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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
COMMISSION FILE NUMBER 000-22207
GUITAR CENTER, INC.
(Exact name of registrant as specified in charter)
DELAWARE 95-4600862
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
5155 CLARETON DRIVE
AGOURA HILLS, CALIFORNIA 91301
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 735-8800
Securities registered pursuant to 12(b) of the Act:
NONE
Securities registered pursuant to 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
Check if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
As of March 24, 1997, the aggregate market value of voting stock held by
nonaffiliates of the Company was approximately $133,144,768 (based upon the
last reported sales price of the Common Stock as reported by the Nasdaq
National Market). Shares of Common Stock held by each executive officer,
director, holders of greater than 10% of the outstanding Common Stock of the
Registrant and persons or entities known to the Registrant to be affiliates
of the foregoing have been excluded in that such persons may be deemed to be
affiliates. This assumption regarding affiliate status is not necessarily a
conclusive determination for other purposes.
Check whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days. YES [ X ] NO [ ].
As of March 24, 1997, there were 18,316,579 shares of Common Stock, par
value $.01 per share, outstanding.
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The Exhibit Index appears on page S-2.
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PART I
ITEM 1. BUSINESS
COMPANY HISTORY
Guitar Center, Inc. ("Guitar Center" or the "Company") 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 (Mr.
Larry Thomas, the Company's President and Chief Executive Officer, and Mr.
Marty Albertson, 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.
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.
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 (including
Messrs. Thomas and Albertson), 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 referred to
herein as the "Investors."
BUSINESS
As of December 31, 1996, Guitar Center operated 28 stores in 15 major
U.S. markets, 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
1994, 1995 and 1996 were $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 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
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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.
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:
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%
_____________________
(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 closing of the Company's initial public offering (the "Offering") on
March 19, 1997 (and before any exercise of the underwriters' overallotment
option) executive officers and key managers beneficially owned approximately
18.8% of the Company's outstanding Common Stock, $.01 par value (the "Common
Stock"). The Company's growth strategy is to continue to increase its
presence in its existing markets and to open 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 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, 1994, 1995 and 1996, the Company had
net income (loss) of $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. See
"Item 13. Certain Relationships and Related Transactions -- 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
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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,
90% 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 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 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.
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
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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.
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,
executive officers and key managers beneficially own approximately 18.8% of
the Company's outstanding Common Stock. See "Item 10. Directors and
Executive Officers of the Registrant" and "Item 13. Security Ownership of
Certain Beneficial Owners and Management."
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.
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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, 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.
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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 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.
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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.
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. As it believes is customary in the
industry, the Company does not have any long-term supply contracts with its
vendors. See "-- Risks Related to the Business -- 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."
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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.
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 "-- Risks Related to the Business -- 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.
8
<PAGE>
STORE LOCATIONS
The table below sets forth certain information concerning Guitar Center
stores:
STORE APPROXIMATE
- ----- YEAR GROSS
OPENED SQUARE FEET LEASE/OWN
------ ----------- ---------
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
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
- -----------------
(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.
<PAGE>
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.
RISKS RELATED TO THE BUSINESS
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 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. 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 "--
Store Locations." 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. The Company
regularly considers and evaluates potential acquisition candidates in new and
existing market areas, is currently evaluating several such opportunities and is
in negotiations regarding one possible acquisition. Any such transactions may
involve the payment by the Company of cash or securities (including equity
securities), or a combination of the foregoing. As of March 24, 1997, the
Company had no existing agreements or commitments to effect any such
acquisition. Accordingly, there can be no assurance that the Company will be
able to identify suitable acquisition candidates available for sale at
reasonable prices or consummate any acquisition or that any current negotiations
will result in an acquisition. 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.
10
<PAGE>
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
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 price of the Common Stock to fluctuate
substantially. See "Item 7. 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 "Item 11.
Executive Compensation." 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 "-- Customer Service."
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 "-- Competition."
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,
11
<PAGE>
respectively. Although the Company has opened 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 "Item 2. 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 HISTORY OF TRADING ON NASDAQ NATIONAL MARKET; VOLATILITY OF STOCK
PRICE. The Company's Common Stock began trading on the Nasdaq National Market
on March 14, 1997. There can be no assurance that an active trading market in
the Company's Common Stock will be maintained. The market price of the shares
of Common Stock could be subject to significant fluctuations in response to the
Company's operating results and other factors, including announcements by
competitors. In addition, the stock market in recent years has experienced
significant price and volume fluctuations that often have been unrelated or
disproportionate to the operating performance of particular companies. These
fluctuations, as well as a shortfall in sales or earnings compared to public
market analysts' expectations, changes in analysts' recommendations or
projections, and general economic and market conditions, may adversely affect
the market price of the Common Stock.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS. This Report 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 section, important factors to consider in 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 Report will in fact be realized. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operation."
ITEM 2. PROPERTIES
Guitar Center leases 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.
See "Item 1. Business -- Store Locations."
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.
ITEM 3. LEGAL PROCEEDINGS
12
<PAGE>
The Company is not a party to any material legal proceedings and is not
aware of any pending or threatened litigation that, if decided adversely to the
Company, would have a material adverse effect on the Company's financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 28, 1996, Guitar Center Management Company, Inc., a California
corporation that was the predecessor to the Company and then-sole stockholder of
the Company ("GCMC"), approved by written consent the merger of GCMC with and
into the Company. The purpose of the merger was to reincorporate the Company in
Delaware and change the name of the Company to its present name.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company effected its initial public offering on March 14, 1997 at a
price of $15.00 per share. The Company's Common Stock is quoted on the Nasdaq
National Market under the symbol "GTRC." On March 24, 1997, the last reported
sale price of the Common Stock on the Nasdaq National Market was $16.00 per
share. At March 24, 1997, there were 45 stockholders of record, excluding the
number of beneficial owners whose shares were held in street name. The Company
believes that the number of beneficial holders is significantly in excess of
this amount.
DIVIDEND POLICY
The Company currently intends to retain any earnings to provide funds for
the operation and expansion of its business and for the servicing and repayment
of indebtedness and does not intend to pay cash dividends on the Common Stock in
the foreseeable future. Under the terms of the indenture governing the
Company's 11% Senior Notes due 2006 (the "Senior Notes"), the Company is not
permitted to pay any dividends on the Common Stock unless certain financial
ratio tests and other conditions are satisfied. In addition, the Company's bank
facility with Wells Fargo Bank, N.A. (the "1996 Credit Facility") contains
certain covenants which, among other things, limit the payment of cash dividends
on the capital stock of the Company. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources." Any determination to pay cash dividends on the Common Stock
in the future will be at the sole discretion of the Company's Board of
Directors.
13
<PAGE>
ITEM 6. SELECTED 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 "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Item 13. Certain
Relationships and Related Transactions -- The Recapitalization," and the
financial statements of the Company and the notes thereto included elsewhere
herein.
<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 PER SHARE AND 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)
------- ------- ------- -------- -------- --------
------- ------- ------- -------- -------- --------
Pro forma net income (loss) per common
share . . . . . . . . . . . . . . . . $ (3.72)
--------
--------
Weighted average common shares
outstanding (4) . . . . . . . . . . . 19,408
--------
--------
OPERATING DATA:
Net sales per gross square foot (5) . . . . $ 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 (6) . . 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 (7) . . 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)
FOOTNOTES APPEAR ON FOLLOWING PAGE.
</TABLE>
14
<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 "Item 13. Certain Relationships
and Related Transactions -- The Recapitalization; -- 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) Weighted average shares outstanding assumes that: (i) the Common Stock
sold in the Offering, the Common Stock issued pursuant to the conversion of
each outstanding share of the Company's Junior Preferred Stock, $.01 par
value ("Junior Preferred Stock"), into 6.667 shares of Common Stock in
connection with the Offering (the "Junior Preferred Stock Conversion") and
the Common Stock issuable upon the exercise of all of the Company's
outstanding warrants and other common stock equivalents were outstanding
during each of the periods presented, and (ii) the Common Stock redeemed in
connection with the Offering was not outstanding during any of the periods
presented. See Notes 1 and 10 to Notes to Financial Statements; "Item 11.
Executive Compensation -- Management Stock Option Agreements; -- 1996
Performance Stock Option Plan" and "Item 13. Certain Relationships and
Related Transactions -- Transactions with Affiliates of Chase Ventures; --
Management Tax Redemption."
(5) 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.
(6) Compares net sales for the comparable periods, excluding net sales
attributable to stores not open for 14 months.
(7) 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.
15
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
As of December 31, 1996, the Company had 28 stores operating in 15 major
markets. 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 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 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 and seven stores in 1996. 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:
Fiscal Year Ended
December 31,
------------------------------
1994 1995 1996
------ ------ ------
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)%
----- ----- -----
----- ----- -----
16
<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 "Item 13. Certain Relationships and
Related Transactions -- The Recapitalization; -- 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
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<PAGE>
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.
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.
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<PAGE>
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.
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). Approximately $22.9 million of the net proceeds from the Offering
was used to redeem, at a premium, all of the Company's outstanding 14% Senior
Preferred Stock, $.01 par value ("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, approximately $18.4 million of the net proceeds from
the Offering will be used to redeem approximately 1,317,000 shares of Common
Stock. Immediately following the closing of the Offering, the Company called
for redemption an aggregate of $33.3 million of Senior Notes. The Company
intends to use approximately $37.9 million of the net proceeds from the
Offering to redeem such Senior Notes, at a premium, 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.
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. 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 Senior 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
Report 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 is currently negotiating a new bank facility
to replace the 1996 Credit Facility, although no agreement has been reached
as of the date of this Report.
The Company has granted the underwriters of the Offering an
over-allotment option to purchase up to an additional 1,012,500 shares of
Common Stock at a price to the public of $15.00 per share (or a net price to
the Company of $13.95 per share). Such option may be exercised by the
underwriters at any time through April 13, 1997.
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.
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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. The Company operated 28
stores as of December 31, 1996, seven of which were opened during fiscal
1996, and presently expects to open approximately eight stores in each of
fiscal 1997 and 1998. 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 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 believes that there may be attractive opportunities to
expand by selectively acquiring existing music product retailers. The
Company regularly considers and evaluates potential acquisition candidates in
new and existing market areas, is currently evaluating several such
opportunities and is in negotiations regarding one possible acquisition. Any
such transactions may involve the payment by the Company of cash or
securities (including equity securities), or a combination of the foregoing.
As of March 24, 1997, the Company had no existing agreements or commitments
to effect any such acquisition. There can be no assurance that the Company
will be able to identify suitable acquisition candidates available for sale
at reasonable prices or consummate any acquisition or that any current
negotiations will result in an acquisition. See "Item 1. Business -- Risks
Related to the Business -- Aggressive Growth Strategy."
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, the Investors 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 "Item 13.
Certain Relationships and Related 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.
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.
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<PAGE>
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.
FORWARD-LOOKING STATEMENTS
This Report 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 "Item 1. Business -- Risks Related to the
Business," there can be no assurance that the forward-looking statements
contained in this Report will in fact be realized.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the index included at "Item 14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
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.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS, DIRECTORS AND KEY MANAGERS
The executive officers, directors and key managers of the Company are as
follows as of March 24, 1997:
<TABLE>
<CAPTION>
YEARS OF
SERVICE WITH
NAME AGE POSITION 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 Officer and Director 17
Bruce Ross . . . . . . . . . 48 Vice President, Chief Financial Officer and Secretary 3
Barry Soosman . . . . . . . . 37 Vice President of Corporate Development and General Counsel 1
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 Manager 13
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
managers 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 the Company since such time. In 1980, he served as the
Company's Advertising Director. In 1984, he became the Company's National
Sales
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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 1990 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. 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 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 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, N.A.
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<PAGE>
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. Mr. Laughlin has an M.B.A.
BOARD OF DIRECTORS
As of the date of this Report, 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 "Item 13. Certain
Relationships and Related Transactions -- Scherr Board Representation Letter."
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<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 (as defined herein)
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
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 "Item 11. Executive Compensation -- 1997 Equity
Participation Plan."
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers and directors, and persons
who own more than ten percent of a registered class of the Company's equity
securities, to file reports of ownership and changes in ownership (Forms 3, 4
and 5) with the Securities and Exchange Commission. Officers, directors and
greater-than-ten-percent holders are required to furnish the Company with
copies of all such forms which they file. To the Company's knowledge, based
solely on the Company's review of such reports or written representations
from certain reporting persons, the Company believes that through March 24,
1997, all filing requirements applicable to its officers, directors,
greater-than-ten-percent beneficial owners and other persons subject to
Section 16(a) of the Exchange Act were complied with.
26
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
1995 AND 1996 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 during the periods presented (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 President and 1995 375,000 $214,285 -- -- 25,645
Chief Operating Officer
Bruce Ross . . . . . . . . . . . . . 1996 $195,000 $58,500 -- 79,599 $11,250
Vice President and Chief 1995 180,000 48,060 -- -- --
Financial Officer
Barry Soosman . . . . . . . . . . . . 1996 $112,500 $10,000 -- 79,599 --
Vice President of Corporate 1995 -- -- -- -- --
Development and General
Counsel
Raymond Scherr (5) . . . . . . . . . 1996 $529,885 -- -- -- $11,250
Chairman and Operator of 1995 1,000,000 -- -- -- 25,645
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 "Item 13. Certain
Relationships and Related Transactions -- The Recapitalization."
(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.
27
<PAGE>
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 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.
28
<PAGE>
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.
OTHER OPTION ARRANGEMENTS
The Investors 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. The Company is not a party to this agreement and has not,
and will not, incur any obligation in connection with such options. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources" and "Item 13. Certain
Relationships and Related 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 this Report.
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 March 24, 1997,
the Company had outstanding under the 1996 Plan options to purchase 713,782
shares of Common Stock, at an exercise price of $10.89 per share (no shares of
which are currently exercisable or will be exercisable within 60 days of
March 24, 1997). The Company will not issue any additional options under the
1996 Plan. The 1996 Plan is administered by the Compensation Committee, which
has the power and authority to grant options under the 1996 Plan, subject to the
Board's prior approval.
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
29
<PAGE>
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 sale of the
Company or termination of the optionee's relationship with the Company
without cause (as defined in the 1996 Plan), or by the optionee with
reasonable justification (as defined in the 1996 Plan) or 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 $10.89 per share under the 1996 Plan. See
"-- Employment Agreements; -- Management Stock Option Agreements; -- 1996
Performance Stock Option Plan; -- 1997 Equity Participation Plan."
Set forth below is a table describing the options granted by the Company to
each of the Named Officers during the year ended December 31, 1996:
<TABLE>
<CAPTION>
INDIVIDUAL OPTION GRANTS IN 1996
--------------------------------------------------------------------------------
PERCENT OF POTENTIAL REALIZABLE VALUE
TOTAL AT ASSUMED ANNUAL
NUMBER OF OPTIONS/ RATES OF STOCK
SECURITIES SARS EXERCISE PRICE APPRECIATION
UNDERLYING GRANTED TO OR BASE FOR OPTION TERM (2)
OPTIONS/SARS EMPLOYEES PRICE ($/ EXPIRATION -------------------------
NAME GRANTED (#)(1) IN 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 $6,907,917
Marty Albertson . . 397,985 29.5 10.89 2006 2,725,880 6,907,917
Bruce Ross . . . . 79,599 5.9 10.89 2006 545,189 1,381,615
Barry Soosman . . . 79,599 5.9 10.89 2006 545,189 1,381,615
Raymond Scherr . . -- -- -- -- -- --
</TABLE>
- -------------------
(1) The securities underlying the options are shares of Common Stock. No SARs
were granted in fiscal 1996. For a description of terms pertaining to such
options and other information relating thereto, see "-- Employment
Agreements; -- Management Stock Option Agreements; -- 1996 Performance
Stock Option Plan."
(2) The potential realizable value assumes a rate of annual compound stock
price appreciation of 5% and 10% from the date the option was granted over
the full option term. These assumed annual compound rates of stock price
appreciation are mandated by the rules of the Securities and Exchange
Commission and do not represent the Company's estimate or projection of
future Common Stock prices.
30
<PAGE>
The following table sets forth, on an aggregated basis, information
regarding securities underlying unexercised options during the year ended
December 31, 1996 by the Named Officers:
<TABLE>
<CAPTION>
OPTION VALUES AT DECEMBER 31, 1996
---------------------------------------------------------------
NUMBER OF VALUE OF
SECURITIES UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR-END (1)(#) FISCAL YEAR-END ($)
------------------------------- -------------------------------
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 March 24, 1997, no options had 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 this Report.
ADMINISTRATION. The Compensation Committee administers the 1997 Plan with
respect to grants to employees or consultants of the Company and the full Board
administers 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
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 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
31
<PAGE>
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 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.
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
32
<PAGE>
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 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
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
33
<PAGE>
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, the remuneration attributable to stock options and SARs which meet the
other requirements of Section 162(m) will not be subject to the $1,000,000
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.
34
<PAGE>
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, and as of the date of this
Report, the Compensation Committee was comprised of Messrs. Ferguson and
Lazarus. 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.
35
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the following table sets forth the ownership of the
Common Stock, as of March 24, 1997, of the Company 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 March 24, 1997, the Company had 18,316,579 shares of Common Stock
outstanding. The Company has granted the underwriters of the Offering an over-
allotment option to purchase up to an additional 1,012,500 shares of Common
Stock. The information in the following table excludes the shares of Common
Stock which may be issued by the Company upon the exercise of such option. Such
option may be exercised by the underwriters at any time through April 13, 1997.
NUMBER OF SHARES PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIALLY OWNED (1) OWNERSHIP (1)
- ---------------------------------------- ---------------------- -------------
Chase Venture Capital Associates, L.P.(2). 4,381,265 23.9%
380 Madison Avenue, 12th Floor
New York, NY 10017
Raymond Scherr (3) . . . . . . . . . . . . 1,710,148 9.3
David Ferguson (4) . . . . . . . . . . . . -- --
Jeffrey Walker (4) . . . . . . . . . . . . -- --
Michael Lazarus (5). . . . . . . . . . . . -- --
Steven Burge (6) . . . . . . . . . . . . . -- --
Larry Thomas (7) . . . . . . . . . . . . . 1,384,816 7.6
Marty Albertson (8). . . . . . . . . . . . 927,637 5.1
Bruce Ross (9) . . . . . . . . . . . . . . 3,850 *
Barry Soosman (10) . . . . . . . . . . . . 49,760 *
All Executive Officers and Directors as a
group (9 persons) (3)-(10) . . . . . . . 4,076,211 22.3
- -------------------
* 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 March 24, 1997, 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, 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. Unless
otherwise indicated, the address for each person is the Company's address
at 5155 Clareton Drive, Agoura Hills, California 91362.
(2) Excludes Investor Options granted by Chase Ventures to certain members of
management for the purchase of 207,899 shares of Common Stock. See "Item
13. Certain Relationships and Transactions -- Options Granted by the
Investors to Certain Members of Management."
(3) 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 such person is 1096 Lakeview Canyon,
Westlake Village, California
36
<PAGE>
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.
(4) 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. 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.
(5) 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 the Investor Options. See "Item 13. Certain Relationships
and 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.
(6) 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 the Investor Options. See "Item 13. Certain Relationships and
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.
(7) 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 "Item 13. Certain Relationships and Related Transactions -- Options
Granted by the Investors to Certain Members of Management."
(8) 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 "Item 13. Certain Relationships and
Related Transactions -- Options Granted by the Investors to Certain Members
of Management."
(9) Represents 3,850 shares of Common Stock issuable upon the exercise of an
Investor Option granted to Mr. Ross by the Investors. See "Item 13.
Certain Relationships and Related Transactions -- Options Granted by the
Investors to Certain Members of Management."
(10) Represents: (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 "Item 13. Certain Relationships and Related
Transactions -- Options Granted by the Investors to Certain Members of
Management."
37
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED 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. 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, $160,000 for legal fees in 1996.
THE RECAPITALIZATION
On June 5, 1996, the Company consummated a series of transactions to effect
the Recapitalization in order to transfer ownership of the Company from its sole
stockholder, the Scherr Trust, to members of management (including Messrs.
Thomas and Albertson), Chase Ventures and an affiliated entity, Wells Fargo and
Weston Presidio. 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,
were 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 "Item 11. Executive Compensation -- Management Stock Option
38
<PAGE>
Agreements." 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.
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. As of
March 24, 1997, Chase Ventures, Wells Fargo and Weston Presidio beneficially
owned 23.9%, 4.8% and 3.6%, respectively, of the Common Stock outstanding.
Chase Ventures is an affiliate of Chase Securities Inc. ("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 for losses incurred in connection with any
misrepresentations or breaches of warranty by the Company or its affiliates.
The Investors 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 VENTURES
In connection with the Recapitalization, the Company entered into a Bridge
Facility with Chemical Bank ("Chemical"), an affiliate of Chase Ventures,
pursuant to which 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 offering of the Senior 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, N.A., purchased approximately 7.14% of the then outstanding
Common Stock. See "Item 12. Security Ownership of Certain Beneficial Owners
and Management." Wells Fargo Bank, N.A. is acting as lender under the 1996
Credit Facility and is being paid customary fees therefor. In addition, the
Company has agreed to pay to Wells Fargo Bank, N.A. promptly upon demand, a
fee of $25,000 in consideration for Wells Fargo Bank, N.A. 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.
39
<PAGE>
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 ("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, 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
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).
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 have received any cash with respect to the underlying stock).
In February 1997, the Company entered into an agreement with Larry Thomas,
Marty Albertson and certain other senior employees pursuant to which the
Company agreed to redeem 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).
40
<PAGE>
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 "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
41
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report:
1. The following financial statements for the Company are included as
part of this Report:
Index to Financial Statements. . . . . . . . . . . . . . . .Page F-1
2. The following financial statement schedule for the Company is
included as part of this Report:
Schedule II -- Valuation and Qualifying Accounts . . . . . .Page II-1
All other schedules have been omitted since the required information
is not present in amounts sufficient to require submission of the
schedules, or because the information required is included in the
financial statements.
(b) No reports on Form 8-K were filed during the quarter ended December 31,
1996.
(c) Those Exhibits, and the Index thereto, required to be filed by Item 601 of
Regulation S-K are attached hereto. Certain management contracts and other
compensation plans or arrangements required to be filed are identified on
the attached Index with an asterisk (*).
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report
to be signed on its behalf by the undersigned, thereunto duly authorized.
GUITAR CENTER, INC.
/s/ LARRY THOMAS
--------------------------------------
Larry Thomas
President and Chief Executive Officer
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Larry Thomas, Marty Albertson and
Bruce Ross, as his attorneys-in-fact, each with the power of substitution,
for him in any and all capacities, to sign any amendment to this Report on
Form 10-K, and to file the same, with exhibits thereto and other documents in
connection therewith with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/s/ LARRY THOMAS President, Chief Executive March 24, 1997
- -------------------------- Officer and Director
Larry Thomas (Principal Executive Officer)
/s/ BRUCE ROSS Vice President, Chief Financial March 24, 1997
- -------------------------- Officer and Secretary (Principal
Bruce Ross Financial and Accounting
Officer)
/s/ MARTY ALBERTSON Executive Vice President, Chief March 24, 1997
- -------------------------- Operating Officer and Director
Marty Albertson
/s/ RAYMOND SCHERR Director March 24, 1997
- --------------------------
Raymond Scherr
/s/ DAVID FERGUSON Director March 24, 1997
- --------------------------
David Ferguson
/s/ JEFFREY WALKER Director March 24, 1997
- --------------------------
Jeffrey Walker
/s/ MICHAEL LAZARUS Director March 24, 1997
- --------------------------
Michael Lazarus
/s/ STEVEN BURGE Director March 24, 1997
- --------------------------
Steven Burge
S-1
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 The Company's Restated Certificate of Incorporation (Incorporated
by reference to Exhibit 3.5 of the Company's Registration
Statement on Form S-1 (Registration 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 on Form S-1
(Registration 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 (Incorporated by
reference to Exhibit 4.1 of the Company's Registration Statement on
Form S-1 (Registration No. 333-10491))
4.2 Form of Restricted Stock Agreements dated as of May 1, 1996 between
the Company and certain members of management (Incorporated by
reference to Exhibit 4.2 of the Company's Registration Statement on
Form S-1 (Registration 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
(Incorporated by reference to Exhibit 4.3 of the Company's
Registration Statement on Form S-1 (Registration No. 333-10491))
4.4 Form of Stock Certificate (Incorporated by reference to Exhibit 4.4
of the Company's Registration Statement on Form S-1 (Registration
No. 333-20931))
10.1 Recapitalization Agreement dated May 1, 1996 by and among the
Company and the stockholders named therein (Incorporated by
reference to Exhibit 10.1 of the Company's Registration Statement
on Form S-1 (Registration No. 333-10491)
10.2 Registration Rights Agreement dated June 5, 1996 among the Company
and the stockholders named therein (Incorporated by reference to
Exhibit 10.2 of the Company's Registration Statement on Form S-1
(Registration 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 (Incorporated by reference to Exhibit 10.3
of the Company's Registration Statement on Form S-1 (Registration
No. 333-10491)
10.4* Employment Agreement dated June 5, 1996 between the Company and
Lawrence Thomas (Incorporated by reference to Exhibit 10.5 of the
Company's Registration Statement on Form S-1 (Registration
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 on Form S-1 (Registration No. 333-20931))
10.6* Employment Agreement dated June 5, 1996 between the Company and
Marty Albertson (Incorporated by reference to Exhibit 10.6 of the
Company's Registration Statement on Form S-1 (Registration
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 on Form S-1 (Registration
No. 333-20931))
10.8* Employment Agreement dated June 5, 1996 between the Company and
Raymond Scherr (Incorporated by reference to Exhibit 10.8 of the
Company's Registration Statement on Form S-1 (Registration
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 on Form S-1 (Registration
No. 333-20931))
10.10 Securities Purchase Agreement dated June 5, 1996 by and among the
Company and the parties named therein (Incorporated by reference to
Exhibit 10.10 of the Company's Registration Statement on Form S-1
(Registration No. 333-10491))
S-2
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
------- ----------
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 on Form S-1
(Registration No. 333-20931))
10.12 Credit Agreement dated June 5, 1996 between the Company and Wells
Fargo Bank, N.A. (Incorporated by reference to Exhibit 10.12 of the
Company's Registration Statement on Form S-1 (Registration
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 (Incorporated by reference to Exhibit 10.13 of the
Company's Registration Statement on Form S-1 (Registration
No. 333-10491))
10.14 Security Agreement dated June 5, 1996 between the Company and Wells
Fargo, N.A. (Incorporated by reference to Exhibit 10.14 of the
Company's Registration Statement on Form S-1 (Registration
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 (Incorporated by reference to Exhibit 10.15
of the Company's Registration Statement on Form S-1 (Registration
No. 333-10491))
10.16* Management Stock Option Agreement dated June 5, 1996 by and between
the Company and Lawrence Thomas (Incorporated by reference to
Exhibit 10.16 of the Company's Registration Statement on Form S-1
(Registration No. 333-10491))
10.17* Management Stock Option Agreement dated June 5, 1996 by and between
the Company and Marty Albertson (Incorporated by reference to
Exhibit 10.17 of the Company's Registration Statement on Form S-1
(Registration No. 333-10491))
10.18 Registration Agreement dated June 5, 1996 among the Company and the
parties named therein (Incorporated by reference to Exhibit 10.11
contained in Registration Statement on Form S-1 (File
No. 333-10491))
10.19 Stockholders Agreement dated June 5, 1996 among the Company, and
the investors listed therein (Incorporated by reference to
Exhibit 10.19 of the Company's Registration Statement on Form S-1
(Registration 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 on Form S-1 (Registration 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 on Form S-1 (Registration
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 on Form S-1 (Registration
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 on Form S-1
(Registration 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 on Form S-1 (Registration
No. 333-20931))
S-3
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
------- ----------
10.25* Form of Employee Stock Purchase Plan Agreement (Incorporated by
reference to Exhibit 10.25 of the Company's Registration Statement
on Form S-1 (Registration No. 333-20931))
10.26* 1997 Equity Participation Plan (Incorporated by reference to
Exhibit 10.26 of the Company's Registration Statement on Form S-1
(Registration 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 on Form S-1
(Registration No. 333-20931))
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 on Form S-1 (Registration No. 333-20931))
10.29* Management Stock Repurchase Agreement (Incorporated by reference to
Exhibit 10.29 of the Company's Registration Statement on Form S-1
(Registration 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 on Form S-1 (Registration
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 (Incorporated
by reference to Exhibit 10.21 contained in Registration Statement on
Form S-1 (File 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
(Incorporated by reference to Exhibit 10.22 contained in
Registration Statement on Form S-1 (File No. 333-10491))
10.33 Notice of Redemption of $33,333,000 aggregate principal amount of
11% Senior Notes due 2006
10.34 Notice of Redemption of all outstanding shares of 14% Senior
Preferred Stock
10.35 Board Representation Agreement dated June 5, 1996
12.1 Ratio of Earnings to Fixed Charges
24.1 Power of Attorney (included on page S-1)
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))
- ----------------
* Management contract or other compensation plan or arrangement.
S-4
<PAGE>
GUITAR CENTER, INC.
INDEX TO FINANCIAL STATEMENTS
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
Schedule
Financial Statement Schedule:
Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . II-1
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 note 13 which is as
of March 19, 1997
F-2
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholder
Guitar Center, Inc.
We have audited the accompanying balance sheet of Guitar Center, Inc. as
of December 31, 1995, and the related statements of operations, stockholders'
equity, and cash flows for each of the two years in the period ended December
31, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Guitar Center,
Inc. at December 31, 1995, and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 1995 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Los Angeles, California
March 6, 1996
F-3
<PAGE>
GUITAR CENTER, INC.
BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1995 1996
-------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,338 $ 47
Accounts receivable, less allowance for doubtful accounts
of $200 (1995) and $150 (1996) . . . . . . . . . . . . . . . . . . . . . . . . . 2,203 4,062
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,281 49,705
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . . . 690 1,388
Employee notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 67
-------- ---------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,594 55,269
Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,276 14,966
Goodwill, net of accumulated amortization of $152 (1995) and $167 (1996) . . . . . . 447 432
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 4,182
-------- ---------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 49,618 $ 74,849
-------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,613 $ 14,005
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,061 7,891
Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,908 --
Merchandise advances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,010 2,401
Current portion of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . -- 3,536
-------- ---------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29,592 27,833
Other long-term liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 263 645
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 100,000
Senior preferred stock, aggregate liquidation preference of $21,602; authorized
4,250,000 shares, issued and outstanding 800,000 shares. . . . . . . . . . . . . . -- 15,186
Stockholders' equity (deficit):
Junior preferred stock aggregate liquidation preference of $144,959. . . . . . . . -- 138,610
Common stock, no par value; authorized 2,500,000 shares, issued and outstanding
1,400,000 at December 31, 1995; $0.01 par value authorized 55,000,000 shares,
issued and outstanding 3,622,804 at December 31, 1996. . . . . . . . . . . . . . 4,987 36
Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- 6,500
Additional paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- (6,966)
Retained earnings (deficit). . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,776 (206,995)
-------- ---------
Total stockholders' equity (deficit) . . . . . . . . . . . . . . . . . . . . . . . . 19,763 (68,815)
-------- ---------
Total liabilities and stockholders' equity (deficit) . . . . . . . . . . . . . . . . $ 49,618 $ 74,849
-------- ---------
-------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
F-4
<PAGE>
GUITAR CENTER, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . $ 129,039 $ 170,671 $ 213,294
Cost of goods sold, buying and occupancy . . . . . . . . . . 92,275 123,415 153,222
---------- ---------- ----------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . 36,764 47,256 60,072
Selling, general and administrative expenses . . . . . . . . 26,143 32,664 41,345
Deferred compensation expense. . . . . . . . . . . . . . . . 1,259 3,087 71,760
---------- ---------- ----------
Operating income (loss). . . . . . . . . . . . . . . . . . . 9,362 11,505 (53,033)
Interest income. . . . . . . . . . . . . . . . . . . . . . . 14 14 8
Interest expense . . . . . . . . . . . . . . . . . . . . . . (266) (382) (12,177)
Transaction expenses . . . . . . . . . . . . . . . . . . . . -- -- (6,942)
Other income (expenses). . . . . . . . . . . . . . . . . . . 45 65 (126)
---------- ---------- ----------
Income (loss) before income taxes. . . . . . . . . . . . . . 9,155 11,202 (72,270)
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . 326 345 139
---------- ---------- ----------
Net income (loss). . . . . . . . . . . . . . . . . . . . . . $ 8,829 $ 10,857 $ (72,409)
---------- ---------- ----------
---------- ---------- ----------
Pro forma data (unaudited):
Income (loss) before taxes . . . . . . . . . . . . . . . . $ 9,155 $ 11,202 $ (72,270)
Pro forma income taxes . . . . . . . . . . . . . . . . . . 4,478 6,144 --
---------- ---------- ----------
Pro forma net income (loss). . . . . . . . . . . . . . . . $ 4,677 $ 5,058 $ (72,270)
---------- ---------- ----------
---------- ---------- ----------
Senior and junior preferred stock dividends. . . . . . . . -- -- 7,951
Net loss available to common stockholders. . . . . . . . . -- -- (80,221)
Pro forma net income (loss) per common share . . . . . . . $ 0.24 $ 0.26 $ (4.13)
---------- ---------- ----------
Weighted average shares outstanding. . . . . . . . . . . . 19,408 19,408 19,408
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
F-5
<PAGE>
GUITAR CENTER, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNIOR ADDITIONAL RETAINED
PREFERRED COMMON PAID IN EARNINGS
STOCK STOCK WARRANTS CAPITAL (DEFICIT) TOTAL
---------- ------ -------- ---------- --------- -----
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 . . . . . . . . . $ -- $ 4,987 $ -- $ -- $ 13,477 $ 18,464
Net income . . . . . . . . . . . . . . . . . -- -- -- -- 8,829 8,829
Distributions to stockholder . . . . . . . . -- -- -- -- (3,869) (3,869)
-------- --------- -------- ------- --------- ---------
Balance at December 31, 1994 . . . . . . . . . -- 4,987 -- -- 18,437 23,424
Net income . . . . . . . . . . . . . . . . . -- -- -- -- 10,857 10,857
Distributions to stockholder . . . . . . . . -- -- -- -- (14,518) (14,518)
-------- --------- -------- ------- --------- ---------
Balance at December 31, 1995 . . . . . . . . . -- 4,987 -- -- 14,776 19,763
S Corporation cash distributions . . . . . . -- -- -- -- (28,057) (28,057)
S Corporation non-cash distributions . . . . -- -- -- -- (1,753) (1,753)
Redemption of prior sole stockholder
interest. . . . . . . . . . . . . . . . . 19,800 (4,787) -- -- (128,115) (113,102)
Reclassification of prior
S Corporation deficit . . . . . . . . . . -- -- -- (10,249) 10,249 --
Issuance of equity to management . . . . . . 49,500 500 -- -- -- 50,000
Issuance of equity to new investors. . . . . 69,300 700 -- -- -- 70,000
Issuance of warrants . . . . . . . . . . . . -- -- 6,500 -- -- 6,500
Options granted to management by
investor group. . . . . . . . . . . . . . -- -- -- 1,918 -- 1,918
Reclassification of excess of par value. . . -- (1,364) -- 1,364 -- --
Sale of equity to management . . . . . . . . 10 -- -- 1 -- 11
Net loss . . . . . . . . . . . . . . . . . . -- -- -- -- (72,409) (72,409)
Undeclared dividend on senior
preferred stock . . . . . . . . . . . . . -- -- -- -- (1,602) (1,602)
Accretion of senior preferred stock. . . . . -- -- -- -- (84) (84)
---------- ------ -------- ---------- ----------- -----------
Balance at December 31, 1996 . . . . . . . . . $ 138,610 $ 36 $ 6,500 $ (6,966) $ (206,995) $ (68,815)
---------- ------ -------- ---------- -----------
---------- ------ -------- ---------- -----------
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
F-6
<PAGE>
GUITAR CENTER, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1994 1995 1996
------------ ---------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . $ 8,829 $ 10,857 $ (72,409)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization. . . . . . . . . . . . . . . . . . 1,488 1,802 2,161
Deferred compensation--repurchase of options . . . . . . . . . . -- -- 49,510
Investor options to management . . . . . . . . . . . . . . . . . -- -- 1,918
(Gain) loss on sale of fixed assets . . . . . . . . . . . . . . 85 (4) 112
Amortization of deferred financing fees. . . . . . . . . . . . . -- -- 215
Changes in operating assets and liabilities:
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . 714 (513) (1,859)
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . (4,785) (2,487) (18,424)
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . 12 (317) (698)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . 30 (154) (511)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 2,139 2,208 1,392
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . 2,871 1,452 830
Deferred compensation. . . . . . . . . . . . . . . . . . . . . 1,259 3,087 (7,908)
Merchandise advances . . . . . . . . . . . . . . . . . . . . . 349 490 391
Other long-term liabilities. . . . . . . . . . . . . . . . . . 296 (33) 382
---------- ---------- ----------
Net cash provided by (used in) operating activities . . . . . . . 13,287 16,388 (44,898)
INVESTING ACTIVITIES
Proceeds from sale of assets. . . . . . . . . . . . . . . . . . . 143 15 433
Purchases of property and equipment . . . . . . . . . . . . . . . (3,277) (3,432) (6,133)
Employee notes. . . . . . . . . . . . . . . . . . . . . . . . . . (39) (42) 15
----------- ----------- ----------
Net cash used in investing activities . . . . . . . . . . . . . . (3,173) (3,459) (5,685)
FINANCING ACTIVITIES
Principal repayments of long-term debt. . . . . . . . . . . . . . (2,575) (825) --
Proceeds from issuance of long term debt. . . . . . . . . . . . . -- -- 100,000
Net change in revolving debt facility . . . . . . . . . . . . . . -- -- 3,536
Distribution of prior shareholder interest. . . . . . . . . . . . -- -- (113,102)
Deferred financing fees paid. . . . . . . . . . . . . . . . . . . -- -- (3,585)
Issuance of common stock. . . . . . . . . . . . . . . . . . . . . -- -- 1,200
Issuance of junior preferred stock. . . . . . . . . . . . . . . . -- -- 69,300
Issuance of senior preferred stock. . . . . . . . . . . . . . . . -- -- 13,500
Issuance of warrants. . . . . . . . . . . . . . . . . . . . . . . -- -- 6,500
Distributions to stockholder. . . . . . . . . . . . . . . . . . . (3,869) (14,518) (28,057)
---------- ---------- ---------
Net cash provided by (used in) financing activities . . . . . . . (6,444) (15,343) 49,292
---------- ---------- ---------
Net increase (decrease) in cash and cash equivalents. . . . . . . 3,670 (2,414) (1,291)
Cash and cash equivalents at beginning of year. . . . . . . . . . 82 3,752 1,338
---------- ---------- ---------
Cash and cash equivalents at end of year. . . . . . . . . . . . . 3,752 1,338 47
---------- ---------- ---------
---------- ---------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 292 $ 357 $ 11,890
---------- ---------- ---------
---------- ---------- ---------
Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . $ 111 $ 346 $ 139
---------- ---------- ---------
---------- ---------- ---------
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES
In 1996, the Company entered into two sale leaseback transactions with its
former sole stockholder aggregating $1,753,000.
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
F-7
<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 ("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.
STORE PREOPENING COSTS
F-8
<PAGE>
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.
F-9
<PAGE>
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.
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.
F-10
<PAGE>
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 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:
DECEMBER 31,
------------------------
1995 1996
---------- ----------
(IN THOUSANDS)
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
----------- ----------
----------- ----------
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.
F-11
<PAGE>
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DECEMBER 31,
------------------------
1995 1996
---------- ---------
(IN THOUSANDS)
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
---------- ----------
---------- ----------
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 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
F-12
<PAGE>
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.
The total minimum rental commitment at December 31, 1996, under
operating leases, is as follows:
AMOUNT
YEAR ENDED DECEMBER 31 (IN THOUSANDS)
- ---------------------- --------------
1997. . . . . . . . . . . . . . . . . . . . . . . . $ 3,281
1998. . . . . . . . . . . . . . . . . . . . . . . . 3,238
1999. . . . . . . . . . . . . . . . . . . . . . . . 3,161
2000. . . . . . . . . . . . . . . . . . . . . . . . 3,147
2001. . . . . . . . . . . . . . . . . . . . . . . . 3,110
Thereafter. . . . . . . . . . . . . . . . . . . . . 13,950
-------
$29,887
-------
-------
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.
F-13
<PAGE>
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.
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.
F-14
<PAGE>
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:
1994 1995 1996
------ ------ ------
(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 $ --
------ ------ ------
------ ------ ------
Pro forma income tax expense differs from the statutory tax rate of 35% as
applied to earnings before income taxes, as follows:
1994 1995 1996
------ ------ ---------
(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 $ --
------ ------ ---------
------ ------ ---------
F-15
<PAGE>
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are presented below:
1996
--------------
(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 liabilities
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. . . . . . . . . . . . . . . . . . . . . . $ --
-------
-------
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.
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
DECEMBER 31,
----------------
1995 1996
----------------
(IN THOUSANDS)
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
------ ------
------ ------
F-16
<PAGE>
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.
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:
PERCENTAGE OF
YEAR BEGINNING JUNE 15, LIQUIDATION VALUE
----------------------- -----------------
1999. . . . . . . . . . . . . . . . . . . . . . . 110%
2000. . . . . . . . . . . . . . . . . . . . . . . 108
2001. . . . . . . . . . . . . . . . . . . . . . . 106
2002. . . . . . . . . . . . . . . . . . . . . . . 104
2003. . . . . . . . . . . . . . . . . . . . . . . 102
2004 and thereafter . . . . . . . . . . . . . . . 100
The Senior Preferred stock is mandatorily 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.
F-17
<PAGE>
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.
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.
F-18
<PAGE>
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, 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.
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). Upon consummation
of the Offering, the Company converted 100% of the outstanding shares of
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. 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 will
use 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 intends to use
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.
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:
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 $ (3.08)
---------
---------
Weighted average shares used in calculation 19,408
---------
---------
F-19
<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 obsolescence & damaged goods $100 $500 -- -- $600
</TABLE>
II-1
<PAGE>
EXHIBIT 10.33
NOTICE OF PRO RATA REDEMPTION TO THE HOLDERS OF
GUITAR CENTER, INC.
11% SENIOR NOTES DUE 2006
NOTICE IS HEREBY GIVEN THAT Guitar Center, Inc. (the "COMPANY") recently
consummated an initial public offering of its Common Stock. The Company
hereby notifies you that the Company will be exercising its option to use a
portion of the net proceeds received from its initial public offering to
redeem (the "REDEMPTION") $33,333,000 aggregate principal amount of its 11%
Senior Notes due 2006 (the "NOTES") pursuant to the terms of Section 3.1 and
3.4 of the indenture governing such Notes (the "INDENTURE") and pursuant to
the terms of paragraph 5 of the Notes. After such redemption (the
"REDEMPTION"), there will be $66,667,000 aggregate principal amount of Notes
outstanding.
THE REDEMPTION. The Depository Trust Company shall select the Notes to
be redeemed on a PRO RATA basis from all holders of record on March 19, 1997.
The Redemption will be effected on April 19, 1997 (the "REDEMPTION DATE").
PAYMENT OF THE REDEMPTION PRICE AND ACCRUED AND UNPAID INTEREST.
Immediately prior to the Redemption Date, the Company will deposit with U.S.
Trust Company of California, N.A., the trustee and paying agent under the
Indenture (the "PAYING AGENT"), $1,100.00 for each Note (having a
denomination of $1,000) that is being redeemed (the "REDEMPTION PRICE"), plus
$33.00 representing all accrued and unpaid interest on each redeemed Note to
the Redemption Date ("ACCRUED AND UNPAID INTEREST"). On the Redemption Date,
the Paying Agent will pay to you the Redemption Price and Accrued and Unpaid
Interest for each redeemed Note.
Unless the Company defaults in its obligations to deposit cash with the
Paying Agent in an amount to fund the payment of the Redemption Price and
Accrued and Unpaid Interest in accordance with the terms of the Indenture or
unless such payments are otherwise prohibited, interest on the Notes called
for redemption ceases to accrue on and after the Redemption Date and the only
remaining right of a holder of a Note being redeemed is such holder's right
to receive payment of the Redemption Price and Accrued and Unpaid Interest.
NEW CERTIFICATES FOR UNREDEEMED PORTION. After the Redemption Date, the
Company will issue a new certificate in the name of Cede & Co. to be held by
the Paying Agent representing an aggregate principal amount of Notes equal to
the unredeemed portion of Notes held by you.
The Notes called for redemption must be presented for payment at one of the
following locations:
BY HAND
U.S. Trust Company of California, N.A.
c/o United States Trust Company of New York
111 Broadway, Lower Level
Corporate Trust Window
New York, NY 10006
<PAGE>
BY MAIL
U.S. Trust Company of California, N.A.
c/o U.S. Trust Company of California, N.A.
P.O. Box 841
Peter Cooper Station
New York, NY 10276-0841
VIA OVERNIGHT MAIL
United States Trust Company of New York
770 Broadway, 13th Floor
New York, NY 10003
Attention: Corporate Trust Operations
From and after April 19, 1997, interest on the Notes called for redemption
will cease to accrue and be payable.
If you have any questions, please call 1 (800) 225-2398.
By: GUITAR CENTER, INC.
U.S. TRUST COMPANY OF CALIFORNIA, N.A.
as Trustee, Registrar and Paying Agent
All holders submitting their Notes for redemption should also submit a
completed Internal Revenue Service Form W-9. Failure to provide a completed
Form W-9 will result in a 31% back-up withholding to bondholders pursuant to
Interest and Dividend Tax Compliance Act of 1983.
*This Cusip Number has been assigned to this issue by Standard & Poor's
Corporation, and is included solely for hte convenience of the Certificate
holders. Neither Guitar Center, In., the Trustee or the Paying Agent shall
be responsible for the selection or use of this Cusip Number nor is any
representation made as to its correctness on the Notes or as indicated in any
redemption notice.
<PAGE>
EXHIBIT 10.34
GUITAR CENTER, INC.
NOTICE OF REDEMPTION
14% SENIOR PREFERRED STOCK
($.01 PAR VALUE)
March 14, 1997
To: DLJ Merchant Banking Partners, L.P.
DLJ International Partners, C.V.
DLJ Merchant Banking Funding Inc.
DLJ First ESC L.L.C.
DLJ Offshore Partners, C.V.
(each, a "RECORD HOLDER," collectively, the "RECORD HOLDERS")
Guitar Center, Inc. (the "COMPANY") recently consummated an initial public
offering of its Common Stock. The Company hereby notifies you that the Company
will be exercising its option to use a portion of the net proceeds received from
its initial public offering to redeem (the "REDEMPTION") all outstanding shares
of its 14% Senior Preferred Stock, $.01 par value (the "SENIOR PREFERRED
STOCK"), pursuant to the terms of Section 5(a) of Subpart A of Article IV of the
Company's Certificate of Incorporation, as in effect on the date hereof (the
"CERTIFICATE OF INCORPORATION").
THE REDEMPTION. The Redemption will be effected on March 19, 1997 (the
"REDEMPTION DATE"). On the Redemption Date, all shares of Senior Preferred
Stock held by each Record Holder will be cancelled, and each Record Holder will
receive a cash payment totalling 103% of the Senior Preferred Liquidation Value
(as defined in the Certificate of Incorporation) of the shares of Senior
Preferred Stock held by such Record Holder plus all accrued and unpaid cash
dividends on such shares to the Redemption Date (such total amount being
referred to herein as the "REDEMPTION AMOUNT").
The following table sets forth the number of shares of Senior Preferred
Stock held of record by each Record Holder and the Redemption Amount with
respect thereto:
Number of Shares of
Record Holder Senior Preferred Stock Redemption Amount
- ------------- ---------------------- -----------------
DLJ Merchant Banking Partners, L.P. 371,539 $10,660,599.02
DLJ International Partners, C.V. 179,691 5,155,869.27
DLJ Merchant Banking Funding Inc. 143,532 4,118,360.00
DLJ First ESC L.L.C. 95,687 2,745,544.64
DLJ Offshore Partners, C.V. 9,551 274,046.60
PAYMENT OF THE REDEMPTION AMOUNT; SURRENDER OF CERTIFICATES. On the
Redemption Date, the Company will wire transfer immediately available funds
representing each Redemption Amount to the respective accounts previously
designated by each Record Holder in accordance with the attached wire transfer
instructions. To collect the Redemption Amount on the Redemption Date, each
Record Holder must surrender to the Company (C/O EVA HERBST DAVIS, LATHAM &
WATKINS, 633 WEST FIFTH STREET, SUITE 4000, LOS ANGELES,
<PAGE>
CALIFORNIA 90071) on or before March 18, 1997, stock certificate(s) (properly
endorsed, if required on the back any such stock certificate) representing
the shares of Senior Preferred Stock held by such Record Holder.
Unless the Company defaults in its obligations to make such wire transfers
or unless such payments are otherwise prohibited, interest on all outstanding
shares of the Senior Preferred Stock shall cease to accrue on and after the
Redemption Date and the only remaining right of a Record Holder is such Record
Holder's right to receive payment of its respective Redemption Amount.
REQUESTS FOR ASSISTANCE. For assistance or if you have any questions,
please contact Eva Herbst Davis of Latham & Watkins at 213-891-8794.
Very truly yours,
GUITAR CENTER, INC.
<PAGE>
EXHIBIT 10.35
BOARD REPRESENTATION AGREEMENT
Board Representation Agreement ("Agreement") dated as of June 5, 1996
between GUITAR CENTER MANAGEMENT COMPANY, INC., a California corporation (the
"Company"), the Raymond Scherr Living Trust (the "Trust") and Raymond Scherr
("Scherr").
W I T N E S S E T H
WHEREAS, the Company and the Trust are parties (defined as the
"Company" and the "Scherr Stockholders," respectively), together with the
"Institutional Investors," the "Undesignated Stockholders" and the "Management
Stockholders," as defined therein, to that certain Stockholders Agreement dated
as of June 5, 1996 (the "Stockholders Agreement");
WHEREAS, the Company and Scherr are parties to that certain Employment
Agreement dated as of June 5, 1996, providing for the employment of Scherr by
the Company in accordance with the terms and conditions thereof;
WHEREAS, pursuant to Section 10 of the Stockholders Agreement, the
Stockholders (as defined therein) have agreed to vote all of the Stockholder
Shares (as defined therein) owned by them for, or consent in writing with
respect to such shares in favor of, the election to the Board of Directors of,
among others, one director designated and approved by the holders of at least a
majority of the then outstanding Scherr Stockholder Shares (as defined therein);
WHEREAS, pursuant to Section 17(a) of the Stockholders Agreement, such
Agreement, including the obligation of Stockholders to vote their shares for (or
otherwise consent to) the election to the Board of Directors of the designee of
the Scherr Stockholders, shall terminate, among other reasons, upon a Qualified
Public Offering (as defined therein);
WHEREAS, the Company and Scherr desire that in the event of
termination of the Stockholders Agreement by reason of a Qualified Public
Offering, that the Company be assured of the continued representation afforded
by Scherr on its Board of Directors so long as Scherr and the Trust continue to
hold a significant equity interest in the Company;
NOW, THEREFORE, the parties hereto agree as follows:
1. DEFINED TERMS. Capitalized terms used herein and not otherwise
defined shall have the meanings ascribed to such terms in the Stockholders
Agreement.
2. AGREEMENT TO NOMINATE, ETC. Subsequent to a termination of the
Stockholders Agreement by reason of a Qualified Public Offering pursuant to
Section 17(a)(B) thereof, and so long as Scherr, his Affiliates and his Family
Group, and the Trust together collectively hold at least five percent (5%) of
the Fully Diluted Common Shares, at each annual meeting of the holders of any
class of Stock, and at each special meeting of the holders of any class of Stock
called for the purpose of electing directors of the Company, and at any time at
which holders of any class of stock shall have the right to, or shall, vote for
or consent in writing to the election of directors of the Company, then, and in
each such event, the Company shall nominate, and cause the nomination of Scherr
to be a member of the Board of Directors, to include Scherr in any proxy
statement and related materials used by the Company in respect of the election
to which such
<PAGE>
nomination pertains, and shall otherwise use its best efforts cause the
election of Scherr as a member of the Board of Directors; provided that the
Company's obligations hereunder shall terminate and be of no further force
and effect in the event that Scherr suffers a Disability or Scherr commits a
Prohibited Act.
As used herein, "DISABILITY" means any long-term disability or
incapacity which (i) renders Scherr unable to substantially perform all of his
duties hereunder for 180 days during any 18-month period or (ii) would
reasonably be expected to render Scherr unable to substantially perform all of
his duties for 180 days during any 18-month period, in each case as determined
by the Board (excluding Scherr if he should be a member of the Board at the time
of such determination) in its good faith judgment.
As used herein, a "PROHIBITED ACT" means (i) the commission by Scherr
or any of his Affiliates under his control of any act of fraud, theft or
criminal dishonesty with respect to the Company or any of its affiliates, or the
conviction of Scherr or any of his Affiliates under his control of any felony,
or the commission of any act or moral turpitude constituting a criminal act,
(ii) a material breach by Scherr of Sections 8.12 or 8.13 of the Purchase
Agreement (as defined in the Stockholder Agreement), or (iii) Scherr takes any
action or fails to take any action which is materially inconsistent with his
position as a director of the Company, as determined in good faith by the vote
of 70% of the directors then in office (excluding Scherr if he should be a
member of the Board at the time of the determination). For purposes of
illustration, an action or inaction described in clause (iii) shall include
Scherr's refusal to execute a customary confidentiality agreement, Scherr's use
for his own benefit or for the benefit of others, confidential or proprietary
information of the Company without the Company's consent, or Scherr's refusal to
certify information about himself and his Affiliates which the Company
reasonably requires to comply with any disclosure or due diligence obligations
pursuant to applicable securities laws or otherwise. Scherr shall not be deemed
to violate clause (iii) if he refuses to take any action if all other directors
of the Company are not requested to take substantially similar actions.
3. MISCELLANEOUS. All the terms and provisions of this Agreement
shall be binding upon and inure to the benefit of and be enforceable by the
respective successors and assigns of the parties hereto, whether so expressed or
not; provided that the rights conferred on Scherr hereby shall be personal to
him and not assignable. This Agreement may be executed and will be consummated
in the state of California and is to be governed by and interpreted under the
laws of that state, without giving effect to the principles of conflicts of laws
thereof.
This Agreement constitutes the entire agreement (other than the
Stockholders Agreement) between the parties hereto with respect to the subject
matter hereof and no amendment, alteration or modification of this Agreement
shall be valid unless in each instance such amendment, alteration or
modification is expressed in a written instrument executed by each of the
parties hereto. No waiver of any provision of this Agreement shall be valid
unless it is expressed in a written instrument duly executed by the party or
parties making such waiver. The failure of any party to insist, in any one or
more instances, upon performance of any of the terms and conditions of this
Agreement shall not be construed as a waiver or relinquishment of any rights
granted hereunder or of the future performance of any such term, covenant or
condition but the obligation of any party with respect thereto shall continue in
full force and effect.
All notices, requests, consents and other communications hereunder
shall be in writing and shall be mailed first class registered with postage
prepaid to the address of the party set forth on the signature page hereto, or
to such other address as a party hereto supplies to each other party in writing.
This Agreement may be executed simultaneously in any number of
counterparts, each of which shall be deemed to be an original, but all of which
together shall constitute one and the same instrument.
<PAGE>
The headings of the sections of this Agreement have been inserted for
the convenience of reference only and shall in no way restrict or modify any of
the terms or provisions hereof.
<PAGE>
IN WITNESS WHEREOF, the undersigned have executed this Agreement as of
the date above written.
GUITAR CENTER MANAGEMENT COMPANY, INC.
By: /s/Larry E. Thomas
---------------------------------
Name: Lawrence E. Thomas
Title:President
Address: 6390 Chesebro Road
Agoura Hills, CA
91301
RAYMOND SCHERR LIVING TRUST
By: /s/Raymond Scherr
----------------------------------
Raymond Scherr, Trustee
Address: 1096 Lakeview Canyon
Westlake Village, CA
91362
/s/Raymond Scherr
----------------------------------
Raymond Scherr, individually
Address: 1096 Lakeview Canyon
Westlake Village, CA
91362
<PAGE>
EXHIBIT 12.1
GUITAR CENTER, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Year Two Months Year Ended
Ended Ended December 31,
October 31, December 31, ----------------------------------------------
1992 1992 1993 1994 1995 1996
------------ ------------ ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Earnings (loss) before incomes taxes $ 4,076 $ 1,424 $ 5,251 $ 9,155 $ 11,202 $(72,270)
Add: Interest expense 536 61 302 266 382 12,177
Portion of rents representative
of interest factor 318 53 347 601 662 952
---------- ---------- ---------- ---------- ---------- ----------
Earnings (loss) as adjusted 4,930 1,538 5,900 10,022 12,246 (59,141)
Fixed charges:
Interest expense 536 61 302 266 382 12,177
Amortization of debt financing
costs -- -- -- -- -- --
Portion of rents representative
of interest factor 318 53 347 601 662 952
---------- ---------- ---------- ---------- ---------- ----------
Total fixed charges 854 114 649 867 1,044 13,129
Ratio of earnings fixed charges 5.8x 13.5x 9.1x 11.6x 11.7x --
---------- ---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ---------- ----------
</TABLE>
(a) The ratio of earnings to fixed charges has been computed based upon
earnings (loss) before provision for income taxes and fixed charges.
Fixed charges consist of interest expense and one third of rental
expense (the proportion deemed representative of the interest factor).
Earnings (loss) before income taxes and fixed charges were
insufficient to cover fixed charges by $72.3 million for the year
ended December 31, 1996.
