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 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. Adjusted EBITDA should be used 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 September 30, 2013
	Guitar Center			Music & Arts		Direct Response			Corporate			Total
Net sales	$	389,367		$	70,387	$	60,929		$	—		$	520,683
Gross profit	106,400			24,127		17,018			(12		)	147,533
Selling, general and administrative expenses	97,011			22,616		19,259			7,484			146,370
Impairment of intangible assets	—			—		—			—			—
Impairment of goodwill	360,100			—		—			—			360,100
Operating income (loss)	(350,711		)	1,511		(2,241		)	(7,496		)	(358,937		)
Depreciation and amortization	15,700			1,450		3,945			1,080			22,175
Adjusted EBITDA	28,103			3,090		1,834			(5,059		)	27,968
Capital expenditures	10,524			2,184		3,026			1,084			16,818

	Three months ended September 30, 2012
	Guitar Center			Music & Arts		Direct Response			Corporate			Total
Net sales	$	366,564		$	64,591	$	65,076		$	—		$	496,231
Gross profit	103,320			23,068		20,530			444			147,362
Selling, general and administrative expenses	84,751			21,539		17,766			7,322			131,378
Operating income (loss)	18,569			1,529		2,764			(6,878		)	15,984
Depreciation and amortization	16,728			1,261		3,659			1,019			22,667
Adjusted EBITDA	36,643			2,867		6,561			(3,492		)	42,579
Capital expenditures	9,736			1,425		1,885			3,270			16,316

	Nine months ended September 30, 2013
	Guitar Center			Music & Arts		Direct Response			Corporate			Total
Net sales	$	1,169,000		$	189,466	$	198,888		$	—		$	1,557,354
Gross profit	322,310			75,028		54,053			(12		)	451,379
Selling, general and administrative expenses	279,097			63,503		60,527			20,490			423,617
Impairment of intangible assets	—			—		2,300			—			2,300
Impairment of goodwill	360,100			—		—			—			360,100
Operating income (loss)	(316,887		)	11,525		(8,774		)	(20,502		)	(334,638		)
Depreciation and amortization	46,072			3,870		11,971			3,284			65,197
Adjusted EBITDA	96,017			16,261		7,641			(10,875		)	109,044
Capital expenditures	26,558			5,678		5,123			6,721			44,080
Total assets
Holdings	1,050,983			139,900		155,196			86,735			1,432,814
Guitar Center	1,050,983			139,900		155,196			91,483			1,437,562

	Nine months ended September 30, 2012
	Guitar Center			Music & Arts		Direct Response			Corporate			Total
Net sales	$	1,125,599		$	173,965	$	211,416		$	—		$	1,510,980
Gross profit	324,327			70,753		62,217			102			457,399
Selling, general and administrative expenses	261,458			61,025		61,943			18,572			402,998
Operating income (loss)	62,869			9,728		274			(18,470		)	54,401
Depreciation and amortization	49,467			3,691		11,486			2,760			67,404
Adjusted EBITDA	116,438			14,049		12,604			(8,212		)	134,879
Capital expenditures	28,487			4,319		6,022			9,953			48,781
Total assets
Holdings	1,461,716			123,439		184,192			76,755			1,846,102
Guitar Center	1,461,716			123,439		184,192			98,865			1,868,212

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 September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Adjusted EBITDA
Guitar Center	$	28,103		$	36,643		$	96,017		$	116,438
Music & Arts	3,090			2,867			16,261			14,049
Direct response	1,834			6,561			7,641			12,604
Corporate	(5,059		)	(3,492		)	(10,875		)	(8,212		)
	27,968			42,579			109,044			134,879

Depreciation and amortization expense	22,175			22,667			65,197			67,404
Interest expense, net	39,264			41,208			119,298			123,726
Non-cash charges	2,002			525			2,255			2,215
Impairment charges	361,029			559			364,131			559
Other adjustments	1,699			2,844			12,099			10,300

Consolidated loss before income taxes	$	(398,201	)	$	(25,224	)	$	(453,936	)	$	(69,325	)

Guitar Center

	Three months ended September 30,						Nine months ended September 30,
	2013			2012			2013			2012
Adjusted EBITDA
Guitar Center	$	28,103		$	36,643		$	96,017		$	116,438
Music & Arts	3,090			2,867			16,261			14,049
Direct response	1,834			6,561			7,641			12,604
Corporate	(5,059		)	(3,492		)	(10,875		)	(8,212		)
	27,968			42,579			109,044			134,879

Depreciation and amortization expense	22,175			22,667			65,197			67,404
Interest expense, net	23,842			21,214			67,699			63,746
Non-cash charges	2,002			525			2,255			2,215
Impairment charges	361,029			559			364,131			559
Other adjustments	1,699			2,844			12,099			10,300

Consolidated loss before income taxes	$	(382,779	)	$	(5,230	)	$	(402,337	)	$	(9,345	)

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.

· Impairment charges for the three and nine months ended September 30, 2103 include an estimated goodwill impairment charge of $360.1 million at our Guitar Center segment.

· 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 nine months ended September 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, but we cannot be certain of what amount, if any, we will recover.

Other adjustments include restructuring charges of $0.2 million for the three months ended September 30, 2012 and $1.9 million for the nine months ended September 30, 2012.