporation executed the within instrument pursuant to its bylaws or a
resolution of its board of Directors.
WITNESS my hand and official seal.
[SEAL] /s/ DONNA M. NAKAMURA
--------------------------------
Notary Public in and for said
County and State
6
<PAGE>
EXHIBIT 16.1
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Gentlemen:
We have read the statements under the heading "Experts" contained in the
Registration Statement on Form S-1 (No. 333-10491) of Guitar Center, Inc. and
are in agreement with the statements contained in the third paragraph therein.
ERNST & YOUNG LLP
April 18, 1997
<PAGE>
EXHIBIT 23.1
CONSENT OF KPMG PEAT MARWICK LLP
The Board of Directors
Guitar Center, Inc.:
The audit referred to in our report dated February 10, 1997, included the
related financial statement schedule as of and for the year ended December 31,
1996, included in the registration statement. This financial statement schedule
is the responsibility of the Company's management. Our responsibility is to
express an opinion on this financial statement schedule based on our audit. In
our opinion, such financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
We consent to the use of our report included herein and to the reference to
our firm under the heading "Experts" in the prospectus.
KPMG PEAT MARWICK LLP
Los Angeles, California
April 18, 1997
<PAGE>
EXHIBIT 23.2
CONSENT OF ERNST & YOUNG LLP
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated March 6, 1996, in the Registration Statement (Form
S-1 No. 333-10491) and related Prospectus of Guitar Center Inc. dated March 10,
1997.
ERNST & YOUNG LLP
Los Angeles, California
April 18, 1997
