UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2013

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

For the transition period from to

Commission File Number 333-175270-07

GUITAR CENTER HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		26-0843262
(State or Other Jurisdiction of		(I.R.S. Employer Identification No.)
Incorporation or Organization)

5795 Lindero Canyon Road
Westlake Village, California 91362		(818) 735-8800
(Address of Principal Executive Offices, including Zip Code)		(Registrant’s Telephone Number, Including Area Code)

Commission File Number 000-22207

GUITAR CENTER, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		95-4600862
(State or Other Jurisdiction of		(I.R.S. Employer Identification No.)
Incorporation or Organization)

5795 Lindero Canyon Road
Westlake Village, California 91362		(818) 735-8800
(Address of Principal Executive Offices, including Zip Code)		(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Holdings*		YES o NO o
Guitar Center*		YES o NO o

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

Holdings		YES x NO o
Guitar Center		YES x NO o

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

Holdings

Large accelerated filer o		Accelerated filer o

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

Guitar Center

Large accelerated filer o		Accelerated filer o

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

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

Holdings		YES o NO x
Guitar Center		YES o NO x

As of May 8, 2013 there were 9,740,160 shares of common stock, $0.01 par value per share, of Holdings outstanding.

As of May 8, 2013, there were 100 shares of common stock, $0.01 par value per share, of Guitar Center outstanding, all of which are owned by Holdings.

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

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Explanatory Note

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

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PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements	1

	Guitar Center Holdings, Inc. and Subsidiaries	1

	Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012 (unaudited)	1

	Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2013 and 2012 (unaudited)	2

	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012 (unaudited)	3

	Guitar Center, Inc. and Subsidiaries	4

	Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012 (unaudited)	4

	Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2013 and 2012 (unaudited)	5

	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2013 and 2012 (unaudited)	6

	Guitar Center Holdings, Inc. and Subsidiaries and Guitar Center, Inc. and Subsidiaries	7

	Combined Notes to Condensed Consolidated Financial Statements (unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	28

PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	28

Item 1A.	Risk Factors	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28

Item 3.	Defaults Upon Senior Securities	28

Item 4.	Mine Safety Disclosures	28

Item 5.	Other Information	28

Item 6.	Exhibits	29

Signatures		30

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par values)

(unaudited)

	March 31, 2013			December 31, 2012
Assets
Current assets:
Cash	$	105,181		$	74,836
Accounts receivable, net of allowance for doubtful accounts of $2,874 and $2,849, respectively	43,846			44,015
Merchandise inventories	559,440			564,959
Prepaid expenses and other current assets	23,299			23,285
Deferred income taxes	3,165			3,165
Total current assets	734,931			710,260
Property and equipment, net of accumulated depreciation and amortization of $266,485 and $250,835, respectively	209,692			213,969
Goodwill	582,378			582,378
Intangible assets, net of accumulated amortization of $205,805 and $200,040, respectively	285,504			291,269
Other assets, net	17,875			18,682
Total assets	$	1,830,380		$	1,816,558

Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable	$	135,404		$	116,973
Accrued expenses and other current liabilities	152,474			132,119
Merchandise advances	33,277			34,901
Current portion of long-term debt	136,542			135,725
Total current liabilities	457,697			419,718
Other long-term liabilities	21,008			20,669
Deferred income taxes	79,484			79,537
Long-term debt	1,444,231			1,445,654
Total liabilities	2,002,420			1,965,578
Commitments and contingencies
Stockholders’ deficit:
Preferred stock, $0.01 par value, 5,000 shares authorized, none issued and outstanding	—			—
Common stock, $0.01 par value, 20,000 shares authorized,9,740 issued and outstanding	97			97
Additional paid-in capital	634,173			633,800
Accumulated deficit	(806,310		)	(782,917		)
Total stockholders’ deficit	(172,040		)	(149,020		)
Total liabilities and stockholders’ deficit	$	1,830,380		$	1,816,558

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

	Three months ended March 31,
	2013			2012
Net sales	$	531,833		$	528,151
Cost of goods sold, buying and occupancy	374,293			364,575
Gross profit	157,540			163,576
Selling, general and administrative expenses	140,606			138,052
Operating income	16,934			25,524
Interest expense	(41,373		)	(41,191		)
Interest income	15			18
Loss before income taxes	(24,424		)	(15,649		)
Income tax expense (benefit)	(1,031		)	561
Net loss	(23,393		)	(16,210		)
Other comprehensive income, net of income tax	—			54
Comprehensive loss	$	(23,393	)	$	(16,156	)

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three months ended March 31,
	2013			2012
Operating activities:
Net loss	$	(23,393	)	$	(16,210	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	21,548			22,645
Net (gain) loss on disposal of property and equipment	(1		)	4
Amortization of deferred financing fees	803			784
Non-cash interest expense	—			82
Stock-based compensation	373			254
Deferred income taxes	(53		)	(262		)
Changes in operating assets and liabilities:
Accounts receivable	169			5,273
Merchandise inventories	5,519			(16,772		)
Prepaid expenses and other current assets	(14		)	(4,959		)
Other assets, net	4			—
Accounts payable	18,431			45,009
Accrued expenses and other current liabilities	23,437			11,539
Merchandise advances	(1,624		)	(1,714		)
Other long-term liabilities	339			(501		)
Net cash provided by operating activities	45,538			45,172

Investing activities:
Purchase of property and equipment	(14,119		)	(11,864		)
Net proceeds from disposal of property and equipment	2			29
Net cash used in investing activities	(14,117		)	(11,835		)

Financing activities:
Repayment of long-term debt	(1,076		)	(161		)
Financing fees	—			(731		)
Net cash used in financing activities	(1,076		)	(892		)
Net increase in cash	30,345			32,445
Cash at beginning of period	74,836			106,036
Cash at end of period	$	105,181		$	138,481

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	9,329		$	9,591
Income taxes	116			443
Non-cash investing and financing activities:
Assets acquired under capital lease	$	470		$	—

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	March 31, 2013			December 31, 2012
Assets
Current assets:
Cash	$	105,181		$	74,836
Accounts receivable, net of allowance for doubtful accounts of $2,874 and $2,849, respectively	43,846			44,015
Merchandise inventories	559,440			564,959
Prepaid expenses and other current assets	23,299			23,285
Deferred income taxes	36,988			34,614
Total current assets	768,754			741,709
Property and equipment, net of accumulated depreciation and amortization of $266,485 and $250,835, respectively	209,692			213,969
Goodwill	582,378			582,378
Intangible assets, net of accumulated amortization of $205,805 and $200,040, respectively	285,504			291,269
Other assets, net	15,781			16,484
Total assets	$	1,862,109		$	1,845,809

Liabilities and Stockholder’s Equity
Current liabilities:
Accounts payable	$	135,404		$	116,973
Accrued expenses and other current liabilities	202,975			199,195
Merchandise advances	33,277			34,901
Current portion of long-term debt	6,758			5,941
Total current liabilities	378,414			357,010
Other long-term liabilities	21,008			20,669
Deferred income taxes	104,153			105,327
Long-term debt	1,009,342			1,010,765
Due to Guitar Center Holdings, Inc.	224,113			224,113
Total liabilities	1,737,030			1,717,884
Commitments and contingencies
Stockholder’s equity:
Common stock, $0.01 par value, 1,000 shares authorized 100 shares issued and outstanding	—			—
Additional paid-in capital	620,563			620,190
Accumulated deficit	(495,484		)	(492,265		)
Total stockholder’s equity	125,079			127,925
Total liabilities and stockholder’s equity	$	1,862,109		$	1,845,809

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

	Three months ended March 31,
	2013			2012
Net sales	$	531,833		$	528,151
Cost of goods sold, buying and occupancy	374,293			364,575
Gross profit	157,540			163,576
Selling, general and administrative expenses	140,606			138,052
Operating income	16,934			25,524
Interest expense	(21,380		)	(21,197		)
Interest income	15			18
Income (loss) before income taxes	(4,431		)	4,345
Income tax expense (benefit)	(1,212		)	1,798
Net income (loss)	(3,219		)	2,547
Other comprehensive income, net of income tax	—			54
Comprehensive income (loss)	$	(3,219	)	$	2,601

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three months ended March 31,
	2013			2012
Operating activities:
Net income (loss)	$	(3,219	)	$	2,547
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization	21,548			22,645
Net (gain) loss on disposal of property and equipment	(1		)	4
Amortization of deferred financing fees	699			681
Non-cash interest expense	—			82
Stock-based compensation	373			254
Deferred income taxes	(3,548		)	(5,173		)
Changes in operating assets and liabilities:
Accounts receivable	169			5,273
Merchandise inventories	5,519			(16,772		)
Prepaid expenses and other current assets	(14		)	(6,046		)
Other assets, net	4			—
Accounts payable	18,431			45,009
Accrued expenses and other current liabilities	6,862			(1,117		)
Merchandise advances	(1,624		)	(1,714		)
Other long-term liabilities	339			(501		)
Net cash provided by operating activities	45,538			45,172

Investing activities:
Purchase of property and equipment	(14,119		)	(11,864		)
Net proceeds from disposal of property and equipment	2			29
Net cash used in investing activities	(14,117		)	(11,835		)

Financing activities:
Repayment of long-term debt	(1,076		)	(161		)
Financing fees	—			(731		)
Net cash used in financing activities	(1,076		)	(892		)
Net increase in cash	30,345			32,445
Cash at beginning of period	74,836			106,036
Cash at end of period	$	105,181		$	138,481

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	9,329		$	9,591
Income taxes	116			443
Non-cash investing and financing activities:
Assets acquired under capital lease	$	470		$	—

See accompanying notes to condensed consolidated financial statements

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Nature of Business and Significant Accounting Policies

Nature of Business

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

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

We are the leading retailer of music products in the United States based on revenue. We operate three businesses under our Guitar Center, direct response and Music & Arts brands.

Our Guitar Center business offers guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment through retail stores and online, along with repair services and rehearsal and/or lesson space in a limited number of stores. As of March 31, 2013, Guitar Center operated 244 Guitar Center stores across the United States, with 151 primary format stores, 80 secondary format stores and 13 tertiary format stores.

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

Our Music & Arts business specializes in band and orchestra instruments for sale and rental, serving students, teachers, band directors and college professors. As of March 31, 2013, Music & Arts operated 110 stores in 22 states, along with the Music & Arts and Woodwind & Brasswind websites.

Principles of Consolidation

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

Unaudited Interim Financial Information

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC, for reporting on Form 10-Q. Accordingly, these notes do not include all disclosures normally included in complete financial statements prepared in accordance with GAAP. We believe the disclosures made are adequate for an understanding of the changes in financial position and performance of the entity since the last annual reporting date. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 26, 2013.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

Our business follows a seasonal pattern, peaking during the holiday selling season in November and December. Fourth quarter sales at our Guitar Center and direct response segments are typically significantly higher than in any other quarter. Accordingly, interim results may not be indicative of results for the entire year. Seasonality for our Music & Arts business centers around band rental season, which starts in August and carries through mid-October, but that seasonality does not have a significant impact on our consolidated results.

Use of Estimates in the Preparation of Financial Statements

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

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

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

2. Goodwill and Intangible Assets

Goodwill

Goodwill at our Guitar Center segment as of March 31, 2013 and December 31, 2012 consisted of a gross amount of $706.2 million, less accumulated impairment losses of $123.8 million.

Other intangible assets

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

		March 31, 2013
	Weighted-	Gross
	Average Useful	Carrying		Accumulated			Intangible
	Life	Amount		Amortization			Assets, Net
Unamortized trademarks	—	$	208,501	$	—		$	208,501
Amortized
Customer relationships	13.0	224,302		(152,612		)	71,690
Favorable lease terms	7.5	57,721		(52,506		)	5,215
Covenants not to compete and other	4.3	785		(687		)	98
		$	491,309	$	(205,805	)	$	285,504

		December 31, 2012
	Weighted-	Gross
	Average Useful	Carrying		Accumulated			Intangible
	Life	Amount		Amortization			Assets, Net
Unamortized trademarks	—	$	208,501	$	—		$	208,501
Amortized
Customer relationships	13.0	224,302		(148,042		)	76,260
Favorable lease terms	7.5	57,721		(51,323		)	6,398
Covenants not to compete and other	4.3	785		(675		)	110
		$	491,309	$	(200,040	)	$	291,269

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

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

	Three months ended March 31,
	2013		2012
Cost of goods sold, buying and occupancy	$	1,183	$	1,627
Selling, general and administrative expenses	4,582		5,778

The future estimated amortization expense related to intangible assets as of March 31, 2013 was as follows (in thousands):

Year
Remainder of 2013	$	16,462
2014	16,387
2015	12,442
2016	9,640
2017	7,620
Thereafter	14,452
Total	$	77,003

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

3. Long-Term Debt

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

	March 31,		December 31,
	2013		2012
Guitar Center
Senior secured asset-based revolving facility	$	—	$	—
Senior secured term loan	620,750		621,762
Obligations under capital leases, payable in monthly installments through 2014 and 2013, respectively	460		54
Senior unsecured notes	394,890		394,890
	1,016,100		1,016,706
Less current portion	6,758		5,941
Guitar Center long-term debt, net of current portion	1,009,342		1,010,765

Holdings
Senior unsecured PIK notes	564,673		564,673
Less current portion	129,784		129,784
Holdings long-term debt, net of current portion	434,889		434,889

Holdings consolidated long-term debt, net of current portion	$	1,444,231	$	1,445,654

Guitar Center long-term debt as of March 31, 2013 consisted of (1) a senior secured asset-based revolving facility, referred to as the asset-based facility, with a maximum availability of $373 million, (2) a senior secured term loan facility, referred to as the term loan, with an initial aggregate principal amount of $650 million and (3) a senior unsecured loan facility, referred to as the senior notes, with an initial aggregate principal amount of $375 million.

Holdings long-term debt as of March 31, 2013 consisted of a senior subordinated unsecured payment-in-kind loan facility, referred to as the senior PIK notes, with an initial aggregate principal amount of $375 million.

Guarantees, dividend restrictions and covenants

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

For information about dividend restrictions among Holdings, Guitar Center and its guarantor subsidiaries, see Note 5 to the audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 26, 2013.

As of March 31, 2013, we were in compliance with all of our debt covenants.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Future maturities

Future maturities and expected payments of long-term debt as of March 31, 2013 were as follows (in thousands):

	Guitar Center		Holdings		Holdings Consolidated
Remainder of 2013 (1)	$	5,067	$	129,784	$	134,851
2014	14,582		—		14,582
2015	6,500		—		6,500
2016	6,500		—		6,500
2017	983,451		—		983,451
2018	—		434,889		434,889
	$	1,016,100	$	564,673	$	1,580,773

(1) We made a one-time principal payment on the senior PIK notes in April 2013. This payment was $129.8 million, which is the amount of previously capitalized PIK interest required to be paid to prevent the senior PIK notes from being treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code. We funded this payment with cash available from operations and amounts drawn on the asset-based revolving credit facility. This amount is included in current portion of long-term debt in Holdings’ condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

	Three months ended March 31, 2013
	Guitar Center		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
	Guitar Center		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.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The following tables present a reconciliation of adjusted EBITDA to consolidated 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

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Adjustments in the calculation of adjusted EBITDA include the following:

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

· 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.

5. Fair Value Measurements

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

Valuation inputs are classified into the following hierarchy:

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

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

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

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

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

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

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

We did not make any non-recurring fair value measurements during the three months ended March 31, 2013.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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

	March 31, 2013				December 31, 2012
	Carrying Amount		Fair Value		Carrying Amount		Fair Value

Guitar Center
Senior secured term loan	$	620,750	$	617,646	$	621,762	$	600,000
Senior unsecured notes	394,890		428,219		394,890		418,579
Capital lease obligations	460		460		54		54
Total Guitar Center	1,016,100		1,046,325		1,016,706		1,018,633

Holdings
Senior unsecured PIK notes	564,673		622,461		564,673		596,965

Holdings consolidated	$	1,580,773	$	1,668,786	$	1,581,379	$	1,615,598

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

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

6. Legal

On September 11, 2009, a putative class action was filed by an individual consumer named David Giambusso in the United States District Court for the Southern District of California. The complaint alleged that Guitar Center and other defendants, including a trade association and a large musical instrument manufacturer, exchanged sensitive information and strategies for implementing minimum advertised pricing, attempted to restrict retail price competition and monopolize at trade association-organized meetings, all in violation of Sections 1 and 2 of the Sherman Antitrust Act and California’s Unfair Competition Law. Subsequently, numerous additional lawsuits were filed in several federal courts (and one state court) attempting to represent comparable classes of plaintiffs with parallel allegations. Some of these lawsuits have expanded the group of defendants to include other manufacturers and others have alleged additional legal theories under state laws.

In December 2009 and January 2010, the Judicial Panel on Multidistrict Litigation issued several orders which had the effect of consolidating all pending actions in federal court under the caption In Re Musical Instruments and Equipment Antitrust Litigation, Case No. MDL-2121 (“MDL 2121”), except one filed in Tennessee. A consolidated amended complaint in MDL 2121 was filed on July 16, 2010, in the United States District Court for the Southern District of California. On August 20, 2010, defendants filed a motion to dismiss the consolidated amended complaint. The hearing was held on November 1, 2010. The court rendered its opinion on August 19, 2011, granting the motion to dismiss with leave to amend. Plaintiffs filed a first amended consolidated class action complaint on September 22, 2011. On December 28, 2011, the Magistrate Judge issued an order limiting the scope of discovery to non-public meetings at NAMM conventions. This ruling was affirmed by the District Court on February 7, 2012. On February 24, 2012, plaintiffs filed a second amended complaint. On March 26, 2012, defendants filed a motion to dismiss the second amended complaint. The motion was heard by the court on May 21, 2012. On August 20, 2012, the court dismissed, with prejudice, plaintiffs’ Sherman Act claim for failure to plead an antitrust conspiracy. On September 9, 2012, defendants filed a motion to alter or amend the judgment, requesting that the court amend the judgment to include the dismissal of plaintiffs’ state-law claims. This motion was denied on jurisdictional grounds. Plaintiffs filed an appeal before the Ninth Circuit Court of Appeals. On March 29, 2013, defendants filed a joint brief in opposition, which is currently pending. With regard to the Tennessee action, we had previously filed a motion to dismiss on September 3, 2010. On February 22, 2011, the plaintiff filed an amended complaint, for which we filed an additional motion to dismiss on March 24, 2011. The parties in the Tennessee action have agreed to cooperate with regard to a scheduling order, accordingly there is no hearing date set for the motion to dismiss. The plaintiffs in the consolidated actions are seeking an injunction against further behavior that has been alleged, as well as monetary damages, restitution and treble damages in unspecified amounts. The plaintiffs in the Tennessee action are seeking no more than $5.0 million in compensatory damages. We are not currently able to estimate a probable outcome or range of loss in this matter.

On August 31, 2011, a putative class action was filed by a former employee in San Francisco Superior Court in an action entitled Carson Pellanda vs. Guitar Center, Inc. The complaint alleges that Guitar Center allegedly violated California wage and hour laws, including failure to provide required meal periods, rest breaks, unpaid work time, and failure to provide accurate itemized wage statements. On October 4, 2011, a first amended complaint was filed, adding new allegations, including wrongful termination. Guitar Center has retained defense counsel. The first amended complaint seeks injunctive relief as well as monetary damages in unspecified amounts. Mediation was held on May 17, 2012. The matter did not settle. On September 6, 2012, a Second Amended Complaint was filed, incorporating the allegations of a parallel wage and hour matter, Gomez vs. Guitar Center Stores, Inc., which was subsequently dismissed. Discovery continues. We are not currently able to estimate a probable outcome or range of loss in this matter.

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GUITAR CENTER HOLDINGS, INC. AND SUBSIDIARIES

GUITAR CENTER, INC. AND SUBSIDIARIES

COMBINED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

On May 24, 2011, a putative class action was filed in Los Angeles Superior Court in an action entitled Jason George vs. Guitar Center, Inc. and Guitar Center Stores, Inc. The complaint alleges that Guitar Center violated the California Song-Beverly Credit Card Act by requesting that its customers provide personal identification information in connection with the use of their credit cards. The complaint seeks monetary damages including statutory civil penalties in amounts of up to $1,000 per violation. This matter was subsequently consolidated with Justin Hupalo vs. Guitar Center, a putative class action alleging violations of the Song-Beverly Credit Card Act, filed on October 27, 2011. Discovery continues. In December 2012, a motion for summary judgment was filed on behalf of Guitar Center. This motion is currently pending. We are not currently able to estimate a probable outcome or range of loss in this matter.

On March 18, 2013, a putative class action was filed in Los Angeles Superior Court in an action entitled Stewart vs. Guitar Center, Inc. and Guitar Center Stores, Inc. The complaint alleges that Guitar Center allegedly violated California wage and hour laws, including failure to provide required meal periods, rest breaks, unpaid work time, and failure to provide accurate itemized wage statements. Guitar Center has retained defense counsel. We are not currently able to estimate a probable outcome or range of loss in this matter.

In addition to the matters described above, we are involved in various claims and legal actions in the normal course of business. We expect to defend all unresolved actions vigorously. We cannot assure you that we will be able to achieve a favorable settlement of these lawsuits or obtain a favorable resolution if they are not settled. However, it is management’s opinion that, after consultation with counsel and a review of the facts, a material loss with respect to our financial position, results of operations and cash flows is not probable from such currently pending normal course of business litigation matters.

7. Subsequent Events

In April 2013, we made a one-time principal payment of $129.8 million on Holdings’ senior PIK notes. This prepayment was the amount of previously capitalized PIK interest required to be paid to prevent the senior PIK notes from being treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code. We funded this payment with cash available from operations and amounts drawn on the asset-based revolving credit facility.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q 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,” “project,” “estimate,” “expect,” “believe,” “intend,” “may,” “will,” “should” and other similar expressions) that are not statements of historical fact should be considered forward-looking statements. 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 future effective tax rates. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including the factors described in the section entitled “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2012, filed with the Securities and Exchange Commission, or the SEC, on March 26, 2013.

Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, world and national political events, general economic conditions, the effectiveness of our promotion and merchandising strategies, the efficient operation of our supply chain, including the continued support of our key vendors, our effective management of business risks, including litigation, and competitive factors applicable to our retail and direct response markets. In light of these risks, there can be no assurance that the forward-looking statements contained in this report will in fact be realized.

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this quarterly report and management’s discussion and analysis of financial condition and results of operations and the consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2012.

The statements made by us in this report represent our views as of the date of this report, and it should not be assumed that the statements made herein remain accurate as of any future date. We do not presently intend to update these statements and undertake no duty to any person to affect any such update under any circumstances.

Amounts shown in tables are generally rounded. Therefore, discrepancies in the tables between totals and the sum of the amounts listed may occur. All amounts are unaudited.

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 offers catalog and online sales of a broad selection of music products under several brand names, including Musician’s Friend and Music 123. 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.

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 2012 segment results in the following management discussion and analysis to reflect these changes.

Our Guitar Center segment is operated primarily out of Guitar Center Stores, Inc., our retail store subsidiary. Our direct response segment is comprised primarily of the online operations of our Musician’s Friend, Inc. and Music 123, Inc. subsidiaries. Our Music & Arts segment is comprised of the retail and online businesses operated under the Music & Arts brand name, which is operated by Guitar Center Stores, Inc., and also includes the operations of our Woodwind & Brasswind, Inc. subsidiary. Our non-operating corporate segment consists primarily of Guitar Center, Inc., the parent company of our operating subsidiaries, and GTRC Services, Inc., which operates shared support services for our operating subsidiaries.

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As of May 8, 2013, our wholly-owned retail subsidiary operated 246 Guitar Center stores in 44 states and 113 Music & Arts stores in 22 states. Our Guitar Center stores consisted of 151 primary format stores, 81 secondary format stores and 14 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 mid-tier metropolitan areas and generally range in size from 8,000 to 15,000 square feet. Tertiary market stores serve smaller population centers and generally range in size from 5,000 to 8,000 square feet.

Our calculation of comparable retail store sales includes sales from stores that have been open for 14 months and does not include sales originated from our Guitar Center website. We do not exclude relocated stores from the calculation of comparable store sales. All references to comparable store sales results in this quarterly report are based on this calculation methodology.

Results of operations

The following tables present the components of net income or loss, as a percentage of sales, for the periods indicated:

Holdings

	Three months ended March 31,
	2013		2012
Net sales	100.0	%	100.0	%
Gross profit	29.6		31.0
Selling, general and administrative expenses	26.4		26.1
Operating income	3.2		4.8
Interest expense, net	7.8		7.8
Loss before income taxes	-4.6		-3.0
Income tax expense (benefit)	-0.2		0.1
Net loss	-4.4	%	-3.1	%

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Guitar Center

	Three months ended March 31,
	2013		2012
Net sales	100.0	%	100.0	%
Gross profit	29.6		31.0
Selling, general and administrative expenses	26.4		26.1
Operating income	3.2		4.8
Interest expense, net	4.0		4.0
Income (loss) before income taxes	-0.8		0.8
Income tax expense (benefit)	-0.2		0.3
Net income (loss)	-0.6	%	0.5	%

Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012

Net sales

Consolidated net sales for the first quarter of 2013 increased 0.7% to $531.8 million, compared to $528.2 million for the same period in 2012.

Net sales from our Guitar Center segment for the first quarter of 2013 increased 1.7% to $400.5 million, compared to $393.7 million for the same period in 2012. Non-comparable retail stores open less than 14 months contributed $16.1 million in incremental net sales in the first quarter of 2013. Comparable retail store sales decreased 2.5%, or $9.4 million and sales from our Guitar Center website increased by 0.3%, or $0.1 million, compared to the same period in 2012. Comparable store sales were negatively affected by a 3.5% decrease in customer traffic, partially offset by an increase in conversion rate of 1.4%, which measures the number of sales transactions relative to the number of customers visiting our stores. We have improved conversion rates at our stores by reducing checkout times and by implementing workforce planning tools to optimally staff our stores during peak customer traffic periods.

Net sales from our direct response segment for the first quarter of 2013 decreased 8.1% to $73.0 million, compared to $79.4 million for the same period in 2012. The decrease in sales was primarily due to a 12.6% decline in order count and an increase in customer discounts, partially offset by an 8.3% increase in average order value. Our direct response segment continues to be affected by the increasingly competitive e-commerce landscape, which has made it more difficult to attract and retain customers. We believe this competition has contributed to the decrease in order count. Customer discounts increased due to greater use of promotional discounting and price matching to compete with other e-commerce retailers. We expect competition to continue to affect this segment’s net sales and gross profit for the foreseeable future. The increase in average order value was primarily due to more items sold per order.

Net sales from our Music & Arts segment for the first quarter of 2013 increased 6.0% to $58.4 million, compared to $55.1 million for the same period in 2012. The increase was primarily due to 4.9% growth in retail sales and our continued success at increasing high-volume bid sales to school districts.

Gross profit

Consolidated gross profit for the first quarter of 2013 decreased 3.7% to $157.5 million, compared to $163.6 million for the same period in 2012. Gross profit margin was 29.6% for the first quarter of 2013, compared to 31.0% for the same period in 2012.

Gross profit margin for our Guitar Center segment was 28.1% for the first quarter of 2013, compared to 29.7% for the same period in 2012. The decrease was primarily due to lower selling margin of 1.1% and higher occupancy costs of 0.2%. Selling margin decreased due to adjustments in selling prices, in the form of merchandise markdowns, promotional discounts and in-store discounts to ensure our “Lowest Price Guarantee” policy. Occupancy costs increased due to higher rent expense related to new store openings.

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Gross profit margin for our direct response segment was 26.0% for the first quarter of 2013, compared to 27.6% for the same period in 2012. The decrease was primarily due to lower selling margin of 1.9%, partially offset by lower freight costs of 0.3%. Selling margin decreased due to adjustments in selling prices, in the form of merchandise markdowns, promotional discounts and price matching. Freight costs decreased primarily due to lower rates on outbound shipping and customers choosing less costly delivery methods.

Gross profit margin for our Music & Arts segment was 44.8% for the first quarter of 2013, compared to 45.4% for the same period in 2012. The decrease was primarily due to lower selling margin of 0.7%, resulting from a shift in sales channel mix with increased sales to school districts at lower margins than rental and retail sales.

Selling, general and administrative expenses

Consolidated selling, general and administrative expenses for the first quarter of 2013 increased 1.9% to $140.6 million, compared to $138.1 million for the same period in 2012. As a percentage of net sales, selling, general and administrative expenses for the first quarter of 2013 were 26.4%, compared to 26.1% for the same period in 2012.

In the first quarter of 2013, we recorded 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. The estimated losses totaled $2.0 million at our direct response segment and $1.0 million at our Guitar Center segment.

Selling, general and administrative expenses for our Guitar Center segment for the first quarter of 2013 were 22.9% of segment net sales, compared to 22.8% for the same period in 2012. The increase was primarily due to the loss on unpaid freight invoices, totaling 0.3% of segment net sales, partially offset by lower depreciation and amortization expense of 0.3%. Depreciation and amortization expense decreased primarily due to lower amortization expense on the segment’s customer relationship intangible asset, which uses an accelerated method based on expected customer attrition rates.

Selling, general and administrative expenses for our direct response segment for the first quarter of 2013 were 30.6% of segment net sales, compared to 28.9% for the same period in 2012. The increase was primarily due to the loss on unpaid freight invoices, totaling 2.8% of segment net sales, partially offset by lower advertising expense of 0.5% and lower restructuring costs of 0.5%. Advertising expense decreased due to reduced catalog circulation and production costs.

Selling, general and administrative expenses for our Music & Arts segment for the first quarter of 2013 were 34.4% of segment net sales, compared to 34.8% for the same period in 2012. The decrease was primarily due to lower relative compensation expense due to higher net sales.

Operating income

Consolidated operating income for the first quarter of 2013 decreased to $16.9 million from $25.5 million for the same period in 2012. As a percentage of net sales, consolidated operating income for the first quarter of 2013 decreased to 3.2%, compared to 4.8% for the same period in 2012.

Interest expense — Holdings and Guitar Center

Net interest expense for Holdings for the first quarter of 2013 increased 0.5% to $41.4 million, compared to $41.2 million for the same period in 2012.

Net interest expense for Guitar Center for the first quarter of 2013 increased 0.9% to $21.4 million, compared to $21.2 million for the same period in 2012.

The increase in interest expense at Holdings and Guitar Center was primarily due to an increase of $0.6 million as a result of new Guitar Center senior notes issued in October 2012, partially offset by $0.5 million lower interest expense on the floating-rate term loan resulting from a decrease in the LIBOR index rate.

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Income tax expense (benefit) - Holdings

Income tax benefit for Holdings for the first quarter of 2013 was $1.0 million, compared to $0.6 million expense for the same period in 2012. The effective tax rate for the first quarter of 2013 was 4.2% compared to -3.6% for the same period in 2012.

The effective tax rate in 2013 and the negative effective tax rate in 2012 were lower than the expected amount, based on federal statutory income tax rates, because we apply a valuation allowance to deferred tax assets that we do not expect to realize in the foreseeable future. We determined, based on available objective evidence, that it is more likely than not that deferred tax assets related to our net operating losses would not be fully realized. Accordingly, we apply a valuation allowance to the related deferred tax assets and we do not recognize income tax benefits related to our net operating losses.

Income tax expense (benefit) - Guitar Center

Income tax benefit for Guitar Center for the first quarter of 2013 was $1.2 million, compared to $1.8 million expense for the same period in 2012. The effective tax rate for the first quarter of 2013 was 27.4% compared to 41.4% for the same period in 2012.

The effective rate was lower in 2013 primarily due to discrete items, including canceled stock options from employee terminations and minimum state taxes that reduced our income tax benefits on pretax net loss.

Liquidity and capital resources

Our principal sources of cash are cash from our business operations and available borrowing capacity under our asset-based revolving credit facility. Our principal uses of cash typically include the financing of working capital, capital expenditures and payments on our indebtedness.

During the first quarter of 2013, cash provided by operating activities totaled $45.5 million for Holdings and Guitar Center.

Our asset-based revolving credit facility provides senior secured financing of up to $373 million, subject to a borrowing base. As of March 31, 2013, the borrowing base was $300.3 million, which supported $8.6 million of outstanding letters of credit and $291.7 million of availability. We drew $100 million on the asset-based facility in April 2013 to fund a mandatory redemption of Holdings’ senior PIK notes and the semi-annual interest payments on our unsecured long-term debt. See “Debt — Senior PIK note redemption” for further discussion of the redemption.

Our business follows a seasonal pattern, peaking during the holiday selling season in November and December. Cash generated from our Guitar Center stores and through our e-commerce businesses are typically significantly higher in the fourth quarter than in any other quarter. Cash requirements to finance working capital are typically highest during the third quarter as we build inventory for holiday season sales. Seasonality for our Music & Arts business centers on band rental season, which starts in August and carries through mid-October, but that seasonality does not have a significant impact on our liquidity.

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 dependent on distributions received from Guitar Center to meet its debt service obligations on the senior PIK notes. The senior PIK notes are not guaranteed by any of Holdings’ subsidiaries.

We believe that the asset-based revolving credit facility 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, working capital requirements and interest payments on our long-term debt.

Given that our primary source of liquidity is cash flows generated from operating activities, our liquidity has been and will continue to be affected by general economic conditions in the United States, particularly with respect to discretionary consumer spending in the retail sector and our ability to generate sales revenue. We plan to expand our retail store presence and increase our investments in e-commerce, with the goal of increasing the operating cash flows from our existing businesses. Our liquidity may also be affected by financial, competitive, legislative and regulatory actors and the cost of litigation claims, among other factors. If we do not have sufficient cash flows from operating activities, we may be required to limit our retail store and e-commerce growth strategies.

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The maturities of the senior notes and senior PIK notes in 2017 and 2018 are significant. If our cash flows and capital resources are insufficient to fund these debt service obligations, we may be required to reduce or delay capital expenditures, sell assets or operations, seek replacement borrowing or seek equity financing. We cannot be certain that we would be able to take any of these actions or that these actions would be successful and permit us to meet our scheduled debt service obligations, which would have a material adverse impact on our business and operations.

Cash flows

Operating activities

Holdings’ and Guitar Center’s net cash provided by operating activities was $45.5 million for the first quarter of 2013. Cash provided by operating activities benefitted from decreases in working capital, primarily a net increase of $18.4 million in accounts payable and an increase in accrued interest expense. The increase in accounts payable was primarily due to the timing of vendor receipts and payments for inventory. The increase in accrued interest expense was due to the timing of scheduled payments on the senior notes and senior PIK notes that occur in April and October. Cash paid for interest was $9.3 million in the first quarter of 2013.

Holdings’ and Guitar Center’s net cash provided by operating activities was $45.2 million for the first quarter of 2012. Cash provided by operating activities was partially offset by an increase in working capital. Significant sources of cash from changes in working capital include a $45.0 million increase in accounts payable, primarily related to the timing of vendor receipts and payments. We received a greater amount of inventory purchases later in the quarter and more of our vendors accepted longer payment terms. Cash paid for interest was $9.6 million in the first quarter of 2012.

Investing activities

Holdings’ and Guitar Center’s net cash used in investing activities was primarily related to capital expenditures.

Holdings’ and Guitar Center’s net cash used in investing activities was $14.1 million for the first quarter of 2013, compared to $11.8 million for the same period in 2012.

Capital expenditures for the first quarter of 2013 included approximately $7 million related to new Guitar Center and Music & Arts stores and $5 million investment in technology development and purchases.

Capital expenditures for the first quarter of 2012 included approximately $6 million related to new Guitar Center stores, $4 million investment in technology development and purchases and $1 million to remodel or refurbish existing Guitar Center and Music & Arts stores.

Financing activities

Holdings’ and Guitar Center’s net cash used in financing activities was $1.1 million for the first quarter of 2013, compared to $0.9 million for the same period in 2012. Repayment of long-term debt in 2013 includes a scheduled principal payment on the term loan. We will be required to make scheduled principal payments of $1.6 million per quarter on the term loan beginning in the second quarter of 2013 and continuing until its maturity. Cash paid for financing fees in 2012 was related to obtaining extended lending commitments on the asset-based facility. Guitar Center made no distributions to Holdings in the first quarter of 2013 or 2012.

Capital Expenditure Requirements

Our capital expenditures generally consist of information technology development, new store opening costs and costs to remodel, relocate and refurbish existing stores.

We opened four new Guitar Center stores during the first quarter of 2013, comprised of two secondary format locations and two tertiary format locations. We opened two new stores between April 1 and May 8, 2013 and we plan to open nine additional stores by the end of 2013. We also plan to open new stores at a rate of 10 to 20 stores per year going forward, in a combination of store formats. New stores generally take a number of years to reach what we consider mature sales levels, generally four years for our primary format stores and three years for our secondary format stores.

We expect our per-store costs for new stores opened in 2013 will be approximately $1.6 million for each primary market store, $1.3 million for each secondary market store and $1.0 million for each tertiary market store. These costs generally consist of leasehold improvements, fixtures and equipment and do not include tenant improvement allowances that we may receive from our landlords to help defray these costs. Additionally, our new primary stores generally require between $1.1 million and $1.6 million of inventory, secondary stores require between $0.8 million to $1.1 million of inventory and tertiary market stores require approximately $0.6 million of inventory upon store opening.

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For 2013, we expect our total capital expenditures will be between $65 million and $70 million. We expect the significant capital expenditures in 2013 will include $20 to $25 million of information technology expenditures, approximately $20 million of new store expenditures and approximately $15 million to remodel, relocate and refurbish existing stores. Planned remodeling and refurbishing expenditures include costs for adding GC Studios lesson and rehearsal space to existing stores.

Debt

Holdings’ consolidated outstanding long-term debt as of March 31, 2013 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, 2013 was $1.581 billion.

Guitar Center’s outstanding long-term debt as of March 31, 2013 consisted of a senior secured term loan and the senior notes. The aggregate outstanding principal balance on this debt as of March 31, 2013 was $1.016 billon.

We also have an asset-based revolving credit facility with 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, 2013, we had no outstanding borrowings on this credit facility. We did not draw any amounts on the asset-based facility during the first quarter of 2013; we drew $100 million in April 2013 to fund a mandatory redemption of the senior PIK notes and the scheduled semi-annual interest payments on the senior notes and the senior PIK notes.

We expect interest payments on the term loan, senior notes and senior PIK notes will be between $140 million and $150 million per year in the years 2013 through 2016 and approximately $130 million in total for the years 2017 and 2018.

As of March 31, 2013, scheduled maturities and principal payments on the term loan, senior notes and senior PIK notes for the years 2013 through 2016 totaled $162 million. This amount includes a $129.8 million redemption of the senior PIK notes that was made in April 2013. The remaining maturities, totaling $1.4 billion, occur in 2017 and 2018.

Our long-term debt agreements include restrictive covenants that could require early payment in the event of default.

Senior PIK note redemption

We made a principal payment of $129.8 million in April 2013 related to the payment-in-kind interest on Holdings’ senior PIK notes. This mandatory principal redemption was the amount required to be redeemed to prevent the senior PIK notes from being treated as “applicable high yield discount obligations” within the meaning of Section 163(i)(1) of the Internal Revenue Code as of April 15, 2013. The redemption price for the portion of each senior PIK note redeemed was 100% of the principal amount of such portion plus any accrued interest thereon on the date of redemption. We funded this payment with cash available from operations and amounts drawn on the asset-based revolving credit facility.

Covenants

See our annual report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 26, 2013, for a summary of the material terms of our term loan credit facility, asset-based revolving credit facility, senior notes and senior PIK notes.

As of March 31, 2013, we were in compliance with our debt covenants. Under the term loan credit agreement, we were required to have a consolidated secured net leverage ratio as of March 31, 2013 that does not exceed 3.5x. As of March 31, 2013, our consolidated secured net leverage ratio was 2.75x.

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Contractual obligations and commercial commitments

Substantially all of the real property used in our business is leased under operating lease agreements. We do not expect new lease agreements entered into during the year to materially affect our liquidity or our financial statements. There have been no other material changes to our contractual obligations since December 31, 2012. See our annual report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 26, 2013, for additional information about our contractual obligations and commercial commitments.

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.

Inflation and changing prices

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 and we have also been experiencing increased product costs as the commodity and labor prices in Asia, particularly in China, have been rising.

Off-balance sheet arrangements

We have no 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 impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Critical accounting estimates

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates” in our annual report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 26, 2013, for a discussion of our critical accounting policies. There have been no significant changes in our critical accounting policies or estimates since the end of 2012.

Recently issued accounting pronouncements

We do not expect the adoption of recently issued accounting pronouncements to have a significant impact on our financial position, results of operations or cash flows.

Item 3. 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 re-price periodically, which will impact our earnings and cash flow.

A 1% increase in the floating interest rate on our term loan would result in approximately $6 million additional interest expense per year.

We are also exposed to interest rate risk on our variable rate asset-based revolving credit facility. Historically, we have not had material interest rate exposure on this credit facility as our borrowings have been in small amounts or for short time periods. We expect our usage of this credit facility to increase in 2013 and future years and our interest rate risk exposure will increase accordingly.

We do not anticipate hedging our interest rate risk on the term loan or the asset-based revolving credit facility in the near term. For the period from January 2008 to January 2013, we had hedged a portion of our interest rate risk on the term loan using interest rate cap agreements; these derivative instruments matured in December 2012 and January 2013.

The interest rates on our senior notes and senior PIK notes are fixed.

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Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures (for each of Holdings and Guitar Center)

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) promulgated under the Securities Act of 1934, as amended, or the “Exchange Act,” that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, and not absolute, assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation prior to filing this report of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2013.

Changes in Internal Control over Financial Reporting (for each of Holdings and Guitar Center)

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the first quarter of 2013 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

For information on legal proceedings, see Note 6 of the combined notes to condensed consolidated financial statements, included in Part I of this quarterly report on Form 10-Q, which is incorporated by reference in response to this Item 1.

Item 1A. Risk Factors

Our risk factors as of March 31, 2013 have not changed materially from those disclosed in our annual report on Form 10-K for the year ended December 31, 2012, as filed with the SEC on March 26, 2013.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

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Item 6. Exhibits

Exhibit Number		Description
10.1		Employment Agreement, dated as of February 14, 2013, by and among Guitar Center, Inc., Guitar Center Holdings, Inc. and Michael Pratt, previously filed as Exhibit 10.1 with Guitar Center, Inc.’s and Guitar Center Holdings, Inc.’s Form 8-K filed on March 20, 2013 and incorporated by reference herein.
31.1		Guitar Center, Inc. Certification of Chief Executive Officer required by Rule 13a-14(a) (17 C.F.R. 240.13a- 14(a))
31.2		Guitar Center, Inc. Certification of Chief Financial Officer required by Rule 13a-14(a) (17 C.F.R. 240.13a- 14(a))
31.3		Guitar Center Holdings, Inc. Certification of Chief Executive Officer required by Rule 13a-14(a) (17 C.F.R. 240.13a- 14(a))
31.4		Guitar Center Holdings, Inc. Certification of Chief Financial Officer required by Rule 13a-14(a) (17 C.F.R. 240.13a- 14(a))
32.1		Guitar Center, Inc. Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Guitar Center Holdings, Inc. Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS *		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

These exhibits are not deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section. Such exhibits will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that we incorporate them by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: May 13, 2013	GUITAR CENTER, INC.

	By:	/s/ MICHAEL PRATT
	Michael Pratt
	Chief Executive Officer (Principal Executive Officer)

	By:	/s/ TIM MARTIN
	Tim Martin
	Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)


Date: May 13, 2013	GUITAR CENTER HOLDINGS, INC.

	By:	/s/ MICHAEL PRATT
	Michael Pratt
	Vice President and Assistant Secretary (Principal Executive Officer)

	By:	/s/ TIM MARTIN
	Tim Martin
	Vice President and Assistant Secretary (Principal Financial and Accounting Officer)

GUITAR CENTER, INC. 10-Q