<PAGE>
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
Date of Report: May 28, 1999
(Date of earliest event reported)
GUITAR CENTER, INC.
(exact name of registrant as specified in its charter)
DELAWARE COMMISSION FILE: 95-4600862
(State or other jurisdiction 000-22207 (IRS Employer
of incorporation or Identification No.)
organization)
5155 CLARETON DRIVE
AGOURA HILLS, CALIFORNIA 91301
(Address of Principal executive offices, including zip code)
(818) 735-8800
(Registrant's telephone number, including area code)
- ------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
<PAGE>
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA INFORMATION AND EXHIBITS.
The sole purpose of this Amendment to the Form 8-K filed on June 4, 1999
is to provide the required financial statements of Musician's Friend, Inc.
and the Combined Proforma Financial Statements in the following exhibits.
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
The following financial statements of Musician's Friend, Inc. are included
in Appendix A hereto and filed herewith:
- Report of Independent Accountants
- Balance Sheets as of December 31, 1997 and 1998
- Statements of Operations and Accumulated Deficit for the years ended
December 31, 1996, 1997 and 1998
- Statements of Cash Flows for the years ended December 31, 1996, 1997 and
1998
- Notes to financial statements
(b) PRO FORMA FINANCIAL INFORMATION.
The following pro forma financial information is included in Appendix B
hereto and filed herewith:
- Pro Forma Combined Financial Statements - Basis of Presentation
- Pro Forma Combined Statements of Earnings:
- For the year ended December 31, 1998
- For the year ended December 31, 1997
- For the year ended December 31, 1996
- Notes to Pro Forma Combined Financial Statements
2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized,
GUITAR CENTER, INC.
Date: August 11, 1999 By /s/ BRUCE ROSS
--------------------------------------
NAME: Bruce Ross
TITLE: Executive Vice President and
Chief Financial Officer
3
<PAGE>
APPENDIX A
Musician's Friend
Financial Statements
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Musician's Friend, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations and changes in accumulated deficit and of cash flows present fairly,
in all material respects, the financial position of Musician's Friend, Inc. (the
"Company") at December 31, 1998 and 1997, and the results of its operations and
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
May 28, 1999
<PAGE>
<TABLE>
<CAPTION>
MUSICIAN'S FRIEND, INC.
BALANCE SHEET
DECEMBER 31, 1998 AND 1997
- ------------------------------------------------------------------------------------------------------------
ASSETS
1998 1997
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 358,709 $ 614,927
Accounts receivables, less allowances (Note 1) 3,038,830 9,852,076
Merchandise inventories 24,103,823 12,979,429
Deferred catalog costs 1,112,164 1,454,794
Prepaid expenses and other current assets 72,333 161,608
------------ ------------
Total current assets 28,685,859 25,062,834
Equipment and leasehold improvements, net (Notes 2 and 5) 7,656,328 3,325,495
Other assets 121,740 19,361
------------ ------------
Total assets $ 36,463,927 $ 28,407,690
------------ ------------
------------ ------------
LIABILITIES AND EQUITY (DEFICIT)
Current liabilities:
Line of credit (Note 3) $ 13,126,500 $ 2,000,000
Accounts payable 16,606,055 11,310,372
Accrued expenses (Note 7) 1,042,178 3,431,565
Merchandise allowances 2,228,638 347,471
Current portion of capital lease obligations (Note 5) 251,052 144,897
Current portion of subordinated notes payable (Note 4) 276,391 848,746
------------ ------------
Total current liabilities 33,530,814 18,083,051
Other long-term liabilities 143,831 -
Capital lease obligations, less current portion (Note 5) 901,067 678,878
Subordinated notes payable to related parties (Notes 4 and 13) 13,071,015 9,708,343
------------ ------------
Total liabilities 47,646,727 28,470,272
------------ ------------
Commitments and contingencies (Notes 8, 9 and 13)
Equity (deficit):
Common stock, par value $0.01: 500,000 shares authorized;
100,000 shares issued and outstanding at December 31, 1998 100 -
Accumulated deficit (11,182,900) (62,582)
------------ ------------
Total equity (deficit) (11,182,800) (62,582)
------------ ------------
Total liabilities and equity (deficit) $ 36,463,927 $ 28,407,690
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
<TABLE>
<CAPTION>
MUSICIAN'S FRIEND, INC.
STATEMENT OF OPERATIONS AND CHANGES IN ACCUMULATED DEFICIT
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Net sales $ 94,052,382 $ 70,697,769 $ 46,373,034
Cost of sales 67,947,415 48,017,520 30,499,939
------------ ------------ ------------
Gross profit 26,104,967 22,680,249 15,873,095
Operating expenses:
Selling general and administrative 34,801,936 17,671,931 10,397,426
------------ ------------ ------------
Operating income (loss) (8,696,969) 5,008,318 5,475,669
Other (expense) income:
Interest expense, net (2,335,975) (963,815) (387,814)
Other income 15,186 101,965 303,192
------------ ------------ ------------
Net income (loss) before income taxes (11,017,758) 4,146,468 5,391,047
Income tax expense (Note 8) 2,560 - -
------------ ------------ ------------
Net income (loss) (11,020,318) 4,146,468 5,391,047
Retained earnings (accumulated deficit) at beginning
of year (62,582) 1,790,950 1,918,076
Distributions to beneficiaries (100,000) (6,000,000) (5,518,174)
------------ ------------ ------------
Retained earnings (accumulated deficit) at end of year $(11,182,900) $ (62,582) $ 1,790,949
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
<TABLE>
<CAPTION>
MUSICIAN'S FRIEND, INC.
STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- ------------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(11,020,318) $ 4,146,468 $ 5,391,047
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization expense 862,505 300,860 100,932
Changes in assets and liabilities:
Accounts receivables 6,813,246 (5,322,280) (3,857,466)
Merchandise inventories (11,124,394) (4,879,355) (1,741,216)
Deferred catalog costs 342,630 (1,055,878) (191,552)
Prepaid expenses and other current assets 89,275 (118,580) (34,936)
Accounts payable 5,295,683 8,351,110 1,451,516
Accrued expenses 324,464 (145,655) 157,941
Other current and non-current liabilities (688,853) 174,840 (936,684)
------------ ----------- -----------
Cash provided by (used in) operating activities (9,105,762) 1,451,530 339,582
------------ ----------- -----------
Cash flows from investing activities:
Purchases of equipment and leasehold improvements (5,193,338) (2,998,429) (352,418)
Decrease (increase) in other assets (102,379) 4,500 4,500
------------ ----------- -----------
Cash used in investing activities (5,295,717) (2,993,929) (347,918)
------------ ----------- -----------
Cash flows from financing activities:
Net proceeds under line of credit agreement 11,126,500 2,000,000 -
Net proceeds from notes payable 2,790,317 4,146,513 6,255,058
Capital lease arrangements 529,698 - -
Payments under capital, lease obligations (201,354) - -
Proceeds from stock issuance 100 - -
Distributions to beneficiaries (100,000) (6,000,000) (5,518,174)
------------ ----------- -----------
Cash provided by financing activities 14,145,261 146,513 736,884
------------ ----------- -----------
Net increase (decrease) in cash and cash equivalents (256,218) (1,395,886) 728,548
Cash and cash equivalents, beginning of year 614,927 2,010,813 1,282,265
------------ ----------- -----------
Cash and cash equivalents, end of year $ 358,709 $ 614,927 $ 2,010,813
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS
The Company is a specialty retailer selling musical instruments nationally
via direct mail and regionally through nine retail stores in Colorado,
Louisiana, Nevada, Oregon, Tennessee, Utah and Washington. See Note 13.
ENTITY REORGANIZATION
On January 1, 1998, Musician's Friend Trust (the "Trust") transferred all of
its assets and liabilities to Musician's Friend, Inc. ("MFI"), a newly
formed Delaware corporation. In exchange, the Trust received all of the
issued and outstanding shares of common stock of MFI, with a par value of
$.01 per share. The accompanying 1997 and 1996 financial statements present
the accounts of the Trust, whereas the accompanying 1998 financial
statements present the accounts of MFI.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with
maturities less than three months at the date of purchase to be cash
equivalents. The Company had $57,223 and $333,517 in money market funds at
December 31, 1998 and 1997, respectively.
REVENUE RECOGNITION
Mail order and internet sales, net of estimated returns and allowances, are
recognized when the related products are shipped to customers. Retail sales
are recognized at the time of sale. Merchandise deposits received in advance
of product shipment are included as current liabilities in the accompanying
balance sheet.
The Company recognizes a provision for estimated future returns and
allowances based upon past and current experience. Such provisions are
recorded as reductions of net sales and cost of sales in the accompanying
statement of operations.
RECEIVABLES
Receivables principally relate to credit card sales due on an installment
basis over two to five months.
Receivables are recorded net of the following allowances:
<TABLE>
<CAPTION>
1998 1997
------------ ---------
<S> <C> <C>
Allowance for doubtful accounts $ 3,257,000 $ 481,000
Sales returns and allowances, net 1,488,300 381,000
------------ ---------
$ 4,745,300 $ 862,000
------------ ---------
------------ ---------
</TABLE>
-1-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES
Merchandise inventories are stated at the lower of cost or market using the
first-in, first-out method to determine cost.
ADVERTISING
The Company capitalizes mail order catalog costs on a catalog-by-catalog
basis. Other advertising is expensed as incurred. These costs are amortized
over the expected period of future benefits, not to exceed five months.
Total advertising expense for the years ended December 31, 1998, 1997 and
1996 aggregated $7,544,686, $5,112,342 and $2,967,581, respectively. Such
expenses are included in selling, general and administrative expenses in the
accompanying statement of operations.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are stated at cost. Expenditures for
additions and major improvements are capitalized and expenditures for
repairs and maintenance are charged to operations as incurred. Depreciation
for financial reporting purposes is determined using the straight-line
method over the estimated useful lives of the assets, ranging from three to
fifteen years. Leasehold improvements are amortized over the shorter of the
life of the asset or the term of the lease. Upon sale or retirement of
equipment, the cost and related accumulated depreciation are removed from
the accounts and the resulting gain or loss is recorded in operations.
STATEMENT OF CASH FLOWS
During the years ended December 31, 1998, 1997 and 1996, the Company made
interest payments of $2,335,975 , $963,815 and $387,814, respectively. In
addition, during the years ended December 31, 1998 and 1997, the Company
entered into non-cash transactions to acquire computer office equipment at a
cost of $529,698 and $834,672, respectively, under capital lease agreements
(Note 5).
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.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' data to conform
with the current year's presentation. Such reclassifications had no effect
on the Company's previously reported results of operations or financial
position.
FAIR VALUE OF FINANCIAL INSTRUMENTS
In December 1991, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 107 (SFAS 107), "Disclosures About
Fair Value of Financial Instruments." SFAS 107 requires disclosure of the
fair value of certain financial instruments.
The recorded amounts of cash and cash equivalents, receivables, accounts
payable and accrued expenses, lines of credit and other current liabilities
as presented in the financial statements approximate fair value because of
the short-term maturity of these instruments. The recorded amount of notes
payable and capital lease obligations approximates fair value as the actual
and imputed interest rates approximate current competitive rates.
-2-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
On January 1, 1998, the Company terminated its trust status 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 attributed 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
as 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 reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies in making its assessment.
2. EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Equipment, furniture and fixtures $ 4,320,888 $ 2,616,905
Leasehold improvements 4,135,150 1,231,875
Instruments 127,974 127,974
Vehicles 24,585 29,585
Construction in progress 863,972 272,892
----------- -----------
9,472,569 4,279,231
Less accumulated depreciation and amortization (1,816,241) (953,736)
----------- -----------
$ 7,656,328 $ 3,325,495
----------- -----------
----------- -----------
</TABLE>
3. LINE OF CREDIT
The Company maintains an operating line of credit with an aggregate
borrowing limit of $16,000,000 for the purchase of inventories. Borrowings
under the line of credit are secured by a UCC filing of inventories,
accounts receivable, equipment and intangibles, and bear interest at rates
up to the bank's prime rate plus .5% (9.0% at December 31, 1998).
Outstanding borrowings under the operating line of credit at December 31,
1998 and 1997 aggregated $13,126,500 and $2,000,000, respectively.
The line of credit agreement contains various affirmative and negative
covenants, including but not limited to the amounts of tangible net worth
and minimum current ratio. At December 31, 1998, the Company was not in
compliance with certain covenants. As a result, the bank could, under the
-3-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
3. LINE OF CREDIT (CONTINUED)
provisions of the line of credit agreement, have declared an event of
default and demanded full payment of all outstanding balances. Subsequent to
year-end, the Company entered into a new line of credit agreement with a
different bank, and the entire balance outstanding on the existing line of
credit was repaid with proceeds from the new line of credit. The new line of
credit expires in February, 2002. In May 1999, the entire outstanding amount
of the new line of credit was fully repaid as a part of the merger (see Note
13).
4. SUBORDINATED NOTES PAYABLE TO RELATED PARTIES
The Company has obtained notes from various related parties to finance the
purchase of equipment and to finance operations. Effective March 6, 1998,
these balances became subordinated to the bank line of credit (Note 3).
Subordinated notes payable to related parties are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Notes payable in monthly installments of principal and
interest at 9%, maturing on varying dates through
February 2003, subordinated to any and all other debt,
unsecured $ 5,416,210 $ 3,802,893
Note payable with interest-only payments at 9% until
maturity in March 2000, subordinated to any and all
other debt, unsecured 2,585,483 2,053,483
Note payable with interest-only payments at 9% until
maturity in March 2001, subordinated to any and all
other debt, unsecured 5,345,713 4,700,713
------------ ------------
13,347,406 10,557,089
Less current portion (276,391) (848,746)
------------ ------------
Long-term portion $ 13,071,015 $ 9,708,343
------------ ------------
------------ ------------
</TABLE>
Maturities of notes payable at December 31, 1998 are summarized as follows:
<TABLE>
<S> <C>
1999 $ 276,391
2000 2,585,483
2001 5,345,713
2002 3,416,819
2003 1,723,000
------------
$ 13,347,406
------------
------------
</TABLE>
-4-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
5. CAPITAL LEASE OBLIGATIONS
At December 31, 1998 and 1997, computer equipment and furniture include
$1,364,370 and $834,672, respectively, of assets held under capital leases
with related accumulated amortization aggregating $248,120 and $71,537,
respectively.
The capital lease agreements require minimum future payments as follows:
<TABLE>
<S> <C>
1999 $ 352,259
2000 352,259
2001 365,642
2002 266,639
2003 57,258
-----------
Total minimum lease payments 1,394,057
Less amount representing interest (241,938)
-----------
Present value of net minimum lease payments 1,152,119
Less current portion (251,052)
-----------
$ 901,067
-----------
-----------
</TABLE>
6. STOCK OPTION PLAN
Effective February 13, 1998, the Company adopted the 1998 Stock Option Plan
(the "Plan"), which consists of two separate qualified stock option plans:
the 1998 Key Employees Stock Option Plan (the "Key Employees Plan"), and the
1998 Employees Stock Option Plan (the "Employee Plan"). The Key Employees
Plan provides for issuance of up to 20,500 shares of common stock and the
Employees Plan provides for issuance of up to 4,500 shares of common stock.
The exercise price for incentive stock options under both Plans are granted
at the fair market value of the underlying shares on the date of grant. The
Plan is administered by the Company's Board of Directors. The Board has the
authority to determine the persons to whom awards will be made, the number
of shares covered by options and their exercise prices, and other terms and
conditions of awards. Options issued under the Plan are generally subject to
a five-year vesting schedule from the date of grant and expire ten years
from original grant date.
All 20,500 and 4,500 stock options available for issuance under the Key
Employees Plan and Employees Plan, respectively were granted during 1998,
and were outstanding as of December 31, 1998. No options were exercisable as
of December 31, 1998. The weighted-average exercise price of the 25,000
options granted during 1998 was $203.50.
See Note 13.
-5-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
6. STOCK OPTION PLAN (CONTINUED)
The following table sets forth the exercise prices, the number of options
outstanding and exercisable, and the remaining contractual lives of the
Company's stock options at December 31, 1998:
<TABLE>
<CAPTION>
NUMBER NUMBER
OUTSTANDING WEIGHTED- EXERCISABLE
COMMON AT AVERAGE AT
EXERCISE DECEMBER 31, CONTRACTUAL DECEMBER 31,
PRICE 1998 LIFE 1998
- ------------ ------------ ----------- --------------
<S> <C> <C> <C>
$ 200.00 20,625 9.2 years -
220.00 4,375 9.2 years -
------ ----
25,000 -
------ ----
------ ----
</TABLE>
FAS 123
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for the
Stock Option Plan. Had compensation cost for the Company's Stock Option Plan
been determined based on the fair value at the grant date for awards during
the year ended December 31, 1998, the Company's net loss would be adjusted
to the pro forma amount indicated below:
<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
Net loss - as reported $11,020,318
Net loss - pro forma $11,203,494
</TABLE>
The fair value of each common stock option grant was estimated on the date
of grant using the minimum value option-pricing model with the following
weighted-average assumptions used for common stock grants during the year
ended December 31, 1998: no dividend yield; a risk-free interest rate of
5.58%, and an expected life of 8 years.
7. BENEFIT PLANS
The Company has a 401(k) benefit plan available to substantially all
employees after a minimum employment period. Employees may contribute
portions of their wages on a tax-deferred basis to the plan. Employees
immediately vest 100% in their own contributions. The Company made
discretionary and matching contributions aggregating $46,969, $84,000 and
$86,996 in 1998, 1997 and 1996, respectively, to the plan.
-6-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
8. INCOME TAXES
From 1994 through 1997, the Company was organized as a trust and claimed it
was not subject to federal and state income taxes. Accordingly, the Company
has not recorded provisions for income taxes since the Trust's income or
loss was attributable to the individual beneficiaries of the Trust and its
related trusts. The tax returns of the Trust and its related trusts were
subject to examination by federal and state taxing authorities.
During 1998, the Internal Revenue Service (IRS) took the position that the
Musician's Friend Trust was an association which is taxable as a corporation
and not as a trust. Accordingly, the IRS asserted that the Company 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
trusts were formed to avoid federal income taxes which were legally owed by
the Company and the individuals involved.
As a result, the IRS issued reports to the Musician's Friend 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 Company had operated as an S
corporation for years prior to 1994. Accordingly, the Company's taxable
income for 1994 and prior years had been attributed to the owners.
The Company is contesting the positions of the Internal Revenue Service.
During 1999, the IRS offered to impose income taxes on the earnings of the
Company as if it had been an S Corporation under the Internal Revenue Code
for all years. Accordingly, pursuant to such offer, the taxable income
(loss) of the Company for all years through December 31, 1997 would be
attributed to the owners of the Company and not to the Company itself. The
owners have not remitted income taxes relating to the Company's taxable
income for 1994-1997.
Based on the proposed offer from the IRS, the Company has not recorded a
liability or provision for income taxes or related penalties and interest on
the accompanying financial statements. However, unless and until the issues
with the IRS are fully resolved, there can be no assurance that the Company
will not be compelled to make income tax payments, with related penalties
and interest relating to its taxable income.
On January 1, 1998, the Company applied for and received C Corporation
status for income tax purposes. The Company incurred net operating losses
during 1998, resulting in the establishment of a deferred tax asset as of
December 31, 1998. The Company has fully reserved such asset due to
uncertainties surrounding the projection of taxable income to future years
and based on the IRS offer described above.
9. COMMITMENTS
The Company leases its operating facilities which include various office
buildings, warehouses, retail stores and related parking lots. In addition,
the Company has lease commitments for various office and warehouse
equipment. All of the leases are operating leases with terms of one to ten
years with five-year renewal options which the Company intends to exercise.
See Note 10 for related party leases.
-7-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
9. COMMITMENTS (CONTINUED)
The following schedule summarizes future minimum rental payments due to
unrelated parties, net of any sublease rentals, under operating leases that
have noncancelable lease terms as of December 31, 1998:
<TABLE>
<S> <C>
1999 $ 1,902,351
2000 1,855,034
2001 1,861,352
2002 1,588,972
2003 1,676,261
Thereafter 6,724,373
------------
$ 15,608,343
------------
------------
</TABLE>
Total rent expense to unrelated parties aggregated $1,230,901, $333,154 and
$103,835 for the years ended December 31, 1998, 1997 and 1996, respectively.
10. RELATED PARTY TRANSACTIONS
The Company leases its corporate office facility from certain owners. The
lease requires monthly payments of $18,232 with annual increases of 5% and
expires August 31, 2000. The Company intends to renew the lease for an
additional five years. Rental expense, aggregating $222,438, $211,845 and
$201,757 for the years ended December 31, 1998, 1997 and 1996, respectively,
is included in general and administrative expense.
Future minimum lease payments under lease agreements with related parties at
December 31, 1998 are summarized as follows:
<TABLE>
<S> <C>
1999 $ 118,696
2000 124,631
2001 130,862
2002 137,405
2003 144,276
Thereafter 797,208
-----------
$ 1,453,078
-----------
-----------
</TABLE>
See Note 13.
During 1998, the Company distributed $100,000 to the Trust for potential
future legal, accounting and other costs related to the conversion to a C
corporation. During 1997 and 1996, the beneficiaries of the Trust provided
certain management services to the Company. Fees for such services totaled
$659,358 and $508,568, respectively. In addition, the Company paid fees of
$240,000 and $204,000 to its board of trustees during 1997 and 1996,
respectively.
-8-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
11. LITIGATION
The Company is involved in various legal proceedings related to its
operations. When it is possible to make a reasonable estimate of the
Company's liability with respect to probable claims, an appropriate
provision is made. While the ultimate disposition of such proceedings is not
determinable, the Company believes that the outcome of such litigation will
not have a significant impact on the Company's financial position or results
of operations. The Company had no provisions related to legal claims at
either December 31, 1998 or 1997.
12. SEGMENT REPORTING
During 1998, the Company began managing its business as two reporting
segments: retail outlets and direct sales. Direct sales include marketing
and distributing products via catalog and/or the internet. The cost of
warehousing and corporate overhead costs are included in the direct sales
segment. While a significant portion of the Company's assets and liabilities
are primarily used by one of the Company's segments, the Company has not yet
segregated its balance sheet accounts into segments. Consequently, no
balance sheet information is available by segment. In addition, the Company
does not yet manage its business beyond operating income (loss). The Company
accounts for its intersegment activity at cost. The following summary
presents the Company's operations by segment:
<TABLE>
<CAPTION>
DIRECT SALES RETAIL COMBINED
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 74,342,730 $ 19,709,652 $ 94,052,382
Cost of sales 54,481,577 13,465,838 67,947,415
------------ ------------ ------------
Gross profit 19,861,153 6,243,814 26,104,967
Operating expenses 26,819,974 7,981,962 34,801,936
------------ ------------ ------------
Operating income (loss) $ (6,958,821) $ (1,738,148) $ (8,696,969)
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
13. SUBSEQUENT EVENT
On May 28, 1999, the Company completed its merger with Guitar Center, Inc.
("GCI"), a publicly held corporation, with GCI as the surviving corporation.
The merger is expected to be accounted for as a pooling of interests. Prior
to the closing of the merger agreement, the subordinated noteholders
collectively contributed all rights, title and interest of the principal
debt, together with all accrued and unpaid interest in the subordinated
notes, for an amount aggregating $13,869,942 as a capital contribution to
the Company in exchange for 86,912.57 shares of Musician's Friend, Inc.
common stock.
In addition, two related party trusts contributed collectively real and
personal property (specifically the Medford Corporate office and warehouse
buildings, structures, fixtures and improvements leased by MFI during 1996,
1997 and 1998) to the Company in exchange for 8,734 shares of Musician's
Friend, Inc. common stock.
-9-
<PAGE>
MUSICIAN'S FRIEND, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- -------------------------------------------------------------------------------
13. SUBSEQUENT EVENT (CONTINUED)
Under the terms of the merger agreement, GCI issued 1,959,970 shares of its
common stock, representing 8.9% of the outstanding stock of the merged
company, to the shareholders of Musician's Friend, Inc. GCI is a retail
music company based in Agoura Hills, California.
Upon consummation of the merger, pre-existing stock options of Company
employees were converted utilizing a ratio of 10.02 to one.
As a part of the merger, a Tax Audit Escrow fund of 20% of the GCI common
stock issued pursuant to the merger was established to compensate for any
damages incurred or sustained by the merged company as a result of or
arising out of tax issues raised in connection with the restructuring of
Musician's Friend, Inc., a Sub-chapter S Corporation prior to 1994, and
another corporation into Musician's Friend Trust, the operations, income
distributions and tax returns of the Trust and related entities subsequent
to that restructuring, the transfer of assets and liabilities by the Trust
to the Company or the IRS reports during 1998 relating to the Trust's
taxable years ended December 31, 1994, 1995 and 1996. See Note 8.
There were no significant transactions between GCI and the Company prior to
the combination.
-10-
<PAGE>
APPENDIX B
Guitar Center, Inc.
Pro Forma Combined Financial Statements
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
These unaudited pro forma combining balance sheet and statements of operations
reflect the financial position and results of operations of Guitar Center, Inc.
("Guitar Center") and Musician's Friend, Inc. ("Musician's Friend"). The pro
forma combined statements of operations of Guitar Center and Musician's Friend
were prepared as if the merger occurred as of the beginning of the periods
presented and are not necessarily indicative of operating results which would
have been achieved had the merger been consummated at the beginning of such
period and should not be construed as representative of future operations.
The pro forma condensed combining financial statements should be read in
conjunction with the 1998 Annual Report on Form 10-K of Guitar Center, the
Quarterly Report on Form 10-Q of Guitar Center for the period ended March 31,
1999, the current report on Form 8-K regarding Guitar Center's merger of
Musician's Friend filed with the Securities and Exchange Commission on June
4,1999, and the audited financial statements of Musician's Friend included in
this Form 8-K filing.
On May 28, 1999, Guitar Center received all the outstanding Musician's Friend
common shares in exchange for 1,959,700 shares of Guitar Center common stock in
a transaction that was accounted for as a pooling of interests. Accordingly, all
financial information has been restated to reflect the combined operations of
Musician's Friend and Guitar Center for the periods indicated.
The preparation of unaudited pro forma combined financial statements requires
management to make estimates and assumptions based on information currently
available. The pro forma adjustments made in connection with the development of
the pro forma information are preliminary and have been made solely for purposes
of developing such pro forma information for illustrative purposes necessary to
comply with the disclosure requirements of the Securities and Exchange
Commission. The unaudited pro forma combined financial statements do not purport
to be indicative of the results of operations for future periods or the combined
financial positions or the results that actually would have been realized had
the entities been a single entity during the periods presented.
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
PRO FORMA CONDENSED COMBINING BALANCE SHEET
DECEMBER 31, 1998
(in 000s)
<TABLE>
<CAPTION>
AS REPORTED
----------------------------------------- PRO FORMA PRO FORMA
ASSETS GUITAR CENTER MUSICIAN'S FRIEND ADJUSTMENTS TOTAL
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 113 $ 359 $ 472
Accounts receivable, net 10,575 3,039 13,614
Merchandise inventories 102,853 24,104 126,957
Prepaid expenses and other current assets 4,990 1,184 6,174
Employee notes - -
--------- -------- --------- -----------
Total current assets 118,531 28,686 - 147,217
Property and equipment, net 34,754 7,656 1,750 (1) 44,160
Deferred income taxes 10,431 - 10,431
Goodwill, net 4,618 - 4,618
Other assets 3,260 122 3,382
--------- -------- --------- -----------
Total assets $ 171,594 $ 36,464 $ 1,750 $ 209,808
--------- -------- --------- -----------
--------- -------- --------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 18,790 $ 16,606 $ 35,396
Accrued expenses 14,648 1,042 (556)(1),(2) 15,134
Merchandise advances 4,918 2,229 7,147
Revolving line of credit 7,723 13,127 20,850
Current portion of long-term debt - 527 (276)(2) 251
--------- -------- --------- -----------
Total current liabilities 46,079 33,531 (832) 78,778
Other long-term liabilities 1,426 1,045 (15)(1) 2,456
Notes payable - related parties 13,071 (13,071)(2) -
Long-term debt 66,691 66,691
Stockholders' equity: -
Common stock, $0.01 par value 201 - 20 (1),(2) 221
Additional paid in capital 228,195 15,648 (1),(2) 243,843
Accumulated deficit (170,998) (11,183) (182,181)
--------- -------- --------- -----------
Total stockholders' equity 57,398 (11,183) 15,668 61,883
--------- -------- --------- -----------
Total liabilities and stockholders' equity $ 171,594 $ 36,464 $ 1,750 $ 209,808
--------- -------- --------- -----------
--------- -------- --------- -----------
</TABLE>
See Notes to Pro Forma Combined Financial Statements
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
QUARTER ENDED MARCH 31, 1999
(IN 000S, EXCEPT PER SHARE DATA)
(unaudited)
<TABLE>
<CAPTION>
AS REPORTED
----------------------------------------- PRO FORMA PRO FORMA
GUITAR CENTER MUSICIAN'S FRIEND ADJUSTMENTS COMBINED
<S> <C> <C> <C> <C>
Net sales $ 109,904 $ 25,534 $135,438
Cost of goods sold, buying and occupancy 81,007 19,382 $100,389
--------- -------- -------- --------
Gross profit 28,897 6,152 35,049
Selling, general and administrative expenses 20,813 7,728 (78) (1) 28,463
Deferred compensation expense - - -
--------- -------- -------- --------
Operating income (loss) 8,084 (1,576) 78 6,586
Other (expense) income
Interest (expense) income, net (2,088) (665) 300 (2) (2,453)
Transaction expense - -
Other (expense) income, net - -
--------- -------- -------- --------
Income (loss) before income taxes 5,996 (2,241) 222 4,133
Income tax expense/ (benefit) 2,099 9 2,108
--------- -------- -------- --------
Income before change in accounting principle 3,897 (2,250) 222 2,025
Cumulative effect of change in accounting
principle - write off of preopening costs 1,074 1,074
--------- -------- -------- --------
Net income $ 2,823 $ (2,250) $ 222 $ 951
--------- -------- -------- --------
--------- -------- -------- --------
Net income per common share
Basic $ 0.14 $ 0.04
Diluted $ 0.14 $ 0.04
Weighted average shares outstanding
Basic 20,101 1,002 (4) 958 (4) 22,061
Diluted 20,846 1,018 (4) 958 (4) 22,822
</TABLE>
See Notes to Pro Forma Combined Financial Statements
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AS REPORTED
----------------------------------------- PRO FORMA PRO FORMA
GUITAR CENTER MUSICIAN'S FRIEND ADJUSTMENTS COMBINED
<S> <C> <C> <C> <C>
Net sales $ 391,665 $ 94,052 $485,717
Cost of goods sold, buying and occupancy 282,023 67,947 349,970
--------- -------- -------- --------
Gross profit 109,642 26,105 - 135,747
Selling, general and administrative expenses 77,182 34,802 (164) (1) 111,820
Deferred compensation expense - - -
--------- -------- -------- --------
Operating income (loss) 32,460 (8,697) 164 23,927
Other (expense) income
Interest (expense) income, net (8,509) (2,336) 1,262 (2) (9,583)
Transaction expense - - -
Other (expense) income, net 324 15 339
--------- -------- -------- --------
Income before income taxes 24,275 (11,018) 1,426 14,683
Income tax benefit (3,158) 2 (3,156)
--------- -------- -------- --------
Net income (loss) $ 27,433 $(11,020) $ 1,426 $ 17,839
--------- -------- -------- --------
--------- -------- -------- --------
Net income per common share
Basic $ 1.39 $ 0.82
Diluted $ 1.31 $ 0.78
Weighted average shares outstanding
Basic 19,766 1,002 (4) 958 (4) 21,726
Diluted 20,923 1,020 (4) 958 (4) 22,901
</TABLE>
See Notes to Pro Forma Combined Financial Statements
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AS REPORTED
----------------------------------------- PRO FORMA PRO FORMA
GUITAR CENTER MUSICIAN'S FRIEND ADJUSTMENTS COMBINED
<S> <C> <C> <C> <C>
Net sales $ 296,655 $ 70,690 $367,353
Cost of goods sold, buying and occupancy 214,345 48,018 $262,363
--------- -------- -------- --------
Gross profit 82,310 22,680 104,990
Selling, general and administrative expenses 56,915 17,672 (124) (1) 74,463
Deferred compensation expense - - -
--------- -------- -------- --------
Operating income (loss) 25,395 5,008 124 30,527
Other (expense) income
Interest (expense) income, net (8,928) (964) 810 (2) (9,022)
Transaction expense (755) - (755)
Other (expense) income, net 535 102 637
--------- -------- -------- --------
Income (loss) before income taxes and
extraordinary loss 16,247 4,146 994 21,387
Income tax expense (benefit) (2,833) - 2,056 (3) (777)
--------- -------- -------- --------
Income before extraordinary loss 19,080 4,146 (1,062) 22,164
Extraordinary loss on early extinguishment
of debt, net of tax benefit of $1,679 (2,739) - (2,739)
--------- -------- -------- --------
Net income $ 16,341 $ 4,146 $ (1,062) $ 19,425
--------- -------- -------- --------
--------- -------- -------- --------
Net income per common share
Basic $ 0.85 $ 0.91
Diluted $ 0.79 $ 0.86
Weighted average shares outstanding
Basic 19,331 1,002 (4) 958 (4) 21,291
Diluted 20,602 1,002 (4) 958 (4) 22,562
</TABLE>
See Notes to Pro Forma Combined Financial Statements
<PAGE>
GUITAR CENTER, INC. AND MUSICIAN'S FRIEND, INC.
PRO FORMA CONDENSED COMBINING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
(IN 000S, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AS REPORTED
----------------------------------------- PRO FORMA PRO FORMA
GUITAR CENTER MUSICIAN'S FRIEND ADJUSTMENTS COMBINED
<S> <C> <C> <C> <C>
Net sales $ 213,294 $ 46,373 259,667
Cost of goods sold, buying and occupancy 153,222 30,500 183,722
----------- -------- -------- ---------
Gross profit 60,072 15,873 - 75,945
Selling, general and administrative expenses 41,345 10,397 (114) (1) 51,628
Deferred compensation expense 71,760 - 71,760
----------- -------- -------- ---------
Operating income (loss) (53,033) 5,476 114 (47,443)
Other (expense) income
Interest (expense) income, net (12,169) (388) 378 (2) (12,179)
Transaction expense (6,942) - (6,942)
Other (expense) income, net (126) 303 177
----------- -------- -------- ---------
Income (loss) before income taxes (72,270) 5,391 492 (66,387)
Income taxes 139 - 2,353 (3) 2,492
----------- -------- -------- ---------
Net income (loss) $ (72,409) $ 5,391 $ (1,861) $(68,879)
----------- -------- -------- ---------
----------- -------- -------- ---------
Net loss per common share
Basic $ (3.75) $ (3.24)
Diluted $ (3.55) $ (3.08)
Weighted average shares outstanding
Basic 19,329 1,002 (4) 958 (4) 21,289
Diluted 20,420 1,002 (4) 958 (4) 22,380
</TABLE>
See Notes to Pro Forma Combined Financial Statements
<PAGE>
The pro forma combined balance sheet as of December 31, 1998 and the pro
forma combined statements of operations for the years ended December 31,
1998, 1997, 1996 and the three months ended March 31, 1999 reflect the
following adjustments necessary to reflect the pooling-of-interests of Guitar
Center and Musician's Friend.
1. To record the contribution of Musician's Friend's corporate headquarters
property previously owned by its shareholders. In connection with the
merger, the property was contributed by the shareholders to Musician's
Friend in exchange for 8,734 shares of Musician's Friend common stock. The
property had a fair value of $1,750,000 at the date of contribution.
Additional adjustments reflect the reversing of related rent expense and
straight line rent liability and recording of related depreciation expense
on the value allocated to the building.
2. To record the exchange of related party notes to equity. In connection
with the merger, certain debt investments with an aggregate amount of
$15,900,000 (including accrued interest) held by certain shareholders
were exchanged for 86,913 shares of common stock. Additional adjustments
recorded to elimination of related party note interest for all statement
of operations presented.
3. The additional unaudited pro forma data is based upon historical combined
income before taxes adjusted to reflect a provision for income taxes as if
Musician's Friend had been a C corporation for all periods presented.
Income tax benefits are not recognized on losses presented for Musicians
Friend, as the post merger losses of Musicians Friend will not be available
to offset income generated at Guitar Center, and it is assumed for purposes
of these pro forma combined financial statements that deferred tax assets
created by such losses will not meet the recognition requirements of SFAS
109, ACCOUNTING FOR INCOME TAXES.
4. Pro forma basic net income (loss) per share is computed based on the
weighted average number of common shares outstanding. Pro forma diluted net
income (loss) per share is computed based on the weighted average number of
common shares plus the dilutive impact of options and convertible
securities for each period after giving effect to the combination on a
pooling-of-interests basis. Pro forma shares and net income (loss) per
share is presented to reflect the issuance of Musician's Friend common
stock (and options for diluted earnings per share) based on the Exchange
ratio of 10.02.
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-26257) of Guitar Center, Inc. of our report
dated May 28, 1999 relating to the financial statements of Musician's Friend,
Inc., which appears in the Current Report on Form 8-K/A of Guitar Center,
Inc. dated August 10, 1999.
PricewaterhouseCoopers LLP
Portland, Oregon
August 9, 1999
