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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K
For Annual and Transition Reports Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934

(Mark One)

For the fiscal year ended December 31, 2000
or

For the transition period from                to                

Commission file number 000-22207

GUITAR CENTER, INC.

(Exact name of registrant as specified in charter)

Registrant's telephone number, including area code: (818) 735-8800

Securities registered pursuant to 12(b) of the Act:
None

Securities registered pursuant to 12(g) of the Act:
Common Stock, $.01 par value
(Title of Class)

    Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form / /

    As of March 12, 2001, the aggregate market value of voting stock held by nonaffiliates of the Company was approximately $206,243 (based upon the last reported sales price of the Common Stock on such date as reported by the Nasdaq National Market). Shares of Common Stock held by each executive officer, director, holder of greater than 10% of the outstanding Common Stock of the Registrant and person or entity known to the Registrant to be affiliates of the foregoing have been excluded in that such persons may be deemed to be affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

    Check 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 at least the past 90 days. Yes /x/  No / /

    As of March 12, 2001 there were 22,105,854 shares of Common Stock, par value $.01 per share, outstanding.

    Portions of the Proxy Statement for the annual stockholders' meeting scheduled to be held on April 26, 2001 are incorporated by reference into Part III.

The Exhibit Index appears on page 28.

PART I

Item 1. BUSINESS

Company History

    Guitar Center, Inc. was founded in 1964 in Hollywood, California. Our flagship Hollywood store currently is one of the nation's largest and best-known retail stores of its kind with approximately 30,600 square feet of retail space. The Hollywood store features one of the largest used and vintage guitar collections in the United States, attracting buyers and collectors from around the world. In front of the Hollywood store is the Rock Walk which memorializes over 70 famous musicians and music pioneers. The Rock Walk attracts several tour buses daily and has helped to create international recognition of the Guitar Center name. In 1972, we opened our second store in San Francisco to capitalize on the emerging San Francisco rock 'n roll scene. By this time, our inventory had been expanded to include drums, keyboards, accessories and pro-audio and recording equipment.

    Throughout the 1980s, we expanded by opening nine stores in five major markets, including Chicago, Dallas and Minneapolis. Since 1990, we have continued our new store expansion and have focused on building the infrastructure necessary to manage our strategically planned growth. Current executive officers and key managers have been with our company for an average of 11 years and two of such executive officers (Mr. Larry Thomas, our Chairman and Co-Chief Executive Officer, and Mr. Marty Albertson, our President and Co-Chief Executive Officer) effectively assumed full operating control in 1992. Since then, we have focused on developing and realizing our long-term goal of expanding our position as the leading music products retailer throughout the United States.

    In May of 1999, we merged with Musician's Friend, Inc. in a stock for stock transaction. Musician's Friend operates the largest direct response channel (catalog and e-commerce) in the musical instruments industry in the United States. Robert Eastman, Chief Executive Officer of Musician's Friend, has been with the company for 17 years.

    Presently, our executive offices are located at 5155 Clareton Drive, Agoura Hills, California 91301, and our telephone number is (818) 735-8800. Effective April 16, 2001, our executive offices will be located at 5795 Lindero Canyon Road, Westlake Village, California 91362; our phone number will not change. We maintain several corporate websites, including www.guitarcenter.com, however none of the information contained on our websites is incorporated by reference in this annual report. Whenever we refer to the "Company" or to "us," or use the terms "we" or "our" in this annual report, we are referring to Guitar Center, Inc. and its subsidiaries.

Business

    As of December 31, 2000, we operated 83 stores, consisting of 79 stores in 42 major U.S. markets, including, among others, areas in or near Los Angeles, San Francisco, Chicago, Miami, Houston, Dallas, Detroit, Boston, Minneapolis, Seattle, Phoenix, Atlanta, New York and Cleveland, and four stores in secondary markets. From 1996 to 2000, our net sales grew at an annual compound growth rate of 31.9%, principally due to comparable store sales growth averaging 10% per year, the opening of new stores, and a 31.0% increase in the direct response channel. We achieved comparable store sales growth of 7%, 10% and 13% for the fiscal years ended December 31, 2000, 1999 and 1998, respectively.

    For the fiscal years ended December 31, 2000, 1999 and 1998, we had net income of $22.5 million, $18.3 million and $16.4 million, respectively.

Retail

    We offer a unique retail concept in the music products industry, combining an interactive, hands-on shopping experience with superior customer service and a broad selection of brand name,

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high-quality products at guaranteed low prices. We create an entertaining and exciting atmosphere in our stores with bold and dramatic merchandise presentations, highlighted by bright, multi-colored lighting, high ceilings, music and videos. We believe approximately 74% of our sales are to professional and aspiring musicians who generally view the purchase of music products as a career necessity. These sophisticated customers rely upon our knowledgeable and highly trained salespeople to answer technical questions and to assist in product demonstrations.

    Our standard prototype store generally ranges in size from 12,000 to 20,000 square feet (as compared to a typical music products retail store which averages approximately 3,200 square feet) and is designed to encourage customers to hold and play instruments. In late 2000 we opened our first new store using a smaller format. Early results from this unit are encouraging and we plan to open additional stores using this format of approximately 8,000 to 10,000 square feet to serve secondary markets. Each large format store carries an average of 7,000 core SKUs and our small format stores carry an average of 5,000 core SKUs, which management believes is significantly greater than a typical music products retail store, and is organized into five departments, each focused on one product category. These departments cater to a musician's specific product needs and are staffed by specialized salespeople, many of whom are practicing musicians. We believe this retail concept differentiates us from our competitors and encourages repeat business.

    The following summarizes certain key operating statistics of our stores and is based upon the stores operated by us for the full year ended December 31:

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Store-level operating income includes individual store revenue and expenses plus allocated rebates, cash discounts, advertising and purchasing department salaries (based upon individual store sales).

    Our retail growth strategy is to continue to increase our presence in our existing markets and to open new stores in strategically selected markets. We will continue to pursue our strategy of clustering stores in major markets to take advantage of operating and advertising efficiencies and to build awareness of our name in new markets. We opened a total of 14 stores in 2000 (including one acquired unit), and presently expect to open approximately 12 to 14 stores in 2001 and approximately 12 to 16 stores in 2002. We also intend to build a distribution center during 2001, with plans to commence operation in early 2002. This initiative will require significant financial and managerial resources for the next several quarters. We have committed substantial resources to building and continually upgrading a corporate infrastructure and management information system that we believe can support our needs, including our expansion plans, for the foreseeable future.

Direct Response

    Our Musician's Friend unit is using its established catalog business to build an integrated e-commerce/catalog business. Through Musician's Friend, we offer musicians a shopping experience that satisfies the need for technical product information, confirmation of needs by a live person, quick and efficient service, and a musician-based staff for after sale support. The catalog presents a fresh assortment of products and promotions throughout the year, mixing big name products with unique and practical offerings. Our website, www.musiciansfriend.com, offers all that is shown in the catalog and more, supported by the same service and staff.

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    The Musician's Friend business is supported by three distribution centers located in Medford, Oregon, Knoxville, Tennessee and Kansas City, Missouri, and a telephone call center located in Salt Lake City, Utah.

    Our call center staff receive product and customer service training in the state-of-the-art call center facility. Extensive product information, including technical information, product features and benefits, and real-time stocking information is available to the staff on their desktop systems via our intranet and back-end information systems. A staff of over 200 associates is trained and ready to respond to questions to help ensure that customers can purchase confidently. Web site visitors are treated to a constantly updated and evolving, information rich shopping experience that includes product availability and purchase recommendations generated through collaborative filtering processes. Questions regarding products can be submitted electronically, or the musician can call our support center directly.

    Orders, whether taken electronically or by an associate in our call center, are processed by our automated transaction system and generally ship within 24 hours. Sophisticated inventory planning systems help ensure that products are in-stock resulting in an initial line item fill rate at time of order in excess of 87%. In 2000, we linked our web site to UPS and FedEx tracking engines to provide customers the online ability to monitor the status of their orders.

    The focus of the Musician's Friend business strategy is to increase market share in the non-bricks and mortar retail segment of our industry. Our mailing and email lists give us a significant base from which to grow. Our catalog circulation, which is broader than any other direct-mail circulation in this industry, provides a unique advertising and marketing platform for e-commerce. In addition, Musician's Friend enjoys significant customer loyalty as evidenced by a high rate of repeat purchases by customers; over one third of Musician's Friend customers place a second order within six months of their first order.

    Our business plan is to continue to leverage our leading industry position and the infrastructure in place, and build on that base to support the rapid growth in e-commerce. We believe that our leadership position and established direct marketing model leverages both internet and direct mail mechanics to provide a significant competitive advantage.

Industry Overview

    The United States retail market for music products in 1999 was estimated in a study by Music USA magazine to be approximately $6.8 billion in net sales, representing a five-year compound annual growth rate of 5.2%. The broadly defined music products market, according to the National Association of Music Merchants, or NAMM, includes retail sales of string and fretted instruments, sound reinforcement and recording equipment, drums, keyboards, print music, pianos, organs, and school band and orchestral instruments. Products currently offered by us include categories of products which account for approximately $4.9 billion of this market, representing a five-year compound annual growth rate of 6.6%. The music products market, as currently defined by NAMM, however, does not include the significant used and vintage product markets or the computer software and apparel markets in which we actively participate.

    The industry is highly fragmented with the nation's leading five music products retailers, as measured by the number of stores operated by such retailers (i.e., Guitar Center/Musician's Friend, Sam Ash Music Corp., MARS Music, Brook Mays/H&H, and Hermes Music), accounting for approximately 18.6% of the industry's estimated total sales. Furthermore, 90% of the industry's estimated 5,900 retailers operate only one or two stores. A typical music products store averages approximately 3,200 square feet and generates an average of approximately $1.0 million in annual net sales. In contrast, one of our stores generally averages between 12,000 and 20,000 square feet and in

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2000 generated an average of approximately $8.7 million in annual net sales for stores open the full year.

    Over the past ten years, technological advances in the industry have resulted in dramatic changes to the nature of music-related products. Manufacturers have combined computers and microprocessor technologies with musical equipment to create a new generation of products capable of high grade sound processing and reproduction. Products featuring this technology are available in a variety of forms and have broad applications across most of our music product categories. Most importantly, rapid technological advances have resulted in the continued introduction of higher quality products offered at lower prices and this trend is continuing. Today an individual consumer can affordably create a home recording studio which interacts with personal computers and is capable of producing high-quality digital recordings. Until recently, this type of powerful sound processing capability was expensive and was typically purchased only by professional sound recording studios.

Business Strategy

Retail

    The goal in the retail stores is to continue to expand our position as the leading music products retailer throughout the United States. The principal elements of our business strategy are as follows:

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Expansion Strategy. Our expansion strategy is to continue to increase our market share in existing markets and to penetrate strategically selected new markets. We opened a total of 14 stores in 2000, 13 stores in 1999, and 16 stores in 1998, and currently anticipate opening approximately 12 to 14 stores in 2001 and approximately 12 to 16 stores in 2002. In preparation for this expansion, we have dedicated a substantial amount of our resources over the past several years to building the infrastructure necessary to support a large national chain. In addition, we have developed a methodology for targeting prospective store sites which includes analyzing demographic and psychographic characteristics of a potential store location. We also believe there may be attractive opportunities to expand by selectively acquiring existing music products retailers and regularly investigate acquisition opportunities. However, in the music industry there are only a small number of companies that would strategically and financially be a beneficial opportunity for us to acquire. Our "average" store is 16,300 square feet, carrying 7,000 SKUs and generating first year sales of $5,700,000, whereas the "average" industry store is 3,200 square feet, carries 2,500 SKUs and generates sales of approximately $1.0 million. We are presently focused on the U.S. market but are planning to enter the Canadian market in 2002 and may consider operations in other countries in the future.



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Extensive Selection of Merchandise. We offer an extensive selection of brand name music products complemented by lesser known, hard to find items and unique, vintage equipment. The average 7,000 core SKUs offered through each of our standard format stores, and an average of 5,000 core SKUs for our small format stores, provide a breadth and depth of in-stock items which we believe is not available from traditional music products retailers.



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Highly Interactive, Musician-Friendly Store Concept. The purchase of musical instruments is a highly personal decision for musicians. We therefore believe that a large part of our success is attributable to our creative instrument presentations and colorful, interactive displays which encourage the customer to hold and play instruments as well as to participate in product demonstrations. Each store also provides private sound-controlled rooms to enhance a customer's listening experience while testing various instruments.



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Exceptional Customer Service. Exceptional customer service is fundamental to our operating strategy. Accordingly, we conduct extensive training programs for our salespeople, who specialize in one of our five product categories. Many of our salespeople are also musicians. With the

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advances in technology and continuous new product introductions in the music products industry, customers increasingly rely on qualified salespeople to offer expert advice and assist in product demonstrations. We believe that our emphasis on training and customer service distinguishes us within the industry and is a critical part of our success.

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Innovative Promotional and Marketing Programs. We sponsor innovative promotional and marketing events, which include in-store demonstrations, famous artist appearances and weekend themed sales events, designed to create significant store traffic and exposure. In addition, our special grand opening activities in new markets are designed to generate consumer awareness for each new store. We believe these events help us to build a loyal customer base and to encourage repeat business. Since our inception, we have compiled a unique, proprietary database containing information on more than five million customers. This database enables us to advertise to select target customers based on historical buying patterns. We believe the typical music products retailer does not have the resources to support large-scale promotional events or an extensive advertising program.



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Guaranteed Low Prices. We endeavor to be the low price leader in each of our markets, as underscored by our 30-day low price guarantee. Our size permits us to take advantage of volume discounts for large orders and other vendor supported programs. Although prices are usually determined on a regional basis, store managers are trained and authorized to adjust prices in response to local market conditions.



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Experienced and Motivated Management Team. Our executive officers and key managers have an average of 11 years employment with Guitar Center and Musician's Friend.

Direct Response

    The goal of the e-commerce/catalog business unit is to capitalize and expand on our leadership position. Comprehensive direct marketing, analysis and leveraging of the extensive customer information available on our information systems are used to define effective marketing campaigns. The presentation of an extensive selection of products and maintenance of an effective degree of continual and informative contact with prospects and customers provide the attention grabbing content that generate results. In 2000, we circulated over 11 million catalogs and sent over 26.1 million e-mails to prospects and customers. This resulted in more than a 42% increase in orders as compared to 1999. The call center took over 1.8 million calls during the year.

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Targeted Marketing. We have experience at targeting appropriate prospect and customer segments with the right offers. Extensive segmentation of customer lists and continual analysis by our circulation department are designed to ensure that the right mix of catalog and e-commerce offers are presented to each segment of customers. Utilizing techniques in demographic data overlay and statistical modeling help ensure that Musician's Friend retains a leadership position in music gear direct marketing.



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Extensive Product Selection. Musician's Friend stocks a broad assortment of products representing most of the premier lines; in some cases we are the exclusive direct sales dealer for the manufacturer. With some manufacturers, the Musician's Friend business unit alone is their second largest dealer behind Guitar Center's retail operations. Each catalog presents 4,000 or more SKUs, selected from the 20,000 or more that we carry. The website presents a more complete selection of products than the catalog due to its significantly lower publishing cost.



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Continual Customer Contact. Prospects and customers receive periodic mailings from Musician's Friend, depending on their particular attributes. Musicians can "opt-in" for weekly electronic newsletters featuring news, information and promotions. Our Platinum Members preferred credit card customers receive additional marketing contacts via monthly statement mailings. Our

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musician-staffed call center is available 24-hours-a-day, seven-days-a-week for questions, technical information and customer service. While browsing the website, customers are presented with customized product recommendations.

Merchandising

    Our merchandising concept differentiates us from most of our competitors. We offer our merchandise at guaranteed low prices and utilize aggressive marketing and advertising to attract new customers and maintain existing customer loyalty. The principal elements of our merchandising philosophy are as follows:

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Extensive Selection of Merchandise. We seek to maintain a broad customer appeal by offering high-quality merchandise at multiple price points to serve musicians ranging from the casual hobbyist to the serious professional performer. We offer products in five primary categories: guitars, amplifiers, percussion instruments, keyboards, and pro-audio and recording equipment.



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Guitars. We believe that our electric, acoustic and bass guitar selections are among the deepest and broadest in the industry. Major manufacturers, including Fender, Gibson (available only at Musician's Friend), Taylor, Martin, PRS, Yamaha, Ovation and Ibanez, are well represented in popular models and colors. We believe we have one of the largest selections of custom, one-of-a-kind and used/vintage guitars of any retailer. Prices range from $175 for entry-level guitars to over $50,000 for special vintage guitars. In addition, our line of stringed instruments includes banjos, mandolins and dobros, among others. We also offer an extensive selection of guitar sound processing units and products that allow the guitar to interface with a personal computer. These products serve crossover demand from the traditional guitarist into new computer-related sound products.



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Amplifiers. We offer an extensive selection of electric, acoustic and bass guitar amplifiers and, in addition, carry a broad selection of boutique and vintage amplifiers with prices ranging from $50 to $5,000. We represent most manufacturers, including Marshall, Fender, Crate, Ampeg, S.W.R. and Mesa Boogie.



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Percussion Instruments. We believe that we are one of the largest sellers of percussion products in the United States. Our offerings range from basic drum kits to free-standing African congos and bongos and other rhythmic and electronic percussion products with prices ranging from $10 to $10,000. We also have a large selection of vintage and used percussion instruments. Name brands include Drum Workshop, Remo, Sabian, Pearl, Yamaha, Premier, Tama and Zildjian. We carry an extensive selection of digital drum kits and hand held digital drum units. The digital units produce a variety of high quality life-like drum sounds and have broad appeal to musicians.



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Keyboards. We carry a wide selection of keyboard products and computer peripheral and software packages with prices ranging from $100 to $5,000. We offer an extensive selection of software for the professional, hobbyist, studio engineer and the post-production market enthusiast. The product line covers a broad range of manufacturers including Roland, Alesis, Korg, Kurzweil, Emu, Yamaha and Ensoniq. We also maintain a broad selection of computer related recording products, including sound cards, sound libraries and composition, sequence and recording software.



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Pro-Audio and Recording Equipment. Our pro-audio and recording equipment division offers products ranging in price from $100 to $25,000 for musicians at every level, from the casual hobbyist to the professional recording engineer. Our products range from recording tape to state-of-the-art digital recorders. We believe we also carry one of the largest assortments of professional stage audio, disc jockey and lighting equipment for small traveling bands, mobile disc jockeys, private clubs and large touring professional bands. Our major brand

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name manufacturers include JBL, Panasonic, Sony, Mackie, Tascam, Yamaha, Roland and Alesis.

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Broad Used Merchandise Selection. In our retail stores, we offer an extensive selection of used merchandise, the majority of which derives from instruments traded in or sold to us by customers. Our trade-in policy provides musicians with an alternative form of payment and the convenience of selling an old instrument and purchasing a new one at a single location. Used products are bought and priced to sell by store managers who are well trained and knowledgeable in the used musical instrument market.

Retail Store Operations

    To facilitate our strategy of accelerated but controlled growth, we have centralized many key aspects of our store operations, including the development of policies and procedures, accounting systems, training programs, store layouts, purchasing and replenishment, advertising and pricing. Such centralization effectively utilizes the experience and resources of our headquarters staff to establish a high level of consistency throughout all of our stores.

    Retail store operations are led by our Senior Vice President of Sales and ten regional sales managers. Store management is comprised of a store manager, a sales manager, an operations manager, two assistant store managers and five department managers. Each store also has a warehouse manager and a sales staff that ranges from 20 to 40 employees.

    We ensure that store managers are well-trained and experienced individuals who will maintain our store concept and philosophy. Each manager completes an extensive training program that instills the values of operating as a business owner, and only experienced store employees are promoted to the position of store manager. We seek to encourage responsiveness and entrepreneurship at each store by providing store managers with a relatively high degree of autonomy relating to operations, personnel and merchandising. Managers play an integral role in the selection and presentation of merchandise, as well as the promotion of our reputation.

    We view our employees as long-term members of our team. We encourage employee development by providing the salesforce with extensive training and the opportunity to increase both compensation and responsibility level through increased product knowledge and performance. Our aggressive growth strategy provides employees with the ability to move into operations, sales and store management positions, an opportunity which management believes is not available at most other music retailers. As we open new stores, key in-store management positions are primarily filled by the qualified and experienced employees from existing stores. By adopting a "promotion from within" strategy, we maintain a well trained, loyal, and enthusiastic sales force that is motivated by our strong opportunities for advancement. Larry Thomas and Marty Albertson, our Chairman and Co-Chief Executive Officer and President and Co-Chief Executive Officer, respectively, began their careers as salespersons at Guitar Center.

Marketing and Promotion

    We maintain two unique and proprietary databases (one for Guitar Center and one for Musician's Friend) containing information on over 5 million customers. We believe that these databases assist in generating repeat business by targeting customers based on their purchasing history and by permitting us to establish and maintain personal relationships with our customers.

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Retail

    For the retail stores, our advertising and promotion strategy is designed to enhance the Guitar Center name and increase consumer awareness and loyalty. The advertising and promotional campaigns are developed around "events" designed to attract significant store traffic and exposure. We regularly plan large promotional events including the Green Tag Sale in March, the Anniversary Sale in August, and the Guitar-a-thon in November. We believe that our special events have a broad reach as many of them have occurred annually during the past twenty years. These events are often coordinated with product demonstrations, interactive displays, clinics and in-store artist appearances.

    As we enter new markets, we initiate an advertising program, including mail and radio promotions, television and Internet campaigns, and other special grand opening activities, designed to accelerate sales volume for each new store. Radio advertising plays a significant part in our store-opening campaign to generate excitement and create customer awareness.

Direct Response

    For e-commerce and catalog customers, we maintain a stream of communication in electronic and print media, presenting them with an optimal and refreshed mix of offers. Extensive analysis of customer behavior and transactions along with the industry expertise of the merchandising staff provide the marketing staff with offers carefully targeted for optimal response. Cooperative marketing relations with key industry suppliers ensure that Musician's Friend customers are kept current with trends presented by the latest music gear.

    The same transactional databases that make accurate market targeting available for catalog and email circulation are enhanced by the information archived from our website traffic. With the use of an analytical engine developed by Net Perceptions, and continued development of additional tools, our merchandising and marketing departments are able to present product and promotional offerings to prospects with an improved likelihood of triggering purchases.

    Our plans for Musician's Friend include the development of catalogs targeted towards particular segments of the musician market. The first such catalog, which is oriented to percussion instruments, is expected to be mailed during the first quarter of 2001.

    We are also examining opportunities to use the Internet to expand further the reach of our brands. These opportunities are being created by the rapid development of content and community sites oriented towards music and musicians. For example, we have a strategic marketing relationship with musician.com, a community site oriented to the needs of professional and aspiring musicians, which involves Musician's Friend as the exclusive e-commerce partner for musician.com and its affiliates guitar.com in the merchandise categories served by us. We also own a passive minority equity interest in musician.com.

Customer Service

Retail

    Exceptional customer service is fundamental to our operating strategy. With the rapid changes in technology and continuous new product introductions, customers depend on salespeople to offer expert advice and to assist with product demonstrations. We believe that our well-trained and highly knowledgeable sales force differentiates us from our competitors and is critical to maintaining customer confidence and loyalty. Our employees are typically musicians who are selected and trained to understand the needs of our customers. Salespeople specialize in one of our five product categories and begin training on their first day of employment. Sales and management training programs are implemented on an ongoing basis to maintain and continually improve the level of customer service and sales support in the stores. Based on examination results, an employee is given a rating which

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determines his or her salary and level of responsibility. We believe that our employee testing program impresses upon our salespeople a sense of professionalism and reduces employee turnover by providing salespeople with the opportunity to increase their salaries by advancing through the certification program. We believe that due to our emphasis on training, we are able to attract and retain well-qualified, highly motivated salespeople committed to providing superior customer service. In addition, each salesperson (in the keyboards and pro-audio and recording departments) is certified by a technical advisory board after satisfactory completion of an extensive training program.

    Our customer base consists of the professional or aspiring musician who makes or hopes to make a living through music and the amateur musician or hobbyist who views music as recreation. Management estimates that professional and aspiring musicians, who view the purchase of musical products as a career necessity, represent approximately 68% of our customer base, and account for approximately 74% of our sales. These customers make frequent visits to a store and develop relationships with the sales force. We generate repeat business and are successful in utilizing our unique and proprietary database to market selectively to these customers based on past buying patterns. In addition, we service touring professionals, providing customized products for musical artists.

Direct Response

    Musician's Friend maintains a staff of over 200 call center and customer service associates, staffing the call center 24-hours-a-day, seven-days-a-week. Customers can contact agents via phone, e-mail or fax for questions regarding products, technical information, recommendations or the status of their accounts. Most of the staff is comprised of musicians who are given extensive and ongoing product training. The Salt Lake City call center houses an extensive product demonstration area and training facility. Weekly product training is conducted by in-house technical staff as well as manufacturers' representatives.

    We maintain a database of product information for use by the agents in our call center which is always available on our corporate intranet. The intranet also makes operational and instructional information available to agents, minimizing their downtime and maximizing their ability to service customer needs effectively. All of this information, along with customer account information, is available in real time, giving agents the ability to keep customers constantly up to date.

    The web site is updated hourly with new product information so customers can work with the latest available information. As this is an area that is constantly evolving, customers are continually presented with new and more extensive information. In addition, the collaborative filtering process results in customized product recommendation to customers browsing the web site.

    To provide the customer with a high degree of satisfaction, we offer a 45-day satisfaction guaranteed return policy and 45-day lowest price guarantee. All information regarding transactions and customer accounts is stored in a database accessible by customer service representatives, ensuring that they can provide customers with timely and accurate information regarding their accounts.

    For customers that have registered e-mail addresses with us, we offer automated order and shipment verification. This provides customers with UPS or Fed Ex order tracking information as soon as their shipment has been processed.

Order Fulfillment

    Musician's Friend orders are fulfilled out of company-operated distribution centers located in Knoxville, Tennessee, Medford, Oregon and our newest facility in Kansas City, Missouri. For orders handled by the call center, associates are presented with inventory information in the distribution center geographically closest to the customer, as well as alternate locations. E-commerce orders are processed automatically through the closest stocking warehouse to the customer. Credit card

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authorization and fraud management systems are automated, minimizing delays in processing. The distribution centers process orders taken before 5 p.m. Eastern time for same-day shipping of in-stock items, minimizing delays in delivery to customers. Orders ship primarily by UPS and Fed Ex. During 2000, our initial line item fill rate was 87%.

    All returns are routed to the Kansas City warehouse in order to consolidate the handling of this merchandise. Returned and blemished products are sold through an outlet store located in the Kansas City facility and by offering such products at reduced prices on the musiciansfriend.com web site.

Purchasing, Distribution and Inventory Control

    Purchasing.  We believe we have excellent relationships with our vendors and, in many instances, are the vendor's largest customer. Given our high volume, we are generally able to receive prompt order fulfillment and access to our vendors' premium products. We maintain a centralized buying group comprised of merchandise managers, buyers, planners and distributors. Merchandise managers and buyers are responsible for the selection and development of product assortments and the negotiation of prices and terms. The planners and distributors are responsible for maintaining inventory levels and allocating the merchandise to the stores and direct response distribution centers. We use two merchandise replenishment systems (one for retail stores and one for the direct response business) which automatically analyze and forecast sales trends for each SKU using various statistical models, supporting the buyers by predicting merchandise requirements. This has resulted in limited "out of stock" positions.

    Our business and expansion plans are dependent to a significant degree upon our vendors. As we believe is customary in the industry, we do not have any long-term supply contracts with our vendors. Please see "—Risks Related to the Business—We Depend on Suppliers."

    Distribution.  At the present time we do not have a central warehouse/distribution center and each of our vendors drop ship directly to each of our retail stores. Our retail operations have reached a sufficient size that we believe there is an opportunity to reduce chainwide inventory levels and therefore reduce working capital requirements by operating a central warehouse/distribution center to service the retail stores. We intend during 2001 to build a central warehouse/distribution center for our retail store operations with a view towards the facility commencing operation in early 2002. We have hired an experienced logistics executive and are actively considering possible sites. Migration from our present "drop-ship" model to a centralized distribution model is an important development in our operating strategy and will require significant financial and managerial resources for the next several quarters.

    The direct response unit presently operates three distribution facilities, located in Knoxville, Tennessee, Medford, Oregon, and Kansas City, Missouri.

    Inventory Control.  We have invested significant time and resources in our inventory control system at the retail stores and believe we have one of the most sophisticated systems in the music products retail industry. We believe the vast majority of music product retailers do not use a computerized inventory management system. We perform inventory cycle counts daily, both to measure shrinkage and to update the perpetual inventory on a store-by-store basis. As appropriate, we also stock balance inventory among stores to assure proper distribution of product and to control overall inventory levels. Our inventory shrinkage level has historically been low, which we attribute to our sophisticated system controls and strong corporate culture.

Retail Store Site Selection

    We believe we have developed unique and, what historically have been, highly effective selection criteria to identify prospective store sites. In evaluating the suitability of a particular location, we

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concentrate on the demographics of our target customer as well as traffic patterns and specific site characteristics such as visibility, accessibility, traffic volume, shopping patterns and availability of adequate parking. Stores are typically located in free-standing locations to maximize their outside exposure and signage.

Management Information Systems

Retail

    We have invested significant resources in management information systems that provide real-time information. The systems have been designed to integrate all major aspects of our business, including sales, gross margins, inventory levels, purchase order management, automated replenishment and merchandise planning. Our highly sophisticated management information systems provide us with the ability to monitor all critical aspects of activity on a real-time basis. Our system capabilities include inter-store transactions, vendor analysis, serial number tracking, inventory analysis and commission sales reporting. We believe that the system we have developed will enable us to continue to improve customer service and operational efficiency and support our needs for the immediately foreseeable future.

Direct Response

    Musician's Friend maintains an extensive transaction processing system as well as systems supporting e-commerce, operations and marketing analysis, and internal support information. All transaction and inventory information is available real-time. The e-commerce web site is updated during the day through a firewall, providing a high degree of security for our internal systems. During 2000 we completed phase one of a security and redundancy enhancement program for our web systems, relocating related hardware and software to Bellingham, Washington. Dedicated systems are used for inventory planning and for web site analysis.

    The systems provide management with extensive marketing, merchandising and operational information, and provide call center and customer service staff with current inventory and customer account information. The choice of platforms and databases provides us with a strong foundation for ongoing development of systems.

Competition

    We are in direct competition with two other major retail chains within the music industry—Sam Ash of New York, New York and Music and Recording Superstores (MARS) of Miami, Florida. In addition, we compete with various direct response companies such as American Music Supply, Sam Ash Music, and Sweetwater Sound. As of December 31, 2000 we were in direct competition with Sam Ash in 18 of our markets and with MARS in 25 of our markets. In recent years, Sam Ash and MARS have continued to open new stores, and we believe they will continue to do so in the future. We expect that there will be additional competitive overlap in new and existing Guitar Center markets. There is, however, room for consolidation within the music industry as the top ten retailers (including Guitar Center/Musician's Friend, Sam Ash and MARS) only account for an estimated 23% of the market compared to an estimated 60% market share held by the top ten specialty retailers in the consumer electronics, home improvement and toy industries.

    We believe that the ability to compete successfully in our markets is determined by several factors, including breadth and quality of product selection, pricing, effective merchandise presentation, customer service, store location and proprietary database marketing programs. Customer satisfaction is paramount to our operating strategy and we believe that providing knowledgeable and friendly customer service gives us a competitive advantage. The store environment is designed to be an entertaining and exciting environment in which to shop. In an effort to exceed customer expectations,

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our stores provide a number of services not generally offered by most competitors, including the ability to hold and use merchandise, product demonstrations and extensive product selection. Salespeople are highly trained and specialize in one of our five product areas. Salespeople are certified by an outside technical advisory board, based on extensive training and product knowledge testing. We believe that this certification process has increased the professionalism of our employees while reducing turnover. Customers are encouraged to help themselves to the displayed instruments and to seek the assistance of the professional salespeople.

    Certain factors, however, could materially and adversely affect our ability to compete successfully in our markets, including, among others, the expansion by us into new markets in which our competitors are already established, competitors' expansion into markets in which we are currently operating, the adoption by competitors of innovative store formats and retail sales methods or the entry into our market by competitors with substantial financial or other resources. See "—Risks Related to the Business—We May Be Unable to Meet Our Growth Strategy" and "—We Have Competitors."

Employees

    As of December 31, 2000, we employed 3,525 people, of whom 2,641 were hourly employees and 884 were salaried. None of our employees are covered by a collective bargaining agreement. We believe that we enjoy good employee relations.

Service Marks

    We have registered the GUITAR CENTER, ROCK WALK, MUSICIAN'S FRIEND, ROGUE, AXMAN, PULSE PERCUSSION, PARADISE, GUITARMAN and RAM service marks with the United States Patent and Trademark Office. We believe that these service marks have become important components of our merchandising and marketing strategy. The loss of the GUITAR CENTER or MUSICIAN'S FRIEND service mark could have a material adverse effect on our business.

Risks Related to the Business

    Described below are some of the risks and uncertainties facing our company. There may be additional risks that we do not presently know of or that we currently consider immaterial. All of these risks could adversely affect our business, results of operations, liquidity and financial position.

We May Be Unable to Meet Our Growth Strategy.

    Our retail store growth strategy includes opening new stores and increasing sales at existing locations. We intend to pursue an aggressive expansion strategy by opening additional stores in new and existing markets. As of December 31, 2000, we operated 83 stores. We opened 14 stores in 2000 and 13 stores in 1999, and plan to open approximately 12 to 14 stores in 2001 and approximately 12 to 16 stores in 2002. Our expansion plan depends on a number of factors, including:

•

Identification of suitable retail sites;



•

Negotiation of acceptable lease terms;



•

Hiring, training and retention of skilled personnel;



•

Sufficient management and financial resources to support the new locations; and



•

Vendor support.

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    We cannot assure that we will achieve our store expansion goals or that our new stores will achieve sales or profitability levels similar to our existing stores. Our expansion strategy includes clustering stores in existing markets. This may result in the transfer of sales to the new store and a reduction in the profitability of an existing store. In addition to the factors noted above, expansion to new markets may present unique competitive and merchandising challenges, including:

•

Significant start-up costs, including promotion and advertising;



•

Management of stores in distant locations;



•

Warehousing future retail locations (we do not currently warehouse our new locations but may if a unique situation becomes available); and



•

Our expansion may involve acquisitions in business segments in which we have limited experience, which will require that we retain existing management.

    Historically, we have achieved significant sales growth in existing stores. Our quarterly comparable stores sales results have fluctuated significantly in the past. Sales growth for comparable periods, excluding net sales attributable to stores not open for 14 months was as follows:

    A variety of factors affect our comparable store sales results, including:

•

Competition;



•

Economic conditions;



•

Consumer and music trends;



•

Changes in our merchandise mix;



•

Product distribution;



•

Transfer of sales to new locations (i.e., market clustering); and



•

Timing of our promotional events.

    Our management is presently anticipating comparable store sales growth of 5% to 7% for the immediate future, although fluctuations will undoubtedly take place from period to period.

    We also believe that our expansion may be accelerated by the acquisition of existing music product retailers. In the ordinary course of our business, we regularly consider, evaluate and enter into negotiations related to potential acquisition opportunities. We may pay for these acquisitions in cash or securities (including equity securities), or a combination of both. We cannot assure that attractive acquisition targets will be available at reasonable prices or that we will be successful in any such transaction. Acquisitions involve a number of special risks, including:

•

Diversion of our management's attention;



•

Integration of the acquired business with our business; and



•

Unanticipated legal liabilities and other circumstances or events.

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We Depend on Suppliers.

    We depend significantly on our suppliers for both our existing stores and the direct response unit and our expansion goals. We do not have any long-term contracts with our suppliers, which we believe is customary in our industry. If we failed to maintain our relationships with our key brand name vendors, we believe this could have a material adverse effect on our business. We believe we currently have adequate supply sources; however, we cannot assure sufficient quantities or the appropriate mix of products will be available in the future to supply our existing stores and expansion plans. This risk is especially prevalent in new markets where our vendors have existing agreements with other dealers and thereby may be unwilling or unable to meet our requirements.

We Have Competitors.

    Our industry is fragmented and highly competitive. We compete with many different types of retailers, including conventional retailers, as well as other catalog and e-commerce retailers, who sell many or most of the items we sell. We anticipate increased competition in our existing markets and planned new markets as other large format music product retailers execute their announced growth plans. Additionally, our expansion to new markets will be inhibited by established competitors in those markets. If our competitors adopt a new, innovative store format or retail selling method, or if a new competitor with substantial financial or other resources enters the market place, then we may fail to achieve market position gains or may lose market share.

We Depend on Key Personnel.

    Our success depends to a significant extent on the services of Larry Thomas, our Chairman and Co-CEO, and Marty Albertson, our President and Co-CEO, and Robert Eastman the CEO of our wholly owned Musician's Friend, Inc. as well as our ability to attract and retain additional key personnel with the skills necessary to manage our existing business and growth plans. The loss of one or more of these individuals or other key personnel could have a material adverse effect on our business, results of operations, liquidity and financial position. In June 1996, we entered into a five-year employment contract with both Mr. Thomas and Mr. Albertson. Additionally, we carry key man insurance on the lives of Mr. Thomas and Mr. Albertson in the amounts of $5.0 million and $3.5 million, respectively. Historically, we have promoted employees from within our organization to fill senior operations, sales, and store management positions. In order to achieve our growth plans, we will depend upon our ability to retain and promote existing personnel to senior management, and we must attract and retain new personnel with the skills and expertise to manage our business. If we cannot hire, retain, and promote qualified personnel, our business, results of operations, financial condition and prospects could be adversely affected.

Our Retail Operations are Concentrated in California.

    As of December 31, 2000, 19 of our 83 stores were located in California and generated 29.0% and 30.7% of our retail sales for 2000 and 1999, respectively. Although we have opened stores in other areas of the United States, a significant percentage of our net sales and results of operations will likely remain concentrated in California for the foreseeable future. As a result, our results of operations and financial condition are heavily dependent upon general consumer trends and other general economic conditions in California and are subject to other regional risks, including earthquakes. We do maintain certain earthquake insurance, but such policies carry significant deductibles and other restrictions.

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Economic Conditions Could Adversely Impact Industry Results; Changing Consumer Preferences Could Also Adversely Impact Us.

    Our business is sensitive to consumer spending patterns, which can be affected by prevailing economic conditions. A downturn in economic conditions in one or more of our markets could have a material adverse effect on our results of operations, financial condition, business and prospects. Although we attempt to stay informed of consumer preferences for musical products and accessories typically offered for sale in our stores, any sustained failure on our part to identify and respond to trends would have a material adverse effect on our results of operations, financial condition, business and prospects.

We Must Manage Efficiently the Expansion of our Web site and the Systems that Process Orders in Our Direct Response Business.

    Our direct response business, particularly our e-commerce business, will require significant investments to respond to anticipated growth and competitive pressures. If we fail to rapidly upgrade our web site in order to accommodate increased traffic, we may lose customers, which would reduce our net sales. Furthermore, if we fail to expand the computer systems that we use to process and ship customer orders and process payments, we may not be able to successfully distribute customer orders. As a result, we could lose customers and our net sales could be reduced. We may experience difficulty in improving and maintaining such systems if our employees or contractors that develop or maintain our computer systems become unavailable to us. We have experienced periodic systems interruptions, which we believe will continue to occur, while enhancing and expanding these computer systems.

We Intend to Implement a New Distribution Center for the Retail Stores which Presents Operational Risks and Will Require a Significant Investment.

    We intend during 2001 to build a central warehouse/distribution center for our retail store operations with a view towards the facility commencing operation in early 2002. Migration from our present "drop-ship" model to a centralized distribution model is an important development in our operating strategy and will require significant financial and managerial resources for the next several quarters. This program involves risks that could include the need to expend greater funds than presently budgeted or disruptions in retail store operations if inventory is not timely provided in the required quantities.

Net Sales of our E-Commerce Business Could Decrease If Our Online Security Measures Fail.

    Our relationships with our e-commerce customers may be adversely affected if the security measures that we use to protect their personal information, such as credit card numbers, are ineffective. If, as a result, we lose many customers, our net sales could decrease. We rely on security and authentication technology that we license from third parties. With this technology, we perform real-time credit card authorization and verification with our bank. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect a customer's personal information. Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. We cannot assure that we can prevent all security breaches.

If We Do Not Respond To Rapid Technological Changes, Our Services Could Become Obsolete And We Could Lose Customers.

    If we face material delays in introducing new services, products and enhancements, our e-commerce customers may forego the use of our services and use those of our competitors. To remain

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competitive, we must continue to enhance and improve the functionality and features of our online store. The Internet and the online commerce industry are rapidly changing. If competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing website and proprietary technology and systems may become obsolete. To develop our website and other proprietary technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards. In addition, the success of e-commerce may result in greater efficiency and lower prices, which could have an adverse effect on selling prices and margins in our retail store business and in our catalog business and generally constrain profitability in the specialty retail business.

We May Need To Change The Manner In Which We Conduct Our Business If Government Regulation Increases.

    The adoption or modification of laws or regulations relating to the Internet could adversely affect the manner in which we currently conduct our e-commerce business. For example, laws related to the taxation of online commercial activity remain in flux. In addition, the growth and development of the market for online commerce may lead to more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the Internet are becoming more prevalent. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, consumer privacy, taxation of e-commerce transactions and the like are interpreted and enforced. Any adverse change in any of these laws or in the interpretation or scope of existing laws could have a material adverse effect on our results of operations, financial condition or prospects.

The Ownership of NOLs Related to the Musician's Friend Business May be Recaptured.

    The former stockholders of the Musician's Friend business are involved in a tax audit with the Internal Revenue Service regarding the conduct of the business prior to the merger with Guitar Center. Those proceedings may result in NOLs that have previously been recognized by us in our consolidated financial statements being deemed to be the property of the former stockholders. This issue is not resolved as of the date of this annual report and we can provide no assurance as to the ultimate outcome of this matter. However, an unfavorable resolution of this matter would result in a charge to our financial statements and the payment of taxes previously offset with the credits.

We Have an Investment in an Internet Community Company that Could Result in Future Charges to our Financial Statements.

    We have an investment of approximately $3.3 million in the equity of the operator of musician.com and guitar.com, Internet community sites oriented towards musicians. We are carrying this investment at cost, and this value was recently validated by third party financing by several venture capital firms. However, if in the future we determine that the fair market value of these shares has been permanently reduced to less than our cost, we would be required under generally accepted accounting principles to recognize a charge to our financial statements.

We Have a Limited History of Trading on the Nasdaq National Market; Our Stock Price Could be Volatile.

    We began trading on the Nasdaq National Market on March 14, 1997. The market price of our shares of common stock has been subject to significant fluctuations in response to our operating results and other factors, including announcements by our competitors, and those fluctuations will likely continue in the future. In addition, the stock market in recent years has experienced significant price

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and volume fluctuations that often have been unrelated or disproportionate to the operating performance of particular companies. These fluctuations, as well as a shortfall in sales or earnings compared to public market analysts' expectations, changes in analysts' recommendations or projections, and general economic and market conditions, may adversely affect the market price of our common stock.

Forward-Looking Statements and Associated Risks.

    This annual report contains forward-looking statements, relating to, among other things, future results of operations, growth plans (including, without limitation, the number and timing of new store openings and the growth of our e-commerce business), sales, gross margin and expense trends, capital requirements and general industry and business conditions applicable to us. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from these forward-looking statements. In addition to the other risks described elsewhere in this section, important factors to consider in evaluating these statements include changes in external competitive market factors, changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the music products industry or the economy in general, the emergence of new or growing specialty retailers of music products and various other competitive factors that may prevent us from competing successfully in existing or future markets. In light of these risks and uncertainties, we can not assure you that the forward-looking statements contained in this annual report will in fact be realized. Further, we do not undertake any duty to update the forward-looking statements contained in this annual report, particularly those related to management's future estimates which are subject to revision due to changes in the business environment that we face.

Item 2. PROPERTIES

    We lease all but three of our stores and presently intend to lease all new locations. We lease our call center facility in Salt Lake City, Utah and the distribution centers, in Knoxville, Tennessee and Kansas City, Missouri. The terms of the store leases are generally for 10 years and typically allow us to renew for two additional five-year terms. Most of the leases require us to pay property tax, utilities, normal repairs, common area maintenance and insurance expenses.

    We lease our corporate offices of approximately 35,700 square feet, which are located at 5155 Clareton Drive, Agoura Hills, California 91301. During April 2001, we will relocate these offices to 69,600 square feet of leased space located at 5795 Lindero Canyon Road, Westlake Village, California 91362. Our direct response business is headquartered in a facility we own located at 931 Chevy Way, Medford, Oregon 97504.

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Store Locations

    The table below sets forth certain information concerning our retail stores as of December 31, 2000:

(1)

Represents stores relocated in 2001.

(2)

Represents stores relocated in 2000.

(3)

Excludes 10,000 square feet consisting of a basement and warehouse space.

(4)

We have signed leases for these locations and presently expect each to open in 2001.

(5)

Excludes 24,000 square feet consisting of a basement and warehouse space.

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Item 3. Legal Proceedings

    We are not a party to any material legal proceedings and are not aware of any pending or threatened litigation that, if decided adversely to the Company, would reasonably be expected to have a material adverse effect on our financial condition. Please see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Income Taxes" for discussion of a tax matter with which we are indirectly involved.

Item 4. Submission of Matters to a Vote of Security Holders

    No matters were submitted to a vote of security holders during the fiscal quarter ended December 31, 2000.

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

Market Information

    Our common stock is quoted on the Nasdaq National Market under the symbol "GTRC." The following table sets forth the high and low closing sale prices for the common stock for the calendar quarters indicated:

    As of March 5, 2001, there were 148 stockholders of record, excluding the number of beneficial owners whose shares were held in street name. We believe that the number of beneficial holders is significantly in excess of such amount based on the security position listings we obtain from time to time for the purpose of facilitating mailings to our stockholders.

Dividend Policy

    We currently intend to retain any earnings to provide funds for the operation and expansion of our business and for the servicing and repayment of indebtedness and do not intend to pay cash dividends on our common stock in the foreseeable future. Under the terms of the indenture governing our senior notes, we are not permitted to pay any dividends on the common stock unless certain financial ratio tests and other conditions are satisfied. In addition, our bank facility with Foothill Capital contains certain covenants which, among other things, limit the payment of cash dividends on the capital stock of the Company. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources." Any determination to pay cash dividends on the common stock in the future will be at the sole discretion of our Board of Directors.

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Item 6. Selected Financial Data

    The selected financial data for the fiscal years ended December 31, 2000, 1999, 1998, 1997 and 1996 has been derived from our audited consolidated financial statements. The selected historical financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations, our consolidated financial statements and the notes thereto included elsewhere in this annual report.

(1)

In 1996, we recorded a non-recurring deferred compensation expense of $71.8 million, of which $69.9 million related to the cancellation and exchange of management stock options pursuant to our 1996 recapitalization and $1.9 million related to a non-cash charge resulting from the grant of stock options to management by certain investors.

(2)

Weighted average shares represents shares calculated on a diluted basis.

(3)

Net sales per gross square foot is presented for retail stores only and does not include new stores opened during the reporting period.

(4)

Compares net sales for the comparable periods, excluding net sales attributable to stores not open for 14 months.

(5)

For the purpose of calculating the ratio of earnings to fixed charges, "earnings" represents income before provision for income taxes and fixed charges. "Fixed charges" consist of interest expense, amortization of debt financing costs, and one third of lease expense, which management believes is representative of the interest components of lease expense. Earnings were insufficient to cover fixed charges by $72.3 million for the year ended December 31, 1996.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

General

    We operated 79 retail locations in 42 major markets and 4 stores in secondary markets as of December 31, 2000. We also operate the largest direct response channel (Musician's Friend catalog and Internet) in the musical instruments industry in the United States. From 1996 to 2000, our net sales grew at an annual compound growth rate of 31.9%, principally due to the comparable store sales growth of our Guitar Center stores averaging 10% per year, the opening of new stores, and a 31.0%, per year increase in the direct response channel. We believe such volume increases are the result of the continued success of the implementation of our business strategy, continued growth in the music products industry and increasing consumer awareness of the Guitar Center and Musician's Friend brand names. We achieved comparable store sales growth of 7%, 10% and 13% for the fiscal years ended December 31, 2000, 1999 and 1998, respectively. As indicated below, we do not expect comparable store sales to continue to increase at historical rates.

    We opened fourteen stores this year, one of which was acquired from Veneman Music in May 2000. Presently, we expect to open approximately 12 to 14 stores in 2001 and 12 to 16 stores in 2002. In preparation for these additional stores, we have dedicated a substantial amount of resources over the past several years to building the infrastructure necessary to support a large, national chain. We have established centralized operating and financial controls and have implemented an extensive training program to ensure a high level of customer service in our stores. We will continue to pursue our strategy of clustering stores in major markets to take advantage of operating and advertising efficiencies and to build awareness of the Guitar Center name in new markets. In some markets this clustering strategy results in some transfer of sales from existing stores to new locations, thereby adversely affecting comparable store sales statistics.

    As we enter new markets, we expect that we will initially incur higher administrative and promotional costs per store than is currently experienced in established markets. We expect competition to continue to increase as other music product retailers attempt to execute national growth strategies. Our business strategy will also emphasize opportunities to grow our direct response business, particularly opportunities to increase our Internet activities. We expect to continue to make significant investments in the e-commerce and related business activities of Guitar Center and Musician's Friend.

    The following table sets forth historical income statement data as a percentage of net sales:

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Fiscal 2000 Compared to Fiscal 1999

    Net sales for the year ended December 31, 2000 increased 26.7% to $786 million, compared with $620 million last year. Net sales from retail stores for fiscal 2000 totaled $652 million, a 21.6% increase from $537 million in fiscal 1999. Sales from new stores contributed $79 million and represent 69% of the total increase in retail store sales. Comparable store sales for the full year increased 7%. The increase in comparable store sales was due to aggressive pricing on certain elements of inventory and good store sales performance due to the effect of successful promotions. Our management is presently anticipating comparable store sales growth of 5% to 7% for the immediate future, although fluctuations will undoubtedly take place from period to period. The foregoing statement is a forward-looking statement and is subject to the qualifications set forth below under "Forward-Looking Statements; Business Risks." Net sales from the direct response channel totaled $133 million in year 2000, a $50 million increase from 1999. Catalog sales increased 32% to $88 million in 2000 from $67 million in 1999. Internet sales for the year increased 170% to $45 million from $16 million last year. Direct response results reflect the increase in average order size, sales facilitated by the third-party credit card introduced in the third quarter of 1999 and the impact of Net Perceptions selling software installed in the first quarter of 2000.

    Gross profit dollars for the year ended December 31, 2000 compared to 1999 increased 25.5% to $205 million from $163 million. Gross profit as a percentage of net sales for the year ended December 31, 2000 compared to 1999 decreased to 26.1% from 26.3%. Gross profit margin percentage for the retail stores in 2000 after buying and occupancy costs was 25.3% compared to 26.0% in 1999. The reduction in gross profit margin relates to increased occupancy costs caused by the number of immature stores in the total store base, increased freight expense as a result of opening new stores farther from some of our key vendors and higher shrink losses. The gross profit margin for the direct response division was 29.8% for 2000 compared to 28.7% in 1999. The increase is principally due to improved selling margin.

    Selling, general and administrative expenses for fiscal 2000 increased 22.0% to $156.7 million from $128.4 million in fiscal 1999. As a percentage of net sales, selling, general and administrative expenses for fiscal 2000 decreased to 19.9% from 20.7% in fiscal 1999. Selling, general and administrative expenses for the retail stores in 2000 and in 1999, inclusive of pre-opening costs and corporate general and administrative expenses, were 19.5% of net sales. These results reflect the leveraging of corporate and administrative expenses offset by additional advertising and marketing expenses, and higher store level selling, general and administrative expenses due to the number of stores that are less than two years old. Selling, general and administrative expenses for the direct response division were 22.4% of sales compared to 28.8% last year. The improvement largely reflects the leveraging of corporate overhead and marketing expenses as a result of the 59.8% increase in sales compared to 1999.

    Transaction and store conversion costs totaled $4.7 million, or 0.8% of sales, during the year ended December 31, 1999. No similar costs were incurred in 2000.

    Operating income for fiscal 2000 increased 59.7% to $48.2 million from $30.2 million in fiscal 1999. The increase is principally due to the increase in operating income from the direct response unit and the absence of transaction expenses compared to 1999. As a percentage of sales, operating income was 6.2% and 4.8% in the years ended December 31, 2000 and 1999, respectively.

    Interest expense, net for fiscal 2000 increased to $12.5 million from $11.2 million in fiscal 1999. Interest expense consisted primarily of interest on our Senior Notes and borrowings under the line of credit for additions to inventory and capital expenditures for our store expansions.

    In 2000, income taxes were recorded at normal income tax rates, whereas in 1999 an income tax benefit was recorded due to the reduction of the valuation reserve on the Company's deferred tax asset, net of current federal and state income taxes. We anticipate that in the future the income tax rate will be approximately 38%.

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    In the first quarter of 1999, a charge to operations of $1.7 million, net of tax of $0.6 million, was incurred for the cumulative effect of a change in accounting principle to expense pre-opening costs. No similar charge was incurred in 2000.

    Net income for fiscal 2000 increased to $22.5 million from $18.3 million in fiscal 1999. The increase was principally due to an increase in operating income from the direct response unit, the absence of transaction expenses compared to prior year, and the cumulative effect of the change in accounting principle as discussed above.

Fiscal 1999 Compared to Fiscal 1998

    Net sales for the year ended December 31, 1999 increased 28% to $620 million, compared with $486 million in 1998. Net sales from retail stores for fiscal 1999 totaled $537 million, a 31% increase from $411 million in fiscal 1998. Sales from new stores contributed $91 million and represent 73% of the total increase in retail store sales. Comparable store sales for the full year increased 10%. The increase in comparable store sales was primarily attributable to increases in unit sales rather than increases in prices or changes in the mix of sales between the product categories. Such volume increases were primarily the result of the continued success of the implementation of our business strategy, continued strong growth in the music products industry and increasing consumer awareness of the Guitar Center name. Catalog sales decreased 5% to $67 million in 1999 from $70 million in 1998, due in part to a change in credit card programs, and its resulting effect on average order size. The new third-party credit card was introduced on October 20, 1999. E-commerce sales for the year increased 319% to $17 million from $4 million in 1998.

    Gross profit dollars for the year ended December 31, 1999 compared to 1998 increased 23% to $163.3 million from $132.2 million. Gross profit as a percentage of net sales for the year ended December 31, 1999 compared to 1998 decreased to 26.3% from 27.2%. Gross profit margin percentage for the retail stores in 1999 after buying and occupancy costs was 26.0% compared to 27.7% in 1998. The reduction in gross profit margin is related to increased occupancy costs due to the number of stores less than two years old (29 stores out of 69 stores), actions taken to clear out merchandise at former Musician's Friend locations, increased freight expense as more stores were opened on the East Coast, and a change in assortment and aggressive pricing on inventory that we wanted to move. The gross profit margin for the direct response division was 28.7% for 1999 compared to 24.8% in 1998. In 1998, significant markdowns were required to clear excess direct response inventories. Markdowns of the same magnitude were not required in 1999. Additionally, during 1998 higher than average inventory shrink occurred in the Musician's Friend distribution facilities.

    Selling, general and administrative expenses for fiscal 1999 increased 18.4% to $128.4 million from $108.4 million in fiscal 1998. As a percentage of net sales, selling, general and administrative expenses for fiscal 1999 decreased to 20.7% from 22.3% in fiscal 1998. Selling, general and administrative expenses for the retail stores in 1999, inclusive of pre-opening costs and corporate general and administrative expenses, were 19.5% of sales compared to 20.2% in 1998. These results reflect the leveraging of corporate expenses, partially offset by higher store level selling, general and administrative expense due to the number of stores that are less than two years old. Selling, general and administrative expenses for the direct response division were 28.8% of sales compared to 34.2% in 1998. In 1998 Musician's Friend incurred substantial bad debt expense related to an in-house installment credit program. This program was substantially terminated in the fourth quarter of 1998.

    Transaction and store conversion costs totaled $4.7 million, or 0.8% of sales, during the year ended December 31, 1999. These costs relate to the acquisition of Musician's Friend during the second quarter of 1999 and principally include financial advisory fees ($1.3 million), legal and accounting fees ($1.2 million), a severance accrual for a former Musician's Friend executive ($0.8 million), as well as costs associated with the conversion of Musician's Friend stores to Guitar Center stores.

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    Operating income for fiscal 1999 increased 27.0% to $30.2 million from $23.8 million in fiscal 1998.

    Interest expense, net for fiscal 1999 increased to $11.2 million from $10.8 million in fiscal 1998. Interest expense consisted principally of interest on our Senior Notes and borrowings under the line of credit. Interest expense includes interest to related parties on our subordinated notes of $0.5 million and $1.3 million for the years ended December 31, 1999 and 1998, respectively.

    Income tax benefit in 1999 was recorded due to the reduction of the valuation reserve on the Company's deferred tax asset, net of current federal and state income taxes.

    In the first quarter of 1999, a charge to operations of $1.7 million, net of tax of $0.6 million, was incurred for the cumulative effect of a change in accounting principle to expense pre-opening costs.

    Net income for fiscal 1999 increased to $18.3 million from $16.4 million in fiscal 1998.

Liquidity and Capital Resources

    Our need for liquidity will arise primarily from interest payable on indebtedness and the funding of capital expenditures and working capital requirements, as well as investments and possible acquisitions. We have historically financed our operations through internally generated funds and borrowings under our credit facilities. We have no mandatory payments of principal on the $66.7 million of Senior Notes outstanding prior to their final maturity in 2006. As of December 31, 2000, we had $35.9 million outstanding under the 2000 Credit Facility, excluding $1.9 million outstanding on standby letters of credit, and had available borrowings of $61.4 million. The 2000 credit facility permits borrowings up to $100 million ($99.2 million at December 31, 2000) and can be increased (at our election) up to $150 million, subject to compliance with the terms of the loan agreement. The credit facility is secured by certain assets and the actual amount available is tied to our inventory and receivable base. A fee of 0.25% is assessed on the unused portion of the 2000 credit facility. Borrowings bear interest at either the prime rate (9.5% at December 31, 2000) plus 0.5% or at LIBOR (6.5% at December 31, 2000) plus 1.5%. The agreement underlying the 2000 credit facility includes certain restrictive covenants. We were in compliance with such requirements as of December 31, 2000.

    For the year ended December 31, 2000, cash provided by operating activities was $36.5 million, most of which represented cash income from operations, net of additions to inventory. Cash used in investing activities totaled $23.4 million, which primarily consisted of capital expenditures for retail store expansions, computer equipment purchases and the launching of our Kansas City warehouse for our direct response unit ($1.1 million), the acquisition of Veneman Music Company ($2.2 million), and an investment in a non-consolidated entity ($3.3 million). Cash used in financing activities totaled $7.0 million, which consisted principally of paying down our credit facilities.

    Inventory increased from $161 million to $199 million, or 24.1%. The increase in inventory was required principally to support existing sales growth and the opening of new retail locations. Inventory per square foot at retail stores was $130 in 2000 compared to $133 in 1999. Inventory increased from $16.4 million to $25.0 million, or 52.3% for the direct response division. The increase in inventory was required principally to support future sales. Our ongoing objective is to improve inventory performance by refining our replenishment processes and systems, and through improved planning, presentation, and display of inventories in our retail stores.

    We intend to pursue an aggressive growth strategy by opening additional stores in new and existing markets. During 2000, we opened fourteen new stores, one of which was acquired from Veneman Music Company in the second quarter of 2000. Each new large format Guitar Center store typically has required approximately $1.8 million for gross inventory. Historically, our cost of capital improvements for an average large format Guitar Center store has been approximately $850,000, consisting of leasehold improvements, fixtures and equipment. We incur higher costs in some geographic areas, particularly the Northeast. We have developed a smaller format Guitar Center store to operate in

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secondary markets or sites that we do not believe will support our large format unit. The first of these units was opened in late 2000. Our small format stores will incur approximately $400,000 in capital expenditures and require approximately $800,000 in inventory.

    During 2001, we expect to incur approximately $20 million to $21 million in capital expenditures.

    We are also currently evaluating additional capital and strategic requirements related to improving our fulfillment facilities and technology and pursuing new opportunities in the e-commerce activities of Guitar Center and Musician's Friend, and related businesses. The initiatives related to fulfillment include leasing a new distribution facility for Musician's Friend in Kansas City, which is operational, and our plan to construct a distribution facility to support the retail business. The construction and operation of the retail distribution facility will require the expenditure of significant capital, as well as the development of a team of key employees to manage this new function. We will also continue to make significant investments in information technology across our businesses and will incur costs and make investments designed to expand the reach of the Guitar Center and Musician's Friend brands on the Internet. The costs of these initiatives and other investments related to our businesses will continue to be significant and are not included in our capital expenditure budget noted above.

    Our expansion strategy is to continue to increase our market share in existing markets and to penetrate strategically selected new markets. We opened a total of 14 stores in 2000 and 13 stores in 1999, and currently anticipate opening approximately 12 to 14 stores in 2001. Some of these stores will be new smaller format units designed for secondary markets. We also believe there may be attractive opportunities to expand by selectively acquiring existing music products retailers. However, in the music industry there are only a small number of companies that would strategically and financially be a beneficial opportunity for us to acquire. Our "average" store is 15,000 square feet, carrying 7,000 SKUs and generating first year sales of $5.5 million, whereas the "average" industry store is 3,200 square feet, carrying 2,500 SKUs and generating sales of $1.0 million. We may also consider acquisitions which are complementary to other parts of our business, such as our direct response division, if attractive opportunities can be identified.

    Our capital resources and liquidity are expected to be provided by net cash flow from operations and additional borrowings under the 2000 Credit Facility. Depending upon market conditions, we may also incur additional indebtedness or issue equity securities. There can be no assurance that such additional capital, if and when required, will be available on terms acceptable to us, if at all.

Newly Issued Accounting Pronouncements

    In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44 (Interpretation 44), Accounting for Certain Transactions Involving Stock Compensation. Interpretation 44 provides criteria for the recognition of compensation expense in certain stock-based compensation arrangements that are accounted for under Accounting Principles Board Opinion No. 25, Accounting for Stock-Based Compensation. Interpretation 44 is effective July  1, 2000, with certain provisions that are effective retroactively to December 15, 1998 and January 12, 2000. Interpretation 44 is not expected to have an impact on our financial statements.

Seasonality

    Our operating results are not highly seasonal, except for the effect of the holiday selling season in November and December. Sales in the fourth quarter are typically significantly higher on a per store basis and through the direct response unit than in any other quarter.

Income Taxes

    The former stockholders of the Musician's Friend business are involved in a tax audit with the Internal Revenue Service regarding the conduct of the business prior to the merger with Guitar Center. Those proceedings may result in NOLs that have previously been recognized by us in our consolidated

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financial statements being deemed to be the property of the former stockholders. Guitar Center has filed a protective claim with the stockholders that such a loss of tax benefit would be subject to indemnification under the express terms of the Agreement and Plan of Merger among the parties dated May 13, 1999. If such NOLs were lost and the indemnification claim asserted and paid, we would be obligated to pay prior period federal income taxes previously offset by the use of NOLs, but would be entitled to an offsetting recovery of common stock held in escrow under the Agreement and Plan of Merger. This issue is not resolved as of the date of this report and we can provide no assurance as to the ultimate outcome of this matter. Given the high level of uncertainty that surrounds this matter, no provision has been made in our financial statements.

Inflation

    We believe that the relatively moderate rates of inflation experienced in recent years have not had a significant impact on our net sales or profitability.

Forward-Looking Statements; Business Risks

    This annual report contains certain forward-looking statements, relating to, among other things, future results of operations, growth plans (including, without limitation, the number and timing of new store openings and the growth of our e-commerce business), sales, gross margin and expense trends, capital requirements and general industry and business conditions applicable to us. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from these forward-looking statements. In addition to the other risks described elsewhere in this annual report, important factors to consider in evaluating these statements include changes in external competitive market factors, changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the music products industry or the economy in general, the emergence of new or growing specialty retailers of music products and various other competitive factors that may prevent us from competing successfully in existing or future markets. In light of these risks and uncertainties, many of which are described in greater detail in "Item 1. Business—Risks Related to the Business," we can not assure you that the forward-looking statements contained in this annual report will in fact be realized. Further, we do not undertake any duty to update the forward-looking statements contained in this annual report, particularly those related to management's future estimates which are subject to revision due to changes in the business environment that we face.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

    Substantially all of our outstanding indebtedness is represented by $66.7 million principal amount of Senior Notes due 2006 with a fixed interest rate of 11% and our line of credit which has a variable rate of interest generally consisting of stated premiums above the London Interbank Offered Rate, or LIBOR. At December 31, 2000, we had $35.9 million outstanding under the line of credit. To the extent prevailing short-term interest rates fluctuate, the interest expense we incur on the line of credit will change with a resulting effect (positive or negative) on our financial position, results of operations and cash flows. However, based on the balances outstanding under the line of credit at year-end 2000, such a fluctuation would have to be relatively significant to have a material financial impact on us. We do not use derivative financial instruments in our investment portfolio. Presently, we do not carry significant cash balances as any cash in excess of our daily operating needs is used to reduce our line of credit borrowings.

Item 8. Financial Statements and Supplementary Data

    See the index included at "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 10-K."

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Item 9. Changes and Disagreements With Accountants on Accounting and Financial Disclosure

    Not Applicable

PART III

Item 10. Directors and Officers of the Registrant

    The information required by this item is incorporated by reference to the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in connection with the Company's annual meeting of stockholders.

Item 11. Executive Compensation

    The information required by this item is incorporated by reference to the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with the Company's annual meeting of stockholders.

Item 12. Security Ownership of Certain Beneficial Owners and Management

    The information required by this item is incorporated by reference to the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with the Company's annual meeting of stockholders.

Item 13. Certain Relationships and Related Transactions

    The information required by this item is incorporated by reference to the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A under the Exchange Act in connection with the Company's annual meeting of stockholders.

PART IV

Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K

(a)

Documents filed as part of this Report:

1.

The following financial statements for the Company are included as part of this Report:

Index to Financial Statements  Page F-1

2.

The following financial statement schedule for the Company is included as part of this Report:

Schedule II—Valuation and Qualifying Accounts  Page II-1

All other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the financial statements.

(b)

On November 9, 2000 Guitar Center filed a Form 8-K including Item 9 information relating to earnings guidance provided to investors.

(c)

Those Exhibits, and the Index thereto, required to be filed by Item 601 of Regulation S-K are attached hereto. Certain management contracts and other compensation plans or arrangements required to be filed are identified on the attached Index with an asterisk (*).

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INDEX TO EXHIBITS

28

29

*

Management contract or other compensation plan or arrangement.

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SIGNATURES

    Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized as of this 12th day of March 2001.

    KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Larry Thomas, Marty Albertson and Bruce Ross, as his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendment to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.

    Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

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INDEX TO FINANCIAL STATEMENTS

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Guitar Center, Inc. and subsidiaries:

    We have audited the accompanying consolidated balance sheets of Guitar Center, Inc. and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2000. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule as listed in the accompanying index. These consolidated financial statements and the consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedule based on our audits. We did not audit the financial statements of Musician's Friend, Inc., a wholly-owned subsidiary, which financial statements reflect total revenues constituting 19 percent of the year ended December 31, 1998 consolidated totals. Those financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Musician's Friend, Inc., is based solely on the report of the other auditors.

    We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

    In our opinion, based on our audits and the report of the other auditor, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Guitar Center, Inc. and subsidiary as of December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

KPMG LLP

Los Angeles, California
February 8, 2001

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REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of
Musician's Friend, Inc.

    In our opinion, the statements of operations, of changes in accumulated deficit and of cash flows of Musician's Friend, Inc. for the year ended December 31, 1998 (not presented separately herein) present fairly, in all material respects, the results of operations and cash flows of Musician's Friend, Inc. for the year ended December 31, 1998, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. We have not audited the financial statements of Musician's Friend, Inc. for any period subsequent to December 31, 1998.

PricewaterhouseCoopers LLP

Portland, Oregon
May 28, 1999

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MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS

    We are responsible for the preparation of our consolidated financial statements and related information appearing in this Annual Report. We believe that the consolidated financial statements fairly reflect the form and substance of transactions and that the financial statements reasonably present our financial position and results of operations in conformity with generally accepted accounting principles. We also have included in our financial statements amounts that are based on estimates and judgments which we believe are reasonable under the circumstances.

    The independent accountants audit our consolidated financial statements in accordance with generally accepted auditing standards and provide an objective, independent review of the fairness of reported operating results and financial position.

    The Board of Directors of the Company has an Audit Committee composed of three non-management Directors. The Committee meets periodically with financial management and the independent accountants to review accounting, internal control, auditing and financial reporting matters.

Los Angeles, California
February 8, 2001

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GUITAR CENTER, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

37

GUITAR CENTER, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

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GUITAR CENTER, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

(In thousands)