10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                            to                           

Commission file number 000-22207

GUITAR CENTER, INC.

(Exact name of registrant as specified in charter)

Delaware	95-4600862
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
5795 Lindero Canyon Road
Westlake Village, California	91362
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (818) 735-8800

Securities registered pursuant to 12(b) of the Act:

None

Securities registered pursuant to 12(g) of the Act:

Common Stock, $.01 par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes x                      No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes o                      No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                      No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o                      No x

As of June 30, 2006, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $1,169,000,000 based on the closing price as reported on the NASDAQ Global Select Market. Shares of Common Stock held by each executive officer, director and each person or entity known to the Registrant to be affiliates of the foregoing have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

As of February 23, 2007, there were 29,502,000 shares of Common Stock, par value $0.01 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement for the 2007 annual stockholders’ meeting are incorporated by reference into Part III.

PART I

Item 1. BUSINESS

Introduction

Guitar Center, Inc. is the leading United States retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment. As of December 31, 2006, our wholly owned retail subsidiary operated 198 Guitar Center stores across the United States, with 134 primary format stores, 61 secondary format stores and 3 tertiary format stores. In addition, as of December 31, 2006, our Music & Arts Center division operated 97 stores specializing in band instruments for sale and rental, serving teachers, band directors, college professors and students. We are also the largest direct response retailer of musical instruments in the United States through our wholly owned subsidiary, Musician’s Friend, Inc., and its catalogs and websites, www.musiciansfriend.com. www.guitarcenter.com, www.wwbw.com, www.music123.com and related websites.

We are a Delaware corporation with principal executive offices located at 5795 Lindero Canyon Road, Westlake Village, California 91362, and our telephone number is (818) 735-8800. We maintain several corporate websites, including www.guitarcenter.com. However, none of the information contained on our websites is incorporated into this annual report. Whenever we refer to the “Company” or “us,” or use the terms “we” or “our” in this annual report, we are referring to Guitar Center, Inc. and its subsidiaries.

History

Guitar Center, Inc. was founded in 1964 in Hollywood, California. Our flagship Hollywood store currently is one of the largest and best-known retail stores of its kind in the United States, with approximately 30,600 square feet of retail space. Our Hollywood store features one of the largest used and vintage guitar collections in the United States, attracting buyers and collectors from around the world. In front of our Hollywood store is the Rock Walk, which memorializes over 200 famous musicians and music pioneers. The Rock Walk has helped to create international recognition of the Guitar Center name.

In May 1999, we acquired Musician’s Friend, Inc., an Oregon-based direct response retailer of musical instruments. Musician’s Friend is the largest direct response retailer of musical instruments in the United States, through its catalog and e-commerce website. In February 2007, we acquired substantially all of the assets of Dennis Bamber, Inc., d/b/a The Woodwind & The Brasswind and Music123, an Indiana-based direct response retailer of musical instruments. We refer to this business as “Woodwind & Brasswind.”

In April 2001, we acquired American Music Group, Ltd. and its related companies, a musical instrument retailer specializing in the sale and rental of band instruments and accessories serving the student and family market. In April 2005, we acquired Music & Arts Center, Inc., a Maryland-based musical instruments retailer which primarily serves the beginning musician and emphasizes rentals, music lessons and band and orchestra instrument sales. Subsequent to the Music & Arts Center acquisition, our American Music and Music & Arts Center businesses were combined into a new division of our retail store subsidiary that operates under the Music & Arts Center name.

Recent Events

On February 9, 2007, we acquired out of a bankruptcy proceeding substantially all of the assets of Dennis Bamber, Inc., also known as The Woodwind & The Brasswind. The acquisition consisted of a variety of direct response catalogs and websites, including those under the brand names Woodwind & Brasswind and Music123, related inventory and other assets. The acquired business operates as a division of our Musician’s Friend subsidiary, through an office, retail outlet and warehouse facility and a distribution center facility, both located in South Bend, Indiana.

2

The Woodwind & Brasswind brand is targeted primarily to online and catalog purchases of band and orchestra instruments, while the Music123 brand name is targeted primarily to online purchases of guitars, amplifiers, percussion instruments, keyboards and pro audio and recording equipment. In connection with the purchase of this business, we entered into leases for the two Woodwind & Brasswind facilities, for a term of 24 months for the approximately 122,000 square foot office, retail outlet and warehouse facility and 18 months for the approximately 220,000 square foot distribution center facility. During the term of the leases, we expect to evaluate and implement a plan to integrate the various functions of the Woodwind & Brasswind business with or into our existing direct response business.

Industry Overview

The United States retail market for music products in 2005 was estimated in a study by the National Association of Music Merchants, or NAMM, to be approximately $7.8 billion in net sales. The broadly defined music products market, according to NAMM, includes retail sales of string and fretted instruments, sound reinforcement and recording equipment, drums, keyboards, print music, pianos, organs, and school band and orchestral instruments. Products currently offered by us include categories of products which account for approximately $7.1 billion of the retail market for music products.

Over the past decade, technological advances in the industry have resulted in dramatic changes to the nature of music-related products. Manufacturers have combined computers and microprocessor technologies with musical equipment to create a new generation of products capable of high grade sound processing and reproduction. Products featuring those technologies are available in a variety of forms and have broad application across most of our music product categories. Rapid technological advances have resulted in the continued introduction of higher quality products offered at lower prices, and we believe this trend will continue. Today, an individual consumer can affordably create a home recording studio which interacts with personal computers and is capable of producing high-quality digital recordings. Until recently, this type of powerful sound processing capability was expensive and was typically purchased primarily by professional sound recording studios.

Business Overview

During 2006, we operated three reportable segments under the classifications of Guitar Center stores, direct response and Music & Arts Center.

Guitar Center Stores

Our Guitar Center stores offer a unique retail concept in the music products industry, combining an interactive, hands-on shopping experience with superior customer service and a broad selection of brand name, high-quality products at guaranteed low prices. We create an entertaining and exciting atmosphere in our stores with bold and dramatic merchandise presentations, highlighted by bright, multi-colored lighting, high ceilings, music and videos. We believe that more than half of our Guitar Center store sales are to professional and aspiring musicians who generally view the purchase of music products as a career necessity. These sophisticated customers rely on our highly trained salespeople to answer technical questions and to assist in product demonstrations.

Our primary format Guitar Center stores are designed to serve major metropolitan population centers. Our primary format Guitar Center store generally ranges in size from 12,000 to 30,000 square feet. In late 2000, we opened our first secondary format store to serve metropolitan areas that previously were not served by our primary format stores. Our standard secondary format Guitar Center store generally ranges in size from 8,000 to 10,000 square feet. In late 2005, we opened our first tertiary market store to serve smaller population centers. Our tertiary format stores generally are expected to be approximately 5,000 square feet.

3

In 2006, we opened a total of 33 Guitar Center stores, including 12 primary format stores, 19 secondary format stores and 2 tertiary format stores. We also added four stores via acquisition consisting of two primary format stores and two secondary format stores. We presently expect to open approximately 16 to 19 new Guitar Center stores in 2007, consisting of 5 to 6 primary format stores, 9 to 11 secondary format stores and up to 2 tertiary format stores.

The following summarizes key operating statistics of our Guitar Center stores and is based on the stores operated by us for the full year ended December 31:

	2006			2005
Number of stores operated for the full year	161			136
Average net sales per square foot	$	580		$	599
Average net sales per store	$	8,740,000		$	9,214,000
Average store-level operating income	$	1,151,000		$	1,502,000
Average store-level operating income margin	13.2		%	16.3		%

These key operating statistics are based on results of Guitar Center stores in operation for at least 12 months as of December 31, 2006 and 2005, respectively. Average net sales per square foot is a measure of sales efficiency based on square footage. Average net sales per store represents the average result of stores open at least 12 months, and is typically adversely affected by the opening of secondary and tertiary format stores which generate lower levels of sales than primary format stores. Although these smaller format stores generate lower levels of sales, these stores cost less to build, stock and operate than our large format stores. Store-level operating income and margin includes individual store revenue and expenses plus allocated rebates, cash discounts and purchasing department salaries (based upon individual store sales).

Direct Response

Our Musician’s Friend subsidiary, which we operate as a separate business unit, is a direct response e-commerce and catalog business. Musician’s Friend offers musicians a shopping experience that includes technical product information, confirmations by a live person, quick and efficient sales and service and a musician-based staff for after-sale support. Musician’s Friend’s catalogs and websites offer an assortment of products and promotions throughout the year, mixing brand name products with unique and practical offerings. In June 2006, GuitarCenter.com was launched as an eCommerce website as part of our direct response division. In February 2007, we acquired the Woodwind & Brasswind business and its websites and catalogs.

Our direct response business is based in Medford, Oregon and is supported by a customer contact center located in Salt Lake City, Utah and a distribution facility located in Kansas City, Missouri. The Kansas City distribution center also houses an outlet store for selling returns and blemished product.

Music & Arts Center

The Music & Arts Center division of our retail store subsidiary operates stores specializing in band and orchestra instruments for sale and rental, serving teachers, band directors, college professors and students. Most of the Music & Arts Center stores also sell a limited assortment of guitars, amplifiers, percussion instruments, keyboards, pro audio and recording equipment, as well as provide music lessons. Music & Arts Center instrument rentals are conducted on-site through our outbound education representatives, over the counter at our retail locations, on-line, and through “affiliate” stores operated by third party musical instrument dealers.

As of December 31, 2006, Music & Arts Center operated 97 retail stores. Existing Music & Arts Center stores range from 830 to 11,500 square feet, with a target store size of approximately 3,800 square feet. Our Music & Arts Center business is based in Frederick, Maryland and is supported there by a

4

distribution facility and call center, along with additional call centers in Liverpool, New York and Horsham, Pennsylvania.

Strategy

Guitar Center Stores

Our Guitar Center stores growth strategy is to continue to increase our presence in existing markets and to open new stores in strategically selected markets, which could include international markets. We expect to continue pursuing our strategy of clustering stores in primary markets to take advantage of operating and advertising efficiencies, as well as opening stores in new and smaller markets to build awareness of our name. Our Guitar Center stores business strategy includes offering an extensive selection of brand name and hard to find new and vintage music products, developing creative and interactive presentations and displays, creating innovative promotional and marketing programs, providing specialized and qualified customer service and providing guaranteed low prices.

Direct Response

Our direct response growth strategy is to increase our market share in the direct response segment of the industry, particularly relating to the Internet portion of the direct response business. While our catalogs remain an important marketing tool, we are focused more on Internet marketing, technology and infrastructure than we have been in the past. Our core strategies include personalization and one-to-one marketing that delivers products and services customized to the specific needs of musicians. Additionally, we are focused on technology and infrastructure that enhances our website user experience, improves our business agility, increases our ‘speed to market’ and further differentiates us from the competition. In our back office, we are making investments to improve our analytic tools and enhance our data warehouse.

Music & Arts Center

Our Music & Arts Center growth strategy is to increase market share by expanding our existing business. We are currently focusing on improving operational efficiencies and reducing working capital requirements. We may moderate our growth plans for this business unit until these improvements are complete.

Merchandising

Guitar Center Stores

Our primary format Guitar Center stores carry an average of 7,200 core stock keeping units, or SKUs, our secondary format Guitar Center stores carry an average of 5,700 core SKUs and our tertiary format Guitar Center stores carry an average of 4,200 core SKUs. Our core SKUs represent our consistent and established product lines which are considered staple products for our customers.

Our stores are organized into five departments (guitars and amplifiers, drums, keyboards, pro audio and recording, and accessories), with each department focused on one product category. These departments address our customer’s specific product needs and are staffed by specialized salespeople, many of whom are practicing musicians. Our trade-in policy provides musicians with an alternative form of payment and the convenience of selling a used instrument and purchasing a new one at a single location. Used products are bought and priced to sell by store managers who are trained and knowledgeable in the used musical instrument market.

·Guitars and Amplifiers. Our guitar and amplifiers department carries a wide variety of new, used and vintage electric, acoustic, classical and bass guitars. Major manufacturers including Fender, Gibson, Martin, PRS, Yamaha, Ovation, Peavey, Line 6 and Ibanez are well represented in popular

5

models and colors. A number of our stores also carry other stringed instruments such as banjos and mandolins. We also offer an extensive selection of guitar sound processing units and products that allow guitars to interface with a personal computer. These products serve crossover demand from the traditional guitarist into new computer-related sound products.

We offer an extensive selection of electric, acoustic and bass guitar amplifiers, including a variety of boutique and vintage amplifiers with prices ranging from $50 to $5,000. We carry amplifiers from most major manufacturers, including Marshall, Fender, Crate, Ampeg, Vox, Peavey, Line 6 and Mesa Boogie.

·Drums. Our drum department carries a range of percussion instruments, from drum kits to congas, bongos and other rhythmic and electronic percussion products. We also carry a selection of vintage and used percussion instruments. We carry name brands such as Drum Workshop, Sabian, Pearl, Gretsch, Yamaha, Tama and Zildjian.

·Keyboards. We carry a wide selection of keyboard products and computer peripheral and software packages. Our keyboard product line covers a wide range of manufacturers, including Roland, Casio, Korg and Yamaha.

·Pro Audio and Recording. Our pro audio and recording department carries live-sound, DJ and recording equipment for musicians at every level, from the casual hobbyist to the professional recording engineer. We maintain a broad selection of computer-related recording products, including sound cards, sound libraries and composition and recording software. Our products range from recording accessories to state-of-the-art digital recording systems. We also carry a large assortment of professional stage audio, DJ and lighting equipment for small traveling bands, mobile DJs, private clubs and large touring professional bands. Our pro audio brand name manufacturers include Digidesign, JBL, Sony, Mackie, Shure, Tascam, Yamaha, Roland, M Audio, KRK, PreSonus and Apple.

·Accessories. Our accessories department offers a wide range of items considered consumables by our musician customers. These items range from guitar strings, picks, cables, straps, performance microphones and stands to sophisticated signal processors that modify and enhance the sound of voices and instruments during performance or recording.

Direct Response

Our direct response business offers primarily new merchandise through its catalogs and on-line through its websites. In addition, our direct response business offers returned and blemished merchandise through its outlet store in Kansas City, Missouri, and on-line through its websites.

Our direct response business offers a product mix that includes the same categories as those offered by our Guitar Center stores, including guitars and amplifiers, drums, keyboard, pro audio and accessories. In addition, our direct response business offers a range of private label products and band and orchestra instruments and accessories that primarily are targeted at intermediate and professional musicians. Our direct response catalogs generally offer an average of approximately 5,000 SKUs and approximately 39,500 SKUs are offered on our websites. We believe that the breadth of SKUs offered by our direct response business differentiates it from many of its competitors.

Music & Arts Center

Our Music & Arts Center business focuses on the student and family music market, particularly band and orchestra instruments. These stores offer band and orchestral instruments and related accessories for sale and rental, musical instrument lessons and a limited assortment of guitars, amplifiers, percussion instruments, keyboards, live-sound/DJ and recording equipment. Our Music & Arts Center stores offer a

6

full range of brass and woodwind band instruments including trumpets, flutes, clarinets, trombones, saxophones, piccolos, French horns, flugelhorns, cornets, baritones and related music accessories. These stores also offer a full range of stringed instruments, such as violins, violas, cellos, string basses and related accessories. These stores carry a wide range of sheet music. Name brand manufacturers carried at Music & Arts Center stores include Leblanc, Jupiter, Gemeinhardt, Selmer, Buffet, Ludwig, Conn, Yamaha, Bach and Eastman.

Operations

Guitar Center Stores

We have centralized many key aspects of our Guitar Center store operations, including the development of policies and procedures, accounting systems, training programs, store site selection, store layouts, purchasing and replenishment, advertising and pricing. This centralization utilizes the experience and resources of our headquarters staff to establish consistency throughout our stores.

Our Executive Vice President of Stores, 4 regional sales managers, 4 regional operations managers, 23 district sales managers and 21 district operation managers manage the Guitar Center stores. Store management for our primary and secondary format stores generally is comprised of a store manager, a sales manager, an operations manager, 2 assistant store managers and 5 department managers. Each store also has a warehouse manager and a commissioned sales staff that ranges from 20 to 40 employees. We expect that our tertiary format stores generally will be managed by a store manager, 2 assistant managers and a sales staff that ranges from 7 to 15 employees.

We provide ongoing training to our store managers and instill in the managers the values of operating as a business owner. We seek to encourage responsiveness and entrepreneurship at each store by providing store managers with a high degree of autonomy relating to operations, personnel and merchandising. Managers also play an integral role in the presentation of merchandise and the promotion and protection of our reputation.

We encourage employee development by providing our sales force with extensive training and the opportunity to increase both compensation and responsibility through increased product knowledge and performance. We provide employees with the ability to move into operations, sales and store management positions. As we open new stores, the qualified and experienced employees from existing stores often fill key in-store management positions. By adopting a “promotion from within” strategy, we maintain a well-trained, loyal and enthusiastic sales force that is motivated by opportunities for advancement. Marty Albertson, our Chief Executive Officer, Mark Galster, our Executive Vice President of Stores, began their careers as a salesperson at Guitar Center stores.

Direct Response

Musician’s Friend operations are managed by the division’s President and Chief Operating Officer.

Music & Arts Center

Music & Arts Centers’ operations are managed by a Senior Vice President of Merchandising, a Senior Vice President of Operations, a Senior Vice President of Sales, and regional, district and store level managers. Store management generally is comprised of a store manager, assistant store manager, one or more educational representatives and related sales and support staff.

Marketing and Promotion

Our proprietary databases are a central element of our marketing and promotion programs. We maintain three unique and proprietary databases that we have developed for Guitar Center, Musician’s

7

Friend and Music & Arts Center. Included in these databases is information on approximately 12 million of our Guitar Center store customers, approximately 8.7 million of our direct response customers and approximately 315,000 of our Music & Arts Center customers. We believe that these databases assist us in identifying customer prospects, in generating repeat business by targeting customers based on their purchasing history and by permitting us to establish and maintain personal relationships with our customers.

Guitar Center Retail

Our advertising and promotion strategy for our Guitar Center stores is designed to enhance the Guitar Center name and increase customer awareness and loyalty. Our advertising and promotional campaigns generally are developed around “events” designed to attract significant store traffic and exposure. We regularly plan large promotional events including the Green Tag Sale in March, the Anniversary Sale in August and the Guitar-a-thon in November/December. These events often are coordinated with product demonstrations, interactive displays, clinics and in-store artist appearances.

As we enter new markets we initiate an advertising program, including mail and radio promotions, television and Internet campaigns and other special grand opening activities. Each element of this advertising program is designed to accelerate sales volume for each new store. Radio advertising plays a significant part in our store opening campaign to generate interest and create customer awareness.

We also maintain a variety of promotional financing alternatives for our customers. Generally, all credit made available to retail customers and all extended payment arrangements are provided by third party consumer credit companies which are non-recourse to us, meaning that the risk of non-payment is borne by the third party provider so long as we comply with its administrative and approval policies. These arrangements also give us the flexibility to offer attractive payment options to our customers on a promotional basis, such as no interest periods, reduced interest rates or deferred payment options. These programs are also non-recourse to us, but we pay the credit provider a fee reflecting the below-market, promotional benefit of the particular program.

Direct Response

Our direct response business maintains regular communication in electronic and print media. We perform an extensive analysis of customer behavior and transactions, and the industry expertise of our merchandising staff provides our marketing staff with offers that are targeted for optimal customer response.

The same transactional databases that make market targeting information available for catalog and e-mail circulation are enhanced by the information archived from our website traffic. Our merchandising and marketing departments use these tools to design personalized product and promotional offerings for prospective customers. We are also making significant investments in enhanced web-based analytical search engine tools and web-based direct marketing initiatives.

8

Our direct response strategy includes the development of catalogs targeted towards particular segments of the musician market. For example, Musician’s Friend produces two small catalogs, the LMI Catalog, which is oriented toward young, school-aged children, and the Giardinelli catalog which is targeted to band and orchestra customers. Our direct response business also targets specific customers with keyboard, percussion and DJ specialty catalogs.

We believe that there may be Internet-based opportunities to expand the reach of our brands. We have expanded our Internet presence to include the www.harmony-central.com and www.musician.com web sites. These opportunities are being created in part by the rapid development of auction, content and community sites oriented towards music and musicians. As part of these opportunities, we are expanding our customer-focused marketing strategy to include personalization and one-to-one marketing designed to deliver products and services customized to specific needs of our musician and aspiring musician customers. We also are completing the installation of a sophisticated internal search and comparison shopping engine that we believe will improve user functionality and enhance search capabilities. We believe that these engines, along with several other planned advancements and improvements to our websites, will continue to enhance the user experience, improve our business agility, increase our ‘speed to market’ and differentiate us from the competition.

Music & Arts Center

Our advertising efforts for the Music & Arts Center stores are focused primarily on the school band and orchestra market and community. For instrument rentals, advertising and promotional campaigns are developed around “rental nights” designed to display our orchestral and band instruments at elementary and middle schools. These events attract band directors, music educators, parents and students. Our key promotional events are held primarily from August through October. In addition to rental nights, we have education representatives that travel around the country to promote and educate band directors on our instruments and our sales and rental programs. We maintain long-term relationships with educators in order to provide visibility to our products and obtain access to student musicians.

Customer Service

Guitar Center Stores

Exceptional customer service is fundamental to our operating strategy. With the rapid changes in technology and continuous new product introductions, we believe that customers depend on our salespeople to offer expert advice and to assist with product demonstrations. Our employees typically are musicians trained to understand the needs of our customers. Guitar Center store salespeople specialize in one of our five product categories and typically begin training on their first day of employment. Guitar Center store sales and management training programs are implemented on an ongoing basis to maintain and improve the level of customer service and sales support in the stores.

Direct Response

Our Musician’s Friend customer contact staff receives product and customer service training in our Salt Lake City, Utah contact center facility. Extensive product information, including technical information, product features and benefits and real-time stocking information is available to the staff on their desktop systems via intranet and back-end information systems. Most of the staff is comprised of musicians who are given extensive and ongoing product training, and the facility houses an extensive product demonstration area and training facility. As of December 31, 2006, we had 268 full-time and 102 part-time customer service employees, staffing the contact center 24 hours a day, seven days a week. Our customer service telephone staff for returns is located in the Kansas City, Missouri distribution center where they are closer to the returns process while assisting customers.

9

For customers that have registered e-mail addresses with us, we offer automated order and shipment verification. This service provides customers with UPS or FedEx order tracking information as soon as their shipment has been processed. To provide customers with a high degree of satisfaction, customers may return items for a full refund within 45 days of purchase. Additionally, if customers find a lower advertised price within 45 days of purchase, we will match the competitor’s advertised price.

Music & Arts Center

Sales at our Music & Arts Center stores are conducted primarily through sales made by our educational sales representatives and sales made over the counter at our retail stores. The majority of our educational representative sales force is comprised of music teachers who are experienced band and orchestra instructors. The customer service functions relating to sales made by our educational representatives generally are conducted by our centralized call center. The customer service functions relating to sales made over the counter at our retail stores generally are conducted by our retail staff, who provide a full service retail experience for our customers.

Purchasing

We believe that we have excellent relationships with our vendors and, in many instances, we are our vendors’ largest customer. Given our high volume, we are generally able to receive prompt order fulfillment and access to our vendors’ premium products. Guitar Center, Musician’s Friend and Music & Arts Center each maintain centralized buying groups. Our centralized buyers include merchandise managers, buyers, planners, forecasters, replenishers and allocators. Merchandise managers and buyers are responsible for the selection and development of product assortments and the negotiation of prices and terms. The planners, forecasters, replenishers and allocators are responsible for maintaining inventory levels and allocating the merchandise to the retail distribution center, stores and direct response fulfillment center. Guitar Center and Musician’s Friend use merchandise replenishment systems which automatically analyze and forecast sales trends for each SKU using various statistical models, supporting the buyers by predicting merchandise requirements.

Our business and expansion plans are dependent to a significant degree upon our vendors. As we believe is customary in the industry, we do not have any long-term supply contracts with our vendors. Please see Item 1A. Risk Factors—We depend on a relatively small number of manufacturers, suppliers and common carriers, and their inability to supply our requirements could adversely impact our business.

Distribution and Inventory Control

Guitar Center Stores

Our distribution center in the Indianapolis, Indiana area supports our Guitar Center retail store operations. Nearly all product flows through the distribution facility, with the exception of special orders, which generally are drop shipments to our stores. A portion of the costs of operating this facility are absorbed into our Guitar Center merchandise inventories and recognized as an element of cost of goods sold when the related inventory is sold. We have numerous commitments necessary to support the operations of the facility, including a lease on the facility. We expanded this facility from approximately 505,000 square feet to approximately 773,000 square feet in 2006.

We have invested significant time and resources in our inventory control system at the Guitar Center stores. We perform inventory cycle counts daily, both to measure shrinkage and to update the perpetual inventory on a store-by-store basis. As appropriate, we also stock balance inventory among stores to assure proper distribution of product and to control overall inventory levels. Our inventory shrinkage level has historically been low, which we attribute to our sophisticated system controls and strong corporate culture.

10

Direct Response

Musician’s Friend orders are fulfilled out of our Kansas City, Missouri distribution center. As we have exceeded the capacity of the existing distribution center, we have leased a new distribution facility of approximately 702,000 square feet located in Kansas City, Missouri, which is expected to be placed in service in the second half of 2007. The existing distribution center is planned to be closed upon expiration of the lease in August 2007.

Orders, whether taken electronically or by an associate in our customer contact center, are processed by our automated transaction system. We have implemented sophisticated inventory planning systems to increase the level of in-stock products with the goal of maintaining a high initial line item fill rate. The initial line item fill rate reflects the percentage of items ordered by our customers that we are able to supply in the initial shipment to that consumer. Split shipments of a single order impose additional shipping, handling and materials costs on us when compared to being able to fulfill an entire order in a single shipment. The technology on our website also permits our customers to monitor their orders online by accessing the UPS and FedEx tracking services.

All Musician’s Friend returns are routed to the Kansas City distribution center where repairs and quality evaluations are made. On site repair and customer service representatives assist our customers, with the goal of reducing the costs associated with returns. Returned and blemished products are sold through the outlet store in the Kansas City facility, and by offering those products at reduced prices on the Musician’s Friend website.

Music & Arts Centers

Products for our Music & Arts Center stores generally are processed through a central distribution facility located in Frederick, Maryland of approximately 60,000 square feet. We have a number of local hubs and/or support centers to guarantee product availability during our peak back to school season. Music & Arts Center also maintains additional call centers in Liverpool, New York and Horsham, Pennsylvania.

Retail Store Site Selection

We have developed a set of selection criteria to identify prospective store sites for our Guitar Center and Music & Arts Center stores. In evaluating the suitability of a particular location, we concentrate on the demographics of our target customer as well as traffic patterns and specific site characteristics such as visibility, accessibility, traffic volume, shopping patterns and availability of adequate parking. Our Guitar Center stores generally are located in free-standing locations and high visibility “power center” shopping centers to maximize their outside exposure and signage, while our Music & Arts Center stores generally are located in specialized shopping centers to maximize traffic from targeted customers such as students and their parents.

Information Technology

Guitar Center Stores

We have invested significant resources in information technology systems that provide real-time information for our Guitar Center stores. These systems have been designed to integrate all major aspects of our business, including sales, gross margins, inventory levels, purchase order management, automated replenishment and merchandise planning. Our system capabilities include inter-store transactions, vendor analysis, serial number tracking, inventory analysis and commission sales reporting.

In 2006, we developed and implemented a data warehouse that enables us to improve our marketing techniques and inventory planning. Also, in 2006, we began operation in our new data center, which

11

augmented the previous operations center by providing increased capacity, improved service levels and improved recovery flexibility. The new data center infrastructure also improves our ability to support anticipated business growth and new technology initiatives. We are in the process of developing and implementing a new point-of-sale system to replace the current sales processing solution which is built on an aging infrastructure and is difficult to enhance for future business requirements. The point-of-sale system is presently scheduled to begin a pilot program in 2008 and will provide us with enhanced customer sales information and more intuitive training modules.

Direct Response

Our direct response business maintains an extensive multi-channel retail transaction processing system, as well as systems supporting e-commerce operations, catalog operations, marketing analysis and internal support information. These systems provide our direct response business with marketing, merchandising and operational information and provide call center and customer service staff with current inventory and customer account information.

We are in the process of developing and implementing a new multi-channel retail transaction processing solution that when implemented will function as the core retail platform, supporting merchandising, inventory management, order management, order entry, distribution center operations and various other major multi-channel direct response business functions. This system is presently scheduled to begin operation in late 2007 or early 2008 and will provide a more flexible and efficient retail platform supporting continued growth objectives, possible international expansion and various other direct response enhancements.

The operations of our direct response business are highly dependent on its information technology systems. Our direct response business does not have redundant Internet or operating systems and currently would be vulnerable to catastrophic events. In the event of a disaster, our direct response business would most likely experience delays in processing and shipping orders until we executed our failure recovery plans. Please see Item 1A. Risk Factors—Our failure to develop and implement critical new systems for our business could adversely impact our business.

Music & Arts Center Stores

We continue to invest significant resources in the development and implementation of information systems at our Music & Arts Center stores. These systems are being designed to operate and control significant business processes, including sales, rentals, store operations, inventory levels, purchase order management, special orders and other financial transactions. These systems are in an early stage of development and will require significant additional resources. This business is not susceptible to using “off-the-shelf” retail solutions because of our large rental business and the presence of off-site sales through affiliates and sales at schools.

Competition

The retail musical instrument industry is highly competitive and fragmented. Our stores compete against other large and small musical instrument retailers, online music retailers, on-line auctions, direct-to-consumer alternatives and a growing number of large mass merchants. A number of large mass merchants, including Wal-Mart, Best Buy, Target and Costco sell musical instruments in categories that we compete in, including entry-level guitars, electronic keyboards and band instruments. Best Buy also operates a store-within-a-store concept for musical instruments which includes a significantly expanded selection of products. These retailers could represent a significant source of future competition for our retail and direct response businesses, particularly if these retailers continue to expand their product lines beyond entry-level merchandise.

12

We primarily are in direct competition with other musical instrument retailers, such as Sam Ash Music based in New York, New York, a major multi-unit retail chain in the music products industry. Sam Ash has continued to open new or acquired stores in markets in which we are located. In addition, our retail stores and direct response business compete with various direct response companies such as American Musical Supply, Sam Ash Music, Sweetwater Sound and Full Compass. Competition within the musical instrument industry remains dynamic and we cannot predict the scope and extent of national and local competition our retail store and direct response businesses will face in the future. In particular, competition within the Internet portion of our direct response business has been increasing and is intense, and we expect that this competition will continue in the future.

We believe that the ability to compete successfully in our markets is determined by several factors, including breadth and quality of product selection, pricing, effective merchandise presentation, customer service, store location and proprietary database marketing programs.

Employees

As of December 31, 2006, we employed 9,540 people, of whom 7,955 were hourly employees and 1,585 were salaried. As of December 31, 2006, we employed 1,730 part time employees and 7,810 full time employees. None of our employees are covered by a collective bargaining agreement. We believe that we enjoy good employee relations.

Brand Names and Service Marks

We believe we own valuable intellectual property including trademarks, service marks and tradenames, some of which are of material importance to our business. These marks and names include “Guitar Center,” “Musician’s Friend” and “Music & Arts Center.” Some of our intellectual property is the subject of numerous United States and foreign trademark and service mark registrations. We believe our intellectual property has significant value and is an important factor in our marketing, our stores and our websites.

Available Information

We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, and its rules and regulations, which we collectively refer to as the Exchange Act. The Exchange Act requires us to file reports, proxy statements and other information with the Securities and Exchange Commission. Copies of these reports, proxy statements and other information can be read and copied at:

SEC Public Reference Room
450 Fifth Street, N.W.
Washington, DC 20549

The Securities and Exchange Commission maintains a website that contains reports, proxy statements and other information regarding issuers that file electronically with the Securities and Exchange Commission. These materials may be obtained electronically by accessing the home page of the Securities and Exchange Commission at http://www.sec.gov.

We make available free of charge on our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file these documents with or furnish them to the Securities and Exchange Commission. We also make available free of charge on our website the charters of the Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee, as well as the Corporate Governance

13

Guidelines and Code of Business Conduct and Ethics (including any amendment to or waiver from a provision of the Code of Business Conduct and Ethics) adopted by our Board of Directors.

References to our website addresses do not constitute incorporation by reference of the information contained on the websites, and such information is not part of this document.

Copies of any of the above-referenced information will also be made available, free of charge, by calling (818) 735-8800 or upon written request to:

Guitar Center, Inc.
Investor Relations
5795 Lindero Canyon Road
Westlake Village, CA 91362

Item 1A. RISK FACTORS

An investment in our securities involves a high degree of risk. Described below are some of the risks and uncertainties facing our company. There may be additional risks that we do not presently know of or that we currently consider immaterial. All of these risks could adversely affect our business, results of operations, liquidity and financial position. A shortfall in comparative sales growth in any period will likely cause a shortfall in earnings, and result in financial performance below that for which we have planned or the investment community expects.

We may be unable to meet our retail store growth strategy, which could adversely affect our results of operations.

Our retail store growth strategy includes opening and/or acquiring new stores in new and existing markets and increasing sales at existing locations. As of December 31, 2006, our wholly owned retail subsidiary operated 198 Guitar Center stores across the United States, with 134 primary format stores, 61 secondary format stores and 3 tertiary format stores. We presently expect to open approximately 16 to 19 new Guitar Center stores in 2007, consisting of 5 to 6 primary format stores, 9 to 11 secondary format stores and up to 2 tertiary format stores. As of December 31, 2006, we also operated 97 Music & Arts Center stores. Our retail growth strategy also involves increasing the number of Music & Arts Center stores through opening approximately 8 to 10 new stores in 2007.

Our planned store opening schedule may be affected by any acquisitions we may transact during a given period. If we complete any such transactions, our planned organic store openings may be reduced.

The success of our retail store expansion plans depends on many factors, including:

·identification of suitable retail sites and appropriate acquisition candidates;

·negotiation of acceptable lease terms;

·hiring, training and retention of skilled personnel;

·availability of adequate capital;

·sufficient management and financial resources to support the new locations;

·vendor support; and

·successful integration of newly-acquired businesses, including the Woodwind & Brasswind business.

A number of these factors are to a significant extent beyond our control. As a result, we do not know whether we will be able to continue to open and/or acquire additional Guitar Center and Music & Arts Center stores at the rates currently anticipated. If we are unable to achieve our retail store expansion goals, or the new stores do not perform to our level of expectations, our results of operations could be adversely

14

affected. During 2006, our new stores did not perform up to our expectations, and we cannot be assured that our new stores will meet our expectations in the future.

If we do not respond to rapid technological changes, our direct response and other e-commerce services could become obsolete and we could lose customers and our business could suffer.

If we face material delays in introducing new services, products and enhancements, our e-commerce customers may forego the use of our services and use those of our competitors. To remain competitive, we must continue to enhance and improve the functionality and features of our online stores and the efficiency and effectiveness of our advertising strategies, including evaluating and implementing effective search engine technologies, on-line advertising and affiliate programs. The Internet and the online commerce industry are rapidly changing. If competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing website and proprietary technology and systems may become obsolete. To develop our website and other proprietary technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards. In addition, our e-commerce operations may require greater efficiency, lower prices, expanded advertising requirements through search engines and other parties, and other competitive factors such as free shipping or extended warranties or return periods in order to compete successfully. Each of these factors could have an adverse effect on selling prices and margins in our business and generally constrain our profitability.

Our business could be adversely affected if we are unable to address unique competitive and merchandising challenges in connection with our plans to open additional Guitar Center and Music & Arts Center retail stores in new markets.

As part of our retail growth strategy, we plan to open and/or acquire additional Guitar Center and Music & Arts Center stores in new markets, which could include international markets. This expansion into new markets will present unique competitive and merchandising challenges, including:

·significant start-up costs, including promotion and advertising;

·higher advertising and other administrative costs as a percentage of sales than is experienced in mature markets that are served by multiple stores, particularly in large urban markets where radio and other media costs are high;

·management of stores in distant locations or foreign countries;

·availability of desirable product lines; and

·potential acquisitions of business lines in which we have limited or no experience.

Any of these factors may lead to a shortfall in revenues or an increase in costs with respect to the operation of these stores. If we are not able to operate these stores profitably, or to our expected level of performance, our results of operations could be adversely affected. During 2006, our new stores did not perform up to our expectations, and we cannot be assured that our new stores will meet our expectations in the future.

Our Guitar Center retail store expansion strategy, including our strategy of clustering retail stores, may adversely impact our comparable store sales.

Historically, we have achieved significant sales growth in existing Guitar Center stores. Our quarterly comparable stores sales results have fluctuated significantly in the past. Sales growth for comparable

15

periods, excluding net sales attributable to stores not open for 14 months, was as follows for our Guitar Center retail stores:

	2006			2005			2004
Quarter 1		6.3	%		5.3	%	11.0	%
Quarter 2		5.1			7.0		8.3
Quarter 3		2.9			6.9		9.0
Quarter 4		1.3			4.6		10.3
Full Year		3.7	%		5.8	%	9.7	%

We do not know whether our new stores will achieve sales or profitability levels similar to our existing stores. Our expansion strategy includes clustering stores in existing markets. Clustering has in the past and may in the future result in the transfer of sales to the new store and a reduction in the profitability of an existing store. In addition, a variety of factors affect our comparable store sales results, including:

·competition;

·economic conditions, including in particular discretionary consumer spending;

·consumer and music trends;

·changes in our merchandise mix;

·product distribution; and

·timing and effectiveness of our promotional events.

A shortfall in comparative sales growth in any period will likely cause a shortfall in earnings, and result in financial performance below that for which we have planned or the investment community expects.

Our failure to maintain and expand our direct response distribution center could adversely impact our business.

The lease for our direct response distribution center expires in August 2007. We are currently developing a larger facility to replace and expand our direct response distribution capabilities to coincide with the expiration of the lease on our current facility. This expansion also is expected to require a significant capital commitment Our failure to complete this transition on time and on budget may result in the need for us to expend additional capital and may impair the efficient operation of our distribution system. In addition, moving our distribution operations to a new facility will result in overlapping operations and duplicative costs during the transition period. In the event the transition does not proceed as planned, these duplicative costs could substantially exceed our budgeted expectations. These events could materially adversely impact our business, results of operations, financial condition and prospects.

Our inability to address the special risks associated with acquisitions could adversely impact our business.

We believe that our expansion may be accelerated by the acquisition of existing music product retailers, such as our acquisition in February 2007 of Woodwind & Brasswind. We regularly investigate acquisition opportunities complementary to our Guitar Center, Musician’s Friend and Music & Arts Center businesses. Accordingly, in the ordinary course of our business, we consider, evaluate and enter into negotiations related to potential acquisition opportunities. We may pay for these acquisitions in cash or securities or a combination of both. There is no assurance that attractive acquisition targets will be available at reasonable prices or that we will be successful in any such transaction. Acquisitions involve a number of special risks, including:

·diversion of our management’s attention;

16

·integration of acquired businesses with our business; and

·unanticipated legal liabilities and other circumstances or events.

The failure to identify complementary acquisitions, the failure to obtain favorable pricing on those acquisitions or the occurrence of any special risks involved in acquisitions could have a material adverse effect on our ability to achieve our growth strategy, and our results of operations could be materially affected as a result.

Our acquisition of the Woodwind & Brasswind business is subject to additional risks. We acquired the assets of this business pursuant to a bankruptcy proceeding, and at the time of the acquisition the business was experiencing declining revenue, was not profitable and had substantially lower initial order fill rates and longer order fill times than we experience with our existing direct response business. In addition to the normal challenges associated with an acquisition described above, we face the challenge of restoring customer loyalty and customer service levels that may have been lost as a result of the financial and operational condition of the business prior to the acquisition. During the transition period during which this business is integrated into our existing direct response business, we will be subject to a variety of duplicative costs and systems, including lease payments, technology platforms and payment systems. We also expect to make a substantial additional investment in this business to restore its inventory levels to those necessary to properly support the business. As a result of these factors and the general condition of the business, we expect that this acquisition will be dilutive to the earnings of our direct response business for the near term. We cannot assure you as to when or what extent this business will become accretive to our financial results. Our failure to have properly identified the strategy that is necessary for this business to achieve profitability, and our failure to execute on that strategy and successfully face the challenges associated with this acquisition, could have a material adverse effect on our results of operations and prospects and could result in a poor or no return on our investments in this business.

Our failure to develop and implement critical new systems for our business could adversely impact our business.

We are in the process of developing and implementing a data warehouse, new point-of-sale system and data center infrastructure for our Guitar Center stores as well as a new multi-channel retail system and warehouse managment system for our direct response business. The development and implementation of these initiatives requires significant management attention and capital resources. Our failure to effectively develop and implement these initiatives on a timely basis could lead to the distraction of our management and the need to expend additional capital resources. Such a failure could reduce the quantity or quality of operating data available to our management necessary to run our business efficiently and as a result could adversely impact our business, results of operations, financial condition and prospects.

We must efficiently manage the expansion of our direct response business in order to service our customers properly, otherwise our business could be adversely affected.

Our direct response business, particularly our e-commerce business, requires significant investments to respond to anticipated growth and competitive pressures. If we fail to rapidly upgrade our website in order to accommodate increased traffic, we may lose customers, which would reduce our net sales. Furthermore, if we fail to expand the computer systems that we use to process and ship customer orders and process payments and the fulfillment facilities we use to manage and ship our inventory, we may not be able to successfully distribute customer orders. We may experience difficulty in improving and maintaining such systems if our employees or contractors that develop or maintain our key systems become unavailable to us. We have experienced periodic service disruptions and interruptions, which we believe will continue to occur, while enhancing and expanding these systems.

17

We depend on a relatively small number of manufacturers, suppliers and common carriers, and their inability to supply our requirements could adversely impact our business.

Brand recognition is of significant importance in the retail music products business. There are a relatively small number of high quality, recognized brand names in the music products business. We depend on this relatively small number of manufacturers and suppliers for both our existing retail stores and our direct response business. We do not have any long-term contracts with our suppliers and any failure to maintain our relationships with our key brand name vendors would have a material adverse effect on our business.

A number of the manufacturers of the products we sell are limited in size and manufacturing capacity and have significant capital or other constraints. These manufacturers may not be able or willing to meet our increasing requirements for inventory, and we cannot be assured that there will be sufficient quantities or the appropriate mix of products available in the future to supply our existing stores and expansion plans. These capacity constraints could lead to extended lead times and shortages of desirable products. The risk is especially prevalent in new markets where our vendors have existing agreements with other dealers and may be unwilling or unable for contractual or other reasons to meet our requirements.

The efficient operation of our distribution center for the Guitar Center stores is also highly dependent upon compliance by our vendors with precise requirements as to the timing, format and composition of shipments, which in many instances require changes and upgrades to the operational procedures and logistics and supply chain management capabilities of our vendors, all of which are outside of our control. Additionally, many of our vendors receive product from overseas and depend on an extensive supply chain including common carriers and port access to transport merchandise into the country. Foreign manufacturing is subject to a number of risks, including political and economic disruptions, the imposition of tariffs, quotas and other import or export controls and changes in governmental policies.

We rely on common carriers to transport product from our vendors to our central distribution center in Indianapolis, Indiana and from the distribution facility to our Guitar Center stores. Similarly, Musician’s Friend relies on common carriers to transport product to its fulfillment center in Kansas City, Missouri and from the fulfillment center to customers. A disruption in the services of common carriers due to weather, employee strikes or other unforeseen events could impact our ability to maintain sufficient quantities of inventory in our retail locations or to fulfill orders by direct response customers.

Significant existing and new competition in our industry could continue to adversely affect our retail business.

The retail music products industry is fragmented and highly competitive. We compete with many different types of music product retailers, including conventional retailers, as well as other catalog and e-commerce retailers, who sell many or most of the items we sell. We believe that large format music product retailers such as our company will seek to expand in part through the acquisition of small, independently owned stores or franchises, and we anticipate increased competition in our existing markets and planned new markets from these consolidating retailers. These retailers may identify target companies or execute their acquisition strategies more effectively than our company. In addition, these retailers may have greater financial resources than us or other competitive advantages. Our expansion to new markets will be inhibited by these and other established competitors. In addition, one or more of our competitors may adopt a new, innovative store format or retail selling method. If we are not able to compete effectively, we may fail to achieve market position gains or may lose market share.

A number of large mass merchants, including Wal-Mart, Best Buy, Target and Costco, sell musical instruments in categories that we compete in, including entry-level guitars, electronic keyboards and band instruments. Best Buy also operates a store-within-a-store concept for musical instruments which includes a significantly expanded selection of products. These retailers could represent a significant source of future

18

competition for our retail and direct response businesses, particularly if these retailers expand their product lines beyond entry-level merchandise.

We must successfully implement our business strategy for our Music & Arts Center business in order to reach profitability and earn an acceptable return on that business.

Historically, our Music & Arts Center business has not been profitable, and we had focused our efforts on significant incremental revenue growth, primarily through acquisitions, to attain profitability for this business. We have recently determined we should focus our immediate efforts on the removal of costs from the business, improving operating efficiencies and reducing working capital needs, rather than significant incremental growth. As a consequence, we plan for the immediate future to reduce our continued investment in this business and to moderate its growth. Most of our anticipated revenue growth for 2007 is planned to come from the inclusion of acquired companies for a full year and the opening of several new stores, principally in Texas. We do not expect to complete any additional acquisitions for this division in 2007. We believe that the success of these new initiatives is critical in allowing this business to attain and sustain profitability. Our failure to have properly identified the strategy that is necessary for this business to achieve profitability, and our failure to execute on the requirements of the initiatives we have identified could have a material adverse effect on our results of operations and prospects and could result in a poor or no return on our investments in this business. In 2006, we recorded an impairment charge related to the write down of goodwill associated with the Music & Arts Center business. If we are unable to favorably change the performance of this business, there may be write downs of the goodwill associated with future acquisitions by this business, or possibly associated with other long-lived assets of this business.

Our Music & Arts Center business is dependent on state and local funding of primary and secondary schools, and decreases in funding could adversely affect our Music & Arts Center business.

Our Music & Arts Center business derives the majority of its revenue from sales or services to music students enrolled in primary and secondary schools. Any decrease in the state and local funding of such music programs could have a material adverse effect on our Music & Arts Center business and its results of operations.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results, and as a result, current and potential stockholders could lose confidence in our financial reporting, which could have a negative market reaction.

Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, requires our management to report on, and our independent registered public accounting firm to attest to, the effectiveness of our internal control over financial reporting. We have implemented an ongoing program to perform the system and process evaluation and testing necessary to continue to comply with these requirements. Accordingly, we must continue to incur significant expenses and devote management resources to Section 404 compliance as necessary. Further, effective internal controls and procedures are necessary for us to provide reliable financial reports. If our internal controls and procedures become ineffective, we may not be able to provide reliable financial reports, and our business and operating results could be harmed.

Our retail operations are concentrated in California, which ties our financial performance to events in that state.

As of December 31, 2006, our corporate headquarters as well as 27 of our 198 Guitar Center stores were located in California. Although we have opened and acquired stores in other areas of the United States, a significant percentage of our net sales and results of operations will likely remain concentrated in California for the foreseeable future. As a result, our results of operations and financial condition are heavily dependent upon general consumer trends and other general economic conditions in California and

19

are subject to other regional risks, including earthquakes. We do maintain earthquake insurance, but such policies carry significant deductibles and other restrictions.

We may be adversely impacted if our security measures fail.

Our relationships with our customers may be adversely affected if the security measures that we use to protect their personal information, such as credit card numbers, are ineffective. We primarily rely on security and authentication technology that we license from third parties. With this technology, we perform real-time credit card authorization and verification with our bank and we are subject to the customer privacy standards of credit card companies. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect our customers’ personal information, and such breaches could lead to loss of confidence of customers or significant fines from credit card companies or regulatory agencies. Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. There is no assurance that we can prevent security breaches or systems failures.

We depend on key personnel including our senior management who are important to the success of our business.

Our success depends to a significant extent on the services of members of our senior management. The loss of one or more of these individuals or other key personnel could have a material adverse effect on our business, results of operations, liquidity and financial position. Historically, we have promoted employees from within our organization to fill senior operations, sales and store management positions. In order to achieve our growth plans, we depend upon our ability to retain and promote existing personnel to senior management, and we must attract and retain new personnel with the skills and expertise to manage our business. If we cannot hire, retain and promote qualified personnel, our business, results of operations, financial condition and prospects could be adversely affected.

Economic conditions or changing consumer preferences could adversely impact us.

Our business is sensitive to consumer spending patterns, which can be affected by prevailing economic conditions. We believe that the musical instruments industry currently is experiencing a cyclical slowdown, and we cannot predict with accuracy the duration or extent of the slowdown. In addition, a general downturn in economic conditions in one or more of our markets, such as occurred after September 11, 2001, could have a material adverse effect on our results of operations, financial condition, business and prospects. Although we attempt to stay informed of consumer preferences for musical products and accessories typically offered for sale in our stores, any sustained failure on our part to identify and respond to trends would have a material adverse effect on our results of operations, financial condition, business and prospects.

If our products contain defects, our business could be harmed significantly.

Products that we develop or sell may expose us to liability from claims by users of those products for damages, including bodily injury or property damage. This risk is expected to increase as we use the capabilities of our Guitar Center and Musician’s Friend distribution centers to increase the private label and other proprietary products that we offer. Many of these products are manufactured by small companies located overseas. We currently maintain products liability insurance coverage in amounts that we believe are adequate. However, there can be no assurance that we will be able to maintain adequate coverage or obtain additional coverage on acceptable terms in the future, or that insurance will provide adequate coverage against all potential claims. Liability from claims of users of our products could result in

20

damage to our reputation and sales, and our failure to maintain adequate products liability insurance could adversely impact our financial condition.

We may need to change the manner in which we conduct our business if government regulation or taxation imposes additional costs and adversely affects our financial results.

The adoption or modification of laws or regulations, or revised interpretations of existing laws, relating to the direct response industry could adversely affect the manner in which we currently conduct our e-commerce and catalog business and the results of operations of that unit. For example, laws and enforcement practices related to the taxation of catalog, telephone and online commercial activity, including the collection of sales tax on direct response sales, remain in flux. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, consumer privacy, sales-based and other taxation of e-commerce transactions and the like are interpreted and enforced. Any adverse change in any of these laws or in the enforcement, interpretation or scope of existing laws could have a material adverse effect on our results of operations, financial condition or prospects.

We face risks created by litigation, governmental proceedings, labor disputes or environmental matters.

Historically, we have been involved in a variety of lawsuits. Current and future litigation that we may face may result in substantial costs and expenses and significantly divert the attention of our management regardless of the outcome, and an unfavorable resolution could have a material adverse effect on our business, financial condition and results of operations. In addition, current and future litigation, governmental proceedings, labor disputes or environmental matters could lead to increased costs or interruptions of our normal business operations.

Our hardware and software systems are vital to the efficient operation of our retail stores and direct response business, and damage to these systems could harm our business.

We rely on our computer hardware and software systems for the efficient operation of our retail stores and direct response business. Our information systems provide our management with real-time inventory, sales and cost information that is essential to the operation of our business. Due to our number of stores, geographic diversity and other factors, we would be unable to generate this information in a timely and accurate manner in the event our hardware or software systems were unavailable. These systems are vulnerable to damage or interruption from a number of factors, including earthquake, fire, flood and other natural disasters and power loss, computer systems failure, or security breaches, Internet and telecommunications or data network failure.

A significant information systems failure could reduce the quality or quantity of operating data available to our management. If this information were unavailable for any extended period of time, our management would be unable to efficiently run our business, which would result in a reduction in our net sales.

Any failure by us to maintain compliance with credit facility covenants could have a material adverse impact on our business.

A significant decrease in our operating results could adversely affect our ability to maintain compliance with required covenants under our credit facility. If these covenants are not complied with, our

21

lenders will have the option to require immediate repayment of all amounts outstanding under the credit facility, if any, or may limit future borrowings under the credit facility. The most likely result would require us to renegotiate certain terms of the credit agreement, obtain a waiver from the lenders, or obtain a new credit agreement with another group of lenders, which may contain different terms or may not be available at all. A failure to maintain, renegotiate or replace our credit facility could materially impact our liquidity.

The volatility of our stock price could affect the value of an investment in our common stock.

The market price of our common stock has been subject to significant fluctuations in response to our operating results and other factors, including announcements by our competitors, and those fluctuations will likely continue in the future. In addition, the stock market in recent years has experienced significant price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of particular companies. These fluctuations, as well as a shortfall in sales or earnings compared to public market analysts’ expectations, changes in analysts’ expectations, changes in analysts’ recommendations or projections, and general economic and market conditions, may adversely affect the market price of our common stock.

Our actual operating results may differ significantly from our projections.

From time to time, we release projections and similar guidance regarding our future performance that represent our management’s estimates as of the date of release. These projections, which are forward-looking statements, are prepared by our management and are qualified by, and subject to, the assumptions and the other information contained or referred to in the release. Our projections are not prepared with a view toward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our registered public accountants nor any other independent expert or outside party compiles or examines the projections and, accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.

Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions with respect to future business decisions, some of which will change. We generally state possible outcomes as high and low ranges which are intended to provide a sensitivity analysis as variables are changed but are not intended to represent that actual results could not fall outside of the suggested ranges. The principal reason that we release this data is to provide a basis for our management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by any such persons.

Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions of the projections furnished by us will not materialize or will vary significantly from actual results. Accordingly, our projections are only an estimate of what management believes is realizable as of the date of release. Actual results will vary from the projections and the variations may be material. Investors should also recognize that the reliability of any forecasted financial data diminishes the farther in the future that the data is projected. In light of the foregoing, investors are urged to put the projections in context and not to place undue reliance on them.

Any failure to successfully implement our operating strategy or the occurrence of any of the events or circumstances set forth in this report could result in the actual operating results being different than the projections, and such differences may be adverse and material.

Item 1B. UNRESOLVED STAFF COMMENTS

None.

22

Item 2. PROPERTIES

Our corporate office, which also serves as the headquarters for our Guitar Center Retail business, is located in Westlake Village, California and consists of 173,000 aggregate square feet of both leased and owned property. Approximately 69,000 square feet are under a lease agreement expiring in April 2009. The remaining square footage, comprised of office and warehouse space, provides growth space for our corporate staff. The distribution center for our Guitar Center stores is located in a leased facility in the Indianapolis, Indiana area, which was expanded from 505,000 to 773,000 square feet in 2006. The lease term expires in December 2018.

Our direct response business is headquartered in a facility of 45,000 square feet that we own located in Medford, Oregon. We lease approximately 25,500 square feet of office space in Salt Lake City, Utah, for our direct response customer contact center facility. This lease expires in December 2008. We lease facilities with approximately 473,000 of aggregate square footage under agreements expiring through August 2007 for use as a distribution center for our direct response division in Kansas City, Missouri. In March 2006, we entered into an agreement to lease a new distribution facility of approximately 702,000 square feet located in Kansas City, Missouri, which is expected to be placed in service in the second half of 2007. Rental payments for the new distribution center commence in February 2007. The current distribution center facilities will be closed upon the opening of the new facility. In February 2007, we entered into leases for an office, retail outlet and warehouse facility and a distribution center facility relating to our Woodwind & Brasswind business, with terms of 24 months and 18 months, respectively. Both of these facilities are in South Bend, Indiana. The office, retail outlet and warehouse facility is approximately 122,000 square feet and the distribution center facility is approximately 220,000 square feet.

Our Music & Arts Center business is headquartered in a leased facility located in Frederick, Maryland. The lease for this property expires in December 2012. We also lease a distribution facility of approximately 60,000 square feet in Frederick, Maryland with a lease expiration of February 2009 and call center facilities of approximately 5,000 aggregate square feet in Liverpool, New York and Horsham, Pennsylvania. The leases for these facilities expire in September 2010 and June 2009, respectively. Additionally, we lease approximately 176,000 square feet of warehouse hub space throughout the United States. The initial lease terms for our warehouses typically range from one to five years.

Store Locations

In connection with our retail business, as of December 31, 2006, we operated 198 Guitar Center stores consisting of approximately 2,899,000 square feet, consisting of 2,845,000 square feet under lease agreements and approximately 54,000 square feet of owned property. The initial lease terms for our Guitar Center retail stores typically range from 10-15 years and allow us to renew for two additional five-year terms. As of December 31, 2006, we operated 97 Music & Arts Center stores consisting of approximately 368,000 square feet, all under lease agreements. The initial lease terms for our Music & Arts Center retail stores typically range from 5-10 years and allow us to renew for one additional five-year term. Most of the leases require us to pay property tax, utilities, normal repairs, common area maintenance and insurance expenses.

23

The table below sets forth the location and opening date for our Guitar Center and Music & Arts Center retail stores as of December 31, 2006:

Store	Year Opened
Guitar Center Stores
Alabama
Mobile		2004
Birmingham		2005
Montgomery		2006
Arizona
Phoenix		1997
Tempe		1997
Tucson		2001
Scottsdale		2003
Arkansas
Little Rock		2002
Southern California
Hollywood		1964
San Diego		1973
Fountain Valley		1980
Sherman Oaks		1982
Covina		1985
Southbay		1985
San Bernardino		1993
Brea		1995
San Marcos		1996
Rancho Cucamonga		1999
El Toro		1999
Oxnard		2000
Bakersfield		2000
Palmdale		2001
Pasadena		2002
Cerritos		2003
Northridge		2005
Murrieta		2006
Northern California
San Francisco		1972
San Jose		1978
El Cerrito		1983
Concord		1996
Fresno		2000
Sacramento		2000
Modesto		2001
Gilroy		2006
Roseville		2006
Colorado
Denver		1998
Englewood		1998
Arvada		1999
Colorado Springs		2002
Pueblo		2005
Connecticut
Manchester		1999
Orange		2002
New London		2006
Florida
North Miami area		1996
South Miami area		1996
West Palm Beach		2001
Orlando		2002
Lakeland		2003
Tampa		2003
Ft. Myers		2004
Orlando		2005
Jacksonville		2005
Tallahassee		2005
Pensacola		2005
Clearwater		2006
Georgia
Atlanta		1997
Marietta		1997
Lawrenceville		2004
Fayetteville		2006
Idaho
Boise		2001
Illinois
South Chicago		1979
North Chicago		1981
Central Chicago		1988
Villa Park		1996
Highland Park		2001
Peoria		2004
Naperville		2004
Rockford		2006
Country Club Hills		2006
Algonquin		2006
Joliet		2006
Fairview Heights		2006
Indiana
Indianapolis		2001
Hobart		2003
South Bend		2004
Ft. Wayne		2005
Terre Haute		2006
Evansville		2006
Greenwood		2006

24

Iowa
Des Moines	2005
Davenport	2006
Kansas
Wichita	2005
Overland Park	2005
Kentucky
Lexington	2006
Louisiana
New Orleans	1999
Baton Rouge	2004
Maine
Portland	2006
Maryland
Towson	1998
Rockville	2000
Glen Burnie	2004
Massachusetts
Boston	1994
Danvers	1996
Natick	1997
N. Attleboro	1998
Millbury	2006
Michigan
Detroit	1994
Southfield	1996
Canton	1998
Grand Rapids	2002
Saginaw	2003
Kalamazoo	2004
Flint	2005
Allen Park	2006
Minnesota
Twin Cities	1988
Edina	1997
Mississippi
Jackson	2005
Missouri
N. St. Louis	1999
Bridgeton	1999
Independence	2005
Nebraska
Lincoln	2006
Nevada
Las Vegas	1998
Summerlin	2005
Reno	2006
New Hampshire
Nashua	2004
New Jersey
Springfield	1998
E. Brunswick	1998
Totowa	1999
Paramus	1999
Cherry Hill	2001
Atlantic City	2002
New Mexico
Albuquerque	2004
New York
Carle Place	1998
Queens	1999
Larchmont	1999
Commack	2000
Buffalo	2000
Rochester	2001
Albany	2003
Manhattan	2003
Syracuse	2005
Brooklyn	2005
North Carolina
Charlotte	2002
Raleigh	2002
Durham	2006
Greensboro	2006
Ohio
Cleveland	1997
Mayfield Heights	1998
Cincinnati	1998
Columbus	2002
Toledo	2004
Akron	2005
Youngstown	2005
Dayton	2006
Oklahoma
Oklahoma City	2000
Tulsa	2005
Oregon
Medford	1987
Eugene	1996
Clackamas	2000
Beaverton	2000
Pennsylvania
Philadelphia	2000
Plymouth Meeting	2001
Monroeville	2001

25

Harrisburg	2003
Pittsburgh	2005
Allentown	2006
Rhode Island
Warwick	2003
South Carolina
Greenville	2005
Charleston	2005
South Dakota
Sioux Falls	2006
Tennessee
Knoxville	1998
Memphis	2003
Nashville	2003
Chattanooga	2005
Texas
Dallas	1989
Arlington	1991
South Houston	1993
North Houston	1994
Central Dallas	1998
Clearlake	1998
Austin	2000
Plano	2000
Corpus Christi	2002
Ft. Worth	2004
South Austin	2005
El Paso	2006
Lubbock	2006
South Antonio	2006
McAllen	2006
Laredo	2006
Brownsville	2006
Lewisville	2006
Beaumont	2006
Utah
Salt Lake City	1998
Ogden	2002
Virginia
Fairfax	1999
Seven Corners	1999
Virginia Beach	2000
Fredericksburg	2003
Richmond	2003
Washington
Tukwila	1997
Kirkland	1997
Seattle	1997
Lynnwood	1998
Tacoma	2001
Spokane	2001
Wisconsin
Brookfield	2004
Madison	2006
Appleton	2006
Music & Arts Center
Arizona
Phoenix	1987
Mesa	1995
Tucson	2004
North Tucson	2005
North Mesa	2006
East Gilbert	2006
East Mesa	2006
Colorado
Englewood	2000
Loveland	2001
Littleton	2002
Westminster	2002
Connecticut
East Hartford	1993
Avon	2002
Vernon	2003
West Hartford	2003
Waterford	2005
Fairfield	2006
Delaware
Wilmington	2000
Florida
Longwood	1986
Jupiter	1995
Jacksonville	2002
Georgia
North Fulton	1996
Lawrenceville	1997
Snellville	1997
Peachtree	2001
Valdosta	2002
Albany	2002
East Cobb	2004
Conyers	2006
Illinois
Naperville	2003
Itasca	2004
Massachusetts
Greenfield	1982

26

Peabody	2006
Newton Centre	2006
Milford	2006
Maryland
Bel Air	1993
Ellicott City	1994
Rockville	1994
Frederick	1996
Germantown	1997
Timonium	1997
Severna Park	1998
South Howard	1999
Hagerstown	2001
Bowie	2004
North Carolina
Burlington	2001
Cary	2003
Huntersville	2003
North Charlotte	2003
Charlotte	2005
New Hampshire
Manchester	2004
New Jersey
Marlton	2003
Princeton	2003
Nevada
Henderson	2002
Summerlin	2005
New York
Syracuse	1970
Pittsford	1975
New York Mills	1999
East Rochester	2006
North Syracuse	2006
Mamaroneck	2006
Lindenhurst	2006
Lake Grove	2006
Ohio
Hillard	2006
Marion	2006
Columbus	2006
Westerville	2006
Worthington	2006
Pennsylvania
Lancaster	1993
Plymouth Meeting	1994
Horsham	1998
Exton	2000
Doylestown	2004
Newton Square	2004
South Carolina
Columbia	1999
Spartanburg	2002
Charleston	2004
Tennessee
Murfreesbro	1993
Cool Springs	2001
Hendersonville	2002
Texas
Houston	2003
Shenandoah	2006
Virginia
Springfield	1989
Richmond	1990
Oakton	1991
Midlothian	1994
Virginia Beach	1995
Manassas	1997
McLean	1997
Kempsville	1998
Sterling	1998
Yorktown	1998
Woodbridge	1999
Chesapeake	2000
Baileys	2001
Burke	2002
Charlottesville	2002

Item 3. LEGAL PROCEEDINGS

On November 29, 2005, a case was filed against us and other defendants, including our Chief Executive Officer, in the United States District Court for the Southern District of Florida. The complaint asserts, among other things, violations of the Federal Racketeering Influenced and Corrupt Organization Act (RICO) and a corresponding Florida statute, Sections 1 and 2 of the Sherman Antitrust Act, Section 2 of the Clayton Act (as amended by the Robinson-Patman Act), the Antidumping Act of 1916, the Florida Antitrust Act of 1980, and the Florida Deceptive and Unfair Trade Practices Act, as well as tortious interference with business relationship under Florida law and civil conspiracy under Florida law by some or

27

all of the identified defendants in connection with the claimed inability of Ace Pro Sound and Recording, LLC to obtain vendor lines for its store. The complaint purports to be made as a class action on behalf of all current and former retail sellers of musical instruments and/or sound equipment and/or recording equipment with stores located in geographical regions in the United States wherein some or all of the defendants have carried on business, and seeks compensatory damages, treble damages, punitive damages, injunctive relief and attorneys fees. Service relating to the complaint was made on January 12, 2006. In May of 2006, defendants filed their motions to dismiss all claims contained in the amended complaint and currently the motion is pending before the court. While we believe this lawsuit is without merit and intend to defend it vigorously, it may, regardless of the outcome, result in substantial expenses and damages to us and may significantly divert the attention of our management. There can be no assurance that we will be able to achieve a favorable settlement of this lawsuit or obtain a favorable resolution of this lawsuit if it is not settled. An unfavorable resolution of this lawsuit could have a material adverse effect on our business, financial condition and results of operations. Regardless of the outcome, the costs and expenses incurred by us to defend this lawsuit could adversely impact our financial condition.

On December 6, 2006, a lawsuit named J. Kevin Snyder v. Guitar Center Stores, Inc. that is a putative class action was filed in Los Angeles Superior Court alleging violations of the Song-Beverly Credit Card Act, based upon Guitar Center’s allegedly unlawful point-of-sale credit card practices.

On January 11, 2007, a lawsuit named Michael Kuhl v. Guitar Center Stores, Inc. was filed by a Guitar Center sales associate as a putative class action in the United States District Court for the Northern District of Illinois. The lawsuit alleges violations of the Illinois Wage Payment and Collection Act and the Fair Labor Standards Act, based upon Guitar Center’s allegedly unlawful payroll deduction policies. The lawsuit has been brought on behalf of plaintiff and all former and current hourly employees in Illinois and nationwide.

We expect to defend these actions vigorously. However, these actions, regardless of the outcome, may result in substantial expenses and damages to us and may significantly divert the attention of our management. There can be no assurance that we will be able to achieve a favorable settlement of these lawsuits or obtain a favorable resolution if they are not settled. An unfavorable resolution of these lawsuits could have a material adverse effect on our business, financial condition and results of operations. Regardless of the outcome, the costs and expenses incurred by us to defend them could adversely impact our financial condition.

In addition to the lawsuits described above, we are involved in various claims and legal actions arising in the ordinary course of our business and, while the results of those proceedings cannot be predicted with certainty, we believe that the final outcome of those matters will not have a material adverse effect on our business, financial condition and results of operations.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fiscal quarter ended December 31, 2006.

28

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is quoted on the NASDAQ Global Select Market under the symbol “GTRC.” The following table sets forth the high and low closing sale prices for the common stock for the calendar quarters indicated:

	2006				2005
	High		Low		High		Low
First quarter	$	57.05	$	46.79	$	60.58	$	50.84
Second quarter	54.34		44.47		62.06		47.17
Third quarter	46.24		36.37		65.00		53.88
Fourth quarter	47.35		41.59		62.20		48.20

As of December 31, 2006, there were 491 stockholders of record, excluding the number of beneficial owners whose shares were held in street name. We believe that the number of beneficial holders is significantly in excess of such amount based on the security position listings we obtain from time to time for the purpose of facilitating mailings to our stockholders.

Dividend Policy

We have historically retained all earnings to provide funds for the operation and expansion of our business and for the servicing and repayment of indebtedness. Our Board of Directors intends to review this practice from time to time based on the capital, investment and debt service needs of our business. The terms of our credit facility with Wells Fargo Retail Finance, LLC and a syndicate of other lenders includes restrictive covenants which, among other things, prohibit the payment of cash dividends on our capital stock. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources. Any determination to pay cash dividends on the common stock in the future will be at the sole discretion of our Board of Directors.

29

Stock Performance Graph

The following graph compares our cumulative total stockholder return on the common stock (no dividends have been paid thereon) with the cumulative total return of (1) the S&P 500 Index and (2) the S&P Retail (Specialty) Index, from December 31, 2001 through December 31, 2006. The comparison assumes an investment of $100 on December 31, 2001 in our common stock and in each of the foregoing indices.

The historical stock market performance of the common stock shown below is not necessarily indicative of future stock performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Guitar Center, Inc., The S & P 500 Index
And The S & P Specialty Stores Index

This performance graph shall not be deemed ‘‘filed’’ with the SEC or subject to Section 18 of the Exchange Act, nor shall it be deemed incorporated by reference in any of our filings under the Securities Act of 1933, as amended.

30

Item 6. SELECTED FINANCIAL DATA

The selected data presented below under the captions “Income Statement Data” and “Balance Sheet and Other Data” for, and as of the end of, each of the years in the five-year periods ended December 31, 2006, are derived from the consolidated financial statements of Guitar Center, Inc. and subsidiaries, which financial statements have been audited by KPMG LLP, independent registered public accounting firm. The consolidated financial statements as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, and the report thereon, are included elsewhere in this annual report. The selected historical financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, our consolidated financial statements and the notes thereto included elsewhere in this annual report.

	Year ended December 31,
	2006			2005			2004			2003			2002
	(in thousands, except per share and operating data)
Income statement data:
Net sales	$	2,029,966		$	1,782,499		$	1,513,172		$	1,275,059		$	1,100,889
Cost of goods sold	1,435,963			1,262,097			1,087,899			931,014			810,474
Gross profit	594,003			520,402			425,273			344,045			290,415
Selling, general and administrative expenses	466,555			388,380			317,585			271,996			236,537
Goodwill impairment	80,160			—			—			—			—
Operating income	47,288			132,022			107,688			72,049			53,878
Interest expense, net	8,448			7,339			5,390			12,540			13,077
Gain on sale of property	2,115			—			—			—			—
Income before income taxes	40,955			124,683			102,298			59,509			40,801
Income taxes	40,531			48,005			38,873			22,649			15,545
Net income	$	424		$	76,678		$	63,425		$	36,860		$	25,256
Diluted net income per share	$	0.01		$	2.67		$	2.29		$	1.47		$	1.09
Diluted weighted average shares outstanding (1)	28,402			29,846			28,976			26,119			23,130
Operating data:
Guitar Center net sales per gross square foot (2)	$	580		$	599		$	585		$	560		$	546
Net sales growth	13.9		%	17.8		%	18.7		%	15.8		%	16.0		%
Increase in Guitar Center comparable store sales (3)	3.7		%	5.8		%	9.7		%	6.9		%	6.5		%
Guitar Center stores open at end of period	198			161			136			122			108
Ratio of earnings to fixed charges (4)	2.6x			6.5x			6.6x			3.5x			2.8x
Net cash provided by operating activities (thousands)	$	21,583		$	65,710		$	85,506		$	58,005		$	12,248
EBITDA (thousands) (5)	$	86,180		$	161,022		$	129,992		$	92,669		$	70,738
Balance sheet and other data:
Net working capital	$	326,539		$	287,098		$	269,859		$	198,713		$	110,825
Property and equipment, net	201,986			149,209			97,349			93,347			89,702
Total assets	927,478			780,190			574,593			460,871			452,399
Total long-term and revolving debt (including current portion)	103,134			132,266			100,000			100,000			149,590
Stockholders’ equity	542,737			404,817			306,682			214,171			154,928
Capital expenditures	84,417			75,493			26,151			24,245			26,309

(1)Weighted average shares represents shares calculated on a diluted basis. For the year ended December 31, 2006, 1.5 million shares of common stock issuable upon conversion of the 4% Senior Convertible Notes (the “Notes”) were deemed to be potential common stock but were excluded in the computation of net income per share as its

31

effect would be antidilutive. For the years ended December 31, 2005 and 2004, the common stock issuable upon conversion of the Notes amounted to 2.9 million shares. For the year ended December 31, 2003, the common stock issuable upon conversion of the Notes amounted to 1.6 million shares. The Notes were called for redemption by the Company on June 15, 2006 and substantially all of the outstanding Notes were converted into common stock prior to the July 15, 2006 redemption date. The diluted earnings per share for 2003 has been restated to conform to EITF 04-08, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.

(2)Net sales per gross square foot is a measure of sales efficiency based on square footage. This calculation is presented for Guitar Center retail stores only, excluding Music & Arts Center retail stores, and does not include new stores opened during the reporting period.

(3)Compares net sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of the latter reporting period. All references in this annual report to comparable store sales results are based on this calculation methodology. This calculation is presented for Guitar Center retail stores only, excluding Music & Arts Center retail stores.

(4)For the purpose of calculating the ratio of earnings to fixed charges, “earnings” represents income before provision for income taxes and fixed charges. “Fixed charges” consist of interest expense, amortization of debt financing costs, and one third of lease expense, which management believes is representative of the interest component of lease expense.

(5)Represents net income before interest expense, income taxes, and depreciation and amortization expense. The reconciliation from reported net income to EBITDA is as follows:

EBITDA	2006		2005		2004		2003		2002
Net income as reported	$	424	$	76,678	$	63,425	$	36,860	$	25,256
Income taxes	40,531		48,005		38,873		22,649		15,545
Interest expense	8,448		7,339		5,390		12,540		13,077
Depreciation and amortization	36,777		29,000		22,304		20,620		16,860
EBITDA	$	86,180	$	161,022	$	129,992	$	92,669	$	70,738

EBITDA is not a measure of financial performance under generally accepted accounting principles. We present EBITDA because many investors view this information as a useful measure of a company’s ability to generate cash flow and service debt or capital obligations, and some of our debt instruments have in the past and may in the future include covenants that use similar concepts. EBITDA should not, however, be considered as a substitute for measures determined under generally accepted accounting principles, such as net income and cash flow from operations. Further, the calculation of EBITDA varies from company to company and thus the amount that we calculated using the methodology described above may not be comparable to the amount of EBITDA reported by other companies.

32

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Guitar Center, Inc. is the leading United States retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment. As of December 31, 2006, our wholly owned retail subsidiary operated 198 Guitar Center stores across the United States, with 134 primary format stores, 61 secondary format stores and 3 tertiary format stores. In addition, as of December 31, 2006, our Music & Arts Center division operated 97 stores specializing in band instruments for sale and rental, serving thousands of teachers, band directors, college professors and students. We are also the largest direct response retailer of musical instruments in the United States through our wholly owned subsidiary, Musician’s Friend, Inc., and its catalogs and websites, www.musiciansfriend.com. www.guitarcenter.com, www.wwbw.com, www.music123.com and related websites. We acquired the www.wwbw.com and www.music123.com websites on February 9, 2007 when Musician’s Friend, Inc. acquired substantially all of the assets of the Dennis Bamber, Inc. and its chapter 11 bankruptcy estate, d/b/a The Woodwind and The Brasswind.

In 2006, we opened a total of 33 Guitar Center stores, including 12 primary format stores, 19 secondary format stores and 2 tertiary format stores. Additionally, we acquired 4 stores from Hermes Trading Company, Inc., a musical instruments retailer. We presently expect to open approximately 16 to 19 new Guitar Center stores in 2007, consisting of 5 to 6 primary format stores, 9 to 11 secondary format stores and up to 2 tertiary format stores.

As we enter new markets, we expect that we will initially incur higher administrative and promotional costs per store than is currently experienced in established markets. As we open multiple stores in markets, we expect that sales at new stores in a market may reduce sales at mature stores in that same market, to some extent. We expect competition to continue to increase as other music product retailers attempt to execute national growth strategies. Our business strategy will also emphasize opportunities to continue to grow each of our brands, including further acquisitions if attractive candidates can be located for reasonable prices.

From 2002 to 2006, our net sales grew at an annual compound growth rate of 16%, principally due to the comparable store sales growth of our Guitar Center retail stores averaging 6% per year, the opening of new stores, and a 20% per year increase in the direct response channel. We believe such volume increases are the result of the continued success of the implementation of our business strategy, continued growth in the music products industry and increasing consumer awareness of the Guitar Center, Musician’s Friend and Music & Arts Center brand names. Our Guitar Center and Music & Arts Center retail stores achieved comparable store sales growth of 3.4%, 5.4%, and 9.4% for the fiscal years ended December 31, 2006, 2005 and 2004, respectively. We believe this growth reflects the strength of our merchandise selection, effective advertising and promotion, and well-trained and committed personnel.

Financial Reporting Change

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), effective for a company’s first fiscal year beginning after June 15, 2005. SFAS No. 123(R) supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123(R) requires all share-based compensation to employees, including grants of employee stock options, to be recognized in the consolidated statements of income based on fair values rather than pro forma footnote disclosure.

33

Effective January 1, 2006, we adopted SFAS No. 123(R), and elected the modified prospective transition method. This method permits us to apply the new requirements on a prospective basis. Accordingly, our results for 2006 are not entirely comparable with prior years, because in 2006 we recognized $15.0 million ($9.3 million net of tax), or $0.33 per diluted share, of stock–based compensation expensed compared to zero in prior years. For additional information on our adoption of SFAS No. 123(R), see Note 9, Stock-Based Compensation, of the Notes to Consolidated Financial Statements in this annual Report on Form 10-K.

Executive Summary

Consolidated net sales in 2006 increased 13.9% to $2.0 billion from $1.8 billion in 2005. Consolidated net income in 2006 decreased 4.0% to $73.6 million, or $2.52 per diluted share, from $76.7 million, or $2.67 per diluted share, in 2005. Financial results were impacted by the recognition of stock-based compensation expenses, as required due to the adoption of SFAS No. 123(R), totaling $15.0 million, or $0.33 per diluted share, for the year ended December 31, 2006.

During 2006, our Guitar Center stores generated 3.7% comparable store sales growth and an increase of 13.6% in total net sales compared to 2005. Sales from new stores totaled $130.9 million and represented 73.1% of the overall increase in sales. In 2006, we opened 33 new Guitar Center stores and added 4 new stores via acquisition. We continue to face a challenging retail environment, which may adversely impact sales and operating margins trends for the foreseeable future.

Musician’s Friend, our direct response unit, generated an increase in net sales of 7.3% in 2006 compared to 2005. The increase in sales primarily reflects the improved leveraging of an expanding buyer file and advertising strategies. Gross profit margins increased by 8.7% in 2006 compared to 2005, reflecting a higher selling margin offset somewhat by reduced shipping and handling revenue resulting from the competitive environment. We continue to face increased competition in the direct response channel, which we expect to impact that segment’s net sales and gross margin for the foreseeable future. Early in 2007, we acquired out of a bankruptcy proceeding substantially all of the assets of Woodwind & Brasswind, a direct response retailer located in South Bend, Indiana. We expect this acquisition to be dilutive to earnings in 2007.

Net sales for our Music & Arts Center segment totaled $145.0 million for 2006 compared to $103.1 million for 2005. The increase in sales was primarily the result of our acquisition on April 15, 2005 of Music & Arts Center, Inc., a Maryland-based musical instrument retailer with an emphasis on the beginning musician. The acquired business was combined with our former American Music business into a new division of our retail store subsidiary that operates under the Music & Arts Center name. Financial results prior to April 15, 2005 for our Music & Arts Center business reflect only our former American Music stores and do not include results from the acquired business. However, comparable sales for the year are computed using the combined comparable sales of Music & Arts Center, Inc. and American Music stores. Comparable sales for the full year increased 0.7%. We saw gross margin increase to 43.3% in 2006 compared to 41.8% in 2005, primarily due to reduced shrink expense and higher selling margin partially offset by higher occupancy costs.

In the fourth quarter of 2006, the Music & Arts Center segment recorded an impairment charge of $80.2 million, or $73.2 million after-tax, or $2.49 per diluted share, related to the write down of goodwill. The determination to write down the goodwill at Music & Arts Center was a result of the segment’s current operating performance and our fourth quarter change in strategy to reduce future investments in the segment and slow down growth in future years. $57.0 million of the total write down of goodwill at Music & Arts Center is not deductible for federal income tax purposes and is also not deductible in certain states. This raised our effective income tax rate for the year to approximately 99.0%.

34

Discussion of Critical Accounting Policies

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ significantly from those estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Additionally, the policy described below regarding credits and other vendor allowances is unique to our industry and deserves the attention of a reader of our financial statements.

Valuation of Inventory

We value our merchandise inventory at the lower of cost using the weighted average method or market. Rental inventories are valued at the lower of cost or market using the specific identification method and are depreciated on a straight-line basis while out under a rental agreement for rent-to-own sales. We record adjustments to the value of inventory based upon obsolescence and changes in market value. Applicable costs associated with bringing inventory through our Guitar Center retail distribution center are capitalized to inventory. The amounts are expensed to cost of goods sold as the associated inventory is sold. Management has evaluated the current level of inventories considering future customer demand for our products, taking into account general economic conditions, growth prospects within the marketplace, competition, market acceptance of current and upcoming products, and management initiatives. Based on this evaluation, we have recorded impairment adjustments to inventory and to cost of goods sold for estimated decreases in net realizable value. These judgments are made in the context of our customers’ shifting needs, product and technological trends, and changes in the demographic mix of our customers. A misinterpretation or misunderstanding of these conditions and uncertainties in the future outlook of our industry or the economy, or other failure to estimate correctly, could result in inventory valuation changes as of any given balance sheet date.

Valuation of Long-Lived Assets

Long-lived assets such as property and equipment and identifiable intangibles with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Goodwill and other intangibles with indefinite lives that are not amortized are required to be reviewed for impairment on an annual basis, or more frequently when triggering events occur. Factors we consider important, which could trigger impairment, include, among other things:

·Significant underperformance relative to historical or projected operating results;

·Significant changes in the manner of our use of the acquired assets or the strategy of our overall business as well as the individual segments of the business;

·Significant negative industry or economic trends; and

·Significant decline in stock value for a sustained period.

For long-lived assets other than goodwill and intangibles that are not amortized, the determination of whether impairment has occurred is based on an estimate of undiscounted future cash flows attributable to the assets, as compared to the carrying value of the assets. Assumptions used in these cash flows are consistent with internal forecasts and consider current and future expected sales volumes and related operating costs and any anticipated increases or declines based on expected market conditions and local

35

business environment factors. If a potential impairment is identified, the amount of the impairment loss recognized would be determined by estimating the fair value of the assets and recording a loss if the fair value was less than the book value. Fair value will be determined based on appraisal values assessed by third parties, if deemed necessary, or a discounted future cash flows analysis. For goodwill and other intangibles that are not amortized, impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the related assets.

Our assessment regarding the existence of impairment factors is based on market conditions and the operational performance of our business. Our review of factors present and the resulting appropriate carrying value of our goodwill, intangibles and other long-lived assets are subject to judgments and estimates that management is required to make.

See Note 3, Goodwill and Intangible Assets, of the Notes to Consolidated Financial Statements in this annual report on Form 10-K.

Sales Returns

As part of our “satisfaction guaranteed” policy, we allow Guitar Center customers to return product generally within 30 days after the date of purchase, and we allow Musician’s Friend customers to return product within 45 days. Music & Arts Center customers have 30 days from the date of purchase to return product. We regularly review and revise, when deemed necessary, our estimates of sales returns based upon historical trends. While our estimates during the past few years have approximated actual results, actual returns may differ significantly from our estimates, either favorably or unfavorably, if factors such as economic conditions or the competitive environment differ from our expectations.

Credits and Other Vendor Allowances

We receive cooperative advertising allowances (i.e., an allowance from the manufacturer to subsidize qualifying advertising and similar promotional expenditures we make relating to the vendor’s products), price protection credits (i.e., credits from vendors with respect to in-stock inventory if the vendor subsequently lowers their wholesale price for such products) and vendor rebates (i.e., credits or rebates provided by vendors based on the purchase of specified products and paid at a later date). Cooperative advertising allowances are recognized as a reduction to selling, general, and administrative expense when we incur the advertising expense eligible for the credit. We recognized cooperative advertising allowances of $11.5 million, $10.1 million and $6.4 million for the years ended December 31, 2006, 2005 and 2004, respectively, recorded as an offset to selling, general and administrative expense. Price protection credits and vendor rebates are accounted for as a reduction of the cost of merchandise inventory and are recorded at the time the credit or rebate is earned. The effect of price protection credits and vendor rebates is recognized in the income statement at the time the related inventory is sold as a reduction in cost of goods sold. The reserve against rebates receivable is determined by specifically identifying uncollectible accounts through an aging review and an analysis of vendor relationships. We received payments for vendor rebates of $33.2 million, $30.6 million and $20.9 million for the years ended December 31, 2006, 2005 and 2004, respectively. We earned and recognized vendor rebates of $33.0 million, $28.3 million and $23.2 million for the years ended December 31, 2006, 2005 and 2004, respectively. None of these credits are recorded as revenue.

Stock-based Compensation

Effective January 1, 2006, we adopted SFAS No. 123(R) to account for our stock-based compensation plans. We elected the modified prospective method of adoption, which permitted application of the new requirements on a prospective basis. Accordingly, prior period amounts have not been restated. Under this application, stock-based compensation is recorded for all awards granted on or after the date of adoption and for the portion of previously granted awards that remain unvested at the date of adoption. Currently,

36

our stock-based compensation expense relates to stock options, our employee stock purchase program, performance share awards, restricted stock awards, and deferred stock awards.

Under SFAS No. 123(R), we determine the fair value of stock options, including options granted under our Employee Stock Purchase Plan (the “ESPP”), using a lattice-based binomial model. Assumptions used in the model were developed in consultation with an outside valuation specialist. The model requires the input of several assumptions including expected volatility, dividend yield, and risk-free rate of return, as well as certain assumptions regarding exercise behavior. Assumptions were developed separately for our senior management from the other participants of our stock plans, since senior management’s exercise behavior is expected to differ materially from the other participants. These assumptions reflect management’s best estimates, but they involve inherent uncertainties based on market conditions, generally outside of our control. As a result, if other assumptions were used, total stock-based compensation cost, as determined in accordance with SFAS No. 123(R) could have been materially impacted. Furthermore, if different assumptions are used for future grants, stock-based compensation could be materially impacted in future periods.

Also, under SFAS No. 123(R), stock-based compensation expense is recorded net of estimated forfeitures. The forfeiture rate assumption used in determining stock-based compensation expense is estimated based on historical data. The actual forfeiture rate could differ from these estimates.

Stock-based compensation expense related to performance share awards issued under our Long Term Incentive Plan (the “LTIP”) is estimated based on our forecasted performance compared to plan targets. At the end of each reporting period, we reevaluate our assessment of performance under the plan and make adjustments to the expense as necessary based on the latest estimates available. Under SFAS No. 123(R), the fair value of performance share awards is based on the market price of the Company’s stock on the date the underlying plan receives compensation committee approval, or other form of a mutual understanding of the key terms and conditions of performance.

Gift Cards

We sell gift cards to our customers in our Guitar Center retail stores and on-line. Revenue from gift card sales is recognized at redemption of the gift card. Our gift cards do not have expiration dates. Based on historical redemption rates, a certain percentage of gift cards will never be redeemed, which is referred to as “breakage.” Estimated breakage income is recognized as the remaining gift card values are redeemed and is recorded as a reduction of cost of goods sold.

Results of Operations

The following table presents our consolidated statements of income, as a percentage of sales, for the periods indicated:

	Fiscal year ended December 31,
	2006		2005		2004
Net sales	100.0	%	100.0	%	100.0	%
Gross profit	29.3		29.2		28.1
Selling, general and administrative expenses	23.0		21.8		21.0
Goodwill impairment	3.9		0.0		0.0
Operating income	2.3		7.4		7.1
Interest expense, net	0.4		0.4		0.3
Gain on sale of property	0.1		0.0		0.0
Income before income tax expense	2.0		7.0		6.8
Income taxes	2.0		2.7		2.6
Net income	0.0	%	4.3	%	4.2	%

37

Fiscal 2006 Compared to Fiscal 2005

Consolidated net sales for the year ended December 31, 2006 increased 13.9% to $2.030 billion, compared with $1.782 billion in 2005.

Net sales from Guitar Center stores for 2006 totaled $1.493 billion, a 13.6% increase from $1.314 billion in 2005. Net sales from new stores contributed $130.9 million and represented 73.1% of the total increase in retail store sales. Comparable Guitar Center store sales for the full year increased 3.7%. Comparable store sales are defined as sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of the reporting period. We believe that comparable store sales are a more useful indicator of store performance than the change in total net sales, since comparable store sales exclude the effects of changes in the number of stores open. We continue to face a challenging retail environment. We believe the musical instruments industry is experiencing a cyclical slowdown, and we cannot predict with accuracy the duration or extent of the slowdown.

On April 15, 2005, we completed our acquisition of Music & Arts Center, Inc., a Maryland-based musical instrument retailer with an emphasis on the beginning musician. The acquired business was combined with our former American Music business into a new division of our retail store subsidiary that operates under the Music & Arts Center name. Financial results for the period of January 1, 2005 through April 15, 2005 reflect only our former American Music stores and do not include results from the acquired business. However, comparable sales for the periods are computed using the combined comparable sales of Music & Arts Center, Inc. and American Music stores. Net sales from the Music & Arts Center segment for 2006 totaled $145.0 million compared to $103.1 million for 2005. The increase in net sales is primarily due to the acquisition of Music & Arts Center, Inc. on April 15, 2005 and acquisitions of other businesses in 2006. Combined comparable sales for the full year increased 0.7%.

Net sales from the Musician’s Friend segment for 2006 totaled $391.7 million, a 7.3% increase from $365.1 million in 2005. The increase primarily reflects the improved leveraging of an expanding buyer file and advertising strategies. We continue to face increased competition in the direct response channel, which we expect to impact that segment’s net sales and gross margin for the foreseeable future.

Consolidated gross profit for the year ended December 31, 2006 compared to 2005 increased 14.1% to $594.0 million from $520.4 million. Gross profit as a percentage of net sales for the year ended December 31, 2006 compared to 2005 increased to 29.3% from 29.2%. As discussed below, we define selling margin as net sales less the cost of the associated merchandise charged by the vendor plus the associated inventory costs from fulfilling inventory through our distribution center. The cost of merchandise inventory is net of all associated vendor discounts and rebates. Freight is not included in selling margin.

Gross profit as a percentage of net sales for the Guitar Center stores was 27.6% in 2006 compared with 28.0% in 2005. The decline in gross profit was primarily due to higher occupancy costs of 0.6% and higher freight expense of 0.1% partially offset by higher selling margin of 0.3%. The higher occupancy costs were primarily due to higher store rent and higher depreciation and amortization expense. Selling margin was benefited by a slight change in product mix, which consisted of more accessories sales and less used instrument sales in 2006 compared to 2005.

The gross profit margin for the Music & Arts Center segment was 43.3% for 2006 compared to 41.8% for 2005. The increase in gross margin was due to reduced shrink expense of 1.2% resulting from a change in estimate in rental instrument recoveries and higher selling margin of 0.6% partially offset by higher occupancy costs of 0.8%. The improved selling margin was driven by a change in product mix and better pricing under the Music & Arts Center business as compared to the former American Music business. During 2005, we discontinued our low margin institutional sales which are not part of our ongoing Music & Arts Center strategy. In addition, the 2005 results included a charge of $588,000 to cost of sales, or 0.6% of

38

sales, reflecting a reduction of the value of certain inventories previously in our American Music assortment that we discontinued upon the acquisition of Music & Arts Center, Inc.

Gross profit margin for the Musician’s Friend segment was 30.2% for the year ended December 31, 2006 compared to 29.8% in 2005. The increased gross margin was primarily due to higher selling margin of 1.3% partially offset by reduced shipping and handling revenue of 0.8% and higher purchasing costs of 0.1%. Reduced shipping and handling revenue resulted from expanded free freight offers due to increased online competition.

Consolidated selling, general and administrative (“SG&A”) expenses for 2006 increased 20.1% to $466.6 million from $388.4 million in fiscal 2005. As a percentage of net sales, selling, general and administrative expenses for 2006 increased to 23.0% from 21.8% in 2005. SG&A expenses were primarily impacted by the recognition of $15.0 million of stock-based compensation expenses in the current year consisting of expenses for stock options and other awards totaling $12.3 million, or 0.6% of sales, and expense under the LTIP totaling $2.7 million, or 0.1% of sales. The components of stock-based compensation for the year ended December 31, 2006 consisted of the following:

				As a % of
	Amount in			consolidated
	millions			net sales
Stock-based compensation expense for the year ended December 31, 2006:
Stock options and other awards for the year ended December 31, 2006		$	11.5		0.6	%
Acceleration of stock option vesting related to the retirement of our former Chief Financial Officer in February 2006		0.8			0.0	%
Total expense from options and other awards		12.3			0.6	%
Expense from LTIP		2.7			0.1	%
Total stock-based compensation expense		$	15.0		0.7	%

The stock-based compensation expense related to stock options, including the ESPP, and other awards was recorded as a result of the adoption of SFAS No. 123(R) effective January 1, 2006. Upon the retirement of our former Chief Financial Officer announced in February 2006, all of his remaining unvested options totaling 32,002 shares immediately vested. Pursuant to SFAS No. 123(R), stock-based compensation expense in the amount of $0.8 million was recorded due to the vesting acceleration. A total of $2.7 million of stock-based compensation expense related to the LTIP was recorded in the year ended December 31, 2006.

SG&A expenses for the Guitar Center stores segment for 2006 were 20.8% as a percentage of net sales compared to 19.9% in 2005. The increase was primarily due to higher expenses for stock-based compensation of 0.6%, advertising spend of 0.2%, credit card programs of 0.2%, and salaries of 0.1%, partially offset by lower legal and settlement costs of 0.2% primarily associated with expense in 2005 related to the settlement of a California wage and hour class action lawsuit.

SG&A expenses for the Music & Arts Center segment were 44.1% of net sales for 2006 compared to 47.9% for 2005. The reduction in expenses was primarily due to expenses totaling $2.8 million, or 2.7% of sales, recorded in 2005 related to the acquisition of Music & Arts Center, Inc. consisting of the elimination of a redundant point of sales system, severance costs, and moving costs to relocate certain American Music employees to the Music & Arts corporate office in Maryland. Excluding the prior year acquisition-related expenses, the SG&A expenses decreased by 1.0% of sales compared to the prior year, which was primarily due to improved leveraging on the higher revenue base of the combined businesses of Music & Arts Center, Inc. and American Music partially offset by higher expenses in stock-based compensation of 0.8%, higher professional fees of 0.5%, and increased advertising and promotional costs of 0.4%. Higher professional fees were primarily due to Sarbanes-Oxley Section 404 compliance efforts.

39

In the fourth quarter of 2006, the Music & Arts Center segment recorded an impairment charge of $80.2 million, or $73.2 million after-tax, or $2.49 per diluted share, related to the write down of goodwill. The determination to write down the goodwill at Music & Arts Center was a result of the segment’s current operating performance and our fourth quarter change in strategy to reduce future investments in the segment and slow down growth in future years.

SG&A expenses for the Musician’s Friend segment were 23.4% of sales for 2006 compared to 21.2% for 2005. The increase was primarily due to higher expenses for stock-based compensation of 1.3%, payroll costs of 0.6%, insurance of 0.2%, and depreciation and amortization of 0.2% partially offset by lower advertising spend of 1.2%. Higher payroll costs were driven by higher office and warehouse salaries. The lower advertising expense was primarily the result of reduced catalog circulation, offset somewhat by higher web-based marketing. Other smaller increases were experienced with tax-related audit expense, contract labor costs, computer maintenance expense, and credit card program expense.

Consolidated operating income decreased to $47.3 million in 2006 from $132.0 million in 2005. As a percentage of net sales, consolidated operating income declined to 2.3% from 7.4% in 2005. This decline reflects the goodwill impairment charge related to the Music & Arts Center of $80.2 million and the higher SG&A expenses resulting primarily from the recognition of stock-based compensation expenses in 2006.

Interest expense, net for 2006 increased to $8.4 million from $7.3 million in 2005. The increase is primarily due to higher borrowings under the revolving credit facility used primarily to fund the acquisition of Music & Arts Center, Inc. on April 15, 2005 and increased working capital requirements offset somewhat by reduced interest resulting from the conversion of the 4% senior notes in July 2006.

The gain on sale of property of $2.1 million recorded in 2006 resulted from the disposition of real estate made available by the relocation of a Guitar Center store.

For the year ended December 31, 2006, a $40.5 million provision for income taxes was recorded compared to $48.0 million in 2005, based on effective tax rates of approximately 99.0% and 38.5%, respectively. The significant increase in the 2006 effective tax rate was due to the $57 million non-deductible portion of the goodwill impairment charge. The remaining charges result from the treatment of incentive stock options under SFAS No. 123(R) offset somewhat by the reduction of a valuation allowance in 2006 of $0.8 million, or $0.03 per diluted share, related to a capital loss recorded in 2001.

Consolidated net income for 2006 decreased to $0.4 million from $76.7 million in 2005 as a result of the combinations of factors described above.

Fiscal 2005 Compared to Fiscal 2004

Consolidated net sales for the year ended December 31, 2005 increased 17.8% to $1.782 billion, compared with $1.513 billion in 2004.

Net sales from Guitar Center stores for 2005 totaled $1.3 billion, a 13.2% increase from $1.2 billion in 2004. Net sales from new stores contributed $85.3 million and represented 55.9% of the total increase in retail store sales. Comparable Guitar Center store sales for the full year increased 5.8%. Comparable store sales are defined as sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of the reporting period. We believe that comparable store sales are a more useful indicator of store performance than the change in total net sales, since comparable store sales exclude the effects of changes in the number of stores open.

The financial information of the Music & Arts Center segment for the year ended December 31, 2005 includes the results of American Music for the entire year and Music & Arts Center from the time of its acquisition on April 15, 2005 through December 31, 2005, while the 2004 results include only American Music. However, comparable store sales for the year ended December 31, 2005 is computed using the comparable store sales of American Music stores for the year ended December 31, 2005 combined with comparable store sales for the Music & Arts Center, Inc. stores for the period from April 15, 2005 through

40

December 31, 2005. Net sales from Music & Arts Center for 2005 totaled $103.1 million compared to $40.4 million in 2004. The increase in net sales is primarily due to the acquisition of Music & Arts Center, Inc. Comparable sales for only American Music locations decreased 16.1%, while comparable sales for only Music & Arts Center locations, increased 9.6%, resulting in the combined comparable sales decrease of 0.3%. Comparable sales decreased at American Music principally due to the reduction in low margin institutional sales which is not part of our ongoing Music & Arts Center strategy.

Net sales from the Musician’s Friend segment totaled $365.1 million in 2005, a $53.8 million, or 17.3%, increase from 2004. The increase primarily reflects the benefits from increased advertising, free freight incentives and improved leveraging of an expanding buyer file offset somewhat by competitors’ expanded free shipping programs and increased competition. We continued to face increased competition. Sales from the contact center, which represents sales placed via phone, live chat, mail and e-mail, increased 4.8% to $145.2 million in 2005 from $138.5 million in 2004. Internet sales from orders placed via the Musician’s Friend, Giardinelli and affiliate web sites increased 27.3% to $219.9 million in 2005 from $172.8 million in 2004. The growth of web-based sales reflects the continued trend of our catalog customers’ preference in using the web to place their orders, the success of web-based promotions and that the web site includes a more complete inventory presentation than our catalogs.

Consolidated gross profit for the year ended December 31, 2005 compared to 2004 increased 22.4% to $520.4 million from $425.3 million. Gross profit as a percentage of net sales for the year ended December 31, 2005 compared to 2004 increased to 29.2% from 28.1%.

Gross profit as a percentage of net sales for the Guitar Center stores was 28.0% compared with 26.7% for each of the years ended December 31, 2005 and 2004. The increase was due to higher selling margin of 1.2% and reduced freight of 0.1%. We define selling margin as net sales less the cost of the associated merchandise charged by the vendor plus the associated inventory costs from fulfilling inventory through our distribution center. The cost of merchandise inventory is net of all associated vendor discounts and rebates. Freight is not included in selling margin.

The gross profit margin for the Music & Arts Center segment was 41.8% for the year ended December 31, 2005 compared to 34.8% for the same period in 2004. The increase in gross profit margin was due to higher selling margin of 9.6% and reduced freight of 0.4%, offset by increased shrink of 1.4% and higher occupancy costs of 1.0%. During the second quarter of 2005, we recorded a charge of $0.6 million to cost of sales, or 0.6% of sales, for the Music & Arts Center division, reflecting a reduction of the value of certain inventories previously in our American Music assortment that we discontinued upon the acquisition of Music & Arts Center, Inc. Otherwise the improved selling margin was driven by a change in product mix and better pricing under the Music & Arts Center business as compared to the American Music business in 2004. We discontinued our low margin institutional sales which are not part of our ongoing Music & Arts Center strategy.

Gross profit margin for the Musician’s Friend segment was 29.8% for the year ended December 31, 2005 compared to 32.3% for the same period in 2004. The 2005 selling margin was significantly impacted by expanded free freight offers made during the year in response to the increased competition and due to lower selling margin driven by increased online competition.

Consolidated SG&A expenses for 2005 increased 22.3% to $388.4 million from $317.6 million in 2004. As a percentage of net sales, selling, general and administrative expenses for 2005 increased to 21.8% from 21.0% in 2004.

SG&A expenses as a percentage of sales for the Guitar Center segment for 2005 decreased to 19.9% from 20.2% in 2004. The decrease was primarily due to leveraging of our advertising spend of 0.3% and payroll costs of 0.2%, reduced bad debt of 0.1%, offset by higher legal and settlement costs associated with the settlement of a California wage and hour class action lawsuit of 0.2% and higher rent costs associated with the termination of two equipment leases of 0.1%.

41

SG&A expenses for Music & Arts Center segment were 47.9% of sales for 2005 compared to 46.2% for the same period in 2004. Excluding acquisition related charges of $2.8 million, selling, general and administrative expenses were 45.1% of sales for 2005 compared to 46.2% for the same period in 2004. The charge of $2.8 million represents the elimination of a redundant point of sales system, severance costs and moving costs to relocate certain American Music employees to the Music & Arts Center corporate office in Maryland. The decrease was due to improved leveraging on the higher revenue base of the combined businesses of Music & Arts Center and American Music. The reductions as a percentage of sales were in payroll of 2.2%, travel costs of 1.2%, supplies of 0.4%, computer maintenance of 0.3% and insurance of 0.4%, offset by higher advertising of 1.8%, amortization of intangibles of 0.7%, depreciation of 0.4%, credit card expense of 0.3%, and consulting fees of 0.2%.

SG&A expenses for the Musician’s Friend segment were 21.2% of sales for 2005 compared to 20.7% for the same period in 2004. The increase was driven by advertising expense related to programs to increase web traffic of 1.2%, offset by reduced credit card expense of 0.1%, reduced bad debt expense of 0.1%, leveraging of payroll of 0.3% and insurance costs of 0.1%, and lower consulting fees of 0.1%.

Consolidated operating income increased 22.6% to $132.0 million in 2005 from $107.7 million in 2004. This increase reflects the strong performance of the Guitar Center stores in 2005, with increased sales of 13.2%, increased gross profit as a percentage of sales of 1.3%, and leveraging of selling, general and administrative expenses as a percentage of sales by 0.3%, when compared to 2004. This was offset by a decline in the direct response operating income of $4.7 million, or down 13.0%, from 2005 compared to 2004. We experienced increased competition in our direct response unit, resulting in lower selling margins and higher marketing and advertising costs. The direct response unit gross profit as a percentage of sales decreased 2.5% while selling general and administrative expenses as a percentage of sales increased 0.5% for 2005 compared to 2004. Music & Arts Center operating loss as a percentage of sales improved from negative 11.4% of sales in 2004 to negative 6.1% of sales in 2005. Excluding acquisition related charges, Music & Arts Center operating loss as a percentage of sales was negative 2.7% of sales in 2005.

Interest expense, net for 2005 increased to $7.3 million from $5.4 million in 2004. The increase was primarily due to interest on borrowings related to the acquisition of Music & Arts Center, Inc., increased inventory levels at our Guitar Center retail stores and purchases of a corporate office building and other property and equipment.

For the year ended December 31, 2005, a $48.0 million provision for income taxes was recorded compared to $38.9 million for the same period in 2004, based on effective tax rates of approximately 38.5% and 38.0%, respectively. There was a change in the effective tax rate as a result of higher blended state income tax rates as well as $0.5 million in non-deductible costs associated with our California wage and hour class action settlement.

Consolidated net income for 2005 increased to $76.7 million from $63.4 million in 2004 as a result of the combinations of factors described above.

42

Liquidity and Capital Resources

Disclosures about Contractual Obligations and Commercial Commitments

The following table aggregates the material contractual obligations and commercial commitments that affect our financial condition and liquidity as of December 31, 2006 (in thousands):

	Payments due by period
			Less than		1-3		4-5		More than
Contractual obligations	Total		1 year		years		years		5 years
Line of credit	$	101,144	$	101,144	$		$		$
Capital lease obligation	1,749		583		1,166		—		—
Operating lease obligations (1)	362,148		58,805		100,762		73,742		128,839
Total	$	465,041	$	160,532	$	101,928	$	73,742	$	128,839

(1)Operating lease commitments consist principally of real property leases for our corporate offices, retail store facilities and distribution centers. These leases frequently include options which permit us to extend the terms beyond the initial fixed lease term. We also have rented personal property through operating leases. Payments for these lease commitments are provided for by cash flows generated from operations. Please see Note 7 to the consolidated financial statements.

Our need for liquidity will arise primarily from the funding of capital expenditures, working capital requirements and payments on our indebtedness, as well as possible acquisitions. We have historically financed our operations primarily through internally generated funds and borrowings under our credit facilities. Please see Item 1A. Risk Factors for a discussion of factors which could reasonably likely result in a decrease in the amount of internally generated funds available to finance capital expenditures and working capital requirements. As of December 31, 2006, we had $101.1 million in borrowings under our credit facility and had available borrowings of $102.6 million (net of $6.2 million of outstanding letters of credit).

On April 26, 2006, we entered into an amendment of our credit facility. The amendment increased the maximum borrowings available under the credit facility from $125 million to $200 million, subject to borrowing base limitations. The amendment allows for the increase of the maximum borrowings to $250 million at the option of the Company. As of December 31, 2006, we had elected to increase the maximum borrowings to $210 million. The amendment also extended the maturity date of the facility to December 2011, reduced the interest rate charged over the applicable index rates and increased the borrowing base as a percentage of working capital. Details of the amendment were included in the Current Report on Form 8-K we filed on April 26, 2006. The actual amount available is tied to our inventory and receivable base, and our obligations under the credit facility are secured by liens on our principal assets. Borrowing options are prime rate (8.00% at December 31, 2006) plus applicable prime margin, or London Interbank Offered Rate or LIBOR (12 month rate at December 31, 2006 was 5.33%), plus applicable LIBOR margin. The applicable prime and LIBOR margins are based upon levels of excess availability and adjusted quarterly. If excess availability is greater than $30 million, the applicable prime margin is -0.25% and applicable LIBOR margin is 0.75%. If excess availability is less than or equal to $30 million and greater than $15 million, the applicable prime margin is 0.00% and the applicable LIBOR margin is 1.00%. If excess availability is less than or equal to $15 million, the applicable prime margin is 0.00% and the applicable LIBOR margin is 1.25%. An unused fee of 0.25% is assessed on the unused portion of the credit facility. The agreement underlying the credit facility includes significant restrictive negative covenants. Among other things, these covenants restrict or prohibit our ability to incur debt and issue specified equity instruments, incur liens on our assets, make any significant changes in our corporate structure or the nature of our business, dispose of assets, make guaranties, prepay debt, engage in a change in control transaction, pay dividends, make investments or acquisitions, engage in transactions with affiliates and incur capital expenditures. The agreement also includes representations and warranties

43

which must be true each time we borrow funds under the credit facility and affirmative covenants. The full text of the contractual requirements imposed by this financing is set forth in the Amended and Restated Loan and Security Agreement and related amendments which have been filed with the Securities and Exchange Commission (“SEC”). Subject to limited cure periods, the lenders under our credit facility may demand repayment of these borrowings prior to stated maturity upon the occurrence of specified events, including if we breach the terms of the agreement, suffer a material adverse change, engage in a change in control transaction, suffer a significant adverse legal judgment, default on other significant obligations, or in the event of specified events of insolvency.

On June 16, 2003, we completed the issuance of $100 million principal amount of 4.00% Senior Convertible Notes (the “Notes”) due 2013. The Notes bore interest at the rate of 4.00% per annum, subject to the payment of contingent interest under certain circumstances commencing January 15, 2006, and were convertible into shares of common stock at a conversion price of $34.58 per share, subject to adjustment under specified circumstances.

On June 15, 2006, we called for redemption of all of our Notes. Holders were able to convert the Notes into shares of common stock at an effective conversion price of approximately $34.58 per share, in lieu of accepting redemption. Holders of substantially all of the outstanding Notes elected to convert their Notes into shares of the Company’s common stock. As a result of these conversions, approximately 2.9 million shares of common stock were issued to the holders that elected to convert their Notes. In connection with the redemption of the unconverted Notes, we paid approximately $3,000 in cash, which includes the redemption and premium payments and cash paid in lieu of fractional shares.

For the years ended December 31, 2006, 2005 and 2004, $562,000, $1.0 million and $1.0 million of amortization of deferred financing fees was included in interest expense. Unamortized deferred financing fees at December 31, 2006, 2005 and 2004 were $0.5 million, $2.5 million and $3.6 million and related accumulated amortization was $0.8 million, $2.1 million and $1.0 million, respectively.

During 2002 we entered into master operating lease agreements with US Bank to lease equipment and other property primarily to support the operations of the distribution center for our Guitar Center retail stores. Under these agreements, we leased a total of $10.5 million in equipment and other property.

The terms of our significant financing agreements, including those related to our credit facility, the Notes and the equipment lease facilities described above, are not dependent on any change in our credit rating. We believe that the key company-specific factors affecting our ability to maintain our existing debt and lease financing relationships and to access such capital in the future are our present and expected levels of profitability and cash flow from operations, our working capital and fixed asset collateral bases, our expected level of capital expenditures, and the level of our equity capital relative to the level of debt obligations. In addition, as noted above, our existing agreements include significant restrictions on future financings, including among others, limits on the amount of indebtedness that we may incur and whether or not such indebtedness may be secured by any of our assets.

As is the case with most multi-unit retailers, substantially all of the real property used in our business is leased under operating lease agreements. Please see Item 2. Properties and Note 7 to the Consolidated Financial Statements. We anticipate incurring increased rent expense starting in the first quarter of 2007 related to our new Musician’s Friend distribution center in Kansas City and our Woodwind & Brasswind operations in South Bend.

Net cash provided by operating activities was $23.3 million for the year ended December 31, 2006 compared to $65.7 million for the same period last year. The largest use of cash was an increase in inventories of $120.6 million. The increase in inventories was primarily due to the opening of 33 new Guitar Center retail stores, an increase in business volumes across all segments and fourth quarter 2006 sales below projected levels. The primary sources of cash were generated from the current period

44

operations and an increase in accounts payable of $32.0 million due mostly to higher business volumes and timing of payments.

Cash used in investing activities decreased to $106.3 million for the year ended December 31, 2006 compared to $157.8 million for the same period last year. The cash used in investing activities for the current year included $84.4 million of capital expenditures, comprised primarily of $45.0 million on new stores and remodels, $20.0 million on computer equipment purchases and $9.2 million related to the expansion of our distribution center facilities. Also, the Music & Arts Center division acquired businesses totaling $13.5 million for the current year. Also, our Guitar Center segment acquired four retail locations from Hermes Trading Company, Inc. for approximately $11.1 million.

Cash provided by financing activities totaled $83.6 million for the year ended December 31, 2006 compared to $46.1 million in the same period last year. The cash provided by financing activities was due to increased borrowings under the revolving line of credit to support business acquisitions, capital expenditures and working capital requirements. In addition, proceeds from the exercise of stock options provided $11.9 million (including $2.5 million in excess tax benefits that are reflected in cash flows from financing activities) and employee purchases of our common stock under the ESPP provided $2.4 million.

We believe that our current operating cash flow, working capital, cash on hand, borrowings available under our credit facility and other sources of liquidity we believe are available to us will be sufficient to meet our obligations in the ordinary course of business over the next 12 months, including capital expenditures and new store openings.

Our known capital resource and liquidity requirements for 2007 are expected to be primarily provided by net cash flow from operations and borrowings available under our credit facility. In addition, the moderation of our growth plans in 2007 by reduced Guitar Center Retail store openings and few Music & Arts Center acquisitions will provide us opportunity to generate incremental cash flows. We will continue to evaluate the best use of those cash flows, including possible changes in our capital structure.

Our known capital resource and liquidity requirements for 2007 are expected to be primarily provided by net cash flow from operations and borrowings available under our credit facility. Traditionally, we have experienced the largest use of cash from operating activities in the latter part of the third quarter and in the fourth quarter due to the build up of inventory to support the holiday season, resulting in additional borrowings under our line of credit.

Depending upon market conditions, we may also elect or be required to raise additional capital in the form of common or preferred equity, debt or convertible securities for the purpose of providing additional capital to fund working capital needs or continued growth of our existing business, or to refinance existing obligations or changes in our capital structure. Any such financing activity will be dependent upon many factors, including our liquidity needs, market conditions and prevailing market terms, and we cannot assure you that future external financing for us will be available on attractive terms or at all.

We intend to open additional stores in new and existing markets. Each new primary format Guitar Center store typically has required approximately $2.0 to $2.5 million in gross inventory. Historically, our cost of capital improvements for a primary format Guitar Center store has been approximately $1.2 million consisting of leasehold improvements, fixtures and equipment. We incur higher costs in some geographic areas, particularly the Northeast, and when we build a larger flagship store. We have developed secondary format Guitar Center stores to build in sites that we do not believe will support our primary format units. We have opened 61 secondary market stores between late 2000 and December 31, 2006. Our secondary format stores have typically required approximately $1.7 million to $2.0 million in gross inventory and approximately $0.9 million in capital improvements. We have opened three tertiary format stores between late 2005 and December 31, 2006 to serve smaller population centers. Our tertiary format stores have required approximately $1.0 million in gross inventory and approximately $0.6 million in capital

45

improvements. These capital expenditures reflect the increasing construction costs that we have been experiencing. We expect these increases to continue for the foreseeable future and these costs may increase above our expectations.

We are also anticipating additional capital and strategic investments related to improving our fulfillment facilities and upgrading our technology and systems, including an enterprise data warehouse, retail point of sale replacement, retail inventory management systems improvements and enterprise systems replacement for our direct response division. We also continue to make significant investments in information technology across our businesses and to incur costs and make investments designed to expand the reach of our businesses on the Internet. The costs of these initiatives and other investments related to our businesses will continue to be significant.

Throughout our history, we have primarily grown organically. However, we also believe there may be attractive opportunities to expand by selectively acquiring existing music products retailers or other complimentary businesses, if attractive opportunities can be identified. While we cannot provide assurance that we will complete any further acquisition transactions, in the ordinary course of our business we investigate and engage in negotiations regarding such opportunities. Acquisitions will be financed with cash on hand, drawings under our existing credit facilities, expansion of our credit facilities, issuance of debt or equity securities, or a combination, depending upon transaction size and market conditions, among other things.

New Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This Interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of FIN 48 to have a material effect on our consolidated financial statements.

In June 2006, the FASB ratified Emerging Issues Task Force issued Issue 06-3, “How Sales Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (“EITF 06-3”). EITF 06-3 requires a company to disclose its accounting policy (i.e., gross or net presentation) regarding the presentation of taxes within the scope of EITF 06-3. If taxes are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented. The guidance is effective for periods beginning after December 15, 2006. EITF 06-3 will not impact the method for recording these taxes in the consolidated financial statements as we have historically presented sales excluding these taxes.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. SAB 108 was effective as of the end of our 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108. The adoption of the provisions of SAB 108 had no impact on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously

46

concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on our operating income or net income.

Seasonality

Our business follows a seasonal pattern, peaking during the holiday selling season in November and December. Sales in the fourth quarter are typically significantly higher on a per store basis and through the direct response unit than in any other quarter. In addition, band rental season for our Music & Arts Center business starts in August and carries through mid-October, but that seasonality does not have a significant impact on our consolidated results.

Inflation

We believe that the relatively moderate rates of inflation experienced in recent years have not had a significant impact on our net sales or profitability. However, in 2007 we anticipate that rising steel, lumber, concrete, labor, fuel and freight costs may increase expenses related to opening, remodeling, operating and relocating our stores, expanding our Musician’s Friend distribution center and operating our business.

Forward-Looking Statements; Business Risks

This annual report contains forward-looking statements relating to, among other things, future results of operations, growth and investment plans, sales, trends in gross margin, growth in the Internet portion of our direct response business and other factors affecting growth in sales and earnings. Specific forward-looking statements are provided regarding our management’s current views regarding comparable store sales, new store openings, capital expenditure levels and the dates new facilities and systems will become operational. Statements regarding new store openings are based largely on our current expectations and are necessarily subject to associated business risks related to, among other things, the identification of suitable sites or acquisition opportunities, the timely construction, staffing and merchandising of those stores and other matters, some of which are outside of our control. Comparable store sales growth is highly dependent upon the state of the economy, the effectiveness of our sales and promotion strategies, and the effect of competition, including other national operators of music products stores attempting to implement national growth strategies. Statements regarding the dates new facilities and systems will become operational are dependent upon third parties and events beyond our control, such as the availability of third party consulting resources, construction delays, technology development delays and other events. Sales and earnings trends are also affected by many other factors including, among others, world and national political events, general economic conditions, the effectiveness of our promotion and merchandising strategies, changes in the music products industry, retail sales trends and the emergence of new or growing specialty retailers of music products.

In light of these risks, there can be no assurance that the forward-looking statements contained in this report will in fact be realized. The statements made by us in this report represent our views as of the date of this report, and it should not be assumed that the statements made herein remain accurate as of any future date. We do not presently intend to update these statements and undertake no duty to any person to affect any such update under any circumstances.

47

For further discussion of risks associated with our business, please see the discussion under the caption Item 1A. Risks Factors.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not have any assets or liabilities which, in our view, impose upon us significant market risk except for our credit facility which has a variable rate of interest generally consisting of stated premiums above LIBOR. At December 31, 2006, we had $101.1 million in outstanding borrowings under our credit facility. As short-term interest rates and the total level of borrowings under the facility fluctuate, the interest expense we incur on our credit facility will change resulting in either a positive or negative effect on our financial position, results of operations and cash flows. At this borrowing level for our credit facility, a one percentage point increase in interest rates would have an unfavorable impact on pre-tax earnings of $1.0 million on an annual basis. The primary interest rate exposure on the credit facility is based on LIBOR. We do not use derivative financial instruments in our investment portfolio. Historically, we have not carried significant cash balances and any cash in excess of our daily operating needs has been used to reduce our borrowings. Excess cash is generally invested in short-term, high quality interest bearing investments.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included at Item 15. Exhibits and Financial Statement Schedules.

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

Item 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the

48

Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2006.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during our most recent fiscal quarter end that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Guitar Center, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Controls Over Financial Reporting, that Guitar Center, Inc. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Guitar Center, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk

49

that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Guitar Center, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Guitar Center, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Guitar Center, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006, and the related financial statement schedule, and our report dated March 1, 2007 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.

/s/ KPMG LLP

Los Angeles, California
March 1, 2007

Item 9B. OTHER INFORMATION

Not Applicable

PART III

Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

We have adopted a code of business conduct and ethics, or code of conduct, containing general guidelines for conducting our business consistent with the highest standards of business ethics. The code of conduct is designed to qualify as a “code of ethics” within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder as well as under applicable rules of the Nasdaq Global Select Market. The code is available on the investor relations section of our website (www.guitarcenter.com), under subsection captioned “Corporate Governance.” To the extent required by law or the rules of the NASDAQ Global Select Market, any amendments to, or waivers from, any provision of the code will be promptly disclosed publicly. To the extent permitted by such requirements, we intend to make such public disclosure by posting the relevant material on the corporate governance page of the investor relations section of our website in accordance with SEC rules.

All additional information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders.

Item 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders.

50

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated by reference into our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders.

Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with our annual meeting of stockholders.

51

PART IV

Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)Documents filed as part of this Report:

1.     The following financial statements for the Company are included as part of this Report:

Index to Financial Statements Page 59

2.The following financial statement schedule for the Company is included as part of this Report:

Schedule II—Valuation and Qualifying Accounts Page II-1

All other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the financial statements.

(b)The Index and Exhibits, required to be filed by Item 601 of Regulation S-K are included with the Report. Management contracts and other compensation plans or arrangements required to be filed are identified on the attached Index with an asterisk (*).

52

Exhibit Number	Description
2.1	Agreement and Plan of Merger, dated as of February 8, 2005, by and among Guitar Center Stores, Inc., a Delaware corporation, GCSI Acquisition Corp., a Maryland corporation, Music & Arts Center, Inc., a Maryland corporation, and the common stockholders of Music & Arts Center, Inc. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated February 8, 2005).
3.1	Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.5 of the Company’s Registration Statement on Form S-1; Registration No. 333-20931).
3.2	Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2005).
4.2	Form of Indenture (Incorporated by reference to Exhibit 4.3 of the Company’s Registration Statement on Form S-3; Registration No. 333-65220).
4.3	Form of Stock Certificate (Incorporated by reference to Exhibit 4.4 of the Company’s Registration Statement on Form S-1; Registration No. 333-20931).
10.1*	Amended 1997 Equity Participation Plan (Incorporated by reference to Exhibit 10.22 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998).
10.2*	Amendment to the 1997 Equity Participation Plan approved by stockholders at the 2000 Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.36 of the Company’s Annual Report on Form 10-K; for the fiscal year ended December 31, 1999).
10.3*	Amendment to the 1997 Equity Participation Plan approved by stockholders at the 2001 Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.37 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2001).
10.4*	Amendment to the 1997 Equity Participation Plan approved July 26, 2001 (Incorporated by reference to Exhibit 10.42 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2001).
10.5*	Amendment to the 1997 Equity Participation Plan approved by stockholders at the 2003 Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.40 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.6*	Amendment to the 1997 Equity Participation Plan approved April 29, 2004 (Incorporated by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004).
10.7*	Form of Employee Stock Purchase Plan as approved by stockholders at the 2001 Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.38 to the Company’s Quarterly Report Form 10-Q for the period ended March 31, 2001).
10.8*	2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to the Definitive 2004 Proxy Statement as filed on Schedule 14A).
10.9*	Form of Amendment to the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated March 11, 2005).
10.10*	Form of Stock Option Agreement under the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004).
10.11*	Form of Restricted Stock Agreement under the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004).

53

10.12*	Form of Non-Employee Director Restricted Stock Agreement under the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K dated July 28, 2005).
10.13*	Form of Deferred Stock Agreement under the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004).
10.14*	Guitar Center, Inc. Senior Executive Performance Bonus Plan (Incorporated by reference to Exhibit 10.35 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.15*	Guitar Center, Inc. 2005 Long Term Incentive Plan (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated July 28, 2005).
10.16*	Form of Indemnification Agreement between the Company and each of its directors and executive officers (Incorporated by reference to Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the period ended December 31, 2005).
10.17*	Compensation Committee Non-Employee Director Equity Compensation Policy (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K dated July 28, 2005).
10.18*	Second Amended and Restated Employment Agreement, dated as of October 8, 2004, between Guitar Center, Inc. and Marty Albertson (Incorporated by reference to Exhibit 99.1 of the Company’s Current Report on Form 8-K dated October 8, 2004).
10.19*	Amendment No. 1 to Second Amended and Restated Employment Agreement made effective as of July 28, 2005 between Guitar Center, Inc., and Marty Albertson (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K dated July 28, 2005).
10.20*	Transition Agreement between Guitar Center, Inc. and Bruce L. Ross, dated effective as of February 10, 2006 (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K dated February 10, 2006).
10.21*	Third Amended and Restated Employment Agreement between Musician’s Friend, Inc. and Robert V. Eastman, dated effective as of January 1, 2006 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated January 30, 2006).
10.22*	Employment Agreement, dated as of April 15, 2005, by and between Music & Arts Center, Inc., a Maryland corporation, and Kenneth O’Brien (Incorporated by reference to Exhibit 99.3 of the Company’s Current Report on Form 8-K dated April 15, 2005).
10.23*	Agreement Not to Compete, dated as of April 15, 2005, by and between Guitar Center Stores, Inc., a Delaware corporation, and Kenneth O’Brien (Incorporated by reference to Exhibit 99.4 of the Company’s Current Report on Form 8-K dated April 15, 2005).
10.24	Lease Agreement, dated as of August 15, 2001, by and between Guitar Center Stores, Inc., and Eaglepoint Partners Two, LLC (Incorporated by reference to Exhibit 10.27 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).
10.25	Master Lease Agreement, dated as of March 4, 2002, between Guitar Center, Inc. and General Electric Capital Corporation (Incorporated by reference to Exhibit 10.31 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2002).

54

10.26	Standard Industrial/Commercial Single-Tenant Lease by and between The J. David Gladstone Institutes, a Charitable Trust, as lessor and Guitar Center, Inc. as lessee relating to 5795 Lindero Canyon Road, Westlake Village, California (Incorporated by reference to Exhibit 10.36 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.27	Addendum to Industrial/Commercial Single-Tenant Lease by and between The J. David Gladstone Institutes, a Charitable Trust, as lessor and Guitar Center, Inc. as lessee relating to 5795 Lindero Canyon Road, Westlake Village, California (Incorporated by reference to Exhibit 10.37 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.28	Standard Commercial Lease by and between Mid-West Terminal Warehouse Company as lessor and Musician’s Friend, Inc. as lessee relating to 1491 North Universal Avenue, Kansas City, Missouri (Incorporated by reference to Exhibit 10.38 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.29	Addendum to Commercial Lease Agreement by and between Mid-West Terminal Warehouse Company, Inc. as lessor and Musician’s Friend, Inc. as lessee relating to 1491 North Universal Avenue, Kansas City, Missouri (Incorporated by reference to Exhibit 10.39 to the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2003).
10.30	First Amendment to Lease dated November 2, 2005, by and between Brownsburg Music LLC and Guitar Center Stores, Inc. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated November 2, 2005).
10.31*	Aircraft Time Sharing Agreement between Guitar Center, Inc. and Marty Albertson, dated February 15, 2006 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated February 10, 2006).
10.32	Second Amended and Restated Loan and Security Agreement entered into as of December 21, 2001, between and among the Company, Guitar Center Stores, Inc., Musician’s Friend, Inc. and the lenders identified therein (Incorporated by reference to Exhibit 10.30 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2001).
10.33	Consent and Amendment, dated as of June 9, 2003, by and among, Wells Fargo Retail Finance, LLC, as the arranger and administrative agent, the lenders named therein, and Guitar Center, Inc., Guitar Center Stores, Inc. and Musician’s Friend, Inc., as borrowers (Incorporated by reference to Exhibit 10.42 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003).
10.34	Second Amendment to Second Amended and Restated Loan and Security Agreement between Guitar Center, Inc. and Wells Fargo Retail Finance, LLC (Incorporated by reference to Exhibit 10.36 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003).
10.35	Third Amendment to Second Amended and Restated Loan and Security Agreement, effective February 8, 2005 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K dated February 8, 2005).
10.36	Lease Agreement between Musician’s Friend, Inc., and Panattoni Development Company, LLC, dated effective as of March 30, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated March 30, 2006).

55

10.37	Fourth Amendment to Second Amended and Restated Loan and Security Agreement, effective April 26, 2006 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated April 26, 2006).
10.38*	Guitar Center, Inc. 2006 Long Term Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated June 21, 2006).
10.39*	Amendment to the Guitar Center, Inc. Amended 1997 Equity Participation Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated November 2, 2006).
10.40*	Amendment to the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated November 2, 2006).
10.41*	Amendment to the 2004 Guitar Center, Inc. Incentive Stock Award Plan (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K dated November 2, 2006).
10.42	Asset Purchase Agreement, dated as of January 30, 2007, by and between Musician’s Friend, Inc. and Dennis Bamber, Inc. D/B/A The Woodwind & the Brasswind and its Chapter 11 Estate (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 5, 2007).
10.43*	Form of amended and restated Executive Severance Benefits Agreement relating to certain executives of Guitar Center, Inc., Guitar Center Stores, Inc. and Musician Friend, Inc. (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2006).
10.44*	Amendment to the Guitar Center, Inc. 2005 Long Term Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K dated February 26, 2007).
10.45*	Amendment to the Guitar Center, Inc., 2006 Long Term Incentive Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K dated February 26, 2007).
12.1	Ratio of Earnings to Fixed Charges (Filed herewith).
21.1	Material subsidiaries of the Registrant as of December 31, 2006 (Filed herewith).
23.1	Consent of Independent Registered Public Accounting Firm (KPMG LLP) (Filed herewith).
24.1	Power of Attorney (Included on page 54).
31.1	Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith).
31.2	Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith).
32.1	Certification of the Company’s Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).
32.2	Certification of the Company’s Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).

*Management contract or other compensation plan or arrangement.

56

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized as of this 1st day of March 2007.

Guitar Center, Inc.

/s/ MARTY ALBERTSON

Marty Albertson

Chairman and Chief Executive Officer

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Marty Albertson, Erick Mason and Leland Smith as his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendment to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

	Name		Title		Date
/s/ MARTY ALBERTSON		Chief Executive Officer and Director		March 1, 2007
Marty Albertson		(Principal Executive Officer)
/s/ ERICK MASON		Executive Vice President and Chief		March 1, 2007
Erick Mason		Financial Officer (Principal Financial Officer)
/s/ DAVID ROBSON		Senior Vice President of Finance		March 1, 2007
David Robson		(Principal Accounting Officer)
/s/ LARRY LIVINGSTON		Director		March 1, 2007
Larry Livingston
/s/ BOB MARTIN		Director		March 1, 2007
Bob Martin
/s/ PAT MACMILLAN		Director		March 1, 2007
Pat MacMillan

57

/s/ GEORGE MRKONIC	Director	March 1, 2007
George Mrkonic
/s/ KENNETH REISS	Director	March 1, 2007
Kenneth Reiss
/s/ WALTER ROSSI	Director	March 1, 2007
Walter Rossi
/s/ PETER STARRETT	Director	March 1, 2007
Peter Starrett
/s/ PAUL TARVIN	Director	March 1, 2007
Paul Tarvin

58

INDEX TO FINANCIAL STATEMENTS

Report of Independent Registered Public Accounting Firm	60
Consolidated Balance Sheets as of December 31, 2006 and 2005	61
Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004	62
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2006, 2005 and 2004	63
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004	64
Notes to Consolidated Financial Statements	66

	Schedule
Financial Statement Schedule:
Valuation and Qualifying Accounts		II-1

59

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders
Guitar Center, Inc.:

We have audited the accompanying consolidated balance sheets of Guitar Center, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited the related financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Guitar Center, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Notes 1 and 9 to the consolidated financial statements, effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Guitar Center, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 1, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Los Angeles, California

March 1, 2007

60

GUITAR CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)

	December 31, 2006			December 31, 2005
Assets
Current assets:
Cash and cash equivalents		$	15,153		$	14,529
Accounts receivable, less allowance for doubtful accounts of $2,618 and $2,844, respectively		53,916			40,844
Merchandise inventories		578,082			445,771
Prepaid expenses and other current assets		16,178			15,533
Deferred income taxes		22,739			13,492
Total current assets		686,068			530,169
Property and equipment, net		201,986			149,209
Goodwill		18,507			85,929
Intangible assets, net		7,612			9,142
Other assets, net		13,305			5,741
Total assets		$	927,478		$	780,190
Liabilities and Stockholders’ Equity
Current liabilities:
Cash overdraft		$	20,243		$	18,482
Accounts payable		93,717			61,015
Accrued expenses and other current liabilities		117,595			106,181
Merchandise advances		26,830			25,127
Borrowings under revolving line of credit		101,144			32,266
Total current liabilities		359,529			243,071
Other long-term liabilities		17,292			11,995
Deferred income taxes		5,165			20,307
Long-term debt		1,416			100,000
Total liabilities		383,402			375,373
Minority interest		1,339			—
Commitments and contingencies (Notes 7 and 11)
Stockholders’ equity:
Preferred stock, 5,000 authorized, none issued and outstanding		—			—
Common stock, $0.01 par value, authorized 100,000 shares at December 31, 2006 and 55,000 shares at December 31, 2005, issued and outstanding 29,469 at December 31, 2006 and 26,092 at December 31, 2005		295			261
Additional paid-in capital		464,217			326,755
Retained earnings		78,225			77,801
Total stockholders’ equity		542,737			404,817
Total liabilities and stockholders’ equity		$	927,478		$	780,190

See accompanying notes to consolidated financial statements.

61

GUITAR CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)

	Year ended December 31,
	2006		2005		2004
Net sales	$	2,029,966	$	1,782,499	$	1,513,172
Cost of goods sold, buying and occupancy	1,435,963		1,262,097		1,087,899
Gross profit	594,003		520,402		425,273
Selling, general and administrative expenses	466,555		388,380		317,585
Goodwill impairment	80,160		—		—
Operating income	47,288		132,022		107,688
Interest expense, net of interest income of $908, $714 and $189, respectively	8,448		7,339		5,390
Gain on sale of property	2,115		—		—
Income before income taxes	40,955		124,683		102,298
Income taxes	40,531		48,005		38,873
Net income	$	424	$	76,678	$	63,425
Net income per share:
Basic	$	0.02	$	2.96	$	2.55
Diluted	$	0.01	$	2.67	$	2.29
Weighted average shares outstanding:
Basic	27,686		25,873		24,856
Diluted	28,402		29,846		28,976

See accompanying notes to consolidated financial statements.

62

GUITAR CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)

								Retained
						Additional		Earnings
	Number of		Common			Paid-in		(Accumulated
	Shares		Stock			Capital		Deficit)				Total
Balance at December 31, 2003		23,998		$	240	$	276,233		$	(62,302	)	$	214,171
Exercise of employee stock options, including tax benefit of $9,756		1,313		14		27,537			—			27,551
Stock issued under employee stock purchase plan		48		—		1,535			—			1,535
Net income		—		—		—			63,425			63,425
Balance at December 31, 2004		25,359		254		305,305			1,123			306,682
Exercise of employee stock options, including tax benefit of $7,591		687		7		19,418			—			19,425
Stock issued under employee stock purchase plan		46		—		2,032			—			2,032
Net income		—		—		—			76,678			76,678
Balance at December 31, 2005		26,092		261		326,755			77,801			404,817
Exercise of employee stock options, including tax benefit of $12,129		422		4		21,526			—			21,530
Stock issued under employee stock purchase plan		64		1		2,425			—			2,426
Stock-based compensation expense		—		—		15,028			—			15,028
Conversion of debt to common stock		2,891		29		98,483			—			98,512
Net income		—		—		—			424			424
Balance at December 31, 2006		29,469		$	295	$	464,217		$	78,225		$	542,737

See accompanying notes to consolidated financial statements.

63

GUITAR CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

	Year ended December 31,
	2006			2005			2004
Operating activities:
Net income	$	424		$	76,678		$	63,425
Adjustments to reconcile net income to net cash provided by operating activities:
Goodwill impairment	80,160			—			—
Depreciation and amortization	36,777			29,000			22,304
(Gain) loss on disposal of property and equipment	(2,115		)	1,849			—
Amortization of deferred financing fees	562			1,045			1,045
Stock-based compensation	15,028			—			—
Tax benefit from exercise of stock options	8,581			7,591			9,756
Deferred income taxes	(23,502		)	(5,476		)	916
Changes in operating assets and liabilities, net of of acquisitions:
Accounts receivable	(12,716		)	(7,415		)	(3,341		)
Merchandise inventories	(120,645		)	(74,188		)	(24,281		)
Prepaid expenses and other current assets	(645		)	(862		)	(1,824		)
Other assets, net	(9,597		)	(733		)	(2,869		)
Cash overdraft	1,761			11,655			(21,067		)
Accounts payable	31,995			4,560			23,061
Accrued expenses and other current liabilities	10,325			19,397			11,990
Merchandise advances	1,654			(1,705		)	5,430
Other long-term liabilities	5,297			4,314			961
Net cash provided by operating activities	23,344			65,710			85,506
Investing activities:
Purchase of property and equipment	(84,417		)	(75,493		)	(26,151		)
Proceeds from sale of property and equipment	2,565			—			—
Purchase of available-for-sale securities	—			(27,305		)	(20,807		)
Proceeds from sale of available-for-sale securities	—			47,460			—
Acquisition of businesses, net of cash acquired	(24,442		)	(102,428		)	(2,775		)
Net cash used in investing activities	(106,294		)	(157,766		)	(49,733		)
Financing activities:
Net change in borrowings under revolving line of credit	68,878			32,266			—
Proceeds from exercise of stock options	9,401			11,834			17,795
Proceeds from stock issued under employee purchase plan	2,426			2,032			1,535
Excess tax benefit from exercise of stock options	2,483			—			—
Other, net	386			—			—
Net cash provided by financing activities	83,574			46,132			19,330
Net increase (decrease) in cash and cash equivalents	624			(45,924		)	55,103
Cash and cash equivalents at beginning of year	14,529			60,453			5,350
Cash and cash equivalents at end of year	$	15,153		$	14,529		$	60,453

64

GUITAR CENTER, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In thousands)

Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest	$	7,775		$	6,005		$	4,665
Income taxes	$	58,011		$	34,747		$	27,611
Non-cash investing and financing activities:
Conversion of long-term debt to common stock	$	98,512		$	—		$	—
Assets acquired under capital lease	1,731			—			—
Acquisition of businesses, in which the fair value of assets and liabilities were as follows:
Accounts receivable	356			5,802			—
Merchandise inventories	11,666			57,655			1,802
Prepaid expenses and other current assets	—			584			—
Property and equipment	701			3,428			120
Goodwill	12,738			59,455			478
Intangible assets	1,625			10,014			375
Other assets	14			—			—
Total assets acquired	27,100			136,938			2,775
Current liabilities	(2,206		)	(21,724		)	—
Other long-term liabilities	—			(738		)	—
Deferred income taxes	887			(12,048		)	—
Minority interest	(1,339		)	—			—
Total liabilities assumed	(2,658		)	(34,510		)
Net assets acquired	$	24,442		$	102,428		$	2,775

See accompanying notes to consolidated financial statements.

65

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006

1. Nature of Business and Significant Accounting Policies

Nature of Business

Guitar Center, Inc. is the leading United States retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment. As of December 31, 2006, our wholly owned retail subsidiary operated 198 Guitar Center stores across the United States, with 134 primary format stores, 61 secondary format stores and 3 tertiary format stores. In addition, as of December 31, 2006, our Music & Arts Center division operated 97 stores specializing in band instruments for sale and rental, serving thousands of teachers, band directors, college professors and students. We are also the largest direct response retailer of musical instruments in the United States through our wholly owned subsidiary, Musician’s Friend, Inc., and its catalogs and websites, www.musiciansfriend.com, www.guitarcenter.com, www.wwbw.com, www.music123.com and related websites.

We acquired the www.wwbw.com and www.music123.com websites on February 9, 2007 when Musician’s Friend, Inc. acquired substantially all of the assets of the Dennis Bamber, Inc. and its chapter 11 bankruptcy estate, d/b/a The Woodwind and The Brasswind.

Principles of Consolidation

The consolidated financial statements include the financial statements of Guitar Center, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles requires the Company 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 our estimates.

Reclassifications

A reclassification has been made to the December 31, 2005 consolidated balance sheet to separately report intangible assets, net, which was previously included with other assets, net. This reclassification has no impact on the previously reported net income or stockholders’ equity.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand and marketable debt securities with original maturities of three months or less.

Accounts Receivable

In the normal course of business, the Company grants credit directly to certain customers, after a credit analysis based on financial and other criteria and generally requires no collateral. Accounts receivable are recorded net of an allowance for doubtful accounts. The Company maintains allowances for

66

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

doubtful accounts for estimated losses that result from the failure of its customers to make their required payments. The Company bases its allowances on analysis of the aging of accounts receivable at the date of the financial statements, assessments of historical collections trends and an evaluation of the impact of current economic conditions.

Merchandise Inventories

Inventories, including used merchandise and vintage guitars, are valued at the lower of cost using the weighted average method or market. Applicable costs associated with bringing inventory through the Guitar Center retail distribution center are capitalized to inventory. The amounts are expensed to cost of goods sold as the associated inventory is sold. Rental inventories are valued at the lower of cost or market using the specific identification method and are depreciated on a straight-line basis while out under the rental agreement for rent-to-own sales. We receive price protection credits and vendor rebates from vendors, which are accounted for as a component of merchandise inventory and are recorded at the time the credit or rebate is earned. The effect of price protection credits and vendor rebates is recognized in the income statement as an effective reduction in cost of goods sold at the time the related item of inventory is sold. None of these credits are recorded as revenue.

Property and Equipment

Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets; generally 5 years for furniture and fixtures, computer equipment and vehicles, and 15 years for buildings. Leasehold improvements are amortized over the shorter of their estimated useful lives or the terms of the related leases. Corporate aircraft is depreciated over 10 years with a 50% salvage value. Maintenance and repair costs are expensed as they are incurred, while renewals and betterments are capitalized.

Goodwill and Other Intangibles

Goodwill represents the excess of the purchase price over the fair value of the net assets acquired resulting from business acquisitions. In 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, which eliminated the systematic amortization of goodwill. As of December 31, 2006 and 2005 we had unamortized goodwill in the amount of $18.5 million and $85.9 million, respectively. We also had unamortized identifiable intangible assets with indefinite lives in the amount of $5.4 million and $5.3 million as of December 31, 2006 and 2005, respectively. Our policy is to test for impairment on an annual basis, or more frequently when triggering events occur. We have tested goodwill and intangible assets for impairment under the provisions of SFAS No. 142 and these tests indicated a goodwill impairment of $80.2 million relating to the Music & Arts segment during the fourth quarter ended December 31, 2006. See Note 3 for further discussion of the goodwill impairment.

Impairment and Disposal of Long-Lived Assets

We account for the impairment or disposal of long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires long-lived assets, such as property and equipment, to be evaluated for impairment whenever events or changes in circumstances

67

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

indicate the carrying value of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by said assets. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs. No impairment was identified for the years ended December 31, 2006, 2005 and 2004.

Merchandise Advances/Gift Cards

Merchandise advances represent layaway deposits which are recorded as a liability pending consummation of the sale when the full purchase price is received from the customer, outstanding gift certificates or gift cards which are recorded as a liability until redemption by the customer, credit on account for customer returns and special orders.

We sell gift cards to our customers in our Guitar Center retail stores and on-line. Revenue from gift card sales is recognized at redemption of the gift card. Our gift cards do not have expiration dates. Based on historical redemption rates, a certain percentage of gift cards will never be redeemed, which is referred to as “breakage.” Estimated breakage income is recognized as the remaining gift card values are redeemed and is recorded as a reduction of cost of goods sold.

Self-Insurance Reserves

We maintain a self-insurance program for workers’ compensation of up to $250,000 per claim and medical insurance of up to $150,000 per claim, with any amounts in excess of these covered by stop-loss insurance coverage. Estimated costs under these programs, including incurred but not reported claims, are recorded as expenses based upon actuarially determined historical experience and trends of paid and incurred claims. Self-insurance reserves for workers’ compensation and medical insurance amounted to $3.3 million and $1.1 million at December 31, 2006 and $3.3 million and $1.0 million at December 31, 2005, respectively. The balances are included in accrued expenses and other current liabilities in the accompanying consolidated balance sheets.

68

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

Revenue Recognition

Retail sales are recognized at the time of sale, net of a provision for estimated returns. Band instrument rentals are recognized on a straight-line basis over the term of the rental agreement, unless a trial period is offered, in which circumstances the rental income for the trial period is amortized over the trial period. The terms of the majority of our rental agreements do not exceed 36 months. Trial periods are usually from one to four months. Direct response sales are recognized when the products are estimated to be received by the customers, net of a provision for estimated returns. Direct response items sold to customers are estimated to be received, on average, three days after shipment. Return allowances are estimated using historical experience.

Advertising Costs

We expense Guitar Center’s and Music & Arts Center’s advertising costs as incurred. Advertising costs included in the consolidated statements of income for the years ended December 31, 2006, 2005 and 2004 were $46.2 million, $36.6 million and $34.0 million, respectively. Musician’s Friend’s non-catalog advertising costs for the years ended December 31, 2006, 2005 and 2004 were $15.0 million, $12.6 million and $5.5 million, respectively. Mail order catalog costs are capitalized on a catalog by catalog basis and are amortized over the expected period of future benefits, not to exceed five months, under the provisions of AICPA Statement of Position 93-7, Reporting of Advertising Costs. Capitalized mail order catalog costs included in prepaid expenses and other current assets at December 31, 2006, 2005 and 2004 were $1.3 million, $1.8 million and $4.5 million, respectively. The realizability of the capitalized mail order catalog costs, are evaluated at each balance sheet date by comparing the carrying amount of such assets on a cost-pool-by-cost-pool basis to the probable remaining future net revenues expected to result directly from such advertising. If the carrying amounts of such deferred mail order catalog costs exceed the remaining future net revenues that probably will be realized from such catalog, the excess capitalized amount is written down and expensed in the current period. There was no write-down of capitalized mail order catalog costs for the years ended December 31, 2006, 2005 and 2004.

We receive cooperative advertising allowances from manufacturers in order to subsidize advertising and similar promotional expenditures we make relating to the vendor’s products. These advertising allowances are recognized as a reduction to selling, general and administrative expense when we incur the advertising costs. Guitar Center, Musician’s Friend and Music & Arts Center recognized cooperative advertising allowances of $11.5 million, $10.1 million and $6.4 million for the years ended December 31, 2006, 2005 and 2004, respectively.

Rent Expense

We lease the majority of our store locations under operating leases that provide for monthly payments that increase over the life of the leases. The aggregate of the minimum annual payments are expensed on a straight-line basis over the term of the related lease. The amount by which straight-line rent expense exceeds actual lease payment requirements in the early years of the leases is accrued as deferred minimum rent and reduced in later years when the actual cash payment requirements exceed the straight-line expense. When a lease includes lease incentives (such as a rent holiday or reimbursement of certain lessee construction costs) or requires fixed escalations of the minimum lease payments, rental expense is

69

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

recognized on a straight-line basis over the initial term of the lease and the difference between the average rental amount charged to expense and amounts payable under the lease is included in deferred rent and lease incentives in the accompanying consolidated balance sheets.

Comprehensive Income

For the years presented, comprehensive income was the same as net income.

Income Taxes

We account for income taxes under SFAS No. 109, Accounting for Income Taxes. Under the asset and liability method of SFAS No. 109, deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.

Stock-based Compensation

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”) to account for our stock-based compensation plans. The Company elected the modified prospective method of adoption, which permitted application of the new requirements on a prospective basis. Accordingly, prior period amounts have not been restated. Under this application, stock-based compensation is recorded for all awards granted on or after the date of adoption and for the portion of previously granted awards that remain unvested at the date of adoption. Estimated compensation for unvested grants that were outstanding as of the effective date will be recognized over the remaining service period using the compensation cost estimated for the SFAS No. 123 pro forma disclosures. Currently, our stock-based compensation expense relates to stock options, our employee stock purchase program (the “ESPP”), performance share awards, restricted stock awards, and deferred stock awards.

Under SFAS No. 123(R), the Company determines the fair value of stock options, including options granted under ESPP, using a lattice-based binomial model. Under the fair value recognition provisions of this statement, stock-based compensation cost for option awards is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period of the award. Assumptions used in the model were developed in consultation with an outside valuation specialist. The model requires the input of several assumptions including expected volatility, dividend yield, and risk-free rate of return, as well as certain assumptions regarding exercise behavior.

70

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

Assumptions were developed separately for our senior management from the other participants of our stock plans, since senior management’s exercise behavior is expected to differ materially from the other participants.

Also, under SFAS No. 123(R), stock-based compensation expense is recorded net of estimated forfeitures. The forfeiture rate assumption used in determining stock-based compensation expense is estimated based on historical data. The actual forfeiture rate could differ from these estimates.

Stock-based compensation expense related to performance share awards issued under our Long Term Incentive Plan (the “LTIP”) is estimated based on our forecasted performance compared to plan targets.

At the end of each reporting period, we reevaluate our assessment of performance under the plan and make adjustments to the expense as necessary based on the latest estimates available. Under SFAS No. 123(R), the fair value of performance share awards is based on the market price of the Company’s stock on the date the underlying plan receives compensation committee approval, or other form of a mutual understanding of the key terms and conditions of performance.

Earnings Per Share

The following table summarizes the reconciliation of basic to diluted weighted average shares for the years ended December 31, 2006, 2005 and 2004 (in thousands, except per share data):

	2006		2005		2004
Net income, as reported	$	424	$	76,678	$	63,425
Add back interest, net of tax, on 4% Senior Convertible Notes(a)	—		2,907		2,931
Net income, excluding interest expense on 4% Senior Convertible Notes	$	424	$	79,585	$	66,356
Basic weighted average shares outstanding	27,686		25,873		24,856
Dilutive effect of stock options outstanding	716		1,081		1,228
Shares issuable on assumed conversion of4% Senior Convertible Notes(b)	—		2,892		2,892
Diluted weighted average shares outstanding	28,402		29,846		28,976
Basic net income per share	$	0.02	$	2.96	$	2.55
Diluted net income per share	$	0.01	$	2.67	$	2.29

(a)Represents the interest expense for the period the 4% Senior Convertible Notes (the “Notes”) were outstanding, including contingent interest and amortization of deferred financing costs, net of tax, using an effective tax rate of 38.5% for 2005 and 38.0% for 2004. The interest expense on the Notes for 2006 was not included in the computation of diluted net income per share as its effect would be antidilutive.

(b)Represents the weighted-average number of common shares issuable upon the conversion of the Notes, up to the date of actual conversion. The shares issuable on assumed conversion of the Notes for 2006 were not included in the computation of diluted net income per share as its effect would be antidilutive.

71

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

For the years ended December 31, 2006, 2005 and 2004, the only potential additional shares of common stock that could become outstanding were shares issuable upon exercise of stock options and conversion of the Notes up to the date of actual conversion. For the years ended December 31, 2006 and 2005, options to acquire weighted-average shares of 1,034,428 and 261,479, respectively, were outstanding but were excluded from the computation of diluted net income per share because their effect was antidilutive. For the year ended December 31, 2004, all options outstanding had a dilutive effect.

For the year ended December 31, 2006, 1.5 million shares of common stock issuable upon conversion of the Notes issued in June 2003 (reflecting an effective conversion price of $34.58) were excluded for the purposes of calculating diluted net income per share as its effect would be antidilutive. For the year ended December 31, 2005 and 2004, the common stock issuable upon conversion of the Notes amounted to 2.9 million shares. Under the “if-converted” method of accounting, the after-tax interest expense, including contingent interest and amortization of deferred financing costs, for the period is added back to net income, unless antidilutive. The Notes were called for redemption by the Company on June 15, 2006 and substantially all of the outstanding Notes were converted into common stock prior to the July 15, 2006 redemption date. See Note 5 for further discussion of the Notes.

In July 2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 04-8, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share that contingently convertible debt instruments, such as our 4% Senior Convertible Notes, should be included in the computation of diluted earnings per share under the if-converted method regardless of whether the market price trigger (or other contingent feature) has been met. The consensus must be applied by retroactive restatement based on the term in effect on the last day of the fiscal period in which the consensus becomes effective. This consensus became effective for all financial statements issued after December 15, 2004. Accordingly, we retroactively restated all earnings per share measures for all periods to reflect the consensus.

Concentration of Credit Risk

Our cash deposits are with various high quality financial institutions. Customer purchases generally are transacted using cash or credit cards. In limited instances, we grant credit for larger purchases, generally to professional musicians, under normal trade terms. Trade accounts receivable were approximately $12.2 million and $10.5 million at December 31, 2006 and 2005, respectively. Credit losses have historically been within our expectations.

Fair Value of Financial Instruments

The principal amount of our revolving line of credit reflects the fair value based upon current rates available to us for similar debt. The book value of all other financial instruments is representative of their fair values.

New Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an

72

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

1. Nature of Business and Significant Accounting Policies (Continued)

enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This Interpretation defines the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of FIN 48 to have a material effect on our consolidated financial statements.

In June 2006, the FASB ratified EITF issued Issue 06-3, “How Sales Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement” (EITF 06-3). EITF 06-3 requires a company to disclose its accounting policy (i.e., gross or net presentation) regarding the presentation of taxes within the scope of EITF 06-3. If taxes are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented. The guidance is effective for periods beginning after December 15, 2006. EITF 06-3 will not impact the method for recording these taxes in the consolidated financial statements as we have historically presented sales excluding these taxes.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. SAB 108 was effective as of the end of our 2006 fiscal year, allowing a one-time transitional cumulative effect adjustment to retained earnings as of January 1, 2006 for errors that were not previously deemed material, but are material under the guidance in SAB 108. The adoption of the provisions of SAB 108 had no impact on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact, if any, the adoption of SFAS No. 157 will have on our operating income or net income.

2. Acquisition of Businesses

During the second quarter of 2006, our Guitar Center division acquired four retail locations in Texas and related net assets from Hermes Trading Company, Inc., a musical instruments retailer, for approximately $11.1 million.

During the year ended December 31, 2006, our Music & Arts Center division acquired a total of 18 stores and related net assets for an aggregate purchase price of approximately $13.5 million.

The aggregate purchase price for the acquisitions for the year ended December 31, 2006 (including purchase price adjustments of $0.4 million) totaled approximately $24.4 million, which was principally allocated to merchandise inventories of $11.7 million and goodwill of $12.7 million.

73

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

2. Acquisition of Businesses (Continued)

The acquisitions were accounted for under the purchase method of accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations. The results of operations of the acquisitions were not material to the consolidated financial statements and, as such, pro forma financial information is not presented for these acquisitions. The results of operations of the acquired businesses are included in the consolidated financial statements from the respective dates of acquisition.

On April 15, 2005, the Company completed the acquisition of Music & Arts Center, Inc., a Maryland-based musical instruments retailer with an emphasis on the beginning musician. At the time of the acquisition, Music & Arts Center, Inc. operated 61 retail locations, primarily located in the Northeast, Mid-Atlantic and Southern regions of the United States. The Company acquired Music & Arts Center, Inc. to expand our existing presence in the band and orchestra instrument business. The acquired business and our existing American Music Group business were combined into a new division under the Music & Arts Center name.

3. Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired resulting from business acquisitions accounted for under the purchase method.

In the fourth quarter of 2006, the Music & Arts Center segment recorded an impairment charge of $80.2 million, related to the write down of goodwill. The determination to write down the goodwill at Music & Arts Center was a result of the segment’s current operating performance and our fourth quarter change in strategy to reduce future investments in the segment and slow down growth in future years.

The changes in the carrying amount of goodwill by reportable segment during the years ended December 31, 2006 and 2005 were as follows (in thousands):

	Guitar		Music &			Musician’s
	Center		Arts			Friend			Total
Balance at December 31, 2004	$	5,382	$	21,092			$	—	$	26,474
Goodwill resulting from acquisitions	—		56,014				3,441		59,455
Balance at December 31, 2005	5,382		77,106				3,441		85,929
Goodwill resulting from acquisitions	9,684		2,624				—		12,308
Goodwill impairment	—		(80,160		)		—		(80,160		)
Goodwill adjustments	—		430				—		430
Balance at December 31, 2006	$	15,066	$	—			$	3,441	$	18,507

74

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

3. Goodwill and Intangible Assets (Continued)

Intangible assets with definite useful lives are amortized over their respective estimated useful lives. The following is a summary of intangible assets as of December 31, 2006 and 2005 (dollars in thousands, life in years):

			December 31, 2006
	Weighted-		Gross
	Average Useful		Carrying		Accumulated
	Life		Amount		Amortization				Total
Unamortized trademark		—	$	5,367		$	—		$	5,367
Amortized
Customer contracts		1.4	847			(379		)	468
Covenants not to compete		3.5	2,950			(1,350		)	1,600
Other		2.6	851			(674		)	177
Intangible assets, net			$	10,015		$	(2,403	)	$	7,612

			December 31, 2005
	Weighted-		Gross
	Average Useful		Carrying		Accumulated
	Life		Amount		Amortization				Total
Unamortized trademark		—	$	5,325		$	—		$	5,325
Amortized
Customer contracts		1.4	3,430			(1,734		)	1,696
Covenants not to compete		3.7	2,200			(596		)	1,604
Other		2.6	834			(317		)	517
Intangible assets, net			$	11,789		$	(2,647	)	$	9,142

Amortization of intangible assets is included in selling, general and administrative expenses. The estimated amortization expense related to intangible assets for each of the five years and thereafter as of December 31, 2006 is as follows (in thousands):

Year
2007	$	1,212
2008	506
2009	304
2010	149
2011	74
Total	$	2,245

75

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

4. Balance Sheet Components

Selected balance sheet components consisted of the following (in thousands):

	December 31,
	2006		2005
Merchandise inventories:
Major goods	$	317,802	$	246,260
Band instruments	104,747		79,378
Accessories	129,004		97,950
Vintage guitars	15,924		11,795
Used major goods	21,341		20,056
	588,818		455,439
Less inventory reserves	10,736		9,668
	$	578,082	$	445,771

Major goods include stringed merchandise, percussion, keyboards, live-sound/DJ and recording equipment. Band instruments include horns, flutes, brass and woodwind instruments. Accessories are comprised of accessories to major goods, and band instruments, apparel, cables and books.

	December 31,
	2006		2005
Property and equipment:
Land	$	7,376	$	7,666
Buildings	21,537		20,091
Furniture and fixtures	36,791		30,656
Transportation equipment	13,286		12,402
Computer equipment	93,308		73,877
Leasehold improvements	163,464		123,992
Construction in progress	19,257		5,965
	355,019		274,649
Less accumulated depreciation and amortization	153,033		125,440
	$	201,986	$	149,209

76

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

4. Balance Sheet Components (Continued)

As of December 31, 2006, $1.7 million of computer equipment was under a capital lease.

	December 31,
	2006		2005
Accrued expenses and other current liabilities:
Wages, salaries and benefits	$	31,834	$	30,564
Accrued income taxes	21,944		18,846
Sales tax payable	16,536		12,813
Accrued advertising	8,268		8,193
Unearned revenue	7,132		5,802
Provision for sales returns	5,765		5,007
Accrued insurance	4,356		4,310
Accrued real estate tax	2,421		1,847
Accrued professional fees	1,893		4,281
Accrued freight	1,482		1,432
Accrued utilities	1,470		922
Current portion of capital lease obligation	574		—
Other	13,920		12,164
	$117,595		$	106,181

5. Long-Term Debt and Revolving Line of Credit

Long-term debt consisted of the following (in thousands):

	December 31,
	2006		2005
Obligations under capital lease, payable in monthly installments through 2009	$	1,731	$	—
Notes, 4%, face amount of $100 million	—		100,000
Other	259		—
	1,990		100,000
Less current portion	574		—
Total long-term debt	$	1,416	$	100,000

On June 16, 2003, the Company completed the issuance of $100 million of Notes due 2013. The Notes bore interest at the rate of 4.00% per annum, subject to the payment of contingent interest under certain circumstances commencing January 15, 2006, and became convertible into shares of common stock at a conversion price of $34.58 per share, subject to adjustment under specified circumstances.

On June 15, 2006, the Company called for redemption all of the outstanding Notes due 2013. Holders were able to convert the Notes into shares of common stock at an effective conversion price of approximately $34.58 per share, in lieu of accepting redemption. Prior to the redemption date of July 15, 2006, holders of substantially all of the remaining outstanding Notes elected to convert their Notes into shares of the Company’s common stock. As a result of these conversions, approximately 2.9 million shares of common stock were issued to the holders that elected to convert their Notes. In connection with the

77

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

5. Long-Term Debt and Revolving Line of Credit (Continued)

redemption of the unconverted Notes, the Company paid approximately $3,000 in cash, which includes the redemption and premium payments and cash paid in lieu of fractional shares. In conjunction with the redemption, the Company reclassified approximately $1.5 million of unamortized debt issuance costs from other assets to additional paid-in capital in the third quarter of 2006.

On April 26, 2006, the Company entered into an amendment of our credit facility. The amendment increased the maximum borrowings available under the credit facility from $125 million to $200 million, subject to borrowing base limitations. The amendment allows for the increase of the maximum borrowings to $250 million at the option of the Company. As of December 31, 2006, we had elected to increase the maximum borrowings to $210 million. The amendment also extended the maturity date of the facility to December 2011, reduced the interest rate charged over the applicable index rates and increased the borrowing base as a percentage of working capital. The actual amount available is tied to our inventory and receivable base, and our obligations under the credit facility are secured by liens on our principal assets. Borrowing options are prime rate (8.00% at December 31, 2006) plus applicable prime margin, or London Interbank Offered Rate or LIBOR (12 month rate at December 31, 2006 was 5.33%), plus applicable LIBOR margin. The applicable prime and LIBOR margins are based upon levels of excess availability and adjusted quarterly. If excess availability is greater than $30 million, the applicable prime margin is -0.25% and applicable LIBOR margin is 0.75%. If excess availability is less than or equal to $30 million and greater than $15 million, the applicable prime margin is 0.00% and the applicable LIBOR margin is 1.00%. If excess availability is less than or equal to $15 million, the applicable prime margin is 0.00% and the applicable LIBOR margin is 1.25%. An unused fee of 0.25% is assessed on the unused portion of the credit facility. The agreement underlying the credit facility includes significant restrictive negative covenants. Among other things, these covenants restrict or prohibit our ability to incur debt and issue specified equity instruments, incur liens on our assets, make any significant changes in our corporate structure or the nature of our business, dispose of assets, make guaranties, prepay debt, engage in a change in control transaction, pay dividends, make investments or acquisitions, engage in transactions with affiliates and incur capital expenditures. The agreement also includes representations and warranties which must be true each time we borrow funds under the credit facility and affirmative covenants. The full text of the contractual requirements imposed by this financing is set forth in the Amended and Restated Loan and Security Agreement and related amendments which have been filed with the SEC. Subject to limited cure periods, the lenders under our credit facility may demand repayment of these borrowings prior to stated maturity upon the occurrence of specified events, including if we breach the terms of the agreement, suffer a material adverse change, engage in a change in control transaction, suffer a significant adverse legal judgment, default on other significant obligations, or in the event of specified events of insolvency.

For the years ended December 31, 2006, 2005 and 2004, $0.6 million, $1.0 million and $1.0 million of amortization of deferred financing fees was included in interest expense. Unamortized deferred financing fees at December 31, 2006, 2005 and 2004 were $0.5 million, $2.5 million and $3.6 million and related accumulated amortization was $0.8 million, $2.1 million and $1.0 million, respectively.

78

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

6. Segment Information

Our reportable business segments are Guitar Center stores, Music & Arts Center stores and Musician’s Friend direct response. Prior to the acquisition of Music & Arts Center, Inc., that segment was referred to as American Music stores. Both brands have similar operations and there has been no change to the internal structure of the overall organization. Therefore, there has been no change in the nature of the company segment reporting. Management evaluates segment performance based primarily on net sales, operating income (loss) and income (loss) before income taxes. Accounting policies of the segments are the same as the accounting policies for the consolidated company. There are no differences between the measurements of profits or losses or assets of the reportable segments and those of the company on a consolidated basis. Our business segments under SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, are consistent with our reporting units under SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 131 establishes standards for the reporting of operating segment information in annual financial statements and in interim financial reports issued to shareholders. SFAS No. 142 requires that goodwill no longer be amortized, reclassifications between goodwill and other intangible assets be made based upon certain criteria, and, once allocated to reporting units (the business segment level, or one level below), that tests for impairment of goodwill be performed at least annually. We will continue to evaluate goodwill annually or whenever events and circumstances indicate that there may be an impairment of the asset value.

79

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

6. Segment Information (Continued)

The following table summarizes financial information for our operating segments for the years ended December 31, 2006, 2005 and 2004 (in thousands):

	2006
	Guitar Center			Music & Arts				Musician’s Friend			Total
Net sales		$	1,493,339		$	144,972			$	391,655	$	2,029,966
Gross profit		412,870			62,803				118,330		594,003
Depreciation and amortization		28,028			5,141				3,608		36,777
Selling, general and adiministrative expenses		310,943			63,950				91,662		466,555
Operating income (loss)		101,927			(81,307		)		26,668		47,288
Income (loss) before income tax (benefit)		105,394			(92,998		)		28,559		40,955
Capital expenditures		73,458			3,805				7,154		84,417
Total assets		682,344			158,503				86,631		927,478

	2005
	Guitar Center			Music & Arts(1)				Musician’s Friend			Total
Net sales		$	1,314,277		$	103,116			$	365,106	$	1,782,499
Gross profit		368,498			43,064				108,840		520,402
Depreciation and amortization		22,157			4,312				2,531		29,000
Selling, general and adiministrative expenses		261,621			49,357				77,402		388,380
Operating income (loss)		106,877			(6,293		)		31,438		132,022
Income (loss) before income tax (benefit)		105,809			(14,095		)		32,969		124,683
Capital expenditures		67,964			1,130				6,399		75,493
Total assets		512,802			197,045				70,343		780,190

	2004
	Guitar Center			Music & Arts (1)				Musician’s Friend			Total
Net sales		$	1,161,511		$	40,400			$	311,261	$	1,513,172
Gross profit		310,674			14,067				100,532		425,273
Depreciation and amortization		18,671			1,469				2,164		22,304
Selling, general and adiministrative expenses		234,549			18,656				64,380		317,585
Operating income (loss)		76,125			(4,589		)		36,152		107,688
Income (loss) before income tax (benefit)		72,789			(7,228		)		36,737		102,298
Capital expenditures		21,240			1,272				3,639		26,151
Total assets		451,677			63,365				59,551		574,593

(1)The information included for the Music & Arts Center division included only the operation of American Music prior to April 15, 2005.

80

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

7. Lease Commitments

The Company leases offices, retail store facilities, distribution centers and various personal property used in our business under operating leases which expire at varying dates through December 2018. Generally, the agreements contain provisions which require paying for normal repairs and maintenance, property taxes and insurance.

The future annual minimum lease payments at December 31, 2006, under capital and operating leases, are as follows (in thousands):

	Capital		Operating
Year	Lease		Leases
2007	$	583	$	58,805
2008	583		54,821
2009	583		45,941
2010	—		39,265
2011	—		34,477
Thereafter	—		128,839
Total minimum lease payments	1,749		$	362,148
Less imputed interest	18
Present value of lease obligations	$	1,731

Total rent expense included in the consolidated statements of income for the years ended December 31, 2006, 2005 and 2004 is $53.8 million, $45.4 million and $38.2 million, respectively.

8. Employee Benefit Plan

We have a defined contribution 401(k) plan with a 401(a) profit-sharing component (the “Plan”) maintained for the exclusive benefit of eligible employees and their beneficiaries. Eligible employees can contribute from one to seventy-five percent of their compensation. At our discretion, we can make matching contributions to the Plan, which will be a uniform percentage of the eligible employees’ contributions. We may also, at our discretion, make profit-sharing contributions to the Plan. The profit-sharing contributions are allocated based on the relative compensation of all eligible employees. Contribution expense was $1.5 million, $3.6 million and $2.1 million for the years ended December 31, 2006, 2005 and 2004.

9. Stock-Based Compensation

Stock-based compensation expense for all stock award plans included in our consolidated statement of income for the year ended December 31, 2006 was $15.0 million ($9.3 million net of tax), or $0.33 per diluted share. There was no stock-based compensation expense for the years ended December 31, 2005 and 2004. As a result of adopting SFAS No. 123(R) on January 1, 2006, income before income taxes and net income for the year ended December 31, 2006 was $12.4 million and $7.7 million lower, respectively, than if we had continued to account for stock-based compensation under APB No. 25. If we had not adopted SFAS No. 123(R), our basic and diluted net income per share for the year ended December 31, 2006 would have been increased by $0.29 and $0.26, respectively. Under the APB No. 25 intrinsic value

81

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

9. Stock-Based Compensation (Continued)

method, the Company would not have recorded stock-based compensation expense in 2006 related to stock option awards, but would have recorded stock-based compensation expense related to awards of performance shares, restricted stock and deferred stock.

Prior to the adoption of SFAS No. 123(R), we presented all tax benefits for deductions resulting from the exercise of stock options as operating cash flows on our consolidated statement of cash flows. SFAS No. 123(R) requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. Total cash flow will remain unchanged from what would have been reported under prior accounting rules. For the year ended December 31, 2006, $2.5 million of excess tax benefits from the exercise of stock options reported in financing cash flows would have been reported as operating cash flows had SFAS No. 123(R) not been adopted.

The following table details the effect on net income and net income per share as if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation during the year ended December 31, 2005 and 2004 (in thousands, except per share data):

	Year ended December 31,
	2005			2004
Net income, as reported		$	76,678		$	63,425
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		6,608			6,271
Pro forma net income		$	70,070		$	57,154
Net income per share:
Basic—as reported		$	2.96		$	2.55
Basic—pro forma		$	2.71		$	2.30
Diluted—as reported		$	2.67		$	2.29
Diluted—pro forma		$	2.44		$	2.07

Incentive Compensation Plans

Our 2004 Incentive Stock Award Plan (as amended, the “2004 Plan”) provides for the issuance of stock options, stock appreciation rights, restricted stock, deferred stock, dividend equivalents, performance awards and stock payments, or any combination thereof. Substantially all stock awards are currently issued under the 2004 Plan.

Prior to fiscal 2004, the Company had adopted various stock option plans (the “Prior Plans”). A small number of grants are expected to be made under the Prior Plans, and outstanding awards under the Prior Plans will continue to be in effect.

82

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

9. Stock-Based Compensation (Continued)

Under the 2004 Plan and the Prior Plans, an aggregate of 1.3 million shares of common stock were available for issuance as of December 31, 2006. The Company generally issues new shares for stock option exercises, performance share awards and restricted stock awards.

Stock Options

Option grants are issued at fair market value on the date of grant and generally vest over four years. Option grants generally expire ten years after the date of grant.

In the second quarter of 2005, we converted to a lattice-based binomial model from a Black-Scholes model. The conversion was implemented beginning with grants issued during the second quarter of 2005. The fair value of our grants issued prior to the second quarter of 2005 was determined using the Black-Scholes model.

Using the lattice-based binomial model, the fair value of each option award is estimated based on the assumptions noted in the following table. Because lattice-based binomial models incorporate ranges of assumptions for inputs, those ranges are disclosed. Expected volatilities are based on historical volatility of the Company’s stock and implied volatilities for open market exchange-traded options issued “near-the-money”. The Company uses historical data to estimate option exercise and employee departure behavior. Assumptions were developed separately for our senior management from the other participants of our stock plans, since senior management’s exercise behavior is expected to differ materially from the other participants. The expected term of share options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The range in expected term results from the different post-vesting behaviors exhibited by senior management and the other participants. The risk free interest rate is based on US Treasury zero-coupon issues with remaining terms similar to the expected term of the options.

The assumptions used to value option grants for the year ended December 31, 2006, 2005 and 2004 are as follows:

	Year ended December 31,
	2006		2005		2004
Valuation Model	Binomial Lattice		Binomial Lattice		Black- Scholes
Expected volatility range	35.2-49.6	%	32-52	%	—
Weighted-average expected volatility	42.6	%	42.0	%	59.6	%
Expected term (in years)	3.98-5.75		5.40-7.38		6.70
Risk-free interest rate	4.4-4.9	%	3.5-4.0	%	3.9	%
Expected dividends	—		—		—
Suboptimal exercise term (multiple of exercise price)	2.0		2.0		—

83

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

9. Stock-Based Compensation (Continued)

Stock option activity for all plans during the year ended December 31, 2006 is as follows:

						Weighted-
			Weighted-			Average		Aggregate
			Average			Remaining		Instrinsic
	No. of		Exercise			Contractual Term		Value
	Shares		Price			(in years)		(in thousands)
Outstanding at December 31, 2005	2,802,394			$	31.94
Granted	558,500			43.58
Exercised	(420,375	)		22.36
Forfeited	(136,848	)		50.62
Expired	—			—
Outstanding at December 31, 2006	2,803,671			$	34.78		6.77		$	37,578
Exercisable at December 31, 2006	1,593,445			$	25.86		5.38		$	32,964

The weighted-average grant-date fair value of options granted during the years 2006, 2005 and 2004 was $18.87, $27.46 and $24.63. The aggregate intrinsic value of options (the amount by which the stock price on the date of exercise exceeded the stock price of the option on the date of grant) exercised during the years 2006, 2005 and 2004 was $10.8 million, $28.0 million and $34.2 million, respectively.

In February 2006, the Company entered into a transition agreement with its former Chief Financial Officer upon his retirement from the Company, which provided for the immediate acceleration of all of his outstanding options totaling 32,002 shares. Included in the stock-based compensation expense for the year ended December 31, 2006 is expense related to this acceleration of $0.8 million ($0.5 million net of tax).

Employee Stock Purchase Plan

Our ESPP is a tax-qualified employee stock purchase plan under which options are permitted to purchase our common stock at a price which is eighty-five percent of the stock’s fair market value on either the first or last day of the offering period, whichever price is lower. The options are then automatically exercised on the last business day of the offering periods, which end in June and December. The participants purchase the shares through payroll deductions.

84

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

9. Stock-Based Compensation (Continued)

The assumptions used to value the ESPP options under the lattice-based binomial model for the year ended December 31, 2006 are as follows:

	Year ended
	December 31, 2006
Valuation Model		Binomial Lattice
Expected volatility range		32-40	%
Weighted-average expected volatility		36.3	%
Expected term		6 months
Risk-free interest rate		4.4-5.0	%
Weighted-average grant-date fair value		$11.84

Total stock-based compensation expense recognized for ESPP options was $0.8 million for the year ended December 31, 2006.

Long Term Incentive Plan

In July 2005, the Company adopted the LTIP, which provides equity incentives to senior management that include not only stock options or similar grants, but also a performance share program that measures performance on a multi-year basis. The performance period under the LTIP began on July 1, 2005 and ends on December 31, 2007. Awards under the LTIP are made under the 2004 Plan or any successor plan. It is expected that each participant will receive an annual grant of stock options under the 2004 Plan, pursuant to its terms. Performance shares in the form of common stock are earned by the participants based upon specified objective performance goals during the performance period of the LTIP. The number of shares issuable could change if we add or subtract executives to or from the plan. The compensation committee also has the discretion to make cash payments in lieu of performance shares. Any subsequent long-term incentive plans established during the performance period for inclusion of new participants are combined for reporting purposes with the LTIP.

The target number of performance shares potentially issuable under the LTIP is expected to be 250,912, with the actual number of shares ultimately issuable to be between zero and twice such amount, depending on actual performance and number of participants. Included in the target performance shares are 21,382 shares for two new executives added to the plan effective April 1, 2006. The performance period for these new participants began on April 1, 2006 and ends on December 31, 2007. The number of target shares was reduced in 2006 by 25,964 shares due to the departure of two participants. The previously recorded stock compensation expense related to these participants were reversed in 2006.

Stock-based compensation expense related to the LTIP is estimated based on forecasted performance during the performance period compared to plan targets. At the end of each reporting period, we reevaluate our assessment of performance under the plan and make adjustments to the expense as necessary based on the latest estimates available. The fair value of performance share awards is based on the market price of the Company’s stock on the date the underlying plan receives compensation committee approval, or other form of a mutual understanding of the key terms and conditions of performance.

85

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

9. Stock-Based Compensation (Continued)

For the year ended December 31, 2006, the Company recorded stock-based compensation expense related to the LTIP of $2.7 million ($1.8 million net of tax), or $0.06 per diluted share.

Restricted Stock Awards/Deferred Stock Awards

Awards of restricted stock and deferred stock are generally made to the non-employee directors of the Company and are measured on the date of grant. These time-based awards vest over three to five years, or sooner in the event of a qualified retirement, and are forfeitable under certain conditions.

A summary of the Company’s awards of performance shares, restricted stock, and deferred stock as of and for the year ended December 31, 2006 is presented below:

				Weighted-Average
				Grant-Date Fair
	No. of Shares(1)			Value
Nonvested balance at December 31, 2005		506,848			$	55.94
Granted		63,051			48.88
Vested		(2,186	)		49.98
Forfeited		(30,546	)		56.32
Nonvested balance at December 31, 2006		537,167			$	55.12

(1)Represents the maximum number of shares that can be issued based on the achievement of certain performance criteria.

The total fair value of restricted stock and deferred stock vested during the year ended December 31, 2006 was immaterial. Based on our latest estimates, there was $2.9 million ($1.6 million net of tax) of total unrecognized compensation cost for nonvested shares, as of December 31, 2006, that is expected to be recognized over a weighted average period of 1.5 years.

86

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

10. Income Taxes

Total income taxes for the years ended December 31, 2006, 2005 and 2004 are as follow (in thousands):

	2006			2005			2004
Current:
Federal	$	55,113		$	48,391		$	34,332
State	8,920			5,090			3,625
Total current tax provision	64,033			53,481			37,957
Deferred:
Federal	(21,941		)	(5,223		)	793
State	(1,561		)	(253		)	123
Total deferred tax provision	(23,502		)	(5,476		)	916
Total income taxes	$	40,531		$	48,005		$	38,873

The charge in lieu of taxes attributable to tax benefit from employee stock options for 2006, 2005 and 2004 are $3.5 million, $7.6 million and $9.8 million, respectively.

Actual income taxes for 2006, 2005 and 2004 differ from the statutory tax rate of 35% as applied to income before income taxes as follows (in thousands):

	2006			2005			2004
Expected income tax expense	$	14,334		$	43,641		$	35,804
State income taxes, net of federal tax benefit	4,396			3,317			2,436
Goodwill impairment	19,879			—			—
Stock options	2,006			—			—
Change in valuation allowance	(1,145		)	(52		)	—
Meals & entertainment and non deductible items	549			1,508			402
Other	512			(409		)	231
Actual income tax expense	$	40,531		$	48,005		$	38,873

87

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

10. Income Taxes (Continued)

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are presented below (in thousands):

	2006			2005
Deferred tax assets:
State net operating loss carryforward	$	38		$	41
Accrued liabilities	9,850			7,893
Merchandise inventories	4,572			5,568
Intangibles	5,757			—
Stock options	2,435			—
Capital loss carryover	132			1,181
Total gross deferred tax assets	22,784			14,683
Deferred tax liabilities:
Depreciation	(4,667		)	(13,551		)
Intangibles	—			(4,820		)
Other	(498		)	(1,936		)
Total gross deferred tax liabilities	(5,165		)	(20,307		)
Net deferred tax assets (liabilities) and net operating losses	17,619			(5,624		)
Less valuation allowance	(45		)	(1,191		)
Net deferred tax assets (liabilities)	$	17,574		$	(6,815	)

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections of future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward periods are reduced. The valuation allowance for 2006 and 2005 consists of capital loss carryforwards and state net operating losses.

The Company accounts for the tax benefit resulting from the employee exercises of non-qualifying stock options or the disqualified disposition of incentive stock options as a reduction in income tax payable and an increase to additional paid-in capital in the accompanying consolidated financial statements. The Company recorded $12.1 million, $7.6 million and $9.8 million of a benefit in 2006, 2005 and 2004, respectively. Of the $12.1 million recorded in 2006, $8.6 million is related to claims for refund for tax years 2003, 2004 and 2005 for deductions for disqualified dispositions of incentive stock options not previously claimed on federal and state tax returns.

88

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

11. Legal

On November 29, 2005, a case was filed against us and other defendants, including our Chief Executive Officer, in the United States District Court for the Southern District of Florida. The complaint asserts, among other things, violations of the Federal Racketeering Influenced and Corrupt Organization Act (RICO) and a corresponding Florida statute, Sections 1 and 2 of the Sherman Antitrust Act, Section 2 of the Clayton Act (as amended by the Robinson-Patman Act), the Antidumping Act of 1916, the Florida Antitrust Act of 1980, and the Florida Deceptive and Unfair Trade Practices Act, as well as tortious interference with business relationship under Florida law and civil conspiracy under Florida law by some or all of the identified defendants in connection with the claimed inability of Ace Pro Sound and Recording, LLC to obtain vendor lines for its store. The complaint purports to be made as a class action on behalf of all current and former retail sellers of musical instruments and/or sound equipment and/or recording equipment with stores located in geographical regions in the United States wherein some or all of the defendants have carried on business, and seeks compensatory damages, treble damages, punitive damages, injunctive relief and attorneys fees. Service relating to the complaint was made on January 12, 2006. In May of 2006, defendants filed their motions to dismiss all claims contained in the amended complaint and currently the motion is pending before the court. While we believe this lawsuit is without merit and intend to defend it vigorously, it may, regardless of the outcome, result in substantial expenses and damages to us and may significantly divert the attention of our management. There can be no assurance that we will be able to achieve a favorable settlement of this lawsuit or obtain a favorable resolution of this lawsuit if it is not settled. An unfavorable resolution of this lawsuit could have a material adverse effect on our business, financial condition and results of operations. Regardless of the outcome, the costs and expenses incurred by us to defend this lawsuit could adversely impact our financial condition. Due to the uncertainty of the outcome and the inability to estimate the possible loss or range of losses, we have not accrued for any potential losses.

On December 6, 2006, a lawsuit named J. Kevin Snyder v. Guitar Center Stores, Inc. that is a putative class action was filed in Los Angeles Superior Court alleging violations of the Song-Beverly Credit Card Act, based upon Guitar Center’s allegedly unlawful point-of-sale credit card practices.

On January 11, 2007, a lawsuit named Michael Kuhl v. Guitar Center Stores, Inc. was filed by a Guitar Center sales associate as a putative class action in the United States District Court for the Northern District of Illinois. The lawsuit alleges violations of the Illinois Wage Payment and Collection Act and the Fair Labor Standards Act, based upon Guitar Center’s allegedly unlawful payroll deduction policies. The lawsuit has been brought on behalf of plaintiff and all former and current hourly employees in Illinois and nationwide.

We expect to defend these actions vigorously. However, these actions, regardless of the outcome, may result in substantial expenses and damages to us and may significantly divert the attention of our management. There can be no assurance that we will be able to achieve a favorable settlement of these lawsuits or obtain a favorable resolution if they are not settled. An unfavorable resolution of these lawsuits could have a material adverse effect on our business, financial condition and results of operations. Regardless of the outcome, the costs and expenses incurred by us to defend them could adversely impact our financial condition. Due to the uncertainty of the outcome and the inability to estimate the possible loss or range of losses, we have not accrued for any potential losses.

In addition to the lawsuits described above, we are involved in various claims and legal actions arising in the ordinary course of our business and, while the results of those proceedings cannot be predicted with

89

GUITAR CENTER, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 2006

11. Legal (Continued)

certainty, we believe that the final outcome of those matters will not have a material adverse effect on our business, financial condition and results of operations.

12. Subsequent Event

On February 9, 2007, the Company acquired substantially all of the assets of the Dennis Bamber, Inc. and its chapter 11 bankruptcy estate, d/b/a The Woodwind & The Brasswind, for approximately $29.9 million. Under the terms of the agreement, our Musician’s Friend subsidiary acquired substantially all of the assets of The Woodwind & The Brasswind, including its inventory of band and orchestra and combo instruments, non-governmental accounts receivable, fixed assets, personal property, trade names and other intangible assets. Musician’s Friend will also assume approximately $2.0 million of specifically identified accrued liabilities. The transaction was funded through the Company’s available cash and credit facility.

13. Quarterly Financial Data (unaudited)

	2006
	First		Second		Third		Fourth			Total
	(in thousands, except per share data)
Net sales	$	470,747	$	457,978	$	472,732	$	628,509		$	2,029,966
Gross profit	$	136,506	$	131,357	$	133,267	$	192,873		$	594,003
Net income (loss)	$	15,707	$	13,429	$	11,321	$	(40,033	)	$	424
Net income (loss) per diluted share	$	0.55	$	0.47	$	0.38	$	(1.36	)	$	0.01

	2005
	First		Second		Third		Fourth		Total
	(in thousands, except per share data)
Net sales	$	396,386	$	402,296	$	421,061	$	562,756	$	1,782,499
Gross profit	$	111,172	$	115,340	$	123,818	$	170,072	$	520,402
Net income	$	15,884	$	12,911	$	14,409	$	33,474	$	76,678
Net income diluted per share	$	0.56	$	0.46	$	0.51	$	1.14	$	2.67

90

Schedule II

GUITAR CENTER, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2006, 2005 and 2004
(amounts in thousands)

	Balance at			Additions		Deductions		Balance
	beginning			charged to		from		at end
	of year			operations		allowance		of year
Allowance for doubtful accounts
December 31, 2006		$	2,844		3,131		3,357	$	2,618
December 31, 2005		$	3,489		3,501		4,146	$	2,844
December 31, 2004		$	1,708		4,126		2,345	$	3,489

II-1

EX-12.1

EXHIBIT 12.1

Guitar Center, Inc.

Computation of Ratio of Earnings to Fixed Charges

(Dollars in Thousands)

(Unaudited)

	Years ended December 31,
Ratio of Earnings to Fixed Charges	2006			2005			2004			2003			2002
Net income	$	424		$	76,678		$	63,425		$	36,860		$	25,256
Income taxes	40,531			48,005			38,873			22,649			15,545
Interest expense, net	8,448			7,339			5,390			12,540			13,077
Estimated interest component of operating lease
rent expense	17,939			15,131			12,747			11,260			9,675
Adjusted operating income	$	67,342		$	147,153		$	120,435		$	83,309		$	63,553
Fixed charges:
Interest expense, net	$	8,448		$	7,339		$	5,390		$	12,540		$	13,077
Estimated interest component of operating lease rent expense	17,939			15,131			12,747			11,260			9,675
	$	26,387		$	22,470		$	18,137		$	23,800		$	22,752
Ratio of earnings to fixed charges	2.6		x	6.5		x	6.6		x	3.5		x	2.8		x

EX-21.1

EXHIBIT 21.1

The following are the Company’s material subsidiaries as of December 31, 2006:

Musician’s Friend, Inc., a Delaware corporation.

Guitar Center Stores, Inc., a Delaware corporation.

EX-23.1

EXHIBIT 23.1

Consent of Independent Registered Public Accounting Firm

To the Board of Directors
Guitar Center, Inc.:

We consent to the incorporation by reference in the registration statements (Nos. 333-137135, 333-134971, 333-124796, 333-115004, 333-110823, 333-105409, 333-98127, 333-88244, 333-65220, 333-62732, 333-62608, 333-62610, 333-39364, 333-88675, 333-88677, 333-53269 and 333-26257) on Forms S-8, S-4 and S-3 of Guitar Center, Inc. of our report dated March 1, 2007, with respect to the consolidated balance sheets of Guitar Center, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006 and the related financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financial reporting as of December 31, 2006, which reports appear in the December 31, 2006, annual report on Form 10-K of Guitar Center, Inc. Our report refers to the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

/s/ KPMG LLP

Los Angeles, California

March 1, 2007

EX-31.1

EXHIBIT 31.1

Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Marty Albertson, certify that:

1.     I have reviewed this Annual Report on Form 10-K of Guitar Center, Inc.;

2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.     The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

a)     designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)     designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)     evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)     disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)     all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 1, 2007
	/s/ MARTY ALBERTSON
	Marty Albertson
	Chief Executive Officer

EX-31.2

EXHIBIT 31.2

Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Erick Mason, certify that:

1.     I have reviewed this Annual Report on Form 10-K of Guitar Center, Inc.;

2.     Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.     Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.     The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

a)     designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)     designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)     evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)     disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.     The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)     all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)     any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 1, 2007
	/s/ ERICK MASON
	Erick Mason
	Chief Financial Officer

EX-32.1

EXHIBIT 32.1

Certification of Co-Chief Executive Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to 18 U.S.C. §1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Guitar Center, Inc. (the “Company”) hereby certifies, to such officer’s knowledge, that:

(i)    the accompanying Annual Report on Form 10-K of the Company for the period ended December 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 1, 2007	/s/ MARTY ALBERTSON
	Marty Albertson
	Chief Executive Officer

EX-32.2

EXHIBIT 32.2

Certification of Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to 18 U.S.C. §1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Guitar Center, Inc. (the “Company”) hereby certifies, to such officer’s knowledge, that:

(i)    the accompanying Annual Report on Form 10-K of the Company for the period ended December 31, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 1, 2007	/s/ ERICK MASON
	Erick Mason
	Chief Financial Officer