10-Q 1 a12-19151_110q.htm 10-Q

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2012

 

OR

 

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

 

For the transition period from                  to                 

 

Commission File Number 333-175270-07

 

GUITAR CENTER HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

26-0843262

(State or Other Jurisdiction of

 

(I.R.S. Employer Identification No.)

Incorporation or Organization)

 

 

 

 

 

5795 Lindero Canyon Road

 

 

Westlake Village, California 91362

 

(818) 735-8800

(Address of Principal Executive Offices, including Zip Code)

 

(Registrant’s Telephone Number, Including Area Code)

 

Commission File Number 000-22207

 

GUITAR CENTER, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

95-4600862

(State or Other Jurisdiction of

 

(I.R.S. Employer Identification No.)

Incorporation or Organization)

 

 

 

 

 

5795 Lindero Canyon Road

 

 

Westlake Village, California 91362

 

(818) 735-8800

(Address of Principal Executive Offices, including Zip Code)

 

(Registrant’s Telephone Number, Including Area Code)

 

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.

 

Holdings*

YES o NO o

Guitar Center*

YES o NO o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Holdings

YES x NO o

Guitar Center

YES x NO o

 

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

 

Holdings

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Guitar Center

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

Holdings

YES o NO x

Guitar Center

YES o NO x

 

As of November 6, 2012 there were 9,740,160 shares of common stock, $0.01 par value per share, of Holdings outstanding.

 

As of November 6, 2012, there were 100 shares of common stock, $0.01 par value per share, of Guitar Center outstanding, all of which are owned by Holdings.

 


*The registrants have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, but are not required to file such reports under such sections.

 

 

 



Table of Contents

 

Explanatory Note

 

This quarterly report on Form 10-Q is a combined quarterly report being filed by Guitar Center, Inc. (“Guitar Center”) and Guitar Center Holdings, Inc. (“Holdings”).  Guitar Center is a direct, wholly-owned subsidiary of Holdings.  Each of Guitar Center and Holdings is filing on its own behalf all of the information contained in this quarterly report that relates to such company.  Where information or an explanation is provided that is substantially the same for each company, such information or explanation has been combined in this quarterly report.  Where information or an explanation is not substantially the same for each company, separate information and explanation has been provided.  In addition, separate condensed consolidated financial statements for each company are included in this quarterly report.

 



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

 

 

 

 

Guitar Center Holdings, Inc. and Subsidiaries

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011 (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2012 and 2011 (unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (unaudited)

3

 

 

 

 

Guitar Center, Inc. and Subsidiaries

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011 (unaudited)

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2012 and 2011 (unaudited)

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011 (unaudited)

6

 

 

 

 

Guitar Center Holdings, Inc. and Subsidiaries and Guitar Center, Inc. and Subsidiaries

 

 

 

 

 

Combined Notes to Condensed Consolidated Financial Statements (unaudited)

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

26

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

Item 4.

Controls and Procedures

36

 

 

 

PART II - OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

37

 

 

 

Item 1A.

Risk Factors

37

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

37

 

 

 

Item 3.

Defaults Upon Senior Securities

37

 

 

 

Item 4.

Mine Safety Disclosures

37

 

 

 

Item 5.

Other Information

37

 

 

 

Item 6.

Exhibits

38

 

 

 

Signatures

 

39

 

i



Table of Contents

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par values)

(unaudited)

 

 

 

September 30,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

9,987

 

$

106,036

 

Accounts receivable, net of allowance for doubtful accounts of $3,324 and $2,979, respectively

 

46,113

 

44,732

 

Merchandise inventories

 

647,330

 

547,960

 

Prepaid expenses and other current assets

 

27,858

 

26,984

 

Deferred income taxes

 

3,165

 

937

 

Total current assets

 

734,453

 

726,649

 

Property and equipment, net of accumulated depreciation and amortization of $238,280 and $194,763, respectively

 

211,770

 

209,097

 

Goodwill, net

 

582,378

 

582,378

 

Intangible assets, net of accumulated amortization of $192,954 and $171,259, respectively

 

298,245

 

320,140

 

Other assets, net

 

19,256

 

20,802

 

Total assets

 

$

1,846,102

 

$

1,859,066

 

 

 

 

 

 

 

Liabilities and Stockholders’ Deficit

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

156,399

 

$

120,010

 

Accrued expenses and other current liabilities

 

148,889

 

128,787

 

Merchandise advances

 

28,108

 

30,982

 

Current portion of long-term debt

 

134,262

 

646

 

Total current liabilities

 

467,658

 

280,425

 

Other long-term liabilities

 

20,030

 

18,690

 

Deferred income taxes

 

78,885

 

76,529

 

Long-term debt

 

1,427,389

 

1,561,489

 

Total liabilities

 

1,993,962

 

1,937,133

 

Commitments and contingencies

 

 

 

Stockholders’ deficit:

 

 

 

 

 

Preferred stock, $0.01 par value, 5,000 shares authorized, none issued and outstanding

 

 

 

Common stock, $0.01 par value, 20,000 shares authorized, 9,740 and 9,742, respectively, issued and outstanding

 

97

 

97

 

Additional paid-in capital

 

633,422

 

632,757

 

Accumulated deficit

 

(781,379

)

(710,748

)

Accumulated other comprehensive loss

 

 

(173

)

Total stockholders’ deficit

 

(147,860

)

(78,067

)

Total liabilities and stockholders’ deficit

 

$

1,846,102

 

$

1,859,066

 

 

See accompanying notes to condensed consolidated financial statements

 

1



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

 

Three months
ended September 30,

 

Nine months
ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

496,231

 

$

488,129

 

$

1,510,980

 

$

1,469,982

 

Cost of goods sold, buying and occupancy

 

348,869

 

343,876

 

1,053,581

 

1,024,064

 

Gross profit

 

147,362

 

144,253

 

457,399

 

445,918

 

Selling, general and administrative expenses

 

131,378

 

143,683

 

402,998

 

422,922

 

Operating income

 

15,984

 

570

 

54,401

 

22,996

 

Interest expense

 

(41,211

)

(40,907

)

(123,756

)

(120,200

)

Interest income

 

3

 

37

 

30

 

202

 

Loss before income taxes

 

(25,224

)

(40,300

)

(69,325

)

(97,002

)

Income tax expense (benefit)

 

434

 

(12,917

)

1,306

 

(32,216

)

Net loss

 

(25,658

)

(27,383

)

(70,631

)

(64,786

)

Other comprehensive income, net of income tax

 

 

111

 

173

 

136

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(25,658

)

$

(27,272

)

$

(70,458

)

$

(64,650

)

 

See accompanying notes to condensed consolidated financial statements

 

2



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Nine months
ended September 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Operating activities:

 

 

 

 

 

Net loss

 

$

(70,631

)

$

(64,786

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

67,404

 

77,487

 

Impairment of property and equipment

 

559

 

 

Net (gain) loss on disposal of property and equipment

 

(2

)

4,786

 

Amortization of deferred financing fees

 

2,388

 

2,154

 

Non-cash interest expense

 

18,637

 

 

Stock-based compensation

 

704

 

1,319

 

Deferred income taxes

 

(103

)

(38,219

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,381

)

1,632

 

Merchandise inventories

 

(99,370

)

(81,817

)

Prepaid expenses and other current assets

 

(3,741

)

(2,662

)

Other assets, net

 

(100

)

112

 

Accounts payable

 

36,389

 

34,443

 

Accrued expenses and other current liabilities

 

1,869

 

17,432

 

Merchandise advances

 

(2,874

)

(3,749

)

Other long-term liabilities

 

1,340

 

2,934

 

Net cash used in operating activities

 

(48,912

)

(48,934

)

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(48,781

)

(35,086

)

Net proceeds from disposal of property and equipment

 

2,909

 

3,982

 

Net cash used in investing activities

 

(45,872

)

(31,104

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Borrowings on asset-based revolving credit facility

 

57,000

 

 

Repayment of asset-based revolving credit facility

 

(57,000

)

 

Repayment of long-term debt

 

(484

)

(480

)

Repurchase of common stock

 

(39

)

(286

)

Financing fees

 

(742

)

(8,400

)

Net cash used in financing activities

 

(1,265

)

(9,166

)

Net decrease in cash

 

(96,049

)

(89,204

)

Cash at beginning of period

 

106,036

 

193,767

 

Cash at end of period

 

$

9,987

 

$

104,563

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

90,264

 

$

86,560

 

Income taxes

 

2,189

 

1,847

 

 

See accompanying notes to condensed consolidated financial statements

 

3



Table of Contents

 

GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

 

 

September 30,
2012

 

December 31,
2011

 

 

 

 

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash

 

$

9,987

 

$

106,036

 

Accounts receivable, net of allowance for doubtful accounts of $3,324 and $2,979, respectively

 

46,113

 

44,732

 

Merchandise inventories

 

647,330

 

547,960

 

Prepaid expenses and other current assets

 

27,858

 

26,093

 

Deferred income taxes

 

27,576

 

29,121

 

Total current assets

 

758,864

 

753,942

 

Property and equipment, net of accumulated depreciation and amortization of $238,280 and $194,763, respectively

 

211,770

 

209,097

 

Goodwill, net

 

582,378

 

582,378

 

Intangible assets, net of accumulated amortization of $192,954 and $171,259, respectively

 

298,245

 

320,140

 

Other assets, net

 

16,955

 

18,192

 

Total assets

 

$

1,868,212

 

$

1,883,749

 

 

 

 

 

 

 

Liabilities and Stockholder’s Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

156,399

 

$

120,010

 

Accrued expenses and other current liabilities

 

180,389

 

171,929

 

Merchandise advances

 

28,108

 

30,982

 

Current portion of long-term debt

 

4,478

 

646

 

Total current liabilities

 

369,374

 

323,567

 

Other long-term liabilities

 

20,030

 

18,690

 

Deferred income taxes

 

102,569

 

117,686

 

Long-term debt

 

992,500

 

996,816

 

Due to Guitar Center Holdings, Inc.

 

263,895

 

303,715

 

Total liabilities

 

1,748,368

 

1,760,474

 

Commitments and contingencies

 

 

 

Stockholder’s equity:

 

 

 

 

 

Common stock, $0.01 par value, 1,000 shares authorized 100 shares issued and outstanding

 

 

 

Additional paid-in capital

 

619,812

 

619,108

 

Accumulated deficit

 

(499,968

)

(495,660

)

Accumulated other comprehensive loss

 

 

(173

)

Total stockholder’s equity

 

119,844

 

123,275

 

Total liabilities and stockholder’s equity

 

$

1,868,212

 

$

1,883,749

 

 

See accompanying notes to condensed consolidated financial statements

 

4



Table of Contents

 

GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

 

Three months
ended September 30,

 

Nine months
ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

496,231

 

$

488,129

 

$

1,510,980

 

$

1,469,982

 

Cost of goods sold, buying and occupancy

 

348,869

 

343,876

 

1,053,581

 

1,024,064

 

Gross profit

 

147,362

 

144,253

 

457,399

 

445,918

 

Selling, general and administrative expenses

 

131,378

 

143,683

 

402,998

 

422,644

 

Operating income

 

15,984

 

570

 

54,401

 

23,274

 

Interest expense

 

(21,217

)

(20,914

)

(63,776

)

(60,222

)

Interest income

 

3

 

37

 

30

 

202

 

Loss before income taxes

 

(5,230

)

(20,307

)

(9,345

)

(36,746

)

Income tax benefit

 

(3,192

)

(6,548

)

(5,037

)

(12,361

)

Net loss

 

(2,038

)

(13,759

)

(4,308

)

(24,385

)

Other comprehensive income, net of income tax

 

 

111

 

173

 

136

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(2,038

)

$

(13,648

)

$

(4,135

)

$

(24,249

)

 

See accompanying notes to condensed consolidated financial statements

 

5



Table of Contents

 

GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Nine months
ended September 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Operating activities:

 

 

 

 

 

Net loss

 

$

(4,308

)

$

(24,385

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

67,404

 

77,487

 

Impairment of property and equipment

 

559

 

 

Net (gain) loss on disposal of property and equipment

 

(2

)

4,786

 

Amortization of deferred financing fees

 

2,079

 

1,846

 

Non-cash interest expense

 

404

 

 

Stock-based compensation

 

704

 

1,319

 

Deferred income taxes

 

(13,803

)

(10,611

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(1,381

)

1,632

 

Merchandise inventories

 

(99,370

)

(81,817

)

Prepaid expenses and other current assets

 

(4,632

)

(5,645

)

Other assets, net

 

(100

)

112

 

Accounts payable

 

36,389

 

34,443

 

Accrued expenses and other current liabilities

 

8,460

 

(7,227

)

Merchandise advances

 

(2,874

)

(3,749

)

Other long-term liabilities

 

1,340

 

2,934

 

Net cash used in operating activities

 

(9,131

)

(8,875

)

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(48,781

)

(35,086

)

Net proceeds from sale of property and equipment

 

2,909

 

3,982

 

Net cash used in investing activities

 

(45,872

)

(31,104

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Borrowings on asset-based revolving credit facility

 

57,000

 

 

Repayment of asset-based revolving credit facility

 

(57,000

)

 

Repayment of long-term debt

 

(484

)

(480

)

Financing fees

 

(742

)

(7,499

)

Repayment to Guitar Center Holdings, Inc.

 

(39,820

)

(41,246

)

Net cash used in financing activities

 

(41,046

)

(49,225

)

Net decrease in cash

 

(96,049

)

(89,204

)

Cash at beginning of period

 

106,036

 

193,767

 

Cash at end of period

 

$

9,987

 

$

104,563

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

50,483

 

$

46,779

 

Income taxes

 

2,189

 

1,847

 

 

See accompanying notes to condensed consolidated financial statements

 

6



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1.     Nature of Business and Significant Accounting Policies

 

Nature of Business

 

Guitar Center Holdings, Inc. is the parent company of wholly-owned Guitar Center, Inc. and its wholly-owned subsidiaries.  All of the company’s operating activities are conducted out of Guitar Center, Inc. and its subsidiaries.  The parent company’s business activities consist solely of debt and equity financing related to its ownership of Guitar Center, Inc.

 

In these notes, we refer to the condensed consolidated financial statements of Guitar Center Holdings, Inc. and its subsidiaries as “Holdings,” except where the context requires otherwise when discussing the debt or equity of the Guitar Center Holdings, Inc. entity. We refer to the condensed consolidated financial statements of Guitar Center, Inc. and its subsidiaries as “Guitar Center.”  The terms “we,” “us,” “our” and “the company” refer to Holdings and Guitar Center collectively.

 

We operate three businesses under our Guitar Center, direct response and Music & Arts brands.

 

Guitar Center is the leading United States retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment. As of September 30, 2012, Guitar Center operated 236 Guitar Center stores across the United States, with 151 primary format stores, 77 secondary format stores and 8 tertiary format stores, along with the Guitar Center website.

 

Our direct response segment is a leading direct response retailer of musical instruments in the United States, and its operations include the Musician’s Friend and other branded websites and catalogs.

 

Music & Arts specializes in band and orchestra instruments for sale and rental, serving students, teachers, band directors and college professors. As of September 30, 2012, Music & Arts operated 109 stores in 22 states, along with the Music & Arts website.

 

Principles of Consolidation

 

The accompanying unaudited condensed consolidated financial statements of Holdings and Guitar Center include the accounts of the respective companies’ wholly-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.

 

Unaudited Interim Financial Information

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC, for reporting on Form 10-Q. Accordingly, these notes do not include all disclosures normally included in complete financial statements prepared in accordance with GAAP.  We believe the disclosures made are adequate for an understanding of the changes in financial position and performance of the entity since the last annual reporting date.  These unaudited condensed financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 27, 2012.

 

7



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The accompanying unaudited condensed consolidated financial statements are prepared on the same basis as our annual consolidated financial statements. We believe the condensed consolidated financial statements contain all adjustments necessary for a fair presentation as prescribed by GAAP. Interim period adjustments are normal and recurring in nature, except where indicated otherwise in these notes.

 

Our business follows a seasonal pattern, peaking during the holiday selling season in November and December. Fourth quarter sales at our Guitar Center and direct response segments are typically significantly higher than in any other quarter. Accordingly, interim results may not be indicative of results for the entire year.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

 

As a result of economic conditions in the United States, there is uncertainty about unemployment, consumer confidence and business and consumer spending. Over the last several years, these factors have reduced our visibility into long-term trends, dampen our expectations of future business performance and have affected our estimates.

 

New Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board, or FASB, issued revised standards related to fair value measurements and disclosures. The revised standards clarify existing fair value measurement principles, modify the application of fair value measurement principles in certain circumstances and expand the disclosure requirements related to fair value measurements.

 

The revised standards are effective for interim and annual reporting periods beginning after December 15, 2011. We adopted the revised standards on January 1, 2012. The change resulted in expanded fair value disclosures in the notes to financial statements and had no effect on our balance sheets, statements of comprehensive loss or cash flows.

 

In June 2011, FASB issued revised standards related to the presentation of comprehensive income. The revised standards eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity and require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of income and comprehensive income or in two separate but consecutive statements.

 

The revised standards are effective for interim and annual reporting periods beginning after December 15, 2011 and must be applied retrospectively to all periods upon adoption. We adopted the revised standards on January 1, 2012, opting to present components of other comprehensive income in a single continuous statement of comprehensive income or loss.

 

In July 2012, FASB issued revised standards related to testing indefinite-lived intangible assets for impairment.  The new standards permit an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. Under the revised standards, an entity would only be required to calculate the fair value of an indefinite-lived intangible asset if the entity determines, based on a qualitative assessment, that the intangible asset is more likely than not impaired. The revised standards are intended to reduce costs and simplify impairment testing for indefinite-lived intangible assets.

 

The revised standards are effective for annual and interim impairment tests of indefinite-lived intangible assets performed for fiscal years beginning after September 15, 2012, with early adoption permitted. We plan to adopt the revised standards for our annual impairment test of indefinite-lived intangible assets performed during the fourth quarter of 2012. We do not expect the adoption of the revised standards to affect our financial statements.

 

8



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

2.     Goodwill and Intangible Assets

 

We have goodwill at our Guitar Center reporting unit, which is also an operating segment. We also have intangible assets primarily related to trademarks, customer relationships and favorable leases.

 

Goodwill

 

The following table presents a summary of goodwill by segment (in thousands):

 

 

 

Guitar

 

Direct

 

 

 

 

 

Center

 

Response

 

Total

 

Balance at September 30, 2012 and December 31, 2011

 

 

 

 

 

 

 

Goodwill

 

$

706,182

 

$

108,929

 

$

815,111

 

Accumulated impairment losses

 

(123,804

)

(108,929

)

(232,733

)

 

 

$

582,378

 

$

 

$

582,378

 

 

Other intangible assets

 

The following tables present a summary of our intangible assets (dollars in thousands, life in years):

 

 

 

 

 

September 30, 2012

 

 

 

Weighted-

 

Gross

 

 

 

 

 

 

 

Average Useful

 

Carrying

 

Accumulated

 

Intangible

 

 

 

Life

 

Amount

 

Amortization

 

Assets, Net

 

Unamortized trademarks

 

 

$

208,501

 

$

 

$

208,501

 

Amortized

 

 

 

 

 

 

 

 

 

Customer relationships

 

13.0

 

224,302

 

(142,294

)

82,008

 

Favorable lease terms

 

7.5

 

57,721

 

(49,999

)

7,722

 

Other

 

4.5

 

675

 

(661

)

14

 

 

 

 

 

$

491,199

 

$

(192,954

)

$

298,245

 

 

 

 

 

 

December 31, 2011

 

 

 

Weighted-

 

Gross

 

 

 

 

 

 

 

Average Useful

 

Carrying

 

Accumulated

 

Intangible

 

 

 

Life

 

Amount

 

Amortization

 

Assets, Net

 

Unamortized trademarks

 

 

$

208,501

 

$

 

$

208,501

 

Amortized

 

 

 

 

 

 

 

 

 

Customer relationships

 

13.0

 

224,302

 

(125,049

)

99,253

 

Favorable lease terms

 

7.5

 

57,721

 

(45,436

)

12,285

 

Covenants not to compete

 

4.2

 

210

 

(209

)

1

 

Other

 

4.5

 

665

 

(565

)

100

 

 

 

 

 

$

491,399

 

$

(171,259

)

$

320,140

 

 

9



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

We amortize intangible assets with finite lives over their respective estimated useful lives. We amortize customer relationship intangible assets using an accelerated method based on expected customer attrition rates. Other intangible assets with finite lives are generally amortized using the straight-line method.

 

Intangible assets with indefinite lives are not amortized. We test indefinite-lived intangible assets for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired.

 

We include amortization of favorable leases in cost of goods sold, buying and occupancy.  We include amortization of other intangible assets such as customer relationships and non-compete agreements in selling, general and administrative expenses.

 

Amortization expense is classified in our condensed consolidated statements of comprehensive loss as follows (in thousands):

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Cost of goods sold, buying and occupancy

 

$

1,423

 

$

1,800

 

$

4,563

 

$

5,780

 

Selling, general and administrative expenses

 

5,776

 

8,843

 

17,331

 

26,553

 

 

The future estimated amortization expense related to intangible assets as of September 30, 2012 was as follows (in thousands):

 

Year

 

 

 

 

 

 

 

Remainder of 2012

 

$

7,083

 

2013

 

22,191

 

2014

 

16,350

 

2015

 

12,408

 

2016

 

9,640

 

Thereafter

 

22,072

 

Total

 

$

89,744

 

 

10



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

3.     Restructuring and Exit Activities

 

In April 2011, we initiated a restructuring plan to realign certain management and support functions across the organization.  As part of the restructuring plan, we relocated the operations of our direct response business from Medford, Oregon to Southern California.  We believe that having our Guitar Center and direct response operations at a single location will improve our ability to execute strategic initiatives.

 

In connection with this restructuring activity, we incurred employee termination costs, which included retention bonuses and severance pay to personnel in Medford and at our corporate office.  We also incurred other transition costs, such as relocation assistance, additional recruiting and travel expense, information technology integration costs and other similar costs.

 

We incurred restructuring costs totaling $1.4 million at our corporate segment and $0.5 million at our direct response segment during the nine months ended September 30, 2012. Restructuring costs incurred during the three months ended September 30, 2012 were not significant.

 

Restructuring costs incurred for each segment during the three and nine months ended September 30, 2011 were as follows (in thousands):

 

 

 

Three months ended September 30, 2011

 

 

 

Guitar Center

 

Direct
Response

 

Corporate

 

Total

 

Employee termination costs

 

$

123

 

$

1,459

 

$

149

 

$

1,731

 

Employee relocation and recruiting costs

 

 

190

 

841

 

1,031

 

Consulting costs

 

65

 

872

 

148

 

1,085

 

Other costs

 

278

 

989

 

334

 

1,601

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

466

 

$

3,510

 

$

1,472

 

$

5,448

 

 

 

 

Nine months ended September 30, 2011

 

 

 

Guitar Center

 

Direct
Response

 

Corporate

 

Total

 

Employee termination costs

 

$

265

 

$

2,819

 

$

1,302

 

$

4,386

 

Employee relocation and recruiting costs

 

45

 

418

 

896

 

1,359

 

Consulting costs

 

66

 

932

 

368

 

1,366

 

Other costs

 

308

 

1,032

 

413

 

1,753

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

684

 

$

5,201

 

$

2,979

 

$

8,864

 

 

11



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Cumulative restructuring costs incurred for each segment from inception of the restructuring plan through September 30, 2012 were as follows (in thousands):

 

 

 

Cumulative amount through September 30, 2012

 

 

 

Guitar Center

 

Direct
Response

 

Corporate

 

Total

 

Employee termination costs

 

$

190

 

$

4,418

 

$

1,043

 

$

5,651

 

Employee relocation and recruiting costs

 

177

 

433

 

2,888

 

3,498

 

Consulting costs

 

150

 

1,546

 

621

 

2,317

 

Other costs

 

987

 

2,011

 

427

 

3,425

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,504

 

$

8,408

 

$

4,979

 

$

14,891

 

 

Cumulative employee termination costs through September 30, 2012 include retention bonuses of $4.4 million and severance payments of $1.3 million under employment agreements with certain executives whose positions were eliminated in the restructuring.

 

Restructuring and exit activity costs are included in selling, general and administrative expenses in our condensed consolidated statements of comprehensive loss.  The restructuring plan did not result in any impairment of property and equipment in 2011 or 2012.

 

The following table summarizes our restructuring accrual activity for the nine months ended September 30, 2012, as it relates to employee termination costs (in thousands):

 

 

 

Termination
Costs

 

Balance at December 31, 2011

 

$

3,926

 

Charges

 

244

 

Cash payments

 

(4,170

)

Balance at September 30, 2012

 

$

 

 

Accrued termination costs as of December 31, 2011 are included in accrued expenses and other current liabilities in our condensed consolidated balance sheets.

 

As of September 30, 2012 the restructuring plan was complete and we do not expect to incur additional restructuring costs.

 

12



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

4.     Long-Term Debt

 

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

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Guitar Center

 

 

 

 

 

Senior secured asset-based revolving facility

 

$

 

$

 

Senior secured term loan

 

621,762

 

621,762

 

Obligations under capital lease, payable in monthly installments through 2013

 

216

 

700

 

Senior unsecured notes

 

375,000

 

375,000

 

 

 

996,978

 

997,462

 

Less current portion

 

4,478

 

646

 

Guitar Center long-term debt, net of current portion

 

992,500

 

996,816

 

 

 

 

 

 

 

Holdings

 

 

 

 

 

Senior unsecured PIK notes

 

564,673

 

564,673

 

Less current portion

 

129,784

 

 

Holdings long-term debt, net of current portion

 

434,889

 

564,673

 

 

 

 

 

 

 

Holdings consolidated long-term debt, net of current portion

 

$

1,427,389

 

$

1,561,489

 

 

Guitar Center long-term debt as of September 30, 2012 consisted of (1) a senior secured asset-based revolving facility, referred to as the asset-based facility, with a maximum availability of $373 million and no amounts drawn, (2) a senior secured term loan facility, referred to as the term loan, with an initial aggregate principal amount of $650 million, (3) a senior unsecured loan facility, referred to as the senior notes, with an aggregate principal amount of $375 million.

 

Holdings long-term debt as of September 30, 2012 consisted of a senior subordinated unsecured payment-in-kind loan facility, referred to as the senior PIK notes, with an initial aggregate principal amount of $375 million.

 

Extended commitments on the asset-based facility

 

During the first quarter of 2012, we obtained a total of $55 million in commitments under the extended terms of the asset-based facility to substitute commitments that were not extended in March 2011. We paid an aggregate of $0.7 million in arrangement, consent and extension fees as part of the transactions.  These commitments extended the maturity date from October 2013 to February 2016 and increased the pricing margin on drawn and undrawn amounts. We can borrow under the asset-based facility at either the (a) London Inter-Bank Offered Rate, or LIBOR, plus a margin based on average borrowings that ranges from 2.75% to 3.25% on extended commitments and from 1.25% to 1.75% on non-extended commitments or (b) prime rate, plus a margin based on average borrowings that ranges from 1.75% to 2.25% on extended commitments and from 0% to 0.5% on non-extended commitments. We are required to pay a commitment fee to the lenders based on undrawn availability at a rate of 0.5% per annum for extended commitments and 0.25% per annum for non-extended commitments.

 

13



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Fees paid were capitalized and are amortized into interest expense using the effective interest method.

 

Senior PIK notes interest reinvestment elections

 

For interest payments due between April 2011 and October 2012 on the senior PIK notes, we had the option to pay 50% of the interest due by issuing additional Guitar Center senior notes. For periods after October 2012, interest on the senior PIK notes is payable only in cash.

 

We did not elect to reinvest any part of the April 2011 or October 2011 interest payments on the senior PIK notes.

 

In the fourth quarter of 2011 we elected to reinvest 50% of the interest payment due in April 2012. However, we were given the option to re-evaluate the election during the first quarter of 2012 and subsequently elected to make the entire interest payment in cash.

 

We elected to cause the holders of our senior PIK notes to reinvest 50% of the October 2012 interest payment on the senior PIK notes in additional senior notes of a like amount.

 

Guarantees, dividend restrictions and covenants

 

Guitar Center’s term loan, asset-based facility and senior notes are guaranteed by substantially all of its subsidiaries. The subsidiary guarantors are 100% owned, all of the guarantees are full and unconditional and joint and several and Guitar Center, Inc. has no assets or operations independent from its subsidiaries within the meaning of Regulation S-X, Rule 3-10. Any non-guarantor subsidiaries are minor.

 

For information about dividend restrictions among Holdings, Guitar Center and its guarantor subsidiaries, see Note 5 to the audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2011, filed with the SEC on March 27, 2012.

 

As of September 30, 2012, we were in compliance with all of our debt covenants.

 

14



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Future maturities

 

Future maturities and expected payments of long-term debt as of September 30, 2012 were as follows (in thousands):

 

 

 

Guitar Center

 

Holdings

 

Holdings
Consolidated

 

Remainder of 2012

 

$

162

 

$

 

$

162

 

2013 (1)

 

5,941

 

129,784

 

135,725

 

2014

 

14,314

 

 

14,314

 

2015

 

6,500

 

 

6,500

 

2016

 

6,500

 

 

6,500

 

2017

 

963,561

 

 

963,561

 

Thereafter

 

 

434,889

 

434,889

 

 

 

$

996,978

 

$

564,673

 

$

1,561,651

 

 


(1)         We anticipate making a one-time principal payment on the senior PIK notes in April 2013. We estimate this payment will be $129.8 million, which is the amount of previously capitalized PIK interest required to be paid to prevent the senior PIK notes from being treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code. This amount is included in current portion of long-term debt in Holdings’ condensed consolidated balance sheet as of September 30, 2012. The remaining unpaid balance of the senior PIK notes will mature in April 2018.

 

Deferred financing fees

 

Amortization of deferred financing fees included in interest expense was as follows (in thousands):

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Holdings

 

$

802

 

$

742

 

$

2,388

 

$

2,154

 

Guitar Center

 

699

 

639

 

2,079

 

1,846

 

 

Unamortized deferred financing fees included in other assets in our condensed consolidated balance sheets were as follows (in thousands):

 

 

 

September 30, 2012

 

December 31, 2011

 

Holdings

 

$

13,877

 

$

15,524

 

Guitar Center

 

11,576

 

12,913

 

 

15



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

5.     Segment Information

 

We have three reporting segments: Guitar Center, direct response and Music & Arts.

 

Beginning in 2012, our corporate segment includes the activities of our shared services subsidiary, GTRC Services, Inc. This shared service organization operates support services for all our brands, including distribution and fulfillment centers, contact centers and technology services that were previously managed separately by our Guitar Center and direct response segments. We believe that centralizing the management of these shared operations will improve our flexibility to efficiently manage these resources. Substantially all of the costs of these shared service operations are allocated among our segments based on estimated usage, as determined primarily based on sales, cost of goods sold or call volume at each business. Segment results for 2011 have been adjusted to reflect this change.

 

The Guitar Center segment sells products and services through Guitar Center retail stores and online.  For the Guitar Center segment, operating costs primarily consist of labor, advertising, depreciation and store occupancy costs.

 

The direct response segment sells products through direct mail catalogs and online.  For the direct response segment, operating costs primarily consist of catalog costs, e-commerce advertising costs and order processing and fulfillment costs.

 

The Music & Arts segment specializes in band instruments for sale and rental, serving students, teachers, band directors and college professors. For the Music & Arts segment, operating costs primarily consist of labor, depreciation and store occupancy costs.

 

Corporate is a non-operating segment, consisting of centralized management, general and administrative functions and unallocated costs of our shared service operations. Interest expense, interest income and income tax expense or benefit are evaluated on a consolidated basis and are not considered in the evaluation of segment results.

 

For the period, our chief operating decision makers included our chief executive officer and chief financial officer serving at that time.  Our chief operating decision makers evaluate segment performance based primarily on net sales and adjusted EBITDA.  Adjusted EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, with adjustments for certain non-cash and non-recurring expenses and other adjustments permitted under our debt agreements.  Management views adjusted EBITDA as an important measure of segment performance because it is considered an indicator of segment operating cash flows and facilitates comparison of operating performance on a consistent basis.  Adjusted EBITDA is a measure which is also used in calculating financial ratios in material debt covenants in our asset-based credit facility and term loan.

 

16



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following tables summarize financial information for our reporting segments (in thousands):

 

 

 

Three months ended September 30, 2012

 

 

 

Guitar
Center

 

Music & Arts

 

Direct
Response

 

Corporate

 

Total

 

Net sales

 

$

366,564

 

$

50,077

 

$

79,590

 

$

 

$

496,231

 

Gross profit

 

103,320

 

19,564

 

24,034

 

444

 

147,362

 

Selling, general and administrative expenses

 

84,601

 

18,481

 

20,674

 

7,622

 

131,378

 

Operating income (loss)

 

18,719

 

1,083

 

3,360

 

(7,178

)

15,984

 

Depreciation and amortization

 

16,728

 

1,132

 

3,788

 

1,019

 

22,667

 

Adjusted EBITDA

 

36,793

 

2,275

 

7,304

 

(3,793

)

42,579

 

Capital expenditures

 

9,736

 

1,425

 

1,885

 

3,270

 

16,316

 

 

 

 

Three months ended September 30, 2011

 

 

 

Guitar
Center

 

Music & Arts

 

Direct
Response

 

Corporate

 

Total

 

Net sales

 

$

358,610

 

$

44,699

 

$

84,820

 

$

 

$

488,129

 

Gross profit

 

102,713

 

18,625

 

22,915

 

 

144,253

 

Selling, general and administrative expenses

 

89,000

 

17,739

 

27,813

 

9,131

 

143,683

 

Operating income (loss)

 

13,713

 

886

 

(4,898

)

(9,131

)

570

 

Depreciation and amortization

 

18,867

 

1,007

 

5,957

 

670

 

26,501

 

Adjusted EBITDA

 

35,050

 

2,176

 

4,121

 

(4,229

)

37,118

 

Capital expenditures

 

6,690

 

982

 

1,835

 

3,934

 

13,441

 

 

 

 

Nine months ended September 30, 2012

 

 

 

Guitar
Center

 

Music & Arts

 

Direct
Response

 

Corporate

 

Total

 

Net sales

 

$

1,125,599

 

$

135,865

 

$

249,516

 

$

 

$

1,510,980

 

Gross profit

 

324,327

 

62,126

 

70,844

 

102

 

457,399

 

Selling, general and administrative expenses

 

261,027

 

51,989

 

70,549

 

19,433

 

402,998

 

Operating income (loss)

 

63,300

 

10,137

 

295

 

(19,331

)

54,401

 

Depreciation and amortization

 

49,467

 

3,357

 

11,820

 

2,760

 

67,404

 

Adjusted EBITDA

 

116,869

 

14,089

 

12,994

 

(9,073

)

134,879

 

Capital expenditures

 

28,487

 

4,319

 

6,022

 

9,953

 

48,781

 

Total assets

 

 

 

 

 

 

 

 

 

 

 

Holdings

 

1,462,007

 

121,588

 

186,509

 

75,998

 

1,846,102

 

Guitar Center

 

1,462,007

 

121,588

 

186,509

 

98,108

 

1,868,212

 

 

17



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

 

Nine months ended September 30, 2011

 

 

 

Guitar
Center

 

Music & Arts

 

Direct
Response

 

Corporate

 

Total

 

Net sales

 

$

1,075,136

 

$

126,897

 

$

267,949

 

$

 

$

1,469,982

 

Gross profit

 

310,443

 

60,264

 

75,211

 

 

445,918

 

Selling, general and administrative expenses

 

258,094

 

50,693

 

83,204

 

30,931

 

422,922

 

Operating income (loss)

 

52,349

 

9,571

 

(7,993

)

(30,931

)

22,996

 

Depreciation and amortization

 

55,883

 

3,148

 

16,413

 

2,043

 

77,487

 

Adjusted EBITDA

 

112,897

 

13,261

 

13,181

 

(13,711

)

125,628

 

Capital expenditures

 

16,589

 

2,998

 

6,254

 

9,245

 

35,086

 

Total assets

 

 

 

 

 

 

 

 

 

 

 

Holdings

 

1,492,607

 

114,151

 

335,344

 

126,694

 

2,068,796

 

Guitar Center

 

1,492,607

 

114,151

 

335,344

 

123,472

 

2,065,574

 

 

Segment operating results of Guitar Center are the same as for Holdings, except that in the nine months ended September 30, 2011, selling, general and administrative expenses of $0.3 million related to the amendments and extension of our long-term debt were incurred at the corporate segment at Holdings and were not allocated to Guitar Center.

 

We record property and equipment at our segments based on direct capital expenditures made at each segment.  We allocate depreciation and amortization expense to our segments based on actual usage for assets used exclusively at each segment, and based on estimated usage, primarily measured by gross sales, for shared assets.  Although depreciation and amortization expense are excluded from adjusted EBITDA, these measures are regularly provided to our chief operating decision makers.

 

Material unallocated assets at our corporate segment primarily consist of cash, property and equipment related to our shared data centers and corporate office facilities, deferred income taxes and capitalized financing fees.

 

We reassigned the assets of our shared data centers and our corporate office facilities and certain cash accounts to the corporate segment upon implementing our shared services organization. Total assets for each segment in 2011 have been adjusted to reflect this change.

 

18



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following tables present a reconciliation of adjusted EBITDA to consolidated loss before income taxes (in thousands):

 

Holdings

 

 

 

Three months 
ended September 30,

 

Nine months 
ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

 

 

 

 

 

 

 

 

Guitar Center

 

$

36,793

 

$

35,050

 

$

116,869

 

$

112,897

 

Music & Arts

 

2,275

 

2,176

 

14,089

 

13,261

 

Direct response

 

7,304

 

4,121

 

12,994

 

13,181

 

Corporate

 

(3,793

)

(4,229

)

(9,073

)

(13,711

)

 

 

42,579

 

37,118

 

134,879

 

125,628

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

22,667

 

26,501

 

67,404

 

77,487

 

Interest expense, net

 

41,208

 

40,870

 

123,726

 

119,998

 

Non-cash charges

 

525

 

820

 

2,215

 

2,485

 

Non-recurring charges

 

 

635

 

 

5,252

 

Impairment charges

 

559

 

 

559

 

 

Other adjustments

 

2,844

 

8,592

 

10,300

 

17,408

 

 

 

 

 

 

 

 

 

 

 

Consolidated loss before income taxes

 

$

(25,224

)

$

(40,300

)

$

(69,325

)

$

(97,002

)

 

Guitar Center

 

 

 

Three months 
ended September 30,

 

Nine months 
ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

 

 

 

 

 

 

 

 

Guitar Center

 

$

36,793

 

$

35,050

 

$

116,869

 

$

112,897

 

Music & Arts

 

2,275

 

2,176

 

14,089

 

13,261

 

Direct response

 

7,304

 

4,121

 

12,994

 

13,181

 

Corporate

 

(3,793

)

(4,229

)

(9,073

)

(13,711

)

 

 

42,579

 

37,118

 

134,879

 

125,628

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

22,667

 

26,501

 

67,404

 

77,487

 

Interest expense, net

 

21,214

 

20,877

 

63,746

 

60,020

 

Non-cash charges

 

525

 

820

 

2,215

 

2,485

 

Non-recurring charges

 

 

635

 

 

5,252

 

Impairment charges

 

559

 

 

559

 

 

Other adjustments

 

2,844

 

8,592

 

10,300

 

17,130

 

 

 

 

 

 

 

 

 

 

 

Consolidated loss before income taxes

 

$

(5,230

)

$

(20,307

)

$

(9,345

)

$

(36,746

)

 

19



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Adjustments in the calculation of adjusted EBITDA include the following:

 

·                  Non-cash charges include stock-based compensation expense and the non-cash portion of rent expense.

·                  Non-recurring charges for the three and nine months ended September 30, 2011 consist of losses realized on the sale of our corporate aircraft.

·                  Other adjustments include restructuring charges, severance payments, bonuses under our long-term management incentive plan, various debt and financing costs, gains and losses on disposal of assets, special charges and management fees paid to Bain Capital, LLC, an affiliate of the majority stockholders.

 

Restructuring charges included in other adjustments were $0.2 million for the three months ended September 30, 2012 and $5.4 million for the three months ended September 30, 2011.

 

Restructuring charges included in other adjustments were $1.9 million for the nine months ended September 30, 2012 and $8.9 million for the nine months ended September 30, 2011.

 

6.              Fair Value Measurements

 

The accounting standards related to fair value measurements define fair value and provide a consistent framework for measuring fair value under GAAP.  Valuation techniques are based on observable and unobservable inputs.  Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect market assumptions.

 

Valuation inputs are classified into the following hierarchy:

 

·                  Level 1 Inputs— Quoted prices for identical instruments in active markets.

·                  Level 2 Inputs— Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

·                  Level 3 Inputs— Instruments with primarily unobservable value drivers.

 

Valuation policies and procedures for fair value measurements using Level 3 inputs are established by finance management reporting to our chief financial officer. We corroborate Level 3 inputs with historical and market information where possible and appropriate and we engage third-party valuation firms to assist us in determining certain fair value measurements.

 

We do not have any material assets or liabilities measured at fair value on a recurring basis.

 

The fair values of cash, receivables, accounts payable, accrued expenses and other current liabilities approximate their carrying values because of their short-term nature.

 

Some assets are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances.  These assets can include long-lived and intangible assets that have been reduced to fair value when they are impaired and long-lived assets that are held for sale.  Assets that are written down to fair value when impaired are not subsequently adjusted to fair value unless further impairment occurs.

 

20



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following tables present the fair value hierarchy for assets and liabilities measured at fair value on a non-recurring basis (in thousands):

 

 

 

Three and nine months ended September 30, 2012

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Total Losses

 

Specific-store leasehold improvements

 

$

 

$

 

$

195

 

$

195

 

$

559

 

 

 

 

Year ended December 31, 2011

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Total Losses

 

Direct response goodwill, net of accumulated impairment losses

 

$

 

$

 

$

 

$

 

$

107,026

 

Direct response trademarks and trade names

 

 

 

11,500

 

11,500

 

32,500

 

Direct response customer relationship intangible asset

 

 

 

6,800

 

6,800

 

13,461

 

Specific-store leasehold improvements

 

 

 

745

 

745

 

1,294

 

 

We estimate the fair value of specific-store leasehold improvements using an income-based approach, considering the cash flows expected over the remaining lease term for each location.  The income-based approach uses unobservable inputs, including projected free cash flow and internal cost of capital and accordingly these fair value measurements have been classified as Level 3 in the fair value hierarchy.

 

21



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following tables present quantitative information about Level 3 inputs used in our fair value measurements:

 

Fair Value Measurement

 

Fair Value at
September 30,
2012

(in thousands)

 

Valuation technique

 

Unobservable input

 

Range

 

Specific-store leasehold improvements

 

$

195

 

Discounted cash flow

 

Weighted-average cost of capital

 

9.8%

 

 

 

 

 

 

 

Long-term revenue growth rate

 

3.0%

 

 

Fair Value Measurement

 

Fair Value at
December 31,
2011
(in thousands)

 

Valuation technique(s)

 

Unobservable input

 

Range

 

Direct response trademarks and trade names

 

$

11,500

 

Discounted cash flow

 

Weighted-average cost of capital

 

16.5%

 

 

 

 

 

 

 

Long-term revenue growth rate

 

1.0%

 

 

 

 

 

 

 

Royalty rates

 

0.5% - 1.5%

 

Direct response customer relationship intangible asset

 

6,800

 

Discounted cash flow

 

Weighted-average cost of capital

 

17.5%

 

 

 

 

 

 

 

Customer attrition rate

 

59.9% - 25.0%

 

Specific-store leasehold improvements

 

745

 

Discounted cash flow

 

Weighted-average cost of capital

 

10.9%

 

 

 

 

 

 

 

Long-term revenue growth rate

 

3.0%

 

 

22



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following table presents the difference between the carrying amount and estimated fair value of our long-term debt (in thousands):

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Guitar Center

 

 

 

 

 

 

 

 

 

Senior secured term loan

 

$

621,762

 

$

595,337

 

$

621,762

 

$

545,596

 

Senior unsecured notes

 

375,000

 

409,771

 

375,000

 

394,542

 

Capital lease obligations

 

216

 

216

 

700

 

700

 

Total Guitar Center

 

996,978

 

1,005,324

 

997,462

 

940,838

 

 

 

 

 

 

 

 

 

 

 

Holdings

 

 

 

 

 

 

 

 

 

Senior unsecured PIK notes

 

564,673

 

616,894

 

564,673

 

609,312

 

 

 

 

 

 

 

 

 

 

 

Holdings consolidated

 

$

1,561,651

 

$

1,622,218

 

$

1,562,135

 

$

1,550,150

 

 

We estimate the fair value of our long-term debt using observable inputs classified as Level 2 in the fair value hierarchy. We use present value and market techniques that consider rates of return on similar credit facilities recently initiated by companies with like credit quality in similar industries, quoted prices for similar instruments, and inquiries with certain investment communities.

 

23



Table of Contents

 

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

7.   Legal

 

On September 11, 2009, a putative class action was filed by an individual consumer named David Giambusso in the United States District Court for the Southern District of California. The complaint alleged that Guitar Center and other defendants, including a trade association and a large musical instrument manufacturer, exchanged sensitive information and strategies for implementing minimum advertised pricing, attempted to restrict retail price competition and monopolize at trade association-organized meetings, all in violation of Sections 1 and 2 of the Sherman Antitrust Act and California’s Unfair Competition Law. Subsequently, numerous additional lawsuits were filed in se