LOUD TECHNOLOGIES INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2004

or

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

For the transition period from to

Commission File Number: 0-26524

LOUD TECHNOLOGIES INC.

(Exact name of registrant as specified in its charter)

Washington		91-1432133
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

16220 Wood-Red Road, N.E., Woodinville, Washington		98072
(Address of principal executive offices)		(Zip Code)

(425) 892-6500
(Registrant’s telephone number, including area code)

N/A
(Former name or former address, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes o No ý

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, no par value		19,624,703
Class		Number of Shares Outstanding (as of April 30, 2004)

LOUD TECHNOLOGIES INC.

FORM 10-Q

For the quarter ended March 31, 2004

INDEX

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Balance Sheets

	Condensed Consolidated Statements of Operations

	Condensed Consolidated Statements of Cash Flows

	Condensed Consolidated Statements of Shareholders’ Equity (Deficit)

	Notes to Condensed Consolidated Financial Statements

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

Item 3.	Quantitative and Qualitative Disclosures About Market Risk

Item 4.	Controls and Procedures

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings

Item 2.	Changes in Securities and Use of Proceeds

Item 3.	Defaults Upon Senior Securities

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

Item 5.	Other Information

Item 6.	Exhibits and Reports on Form 8-K

SIGNATURES

LOUD TECHNOLOGIES INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share amounts)

	March 31, 2004			December 31, 2003
ASSETS
Current assets:
Cash and cash equivalents	$	231		$	757
Accounts receivable, net of allowance for doubtful accounts of $1,649 and $2,163, respectively	12,047			13,683
Income taxes receivable	193			188
Inventories, net	16,896			18,930
Prepaid expenses and other current assets	3,659			2,280
Total current assets	33,026			35,838

Property, plant and equipment, net	8,351			8,381
Intangible assets, net	5,446			5,552
Other assets, net	529			651
Total assets	$	47,352		$	50,422

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Short-term borrowings	$	6,332		$	7,868
Accounts payable	9,008			5,285
Accrued liabilities	7,811			9,142
Income taxes payable	1,346			1,288
Current portion of long-term debt	500			500
Payable to former Italian subsidiary	9,173			9,173
Total current liabilities	34,170			33,256

Long-term debt, excluding current portion	16,343			16,262
Other liabilities	62			72
Total liabilities	50,575			49,590

Commitments and contingencies

Shareholders’ equity:
Preferred stock, no par value. Authorized 5,000,000 shares, no shares issued and outstanding	—			—
Common stock, no par value. Authorized 40,000,000 shares, issued and outstanding 19,608,036 shares at March 31, 2004 and December 31, 2003	33,898			33,999
Accumulated deficit	(37,121		)	(33,167		)
Total shareholders’ equity (deficit)	(3,223		)	832
Total liabilities and shareholders’ equity (deficit)	$	47,352		$	50,422

See accompanying notes to condensed consolidated financial statements.

LOUD TECHNOLOGIES INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

	Three Months Ended March 31,
	2004			2003

Net sales	$	25,681		$	32,746
Cost of sales	18,769			26,005
Gross profit	6,912			6,741

Operating expenses:
Selling, general and administrative	8,292			9,811
Research and development	1,972			2,322
Restructuring costs	—			696
Total operating expenses	10,264			12,829

Operating loss	(3,352		)	(6,088		)

Other income (expense):
Interest income	—			15
Interest expense	(761		)	(518		)
Other	164			201
Total other income (expense)	(597		)	(302		)

Loss before income taxes and discontinued operations	(3,949		)	(6,390		)

Provision for income taxes	5			12

Loss from continuing operations	(3,954		)	(6,402		)

Loss from discontinued operations, net of income tax expense of $0 and $613, respectively	—			(1,992		)

Net loss	$	(3,954	)	$	(8,394	)

Basic and diluted net loss per share:

Net loss from continuing operations	$	(0.19	)	$	(0.41	)

Net loss from discontinued operations	—			(0.13		)

Basic and diluted net loss per share	$	(0.19	)	$	(0.54	)

See accompanying notes to condensed consolidated financial statements.

LOUD TECHNOLOGIES INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

	Three Months Ended March 31,
	2004			2003
Operating activities
Net loss	$	(3,954	)	$	(8,394	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	768			2,183
Loss (gain) on asset dispositions	(111		)	106
Deferred stock compensation	14			101
Non-cash interest expense	245			—
Changes in operating assets and liabilities:
Accounts receivable	1,689			1,909
Inventories	2,040			5,822
Prepaid expenses and other current assets	(1,810		)	325
Other assets	121			143
Accounts payable and accrued expenses	2,827			(1,975		)
Income taxes	61			1,127
Other long term-liabilities	(10		)	(9		)
Net cash provided by operating activities	1,880			1,338

Investing activities
Purchases of property, plant and equipment	(839		)	(276		)
Proceeds from sales of property, plant and equipment	752			—
Net cash used in investing activities	(87		)	(276		)

Financing activities
Proceeds from sale of stock and exercise of stock options	—			3,583
Proceeds from long-term debt and warrants	—			17,500
Payments on long-term debt	(764		)	(16,044		)
Net payments on bank line of credit and short-term borrowings	(1,555		)	(7,554		)
Net cash used in financing activities	(2,319		)	(2,515		)

Effect of exchange rate changes on cash	—			105

Decrease (increase) in cash and cash equivalents	(526		)	(1,348		)

Cash and cash equivalents at beginning of period	757			3,062
Cash and cash equivalents at end of period	$	231		$	1,714

See accompanying notes to condensed consolidated financial statements.

LOUD TECHNOLOGIES INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

Three months ended March 31, 2004

(In thousands)

	Common Stock				Accumulated Deficit			Total
	Shares	Amount			Accumulated Deficit			Total

Balance at December 31, 2003	19,608	$	33,999		$	(33,167	)	$	832
Offering costs related to February 2003 stock offering	—	(115		)	—			(115		)
Amortization of deferred stock compensation	—	14			—			14
Net loss	—	—			(3,954		)	(3,954		)
Balance at March 31, 2004	19,608	$	33,898		$	(37,121	)	$	(3,223	)

See accompanying notes to condensed consolidated financial statements.

LOUD TECHNOLOGIES INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2004

(Unaudited)

1. Description of Business

We develop, manufacture and sell high-quality, affordable digital and analog audio mixers, speakers, amplifiers and other professional audio equipment on a worldwide basis. Our products are used by professional musicians, sound installation contractors and broadcast professionals in sound recordings, live presentations systems and installed sound contractors. We have our primary operations in the United States and the U.K.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared by LOUD Technologies Inc. (“LOUD” or the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial statements and include the accounts of the Company and its subsidiaries. They do not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003. In our opinion, all normal recurring adjustments necessary for the fair presentation of the results of the interim periods are reflected herein. Operating results for the three-month period ended March 31, 2004, are not necessarily indicative of future financial results.

Revenue Recognition

Revenues from sales of products, net of sales discounts, returns and allowances, are generally recognized upon shipment under an agreement with a customer when risk of loss has passed to the customer, all significant contractual obligations have been satisfied, the fee is fixed or determinable and collection of the resulting receivable is considered probable. Products are generally shipped “FOB shipping point” with no right of return. Sales with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are rare and insignificant and are deferred until the contingencies have been satisfied or the contingent period has lapsed. We generally warrant our products against defects in materials and workmanship for periods of between one and six years. The estimated cost of warranty obligations, sales returns and other allowances are recognized at the time of revenue recognition based on contract terms and prior claims experience. A provision for future warranty costs is recorded at the time of sale of products.

Stock-Based Compensation

Stock-based employee compensation plans are accounted for using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FAS Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price or if options were issued to non-employees.

We have elected to apply the disclosure-only provisions of FAS No. 123, Accounting for Stock-Based Compensation as amended by FAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of FAS No. 123.

FAS No. 123, as amended, permits companies to recognize, as expense over the vesting period, the fair value of all stock-based awards on the date of grant. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Because our stock-based compensation plans have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, management believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of awards from the plan. Therefore, as permitted, we apply the existing accounting rules under APB No. 25 and provide pro forma net loss and pro forma loss per share disclosures for stock-based awards made as if the fair value method defined in FAS No. 123, as amended, had been applied.

The following table summarizes relevant information as to the reported amounts under the Company’s intrinsic value method of accounting for stock awards, with supplemental information as if the fair value recognition provisions of FAS No. 123, as amended, had been applied:

	Three months ended March 31,
	2004			2003
	(in thousands)

Net loss:
As reported	$	(3,954	)	$	(8,394	)
Add: Stock-based employee compensation included in reported net loss	—			67
Less: Stock-based employee compensation determined under fair-value based method	(214		)	(352		)
Pro forma	$	(4,168	)	$	(8,679	)

Basic and diluted net loss per share:
As reported	$	(0.19	)	$	(0.54	)
Pro forma	$	(0.20	)	$	(0.55	)

Reclassifications

Certain prior year amounts have been reclassified to conform with current year presentation.

3. Discontinued Operations

On December 10, 2003, Mackie Designs (Netherlands) B.V. (“Mackie Netherlands”), a wholly-owned subsidiary of the Company, sold all of the shares of Mackie Designs (Italy) S.p.A. (“Mackie Italy”), a wholly-owned subsidiary of Mackie Netherlands, to Knight Italia S.p.A. (“Knight Italia”) for a nominal amount, pursuant to an Agreement by and among the Company, Mackie Netherlands and Knight Italia.

Prior to the sale, Mackie Netherlands filed to place Mackie Italy into a Concordato Preventivo, an Italian form of court-supervised liquidation (the “Concordato”). Knight Italia has made an irrevocable offer to the court to lease or purchase the former Mackie Italy factory in Reggio Emilia, Italy, the RCF brand name and significant other Italian-based assets. In December 2003, the Company fulfilled its obligation under the Concordato filing to purchase approximately $620,000 of finished inventory. The Concordato

filing is subject to approval by a majority of the creditors and then by an Italian court which approval is expected in 2004. In the event the court denies the bankruptcy, Italian law may permit actions to be taken against the Company including demanding a refund of any payments made to the Company in the prior two years.

The Company, its subsidiaries, the Company’s directors or officers, or any associates of its directors or officers do not have any material relationship with Knight Italia, other than as a new supplier of components and equipment.

The disposition of these operations is accounted for as a discontinued operation. At March 31, 2004 and December 31, 2003, we do not show any assets or liabilities of this entity on our consolidated balance sheet. We have reclassified and condensed the results of discontinued operations on our consolidated statements of operations for thre three months ended March 31, 2003. Cash flows from these operations are included in our consolidated statements of cash flows for the three months ended March 31, 2003. Summarized operating results of the discontinued operations for the three months ended March 31, 2003 (in thousands):

Revenues	$	7,793
Gross profit	1,126
Operating loss	(1,073		)
Loss before income taxes	(1,379		)
Income tax expense	613
Loss from discontinued operations	(1,992		)

Interest was allocated to discontinued operations based on actual debt held by Mackie Italy.

4. Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share for the three months ended March 31, 2004 and 2003. Stock options to purchase 3,978,000 and 3,666,000 shares in 2004 and 2003, respectively, were excluded from the calculation of diluted per share amounts because they are antidilutive. The 1.2 million warrants issued in connection with the debt to Sun Mackie LLC, an affiliate of Sun Capital Partners Inc., a private investment firm, (see Note 8) and 83,333 vested stock options at an exercise price of $.01 are considered outstanding common shares and are included in the denominator for computation of basic and diluted net loss per share.

	Three months ended March 31,
	2004			2003
	(in thousands, except per share data)
Numerator:
Net loss from continuing operations	$	(3,954	)	$	(6,402	)
Net loss from discontinued operations	—			(1,992		)
Numerator for basic and diluted net loss per share	$	(3,954	)	$	(8,394	)

Denominator:
Weighted average shares outstanding	19,608			15,665
Dilutive potential common shares from outstanding stock options and warrants	1,283			—
Denominator for basic and diluted net loss per share – weighted average shares	20,891			15,665

Basic and diluted net loss per share:
Continuing operations	$	(0.19	)	$	(0.41	)
Discontinued operations	—			(0.13		)

Basic and diluted net loss per share	$	(0.19	)	$	(0.54	)

5. Inventories

Inventories consist of the following:

	March 31, 2004		December 31, 2003
	(in thousands)

Raw materials	$	3,840	$	4,383
Work in process	624		543
Finished goods	12,432		14,004
	$	16,896	$	18,930

6. Intangible Assets

Intangible assets consist of the following:

	March 31, 2004		December 31, 2003
	(in thousands)
Developed technology	$5,200		$5,200
Trademark	1,380		1,380
Covenant not to compete	285		285
	6,865		6,865
Less accumulated amortization	(1,419	)	(1,313	)
	$5,446		$5,552

7. Restructuring costs

During 2003, management approved and implemented a restructuring plan in order to adjust operations. Major actions primarily involved the reduction of workforce due to our decision to close certain manufacturing facilities. We incurred $1.6 million in restructuring expenses, of which $696,000 relates to the three months ended March 31, 2003, primarily representing employee severance and related costs for approximately 210 displaced employees. The restructuring accrual is summarized as follows:

Restructuring Accrual at December 31, 2003		Amount Paid			Restructuring Accrual at March 31, 2004

$	304,000	$	(124,000	)	$	180,000

We expect to pay the remaining liability by December 31, 2004.

8. Financing

In April 2004, we executed Loan Amendment and Waiver agreements on our line of credit, U.S. term loan and U.S. subordinated note payable, waiving penalties for prior noncompliance and amending the financial covenants. Management believes the Company will remain in compliance with the new covenants through December 31, 2004.

In April 2004, we received a commitment letter from Sun Capital Partners III QP, LP, an affiliate of Sun Capital Partners, Inc., to provide up to $2 million, in the aggregate, in debt or equity financing to the Company through December 31, 2004, if necessary to enable the Company to meet it’s obligations as they become due. If the financing is in the form of debt financing, it is expected that the terms will be generally similar to the terms of the existing subordinated or senior debt arrangements, adjusted as necessary for market conditions. If the financing is in the form of equity financing, it is expected the terms will be at fair value based on the current market conditions.

(a) Short-term borrowings

We have a revolving line of credit to borrow up to $26.0 million limited to a percentage of eligible collateral. Interest is due monthly and is based on the banks prime rate or LIBOR plus a specified margin. At March 31, 2004, the average interest rate was 4.70%. This revolving line of credit is secured by substantially all U.S. assets and accounts receivable of our U.K. subsidiary. At March 31, 2004, we had an outstanding balance on our line of credit of $6.3 million and available excess borrowing capacity of $2.9 million.

(b) Long-term debt

At March 31, 2004 and December 31, 2003, our long-term debt consisted of the following, in thousands:

	March 31, 2004			December 31, 2003
	(In thousands)

U.S. term loans	$	1,486		$	2,250
U.S. subordinated note payable	11,207			11,000
Note payable to related party (face value $4.0 million)	4,150			3,512
	16,843			16,762
Less: current portion	(500		)	(500		)
Long-term portion of debt	$	16,343		$	16,262

U.S. term loans

Our U.S. term loan is payable in monthly payments of $42,000, until paid in full. In the first quarter of 2004, we paid $639,000 on this loan from sales of equipment secured by the loan due to our closure of manufacturing facilities in Woodinville, Washington. This loan and the line of credit held by the same financial institution, are both secured by substantially all of the assets of the Company, and are both senior to other long-term debt. The term loan bears interest at the bank’s prime rate plus a specified margin. This rate was 5.0% at March 31, 2004.

U.S. subordinated note payable

The U.S. subordinated note payable accrues interest at 10% per annum. Minimum interest payments are made monthly at 8%, with the remaining 2% paid if certain available cash flows are met, otherwise, the 2% is added back to principal. Principal payments on this note begin in May 2005, based on our 2004 earnings before interest, taxes, depreciation and amortization, less cash taxes paid, certain capital expenditures and certain debt repayments (adjusted EBITDA). If the 2004 adjusted EBITDA is positive, we would make payments during the twelve months beginning May 2005 of 50% of adjusted EBITDA up to $1.7 million; no payments would be made if adjusted EBITDA and line of credit availability amounts fail to meet a certain threshold. The principal is due May 2006.

Note payable to related party

In March 2003, our primary shareholder, Sun Mackie provided $4.0 million for a note payable and warrants to purchase 1.2 million shares of common stock at $0.01 per share. We valued the warrants issued in this transaction at $0.6 million and the note payable at $3.4 million. We are increasing the value

of the loan to its face value of $4.0 million over its 4-year life through additional non-cash interest expense. Interest accrues at 15% of the face value, payable annually on March 31 if a specified adjusted EBITDA of the prior year is achieved. As this threshold was not met, at March 31, 2004, the accrued interest of $0.6 million was added to the principal balance. The note is payable in full in March 2007.

9. Guarantees

In November 2002, the FASB issued FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 provides expanded accounting guidance surrounding liability recognition and disclosure requirements related to guarantees, as defined by this Interpretation. We adopted the disclosure provision requirements of FIN No. 45 during the year ended December 31, 2002. In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of FIN No. 45 except for standard indemnification and warranty provisions and give rise only to the disclosure requirements prescribed by FIN No. 45.

Indemnification and warranty provisions contained within our sales agreements are generally consistent with those prevalent in our industry. The duration of product warranties is generally one to six years following delivery of products. We provide standard warranties with the sale of our products. The estimated cost of providing the product warranty is recorded at the time revenue is recognized. Warranty costs represent those associated with the repair or replacement of product that fails to meet our standard warranty against defects in material and workmanship. Should actual product failure rates differ from our estimates, revisions to our estimated accruals would be required.

The warranty liability is summarized as follows (in thousands):

	Three months ended March 31,
	2004		2003

Balance, beginning of period	1,081		1,525
Charged to cost of sales	682		904
Applied to liability	(696	)	(910	)
Balance, end of period	1,067		1,519

10. Contingencies

We have effectively eliminated our liability related to the subrogated claims which have been asserted against us from insurance companies who prior to our acquisition of Eastern Acoustic Works, Inc. (EAW), paid claims made by EAW’s landlord and other tenants of the Whitinsville building who were affected by a fire started by a loaned employee in a portion of the building in 1996. In May 2004, the Company entered into an agreement with the landlord’s carrier regarding the matter whereby the carrier will not collect from the Company in excess of any funds received from the Company’s carrier. The Company has a continuing obligation to proceed against its carrier for a declaratory judgment should the lawsuit against the Company result in a judgment favorable to the landlord’s carrier, but all legal fees associated with such an action will be paid by the landlord’s carrier.

We are also involved in various legal proceedings and claims that arise in the ordinary course of business. We currently believe that these matters will not have a material adverse impact on our financial position, liquidity or results of operations.

We sold our investment in our Italian subsidiary during 2003, which has also been placed in an Italian form of court-supervised liquidation. In the event the court denies the liquidation plan, Italian law may permit actions to be taken against the Company including demanding a refund of any payments made to the Company in the prior two years. We believe this possibility to be remote.

11. Quarterly Financial Data (revised from amounts shown in 10-K) (In thousands, except per share data)

	2003
	First			Second			Third			Fourth(a)
Net Sales	$	32,746		$	35,653		$	33,457		$	28,910
Gross profit	6,511			8,728			6,087			7,984
Loss from continuing operations	(6,402		)	(2,997		)	(2,797		)	(3,216		)
Loss from discontinued operations	(1,992		)	(1,255		)	(507		)	(2,629		)
Net loss	(8,394		)	(4,252		)	(3,304		)	(5,845		)
Basic and diluted loss per share	(0.54		)	(0.20		)	(0.16		)	(0.28		)

(a) Inventory adjustments of approximately $0.9 million related to products no longer marketable and excess material were recorded in the fourth quarter of 2003.

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

The following discussion and analysis should be read in conjunction with our financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003. This discussion contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Actual results could differ materially from those discussed herein. The cautionary statements made in this Quarterly Report on Form 10-Q and the Annual Report on Form 10-K should be read as being applicable to all forward-looking statements wherever they appear. We undertake no obligation to publicly release any revisions to these forward-looking statements that may be required to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “project,” “will be,” “will continue,” “will likely result,” or words or phrases of similar meaning.

Overview

LOUD Technologies Inc., a Washington corporation formed in 1988, engineers, manufactures and markets professional audio reproduction and recording equipment and software under the brand names Mackie, TAPCO, SIA, EAW and EAW Commercial.

Our primary products include analog mixers, sound reinforcement speakers, professional loudspeaker systems, installed paging and music distribution systems, preamplifiers, power amplifiers, and A/V software control surfaces, digital mixers, i/o devices and acoustic test and measurement software. These products are used in a variety of applications, including home and commercial recording studios, live performances and fixed installations of all sizes.

Critical Accounting Policies and Judgments

The preparation of these condensed financial statements in conformity with generally accepted accounting principles in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and that require management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions or conditions.

Inventory Valuation. We believe our policy on valuing inventory, including market value adjustments, is our primary critical accounting policy. Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out method, or market. Included in our inventories balance are demonstration products used by our sales representatives and marketing department including finished goods that have been shipped to customers for evaluation. Market value adjustments are recorded for obsolete material, slow-moving product, service and demonstration products. We make judgments regarding the carrying value of our inventory based upon current market conditions. These conditions may change depending upon competitive product introductions, customer demand and other factors. If the market for our previously released products changes, we may be required to write down the cost of our

inventory.

Allowance for Doubtful Accounts. We make ongoing estimates relating to the collectibility of our accounts receivable and maintain an allowance for estimated losses resulting from the inability of our customers to meet their financial obligations to us. In determining the amount of the allowance, we consider our historical level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger allowance may be required. In the event we determine a smaller or larger allowance appropriate, we would record a credit or a charge to selling and administrative expense in the period in which we made such a determination.

Long-lived Assets. We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Significant judgment is used in assessing factors which might trigger impairment including significant underperformance relative to expected operating results, significant changes in our use of the assets or the strategy for our overall business, and significant negative industry or economic trends. As we continue to review our distribution methods and transition our manufacturing to third parties, this may result in circumstances where the carrying value of certain long-lived assets may not be recoverable.

Warranty. We provide standard warranties with the sale of our products. The estimated cost of providing the product warranty is recorded at the time revenue is recognized. Our warranty term varies based on product lines and is generally between one to six years. Warranty costs represent those associated with the repair or replacement of product that fails to meet our standard warranty against defects in material and workmanship. Should actual product failure rates differ from our estimates, revisions to our estimated accruals would be required.

Revenue Recognition. Revenues from sales of products, net of sales discounts, returns and allowances, are generally recognized upon shipment under an agreement with a customer when risk of loss has passed to the customer, all significant contractual obligations have been satisfied, the fee is fixed or determinable and collection of the resulting receivable is considered probable. Products are generally shipped “FOB shipping point” with no right of return. Sales with contingencies, such as rights of return, rotation rights, conditional acceptance provisions and price protection, are rare and insignificant. We generally warrant our products against defects in materials and workmanship for periods of between one and six years. The estimated cost of warranty obligations, sales returns and other allowances are recognized at the time of revenue recognition based on contract terms and prior claims experience.

Income Taxes. As part of the process of preparing our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or change this allowance in a period, it may materially impact the tax provision in the Statement of Operations.

Estimates and Assumptions Related to Financial Statements

The discussion and analysis of our financial condition and results of operations is based upon our

unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those affecting revenue recognition, the allowance for doubtful accounts, inventory valuation, intangible assets, income taxes and general business contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Results of Operations

Net Sales

Net sales from continuing operations decreased by 21% to $25.7 million during the three months ended March 31, 2004 from $32.7 million in the comparable period in 2003. Sales were negatively impacted during the latter part of 2003 and the beginning of 2004 due to our being out of stock on certain products. These product outages were due to the migration of certain product manufacturing from Woodinville, Washington and our former Italian subsidiary to contract manufacturers.

We believe we will continue to have product shortages during the second quarter of 2004. In 2004, we anticipate introducing and shipping new products, resulting in increased revenues in 2004 over 2003. These new products will include introductions of more affordable product lines; entrance into the desktop recording line and feature-rich additions to our core analog mixer product lines.

Gross Profit

Gross profit increased to $6.9 million, or 27% of net sales, in the three months ended March 31, 2004 from $6.7 million, or 21% of net sales, in the three months ended March 31, 2003. The increase in gross margins is primarily due to the write-down of excess and obsolete inventory of approximately $1.6 million in the first quarter of 2003 compared to $0.3 million in the first quarter of 2004.

We expect our gross margins to continue to increase in the second quarter of 2004, with continued advances throughout the remainder of 2004. During the first half of 2004, we will be incurring one time transition costs with new and existing contract manufacturers or suppliers of materials for contract manufacturing, as well as reduced margins related to discounts on discontinued models which will keep our margins lower than the second half of 2004, when we anticipate the transitions will be complete.

Selling, General and Administrative

Selling, general and administrative expenses decreased by $1.5 million to $8.3 million in the three months ended March 31, 2004 from $9.8 million in the comparable period in 2003. The decline in these expenses is due to reductions in the number of employees through layoffs or attrition during 2003. Additionally, included in selling costs are commissions paid to third parties, which were lower due to lower revenues during the three months ended March 31, 2004, compared to the three months ended March 31, 2003. Expenses in the first quarter of 2003 included certain one-time items related to the equity investment by Sun Mackie, LLC including run-off policies for directors’ and officers’ liability insurance totaling approximately $500,000. We anticipate selling, general and administrative costs to be lower during the remainder of 2004 than in 2003, primarily due to cost reduction initiatives completed in 2003.

Research and Development

Research and development expenses decreased by $0.3 million to $2.0 million in the three months ended March 31, 2004 from $2.3 million in the three months ended March 31, 2003. This decrease relates primarily to headcount reductions made during 2003 and the closure of a research facility we had in Belgium during the first half of 2003. We will continue to outsource certain development products to third parties, which will cause these expenses to be higher in some quarters than others, depending on when these contracts occur. We are and will continue to invest in new products and improvements to existing products and we believe that the restructuring measures taken in 2003 will enable us to be more efficient in our research and development expenditures. Accordingly, we anticipate our research and development costs will be lower during the remainder of 2004 than in 2003.

Restructuring Costs

During 2003, we incurred $1.6 million in restructuring expenses, of which $696,000 related to the first quarter of 2003, primarily representing employee severance and related costs for displaced employees associated with our closing down the manufacturing facility in Woodinville, Washington, after production of goods had terminated. We believe we will begin to fully recognize the benefits of this restructuring in the second to third quarters of 2004, in the form of higher product margins on the goods previously manufactured in the U.S. Additionally, we may have additional restructuring expenses in 2004 related to future minimum lease payments of under-utilized warehouse space when we fully exit the space.

Other Income (Expense)

Net other expense was $597,000 for the three months ended March 31, 2004 as compared to net other expense of $302,000 in the three months ended March 31, 2003. Included in these amounts is interest expense which increased to $761,000 in the first quarter of 2004 from $518,000 in the corresponding period of 2003 due to higher average interest rates.

Income Tax Benefit

Income tax expense for the first quarter of 2004 was $5,000 compared to $12,000 for the comparable period in 2003. Tax expense primarily relates to our non-U.S. subsidiaries. No tax benefit is recognized in connection with our tax losses as recognition of such benefit depends on future profits, which is not assured. We calculate the current tax rate based upon our estimate of the tax rate to be achieved for the full year.

Discontinued Operations

Discontinued operations relates to our former subsidiary, Mackie Italy, which was sold in December 2003. We incurred a loss on discontinued operations of $2.0 million during the three months ended March 31, 2003. During this period, the loss consisted of a $1.1 million loss from operations, $0.3 million net interest expense and $0.6 million in tax expense.

Liquidity and Capital Resources

necessary for market conditions. If the financing is in the form of equity financing, it is expected the terms will be at fair value based on the current market conditions.

In April 2004, we executed Loan Amendment and Waiver agreements on our line of credit, U.S. term loan and U.S. subordinated note payable, waiving penalties for prior noncompliance and amending the future financial covenants. Management believes the Company will remain in compliance with the new covenants through December 31, 2004.

As of March 31, 2004, we had cash and cash equivalents of $231,000 and total debt and short-term borrowings of $23.2 million. We had excess availability on our line of credit of $2.9 million at March 31, 2004.

Net Cash from Operating Activities

Cash provided by operating activities was $1.9 million in the three months ended March 31, 2004 and $1.3 million for the comparable period in 2003. Net cash provided by operating activities in the first three months of 2004 was primarily attributable to decreases in inventories, accounts receivable and other assets offset by an increase in prepaid expenses and other current assets. In the first three months of 2003, cash provided by operating activities was primarily attributable to a decrease in inventories and accounts receivable offset by decreases in accounts payable and accrued expenses. During the remainder of 2004, we anticipate growing our inventory levels and accounts receivable as revenues and product availability increase. Accounts payable are expected to continue to grow in 2004 due primarily to forecasted increases in inventory.

Net Cash Used in Investing Activities

Cash used in investing activities was $0.1 million for the first three months of 2004 and $0.3 million for the first three months of 2003. The cash flows used in investing activities in 2004 consisted primarily of purchases of capital expenditures for tooling used in manufacturing by our contract manufacturers. Cash used in investing activities in the first quarter of 2003 primarily consisted of purchases of manufacturing equipment and office equipment.

As part of our third party manufacturing agreements, many of our contract manufacturers require that we invest in tooling equipment prior to the start of manufacture. Accordingly, we anticipate capital spending at the same level or higher in each of the remaining quarters of 2004.

Net Cash Used in Financing Activities

Cash used in financing activities was $2.3 million during the first three months of 2004 and $2.5 million during the first three months of 2003. Financing activities during the first quarter of 2004 relates primarily to payments on our term loan of $0.8 million and net repayments on our line of credit of $1.6 million. Financing activities in the first quarter of 2003 included $3.6 million in net proceeds from the sale of stock to Sun Mackie LLC, an affiliate of Sun Capital Partners, Inc., a private investment firm, $17.5 million of borrowings on new term loans and notes payable, offset by $16.0 million in repayments of debt and $7.6 million in net repayments on lines of credit.

Payments and Proceeds from Long-term Debt, Line of Credit and Other Short-term Borrowings

In addition to its equity investment, Sun Mackie provided $4.0 million in debt financing in March 2003. Interest accrues at 15% and is scheduled to be paid annually beginning in March 2004, if excess available cash exists, as defined by the senior credit agreement. The principal is due in a lump sum payment in

2007. In addition to the loan from Sun Mackie, we issued warrants to purchase an additional 1.2 million common shares at an exercise price of $0.01 per share.

In connection with this agreement with Sun Mackie in March 2003, we refinanced all of our debt obligations, paying down a net of $4.3 million. We entered into a $2.5 million term loan and a line of credit providing up to $26.0 million with a new U.S. lender. Availability under this line of credit is limited to eligible collateral; initial funding was $11.6 million. Principal payments on the term loan are due in equal monthly payments over five years, beginning in July 2003. Interest is due monthly calculated at the bank’s prime rate plus 0.75% or Eurodollar Rate plus 3.5%. Both the revolving line of credit and term loan are secured by all U.S. based assets including, but not limited to, accounts receivable, inventory, fixed assets, intangible assets and patents. Additionally, a portion of the revolving line of credit is provided in the U.K. and is secured by accounts receivable of LOUD Technologies (Europe) Plc.

Our previous U.S. lender has provided a loan totaling $11.0 million, which is subordinate to the Loan and Security Agreement with our new U.S. lender. Principal is due beginning in May 2004 based upon our 2003 earnings before interest, taxes, depreciation and amortization, less cash taxes paid, certain capital expenditures and certain debt repayments. Interest accrues at a rate of 10% per annum and is paid subject to certain availability tests as we have availability under the Loan and Security Agreement.

Under the terms of the line of credit and subordinated loan agreements, we are required to maintain certain financial ratios, such as a cumulative EBITDA calculation. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, acquisitions, and an annual capital expenditure limit. At December 31, 2003, and during all measurement periods during 2003, we were out of compliance with certain of our financial covenants. As part of our loan amendments in April 2004, we have set new financial covenants and the lender has waived any penalties for past periods of non-compliance.

We have taken various actions to improve results of operations and ensure our ongoing ability to cover scheduled debt servicing payments, including headcount reductions and other cost containment measures. Over the last two years, these measures included the following items:

• closing the manufacturing facility in Woodinville, Washington, in order to outsource the manufacturing of the majority of our products offshore;

• sale and liquidation of Mackie Italy;

• bankruptcy and closure of Mackie Belgium;

• closure of certain international sales offices;

• layoffs across all areas, primarily manufacturing related;

• reduction of capital expenditures;

• replacement of debt instruments with instruments with longer lives;

• reorganization of our management team.

Our continued liquidity is dependent upon the following key factors:

Delivery of new products

We anticipate launching a number of new products during 2004, which will increase our revenues. We anticipate sales from new products will become meaningful towards the latter part of the second quarter to the third quarter. We believe this increase in revenues from new products in addition to sales from our continuing core products will turn around the two prior years of decline of revenues.

Ability to stay in compliance with debt covenants

We have entered into an amendment of our line of credit and term loans, which have revised debt covenants. The key financial covenants are achievement of a certain EBITDA targets for the term of the agreement or, during the period until September 30, 2004, maintenance of $2.5 million in excess borrowing availability.

Improvement in gross margins

In order to achieve our projected results from operations, we anticipate realizing increases in our gross margins as both a percentage of net sales and in whole dollar amounts. Meeting these targets is contingent upon successful transition of product manufacturing to more cost efficient sources offshore. We believe the bulk of this transition has occurred and anticipate seeing these higher margins as soon as the second quarter of 2004.

Commitments

We had the following material contractual commitments related to operating leases for equipment facilities at March 31, 2004. In addition, we had material obligations related to short-term and long-term debt arrangements, excluding our line of credit of $6.3 million at March 31, 2004:

	Payments due by period
	Total		Less than 1 year		1-3 years		3-5 years
	(In thousands)

Operating Leases	$	5,847	$	2,084	$	3,712	$	51
Short-term and Long-term Debt	17,293		500		16,793
Total	$	23,140	$	2,584	$	20,505	$	51

We believe we have adequate resources to meet our obligations as they come due through December 31, 2004.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks, including changes in foreign currency rates and interest rates. We may enter into various derivative transactions to manage certain of these exposures; however, we did not have any derivative financial instruments as of March 31, 2004.

At March 31, 2004, we had a variable rate line of credit of $6.3 million. As such, changes in U.S. interest rates affect interest paid on debt and we are exposed to interest rate risk. For the quarter ended March 31, 2004, an increase in the average interest rate of 10%, i.e. from 4.75% to 5.23%, would have resulted in an approximately $8,000 increase in net loss before income taxes and discontinued operations. The fair value of such debt approximates the carrying amount on the consolidated balance sheet at March 31, 2004.

Our non-U.S. subsidiaries have functional currencies of the U.S. Dollar and are translated into U.S. dollars at exchange rates in effect at the balance sheet date. These subsidiaries are located in Western Europe and the U.K. Income and expense items are translated at the average exchange rates prevailing during the period. A 10% decrease in the value of the U.S. Dollar compared to the local currencies of our

non-U.S. subsidiaries, throughout the quarter ended March 31, 2004, would have resulted in an approximately $45,000 increase to the net loss before income taxes.

Item 4. Controls and Procedures

At March 31, 2004, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the date of the evaluation, our disclosure controls and procedures were effective.

There have been no significant changes in our internal control or in other factors that could significantly affect these controls during our last fiscal quarter.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

At March 31, 2004, we were not in compliance with certain financial covenants of our debt agreements. In April 2004, we executed Loan Amendment and Waiver agreements on our line of credit, U.S. term loan and U.S. subordinated note payable, waiving penalties for prior noncompliance and amending the future financial covenants. Management believes the Company will remain in compliance with the new covenants through December 31, 2004.

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

None.

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

On January 8, 2004, a Current Report on Form 8-K/A was filed to amend the financial statements and pro forma financial information required under Item 7 of the Current Report on Form 8-K filed on December 24, 2003.

SIGNATURES

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

		LOUD Technologies Inc.
		(Registrant)

Dated: May 14, 2004	By:	/s/ James T. Engen
		James T. Engen
		President, Chief Executive Officer and Director

Dated: May 14, 2004	By:	/s/ Timothy P. O’Neil
		Timothy P. O’Neil
		Chief Financial Officer, Vice President, Secretary and Treasurer (Principal Financial and Accounting Officer)

EXHIBIT INDEX

Exhibit Number		Document Description

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

PART I.

FINANCIAL INFORMATION

(In thousands, except share amounts)

Reclassifications