S-4 1 a11-14720_1s4.htm S-4

Table of Contents

 

As filed with the Securities and Exchange Commission on June 30, 2011

Registration No. 333-                   

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM S-4

 


 

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 


 

GUITAR CENTER HOLDINGS, INC.

(Exact Name of Each Registrant as Specified in Its Charter)

 

Delaware

 

5731

 

26-0843262

(State or Other Jurisdiction of
Incorporation or Organization)

 

(Primary Standard Industrial Classification Code
Number)

 

(I.R.S. employer
identification number)

 

GUITAR CENTER, INC.

(Exact Name of Each Registrant as Specified in Its Charter)

 

Delaware

 

5731

 

95-4600862

(State or Other Jurisdiction of
Incorporation or Organization)

 

(Primary Standard Industrial Classification Code
Number)

 

(I.R.S. employer
identification number)

 

5795 Lindero Canyon Road

Westlake Village, California 91362

(818) 735-8800

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 


 

Leland P. Smith

Executive Vice President, Chief Administrative Officer and Secretary

5795 Lindero Canyon Road

Westlake Village, California 91362

(818) 735-8800

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 


 

Copy to:

 

Dennis M. Myers, P.C.

Kirkland & Ellis LLP

300 North LaSalle Street

Chicago, Illinois 60654

(312) 862-2000

 

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as reasonably practicable after this registration statement becomes effective.

 

If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box.  o

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the “Securities Act”), check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of 1934 (Check One):

 

Guitar Center Holdings, Inc.

 

Large accelerated filer: o

 

Accelerated filer:

o

Non-accelerated filer (Do not check if a smaller reporting company): x

 

Smaller reporting company:

o

 

Guitar Center, Inc.

 

Large accelerated filer: o

 

Accelerated filer:

o

Non-accelerated filer (Do not check if a smaller reporting company): x

 

Smaller reporting company:

o

 

If applicable, place an X in the box to designate the appropriate rule provision relied upon in conducting this transaction:

Exchange Act Rule 13e-4(i) (Cross-Border Issuer Tender Offer):  o

Exchange Act Rule 14d-1(d) (Cross-Border Third-Party Tender Offer):  o

 


 

CALCULATION OF REGISTRATION FEE

 

 

 

 

 

 

Title of Each Class of
Securities To Be Registered

 

Proposed
Maximum
Aggregate
Offering Price(1)

 

Amount of
Registration Fee

 

14.09% Senior PIK Notes due 2018

 

$

564,672,894

 

$

65,559

 

11.50% Senior Notes due 2017

 

$

375,000,000

 

$

43,538

 

11.50% Senior Notes due 2017(2)

 

$

39,782,000

 

$

4,619

 

Guarantees related to the 11.50% Senior Notes due 2017(3)

 

N/A

 

N/A

 

Total

 

$

979,454,894

 

$

113,716

 

 

(1)          Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(o) promulgated under the Securities Act of 1933, as amended (the “Securities Act”).

 

(2)          Guitar Center, Inc. is registering an additional amount of 11.50% Senior Notes due 2017 which may be issued, at the option of Guitar Center Holdings, Inc., in exchange for the assignment of cash interest payments on the 14.09% Senior PIK Notes due 2018 to Guitar Center, Inc.  Such additional principal amount constitutes the maximum amount of the 11.50% Senior Notes due 2017 which may be issued in exchange for the assignment of cash interest payments on the 14.09% Senior PIK Notes due 2018.

 

(3)          No separate consideration will be received for the guarantees, and no separate fee is payable, pursuant to Rule 457(n) under the Securities Act.

 


 

THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.

 

TABLE OF ADDITIONAL REGISTRANTS

 

Name of Additional Registrants

 

State or Other
Jurisdiction of
Incorporation
or Formation

 

Primary Standard Industrial
Classification Code Number

 

I.R.S. Employer
Identification No.

GTRC Services, Inc.(1)

 

DE

 

5731

 

27-4709503

Guitar Center Gift Card Company, LLC(1)

 

VA

 

5731

 

26-4463370

Guitar Center Stores, Inc.(1)

 

DE

 

5731

 

95-4774340

Harmony Central Group, LLC(2)

 

DE

 

5731

 

45-2444323

Musician’s Friend, Inc.(2)

 

DE

 

5731

 

93-1235414

Music123, Inc.(2)

 

DE

 

5731

 

27-4709168

 


(1)          Address and telephone numbers of principal executive offices are the same as those of Guitar Center, Inc.

(2)          Address and telephone numbers of principal executive offices are 931 Chevy Way, Medford, Oregon 97504, (541) 774-5173.

 

 

 



Table of Contents

 

Explanatory Note

 

This Registration Statement on Form S-4 is a combined registration statement 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 Registration Statement on Form S-4 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 Registration Statement on Form S-4.  Where information or an explanation is not substantially the same for each company, separate information and explanation has been provided.  In addition, separate consolidated financial statements for each company are included in this Registration Statement on Form S-4.

 



Table of Contents

 

The information in this preliminary prospectus is not complete and may be changed.  This preliminary prospectus is not an offer to sell these securities and it is not a solicitation of an offer to buy these securities in any jurisdiction where the offering is not permitted.

 

Subject to Completion, dated June 30, 2011

 

Preliminary Prospectus

 

Guitar Center, Inc.

Exchange Offer for

$414,782,000 of 11.50% Senior Notes due 2017

 

Guitar Center Holdings, Inc.

Exchange Offer for

$564,672,894 of 14.09% Senior PIK Notes due 2018

 

Offers for (i) outstanding 11.50% Senior Notes due 2017 of Guitar Center, Inc., in the aggregate principal amount of $375,000,000 (which we refer to as the “old senior notes”) in exchange for up to $375,000,000 in aggregate principal amount of 11.50% Senior Notes due 2017 which have been registered under the Securities Act of 1933, as amended (which we refer to as the “senior exchange notes”), and (ii) outstanding 14.09% Senior PIK Notes due 2018 of Guitar Center Holdings, Inc., in the aggregate principal amount of $564,672,894 (which we refer to as the “old senior PIK notes”) in exchange for up to $564,672,894 in aggregate principal amount of 14.09% Senior PIK Notes due 2018 which have been registered under the Securities Act of 1933, as amended (which we refer to as the “senior PIK exchange notes,” or together with the old senior PIK notes the “senior PIK notes”). We are also registering an additional $39,782,000 of senior exchange notes (the “additional senior exchange notes”) which may be issued, at the option of Guitar Center Holdings, Inc., in exchange for the assignment by the holders of the senior PIK notes of cash interest payments on the senior PIK notes to us.

 

In this prospectus, we collectively refer to the old senior notes and the old senior PIK notes as the “old notes,” the senior exchange notes and the senior PIK exchange notes as the “exchange notes,” and the old notes and the exchange notes as the “notes.”  We also collectively refer to the old senior notes and senior exchange notes as the “senior notes” and the old senior PIK notes and senior PIK exchange notes as the “senior PIK notes.”

 

Material Terms of the Exchange Offers:

 

·                  Expire 5:00 p.m., New York City time, on                , 2011, unless extended.

 

·                  You may withdraw tendered outstanding old notes any time before the expiration of the respective exchange offer.

 

·                  Not subject to any condition other than that the exchange offers do not violate applicable law or any interpretation of the staff of the United States Securities and Exchange Commission (the “SEC”).

 

·                  We can amend or terminate the exchange offers.

 

·                  We will exchange all outstanding old senior notes and old senior PIK notes that are validly tendered and not validly withdrawn for an equal principal amount of senior exchange notes and senior PIK exchange notes that are freely tradable.

 

·                  We will not receive any proceeds from the exchange offers.

 

·                  The exchange of notes should not be a taxable exchange for U. S. federal income tax purposes.

 

Terms of the Exchange Notes:

 

·                  The terms of the exchange notes are substantially identical to those of the old notes, except the transfer restrictions, registration rights and additional interest provisions relating to the old notes do not apply to the exchange notes.

 

·                  The senior exchange notes will be effectively subordinated to all of our existing and future senior secured debt, including our senior secured credit facilities, to the extent of the value of the assets securing such debt, will rank equally with all of our existing and future unsecured senior debt and will rank senior to all of our existing and future senior subordinated and subordinated debt. The senior exchange notes will be guaranteed on an unsecured senior basis by each of our existing and future United States subsidiaries that is a guarantor under our senior secured credit facilities or that guarantees certain other indebtedness in the future. The senior PIK exchange notes will be general unsecured senior obligations of Guitar Center Holdings, Inc. and will rank equally with all of its existing and future senior debt, but will be effectively subordinated to all of its secured obligations and structurally subordinated to all liabilities of its subsidiaries, including Guitar Center, Inc. The senior PIK exchange notes will not be guaranteed by us or any subsidiaries of Guitar Center Holdings, Inc.

 

·                  The senior exchange notes will mature on October 15, 2017 and the senior PIK exchange notes will mature on April 15, 2018.  Each of the senior exchange notes and the senior PIK exchange notes will bear interest semi-annually in arrears on April 15 and October 15 of each year, commencing October 15, 2011. The terms of the additional senior exchange notes will be identical to those of the outstanding senior exchange notes. See “Description of Senior Exchange Notes—Principal, Maturity and Interest.”

 

·                  We or Guitar Center Holdings, Inc., as applicable, may redeem the exchange notes in whole or in part from time to time. See “Description of Senior Exchange Notes” and “Description of Senior PIK Exchange Notes.”

 

·                  Upon the occurrence of specific kinds of changes of control, we or Guitar Center Holdings, Inc., must offer to repurchase all of the senior exchange notes or the senior PIK exchange notes, as applicable, at 101% of their principal amount, plus accrued and unpaid interest, if any, to the repurchase date.

 

For a discussion of the specific risks that you should consider before tendering your outstanding old notes in the exchange offers, see “Risk Factors” beginning on page 10 of this prospectus.

 

There is no established trading market for the old notes or the exchange notes.

 

Each broker-dealer that receives exchange notes for its own account pursuant to the exchange offers must acknowledge that it will deliver a prospectus in connection with any resale of such exchange notes. A broker dealer who acquired old notes as a result of market-making activities or other trading activities may use this exchange offer prospectus, as supplemented or amended from time to time, in connection with any resales of the exchange notes.

 

Neither the SEC nor any state securities commission has approved or disapproved of the exchange notes or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

The date of this prospectus is              , 2011.

 



Table of Contents

 


 

TABLE OF CONTENTS

 

 

Page

 

 

Prospectus Summary

1

Risk Factors

10

Disclosure Regarding Forward-Looking Statements

23

Exchange Offers

25

Use of Proceeds

33

Capitalization

34

Selected Historical Consolidated Financial Information

35

Business

54

Management

63

Executive Compensation

65

Security Ownership of Certain Beneficial Owners and Management

76

Certain Relationships and Related Party Transactions

77

Description of Certain Other Indebtedness

78

Description of Senior Exchange Notes

83

Description of Senior PIK Exchange Notes

122

Book-entry, Delivery and Form

162

Certain United States Federal Income Tax Considerations

164

Certain ERISA Considerations

165

Plan of Distribution

166

Legal Matters

167

Experts

167

Where You Can Find More Information

167

Index to Financial Statements

F-1

 


 

Each broker-dealer that receives exchange notes for its own account in exchange for old notes that were acquired as a result of market-making activities or other trading activities must acknowledge that it will deliver a prospectus in connection with any resale of such exchange notes.  By so acknowledging and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an “underwriter” within the meaning of the Securities Act of 1933, as amended (the “Securities Act”). A broker-dealer who acquired old notes as a result of market-making activities or other trading activities may use this prospectus, as supplemented or amended from time to time, in connection with any resales of the exchange notes. We have agreed that, for a period of up to 180 days after the closing of the exchange offers, we will make this prospectus available for use in connection with any such resale. See “Plan of Distribution.”

 

You should rely only on the information contained in this prospectus. We have not authorized any person to provide you with information different from that contained in this prospectus. This prospectus does not constitute an offer to sell or a solicitation of an offer to buy securities other than those specifically offered hereby or an offer to sell any securities offered hereby in any jurisdiction where, or to any person whom, it is unlawful to make such an offer or solicitation. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our 11.50% Senior Notes due 2017 or our 14.09% Senior PIK Notes due 2018.

 


 



Table of Contents

 

PROSPECTUS SUMMARY

 

This summary highlights material information about our business and the notes. This is a summary of material information contained elsewhere in this prospectus and does not contain all of the information that may be important to you. For a more complete understanding of our business and the exchange notes, you should read this entire prospectus, including the section entitled “Risk Factors” and the financial statements and related notes included elsewhere in this prospectus. Unless otherwise indicated or the context otherwise requires, the (i) terms “we,” “us,” “the Company,” “Guitar Center,” “our” and other similar terms refer to the business of Guitar Center, Inc. and its consolidated subsidiaries, except with respect to the information regarding the terms of the old senior notes or the senior exchange notes, in which case “Guitar Center” refers only to Guitar Center, Inc. and not to any of its subsidiaries and (ii) the term “Holdings” refers to Guitar Center Holdings, Inc. and its subsidiaries, except with respect to information regarding the terms of the old senior PIK notes and senior PIK exchange notes,  in which case “Holdings” refers only to Guitar Center Holdings, Inc. and not to any of its subsidiaries.  For accounting purposes, the term “predecessor” refers to Guitar Center and its subsidiaries for periods prior to the Transactions described in this prospectus, and the term “successor” refers to Holdings and its subsidiaries for periods following the Transactions.

 

Our Company

 

We are the leading United States retailer of guitars, amplifiers, percussion, keyboards and pro-audio and recording equipment, based on revenue. As of March 31, 2011, our retail store subsidiary operated 216 Guitar Center stores across the United States. In addition, as of March 31, 2011, the Music & Arts division of our retail store subsidiary operated 99 retail stores specializing in band and orchestra instruments for sale and rental, serving teachers, band directors, college professors and students. We also are the largest direct response retailer of musical instruments and related products in the United States through our wholly owned subsidiary, Musician’s Friend, Inc., and its catalogs and owned or operated websites.

 

Holdings is our parent company and has no material assets or operations other than its ownership of Guitar Center, Inc.

 

The Transactions

 

On October 9, 2007, Holdings, a company controlled by an affiliate of Bain Capital Partners, LLC (“Bain Capital”), acquired Guitar Center in a transaction having an aggregate value of approximately $2.1 billion, excluding fees and expenses. The acquisition was effected through the merger of VH MergerSub, Inc. (“Merger Sub”), a wholly owned subsidiary of Holdings, with and into Guitar Center, which was the surviving corporation. Immediately following the merger, Guitar Center became a wholly owned direct subsidiary of Holdings.

 

Holdings is owned by investment funds associated with Bain Capital, a co-investor and certain members of our senior management (the “management investors”), to whom we refer collectively as the “equity investors.”

 

The acquisition resulted in the occurrence of the following events, which we refer to collectively as the “Transactions”:

 

·                  the purchase by the equity investors of equity interests of Holdings for approximately $625.0 million in cash and/or, with respect to the management investors, through a roll-over of existing Guitar Center equity;

 

·                  the entering into by Merger Sub of the senior secured credit facilities, consisting of a $650.0 million term loan and a $375.0 million asset-based senior secured revolving credit facility, of which approximately $148.2 million was drawn at closing;

 

·                  the entering into by Merger Sub of a senior unsecured initial loan consisting of a $375.0 million term loan;

 

·                  the entering into by Holdings of a senior unsecured initial loan consisting of a $375.0 million term loan;

 

·                  the refinancing of our historical debt, including accrued and unpaid interest, of approximately $161.3 million;

 

·                  the merger of Merger Sub with and into Guitar Center, with Guitar Center as the surviving corporation, and the payment of the related merger consideration; and

 

·                  the payment of approximately $66.4 million of estimated fees and expenses related to the Transactions.

 

As a result of the merger, all obligations of Merger Sub under the senior secured credit facilities and the senior unsecured initial loan became obligations of Guitar Center.

 

On August 7, 2008, the senior unsecured initial loan of Guitar Center was exchanged for the old senior notes and the senior unsecured initial loan of Holdings was exchanged for the old senior PIK notes.  On March 2, 2011, the indentures pursuant to which the old senior notes and the old senior PIK notes were issued were amended and restated in their entirety.  The amendments to the indentures were approved by all of the holders of the old notes and included, among other changes, extensions of the maturity dates of the old senior notes to October 15, 2017 and the old senior PIK notes to April 15, 2018.

 

1



Table of Contents

 

Sponsor

 

Bain Capital is a global private investment firm that manages several pools of capital including private equity, venture capital, public equity, credit products and absolute return with approximately $64 billion in assets under management. Since its inception in 1984, Bain Capital has made private equity investments and add-on acquisitions in more than 300 companies in a variety of industries around the world. Bain Capital’s consumer and retail private equity investments have included such leading businesses as Toys “R” Us, Bright Horizons Family Solutions, Michaels Stores, Dollarama, Burlington Coat Factory, Gymboree, Dunkin’ Brands and Lilliput Kidswear. Headquartered in Boston, Bain Capital has offices in New York, Chicago, London, Munich, Hong Kong, Shanghai, Tokyo and Mumbai.

 

2



Table of Contents

 

Summary of the Exchange Offers

 

The summary below describes the principal terms of the exchange offers.  Certain of the terms and conditions described below are subject to important limitations and exceptions. The “Exchange Offers” section of this prospectus contains a more detailed description of the terms and conditions of the exchange offers.

 

Initial Placement of Old Notes

 

On August 7, 2008, we sold, through a private placement exempt from the registration requirements of the Securities Act, $375,000,000 of our 11.50% Senior Notes due 2015 and $401,758,438 of our 14.09% Senior PIK Notes due 2016.  The terms of those notes, including the maturity dates, were amended on March 2, 2011.  From the original issuance of the old senior PIK notes until October 15, 2010, Holdings paid interest on such notes by increasing the principal amount of the senior PIK notes for the entire amount of the interest payment.  All of the old notes are eligible to be exchanged for exchange notes.

 

 

 

Exchange and Registration Rights Agreements

 

Simultaneously with the private placement, we entered into exchange and registration rights agreements with the initial purchasers of the old notes (the “Registration Rights Agreements”). Under the Registration Rights Agreements, we are required to use our reasonable best efforts to cause a registration statement for substantially identical debt securities (and related guarantees in the case of Guitar Center), which will be issued in exchange for the old notes, to be filed with the SEC. The purchasers of the old notes waived these requirements until April 1, 2011. You may exchange your old notes for exchange notes in these exchange offers. You should read the discussion under the headings “—Summary of Terms of the Exchange Notes,” “Exchange Offers,” “Description of Senior Exchange Notes” and “Description of Senior PIK Exchange Notes” for further information regarding the exchange offers and exchange notes.

 

 

 

Exchange Notes Offered

 

We are offering (i) $414,782,000 aggregate principal amount of 11.50% Senior Notes due 2017, $375,000,000 aggregate principal amount of which is to be issued in exchange for and in replacement of $375,000,000 aggregate principal amount of old senior notes, and $39,782,000 aggregate principal amount of which may, at the election of Holdings, be issued to the holders of the senior PIK notes in exchange for the assignment by such holders of cash interest payments on the senior PIK notes to us, and (ii) $564,672,894 aggregate principal amount of 14.09% Senior PIK Notes due 2018.

 

 

 

Exchange Offers

 

We are offering to exchange the old notes for a like principal amount at maturity of the exchange notes. Old notes may be exchanged only in integral principal multiples of $1,000. The exchange offers are being made pursuant to the Registration Rights Agreements which grant the initial purchasers and any subsequent holders of the old notes certain exchange and registration rights. These exchange offers are intended to satisfy those exchange and registration rights with respect to the old notes. After the exchange offers are complete, you will no longer be entitled to any exchange or registration rights with respect to your old notes.

 

 

 

Expiration Date; Withdrawal of Tender

 

The exchange offers will expire 5:00 p.m., New York City time, on                  , 2011, or a later time if we choose to extend either or both of the exchange offers in our sole and absolute discretion. You may withdraw your tender of old notes at any time prior to the expiration date. All outstanding old notes that are validly tendered and not validly withdrawn will be exchanged. Any old notes not accepted by us for exchange for any reason will be returned to you at our expense promptly after the expiration or termination of the exchange offers.

 

 

 

Broker-Dealer

 

Each broker-dealer acquiring exchange notes issued for its own account in exchange for old notes, which it acquired through market-making activities or other trading activities, must acknowledge that it will deliver a proper prospectus when any exchange notes issued in the exchange offers are transferred. A broker-dealer may use this prospectus for an offer to resell, a resale or other retransfer of the exchange notes issued in the exchange offers.

 

 

 

Prospectus Recipients

 

We mailed this prospectus and the related exchange offer documents to registered holders of the old notes as of                   , 2011.

 

3



Table of Contents

 

Conditions to the Exchange Offers

 

Our obligation to accept for exchange, or to issue the exchange notes in exchange for, any old notes is subject to certain customary conditions, including our determination that the exchange offers do not violate any law, statute, rule, regulation or interpretation by the staff of the SEC or any regulatory authority or other foreign, federal, state or local government agency or court of competent jurisdiction, some of which may be waived by us. We currently expect that each of the conditions will be satisfied and that no waivers will be necessary. See “Exchange Offers—Conditions to the Exchange Offers.”

 

 

 

Procedures for Tendering Old Notes Held in the Form of Book-Entry Interests

 

The old notes were issued as global securities and were deposited upon issuance with The Bank of New York Mellon Trust Company, N.A., as custodian for The Depository Trust Company (“DTC”).

 

 

 

 

 

Beneficial interests in the outstanding old notes, which are held by direct or indirect participants in DTC, are shown on, and transfers of the old notes can only be made through, records maintained in book-entry form by DTC.

 

 

 

 

 

You may tender your outstanding old notes by instructing your broker or bank where you keep the old notes to tender them for you. In some cases you may be asked to submit the letter of transmittal that may accompany this prospectus. By tendering your old notes you will be deemed to have acknowledged and agreed to be bound by the terms set forth under “Exchange Offers.” Your outstanding old notes must be tendered in denominations of $2,000 and integral multiples of $1,000 in excess thereof.

 

 

 

 

 

In order for your tender to be considered valid, the exchange agent must receive a valid letter of transmittal together with your outstanding old notes, or confirmation of book-entry transfer of your outstanding old notes into the exchange agent’s account at DTC, in each case, under the procedures described in this prospectus under the heading “Exchange Offers,” on or before 5:00 p.m., New York City time, on the expiration date of the exchange offers.

 

 

 

Special Procedures for Beneficial Owners

 

If you are the beneficial owner of book-entry interests and your name does not appear on a security position listing of DTC as the holder of the book-entry interests or if you are a beneficial owner of old notes that are registered in the name of a broker, dealer, commercial bank, trust company or other nominee and you wish to tender the book-entry interest or old notes in the exchange offers, you should contact the person in whose name your book-entry interests or outstanding notes are registered promptly and instruct that person to tender on your behalf.

 

 

 

Guaranteed Delivery Procedures

 

If you wish to tender your old notes and your old notes are not immediately available or you cannot deliver your old notes, the letter of transmittal or any other documents required by the letter of transmittal prior to the expiration date or you cannot comply with the procedures of the Automated Tender Offer Program System of DTC prior to the expiration date, you must tender your old notes according to the guaranteed delivery procedures set forth in this prospectus under “The Exchange Offer—Procedures for Tendering Old Notes—Guaranteed Delivery Procedures.”

 

 

 

United States Federal Income Tax Considerations

 

The exchange offers should not result in any income, gain or loss to the holders of old notes or to us for United States federal income tax purposes. See “Certain United States Federal Income Tax Considerations.”

 

 

 

Use of Proceeds

 

We will not receive any proceeds from the issuance of the exchange notes in the exchange offers.

 

 

 

Exchange Agent

 

The Bank of New York Mellon Trust Company, N.A. is serving as the exchange agent for the exchange offers.

 

4



Table of Contents

 

Consequences of Not Exchanging Old Notes

 

If you do not exchange your old notes in the exchange offers, your old notes will continue to be subject to the restrictions on transfer currently applicable to the old notes. In general, you may offer or sell your old notes only:

 

·                  if they are registered under the Securities Act and applicable state securities laws;

 

·                  if they are offered or sold under an exemption from registration under the Securities Act and applicable state securities laws; or

 

·                  if they are offered or sold in a transaction not subject to the Securities Act and applicable state securities laws.

 

We do not currently intend to register the old notes under the Securities Act. For more information regarding the consequences of not tendering your old notes and our obligation to file a shelf registration statement, see “Exchange Offers—Consequences of Failure to Exchange.”

 

5



Table of Contents

 

Summary of Terms of the Exchange Notes

 

The following is a brief summary of the terms of the exchange notes. For a more complete description of the terms of the exchange notes, see “Description of Senior Exchange Notes” and “Description of Senior PIK Exchange Notes.”

 

Issuers

 

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

 

 

 

Exchange Notes Offered

 

$414,782,000 aggregate principal amount of 11.50% Senior Notes due 2017 of Guitar Center, $375,000,000 aggregate principal amount of which is to be issued in exchange for and in replacement of $375,000,000 aggregate principal amount of old senior notes, and $39,782,000 aggregate principal amount of which may, at the election of Holdings, be issued to the holders of the senior PIK notes in exchange for the assignment by such holders of cash interest payments on the senior PIK notes to us.

 

$564,672,894 aggregate principal amount of 14.09% Senior PIK Notes due 2018 of Holdings.

 

 

 

Maturity

 

The senior exchange notes will mature on October 15, 2017. The senior PIK exchange notes will mature on April 15, 2018.

 

 

 

Interest Payment Dates

 

Interest on the senior exchange notes will accrue at a rate of 11.50% per annum, payable semi-annually in cash in arrears on April 15 and October 15 of each year, commencing October 15, 2011.  Interest on the senior exchange notes will accrue from the last interest date on which interest was paid on your old senior notes if you effectively tender your old senior notes for senior exchange notes.

 

Interest on the senior PIK exchange notes will accrue at a rate of 14.09% per annum, payable semi-annually in arrears on April 15 and October 15 of each year, commencing October 15, 2011. Interest on the senior PIK exchange notes will accrue from the last interest date on which interest was paid on your old senior PIK notes if you effectively tender your old senior PIK notes for senior PIK exchange notes.

 

Until and through October 15, 2010, Holdings paid interest on the old senior PIK notes by increasing the principal amount of such notes for the entire amount of the interest payment.  On April 15, 2011, Holdings paid interest on the old senior PIK notes in cash.  Holdings may pay interest on the senior PIK exchange notes only in cash for the interest payment due October 15, 2011.

 

Pursuant to an assignment and assumption agreement dated as of March 2, 2011, for the interest payments due April 15, 2012 and October 15, 2012, Holdings will pay interest on the senior PIK exchange notes in cash, but may elect to require the holders of the senior PIK exchange notes to assign to Guitar Center 50% of their right to receive the cash interest payable on the senior PIK exchange notes in exchange for the issuance of additional senior notes of Guitar Center in an aggregate principal amount equal to the assigned interest.  Each assignment of the right to receive the cash interest payable on the senior PIK exchange notes is subject to the satisfaction of certain conditions.  See “Description of the Senior PIK Exchange Notes—Principal, Maturity and Interest.”  For periods following the interest payment due October 15, 2012, Holdings will pay interest only in cash but will not be permitted to make the election described in the prior sentence.

 

 

 

Optional Redemption

 

We and Holdings, respectively, may redeem some or all of the respective exchange notes, at any time on or after October 15, 2013, in each case, at the redemption prices set forth in this prospectus, together with accrued and unpaid interest, if any, to the date of redemption.

 

We and Holdings, respectively, also may redeem some or all of the respective exchange notes at any time prior to October 15, 2013, in each case, at a price equal to 100% of the principal amount of the exchange notes to be redeemed plus a “make whole” premium and accrued and unpaid interest, if any, to the date of redemption.

 

6



Table of Contents

 

 

 

The redemption of the exchange notes will be subject, in all instances, to the restrictions contained in the indentures governing the notes. See “Description of Senior Exchange Notes—Optional Redemption” and “Description of Senior PIK Exchange Notes—Optional Redemption.”

 

 

 

Mandatory Offers to Purchase

 

If we or Holdings, as applicable, experience a change of control, we or Holdings, as applicable, will be required to make an offer to purchase the respective exchange notes at a price equal to 101% of their principal amount, together with accrued and unpaid interest, if any, to the date of purchase. See “Description of Senior Exchange Notes—Repurchase at the Option of Holders—Change of Control” and “Description of Senior PIK Exchange Notes—Repurchase at the Option of Holders—Change of Control.”

 

Certain asset dispositions will be triggering events which may require us to use the proceeds from those asset dispositions to make an offer to purchase the exchange notes at 100% of their principal amount, together with accrued and unpaid interest, if any, to the date of repurchase. See “Description of Senior Exchange Notes—Repurchase at the Option of Holders—Asset Sales” and “Description of Senior PIK Exchange Notes— Repurchase at the Option of Holders—Asset Sales.”

 

 

 

Mandatory Principal Redemption

 

If the senior PIK exchange notes would otherwise constitute “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code of 1986, as amended (the “Code”), at the end of the first accrual period ending after the fifth anniversary of November 28, 2007 (the “AHYDO Redemption Date”), Holdings will be required to redeem for cash a portion of each senior PIK exchange note then outstanding equal to the “Mandatory Principal Redemption Amount” (such redemption, a “Mandatory Principal Redemption”). The redemption price for the portion of each senior PIK exchange note redeemed pursuant to a Mandatory Principal Redemption will be 100% of the principal amount of such portion plus accrued and unpaid interest, if any, to the date of redemption. The “Mandatory Principal Redemption Amount” means the portion of a senior PIK exchange note required to be redeemed to prevent such note from being treated as an “applicable high yield discount obligation” within the meaning of Section 163(i)(1) of the Code. No partial redemption or repurchase of the senior PIK exchange notes prior to the AHYDO Redemption Date pursuant to any other provision of the indenture governing the senior PIK exchange notes will alter Holdings’ obligation to make the Mandatory Principal Redemption with respect to any senior PIK exchange notes that remain outstanding on the AHYDO Redemption Date. See “Description of Senior PIK Exchange Notes—Mandatory Redemption.”

 

 

 

Guarantees

 

The senior exchange notes will be guaranteed on an unsecured senior basis by each of our United States direct or indirect restricted subsidiaries that is a guarantor under our senior secured credit facilities.

 

Any United States restricted subsidiary that incurs any indebtedness (other than certain permitted indebtedness) or that in the future guarantees our indebtedness, including indebtedness under our senior secured credit facilities or indebtedness of any other guarantor, will also guarantee the senior exchange notes. Each guarantee will be released if the guarantor is released from its guarantee under our senior secured credit facilities, is not an obligor under any indebtedness other than certain permitted indebtedness and does not guarantee any indebtedness of the Company or the other guarantors. If we fail to make payments on the senior exchange notes, our guarantors must make them instead.

 

7



Table of Contents

 

 

 

The senior PIK exchange notes will not be guaranteed by us or any of Holdings’ subsidiaries.

 

 

 

Ranking

 

The senior exchange notes and the related guarantees will be our and the guarantors’ unsecured senior obligations and will:

 

·      be effectively subordinated to all of our and the guarantors’ existing and future senior secured debt, including our senior secured credit facilities, to the extent of the value of the assets securing such debt;

 

·      rank equally in right of payment with all of our and the guarantors’ existing and future unsecured senior debt; and

 

·      be senior in right of payment to all of our and the guarantors’ existing and future subordinated debt.

 

The senior PIK exchange notes will be general unsecured senior obligations of Holdings and will be senior to all of Holdings’ existing and future subordinated debt and pari passu with all existing and future unsubordinated debt, but will be effectively subordinated to all of its secured obligations and structurally subordinated to all liabilities of Holdings’ subsidiaries, including Guitar Center.

 

In addition, the notes and the guarantees of the senior exchange notes will be structurally subordinated to all of the existing and future liabilities and obligations (including trade payables, but excluding intercompany liabilities) of each of our non-guarantor subsidiaries.

 

As of March 31, 2011:

 

·      we and the guarantors had approximately $621.8 million of senior secured indebtedness under our senior secured credit facilities (excluding approximately $252.6 million of undrawn availability under our senior secured asset-based revolving credit facility, after giving effect to $7.4 million of outstanding letters of credit), all of which is effectively senior to the notes;

 

·      we and the guarantors had approximately $997.9 million of senior indebtedness, including our senior secured indebtedness and the senior exchange notes described herein, all of which is senior to the senior PIK exchange notes; and

 

·      our non-guarantor subsidiaries had approximately $4.0 million of total liabilities, all of which is structurally senior to the notes.

 

 

 

Certain Covenants

 

The senior exchange notes and the senior PIK exchange notes will be issued under separate indentures. The indentures governing the notes contain covenants that, among other things, limit our and Holdings’ ability and the ability of our and Holdings’ restricted subsidiaries to:

 

·      incur or guarantee additional indebtedness, or issue disqualified stock or preferred stock;

 

·      pay dividends or make distributions to our stockholders;

 

·      repurchase or redeem capital stock or subordinated indebtedness;

 

·      make investments or acquisitions;

 

·      incur restrictions on the ability of certain of our subsidiaries to pay dividends or to make other payments to us;

 

·      enter into transactions with affiliates;

 

·      create liens;

 

·      merge or consolidate with other companies or transfer all or

 

8



Table of Contents

 

 

 

substantially all of our assets;

 

·      transfer or sell assets, including capital stock of subsidiaries; and

 

·      prepay, redeem or repurchase debt that is junior in right of payment to the notes.

 

These covenants are subject to important exceptions and qualifications described in the applicable indenture. See “Description of Senior Exchange Notes” and “Description of Senior PIK Exchange Notes.”

 

 

 

Assignment and Assumption Agreement

 

Pursuant to the assignment and assumption agreement, the holders of the senior PIK exchange notes may not assign, pledge, transfer or otherwise dispose of any beneficial interest in the senior PIK exchange notes other than to a person or entity who executes and delivers to Holdings a joinder to the assignment and assumption agreement, thereby agreeing to be bound by all of the obligations of the agreement.

 

 

 

No Public Market

 

The exchange notes will be freely transferable but will be new securities for which there will not initially be a market. Accordingly, we cannot assure you whether a market for the exchange notes will develop or as to the liquidity of any market.

 

 

 

Use of Proceeds

 

We will not receive any proceeds from the issuance of the exchange notes in the exchange offers.

 

Risk Factors

 

You should consider carefully all of the information included in this prospectus and, in particular, the information under the heading “Risk Factors” beginning on page 10 prior to deciding to tender your old notes in the exchange offers.

 

9



Table of Contents

 

RISK FACTORS

 

Participating in the exchange offers is subject to a number of important risks and uncertainties, some of which are described below. Any of the following risks could materially and adversely affect our business, cash flows, financial condition or results of operations. In such a case, you may lose all or part of your investment in the notes. You should carefully consider the following factors in addition to the other information included in this prospectus before investing in the exchange notes.

 

Risks Relating to the Exchange Offers

 

Because there is no public market for the exchange notes, you may not be able to resell your notes.

 

The exchange notes will be registered under the Securities Act, but will constitute a new issue of securities with no established trading market, and there can be no assurance as to:

 

·                  the liquidity of any trading market that may develop;

 

·                  the ability of holders to sell their exchange notes; or

 

·                  the price at which holders would be able to sell their exchange notes.

 

If a trading market were to develop, the exchange notes may trade at higher or lower prices than their principal amount or purchase price, depending on many factors, including prevailing interest rates, the market for similar securities and our financial performance.

 

We offered the old notes in reliance upon an exemption from registration under the Securities Act and applicable state securities laws.  Therefore, the old notes may be transferred or resold only in a transaction registered under or exempt from the Securities Act and applicable state securities laws.  We are conducting the exchange offers pursuant to an effective registration statement, whereby we are offering to exchange the old notes for nearly identical notes that you will be able to trade without registration under the Securities Act provided you are not one of our affiliates.  We cannot assure you that the exchange offers will be conducted in a timely fashion.  Moreover, we cannot assure you that an active or liquid trading market for the exchange notes will develop.  For more information, see “Exchange Offers.”

 

You must comply with the exchange offer procedures in order to receive new, freely tradable exchange notes.

 

Delivery of exchange notes in exchange for old notes tendered and accepted for exchange pursuant to the exchange offers will be made only after timely receipt by the exchange agent of book-entry transfer of old notes into the exchange agent’s account at DTC, as depositary, including an agent’s message (as defined herein). We are not required to notify you of defects or irregularities in tenders of old notes for exchange. Exchange notes that are not tendered or that are tendered but we do not accept for exchange will, following consummation of the exchange offers, continue to be subject to the existing transfer restrictions under the Securities Act and, upon consummation of the exchange offers, certain registration and other rights under the Registration Rights Agreements will terminate. See “Exchange Offers—Procedures for Tendering Old Notes” and “Exchange Offers—Consequences of Failure to Exchange.”

 

Holders of old notes who fail to exchange their old notes in the exchange offers will continue to be subject to restrictions on transfer.

 

If you do not exchange your old notes for exchange notes in the exchange offer, you will continue to be subject to the restrictions on transfer applicable to the old notes. The restrictions on transfer of your old notes arise because we issued the old notes under exemptions from, or in transactions not subject to, the registration requirements of the Securities Act and applicable state securities laws.  In general, you may only offer or sell the old notes if they are registered under the Securities Act and applicable state securities laws, or offered and sold under an exemption from these requirements. We do not plan to register the old notes under the Securities Act. For further information regarding the consequences of not tendering your old notes in the exchange offers, see the discussion herein under the caption “Exchange Offers—Consequences of Failure to Exchange.”

 

Some holders who exchange their old notes may be deemed to be underwriters, and these holders will be required to comply with the registration and prospectus delivery requirements in connection with any resale transaction.

 

If you exchange your old notes in the exchange offers for the purpose of participating in a distribution of the exchange notes, you may be deemed to have received restricted securities and, if so, will be required to comply with the registration and prospectus delivery requirements of the Securities Act in connection with any resale transaction.

 

10



Table of Contents

 

Risks Relating to the Notes

 

Our and Holdings’ level of indebtedness could adversely affect our and Holdings’ ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under the notes.

 

We and Holdings are highly leveraged.  As of March 31, 2011, our total consolidated indebtedness was $1,562.6 million, which includes Holdings indebtedness of $564.7 million. This level of indebtedness could have important consequences to you, including the following:

 

·                  it will limit our and Holdings’ ability to borrow money or sell stock to fund our working capital, capital expenditures, acquisitions and debt service requirements and other financing needs;

 

·                  our and Holdings’ interest expense would increase if interest rates in general increase because a substantial portion of our indebtedness, including all of our indebtedness under our senior secured credit facilities, bears interest at floating rates;

 

·                  it may limit our and Holdings’ flexibility in planning for, or reacting to, changes in our business and future business opportunities;

 

·                  we and Holdings are more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;

 

·                  it may make us and Holdings more vulnerable to a downturn in our business, our industry or the economy in general;

 

·                  the debt service requirements of our other indebtedness could make it more difficult for us to make payments on the notes;

 

·                  a substantial portion of our and Holdings’ cash flow from operations will be dedicated to the repayment of our indebtedness, including indebtedness we may incur in the future, and will not be available for other purposes; and

 

·                  there would be a material adverse effect on our and Holdings’ business and financial condition if we were unable to service our indebtedness or obtain additional financing as needed.

 

Despite our substantial indebtedness, we and Holdings may still incur significantly more debt, which could further exacerbate the risks described above.

 

We and Holdings and our subsidiaries may be able to incur substantial additional indebtedness in the future. The terms of the indentures governing the notes and the agreements governing our senior secured credit facilities will not fully prohibit us and Holdings or our subsidiaries from doing so. Under the indentures governing the notes, in addition to specified permitted indebtedness, we and Holdings will be able to incur additional indebtedness so long as on a pro forma basis our fixed charge coverage ratio (as defined in the indentures) is at least 2.0 to 1.0. In addition, if we and Holdings incur any additional indebtedness that ranks equally with the notes, the holders of that debt will be entitled to share ratably with you in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of us. If new debt is added to our and our subsidiaries’ current debt levels, the related risks that we and they now face could intensify.  See “Description of Certain Other Indebtedness.”

 

We and Holdings may not be able to generate sufficient cash flows to meet our and Holdings’ debt service obligations.

 

Our and Holdings’ ability to make scheduled payments or to refinance our debt obligations depends on our and Holdings’ financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We and Holdings cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.  See “Management’s discussion and analysis of financial condition and results of operations—Liquidity and capital resources.”

 

If our and Holdings’ cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness, including the notes. We and Holdings cannot assure you that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements, including our senior secured credit facilities. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our and Holdings’ debt service and other obligations. Our senior secured credit facilities and the indentures that govern the notes will restrict our ability to dispose of assets and use the proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds which we could realize from them and these proceeds may

 

11



Table of Contents

 

not be adequate to meet any debt service obligations then due.  See “Description of Certain Other Indebtedness,” “Description of Senior Exchange Notes—Repurchase at the Option of Holders—Asset Sales” and “Description of Senior PIK Exchange Notes—Repurchase at the Option of Holders—Asset Sales.”

 

If we and Holdings cannot make scheduled payments on our debt, we will be in default and, as a result:

 

·                  our and Holdings’ debt holders could declare all outstanding principal and interest to be due and payable;

 

·                  the lenders under our senior secured credit facilities could terminate their commitments to lend us money and foreclose against the assets securing their borrowings; and

 

·                  we and Holdings could be forced into bankruptcy or liquidation, which could result in you losing your investment in the notes.

 

Restrictive covenants in our credit agreements and the indentures governing the notes will restrict our ability to operate our business and to pursue our business strategies.

 

The credit agreements governing our senior secured credit facilities and the indentures governing the notes contain, and any future indebtedness we incur may contain, various covenants that limit our ability to, among other things:

 

·                  incur or guarantee additional debt;

 

·                  incur debt that is junior to senior indebtedness and senior to the senior PIK notes;

 

·                  pay dividends or make distributions to our stockholders;

 

·                  repurchase or redeem capital stock or subordinated indebtedness;

 

·                  make loans, capital expenditures or investments or acquisitions;

 

·                  incur restrictions on the ability of certain of our subsidiaries to pay dividends or to make other payments to us;

 

·                  enter into transactions with affiliates;

 

·                  create liens;

 

·                  merge or consolidate with other companies or transfer all or substantially all of our assets;

 

·                  transfer or sell assets, including capital stock of subsidiaries; and

 

·                  prepay, redeem or repurchase debt that is junior in right of payment to the notes.

 

As a result of these covenants, we are limited in the manner in which we conduct our business, and we may be unable to engage in favorable business activities or finance future operations or capital needs. Our senior secured credit facilities also require Holdings to comply with financial covenants, including covenants with respect to, in the case of the term loan facility, a maximum consolidated senior secured net leverage ratio and, in the case of the asset-based revolving credit facility, so long as the excess availability thereunder falls below certain thresholds, a minimum consolidated fixed charge coverage ratio. A breach of any of these covenants could result in a default under our senior secured credit facilities. Upon the occurrence of an event of default under our senior secured credit facilities, the lenders:

 

·                  will not be required to lend any additional amounts to us;

 

·                  could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable, which would result in an event of default under the notes;

 

·                  could require us to apply all of our available cash to repay these borrowings; or

 

·                  could prevent us from making payments on the senior PIK notes, which could result in an event of default under the notes.

 

If we were unable to repay those amounts, the lenders under our senior secured credit facilities could proceed against the collateral granted to them to secure that indebtedness. We, the co-borrowers and the guarantors in respect of such facilities pledged a significant portion of our respective assets as collateral under our senior secured credit facilities. If the lenders under our senior secured credit facilities accelerate the repayment of borrowings, we cannot assure you that Holdings or we will have sufficient assets to repay our senior secured credit facilities and our other indebtedness, including the notes, or borrow sufficient funds to refinance such indebtedness. Even if we are able to obtain new financing, it may not be on commercially reasonable terms, or terms that are acceptable to us.  See “Description of Certain Other Indebtedness.”

 

12



Table of Contents

 

Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

 

Borrowings under our senior secured credit facilities are at variable rates of interest and expose us to interest rate risk.  If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income would decrease. As of March 31, 2011, we had approximately $621.8 million of variable rate debt (not including approximately $252.6 million of additional undrawn availability under our senior secured asset-based revolving credit facility, after giving effect to $7.4 million of outstanding letters of credit). A 1.0% increase in the interest rate on our floating rate debt would have increased annual interest expense under our senior secured credit facilities by approximately $6.2 million. Although we have entered into interest rate caps involving the exchange of floating for fixed rate interest payments to reduce interest rate volatility, we may in the future be unable to continue to do so.

 

The notes and the related guarantees are effectively subordinated to all of our and Holdings’ secured debt and if a default occurs, we may not have sufficient funds to fulfill our obligations under the notes and the related guarantees.

 

The notes and the related guarantees are general unsecured obligations but our obligations under our senior secured credit facilities and each guarantor’s obligations under its guarantee of our senior secured credit facilities is secured by a security interest in substantially all of our assets and the assets of our guarantors. The notes are effectively subordinated to all of our and our guarantors’ secured indebtedness to the extent of the value of the assets securing that indebtedness. The senior PIK notes are general unsecured senior obligations of Holdings and are pari passu with or senior to all of Holdings’ existing and future debt, but are effectively subordinated to all of its secured obligations and structurally subordinated to all liabilities of Holdings’ subsidiaries, including Guitar Center. In addition, the indentures governing the notes, subject to some limitations, permit us to incur additional secured indebtedness and your notes and any related guarantees will be effectively junior to any additional secured indebtedness we may incur.

 

In the event of our bankruptcy, liquidation, reorganization or other winding up, our assets that secure our secured indebtedness will be available to pay obligations on the notes only after all secured indebtedness and, in the case of the senior PIK notes, all liabilities of Holdings’ subsidiaries and, in the case of the senior notes, all liabilities of our non-guarantor subsidiaries, have been fully paid.  Because our senior secured credit facilities are secured obligations, if we fail to comply with the terms of our senior secured credit facilities and those creditors accelerated the payment of all the funds borrowed thereunder and we were unable to repay such indebtedness, they could foreclose on substantially all of our assets and the assets of the guarantors of the notes which serve as collateral.  In this event, our secured creditors would be entitled to be repaid in full from the proceeds of the liquidation of those assets before those assets would be available for distribution to other creditors, including holders of the notes.  Holders of the notes will participate in our remaining assets ratably with all holders of our unsecured indebtedness that is deemed to be of the same class as the notes, and potentially with all of our other general creditors. We advise you that there may not be sufficient assets remaining to pay amounts due on any or all the notes and any related guarantees then outstanding. The guarantees of the senior notes will have a similar ranking with respect to secured and unsecured indebtedness of the guarantors as the senior notes do with respect to our secured and unsecured indebtedness, as well as with respect to any unsecured obligations expressly subordinated in right of payment to the guarantees.

 

Our failure to comply with the covenants contained in the credit agreements governing our senior secured credit facilities or our other debt agreements, including as a result of events beyond our control, could result in an event of default which could materially and adversely affect our operating results and our financial condition.

 

Our credit agreements require Holdings to maintain specified financial ratios, including, in the case of the term loan facility, a maximum ratio of consolidated senior secured net indebtedness to EBITDA and, in the case of the asset-based revolving credit facility, so long as the excess availability thereunder falls below certain thresholds, a minimum consolidated fixed charge coverage ratio. In addition, our credit agreement and the indentures governing the notes require us to comply with various operational and other covenants. If there were an event of default under any of our debt instruments that was not cured or waived, the holders of the defaulted debt could cause all amounts outstanding with respect to the debt to be due and payable immediately, which in turn would result in cross defaults under our other debt instruments. Our assets and cash flow may not be sufficient to fully repay borrowings under our outstanding debt instruments, either upon maturity or if accelerated upon an event of default.

 

If, when required, we are unable to repay, refinance or restructure our indebtedness under, or amend the covenants contained in, our credit agreements, or if a default otherwise occurs, the lenders under our senior secured credit facilities could elect to terminate their commitments thereunder, cease making further loans, declare all borrowings outstanding, together with accrued interest and other fees, to be immediately due and payable, institute foreclosure proceedings against those assets that secure the borrowings under our senior secured credit facilities and prevent us from making payments on the notes. Any such actions could force us into bankruptcy or liquidation, and we cannot provide any assurance that we could repay our obligations under the notes in such an event.

 

13



Table of Contents

 

The notes are structurally subordinated in right of payment to the indebtedness and other liabilities of those of our existing and future subsidiaries that do not guarantee the notes, and to the indebtedness and other liabilities of any guarantor whose guarantee of the senior notes is deemed to be unenforceable.

 

To the extent we create or acquire foreign subsidiaries, those subsidiaries would only be required to guarantee the notes under very limited circumstances. Moreover, for the reasons described below under “—Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors,” the guarantees that are given may be unenforceable in whole or in part.

 

The claims of creditors of any entity that does not guarantee the notes or of any guarantor whose guarantee of the notes is unenforceable is required to be paid before the holders of the notes have a claim (if any) against those entities and their assets. Therefore, if there was a dissolution, bankruptcy, liquidation or reorganization of any such entity, the holders of the notes would not receive any amounts with respect to the notes from the assets of such entity until after the payment in full of the claims of creditors (including preferred stockholders) of such entity.

 

As of March 31, 2011, the total liabilities of our consolidated subsidiaries that are not guarantors of the senior notes would have been $4.0 million. These non-guarantor consolidated subsidiaries have approximately $4.5 million in assets as of that date.

 

Holdings is the sole obligor under the senior PIK notes, and its subsidiaries, including Guitar Center and its subsidiaries, do not and will not guarantee Holdings’ obligations under the senior PIK notes and do not have any obligation with respect to the senior PIK notes.  The senior PIK notes are structurally subordinated in right of payment to all of Guitar Center’s indebtedness and other liabilities and the indebtedness and liabilities of Guitar Center’s existing and future subsidiaries.

 

Holdings is a holding company that has no operations of its own and derives all of its revenues and cash flow from its subsidiaries.  Holdings’ subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay amounts due under the senior PIK notes or to make any funds available to pay those amounts, whether by dividend, distribution, loan or other payments. Our ability, and the ability of our subsidiaries, to generate sufficient cash from operations to make distributions to Holdings depend upon our future operating performance, which is affected by general economic, financial, competitive, legislative, regulatory, business and other factors beyond our control. The senior PIK notes are general unsecured senior obligations of Holdings and are structurally subordinated to all liabilities of Holdings’ subsidiaries, including Guitar Center. The claims of our creditors to us or our subsidiaries are required to be paid before the holders of the senior PIK notes have a claim (if any) against those entities and their assets. Therefore, if there was a dissolution, bankruptcy, liquidation or reorganization of any such entity, the holders of the senior PIK notes would not receive any amounts with respect to the senior PIK notes from the assets of such entity until after the payment in full of the claims of creditors (including preferred stockholders) of such entity.

 

Since the notes are unsecured, your right to enforce remedies is limited by the rights of holders of secured debt.

 

Our and Holdings’ obligations under the notes and the guarantors’ obligations under the guarantees are not secured by any of our assets, while our obligations and the obligations of the guarantors under our senior secured credit facilities are secured by substantially all of the assets and intercompany loans made by the issuer, the co-borrowers and the guarantors, and pledges of the outstanding shares of capital stock of all of our domestic subsidiaries and a portion of the capital stock of potential future foreign subsidiaries. Therefore, the lenders under our senior secured credit facilities, and the holders of any other secured debt that we or the guarantors may incur in the future, have claims with respect to these assets that have priority over the claims of holders of these notes. See “Description of Certain Other Indebtedness—Senior Secured Term Loan Facility” and “—Senior Secured ABL Credit Facility.”

 

Holders of the senior PIK exchange notes may not transfer or dispose of such notes unless the recipient agrees to be bound by all of the obligations under the Assignment and Assumption Agreement.

 

Pursuant to an assignment and assumption agreement dated as of March 2, 2011, for the interest payments due April 15, 2012 and October 15, 2012, Holdings will pay interest on the senior PIK exchange notes in cash, but may elect to require the holders of the senior PIK exchange notes to assign to Guitar Center 50% of their right to receive the cash interest payable on the senior PIK exchange notes in exchange for the issuance of additional senior notes of Guitar Center in an aggregate principal amount equal to the assigned interest. The assignment and assumption agreement further provides that the holders of the senior PIK exchange notes may not assign, pledge, transfer or otherwise dispose of any beneficial interest in the senior PIK exchange notes other than to a person or entity who executes and delivers to Holdings a joinder to the agreement, agreeing to be bound by the agreement.  These arrangements may materially adversely affect the liquidity of any trading market that may develop for the senior PIK exchange notes, the ability of holders to sell or otherwise dispose of their senior PIK exchange notes or the price at which holders would be able to sell or otherwise dispose of their senior PIK exchange notes.

 

14



Table of Contents

 

Federal and state statutes allow courts, under specific circumstances, to void guarantees and require note holders to return payments received from guarantors.

 

The issuance of the guarantees of the senior notes by the guarantors may be subject to review under state and federal laws if a bankruptcy, liquidation or reorganization case or a lawsuit, including in circumstances in which bankruptcy is not involved, were commenced at some future date by, or on behalf of, the unpaid creditors of a guarantor. Under the United States bankruptcy law and comparable provisions of state fraudulent transfer and conveyance laws, any guarantees of the senior notes could be voided, or claims in respect of a guarantee could be subordinated to all other existing and future debts of that guarantor if, among other things, and depending upon the jurisdiction whose laws are applied, the guarantor, at the time it incurs the indebtedness evidenced by its guarantee or, in some jurisdictions, when payments came due under such guarantee:

 

·                  issued the guarantee with the intent of hindering, delaying or defrauding any present or future creditor; or

 

·                  received less than reasonably equivalent value or fair consideration for the incurrence of such guarantee and (1) was insolvent or rendered insolvent by reason of such incurrence, (2) was engaged in a business or transaction for which the guarantor’s remaining assets constitute unreasonably small capital, or (3) intended to incur, or believed or reasonably should have believed that it would incur, debts beyond its ability to pay such debts as they mature.

 

A court would likely find that a guarantor did not receive reasonably equivalent value or fair consideration for its guarantee unless it benefited substantially directly or indirectly from the issuance of the notes.

 

The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if:

 

·                  the sum of its debts, including contingent liabilities, was greater than the fair saleable value of all of its assets;

 

·                  the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

 

·                  it could not pay its debts as they become due. Each guarantee contains a provision intended to limit the guarantor’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer. This provision may not be effective to protect the guarantees from being voided under fraudulent transfer law, or may reduce the guarantor’s obligation to an amount that effectively makes the guarantee worthless.

 

We cannot be certain as to the standard that a court would use to determine whether or not a guarantor was solvent upon issuance of the guarantee or, regardless of the actual standard applied by the court, that the issuance of the guarantee of the notes would not be voided or subordinated to our or any guarantor’s other debt.

 

If a guarantee were legally challenged, such guarantee could also be subject to the claim that, since the guarantee was incurred for the issuer’s benefit, and only indirectly for the benefit of the guarantor, the obligations of the guarantor were incurred for less than fair consideration. A court could thus void the obligations under a guarantee, subordinate it to a guarantor’s other debt or take other action detrimental to the holders of the notes.

 

If a court voided a guarantee, you would no longer have a claim against such guarantor for amounts owed in respect of such guarantee. In addition, a court might direct you to repay any amounts already received from such guarantor. If a court were to void any guarantee, funds may not be available from any other source to pay our obligations under the notes.

 

We and Holdings may not be able to purchase the notes upon a change of control, which would result in a default under the indentures governing the notes and would adversely affect our business and financial condition.

 

Upon the incurrence of specific kinds of change of control events, we and Holdings must offer to purchase the notes at 101% of the principal amount thereof plus accrued and unpaid interest to the purchase date. We and Holdings may not have sufficient funds available to make any required repurchases of the notes, and restrictions under our credit agreement may not allow that repurchase. If we and Holdings fail to repurchase notes in that circumstance, we will be in default under the indentures governing the notes and, in turn, under our credit agreement. In addition, certain change of control events will constitute an event of default under our credit agreements. A default under our credit agreements would result in an event of default under the indentures governing the notes if the administrative agent or the lenders accelerate our debt under our senior secured credit facilities. Upon the occurrence of a change of control, we could seek to refinance the indebtedness under our senior secured credit facilities and the notes or obtain a waiver from the lenders or you as a holder of the notes. We cannot assure you, however, that we would be able to obtain a waiver or refinance our indebtedness on commercially reasonable terms, if at all. Any future debt that we incur may also contain restrictions on repayment of the notes upon a change of control.

 

15



Table of Contents

 

The interests of our controlling stockholder may conflict with your interests as a holder of the notes.

 

Bain Capital controls the issuers and each of the guarantors of the notes. Bain Capital has the ability to elect a majority of our Board of Directors and the Board of Directors of Holdings, as well as to select our management team, determine our corporate and management policies and make decisions relating to fundamental corporate actions. The directors have the authority to make decisions affecting our capital structure, including the issuance of additional debt and declaration of dividends. In addition, the directors may authorize transactions, such as acquisitions, that could enhance the equity investment of Bain Capital while involving risks to your interest. Bain Capital’s interests may not be aligned with your interests as a holder of the notes.  See “Certain Relationships and Related Party Transactions” and “Security Ownership of Certain Beneficial Owners and Management.”

 

Risks Related to Our Business

 

Our failure to effectively implement the relocation of our direct response operations could adversely affect us.

 

In April 2011, we announced plans to relocate our direct response operations currently located in Medford, Oregon, to Southern California early in 2012.  Our direct response operations in Oregon are significant. Planning and implementing this transition will require significant management and operational resources and is likely to result in substantial costs and expenses.  We believe the one-time costs related to this relocation may be between $7 million and $12 million.  The transition may significantly divert the attention of our management and operational resources and may disrupt the operation of our direct response or other businesses.  In addition, the relocation may result in our failure to retain key direct response employees, and will require us to recruit additional employees in Southern California.  Our failure to retain and recruit key employees would require further management resources and may result in the disruption of operations.

 

Further, our direct response business currently does not have a physical presence in California, and as a result does not collect and remit sales tax on behalf of California customers.  After the relocation, this business will be required to collect and remit sales tax in California.  We do not know to what extent, if any, collecting and remitting sales tax in California will negatively impact our sales in that state.

 

The failure to successfully plan and implement this transition could have a material adverse effect on our business, financial condition and results of operations.

 

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. The United States economy generally, and the music products industry in particular, is experiencing a cyclical slowdown.  We cannot predict with accuracy the duration or extent of the slowdown. This downturn in general economic conditions has had an adverse effect on our results of operations. We believe that the sensitivity of our operations to general economic conditions and consumer spending patterns has increased as new types of competitors have entered the market and we have expanded our customer base to a greater number of hobbyists and semi-professional musicians and have expanded our footprint to smaller markets.  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 conditions, business and prospects.

 

Significant existing and new competition in our industry could adversely affect us.

 

The retail musical instrument industry is highly competitive and fragmented. Our stores compete against other large and small musical instrument retailers, online music retailers, online auctions, direct-to-consumer alternatives and a growing number of large mass merchants.  These competitors sell many or most of the items we sell and may have greater financial or operational resources than us.

 

Large online companies such as Amazon and eBay increasingly have expanded their offerings of musical instruments and related products.  These companies have significant brand recognition and financial and operational resources dedicated to online direct and marketplace operations.  In addition, our retail stores and online operations compete with other direct response musical instrument companies such as American Musical Supply, Sweetwater Sound and Full Compass.

 

In addition, our online and other direct response 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.

 

A number of large mass merchants, including Wal-Mart, Best Buy, Target and Costco, sell music products in categories in which we compete. Best Buy also operates a store-within-a-store concept for music products which includes a significantly expanded selection of products.  These retailers represent a significant source of competition for our retail and direct response operations.

 

16



Table of Contents

 

We are in direct competition with numerous small local and regional musical instrument retailers as well as large national retailers such as Sam Ash Music based in New York, New York. Sam Ash has continued to open and maintain stores in markets in which we are located.  If we are not able to compete effectively with these competitors, we may fail to achieve market position gains or may lose market share.

 

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 operations will face in the future. In particular, competition within the online portion of our businesses has been increasing and is intense, and we expect that this competition will continue in the future.

 

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

 

We are in the process of developing and implementing new technology systems, including a new e-commerce platform, a new multi-channel retail system and a new human resources information system. The development and implementation of these systems require 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 significant additional capital resources. Such a failure could reduce the shopping experience of customers compared to our competitors and impact the 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 may not be able to grow sales in our existing Guitar Center stores.

 

Our quarterly comparable stores sales results have fluctuated significantly in the past, and in particular during the current economic downtown. We do not know whether our new stores or recently opened stores will achieve sales or profitability levels similar to our mature stores.

 

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 could adversely affect our results of operations and liquidity.

 

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 increasing sales at existing Guitar Center and Music & Arts locations and opening new locations. The success of any new Guitar Center or Music & Arts stores will depend 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.

 

A number of these factors are to a significant extent beyond our control.  If we are unable to successfully implement our retail growth strategy, or if new stores do not perform to our level of expectations, our results of operations would be adversely affected.

 

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 retail stores in new markets.

 

Part of our retail growth strategy includes plans to open and/or acquire additional Guitar Center and Music & Arts stores in new markets. This expansion into new markets will present unique competitive and merchandising challenges, including:

 

17



Table of Contents

 

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

 

·                  the increasing difficulty in identifying large untapped markets and the consequent expansion into smaller markets that may have different competitive landscapes and customer profiles;

 

·                  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;

 

·                  the availability of desirable product lines;

 

·                  the potential acquisitions of business lines or geographies in which we have limited or no experience; and

 

·                  the management of stores in distant locations or possibly foreign countries.

 

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.

 

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

 

Brand recognition is of particular 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 there may not be sufficient quantities or the appropriate mix of products available in the future to supply our existing and future stores. 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. Additionally, many of our vendors receive products 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, including rail and trucking, to transport products from our vendors to our central distribution centers and from these centers to either our stores or 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.

 

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 our direct response business. Our e-commerce systems are responsible for online product sales, customer service and product marketing to our customers and prospective customers. In addition, our information systems provide our management with 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.

 

In addition, 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 and operating results.

 

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 other parties. With this technology, we perform real-time credit card authorization and

 

18



Table of Contents

 

verification with our banks and we are subject to the customer privacy standards of credit card companies and various consumer protection laws. We cannot predict whether there will be a compromise or breach of the technology we use to protect our customers’ personal information. If there is a compromise or breach of this nature, there is the potential that parties could seek damages from us, we could lose the confidence of customers or be subject to 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.

 

We need to comply with credit and debit card security regulations.

 

As a merchant who processes credit and debit card payments from customers, we are required to comply with the Payment Card Industry data security requirements imposed on us for the protection and security of our customers’ credit and debit card information.  If we are unable to remain compliant with these requirements, our business could be harmed because we could incur significant fines from payment card companies or we could be prevented in the future from accepting customer payments by means of a credit or debit card.  We also may need to expend significant management and financial resources to become or remain compliant with these requirements, which could divert these resources from other initiatives and adversely impact our financial results.

 

Our reliance on foreign manufacturers and suppliers increases our risk of obtaining adequate, timely and cost-effective product supplies.

 

We rely to a significant extent on foreign manufacturers of various products that we sell, particularly manufacturers located in China. In addition, many of our domestic suppliers purchase a significant portion of their products from foreign sources. This reliance increases the risk that we will not have adequate and timely supplies of various products due to local political, economic, social or environmental conditions (including acts of terrorism, the outbreak of war, or the occurrence of natural disaster), transportation delays (including dock strikes and other work stoppages), restrictive actions by foreign governments, or changes in United States laws and regulations affecting imports or domestic distribution. Reliance on foreign manufacturers also increases our exposure to fluctuations in exchange rates and trade infringement claims and reduces our ability to return product for various reasons.

 

Additionally, the cost of labor and wage taxes have increased in China, which means we are at risk of higher costs associated with goods manufactured in China.  Significant increases in wages or wage taxes paid by contract facilities may increase the cost of goods manufactured in China, which could have a material adverse effect on our profit margins and profitability.

 

All of our products manufactured overseas and imported into the United States are subject to duties collected by the United States Customs Service. We may be subjected to additional duties, significant monetary penalties, the seizure and forfeiture of the products we are attempting to import or the loss of import privileges if we or our suppliers are found to be in violation of United States laws and regulations applicable to the importation of our products.

 

Product recalls and/or product liability, as well as changes in product safety and other consumer protection laws, may adversely impact our operations, product offerings, reputation, results of operations, cash flow and financial condition.

 

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 increase the number and complexity of the proprietary products that we offer. Many of these products are manufactured by small companies located overseas. We currently maintain product liability insurance coverage in amounts that we believe are adequate. However, we may not carry or be able to maintain adequate coverage or obtain additional coverage on acceptable terms in the future. Liability from claims of users of our products could result in damage to our reputation and sales, and our failure to maintain adequate products liability insurance could adversely impact our financial condition.

 

In addition, we are subject to regulations by a variety of federal, state and international regulatory authorities, including the Consumer Product Safety Commission. We purchase products from hundreds of vendors.  Since a majority of our merchandise is manufactured in foreign countries, one or more of our vendors might not adhere to product safety requirements or our quality control standards, and we might not identify the deficiency before merchandise ships to our stores. Any issues of product safety, including those manufactured in foreign countries, could cause us to recall some of those products.  If the recall affects our proprietary products, or if our vendors are unable or unwilling to recall products failing to meet our quality standards, we may be required to recall those products at a substantial cost to us. These recalls may adversely impact our reputation and brands, potentially leading to increases in customer litigation against us. Further, to the extent we are unable to replace any recalled products, we may have to reduce our merchandise offerings, resulting in a decrease in sales, especially if the unavailability occurs near or during a seasonal period.

 

19



Table of Contents

 

Moreover, changes in product safety or other consumer protection laws could lead to increased costs to us for merchandise, or additional labor costs associated with readying merchandise for sale. Long lead times on merchandise ordering cycles increase the difficulty for us to plan and prepare for potential changes to applicable laws.  The Consumer Product Safety Improvement Act of 2008 imposes significant requirements on manufacturing, importing, testing and labeling requirements for our products.  In addition, various federal and state regulations directly impact our products, such as the Lacey Act, the Formaldehyde Air Toxic Control Measure issued by the California Air Resources Board and the upcoming effectiveness of the California Transparency in Supply Chains Act.  In the event that we are unable to timely comply with regulatory changes, significant fines or penalties could result, and could adversely affect our reputation, results of operations, cash flow and financial condition.

 

We have outsourced some of our information technology functions, which makes us more dependent upon third parties.

 

We  place significant reliance on a third party provider for the outsourcing of a variety of our information technology functions. These functions are generally performed in an offshore location, with our oversight. As a result, we are relying on third parties to ensure that these functional needs are sufficiently met. This reliance subjects us to risks arising from the loss of control over these processes, changes in pricing that may affect our operating results and potentially the termination of provision of these services by our supplier. If our service providers fail to perform, we may have difficulty arranging for an alternate supplier or rebuilding our own internal resources, and we could incur significant costs, all of which may have a significant adverse effect on our business.

 

We may outsource other administrative functions in the future, which would further increase our reliance on third parties. Further, the use of offshore service providers may expose us to risks related to local political, economic, social or environmental conditions (including acts of terrorism, the outbreak of war, or the occurrence of natural disaster), restrictive actions by foreign governments or changes in United States laws and regulations.

 

Any changes in the way that online business is regulated or taxed could impose additional costs on us and adversely affects our financial results.

 

The adoption or modification of laws or regulations, or revised interpretations of existing laws, relating to the online commerce industry could adversely affect the manner in which we currently conduct our online and catalog business and the results of operations of those businesses. 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 recent years, states increasingly have focused on the taxation of out of state retailers in an effort to reduce their budget shortfalls.  As the result of aggressive taxation positions, we have had to terminate our direct response advertisers that are located in states where new laws have passed.  In addition, we at times are subject to information requests and claims by states relating to state sales and use tax matters.

 

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.

 

Changes in health care regulations and costs may adversely impact our business.

 

Our operations are subject to health care regulations.  There are a number of existing and proposed legislative and regulatory initiatives relating to health care that could adversely impact our business. In particular, we expect that the Patient Protection and Affordable Care Act will increase our annual health care costs, with the most significant increases coming in 2014.

 

In addition, we self-insure our workers’ compensation claims up to $500,000 per claim and medical insurance claims of up to $350,000 per claim, with excess amounts covered by stop-loss insurance coverage.  As a result, increases in health care claims or coverage costs may adversely impact our financial condition.

 

We face risks created by litigation and governmental proceedings.

 

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.

 

20



Table of Contents

 

From time to time, the litigation we have faced has included purported class action lawsuits based on our credit card practices, payroll practices and other matters, and we may face other purported class action lawsuits in the future. The costs of these lawsuits could be significant, particularly if a plaintiff were to succeed in obtaining certification of a class nationwide or in a large region in which we operate.

 

We are the largest musical instrument retailer in the United States by revenue. Our significant size within our industry may increase the scrutiny that we receive regarding antitrust or other matters.  In the past, we have been subject to an investigation by the Federal Trade Commission regarding our pricing practices.  While this investigation was resolved without any action by the Federal Trade Commission, private litigants used some of the information from a related investigation of a major trade association to bring class action claims against us.  See “Business—Legal proceedings” for more detail on these claims.  These actions, as well as other current and future litigation or governmental proceedings, could lead to increased costs or interruptions of our normal business operations and may adversely affect our financial condition and results of operations.

 

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

 

Our Music & Arts 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 would have a material adverse effect on our Music & Arts business and its results of operations.

 

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, including in foreign markets. We regularly investigate acquisition opportunities complementary to our Guitar Center, direct response and Music & Arts 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. Attractive acquisition targets may not be available at reasonable prices or we may not be successful in any such transaction. Acquisitions involve a number of special risks, including:

 

·                  diversion of our management’s attention;

 

·                  integration of acquired businesses with our business; and

 

·                  unanticipated legal liabilities and other circumstances or events.

 

Our failure to identify complementary acquisitions, our 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.

 

Significant increases in fuel prices could adversely impact us.

 

Increased fuel costs have increased both the cost of the products that we purchase as well as the transportation of these products between our distribution or fulfillment centers and our stores or consumers.  In addition, fluctuations in gas prices have disrupted consumer spending by leaving consumers with comparatively less money to spend for retail and entertainment.  This disruption may lead to reduced sales.  Either of these trends could have a material adverse effect on our results of operations, financial conditions, business and prospects.

 

Claims of infringement of intellectual property rights of third parties or inadequately acquiring or protecting our intellectual property could harm our ability to compete or grow.

 

Parties have filed, and in the future may file, claims against us alleging that we have infringed third party intellectual property rights. If we are held liable for infringement, we could be required to pay damages or obtain licenses or to cease making or selling certain products. Licenses may not be available at all, or may not be available on commercially reasonable terms, and the cost to defend these claims, whether or not meritorious, could be significant and could divert the attention of management.

 

We could also have our intellectual property infringed. We rely on the trademark, copyright and trade secret laws of the United States and other countries to protect our proprietary rights, but there can be no guarantee that these will adequately protect all of our rights, or that any of our intellectual property rights will not be challenged or held invalid or unenforceable in a dispute with third parties. If we are unable to enforce our intellectual property rights against third parties, our business, financial condition and results of operations may be adversely affected.

 

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,

 

21



Table of Contents

 

liquidity and financial position.  In order to achieve our growth plans, we depend upon our ability to retain and promote existing 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.

 

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 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 not to rely upon, or otherwise consider, our projections in making an investment decision in respect of the notes.

 

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

 

22



Table of Contents

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains “forward-looking statements.” You should not place undue reliance on these statements. Forward-looking statements include information concerning our liquidity and our possible or assumed future results of operations, including descriptions of business strategies. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may” or similar expressions. These statements are based on certain assumptions that we have made in light of our experience in the industry as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate in these circumstances. As you read and consider this prospectus, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties and assumptions. Many factors could affect our actual financial results and could cause actual results to differ materially from those expressed in the forward-looking statements.

 

The following are some, but not necessarily all, of the factors that may cause actual results to differ from those anticipated or predicted:

 

·                  our ability to effectively implement the relocation of our direct response operations;

 

·                  economic conditions or changing consumer preferences;

 

·                  significant existing or new competition in our industry;

 

·                  our ability to develop and implement critical new technology systems for our business;

 

·                  our ability to grow sales in our existing Guitar Center stores;

 

·                  our ability to meet our retail store growth strategy;

 

·                  our ability to address unique competitive and merchandising challenges in connection with our plans to open additional retail stores in new markets;

 

·                  our dependence on a relatively small number of manufacturers, suppliers and common carriers;

 

·                  damage or disruption to our hardware and software systems;

 

·                  the failure of our security measures;

 

·                  our ability to comply with credit and debit card security regulations;

 

·                  our reliance on foreign manufacturers and suppliers;

 

·                  product recalls and/or product liability, as well as changes in product safety and other consumer protection laws;

 

·                  our dependence on third parties for certain of our information technology functions;

 

·                  changes in the way that online business is regulated or taxes;

 

·                  changes in health care regulations and costs;

 

·                  litigation and government proceedings;

 

·                  decreases in funding of music programs in primary and secondary schools;

 

·                  our ability to address risks associated with acquisitions;

 

·                  significant increases in fuel prices;

 

·                  our infringement of intellectual property rights of third parties or our failure to adequately acquire or protect our intellectual property; and

 

·                  our ability to retain key personnel, including our senior management.

 

In light of these risks, uncertainties and assumptions, the forward-looking statements contained in this prospectus might not prove to be accurate and you should not place undue reliance upon them.  All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements.  All such

 

23



Table of Contents

 

statements speak only as of the date made, and we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

24



Table of Contents

 

EXCHANGE OFFERS

 

Purpose of the Exchange Offers

 

The exchange offers are designed to provide holders of old notes with an opportunity to acquire exchange notes which, unlike the old notes, will be freely transferable at all times, subject to any restrictions on transfer imposed by state “blue sky” laws and provided that the holder is not our affiliate within the meaning of the Securities Act and represents that the exchange notes are being acquired in the ordinary course of the holder’s business and the holder is not engaged in, and does not intend to engage in, a distribution of the exchange notes.

 

The old notes were issued and sold in a transaction not registered under the Securities Act in reliance upon the exemption provided by Section 4(2) of the Securities Act. The old notes may not be reoffered, resold or transferred other than (i) to us or our subsidiaries, (ii) to a qualified institutional buyer in compliance with Rule 144A under the Securities Act, (iii) outside the United States to a non-United States person within the meaning of Regulation S under the Securities Act, (iv) pursuant to the exemption from registration provided by Rule 144 under the Securities Act (if available) or (v) pursuant to an effective registration statement under the Securities Act.

 

In connection with the original issuance and sale of the old notes, we and Holdings entered into the Registration Rights Agreements, pursuant to which we and Holdings agreed to file with the SEC registration statements covering the exchange by us of the exchange notes for the old notes, pursuant to the exchange offers. The Registration Rights Agreements provide that we will file with the SEC exchange offer registration statements on an appropriate form under the Securities Act and offer to holders of old notes who are able to make certain representations the opportunity to exchange their old notes for exchange notes.  Pursuant to letters dated November 21, 2008, the holders of the old notes waived the Company’s obligation under the Registration Rights Agreements to file with the SEC exchange offer registration statements.  Such waivers were revoked by the holders of the old notes effective as of April 1, 2011.

 

Under existing interpretations by the staff of the SEC as set forth in no-action letters issued to third parties in other transactions, the exchange notes would, in general, be freely transferable after the exchange offers without further registration under the Securities Act; provided, however, that in the case of broker-dealers participating in the exchange offers, a prospectus meeting the requirements of the Securities Act must be delivered by such broker-dealers in connection with resales of the exchange notes. We have agreed to furnish a prospectus meeting the requirements of the Securities Act to any such broker-dealer for use in connection with any resale of any exchange notes acquired in the exchange offers. A broker-dealer that delivers such a prospectus to purchasers in connection with such resales will be subject to certain of the civil liability provisions under the Securities Act and will be bound by the provisions of the Registration Rights Agreements (including certain indemnification rights and obligations).

 

We do not intend to seek our own interpretation regarding the exchange offers, and we cannot assure you that the staff of the SEC would make a similar determination with respect to the exchange notes as it has in other interpretations to third parties.

 

Each holder of old notes that exchanges such old notes for exchange notes in the exchange offers will be deemed to have made certain representations, including representations that (i) any exchange notes to be received by it will be acquired in the ordinary course of its business, (ii) it has no arrangement or understanding with any person to participate in the distribution (within the meaning of the Securities Act) of exchange notes and (iii) it is not our affiliate as defined in Rule 405 under the Securities Act, or if it is an affiliate, it will comply with the registration and prospectus delivery requirements of the Securities Act to the extent applicable.

 

If the holder is not a broker-dealer, it will be required to represent that it is not engaged in, and does not intend to engage in, the distribution of old notes or exchange notes. If the holder is a broker-dealer that will receive exchange notes for its own account in exchange for old notes that were acquired as a result of market-making activities or other trading activities, it will be required to acknowledge that it will deliver a prospectus in connection with any resale of such exchange notes.

 

Terms of the Exchange Offers; Period for Tendering Outstanding Old Notes

 

Upon the terms and subject to the conditions set forth in this prospectus and in the letter of transmittal, we will accept any and all old notes validly tendered and not withdrawn prior to 5:00 p.m., New York City time, on the expiration date of the exchange offers. We will issue $1,000 principal amount of exchange notes in exchange for each $1,000 principal amount of old notes accepted in the exchange offers. Holders may tender some or all of their outstanding old notes pursuant to the exchange offers. However, old notes may be tendered only in denominations of $2,000 and integral multiples of $1,000 in excess thereof.

 

The form and terms of the exchange notes are the same as the form and terms of the old notes except that:

 

25



Table of Contents

 

(1)          the exchange notes will bear a Series B designation and a different CUSIP Number from the old notes (though notwithstanding such series designation and different CUSIP Number, the old notes and the exchange notes shall constitute a single series of notes under the respective indentures governing the notes);

 

(2)          the exchange notes will have been registered under the Securities Act and will not bear legends restricting their transfer; and

 

(3)          the holders of the exchange notes will not be entitled to certain rights under the Registration Rights Agreements, including the provisions providing for an increase in the interest rate on the old notes in certain circumstances relating to the timing of the exchange offers, all of which rights will terminate when the exchange offers to which this prospectus relates are consummated.

 

The exchange notes will evidence the same debt as the old notes and will be entitled to the benefits of the indentures governing the notes.

 

As of March 31, 2011, approximately $939.7 million in aggregate principal amount of old notes were outstanding.  This prospectus and the letter of transmittal are being sent to all registered holders of the old notes.  There will be no fixed record date for determining registered holders of old notes entitled to participate in the exchange offers.

 

Holders of old notes do not have any appraisal or dissenters’ rights under the General Corporate Law of the State of Delaware, or the indentures governing the notes, in connection with the exchange offers.  We intend to conduct the exchange offers in accordance with the applicable requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

 

We will be deemed to have accepted validly tendered old notes when, as and if we have given oral (promptly confirmed in writing) or written notice of our acceptance to the exchange agent. The exchange agent will act as agent for the tendering holders for the purpose of receiving the exchange notes from us.

 

If any tendered old notes are not accepted for exchange because of an invalid tender, the occurrence of specified other events set forth in this prospectus or otherwise in our sole discretion, the certificates for any unaccepted old notes will be promptly returned, without expense, to the tendering holder thereof promptly following the expiration date of the exchange offers.

 

Holders who tender old notes in the exchange offers will not be required to pay brokerage commissions or fees or transfer taxes with respect to the exchange of old notes pursuant to the exchange offers. We will pay all charges and expenses, other than transfer taxes in certain circumstances, in connection with the exchange offers. See “—Fees and Expenses” and “—Transfer Taxes” below.

 

The exchange offers will remain open for at least 20 full business days. The term “expiration date” will mean 5:00 p.m., New York City time, on                   , 2011, unless we or Holdings, respectively, in our or its sole discretion, extend the exchange offers, in which case the term “expiration date” will mean the latest date and time to which the exchange offers are extended.

 

To extend the exchange offers, prior to 9:00 a.m., New York City time, on the next business day after the previously scheduled expiration date, we and Holdings will:

 

(1)          notify the exchange agent of any extension by oral notice (promptly confirmed in writing) or written notice, and

 

(2)          issue a notice by press release or other public announcement.

 

Any announcement of delay in acceptance, extension, termination or amendment will be followed as promptly as practicable by oral or written notice thereof to the registered holders.

 

We reserve the right, in our sole discretion:

 

(1)          if any of the conditions below under the caption “—Conditions to the Exchange Offers” shall have not been satisfied,

 

(a)          to delay accepting any old notes, but only to the extent that such a delay is the result of an extension of the Exchange Offers and permitted by Rule 14e-1 promulgated under the Exchange Act.

 

(b)         to extend the exchange offers, or

 

(c)          to terminate the exchange offers, or

 

(2)          to amend the terms of the exchange offers in any manner.

 

Such decision will also be communicated in a press release or other public announcement prior to 9:00 a.m., New York City time, on the next business day following such decision.  Any delay in acceptance, extension, termination or amendment will be followed as promptly as practicable by written notice to the registered holders.  In the event of a material change to the terms of an Exchange Offer, including the waiver of a material condition, we will extend the terms of the applicable Exchange Offer, if necessary, so that at least five business days remain in such Exchange Offer following notice of any such material change.

 

26



Table of Contents

 

Interest on the Exchange Notes

 

No interest will be paid on either the exchange notes or the old notes at the time of the exchange.  The exchange notes will accrue interest from and including the last interest payment date on which interest has been paid on the old notes.  Accordingly, the holders of old notes that are accepted for exchange will not receive accrued and unpaid interest on old notes at the time of tender.  Rather, that interest will be payable on the exchange notes delivered in exchange for the old notes on the first interest payment date after the expiration date of the exchange offers.

 

Interest on the exchange notes is payable semi-annually in arrears on April 15 and October 15 of each year, commencing October 15, 2011.

 

Procedures for Tendering Old Notes

 

Only a holder of old notes may tender outstanding old notes in the exchange offers. To tender in the exchange offers, a holder must complete, sign and date the letter of transmittal, or a facsimile thereof, have the signatures thereon guaranteed if required by the letter of transmittal or transmit an agent’s message in connection with a book-entry transfer, and, unless transmitting an agent’s message in connection with a book-entry transfer, mail or otherwise deliver the letter of transmittal or the facsimile, together with the old notes and any other required documents, to the exchange agent prior to 5:00 p.m., New York City time, on the expiration date.  To be tendered effectively, the old notes, letter of transmittal or an agent’s message, as applicable, and all other required documents must be completed and received by the exchange agent at the address set forth below under “—Exchange Agent” prior to 5:00 p.m., New York City time, on the expiration date, unless you comply with the guaranteed delivery procedures described below.  Delivery of the old notes may be made by book-entry transfer in accordance with the procedures described below.  Confirmation of the book-entry transfer must be received by the exchange agent prior to 5:00 p.m., New York City time on the expiration date.

 

The term “agent’s message” means a message, transmitted by a book-entry transfer facility to, and received by, the exchange agent forming a part of a confirmation of a book-entry, which states that the book-entry transfer facility has received an express acknowledgment from the participant in the book-entry transfer facility tendering the old notes that the participant has received and agrees: (1) to participate in DTC’s Automated Tender Offer Program (referred to herein as “ATOP”); (2) to be bound by the terms of the letter of transmittal, or in the case of an agent’s message relating to guaranteed delivery, that such participant has received and agrees to be bound by the applicable notice of guaranteed delivery; and (3) that we may enforce such agreement against the participant.

 

To participate in the exchange offers, each holder will be required to make the following representations to us or Holdings, as applicable:

 

(1)          you or any other person acquiring exchange notes in exchange for your old notes in the exchange offers is acquiring them in the ordinary course of business;

 

(2)          neither you nor any other person acquiring exchange notes in exchange for your old notes in the exchange offers is engaging, in or intends to engage in, a distribution of the exchange notes within the meaning of the federal securities laws;

 

(3)          neither you nor any other person acquiring exchange notes in exchange for your old notes has an arrangement or understanding with any person (including us or any of our affiliates) to participate in the distribution of exchange notes issued in the exchange offers;

 

(4)          neither you nor any other person acquiring exchange notes in exchange for your old notes is our “affiliate” as defined under Rule 405 of the Securities Act; and

 

(5)          if you or another person acquiring exchange notes in exchange for your old notes is a broker-dealer and you acquired the old notes as a result of market-making activities or other trading activities, you acknowledge that you will deliver a prospectus meeting the requirements of the Securities Act in connection with any resale of the exchange notes.

 

Broker-dealers who cannot make the representations in item (5) of the paragraph above cannot use this exchange offer prospectus in connection with resales of the exchange notes issued in the exchange offers.

 

If you are our “affiliate,” as defined under Rule 405 of the Securities Act, if you are a broker-dealer who acquired your old notes in the initial offering and not as a result of market-making activities or other trading activities, or if you are engaged in or intend to engage in, or have an arrangement or understanding with any person to participate in, a distribution of exchange notes acquired in the exchange offers, you or that person:

 

(1)          may not rely on the applicable interpretations of the staff of the SEC and therefore may not participate in the exchange offers; and

 

(2)          must comply with the registration and prospectus delivery requirements of the Securities Act or an exemption therefrom when reselling the old notes.

 

27



Table of Contents

 

The tender by a holder and our or Holdings’, as applicable, acceptance thereof will constitute an agreement between the holder and us or Holdings, in accordance with the terms and subject to the conditions set forth in this prospectus and in the letter of transmittal or agent’s message.

 

The method of delivery of old notes and the letter of transmittal or agent’s message and all other required documents to the exchange agent is at the election and sole risk of the holder. As an alternative to delivery by mail, holders may wish to consider overnight or hand delivery service. In all cases, sufficient time should be allowed to assure delivery to the exchange agent before the expiration date. No letter of transmittal or old notes should be sent to us or Holdings. Holders may request their respective brokers, dealers, commercial banks, trust companies or nominees to effect the above transactions for them.

 

Any beneficial owner whose outstanding old notes are registered in the name of a broker, dealer, commercial bank, trust company or other nominee and who wishes to tender should contact the registered holder promptly and instruct the registered holder to tender on the beneficial owner’s behalf. See “Instructions to Letter of Transmittal” included with the letter of transmittal.

 

Signatures on a letter of transmittal or a notice of withdrawal, as the case may be, must be guaranteed by a member firm of a registered national securities exchange or of the National Association of Securities Dealers, Inc., a commercial bank or trust company having an office or correspondent in the United States or by an “eligible guarantor institution” within the meaning of Rule 17Ad-15 promulgated under the Exchange Act (banks; brokers and dealers; credit unions; national securities exchanges; registered securities associations; learning agencies; and savings associations) (each an “Eligible guarantor Institution”) unless the outstanding old notes tendered pursuant to the letter of transmittal are tendered (1) by a registered holder who has not completed the box entitled “Special Registration Instructions” or “Special Delivery Instructions” on the letter of transmittal or (2) for the account of an Eligible guarantor Institution. In the event that signatures on a letter of transmittal or a notice of withdrawal, as the case may be, are required to be guaranteed, the guarantee must be by an Eligible guarantor Institution.

 

If the letter of transmittal is signed by a person other than the registered holder of any outstanding old notes listed in this prospectus, the outstanding old notes must be endorsed or accompanied by a properly completed bond power, signed by the registered holder as the registered holder’s name appears on the outstanding old notes with the signature thereon guaranteed by an Eligible guarantor Institution.

 

If the letter of transmittal or any bond powers are signed by trustees, executors, administrators, guardians, attorneys-in-fact, officers of corporations or others acting in a fiduciary or representative capacity, the person signing should so indicate when signing, and evidence satisfactory to us of its authority to so act must be submitted with the letter of transmittal.

 

We and Holdings understand that the exchange agent will make a request promptly after the date of this prospectus to establish accounts with respect to the old notes at DTC for the purpose of facilitating the exchange offers, and subject to the establishment thereof, any financial institution that is a participant in DTC’s system may make book-entry delivery of old notes by causing DTC to transfer the old notes into the exchange agent’s account with respect to the old notes in accordance with DTC’s procedures for the transfer.  Although delivery of the old notes may be effected through book-entry transfer into the exchange agent’s account at DTC, unless an agent’s message is received by the exchange agent in compliance with ATOP, an appropriate letter of transmittal properly completed and duly executed with any required signature guarantee and all other required documents must in each case be transmitted to and received or confirmed by the exchange agent at its address set forth in this prospectus prior to 5:00 p.m., New York City time, on the expiration date, unless the guaranteed delivery procedures described below are complied with. Delivery of documents to DTC does not constitute delivery to the exchange agent.

 

Holders of old notes who are unable to deliver confirmation of the book-entry tender of their old notes into the exchange agent’s account at the book-entry transfer facility or all other documents required by the accompanying letter of transmittal to the exchange agent prior to the expiration date must tender their old notes according to the guaranteed delivery procedures described below.

 

All questions as to the validity, form, eligibility, including time of receipt, acceptance of tendered old notes and withdrawal of tendered old notes will be determined by us or Holdings, as applicable, in our or its sole discretion, which determination will be final and binding. We and Holdings reserve the absolute right to reject any and all old notes not properly tendered or any old notes our or its acceptance of which would, in the opinion of counsel, be unlawful. We and Holdings also reserve the right in our or its sole discretion to waive any defects, irregularities or conditions of tender as to particular old notes, provided however that, to the extent such waiver includes any condition to tender, we or Holdings will waive such condition as to all tendering holders. Our and Holdings’ interpretation of the terms and conditions of the exchange offers, including the instructions in the letter of transmittal, will be final and binding on all parties. Unless waived, any defects or irregularities in connection with tenders of old notes must be cured within the time we or Holdings determine. Although we and Holdings intend to notify holders of defects or irregularities with respect to tenders of old notes, neither we, Holdings, the exchange agent nor any other person will incur any liability for failure to give such notification. Tenders of old

 

28



Table of Contents

 

notes will not be deemed to have been made until the defects or irregularities have been cured or waived. Any old notes received by the exchange agent that are not properly tendered and as to which the defects or irregularities have not been cured or waived will be returned by the exchange agent to the tendering holders, unless otherwise provided in the letter of transmittal, promptly following the expiration date.

 

Guaranteed Delivery Procedures

 

If you wish to tender your old notes but your old notes are not immediately available or you cannot deliver your old notes, the accompanying letter of transmittal and all other required documents to the exchange agent or comply with the procedures under ATOP prior to the expiration date, you may still tender if:

 

·                  the tender is made through an Eligible Guarantor Institution;

 

·                  prior to the expiration date, the exchange agent receives from such Eligible Guarantor Institution either a properly completed and duly executed notice of guaranteed delivery, by facsimile transmission, mail, or hand delivery or a properly transmitted agent’s message and notice of guaranteed delivery, that (1) sets forth your name and address, the certificate number(s) of such old notes and the principal amount of old notes tendered; (2) states that the tender is being made thereby; and (3) guarantees that, within three New York Stock Exchange, Inc. trading days after the expiration date, the letter of transmittal, or facsimile thereof, together with the old notes or a book-entry confirmation, and any other documents required by the letter of transmittal, will be deposited by the Eligible Guarantor Institution with the exchange agent; and

 

·                  the exchange agent receives the properly completed and executed letter of transmittal or facsimile thereof, as well as certificate(s) representing all tendered old notes in proper form for transfer or a book-entry confirmation of transfer of the old notes into the exchange agent’s account at DTC and all other documents required by the letter of transmittal within three New York Stock Exchange, Inc. trading days after the expiration date.

 

Upon request, the exchange agent will send to you a notice of guaranteed delivery if you wish to tender your old notes according to the guaranteed delivery procedures.

 

Withdrawal of Tenders

 

Except as otherwise provided in this prospectus, tenders of old notes may be withdrawn at any time prior to 5:00 p.m., New York City time, on the expiration date.

 

To withdraw a tender of old notes in either of the exchange offers, either a notice of withdrawal must be received by the exchange agent at its address set forth in this prospectus or you must comply with the appropriate withdrawal procedures of DTC’s ATOP. Any notice of withdrawal must be in writing and:

 

(1)          specify the name of the person having deposited the old notes to be withdrawn;

 

(2)          identify the old notes to be withdrawn, including the certificate number(s) and principal amount of the old notes, or, in the case of old notes transferred by book-entry transfer, the name and number of the account at DTC to be credited;

 

(3)          be signed by the holder in the same manner as the original signature on the letter of transmittal by which the old notes were tendered, including any required signature guarantees, or be accompanied by documents of transfer sufficient to have the trustee with respect to the old notes register the transfer of the old notes into the name of the person withdrawing the tender; and

 

(4)          specify the name in which any old notes are to be registered, if different from that of the person depositing the old notes to be withdrawn.

 

All questions as to the validity, form and eligibility, including time of receipt, of withdrawal notices will be determined by us or Holdings, as applicable, in our or its sole discretion, which determination will be final and binding on all parties. Any old notes so withdrawn will be deemed not to have been validly tendered for purposes of the exchange offers and no exchange notes will be issued with respect thereto unless the old notes so withdrawn are validly retendered. Any old notes which have been tendered but which are not accepted for exchange will be returned to the holder thereof without cost to the holder as promptly as practicable after withdrawal, rejection of tender or termination of the exchange offers.  Properly withdrawn old notes may be retendered by following one of the procedures described above under “—Procedures for Tendering Old Notes” at any time prior to the expiration date.

 

Conditions to the Exchange Offers

 

Notwithstanding any other provision of the exchange offers, or any extension of the exchange offers, we and Holdings will not be required to accept for exchange, or to issue exchange notes in exchange for, any outstanding old notes and may

 

29



Table of Contents

 

terminate the exchange offers (whether or not any old notes have been accepted for exchange) or amend the exchange offers, if any of the following conditions has occurred or exists or has not been satisfied, or has not been waived by us or Holdings in our or its sole reasonable discretion, prior to the expiration date:

 

·                  there is instituted or pending any action or proceeding before, or any injunction, order or decree issued by, any court or governmental agency or other governmental regulatory or administrative agency or commission:

 

(1)          seeking to restrain or prohibit the making or completion of the exchange offers or any other transaction contemplated by the exchange offers, or assessing or seeking any damages as a result of this transaction; or

 

(2)          resulting in a material delay in our or Holdings’ ability to accept for exchange or exchange some or all of the old notes in the exchange offers; or

 

(3)          any statute, rule, regulation, order or injunction has been sought, introduced, enacted, promulgated or deemed applicable to the exchange offers or any of the transactions contemplated by the exchange offers by any governmental authority, domestic or foreign; or

 

·                  any action has been taken by any governmental authority, domestic or foreign, that, in our or Holdings’, as applicable, sole reasonable judgment, would directly or indirectly result in any of the consequences referred to in clauses (1), (2) or (3) above or, in our or Holdings’, as applicable, sole reasonable judgment, would result in the holders of exchange notes having obligations with respect to resales and transfers of exchange notes which are greater than those described in the interpretation of the SEC referred to above, or would otherwise make it inadvisable to proceed with the exchange offers; or the following has occurred:

 

(1)          any general suspension of or general limitation on prices for, or trading in, securities on any national securities exchange or in the over-the-counter market; or

 

(2)          any limitation by a governmental authority which adversely affects our or Holdings’ ability to complete the transactions contemplated by the exchange offers; or

 

(3)          a declaration of a banking moratorium or any suspension of payments in respect of banks in the United States or any limitation by any governmental agency or authority which adversely affects the extension of credit; or

 

(4)          a commencement of a war, armed hostilities or other similar international calamity directly or indirectly involving the United States, or, in the case of any of the preceding events existing at the time of the commencement of the exchange offers, a material acceleration or worsening of these calamities; or

 

·                  any change or any development has occurred in our or Holdings’ business, financial condition, operations or prospects and those of our or its subsidiaries taken as a whole that is or may be adverse to us or Holdings, or we or Holdings have become aware of facts that have or may have an adverse impact on the value of the old notes or the exchange notes, which in our or Holdings’ sole reasonable judgment in any case makes it inadvisable to proceed with the exchange offers and/or with such acceptance for exchange or with such exchange; or

 

·                  there shall occur a change in the current interpretation by the staff of the SEC which permits the exchange notes issued pursuant to the exchange offers in exchange for old notes to be offered for resale, resold and otherwise transferred by holders thereof (other than broker-dealers and any such holder which is our affiliate within the meaning of Rule 405 under the Securities Act) without compliance with the registration and prospectus delivery provisions of the Securities Act, provided that such exchange notes are acquired in the ordinary course of such holders’ business and such holders have no arrangement or understanding with any person to participate in the distribution of such exchange notes; or

 

·                  any law, statute, rule or regulation shall have been adopted or enacted which, in our or Holdings’ reasonable judgment, would impair our ability to proceed with the exchange offers; or

 

·                  a stop order shall have been issued by the SEC or any state securities authority suspending the effectiveness of the registration statement, or proceedings shall have been initiated or any governmental approval has not been obtained, which approval we or Holdings, as applicable, shall, in our or its sole reasonable discretion, deem necessary for the consummation of the exchange offers as contemplated hereby; or

 

·                  we or Holdings have received an opinion of counsel experienced in such matters to the effect that there exists any actual legal impediment (including a default under an agreement, indenture or

 

30



Table of Contents

 

other instrument or obligation to which we or Holdings are a party or by which we or Holdings are bound) to the consummation of the transactions contemplated by the exchange offers.

 

If we or Holdings determine in our or its sole reasonable discretion that any of the foregoing events or conditions has occurred or exists or has not been satisfied, we or Holdings may, subject to applicable law, terminate the applicable exchange offer (whether or not any old notes have been accepted for exchange) or may waive any such condition or otherwise amend the terms of the exchange offers in any respect. If such waiver or amendment constitutes a material change to the exchange offers, we or Holdings will promptly disclose such waiver or amendment by means of a prospectus supplement that will be distributed to the registered holders of the old notes and will extend the exchange offers to the extent required by Rule 14e-1 promulgated under the Exchange Act and to ensure that the exchange offers remain open for at least five business days following such disclosure.

 

These conditions are for our and Holdings’ sole benefit and we or Holdings may assert them regardless of the circumstances giving rise to any of these conditions, or we or Holdings may waive them, in whole or in part, in our or its sole reasonable discretion, provided that we or Holdings will not waive any condition with respect to an individual holder of old notes unless we or Holdings waive that condition for all such holders. Any reasonable determination made by us or Holdings concerning an event, development or circumstance described or referred to above will be final and binding on all parties. Our or Holdings’ failure at any time to exercise any of the foregoing rights will not be a waiver of our or its rights and each such right will be deemed an ongoing right which may be asserted at any time before the expiration of the exchange offers.

 

Exchange Agent

 

We have appointed The Bank of New York Mellon Trust Company, N.A. as the exchange agent for the exchange offers. You should direct questions or requests for assistance with respect to the tender procedures, and requests for additional copies of this prospectus, the accompanying letter of transmittal and notices of guaranteed delivery to the exchange agent addressed as follows:

 

THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A., EXCHANGE AGENT

 

By mail, hand delivery or overnight courier:

 

Bank of New York Mellon Corporation

Corporate - Reorganization Unit

Attention:  Carolle Montreuil

480 Washington Boulevard - 27th Floor

Jersey City, NJ 07310

 

For Information Call:

 

(212) 815-5920

 

For facsimile transmission (for eligible institutions only):

 

(212) 298-1915

 

Confirm by Telephone:

 

(212) 815-5920

 

Delivery to an address other than set forth above will not constitute a valid delivery.

 

Fees and Expenses

 

We and Holdings will pay the exchange agent customary fees for its services, reimburse the exchange agent for its reasonable out-of-pocket expenses incurred in connection with the provisions of these services and pay other registration expenses, including registration and filing fees, fees and expenses of compliance with federal securities and state blue sky securities laws, printing expenses, messenger and delivery services and telephone, fees and disbursements to our counsel, application and filing fees and any fees and disbursements to our independent certified public accountants. Neither we nor Holdings will make any payment to brokers, dealers, or others soliciting acceptances of the exchange offers except for reimbursement of mailing expenses.

 

Additional solicitations may be made by telephone, facsimile or in person by our and our affiliates’ officers, employees and by persons so engaged by the exchange agent.

 

31



Table of Contents

 

Accounting Treatment

 

The exchange notes will be recorded at the same carrying value as the existing old notes, as reflected in our and Holdings’ accounting records on the date of exchange. Accordingly, neither we nor Holdings will recognize any gain or loss for accounting purposes. The expenses of the exchange offers will be capitalized and expensed over the term of the exchange notes.

 

Transfer Taxes

 

If you tender outstanding old notes for exchange you will not be obligated to pay any transfer taxes. However, if you instruct us to register exchange notes in the name of, or request that your old notes not tendered or not accepted in the exchange offers be returned to, a person other than the registered tendering holder, you will be responsible for paying any transfer tax owed.

 

You May Suffer Adverse Consequences if you Fail to Exchange Outstanding Old Notes

 

If you do not tender your outstanding old notes, you will not have any further registration rights and your old notes will continue to be subject to the provisions of the respective indentures governing the notes regarding transfer and exchange of the old notes and the restrictions on transfer of the old notes imposed by the Securities Act and states securities laws when we and Holdings complete the exchange offers. These transfer restrictions are required because the old notes were issued under an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws. Accordingly, if you do not tender your old notes in the exchange offers, your ability to sell your old notes could be adversely affected. Once we and Holdings have completed the exchange offers, holders who have not tendered notes will not continue to be entitled to any increase in interest rate that the Registration Rights Agreements and indentures governing the notes provide for if we do not complete the exchange offers.

 

Consequences of Failure to Exchange

 

The old notes that are not exchanged for exchange notes pursuant to the exchange offers will remain restricted securities. Accordingly, the old notes may be resold only:

 

(1)          to us or Holdings, as applicable, upon redemption thereof or otherwise;

 

(2)          so long as the outstanding securities are eligible for resale pursuant to Rule 144A under the Securities Act, to a person inside the United States who is a qualified institutional buyer within the meaning of Rule 144A in a transaction meeting the requirements of Rule 144A, in accordance with Rule 144 under the Securities Act, or pursuant to another exemption from the registration requirements of the Securities Act, which other exemption is based upon an opinion of counsel reasonably acceptable to us;

 

(3)          outside the United States to a foreign person in a transaction meeting the requirements of Rule 904 under the Securities Act; or

 

(4)          pursuant to an effective registration statement under the Securities Act, in each case in accordance with any applicable securities laws of any state of the United States.

 

32



Table of Contents

 

USE OF PROCEEDS

 

The exchange offers are intended to satisfy our obligations under the Registration Rights Agreements. We will not receive any cash or other proceeds from the issuance of the exchange notes. The old notes properly tendered and exchanged for exchange notes will be retired and cancelled. Accordingly, no additional debt will result from the exchange. We have agreed to bear the expense of the exchange offers.

 

33



Table of Contents

 

CAPITALIZATION

 

The following table sets forth the consolidated capitalization of Guitar Center and of Holdings as of March 31, 2011.  The exchange offers will not affect such capitalization on a pro forma basis because the exchange will not change the amount of outstanding indebtedness of Guitar Center or Holdings.  This table should be read in conjunction with “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and the accompanying notes thereto included elsewhere in this registration statement.

 

 

 

As of March 31, 2011

 

 

 

Guitar Center
(unaudited)

 

Holdings
(unaudited)

 

 

 

(dollars in millions)

 

Cash

 

$

197.4

 

$

197.4

 

Debt, including current maturities:

 

 

 

 

 

Senior secured credit facilities:

 

 

 

 

 

Term loan facility

 

621.8

 

621.8

 

Asset-based revolving credit facility (1)

 

 

 

Senior notes due 2017

 

375.0

 

375.0

 

Senior PIK notes due 2018

 

 

564.7

 

Other (2)

 

1.1

 

1.1

 

Total debt

 

997.9

 

1,562.6

 

Total stockholders’ equity

 

277.4

 

146.4

 

Total capitalization

 

$

1,342.0

 

$

1,906.4

 

 


(1)          The asset-based revolving credit facility has a maximum borrowing capacity of $373 million, of which $120 million matures in 2013 and $253 million matures in 2016.  See our audited consolidated financial statements and unaudited condensed consolidated interim financial statements and the notes thereto included elsewhere in this registration statement.

 

(2)          Consists of a capital lease obligation, of which $0.6 million was recorded as a current liability as of March 31, 2011.

 

34



Table of Contents

 

SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION

 

The following table sets forth our selected historical consolidated financial data for the periods and at the dates indicated. We derived the selected historical financial data as of December 31, 2009 and 2010 and for the years ended December 31, 2008, 2009 and 2010 from our audited historical consolidated financial statements included elsewhere in this registration statement.  We derived the selected historical financial data as of December 31, 2006, 2007 and 2008, and for the year ended December 31, 2006 and the periods from January 1, 2007 to October 9, 2007 and from October 10, 2007 to December 31, 2007 from our audited historical consolidated financial statements not included in this registration statement. We derived the selected historical financial data as of and for the three months ended March 31, 2010 and 2011 from our unaudited historical consolidated financial statements included in this registration statement, and those financial statements include, in our management’s opinion, all adjustments, consisting only of normal and recurring adjustments, necessary to fairly state the consolidated results of operations and consolidated financial condition of our business for those periods. Our historical results included below and elsewhere in this registration statement are not necessarily indicative of our future performance.

 

The following selected financial data should be read in conjunction with “Management’s discussion and analysis of financial condition and results of operations” and our consolidated financial statements and the accompanying notes thereto included elsewhere in this registration statement. Our historical results are not necessarily indicative of the results to be expected in any future period.  Amounts in tables may not add due to rounding.

 

Financial data of Holdings, except where otherwise indicated

 

 

 

Predecessor (1)

 

Successor

 

Successor

 

 

 

Year ended
December 31,

 

Period from
January 1,
2007 to
October 9,

 

Period from
October 10,
2007 to
December 31,

 

Year ended December 31,

 

Three months
ended March 31,

 

(Dollars in millions)

 

2006

 

2007 (2)

 

2007 (2)

 

2008

 

2009

 

2010

 

2010

 

2011

 

Income statement data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

2,030.0

 

$

1,620.0

 

$

631.5

 

$

2,228.6

 

$

2,004.2

 

$

2,010.9

 

$

487.4

 

$

502.8

 

Gross profit

 

594.0

 

461.6

 

174.8

 

631.0

 

589.4

 

605.9

 

149.0

 

156.1

 

Operating income (loss)

 

49.4

 

24.5

 

26.2

 

(202.2

)

(87.9

)

59.7

 

18.6

 

20.6

 

Net income (loss)

 

0.4

 

6.3

 

(8.0

)

(219.5

)

(189.9

)

(56.4

)

(11.0

)

(11.5

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance sheet data (at end of period):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

927.5

 

 

 

2,702.2

 

2,318.1

 

2,140.1

 

2,120.7

 

2,120.7

 

2,119.2

 

Long-term debt

 

1.4

 

 

 

1,479.9

 

1,450.4

 

1,490.9

 

1,562.1

 

1,490.7

 

1,562.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other financial data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

36.8

 

34.8

 

24.4

 

137.0

 

113.8

 

104.9

 

26.3

 

25.3

 

Capital expenditures (3)

 

84.4

 

50.8

 

16.5

 

39.4

 

45.2

 

47.9

 

7.0

 

9.0

 

Adjusted EBITDA (4)

 

187.0

 

119.0

 

55.9

 

191.7

 

179.3

 

184.3

 

48.9

 

49.0

 

Guitar Center total debt

 

103.3

 

160.7

 

1,107.0

 

1,028.9

 

1,018.9

 

998.1

 

998.6

 

997.9

 

Holdings total debt

 

 

 

375.0

 

430.0

 

492.8

 

564.7

 

492.8

 

564.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other operating data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Guitar Center stores at beginning of period

 

161

 

198

 

213

 

214

 

214

 

214

 

214

 

214

 

Opened Guitar Center stores

 

37

 

15

 

1

 

 

 

 

 

2

 

Closed Guitar Center stores

 

 

 

 

 

 

 

 

 

Guitar Center stores at end of period

 

198

 

213

 

214

 

214

 

214

 

214

 

214

 

216

 

 

35



Table of Contents

 


(1)          On October 9, 2007, Guitar Center merged with an entity substantially owned by affiliates of Bain Capital.  In connection with the merger, Holdings acquired all of the outstanding capital stock of the predecessor for aggregate cash consideration of approximately $1.9 billion. Holdings, which is substantially owned by affiliates of Bain Capital, owns 100% of the stock of Guitar Center.

 

(2)          For 2007, historical financial results for the predecessor and successor are presented separately. The separate presentation is required because there was a change in accounting basis when purchase accounting was applied in the Transactions.  Purchase accounting requires that the historical carrying value of assets acquired and liabilities assumed be adjusted to fair value.  Operating results may not be comparable on a period-to-period basis due to the different cost basis resulting from allocation of the purchase price.

 

(3)          Capital expenditures include additions to our property, plant, and equipment and do not include any expenditures to add to our rental instruments inventory.

 

(4)          The following table discloses Holdings’ EBITDA (earnings before interest, taxes, depreciation and amortization) and Adjusted EBITDA (EBITDA adjusted for other items described below), which are non-GAAP financial measures. Generally, a non-GAAP financial measure is a numerical measure of a company’s performance, financial position or cash flows that either excludes or includes amounts that are not normally included or excluded in the most directly comparable measure calculated and presented in accordance with GAAP. EBITDA and Adjusted EBITDA do not represent and should not be considered as alternatives to net income or cash flow from operations, as determined under GAAP. We believe that EBITDA and Adjusted EBITDA provide investors with helpful information with respect to our operations and cash flows. We included EBITDA and Adjusted EBITDA to provide additional information with respect to our ability to meet our future debt service, capital expenditures and working capital requirements.

 

In addition, we present Adjusted EBITDA because it is based on “Consolidated Adjusted EBITDA”, a measure which is used in calculating financial ratios in several material debt covenants in our asset-based credit facility.  Borrowings under the asset-based credit facility are a key source of liquidity and our ability to borrow under this facility depends upon, among other things, our compliance with such financial ratio covenants.  Adjusted EBITDA is defined as EBITDA adjusted to exclude non-cash items and certain other adjustments to consolidated net income permitted under our debt agreements.  We believe the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA is appropriate to provide additional information to investors about how the covenants in our debt agreements operate and about certain non-cash items, items that we do not expect to continue at the same level and other items.  The material covenants in our debt agreements are discussed in “Description of Certain Other Indebtedness,” “Description of Senior Exchange Notes,” and “Description of Senior PIK Exchange Notes.”

 

EBITDA and Adjusted EBITDA have limitations as analytical tools, and you should not consider them either in isolation or as substitutes for analyzing our results as reported under GAAP. Some of these limitations are:

 

·                  EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;

 

·                  EBITDA and Adjusted EBITDA do not reflect our interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

·                  EBITDA and Adjusted EBITDA do not reflect our tax expense or the cash requirements to pay our taxes;

 

·                  EBITDA and Adjusted EBITDA do not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments;

 

·                  although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; and

 

·                  other companies in our industry may calculate EBITDA and Adjusted EBITDA differently, limiting their usefulness as comparative measures.

 

The following table summarizes the calculation of Holdings’ historical EBITDA and Adjusted EBITDA and provides a reconciliation to net income (loss) for the periods indicated:

 

36



Table of Contents

 

 

 

Predecessor

 

Successor

 

Successor

 

 

 

Year ended
December 31,

 

Period from
January 1,
2007 to
October 9,

 

Period from
October 10,
2007 to
December 31,

 

Year ended December 31,

 

Three months
ended March 31,

 

(Dollars in millions)

 

2006

 

2007

 

2007

 

2008

 

2009

 

2010

 

2010

 

2011

 

Net income (loss)

 

$

0.4

 

$

6.3

 

$

(8.0

)

$

(219.5

)

$

(189.9

)

$

(56.4

)

$

(11.0

)

$

(11.5

)

Interest expense, net of interest income

 

8.4

 

7.3

 

38.5

 

148.1

 

137.0

 

145.2

 

35.5

 

38.4

 

Income tax expense (benefit)

 

40.6

 

11.4

 

(4.1

)

(130.6

)

(35.1

)

(29.1

)

(5.9

)

(6.3

)

Depreciation and amortization

 

36.8

 

34.8

 

24.4

 

137.0

 

113.8

 

104.9

 

26.3

 

25.3

 

EBITDA

 

86.2

 

59.7

 

50.8

 

(65.1

)

25.9

 

164.6

 

44.9

 

45.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjustments to EBITDA

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-cash charges (a)

 

19.7

 

34.5

 

1.2

 

5.3

 

4.6

 

5.2

 

1.0

 

1.1

 

Impairment charges

 

80.2

 

 

 

234.6

 

135.7

 

0.9

 

 

 

Non-recurring charges (b)

 

 

22.9

 

2.5

 

6.3

 

5.4

 

1.3

 

1.3

 

1.0

 

Other adjustments (c)

 

0.9

 

2.0

 

1.4

 

10.6

 

7.8

 

12.4

 

1.7

 

1.0

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

187.0

 

$

119.0

 

$

55.9

 

$

191.7

 

$

179.3

 

$

184.3

 

$

48.9

 

$

49.0

 

 


Adjustments in the calculation of Adjusted EBITDA include the following:

 

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

 

Stock-based compensation for the predecessor periods includes compensation expense recognized on stock option awards, employee share purchase program and restricted stock awards.  Stock-based compensation for the successor periods includes compensation expense recognized on stock option awards.

 

Non-cash rent expense represents the difference between cash rent expense and GAAP rent expense, which includes a non-cash amount due to the straight-line recording of rent expense, and cash received for tenant improvements. Under GAAP, cash received for tenant improvements is amortized and reduces reported rent expense over the term of the lease. In purchase accounting, the amortization of historical cash received for tenant improvement is eliminated. Our adjustment eliminates the historical amortization of the tenant allowances and replaces it with the cash received for such allowances in each period.

 

(b)         Non-recurring charges include various debt and financing costs, reorganization expenses and special charges.

 

Non-recurring charges in 2007 include third-party costs, primarily legal fees, related to our acquisition by Bain Capital in 2007, an exchange of our long-term debt in 2008 and amendments and extensions of our credit facilities in 2011.

 

Non-recurring charges in 2009  include $1.3 million of consulting and other transition expenses related to outsourcing certain information technology functions.

 

Special charges in 2009 include a $3.9 million sales tax audit settlement.

 

(c)          Other adjustments include severance payments, accrued bonuses under our long term management incentive plan, gains and losses on disposal of assets and management fees paid to Bain Capital.

 

37



Table of Contents

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with “Selected Historical Consolidated Financial Information” and our consolidated financial statements and related notes included elsewhere in this registration statement.

 

The following discussion, as well as other portions of this registration statement, contains forward-looking statements that reflect our plans, estimates and beliefs. Any statements (including, but not limited to, statements to the effect that we or our management “anticipate,” “plan,” “estimate,” “expect,” “believe,” “intend,” and other similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this registration statement. Specific examples of forward-looking statements include, but are not limited to, statements regarding our forecasts of financial performance, capital expenditures, working capital requirements and forecasts of effective tax rate. Our actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this registration statement, and particularly in “Risk Factors.” Amounts shown in the tables below are generally rounded.  Therefore, discrepancies in the tables between totals and the sum of the amounts listed may occur.

 

Overview

 

We are the leading retailer of music products in the United States, based on revenue. We operate three reportable business segments: Guitar Center, direct response and Music & Arts.  Our Guitar Center segment offers guitars, amplifiers, percussion instruments, keyboards and pro audio and recording equipment through our retail stores and online, along with repair services and rehearsal and/or lesson space in a limited number of stores. Our direct response segment brands offer catalog and online sales of a broad selection of music products under several brand names, including Musician’s Friend, Music123 and Woodwind & Brasswind. Our Music & Arts segment offers band and orchestra instruments for rental and sale, music lessons and a limited selection of products of the type offered by our Guitar Center segment.

 

As of March 31, 2011, our wholly owned retail subsidiary operated 216 Guitar Center stores in 42 states and 99 Music & Arts stores in 19 states. As of March 31, 2011, our Guitar Center stores consisted of 141 primary format stores, 72 secondary format stores and three tertiary format stores. The store format is determined primarily by the size of the market in which it is located. Our primary format stores serve major metropolitan population centers and generally range in size from 13,000 to 30,000 square feet. Our secondary format stores serve metropolitan areas not served by our primary format stores and generally range in size from 8,000 to 14,000 square feet.  Tertiary market stores serve smaller population centers and are approximately 5,000 square feet.

 

History

 

Guitar Center was founded in 1964 in Hollywood, California. Our flagship Hollywood store 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. We believe 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 musical instrument retailer. Musician’s Friend is the largest direct response retailer of music products in the United States, through both its catalogs and e-commerce websites.

 

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

 

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 music products. We refer to these businesses as “Woodwind & Brasswind” and “Music123.”

 

Acquisition by Bain Capital, LLC

 

On October 9, 2007, Guitar Center merged with an entity substantially owned by affiliates of Bain Capital.  In connection with the merger, Holdings acquired all of the outstanding capital stock of the predecessor for aggregate cash consideration of approximately $1.9 billion. Holdings, which is substantially owned by affiliates of Bain Capital, owns 100% of the stock of Guitar Center.

 

38



Table of Contents

 

Purchase accounting

 

Our consolidated financial statements for the periods following the acquisition vary in important respects from the historical consolidated financial statements for periods prior to the acquisition. We accounted for the acquisition using the purchase method of accounting.  As a result, the purchase price for the Guitar Center business (including estimated transaction expenses) was allocated to the tangible and intangible assets acquired and liabilities assumed based upon their respective fair values as of the date of the acquisition. The excess of the purchase price over these allocations was assigned to goodwill, which is not amortized for accounting purposes but is subject to testing for impairment at least annually.

 

The allocation of the purchase price of the assets acquired in the acquisition resulted in increased amortization and depreciation expense relating to our intangible assets and operating assets, because we recorded the intangible assets at fair value and adjusted the book value of our tangible assets to fair value. We extended the remaining depreciable lives of our operating assets to reflect the estimated useful lives for purposes of calculating periodic depreciation, and we are amortizing definite-lived intangible assets over their estimated useful lives. We also adjusted the book value of inventory to fair value, which increased the costs and expenses recognized by us upon the sale of this inventory.

 

Increased leverage

 

We are highly leveraged and interest expense significantly affects our net income.  Holdings assumed $1,548 million of indebtedness in connection with the acquisition and as of March 31, 2011, Holdings’ aggregate indebtedness was $1,562.6 million.

 

Our indebtedness may limit our flexibility in planning for, or reacting to, changes in our business and future business opportunities since a substantial portion of our cash flow from operations will be dedicated to the repayment of debt, and this may place us at a competitive disadvantage to some of our competitors that may be less leveraged. Our leverage may make us more vulnerable to a downturn in our business, industry or the economy in general. See “Risk Factors—Our and Holdings’ level of indebtedness could adversely affect our and Holdings’ ability to raise capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from fulfilling our obligations under the notes.”

 

Important factors affecting our operating results and financial condition

 

We believe that a number of key revenue and cost factors are significant to understanding the operation of our business. Our business also is influenced by general economic and retail industry conditions, as well as trends in the music products industry.

 

Revenue and cost factors

 

·                  Guitar Center store growth. A significant factor affecting the operating results of our Guitar Center business is our rate of store growth. We grew quickly during the period between January 1, 2005 and December 31, 2007, with over one-third of our Guitar Center stores being opened or acquired during that period.  The high level of capital expenditures and related working capital requirements we incurred in connection with opening these stores, coupled with the lower sales of these less mature stores, had a negative impact on our short-term operating results.  During the period from January 1, 2008 to December 31, 2010, we did not open any new stores in order to focus on development of our store management and sales force and to allow existing new stores to reach mature sales levels.  Having largely achieved these objectives, we plan to open approximately 10 to 15 new stores per year beginning in 2011.

 

·                  Store maturity. New stores generally take a number of years to reach what we consider mature sales levels. We generally expect our primary format and secondary format stores to reach mature sales levels in approximately four years and three years, respectively.

 

·                  New store expenses. The initial capital expenditures we target in opening new stores are approximately $1.3 million for primary format stores and $1.1 million for secondary format stores. In addition, we target initial inventory requirements for new stores at $1.1 million to $1.2 million for primary format stores and $0.9 million to $1.0 million for secondary format stores. We also incur costs to hire and train store personnel and to link our new stores to our distribution and support systems. Outside of opening new stores, our business historically has required relatively low maintenance capital expenditures.

 

·                  Proprietary products. Our Guitar Center stores’ operating profit is affected by the mix of products we sell. In particular, our average gross selling margin for our proprietary products is significantly higher than for branded products in corresponding categories. Part of our business strategy is to further develop our proprietary products to take advantage of this greater profitability. Our proprietary products sales have grown from 7.4% of our net sales in 2006 to 12.3% of our net sales in 2010. We endeavor to strike a balance between expanding our proprietary products and maintaining good relationships with our vendors who offer competing brand name products.

 

39



Table of Contents

 

·                  Online marketing. Our direct response business is primarily focused on online sales of our products, although our catalogs remain an important marketing tool. In addition, our online channels for Guitar Center and Music & Arts are becoming increasingly important sales channels.  We must act quickly to respond to online marketing trends, and we incur significant costs to upgrade our infrastructure to respond to these trends. During 2009 and 2010, we invested significant capital in developing a sophisticated internal search and comparison shopping engine that we believe improved user functionality and enhanced search capability. In 2010 and continuing in 2011, we are developing enhanced capabilities for our Guitar Center online channel to allow our customers more flexibility to purchase products that can be picked up in-store, delivered from retail store locations or shipped directly to the customer.

 

·                  Music & Arts efficiencies. In recent years, we have focused on improving the operational efficiencies of and reducing working capital requirements of our Music & Arts segment. Among other things, we have reduced selling, general and administrative expenses for this business and made operational changes to achieve better returns on our rental inventory fleet.  We do not expect significant growth in this segment in the near term, but our long-term strategy includes opening new stores and acquiring businesses within this fragmented market and integrating them with our Music & Arts business.

 

Economic and demographic factors

 

·                  Discretionary spending. We believe that our Guitar Center customers comprise a mix of professional and aspiring professional musicians, novice musicians and hobbyists.  We believe that professional and aspiring professional musicians view their purchases as a career necessity and these sales are less sensitive to general retail economic trends. However, a significant portion of sales to other customer groups in our Guitar Center and other businesses depends on discretionary spending by consumers. We expect that overall consumer confidence and discretionary spending will continue to have a significant impact on our sales.

 

·                  Market saturation. From 1997 to 2006, our revenue grew significantly through the addition of new Guitar Center stores and through acquisitions.  As a result, there are fewer remaining unsaturated large population centers in the United States where we could open new primary format stores.  We believe new store growth is likely to include a greater proportion of secondary and tertiary format stores, which typically deliver lower operating margins than our primary format stores.

 

Results of operations

 

The following table sets forth the various components of consolidated statements of operations for the periods indicated, expressed as a percentage of net sales.

 

 

 

Year ended
December 31,

 

Three months ended
March 31,

 

 

 

2008

 

2009

 

2010

 

2010

 

2011

 

Net sales

 

100.0

%

100.0

%

100.0

%

100.0

%

100.0

%

Gross profit

 

28.3

 

29.4

 

30.1

 

30.6

 

31.0

 

Selling, general and administrative expenses

 

27.1

 

27.1

 

27.2

 

26.8

 

26.9

 

Impairment of goodwill and other intangible assets

 

10.3

 

6.7

 

 

 

 

Operating income (loss)

 

(9.1

)

(4.4

)

3.0

 

3.8

 

4.1

 

Interest expense, net of interest income

 

6.6

 

6.8

 

7.2

 

7.3

 

7.6

 

(Loss) before income taxes

 

(15.7

)

(11.2

)

(4.3

)

(3.5

)

(3.5

)

Income tax (benefit)

 

(5.9

)

(1.7

)

(1.4

)

(1.2

)

(1.3

)

Net loss

 

(9.9

)

(9.5

)

(2.8

)

(2.3

)

(2.3

)

 

Segment operating results

 

Beginning in the first quarter of 2011, we reorganized our operating segments to emphasize a brand reporting structure.  We had previously defined our operating segments by sales or fulfillment channel, whether through our Guitar Center retail stores, internet and catalog direct response business or the rental-focused Music & Arts retail stores. As a result of this change, the Guitar Center segment includes the sales and operating expenses of our Guitar Center online operations as well as our Guitar Center stores. Similarly, the Music & Arts segment includes the sales and operating expenses of our Music & Arts online operations as well as our Music & Arts stores.  We had previously reported the results of our Guitar Center and Music & Arts online operations with the direct response segment.

 

40



Table of Contents

 

Three months ended March 31, 2011 compared to the three months ended March 31, 2010

 

Net sales

 

Consolidated net sales for the three months ended March 31, 2011 increased 3.2% to $502.8 million, compared to $487.4 million for the same period in 2010.

 

Net sales from the Guitar Center segment for the three months ended March 31, 2011 totaled $363.8 million, an increase of 3.7% from $351.0 for the same period in 2010.  Two new stores were opened during the first quarter of 2011 which contributed $1.4 million in sales.  Comparable retail store sales increased 3.0% and sales from our Guitar Center online operations increased 7.5% compared to the same period in 2010.

 

Net sales from direct response for the three months ended March 31, 2011 totaled $97.3 million, an increase of 1.9% from $95.5 million for the same period in 2010.  We experienced sales increases in both catalog and online sales.  In the first quarter of 2011, gross sales increased $3.2 million compared to the same period in 2010 while shipping and handling revenue decreased $1.1 million. We began offering free shipping on most orders on our Musician’s Friend website in the fourth quarter of 2010 to better compete with other e-commerce retailers.  Our direct response segment continues to face increasing competition as established online retailers add musical instruments to their product offerings. We expect this competition to affect direct response’s net sales and gross profit for the foreseeable future.

 

Net sales from Music & Arts for the three months ended March 31, 2011 totaled $41.7 million, an increase of 1.7% from $41.0 million for the same period in 2010.  Sales increased at our retail stores and our Music & Arts online operations.

 

Gross profit

 

Consolidated gross profit for the three months ended March 31, 2011 increased 4.8% to $156.1 million, compared to $149.0 for the same period in 2010. Gross profit as a percentage of net sales for the three months ended March 31, 2011 increased to 31.0% from 30.6% for the same period in 2010.

 

Gross profit margin for our Guitar Center segment was 29.4% for the three months ended March 31, 2011 compared with 28.8% for the same period in 2010.  The increase was primarily due to lower occupancy costs of 0.5% and increased selling margin of 0.3%, partially offset by lower gift card breakage of 0.2%.  Occupancy costs decreased primarily due to lower depreciation expense, reflecting the slower pace of capital expenditures on store remodels and relocations.  The increase in selling margin was driven by product mix and pricing.

 

Gross profit margin for direct response was 28.2% for the three months ended March 31, 2011 compared to 28.7% for the same period in 2010. The decrease was primarily due to higher freight costs of 0.4% and lower selling margin of 0.2%. Selling margin was affected by free customer shipping and competition.  Freight costs increased as a percentage of net sales due to rising fuel surcharges and the effect of free customer shipping.

 

Gross profit margin for Music & Arts was 52.3% for the three months ended March 31, 2011 compared to 50.2% for the same period in 2010. The increase was primarily due to higher selling margin of 1.6% and lower shrink expense of 0.3%.  Selling margin on instrument sales and rentals benefited from better pricing from certain key vendors and efficient utilization of rental inventory.  Shrink expense decreased due to operational improvements in inventory control.

 

Selling, general and administrative expenses

 

Consolidated selling, general and administrative expenses of Holdings for the three months ended March 31, 2011 increased 3.9% to $135.5 million, compared to $130.4 million for the same period in 2010.  As a percentage of net sales, selling, general and administrative expenses for the three months ended March 31, 2011 increased to 26.9% from 26.8% for the same period in 2010. The increase was primarily due to higher advertising costs, expenses related to the modification of our long-term debt and increasing group medical expenses, partially offset by lower taxes and licenses resulting from a sales tax audit assessment in the prior year.

 

Consolidated selling, general and administrative expenses of Guitar Center for the three months ended March 31, 2011 were $135.2 million, compared to $130.4 million for the same period in 2010.  The difference between Holdings and Guitar Center selling, general and administrative expenses relates to debt modification expenses incurred by Holdings.

 

Selling, general and administrative expenses for the Guitar Center segment for the three months ended March 31, 2011 were 23.5% of segment net sales compared to 24.1% for the same period in 2010. The decrease was primarily due to lower taxes and licenses expense of 0.4% and lower amortization expense on intangible assets of 0.3%, partially offset by smaller increases in credit card fees and grand opening costs.  Taxes and licenses expense decreased due to final settlement of a sales tax audit during the first quarter of 2010. Amortization expense decreased on our customer relationship intangible assets.

 

41



Table of Contents

 

Selling, general and administrative expenses for direct response for the three months ended March 31, 2011 were 28.1% of segment net sales compared to 25.8% for the same period in 2010. The increase was primarily due to higher advertising expense of 1.6%, higher compensation expense of 0.6% and higher recruiting and relocation expenses of 0.3%, partially offset by lower bad debt expense of 0.3%.  Advertising expense increased primarily due to greater use of pay-per-click and digital advertising tactics compared to the prior year period.  The increase in compensation, recruiting and relocation expenses are primarily due to increased headcount in management and administrative positions compared to the prior year period bad debt expense decreased due to the recovery of aged commercial accounts receivable.

 

Selling, general and administrative expenses for Music & Arts for the three months ended March 31, 2011 were 38.3% of segment net sales compared to 37.6% for the same period in 2010.  The increase was primarily due to higher compensation expenses of 0.2%.  Music & Arts also experienced increases in group medical expenses, advertising expense and operating costs for the www.musicarts.com website.  Compensation expenses was higher due to headcount increases primarily in sales and marketing, increased payroll costs related to supporting the growth of the online business and higher payroll tax rates compared to the prior year.

 

Operating income (Holdings)

 

Consolidated operating income for the three months ended March 31, 2011 increased 10.8% to $20.6 million, compared to $18.6 million for the same period in 2010. As a percentage of net sales, consolidated operating income for the three months ended March 31, 2011 increased to 4.1%, compared to 3.8% for the same period in 2010.

 

Operating income (Guitar Center)

 

Consolidated operating income for the three months ended March 31, 2011 increased 12.3% to $20.9 million, compared to $18.6 million for the same period in 2010. As a percentage of net sales, consolidated operating income for the three months ended March 31, 2011 increased to 4.2%, compared to 3.8% for the same period in 2010.

 

Interest expense (Holdings)

 

Net interest expense for Holdings for the three months ended March 31, 2011 increased 8.2% to $38.4 million, compared to $35.5 million for the same period in 2010.  The increase was due to the addition of accrued interest to the outstanding principal on our old senior PIK notes.  In accordance with the senior PIK notes, accrued interest payable semi-annually from April 2008 to October 2010 was permitted to be deferred and added to the outstanding principal balance. We elected to defer the interest payment and increase the principal balance on the old senior PIK notes for each of those periods.

 

Interest expense (Guitar Center)

 

Net interest expense for Guitar Center for the three months ended March 31, 2011 increased 2.2% to $18.4 million, compared to $18.0 million for the same period in 2010.  The increase was primarily due to increases in the LIBOR index rate on our floating-rate term loan.

 

Income tax benefit (Holdings)

 

Income tax benefit for the three months ended March 31, 2011 was $6.3 million, compared to $5.9 million for the same period in 2010. The effective tax rate for the first quarter of 2011 was 35.6% compared to 34.9% in the prior year period. The effective rate was higher for the first quarter of 2011 due to a decrease in the reserve for uncertain income tax positions.

 

Income tax expense (Guitar Center)

 

Income tax expense for the three months ended March 31, 2011 was $0.7 million, compared to $0.4 million for the same period in 2010. The effective tax rate for the first quarter of 2011 was 28.5% compared to 66.9% in the prior year period. The difference in the effective rate was due to higher effective state income tax rates and more non-deductible expenses incurred in 2010.

 

Fiscal 2010 compared to fiscal 2009

 

Net sales

 

Consolidated net sales for 2010 increased 0.3% to $2,011 million, compared to $2,004 million in 2009.

 

Net sales from our Guitar Center segment in 2010 totaled $1,445 million, a 0.7% increase from $1,435 million in 2009.  Our Guitar Center online sales increased $11.7 million compared to 2009, reflecting our efforts to leverage the existing retail store customer base.  Comparable store sales decreased 0.1%, or $1.6 million. We did not open any new stores during 2010.

 

Net sales from direct response in 2010 totaled $390.4 million, a 0.8% decrease from $393.7 million in 2009. The decrease primarily reflects the impact of increased e-commerce competition, particularly in the form of free shipping offered by other e-commerce merchants and established online retailers adding musical instruments to their product offerings. We expect this competition to affect the direct response segment’s net sales and gross margin for the foreseeable future.

 

42



Table of Contents

 

Net sales from Music & Arts in 2010 totaled $175.7 million, a 0.1% decrease from $175.9 million in 2009.

 

Gross profit

 

Consolidated gross profit for 2010 increased 2.8% to $605.9 million, compared to $589.4 million for 2009. Consolidated gross profit as a percentage of net sales for 2010 increased to 30.1% from 29.4% in 2009.

 

Gross profit margin for our Guitar Center segment was 28.8% in 2010 compared with 27.8% in 2009.  The increase in gross profit was primarily due to higher selling margin of 0.6% and lower occupancy costs of 0.5%.  Selling margin benefited from product mix and increased sales penetration on our proprietary brands.  Occupancy costs were lower primarily due to decreased depreciation and amortization expense on store assets, reflecting the slower pace of capital spending on store refurbishment and relocations compared to earlier years.

 

Gross profit margin for direct response was 28.1% in 2010 compared with 28.5% in 2009.  The decrease was primarily due to higher shrink expense of 0.6% and lower gift card breakage of 0.3%, partially offset by improved selling margin of 0.3%.  Shrink expense was higher due to increased volume of replacement merchandise shipped to customers. The decrease in gift card breakage reflects current trends in our gift card redemption patterns.

 

Gross profit margin for Music & Arts was 45.6% in 2010 compared with 44.3% in 2009.  The increase was due to higher selling margin of 1.5% and reduced shrink expense of 0.6%, partially offset by higher freight expense of 0.7%.  Selling margin benefited from a reduction in rental inventory purchases by moving owned inventory among locations to meet demand.  This strategy also contributed to the increase in freight expense.  Shrink expense decreased due to better recovery rates for rental instruments on delinquent accounts.

 

Selling, general and administrative expenses

 

Consolidated selling, general and administrative expenses for 2010 increased 0.4% to $546.1 million, compared to $543.8 million for 2009. As a percentage of net sales, selling, general and administrative expenses for 2010 increased to 27.2% from 27.1% in 2009. Selling, general and administrative expenses were affected by higher compensation expense, in part resulting from severance expense recognized upon the retirement of a key executive in November 2010.  The increase in compensation expense was partially offset by lower amortization expense on our customer relationship intangible assets.

 

Selling, general and administrative expenses for our Guitar Center segment in 2010 were 24.1% of net sales compared to 24.2% in 2009. The decrease was primarily due to lower advertising expense of 0.2% and lower taxes and licenses expense of 0.2%, partially offset by higher compensation expense of 0.3%.  Compensation expense increased due to the combination of higher bonus expense and the deleveraging effect of lower net sales.

 

Selling, general and administrative expenses for direct response were 27.1% of sales in 2010 compared to 28.3% in 2009. The decrease was primarily due to lower compensation expense of 0.8% and lower depreciation and amortization expense of 0.6%, partially offset by higher advertising expense of 0.5%.  Compensation expense was lower due to labor efficiencies achieved in our order processing centers.  The decrease in depreciation and amortization is primarily from lower amortization expense on our customer relationship intangible assets.

 

Selling, general and administrative expenses for Music & Arts were 39.0% of net sales in 2010 compared to 37.9% in 2009.  The increase was primarily due to higher compensation expense of 0.8% and higher group medical costs of 0.4%.  Compensation expense was higher primarily due to additional retail staff added during the second half of 2010 at temporary locations to increase back-to-school and holiday season sales.  Group medical expense was higher due to increased claims costs on our self-insured medical plan.

 

Operating income (loss)

 

Consolidated operating income for 2010 increased 168.0% to $59.7 million, compared to a $87.9 million operating loss in 2009. As a percentage of net sales, consolidated operating income for 2010 increased to 3.0%, compared to a loss of 4.4% in 2009.  The improvement in operating income was primarily the result of impairment charges of $133.5 million in 2009 on goodwill and trademark intangible assets and the increase in gross profit in 2010 compared to 2009.

 

Interest expense (Holdings)

 

Net interest expense for Holdings for 2010 increased 6.0% to $145.2 million, compared to $137.0 million in 2009. The increase was due to accrued interest added to the outstanding principal on our old senior PIK notes.  In accordance with the old senior PIK notes, accrued interest payable semi-annually from April 2008 to October 2010 was permitted to be deferred and added to the outstanding principal balance. We elected to defer the interest payment and increase the principal balance on the old senior PIK notes for each of those periods. Higher interest expense on the old senior PIK notes was partially offset by lower interest expense in 2010 on our floating-rate term loan resulting from principal payments of $20.1 million in 2010 and lower interest rates.

 

43



Table of Contents

 

Interest expense (Guitar Center)

 

Net interest expense for Guitar Center for 2010 decreased 1.7% to $70.8 million, compared to $72.0 million in 2009, primarily due to the decrease in the LIBOR index rate on our floating-rate term loan.

 

Income tax benefit (Holdings)

 

Income tax benefit for Holdings for 2010 was $29.1 million, compared to $35.1 million in 2009. The effective tax rate for 2010 was 34.1% compared to 15.6% in 2009. The effective rate was lower in 2009 due to impairment charges for goodwill that are not recognized for income tax purposes.

 

Income tax benefit (Guitar Center)

 

Income tax benefit for Guitar Center for 2010 was $2.3 million, compared to $12.3 million in 2009. The effective tax rate for 2010 was 20.3% compared to 7.7% in 2009. The effective rate was lower in 2009 due to impairment charges for goodwill that are not recognized for income tax purposes.

 

Fiscal 2009 compared to fiscal 2008

 

Net sales

 

Consolidated net sales for 2009 decreased 10.1% to $2,004 million, compared to $2,229 million in 2008.  Net sales was primarily affected by the economic downturn that began in 2008.

 

Net sales from our Guitar Center segment for 2009 totaled $1,435 million, a 10.7% decrease from $1,606 million in 2008.  The decrease was primarily related to the economic downturn that began to affect us during the second half of 2008, and was primarily seen in our retail store locations, with a 11.9% comparable stores sales decrease compared to 2008.  However, sales from our Guitar Center online operations increased 22.7%, from $55.4 million in 2008 to $67.9 million in 2009.  This increase in e-commerce sales reflects our successful efforts to leverage the existing Guitar Center retail customer base and the benefit of the broader online product assortment. We did not open any new Guitar Center stores during 2009.

 

Net sales from direct response for 2009 totaled $393.7 million, a 11.8% decrease from $446.2 million in 2008.  Direct response sales decreased at our core brands, primarily due to the economic downturn that began to affect us in the third quarter of 2008 and increasing competition and expanded free shipping programs at our competitors.

 

Net sales from Music & Arts for 2009 totaled $175.9 million compared to $176.0 million in 2008.

 

Gross profit

 

Consolidated gross profit for 2009 decreased 6.6% to $589.4 million, compared to $631.0 million for 2008. Consolidated gross profit as a percentage of net sales for 2009 increased to 29.4% from 28.4% in 2008.

 

Gross profit margin for our Guitar Center segment was 27.8% in 2009 compared to 26.9% in 2008. The increase was primarily due to higher selling margin of 0.6% and smaller decreases in shrink and freight expense.  Selling margin benefited from increased sales penetration of our proprietary brands and discount management policies at our retail stores.

 

Gross profit margin for direct response was 28.5% in 2009 compared to 28.6% in 2008.  The decrease was due to lower selling margin of 0.8%, partially offset by lower freight expense of 0.3%.  We also saw smaller favorable variances in gift card breakage and shrink.  Selling margin was primarily affected by competition. Freight expense decreased as a result of packaging efficiency,  lower costs on outbound shipments and reduced fuel surcharges.

 

Gross profit margin for Music & Arts was 44.3% in 2009 compared to 40.0% in 2008. The increase was due to higher selling margin of 2.8%, lower obsolescence markdowns of 1.1% and lower shrink expense of 0.4%.  Selling margin benefited from product mix, with a greater proportion of rental sales.  Obsolescence markdowns were lower due to our converting obsolete or non-preferred brand merchandise into rental inventory. Shrink expense decreased as a result of inventory control improvements.

 

Selling, general and administrative expenses

 

Consolidated selling, general and administrative expenses for 2009 decreased 10.0% to $543.8 million, compared to $603.9 million for 2008. As a percentage of net sales, selling, general and administrative expenses for 2009 were 27.1%, consistent with 2008.  Amortization expense was 0.3% lower as a percentage of net sales as a result of an impairment charge on our customer relationship intangible assets in 2008.  Compensation expense was lower in 2009 compared to 2008, but 0.3% higher as a percentage of net sales due to the deleveraging effect of lower net sales.  Taxes and licenses were 0.3% higher as a percentage of net sales due to increased reserves for sales tax assessments.

 

Selling, general and administrative expenses for our Guitar Center segment were 24.2% of net sales in 2009 compared to 23.3% in 2008.  The increase was primarily due to higher compensation expenses of 0.7% and higher taxes and licenses

 

44



Table of Contents

 

expense of 0.4%, partially offset by lower advertising expense of 0.4%.  Compensation expense was lower in 2009 due to a headcount reduction completed in the fourth quarter of 2008. However, as a percentage of sales, compensation expense increased due to the deleveraging effect of lower net sales. Taxes and licenses expense increased due to an audit assessment on prior years’ sales tax collections. Advertising expense was lower primarily due to reduced quantities and lower per-unit costs for direct mail advertising.

 

Selling, general and administrative expenses for direct response were 28.3% of net sales in 2009 compared to 30.3% in 2008. The decrease was primarily due to lower compensation expense of 1.4% and lower amortization expense on intangible assets of 0.8%, partially offset by higher advertising expense of 0.3%.  Compensation expense decreased due to a headcount reduction in the fourth quarter of 2008. Amortization expense was lower due to an impairment of our customer relationship intangible asset recognized in 2008. Advertising expense was lower in 2009 compared to 2008, primarily due to reduced catalog page counts and circulation, but higher as a percentage of net sales due to the decrease in sales.

 

Selling, general and administrative expenses for Music & Arts were 37.9% of net sales in 2009 compared to 40.4% in 2008.  The decrease was primarily due to lower depreciation and amortization expense of 1.5%, lower compensation and contract labor expenses of 0.6% and lower bad debt expense of 0.3%.  Amortization expense decreased due to the expiration of three non-compete agreements from business acquisitions.  Compensation expense was lower primarily due to reduced headcount.  Bad debt expense decreased due to better collection and recovery rates.

 

Operating loss

 

Consolidated operating loss for 2009 decreased 56.5% to $87.9 million, compared to a $202.2 million operating loss in 2008. As a percentage of net sales, consolidated operating loss for 2009 decreased to 4.4%, compared to an operating loss of 9.1% in 2008.  The decrease in operating loss was primarily the result of impairment charges of $229.3 million in 2008 on trademark intangible assets and goodwill and the decrease in selling, general and administrative expenses.

 

Interest expense (Holdings)

 

Net interest expense for Holdings for 2009 decreased 7.5% to $137.0 million, compared to $148.1 million in 2008.  The decrease was due to lower interest rates in 2009 on our floating-rate term loan as compared to 2008 and decreased usage of our asset-based revolving credit facility.  These reductions were partially offset by increased interest expense on our old senior PIK notes.  In accordance with the old senior PIK notes, accrued interest payable semi-annually from April 2008 to October 2010 was permitted to be deferred and added to the outstanding principal balance. We elected to defer interest payment and increase the principal balance for each of those periods, resulting in higher interest expense in 2009 as compared to 2008.

 

Interest expense (Guitar Center)

 

Net interest expense for Guitar Center for 2009 decreased 21.1% to $72.0 million, compared to $91.3 million in 2008, primarily due to declines in the LIBOR index rate on our floating-rate term loan.  In 2009 we paid a weighted-average rate of 3.9%, compared to 6.4% in 2008.

 

Income tax benefit (Holdings)

 

Income tax benefit for 2009 was $35.1 million, compared to $130.6 million in 2008. The effective tax rate for 2009 was 15.6% compared to 37.3% in 2008.  The effective rate was lower in 2009 due to impairment charges for goodwill that are not recognized for income tax purposes.

 

Income tax benefit (Guitar Center)

 

Income tax benefit for 2009 was $12.3 million, compared to $108.0 million in 2008. The effective tax rate for 2009 was 7.7% compared to 36.8% in 2008.  The effective rate was lower in 2009 due to impairment charges for goodwill that are not recognized for income tax purposes.

 

Liquidity and capital resources

 

Our principal sources of cash are cash generated from operating activities and available borrowing capacity under our asset-based revolving credit facility.  Our asset-based revolving credit facility provides senior secured financing of up to $373 million, subject to a borrowing base.  As of March 31, 2011, the borrowing base was $260.0 million, which supported $7.4 million of outstanding letters of credit and $252.6 million of availability.

 

Our principal uses of cash have included capital expenditures, the financing of working capital and payments on our indebtedness.

 

Holdings’ business activities consist solely of debt and equity financing related to its ownership of Guitar Center, and consequently Holdings does not generate cash flows other than amounts distributed to it by Guitar Center.  Holdings is

 

45



Table of Contents

 

dependent on distributions received from Guitar Center to meet its debt service obligations on the senior PIK note, and the senior PIK note is not guaranteed by any of Holdings’ subsidiaries.

 

Cash flows

 

Operating activities

 

Holdings’ net cash provided by operating activities was $20.9 million for the three months ended March 31, 2011, compared to $52.4 million for the same period in 2010. The primary sources of cash during the three months ended March 31, 2011 were a decrease in accounts receivable of $8.0 million reflecting seasonal collection trends and the favorable effect of leveraging accounts payable and accrued expenses.  The primary sources of cash during the three months ended March 31, 2010 were a decrease in merchandise inventories of $26.3 million related to our efforts to optimize working capital and inventory levels, more efficient management of working capital, including accounts payable, and a decrease in accounts receivable reflecting seasonal collection trends.

 

Guitar Center’s net cash provided by operating activities was $21.2 million for the three months ended March 31, 2011, compared to $52.4 million for the same period in 2010. The operating cash flow difference between Holdings and Guitar Center represents expenses related to the modification of Holdings’ long-term debt.

 

Net cash provided by operating activities was $143.4 million in 2010, compared to $162.4 million in 2009.  The decrease is primarily related to investments in working capital.  In 2009, we reduced inventory levels in used and discontinued merchandise in an effort to maintain efficient working capital.  In 2010, cash flows related to inventory purchasing had returned to normal replenishment levels.

 

Net cash provided by operating activities was $162.4 million in 2009, compared to $123.4 in 2008.  The increase is primarily the result of reduced inventory purchasing in response to the decline in sales during the year.

 

Investing activities

 

Cash used in investing activities was $9.0 million for the three months ended March 31, 2011, compared to $7.0 million for the same period in 2010.  Substantially all cash used in investing activities represents capital expenditures.  Capital expenditures for the three months ended March 31, 2011 included approximately $4.5 million in information technology development and purchases and $3.2 million related to new Guitar Center stores. Capital expenditures for the three months ended March 31, 2010 included approximately $5.5 million in information technology development and purchases.

 

Cash used in investing activities was $47.9 million in 2010, $45.2 million in 2009 and $42.1 million in 2008.  During each of these years, we continued to invest in our stores and in our e-commerce infrastructure to support the long-term growth of the company.  We began opening new Guitar Center stores in 2011, and we expect to open approximately 10 to 15 stores per year, which is likely to increase our capital expenditures as well as working capital needs.

 

Financing activities

 

Cash used in financing activities was $8.3 million for the three months ended March 31, 2011, compared to $20.3 million in the same period in 2010.  Cash used in financing activities in 2011 was primarily related to the payment of fees to our lenders in connection with an amendment of the terms and extension of maturity dates for our long-term debt.  In 2010, we made a prepayment of principal of $20.1 million on our term loan facility relating to excess 2009 cash flow.  A similar prepayment was not required in 2011 for 2010 cash flow.

 

Cash used in financing activities in 2010 was $21.5 million, compared to $12.7 million in 2009.  In 2010, we made a mandatory prepayment of principal of $20.1 million and $4.5 million in 2009.  The prepayment reduces our obligation to make quarterly principal payments to the extent that the prepayment exceeds the scheduled principal payments.  Future prepayments may be required depending upon our operating cash flows from year to year.

 

Cash used in financing activities in 2009 was $12.7 million, compared to $78.4 million in 2008.  In the first quarter of 2009 and during 2008 we paid down the outstanding principal balance on our revolving asset-based facility.  During 2010 and 2009, cash provided by our operating cash flows were sufficient for our operating and debt service requirements and we did not draw upon the asset-based facility.

 

Capital expenditures

 

We did not open any new stores between 2008 and 2010.  Beginning in 2011, we began resuming growing our business through opening new stores.  We intend to open new stores at a rate of 10 to 15 stores per year, and we opened two stores during the first three months of 2011.  We expect the new stores will be a combination of store formats. New stores generally take a number of years to reach what we consider mature sales levels. We generally expect our primary format stores to reach mature sales levels in approximately four years and our secondary format stores in three years.

 

46



Table of Contents

 

Historically, our cost of capital improvements for Guitar Center stores has been approximately $1.2 million for a primary market store and $0.9 million for a secondary market store.  These costs generally consist of leasehold improvements, fixtures and equipment. We expect that our costs for capital improvements for stores opened in 2011 will be approximately $1.3 million for primary format stores and $1.1 million for secondary format stores.  Additionally, our new primary stores generally require between $1.1 million and $1.2 million of gross inventory and secondary stores require between $0.9 million to $1.0 million of gross inventory upon store opening.

 

For 2011, we expect our capital expenditures to be approximately $60.0 million. This amount primarily is comprised of approximately $34.0 million investment in information technology, $19.0 million in build-out, renovation and relocation costs for new and existing Guitar Center stores and $7.0 million of other capital expenditures.

 

Prospective cash flows

 

We expect our primary sources of liquidity will be cash flow generated from operations and the availability of funds under our asset-based revolving credit facility. As of March 31, 2011, the borrowing base was $260.0 million, which supported $7.4 million of outstanding letters of credit and $252.6 million of availability. We expect that our primary liquidity requirements will be for debt service, working capital and capital expenditures.

 

Debt

 

Our outstanding long-term debt as of March 31, 2011 consisted of a senior secured term loan, the senior notes and the senior PIK notes.  The aggregate outstanding principal balance on this debt as of March 31, 2011 was $1,561 million.  We expect interest payments on our long-term debt will be between $148 million and $157 million per year through 2016 and $143 million for years thereafter.

 

The majority of scheduled maturities of our long-term debt occur in 2017 and 2018, with total maturities of $1,528 million in those years.  Scheduled maturities and principal payments for the years 2011 through 2016 total $33.2 million.  Our long-term debt agreements include restrictive covenants that could require early payment in the event of default. The payment terms, interest rates, fees and covenants associated with these debts are described in greater detail in the notes to the consolidated financial statements included in this registration statement.

 

We have an asset-based revolving credit facility that has a maximum borrowing amount of $373 million, subject to a borrowing base which is calculated monthly based on specified percentages of the value of eligible inventory, credit card receivables and trade receivables.  As of March 31, 2011, we had no outstanding principal balance on the asset-based credit facility.

 

We believe that the asset-based revolving credit facility, our cash and cash equivalents and funds generated from operations will be adequate to fund debt service requirements, capital expenditures and working capital requirements for the next 12 months. Over the longer term, we expect that operating cash flows from our existing businesses will continue to be adequate to fund capital expenditures and working capital requirements.  We plan to expand our retail store presence and increase our market share in e-commerce, increasing the operating cash flows from our existing businesses to fund debt service requirements. Our ability to continue to fund these items and continue to reduce debt may be affected by general economic, financial, competitive, legislative and regulatory factors and the cost of litigation claims, among other factors.

 

As of March 31, 2011, we were in compliance with our debt convenants. Under the Term Loan credit agreement, we were required to have a consolidated secured net leverage ratio as of March 31, 2011 that does not exceed 3.5x.  As of March 31, 2011, our consolidated secured net leverage ratio was 2.37x.

 

We also believe that our current financial position and financing plans will provide flexibility in financing activities and permit us to respond to changing conditions in credit markets. However, we cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to use under our asset-based revolving credit facility in an amount sufficient to enable us to pay our indebtedness, including the notes, or to fund our other liquidity needs. We also may need to incur additional indebtedness to finance any future acquisitions.

 

A summary of the material terms of our term loan credit facility, asset-based revolving credit facility, senior notes and senior PIK notes are described below.  For additional information, see “Description of Certain Other Indebtedness,” “Description of Senior Exchange Notes” and “Description of Senior PIK Exchange Notes.”

 

Senior Secured Term Loan Credit Facility

 

On October 9, 2007, we entered into a senior secured term loan credit facility.  The term loan facility was amended as of March 2, 2011.

 

The term loan facility matures on April 9, 2017 for term loans that were extended pursuant to the amendment in March 2011, and October 9, 2014 for term loans that were not extended at that time.  As of March 31, 2011, the term loan facility consisted of approximately $612.8 million of extended term loans and $9.0 million of non-extended term loans. The term loan facility permits extensions to the maturity of the term loans and modifications to their terms so long as certain conditions are satisfied.

 

47



Table of Contents

 

The borrower under the term loan facility is Guitar Center. All obligations under the term loan facility are unconditionally guaranteed by our primary subsidiaries. The collateral for borrowings under the term loan facility consists of a second-priority security interest in our asset-based facility collateral, which includes all accounts receivable arising from the sale of inventory and other goods and services, inventory, cash, deposit accounts and, in each case, proceeds thereof.  The collateral also includes a first-priority security interest in all of the capital stock in subsidiaries held by Holdings, Guitar Center and the guarantors, substantially all plant, material owned real property and equipment of Guitar Center and the guarantors and substantially all other personal property of Guitar Center and the guarantors other than the asset-based facility collateral, including patents, copyrights, trademarks, other general intangibles and proceeds of the foregoing.

 

At our option, loans under the term loan facility may be maintained from time to time as “prime rate” loans or “LIBO rate” loans.  Prime rate loans bear interest at the applicable margin (as defined below) in excess of (1) the highest of the variable annual rate of interest determined by JPMorgan Chase Bank, N.A. as its “prime rate,” (2) 1/2 of 1.00% per annum in excess of the federal funds rate or (3) a LIBO Rate applicable to an interest period of one month (or, if higher, and only in the case of extended term loans, three months) on such day plus 1.00% per annum.  LIBO rate loans bear interest at the applicable margin in excess of a LIBO Rate. The “applicable margin” means a percentage per annum equal to, in the case of any (1) non-extended term loan that is a prime rate loan, 2.50%, (2) non-extended term loan that is a LIBO rate loan, 3.50%, (3) extended term loan that is a prime rate loan, 4.25% and (4) extended term loan that is a LIBO rate loan, 5.25%.

 

Once repaid, no amounts under the term loans may be re-borrowed.

 

The term loan facility provides for incremental term loan facilities in an aggregate principal amount of $50.0 million plus the amount available such that the consolidated secured net leverage ratio is less than or equal to 2.75:1.00 on a pro forma basis after giving effect to the incremental indebtedness, provided that each incremental term loan facility shall be no less than $10.0 million (unless such lesser amount represents all remaining availability under the incremental term loan facilities) and no default or event of default shall exist or arise from the incremental facility.

 

The term loan facility requires us to comply with customary affirmative and negative covenants.  It also requires us to comply with financial covenants, including covenants with respect to our consolidated secured net leverage ratio.  The consolidated secured net leverage ratio covenant becomes more restrictive over time.  For more information on the covenants in the term loan facility, see “Description of Certain Other Indebtedness—Senior Secured Term Loan Credit Facility—Covenants.”

 

Asset-Based Revolving Credit Facility

 

On October 9, 2007, Guitar Center, as lead borrower, entered into a senior secured asset-based loan facility.  The asset-based facility was amended on March 2, 2011.

 

The asset-based facility matures on February 9, 2016 for the portion that was extended pursuant to the amendment in March 2011, and October 9, 2013 for the portion that was not extended. However, if the stated maturity date of any term loans under the term loan facility, or permitted indebtedness that replaces or refinances those term loans, is prior to April 10, 2016, then the maturity date for the extended portion of the facility will be 91 days prior to the earliest stated maturity date of the non-extended term loans. As of March 31, 2011, the asset-based facility consisted of a $253.0 million extended revolving credit facility and a $120.0 million non-extended revolving credit facility, including a $25.0 million swing line sub-facility and a $100.0 million letter of credit sub-facility.  There were no outstanding borrowings under the asset-based facility as of March 31, 2011.

 

Borrowers under the asset-based facility include Guitar Center, Guitar Center Stores, Inc. and Musician’s Friend, Inc. All obligations under the asset-based facility are unconditionally guaranteed by our primary subsidiaries. The collateral for borrowings under the asset-based facility consists of a first-priority security interest in the asset-based collateral and a second-priority security interest in the term loan collateral.

 

At our option, loans under the asset-based facility may be maintained from time to time as prime rate loans or LIBO rate loans.  Prime rate loans bear interest at the applicable margin (as defined below) in excess of the highest of (1) the variable annual rate of interest determined by JPMorgan Chase Bank, N.A. as its “prime rate,” (2) 1/2 of 1.00% per annum in excess of the federal funds rate and (3) a LIBO Rate applicable to an interest period of one month on such day plus 1.00% per annum.  LIBO rate loans bear interest at the applicable margin in excess of a LIBO Rate which is adjusted for maximum reserves. The “applicable margin” is defined to mean a percentage per annum based on our average daily excess availability.  If our average daily excess availability is greater than $250.0 million, the applicable margin is equal to, in the case of any (1) non-extended asset-based loan that is a prime rate loan, 0.00%, (2) non-extended asset-based loan that is a LIBO rate loan, 1.25%, (3) extended asset-based loan that is a prime rate loan, 1.75% and (4) extended asset-based loan that is a LIBO rate loan, 2.75%.  If our average daily excess availability is greater than $125.0 million but less than or equal to $250.0 million, the applicable margin is equal to, in the case of any (1) non-extended asset-based loan that is a prime rate loan, 0.25%, (2) non-extended asset-based loan that is a LIBO rate loan, 1.50%, (3) extended asset-based loan that is a prime rate loan, 2.00% and (4) extended asset-based loan that is a LIBO rate loan, 3.00%. If our average daily excess availability is less than or equal to $125.0 million, the applicable margin is equal to, in the case of any (1) non-extended asset-based loan that is a prime rate

 

48



Table of Contents

 

loan, 0.50%, (2) non-extended asset-based loan that is a LIBO rate loan, 1.75%, (3) extended asset-based loan that is a prime rate loan, 2.25% and (4) extended asset-based loan that is a LIBO rate loan, 3.25%.

 

The borrowers pay the administrative agent, for the account of the non-extended asset-based facility lenders, an aggregate fee at a rate per annum equal to 0.25% per annum of the average daily balance of the unused commitments under the non-extended portion of the facility quarterly in arrears. This fee is 0.50% per annum of the average daily balance of the unused commitments under the extended portion of the facility for the extended asset-based facility lenders.

 

Revolving loans may be borrowed, repaid and re-borrowed at any time to fund our working capital needs and for other general corporate purposes.  The asset-based facility provides for incremental revolving credit facilities to increase the aggregate of the then outstanding extended commitments in an aggregate principal amount of $75.0 million, plus an amount equal to the aggregate amount of the terminated non-extended commitments.

 

The asset-based facility requires us to comply with customary affirmative and negative and financial covenants.  It also requires us to comply with financial covenants which require us to maintain our consolidated fixed charge coverage ratio as of the last day of each fiscal quarter of at least 1.00 to 1.00.  For more information on the covenants in the asset-based facility, see “Description of Certain Other Indebtedness—Senior Secured ABL Credit Facility—Covenants.”

 

Notes

 

On August 7, 2008, we issued $375,000,000 of the senior notes and Holdings issued $401,758,428 of the senior PIK notes.  The terms of the senior notes and senior PIK notes, including the maturity dates, were amended on March 2, 2011.  As of March 31, 2011, we and Holdings, respectively, had outstanding $375,000,000 in aggregate principal amount of senior notes and $564,672,894 in aggregate principal amount of senior PIK notes.

 

The senior notes mature on October 15, 2017 and the senior PIK notes mature on April 15, 2018.  Interest on the senior notes accrues at a rate of 11.50% per annum, payable semi-annually in cash in arrears on April 15 and October 15 of each year.  Interest on the senior PIK notes accrues at a rate of 14.09% per annum, payable semi-annually in arrears on April 15 and October 15 of each year.  Until and through October 15, 2010, Holdings paid interest on the senior PIK notes by increasing the principal amount of such notes for the entire amount of the interest payment.

 

The senior notes are guaranteed on an unsecured senior basis by each of our subsidiaries that is a guarantor under our senior secured credit facilities described above.  The senior PIK notes are not guaranteed by us or any of our subsidiaries.

 

The indentures governing the notes contain covenants limiting, among other things, our and Holdings’ ability and the ability of restricted subsidiaries to: (1) incur or guarantee additional indebtedness, or issue disqualified stock or preferred stock; (2) pay dividends or make distributions to our stockholders; (3) repurchase or redeem capital stock or subordinated indebtedness; (4) make investments or acquisitions; (5) incur restrictions on the ability of certain of our subsidiaries to pay dividends or to make other payments to us; (6) enter into transactions with affiliates; (7) create liens; (8) merge or consolidate with other companies or transfer all or substantially all of our assets; (9) transfer or sell assets, including capital stock of subsidiaries; and (10) prepay, redeem or repurchase debt that is junior in right of payment to the notes.

 

We may redeem some or all of the senior notes at any time on or after October 15, 2013 at 100% of the principal amount of senior notes to be redeemed, together with accrued and unpaid interest, if any, to the date of redemption.

 

Holdings may redeem some or all of the senior PIK notes at any time on or after October 15, 2013 at the redemption prices (expressed as percentages of principal amount of senior PIK notes to be redeemed) set forth below, together with accrued and unpaid interest, if any, to the date of redemption:

 

Period

 

Percentage

 

October 15, 2013 - October 14, 2014

 

101.7613

%

October 15, 2014 and thereafter

 

100.000

%

 

We and Holdings, respectively, also may redeem some or all of the respective notes at any time prior to October 15, 2013, in each case, at a price equal to 100% of the principal amount of the notes to be redeemed plus a “make whole” premium and accrued and unpaid interest, if any, to the date of redemption.

 

If we or Holdings, as applicable, experiences a change of control, we or Holdings, as applicable, will be required to make an offer to purchase the senior notes or senior PIK notes, as applicable, at a price equal to 101% of their principal amount, together with accrued and unpaid interest, if any, to the date of purchase.  In addition, certain asset dispositions are triggering events which may require us or Holdings to use the proceeds from those asset dispositions to make an offer to purchase the senior notes or senior PIK notes, as applicable, at 100% of their principal amount, together with accrued and unpaid interest, if any, to the date of purchase.

 

49



Table of Contents

 

If the senior PIK notes would otherwise constitute “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code at the end of the first accrual period ending after the fifth anniversary of November 28, 2007, Holdings will be required to redeem for cash a portion of each senior PIK note then outstanding equal to the “mandatory principal redemption amount.” The redemption price for the portion of each senior PIK note redeemed will be 100% of the principal amount of such portion plus any accrued interest thereon on the date of redemption. The “mandatory principal redemption amount” means the portion of a senior PIK note required to be redeemed to prevent such note from being treated as an “applicable high yield discount obligation” within the meaning of Section 163(i)(1) of the Internal Revenue Code.  As of December 31, 2010, payment-in-kind interest of $189.7 million had been added to the initial principal balance senior PIK notes, and we estimate that the payment would be the total accrued payment-in-kind amount as of the payment date, less the first annual payment-in-kind amount of $55 million. See the notes to our consolidated financial statements for more detail on this payment.

 

The indentures governing the notes contain customary events of default, including, but not limited to, cross-defaults among other debt agreements.  An event of default, if not cured, could cause cross-default causing substantially all of our indebtedness to become due.

 

Certain dividend restrictions

 

The guarantors under the term loan facility, the asset-based facility and the senior notes are generally not restricted in their ability to dividend or otherwise distribute funds to Guitar Center except for restrictions imposed under applicable state corporate law.  However, Guitar Center is limited in its ability to pay dividends or otherwise make distributions to Holdings under the term loan facility, the asset-based facility and the indenture governing the senior notes.  Specifically, the term loan facility and the asset-based facility each prohibits Guitar Center from making any distributions to Holdings except for limited purposes, including, but not limited to:  (i) the payment of interest on the senior PIK notes by Holdings so long as no payment or bankruptcy event of default exists; (ii) general corporate, overhead and similar expenses of Holdings incurred in the ordinary course of business, (iii) the payment of taxes by Holdings as the parent of a consolidated group that includes Holdings, Guitar Center and the guarantors, (iv) the partial redemption or prepayment of the senior PIK notes by Holdings to the extent necessary to make an “applicable high yield discount obligation” (AHYDO) “catch-up” payment thereon and (v) advisory fees of Holdings not to exceed the amounts payable in respect thereof under the advisory agreement with Bain Capital as in effect on October 9, 2007 so long as certain events of default do not exist.

 

The senior notes indenture provides that Guitar Center can generally pay dividends and make other distributions to Holdings in an amount not to exceed (a) 50% of Guitar Center’s consolidated net income for the period beginning March 2, 2011 and ending as of the end of the last fiscal quarter before the proposed payment, plus (b) 100% of the net cash proceeds received by Guitar Center from the issuance and sale of capital stock, plus (c) 100% of cash contributions to Guitar Center’s capital, plus (d) to the extent not included in consolidated net income, 100% of the amount received in cash from the sale or other disposition of certain investments, provided that certain conditions are satisfied, including that Guitar Center would, at the time of the proposed payment and after giving pro forma effect thereto, have been permitted to incur at least $1.00 of additional indebtedness pursuant to the fixed charge coverage ratio test set forth in the indenture.  Notwithstanding the foregoing, the senior notes indenture provides that Guitar Center can generally pay dividends and make other distributions to Holdings to, among other things, fund (A) interest payments on the senior PIK notes, (B) any mandatory redemption of a portion of the senior PIK notes pursuant to the senior PIK notes indenture, (C) an offer to purchase upon a change of control or asset sale to the extent required by the terms of the senior PIK notes indenture, (D) tax payments, (E) general corporate overhead and operating expenses and (F) fees of Holdings under the advisory agreement with Bain Capital.

 

Contractual obligations and commercial commitments

 

The following table reflects our significant contractual cash obligations as of December 31, 2010. Some of the figures included in this table are based on management’s estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties and other factors. Because these estimates and assumptions are necessarily subjective, the obligations we will actually pay in future periods may vary from those reflected in the table.

 

 

 

Payments due by period
(dollars in millions)

 

 

 

Total

 

Less than
1 year

 

1 – 3 years

 

3 – 5 years

 

More than
5 years

 

Guitar Center:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt obligations(1)

 

$

996.8

 

$

 

$

20.2

 

$

13.0

 

$

963.6

 

Interest on long-term debt(2)

 

507.8

 

77.5

 

231.7

 

151.9

 

46.7

 

Capital lease obligations(3)

 

1.3

 

0.6

 

0.7

 

 

 

Operating lease obligations(4)

 

328.5

 

66.0

 

163.2

 

66.9

 

32.4

 

Management advisory agreement (5)

 

26.0

 

4.0

 

8.0

 

8.0

 

6.0

 

Total

 

1,860.4

 

148.1

 

423.8

 

239.8

 

1,048.7

 

Holdings:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt obligations (6)

 

564.7

 

 

 

 

564.7

 

Interest on long-term debt (6)

 

544.7

 

79.6

 

225.8

 

143.6

 

95.7

 

Total

 

1,109.4

 

79.6

 

225.8

 

143.6

 

660.4

 

 


(1)          Includes payment of the term loan and senior notes.

(2)          Includes interest on all long-term debt of Guitar Center.  Future interest on the floating-rate term loan assumes the rate in effect as of December 31, 2010 will remain constant in future periods.

(3)          Capital lease obligations include insignificant interest payments.

(4)          Represents minimum rent payments for operating leases under current terms.

(5)          Minimum fees under an advisory agreement with Bain Capital, in effect until October 2017.

(6)          Principal and interest payments on the senior PIK notes.  An election is available to us under the senior PIK notes to pay the accrued paid-in-kind interest, less the first annual paid-in-kind amount of $55 million. We anticipate making this payment in April 2013 in the amount $134.7 million.

 

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, we have experienced increases in freight costs related to receiving inventory in our distribution and fulfillment centers and distribution of inventory to stores and direct response customers.  We have also been experiencing increased product costs as the commodity and labor prices in Asia, particularly in China, have been rising.

 

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 in our Guitar Center stores on a per store basis and through the direct response segment than in any other quarter. In addition, band rental season for our Music & Arts stores starts in August and carries through mid-October, but that seasonality does not have a significant impact on our consolidated results.

 

50



Table of Contents

 

Off-balance sheet arrangements

 

We have no material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K that have or are reasonably likely to have a material current or future on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

 

Quantitative and qualitative disclosures about market risk

 

We have market risk exposure arising from changes in interest rates on our term loan credit facility. The interest rates on our term loan facility will reprice periodically, which will impact our earnings and cash flow. The interest rates on our senior notes are fixed.

 

In January 2008, we entered into two interest rate cap agreements which protect us from increases in the hedged cash flows on a portion of our floating-rate term loan, which is indexed to LIBOR. The cap agreements provide for monthly payments to be received from the counterparty when the 1-month LIBOR rate on each reset date exceeds the strike rate of 7% in a given reset period.  The payments represent the excess of 1-month LIBOR rate over the strike rate, applied to the notional amount of the cap agreements.

 

We paid a premium of $0.8 million to enter into the cap agreements, with an initial aggregate notional value of $500 million that amortizes by $50 million per year starting in 2009.  The individual cap agreements are in the notional amounts of $200 million, which matures on December 31, 2012, and $300 million, which matures on January 31, 2013.  As of December 31, 2010, the cap agreements had a combined notional amount of $400 million and were designated as cash flow hedges of interest rate risk.  Changes in fair value of the cap agreements included a $0.4 million loss for 2010, $0.4 million of income for 2009 and a $0.3 million loss for 2008.  We do not expect the financial impact of the cap agreements to be material during the remainder of their terms.  See the notes to our financial statements for more detail.

 

Critical accounting policies and estimates

 

We have prepared our consolidated financial statements in conformity with accounting principles generally accepted in the United States.  These accounting principles require us to make a number of estimates and assumptions that affect some of the reported amounts.  Actual results could differ significantly from those estimates under different assumptions and conditions. We believe 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 weighted average cost method or market value. We value rental inventories at the lower of cost or market using the specific identification method.  We depreciate rental inventories 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 adjustments to inventory with a corresponding charge 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 misunderstanding of these conditions could result in inventory valuation changes as of any given balance sheet date.

 

Valuation of long-lived assets

 

We evaluate long-lived assets, such as property and equipment and intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We consider the following factors, among other things, to be important indicators of impairment:

 

·                  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

 

51



Table of Contents

 

·                  significant decline in the estimated fair value of our reporting units or projected cash flows from our stores.

 

For long-lived assets, such as property and equipment and intangible assets with finite lives, we evaluate for impairment by comparing the carrying value of the assets to the estimated undiscounted future cash flows expected to be generated by the assets.  If a potential impairment is identified, we recognize an impairment loss for the amount by which the carrying amount exceeds the fair value of the asset.  Fair value may be determined based on appraisal values assessed by third parties, if deemed necessary, or a discounted future cash flows analysis.

 

Goodwill and other intangible assets

 

We evaluate goodwill for impairment annually and we evaluate all intangible assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the assets may be impaired.

 

The goodwill impairment test is a two-step test.  In the first step of the test, we evaluate goodwill for impairment by comparing the estimated fair value of each segment that has goodwill to its carrying value.  We estimate the fair value of each segment using a combination of market multiple and discounted cash flow analyses, and comparable transactions whenever possible.  If the step one analysis indicates goodwill may be impaired, we perform the second step of the test by allocating the segments’ fair values to its assets and liabilities as if it had been acquired in a business combination.  We determine the fair values of assets and liabilities. We recognize an impairment loss for the amount by which the implied goodwill from the step two analysis exceeds the carrying amount of goodwill at the segment.

 

The impairment test for intangible assets with indefinite lives involves a comparison of the estimated fair value of the intangible asset with its carrying value.  The estimated fair values of trademarks with indefinite lives are also determined using a discounted cash flow analysis.

 

For the undiscounted and discounted cash flow analyses used in our impairment tests, we use assumptions that are consistent with our internal forecasts.  We consider current and future expected sales volumes and related operating costs and any anticipated increases or decreases based on expected market conditions and local business environment factors.  Significant management judgment is required in the forecasts of future operating results that are used in both undiscounted and discounted impairment tests.  It is possible that our plans may change and estimates may prove to be inaccurate.  If actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

 

See the notes to the consolidated financial statements included elsewhere in this registration statement for further discussion of impairment of goodwill and other intangible assets.

 

Self-Insurance reserves

 

We maintain a self-insurance program for workers’ compensation of up to $500,000 per claim and medical insurance of up to $350,000 per claim, with excess amounts covered by stop-loss insurance coverage.  We recognize a liability for the undiscounted estimated ultimate cost of claims that are known, claims that are incurred but not reported and defense costs.  Our self-insurance reserves are based on an actuarial analysis of historical experience and trends in paid and incurred claims.

 

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 our direct response segment customers to return products within 45 days. Music & Arts customers have 30 days from the date of purchase to return products. 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 (allowances from the manufacturer to subsidize qualifying advertising and similar promotional expenditures we make relating to the vendor’s products), price protection credits (credits from vendors with respect to in-stock inventory if the vendor subsequently lowers its wholesale price for such products) and vendor rebates (credits or rebates provided by vendors based on the purchase of specified products and paid at a later date).

 

We recognize cooperative advertising allowances as a reduction to selling, general, and administrative expense when we incur the advertising expense eligible for the credit.

 

We account for price protection credits and vendor rebates as a reduction of the cost of merchandise inventory.  We record these credits and rebates at the time the credit or rebate is earned. We recognize the effect of price protection credits

 

52



Table of Contents

 

and vendor rebates as a reduction of cost of goods sold at the time the related inventory is sold. We reserve for the portion of vendor rebates we estimate will be uncollectible.  We estimate the portion of vendor rebates that will be uncollectible through an aging review, specific identification and an analysis of vendor relationships. None of these credits are recorded as revenue.

 

Gift cards

 

We sell gift cards to our customers in our Guitar Center retail stores and online through our two gift card subsidiaries. Revenue from gift card sales is recognized upon redemption of the gift card. Other than a limited number of promotional gift cards, our gift cards do not have expiration dates. Based on historical redemption rates, a certain percentage of gift cards will never be redeemed, which we refer 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.

 

Recent accounting pronouncements

 

In October 2009, the FASB issued revised standards related to multiple deliverable revenue arrangements.  The revised standards apply to revenue arrangements that involve the delivery of multiple products or services over different time periods.  The revised standards establish a hierarchy for determining the selling price of deliverables in a revenue arrangement, address how to separate deliverables and provide guidance on how to measure and allocate revenue to the deliverables in a multiple-deliverable arrangement.  The revised standards enable vendors to recognize revenue in a manner that more closely reflects the economics of multiple-deliverable arrangements.  In addition, the revised standards expand the disclosure requirements with the intent of providing users of financial statements with a greater understanding of how vendors allocate revenue in selling arrangements, judgments made in allocating revenue and how those judgments affect the timing and amount of revenue recognition.

 

The revised standards are effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. We adopted the revised standards effective January 1, 2011.  Adoption of the revised standards did not have a material impact on our financial statements.

 

In January 2010, the FASB issued revised standards related to fair value measurements and disclosures.  The revised standards expand and clarify disclosure requirements related to fair value measurements to include a greater level of disaggregated information and more expansive disclosures about valuation techniques and inputs to fair value measurements.  The revised standards require disclosure of significant amounts for which valuation techniques change between quoted market prices for identical financial instruments and quoted market prices for similar financial instruments and the reasons for the change.  In addition, for fair value measurements that use significant internally-developed assumptions, information about purchases, sales, issuances, and settlements should be disclosed on a gross basis rather than net.  The revised standards require that fair value measurement disclosures are provided for each class of assets and liabilities and provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements.

 

The revised disclosure standards are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in fair value measurements that use significant internally-developed assumptions.  Those disclosures are effective for interim and annual reporting periods beginning after December 15, 2010.  We adopted the revised standards beginning in the first quarter of 2010.  The change had no effect on our financial statements.

 

In December 2010, the FASB issued revised standards related to performing goodwill impairment testing for reporting units with zero or negative carrying amounts.  When a goodwill impairment test is performed (either on an annual or interim basis), an entity must assess whether the carrying amount of a reporting unit exceeds its fair value (step 1).  If it does, the entity must perform an additional test to determine whether goodwill has been impaired and to calculate the amount of that impairment (step 2).  The revised standards require that for reporting units with zero or negative carrying amounts, step 2 of the goodwill impairment test must be performed if it is more likely than not that a goodwill impairment test exists, taking qualitative factors into account.  The revised standards eliminate an entity’s ability to assert that a reporting unit is not required to perform step 2 because the carrying amount of the reporting unit is zero or negative despite the existence of qualitative factors that indicate the goodwill is more likely than not impaired.  The revised standards do not modify existing standards on how to determine the carrying amount or measure the fair value of the reporting unit.

 

The revised standards are effective for fiscal years beginning after December 15, 2010, with early adoption prohibited.  We adopted the revised standards effective January 1, 2011.  The change had no effect on our financial statements.

 

53



Table of Contents

 

BUSINESS

 

Overview

 

Introduction

 

We are the leading retailer of music products in the United States. We operate three businesses under our Guitar Center, direct response and Music & Arts brands.  Our Guitar Center brand offers guitars, amplifiers, percussion instruments, keyboards and pro audio and recording equipment through our retail stores and online, along with repair services and limited number of rehearsal and lesson services. Our direct response brands offer catalog and online sales of a broad selection of music products under several owned or operated brand names, including Musician’s Friend, Music123 and Woodwind & Brasswind. Our Music & Arts brand offers band and orchestra instruments for rental and sale, music lessons and a limited selection of products of the type offered by our Guitar Center stores.

 

As of March 31, 2011, our wholly owned retail subsidiary operated 216 Guitar Center stores in 42 states and 99 Music & Arts stores in 19 states.

 

Holdings is our parent company and has no material assets or operations other than its ownership of Guitar Center, Inc.

 

Guitar Center stores

 

Our Guitar Center stores offer an interactive, hands-on shopping experience with an emphasis on customer service and a broad selection of brand-name, high quality products at competitive prices. We believe we create an entertaining and exciting atmosphere in our stores with bold and dramatic merchandise presentations arranged by product category to create a “shop within a shop” customer experience. Customers can obtain technical information and relevant insight from sales personnel and are encouraged to try products on display. We believe that a significant portion of our Guitar Center store sales are to professional and aspiring-professional musicians who generally view the purchase of music products as a career necessity. These sophisticated customers rely on our knowledgeable salespeople to answer technical questions, provide advice and assist in product demonstrations.

 

As of March 31, 2011, our Guitar Center stores consisted of 141 primary format stores, 72 secondary format stores and three tertiary format stores. The store format is determined primarily by the size of the market in which it is located. Our primary format stores serve major metropolitan population centers and generally range in size from 13,000 to 30,000 square feet. Our secondary format stores serve metropolitan areas not served by our primary format stores and generally range in size from 8,000 to 14,000 square feet.  Tertiary market stores serve smaller population centers and are approximately 5,000 square feet.  We also operate one lesson and rehearsal facility in Southern California under the GC Studios name.  We also are beginning to include rehearsal and lesson space in some of our newest stores.

 

Guitar Center also offers online sales and research through its website.  This online channel allows Guitar Center to operate a multi-channel business that allows customers to interact between the brick-and-mortar and online operations.

 

Our Guitar Center stores are supported by a distribution facility located near Indianapolis, Indiana.

 

Direct response

 

Our direct response segment operates a direct response e-commerce and catalog business, offering a shopping experience that includes technical product information, order confirmations by a live person, quick and efficient sales and service and a musician-based staff for after-sale support. We believe that we have the largest music products direct sale business in the United States. Our direct response business includes owned or operated catalogs and websites under various brands, including Musician’s Friend, Music123 and Woodwind & Brasswind. We acquired the Woodwind & Brasswind and Music123 businesses and their websites and catalogs in February 2007.

 

Our direct response business currently is based in Medford, Oregon and is supported by customer contact centers located in Salt Lake City, Utah, and South Bend, Indiana, and a distribution facility located in Kansas City, Missouri. In April 2011, we announced plans to relocate our direct response operations currently located in Medford, Oregon, to Southern California in early 2012.  See “Risks relating to our business - Our failure to effectively implement the relocation of our direct response operations could adversely affect us.”

 

Music & Arts

 

Our Music & Arts business operates stores specializing in band and orchestra instruments for sale and rental to teachers, band directors, college professors and students. Most of our Music & Arts stores also sell a limited assortment of guitars, amplifiers, percussion instruments, keyboards, pro audio equipment and recording equipment, as well as provide in-store music lessons. Music & Arts instrument rentals are conducted on-site at educational institutions through our outbound education representatives, over-the-counter at our retail locations and through affiliated stores operated by third parties.

 

54



Table of Contents

 

Our Music & Arts business is the largest retailer of musical products to students and beginner musicians with 99 stores as of March 31, 2011.  Music & Arts also maintains approximately 114 educational representatives who are employees and 280 affiliates, who together with in-store rentals generated 271,000 rental contracts for the 12 months ended March 31, 2011. Our Music & Arts stores range from 830 to 11,500 square feet, with an average store size of approximately 3,500 square feet.  Music & Arts also operates online through its www.musicarts.com website.

 

Our Music & Arts business is based in Frederick, Maryland and is supported there by a distribution facility and contact center.

 

Industry

 

The marketplace has changed materially since we opened in 1964. Musical instruments and accessories historically have been sold through small, local, “mom and pop” stores. Today’s marketplace is much more sophisticated. The consumer landscape is more diverse, with each category of musician having different expectations, price sensitivities, purchasing habits and approaches to music. Customers are not satisfied with “one-size fits all” offerings and very few purchasing decisions are made solely on price. Further, musical instruments comprise a broad range of products each with their own underlying trends, including not only traditional products like guitars and drums, but also newer technology-intensive products like home recording equipment.

 

Over the past decade, technological advances in the music industry have resulted in dramatic changes in the nature of many 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 music product categories.

 

Technological innovation and the internet continue to increase the accessibility of producing, distributing and consuming music. Today, many musicians can affordably create a home recording studio that interacts with a personal computer and is capable of producing high-quality digital recordings. Until recently, this type of powerful sound processing capability was prohibitively expensive and was purchased primarily by professional sound recording studios.  In addition, musicians have evolving new distribution channels for their music, such as online music stores and social media websites.  These new distribution channels have dramatically altered the music distribution business by providing musicians with more direct and low cost access to potential listeners than under the traditional record company distribution business model.

 

Our competitive strengths

 

Market leader in fragmented industry. We are the leading retailer of music products in the United States based on net sales. We believe that our broad brick-and-mortar geographic footprint coupled with our significant online operations are key competitive strengths.

 

Recognized brand equity with sophisticated sales personnel. We believe the Guitar Center brand is widely recognized among professional and aspiring-professional musicians. This brand is supported by Guitar Center’s customer focused retail environment, which arranges a broad range of products in displays by product category to create a “shop within a shop” customer experience and service function. Sales personnel are key to the success of the shopping experience we offer, and they are often serious musicians with relevant industry experience who understand the needs of our sophisticated customer base. Our distinct retail store service also carries over into our online shopping experience through our Guitar Center and Music & Arts online operations and our direct response business. We believe our online operations are known for a high level of customer service, including technical product information, efficient service and a musician-based staff for additional support.

 

Diversified business model. Our combination of a multichannel retail presence and strong direct response business provides us with a diverse business model in which to address the rapidly changing needs of musicians. In addition, our three distinct businesses allow us to address the needs of a range of musicians, from beginners to hobbyists to professionals. Through our wide range and depth of customer relationships, we can monitor trends and adapt to and seize market opportunities.

 

Strong relationships with our vendors. We have long, established relationships with many of our vendors. Our size, brand recognition and historical payment credibility provide us with purchasing advantages compared to our smaller, local competitors. Our vendor relationships give us access to the latest products and exclusive inventories, expand our product base and allow us to appeal to diverse customer tastes. We also engage in special marketing campaigns, and, on limited occasions, we offer exceptional, limited edition products, often at premium prices. Though we do not necessarily view these products as recurring, limited edition products strengthen our brand equity and advance our reputation as an industry leader.

 

55



Table of Contents

 

Experienced management team and equity sponsor. We have a highly experienced management team with extensive industry knowledge. Our management team has worked with our skilled workforce to develop innovative new products, forge durable customer and vendor relationships and consistently maintain profitability and industry leadership.  In addition, our equity sponsor, Bain Capital, is a leading global private investment firm. Bain Capital has deep experience in a variety of industries, including the retail industry, which enables it to provide us and our management with significant strategic and operational guidance.

 

Our strategy

 

Continue to improve productivity in our Guitar Center brand. We are focused on improving the productivity of our Guitar Center brand through opening new stores, enhancing our multichannel capabilities and offering additional services to musicians such as repairs, lessons and rehearsal space. We intend to devote significant resources to enhancing the multichannel coordination between our in-store and online sales strategies. We will also continue to implement our logistics, systems and inventory management initiatives.

 

Enhance our sales and merchandise margins. We intend to expand our offering of proprietary products, which typically have higher profit margins when compared to branded products. Our proprietary product offering historically has been focused on “commodity” merchandise, such as cables, bags and accessories. However, we also intend to continue to expand our proprietary product offering in less “commoditized” product lines. The average gross margin for proprietary products is significantly higher than branded products in corresponding categories.

 

Enhance our direct response brands. We are focused on maintaining our market leading revenue position within our direct response brands. Our core strategies include personalization and one-to-one marketing that delivers products and services customized to the specific needs of musicians. We believe our continued focus on technology and infrastructure will enhance our direct response website user experience, improve our market responsiveness, increase our “speed to market” and further differentiate us from our competition.

 

Continue to build our Music & Arts brand. Our Music & Arts strategy is to continue focusing on improving operational efficiencies and reducing working capital requirements. Our longer-term Music & Arts strategy also includes opening additional stores and acquiring businesses within this fragmented market. In addition, we intend to continue to grow the music instrument rental business, which we believe will provide us with additional opportunities to attract young musicians as customers. We believe that attracting musicians at a young age will develop brand loyalty and enhance their lifetime value to us.

 

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.  In addition, our Guitar Center online channel offers a more expansive selection of SKUs.

 

Our stores are organized by product areas, with each area focused on specific products categories such as guitars, basses, amplifiers, drums and percussion, keyboards, pro audio and recording, DJ and live sound and used and vintage equipment. These departments address our customer’s specific product needs and are staffed by specialized salespeople, many of whom also are practicing musicians. We also offer a trade-in policy that 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 and vintage products are purchased and priced to sell by store managers, who are specially trained in the used musical instrument market.

 

Below is an overview of our principal departments:

 

·                  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, Ibanez, Line 6, Martin, Music Man, Ovation, PRS, Peavey and Yamaha are represented. A number of our stores also carry other stringed instruments such as banjos, mandolins and ukuleles. 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. We carry amplifiers from most major manufacturers, including Ampeg, Crate, Fender, Line 6, Marshall, Mesa Boogie, Peavey and Vox.

 

·                  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, Gretsch, Pearl, Sabian, Tama, Yamaha and Zildjian.

 

56



Table of Contents

 

·                  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 Korg, Roland 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 Apple, Avid, JBL, KRK, M-Audio, Mackie, PreSonus, Roland, Shure, Sony, Tascam and Yamaha.

 

Direct response

 

Our direct response business offers merchandise through its catalogs and online 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 proprietary 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 8,000 SKUs, while approximately 51,500 SKUs are offered on our websites.

 

Music & Arts

 

Our Music & Arts 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 stores offer a 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 stores include Leblanc, Jupiter, Gemeinhardt, Selmer, Buffet, Ludwig, Conn, Yamaha, Bach and Eastman.

 

Operations

 

Guitar Center

 

Our Guitar Center brands are managed by an Executive Vice President, Guitar Center Brands.  These operations include the multichannel retail and online operations of the brand, which is headed by an Executive Vice President, Multichannel.

 

Our Executive Vice President of Stores, regional sales managers, district sales managers and 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, two assistant store managers and five department managers. Each store also has a warehouse manager and a commissioned sales staff that ranges from approximately 10 to 40 employees. Our tertiary format stores are managed by a store manager, two assistant managers and a sales staff that ranges from seven to 15 employees.

 

Direct response

 

Our direct response operations are managed by an Executive Vice President, Direct Brands.  Each brand within the direct response business is managed by a brand manager.

 

Music & Arts

 

The operations of our Music & Arts business are managed by a Chief Executive Officer, an Executive Vice President of Operations, an Executive 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 proprietary databases that we have developed for Guitar Center, Musician’s Friend and Music & Arts. Included in these databases is information on millions of our customers.  We believe that these databases assist us in identifying customer prospects, generating repeat business by targeting customers based on their purchasing history and establishing and maintaining personal relationships with our customers.

 

57



Table of Contents

 

Guitar Center stores

 

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, the Anniversary Sale and the Guitar-a-thon. These events often are coordinated with product demonstrations, interactive displays, clinics and in-store artist appearances.  We have begun to use television advertising to supplement or promote these events and to create general brand awareness.  In addition, our online channel conducts marketing and promotion through many of the same methods as our direct response operations.

 

As we enter new markets, we initiate an advertising program, including mail and radio promotions, internet campaigns and other special grand opening activities. Each element of this advertising program is designed to accelerate sales volume for each new store.

 

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, such 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 customer 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.  Our merchandising and marketing departments use our customer research 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.

 

Our direct response strategy includes the development of catalogs targeted towards particular segments of the musician market.

 

Music & Arts

 

Our advertising efforts for the Music & Arts 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 outside sales education representatives to promote and educate band directors on our instruments and our sales and rental programs. We also strive to 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 often are musicians trained to understand the needs of our customers. Guitar Center store salespeople specialize in one of our 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.  Support for our online customers is handled through experienced contact center staff.

 

Direct response

 

Our direct response customer contact staff receives product and customer service training in our Salt Lake City, Utah and South Bend, Indiana contact center facilities. 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. Many of the staff are musicians who are given extensive and ongoing product training. We have full-time and part-time customer service employees staffing the contact center 24 hours a day, seven days a week.

 

58



Table of Contents

 

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

 

Sales at our Music & Arts 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 contact 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.

 

Currently, Guitar Center, direct response and Music & Arts each maintain buying groups. Our 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.  In connection with the relocation of our direct response operations in Oregon to Southern California in 2012, we expect to begin operating a variety of functions, such as buying, through a centralized shared services organization.

 

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. See “Risk Factors—Risks Related to Our Business—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. We have numerous commitments necessary to support the operations of the facility, including a lease on the facility.

 

We have invested significant time and resources in our inventory control system at the Guitar Center stores. We perform frequent inventory cycle counts, 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.

 

Direct response

 

Direct response and other brand online orders are fulfilled out of our Kansas City, Missouri fulfillment center.  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.

 

Music & Arts

 

Products for our Music & Arts stores generally are processed through a central distribution facility located in Frederick, Maryland. We have a number of local hubs and/or support centers to enhance product availability during our peak back to school season.

 

59



Table of Contents

 

Retail store site selection

 

We have developed a set of selection criteria to identify prospective store sites for our Guitar Center and Music & Arts 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 stores generally are located in specialized shopping centers to maximize traffic from targeted customers such as students and their parents.

 

The initial lease terms for our Guitar Center stores typically range from 10 to 15 years and allow us to renew for two additional five-year terms. The initial lease terms for our Music & Arts stores typically range from 5 to 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.

 

Information technology

 

Retail 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.

 

Online sales

 

We maintain 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 us with marketing, merchandising and operational information and provide contact center and customer service staff with current inventory and customer account information.

 

Music & Arts

 

We continue to invest significant resources in the development and implementation of information systems at our Music & Arts 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, online auctions, direct-to-consumer alternatives and a growing number of large mass merchants.

 

Large online companies such as Amazon and eBay increasingly have expanded their offerings of musical instruments and related products.  In addition, our retail stores and online operations compete with other direct response musical instrument companies such as American Musical Supply, Sweetwater Sound and Full Compass.

 

A number of large mass merchants, including Wal-Mart, Best Buy, Target and Costco, sell music products in categories in which we compete. Best Buy also operates a store-within-a-store concept for music products which includes a significantly expanded selection of products.

 

We are in direct competition with numerous small local and regional musical instrument retailers as well as large national retailers such as Sam Ash Music based in New York, New York. Sam Ash has continued to open and maintain stores in markets in which we are located.

 

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 operations will face in the future. In particular, competition within the online portion of our businesses has been increasing and is intense, and we expect that this competition will continue in the future.

 

60



Table of Contents

 

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.  See “Risks Related to Our Business - Significant existing and new competition in our industry could adversely affect us.”

 

Employees

 

As of March 31, 2011, we employed 9,148 people, of whom 1,792 were part time employees and 7,356 were 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.” We rely on the trademark, copyright and trade secret laws of the United States and other countries to protect our proprietary rights. 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.

 

Properties

 

Our corporate headquarters and headquarters for our Guitar Center brand operations 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 2017. These properties consist of office and warehouse space. Our direct response operations are currently headquartered in a facility of 45,000 square feet that we own in Medford, Oregon. Our Music & Arts operations are headquartered in a leased facility located in Frederick, Maryland. The lease for this property expires in December 2012.  While we believe that in general our existing facilities are adequate for our current needs, we are looking for additional space in Southern California in connection with the relocation of our direct response business.

 

The distribution center for our Guitar Center stores is located in a leased facility near Indianapolis, Indiana, which is approximately 773,000 square feet in size. The lease term expires in December 2018.  We lease a facility in Kansas City, Missouri, with approximately 702,000 of aggregate square footage under an agreement expiring in March 2016 for use as a fulfillment center for our online operations.  We also lease a distribution facility of approximately 60,000 square feet in Frederick, Maryland, for our Music & Arts operations, with a lease expiration of February 2014.

 

We lease approximately 25,500 square feet of office space in Salt Lake City, Utah, for a customer contact center facility. This lease expires in December 2011.  We also lease an office, warehouse and contact center facility of approximately 122,000 square feet for our Woodwind & Brasswind business in South Bend, Indiana.  The lease on this facility expires in February 2012.  We currently are exploring our options with respect to these two properties.

 

The initial lease terms for our Guitar Center stores typically range from 10 to 15 years and allow us to renew for two additional five-year terms. The initial lease terms for our Music & Arts stores typically range from five to 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.

 

As of March 31, 2011, we operated 216 Guitar Center stores consisting of approximately 3.3 million square feet, including approximately 3.2 million square feet of leased space and approximately 54,000 square feet of owned space. As of March 31, 2011, we operated 99 Music & Arts stores consisting of approximately 346,000 square feet, all of which is leased.

 

A breakdown of our retail store locations as of March 31, 2011, is as follows:

 

 

 

Number of Stores

 

State

 

Guitar Center

 

Music & Arts

 

Total

 

AL

 

3

 

 

3

 

AR

 

2

 

 

2

 

AZ

 

5

 

4

 

9

 

CA

 

29

 

 

29

 

CO

 

6

 

3

 

9

 

CT

 

3

 

6

 

9

 

DE

 

 

1

 

1

 

FL

 

13

 

3

 

16

 

GA

 

4

 

8

 

12

 

IA

 

3

 

 

3

 

 

61



Table of Contents

 

ID

 

1

 

 

1

 

IL

 

12

 

2

 

14

 

IN

 

7

 

 

7

 

KS

 

2

 

 

2

 

KY

 

3

 

 

3

 

LA

 

2

 

 

2

 

MA

 

5

 

3

 

8

 

MD

 

3

 

10

 

13

 

ME

 

1

 

 

1

 

MI

 

8

 

 

8

 

MN

 

4

 

 

4

 

MO

 

4

 

 

4

 

MS

 

1

 

 

1

 

NC

 

4

 

7

 

11

 

NE

 

1

 

 

1

 

NH

 

1

 

1

 

2

 

NJ

 

7

 

3

 

10

 

NM

 

1

 

 

1

 

NV

 

3