Segment Information

6 Months Ended

Jun. 30, 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 reported together with our direct response segment. Management determined it was appropriate to evaluate the Music & Arts and Woodwind & Brasswind brands 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 June 30, 2013
	Guitar Center		Music & Arts		Direct Response			Corporate			Total
Net sales	$	379,135	$	60,714	$	64,989		$	—		$	504,838
Gross profit	103,443		24,765		18,096			—			146,304
Selling, general and administrative expenses	90,424		20,833		18,962			6,420			136,639
Impairment of intangible assets	—		—		2,300			—			2,300
Operating income (loss)	13,019		3,932		(3,166		)	(6,420		)	7,365
Depreciation and amortization	14,995		1,168		3,984			1,327			21,474
Adjusted EBITDA	29,914		5,325		3,056			(3,001		)	35,294
Capital expenditures	6,989		1,987		1,167			3,000			13,143

	Three months ended June 30, 2012
	Guitar Center		Music & Arts		Direct Response			Corporate			Total
Net sales	$	365,331	$	54,305	$	66,962		$	—		$	486,598
Gross profit	103,937		22,663		19,757			103			146,460
Selling, general and administrative expenses	87,024		20,321		21,250			4,973			133,568
Operating income (loss)	16,913		2,342		(1,493		)	(4,870		)	12,892
Depreciation and amortization	16,095		1,250		3,833			914			22,092
Adjusted EBITDA	34,124		4,134		2,550			(1,738		)	39,070
Capital expenditures	12,432		2,048		2,618			3,503			20,601

	Six months ended June 30, 2013
	Guitar Center		Music & Arts		Direct Response			Corporate			Total
Net sales	$	779,633	$	119,079	$	137,959		$	—		$	1,036,671
Gross profit	215,911		50,899		37,034			—			303,844
Selling, general and administrative expenses	182,087		40,886		41,267			13,005			277,245
Impairment of intangible assets	—		—		2,300			—			2,300
Operating income (loss)	33,824		10,013		(6,533		)	(13,005		)	24,299
Depreciation and amortization	30,371		2,420		8,026			2,205			43,022
Adjusted EBITDA	67,914		13,171		5,807			(5,816		)	81,076
Capital expenditures	16,035		3,494		2,097			5,636			27,262
Total assets
Holdings	1,406,664		135,751		153,511			80,015			1,775,941
Guitar Center	1,406,664		135,751		153,511			112,336			1,808,262

	Six months ended June 30, 2012
	Guitar Center		Music & Arts		Direct Response			Corporate			Total
Net sales	$	759,036	$	109,374	$	146,340		$	—		$	1,014,750
Gross profit	221,006		47,686		41,688			(343		)	310,037
Selling, general and administrative expenses	176,707		39,487		44,176			11,250			271,620
Operating income (loss)	44,299		8,199		(2,488		)	(11,593		)	38,417
Depreciation and amortization	32,739		2,430		7,827			1,741			44,737
Adjusted EBITDA	79,795		11,182		6,042			(4,720		)	92,299
Capital expenditures	18,751		2,894		4,137			6,683			32,465
Total assets
Holdings	1,442,926		124,163		175,188			83,290			1,825,567
Guitar Center	1,442,926		124,163		175,188			104,825			1,847,102

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 also 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, internally-developed software costs, corporate office facilities, deferred income taxes and capitalized financing fees.

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

Holdings

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Adjusted EBITDA
Guitar Center	$	29,914		$	34,124		$	67,914		$	79,795
Music & Arts	5,325			4,134			13,171			11,182
Direct response	3,056			2,550			5,807			6,042
Corporate	(3,001		)	(1,738		)	(5,816		)	(4,720		)
	35,294			39,070			81,076			92,299
Depreciation and amortization expense	21,474			22,092			43,022			44,737
Interest expense, net	38,676			41,345			80,034			82,519
Non-cash charges	(78		)	794			253			1,690
Impairment charges	3,102			—			3,102			—
Other adjustments	3,431			3,292			10,400			7,455
Consolidated loss before income taxes	$	(31,311	)	$	(28,453	)	$	(55,735	)	$	(44,102	)

Guitar Center

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Adjusted EBITDA
Guitar Center	$	29,914		$	34,124		$	67,914		$	79,795
Music & Arts	5,325			4,134			13,171			11,182
Direct response	3,056			2,550			5,807			6,042
Corporate	(3,001		)	(1,738		)	(5,816		)	(4,720		)
	35,294			39,070			81,076			92,299
Depreciation and amortization expense	21,474			22,092			43,022			44,737
Interest expense, net	22,492			21,351			43,857			42,532
Non-cash charges	(78		)	794			253			1,690
Impairment charges	3,102			—			3,102			—
Other adjustments	3,431			3,292			10,400			7,455
Consolidated loss before income taxes	$	(15,127	)	$	(8,459	)	$	(19,558	)	$	(4,115	)

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 of Holdings.

Other adjustments for the six months ended June 30, 2013 include a loss of $3.0 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 include restructuring charges of $0.6 million for the three months ended June 30, 2012 and $1.7 million for the six months ended June 30, 2012.