<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 21, 1997
REGISTRATION NO. 333-15139
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------------
CD WAREHOUSE, INC.
(Name of Small Business Issuer in its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 5735 73-1504999
(State or Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification
Number)
</TABLE>
722 N. BROADWAY
OKLAHOMA CITY, OKLAHOMA 73102
(405) 232-2797
(Address and Telephone Number of Principal Executive Offices)
JERRY W. GRIZZLE, PRESIDENT
CD WAREHOUSE, INC.
722 N. BROADWAY
OKLAHOMA CITY, OKLAHOMA 73102
(405) 232-2797
(Name, Address and Telephone Number of Agent for Service)
------------------------
COPIES TO:
JEANETTE C. TIMMONS, ESQ. DOUGLAS A. BRANCH, ESQ.
Day Edwards Federman Propester & Phillips McFall McCaffrey McVay &
Christensen, P.C. Murrah, P.C.
210 Park Avenue, Suite 2900 211 North Robinson
Oklahoma City, Oklahoma 73102 Oklahoma City, Oklahoma 73102
(405) 239-2121 (405) 235-4100
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
------------------------
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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- --------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED JANUARY 21, 1997
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
PROSPECTUS
1,000,000 SHARES
CD WAREHOUSE, INC.
COMMON STOCK
All of the 1,000,000 shares of common stock, $.01 par value per share (the
"Common Stock"), offered hereby (the "Offering") are being sold by CD Warehouse,
Inc. (the "Company"). Prior to this Offering, there has been no public market
for the Common Stock of the Company. It is currently anticipated that the
initial public offering price will be between $5.00 and $6.25 per share. See
"Underwriting" for information relating to the method of determining the initial
public offering price. The Common Stock has been approved for quotation on the
Nasdaq SmallCap Market under the trading symbol "CDWI" subject to notice of
issuance.
THESE SECURITIES ARE SPECULATIVE IN NATURE, INVOLVE A HIGH DEGREE OF RISK
AND SUBSTANTIAL DILUTION AND SHOULD BE CONSIDERED ONLY BY PERSONS WHO CAN AFFORD
THE LOSS OF THEIR ENTIRE INVESTMENT. SEE "RISK FACTORS" ON PAGE 7.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING DISCOUNTS PROCEEDS TO
PRICE TO PUBLIC AND COMMISSIONS (1) COMPANY (2)(3)
<S> <C> <C> <C>
Per Share.............................. $ $ $
Total (3).............................. $ $ $
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.
(2) Before deducting expenses in connection with this Offering payable by the
Company, including a nonaccountable expense allowance to be paid to Capital
West Securities, Inc. in the amount of $ ($ if the Underwriters'
over-allotment option is exercised in full), estimated at $ . See "Use
of Proceeds" and "Underwriting."
(3) The Company has granted the Underwriters an option, exercisable within 30
business days from the date of this Prospectus, to purchase up to 150,000
additional shares of Common Stock upon the same terms and conditions as set
forth above, solely to cover over-allotments, if any. If such over-allotment
option is exercised in full, the total Price to Public, Underwriting
Discounts and Commissions and Proceeds to Company will be $ , $
and $ , respectively. See "Underwriting."
The Common Stock is being offered by the Underwriters, subject to prior
sale, when, as and if delivered to and accepted by the Underwriters and subject
to the approval of certain legal matters by counsel and to certain other
conditions. It is expected that delivery of certificates representing the shares
of Common Stock will be made against payment therefor at the offices of Capital
West Securities, Inc., Oklahoma City, Oklahoma, on or about , 1997.
CAPITAL WEST SECURITIES, INC.
WESTPORT RESOURCES INVESTMENT SERVICES, INC.
BERTHEL FISHER & COMPANY
FINANCIAL SERVICES, INC.
The date of this Prospectus is , 1997.
<PAGE>
The picture on the inside front cover of the Prospectus depicts a CD Warehouse,
Inc., storefront. On the top half of the inside back cover is a map with
pinpoint markings which represent CD Warehouse, Inc., store locations
nationwide, and on the bottom half of the inside back cover is depicted the
interior of a CD Warehouse Store.
------------------------
The Company intends to furnish its stockholders with annual reports
containing audited financial statements certified by an independent public
accounting firm and with quarterly reports for the first three quarters of each
fiscal year containing unaudited financial information.
------------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICES OF THE COMMON STOCK
AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION, INCLUDING "RISK FACTORS" AND FINANCIAL STATEMENTS, INCLUDING THE
NOTES THERETO, APPEARING ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE
INDICATED, ALL INFORMATION CONTAINED IN THIS PROSPECTUS (I) ASSUMES AN INITIAL
OFFERING PRICE OF $5.00 PER SHARE (THE MINIMUM OF THE RANGE APPEARING ON THE
COVER OF THIS PROSPECTUS); (II) ASSUMES THAT THE UNDERWRITERS' OVER-ALLOTMENT
OPTION IS NOT EXERCISED; AND (III) GIVES EFFECT TO THE CDIL ACQUISITION AND THE
MACDONALD ACQUISITION (AS DESCRIBED ELSEWHERE IN THIS PROSPECTUS). EXCEPT FOR
THE HISTORICAL INFORMATION CONTAINED HEREIN, THIS PROSPECTUS CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS REGARDING THE COMPANY'S BUSINESS AND PROSPECTS THAT
ARE BASED UPON NUMEROUS ASSUMPTIONS ABOUT FUTURE CONDITIONS WHICH MAY ULTIMATELY
PROVE TO BE INACCURATE AND ACTUAL EVENTS AND RESULTS MAY MATERIALLY DIFFER FROM
ANTICIPATED RESULTS DESCRIBED IN SUCH STATEMENTS. THE COMPANY'S ABILITY TO
ACHIEVE SUCH RESULTS IS SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, SUCH AS
THOSE INHERENT GENERALLY IN THE RETAIL AND FRANCHISING INDUSTRIES, THE IMPACT OF
COMPETITION AND PRICING, CHANGING MARKET CONDITIONS, THE RISKS DETAILED IN THE
SECTIONS ENTITLED "RISK FACTORS" AND "LEGAL PROCEEDINGS," AND OTHER RISKS
DETAILED THROUGHOUT THIS PROSPECTUS. THESE FORWARD-LOOKING STATEMENTS REPRESENT
THE COMPANY'S JUDGMENT AS OF THE DATE OF THE FILING OF THIS PROSPECTUS. THE
COMPANY DISCLAIMS, HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE THESE
FORWARD-LOOKING STATEMENTS. AS A RESULT, THE READER IS CAUTIONED NOT TO PLACE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. AS USED IN THIS PROSPECTUS, THE
WORD "COMPANY" MEANS CD WAREHOUSE, INC. AND ITS WHOLLY OWNED SUBSIDIARY, COMPACT
DISCS MANAGEMENT, INC., UNLESS THE CONTEXT INDICATES OTHERWISE.
THE COMPANY
The Company was formed in September 1996 to acquire the assets of Compact
Discs International, Ltd. ("CDIL"), a Texas limited partnership which franchises
and operates stores throughout the United States and England under the name "CD
Warehouse." CD Warehouse stores sell, trade and buy new and preowned compact
discs ("CD's") and related products. According to the January 1996 issue of
ENTREPRENEUR MAGAZINE, CDIL was ranked among the top 30 new franchises in the
United States. At September 30, 1996, there were 109 franchised CD Warehouse
stores in 26 states and England.
CD Warehouse stores sell CD's, take customers' CD's in trade or buy
customers' CD's for cash. The CD Warehouse concept capitalizes on the emergence
of CD's as the prevailing form of prerecorded music. Because the CD is encased
in plastic and read by a laser, the playing of CD's, and even the occasional
careless handling of CD's, rarely cause damage that will impair performance or
result in any degradation of sound quality. In the absence of pronounced abuse,
CD's may reasonably be expected to last for decades. The CD Warehouse
remarketing concept emphasizes consumer value by offering quality preowned CD's
at substantial savings and responding to consumers' desire to recycle
merchandise they no longer want or use but which has intrinsic value. The CD
Warehouse marketing slogan, "selling compact discs at compact prices," embodies
this concept.
A typical CD Warehouse store, located in a high traffic strip shopping
center, will occupy between 1,000 and 2,000 square feet and offer between 8,000
and 12,000 selections, with approximately 80% of the dollar sales volume being
preowned selections and the balance being new releases from the major music
categories. At each CD Warehouse store, a customer selects from a number of new
and preowned CD's and may listen to preowned CD's before purchase. Typically,
each CD Warehouse store carries the majority of the Billboard Top 100 selections
as "new" inventory, filling out its inventory selection with preowned CD's which
are purchased for $1 to $4 and remarketed for $6 to $9.
The Company believes that a growing consumer willingness to purchase
preowned CD's provides an expanding market niche in the retail music industry
for CD remarketers. The Company's business strategy is to establish itself as
the recognized industry leader in the domestic buy-sell-trade retail CD
marketplace by pursuing a three-fold approach: (1) offering quality, preowned
CD's at exceptional value; (2) selling new releases at competitive prices; and
(3) offering to accept as a trade, or buy for cash, selected CD's from
customers.
3
<PAGE>
The Company's expansion strategy for 1997 is to open 9 to 12 Company-owned
stores and 18 to 24 franchised stores. Management believes that, in addition to
the Company, Disc-Go-Round-Registered Trademark- and The Wherehouse are the only
national chains engaged in the sale of preowned CD's. Based on the Quarterly
Report on Form 10-Q for the Quarter Ended June 29, 1996 of Grow Biz
International, Inc. the parent corporation of Disc-Go-Round-Registered
Trademark-, and the Quarterly Report on Form 10-Q for the Quarter Ended July 31,
1996 of Wherehouse Entertainment, Inc., the Company believes that the 109 stores
in the CD Warehouse system currently account for approximately 23% of the
estimated 480 chain-based CD reseller stores that operate throughout the United
States. Management believes that the market for CD remarketers is fragmented and
underserved, and that the Company can capitalize on the demand by expanding the
CD Warehouse concept in targeted markets.
Simultaneously with the closing of the Offering, the Company will acquire
substantially all of the assets of CDIL (the "CDIL Assets") for a purchase price
of $3.2 million (the "CDIL Acquisition"). See "Certain Transactions--CDIL
Acquisition." The Company has agreed to pay certain unaffiliated parties a
finder's fee of $100,000 for their assistance in identifying CDIL for potential
acquisition or investment. The Company has made a nonrefundable payment of
$40,000 in partial satisfaction of this obligation and is required to pay the
balance of $60,000 at the closing of the CDIL Acquisition. None of the proceeds
of the Offering will be used to pay the remaining obligation relating to the
finder's fee.
In a related transaction (the "MacDonald Acquisition"), which also will
occur simultaneously with the closing of the Offering, the Company's wholly
owned subsidiary, Compact Discs Management, Inc. ("CD Management") will acquire
the equity interests of Bruce D. MacDonald (together with his affiliates,
"MacDonald") with respect to 36 franchised CD Warehouse stores. Pursuant to the
MacDonald Acquisition, the Company will acquire 100% ownership of an existing
store in Dallas, Texas (the "Montfort Street Store") and minority equity
interests (including MacDonald's interest as a managing general partner or
limited liability company manager) in 35 other existing stores (the "MacDonald
Equity Interests"). The Company has formed CD Management to act as the successor
general partner or manager of, respectively, 15 partnerships and two limited
liability companies originally organized by MacDonald to fund, own and operate
the 35 franchised stores in which MacDonald holds a minority equity interest.
Upon acquisition of the Montfort Street Store and the MacDonald Equity Interests
(collectively, the "MacDonald Assets"), the Company will manage and have an
interest in 36 of the 109 stores in the CD Warehouse system. Pursuant to the
MacDonald Acquisition, the Company will issue to MacDonald 80,000 shares of the
Company's Common Stock. See "Certain Transactions--MacDonald Acquisition." The
Offering will not be closed unless there is a simultaneous closing of the CDIL
Acquisition and the MacDonald Acquisition. Upon consummation of the CDIL
Acquisition and the MacDonald Acquisition, the Company will acquire the rights
to the CD Warehouse name, assume CDIL's role as franchisor under the franchise
agreements to which CDIL is a party and manage and have an interest in the CD
Warehouse Stores in which MacDonald has an interest.
During the year ended December 31, 1995, and the nine months ended September
30, 1996, on a pro forma basis taking into account the CDIL Acquisition and the
MacDonald Acquisition, the Company had pro forma total revenues of approximately
$4,153,000 and $3,545,000, respectively, and pro forma net income, as adjusted,
of approximately $168,000 and $140,000, respectively. There can be no assurance
that the historical level of the Company's revenues and net income will continue
to be achieved in the future. See "Risk Factors," "Business" and "Certain
Transactions."
The Company was incorporated under the laws of the State of Delaware in
September 1996. The Company's principal office is located at 722 N. Broadway,
Oklahoma City, Oklahoma 73102, and its telephone number is (405) 232-2797.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the
Company..................... 1,000,000 shares
Shares of Common Stock to be
outstanding after the
Offering.................... 1,780,000 shares (1)(2)
Use of Proceeds............... To purchase the CDIL Assets, open new Company
stores and remodel existing stores in which the
Company owns an interest and manages and for
working capital and general corporate purposes.
Nasdaq SmallCap Market
Symbol...................... CDWI
</TABLE>
- ------------------------
(1) Includes 350,000 shares of Common Stock for which Mark E. Kane, the founder
of CDIL, previously has subscribed, but the payment for which is conditioned
upon the consummation of the Offering, and 80,000 shares of Common Stock to
be issued to Bruce D. MacDonald in connection with the MacDonald
Acquisition.
(2) Excludes 400,000 shares of Common Stock reserved for issuance pursuant to
the Company's 1996 Stock Option Plan. See "Management--1996 Stock Option
Plan" and "Description of Securities."
RISK FACTORS
Investment in the Common Stock offered hereby involves a high degree of risk
and immediate substantial dilution. See "Risk Factors" and "Dilution."
5
<PAGE>
SUMMARY--FINANCIAL AND OPERATING DATA
The following table sets forth historical financial information, on a
combined basis, of the operations of CDIL, as well as historical financial
information attributable to the MacDonald Assets to be acquired by the Company
upon successful completion of this Offering. The information is derived from the
audited financial statements of CDIL and CD Acquisitions (a joint venture which
was acquired by CDIL effective January 1, 1996), for each of the two years in
the period ended December 31, 1995 and from the internally-prepared financial
statements of such entities for the year ended December 31, 1993 and the nine
months ended September 30, 1995 and 1996 appearing elsewhere in this Prospectus,
and should be read in conjunction with such Financial Statements including the
Notes thereto. See "Combined Statements of Operations," "Pro Forma Combined
Condensed Financial Statements" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations." The historical information and
pro forma disclosures are further explained in the accompanying notes.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
YEARS ENDED DECEMBER 31, ------------------------
--------------------------------------------
AS AS AS
HISTORICAL COMBINED(1) ADJUSTED(2) ADJUSTED(2) ADJUSTED(2)
------------------------------- ----------- ----------- -----------
1993 1994 1995 1995 1995 1996
--------- --------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS, EXCEPT SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Total revenues................................. $ 719 $ 2,627 $ 4,153 $ 4,153 $ 2,772 $ 3,545
Operating income (1)........................... 85 126 370 206 120 166
Pro forma net income (1)(2).................... 67 110 277 168 104 140
Pro forma net income per share (2)............. .09 .06 .08
Shares used in computation..................... 1,780,000 1,780,000 1,780,000
</TABLE>
- --------------------------
(1) The operations to be acquired were organized as partnerships. Salaries for
the partners were not reflected as salary expense but rather as a reduction
of partnership equity. In addition, no provisions were included for income
taxes since the earnings were distributed directly to the partners.
Historical results have been adjusted to reflect the cash distributions to
partners as compensation expense in the determination of operating and net
income and to provide for income taxes in each of the periods.
(2) The amounts presented "as adjusted" are calculated as if the CDIL
Acquisition, the MacDonald Acquisition and the Offering were completed as of
January 1, 1995.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
($ IN THOUSANDS)
STORE DATA:
System-wide sales............................................. $ 2,778 $ 11,550 $ 20,868 $ 15,119 $ 18,891
Store Count:
Beginning................................................... 2 19 67 67 96
Open........................................................ 17 51 36 28 16
Close....................................................... -- 3 7 4 3
Ending...................................................... 19 67 96 91 109
</TABLE>
6
<PAGE>
RISK FACTORS
An investment in the securities being offered hereby involves substantial
risk. Prospective investors should carefully consider the following factors, in
addition to the other information set forth in this Prospectus.
NO OPERATING HISTORY. Although CD Warehouse stores have operated since late
1992, the Company is only recently formed and will commence its operations upon
the acquisition of CDIL's franchise operations and the concurrent MacDonald
Acquisition. Although members of the Company's management have extensive
experience in the franchise industry, only Mr. MacDonald has any experience in
the retail music industry or in CD Warehouse franchises, and the Company itself
has no operating history upon which investors may base their evaluation of the
Company's performance. As a result of the Company's lack of operating history,
period-to-period comparisons of operating results may not be meaningful and
results of operations from prior periods may not be indicative of future
results. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
EXPANSION. The Company's growth will depend in part on its ability to open
and operate new stores on a profitable basis. Upon consummation of the CDIL
Acquisition and the MacDonald Acquisition, the Company will have an interest in
109 stores, 35 of which will be managed by its subsidiary, CD Management. By the
end of 1997, the Company contemplates having approximately 45 to 48 Company-
owned or managed stores and 91 to 97 franchised stores in operation. There can
be no assurance that the Company will achieve these goals for 1997. The opening
and success of new stores will depend on various factors, including customer
acceptance of the Company's buy-sell-trade concept in new markets, the
availability of suitable store sites, the negotiation of acceptable lease or
purchase terms for new locations, the financial and other capabilities of the
Company and its franchisees, the ability of the Company to manage the
anticipated expansion and hire and train personnel and general economic and
business conditions. Some of the foregoing factors are not within the control of
the Company or its franchisees. See "Business--Expansion Strategy" and
"--Government Regulation."
The Company's expansion will also require the implementation and integration
of enhanced operational and financial systems and additional management,
operational and financial resources. Failure to implement and integrate these
systems and add these resources could have a material adverse effect on the
Company's results of operations and financial condition. There can be no
assurance that the Company will be able to manage its expanding operations
effectively or that it will be able to maintain or accelerate the growth of its
predecessor, CDIL. On a pro forma basis, the Company experienced growth in
revenues and net income in 1995 and for the nine months ended September 30,
1996. There can be no assurance that the Company will continue to experience
growth in, or maintain the present level of, revenues or net earnings.
DEPENDENCE ON FRANCHISEES. Prior to the implementation of the Company's
plan to own and open new stores, the Company will be primarily reliant upon its
revenues from initial franchise fees, continuing royalty payments from its
franchisees and wholesale CD sales throughout the current store system. If the
Company's franchisees encounter business or operational difficulties, the
Company's revenues from royalties will be adversely affected. Such difficulties
may also negatively impact the Company's ability to sell new franchises.
Consequently, the Company's financial prospects are significantly related to the
success of its franchised stores, over which the Company has limited operational
control. There can be no assurance that the Company will be able to successfully
attract new franchises or that the Company's franchisees will be able to
successfully operate existing or develop and operate additional CD Warehouse
stores. See "Business--Expansion Strategy" and "Business--Franchise Program."
GOVERNMENT REGULATION. The Company is subject to federal regulation and
certain state laws which govern the offer and sale of franchises. Many state
franchise laws impose substantive requirements on franchise agreements,
including limitations on non-competition provisions and termination or
non-renewal of a franchise. Some states require that certain franchise offering
materials be registered before franchises
7
<PAGE>
can be offered or sold in that state. The failure to obtain or retain any
requisite licenses or approvals to sell franchises could adversely affect the
Company's results of operations. CDIL is subject to a currently effective cease
and desist order as a result of CDIL's failure to register its franchise in the
State of South Dakota. See "Legal Proceedings." Additionally, while royalty
payments are required to be paid on the sale of new CD's, no such payments are
currently required on the sale of preowned CD's. The future enactment, adoption
or amendment of laws or regulations, such as establishing basic franchisee
rights, or the imposition of royalties on the sales of preowned CD's, could
adversely affect the Company's results of operations. See "Business--Franchise
Program" and "Business--Government Regulation."
COMPETITION. The prerecorded music market is highly competitive. The
Company competes with other chain retailers who specialize in prerecorded music,
discounters and other mass merchandisers, direct mail programs such as record
clubs, and local operators. In the Company's judgment, small operators may be
well located, but usually have significant disadvantages in inventory selection
and cost relative to chain retailers. The Company is aware of, and competes
with, one franchisor of stores which sell preowned and new CD's,
Disc-Go-Round-Registered Trademark-, and one national music and video retail
chain, Wherehouse Entertainment, Inc., which in recent years has begun selling
preowned CD's. An increase in the number of competitors, particularly the large
chains, selling preowned CD's in the Company's territories could have an adverse
impact on the Company's results of operations and expansion plans. See
"Business-- Competition."
TECHNOLOGICAL ADVANCEMENT. The advent of the CD as the prevailing form of
prerecorded music is less than 15 years old. The CD has during this period
surpassed vinyl records and subsequently audio cassette tapes as the dominant
form of music reproduction. Subsequent technological advancements in music
reproduction media may occur which may adversely affect the CD marketplace as it
exists today. Further refinement in size and capacity of CD's is currently
anticipated. The Company's strategy is to adapt the CD Warehouse concept to
compete effectively as the industry changes. However, the evolution of music
reproduction media could occur in such a manner, or at a pace, that would
adversely affect the Company's results of operations and profitability.
POSSIBLE ACQUISITIONS. The Company's growth strategy includes possible
acquisitions of CD music retailers specializing in preowned CD titles. However,
no assurance can be given that the Company will be able to find attractive
acquisition candidates, consummate additional acquisitions or that it will
successfully integrate, convert or operate any acquired business. In the event
that the Company makes acquisitions, there can be no assurance that any such
acquisition and resulting conversion expenses, including loss of unit sales
during the remodel period, will not have a material adverse effect upon the
Company's operating results, particularly during the period in which such
operations are being integrated into the Company. Furthermore, the Company's
ability to make acquisitions may depend upon its ability to obtain financing.
There can be no assurance that the Company will be able to obtain financing or,
if available, that such financing will be on acceptable terms. See
"Business--Expansion" and "--Possible Need for Additional Funds." The Company
has no plan, proposal, agreement, understanding or arrangement to acquire or
merge with any specific business or company, nor has it identified any specific
business or company for investigation and evaluation.
LACK OF INDEPENDENT APPRAISALS OF PURCHASE PRICE OF CDIL ASSETS AND
MACDONALD ASSETS. No independent appraisals were obtained in determining the
purchase price of the CDIL Assets and the MacDonald Assets. Although the terms
of the purchase prices were negotiated at arm's-length by the respective
parties, no assurance can be given that the consideration paid by the Company
with respect to the CDIL Assets and the MacDonald Assets accurately reflects the
fair market value of such assets. See "Certain Transactions."
RISKS OF LEVERAGE. There are currently no limitations relating to the
Company's ability to borrow funds to increase the amount of capital available to
the Company to effect a business combination or otherwise finance the operations
of any acquired business. The amount and nature of any borrowings by
8
<PAGE>
the Company will depend on numerous considerations, including the Company's
capital requirements, the Company's perceived ability to meet debt services on
any such borrowings, and then-prevailing conditions in the financial markets, as
well as general economic conditions. There can be no assurance that debt
financing, if required or otherwise sought, will be available on terms deemed to
be commercially acceptable and in the best interest of the Company. The
inability of the Company to borrow funds required to effect or facilitate a
business combination, or to provide funds for an additional infusion of capital
into an acquired business, may have a material adverse effect on the Company's
financial condition and future prospects. Additionally, to the extent that debt
financing ultimately proves to be available, any borrowings may subject the
Company to various risks traditionally associated with incurring of
indebtedness, including (i) if the Company's operating revenues after the
business combination were to be insufficient to pay debt service, there would be
a risk of default and foreclosure on the Company's assets; (ii) if a loan
agreement contains covenants that require the maintenance of certain financial
ratios or reserves, and any such covenant is breached without a waiver or
renegotiation of the terms of that covenant, then the lender could have the
right to accelerate the payment of the indebtedness even if the Company has made
all principal and interest payments when due; (iii) if the interest rate on a
loan fluctuated or the loan was payable on demand, the Company would bear the
risk of variations in the interest rate or demand for payment; and (iv) if the
terms of a loan did not provide for amortization prior to maturity of the full
amount borrowed and the "balloon" payment could not be refinanced at maturity on
acceptable terms, the Company might be required to seek additional financing
and, to the extent that additional financing is not available on acceptable
terms, to liquidate its assets. Furthermore, an acquired business may have
previously incurred debt financing and, therefore, may already be subject to the
risks inherent thereto, as discussed above.
DEPENDENCE ON KEY PERSONNEL; NO KEY MAN INSURANCE. The Company's future
success will be highly dependent on the continued efforts of Jerry W. Grizzle,
President and Chief Executive Officer; Gary D. Johnson, Chief Operating Officer
and Executive Vice President; Bruce D. MacDonald, Vice President-- Company Store
Operations; and Doyle E. Motley, Senior Vice President and Chief Financial
Officer. Although the Company has employment agreements with all of its senior
management, the Company presently does not own any key man life insurance
policies with respect to any of such individuals, and the loss of the services
of one or more of such key personnel could have a material adverse effect upon
the Company's results of operations. The Company is presently reviewing the
desirability of obtaining key man life insurance policies with respect to the
Chief Executive Officer and the Chief Operating Officer. The Company's success
is also dependent upon its ability to attract and retain skilled retail managers
and employees who are also knowledgeable in music and the ability of its key
personnel to manage the Company's growth and integrate its operations. There can
be no assurance that the Company will be successful in attracting and retaining
such personnel. See "Management."
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS; SEASONALITY. The Company
expects to experience fluctuations in future quarterly operating results that
may be caused by many factors, including variations in the number and timing of
store openings, the quality of release titles available for sale, additional and
existing competition, marketing programs, weather, special or unusual events and
national, regional and local economic conditions that may affect retailers in
general. Any concentration of new store openings and the related new store
pre-opening costs near the end of a fiscal quarter could have an adverse effect
on the financial results for that quarter and could, in certain circumstances,
lead to fluctuations in quarterly financial results. The retail music business
is somewhat seasonal, with revenues in September and October generally being
lower compared to other months of the year. The Company anticipates that its
revenues will track traditional consumer music-buying habits. Therefore,
revenues are expected to decline during the fall months of the third fiscal
quarter and increase during the late fourth-quarter peak holiday season. As a
result, the Company believes that period-to-period comparisons of its results of
operations are not and will not necessarily be meaningful, and should not be
relied upon, as an indication of future performance. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
9
<PAGE>
CONTROL BY MANAGEMENT. The Company's executive officers and directors and
their respective affiliates will beneficially own an aggregate of approximately
24.1% of the Company's outstanding shares of Common Stock after the Offering
(approximately 22.3% if the Underwriters' over-allotment option is exercised in
full). Additionally, Mark E. Kane, the founder of CDIL, will own approximately
19.7% of the Company's outstanding shares of Common Stock after the Offering
(approximately 18.1% if the Underwriters' over-allotment option is exercised in
full). Such stockholders, if voting together, may, as a practical matter, have
sufficient voting power to elect the board of directors of the Company (the
"Board of Directors"), exercise significant control over the business, policies
and affairs of the Company and, in general, determine the outcome of any
corporate transaction or other matters submitted to the stockholders for
approval, such as any amendment to the certificate of incorporation of the
Company (the "Certificate of Incorporation"), any merger, consolidation, sale of
all or substantially all of the Company's assets or "going private" transactions
and prevent or cause a change in control of the Company, all of which may
adversely affect the market price of the Common Stock. See "Principal
Stockholders."
ANTI-TAKEOVER PROVISIONS. Certain provisions of the Delaware General
Corporation Law (the "DGCL") may delay, discourage or prevent a change in
control of the Company. Such provisions may discourage bids for the Common Stock
at a premium over the market price of the Common Stock and may adversely affect
the market price and the voting and other rights of the holders of Common Stock.
In addition, the Board of Directors has the authority without action by the
Company's stockholders to fix the rights, privileges and preferences of and to
issue shares of the Company's preferred stock, par value $.01 per share (the
"Preferred Stock"), which may have the effect of delaying, deterring or
preventing a change in control of the Company. See "Description of Capital
Stock--Preferred Stock" and "--Anti-Takeover Effects of Delaware Law."
In addition to the authorization of Preferred Stock, the Company's
Certificate of Incorporation and Bylaws include several other provisions which
may have the effect of inhibiting a change of control of the Company. These
include a classified Board of Directors, no stockholder action by written
consent and advance notice requirements for stockholder proposals and director
nominations. The provisions may discourage a party from making a tender offer
for or otherwise attempting to obtain control of the Company.
SUBSTANTIAL DILUTION. On the basis of an assumed offering price of $5.00
per share (the minimum of the range set forth on the cover of this Prospectus),
and assuming the consummation of the CDIL Acquisition and the MacDonald
Acquisition, this Offering involves an immediate dilution of approximately $4.04
per share of Common Stock (approximately 81% of the offering price per share)
between the offering price per share and the pro forma net tangible book value
per share of the Common Stock immediately after the completion of this Offering.
See "Dilution."
LIMITED UNDERWRITING EXPERIENCE. Capital West Securities, Inc., one of the
Underwriters, was first registered as a broker-dealer in May 1995 and has
participated in only four public equity offerings as an underwriter. Prospective
purchasers of the securities offered hereby should consider this limited
experience in evaluating this Offering. See "Underwriting."
ABSENCE OF PRIOR PUBLIC MARKET; POSSIBLE VOLATILITY OF STOCK PRICE. Prior
to the Offering, there has been no public market for the Common Stock. Although
the Company's Common Stock has been approved for listing on the Nasdaq SmallCap
Market under the trading symbol "CDWI," there can be no assurance that an active
public market will develop for the Common Stock. The initial public offering
price will be determined through negotiations between the Company and the
Underwriters, and may not be indicative of the market price for the Common Stock
after the completion of the Offering. Among the factors to be considered in such
negotiations are prevailing market conditions, the pro forma results of
operations of the Company in recent periods, the market capitalizations and
stages of development of other companies which the Company and the Underwriters
believe to be comparable to the Company,
10
<PAGE>
estimates of the business potential of the Company, the present state of the
Company's development and other factors, if any, deemed relevant. See
"Underwriting."
Moreover, the trading price of the Company's Common Stock could be subject
to fluctuations in response to quarterly variations in results of operations,
announcements of technological innovations or new services or products by the
Company or its competitors, changes in financial estimates by securities
analysts and other events or factors. See "Business and Properties." Recent
history relating to the market prices of other newly public companies indicates
that the market price of the Company's Common Stock following the Offering may
be highly volatile. At various times, the stock market has experienced
volatility that has particularly affected the market prices for stock of
particular industry groups, such as retail-oriented companies, often without
regard to a particular company's operating results.
POSSIBLE DELISTING FROM NASDAQ SMALLCAP MARKET; DISCLOSURE RELATING TO LOW
PRICED STOCKS. Although the Company's Common Stock has been approved for listing
on the Nasdaq SmallCap Market, there can be no assurance that a trading market
will develop or, if developed, that it will be maintained. In addition, there
can be no assurance that the Company will in the future meet the maintenance
criteria for continued quotation of the securities on the Nasdaq SmallCap
Market. The maintenance criteria for the Nasdaq SmallCap Market include, among
other things, $2,000,000 in total assets, $1,000,000 in capital and surplus, a
public float of 100,000 shares with a market value equal to $200,000, two market
makers and a minimum bid price of $1.00 per share of common stock. If an issuer
does not meet the $1.00 minimum bid price standard, it may, however, remain on
the Nasdaq SmallCap Market if the market value of its public float is at least
$1,000,000 and the issuer has at least $2,000,000 in equity. If the Company were
removed from the Nasdaq SmallCap Market, trading, if any, in the Common Stock
would thereafter have to be conducted in the over-the-counter market in the
so-called "pink sheets" or, if then available, the NASD's OTC Electronic
Bulletin Board. As a result, an investor would find it more difficult to dispose
of, and to obtain accurate quotations as to the value of, such securities.
In addition, if the Common Stock is delisted from trading on the Nasdaq
SmallCap Market and the trading price of the Common Stock is less than $5.00 per
share at a time when the net tangible assets of the Company are less than
$5,000,000, trading in the Common Stock would also be subject to the
requirements of Rule 15g-9 promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"). Under such rule, broker/dealers who
recommend such low-priced securities to persons other than established customers
and accredited investors must satisfy special sales practice requirements,
including a requirement that they make an individualized written suitability
determination for the purchaser and receive the purchaser's written consent
prior to the transaction. The Securities Enforcement Remedies and Penny Stock
Reform Act of 1990 also requires additional disclosure in connection with any
trades involving a stock defined as a penny stock (generally, according to
recent regulations adopted by the Commission, any equity security not traded on
an exchange or quoted on the Nasdaq SmallCap Market that has a market price of
less than $5.00 per share, subject to certain exceptions), including the
delivery, prior to any penny stock transaction, of a disclosure schedule
explaining the penny stock market and the risks associated therewith. Such
requirements could severely limit the market liquidity of the Common Stock and
the ability or purchasers in this Offering to sell their securities in the
secondary market. There can be no assurance that the Common Stock will not be
delisted or treated as a penny stock.
SHARES ELIGIBLE FOR FUTURE SALE. After the completion of the Offering and
the MacDonald Acquisition, 1,780,000 shares of Common Stock will be outstanding.
See "Certain Transactions." Of such shares, the 1,000,000 shares sold pursuant
to the Offering will be tradeable without restriction by persons other than
"affiliates" of the Company. The remaining 780,000 shares of Common Stock to be
outstanding after the Offering are "restricted securities" within the meaning of
Rule 144 under the Securities Act of 1933, as amended (the "Securities Act") and
may not be publicly resold, except in compliance with the registration
requirements of the Securities Act or pursuant to an exemption from
registration, including that provided by Rule 144 promulgated under the
Securities Act.
11
<PAGE>
The directors and executive officers of the Company (including Bruce D.
MacDonald), as well as Mark E. Kane, collectively will hold 780,000 shares (the
"Affiliate Shares"), or approximately 43.8%, of the outstanding shares of Common
Stock after the Offering. Such individuals have agreed not to, directly or
indirectly, offer, sell, assign, transfer, encumber, pledge, contract to sell,
grant an option to purchase or otherwise dispose of any Common Stock for a
period of 24 months after the date of this Prospectus without the prior written
consent of Capital West Securities, Inc. Upon expiration of the 24-month period,
244,706 of the Affiliate Shares will be eligible for immediate resale without
restriction under the Securities Act, subject, in certain cases, to certain
volume, timing and other requirements of Rule 144 promulgated under the
Securities Act (with 162,353 of such shares entitled to piggyback registration
rights for a period of two years thereafter). The remaining 535,294 Affiliate
Shares are subject to escrow agreements required by certain state securities
regulatory agencies, the terms of which provide that such shares be held in
escrow for up to six years, subject to earlier release if the Company attains
certain levels of earnings for any two consecutive fiscal years or the Common
Stock trades at 175% of the public offering price per share for at least 90
consecutive trading days at least one year after the effective date of the
Offering. Sales of substantial amounts of Common Stock, or the perception that
such sales could occur, could adversely affect the prevailing market price of
the Common Stock. See "Shares Eligible for Future Sale" and "Underwriting."
ABSENCE OF DIVIDENDS. The Company has never declared or paid any dividends
on the Common Stock and does not anticipate paying any cash dividends on the
Common Stock in the foreseeable future. See "Dividend Policy."
POSSIBLE NEED FOR ADDITIONAL FUNDS. Bank of Oklahoma, N.A., Oklahoma City,
Oklahoma has agreed to provide the Company a $2,000,000 credit facility (the
"Credit Facility") upon completion of the Offering. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." Based on current
pro forma levels of operations and the Company's current plans for expansion,
the Company anticipates that its existing capital resources, including the
Credit Facility, together with the proceeds of the Offering, will enable it to
maintain its operations for the foreseeable future. However, the Company may
require additional funds to sustain and expand its sales and marketing
activities, particularly if a well-financed competitor emerges. Adequate funds
for these and other purposes on terms acceptable to the Company, whether through
additional equity financing, debt financing or other sources, may not be
available when needed or may result in significant dilution to existing
stockholders. The inability to obtain sufficient funds from operations or
external sources would have a material adverse effect on the Company's business,
results of operations and financial condition. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
12
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 1,000,000 shares of
Common Stock being offered hereby are estimated to be approximately $4,175,000
(approximately $4,801,250 if the Underwriters' over-allotment option is
exercised in full), assuming an initial offering price of $5.00 per share (the
minimum of the range appearing on the cover of this Prospectus). The Company
expects to use the net proceeds (assuming no exercise of the Underwriters'
over-allotment option) approximately as follows:
<TABLE>
<CAPTION>
APPROXIMATE APPROXIMATE PERCENTAGE
USE DOLLAR AMOUNT OF NET PROCEEDS
- -------------------------------------------------------------------------- -------------- -----------------------
<S> <C> <C>
Funding of CDIL Acquisition (1)........................................... $ 3,100,000 74.2%
Opening or remodeling of Company stores (2)............................... 800,000 19.2%
Working capital and general corporate purposes............................ 275,000 6.6%
-------------- ------
Total................................................................... $ 4,175,000 100.0%
-------------- ------
-------------- ------
</TABLE>
- ------------------------
(1) Represents the balance of the $3,200,000 purchase price for the CDIL Assets.
See "Business and Properties--General" and "Certain Transactions."
(2) Represents anticipated costs of approximately $84,000 per store for a
minimum of nine Company-owned stores which the Company plans to open in
1997. See "Business and Properties--Company Store Program."
The CDIL Acquisition will be completed immediately upon consummation of the
Offering. Pending any other use of the proceeds, the Company intends to invest
the remaining proceeds from the Offering in investment grade short-term,
interest-bearing securities.
DIVIDEND POLICY
To date, the Company has not paid any dividends on its Common Stock. The
payment of dividends, if any, in the future is within the discretion of the
Board of Directors and will depend on the Company's earnings, its capital
requirements and financial condition and other relevant factors. The Company
does not expect to declare or pay any dividends on Common Stock in the
foreseeable future.
13
<PAGE>
DILUTION
At October 15, 1996, the pro forma, as adjusted, net tangible book value of
the Company's Common Stock was approximately $1,714,000, or $.96 per share. Net
tangible book value per share of Common Stock is defined as total tangible
assets of the Company less total liabilities, divided by the total number of
shares of Common Stock outstanding. The combination of this Offering and the
consummation of both the CDIL Acquisition and the MacDonald Acquisition
represent an immediate dilution of $4.04 per share to new investors purchasing
shares of Common Stock in this Offering, assuming an initial public offering
price of $5.00 per share (the minimum of the range set forth on the cover of
this Prospectus).
The following table summarizes the number of shares of Common Stock
purchased from the Company, the total consideration paid to the Company and the
average price paid per share by existing or subscribed stockholders and new
investors purchasing shares in this Offering:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- ------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------------- ------- ------------- ------- -----------
<S> <C> <C> <C> <C> <C>
Existing or subscribed stockholders
(cash)................................. 700,000(1) 39.3% $ 700,000 11.5% $ 1.00
MacDonald stock.......................... 80,000 4.5% 400,000(2) 6.6% $ 5.00
New investors............................ 1,000,000 56.2% 5,000,000 81.9% $ 5.00
------------- ------- ------------- -------
Total.................................. 1,780,000 100.0% $ 6,100,000 100.0%
------------- ------- ------------- -------
------------- ------- ------------- -------
</TABLE>
- ------------------------
(1) Includes 350,000 shares of Common Stock for which Mark E. Kane, the founder
of CDIL, previously has subscribed, but the payment for which is conditioned
upon the consummation of the Offering. See "Certain Transactions--CDIL
Acquisition."
(2) Represents the purchase price paid for the MacDonald Assets. See "Certain
Transactions--MacDonald Acquisition."
14
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company at October
15, 1996 and as adjusted to give effect to the sale of the 1,000,000 shares of
Common Stock offered hereby at an assumed per-share price of $5.00 (the minimum
of the range appearing on the cover of this Prospectus) and the application of
the estimated net proceeds as described under "Use of Proceeds." This table
should be read in conjunction with "Use of Proceeds," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and Notes appearing elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
OCTOBER 15, 1996
------------------------
ACTUAL AS ADJUSTED
---------- ------------
<S> <C> <C>
Stockholders' Equity:
Common Stock; $.01 par value, 10,000,000 shares authorized; 350,000 shares issued and
outstanding; 1,780,000 shares as adjusted (1)(2).................................... $ 3,500 $ 17,800
Preferred Stock; $.01 par value, 5,000,000 shares authorized, no shares issued and
outstanding, actual or adjusted..................................................... -- --
Additional paid-in capital............................................................ 346,500 5,257,200
Retained earnings..................................................................... -- --
---------- ------------
Total capitalization................................................................ $ 350,000 $ 5,275,000
---------- ------------
---------- ------------
</TABLE>
- ------------------------
(1) Includes 350,000 shares of Common Stock for which Mark E. Kane, the founder
of CDIL, previously has subscribed, but the payment for which is conditioned
upon the consummation of the Offering, and 80,000 shares of Common Stock to
be issued to Bruce D. MacDonald in connection with the MacDonald
Acquisition. See "Certain Transactions."
(2) Excludes 400,000 shares of Common Stock reserved for issuance pursuant to
the Company's 1996 Stock Option Plan. See "Management--1996 Stock Option
Plan" and "Description of Securities."
15
<PAGE>
COMBINED STATEMENTS OF OPERATIONS
The following table (unaudited) sets forth the combined historical results
of operations of CDIL, CD Acquisitions and the MacDonald Assets to be acquired
by the Company. The historical information has been adjusted to eliminate
operations to be retained by CDIL and to provide charges for executive
compensation and income taxes as explained below. The information should be read
in conjunction with the historical Financial Statements and the Pro Forma
Combined Condensed Financial Statements included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Revenues:
Retail store sales............................................... $ 372 $ 316 $ 281 $ 213 $ 178
Wholesale merchandise sales...................................... 139 1,568 2,717 1,746 2,442
Software income, net............................................. 10 62 24 1 8
Royalty income................................................... 112 527 947 670 856
Franchise and development fees................................... 86 154 184 142 61
--------- --------- --------- --------- ---------
Total revenues................................................. 719 2,627 4,153 2,772 3,545
Costs and expenses:
Cost of sales--retail store sales................................ 272 196 180 134 109
Cost of sales--wholesale merchandise sales....................... 139 1,539 2,511 1,584 2,298
Retail store operating expenses.................................. 88 79 68 51 51
General and administrative (2)................................... 135 681 1,015 782 972
Depreciation and amortization.................................... -- 6 9 8 9
--------- --------- --------- --------- ---------
Total costs and expenses....................................... 634 2,501 3,783 2,559 3,439
--------- --------- --------- --------- ---------
Operating income................................................... 85 126 370 213 106
Other income....................................................... 16 40 49 39 47
--------- --------- --------- --------- ---------
Income before pro forma provision for income taxes................. 101 166 419 252 153
Pro forma provision for income taxes (2)........................... 34 56 142 86 52
--------- --------- --------- --------- ---------
Pro forma net income (2)........................................... $ 67 $ 110 $ 277 $ 166 $ 101
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
- ------------------------
(1) Operations to be retained by CDIL have been eliminated from the combined
information presented above.
(2) The operations to be acquired were organized as partnerships and did not
historically include charges for executive compensation or income taxes. The
information presented above includes charges for executive compensation
based on the cash distribution to partners in each of the periods presented.
Such amounts, which are included in general and administrative expenses are:
<TABLE>
<S> <C>
Years ended December 31, Nine months ended September 30,
1993--$ 82,000 1995--$252,000
1994--$227,000 1996--$405,000
1995--$296,000
</TABLE>
The pro forma provisions for income taxes are based on a rate of 34% applied
to pro forma income before income tax in each of the periods presented.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
The Company was formed in September 1996 to acquire the assets of CDIL, a
Texas limited partnership which franchises and operates stores throughout the
United States and England under the name "CD Warehouse." The first CD Warehouse
store was opened in 1992. Under the CD Warehouse name, there are currently 106
domestic units operating in 26 states and 3 international units operating in
England.
Simultaneously with the closing of the Offering, the Company will acquire
the CDIL Assets for a purchase price of $3.2 million. See "Certain
Transactions--CDIL Acquisition." In a related transaction, which also will occur
simultaneously with the closing of the Offering, the Company will acquire the
equity interests of MacDonald in 36 franchised CD Warehouse stores. Pursuant to
the MacDonald Acquisition, the Company will acquire 100% ownership of
MacDonald's Montfort Street Store and minority equity interests (including
MacDonald's interest as a managing general partner or limited liability company
manager) in the other 35 existing stores in which MacDonald has an interest.
Upon acquisition of the Montfort Street Store and the MacDonald Equity
Interests, the Company will manage and have an interest in 36 of the 109 stores
in the CD Warehouse system. The Offering will not be closed unless there is a
simultaneous closing of the CDIL Acquisition and the MacDonald Acquisition. Upon
consummation of the CDIL Acquisition and the MacDonald Acquisition, the Company
will acquire the rights to the CD Warehouse name, assume CDIL's role as
franchisor under the franchise agreements to which CDIL is a party and manage
and have an interest in the CD Warehouse stores in which MacDonald has an
interest.
The following discussion and analysis reviews the operations to be acquired
by the Company in connection with the CDIL Acquisition and the MacDonald
Acquisition for the years ended December 31, 1993, 1994 and 1995 and for the
nine months ended September 30, 1996. All of such periods reflect the historical
operations of CDIL and financial information attributable to the MacDonald
Assets. The following discussion and analysis should be read in conjunction with
the discussion about risk factors and the financial statements of the Company,
CDIL and CD Acquisitions and notes related thereto and "Combined Statements of
Operations" included elsewhere in this Prospectus.
CDIL previously conducted its business through two separate entities, CDIL
and CD Acquisitions. CD Acquisitions was formed to support the inventory needs
of the CD Warehouse franchise system and engaged in the wholesale supply of new
and preowned CD's to the franchise system, as well as sales of computer hardware
and proprietary software to franchisees. CDIL and CD Acquisitions were merged
effective January 1, 1996 as a Texas limited partnership.
Historically, CDIL has had only a limited involvement in direct retail
operations. The assets acquired from CDIL include minority interests in three
partnerships which operate stores in Memphis, Tennessee, Edmond, Oklahoma and
Tulsa, Oklahoma. The earnings from such partnerships are reflected as other
income and the investment in those partnerships is reflected as an asset on
CDIL's balance sheet. The retail store sales relate to the earnings attributable
to the Montfort Street Store being acquired from MacDonald.
On a pro forma basis, the Company's revenues are derived from three
principal sources: (1) franchise fees and royalties from franchised stores; (2)
sales of CD's and proprietary software to stores in the franchise system; and
(3) revenues attributable to the Montfort Street Store. Franchise and
development fees are initially recorded as deferred revenue until each
franchised store opens, at which time such fees are recorded as revenue.
Cost of sales include the cost for CD's sold at retail and those sold at
wholesale to franchised stores. Operating expenses consist primarily of labor
costs, rent and advertising. General and administrative
17
<PAGE>
expenses include corporate and administrative salaries, accounting, legal and
direct costs associated with franchise operations.
RESULTS OF OPERATIONS
The following table sets forth the percentage relationship of certain
operating statement data to total revenues, except as otherwise indicated:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------- ------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
REVENUES:
Retail store sales.............................. 51.7% 12.0% 6.8% 7.7% 5.0%
Wholesale merchandise sales..................... 19.3% 59.7% 65.4% 63.0% 68.9%
Software income, net............................ 1.4% 2.4% .6% --% .2%
Royalty income.................................. 15.6% 20.1% 22.8% 24.2% 24.2%
Franchise and development fees.................. 12.0% 5.8% 4.4% 5.1% 1.7%
----- ----- ----- ----- -----
Total revenues................................ 100.0% 100.0% 100.0% 100.0% 100.0%
COST AND EXPENSES:
Cost of sales--retail store sales (1)........... 73.1% 62.0% 64.1% 62.9% 61.2%
Cost of sales--wholesale merchandise sales
(2)........................................... 100.0% 98.2% 92.4% 90.7% 94.1%
Retail store operating expenses (1)............. 23.7% 25.0% 24.2% 23.9% 28.7%
General and administrative...................... 18.8% 25.9% 24.4% 28.2% 27.4%
Depreciation and amortization................... -- % .2% .2% .3% .3%
OPERATING INCOME.................................. 11.8% 4.8% 8.9% 7.7% 3.0%
PRO FORMA NET INCOME.............................. 9.3% 4.2% 6.7% 6.0% 2.8%
</TABLE>
- ------------------------
(1) As a percentage of sales from the majority owned retail store.
(2) As a percentage of wholesale merchandise sales.
NINE MONTHS ENDED SEPTEMBER 30, 1995 COMPARED WITH THE NINE MONTHS ENDED
SEPTEMBER 30, 1996
REVENUES
Total revenues increased by $773,000, or 28%, to $3,545,000 for the nine
months ended September 30, 1996 compared to $2,772,000 for the nine months ended
September 30, 1995. This increase resulted primarily from the 16 franchised
stores opened during the nine months ended September 30, 1996, as well as from
the 36 stores opened periodically throughout 1995 (which contributed revenues
for the entire period in 1996), and the resulting increases in royalties and
merchandise sales to more stores.
Wholesale sales to franchised stores increased $696,000, or 40%, to
$2,442,000 for the nine months ended September 30, 1996 compared to $1,746,000
for the nine months ended September 30, 1995. This increase resulted primarily
from the opening inventory packages purchased by the 16 new franchised stores
opened during the nine months ended September 30, 1996.
Royalties from franchised stores increased $186,000, or 28%, to $856,000 for
the nine months ended September 30, 1996 compared to $670,000 for the nine
months ended September 30, 1995. This increase resulted primarily from the 16
new franchised stores opened during the nine months ended September 30, 1996, as
well as from the 36 stores opened periodically throughout 1995 (which
contributed revenues for the entire period in 1996).
18
<PAGE>
COSTS AND EXPENSES
Cost of sales for wholesale sales to franchised stores increased $714,000,
or 45%, to $2,298,000 for the nine months ended September 30, 1996 compared to
$1,584,000 for the nine months period September 30, 1995. This increase is
primarily the result of greater volume due to the increased number of stores
opened during the period, as well as higher product cost from suppliers.
General and administrative expenses increased by $190,000, or 24%, to
$972,000 for the nine months ended September 30, 1996 compared to $782,000 for
the nine months ended September 30, 1995. This increase resulted from the 16 new
franchised stores opened during the nine months ended September 30, 1996 and the
increase of executive salaries taken by the previous officers of $405,000 for
the nine months ended September 30, 1996 compared to $252,000 for the same
period of 1995.
NET INCOME
Net income decreased $65,000, or 39%, to $101,000 for the nine months ended
September 30, 1996 compared to $166,000 for the same period ended September 30,
1995. This decrease was primarily due to the additional $153,000 in salary taken
by CDIL's owners compared to the prior period.
YEAR ENDED DECEMBER 31, 1994 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1995
REVENUE
Total revenues increased by $1,526,000, or 58%, to $4,153,000 for the year
ended December 31, 1995 compared to $2,627,000 for the year ended December 31,
1994. This increase was attributable primarily to the effect of 36 new
franchised stores opened during 1995, as well as from the 51 stores opened
periodically throughout 1994 (which contributed revenues for the entire period
in 1995), and the resulting increase in royalties and merchandise sales.
Wholesale sales to franchised stores increased by $1,149,000, or 73%, to
$2,717,000 for the year ended December 31, 1995 compared to $1,568,000 for the
year ended December 31, 1994. This increase was primarily the result of the 50%
increase in the number of stores as well as increasing sales to all stores.
Royalties from franchised stores increased $420,000, or 80%, to $947,000 for
the year ended December 31, 1995 compared to $527,000 for the year ended
December 31, 1994. This increase resulted primarily from the 36 new franchised
stores opened during 1995, as well as from the 51 stores opened periodically
throughout 1994 (which contributed revenues for the entire period in 1995).
COSTS AND EXPENSES
Cost of sales for wholesale sales to franchised stores increased by
$972,000, or 63%, to $2,511,000 for the year ended December 31, 1995 compared to
$1,539,000 for the year ended December 31, 1994. This increase is primarily the
result of greater volume due to the increased number of stores opened during the
period, as well as higher product cost from suppliers.
General and administrative expenses increased by $334,000, or 49%, to
$1,015,000, for the year ended December 31, 1995 compared to $681,000 for the
year ended December 31, 1994. This increase was due primarily to greater
franchise activity and support for the 36 new franchised store openings in 1995,
as well as from the 51 stores opened periodically throughout 1994 (the full
effects of which were recognized for the entire period in 1995).
The Company recognized approximately $113,500 as bad debt expense for the
year ended December 31, 1995 compared to no bad debt expense for the previous
year. The increase was due to the closing of seven franchised stores during
1995, as well as to royalty revenues previously recognized which were deemed
uncollectible in 1995 because of the operating status of certain franchised
stores.
19
<PAGE>
NET INCOME
Net income increased $167,000, or 152%, to $277,000 for the year ended
December 31, 1995 compared to $110,000 for the same period ended December 31,
1994. This increase was attributable primarily to the higher royalty income from
the 36 new franchised stores opened during 1995, as well as from the 51 stores
opened periodically throughout 1994 (which contributed revenues for the entire
period in 1995)
YEAR ENDED DECEMBER 31, 1993 COMPARED WITH THE YEAR ENDED DECEMBER 31, 1994
CDIL began franchising stores in 1993, and had 19 stores open at year end
1993. During 1994, 51 stores opened. All items of revenue, costs and expenses
and net income increased significantly in 1994 as compared to 1993, due almost
entirely to the 168% increase in franchised stores open.
REVENUES
Total revenues increased by $1,908,000 to $2,627,000 for the year ended
December 31, 1994 compared to $719,000 for the year ended December 31, 1993.
Wholesale sales to franchised stores increased by $1,429,000 to $1,568,000
for the year ended December 31, 1994 compared to $139,000 for the year ended
December 31, 1993.
Royalties from franchised stores increased $415,000 to $527,000 for the year
ended December 31, 1994 compared to $112,000 for the year ended December 31,
1993.
COSTS AND EXPENSES
Cost of goods sold for wholesale sales to franchised stores increased by
$1,400,000 to $1,539,000 for the year ended December 31, 1994 compared to
$139,000 for the year ended December 31, 1993.
General and administrative expenses increased by $546,000 to $681,000
compared to $135,000 for the year ended December 31, 1993. This increase was due
primarily to the increased franchise activity and administrative support
necessary for the 51 new franchised store openings as well as the increased
wholesale merchandise operations.
NET INCOME
Net income increased by $43,000, or 64%, to $110,000 for the year ended
December 31, 1994 compared to $67,000 for the year ended December 31, 1993 as a
result of the growth in the number of stores discussed above.
LIQUIDITY AND CAPITAL RESOURCES
Historically, CDIL has required capital primarily for the development of the
franchise system and to fund inventory purchases for CD Acquisitions. CDIL has
historically funded such expenditures with cash provided by operations. Net cash
provided by operating activities of CDIL was $279,000 and $316,000 for the years
ended December 31, 1994 and December 31, 1995, respectively, and $587,000 for
the nine months ended September 30, 1996.
The Company will have available approximately $1,500,000 in working capital
from the proceeds of the Offering and the stock subscription of Mark E. Kane in
connection with the CDIL Acquisition. This available capital will be used to
support an aggressive Company store development program. In addition, the
Company will be developing a standard decor package to establish the identity of
the system through its appearance. Once the decor package is developed, the
Company will evaluate the need to remodel the 36 stores in which the Company
will have an equity interest as a result of the MacDonald Acquisition.
20
<PAGE>
The Company will also use its capital resources to take advantage of any
suitable acquisition opportunities. The preowned CD market consists of numerous
single store operators that the Company believes may be candidates for
acquisition and conversion to the CD Warehouse concept.
The Company and Mr. Grizzle are parties to a Finders and Release Agreement
(the "Finders' Agreement"), pursuant to which the Company has agreed to pay
certain unaffiliated parties a finder's fee of $100,000 for their assistance in
identifying CDIL for potential acquisition or investment. The Company has made a
nonrefundable payment of $40,000 in partial satisfaction of this obligation and
is required to pay the balance of $60,000 at the closing of the CDIL
Acquisition. None of the proceeds of the Offering will be used to pay the
remaining obligation under the Finders' Agreement.
In addition to the working capital expected to be available from the
proceeds of the Offering after completion of the CDIL Acquisition, Bank of
Oklahoma, N.A., Oklahoma City, Oklahoma has agreed to provide the Company a
$2,000,000 credit facility upon completion of the Offering. The Credit Facility
will bear an interest rate equal to .75% over Chase Manhattan's prime rate,
adjusted semi-annually. No funds have been borrowed under this Credit Facility.
It is the Company's opinion that the excess proceeds generated from the
Offering, combined with the Credit Facility, will be sufficient to support the
ongoing activities of the business for the foreseeable future.
21
<PAGE>
PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
The accompanying Pro Forma Combined Condensed Financial Statements reflect
the historical financial position and results of operations of the Company
adjusted for the acquisitions, using the purchase method of accounting, to be
completed upon the successful completion of this Offering.
The Pro Forma Combined Condensed Balance Sheet as of September 30, 1996
assumes capitalization of the Company by such date and the completion of this
Offering and resulting acquisition of the CDIL Assets and the MacDonald Assets.
The Pro Forma Combined Condensed Statements of Operations for the year ended
December 31, 1995 and for the nine months ended September 30, 1995 and September
30, 1996 have been prepared assuming the Offering and resulting acquisition of
the CDIL Assets and the MacDonald Assets were completed on January 1, 1995.
The pro forma adjustments are based upon available information and
assumptions that management of the Company believes are reasonable. The Pro
Forma Combined Condensed Financial Statements do not purport to represent the
financial position or results of operations which would have occurred had such
transactions been consummated on the dates indicated or the Company's financial
position or results of operations for any future date or period. These Pro Forma
Combined Condensed Financial Statements and notes thereto should be read in
conjunction with the historical financial statements and notes included
elsewhere herein.
22
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED BALANCE SHEET (NOTE)
SEPTEMBER 30, 1996
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
HISTORICAL
-----------------------------------------------
COMPACT PRO FORMA
CD DISCS ADJUSTMENTS--
WAREHOUSE, INTERNATIONAL, MACDONALD OFFERING & AS
INC. LTD. ASSETS ACQUISITIONS ADJUSTED
----------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents............. $ 250,000 $ 220,343 $ 457 $ 4,219,364(1)
(220,343)(2)
(3,100,000)(2)
(80,000)(3)
350,000(5) $ 1,639,821
Accounts receivable, net.............. -- 361,677 -- (178,736)(2) 182,941
Merchandise inventory................. -- 579,169 46,762 (47,291)(2) 578,640
Prepaid expenses and other............ -- 12,423 2,345 (12,423)(2) 2,345
----------- ------------- ------------- ------------- -------------
Total current assets.................... 250,000 1,173,612 49,564 930,571 2,403,747
Furniture, fixtures and equipment,
net................................... -- 40,893 824 (4,860)(2) 36,857
Investment in partnerships.............. -- 70,219 39,329 (18,290)(2) 91,258
Intangible and other assets, net........ 206,394 4,946 -- (44,364)(1)
(1,474)(2)
3,001,791(2)
80,000(3)
313,234(4) 3,560,527
----------- ------------- ------------- ------------- -------------
Total assets............................ $ 456,394 $ 1,289,670 $ 89,717 $ 4,256,608 $ 6,092,389
----------- ------------- ------------- ------------- -------------
----------- ------------- ------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................... $ 55,394 $ 636,822 $ -- $ (27,082)(2) $ 665,134
Accrued liabilities................... -- 4,017 2,951 (6,813)(2) 155
Advances and deposits................. 51,000 101,100 -- -- 152,100
----------- ------------- ------------- ------------- -------------
Total current liabilities............... 106,394 741,939 2,951 (33,895) 817,389
Minority interest....................... -- 905 -- (905)(2) --
Stockholders' equity:
Common stock.......................... 3,500 -- -- 10,000(1)
800(4)
3,500(5) 17,800
Additional paid-in capital............ 346,500 -- -- 4,165,000(1)
399,200(4)
346,500(5) 5,257,200
Partners' capital..................... -- 546,826 86,766 (546,826)(2)
(86,766)(4) --
----------- ------------- ------------- ------------- -------------
350,000 546,826 86,766 4,291,408 5,275,000
----------- ------------- ------------- ------------- -------------
Total liabilities and stockholders'
equity................................ $ 456,394 $ 1,289,670 $ 89,717 $ 4,256,608 $ 6,092,389
----------- ------------- ------------- ------------- -------------
----------- ------------- ------------- ------------- -------------
</TABLE>
23
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED BALANCE SHEET (NOTE)
SEPTEMBER 30, 1996
(UNAUDITED)
NOTE: The Company was formed in September 1996. For purposes of this Pro Forma
Combining Balance Sheet, it is assumed capitalization occurred at
September 30, 1996. The Company has not had any operations to date.
Combining and Pro Forma Adjustments:
<TABLE>
<C> <S> <C>
(1) To record the issuance of 1,000,000 shares of Common Stock of the Company in
connection with this Offering:
Estimated Offering proceeds..................................................... $ 5,000,000
Estimated expenses of Offering (including $44,364 incurred to date)............. 825,000
------------
Estimated net proceeds of Offering.............................................. 4,175,000
Offering expenses previously incurred........................................... 44,364
------------
Estimated net cash proceeds..................................................... $ 4,219,364
------------
------------
(2) Acquisition of specified assets of CDIL and assumption of specified liabilities:
Net assets at September 30, 1996................................................ $ 546,826
Less net assets retained by CDIL:...............................................
Retail store.................................................................... (56,264)
Investment in partnership....................................................... (18,290)
Cash and accounts receivable, net of accounts payable and accrued liabilities... (374,063)
------------
Net assets acquired............................................................. 98,209
Acquisition price............................................................... 3,200,000
------------
Excess of purchase price over assets acquired................................... 3,101,791
Escrow deposit--to be paid to CDIL.............................................. (100,000)
------------
$ 3,001,791
------------
------------
(3) Payment of balance of finder's fee.............................................. $ 80,000
------------
------------
(4) Acquisition of MacDonald Assets for 80,000 shares of Common Stock:
Purchase price.................................................................. $ 400,000
Less net assets at September 30, 1996........................................... 86,766
------------
Excess of purchase price over assets acquired................................... $ 313,234
------------
------------
(5) Payment of Common Stock subscription by initial stockholders.................... $ 350,000
------------
------------
</TABLE>
24
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL--ACQUIRED OPERATIONS
-------------------------------------------------
COMPACT DISCS
INTERNATIONAL, CD MACDONALD
LTD. ACQUISITIONS ASSETS
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Company operations:
Retail store sales.................. $ 291,948 $ -- $ 281,144
Wholesale merchandise sales......... -- 2,717,043 --
Software income, net................ 23,683 -- --
Franchise operations:
Royalty income...................... 946,640 -- --
Franchise and development fees...... 184,250 -- --
------------- ------------- -------------
Total revenues........................ 1,446,521 2,717,043 281,144
Operating costs and expenses:
Cost of sales-retail store sales.... 181,312 -- 179,568
Cost of sales-wholesale merchandise
sales............................. -- 2,511,032 --
Retail store operating expenses..... 71,253 -- 67,800
General and administrative.......... 641,191 77,918 --
Depreciation and amortization....... 9,645 -- --
Minority interest................... 7,293 -- --
------------- ------------- -------------
910,694 2,588,950 247,368
------------- ------------- -------------
Operating income...................... 535,827 128,093 33,776
Other income.......................... 2,987 -- 45,707
------------- ------------- -------------
Income before income taxes............ 538,814 128,093 79,483
Pro forma provision for income
taxes............................... -- -- --
------------- ------------- -------------
Pro forma net income.................. $ 538,814 $ 128,093 $ 79,483
------------- ------------- -------------
------------- ------------- -------------
Pro forma net income per share........
Shares used in computation............
<CAPTION>
PRO FORMA
ADJUSTMENTS
PRO FORMA FOR THE
COMBINING PRO FORMA OFFERING AND
ADJUSTMENTS COMBINED ACQUISITIONS AS ADJUSTED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales.................. $ (291,948)(1) $ 281,144 $ 281,144
Wholesale merchandise sales......... 2,717,043 2,717,043
Software income, net................ 23,683 23,683
Franchise operations:
Royalty income...................... 946,640 946,640
Franchise and development fees...... 184,250 184,250
------------- ------------- -------------
Total revenues........................ (291,948) 4,152,760 4,152,760
Operating costs and expenses:
Cost of sales-retail store sales.... (181,312)(1) 179,568 179,568
Cost of sales-wholesale merchandise
sales............................. 2,511,032 2,511,032
Retail store operating expenses..... (71,253)(1) 67,800 67,800
General and administrative.......... 296,277(3) 1,015,386 $ (15,777)(5) 999,609
Depreciation and amortization....... (487)(1) 9,158 180,000(6) 189,158
Minority interest................... (7,293)(1) -- --
------------- ------------- ------------- -------------
35,932 3,782,944 164,223 3,947,167
------------- ------------- ------------- -------------
Operating income...................... (327,880) 369,816 (164,223) 205,593
Other income.......................... 48,694 48,694
------------- ------------- ------------- -------------
Income before income taxes............ (327,880) 418,510 (164,223) 254,287
Pro forma provision for income
taxes............................... 142,000(4) 142,000 (56,000)(7) 86,000
------------- ------------- ------------- -------------
Pro forma net income.................. $ (469,880) $ 276,510 $ (108,223) $ 168,287
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Pro forma net income per share........ $ .09
-------------
-------------
Shares used in computation............ 1,780,000
-------------
-------------
</TABLE>
25
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL--ACQUIRED OPERATIONS
-------------------------------
COMPACT DISCS
INTERNATIONAL, MACDONALD
LTD. (NOTE) ASSETS
------------- -------------
<S> <C> <C>
Revenues:
Company operations:
Retail store sales....................... $ 220,887 $ 213,080
Wholesale merchandise sales.............. 1,745,403 --
Software income, net..................... 1,242 --
Franchise operations:
Royalty income........................... 670,401 --
Franchise and development fees........... 142,250 --
------------- -------------
Total revenues............................. 2,780,183 213,080
Operating costs and expenses:
Cost of sales--retail store sales........ 137,551 133,843
Cost of sales--wholesale merchandise
sales.................................. 1,583,822 --
Retail store operating expenses.......... 53,275 50,738
General and administrative............... 530,410
Depreciation and amortization............ 8,555
Minority interest........................ 5,637
------------- -------------
2,319,250 184,581
------------- -------------
Operating income........................... 460,933 28,499
Other income............................... 89 38,637
------------- -------------
Income before income taxes................. 461,022 67,136
Pro forma provision for income taxes....... -- --
------------- -------------
Pro forma net income....................... $ 461,022 $ 67,136
------------- -------------
------------- -------------
Pro forma net income per share.............
Shares used in computation.................
<CAPTION>
PRO FORMA
ADJUSTMENTS
PRO FORMA FOR THE
COMBINING PRO FORMA OFFERING AND
ADJUSTMENTS COMBINED ACQUISITIONS AS ADJUSTED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales....................... $ (220,887)(1) $ 213,080 $ 213,080
Wholesale merchandise sales.............. -- 1,745,403 1,745,403
Software income, net..................... -- 1,242 1,242
Franchise operations:
Royalty income........................... -- 670,401 670,401
Franchise and development fees........... -- 142,250 142,250
------------- ------------- -------------
Total revenues............................. (220,887) 2,772,376 2,772,376
Operating costs and expenses:
Cost of sales--retail store sales........ (137,551)(1) 133,843 133,843
Cost of sales--wholesale merchandise
sales.................................. 1,583,822 1,583,822
Retail store operating expenses.......... (53,275)(1) 50,738 50,738
General and administrative............... 251,997(3) 782,407 $ (41,622)(5) 740,785
Depreciation and amortization............ 8,555 135,000(6) 143,555
Minority interest........................ (5,637)(1) -- --
------------- ------------- ------------- -------------
55,534 2,559,365 93,378 2,652,743
------------- ------------- ------------- -------------
Operating income........................... (276,421) 213,011 (93,378) 119,633
Other income............................... -- 38,726 -- 38,726
------------- ------------- ------------- -------------
Income before income taxes................. (276,421) 251,737 (93,378) 158,359
Pro forma provision for income taxes....... 86,000(4) 86,000 (32,000)(7) 54,000
------------- ------------- ------------- -------------
Pro forma net income....................... $ (362,421) $ 165,737 $ (61,378) $ 104,359
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Pro forma net income per share............. $ .06
-------------
-------------
Shares used in computation................. 1,780,000
-------------
-------------
</TABLE>
Note: CD Acquisitions included with CDIL as though a combined entity. Such
entities were merged January 1, 1996.
26
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1996
(UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL--ACQUIRED OPERATIONS
-------------------------------
COMPACT DISCS
INTERNATIONAL, MACDONALD
LTD. (NOTE) ASSETS
------------- -------------
<S> <C> <C>
Revenues:
Company operations:
Retail store sales....................... $ 200,329 $ 178,399
Wholesale merchandise sales.............. 2,442,442
Software income, net..................... 8,057
Franchise operations:
Royalty income........................... 856,175
Franchise and development fees........... 60,500
------------- -------------
Total revenues............................. 3,567,503 178,399
Operating costs and expenses:
Cost of sales--retail store sales........ 125,419 109,255
Cost of sales--wholesale merchandise
sales.................................. 2,297,730
Retail store operating expenses.......... 58,517 50,597
General and administrative............... 567,102
Depreciation and amortization............ 9,218
Minority interest........................ 3,165
------------- -------------
3,061,151 159,851
------------- -------------
Operating income........................... 506,352 18,547
Other income............................... 31,965 27,270
------------- -------------
Income before income taxes................. 538,317 45,817
Pro forma provision for income taxes....... --
------------- -------------
Pro forma net income....................... $ 538,317 $ 45,817
------------- -------------
------------- -------------
Pro forma net income per share.............
Shares used in computation.................
<CAPTION>
PRO FORMA
ADJUSTMENTS
PRO FORMA FOR THE
COMBINING PRO FORMA OFFERING AND
ADJUSTMENTS COMBINED ACQUISITIONS AS ADJUSTED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Company operations:
Retail store sales....................... $ (200,329)(1) $ 178,399 $ 178,399
Wholesale merchandise sales.............. 2,442,442 2,442,442
Software income, net..................... 8,057 8,057
Franchise operations:
Royalty income........................... 856,175 856,175
Franchise and development fees........... 60,500 60,500
------------- ------------- -------------
Total revenues............................. (200,329) 3,545,573 3,545,573
Operating costs and expenses:
Cost of sales--retail store sales........ (125,419)(1) 109,255 109,255
Cost of sales--wholesale merchandise
sales.................................. 2,297,730 2,297,730
Retail store operating expenses.......... (58,517)(1) 50,597 50,597
General and administrative............... 405,184(3) 972,286 $ (194,809)(5) 777,477
Depreciation and amortization............ 9,218 135,000(6) 144,218
Minority interest........................ (3,165)(1) -- --
------------- ------------- ------------- -------------
218,083 3,439,085 (59,809) 3,379,276
------------- ------------- ------------- -------------
Operating income........................... (418,412) 106,487 59,809 166,296
Other income............................... (12,290)(2) 46,945 -- --
------------- ------------- ------------- -------------
Income before income taxes................. (430,702) 153,432 59,809 213,241
Pro forma provision for income taxes....... 52,000(4) 52,000 21,000(7) 73,000
------------- ------------- ------------- -------------
Pro forma net income....................... $ (482,702) $ 101,432 $ 38,809 $ 140,241
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Pro forma net income per share............. $ .08
-------------
-------------
Shares used in computation................. 1,780,000
-------------
-------------
</TABLE>
Note: Effective January 1, 1996, CD Acquisitions was merged into CDIL and is
included in consolidated CDIL amounts.
27
<PAGE>
CD WAREHOUSE, INC.
PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
PRO FORMA ADJUSTMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
YEAR ENDED ENDED ENDED
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
1995 1995 1996
------------- ------------- -------------
<C> <S> <C> <C> <C>
(1) Eliminate retail store operations of majority-owned store of
CDIL--to be retained by CDIL:
Retail store sales.......................................... $ 291,948 $ 220,887 $ 200,329
Cost of sales............................................... 181,312 137,551 125,419
Retail store operating expense.............................. 71,253 53,275 58,517
Depreciation and amortization............................... 487 -- --
Minority interest........................................... 7,293 5,637 3,165
------------- ------------- -------------
260,345 196,463 187,101
------------- ------------- -------------
Net......................................................... $ 31,603 $ 24,424 $ 13,228
------------- ------------- -------------
------------- ------------- -------------
(2) Eliminate equity in earnings of investment in partnership of
retail store located in Orange Park, Florida--to be
retained by CDIL.......................................... $ -- $ -- $ 12,290
------------- ------------- -------------
------------- ------------- -------------
(3) Allocate partner cash distributions as salaries of officers
of CDIL................................................... $ 296,277 $ 251,997 $ 405,184
------------- ------------- -------------
------------- ------------- -------------
(4) Provide for income taxes at statutory rate on income of
partnership entities after above adjustments:
Combined pre-tax combined income before pro forma
adjustment................................................ $ 746,390 $ 528,158 $ 584,134
Adjustments, net--above..................................... (327,880) (276,421) (430,702)
------------- ------------- -------------
$ 418,510 $ 251,737 $ 153,432
------------- ------------- -------------
------------- ------------- -------------
Pro forma income taxes...................................... $ 142,000 $ 86,000 $ 52,000
------------- ------------- -------------
------------- ------------- -------------
(5) Adjust executive compensation as a result of employment
arrangements with new officers of the Company:
New officers' compensation.................................. $ 280,500 $ 210,375 $ 210,375
Pro forma adjustment for partners' cash draws............... (296,277) (251,997) (405,184)
------------- ------------- -------------
Net......................................................... $ (15,777) $ (41,622) $ (194,809)
------------- ------------- -------------
------------- ------------- -------------
(6) Amortization of estimated goodwill on purchase transaction
over twenty-year period................................... $ 180,000 $ 135,000 $ 135,000
------------- ------------- -------------
------------- ------------- -------------
(7) Pro forma income tax effect of adjustments for the offering
and acquisition........................................... $ (56,000) $ (32,000) $ 21,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
28
<PAGE>
BUSINESS AND PROPERTIES
GENERAL
The Company was formed in September 1996 to acquire the assets of CDIL, a
Texas limited partnership which franchises stores throughout the United States
and England under the name "CD Warehouse." CD Warehouse stores sell, trade and
buy new and preowned CD's and related products. According to the January 1996
issue of ENTREPRENEUR MAGAZINE, CDIL was ranked among the top 30 new franchises
in the United States. At September 30, 1996, there were 109 CD Warehouse stores
in 26 states and England.
The CD is a digital storage medium developed by Phillips Electronics of the
Netherlands and Sony Corporation of Japan and introduced commercially in the
U.S. in 1983. The pronounced freedom from surface noise, the absence of tape
hiss, and the large dynamic range of the CD (i.e., the ability to play very
quiet and very loud passages without excessive distortion) have made the
digitally-recorded CD a success in the music industry. Moreover, improved
mechanical isolation of CD players, information buffering and rapid random
access have made CD playing acceptable for automobile as well as home use.
According to the Recording Industry Association of America (the "RIAA"), CD
sales in the United States were over 700 million units in 1995, generating
annual sales exceeding $9 billion. The lack of any audible difference between
new and preowned CD's, durability of the medium, cost savings and the
accumulating stock of available CD's for resale, suggest the possibility for
rapid market growth in the preowned CD market.
CD Warehouse stores sell CD's, take customers' CD's in trade or buy
customers' CD's for cash. The CD Warehouse concept capitalizes on the emergence
of CD's as the prevailing form of prerecorded music. Because the CD is encased
in plastic and read by a laser, the playing of CD's, and even the occasional
careless handling of CD's, rarely cause damage that will impair performance or
result in any degradation of sound quality. In the absence of pronounced abuse,
CD's may reasonably be expected to last for decades; premium (gold-plated) CD's
may last significantly longer. Such extraordinary durability, coupled with the
standard error-correction circuitry in CD players, means that preowned CD's are
essentially indistinguishable from new CD's in terms of audible performance. By
offering quality preowned CD's at substantial savings and responding to
consumers' desire to recycle merchandise they no longer want or use but which
has intrinsic value, the CD Warehouse remarketing concept emphasizes consumer
value. The CD Warehouse marketing slogan, "selling compact discs at compact
prices," embodies this concept.
A typical CD Warehouse store, located in a high traffic strip shopping
center, will occupy between 1,000 and 2,000 square feet and offer between 8,000
and 12,000 selections, with approximately 80% of the dollar sales volume being
preowned selections and the balance being new releases from the major music
categories. At each CD Warehouse store, a customer selects from a number of new
and preowned CD's and may listen to preowned CD's before purchase. Typically,
each CD Warehouse store carries the majority of the Billboard Top 100 selections
as "new" inventory, filling out its inventory selection with preowned CD's which
are purchased for $1 to $4 and remarketed for $6 to $9.
The Company's expansion strategy for 1997 is to open 9 to 12 Company-owned
stores and 18 to 24 franchised stores. Simultaneously with the closing of the
Offering, the Company will acquire the CDIL Assets for a purchase price of $3.2
million. See "Certain Transactions--CDIL Acquisition." In a related transaction,
which also will occur simultaneously with the closing of the Offering, the
Company will acquire the equity interests of MacDonald in 36 franchised CD
Warehouse stores. See "Certain Transactions-- MacDonald Acquisition." The
Offering will not be closed unless there is a simultaneous closing of the CDIL
Acquisition and the MacDonald Acquisition. Upon consummation of the CDIL
Acquisition and the MacDonald Acquisition, the Company will acquire the rights
to the CD Warehouse name, assume CDIL's role as franchisor under the franchise
agreements to which CDIL was a party and manage and have an interest in the CD
Warehouse Stores in which MacDonald had an interest.
29
<PAGE>
During the year ended December 31, 1995 and the nine months ended September
30, 1996, on a pro forma basis taking into account the CDIL Acquisition and the
MacDonald Acquisition, the Company had pro forma total revenues of approximately
$4,153,000 and $3,545,000, respectively, and pro forma net income, as adjusted,
of approximately $168,000 and $140,000, respectively. There can be no assurance
that the historical level of the Company's revenues and net income will continue
to be achieved in the future. See "Risk Factors," "--Business Strategy" and
"Certain Transactions."
Certain statements contained herein relating to the Company's proposed
business strategy and expansion plans are not based on historical facts, but are
forward-looking statements that are based upon numerous assumptions about future
conditions which may ultimately prove to be inaccurate and actual events and
results may materially differ from anticipated results described in such
statements. The Company's ability to achieve such results is subject to certain
risks and uncertainties, such as those inherent generally in the retail and
franchising industries, the impact of competition and pricing, changing market
conditions, the risks detailed in the sections entitled "Risk Factors" and
"Legal Proceedings," and other risks detailed throughout this Prospectus. These
forward-looking statements represent the Company's judgment as of the date of
this Prospectus. The Company disclaims, however, any intent or obligation to
update these forward-looking statements. As a result, the reader is cautioned
not to place reliance on these forward-looking statements.
BUSINESS STRATEGY
The Company believes that a growing consumer willingness to purchase
preowned CD's, provides an expanding market niche in the retail music industry
for CD remarketers. The Company's business strategy is to establish itself as
the recognized industry leader in the domestic buy-sell-trade retail CD
marketplace by pursuing a three-fold approach: (1) offering quality, preowned
CD's at exceptional value; (2) selling new releases at competitive prices; and
(3) offering to accept as a trade, or buy for cash, selected CD's from
customers.
The Company's expansion strategy for 1997 is to open 9 to 12 Company-owned
stores and 18 to 24 franchised stores. Management believes that, in addition to
the Company, Disc Go Round and The Wherehouse are the only national chains
engaged in the sale of preowned CD's. Based on publicly available information
regarding such companies, the Company believes that CD Warehouse stores
currently account for approximately 23% of the estimated 480 chain-based CD
reseller stores that operate throughout the United States. Management believes
that the market for CD remarketers is fragmented and underserved, and that the
Company can increase its market share by expanding the CD Warehouse concept in
targeted markets. To accomplish this objective, the Company intends to employ a
business strategy that includes the following elements:
INVENTORY MANAGEMENT SYSTEM. The Company considers its inventory management
system, which is a proprietary software program, to be essential to the success
of its business strategy and the CD Warehouse concept. The program, which has a
database in excess of 60,000 titles and includes catalogs from all the major
record labels, assists each store in selectively procuring preowned CD's by
supplying buying guidelines for every CD offered. The ability to access this
data instantly gives store operators the capability to make an informed decision
on every CD presented by a customer for purchase or trade, by reviewing the
title's historic store sales data, as well as the recommended purchase price
that the CD has been assigned by the Company. By scanning each CD (utilizing bar
coding capability), the program also records point-of-sale data for all
transactions, including customer profiles with which mailing lists may be
created. Additionally, as each transaction is entered, the program prints
customer receipts and compiles inventory by title, including respective costs,
selling price and gross profit results. Accordingly, the program can generate
reports of comprehensive data for any selected period or any facet of store
operations, including sales by title, sales by dollar volume, inventory by
title, individual transaction summaries, acquisitions for any period, system
adjustments, cash register reconciliation and other pertinent financial
information.
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<PAGE>
The Company believes that its inventory management system contributes to
more efficient system-wide management of inventory by reducing the need to
purchase new titles from music distributors for new store inventories and
affording existing stores the opportunity to sell excess inventory. See
"--Operations--Acquisition of Preowned CD's."
CUSTOMER SERVICE. The Company emphasizes excellent customer service and
seeks to employ, and to sell franchises to, motivated and energetic people.
Management has adopted an owner/operator principle in which the store manager
has a vested interest in increasing sales and profitability. It is management's
intent to encourage this same philosophy to its multi-unit franchises. The
Company also intends to foster enthusiasm for its customer service philosophy
and the CD Warehouse concept through annual franchise conventions, regional
meetings and other frequent contacts with its franchisees and store managers.
TARGETED EXPANSION. The Company believes that its existing core and
developing markets offer significant growth opportunity for both Company-owned
and franchised store development. During 1997, the Company intends to
concentrate its expansion of Company-owned stores in markets where it can
cluster stores, thereby expanding consumer awareness and creating significant
operating, distribution and advertising efficiencies. To increase its
penetration of core markets, the Company intends to co-develop markets with
franchisees, divide markets among franchisees or divide markets among the
Company and franchisees. The Company also intends to cluster its Company-owned
stores and franchised stores through the use of area development agreements and
its site selection approval process. The Company believes that this approach
will result in increased average store sales.
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<PAGE>
STORE LOCATIONS
The table below illustrates the location by state of all CD Warehouse retail
stores in the United States and England as of September 30, 1996:
DOMESTIC
ALABAMA
Decatur
Huntsville
ARKANSAS
Little Rock*
COLORADO
Colorado Springs
Denver*
Ft. Collins*
FLORIDA
Ft. Myers
Jacksonville*
Lake Park
Naples
Neptune Beach*
Orange Park*
Tallahassee
Tampa*
Venice
GEORGIA
Atlanta
Martinez
IDAHO
Idaho Falls
ILLINOIS
Carol Stream
Lombard
Streamwood
Wheaton
IOWA
Des Moines
KANSAS
Overland Park*
Shawnee*
Wichita*
LOUISIANA
Baton Rouge*
Bossier City
Lafayette*
Metarie*
Shreveport
Slidell
MARYLAND
Laurel
MISSOURI
Ballwin
Branson*
Cape Girardeau
Gladstone*
Springfield*
St. Louis
MONTANA
Bozeman
NEBRASKA
Omaha*
NEW MEXICO
Albuquerque
OHIO
Cincinnati--Beechmont Ave
Cincinnati--Montgomery
Columbus
Mayfield Heights
Miamisburg
Parma Heights
Toledo
OKLAHOMA
Edmond*
Oklahoma City--N May*
Oklahoma City--NW Expressway*
Tulsa--S Sheridan*
Tulsa--S Peoria
OREGON
Portland--SW Washington St.
Portland--NE Broadway
SOUTH CAROLINA
Columbia
Greenville
SOUTH DAKOTA
Rapid City
TENNESSEE
Jackson
Memphis*
TEXAS
Abilene
Arlington--Cooper Street*
Arlington--N Collins
Austin--Research Blvd
Austin--Guadalupe
Beaumont*
Carrollton
College Station*
Dallas--Montfort**
Dallas--Oak Lawn
Dallas--Preston
Dallas--Skillman
Dallas--Walnut Hill
Denton*
El Paso
Ft. Worth--Berry Street
Ft. Worth--S. Hulen
Garland
Houston--FM 1960
Houston--Shepherd*
Irving*
Lewisville*
Lubbock
Mesquite*
Midland
N. Richland Hills
Plano
San Angelo
San Antonio--NW Military
San Antonio--Thousand Oaks
San Antonio--Evers
San Antonio--Broadway
Sherman
Temple
Waco*
Webster
Wichita Falls
UTAH
Provo
St. George
Taylorsville*
VIRGINIA
Alexandria*
WASHINGTON
Seattle
WISCONSIN
Appleton
Brookfield
Kenosha
INTERNATIONAL/UK
Ealing
Leeds
London
- ------------------------------
* Franchise store operations managed by CD Management, a wholly-owned
subsidiary of the Company, which also owns a minority equity interest in the
indicated store.
** To be acquired as a Company-owned store upon completion of the Offering.
EXPANSION STRATEGY
The first CD Warehouse store opened in Dallas, Texas in August 1992 and by
September 30, 1996 there were a total of 109 CD Warehouse stores in 26 states
and England, all but two of which were
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<PAGE>
franchised. In 1997, the Company expects to open between 12 and 24 new
franchised stores and 9 to 12 new Company-owned stores. Key elements of the
Company's expansion strategy include:
AGGRESSIVE, BALANCED GROWTH. The Company's expansion strategy is to balance
the growth of its Company-owned and franchised stores by increasing its emphasis
on Company-owned store expansion. A Company-owned store provides a greater
potential economic return to the Company than does a franchised store. The
Company believes that, in many cases, the Company will be able to take advantage
of a promising new location by establishing a Company-owned store when a delay
in finding a qualified franchisee might jeopardize the Company's ability to
secure the site. Company-owned stores also provide a training ground for
Company-owned store and district managers and a controllable testing ground for
new products and promotions, operating and training methods and merchandising
techniques. The Company also plans to open additional franchised stores, which
will enable the Company to expand its system more quickly with no capital
investment. Proceeds from the Offering and the Credit Facility will be used to
support this growth.
NAME RECOGNITION AND NEW MARKET PENETRATION. The Company believes the
visibility of its stores at high traffic strip shopping centers has generated
good name recognition in the areas in which stores currently are located. CD
Warehouse stores historically have been concentrated in the Southwest United
States, but recent growth has generated a gradual shift outward into adjoining
states and scattered parts of the Midwestern and Southeastern United States. The
Company's expansion strategy involves initially the building-out of these
existing markets and subsequently the further penetration of developing markets
through the clustering of both Company-owned and franchised stores. This
expansion strategy is designed to take advantage of operational and advertising
efficiencies through store clustering within television and other advertising
markets, thereby increasing market penetration and consumer awareness. To
accelerate penetration of larger markets, the Company intends to co-develop
markets with franchisees or divide markets among franchisees, and intends to
utilize market co-development where appropriate. In determining which new
markets to develop, the Company considers many factors, including the size of
the market, demographics and population trends, competition and real estate
availability and pricing.
INTERNATIONAL FRANCHISE EXPANSION. There are three franchised stores
currently operating in England. In connection with the CDIL Acquisition, the
Company has entered into a master franchise agreement (the "Worldwide Area
Development Agreement") with the founder of CDIL, Mark E. Kane. The Worldwide
Area Development Agreement provides for a period of ten years for development of
franchise operations worldwide, excluding the United States, Canada and Mexico,
and includes a provision which allows the Company, at its option, to purchase
Mr. Kane's interest in any franchised operations developed pursuant to the
Worldwide Area Development Agreement. The development schedule under the
agreement requires that Mr. Kane open 100 stores over the ten year period. There
is no assurance that Mr. Kane will be successful in opening these stores. The
Company's intent is to focus its own efforts on developing the CD Warehouse
franchise system domestically, and it considers the Worldwide Area Development
Agreement an attractive vehicle to utilize the expertise of Mr. Kane to develop
the international franchise system. See "Certain Transactions--Worldwide Area
Development Agreement."
CONSIDERATION OF ACQUISITIONS. Concurrently with the Offering, the Company
will acquire the interests of MacDonald, the largest CD Warehouse franchisee.
The Company intends to pursue the acquisition of other local and regional
preowned music retailers to implement its strategy of building out current
markets and establishing itself in new target markets that may be concurrently
developed by the Company as well as franchised stores.
NEW STORE CONCEPT. The Company intends to examine the need for a new,
consistent appearance, both externally and internally, for all stores. A
prototype unit has opened in August 1996, in Plano Texas. This particular store
carries slightly more inventory (16,000 titles) and utilizes updated decor and
lighting schemes. The Company believes that by offering a larger variety in both
new and preowned titles, the Company will improve store sales; however, the
opportunities for greater sales must be balanced against
33
<PAGE>
the increased inventory costs. A component of developing the new store concept
is to devise a uniform, low cost remodel plan for the system as a whole. The
cost of remodeling non-Company-owned stores will be borne by the respective
franchisees.
OPERATIONS
ACQUISITION OF PREOWNED CD'S. A key component of the CD Warehouse concept
is to accept as a trade or buy for cash selected CD's from customers;
accordingly, the Company anticipates that it will obtain its preowned CD
inventory primarily from within the system itself. Additionally, utilizing its
inventory management system, which is a proprietary program, the Company affords
existing stores the opportunity to sell excess inventory. As new stores are
developed, opening packages of inventory are assembled by the Company and sold
to franchisees. The demand for inventory by new stores allows existing stores to
sell excess inventory. The Company has a policy of buying available inventory
directly from the retail locations and, with modem and Internet capability, the
Company compiles real-time inventory information. If, for example, it is
determined that a store may be overstocked on a particular selection, the
Company may purchase the selection and resell it to another unit or as part of
the opening inventory of a new store. The Company believes that this is a
significant advantage in comparison to its competitors since the Company can
review all titles available and source its own system for inventory. Management
anticipates, based on CDIL's operational history, that as much as 75% of the
opening inventory for a new store can be purchased from the current system of CD
Warehouse stores. This constant inventory turnover allows existing stores to
make a reasonable profit and provide a source of capital while providing an
opportunity for the Company to acquire quality inventory to open new stores or
update an existing location's inventory.
PURCHASING OF NEW CD'S, OTHER POINT-OF-SALE ITEMS AND STORE FIXTURES. For
new music releases, the Company will contract with six major industry CD
suppliers (Sony Music; Warner/Electra/Atlantic Corp. (subsidiary of Time
Warner); BMG Music (subsidiary of Bertelsman); UNI (subsidiary of Seagrams);
PolyGram (subsidiary of Philips); and EMI (subsidiary of Thorn-EMI)) to provide
the necessary access to new titles. As these new releases become available, the
Company reviews all titles and determines what specific releases will be
acquired for sale to the system. The Company then provides franchisees and
Company-owned stores with a weekly sales program which lists new releases,
catalog titles (i.e., Elvis Presley, Pink Floyd, movie soundtracks, etc.),
preowned titles and various point of sale and merchandising items. The Company
negotiates with vendors on behalf of the system for inventory display racks,
lighting and related products which are then shipped directly from the
manufacturers to the individual stores.
As the system grows, the Company believes that additional quantity discounts
can be negotiated with the respective equipment and product suppliers. The
Company maintains its own distribution facility to provide its franchise and
Company-owned stores with available new and preowned CD's. Additionally, the
Company is reviewing the possibility of forward warehousing inventory in
specific regions to reduce the shipping time and related shipping costs.
MARKETING AND ADVERTISING
Historically, CDIL has had only a limited involvement in direct retail
operations, and therefore has not conducted significant advertising or marketing
programs. Although the Company provides new stores with certain pre-opening
items and point-of-sale materials (additional point-of-sales materials are
available to all stores at no cost from the record companies), CD Warehouse
franchisees currently conduct marketing and advertising activities independently
through newspapers and radio, the funds for which are reserved pursuant to the
franchise agreement, which provides for each store to reserve 1.5% of sales to
spend specifically on advertising. It is the Company's intent, as markets reach
relative points of saturation, to develop an advertising cooperative managed by
the Company to support enhanced advertising (i.e., television, direct mail,
etc.). Additionally, the Company is considering making preowned CD's available
for sale through Internet access.
34
<PAGE>
FRANCHISING PROGRAM
GENERAL. The Company's predecessor, CDIL, commenced franchising the CD
Warehouse concept in 1993. Upon completion of the Offering and the concurrent
closings of the CDIL Acquisition and the MacDonald Acquisition, the Company will
have 36 Company-owned or controlled stores and 73 franchised stores in 26 states
and England. The Company expects that 18 to 24 franchised stores will open by
the end of 1997. However, there can be no assurance that all of these stores
will be opened or that the development schedule set forth in each area
development agreement will be achieved.
The Company's franchise agreement entitles the franchisee to use the
Company's trade names, service marks and trademark. Additionally, pursuant to
the franchise agreement, the Company provides franchisees with design plans,
color schemes, signs and fixtures for store premises; buying and selling
guidelines; computerized inventory management system; initial inventory,
operations and financial control guidelines; initial management training; and
advertising assistance.
The following table sets forth the number of CD Warehouse stores opened and
closed since the inception of the CD Warehouse franchise system:
<TABLE>
<CAPTION>
PERIOD ENDING
1992 1993 1994 1995 SEPTEMBER 30, 1996 TOTAL
----- ----- ----- ----- ------------------- -----
<S> <C> <C> <C> <C> <C> <C>
Opened.................................... 2 17 51 36 16 122
Closed.................................... 0 0 3 7 3 13
---
109
</TABLE>
FRANCHISE SOURCING AND SELECTION. The majority of new franchises are
awarded to persons referred by existing franchisees, interested consumers who
have visited CD Warehouse stores and existing franchisees. Franchisees are
approved by the Company on the basis of the applicant's net worth and liquidity,
together with an assessment of work ethic and personality compatibility with the
Company's operating philosophy. Currently, 19 franchisees own two or more CD
Warehouse stores and 16 franchisees own a single store. The largest number of
stores owned or managed by a single franchisee is 36 which, upon completion of
the Offering and the MacDonald Acquisition, will become Company-owned or managed
stores.
FRANCHISE MARKETING PROGRAM. The Company's franchise marketing program
seeks to attract prospective franchisees with management experience, a minimum
level of net worth and strong interest in the retail music business. The Company
markets its franchise opportunities by advertising in selected business
magazines and franchise-oriented publications. Each inquiry is responded to and
an initial determination is made as to the prospects' qualifications to become a
CD Warehouse franchisee. Once initially qualified, the prospect is mailed the
Company's brochure and marketing materials. The inquiry is then followed up on
within a period of two weeks. In June 1996, CDIL implemented an enhanced
advertising strategy utilizing ENTREPRENEUR MAGAZINE. The Company believes that
the new marketing program has resulted in heightened awareness of CD Warehouse
as a franchise opportunity.
The Company also intends to establish a home page via the Internet (World
Wide Web) that will provide information concerning CD Warehouse franchise
opportunities.
TRAINING AND SUPPORT. The Company's philosophy is one of service and
commitment to its franchise system and it intends to implement a plan to enhance
franchise support services. Each franchise owner/ operator and each franchised
store manager is required to complete a comprehensive training program in store
operation and management. Topics covered in the training course include the
Company's philosophy of store operation and management, customer service,
merchandising, marketing, pricing, inventory and cost control, record keeping,
labor scheduling and personnel management. Training is based on standard
operating policies and procedures contained in an operations manual provided to
all franchisees, which the franchisee is required to follow by terms of the
franchise agreement. Additionally, trainees are provided
35
<PAGE>
with a complete orientation to Company operations by meeting with members of the
senior management of the Company. Training continues through the opening of the
store, where Company field personnel assist and guide the franchisee in all
areas of operation.
THE FRANCHISE AGREEMENT; TERMS AND CONDITIONS. The domestic offer and sale
of CD Warehouse franchises is made by its Uniform Franchise Offering Circular
prepared in accordance with federal and state laws and regulations. States that
regulate the sale and operation of franchises require a franchisor to register
or file certain notices with the state authorities prior to offering and selling
franchises in those states.
Under the current form of domestic franchise agreement, franchisees pay the
Company an initial franchise fee of $6,000 and royalties equal to 5% of monthly
gross sales. It is expected that the initial fee will increase as the Company
enhances franchise services. Franchisees are generally granted exclusive
territory with respect to the operation of CD Warehouse stores only in the
immediate vicinity of their stores.
The franchise agreement requires franchisees to purchase from the Company
certain proprietary software and the store's initial inventory, and to comply
with the Company's procedures of operation, to permit inspections and audits by
the Company and to remodel stores to conform with standards in effect from time
to time for the CD Warehouse system. The Company may terminate the franchise
agreement upon the failure of the franchisee to comply with the conditions of
the agreement and upon the occurrence of certain events, such as insolvency or
bankruptcy of the franchisee or the commission by the franchisee of any unlawful
or deceptive practice, which in the judgment of the Company is likely to
adversely affect the CD Warehouse system. The Company's ability to terminate
franchise agreements pursuant to such provisions is subject to applicable
bankruptcy and state laws and regulations. See "--Regulation."
The franchise agreement prohibits the transfer or assignment of any interest
in a franchise without the prior written consent of the Company. The agreement
also gives the Company a right of first refusal to purchase any interest in a
franchise if a proposed transfer would result in a change of control of that
franchise. The refusal right, if exercised, would allow the Company to purchase
the interest proposed to be transferred under the same terms and conditions and
for the same price as offered by the proposed transferee.
The term of each franchise agreement is ten years, and franchisees generally
have the right to renew for an additional ten-year term. All of the franchise
agreements to be assigned to the Company in connection with the CDIL Acquisition
will expire between 2002 and 2006.
UNIT ECONOMICS. The Company believes that future CD Warehouse stores can be
opened for an initial investment of approximately $100,000. The estimated
initial investment is comprised of the following:
<TABLE>
<S> <C>
Franchise fee............................................. $ 6,000
Inventory................................................. 50,000
Leasehold improvements.................................... 11,500
Proprietary software and related hardware................. 4,500
Signage (exterior and interior)........................... 5,500
Fixtures and equipment.................................... 10,000
Lease and utility deposits................................ 2,500
Initial working capital................................... 10,000
---------
$ 100,000
---------
---------
</TABLE>
Management believes that a key indicator of the success of a franchise
location is the sales to capitalization ratio. That ratio is defined as the
annual sales revenue generated by the business divided by
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<PAGE>
the capitalization costs to open the business. For the year ended December 31,
1995, average unit sales on a comparable basis were $276,338. Based on an
initial estimated capitalization of $100,000, the sales to capitalization ratio
to open a new CD Warehouse store is 2.76 to 1.
FRANCHISE FINANCING. The Company's predecessor did not provide prospective
franchisees with financing for its stores. Typically, franchisees have obtained
their own sources of such financing and have not required the Company's
assistance. The Company plans to develop relationships with sources of franchise
financing which will serve both franchised and Company-owned store development.
COMPANY STORE PROGRAM
As a result of the MacDonald Acquisition, the Company will have interests in
and will manage 36 CD Warehouse stores and intends to open 9 to 12 Company-owned
stores in 1997. Although Company-owned stores require an initial capital outlay
by the Company, they also provide a greater potential economic return to the
Company than franchised stores. The Company estimates that the cost of opening a
new Company-owned store is approximately $84,000, excluding franchise fee and
initial working capital applicable to franchisees.
Company-owned stores also permit market penetration, or seeding, in the
absence of an immediately-viable multi-location franchise operator. Company
stores provide an opportunity to continually refine the Company's standard store
model in order to respond to market dynamics. Variations in inventory mix,
ancillary product offerings, and marketing and sales techniques can be tested
and refined before implementation throughout the system.
The Company believes in the owner-operator concept. It is the intent that
each Company-owned store will be operated by an owner-manager. The Company
believes that this relationship provides operators with an incentive to perform
with a higher degree of commitment to the store's business. As a market is
developed, owner-managers will be given opportunities to progress into
multi-unit management. A typical multi-unit supervisor will own up to 20% of
each unit under his supervision. With the exception of the 35 franchised stores
in which the Company will acquire a minority ownership interest pursuant to the
MacDonald Acquisition, the Company will always retain a majority ownership in
the operating partnerships.
Managers of Company-owned stores are required to comply with all Company
operating standards and undergo training and receive support from the Company
similar to the training and support provided to franchisees. See "--Franchising
Program--Training and Support." The Company's Vice President-- Company Store
Operations and his staff intend to regularly visit Company-owned stores to
ensure compliance with Company standards and procedures and to provide advice
and support.
GOVERNMENTAL REGULATION
The Company is subject to various federal, state and local laws affecting
its business. Each of the Company's stores is subject to licensing and
regulation by a number of governmental authorities, which include taxing, zoning
and building agencies in the state or municipality in which the store is
located. Difficulties in obtaining or failures to obtain required licenses or
approvals could delay or prevent the opening a new store in a particular area.
The Company is subject to Federal Trade Commission ("FTC") regulation and
various state laws which regulate the offer and sale of franchises. The FTC has
adopted a rule that requires franchisors to make certain disclosures to
prospective franchise owners prior to the offer or sale of franchises. This rule
requires the disclosure of information necessary for a franchise owner to make
an informed decision as to whether to enter into a franchise relationship and
delineates the circumstances in which franchisors may make predictions on future
sales, income and profits. Failure to comply with this rule constitutes an
unfair or deceptive act or practice under the Federal Trade Commission Act.
Additionally, numerous states have
37
<PAGE>
in recent years adopted laws regulating franchise operations and the
franchisor-franchisee relationship, and similar legislation is pending in
Congress and several other states. Existing laws and pending proposals vary from
filing and disclosure requirements in the offer and sale of franchises to the
application of statutory standards regulating the establishment and termination
of franchise relationships. These laws generally apply to both area and
individual franchises. Although the foregoing matters may result in some
modification in the Company's franchising activities and some delays or failures
in enforcing certain of its rights and remedies under certain area or individual
franchise agreements, such modifications, delays or failures have not had a
material adverse effect on the Company's operations or business. However, the
law applicable to franchise operations and relationships is still developing,
and the Company is unable to predict the effect, if any, on its operations of
additional requirements or restrictions that may be enacted or promulgated or of
court decisions that may be adverse to the franchise industry. While it is
difficult to assess potential effects of federal and state legislation in the
U.S. or new international laws that may impact the industry, the Company does
not anticipate any material adverse effects from such legislation or laws at
this time.
The Company's operations are also subject to federal and state laws
governing such matters as wages, working conditions and overtime.
COMPETITION
The Company competes in the retail music industry, which is highly
competitive in price, selection, service and location and is often affected by
changes in consumer trends, economic conditions, demographics, traffic patterns
and technological innovations. The following profile provides an overview and
comparison of how the retail "new release" CD industry and the emerging retail
"remarketing" or "buy-sell-trade" CD industry are currently structured and
segmented.
According to the RIAA, CD sales in the United States were over 700 million
units in 1995, generating annual sales exceeding $9 billion. The Company has
various competitors in the industry who sell new recordings and music related
merchandise. These companies vary from those who are specialty music stores in
malls (such as Musicland, Camelot) and those who utilize free-standing buildings
(such as Blockbuster Music, The Wherehouse). Empirical studies conducted by the
Company indicate that companies in mall locations typically charge $15.99 to
$17.99 for their front-line CD products. Those in free-standing buildings
generally have much larger facilities (between 12,000 to 20,000 square feet).
Their selling price for front-line items range between $13.99 and $15.99, with
the latest top 20 releases on sale for $11.99 to $13.99 per CD. None of these
"superstores" sell preowned music except for The Wherehouse, which has generally
offered an inventory of preowned CD's in less than 500 square feet of space with
limited selections.
Other retailers offering pre-recorded music include major national discount
stores, such as Wal-Mart, K-Mart and Target stores. These national discounters
maintain a very small number of new music titles while offering no preowned
music. Their pricing will typically vary from $11.99 to $13.99 per item in
approximately 1,000 square feet of space. In another category are the
multi-media electronic stores (such as Best Buy, Circuit City), which have
generally utilized approximately 1,000 square feet of space and discount their
new releases at prices which range generally from $9.99 to $12.99 per item. The
Company believes that, while many of its competitors in the new CD market offer
a greater number of selections, the Company competes favorably with such
competitors on the basis of price. Additionally, while many competitors selling
new releases are located in more desirable locations, the Company believes that
its focus on preowned CD's offers a competitive advantage in attracting
purchasers of both new and preowned CD's.
The CD Warehouse system competes currently with one other national company
specializing in the sale of preowned CD's. Disc-Go-Round-Registered Trademark-
is a Minneapolis-based company owned by Grow Biz International, Inc., a
franchisor of several other concepts including Play It Again Sports.
Disc-Go-Round-Registered Trademark-
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<PAGE>
maintains smaller quantities of preowned inventory than does CD Warehouse. Both
CD Warehouse and Disc-Go-Round-Registered Trademark- sell preowned CD's at $6.00
to $9.00 and new releases at $10.99 to $12.99, as compared to Best Buy and
Circuit City prices of new CD's which range generally from $9.99 to $12.99 per
selection. Grow Biz International, Inc.'s Form 10-Q for the Quarter Ended June
29, 1996 indicates that there are currently 107 units in the
Disc-Go-Round-Registered Trademark- system, as compared to 109 units in the CD
Warehouse system.
The Company believes that CD Warehouse stores compete favorably with its
competition in the preowned CD market in terms of price, selection, service and
location.
The Company also competes in the franchise industry for prospective
franchisees. With respect to the only other franchisor known to the Company to
engage in a business similar to that of the Company, the Company believes that
it competes favorably.
TRADEMARKS AND SERVICE MARKS
In connection with the CDIL Acquisition, the Company will acquire all right,
title and interest in the name "CD Warehouse" which is registered with the
United States Patent and Trademark Office. The Company believes that the
trademark has significant value and is important to its marketing efforts.
PROPERTIES
The Company's principal executive offices currently are located at 722 N.
Broadway, Oklahoma City, Oklahoma 73012, where it leases from a director of the
Company approximately 800 square feet under a month-to-month lease with a
monthly lease payment of $600. See "Certain Transactions."
CDIL maintains its offices and warehouse operations at 1710 Firman, Suite
300, Richardson, Texas 75081. The total facility is approximately 4,500 square
feet and is held under a lease expiring in March 1997 with a monthly lease
payment of $2,087. Approximately 2,500 square feet consists of office space and
the remainder is utilized as a warehouse. Upon completing the CDIL Acquisition,
the Company will share offices with CDIL during a transition period anticipated
to last approximately four months. The transition period will allow the Company
to plan an orderly move of the CD Warehouse system operations to Oklahoma City.
Upon the expiration of the CDIL lease, the Company anticipates that it will
relocate its principal offices to a larger facility in Oklahoma City. The
Company has solicited the services of the largest commercial realtor in Oklahoma
City to assist in locating suitable facilities. None of the proceeds from this
Offering will be used in connection with the establishment of the Company's
office and warehouse facility in Oklahoma City.
EMPLOYEES
Upon commencement of operations, the Company will employ 13 employees, 11 on
a full-time basis. None of the Company's employees are represented by a labor
union and the Company believes that its relations with its employees are good.
LEGAL PROCEEDINGS
From time to time, the Company may be involved in litigation relating to
claims arising out of its normal business operation. The Company is not now
engaged in any legal proceedings.
CDIL is subject to a currently effective order from the State of South
Dakota, issued by the South Dakota Division of Securities, to cease and desist
and refrain from offering or selling franchises in the State of South Dakota
until CDIL has complied with the South Dakota franchise registration laws. The
basis for the cease and desist order was that CDIL sold a franchise to two South
Dakota residents and had not registered the franchise in South Dakota. The
Company intends to seek registration of its franchise in South Dakota as soon as
practicable after completion of the Offering and the CDIL Acquisition.
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<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth certain information regarding the directors,
executive officers and key employees of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- ----------------------------------------------------------------------
<S> <C> <C>
Jerry W. Grizzle.............. 44 Chairman of the Board of Directors, President and Chief Executive
Officer
Gary D. Johnson............... 37 Chief Operating Officer, Executive Vice President and Director
Bruce D. MacDonald............ 41 Vice President-Company Store Operations
Doyle E. Motley............... 42 Senior Vice President and Chief Financial Officer
Christopher M. Salyer......... 44 Director
Ronald V. Perry............... 47 Director
</TABLE>
JERRY W. GRIZZLE founded the Company in September 1996 and has served as
Chairman of the Board of Directors, President and Chief Executive Officer of the
Company since that time. From 1984 to 1991, Mr. Grizzle was Vice President and
Treasurer of Sonic Corporation, a publicly held fast food franchisor with over
1,500 units operating in 26 states, and from 1991 to 1994, he owned and operated
Orbit Finer Foods, a privately owned Mexican food product manufacturer. For a
four-month period in 1994, Mr. Grizzle served as President of Skolniks, Inc., a
publicly held bagel manufacturer ("Skolniks"). Mr. Grizzle resigned from
Skolniks in October 1994 as a result of significant disagreements with the Board
of Directors over Skolniks' corporate practices; subsequent to Mr. Grizzle's
resignation, Skolniks was the subject of an involuntary Chapter 11 proceeding.
Mr. Grizzle received his B.S. degree in Accounting from Southwestern Oklahoma
State University in 1976 and received an M.B.A. in 1983 from the University of
Central Oklahoma. He is currently completing his Ph.D. in Marketing at Oklahoma
State University, and holds the rank of Colonel in the Oklahoma Army National
Guard.
GARY D. JOHNSON has been Executive Vice President, Chief Operating Officer
of the Company and a director of the Company since the Company's inception in
September 1996. For the past nine years, from 1987 to 1996, Mr. Johnson served
as Vice President of Purchasing and Distribution for Sonic Corp. In such
capacity, Mr. Johnson was responsible for cooperative purchasing and management
of all procurement functions and distribution for the Sonic system. Mr. Johnson
received his B.S. degree in Business Management from Southwestern Oklahoma State
University in 1981.
BRUCE D. MACDONALD will be appointed to Vice President-Company Store
Operations upon completion of the offering. Prior to the Company's acquisition
of CDIL, Mr. MacDonald owned an interest in and managed 36 CD Warehouse retail
stores. Mr. MacDonald is a certified public accountant and began his career at
Arthur Andersen in 1977, after graduating with a B.B.A. degree from Southern
Methodist University in 1977. For at least the last five years, Mr. MacDonald
has been self-employed as a certified public accountant, in addition to his
activities as a CD Warehouse franchisee.
DOYLE E. MOTLEY will be appointed to Senior Vice President and Chief
Financial Officer of the Company upon completion of the Offering. For the past
two years, Mr. Motley has served as an internal auditor for Bob Moore Financial
Group, a multi-state auto dealership. Prior to that, from 1991 to 1994, Mr.
Motley served as Chief Financial Officer of Orbit Finer Foods. For a four-month
period in 1994, Mr. Motley served as Chief Financial Officer of Skolniks. Mr.
Motley resigned from Skolniks in October 1994 as a result of significant
disagreements with the Board of Directors over Skolniks' corporate practices;
subsequent to Mr. Motley's resignation, Skolniks was the subject of an
involuntary Chapter 11 proceeding.
CHRISTOPHER M. SALYER has been a member of the Board of Directors since
October 1996. Mr. Salyer is currently serving as the Chairman and Chief
Executive Officer of Accounting Principals, Inc., a company
40
<PAGE>
specializing in the placement of accounting personnel. From February 1984
through December 1994, Mr. Salyer served as the Chairman and Chief Executive
Officer of National Check Cashers Corporation, a retail financial services
company. He received his B.B.A. degree from Southern Methodist University in
1973 and received an M.B.A. in 1974 from Babson College in Boston,
Massachusetts. Mr. Salyer is a certified public accountant.
RONALD V. PERRY has been a member of the Board of Directors since October
1996. Mr. Perry has served as the President and Chief Operating Officer of Prime
Time Travel, Inc., a travel agency specializing in providing services to a
corporate client base since August 1986. During this same period of time Mr.
Perry has also served as the President and Chief Operating Officer of Prime Cut
Restaurants, Inc. which owns and operates four restaurants. Mr. Perry received
his B.B.A. degree from Oklahoma State University in 1971.
THE BOARD OF DIRECTORS
The Company's Bylaws authorize a maximum of nine directors and a minimum of
five directors. The Bylaws also provide that the directors shall be divided into
three classes, as nearly equal in number as possible, with each class serving
staggered three-year terms. Currently, the Board of Directors consists of four
directors. The Board of Directors is continuing to search for additional
qualified and available nominees to fill the remaining vacant Board of Directors
seats which, when filled, will have a term expiring in 1999.
The Company has agreed with the Underwriters that it will recommend and use
its best efforts to cause a designee of Capital West Securities, Inc. who is
reasonably satisfactory to the Company to be elected as a full voting member of
its Board of Directors. As of the date of this Prospectus, Capital West
Securities, Inc. has not named a nominee for election to board membership.
EXECUTIVE COMPENSATION
The Company was formed in September 1996 and has not paid any executive
compensation. The Company has entered into employment agreements with each of
the executive officers of the Company, the terms of which are set forth under
"--Employment Agreements."
DIRECTORS' COMPENSATION
Directors who are not officers of the Company are to be paid $1,000 for each
Board of Director's meeting attended.
1996 STOCK OPTION PLAN
The Company's Board of Directors and stockholders have approved the 1996
Stock Option Plan. The description in this Prospectus of the principal terms of
the 1996 Option Plan is a summary, does not purport to be complete, and is
qualified in its entirety by the full text of the 1996 Option Plan, a copy of
which has been filed as an exhibit to the Registration Statement of which this
Prospectus is a part.
Pursuant to the 1996 Option Plan, employees, officers, directors,
consultants and advisers of the Company are eligible to receive awards of stock
options. The 1996 Stock Option Plan provides for grants of "incentive stock
options" ("ISO's") meeting the requirements of Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"), and "non-qualified stock options"
("NQSO's").
Under the 1996 Option Plan, the Company has reserved 400,000 shares of
Common Stock for issuance of awards under the 1996 Option Plan (subject to
antidilution and similar adjustments).
The 1996 Option Plan will be administered by a Compensation Committee (the
"Committee") composed of two or more directors of the Company who are
"Non-Employee Directors" as such term is
41
<PAGE>
used in Rule 16b-3 promulgated under the Exchange Act. Subject to the provisions
of the 1996 Option Plan, the Committee will determine the type of award, when
and to whom awards will be granted, the number of shares covered by each award
and the terms, provisions and kind of consideration payable with respect to
awards. The Committee may interpret the 1996 Option Plan and may at any time
adopt such rules and regulations for the 1996 Option Plan as it deems advisable.
The Committee may, additionally, cancel or amend awards.
In determining the persons to whom awards shall be granted and the number of
shares covered by each award the Committee shall take into account the duties of
the respective persons, their present and potential contribution to the success
of the Company and such other factors as the Committee shall deem relevant in
connection with accomplishing the purposes of the 1996 Option Plan.
An option may be granted on such terms and conditions as the Committee may
approve, and generally may be exercised for a period of up to 10 years from the
date of grant. Generally, both NQSO's and ISO's will be granted with an exercise
price equal to the "Fair Market Value" (as defined in the 1996 Option Plan) on
the date of grant. In the case of ISO's, certain limitations will apply with
respect to the aggregate value of option shares which can become exercisable for
the first time during any one calendar year, and certain additional limitations
will apply to ISO's granted to an employee who possesses more than 10% of the
total combined voting power of all classes of stock of the Company. The
Committee may provide for the payment of the option price in cash, by delivery
of other Common Stock having a Fair Market Value equal to such option price, by
a combination thereof or by such other manner as the Committee shall determine.
Options granted under the 1996 Option Plan will become exercisable at such times
and under such conditions as the Committee shall determine. Other than in the
case of death, options generally may not be exercised more than three months
after an employee terminates employment with the Company for any reason other
than termination for cause or voluntary termination without the consent of the
Company (in which event options shall terminate immediately, unless the
Committee shall otherwise determine). Each year that a director is elected or
reelected to his position at the Company, an option to purchase 6,000 shares of
Common Stock will be granted with an exercise price equal to the Fair Market
Value on the date of grant. No options have been granted to date. Pursuant to
the terms of the 1996 Stock Option Plan, directors elected prior to the closing
of the Offering shall be granted 6,000 shares of Common Stock on the effective
date of the registration statement to which this Offering relates, with an
exercise price equal to the Offering price per share on the effective date,
subject to pro-rata vesting over a three-year period.
The Board may at any time and from time to time suspend, amend, modify or
terminate the 1996 Option Plan; provided, however, that, to the extent required
by Rule 16b-3 promulgated under the Exchange Act or any other law, regulation or
stock exchange rule, no such change shall be effective without the requisite
approval of the Company's stockholders. In addition, no such change may
adversely affect any award previously granted, except with the written consent
of the grantee.
No awards may be granted under the 1996 Option Plan after the tenth
anniversary of the approval of the 1996 Option Plan.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with Jerry W. Grizzle, Gary D.
Johnson, Bruce D. MacDonald and Doyle E. Motley (each an "Employee" and
collectively, the "Employees"). Each of these agreements, other than that of Mr.
Grizzle, runs for a term of one year and automatically renews for additional
one-year terms unless terminated by either the Company or Employee. Mr.
Grizzle's agreement runs for a term of five years and automatically renews for
additional five-year terms unless terminated by either the Company or Mr.
Grizzle. Under the respective agreements, Mr. Grizzle will receive an annual
salary of $100,000, Mr. Johnson will receive an annual salary of $90,000, Mr.
MacDonald will receive an annual salary of $100,000 upon commencement of his
employment, and Mr. Motley will receive an annual salary of $65,000 upon
commencement of his employment. In addition, each Employee may be entitled to
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<PAGE>
receive incentive compensation. Such incentive compensation consists of an
annual bonus if certain individual and Company objectives are achieved. "Cause"
for termination of an Employee includes: the conviction of a felony; the
perpetration of a fraud, or misappropriation or embezzlement of property of the
Company; willful misconduct with respect to the duties or obligations of the
Employee under his employment agreement; or intentional or continual neglect of
duties. For two years following the termination of an Employee, the Employee is
prohibited from engaging in or assisting in any business which is identical,
competitive with, or comparable to, the Company's business within any area in
which Employee rendered services to the Company. Each agreement contains a
provision prohibiting the Employees subsequent to termination of employment from
disclosing to third parties proprietary information relating to the Company.
OFFICER AND DIRECTOR LIABILITY
As permitted by the provisions of the DGCL, the Company's Certificate of
Incorporation eliminates, in certain circumstances, the monetary liability of
directors of the Company for a breach of their fiduciary duty as directors.
These provisions do not eliminate the liability of a director (i) for a breach
of a director's duty of loyalty to the Company or its stockholders; (ii) for
acts or omissions by a director not in good faith or which involve intentional
misconduct or a knowing violation of law; (iii) for liability arising under
Section 174 of the DGCL (relating to the declaration of dividends and purchase
or redemption of shares in violation of the DGCL); or (iv) for any transaction
from which the director derived an improper personal benefit. In addition, these
provisions do not eliminate the liability of a director for violations of
federal securities laws or limit the rights of the Company or its stockholders,
in appropriate circumstances, to seek equitable remedies such as injunctive or
other forms of non-monetary relief. Such remedies may not be effective in all
cases.
The Company's Certificate of Incorporation provides that the Company shall
indemnify all directors and officers of the Company to the full extent permitted
by the DGCL. Under such provisions, any director or officer, who in his capacity
as such, is made or threatened to be made, a party to any suit or proceeding,
may be indemnified if the Board of Directors determines such director or officer
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interest of the Company. The Certificate and the DGCL
further provide that such indemnification is not exclusive of any other rights
to which such individuals may be entitled under the Certificate of
Incorporation, the Bylaws, any agreement, vote of stockholders or disinterested
directors or otherwise.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions or otherwise, the Company has been advised
that in the opinion of the Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
CERTAIN TRANSACTIONS
CDIL ACQUISITION
At the closing of the Offering, the Company will acquire for a purchase
price of $3,200,000 (of which $100,000 has previously been paid in the form of
an earnest money deposit) substantially all of the assets of CDIL pursuant to
the CDIL Acquisition. The assets being acquired consist of all of CDIL's: (a)
rights as the franchisor under existing franchise agreements and existing area
development agreements; (b) inventory of new and used CD's; (c) accounts, notes
and warranty receivables; (d) trademarks and other intellectual property rights;
(e) business records, including but not limited to CDIL's customer lists, vendor
lists, prospective franchisee lists, franchise files, accounting and tax records
concerning the same, sales literature and promotional materials; (f) software
programs; (g) furniture, equipment, files and other assets located at CDIL's
corporate offices; and (h) the equity interests of CDIL in CD Warehouse stores
in Tulsa (two), Oklahoma, Edmond, Oklahoma and Memphis, Tennessee. The Company
will be entitled to all
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<PAGE>
franchise fees and royalties accruing to CDIL after the closing date of the CDIL
Acquisition. As part of the CDIL Acquisition, the Company will assume CDIL's
accounts payable for the inventory being acquired as of the closing date, as
well as CDIL's obligations under the franchise agreements and franchise and area
development agreements. If the aggregate value of the inventory and the amount
of receivables as of the closing date of the CDIL Acquisition is less than the
amount of payables as of such date, the purchase price shall be reduced by an
amount equal to such difference.
Pursuant to the CDIL Acquisition, Mark E. Kane, the founder and manager of
CDIL, will be granted a World Wide Area Development Agreement at the closing of
that transaction. Under the terms of the Worldwide Area Development Agreement,
Kane will be granted the right to develop, as a franchisee of the Company, on a
worldwide basis (excluding the United States, Mexico and Canada) CD Warehouse
franchise operations for a ten year period. The development schedule requires
that Mr. Kane open 100 stores during the term of the Worldwide Area Development
Agreement, in accordance with an agreed schedule. Failure to open the requisite
number of stores pursuant to the schedule could result in termination of the
World Wide Area Development Agreement, although such termination would not
affect any rights of Mr. Kane to operate CD Warehouse stores already opened and
operating under an existing franchise agreement. The Worldwide Area Development
Agreement provides that the Company may, at its option for a period of seven
years beginning three years from the date of the grant thereof, purchase Mr.
Kane's interest in any franchised operations developed pursuant to the
agreement. The Worldwide Area Development Agreement provides that Mr. Kane will
pay the Company an amount to be jointly determined by the Company and Mr. Kane
on a country-by-country basis, provided that the Company will receive a
franchise fee of not less than $3,000 per store, a minimum royalty of 1% of
gross sales based on individual store sales volume and 20% of the total fee
received by Mr. Kane from each subfranchisee. Additionally, at the closing of
the CDIL Acquisition, the Company will grant Mr. Kane, pursuant to a Domestic
Area Development Agreement, the exclusive right to develop ten domestic CD
Warehouse stores, subject to the Company's approval as to the location of such
stores. Pursuant to the Domestic Area Development Agreement, no initial
franchise fee will be payable by Mr. Kane with respect to the ten franchise
stores, although Mr. Kane will pay a royalty of 2% of net sales for any CD
Warehouse store opened by him pursuant to these franchise agreements. Mr. Kane
will also be granted two franchise agreements by the Company for CD Warehouse
Stores currently owned and operated by Mr. Kane in Ft. Worth, Texas and Plano,
Texas pursuant to which Mr. Kane will not be required to pay to the Company any
royalties or franchise fee.
In connection with the CDIL Acquisition, Mr. Kane has subscribed for 350,000
shares of Common Stock, at a subscription price of $1.00 per share. Payment of
the subscription is conditioned upon the successful completion of the Offering
and the CDIL Acquisition.
MACDONALD ACQUISITION
Simultaneously with the closing of the Offering, the Company will acquire
the CD Warehouse franchise interests of Bruce D. MacDonald, Vice
President-Company Store Operations. Mr. MacDonald acts as franchisee, either on
his own account or as general partner or manager of entities which themselves
act as franchisees, of 36 CD Warehouse stores. Pursuant to the MacDonald
Acquisition the Company will acquire 100% ownership of the Montfort Street Store
and minority equity interests (including MacDonald's interest as a managing
general partner or limited liability company manager), in the 35 other
franchised stores. The Company has formed CD Management as a wholly owned
subsidiary to act as the successor general partner or manager of the 15
partnerships and two limited liability companies originally organized by
MacDonald to fund, own and operate the 35 franchised stores in which MacDonald
holds an equity interest. Upon acquisition of the Montfort Street Store and the
MacDonald Equity Interests, the Company upon consummation of the MacDonald
Acquisition will manage and own an interest in 36 of the 109 stores in the CD
Warehouse system. The MacDonald Equity Interests to be acquired by the Company
range from 1% to 50%, although certain percentages of ownership are earned only
after partnership
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payout, as defined in the respective partnership agreement. Upon consummation of
the MacDonald Acquisition, the Company will be vested with equity interests
ranging from 1% to 50%. Pursuant to the MacDonald Acquisition, the Company will
issue to MacDonald 80,000 shares of the Company's Common Stock.
ACCOUNTING SERVICES
Bruce D. MacDonald has ownership in an accounting firm with which the
Company has contracted to provide services for the Company's stores. This
agreement provides that each store will be charged $150 per store, per month for
certain accounting and bookkeeping services rendered.
OFFICE LEASE
The Company has entered into a lease agreement with an affiliate of
Christopher M. Salyer, a director of the Company, for its temporary executive
offices at 722 North Broadway, Oklahoma City, Oklahoma 73102. The total office
space is approximately 800 square feet and is held under the lease on a month to
month basis with monthly lease payment of $600. Additionally, upon completing
the CDIL Acquisition, the Company will share operational facilities with CDIL
during a transitional period anticipated to last approximately four months. CDIL
is owned or controlled by Mark E. Kane, who will be a principal stockholder of
the Company upon completion of the Offering. The Company and CDIL have agreed
that the Company will not incur any lease payment for sharing the CDIL facility
during the transition period. The Company intends to consolidate its executive
and operational offices into a larger facility in Oklahoma City, Oklahoma
following the transition period.
FUTURE TRANSACTIONS
All future and ongoing transactions between the Company and its directors,
officers, principal stockholders or affiliates will be on terms no less
favorable to the Company than may be obtained from unaffiliated third parties,
and any such transactions will be approved by a majority of disinterested and
independent directors of the Company.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information as of October 15, 1996, and as
adjusted to reflect the sale of the 1,000,000 shares of Common Stock offered
hereby, concerning the beneficial ownership of Common Stock by each of the
Company's directors, each executive officer named in the table under the heading
"Management-Directors, Executive Officers and Key Employees," and all directors
and executive officers of the Company as a group, and by each person who is
known by the Company to own more than 5% of the outstanding shares of Common
Stock. Unless otherwise indicated, the beneficial owner has sole voting and
investment power with respect to such stock.
<TABLE>
<CAPTION>
PERCENT OF
CLASS PERCENT OF
NAME AND ADDRESS NUMBER OF SHARES BEFORE NUMBER OF SHARES CLASS
OF BENEFICIAL HOLDER(1) BEFORE OFFERING OFFERING AFTER OFFERING AFTER OFFERING
- ------------------------------------------- ----------------- -------------- ----------------- ---------------
<S> <C> <C> <C> <C>
Jerry W. Grizzle* (2)(3)................... 250,000 71.43% 250,000 14.04%
Gary D. Johnson* (2)....................... 75,000 21.43% 75,000 4.21%
Bruce D. MacDonald (4)..................... (5) 0% 80,000(5) 4.49%
Doyle E. Motley (2)........................ 25,000 7.14% 25,000 1.40%
Mark E. Kane (4)........................... (6) 0% 350,000(6) 19.66%
All executive officers and directors as a 350,000 100.00% 430,000 24.14%
group (7 persons)........................
</TABLE>
- ------------------------
* Director
(1) Unless otherwise noted, the Company believes that each person named in the
table has sole voting and investment power with respect to all shares
beneficially owned by such person.
(2) Address is c/o CD Warehouse, Inc., 722 N. Broadway, Oklahoma City, Oklahoma
73102.
(3) 230,000 shares are held in the name of the Jerry W. Grizzle and Shawn L.
Grizzle Revocable Living Trust, dtd. 1/6/94, and 10,000 shares each are held
in the names of Mr. and Mrs. Grizzle's children, Brittany and Matthew.
(4) Address is c/o CDIL, 710 Firman Drive, Suite 300, Richardson, Texas.
(5) The shares shown as owned by Mr. MacDonald after the Offering will be issued
in connection with the MacDonald Acquisition. See "Certain
Transactions--MacDonald Acquisition."
(6) Mr. Kane has subscribed for 350,000 shares of Common Stock, the payment of
which is conditioned upon the consummation of the Offering.
DESCRIPTION OF SECURITIES
The authorized capital stock of the Company consists of (i) 10,000,000
shares of Common Stock, having a par value of $.01 per share, and (ii) 5,000,000
shares of Preferred Stock, having a par value of $.01 per share. Immediately
prior to this Offering, 350,000 shares of Common Stock were issued and
outstanding, and no shares of Preferred Stock were issued and outstanding. A
total of 400,000 shares of Common Stock has been reserved for grants of options
under the 1996 Stock Option Plan.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share on all
matters submitted to a vote of stockholders. There is no cumulative voting with
respect to the election of directors. Accordingly, holders of a majority of the
shares entitled to vote in any election of directors may elect all of the
directors standing for election. Subject to preferences that may be applicable
to any then outstanding class of
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preferred stock, the holders of Common Stock are entitled to receive such
dividends, if any, as may be declared by the Board of Directors from time to
time out of legally available funds. Upon liquidation, dissolution or winding up
of the Company, the holders of Common Stock are entitled to share ratably in all
assets of the Company that are legally available for distribution, after payment
of all debts and other liabilities and subject to the prior rights of holders of
any class of preferred stock then outstanding. The holders of Common Stock have
no preemptive, subscription, redemption or conversion rights. The rights,
preferences and privileges of holders of Common Stock are subject to the rights
of the holders of shares of any series of preferred stock that the Company may
issue in the future.
PREFERRED STOCK
Shares of Preferred Stock may be issued from time to time in one or more
series with such designations, voting powers, if any, preferences and relative,
participating, optional or other special rights, and such qualifications,
limitations and restrictions thereof, as are determined by resolution of the
Board of Directors of the Company. The issuance of preferred stock, while
providing flexibility in connection with possible financings, acquisitions and
other corporate purposes, could, among other things, adversely affect the voting
power of holders of Common Stock and, under certain circumstances, be used as a
means of discouraging, delaying or preventing a change in control of the
Company. Currently, the Company has no shares of Preferred Stock outstanding.
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Certificate of Incorporation and By-laws
may be deemed to have anti-takeover effects and may delay, defer or prevent a
tender offer or takeover attempt that a stockholder might consider to be in such
stockholder's best interest, including those attempts that might result in a
premium over the market price for the shares held by stockholders.
CLASSIFIED BOARD. The Company's By-laws provide that (i) the Board of
Directors is divided into three classes of as equal size as possible, (ii) the
number of directors is to be fixed from time to time by the Board of Directors,
and (iii) the term of office of each class expires in consecutive years so that
each year only one class is elected. These provisions may render more difficult
a change in control of the Company or the removal of incumbent management.
NO STOCKHOLDER ACTION BY WRITTEN CONSENT; SPECIAL MEETINGS. The Company's
Certificate of Incorporation provides that no action shall be taken by
stockholders except at an annual or special meeting of stockholders, and
prohibits action by written consent in of lieu of a meeting. The Company's
By-laws provides that, unless otherwise proscribed by law, special meetings of
stockholders can only be held pursuant to a resolution of the Board of
Directors.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATIONS. The By-laws establish an advance notice procedure for the
nomination, other than by or at the direction of the Board of Directors or a
committee thereof, of candidates for election as directors as well as for other
stockholder proposals to be considered at stockholders' meetings.
Notice of stockholder proposals and director nominations must be timely
given in writing to the Secretary of the Company prior to the meeting at which
the matters are to be acted upon or Directors are to be elected. In all cases,
to be timely, notice must be received at the principal executive offices of the
Company not less than 40 days before the meeting, or, if on the day notice of
the meeting is given to the stockholders less than 45 days remain until the
meeting, (i) five days after notice is given but not less than five days prior
to the meeting in the case of stockholder proposals, and (ii) 10 days after
notice is given in the case of director nominations.
Notice to the Company from a stockholder who proposes to nominate a person
at a meeting for election as a director must contain all information about that
person as would be required to be included
47
<PAGE>
in a proxy statement soliciting proxies for the election of the proposed nominee
(including such person's written consent to serve as a Director if so elected)
and certain information about the stockholder proposing to nominate that person.
Stockholder proposals must also include certain specified information.
These limitations on stockholder proposals do not restrict a stockholder's
right to include proposals in the Company's annual proxy materials pursuant to
rules promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act").
SECTION 203 OF THE DGCL. Section 203 of the DGCL prohibits a publicly held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless (i)
prior to the date of the business combination, the transaction is approved by
the board of directors of the corporation, or (ii) upon consummation of the
transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owns at least 85% of the outstanding
voting stock, or (iii) on or after such date the business combination is
approved by the board of directors and by the affirmative vote of at least
66 2/3% of the outstanding voting stock which is not owned by the interested
stockholder. A "business combination" includes mergers, asset sales and other
transactions resulting in a financial benefit to the stockholder. An "interested
stockholder" is a person who, together with affiliates and associates, owns (or
within three years, did own) 15% or more of the corporation's voting stock. The
effect of such statute may be to discourage certain types of transactions
involving an actual or potential change in control of the Company.
TRANSFER AGENTS, WARRANT AGENT AND REGISTRAR
The transfer agent for the Common Stock is Liberty Bank & Trust Company of
Oklahoma City, N.A.
SHARES ELIGIBLE FOR FUTURE SALE
POSSIBLE RULE 144 SALES. Upon completion of the Offering described in this
Prospectus, the Company will have outstanding 1,780,000 shares of Common Stock.
Of these shares all of the 1,000,000 shares sold in the Offering (assuming no
exercise of the Underwriters' over-allotment option) will be freely transferable
by persons other than affiliates (as defined in regulations under the Securities
Act), without restriction or further registration under the Securities Act.
The remaining 780,000 shares of Common Stock outstanding are held by certain
directors and executive officers of the Company (including Bruce D. MacDonald),
as well as Mark E. Kane (collectively, the "Affiliate Shares"). Such Affiliate
Shares are "Restricted Securities" within the meaning of Rule 144 under the
Securities Act and may not be sold in the absence of registration under the
Securities Act, unless an exemption from registration is available, including
the exemption provided by Rule 144. Under Rule 144 as currently in effect, none
of such shares are currently eligible for sale. Additionally, the holders of the
Affiliate Shares have agreed not to sell their shares until 24 months after the
date of this Prospectus without obtaining the prior written approval of Capital
West Securities, Inc. See "Underwriting." Upon expiration of the 24-month
period, 244,706 of the Affiliate Shares will be eligible for immediate resale
without restriction under the Securities Act, subject, in certain cases, to
certain volume, timing and other requirements of Rule 144 (with 162,353 of such
shares entitled to piggyback registration rights for a period of two years
thereafter). The remaining 535,294 Affiliate Shares are subject to escrow
agreements required by certain state securities regulatory agencies, the terms
of which provide that such shares be held in escrow for up to six years, subject
to earlier release if the Company attains certain levels of earnings for any two
consecutive fiscal years or the Common Stock trades at 175% of the public
offering price per share for at least 90 consecutive trading days at least one
year after the effective date of the Offering.
In general, under Rule 144 as currently in effect, any person (or persons
whose shares are aggregated for purposes of Rule 144) who beneficially owns
Restricted Securities with respect to which at least two years have elapsed
since the later of the date the shares were acquired from the Company or from an
48
<PAGE>
affiliate of the Company, is entitled to sell, within any three month period, a
number of shares that does not exceed the greater of (i) 1% of the then
outstanding shares of Common Stock of the Company, or (ii) the average weekly
trading volume in Common Stock during the four calendar weeks preceding such
sale. Sales under Rule 144 are also subject to certain manner-of-sale provisions
and notice requirements, and to the availability of current public information
about the Company. A person who is not an affiliate, has not been an affiliate
within 90 days prior to sale and who beneficially owns Restricted Securities
with respect to which at least three years have elapsed since the later of the
date the shares were acquired from the Company or from an affiliate of the
Company, is entitled to sell such shares under Rule 144(k) without regard to any
of the volume limitations or other requirements described above.
The Company can make no prediction as to the effect, if any, that sales of
shares of Common Stock or the availability of shares for sale will have on the
market price of Common Stock. Nevertheless, sales of significant amounts of
Common Stock could adversely affect the prevailing market price of Common Stock,
as well as impair the ability of the Company to raise capital through the
issuance of additional equity securities. Prior to this Offering, there has been
no trading market for the Common Stock. The Company anticipates that the trading
market in the Common Stock, if any, will be limited based upon the number of
shares currently outstanding and anticipated to be sold in this Offering.
49
<PAGE>
UNDERWRITING
Capital West Securities, Inc., Westport Resources Investment Services, Inc.
and Berthel Fisher & Company Financial Services, Inc. (the "Underwriters") have
severally agreed, subject to the terms and conditions of the Underwriting
Agreement, to purchase from the Company the number of shares of Common Stock set
forth opposite their respective names below. The nature of the obligations of
the Underwriters is such that if any of such shares are purchased, all must be
purchased.
<TABLE>
<CAPTION>
NUMBER OF
NAME SHARES
- ------------------------------------------------------------ ----------
<S> <C>
Capital West Securities, Inc. ..............................
Westport Resources Investment Services, Inc. ...............
Berthel Fisher & Company Financial Services, Inc............
----------
Total..................................................... 1,000,000
----------
----------
</TABLE>
The Underwriters have advised the Company that the Underwriters propose
initially to offer the shares of Common Stock offered hereby to the public at
the price to public set forth on the cover page of this Prospectus. The
Underwriters may allow a concession to selected dealers who are members of the
National Association of Securities Dealers, Inc. ("NASD") not in excess of
$ per share, and the Underwriters may allow, and such dealers may
reallow, to members of the NASD a concession not in excess of $ per
share. After the public offering, the price to public, the concession and the
reallowance may be changed by the Underwriters.
Capital West, one of the Underwriters, was first registered as a
broker-dealer in May 1995. Capital West has participated in only four public
equity offerings as an underwriter, although certain of its employees have had
experience in underwriting public offerings while employed by other
broker-dealers. Prospective purchasers of the securities offered hereby should
consider this limited experience in evaluating this Offering.
The Company has granted an option to the Underwriters, exercisable within 30
business days after the date of this Prospectus, to purchase up to an aggregate
of 150,000 additional shares of Common Stock, at the initial price to public,
less the underwriting discount, set forth on the cover page of this Prospectus.
The Underwriters may exercise the option only for the purpose of covering
over-allotments. To the extent that the Underwriters exercise such option, each
Underwriter will be committed, subject to certain conditions, to purchase from
the Company on a pro rata basis that number of additional shares of Common Stock
which is proportionate to such Underwriters' initial commitment.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act.
The Company has agreed to pay to Capital West Securities, Inc. a
nonaccountable expense allowance of 3% of the gross proceeds derived from the
sale of the shares of Common Stock underwritten (including the sale of any
shares of Common Stock subject to the Underwriters' over-allotment option),
$50,000 of which has been paid as of the date of this Prospectus. The Company
also has agreed to pay all expenses in connection with qualifying the Common
Stock offered hereby for sale under the laws of such states as the Underwriters
may designate and registering the Offering with the NASD, excluding filing fees
and fees and expenses of counsel retained for such purposes by the Underwriters
(which shall be paid by Capital West Securities, Inc. from the nonaccountable
expense allowance).
In connection with this Offering, the Company has agreed to sell to the
Underwriters, for a price of $.001 per warrant, warrants (the "Underwriters'
Warrants") to purchase shares of Common Stock equal to 10% of the total number
of shares sold pursuant to this Offering, excluding shares subject to the over-
allotment option. The Underwriters' Warrants are exercisable at a price equal to
150% of the initial public offering price ($7.50 assuming an initial public
offering price of $5.00 per share) for a period of four years
50
<PAGE>
commencing one year from the date of this Prospectus (the "Exercise Period").
The Underwriters' Warrants grant to the holders thereof, with respect to the
registration under the Securities Act of the securities directly and indirectly
issuable upon exercise of the Underwriters' Warrants, one demand registration
right during the Exercise Period, as well as piggyback registration rights at
any time. The Company, its executive officers and directors, and all of its
current stockholders have agreed that for a period of 24 months after the date
of this Prospectus, they will not offer, sell or otherwise dispose of any shares
of Common Stock beneficially owned or controlled by them (including subsequently
acquired shares) without the prior written consent of Capital West Securities,
Inc.
The Company has agreed with the Underwriters to use its best efforts to
cause a designee of Capital West Securities, Inc. who is reasonably satisfactory
to the Company to be elected as a full voting member of its Board of Directors.
As of the date of this Prospectus, Capital West Securities, Inc. has not named a
nominee for election to board membership.
Prior to this Offering, there has been no market for the Common Stock and
there can be no assurance that a regular trading market will develop upon the
completion of this Offering. The initial public offering price was determined by
negotiations between the Company and the Underwriters. The primary factors
considered in determining such offering price included the history of and
prospects for the Company's business and the industry in which the Company
competes, market valuation of comparable companies, market conditions for public
offerings, the prospects for future earnings of the Company, an assessment of
the Company's management, the general condition of the securities markets, the
demand for similar securities of comparable companies and other relevant
factors.
The Underwriters have advised the Company that the Underwriters do not
expect any sales by the Underwriters to accounts over which they exercise
discretionary authority.
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered hereby
has been passed upon for the Company by Day Edwards Federman Propester &
Christensen, P.C., Oklahoma City, Oklahoma. Phillips McFall McCaffrey McVay &
Murrah, P.C., Oklahoma City, Oklahoma, has served as counsel to the Underwriters
in connection with this Offering.
EXPERTS
The consolidated balance sheet of CD Warehouse, Inc. at October 15, 1996,
appearing in this Prospectus and Registration Statement has been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and is included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.
The consolidated financial statements of Compact Discs International, Ltd.
and the financial statements of CD Acquisitions at December 31, 1995 and for
each of the two years in the period then ended, appearing in this Prospectus and
Registration Statement have been audited by Huselton & Morgan, P.C., independent
auditors, as set forth in their reports thereon appearing elsewhere herein, and
are included in reliance upon such reports given upon the authority of such firm
as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed a Registration Statement on Form SB-2 (the
"Registration Statement") with the Commission under the Securities Act with
respect to the securities offered hereby. As permitted by the rules and
regulations of the Commission, this Prospectus does not contain all of the
information set forth in the Registration Statement and in the exhibits and
schedules thereto. For further information with respect to the Company and the
securities offered hereby, reference is made to the Registration Statement and
the exhibits thereto. Statements contained in this Prospectus concerning the
provisions of documents
51
<PAGE>
filed with the Registration Statement as exhibits and schedules are necessarily
summaries of such documents, and each such statement is qualified in its
entirety by reference to the copy of the applicable document filed with the
Commission. The Registration Statement, including the exhibits and schedules
thereto, may be inspected without charge and copied upon payment of the charges
prescribed by the Commission at the Public Reference Room of the Commission,
Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission
maintains a website that contains reports, proxy and information statements and
other information regarding issuers that file electronically with the Commission
at http://www.sec.gov.
52
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
FINANCIAL STATEMENT OF CD WAREHOUSE, INC.
Report of Independent Auditors.......................................... F-3
Consolidated Balance Sheet at October 15, 1996.......................... F-4
Notes to Consolidated Balance Sheet..................................... F-5
FINANCIAL STATEMENTS OF COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
Independent Auditors' Report............................................ F-8
Consolidated Balance Sheet at December 31, 1995......................... F-9
Consolidated Statements of Income for the years ended December 31, 1994
and 1995.............................................................. F-10
Consolidated Statements of Partners' Capital for the years ended
December 31, 1994 and 1995............................................ F-11
Consolidated Statements of Cash Flows for the years ended December 31,
1994 and 1995......................................................... F-12
Notes to Consolidated Financial Statements.............................. F-13
FINANCIAL STATEMENTS OF CD ACQUISITIONS
Independent Auditors' Report............................................ F-18
Balance Sheet at December 31, 1995...................................... F-19
Statements of Income and Venturers' Capital for the years ended December
31, 1994 and 1995..................................................... F-20
Statements of Cash Flows for the years ended December 31, 1994 and
1995.................................................................. F-21
Notes to Financial Statements........................................... F-22
UNAUDITED COMBINED FINANCIAL STATEMENTS OF COMPACT DISCS INTERNATIONAL,
LTD. AND SUBSIDIARY AND CD ACQUISITIONS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1995 AND CONSOLIDATED FINANCIAL STATEMENTS OF COMPACT
DISCS INTERNATIONAL, LTD. AND SUBSIDIARY FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1996
Consolidated Balance Sheet at September 30, 1996........................ F-24
Statements of Income for the nine months ended September 30, 1995 and
1996.................................................................. F-25
Statements of Partners' Capital for the nine months ended September 30,
1995 and 1996......................................................... F-27
Statements of Cash Flows for the nine months ended September 30, 1995
and 1996.............................................................. F-28
Notes to Financial Statements........................................... F-29
</TABLE>
F-1
<PAGE>
CONSOLIDATED BALANCE SHEET
CD WAREHOUSE, INC.
OCTOBER 15, 1996
WITH REPORT OF INDEPENDENT AUDITORS
F-2
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Stockholders
CD Warehouse, Inc.
We have audited the accompanying consolidated balance sheet of CD Warehouse,
Inc. as of October 15, 1996. This consolidated balance sheet is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this balance sheet based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheet is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheet. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall balance sheet presentation. We
believe that our audit of the balance sheet provides a reasonable basis for our
opinion.
In our opinion, the consolidated balance sheet referred to above presents
fairly, in all material respects, the consolidated financial position of CD
Warehouse, Inc. at October 15, 1996, in conformity with generally accepted
accounting principles.
/s/ ERNST & YOUNG LLP
Oklahoma City, Oklahoma
October 26, 1996
except for the second paragraph of Note 2 as to which the date is
December 10, 1996
F-3
<PAGE>
CD WAREHOUSE, INC.
CONSOLIDATED BALANCE SHEET
OCTOBER 15, 1996
ASSETS
<TABLE>
<CAPTION>
Current assets:
<S> <C>
Cash and cash equivalents....................................................... $ 250,000
Organization costs................................................................ 2,431
Cash in escrow (NOTE 3)........................................................... 100,000
Deferred acquisition costs (NOTE 3)............................................... 59,599
Deferred offering costs (NOTE 3).................................................. 44,364
-------------
$ 456,394
-------------
-------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................ $ 55,394
Advances by stockholder (NOTE 3)................................................ 51,000
-------------
Total current liabilities......................................................... 106,394
Commitments (NOTE 3)
Stockholders' equity (NOTE 2):
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued....... --
Common stock, $.01 par value; 10,000,000 shares authorized, 350,000 shares
issued and outstanding........................................................ 3,500
Paid-in capital................................................................. 346,500
-------------
Total stockholders' equity........................................................ 350,000
-------------
$ 456,394
-------------
-------------
</TABLE>
See accompanying notes.
F-4
<PAGE>
CD WAREHOUSE, INC.
NOTES TO CONSOLIDATED BALANCE SHEET
OCTOBER 15, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND CONSOLIDATION
The consolidated balance sheet includes the accounts of CD Warehouse, Inc.
(the "Company") and its wholly-owned subsidiary, CD Management, Inc. ("CDM").
The Company was formed in Delaware on September 5, 1996. The Company has had no
operations during the period from September 5, 1996 to October 15, 1996.
CASH EQUIVALENTS
Cash equivalents include money-market investments with maturities of three
months or less when purchased.
ORGANIZATION COSTS
Organization costs will be amortized on a straight-line basis over five
years.
DEFERRED ACQUISITION COSTS
Costs incurred related to a proposed business acquisition (NOTE 3) have been
deferred and will be capitalized upon completion of the acquisition or charged
to expense if the acquisition is not completed.
DEFERRED OFFERING COSTS
Specific incremental costs directly attributable to a proposed initial
public offering of common stock (NOTE 3) have been deferred and will be charged
against the gross proceeds of the offering or charged to expense if the offering
is aborted.
2. STOCKHOLDERS' EQUITY
Effective September 5, 1996 and October 1, 1996, the Company obtained stock
subscription agreements for the sale of an aggregate of 700,000 shares of common
stock at $1 per share. During October 1996, the Company received $250,000 in
cash and the assignment of $100,000 cash in escrow (NOTE 3) in exchange for the
issuance of 350,000 shares of common stock. The subscription agreement for the
remaining 350,000 shares provides for payment to the Company concurrently with
the closing of the Company's proposed initial public offering of common stock
(NOTE 3).
On December 10, 1996, the Company adopted the 1996 Stock Option Plan which
provides for grants of up to 400,000 shares of common stock to certain
employees, officers, directors and others. Generally, the purchase price of
stock issuable upon exercise of the options will be at least equal to the fair
market value of the stock on the dates of grant. Generally, options are
exercisable no longer than ten years from the dates of grant. No options have
been granted to date. The Company has agreed to grant options to purchase 6,000
shares annually, subject to pro-rata vesting over a three-year period, to each
director.
3. COMMITMENTS
On October 1, 1996, the Company entered into an Asset Purchase Agreement
(the "Agreement") which provides for the purchase of substantially all of the
assets of Compact Discs International, Ltd. ("CDIL") for $3.2 million, subject
to downward adjustment, in cash. CDIL is engaged principally in the
F-5
<PAGE>
CD WAREHOUSE, INC.
NOTES TO CONSOLIDATED BALANCE SHEET
OCTOBER 15, 1996
3. COMMITMENTS (CONTINUED)
business of selling new and preowned audio compact discs to its franchisees. On
October 4, 1996, $100,000 in earnest money was placed in escrow pursuant to the
Agreement.
The Agreement also provides for the Company to enter into an area
development agreement (the "ADA") with the principal owner of CDIL. The ADA
provides for the right to develop franchise operations worldwide, except for the
United States, Canada and Mexico. The Company has the right, during a specified
period of time, to cancel the ADA and to acquire any franchise developed under
the ADA at a specified multiple of earnings. In addition, the Company has agreed
to grant to the principal owner of CDIL (1) ten domestic franchises with no
initial franchise fee and royalties of 2% of net sales and (2) two renewal
franchises with no franchise fee or royalty payments. Except as provided for in
the above mentioned franchise agreements, CDIL and the principal owner of CDIL
have entered into covenants not to compete with the Company for a period of ten
years.
In connection with the Agreement and the proposed initial public offering, a
stockholder has incurred costs of $51,000 (including $20,000 relating to a
finder's fee contingent upon the closing of the purchase) through October 15,
1996, on behalf of the Company, for payment of services related to such
transactions. Upon closing of the purchase, the Company will be liable for the
balance of the finder's fee in the amount of $80,000.
On October 10, 1996, the Company and CDM entered into agreements which
provide for the purchase of all of the franchise interests of the largest CDIL
franchisee in exchange for 80,000 shares of the Company's common stock.
Closings of the above mentioned purchases are subject to the satisfaction of
several conditions precedent, including the Company's completion of an initial
public offering of its common stock, or closing of another financing
arrangement, by February 28, 1997 for at least $3.5 million.
The Company has entered into employment agreements with the four existing or
committed officers of the Company, effective after the Company's completion of
an initial public offering. The employment agreements are for terms of one and
five years with renewal options of one and five years and total $355,000
annually for the four individuals.
F-6
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
WITH
INDEPENDENT AUDITORS' REPORT
F-7
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the General Partner
Compact Discs International, Ltd. and Subsidiary
We have audited the accompanying consolidated balance sheet of Compact Discs
International, Ltd. (A Texas Limited Partnership) and Subsidiary as of December
31, 1995, and the related consolidated statements of income, partners' capital,
and cash flows for each of the two years then ended. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Compact Discs International, Ltd. and Subsidiary as of December 31, 1995, and
the consolidated results of its operations and its cash flows for each of the
two years then ended in conformity with generally accepted accounting
principles.
/s/ HUSELTON & MORGAN, P.C.
Dallas, Texas
March 6, 1996, except for Note 2,
as to which the date is October 10, 1996
F-8
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1995
ASSETS
<TABLE>
<S> <C>
Current assets
Cash............................................................................ $ 48,495
Accounts receivable (net of allowance of $70,171)............................... 228,887
Due from CD Acquisitions........................................................ 111,316
Inventory....................................................................... 50,275
Prepaid expenses................................................................ 1,179
---------
Total current assets.......................................................... 440,152
---------
Furniture, fixtures and equipment (net of accumulated depreciation)............... 39,108
---------
Investment in partnerships........................................................ 25,231
Other assets (net of amortization)................................................ 5,288
---------
Total investment and other assets............................................. 30,519
---------
Total assets.................................................................. $ 509,779
---------
---------
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities
Accounts payable................................................................ $ 4,075
Sales tax payable............................................................... 2,219
Payroll taxes payable........................................................... 744
Development fees advanced....................................................... 60,521
---------
Total current liabilities..................................................... 67,559
---------
Minority interest................................................................. 11,981
Partners' capital................................................................. 430,239
---------
Total liabilities and partners' capital....................................... $ 509,779
---------
---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Revenue
Royalty income........................................................................ $ 526,714 $ 946,640
Retail sales.......................................................................... 272,119 291,948
Franchise fees........................................................................ 146,428 109,750
Development fees...................................................................... 7,500 74,500
Software income....................................................................... 62,400 23,683
----------- -----------
Total revenue....................................................................... 1,015,161 1,446,521
----------- -----------
Expenses
Salaries.............................................................................. 215,712 332,333
Cost of goods sold--retail sales...................................................... 183,344 181,312
Bad debts............................................................................. 0 113,539
Travel................................................................................ 33,819 44,029
Telephone & utilities................................................................. 20,774 43,208
Rent.................................................................................. 37,188 41,027
Taxes................................................................................. 21,734 29,289
Professional fees..................................................................... 53,798 19,006
Office expense........................................................................ 8,323 18,487
Advertising........................................................................... 31,266 14,745
Depreciation.......................................................................... 14,065 9,189
Miscellaneous......................................................................... 0 8,666
Printing.............................................................................. 11,208 7,927
Insurance............................................................................. 884 5,768
Auto expense.......................................................................... 4,229 5,314
Entertainment......................................................................... 3,220 4,974
Postage............................................................................... 3,226 4,578
Promotion............................................................................. 1,369 4,218
Licenses.............................................................................. 0 4,136
Supplies.............................................................................. 2,706 4,011
Contract labor........................................................................ 1,780 2,542
Repairs & maintenance................................................................. 3,673 1,594
Security.............................................................................. 0 1,355
Bank charges.......................................................................... 408 820
Amortization.......................................................................... 285 456
Dues & subscriptions.................................................................. 195 455
Photography........................................................................... 69 356
Interest expense...................................................................... 621 46
Fees.................................................................................. 0 21
Litigation settlement................................................................. 39,793 0
Penalty............................................................................... 452 0
Commissions........................................................................... 8,500 0
----------- -----------
Total expenses...................................................................... 702,641 903,401
----------- -----------
Operating income........................................................................ 312,520 543,120
Other income
Equity in income of partnerships...................................................... 0 2,898
Interest income....................................................................... 0 89
Miscellaneous......................................................................... 3,405 0
----------- -----------
Net income before minority interest..................................................... 315,925 546,107
Minority interest....................................................................... (2,632) (7,293)
----------- -----------
Net income.......................................................................... $ 313,293 $ 538,814
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-10
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Beginning balance....................................................................... $ 101,613 $ 187,702
Net income.............................................................................. 313,293 538,814
Distributions........................................................................... (227,204) (296,277)
----------- -----------
Ending balance.......................................................................... $ 187,702 $ 430,239
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-11
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income.......................................................................... $ 313,293 $ 538,814
Noncash items
Bad debt expense.................................................................... 0 70,171
Depreciation and amortization....................................................... 14,350 9,645
Minority interest................................................................... 1,227 7,293
Equity in income of partnerships.................................................... 0 (2,898)
Adjustments to reconcile net income to cash provided by operating activities
Increase in accounts receivable................................................... (38,946) (224,071)
Increase in due from CD Acquisitions.............................................. (64,023) (69,791)
Increase in inventory............................................................. (8,811) (11,327)
Increase in prepaid expenses...................................................... (2,087) (1,179)
Increase in organization cost..................................................... (1,400) 0
Increase in development fees advanced............................................. 57,000 13,521
Increase (decrease) in accrued liabilities........................................ 5,976 (11,829)
Increase (decrease) in accounts payable........................................... 2,163 (1,997)
----------- -----------
Net cash provided by operating activities....................................... 278,742 316,352
Cash flows from investing activities
Purchase of fixed assets.............................................................. (37,044) (17,355)
Distributions from partnership--Memphis store......................................... 0 167
Distribution to minority interest owner............................................... 0 (5,040)
----------- -----------
Net cash used by investing activities........................................... (37,044) (22,228)
Cash flows from financing activities
Distributions to partners............................................................. (227,204) (296,277)
Repayment of loan to Leo Kane......................................................... (8,979) (2,842)
Loan from Leo Kane.................................................................... 11,821 0
----------- -----------
Net cash used by financing activities........................................... (224,362) (299,119)
Net increase (decrease) in cash......................................................... 17,336 (4,995)
Cash at beginning of year............................................................... 36,154 53,490
----------- -----------
Cash at end of year..................................................................... $ 53,490 $ 48,495
----------- -----------
----------- -----------
</TABLE>
Supplemental information:
1994-- A note payable in the amount of $11,821 was given for the purchase of
two automobiles.
1995-- Trade receivables in the amount of $22,500 are exchanged for a minority
interest in a general partnership.
-- Development fees advanced in the amount of $22,500 are used to satisfy
various trade receivables.
The accompanying notes are an integral part of these financial statements.
F-12
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995
1. ORGANIZATION
THE COMPANY
Compact Discs International, Ltd. (the "Company") is a Texas limited
partnership which conducts business under the name "CD Warehouse" and maintains
its principal office in Richardson, Texas.
The Company offers and sells single-unit franchises and development rights
for multi-unit franchises for the operation of retail sales outlets which buy,
sell and trade new and used compact discs and related items (Note 8). As of
December 31, 1994 and 1995, the Company has executed 73 and 112 franchise
agreements respectively for the operation of stores, of which 67 were
operational in 1994 and 96 are operational in 1995. The Company has 11
development agreements in place as of December 31, 1995.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and CD Warehouse - Fort Worth, an 81.25% owned subsidiary; the remaining 18.75%
is owned by an unrelated third party investor. All significant intercompany
accounts and transactions have been eliminated in consolidation. Minority
interest in the consolidated subsidiary represents the minority owner's
proportionate share of the equity of CD Warehouse - Fort Worth.
INVENTORY
Inventory consists primarily of both new and used compact discs. All
inventory is valued at the lower of cost or market using the first-in, first-out
(FIFO) method. The inventory is located for resale at the subsidiary's location
in Fort Worth, Texas.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are stated at cost. The provision for
depreciation has been calculated using the straight-line method. Useful lives
range from 3 to 7 years.
OTHER ASSETS
Organization costs and the Company's trademark are being amortized using the
straight-line method over five and fifteen years, respectively.
INVESTMENT IN PARTNERSHIPS
The Company records its ownership in two minority-owned partnerships that
own CD Warehouse stores using the equity method of accounting.
REVENUE RECOGNITION
Franchise fees are non-refundable. Franchise fee income is recognized upon
the opening of the related store. The Company's commitment and obligations to
franchisees are not significant after the store is opened. Development right
fees paid are recognized as income on a prorated basis as the franchise units
within a development agreement are opened. Development fees are non-refundable,
but can be applied
F-13
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994 AND 1995
1. ORGANIZATION (CONTINUED)
against future franchise fees and royalty fees due from development franchisees.
Royalties are based on a percentage of franchisees' monthly gross sales and are
recognized when earned. Specially designed software and computer equipment are
sold to the franchisees, and the related income is recognized when earned.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results may differ from those estimates.
2. CHANGE IN METHOD OF ACCOUNTING
Subsequent to the original audit date of these financial statements, March
6, 1996, management of the Company changed its method of accounting for
development fee income. In the prior financial statements, the total amount
deposited for development rights was recognized as income upon the opening of
the first franchise within a development agreement. As Note 1 indicates, these
financial statements recognize development fee income on a prorated basis as the
franchise units within a development agreement are opened. The change increased
income $4,095, increased development fee advances $50,321, and decreased
partners' capital $50,321, from what was originally reported in the financial
statements audited March 6, 1996.
3. FURNITURE, FIXTURES AND EQUIPMENT
Components of furniture, fixtures and equipment at December 31, 1994 and
1995 are as follows:
<TABLE>
<CAPTION>
1994 1995
---------- ----------
<S> <C> <C>
Equipment....................................................................... $ 15,708 $ 28,861
Furniture and fixtures.......................................................... 19,339 23,541
Automobiles..................................................................... 12,386 12,386
Leasehold improvements.......................................................... 10,102 10,101
---------- ----------
Total....................................................................... 57,535 74,889
Accumulated depreciation........................................................ (26,592) (35,781)
---------- ----------
Total....................................................................... $ 30,943 $ 39,108
---------- ----------
---------- ----------
</TABLE>
F-14
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994 AND 1995
4. OTHER ASSETS
Components of other assets at December 31, 1994 and 1995 are as follows:
<TABLE>
<CAPTION>
1994 1995
--------- ---------
<S> <C> <C>
Deposits............................................................................. $ 3,561 $ 3,560
Organization costs................................................................... 2,150 2,150
Trademark............................................................................ 394 394
--------- ---------
Total............................................................................ 6,105 6,104
Accumulated amortization............................................................. (360) (816)
--------- ---------
Total............................................................................ $ 5,745 $ 5,288
--------- ---------
--------- ---------
</TABLE>
5. INVESTMENT IN PARTNERSHIPS
In the latter part of 1995 the Company entered into two partnership
agreements to own and operate retail CD outlets in Tulsa, Oklahoma and Memphis,
Tennessee. At December 31, 1995, the Company has the following investments in
general partnerships:
<TABLE>
<CAPTION>
PERCENTAGE
PARTNERSHIP OWNED
- -------------------------------------------------------------------------------------------- -----------
<S> <C>
CD Warehouse--Tulsa......................................................................... 50
CD Warehouse--Memphis....................................................................... 25
</TABLE>
At December 31, 1995, the Company's investment in partnerships and equity in
the income of these partnerships for the year then ended consist of the
following:
<TABLE>
<CAPTION>
INVESTMENT IN PARTNERSHIP
PARTNERSHIP INCOME
------------- -----------
<S> <C> <C>
CD Warehouse--Tulsa......................................................... $ 22,853 $ 353
CD Warehouse--Memphis....................................................... 2,378 2,545
------------- -----------
$ 25,231 $ 2,898
------------- -----------
------------- -----------
</TABLE>
The following summarizes the activity of the CD Warehouse--Tulsa and the CD
Warehouse-- Memphis partnerships for the year ended December 31, 1995:
<TABLE>
<CAPTION>
CD WAREHOUSE CD WAREHOUSE
TULSA MEMPHIS
-------------- --------------
<S> <C> <C>
Total assets...................................................................... $ 65,157 $ 58,722
Total liabilities................................................................. 5,388 3,210
------- -------
Net assets.................................................................... $ 59,769 $ 55,512
------- -------
------- -------
Revenues.......................................................................... $ 24,683 $ 98,734
------- -------
------- -------
Net income........................................................................ $ 707 $ 10,180
------- -------
------- -------
</TABLE>
F-15
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1994 AND 1995
6. COMMITMENTS AND CONTINGENCIES
The Company leases office space under a non-cancelable operating lease
agreement. The agreement expires in 1997. The Company also leases retail space
for its store operation. This agreement expires in 1996. Total rent expense for
the years ended December 31, 1994 and 1995 was $37,188 and $41,027,
respectively.
The following is a schedule of future minimum lease payments for the above
leases as of December 31, 1995:
<TABLE>
<S> <C>
Year ending December 31, 1996.............................................. $ 27,426
Year ending December 31, 1997.............................................. 5,694
---------
$ 33,120
---------
---------
</TABLE>
7. INCOME TAXES
Taxable income of the Company is includable in the income returns of the
individual partners; therefore, no provision for income taxes has been made in
the accompanying financial statements.
8. RELATED-PARTY TRANSACTIONS
In 1994 the Company purchased from Mr. Leo Kane, a limited partner, two
automobiles for a total of $11,821. Mr. Leo Kane received a note for the
purchase. In 1994, the Company was making note payments of $800 per month. For
the year ended December 31, 1994, the Company had reduced the note by $8,979 and
paid Mr. Leo Kane interest of $621. The note was fully paid in 1995, reducing
the note by $2,842. Interest paid to Mr. Leo Kane in 1995 is $44.
The partners of the Company own, through a joint venture, CD Acquisitions,
"CDA." CDA sells new and used merchandise to franchisees. The franchisees
included CD Warehouse--Fort Worth, Tulsa and Memphis. Sales to these three
franchisees amounted to $31,000 and $108,800 in the years ending December 31,
1994 and 1995, respectively. CDA operates out of the Company's location with no
contribution to overhead expenses.
CDA owes the Company $64,023 and $111,316 at December 31, 1994 and 1995,
respectively.
F-16
<PAGE>
CD ACQUISITIONS
FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
WITH
INDEPENDENT AUDITORS' REPORT
F-17
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Venturers
CD Acquisitions
We have audited the accompanying balance sheet of CD Acquisitions (A Joint
Venture) as of December 31, 1995, and the related statements of income,
venturers' capital, and cash flows for each of the two years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CD Acquisitions as of
December 31, 1995, and the results of its operations and its cash flows for each
of the two years then ended in conformity with generally accepted accounting
principles.
/s/ HUSELTON & MORGAN, P.C.
Dallas, Texas
October 5, 1996
F-18
<PAGE>
CD ACQUISITIONS
(A JOINT VENTURE)
BALANCE SHEET
DECEMBER 31, 1995
ASSETS
<TABLE>
<S> <C>
Current assets
Cash............................................................................ $ 159,444
Accounts receivable, net of allowance of $12,859................................ 194,441
Inventory....................................................................... 305,757
Prepaid insurance............................................................... 7,913
---------
Total current assets.......................................................... 667,555
---------
---------
Total assets.................................................................. $ 667,555
---------
---------
LIABILITIES AND VENTURERS' CAPITAL
Current liabilities
Accounts payable................................................................ $ 411,805
Due to Compact Discs International, Ltd......................................... 111,316
Advances from CD Stores......................................................... 7,997
Accrued insurance............................................................... 6,430
Sales tax payable............................................................... 1,911
---------
Total current liabilities..................................................... 539,459
---------
Venturers' capital................................................................ 128,096
---------
Total liabilities and venturers' capital...................................... $ 667,555
---------
---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE>
CD ACQUISITIONS
(A JOINT VENTURE)
STATEMENTS OF INCOME AND VENTURERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
------------- -------------
<S> <C> <C>
Net Sales........................................................................... $ 1,567,566 $ 2,717,043
Cost of goods sold.................................................................. (1,539,006) (2,511,032)
------------- -------------
Gross profit on sales............................................................... 28,560 206,011
------------- -------------
Administrative and selling expenses................................................. 18,694 77,918
------------- -------------
Net income........................................................................ 9,866 128,093
Venturers' capital (deficit), beginning of year..................................... (9,863) 3
------------- -------------
Venturers' capital, end of year..................................................... $ 3 $ 128,096
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE>
CD ACQUISITIONS
(A JOINT VENTURE)
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1994 AND 1995
<TABLE>
<CAPTION>
1994 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................................. $ 9,866 $ 128,093
Adjustments to reconcile net income to cash provided by operating activities
Bad debt expense..................................................................... 0 12,859
(Increase) decrease in:
Accounts receivable.................................................................. (203,677) 10,342
Inventory............................................................................ (131,205) (145,948)
Prepaid insurance.................................................................... 0 (7,913)
----------- -----------
Increase in:
Accounts payable..................................................................... 350,636 90,412
Accrued expenses..................................................................... 0 12,522
----------- -----------
Net cash provided by operating activities............................................ 25,620 100,367
Cash at beginning of year................................................................ 33,457 59,077
----------- -----------
Cash at end of year...................................................................... $ 59,077 $ 159,444
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE>
CD ACQUISITIONS
(A JOINT VENTURE)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995
1. ACCOUNTING AND FINANCIAL REPORTING POLICIES
CD Acquisitions (the "Company") is a joint venture among two individuals and
a limited liability company owned by one of the same individuals and his spouse.
The principal office of operations is located in Richardson, Texas. The Company
is a wholesale distributor of new and used compact discs.
The significant accounting policies utilized in the preparation of the
financial statements are as follows:
INVENTORY
Inventory of the Company consists of compact discs for sale to franchisees
of an affiliate (Note 2). Inventory is stated at the lower of cost or market.
Cost is determined by using a moving average method.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results may differ from those estimates.
2. RELATED PARTY TRANSACTIONS
At December 31, 1994 and 1995, the Company has the following balance owed to
related parties:
<TABLE>
<CAPTION>
1994 1995
--------- ----------
<S> <C> <C>
Due to Compact Discs International, Ltd................................ $ 64,023 $ 111,316
--------- ----------
--------- ----------
</TABLE>
Owners of the joint venture also own an interest in Compact Discs
International, Ltd. ("CDIL"). CDIL offers and sells single-unit franchises and
development rights for multi-unit franchises for the operation of retail outlets
which buy, sell and trade new and used compact discs. All of the Company's 1994
and 1995 sales were to franchisees of CDIL. The Company operates out of the
office and warehouse of CDIL at no charge to the Company.
3. INCOME TAXES
Taxable income or loss of the Company is includable in the income tax
returns of the venturers; therefore, no provision for income taxes has been made
in the accompanying financial statements.
F-22
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS (A JOINT VENTURE)
UNAUDITED COMBINED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD.
AND SUBSIDIARY
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
F-23
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
SEPTEMBER 30, 1996
ASSETS
<TABLE>
<S> <C>
Current assets
Cash.......................................................................... $ 220,343
Accounts receivable (net of allowance of $107,158)............................ 361,677
Inventory..................................................................... 579,169
Prepaid expenses.............................................................. 12,423
--------------
Total current assets........................................................ 1,173,612
--------------
Furniture, fixtures and equipment (net of accumulated depreciation)............. 40,893
--------------
Investments in partnerships..................................................... 70,219
Other assets (net of amortization).............................................. 4,946
--------------
Total investments and other assets............................................ 75,165
--------------
Total assets................................................................ $ 1,289,670
--------------
--------------
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities
Accounts payable.............................................................. $ 636,822
Sales tax payable............................................................. 3,868
Payroll taxes payable......................................................... 149
Development fees advanced..................................................... 41,100
Advances from CD stores....................................................... 60,000
--------------
Total current liabilities................................................... 741,939
--------------
Minority interest............................................................... 905
Partners' capital............................................................... 546,826
--------------
Total liabilities and partners' capital..................................... $ 1,289,670
--------------
--------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
COMBINED STATEMENT OF INCOME
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Revenue
Retail sales........................................................................ $ 1,966,290 $ 2,642,771
Royalty income...................................................................... 670,401 856,175
Computer/Software income............................................................ 96,814 53,295
Franchise fees...................................................................... 61,250 53,000
Development fees.................................................................... 81,000 7,500
------------ ------------
Total revenue....................................................................... 2,875,755 3,612,741
------------ ------------
Expenses
Cost of goods sold--retail sales.................................................... 1,721,373 2,423,149
Salaries............................................................................ 274,935 255,886
Bad debts........................................................................... 87,210 106,213
Cost of goods sold--computer........................................................ 95,572 45,238
Professional fees................................................................... 9,557 35,408
Rent................................................................................ 31,298 32,841
Telephone & utilities............................................................... 39,286 26,395
Travel.............................................................................. 30,775 25,978
Taxes............................................................................... 25,664 22,303
Commissions......................................................................... 0 21,478
Insurance........................................................................... 1,761 20,031
Office expense...................................................................... 15,481 15,588
Advertising......................................................................... 25,487 9,054
Promotion........................................................................... 800 9,015
Depreciation........................................................................ 8,184 8,876
Printing............................................................................ 6,393 7,966
Postage............................................................................. 3,075 6,496
Supplies............................................................................ 3,093 4,849
Auto expense........................................................................ 3,142 4,105
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
COMBINED STATEMENT OF INCOME (CONTINUED)
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENT OF INCOME (CONTINUED)
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Expenses (continued)
Repairs & maintenance............................................................... 1,289 3,929
Entertainment....................................................................... 3,141 3,783
Licenses............................................................................ 4,136 3,770
Miscellaneous....................................................................... 10,929 3,750
Contract labor...................................................................... 1,792 2,400
Security............................................................................ 884 1,879
Dues & subscriptions................................................................ 455 1,382
Bank charges........................................................................ 992 939
Amortization........................................................................ 371 342
Photography......................................................................... 288 140
Interest expense.................................................................... 44 41
Litigation settlement............................................................... 1,778 0
------------ ------------
Total expenses.................................................................... 2,409,185 3,103,224
------------ ------------
Operating income...................................................................... 466,570 509,517
Other income
Equity in income of partnerships.................................................... 0 31,962
Interest income..................................................................... 89 3
------------ ------------
Net income before minority interest................................................... 466,659 541,482
Minority interest..................................................................... (5,637) (3,165)
------------ ------------
Net income........................................................................ $ 461,022 $ 538,317
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
COMBINED STATEMENT OF PARTNERS' CAPITAL
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENT OF PARTNERS' CAPITAL
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Beginning balance....................................................................... $ 187,705 $ 558,335
Net income.............................................................................. 461,022 538,317
Distributions:
Cash.................................................................................. (251,997) (405,184)
Noncash............................................................................... 0 (144,642)
----------- -----------
Ending balance.......................................................................... $ 396,730 $ 546,826
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
COMBINED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................................................ $ 461,022 $ 538,317
Noncash items
Bad debt expense.................................................................... 87,210 106,213
Depreciation and amortization....................................................... 8,555 9,218
Equity in income of partnerships.................................................... 0 (31,962)
Minority interest................................................................... 5,637 3,165
Adjustments to reconcile net income to cash provided by
operating activities
(Increase) in accounts receivable................................................... (45,516) 53,728
Increase (decrease) in accounts payable............................................. (14,146) 109,626
(Increase) in inventory............................................................. (233,287) (223,137)
Increase in accrued liabilities..................................................... 5,015 25,295
(Increase) in prepaid expenses...................................................... 0 (3,332)
----------- -----------
Net cash provided by operating activities......................................... 274,490 587,131
Cash flows from investing activities
Purchase of fixed assets.............................................................. (14,306) (10,660)
----------- -----------
Net cash used by investing activities............................................. (14,306) (10,660)
Cash flows from financing activities
Distributions to partners............................................................. (251,997) (549,826)
Minority interest distributions....................................................... (4,610) (14,241)
----------- -----------
Net cash used by financing activities............................................. (256,607) (564,067)
----------- -----------
Net increase in cash.................................................................... 3,577 12,404
Cash at beginning of period............................................................. 112,567 207,939
----------- -----------
Cash at end of period................................................................... $ 116,144 $ 220,343
----------- -----------
----------- -----------
</TABLE>
SUPPLEMENTAL INFORMATION:
Accounts receivable due from partners of the Company in the amount of
$144,642 were discharged and recognized as a distribution to the partners.
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
1. ORGANIZATION
THE COMPANY
Compact Discs International, Ltd. (the "Company") is a Texas limited
partnership which conducts business under the name "CD Warehouse" and maintains
its principal office in Richardson, Texas.
Effective January 1, 1996, CD Acquisitions ("CDA"), a joint venture owned
and operated by CDIL's partners, was merged into CDIL. The financial information
at August 31, 1995 is comprised of combined figures of the Company and CDA in
order to provide comparative totals for September 30, 1996.
The Company offers and sells single-unit franchises and development rights
for multi-unit franchises for the operation of retail sales outlets which buy,
sell and trade new and used compact discs and related items. As of September 30,
1995 and 1996, the Company has executed 104 and 114 franchise agreements,
respectively, for the operation of stores, of which 91 were operational in 1995
and 109 are operational in 1996. The Company has 11 development agreements in
place as of September 30, 1995 and 3 as of September 30, 1996.
FINANCIAL STATEMENTS
These financial statements are unaudited and reflect all adjustments,
consisting only of adjustments of a normal recurring nature, which are, in the
opinion of management, necessary for a fair presentation of the interim periods.
The results of operations for the nine months ended September 30, 1996 are not
necessarily indicative of the results to be expected for the full year.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and CD Warehouse-- Fort Worth, an 81.25% owned subsidiary; the remaining 18.75%
is owned by an unrelated third party investor. All significant intercompany
accounts and transactions have been eliminated in consolidation. Minority
interest in the consolidated subsidiary represents the minority owner's
proportionate share of the equity of CD Warehouse--Fort Worth.
INVENTORY
Inventory consists primarily of both new and used compact discs. All
inventory is valued at the lower of cost or market using the first-in, first-out
(FIFO) method.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are stated at cost. The provision for
depreciation has been calculated using the straight-line method. Useful lives
range from 3 to 7 years.
F-29
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996
1. ORGANIZATION (CONTINUED)
OTHER ASSETS
Organization costs and the Company's trademark are being amortized using the
straight-line method over five and fifteen years, respectively.
INVESTMENT IN PARTNERSHIPS
The Company records its ownership in four minority-owned partnerships that
own CD Warehouse stores using the equity method of accounting.
REVENUE RECOGNITION
Franchise fees are non-refundable. Franchise fee income is recognized upon
the opening of the related store. The Company's commitment and obligations to
franchisees are not significant after the store is opened. Development right
fees paid are recognized as income on a prorated basis as franchise units within
a development agreement are opened. Development fees are non-refundable, but can
be applied against future franchise fees and royalty fees due from development
franchisees. Royalties are based on a percentage of franchisees' monthly gross
sales, and are recognized when earned. Specially designed software and computer
equipment are sold to the franchisees, and the related income is recognized when
earned.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results may differ from those estimates.
2. FURNITURE, FIXTURES AND EQUIPMENT
Components of furniture, fixtures and equipment at September 30, 1996 are as
follows:
<TABLE>
<S> <C>
Equipment......................................................... $ 31,607
Furniture and fixtures............................................ 24,537
Automobiles....................................................... 16,528
Leasehold improvements............................................ 10,101
---------
Total..................................................... 82,773
Accumulated depreciation.......................................... (41,880)
---------
Total..................................................... $ 40,893
---------
---------
</TABLE>
F-30
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996
3. OTHER ASSETS
Components of other assets at September 30, 1996 are as follows:
<TABLE>
<S> <C>
Deposits........................................................... $ 3,560
Organization costs................................................. 2,150
Trademark.......................................................... 394
---------
Total...................................................... 6,104
Accumulated amortization........................................... (1,158)
---------
Total...................................................... $ 4,946
---------
---------
</TABLE>
4. INVESTMENTS IN PARTNERSHIPS
In the latter part of 1995 and in 1996, the Company entered into partnership
agreements to own and operate retail CD outlets in Tulsa, Oklahoma; Memphis,
Tennessee; Orange Park, Florida; and Edmond, Oklahoma. At September 30, 1996,
the Company has the following investments in general partnerships:
<TABLE>
<CAPTION>
PERCENTAGE
PARTNERSHIP OWNED
- ---------------------------------------------------------------------------------- ---------------
<S> <C>
CD Warehouse--Tulsa............................................................... 50
CD Warehouse--Memphis............................................................. 25
CD Warehouse--Orange Park......................................................... 50
CD Warehouse--Edmond.............................................................. 50
</TABLE>
The Company held no investments prior to September 30, 1995.
At September 30, 1996, the Company's investments in partnerships and equity
in the income of these partnerships for the nine months ended September 30, 1996
consist of the following:
<TABLE>
<CAPTION>
INVESTMENT IN PARTNERSHIP
PARTNERSHIP INCOME
------------- -----------
<S> <C> <C>
CD Warehouse--Tulsa............................................... $ 27,888 $ 9,285
CD Warehouse--Memphis............................................. 3,389 10,386
CD Warehouse--Orange Park......................................... 18,290 12,291
CD Warehouse--Edmond.............................................. 20,652 0
------------- -----------
$ 70,219 $ 31,962
------------- -----------
------------- -----------
</TABLE>
F-31
<PAGE>
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
AND CD ACQUISITIONS
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995
AND
COMPACT DISCS INTERNATIONAL, LTD. AND SUBSIDIARY
(A TEXAS LIMITED PARTNERSHIP)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996
4. INVESTMENTS IN PARTNERSHIPS (CONTINUED)
The following summarizes the activity of the CD Warehouse equity investments
of the Company for the nine months ending September 30, 1996:
<TABLE>
<CAPTION>
CD WAREHOUSE CD WAREHOUSE CD WAREHOUSE CD WAREHOUSE
EDMOND ORANGE PARK TULSA MEMPHIS
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Total assets...................................... $ 32,716 $ 85,608 $ 64,208 $ 66,912
Total liabilities................................. 32,630 2,425 321 2,193
-------------- -------------- -------------- --------------
Net assets...................................... $ 86 $ 83,183 $ 63,887 $ 64,719
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
Revenues.......................................... $ 36,001 $ 176,381 $ 192,094 $ 283,702
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
Net income........................................ $ 86 $ 24,580 $ 18,570 $ 41,545
-------------- -------------- -------------- --------------
-------------- -------------- -------------- --------------
</TABLE>
5. COMMITMENTS AND CONTINGENCIES
The Company leases office space under a non-cancelable operating lease
agreement. The agreement expires in 1997. The Company also leases retail space
for its store operation. This agreement expires in 1996. Total rent expense for
the nine months ending September 30, 1995 and 1996 was $31,298 and $32,841,
respectively.
The following is a schedule of future minimum lease payments for the above
leases as of September 30, 1996:
<TABLE>
<S> <C>
1996............................................................... $ 6,857
1997............................................................... 5,694
---------
$ 12,551
---------
---------
</TABLE>
6. INCOME TAXES
Taxable income of the Company is includable in the income tax returns of the
individual partners; therefore, no provision for income taxes has been made in
the accompanying financial statements.
7. RELATED-PARTY TRANSACTIONS
The Company sells new and used merchandise to franchisees. The franchisees
include the investee stores of CD Warehouse--Fort Worth, Tulsa, Memphis, Orange
Park, and Edmond. Sales to these five franchisees amounted to $77,644 and
$145,267 for the nine months ending September 30, 1995 and 1996.
F-32
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER,
TO, OR A SOLICITATIONOF, ANY PERSON IN ANY JURISDICTION WHERE SUCH OFFER OR
SOLICITATION WOULD BE UNLAWFUL.NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary........................................................ 3
Risk Factors.............................................................. 7
Use of Proceeds........................................................... 13
Dividend Policy........................................................... 13
Dilution.................................................................. 14
Capitalization............................................................ 15
Combined Statements of Operations......................................... 16
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 17
Pro Forma Combined Condensed Financial Statement.......................... 22
Business and Properties................................................... 29
Management................................................................ 40
Certain Transactions...................................................... 43
Principal Stockholders.................................................... 46
Description of Securities................................................. 46
Shares Eligible for Future Sale........................................... 48
Underwriting.............................................................. 50
Legal Matters............................................................. 51
Experts................................................................... 51
Additional Information.................................................... 51
Financial Statements...................................................... F-1
</TABLE>
1,000,000 SHARES
[LOGO]
COMMON STOCK
---------------------
PROSPECTUS
---------------------
CAPITAL WEST
SECURITIES, INC.
WESTPORT RESOURCES
INVESTMENT SERVICES, INC.
BERTHEL FISHER & COMPANY
FINANCIAL SERVICES, INC.
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
CD WAREHOUSE, INC.
REGISTRATION STATEMENT ON FORM SB-2
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
The General Corporation Law of the State of Delaware grants every
corporation the power to indemnify any person who was or is a party or is
threatened to be made a party to any threatened, pending, or completed action,
suit, or proceeding, whether civil, criminal, administrative, or investigative,
other than an action by or in the right of the corporation, by reason of the
fact that he is or was a director, officer, employee, or agent of the
corporation, or is or was serving at the request of the corporation as a
director, officer, employee, or agent of another corporation, partnership, joint
venture, trust, or other enterprise, against expenses, including attorneys'
fees, judgments, fines, and amounts paid in settlement actually and reasonably
incurred by him in connection with such action, suit, or proceeding if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the corporation, and, with respect to any criminal action
or proceeding, had no reasonable cause to believe his conduct was unlawful.
The Delaware statute also grants every corporation the power to indemnify
any person who was or is a party or is threatened to be made a party to any
threatened, pending, or completed action or suit by or in the right of the
corporation to procure a judgment in its favor by reason of the fact that he is
or was a director, officer, employee, or agent of the corporation, or is or was
serving at the request of the corporation as a director, officer, employee, or
agent of another corporation, partnership, joint venture, trust, or other
enterprise against expenses, including attorneys' fees, actually and reasonably
incurred by him in connection with the defense or settlement of such action or
suit if he acted in good faith and in a manner he reasonably believed to be in
or not opposed to the best interests of the corporation, except that no
indemnification shall be made in respect of any claim, issue, or matter as to
which such person shall have been adjudged to be liable for negligence or
misconduct in the performance of his duty to the corporation unless and only to
the extent that the court in which such action or suit was brought shall
determine upon application that, despite the adjudication of liability but in
view of all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the court shall deem proper.
The Delaware statute provides that to the extent that a director, officer,
employee, or agent of a corporation has been successful on the merits or
otherwise in defense of any action, suit, or proceeding referred to in the
statute, or in defense of any claim, issue, or matter therein, he shall be
indemnified against expenses, including attorneys' fees, actually incurred by
him in connection therewith.
Articles Nine and Eleven of the Registrant's Certificate of Incorporation
indemnify and exculpate the directors, officers, employees, and agents of the
Registrant from and against certain liabilities. Article Nine provides that the
Registrant shall indemnify to the full extent permitted under the General
Corporation Law of the State of Delaware any director, officer, employee, or
agent of the Registrant. Article Eleven provides that a director of the
Registrant shall have no personal liability to the Registrant or its
shareholders for monetary damages for breach of fiduciary duty as a director,
except for liability (a) for any breach of the director's duty of loyalty to the
Registrant or its shareholders, (b) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (c) for acts
or omissions specified in Section 174 of the General Corporation Law of the
State of Delaware regarding the unlawful payment of dividends and the unlawful
purchase or redemption of the Registrant's stock, and (d) for any transaction
from which the director derived an improper personal benefit.
II-1
<PAGE>
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than
underwriting discounts and commissions. All expenses of registration will be
borne by the Company. All of the amounts shown are estimates, except the
registration fee, and assume exercise of the underwriters' over-allotment
option.
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee............ $ 3,108.94
NASD fees...................................................... $ 1,300.00
Underwriters' non-accountable expense allowance................ $215,625.00
Legal fees and expenses........................................ $80,000.00
Accounting fees and expenses................................... $40,000.00
Printing and engraving expenses................................ $25,000.00
Nasdaq application fees........................................ $ 6,780.00
----------
TOTAL EXPENSES............................................... $371,813.94
----------
----------
</TABLE>
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
The following sets forth certain information regarding sales of securities
of the Company issued within the past three years, which were not registered
pursuant to the Securities Act of 1933, as amended (the "Securities Act").
The Company was organized as a Delaware corporation in September 1996. The
initial subscribing stockholders, who each subscribed on September 5, 1996, were
Jerry W. Grizzle for 230,000 shares of Common Stock, Matthew Grizzle (Mr.
Grizzle's son) under the Uniform Transfers to Minors Act ("UTMA") for 10,000
shares of Common Stock, Brittany Grizzle (Mr. Grizzle's daughter) under the UTMA
for 10,000 shares of Common Stock, Gary D. Johnson for 75,000 shares of Common
Stock and Doyle E. Motley for 25,000 shares of Common Stock. Each of such
stockholders paid a purchase price of $1.00 per share for the Common Stock thus
purchased. No sales commissions were paid in connection with such issuance. The
securities were issued in reliance on the exemption from registration provided
by Section 4(2) of the Securities Act.
The Company entered into a subscription agreement on October 1, 1996 with
Mark E. Kane for the sale to him of 350,000 shares of Common Stock, at a
purchase price of $1.00 per share. Payment of the subscription price is
conditioned upon the successful completion of the offering of Common Stock to
which this Registration Statement relates. Additionally, pursuant to agreements
with the Company and CD Management dated October 10, 1996, Bruce D. MacDonald
will be issued an aggregate of 80,000 shares of Common Stock in exchange for the
assignment to the Company or CD Management of certain equity interests owned by
MacDonald or his affiliates in 36 CD Warehouse franchise stores (the "MacDonald
Acquisition"). Issuance of the 80,000 shares, and completion of the MacDonald
Acquisition, is conditioned upon the successful completion of the offering of
Common Stock to which this Registration Statement relates. No sales commissions
were paid in connection with the subscription agreements. The securities, when
issued, will be issued in reliance on the exemption from registration provided
by Section 4(2) of the Securities Act.
II-2
<PAGE>
ITEM 27. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NAME OF EXHIBIT
- --------- --------------------------------------------------------------------------------------------------
<C> <S>
1.1 Underwriting Agreement between the Company and Capital West Securities, Inc., Westport Resources
Investment Services, Inc. and Berthel Fisher & Company Financial Services, Inc. (filed
electronically herewith)
2.1* Asset Purchase Agreement, dated as of October 1, 1996, by and among Compact Discs International,
Ltd., Mark E. Kane ("Kane") and the Company
2.2* Asset Purchase Agreement, dated as of October 10, 1996, by and between Bruce D. MacDonald
("MacDonald") and the Company
2.3* Assignment and Assumption Agreement, dated as of October 10, 1996, by and between MacDonald and
the Company
2.4* World-Wide Area Development Agreement, dated as of October 10, 1996, by and between Kane and the
Company
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
4.1* Specimen Certificate of the Common Stock
4.2 See Articles IV and VIII of the Company's Certificate of Incorporation and Article II of the
Company's Bylaws (included herein as Exhibits 3.1 and 3.2, respectively)
4.3 Form of Warrant Agreement between the Company and the Underwriters (filed electronically herewith)
4.4 Bank of Oklahoma, N.A. Credit Facility Commitment Letter (filed electronically herewith)
4.5* 1996 Stock Option Plan
5.1* Opinion of Day Edwards Federman Propester & Christensen, P.C. as to the legality of the securities
being registered
10.1* Employment Agreement by and between the Company and Grizzle
10.2* Employment Agreement by and between the Company and Johnson
10.3* Employment Agreement by and between the Company and MacDonald
10.4* Employment Agreement by and between the Company and Motley
10.5* Finders and Release Agreement, dated as of September 3, 1996, by and among the Company; Grizzle;
CDI Acquisition JV, a Texas joint venture; and CD Partners JV, a Texas joint venture
10.6* Asset Purchase Agreement, dated as of October 1, 1996, by and among Compact Discs International,
Ltd., Kane and the Company (included herein as Exhibit 2.1)
10.7* Asset Purchase Agreement, dated as of October 10, 1996, by and between MacDonald and the Company
(included herein as Exhibit 2.2)
10.8* Assignment and Assumption Agreement, dated as of October 10, 1996, by and between MacDonald and
the Company (included herein as Exhibit 2.3)
10.9 Bank of Oklahoma, N.A. Credit Facility Commitment Letter (included herein as Exhibit 4.4)
10.10* Form of Franchise Agreement
10.11* Form of Lock-up Agreement
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NAME OF EXHIBIT
- --------- --------------------------------------------------------------------------------------------------
<C> <S>
10.12* Form of Partnership Agreement
10.13* Form of Development Agreement
10.14* Lease Agreement dated October 28, 1996 by and between the Company and Magnolia Enterprises, Inc.
21.1* List of subsidiaries
23.1 Consent of Huselton & Morgan, P.C., Independent Accountants (filed electronically herewith)
23.2 Consent of Ernst & Young LLP., Independent Accountants (filed electronically herewith)
23.3 Consent of Day Edwards Federman Propester & Christensen, P.C. (included in Exhibit 5.1)
24.1* Powers of Attorney
</TABLE>
- ------------------------
* Previously filed.
ITEM 28. UNDERTAKINGS.
1. The undersigned Registrant hereby undertakes:
(a) To provide to the Underwriters at the closing specified in the
Underwriting Agreement certificates in such denominations and registered in such
names as required by the Underwriters to permit prompt delivery to each
purchaser.
(b) For determining any liability under the Securities Act, treat the
information omitted from the form of prospectus filed as part of this
Registration Statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act as part of this Registration Statement as of the time
the Commission declared it effective.
(c) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to:
(i) include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) reflect in the Prospectus any facts or events which, individually
or together, represent a fundamental change in the information in
the registration statement; and
(iii) include any additional or changed material information on the plan
of distribution.
(d) That, for the purpose of determining liability under the Securities Act,
each post-effective amendment shall be deemed to be a new registration statement
of the securities offered, and the offering of the securities at that time shall
be deemed to be the initial bona fide offering thereof.
(e) To file a post-effective amendment to remove from registration any of
the securities that remain unsold at the termination or end of the offering.
2. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
II-4
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
the requirements of filing on Form SB-2 and has duly caused this Amendment No. 2
to the Registration Statement on Form SB-2, File No. 333-15139, to be signed on
its behalf by the undersigned, thereon duly authorized in the City of Oklahoma
City, State of Oklahoma, on January 21, 1997.
CD WAREHOUSE, INC.
a Delaware corporation
By: /s/ *GARY D. JOHNSON
-----------------------------------------
Gary D. Johnson
EXECUTIVE VICE PRESIDENT AND
CHIEF OPERATING OFFICER
Pursuant to the requirement of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed below by the following
persons in the capacities and on the dates indicated:
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ *GARY D. JOHNSON Chairman of the Board of
- ------------------------------ Directors; President and January 21, 1997
Jerry W. Grizzle Chief Executive Officer
/s/ GARY D. JOHNSON Executive Vice President;
- ------------------------------ Chief Operating Officer; January 21, 1997
Gary D. Johnson Director
/s/ *GARY D. JOHNSON
- ------------------------------ Vice President--Company January 21, 1997
Bruce D. MacDonald Store Operations
/s/ DOYLE E. MOTLEY
- ------------------------------ Sr. Vice President, Chief January 21, 1997
Doyle E. Motley Financial Officer
/s/ *GARY D. JOHNSON
- ------------------------------ Director January 21, 1997
Christopher M. Salyer
/s/ *GARY D. JOHNSON
- ------------------------------ Director January 21, 1997
Ronald V. Perry
*By: /s/ GARY D. JOHNSON
- ------------------------------
ATTORNEY-IN-FACT
II-5
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NAME OF EXHIBIT
- --------- --------------------------------------------------------------------------------------------------
<C> <S>
1.1 Underwriting Agreement between the Company and Capital West Securities, Inc., Westport Resources
Investment Services, Inc. and Berthel Fisher & Company Financial Services, Inc. (filed
electronically herewith)
2.1* Asset Purchase Agreement, dated as of October 1, 1996, by and among Compact Discs International,
Ltd., Mark E. Kane ("Kane") and the Company
2.2* Asset Purchase Agreement, dated as of October 10, 1996, by and between Bruce D. MacDonald
("MacDonald") and the Company
2.3* Assignment and Assumption Agreement, dated as of October 10, 1996, by and between MacDonald and
the Company
2.4* World-Wide Area Development Agreement, dated as of October 10, 1996, by and between Kane and the
Company
3.1* Amended and Restated Certificate of Incorporation
3.2* Amended and Restated Bylaws
4.1* Specimen Certificate of the Common Stock
4.2 See Articles IV and VIII of the Company's Certificate of Incorporation and Article II of the
Company's Bylaws (included herein as Exhibits 3.1 and 3.2, respectively)
4.3 Form of Warrant Agreement between the Company and the Underwriters (filed electronically herewith)
4.4 Bank of Oklahoma, N.A. Credit Facility Commitment Letter (filed electronically herewith)
4.5* 1996 Stock Option Plan
5.1* Opinion of Day Edwards Federman Propester & Christensen, P.C. as to the legality of the securities
being registered
10.1* Employment Agreement by and between the Company and Grizzle
10.2* Employment Agreement by and between the Company and Johnson
10.3* Employment Agreement by and between the Company and MacDonald
10.4* Employment Agreement by and between the Company and Motley
10.5* Finders and Release Agreement, dated as of September 3, 1996, by and among the Company; Grizzle;
CDI Acquisition JV, a Texas joint venture; and CD Partners JV, a Texas joint venture
10.6* Asset Purchase Agreement, dated as of October 1, 1996, by and among Compact Discs International,
Ltd., Kane and the Company (included herein as Exhibit 2.1)
10.7* Asset Purchase Agreement, dated as of October 10, 1996, by and between MacDonald and the Company
(included herein as Exhibit 2.2)
10.8* Assignment and Assumption Agreement, dated as of October 10, 1996, by and between MacDonald and
the Company (included herein as Exhibit 2.3)
10.9 Bank of Oklahoma, N.A. Credit Facility Commitment Letter (included herein as Exhibit 4.4)
10.10* Form of Franchise Agreement
10.11* Form of Lock-up Agreement
10.12* Form of Partnership Agreement
10.13* Form of Development Agreement
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER NAME OF EXHIBIT
- --------- --------------------------------------------------------------------------------------------------
<C> <S>
10.14* Lease Agreement dated October 28, 1996 by and between the Company and Magnolia Enterprises, Inc.
21.1* List of subsidiaries
23.1 Consent of Huselton & Morgan, P.C., Independent Accountants (filed electronically herewith)
23.2 Consent of Ernst & Young LLP., Independent Accountants (filed electronically herewith)
23.3 Consent of Day Edwards Federman Propester & Christensen, P.C. (included in Exhibit 5.1)
24.1* Powers of Attorney
</TABLE>
- ------------------------
* Previously filed.
<PAGE>
1,000,000 Shares
CD WAREHOUSE, INC.
(a Delaware corporation)
(Par Value $.01 Per Share)
UNDERWRITING AGREEMENT
January __, 1997
CAPITAL WEST SECURITIES, INC.
WESTPORT RESOURCES INVESTMENT SERVICES, INC. and
BERTHEL FISHER & COMPANY FINANCIAL SERVICES, INC.
c/o Capital West Securities, Inc.
211 N. Robinson
16th Floor, One Leadership Square
Oklahoma City, Oklahoma 73102
Ladies/Gentlemen:
CD Warehouse, Inc., a Delaware corporation (the "Company"), hereby confirms
its agreement with Capital West Securities, Inc. ("Capital West"), Westport
Resources Investment Services, Inc. and Berthel Fisher & Company Financial
Services, Inc. (herein collectively called the "Underwriters") as follows:
1. DESCRIPTION OF SHARES. The Company proposes to issue and sell
1,000,000 shares (the "Firm Shares") of its authorized and unissued common
stock, par value $.01 per share (the "Common Stock") to the several
Underwriters. The Company also proposes to grant to the Underwriters an option
as provided in Section 7 hereof. As used in this Agreement, the term "Shares"
shall include the Firm Shares and the Option Shares. All shares of Common Stock
of the Company, including the Shares, are hereinafter referred to as "Common
Stock."
2. REPRESENTATIONS, WARRANTIES AND AGREEMENTS OF THE COMPANY. Unless
otherwise indicated or the context otherwise requires, references to the
"Company" in this Section 2 are references to CD Warehouse, Inc., a Delaware
corporation. The Company represents and warrants to and agrees with each
Underwriter, as follows:
(a) A registration statement on Form SB-2 (File No. 333-15139) with
respect to the Shares, including a prospectus subject to completion, has been
prepared by the Company in conformity with the requirements of the Securities
Act of 1933, as amended (the "Act"), and the applicable rules and regulations
(the "Rules and Regulations") of the Securities and Exchange Commission (the
"Commission") under the Act and has been filed with the Commission; such
amendments to such registration statement and such amended prospectuses subject
to completion, as may have been required prior to the date hereof have been
similarly prepared and filed with the
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Commission; and the Company will file such additional amendments to such
registration statement and such amended prospectuses subject to completion,
as may hereafter be required. Copies of such registration statement and any
amendments and of each related prospectus subject to completion have been
delivered to you.
If the registration statement has been declared effective under the
Act by the Commission, the Company will prepare and promptly file with the
Commission the information omitted from the registration statement pursuant to
Rule 430A(a) of the Rules and Regulations or as part of a post-effective
amendment to the registration statement (including a final form of prospectus).
If the registration statement has not been declared effective under the Act by
the Commission, the Company will prepare and promptly file a further amendment
to the registration statement, including a final form of prospectus. The term
"Registration Statement" as used in this Agreement shall mean such registration
statement, including financial statements, schedules and exhibits, in the form
in which it became or becomes, as the case may be, effective (including, if the
Company omitted information from the registration statement pursuant to Rule
430A(a) of the Rules and Regulations, the information deemed to be a part of the
registration statement at the time it became effective pursuant to Rule 430A(b)
of the Rules and Regulations) and, in the event of any amendment thereto after
the effective date of such registration statement, shall also mean (from and
after the effectiveness of such amendment) such registration statement as so
amended. The term "Prospectus" as used in this Agreement shall mean the
prospectus relating to the Shares as included in such Registration Statement at
the time it becomes effective (including, if the Company omitted information
from the Registration Statement pursuant to Rule 430A(a) of the Rules and
Regulations, the information deemed to be a part of the Registration Statement
at the time it became effective pursuant to Rule 430A(b) of the Rules and
Regulations), except that if any revised prospectus shall be provided to the
Underwriters by the Company for use in connection with the offering of the
Shares that differs from the Prospectus on file with the Commission at the time
the Registration Statement became or becomes, as the case may be, effective
(whether or not such revised prospectus is required to be filed with the
Commission pursuant to Rule 424(b)(3) of the Rules and Regulations), the term
"Prospectus" shall refer to such revised prospectus from and after the time it
is first provided to the Underwriters for such use.
(b) The Commission has not issued any order preventing or suspending
the use of any Preliminary Prospectus or instituted proceedings for that
purpose, and each such Preliminary Prospectus has conformed in all material
respects to the requirements of the Act and the Rules and Regulations and, as of
its date, has not included any untrue statement of a material fact or omitted to
state a material fact necessary to make the statements therein, or necessary to
make the statements therein, in the light of the circumstances under which they
were made, not misleading; and at the time the Registration Statement became or
becomes, as the case may be, effective and at all times subsequent thereto up,
to and on the Closing Date (hereinafter defined) and on any later date on which
Option Shares are to be purchased, (i) the Registration Statement and the
Prospectus, and any amendments or supplements thereto, contained and will
contain all material information required to be included therein by the Act and
the Rules and Regulations and will in all material respects conform to the
requirements of the Act and the Rules and Regulations, and (ii) neither the
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Registration Statement nor the Prospectus, nor any amendments or supplements
thereto, will include any untrue statement of a material fact or omit to state
any material fact required to be stated therein or necessary to make the
statements therein, in the light of the circumstances under which they were
made, not misleading; provided, however, that none of the representations and
warranties contained in this subparagraph shall apply to information contained
in or omitted from the Registration Statement or the Prospectus or any such
amendment or supplement in reliance upon, and in conformity with, written
information furnished to the Company by any Underwriter specifically for
inclusion therein.
(c) Each of the Company and Compact Discs Management, Inc., its
sole Subsidiary (as such term is defined in Rule 405 under the Act) has been
duly incorporated and is validly existing as a corporation in good standing
under the laws of the jurisdiction of its organization, with full corporate
power and authority to own, lease and operate its properties and to conduct
its business as described in the Registration Statement; each of the Company
and its Subsidiary is duly qualified to do business as a foreign corporation
and is in good standing in each jurisdiction in which the ownership or
leasing of its properties or the conduct of its business requires such
qualification except where the failure to be so qualified or to be in good
standing would not have a material adverse effect on the condition (financial
or otherwise), earnings, operations, business or business prospects of the
Company and its Subsidiary considered as a whole; except for regulatory
approvals with respect to the offer and sale of franchise opportunities
(which the Company will obtain prior to conducting any such activity) each of
the Company and its Subsidiary is in possession of and operating in
compliance with all authorizations, licenses, certificates, consents, orders
and permits from state, Federal and other regulatory authorities which are
material to the conduct of its business, all of which are valid and in full
force and effect; neither the Company nor its Subsidiary is in violation of
its charter or bylaws or in default in the performance or observance of any
material obligation, agreement, covenant or condition contained in any
material indenture, mortgage, deed of trust, loan agreement, bond, debenture,
note agreement or other evidence of indebtedness, or any material lease,
contract, joint venture, or other agreement or instrument to which it is a
party or by which its property is bound or in violation of any law, order,
rule, regulation, writ, injunction, judgment or decree of any government,
governmental agency or body or court, domestic or foreign, of which it has
knowledge except such failures to comply as would not, individually or in the
aggregate, have a material adverse effect on the Company and its Subsidiary
considered as a whole.
(d) The Company has full legal right, power and authority to enter
into this Agreement and perform the transactions contemplated hereby. This
Agreement and the Warrant Agreement (the "Warrant Agreement") by and between the
Company and the Underwriters have been duly authorized, executed and delivered
by the Company and are valid and binding agreements on the part of the Company,
enforceable in accordance with their respective terms, except as rights to
indemnification and contribution hereunder may be limited by applicable law and
except as the enforcement hereof may be limited by applicable bankruptcy,
insolvency, reorganization, moratorium or other similar laws relating to or
affecting creditors' rights generally, or by general equitable principles; the
performance of this Agreement and the Warrant Agreement and the consummation of
the transactions herein and therein contemplated will not result in a breach or
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violation of any of the terms and provisions of, or constitute a default under,
(i) any material indenture, mortgage, deed of trust, loan agreement, bond,
debenture, note agreement or other evidence of indebtedness, or any material
lease, contract, joint venture or other agreement or instrument to which the
Company is a party or by which the property of the Company is bound including
any licenses from third parties, or (ii) the Certificate of Incorporation and
Bylaws of the Company, or (iii) any law, order, rule, regulation, writ,
injunction, judgment or decree of any government or governmental agency or body
or court, domestic or foreign, having jurisdiction over the Company or over the
properties of the Company, except for breaches, violations or defaults that
individually or in the aggregate, would not have a material adverse effect on
the Company; and no consent, approval, authorization or order of any court or
governmental agency or body is required for the consummation of the transactions
herein contemplated, except such as may be required under the Act, the
Securities and Exchange Act of 1934, as amended (the "Exchange Act"), or under
state or other securities or Blue Sky laws, all of which requirements have been
satisfied in all material respects.
(e) Except as disclosed in the Registration Statement or the
Prospectus, there is no action, suit or proceeding before or by any court or
governmental agency or body, domestic or foreign, now pending, or, to the
knowledge of the Company, threatened, against or affecting the Company or its
Subsidiary which (i) is required to be disclosed in the Registration Statement
or the Prospectus or which might result in any material adverse change in the
condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Company and its Subsidiary considered as one
enterprise, or which might materially and adversely affect the properties or
assets thereof; or (ii) which might be expected to materially and adversely
affect the consummation of the transactions contemplated by this Agreement; all
pending legal or governmental proceedings to which the Company or its Subsidiary
is a party or of which any of their respective properties or assets is the
subject which are not described in the Registration Statement, including
ordinary routine litigation incidental to the Company's business, could not
reasonably be expected to result in a material adverse change in the condition,
financial or otherwise, or the earnings, business affairs or business properties
of the Company and its Subsidiary considered as one enterprise; and there are no
contracts or documents of the Company or its Subsidiary which are required to be
described in the Registration Statement or the Prospectus, or to be filed as
exhibits thereto, by the Act or by the Rules and Regulations which have not been
accurately described in all material respects and filed as exhibits to the
Registration Statement. To the best of the Company's knowledge, the contracts
so described in the Prospectus are in full force and effect on the date hereof,
and neither the Company nor its Subsidiary is in breach of or default under, and
to the Company's knowledge, no other party is in material breach of or material
default under, any of such contracts.
(f) All outstanding shares of capital stock of the Company have been
duly authorized and validly issued and are fully paid and nonassessable, have
been issued in compliance with all Federal and state securities laws, were not
issued in violation of or subject to any preemptive rights or other rights to
subscribe for or purchase securities (other than such preemptive rights or other
rights to subscribe for or purchase securities as were fully complied with or
expressly waived
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or with respect to the violation of which the right to make claim is barred by
the applicable statute of limitations), and the authorized and outstanding
capital stock of the Company conforms in all material respects to the
statements relating thereto contained in the Registration Statement and the
Prospectus (and such statements correctly state the substance of the
instruments defining the capitalization of the Company); the Firm Shares and
the Option Shares to be purchased from the Company hereunder have been duly
authorized for issuance and sale to the Underwriters pursuant to this
Agreement and, when issued and delivered by the Company against payment
therefor in accordance with the terms of this Agreement, will be duly and
validly issued and fully paid and nonassessable; the shares of Common Stock
issuable under the warrant (the "Underwriters' Warrant") to be granted to the
Underwriters under the Warrant Agreement have been duly authorized for
issuance and sale to the Underwriters pursuant to this Agreement and, when
issued and delivered by the Company against payment therefor in accordance
with the terms of the Warrant Agreement, will be duly and validly issued and
fully paid and nonassessable; and no preemptive right, co-sale right,
registration right, right of first refusal or other similar right of
stockholders exists with respect to any of the Firm Shares, Option Shares or
shares of Common Stock issuable under the Underwriters' Warrant or the
issuance and sale thereof other than those that have been expressly waived
prior to the date hereof and those that will automatically expire upon the
consummation of the transactions contemplated on the Closing Date. No further
approval or authorization of any stockholder, the Board of Directors or others
is required for the issuance and sale or transfer of the Shares except as may
be required under the Act, the Exchange Act or under state or other securities
or Blue Sky laws. Except as disclosed in or contemplated by the Prospectus
and the financial statements of the Company (including the notes thereto)
included in the Prospectus, the Company has no outstanding options to
purchase, or any preemptive rights or other rights to subscribe for or to
purchase, any securities or obligations convertible into, or any contracts or
commitments to issue or sell, shares of its capital stock or any such options,
rights, convertible securities or obligations. The description of the
Company's stock option, stock bonus and other stock plans or arrangements, and
the options or other rights granted and exercised thereunder, set forth in the
Prospectus accurately and fairly presents the information required to be shown
with respect to such plans, arrangements, options and rights. The shares of
Common Stock reserved for issuance upon exercise of the Company's outstanding
options and warrants have been duly and validly authorized and are sufficient
in number to meet the exercise requirements of such options.
(g) Ernst & Young LLP, which has examined the financial statements
(together with related schedules and notes) of the Company filed with the
Commission as a part of the Registration Statement and which are included in the
Prospectus, and Huselton & Morgan, P.C., which has examined the financial
statements (together with related schedules and notes) of Compact Discs
International, Ltd. ("CDIL") filed with the Commission as a part of the
Registration Statement and which are included in the Prospectus, are to the
Company's knowledge, independent accountants within the meaning of the Act and
the Rules and Regulations; the audited and pro forma financial statements of the
Company and CDIL, together with the related schedules and notes, and the
unaudited financial information, forming part of the Registration Statement and
Prospectus, fairly present the financial position and the results of operations
of the Company at the respective dates and for the respective periods to which
they apply; and all audited and pro forma financial
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statements, together with the related schedules and notes, and the unaudited
and pro forma financial information, filed with the Commission as part of the
Registration Statement, have been prepared in accordance with generally
accepted accounting principles consistently applied throughout the periods
involved except as may be otherwise stated therein. The selected and summary
financial and statistical data included in the Registration Statement present
fairly the information shown therein and have been compiled on a basis
consistent with the audited financial statements presented therein. No other
financial statements or schedules are required to be included in the
Registration Statement.
(h) Since the respective dates as of which information is given in
the Registration Statement and the Prospectus, except as otherwise stated
therein, (i) there has been no material adverse change in the condition,
financial or otherwise, or in the earnings, business affairs or business
prospects of the Company, whether or not arising in the ordinary course of
business, (ii) there have been no transactions entered into by the Company other
than those in the ordinary course of business, which are material with respect
to the Company, (iii) there has been no obligation that is material to the
Company, direct or contingent, incurred by the Company or any Subsidiary, except
obligations incurred in the ordinary course of business, (iv) there has been no
change in the capital stock of the Company, (v) there has been no change in the
outstanding indebtedness of the Company which is material to the Company, (vi)
except as described in the Prospectus, there has been no dividend or
distribution of any kind declared, paid or made by the Company on behalf of any
class of its respective capital stock, or (vii) to the knowledge of the Company,
there has been no change in any Federal, state, or other laws, rules, or
regulations (or interpretations thereof) applicable to the business of the
Company that would have a material adverse effect on the Company, and, to the
knowledge of the Company, no such change is pending other than as described in
the Prospectus.
(i) Except as described in the Prospectus, (i) the Company and its
Subsidiary have good and marketable title to all properties and assets described
in the Prospectus as owned by them, free and clear of all liens, charges,
encumbrances or restrictions of any kind, except those described in the
Prospectus, or those not material, singly or in the aggregate, to the business
of the Company and its Subsidiary considered as a whole, (ii) the agreements to
which the Company is a party described in the Prospectus are valid agreements,
enforceable by the Company, except as the enforcement thereof may be limited by
applicable bankruptcy, insolvency, reorganization, moratorium or other similar
laws affecting creditors' rights generally or by general equitable principles,
and (iii) the Company has valid and enforceable leases for the properties
described in the Prospectus as leased by it except as enforcement may be limited
by applicable bankruptcy, insolvency, reorganization, moratorium or other
similar laws relating to or affecting creditors' rights generally or by general
equitable principles.
(j) All Federal, state, local and foreign tax returns required to be
filed by the Company or its Subsidiary in any jurisdiction have been filed, and
all material taxes, including withholding taxes, penalties and interest,
assessments, fees and other charges due or claimed to be due from such entities
have been paid other than those being contested in good faith and for which
adequate reserves have been provided or those currently payable without penalty
or interest; and adequate charges, accruals and reserves have been provided for
in the financial statements referred
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to in Section 2(g) above in respect of all Federal, state, local and foreign
taxes for all periods as to which the tax liability of the Company or its
Subsidiary has not been finally determined or remains open to examination by
applicable taxing authorities.
(k) No labor dispute with the employees of the Company or its
Subsidiary exists or, to the knowledge of the Company, is imminent; and the
Company is not aware of any existing or imminent labor disturbance by the
employees of any of its principal suppliers, manufacturers, contractors or
customers which might be expected to result in any material adverse change in
the condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Company and its Subsidiary considered as one
enterprise. No collective bargaining agreement exists with any of the Company's
employees and, to the Company's knowledge, no such agreement is imminent.
(l) The Company and its Subsidiary own or possess, or can acquire on
reasonable terms, the patents, patent rights, licenses, inventions, copyrights,
know-how (including trade secrets and other unpatented and/or unpatentable
proprietary or confidential information, systems or procedures), trademarks,
service marks and trade names presently employed by them in connection with the
business now operated by them and neither the Company nor its Subsidiary has
received any notice or is otherwise aware of any infringement of or conflict
with asserted rights of others with respect to any patent or proprietary rights
or of any facts or circumstances which would render any patent and proprietary
rights invalid or inadequate to protect the interest of the Company or its
Subsidiary therein, and which infringement or conflict (if the subject of any
unfavorable decision, ruling or finding) or invalidity or inadequacy singly or
in the aggregate, would result in any material adverse change in the condition,
financial or otherwise, or in the earnings, business affairs or business
prospects of the Company and its Subsidiary considered as one enterprise.
(m) Except as set forth in the Prospectus, the Company and its
Subsidiary are in compliance in all material respects with all applicable laws,
statutes, ordinances, rules or regulations, the enforcement of which,
individually or in the aggregate, would be reasonably expected to have a
material adverse effect on the condition, financial or otherwise, or the
earnings, business affairs or business prospects of the Company and its
Subsidiary considered as one enterprise.
(n) The Common Stock has been approved for quotation on the Nasdaq
SmallCap Market subject to official notice of issuance.
(o) The Company has been advised concerning the Investment Company
Act of 1940, as amended (the "1940 Act"), and the rules and regulations
thereunder, and has in the past conducted, and intends in the future to conduct,
its affairs in such a manner as to ensure that it will not become an "investment
company" within the meaning of the 1940 Act and such rules and regulations.
(p) The Company has not distributed and will not distribute prior to
the Closing Date or on any date on which Option Shares are to be purchased, as
the case may be, any offering
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material in connection with the offering and sale of the Shares other than the
Prospectus, the Registration Statement and other materials permitted by the
Act.
(q) The Company has not at any time during the last five years (i)
made any unlawful contribution to any candidate for foreign office, or failed to
disclose fully any contribution in violation of law, or (ii) made any payment to
any Federal or state governmental officer or official, or other person charged
with similar public or quasi-public duties, other than payments required or
permitted by the laws of the United States or any jurisdiction thereof.
(r) The Company has not taken and will not take, directly or
indirectly, any action designed to or that might be reasonably expected to cause
or result in stabilization or manipulation of the price of the Common Stock to
facilitate the sale or resale of the Shares. The Company has not effected any
sales of securities required to be disclosed in Item 26 of Form SB-2 under the
Act, other than as disclosed in the Registration Statement.
(s) Each officer and director of the Company, each beneficial owner
of at least 5% of the outstanding shares of Common Stock and options and
warrants to purchase Common Stock outstanding prior to the effective date of the
Registration Statement and Mark E. Kane have agreed in writing that such
persons will not, for a period expiring 24 months after the effective date of
the Registration Statement, offer to sell, contract to sell, sell short, or
otherwise sell or dispose of any shares of Common Stock of the Company, any
options or warrants to purchase any shares of Common Stock of the Company, or
any securities convertible into or exchangeable for shares of the Common Stock
owned directly by such person or with respect to which such person has the power
of disposition otherwise than (i) as a gift or gifts, provided the donee or
donees thereof agree to be bound by this restriction or (ii) with the prior
written consent of Capital West.
(t) Except as described in the Registration Statement, (i) neither
the Company nor its Subsidiary is in violation of any Federal, state, local or
foreign laws or regulations relating to pollution or protection of human health,
the environment (including, without limitation, ambient air, surface water,
groundwater, land surface or subsurface strata) or wildlife, including, without
limitation, laws and regulations relating to the release or threatened release
of chemicals, pollutants, contaminants, wastes, toxic substances, hazardous
substances, petroleum or petroleum products (collectively, "Environmental
Materials") or to the manufacture, processing, distribution, use, treatment,
storage, disposal, transport or handling of Environmental Materials
(collectively, the "Environmental Laws"), except such violations as would not,
singly or in the aggregate, have a material adverse effect on the condition,
financial or otherwise, or the earnings, business affairs or business prospects
of the Company and its Subsidiary considered as one enterprise, and (ii) to the
best of the Company's knowledge, there are no events or circumstances that could
form the basis of an order for clean-up or remediation, or an action, suit or
proceeding by any private party or governmental body or agency, against or
affecting the Company or its Subsidiary relating to any Environmental Materials
or the violation of any Environmental Laws, which, singly or in the aggregate,
could reasonably be expected to have a material adverse effect on the condition,
financial
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or otherwise, or the earnings, business affairs or business prospects of the
Company and its Subsidiary considered as one enterprise.
(u) The Company and its Subsidiary maintain a system of internal
accounting controls sufficient to provide reasonable assurances that (i)
transactions are executed in accordance with management's general or specific
authorizations; (ii) transactions are recorded as necessary to permit
preparation of financial statements in conformity with generally accepted
accounting principles as in effect in the United States and to maintain asset
accountability; (iii) access to bank accounts is permitted only in accordance
with management's general or specific authorization; and (iv) the recorded
accountability for assets is compared with existing assets at reasonable
intervals and appropriate action is taken with respect to any differences.
(v) There are no outstanding loans, advances (except normal advances
for business expenses in the ordinary course of business) or guarantees of
indebtedness by the Company to or for the benefit of any of the officers or
directors of the Company or any of the members of the families of any of them,
except as disclosed in the Registration Statement and the Prospectus. Neither
the Company nor any employee or agent of the Company has made any payment or
transfer of any funds or assets of the Company or conferred any personal benefit
by use of the Company's assets, or received any funds, assets or personal
benefit in violation of any law, rule or regulation.
(w) On the Closing Date and upon delivery of the Option Shares, as
applicable, all transfer and other taxes (other than income taxes) that are
required to be paid in connection with the sale and transfer of the Shares to
the Underwriters will have been paid.
(x) The Company does not currently have and has never had any pension
plan subject to the provisions of the Employee Retirement Income Security Act of
1974, as amended, including the regulations and published interpretations
thereunder ("ERISA"); no "reportable event" (as defined in ERISA) has occurred
with respect to any "pension plan" (as defined in ERISA) for which the Company
would have any liability, the Company has not incurred and does not expect to
incur liability under (i) Title IV of ERISA with respect to termination of, or
withdrawal from, any "pension plan" or (ii) Sections 412 or 4971 of the Internal
Revenue Code of 1986, as amended, including the regulations and published
interpretations thereunder (the "Code"); and each "pension plan" for which the
Company would have any liability that is intended to be qualified under Section
401(a) of the Code is so qualified in all material respects and nothing has
occurred, whether by action or by failure to act, which would cause the loss of
such qualification.
(y) The Company confirms as of the date hereof that it is in
compliance with all provisions of Section 517.075, Florida Statutes (Chapter
92-198, Laws of Florida) AN ACT RELATING TO DISCLOSURE OF DOING BUSINESS WITH
CUBA (the "Cuba Act"), and the Company further agrees that if it commences
engaging in business with the government of Cuba or with any person or affiliate
located in Cuba after the date the Registration Statement becomes or has become
effective with the Commission or the Florida Department of Banking and Finance
(the "Department"), whichever date is later, or if the information reported or
incorporated by reference in the Prospectus, if any,
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concerning the Company's business in Cuba or with any person or affiliate
located in Cuba changes in any material way, the Company will provide the
Department notice of such business or change, as appropriate, in a form
acceptable to the Department.
(z) Any certificate signed by any officer of the Company and
delivered to the Underwriters or to counsel for the Underwriters shall be deemed
a representation and warranty by the Company to each Underwriter as to the
matters covered thereby.
3. PURCHASE, SALE AND DELIVERY OF SHARES. On the basis of the
representations and warranties herein contained and subject to the terms and
conditions herein set forth, the Company agrees to sell to each Underwriter,
severally, and not jointly, and each Underwriter, severally and not jointly,
agrees to purchase from the Company, respectively, at a purchase price per share
of $______ per Share, the number of Shares set forth in SCHEDULE A hereto
(subject to adjustment as provided in Section 10).
Delivery of definitive certificates for the Firm Shares to be
purchased by the Underwriters pursuant to this Section 3 shall be made against
payment of the purchase price therefor by the several Underwriters by certified
or official bank check in next day funds, payable to the order of the Company at
the offices of Capital West Securities, Inc., 211 N. Robinson, 16th Floor, One
Leadership Square, Oklahoma City, Oklahoma 73102, or at such other place as
shall be agreed upon by the Underwriters and the Company, at 9:30 a.m. on the
fourth business day following the first day that Shares are traded (or at such
time and date to which payments and delivery shall have been postponed pursuant
to Section 10 hereof), such time and date of payment and delivery being herein
called the "Closing Date." The certificates for the Firm Shares to be so
delivered will be made available to you at such office or at such other location
as you may reasonably request for checking at least one business day prior to
the Closing Date and will be in such names and denominations as you may request,
such request to be made at least two business days prior to the Closing Date.
If the Underwriters so elect, delivery of the Shares may be made by credit
through full fast transfer to the accounts at Depository Trust Company
designated by the Underwriters.
It is understood that Capital West, individually and not as
representative of the several Underwriters, may (but shall not be obligated to)
make payment of the purchase price on behalf of any Underwriter or Underwriters
whose check or checks shall not have been received by Capital West prior to the
Closing Date for the Firm Shares to be purchased by such Underwriter or
Underwriters. Any such payment by Capital West shall not relieve any such
Underwriter or Underwriters of any of its or their obligations hereunder.
After the Registration Statement becomes effective, the several
Underwriters intend to offer the Firm Shares to the public as set forth in the
Prospectus.
The information set forth in the last paragraph on the front cover
page (insofar as such information relates to the Underwriters) and under
"Underwriting" in any Preliminary Prospectus and in the final form of Prospectus
filed pursuant to Rule 424(b) constitutes the only information
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furnished by the Underwriters to the Company for inclusion in any Preliminary
Prospectus, the Prospectus or the Registration Statement, and you, on behalf
of the respective Underwriters, represent and warrant to the Company that the
statements made therein do not include any untrue statement of a material fact
or omit to state a material fact required to be stated therein or necessary to
make such statements, in the light of the circumstances in which they were
made, not misleading.
4. FURTHER COVENANTS OF THE COMPANY. The Company covenants with the
several Underwriters as follows:
(a) The Company will use its best efforts to cause the Registration
Statement and any amendment thereof, if not effective at the time and date
that this Agreement is executed and delivered by the parties hereto, to
become effective as promptly as possible; it will notify you, promptly
after it shall receive notice thereof, of the time when the Registration
Statement or any subsequent amendment to the Registration Statement has
become effective or any supplement to the Prospectus has been filed; if the
Company omitted information from the Registration Statement at the time it
was originally declared effective in reliance upon Rule 430A(a) of the
Rules and Regulations, the Company will provide evidence satisfactory to
you that the Prospectus contains such information and has been filed,
within the time period prescribed, with the Commission pursuant to
subparagraph (1) or (4) of Rule 424(b) of the Rules and Regulations or as
part of a post-effective amendment to such Registration Statement as
originally declared effective which is declared effective by the
Commission; if for any reason the filing of the final form of Prospectus is
required under Rule 424(b)(3) of the Rules and Regulations, it will provide
evidence satisfactory to you that the Prospectus contains such information
and has been filed with the Commission within the time period prescribed;
it will notify you promptly of any request by the Commission for the
amending or supplementing of the Registration Statement or Prospectus or
for additional information; promptly upon your request, it will prepare and
file with the Commission any amendments or supplements to the Registration
Statement or Prospectus which, in the opinion of counsel for the several
Underwriters, may be necessary or advisable in connection with the
distribution of the Shares by the Underwriters; it will promptly prepare
and file with the Commission, and promptly notify you of the filing of, any
amendments or supplements to the Registration Statement or Prospectus which
may be necessary to correct any statements or omissions, if, at any time
when a prospectus relating to the Shares is required to be delivered under
the Act, any event shall have occurred as a result of which the Prospectus
or any other prospectus relating to the Shares as then in effect would
include any untrue statement of a material fact necessary to make the
statements therein, in the light of the circumstances under which they were
made, not misleading; in case any Underwriter is required to deliver a
prospectus nine months or more after the effective date of the Registration
Statement in connection with the sale of the Shares, it will prepare
promptly upon request, but at the expense of such Underwriter, such
amendment or amendments to the Registration Statement and such prospectus
or prospectuses as may be necessary to permit compliance with the
requirements of Section 10(a)(3) of the Act; and it will file no amendment
or supplement to the Registration Statement or Prospectus which shall not
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previously have been submitted to you a reasonable time prior to the
proposed filing thereof or to which you shall reasonably object in writing,
subject, however, to compliance with the Act, the Rules and Regulations
thereunder and the provisions of this Agreement.
(b) The Company will advise you, promptly after it shall receive
notice or obtain knowledge thereof of the issuance of any stop order by the
Commission suspending the effectiveness of the Registration Statement or of
the initiation or threat of any proceeding for that purpose; and it will
promptly use its best efforts to prevent the issuance of any stop order or
to obtain its withdrawal at the earliest possible moment if such stop order
should be issued.
(c) The Company will use its best efforts to qualify the Shares for
offering and sale under the securities laws of such jurisdictions as you
may designate and to continue such qualifications in effect for so long as
may be required for purposes of the distribution of the Shares, except that
the Company shall not be required in connection therewith or as a condition
thereof to qualify as a foreign corporation or to execute a general consent
to service of process in any jurisdiction or to make any undertaking with
respect to the conduct of its business. In each jurisdiction in which the
Shares shall have been qualified as above provided, the Company will make
and file such statements and reports in each year as are or may be
reasonably required by the laws of such jurisdiction.
(d) The Company will furnish you, as soon as available, copies of the
Registration Statement (three of which will be signed and which will
include all exhibits), each Preliminary Prospectus, the Prospectus and any
amendments or supplements to such documents, including any prospectus
prepared to permit compliance with Section 10(a)(3) of the Act, all in such
quantities as you may from time to time reasonably request.
(e) The Company will make generally available to its stockholders as
soon as practicable, but in any event not later than the 45th day following
the end of the fiscal quarter first occurring after the first anniversary
of the effective date of the Registration Statement, an earnings statement
(which will be in reasonable detail but need not be audited) complying with
the provisions of Section 11(a) of the Act and covering a twelve-month
period beginning after the effective date of the Registration Statement.
(f) As long as the Company is a reporting company under the Exchange
Act, the Company will furnish to its stockholders, as soon as practicable
after the end of each respective period, annual reports (including
financial statements audited by independent certified public accountants)
and unaudited quarterly reports of operations for each of the first three
quarters of the fiscal year, and for a period of five years after the
effective date of the Registration Statement, the Company will furnish to
the several Underwriters hereunder, upon request (i) concurrently with
furnishing such reports to its stockholders, statements of operations of
the Company for each of the first three quarters in the form furnished to
the Company's stockholders; (ii) concurrently with furnishing to its
stockholders, a balance sheet
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of the Company as of the end of such fiscal year, together with
statements of operations, of stockholders' equity, and of cash flows of
the Company for such fiscal year, accompanied by a copy of the
certificate or report thereon of independent accountants; (iii) as soon
as they are available, copies of all reports and financial statements
furnished to or filed with the Commission, any securities exchange or
the National Association of Securities Dealers, Inc. ("NASD"); (v)
every material press release and every material news item or article in
respect of the Company or its affairs which was released or prepared by
the Company (excluding, in each case customary product-related press
releases and articles); and (vi) any additional information of a public
nature concerning the Company, or its business which you may reasonably
request. During such five-year period, if the Company shall have active
subsidiaries, the foregoing financial statements shall be on a
consolidated basis to the extent that the accounts of the Company and
its Subsidiary are consolidated, and shall be accompanied by similar
financial statements for any significant subsidiary which is not so
consolidated. For a period of five years from the date of the
Registration Statement, the Company will furnish to you and, upon
request, to each of the other Underwriters, as soon as available, a copy
of each report of the Company mailed to holders of the Common Stock or
publicly filed with the Commission or any automated quotation system or
national securities exchange on which any class of securities of the
Company is listed.
(g) The Company will apply the net proceeds from the sale of the
Shares being sold by it in the manner set forth under the caption "Use of
Proceeds" in the Prospectus.
(h) The Company will maintain a transfer agent and, if necessary
under the jurisdiction of incorporation of the Company, a registrar (which
may be the same entity as the transfer agent) for its Common Stock.
(i) The Company will file Form SR in conformity with the requirements
of the Act and the Rules and Regulations.
(j) If the transactions contemplated hereby are not consummated by
reason of any failure, refusal or inability on the part of the Company to
perform any agreement on its part to be performed hereunder or to fulfill
any condition of the Underwriters' obligations hereunder, or if the Company
shall terminate this Agreement under Section 11(a), the Company will
reimburse the several Underwriters for all out-of-pocket accountable
expenses (including fees and disbursements of counsel for the several
Underwriters) actually incurred by the Underwriters in investigating,
preparing to market or marketing the Shares, up to an aggregate of $50,000,
which amount has already been paid and which shall be reimbursed to the
Company to the extent not actually incurred.
(k) If at any time during the 90-day period after the Registration
Statement becomes effective, any rumor, publication or event relating to or
affecting the Company shall occur as a result of which in your opinion the
market price of the Common Stock has been or is likely to be materially
affected (regardless of whether such rumor, publication or event
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<PAGE>
necessitates a supplement to or amendment of the Prospectus), the Company
will, after written notice from you advising the Company to the effect set
forth above, forthwith prepare, consult with you concerning the substance
of, and disseminate a press release or other public statement, reasonably
satisfactory to you, responding to or commenting on such rumor, publication
or event.
(l) During a period of 90 days from the effective date of the
Registration Statement, the Company will not file a registration statement
registering shares under any employee benefit plan.
(m) On the Closing Date the Company will sell to you, for $.001 per
share of Common Stock covered by each warrant, the Underwriters' Warrants
to purchase one share of Common Stock of the Company for each ten shares of
the Company's Common Stock which have been sold (or purchased by the
Underwriters), excluding any over-allotment shares, as set forth in the
Prospectus. The Underwriters' Warrants shall have the terms and be in the
form filed as an exhibit to the Registration Statement. At any time during
the period commencing 12 months and ending five years after the effective
date of the offering and at the written request of the then holders of 51%
of the Underwriters' Warrants and the Common Stock of the Company issued
upon the exercise of the Underwriters' Warrants, and on one occasion, the
Company will file with the Commission and process to effectiveness a
registration statement covering not less than 51% of the shares of the
Common Stock of the Company issuable and/or issued upon the exercise of the
Underwriters' Warrants. The Company must file a registration statement
only if the shares of Common Stock issuable under the Underwriters'
Warrants cannot be sold without registration under Rule 144 promulgated
under the Act. The Company agrees to use its commercially reasonable best
efforts to cause the filing to become effective. The costs of the filing
of such registration statement including but not limited to, legal
(including legal fees relating to clearance in the various states, limited
however to such states as may be reasonably requested), accounting and
printing fees, shall be borne by the Company but the Company shall not be
responsible for the cost of any separate counsel to review the registration
statement on behalf of or to advise the selling stockholders and shall not
be responsible for the payment of any underwriting discount or commissions
with respect to such sale. Such registration statement shall comply with
any undertaking applicable to such shares. If the Company otherwise than
upon the request of the owners of the Underwriters' Warrants or the shares
of Common Stock issuable upon the exercise thereof files a registration
statement under the Act with respect to any of its securities at any time
(other than on Form S-4, S-8, or any other form that does not provide for
resales by selling security holders), the Company will give such persons 30
days' notice of its intention to do so, and at their written request given
within 10 days of the receipt of such notice, will include in such
registration statement such number of such Shares as they may specify, all
at no cost to them (except for underwriting discounts and the fees and
expenses of counsel to such holders). In connection with any such
registration statement covering all or a part of such shares, the Company
agrees that it will covenant with the owners of such shares with respect to
such shares and the offering thereof, in customary form
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<PAGE>
substantially to the effect contained in this Section 4. If the
offering pursuant to any registration statement provided for herein is
made through underwriters, the Company agrees to enter into an
underwriting agreement in customary form with such underwriters in which
the Company and the underwriters and each person who controls such
underwriters within the meaning of the Act grant to each other customary
reciprocal indemnities against liabilities under the Act.
(n) As long as the Company is a reporting company under the Exchange
Act, the Company will comply with the Act, the Exchange Act, the rules and
regulations of the NASD and applicable state securities or Blue Sky laws so
as to permit the continuance of sales and dealings in the Common Stock
under the Act, the Exchange Act, the rules and regulations of the NASD, and
applicable state securities or Blue Sky laws, including the filing with the
NASD and the Commission of all reports required to be filed pursuant to the
applicable provisions of the rules and regulations of the NASD, the Act,
and the Exchange Act, and will deliver to the holders of the Common Stock
all reports required to be provided to such holders pursuant to the
applicable provisions of the rules and regulations of the NASD, the Act,
the Exchange Act, and applicable state securities or Blue Sky laws.
(o) Immediately following the later to occur of: (i) the Option
Closing Date, as defined in Section 6(h)(3), below, or (ii) 30 days
following the Closing Date, the Company shall take and complete all
necessary corporate and stockholder action that will allow Capital West
to designate one person of its choosing to serve as a member of the
Board of Directors of the Company.
5. EXPENSES.
(a) The Company agrees with each Underwriter that the Company will
pay and bear all costs and expenses in connection with the preparation,
printing and filing of the Registration Statement (including financial
statements, schedules and exhibits), Preliminary Prospectuses and the
Prospectus and any amendments or supplements thereto; the printing of this
Agreement, the Preliminary Blue Sky Survey and any Supplemental Blue Sky
Survey, the Underwriters' Questionnaire and Power of Attorney and any
instruments related to any of the foregoing; the issuance and delivery of the
Shares hereunder to the several Underwriters, including transfer taxes, if
any, and the cost of all certificates representing the Shares and transfer
agents' and registrars' fees; the fees and disbursements of counsel for the
Company; all fees and other charges of the Company's independent public
accountants (inclusive of the fees of Huselton & Morgan); the cost of
furnishing to the several Underwriters copies of the Registration Statement
(including appropriate exhibits), Preliminary Prospectus and the Prospectus,
and any amendments or supplements to any of the foregoing; and all postage
costs incurred in connection with the qualification of the Shares under the
laws of such jurisdictions as you may designate; and all other expenses
directly incurred by the Company in connection with the performance of its
obligations hereunder.
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<PAGE>
(b) Capital West shall be entitled to receive from the Company, for
itself and not as representative of the Underwriters, a nonaccountable expense
allowance equal to three percent of the aggregate public offering price of
Shares sold to the Underwriters in connection with the Offering (out of which
the Capital West shall pay all filing fees, expenses and disbursements, except
for postage costs, incurred in connection with the qualification of the Shares
under the laws of such jurisdictions as you may designate including fees and
expenses of Underwriters' counsel), reduced by any amounts advanced by the
Company to Capital West pursuant to the terms of the Letter of Intent. Capital
West shall be entitled to withhold this allowance on the Closing Date.
(c) In addition to its other obligations under Section 8(c), the
Underwriters agree that, as an interim measure during the pendency of any claim,
action, investigation, inquiry or other proceeding described in Section 8(c),
they will reimburse the Company on a monthly basis for all reasonable legal or
other expenses incurred in connection with investigating or defending any such
claim, action, investigation, inquiry or other proceeding, notwithstanding the
absence of a judicial determination as to the propriety and enforceability of
the Underwriters' obligation to reimburse the Company for such expenses and the
possibility that such payments might later be held to have been improper by a
court of competent jurisdiction. To the extent that any such interim
reimbursement payment is so held to have been improper, the Company shall
promptly return such payment to the Underwriters together with interest,
compounded daily, determined on the basis of the Prime Rate. Any such interim
reimbursement payments which are not made to the Company within 30 days of a
request for reimbursement shall bear interest at the Prime Rate from the date of
such request.
(d) It is agreed that any controversy arising out of the operation of
the interim reimbursement arrangements set forth in Sections 5(a)(ii) and 5(c)
hereof, including the amounts of any requested reimbursement payments, the
method of determining such amounts and the basis on which such amounts shall be
apportioned among the reimbursing parties, shall be settled by arbitration
conducted under the provisions of the Constitution and Rules of the Board of
Governors of the New York Stock Exchange, Inc. or pursuant to the Code of
Arbitration Procedure of the National Association of Securities Dealers, Inc.
Any such arbitration must be commenced by service of a written demand for
arbitration or a written notice of intention to arbitrate, therein electing the
arbitration tribunal. In the event the party demanding arbitration does not
make such designation of an arbitration tribunal in such demand or notice, then
the party responding to said demand or notice is authorized to do so. Any such
arbitration will be limited to the operation of the interim reimbursement
provisions contained in Sections 5(a)(ii) and 5(c) hereof and will not resolve
the ultimate propriety or enforceability of the obligation to indemnify for
expenses which is created by the provisions of Sections 8(a), 8(b) and 8(c).
6. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations of the
Underwriters to purchase and pay for Shares as provided herein shall be subject
to the accuracy, as of the date hereof and the Closing Date and any later date
on which Option Shares are to be purchased (the "Option Closing Date"), as the
case may be, of the representations and warranties of the Company herein, to the
performance by the Company of its obligations hereunder, and to the following
additional conditions:
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(a) The Registration Statement shall have become effective not later
than 5:30 p.m. on the date hereof, or with the consent of the Underwriters, at a
later time and date, not later, however, than 5:30 p.m. on the first business
day following the date hereof, or at such later time and date as may be approved
by a majority in interest of the Underwriters; and no stop order suspending the
effectiveness of the Registration Statement shall have been issued under the
Act or proceedings therefor initiated or threatened by the Commission and any
request on the part of the Commission for additional information (to be included
in the Registration Statement or the Prospectus or otherwise) shall have been
complied with to the reasonable satisfaction of counsel to the Underwriters. If
the Company has elected to rely upon Rule 430A of the Rules and Regulations, the
price of the Shares and any price-related information previously omitted from
the effective Registration Statement pursuant to such Rule 430A shall have been
transmitted to the Commission for filing pursuant to Rule 424(b) of the Rules
and Regulations within the prescribed time period, and prior to the Closing Date
the Company shall have provided evidence satisfactory to the Underwriters of
such timely filing, or a post-effective amendment providing such information
shall have been promptly filed and declared effective in accordance with the
requirements of Rule 430A of the Rules and Regulations. Qualification under the
securities laws of such states as you may deem necessary to the success of the
underwriting of the issue and sale of the Shares upon the terms and conditions
set forth in this Agreement or contemplated by this Agreement and containing no
provisions unacceptable to you will have been secured, and no stop order (or the
equivalent thereof) will be in effect denying or suspending effectiveness of
such qualification, nor will any stop order proceedings (or the equivalent
thereof) with respect thereto be instituted or pending or threatened under such
laws.
(b) At the Closing Date and the Option Closing Date, if any, counsel
for the Underwriters shall have been furnished with such documents and opinions
as they may require for the purpose of enabling them to pass upon the issuance
and sale of the Shares as contemplated herein and related proceedings or in
order to evidence the accuracy of any of the representations and warranties, or
the fulfillment of any of the conditions, herein contained; and all proceedings
taken by the Company in connection with the issuance and sale of the Shares as
herein contemplated shall be satisfactory in form and substance to the
Underwriters and counsel for the Underwriters.
(c) There shall not have been, since the date hereof or since the
respective dates as of which information is given in the Registration Statement
and the Prospectus, any change in the condition (financial or otherwise),
earnings, operations, business affairs or business prospects of the Company and
its Subsidiary considered as one enterprise, whether or not arising in the
ordinary course of business which, in your sole judgment, is material and
adverse and that makes it, in your sole judgment, impracticable or inadvisable
to proceed with the public offering of the Shares as contemplated by the
Prospectus, and the Underwriters shall have received a certificate of the
President or Vice President of the Company and of the chief financial or chief
accounting officer of the Company, dated as of the Closing Date, to the effect
that (i) there has been no such material adverse change, (ii) the
representations and warranties in Section 2 hereof are true and correct with the
same force and effect as though expressly made at and as of the Closing Date,
(iii) the Company has complied with all agreements and satisfied all conditions
on its part to be performed or satisfied
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<PAGE>
at or prior to the Closing Date, and (iv) no stop order suspending the
effectiveness of the Registration Statement has been issued and no proceedings
for that purpose have been initiated or threatened by the Commission or any
Blue Sky jurisdiction.
(d) At the Closing Date the Underwriters shall have received:
(1) The opinion, dated as of the Closing Date of Day Edwards
Federman Propester & Christensen P.C., counsel for the Company, in form and
substance satisfactory to counsel for the Underwriters, to the effect that:
(i) The Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of the State of
Delaware.
(ii) The Company has corporate power and authority to own, lease
and operate its properties and to conduct its business as described in the
Registration Statement and the Prospectus and to enter into and perform its
obligations under this Agreement and to issue, sell and deliver to the
Underwriters the Firm Shares or the Option Shares, as the case may be, to be
issued and sold by it hereunder.
(iii) The Company is duly qualified to do business as a
foreign corporation and is in good standing in the States of Oklahoma and Texas,
and to the best of its knowledge is not required to be qualified to do business
as a foreign corporation in any other jurisdiction.
(iv) At the Closing Date, after giving effect to the sale of the
Firm Shares, the authorized capital stock of the Company is as set forth in the
Prospectus under the caption "Capitalization" as of the dates stated therein;
the issued and outstanding shares of Common Stock have been duly authorized and
validly issued and are fully paid and nonassessable and have not been issued in
violation of any preemptive right contained in the Certificate of Incorporation
or Bylaws of the Company or, to such counsel's knowledge, any co-sale right,
registration right, right of first refusal or other similar right (other than
such preemptive rights or other rights to subscribe for or purchase securities
as were fully complied with or expressly waived or with respect to the violation
of which the right to make a claim is barred by the applicable statute of
limitation).
(v) The Firm Shares and the Option Shares, as the case may be,
to be purchased from the Company hereunder have been duly authorized for
issuance and sale to the Underwriters pursuant to this Agreement and, when
issued and delivered by the Company pursuant to this Agreement against payment
therefor in accordance with the terms hereof, will be validly issued and fully
paid and nonassessable, and will not be issued in violation of any preemptive
right under the Certificate of Incorporation or Bylaws of the Company or, to
such counsel's knowledge, any co-sale right, right of first refusal or other
similar right and the stockholders of the Company have no preemptive right under
the Certificate of Incorporation or Bylaws of the Company or, to such counsel's
knowledge, other rights to purchase any of the Shares; the shares of Common
Stock reserved for issuance upon the exercise of the Underwriters' Warrants have
been duly and validly
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authorized and are sufficient in number to meet the exercise requirements
thereof, and such shares of Common Stock, when issued upon exercise, will be
duly and validly issued, fully paid (assuming exercise in accordance with the
Warrant Agreement and receipt by the Company of the exercise price thereof)
and nonassessable; the stockholders of the Company have no preemptive right
under the Certificate of Incorporation or Bylaws of the Company or, to such
counsel's knowledge, other rights to purchase any of the Shares; and the
shares of Common Stock reserved for issuance upon the exercise of the
Company's outstanding options have been duly and validly authorized and are
sufficient in number to meet the exercise requirements of such options, and
such shares of Common Stock, when issued upon exercise, will be duly and
validly issued, fully paid (assuming exercise in accordance with the governing
instruments therefor and receipt by the Company of the exercise price thereof)
and nonassessable.
(vi) The issuance of the Shares to be purchased hereunder is not
subject to preemptive or other similar rights arising by operation of law or, to
the best of their knowledge and information, otherwise.
(vii) The Subsidiary has been duly incorporated and is validly
existing as a corporation and is in good standing under the laws of the
jurisdiction of its incorporation, has full corporate power and authority to
own, lease and operate its properties and to conduct it business as described
in the Registration Statement, and is duly qualified as a foreign corporation
to transact business and is in good standing in the States of Arkansas,
Colorado, Florida, Kansas, Louisiana, Missouri, Nebraska, Oklahoma,
Tennessee, Texas, Utah and Virginia, and to the best of its knowledge the
Subsidiary is not required to be qualified to do business as a foreign
corporation in any other jurisdiction; all of the issued and outstanding
capital stock of such Subsidiary have been duly authorized and validly
issued, is fully paid and nonassessable and, to the best of their knowledge
and information, is owned by the Company directly or through subsidiaries,
free and clear of any security interest, mortgage, pledge, lien, encumbrance,
claim or equity.
(viii) This Agreement and the Warrant Agreement have been duly
authorized by all necessary corporate action on the part of the Company and have
been duly executed and delivered by the Company and assuming due authorization,
execution and delivery by the Underwriters, are valid and binding agreements of
the Company, except insofar as indemnification and contribution provisions may
be limited by applicable law or equitable principles, and except as
enforceability may be limited by bankruptcy, insolvency, reorganization,
moratorium or similar laws affecting creditors' rights generally or any general
equitable principles;
(ix) The Registration Statement has been declared effective under
the Act; any required filing of the Prospectus pursuant to Rule 424(b) has been
made in the manner and within the time period required by Rule 424(b) and, to
the best of their knowledge and information, no stop order suspending the
effectiveness of the Registration Statement has been issued under the Act or
proceedings therefor have been initiated or are pending or threatened by the
Commission.
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(x) The Registration Statement, Prospectus and each amendment or
supplement to the Registration Statement and Prospectus, as of their respective
effective or issue dates (other than the financial statements and supporting
schedules included therein, as to which no opinion need be rendered) complied as
to form in all material respects with the requirements of the Act and the
applicable Rules and Regulations.
(xi) The terms and provisions of the capital stock of the Company
conform in all material respects to the description thereof contained in the
Prospectus under the caption "Description of Securities";
(xii) The information in the Prospectus under the caption
"Description of Securities" to the extent that they constitute matters of law or
legal conclusions, has been reviewed by such counsel and accurately and fairly
summarizes in such counsel's opinion the matters described therein and to the
knowledge of such counsel, there are no outstanding options, warrants,
convertible securities, or other rights to acquire from the Company any capital
stock, except as described in the Registration Statement; in addition, the forms
of certificates evidencing the Company stock comply with Delaware law;
(xiii) To the best of their knowledge and information, except
as set forth in the Prospectus, there is not pending or threatened any action,
suit, proceeding, inquiry or investigation, to which the Company or its
Subsidiary is a party, or to which the property of the Company or its Subsidiary
is subject, before or brought by any court or government agency or body, which
might reasonably be expected to result in any material adverse change in the
condition, financial or otherwise, or in the earnings, business affairs or
business prospects of the Company and its Subsidiary considered as one
enterprise, or which might reasonably be expected to materially and adversely
affect the properties or assets thereof or the consummation of this Agreement or
the performance by the Company of its obligations hereunder; and all pending
legal or governmental proceedings to which the Company or its Subsidiary is a
party or that affect any of their respective properties that are not described
in the Prospectus, including ordinary routine litigation incidental to the
business, could not reasonably be expected to result in a material adverse
change in the condition, financial or otherwise, or in the earnings, business
affairs or business prospects of the Company and its Subsidiary considered as
one enterprise.
(xiv) The information in the Prospectus under the captions
"Business and Properties - Legal Proceedings", " - Governmental Regulation" and
"- Properties", "Certain Transactions" and "Description of Capital Stock" in the
Prospectus and Items 24 and 26 of Part II of the Registration Statement to the
extent that such items constitute matter of law, summaries of legal matters,
documents or proceedings, or legal conclusions, has been reviewed by them and is
correct in all material respects, and there are no legal or governmental
actions, suits or proceedings pending or threatened against the Company or its
Subsidiary that are required to be described in the Prospectus are not described
as required by the Act or the applicable Rules and Regulations.
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(xv) All descriptions in the Prospectus of contracts and other
documents are accurate in all material respects; to the best of their
knowledge and information, there are no agreements, no contracts, indentures,
mortgages, loan agreements, notes, leases or other instrument required to be
described or referred to in the Registration Statement or to be filed as
exhibits thereto other than those described or referred to therein or filed
as exhibits thereto, the descriptions thereof or references thereto are
correct in all material respects, and to the best of counsel's knowledge
and information, the Company is not in default in the due performance or
observance of any material obligation, agreement, covenant or condition
contained in any contract, indenture, mortgage, loan agreement, note, lease
or other instrument so described, referred to or filed as exhibits thereto.
(xvi) No authorization, approval, consent or order of any
court or governmental authority or agency (other than under the Act or the Rules
and Regulations, which have been obtained, or as may be required under the
securities or Blue Sky laws of the various states) is required in connection
with the due authorization, execution and delivery of this Agreement or for the
offering, issuance or sale of the Shares to the Underwriters; and the execution,
delivery and performance of this Agreement and the consummation of the
transactions contemplated herein and compliance by the Company with its
obligations hereunder (other than performance of the Company's indemnification
and contribution obligations hereunder, concerning which no opinion need be
expressed) will not, whether with or without the giving of notice or lapse of
time or both, conflict with or constitute a breach or violation of, or default
under, or result in the creation or imposition of any lien, charge or
encumbrance upon any property or assets of the Company or its Subsidiary
pursuant to any material contract, indenture, mortgage, loan agreement, note,
lease or other instrument to which the Company or its Subsidiary is a party or
by which it or any of them may be bound, or to which any of the property or
assets of the Company or its Subsidiary is subject, nor will such action result
in any violation of the provisions of the Certificate of Incorporation or Bylaws
of the Company, or any applicable law, administrative regulation or court
decree, provided, however, no opinion need be rendered concerning state
securities or Blue Sky laws.
(xvii) To the best of such counsel's knowledge and information,
with the exception of the Underwriters' Warrants, no holder of any security of
the Company has any right to require registration of any shares of Common
Stock or any other security of the Company and, except as set forth in the
Registration Statement and Prospectus, all holders of securities of the
Company having rights to registration of such shares of Common Stock, or other
securities, because of the filing of the Registration Statement by the Company
have, with respect to the offering contemplated thereby, waived such rights or
such rights have expired by reason of lapse of time following notification of
the Company's intent to file the Registration Statement, or have included
securities in the Registration Statement pursuant to the exercise of such
rights.
(xviii) The Company is not an "investment company" or an entity
"controlled" by an "investment company" as such terms are defined in the 1940
Act.
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(xix) To the best of such counsel's knowledge and
information, neither the Company nor its Subsidiary are in violation of their
charter or by-laws.
In rendering such opinion, such counsel may rely as to matters of fact
(but not as to legal conclusions), to the extent they deem proper, on
certificates of responsible officers of the Company and public officials. Such
opinion shall not state that it is to be governed or qualified by, or that it is
otherwise subject to, any treatise, written policy or other document relating to
legal opinions, including with limitation, the Legal Opinion Accord of the ABA
Section of Business Law (1991).
In giving their opinion required by subsection (d)(1) of this Section,
Day Edwards Federman Propester & Christensen, P.C. shall additionally state that
nothing has come to their attention that would lead them to believe that the
Registration Statement, at the time it became effective, contained an untrue
statement of a material fact or omitted to state a material fact required to be
stated therein or necessary to make the statements therein not misleading or
that the Prospectus, at the effective date of the Registration Statement (unless
the term "Prospectus" refers to a prospectus which has been provided to the
Underwriters by the Company for use in connection with the offering of the
Shares which differs from the Prospectus declared effective by the Commission,
in which case at the time it is first provided to the Underwriters for such use)
or at the Closing Date, included an untrue statement of a material fact or
omitted to state a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading. Such opinion may state that such counsel does not assume any
responsibility for the accuracy, completeness or fairness of the statements
contained in the Registration Statement and the Prospectus except as otherwise
expressly provided in such opinion, and such counsel need express no opinion or
belief as to the financial statements, schedules, and other financial or
statistical data included in the Registration Statement or Prospectus.
(2) The opinion, dated as of Closing Date, of Phillips McFall
McCaffrey McVay and Murrah, P.C., counsel for the Underwriters, in form and
substance satisfactory to you, with respect to the sufficiency of all such
corporate proceedings and other legal matters relating to this Agreement and the
transactions contemplated hereby as you may reasonably require, and the Company
shall have furnished to such counsel such papers, opinions and information as
they request to enable them to pass upon such matters.
(e) At the time of the execution of this Agreement, the Underwriters
shall have received from Ernst & Young LLP a letter dated such date, in form and
substance satisfactory to the Underwriters, to the effect that:
(1) they are independent public accountants with respect to the
Company and its Subsidiary within the meaning of the Act and the Rules and
Regulations;
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(2) it is their opinion that the consolidated balance sheet
included in the Registration Statement and covered by their opinion therein
complies as to form in all material respects with the applicable accounting
requirements of the Act and the Rules and Regulations;
(3) based upon limited procedures set forth in detail in such
letter, nothing has come to their attention which causes them to believe that,
at a specified date not more than three days prior to the date of this
Agreement, (A) the unaudited consolidated balance sheet of the Company and its
Subsidiary included in the Registration Statement does not comply as to form in
all material respects with the applicable accounting requirements of the Act and
the Rules and Regulations or is not presented in conformity with generally
accepted accounting principles applied on a basis substantially consistent with
that of the audited financial statements included in the Registration Statement,
or (B) at a specified date not more than three days prior to the date of this
Agreement, there has been any change in the capital stock of the Company or any
increase in the combined long term debt of the Company and its Subsidiary or any
decrease in combined net current assets or net assets as compared with the
amounts shown in the October 15, 1996 balance sheet included in the Registration
Statement or, during the period from October 15, 1996 to a specified date not
more than three days prior to the date of this Agreement, there were any
decreases, as compared with the corresponding period in the preceding year, in
combined revenues, net income or net income per share of the Company and its
Subsidiary, except in all instances for changes, increases or decreases which
the Registration Statement and the Prospectus disclose have occurred or may
occur;
(4) in addition to the examination referred to in their opinion
and the limited procedures referred to in clause (3) above, they have carried
out certain specified procedures, not constituting an audit, with respect to
certain amounts, percentages and financial information which are included in the
Registration Statement and Prospectus and which are specified by the
Underwriters, and have found such amounts, percentages and financial information
to be in agreement with the relevant accounting, financial and other records of
the Company and its Subsidiary identified in such letter; and
(5) they have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-B and on the
basis of limited procedures specified in such letter nothing came to their
attention as a result of the foregoing procedures that caused them to believe
that this information does not conform in all material respects with the
disclosure requirements of Item 402 of Regulation S-B.
(f) At the time of the execution of this Agreement, the Underwriters
shall have received from Huselton & Morgan, a letter dated such date, in form
and substance satisfactory to the Underwriters, to the effect that:
(1) they are independent public accountants with respect to
Compact Discs International, Ltd. and its Subsidiary ("CDIL") for the years
ended December 31, 1994 and 1995
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and with respect to CD Acquisitions ("CDA") for the years ended December 31,
1994 and 1995 within the meaning of the Act and the Rules and Regulations;
(2) it is their opinion that the financial statements and
supporting schedules included in the Registration Statement and covered by their
opinion therein comply as to form in all material respects with the applicable
accounting requirements of the Act and the Rules and Regulations;
(3) based upon limited procedures set forth in detail in such
letter, nothing has come to their attention which causes them to believe that,
at a specified date not more than three days prior to the date of this
Agreement, (A) the unaudited combined or consolidated financial statements and
supporting schedules of CDIL and CDA included in the Registration Statement do
not comply as to form in all material respects with the applicable accounting
requirements of the Act and the Rules and Regulations or are not presented in
conformity with generally accepted accounting principles applied on a basis
substantially consistent with that of the audited financial statements included
in the Registration Statement, (B) the unaudited combined or consolidated
financial statements and supporting schedules of CDIL and CDA included in the
Registration Statement were not determined on a basis substantially consistent
with that used in determining the corresponding amounts in the audited combined
financial statement included in the Registration Statement, or (C) at a
specified date not more than three days prior to the date of this Agreement,
there has been any change in partners' capital, other than the net increase due
to income and distributions made for the one month period, increase in long-term
debt, or decrease in consolidated net current assets or partners' capital of the
consolidated companies as compared with the amounts shown in the September 30,
1996 unaudited consolidated financial statements included in the Registration
Statement or, during the period from October 1, 1996 to a specified date not
more than three days prior to the date of this Agreement, there were any
decreases, as compared with the corresponding period in the preceding year, in
consolidated net sales or in the total amount of net income, except in all
instances for changes, increases or decreases which the Registration Statement
and the Prospectus disclose have occurred or may occur;
(4) in addition to the examination referred to in their opinions
and the limited procedures referred to in clause (3) above, they have carried
out certain specified procedures, not constituting an audit, with respect to
certain amounts, percentages and financial information which are included in the
Registration Statement and Prospectus and which are specified by the
Underwriters, and have found such amounts, percentages and financial information
to be in agreement with the relevant accounting, financial and other records of
the Company and its Subsidiary identified in such letter; and
(5) they have compared the information in the Prospectus under
selected captions with the disclosure requirements of Regulation S-B and on the
basis of limited procedures specified in such letter nothing came to their
attention as a result of the foregoing procedures that caused them to believe
that this information does not conform in all material respects with the
disclosure requirements of Item 402 of Regulation S-B.
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(g) At the Closing Date, the Underwriters shall have received from
each of Ernst & Young LLP and Huselton & Morgan, P.C., a letter, dated as of the
Closing Date, to the effect that they reaffirm the statements made in the letter
furnished pursuant to subsections (e) and (f), respectively, of this Section 6,
except that the specified date referred to shall be a date not more than three
days prior to the Closing Date and, if the Company has elected to rely on Rule
430A of the 1933 Act Regulations, to the further effect that they have carried
out procedures as specified in clause (4) of subsections (e) and (f) of this
Section 6 with respect to certain amounts, percentages and financial information
specified by the Underwriters and deemed to be a part of the Registration
Statement pursuant to Rule 430(A)(b) and have found such amounts, percentages
and financial information to be in agreement with the records specified in such
clause (4).
(h) At the Closing Date, the Common Stock shall have been approved
for listing on the Nasdaq SmallCap Market.
(i) In the event that the Underwriters exercise their option provided
in Section 7 hereof to purchase all or any portion of the Option Shares, the
representations and warranties of the Company contained herein and the
statements in any certificates furnished by the Company hereunder shall be true
and correct as of the Option Closing Date and, at the Option Closing Date, the
Underwriters shall have received:
(1) A certificate, dated the Option Closing Date, of the
President or a Vice President of the Company and of the Chief Financial
or Chief Accounting Officer of the Company confirming that the
certificate delivered at the Closing Date pursuant to Section 5(c) hereof
remains true and correct as of the Option Closing Date (except that all
references in such Section to "Closing Date" shall be deemed to refer to
the "Option Closing Date").
(2) The opinions of Day Edwards Federman Propester &
Christensen, P.C., counsel for the Company, in form and substance
satisfactory to counsel for the Underwriters, dated the Option Closing
Date, relating to the Option Shares and otherwise to the same effect as
the opinion required by Section 5(b)(1) hereof (except that all
references in such Section to "Closing Date" shall be deemed to refer to
the "Option Closing Date").
(3) The opinion of Phillips McFall McCaffrey McVay & Murrah,
P.C., counsel for the Underwriters, dated the Option Closing Date,
relating to the Option Shares to be purchased on the Option Closing Date
and otherwise to the same effect as the opinion required by Section
5(b)(2) hereof (except that all references in such Section to "Closing
Date" shall be deemed to refer to the "Option Closing Date").
(4) A letter from each of Ernst & Young LLP and Huselton &
Morgan, P.C., in form and substance satisfactory to the Underwriters and
dated the Option Closing Date, substantially the same in form and
substance as the letter furnished to the Underwriters pursuant to Section
5(e) hereof, except that the "specified date" in the letter furnished
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pursuant to this Section 5(h)(4) shall be a date not more than three days
prior to the Option Closing Date.
(j) All conditions for closing required under the terms of that
certain Asset Purchase Agreement (the "CDIL Agreement"), dated October 1, 1996,
by and among the Company, CDIL and Mark E. Kane, shall have been satisfied by
all parties thereto on or before the Closing Date and the Underwriters shall
have received a certificate, dated the Closing Date, of the President or a Vice
President of the Company, Mark E. Kane, and of the general partner of CDIL,
confirming the foregoing and that the CDIL Agreement will close on the Closing
Date if there is a closing under this Agreement.
(k) All conditions for closing required under the terms of that
certain Asset Purchase Agreement (the "MacDonald Agreement"), dated October 10,
1996, by and between Bruce D. MacDonald and the Company, shall have been
satisfied by all parties thereto on or before the Closing Date and the
Underwriters shall have received a certificate, dated the Closing Date, of the
President or a Vice President of the Company and Bruce D. MacDonald, confirming
the foregoing and that the MacDonald Agreement will close on the Closing Date if
there is a closing under this Agreement.
(l) The Company and the Underwriters shall have entered into the
Warrant Agreement and the Company shall have sold to the Underwriters the
Underwriters' Warrants, which shall be in the form attached as an exhibit to the
Warrant Agreement.
If any condition specified in this Section shall not have been
fulfilled when and as required to be fulfilled, this Agreement may be terminated
by the Representative by notice to the Company at any time at or prior to
Closing Date, and such termination shall be without liability of any party to
any other party except as provided in Section 4 and except that Sections 4(j)
and 8 shall survive any such termination and remain in full force and effect.
7. OPTION SHARES.
(a) On the basis of the representations and warranties herein contained,
but subject to the terms and conditions herein set forth, the Company hereby
grants to the several Underwriters, for the purpose of covering
over-allotments in connection with the distribution and sale of the Firm
Shares only, a non-transferable option to purchase up to an aggregate 150,000
Option Shares at the purchase price per share for the Firm Shares set forth
in Section 3 hereof. Such option may be exercised by Capital West on behalf
of the several Underwriters on one occasion in whole or in part during the
period of 30 days from and after the date on which the Firm Shares are
initially offered to the public, by giving notice to the Company. The number
of Option Shares to be purchased by each Underwriter upon the exercise of
such option shall be the same proportion of the total number of Option Shares
to be purchased by the several Underwriters pursuant to the exercise of such
option as the number of Firm Shares purchased by such Underwriter (set forth
in SCHEDULE
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A hereto) bears to the total number of Firm Shares purchased by the several
Underwriters (set forth in SCHEDULE A hereto), adjusted by the Underwriters
in such manner as to avoid fractional shares.
Delivery of definitive certificates for the Option Shares to be
purchased by the several Underwriters pursuant to the exercise of the option
granted by this Section 7 shall be made against payment of the purchase price
therefor by the several Underwriters by certified or official bank check or
checks drawn in same day funds, payable to the order of the Company. Such
delivery and payment shall take place at the offices of Capital West Securities,
Inc., 211 N. Robinson, 16th Floor, Oklahoma City, Oklahoma 73102 or at such
other place as may be agreed upon between the Underwriters and the Company on
the Closing Date, if written notice of the exercise of such option is received
by the Company not later than three full business days prior to the Closing
Date.
The certificates for the Options Shares so to be delivered will be
made available to you at such office or other location including, without
limitation, in Oklahoma City, as you may reasonably request for checking at
least two full business days prior to the date of payment and delivery and will
be in such names and denominations as you may request, such request to be made
at least three full days prior to such date of payment and delivery. If the
Underwriters so elects, delivery of the Shares may be made by credit through
full fast transfer to the accounts at Depository Trust Company by the
Underwriters.
It is understood that Capital West, individually, and not as the
representative of the Underwriters, may (but shall not be obligated to) make
payment of the purchase price on behalf of any Underwriter or Underwriters whose
check or checks shall not have been received by you prior to the date of payment
and delivery for the Option Shares to be purchased by such Underwriter or
Underwriters. Any such payment by Capital West shall not relieve any
Underwriters of any of its or their obligations hereunder.
(b) Upon exercise of any option provided for in Section 7(a) hereof the
obligations of the Underwriters to purchase such Option Shares will be subject
(as of the date hereof and as of the date of payment for such Option Shares) to
the accuracy of and compliance with the representations and warranties of the
Company herein, to the accuracy of the statements of the Company and officers of
the Company made pursuant to the provisions hereof, to the performance by the
Company of their respective obligations hereunder, and to the condition that all
proceedings taken at or prior to the payment date in connection with the sale
and transfer of such Option Shares shall be satisfactory in form and substance
to you and to Underwriters' counsel, and you shall have been furnished with all
such documents, certificates and opinions as you may reasonably request in order
to evidence the accuracy and completeness of any of the representations,
warranties or statements, the performance of any of the covenants of the Company
or the compliance with any of the conditions herein contained.
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8. INDEMNIFICATION AND CONTRIBUTION.
(a) The Company agrees to indemnify and hold harmless each
Underwriter against any losses, claims, damages or liabilities, joint or
several, as incurred, to which such Underwriter may become subject under the
Act or otherwise, insofar as such losses, claims, damages or liabilities (or
actions in respect thereof) arise out of or are based upon (i) any breach of
any representation, warranty, agreement or covenant of the Company herein
contained, or (ii) any untrue statement or alleged untrue statement made by
the Company in Section 2 hereof, or (iii) any untrue statement or alleged
untrue statement of a material fact contained (A) in the Registration
Statement, any Preliminary Prospectus, the Prospectus or any amendment or
supplement thereto, or (B) in any blue sky application or other document
executed by the Company specifically for that purpose or based upon written
information furnished by the Company filed in any state or other jurisdiction
in order to qualify any or all of the Shares under the securities laws
thereof (any such application, documents or information being hereinafter
called a "Blue Sky Application"), or (iii) the omission or alleged omission
to state in the Registration Statement or any amendment thereto a material
fact required to be stated therein or necessary to make the statements
therein not misleading, or the omission or alleged omission to state in any
Preliminary Prospectus, the Prospectus or any supplement thereto or in any
Blue Sky Application a material fact required to be stated therein or
necessary to make the statements therein, in the light of the circumstances
under which they were made, not misleading; and shall reimburse each
Underwriter for any legal or other expenses reasonably incurred by such
Underwriter in connection with investigating or defending against or
appearing as a third-party witness in connection with any such loss, claim,
damage, liability or action, notwithstanding the possibility that payments
for such expenses might later be held to be improper, in which case the
person receiving them shall promptly refund them; except that the Company
shall not be liable in any such case to the extent, but only to the extent,
that any such loss, claim, damage or liability arises out of or is based upon
an untrue statement or alleged untrue statement or omission or alleged
omission made in the Registration Statement, such Preliminary Prospectus or
the Prospectus, or any amendment or supplement, in reliance upon and in
conformity with written information furnished to the Company by or on behalf
of any Underwriter specifically for use in the preparation thereof and,
provided further, that the indemnity agreement provided in this Section 8(a)
with respect to any Preliminary Prospectus shall not inure to the benefit of
any Underwriter from whom the person asserting any losses, claims, charges,
liabilities or litigation based upon any untrue statement or alleged untrue
statement of material fact or omission or alleged omission to state therein a
material fact purchased Shares, if a copy of the Prospectus in which such
untrue statement or alleged untrue statement or omission or alleged omission
was corrected has not been sent or given to such person within the time
required by the Act and the Rules and Regulations thereunder, unless such
failure is the result of noncompliance by the Company with Section 4(c)
hereof.
(b) Each Underwriter severally, but not jointly, shall indemnify and
hold harmless the Company against any losses, claims, damages or liabilities,
joint or several, as incurred, to which the Company may become subject, under
the Act or otherwise, insofar as such losses, claims, damages or liabilities (or
actions in respect thereof) arise out of or are based upon (i) any untrue
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statement or alleged untrue statement of a material fact contained (A) in the
Registration Statement, Preliminary Prospectus, the Prospectus or any amendment
or supplement thereto, or (B) in any Blue Sky Application, or (ii) the omission
or alleged omission to state in the Registration Statement or any amendment
thereto a material fact required to be stated therein or necessary to make the
statements therein not misleading, or the omission or alleged omission to state
in any Preliminary Prospectus, the Prospectus or any supplement thereto or in
any Blue Sky Application a material fact required to be stated therein or
necessary to make the statements therein, in the light of the circumstances
under which they were made, not misleading; except that such indemnification
shall be available in each such case to the extent, but only to the extent, that
such untrue statement or alleged untrue statement or omission or alleged
omission was made in reliance upon and in conformity with written information
furnished to the Company through the Underwriters by or on behalf of such
Underwriter specifically for use in the preparation thereof; and shall reimburse
any legal or other expenses reasonably incurred by the Company in connection
with investigation or defending against any such loss, claim, damage, liability
or action.
(c) Promptly after receipt by an indemnified party under subsection
(a) or (b) above of notice of any claim or the commencement of any action, the
indemnified party shall, if a claim in respect thereof is to be made against the
indemnifying party under such subsection, notify the indemnifying party in
writing of the claim or the commencement of that action; the failure to notify
the indemnifying party shall not relieve it from any liability which it may have
to an indemnified party otherwise than under such subsection. If any such claim
or action shall be brought against an indemnified party, and it shall notify the
indemnifying party thereof, the indemnifying party shall be entitled to
participate therein and, to the extent that it wishes, jointly with any other
similarly notified indemnifying party, to assume the defense thereof with
counsel reasonably satisfactory to the indemnified party; provided, however, if
the defendants in any such action include both the indemnified parties and the
indemnifying party and the indemnified party shall have reasonably concluded
that there may be legal defenses available to it and/or other indemnified
parties which are different from or additional to those available to the
indemnifying party, the indemnified party or parties shall have the right to
select separate counsel to assume such legal defenses and to otherwise
participate in the defense of such action on behalf of such indemnified party or
parties. After notice from the indemnifying party to the indemnified party of
its election to assume the defense of such claim or action, the indemnifying
party shall not be liable to the indemnified party under such subsection for any
legal or other expenses subsequently incurred by the indemnified party in
connection with the defense thereof unless (i) the indemnified party shall have
employed separate counsel in accordance with the proviso to the preceding
sentence (it being understood, however, that the indemnifying party shall not be
liable for the expenses of more than one separate counsel (together with
appropriate local counsel) approved by the indemnifying party, representing all
the indemnified parties under Section 8(a) and 8(b) hereof who are parties to
such action), (ii) the indemnifying party shall not have employed counsel
satisfactory to the indemnified party to represent the indemnified party within
a reasonable time after notice of commencement of the action, or (iii) the
indemnifying party has authorized the employment of counsel for the indemnified
party at the expense of the indemnifying party. In no event shall any
indemnifying party be liable in respect of any amounts paid in settlement of any
action unless the indemnifying party shall have
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approved the terms of such settlement; provided, however, that such consent
shall not be unreasonably withheld.
(d) In order to provide for just and equitable contribution in any
action in which a claim for indemnification is made pursuant to this Section 8
for which it is judicially determined (by the entry of a final judgment or
decree by a court of competent jurisdiction and the expiration of time to appeal
or the denial of the last right of appeal) that such indemnification may not be
enforced in such case notwithstanding the fact that this Section 8 provides for
indemnification in such case, all the parties hereto shall contribute to the
aggregate losses, claims, damages or liabilities to which they may be subject
(after contribution from others) in such proportion so that the Underwriters are
responsible pro rata for the portion represented by the percentage that the
underwriting discount bears to the initial public offering price, and the
Company is responsible for the remaining portion; provided, however, that (i) no
Underwriter shall be required to contribute any amount in excess of the
underwriting discount applicable to the Shares purchased by such Underwriter,
and (ii) no person guilty of a fraudulent misrepresentation (within the meaning
of Section 11(f) of the Act) shall be entitled to a contribution from any person
who is not guilty of such fraudulent misrepresentation. This subsection (d)
shall not be operative as to any Underwriter to the extent that the Company has
received indemnity under this Section 8.
(e) The obligations of the Company under this Section 8 shall be in
addition to any liability which the Company may otherwise have, and shall
extend, upon the same terms and conditions, to each officer and director of each
Underwriter and to each person, if any, who controls any Underwriter within the
meaning of the Act; and the obligations of the Underwriters under this Section 8
shall be in addition to any liability that the respective Underwriters may
otherwise have, and shall extend, upon the same terms and conditions, to each
director of the Company (including any person who, with his consent, is named in
the Registration Statement as about to become a director of the Company), to
each officer of the Company who has signed the Registration Statement and to
each person, if any, who controls the Company within the meaning of the
Securities Act, in either case, whether or not such person is a party to any
action or proceeding.
(f) The parties to this Agreement hereby acknowledge that they are
sophisticated business persons who were represented by counsel during the
negotiations regarding the provisions hereof including without limitation the
provisions of this Section 8, and are fully informed regarding said provisions.
They further acknowledge that the provisions of this Section 8 fairly allocate
the risks in light of the ability of the parties to investigate the Company and
its business in order to assure that adequate disclosure is made in the
Registration Statement and Prospectus as required by the Act and the Exchange
Act. The parties are advised that Federal or state public policy, as
interpreted by the courts in certain jurisdictions, may be contrary to certain
of the provisions of this Section 8, and the parties hereto hereby expressly
waive and relinquish any right or ability to assert such public policy as a
defense to a claim under this Section 8 and further agree not to attempt to
assert any such defense.
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9. REPRESENTATIONS, WARRANTIES AND AGREEMENTS TO SURVIVE DELIVERY. All
representations, warranties, covenants and agreements of the Company contained
in this Agreement (including, without limitation, the agreements of the Company
set forth in Sections 4(i)-(l)), or contained in certificates of officers of the
Company submitted pursuant hereto, and the indemnity and contribution agreements
contained in Section 8 hereof, shall remain operative and in full force and
effect, regardless of any investigation made by or on behalf of any Underwriter
or controlling person, or by or on behalf of the Company, or any of its
officers, controlling persons or directors and shall survive delivery of the
Shares to the several Underwriters hereunder or termination of this Agreement.
10. SUBSTITUTION OF UNDERWRITERS. If any Underwriter or Underwriters
shall fail to take up and pay for the number of Firm Shares agreed by such
Underwriter or Underwriters to be purchased hereunder upon tender of such Firm
Shares in accordance with the terms hereof, and if the aggregate number of Firm
Shares which such defaulting Underwriter or Underwriters so agreed but failed to
purchase does not exceed 10% of the Firm Shares, the remaining Underwriters
shall be obligated, severally in proportion to their respective commitments
hereunder, to take up and pay for the Firm Shares of such defaulting Underwriter
or Underwriters.
If any Underwriter or Underwriters so defaults and the aggregate number of
Firm Shares which such defaulting Underwriter or Underwriters agreed but failed
to take up and pay for exceeds 10% of the Firm Shares, the remaining
Underwriters shall have the right, but shall not be obligated, to take up and
pay for (in such proportions as may be agreed upon among them) the Firm Shares
which the defaulting Underwriter or Underwriters so agreed but failed to
purchase. If such remaining Underwriters do not, at the Closing Date, take up
and pay for the Firm Shares which the defaulting Underwriter or Underwriters so
agreed but failed to purchase, the Closing Date shall be postponed for twenty-
four hours to allow the several Underwriters the privilege of substituting
within twenty-four hours (including non-business hours) another underwriter or
underwriters (which may include any nondefaulting Underwriter) satisfactory to
the Company. If no such underwriter or underwriters shall have been substituted
as aforesaid by such postponed Closing Date, the Closing Date may, at the option
of the Company, be postponed for a further twenty-four hours, if necessary to
allow the Company the privilege of finding another underwriter or underwriters,
satisfactory to you, to purchase the Firm Shares which the defaulting
Underwriter or Underwriters so agreed but failed to purchase. If it shall be
arranged for the remaining Underwriters or substituted underwriters to take up
the Firm Shares of the defaulting Underwriter or Underwriters as provided in
this Section, (i) the Company shall have the right to postpone the time of
delivery for a period of not more than seven full business days, in order to
effect whatever changes may thereby be made necessary in the Registration
Statement or the Prospectus, or in any other documents or arrangements, and the
Company agrees promptly to file any amendments to the Registration Statement or
supplements to the Prospectus which may thereby be made necessary, and (ii) the
respective number of Firm Shares to be purchased by the remaining Underwriters
and substitute underwriters shall be taken as the basis of their underwriting
obligation. If the remaining Underwriters shall not take up and pay for all
such Firm Shares so agreed to be purchased by the defaulting Underwriter or
Underwriters or substitute another underwriter or underwriters as aforesaid and
the Company shall not find or shall not elect
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to seek another underwriter or underwriters for such Firm Shares as aforesaid,
then this Agreement shall terminate.
In the event of any termination of this Agreement pursuant to the preceding
paragraph of this Section, neither the Company shall be liable to any
Underwriter (except as provided in Sections 5 and 8 hereof nor shall any
Underwriter (other than an Underwriter who shall have failed, otherwise than for
some reason permitted under this Agreement, to purchase the number of Firm
Shares agreed by such Underwriter to be purchased hereunder, which Underwriter
shall remain liable to the Company and the other Underwriters for damages, if
any, resulting from such default) be liable to the Company (except to the extent
provided in Sections 5 and 8 hereof).
The term "Underwriter" in this Agreement shall include any person
substituted for an Underwriter under this Section.
11. EFFECTIVE DATE OF THIS AGREEMENT AND TERMINATION.
(a) This Agreement shall become effective at the later of (i)
execution of this Agreement, or (ii) when notification of the effectiveness of
the Registration Statement has been released by the Commission.
(b) You shall have the right to terminate this Agreement by giving
notice as hereinafter specified at any time at or prior to the Closing Date (i)
if the Company shall have failed, refused or been unable, to perform any
agreement on its part to be performed, or because any other condition of the
Underwriters' obligations hereunder required to be fulfilled by the Company is
not fulfilled including, without limitation, any change in the financial
condition, earnings, operations, business, management, technical staff, or
business prospects of the Company from that set forth in the Registration
Statement or Prospectus which, in your sole judgment, is material and adverse,
or (ii) if trading on the New York Stock Exchange or the Nasdaq Stock Market
shall have been suspended, or minimum or maximum prices for trading shall have
been fixed, or maximum ranges for prices for securities shall have been required
on the New York Stock Exchange or the Nasdaq Stock Market, by the New York Stock
Exchange, the Nasdaq Stock Market or by order of the Commission or any other
governmental authority having jurisdiction, or if a banking moratorium shall
have been declared by Federal, New York, Oklahoma, Delaware or Texas
authorities, or (iii) if on or prior to the Closing Date, or on or prior to any
later date on which Option Shares are to be purchased, as the case may be, the
Company shall have sustained a loss by strike, fire, flood, earthquake, accident
or other calamity of such character as to interfere materially and adversely
with the conduct of the business and operations of the Company regardless of
whether or not such loss shall have been insured, or (iv) if there shall have
been a material adverse change in the general political or economic conditions
or financial markets in the United States as in your reasonable judgment makes
it inadvisable or impracticable to proceed with the offering, sale and delivery
of the Shares, or (v) if on or prior to the Closing Date, or on or prior to any
later date on which Option Shares are to be purchased, as the case may be, there
shall have been an outbreak or escalation of hostilities or other international
or domestic calamity, crises or material adverse change in political,
32
<PAGE>
financial or economic conditions, the effect of which on the financial markets
of the United States is such as to make it in your reasonable judgment,
inadvisable to proceed with the marketing of the Shares. In the event of
termination pursuant to this Section 11(b), the Company shall remain obligated
to pay costs and expenses pursuant to Section 4(j), 5 and 8 hereof.
If you elect to prevent this Agreement from becoming effective or to
terminate this Agreement as provided in this Section 11, you shall promptly
notify the Company by telephone or telecopy, in each case confirmed by letter.
If the Company shall elect to prevent this Agreement from becoming effective,
the Company shall promptly notify you by telephone or telecopy, in each case,
confirmed by letter.
12. NOTICES. All notices and other communications hereunder shall be in
writing and shall be deemed to have been given if mailed or transmitted by any
standard form of telecommunication. Notices to the Underwriters shall be
directed to the Underwriters in care of Capital West Securities, Inc., 211 N.
Robinson, 16th Floor, One Leadership Square, Oklahoma City, Oklahoma 73102,
attention of Robert O. MacDonald; notices to the Company shall be directed to it
at 722 N. Broadway, Oklahoma City, Oklahoma 73102, attention of Chief Executive
Officer.
13. PARTIES. This Agreement shall inure to the benefit of and be binding
upon the several Underwriters and the Company and their respective executors,
administrators, successors, and assigns. Nothing expressed or mentioned in this
Agreement is intended or shall be construed to give any person or corporation,
other than the parties hereto and their respective executors, administrators,
successors, and assigns and the controlling persons and officers and directors
referred to in Section 8 hereof any legal or equitable right, remedy or claim
under or in respect of this Agreement or any provisions herein contained. This
Agreement and all conditions and provisions hereof are intended to be for the
sole and exclusive benefit of the parties hereto and their respective executors,
administrators, successors, and assigns and said controlling persons and said
officers and directors, and for the benefit of no other person or corporation.
No purchaser of the Shares from any Underwriter shall be construed to be a
successor by reason merely of such purchase.
14. GOVERNING LAW. This Agreement and the Pricing Agreement shall be
governed by and construed in accordance with the laws of the State of Oklahoma
applicable to agreements made and to be performed in said State. Specified times
of day refer to Central time.
15. COUNTERPARTS. This Agreement may be signed in several counterparts,
each of which will constitute an original.
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<PAGE>
lf the foregoing correctly sets forth your understanding of our agreement,
please sign in the space provided below for that purpose, whereupon this
instrument, along with all counterparts, will become a binding agreement among
the several Underwriters and the Company in accordance with its terms.
CD WAREHOUSE, INC.
By:
---------------------------------
Jerry W. Grizzle, President
CONFIRMED AND ACCEPTED, as of the date first above written:
CAPITAL WEST SECURITIES, INC.
By:
---------------------------------
Robert O. McDonald, Chairman
WESTPORT RESOURCES
INVESTMENT SERVICES, INC.
By:
---------------------------------
Robert O. McDonald, Attorney in Fact
BERTHEL FISHER & COMPANY
FINANCIAL SERVICES, INC.
By:
---------------------------------
Robert O. McDonald, Attorney in Fact
34
<PAGE>
SCHEDULE A
UNDERWRITER SHARES PURCHASED
----------- ----------------
Capital West Securities, Inc.
Westport Resources Investment Services, Inc.
Berthel Fisher & Company Financial Services, Inc.
<PAGE>
CD WAREHOUSE, INC.
WARRANT AGREEMENT
January ___, 1997
CAPITAL WEST SECURITIES, INC.
WESTPORT RESOURCES
INVESTMENT SERVICES, INC.
BERTHEL FISHER & COMPANY
FINANCIAL SERVICES, INC.
c/o Capital West Securities, Inc.
211 N. Robinson
16th Floor, One Leadership Square
Oklahoma City, Oklahoma 73102
Ladies and Gentlemen:
CD Warehouse, Inc., a Delaware corporation (the "Company"), agrees to issue
and sell to you warrants (the "Warrants") to purchase the number of shares of
common stock, $0.01 par value per share (the "Common Stock"), of the Company set
forth herein, subject to the terms and conditions contained herein.
1. ISSUANCE OF WARRANTS; EXERCISE PRICE. The Warrants, which shall be in
the form attached hereto as Exhibit A, shall be issued to you concurrently with
the execution hereof in consideration of the payment by you to the Company of
the sum of $0.001 cash per share of Common Stock subject to the Warrants, the
receipt and sufficiency of which are hereby acknowledged. The Warrant shall
provide that you, or such other holder or holders of the Warrants to whom
transfer is authorized in accordance with the terms of this Agreement, shall
have the right to purchase an aggregate of 100,000 shares of Common Stock for an
exercise price equal to $_____ per share (the "Exercise Price") or $____________
in the aggregate. The number, character and Exercise Price of such shares of
Common Stock are subject to adjustment as hereinafter provided, and the term
"Common Stock" shall mean, unless the context otherwise requires, the stock and
other securities and property receivable upon exercise of the Warrants. The
term "Exercise Price" shall mean, unless the context otherwise requires, the
price per share of the Common Stock purchasable under the Warrants as set forth
in this Section 1, as adjusted from time to time pursuant to Section 6.
2. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants
to you and to each subsequent holder of Warrants and agrees that:
(a) This Agreement has been duly authorized, executed and delivered
by the Company and constitutes the valid and binding obligation of the Company
enforceable in accordance with its terms; and neither the issuance of the
Warrants nor the issuance of the shares of Common Stock issuable upon exercise
of the Warrants will result in a breach or violation of any terms or provisions
of, or constitute a default under, any contract, indenture, mortgage, deed of
trust, loan agreement or other agreement or instrument to which the Company is a
party or by which the Company is bound, the
<PAGE>
Certificate of Incorporation or Bylaws of the Company, or any law, order,
rule, regulation or decree of any government, governmental instrumentality or
court, domestic or foreign, or result in the creation or imposition of any
lien, charge or encumbrance upon any property or assets of the Company.
(b) No consent, approval, authorization or order of any court or
governmental agency or body is required for the sale and issuance of the
Warrants or the sale and issuance of the shares of Common Stock issuable upon
exercise of the Warrants, except such as have been obtained or may be required
under the Securities Act of 1933, as amended (the "Act"), and such as may be
required under state securities or blue sky laws in connection with the issuance
of the Warrants and the shares of Common Stock issuable upon exercise of the
Warrants. Upon exercise of the Warrants by the holder thereof, the shares of
Common Stock with respect to which the Warrants are exercised will be validly
issued, fully paid, and nonassessable, and good and marketable title to such
shares of Common Stock shall be delivered to such holder free and clear of all
liens, encumbrances, equities, claims or preemptive or similar rights.
(c) During the term of this Agreement, the Company shall make timely
filings of all periodic and other reports and forms and other materials required
(but only to the extent required) to be filed with the Securities and Exchange
Commission (the "Commission") pursuant to the Act or the Securities Exchange Act
of 1934, as amended, and with any national securities exchange or quotation
system upon which any of the securities of the Company may be listed.
3. NOTICES OF RECORD DATE; ETC. In the event of (i) any taking by the
Company of a record date with respect to the holders of any class of securities
of the Company for purposes of determining which of such holders are entitled to
dividends or other distributions (other than regular quarterly dividends), or
any right to subscribe for, purchase or otherwise acquire shares of stock of any
class or any other securities or property, or to receive any other right, (ii)
any capital reorganization of the Company, or reclassification or
recapitalization of capital stock of the Company or any transfer in one or more
related transactions of all or a majority of the assets or revenue or income
generating capacity of the Company to, or consolidation or merger of the Company
with or into, any other entity or person, or (iii) any voluntary or involuntary
dissolution or winding up of the Company, then and in each such event the
Company will mail or cause to be mailed to each holder of a Warrant at the time
outstanding a notice specifying, as the case may be, (A) the date on which any
such record is to be taken for the purpose of such dividend, distribution or
right, and stating the amount and character of such dividend, distribution or
right; or (B) the date on which any such reorganization, reclassification,
recapitalization, transfer, consolidation, merger, conveyance, dissolution,
liquidation or winding-up is to take place and the time, if any is to be fixed,
as of which the holders of record of Common Stock (or any other class of stock
or securities of the Company, or another issuer pursuant to Section 6,
receivable upon the exercise of the Warrants) shall be entitled to exchange
their shares of Common Stock (or such other stock or securities) for securities
or other property deliverable upon such event. Any such notice shall be
deposited in the United States mail, postage prepaid, at least ten (10) days
prior to the date therein specified, and the holders(s) of the Warrant(s) may
exercise the Warrant(s) and participate in such event as a registered holder of
Common Stock, upon exercise of the Warrant(s) so held, within the ten (10) day
period from the date of mailing of such notice.
2
<PAGE>
4. NO IMPAIRMENT. The Company shall not, by amendment of its
organizational documents or through any reorganization, transfer of assets,
consolidation, merger, dissolution, issue or sale of securities, or any other
action, avoid or seek to avoid the observance or performance of any of the terms
of this Agreement or of the Warrants, but will at all times in good faith take
any and all action as may be necessary in order to protect the rights of the
holders of the Warrants against impairment. Without limiting the generality of
the foregoing, the Company (a) will at all times reserve and keep available,
solely for issuance and delivery upon exercise of the Warrants, shares of Common
Stock issuable from time to time upon exercise of the Warrants, (b) will not
increase the par value of any shares of stock receivable upon exercise of the
Warrants above the amount payable in respect thereof upon such exercise, and (c)
will take all such action as may be necessary or appropriate in order that the
Company may validly and legally issue fully paid and non-assessable stock upon
the exercise of the Warrants, or any of them.
5. EXERCISE OF WARRANTS. At any time and from time to time on and after
the first anniversary of the date hereof and expiring on the fifth anniversary
of the effective date of the public offering of the Common Stock at 5:00 p.m.,
Oklahoma City, Oklahoma time, Warrants may be exercised as to all or any portion
of the whole number of shares of Common Stock covered by the Warrants by the
holder thereof by surrender of the Warrants, accompanied by a subscription for
shares to be purchased in the form attached hereto as Exhibit B and by a check
payable to the order of the Company in the amount required for purchase of the
shares as to which the Warrant is being exercised, delivered to the Company at
its principal office at 722 North Broadway, Oklahoma City, Oklahoma 73102,
Attention: President. Warrants may also be exercised from time to time, without
any payment required for the purchase of the shares as to which the Warrant is
being exercised, as to all or any portion of the number of shares of Common
Stock covered by the Warrant(s) by the holder thereof by surrender of the
Warrants, accompanied by a subscription for shares in the form attached as
Exhibit C, pursuant to which the holder thereof will be entitled to receive upon
such surrender of the Warrant(s) (and without any further payment) that number
of shares of Common Stock equal to the product of the number of shares of Common
Stock obtainable upon exercise of the Warrant(s) (or the portion thereof as to
which the exercise relates) multiplied by a fraction: (i) the numerator of which
shall be the difference between the then Current Value (as defined in this
Section 5 and Section 7(d)) of one full share of Common Stock on the date of
exercise and the Exercise Price, and (ii) the denominator of which shall be the
Current Value of one full share of Common Stock on the date of exercise. Upon
the exercise of a Warrant in whole or in part, the Company will within five (5)
days thereafter, at its expense (including the payment by the Company of any
applicable issue or transfer taxes), cause to be issued in the name of and
delivered to the Warrant holder a certificate or certificates for the number of
fully paid and non-assessable shares of Common Stock to which such holder is
entitled upon exercise of the Warrant. In the event such holder is entitled to
a fractional share, in lieu thereof such holder shall be paid a cash amount
equal to such fraction, multiplied by the Current Value of one full shares of
Common Stock on the date of exercise. Certificates for shares of Common Stock
issuable by reason of the exercise of the Warrant or Warrants shall be dated and
shall be effective as of the date of the surrendering of the Warrant for
exercise, notwithstanding any delays in the actual execution, issuance or
delivery of the certificates for the shares so purchased. In the event a
Warrant or Warrants is exercised as to less than the aggregate amount of all
shares of Common Stock issuable upon exercise of all Warrants held by such
person, the Company shall issue a new Warrant to the holder of the Warrant so
exercised covering the aggregate number of shares of Common Stock as to which
Warrants remain unexercised.
3
<PAGE>
For purposes of this section, Current Value is defined (i) in the case
for which a public market exists for the Common Stock at the time of such
exercise, according to Section 7(d), and (ii) in the case no public market
exists at the time of such exercise, at the Appraised Value. For the purposes
of this Agreement, "Appraised Value" is the value determined in accordance with
the following procedures. For a period of five (5) days after the date of an
event (a "Valuation Event") requiring determination of Current Value at a time
when no public market exists for the Common Stock (the "Negotiation Period"),
each party to this Agreement agrees to negotiate in good faith to reach
agreement upon the Appraised Value of the securities or property at issue, as of
the date of the Valuation Event, which will be the fair market value of such
securities or property, without premium for control or discount for minority
interests, illiquidity or restrictions on transfer. In the event that the
parties are unable to agree upon the Appraised Value of such securities or other
property by the end of the Negotiation Period, then the Appraised Value of such
securities or property will be determined for purposes of this Agreement by a
recognized appraisal or investment banking firm mutually agreeable to the
holders of the Warrants and the Company (the "Appraiser"). If the holders of
the Warrants and the Company cannot agree on an Appraiser within two (2)
business days after the end of the Negotiation Period, the Company, on the one
hand, and the holders of the Warrants, on the other hand, will each select an
Appraiser within ten (10) business days after the end of the Negotiation Period
and those two Appraisers will select ten (10) days after the end of the
Negotiation Period an independent Appraiser to determine the fair market value
of such securities or property, without premium for control or discount for
minority interests. Such independent Appraiser will be directed to determine
fair market value of such securities or property as soon as practicable, but in
no event later than thirty (30) days from the date of its selection. The
determination by an Appraiser of the fair market value will be conclusive and
binding on all parties to this Agreement. Appraised Value of each share of
Common Stock at a time when (i) the Company is not a reporting company under the
Exchange Act and (ii) the Common Stock is not traded in the organized securities
markets, will, in all cases, be calculated by determining the Appraised Value of
the entire Company taken as a whole and dividing that value by the number of
shares of Common Stock then outstanding, without premium for control or discount
for minority interests, illiquidity or restrictions on transfer. The costs of
the Appraiser will be borne by the Company. In no event will the Appraised
Value of the Common Stock be less than the per share consideration received or
receivable with respect to the Common Stock or securities or property of the
same class in connection with a pending transaction involving a sale, merger,
recapitalization, reorganization, consolidation, or share exchange, dissolution
of the Company, sale or transfer of all or a majority of its assets or revenue
or income generating capacity, or similar transaction.
6. PROTECTION AGAINST DILUTION. The Exercise Price for the shares of
Common Stock and number of shares of Common Stock issuable upon exercise of the
Warrants is subject to adjustment from time to time as follows:
(a) STOCK DIVIDENDS, SUBDIVISIONS, RECLASSIFICATIONS, ETC.. In case
at any time or from time to time after the date of execution of this Agreement,
the Company shall (i) take a record of the holders of Common Stock for the
purpose of entitling them to receive a dividend or a distribution on shares of
Common Stock payable in shares of Common Stock or other class of securities,
(ii) subdivide or reclassify its outstanding shares of Common Stock into a
greater number of shares, or (iii) combine or reclassify its outstanding Common
Stock into a smaller number of shares, then, and in each such case, the Exercise
Price in effect at the time of the record date for such dividend or distribution
or
4
<PAGE>
the effective date of such subdivision, combination or reclassification shall
be adjusted in such a manner that the Exercise Price for the shares issuable
upon exercise of the Warrants immediately after such event shall bear the same
ratio to the Exercise Price in effect immediately prior to any such event as the
total number of shares of Common Stock outstanding immediately prior to such
event shall bear to the total number of shares of Common Stock outstanding
immediately after such event.
(b) ADJUSTMENT OF NUMBER OF SHARES PURCHASABLE. When any adjustment
is required to be made in the exercise Price under this Section 6, (i) the
number of shares of Common Stock issuable upon exercise of the Warrants shall be
changed (upward to the nearest full share) to the number of shares determined by
dividing (x) an amount equal to the number of shares issuable pursuant to the
exercise of the Warrants immediately prior to the adjustment, multiplied by the
Exercise Price in effect immediately prior to the adjustment, by (y) the
Exercise Price in effect immediately after such adjustment, and (ii) upon
exercise of the Warrant, the holder will be entitled to receive the number of
shares of other securities referred to in Section 6(a) that such holder would
have received had the Warrant been exercised prior to the events referred to in
Section 6(a).
(c) ADJUSTMENT FOR REORGANIZATION, CONSOLIDATION, MERGER, ETC.. In
case of any reorganization or consolidation of the Company with, or any merger
of the Company with or into, another entity (other than a consolidation or
merger in which the Company is the surviving corporation) or in case of any sale
or transfer to another entity of the majority of assets of the Company, the
entity resulting from such reorganization or consolidation or surviving such
merger or to which such sale or transfer shall be made, as the case may be,
shall make suitable provision (which shall be fair and equitable to the holders
of Warrants) and shall assume the obligations of the Company hereunder (by
written instrument executed and mailed to each holder of the Warrants then
outstanding) pursuant to which, upon exercise of the Warrants, at any time after
the consummation of such reorganization, consolidation, merger or conveyance,
the holder shall be entitled to receive the stock or other securities or
property that such holder would have been entitled to upon consummation if such
holder had exercised the Warrants immediately prior thereto, all subject to
further adjustment as provided in this Section 6.
(d) CERTIFICATE AS TO ADJUSTMENTS. In the event of adjustment as
herein provided in paragraphs of this Section 6, the Company shall promptly mail
to each Warrant holder a certificate setting forth the Exercise Price and number
of shares of Common Stock issuable upon exercise after such adjustment and
setting forth a brief statement of facts requiring such adjustment. Such
certificate shall also set forth a brief statement of facts requiring such
adjustment. Such certificate shall also set forth the kind and amount of stock
or other securities or property into which the Warrants shall be exercisable
after any adjustment of the Exercise Price as provided in this Agreement.
(e) MINIMUM ADJUSTMENT. Notwithstanding the foregoing, no
certificate as to adjustment of the Exercise Price hereunder shall be made if
such adjustment results in a change in the Exercise Price then in effect of less
than five cents ($0.05) and any adjustment of less than five cents ($0.05) of
any Exercise Price shall be carried forward and shall be made at the time of and
together with any subsequent adjustment that, together with the adjustment or
adjustments so carried forward, amounts to five cents ($0.05) or more; provided
however, that upon the exercise of a Warrant, the Company shall
5
<PAGE>
have made all necessary adjustments (to the nearest cent) not theretofore made
to the Exercise Price up to and including the date upon which such Warrant is
exercised.
7. REGISTRATION RIGHTS.
(a) The Company agrees that upon written notice given to the Company
at any time on or after the first anniversary of the effective date of the
public offering of the Common Stock but before the fifth anniversary of the
effective date of the public offering, from the holder or holders of not less
than fifty-one percent (51%) of the shares issued and issuable upon exercise of
the Warrants, of a proposed distribution by such holder or holders of Common
Stock issued or issuable upon exercise of Warrants, the Company will, within 45
days after receipt of such notice, promptly prepare, file and diligently
prosecute to effectiveness, an appropriate filing with the Commission of a
registration statement covering the proposed sale or distribution of all or any
part of such shares under the Securities Act of 1933, as amended (the "Act"),
and the appropriate registration statements or applications under the securities
laws of such states as such holders, in their discretion, shall determine, and
will use its reasonable best efforts to have such registration and application
(including both the registration under the Act and the registration or
application made under the various state securities laws) declared effective as
soon as practicable after the filing thereof and to remain effective for such
period that may be reasonably necessary to complete the distribution of
securities so registered or qualified. At least 15 days prior to such filing,
the Company shall give written notice of such proposed filing to each registered
holder of any Warrants at the holders' addresses appearing on the records of the
Company and to each registered holder of Common Stock purchased from the
exercise of any Warrants at such holder's address appearing on the Company
records, and shall offer to include in such registration statement any proposed
distribution of such Common Stock held or to be held by each such registered
holder; provided, however, that except as provided in Section 7(e), the Company
need not effect the registration of the sale or distribution of Common Stock
purchased upon exercise of Warrants more than once. All expenses, disbursements
and fees (including fees and expenses of counsel for the Company, special
auditing fees specifically attributable to the sale by the selling holder or
holders of Common Stock, printing expenses (including all necessary copies of
the registration statement and prospectuses contained therein), registration and
filing fees and blue sky fees and expenses, and fees and charges of the
Company's transfer agent and registrar for services rendered in connection
therewith) shall be borne by the Company; provided, however, that the Company
shall not be required to pay for any expenses of any registration proceeding
begun (in which case holders shall bear such expenses), if the registration
request is subsequently withdrawn at any time at the request of the holder or
holders of not less than 51% of the shares issued and issuable upon exercise of
the Warrants, unless such withdrawal is due to the misconduct of the Company or
due to an unforeseen material adverse change in the business, properties,
prospects or financial condition of the Company occurring prior to the
effectiveness of the registration statement, in which case the Company will
continue to bear such expenses.
(b) In connection with any registration under the Act and specified
state securities law pursuant to this Agreement, the Company will, without
charge, furnish each holder whose shares are registered thereunder with copies
of the registration statement and all amendments thereto and will, without
charge, supply each such holder with copies of any preliminary and final
prospectus
6
<PAGE>
included therein in such quantities as may be necessary for the purposes of
such proposed sale or distribution that the holder or holders may reasonably
request.
(c) In connection with any registration of shares pursuant to this
Section 7, the holders whose shares are being registered shall furnish the
Company with such information concerning such holders and the proposed sale or
distribution as shall be required for use in the preparation of such
registration statement and applications.
(d) Notwithstanding the foregoing provisions of this Section 7, upon
receipt of such written notice from the holder or holders of not less than fifty
one percent (51%) of the shares issued and issuable upon exercise of the
Warrants requesting that the Company effect registration of the sale or
distribution of Common Stock as provided in Section 7(a) or upon election by
holders of Warrants or Common Stock to participate in a registration pursuant to
Section 7(e), the Company shall have the option, for a period of ten (10) days
thereafter, to purchase all or any such Warrants and all or any such shares of
Common Stock acquired pursuant to the exercise of the Warrants and held by
holders providing the request for registration under Section 7(a) and/or 7(e)
and held by any other holder of Warrants or shares issued and will exercise its
option if it so elects as follows:
(i) as to such Warrants, at a price per Warrant equal to the
difference between (A) the average of the means between the closing bid and
asked prices of the Common Stock in the over-the-counter market for 20
consecutive business days commencing 30 business days before the date of receipt
of such notice, (B) if the Common Stock is quoted on the Nasdaq SmallCap Market,
at the average of the means of the daily closing bid and asked prices of the
Common Stock for 20 consecutive business days commencing 30 business days before
the date of such notice, or (C) if the Common Stock is listed on any national
securities exchange or quoted on the Nasdaq National Market System, at the
average of the daily closing prices of the Common Stock for 20 consecutive
business days commencing 30 business days before the date of such notice and the
Exercise Price of the Warrant at the time of receipt of such notice; and
(ii) as to shares of Common Stock previously purchased pursuant
to the exercise of Warrants, at a price per share equal to (A) the average of
the means between the closing bid and asked prices of the Common Stock in the
over-the-counter market for 20 consecutive business days commencing 30 business
days before the date of such notice, (b) if the Common Stock is quoted on the
Nasdaq SmallCap Market, at the average of the means of the daily closing bid and
asked prices of the Common Stock for 20 consecutive business days commencing 30
business days before the date of such notice or (C) if the Common Stock is
listed on any national securities exchange or the Nasdaq National Market System,
at the average of the daily closing prices of the Common Stock for 20
consecutive business days commencing 30 business days before the date of such
notice (such value of shares so determined in this Section 7(d)(ii), as the case
may be, is referred to herein as the "Current Value").
(e) If any time on or after the first anniversary of the date hereof
but before the fifth anniversary of the date hereof the Company proposes to file
a registration statement under the
7
<PAGE>
Act covering a proposed sale of shares of Common Stock, it shall give to each
holder who then owns any Warrants or any shares of Common Stock acquired
pursuant to the exercise of the Warrants notice of such proposed registration
at least 30 days prior to the filing of the registration statement and shall
afford each such holder who then proposed to sell or distribute publicly any
of the shares subject to the Warrants upon giving not less than 10 days notice
prior to such filing, the opportunity to have such shares included in the
securities registered under the registration statement. All expenses,
disbursements and fees (including, but without limitation, fees and expenses
of counsel, auditing fees, printing expenses, SEC filing fees and expenses,
but excluding any underwriting discounts or commissions) incurred in
connection with the registration by the Company of the sale of any shares for
any such holder under this Section 7(e) shall be borne by the Company.
8. INDEMNIFICATION; CONTRIBUTION.
(a) The Company will indemnify and hold harmless each holder and each
affiliate thereof of Common Stock registered pursuant to this Agreement with the
Commission, or under any Blue Sky Law or regulation against any losses, claims,
damages, or liabilities, joint or several, to which such holder may become
subject under the Act or otherwise, insofar as such losses, claims, damages, or
liabilities (or actions in respect thereof) arise out of or are based upon an
untrue statement or alleged untrue statement of a material fact contained in any
preliminary prospectus, registration statement, prospectus, or any amendment or
supplement thereto, or arise out of or are based upon the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, and will reimburse each
such holder and affiliate for any legal or other expenses reasonably incurred by
such holder in connection with investigating or defending any such action or
claim regardless of the negligence of any such holder or affiliate; provided,
however, that the Company shall not be liable in any such case to the extent
that any such loss, claim, damage, or liability arises out of or is based upon
an untrue statement or alleged untrue statement or omission or alleged omission
made in any preliminary prospectus, registration statement or prospectus, or any
such amendment or supplement thereto, in reliance upon and in conformity with
written information furnished to the Company by any such holder expressly for
use therein.
(b) Each holder of Common Stock registered pursuant to this Agreement
will indemnify and hold harmless the Company against any losses, claims,
damages, or liabilities to which the Company may become subject, under the Act
or otherwise, insofar as such losses, claims, damages, or liabilities (or
actions in respect thereof) arise out of or are based upon an untrue statement
or alleged untrue statement of a material fact contained in any preliminary
prospectus, registration statement or prospectus, or any amendment or supplement
thereto, or arise out of or are based upon the omission or alleged omission to
state therein a material fact required to be stated therein or necessary to make
the statements therein not misleading, in each case to the extent, but only to
the extent, that such untrue statement or alleged untrue statement or omission
or alleged omission was made in any preliminary prospectus, registration
statement or prospectus, or any amendment or supplement thereto, in reliance
upon and in conformity with written information furnished to the Company by such
holder expressly for use therein.
8
<PAGE>
(c) Promptly after receipt by an indemnified party under Sections
8(a) or (b) above of the commencement of any action, such indemnified party
shall, if a claim in respect thereof is to be made against the indemnifying
party under either such subsection, notify the indemnifying party in writing of
the commencement thereof; but the omission so to notify the indemnifying party
shall not relieve it from any liability that it may otherwise have to any
indemnified party. In case any such action shall be brought against any
indemnified party and it shall notify the indemnifying party of the commencement
thereof the indemnifying party shall be entitled to assume the defense thereof
by notice in writing to the indemnified party. After notice from the
indemnifying party to such indemnified party of its election to assume the
defense thereof, the indemnifying party shall not be liable to such indemnified
party under either of such subsections for any legal expenses of other counsel
or any other expense, in each case subsequently incurred by such indemnified
party, in connection with the defense thereof other than reasonable costs of
investigation incurred prior to the assumption by the indemnifying party, unless
such expenses have been specifically authorized in writing by the indemnifying
party, the indemnifying party has failed to assume the defense and employ
counsel, or the named parties to any such action include both the indemnified
party and the indemnifying party, as appropriate, and such indemnified party has
been advised by counsel that the representation of such indemnified party has
been advised by counsel that the representation of such indemnified party and
the indemnifying party by the same counsel would be inappropriate due to actual
or potential differing interests between them, in each of which cases the fees
of counsel for the indemnified party will be paid by the indemnifying party.
(d) If the indemnification provided for in this Section 8 is
unavailable or insufficient to hold harmless an indemnified party under Section
8(a) or 8(b) in respect of any losses, claims, damages, or liabilities (or
action in respect thereof) referred to therein, then each indemnifying party
shall contribute to the amount paid or payable by such indemnified party as a
result of such losses, claims, damages, or liabilities (or actions in respect
thereof) in such proportion as is appropriate to reflect the relative benefits
received by the Company and the holder or holders from this Agreement and from
the offering of the shares of Common Stock. If, however, the allocation
provided by the immediately preceding sentence is not permitted by applicable
law, then each indemnifying party shall contribute to such amount paid or
payable by such indemnified party in such proportion as is appropriate to
reflect not only such relative benefits but also the relative fault of the
Company and the holders in connection with the statement or omissions that
resulted in such losses, claims, damages, or liabilities (or actions in respect
thereof), as well as any other relevant equitable considerations. The relative
fault shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by the Company
or the holder and the parties' relative intent, knowledge, access to information
and opportunity to correct or prevent such statement or omission. The Company
and the holders agree that it would not be just and equitable if contribution
pursuant to this Section 8(d) were determined by pro rata allocation (even if
the holders were treated as one entity for such purpose) or by any other method
of allocation that does not take into account the equitable considerations
referred to above in this subsection (e). Except as provided in Section 8(c),
the amount paid or payable by an indemnified party as a result of the losses,
claims, damages, or liabilities (or actions in respect thereof) referred to
above in this Section
9
<PAGE>
8(d) shall be deemed to include any legal or other expenses reasonably
incurred by such indemnified party in connection with investigation or
defending any such action or claim. No person guilty of fraudulent
misrepresentation (within the meaning of Section 11(f) of the Act) shall be
entitled to contribution from any person who was not guilty of such fraudulent
misrepresentation. Notwithstanding any provision in this Section 8(d) to the
contrary, no holder shall be liable for any amount, in the aggregate, in
excess of the net proceeds to such holder from the sale of such holder's
shares (obtained upon exercise of Warrants) giving rise to such losses,
claims, damages, or liabilities.
(e) The obligations of the Company under this Section 8 shall be in
addition to any liability that the Company may otherwise have and shall extend,
upon the same terms and conditions, to each person, if any, who controls any
holder of Warrants within the meaning of the Act. The obligations of the
holders of Common Stock under this Section 8 shall be in addition to any
liability that such holders may otherwise have and shall extend, upon the same
terms and conditions to each person, if any, who controls the Company within the
meaning of the Act.
9. STOCK EXCHANGE LISTING. In the event the Company lists its Common
Stock on any national securities exchange, the Company will, at its expense,
also list on such exchange, upon exercise of a Warrant, all shares of Common
Stock issuable pursuant to such Warrant.
10. SPECIFIC PERFORMANCE. The Company stipulates that remedies at law, in
money damages, available to the holder of a Warrant, or of a holder of Common
Stock issued pursuant to exercise of a Warrant, in the event of any default or
threatened default by the Company in the performance of or compliance with any
of the terms of this Agreement are not and will not be adequate. Therefore, the
Company agrees that the terms of this Agreement may be specifically enforced by
a decree for the specific performance of any agreement contained herein or by an
injunction against a violation of any of the terms hereof or otherwise.
11. SUCCESSORS AND ASSIGNS; BINDING EFFECT. This Agreement shall be
binding upon and inure to the benefit of you and the Company and their
respective successors and permitted assigns.
12. NOTICES. Any notice hereunder shall be given by registered or
certified mail, if to the Company, at its principal office referred to in
Section 5 and, if to the holders, to their respective addresses shown in the
Warrant ledger of the Company, provided that any holder may at any time on three
(3) days' written notice to the Company designate or substitute another address
where notice is to be given. Notice shall be deemed given and received after a
certified or registered letter, properly addressed with postage prepaid, is
deposited in the U.S. mail.
13. SEVERABILITY. Every provision of this Agreement is intended to be
severable. If any term or provision hereof is illegal or invalid for any reason
whatsoever, such illegality or invalidity shall not affect the remainder of this
Agreement.
10
<PAGE>
14. ASSIGNMENT; REPLACEMENT OF WARRANTS. If the Warrant or Warrants are
assigned, in whole or in part, the Warrants shall be surrendered at the
principal office of the Company, and thereupon, in the case of a partial
assignment, a new Warrant shall be issued to the holder thereof covering the
number of shares not assigned, and the assignee shall be entitled to receive a
new Warrant covering the number of shares so assigned. Upon receipt of evidence
reasonably satisfactory to the Company of the loss, theft, destruction, or
mutilation of any Warrant and appropriate bond or indemnification protection,
the Company shall issue a new Warrant of like tenor. Except as contemplated by
Section 7 of this Agreement, the Warrants will not be transferred, sold, or
otherwise hypothecated by you or any other person and the Warrants will be
nontransferable, except to (i) one or more persons, each of which on the date of
transfer is an officer, shareholder, or employee of you; (ii) a partnership or
partnerships, the partners of which are you and one or more persons, each of
whom on the date of transfer is an officer to you; (iii) a successor to you in
merger or consolidation; (iv) a purchaser of all or substantially all of your
assets; or (v) a person that receives a Warrant upon death of a Holder pursuant
to will, trust, or the laws of intestate succession.
15. GOVERNING LAW. This Agreement shall be governed and construed in
accordance with the laws of the State of Oklahoma without giving effect to the
principles of choice of laws thereof.
16. DEFINITION. All references to the word "you", and to "Capital West
Securities, Inc." in this Agreement shall be deemed to apply with equal effect
to any persons or entities to whom Warrants have been transferred in accordance
with the terms hereof, and, where appropriate, to any persons or entities
holding shares of Common Stock issuable upon exercise of Warrants.
17. HEADINGS. The headings herein are for purposes of reference only and
shall not limit or otherwise affect the meaning of any of the provisions hereof.
Very truly yours,
CD WAREHOUSE, INC.
By:
-------------------------------
Jerry W. Grizzle, President
11
<PAGE>
Accepted as of the _____ day of January, 1997.
CAPITAL WEST SECURITIES, INC.
By:
----------------------------------
Robert O. McDonald, Chairman
WESTPORT RESOURCES
INVESTMENT SERVICES, INC.
By:
----------------------------------
BERTHEL FISHER & COMPANY
FINANCIAL SERVICES, INC.
By:
----------------------------------
12
<PAGE>
EXHIBIT A
CD WAREHOUSE, INC.
COMMON STOCK PURCHASE WARRANT
THIS IS TO CERTIFY that _________________________________ or its assigns as
permitted in that certain Warrant Agreement (the "Warrant Agreement") dated
January __, 1997, between the Company (as hereinafter defined) and Capital West
Securities, Inc., Westport Resources Investment Services, Inc. and Berthel
Fisher & Company Financial Services, Inc. is entitled to purchase at any time or
from time to time on or after January __, 1998 until 5:00 p.m., Oklahoma City,
Oklahoma time on January __, 2002, an aggregate of ______________ shares of
Common Stock, par value $0.01 per share, of CD Warehouse, Inc., a Delaware
corporation (the "Company"), for an exercise price per share as set forth in the
Warrant Agreement referred to herein. This Warrant is issued pursuant to the
Warrant Agreement, and all rights of the holder of this Warrant are further
governed by, and subject to the terms and provisions of such Warrant Agreement,
copies of which are available upon request to the Company. The holder of this
Warrant and the shares issuable upon the exercise hereof shall be entitled to
the benefits, rights and privileges and subject to the obligations, duties and
liabilities provided in the Warrant Agreement.
The issuance of this Warrant and the shares issuable upon the due and
timely exercise hereof have not been registered under the Securities Act of
1933, as amended (the "Act"), or any similar state securities law or act, and,
as such, no public offering of either this Warrant of any of the shares of
Common Stock issuable upon exercise of this Warrant may be made other than under
an exemption under the Act or until the effectiveness of a registration
statement under such Act covering such offering. Transfer of this Warrant is
restricted as provided in Section 14 of the Warrant Agreement.
Subject to the provisions of the Act, of the Warrant Agreement and of this
Warrant, this Warrant and all rights hereunder are transferable, in whole or in
part, only to the extent expressly permitted in such documents and then only at
the office of the Company at 722 North Broadway, Oklahoma City, Oklahoma 73102,
Attention: President, by the holder hereof or by a duly authorized attorney-in-
fact, upon surrender of this Warrant duly endorsed, together with the Assignment
hereof duly endorsed. Until transfer hereof on the books of the Company, the
Company may treat the registered holder hereof as the owner hereof for all
purposes.
IN WITNESS WHEREOF, the Company has caused this Warrant to be executed and
its corporate seal to be hereunto affixed by its proper corporate officers
thereunto duly authorized.
CD WAREHOUSE, INC.
By:
---------------------------------
Jerry W. Grizzle, President
(SEAL)
Attest:
- -------------------------------------
Doyle E. Motley, Secretary
<PAGE>
[LETTERHEAD]
January 16, 1997
Mr. Jerry Grizzle
CD Warehouse, Inc.
722 North Broadway
Oklahoma City, Oklahoma 73102
Dear Jerry:
On behalf of Bank of Oklahoma, N.A. ("Bank"), I am pleased to confirm our
commitment for a secured Revolving Line of Credit for CD Warehouse, Inc.
("Borrower"). This commitment is subject to satisfactory legal documentation
using the terms and conditions hereafter described.
The general terms and conditions of the credit facility shall include but not
be limited to the following:
BORROWER: CD Warehouse, Inc.
AMOUNT: $2,000,000 Revolving Line of Credit
USE OF PROCEEDS: To provide funds for the development of new company-owned
stores; the remodeling of existing company-owned stores; or
the acquisition of existing franchise locations.
MATURITY: The note will mature December 31, 1999.
RATE & FEES: - The note will bear interest at Chase Manhattan National
Prime plus 0.75%, floating. Rate to change on date of
change.
- A non-use fee of 0.25% per annum on the unused portion
will be charged quarterly in arrears.
PREPAYMENT: Interest will be payable monthly during the term of the
facility. Outstanding principal will be "carved out" of
the line on an annual basis and placed on a reasonable
amortization.
<PAGE>
Mr. Jerry Grizzle
January 16, 1997
Page 2
COLLATERAL: - A first security interest in any leasehold
improvements, furniture and fixtures, and other assets
financed under the proposed facility.
- An assignment of all franchise agreements between the
individual franchises and the Borrower, whether now in
existence or hereafter executed, together with all
proceeds thereof.
- A first and prior security interest in all of the
Borrower's tangible and intangible assets, and all
proceeds, products, and increases thereof.
- Any outstanding amounts under the line will be
collateralized 110% by liquid assets (e.g., marketable
securities or certificates of deposit). Collateral will
be pledged by the guarantor(s) and the Bank must be able
to perfect a security interest in the collateral.
GUARANTOR(S): Unlimited guarantee(s) of individuals acceptable to the
Bank.
LOAN AGREEMENT: This Commitment will be governed by a Loan Agreement in
form satisfactory to the Bank and its counsel that details
the various terms and provisions of the commitment and all
other documents that are necessary to in fulfilling this
proposal. Major loan covenants include the following:
- Borrower will complete, or will have completed, a
public offering raising a minimum of $5,000,000 of market
capitalization. Concurrent with the offering, the
Borrower will complete the CDIL Acquisition and the
MacDonald Acquisition.
- Borrower will provide to the Bank monthly unaudited
financial statements within 30 days of month end, 10-Q
statement within 45 days of quarter end, and an annual
audited financial statement and 10-K statement within 90
days of fiscal year end.
- Borrower will notify Bank of any changes in senior
management. If deemed material by the Bank, it could
constitute an event default.
<PAGE>
Mr. Jerry Grizzle
January 16, 1997
Page 3
COSTS & FEES: Borrower agrees to pay all reasonable expenses incurred by
the Bank in conjunction with this transaction, including, but
not limited to: legal fees, recording fees, and filing fees
associated with the preparation of loan documents.
BORROWING
AUTHORIZATION: Prior to the loan closing, the Borrower must furnish a
properly executed corporate borrowing resolution and any
other requested evidence of its authority to borrow.
INSURANCE: Borrower shall maintain property and general liability
insurance acceptable to the Bank and naming the Bank as an
additional insured party.
COMMITMENT
MODIFICATIONS: This Commitment may not be modified except by written
agreement signed by the Borrower and the Bank.
ASSIGNMENT OF
COMMITMENT: This Commitment may not be assigned without written
consent of the Bank.
THIRD PARTY
BENEFICIARY
RIGHTS: No person who is not a party to this Commitment shall have
or enjoy any rights under this Commitment; also, all third-
party beneficiary rights are expressly negated. Without
limiting the generality of the foregoing, no one other than
the Borrower shall have any rights to obtain or compel a
disbursement of the proceeds of the loan under this
Commitment.
PENDING
LITIGATION: Borrower/Guarantor shall certify to the Bank that no
litigation or proceedings are pending or threatened which
might adversely affect Borrower's/Guarantor's ability to
carry on its business in the normal course.
REPRESENTATION
OF FACTS: This Commitment is subject to the accuracy of all
information, representations and materials submitted with
or in support of loan approval.
ADDITIONAL
DOCUMENTATION: Borrower agrees to provide any additional information and
documentation as may be requested to fully perfect this
Commitment.
<PAGE>
Mr. Jerry Grizzle
January 16, 1997
Page 4
LOAN CLOSING: Borrower agrees to close the loan in accordance with the
provisions of this letter, the Credit Agreement, and all
other related documents.
DOCUMENTATION: The documents, instruments and agreements which the Bank
deems necessary to evidence the transactions contemplated
by this Commitment shall be in form acceptable to the Bank
and its counsel.
This Commitment is open for your acceptance until the close of business
February 16, 1997. To acknowledge your acceptance, please return a signed copy
of this letter to my attention at the following address:
BANK OF OKLAHOMA, N.A., OKLAHOMA CITY
ATTENTION: TODD WRIGHT
P.O. BOX 24128
OKLAHOMA CITY, OKLAHOMA 73124
The Bank appreciates the opportunity to be able to provide you with this
proposal, which we feel will accommodate your credit needs. Please call me if
you would like to discuss any of the provisions in this commitment.
Sincerely,
/s/ TODD G. WRIGHT
Todd G. Wright
AGREED AND ACCEPTED on this ____ Day of _____________________, 1997.
CD Warehouse, Inc.
- -------------------------------------
Jerry Grizzle, Chairman, President,
and CEO
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated March 6, 1996, except for Note 2, as to which the
date is October 10, 1996, with respect to the financial statements of Compact
Discs International, Ltd. and to our report dated October 5, 1996 with respect
to the financial statements of CD Acquisitions included in Amendment No. 2 to
the Registration Statement (Form SB-2 No. 333-15139) and related Prospectus of
CD Warehouse, Inc. for the registration of 1,000,000 shares of its common stock.
/S/ HUSELTON & MORGAN, P.C.
Dallas, Texas
January 15, 1997
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated October 26, 1996, except for the second paragraph of
Note 2 as to which the date is December 10, 1996, in Amendment No. 2 to the
Registration Statement (Form SB-2 No. 333-15139) and related Prospectus of CD
Warehouse, Inc. for the registration of 1,000,000 shares of its common stock.
/s/ ERNST & YOUNG LLP
Oklahoma City, Oklahoma
January 15, 1997
