Segment Information

3 Months Ended

Mar. 31, 2013

Segment Information

Segment Information

4. Segment Information

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

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

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

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

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

Beginning in 2013, our Music & Arts segment includes the operations of our Woodwind & Brasswind branded website and catalogs, which were previously managed together with our direct response segment. Management determined it was appropriate to operate the Music & Arts and Woodwind & Brasswind brands under common management and to evaluate their performance together, given the similarity of product lines offered and target customers of these brands. In addition, management elected in 2013 to allocate the costs of certain shared corporate services to our Guitar Center and direct response segments to provide better visibility into usage at each segment. We have adjusted the 2012 segment disclosures to reflect these changes in the measures of segment performance that are provided to our chief operating decision makers.

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

Adjusted EBITDA is not a recognized measurement under GAAP and should not be used in isolation or as a substitute for GAAP measures when analyzing our operating performance. Readers should use adjusted EBITDA in addition to, and not as an alternative for, net income or loss as determined in accordance with GAAP. Because not all companies use identical calculations, our presentation of adjusted EBITDA may not be comparable to similarly titled measures of other companies. Furthermore, adjusted EBITDA is not intended to be a measure of free cash flow for our management’s discretionary use, as it does not consider certain cash requirements such as income tax payments, capital expenditures, working capital and debt service payments.

The following tables summarize financial information for Holdings’ and Guitar Center’s reportable segments (in thousands):

	Three months ended March 31, 2013
	GuitarCenter		Music & Arts		Direct Response			Corporate			Total
Net sales	$	400,498	$	58,365	$	72,970		$	—		$	531,833
Gross profit	112,467		26,134		18,939			—			157,540
Selling, general and administrative expenses	91,663		20,053		22,305			6,585			140,606
Operating income (loss)	20,804		6,081		(3,366		)	(6,585		)	16,934
Depreciation and amortization	15,377		1,251		4,042			878			21,548
Adjusted EBITDA	37,999		7,846		2,751			(2,814		)	45,782
Capital expenditures	9,046		1,507		933			2,633			14,119
Total assets
Holdings	1,421,408		117,150		158,165			133,657			1,830,380
Guitar Center	1,421,408		117,150		158,165			165,386			1,862,109

	Three months ended March 31, 2012
	GuitarCenter		Music & Arts		Direct Response			Corporate			Total
Net sales	$	393,704	$	55,069	$	79,378		$	—		$	528,151
Gross profit	117,069		25,022		21,930			(445		)	163,576
Selling, general and administrative expenses	89,683		19,166		22,926			6,277			138,052
Operating income (loss)	27,386		5,856		(996		)	(6,722		)	25,524
Depreciation and amortization	16,645		1,180		3,994			826			22,645
Adjusted EBITDA	45,671		7,048		3,492			(2,982		)	53,229
Capital expenditures	6,319		846		1,519			3,180			11,864
Total assets
Holdings	1,480,250		108,267		169,336			140,994			1,898,847
Guitar Center	1,480,250		108,267		169,336			165,780			1,923,633

We record property and equipment at our segments based on direct capital expenditures made at each segment.  Total assets of our direct response segment include the assets of our order fulfillment center and customer contact centers, and certain other assets that support the online operations of our Guitar Center and Music & Arts segments. We allocate depreciation and amortization expense to our segments based on actual usage for assets used exclusively at each segment, and based on estimated usage, primarily measured by gross sales, for shared assets.

Material unallocated assets at our corporate segment primarily consist of cash, shared information technology infrastructure assets, including our data centers, corporate office facilities, deferred income taxes and capitalized financing fees.

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

Holdings

	Three months ended March 31,
	2013			2012
Adjusted EBITDA
Guitar Center	$	37,999		$	45,671
Music & Arts	7,846			7,048
Direct response	2,751			3,492
Corporate	(2,814		)	(2,982		)
	45,782			53,229
Depreciation and amortization expense	21,548			22,645
Interest expense, net	41,358			41,173
Non-cash charges	331			896
Other adjustments	6,969			4,164
Consolidated loss before income taxes	$	(24,424	)	$	(15,649	)

Guitar Center

	Three months ended March 31,
	2013			2012
Adjusted EBITDA
Guitar Center	$	37,999		$	45,671
Music & Arts	7,846			7,048
Direct response	2,751			3,492
Corporate	(2,814		)	(2,982		)
	45,782			53,229
Depreciation and amortization expense	21,548			22,645
Interest expense, net	21,365			21,179
Non-cash charges	331			896
Other adjustments	6,969			4,164
Consolidated income (loss) before income taxes	$	(4,431	)	$	4,345

Adjustments in the calculation of adjusted EBITDA include the following:

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

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

Other adjustments for the three months ended March 31, 2013 include a loss of $3.1 million related to payments we made to a third-party freight invoice processor that ceased operations. We plan to pursue the recovery of this amount from the third-party processor, but we cannot be certain of what amount, if any, we will recover.

Other adjustments for the three months ended March 31, 2012 include restructuring charges of $1.1 million.