PROSPECTUS
$110,000,000
MTS, INCORPORATED [LOGO]
OFFER TO EXCHANGE NEW 9 3/8% SENIOR SUBORDINATED NOTES DUE 2005
WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT FOR ALL
OUTSTANDING 9 3/8% SENIOR SUBORDINATED NOTES DUE 2005
THE NEW 9 3/8% SENIOR SUBORDINATED NOTES DUE 2005 WILL BE EFFECTIVELY
SUBORDINATE TO ALL OTHER OUTSTANDING INDEBTEDNESS OF MTS, INCORPORATED AND MTS,
INCORPORATED HAS NOT ISSUED AND HAS NO CURRENT PLANS, ARRANGEMENTS OR AGREEMENTS
TO ISSUE ANY ADDITIONAL INDEBTEDNESS TO WHICH THE NEW 9 3/8% SENIOR SUBORDINATED
NOTES WOULD BE JUNIOR, PARI PASSU, OR SENIOR.
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M. NEW YORK CITY TIME ON OCTOBER 16,
1998, UNLESS EXTENDED. THERE WILL BE NO EXTENSION OF THE EXCHANGE OFFER BEYOND
5:00 P.M. NEW YORK CITY TIME ON NOVEMBER 15, 1998.
MTS, INCORPORATED, a California corporation (the "Company"), hereby offers upon
the terms and subject to the conditions set forth in this Prospectus (the
"Prospectus") and the accompanying Letter of Transmittal (the "Letter of
Transmittal") (the offering pursuant to the Prospectus together with the Letter
of Transmittal herein the "Exchange Offer") to exchange up to an aggregate
principal amount of $110,000,000 of its New 9 3/8% Senior Subordinated Notes due
2005 (the "New Notes") for up to an aggregate principal amount of $110,000,000
of the Company's outstanding 9 3/8% Senior Subordinated Notes due 2005 (the
"Existing Notes"). The terms of the New Notes are substantially identical in all
material respects to those of the Existing Notes, except that the New Notes (i)
have been registered under the Securities Act of 1933, as amended (the
"Securities Act"), and therefore will not be subject to certain restrictions on
transfer applicable to the Existing Notes, and (ii) will not be entitled to
registration or other rights under the Registration Rights Agreement (as
defined), including the provision in the Registration Rights Agreement for
payment of Additional Interest (as defined in the Registration Rights Agreement)
upon failure by the Company to consummate the Exchange Offer or the occurrence
of certain other events. See "Description of the Existing Notes." The New Notes
will be issued pursuant to, and the Holders thereof (the "New Holders") will be
entitled to the benefit of, the Indenture (as defined below) governing the
Existing Notes. In the event that the Exchange Offer is consummated, any
Existing Notes which remain outstanding after consummation of the Exchange Offer
will vote together as a single class with the New Notes issued in the Exchange
Offer for purposes of determining whether Holders of the requisite percentage in
outstanding principal amount of Notes (as defined below) have taken certain
actions or exercised certain rights under the Indenture. See "Description of New
Notes", "The Exchange Offer." Holders of Existing Notes are referred to herein
as "Existing Holders", and Existing Holders together with New Holders are
referred to herein collectively as "Holders." The New Notes together with the
Existing Notes are referred to herein collectively as the "Notes." The Indenture
dated as of April 23, 1998 between the Company and State Street Bank and Trust
Company of California, N.A., as Trustee (the "Trustee"), is hereinafter referred
to as the "Indenture." Unless otherwise indicated or defined herein, capitalized
terms followed by the parenthetical remark "(as defined)" shall have the
meanings given to them in the Indenture.
CONTINUED ON FOLLOWING PAGE
THIS PROSPECTUS AND THE LETTER OF TRANSMITTAL ARE FIRST BEING SENT TO EXISTING
HOLDERS ON OR ABOUT
SEPTEMBER 16, 1998.
--------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 12 FOR A DISCUSSION OF CERTAIN FACTORS
WHICH EXISTING HOLDERS SHOULD CONSIDER IN CONNECTION WITH THE EXCHANGE OFFER.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS OR THE LETTER OF TRANSMITTAL. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
SEPTEMBER 14, 1998
(CONTINUATION OF COVER PAGE)
Interest on the Notes will be payable semi-annually on May 1 and November 1
of each year, commencing November 1, 1998.
The Notes will be redeemable at the option of the Company, in whole or in
part, at any time on or after May 1, 2002, at the redemption prices (expressed
as a percentage of principal amount) set forth herein, plus accrued and unpaid
interest and Additional Interest, if any, thereon to the date of redemption. In
addition, at any time and from time to time on or prior to May 1, 2001, the
Company may, in its discretion, redeem up to 35% of the original aggregate
principal amount of the Notes at a redemption price equal to 109.375% of the
principal amount thereof, plus accrued and unpaid interest and Additional
Interest, if any, thereon to the date of redemption, with the net proceeds of
one or more Equity Offerings (as defined); PROVIDED that at least 65% of the
original aggregate principal amount of the Notes remains outstanding immediately
after each such redemption.
Upon the occurrence of a Change of Control (as defined), the Holders of the
Notes will have the right to require the Company to repurchase their Notes, in
whole or in part, at a price equal to 101% of the aggregate principal amount
thereof, plus accrued and unpaid interest and Additional Interest, if any,
thereon to the date of repurchase. See "Description of Notes--Offer to Purchase
upon Change of Control." If a Change of Control were to occur, there can be no
assurance that the Company would be able to repurchase any of the Notes tendered
for repurchase. See "Risk Factors--Change of Control."
The Notes are unsecured and are subordinate in right of payment to all
existing and future Senior Indebtedness (as defined) of the Company which
constitutes all of the Indebtedness of the Company other than the Notes. The
Company has no indebtedness junior to the Notes and has no current plans,
arrangements or agreements to issue indebtedness junior to, pari passu with, or
senior to, the Notes. As of April 30, 1998, the Company had approximately $131.1
million of Senior Indebtedness outstanding on a consolidated basis and had
unused availability under its New Credit Facility (as defined), of up to $154.4
million, of which approximately $124.5 million was available under the borrowing
base formula contained in the New Credit Facility. See "Capitalization,"
"Description of New Credit Facility" and "Description of Notes--Subordination."
On April 23, 1998, the Company issued $110.0 million in aggregate principal
amount of Existing Notes. The Existing Notes were issued pursuant to exemptions
from, or in transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws. The New Notes are being
offered under this Prospectus, which is part of a registration statement of the
Company on Form S-4 (the "Exchange Offer Registration Statement", which term
shall encompass all amendments, exhibits, annexes and schedules thereto), in
order to satisfy certain obligations of the Company under the Registration
Rights Agreement (as defined). Once the Exchange Offer is consummated, the
Company generally will have no further obligations to register any of the
Existing Notes not tendered by Existing Holders for exchange. See "Risk
Factors--Consequences of Failure to Exchange."
The New Notes generally will be issued in the form of Global Securities (as
defined) which will be deposited with, or on behalf of, the Depositary (as
defined) and registered in its name or in the name of a nominee of the
Depositary. Beneficial interests in the Global Securities representing the New
Notes will be shown on, and transfers thereof will be effected through, records
maintained by the Depositary. See "Book-Entry; Delivery and Form."
The Company will accept for exchange any and all Existing Notes which are
properly tendered in the Exchange Offer prior to 5:00 p.m., New York City time,
on October 16, 1998 (30 days after this Prospectus was sent to Existing
Holders), unless extended by the Company in its sole discretion (the "Expiration
Date"). The Company will not extend the Expiration Date beyond 5:00 p.m., New
York City time, on November 15, 1998 (60 days after this Prospectus was sent to
Existing Holders). Tenders of Existing Notes may be withdrawn at any time prior
to 5:00 p.m., New York City time, on the Expiration Date. In the event the
Company terminates the Exchange Offer and does not accept for exchange any
ii
(CONTINUATION OF COVER PAGE)
Existing Notes with respect to the Exchange Offer, the Company will promptly
return the Existing Notes to the Holders thereof. The Exchange Offer is not
conditioned upon any minimum principal amount of Existing Notes being tendered
for exchange, but is subject to certain events and conditions that may be waived
by the Company and to the terms and provisions of the Registration Rights
Agreement. The Existing Notes may be tendered in whole or in part solely in
integral multiples of $1,000.
The Company is making the Exchange Offer in reliance on the position of the
staff of the Division of Corporation Finance (the "Staff") of the Securities and
Exchange Commission (the "Commission") as set forth in the Staff's EXXON CAPITAL
HOLDINGS CORPORATION no-action letter (available May 13, 1988) (the "Exxon
Capital No-Action Letter"), MORGAN STANLEY & CO. INCORPORATED no-action letter
(available June 5, 1991) (the "Morgan Stanley No-Action Letter"), SHEARMAN &
STERLING no-action letter (available July 2, 1993) (the "Shearman & Sterling
No-Action Letter"), and other interpretive letters addressed to third parties in
other transactions. However, the Company has not sought its own interpretive
letter addressing such matters and there can be no assurance that the Staff
would make a similar determination with respect to the Exchange Offer as it has
in such interpretive letters to third parties. Based on these interpretations by
the Staff, and subject to the two immediately following sentences, the Company
believes that New Notes issued pursuant to this Exchange Offer in exchange for
Existing Notes may be offered for resale, resold and otherwise transferred by a
Holder thereof (other than a Holder who is a broker-dealer) without further
compliance with the registration and prospectus delivery requirements of the
Securities Act, provided that such New Notes are acquired in the ordinary course
of such Holder's business and that such Holder is not participating, and has no
arrangement or understanding with any person to participate, in a distribution
(within the meaning of the Securities Act) of such New Notes. However, any
Holder of Existing Notes who (i) is an "affiliate" of the Company (within the
meaning of Rule 405 under the Securities Act), (ii) does not acquire such New
Notes in the ordinary course of its business, (iii) intends to participate in
the Exchange Offer for the purpose of distributing New Notes, or (iv) is a
broker-dealer who purchased such Existing Notes directly from the Company, (a)
will not be able to rely on the interpretations of the Staff set forth in the
above-mentioned interpretive letters, (b) will not be permitted or entitled to
tender such Existing Notes in the Exchange Offer, and (c) must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any sale or other transfer of such Existing Notes unless such
sale is made pursuant to an exemption from such requirements. In addition, as
described below, if any broker-dealer holds Existing Notes acquired for its own
account as a result of market-making or other trading activities and exchanges
such Existing Notes for New Notes in the Exchange Offer (an "Exchanging
Dealer"), then such Exchanging Dealer may be deemed a statutory "underwriter"
within the meaning of the Securities Act and must deliver a prospectus meeting
the requirements of the Securities Act in connection with any resales of such
New Notes.
Each Holder of Existing Notes who wishes to exchange Existing Notes for New
Notes in the Exchange Offer will be required to represent that (i) it is not an
affiliate of the Company, (ii) any New Notes to be received by it are being
acquired in the ordinary course of its business, (iii) it has no arrangement or
understanding with any person to participate in the distribution of such New
Notes, and (iv) it is not engaged in, and does not intend to engage in, a
distribution of the New Notes. Each broker-dealer that receives New Notes for
its own account pursuant to the Exchange Offer must acknowledge that it acquired
the Existing Notes for its own account as a result of market-making activities
or other trading activities (and not directly from the Company) and must agree
that it will deliver a prospectus meeting the requirements of the Securities Act
in connection with any resale of such New Notes. The Letter of Transmittal
states that by so acknowledging and by delivering a prospectus, such an
Exchanging Dealer will not be deemed to admit that it is an "underwriter" within
the meaning of the Securities Act. Based on the position taken by the Staff in
the interpretive letters referred to above, the Company believes that Exchanging
Dealers may fulfill their prospectus delivery requirements with respect to the
New Notes received upon exchange of such Existing Notes with a prospectus
meeting the requirements
iii
(CONTINUATION OF COVER PAGE)
of the Securities Act, which may be the prospectus prepared for an exchange
offer so long as it contains a description of the plan of distribution with
respect to the resale of such New Notes. Accordingly, this Prospectus, as it may
be amended or supplemented from time to time, may be used by an Exchanging
Dealer during the period referred to below in connection with resales of New
Notes received in exchange for Existing Notes where such Existing Notes were
acquired by such Exchanging Dealer for its own account as a result of
market-making or other trading activities. Subject to certain provisions set
forth in the Registration Rights Agreement, the Company has agreed that this
Prospectus, as it may be amended or supplemented from time to time, may be used
by an Exchanging Dealer in connection with resales of such New Notes for a
period of 180 days following effectiveness of the Exchange Offer Registration
Statement. See "Plan of Distribution." Any Exchanging Dealer who is an affiliate
of the Company may not rely on such interpretive letters and must comply with
the registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction. See "The Exchange Offer--Resales of New
Notes."
In that regard, each Exchanging Dealer who surrenders Existing Notes
pursuant to the Exchange Offer will be deemed to have agreed, by execution of
the Letter of Transmittal, that, upon receipt of notice from the Company of the
occurrence of any event or the discovery of any fact which makes any statement
contained or incorporated by reference in this Prospectus untrue in any material
respect or which causes this Prospectus to omit to state a material fact
necessary in order to make the statements contained or incorporated by reference
herein, in light of the circumstances under which they were made, not
misleading, or of the occurrence of certain other events specified in the
Registration Rights Agreement, such Exchanging Dealer will suspend the sale of
New Notes pursuant to this Prospectus until the Company has amended or
supplemented this Prospectus to correct such misstatement or omission and has
furnished copies of the amended or supplemented Prospectus to such Exchanging
Dealer or the Company has given notice that the sale of the New Notes may be
resumed, as the case may be.
The New Notes will be a new issue of securities for which there currently is
no market. Although the Initial Purchasers have informed the Company that they
currently intend to make a market in the New Notes, they are not obligated to do
so, and any such market making may be discontinued at any time without notice.
As the Existing Notes were issued, and the New Notes are being issued, to a
limited number of institutions who typically hold similar securities for
investment, the Company does not expect that an active public market for the New
Notes will develop. Accordingly, there can be no assurance as to the
development, liquidity or maintenance of any market for the New Notes. The
Company does not currently intend to apply for listing of the New Notes on any
securities exchange or for quotation through the Nasdaq Stock Market.
Any Existing Notes not tendered and accepted in the Exchange Offer will
remain outstanding and will be entitled to all the same rights and will be
subject to the same limitations applicable thereto under the Indenture (except
for those rights which terminate upon consummation of the Exchange Offer).
Following consummation of the Exchange Offer, the Holders of Existing Notes will
continue to be subject to the existing restrictions upon transfer thereof and
the Company will have no further obligation to such Existing Holders (except for
limited instances involving the Initial Purchasers and Existing Holders that are
not eligible to participate in the Exchange Offer) to provide for registration
under the Securities Act of the Existing Notes held by them. To the extent that
Existing Notes are tendered and accepted in the Exchange Offer, an Existing
Holder's ability to sell untendered Existing Notes could be adversely affected.
See "Risk Factors--Consequences of Failure to Exchange."
Each New Note will bear interest from the most recent date to which interest
has been paid or duly provided for on the Existing Note surrendered in exchange
for such New Note or, if no such interest has been paid or duly provided for on
such Existing Note, from April 23, 1998. Holders of the Existing Notes
iv
(CONTINUATION OF COVER PAGE)
whose Existing Notes are accepted for exchange will not receive accrued interest
on such Existing Notes for any period from and after the last Interest Payment
Date to which interest has been paid or duly provided for on such Existing Notes
prior to the original issue date of the New Notes or, if no such interest has
been paid or duly provided for, will not receive any accrued interest on such
Existing Notes, and will be deemed to have waived the right to receive any
interest on such Existing Notes accrued from and after such Interest Payment
Date or, if no such interest has been paid or duly provided for, from and after
April 23, 1998.
The Company will not receive any cash proceeds from the issuance of the New
Notes offered hereby. The Company has agreed to pay all required expenses of the
Exchange Offer. See "The Exchange Offer--Fees and Expenses." No dealer-manager
is being used in connection with this Exchange Offer. See "Use of Proceeds" and
"Plan of Distribution."
THIS PROSPECTUS AND THE RELATED LETTER OF TRANSMITTAL CONTAIN IMPORTANT
INFORMATION. HOLDERS OF EXISTING NOTES ARE URGED TO READ THIS PROSPECTUS AND THE
RELATED LETTER OF TRANSMITTAL CAREFULLY BEFORE DECIDING WHETHER TO TENDER THEIR
EXISTING NOTES PURSUANT TO THE EXCHANGE OFFER.
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY
OTHER THAN THE NEW NOTES, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY OF THE NEW NOTES TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO
SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
UP THROUGH AND INCLUDING DECEMBER 15, 1998 (90 DAYS AFTER THIS PROSPECTUS
WAS SENT TO EXISTING HOLDERS), ALL DEALERS EFFECTING TRANSACTIONS IN THE NEW
NOTES, WHETHER OR NOT PARTICIPATING IN THE EXCHANGE OFFER, MAY BE REQUIRED TO
DELIVER A PROSPECTUS IN CONNECTION WITH SUCH TRANSACTION.
EACH PROSPECTIVE PURCHASER OF THE NEW NOTES MUST COMPLY WITH ALL LAWS AND
REGULATIONS APPLICABLE TO IT IN FORCE IN ANY JURISDICTION IN WHICH IT PURCHASES,
OFFERS OR SELLS THE NEW NOTES OR POSSESSES OR DISTRIBUTES THIS PROSPECTUS AND
MUST OBTAIN ANY CONSENT, APPROVAL OR PERMISSION REQUIRED TO BE OBTAINED BY IT
FOR THE PURCHASE, OFFER OR SALE BY IT OF THE NEW NOTES UNDER THE LAWS AND
REGULATIONS APPLICABLE TO IT IN FORCE IN ANY JURISDICTION TO WHICH IT IS SUBJECT
OR IN WHICH IT MAKES SUCH PURCHASES, OFFERS OR SALES, AND THE COMPANY SHALL NOT
HAVE ANY RESPONSIBILITY THEREFOR.
FORWARD-LOOKING STATEMENTS
THIS PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE KNOWN AND
UNKNOWN RISKS AND UNCERTAINTIES. WHEN USED IN THIS PROSPECTUS, THE WORDS
"ANTICIPATES," "BELIEVES," "ESTIMATES," "EXPECTS," "INTENDS," "PLANS" AND
SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED
BY SUCH FORWARD-LOOKING STATEMENTS AS A RESULT OF FACTORS SET FORTH HEREIN. SUCH
FACTORS INCLUDE, BUT ARE NOT LIMITED TO, THE CAUTIONARY STATEMENTS SET
v
(CONTINUATION OF COVER PAGE)
FORTH UNDER THE CAPTIONS "RISK FACTORS," "MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" AND "BUSINESS" HEREIN. FACTORS
THAT MAY CAUSE SUCH DIFFERENCES INCLUDE, WITHOUT LIMITATION: (1) COMPETITION;
(2) INCREASED COSTS; (3) LOSS OR RETIREMENT OF KEY MEMBERS OF MANAGEMENT; (4)
INCREASES IN THE COMPANY'S COST OF BORROWINGS OR INABILITY OR UNAVAILABILITY OF
ADDITIONAL DEBT OR EQUITY CAPITAL OR OTHER FORMS OF FINANCING (SUCH AS TRADE
CREDIT, EQUIPMENT LEASE TERMS, AND COOPERATIVE ADVERTISING ALLOWANCES); (5)
CHANGES IN TECHNOLOGY FOR THE DELIVERY OF RECORDED MUSIC, INCLUDING NEW FORMS OF
DISTRIBUTION OF RECORDED MUSIC SUCH AS THE INTERNET AND DIRECT DOWN LOADING OF
RECORDED MUSIC BY CONSUMERS; AND (6) CHANGES IN GENERAL ECONOMIC CONDITIONS IN
THE MARKETS IN WHICH THE COMPANY MAY, FROM TIME TO TIME, COMPETE. MANY OF SUCH
FACTORS WILL BE BEYOND THE CONTROL OF THE COMPANY AND ITS MANAGEMENT. ALL
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS PROSPECTUS ARE BASED ON INFORMATION
AVAILABLE TO THE COMPANY ON THE DATE HEREOF. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE THE RESULT OF ANY REVISIONS TO THESE
FORWARD-LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES
AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. FOR
FURTHER INFORMATION ON OTHER FACTORS WHICH COULD AFFECT THE FINANCIAL RESULTS OF
THE COMPANY AND SUCH FORWARD-LOOKING STATEMENTS, SEE "RISK FACTORS."
MARKET AND INDUSTRY DATA
THE INFORMATION CONTAINED HEREIN INCLUDES CERTAIN DEMOGRAPHIC AND ECONOMIC
INFORMATION FOR THE UNITED STATES AND INTERNATIONALLY. ALTHOUGH THE COMPANY HAS
OBTAINED THIS INFORMATION FROM SOURCES IT BELIEVES TO BE RELIABLE, THE COMPANY
HAS NOT INDEPENDENTLY VERIFIED THIS INFORMATION AND THERE CAN BE NO ASSURANCE AS
TO ITS ACCURACY. FURTHER, BECAUSE COMPETITORS OF THE COMPANY GENERALLY DO NOT
MAKE AVAILABLE INFORMATION REGARDING THEIR SALES IN SPECIFIC REGIONS, MARKET
SHARE INFORMATION, CERTAIN OPERATING INFORMATION AND CERTAIN OTHER INFORMATION
IS SUBJECT TO A NUMBER OF ESTIMATES AND ASSUMPTIONS. WHILE THE COMPANY BELIEVES
SUCH INFORMATION TO BE RELIABLE, THERE CAN BE NO ASSURANCE AS TO ITS ACCURACY.
UNLESS OTHERWISE STATED, ALL REFERENCES TO U.S. INDUSTRY DATA AND U.S.
INDUSTRY TRENDS ARE BASED ON INFORMATION FROM THE RECORDING INDUSTRY ASSOCIATION
OF AMERICA ("RIAA") AND ALL REFERENCES TO INTERNATIONAL INDUSTRY DATA AND
INTERNATIONAL INDUSTRY TRENDS ARE BASED ON INFORMATION FROM THE 1998 MUSIC
BUSINESS INTERNATIONAL WORLD REPORT (THE "MBI REPORT"). U.S. DATA IS REPORTED AS
THE RETAIL VALUE OF PRODUCTS SHIPPED TO MUSIC RETAILERS BY SUPPLIERS.
INTERNATIONAL DATA IS REPORTED AS RETAIL SALES.
------------------------
"TOWER," "TOWER RECORDS-VIDEO-BOOKS," and "WOW!" are among the trademarks of
the Company. This Prospectus contains other trade names and trademarks of the
Company and of other organizations.
The Company maintains a website at HTTP://WWW.TOWERRECORDS.COM and an online
store on America Online at keyword "TOWER." Information contained on the
Company's website or on America Online shall not be deemed to constitute a part
of this Prospectus.
vi
SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY, AND SHOULD BE READ IN
CONJUNCTION WITH, THE MORE DETAILED INFORMATION, RISK FACTORS AND THE
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN THIS
PROSPECTUS. UNLESS OTHERWISE REFERRED TO HEREIN OR THE CONTEXT OTHERWISE
REQUIRES, REFERENCES TO "MTS," "TOWER" OR THE "COMPANY" SHALL MEAN MTS,
INCORPORATED AND ITS CONSOLIDATED SUBSIDIARIES. ALL INFORMATION IN THIS
PROSPECTUS, INCLUDING FINANCIAL INFORMATION, REFLECTS THE REORGANIZATION (AS
DEFINED BELOW). ALL REFERENCES TO FISCAL YEARS IN THIS PROSPECTUS ARE TO THE
FISCAL YEARS ENDED ON JULY 31 OF EACH YEAR. PROSPECTIVE INVESTORS SHOULD
CAREFULLY CONSIDER ALL OF THE INFORMATION SET FORTH IN THIS PROSPECTUS AND, IN
PARTICULAR, SHOULD EVALUATE THE SPECIFIC FACTORS SET FORTH UNDER "RISK FACTORS"
FOR RISKS INVOLVED WITH AN INVESTMENT IN THE NEW NOTES.
THE COMPANY
OVERVIEW
Founded in 1960, Tower is the second largest specialty retailer of recorded
music headquartered in the United States in terms of revenues and is one of the
largest and most widely-recognized music retailers in the world. The Company
operates a total of 183 stores worldwide, consisting of 119 U.S. stores in 20
states and 64 international stores in 11 countries. Management believes that
Tower is one of the leading music retailers in each of the U.S. major
metropolitan areas in which it operates (many of which are the fastest growing
markets in the United States). The Company offers a diversified line of music
products including compact discs, recorded audio cassettes, recorded video
cassettes, laser discs, digital video discs ("DVD") and other complementary
products, including books, magazines, blank tapes, software titles, and
accessories. As of April 30, 1998, Tower's aggregate outstanding indebtedness
was $241.1 million, and for the nine month period ended April 30, 1998 Tower's
ratio of earnings to fixed charges was 1.5x and net revenues were $771.4
million.
Tower attracts and retains customers who buy music on a year-round basis by
providing an extensive product selection in an interactive, entertaining
environment. Tower stores feature extended store hours, in-store listening
stations and knowledgeable and motivated sales personnel. These factors,
combined with the Company's competitive pricing, make Tower stores a preferred
shopping destination. Tower offers one of the broadest selections of recorded
music, including recent releases, older releases and various other music formats
primarily in stand-alone locations in densely populated urban and suburban
areas. Tower stores are typically larger in square footage and have lower rents
as a percentage of revenues than comparable mall-based music specialty
retailers. Most of the Company's domestic stores exceed 10,000 square feet and
carry at least 50,000 music titles. Flagship stores, which are located in major
metropolitan areas such as Boston, Buenos Aires, Chicago, Glasgow, Hong Kong,
Honolulu, London, Los Angeles, New Orleans, New York, Osaka, Philadelphia, San
Francisco, Seattle, Singapore, Taipei, Tokyo, Toronto and Washington, D.C.,
typically exceed 20,000 square feet and carry between 80,000 and 120,000 music
titles. In addition to the BILLBOARD Top 50, Tower offers competitive pricing on
the full range of its product offerings. Management believes that Tower's
success in attracting loyal customers increases store traffic and sales
throughout the year and has been a factor in making the Company less dependent
upon the success of new music releases and calendar fourth quarter sales than
many of its U.S. competitors.
Due to Tower's high sales volume and long-standing relationships with
vendors and music manufacturers, the Company receives substantial cooperative
advertising allowances, beneficial purchasing terms, short lead times on
inventory fulfillment, product return rights, and drop shipments of orders
directly to its stores. Tower monitors the quantity and mix of inventory in each
of its stores through a central inventory management system. However, unlike
many of its competitors (who purchase and distribute from a central location),
Tower's store managers are given discretion in managing the level and mix of the
inventory in their stores in order to most effectively market to each store's
demographic customer base. The Company believes that this policy has been an
important factor in Tower's strategy
1
to minimize its product return levels, thereby reducing restocking fees,
improving operating margins and sustaining favorable vendor relations.
In order to increase and diversify its revenue base, Tower became the first
U.S.-based music retailer to implement an international growth strategy. This
expansion, which commenced in 1979, initially focused on the Japanese market
(which is currently the world's second largest market for recorded music, with
net sales of approximately $6.8 billion in 1996) and enabled Tower to become a
market leader in Japan for recorded music. Tower implemented a similar expansion
strategy in the United Kingdom beginning in 1986. The Company currently has more
international locations than any other U.S.-based music retailer and, for the
1997 fiscal year, derived approximately 40% of its total net revenues from
international sales. Tower currently operates 41 stores in Japan; six in
England; three each in Hong Kong, Israel and Singapore; two each in Mexico and
Taiwan; and one each in Argentina, Canada, Ireland and Scotland. In addition,
the Company has entered into franchise agreements with local operators in
Colombia, Malaysia, South Korea and Thailand.
The Company was incorporated in California in 1960 and maintains its
principal executive office at 2500 Del Monte Street, West Sacramento, California
95691. Its telephone number is (916) 373-2500.
INDUSTRY
The worldwide market for recorded music has grown from approximately $29.4
billion in calendar 1992 to approximately $40.2 billion in calendar 1996. The
top five markets, North America, Western Europe, Japan, Latin America and Asia
(outside of Japan), individually accounted for approximately 32.9%, 32.8%,
17.0%, 6.2% and 5.6%, respectively, and collectively accounted for approximately
94.5%, of the global market in calendar 1996. Management believes that the
following factors are the primary drivers of growth in the industry globally:
(i) overall population growth in major markets, (ii) technological innovations
in the delivery of recorded music, (iii) continued compact disc format
penetration and (iv) the success of new music releases.
In the United States, there are four primary channels of recorded music
distribution: specialty music retail stores, discount and consumer electronics
stores, record clubs, and mail order and other channels, which accounted for
approximately 49.9%, 31.5%, 14.3% and 4.3% of unit shipments, respectively, in
calendar 1996. The U.S. market for recorded music has grown from approximately
$9.0 billion in calendar 1992 to approximately $12.2 billion in calendar 1997.
However, beginning in 1995, the volume of recorded music shipped to retailers
slowed and then declined by approximately 2.0% in 1997 primarily due to: (i)
overshipment of product by manufacturers to certain retailers in 1995 and 1996,
(ii) store rationalization by certain mall-based and discount music retailers
following an aggressive overexpansion of music retail square footage from 1992
to 1994, (iii) a lack of new technological innovations influencing the delivery
of recorded music, (iv) continued maturation of the compact disc format, and (v)
disappointing new releases. Management believes that the market and the outlook
for music retailers improved in the United States starting in the second half of
calendar 1997, primarily due to a reduction in domestic music retail square
footage as certain electronics retailers reduced music store selling space and
narrowed their catalog selections in response to difficulties in successfully
implementing "loss leader" music retail sales strategies, continued store
consolidation of mall-based music retailers, the release of several successful
new titles and positive demographic trends. The Company believes that it is
well-situated in the industry because of its store base, merchandising strategy
and long-standing supplier relationships. See "Market and Industry Data."
2
THE RECAPITALIZATION
Prior to April 1998, substantially all of the capital stock of the Company
was owned by a revocable trust established by the Company's founder, Russell M.
Solomon (the "Russell Solomon Trust"). In April 1998, the Company consummated
certain transactions designed to consolidate substantially all of the Tower
business operations in the Company (the "Reorganization," as described more
fully in "Certain Transactions--The Reorganization"), and also transferred
certain assets to the Trusts (the "Prior Asset Exchange," as defined in "Certain
Transactions--Prior Transfer of Certain Assets to Trusts"), which were
established for the benefit of Mr. Solomon's sons, Michael Solomon and David
Solomon. As a result of the Reorganization, the Company is now a wholly-owned
subsidiary of a recently formed holding company, TOWER RECORDS, INCORPORATED
("Parent"). The Reorganization included an exchange by the Company's
shareholders of their common shares in the Company for a controlling equity
interest in Parent. As part of the Reorganization, the Trusts and certain
Solomon family members contributed to Parent certain business assets (subject to
certain liabilities), including wholesale distribution operations, in exchange
for the remaining equity interest in Parent. Separately, Parent contributed such
assets and liabilities received from the Trusts and such Solomon family members
to the Company. See "The Recapitalization--The Reorganization," "Certain
Transactions--The Reorganization," and Note 2 to "Consolidated Financial
Statements."
In April 1998 the Company refinanced previously outstanding indebtedness of
approximately $168.0 million under its former $195.0 million senior revolving
credit facility (the "Former Credit Facility") and approximately $64.3 million
of other previously outstanding indebtedness by consummating the Existing Notes
Offering and entering into certain new senior secured revolving credit
facilities (such new secured credit facilities, collectively, the "New Credit
Facility" and, together with the Existing Notes Offering, the "Refinancing")
(the Refinancing and the Reorganization are hereinafter collectively referred to
as the "Recapitalization"). The New Credit Facility provides for an aggregate
$275.0 million commitment, of which approximately $150.0 million can be borrowed
in Japanese yen and a portion in British pounds. Aggregate borrowings are
subject to compliance with a borrowing base formula. As of April 30, 1998, an
aggregate of approximately $245.1 million was available under the New Credit
Facility based upon the borrowing base formula, of which approximately $120.6
million had been drawn. See "The Recapitalization--The Refinancing,"
"Capitalization" and "Description of New Credit Facility."
3
THE EXCHANGE OFFER
SECURITIES OFFERED................ $110,000,000 in aggregate principal amount of New 9 3/8%
Senior Subordinated Notes due 2005.
THE EXCHANGE OFFER................ $1,000 principal amount of the New Notes in exchange for
each $1,000 principal amount of Existing Notes. As of
the date hereof, $110,000,000 aggregate principal amount
of Existing Notes are outstanding. The Company will
issue the New Notes to New Holders on or promptly after
the Expiration Date.
Based on an interpretation by the Staff set forth in
no-action letters issued to third parties, the Company
believes that New Notes issued pursuant to the Exchange
Offer in exchange for Existing Notes may be offered for
resale, resold and otherwise transferred by any Holder
thereof (other than any such Holder which is an
affiliate of the Company or is a broker-dealer which
acquired such Existing Notes directly from the Company)
without compliance with the registration and prospectus
delivery provisions of the Securities Act, provided that
(i) such New Notes are acquired in the ordinary course
of such Holder's business, (ii) such Holder has no
arrangement or understanding with any person to
participate in the distribution of such New Notes, and
(iii) such Holder is not engaged in, and does not intend
to engage in the, or a, distribution of the New Notes.
Each Exchanging Dealer that acquired such Existing Notes
as a result of market making or other trading activity
and that receives New Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will
deliver a prospectus in connection with any resale of
such New Notes. The Company has agreed that this
Prospectus, as it may be amended or supplemented from
time to time, may be used, subject to certain provisions
of the Registration Rights Agreement, by such an
Exchanging Dealer in connection with such resales for a
period of 180 days following effectiveness of the
Exchange Offer Registration Statement. See "The Exchange
Offer--Resales of New Notes" and "Plan of Distribution."
Any Existing Holder who (i) is an affiliate of the
Company, (ii) does not acquire such New Notes in the
ordinary course of its business, (iii) tenders in the
Exchange Offer with the intention to participate, or for
the purpose of participating, in a distribution of the
New Notes, or (iv) is a broker-dealer which acquired
such Existing Notes directly from the Company, could not
rely on the position of the Staff enunciated in the
Exxon Capital No-Action Letter, the Morgan Stanley
No-Action Letter or similar no-action letters and, in
the absence of an exemption therefrom, must comply with
the registration and prospectus delivery requirements of
the Securities Act in connection with the resale of the
New Notes. Failure to comply with such requirements in
such instance may result in such Holder
4
incurring liability under the Securities Act for which
the Holder is not indemnified by the Company.
No federal or state regulatory requirements must be
complied with or approval obtained in connection with
the Exchange Offer, other than registration requirements
under the Securities Act and compliance with the
registration or comparable provisions of applicable
state securities laws.
EXPIRATION DATE................... 5:00 p.m., New York City time, on October 16, 1998 (30
days after this Prospectus was sent to Existing
Holders), unless the Exchange Offer is extended by the
Company in its sole discretion, in which case the term
"Expiration Date" means the latest date and time to
which the Exchange Offer is extended. The Company will
not extend the Expiration Date beyond 5:00 p.m., New
York City time, on November 15, 1998 (60 days after this
Prospectus was sent to Existing Holders).
INTEREST ON THE NEW NOTES AND THE
EXISTING NOTES.................. Each New Note will bear interest from the most recent
date to which interest has been paid or duly provided
for on the Existing Note surrendered in exchange for
such New Note or, if no such interest has been paid or
duly provided for on such Existing Note, from April 23,
1998. Holders of the Existing Notes whose Existing Notes
are accepted for exchange will not receive accrued
interest on such Existing Notes for any period from and
after the last Interest Payment Date to which interest
has been paid or duly provided for on such Existing
Notes prior to the original issue date of the New Notes
or, if no such interest has been paid or duly provided
for, will not receive any accrued interest on such
Existing Notes, and will be deemed to have waived the
right to receive any interest on such Existing Notes
accrued from and after such Interest Payment Date or, if
no such interest has been paid or duly provided for,
from and after April 23, 1998.
AMENDMENT OR TERMINATION OF THE
EXCHANGE OFFER.................. The Company is not required to accept any Existing Notes
for exchange, and may amend or terminate the Exchange
Offer in its sole discretion at any time before
acceptance of such Existing Notes for exchange. By way
of example, the following constitute some, but not all,
of the reasons the Company might choose to amend or
terminate the Exchange Offer: (i) the Exchange Offer
would violate applicable law, (ii) a judicial or
administrative action or proceeding might materially
impair the Company's ability to proceed with the
Exchange Offer, (iii) any necessary governmental
approvals are not obtained, (iv) a stock market or
banking moratorium has occurred, or (v) a stop order has
been issued or threatened which would suspend
effectiveness of the Exchange Offer Registration
Statement. See "The Exchange Offer--Amendments;
Termination."
5
PROCEDURES FOR TENDERING EXISTING
NOTES........................... Each Existing Holder wishing to accept the Exchange
Offer must complete, sign and date the accompanying
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein and
therein, and mail or otherwise deliver the Letter of
Transmittal, or such facsimile, together with the
Existing Notes and any other required documentation to
the Exchange Agent (as defined below) at the address set
forth in the Letter of Transmittal. PERSONS HOLDING
EXISTING NOTES THROUGH THE DEPOSITARY (INITIALLY THE
DEPOSITORY TRUST COMPANY ("DTC")) AND WISHING TO ACCEPT
THE EXCHANGE OFFER MUST DO SO PURSUANT TO DTC'S
AUTOMATED TENDER OFFER PROGRAM ("ATOP"), BY WHICH EACH
TENDERING PARTICIPANT WILL AGREE TO BE BOUND BY THE
LETTER OF TRANSMITTAL. By executing or agreeing to be
bound by the Letter of Transmittal, each Existing Holder
will represent to the Company that, among other things,
such Holder (i) is not an affiliate of the Company, (ii)
is acquiring the New Notes in the ordinary course of
business, (iii) has no arrangement or understanding with
any person to participate in the distribution of such
New Notes, and (iv) is not engaged in, and does not
intend to engage in, a distribution of the New Notes.
SPECIAL PROCEDURES FOR BENEFICIAL
OWNERS.......................... Any beneficial owner whose Existing Notes are registered
in the name of a broker, dealer, commercial bank, trust
company or other nominee and who wishes to tender should
contact such registered Holder promptly and instruct
such registered Holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes to
tender on such owner's own behalf, such owner must,
prior to completing and executing the Letter of
Transmittal and delivering its Existing Notes, either
make appropriate arrangements to register ownership of
the Existing Notes in such owner's name or obtain a
properly completed bond power from the registered
Holder. The transfer of registered ownership may take
considerable time.
GUARANTEED DELIVERY PROCEDURES.... Existing Holders who wish to tender their Existing Notes
and whose Existing Notes are not immediately available
or who cannot deliver their Existing Notes, the Letter
of Transmittal or any other documents required by the
Letter of Transmittal to the Exchange Agent (or comply
with the procedures for book-entry transfer) prior to
the Expiration Date must tender their Existing Notes
according to the guaranteed delivery procedures set
forth in "The Exchange Offer--Guaranteed Delivery
Procedures."
WITHDRAWAL RIGHTS................. Tenders may be withdrawn at any time prior to 5:00 p.m.,
New York City time, on the Expiration Date pursuant to
the procedures described under "The Exchange Offer--
Withdrawals of Tenders."
6
ACCEPTANCE OF EXISTING NOTES AND
DELIVERY OF NEW NOTES........... The Company will accept for exchange any and all
Existing Notes that are properly tendered in the
Exchange Offer prior to 5:00 p.m., New York City time,
on the Expiration Date. The New Notes issued pursuant to
the Exchange Offer will be delivered promptly following
the Expiration Date. See "The Exchange Offer--Terms of
the Exchange Offer."
FEDERAL INCOME TAX
CONSIDERATIONS.................. The exchange of the New Notes for the Existing Notes
pursuant to the Exchange Offer will not be taxable to
the Holders thereof for federal income tax purposes.
However, no ruling has been obtained from the Internal
Revenue Service in connection with the Exchange Offer.
See "Federal Income Tax Considerations."
EFFECT ON HOLDERS OF EXISTING
NOTES........................... As a result of the making of this Exchange Offer, the
Company will have fulfilled certain of its obligations
under the Registration Rights Agreement, and Existing
Holders who do not tender their Existing Notes, except
for limited instances involving the Initial Purchasers
and Existing Holders that are not eligible to
participate in the Exchange Offer, will not have any
further registration rights under the Registration
Rights Agreement or otherwise. See "The Exchange
Offer--Purposes and Effect of Exchange Offer." Such
Existing Holders will continue to hold the untendered
Existing Notes and will be entitled to all the rights
and subject to all the limitations applicable thereto
under the Indenture, except to the extent such rights or
limitations, by their terms, terminate or cease to have
further effectiveness as a result of the Exchange Offer.
All untendered Existing Notes will continue to be
subject to certain restrictions on transfer.
Accordingly, if any Existing Notes are tendered and
accepted in the Exchange Offer, the trading market for
the untendered Existing Notes could be adversely
affected.
EXCHANGE AGENT.................... State Street Bank and Trust Company of California, N.A.
7
SUMMARY OF TERMS OF NEW NOTES
The form and terms of the New Notes are the same as the form and terms of
the Existing Notes (which they replace) except that (i) the New Notes have been
registered under the Securities Act and, therefore, will not bear legends
restricting the transfer thereof, and (ii) the Holders of New Notes, except for
limited instances involving the Initial Purchasers and certain Holders that are
not eligible to participate in the Exchange Offer, will not be entitled to
further registration rights under the Registration Rights Agreement, which
rights will be satisfied when the Exchange Offer is consummated, and will not be
entitled to any payments of Additional Interest for failure to satisfy such
rights. The New Notes will evidence the same debt as the Existing Notes and will
be entitled to the benefits of the Indenture. See "Description of Notes."
ISSUER............................ MTS, INCORPORATED
SECURITIES OFFERED.............................. $110,000,000 aggregate principal amount of New 9 3/8% Senior Subordinated Notes
due 2005.
MATURITY........................................ May 1, 2005.
INTEREST PAYMENT DATES.......................... May 1 and November 1, commencing November 1, 1998.
SINKING FUND.................................... None.
OPTIONAL REDEMPTION............................. Except as described below, the Company may not redeem the Notes prior to May 1,
2002. On or after such date, the Company may redeem the Notes, in whole or in
part, at the redemption prices set forth herein, together with accrued and
unpaid interest, if any, to the date of redemption. In addition, at any time
and from time to time on or prior to May 1, 2001, the Company may redeem up to
35% of the aggregate principal amount of the Notes with the net cash proceeds
of one or more private or public Equity Offerings received by the Company, at a
redemption price equal to 109.375% of the principal amount to be redeemed,
together with accrued and unpaid interest, if any, to the date of redemption,
provided that at least 65% of the originally issued aggregate principal amount
of the Notes remains outstanding after each such redemption. See "Description
of the Notes--Optional Redemption."
CHANGE OF CONTROL............................... Upon the occurrence of a Change of Control, the Company will be required to
make an offer to repurchase the Notes at a price equal to 101% of the principal
amount thereof, together with accrued and unpaid interest, if any, to the date
of purchase. The Company's ability to repurchase the Notes upon a Change of
Control is subject to a number of financial and legal limitations, including a
prohibition on most such repurchases under the New Credit Facility. Upon the
occurrence of a Change of Control, if it is prohibited by the terms of any
outstanding Indebtedness from making an Offer to Repurchase (as defined) or
from repurchasing the Notes, the Company is required to either (i) repay all
such Indebtedness and terminate all commitments outstanding thereunder or (ii)
obtain the requisite consents under any such Indebtedness required to permit
the Offer to Repurchase or the repurchase of the Notes. The New Credit Facility
provides for loans up to a
8
maximum amount of $275 million and, if the requisite consents from the lenders
thereunder are not forthcoming, it is unlikely that the Company would be able
to repay all of its obligations under the New Credit Facility and repurchase
the Notes unless it could obtain alternative financing. There can be no
assurance that the Company would be able to obtain any such financing on
commercially reasonable terms, or at all, and consequently no assurance can be
given that the Company would be able to repurchase any of the Notes tendered
pursuant to such an Offer to Purchase. See "Risk Factors-- Change of Control"
and "Description of the Notes--Offer to Purchase upon Change of Control."
RANKING......................................... The Notes are unsecured and are subordinated in right of payment to all
existing and future Senior Indebtedness of the Company. The Notes rank pari
passu in right of payment with any future senior subordinated indebtedness of
the Company and rank senior to all Subordinated Indebtedness of the Company.
The Notes are effectively subordinated to all indebtedness and other
obligations of the Company's existing and future subsidiaries. As of April 30,
1998, the aggregate principal amount of the Company's outstanding Senior
Indebtedness was approximately $131.1 million and had unused availability under
its New Credit Facility of up to $154.4 million, of which approximately $124.5
million was available under the Borrowing Base formula contained in the New
Credit Facility. As of April 30, 1998, the Company had no Subordinated
Indebtedness outstanding and no senior subordinated indebtedness outstanding
other than the Notes and has no current plans, arrangements or agreements to
issue indebtedness junior to, pari passu with, or senior to, the Notes. See
"Description of the Notes--Subordination of the Notes."
RESTRICTIVE COVENANTS........................... The Indenture, under which the Existing Notes were and the New Notes will be
issued, limits, among other things, (i) the incurrence of additional
indebtedness by the Company and its Restricted Subsidiaries (as defined), (ii)
the payment of dividends on, and redemption of, capital stock of the Company
and the redemption of certain subordinated obligations of the Company, (iii)
Investments (as defined), (iv) sales of assets and Restricted Subsidiary stock,
(v) transactions with Affiliates (as defined) and (vi) consolidations, mergers
and transfers of all or substantially all of the Company's assets. The
Indenture also prohibits certain restrictions on distributions from Restricted
Subsidiaries. However, all of these limitations and prohibitions are subject to
a number of important qualifications and exceptions. See "Description of the
Notes--Certain Covenants."
TRANSFER RESTRICTIONS........................... For restrictions on transfer of the New Notes, see "The Exchange Offer--Resale
of New Notes."
9
USE OF PROCEEDS................................. All Existing Notes received and accepted by the Company, in its sole
discretion, for exchange in the Exchange Offer will be cancelled.
RISK FACTORS
Prospective investors should carefully consider all of the information set
forth in this Prospectus and, in particular, should evaluate the specific
factors set forth under "Risk Factors" for risks involved with an investment in
the Notes. Such risks include: (i) the Company's substantial leverage consisting
of $241.1 million in total debt as of April 30, 1998 and debt service
obligations as defined by the ratio of earnings to fixed charges of 1.5x for the
nine-month period ended April 30, 1998 (for definition, please refer to Notes to
Selected Historical Consolidated Financial Information), (ii) the subordination
of the Notes to all existing and future Senior Indebtedness, which was $131
million as of April 30, 1998, and (iii) the impact of worldwide economic
conditions and cyclicality of the music industry.
10
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
The summary historical consolidated financial information presented below as
of July 31, 1996 and 1997 and for each of the years in the three-year period
ended July 31, 1997 have been derived from and should be read in conjunction
with the audited consolidated financial statements of the Company included
elsewhere in this Prospectus. The summary historical consolidated financial
information presented below as of July 31, 1993, 1994 and 1995 and for each of
the years in the two-year period ended July 31, 1994 have been derived from the
audited consolidated financial statements of the Company not included elsewhere
in this Prospectus. The summary historical consolidated financial information as
of April 30, 1998 and for the nine months ended April 30, 1997 and 1998 have
been derived from and should be read in conjunction with the unaudited
consolidated financial statements of the Company included elsewhere in this
Prospectus. The summary historical consolidated financial data as of April 30,
1997 have been derived from the unaudited financial statements of the Company
not included in this Prospectus. The summary historical consolidated financial
information has been retroactively restated to give effect to the
Reorganization. The unaudited consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements and
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the Company's financial condition and
results of operations for those periods. Operating results for the nine months
ended April 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended July 31, 1998 or for any future period. This data
should be read in conjunction with the consolidated financial statements and
notes thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Selected Historical Consolidated Financial Information"
and other financial information included elsewhere in this Prospectus.
NINE
MONTHS
ENDED
YEAR ENDED JULY 31, APRIL 30,
----------------------------------------------------- ---------
1993 1994 1995 1996 1997 1997
--------- --------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
INCOME STATEMENT DATA:
Net revenues........................................... $ 699.4 $ 808.5 $ 950.6 $ 1,001.0 $ 991.8 $ 752.5
Gross profit........................................... 225.4 264.6 310.0 324.9 322.5 244.1
Selling, general and administrative expenses........... 183.7 212.6 255.1 270.4 267.6 202.1
Depreciation and amortization.......................... 15.1 17.4 22.9 20.9 26.4 17.3
--------- --------- --------- --------- --------- ---------
Income from operations................................. 26.6 34.6 32.0 33.6 28.5 24.7
Interest expense....................................... 6.7 7.8 11.5 14.9 14.3 11.5
Net income............................................. 14.7 17.3 15.1 10.0 3.5 5.3
OTHER DATA:
Ratio of earnings to fixed charges(a).................. 2.4x 2.2x 1.8x 1.5x 1.3x 1.4x
BALANCE SHEET DATA (AT PERIOD END):
Total assets........................................... $ 346.9 $ 412.7 $ 505.1 $ 528.8 $ 544.6 $ 541.9
Total debt (including current maturities).............. 116.2 140.5 199.6 202.8 211.3 222.9
Shareholders' equity................................... 95.0 112.1 127.5 135.1 134.0 135.4
1998
---------
INCOME STATEMENT DATA:
Net revenues........................................... $ 771.4
Gross profit........................................... 246.5
Selling, general and administrative expenses........... 204.8
Depreciation and amortization.......................... 17.6
---------
Income from operations................................. 24.1
Interest expense....................................... 10.4
Net income............................................. 7.4
OTHER DATA:
Ratio of earnings to fixed charges(a).................. 1.5x
BALANCE SHEET DATA (AT PERIOD END):
Total assets........................................... $ 531.6
Total debt (including current maturities).............. 241.1
Shareholders' equity................................... 127.2
- ------------------------
(a) Ratio of earnings to fixed charges is computed by dividing (i) the sum of
income before taxes and fixed charges by (ii) fixed charges. Fixed charges
consist of the sum of interest expense, interest expense capitalized, the
amortization of deferred financing costs, and 35% of rental expense
representing management's determination of a reasonable approximation of
interest costs on rents.
11
RISK FACTORS
AN INVESTMENT IN THE NEW NOTES OFFERED HEREBY IS SPECULATIVE IN NATURE AND
INVOLVES A HIGH DEGREE OF RISK. PROSPECTIVE PURCHASERS OF THE NEW NOTES OFFERED
HEREBY SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS, AS WELL AS THE
OTHER INFORMATION SET FORTH IN THIS PROSPECTUS, PRIOR TO MAKING AN INVESTMENT IN
THE NEW NOTES. THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE KNOWN AND UNKNOWN RISKS AND UNCERTAINTIES. SEE THE COVER PAGE,
"FORWARD-LOOKING STATEMENTS."
SUBSTANTIAL LEVERAGE AND DEBT SERVICE OBLIGATIONS
After giving effect to the Recapitalization, including the Existing Notes
Offering, the initial borrowings under the New Credit Facility and the
application of the proceeds therefrom, the Company is substantially leveraged.
On such a basis, the Company's aggregate outstanding indebtedness was $241.1
million and the Company's shareholders' equity was $127.2 million at April 30,
1998. The Company also has substantial rental obligations. The New Credit
Facility and the Indenture permit the Company and its subsidiaries to incur or
guarantee certain additional indebtedness, subject to certain limitations. The
New Credit Facility matures prior to the maturity of the Notes. In the event
that the Company is unable to refinance the New Credit Facility, its ability to
repay the principal and interest on the Notes would be adversely affected. See
"The Recapitalization--The Refinancing," "Use of Proceeds," "Capitalization,"
"Description of New Credit Facility" and "Description of the Notes."
The Company's substantial degree of leverage could have important
consequences to its lenders, including but not limited to, the following: (i)
the Company's ability to obtain additional financing for working capital,
capital expenditures, acquisitions, general corporate purposes or other purposes
may be impaired in the future, (ii) a substantial portion of the Company's cash
flow from operations must be dedicated to the payment of principal and interest
on its indebtedness, thereby reducing the funds available to the Company for
other purposes, (iii) certain of the Company's borrowings, including those under
the New Credit Facility, will be at variable rates of interest which exposes the
Company to interest rate fluctuation risk, (iv) the Company may be hindered in
its ability to adjust rapidly to changing market conditions and (v) the Company
could be more vulnerable in the event of a downturn in general economic
conditions or its business.
The Company's ability to repay or to refinance its obligations with respect
to its indebtedness and meet its other obligations (including substantial rental
obligations) will depend on its financial and operating performance, which, in
turn, is subject to prevailing economic and competitive conditions in the United
States and other countries where it operates and to certain financial, business
and other factors, many of which are beyond the Company's control. See the cover
page, "Forward-Looking Statements."
There can be no assurance that the Company's cash flow and capital resources
will be sufficient for payment of interest on and principal of its indebtedness
in the future. If the Company's cash flow and capital resources are insufficient
to fund its debt service obligations, the Company may be forced to reduce or
delay capital expenditures, sell assets, seek to obtain additional equity
capital, or restructure its debt. There can be no assurance that any such
alternative measures would be successful or would permit the Company to meet its
scheduled debt obligations. In the absence of sufficient cash flow and capital
resources, the Company could face substantial liquidity problems and could be
required to dispose of material assets or operations to meet its debt service
and other obligations, and there can be no assurance as to whether the Company's
lenders would consent to such actions, or as to the timing or amount of the
proceeds that the Company could realize from such actions.
SUBORDINATION OF NOTES
The payment of principal of and interest on, and any premium or other
amounts owing in respect of, the Notes is subordinated to the prior payment in
full of all existing and future Senior Indebtedness of the
12
Company, including all amounts owing or guaranteed under the New Credit
Facility. Consequently, in the event of a bankruptcy, liquidation, dissolution,
reorganization or similar proceeding with respect to the Company, assets of the
Company will be available to pay obligations on the Notes only after all Senior
Indebtedness of the Company has been paid in full, and there can be no assurance
that there will be sufficient assets to pay amounts due on any or all of the
Notes. The Notes are effectively subordinated to all indebtedness and other
obligations of the Company's existing and future subsidiaries. See "Description
of the Notes---Subordination of the Notes." At April 30, 1998, the Company had
approximately $131.1 million of Senior Indebtedness outstanding, of which
approximately $17.3 million constituted indebtedness of the Company's
subsidiaries.
CYCLICALITY OF THE MUSIC INDUSTRY AND THE IMPACT OF TECHNOLOGICAL INNOVATIONS
The Company's business is affected by the release of "hit" music titles,
which can create cyclical trends in sales distinctive to the music industry. It
is not possible to determine the timing of these cycles or the future
availability of hit titles. The Company's business may also be affected by
changes in music entertainment technology. While technological advances such as
compact discs have had a favorable impact on industry growth in the past, there
can be no assurance that future advances will continue to have a favorable
impact on music entertainment product retailers. In particular, Internet and
cable technologies coupled with high-quality digital recording technologies
could allow direct downloading of recorded music by consumers. If the industry
experiences a dearth of hit music titles or such technological changes were to
result in significant changes in existing distribution channels for prerecorded
music, the Company's business, financial condition or results of operations
could be materially and adversely affected.
COMPETITION
The retail music business is highly competitive. The Company competes with a
wide variety of music retailers, including regional and national mall-based
music chains, international chains, deep-discount retailers, mass merchandisers,
consumer electronics outlets, mail order, record clubs and independent
operators, some of which have greater financial and other resources than the
Company. In retail music sales, some of the Company's competitors have been
expanding into the Company's markets. Further, the Company expects continued
growth in competing home entertainment options, including the Internet and
larger numbers of television and music channels offered by cable companies. Such
competition may reduce sales at music stores, put pressure on gross margins,
increase operating expenses and decrease profit margins in specific markets.
There can be no assurances that the music retail business will continue to be a
viable business, that retail stores will continue to be a primary channel for
distribution of recorded music, or that the Company will continue to compete
successfully within the music retail store sector and within the music retail
business generally. See "Business-- Competition."
CONSUMER SPENDING
The Company's business is directly affected by the level of consumer
spending. One of the primary factors that affects consumer spending is the
general state of the local economies in which the Company operates. Lower levels
of consumer spending in regions in which the Company has significant operations
could have a material adverse effect on the Company's business, financial
condition or results of operations.
RISKS ASSOCIATED WITH EXPANSION
The Company's future financial prospects will depend in part on its ability
to open and operate new stores profitably. During the two year period ended July
31, 1997, the Company opened two new stores in the United States and 23 new
stores internationally. The Company intends to open additional stores in
13
both existing and new, U.S. and international geographic markets. However, the
opening of additional stores in an existing market could result in lower net
sales from existing Company stores in that market. The success of the Company's
planned expansion will be dependent upon many factors, including the
identification of suitable markets, the availability and leasing of suitable
store locations on acceptable terms, the hiring, training and retention of
qualified management and other store personnel, the availability of appropriate
financing and general economic conditions. To manage its planned expansion, the
Company must ensure the continuing adequacy of its existing product distribution
facilities, store management controls, financial controls and information
systems. There can be no assurance that the Company will be able to adequately
anticipate all of the demands which continuing expansion will impose on its
operating systems, that new stores will be effectively integrated into the
Company's existing operations or that such stores will be profitable.
In addition, the new geographic markets into which the Company is expanding
may present competitive and merchandising challenges that are different from
those currently faced by the Company in its existing geographic markets. The
Company may incur higher costs related to advertising and distribution in
connection with entering certain new markets. If the Company opens stores in new
markets that do not perform to the Company's expectations, if new stores do not
reach profitability as soon as expected or if stores openings are delayed, the
Company's business, financial condition or results of operations could be
materially adversely affected.
RISKS RELATING TO INTERNATIONAL OPERATIONS
The Company has substantial operations and assets located outside the United
States, primarily in the United Kingdom and Japan. With respect to international
operations, principally all of Tower's revenues and costs (including borrowing
costs) are incurred in the local currency, except that certain inventory
purchases are tied to U.S. dollars. The Company's financial performance on a
U.S. dollar-denominated basis has historically been significantly affected by
changes in currency exchange rates. Changes in certain exchange rates could
adversely affect the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
International operations are also subject to a number of other special
risks, including trade barriers, exchange controls, governmental expropriation,
political risks and risks of increases in taxes. In addition, the laws of
certain foreign countries do not protect the Company's trademark, trade name,
copyright and other intellectual property rights to the same extent as do the
laws of the United States. Also, various jurisdictions outside the United States
have laws limiting the right and ability of non-U.S. subsidiaries and affiliates
to pay dividends and remit earnings to affiliated companies unless specified
conditions are met. Earnings of international subsidiaries are subject to income
taxes of non-U.S. jurisdictions that reduce cash flow available to meet required
debt service and other obligations of the Company.
RESTRICTIVE COVENANTS
The New Credit Facility contains a number of significant covenants that
restrict the manner in which the Company conducts its business, and require the
Company to comply with specified ratios and financial tests. See "Description of
New Credit Facility." The Indenture also contains certain restrictive covenants.
See "Description of the Notes--Certain Covenants." The Company's ability to
comply with these covenant requirements may be affected by events beyond its
control, including prevailing economic, financial and industry conditions. The
breach of any such covenants or restrictions could result in a default under the
relevant financing agreements that would permit the relevant lenders or debt
holders to declare all amounts outstanding thereunder to be due and payable,
together with accrued and unpaid interest, and the commitments of the lenders
under the New Credit Facility to make further extensions of credit thereunder
could be terminated.
14
LIMITATION ON ABILITY TO REPURCHASE NOTES UPON CHANGE OF CONTROL
The Indenture provides that, upon the occurrence of a Change of Control, the
Company will be required to make an offer to repurchase all of the Notes issued
and then outstanding under the Indenture at a purchase price equal to 101% of
the principal amount thereof plus accrued and unpaid interest thereon and other
amounts due with respect thereto through the date of repurchase. See
"Description of the Notes--Offer to Repurchase upon Change of Control." Any
Change of Control under the Indenture would constitute a default under the New
Credit Facility. Therefore, upon the occurrence of a Change of Control, the
lenders under the New Credit Facility would have the right to accelerate their
loans and the holders of the Notes would have the right to require the Company
to repurchase their Notes. Upon such event, such lenders would be entitled to
receive payment of all outstanding obligations under the New Credit Facility
before the Company may repurchase any of the Notes tendered pursuant to such an
offer. See "Description of New Credit Facility." If a Change of Control were to
occur, it is unlikely that the Company would be able to repay all of its
obligations under the New Credit Facility and the Notes unless it could obtain
alternative financing. There can be no assurance that the Company would be able
to obtain any such financing on commercially reasonable terms, or at all, and
consequently no assurance can be given that the Company would be able to
repurchase any of the Notes tendered pursuant to such an offer.
DEPENDENCE ON KEY PERSONNEL
The Company believes that its future prospects depend to a significant
extent on the services of its executive officers, as well as its ability to
attract and retain additional key personnel with the skills and expertise
necessary to manage its planned growth. The loss or unavailability of the
services of certain of the Company's executive officers and other key management
personnel, including its founder, Russell M. Solomon, could have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management."
CONTROL BY PRINCIPAL SHAREHOLDER
Russell M. Solomon, President and Chief Executive Officer and a director of
the Company, beneficially owns a majority of Parent's outstanding voting
securities. Accordingly, Mr. Solomon has the ability to elect all of the members
of the Board of Directors of Parent and to determine the outcome of any matter
submitted to the shareholders for approval, including corporate transactions
such as mergers, consolidations and the sale of all or substantially all of the
assets of the Company. See "Ownership of Capital Stock."
DEPENDENCE ON INFORMATION SYSTEMS; YEAR 2000 TECHNOLOGY RISK
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, within the
next two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. The Company has
budgeted for and is currently utilizing in-house information technology staff
and outside consultants to analyze and upgrade its management systems software
to make it Year 2000 compliant, a process which the Company expects to complete
in late 1998. The Company also intends to implement its ISP system in Japan in
early 1999 which should make the Company's entire inventory management system
Year 2000 compliant. Failure by the Company to complete implementation of the
required changes to address Year 2000 requirements prior to the year 2000 might
result in significant difficulties in the Company's administration of corporate
and inventory software systems and consequently have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company has not conducted a review of the preparations of its major vendors,
distributors and shippers to meet the Year 2000 requirements and
15
does not have a basis to assess the impact, if any, that the Year 2000
requirements will have on its vendors, distributors and shippers and
consequently on the Company. Failure by the Company's vendors, distributors,
shippers and other parties with which the Company does business to address Year
2000 requirements could adversely affect the Company's ability to distribute
products for some period of time and otherwise disrupt the Company's business
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Compliance."
ABSENCE OF PUBLIC MARKET FOR THE NOTES
The Existing Notes are currently owned by a relatively small number of
beneficial owners. The Existing Notes have not been registered under the
Securities Act or any state securities laws and, unless so registered and to the
extent not exchanged for the New Notes, may not be offered or sold except
pursuant to an exemption from, or in a transaction not subject to, the
registration requirements of the Securities Act and applicable state securities
laws. Any Existing Notes tendered and exchanged in the Exchange Offer will
reduce the aggregate principal amount of Existing Notes outstanding. Following
the consummation of the Exchange Offer, Existing Holders who did not tender
their Existing Notes generally will not have any further registration rights
under the Registration Rights Agreement, and such Existing Notes will continue
to be subject to certain restrictions on transfer. Accordingly, the liquidity of
the market for such Existing Notes could be adversely affected. The Existing
Notes are currently eligible for sale pursuant to Rule 144A through The Portal
Market of the National Association of Securities Dealers, Inc. ("Portal").
Because the Company anticipates that most Existing Holders will elect to
exchange such Existing Notes for New Notes in order to reduce restrictions on
the resale of New Notes under the Securities Act, the Company anticipates that
the liquidity of the market for any Existing Notes remaining after the
consummation of the Exchange Offer may be substantially limited.
The New Notes will constitute a new issue of securities for which there is
currently no active trading market. If the New Notes are traded after their
initial issuance, they may trade at a discount from their initial offering
price, depending upon prevailing interest rates, the market for similar
securities and other factors including general economic conditions and the
current financial condition, results of operations and business prospects of the
Company. Although the New Notes will generally be permitted to be resold or
otherwise transferred by non-affiliates of the Company without compliance with
the registration and prospectus delivery requirements of the Securities Act, the
Company does not intend to apply for a listing or quotation of the New Notes on
any securities exchange or stock market. The Initial Purchasers have informed
the Company that they currently intend to make a market in the New Notes.
However, the Initial Purchasers are not obligated to do so, and any such
market-making may be discontinued at any time without notice. In addition, such
market-making activity will be subject to the limits imposed under the Exchange
Act. Accordingly, there can be no assurance as to the development, liquidity or
maintenance of any market for the New Notes, or, in the case of non-tendering
Existing Holders, the trading market for the Existing Notes following the
Exchange Offer. If no trading market develops or is maintained, New Holders may
experience difficulty in reselling New Notes or may be unable to sell them.
The liquidity of, and trading market for, the Existing Notes or the New
Notes also may be adversely affected by general declines in the market for
similar securities. Such a decline may adversely affect such liquidity and
trading markets independent of the financial performance of, and prospects for,
the Company.
CONSEQUENCES OF FAILURE TO EXCHANGE
Existing Holders who do not exchange their Existing Notes for New Notes
pursuant to the Exchange Offer will continue to be subject to the restrictions
on transfer of such Existing Notes as set forth in the legend thereon as a
consequence of the original issuance of the Existing Notes pursuant to
exemptions from, or in transactions not subject to, the registration
requirements of the Securities Act and applicable state securities laws. In
general, the Existing Notes may not be offered or sold, unless (i) to a person
who
16
the seller reasonably believes is a qualified institutional buyer in a
transaction meeting the requirements of Rule 144A, in a transaction meeting the
requirements of Rule 144A under the Securities Act, (ii) in a transaction
occurring outside the United States to a foreign person, which transaction meets
the requirements of Rule 904 under the Securities Act, (iii) in accordance with
another exemption from the registration requirements of the Securities Act (and
based upon an opinion of counsel if the Company so requests), (iv) to the
Company, or (v) pursuant to an effective registration statement, and, in each
case, in accordance with any applicable securities laws of any state of the
United States or any other applicable jurisdiction. The Company does not
currently anticipate that it will register the Existing Notes under the
Securities Act. Based on interpretations by the Staff, as set forth in no-action
letters issued to third parties, the Company believes that New Notes issued
pursuant to the Exchange Offer in exchange for Existing Notes may be offered for
resale, resold or otherwise transferred by Holders thereof (other than any such
Holder which is an affiliate of the Company or is a broker-dealer which acquired
such Existing Notes directly from the Company) without compliance with the
registration and prospectus delivery requirements of the Securities Act,
provided that (i) such New Notes are acquired in the ordinary course of such
Holder's business, (ii) such Holder has no arrangement or understanding with any
person to participate in the distribution of such New Notes, (iii) such Holder
is not engaged in and does not intend to engage in a distribution of the New
Notes, and provided that Exchanging Dealers will be subject to prospectus
delivery requirements in connection with any resale. However, the Commission has
not considered the Exchange Offer in the context of a no-action letter
addressing such matters and there can be no assurance that the Staff would make
a similar determination with respect to the Exchange Offer.
17
THE EXCHANGE OFFER
The following discussion sets forth or summarizes the material terms of the
Exchange Offer, including those set forth in the Letter of Transmittal
distributed with this Prospectus. This summary is qualified in its entirety by
reference to the full text of the documents underlying the Exchange Offer
(including the Indenture and the Registration Rights Agreement), which are
exhibits to the Exchange Offer Registration Statement.
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Existing Notes were sold by the Company to the Initial Purchasers on
April 23, 1998, and were subsequently resold (i) to qualified institutional
buyers pursuant to Rule 144A under the Securities Act, and (ii) pursuant to
offers and sales that occurred outside the United States within the meaning of
Regulation S under the Securities Act. In connection with the offering of the
Existing Notes, the Company entered into the Registration Rights Agreement,
which requires, among other things, that the Company (i) file with the
Commission a registration statement under the Securities Act with respect to an
issue of new notes of the Company identical in all material respects (other than
transfer restrictions, registration rights and the requirement, under certain
circumstances, to pay Additional Interest) to the Existing Notes (which
obligation has been satisfied by the filing of the Exchange Offer Registration
Statement), (ii) use their best efforts to cause such registration statement to
become effective under the Securities Act and (iii) upon the effectiveness of
that registration statement, offer to the Holders of the Existing Notes the
opportunity to exchange their Existing Notes for a like principal amount of New
Notes, which would be issued without a restrictive legend and may generally be
reoffered and resold by the Holder without restrictions or limitations under the
Securities Act, subject to the terms and conditions of the Exxon Capital, Morgan
Stanley and Shearman & Sterling No-Action Letters. See the discussion set forth
on the cover page of this Prospectus and the information under the captions
"Prospectus Summary--The Exchange Offer" and "--Resale of New Notes."
Any Existing Notes tendered and exchanged in the Exchange Offer will reduce
the aggregate principal amount of Existing Notes outstanding. Following the
consummation of the Exchange Offer, Existing Holders who did not tender their
Existing Notes generally will not have any further registration rights under the
Registration Rights Agreement, and such Existing Notes will continue to be
subject to certain restrictions on transfer. Accordingly, the liquidity of the
market for such Existing Notes could be adversely affected. The Existing Notes
are currently eligible for sale pursuant to Rule 144A or outside the United
States pursuant to Regulation S. Because the Company anticipates that most
Existing Holders will elect to exchange such Existing Notes for New Notes due to
the reduction of restrictions on the resale of New Notes under the Securities
Act, the Company anticipates that the liquidity of the market for any Existing
Notes remaining after the consummation of the Exchange Offer may be
substantially limited.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Existing
Notes validly tendered and not withdrawn prior to 5:00 p.m., New York City time
on the Expiration Date. The Company will issue $1,000 principal amount of New
Notes in exchange for each $1,000 principal amount of outstanding Existing Notes
accepted in the Exchange Offer. Existing Holders may tender some or all of their
Existing Notes pursuant to the Exchange Offer. However, Existing Notes may be
tendered only in integral multiples of $1,000. The form and terms of the New
Notes are the same as the form and terms of the Existing Notes except that (i)
the New Notes have been registered under the Securities Act and hence will not
bear legends restricting the transfer thereof, and (ii) New Holders generally
will not be entitled to certain rights under the Registration Rights Agreement
or Additional Interest, which rights generally will terminate upon consummation
of the
18
Exchange Offer. The New Notes will evidence the same debt as the Existing Notes
and will be entitled to the benefits of the Indenture.
Existing Holders do not have any appraisal or dissenters' rights under the
California General Corporation Law or the Indenture in connection with the
Exchange Offer. The Company intends to conduct the Exchange Offer in accordance
with the applicable requirements of the Exchange Act and the rules and
regulations of the Commission thereunder, including Rule 14e-1.
The Company shall be deemed to have accepted validly tendered Existing Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering Existing
Holders for the purpose of receiving the New Notes from the Company.
If any tendered Existing Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, the tendered certificates, if any, for any such unaccepted Existing
Notes will be returned, without expense, to the tendering Existing Holder
thereof as promptly as practicable after the Expiration Date.
Existing Holders who tender Existing Notes in the Exchange Offer will not be
required to pay brokerage commissions or fees or, subject to the instructions in
the Letter of Transmittal, transfer taxes with respect to the exchange of
Existing Notes pursuant to the Exchange Offer. The Company will pay all required
charges and expenses, other than transfer taxes in certain circumstances, in
connection with the Exchange Offer. See "--Fees and Expenses."
EXPIRATION DATE; EXTENSIONS
As defined above, the term "Expiration Date" shall mean 5:00 p.m., New York
City time, on October 16, 1998 (30 days after this Prospectus was sent to
Existing Holders), unless the Company, in its sole discretion, extends the
Exchange Offer, in which case the term "Expiration Date" shall mean the latest
date and time to which the Exchange Offer is extended. The Company will not
extend the Expiration Date beyond 5:00 p.m., New York City time, on November 15,
1998 (60 days after this Prospectus was sent to Existing Holders).
To extend the Exchange Offer, the Company will notify the Exchange Agent of
any extension by oral or written notice, followed by a public announcement
thereof no later than 9:00 a.m., New York City time, on the next business day
after the previously scheduled expiration date.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Existing Notes, to extend the Exchange Offer or to terminate the
Exchange Offer by giving oral or written notice of such delay, extension or
termination to the Exchange Agent, or (ii) to amend the terms of the Exchange
Offer in any manner. Any such delay in acceptance, extension, termination or
amendment will be followed as promptly as practicable by a public announcement
thereof. See "--Amendments; Termination."
INTEREST ON NEW NOTES
Each New Note will bear interest from the most recent date to which interest
has been paid or duly provided for on the Existing Note surrendered in exchange
for such New Note or, if no such interest has been paid or duly provided for on
such Existing Note, from April 23, 1998. Holders of the Existing Notes whose
Existing Notes are accepted for exchange will not receive accrued interest on
such Existing Notes for any period from and after the last Interest Payment Date
to which interest has been paid or duly provided for on such Existing Notes
prior to the original issue date of the New Notes or, if no such interest has
been paid or duly provided for, will not receive any accrued interest on such
Existing Notes, and will be deemed to have waived the right to receive any
interest on such Existing Notes accrued from and after such Interest Payment
Date or, if no such interest has been paid or duly provided for, from and after
April 23, 1998. Interest on the New Notes will be payable semi-annually on each
May 1 and November 1, commencing on November 1, 1998.
19
PROCEDURES FOR TENDERING
Only a Holder of Existing Notes may tender such Existing Notes in the
Exchange Offer. To tender in the Exchange Offer, an Existing Holder must
complete, sign and date the Letter of Transmittal, or a facsimile thereof, have
the signatures thereon guaranteed if required by the Letter of Transmittal, and
mail or otherwise deliver such Letter of Transmittal or such facsimile, together
with the Existing Notes and any other required documents, to the Exchange Agent
so as to be received by the Exchange Agent at the address set forth below prior
to 5:00 p.m., New York City time, on the Expiration Date. Delivery of the
Existing Notes may be made by book-entry transfer in accordance with the
procedures described below. Confirmation of such book-entry transfer must be
received by the Exchange Agent prior to the Expiration Date.
By executing the Letter of Transmittal, each Holder will make to the Company
the representation set forth below in the second paragraph under the heading
"--Resale of New Notes."
The tender by an Existing Holder and the acceptance thereof by the Company
will constitute an agreement between such Existing Holder and the Company in
accordance with the terms and subject to the conditions set forth herein and in
the Letter of Transmittal.
THE METHOD OF DELIVERY OF EXISTING NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. NO
LETTER OF TRANSMITTAL OR NOTES SHOULD BE SENT TO THE COMPANY. HOLDERS MAY
REQUEST THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR
NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner whose Existing Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact the registered Existing Holder promptly and instruct
such registered Existing Holder to tender on such beneficial owner's behalf.
Signatures on the Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by an Eligible Institution (as defined below)
unless the Existing Notes tendered pursuant thereto (i) are signed by the
registered Existing Holder, unless such Existing Holder has completed the box
entitled "Special Exchange Instructions" or "Special Delivery Instructions" on
the Letter of Transmittal, or (ii) are tendered for the account of an Eligible
Institution. In the event that signatures on a Letter of Transmittal or a notice
of withdrawal, as the case may be, are required to be guaranteed, such guarantee
must be by a member firm of a registered national securities exchange or of the
National Association of Securities Dealers, Inc., a commercial bank or trust
company having an office or correspondent in the United States, or an "eligible
guarantor institution" within the meaning of Rule 17Ad-15 under the Exchange Act
(an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the registered
Holder of any Existing Notes listed therein, such Existing Notes must be
endorsed or accompanied by a properly completed bond power, signed by such
registered Existing Holder as such registered Existing Holder's name appears on
such Existing Notes, with the signature thereon guaranteed by an Eligible
Institution.
If the Letter of Transmittal or any Existing Notes or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
20
All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Existing Notes and withdrawal of tendered
Existing Notes will be determined by the Company in its sole discretion, which
determination will be final and binding. The Company reserves the absolute right
to reject any and all Existing Notes not properly tendered or any Existing Notes
the Company's acceptance of which would, in the opinion of counsel for the
Company, be unlawful. The Company also reserves the right to waive any defects,
irregularities or conditions of tender as to particular Existing Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Existing Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify Existing Holders
of defects or irregularities with respect to tenders of Existing Notes, none of
the Company, the Exchange Agent or any other person shall incur any liability
for failure to give such notification. Tenders of Existing Notes will not be
deemed to have been made until such defects or irregularities have been cured or
waived. Any Existing Notes received by the Exchange Agent that are not properly
tendered and as to which the defects or irregularities have not been cured or
waived will be returned by the Exchange Agent to the tendering Existing Holders,
unless otherwise provided in the Letter of Transmittal, as soon as practicable
following the Expiration Date.
TENDER OF EXISTING NOTES HELD THROUGH DTC
The Exchange Agent and DTC have confirmed that the Exchange Offer is
eligible for ATOP, the DTC Automated Tender Offer Program. Accordingly, DTC
participants may, in lieu of physically completing and signing the applicable
Letter of Transmittal and delivering it to the Exchange Agent, electronically
transmit their acceptance of the Exchange Offer by causing DTC to transfer
Existing Notes to the Exchange Agent in accordance with DTC's ATOP procedures
for transfer. DTC will then send an Agent's Message (as defined below) to the
Exchange Agent.
The term "Agent's Message" means a message transmitted by DTC, received by
the Exchange Agent and forming part of the Book-Entry Confirmation, which states
that DTC has received an expressed acknowledgment from a participant in DTC that
is tendering Existing Notes which are the subject of such Book-Entry
Confirmation, that such participant has received and agrees to be bound by the
terms of the applicable Letter of Transmittal (or, in the case of an Agent's
Message relating to guaranteed delivery, that such participant has received and
agrees to be bound by the applicable Notice of Guaranteed Delivery), and that
the Company may enforce such agreement against such participant.
PERSONS TENDERING EXISTING NOTES THROUGH ATOP THEREBY AGREE TO BE BOUND BY
THE LETTER OF TRANSMITTAL AND WILL BE DEEMED TO HAVE MADE THE REPRESENTATION SET
FORTH BELOW IN THE SECOND PARAGRAPH UNDER THE HEADING "--RESALE OF NEW NOTES."
BOOK-ENTRY DELIVERY PROCEDURES
Within two business days after the date hereof, the Exchange Agent will
establish accounts with respect to the Existing Notes at DTC, for purposes of
the Exchange Offer. Any financial institution that is a participant in DTC may
make book-entry delivery of the Existing Notes by causing DTC to transfer such
Existing Notes into the Exchange Agent's account at DTC in accordance with DTC
procedures for such transfer. Timely book-entry delivery of Existing Notes
pursuant to the Exchange Offer, however, requires receipt of a Book-Entry
Confirmation prior to the Expiration Date. In addition, although delivery of
Existing Notes may be effected through book-entry transfer into the Exchange
Agent's account at DTC, the Letter of Transmittal (or a manually signed
facsimile thereof), together with any required signature guarantees and any
other required documents, or an Agent's Message in connection with a book-entry
transfer, must, in any case, be delivered or transmitted to and received by the
Exchange Agent prior to the Expiration Date to receive New Notes for tendered
Existing Notes, or the guaranteed delivery
21
procedure described below must be complied with. Tender will not be deemed made
until such documents or Agent's Message are received by the Exchange Agent.
Delivery of documents or information to DTC does not constitute delivery to the
Exchange Agent.
GUARANTEED DELIVERY PROCEDURES
Existing Holders who wish to tender their Existing Notes and (i) whose
Existing Notes are not immediately available, (ii) who cannot deliver their
Existing Notes, the Letter of Transmittal or any other required documents to the
Exchange Agent, or (iii) who cannot complete the procedures for book-entry
transfer, prior to the Expiration Date, may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent receives from such
Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand delivery)
setting forth the name and address of the Existing Holder, the certificate
number(s) of such Existing Notes and the principal amount of Existing Notes
tendered, stating that the tender is being made thereby and guaranteeing
that, on or prior to three New York Stock Exchange trading days after the
Expiration Date, the Letter of Transmittal (or facsimile thereof), together
with the certificate(s) representing the Existing Notes (or a confirmation
of book-entry transfer of such Existing Notes into the Exchange Agent's
account at DTC) and any other documents required by the Letter of
Transmittal, will be deposited by the Eligible Institution with the Exchange
Agent; and
(c) such properly completed and executed Letter of Transmittal (or
facsimile thereof), as well as the certificate(s) representing all tendered
Existing Notes in proper form for transfer (or a confirmation of book-entry
transfer of such Existing Notes into the Exchange Agent's account at DTC)
and all other documents required by the Letter of Transmittal, are received
by the Exchange Agent within three New York Stock Exchange trading days
after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to Existing Holders who wish to tender their Existing Notes according to
the guaranteed delivery procedures set forth above.
WITHDRAWALS OF TENDERS
Except as otherwise provided herein, tenders of Existing Notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the Expiration
Date.
To withdraw a tender of Existing Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at the address set forth herein prior to 5:00 p.m., New York City time, on
the Expiration Date. Any such notice of withdrawal must (i) specify the name of
the person having deposited the Existing Notes to be withdrawn (the
"Depositor"), (ii) identify the Existing Notes to be withdrawn (including the
certificate number(s) and principal amount of such Existing Notes, or, in the
case of Existing Notes transferred by book-entry transfer, the name and number
of the account at DTC to be credited), (iii) be signed by the Existing Holder in
the same manner as the original signature on the Letter of Transmittal by which
such Existing Notes were tendered (including any required signature guarantees)
or be accompanied by documents of transfer sufficient to have the Trustee
register the transfer of such Existing Notes into the name of the person
withdrawing the tender, and (iv) specify the name in which any such Existing
Notes are to be registered, if different from that of the Depositor. All
questions as to the validity, form and eligibility (including time or receipt)
of such notices will be determined by the Company, whose determination shall be
final and binding on all parties. Any Existing Notes so withdrawn will be deemed
not to have been validly tendered for purposes of the Exchange Offer and no New
Notes will be issued with respect thereto unless the Existing Notes so
22
withdrawn are validly retendered. Any Existing Notes which have been tendered
but which are not accepted for exchange will be returned to the Holder thereof
without cost to such Existing Holder as soon as practicable after withdrawal,
rejection of tender or termination of the Exchange Offer. Properly withdrawn
Existing Notes may be retendered by following one of the procedures described
above under "--Procedures for Tendering" at any time prior to the Expiration
Date.
AMENDMENTS; TERMINATION
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or to exchange New Notes for any Existing
Notes, and may amend or terminate the Exchange Offer in its sole discretion
before the acceptance of such Existing Notes. By way of example, the following
constitute some, but not all, of the reasons for which the Company might choose
to amend or terminate the Exchange Offer:
(a) in the opinion of counsel to the Company or the Guarantors, if any,
the Exchange Offer or any part thereof contemplated herein violates any
applicable law or interpretation of the Staff;
(b) any action or proceeding shall have been instituted or threatened in
any court or by any governmental agency which might materially impair the
ability of the Company to proceed with the Exchange Offer or any material
adverse development shall have occurred in any existing action or proceeding
with respect to either the Company or the Guarantors, if any;
(c) any governmental approval has not been obtained, which approval the
Company shall deem necessary for the consummation of the Exchange Offer as
contemplated hereby;
(d) any cessation of trading on the Nasdaq Stock Market or any exchange,
or any banking moratorium, shall have occurred, as a result of which the
Company is unable to proceed with the Exchange Offer; or
(e) a stop order shall have been issued by the Commission or any state
securities authority suspending the effectiveness of the Exchange Offer
Registration Statement or proceedings shall have been initiated or, to the
knowledge of the Company, threatened for that purpose.
In its sole discretion, the Company may (i) refuse to accept any Existing
Notes and return all tendered Existing Notes to the tendering Existing Holders,
(ii) extend the Exchange Offer and retain all Existing Notes tendered prior to
the expiration of the Exchange Offer, subject, however, to the rights of
Existing Holders to withdraw such Existing Notes (see "--Withdrawals of
Tenders"), or (iii) accept all properly tendered Existing Notes which have not
been validly withdrawn.
EXCHANGE AGENT
State Street Bank and Trust Company of California, N.A., will act as
Exchange Agent for the Exchange Offer with respect to the Existing Notes.
23
Questions and requests for assistance, requests for additional copies of
this Prospectus or of the Letter of Transmittal for the Existing Notes and
requests for copies of the Notice of Guaranteed Delivery should be directed to
the Exchange Agent, addressed as follows:
By Hand, Overnight Courier State Street Bank and Trust Company
or Mail: of California, N.A. Exchange Agent
c/o State Street Bank and Trust Company
2 International Place, 4th Floor
Boston, MA 02110
Attention: Kellie Mullen, Corporate Trust
Dept.
Confirm by Telephone: 617-664-5587
By Facsimile: 617-664-5290
FEES AND EXPENSES
The required expenses of soliciting Existing Notes for exchange will be
borne by the Company. The principal solicitation is being made by mail by the
Exchange Agent. However, additional solicitation may be made by telephone,
facsimile or in person by officers and regular employees of the Company and its
affiliates and by persons so engaged by the Exchange Agent.
The Company will pay the Exchange Agent reasonable and customary fees as
negotiated for its services and will reimburse it for its reasonable
out-of-pocket expenses in connection therewith and pay other registration
expenses, including fees and expenses, as negotiated, of the Trustee (as
defined), filing fees, blue sky fees and printing and distribution expenses.
RESALE OF NEW NOTES
The Company is making the Exchange Offer in reliance on the position of the
Staff as set forth in the Exxon Capital No-Action Letter, the Morgan Stanley
No-Action Letter and the Shearman & Sterling No-Action Letter, and other
interpretive letters addressed to third parties in other transactions. However,
the Company has not sought its own interpretive letter addressing such matters
and there can be no assurance that the Staff would make a similar determination
with respect to the Exchange Offer as it has in such interpretive letters to
third parties. Based on these interpretations by the Staff, and subject to the
two immediately following sentences, the Company believes that New Notes issued
pursuant to this Exchange Offer in exchange for Existing Notes may be offered
for resale, resold and otherwise transferred by a Holder thereof (other than a
Holder who is a broker-dealer) without further compliance with the registration
and prospectus delivery requirements of the Securities Act, provided that such
New Notes are acquired in the ordinary course of such Holder's business and that
such Holder is not participating, and has no arrangement or understanding with
any person to participate, in a distribution (within the meaning of the
Securities Act) of such New Notes. However, any Holder of Existing Notes who (i)
is an "affiliate" of the Company (within the meaning of Rule 405 under the
Securities Act), (ii) does not acquire such New Notes in the ordinary course of
its business, (iii) intends to participate in the Exchange Offer for the purpose
of distributing New Notes, or (iv) is a broker-dealer who purchased such
Existing Notes directly from the Company, (a) will not be able to rely on the
interpretations of the Staff set forth in the above-mentioned interpretive
letters, (b) will not be permitted or entitled to tender such Existing Notes in
the Exchange Offer, and (c) must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with any sale or other
transfer of such Existing Notes unless such sale is made pursuant to an
exemption from such requirements. In addition, as described below, an Exchanging
Dealer may be deemed a statutory "underwriter" within the meaning of the
Securities Act and must deliver a prospectus meeting the requirements of the
Securities Act in connection with any resales of such New Notes.
24
Each Holder of Existing Notes who wishes to exchange Existing Notes for New
Notes in the Exchange Offer will be required to represent that (i) it is not an
affiliate of the Company, (ii) any New Notes to be received by it are being
acquired in the ordinary course of its business, (iii) it has no arrangement or
understanding with any person to participate in, and (iv) it is not engaged in,
and does not intend to engage in, a distribution of the New Notes a distribution
(within the meaning of the Securities Act) of such New Notes. Each broker-dealer
that receives New Notes for its own account pursuant to the Exchange Offer must
acknowledge that it acquired the Existing Notes for its own account as a result
of market-making activities or other trading activities (and not directly from
the Company) and must agree that it will deliver a prospectus meeting the
requirements of the Securities Act in connection with any resale of such New
Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, such an Exchanging Dealer will not be deemed to admit
that it is an "underwriter" within the meaning of the Securities Act. Based on
the position taken by the Staff in the interpretive letters referred to above,
the Company believes that Exchanging Dealers may fulfill their prospectus
delivery requirements with respect to the New Notes received upon exchange of
such Existing Notes with a prospectus meeting the requirements of the Securities
Act, which may be the prospectus prepared for an exchange offer so long as it
contains a description of the plan of distribution with respect to the resale of
such New Notes. Accordingly, this Prospectus, as it may be amended or
supplemented from time to time, may be used by an Exchanging Dealer during the
period referred to below in connection with resales of New Notes received in
exchange for Existing Notes where such Existing Notes were acquired by such
Exchanging Dealer for its own account as a result of market-making or other
trading activities. Subject to certain provisions set forth in the Registration
Rights Agreement, the Company has agreed that this Prospectus, as it may be
amended or supplemented from time to time, may be used by an Exchanging Dealer
in connection with resales of such New Notes for a period of 180 days following
effectiveness of the Exchange Offer Registration Statement. See "Plan of
Distribution." Any Exchanging Dealer who is an affiliate of the Company may not
rely on such interpretive letters and must comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale transaction. See "The Exchange Offer--Resales of New Notes."
In that regard, each Exchanging Dealer who surrenders Existing Notes
pursuant to the Exchange Offer will be deemed to have agreed, by execution of
the Letter of Transmittal, that, upon receipt of notice from the Company of the
occurrence of any event or the discovery of any fact which makes any statement
contained or incorporated by reference in this Prospectus untrue in any material
respect or which causes this Prospectus to omit to state a material fact
necessary in order to make the statements contained or incorporated by reference
herein, in light of the circumstances under which they were made, not misleading
or of the occurrence of certain other events specified in the Registration
Rights Agreement, such Exchanging Dealer will suspend the sale of New Notes
pursuant to this Prospectus until the Company has amended or supplemented this
Prospectus to correct such misstatement or omission and has furnished copies of
the amended or supplemented Prospectus to such Exchanging Dealer or the Company
has given notice that the sale of the New Notes may be resumed, as the case may
be.
CONSEQUENCES OF FAILURE TO EXCHANGE
As a result of the making of this Exchange Offer, the Company will have
fulfilled certain of its obligations under the Registration Rights Agreement,
and Holders of Existing Notes who do not tender their Notes, except for certain
instances involving the Initial Purchasers or Existing Holders who are not
eligible to participate in the Exchange Offer, will not have any further
registration rights under the Registration Rights Agreement or otherwise or
rights to receive Additional Interest for failure to register. Accordingly, any
Holder of Existing Notes that does not exchange that Holder's Existing Notes for
New Notes will continue to hold the untendered Existing Notes and will be
entitled to all the rights and subject to all the limitations applicable thereto
under the Indenture, except to the extent that such rights or
25
limitations, by their terms, terminate or cease to have further effectiveness as
a result of the Exchange Offer.
The Existing Notes that are not exchanged for New Notes pursuant to the
Exchange Offer will remain restricted securities. Accordingly, such Existing
Notes may be resold only (i) to a person who the seller reasonably believes is a
qualified institutional buyer in a transaction meeting the requirements of Rule
144A, in a transaction meeting the requirements of Rule 144A under the
Securities Act, (ii) in a transaction occurring outside the United States to a
foreign person, which transaction meets the requirements of Rule 904 under the
Securities Act, (iii) in accordance with another exemption from the registration
requirements of the Securities Act (and based upon an opinion of counsel if the
Company so requests), (iv) to the Company, or (v) pursuant to an effective
registration statement, and, in each case, in accordance with any applicable
securities laws of any State of the United States or any other applicable
jurisdiction.
OTHER
Participation in the Exchange Offer is voluntary and Existing Holders should
carefully consider whether to accept. Holders of the Existing Notes are urged to
consult their financial and tax advisors in making their own decision on what
action to take.
The Company may in the future seek to acquire untendered Existing Notes in
open market or privately negotiated transactions, through subsequent exchange
offers or otherwise. The Company has no present plans to acquire any Existing
Notes that are not tendered in the Exchange Offer or to file a registration
statement to permit resales of any untendered Existing Notes.
26
THE RECAPITALIZATION
THE REORGANIZATION
Prior to April 1998, substantially all of the capital stock of the Company
was owned by the Russell Solomon Trust. In April 1998, the Company consummated
the Reorganization, which consolidated substantially all of the Tower business
operations in the Company, and also transferred certain assets to the Trusts. As
a result of the Reorganization, the Company is now a wholly-owned subsidiary of
Parent. The Reorganization included an exchange by the Company's shareholders of
their common shares in the Company for a controlling equity interest in the
Parent. As part of the Reorganization, the Trusts and certain Solomon family
members contributed to Parent certain business assets (subject to certain
liabilities), including wholesale distribution operations, in exchange for the
remaining equity interest in Parent. Separately, Parent contributed such assets
and liabilities to the Company. In addition, the Company transferred certain
assets with a book value of approximately $2.9 million to the Trusts in exchange
for inventory of the Trusts with an equal book value. See "Certain
Transactions--The Reorganization" and Note 2 to "Consolidated Financial
Statements." As a result of the Reorganization and the planned or already
consummated elimination by merger of certain domestic U.S. subsidiaries of the
Company, substantially all of the Company's U.S. store operations and U.K.
operations will be owned directly by the Company. The Company's other
international operations will be conducted by subsidiaries of the Company or, in
certain cases, joint ventures, and the Company's U.S. distribution operations
will be conducted by a subsidiary of the Company.
THE REFINANCING
The Company refinanced previously outstanding indebtedness of approximately
$168.0 million under its $195.0 million Former Credit Facility and approximately
$64.3 million of other previously outstanding indebtedness by consummating the
Existing Notes Offering and entering into the New Credit Facility. The New
Credit Facility provides for an aggregate $275.0 million commitment, of which
approximately $150.0 million can be borrowed in Japanese yen and a portion in
British pounds. Aggregate borrowings are subject to compliance with a borrowing
base formula. As of April 30, 1998, an aggregate of approximately $245.1 million
was available under the New Credit Facility based upon the borrowing base
formula, of which $120.6 million had been drawn. See "Capitalization" and
"Description of New Credit Facility."
The New Credit Facility is structured as two separate but interrelated
facilities: the Facility A Revolving Line and the Facility B Revolving Line. The
Facility A Revolving Line is a U.S. $125.0 million revolving credit facility
(which allows a portion to be borrowed in British pounds) and is available in
full to MTS and available in an amount not to exceed $25.0 million to Tower
Records Kabushiki Kaisha, the Company's Japanese operating subsidiary ("TRKK").
The Facility B Revolving Line is a Japanese yen revolving credit facility (which
also allows a portion to be borrowed in U.S. dollars) in an aggregate available
principal amount equal to the yen equivalent of U.S. $150.0 million and is
available to both MTS and TRKK in full. See "Description of New Credit
Facility."
27
USE OF PROCEEDS
The Company will not receive any cash proceeds from the Exchange Offer. In
consideration for issuing the New Notes in exchange for Existing Notes as
described in this Prospectus, the Company will receive Existing Notes in like
principal amount. The Existing Notes surrendered in exchange for the New Notes
will be retired and canceled.
The terms and conditions of the Existing Notes to be retired and canceled in
the Exchange Offer are identical in all material respects to those of the New
Notes, except that the New Notes will be registered securities whereas the
Existing Notes are not, and except that holders of the New Notes will not be
entitled to registration rights and will not be entitled to Additional Interest
under the Registration Rights Agreement.
The $110.0 million of gross proceeds from the Existing Notes Offering
(before deductions of discounts and other expenses of the Existing Notes
Offering), together with borrowings under the New Credit Facility, which were
approximately $127.0 million initially, were used to (i) refinance the Company's
$168.0 million of borrowings under the Former Credit Facility, (ii) refinance
approximately $64.3 million of other existing indebtedness, and (iii) pay fees
and expenses of approximately $3.8 million, incurred in connection with the
Recapitalization. See "Summary--The Recapitalization" and "Description of New
Credit Facility."
The amounts previously outstanding under the Former Credit Facility
consisted of revolving loans for working capital purposes which would have
matured on May 1, 1998. Such loans bore interest at variable rates determined
from time to time by adding a margin to the Eurodollar Rate ("EURO") or the
prime rate. At January 31, 1998, the interest rate was approximately 6.98%. The
other existing senior indebtedness, as adjusted to give effect to the
Refinancing as if it had occurred on January 31, 1998, consisted of (i) a
yen-denominated senior note which would have matured on May 2, 1998 in the
amount of approximately $45.6 million, bearing interest at a rate per annum of
1.88%, which was incurred to refinance certain previously existing indebtedness,
(ii) a yen-denominated senior note which would have matured on November 1, 1998
in the amount of approximately $27.0 million, bearing interest at a rate per
annum of 1.42%, which was incurred for working capital purposes, (iii)
yen-denominated revolving loans which would have matured on November 1, 1998, in
the amount of approximately $13.4 million, bearing interest at variable rates
(1.62% as of January 31, 1998), which was incurred for working capital purposes,
(iv) a yen-denominated term loan note which would have matured on March 25,
1999, in the amount of approximately $7.9 million, bearing interest at a rate
per annum of 2.40%, which was incurred to refinance certain previously existing
indebtedness and (v) a yen-denominated term loan note which would have matured
on February 25, 2002, in the amount of approximately $3.9 million, bearing
interest at a rate per annum of 2.50%, which was incurred for working capital
purposes and equipment purchases.
28
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of April 30, 1998. This table should be read in conjunction with
"Selected Historical Consolidated Financial Information," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the consolidated financial statements and the related notes thereto included
elsewhere in this Prospectus.
AS OF APRIL
30, 1998
-----------
(DOLLARS IN
MILLIONS)
Cash and cash equivalents............................................................................ $ 10.7
-----------
-----------
Total debt (including current maturities):
New Credit Facility(a)............................................................................. 120.6
Other existing indebtedness........................................................................ 10.5(b)
-----------
Total senior debt................................................................................ 131.1
Existing Notes..................................................................................... 110.0
-----------
Total debt....................................................................................... 241.1
Shareholders' equity............................................................................. 127.2
-----------
Total capitalization............................................................................. $ 368.3
-----------
-----------
- ------------------------
(a) The New Credit Facility provides for an aggregate $275.0 million commitment,
of which approximately $150.0 million can be borrowed in Japanese yen (and a
portion in British pounds), subject to compliance with a borrowing base
formula. As of April 30, 1998, an aggregate of approximately $245.1 million
was available under the New Credit Facility. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" and "Description of New Credit Facility."
(b) Other existing indebtedness which remains outstanding includes a $3.0
million 8.21% term loan note, a $3.7 million 8.50% real estate loan and $3.8
million of other obligations. See Note 7 to "Consolidated Financial
Statements."
29
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
The selected historical consolidated financial information presented below
as of July 31, 1996 and 1997 and for each of the years in the three-year period
ended July 31, 1997 have been derived from and should be read in conjunction
with the audited consolidated financial statements of the Company included
elsewhere in this Prospectus. The selected historical consolidated financial
information presented below as of July 31, 1993, 1994 and 1995 and for each of
the years in the two-year period ended July 31, 1994 have been derived from the
audited consolidated financial statements of the Company not included elsewhere
in this Prospectus. The selected historical consolidated financial information
as of April 30, 1998 and for the nine months ended April 30, 1997 and 1998 have
been derived from and should be read in conjunction with the unaudited
consolidated financial statements of the Company included elsewhere in this
Prospectus. The selected historical consolidated financial data as of April 30,
1997 have been derived from the unaudited financial statements of the Company
not included in this Prospectus. The selected historical consolidated financial
information has been retroactively restated to give effect to the
Reorganization. The unaudited consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements and
include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the Company's financial condition and
results of operations for those periods. Operating results for the nine months
ended April 30, 1998, are not necessarily indicative of the results that may be
expected for the year ended July 31, 1998 or for any future period. This data
should be read in conjunction with the consolidated financial statements and
notes thereto, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Summary Historical Consolidated Financial Information"
and other financial information included elsewhere in this Prospectus.
NINE
MONTHS
ENDED
FISCAL YEAR ENDED JULY 31, APRIL 30,
----------------------------------------------------- ---------
1993 1994 1995 1996 1997 1997
--------- --------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
INCOME STATEMENT DATA:
Net revenues........................................... $ 699.4 $ 808.5 $ 950.6 $ 1,001.0 $ 991.8 $ 752.5
Cost of sales.......................................... 474.0 543.9 640.6 676.1 669.3 508.4
--------- --------- --------- --------- --------- ---------
Gross profit......................................... 225.4 264.6 310.0 324.9 322.5 244.1
Selling, general and administrative expenses........... 183.7 212.6 255.1 270.4 267.6 202.1
Depreciation and amortization.......................... 15.1 17.4 22.9 20.9 26.4 17.3
--------- --------- --------- --------- --------- ---------
Income from operations................................. 26.6 34.6 32.0 33.6 28.5 24.7
Other income (expense):
Interest expense....................................... 6.7 7.8 11.5 14.9 14.3 11.5
Foreign currency translation gain (loss)............... 4.3 1.0 5.6 (1.4) (3.6) (0.5)
Other income (expenses)................................ 0.5 (0.4) 0.1 (0.1) (1.1) (0.8)
--------- --------- --------- --------- --------- ---------
Income before taxes, minority interest, change in
accounting and extraordinary item.................... 24.7 27.4 26.2 17.2 9.5 11.9
Provision for income taxes............................. 9.8 10.7 10.9 7.0 4.5 5.3
--------- --------- --------- --------- --------- ---------
Income before minority interest, change in accounting
and extraordinary item............................... 14.9 16.7 15.3 10.2 5.0 6.6
Other items(a)......................................... (0.2) 0.6 (0.2) (0.2) (1.5) (1.3)
--------- --------- --------- --------- --------- ---------
Net income............................................. $ 14.7 $ 17.3 $ 15.1 $ 10.0 $ 3.5 $ 5.3
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
OTHER DATA:
Ratio of earnings to fixed charges(b).................. 2.4x 2.2x 1.8x 1.5x 1.3x 1.4x
BALANCE SHEET DATA (AT PERIOD END):
Total assets........................................... $ 346.9 $ 412.7 $ 505.1 $ 528.8 $ 544.6 $ 541.9
Total debt (including current maturities).............. 116.2 140.5 199.6 202.8 211.3 222.9
Shareholders' equity................................... 95.0 112.1 127.5 135.1 134.0 135.4
1998
---------
INCOME STATEMENT DATA:
Net revenues........................................... $ 771.4
Cost of sales.......................................... 524.9
---------
Gross profit......................................... 246.5
Selling, general and administrative expenses........... 204.8
Depreciation and amortization.......................... 17.6
---------
Income from operations................................. 24.1
Other income (expense):
Interest expense....................................... 10.4
Foreign currency translation gain (loss)............... (0.8)
Other income (expenses)................................ 0.1
---------
Income before taxes, minority interest, change in
accounting and extraordinary item.................... 13.0
Provision for income taxes............................. 5.5
---------
Income before minority interest, change in accounting
and extraordinary item............................... 7.5
Other items(a)......................................... (.1)
---------
Net income............................................. $ 7.4
---------
---------
OTHER DATA:
Ratio of earnings to fixed charges(b).................. 1.5x
BALANCE SHEET DATA (AT PERIOD END):
Total assets........................................... $ 531.6
Total debt (including current maturities).............. 241.1
Shareholders' equity................................... 127.2
See Notes to Selected Historical Consolidated Financial Information
30
NOTES TO SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
(a) Other items is comprised of minority interests in net income of
subsidiaries, cumulative effect of change in accounting principle and
extraordinary item.
(b) Ratio of earnings to fixed charges is computed by dividing (i) the sum of
income before taxes and fixed charges by (ii) fixed charges. Fixed charges
consist of the sum of interest expense, interest expense capitalized, the
amortization of deferred financing costs, and 35% of rental expense
representing management's determination of a reasonable approximation of
interest costs on rents.
31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Historical Consolidated Financial Information," and the consolidated financial
statements of the Company and the notes thereto included elsewhere in this
Prospectus. The results shown herein are not necessarily indicative of the
results to be expected in any future period. The following discussion contains
forward-looking statements that involve known and unknown risks and
uncertainties. Use of the words "anticipates," "believes," "estimates,"
"expects," "intends," "plans" and similar expressions is intended to identify
forward-looking statements. The Company's actual results could differ materially
from those expressed or implied by such forward-looking statements as a result
of factors set forth herein. Such factors include, but are not limited to, the
cautionary statements set forth below and under the captions "Forward-Looking
Statements" (on the cover page), "Risk Factors" and "Business" herein. All
forward-looking statements included in this Prospectus are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements.
GENERAL
Founded in 1960, Tower is the second largest specialty retailer of recorded
music in the United States and is one of the largest and most widely-recognized
music retailers in the world. The Company operates a total of 183 stores
worldwide, consisting of 119 U.S. stores in 20 states and 64 international
stores in 11 countries. Over Tower's 38-year operating history, the Company has
closed only eight stores. Management believes that Tower is one of the leading
music retailers in each of the U.S. major metropolitan areas in which it
operates (many of which are the fastest growing markets in the United States).
The Company offers a diversified line of products including compact discs,
recorded audio cassettes, recorded video cassettes, laser discs, DVD and other
complementary products, including books, magazines, blank tapes, software
titles, and accessories. Management believes that Tower's highly recognizable
brand name, prime store locations, depth of music catalog, knowledgeable
customer service and entertaining, interactive store environments enable it to
effectively target a broad music consumer demographic and to continue to foster
strong customer loyalty. For the nine month period ended April 30, 1998, Tower's
net revenues were $771.4 million.
RESULTS OF OPERATIONS
NINE MONTHS ENDED APRIL 30, 1998 COMPARED TO NINE MONTHS ENDED APRIL 30,
1997
NET REVENUES. Net revenues were $771.4 million for the nine months ended
April 30, 1998, an increase of $18.9 million or 2.5% (or 5.2% excluding the
unfavorable effects of U.S. dollar-Japanese yen exchange rate movements), from
$752.5 million for the nine months ended April 30, 1997. The Company's net
revenues were derived from U.S. sales of $479.5 million and international sales
of $291.9 million for the nine months ended April 30, 1998 compared to $454.2
million in the U.S. and $298.3 million internationally for the nine months ended
April 30, 1997. Record and tape sales for the period ended April 30, 1998
represented 88.9% of the Company's net revenues versus 89.8% for the period
ended April 30, 1997. Retail sales represented 97.6% of the Company's net
revenues for the nine-month period ended April 30,1998 versus 97.1% for the
nine-month period ended April 30, 1997. The increase in the Company's net
revenues was primarily due to (i) an increase in store sales, (ii) a decrease in
overall music retail square footage as many mall-based music retailers
consolidated store locations, (iii) a
reduction in electronics music retailers' music selling space and a narrowing of
catalog selections in response to difficulties in successfully implementing
"loss leader" music retail sales strategies, and (iv) an increase in the number
of popular new releases.
32
GROSS PROFIT. Gross profit was $246.5 million for the nine months ended
April 30, 1998, an increase of $2.4 million or 1.0%, from $244.1 million for the
nine months ended April 30, 1997. Gross profit as a percentage of net revenues
decreased to 32.0% for the nine months ended April 30, 1998 as compared to 32.4%
for the nine months ended April 30, 1997. The Company believes that the primary
factor contributing to the decline was the rapidly weakening yen and pricing in
Japan not keeping pace with the increased cost of a dollar-sensitive product.
Pricing pressures in other Asian markets also resulted in decreased margins in
these regions.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $204.8 million for the nine months ended April 30,
1998, an increase of $2.7 million or 1.3% from $202.1 million for the nine
months ended April 30, 1997. Advertising and promotion reimbursements and
rebates exceeded expenses by $1.3 million for the nine months ended April 30,
1998 due primarily to contractual vendor support programs exceeding advertising
expenses and promotional costs and remained unchanged from the nine month period
ended April 30, 1997. The primary components of the Company's advertising
expense are cooperative and noncooperative advertising, in-store promotions and
costs, and business promotion and entertainment. Gross advertising and promotion
expense totaled $48.1 million for the nine months ended April 30, 1998, an
increase of $2.8 million from gross advertising expense of $45.3 million for the
nine months ended April 30, 1997. The Company derives the majority of its
advertising receipts from cooperative advertising reimbursements and additional
payments received from vendor POS and promotions and media vendor rebates. Gross
advertising reimbursements and promotional payments received totaled $49.4
million for the nine months ended April 30, 1998, an increase of $2.8 million
from gross advertising reimbursements and vendor POS and promotional payments of
$46.6 million for the nine months ended April 30, 1997. As a percentage of net
revenues, selling, general and administrative expenses declined slightly for the
nine months ended April 30, 1998 as compared to the nine months ended April 30,
1997, primarily due to the Company's success in containing wages and variable
costs.
INCOME FROM OPERATIONS. Income from operations was $24.1 million for the
nine months ended April 30, 1998, a decrease of $0.6 million from $24.7 million
for the nine months ended April 30, 1997. As a percentage of net revenues,
income from operations decreased to 3.1% for the nine months ended April 30,
1998 from 3.3% for the nine months ended April 30, 1997.
NET INCOME. Net income was $7.4 million for the nine months ended April 30,
1998, an increase of $2.1 million or 39.6% from $5.3 million for the nine months
ended April 30, 1997.
FISCAL YEAR ENDED JULY 31, 1997 COMPARED TO FISCAL YEAR ENDED JULY 31, 1996
NET REVENUES. Net revenues were $991.8 million for the fiscal year ended
July 31, 1997, a decrease of $9.2 million or 0.9% (or a 2.5% increase excluding
the unfavorable effects of U.S. dollar-Japanese yen exchange rate movements)
from $1,001.0 million for the fiscal year ended July 31, 1996. The Company's
revenues were derived from U.S. sales of $596.9 million and international sales
of $394.9 million for the fiscal year ended July 31, 1997 compared to $584.7
million in the U.S. and $416.4 million internationally for the fiscal year ended
July 31, 1996. Record and tape sales for the period ended July 31, 1997
represented 89.6% of the Company's net revenues versus 88.8% for the period
ended July 31, 1996. Retail sales represented 97.0% of the Company's net
revenues for the fiscal year ended July 31, 1997 versus 95.8% for the fiscal
year ended July 31, 1996.
GROSS PROFIT. Gross profit was $322.5 million for the fiscal year ended
July 31, 1997, a decrease of $2.4 million or 0.7% from $324.9 million for the
fiscal year ended July 31, 1996. Gross profit as a percentage of net revenues
remained constant at 32.5% for the fiscal year ended July 31, 1997 compared to
the fiscal year ended July 31, 1996. The Company believes that the primary
factors contributing to its relatively stable gross profit during these periods
were Tower's focus on customers who purchase
33
deep-catalog (and consequently higher margin) product, strong inventory
management and favorable purchasing terms from vendors.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $267.6 million for the fiscal year ended July 31,
1997, a decrease of $2.8 million or 1.0% from $270.4 million for the fiscal year
ended July 31, 1996. Net advertising revenue was $1.5 million for the fiscal
year ended July 31, 1997, a change of $4.8 million from the net advertising
expense of $3.3 million for the fiscal year ended July 31, 1996 due primarily to
contractual vendor support programs exceeding advertising expenses and
promotional costs. Net advertising expense decreased due to a reduction of $3.2
million in institutional (noncooperative) advertising expenditures and an
increase of $1.4 million in vendor payments for in-store promotions. The primary
components of the Company's advertising expense are cooperative advertising,
noncooperative advertising, in-store promotions and costs, and business
promotion and entertainment. The Company derives the majority of its advertising
receipts from cooperative advertising and additional payments received from
vendor POS and promotions and media vendor rebates. Gross advertising and
promotion expense totaled $57.5 million for the fiscal year ended July 31, 1997,
a decrease of $1.8 million from gross advertising expense of $59.3 million for
the fiscal year ended July 31, 1996. Gross advertising reimbursements and
promotional payments received totaled $59 million for the fiscal year ended July
31, 1997, an increase of $3 million from gross advertising reimbursements and
vendor POS and promotional payments of $55.9 million for the fiscal year ended
July 31, 1996. As a percentage of net revenues, selling, general and
administrative expenses remained constant at 27.0% for the fiscal years ended
July 31, 1997 and 1996.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization was $26.4
million for the fiscal year ended July 31, 1997 compared to $20.9 million for
the fiscal year ended July 31, 1996, an increase of approximately $5.5 million,
primarily due to the write-off of leasehold improvements with a net book value
of approximately $4.6 million associated with the closure of one store located
in New York City.
INCOME FROM OPERATIONS. Income from operations was $28.5 million for the
fiscal year ended July 31, 1997, a decrease of $5.0 million or 15.0% from $33.6
million for the fiscal year ended July 31, 1996. As a percentage of net
revenues, income from operations decreased to 2.9% for the fiscal year ended
July 31, 1997 from 3.4% for the fiscal year ended July 31, 1996.
OTHER EXPENSE. Other expense (net) was $19.0 million for the fiscal year
ended July 31, 1997 compared to $16.4 million for the fiscal year ended July 31,
1996, which represented an increase of $2.6 million which was primarily due to a
foreign currency transaction loss of $3.6 million for the fiscal year ended July
31, 1997 compared to a foreign currency transaction loss of $1.4 million for the
fiscal year ended July 31, 1996. The Company does significant business
transactions in currencies other than the U.S. dollar. Exchange losses result
from the day to day fluctuations in foreign currency exchange rates, due
primarily to the weakening yen and other Asian currencies against the U.S.
dollar.
EXTRAORDINARY CHARGES. An extraordinary charge (net of tax) of $1.2 million
was incurred in total in fiscal 1997 as a result of the early repayment of
certain privately placed debt.
NET INCOME. Net income was $3.5 million for the fiscal year ended July 31,
1997, a decrease of $6.5 million or 64.7% from $10.0 million for the fiscal year
ended July 31, 1996.
FISCAL YEAR ENDED JULY 31, 1996 COMPARED TO FISCAL YEAR ENDED JULY 31, 1995
NET REVENUES. Net revenues were $1,001.0 million for the fiscal year ended
July 31, 1996, an increase of $50.5 million or 5.3% (or 8.9% after allowing for
the effect of U.S. dollar-Japanese yen exchange rate movements), from $950.6
million for the fiscal year ended July 31, 1995. The Company's revenues were
derived from U.S. sales of $584.7 million and international sales of $416.4
million for the fiscal year ended July 31, 1996 compared to $605.1 million in
the U.S. and $345.4 million internationally
34
for the fiscal year ended July 31, 1995. Record and tape sales for the period
ended July 31, 1996 represented 88.8% of the Company's net revenues versus 87.8%
for the period ended July 31, 1995. Retail sales represented 95.8% of the
Company's net revenues for the fiscal year ended July 31, 1996 versus 95.4% for
the fiscal year ended July 31, 1995. The growth in revenues was primarily due to
an increase in net revenues from the Company's operations in Japan, which
benefitted from the opening of ten new stores and strong comparable same store
sales.
GROSS PROFIT. Gross profit was $324.9 million for the fiscal year ended
July 31, 1996, an increase of $14.9 million or 4.8% from $310.0 million for the
fiscal year ended July 31, 1995. Gross profit as a percentage of revenues
decreased slightly to 32.5% for the fiscal year ended July 31, 1996 from 32.6%
for the fiscal year ended July 31, 1995. The Company believes that the primary
factors contributing to its relatively stable gross margins during these periods
were Tower's focus on customers who purchase deep-catalog (and consequently
higher margin) product, strong inventory management and favorable purchasing
terms from vendors.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $270.4 million for the fiscal year ended July 31,
1996, an increase of $15.3 million or 6.0%, from $255.1 million for the fiscal
year ended July 31, 1995. Net advertising expense was $3.3 million for the
fiscal year ended July 31, 1996, a decrease of $4.7 million from the net
advertising expense of $8.0 million for the fiscal year ended July 31, 1995, due
principally to an increase of $4.9 million in vendor reimbursements for in-store
promotions. The primary components of the Company's advertising expense are
cooperative advertising, noncooperative advertising, in-store promotions and
costs, and business promotion and entertainment. The Company derives the
majority of its advertising receipts from cooperative advertising and additional
payments received from vendor POS and promotions and media vendor rebates. Gross
advertising and promotion expense totaled $59.3 million for the fiscal year
ended July 31, 1996, an increase of $1.7 million from gross advertising expense
of $57.6 million for the fiscal year ended July 31, 1995. Gross advertising
reimbursements and promotional payments received totaled $55.9 million for the
fiscal year ended July 31, 1996, an increase of $6.3 million from gross
advertising reimbursements and vendor POS and promotional payments of $49.6
million for the fiscal year ended July 31, 1995. As a percentage of net
revenues, selling, general and administrative expenses increased to 27.0% for
the fiscal year ended July 31, 1996 from 26.8% for the fiscal year ended July
31, 1995. This slight increase was primarily attributable to increased occupancy
expense as more locations were opened in Japan which commanded higher rents. The
increase in occupancy expense was partially offset by the Company's success in
managing other operating expenses, with reductions as a percentage of total
revenues occurring in wages, advertising and other variable expenses.
INCOME FROM OPERATIONS. Income from operations was $33.6 million for the
fiscal year ended July 31, 1996, an increase of $1.6 million or 4.9%, from $32.0
million for the fiscal year ended July 31, 1995. As a percentage of net
revenues, income from operations remained constant at 3.4% for the fiscal year
ended July 31, 1996 as compared to the fiscal year ended July 31, 1995.
OTHER EXPENSE. Other expense (net) was $16.4 million for the fiscal year
ended July 31, 1996 compared to $5.8 million for the fiscal year ended July 31,
1995, an increase of approximately $10.6 million, primarily due to an increase
in interest expense from $11.5 million in fiscal 1995 to $14.9 million in fiscal
1996 and a foreign currency translation loss of $1.4 million for the fiscal year
ended July 31, 1996 compared to a $5.6 million foreign currency translation gain
for the fiscal year ended July 31, 1995. The Company does significant business
transactions in currencies other than the U.S. dollar. Exchange losses result
from the day to day fluctuations in currency exchange rates, due primarily to
the weakening yen and other Asian currencies against the U.S. dollar.
NET INCOME. Net income was $10.0 million for the fiscal year ended July 31,
1996, a decrease of $5.1 million or 33.6% from $15.1 million for the fiscal year
ended July 31, 1995.
35
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $16.4 million and $28.0
million for the nine months ended April 30, 1998 and 1997, respectively, and
$52.2 million in fiscal 1997 and $48.2 million in fiscal 1996. For the nine
months ended April 30, 1998, inventory provided a source of cash due to minimal
store expansion and a continued focus on inventory management. Inventory
management continues to remain the same with POS reporting available at
headquarters and at the store level. In 1997 and 1996 cash used for inventory
purchases was $8.3 million and $26.6 million, respectively, and was primarily
related to inventory requirements associated with store expansion. The decrease
in cash flow from operations for the period ended April 30, 1998 compared to the
comparable period in fiscal 1997 was primarily due to payments reducing accounts
payable. The use of cash in 1995 for inventory needs was associated with a
one-time build up of catalog product.
Capital expenditures for the nine months ended April 30, 1998 as well as
fiscal 1997 and 1996 were primarily for store expansion and consisted primarily
of improvements to existing stores and new stores both domestically and in Asia.
Interest payments on the Notes and on the New Credit Facility will impose
significant liquidity demands upon the Company comparable to those of recent
years. In addition to its debt service obligations, the Company will require
liquidity for capital expenditures, lease obligations and general working
capital needs. Total capital expenditures for 1998 are expected to be
approximately $25.0 million, of which approximately $5.0 million will be related
to maintenance capital requirements.
The Company believes that the cash flow generated from its operations,
together with amounts available under the New Credit Facility, should be
sufficient to fund its debt service requirements, lease obligations, working
capital needs, its currently expected capital expenditures and other operating
expenses for the foreseeable future. The New Credit Facility provides the
Company with available borrowings up to an aggregate amount of $275.0 million,
of which approximately $150.0 million can be borrowed in Japanese yen and a
portion in British pounds, subject to compliance with the borrowing base
formula. As of April 30, 1998, approximately $245.1 million was available under
the New Credit Facility based upon the borrowing base formula, of which $120.6
million had been drawn. The Company's future operating performance and ability
to service or refinance the Notes and the New Credit Facility will be subject to
future economic conditions and to financial, business and other factors, many of
which are beyond the Company's control. See "Risk Factors."
The New Credit Facility and the Notes impose certain restrictions on the
Company's ability to make capital expenditures and limit the Company's ability
to incur additional indebtedness. Such restrictions could limit the Company's
ability to respond to market conditions, to provide for unanticipated capital
investments or to take advantage of business or acquisition opportunities. The
covenants contained in the New Credit Facility and the Notes also, among other
things, limit the ability of the Company to dispose of assets, repay
indebtedness or amend other debt instruments, pay distributions, create liens on
assets, enter into sale and leaseback transactions, make investments, loans or
advances and make acquisitions.
SEASONALITY
Retail music sales in the United States are typically higher during the
calendar fourth quarter as a result of consumer purchasing patterns due to
increased store traffic and impulse buying by holiday shoppers. As a result, the
majority of U.S. music retailers and, more specifically, the mall-based
retailers rely heavily on the calendar fourth quarter to achieve annual sales
and profitability results. Tower's deep-catalog approach to prerecorded music
appeals to customers who purchase music on a year-round basis. Consequently,
Tower has historically been able to maintain consistency with its gross margins,
has had reduced seasonal reliance and has more operating flexibility than its
mall-based competitors. In addition, international markets exhibit less fourth
quarter seasonality than U.S. markets and Tower's
36
international presence has historically further reduced this reliance on the
U.S. holiday shopping season.
INFLATION
The Company believes that the recent low rates of inflation in the United
States, Japan and the United Kingdom, where it primarily operates, have not had
a significant effect on its net sales or operating results. The Company attempts
to offset the effects of inflation through price increases and control of
expenses.
FOREIGN EXCHANGE MANAGEMENT
The Company has substantial operations and assets located outside the United
States, primarily in the United Kingdom and Japan. With respect to international
operations, principally all of Tower's revenues and costs (including borrowing
costs) are incurred in the local currency, except that certain inventory
purchases are tied to U.S. dollars. The Company's financial performance on a
U.S. dollar-denominated basis has historically been significantly affected by
changes in currency exchange rates. The Company believes that the matching of
revenues and expenses in local currency, as well as its foreign exchange hedging
activities and borrowings in foreign currencies, mitigate the effect of
fluctuating currency exchange rates. Nonetheless, changes in certain exchange
rates could adversely affect the Company's business, financial condition and
results of operations. The Company believes that enhancement of its
international banking relationships under the New Credit Facility will provide
additional hedging opportunities for its foreign currency exposure management.
See "Risk Factors--Risks Relating to International Operations."
RECENT ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards (SFAS) No. 130, REPORTING
COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, were issued in June 1997. The Company will
adopt both of the statements beginning July 31, 1999.
SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income is a measure of all changes in the equity of the Company as a result of
recognized transactions and other economic events of the period other than
transactions with shareholders in their capacity as shareholders. Had the
provisions of SFAS No. 130 been applied for the years ended July 31, 1995, 1996
and 1997, comprehensive income would have consisted primarily of net income and
foreign currency translation adjustments.
SFAS No. 131 requires that the Company report financial and descriptive
information about its reportable operating segments using the "management
approach" model. Under the management approach model, segments are defined based
on the way the Company's management internally evaluates segment performance and
decides how to allocate resources to segments. The Company is in the process of
evaluating the impact of this pronouncement on its segment disclosures.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, within the
next two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements.
37
The Company has budgeted for and is currently utilizing in-house information
technology staff and outside consultants to analyze and upgrade its corporate
management software to make it Year 2000 compliant, a process which the Company
expects to complete in late 1998 at a cost of approximately $250,000. The
Company also intends to implement its ISP system in Japan in early 1999 which
should make the Company's entire inventory management system Year 2000
compliant. The Company has not completed a review of the preparations of its
major vendors, distributors and shippers to meet the Year 2000 requirements and
does not yet have a basis to assess the impact, if any, that the Year 2000
requirements will have on its vendors, distributors and shippers and
consequently on the Company. Because the Company is able to order directly from
its major vendors and some independent distributors and have product
drop-shipped directly to stores, any failure of such vendors and distributors or
of shippers to institute or complete their own programs to address Year 2000
requirements could adversely impact the Company's distribution system. Failure
by the Company to complete implementation of the required changes to address
Year 2000 requirements prior to the Year 2000 might result in significant
difficulties in the Company's administration of corporate and inventory tracking
software systems. Failure by the Company's vendors and distributors, shippers
and other parties with which the Company does business to address Year 2000
requirements could significantly impact the ability of the Company to distribute
products for some period of time and otherwise disrupt the Company's business
operations. Such problems could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Risk Factors--Year
2000 Compliance."
38
BUSINESS
OVERVIEW
Founded in 1960, Tower is the second largest specialty retailer of recorded
music headquartered in the United States in terms of revenues and is one of the
largest and most widely-recognized music retailers in the world. The Company
operates a total of 183 stores worldwide, consisting of 119 U.S. stores in 20
states and 64 international stores in 11 countries. Management believes that
Tower is one of the leading music retailers in each of the U.S. major
metropolitan areas in which it operates (many of which are the fastest growing
markets in the United States). The Company offers a diversified line of music
products including compact discs, recorded audio cassettes, recorded video
cassettes, laser discs, DVD and other complementary products, including books,
magazines, blank tapes, software titles, and accessories. As of April 30, 1998,
Tower's aggregate outstanding indebtedness was $241.1 million, and for the nine
month period ended April 30, 1998 Tower's ratio of earnings to fixed charges was
1.5x and net revenues were $771.4 million.
Tower attracts and retains customers who buy music on a year-round basis by
providing an extensive product selection in an interactive, entertaining
environment. Tower stores feature extended store hours, in-store listening
stations and knowledgeable and motivated sales personnel. These factors,
combined with the Company's competitive pricing, make Tower stores a preferred
shopping destination. Tower offers one of the broadest selections of recorded
music, including recent releases, older releases and various other music formats
primarily in stand-alone locations in densely populated urban and suburban
areas. Tower stores are typically larger in square footage and have lower rents
as a percentage of revenues than comparable mall-based music specialty
retailers. Most of the Company's domestic stores exceed 10,000 square feet and
carry at least 50,000 music titles. Flagship stores, which are located in major
metropolitan areas such as Boston, Buenos Aires, Chicago, Glasgow, Hong Kong,
Honolulu, London, Los Angeles, New Orleans, New York, Osaka, Philadelphia, San
Francisco, Seattle, Singapore, Taipei, Tokyo, Toronto and Washington, D.C.,
typically exceed 20,000 square feet and carry between 80,000 and 120,000 music
titles. In addition to the BILLBOARD Top 50, Tower offers competitive pricing on
the full range of its product offerings. Management believes that Tower's
success in attracting loyal customers increases store traffic and sales
throughout the year and has been a factor in making the Company less dependent
upon the success of new music releases and calendar fourth quarter sales than
many of its U.S. competitors.
Due to Tower's high sales volume and long-standing relationships with
vendors and music manufacturers, the Company receives substantial cooperative
advertising allowances, beneficial purchasing terms, short lead times on
inventory fulfillment, product return rights and drop shipments of orders
directly to its stores. Tower monitors the quantity and mix of inventory in each
of its stores through a central inventory management system. However, unlike
many of its competitors (who purchase and distribute from a central location),
Tower's store managers are given discretion in managing the level and mix of the
inventory in their stores in order to most effectively market to each store's
demographic customer base. The Company believes that this policy has been an
important factor in Tower's strategy to minimize its product return levels,
thereby reducing restocking fees, improving operating margins and sustaining
favorable vendor relations.
In order to increase and diversify its revenue base, Tower became the first
U.S.-based music retailer to implement an international growth strategy. This
expansion, which commenced in 1979, initially focused on the Japanese market
(which is currently the world's second largest market for recorded music, with
net sales of approximately $6.8 billion in 1996) and enabled Tower to become a
market leader in Japan for recorded music. Tower implemented a similar expansion
strategy in the United Kingdom beginning in 1986. The Company currently has more
international locations than any other U.S.-based music retailer and, for the
1997 fiscal year, derived approximately 40% of its total net revenues from
international sales. Tower currently operates 41 stores in Japan; six in
England; three
39
each in Hong Kong, Israel and Singapore; two each in Mexico and Taiwan; and one
each in Argentina, Canada, Ireland and Scotland. In addition, the Company has
entered into franchise agreements with local operators in Colombia, Malaysia,
South Korea and Thailand.
INDUSTRY
The worldwide market for recorded music has grown from approximately $29.4
billion in calendar 1992 to approximately $40.2 billion in calendar 1996. The
top five markets, North America, Western Europe, Japan, Latin America and Asia
(outside of Japan), individually accounted for approximately 32.9%, 32.8%,
17.0%, 6.2% and 5.6%, respectively, and collectively accounted for approximately
94.5%, of the global market in calendar 1996. Management believes that the
following factors are the primary drivers of growth in the industry globally:
(i) overall population growth in major markets, (ii) technological innovations
in the delivery of recorded music, (iii) continued compact disc format
penetration and (iv) the success of new music releases.
In the United States, there are four primary channels of recorded music
distribution: specialty music retail stores, discount and consumer electronics
stores, record clubs, and mail order and other channels, which accounted for
approximately 49.9%, 31.5%, 14.3% and 4.3% of unit shipments, respectively, in
calendar 1996. The U.S. market for recorded music has grown from approximately
$9.0 billion in calendar 1992 to approximately $12.2 billion in calendar 1997.
However, beginning in 1995, the volume of recorded music shipped to retailers
slowed and then declined by approximately 2.0% in 1997 primarily due to: (i)
overshipment of product by manufacturers in 1995 and 1996 to certain retailers,
(ii) store rationalization by certain mall-based and discount music retailers
following an aggressive overexpansion of music retail square footage from 1992
to 1994, (iii) a lack of new technological innovations influencing the delivery
of recorded music, (iv) continued maturation of the compact disc format, and (v)
disappointing new releases. Management believes that the market and the outlook
for music retailers improved in the United States starting in the second half of
calendar 1997, primarily due to a reduction in domestic music retail square
footage as certain electronics retailers reduced music store selling space and
narrowed their catalog selections in response to difficulties in successfully
implementing "loss leader" music retail sales strategies, continued store
consolidation of mall-based music retailers, the release of several successful
new titles and positive demographic trends. The Company believes that it is
well-situated in the industry because of its store base, merchandising strategy
and long-standing supplier relationships. See "Market and Industry Data."
OPERATIONS
Tower currently operates a total of 183 stores worldwide, consisting of 119
U.S. retail stores in 20 states and 64 international stores in 11 countries. The
Company's operating structure consists of (i) its U.S. stores and wholesaling
operations, (ii) its Asian stores and wholesaling operations, and (iii) its U.K.
and Ireland stores and wholesaling operations. The Company's operations are
directed by an Executive Committee comprised of eight executive officers. See
"Management."
UNITED STATES. The Company's U.S. operations currently consist of 119
retail stores. In the United States, Tower has organized its operations into 12
geographic regions, each headed by a regional manager who has responsibility for
sales and merchandising, day-to-day operations and administration. Tower's
corporate headquarters provides central support to each region, including
systems, distribution, accounting and national marketing programs. The corporate
headquarters also gives final approval for all new store sites and store design
and oversees quality standards and other critical elements of the Tower concept.
The Company believes that by organizing its operations in this manner, it can
more effectively manage its business, thereby enhancing its ability to achieve
its expansion plans without compromising operating standards.
40
To pursue growth opportunities through new store formats and merchandising
strategies, Tower initiated an operating agreement with The Good Guys!, Inc.
("The Good Guys!"), a leading electronics retailer to open stores under the
"WOW!" name. The WOW! stores sell both recorded music and consumer electronics
equipment, offering the shopper both convenience and a broad product offering.
During calendar 1996, WOW! stores were opened in Las Vegas, Nevada and Long
Beach, California. Two additional WOW! stores are scheduled to open in Southern
California in calendar 1998. Under the WOW! store format, Tower and The Good
Guys! each manage, operate and lease from the landlord their respective sections
of the store.
ASIA. Tower's Asian operations consist of 41 stores in Japan, three in Hong
Kong, three in Singapore and two in Taiwan. All Asian store managers report to
the Director of Asian Operations located in Japan. A portion of the U.S.-sourced
product is shipped to the Asian stores through the Company's U.S. distribution
facilities. The balance of product is shipped through a variety of sources
worldwide.
UNITED KINGDOM AND IRELAND. The Company currently operates seven stores in
the United Kingdom and one store in Ireland. All store managers in the United
Kingdom and Ireland report to the Director of European Operations located in
London. A portion of U.S.-sourced product is shipped through the Company's U.S.
distribution operations. The balance of product is shipped through a variety of
sources worldwide.
JOINT VENTURES AND FRANCHISES
The Company has joint venture operations in Argentina, Israel and Mexico.
These arrangements enable Tower to enter into additional foreign markets and
obtain an improved understanding of local product demand and operating
procedures while benefiting from a sharing of capital commitments. Under joint
venture arrangements, Tower manages store operations, utilizing input from local
investors. Some product is sourced through Tower's distribution operations.
Joint venture operations are managed from Tower's corporate headquarters. The
Company anticipates that future expansion in most international markets will be
through wholly-owned subsidiaries or through franchises rather than joint
ventures.
The Company has entered into franchise agreements to operate stores in
Colombia, the Philippines, Malaysia, South Korea and Thailand. Additional
franchised stores are planned for other countries. The Company has focused its
franchising operations in developing markets where the operating environment
makes direct operations less desirable. Franchised stores are managed by the
local operator with input from the Company on store format and merchandising.
The Company benefits from these franchise agreements through the distribution of
products as well as through royalty income and trademark licensing fees.
STORE FORMAT AND LOCATIONS
Tower has differentiated itself from competing music retailers with its
strategic store locations, which generally feature a large, centrally-located
store in a densely populated urban area complemented by nearby urban and
suburban stand-alone stores. Tower's flagship stores in major markets typically
exceed 20,000 square feet, with the majority of all stores exceeding 10,000
square feet. Newer stores range from 15,000 to 25,000 square feet, depending on
the market and location. The Company's larger, stand-alone locations provide it
with various operating efficiencies, including lower rent expenses and lower per
unit costs than comparable mall-based retailers. The Company's large base of
high-volume, stand-alone stores enables it to receive drop-shipments of product
directly to store locations (thereby reducing the costs associated with
warehousing and distribution). Management believes that its portfolio of
strategically located stores would be difficult to replicate.
The Company believes that the selection of locations for its stores is
critical to the success of its operations. The site-selection process consists
of an in-depth analysis of regional demographics,
41
consumer purchasing habits and traffic within a specific area. Senior management
is actively involved in this process and grants all final site approval,
evidencing the Company's commitment to continued growth and its focus on
successful, long-lasting locations. Over Tower's 38-year operating history, the
Company has closed only eight stores.
Tower management has consistently identified and developed locations and
markets in the United States and internationally that have generated significant
sales growth and profitability. The Company has taken a disciplined approach to
new store growth, expanding from 135 stores worldwide in the fiscal year ended
July 31, 1992 to 183 stores worldwide as of April 30, 1998. During the two-year
period ended July 31, 1997, the Company opened two stores in the United States
and 23 stores internationally (including 17 in Japan), while closing or
combining four existing outlets. The Company plans to continue to leverage its
strong brand name and proven store format in new and existing markets in
locations that meet the Company's demographic and performance criteria.
PRODUCTS
The Company offers a diverse line of products including compact discs,
recorded audio cassettes, recorded video cassettes, laser discs, DVD and other
complementary products, including books, magazines, blank tapes, software
titles, and accessories.
RECORDED MUSIC. The Company's primary source of revenue is the sale of
recorded music on compact discs and audio cassettes. For fiscal years 1995, 1996
and 1997, and for the nine months ending April 30, 1997 and 1998, recorded music
sales accounted for approximately 87.6%, 88.5%, 89.2%, 89.4% and 88.5%,
respectively, of Tower's worldwide net revenues. The Company's stores carry a
wide selection of compact discs and audio cassettes purchased from all major and
most independent recording companies, which, except for new releases and special
promotions, are arranged in the stores by genre and alphabetically by artist or
group. Tower differentiates itself from its competitors through the breadth and
depth of its product selection. Tower's strategy is to offer the broadest
selection of recorded music for its customers, including recent BILLBOARD Top 50
releases as well as a comprehensive variety of older releases and diverse music
formats. Most of the Company's stores carry at least 50,000 music titles, while
flagship stores located in major markets, such as Boston, Buenos Aires, Chicago,
Glasgow, Hong Kong, Honolulu, London, Los Angeles, New Orleans, New York, Osaka,
Philadelphia, San Francisco, Seattle, Singapore, Taipei, Tokyo, Toronto and
Washington, D.C., usually carry between 80,000 and 120,000 music titles. By
contrast, management believes that the U.S. industry average for mall-based
music retailers is approximately 5,000 to 10,000 music titles per store (focused
primarily on deeply discounted, high-volume products from the BILLBOARD Top 50).
VIDEO PRODUCTS. In addition to recorded music, the majority of Tower stores
sell videocassette, laser disc and DVD products. For fiscal years 1995, 1996 and
1997, video sales accounted for approximately 7.1%, 6.6% and 6.1%, respectively,
and for the nine month periods ending April 30, 1997 and 1998, accounted for
6.1% and 7.4%, respectively, of Tower's worldwide net revenues. Selected stores
also offer video rentals. These video products generally command larger gross
margins than the Company's recorded music products. In late 1996, DVD was
introduced as an alternative medium that could eventually replace the laser
disc. DVD offers the consumer laser technology in a smaller disc format with
superior picture quality and audio fidelity. The Company anticipates that in the
next few years, sales of DVD players will begin to replace sales of laser disc
players and video cassette recorders as the new technology becomes more widely
available. The Company believes that it is well-positioned to capitalize on the
growing DVD market and is considered an industry leader in sales of this format.
COMPLEMENTARY PRODUCTS. To complement music buyers' interests, Tower stores
also sell books, magazines, blank tapes, software titles, and accessories. As of
April 30, 1998, the Company operated 13 stand-alone book stores. These
complementary products generally command larger gross margins than the Company's
recorded music products.
42
MARKETING, ADVERTISING AND PROMOTION
Tower aggressively markets, advertises and promotes its products and its
brand image to generate customer awareness of its extensive selection of music
titles, knowledgeable customer service and interactive and entertaining store
environments. Tower advertises in a variety of national and local print and
broadcast media, including television, magazines, newspapers and billboards.
Tower targets a wide range of customers, from teenagers to senior citizens, who
purchase music on a year-round basis. The Company believes that its clustering
of stores in strategic markets allows it to maximize its use of marketing,
advertising and promotional U.S. dollars. In addition, Tower attracts large
corporate sponsors such as American Express, IBM and MasterCard for promotions
and events. Tower also produces several music publications under the names PULSE
(U.S.), BOUNCE (Japan), TOP (U.K.), PULSE LATINO (Latin America) and PASS
(Taiwan) with a combined annual circulation of approximately 625,000. Tower
maintains a reputation for unique marketing through in-store appearances and
live performances by recording artists, campaigns and promotions with suppliers
and other third parties, book signings, tie-ins with local music events (e.g.,
Nashville's Fan Fair and the Monterey Jazz Festival) as well as involvement in
national music events, such as sponsorship of the 1998 Lilith Tour.
Tower believes that its strong focus on localized marketing provides it with
a significant advantage over many of its competitors. The Company's localized
marketing approach includes local promotions of concerts and in-store
appearances by musicians, as well as providing Tower store managers discretion
(subject to parameters set by the Company's regional and national product
managers) to customize product inventory in their stores to the demographics and
buying patterns of their local market. Depending on local demographics,
merchandise mix and promotions can be shifted toward certain music genres. For
example, in New York City, Tower's Lincoln Center store places a greater
emphasis on its classical music selection than the downtown store, which
emphasizes the latest trends in rock music.
As one of the nation's largest music retailers and due to the diversity and
depth of its music selection, the Company has developed strong supplier
relationships. As a result, the Company receives substantial cooperative
advertising allowances, beneficial purchasing terms, short lead times on
inventory fulfillment, product return rights (subject to certain terms and
restocking fees), and drop shipments of orders directly to its stores, all of
which have contributed to Tower's historically favorable operating margins.
Cooperative advertising funds are provided to promote recorded music products of
a specific genre or on a label-wide basis. Tower advertises jointly with
recording companies worldwide in local and national media markets and receives
substantial financial support from them. Cooperative advertising offsets a
significant portion of the Company's advertising expenses.
The Company has also introduced an affinity MasterCard credit card which
capitalizes on the Tower brand name and enables the Company to track purchasing
patterns by cardholding customers.
SUPPLIERS
RECORDED MUSIC. The majority of Tower's music purchases come from six major
suppliers with which Tower has developed long-standing relationships. As a
result of these relationships and Tower's high sales volume, the Company
receives substantial cooperative advertising allowances, beneficial purchasing
terms, short lead times on inventory fulfillment, competitive pricing programs
and drop shipments of orders directly to its stores. In addition, the Company
purchases product from numerous independent distributors and labels. Unsold
music product may be returned to the manufacturer at any time that the title
remains in the current music catalog of a manufacturer; however, restocking fees
are assessed for returned product. Catalog changes are generally made only after
advance notice, allowing the Company to return excess inventory before a title
is discontinued. None of the Company's major suppliers limits returns of
inventory.
COMPLEMENTARY PRODUCTS. Book and magazine purchases require coordination
with a greater number of vendors than music purchases. Returned books and
magazines are not subject to restocking
43
charges. Although management believes that its current book and magazine
purchasing procedures are efficient, it is considering various alternatives that
would allow Tower stores to order directly from publishers and shorten delivery
time.
Pre-recorded video cassettes, DVD products, laser discs and software titles
are purchased from a limited number of vendors for shipment through the
Company's U.S. distribution operations, or are drop-shipped directly to stores.
Unsold video products and software titles may be returned to distributors for
full refunds.
PURCHASING, INVENTORY MANAGEMENT AND DISTRIBUTION
The Company believes that it has developed state-of-the-art inventory
purchasing, management and distribution systems.
Unlike most of its competitors, Tower's purchasing is partly decentralized.
Tower store managers are given discretion to manage the levels and mix of
merchandise in their stores. These managers work closely with regional and
national product managers to customize product inventory in their stores to the
demographics and buying patterns of their local markets. The Company believes
that the skill of its store managers in merchandising to local tastes is an
important factor in Tower controlling its historical product return levels,
thereby reducing restocking fees and improving margins and maintaining favorable
vendor relations.
The Company's ISP system enables management to monitor up-to-the-moment
levels and mix of its inventory in each of its stores. The ISP system provides
instantaneous on-line information regarding quantities on hand, turns at the
store level and on a combined basis, historical movement reports by SKU, pricing
and cost data and customer service information. The ISP system also identifies
slow-moving and deleted titles and overstocked items, and provides suggested
replenishment information to store buyers. By utilizing the ISP system, store
managers are able to pre-set and adjust quantities on hand and establish
"just-in-time" reorder points. This system enables the store managers to carry
appropriate levels of deep-catalog product and to maintain sufficient inventory
levels for fast-moving product.
The Company's U.S. distribution operations distribute products that are not
drop-shipped to Tower stores, and distribute a portion of the product to the
Company's international subsidiaries, joint ventures and franchisees. The
Company also wholesales products, particularly independent label recorded music,
to other retailers in both the U.S. and international markets. In addition, the
Company has established export wholesaling branches in Japan and the United
Kingdom. This enables the Company to export international catalog product to
music retailers, taking advantage of the economies of scale, while providing
prompt delivery.
The Company also sells recorded music both via mail order and over the
Internet. The Company maintains a website at HTTP:/ /WWW.TOWERRECORDS.COM and an
online store on America Online at keyword "TOWER." Mail order and Internet sales
are fulfilled through the Company's U.S. distribution facility allowing
overnight delivery to customers in many cases.
COMPETITION
The retail music industry is highly competitive. In the United States there
are four primary channels of recorded music distribution: specialty music retail
stores, discount and consumer electronics stores, record clubs, and mail order
and other channels, which accounted for approximately 49.9%, 31.5%, 14.3% and
4.3% of unit shipments, respectively, in calendar 1996. The Company competes
with a wide variety of music retailers, including regional and national
mall-based music chains, international chains, deep-discount retailers, mass
merchandisers, consumer electronics outlets, record clubs, mail order, and
independent operators. The Company believes the principal competitive factors in
the retail music
44
industry are brand name recognition, selection, pricing, inventory management,
marketing, store location and management expertise. The Company believes that it
competes favorably with respect to each of these factors.
MAJOR INTERNATIONAL CHAINS. In certain of its major, metropolitan markets,
the Company competes directly with HMV and Virgin-large, international music
retailers-that, like the Company, emphasize a broad selection of titles.
Management believes that HMV and Virgin tend to cater to a sophisticated and
less price-sensitive customer base; Tower's customer base includes not only such
customers but also extends to a much broader demographic. Further, management
believes that Tower's approach to localized marketing, advertising and
merchandising, coupled with its more competitive pricing, differentiates Tower
from HMV and Virgin. In 1997, HMV had 15 stores in the United States, primarily
on the East Coast, while Virgin had 11 stores in the United States, located
primarily in tourist destinations. HMV and Virgin also had 20 and eight stores,
respectively, in Japan, and 105 and 38 stores, respectively, in the United
Kingdom, the other major markets in which the Company competes. HMV and Virgin
are expected to open additional stores, some of which may be in locations that
would compete directly with Tower.
MALL-BASED MUSIC RETAILERS. The Company also competes with various
mall-based music retailers such as Musicland, Transworld Entertainment,
Wherehouse Entertainment and Camelot. These competitors tend to occupy mall
locations and, in the Company's judgment, often face significant competitive
disadvantages, such as reduced inventory selection due to size constraints on
mall retail space, larger overhead costs generated by higher rent and occupancy
costs, higher per unit costs, higher costs associated with warehousing and
distribution, and lack of an international infrastructure and savvy brand-name
identity. In recent years, many of the mall-based music retailers whose revenues
are heavily dependent upon BILLBOARD Top 50 sales have had difficulty competing
effectively with the selling tactics of the large discounters, and have been
closing unprofitable stores in an attempt to minimize operating losses. Several
mall-based music retailers, including Camelot Music, Peppermint, Record Giant,
Peaches Entertainment, Strawberries and Wherehouse Entertainment, have filed for
bankruptcy.
DISCOUNTERS AND CONSUMER ELECTRONICS STORES. Specialty music retailers have
experienced increased competition from the entrance into the retail music
industry of large discounters and consumer electronics stores such as Wal-Mart,
Kmart, Target, Circuit City, Best Buy, Barnes and Noble and Borders. The market
share of specialty music retailers dropped from 70% in 1990 to 50% in 1996 while
the market share of the large discounters and consumer electronics stores
increased over the same period. These large discounters and consumer electronics
stores typically feature BILLBOARD Top 50 recordings with minimal or no gross
margin with the intent of generating additional store traffic and cross-selling
other, higher margin products, such as consumer electronics. Tower believes that
its operations have been less adversely affected than mall-based music retailers
by the selling tactics of the large discounters and consumer electronics stores
because of its emphasis on deep-catalog merchandising.
OTHER. The Company expects continued growth in competing home entertainment
options, including the Internet and larger numbers of television and music
channels offered by cable companies. The further development of Internet and
cable technologies, coupled with high quality digital recording technologies,
could enable direct downloading of recorded music by consumers, which could
result in significant changes in existing distribution channels for prerecorded
music. Such a development could have a material adverse effect on the Company's
business, financial condition or results of operations. See "Risk
Factors--Trends Affecting the Music Industry."
TRADEMARKS
Tower regards its trademarks and service marks as having significant
worldwide value and as being important to its marketing efforts and brand name
recognition. Tower has registered its TOWER
45
RECORDS-VIDEO-BOOKS trademark and variations thereof, along with numerous other
trademarks, with the United States Patent and Trademark Office on the Principal
Register. The Company has applications pending for a number of additional marks.
The Company also has registered its TOWER trademark, or variations thereof, in
numerous foreign countries. The Company's policy is to pursue the registration
of its marks whenever possible and to vigorously oppose any infringement of its
trademarks and trade names.
PROPERTIES
The Company's headquarters are located in approximately 90,000 square feet
of leased facilities in West Sacramento, California. These facilities house the
Company's management, marketing and sales personnel. The lease for these
facilities terminates on April 30, 1999. The Company believes that there is
sufficient office space available at favorable leasing terms in the Sacramento
area to satisfy any additional needs of the Company that may result from future
expansion.
As of April 30, 1998, Tower's total leased space consisted of approximately
2.1 million square feet of space worldwide. As of April 30, 1998, the Company
was a party to approximately 200 real estate leases and subleases, relating to
nearly all of its store locations as well as its administrative and warehouse
facilities. Substantially all of these are recorded as operating leases. The
leases expire between 1998 and 2024, with renewal options varying between one
and 20 years. Lease terms typically provide a minimum payment plus modifications
for changes in the consumer price index and/or other specified increases. Most
of the U.S. stores operate as stand-alone locations.
EMPLOYEES
As of December 31, 1997, the Company employed approximately 6,800 persons,
of whom approximately 965 were employed on a part-time basis. None of the
Company's employees is covered by a collective bargaining agreement. The Company
considers its employee relations to be good.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
The Company has received a document request in connection with an
investigation by the Federal Trade Commission into certain trade practices by
major recording companies involving the implementation of minimum advertised
price ("MAP") programs in response to the deep discounting tactics of large
discounters and consumer electronic stores and the threat of withdrawal of
cooperative advertising and promotional funds for retailers which fail to
observe the MAP guidelines. The Company does not believe it is a target of the
inquiry. The Company does not expect the outcome of this investigation to have a
material effect on its business, financial condition or results of operations.
46
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information with respect to the
executive officers and directors of the Company:
YEARS WITH
NAME AGE POSITION TOWER
- ---------------------------- --- ---------------------------------------------------------------- ---------------
Russell M. Solomon.......... 72 President, Chief Executive Officer and Director 38
Michael T. Solomon.......... 49 Executive Vice President, General Counsel and Director 11
DeVaughn D. Searson......... 53 Chief Financial Officer, Secretary, Treasurer and Director 10
Stanley L. Goman............ 49 Senior Vice President--Retail Operations 30
Christopher S. Hopson....... 45 Senior Vice President--Advertising/Marketing 28
Keith Cahoon................ 42 Managing Director--Far East Operations 19
Andy D. Lown................ 32 Managing Director--European Operations 12
The Company's operations are directed by an Executive Committee comprised of
the following listed officers:
RUSSELL M. SOLOMON has served as President, Chief Executive Officer and a
Director of the Company since the Company's founding in 1960, and is a member of
the Company's Executive Committee. Mr. Solomon has served as President of the
National Association of Recording Merchandisers ("NARM") and as a Board member
of the Video Software Dealers Association. Mr. Solomon is also a member of the
Board of Directors of The Good Guys!. Mr. Solomon is the father of Michael T.
Solomon.
MICHAEL T. SOLOMON has served as a Director of the Company since 1982, as
Vice President and General Counsel of the Company since 1987 and as Executive
Vice President since May 1998, and is a member of the Company's Executive
Committee. Mr. Solomon has served on several NARM subcommittees and is a member
of the California Bar Association. Mr. Solomon is the son of Russell M. Solomon.
DEVAUGHN D. SEARSON has served as Chief Financial Officer of the Company
since 1988 and is a member of the Company's Executive Committee. Mr. Searson has
also served as a Director of the Company since May 1998. Prior to joining the
Company, Mr. Searson was President and Managing Partner of Searson & Company,
CPAs, the Company's outside accounting firm at the time, and served as the
Company's outside accountant for 11 years. Mr. Searson is a certified public
accountant.
STANLEY L. GOMAN has been an employee of the Company since 1967 and
currently serves as Senior Vice President-Retail Operations. Mr. Goman is a
member of the Company's Executive Committee. Mr. Goman presently serves as
Treasurer of NARM, and has also served as Chairman of the NARM Retail Advisory
Committee.
CHRISTOPHER S. HOPSON has been an employee of the Company since 1970 and has
served as Senior Vice President-Advertising/Marketing since 1989. Mr. Hopson is
a member of the Company's Executive Committee.
KEITH CAHOON has served as Managing Director of the Company's Far East
Operations since 1984. Mr. Cahoon is a member of the Company's Executive
Committee.
ANDY D. LOWN has been an employee of the Company since 1986 and currently
serves as Managing Director of the Company's European and Middle East
operations. Mr. Lown is a member of the Company's Executive Committee. Mr. Lown
also serves on the Executive Committee, Operations Committee and Supervisory
Committee of the British Association of Record Dealers and on the Board of the
British Photographic Association.
47
The Company's directors are all employees of the Company and do not receive
separate compensation for their services as directors. Each director has been
elected to serve until his successor has been elected and qualified at the next
annual meeting of the shareholders of the Company.
EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION TABLES
The following table shows the total compensation of (i) the Chief Executive
Officer and (ii) the next four highest-earning executive officers of the Company
for the year ended December 31, 1997, based on combined salary plus bonuses (the
Chief Executive Officer and such executive officers are hereinafter referred to
as the "MTS Named Executive Officers"):
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
---------------------------------------------------
OTHER ANNUAL ALL OTHER
SALARY BONUS COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($) ($)(A)
- ---------------------------------------------- --------- ----------- ----------- -------------- ---------------
Russell M. Solomon............................ 1997 $ 630,180 $ 300,000 -- $ 6,259
President and Chief Executive Officer
Walter S. Martin.............................. 1997 531,300 300,000 -- 6,259
Executive Vice President and
Secretary/Treasurer
Michael T. Solomon............................ 1997 334,972 86,000 -- 6,259
Vice President and General Counsel
Stanley L. Goman.............................. 1997 197,200 91,000 -- 6,259
Senior Vice President--Retail Operations
Keith Cahoon.................................. 1997 173,467(b) -- $ 184,714(b) 6,259
Managing Director--Far East Operations
- ------------------------
(a) Represents Company contributions to the Company's retirement plan on behalf
of the MTS Named Executive Officers.
(b) Calculated at an exchange rate of 120 Japanese yen per U.S. dollar.
EMPLOYMENT AGREEMENTS
The Company does not currently have employment agreements with any of its
employees.
ADDITIONAL AGREEMENTS, ARRANGEMENTS AND UNDERSTANDINGS
The Company's Articles of Incorporation contain provisions that eliminate
the personal liability of its directors for monetary damages to the fullest
extent permitted by law and authorize the Company to indemnify its directors and
officers to the fullest extent permitted by law. Such limitation of liability
does not affect the availability of equitable remedies such as injunctive relief
or rescission.
The Company has entered into indemnification agreements with its officers
and directors containing provisions which are in some respects broader than the
specific indemnification provisions contained in the California Corporations
Code, including advancement of expenses to the indemnitee, the indemnitee's
right to select counsel and continuation of indemnification after indemnitee's
separation from the Company. The indemnification agreements may require the
Company, among other things, to indemnify such officers and directors against
certain liabilities arising from willful misconduct of a culpable nature and to
advance their expenses incurred as a result of any proceeding against them as to
which they could be indemnified.
48
OWNERSHIP OF CAPITAL STOCK
The following table sets forth certain information regarding ownership of
the Company's Common Stock as of the date of this Prospectus by: (i) each person
who is known by the Company to own beneficially more than five percent of the
Company's Common Stock, (ii) each of the Company's directors, (iii) MTS Named
Executive Officers, and (iv) all directors and MTS Named Executive Officers as a
group. Except as otherwise indicated, the Company believes that the beneficial
owners of the Company's Common Stock listed below have sole investment and
voting power with respect to such shares, subject to community property laws.
AMOUNT AND NATURE
OF BENEFICIAL PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER(A) OWNERSHIP(B)(C) OWNERSHIP
- ------------------------------------------------------------------------------------ ----------------- -------------
Russell M. Solomon(d)............................................................... 620 62.0%
Walter S. Martin.................................................................... -- --
Michael T. Solomon(e)............................................................... 372 37.2
Stanley L. Goman.................................................................... -- --
Keith Cahoon........................................................................ -- --
All executive officers and directors as a group (8 persons)......................... 992 99.2%
- ------------------------
(a) The address of each named individual is the address of the principal
executive office of the Company as set forth herein.
(b) The numbers presented indicate the number of shares beneficially owned.
Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect to
securities. Shares of Common Stock subject to options or warrants currently
exercisable or exercisable within 60 days are deemed to be beneficially
owned by the person holding such option or warrant for computing the
percentage ownership of such person, but are not treated as outstanding for
computing the percentage of any other person. As of the date hereof, the
Company had no such options or warrants outstanding.
(c) Such share amounts solely reflect indirect ownership of the Class B Common
Stock of the Company, the only outstanding class of capital stock of the
Company. There are 1,000 shares of Class B Common Stock of the Company
outstanding, all of which are owned by Parent, and Russell Solomon
beneficially owns 620 shares, or 62.0%, and Michael Solomon beneficially
owns 372 shares, or 37.2%, of the outstanding Common Stock of Parent.
(d) Russell Solomon has sole voting and investment power with respect to such
shares as Trustee of the Russell Solomon Trust.
(e) Michael Solomon has sole voting and investment power with respect to 364 of
such shares as Trustee of the Michael Solomon 1994 Trust (the "Michael
Solomon Trust"), the David Solomon 1994 Trust (the "David Solomon Trust"),
the Andrew C. Solomon Trust, and the Aaron O. Solomon Trust, which own 180,
180, 2 and 2 of such shares, respectively. Michael Solomon is also the
beneficiary of the Michael Solomon Trust.
49
CERTAIN TRANSACTIONS
The following diagram presents graphically the transactions consummated in
the Prior Asset Exchange and the Reorganization, as discussed below:
[DIAGRAM]
50
THE REORGANIZATION
The Company recently reorganized its corporate structure to consolidate
substantially all of its business operations in the Company.
In March 1998, Russell M. Solomon and the Trusts caused Parent to be formed.
In April 1998, Parent issued shares of its Common Stock to the following persons
in the following final proportions: 62.4% to the Russell Solomon Trust and
certain trusts for the benefit of his grandchildren; 0.8% to Michael Solomon;
0.8% to David Solomon; 18.0% to the Michael Solomon Trust; and 18.0% to the
David Solomon Trust. In exchange for such shares of Common Stock, Parent
received the following assets: (i) from the Russell Solomon Trust and certain
trusts for the benefit of his grandchildren, 100% of the outstanding shares of
the Company; (ii) from Michael Solomon and David Solomon, the outstanding shares
of a corporation holding certain real estate on which a store facility is
located in San Francisco, California, and the outstanding shares of a
corporation holding certain real estate on which a store parking lot is located
in Los Angeles, California; (iii) from the Trusts, the following assets and
liabilities: (a) the Japanese Trademark Rights (including the rights to certain
unpaid royalties), (b) certain intercompany receivables owed to the Trusts in
the amount of $3.5 million and intercompany payables owed by the Trusts in the
amount of $14.2 million, (c) all of the equity interests in Three A's, Jeremy's
Holdings, LLC, a Delaware limited liability company, and Tower Domestic, Inc.,
which owns one Tower store, (d) the cash surrender value rights as of April 1998
of certain life insurance policies, and (e) a loan liability of $5.0 million
which constitutes part of the Existing Indebtedness. Parent subsequently
contributed to the Company all of the assets and liabilities received by Parent
from the Trusts, Michael Solomon and David Solomon.
PRIOR ASSET EXCHANGE AND OTHER TRANSACTIONS
Prior to the consummation of the transactions constituting the
Reorganization set forth in the previous paragraph, the Company transferred
certain assets with a book value of approximately $2.9 million to the Trusts in
exchange for inventory of the Trusts with an equal book value (such transfers
herein referred to as the "Prior Asset Exchange"). The principal business
purpose of the Prior Asset Exchange was to transfer certain primarily non-income
producing assets of a personal nature out of the Company and into the Trusts.
Although the Prior Asset Exchange preceded the Reorganization, the Prior
Asset Exchange and the Reorganization have been reflected for accounting
purposes in the consolidated financial statements as occurring in the same
transaction.
The Company currently anticipates that it will cause its wholly-owned
subsidiary, T.R. Services, Inc., a California corporation which operates the
Company's stores in the United Kingdom and wholly owns a subsidiary which
operates the Company's stores in Ireland, to transfer substantially all of its
assets to the Company.
The Company operated four stores through four separate subsidiaries in which
there existed minority interests. The Company recently bought out the minority
interests in each of these subsidiaries at fair market value, and each such
subsidiary was subsequently eliminated in an upstream merger.
The Company also conducted upstream mergers to eliminate Tower Domestic,
Inc. and Queen Anne Record Sales, subsidiaries of the Company.
1994 TRANSFER OF CERTAIN ASSETS TO TRUSTS
In July 1994, MTS transferred the assets of its U.S. wholesale and
distribution operations to Three A's Holdings, L.L.C., a Delaware limited
liability company ("Three A's"), which was at such time owned equally by the
Michael Solomon Trust and the David Solomon Trust (the "Trusts"), in exchange
for cash in the amount of approximately $280,000 and the assumption of certain
liabilities in the amount of approximately $3.8 million. Along with the purchase
of the distribution operations, the Trusts concurrently purchased certain
trademark and related rights to use the TOWER trademark in Japan (the "Japanese
Trademark Rights") from the Company for cash in the amount of $500,000 and a
promissory note in the amount of $11.5 million.
51
The $11.5 million promissory note from the Trusts to the Company bore
interest at a rate of 8.5% per annum. The largest aggregate amount of
indebtedness outstanding on such loan at any time since July 31, 1996 and the
amount outstanding on such loan as of April 20, 1998, was $9.5 million. Michael
Solomon is the trustee of both Trusts, and is the beneficiary of the Michael
Solomon Trust. As a result of the Reorganization, such promissory note was
cancelled and is no longer outstanding.
LIFE INSURANCE
The Company maintains split-dollar life insurance policies on the lives of
Russell M. Solomon and Doris E. Solomon for the benefit of certain family
trusts. The aggregate annual premiums on such policies paid by the Company are
approximately $3.6 million. The Company will receive the first proceeds of the
policies up to the aggregate premiums paid by the Company or the cash surrender
value attributable thereto, whichever is greater.
In addition, the Company maintains key-man life insurance policies on the
lives of certain executive officers of the Company. Aggregate annual premiums on
such policies are approximately $0.3 million. The Company is the beneficiary of
the key-man policies.
CERTAIN INDEBTEDNESS OF MANAGEMENT AND AFFILIATES
As of April 30, 1998, Russell Solomon, the President, CEO and a director of
the Company, owed the Trusts the amounts of $244,211 and $94,055 under a loan
from and a merchandise account, respectively, with the Company, both of which
are interest-free. Before the Prior Asset Exchange, such amounts were owed by
Russell Solomon to the Company. In the Prior Asset Exchange, the Company
transferred the receivable to the Trusts. The largest amounts of such
indebtedness outstanding at any time since the beginning of fiscal 1997 were
$244,211 and $94,055, respectively.
As of April 30, 1998, Michael Solomon, the Executive Vice President, General
Counsel and a director of the Company, owed the Trusts the amounts of $729,972
and $78,018 under a loan from and a merchandise account, respectively, with the
Company, both of which are interest-free. Before the Prior Asset Exchange, such
amounts were owed by Michael Solomon to the Company. In the Prior Asset
Exchange, the Company transferred the receivable to the Trusts. The largest
amounts of such indebtedness outstanding at any time since the beginning of
fiscal 1997 were $729,972 and $78,108, respectively.
As of April 30, 1998, Stanley Goman, the Senior Vice President--Retail
Operations of the Company, owed the Company the amounts of $65,479 and $50,479
under a loan from the Company bearing interest at 9.5% per annum and an
interest-free merchandise account, respectively, with the Company. The largest
amounts of such indebtedness outstanding at any time since the beginning of
fiscal 1997 were $61,602 and $50,479, respectively.
As of April 30, 1998, Christopher Hopson, the Senior Vice
President--Advertising/Marketing of the Company, owed the Company the amounts of
$150,534 and $17,319 under a home loan from the Company bearing interest at 9.5%
per annum and an interest-free merchandise account, respectively, with the
Company. The largest amounts of such indebtedness outstanding at any time since
the beginning of fiscal 1997 were $150,534 and $17,319, respectively.
Prior to the Reorganization, the Trusts had, in increments over a number of
years, borrowed a total of $4,665,506 from the Company at interest rates
averaging approximately 8.5% in order to cover premium payments on certain life
insurance policies for the benefit of the Trusts. In the Reorganization, the
liability on such loans, including all accrued and unpaid interest thereon, was
first assumed by Parent from the Trusts, and then assumed by the Company from
Parent. Upon such assumption by the Company, such loan liability was cancelled
by offset against the related receivable held by the Company. The greatest
amount of such liability outstanding at any time since the beginning of fiscal
1997 was $4,665,506 plus accrued and unpaid interest.
52
DESCRIPTION OF NEW CREDIT FACILITY
In connection with the Refinancing, the Company entered into a credit
agreement (the "Credit Agreement") with a syndicate of financial institutions
(the "Lenders") for which The Chase Manhattan Bank acts as administrative agent
(the "Administrative Agent") and Chase Securities Inc. acted as advisor and
arranger.
GENERAL. The New Credit Facility, which provides borrowing availability up
to a maximum aggregate principal amount of $275,000,000, consists of (i) a U.S.
dollar-based Facility A Revolving Line in the principal amount of up to
$125,000,000 (the "Facility A Commitment"), and (ii) a Japanese yen-based
Facility B Revolving Line in the principal amount of up to the equivalent in yen
(the "Yen Equivalent") on a date to be selected prior to the initial funding
date of $150,000,000, based on then-prevailing U.S. dollar-yen exchange rate
(the "Facility B Commitment").
A portion of the Facility A Commitment may be borrowed in British pounds
sterling ("Sterling"), such that the aggregate equivalent in U.S. dollars (the
"Dollar Equivalent") of all loans under the Facility A Revolving Line (the
"Facility A Loans") does not exceed U.S. $125,000,000. A portion of the Facility
B Commitment may be borrowed in U.S. dollars, such that the aggregate Yen
Equivalent of all loans under the Facility B Revolving Line (the "Facility B
Loans") does not exceed the Yen Equivalent of the Facility B Commitment. The
Dollar Equivalent of yen- and Sterling-denominated Facility A Loans, and the Yen
Equivalent of U.S. dollar-denominated Facility B Loans, will be calculated from
time to time, based on prevailing foreign exchange rates as of the end of each
calendar quarter, or more frequently, under certain circumstances. Prevailing
foreign exchange rates on any date will be determined with reference to the then
most recent fixing of exchange rates by (i) the Federal Reserve Bank of New
York, in the case of U.S. dollars, (ii) the Bank of Tokyo, in the case of yen,
and (iii) the Bank of England, in the case of Sterling.
Each of the Facility A Revolving Line and the Facility B Revolving Line will
be available to the Company and TRKK (collectively, the "Borrowers" and
individually, a "Borrower"). The Company may borrow up to the full principal
amount of the Credit Facilities. TRKK may borrow up to the full principal amount
of the Facility B Revolving Line and up to an aggregate of the Dollar Equivalent
of $25,000,000 under the Facility A Revolving Line.
INTEREST RATES; FEES. Interest on loans outstanding under the Credit
Facilities will accrue based on one or more rates selected by the applicable
Borrower, including (i) the alternate base rate (the "Alternate Base Rate") for
U.S. dollar-denominated loans, (ii) the money market rate (the "Money Market
Rate") for U.S. dollar-denominated loans, (iii) the yen base rate (the "Yen Base
Rate") for yen-denominated loans, (iv) a eurocurrency rate (the "LIBO Rate") for
U.S. dollar- or Sterling-denominated loans or a yen-based eurocurrency rate (the
"TIBO Rate") for yen-denominated loans, in each case plus an applicable margin
(the "Applicable Margin"), and (v) Sterling-denominated interest rate to be
agreed upon at the time the loan is made ("Special Sterling Rate") on
Sterling-denominated loans. The Alternate Base Rate is defined as, on any date,
the greatest of (x) the prime commercial lending rate of The Chase Manhattan
Bank, (y) the secondary market rate for certificates of deposit, adjusted for
reserves and assessments, plus 1%, and (z) the federal funds rate published from
time to time by the Federal Reserve Bank of New York, plus 1/2%. The Money
Market Rate is defined as the rate quoted from time to time by the
Administrative Agent and certain other Lenders designated as "Reference Banks"
for loans in U.S. dollars of a comparable principal amount and maturity. The Yen
Base Rate is the prime rate publicly announced from time to time in Tokyo, Japan
by the Facility B Swingline Lender. The LIBO Rate is defined as the rate for
eurocurrency deposits of U.S. dollars or Sterling, as applicable, for one, two,
three or six months, displayed on page 3740 or 3750 of Dow Jones Markets two
business days prior to the date the loan is to be made (or, if such rate is not
available, the rate at which such deposits are offered to the Administrative
Agent in the applicable interbank market). The TIBO Rate is defined as the rate
for eurocurrency deposits of yen for one, two, three or six months, displayed on
Reuters Screen Page TIBM
53
for the average of five banks two business days prior to the date the loan is to
be made (or, if such rate is not available, the rate at which such deposits are
offered by the Facility B Swingline Lender in the Tokyo interbank market). The
Applicable Margin over the LIBO Rate and TIBO Rate will be based upon the ratio
of (x) earnings before interest expense, taxes, depreciation, amortization and
rental expense, to (y) the sum of interest expense plus rental expense plus cash
dividends paid with respect to preferred stock plus the current portion of
indebtedness for the Borrowers and their subsidiaries (the "Fixed Charge
Coverage Ratio"), and will range from 0.40% to 0.90% per annum. The initial
Applicable Margin is 0.60% per annum.
The Company will be charged a facility fee per annum on the average daily
amount of the Facility A Commitment and the Facility B Commitment, regardless of
whether such Commitments are used or unused. The amount of the facility fee will
be tied to the Fixed Charge Coverage Ratio, and will range from 0.225% to 0.35%
per annum. The initial facility fee is 0.275% per annum.
REPAYMENT. Loans under the Credit Facilities may be borrowed, repaid and
reborrowed from time to time until the third anniversary of the closing of the
Credit Agreement (the "Credit Facilities Maturity Date"), subject to certain
customary conditions on the date of any such loan. The Company may request an
extension of Credit Facilities Maturity Date prior to either or both of the
first and second anniversaries of the closing of the Credit Agreement (but in no
event beyond the fifth anniversary of the closing of the Credit Agreement).
Either or both of the Facility A Revolving Line or the Facility B Revolving Line
may be extended by the Company for a one year period if, and to the extent that,
Lenders holding at least 51% of the Facility A Commitment and/or the Facility B
Commitment, as applicable, approve such extension.
SECURITY. The obligations under the New Credit Facility and the related
documents are expected to be secured by (i) a first priority lien on the
inventory and accounts receivable of MTS, Three A's and certain other material
subsidiaries, and (ii) a pledge of 65% of the capital stock of each material
foreign subsidiary of MTS. In addition, the obligations of TRKK and each other
material foreign subsidiary under the New Credit Facility and the related
documents are expected to be secured by a first priority lien on the inventory
and receivables of TRKK and each other material foreign subsidiary. At such time
as (x) no default shall have occurred and be continuing under the New Credit
Facility and related documents, and (y) MTS shall have outstanding any senior
unsecured non-credit enhanced long-term indebtedness for borrowed money that
shall be rated BBB- or better by Standard & Poor's Rating Group and Baa3 or
better by Moody's Investors Service, Inc., such liens shall be released (the
"Collateral Release").
GUARANTEES. The obligations of TRKK under the New Credit Facility and the
related documents are expected to be guaranteed by MTS, Three A's and certain
other material subsidiaries.
PREPAYMENTS. The Borrowers may make prepayments on loans under the New
Credit Facility at any time, upon prior notice to the Administrative Agent. The
Company will be required to make prepayments on loans under the New Credit
Facility if and to the extent that, as of the end of any calendar quarter (or
more frequently, under certain circumstances), giving effect to prevailing
foreign exchange rates on such date, the Dollar Equivalent of outstanding
Facility A Loans is more than 105% of the Facility A Commitment, or the Yen
Equivalent of outstanding Facility B Loans is more than 105% of the Facility B
Commitment.
CONDITIONS AND COVENANTS. The obligations of the Lenders under the New
Credit Facility are subject to the satisfaction of certain conditions precedent
customary in similar credit facilities or otherwise appropriate under the
circumstances. MTS and its subsidiaries are subject to certain negative
covenants contained in the Credit Agreement, including without limitation
covenants that restrict, subject to specified exceptions, (i) the incurrence of
additional indebtedness and other obligations and the granting of additional
liens, (ii) mergers, acquisitions, investments and acquisitions and dispositions
of assets, (iii) investments, loans and advances, (iv) dividends, stock
repurchases and redemptions, (v) prepayment or repurchase of other indebtedness
and amendments to certain agreements governing
54
indebtedness, including the Indenture and the Notes, (vi) engaging in
transactions with affiliates or subsidiaries, (vii) capital expenditures, and
(viii) sale and leaseback transactions. The Credit Agreement also contains
customary affirmative covenants, including compliance with ERISA and
environmental and other laws, payment of taxes, maintenance of corporate
existence and rights, maintenance of insurance, financial reporting, and use of
proceeds of loans. In addition, the Credit Agreement requires MTS and its
subsidiaries to maintain compliance with certain specified financial covenants,
including maximum capital expenditures, a minimum fixed charge coverage ratio
and a minimum tangible net worth. In addition, so long as the Collateral Release
shall not have occurred, the Borrowers and their subsidiaries will be required
to maintain a minimum ratio of (x) inventory and receivables with respect to
which the Lenders have a first priority lien (less reserves maintained in
accordance with GAAP (as defined)), to (y) aggregate indebtedness under the New
Credit Facility, less cash and cash equivalents (the "Balance Sheet Coverage
Ratio") of 1.25 to 1.00. Following the Collateral Release, the Balance Sheet
Coverage Ratio will no longer apply, but the Borrowers and their subsidiaries
will be required to maintain a maximum ratio of Senior Indebtedness (as defined
in the Credit Agreement) to earnings before interest expense, taxes,
depreciation and amortization. Certain of these financial, negative and
affirmative covenants are more restrictive than those set forth in the
Indenture.
EVENTS OF DEFAULT. The Credit Agreement also includes events of default
that are typical for senior credit facilities and appropriate in the context of
the Refinancing, including, without limitation, non-payment of principal,
interest or fees, violation of covenants, inaccuracy of representations and
warranties in any material respect, cross default to certain other indebtedness
and agreements, bankruptcy and insolvency events, material judgments and
liabilities, defaults or judgments under ERISA and change of control. The
occurrence of any of such events of default could result in acceleration of the
Borrowers' obligations under the Credit Agreement and foreclosure on the
collateral securing such obligations, which could have material adverse results
to holders of the Notes.
55
DESCRIPTION OF THE NOTES
The Existing Notes were, and the New Notes will be, issued under the
Indenture, dated as of April 23, 1998, between the Company and State Street Bank
and Trust Company of California, N.A., as trustee. The following summary of
certain provisions of the Indenture does not purport to be complete and is
subject to, and is qualified in its entirety by reference to, the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"), and to all of the
provisions of the Indenture, including the definitions of certain terms therein
and those terms made a part of the Indenture by reference to the Trust Indenture
Act, as in effect on the date of the Indenture. The Notes are subject to all
such provisions, and Holders of Notes are referred to the Indenture and the
Trust Indenture Act for a statement thereof. The definitions of certain terms
used in the following summary are set forth below under "--Certain Definitions."
As used in this section, the term "Company" refers to MTS, INCORPORATED and not
to any of its Subsidiaries.
The Notes are issued only in registered form, without coupons, in
denominations of $1,000 and integral multiples of $1,000. Initially, the Trustee
will serve as Registrar and Paying Agent for the Notes. The Notes may be
presented for registration or transfer and exchange at the offices of the
Registrar, which initially will be the Trustee's corporate trust office, in New
York, New York. No service charge will be made for any registration of transfer
or exchange of the Notes, except for any tax or other governmental charge that
may be imposed in connection therewith. The Company will pay principal (and
premium, if any) on the Notes at the Trustee's corporate trust office. At the
Company's option, interest may be paid at the Trustee's corporate trust office
or by check mailed to the registered addresses of the Holders as such addresses
appear in the Note register.
The Notes are general unsecured obligations of the Company and are
subordinated in right of payment to all current and future Senior Indebtedness,
including borrowings under the New Credit Facility. Borrowings under the New
Credit Facility are secured by the Company's accounts receivable and Inventory,
and a pledge of 65% of the capital stock of certain Foreign Subsidiaries. The
Notes rank pari passu in right of payment with all other senior subordinated
Indebtedness of the Company issued in the future, if any, and senior in the
right of payment to all subordinated Indebtedness of the Company issued in the
future, if any. To the extent the Company's future domestic Restricted
Subsidiaries meet certain materiality tests, such Restricted Subsidiaries will
guarantee the Notes on a senior subordinated basis. See "--Future Guarantees."
As of April 30, 1998, the Company had Senior Indebtedness of approximately
$131.1 million of which approximately $17.3 million constituted indebtedness of
the Company's Restricted Subsidiaries, (exclusive, in each case, of the unused
revolving loan availability of approximately $124.5 million under the New Credit
Facility).
PRINCIPAL, MATURITY AND INTEREST
The Notes are limited to $110.0 million aggregate principal amount and will
mature on May 1, 2005. Interest on the Notes will accrue at a rate of 9 3/8% per
annum and will be payable semi-annually in arrears on each May 1 and November 1,
commencing on November 1, 1998, to the Holders of record of Notes at the close
of business on April 15 and October 15, respectively, immediately preceding such
interest payment date. Interest will accrue from the most recent interest
payment date to which interest has been paid or, if no interest has been paid,
from the date of issuance. Interest will be computed on the basis of a 360-day
year of twelve 30-day months.
OPTIONAL REDEMPTION
The Notes will be redeemable at the option of the Company, in whole or in
part, at any time on or after May 1, 2002, at the redemption prices (expressed
as a percentage of principal amount) set forth below, plus accrued and unpaid
interest thereon, if any, to the redemption date (subject to the right of
56
Holders of record on the relevant record date to receive interest due on the
relevant interest payment date), if redeemed during the twelve-month period
beginning on May 1 of the years indicated below:
REDEMPTION
YEAR PRICE
- -------------------------------------------------------------------------------- ------------
2002............................................................................ 104.688%
2003............................................................................ 102.344%
2004............................................................................ 100.000%
In addition, at any time and from time to time on or prior to May 1, 2001,
the Company may redeem in the aggregate up to 35% of the originally issued
aggregate principal amount of the Notes with the net cash proceeds of one or
more Equity Offerings received by the Company at a redemption price in cash
equal to 109.375% of the principal amount thereof, plus accrued and unpaid
interest thereon, if any, to the date of redemption (subject to the right of
Holders of record on the relevant record date to receive interest due on the
relevant interest payment date); PROVIDED, HOWEVER, that at least 65% of the
originally issued aggregate principal amount of the Notes must remain
outstanding immediately after giving effect to each such redemption (excluding
any Notes held by the Company or any of its Affiliates). Notice of any such
redemption must be given within 60 days after the date of the closing of the
relevant Equity Offering received by the Company.
SELECTION AND NOTICE OF REDEMPTION
In the event that less than all of the Notes are to be redeemed at any time
pursuant to an optional redemption, selection of such Notes for redemption will
be made by the Trustee in compliance with the requirements of the principal
national securities exchange, if any, on which the Notes are listed or, if the
Notes are not then listed on a national securities exchange, on a pro rata
basis, by lot or by such method as the Trustee shall deem fair and appropriate;
PROVIDED, HOWEVER, that no Notes of a principal amount of $1,000 or less shall
be redeemed in part; PROVIDED, FURTHER, HOWEVER, that if a partial redemption is
made with the net cash proceeds of an Equity Offering received by the Company,
selection of the Notes or portions thereof for redemption shall be made by the
Trustee only on a pro rata basis or on as nearly a pro rata basis as is
practicable (subject to the procedures of DTC), unless such method is otherwise
prohibited. Notice of redemption shall be mailed by first-class mail at least 30
but not more than 60 days before the redemption date to each Holder of Notes to
be redeemed at its registered address. If any Note is to be redeemed in part
only, the notice of redemption that relates to such Note shall state the portion
of the principal amount thereof to be redeemed. A new Note in a principal amount
equal to the unredeemed portion thereof will be issued in the name of the Holder
thereof upon cancellation of the original Note. On and after the redemption
date, interest will cease to accrue on Notes or portions thereof called for
redemption as long as the Company has deposited with the Paying Agent for the
Notes funds in satisfaction of the applicable redemption price pursuant to the
Indenture.
SUBORDINATION OF THE NOTES
The payment of the principal of, premium, if any, and interest on the Notes
is subordinated in right of payment, to the extent and in the manner provided in
the Indenture, to the prior payment in full in cash or cash equivalents of all
Senior Indebtedness.
Upon any payment or distribution of assets or securities of the Company of
any kind or character, whether in cash, property or securities, upon any
dissolution or winding up or total liquidation or reorganization of the Company,
whether voluntary or involuntary or in bankruptcy, insolvency, receivership or
other proceedings, (excluding any payment or distribution of Permitted Junior
Securities and excluding any payment from funds deposited in accordance with,
and held in trust for the benefit of Holders as set forth in "Legal Defeasance
and Covenant Defeasance" (a "Defeasance Trust Payment")), all Senior
Indebtedness then due shall first be paid in full in cash or cash equivalents
before the Holders of the Notes or the Trustee on behalf of such Holders shall
be entitled to receive any payment by the
57
Company of the principal of, premium, if any, or interest on the Notes, or any
payment by the Company to acquire any of the Notes for cash, property or
securities, or any distribution by the Company with respect to the Notes of any
cash, property or securities (excluding any payment or distribution of Permitted
Junior Securities and excluding any Defeasance Trust Payment). Before any
payment may be made by, or on behalf of, the Company of the principal of,
premium, if any, or interest on the Notes upon any such dissolution or winding
up or total liquidation or reorganization, whether voluntary or involuntary or
in bankruptcy, insolvency, receivership or other proceedings, any payment or
distribution of assets or securities of the Company of any kind or character,
whether in cash, property or securities (excluding any payment or distribution
of Permitted Junior Securities and excluding any Defeasance Trust Payment), to
which the Holders of the Notes or the Trustee on their behalf would be entitled,
but for the subordination provisions of the Indenture, shall be made by the
Company or by any receiver, trustee in bankruptcy, liquidation trustee, agent or
other Person making such payment or distribution, directly to the holders of the
Senior Indebtedness (pro rata to such holders on the basis of the respective
amounts of Senior Indebtedness held by such holders) or their representatives or
to the trustee or trustees or agent or agents under any agreement or indenture
pursuant to which any of such Senior Indebtedness may have been issued, as their
respective interests may appear, to the extent necessary to pay all such Senior
Indebtedness in full in cash or cash equivalents after giving effect to any
prior or concurrent payment, distribution or provision therefor, to or for the
holders of such Senior Indebtedness.
No direct or indirect payment (excluding any payment or distribution of
Permitted Junior Securities and excluding any Defeasance Trust Payment) by the
Company of principal of, premium, if any, or interest on the Notes, whether
pursuant to the terms of the Notes, upon acceleration, pursuant to an Offer to
Purchase, as a payment into the Defeasance Trust or otherwise, shall be made if,
at the time of such payment, there exists a default in the payment of all or any
portion of any Senior Indebtedness, whether at maturity, on account of mandatory
redemption or prepayment, acceleration or otherwise, and such default shall not
have been cured or waived or the benefits of this sentence waived by or on
behalf of the holders of such Senior Indebtedness. In addition, during the
continuance of any non-payment event of default with respect to any Designated
Senior Indebtedness pursuant to which the maturity thereof may be immediately
accelerated, and upon receipt by the Trustee of written notice (a "Payment
Blockage Notice") from the holder or holders of such Designated Senior
Indebtedness or the trustee or agent acting on behalf of the holders of such
Designated Senior Indebtedness, then, unless and until such event of default has
been cured or waived or has ceased to exist or such Designated Senior
Indebtedness has been discharged or repaid in full in cash or the benefits of
these provisions have been waived by the holders of such Designated Senior
Indebtedness, no direct or indirect payment (excluding any payment or
distribution of Permitted Junior Securities and excluding any Defeasance Trust
Payment) will be made by the Company of principal of, premium, if any, or
interest on the Notes, whether pursuant to the terms of the Notes, upon
acceleration, pursuant to an Offer to Purchase or otherwise, to such Holders,
during a period (a "Payment Blockage Period") commencing on the date of receipt
of such notice by the Trustee and ending 179 days thereafter. Notwithstanding
anything in the subordination provisions of the Indenture or the Notes to the
contrary, (x) in no event will a Payment Blockage Period extend beyond 179 days
from the date the Payment Blockage Notice in respect thereof was given, (y)
there shall be a period of at least 181 consecutive days in each 360-day period
when no Payment Blockage Period is in effect and (z) not more than one Payment
Blockage Period may be commenced with respect to the Notes during any period of
360 consecutive days. No event of default that existed or was continuing on the
date of commencement of any Payment Blockage Period with respect to the
Designated Senior Indebtedness initiating such Payment Blockage Period (to the
extent the holder of Designated Senior Indebtedness, or trustee or agent, giving
notice commencing such Payment Blockage Period had knowledge of such existing or
continuing event of default) may be, or be made, the basis for the commencement
of any other Payment Blockage Period by the holder or holders of such Designated
Senior Indebtedness or the trustee or agent acting on behalf of such Designated
58
Senior Indebtedness, whether or not within a period of 360 consecutive days,
unless such event of default has been cured or waived for a period of not less
than 90 consecutive days.
The failure to make any payment or distribution for or on account of the
Notes by reason of the provisions of the Indenture described under this
"Subordination of the Notes" heading will not prevent, or be construed as
preventing, the occurrence of any Default or Event of Default in respect of the
Notes. See "Events of Default" below.
By reason of the subordination provisions described above, in the event of
insolvency of the Company, funds which would otherwise be payable to Holders of
the Notes will be paid to the holders of Senior Indebtedness to the extent
necessary to pay the Senior Indebtedness in full in cash, and the Company may be
unable to meet fully or at all its obligations with respect to the Notes.
Furthermore, by reason of such subordination, in the event of any such
insolvency of the Company, creditors of the Company who are holders of Senior
Indebtedness may recover more, ratably, than other creditors of the Company,
including Holders of the Notes.
FUTURE GUARANTEES
The Indenture also provides that at any time either (x) in excess of 10.0%
of the consolidated net assets of the Company are owned by Restricted
Subsidiaries (other than Foreign Subsidiaries) of the Company or (y) in excess
of 10.0% of the Consolidated EBITDA of the Company is derived from Restricted
Subsidiaries (other than Foreign Subsidiaries) of the Company, within 90 days of
the filing of the financial statements with the Commission which indicate that
either clause (x) or clause (y) above is applicable, the Company shall cause
such Restricted Subsidiaries (other than Foreign Subsidiaries) to (i) execute
and deliver to the Trustee a supplemental indenture in form reasonably
satisfactory to the Trustee pursuant to which such Restricted Subsidiary shall
become a party to the Indenture and thereby unconditionally guarantee on an
unsecured senior subordinated basis (on substantially the same terms as the
subordination of the Notes) (a "Guarantee") all of the Company's Obligations
under the Notes and the Indenture on the terms set forth therein and (ii)
deliver to the Trustee an opinion of counsel that such supplemental indenture
has been duly authorized, executed and delivered by such Restricted Subsidiary
and constitutes a valid, binding and enforceable obligation of such Restricted
Subsidiary (which opinion may be subject to customary assumptions and
qualifications). Thereafter, such Restricted Subsidiary shall (unless released
in accordance with the terms of the Indenture) be a guarantor (a "Guarantor")
for all purposes of the Indenture. The Guarantee of a Guarantor will be released
upon the sale or transfer of a majority of the capital stock of such Guarantor
owned directly or indirectly by the Company, provided that such sale or transfer
complies with all of the terms of the Indenture, or such Guarantor becoming an
Unrestricted Subsidiary in accordance with the terms of the Indenture.
Each Guarantee will be a continuing guarantee and will (a) remain in full
force and effect until payment in full of all of the obligations covered
thereby, (b) be binding upon each Guarantor and (c) inure to the benefit of and
be enforceable by the Trustee, the Holders and their successors, transferees and
assigns.
OFFER TO PURCHASE UPON CHANGE OF CONTROL
Following the occurrence of a Change of Control (the date of such occurrence
being the "Change of Control Date"), the Company shall notify the Holders of the
Notes of such occurrence in the manner prescribed by the Indenture and shall,
within 60 days after the Change of Control Date, make an Offer to Purchase all
Notes then outstanding at a purchase price in cash equal to 101% of the
aggregate principal amount thereof, plus accrued and unpaid interest thereon, if
any, to the Purchase Date (subject to the right of Holders of record on the
relevant record date to receive interest due on the relevant interest payment
date).
59
If a Change of Control occurs which also constitutes an event of default
under the New Credit Facility, the lenders under the New Credit Facility would
be entitled to exercise the remedies available to a secured lender under
applicable law and pursuant to the terms of the New Credit Facility.
Accordingly, any claims of such lenders with respect to the assets of the
Company will be prior to any claim of the Holders of the Notes with respect to
such assets.
If the Company makes an Offer to Purchase, the Company will comply with all
applicable tender offer laws and regulations, including, to the extent
applicable, Section 14(e) and Rule 14e-1 under the Exchange Act, and any other
applicable Federal or state securities laws and regulations and any applicable
requirements of any securities exchange on which the Notes are listed, and any
violation of the provisions of the Indenture relating to such Offer to Purchase
occurring as a result of such compliance shall not be deemed a Default or an
Event of Default.
The Change of Control provisions of the Indenture will not apply in the
event of (i) changes in a majority of the Board of Directors of the Company so
long as a majority of the Board of Directors consists of individuals who at the
beginning of any two year period constituted the Board of Directors of the
Company or who are new directors whose election by such Board of Directors or
whose nomination for election by the shareholders of the Company was approved by
a vote of a majority of the directors of the Company then still in office who
were either directors at the beginning of such period or whose election or
nomination for election was previously so approved, or (ii) certain transactions
with Permitted Holders, who include members of management of the Company and
certain of their affiliates. THE CHANGE OF CONTROL PROVISIONS ARE NOT INTENDED
TO AFFORD HOLDERS OF NOTES PROTECTION IN THE EVENT OF CERTAIN HIGHLY LEVERAGED
TRANSACTIONS, REORGANIZATIONS, RECAPITALIZATIONS, RESTRUCTURINGS, MERGERS AND
SIMILAR TRANSACTIONS THAT MIGHT ADVERSELY AFFECT THE HOLDERS OF NOTES, BUT THAT
WOULD NOT CONSTITUTE A CHANGE OF CONTROL. The Company could, in the future,
enter into such transactions, including transactions involving the Permitted
Holders, that would not constitute a Change of Control under the Indenture, but
that would increase the amount of Indebtedness of the Company outstanding at
such time or otherwise affect the Company's capital structure or credit rating.
However, the Indenture contains certain limitations on the ability of the
Company to incur additional Indebtedness and to engage in certain mergers,
consolidations and sales of assets, whether or not a Change of Control is
involved. See "Certain Covenants-- Limitation on Indebtedness" and "Certain
Covenants--Merger, Sale of Assets, etc."
The occurrence of certain of the events that would constitute a Change of
Control under the Indenture would constitute an event of default under the New
Credit Facility. Future Senior Indebtedness of the Company and its Subsidiaries
may also contain prohibitions of certain events that would constitute a Change
of Control or require such Senior Indebtedness to be repurchased upon a Change
of Control. Moreover, the exercise by the Holders of their right to require the
Company to repurchase the Notes could cause a default under such Senior
Indebtedness, even if the events constituting a Change of Control do not. Upon
the occurrence of a Change of Control, if it is prohibited by the terms of any
outstanding Indebtedness from making an Offer to Repurchase or from repurchasing
the Notes, the Company is required to either (i) repay all such Indebtedness and
terminate all commitments outstanding thereunder or (ii) obtain the requisite
consents under any such Indebtedness required to permit the Offer to Repurchase
or the repurchase of the Notes. The New Credit Facility provides for loans up to
a maximum amount of $275.0 million and, if the requisite consents from the
lenders thereunder are not forthcoming, it is unlikely that the Company would be
able to repay all of its obligations under the New Credit Facility and
repurchase the Notes unless it could obtain alternative financing. In addition,
although it currently has no outstanding securities or liabilities which are
pari passu with the Notes, the Company could in the future incur such pari passu
obligations which could have change of control provisions similar to those in
the Indenture requiring repurchase of such obligations at the same time as the
repurchase of the Notes. Finally, the terms of certain agreements of the
Company's Subsidiaries may contain certain restrictions (which are permitted
under the terms of the Indenture) on the ability of such Subsidiaries to pay
dividends or make loans to the Company. The existence of pari passu obligations
60
and restrictions on dividends and loans could further increase the Company's
need to obtain alternative financing to facilitate a repurchase of the Notes in
the event of a Change of Control. There can be no assurance that the Company
would be able to obtain any such financing on commercially reasonable terms, or
at all, and consequently no assurance can be given that the Company would be
able to repurchase any of the Notes tendered pursuant to such an Offer to
Purchase.
None of the provisions in the Indenture relating to a purchase of Notes upon
a Change of Control is waivable either by the Board of Directors of the Company
or by the Trustee. Without the consent of each Holder of Notes affected thereby,
no amendment to the Indenture may modify the provisions of the Indenture
requiring the Company to make an Offer to Purchase upon a Change of Control in a
manner materially adverse to any such Holder.
CERTAIN COVENANTS
LIMITATION ON INDEBTEDNESS. The Indenture will provide that the Company
shall not, and shall not cause or permit any Restricted Subsidiary to, directly
or indirectly, Incur any Indebtedness (including Acquired Indebtedness), except
for Permitted Indebtedness; PROVIDED, HOWEVER, that the Company may Incur
Indebtedness if, at the time of and immediately after giving pro forma effect to
such Incurrence of Indebtedness and the application of the proceeds therefrom,
the Consolidated Coverage Ratio would be greater than (x) 2.0 to 1.00 if such
Indebtedness is Incurred prior to the second anniversary of the Issue Date or
(y) 2.25 to 1.00 if such Indebtedness is incurred thereafter.
The limitations contained in the preceding paragraph will not apply to the
Incurrence of any of the following (collectively, "Permitted Indebtedness"),
each of which shall be given independent effect:
(a) Indebtedness under the Notes and any Guarantees;
(b) Indebtedness Incurred under the New Credit Facility in an aggregate
principal amount at any one time outstanding not to exceed the greater of
(x) the maximum committed amount (without giving effect to any borrowing
base restrictions) under the New Credit Facility on the Issue Date or (y)
the sum of (i) the cash and Cash Equivalents of the Company and its
Restricted Subsidiaries, (ii) 80% of the then book value of accounts
receivable of the Company and its Restricted Subsidiaries as such amount
would appear on a consolidated balance sheet of the Company prepared in
accordance with GAAP, and (iii) 80% of the then book value of Inventory of
the Company and its Restricted Subsidiaries;
(c) Indebtedness of any Restricted Subsidiary of the Company owed to and
held by the Company or any Restricted Subsidiary, and Indebtedness of the
Company owed to and held by any Restricted Subsidiary and that is unsecured
and subordinated in right of payment in liquidation to the payment of the
Company's obligations under any Senior Indebtedness, the Indenture and the
Notes; PROVIDED, HOWEVER, that an Incurrence of Indebtedness that is not
otherwise permitted by this clause (c) shall be deemed to have occurred upon
(i) any sale or other disposition of any Indebtedness of the Company or any
Restricted Subsidiary of the Company referred to in this clause (c) to a
Person (other than the Company or a Restricted Subsidiary), or (ii) any sale
or other disposition of Equity Interests of any Subsidiary which holds
Indebtedness of the Company or another Subsidiary;
(d) Indebtedness under Interest Rate Protection Obligations; PROVIDED,
HOWEVER, that such Interest Rate Protection Obligations have been entered
into for bona fide business purposes and not for speculation;
(e) Purchase Money Indebtedness and Capitalized Lease Obligations of the
Company or any Restricted Subsidiary in an aggregate principal amount
(including refinancings thereof) at any one time outstanding not to exceed
5% of aggregate total revenue of the Company and its Restricted Subsidiaries
during the most recently completed four fiscal quarter period on a
consolidated basis (determined at the time of Incurrence); PROVIDED,
HOWEVER, that the Company and its Restricted
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Subsidiaries may incur any amount of additional Indebtedness of the type
specified above in this clause (e) which is secured by real estate and any
improvements thereon so long as the sole recourse of the obligee with
respect to such Indebtedness is to the real property and/or improvements
financed, fixtures related thereto and any accessions and additions thereto,
replacements and substitutions therefor and the proceeds (including
insurance proceeds thereof);
(f) Indebtedness under Currency Agreements; PROVIDED, HOWEVER, that
such Currency Agreements have been entered into for bona fide business
purposes and not for speculation;
(g) Existing Indebtedness;
(h) Indebtedness to the extent representing a replacement, renewal,
defeasance, refinancing or extension (collectively, a "refinancing") of any
outstanding Indebtedness; PROVIDED, HOWEVER, that (i) any such refinancing
shall not exceed the sum of the principal amount (or accreted amount
(determined in accordance with GAAP), if less) of the Indebtedness being
refinanced (or in the case of a refinancing of the New Credit Facility the
maximum permitted amount under clause (b) above), plus the amount of accrued
interest thereon, plus the amount of any reasonably determined prepayment
premium necessary to accomplish such refinancing and such reasonable fees
and expenses incurred in connection therewith, (ii) Indebtedness
representing a refinancing of Indebtedness other than Senior Indebtedness
shall have a Weighted Average Life to Maturity equal to or greater than the
Weighted Average Life to Maturity of the Indebtedness being refinanced and
(iii) Indebtedness that is PARI PASSU with, or subordinate to the Notes may
only be refinanced with Indebtedness that is made PARI PASSU with or
subordinate in right of payment to the Notes and Subordinated Indebtedness
may only be refinanced with Subordinated Indebtedness; PROVIDED, FURTHER,
that Indebtedness of the Company may be refinanced by Indebtedness of a
Restricted Subsidiary and Indebtedness of a Restricted Subsidiary of the
Company may be refinanced by Indebtedness of the Company;
(i) guarantees by the Company or a Restricted Subsidiary of
Indebtedness Incurred by the Company or a Restricted Subsidiary so long as
the Incurrence of such Indebtedness is otherwise permitted by the terms of
the Indenture.
(j) Acquired Indebtedness and Indebtedness Incurred in connection with
the acquisition of assets; PROVIDED that such Indebtedness was incurred by
the prior owner of such assets prior to such acquisition by the Company or
one of its Subsidiaries and was not incurred in connection with, or in
contemplation of, such acquisition by the Company or one of its Restricted
Subsidiaries; PROVIDED FURTHER that the principal amount (or accreted value,
as applicable) of such Indebtedness, together with any other outstanding
Indebtedness (including refinancings thereof) incurred pursuant to this
clause (j), does not exceed $5.0 million;
(k) additional Indebtedness of Restricted Subsidiaries of the Company,
incurred after the Issue Date, in an aggregate principal amount at any time
outstanding (including refinancings thereof) not to exceed $20.0 million;
(l) Indebtedness in respect of worker's compensation, self-insurance
obligations, performance, surety, appeal and similar bonds and completion
guarantees provided in the ordinary course of business;
(m) Indebtedness incurred in connection with the acquisition of capital
stock of Restricted Subsidiaries existing on the Issue Date representing
minority interests in such Restricted Subsidiaries in an aggregate principal
amount (including refinancings thereof) not to exceed $2.0 million; and
(n) additional Indebtedness of the Company or any of its Restricted
Subsidiaries, Incurred after the Issue Date, in an aggregate principal
amount at any time outstanding (including refinancings thereof), not to
exceed $20.0 million.
62
For purposes of determining compliance with this covenant, in the event that
an item of Indebtedness meets the criteria of more than one of the categories of
Permitted Indebtedness described in clauses (a) through (n) above or is entitled
to be Incurred pursuant to the first paragraph of this covenant, the Company
shall, in its sole discretion, classify such item of Indebtedness in any manner
that complies with this covenant and such item of Indebtedness will be treated
as having been incurred pursuant to only one of such clauses or pursuant to the
first paragraph hereof or as having been divided and incurred pursuant to more
than one of such clauses or the first paragraph hereof. Accrual of interest, the
accretion of accreted value and the payment of interest in the form of
additional Indebtedness will not be deemed to be an incurrence of Indebtedness
for purposes of this covenant. If the Indebtedness is Incurred, denominated and
payable in other than United States currency, then the Indebtedness shall be
converted into United States currency using the spot foreign exchange rate of
the currency in which such Indebtedness is Incurred, denominated and payable on
the date of Incurrence of such Indebtedness. Indebtedness Incurred under clause
(h) above as a refinancing of the New Credit Facility may be Incurred as two or
more separate facilities entered into at the same time or at different times so
long as such facilities in the aggregate constitute a refinancing of the New
Credit Facility in a maximum amount not to exceed the amount permitted under
clause (b) above.
LIMITATION ON SENIOR SUBORDINATED INDEBTEDNESS. The Indenture provides that
the Company shall not, directly or indirectly, Incur, or suffer to exist, any
Indebtedness that by its terms would expressly rank senior in right of payment
to the Notes and subordinate in right of payment to any other Indebtedness of
the Company.
LIMITATION ON RESTRICTED PAYMENTS. The Indenture provides that the Company
shall not, and shall not cause or permit any Restricted Subsidiary of the
Company to, directly or indirectly
(i) declare or pay any dividend or any other distribution on any Equity
Interests of the Company or make any payment or distribution to the direct
or indirect holders (in their capacities as such) of Equity Interests of the
Company (other than any dividends, distributions and payments made solely in
Qualified Equity Interests of the Company or in options, warrants or other
rights to purchase Qualified Equity Interests of the Company);
(ii) purchase, redeem or otherwise acquire or retire for value any
Equity Interests of the Company or any Subsidiary of the Company (other than
any such Equity Interests owned by the Company or any Restricted Subsidiary
of the Company);
(iii) make any Investment in any Person (other than Permitted
Investments); or
(iv) designate any Restricted Subsidiary as an Unrestricted Subsidiary;
(any such payment or any other action (other than any exception thereto)
described in (i), (ii) or (iii), a "Restricted Payment"), unless
(a) no Default or Event of Default shall have occurred and be
continuing at the time or immediately after giving effect to such
Restricted Payment;
(b) immediately after giving effect to such Restricted Payment, the
Company would be able to incur $1.00 of additional Indebtedness (other
than Permitted Indebtedness) under the Consolidated Coverage Ratio test
set forth in the first paragraph of "--Limitation on Indebtedness;" and
(c) immediately after giving effect to such Restricted Payment, the
aggregate amount of all Restricted Payments declared or made on or after
the Issue Date (excluding Restricted Payments permitted by clauses (ii)
and (iv) of the next succeeding paragraph) does not exceed an amount
equal to the sum of (1) 50% of cumulative Consolidated Net Income
determined for the period (taken as one period) from the beginning of the
first fiscal quarter commencing after the Issue Date and ending on the
last day of the most recent fiscal quarter immediately
63
preceding the date of such Restricted Payment for which consolidated
financial information of the Company is available (or if such cumulative
Consolidated Net Income shall be a loss, minus 100% of such loss), plus
(2) the aggregate net cash proceeds received by the Company either (x) as
capital contributions to the Company after the Issue Date or (y) from the
issue and sale (other than to a Subsidiary of the Company) of its
Qualified Equity Interests after the Issue Date (excluding the net
proceeds from any issuance and sale of Qualified Equity Interests
financed, directly or indirectly, using funds borrowed from the Company
or any Subsidiary of the Company until and to the extent such borrowing
is repaid), plus (3) the principal amount (or accreted amount (determined
in accordance with GAAP), if less) of any Indebtedness of the Company or
any Subsidiary of the Company Incurred after the Issue Date which has
been converted into or exchanged for Qualified Equity Interests of the
Company (minus the amount of any cash or property distributed by the
Company or any Subsidiary of the Company upon such conversion or
exchange), plus (4) in the case of the disposition or repayment of any
Investment constituting a Restricted Payment made after the Issue Date,
an amount equal to 100% of the net cash proceeds thereof (or dividends,
distributions or interest payments received in cash thereon), plus (5)
with respect to any Unrestricted Subsidiary that has been designated or
re-designated as a Restricted Subsidiary after the Issue Date, the direct
or indirect proportionate interest of the Company in such Subsidiary
multiplied by an amount equal to the excess of (x) the total assets of
such Subsidiary, valued on an aggregate basis at Fair Market Value, over
(y) the total liabilities of such Subsidiary, determined in accordance
with GAAP, plus (6) $5.0 million.
The foregoing provisions will not prevent (i) the payment of any dividend or
distribution on, or redemption of, Equity Interests within 60 days after the
date or declaration of such dividend or distribution or the giving of formal
notice of such redemption, if at the date of such declaration or giving of such
formal notice such payment or redemption would comply with the provisions of the
Indenture; (ii) the purchase, redemption, retirement or other acquisition of any
Equity Interests of the Company in exchange for, or out of the net cash proceeds
of the substantially concurrent issue and sale (other than to a Subsidiary of
the Company) of, Qualified Equity Interests received by the Company; PROVIDED,
HOWEVER, that any such net cash proceeds or any Equity Interest issued in
exchange for such retired Equity Interests are excluded from clause (c)(2) of
the preceding paragraph (and were not included therein at any time) and are not
used to redeem the Notes pursuant to "Optional Redemption" above; (iii) payments
by the Company to, or to enable Parent to, purchase, redeem or acquire for value
shares of capital stock of the Company or Parent (other than Disqualified Equity
Interests) or options on such shares held by officers or employees or former
officers or employees (or their estates or beneficiaries under their estates)
upon the death, disability, retirement or termination of employment of such
current or former officers or employees pursuant to the terms of an employee
benefit plan or any other agreement pursuant to which such shares of capital
stock or options were issued or pursuant to a severance, buy-sell or right of
first refusal agreement with such current or former officer or employee;
PROVIDED, HOWEVER, that the aggregate cash consideration paid, or distributions
made, pursuant to this clause (iii) do not in any one fiscal year exceed $5.0
million; (iv) Investments constituting Restricted Payments made as a result of
the receipt of non-cash consideration from any Asset Sale made pursuant to and
in compliance with "--Disposition of Proceeds of Asset Sales" below; (v) the
purchase of capital stock representing minority interests in Restricted
Subsidiaries; PROVIDED, HOWEVER, that the aggregate cash consideration paid
pursuant to this clause (v) does not exceed $5.0 million; (vi) the payment of
premiums in connection with the maintenance of Permitted Life Insurance; (vii)
payments by the Company to Parent to fund the payment by Parent of audit,
accounting, legal or other similar expenses, to pay franchise or other similar
taxes and to pay other corporate overhead expenses, so long as such dividends
are paid as and when needed by Parent so long as the aggregate amount of
payments pursuant to this clause (vii) does not exceed $1.0 million in any
fiscal year; and (viii) payments by the Company to fund taxes of Parent for a
given taxable year in an amount equal to the Company's
64
"separate return liability," as if the Company were the parent of a consolidated
group (for purposes of this clause (viii) "separate return liability" for a
given taxable year shall mean the hypothetical United States tax liability of
the Company defined as if the Company had filed its own U.S. federal tax return
for such taxable year); PROVIDED, HOWEVER, that in the case of each of clauses
(ii), (iii) and (iv), no Default or Event of Default shall have occurred and be
continuing or would arise therefrom.
The amount of any non-cash Restricted Payment shall be deemed to be equal to
the Fair Market Value thereof at the date of the making of such Restricted
Payment.
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING
SUBSIDIARIES. The Indenture provides that the Company shall not, and shall not
cause or permit any Restricted Subsidiary of the Company to, directly or
indirectly, create or otherwise cause or suffer to exist or become effective any
encumbrance or restriction on the ability of any Restricted Subsidiary of the
Company to (a) pay dividends or make any other distributions to the Company or
any Restricted Subsidiary of the Company on its Equity Interests or with respect
to any other interest or participation in, or measured by, its profits, or pay
any Indebtedness owed to the Company or any Restricted Subsidiary of the
Company, (b) make loans or advances to, or guarantee any Indebtedness or other
obligations of, or make any Investment in, the Company or any Restricted
Subsidiary of the Company or (c) transfer any of its properties or assets to the
Company or any Restricted Subsidiary of the Company, except for such
encumbrances or restrictions existing under or by reason of (i) the New Credit
Facility as in effect on the Issue Date, any other agreement of the Company or
its Restricted Subsidiaries outstanding on the Issue Date as in effect on the
Issue Date and any other agreement of the Company or its Restricted Subsidiaries
outstanding from time to time governing Senior Indebtedness, and any amendments,
restatements, renewals, replacements or refinancings thereof; (ii) applicable
law; (iii) any instrument governing Indebtedness or Equity Interests of an
Acquired Person acquired by the Company or any Restricted Subsidiary of the
Company as in effect at the time of such acquisition (except to the extent such
Indebtedness was Incurred by such Acquired Person in connection with, as a
result of or in contemplation of such acquisition); PROVIDED, HOWEVER, that such
encumbrances and restrictions are not applicable to the Company or any
Restricted Subsidiary of the Company, or the properties or assets of the Company
or any Restricted Subsidiary of the Company, other than the Acquired Person;
(iv) customary non-assignment, subletting or restriction on transfer provisions
or restrictions on cash or other deposits or net worth maintenance provisions
under leases, licenses or other contracts entered into in the ordinary course of
business; (v) Purchase Money Indebtedness for property acquired in the ordinary
course of business that only imposes encumbrances and restrictions on the
property so acquired and the proceeds thereof; (vi) any agreement for the sale
or disposition of the Equity Interests or assets of any Subsidiary of the
Company; PROVIDED, HOWEVER, that such encumbrances and restrictions described in
this clause (vi) are only applicable to such Subsidiary or assets, as
applicable, and any such sale or disposition is made in compliance with
"Disposition of Proceeds of Asset Sales" below to the extent applicable thereto;
(vii) refinancing Indebtedness permitted under clause (h) of the second
paragraph of "Limitation on Indebtedness" above; or (viii) the Indenture.
LIMITATION ON LIENS. The Indenture provides that the Company shall not, and
shall not cause or permit any Restricted Subsidiary of the Company to, directly
or indirectly, Incur, or suffer to exist, any Liens of any kind against or upon
any of their respective properties or assets now owned or hereafter acquired, or
any proceeds therefrom or any income or profits therefrom, to secure any
Indebtedness unless contemporaneously therewith effective provision is made to
secure the Notes and all other amounts due under the Indenture, equally and
ratably with such Indebtedness (or, in the event that such Indebtedness is
subordinated in right of payment to the Notes prior to such Indebtedness) with a
Lien on the same properties and assets securing such Indebtedness for so long as
such Indebtedness is secured by such Lien, except for (i) Liens securing Senior
Indebtedness and (ii) Permitted Liens.
65
DISPOSITION OF PROCEEDS OF ASSET SALES. The Indenture provides that the
Company shall not, and shall not cause or permit any Restricted Subsidiary of
the Company to, directly or indirectly, make any Asset Sale, unless (i) the
Company or such Restricted Subsidiary, as the case may be, receives
consideration at the time of such Asset Sale at least equal to the Fair Market
Value of the assets sold or otherwise disposed of, and (ii) at least 75% of the
consideration therefor received by the Company or such Restricted Subsidiary is
in the form of (a) cash or Cash Equivalents or (b) property or assets that are
used or useful in a Permitted Business, or Equity Interests of any Person
primarily engaged in a Permitted Business if, as a result of the acquisition by
the Company or any Restricted Subsidiary thereof, such Person becomes a
Restricted Subsidiary; PROVIDED that the amount of (x) any liabilities of the
Company or any Restricted Subsidiary (other than contingent liabilities and
liabilities of the Company that are by their terms subordinated to the Notes or
any guarantee thereof) that are assumed by the transferee of any such assets
pursuant to the customary novation agreement that releases the Company or such
Restricted Subsidiary from further liability and (y) any notes or other
obligations received by the Company or any such Restricted Subsidiary from such
transferee that are converted by the Company or such Restricted Subsidiary into
cash or Cash Equivalents (to the extent of the cash or Cash Equivalents
received) within 360 days following the closing of such Asset Sale, will be
deemed to be cash for purposes of this provision; PROVIDED FURTHER that the 75%
limitation referred to above shall not apply to any sale, transfer or other
disposition of assets in which the cash portion of the consideration received
therefor, determined in accordance with the foregoing proviso, is equal to or
greater than what the after-tax net proceeds would have been had such
transaction complied with the aforementioned 75% limitation.
The Company or such Restricted Subsidiary of the Company, as the case may
be, may (i) apply the Net Cash Proceeds of any Asset Sale within 360 days of
receipt thereof to repay Senior Indebtedness, or (ii) make an Investment in
property or assets that are used or useful in a Permitted Business, or Equity
Interests of any Person primarily engaged in a Permitted Business if, as a
result of the acquisition by the Company or any Restricted Subsidiary thereof,
such Person becomes a Restricted Subsidiary.
To the extent all or part of the Net Cash Proceeds of any Asset Sale are not
applied as described in clause (i) or (ii) of the immediately preceding
paragraph within the time periods set forth therein (the "Net Proceeds
Utilization Date") (such Net Cash Proceeds, the "Unutilized Net Cash Proceeds"),
the Company shall, within 20 days after such Net Proceeds Utilization Date, make
an Offer to Purchase all outstanding Notes up to a maximum principal amount
(expressed as a multiple of $1,000) of Notes equal to such Unutilized Net Cash
Proceeds, at a purchase price in cash equal to 100% of the principal amount
thereof, plus accrued and unpaid interest thereon, if any, to the Purchase Date;
PROVIDED, HOWEVER, that the Offer to Purchase may be deferred until there are
aggregate Unutilized Net Cash Proceeds equal to or in excess of $15.0 million,
at which time the entire amount of such Unutilized Net Cash Proceeds, and not
just the amount in excess of $15.0 million, shall be applied as required
pursuant to this paragraph.
With respect to any Offer to Purchase affected pursuant to this covenant,
among the Notes, to the extent the aggregate principal amount of Notes tendered
pursuant to such Offer to Purchase exceeds the Unutilized Net Cash Proceeds to
be applied to the repurchase thereof, such Notes shall be purchased pro rata
based on the aggregate principal amount of such Notes tendered by each Holder.
To the extent the Unutilized Net Cash Proceeds exceed the aggregate amount of
Notes tendered by the Holders of the Notes pursuant to such Offer to Purchase,
the Company may retain and utilize any portion of the Unutilized Net Cash
Proceeds not required to be applied to repurchase Notes tendered pursuant to
such Offer for any purpose consistent with the other terms of the Indenture.
In the event that the Company makes an Offer to Purchase the Notes, the
Company shall comply with any applicable securities laws and regulations,
including any applicable requirements of Section 14(e) of, and Rule 14e-1 under,
the Exchange Act, and any violation of the provisions of the Indenture relating
to such Offer to Purchase occurring as a result of such compliance shall not be
66
deemed an Event of Default or an event that with the passing of time or giving
of notice, or both, would constitute an Event of Default.
Each Holder shall be entitled to tender all or any portion of the Notes
owned by such Holder pursuant to the Offer to Purchase, subject to the
requirement that any portion of a Note tendered must be tendered in an integral
multiple of $1,000 principal amount and subject to any proration among tendering
Holders as described above.
MERGER, SALE OF ASSETS, ETC. The Indenture provides that the Company shall
not consolidate with or merge with or into any other Person and the Company
shall not sell, convey, assign, transfer, lease or otherwise dispose of all or
substantially all of the Company's properties and assets to any entity in a
single transaction or series of related transactions, unless: (i) either (x) the
Company shall be the Surviving Person or (y) the Surviving Person (if other than
the Company) shall be a Person organized and validly existing under the laws of
the United States of America or any State thereof or the District of Columbia
and shall, in any such case, expressly assume by a supplemental indenture, the
due and punctual payment of the principal of, premium, if any, and interest on
all the Notes and the performance and observance of every covenant of the
Indenture and the Exchange and Registration Rights Agreement to be performed or
observed on the part of the Company; and (ii) immediately thereafter on a pro
forma basis, no Default or Event of Default shall have occurred and be
continuing.
For purposes of the foregoing, the transfer (by lease, assignment, sale or
otherwise, in a single transaction or series of transactions) of all or
substantially all the properties and assets of one or more Restricted
Subsidiaries of the Company the Equity Interests of which constitutes all or
substantially all the properties and assets of the Company shall be deemed to be
the transfer of all or substantially all the properties and assets of the
Company.
TRANSACTIONS WITH AFFILIATES. The Indenture provides that the Company shall
not and shall not cause or permit any Restricted Subsidiary of the Company to,
directly or indirectly, conduct any business or enter into any transaction (or
series of related transactions) with or for the benefit of any of their
respective Affiliates (including, without limitation, any Unrestricted
Subsidiary or the Company) or any officer, director or employee of the Company
or any Subsidiary of the Company (each an "Affiliate Transaction"), unless (i)
such Affiliate Transaction is on terms which are no less favorable to the
Company or such Restricted Subsidiary, as the case may be, than would be
available in a comparable transaction with an unaffiliated third party and (ii)
if such Affiliate Transaction (or series of related Affiliate Transactions)
involves aggregate payments or other consideration having a Fair Market Value in
excess of $5.0 million in any fiscal year, such Affiliate Transaction is in
writing and a majority of the disinterested members, if any, of the Board of
Directors of the Company shall have approved such Affiliate Transaction and
determined that such Affiliate Transaction complies with the foregoing
provisions. In addition, any Affiliate Transaction involving aggregate payments
or other consideration having a Fair Market Value in excess of $10.0 million
will also require a written opinion from an Independent Financial Advisor (filed
with the Trustee) stating that the terms of such Affiliate Transaction are fair,
from a financial point of view, to the Company or its Subsidiaries involved in
such Affiliate Transaction, as the case may be.
Notwithstanding the foregoing, the restrictions set forth in this covenant
shall not apply to (i) transactions with or among the Company and any Restricted
Subsidiary or between or among Restricted Subsidiaries or between the Company
and/or one or more of its Restricted Subsidiaries on the one hand, and
Non-Affiliated Joint Ventures, on the other hand; (ii) reasonable fees and
compensation (including customary benefit, deferred compensation, retirement and
stock incentive or similar plans) paid or made available to and indemnity
provided on behalf of, officers, directors, employees, consultants or agents of
the Company or any Restricted Subsidiary of the Company as determined in good
faith by the Company's Board of Directors; (iii) advances and loans to employees
for relocation, entertainment and travel expenses, drawing accounts and other
matters in the ordinary course of business, (iv) any transactions undertaken
pursuant to any contractual obligations in existence on the
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Issue Date (as in effect on the Issue Date), (v) any Restricted Payments made in
compliance with "Limitation on Restricted Payments" above, and (vi) transactions
in connection with the maintenance of Permitted Life Insurance.
PROVISION OF FINANCIAL INFORMATION. The Indenture provides that whether or
not the Company is subject to Section 13(a) or 15(d) of the Exchange Act, or any
successor provision thereto, the Company shall file with the SEC (if permitted
by SEC practice and applicable law and regulations) the annual reports,
quarterly reports and other documents which the Company would have been required
to file with the SEC pursuant to such Section 13(a) or 15(d) or any successor
provision thereto if the Company were so subject, such documents to be filed
with the SEC on or prior to the respective dates (the "Required Filing Dates")
by which the Company would have been required so to file such documents if the
Company were so subject. The Company shall also in any event (a) within 15 days
of each Required Filing Date (whether or not permitted or required to be filed
with the SEC) (i) transmit (or cause to be transmitted) by mail to all Holders,
as their names and addresses appear in the Note register, without cost to such
Holders, and (ii) file with the Trustee, copies of the annual reports, quarterly
reports and other documents which the Company is required to file with the SEC
pursuant to the preceding sentence, or, if such filing is not so permitted,
information and data of a similar nature, and (b) if, notwithstanding the
preceding sentence, filing such documents by the Company with the SEC is not
permitted by SEC practice or applicable law or regulations, promptly upon
written request supply copies of such documents to any Holder. In addition, for
so long as any Notes remain outstanding and prior to the later of the
consummation of the Exchange Offer and the filing of the initial Shelf
Registration Statement, if required, the Company will furnish to the Holders and
to securities analysts and prospective investors, upon their request, the
information required to be delivered pursuant to Rule 144A(d)(4) under the
Securities Act, and, to any beneficial Holder of Notes, if not obtainable from
the SEC, information of the type that would be filed with the SEC pursuant to
the foregoing provisions, upon the request of any such Holder. The first such
report was for the fiscal period ending April 30, 1998.
DESIGNATION OF UNRESTRICTED SUBSIDIARIES. The Indenture will provide that
the Company may designate after the Issue Date any Subsidiary of the Company as
an "Unrestricted Subsidiary" under the Indenture (a "Designation") only if:
(i) no Default or Event of Default shall have occurred and be
continuing at the time of or after giving effect to such Designation;
(ii) immediately after giving effect to such Designation, the Company
could Incur $1.00 of additional Indebtedness (other than Permitted
Indebtedness) under the "Limitation on Indebtedness" covenant; and
(iii) the Company would be permitted to make an Investment (other than a
Permitted Investment) at the time of Designation (assuming the effectiveness
of such Designation) pursuant to the first paragraph of the "Limitation on
Restricted Payments" covenant in an amount (the "Designation Amount") equal
to the Fair Market Value of the parent's proportionate interest in the net
worth of such Subsidiary on such date calculated in accordance with GAAP.
Neither the Company nor any Restricted Subsidiary shall at any time (x)
provide credit support for or guarantee any Indebtedness of any Unrestricted
Subsidiary (including any undertaking, agreement or instrument evidencing such
Indebtedness); provided, that the Company may pledge Equity Interests or
Indebtedness of any Unrestricted Subsidiary on a nonrecourse basis such that the
pledgee has no claim whatsoever against the Company other than to obtain such
pledged property, (y) be directly or indirectly liable for any Indebtedness of
any Unrestricted Subsidiary or (z) be directly or indirectly liable for any
Indebtedness which provides that the holder thereof may (upon notice, lapse of
time or both) declare a default thereon or cause the payment thereof to be
accelerated or payable prior to its final scheduled maturity upon the occurrence
of a default with respect to any Indebtedness of any Unrestricted Subsidiary,
except for any non-recourse guarantee given solely to support the pledge by the
Company of the
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capital stock of any Unrestricted Subsidiary. For purposes of the foregoing, the
Designation of a Subsidiary of the Company as an Unrestricted Subsidiary shall
be deemed to include the Designation of all of the Subsidiaries of such
Subsidiary.
The Company may revoke any Designation of a Subsidiary as an Unrestricted
Subsidiary (a "Revocation") only if:
(i) no Default or Event of Default shall have occurred and be
continuing at the time of and after giving effect to such Revocation;
(ii) all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately following such Revocation would, if Incurred at such
time, be permitted to be Incurred for all purposes of the Indenture; and
(iii) any transaction (or series of related transactions) between such
Subsidiary and any of its Affiliates that occurred while such Subsidiary was
an Unrestricted Subsidiary would be permitted by the "Transactions with
Affiliates" covenant described below as if such transaction (or series of
related transactions) had occurred at the time of such Revocation.
All Designations and Revocations must be evidenced by resolutions of the
Board of Directors of the Company, delivered to the Trustee certifying
compliance with the foregoing provisions.
EVENTS OF DEFAULT AND REMEDIES
The occurrence of any of the following is defined as an "Event of Default"
under the Indenture: (a) failure to pay principal of (or premium, if any, on)
any Note when due (whether or not prohibited by the provisions of the Indenture
described under "Subordination of the Notes" above); (b) failure to pay any
interest on any Note when due, continued for 30 days or more (whether or not
prohibited by the provisions of the Indenture described under "Subordination of
the Notes" above); (c) default in the payment of principal of or interest on any
Note required to be purchased pursuant to any Offer to Purchase required by the
Indenture when due and payable or failure to pay on the Purchase Date the
purchase price for any Note validly tendered pursuant to any Offer to Purchase
(whether or not prohibited by the provisions of the Indenture described under
"Subordination of the Notes" above); (d) failure to perform or comply with any
of the provisions described under "Certain Covenants--Merger, Sale of Assets,
etc." above; (e) failure to perform any other covenant, warranty or agreement of
the Company under the Indenture or in the Notes, continued for 30 days or more
after written notice to the Company by the Trustee or Holders of at least 25% in
aggregate principal amount of the outstanding Notes; (f) default or defaults
under the terms of one or more instruments evidencing or securing Indebtedness
of the Company or any Significant Restricted Subsidiaries having an outstanding
principal amount of $15.0 million or more individually or in the aggregate that
has resulted in the acceleration of the payment of such Indebtedness or failure
by the Company or any Significant Restricted Subsidiary to pay principal when
due at the stated maturity of any such Indebtedness and such default or defaults
shall have continued after any applicable grace period and shall not have been
cured or waived; (g) the rendering of a final judgment or judgments (not subject
to appeal) against the Company or any Significant Restricted Subsidiary in an
amount of $15.0 million or more (net of any amounts covered by reputable and
creditworthy insurance companies) which remains undischarged or unstayed for a
period of 60 days after the date on which the right to appeal has expired; or
(h) certain events of bankruptcy, insolvency or reorganization affecting the
Company or any of its Significant Restricted Subsidiaries.
If an Event of Default with respect to the Notes (other than an Event of
Default described in clause (h) of the preceding paragraph) occurs and is
continuing, the Trustee or the Holders of at least 25% in aggregate principal
amount of the outstanding Notes, by notice in writing to the Company may declare
the unpaid principal of (and premium, if any) and accrued interest to the date
of acceleration on all the outstanding Notes to be due and payable immediately
and, upon any such declaration, such principal
69
amount (and premium, if any) and accrued interest, notwithstanding anything
contained in the Indenture or the Notes to the contrary, will become immediately
due and payable. If an Event or Default specified in clause (i) of the preceding
paragraph with respect to the Company occurs under the Indenture, the Notes will
ipso facto become immediately due and payable without any declaration or other
act on the part of the Trustee or any Holder of the Notes.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing, the Trustee
will be under no obligation to exercise any of its rights or powers under the
Indenture at the request or direction of any of the Holders of Notes, unless
such Holders shall have offered to the Trustee reasonable indemnity. Subject to
such provisions for the indemnification of the Trustee, the Holders of a
majority in aggregate principal amount of the outstanding Notes will have the
right to direct the time, method and place of conducting any proceeding for any
remedy available to the Trustee, or exercising any trust or power conferred an
such Trustee.
Any such declaration with respect to the Notes may be rescinded and annulled
by the Holders of a majority in aggregate principal amount of the outstanding
Notes upon the conditions provided in the Indenture. For information as to
waiver of defaults, see "Modification and Waiver" below.
The Indenture provides that the Trustee shall, within 30 days after the
occurrence of any Default or Event of Default with respect to the Notes
outstanding, give the Holders of the Notes thereof notice of all uncured
Defaults or Events of Default thereunder known to it; PROVIDED, HOWEVER, that,
except in the case of a Default or an Event of Default in payment with respect
to the Notes or a Default or Event of Default in complying with "Certain
Covenants--Merger, Sale of Assets, etc." above, the Trustee shall be protected
in withholding such notice if and so long as a committee of its trust officers
in good faith determines that the withholding of such notice is in the interest
of the Holders of the Notes.
No Holder of any Note will have any right to institute any proceeding with
respect to the Indenture or for any remedy thereunder, unless such Holder shall
have previously given to the Trustee written notice of a continuing Event of
Default thereunder and unless the Holders of at least 25% of the aggregate
principal amount of the outstanding Notes shall have made written request, and
offered reasonable indemnity, to the Trustee to institute such proceeding, and
the Trustee shall have not have received from the Holders of a majority in
aggregate principal amount of such outstanding Notes a direction inconsistent
with such request and shall have failed to institute such proceeding within 60
days. However, such limitations do not apply to a suit instituted by a Holder of
such a Note for enforcement of payment of the principal of and premium, if any,
or interest on such Note on or after the respective due dates expressed in such
Note.
The Company will be required to furnish to the Trustee annually a statement
as to the performance by the Company of certain of its obligations under the
Indenture and as to any material default in such performance.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES, INCORPORATOR,
MANAGER AND SHAREHOLDERS
No director, officer, employee, incorporator, manager or shareholder of the
Company or any of its Affiliates, as such, shall have any liability for any
obligations of the Company under the Notes or the Indenture or for any claim
based on, in respect of, or by reason of, such obligations or their creation.
Each Holder of Notes by accepting a Note waives and releases all such liability.
The waiver and release are part of the consideration for issuance of the Notes.
Such waiver may not be effective to waive liabilities under the federal
securities laws and it is the view of the Commission that such a waiver is
against public policy.
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LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance"). Such Legal Defeasance means that the Company shall be deemed to
have paid and discharged the entire indebtedness represented by the outstanding
Notes, except for (i) the rights of Holders to receive payments in respect of
the principal of, premium, if any, and interest on the Notes when such payments
are due, (ii) the Company's obligations with respect to the Notes concerning
issuing temporary Notes, registration of Notes, mutilated, destroyed, lost or
stolen Notes and the maintenance of an office or agency for payments, (iii) the
rights, powers, trust, duties and immunities of the Trustee and the Company's
obligations in connection therewith and (iv) the Legal Defeasance provisions of
the Indenture. In addition, the Company may, at its option and at any time,
elect to have the obligations of the Company released with respect to certain
covenants that are described in the Indenture ("Covenant Defeasance") and
thereafter any omission to comply with such obligations shall not constitute a
Default or an Event of Default with respect to the Notes. In the event Covenant
Defeasance occurs, certain events (not including non-payment, bankruptcy,
receivership, reorganization and insolvency events) described under "Events of
Default" will no longer constitute an Event of Default with respect to the
Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit of
the Holders cash in U.S. dollars, noncallable U.S. government obligations, or a
combination thereof, in such amounts as will be sufficient, in the opinion of a
nationally recognized firm of independent public accountants to pay the
principal of, premium, if any, and interest on the Notes on the stated date for
payment thereof or on the applicable redemption date, as the case may be; (ii)
in the case of Legal Defeasance, the Company shall have delivered to the Trustee
an opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that (A) the Company has received from, or there has been published
by, the Internal Revenue Service, a ruling or (B) since the Issue Date, there
has been a change in the applicable federal income tax law, in either case to
the effect that, and based thereon such opinion of counsel shall confirm that,
the Holders will not recognize income, gain or loss for federal income tax
purposes as a result of such Legal Defeasance and will be subject to federal
income tax on the same amounts, in the same manner and at the same times as
would have been the case if such Legal Defeasance had not occurred; (iii) in the
case of Covenant Defeasance, the Company shall have delivered to the Trustee an
opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that the Holders will not recognize income, gain or loss for federal
income tax purposes as a result of such Covenant Defeasance and will be subject
to federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if such Covenant Defeasance had not occurred;
(iv) no Default or Event of Default shall have occurred and be continuing on the
date of such deposit or insofar as Events of Default from bankruptcy or
insolvency events are concerned, at any time in the period ending on the 91st
day after the date of deposit; (v) such Legal Defeasance or Covenant Defeasance
shall not result in a breach or violation of, or constitute a default under the
Indenture or any other material agreement or instrument to which the Company or
any of its Subsidiaries in a party or by which the Company or any of its
Subsidiaries is bound; (vi) the Company shall have delivered to the Trustee an
officers' certificate stating that the deposit was not made by the Company with
the intent of preferring the Holders over any other creditors of the Company or
with the intent of defeating, hindering, delaying or defrauding any other
creditors of the Company or others; (vii) the Company shall have delivered to
the Trustee an officers' certificate and an opinion of counsel, each stating
that all conditions precedent provided for or relating to the Legal Defeasance
or the Covenant Defeasance have been complied with; (viii) the Company shall
have delivered to the Trustee an opinion of counsel to the effect that (A) the
trust funds will not be subject to any rights of holders of Senior Indebtedness,
including, without limitation, those arising under the Indenture and (B)
assuming no intervening bankruptcy of the Company between the date of deposit
and the 91st day following the date of the deposit and that no Holder is an
insider of the Company, after the 91st day following the date of the deposit,
the trust funds will not be subject to the
71
effect of any applicable bankruptcy, insolvency, reorganization or similar laws
affecting creditors' rights generally; and (ix) certain other customary
conditions precedent are satisfied. Notwithstanding the foregoing, the opinion
of counsel required by clause (ii) above need not be delivered if all Notes not
theretofore delivered to the Trustee for cancellation (x) have become due and
payable, (y) will become due and payable on the maturity date within one year or
(z) are to be called for redemption within one year under arrangements
satisfactory to the Trustee for the giving of notice of redemption by the
Trustee in the name, and at the expense, of the Company.
GOVERNING LAW
The Indenture, the Notes and the Guarantees, if any, are governed by the
laws of the State of New York without regard to principles of conflicts of laws.
MODIFICATION AND WAIVER
Modifications, waivers and amendments of the Indenture may be made by the
Company and the Trustee with the consent of the Holders of a majority in
aggregate principal amount of the outstanding Notes (including consents obtained
in connection with a tender offer or exchange offer for the Notes); PROVIDED,
HOWEVER, that no such modification, waiver or amendment to the Indenture may,
without the consent of the Holder of each Note affected thereby, (a) change the
maturity of the principal of or any installment of interest on any such Note or
alter the optional redemption or repurchase provisions of any such Note or the
Indenture in a manner adverse to the Holders of the Notes; (b) reduce the
principal amount of (or the premium of) any such Note; (c) reduce the rate of or
extend the time for payment of interest on any such Note; (d) change the place
or currency of payment of principal of (or premium) or interest on any such
Note; (e) modify any provisions of the Indenture relating to the waiver of past
defaults (other than to add sections of the Indenture or the Notes subject
thereto) or the right of the Holders of Notes to institute suit for the
enforcement of any payment on or with respect to any such Note or Guarantee or
the modification and amendment provisions of the Indenture and the Notes (other
than to add sections of the Indenture or the Notes which may not be modified,
amended, supplemented or waived without the consent of each Holder affected);
(f) reduce the percentage of the principal amount of outstanding Notes necessary
for amendment to or waiver of compliance with any provision of the Indenture or
the Notes or for waiver of any Default in respect thereof; (g) waive a default
in the payment of principal of, interest on, or redemption payment with respect
to, the Notes (except a rescission of acceleration of the Notes by the Holders
thereof as provided in the Indenture and a waiver of the payment default that
resulted from such acceleration); (h) modify the ranking or priority of any Note
in respect thereof in any manner adverse to the Holders or modify the definition
of Senior Indebtedness or amend or modify the subordination provisions of the
Indenture in any manner adverse to the Holders of the Notes; or (i) modify the
provisions of any covenant (or the related definitions) in the Indenture
requiring the Company to make an Offer to Purchase in a manner materially
adverse to the Holders of Notes affected thereby otherwise than in accordance
with the Indenture.
The Holders of a majority in aggregate principal amount of the outstanding
Notes, on behalf of all Holders of Notes, may waive compliance by the Company
with certain restrictive provisions of the Indenture. Subject to certain rights
of the Trustee, as provided in the Indenture, the Holders of a majority in
aggregate principal amount of the Notes, on behalf of all Holders, may waive any
past default under the Indenture (including any such waiver obtained in
connection with a tender offer or exchange offer for the Notes), except a
default in the payment of principal, premium or interest or a default arising
from failure to purchase any Notes tendered pursuant to an Offer to Purchase, or
a default in respect of a provision that under the indenture cannot be modified
or amended without the consent of the Holder of each Note that is affected.
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THE TRUSTEE
Except during the continuance of a Default, the Trustee will perform only
such duties as are specifically set forth in the Indenture. During the existence
of a Default, the Trustee will exercise such rights and powers vested in it
under the Indenture and use the same degree of care and skill in its exercise as
a prudent person would exercise under the circumstances in the conduct of such
person's own affairs.
The Indenture and provisions of the Trust Indenture Act incorporated by
reference therein contain limitations on the rights of the Trustee, should it
become a creditor of the Company or any other obligor upon the Notes, to obtain
payment of claims in certain cases or to realize on certain property received by
it in respect of any such claim as security or otherwise. The Trustee is
permitted to engage in other transactions with the Company or an Affiliate of
the Company; PROVIDED, HOWEVER, that if it acquires any conflicting interest (as
defined in the Indenture or in the Trust Indenture Act), it must eliminate such
conflict or resign.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full definition of all such terms, as well as any
other capitalized terms used.
"ACQUIRED INDEBTEDNESS" means Indebtedness of a Person (a) assumed in
connection with an Acquisition from such Person, or (b) existing at the time
such Person becomes a Subsidiary of the Company or is merged or consolidated
with or into the Company or any Restricted Subsidiary of the Company, in each
case other than Indebtedness of the Acquired Person actually repaid concurrent
with any such transaction.
"ACQUIRED PERSON" means, with respect to any specified Person, any other
Person which merges with or into or becomes a Subsidiary of such specified
Person.
"ACQUISITION" means (i) any capital contribution (by means of transfers of
cash or other property to others or payments for property or services for the
account or use of others, or otherwise) by the Company or any Restricted
Subsidiary of the Company to any other Person, or any acquisition or purchase of
Equity Interests of any other Person by the Company or any Restricted Subsidiary
of the Company, in either case pursuant to which such Person shall become a
Subsidiary of the Company or shall be consolidated with or merged into the
Company or any Restricted Subsidiary of the Company or (ii) any acquisition by
the Company or any Restricted Subsidiary of the Company of the assets of any
Person which constitute substantially all of an operating unit or line of
business of such Person or which is otherwise outside of the ordinary course of
business.
"AFFILIATE" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control,"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise. Unrestricted
Subsidiaries of the Company shall be deemed Affiliates of the Company.
"ASSET SALE" means any direct or indirect sale, conveyance, transfer, lease
(that has the effect of a disposition) or other disposition (including, without
limitation, any merger or consolidation) to any Person other than the Company or
a Restricted Subsidiary, in one transaction or a series of related transactions,
of (i) any Equity Interest of any Restricted Subsidiary of the Company (other
than directors' qualifying shares, to the extent mandated by applicable law);
(ii) any assets of the Company or any Restricted Subsidiary of the Company which
constitute substantially all of an operating unit or line of business of the
Company or any Restricted Subsidiary of the Company; or (iii) any other property
or
73
asset of the Company or any Restricted Subsidiary of the Company outside of the
ordinary course of business (including the receipt of proceeds paid on account
of the loss of or damage to any property or asset and awards of compensation for
any asset taken by condemnation, eminent domain or similar proceedings). For the
purposes of this definition, the term "Asset Sale" shall not include (a) any
transaction consummated in compliance with "Certain Covenants--Merger, Sale of
Assets, etc." above and the creation of any Lien not prohibited by "Certain
Covenants--Limitation on Liens" above; (b) sales of property or equipment that
has become worn out, obsolete or damaged or otherwise unsuitable for use in
connection with the business of the Company or any Restricted Subsidiary of the
Company, as the case may be; (c) any transaction consummated in compliance with
"Certain Covenants--Limitation on Restricted Payments" above; (d) a transfer of
assets from the Company to a Restricted Subsidiary, from a Restricted Subsidiary
to the Company or from a Restricted Subsidiary to another Restricted Subsidiary.
In addition, solely for purposes of "Certain Covenants--Disposition of Proceeds
of Asset Sales" above, any sale, conveyance, transfer, lease or other
disposition of any property or asset, whether in one transaction or a series of
related transactions, involving assets with a Fair Market Value not in excess of
$2.0 million in any fiscal year, shall be deemed not to be an Asset Sale. For
purposes of this definition, "ordinary course of business" shall be deemed to
include, without limitation, (i) the sale of rental inventory, consistent with
past practices, and (ii) closure of a store.
"ATTRIBUTABLE INDEBTEDNESS" in respect of a sale and lease-back transaction
means, as at the time of determination, the present value (discounted according
to GAAP at the cost of indebtedness implied in the lease) of the total
obligations of the lessee for rental payments during the remaining term of the
lease included in such sale and lease-back transaction (including any period for
which such lease has been extended).
"BOARD OF DIRECTORS" means the Board of Directors of the Company or any
committee thereof duly authorized to act on behalf of such Board of Directors.
"BOARD RESOLUTION" means, with respect to any Person, a duly adopted
resolution of the Board of Directors of such Person.
"BUSINESS DAY" means any day other than a Saturday, a Sunday or a day on
which banking institutions in New York, New York or Los Angeles, California are
not required to be open.
"CAPITAL LEASE OBLIGATION" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be so required to be capitalized on the balance sheet in accordance
with GAAP; PROVIDED that liabilities in respect of real property leases shall
not be deemed Capital Lease Obligations regardless of their classification in
accordance with GAAP.
"CASH EQUIVALENTS" means: (a) United States dollars, (b) securities issued
or directly and fully guaranteed or insured by the United States government or
any agency or instrumentality thereof having maturities of not more than one
year from the date of acquisition, (c) certificates of deposit, time deposits
and eurodollar time deposits with maturities of not more than one year from the
date of acquisition, bankers' acceptances with maturities of not more than one
year from the date of acquisition and overnight bank deposits, in each case with
any lender party to the New Credit Facility or any Indebtedness Incurred as a
refinancing of the New Credit Facility or with any commercial bank having
capital and surplus in excess of $500.0 million, (d) repurchase obligations with
a term of not more than thirty days for underlying securities of the types
described in clauses (b) and (c) above entered into with any financial
institution meeting the qualifications specified in clause (c) above, (e)
commercial paper rated at least P-2 by Moody's Investors Service, Inc. or at
least A-2 by Standard & Poor's Ratings Services with maturities of not more than
270 days from the date of acquisition, (f) readily marketable direct obligations
issued by any State of the United States of America or any political subdivision
thereof having maturities of not more than one year from the date of acquisition
and rated at least A by Moody's Investors Service, Inc. or A by Standard &
Poor's Ratings Services, (g) investment funds investing 95% of their assets in
securities of the types described in clauses (a) through (f) above; and (h) in
the case of any
74
Foreign Subsidiary, Investments: (i) in direct obligations of the sovereign
nation (or any agency thereof) in which such Foreign Subsidiary is organized and
is conducting business or in obligations fully and unconditionally guaranteed by
such sovereign nation (or any agency thereof) or (ii) of the type and maturity
described in clauses (b) and (c) above of foreign obligers, which Investment or
obligers (or the parents of such obligers) have ratings described in such
clauses or equivalent ratings from comparable foreign rating agencies and (h)
other Investments which would constitute cash equivalents in accordance with
GAAP.
"CHANGE OF CONTROL" means the occurrence of any of the following events
(whether or not approved by the Board of Directors of the Company); (i) any
Person (as such term is used in Sections 13(d) and 14(d) of the Exchange Act,
including any group acting for the purpose of acquiring, holding or disposing of
securities within the meaning of Rule 13d-5(b)(1) under the Exchange Act), other
than one or more Permitted Holders and their Related Parties, is or becomes the
"beneficial owner" (as defined in Rule 13d-3 and 13d-5 under the Exchange Act,
except that a Person shall be deemed to have "beneficial ownership" of all
shares that any such Person has the right to acquire, whether such right is
exercisable immediately or only after the passage of time, upon the happening of
an event or otherwise), directly or indirectly, of more than 50% of the total
voting power of the then outstanding Voting Equity Interests of the Company;
(ii) the Company consolidates with, or merges with or into, another Person
(other than a Wholly Owned Restricted Subsidiary) or the Company or any of its
Restricted Subsidiaries sells, assigns, conveys, transfers, leases or otherwise
disposes of all or substantially all of the assets of the Company and its
Restricted Subsidiaries (determined on a consolidated basis) to any Person
(other than the Company or any Wholly Owned Restricted Subsidiary), other than
any such transaction where immediately after such transaction the Person or
Persons that "beneficially owned" (as defined in Rules 13d-3 and 13d-5 under the
Exchange Act, except that a Person shall be deemed to have "beneficial
ownership" of all securities that such Person has the right to acquire, whether
such right is exercisable immediately or only after the passage of time)
immediately prior to such transaction, directly or indirectly, a majority of the
total voting power of the then outstanding Voting Equity Interests of the
Company "beneficially own" (as so determined), directly or indirectly, a
majority of the total voting power of the then outstanding Voting Equity
Interests of the surviving or transferee Person; (iii) during any period of two
consecutive years, individuals who at the beginning of such period constituted
the Board of Directors of the Company (together with any new directors whose
election by such Board of Directors or whose nomination for election by the
shareholders of the Company was approved by a vote of a majority of the
directors of the Company then still in office who were either directors at the
beginning of such period or whose election or nomination for election was
previously so approved) cease for any reason to constitute a majority of the
Board of Directors of the Company then in office; or (iv) the Company is
liquidated or dissolved or adopts a plan of liquidation or dissolution other
than in a transaction which complies with the provisions described under
"--Merger, Sale of Assets, etc." For purposes of this definition, beneficial
ownership of Parent shall be deemed to be pro rata beneficial ownership of that
portion of the Company owned by Parent.
"CHANGE OF CONTROL DATE" has the meaning set forth under "Offer to Purchase
upon Change of Control" above.
"CONSOLIDATED COVERAGE RATIO" as of any date of determination means the
ratio of (i) the aggregate amount of Consolidated EBITDA for the four quarter
period of the most recent four consecutive fiscal quarters ending prior to the
date of such determination (the "Four Quarter Period") to (ii) Consolidated
Interest Expense for such Four Quarter Period; PROVIDED, HOWEVER, that (1) if
the Company or any Restricted Subsidiary of the Company has incurred any
Indebtedness since the beginning of such Four Quarter Period that remains
outstanding on such date of determination or if the transaction giving rise to
the need to calculate the Consolidated Coverage Ratio is an Incurrence of
Indebtedness, Consolidated EBITDA and Consolidated Interest Expense for such
Four Quarter Period shall be calculated after giving effect on a pro forma basis
to such Indebtedness as if such Indebtedness had been Incurred on the first
75
day of such Four Quarter Period (PROVIDED that if such Indebtedness is revolving
Indebtedness the amount thereof deemed to be incurred as of the first day of
such Four Quarter Period shall be the average daily balance of such Indebtedness
during the period since such revolving Indebtedness was initially incurred) and
the discharge of any other Indebtedness repaid, repurchased or otherwise
discharged with the proceeds of such new Indebtedness as if such discharge had
occurred on the first day of such Four Quarter Period, (2) if since the
beginning of such Four Quarter Period the Company or any Restricted Subsidiary
of the Company shall have made any Asset Sale, the Consolidated EBITDA for such
Four Quarter Period shall be reduced by an amount equal to the Consolidated
EBITDA (if positive) directly attributable to the assets that are the subject of
such Asset Sale for such Four Quarter Period or increased by an amount equal to
the Consolidated EBITDA (if negative) directly attributable thereto for such
Four Quarter Period and Consolidated Interest Expense for such Four Quarter
Period shall be reduced by an amount equal to the Consolidated Interest Expense
directly attributable to any Indebtedness of the Company or any Restricted
Subsidiary of the Company repaid, repurchased or otherwise discharged with
respect to the Company and its continuing Subsidiaries in connection with such
Asset Sale for such Four Quarter Period (or, if the Equity Interests of any
Restricted Subsidiary of the Company are sold, the Consolidated Interest Expense
for such Four Quarter Period directly attributable to the Indebtedness of such
Restricted Subsidiary to the extent the Company and its continuing Subsidiaries
are no longer liable for such Indebtedness after such sale), (3) if since the
beginning of such Four Quarter Period the Company or any Restricted Subsidiary
of the Company (by merger or otherwise) shall have made an Investment in any
Subsidiary of the Company (or any Person that becomes a Restricted Subsidiary of
the Company) or an acquisition of assets, including any acquisition of assets
occurring in connection with a transaction causing a calculation to be made
hereunder, which constitutes all or substantially all of an operating unit of a
business, Consolidated EBITDA and Consolidated Interest Expense for such Four
Quarter Period shall be calculated after giving pro forma effect thereto
(including the Incurrence of any Indebtedness) as if such Investment or
acquisition occurred on the first day of such Four Quarter Period, (4) if since
the beginning of such Four Quarter Period any Person (that subsequently became a
Subsidiary or was merged with or into the Company or any Restricted Subsidiary
of the Company since the beginning of such Four Quarter Period) shall have made
any Asset Sale or any Investment or acquisition of assets that would have
required an adjustment pursuant to clause (2) or (3) above if made by the
Company or a Subsidiary of the Company during such Four Quarter Period,
Consolidated EBITDA and Consolidated Interest Expense for such Four Quarter
Period shall be calculated after giving pro forma effect thereto as if such
Asset Sale, Investment or acquisition of assets occurred on, with respect to any
Investment or acquisition, the first day of such Four Quarter Period and, with
respect to any Asset Sale, the day prior to the first day of such Four Quarter
Period, and (5) if since the beginning of such period the Company shall have
received the proceeds of an Equity Offering, Consolidated Interest Expense for
such period shall be reduced by an amount equal to the Consolidated Interest
Expense directly attributable to any Indebtedness of the Company or any
Restricted Subsidiary repaid, repurchased, defeased or otherwise discharged with
respect to the Company and its Restricted Subsidiaries in connection with such
receipt of proceeds of such Equity Offering for such period. For purposes of
this definition, whenever pro forma effect is to be given to an acquisition of
assets, the amount of income or earnings relating thereto and the amount of
Consolidated Interest Expense associated with any Indebtedness Incurred in
connection therewith, the pro forma calculations shall be determined in
accordance with Regulation S-X under the Securities Act as in effect on the date
of such calculation. If any Indebtedness bears a floating rate of interest and
is being given pro forma effect, the interest expense on such Indebtedness shall
be calculated as if the rate in effect on the date of determination had been the
applicable rate for the entire period (taking into account any agreement under
which Interest Rate Protection Obligations are outstanding applicable to such
Indebtedness if such agreement under which such Interest Rate Protection
Obligations are outstanding has a remaining term as at the date of determination
in excess of 12 months); PROVIDED, HOWEVER, that the Consolidated Interest
Expense of the Company attributable to interest on any Indebtedness Incurred
under a revolving
76
credit facility computed on a pro forma basis shall be computed based upon the
average daily balance of such Indebtedness during the Four Quarter Period.
"CONSOLIDATED EBITDA" means, for any period, the Consolidated Net Income for
such period, plus the following to the extent deducted in calculating such
Consolidated Net Income: (i) Consolidated Income Tax Expense for such period;
(ii) Consolidated Interest Expense for such period; and (iii) Consolidated
Non-cash Charges for such period, less all non-cash items increasing
Consolidated Net Income for such period.
"CONSOLIDATED INCOME TAX EXPENSE" means, with respect to the Company for any
period, the provision for Federal, state, local and foreign income taxes of the
Company and its Restricted Subsidiaries for such period as determined on a
consolidated basis in accordance with GAAP.
"CONSOLIDATED INTEREST EXPENSE" means, with respect to the Company for any
period, without duplication, the sum of (i) the interest expense of the Company
and its Subsidiaries for such period as determined on a consolidated basis in
accordance with GAAP, including, without limitation, (a) any amortization of
debt discount, (b) the net cost under Interest Rate Protection Obligations
(including any amortization of discounts), (c) the interest portion of any
deferred payment obligation, (d) all commissions, discounts and other fees and
charges owed with respect to letters of credit and bankers' acceptance
financing, (e) all capitalized interest and all accrued interest, (f) non-cash
interest expense and (g) interest on Indebtedness of another Person that is
guaranteed by the Company or any Subsidiary of the Company actually paid by the
Company or any Subsidiary of the Company, (ii) preferred stock dividend
requirements on the preferred stock described in clause (h) of the definition of
Indebtedness and (iii) the interest component of Capitalized Lease Obligations
paid, accrued and/or scheduled to be paid or accrued by the Company and its
Subsidiaries during such period as determined on a consolidated basis in
accordance with GAAP. Notwithstanding the foregoing, Consolidated Interest
Expense shall not include any expense of the Company incurred as one-time
payments in connection with the extension of certain Indebtedness of the Company
in February 1998.
"CONSOLIDATED NET INCOME" means, for any period, the consolidated net income
(loss) of the Company and its Subsidiaries, provided, however, that there shall
not be included in such Consolidated Net Income: (i) any net income (loss) of
any Person if such Person is not a Restricted Subsidiary of the Company, except
that the Company's equity in the net income of any such Person for such period
shall be included in determining such Consolidated Net Income up to the
aggregate amount of cash actually distributed by such Person during such period
to the Company or a Restricted Subsidiary as a dividend or distribution; (ii)
any net income (loss) of any Person acquired by the Company or a Restricted
Subsidiary of the Company in a pooling of interests transaction for any period
prior to the date of such acquisition; PROVIDED that there shall not be any such
exclusion of the net income (loss) of any Person acquired in connection with the
Reorganization; (iii) any net income (but not loss) of any Restricted Subsidiary
of the Company that is not a Guarantor if such Restricted Subsidiary is subject
to restrictions, directly or indirectly, on the payment of dividends or the
making of distributions by such Subsidiary, directly or indirectly, to the
Company to the extent of such restrictions; (iv) any gain or loss realized upon
the sale or other disposition of any asset of the Company or its Restricted
Subsidiaries (including pursuant to any sale/lease-back transaction) outside of
the ordinary course of business including, without limitation, on or with
respect to Investments (and excluding dividends, distributions or interest
thereon); (v) any extraordinary gain or loss in accordance with GAAP; (vi) the
cumulative effect of a change in accounting principles after the Issue Date; and
(vii) any restoration to income of any contingency reserve of an extraordinary,
non-recurring or unusual nature, except to the extent that provision for such
reserve was made out of Consolidated Net Income accrued at any time following
the Issue Date.
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"CONSOLIDATED NON-CASH CHARGES" means, with respect to any Person, for any
period the sum of (a) depreciation, (b) amortization and (c) other non-cash
items presented on such Person's consolidated statement of cash flows as
"Adjustments to Reconcile Net Income to Net Cash Provided by Operating
Activities," determined on a consolidated basis in accordance with GAAP.
"CURRENCY AGREEMENT" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement relating to fluctuations in
currency values.
"DEFAULT" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
"DESIGNATED SENIOR INDEBTEDNESS" means (a) any Indebtedness outstanding
under the New Credit Facility and (b) any other Senior Indebtedness which, at
the time of determination, has an aggregate principal amount outstanding,
together with any commitments to lend additional amounts, of at least $10.0
million, if the instrument governing such other Senior Indebtedness expressly
states that such Indebtedness is "Designated Senior Indebtedness" for purposes
of the Indenture.
"DISPOSITION" means, with respect to any Person, any merger, consolidation
or other business combination involving such Person (whether or not such Person
is the Surviving Person) or the sale, assignment, transfer, lease, conveyance or
other disposition of all or substantially all of such Person's assets.
"DISQUALIFIED EQUITY INTEREST" means any Equity Interest which, by its terms
(or by the terms of any security into which it is convertible or for which it is
exchangeable at the option of the holder thereof), or upon the happening of any
event, matures or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or redeemable at the option of the holder thereof, in
whole or in part, or exchangeable into Indebtedness on or prior to the earlier
of the maturity date of the Notes or the date on which no Notes remain
outstanding.
"DOMESTIC SUBSIDIARY" means, with respect to a Subsidiary, a Subsidiary
whose jurisdiction of incorporation or formation is the United States, any state
thereof or the District of Columbia.
"EQUITY INTEREST" in any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) corporate stock or other equity
participations, including partnership interests, whether general or limited, in
such Person, including any Preferred Equity Interests.
"EQUITY OFFERING" means (i) an underwritten public offering of Qualified
Equity Interests of Parent or the Company pursuant to an effective registration
statement filed under the Securities Act (excluding registration statements
filed on Form S-8) or (ii) a private offering of Qualified Equity Interests of
Parent or the Company pursuant to an exemption from registration under the
Securities Act in an aggregate purchase price of not less than $50.0 million.
"EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended, and
the rules and regulations promulgated by the SEC thereunder.
"EXISTING INDEBTEDNESS" means Indebtedness of the Company and its
Subsidiaries (other than Indebtedness under the New Credit Facility) in
existence on the Issue Date, until such amounts are repaid.
"EXPIRATION DATE" has the meaning set forth in the definition of "Offer to
Purchase" below.
"FAIR MARKET VALUE" means, with respect to any asset, the price (after
taking into account any liabilities relating to such assets) which could be
negotiated in an arm's-length free market transaction, for cash or other
consideration, between a willing seller and a willing and able buyer, neither of
which is under any compulsion to complete the transaction; PROVIDED, HOWEVER,
that the Fair Market Value of any such asset shall be determined conclusively by
the Board of Directors of the Company acting in good
78
faith, and, with respect to any determination of Fair Market Value in excess of
$10.0 million, shall be evidenced by a Board Resolution delivered to the
Trustee.
"FOREIGN SUBSIDIARY" means, with respect to a Subsidiary, a Subsidiary other
than a Domestic Subsidiary.
"FOUR QUARTER PERIOD" has the meaning set forth in the definition of
"Consolidated Coverage Ratio" above.
"GAAP" means, at any date of determination, generally accepted accounting
principles in effect in the United States which are applicable at the Issue Date
and which are consistently applied for all applicable periods, including those
set forth in (i) the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants, (ii) statements
and pronouncements of the Financial Accounting Standards Board, and (iii) such
other statements by such other entity as approved by a significant segment of
the accounting profession.
"GUARANTEE" means, as applied to any obligation, (i) a guarantee (other than
by endorsement of negotiable instruments for collection in the ordinary course
of business), direct or indirect, in any manner, of any part or all of such
obligation and (ii) an agreement, direct or indirect, contingent or otherwise,
the practical effect of which is to assure in any way the payment or performance
(or payment of damages in the event of non-performance) of all or any part of
such obligation, including, without limiting the foregoing, the payment of
amounts drawn down by letters of credit.
"GUARANTORS" means each Subsidiary of the Company (other than Foreign
Subsidiaries and Unrestricted Subsidiaries) which is required to become a
Guarantor pursuant to the terms of the Indenture.
"HOLDERS" means the registered holders of the Notes.
"INCUR" means, with respect to any Indebtedness or other obligation of any
Person, to create, issue, incur (including by conversion, exchange or
otherwise), assume, guarantee or otherwise become liable in respect of such
Indebtedness or other obligation or the recording, as required pursuant to GAAP
or otherwise, of any such Indebtedness or other obligation on the balance sheet
of such Person (and "Incurrence," "Incurred" and "Incurring" shall have meanings
correlative to the foregoing). Indebtedness of any Acquired Person or any of its
Subsidiaries existing at the time such Acquired Person becomes a Subsidiary of
the Company (or is merged into or consolidated with the Company or any
Restricted Subsidiary of the Company), whether or not such Indebtedness was
Incurred in connection with, as a result of, or in contemplation of, such
Acquired Person becoming a Restricted Subsidiary of the Company (or being merged
into or consolidated with the Company or any Restricted Subsidiary), shall be
deemed Incurred at the time any such Acquired Person becomes a Subsidiary or
merges into or consolidates with the Company or any Restricted Subsidiary.
"INDEBTEDNESS" means (without duplication), with respect to any Person,
whether recourse is to all or a portion of the assets of such Person, (a) the
principal amount of every obligation of such Person for money borrowed; (b) the
principal amount of every obligation of such Person evidenced by bonds,
debentures, notes or other similar instruments, including the principal amount
of such obligations incurred in connection with the acquisition of property,
assets or businesses; (c) reimbursement obligations of such Person with respect
to letters of credit, bankers' acceptances or similar facilities issued for the
account of such Person; (d) the principal amount of obligations of such Person
issued or assumed as the deferred purchase price of property or services (but
excluding trade accounts payable incurred in the ordinary course of business and
payable in accordance with industry practices, or other accrued liabilities
arising in the ordinary course of business); (e) Capital Lease Obligations of
such Person; (f) net obligations under Interest Rate Protection Obligations or
similar agreements or Currency Agreements of such Person; (g) Attributable
Indebtedness; (h) any Disqualified Equity Interests of the Company or any
preferred stock of any Restricted Subsidiary of the Company not held by the
Company or a Restricted
79
Subsidiary; (i) obligations of the type referred to in clauses (a) through (j)
of another Person and all dividends of another Person the payment of which, in
either case, such Person has guaranteed or is responsible or liable for,
directly or indirectly, as obligor, guarantor or otherwise; and (j) any and all
deferrals, renewals, extensions and refundings of, or amendments, modifications
or supplements to, any liability of the kind described in any of the preceding
clauses (a) through (i) above. Indebtedness (i) with respect to reimbursement
obligations as described under clause (c) above, shall not be deemed Incurred if
satisfied within 15 Business Days of such Incurrence and (ii) which provides
that an amount less than the principal amount thereof shall be due upon any
declaration of acceleration thereof shall be deemed to be Incurred or
outstanding in an amount equal to the accreted value thereof at the date of
determination.
"INDEPENDENT FINANCIAL ADVISOR" means a nationally recognized accounting,
appraisal, investment banking firm or consultant (i) which does not, and whose
directors, officers and employees or Affiliates do not, have a direct or
indirect financial interest in the Company and (ii) which, in the judgment of
the Board of Directors of the Company, is otherwise independent and qualified to
perform the task for which it is to be engaged.
"INTEREST" means, with respect to the Notes, the sum of any cash interest
and any Additional Interest (as defined under "Exchange and Registration Rights
Agreement" below) on the Notes.
"INTEREST RATE PROTECTION OBLIGATIONS" means, with respect to any Person,
the Obligations of such Person under (i) interest rate swap agreements, interest
rate cap agreements and interest rate collar agreements, and (ii) other
agreements or arrangements relating to fluctuations in interest rates.
"INVENTORY" means, with respect to any Person as of any date of
determination, the then book value of inventory which would appear on the
consolidated balance sheet of such Person in accordance with GAAP, plus the then
book value of video rental product recorded on the books of such Person in
accordance with GAAP.
"INVESTMENT" means, with respect to any Person, any direct or indirect loan,
advance, guarantee or other extension of credit or capital contribution to (by
means of transfers of cash or other property or assets to others or payments for
property or services for the account or use of others, or otherwise), or
purchase or acquisition of capital stock, bonds, notes, debentures or other
securities or evidences of Indebtedness issued by, any other Person. For
purposes of the "Limitation on Restricted Payments" covenant above, the amount
of any Investment shall be the original cost of such Investment, plus the cost
of all additions thereto, but without any other adjustments for increases or
decreases in value, or write-ups, write-downs or write-offs with respect to such
Investment; reduced by the payment of dividends or distributions in connection
with such Investment or any other amounts received in respect of such
Investment; PROVIDED, HOWEVER, that no such payment of dividends or
distributions or receipt of any such other amounts shall reduce the amount of
any Investment if such payment of dividends or distributions or receipt of any
such amounts would be included in Consolidated Net Income. In determining the
amount of any investment involving a transfer of any property or asset other
than cash, such property shall be valued at its fair market value at the time of
such transfer, as determined in good faith by the Board of Directors (or
comparable body) of the Person making such transfer.
"ISSUE DATE" means the original issue date of the Notes.
"LIEN" means any lien, mortgage, charge, security interest, hypothecation,
assignment for security or encumbrance of any kind (including any conditional
sale or capital lease or other title retention agreement, any lease in the
nature thereof, and any agreement to give any security interest).
"MATURITY DATE" means the date, which is set forth on the face of the Notes,
on which the Notes will mature.
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"NET CASH PROCEEDS" means the aggregate proceeds in the form of cash or Cash
Equivalents received by the Company or any Restricted Subsidiary of the Company
in respect of any Asset Sale, including all cash or Cash Equivalents received
upon any sale, liquidation or other exchange of proceeds of Asset Sales received
in a form other than cash or Cash Equivalents, net of (a) the direct costs
relating to such Asset Sale (including, without limitation, legal, accounting
and investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof; (b) taxes paid or payable as a result thereof
(after taking into account any available tax credits or deductions and any tax
sharing arrangements); (c) amounts required to be applied to the repayment of
Indebtedness secured by a Lien on the asset or assets that were the subject of
such Asset Sales; (d) amounts deemed, in good faith, appropriate by the Board of
Directors of the Company to be provided as a reserve, in accordance with GAAP,
against any liabilities associated with such assets which are the subject of
such Asset Sale; including, without limitation, pension and other
post-employment benefit liabilities, liabilities related to environmental
matters and liabilities under any indemnification obligations associated with
such Asset Sale, all as reflected in an officers' certificate delivered to the
Trustee (provided that the amount of any such reserves shall be deemed to
constitute Net Cash Proceeds at the time such reserves shall have been reversed
or are not otherwise required to be retained as a reserve); and (e) with respect
to Asset Sales by a Restricted Subsidiary, the portion of such cash payments
attributable to Persons holding a minority interest in such Restricted
Subsidiary.
"NET PROCEEDS UTILIZATION DATE" has the meaning set forth in the second
paragraph under "Certain Covenants-Disposition of Proceeds of Asset Sales"
above.
"NEW CREDIT FACILITY" means the Credit Agreement dated April 23, 1998, by
and among the Company, the Subsidiaries of the Company identified on the
signature pages thereto, the lenders named therein, and The Chase Manhattan
Bank, as Agent, as amended, including any deferrals, renewals, extensions,
replacements, refinancings or refundings thereof, or amendments, modifications
or supplements thereto and any agreement providing therefor, whether by or with
the same or any other lender, creditor, group of lenders or group of creditors,
and including related notes, guarantee and note agreements and other instruments
and agreements executed in connection therewith.
"NON-AFFILIATED JOINT VENTURE" means any Person (other than a Subsidiary) in
which the Company or its Subsidiaries have an ownership interest in excess of
25% and in which no Affiliate of the Company has any other interest; provided,
however, that the business of such joint venture relates to the development,
marketing or sale of products of the Company and its Subsidiaries.
"OBLIGATIONS" means any principal, interest (including, without limitation,
Post-Petition Interest), premium, if any, penalties, fees, indemnifications,
reimbursement obligations, damages and other liabilities payable under the
documentation governing any Indebtedness.
"OFFER" has the meaning set forth in the definition of "Offer to Purchase"
below.
"OFFER TO PURCHASE" means a written offer (the "Offer") sent by or on behalf
of the Company by first-class mail, postage prepaid, to each Holder at his
address appearing in the register for the Notes on the date of the Offer
offering to purchase up to the principal amount of Notes specified in such Offer
at the purchase price specified in such Offer (as determined pursuant to the
Indenture). Unless otherwise required by applicable law, the Offer shall specify
an expiration date (the "Expiration Date") of the Offer to Purchase, which shall
be not less than 30 nor more than 90 days after the date of such Offer, and a
settlement date (the "Purchase Date") for purchase of Notes to occur no later
than five Business Days after the Expiration Date. The Company shall notify the
Trustee at least 15 Business Days (or such shorter period as is acceptable to
the Trustee) prior to the mailing of the Offer of the Company's obligation to
make an Offer to Purchase, and the Offer shall be mailed by the Company or, at
the Company's request, by the Trustee in the name and at the expense of the
Company. The Offer shall contain all the information required by applicable law
to be included therein and shall contain all instructions and materials
necessary to enable such Holders to tender Notes pursuant to the Offer to
81
Purchase. The Offer shall also state: (1) the Section of the Indenture pursuant
to which the Offer to Purchase is being made and (2) the circumstances and
relevant facts and relevant financial information regarding the Offer to
Purchase.
An Offer to Purchase shall be governed by and effected in accordance with
the provisions above pertaining to any Offer.
"OPINION OF COUNSEL" means a written opinion from legal counsel who is
reasonably acceptable to the Trustee. The counsel may be an employee of or
counsel to the Company or the Trustee.
"PERMITTED BUSINESS" means the businesses engaged in by the Company and its
Subsidiaries as of the Issue Date, businesses utilizing the TOWER trademark, and
businesses which are reasonably related or incidental to the foregoing or which
are extensions thereof.
"PERMITTED HOLDER" means each of Russell M. Solomon, Doris E. Solomon, the
Trusts, Michael Solomon, David Solomon, Stanley Goman, DeVaughn Searson and
Christopher Hopson.
"PERMITTED INDEBTEDNESS" has the meaning set forth in the second paragraph
of "Certain Covenants--Limitation on Indebtedness" above.
"PERMITTED INVESTMENTS" means (a) Investments in Cash Equivalents or deposit
accounts maintained in the ordinary course of business; (b) Investments in
prepaid expenses, negotiable instruments held for collection and lease, utility
and workers' compensation, performance and other similar deposits; (c)
Investments under Interest Rate Protection Obligations and Currency Agreements;
(d) Investments received in connection with the bankruptcy or reorganization of
suppliers and customers and in settlement of delinquent obligations of, and
other disputes with, customers and suppliers, in each case arising in the
ordinary course of business; (e) Investments in the Company and Investments in a
Restricted Subsidiary of the Company and Investments in a Person which is
engaged in (or immediately after such Investment will be engaged in) a Permitted
Business and if as a result of such Investment (i) such Person becomes a
Restricted Subsidiary or (ii) such Person is merged, consolidated or amalgamated
with or into, or transfers or conveys substantially all of its assets to, or is
liquidated into, the Company or a Restricted Subsidiary; (f) Investments
acquired in exchange for Qualified Equity Interests; (g) loans or advances to
officers or employees of the Company and its Restricted Subsidiaries in the
ordinary course of business for bona fide business purposes of the Company and
its Subsidiaries (including travel and moving expenses); (h) any Investment
existing on the Issue Date and any amendment, modification, restatement,
supplement, extension, renewal, refunding, replacement, refinancing, in whole or
in part, thereof; (i) any Investment accepted as a result of the receipt of
non-cash consideration from an Asset Sale that was made pursuant to and in
compliance with the covenant described above under the caption "--Certain
Covenants--Disposition of Proceeds of Asset Sales;" (j) advances and extensions
of credit in the nature of accounts receivable or notes receivable arising from
the sale or lease of goods or services or the licensing of property in the
ordinary course of business; (k) Investments in Non-Affiliated Joint Ventures in
an aggregate amount not to exceed $5.0 million during any fiscal year; (l) other
Investments by the Company or any Restricted Subsidiary in any Person having an
aggregate fair market value (measured as of the date each such Investment is
made and without giving effect to subsequent changes in value), when taken
together with all other Investments made pursuant to this clause (l) that are at
the time outstanding, not to exceed $15.0 million; and (l) intercompany
Investments permitted under clauses (c), (h) and (i) of the covenant described
under the caption "--Certain Covenants-- Limitation on Indebtedness."
"PERMITTED JUNIOR SECURITIES" means any securities of the Company or any
other Person that are (i) Equity Interests or (ii) debt securities expressly
subordinated in right of payment to all Senior Indebtedness that may at the time
be outstanding (and any Indebtedness or debt securities issued in exchange for
Senior Indebtedness), to substantially the same extent as, or to a greater
extent than, the Notes are subordinated as provided in the Indenture, in any
event pursuant to a court order so providing
82
and as to which (a) the rate of interest on such securities shall not exceed the
effective rate of interest on the Notes on the Issue Date, (b) such securities
shall not be entitled to the benefits of covenants or defaults materially more
beneficial to the holders of such securities than those in effect with respect
to the Notes on the Issue Date and (c) such securities shall not provide for
amortization (including sinking fund and mandatory prepayment provisions)
commencing prior to the date six months following the final scheduled maturity
date of the Senior Indebtedness (as modified by the plan of reorganization of
readjustment pursuant to which such securities are issued).
"PERMITTED LIENS" means (i) Liens securing Senior Debt of the Company and
its Restricted Subsidiaries; (ii) Liens existing on the Issue Date; (iii) Liens
on the assets of the Company or any of its Restricted Subsidiaries to secure
Interest Rate Protection Obligations and Currency Agreements permitted by the
Indenture to be incurred; (iv) Liens on property of a Person existing at the
time such Person or such Person's parent corporation becomes a Subsidiary of the
Company or any Subsidiary of the Company; PROVIDED THAT such Liens were in
existence prior to the contemplation of such transaction and do not extend to
any assets other than those of such Person; (v) Liens on property existing at
the time of acquisition thereof by the Company or any Subsidiary of the Company,
PROVIDED THAT such Liens were in existence prior to the contemplation of such
acquisition and extend only to the property so acquired and the proceeds
thereof; (vi) Liens to secure any Indebtedness permitted by clause (h) of the
covenant described above under the caption "--Certain Covenants--Limitation on
Indebtedness" incurred to refinance any Indebtedness secured by any Lien
referred to in the foregoing clauses (i) through (v), PROVIDED, HOWEVER, that
such new Lien shall be limited to all or part of the same property that secured
the original Lien (PROVIDED THAT such Liens may extend to after-acquired
property, including any assets or Equity Interests of any subsequently formed or
acquired Subsidiary, if such original Lien included such property or assets as
collateral) and the Indebtedness secured by such Lien at such time is not
increased to any amount greater than permitted under the covenant described
above under the caption "--Certain Covenants--Limitation on Indebtedness," or,
in the case of other Senior Debt, or, in the case of other Indebtedness, the
outstanding principal amount or, if greater, committed amount of the
Indebtedness described under clauses (i) through (v), as the case may be, at the
time the original Lien became a Permitted Lien; (vii) Liens in favor of the
Company or any Guarantor; (viii) Liens incurred in the ordinary course of
business of the Company or any Restricted Subsidiary that (a) are not incurred
in connection with the borrowing of money or the obtaining of advances or credit
(other than trade credit and accruals in the ordinary course of business) and
(b) do not in the aggregate materially detract from the value of the property or
materially impair the use thereof in the operation of business by the Company or
such Restricted Subsidiary; (ix) Liens to secure the performance of statutory
obligations, surety or appeal bonds, performance bonds, letters of credit,
deposits to secure the performance of bids, trade contracts, government
contracts, leases or licenses or other obligations of a like nature incurred in
the ordinary course of business (including, without limitation, landlord Liens
on leased properties); (x) Liens for taxes, assessments or governmental charges
or claims that are not yet delinquent or that are being contested in good faith
by appropriate proceedings promptly instituted and diligently prosecuted,
PROVIDED THAT any reserve or other appropriate provision as shall be required to
conform with GAAP shall have been made therefor; (xi) Liens to secure
Indebtedness (including Capital Lease Obligations) permitted by clause (e) of
the covenant described above under the caption "--Certain Covenants--Limitation
on Indebtedness" covering only the assets acquired or financed with such
Indebtedness, together with any additions and accessions thereto and
replacements, substitutions and proceeds (including insurance proceeds) thereof;
(xii) carriers', warehousemen's, mechanics', landlords', materialmen's,
repairmen's or other like Liens arising in the ordinary course of business in
respect of obligations not overdue for a period in excess of 90 days or which
are being contested in good faith by appropriate proceedings promptly instituted
and diligently prosecuted; PROVIDED, that any reserve or other appropriate
provision as shall be required to conform with GAAP shall have been made
therefor; (xiii) easements, rights-of-way, zoning and similar restrictions and
other similar encumbrances or title defects incurred, or leases or subleases
granted to others, in the ordinary course of business, which do not in any case
materially
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detract from the value of the property subject thereto or do not interfere with
or adversely affect in any material respect the ordinary conduct of the business
of the Company and its Restricted Subsidiaries taken as a whole; (xiv) Liens in
favor of customs and revenue authorities to secure payment of customs duties in
connection with the importation of goods in the ordinary course of business and
other similar Liens arising in the ordinary course of business; (xv) leases or
subleases granted to third Persons not interfering with the ordinary course of
business of the Company or its Restricted Subsidiaries; (xvi) Liens (other than
any Lien imposed by ERISA or any rule or regulation promulgated thereunder)
incurred or deposits made in the ordinary course of business in connection with
workers' compensation, unemployment insurance, and other types of social
security; (xvii) deposits made in the ordinary course of business to secure
liability to insurance carriers, and Liens on the proceeds of insurance granted
to insurance carriers solely to secure the payment of financed premiums; (xviii)
any attachment or judgment Lien not constituting an Event of Default under
clause (g) of the first paragraph of the section described above under the
caption "--Events of Default and Remedies;" (xix) any interest or title of a
lessor or sublessor under any operating lease; (xx) Liens arising by virtue of
any common law, statutory or contractual provision relating to bankers' liens,
rights of set-off or similar rights and remedies as to deposit or securities
accounts maintained in the ordinary course of business; (xxi) Liens in favor of
a trustee under any indenture securing amounts due to the trustee in connection
with its services under such indenture, (xxii) Liens under licensing agreements
for use of intellectual property entered into in the ordinary course of
business; (xxiii) purchase money Liens on Inventory and the proceeds thereof
securing obligations owed to vendors in the ordinary course of business; and
(xxiv) Liens arising out of consignments or similar arrangements for the sale of
goods entered into in the ordinary course of business.
"PERMITTED LIFE INSURANCE" means life insurance on the lives of Russell M.
Solomon and Doris Solomon, the beneficiaries of which are the Company (up to the
amounts of the premiums paid by the Company) and the Trusts, and certain other
similar life insurance policies maintained on the lives of executive officers of
the Company, in each case described under the caption "Certain Transactions."
"PERSON" means any individual, corporation, partnership, joint venture,
association, joint-stock company, limited liability company, limited liability
limited partnership, trust, unincorporated organization or government or any
agency or political subdivision thereof.
"PREFERRED EQUITY INTEREST," in any Person, means an Equity Interest of any
class or classes (however designated) which is preferred as to the payment of
dividends or distributions, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person, over Equity
Interests of any other class in such Person.
"PRINCIPAL" of a debt security means the principal of the security plus,
when appropriate, the premium, if any, on the security.
"PURCHASE DATE" has the meaning set forth in the definition of "Offer to
Purchase" above.
"PURCHASE MONEY INDEBTEDNESS" means Indebtedness of the Company or any
Subsidiary of the Company (including, without limitation, conditional sale
obligations and title retention agreements) Incurred for the purpose of
financing all or any part of the purchase price or the cost of construction or
improvement of any property (real or personal) (if incurred within 270 days of
the date of purchase or completion of such construction or improvement);
PROVIDED, HOWEVER, that the aggregate principal amount of such Indebtedness does
not exceed the lesser of the Fair Market Value of such property or such purchase
price or cost, including any refinancing of such Indebtedness that does not
increase the aggregate principal amount (or accreted amount, if less) thereof,
plus any premium required to accomplish such refinancing, as of the date of
refinancing.
"QUALIFIED EQUITY INTEREST" in any Person means any Equity Interest in such
Person other than any Disqualified Equity Interest.
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"RELATED PARTY" with respect to any Permitted Holder means (i) any
controlling stockholder, 51% (or more) owned Subsidiary, or spouse or immediate
family member (in the case of an individual) of such Permitted Holder or (ii)
any trust, corporation, partnership or other entity, the beneficiaries,
stockholders, partners, owners or Persons beneficially holding a 51% or more
controlling interest of which consist of such Permitted Holder and/or such other
Persons referred to in the immediately preceding clause (i).
"RESTRICTED SUBSIDIARY" means any Subsidiary of the Company that has not
been designated by the Board of Directors of the Company, by a resolution of the
Board of Directors of the Company delivered to the Trustee, as an Unrestricted
Subsidiary pursuant to the "Designation of Unrestricted Subsidiaries" covenant.
Any such designation may be revoked by a resolution of the Board of Directors of
the Company delivered to the Trustee, subject to the provisions of such
covenant.
"SEC" means the Securities and Exchange Commission.
"SENIOR INDEBTEDNESS" means, at any date, (a) all Indebtedness of the
Company under the New Credit Facility; (b) all other Indebtedness of the
Company, unless the instrument under which such Indebtedness of the Company is
Incurred expressly provides that such Indebtedness is not senior or superior in
right of payment to the Notes, and (c) all Obligations with respect to the
foregoing. Notwithstanding the foregoing, Senior Indebtedness shall not include
(a) to the extent that it may constitute Indebtedness, any Obligation for
Federal, state, local or other taxes; (b) any Indebtedness among or between the
Company and any Subsidiary of the Company or any Affiliate of the Company or any
of such Affiliate's Subsidiaries; (c) to the extent that it may constitute
Indebtedness, any Obligation in respect of any trade payable Incurred for the
purchase of goods or materials, or for services obtained, in the ordinary course
of business; (d) that portion of any Indebtedness that is Incurred in violation
of the Indenture; (e) Indebtedness evidenced by the Notes; (f) Indebtedness of
the Company that is expressly subordinate or junior in right of payment to any
other Indebtedness of the Company; (g) to the extent that it may constitute
Indebtedness, any obligation owing under leases (other than Capitalized Lease
Obligations) or management agreements; and (h) any obligation that by operation
of law is subordinate to any general unsecured obligations of the Company. No
Indebtedness shall be deemed to be subordinated to other Indebtedness solely
because such other Indebtedness is secured.
"SIGNIFICANT RESTRICTED SUBSIDIARY" means, at any date of determination, (a)
any Subsidiary of the Company that together with its Subsidiaries (i) for the
most recent fiscal year of the Company accounted for more than, 10.0% of the
consolidated revenues of the Company and its Subsidiaries or (ii) as of the end
of such fiscal year, owned more than 10.0% of the consolidated assets of the
Company and its Subsidiaries, all as set forth on the consolidated financial
statements of the Company and the Subsidiaries for such year prepared in
conformity with GAAP, and (b) any Subsidiary of the Company which, when
aggregated with all other Subsidiaries of the Company that are not otherwise
Significant Restricted Subsidiaries and as to which any event described in
clause (h) of "Events of Default" above has occurred, would constitute a
Significant Restricted Subsidiary under clause (a) of this definition.
"STATED MATURITY" means, when used with respect to any Note or any
installment of interest thereon, the date specified in such Note as the fixed
date on which the principal of such Note or such installment of interest is due
and payable.
"SUBORDINATED INDEBTEDNESS" means, with respect to the Company, any
Indebtedness of the Company which is expressly subordinated in right of payment
to the Notes.
"SUBSIDIARY" means, with respect to any Person, (a) any corporation of which
the outstanding Voting Equity Interests having at least a majority of the votes
entitled to be cast in the election of directors shall at the time be owned,
directly or indirectly, by such Person, or (b) any other Person of which at
least a majority of Voting Equity Interests are at the time, directly or
indirectly, owned by such first named Person.
85
"SURVIVING PERSON" means, with respect to any Person involved in or that
makes any Disposition, the Person formed by or surviving such Disposition or the
Person to which such Disposition is made.
"TRUSTS" means, collectively, The Michael Solomon 1994 Trust and The David
Solomon 1994 Trust created under the trust agreement, dated as of July 29, 1994,
known as The Russell M. and Doris E. Solomon 1994 Children's Trust, as amended.
"UNRESTRICTED SUBSIDIARY" means any Subsidiary of the Company designated as
such pursuant to the "Designation of Unrestricted Subsidiaries" covenant. Any
such designation may be revoked by a resolution of the Board of Directors of the
Company delivered to the Trustee, subject to the provisions of such covenant.
"UNUTILIZED NET CASH PROCEEDS" has the meaning set forth in the third
paragraph under "Certain Covenants--Disposition of Proceeds of Asset Sales"
above.
"VOTING EQUITY INTERESTS" means Equity Interests in a corporation or other
Person with voting power under ordinary circumstances entitling the holders
thereof to elect the Board of Directors or other governing body of such
corporation or Person.
"WEIGHTED AVERAGE LIFE TO MATURITY" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (a) the sum of the
products obtained by multiplying (i) the amount of each then remaining
installment, sinking fund, serial maturity or other required scheduled payment
of principal, including payment of final maturity, in respect thereof, by (ii)
the number of years (calculated to the nearest one-twelfth) that will elapse
between such date and the making of such payment, by (b) the then outstanding
aggregate principal amount of such Indebtedness.
"WHOLLY OWNED RESTRICTED SUBSIDIARY" means any Restricted Subsidiary of the
Company all of the outstanding Voting Equity Interests (other then directors'
qualifying shares) of which are owned, directly or indirectly, by the Company.
86
FEDERAL INCOME TAX CONSIDERATIONS
The following sets forth the material anticipated federal income tax
consequences expected to result to Holders from the Exchange Offer and from the
purchase, ownership and disposition of the New Notes. The description of the
federal income tax consequences set forth below is based upon the Internal
Revenue Code of 1986, as amended (the "Code"), and judicial decisions and
administrative interpretations thereunder, as of the date hereof, and such
authorities may be repealed, revoked, modified or otherwise interpreted or
applied so as to result in federal income tax consequences different from those
described below. There can be no assurance that the Internal Revenue Service
(the "IRS") will not challenge one or more of the tax consequences described
herein, and the Company has not obtained, nor does it intend to obtain, a ruling
from the IRS or an opinion of counsel with respect to the U.S. federal income
tax consequences of acquiring or holding New Notes. The description below
pertains only to U.S. Holders, except as described below under the caption
"Non-U.S. Holders." As used herein, U.S. Holders means (i) citizens or residents
(within the meaning of Section 7701(b) of the Code) of the United States, (ii)
corporations, partnerships or other entities created in or under the laws of the
United States or any political subdivision thereof, (iii) estates, the income of
which is subject to United States federal income taxation regardless of its
source, and (iv) in general, trusts subject to the primary supervision of a
court within the United States and the control of a United States person as
described in Section 7701(a)(30) of the Code.
This description does not purport to deal with all aspects of U.S. federal
income taxation that may be relevant to a particular Holder in light of the
Holder's circumstances (for example, persons subject to the alternative minimum
tax provisions of the Code). Also, it is not intended to be wholly applicable to
all categories of investors, some of which (such as dealers in securities,
banks, insurance companies, tax-exempt organizations, and persons holding New
Notes as part of a hedging or conversion transaction or straddle or persons
deemed to sell New Notes under the constructive sale provisions of the Code) may
be subject to special rules. The description below is premised upon the
assumption that the New Notes and Existing Notes constitute indebtedness for
U.S. federal income tax purposes, and that the Existing Notes and New Notes are
held (or would be held if acquired) as capital assets within the meaning of
Section 1221 of the Code. This description does not describe the tax
considerations applicable to subsequent purchasers. The description also does
not describe any aspect of state, local or foreign law, nor federal estate and
gift tax law.
EACH PROSPECTIVE HOLDER AND, SUBSEQUENT TO THE EXCHANGE OFFER, EACH HOLDER,
OF NEW NOTES IS STRONGLY URGED TO CONSULT ITS OWN TAX ADVISOR INCLUDING WITH
RESPECT TO ITS PARTICULAR TAX SITUATION THE TAX EFFECTS OF ANY STATE, LOCAL,
FOREIGN OR OTHER TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.
EXCHANGE OF NOTES
The exchange of Existing Notes for New Notes pursuant to the Exchange Offer
will not be a taxable exchange for U.S. federal income tax purposes.
Accordingly, a Holder will have the same adjusted issue price, adjusted basis
and holding period in the New Notes as it had in the Existing Notes immediately
before the exchange.
STATED INTEREST
The New Notes will be issued without original issue discount. Stated
interest on the Existing Notes and New Notes will be includable in the Holder's
income under such Holder's method of accounting.
BOND PREMIUM
Generally, if the New Notes are purchased, or if the Existing Notes were
purchased, for an amount in excess of the amount payable at the maturity date
(or a call date, if appropriate) of the New Notes, such
87
excess will constitute amortizable bond premium that the Holder may elect to
amortize under the constant interest method over the period from the date of
acquisition to the date of maturity (or until an earlier call date). If bond
premium is amortized, the amount required to be included in the Holder's income
each year with respect to interest on the Note will be reduced by the amount of
amortizable bond premium allocable to such year. An election to amortize bond
premium is available only if the New Notes are held as capital assets. This
election is revocable only with the consent of the IRS and applies to all
obligations owned or subsequently acquired by the Holder. To the extent the
excess is deducted as amortizable bond premium, the Holder's adjusted tax basis
in the New Notes will be reduced.
MARKET DISCOUNT ON THE NEW NOTES
To the extent a Holder had market discount with respect to an Existing Note,
the Holder generally will have market discount with respect to a New Note. Any
principal payment or gain realized by a Holder on disposition or retirement of a
New Note will be treated as ordinary income to the extent that there is accrued
market discount on the New Note. Unless a Holder elects to accrue under a
constant-interest method, accrued market discount is the total market discount
multiplied by a fraction, the numerator of which is the number of days the
Holder has held the obligation and the denominator of which is the number of
days from the date the Holder acquired the obligation under its maturity. A
Holder may be required to defer a portion of its interest deductions for the
taxable year attributable to any indebtedness incurred or continued to purchase
or carry a New Note purchased with market discount. Any such deferred interest
expense would not exceed the market discount that accrues during such taxable
year and is, in general, allowed as a deduction not later than the year in which
such market discount is includable in income. If the Holder elects to include
market discount in income currently as it accrues on all market discount
instruments acquired by the Holder in that taxable year or thereafter, the
interest deferral rule described above will not apply.
SALE, EXCHANGE OR RETIREMENT OF THE NEW NOTES
Upon the sale, exchange or retirement of a New Note, the Holder generally
will recognize gain or loss equal to the difference between the amount realized
on the sale, exchange or retirement (which does not include any amount
attributable to accrued but unpaid interest) and the Holder's adjusted tax basis
in the New Note. A Holder's adjusted tax basis in a New Note will generally
equal the Holder's adjusted basis for the Existing Note exchanged therefor
increased by any original issue discount or market discount previously included
in income by such Holder with respect to such New Note and decreased by any
payments received thereon that are not qualified stated interest and the amount
of any amortizable bond premium applied to reduce interest on the New Note.
Gain or loss realized on the sale, exchange or retirement of a New Note will
be capital (subject to the market discount rules, discussed above), and will be
long-term if at the time of sale, exchange or retirement the New Note has been
held or deemed held for more than one year. Under recently enacted federal
legislation which is retroactively effective as of January 1, 1998, gain on most
capital assets held by an individual more than one year is subject to a maximum
rate of tax of 20%. The deductibility of capital losses is subject to
limitations.
NON-U.S. HOLDERS
The following sets forth the material anticipated U.S. federal income and
estate tax consequences expected to result to Non-U.S. Holders from the
ownership and disposition of New Notes by Non-U.S. Holders. As used herein, a
Non-U.S. Holder means any Holder other than a U.S. Holder.
88
INTEREST
Interest paid by the Company to a Non-U.S. Holder generally will not be
subject to United States federal income or withholding tax if such interest is
not effectively connected with the conduct of a trade or business within the
United States by such Non-U.S. Holder and pursuant to the "portfolio interest
exception" such Non-U.S. Holder: (i) does not actually or constructively own 10%
or more of the total combined voting power of all classes of stock of the
Company; (ii) is not a controlled foreign corporation with respect to which the
Company is a "related person" within the meaning of the code; and (iii)
certifies, under penalties of perjury, that such Holder is not a United States
person and provides such Holder's name and address. Recently adopted Treasury
Regulations that will be effective beginning January 1, 2000 (the "New
Regulations") would modify the foregoing certification requirement in certain
respects. Prospective holders are urged to consult their own tax advisors as to
the certification and other requirements under the New Regulations.
GAIN ON DISPOSITION
A Non-U.S. Holder will generally not be subject to United States federal
income tax on gain recognized on a sale, redemption or other disposition of a
New Note unless: (i) the gain is effectively connected with the conduct of a
trade or business within the United States by the Non-U.S. Holder; or (ii) in
the case of a Non-U.S. Holder who is a nonresident alien individual and holds
the Note as a capital asset, such Holder is present in the United States for 183
or more days in the taxable year and certain other requirements are met.
FEDERAL ESTATE TAXES
If interest on the New Notes is exempt from withholding of United States
federal income tax under the portfolio interest exception described above, the
New Notes will generally not be included in the estate of a deceased Non-U.S.
Holder for United States federal estate tax purposes.
BACKUP WITHHOLDING
A Holder of the New Notes may be subject to backup withholding at a rate of
31% with respect to interest paid or accrued on, and gross proceeds of a sale
of, the New Notes unless (i) such Holder is a corporation or comes within
certain other exempt categories and, when required, demonstrates this fact or
(ii) provides a correct taxpayer identification number, certifies as to no loss
of exemption from backup withholding and otherwise complies with applicable
requirements of the backup withholding rules. A Holder of the New Notes who does
not provide such Holder's correct taxpayer identification number may be subject
to penalties imposed by the IRS.
In general, payment of the proceeds from the sale of Notes to or through a
United States office of a broker is subject to both United States backup
withholding and information reporting unless the Holder or beneficial owner
certifies its non-United States status under penalties of perjury or otherwise
establishes an exemption. United States information reporting and backup
withholding generally will not apply to a payment made outside the United States
of the proceeds of a sale of Notes through an office outside the United States
of a non-United States broker. However, United States information reporting
requirements (but not backup withholding) will apply to a payment made outside
the United States of the proceeds of a sale of Notes through an office outside
the United States of a broker that is a United States person, that derives 50%
or more of its gross income for a specified three-year period from the conduct
of a trade or business in the United States, or that is a "controlled foreign
corporation" as to the United States, unless the broker has documentary evidence
in its files that the Holder or beneficial owner is a non-United States person
or the Holder or beneficial owner otherwise establishes an exemption.
The New Regulations would modify the application of the information
reporting requirements and the backup withholding tax to Non-U.S. Holders
beginning January 1, 2000. Amounts withheld under the
89
backup withholding rules may be credited against a Holder's tax liability, and a
Holder may obtain a refund of any excess amounts withheld under the backup
withholding rules by filing the appropriate claim for refund with the IRS.
THE FOREGOING DESCRIPTION OF FEDERAL INCOME TAX CONSEQUENCES DOES NOT
CONSTITUTE TAX ADVICE, AND IS NOT BASED UPON ANY OPINION OF COUNSEL.
ACCORDINGLY, EACH HOLDER OF THE EXISTING NOTES SHOULD CONSULT SUCH HOLDER'S OWN
TAX ADVISOR WITH RESPECT TO THE TAX CONSEQUENCES TO SUCH HOLDER OF THE
ACQUISITION, OWNERSHIP AND DISPOSITION OF THE NEW NOTES.
PLAN OF DISTRIBUTION
This Prospectus, as it may be amended or supplemented from time to time, may
be used by Exchanging Dealers in connection with resales of New Notes received
in exchange for Existing Notes where such Existing Notes were acquired as a
result of market-making activities or other trading activities. Each Exchanging
Dealer that receives New Notes for its own account pursuant to the Exchange
Offer must acknowledge that it will deliver a prospectus in connection with any
resale of such New Notes. The Company has agreed that under certain
circumstances, for a period of up to 180 days after the Expiration Date, it will
make this Prospectus, as amended or supplemented, available to any Exchanging
Dealer for use in connection with any such resale. In addition, up through and
including December 15, 1998 (90 days after this Prospectus was sent to Existing
Holders), all dealers effecting transactions in the New Notes, whether or not
participating in the Exchange Offer, may be required to deliver a prospectus in
connection with such transaction.
The Company will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the New Notes or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer or the purchasers of any such New Notes. Any Exchanging Dealer
that acquired Existing Notes as a result of market making activities or other
trading activities and who resells New Notes that were received by it pursuant
to the Exchange Offer and any broker or dealer that participates in a
distribution of such New Notes may be deemed to be an "underwriter" within the
meaning of the Securities Act and any profit on any such resale of New Notes and
any commission or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that, by acknowledging that it will deliver and by delivering a
prospectus, an Exchanging Dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of up to 180 days following effectiveness of the Exchange Offer
Registration Statement, and subject to certain conditions, the Company will
promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such documents
in the Letter of Transmittal. The Company has agreed to pay all required
expenses incident to the Exchange Offer (including the expenses of one counsel
for the Existing Holders) other than commissions or concessions of any
broker-dealers and will indemnify the Existing Holders (including any
broker-dealers) against certain liabilities, including liabilities under the
Securities Act.
LEGAL MATTERS
The validity of the New Notes offered hereby will be passed upon for the
Company by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo
Alto, California.
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EXPERTS
The consolidated balance sheets as of July 31, 1996 and 1997 and the
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended July 31, 1997 of MTS, INCORPORATED and
Subsidiaries have been included in this Prospectus in reliance upon the report
of PricewaterhouseCoopers LLP ("PwC") (formerly Coopers & Lybrand L.L.P.),
independent accountants, appearing elsewhere herein, and upon the authority of
said firm as experts in accounting and auditing.
Effective July 28, 1998 the Company engaged Arthur Andersen LLP ("Arthur
Andersen") as the Company's principal accountants to audit the Company's
financial statements on a prospective basis. PwC served as the Company's
independent auditors from 1989 until the Company's dismissal of PwC effective
July 28, 1998, which dismissal, and the engagement of Arthur Andersen, were
approved by the Company's Board of Directors. PwC performed audits of the
Company's consolidated financial statements for the two years ended July 31,
1997. The reports of PwC on the consolidated financial statements of the Company
for such periods did not contain an adverse opinion or disclaimer of opinion and
were not qualified or modified as to uncertainty, audit scope or accounting
principles.
Except as discussed below, in connection with its audits of the Company's
financial statements for the two most recent fiscal years and through July 28,
1998, there have been no disagreements between the Company and PwC on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements, if not resolved to the
satisfaction of PwC, would have caused PwC to make reference thereto in its
report on the Company's financial statements for such years.
In connection with the preparation of the Company's July 31, 1997
consolidated financial statements, the Company classified certain bank loans
aggregating $151.4 million as noncurrent liabilities pursuant to its
interpretation of the provisions of Statement of Financial Accounting Standards
No. 6, CLASSIFICATION OF SHORT-TERM OBLIGATIONS EXPECTED TO BE REFINANCED. In
March 1998, PwC advised the Company that it believed that the classification of
the bank loans described above as noncurrent liabilities was incorrect. The
Company agreed to reclassify the bank loans as current liabilities. The
Company's Board of Directors did not discuss the subject matter of such
disagreement with PwC. The Company has authorized PwC to respond fully to any
inquiries which Arthur Andersen might have concerning the subject matter of such
disagreement.
ADDITIONAL INFORMATION
The Company has filed with the Commission the Exchange Offer Registration
Statement on Form S-4 pursuant to the Securities Act, and the rules and
regulations promulgated thereunder, covering the New Notes being offered hereby.
This Prospectus does not contain all the information set forth in the Exchange
Offer Registration Statement. For further information with respect to the
Company and the Exchange Offer, reference is made to the Exchange Offer
Registration Statement. Statements made in this Prospectus as to the contents of
any contract, agreement or other document referred to are necessarily
incomplete. With respect to each such contract, agreement or other document
filed as an exhibit to the Exchange Offer Registration Statement, reference is
made to the exhibit for a more complete description of the document or matter
involved, and each such statement shall be deemed qualified in its entirety by
such reference.
As a result of the effectiveness of the Exchange Offer Registration
Statement, the Company is now subject to the informational requirements of
Section 13 of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), by virtue of Section 15(d) of the Exchange Act, and in accordance
therewith will file reports and other information as required with the
Commission as long as such reporting is required under Section 15(d) of the
Exchange Act. Periodic reports and other information filed by the Company can be
inspected and copied at the public reference facilities of the Commission's
91
principal office at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024,
Washington, D.C. 20549, and the regional offices of the Commission at Seven
World Trade Center, 13th Floor, New York, New York 10048 and 500 West Madison
Street, 14th Floor, Chicago, Illinois 60661. Copies of such material can be
obtained from the public reference facilities of the Commission at Judiciary
Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, at prescribed
rates. In addition, the Commission maintains a website (http://www.sec.gov) that
also contains certain reports and other information filed by the Company.
In addition, the Company has agreed that, whether or not it is required to
do so by the rules and regulations of the Commission, for so long as any Notes
remain outstanding, it will furnish to the Holders and, to the extent permitted
by applicable law or regulation, file with the Commission all annual reports,
quarterly reports and other documents which the Company would have been required
to file pursuant to Section 13(a) or 15(d) of the Exchange Act.
92
MTS, INCORPORATED AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
---------
Report of Independent Accountants.......................................................................... F-2
Consolidated Balance Sheets as of July 31, 1996, and 1997, and April 30, 1998 (unaudited).................. F-3
Consolidated Statements of Income for the fiscal years ended July 31, 1995, 1996, and 1997, and for the
nine months ended April 30, 1997 and 1998 (unaudited).................................................... F-4
Consolidated Statements of Changes in Shareholders' Equity for the fiscal years ended July 31, 1995, 1996,
and 1997, and for the nine months ended April 30, 1998 (unaudited)....................................... F-5
Consolidated Statements of Cash Flows for the fiscal years ended July 31, 1995, 1996, and 1997, and for the
nine months ended April 30, 1997 and 1998 (unaudited).................................................... F-6
Notes to Consolidated Financial Statements................................................................. F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of MTS, INCORPORATED
and Subsidiaries
West Sacramento, California
We have audited the accompanying consolidated balance sheets of MTS,
INCORPORATED and Subsidiaries as of July 31, 1996 and 1997, and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended July 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MTS,
INCORPORATED and Subsidiaries as of July 31, 1996 and 1997, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended July 31, 1997, in conformity with generally accepted accounting
principles.
/s/ COOPERS & LYBRAND L.L.P.
Sacramento, California
October 29, 1997, except for
Notes 2 and 3 as to which the
dates are April 20, 1998 and
March 20, 1998, respectively
F-2
MTS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
JULY 31,
------------------------
1996 1997
----------- ----------- APRIL 30,
1998
-----------
(UNAUDITED)
ASSETS
Current Assets:
Cash and cash equivalents............................................... $ 8,253 $ 6,607 $ 10,685
Receivables, net........................................................ 22,248 20,698 20,864
Merchandise inventories................................................. 273,726 282,015 265,531
Prepaid expenses........................................................ 12,796 9,085 6,344
Deferred tax assets..................................................... -- 425 6,863
----------- ----------- -----------
Total current assets................................................ 317,023 318,830 310,287
Fixed assets, net......................................................... 188,631 190,357 177,763
Deferred tax assets....................................................... -- 7,566 9,265
Other assets.............................................................. 23,116 27,825 34,325
----------- ----------- -----------
Total assets........................................................ $ 528,770 $ 544,578 $ 531,640
----------- ----------- -----------
----------- ----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt.................................... $ 8,671 $ 163,171 $ 1,892
Accounts payable........................................................ 148,771 163,956 130,754
Accrued liabilities..................................................... 29,588 28,876 29,381
Income taxes payable.................................................... 3,029 191 --
Deferred revenue, current portion....................................... 2,229 2,877 3,118
Deferred tax liabilities................................................ 4,068 -- --
----------- ----------- -----------
Total current liabilities........................................... 196,356 359,071 165,145
Long-term liabilities:
Long-term debt, less current maturities................................. 194,099 48,096 239,169
Deferred revenue, less current portion.................................. 196 184 174
----------- ----------- -----------
Total liabilities................................................... 390,651 407,351 404,488
----------- ----------- -----------
Minority equity in subsidiaries........................................... 2,972 3,196 --
----------- ----------- -----------
Commitments and contingencies (Notes 10 and 15)
Shareholders' equity:
Common stock:
Class A, no par value; 5,000,000 shares authorized; 500 shares issued
and outstanding at July 31, 1996 and 1997; none at April 30, 1998... 3 3 --
Class B, no par value; 10,000,000 shares authorized; 500 shares issued
and outstanding at July 31, 1996 and 1997; 1,000 issued and
outstanding at April 30, 1998....................................... 3 3 6
Additional paid-in capital.............................................. 780 780 780
Retained earnings....................................................... 134,361 133,245 126,366
----------- ----------- -----------
Total shareholders' equity.......................................... 135,147 134,031 127,152
----------- ----------- -----------
Total liabilities and shareholders' equity.......................... $ 528,770 $ 544,578 $ 531,640
----------- ----------- -----------
----------- ----------- -----------
The accompanying notes are an integral part of the financial statements.
F-3
MTS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
FOR THE NINE
MONTHS ENDED
FOR THE YEAR ENDED JULY 31, APRIL 30,
----------------------------------------- ------------------------
1995 1996 1997
------------- ------------- -----------
1997 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
Net revenue............................... $ 950,561 $ 1,001,035 $ 991,810 $ 752,523 $ 771,403
Cost of sales............................. 640,587 676,155 669,279 508,421 524,918
------------- ------------- ----------- ----------- -----------
Gross profit.......................... 309,974 324,880 322,531 244,102 246,485
Selling, general and administrative
expenses................................ 255,140 270,353 267,620 202,099 204,776
Depreciation and amortization............. 22,820 20,938 26,365 17,276 17,602
------------- ------------- ----------- ----------- -----------
Income from operations................ 32,014 33,589 28,546 24,727 24,107
Other income and (expenses):
Interest expense........................ (11,467) (14,905) (14,298) (11,464) (10,422)
Foreign currency translation gain
(loss)................................ 5,622 (1,425) (3,552) (538) (766)
Other income and (expenses)............. 56 (62) (1,154) (795) 108
------------- ------------- ----------- ----------- -----------
Income before taxes, extraordinary
item and minority interest.......... 26,225 17,197 9,542 11,930 13,027
Provision for income taxes................ 10,920 7,013 4,543 5,326 5,447
------------- ------------- ----------- ----------- -----------
Income before extraordinary item and
minority interest................... 15,305 10,184 4,999 6,604 7,580
Minority interest in net income of
subsidiaries............................ 192 149 224 115 139
------------- ------------- ----------- ----------- -----------
Income before extraordinary item...... 15,113 10,035 4,775 6,489 7,441
Extraordinary loss on extinguishment of
debt, net of income taxes of $824....... -- -- 1,236 1,236 --
------------- ------------- ----------- ----------- -----------
Net income............................ $ 15,113 $ 10,035 $ 3,539 $ 5,253 $ 7,441
------------- ------------- ----------- ----------- -----------
------------- ------------- ----------- ----------- -----------
Basic and diluted earnings per share:
On income before extraordinary item..... $ 15,113.47 $ 10,035.73 $ 4,774.83 $ 6,489.41 $ 7,440.62
------------- ------------- ----------- ----------- -----------
------------- ------------- ----------- ----------- -----------
On net income........................... $ 15,113.47 $ 10,035.73 $ 3,539.31 $ 5,253.89 $ 7,440.62
------------- ------------- ----------- ----------- -----------
------------- ------------- ----------- ----------- -----------
The accompanying notes are an integral part of the financial statements.
F-4
MTS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
COMMON STOCK
----------------------------------------------------------------------------
COMMON STOCK SERIES A SERIES B
------------------------ ------------------------ ------------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
----------- ----------- ----------- ----------- ----------- -----------
Balance, August 1, 1994............................ 500 $ 6 -- $ -- -- $ --
Reissuance of common stock....................... (500) (6) 500 6 500 --
Stock dividend accounted for as a stock split.... -- -- -- (3) -- 3
Trust distributions.............................. -- -- -- -- -- --
Net income....................................... -- -- -- -- -- --
Tranlation adjustment, net of income taxes....... -- -- -- -- -- --
--- ----------- --- ----------- ----- -----------
Balance, July 31, 1995............................. -- -- 500 3 500 3
Trust distributions.............................. -- -- -- -- -- --
Net income....................................... -- -- -- -- -- --
Translation adjustment, net of income taxes...... -- -- -- -- -- --
--- ----------- --- ----------- ----- -----------
Balance, July 31, 1996............................. -- -- 500 3 500 3
Trust distributions.............................. -- -- -- -- -- --
Net income....................................... -- -- -- -- -- --
Translation adjustment, net of income taxes...... -- -- -- -- -- --
--- ----------- --- ----------- ----- -----------
Balance, July 31, 1997............................. -- -- 500 3 500 3
Trust distribution (unaudited)................... -- -- -- -- -- --
Net income (unaudited)........................... -- -- -- -- -- --
Translation adjustment, net of income taxes
(unaudited).................................... -- -- -- -- -- --
Conversion of Class A to Class B common shares as
part of Reorganization (unaudited)............. -- -- (500) (3) 500 3
--- ----------- --- ----------- ----- -----------
Balance, April 30, 1998 (unaudited)................ -- $ -- -- $ -- 1,000 $ 6
--- ----------- --- ----------- ----- -----------
--- ----------- --- ----------- ----- -----------
RETAINED EARNINGS
-------------------------------------
BEFORE AFTER
ADDITIONAL CUMULATIVE CUMULATIVE CUMULATIVE
PAID-IN TRANSLATION TRANSLATION TRANSLATION
CAPITAL ADJUSTMENT ADJUSTMENT ADJUSTMENT TOTAL
------------- ----------- ----------- ----------- ---------
Balance, August 1, 1994............................ $ 780 $ 122,209 $ (10,923) $ 111,286 $ 112,072
Reissuance of common stock....................... -- -- -- -- --
Stock dividend accounted for as a stock split.... -- -- -- -- --
Trust distributions.............................. -- (175) -- (175) (175)
Net income....................................... -- 15,113 -- 15,113 15,113
Tranlation adjustment, net of income taxes....... -- -- 454 454 454
----- ----------- ----------- ----------- ---------
Balance, July 31, 1995............................. 780 137,147 (10,469) 126,678 127,464
Trust distributions.............................. -- (357) -- (357) (357)
Net income....................................... -- 10,035 -- 10,035 10,035
Translation adjustment, net of income taxes...... -- -- (1,995) (1,995) (1,995)
----- ----------- ----------- ----------- ---------
Balance, July 31, 1996............................. 780 146,825 (12,464) 134,361 135,147
Trust distributions.............................. -- (126) -- (126) (126)
Net income....................................... -- 3,539 -- 3,539 3,539
Translation adjustment, net of income taxes...... -- -- (4,529) (4,529) (4,529)
----- ----------- ----------- ----------- ---------
Balance, July 31, 1997............................. 780 150,238 (16,993) 133,245 134,031
Trust distribution (unaudited)................... -- (10,099) -- (10,099) (10,099)
Net income (unaudited)........................... -- 7,441 -- 7,441 7,441
Translation adjustment, net of income taxes
(unaudited).................................... -- -- (4,221) (4,221) (4,221)
Conversion of Class A to Class B common shares as
part of Reorganization (unaudited)............. -- -- -- -- --
----- ----------- ----------- ----------- ---------
Balance, April 30, 1998 (unaudited)................ $ 780 $ 147,580 $ (21,214) $ 126,366 $ 127,152
----- ----------- ----------- ----------- ---------
----- ----------- ----------- ----------- ---------
The accompanying notes are an integral part of the financial statements.
F-5
MTS, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED JULY 31,
----------------------------------
1995 1996 1997
--------- ------------ --------- FOR THE NINE
MONTHS ENDED
APRIL 30,
------------------------
1997 1998
----------- -----------
(UNAUDITED) (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................... $ 15,113 $ 10,035 $ 3,539 $ 5,253 $ 7,441
Adjustments to reconcile net income to net cash
provided by operating actvities:
Depreciation and amortization................. 28,380 26,784 32,127 21,651 21,229
Provision (recovery) for losses on accounts
receivable.................................. 145 (95) 23 (19) (17)
Loss on disposal of depreciable assets........ 3,621 2,432 2,678 2,150 1,514
Exchange (gain) loss.......................... (3,008) 763 1,902 1,983 2,831
Other non-cash expense........................ 411 249 834 283 357
Provision for deferred taxes.................. 5,280 789 360 820 (1,415)
Minority interests in net income of
subsidiaries................................ 192 149 223 114 140
Extraordinary loss on extinguishment of
debt........................................ -- -- 1,236 1,236 --
(Decrease) increase in cash resulting from
changes in:
Accounts receivable......................... (1,233) 3,960 1,551 (241) (149)
Inventories................................. (52,634) (26,624) (8,290) (6,097) 16,484
Prepaid expenses............................ (8,451) 287 3,711 3,424 2,654
Accounts payable............................ 11,141 19,260 15,183 (2,490) (33,202)
Accrued liabilities......................... 1,663 10,140 (3,549) (588) (1,228)
Deferred revenue............................ 169 77 635 567 (231)
--------- ------------ --------- ----------- -----------
Net cash provided by operating
activities.............................. 789 48,206 52,163 28,046 16,408
--------- ------------ --------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets..................... (50,163) (48,730) (45,012) (27,954) (16,787)
Acquisition of investments and artwork.......... (716) (7,025) (5,467) (3,737) (5,520)
Increase in deposits............................ (933) (835) (1,701) (1,610) (1,491)
Refund of deposits.............................. 2,369 791 121 37 1,464
Increase in intangibles......................... (922) (3,080) (681) (475) (5,740)
--------- ------------ --------- ----------- -----------
Net cash used in investing activities..... (50,365) (58,879) (52,740) (33,739) (28,074)
--------- ------------ --------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loans to shareholders, officers and employees... (657) (345) (223) (247) (60)
Proceeds from employee loan repayments.......... 218 520 572 368 81
Trust distributions............................. (175) (357) (126) (127) --
Principal payments under long-term financing
agreements.................................... (45,651) (32,523) (93,672) (97,939) (207,060)
Proceeds from issuance of long-term financing
agreements.................................... 143,082 38,941 102,169 125,144 231,400
Net repayments under line-of-credit
aggrements.................................... (40,000) -- -- -- --
--------- ------------ --------- ----------- -----------
Net cash provided by financing
activities.............................. 56,817 6,236 8,720 27,199 24,361
--------- ------------ --------- ----------- -----------
Effect of exchange rate changes on cash........... (3,662) (7,289) (9,789) (16,689) (8,617)
--------- ------------ --------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents............................. 3,579 (11,726) (1,646) 4,817 4,078
Cash and cash equivalents, beginning of period.... 16,400 19,979 8,253 8,253 6,607
--------- ------------ --------- ----------- -----------
Cash and cash equivalents, end of period.......... $ 19,979 $ 8,253 $ 6,607 $ 13,070 $ 10,685
--------- ------------ --------- ----------- -----------
--------- ------------ --------- ----------- -----------
The accompanying notes are an integral part of the financial statements.
F-6
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION POLICY--The consolidated financial statements include the
accounts of MTS, INCORPORATED and its majority and wholly owned subsidiaries
(Company). As the result of a reorganization in April 1998 of the retail
business assets of the shareholder and his family, the financial statements
include, on a retroactive basis, the accounts of businesses previously held by
two trusts for the benefit of the shareholder's sons (Trusts) as well as the
accounts of two S corporations owned by the shareholder's sons (S Corporations)
(Note 2).
The Company has 50% investments in certain foreign joint ventures that are
accounted for using the equity method. In September 1995, the Company acquired
the stock of two joint ventures from its former partners; consequently, income
or loss of those operations is included in the consolidated statement of income
from the date that the Company acquired a controlling interest.
All material intercompany balances and transactions have been eliminated in
consolidation.
GENERAL--The Company operates retail stores under the name Tower offering a
diversified line of recorded music products and other complementary products
throughout the United States, Japan, the United Kingdom and other parts of the
world.
INTERIM RESULTS (UNAUDITED)--The accompanying balance sheet as of April 30,
1998, and the statements of income, changes in stockholders' equity and cash
flows for the nine-month periods ended April 30, 1997 and 1998, are unaudited.
In the opinion of management, these statements have been prepared on the same
basis as the audited financial statements and include all adjustments,
consisting of only normal recurring adjustments, necessary for the fair
presentation of the results of the interim periods. The data disclosed in these
notes to the financial statements for those interim periods are also unaudited.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid temporary
cash investments with maturities of three months or less when purchased to be
cash equivalents for purposes of the statement of cash flows. The Company's bank
deposits generally exceed the federally insured limit.
INVENTORIES--Inventories are stated at the lower of cost or market. Cost is
determined principally by the first-in, first-out method. The Company does not
provide an allowance for inventory markdowns, due to music industry return
policies which generally provide for full recovery of cost upon return.
PROPERTY AND EQUIPMENT--Property and equipment are carried at cost.
Depreciation is computed using the straight-line method. Depreciation is
computed on all fixed assets with the exception of land. Buildings are
depreciated over 40 years, leasehold improvements over an average of 15 years,
store fixtures over 7 to 10 years, and equipment and vehicles over 5 years.
Leasehold improvements are amortized using the straight-line method over the
shorter of their estimated useful lives or the lease term. When assets are
retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts and any resulting gain or loss is reflected in
income for the period. The cost of maintenance and repairs is charged to income
as incurred; significant renewals and betterments are capitalized.
Amortization of video rental cassettes is calculated based on a straight
line method over three years. When the popularity of renting the new release
declines (usually after approximately six months)
F-7
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
redundant copies are transferred from rental stock to merchandise inventories
for sale to customers at net realizable value. A write down to net realizable
value is recorded in cost of sales at the time of the transfer from rental to
held-for-sale classification.
STORE PREOPENING COSTS--Costs of a noncapital nature incurred prior to
opening of new stores are expensed as incurred.
INTANGIBLES--Intangibles primarily represent the excess of cost over the
fair value of businesses acquired and debt issuance costs. The Company amortizes
goodwill using the straight-line method over 40 years. Debt issuance costs are
amortized over the term of the related debt using the effective interest rate
method.
INCOME TAXES--The Company accounts for income taxes under the liability
method. Deferred taxes are recorded based on the difference between the
financial statement and tax basis of assets and liabilities. A valuation
allowance would be established to reduce deferred tax assets if it is more
likely than not that all, or a portion, of the deferred tax asset will not be
realized. No allowance against deferred tax assets was provided at July 31, 1997
or April 30, 1998.
EARNINGS PER SHARE--Effective January 31, 1998, the Company adopted the
provisions of SFAS No. 128, EARNINGS PER SHARE, which was effective for
accounting periods ending after December 15, 1997. SFAS No. 128 changed the
method of calculating earnings per share and requires a dual presentation of
basic and diluted earnings per share. In accordance with the provisions of SFAS
No. 128, earnings per share information for all periods presented have been
stated under the methodology and disclosures specified in SFAS No. 128.
REVENUE RECOGNITION--The Company's revenue is primarily from retail sales
comprised of recorded music (including compact discs and audio cassettes), video
sales (including recorded video cassettes, laser discs and DVD) and other
complementary products (including books, magazines, blank tapes, software titles
and accessories) through the Company's stores and are recognized at the point of
the retail transaction. Reductions of revenues for returns by customers are
generally provided at the point of the return due to infrequency and occurrence
within short intervals of the sale.
TRANSLATION OF FOREIGN CURRENCY--The value of the U.S. dollar rises and
falls day-to-day on foreign currency exchanges. Since the Company does business
in several foreign countries, these fluctuations affect the Company's financial
position and results of operations. In accordance with SFAS No. 52, FOREIGN
CURRENCY TRANSLATION, all foreign assets and liabilities have been translated at
the exchange rates prevailing at the respective balance sheet dates, and all
income statement items have been translated using the weighted average exchange
rates during the respective years. The net gain or loss resulting from
translation upon consolidation into the combined financial statements is
reported as a separate component of retained earnings. Some transactions of the
Company and its foreign subsidiaries are made in currencies different from their
own. Translation gains and losses from these transactions are included in income
as they occur.
RISK MANAGEMENT INSTRUMENTS--The Company enters into foreign exchange
contracts as a hedge against variations in exchange rates on accounts and notes
payable due in foreign currency.
F-8
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Market value gains and losses related to foreign exchange contracts are
recognized and offset foreign exchange gains and losses on foreign accounts and
notes payable. Counterparties to risk management instruments are major financial
institutions. Credit loss from counterparty nonperformance is not anticipated.
ADVERTISING EXPENSE--Advertising expenses are recorded as an expense when
incurred. Cooperative advertising rebates and supplier promotional and in-store
advertising reimbursements earned are recognized as reductions to advertising
expense in the period the advertisements are run or the merchandising programs
are provided. Certain other rebates from media vendors are also credited to
advertising expense in the period the related advertising expenses are incurred.
Such rebates and reimbursements are in consideration for ad production and
placement activities performed by the Company, and are negotiated under
contractual agreements on a case-by-case basis. Net advertising and marketing
expense (revenue) was $7,965,000, $3,306,000 and ($1,469,000) for the years
ended July 31, 1995, 1996 and 1997, respectively and ($1,300,000) and
($1,345,000) for the nine-month periods ended April 30, 1997 and 1998.
ACCOUNTING ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
GIFT CERTIFICATES--The Company offers gift certificates for sale. A deferred
income account is established for gift certificates issued. When gift
certificates are redeemed at the store level, the deferred income account is
charged and revenue is credited.
NEW ACCOUNTING PRONOUNCEMENTS--Statement of Financial Accounting Standards
(SFAS) No. 130, REPORTING COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURE
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION, were issued in June
1997. The Company will adopt both of the statements on their effective date,
which will be in the Company's fiscal year ending July 31, 1999.
SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income is a measure of all changes in the equity of the Company as a result of
recognized transactions and other economic events of the period other than
transactions with shareholders in their capacity as shareholders. Had the
provisions of SFAS No. 130 been applied for the years ended July 31, 1995, 1996
and 1997, comprehensive income would have consisted primarily of net income and
foreign currency translation adjustments.
SFAS No. 131 requires that the Company report financial and descriptive
information about its reportable operating segments using the "management
approach" model. Under the management approach model, segments are defined based
on the way the Company's management internally evaluates segment performance and
decides how to allocate resources to segments. The Company is in the process of
evaluating the impact of this pronouncement on its segment disclosures.
F-9
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESTATEMENT AND RECLASSIFICATIONS--The unaudited consolidated financial
statements as of and for the nine-month period ended April 30, 1998 have been
restated for reductions to consolidated net income of approximately $1,254,000
primarily due to adjustments arising from the true-up of the perpetual inventory
to agree with the physical inventory of the Company's Japanese subsidiary.
Certain reclassifications have been made to the consolidated financial
statements for the years ended July 31, 1995 and 1997 to conform with the
Company's 1998 classification policies. These reclassifications had no effect on
shareholders' equity or net income.
NOTE 2--REORGANIZATION
In April 1998, the Company consummated certain transactions designed to
consolidate substantially all of the Tower business operations into the Company
(such transactions collectively, the "Reorganization") as a result of which the
Company became a wholly owned subsidiary of TOWER RECORDS, INCORPORATED
(Parent). The Company also, prior to the Reorganization, transferred certain
assets to the Trusts in April 1998.
The Reorganization included an exchange by the Company's shareholders of
their common shares in the Company for a controlling equity interest in the
Parent. As part of the Reorganization, two irrevocable trusts established by the
Company's principal shareholder for the benefit of his sons (the Trusts) and the
shareholders of two S corporations (the S Corporations), contributed certain
assets, liabilities and equity ownership interests in businesses to the Parent
in exchange for the remaining equity interest in the Parent. The assets,
liabilities and businesses contributed by the Trusts and the shareholders of the
S Corporations consist of one Tower store, land used in the Tower business,
trademark rights to the Tower name in Japan and all royalties accrued in
connection therewith on and after February 1, 1998, a recorded music wholesale
operation, intercompany receivables and payables, bank debt and the cash
surrender value as of April 1998 (see Note 6) of certain second-to-die split
value life insurance policies on the lives of the Parent's principal shareholder
and his wife. The Parent then contributed to the Company the assets and
liabilities it received from the Trusts and the shareholders of the S
corporations.
The Reorganization was a combination of businesses under common control and,
accordingly, has been accounted for in a manner similar to a
pooling-of-interests. Accordingly, the assets and liabilities the Company
received from the Parent in the Reorganization and the historical results of
operations of such business assets are included, on a retroactive basis, in the
Company's consolidated balance sheets and statements of income for all periods
presented at the previous accounting basis of the Trusts and shareholders of the
S corporations.
Also, it is the Company's intention that T.R. Services, a subsidiary of the
Company, will be eliminated by upstream merger of the subsidiary into the
Company. The Company recently reacquired all minority interests in certain
subsidiaries of MTS, INCORPORATED which the Company eliminated through upstream
mergers into the Company. The Company also eliminated Tower Domestic, Inc. and
Queen Anne Record Sales, subsidiaries of the Company, through upstream mergers
into the Company.
Prior to the Reorganization, the Company transferred to the Trusts certain
assets with a book value of $2,860,000 in exchange for inventory of the Trusts
with an equal book value (the "Prior Asset Exchange"). Although the Prior Asset
Exchange preceded the Reorganization, the Prior Asset Exchange
F-10
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 2--REORGANIZATION (CONTINUED)
and the Reorganization have been reflected for accounting purposes in the
consolidated financial statements as occurring in the same transaction. The
exchange of assets was accounted for at the historical cost basis of the Company
and the Trusts as a transfer between businesses under common control.
Accordingly, no gain or loss was recognized. The principal business purpose of
the Prior Asset Exchange was to transfer certain primarily non-income producing
assets of a personal nature out of the Company and into the Trusts.
In the Reorganization, the Trusts transferred to the Parent certain business
assets and liabilities, intercompany accounts, and the cash surrender value of
certain life insurance policies and retained their cash, certain receivables and
other assets and liabilities with an aggregate net book value of $10,099,000,
net of related deferred taxes. The principal asset retained is a noninterest
bearing trademark royalty receivable from the Company amounting to $12,891,000
offset by a related deferred tax liability of $5,801,000. Since the Company's
consolidated financial statements are inclusive of the Trusts' transactions
after retroactive restatement, the assets retained by the Trusts are reflected
as distributions of retained earnings on the date of the Reorganization. The
impact on the Company's income statements had the assets and liabilities
retained by the Trusts not been included in the historical financial statements
is immaterial.
In accordance with the Company's articles of incorporation, each outstanding
share of its Class A common stock automatically converted to one share of Class
B common stock upon exchange of the Company's common shares by the shareholders
for shares of the Parent as part of the Reorganization.
F-11
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 3--EARNINGS PER SHARE
A reconciliation of the numerators and denominators of the basic and diluted
earnings per share computations under SFAS No. 128 is as follows (in thousands,
except per share information):
FOR THE NINE MONTHS ENDED
FOR THE YEAR ENDED JULY 31, APRIL 30,
------------------------------------------ -------------------------
1995 1996 1997 1997 1998
------------- ------------- ------------ ------------ -----------
(UNAUDITED) (UNAUDITED)
Income available to common shareholders
before extraordinary item............. $ 15,113 $ 10,035 $ 4,775 $ 6,489 $ 7,441
Extraordinary item...................... -- -- (1,236) (1,236) --
------------- ------------- ------------ ------------ -----------
$ 15,113 $ 10,035 $ 3,539 $ 5,253 $ 7,441
------------- ------------- ------------ ------------ -----------
------------- ------------- ------------ ------------ -----------
Weighted average shares outstanding for
determination of:
Basic earnings per share.............. 1,000 1,000 1,000 1,000 1,000
------------- ------------- ------------ ------------ -----------
------------- ------------- ------------ ------------ -----------
Diluted earnings per share............ 1,000 1,000 1,000 1,000 1,000
------------- ------------- ------------ ------------ -----------
------------- ------------- ------------ ------------ -----------
Basic earnings per share:
On income before extraordinary item... $ 15,113.47 $ 10,035.73 $ 4,774.83 $ 6,489.41 $ 7,440.62
On extraordinary item................. -- -- (1,235.52) (1,235.52) --
------------- ------------- ------------ ------------ -----------
On net income......................... $ 15,113.47 $ 10,035.73 $ 3,539.31 $ 5,253.89 $ 7,440.62
------------- ------------- ------------ ------------ -----------
------------- ------------- ------------ ------------ -----------
Diluted earnings per share is the same as basic earnings per share since the
Company has a simple capital structure with only common shares outstanding.
F-12
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 4--RECEIVABLES
Receivables consist of (in thousands):
JULY 31,
-------------------- APRIL 30,
1996 1997 1998
--------- --------- ------------
(UNAUDITED)
Trade receivables, less allowance for doubtful accounts
of $448, $420 and $452................................. $ 15,387 $ 16,914 $ 16,274
Officers and employee receivables, including notes, less
allowance for doubtful accounts of $98, $103 and $78... 2,199 1,736 2,243
Notes receivable, shareholders and family members,
current portion........................................ 371 371 --
Other receivables........................................ 4,291 1,677 2,347
--------- --------- ------------
$ 22,248 $ 20,698 $ 20,864
--------- --------- ------------
--------- --------- ------------
The Company has receivables of approximately $5,011,000, $4,930,000 and
$5,510,000 from sales of product for resale and supplies to unconsolidated
foreign joint ventures at July 31, 1996 and 1997, and April 30, 1998
respectively.
NOTE 5--FIXED ASSETS
Fixed assets consist of (in thousands):
JULY 31,
------------------------ APRIL 30,
1996 1997 1998
----------- ----------- ------------
(UNAUDITED)
Land.................................................. $ 10,362 $ 9,876 $ 9,527
Buildings............................................. 19,355 19,708 19,049
Leasehold improvements................................ 137,913 134,876 138,198
Video rental cassettes................................ 20,538 20,241 19,245
Store fixtures........................................ 38,877 41,910 45,724
Equipment............................................. 98,341 115,982 113,775
Vehicles.............................................. 822 581 507
----------- ----------- ------------
326,208 343,174 346,025
Less: accumulated depreciation and amortization....... 137,577 152,817 168,262
----------- ----------- ------------
$ 188,631 $ 190,357 $ 177,763
----------- ----------- ------------
----------- ----------- ------------
The cost to build new store fixtures and improvements includes a portion of
the interest expense. Interest capitalized was $487,000, $135,000 and $192,000,
for the years ended July 31, 1995, 1996 and 1997 respectively, and $120,000 and
$106,000 for the nine-month periods ended April 30, 1997 and 1998, respectively.
F-13
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 5--FIXED ASSETS (CONTINUED)
Depreciation and amortization of fixed assets was $28,059,000, $26,330,000
and $31,479,000 for the years ended July 31, 1995, 1996 and 1997, respectively,
and $21,651,000 and $21,229,000 for the nine-month periods ended April 30, 1997
and 1998, respectively.
NOTE 6--OTHER ASSETS
Other assets consist of (in thousands):
JULY 31,
--------------------
1996 1997 APRIL 30, 1998
--------- --------- --------------
(UNAUDITED)
Notes receivable, shareholders and family members,
less current portion................................ $ 400 $ 785 $ --
Notes receivable, officers and employees, less current
portion............................................. 2,040 2,280 1,920
Investment in foreign joint ventures.................. 1,021 1,962 3,197
Securities and artwork................................ 736 994 2
Cash surrender value of officers' life insurance...... 5,554 8,956 11,776
Deposits.............................................. 6,714 7,298 6,818
Goodwill, debt issuance costs and other intangible
assets, net of accumulated amortization of $1,655,
$3,336 and $4,176................................... 6,651 5,550 10,612
--------- --------- --------------
$ 23,116 $ 27,825 $ 34,325
--------- --------- --------------
--------- --------- --------------
Cash surrender value of life insurance at July 31, 1997 includes $6,496,000
($7,932,000 at April 30, 1998) as to split value life insurance policies on the
lives of the Company's Parent's principal shareholder and his wife for the
benefit of certain family trusts. Under the terms of the policies, the Company
will receive the first proceeds of the policies up to the aggregate premiums
paid by the Company, except for one group of policies as to which the Company
will receive the first proceeds of the policies up to the sum of the aggregate
premiums paid by the Company plus $7,634,000 representing the cash surrender
value of the policies when received by the Company in April 1998 as part of the
Reorganization. The balance of the proceeds will be paid to the Trusts. Premiums
on the policies amount to $3.6 million per year which are recorded as expense,
net of increases in the cash surrender value of the policies. Life insurance
expense related to these policies amounted to $220,000, $352,000 and $274,000 in
the years ended July 31, 1995, 1996 and 1997, and $137,000 and $82,000 in the
nine month periods ended April 30, 1997 and 1998, respectively.
F-14
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 7--LONG-TERM DEBT
Long-term debt consists of (in thousands):
JULY 31,
------------------------ APRIL 30,
1996 1997 1998
----------- ----------- ------------
(UNAUDITED)
9.375% Senior Subordinated Notes, uncollateralized, interest payable
semiannually, principal due May 2005.................................... $ -- $ -- $ 110,000
Senior Revolving Credit Facility, collateralized, variable interest
payable monthly (6.23% at April 30, 1998), principal due April 2001..... -- -- 120,629
7.37% to 10.05% Senior notes, uncollateralized, interest payable
quarterly, retired in January 1997...................................... 48,364 -- --
Revolving credit line, uncollateralized, variable interest payable monthly
(6.63% at July 31, 1997 and 6.98% at April 30, 1998), retired in April
1998.................................................................... 134,000 102,000 --
1.88% Senior note, uncollateralized, interest payable quarterly, retired
in April 1998........................................................... -- 49,374 --
1.42% Senior note, uncollateralized, interest payable quarterly, retired
in April 1998........................................................... -- 29,175 --
2.40% to 2.50% term loan notes, uncollateralized, principal and interest
payable quarterly, retired in April 1998................................ 18,142 17,017 --
Other obligations, 8.21% to 12.5%, principal and interest generally due in
monthly installments, collateralized by certain real property, equipment
and leasehold improvements.............................................. 2,264 13,701 10,432
----------- ----------- ------------
Total Long-term Debt...................................................... 202,770 211,267 241,061
Less Current Portion...................................................... 8,671 163,171 1,892
----------- ----------- ------------
Noncurrent Debt........................................................... $ 194,099 $ 48,096 $ 239,169
----------- ----------- ------------
----------- ----------- ------------
In April, 1998 the Company refinanced on a long-term basis certain
obligations outstanding under its revolving credit lines and senior notes and
term notes by consummating an offering of $110.0 million of 9.375% senior
subordinated notes (Notes) and entering into a new senior revolving credit
facility (New Credit Facility) of up to $275.0 million.
F-15
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 7--LONG-TERM DEBT (CONTINUED)
The Notes have options to redeem in part at various premiums throughout the
duration of the indenture. The New Credit Facility consists of two
sub-facilities (one for a maximum of $125.0 million and one for a maximum of
Japanese yen of 19,810,500,000, which amounted to $150.0 million at inception)
and matures in April 2001 with two provisions to extend for an additional
one-year period subject to certain terms and conditions. Maximum borrowings
under the New Credit Facility are subject to a borrowing base formula and are
collateralized by a majority of the Company's inventory, accounts receivable and
a pledge of 65% of the capital stock of its Japanese subsidiary. The New Credit
Facility bears interest at various variable rates, including (as defined in the
agreements) a Money Market Rate, ABR rate, Yen Base Rate and Euro Rate, plus an
annual facility fee. As of April 30, 1998, $124.5 million of additional
borrowing capacity was available under the New Credit Facility.
There are various restrictive terms and covenants under the senior notes,
term notes and revolving credit lines (some of which were amended in 1997),
relating to occurrence of material adverse financial or operating conditions,
minimum levels of net worth, minimum ratios of current assets to current
liabilities, net worth to debt, cash flow to fixed charges, inventory and
receivables to certain debt and certain limitations on additional indebtedness,
liens or encumbrances on assets, long-term lease transactions, capital
expenditures, and issuance of capital stock.
In connection with retirement of Senior Notes in January 1997, the Company
recorded an extraordinary loss consisting of prepayment penalties.
Maturities of long-term debt obligations are as follows (in thousands):
TWELVE-MONTH
PERIOD ENDING
--------------------------
JULY 31, APRIL 30,
------------ ------------
1998.............................................................. $ 163,171 --
1999.............................................................. 36,067 $ 1,892
2000.............................................................. 2,872 1,502
2001.............................................................. 2,827 121,629
2002.............................................................. 1,837 859
Thereafter........................................................ 4,493 115,179
------------ ------------
Total......................................................... $ 211,267 $ 241,061
------------ ------------
------------ ------------
NOTE 8--DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of the Company's financial instruments approximates
the related carrying value. The following methods and assumptions were used to
estimate the fair value of each class of financial instruments:
CASH AND CASH EQUIVALENTS AND NOTES RECEIVABLE--The carrying amount
approximates fair value because of the short-term maturity of these instruments.
F-16
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 8--DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
LONG-TERM DEBT--The fair value of the Company's fixed rate long-term debt
was estimated based upon the discounted amount of future cash flows using rates
offered to the Company for debt of a similar nature using remaining average
maturities and taking into account the global markets in which funds are
available to the Company. The carrying value of the Company's variable rate debt
approximates fair value due to the variable nature of interest rates.
RISK MANAGEMENT INSTRUMENTS--Foreign exchange and interest rate risk
management instruments are recorded at their estimated value based on quoted
market prices of comparable contracts.
DEPOSITS--The fair value is not determinable since there is no market for
these deposits and the date of recovery of the amount on deposit depends on
future events.
NOTE 9--SHAREHOLDERS' EQUITY
COMMON STOCK--The Company's articles of incorporation authorize issuance of
two classes of common stock: Class A and Class B. Class A and Class B Common
Stock have no par value and have the same rights and privileges except that
Class A common has ten votes per share on all matters while Class B common has
one vote per share on all matters and Class B common has priority voting rights,
as a separate class, to elect twenty-five percent of the total membership of the
Board of Directors.
In accordance with the Company's Articles of Incorporation, each share of
Class A common automatically converted into one share of Class B common stock
upon the exchange by the shareholders of the Company's common shares for shares
of the Parent as part of the Reorganization (see Note 2).
PREFERRED STOCK--Preferred stock (1,000,000 shares authorized) may be issued
from time to time in one or more series. The Board of Directors is authorized to
determine the rights, preferences, privileges and restrictions granted to or
imposed upon unissued series of preferred stock and to fix the number of shares
of any such series.
NOTE 10--LEASES
OPERATING LEASES--The Company leases substantially all of its retail stores,
warehouses and administrative facilities. Those operating lease agreements
expire through 2023 and generally have renewal options of one to twenty years.
The terms of the leases provide for fixed or minimum payments plus, in some
cases, contingent rents based on the consumer price index, or percentages of
sales in excess of specified minimum amounts or other specified increases. The
Company is generally responsible for maintenance, insurance and property taxes.
F-17
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 10--LEASES (CONTINUED)
Minimum future obligations on noncancelable operating leases are as follows
(in thousands):
YEAR ENDING JULY 31,
- ---------------------------------------------------------------------------------
1998........................................................................... $ 38,805
1999........................................................................... 38,462
2000........................................................................... 36,372
2001........................................................................... 31,521
2002........................................................................... 30,097
Thereafter..................................................................... 185,596
-----------
Total Minimum Future Rental Payments......................................... $ 360,853
-----------
-----------
Total rental expenses (including taxes and maintenance, when included in
rent, contingent rents and accruals to recognize minimum rents on the
straight-line basis over the term of the lease) relating to all operating leases
are as follows (in thousands):
FOR THE NINE MONTHS
FOR THE YEAR ENDED JULY 31, ENDED APRIL 30,
------------------------------- ------------------------
1997 1998
1995 1996 1997 ----------- -----------
--------- --------- ---------
(UNAUDITED) (UNAUDITED)
Minimum rentals.................................... $ 53,276 $ 62,318 $ 64,808 $ 48,412 $ 48,731
Contingent rentals................................. 4,089 4,211 5,141 3,642 4,344
--------- --------- --------- ----------- -----------
$ 57,365 $ 66,529 $ 69,949 $ 52,054 $ 53,075
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
F-18
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 11--INCOME TAXES
The provision for income taxes is allocated between income from operations,
extraordinary loss on extinguishment of debt and cumulative translation
adjustments to retained earnings. The provision for income taxes on income from
operations consists of:
FOR THE YEAR ENDED JULY 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
Current:
U.S. Federal................................................................... $ -- $ 4,220 $ 843
State and Local................................................................ 1,352 (185) 424
Foreign........................................................................ 4,288 2,189 2,916
--------- --------- ---------
5,640 6,224 4,183
--------- --------- ---------
Deferred:
U.S. Federal................................................................... 2,178 (3,467) 1,106
State and Local................................................................ 919 773 237
Foreign........................................................................ 2,183 3,483 (983)
--------- --------- ---------
5,280 789 360
--------- --------- ---------
Provision for income taxes....................................................... $ 10,920 $ 7,013 $ 4,543
--------- --------- ---------
--------- --------- ---------
The effective tax rates (i.e. provision for income taxes as a percent of
income before income taxes) differs from the statutory federal income tax rate
as follows:
FOR THE YEAR ENDED JULY 31,
----------------------------------------------------------------
1995 % 1996 % 1997 %
--------- --------- --------- --------- --------- ---------
Federal income tax, at statutory rate......................... $ 9,179 35.0% $ 6,019 35.0% $ 3,339 35.0%
Trust taxes in excess of (less than) C corporation rate....... (1,140) (4.3) 170 0.8 229 2.4
State and local income taxes, net of federal benefit.......... 1,534 5.8 871 5.2 362 3.8
Foreign taxes................................................. 6,470 25.6 5,672 32.7 1,933 20.3
Foreign tax credit recognized................................. (5,207) (20.8) (5,672) (32.7) (1,933) (20.3)
Other, principally permanent differences...................... 84 0.3 (47) (0.2) 613 6.4
--------- --------- --------- --------- --------- ---------
Provision for income taxes.................................... $ 10,920 41.6% $ 7,013 40.8% $ 4,543 47.6%
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
The effective tax rate prior to the Reorganization in April 1998 was
influenced by higher statutory tax rates applicable to trust income than to C
corporation income and deductibility of distributions of trust income within
certain time frames of when earned.
F-19
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 11--INCOME TAXES (CONTINUED)
Deferred income tax assets and liabilities consist of the tax effects of
temporary differences related to the following (in thousands):
JULY 31,
--------------------
1996 1997
--------- ---------
Deferred tax assets:
Foreign tax credits.................................................. $ 10,145 $ 11,816
Cumulative translation adjustment to retained earnings............... 8,873 12,896
Tax, but not book, gain on transactions between MTS and Trusts....... 4,166 3,626
California state franchise tax....................................... 1,224 1,792
Vacation Accrual..................................................... 711 632
Capitalized inventory costs.......................................... 727 383
Other nondeductible expenses and accelerated income items............ 1,499 1,483
--------- ---------
Total deferred tax assets.......................................... 27,345 32,628
--------- ---------
Deferred tax liabilities:
Depreciation and amortization........................................ 20,712 15,293
Differences between tax and accounting in inclusion of income from
foreign operations................................................. 5,311 3,413
Cash to accrual difference on Trusts................................. 3,504 4,264
Other accelerated deductions and deferred income items............... 1,886 1,667
--------- ---------
Total deferred tax liabilities..................................... 31,413 24,637
--------- ---------
Net deferred tax assets (liabilities)............................ $ (4,068) $ 7,991
--------- ---------
--------- ---------
Deferred tax assets and liabilities are reflected in the Company's
consolidated balance sheets as follows (in thousands):
JULY 31,
--------------------
1996 1997
--------- ---------
Current deferred tax assets (liabilities)............................... $ (4,068) $ 425
Non-current deferred tax assets (liabilities)........................... -- 7,566
--------- ---------
Net deferred tax assets (liabilities)............................... $ (4,068) $ 7,991
--------- ---------
--------- ---------
Net deferred tax assets increased by $8,137,000 during the nine month period
ended April 30, 1998, including an increase of $6,042,000 in April 1998 as a
result of the elimination of deferred tax liabilities associated with assets
retained by the Trusts as part of the Reorganization (Note 2).
F-20
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 12--PENSION PLAN
PROFIT SHARING--Substantially all full-time domestic employees with
twenty-four months of service who have attained age twenty-one participate in
the Company's profit sharing retirement programs. The plans provide for
discretionary contributions as determined annually by the Board of Directors of
up to 15% of all eligible compensation. Costs under the plans are funded on an
annual basis.
The Company also maintains a plan for employees of their Japanese
subsidiary. The plan covers substantially all employees of the Japanese
operations. The plan provides for a lump sum payment upon termination without
cause based on term of service and compensation level. A liability for plan
payments is accrued equal to the amount that would result from termination of
all employees based on service to date and current compensation levels. As
permitted by Japanese law, the plan is not funded.
Pension expense under the pension plans amounted to $1,889,000, $1,792,000
and $1,719,000 for the years ended July 31, 1995, 1996 and 1997, respectively,
and $1,200,000 and $1,100,000 for the nine month periods ended April 30, 1997
and 1998, respectively.
F-21
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 13--SEGMENT AND GEOGRAPHIC INFORMATION:
The Company operates predominantly in the recorded music retail industry.
Financial information relating to the Company's principal foreign operations
is as follows (in thousands):
FOR THE NINE
MONTHS ENDED
FOR THE YEAR ENDED JULY 31, APRIL 30,
--------------------------------------- ------------------------
1997 1998
1995 1996 1997 ----------- -----------
----------- ------------- -----------
(UNAUDITED) (UNAUDITED)
Net Revenue:
United States:
Unaffiliated customer sales.............. $ 560,484 $ 520,960 $ 553,292 $ 433,539 $ 453,442
Interarea transfers...................... 44,651 63,392 44,092 20,648 26,085
----------- ------------- ----------- ----------- -----------
605,135 584,352 597,384 454,187 479,527
----------- ------------- ----------- ----------- -----------
Japan:
Unaffiliated customer sales.............. 284,309 334,586 304,630 230,003 219,758
Interarea transfers...................... 0 0 0 0 0
----------- ------------- ----------- ----------- -----------
284,309 334,586 304,630 230,003 219,758
----------- ------------- ----------- ----------- -----------
Great Britain and Ireland:
Unaffiliated customer sales.............. 53,145 56,590 59,774 45,436 48,693
Interarea transfers...................... 1,575 1,045 1,858 1,393 2,341
----------- ------------- ----------- ----------- -----------
54,720 57,635 61,632 46,829 51,034
----------- ------------- ----------- ----------- -----------
Other:
Unaffiliated customer sales.............. 6,397 24,462 28,164 21,504 21,084
Interarea transfers...................... 0 0 0 0 0
----------- ------------- ----------- ----------- -----------
6,397 24,462 28,164 21,504 21,084
----------- ------------- ----------- ----------- -----------
$ 950,561 $ 1,001,035 $ 991,810 $ 752,523 $ 771,403
----------- ------------- ----------- ----------- -----------
----------- ------------- ----------- ----------- -----------
Operating income (loss):
United States.............................. $ 15,171 $ 13,747 $ 12,831 $ 13,194 $ 18,079
Japan...................................... 15,607 19,605 14,825 11,047 6,948
Great Britain and Ireland.................. 935 440 1,081 372 639
Other...................................... 301 (203) (191) 114 (1,559)
----------- ------------- ----------- ----------- -----------
$ 32,014 $ 33,589 $ 28,546 $ 24,727 $ 24,107
----------- ------------- ----------- ----------- -----------
----------- ------------- ----------- ----------- -----------
F-22
MTS, INCORPORATED AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED WITH RESPECT TO THE NINE MONTH PERIODS
ENDED APRIL 30, 1997 AND 1998)
NOTE 13--SEGMENT AND GEOGRAPHIC INFORMATION: (CONTINUED)
JULY 31,
------------------------------------- APRIL 30,
1995 1996 1997 1998
----------- ----------- ----------- -----------
(UNAUDITED)
Identifiable assets:
United States.............................................. $ 368,302 $ 359,735 $ 373,273 $ 378,981
Japan...................................................... 106,789 122,952 121,778 105,497
Great Britain and Ireland.................................. 27,700 30,077 29,937 31,591
Other...................................................... 2,303 16,006 19,590 15,571
----------- ----------- ----------- -----------
$ 505,094 $ 528,770 $ 544,578 $ 531,640
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
United States net revenue includes export sales to non-affiliated customers
of $-0-, $-0- and $3,856,000 for the years ended July 31, 1995, 1996 and 1997,
respectively, and $1,585,000 and $5,059,000 for the nine-month periods ended
April 30, 1997 and 1998, respectively.
NOTE 14--FORWARD EXCHANGE CONTRACTS
At July 31, 1997, the Company had outstanding forward exchange contracts
maturing on dates through July 1998, to buy approximately $16,000,000 in foreign
currency (1,825 million yen at the spot rate). The contracts are for the purpose
of hedging foreign currency exposure on specific commitments and a net exposed
liability position of the Company's operations in Japan, as well as to take
advantage of expected changes in exchange rates. At April 30, 1998, the Company
had outstanding forward exchange contracts maturing through October 1998, to buy
approximately $9,000,000 in foreign currency (1,084 million yen at the spot
rate).
NOTE 15--SUPPLEMENTAL CASH FLOW INFORMATION
During the twelve months ending July 31, 1995, 1996 and 1997, the Company
made income tax payments of $13,964,000, $4,057,000 and $5,440,000, and interest
payments (net of amounts capitalized) of $11,173,000, $13,562,000 and
$17,434,000, respectively.
During the nine months ending April 30, 1997 and 1998, the Company made
income tax payments of $6,765,000 and $4,109,000, respectively, and interest
payments (net of amounts capitalized) of $13,343,000 and $11,279,000,
respectively.
F-23
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THE PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY EXCHANGE OF EXISTING NOTES FOR NEW NOTES
MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT
THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS
DATE. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF
AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO WHICH IT RELATES.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN
OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
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TABLE OF CONTENTS
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 12
The Exchange Offer........................................................ 18
The Recapitalization...................................................... 27
Use of Proceeds........................................................... 28
Capitalization............................................................ 29
Selected Historical Consolidated Financial Information.................... 30
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................. 32
Business.................................................................. 39
Management................................................................ 47
Ownership of Capital Stock................................................ 49
Certain Transactions...................................................... 50
Description of New Credit Facility........................................ 53
Description of the Notes.................................................. 56
Federal Income Tax Considerations......................................... 87
Plan of Distribution...................................................... 90
Legal Matters............................................................. 90
Experts................................................................... 91
Additional Information.................................................... 91
Index to Financial Statements............................................. F-1
PROSPECTUS
$110,000,000
MTS, INCORPORATED
EXCHANGE OFFER WITH RESPECT TO 9 3/8% SENIOR SUBORDINATED NOTES DUE 2005
[LOGO]
EXCHANGE AGENT:
State Street Bank and Trust Company
of California Exchange Agent
c/o State Street Bank and Trust Company
2 International Place, 4th Floor
Boston, MA 02110
Attn: Kellie Mullen, Corporate Trust Dept.
Tel: 617-664-5587
Fax: 617-664-5290
SEPTEMBER 14, 1998