<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________
Commission File No. 000 - 22207
GUITAR CENTER, INC.
------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 95-4600862
------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5155 CLARETON DRIVE
AGOURA HILLS, CALIFORNIA 91301
------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(818) 735-8800
------------------------------------------------------------------------------
Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
As of November 9, 1999, 22,072,590 shares of our Common Stock, $.01 par
value, were outstanding.
1
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
INDEX
-----
Part I. Financial Information
<TABLE>
<S> <C>
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Condensed Consolidated Balance Sheets - September 30, 1999 and December 31, 1998 ..........3
Condensed Consolidated Statements of Income - Three months ended
September 30, 1999 and 1998................................................................4
Condensed Consolidated Statements of Income - Nine months ended
September 30, 1999 and 1998................................................................5
Condensed Consolidated Statements of Cash Flows - Nine months ended
September 30, 1999 and 1998 ...............................................................6
Notes to Condensed Consolidated Financial Statements .....................................7
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ...........................................................11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......................17
Part II. Other Information
Item 1. Not Applicable
Item 2. Not Applicable
Item 3. Not Applicable
Item 4. Not Applicable
Item 5. Not Applicable
Item 6. Exhibits and Reports on Form 8-K ...............................................17
</TABLE>
2
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------------- --------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 400 $ 472
Inventories, net of reserves 147,769 126,957
Accounts receivable, net of reserves 14,729 13,614
Prepaid expenses and deposits 3,678 3,324
Pre-opening costs and other current assets - 2,850
-------------- ---------------
Total current assets 166,576 147,217
Property and equipment, net 53,002 42,410
Goodwill, net 4,495 4,618
Deferred tax assets 10,431 10,431
Deposits and other assets, non-current 6,082 3,382
-------------- ---------------
$ 240,586 $ 208,058
============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,318 $ 35,152
Accrued expenses and other current liabilities 17,352 15,934
Merchandise advances 6,506 7,147
Line of credit 51,514 20,850
Current portion of long term debt 251 527
-------------- ---------------
Total current liabilities 104,941 79,610
Rent equalization 1,876 1,570
Long term debt 67,909 80,663
-------------- ---------------
Total liabilities 174,726 161,843
Stockholders' equity
Common stock, $0.01 par value, authorized
55,000,000 shares, issued and outstanding
22,072,590 at September 30, 1999 and
20,092,943 at December 31, 1998, respectively 221 201
Additional paid in capital 244,003 228,195
Accumulated deficit (178,364) (182,181)
-------------- ---------------
Total stockholders' equity 65,860 46,215
-------------- ---------------
$ 240,586 $ 208,058
============== ===============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------------ ------------------------
<S> <C> <C>
Net sales $152,523 $118,009
Cost of goods sold, buying and occupancy 113,539 85,907
-------- --------
Gross profit 38,984 32,102
Selling, general and administrative 32,200 27,230
Transaction and conversion costs 543 -
-------- --------
Operating income 6,241 4,872
Interest expense, net 2,848 2,586
Interest expense to related parties - 303
Income before income taxes 3,393 1,983
Income taxes - 261
-------- --------
Net income $ 3,393 $ 1,722
======== ========
Net income per share
Basic $ 0.15 $ 0.08
======== ========
Diluted $ 0.15 $ 0.07
======== ========
Weighted average shares outstanding
Basic 22,072 22,036
======== ========
Diluted 22,072 23,003
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------------ ------------------------
<S> <C> <C>
Net sales $ 427,140 $ 340,256
Cost of goods sold, buying and occupancy 316,080 247,744
--------- ---------
Gross profit 111,060 92,512
Selling, general and administrative 91,522 78,472
Transaction and conversion costs 4,170 -
--------- ---------
Operating income 15,368 14,040
Interest expense, net 7,877 7,075
Interest expense to related parties 501 890
Other - (324)
--------- ---------
Income before income taxes and cumulative effect
of a change in accounting principle 6,990 6,399
Income taxes 2,099 564
--------- ---------
Income before cumulative effect of a change in
accounting principle 4,891 5,835
Cumulative effect of changing accounting principle
to write-off pre-opening costs, net of tax 1,074 -
--------- ---------
Net income $ 3,817 $ 5,835
========= =========
Net income per share
Basic
Income before cumulative effect of a change
in accounting principle $ 0.22 $ 0.27
Cumulative effect of changing accounting
principle to write-off pre-opening costs (0.05) -
--------- ---------
Net income $ 0.17 $ 0.27
========= =========
Diluted
Income before cumulative effect of a change
in accounting principle $ 0.22 $ 0.26
Cumulative effect of changing accounting
principle to write-off pre-opening costs (0.05) -
--------- ---------
Net income $ 0.17 $ 0.26
========= =========
Weighted average shares outstanding
Basic 22,069 21,618
========= =========
Diluted 22,462 22,853
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------
1999 1998
--------------------- ---------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 3,817 $ 5,835
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 5,866 3,492
Amortization of deferred financing fees 180 180
Gain on sale of property - (324)
Cumulative effect of change in accounting principle to
write-off pre-opening costs 1,652 -
Changes in operating assets and liabilities:
Accounts receivable (1,115) 4,065
Merchandise inventories (20,812) (24,499)
Prepaid expenses (354) (1,914)
Other assets (1,696) (124)
Accounts payable (5,834) (8,065)
Accrued expenses and other current liabilities 1,418 (6,490)
Other long term liabilities 306 418
Merchandise advances (641) 1,121
-------- --------
Net cash provided by (used in) operating activities (17,213) (26,305)
INVESTING ACTIVITIES
Proceeds from sale of property - 733
Purchase of property and equipment (13,681) (15,780)
Payment for purchase of Rhythm City, Inc., net of cash
acquired - (1,058)
-------- --------
Net cash used in investing activities (13,681) (16,105)
FINANCING ACTIVITIES
Net change in revolving debt facility 30,664 31,949
Proceeds from exercise of stock options 208 757
Warrant underwriting - (98)
Payments under capital lease (50) -
Borrowings under related party debt - 3,183
-------- --------
Net cash provided by financing activities 30,822 35,791
Net increase (decrease) in cash and cash equivalents (72) (6,619)
Cash and cash equivalents at beginning of year 472 8,370
-------- --------
Cash and cash equivalents at end of period $ 400 $ 1,751
======== ========
NON CASH INVESTING ACTIVITIES
Contribution of land and building 1,750 -
Borrowings under capital lease 890 -
Related party debt converted to common stock 13,870 -
</TABLE>
See accompanying notes to condensed consolidated financial statements.
6
<PAGE>
GUITAR CENTER, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. General
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly the financial position of Guitar Center, Inc., a
Delaware corporation ("Guitar Center" or the "Company"), as of
September 30, 1999, and the results of operations and cash flows for
the nine months ended September 30, 1999 and 1998. The accompanying
financial statements should be read in conjunction with the audited
financial statements and notes thereto contained in our Annual Report
on Form 10-K for the year ended December 31, 1998 and the Musician's
Friend audited financial statements and notes thereto for the year
ended December 31, 1998 contained in the Form 8-K/A filed August 11,
1999.
The results of operations for the nine months ended September 30, 1999
are not necessarily indicative of the results to be expected for the
full year.
2. Merger
On May 28, 1999, we acquired all of the stock of Musician's Friend,
Inc., a Delaware corporation ("Musician's Friend"), pursuant to a
merger agreement. Each share of Musician's Friend common stock was
converted into approximately 10.02 shares of Guitar Center common
stock. In total, 1,959,970 shares of common stock were issued and stock
options to purchase 250,505 shares of common stock were assumed. The
assumed stock options have exercise prices of $19.96 to $21.96 per
share, with a weighted average exercise price of $20.31.
Under the terms of the merger agreement, 30% of the total shares issued
were placed in escrow for general indemnification purposes and for
indemnification against damages related to specific tax issues.
The merger was accounted for under the pooling of interests method.
Accordingly, the financial statements of Guitar Center have been
restated for all periods to include the results of Musician's Friend.
The following reflects net sales and net income (loss) of the
previously separate companies for the period before the combination was
consummated and for the period ending September 30, 1998, which are
included in the current combined net sales and net income (loss) (in
thousands):
<TABLE>
<CAPTION>
Five Months Ended
May 28, 1999
Guitar Center Musician's Friend
1999 1999
---------------------------------------------------
<S> <C> <C>
Net sales $185,403 43,411
Net income (loss) $ 5,241 (3,044)
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
Guitar Center Musician's Friend Guitar Center Musician's Friend
1998 1998 1998 1998
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $96,197 21,812 $272,673 67,583
Net income (loss) $ 4,714 (2,992) $ 13,790 (7,955)
</TABLE>
Due to the seasonal nature of these business segments, especially
retail operations, the above net revenue and operating results for the
third quarter and the nine months ended September 30, 1998 are not
necessarily indicative of the results to be expected for the full year.
7
<PAGE>
3. Accounting Policies
REVENUE RECOGNITION
Retail sales are recognized at the time of sale, net of a provision for
estimated returns. Mail order and Internet sales are recognized when
the related products are shipped to customers, net of a provision for
estimated returns. Previously, we entered into numerous installment
transactions in our catalog and Internet business. Such programs were
substantially terminated in the fourth quarter of 1998.
ADVERTISING
We expense retail advertising as incurred. Mail order catalog costs are
capitalized on a catalog by catalog basis and are amortized over the
expected period of future benefits, not to exceed five months, under
the provisions of SOP 93-7.
4. Income Taxes
As a result of the $72.4 million loss incurred in connection with the
recapitalization completed in fiscal 1996, Guitar Center, Inc. had a
net operating loss carryforward for federal income taxes of
approximately $41.8 million as of December 31, 1998. A provision for
income taxes of $2.1 million has been made in the condensed
consolidated statement of operations for the nine months ended
September 30, 1999.
Income taxes for the nine months ended September 30, 1999 include
income taxes provided on the income of Guitar Center prior to the
merger with Musician's Friend. The losses incurred by Musician's Friend
prior to the merger have not been utilized to offset income from Guitar
Center, nor has a deferred tax benefit been recorded due to uncertainty
concerning the realizability of such benefit.
From 1994 through 1997, the Musician's Friend business was operated by
Musician's Friend Trust, an Oregon business trust (the "Trust"), which,
as a trust, claimed it was not subject to federal and state income
taxes. Accordingly, Musician's Friend has not recorded provisions for
income taxes during this period since the Trust's income or loss was
attributable to the individual beneficiaries of the Trust and its
related trusts.
During 1998, the Internal Revenue Service ("IRS") took the position
that the Trust was an association which is taxable as a corporation and
not as a trust. Accordingly, the IRS asserted that the Trust was
required to file its tax returns and pay income taxes at corporate
rates in effect. Alternatively, the IRS contended that the Trust and
related beneficiary were formed to avoid federal income taxes which
were legally owed by the Trust and the individuals involved. As a
result, the IRS issued reports to the Trust claiming taxes due of
$4,443,000 for the years 1994 - 1996, with penalties aggregating
$1,286,000 and related interest. No claims relating to 1997 have been
quantified to date in the IRS reports. The Musician's Friend business
was operated as an S corporation for years prior to 1994. Accordingly,
Musician's Friend's taxable income for 1994 and prior years had been
attributed to the owners. Effective January 1, 1998, the Trust
contributed the Musician's Friend business to a Delaware corporation
taxable as a C corporation. By the express terms of the contribution
agreement, that corporation did not assume any liability of the Trust
or its beneficiaries for prior period taxes.
The Trust is contesting the positions of the IRS. Guitar Center has not
provided for income tax expense related to this matter in its
consolidated financial statements because its subsidiary, Musician's
Friend, Inc., did not assume any liabilities related to this dispute
when it was formed in January 1998 and therefore Guitar Center believes
the liability related to any resolution of this matter properly resides
with the Trust and its beneficiaries. As with any form of litigation,
however, there is uncertainty regarding the ultimate outcome of this
matter. Accordingly,
8
<PAGE>
pursuant to the merger agreement, 20% of the shares otherwise issuable
to the former stockholders of Musician's Friend have been placed in
escrow pending resolution of this matter.
5. Line of Credit
In July 1999, we terminated our prior credit facility and entered into
a new $60 million secured revolving line of credit (the "1999
Facility") with Wells Fargo Bank which is available through July 1,
2004. This increased availability had been made available from and
after June 1, 1999 as an amendment to the prior facility. The 1999
Facility provides for revolving credit or term loan borrowings up to
$60 million in the aggregate. The 1999 Facility is secured by specified
inventory, receivables and intellectual property rights. A fee of 0.25%
is assessed on the unused portion of the 1999 Facility.
Under the terms of the 1999 Facility, we are subject to various
financial and other covenants. We were in compliance with such
covenants at September 30, 1999. Borrowings under the 1999 Facility
bear interest at either the prime rate or at LIBOR plus 1.5%, at our
option, with interest due monthly. At September 30, 1999, we had $51.5
million outstanding under our 1999 Facility.
6. Transaction and Conversion Costs
Transaction and store conversion costs totaled $4.2 million during the
nine months ended September 30, 1999. These costs relate to the merger
with Musician's Friend during the second quarter of 1999 and
principally include financial advisory fees, legal and accounting fees,
a severance accrual for a former Musician's Friend executive, and
certain costs associated with the conversion of Musician's Friend
stores to the Guitar Center format.
7. Change in Accounting for Store Pre-Opening Costs
Effective January 1, 1999, we adopted AICPA Statement of Position 98-5,
"Reporting on the Costs of Start-up Activities" (SOP 98-5), which
requires all store pre-opening costs to be expensed as incurred. As
result of this adoption, we recorded a charge for the cumulative effect
of this change in accounting principle of $1,074,000 (net of taxes of
$578,000), in the Statement of Operations for the nine months ending
September 30, 1999 relative to the adoption of SOP 98-5.
The following illustrates the pro forma amounts assuming the new
accounting policy for pre-opening costs was applied retroactively ($ in
000's, except per share data):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999 1998
------------- ------------
<S> <C> <C>
Net income $4,891 $6,685
Net income per share:
Basic $ 0.22 $ 0.31
Diluted $ 0.22 $ 0.29
</TABLE>
9
<PAGE>
8. Segment Information
In accordance with the requirements of SFAS 131, "Disclosures about
Segments of and Enterprise and Related Information," our reportable
businesses segments are retail (stores) and direct response (catalog
and Internet). Management evaluates segment performance based primarily
on revenue and income before income taxes.
Sales, income before income taxes and cumulative effect, and total
assets are summarized as follows for the third quarter and nine months
ended September 30, 1999 and September 30, 1998 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------- ------------------------------
RETAIL DIRECT RESPONSE RETAIL DIRECT RESPONSE
1999 1999 TOTAL 1999 1999 TOTAL
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Sales $132,590 19,933 152,523 $373,082 54,058 427,140
Income before income
taxes and cumulative
effect 4,028 (635) 3,393 11,434 (4,444) 6,990
Total Assets $220,810 19,776 240,586 220,810 19,776 240,586
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
------------------------------- ------------------------------
RETAIL DIRECT RESPONSE RETAIL DIRECT RESPONSE
1998 1998 TOTAL 1998 1998 TOTAL
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Sales $100,697 17,312 118,009 $284,929 55,327 340,256
Income before income
taxes and cumulative
effect 3,982 (1,999) 1,983 12,819 (6,420) 6,399
Total Assets $167,994 21,623 189,617 $167,994 21,623 189,617
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
We operated 64 retail locations in 33 major markets and three stores in
secondary markets as of September 30, 1999, and with the acquisition of
Musician's Friend, we now operate the largest direct response channel (catalog
and Internet) in the musical instruments industry in the United States. From
1994 to 1998, our net sales grew at an annual compound rate of 32.3%,
principally due to the comparable store sales growth of our Guitar Center stores
averaging 15.2% per year, the opening of new stores, and a 26% increase in the
direct response channel. Our management believes such volume increases are the
result of the continued success of the implementation of our business strategy,
continued growth in the music products industry and increasing consumer
awareness of the Guitar Center and Musician's Friend brand names. We do not
expect comparable store sales to continue to increase at historical rates.
We opened twelve Guitar Center stores in 1998 and, as of September 30,
1999, had opened ten additional Guitar Center stores this year. Presently, we
expect to open an additional two Guitar Center stores during the remainder of
1999. We opened four stores in 1998 under the Musician's Friend brand and opened
one additional Musician's Friend store in January of 1999. Of the nine
Musician's Friend retail locations acquired, we have rebranded seven of the nine
stores to the Guitar Center name and format. This conversion process took four
months and encompassed three stages: back room infrastructure, store remodeling,
and remerchandising. As of September 30, 1999, we had completed stage one of the
conversion for six retail locations. The two small format Musician's Friend
locations will likely continue to operate under the Musician's Friend brand.
However, all retail locations are being integrated with the existing Guitar
Center stores infrastructure. In preparation for these additional stores,
management had dedicated a substantial amount of resources over the past several
years to building the infrastructure necessary to support a large, national
chain. We believe the infrastructure is in place to support our needs for the
immediate foreseeable future, including our present expansion plans. We will
continue to pursue our 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 this clustering strategy
results in some transfer of sales from existing stores to new locations. As we
enter new markets, management expects that we will initially incur higher
administrative and promotional costs per store than is currently experienced in
established markets. We also expect competition to continue to increase over
time as other music products retailers attempt to execute national growth
strategies.
The following table sets forth historical income statement data as a
percentage of net sales:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Gross profit 25.6 27.2 26.0 27.2
Selling, general, and administrative expenses 21.1 23.1 21.4 23.1
Transaction and conversion costs 0.4 -- 1.0 --
------------ ------------ ------------ -------------
Operating income 4.1 4.1 3.6 4.1
Interest expense, net 1.9 2.2 1.8 2.1
Interest expense to related parties -- 0.3 0.1 0.3
Other -- -- -- (0.1)
Income before income taxes and cumulative
effect of a change in accounting principle 2.2 1.7 1.6 1.9
Income taxes -- 0.2 0.5 0.2
------------ ------------ ------------ -------------
Income before cumulative effect of a
change in accounting principle 2.2 1.5 1.1 1.7
Cumulative effect of a change in accounting
principle to write-off pre-opening costs, net of tax -- -- 0.2 --
------------ ------------ ------------ -------------
Net income 2.2 1.5 0.9 1.7
------------ ------------ ------------ -------------
</TABLE>
11
<PAGE>
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE THREE MONTHS
ENDED SEPTEMBER 30, 1998.
Net sales increased to $152.5 million for the three months ended
September 30, 1999, from $118.0 million for the comparable prior period, a 29.2%
increase. Net sales from retail stores totaled $132.6 million, an increase of
$31.9 million, or 31.7%. Sales from new stores contributed $21.2 million, or
66.1% of the increase. Comparable store sales increased 11%. The increase in
comparable store sales was due to aggressive pricing on certain elements of
inventory, particularly at former Musician's Friend stores and store sales
performance due to the effect of successful promotions. Our management is
presently anticipating comparable store sales growth of 5 to 7 percent for the
immediate future. The foregoing guidance is subject to the qualifications set
forth below under "Forward Looking Statements; Business Risks." Net sales from
the catalog and Internet channel totaled $19.9 million, a $2.6 million increase
from the third quarter of 1998. The increase was due to a 381% increase in
Internet sales, partially offset by a 4% decline in catalog sales. Catalog sales
were adversely effected by an average order approximately one-third smaller than
in 1998, when Musician's Friend offered its in-house installment credit program.
The program was discontinued in the fourth quarter of 1998, and the division's
new third-party non-recourse credit card did not become available until October
1999.
Gross profit dollars for the three months ended September 30, 1999
compared to 1998 increased 21.4% to $39.0 million from $32.1 million. Gross
profit as a percentage of net sales for the three months ended September 30,
1999 compared to 1998 decreased to 25.6% from 27.2%. Gross profit margin
percentage for the retail stores after buying and occupancy costs was 25.3%
compared to 27.4% in the third quarter of 1998. The reduction in gross profit
margin quarter over quarter is due to increased occupancy costs due to the
number of stores less than two years old (29 stores out of 67 stores),
actions taken to clear out merchandise at former Musician's Friend locations,
increased freight expense as more stores are opened on the East Coast, and a
change in assortment and aggressive pricing on inventory that we wanted to
move. The gross profit margin for the catalog / Internet division was 27.5%
for the quarter compared to 25.8% in the third quarter of 1998. In 1998
significant markdowns were required to clear excess catalog and Internet
inventories. Markdowns of the same magnitude have not been required to date
in 1999. Additionally, during 1998 higher than average shrink occurred in the
Musicians's Friend distribution facilities.
Selling, general and administrative expenses for the three months ended
September 30, 1999 compared to 1998 increased 18.3% to $32.2 million from $27.2
million. Selling, general and administrative expenses for the three months ended
September 30, 1999 compared to 1998 decreased to 21.1%, as a percentage of
sales, from 23.1%. Selling, general and administrative expenses for the retail
stores in the third quarter, inclusive of pre-opening costs and corporate
general and administrative expenses, was 20.1% as a percentage of sales compared
to 21.2% in last year's third quarter. These results reflect the leveraging of
corporate expenses, partially offset by higher store level selling, general and
administrative expense due to the number of stores that are less than two years
old. Selling, general and administrative expenses for the catalog / Internet
division were 28.1% as a percentage of sales in the third quarter compared to
33.7 % in the same period last year. In 1998 Musician's Friend incurred
substantial bad debt expense related to its in-house installment credit program.
This program was substantially terminated in the fourth quarter of 1998.
Transaction and store conversion costs totaled $0.5 million, or 0.4% of
sales, during the three months ended September 30, 1999. These costs relate to
the acquisition of Musician's Friend during the second quarter of 1999 and
principally include costs associated with the conversion of Musician's Friend
stores to Guitar Center stores.
Operating income for the three months ended September 30, 1999 was $6.2
million compared to $4.9 million for the same three months of 1998, an increase
of 28.1%. The increase is principally the result of the increase in sales and
leveraging of corporate expenses. In addition, in 1998 Musician's Friend
incurred substantial bad debt expense related to its in-house installment credit
program. This program was substantially terminated in the fourth quarter of
1998. As a percentage of sales, operating income was 4.1% in the three months
ended September 30, 1999 and 1998.
12
<PAGE>
Interest expense, net for the three months ended September 30, 1999
decreased to $2.8 million from $2.9 million in the same period of 1998.
In the nine months ended September 30, 1999, $2.1 million provision for
income taxes was recorded. As the majority of the tax benefits related to the
net operating loss carryforward had been recognized as of December 31, 1998, the
Company's effective tax rate for the three months ended September 30 represents
the combined federal and state rates expected to be realized for the full year,
offset partially by the recognition of the remaining NOL.
Net income for the three months ended September 30, 1999 was $3.4
million, compared to net income of $1.7 million in the third quarter of 1998,
principally as a result of leveraging of corporate expenses. In addition, in
1998 Musician's Friend incurred substantial bad debt expense related to its
in-house installment credit program. This program was substantially terminated
in the fourth quarter of 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1998.
Net sales increased to $427.1 million for the nine months ended
September 30, 1999, from $340.3 million for the comparable prior period, a 25.5%
increase. Net sales from retail stores totaled $373.1 million, an increase of
$88.2 million, or 30.9%. Sales from new stores contributed $63.0 million, or
71.0% of the increase. Comparable store sales increased 9% due to aggressive
pricing on certain elements of inventory, particularly at former Musician's
Friend stores and store sales performance due to the effect of successful
promotions. Net sales from the catalog and Internet channel totaled $54.1
million, a $1.3 million decrease from the nine months ended September 30, 1998.
The reduction in sales was primarily due to the substantial termination of the
in-house installment credit program in the fourth quarter of 1998 and its impact
on the average order size of catalog transactions. This reduction was partially
offset by a 413.4% increase in Internet sales in the nine months ended September
30, 1999 compared to the same period in 1998.
Gross profit dollars for the nine months ended September 30, 1999
compared to 1998 increased 20.0% to $111.1 million from $92.5 million. Gross
profit as a percentage of net sales for the nine months ended September 30, 1999
compared to 1998 decreased to 26.0% from 27.2%. Gross profit margin percentage
for the retail stores after buying and occupancy costs was 25.7% compared to
27.6% in the nine months ended September 30, 1998. The reduction in gross profit
margin quarter over quarter is due to increased occupancy costs due to the
number of stores less than two years old (29 stores out of 67 stores), increased
freight expense as more stores are opened on the East Coast, and a general
increase in the cost of certain products. The gross profit margin for the
catalog / Internet division was 28.4% for the nine months ended September 30,
1999 compared to 25.3% in the nine months ended September 30, 1998. In 1998
significant markdowns were required to clear excess catalog and Internet
inventories. Markdowns of the same magnitude have not been required to date in
1999. Additionally, during 1998 higher than average shrink occurred in the
unit's distribution facilities.
Selling, general and administrative expenses for the nine months ended
September 30, 1999 compared to 1998 increased 16.6% to $91.5 million from $78.5
million. Selling, general and administrative expenses for the nine months ended
September 30, 1999 compared to 1998 decreased to 21.4%, as a percentage of
sales, from 23.1%. Selling, general and administrative expenses for the retail
stores in the third quarter, inclusive of pre-opening costs and corporate
general and administrative expenses, was 20.0% as a percentage of sales compared
to 20.9% in the nine months ended September 30, 1998. These results reflect the
leveraging of corporate expenses, partially offset by higher store level
selling, general and administrative expense due to the number of stores that are
less than two years old. Selling, general and administrative expenses for the
catalog / Internet division were 31.2% in the nine months ended September 30,
1999 compared to 34.0% in the same period last year. In 1998 Musician's Friend
incurred substantial bad debt expense related to its in-house installment credit
program. This program was substantially terminated in the fourth quarter of
1998.
Transaction and store conversion costs totaled $4.2 million, or 1.0% of
sales, during the nine months ended September 30, 1999. These costs relate to
the acquisition of Musician's Friend during the
13
<PAGE>
second quarter of 1999 and principally include financial advisory fees, legal
and accounting fees and severance costs for a former Musician's Friend
executive.
Operating income for the nine months ended September 30, 1999 was
$15.4 million compared to $14.0 million for the same nine months of 1998. The
increase is principally the result of leveraging corporate expenses. In
addition, in 1998 Musician's Friend incurred substantial bad debt expense
related to its in-house installment credit program. This program was
substantially terminated in the fourth quarter of 1998. As a percentage of
sales, operating income was 3.6% and 4.1% in the nine months ended September
30, 1999 and 1998, respectively.
Interest expense, net for the nine months ended September 30, 1999
increased to $8.4 million from $8.0 million in the same period of 1998. Interest
expense includes interest to related parties of $0.5 million and $0.9 million
for the nine months ended September 30, 1999 and 1998, respectively.
In the nine months ended September 30, 1999, $2.1 million provision for
income taxes was recorded. As the majority of the tax benefits related to the
net operating loss carryforward had been recognized as of December 31, 1998, the
Company's effective tax rate for the nine months ended September 30 represents
the combined federal and state rates expected to be realized for the full year,
offset partially by the recognition of the remaining NOL.
Net income for the nine months ended September 30, 1999 was $3.8
million, compared to $5.8 million in the same period of 1998, principally as a
result of the effect of the transaction and conversion costs as discussed above,
and income taxes.
LIQUIDITY AND CAPITAL RESOURCES
On May 13, 1999, we completed the merger with Musician's Friend ("MF").
Each outstanding share of MF common stock was converted into the right to
receive approximately 10.02 shares of Guitar Center common stock. In connection
with the merger we issued an aggregate of 1,959,970 shares of common stock and
assumed options (from Musician's Friend) to purchase 250,505 shares of common
stock. In addition, we refinanced MF's outstanding obligations under its secured
credit facility in the aggregate amount of approximately $17.3 million and
incurred transaction and conversion expenses of approximately $4.2 million. The
source of funds was borrowings under our credit facility. In July 1999, we
terminated our prior credit facility (1997 Credit Facility) and entered into the
1999 Credit Facility which allows for borrowings up to $60 million and expires
on July 1, 2004. This increased availability had been made available from and
after June 1, 1999 as an amendment to the prior facility. The 1999 Facility is
secured by specified inventory, receivables and intellectual property rights. A
fee of 0.25% is assessed on the unused portion of the 1999 Facility. The
agreement underlying the 1999 Credit Facility includes certain restrictive
covenants, which among other things, require us to maintain certain financial
ratios. We were in compliance with respect to such requirements as of September
30, 1999. We have outstanding capital leases of approximately $1.1 million
related to computer equipment financings which will remain in place.
Our need for liquidity will arise primarily from interest payable on
indebtedness and the funding of capital expenditures and working capital
requirements, as well as possible acquisitions. We have historically financed
our operations through internally generated funds and borrowings under our
credit facilities. We are seeking to obtain additional borrowing capacity
under a revolving credit facility which will allow us to borrow significantly
in excess of the amount available under the 1999 Credit Facility. A new
credit facility has not yet been entered into, although we have received a
preliminary commitment from an institutional lender. We have no mandatory
payments of principal on the $66.7 million of Senior Notes outstanding prior
to their final maturity in 2006. As of September 30, 1999, we had $51.5
million outstanding under our credit facility with Wells Fargo Bank,
excluding $100,000 outstanding on standby letters of credit, and had
available borrowings of approximately $8.5 million.
For the nine months ended September 30, 1999, cash used by operating
activities was $17.2 million, most of which represented additions to inventory.
Cash used in investing activities totaled $13.7 million, which principally
consisted of capital expenditures under our store expansion program. Cash
14
<PAGE>
provided by financing activities totaled $30.8 million, which principally
consisted of borrowings under the credit facility.
We intend to pursue an aggressive growth strategy by opening additional
stores in new and existing markets. During the nine months ended September 30
1999, we opened eleven new stores of which one was operated by Musician's
Friend. Each new Guitar Center store typically has required approximately $1.8
million for gross inventory. Historically, our cost of capital improvements for
an average Guitar Center new store has been approximately $850,000, consisting
of leasehold improvements, fixtures and equipment. We are currently evaluating
the costs of remodeling the large format Musician's Friend store locations that
will be rebranded to the Guitar Center name. Inventory requirements for these
locations should not significantly change. The costs to provide the additional
information technology resources to bring the nine Musician's Friend stores in
line with Guitar Center standards will approximate $85,000 per store. We are
also currently evaluating additional capital and strategic requirements related
to improving the technology for the Internet business. Such costs could be
significant.
Our expansion strategy is to continue to increase our market share
in existing markets and to penetrate strategically selected new markets. We
opened a total of 16 stores in 1998 and 11 stores in 1997, of which two were
purchased, and currently anticipate opening approximately two additional
stores in 1999 and approximately 14 to 16 stores in 2000. In preparation for
this expansion, we have dedicated a substantial amount of our resources over
the past several years to building the infrastructure necessary to support a
large national chain. We also believe there may be attractive opportunities
to expand by selectively acquiring existing music products retailers.
However, in the music industry there are only a small number of companies
that would strategically and financially be a beneficial opportunity for us
to acquire. Our "average" store is 15,000 square feet, carrying 7,000 SKUs
and generating first year sales of $6.4 million whereas the "average"
industry store is 4,900 square feet, carrying 2,500 SKUs and generating sales
of $1.2 million.
Management is seeking to obtain additional borrowing under a
revolving credit facility in order to maintain 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 our present plans for expansion as described elsewhere in
this Report. Our capital resources and liquidity are expected to be provided
by net cash flow from operations and the additional borrowings under the 1999
Credit Facility or a successor facility. Depending upon market conditions, we
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 us, if at all.
SEASONALITY
Our operating results are not highly seasonal, although, as with most
retailers, sales in the fourth quarter are typically higher than any other
quarter.
YEAR 2000
The Year 2000 issue is primarily the result of computer programs using
a two-digit format, as opposed to four digits, to indicate the year. Computer
programs that are date dependent are found in the software that operates many IT
systems as well as in the computer based devices which control many types of
electronic equipment. Computer programs that are not Year 2000 compliant will be
unable to interpret dates beyond the year 1999, which could cause a system
failure or other computer errors, leading to a disruption in the operation of
the related IT systems or electronic equipment.
In 1997, we established a project plan to investigate the Year 2000
compliance of our internal and third party computer system applications and
hardware. The objective was to verify third party compliance and complete
internal compliance prior to year end 1999. All work has been substantially
completed including a major software project related to our inventory management
system implemented in April of 1999. As of the date of this Report, we believe
that all of our significant IT systems will be Year 2000 compliant by the end of
1999. We currently do not have a contingency plan with regard to the Year 2000.
During the fourth quarter of 1999, we will continue to evaluate whether and to
what extent contingency arrangements should be implemented.
15
<PAGE>
We have also endeavored to assess the Year 2000 compliance of the
outside parties upon which we are most dependent, including large vendors of the
products resold by us. While we are not aware of any material compliance
difficulties expected by any such supplier, our ability to obtain accurate
information is necessarily limited. A number of our vendors manufacture their
products overseas, also making accurate information difficult to obtain. Those
vendors, as well as ourselves, are also dependent upon the continued normal
functioning of surface and air transportation, electric utility and voice and
data transmission infrastructure, and the electronic payments systems and other
activities of large financial institutions. Many of these companies have very
significant Year 2000 compliance programs underway because they tend to be
dependent on large, proprietary "legacy" computing systems that are particularly
susceptible to Year 2000 problems. The success of these compliance programs will
prove important to us and our business.
Based on the assessment efforts to date, however, we do not believe
that the Year 2000 issue will have a material adverse effect on our financial
condition or results of operations. Our beliefs and expectations, however, are
based on assumptions and expectations that ultimately may prove to be
inaccurate. We believe that by the end of 1999, we will be able to fully
determine its most reasonably likely worst case scenarios. Potential sources of
risk include:
- the inability of principal suppliers to be Year 2000 ready, which could
result in delays in product deliveries from such suppliers;
- disruption of the distribution channel, including ports, and
transportation vendors, as a result of a general failure of systems and
necessary infrastructure such as electric power supply, voice and data
communications and financial payment systems; and
- unexpected failures of systems or devices that are misidentified as
being Year 2000 compliant or which prove unexpectedly to contain
non-compliant, date-dependent computer code.
As of the date of this Report, we do not expect the future costs
associated with our Year 2000 efforts to be substantial. To date, we have spent
minimal resources on the Year 2000 issue, as such, primarily due to an already
established, long term plan to upgrade and modernize our systems which we have
been implementing since 1995. The Year 2000 issues have been addressed as part
of the overall global system strategies. Our statements concerning future costs
do not include time and costs that may be incurred by us as a result of the
failure of any third parties, including suppliers, to become Year 2000
compliant, or costs to implement any contingency plans.
The information above contains forward-looking statements which reflect
the current views of our company with respect to Year 2000 compliance and the
related costs and possible impact on its financial performance. As indicated
above, these assessments may prove to be inaccurate. The Year 2000 problem is
novel. Neither Guitar Center nor any of our suppliers is experienced at
identifying and remediating a problem of this sort which represents a systemic
defect that, if not corrected, will cause the failure of computer systems and
computer-controlled devices that are pervasive in the infrastructure of business
and government.
INFLATION
We believe that the relatively moderate rates of inflation experienced
in recent years have not had a significant impact on our net sales or
profitability.
FORWARD LOOKING STATEMENTS; BUSINESS RISKS
This Report contains forward-looking statements relating to, among
other things, future results of operations, growth plans, sales, gross margin
and expense trends, capital requirements, liquidity requirements and general
industry and business conditions applicable to Guitar Center. These
forward-looking statements are based largely on our current expectations and are
subject to risks and uncertainties. Actual results could differ materially from
these forward-looking statements. Important factors to consider in evaluating
any of these forward-looking statements include changes in external competitive
market
16
<PAGE>
factors, the effectiveness of our promotion and merchandising strategies,
changes in our business strategy or any inability to execute our business
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 us from
competing successfully in existing or future markets. We are also dependent
on our continuing access to the credit markets to fund our working capital
and growth capital requirements. These matters and other business risks to
which Guitar Center is subject are discussed in our periodic reports and
registration statements filed from time to time with the Securities and
Exchange Commission. In particular, a discussion of some of the business
risks that we face is contained under the caption "Item 1., Business Risks
Related to the Business" on pages 11 through 13 of our 1998 Annual Report on
Form 10-K. We do not presently intend to update any of these forward looking
statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Guitar Center does not have any assets or liabilities which in its view
impose upon it significant market risk except that it has outstanding $66.7
million in aggregate principal amount of 11% Senior Notes due 2006. These senior
notes constitute long-term, fixed interest rate obligations for which market
quotations are available.
Part II. OTHER INFORMATION
Item 6. Exhibits
(a) Exhibit 10.33 Employee Assistance Loan Program Agreement
between Guitar Center, Inc. and Bruce Ross,
along with related Full Recourse Promissory
Note
Exhibit 11. Income per share.
Exhibit 27. Financial Data Schedule.
(b) Reports of Form 8-K. The Registrant filed a current Report
on Form 8-K on June 4, 1999, reporting under Item 2
(Acquisition and Disposition of Assets), the Merger with
Musician's Friend, Inc. effective May 28, 1999. The
Registrant filed an amendment to Form 8-K on August 11,
1999, to include the audited financial statements of
Musician's Friend, Inc. as of and for the three years ended
December 31, 1998, and unaudited proforma condensed
consolidated financial statements of the Registrant and its
Subsidiaries as of and for the three year period ended
December 31, 1998.
17
<PAGE>
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized as of the 11th day of November 1999.
Guitar Center, Inc.
/s/ Bruce L. Ross
---------------------------------------
Bruce L. Ross, Executive Vice President,
Chief Financial Officer and Secretary
(Duly Authorized Officer and Principal Financial
and Accounting Officer)
18
<PAGE>
Exhibit Index
EXHIBIT NO. DESCRIPTION
10.33 Employee Assistance Loan Program Agreement between Guitar
Center, Inc. and Bruce Ross, along with related Full Recourse
Promissory Note
11 Income per share.
27 Financial Data Schedule.
19
<PAGE>
Exhibit 10.33
GUITAR CENTER, INC.
EMPLOYEE ASSISTANCE LOAN PROGRAM AGREEMENT
Guitar Center, Inc. ("GUITAR CENTER" or the "COMPANY") has, under
authority granted by its Board of Directors, established an employee
assistance loan program (the "PROGRAM") to make loans to certain specified
employees for the purpose of assisting those employees in purchasing Guitar
Center common stock, par value $.01 per share ("COMMON STOCK"). The
undersigned ("PARTICIPANT"), in consideration for being permitted to draw a
loan from the Company, agrees to be bound by the terms of this Agreement and
the associated promissory note(s) also being executed and delivered to the
Company.
1. GENERAL. The Program was instituted to encourage greater
stock ownership by specified members of senior management by facilitating the
purchase of Guitar Center Common Stock. In accordance with this Agreement,
Guitar Center will extend, and Participant may borrow, funds up to the
maximum amount identified on the signature page hereof for the sole purpose
of purchasing Guitar Center Common Stock in unsolicited open market purchases
(each such draw, a "LOAN"). Such Loan(s) may be drawn solely for purchases
made in accordance with this Agreement from the date hereof through November
30, 1999, provided that on the date such purchase is made the Participant (i)
is an employee of Guitar Center or a majority-owned subsidiary and (ii) is
not in breach of this Agreement or any related promissory note.
2. ADMINISTRATION OF THE PROGRAM. The Board of Directors will,
in its discretion, establish rules and regulations appropriate for the proper
administration of the Program and will have full authority and power to
interpret and construe any provision of the Program. Decisions of the Board
of Directors are final, binding and conclusive on all persons who have an
interest in the Program. The Program will be administered by either (a) the
Board, (b) a committee or (c) a senior executive officer appointed by the
Board in its sole discretion (the "ADMINISTRATOR").
3. EVIDENCE OF PROGRAM LOANS. Each extension of a Loan under the
Program will be represented by a full recourse promissory note executed by
the Eligible Participant in the form attached hereto as Exhibit A (the
"PROMISSORY NOTE"). AS A FULL RECOURSE PROMISSORY NOTE, ALL PRINCIPAL,
INTEREST AND OTHER OBLIGATIONS DUE TO GUITAR CENTER UNDER THE PROMISSORY NOTE
AND THIS AGREEMENT WILL CONSTITUTE THE PERSONAL RESPONSIBILITY OF THE
PARTICIPANT AND MUST BE PAID REGARDLESS OF ANY APPRECIATION OR DEPRECIATION
IN THE COMMON STOCK PURCHASED WITH THE PROCEEDS FROM THE LOAN(S). Under the
terms of the Promissory Note, interest on the Loans will be paid annually,
with the principal paid in one lump sum on the fifth anniversary of the date
of the Promissory Note, unless accelerated as provided for in the Promissory
Note. The Promissory Note may also be prepaid in whole or in part at any
time, and, in the case of default, death, ceasing to be an employee of Guitar
Center or any majority-owned subsidiary, or the sale of Guitar Center, must
be repaid.
4. PROCEDURE FOR STOCK PURCHASES; SAFEKEEPING OF SHARE
CERTIFICATES. The sole use of proceeds from the Loans funded to Participant
under this Program shall be to purchase Common Stock in unsolicited, open
market transactions. All purchases of Common Stock under the Program must be
executed through a brokerage firm identified by the Company, and
disbursements of Loans will only be made directly to the designated broker
upon presentation to the Company of trade confirmations which comply with the
Program. Participant will be responsible for all transaction costs
including, without limitation, brokerage commissions. All shares of Common
Stock purchased by the Participant under the Program shall be held only in
certificated form. The certificates for the Shares will be issued and
initially held by Guitar Center for safekeeping. Upon the Participant's
written request, Guitar Center will deliver the certificates to the
Participant. Guitar Center will not rely on the certificates as collateral
for the Loan. Guitar Center may, in its discretion, place any appropriate
legend on such certificates to assure
<PAGE>
compliance with this Program, the internal stock trading policies of Guitar
Center and all applicable securities laws.
5. VOLUNTARY AND DISCRETIONARY NATURE OF PROGRAM. The extension
of Loans under this Program is entirely discretionary, and the obligation of
Guitar Center to make additional Loans hereunder may be terminated by it, in
the sole discretion of the Administrator at any time. Nothing in the Program
is meant to limit or restrict the right of Guitar Center or any subsidiary of
Guitar Center to terminate the employment of Participant at any time, with or
without cause and with or without notice, or to change the compensation or
other terms and conditions of employment of a Participant at any time. The
Board of Directors may from time to time alter, amend, suspend or discontinue
this Program and make further rules for its administration.
6. INVESTMENT DECISION MADE SOLELY BY PARTICIPANT. The decision
to participate in the Program has been made solely by Participant who has and
will continue to make his or her own investment decision as to whether or not
taking out Loans to purchase Common Stock is prudent or advisable in the
personal circumstances of Participant. Participant is not relying on any
oral statement of any representative of Guitar Center to make its investment
decision.
7. COMPLIANCE WITH COMPANY TRADING POLICIES REQUIRED.
Participant acknowledges that Guitar Center has established policies which
restrict the times that employees, including Participant, may trade in the
Common Stock, and Participant acknowledges that he or she is familiar with
such policies and has and will continue to comply with the policies. Nothing
in this Program shall act to relieve any person from the application of such
policies, any requirement of the federal securities laws (E.G., compliance
with Section 16(a) reporting, trading limitation of shares held by
affiliates, prohibition on trading when in possession of material inside
information as provided in Rule 10b-5) or any other applicable policy of
Guitar Center or legal requirement.
8. ASSIGNABILITY. The rights to receive the Loans and purchase
the Common Stock under this Program are not transferable or assignable by the
Participant.
9. FEDERAL INCOME TAX CONSEQUENCES. Guitar Center makes no
representations regarding the federal income tax consequences of being a
Participant in the Program. Participant acknowledges that he or she has been
directed by Guitar Center to seek independent professional assistance
regarding the legal and tax consequences of entering into this agreement and
participating in the Program including, for example, the tax treatment of any
gain or loss on sale of the Common Stock or whether or not interest payments
to the Company will be deductible.
10. ERISA DOES NOT APPLY; PLAN NOT TAX QUALIFIED. The Program is
not subject to the provisions of the Employee Retirement Income Security Act
of 1974, as amended (commonly referred to as "ERISA"), and is not a qualified
program under Section 401(a) of the Internal Revenue Code of 1986, as amended
or any other federal income tax provision which might provide favorable tax
treatment.
11. MISCELLANEOUS.
(a) ENTIRE AGREEMENT. This agreement and the other documents
referred to herein constitutes the complete and exclusive statement of the
agreement between Guitar Center and the Participant with respect to the
subject matter herein set forth and supersedes all prior agreements by and
between the parties.
(b) AMENDMENTS. This agreement may not be amended, altered or
terminated except in writing executed by or on behalf of each party.
2
<PAGE>
(c) INUREMENT. Except as otherwise set forth above, this
agreement shall be binding upon the parties hereto and their respective
heirs, executors, administrators, legal representatives, successors and
permitted assigns.
(d) LANGUAGE. The language used in this Agreement shall be
deemed to be language chosen by the parties thereto to express their mutual
intent and no rule of strict construction against any party shall apply to
any term or condition thereof
(e) GOVERNING LAW. This Agreement shall be governed by and
construed in accordance with the laws of the State of New York.
(f) ARBITRATION. Any controversy or claim arising out of or
relating to this agreement, or the breach thereof, shall be settled by
binding arbitration in accordance with the commercial rules of the American
Arbitration Association by a single arbitrator in a location to be agreed
to by the parties, and judgment upon the award rendered by the arbitrator
may be entered in any court having jurisdiction thereof and shall not be
appealable.
(g) COMPLIANCE WITH LAW. It is the intention of the parties
that this agreement comply with all applicable laws, including all
applicable laws relating to the maximum rate of permissible interest. In
the event it shall be finally determined that any provision of this
agreement is illegal or unenforceable, it is the express intention of the
parties that the agreement then be reformed to the minimum extent necessary
to cause the subject provision to then constitute a legal and enforceable
agreement of the parties.
(h) COUNTERPARTS: This Agreement may be executed in
counterparts, each of which shall constitute an original but all of which
taken together shall constitute but one agreement.
(Signature Page Follows)
3
<PAGE>
IN WITNESS WHEREOF, the parties have executed this Employee
Assistance Loan Program Agreement as of the date set forth on this signature
page.
GUITAR CENTER, INC. Effective Date:__________, 1999
By:
------------------------------------
- ---------------------------------------
(Signature of Participant)
Name of Participant:
-------------------
- ---------------------------------------
Tax Identification or
Social Security Number
- ---------------------------------------
Address for Notice
- ---------------------------------------
Facsimile Number
Maximum Loan Amount: $
----------------
4
<PAGE>
$ 49,031.50
AGOURA HILLS, CALIFORNIA September 15, 1999
FULL RECOURSE PROMISSORY NOTE
FOR VALUE RECEIVED, the undersigned, BRUCE ROSS ("DEBTOR"),
promises to pay to the order of GUITAR CENTER, INC., a Delaware corporation,
or its order ("GUITAR CENTER" or "PAYEE"), the principal sum of Forty-nine
Thousand Thirty-one Dollars and Fifty Cents ($49,031.50) together with
interest from the date hereof on the balance of principal remaining from time
to time unpaid at a per annum interest rate equal to the lower of (a) the
prime rate as established from time to time by Wells Fargo Bank, N.A. or (b)
the highest interest rate which may be charged under applicable law, computed
upon the actual number of days elapsed, such principal to be payable in one
lump sum on the fifth anniversary of the date hereof unless accelerated as
hereinafter provided. Interest on the principal remaining from time to time
unpaid shall be paid annually on each anniversary date of this Note and at
maturity, whether by acceleration or otherwise. All payments of principal
and interest shall be paid in lawful money of the United States of America
and shall be made at the offices of Guitar Center, Inc. at 5155 Clareton
Drive, Agoura Hills, California 91301, or at such other place as the Payee or
holder hereof may, from time to time, designate in writing. This Note shall
bear interest after default at a rate of interest equal to the lower of (x)
the highest interest rate which may be charged under applicable law or (y)
fifteen percent (15%) per annum, such default interest to be payable on
demand. This Note is issued in accordance with a related Employee Assistance
Loan Program Agreement (as such agreement may be amended from time to time,
the "LOAN AGREEMENT") between Debtor and Guitar Center, and is expressly
subject to all of the terms and conditions of the Loan Agreement which are
hereby expressly incorporated by reference herein. Any interested party may
obtain a copy of the Loan Agreement from the Corporate Secretary of Guitar
Center at its principal corporate offices.
This Note is subject to the following additional provisions:
1. ACCELERATION. The entire principal amount then remaining
unpaid hereunder together with all accrued interest hereon must be paid in
full prior to maturity as follows: (a) ten (10) days after Debtor's ceasing
to be an employee of Guitar Center or a majority-owned subsidiary of Guitar
Center; (b) contemporaneous with the closing of any transaction involving the
sale of a majority interest in Guitar Center to a third party, whether by
tender offer, merger, or other similar transaction; (c) sixty (60) days after
the death of the Debtor; or (d) in accordance with Section 3.
2. VOLUNTARY PREPAYMENT. This Note may be prepaid in whole or in
part at any time and from time to time, without penalty or premium. Any such
prepayment will be applied first to accrued but unpaid interest and then to
principal.
3. DEFAULT. Upon the occurrence of any one or more of the
following events, the entire principal amount then remaining unpaid hereunder
together with all accrued interest hereon shall at once become due and
payable without further notice to Debtor:
(a) Any default in the payment of principal or any installment
of interest under this Note when due and payable, and the continuance
thereof for a period of five (5) days after written notice to Debtor
of such default;
(b) Any default by Debtor in any of its obligations provided in
the Loan Agreement (other than a payment default as provided for in
clause (a), above), and the continuance thereof for a period of ten
(10) days after written notice to Debtor of such default; or
(c) The insolvency of Debtor, the inability of Debtor to pay his
debts as they mature, an assignment by Debtor for the benefit of
creditors, or the filing of a petition in bankruptcy or the
commencement of any proceedings under any bankruptcy, insolvency or
similar laws relating to the relief
5
<PAGE>
of debtors by or against Debtor and, if filed against Debtor, such
petition or proceeding remains undismissed for a period of sixty (60)
days.
4. COSTS OF ENFORCEMENT AND COLLECTION. Debtor agrees to pay,
upon the demand of Payee therefor, any and all reasonable costs, fees and
expenses (including reasonable attorney's fees, costs and expenses) incurred
in enforcing any of Payee's rights hereunder. To the extent not paid within
fifteen days of presentment of the related invoice(s), such costs, fees and
expenses shall be added to the principal amount of this Note and thereby
become part of Debtor's obligations hereunder. Debtor's liability for all
reasonable expenses and fees hereunder also extends to the collection of any
judgment, which results from Payee's enforcement of its rights and remedies
hereunder.
5. FULL RECOURSE PERSONAL OBLIGATION. DEBTOR ACKNOWLEDGES THAT
THIS NOTE IS THE PERSONAL, FULL RECOURSE OBLIGATION OF DEBTOR AND THAT ALL
PRINCIPAL, INTEREST AND OTHER OBLIGATIONS DUE TO GUITAR CENTER HEREUNDER ARE
THE PERSONAL RESPONSIBILITY OF DEBTOR AND MUST BE PAID REGARDLESS OF ANY
APPRECIATION OR DEPRECIATION IN THE STOCK PURCHASED WITH THE PROCEEDS HEREOF
IN ACCORDANCE WITH THE LOAN AGREEMENT.
6. MISCELLANEOUS. No modification, waiver, estoppel, amendment
or discharge of this Note will be valid unless the same is in writing and
signed by the party against which the enforcement of such modification,
waiver, estoppel, amendment or discharge is sought.
Any notices and demands required or permitted under this Note to
be given to the undersigned shall be in writing and shall be delivered either
in person, by facsimile or by United States registered or certified mail,
return receipt requested, postage prepaid, addressed to the Debtor at the
address or facsimile number set forth below his signature. Notices and
demands given in the manner aforesaid will be deemed sufficiently given or
served for all purposes under this Note at the time such notice or demand is
faxed or mailed, as applicable.
No delay or omission by the Payee or any transferee or legal
holder in exercising any right or power hereunder will impair such right or
power or be construed to be a waiver of any default of the Debtor hereunder.
This Note is submitted by Debtor to Payee at Payee's principal
place of business and is deemed to have been made thereat. This Note is
governed by, and construed in accordance with, the laws of the State of New
York, and is binding on Debtor, his heirs, personal representatives and
assigns, and inures to the benefit of Payee and its successors and assigns.
Debtor hereby waives presentment for payment, notice of dishonor,
protest, notice of presentment and notice of protest.
- ---------------------------------- ----------------------------------
(Signature of Debtor) Tax Identification or
Social Security Number
Name of Debtor:
-------------------
----------------------------------
Address for Notice
----------------------------------
Facsimile Number
6
<PAGE>
EXHIBIT 11
GUITAR CENTER, INC.
COMPUTATION OF INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, September 30,
------------------------------------ ----------------------------------
1999 1998 1999 1998
------------- -------------- -------------- ------------
<S> <C> <C> <C> <C>
Income (loss) before cumulative effect of change
in accounting principle $ 3,393 $ 1,722 $ 4,891 $ 5,835
Cumulative effect of change in accounting
principle - write-off of pre-opening costs - - 1,074 -
------------- -------------- -------------- ------------
Net income 3,393 1,722 3,817 5,835
============= ============== ============== ============
Weighted average shares outstanding
Basic 22,072 22,036 22,069 21,618
============= ============== ============== ============
Diluted 22,072 23,003 22,462 22,853
============= ============== ============== ============
Income per common share
Basic
Income before cumulative effect of change
in accounting principle $ 0.15 $ 0.08 $ 0.22 $ 0.27
Cumulative effect of change in accounting
principle - write-off of pre-opening costs - - (0.05) -
------------- -------------- -------------- ------------
Net income $ 0.15 $ 0.08 $ 0.17 $ 0.27
============= ============== ============== ============
Diluted
Income before cumulative effect of change
in accounting principle $ 0.15 $ 0.07 $ 0.22 $ 0.26
Cumulative effect of change in accounting
principle - write-off of pre-opening costs - - (0.05) -
------------- -------------- -------------- ------------
Net income $ 0.15 $ 0.07 $ 0.17 $ 0.26
============= ============== ============== ============
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 400
<SECURITIES> 0
<RECEIVABLES> 17,176
<ALLOWANCES> 2,447
<INVENTORY> 147,769
<CURRENT-ASSETS> 166,576
<PP&E> 76,543
<DEPRECIATION> 23,541
<TOTAL-ASSETS> 240,586
<CURRENT-LIABILITIES> 104,941
<BONDS> 67,909
0
0
<COMMON> 221
<OTHER-SE> 65,639
<TOTAL-LIABILITY-AND-EQUITY> 240,586
<SALES> 427,140
<TOTAL-REVENUES> 427,140
<CGS> 316,080
<TOTAL-COSTS> 95,692
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,378
<INCOME-PRETAX> 6,990
<INCOME-TAX> 2,099
<INCOME-CONTINUING> 4,891
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 1,074<F1>
<NET-INCOME> 3,817
<EPS-BASIC> 0.17
<EPS-DILUTED> 0.17
<FN>
<F1>Represents a charge for pre-opening costs recorded as a cumulative effect of a
change in accounting principle, net of tax
</FN>
</TABLE>
