Guitar Center on the skids,

[CJ]

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"From all sides, it looks like Guitar Center may be in a slow spiral into oblivion. That sounds harsh, but things aren’t going well for the company and haven’t been for years. Moody’s downgraded them…again. S&P Downgraded them…again. They haven’t posted a net profit in several years. They’re getting screwed in loan interest. And, to top it all off, rumors are circulating that manufacturers are getting antsy with GC’s poor performance.





A bit of history is in order.

Guitar Center was founded in California in 1959 by a dude named Wayne Mitchell. Originally an organ dealer named The Organ Center, they started finding more money in Vox guitars and amps. Changing their name to The Vox Center in 1964. The name didn’t last too long, and by 1970, Mitchell finally changed the name to Guitar Center.

But the big story behind GC is the name Larry Thomas. Starting out as a salesman in 1977 in the San Francisco store, Larry made his way up to CEO and President in less than 20 years. After taking over in 1991, Larry was the guy who made GC “The largest music retailer in the world.

It’s a great American story. A young man starts off at the bottom of the ladder, works his way up, and ushers his company into greatness.

If only it had stopped there.

On June 27, 2007 GC was bought out by Bain Capital for $1.9 billion plus assumed debt. With the debt, Bain had written a $2.1 billion dollar check for Guitar Center and all of its subsidiaries.

For those who don’t know, Bain Capital is a private equity and venture capital group that was founded in 1984 by current presidential nominee Mitt Romney. Basically, Bain buys companies, restructures them, and then sells them off at a profit. There are some success stories, and some no-so-success stories.

Unfortunately, when it came to Guitar Center, Bain hasn’t had much luck. One of the common complaints among GC employees after the restructuring involves their compensation. It’s hard to believe, but Guitar Center used to offer comprehensive pension and benefit plans. It’s the usual story. Outsource IT to India, freeze raises for years, increase management but cutting back on sales personnel by making them part-time, making it difficult to keep the floor covered.

And being hit by a recession right after the buy out didn’t help matters any.



Where are we now?
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Guitar Center is more than 1.6 billion dollars in debt. I’ll say that again so that you can fully grasp what I’m saying. Guitar Center owes 1,600,000,000.00 dollars to other people. As of March of last year, they had been on their knees begging to get a 2.5 year extension on $650 million of that total debt load. For an extension to April 2017, GC agreed to a 9.9% total interest rate.

An interest rate of 9.9% means that GC needs to pay back $64,350,000 dollars in interest on that $650 million dollar loan. And that’s only one loan! They have another for $622 million that they’re asking for an 18-month deferment on 50% of the interest payments. Who knows what the interest is on that bastard.

Even though GC murdered its competition by having over $2 billion in sales in 2011 – Doubling Sam Ash’s sales at the no. 2 spot – they still don’t have enough cash flow to cover even the interest in its debts. Which is explained in the Moody’s downgrade.

So, how does the world’s top seller of music gear end up not making enough money to cover their debt?

First, you need to know that that $2 billion figure is not just GC’s brick and mortar stores. That figure includes Musician’s Friend, Harmony Central, Music and Arts, and all of their subsidiaries.

That $2 billion ain’t profit. To give you an idea of the costs of running the GC empire:  According to Moody’s, in May of 2011, Guitar Center’s earnings, before “interest, taxes, depreciation, and amortization,” was estimated at $170 million. Dropping down from $2 billion to $170 million is one hell of a kick to the head.

From here it gets a bit harder to follow.

You see, in the business world, earnings aren’t the same thing as profit. According to Guitar Center’s filings for 2011, their Gross Profit is about 30% of their total sales or $60 million. “Interest, taxes, depreciation, and amortization” must be damn expensive if it took them from $170 million to $60 million.

To add to the cluster-frak sundae that is Guitar Center’s finances, according to their 2011 filings, Guitar Center had a Net loss of 7.4% or $111 million. My guess is that number includes payments on taxes and loan interest. Either way, if GC continues working with a Net loss of $111 million with a $1.6 billion dollar debt load, they might as well put their heads between their legs and kiss their ass goodbye.

Recently Moody’s has downgraded Guitar Center’s liquidity rating to Speculative Liquidity Grade – 3. Basically, it means that GC doesn’t have enough money to cover its interest expenses. On top of that, Moody’s is pretty sure that GC’s performance won’t improve over the next 12 months.



What’s going to happen now?

Well, that’s a tough question to answer. There are too many companies that have their hats in the ring to let Guitar Center go into bankruptcy so easily. Also, manufacturers are getting pissed at GC. Most of that mounting debt is probably due to them for product. And Guitar Center has been telling a lot of the manufacturers to piss off. But, most of these manufactures can’t simply jump ship. They sell too much of their stuff through GC. Most of them are probably just sitting quietly and trying to ride out the storm. But if things get much worse, don’t be surprised if you seen big brands pulling their lines.

Guitar Center’s reaction seems to be to get further into debt by opening more brick and mortar stores. They’re trying to make themselves look pretty, like nothing’s wrong. “Don’t worry. We’re expanding. Everything’s great.” All the while, they’re only burying themselves deeper under a mountain of debt."


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Last week, we learned that Guitar Center layed off a good chunk of executive employees, 40 to be exact, and the financial analysis did not look good.

In a new report on our sister site, Gear Gods, we learn things are getting way worse before they get better. Gear Gods reports the number of people canned is up from 40 to 180! There have been a lot of changes in the Guitar Center leadership and now, the whole company is being run by non-music people:

    So, Guitar Center is barely a year under its new ownership, and less than two months under new corporate management, and reports from sources inside the company say that chaos is starting to break loose. The firings, which took place in two phases, included some people at the senior level, vice presidents and other assorted veterans. One former employee who was part of this most recent round of layoffs and who spoke to Gear Gods on the condition of anonymity tells us that Guitar Center is now a “company run by non-music people,” and that after the firings, our subsequent coverage, and Garland’s grim predictions, it’s a madhouse at their corporate HQ in Westlake.

Even worse? With no plans on paper for future growth, investors are pulling out big time:

    Guitar Center’s secured bonds have been tanking since last July, and are taking a pretty consistent hit each day, according to data from the Financial Industry Regulation Authority. Just yesterday investors pulled $11 million out of the company, the kind of hit that is highly abnormal in this sort of bond market. It’s too early to call this a “run” on GC’s bonds, but it sure looks like a heck of a lot of people are starting to jump ship. And of course, once word starts to go around that the company’s not looking so hot, and that it’s a mess at the highest rungs of power, and then one investor pulls out… well, then another one pulls out, and then another, and another, and another, and another.

I highly recommend you head over to GearGods and read their entire report on how Guitar Center is turning into a sinking ship.

 

[JohnRoberts]

Must be time for them to do an Undercover Boss episode.  ;D

JR

 

[pucho812]

they been on the skids for a long time well before bain purchased them and their debt. The one thing Guitar center has going for them is a lot of their retail stores they own. They own the real estate.  So figure how much they own in real estate? must be a lot.  I don't wish them any ill-will but who knows where this will go.

 

[JohnRoberts]

I was actually involved in at least one high level meeting with GG executives back in my former job and I was very impressed with their professionalism and judgement. But that was almost two decades ago and a lot of water has flowed under the bridge since then.

JR

 

[fazer]

It sounds like a hard fix and flip but thats life in 21st century.  The real estate would be quite valuable at least in CO.

 

[PRR]

The big-picture problem is that many manufacturers have seen GC as their one-stop selling solution. Do a deal with GC, even if they crush your balls, and you have huge piles of product in every town in America (except mine). If GC actually gets so bound-up that they can't do business (extending payments from months to some-day), a lot of music industry manufacturers will be hurting.

 

[sahib]

.....If GC actually gets so bound-up that they can't do business (extending payments from months to some-day), a lot of music industry manufacturers will be hurting.

Indeed and if you are not prepared for that it hurts even more. They take huge stocks every year but your profit margins are very low. If they go bust without paying you one month's stock, not only your entire year's profit is wiped out, you also run into loss that may be too much for you.

 

[pvision]

They take huge stocks every year but your profit margins are very low. If they go bust without paying you one month's stock, not only your entire year's profit is wiped out, you also run into loss that may be too much for you.

So if GC is a big customer of yours, they're probably paying your wage bill & overheads… just

It's illegal to trade whilst insolvent here - how do they keep trading if they have debt & make a loss?  Financial smoke & mirrors?

Nick Froome

 

[JohnRoberts]

I won't speculate about things I don't know, like how manufacturers are dealing with GC, but their funny financial engineering is not exactly a secret to the industry, so any prudent manufacturer will monitor receivables. There was a fairly public back and forth with Behringer about payments and IIRC product was withheld for some time. Of course small companies do not have the leverage that a Behringer does.

I still see value in the GC brand, while is looks like they could use a reset of balance sheet debt.

Montgomery Ward  used to be known as a company killer for building up a small manufacturer with strong sales to make them dependent, then squeezing them on price occasionally all the way out of business.  Those who do not study history are doomed to repeat it.  GC may not be trying to hurt manufacturers but when short on working capital expanding trade credit where ever they can get it, is an obvious ploy.

JR

 

[PRR]

> It's illegal to trade whilst insolvent here

The Bentley rule.

I don't think it is that simple in the US.

> how do they keep trading if they have debt & make a loss?  Financial smoke & mirrors?

S&M. Exactly. They have money today. It is a strong brand and they can find money-people to join-in, on hopes of future interest and profits, or eventual break-up value. The concern is that the monthly cost of S&M may have exceeded actual monthly sales revenue, and that investors may notice this, and decline to ante-up for the next round.

Remember that both Ford and GM have historically lost money making cars. They stay in business because of financial transactions. Car-loans the obvious, but they have branched way beyond that. GE factory is dull, but GE Capital writes loans when a power company needs new turbines and dynamos, or for many other propositions. That's all open and long-established; it gets trickier when a young company first starts cash-games.

S&M is hardly unusual here. My telephone company was a podunk rural operation who took-over nearly all of New England Bell when the Bell folks decided that cell-phones are a real fad and land-lines are dying. Within a couple years they were technically bankrupt, but as a monopoly carrier they kept doing business. They now seem to be sprucing-up the operation (forcing more modern less-generous contracts on linemen, adding DSL in glory-areas but not here) for (we assume) a sale to some capitalist group. Tightly-run, a telco "should" still be a small steady cash cow. However the big loot is in turning-around to someone else.

 

[JohnRoberts]

> It's illegal to trade whilst insolvent here

The Bentley rule.

I don't think it is that simple in the US.

> how do they keep trading if they have debt & make a loss?  Financial smoke & mirrors?

S&M. Exactly. They have money today. It is a strong brand and they can find money-people to join-in, on hopes of future interest and profits, or eventual break-up value. The concern is that the monthly cost of S&M may have exceeded actual monthly sales revenue, and that investors may notice this, and decline to ante-up for the next round.

GTRC the publicly traded stock stock has been delisted for some time, The investors (owners) are now hedge fund/buyout firm types, that should know better.  The economic distortions that made debt so cheap fueled them becoming too debt heavy. The GC principals probably long since cashed in their chips and left dodge.  The new guys are probably wondering what happened.  8)

Remember that both Ford and GM have historically lost money making cars. They stay in business because of financial transactions. Car-loans the obvious, but they have branched way beyond that. GE factory is dull, but GE Capital writes loans when a power company needs new turbines and dynamos, or for many other propositions. That's all open and long-established; it gets trickier when a young company first starts cash-games.

Not quite that simple and the current low interest rate environment has made corporate finance divisions less attractive (even Peavey has their own finance division PVF). While the occupy and anti-corporate crowd were complaining about GE paying almost no taxes after the economic collapse in 2007-2008, they neglect to mention that GE suffered such massive real losses in their finance divisions, that they were able to offset parent company profits for several years.

While the big 3 car companies have probably never made a profit on the small cars the government coerced them to make to meet fleet mileage standards, the SUV and big pick-up truck models are nicely  profitable and cheap gas has reignited those sales.

Likewise they are all international companies with business around the world so they need to be profitable in the bottom line calculus for the entire corporation or they will (should?) cease to exist.  Chrysler was bailed out twice and GM once. Few paid close attention to the government expedited bankruptcy that GM enjoyed (the debt holders noticed), and there is a whole entity set up to deal with all the obsolete factory buildings and unprofitable old GM production equipment.

S&M is hardly unusual here. My telephone company was a podunk rural operation who took-over nearly all of New England Bell when the Bell folks decided that cell-phones are a real fad and land-lines are dying. Within a couple years they were technically bankrupt, but as a monopoly carrier they kept doing business. They now seem to be sprucing-up the operation (forcing more modern less-generous contracts on linemen, adding DSL in glory-areas but not here) for (we assume) a sale to some capitalist group. Tightly-run, a telco "should" still be a small steady cash cow. However the big loot is in turning-around to someone else.

The telephone company math is funny...much of the cash flow revenue (income?) goes to pay fat dividends (for companies like ATT) while there are huge capital investment budgets and huge "depreciation" items on the balance sheet. This is not exactly smoke and mirrors but borderline funny accounting math.  Turning the internet into a regulated utility may open that up to similar business models. While i don't know that the phone companies are exemplary organizations to replicate.  (They once were with Bell Labs et al).

JR

PS: Have the phone companies re-assembled back together enough that we can break them up again.  ;D ;D

 

[Krcwell]

In regard to insolvent retailers who can still purchase product from manufacturers, I'm dealing with this exact situation at work. I work for a premium consumer goods company, and a once major customer of ours is in a similar situation as GC.

We purchase credit insurance against the total line of credit we extend to this customer, which costs several points on total GM, but we're covered if they go belly up. We pay for the credit insurance because it is still profitable for us to do business with them, however their credit insurance rates have increased significantly in the last 2 years, so we reduce their available credit to help compensate, but eventually lose more GM.  The game continues until it's no longer profitable.

 

[Rochey]

wow, that is FASCINATING!

So you provide credit to your distributor/reseller (say 90 days, or 180 days), and take an insurance out on that loan, so that if they don't repay (i.e. go belly up), the insurance will pay you?

Wow. Just wow.

 

[JohnRoberts]

Premium products may support enough of a profit margin to pay for insurance against receivables, many value product manufacturers are working on thin margins to start with so insurance would require higher prices which might price them out of competition,. Of course if the vendor is in trouble another way to deal with that is to sell them goods on a COD basis. While that requires them to have cash. If the product is strong enough they will pay it, or not get it.  I used to have a rubber stamp that said "cash or money order only" so the UPS driver would not accept a rubber check.

Dealers who are in money trouble will try to flip the inventory before they have to pay for it... I recall as a small manufacturer having dealers string us out 90 days or more.  When a dealer gets in trouble you will usually see them not have inventory of the more attractive easy to sell products because they have already sold them.

I sure don't miss dealing with flaky dealers. It's all a relative power thing, big dealers and big manufacturers have some leverage against small dealers or small manufacturers. Big dealers and big manufacturers have a tug of war.

JR

 

[Krcwell]

John nailed it.

60 day payment terms, retailer keeps 5-6 weeks of inventory, they can flip it and pay for it within the terms. Where they end up losing out is big promotional periods (think black friday and holiday shopping season) where they don't have the credit to load in a bunch of inventory that will get eaten up quickly by consumers. These promotional periods make up more of a retailers revenue than most would imagine. You don't have it when they want it, your customers migrate elsewhere, slow death spiral.

 

[Ethan]

I'm curious when the Net-30-60-x  terms first became standard practice in buy/sell merch business.  It would seem that from the start it's a system designed to thrive on borrowed time and inevitably fail when cash dries up.  If the only option was to "pre"-pay for goods, this would be a non-issue.  I understand that a Net-30 is a grace period for a retailer to try to sell the product and make a profit before having to pay for said product but this creates risk for both the manufacturer and retailer.  If every retailer had to pre-pay for product, perhaps they'd be forced to become better retailers...spending more time doing their due diligence on what products will actually sell, rather than hoping that they can sell something before the 30 days is up to cover their debt.

I've wondered this for a while because this problem extends far beyond audio. It's become the bedrock of modern trade...We live in the "I'll pay you tomorrow" economy.

 

[JohnRoberts]

Well before my time but net-30 or net-however many days terms were probably to allow time for the merchandise or goods to be shipped from the seller to the buyer, received by the buyer, and that receipt reported to the accounts payable clerk so the invoice can be paid, and then that payment make its way back to the seller. 30 days is not extraordinary for that round trip journey, even a few decades ago.

Payment terms for the MI industry or retail in general are interesting. One metric in all business is inventory turns, or how long does it take to turn over 100% of the store's inventory. A well managed retailer that is buying smart and selling with thin margins can enjoy several full turns a year. Hot, fast moving SKUs can sell before the merchant has to pay for them, an ideal retail situation... In practice there will be plenty of slow moving inventory to drag down the average number of turns and consume precious working capital.

Looking at payment terms from the sellers perspective can be even slower moving. A manufacturer of electronic products may start bringing in parts to build subassemblies for a finished product months before final assembly of that product happens. A manufacturer will have much slower inventory turns ratio than a merchant. A small manufacturer who also suffers from slow paying customers can have capital tied up, first in parts, then in accounts receivable for 6 months or more. Even with good sales growth it can take a lot of working capital to support all the work in process. I recall serious cash flow problems while being nicely profitable (on paper) and enjoying good sales growth.

There are always notable exceptions and one "magic" business model was Dell computer, selling computers direct to end users. With the computers built to order and shipped from China. They would literally get paid in full before they ordered the sub assemblies to assemble into finished computers to ship to the customers. The beauty of the Dell business model is that the sales were able to fully fund the growth of the business and that model worked brilliantly for years.

JR

PS: You didn't ask about discounts like 2%-10, N-30. Yes sellers will often offer the customer a 1% or 2% discount just to pay the invoice 20 days sooner. This comes out to a pretty high annual interest rate earned on that money, but the reality is many customers don't pay 30 day invoices in 30 days, or 45, or 60.... I'll take 99% or 98% of what I'm owed quickly any day.  Note: I also take the 2% discount when paying invoices because it is a good return on my capital. Where else can you earn 2% in 3 weeks?   

 

[AusTex64]

A lot of manufacturers borrow on receivables. So if they can invoice it, it becomes liquid cash the manufacturer can use to keep the wheels rolling. In the Mom and Pop model of retailing, extended terms are often a win for all concerned. In this model, manufacturers are much larger than the retailers thus have more financial power. In my business, I definitely have limited capital, but pretty good sales ability. If a supplier will give me Net 90 terms for taking more product, and they offer a better price for volume that offers another advantage. If I can sell enough to pay the invoice within terms, why wouldnt I take advantage of that? Especially if the manufacturer has inventory sitting around, they have either paid for the parts and labor, or they also owe vendors and the credit line. Again, if they can invoice and then borrow against the receiveable to pay bills, it's good for them too.

 

[JohnRoberts]

A lot of manufacturers borrow on receivables. So if they can invoice it, it becomes liquid cash the manufacturer can use to keep the wheels rolling.

Yup that is called "factoring" or factors are investors who buy the receivable often discounted for payment uncertainty. The older the receivable the less it is worth.  With some manufacturers operating on single digit profit margins there is not much room to give up a few points here and there.

In the Mom and Pop model of retailing, extended terms are often a win for all concerned. In this model, manufacturers are much larger than the retailers thus have more financial power. In my business, I definitely have limited capital, but pretty good sales ability. If a supplier will give me Net 90 terms for taking more product, and they offer a better price for volume that offers another advantage. If I can sell enough to pay the invoice within terms, why wouldnt I take advantage of that? Especially if the manufacturer has inventory sitting around, they have either paid for the parts and labor, or they also owe vendors and the credit line. Again, if they can invoice and then borrow against the receiveable to pay bills, it's good for them too.

I have seen a lot of M&P dealers give up due to competition from chains. 

Large manufacturers can have finance divisions that floor-plan more expensive SKUs helping small dealers carry more stock. At the end of the day the product still has to be attractive and sell through to the end user before carrying costs consume all profits.  Part of the work of sales reps is to check out the health of their dealers with regular visits. Mainly to make sure they still have the inventory sitting on their sales floor they say they do and the business looks healthy.

If a manufacturer's cash flow is down to the point of needing to factor out receivables, their profit margin usually suffers and this is generally not good for the long term health of the business.  To factor receivables long term you need to start out with higher profit margins, and if the products don't sell through distribution the dealers will never pay. If the factors don't get paid they stop buying the receivables, etc.

To bring this back on topic this thread is discussing GC who is not a small retailer, but suffers common retailer problems. 

JR

PS: It is common for manufacturers and retailers to think that the other has the easier ride. Neither one looks very easy to me.

 

[Ethan]

Note: I also take the 2% discount when paying invoices because it is a good return on my capital. Where else can you earn 2% in 3 weeks? 

Good point!