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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to ___________________.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 000-21887
CD WAREHOUSE, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 73-1504999
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1204 SOVEREIGN ROW, OKLAHOMA CITY, OKLAHOMA 73108
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (405) 949-2422
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<S> <C>
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01 PAR VALUE PER SHARE
(Title of Class)
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Check whether the registrant (1) has filed all reports required by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
Yes X No
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Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. X
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Registrant's revenues for its most recent fiscal year were $31,912,276.
As of March 20, 2000, the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked prices of such stock, was $7,217,245.
As of March 20, 2000, there were 3,660,295 shares of Common Stock outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
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DOCUMENTS INCORPORATED BY REFERENCE: REGISTRANT'S PROXY STATEMENT FOR THE 2000
ANNUAL MEETING OF STOCKHOLDERS IS INCORPORATED BY REFERENCE IN PART III, ITEMS 9
THROUGH 12, OF THIS FORM 10-KSB.
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FORM 10-KSB
TABLE OF CONTENTS
Item PART I Page
1. Description of Business 1
2. Description of Property 12
3. Legal Proceedings 13
4. Submission of Matters to a Vote of Security Holders 13
PART II
5. Market for Common Equity and Related Stockholder Matters 14
6. Management's Discussion and Analysis or Plan of Operation 14
7. Financial Statements 20
8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure 20
PART III
9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 20
10. Executive Compensation 20
11. Security Ownership of Certain Beneficial Owners and Management 20
12. Certain Relationships and Related Transactions 20
13. Exhibits and Reports on Form 8-K 20
Signatures 23
Financial Information Appendix A
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DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
THIS REPORT INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), AND SECTION
21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. ALL STATEMENTS OTHER
THAN STATEMENTS OF HISTORICAL FACTS INCLUDED IN THIS REPORT, INCLUDING, WITHOUT
LIMITATION, STATEMENTS REGARDING THE COMPANY'S FUTURE FINANCIAL POSITION,
BUSINESS STRATEGY, BUDGETS, PROJECTED COSTS AND PLANS AND OBJECTIVES OF
MANAGEMENT FOR FUTURE OPERATIONS, ARE FORWARD-LOOKING STATEMENTS. IN ADDITION,
FORWARD-LOOKING STATEMENTS GENERALLY CAN BE IDENTIFIED BY THE USE OF
FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY," "WILL," "EXPECT," "INTEND,"
"ESTIMATE," "ANTICIPATE" OR "BELIEVE" OR THE NEGATIVE THEREOF OR VARIATIONS
THEREON OR SIMILAR TERMINOLOGY. ALTHOUGH THE COMPANY BELIEVES THAT THE
EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT CAN
GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO HAVE BEEN CORRECT. SUCH
STATEMENTS 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. IMPORTANT FACTORS
THAT COULD ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S EXPECTATIONS
("CAUTIONARY STATEMENTS") INCLUDE THE RISKS INHERENT GENERALLY IN THE RETAIL AND
FRANCHISING INDUSTRIES, THE IMPACT OF COMPETITION AND PRICING, CHANGING MARKET
CONDITIONS, THE RISKS DISCLOSED UNDER "ITEM 6-MANAGEMENT'S DISCUSSION AND
ANALYSIS OR PLAN OF OPERATION" AND ELSEWHERE IN THIS REPORT. ALL SUBSEQUENT
WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY, OR
PERSONS ACTING ON ITS BEHALF, ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE
CAUTIONARY STATEMENTS. THE COMPANY ASSUMES NO DUTY TO UPDATE OR REVISE ITS
FORWARD-LOOKING STATEMENTS BASED ON CHANGES IN INTERNAL ESTIMATES OR
EXPECTATIONS OR OTHERWISE. AS A RESULT, THE READER IS CAUTIONED NOT TO PLACE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. FURTHER, THERE CAN BE NO ASSURANCE
THAT THE HISTORICAL LEVEL OF THE COMPANY'S REVENUES AND GROWTH WILL CONTINUE TO
BE ACHIEVED IN THE FUTURE.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
CD Warehouse, Inc. (together with its wholly owned subsidiaries, the
"Company") is engaged in the franchising and ownership of music stores offering
new and pre-owned compact discs ("CDs") and related products under two similar
but distinct franchise systems, "CD Warehouse" and "Disc Go Round." The term "CD
Warehouse System" encompasses the two franchise systems and their respective
stores, which variously operate under the trade names "CD Warehouse," "Disc Go
Round", "CD Exchange" and "Music Trader." Since its initial public offering in
January 1997 (the "IPO"), the Company has engaged in a program of expansion to
achieve strong market recognition in the retail music industry. This expansion
has been accomplished primarily through the sale of new franchises and the
acquisition and conversion of independently owned retail music stores to
company-owned stores, as well as the acquisition by the Company of existing
franchised stores. During 1999, the most significant factor contributing to the
Company's store and revenue growth was the acquisition of Music Trader, Inc., a
16-store retail music chain based in Southern California. At December 31, 1999,
the CD Warehouse System had an aggregate 339 stores in 39 states and the
District of Columbia, Canada, England, France, Guatemala and Venezuela, with 185
franchised stores and 75 company-owned stores operating under the CD Warehouse
concept (utilizing either the CD Warehouse, CD Exchange or Music Trader trade
name) and 79 franchised stores operating under the Disc Go Round concept
(utilizing either the Disc Go Round or CD Exchange trade name). The term "CD
Warehouse" encompasses the CD Warehouse, CD Exchange and Music Trader stores
operating within the CD Warehouse franchise system, and the term "Disc Go Round"
encompasses the Disc Go Round and CD Exchange stores operating within the Disc
Go Round franchise system.
CD Warehouse and Disc Go Round stores sell their products to the general
public in the market area where the respective store is located. A typical
store, located in a high traffic strip shopping center, will occupy between
1,200 and 2,500 square feet and offer between 10,000 and 16,000 selections, with
approximately 52% of the dollar sales volume being pre-owned selections and the
balance being new releases from the major music categories. At each CD Warehouse
and Disc Go Round store, a customer selects from a number of new and pre-owned
CDs and may listen to pre-owned CDs before purchase. CD Warehouse and Disc Go
Round stores sell CDs, take customers' CDs in trade or buy customers' CDs for
cash. Typically, each store carries the majority of the Billboard Top 100
selections as "new" inventory, filling out its inventory selection with
pre-owned CDs which are purchased for $1 to $4 and remarketed for $6 to $9.
1
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During the year ended December 31, 1999, the Company had total revenues of
approximately $31,912,000, and net loss of approximately $1,141,000. The
Company's expansion strategy for 2000 is to open 25 to 30 franchised stores. The
Company also plans to further develop and market its internet site,
HTTP://WWW.CDWAREHOUSE.COM, which offers both new and used CDs. See "ITEM
1-Description of Business-Competition."
HISTORY
The Company was formed in September 1996 to acquire the assets of Compact
Discs International, Ltd. ("CDIL"), a Texas limited partnership which franchised
stores throughout the United States and England under the name "CD Warehouse." A
portion of the proceeds of the Company's IPO was used to fund the $3.2 million
acquisition (the "CDIL Acquisition"), which was consummated simultaneously with
the closing of the IPO. See Item 12-Certain Relationships and Related
Transactions. In a related transaction (the "MacDonald Acquisition"), which also
occurred simultaneously with the closing of the IPO, the Company acquired the
equity interests of Bruce D. MacDonald (together with his affiliates,
"MacDonald") in various partnerships or other entities which were franchisees of
an aggregate 36 franchised CD Warehouse stores. See Item 12-Certain
Relationships and Related Transactions. As a result of the CDIL Acquisition and
the MacDonald Acquisition, the Company acquired the rights to the CD Warehouse
name, assumed CDIL's role as franchisor under the franchise agreements to which
CDIL was a party and acquired interests in the CD Warehouse stores in which
MacDonald had an interest.
RECENT EVENTS
On February 22, 1999, the Company completed the purchase of a 16-store
retail music chain located in San Diego, California and surrounding areas and
operating under the name "Music Trader." The Company operates the 16 stores as
company-owned stores under the CD Warehouse concept. The total purchase price
for the transaction, which was structured as an acquisition of the assets
relating to the 16 stores, was $4,000,000, comprised of $3,000,000 in cash and
$1,000,000 in Common Stock of the Company, valued for purposes of the
acquisition at $11.80 per share.
Effective January 4, 2000, Gary D. Johnson resigned his positions as
Director, Executive Vice President and Chief Operating Officer of the Company.
On March 1, 2000, the Company entered into an agreement with Mr. Johnson to sell
to him two company-owned stores, as well as a store "package" (consisting of the
furniture, fixtures and inventory necessary to open a CD Warehouse store), for
an aggregate purchase price of $425,505 (the "Johnson Sale"). The sale was
consummated on March 21, 2000.
BUSINESS STRATEGY
The Company's business strategy of offering a mix of both new and pre-owned
CDs is based on its belief that there is a growing consumer willingness to
purchase pre-owned CDs, which is providing an expanding market niche in the
retail music industry for CD resellers. 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, pre-owned CDs at exceptional value; (2) offering to accept as
a trade, or buy for cash, selected CDs from customers; and (3) selling new
releases at competitive prices.
According to the Recording Industry Association of America (the "RIAA"),
annual CD sales in the United States for 1999 were $12.8 billion which
represented a 12.3% increase from 1998 domestic CD sales of $11.4 billion. The
lack of any audible difference between new and pre-owned CDs, durability of the
medium, cost savings and the accumulating stock of available CDs for resale,
suggest the possibility for rapid market growth in the pre-owned CD market.
Because the CD is encased in plastic and read by a laser, the playing of CDs,
and even the occasional careless handling of CDs, rarely cause damage that will
impair performance or result in any degradation of sound quality. In the absence
of pronounced abuse, CDs may reasonably be expected to last for decades; premium
(gold-plated) CDs may last for centuries. Such extraordinary durability, coupled
with the standard error-correction circuitry in CD players, means that pre-owned
CDs are essentially indistinguishable from new CDs in terms of audible
performance. By offering quality pre-owned CDs 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.
2
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Management believes that, in addition to the Company, Hastings
Entertainment, Inc. and Wherehouse Entertainment, Inc. are the only national
chains selling pre-owned CDs on any significant scale. The Company believes that
it can increase its market share by expanding the CD Warehouse System in
targeted markets. The Company's expansion strategy for 2000 is to open 25 to 30
franchised stores. To accomplish this objective, the Company employs a business
strategy that includes the following elements:
INVENTORY MANAGEMENT SYSTEM. The Company considers its inventory management
system, which is a software program proprietary to the CD Warehouse concept, to
be essential to the success of its business strategy. The program, which has a
database in excess of 270,000 titles and includes catalogs from all the major
record labels, assists each store in selectively procuring pre-owned CDs by
supplying buying directions 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 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 includes point-of-sale recording of all
transactions, including customer profiles with which mailing lists may be
created. Additionally, as each transaction is entered, the program provides for
the printing of customer receipts which concurrently 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 virtually any other pertinent financial information. Disc Go Round stores
utilize an inventory and point-of-sale software that offers comparable
management reporting capability but lacks the ranking by levels of the CD
Warehouse database.
The Company believes that the proprietary 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. As new stores are developed, opening packages of inventory are
assembled by the Company and sold to the franchisees. The demand for inventory
by new stores allows existing stores to sell excess inventory. 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 as much as 75% of the opening inventory for a new store can be
purchased from system 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.
The Company is finalizing an upgraded version of its proprietary software
system. The upgrade is expected to include such enhancements as (i) a
communications interface that will allow all stores to communicate with the
Company and with each other, and (ii) an accounting package that will produce a
profit and loss statement from the information captured by a store's
point-of-sale register. The Company expects to introduce the software upgrade to
all CD Warehouse stores during 2001.
CUSTOMER SERVICE. The Company emphasizes excellent customer service and
seeks to employ, and to sell franchises to, motivated and energetic people. The
Company also seeks to foster enthusiasm for its customer service philosophy and
its franchise concepts 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 franchised store
development. The Company concentrates its expansion of 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 historically has co-developed
markets with franchisees, divided markets among franchisees or divided markets
among the Company and franchisees, "clustering" both company-owned and
franchised stores through the use of area development agreements and its site
selection approval process. The Company believes that this approach has
contributed to increased average store sales. For 2000, the Company has
determined to focus its efforts on market expansion through increased franchised
store development, rather than company-store development.
3
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STORE LOCATIONS
The table below shows the location, as of December 31, 1999 of all CD
Warehouse and Disc Go Round stores (which also includes, for each franchise
system, stores operating under the trade name "CD Exchange" or "Music Trader")
in the United States, Canada, England, France, Guatemala and Venezuela:
DOMESTIC
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ALABAMA
Birmingham++
Daphne++
Homewood++
Hoover++
Huntsville (2)++
Mobile (2)++
ARIZONA
Tempe++
ARKANSAS
Fayetteville++
Fort Smith++
Little Rock *
North Little Rock*
CALIFORNIA
Chula Vista*
El Cajon*
Encinitas*
Escondido*
Huntington Beach+
Oceanside*
Palm Desert+
Poway*
San Diego (8)*
San Marcos*
Santee*
COLORADO
Arvada+
Colorado Springs++
Ft. Collins*
Littelton+
DELAWARE
Newark+
Wilmington+
FLORIDA
Coral Gables*
Davie++
Daytona Beach*
Deland*
Fern Park*
Ft. Lauderdale (2)++
Ft. Myers++
Gainesville++
Jacksonville (2)*
Lake Park++
Melbourne*
Miami Lakes*
Miami*
Naples++
Neptune Beach*
North Miami*
Orange Park*
Orlando*
Orlando+
Ormond Beach*
Penbrooke Pines++
Port Charlottee++
Sanford*
Tallahassee (3)++
Tampa+
Venice++
GEORGIA
Atlanta (2)++
Atlanta+
Duluth++
Marietta (2)++
Martinez++
Morrow++
IDAHO
Idaho Falls++
ILLINOIS
Carbondale++
Chicago (2)+
Harwood Heights+
Moline+
North Riverside+
Streamwood++
INDIANA
Bloomington+
Indianapolis++
Indianapolis (3)+
Mishawaka+
IOWA
Ames+
Cedar Rapids++
Cedar Rapids+
Clive+
Davenport++
Davenport+
Des Moines (2)++
Des Moines+
Iowa City++
Sioux City++
Waterloo++
Waterloo+
KANSAS
Overland Park*
Shawnee*
Wichita++
Olathe*
KENTUCKY
Lexington++
Louisville+
Paducah++
LOUISIANA
Baton Rouge*
Baton Rouge++
Gretna++
Lafayette*
Metarie*
New Orleans++
Shreveport++
Shreveport+
MARYLAND
Elkridge++
Laurel++
MICHIGAN
East Lansing++
Grand Rapids (2)++
Holland+
Kalamazoo++
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MINNESOTA
Bemidji+
Blaine++
Brooklyn Center++
Burnsville++
Duluth+
Edina++
Maple Grove+
Maplewood++
Minneapolis (2)++
Roseville++
St. Cloud++
MISSOURI
Arnold++
Ballwin++
Cape Girardeau++
Gladstone*
Independence*
Kansas City*
Lee Summit*
Maryland Heights++
O'Fallon++
Springfield*
St. Louis++
MONTANA
Bozeman++
Great Falls++
NEBRASKA
Lincoln*
Omaha*
NEVADA
Las Vegas*
NEW JERSEY
Belleville++
Freehold+
Laurel Springs++
Northfield++
Voorhees+
NEW YORK
Endicott+
Guilderland+
Huntington Station++
Rockville Center++
Wantaugh+
White Plains++
NORTH CAROLINA
Cary+
Charlotte (3)++
Durham+
Fayettville++
Goldsboro++
Raleigh+
Wilmington+
Wilson++
NORTH DAKOTA
Fargo++
OHIO
Beavercreek+
Boardman++
Canton++
Centerville+
Cincinnati(2)+
Cleveland Heights++
Columbus (4)++
Fairlawn++
Holland++
Mayfield Heights++
Mentor++
Miamisburg++
Niles++
Parma Heights++
Toledo++
OKLAHOMA
Edmond*
Midwest City*
Norman*
Oklahoma City (3)*
Shawnee*
Stillwater (2)*
Tulsa*
Tulsa++
OREGON
Beaverton+
Portland+
PENNSYLVANIA
Allentown+
Conshohocken+
Easton+
Erie+
Greensburg++
Harrisburg++
Lancaster++
Mechanicsburg++
Monroeville++
Philadelphia+
Pittsburgh (2)++
Pittsburgh+
State College++
West Mifflin++
SOUTH CAROLINA
Columbia+
Greenville (2)++
SOUTH DAKOTA
Sioux Falls+
TENNESSEE
Antioch++
Bartlett+
Clarksville++
Jackson++
Madison++
Memphis*
Murfreesboro++
Nashville++
TEXAS
Abilene*
Addison*
Arlington (3)++
Austin (4)++
Carrollton*
College Station+
Corpus Christi++
Corpus Christi+
Dallas (7)++
Denton ++
Duncanville++
El Paso*
Ft. Worth++
Garland*
Grand Prairie++
Houston (6)*
Houston+
Hurst++
Irving++
Lewisville++
Longview++
Lubbock++
Mesquite++
Midland*
North Richland Hills++
Plano*
Round Rock++
San Angelo++
San Antonio (7)++
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TEXAS (con't)
San Marcos++
Sherman++
Texarkana++
Waco*
Webster*
Wichita Falls*
UTAH
Provo++
Provo+
Salt Lake City++
St. George++
Taylorsville++
VERMONT
Burlington+
VIRGINIA
Alexandria++
Fairfax++
WASHINGTON
Belleville++
Bremerton++
Kennewick+
Linwood+
Seattle++
Seattle(3)+
WISCONSIN
Appleton++
Appleton+
Brookfield++
Brookfield+
East Milwaukee+
Green Bay+
Greenfield+
Greenfield++
Janesville+
Kenosha++
Madison(3)+
Madison++
Racine++
DISTICT OF COLUMBIA
Washington++
INTERNATIONAL
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CANADA
Charlottetown/PE+
Dartmouth/NS+
Halifax/NS+
Kingston/ON++
Ottawa/ON (2) ++
Thunder Bay/ON++
Winnipeg/MB (3)+
ENGLAND
Ealing++
Leeds++
London++
Watford++
FRANCE
Caen++
GUATEMALA
Guatemala City++
VENEZUELA
Caracus++
_____________________________
* Indicates company-owned store.
++ Indicates CD Warehouse franchised store.
+ Indicates Disc Go Round franchised store.
EXPANSION STRATEGY
The first CD Warehouse store opened in Dallas, Texas in August 1992 and, as
of December 31, 1999, the CD Warehouse System had an aggregate 339 stores in 39
states and the District of Columbia, Canada, England, France, Guatemala and
Venezuela, with 185 franchised stores and 75 company-owned stores operating
under the CD Warehouse concept and 79 franchised stores operating under the Disc
Go Round concept. Key elements of the Company's expansion strategy include:
AGGRESSIVE, BALANCED GROWTH. Historically, the Company's expansion strategy
has been to increase the number of franchised stores by selective utilization of
Company-owned stores in a particular market area. The Company believes that, in
many cases, the Company has been able to take advantage of a promising new
location by establishing a Company-owned store when a delay in finding a
qualified franchisee might have jeopardized 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.
However, the cornerstone of the Company's expansion strategy remains the
addition of new franchised stores in the system, which enables the Company to
expand its system more quickly with no capital investment. For 2000, the Company
has determined to focus its efforts on market expansion through increased
domestic franchised store development, rather than company-store development.
6
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NAME RECOGNITION AND NEW MARKET PENETRATION. The Company believes the
visibility of its stores at high traffic, Class A, strip shopping centers has
generated good name recognition in the areas in which stores currently are
located. The Company's expansion strategy involves the building-out of existing
markets and the further penetration of developing markets through clustering of
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. In determining which new markets to develop, the Company
considers many factors, including the size of the market, demographics, cost of
media, population trends, competition and real estate availability and pricing.
CONSIDERATION OF ACQUISITIONS. During 1999, the most significant factor
attributable to the Company's store and revenue growth was the acquisition of
Music Trader, Inc., a 16-store retail music chain based in Southern California.
The Company may consider acquisition of other local and regional pre-owned music
retailers to implement its strategy of building out current markets and
establishing itself in new target markets. However, it is the Company's present
intention to focus its expansion strategy on domestic franchised store
development.
OPERATIONS
ACQUISITION OF PRE-OWNED CDS. A key component of the two franchise concepts
within the CD Warehouse System is the purchase or trade of selected CDs from
customers; accordingly, the Company obtains a significant portion of its
pre-owned 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 the franchisees. The demand for inventory by new stores allows
existing stores to sell excess inventory. 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 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. As much as 75% of the opening inventory for a new store
can be purchased from system 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 CDS, OTHER POINT-OF-SALE ITEMS AND STORE FIXTURES. For
new music releases, the Company contracts with outside third-party distributors.
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 franchised
and Company-owned stores with supplies and related materials.
MARKETING AND ADVERTISING
CD WAREHOUSE STORES. 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.
Additionally, the CD Warehouse franchise agreements provide for each store to
spend 2.5% of sales specifically on advertising, with each CD franchisee
conducting its own marketing and advertising activities independently through
newspapers and radio. In 1999, the Company activated a mandatory concept-wide
advertising fund (the "SAF"). The Company expects that the SAF will become the
primary creative and production vehicle for all marketing efforts respecting the
CD Warehouse concept.
DISC GO ROUND STORES. Disc Go Round franchisees under existing franchise
agreements are required to spend 5% of their gross sales on approved advertising
and marketing. In addition, all Disc Go Round franchisees are required to pay
the Company an annual advertising production fee of $500.
Under the current form of Disc Go Round franchise agreement, applicable for
renewals, Disc Go Round franchisees are required to spend during each calendar
quarter 2.5% of the store's gross sales to advertise and promote the store, of
which 1 3/4% is spent directly by the store in local market advertising, and
3/4% is paid to the Company to be deposited into a concept-wide advertising fund
to market the Disc Go Round concept.
7
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FRANCHISING PROGRAM
CD WAREHOUSE
GENERAL. As of December 31, 1999, there were a total of 174 franchised CD
Warehouse stores in 32 states and the District of Columbia, and eleven CD
Warehouse stores in Canada, England, France, Guatemala and Venezuela. The
Company expects to open 25 to 30 new CD Warehouse franchised stores by the end
of 2000. 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. Pursuant to the terms of existing area development
agreements, a total of 52 stores are committed to be opened over the next two
years.
The CD Warehouse franchise agreement provides the franchisee the right to
use or be provided, as the case may be, the Company's trade names, service marks
and trademarks; 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.
FRANCHISE SOURCING AND SELECTION. The majority of new franchises are
individuals responding to advertisements in national publications such as
Entrepreneur Magazine and The Franchise Handbook. Various publications also
publish articles or rankings of top-selling franchises (e.g., in February 1999,
Entrepreneur Magazine ranked the Company 20th in its list of 101 fastest-growing
franchises and 57th in its 20th Annual Franchise 500), which also elicit
inquiries from potential 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.
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 prospect's qualifications to become a
CD Warehouse franchisee. Once an inquiry is received, the prospect is mailed the
Company's brochure and marketing materials. The inquiry is then followed up on
within a period of two weeks.
The Company has established a home page via the Internet (World Wide Web)
that will provide detail on the franchise opportunities presented by operating a
CD Warehouse store. The Company's homepage can be accessed at
HTTP://WWW/CDWI.COM/.
TRAINING AND SUPPORT. The Company's philosophy is one of service and
commitment to its system. Each franchise owner/operator and each company 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 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, CD Warehouse
franchisees generally pay the Company an initial franchise fee of $20,000,
royalties equal to 5% of monthly gross sales, an advertising fund fee of 3/4% of
monthly gross sales and a one-time software licensing gee of $3,000. 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
8
<PAGE>
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.
The franchise agreement prohibits the transfer or assignment of any
interest in a franchise without the prior written consent of the Company. The
franchise 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 with the
payment of an amount equal to 20% of the then-existing franchise fee. All of the
franchise agreements 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 $132,300 to $169,000. The estimated initial
investment is comprised of the following:
MINIMUM MAXIMUM
------- -------
Franchise Fee $ 20,000 $ 20,000
Software License Fee 3,000 3,000
Lease & Utility Deposits 1,500 4,000
Leasehold Improvements 18,000 22,000
Contractor 11,000 15,000
Computer Hardware 8,000 12,000
Fixtures and Equipment 17,000 19,500
Initial Inventory 40,000 50,000
Signage 6,000 7,500
Travel & Expense of Training 1,000 1,500
Insurance 500 1,000
Miscellaneous Opening Cost 800 2,000
New Store Marketing & Advertising 500 1,500
Operating Cash on Hand 5,000 10,000
----- ------
Total $ 132,300 $ 169,000
======= =======
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 the capitalization
costs to open the business. For the year ended December 31, 1999, average unit
sales on a comparable basis were $372,000. Based on an average initial estimated
capitalization of $150,650, the sales to capitalization ratio to open a new CD
Warehouse store is 2.47 to 1.
FRANCHISE FINANCING. Typically, franchisees obtain their own sources of
financing and do not require the Company's assistance. However, the Company has
established a relationship with GE Capital Business Asset Funding Corporation
whereby such company provides financing to qualifying franchisees. Franchisees
are not obligated to secure financing from such lender, nor is the Company a
party to any such financing ultimately obtained by the franchisee.
DISC GO ROUND
GENERAL. As of December 31, 1999, there were a total of 73 Disc Go Round
stores in 26 states and six Disc Go Round stores in Canada. The Company has
determined that it will not sell or offer for sale any additional Disc Go Round
franchises. While the Company will honor its ongoing obligations as the
successor franchisor under the Disc Go Round franchise agreements that it
acquired, it intends to encourage the existing Disc Go Round franchisees to
become CD Warehouse franchisees and to convert their Disc Go Round stores to CD
Warehouse stores.
9
<PAGE>
THE FRANCHISE AGREEMENT; TERMS AND CONDITIONS. The domestic renewal of Disc
Go Round franchises is made by a Uniform Franchise Offering Circular prepared in
accordance with federal and state laws and regulations.
Generally, the form of franchise agreement under which substantially all of
the existing Disc Go Round franchises currently operate provides that Disc Go
Round franchisees pay the Company (i) royalties equal to 5% of weekly gross
sales, and an annual marketing fee of $500.
Under the form of domestic franchise agreement applicable to renewing Disc
Go Round franchisees, franchisees generally will pay the Company a renewal
franchise fee of $5,000, and royalties equal to 5% of monthly gross sales.
Franchisees are generally granted exclusive territory with respect to the
operation of Disc Go Round stores only in the immediate vicinity of their
stores.
The Disc Go Round franchise agreement requires franchisees 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 Disc Go Round 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 Disc Go Round system. The Company's ability to terminate
franchise agreements pursuant to such provisions is subject to applicable
bankruptcy and state laws and regulations.
The franchise agreement prohibits the transfer or assignment of any
interest in a franchise without the prior written consent of the Company. The
franchise 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.
Existing Disc Go Round franchises may be renewed for a renewal term of five
years; however, franchisees will not have the right to a subsequent term of
renewal. The Company's ability to not renew franchise agreements pursuant to
such provision is subject to applicable state laws and regulations.
INTERNATIONAL FRANCHISE OPERATIONS
There are 11 CD Warehouse franchised stores and six Disc Go Round
franchised stores currently operating in Canada, England, France, Guatemala and
Venezuela. In January 1997, the Company entered into a master franchise
agreement (the "Worldwide Area Development Agreement") with Mark E. Kane, the
founder of CDIL. The Worldwide Area Development Agreement provided for a period
of ten years for development of franchise operations worldwide, excluding the
United States, Canada and Mexico, and included a provision which allowed 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 required that Mr. Kane open 100 stores
over the ten-year period. In June 1998, the Company filed an arbitration claim
against Mr. Kane, alleging breach of the Worldwide Area Development Agreement
and seeking cancellation of the agreement. Pursuant to a settlement agreement
between the parties effective March 15, 1999, the Worldwide Area Development
Agreement was terminated, with all development rights under such agreement
reverting to the Company.
COMPANY STORE PROGRAM
Company-owned stores 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.
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 Item
1-Description of Business. The Company's Director of Company Store Operations
and his staff regularly visit company-owned stores to ensure compliance with
Company standards and procedures and to provide advice and support.
10
<PAGE>
The following table sets forth the number of stores opened and closed
throughout the CD Warehouse System during fiscal 1999:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 OPENED CLOSED TRANSFERS 1999
-------------- -------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C>
FRANCHISED STORES
Domestic-CD Warehouse 128 22 (7) 31 174
Domestic-Disc Go Round 120 -- (12) (35) 73
--- -- --- --- ---
248 22 (19) (4) 247
International-CD Warehouse 7 2 -- 2 11
International-Disc Go Round 8 -- -- (2) 6
-- -- --- --- ---
15 2 -- -- 17
COMPANY-OWNED STORES
Domestic-CD Warehouse 51 25 (5) 4 75
Domestic-Disc Go Round -- -- -- -- --
--- -- --- --- ---
51 25 (5) 4 75
--- -- --- --- ---
Total 314 49 (24) -- 339
=== == === === ===
</TABLE>
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 that 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 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.
11
<PAGE>
According to the RIAA, CD sales in the United States were over $12.8
billion in 1999. The Company has various competitors in the industry that sell
new recordings and music related merchandise. These companies vary from those
who are specialty music stores in malls (such as Sam Goody's and Camelot), those
who utilize freestanding buildings (such as Wherehouse Entertainment, Inc. and
Hastings Entertainment, Inc.) and those who sell via the Internet (such as CDNow
and Amazon.com). 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 freestanding 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 $17.99, with the latest top 20
releases on sale for $11.99 to $13.99 per CD. None of these "superstores" sell
pre-owned music except for Wherehouse Entertainment, Inc. and Hastings
Entertainment, Inc.
Other retailers offering music include major national discount stores,
including Wal-Mart, K-Mart and Target stores. These national discounters
maintain a very small number of new music titles while offering no pre-owned
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 and Circuit City), which have
generally utilized approximately 1,000 square feet of space and discount their
new releases from $12.99 to $17.99 per item.
Other competitors include specialty Internet retailers such as CDNow, and
more general Internet retailers, such as Amazon.com, which have targeted the
prerecorded music market. In response to this growth in electronic commerce and
the future potential for on-line sales of prerecorded music product, the Company
launched its own Internet commerce site, HTTP://WWW.CDWAREHOUSE.COM, in December
1998. The website, which experienced initial difficulties in uploading the used
inventory of company-owned stores, became fully operational in August 1999, and
now offers both new and used product. Additionally, the Company anticipates that
the website will also be available for participation by franchised stores in
2000. The Company believes that its ability to offer hard to find, out of print
product, will provide it with a competitive advantage over other Internet
retailers of prerecorded music. However, the e-commerce market is new, rapidly
evolving and intensely competitive, and the Company expects that competition
will further intensify in the future. Barriers to entry are minimal, and current
and new competitors can launch new sites at a relatively low cost.
The Company believes that CD Warehouse stores compete favorably with its
competition in the pre-owned CD market in terms of price, selection, service and
location.
In selling franchises, the Company also competes with many franchisors of
retail and other business opportunities.
TRADEMARKS AND SERVICE MARKS
The names "CD Warehouse," "Disc Go Round," and "CD Exchange" are registered
with the United States Patent and Trademark Office. The Company also has
registered its copyright on its proprietary software system and has made
application for the service marks for the phrases "The Future of Music" and "A
New Spin on Music." The Company believes that its trademarks, service marks and
copyright have significant value and are important to its marketing efforts.
EMPLOYEES
The Company as of March 10, 2000 employs 285 full-time and 150 part-time
employees. None of the Company's employees are represented by a labor union and
the Company believes that its relations with its employees are good.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's principal executive offices are located at 1204 Sovereign
Row, Oklahoma City, OK 73108. The total facility is approximately 26,000 square
feet and is held under a 60-month lease with a monthly lease payment of
approximately $14,200. The expiration date of the lease is January 31, 2004.
Approximately 11,000 square feet is used for administrative purposes and the
balance of the space is utilized as a warehouse.
The Company leases space for its 75 company-owned retail stores, typically
for a fixed monthly rental and operating costs. Aggregate rental expense under
these store leases and the Company's executive offices totaled
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<PAGE>
$2,157,918 for 1999. Total rental amounts of $6,454,200 under these
noncancelable leases are due as follows: 2000-$1,902,896; 2001-$1,685,979;
2002-$1,363,796; 2003-$1,083,209; 2004-$403,579 and thereafter-$14,741.
ITEM 3. LEGAL PROCEEDINGS.
In November 1999, the Company settled an arbitration proceeding brought by
Jimick Products, Inc. ("Jimick") in 1998, pursuant to which Jimick had alleged,
inter alia, that certain of the Disc Go Round franchised stores acquired by the
Company in June 1998 and located in Jimick's development area encroached upon
Jimick's development area in violation of its agreements with the Company. As a
result of the settlement agreement entered into between the parties, Jimick
agreed to immediately pay all outstanding obligations due to the Company and to
sell to the Company three franchised CD Warehouse stores located in Wisconsin.
The settlement agreement also acknowledged the Company's right to acquire other
franchise concepts and operate them separately from existing franchise concepts
without Jimick asserting that either the acquisition or operation of such other
franchise concepts in any way violates the terms of the now or then existing
Franchise Agreements or Area Development Agreements. Other than the three
Wisconsin stores sold to the Company, Jimick will remain a franchisee of the CD
Warehouse system and will have certain future franchise development rights. In
March 2000, the parties entered into a supplemental agreement pursuant to which
the Company agreed to pay approximately $700,000 to Jimick in settlement of all
issues between the parties. Of such amount, approximately $225,000 is payable by
March 31, 2000, with the balance of $475,000 payable in twelve monthly
installments commencing April 5, 2000 and bearing interest at a rate of 8.5% per
annum. See "Item 7. Management's Discussion and Analysis or Plan of
Operation-Liquidity and Capital Resources."
During 1999, the Company was also involved in various proceedings relating
to claims arising out of its normal business operations. The Company believes
that such litigation, most of which had been settled as of the date of this
Report, should not have a material adverse effect on the Company's financial
position. See "Item 7. Management's Discussion and Analysis or Plan of
Operation-Liquidity and Capital Resources."
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
13
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET FOR COMMON EQUITY
The Company's Common Stock began trading on the NASDAQ Small Cap Market
System on January 22, 1997, under the symbol "CDWI." Effective July 26, 1999,
the Company's securities began trading on the NASDAQ National Market System. The
following table sets forth, for the periods indicated, the high and low sale
price per share for the Company's Common Stock:
1999 1998
------------------------ ----------------------
HIGH LOW HIGH LOW
----------- ----------- ----------- --------
First Quarter.............. $15.25 $9.75 $ 7.6875 $3.50
Second Quarter............. $10.50 $7.125 $16.75 $7.8125
Third Quarter.............. $ 9.125 $4.625 $24.9375 $6.75
Fourth Quarter............. $ 6.6875 $3.25 $23.625 $5.00
At March 20, 2000, there were approximately 68 registered holders of record
of the Common Stock.
The Company has not paid cash dividends on its Common Stock since its
inception and intends to retain earnings for the continued expansion of its
business.
RECENT SALES OF UNREGISTERED SECURITIES
The following sets forth certain information regarding recent sales of the
Company's securities, which were not registered under the Securities Act.
Pursuant to an Asset Purchase Agreement between Compact Discs Management
and Music Trader, Inc. ("Music Trader"), Jeffrey D. Clark and Debbi
McGill-Clark, dated February 22, 1999, the Company purchased substantially all
of the assets related to Music Trader's retail music business. One million
dollars of the $4,000,000 purchase price was paid by the issuance to Music
Trader of 84,745 shares of restricted Common Stock of the Company, calculated by
dividing $1,000,000 by the average of the closing prices of the common stock, as
quoted by Nasdaq, for the five trading days preceding the closing. Pursuant to
the terms of the Asset Purchase Agreement, Music Trader was granted certain
"piggyback" registration rights with respect to the 84,745 shares issued in
connection with the transaction.
No sales commissions were paid in connection with the above stock issuance.
The securities were issued in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
CERTAIN FORWARD-LOOKING STATEMENTS CONTAINED HEREIN REGARDING THE COMPANY'S
BUSINESS AND PROSPECTS 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, AND OTHER RISKS. ANY FORWARD-LOOKING STATEMENTS CONTAINED HEREIN
REPRESENT THE COMPANY'S JUDGMENT AS OF THE DATE HEREOF. THE COMPANY DISCLAIMS,
HOWEVER, ANY INTENT OR OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS. AS
A RESULT, THE READER IS CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE
FORWARD-LOOKING STATEMENTS. AS USED IN HEREIN, THE WORD "COMPANY" MEANS CD
WAREHOUSE, INC. AND ITS WHOLLY OWNED SUBSIDIARIES, COMPACT DISCS MANAGEMENT,
INC., AND CD WAREHOUSE FINANCE COMPANY UNLESS THE CONTEXT INDICATES OTHERWISE.
14
<PAGE>
STATEMENTS OF OPERATIONS
The following table sets forth the Company's results of operations for the
year ended December 31, 1999 and 1998. The information should be read in
conjunction with the historical Financial Statements included elsewhere in this
document.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
1999 1998
---- ----
(IN THOUSANDS EXCEPT SHARE DATA)
<S> <C> <C>
Revenues:
Retail store sales.............................. $ 26,969 $ 9,966
Wholesale merchandise sales..................... 832 2,127
Software income, net............................ 71 92
Royalty income.................................. 3,860 2,827
Franchise and development fees.................. 180 188
Management fees................................. -- 62
-------- --------
Total revenues................................ 31,912 15,262
Operating costs and expenses:
Cost of sales - retail store sales.............. 16,186 5,902
Cost of sales - wholesale merchandise sales..... 678 1,915
Retail store operating expenses................. 10,209 3,307
General and administrative...................... 4,997 2,512
Depreciation and amortization................... 1,516 617
-------- --------
Total costs and expenses.......................... 33,586 14,253
-------- --------
Operating income (loss............................ (1,674) 1,009
Other income (expense), net....................... (151) 232
-------- --------
Income (loss) before income taxes................. (1,825) 1,241
Provision (credit) for income taxes............... (684) 466
-------- --------
Net income (loss)................................. $ (1,141) $ 775
======== ========
Net income loss per share-basic................... $ (.31) $ .27
======== ========
Net income loss per share-diluted................. $ (.31) $ .25
======== ========
Shares used in computation-basic.................. 3,642,442 2,923,090
========= =========
Shares used in computation-diluted................ 3,642,442 3,136,485
========= =========
</TABLE>
RESULTS OF OPERATIONS
The Company derives its revenues primarily from retail sales of its
company-owned stores, wholesale merchandise sales to franchisees of the Company
and royalty fees from franchisees. The Company also receives revenues from
initial franchise fees, area development fees, management fees and software
income. Retail store cost of sales and operating expenses relate directly to
company-owned retail store sales. Wholesale merchandise sales and associated
cost of sales relate to the Company's franchising operations. Other expenses,
such as depreciation, amortization, and general and administrative expenses,
relate to company-owned store operations, as well as the Company's franchising
operations. The number and sales volumes of company-owned retail stores directly
affect the Company's revenues and expenses. The Company's revenues and, to a
lesser extent, expenses, also are affected by the number and sales volumes of
franchised stores. Initial franchise fees are directly affected by the number of
franchised store openings.
15
<PAGE>
The following table sets forth the percentage relationship to total
revenues, unless otherwise indicated, of certain items included in the Company's
statement of income:
YEARS ENDED DECEMBER 31,
------------------------
1999 1998
---- ----
REVENUES:
Retail store sales................................ 84.5% 65.3%
Wholesale merchandise sales....................... 2.6% 14.0%
Software income, net.............................. .2% .6%
Royalty income.................................... 12.1% 18.5%
Management fees................................... .0% .4%
Franchise and development fees.................... .6% 1.2%
------ ------
Total revenues................................ 100.0% 100.0%
COST AND EXPENSES:
Cost of sales - retail store sales (1)............ 60.0% 59.2%
Cost of sales - wholesale merchandise sales (2)... 81.5% 90.0%
Retail store operating expenses (1)............... 37.9% 33.2%
General and administrative........................ 15.7% 16.5%
Depreciation and amortization..................... 4.8% 4.0%
OPERATING INCOME (LOSS)............................. (5.2)% 6.6%
NET INCOME (LOSS)................................... (3.6)% 5.1%
- ----------------------
(1) As a percentage of retail store sales.
(2) As a percentage of wholesale merchandise sales.
YEARS ENDED DECEMBER 31,
------------------------
1999 1998
---- ----
Sales Data:
System wide sales:
CD Warehouse $ 81,062,313 $ 54,845,432
Disc Go Round 26,584,796 16,259,865 (1)
------------ ------------
$107,647,109 $ 71,105,259
============ ============
Percentage increase:
CD Warehouse 48% 50%
Disc Go Round 64% (1)
Change in comparable retail store sales (2) 11% 16%
============ ============
- --------------------
(1) Data only reflects activity for Disc Go Round after its June 1998
acquisition by the Company.
(2) Represents percentage increase only for CD Warehouse stores open in
both periods reported, since Disc Go Round stores were acquired in June
1998.
16
<PAGE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998.
REVENUES
Retail store sales increased $17,003,000 to $26,969,000 for the year ended
December 31, 1999, compared to $9,966,000 for the year ended December 31, 1998.
The 171% increase in retail store sales is the result of having 75 company
stores in operation during the year ended December 31, 1999 compared to only 28
during the same period in 1998.
Wholesale merchandise sales decreased 61% to $832,000 for the year ended
December 31, 1999, compared to $2,127,000 for the same period in 1998. The
decrease is due to the Company discontinuing its "one-stop" warehouse operations
in May 1998, which acquired new CD releases from the major record labels and
sold them to the franchise system with minimal mark up. The Company has
determined to focus its efforts on warehousing used product to open new stores
and to sell used product to the franchise system.
Royalty income increased $1,033,000 to $3,860,000 for the year ended
December 31, 1999, compared to $2,827,000 for the same period in 1998. A
substantial portion of the increase is attributable to the inclusion of the Disc
Go Round franchise stores to the Company's operations in July 1998, which
contributed approximately $725,000 of royalty income during the first six months
of 1999. Additionally, same store sales for stores operating as CD Warehouse
increased by 11% for the year ended December 31, 1999, with monthly average
sales for all CD Warehouse stores increasing from $28,973 for the year ended
December 31, 1998 to $31,011 for the same period in 1999. No same store sales
information is available for Disc Go Round stores for the period preceding the
Company's acquisition of the Disc Go Round franchise system in June 1998.
COSTS AND EXPENSES
Cost of sales for retail store sales increased $10,284,000 for the year
ended December 31, 1999 compared to the same period in 1998. This 174% increase
is consistent with the increase of retail store revenue discussed above. Cost of
sales as a percentage of sales remained fairly constant at 60% of sales for the
year ended December 31, 1999 compared to 59% for the year ended December 31,
1998.
Cost of sales for wholesale merchandise decreased $1,237,000 to $678,000
for the year ended December 31, 1999, compared to $1,915,000 in 1998. The 65%
decrease is consistent with the decrease in wholesale merchandise sales. Cost of
sales was 82% of sales for the year ended December 31, 1999 compared to 90% for
the comparable period in 1998.
Retail store operating expenses increased $6,902,000 to $10,209,000 for the
year ended December 31, 1999, compared to $3,307,000 for the year ended December
31, 1998. The 209% increase is due to the increase of company-owned stores
discussed above. Retail store operating expense was 38% of retail store revenue
for the year ended December 31, 1999, compared to 33% of retail store revenue
for the same period in 1998. The increase in retail store operating expense as a
percentage of retail store revenue is attributable principally to (i) expenses
associated with the Company's new advertising campaign, aimed to aggressively
position itself against its competitors, which have also recently launched
marketing blitzes, (ii) increased payroll costs associated with retail store
preparation to upload the stores' used inventory for sale on the Company's
E-Commerce website, and costs associated with absorbing the acquisition of the
16 Music Trader stores late in the first quarter of 1999.
General and administrative expenses increased by $2,485,000 to $4,997,000
for the year ended December 31, 1999, compared to $2,512,000 for the year ended
December 31, 1998. This increase resulted from the continued growth in
company-owned stores (increase of 24 stores). The year ended December 31, 1999
also included costs associated with operating two separate franchise concepts,
certain non-recurring legal and administrative expenses and implementing
operations of the Company's E-Commerce site in all company stores.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased $899,000 to $1,516,000 for the year
ended December 31, 1999, compared to $617,000 for the same period in 1998. The
increase was attributable to the addition of 24 company-owned stores, costs
17
<PAGE>
associated with E-commerce and the amortization of goodwill associated with
various acquisitions (discussed in the financial statements) effected during
1998 and 1999.
NET INCOME (LOSS)
The Company experienced a net loss of $1,141,000 for the year ended
December 31, 1999, compared to net income of $775,000 during the same period in
1998. The net loss was due primarily to the increase in retail operating
expenses and general and administrative costs described above. Net loss was also
affected by the decrease in other income of $383,000. This was caused by the
reduction of interest income of approximately $171,000 combined with increase of
interest expense of $228,000.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1999 the Company had working capital of $9,492,000 and cash
and cash equivalents aggregating $1,070,000, compared to working capital of
$8,543,000 and cash and cash equivalents of $4,442,000 at December 31, 1998. Net
cash used by operating activities was $1,173,000 for the year ended December 31,
1999, compared to net cash used for operating activities of $325,000 for the
year ended December 31, 1998. The net cash used by operations for the year ended
December 31, 1999 relates principally to an increase in inventory of $1,512,000,
resulting from both an increase in company stores as well as continued planned
growth of per store inventory quantities. This increase was offset by an
increase in accounts payable of $976,000, consisting primarily of amounts due to
E-Commerce related vendors. The net cash used for operating activities for the
year ended December 31, 1998 was due principally to the reduction of amounts due
the major labels because of the company's decision to discontinue its warehouse
operations relating to new CDs and increase in retail store inventory.
Net cash used for investing activities was $6,863,000 for the year ended
December 31, 1999, compared to $11,233,000 for the same period in 1998. The
significant uses of cash for investing activities in 1999 relate to the
acquisition of Music Trader, Inc. in February 1999, development costs relating
to E-Commerce, and continued company store growth. The use in 1998 related
primarily to the acquisition of Disc Go Round in June 1998.
Net cash provided from financing activities was $4,663,000 for the year
ended December 31, 1999, compared to $14,878,000 for the same period in 1998.
The net cash provided from financing in 1999 relates to debt of $4,476,000 used
to acquire Music Trader, Inc. and open new company stores, as well as proceeds
from the exercise of stock warrants issued in connection with the Company's
initial public offering. The net cash provided from financing in 1998 relates
primarily to the proceeds of the private placement of 1,624,300 shares of common
stock in May 1998.
In October 1998 the Company formed a wholly owned subsidiary, CD Warehouse
Finance Company, to finance the growth of qualified franchisees. As of December
31, 1999, the financing subsidiary had funded $228,000 for the development or
remodel of three new franchised stores. In connection with the Company's new
credit facility obtained in December 1999, an affiliate of the Company's
asset-based lender is now offering financing to the Company's qualified
franchisees, and the Company no longer offers financing services.
The Company is continuing the implementation of its Internet E-commerce
website (HTTP://WWW.CDWAREHOUSE.COM/). The website "went live" in December 1998
and offers both new and used CDs. As previously reported, the Company has
experienced difficulties in the process of expanding its Internet website to
include all used inventory of its company stores. During 1999, the Company's
principal E-Commerce partner and project developer worked with the Company to
resolve these difficulties, and the majority of the company stores have now
uploaded their used inventory on-line. However, during such period, the Company
did not market or advertise its website, and sales during 1999 from the website
were minimal. The Company intends to seek strategic alliances and partnerships
that will allow it to effectively market its website and to generate sufficient
revenue to cover the costs associated with operating the site. To date, the
Company has incurred costs in excess of $2,000,000 in development of the
website, and it is expected that additional costs will be incurred in further
project development. A significant portion of the Company's accounts payable
during 1999 related to amounts owed to its principal E-Commerce vendors;
however, as a result of funding obtained by the Company in December 1999 under a
new $15,000,000 revolving credit facility, described below, the Company has paid
or entered into installment payment agreements with its principal E-commerce
vendors with respect to the outstanding balance. The Company expects to have all
such installments paid by July 2000.
18
<PAGE>
In addition to its working capital at December 31, 1999, the Company has a
$15,000,000 revolving credit facility (the "Facility") with an asset-based
lender. The Facility, obtained in December 1999, replaced the Company's
$7,000,0000 credit facility with Bank One Oklahoma, N.A. As of December 31, 1999
the Company had $4,476,000 outstanding under the Facility. The term of the
Facility expires in December 2002, at which time the principal and unpaid
interest are due. Amounts borrowed under the Facility bear a variable rate of
interest equal to an index rate (of thirty-day commercial paper) plus 2.75%.
Borrowings under the Facility are limited to a borrowing base calculation as
determined by stated percentages of compact discs in inventory. Available
borrowings under the Facility as of December 31, 1999 were approximately
$586,000. All assets of the Company are pledged as collateral under the
Facility. The Facility requires the Company to maintain certain financial
convenants including fixed charge coverage, minimum tangible net worth, and
limits on capital expenditures.
As a result of the recent settlement of various legal proceedings, the
Company is obligated to make payments totaling approximately $1,000,000 over the
next twelve months. See "Item 3. Legal Proceedings." The Company anticipates
that it will be able to make the first of the scheduled payments from the
proceeds of the Johnson Sale, which closed on March 21, 2000, as well as from
working capital and/or borrowings from the Facility. See "Item 1. Description of
Business-Recent Events."
In response to the net loss reported for the fouth quarter of 1999 and for
the year then ended, the Company implemented certain cost saving measures during
January and February of 2000. However, since these savings were not realized in
January 2000, operating results for this period caused the fixed coverage ratio
to fall below the requirement imposed by the Facility. The asset-based lender
has agreed to waive this covenant until March 2000, when operating results
should reflect these cost savings. Proceeds of the Facility were used to repay
existing indebtedness, including $3.5 million to retire the Company's existing
credit facility. It is the Company's opinion that the current working capital at
December 31, 1999, combined with the Facility, will be sufficient to support
ongoing activities of the Company for the foreseeable future.
YEAR 2000 ISSUES
During 1999, the Company took various initiatives intended to ensure that
its computer equipment and software would function properly with respect to
dates in the year 2000 and thereafter. For this purpose, the term "computer
equipment and software" includes accounting, data processing, and telephone/PBX
systems, cash registers, hand-held terminals, scanning equipment, and other
miscellaneous systems, as well as systems that are not commonly thought of as IT
systems, such as alarm systems, fax machines, or other miscellaneous systems.
Year 2000 problems were the result of computer programs being written using two
digits (rather than four) to define the applicable year. Computer equipment and
software and devices with imbedded technology that are time-sensitive could have
recognized a date using "00" as the year 1900 rather than the year 2000. This
could have resulted in a system failure or miscalculations causing disruptions
of operations, including, among other things, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
Utilizing internal resources for Year 2000 identification, assessment,
remediation and testing, by December 31, 1999, the Company had completed 100
percent of the initiatives necessary to fully address potential Year 2000 issues
relating to its computer equipment and software. The Company also surveyed its
significant vendors and service providers to determine the extent to which
interfaces with such entities were vulnerable to Year 2000 issues and whether
the products and services purchased from such entities were Year 2000 compliant.
The Company funded its Year 2000 efforts primarily with internal resources
and does not anticipate making any future expenditures in connection therewith.
Although the Company did not separately track its internal costs related to Year
2000 efforts, which included compensation of employees working on Year 2000
projects, it believes that such costs did not exceed $50,000.
The Company believes that the Year 2000 issue did not pose significant
operational problems for the Company. However, if all Year 2000 issues were not
properly identified, or assessment, remediation and testing were not fully
effected, there can be no assurance that the Year 2000 issue will not materially
impact the Company's results of operations or adversely affect the Company's
relationships with customers, vendors, suppliers or franchisees. Additionally,
there can be no assurance that the Year 2000 issues of other entities will not
have a material adverse impact on the Company's systems or results of
operations.
19
<PAGE>
As of March 20, 2000, management is not aware of any significant Year 2000
issues with the Company's computer equipment and software.
ITEM 7. FINANCIAL STATEMENTS.
The consolidated financial statements of the Company are incorporated by
reference from pages F-1 through F-21 of the attached Appendix, and include the
following:
Consolidated Financial Statements of CD Warehouse, Inc.
(1) Report of Independent Auditors
(2) Consolidated Balance Sheet at December 31, 1999
(3) Consolidated Statements of Operations for the years ended December 31,
1999 and December 31, 1998
(4) Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999 and December 31, 1998
(5) Consolidated Statements of Cash Flows for the years ended December 31,
1999 and December 31, 1998
(6) Notes to Consolidated Financial Statements
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no material disagreements between the Company and its
independent accountants on accounting and financial disclosure matters which are
required to be reported under this Item for the period for which this Report is
filed.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH 16(A) OF THE EXCHANGE ACT
The information required will be contained in the Company's Proxy Statement
for the 2000 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 10. EXECUTIVE COMPENSATION.
The information required will be contained in the Company's Proxy Statement
for the 2000 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required will be contained in the Company's Proxy Statement
for the 2000 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required will be contained in the Company's Proxy Statement
for the 2000 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements are attached hereto as Appendix A and
included herein on pages F-1 through F-21.
20
<PAGE>
(2) The exhibits set forth on the following Exhibit Index are
filed with this Report or are incorporated by reference as set
forth therein.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT INDEX PAGE
------- ------------- ----
<S> <C> <C>
3.1 Amended and Restated Certificate of Incorporation (filed as Exhibit 3.1 to the Company's Registration
Statement on Form SB-2, file number 333-15139 and incorporated herein by reference)...................... #
3.2 Amended and Restated Bylaws (filed as Exhibit 3.2 to the Company's Registration Statement on Form SB-2,
file number 333-15139 and incorporated herein by reference).............................................. #
4.1 Specimen Certificate of the Common Stock (filed as Exhibit 4.1 to the Company's Registration Statement
SB-2, file number 333-15139 and incorporated herein by reference)........................................ #
4.2 See Articles IV and VIII of the Company's Amended and Restated Certificate of Incorporation and Article
II of the Company's Amended and Restated Bylaws (filed as Exhibit 4.2 to the Company's Registration
Statement on Form SB-2, file number 333-15139 and incorporated herein by reference)...................... #
4.3 Form of Warrant Agreement between the Company and the Underwriters (filed as Exhibit 4.3 to the
Company's Registration Statement on Form SB-2, file number 333-15139 and incorporated herein by
reference)............................................................................................... #
4.4 Warrant Agreement dated May 22, 1998, by and among the Company, Comvest Partners, Inc. and Capital West
Securities (filed as Exhibit 4.4 to the Company's Annual Report on Form 1--KSB for the fiscal year ended
December 31, 1998, file number 73-1504999 and incorporated herein by reference).......................... #
4.5 Amended 1996 Stock Option Plan (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-8
dated February 19, 1999, file number 333-72651 and incorporated herein by reference)..................... #
10.1 Employment Agreement by and between the Company and Grizzle (filed as Exhibit 10.1 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and incorporated herein by reference)......... #
10.2 Employment Agreement by and between the Company and Motley (filed as Exhibit 10.4 to the Company's
Registration Statement on Form SB-2, file number 333-15139 and incorporated herein by reference)......... #
10.3 Asset Purchase Agreement, dated as of June 16, 1998, by and between the Company and the Grow Biz
International, Inc. (filed as Exhibit 10.1 to the Company's Form 8-K dated June 26, 1998 and incorporated
herein by reference)..................................................................................... #
10.4 Form of Franchise Agreement (filed as Exhibit 10.10 to the Company's Registration Statement on Form
file number 333-15139 and incorporated herein by reference).............................................. #
10.5 Form of Lockup Agreement (filed as Exhibit 10.11 to the Company's Registration Statement on Form SB-2,
file number 333-15139 and incorporated herein by reference).............................................. #
10.6 Form of Development Agreement (filed as Exhibit 10.13 to the Company's Registration Statement on Form
SB-2, file number 333-15139 and incorporated herein by reference)........................................ #
10.7 Lease Agreement dated April 17, 1997 by and between Will Rogers Service Center Phase IV Associates and
CD Warehouse, Inc. (filed as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the Quarter
ended June 30, 1998 and incorporated herein by reference)................................................ #
10.8 Loan Agreement, dated February 17, 1999, between the Company and Bank One, Oklahoma, N.A. (filed as
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT INDEX PAGE
------- ------------- ----
<S> <C> <C>
Exhibit 5.1 to the Company's Form 8-K dated February 24, 1999 and incorporated herein by reference)...... #
*10.9 Loan and Security Agreement dated as of December 28, 1999, among General Electric Capital Corporation as
lender and the Company and its subsidiary, Compact Discs Management, Inc., as borrowers.................. 48
*21.1 List of subsidiaries..................................................................................... 84
*23.1 Consent of Ernst & Young LLP............................................................................. 85
*27.1 Financial Data Schedule.................................................................................. 86
# Incorporated by reference.
* Filed herewith.
(b) A report on Form 8-K was filed by the Company on October 5, 1999, reporting under "ITEM 5 - OTHER
EVENTS" the Company's execution of a letter of intent to merge its operations with CD Plus.com Ltd. A press release
dated December 3, 1999 announced that the Company had postponed such merger discussions.
</TABLE>
22
<PAGE>
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
March 28, 2000 CD WAREHOUSE, INC.,
a Delaware corporation
/s/Jerry W. Grizzle
-------------------------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME AND TITLE DATE
--------------- ----
/s/ Jerry W. Grizzle March 28, 2000
- --------------------
Jerry W. Grizzle
Chairman of the Board of Directors;
President and Chief Executive Officer
/s/ Doyle E. Motley
- -------------------
Doyle E. Motley March 28, 2000
Sr. Vice President, Chief Financial Officer,
Secretary and Treasurer
(Principal Financial and Accounting Officer)
/s/ Robert O. McDonald March 23, 2000
- ----------------------
Robert O. McDonald
Director
/s/ Christopher M. Salyer March 24, 2000
- -------------------------
Christopher M. Salyer
Director
/s/ Ronald V. Perry March 28, 2000
- -------------------
Ronald V. Perry
Director
23
<PAGE>
[THIS PAGE LEFT BLANK INTENTIONALLY]
24
<PAGE>
APPENDIX A
CONSOLIDATED FINANCIAL STATEMENTS
CD WAREHOUSE, INC.
YEARS ENDED DECEMBER 31, 1999 AND 1998
WITH REPORT OF INDEPENDENT AUDITORS
25
<PAGE>
[THIS PAGE LEFT BLANK INTENTIONALLY]
26
<PAGE>
CD Warehouse, Inc.
Consolidated Financial Statements
Years ended December 31, 1999 and 1998
CONTENTS
Report of Independent Auditors..........................................F-2
Consolidated Financial Statements
Consolidated Balance Sheet..............................................F-3
Consolidated Statements of Operations...................................F-4
Consolidated Statements of Stockholders' Equity.........................F-5
Consolidated Statements of Cash Flows...................................F-6
Notes to Consolidated Financial Statements..............................F-8
F-1
<PAGE>
Report of Independent Auditors
The Board of Directors and Stockholders
CD Warehouse, Inc.
We have audited the accompanying consolidated balance sheet of CD Warehouse,
Inc. as of December 31, 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the two years in the
period ended December 31, 1999. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits of the financial statements 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 CD
Warehouse, Inc. at December 31, 1999, and the consolidated results of its
operations and its cash flows for each of the two years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
/s/ERNST & YOUNG LLP
Oklahoma City, Oklahoma
February 25, 2000
F-2
<PAGE>
<TABLE>
<CAPTION>
CD Warehouse, Inc.
Consolidated Balance Sheet
December 31, 1999
ASSETS
<S> <C>
Current assets:
Cash and cash equivalents $ 1,069,560
Accounts receivable, net of allowance for doubtful accounts of $139,864 948,252
Notes receivable (NOTE 4) 87,159
Merchandise inventory 8,908,331
Prepaid expenses and other 237,915
Income taxes refundable 780,229
----------------
Total current assets 12,031,446
Furniture, fixtures and equipment, net (NOTE 5) 4,911,287
Notes receivable, due after one year (NOTE 4) 51,112
Intangibles and other assets, net (NOTE 6) 11,883,905
----------------
Total assets $ 28,877,750
================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,615,705
Accrued liabilities 787,186
Advances and deposits 137,000
----------------
Total current liabilities 2,539,891
Long-term debt (NOTE 7) 4,475,977
Deferred income taxes (NOTE 8) 47,000
Commitments and contingencies (NOTE 11)
Stockholders' equity (NOTE 9):
Preferred stock, $.01 par value; 5,000,000 shares authorized, none issued
Common stock, $.01 par value; 10,000,000 shares authorized,
3,660,295 shares issued and outstanding 36,603
Additional paid-in capital 21,758,158
Retained earnings 20,121
----------------
Total stockholders' equity 21,814,882
----------------
Total liabilities and stockholders' equity $ 28,877,750
================
SEE ACCOMPANYING NOTES.
</TABLE>
F-3
<PAGE>
<TABLE>
<CAPTION>
CD Warehouse, Inc.
Consolidated Statements of Operations
YEAR ENDED DECEMBER 31,
1999 1998
----------------------------
<S> <C> <C>
Revenues:
Company operations:
Retail store sales $ 26,968,793 $ 9,965,694
Wholesale merchandise sales 832,598 2,127,025
Software income, net 71,223 92,062
Franchise operations:
Royalty income 3,859,662 2,827,205
Franchise and development fees 180,000 187,500
Management fees - 62,417
----------------------------
Total revenues 31,912,276 15,261,903
Operating costs and expenses:
Cost of sales-retail store sales 16,185,685 5,901,735
Cost of sales-wholesale merchandise sales 678,144 1,914,723
Retail store operating expenses 10,209,365 3,307,424
General and administrative 4,997,385 2,511,436
Depreciation and amortization 1,516,061 617,250
----------------------------
Total costs and expenses 33,586,640 14,252,568
----------------------------
Operating income (loss) (1,674,364) 1,009,335
Other income (expense):
Interest income 40,017 210,635
Interest expense (227,550) -
Other, net 36,765 21,382
----------------------------
(150,768) 232,017
----------------------------
Income (loss) before income taxes (1,825,132) 1,241,352
Provision (credit) for income taxes (NOTE 8) (684,000) 466,000
---------------------------
Net income (loss) $ (1,141,132) $ 775,352
============================
Net income (loss) per share-basic and diluted:
Basic $(.31) $.27
============================
Diluted $(.31) $.25
============================
Shares used in computations:
Basic 3,642,442 2,923,090
============================
Diluted 3,642,442 3,136,485
============================
SEE ACCOMPANYING NOTES.
</TABLE>
F-4
<PAGE>
<TABLE>
<CAPTION>
CD Warehouse, Inc.
Consolidated Statements of Stockholders' Equity
ADDITIONAL
COMMON STOCK PAID-IN RETAINED
--------------------------
SHARES AMOUNT CAPITAL EARNINGS
-------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1997 1,820,000 $ 18,200 $ 5,348,543 $ 385,901
Exercise of stock options 6,250 63 23,375 -
Sale of common stock (net of
offering costs) 1,624,300 16,243 14,838,337 -
Issuance of common stock in
exchange for partnership
interests 100,000 1,000 361,500 -
Net income - - - 775,352
-------------------------------------------------------
Balance at December 31, 1998 3,550,550 35,506 20,571,755 1,161,253
Exercise of stock warrants 25,000 250 187,250 -
Issuance of common stock 84,745 847 999,153 -
Net loss - - - (1,141,132)
-------------------------------------------------------
Balance at December 31, 1999 3,660,295 $ 36,603 $21,758,158 $ 20,121
=======================================================
SEE ACCOMPANYING NOTES.
</TABLE>
F-5
<PAGE>
<TABLE>
<CAPTION>
CD Warehouse, Inc.
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31,
1999 1998
----------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (1,141,132) $ 775,352
Adjustments to reconcile net income (loss) to net cash used
for operating activities:
Depreciation and amortization 1,516,061 617,250
Deferred income taxes (51,000) 73,000
Refundable income taxes (633,000) -
Loss on disposal of assets, net 90,930 19,588
Net changes in operating assets and liabilities, exclusive
of business acquisitions:
Accounts receivable, net 37,966 (404,450)
Inventories (1,511,931) (849,087)
Prepaid expenses and other (112,889) (57,446)
Investment in partnerships - (57,955)
Other assets (316,009) (4,366)
Accounts payable 975,686 (552,103)
Accrued liabilities 473,936 116,343
Advances and deposits 44,000 (97,000)
Income taxes payable (545,614) 193,385
Minority interest - (97,398)
----------------------------
Total adjustments (31,864) (1,100,239)
----------------------------
Net cash used for operating activities (1,172,996) (324,887)
(CONTINUED ON FOLLOWING PAGE)
</TABLE>
F-6
<PAGE>
<TABLE>
<CAPTION>
CD Warehouse, Inc.
Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31,
1999 1998
----------------------------
<S> <C> <C>
CASH FLOWS FROM INVESTING ACTIVITIES
Notes receivable:
Advances $ (10,000) $ (218,000)
Collections 82,695 7,034
Purchases of furniture, fixtures and equipment (3,142,529) (1,434,360)
Proceeds from disposal of assets 107,000 115,030
Acquisition of businesses:
Excess of purchase price over assets acquired (1,585,101) (7,631,259)
Accounts receivable (9,780) (54,740)
Inventory (2,029,978) (1,743,899)
Prepaid and other (3,765) (10,000)
Furniture, fixtures and equipment (243,352) (449,315)
Other assets (28,565) (61,978)
Accounts payable - 87,890
Accrued liabilities - 60,687
Advances and deposits - 100,000
-----------------------------
Net cash used for investing activities (6,863,375) (11,232,910)
CASH FLOWS FROM FINANCING ACTIVITIES
Notes payable:
Advances 8,475,977 280,938
Repayments (4,000,000) (280,938)
Proceeds from sale of common stock, net - 14,854,580
Exercise of stock options and warrants 187,500 23,438
----------------------------
Net cash provided by financing activities 4,663,477 14,878,018
----------------------------
Net increase (decrease) in cash and cash equivalents (3,372,894) 3,320,221
Cash and cash equivalents at beginning of year 4,442,454 1,122,233
----------------------------
Cash and cash equivalents at end of year $ 1,069,560 $ 4,442,454
============================
SEE ACCOMPANYING NOTES.
</TABLE>
F-7
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements
December 31, 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND OPERATIONS
CD Warehouse, Inc. and its wholly-owned subsidiaries, Compact Discs Management,
Inc. and CD Warehouse Finance Company (together the "Company") are engaged in
the franchising and ownership of retail music stores offering new and preowned
compact discs ("CDs") and related products. The Company was formed in Delaware
on September 5, 1996 and had only limited operations prior to its Initial Public
Offering and simultaneous business acquisition in January 1997. At December 31,
1999, the Company owns and operates 75 retail music stores located throughout
the United States and has 247 franchised stores throughout the United States,
and 17 stores located in Canada, England, France, Guatemala and Venezuela.
In December 1998, the Company established an internet website which provides a
worldwide electronic store front for the sale of new and preowned CDs, related
music products, and concert and event tickets.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of CD
Warehouse, Inc. and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH EQUIVALENTS
Cash equivalents include money-market investments and investments in commercial
paper with maturities of three months or less when purchased.
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value.
The carrying amounts of cash and cash equivalents, trade receivables, and trade
accounts payable approximate fair value because of the short maturity of those
instruments. The Company's notes receivable from franchisees are at terms
consistent with market rate for the length of the note and risk of the borrower.
As such, the carrying amount for notes receivable approximates fair value.
Long-term debt has a floating interest rate and, therefore, the carrying amount
of long-term debt approximates its fair value.
INVENTORY
Inventory consists of new and preowned compact discs and is recorded at the
lower of average cost or market.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment, including leasehold improvements, are
recorded at cost and are depreciated on a straight-line basis over the estimated
useful lives of the assets which range from five to ten years.
INTANGIBLES
Intangible assets relate principally to the excess cost over net assets acquired
of business and store acquisitions. Amortization of such costs are for periods
ranging from ten to twenty years.
LONG-LIVED ASSETS
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," long-lived assets held and used by the Company are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. For purposes of evaluating
the recoverability of long-lived assets, the recoverability test is performed
F-9
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
using undiscounted net cash flows of the individual stores for long-lived assets
identified with individual stores, undiscounted net cash flows for acquired
franchises, and consolidated undiscounted net cash flows for long-lived assets,
not otherwise identifiable. During 1999, the Company recorded an impairment
charge to retail store operating expenses of approximately $180,000, which
represents the write-down of estimated unrecoverable assets associated with
individual stores. No significant impairments were identified in 1998.
FRANCHISE FEES AND ROYALTIES
Initial franchise fees are nonrefundable and are recognized in income when all
material services or conditions relating to the sale of the franchise have been
substantially performed or satisfied by the Company. Area development fees are
nonrefundable and are recognized in income on a pro rata basis when the
conditions for revenue recognition under the individual development agreements
are met. Royalties from franchise operations are recognized in income as earned.
ADVERTISING COSTS
Costs incurred in connection with advertising and promotion of the Company's
products are expensed as incurred. Such costs amounted to approximately
$1,053,000 and $392,000 in 1999 and 1998, respectively.
STOCK OPTIONS
The Company accounts for employee stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations. No
compensation expense is recorded with respect to stock options granted at prices
equal to the market value of the Company's common stock at the date of grant.
Upon exercise, the excess of the proceeds over the par value of the shares
issued is credited to additional paid-in capital.
ADVERTISING FUND
The Company operates an Advertising Fund which receives contributions from
franchisees and the Company based on sales. These funds are used to provide and
support national advertising for the CD Warehouse brand. These funds and the
related expenditures are not included in the accompanying consolidated financial
statements.
F-10
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NET INCOME PER SHARE
The Company accounts for earnings per share in accordance with Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share." SFAS
128 requires the disclosure of Basic and Diluted Earnings per Share ("EPS").
Basic EPS is calculated using income available to common shareowners divided by
the weighted average of common shares outstanding during the year. Diluted EPS
is similar to Basic EPS except that the weighted average of common shares
outstanding is increased to include the number of additional common shares that
would have been outstanding if the dilutive potential common shares, such as
options, had been issued. The treasury stock method is used to calculate
dilutive shares which reduces the gross number of dilutive shares by the number
of shares purchasable from the proceeds of the options assumed to be exercised
(NOTE 9).
SUPPLEMENTAL CASH FLOW INFORMATION
For the years ending December 31, 1999 and 1998, the Company had the following
noncash investing and financing activities:
In 1999, the Company acquired the assets of Music Trader, Inc. for cash of
$3,000,000 and 84,745 shares of the Company's common stock valued at $11.80
per share. The noncash portion of this transaction is as follows:
Costs in excess of net assets acquired, net $ 985,769
Inventory 2,837,312
Furniture, fixtures and equipment 160,000
Accounts receivable 9,780
Other assets 7,139
-------------
4,000,000
Less cash paid (3,000,000)
-------------
$ 1,000,000
=============
F-11
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED)
In 1998, the Company purchased partnership interests of a Company
franchisee for cash of $173,471 and 100,000 shares of the Company's common
stock valued at $3.625 per share. The noncash portion of this transaction
is as follows:
<TABLE>
<CAPTION>
<S> <C>
Costs in excess of net assets acquired, net $ 281,412
Inventory 221,208
Furniture, fixtures and equipment 70,080
Other assets 10,616
Accounts payable and accrued liabilities (47,345)
-------------
535,971
Less cash paid (173,471)
-------------
$ 362,500
=============
</TABLE>
Income taxes paid in 1999 and 1998 totaled $545,614 and $199,615,
respectively. Interest paid in 1999 and 1998 totaled $227,550 and $2,374,
respectively.
2. PUBLIC OFFERING
In May 1998, the Company completed a private placement ("Placement") of
1,624,300 shares of common stock at $10.00 per share. Proceeds from the
Placement, after deducting the placement discount and placement expenses,
were approximately $14.8 million. The net proceeds from the Placement were
used for acquisitions, expansion, provision of financing to franchisees,
and working capital. The Company effected a Registration Statement on Form
S-3 related to such shares in September 1998.
F-12
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
3. BUSINESS ACQUISITIONS
In January 1998, the Company purchased five CD Warehouse stores from a
franchisee ("ZDTMAC") for cash of $173,471 and 100,000 shares of common stock
valued at $3.625 per share for a total purchase price of $535,971. The
acquisition was recorded under the purchase method of accounting and resulted in
an allocation of excess of purchase price over net assets acquired of $281,412
which is amortized on a straight-line basis over ten years.
In June 1998, the Company acquired the assets of three retail stores and
franchise rights for 134 franchisees of Disc Go Round ("DGR"), a competing
retailer of new and preowned compact discs, for cash of $7 million and
assumption of liabilities of $100,000. The acquisition was accounted for under
the purchase method of accounting and resulted in an allocation of excess of
purchase price over net assets acquired of $6,830,992 which is amortized on a
straight-line basis over fifteen years.
In October 1998, the Company acquired, for cash of $1,737,867, the assets and
liabilities of three partnerships which collectively owned 16 CD Warehouse
stores. The Company, through its wholly-owned subsidiary, Compact Discs
Management, Inc., previously owned a majority or minority interest in these
partnerships. Upon the acquisition of these assets and liabilities, the related
partnerships were dissolved. The acquisition was accounted for under the
purchase method of accounting and resulted in an allocation of excess of
purchase price over net assets acquired of $629,245, which is amortized on a
straight-line basis over ten years.
In February 1999, the Company acquired the assets of Music Trader, Inc., a
16-store retail music chain based in Southern California for cash of $3,000,000
and 84,745 shares for the Company's common stock for a total purchase price of
approximately $4,000,000. The acquisition was recorded under the purchase method
of accounting and resulted in an allocation of excess of purchase price over net
assets acquired for $985,769 which is amortized on a straight-line basis over
ten years.
F-13
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
3. BUSINESS ACQUISITIONS (CONTINUED)
The acquisitions described above were accounted for by the purchase method of
accounting for business combinations. Accordingly, the accompanying consolidated
statements of operations do not include any revenues or expenses related to
these acquisitions prior to the respective closing dates. The cash portions of
the acquisitions were financed through debt and proceeds from the Company's
private placement of common stock and operating cash flows. Following are the
Company's unaudited pro forma results for 1999 and 1998 assuming the
acquisitions occurred on January 1, 1998 (in thousands, except for per share
data):
1999 1998
-------------------------
Total revenues $32,965,225 $28,087,676
Net income (loss) $(1,063,994) $ 1,200,947
Net income (loss) per common share:
Basic $(.29) $.33
Diluted $(.29) $.31
Weighted average common shares:
Basic 3,654,747 3,635,295
Diluted 3,654,747 3,848,690
These unaudited pro forma results have been prepared for comparative purposes
only and include certain adjustments, including amortization of goodwill as a
result of the acquisitions and do not purport to be indicative of the results of
operations which would have actually resulted had the combinations been in
effect on January 1, 1998, or of future results of operations.
The Company also acquired the assets of five individual retail stores from
franchisees during 1999 for cash totaling $900,541. The acquisitions were
accounted for under the purchase method of accounting and resulted in the
allocation of excess of purchase price over net assets acquired of $599,332
which is amortized on a straight-line basis over ten years.
F-14
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
4. NOTES RECEIVABLE
During 1998, the Company formed CD Warehouse Finance Company to provide
financing to new and existing franchisees. The financing is provided in the form
of notes receivable, secured by store assets and guarantees of the franchisees.
The notes generally require monthly payments of principal and interest, have a
two to four year term, and bear interest at 10.05%. Amounts outstanding under
these notes totaled $138,271 at December 31, 1999.
5. FURNITURE, FIXTURES AND EQUIPMENt
At December 31, 1999, furniture, fixtures and equipment, including leasehold
improvements, were comprised of the following:
Furniture, fixtures and equipment located at:
Corporate headquarters $ 918,272
Retail stores 2,756,151
Internet website 2,052,546
----------------
5,726,969
Accumulated depreciation (815,682)
----------------
$ 4,911,287
================
Depreciation expense totaled $654,403 and $162,667 for 1999 and 1998,
respectively.
6. INTANGIBLES AND OTHER ASSETS
Intangibles and other assets consist of the following at December 31, 1999:
Excess of purchase price over net assets acquired
in business acquisitions $ 12,882,538
Deposits and other 476,783
----------------
13,359,321
Accumulated amortization (1,475,416)
----------------
$ 11,883,905
================
Amortization of goodwill totaled $861,658 and $454,583 in 1999 and 1998,
respectively.
F-15
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT
In December 1999, the Company executed a $15,000,000 revolving credit loan (the
"Loan") with an asset-based lender. As of December 31, 1999, the Company had
$4,475,977 outstanding under the Loan. The term of the Loan expires in December
2002, at which time the principal and unpaid interest are due. The Loan bears a
variable rate of interest at an index rate (thirty-day commercial paper) plus
2.75% (8.3% at December 31, 1999). The borrowings under the Loan are limited to
a borrowing base calculation as determined by stated percentages of compact
discs in inventory. Available borrowings under the Loan at December 31, 1999
were approximately $586,000. All assets of the Company are pledged as collateral
under the Loan. The Loan requires the Company to maintain certain financial
covenants including fixed charge coverage, minimum tangible net worth, and
limits capital expenditures. Proceeds of the Loan were used to repay existing
indebtedness including $3.5 million to retire an existing credit facility with a
bank that had been executed in February 1999.
8. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The approximate tax
effect of each type of temporary difference that is used in computing deferred
tax assets and liabilities at December 31, 1999 is as follows.
DEFERRED TAX ASSETS
Allowances for doubtful accounts $ 51,750
Inventory reserves 40,290
Net operating loss carryforwards (expiring in 2019) 120,000
Other 49,960
----------
Total deferred tax assets 262,000
DEFERRED TAX LIABILITIES
Tax depreciation in excess of financial 185,967
Tax amortization in excess of financial 123,033
----------
Total deferred tax liabilities 309,000
----------
Net deferred tax liabilities $ 47,000
==========
F-16
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES (CONTINUED)
The significant components of income tax expense for the years ended December
31, 1999 and 1998 are as follows:
1999 1998
-----------------------
Current tax expense (credit):
Federal $(528,000) $ 339,000
State (105,000) 54,000
-----------------------
(633,000) 393,000
Deferred tax expense (credit):
Federal (47,000) 62,000
State (4,000) 11,000
-----------------------
(51,000) 73,000
-----------------------
$(684,000) $ 466,000
=======================
The provision for income taxes differs from the computed "expected" income tax
provision using federal statutory rates on income before income taxes for the
following reasons:
YEAR ENDED DECEMBER 31,
1999 1998
-----------------------
Computed "expected" income tax (credit) $(620,545) $ 422,059
Increases (decreases) in taxes resulting from:
State income taxes, net of federal benefit (63,203) 43,013
Other (252) 928
-----------------------
$(684,000) $ 466,000
=======================
F-17
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY
EARNINGS PER SHARE
<TABLE>
<CAPTION>
1999 1998
-------------------------
<S> <C> <C>
Income:
Income (loss) available to common shareowners $(1,141,132) $775,352
=========================
Weighted average shares:
Outstanding 3,642,442 2,923,090
Dilutive shares assuming:
Exercise of stock options - 276,750
Exercise of warrants - 262,430
Less: Shares purchasable with proceeds - (325,785)
--------------------------
Total shares 3,642,442 3,136,485
=========================
Basic EPS $(.31) $.27
=========================
Diluted EPS $(.31) $.25
=========================
Antidilutive stock options and warrants excluded 166,928 -
=========================
</TABLE>
STOCK OPTIONS
In December 1996, the Company adopted the 1996 Stock Option Plan ("Plan") which,
as amended, provides for grants of up to 600,000 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. The Company has
agreed to grant options to purchase 10,000 shares annually to each director. No
options were granted through December 31, 1996. In 1999 and 1998, options to
acquire 108,550 and 95,000 common shares, respectively, were granted under the
Plan at option prices equal to the fair market value of the common stock on the
date of grant. Additionally, in 1999 and 1998, options to acquire 25,000 and
12,000 common shares, respectively, were granted to consultants and directors at
option prices equal to the fair market value of the common stock on the date of
grant. No expense related to options granted was recorded in 1999 and 1998.
F-18
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
Stock option transactions for 1999 and 1998 are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
------------------------------- ------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 361,750 $ 6.01 261,000 $ 3.84
Granted 133,550 $ 9.23 107,000 $11.18
Exercised - (6,250) $ 3.75
Canceled, forfeited, or expired (5,000) $ 11.75 -
--------------- --------------
Outstanding at end of year 490,300 $ 6.83 361,750 $ 6.01
=============== ==============
Exercisable at end of year 303,084 $ 6.93 88,042 $ 3.84
=============== ==============
Weighted average fair value of options
granted during year $6.25 $4.34
=============== ==============
</TABLE>
Outstanding options to acquire 490,300 shares of stock at December 31, 1999 had
exercise prices ranging from $3.13 to $12.88 per share and had a weighted
average remaining contractual life of 8.75 years.
The following pro forma information, as required by Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS
123"), presents net income and earnings per share information as if the Company
had accounted for stock options issued in 1999 and 1998 using the fair value
method prescribed by the Statement. The fair value of issued stock options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following assumptions for 1999 and 1998, respectively: weighted average
risk-free interest rate of 5.03% and 5.49%; no dividends over the option term;
stock price volatility factor of .808 and .363, and a weighted average expected
option life of five years. For the purpose of the following pro forma
information, the estimated fair value as determined by the model was amortized
to expense over the respective vesting period. The SFAS 123 pro forma
information presented below is not necessarily indicative of the pro forma
effects to be presented in future periods.
F-19
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
The SFAS 123 pro forma information is as follows:
YEAR ENDED DECEMBER 31,
1999 1998
---------------------------------
Net income (loss):
As reported $(1,141,132) $775,352
Pro forma $(1,734,332) $471,769
Basic earnings (loss) per share:
As reported $(.31) $.27
Pro forma $(.47) $.16
Diluted earnings (loss) per share:
As reported $(.31) $.25
Pro forma $(.47) $.15
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of fair value of its stock options.
WARRANTS
In connection with its Initial Public Offering in 1997, the Company sold to the
underwriters, for a price of $.001 per warrant, warrants to purchase 100,000
shares of common stock. The underwriters' warrants are exercisable at $7.50 per
share through January 2002. During 1999, warrants were exercised for 25,000
shares of common stock for cash of $187,500.
In connection with the Placement, the placement agents were granted warrants to
purchase 162,430 shares of common stock exercisable at $10.00 per share through
2003.
F-20
<PAGE>
CD Warehouse, Inc.
Notes to Consolidated Financial Statements (continued)
10. EMPLOYEE BENEFIT PLAN
In 1999, the Company adopted a 401(k) Plan (the "Plan") for eligible employees.
Employees who have completed one year of service with the Company and are 18
years of age are eligible to participate in the Plan. Participating employees
may authorize payroll deductions up to 15% of their annual compensation. The
Company matches 50% of the first 6% of the employees' compensation contributed
to the Plan. Company contributions are subject to vesting at the rate of 20%
each year upon completion of two years of service, with 100% vesting after six
years. Matching contributions of $20,615 were made by the Company during 1999.
11. COMMITMENTS AND CONTINGENCIES
The Company has entered into employment agreements with two officers of the
Company. The employment agreements are for terms of one and five years with
renewal options of one and five years and total $212,000 annually for the two
individuals.
The Company has entered into operating leases primarily for its retail store
locations and corporate facilities. Rental expense under these leases totaled
$2,157,918 and $801,200 for 1999 and 1998, respectively. Total rental amounts of
$6,454,200 under these noncancelable leases are due as follows: 2000-$1,902,896,
2001-$1,685,979, 2002-$1,363,796, 2003-$1,083,209, 2004-$403,579 and
thereafter-$14,741.
The Company is also involved in legal proceedings and litigation arising in the
ordinary course of business. In the opinion of management, the outcome of such
proceedings and litigation currently pending will not materially affect the
Company's consolidated financial statements.
12. BUSINESS SEGMENT INFORMATION
The Company is engaged principally in one line of business-the sale of
prerecorded music compact discs and related products in Company and franchisee
owned retail stores-which represents approximately 99% of consolidated revenues.
There are no material amounts of sales among geographic areas, individual
foreign countries, or individual customers. All of the Company's long-lived
assets are located within the domestic United States.
F-21
<PAGE>
EXHIBIT 10.9
LOAN AND SECURITY AGREEMENT
DATED AS OF DECEMBER 28, 1999
AMONG
GENERAL ELECTRIC CAPITAL CORPORATION
AS LENDER
AND
CD WAREHOUSE, INC.
AND
COMPACT DISCS MANAGEMENT, INC.
AS BORROWERS
<PAGE>
INDEX OF EXHIBITS AND SCHEDULES
-------------------------------
Schedule A - Definitions
Schedule B - Lender's and Borrowers' Addresses for Notices
Schedule C - Letters of Credit
Schedule D - Cash Management System
Schedule E - Fees and Expenses
Schedule F - Schedule of Documents
Schedule G - Financial Covenants
Disclosure Schedule (3.2) - Places of Business; Corporate Names
Disclosure Schedule (3.6) - Real Estate
Disclosure Schedule (3.7) - Stock; Affiliates
Disclosure Schedule (3.12) - ERISA
Disclosure Schedule (3.13) - Litigation
Disclosure Schedule (3.14) - Intellectual Property
Disclosure Schedule (3.16) - Environmental Matters
Disclosure Schedule (3.17) - Insurance
Disclosure Schedule (3.19) - Contracts (Offset Risk)
Disclosure Schedule (5(b)) - Indebtedness
Disclosure Schedule (5(e)) - Liens
Disclosure Schedule (6.1) - Actions to Perfect Liens
Exhibit A - Form of Notice of Revolving Credit Advance and Borrowing Base
Certificate
Exhibit B - Other Reports and Information
Exhibit C - Inventory Rollforward and Reconciliation
Exhibit D - Form of Accounts Payable Analysis
Exhibit E - Form of Revolving Credit Note
Exhibit F - Form of Store Account Agreement
Exhibit G - Form of Blocked Account Agreement
Exhibit H - Form of Secretarial Certificate
Exhibit I - Form of Power of Attorney
Exhibit J - Form of Certificate of Compliance
Exhibit K - Form of Lockbox Agreement
Exhibit L - Form of Landlord's Waiver and Consent (Warehouse Locations)
Exhibit M - Form of Landlord's Waiver and Consent (Store Locations)
Exhibit N - Form of Joint and Several Guarantee
Exhibit 0 - Form of Opinion of Counsel to Borrower
Exhibit P - Intentionally Deleted
Exhibit Q - Form of Standard Payoff Letter
Exhibit R - Form of U.C.C. Schedule
Exhibit S - Form of Payment of Proceeds Letter
<PAGE>
GE Capital
TRANSACTION SUMMARY AS OF THE DATE OF THIS AGREEMENT
- --------------------------------------------------------------------------------
REVOLVING CREDIT LOAN
<TABLE>
<S> <C>
Maximum Amount: $ 15,000,000
--------------
Term: 3 years
----
Revolving Credit Rate: Index Rate plus 2.75%
---------------------
Letter of Credit Subfacility: n/a
----------------------------
Borrowing Base: the lesser of (a) the sum at such
-------------- time of sixty five percent (65%) of
the value of such Borrower's Eligible
Inventory consisting of eligible pre-
owned compact disc inventory and
seventy percent (70%) of the value of
such Borrower's Eligible Inventory
consisting of eligible new compact
disc inventory, in each case as
determined by Lender, valued on a
first-in, first-out basis (at the
lower of cost or marker), or (b)
ninety percent (90%) of the GOB value
of the pre-owned and new compact disc
inventory of such Borrower as
reflected on the most recent
Inventory Appraisal obtained by
Lender.
FEES
Closing Fee: $112,500
-----------
Collateral Monitoring Fee: $25,000 per annum
-------------------------
Unused Line Fee: .25%
---------------
Letter of Credit Fee: n/a
--------------------
Prepayment Fee: 3% in year one; 2% in year two; and
-------------- 1% in year three.
</TABLE>
The Loans described generally here are established and governed by the terms and
conditions set forth below in this Agreement and the other Loan Documents, and
if there is any conflict between this general description and the express terms
and conditions below or elsewhere in the Loan Documents, such other express
terms and conditions shall control.
- --------------------------------------------------------------------------------
<PAGE>
This LOAN AND SECURITY AGREEMENT is dated as of December 28, 1999, and
agreed to by and among CD WAREHOUSE. INC., a Delaware corporation ("Leading
Borrower"), and COMPACT DISCS MANAGEMENT, INC., a Delaware corporation ("Second
Borrower" (Leading Borrower and Second Borrower being collectively referred to
as "Borrowers" and each a "Borrower"), any other Credit Party executing this
Agreement, and GENERAL ELECTRIC CAPITAL CORPORATION, a New York corporation
("Lender").
Recitals
A. Borrowers desire to obtain the Loans and other financial
accommodations from Lender and Lender is willing to provide the Loans and
accommodations all in accordance with the terms of this Agreement.
B. Capitalized terms used herein shall have the meanings assigned to
them in Schedule A and, for purposes of this Agreement and the other Loan
----------
Documents, the rules of construction set forth in Schedule A shall govern. All
----------
Schedules, Attachments, Addenda and Exhibits (collectively, "Appendices")
hereto, or expressly identified to this Agreement, are incorporated herein by
reference, and taken together with this Agreement, constitute but a single
agreement.
Agreement
NOW, THEREFORE, in consideration of the premises and the mutual covenants
hereinafter contained, the parties hereto agree as follows:
1. Amount and Terms of Credit
1.1 Loans. (a) Subject to the terms and conditions of this Agreement,
-----
from the Closing Date and until the Commitment Termination Date (i) Lender
agrees (A) to make available advances (each, a "Revolving Credit Advance") and
(B) to incur Letter of Credit Obligations, in an aggregate outstanding amount
for any Borrower not to exceed the Borrowing Availability of such Borrower, and
(ii) any Borrower may at the request of Leading Borrower as agent for such
Borrower from time to time borrow, repay and reborrow, and may cause Lender to
incur Letter of Credit Obligations, under this Section 1.1.
(b) Leading Borrower, as agent for each Borrower, shall request each
Revolving Credit Advance by written notice to Lender substantially in the form
of Exhibit A (each a "Notice of Revolving Credit Advance") given no later than
---------
12:00 noon (New York City time) on the Business Day of the proposed Revolving
Credit Advance. Lender shall be fully protected under this Agreement in relying
upon, and shall be entitled to rely upon, (i) any Notice of Revolving Credit
Advance believed by Lender to be genuine, and (ii) the assumption that the
Persons making electronic requests or executing and delivering a Notice of
Revolving Credit Advance were duly authorized, unless the responsible individual
acting thereon for Lender shall have actual knowledge to the contrary. As an
accommodation to Borrowers, Lender may permit
1
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telephonic or facsimile requests for a Revolving Credit Advance and electronic
or facsimile transmittal of instructions, authorizations, agreements or reports
to Lender by any Borrower. Unless each Borrower specifically directs Lender in
writing not to accept or act upon telephonic, facsimile or electronic
communications from any Borrower, Lender shall have no liability to any Borrower
for any loss or damage suffered by any Borrower as a result of Lender's honoring
of any requests, execution of any instructions, authorizations or agreements or
reliance on any reports communicated to it telephonically, by facsimile or
electronically and purporting to have been sent to Lender by any Borrower and
Lender shall have no duty to verify the origin of any such communication or the
identity or authority of the Person sending it. The Revolving Credit Loan shall
be evidenced by, and be repayable in accordance with the terms of, the Revolving
Credit Note and this Agreement.
(c) In making any Loan hereunder Lender, shall be entitled to rely upon
the most recent Borrowing Base Certificate delivered to Lender by such Borrower
and other information available to Lender. Lender shall be under no obligation
to make any further Revolving Credit Advance to any Borrower or incur any other
Obligation if any Borrower shall have failed to deliver a Borrowing Base
Certificate to Lender by the time specified in Section 4.1(b).
(d) Notwithstanding anything to the contrary contained in this Agreement,
including Schedule C, Lender shall have no obligations to incur Letter of Credit
----------
Obligations for the account of Borrower.
1.2 Term and Prepayment. Upon the Commitment Termination Date the
-------------------
obligation of Lender to make Revolving Credit Advances and extend other credit
hereunder shall immediately terminate and Borrowers shall pay to Lender in full,
in cash: (i) all outstanding Revolving Credit Advances and all accrued but
unpaid interest thereon; (ii) an amount sufficient to enable Lender to hold cash
collateral as specified in Schedule C and (iii) all other non-contingent
----------
Obligations due to or incurred by Lender.
(b) If the Revolving Credit Loan attributable to any Borrower shall at
any time exceed such Borrower's Borrowing Availability, then such Borrower shall
immediately repay the Revolving Credit Loan in the amount of such excess.
(c) Each Borrower shall have the right, at any time upon 30 days prior
written notice to Lender to (i) terminate voluntarily Borrowers' right to
receive or benefit from, and Lender's obligation to make and to incur, Revolving
Credit Advances and Letter of Credit Obligations and (ii) prepay all of the
Obligations. The effective date of termination of the Revolving Credit Loan
specified in such notice shall be the Commitment Termination Date. If any
Borrower exercises the right of termination and prepayment, or if Lender's
obligation to make Loans is terminated for any reason prior to the Stated Expiry
Date then in effect (including as a result of the occurrence of a Default),
Borrowers shall pay to Lender the applicable Prepayment Fee.
1.3 Use of Proceeds. Borrowers shall use the proceeds of the Loans to
---------------
refinance on the Closing Date certain outstanding Indebtedness as provided in
Section 2.1(b) and for working capital and other general corporate purposes.
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1.4 Single Loan. The Loans and all of the other Obligations of any
-----------
Borrower to Lender shall constitute one general obligation of such Borrower
secured by all of the Collateral.
1.5 Interest (a) Each Borrower shall pay interest to Lender on the
--------
aggregate outstanding Revolving Credit Advances attributable to such Borrower at
a floating rate equal to the Index Rate plus two and seventy five hundredths
percent (2.75 %) per annum (the "Revolving Credit Rate"). All computations of
interest, and all calculations of the Letter of Credit Fee, shall be made by
Lender on the basis of a three hundred and sixty (360) day year, in each case
for the actual number of days occurring in the period for which such interest or
fee is payable. Each determination by Lender of an interest rate hereunder shall
be conclusive and binding for all purposes, absent manifest error. In no event
will Lender charge interest at a rate that exceeds the highest rate of interest
permissible under any law that a court of competent jurisdiction shall, in a
final determination, deem applicable.
(b) Interest shall be payable on the outstanding Revolving Credit
Advances (i) in arrears for the preceding calendar month on the first day of
each calendar month, (ii) on the Commitment Termination Date, and (iii) if any
interest accrues or remains payable after the Commitment Termination Date, upon
demand by Lender.
(c) Effective upon the occurrence of any Event of Default and for so long
as any Event of Default shall be continuing, the Revolving Credit Rate and the
Letter of Credit Fee shall automatically be increased by two percentage points
(2%) per annum (such increased rate, the "Default Rate"), and all outstanding
Obligations, including unpaid interest and Letter of Credit Fees, shall continue
to accrue interest from the date of such Event of Default at the Default Rate
applicable to such Obligations.
(d) If any interest or other payment (including Unused Line Fees, Letter
of Credit Fees and Collateral Monitoring Fees) to Lender under this Agreement
becomes due and payable on a day other than a Business Day, such payment date
shall be extended to the next succeeding Business Day and interest thereon shall
be payable at the then applicable rate during such extension.
1.6 Cash Management System. On or prior to the Closing Date and until the
----------------------
Termination Date, each Borrower will establish and maintain the cash management
system described in Schedule D. All payments in respect of the Collateral shall
----------
be made to or deposited in the accounts described in Schedule D in accordance
----------
with the terms thereof.
1.7 Fees. Borrowers agree to pay to Lender the Fees set forth in
----
Schedule E.
1.8 Receipt of Payments. Each Borrower shall make each payment under this
-------------------
Agreement (not otherwise made pursuant to Section 1.9) without set-off,
counterclaim or deduction and free and clear of all Taxes not later than 12:00
noon (New York City time) on the day when due in lawful money of the United
States of America in immediately available funds to the Collection Account. If
any Borrower shall be required by law to deduct any Taxes from any payment to
Lender under any Loan Document, then the amount payable to Lender shall
3
<PAGE>
be increased so that, after making all required deductions, Lender receives an
amount equal to that which it would have received had no such deductions been
made. For purposes of computing interest and Fees, all payments shall be deemed
received by Lender 1 Business Day following receipt of immediately available
funds in the Collection Account. For purposes of determining the Borrowing
Availability, payments shall be deemed received by Lender upon receipt of
immediately available funds in the Collection Account.
1.9 Application and Allocation of Payments. Each Borrower irrevocably
--------------------------------------
agrees that Lender shall have the continuing and exclusive right to apply any
and all payments against the then due and payable Obligations in such order as
Lender may deem advisable. Lender is authorized to, and at its option may
(without prior notice or precondition and at any time or times), but shall not
be obligated to, make or cause to be made Revolving Credit Advances on behalf of
any Borrower for: (a) payment of all Fees, expenses, indemnities, charges,
costs, principal, interest, or other Obligations owing by such Borrower under
this Agreement or any of the other Loan Documents, (b) the payment, performance
or satisfaction of any of such Borrower's obligations with respect to
preservation of the Collateral or otherwise under this Agreement, or (c) any
premium in whole or in part required in respect of any of the policies of
insurance required by this Agreement, even if the making of any such Revolving
Credit Advance causes the outstanding balance of the Revolving Credit Loan
attributable to any Borrower to exceed such Borrower's Borrowing Availability,
and each Borrower agrees to repay immediately, in cash, any amount by which the
Revolving Credit Loan attributable to such Borrower exceeds its Borrowing
Availability.
1.10 Accounting. Lender is authorized to record on its books and records
----------
the date and amount of each Loan and each payment of principal thereof and such
recordation shall constitute prima facie evidence of the accuracy of the
information so recorded. Lender shall provide Borrowers on a monthly basis a
statement and accounting of such recordations but any failure on the part of the
Lender to keep any such recordation (or any errors therein) or to send a
statement thereof to any Borrower shall not in any manner affect the obligation
of any Borrower to repay (with applicable interest) the Loans made to such
Borrower under this Agreement. Except to the extent that any Borrower shall,
within 30 days after such statement and accounting is received, notify Lender in
writing of any objection such Borrower may have thereto (stating with
particularity the basis for such objection), such statement and accounting shall
be deemed final, binding and conclusive upon such Borrower, absent manifest
error.
1.11 Indemnity. Each Borrower and each other Credit Party executing this
---------
Agreement jointly and severally agree to indemnify and hold Lender and its
Affiliates, and their respective employees, attorneys and agents (each, an
"Indemnified Person"), harmless from and against any and all suits, actions,
proceedings, claims, damages, losses, liabilities and expenses of any kind or
nature whatsoever (including attorneys' fees and disbursements and other costs
of investigation or defense, including those incurred upon any appeal) which may
be instituted or asserted against or incurred by any such Indemnified Person as
the result of credit having been extended, suspended or terminated under this
Agreement and the other Loan Documents or with respect to the execution,
delivery, enforcement, performance and administration of, or in any other way
arising out of or relating to, this Agreement and the other Loan Documents or
any other documents or transactions contemplated by or referred to herein or
therein and any actions
4
<PAGE>
or failures to act with respect to any of the foregoing, including any and all
product liabilities, Environmental Liabilities, Taxes and legal costs and
expenses arising out of or incurred in connection with disputes between or among
any parties to any of the Loan Documents (collectively, "Indemnified
Liabilities"), except to the extent that any such Indemnified Liability is
finally determined by a court of competent jurisdiction to have resulted solely
from such Indemnified Person's gross negligence or willful misconduct. NO
INDEMNIFIED PERSON SHALL BE RESPONSIBLE OR LIABLE TO ANY CREDIT PARTY, ANY
SUCCESSOR, ASSIGNEE OR THIRD PARTY BENEFICIARY OR ANY OTHER PERSON ASSERTING
CLAIMS DERIVATIVELY THROUGH SUCH PARTY, FOR ANY ACT OR FAILURE TO ACT UNDER ANY
POWER OF ATTORNEY OR FOR INDIRECT, PUNITIVE, EXEMPLARY OR CONSEQUENTIAL DAMAGES
WHICH MAY BE ALLEGED AS A RESULT OF CREDIT HAVING BEEN EXTENDED, SUSPENDED OR
TERMINATED UNDER THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT OR AS A RESULT OF ANY
OTHER TRANSACTION CONTEMPLATED HEREUNDER OR THEREUNDER.
1.12 Borrowing Base: Reserves. The Borrowing Base of each Borrower shall
------------------------
be determined by Lender (including the eligibility of Accounts and Inventory)
based on the most recent Borrowing Base Certificate delivered to Lender in
accordance with Section 4. 1(b) and such other information available to Lender.
Without limiting any other rights and remedies of Lender hereunder or under the
other Loan Documents, the Revolving Credit Loan shall be subject to Lender's
continuing right to withhold from any Borrower's Borrowing Availability
reserves, and to increase and decrease such reserves from time to time, if and
to the extent that in Lender's good faith credit judgment such reserves are
necessary, including to protect Lender's interest in the Collateral or possible
diminution of the value of any Collateral or possible non-payment of any of the
Obligations or for any Taxes or in respect of any state of facts which could
constitute a Default. Lender may, at its option, implement reserves by
designating as ineligible a sufficient amount of Inventory which would otherwise
be Eligible Inventory, so as to reduce any Borrower's Borrowing Base by the
amount of the intended reserves.
2. Conditions Precedent
2.1 Conditions to the Initial Loans. Lender shall not be obligated to
-------------------------------
make any of the Loans or to perform any other action hereunder, until the
following conditions have been satisfied in a manner satisfactory to Lender in
its sole discretion, or waived in writing by Lender:
(a) the Loan Documents to be delivered on or before the Closing Date
shall have been duly executed and delivered by the appropriate parties, all as
set forth in the Schedule of Documents (Schedule F)
----------
(b) all of the obligations of Borrowers to Bank One, Oklahoma, N.A. under
their financing documentation as in effect immediately prior to the Closing Date
will be performed and paid in full from the proceeds of the initial Loans and
all Liens upon any of the property of any Borrower or any other Credit Party in
respect thereof shall have been terminated immediately upon such payment;
5
<PAGE>
(c) Lender shall have received evidence satisfactory to it that the
insurance policies provided for in Section 3.17 are in full force and effect,
together with appropriate evidence showing loss payable or additional insured
clauses or endorsements in favor of Lender as required under such Section;
(d) as of the Closing Date Net Borrowing Availability for all Borrowers
combined shall be not less than $500,000 after giving effect to the initial
Revolving Credit Advance (on a pro forma basis, with trade payables being paid
currently, and expenses and liabilities being paid in the ordinary course of
business and without acceleration of sales); and
(e) Lender shall have received an opinion of counsel to the Borrowers with
respect to the Loan Documents in form and substance satisfactory to Lender.
2.2 Further Conditions to the Loans. Lender shall not be obligated to
-------------------------------
fund any Loan (including the initial Loans), if, as of the date thereof:
(a) any representation or warranty by any Credit Party contained herein or
in any of the other Loan Documents shall be untrue or incorrect as of such date,
except to the extent that any such representation or warranty is expressly
stated to relate to a specific earlier date, in which case, such representation
and warranty shall be true and correct as of such earlier date; or
(b) any event or circumstance which has had or reasonably could be expected
to have a Material Adverse Effect shall have occurred since the Closing Date; or
(c) any Default shall have occurred and be continuing or would result after
giving effect to such Loan; or
(d) after giving effect to such Loan the Revolving Credit Loan attributable
to any Borrower would exceed the Borrowing Availability of such Borrower.
2.3 Agent. The request and acceptance by Leading Borrower, as agent for
-----
each Borrower, of the proceeds of any Loan, and the request by Leading Borrower,
as agent for each Borrower, for the incurrence by Lender of any Letter of Credit
Obligations, as the case may be, shall be deemed to constitute, as of the date
of such request and the date of such acceptance, (i) a representation and
warranty by each Borrower that the conditions in Section 2.2 have been satisfied
and (ii) a restatement by each Borrower of each of the representations and
warranties made by such Borrower in any Loan Document and a reaffirmation by
each Borrower of the granting and continuance of Lender's Liens pursuant to the
Loan Documents.
3. Representations, Warranties and Affirmative Covenants
To induce Lender to enter into this Agreement and to make the Loans, each
Borrower and each other Credit Party executing this Agreement represent and
warrant to Lender (each of which representations and warranties shall survive
the execution and delivery of this Agreement), and promise to and agree with
Lender until the Termination Date as follows:
6
<PAGE>
3.1 Corporate Existence: Compliance with Law. Each Corporate Credit
----------------------------------------
Party: (a) is, as of the Closing Date, and will continue to be (i) a corporation
duly organized, validly existing and in good standing under the laws of the
jurisdiction of its incorporation or formation, (ii) duly qualified to do
business and in good standing in each other jurisdiction where its ownership or
lease of property or the conduct of its business requires such qualification,
except where the failure to be so qualified could not reasonably be expected to
have a Material Adverse Effect, and (iii) in compliance with all Requirements of
Law and Contractual Obligations, except to the extent failure to comply
therewith could not, individually or in the aggregate, reasonably be expected to
have a Material Adverse Effect; and (b) has and will continue to have (i) the .
requisite corporate power and authority and the legal right to execute, deliver
and perform its obligations under the Loan Documents, and to own, pledge,
mortgage or otherwise encumber and operate its properties, to lease the property
it operates under lease, and to conduct its business as now, heretofore or
proposed to be conducted, and (ii) all licenses, permits, franchises, rights,
powers, consents or approvals from or by all Persons or Governmental Authorities
having jurisdiction over such Corporate Credit Party which are necessary or
appropriate for the conduct of its business.
3.2 Executive Offices: Corporate or Other Names. The location of each
-------------------------------------------
Corporate Credit Party's chief executive office, corporate offices, warehouses,
other locations of Collateral and locations where records with respect to
Collateral are kept (including in each case the county of such locations) are as
set forth in Disclosure Schedule (3.2) and, except as set forth in such
-------------------------
Disclosure Schedule, such locations have not changed during the preceding twelve
months. As of the Closing Date, during the prior five years, except as set forth
in Disclosure Schedule (3.2), no Corporate Credit Party has been known as or
-------------------------
conducted business in any other name (including trade names).
3.3 Corporate Power: Authorization: Enforceable Obligations. The
-------------------------------------------------------
execution, delivery and performance by each Credit Party of the Loan Documents
to which it is a party, and the creation of all Liens provided for herein and
therein: (a) are and will continue to be within such Credit Party's power and
authority; (b) have been and will continue to be duly authorized by all
necessary or proper action; (c) are not and will not be in violation of any
Requirement of Law or Contractual Obligation of such Credit Party; (d) do not
and will not result in the creation or imposition of any Lien (other than
Permitted Encumbrances) upon any of the Collateral: and (e) do not and will not
require the consent or approval of any Governmental Authority or any other
Person. As of the Closing Date, each Loan Document shall have been duly executed
and delivered on behalf of each Credit Party party thereto, and each such Loan
Document upon such execution and delivery shall be and will continue to be a
legal, valid and binding obligation of such Credit Party, enforceable against it
in accordance with its terms, except as such enforcement may be limited by
bankruptcy, insolvency and other similar laws affecting creditors' rights
generally.
3.4 Financial Statements and Projections: Books and Records. (a) The
-------------------------------------------------------
Financial Statements delivered by each Borrower to Lender for its most recently
ended Fiscal Year and Fiscal Month, are true, correct and complete and reflect
fairly and accurately the financial condition of such Borrower as of the date of
each such Financial Statement in accordance with GAAP. The Projections most
recently delivered by each Borrower to Lender have been prepared
7
<PAGE>
in good faith, with care and diligence and use assumptions that are reasonable
under the circumstances at the time such Projections were prepared and as of the
date delivered to Lender and all such assumptions are disclosed in the
Projections.
(b) Each Borrower and each other Corporate Credit Party shall keep
adequate Books and Records with respect to the Collateral and its business
activities in which proper entries, reflecting all consolidated and
consolidating financial transactions, and payments and credits received on, and
all other dealings with, the Collateral, will be made in accordance with GAAP
and all Requirements of Law and on a basis consistent with the Financial
Statements.
3.5 Material Adverse Change. Between the date of each Borrower's most
-----------------------
recently audited Financial Statements delivered to Lender and the Closing Date:
(a) no Corporate Credit Party has incurred any obligations, contingent or non-
contingent liabilities, or liabilities for Charges, long-term leases or unusual
forward or long-term commitments which are not reflected in the Projections
delivered on the Closing Date and which could, alone or in the aggregate,
reasonably be expected to have a Material Adverse Effect; (b) there has been no
material deviation from such Projections; and (c) no events have occurred which
alone or in the aggregate has had or could reasonably be expected to have a
Material Adverse Effect. No Requirement of Law or Contractual Obligation of any
Credit Party has or have had or could reasonably be expected to have a Material
Adverse Effect and no Credit Party is in default, and to such Credit Party's
knowledge no third party is in default, under or with respect to any of its
Contractual Obligations, which alone or in the aggregate has had or could
reasonably be expected to have a Material Adverse Effect.
3.6 Real Estate; Property. The real estate listed in Disclosure Schedule
--------------------- -------------------
(3.6) constitutes all of the real property owned, leased, or used by each
- -----
Corporate Credit Party in its business, and such Credit Party will not execute
any material agreement or contract in respect of such real estate after the date
of this Agreement without giving Lender prompt prior written notice thereof.
Each Corporate Credit Party holds and will continue to hold good and marketable
fee simple title to all of its owned real estate, and good and marketable title
to all of its other properties and assets, and valid and insurable leasehold
interests in all of its leases (both as lessor and lessee, sublessee or
assignee), and none of the properties and assets of any Corporate Credit Party
are or will be subject to any Liens, except Permitted Encumbrances. With respect
to those premises identified in Disclosure Schedule (3.2) consisting of
-------------------------
warehouses or the corporate offices of a Credit Party, on or prior to the
Closing Date a landlord agreement in the form of Exhibit L to this Agreement or
otherwise acceptable to Lender has been obtained. With respect to all of the
other premises identified in Disclosure Schedule (3.2), each Credit Party shall
-------------------------
use its best efforts both before the Closing Date and thereafter to have
executed and delivered to Lender a landlord agreement in the form of Exhibit M
to this Agreement or otherwise acceptable to Lender.
3.7 Ventures. Subsidiaries and Affiliates: Outstanding Stock and
------------------------------------------------------------
Indebtedness. Except as set forth in Disclosure Schedule (3.7), as of the
- ------------ -------------------------
Closing Date no Corporate Credit Party has any Subsidiaries, is engaged in any
joint venture or partnership with any other Person, or is an Affiliate of any
other Person. All of the issued and outstanding Stock of each Corporate Credit
Party (including all rights to purchase, options, warrants or similar rights or
agreements pursuant
8
<PAGE>
to which any Corporate Credit Party may be required to issue, sell, repurchase
or redeem any of its Stock) as of the Closing Date is owned by each of the
Stockholders (and in the amounts) set forth on Disclosure Schedule (3.7). All
-------------------------
outstanding Indebtedness of each Corporate Credit Party as of the Closing Date
is described in Disclosure Schedule (5(b)).
--------------------------
3.8 Government Regulation. No Corporate Credit Party is subject to or
---------------------
regulated under or any Federal or state statute, rule or regulation that
restricts or limits such Person's ability to incur Indebtedness, pledge its
assets, or to perform its obligations under the Loan Documents. The making of
the Loans, the application of the proceeds and repayment thereof, and the
consummation of the transactions contemplated by the Loan Documents do not and
will not violate any Requirement of Law.
3.9 Margin Regulations. No Corporate Credit Party is engaged, nor will it
------------------
engage, principally or as one of its important activities, in the business of
extending credit for the purpose of "purchasing" or "carrying" any "margin
security" as such terms are defined in Regulation U of the Federal Reserve Board
as now and from time to time hereafter in effect (such securities being referred
to herein as "Margin Stock"). No Corporate Credit Party owns any Margin Stock,
and none of the proceeds of the Loans or other extensions of credit under this
Agreement will be used, directly or indirectly, for the purpose of purchasing or
carrying any Margin Stock, for the purpose of reducing or retiring any
Indebtedness which was originally incurred to purchase or carry any Margin Stock
or for any other purpose which might cause any of the Loans or other extensions
of credit under this Agreement to be considered a "purpose credit" within the
meaning of Regulation T, U or X of the Federal Reserve Board. No Corporate
Credit Party will take or permit to be taken any action which might cause any
Loan Document to violate any regulation of the Federal Reserve Board.
3.10 Taxes: Charges. Except as disclosed on Disclosure Schedule (3.10) all
-------------- --------------------------
tax returns, reports and statements required by any Governmental Authority to be
filed by Borrower or any other Credit Party have, as of the Closing Date, been
filed and will, until the Termination Date, be filed with the appropriate
Governmental Authority and no tax Lien has been filed against any Credit Party
or any Credit Party's property. Proper and accurate amounts have been and will
be withheld by Borrower and each other Credit Party from their respective
employees for all periods in complete compliance with all Requirements of Law
and such withholdings have and will be timely paid to the appropriate
Governmental Authorities. Disclosure Schedule (3.10) sets forth as of the
--------------------------
Closing Date those taxable years for which any Credit Party's tax returns are
currently being audited by the IRS or any other applicable Governmental
Authority and any assessments or threatened assessments in connection with such
audit, or otherwise currently outstanding. Except as described on Disclosure
Schedule (3.10), none of the Credit Parties and their respective predecessors
are liable for any Charges: (a) under any agreement (including any tax sharing
agreements or agreement extending the period of assessment of any Charges) or
(b) to each Credit Party's knowledge, as a transferee. As of the Closing Date,
no Credit Party has agreed or been requested to make any adjustment under IRC
Section 481(a), by reason of a change in accounting method or otherwise, which
could reasonably be expected to have a Material Adverse Effect
9
<PAGE>
3.11 Payment of Obligations. Each Credit Party will pay, discharge or
----------------------
otherwise satisfy at or before maturity or before they become delinquent, as the
case may be, all of its Charges and other obligations of whatever nature, except
where the amount or validity thereof is currently being contested in good faith
by appropriate proceedings and reserves in conformity with GAAP with respect
thereto have been provided on the books of such Credit Party and none of the
Collateral is or could reasonably be expected to become subject to any Lien or
forfeiture or loss as a result of such contest.
3.12 ERISA. No ERISA Event has occurred or is reasonably expected to occur
-----
that, when taken together with all other existing ERISA Events, could reasonably
be expected to result in a liability of any Credit Party of more than the
Minimum Actionable Amount. The present value of all accumulated benefit
obligations of the Credit Parties under each Plan (based on the assumptions used
for purposes of Statement of Financial Accounting Standards No. 87) did not, as
of the date of the most recent Financial Statements reflecting such amounts,
exceed the fair market value of the assets of such Plan by more than the Minimum
Actionable Amount, and the present value of all accumulated benefit obligations
of all underfunded Plans (based on the assumptions used for purposes of
Statement of Financial Account Standards No. 87) did not, as of the date of the
most recent Financial Statements reflecting such amounts, exceed the fair market
value of the assets of such underfunded Plans by more than the Minimum
Actionable Amount. No Credit Party or ERISA Affiliate has incurred or reasonably
expects to incur any Withdrawal Liability in excess of the Minimum Actionable
Amount.
3.13 Litigation. No Litigation is pending or, to the knowledge of any
----------
Credit Party, threatened by or against any Credit Party or against any Credit
Party's properties or revenues (a) with respect to any of the Loan Documents or
any of the transactions contemplated hereby or thereby, or (b) which could
reasonably be expected to have a Material Adverse Effect. Except as set forth on
Disclosure Schedule (3.13), as of the Closing Date there is no Litigation
- --------------------------
pending or, to the knowledge of any Credit Parry, threatened against any Credit
Party which seeks damages in excess of the Minimum Actionable Amount or
injunctive relief or alleges criminal misconduct of any Credit Party. Each
Credit Party shall notify Lender promptly upon learning of the existence,
threatened or commencement of any Litigation against any Credit Party, any ERISA
Affiliate or any Plan which seeks damages in excess of the Minimum Actionable
Amount or any allegation of criminal misconduct against any Credit Party.
3.14 Intellectual Property. As of the Closing Date, all material
---------------------
Intellectual Property owned or used by any Corporate Credit Party is listed,
together with application or registration numbers, where applicable, in
Disclosure Schedule (3.14). Each Corporate Credit Party owns, or is licensed to
- --------------------------
use, all Intellectual Property necessary to conduct its business as currently
conducted except for such Intellectual Property the failure of which to own or
license could not reasonably be expected to have a Material Adverse Effect. Each
Corporate Credit Party will maintain the patenting and registration of all
Intellectual Property with the United States Patent and Trademark Office, the
United States Copyright Office, or other appropriate Governmental Authority and
each Corporate Credit Party will promptly patent or register, as the case may
be, all new Intellectual Property and notify Lender in writing five (5) Business
Days prior to filing any such new patent or registration.
10
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3.15 Full Disclosure. No information contained in any Loan Document, the
---------------
Financial Statements or any written statement furnished by or on behalf of any
Credit Party under any Loan Document, or to induce Lender to execute the Loan
Documents, contains any untrue statement of a material fact or omits to state a
material fact necessary to make the statements contained herein or therein not
misleading in light of the circumstances under which they were made.
3.16 Hazardous Materials. Except as set forth on Disclosure Schedule
------------------- -------------------
(3.16), as of the Closing Date, (a) each real property location owned, leased or
- ------
occupied by each Corporate Credit Party (the "Real Property") is, to the
knowledge of each Credit Party, maintained free of contamination from any
Hazardous Material, (b) to the knowledge of each Credit Party, no Corporate
Credit Party is subject to any Environmental Liabilities or potential
Environmental Liabilities, in excess of the Minimum Actionable Amount in the
aggregate, (c) no notice has been received by any Corporate Credit Party
identifying it as a "potentially responsible party" or requesting information
under CERCLA or analogous state statutes, and to the knowledge of any Credit
Party, there are no facts, circumstances or conditions that may result in any
Corporate Credit Party being identified as a "potentially responsible party"
under CERCLA or analogous state statutes; and (d) each Corporate Credit Party
has provided to Lender copies of all existing environmental reports, reviews and
audits and all written information pertaining to actual or potential
Environmental Liabilities, in each case relating to any Corporate Credit Party.
Each Corporate Credit Party: (i) shall comply in all material respects with all
applicable Environmental Laws and Environmental Permits; (ii) shall notify
Lender in writing within seven days if and when it becomes aware of any Release,
on, at, in, under, above, to, from or about any of its Real Property; and (iii)
shall promptly forward to Lender a copy of any order, notice, permit,
application, or any communication or report received by it or any other Credit
Party in 'connection with any such Release.
3.17 Insurance. As of the Closing Date, Disclosure Schedule (3.17) lists
--------- --------------------------
all insurance of any nature maintained for current occurrences by Borrowers and
each other Corporate Credit Party, as well as a summary of the terms of such
insurance. Each Corporate Credit Party shall deliver to Lender certified copies
and endorsements to all of its and those of its Subsidiaries (a) "All Risk" and
business interruption insurance policies naming Lender loss payee, and (b)
general liability and other liability policies naming Lender as an additional
insured. All policies of insurance on real and personal property will contain an
endorsement, in form and substance acceptable to Lender, showing loss payable to
Lender (Form 438 BFU or equivalent) and extra expense and business interruption
endorsements. Such endorsement, or an independent instrument furnished to
Lender, will provide that the insurance companies will give Lender at least 30
days prior written notice before any such policy or policies of insurance shall
be altered or canceled and that no act or default of any Borrower or any other
Person shall affect the right of Lender to recover under such policy or policies
of insurance in case of loss or damage. Each Corporate Credit Party shall direct
all present and future insurers under its "All Risk" policies of insurance to
pay all proceeds payable thereunder directly to Lender. If any insurance
proceeds are paid by check, draft or other instrument payable to any Credit
Party and Lender jointly, Lender may endorse such Credit Party's name thereon
and do such other things as Lender may deem advisable to reduce the same to
cash. Lender reserves the right at any time, upon review of each Credit Party's
risk profile, to require additional forms and limits of insurance. Each
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Corporate Credit Party shall, on each anniversary of the Closing Date and from
time to time at Lender's request, deliver to Lender a report by a reputable
insurance broker, satisfactory to Lender, with respect to such Person's
insurance policies.
3.18 Deposit and Loan Disbursement Accounts. Attachments I and II to
--------------------------------------
Schedule D lists all banks and other financial institutions at which any
- ----------
Borrower or any other Corporate Credit Party maintains deposits and/or other
accounts, including the Loan Disbursement Accounts, and such Attachment
correctly identifies the name, address and telephone number of each such
depository, the name in which the account is held, a description of the purpose
of the account, and the complete account number.
3.19 Inventory. As of the date of each Borrowing Base Certificate
---------
delivered to Lender, all Inventory listed thereon as Eligible Inventory shall be
Eligible Inventory. Each Borrower shall notify Lender promptly of any event or
circumstance which to such Borrower's knowledge would cause Lender to consider
any then existing Inventory as no longer constituting Eligible Inventory.
3.20 Conduct of Business: Maintenance of Existence. Each Corporate Credit
---------------------------------------------
Party (a) shall conduct its business substantially as now conducted or as
otherwise permitted hereunder and preserve all of its rights, privileges and
franchises necessary and desirable in connection therewith, and (b) shall at all
times maintain, preserve and protect all of the Collateral and such Credit
Party's other property, used or useful in the conduct of its business and keep
the same in good repair, working order and condition (taking into consideration
ordinary wear and tear) and from time to time make, or cause to be made, all
necessary or appropriate repairs, replacements and improvements thereto
consistent with industry practices.
3.21 Further Assurances. At any time and from time to time, upon the
------------------
written request of Lender and at the sole expense of Borrowers, Borrowers and
each other Credit Party shall promptly and duly execute and deliver any and all
such further instruments and documents and take such further action as Lender
may reasonably deem desirable (a) to obtain the full benefits of this Agreement
and the other Loan Documents, (b)to protect, preserve and maintain Lender's
rights in the Collateral, or any of it, and under this Agreement, or (c) to
enable Lender to exercise all or any of the rights and powers herein granted.
3.22 Year 2000 Covenants. On or before December 31, 1999, each Corporate
-------------------
Credit Party shall eliminate all Year 2000 Problems, except where the failure to
correct the same could not reasonably be expected to have a Material Adverse
Effect, individually or in the aggregate.
4. Financial Matters; Reports
4.1 Reports and Notices. Each Borrower represents, agrees and promises
-------------------
that from and after the Closing Date until the Termination Date, each Borrower
shall deliver to Lender:
(a) no later than the second Business Day of each week, a summary of the
perpetual inventory as of the end of the previous week, accompanied by
supporting detail and documentation as Lender may request;
12
<PAGE>
(b) within 20 days following the end of each Fiscal Month, an inventory,
perpetual or physical (as requested by Lender), and a reconciliation of the
inventory, perpetual or physical (as the case may be), to such Borrower's
general ledger and from the general ledger to the Financial Statements for such
Fiscal Month, accompanied by supporting detail and documentation as Lender may
request;
(c) as frequently as Lender may request and in any event no later than the
end of the second Business Day of each week, a Borrowing Base Certificate in the
form of Exhibit C as of the end of the previous week, detailing ineligible
---------
Inventory for adjustment to the Borrowing Base, certified as true and correct by
the Chief Financial Officer of such Borrower or such other officer as is
acceptable to Lender;
(d) within 20 days following the end of each Fiscal Month, an Accounts
Payable Analysis in the Form of Exhibit D (together with an accounts payable
---------
aging), certified as true and correct by the Chief Financial Officer of such
Borrower or such other officer as is acceptable to Lender;
(e) within 30 days following the end of each Fiscal Month, the Financial
Statements for such Fiscal Month, and accompanied by a certification in the form
of Exhibit J by the Chief Executive Officer or Chief Financial Officer of such
---------
Borrower that such Financial Statements are complete and correct, that there was
no Default (or specifying those Defaults of which he or she was aware), and
showing in reasonable detail the calculations used in determining compliance
with the financial covenants hereunder;
(f) within 45 days following the end of each Fiscal Quarter, the Financial
Statements for such Fiscal Quarter, and accompanied by a certification in the
form of Exhibit J by the Chief Executive Officer or Chief Financial Officer of
---------
such Borrower that such Financial Statements are complete and correct, that
there was no Default (or specifying those Defaults of which he or she was
aware), and showing in reasonable detail the calculations used in determining
compliance with the financial covenants hereunder, and providing comparisons to
budget and actual results for the corresponding period during the prior Fiscal
Year, both on a quarterly and year-to-date basis.
(g) within 90 days following the close of each Fiscal Year, the Financial
Statements for such Fiscal Year certified without qualification by an
independent certified accounting firm acceptable to Lender, which shall provide
comparisons to the prior Fiscal Year, and shall be accompanied by (i) a
statement in reasonable detail showing the calculations used in determining
compliance with the financial covenants hereunder, (ii) a report from such
Borrower's accountants to the effect that in connection with their audit
examination nothing has come to their attention to cause them to believe that a
Default has occurred or specifying those Defaults of which they are aware, and
(iii) any management letter that may be issued;
(h) not less than 30 days prior to the close of each Fiscal Year,
beginning with the Fiscal Year ending December 31, 2000, the Projections, which
will be prepared by such Borrower in good faith, with care and diligence, and
using assumptions which are reasonable
13
<PAGE>
under the circumstances at the time such Projections are delivered to Lender and
disclosed therein when delivered; and
(i) all the reports and other information set forth on Exhibit B in the
---------
time frames set forth therein.
4.2 Financial Covenants. Each Borrower shall not breach any of the
-------------------
financial covenants set forth in Schedule G.
----------
4.3 Other Reports and Information. Each Borrower shall advise Lender
-----------------------------
promptly, in reasonable detail, of: (a) any Lien, other than Permitted
Encumbrances, attaching to or asserted against any of the Collateral or any
occurrence causing a material loss or decline in value of any Collateral and the
estimated (or actual, if available) amount of such loss or decline; (b) any
material change in the composition of the Collateral; and (c) the occurrence of
any Default or other event which has had or could reasonably be expected to have
a Material Adverse Effect. Each Borrower shall, upon request of Lender, furnish
to Lender such other reports and information in connection with the affairs,
business, financial condition, operations, prospects or management of such
Borrower or any other Credit Party or the Collateral as Lender may request, all
in reasonable detail.
5. Negative Covenants
Each Borrower and each Credit Party executing this Agreement covenants and
agrees (for itself and each other Credit Party) that, without Lender's prior
written consent, from the Closing Date until the Termination Date, neither any
Borrower nor any other Corporate Credit Party shall, directly or indirectly. by
operation of law or otherwise:
(a) merge with, consolidate with, acquire all or substantially all of the
assets or capital stock of, or otherwise combine with or make any investment in
or, except as provided in clause 5(c) below, loan or advance to, any Person or
form any Subsidiary; provided, however, the foregoing shall not prohibit the
-------- -------
acquisition (a "Store Acquisition") by Second Borrower of the assets of a retail
store in the same business as Second Borrower if, and only if, each of the
following conditions are first satisfied: (i) the total purchase price payable
for the assets being acquired in such Store Acquisition is no more than
$125,000, (ii) there is no more than one (1) Store Acquisition closed in any
Fiscal Quarter, (iii) immediately before and after giving effect to the closing
of such Store Acquisition, Net Borrowing Availability shall exceed $250,000 and
no Default or Event of Default shall exist, (iv) Borrowers and each Credit Party
shall have given Lender not less than thirty (30) days prior written notice of
the closing of such Store Acquisition and the material terms thereof, including
the location of the Collateral and other assets being acquired and the purchase
price payable therefor, and shall have taken all actions deemed necessary or
appropriate by Lender to continuously protect and perfect Lender's Liens upon
the Collateral;
(b) cancel any debt owing to it or create, incur. assume or permit to
exist any Indebtedness, except: (i) the Obligations, (ii) Indebtedness existing
as of the Closing Date set forth on Disclosure Schedule 5(b), (iii) deferred
taxes, (iv) by endorsement of instruments or
14
<PAGE>
items of payment for deposit to the general account of such Credit Party, (v)
for Guaranteed Indebtedness incurred for the benefit of Borrower if the primary
obligation is permitted by this Agreement; and (vi) additional Indebtedness
(including Purchase Money Indebtedness) incurred after the Closing Date in an
aggregate outstanding amount for all such Corporate Credit Parties combined not
exceeding $50,000;
(c) enter into any lending, borrowing or other commercial transaction with
any of its employees, directors, Affiliates or any other Credit Party (including
upstreaming and downstreaming of cash and intercompany advances and payments by
a Credit Party on behalf of another Credit Party which are not otherwise
permitted hereunder) other than loans or advances to employees in the ordinary
course of business in an aggregate outstanding amount not exceeding $50,000;
(d) make any changes in any of its business objectives, purposes, or
operations which could reasonably be expected to adversely affect repayment of
the Obligations or could reasonably be expected to have a Material Adverse
Effect or engage in any business other than that presently engaged in or
proposed to be engaged in the Projections delivered to Lender on the Closing
Date or amend its charter or by-laws or other organizational documents;
(e) create or permit any Lien on any of its properties or assets, except
for Permitted Encumbrances;
(f) sell, transfer, issue, convey, assign or otherwise dispose of any of
its assets or properties, including its Accounts or any shares of its Stock or
engage in any sale-leaseback, synthetic lease or similar transaction; provided,
--------
however, the foregoing shall not prohibit: (i) the sale of Inventory or obsolete
- -------
or unnecessary Equipment in the ordinary course of its business); or (ii) a sale
of the assets comprising a retail store (a "Store Sale") by Second Borrower if,
and only if, each of the following conditions are first satisfied: (1) the total
purchase price payable for the assets being sold in such Store Sale is payable
in cash at the closing and is in an amount not less than the amount of the
Borrowing Base attributable to the Inventory being sold in such Store Sale, (2)
there is no more than three (3) Store Sales closed in any Fiscal Quarter, (3)
Borrowers and each Credit Party shall have given Lender not less than thirty
(30) days prior written notice of the closing of such Store Sale and the
material terms thereof, including the description of the Collateral and other
assets being sold and the purchase price payable therefor, (4) immediately
before and after giving effect to the closing of such Store Acquisition, no
Default or Event of Default shall exist, and (5) all of the proceeds of such
Store Sale are paid to Lender for application to the Obligations;
(g) change its name, chief executive office, corporate offices, warehouses
or other Collateral locations, or location of its records concerning the
Collateral, or acquire, lease or use any real estate after the Closing Date
without such Person, in each instance, giving thirty (30) days prior written
notice thereof to Lender and taking all actions deemed necessary or appropriate
by Lender to continuously protect and perfect Lender's Liens upon the
Collateral;
15
<PAGE>
(h) establish any depository or other bank account of any kind with any
financial institution (other than the accounts set forth on Attachment 1 to
Schedule D) without Lender's prior written consent; or
(i) make or permit any Restricted Payment.
6. Security Interest
6.1 Grant of Security Interest. (a) As collateral security for the prompt
--------------------------
and complete payment and performance of the Obligations, each of the Borrowers
and each other Credit Party executing this Agreement hereby grants to the Lender
a security interest in and Lien upon all of its property and assets, whether
real or personal, tangible or intangible, and whether now owned or hereafter
acquired, or in which it now has or at any time in the future may acquire any
right, title, or interest, including all of the following property in which it
now has or at any time in the future may acquire any right, title or interest:
all Accounts; all bank and deposit accounts and all funds on deposit therein;
all cash and cash equivalents; all commodity contracts; all investments and
Investment Property; all Inventory and Equipment; all Goods; all Chattel Paper,
Documents and Instruments; all Books and Records; all General Intangibles
(including all Intellectual Property, Stock, contract rights, and chooses in
action); and to the extent not otherwise included, all Proceeds and products of
all and any of the foregoing and all collateral security and guarantees given by
any Person with respect to any of the foregoing, but excluding in all events
Hazardous Waste (all of the foregoing, together with any other collateral
pledged to the Lender pursuant to any other Loan Document, collectively, the
"Collateral").
(b) Each Borrower, Lender and each other Credit Party executing this
Agreement agree that this Agreement creates, and is intended to create, valid
and continuing Liens upon the Collateral in favor of Lender. Each Borrower and
each other Credit Party executing this Agreement represents, warrants and
promises to Lender that: (i) each Borrower and each other Credit Party granting
a Lien in Collateral is the sole owner of each item of the Collateral upon which
it purports to grant a Lien pursuant to the Loan Documents, and has good and
marketable title thereto free and clear of any and all Liens or claims of
others, other than Permitted Encumbrances; (ii) the security interests granted
pursuant to this Agreement, upon completion of the filings and other actions
listed on Disclosure Schedule 6.1 (which, in the case of all filings and other
-----------------------
documents referred to in said Schedule, have been delivered to the Lender in
duly executed form) will constitute valid perfected security interests in all of
the Collateral in favor of the Lender as security for the prompt and complete
payment and performance of the Obligations, enforceable in accordance with the
terms hereof against any and all creditors of and purchasers from any Credit
Party (other than purchasers of Inventory in the ordinary course of business)
and such security interests are prior to all other Liens on the Collateral in
existence on the date hereof except for Permitted Encumbrances which have
priority by operation of law; and (iii) no effective security agreement,
financing statement, equivalent security or Lien instrument or continuation
statement covering all or any part of the Collateral is or will be on file or of
record in any public office, except those relating to Permitted Encumbrances.
Each Borrower and each other Credit Party executing this Agreement promise to
defend the right, title and interest of Lender in and to the Collateral against
the claims and demands of all Persons whomsoever, and each shall take such
actions, including (x) the prompt delivery of all original Instruments, Chattel
16
<PAGE>
Paper and certificated Stock owned by such Borrower and each other Credit Party
granting a Lien on Collateral to Lender, (y) notification of Lender's interest
in Collateral at Lender's request, and (z) the institution of litigation against
third parties as shall be prudent in order to protect and preserve each Credit
Party's and Lender's respective and several interests in the Collateral. Each
Borrower (and any other Credit Party granting a Lien in Collateral) shall mark
its Books and Records pertaining to the Collateral to evidence the Loan
Documents and the Liens granted under the Loan Documents. All Chattel Paper
shall be marked with the following legend: "This writing and the obligations
evidenced or secured hereby are subject to the security interest of General
Electric Capital Corporation."
6.2 Lender's Rights. (a) Lender may. (i) at any time in Lender's own name
---------------
or in the name of any Borrower, communicate with Account Debtors, parties to
Contracts, and obligors in respect of Instruments, Chattel Paper or other
Collateral to verify to Lender's satisfaction, the existence, amount and terms
of any such Accounts, Contracts, Instruments or Chattel Paper or other
Collateral, and (ii) at any time during the existence of an Event of Default,
and without prior notice to any Borrower or any other Credit Party, notify
Account Debtors, parties to Contracts, and obligors in respect of Chattel Paper,
Instruments, or other Collateral that the Collateral has been assigned to Lender
and that payments shall be made directly to Lender. Upon the request of Lender
made at any time during the existence of an Event of Default, each Borrower
shall so notify such Account Debtors, parties to Contracts, and obligors in
respect of Instruments, Chattel Paper or other Collateral. Each Borrower hereby
constitutes Lender or Lender's designee as such Borrower's attorney with power
to endorse such Borrower's name upon any notes, acceptance drafts, money orders
or other evidences of payment or Collateral.
(b) It is expressly agreed by each Borrower that, notwithstanding anything
herein to the contrary, each Borrower shall remain liable under each Contract,
Instrument and License to observe and perform all the conditions and obligations
to be observed and performed by it thereunder, and Lender shall have no
obligation or liability whatsoever to any Person under any Contract, Instrument
or License (between any Borrower or any other Credit Party and any Person other
than Lender) by reason of or arising out of the execution, delivery or
performance of this Agreement, and Lender shall not be required or obligated in
any manner (i) to perform or fulfill any of the obligations of any Borrower,
(ii) to make any payment or inquiry, or (iii) to take any action of any kind to
collect, compromise or enforce any performance or the payment of any amounts
which may have been assigned to it or to which it may be entitled at any time or
times under or pursuant to any Contract, Instrument or License.
(c) Each Borrower and each other Credit Party shall, with respect to each
owned, leased, or controlled property or facility, during normal business hours
and upon reasonable advance notice (unless a Default shall have occurred and be
continuing, in which event no notice shall be required and Lender shall have
access at any and all times): (i) provide access to such facility or property to
Lender and any of its officers, employees and agents, as frequently as Lender
determines to be appropriate; (ii) permit Lender and any of its officers,
employees and agents to inspect, audit and make extracts and copies from all of
such Borrower's and such Credit Party's Books and Records (or, take the
originals of that portion of such Books and Records which are reasonably
necessary for Lender's enforcement or collection of any of the Collateral); and
(iii) permit Lender to inspect, review, evaluate and make physical verifications
17
<PAGE>
and appraisals of the Inventory and other Collateral in any manner and through
any medium that Lender considers advisable, and each Borrower and such Credit
Party agree to render to Lender, at such Borrower's and such Credit Party's cost
and expense, such clerical and other assistance as may be reasonably requested
with regard thereto.
(d) After the occurrence and during the continuance of a Default, each
Borrower at its own expense, shall cause the certified public accountant then
engaged by such Borrower to prepare and deliver to Lender at any time and from
time to time, promptly upon Lender's request, the following reports: (i) a
reconciliation of all Accounts; (ii) an aging of all Accounts; (iii) trial
balances; and (iv) test verifications of such Accounts as Lender may request.
Each Borrower, at its own expense, shall cause its certified independent public
accountants to deliver to Lender the results of any physical verifications of
all or any portion of the Inventory made or observed by such accountants when
and if such verification is conducted. Lender shall be permitted to observe and
consult with each Borrower's accountants in the performance of these tasks.
6.3 Lender's Appointment as Attorney-in-fact. On the Closing Date, each
----------------------------------------
Borrower and each other Credit Party executing this Agreement shall execute and
deliver a Power of Attorney in the form attached as Exhibit I. The power of
---------
attorney granted pursuant to the Power of Attorney and all powers granted under
any Loan Document are powers coupled with an interest and shall be irrevocable
until the Termination Date. The powers conferred on Lender under the Power of
Attorney are solely to protect Lender's interests in the Collateral and shall
not impose any duty upon it to exercise any such powers. Lender agrees and
promises that (a) it shall not exercise any power or authority granted under the
Power of Attorney unless an Event of Default has occurred and is continuing, (b)
Lender shall only exercise the powers granted under the Power of Attorney in
respect of Collateral, provided, except as otherwise required by applicable law,
Lender shall not have any duty as to any Collateral, and Lender shall be
accountable only for amounts that it actually receives as a result of the
exercise of such powers. Each Borrower and each other Credit Party executing
this Agreement also hereby authorizes Lender to file any financing or
continuation statement without the signature of such Borrower or such Credit
Party to the extent permitted by applicable law.
6.4 Grant of License to Use Intellectual Property Collateral. Each
--------------------------------------------------------
Borrower and each other Credit Party executing this Agreement hereby grants to
Lender an irrevocable, non-exclusive license (exercisable upon the occurrence
and during the continuance of an Event of Default without payment of royalty or
other compensation to any Borrower or such Credit Party) to use, transfer,
license or sublicense any Intellectual Property now owned, licensed to, or
hereafter acquired by such Borrower or such Credit Party, and wherever the same
may be located, and including in such license access to all media in which any
of the licensed items may be recorded or stored and to all computer and
automatic machinery software and programs used for the compilation or printout
thereof, and represents, promises and agrees that any such license or sublicense
is not and will not be in conflict with the contractual or commercial rights of
any third Person; provided, that such license will terminate on the Termination
Date.
18
<PAGE>
7. Events of Default: Rights and Remedies
7.1 Events of Default. The occurrence of any one or more of the following
-----------------
events (regardless of the reason therefor) shall constitute an "Event of
Default" hereunder which shall be deemed to be continuing until waived in
writing by Lender in accordance with Section 10.3:
(a) any Borrower shall fail to make any payment in respect of any
Obligations when due and payable or declared due and payable; or
(b) Borrower or any other Credit Party shall fail or neglect to perform,
keep or observe any of the covenants, promises, agreements, requirements,
conditions or other terms or provisions contained in Section 1, Sections 3.1,
3.2, 3.17, 3.18, 3.19, 3.20, 4.2 or Section 5 of this Agreement; or (ii)
Borrower or any other Credit Party shall fail or neglect to perform, keep or
observe any of the other covenants, promises, agreements, requirements,
conditions or other terms or provisions contained in this Agreement (other than
those set forth in the Sections referred to in clause (i) immediately above) or
any of the other Loan Documents, regardless of whether such breach involves a
covenant, promise, agreement, condition, requirement, term or provision with
respect to a Credit Party that has not signed this Agreement, and such breach is
not remediable or, if remediable, continues unremedied for a period of five (5)
Business Days after the earlier to occur of (x) the date on which such breach is
known or reasonably should have become known to any officer of the Borrower or
such Credit Party and (y) the date on which Lender shall have notified the
Borrower or such other Credit Party of such breach; or
(c) an event of default shall occur under any Contractual Obligation of any
Borrower or any other Credit Party (other than this Agreement and the other Loan
Documents), and such event of default (i) involves the failure to make any
payment (whether or not such payment is blocked pursuant to the terms of an
intercreditor agreement or otherwise), whether of principal, interest or
otherwise, and whether due by scheduled maturity, required prepayment,
acceleration, demand or otherwise, in respect of any Indebtedness (other than
the Obligations) of such Person in an aggregate amount exceeding the Minimum
Actionable Amount, or (ii) causes (or permits any holder of such Indebtedness or
a trustee to cause) such Indebtedness, or a portion thereof, in an aggregate
amount exceeding the Minimum Actionable Amount to become due prior to its stated
maturity or prior to its regularly scheduled dates of payment; or
(d) any representation or warranty in this Agreement or any other Loan
Document, or in any written statement pursuant hereto or thereto, or in any
report, financial statement or certificate made or delivered to Lender by any
Borrower or any other Credit Party shall be untrue or incorrect as of the date
when made or deemed made, regardless of whether such breach involves a
representation or warranty with respect to a Credit Party that has not signed
this Agreement; or
(e) there shall be commenced against any Borrower or any other Credit Party
any Litigation seeking issuance of a warrant of attachment, execution, distraint
or similar process against all or any substantial part of its assets which
results in the entry of an order for any such relief which remains unstayed or
undismissed for thirty (30) consecutive days; or any Borrower or any other
Credit Party shall have concealed, removed or permitted to be concealed or
19
<PAGE>
removed, any part of its property with intent to hinder, delay or defraud its
creditors or any of them or made or suffered a transfer of any of its property
or the incurring of an obligation which may be fraudulent under any bankruptcy,
fraudulent transfer or other similar law; or
(f) a case or proceeding shall have been commenced involuntarily against
any Borrower or any other Credit Party in a court having competent jurisdiction
seeking a decree or order: (i) under the United States Bankruptcy Code or any
other applicable Federal, state or foreign bankruptcy or other similar law, and
seeking either (x) the appointment of a custodian, receiver, liquidator,
assignee, trustee or sequestrator (or similar official) for such Person or of
any substantial part of its properties, or (y) the reorganization or winding up
or liquidation of the affairs of any such Person, and such case or proceeding
shall remain undismissed or unstayed for sixty (60) consecutive days or such
court shall enter a decree or order granting the relief sought in such case or
proceeding; or (ii) invalidating or denying any Person's right, power, or
competence to enter into or perform any of its obligations under any Loan
Document or invalidating or denying the validity or enforceability of this
Agreement or any other Loan Document or any action taken hereunder or
thereunder; or
(g) any Borrower or any other Credit Party shall (i) commence any case,
proceeding or other action under any existing or future law of any jurisdiction,
domestic or foreign, relating to bankruptcy, insolvency, reorganization,
conservatorship or relief of debtors, seeking to have an order for relief
entered with respect to it or seeking appointment of a custodian, receiver,
liquidator, assignee, trustee or sequestrator (or similar official) for it or
any substantial part of its properties, (ii) make a general assignment for the
benefit of creditors, (iii) consent to or rake any action in furtherance of, or,
indicating its consent to, approval of, or acquiescence in, any of the acts set
forth in paragraphs (e) or (f) of this Section 7.1 or clauses (i) and (ii) of
this paragraph (g), or (iv) shall admit in writing its inability to, or shall be
generally unable to, pay its debts as such debts become due; or
(h) a final judgment or judgments for the payment of money in excess of
the Minimum Actionable Amount in the aggregate shall be rendered against any
Borrower or any other Credit Party, unless the same shall be (i) fully covered
by insurance and the issuer(s) of the applicable policies shall have
acknowledged full coverage in writing within fifteen (15) days of judgment, or
(ii) vacated, stayed, bonded, paid or discharged within a period of fifteen (15)
days from the date of such judgment; or
(i) any other event shall have occurred which has had or could reasonably
be expected to have a Material Adverse Effect and Lender shall have given any
Borrower notice thereof; or
(j) any provision of any Loan Document shall for any reason cease to be
valid, binding and enforceable in accordance with its terms, or any Lien
granted, or intended by the Loan Documents to be granted, to Lender shall cease
to be a valid and perfected Lien having the first priority (or a lesser priority
if expressly permitted in the Loan Documents) in any of the Collateral (or any
Credit Party shall so assert any of the foregoing); or
(k) a Change of Control shall have occurred with respect to any Corporate
Credit Party; or
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(l) an ERISA Event shall have occurred that, in the opinion of the Lender,
when taken together with all other ERISA Events that have occurred and are then
continuing, could reasonably be expected to result in liability of any Credit
Party in an aggregate amount exceeding the Minimum Actionable Amount.
7.2 Remedies. (a) If any Default shall have occurred and be continuing,
--------
then Lender may terminate or suspend its obligation to make further Revolving
Credit Advances and to incur additional Letter of Credit Obligations. In
addition, if any Event of Default shall have occurred and be continuing, Lender
may, without notice, take any one or more of the following actions: (i) declare
all or any portion of the Obligations to be forthwith due and payable, including
contingent liabilities with respect to Letter of Credit Obligations, whereupon
such Obligations shall become and be due and payable; (ii) require that all
Letter of Credit Obligations be fully cash collateralized pursuant to Schedule C
----------
or (iii) exercise any rights and remedies provided to Lender under the Loan
Documents or at law or equity, including all remedies provided under the Code:
provided, that upon the occurrence of any Event of Default specified in Sections
- --------
7.1 (e), (f) or (g), the Obligations shall become immediately due and payable
(and any obligation of Lender to make further Loans, if not previously
terminated, shall immediately be terminated) without declaration, notice or
demand by Lender.
(b) Without limiting the generality of the foregoing, each Borrower and
each other Credit Party executing this Agreement expressly agrees that upon the
occurrence of any Event of Default, Lender may collect, receive, assemble,
process, appropriate and realize upon the Collateral, or any part thereof, and
may forthwith sell, lease, assign, give an option or options to purchase or
otherwise dispose of and deliver said Collateral (or contract to do so), or any
part thereof, in one or more parcels at public or private sale or sales, at any
exchange at such prices as it may deem best, for cash or on credit or for future
delivery without assumption of any credit risk. Lender shall have the right upon
any such public sale or sales and, to the extent permitted by law, upon any such
private sale or sales, to purchase for the benefit of Lender the whole or any
part of said Collateral so sold, free of any right or equity of redemption,
which equity of redemption each Borrower and each other Credit Party executing
this Agreement hereby releases. Such sales may be adjourned, or continued from
time to time with or without notice. Lender shall have the right to conduct such
sales on any Credit Party's premises or elsewhere and shall have the right to
use any Credit Party's premises without rent or other charge for such sales or
other action with respect to the Collateral for such time or times as Lender
deems necessary or advisable.
(c) Each Borrower and each other Credit Party executing this Agreement
further agrees, upon the occurrence and during the continuance of an Event of
Default and at Lender's request, to assemble the Collateral and make it
available to Lender at places which Lender shall reasonably select, whether at
its premises or elsewhere. Until Lender is able to effect a sale, lease, or
other disposition of the Collateral, Lender shall have the right to complete,
assemble, use or operate the Collateral or any part thereof, to the extent that
Lender deems appropriate, for the purpose of preserving such Collateral or its
value or for any other purpose. Lender shall have no obligation to any Credit
Party to maintain or preserve the rights of such Credit Party as against third
parties with respect to any Collateral while such Collateral is in the
possession of
21
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Lender. Lender may, if it so elects, seek the appointment of a receiver or
keeper to take possession of any Collateral and to enforce any of Lender's
remedies with respect to such appointment without prior notice or hearing. To
the maximum extent permitted by applicable law, each Borrower and each other
Credit Party executing this Agreement waives all claims, damages, and demands
against Lender, its Affiliates, agents, and the officers and employees of any of
them arising out of the repossession, retention or sale of any Collateral except
such as are determined in a final judgment by a court of competent jurisdiction
to have arisen solely out of the gross negligence or willful misconduct of such
Person. Each Borrower and each other Credit Party executing this Agreement
agrees that ten (10) days prior notice by Lender to such Credit Party of the
time and place of any public sale or of the time after which a private sale may
take place is reasonable notification of such matters. Each Borrower and each
other Credit Party shall remain liable for any deficiency if the proceeds of any
sale or disposition of the Collateral are insufficient to pay all amounts to
which Lender is entitled.
(d) Lender's rights and remedies under this Agreement shall be cumulative
and nonexclusive of any other rights and remedies which Lender may have under
any Loan Document or at law or in equity. Recourse to the Collateral shall not
be required. All provisions of this Agreement are intended to be subject to all
applicable mandatory provisions of law that may be controlling and to be
limited, to the extent necessary, so that they do not render this Agreement
invalid or unenforceable, in whole or in part.
7.3 Waivers by Credit Parties. Except as otherwise provided for in this
-------------------------
Agreement and to the fullest extent permitted by applicable law, each Borrower
and each other Credit Party executing this Agreement waives: (a) presentment,
demand and protest, and notice of presentment, dishonor, intent to accelerate,
acceleration, protest, default, nonpayment, maturity, release, compromise.
settlement, extension or renewal of any or all Loan Documents, the Notes or any
other notes, commercial paper, Accounts, Contracts, Documents, Instruments,
Chattel Paper and guaranties at any time held by Lender on which such Credit
Party may in any way be liable, and hereby ratifies and confirms whatever Lender
may do in this regard; (b) all rights to notice and a hearing prior to Lender's
taking possession or control of, or to Lender's replevy, attachment or levy
upon, any Collateral or any bond or security which might be required by any
court prior to allowing Lender to exercise any of its remedies; and (c) the
benefit of all valuation, appraisal and exemption laws. Each Borrower and each
other Credit Party executing this Agreement acknowledges that it has been
advised by counsel of its choices and decisions with respect to this Agreement,
the other Loan Documents and the transactions evidenced hereby and thereby.
7.4 Proceeds. The Proceeds of any sale, disposition or other realization
--------
upon any Collateral shall be applied by Lender upon receipt to the Obligations
in such order as Lender may deem advisable in its sole discretion (including the
cash collateralization of any Letter of Credit Obligations), and after the
indefeasible payment and satisfaction in full in cash of all of the Obligations,
and after the payment by Lender of any other amount required by any provision of
law, including Section 9-504(1)(c) of the Code (but only after Lender has
received what Lender considers reasonable proof of a subordinate party's
security interest), the surplus, if any, shall be paid to Borrowers or their
representatives or to whomsoever may be lawfully entitled to receive the same,
or as a court of competent jurisdiction may direct.
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<PAGE>
8. Successors and Assigns
Each Loan Document shall be binding on and shall inure to the benefit of
each Borrower and each other Credit Party executing such Loan Document, Lender,
and their respective successors and assigns, except as otherwise provided herein
or therein. Neither any Borrower nor any other Credit Party may assign,
transfer, hypothecate, delegate or otherwise convey its rights, benefits,
obligations or duties under any Loan Document without the prior express written
consent of Lender. Any such purported conveyance by such Borrower or such Credit
Party without the prior express written consent of Lender shall be void. There
shall be no third party beneficiaries of any of the terms and provisions of any
of the Loan Documents. Lender reserves the right at any time to create and sell
participations in the Loans and the Loan Documents and to sell, transfer or
assign any or all of its rights in the Loans and under the Loan Documents.
9. Guarantor Waivers by Borrowers
IF AND TO THE EXTENT THAT ANY OBLIGATION OF ANY BORROWER TO LENDER SHALL BE
CONSIDERED AN OBLIGATION OF GUARANTY OR SURETYSHIP, THEN THIE FOLLOWING
PROVISIONS OF THIS SECTION 9 SHALL APPLY WITH RESPECT TO EACH SUCH BORROWER
SOLELY TO THE EXTENT THAT SUCH BORROWER IS DEEMED TO ACT IN THE CAPACITY OF A
GUARANTOR AND SHALL NOT EFFECT A WAIVER OF RIGHTS IN SUCH PERSON'S CAPACITY AS A
BORROWER: -
(A) SUCH BORROWER EXPRESSLY WAIVES THE RIGHT TO REQUIRE LENDER FIRST TO
PURSUE ANY OTHER PERSON, THE COLLATERAL, OR ANY OTHER SECURITY OR GUARANTY THAT
MAY BE HELD FOR THE OBLIGATIONS, OR TO APPLY ANY SUCH SECURITY OR GUARANTY TO
THE OBLIGATIONS BEFORE SEEKING FROM SUCH BORROWER PAYMENT IN FULL OF ITS
LIABILITIES TO LENDER OR PROCEEDING AGAINST SUCH BORROWER FOR SAME.
(B) SUCH BORROWER ACKNOWLEDGES THAT IF LENDER MAY, UNDER APPLICABLE LAW,
PROCEED TO REALIZE ITS BENEFITS UNDER ANY OF THE LOAN DOCUMENTS GIVING LENDER A
UEN UPON ANY COLLATERAL. WHETHER OWNED BY ANY BORROWER OR BY ANY OTHER PERSON,
EITHER BY JUDICIAL FORECLOSURE OR BY NON-JUDICIAL SALE OR ENFORCEMENT, LENDER
MAY, AT ITS SOLE OPTION, DETERMINE WHICH OF ITS REMEDIES OR RIGHTS IT MAY PURSUE
WITHOUT AFFECTING ANY OF ITS RIGHTS AND REMEDIES. IF, IN THE EXERCISE OF ANY OF
ITS RIGHTS AND REMEDIES, LENDER SHALL FORFEIT ANY OF ITS RIGHTS OR REMEDIES,
INCLUDING ITS RIGHT TO ENTER A DEFICIENCY JUDGMENT AGAINST ANY BORROWER OR ANY
OTHER PERSON, WHETHER BECAUSE OF ANY APPLICABLE LAWS PERTAINING TO "ELECTION OF
REMEDIES" OR THE LIKE, SUCH BORROWER HEREBY CONSENTS TO SUCH ACTION BY LENDER
AND WAIVES ANY CLAIM BASED UPON SUCH ACTION, EVEN IF SUCH ACTION BY LENDER SHALL
RESULT IN A FULL OR PARTIAL LOSS OF ANY RIGHTS OF SUBROGATION WHICH SUCH
BORROWER MIGHT OTHERWISE HAVE HAD BUT FOR SUCH ACTION BY LENDER. ANY ELECTION OF
REMEDIES WHICH RESULTS IN
23
<PAGE>
THE DENIAL OR IMPAIRMENT OF THE RIGHT OF LENDER TO SEEK A DEFICIENCY JUDGMENT
AGAINST ANY BORROWER SHALL NOT IMPAIR ANY OTHER BORROWER'S OBLIGATION TO PAY THE
FULL AMOUNT OF THE OBLIGATIONS. IN THE EVENT LENDER SHALL BID AT ANY FORECLOSURE
OR TRUSTEE'S SALE OR AT ANY PRIVATE SALE PERMUTED BY LAW OR THE LOAN DOCUMENTS,
LENDER MAY BID ALL OR LESS THAN THE AMOUNT OF TITLE OBLIGATIONS AND THE AMOUNT
OF SUCH BID NEED NOT BE PAID BY LENDER BUT SHALL BE CREDITED AGAINST THE
OBLIGATIONS. THE AMOUNT OF THE SUCCESSFUL BID AT ANY SUCH SALE, WHIETIJER LENDER
OR ANY OTHER PARTY IS THE SUCCESSFUL BIDDER, SHALL BE CONCLUSIVELY DEEMED TO BE
THE FAIR MARKET VALUE OF THE COLLATERAL AND THE DIFFERENCE BETWEEN SUCH BID
AMOUNT AND THE REMAINING BALANCE OF THE OBLIGATIONS SHALL BE CONCLUSIVELY DEEMED
TO BE THE AMOUNT OF THE OBLIGATIONS GUARANTEED BY SUCH BORROWER, NOTWITHSTANDING
THAT ANY PRESENT OR FUTURE LAW OR COURT DECISION OR RULING MAY HAVE THE EFFECT
OF REDUCING THE AMOUNT OF ANY DEFICIENCY CLAIM TO WHICH LENDER MIGHT OTHERWISE
BE ENTITLED BUT FOR SUCH BIDDING AT ANY SUCH SALE.
(C) SUCH BORROWER AGREES THAT LENDER SHALL BE UNDER NO OBLIGATION TO (I)
MARSHAL ANY ASSETS IN FAVOR OF SUCH BORROWER, (II) PROCEED FIRST AGAINST ANY
OTHER BORROWER OR PERSON OR ANY PROPERTY OF ANY OTHER BORROWER OR PERSON OR
AGAINST ANY COLLATERAL, (III) ENFORCE FIRST ANY OTHER GUARANTY OBLIGATIONS WITH
RESPECT TO, OR SECURITY FOR, THE OBLIGATIONS, OR (IV) PURSUE ANY OTHER REMEDY IN
LENDER'S POWER THAT SUCH BORROWER MAY NOT BE ABLE TO PURSUE ITSELF AND THAT MAY
LIGHTEN SUCH BORROWER'S BURDEN, ANY RIGHT TO WHICH SUCH BORROWER HEREBY
EXPRESSLY WAIVES.
(D) EACH BORROWER ACKNOWLEDGES THAT THE FOREGOING WAIVERS ARE A MATERIAL
INDUCEMENT TO LENDER'S ENTERING INTO THIS AGREEMENT AND THAT LENDER IS RELYING
UPON THE FOREGOING WAIVERS IN ITS FUTURE DEALINGS WITH SUCH BORROWER. EACH
BORROWER WARRANTS AND REPRESENTS THAT IT HAS REVIEWED THE FOREGOING WAIVERS WITH
ITS LEGAL COUNSEL AND HAS KNOWINGLY AND VOLUNTARILY WAIVED ITS JURY TRIAL RIGHTS
FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, THIS
AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT.
10. Miscellaneous
10.1 Complete Agreement: Modification of Agreement. This Agreement and
---------------------------------------------
the other Loan Documents constitute the complete agreement between the parties
with respect to the subject matter hereof and thereof, supersede all prior
agreements, commitments, understandings or inducements (oral or written,
expressed or implied), and no Loan Document may be modified, altered or amended
except by a written agreement signed by Lender, and each other Credit Party a
party to such Loan Document. Each Borrower and each other Credit Party executing
this
24
<PAGE>
Agreement or any other Loan Document shall have all duties and obligations under
this Agreement and such other Loan Document from the date of its execution and
delivery, regardless of whether the initial Loan has been funded at that time.
10.2 Expenses. Borrowers agree to pay or reimburse Lender for all costs and
--------
expenses (including the fees and expenses of all special counsel, advisors,
consultants (including environmental and management consultants) and auditors
retained in connection therewith), incurred in connection with: (a) the
preparation, negotiation, execution, delivery, performance and enforcement of
the Loan Documents and the preservation of any rights thereunder; (b) collection
including deficiency collections; (c) the forwarding to a Borrower or any other
Person on behalf of a Borrower by Lender of the proceeds of any Loan (including
a wire transfer fee of $20 per wire transfer); (d) any amendment, extension,
modification or waiver of, or consent with respect to any Loan Document or
advice in connection with the administration of the Loans or the rights
thereunder; (e) any litigation, contest, dispute, suit, proceeding or action
(whether instituted by or between any combination of Lender, a Borrower or any
other Person or Persons), and an appeal or review thereof, in any way relating
to the Collateral, any Loan Document, or any action taken or any other
agreements to be executed or delivered in connection therewith, whether as a
party' witness or otherwise; and (f) any effort (i) to monitor the Loans, (ii)
to evaluate, observe or assess a Borrower or any other Credit Party or the
affairs of such Person, and (iii) to verify, protect, evaluate, assess,
appraise, collect, sell, liquidate or otherwise dispose of the Collateral.
Borrowers also agree to pay or reimburse Lender for the costs of conducting an
Inventory Appraisal consisting of an onsite visit and evaluation every twelve
(12) months or, during the existence of an Event of Default, at more frequent
intervals as Lender shall determine. For so long as no Event of Default exists,
Borrowers shall have no obligations to reimburse Lender for the costs and
expenses of Inventory Appraisals consisting of desktop evaluations.
10.3 No Waiver. Neither Lender's failure, at any time or times, to require
---------
strict performance by any Borrower or any other Credit Party of any provision of
any Loan Document, nor Lender's failure to exercise, nor any delay in
exercising, any right, power or privilege hereunder, (a) shall waive, affect or
diminish any right of Lender thereafter to demand strict compliance and
performance therewith, or (b) shall operate as a waiver thereof. No single or
partial exercise of any right, power or privilege hereunder shall preclude any
other or future exercise thereof or the exercise of any other right, power or
privilege. Any suspension or waiver of a Default or other provision under the
Loan Documents shall not suspend, waive or affect any other Default under any
Loan Document, whether the same is prior or subsequent thereto and whether of
the same or of a different type, and shall not be construed as a bar to any
right or remedy which Lender would otherwise have had on any future occasion.
None of the undertakings, indemnities, agreements, warranties, covenants and
representations of any Borrower or any other Credit Party to Lender contained in
any Loan Document and no Default by any Borrower or any other Credit Party under
any Loan Document shall be deemed to have been suspended or waived by Lender,
unless such waiver or suspension is by an instrument in writing signed by an
officer or other authorized employee of Lender and directed to such Borrower
specifying such suspension or waiver (and then such waiver shall be effective
only to the extent therein expressly set forth), and Lender shall not, by any
act (other than execution of a formal written waiver), delay, omission or
otherwise, be deemed to have waived any of its rights or remedies hereunder.
25
<PAGE>
10.4 Severability: Section Titles. Wherever possible, each provision of the
----------------------------
Loan Documents shall be interpreted in such manner as to be effective and valid
under applicable law, but if any provision of any Loan Document shall be
prohibited by or invalid under applicable law, such provision shall be
ineffective to the extent of such prohibition or invalidity, without
invalidating the remainder of such provision or the remaining provisions of such
Loan Document. Except as otherwise expressly provided for in the Loan Documents,
no termination or cancellation (regardless of cause or procedure) of any
financing arrangement under the Loan Documents shall in any way affect or impair
the Obligations, duties, covenants, representations and warranties, indemnities,
and liabilities of any Borrower or any other Credit Party or the rights of
Lender relating to any unpaid Obligation (due or not due, liquidated, contingent
or unliquidated), or any transaction or event occurring prior to such
termination, or any transaction or event, the performance of which is not
required until after the Commitment Termination Date, all of which shall not
terminate or expire, but rather shall survive such termination or cancellation
and shall continue in full force and effect until the Termination Date;
provided, that all indemnity obligations of the Credit Parties under the Loan
Documents shall survive the Termination Date. The Section titles contained in
any Loan Document are and shall be without substantive meaning or content of any
kind whatsoever and are not a part of the agreement between the parties hereto.
10.5 Authorized Signature. Until Lender shall be notified in writing by any
--------------------
Borrower or any other Credit Party to the contrary, the signature upon any
document or instrument delivered pursuant hereto and believed by Lender or any
of Lender's officers, agents, or employees to be that of an officer of such
Borrower or such other Credit Party listed in the Secretarial Certificate in the
form of Exhibit H shall bind such Borrower and such other Credit Party and be
---------
deemed to be the act of such Borrower or such other Credit Party affixed
pursuant to and in accordance with resolutions duly adopted by such Borrower's
or such other Credit Party's Board of Directors, and Lender shall be entitled to
assume the authority of each signature and authority of the person whose
signature it is or appears to be unless the person acting in reliance of such
signature shall have actual knowledge of the fact that such signature is false
or the person whose signature or purported signature is presented is without
authority.
10.6 Notices. Except as otherwise provided herein, whenever any notice,
-------
demand, request or other communication shall or may be given to or served upon
any party by any other party, or whenever any party desires to give or serve
upon any other party any communication with respect to this Agreement, each such
notice, demand, request or other communication shall be in writing and shall be
deemed to have been validly served, given or delivered (a) upon the earlier of
actual receipt and three (3) days after deposit in the United States Mail,
registered or certified mail, return receipt requested, with proper postage
prepaid, (b) upon transmission, when sent by telecopy or other similar facsimile
transmission (with such telecopy or facsimile promptly confirmed by delivery of
a copy by personal delivery or United States Mail as otherwise provided in this
Section 10.6), (c) one (1) Business Day after deposit with a reputable overnight
courier with all charges prepaid or (d) when hand-delivered, all of which shall
be addressed to the party to be notified and sent to the address or facsimile
number indicated in Schedule B or to such other address (or facsimile number) as
----------
may be substituted by notice given as herein provided. The giving of any notice
required hereunder may be waived in writing by the
26
<PAGE>
party entitled to receive such notice. Failure or delay in delivering copies of
any notice, demand, request or other communication to any Person (other than any
Borrower or Lender) designated in Schedule B to receive copies shall in no way
----------
adversely affect the effectiveness of such notice, demand, request or other
communication.
10.7 Counterparts. Any Loan Document may be executed in any number of
------------
separate counterparts by one or more of the parties thereto, and all of said
counterparts taken together shall constitute one and the same instrument.
10.8 Time of the Essence. Time is of the essence for performance of the
-------------------
Obligations under the Loan Documents.
10.9 GOVERNING LAW. THE LOAN DOCUMENTS AND THE OBLIGATIONS ARISING UNDER
--------- ---
THE LOAN DOCUMENTS SHALL BE GOVERNED BY, AND CONSTRUED AND ENFORCED IN
ACCORDANCE WITH. THE LAWS OF THE STATE OF NORTH CAROLINA APPLICABLE TO CONTRACTS
MADE AND PERFORMED IN SUCH STATE, WITHOUT REGARD TO THE PRINCIPLES THEREOF
REGARDING CONFLICTS OF LAWS, AND ANY APPLICABLE LAWS OF THE UNITED STATES OF
AMERICA.
10.10 SUBMISSION TO JURISDICTION: WAIVER OF JURY TRIAL. (A) EACH BORROWER
------------------------------------------------
AND EACH OTHER CREDIT PARTY EXECUTING THIS AGREEMENT HEREBY CONSENT AND AGREE
THAT THE STATE OR FEDERAL COURTS LOCATED IN NORTH CAROLINA SHALL HAVE EXCLUSIVE
JURISDICTION TO HEAR AND DETERMINE ANY CLAIMS OR DISPUTES BETWEEN SUCH BORROWER
AND SUCH CREDIT PARTY AND LENDER PERTAINING TO THIS AGREEMENT OR ANY OF THE
OTHER LOAN DOCUMENTS OR TO ANY MATTER ARISING OUT OF OR RELATED TO THIS
AGREEMENT OR ANY OF THE OTHER LOAN DOCUMENTS; PROVIDED, THAT LENDER, SUCH
--------
BORROWER AND SUCH CREDIT PARTY ACKNOWLEDGE THAT ANY APPEALS FROM THOSE COURTS
MAY HAVE TO BE HEARD BY A COURT LOCATED OUTSIDE OF NORTH CAROLINA: AND FURTHER
--- -------
PROVIDED, THAT NOTHING IN THIS AGREEMENT SHALL BE DEEMED OR OPERATE TO PRECLUDE
- --------
LENDER FROM BRINGING SUIT OR TAKING OTHER LEGAL ACTION IN ANY OTHER JURISDICTION
TO COLLECT THE OBLIGATIONS, TO REALIZE ON THE COLLATERAL OR ANY OTHER SECURITY
FOR THE OBLIGATIONS, OR TO ENFORCE A JUDGMENT OR OTHER COURT ORDER IN FAVOR OF
LENDER. SUCH BORROWER AND EACH OTHER CREDIT PARTY EXECUTING THIS AGREEMENT
EXPRESSLY SUBMIT AND CONSENT IN ADVANCE TO SUCH JURISDICTION IN ANY ACTION OR
SUIT COMMENCED IN ANY SUCH COURT, AND SUCH BORROWER AND SUCH CREDIT PARTY HEREBY
WAIVE ANY OBJECTION WHICH IT MAY HAVE BASED UPON LACK OF PERSONAL JURISDICTION,
IMPROPER VENUE OR FORUM NON CONVENIENS. EACH BORROWER AND EACH OTHER CREDIT
----- --- ----------
PARTY EXECUTING THIS AGREEMENT HEREBY WAIVE PERSONAL SERVICE OF THE SUMMONS,
COMPLAINT AND OTHER PROCESS ISSUED IN ANY SUCH ACTION OR SUIT AND AGREE THAT
SERVICE OF SUCH SUMMONS, COMPLAINT AND OTHER PROCESS MAY BE MADE BY REGISTERED
OR CERTIFIED MAIL ADDRESSED TO SUCH
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<PAGE>
BORROWER OR SUCH CREDIT PARTY AT THE ADDRESS SET FORTH IN SCHEDULE B OF THIS
----------
AGREEMENT AND THAT SERVICE SO MADE SHALL BE DEEMED COMPLETED UPON THE EARLIER OF
SUCH BORROWER'S OR SUCH CREDIT PARTY'S ACTUAL RECEIPT THEREOF OR THREE (3) DAYS
AFTER DEPOSIT IN THE U.S. MAILS, PROPER POSTAGE PREPAID.
(B) THE PARTIES DESIRE THAT THEIR DISPUTES BE RESOLVED BY A JUDGE APPLYING
SUCH APPLICABLE LAWS. THEREFORE, TO ACHIEVE THE BEST COMBINATION OF THE BENEFITS
OF THE JUDICIAL SYSTEM AND OF ARBITRATION, THE PARTIES HERETO WAIVE ALL RIGHTS
TO TRIAL BY JURY IN ANY ACTION, SUIT, OR PROCEEDING BROUGHT TO RESOLVE ANY
DISPUTE, WHETHER ARISING IN CONTRACT, TORT, OR OTHERWISE BETWEEN LENDER, ANY
BORROWER AND ANY CREDIT PARTY ARISING OUT OF, CONNECTED WITH, RELATED OR
INCIDENTAL TO THE RELATIONSHIP ESTABLISHED BETWEEN THEM IN CONNECTION WITH THE
LOAN DOCUMENTS OR THE TRANSACTIONS RELATED THERETO.
10.11 Press Releases. Each Credit Party executing this Agreement agrees
--------------
that neither it nor its Affiliates will in the future issue any press release or
other public disclosure using the name of General Electric Capital Corporation
or its affiliates or referring to this Agreement or the other Loan Documents
without at least two (2) Business Days' prior notice to Lender and then only,
and to the extent that, the issuance of such press release or other public
disclosure is required by applicable law. Without the prior written consent of
Lender, no Credit Party nor any of its Affiliates shall issue any press release
or other public disclosure which is not required to be issued by applicable law
and which uses the name of General Electric Capital Corporation or its
affiliates or refers to this Agreement or the other Loan Documents. Each Credit
Party consents to the publication by Lender of a tombstone or similar
advertising material relating to the financing transactions contemplated by this
Agreement.
10.12 Reinstatement. This Agreement shall continue to be effective, or be
-------------
reinstated, as the case may be, if at any time payment of all or any part of the
Obligations is rescinded or must otherwise be returned or restored by the Lender
upon the insolvency, bankruptcy, dissolution, liquidation or reorganization of
any Borrower or any other Credit Party, or otherwise, all as though such
payments had not been made.
11. Cross-Guaranty
11.1 Cross-Guaranty. Each Borrower hereby absolutely and unconditionally
--------------
guarantees to Lender and its successors and assigns the full and prompt payment
(whether at stated maturity, by acceleration or otherwise) and performance of
all Obligations owed or hereafter owing to Lender by each other Borrower,
including that portion of the Revolving Credit Loan attributable to each other
Borrower. Each Borrower agrees that its guaranty obligation hereunder is a
continuing guaranty of payment and performance and not of collection, and that
its obligations under this Section 11 shall be absolute and unconditional,
irrespective of, and unaffected by:
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<PAGE>
(a) the genuineness, validity, regularity, enforceability or any future
amendment of, or change in, this Agreement, any other Loan Document or any other
agreement, document or instrument to which any Borrower is or may become a
party;
(b) the absence of any action to enforce this Agreement (including this
Section 11) or any other Loan Document or the waiver or consent by Lender with
respect to any of the provisions hereof or thereof;
(c) the existence, value or condition of, or failure to perfect its Lien
against, any security for the Obligations or any action, or the absence of any
action, by Lender in respect thereof (including the release of any such
security);
(d) the insolvency of any Credit Party; or
(e) any other action or circumstances which might otherwise constitute a
legal or equitable discharge or defense of a surety or guarantor, it being
agreed by each Borrower that its obligations under this Section 11 shall not be
discharged until the payment and performance, in full, of the Obligations has
occurred. Each Borrower shall be regarded, and shall be in the same position, as
principal debtor with respect to the Obligations guaranteed hereunder.
11.2 Waivers by Borrowers. Each Borrower expressly waives all rights it
--------------------
may have now or in the future under any statute, or at common law, or at law or
in equity, or otherwise, to compel Lender to marshall assets or to proceed in
respect of the Obligations guaranteed hereunder against any other Credit Party,
any other party or against any security for the payment and performance of the
Obligations before proceeding against, or as a condition to proceeding against,
such Borrower. It is agreed among each Borrower and Lender that the foregoing
waivers are of the essence of the transactions contemplated by this Agreement
and the other Loan Documents and that, but for the provisions of this Section 11
and such waivers, Lender would decline to enter into this Agreement.
11.3 Benefit of Guaranty. Each Borrower agrees that the provisions of
-------------------
this Section 11 are for the benefit of Lender and its successors, transferees,
endorsees and assigns, and nothing herein contained shall impair, as between any
other Borrower and Lender, the obligations of such other Borrower under the Loan
Documents.
11.4 Subordination of Subrogation, Etc. Notwithstanding anything to the
----------------------------
contrary in this Agreement or in any other Loan Document, and except as set
forth in Section 11.7, each Borrower hereby expressly and irrevocably
subordinates to payment of the Obligations any and all rights at law or in
equity to subrogation, reimbursement, exoneration, contribution, indemnification
or set off and any and all defenses available to a surety, guarantor or
accommodation co-obligor until the Obligations are indefeasibly paid in full in
cash. Each Borrower acknowledges and agrees that this waiver is intended to
benefit Lender and shall not limit or otherwise affect such Borrower's liability
hereunder or the enforceability of this Section
29
<PAGE>
11, and that Lender and its successors and assigns are intended third party
beneficiaries of the waivers and agreements set forth in this Section 11.4.
11.5 Election of Remedies. If Lender may, under applicable law, proceed
--------------------
to realize its benefits under any of the Loan Documents giving Lender a Lien
upon any Collateral, whether owned by any Borrower or by any other Person,
either by judicial foreclosure or by non-judicial sale or enforcement, Lender
may, at its sole option, determine which of its remedies or rights it may pursue
without affecting any of its rights and remedies under this Section 11. If, in
the exercise of any of its rights and remedies, Lender shall forfeit any of its
rights or remedies, including its right to enter a deficiency judgment against
any Borrower or any other Person. whether because of any applicable laws
pertaining to "election of remedies' or the like, each Borrower hereby consents
to such action by Lender and waives any claim based upon such action, even if
such action by Lender shall result in a full or partial loss of any rights of
subrogation which such Borrower might otherwise have had but for such action by
Lender. Any election of remedies which results in the denial or impairment of
the right of Lender to seek a deficiency judgment against any Borrower shall not
impair any other Borrower's obligation to pay the full amount of the
Obligations. In the event Lender shall bid at any foreclosure or trustee's sale
or at any private sale permitted by law or the Loan Documents, Lender may bid
all or less than the amount of the Obligations and the amount of such bid need
not be paid by Lender but may be credited against the Obligations. The amount of
the successful bid at any such sale, whether Lender or any other party is the
successful bidder, shall be conclusively deemed to be the fair market value of
the Collateral and the difference between such bid amount and the remaining
balance of the Obligations shall be conclusively deemed to be the amount of the
Obligations guaranteed under this Section 11, notwithstanding that any present
or future law or court decision or ruling may have the effect of reducing the
amount of any deficiency claim to which Lender might otherwise be entitled but
for such bidding at any such sale. In addition, each Borrower waives all rights
and defenses arising out of an election of remedies by Lender, even though the
election of remedies, such as a non-judicial foreclosure with respect to
security for the Obligations, has destroyed any Borrower's rights of subrogation
and reimbursement against the principal by the operation of Section 580d of the
California Code of Civil Procedure or otherwise.
11.6 Limitation. Notwithstanding any provision herein contained to the
----------
contrary, each Borrower's liability under this Section 11 (which liability is in
any event in addition to amounts for which such Borrower is primarily liable
under Section 1) shall be limited to an amount not to exceed as of any date of
determination the greater of:
(a) the net amount of all Loans advanced to any other Borrower under this
Agreement and then re-loaned or otherwise transferred to, or for the benefit of,
such Borrower; and
(b) the amount which could be claimed by Lender from such Borrower under
this Section 11 without rendering such claim voidable or avoidable under Section
548 of Chapter 11 of the United States Bankruptcy Code or under any applicable
state Uniform Fraudulent Transfer Act, Uniform Fraudulent Conveyance Act or
similar statute or common law after taking into account, among other things,
such Borrower's right of contribution and indemnification from each other
Borrower under Section 11.7.
30
<PAGE>
11.7 Contribution with Respect to Guaranty Obligations. (a) To the extent
-------------------------------------------------
that any Borrower shall make a payment under this Section 11 of all or any of
the Obligations (other than Loans made to that Borrower for which it is
primarily liable) (a "Guarantor Payment") which, taking into account all other
Guarantor Payments then previously or concurrently made by any other Borrower,
exceeds the amount which such Borrower would otherwise have paid if each
Borrower had paid the aggregate Obligations satisfied by such Guarantor Payment
in the same proportion that such Borrower's "Allocable Amount" (as defined
below) (as determined immediately prior to such Guarantor Payment) bore to the
aggregate Allocable Amounts of each of the Borrowers as determined immediately
prior to the making of such Guarantor Payment, then, following indefeasible
payment in full in cash of the Obligations and termination of the Commitments,
such Borrower shall be entitled to receive contribution and indemnification
payments from, and be reimbursed by, each other Borrower for the amount of such
excess, pro rata based upon their respective Allocable Amounts in effect
immediately prior to such Guarantor Payment.
(b) As of any date of determination, the "Allocable Amount" of any
Borrower shall be equal to the maximum amount of the claim which could then be
recovered from such Borrower under this Section 11 without rendering such claim
voidable or avoidable under Section 548 of Chapter 11 of the United States
Bankruptcy Code or under any applicable state Uniform Fraudulent Transfer Act,
Uniform Fraudulent Conveyance Act or similar statute or common law.
(c) This Section 11.7 is intended only to define the relative rights of
Borrowers and nothing set forth in this Section 11.7 is intended to or shall
impair the obligations of each Borrower to pay any amounts as and when the same
shall become due and payable in accordance with the terms of this Agreement,
including Section 11.1. Nothing contained in this Section 11.7 shall limit the
liability of any Borrower to pay the Loans made directly or indirectly to that
Borrower and accrued interest, Fees and expenses with respect thereto for which
such Borrower shall be primarily liable.
(d) The parties hereto acknowledge that the rights of contribution and
indemnification hereunder shall constitute assets of Borrower to which such
contribution and indemnification is owing.
(e) The rights of the indemnifying Borrowers against other Credit Parties
under this Section 11.7 shall be exercisable upon the full and indefeasible
payment of the Obligations and the termination of Lender's obligation to extend
any credit under this Agreement.
11.8 Liability Cumulative. The liability of Borrowers under this Section 11
--------------------
is in addition to and shall be cumulative with all liabilities of each Borrower
to Lender under this Agreement and the other Loan Documents to which such
Borrower is a party or in respect of any Obligations or obligation of the other
Borrower, without any limitation as to amount, unless the instrument or
agreement evidencing or creating such other liability specifically provides to
the contrary.
[Signatures Begin on the Next Page]
31
<PAGE>
IN WITNESS WHEREOF, this Loan and Security Agreement has been duly executed
as of the date first written above.
BORROWERS:
CD WAREHOUSE, INC.
By: /s/ Jerry W. Grizzle
--------------------------------------
Name: Jerry W. Grizzle
Title: President
COMPACT DISCS MANAGEMENT, INC.
By: /s/ Jerry W. Grizzle
--------------------------------------
Name: Jerry W. Grizzle
Title: Chairman
OTHER CREDIT PARTIES:
CD WAREHOUE FINANCE COMPANY
By: /s/Jerry W. Grizzle
--------------------------------------
Name: Jerry W. Grizzle
Title: Chairman
CD WAREHOUSE.COM, INC.
By: /s/ Jerry W. Grizzle
--------------------------------------
Name: Jerry W. Grizzle
Title: Chairman
COMPACT DISCS DISTRIBUTION, INC.
By: /s/ Jerry W. Grizzle
-------------------------------------
Name: Jerry W. Grizzle
Title: Chairman
32
<PAGE>
LENDER:
GENERAL ELECTRIC CAPITAL CORPORATION
By: /s/ Peter B. Cooney
---------------------------------------
Name: Peter B. Cooney
Title: Duly Authorized Signatory
33
<PAGE>
EXHIBIT 21.1
LIST OF SUBSIDIARIES AS OF
DECEMBER 31, 1999
(1) Compact Discs Management, Inc., a Delaware corporation.
(2) CD Warehouse Finance Company, a Nevada corporation.
(3) CD Warehouse.com, Inc., a Nevada corporation.
(4) Compact Discs Distribution, Inc., a Nevada corporation.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement Form
S-8 No. 333-72651 pertaining to the CD Warehouse, Inc. Amended 1996 Stock Option
Plan, the Registration Statement Form S-3 No. 333-58451 for the registration of
2,036,730 shares of common stock and the Registration Statement Form S-3 No.
333-72755 for the registration of 316,430 shares of common stock, and the
related Prospectuses of our report dated February 25, 2000, with respect to the
consolidated financial statements of CD Warehouse, Inc. included in the Annual
Report Form 10-KSB for the year ended December 31, 1999.
/s/ ERNST & YOUNG LLP
Oklahoma City, Oklahoma
March 29, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10KSB
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,069,560
<SECURITIES> 0
<RECEIVABLES> 1,088,116
<ALLOWANCES> (139,864)
<INVENTORY> 8,908,331
<CURRENT-ASSETS> 12,031,446
<PP&E> 5,736,969
<DEPRECIATION> (815,682)
<TOTAL-ASSETS> 28,877,750
<CURRENT-LIABILITIES> 2,539,891
<BONDS> 0
0
0
<COMMON> 36,603
<OTHER-SE> 21,778,279
<TOTAL-LIABILITY-AND-EQUITY> 28,877,750
<SALES> 27,872,614
<TOTAL-REVENUES> 31,912,276
<CGS> 16,863,829
<TOTAL-COSTS> 33,586,640
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 227,550
<INCOME-PRETAX> (1,825,132)
<INCOME-TAX> (684,000)
<INCOME-CONTINUING> (1,141,132)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,141,132)
<EPS-BASIC> (.31)
<EPS-DILUTED> (.31)
</TABLE>
