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Article by DailyStocks_admin    (01-28-09 06:08 AM)

Filed with the SEC from Jan 15 to Jan 21:

Loud Technologies (LTEC)
Sun Mackie said it is unable to complete its proposed going-private transaction with Loud. In early November, Sun Mackie proposed acquiring all of the shares it didn't already own for $1.45 apiece. Sun Mackie said the two parties couldn't agree on the proposed transaction. As previously announced, Loud's board is voluntarily delisting its common stock from the Nasdaq Capital Market and terminating the registration of its stock under the Securities Exchange Act. Sun Mackie has 5,388,355 shares (82.3%).

BUSINESS OVERVIEW

Overview

LOUD Technologies Inc. (“LOUD” or the “Company”) was founded in 1988. The Company was incorporated in Washington under the name Mackie Designs Inc., and subsequently changed its name to LOUD Technologies Inc. LOUD is one of the world’s largest dedicated professional audio and music products companies. As the corporate parent for world-recognized brands Alvarez ® , Ampeg ® , Crate ® , EAW ® , Knilling ® , Mackie ® , Martin Audio ® , SIA ® and TAPCO ® , LOUD engineers, manufactures, markets and distributes a wide range of professional audio and musical instrument products worldwide. Additionally, LOUD is a distributor of branded professional audio and music accessories through our SLM Marketplace catalog.

Our product lines include sound reinforcement speakers, analog mixers, guitar and bass amplifiers, professional loudspeaker systems, and branded musical instruments. These products can be found in professional and project recording studios, video and broadcast suites, post-production facilities, sound reinforcement applications including churches and nightclubs, retail locations, and on major musical concert tours. We distribute our products primarily through retail dealers, mail order outlets and installed sound contractors. Our primary operations are in the United States with other operations in the United Kingdom, Canada, China and Japan.

On March 4, 2005, we acquired all of the shares of St. Louis Music, Inc., a Missouri-based manufacturer, distributor and importer of guitar and bass amplifiers, branded musical instruments, and professional audio products. This transaction is explained in more detail in Note 16 of the accompanying financial statements.

On April 11, 2007, we acquired all of the outstanding capital stock of Martin Audio, Ltd. (“Martin Audio”), a UK-based manufacturer of loudspeakers and related equipment. This transaction is explained in more detail in Note 16 of the accompanying financial statements. In order to facilitate this acquisition, on March 30, 2007 we completed a refinancing and closed on a new $112 million senior secured credit facility. The financial covenants related to this credit facility were amended on March 6, 2008. These transactions are explained in more detail in Note 10 of the accompanying financial statements.

As a condition to entering into a waiver and amendment to the senior secured credit facility on March 6, 2008 waiving certain defaults of the financial covenants of the senior secured credit facility, the lender requested that the Company seek $7.5 million in subordinated financing. In response to this request, on March 18, 2008 we issued a $7.5 million Convertible Senior Subordinated Secured Promissory Note due 2012 to our controlling stockholder, Sun Mackie that is secured by all of the assets of the Company now owned and thereafter acquired. This transaction is explained in more detail in Note 18 of the accompanying financial statements.

As of December 31, 2007, 3,409,382 shares, representing 73.8% of our outstanding common stock, were owned by affiliates of Sun Capital Partners, Inc., a private investment firm. Accordingly, we are a controlled company within the meaning of the NASD rules governing companies listed on the Nasdaq Capital Market and, as discussed in greater detail below and in our proxy statement for our 2007 annual shareholder meeting, we are therefore exempt from application of certain of the corporate governance rules, particularly including those relating to independent board composition and compensation and nominating committee requirements.

Our stock trades on the Nasdaq Capital Market tm under the symbol “LTEC”.

“MACKIE,” the running man figure, “TAPCO,” “EAW,” and “SIA” are registered trademarks or “common law” trademarks of LOUD Technologies Inc. “Alvarez”, “Ampeg”, “Crate”, and “Knilling” are registered trademarks of our wholly owned subsidiary, St. Louis Music, Inc. “Martin Audio” is a registered trademark of our wholly owned subsidiary, Martin Audio, Ltd. To the extent our trademarks are unregistered, we are unaware of any conflicts with trademarks owned by third parties. This document contains names and marks of other companies, and we claim no rights in the trademarks, service marks and trade names of entities other than those in which we have a financial interest or licensing right.

Marketing

LOUD focuses on innovative marketing for each LOUD brand. As a result, each brand holds a unique position in its respective marketplace. Each brand is supported by a dedicated team of brand-specific product, business and communication resources handling all media planning, buying, print literature and advertising design, web design, public relations, product documentation, product training, as well as end-user and dealer trade shows and special events.

Our Major Brands

Alvarez is an acoustic guitar line geared to players of all levels — from entry-level to professional.

Ampeg is the industry standard in bass amplification for more than 50 years.

Crate is an entry-level brand of musical instrument amplification products.

EAW represents precision engineered, technologically superior loudspeakers and digital mixers. EAW systems are found in public spaces including sporting arenas, churches, nightclubs, and on major musical concert tours.

Mackie is innovative professional audio systems for both recording and sound reinforcement applications.

Martin Audio is world-class loudspeaker systems with leading edge designs.

Distribution and Sales

Sales to customers in the United States represented 53%, 66% and 63% of our total net sales in 2007, 2006 and 2005, respectively. In the United States, for EAW products, we use a network of independent representatives. These products are sold in musical instrument stores, professional audio outlets and several mail order outlets. For Alvarez, Ampeg, Crate, Mackie, St. Louis Music Accessories, Tapco, Knilling and Martin Audio products, we use a dedicated, domestic employee sales force (we employed approximately 22 salespersons as of December 31, 2007) that sells to musical instrument stores, retail locations, professional audio outlets and several mail order outlets. Sales to our top 10 U.S. dealers represented approximately 23%, 29% and 27% of net sales made in 2007, 2006 and 2005, respectively. One dealer, Guitar Center, Inc., accounted for approximately 16%, 19% and 17% of net sales in 2007, 2006 and 2005, respectively. Guitar Center, Inc. was the only dealer accounting for over 10% of net sales during any one year during this period.

Internationally, our products are offered direct to dealers in the United Kingdom, Canada, France, Germany, Belgium, Netherlands and Luxembourg primarily through our subsidiaries in the United Kingdom and Canada. We also sell direct to dealers in Japan. Our products are also distributed through local distributors in countries where we do not have direct operations. No single international distributor accounted for more than 10% of international net sales during any one year in this period.

Customer Support

Customer support programs are designed to enhance brand loyalty by building customer understanding of product use and capabilities. The customer service and support operation also provides us with a means of understanding customer requirements for future product enhancements. This understanding comes through direct customer contact, as well as through close analysis of responses to various product registration surveys.

Product support specialists are located in Woodinville, Washington and Whitinsville, Massachusetts to provide direct technical service and support. Technical support is provided either through a toll-free number or web-based support during scheduled business hours, and via the website after business hours. Customers requiring warranty service or repair on products sold in the United States are instructed to contact Technical Support via telephone or the web. Once Technical Support validates the warranty claim, depending on the product and the nature of the problem, we offer an advance replacement unit or a warranty repair at one of our authorized service center locations throughout the United States. Internationally, our subsidiaries in the United Kingdom, as well as our independent distributors, are utilized to provide product support and are also responsible for warranty repairs for products sold into their markets. Additionally, certain products returned to stock are processed through a contract repair facility in Shanghai, China.

Research and Development

We pride ourselves on employing the top engineering and product design talent in the professional-audio and musical instrument industries. Research and development teams are located in Woodinville, Washington; Whitinsville, Massachusetts; High Wycombe, United Kingdom; Shenzhen, China; and Victoria, B.C., Canada. We also utilize contract engineering service groups to supplement our in-house personnel. Research and development activities by LOUD Technologies during 2007, 2006 and 2005 was approximately $11.6 million, $11.8 million, and $10.3 million, respectively.

Competition

The professional audio and musical instrument industries are fragmented and highly competitive. There are numerous manufacturers, which run the gamut from large to small manufacturers both domestic and international, and offer products that vary widely in price and quality and are distributed through a variety of channels. LOUD competes primarily on the basis of product quality and reliability, price, ease of use, brand name recognition and reputation, ability to meet customers’ changing requirements and customer service and support. We compete with a number of professional audio and musical instrument manufacturers, several of whom have significantly greater development, sales and financial resources. Our primary market competitors are subsidiaries of Bosch GmbH; Fender Musical Instruments Corporation; Harman International Industries; and Yamaha Corporation.

Proprietary Technologies

We have a strong interest in protecting the intellectual property that reflects our original research, creative development and product development. As such, we have sought protection through patents, copyrights, trademarks and trade secrets and have applied and filed for various design and utility patents, both domestically and internationally. We have actively used certain trademarks, and have applied for and registered specific trademarks in the United States and in foreign countries. While the registration of patents and trademarks, and the use of copyrights, trade secrets and other intellectual property protections provides us with certain legal rights, there can be no assurance that any such registration will prevent others from infringing upon these trademarks.

Manufacturing

In 2006, we began the process of transferring our remaining domestic manufacturing overseas. All of our domestic manufacturing plants were closed by the end of the second quarter of 2007 as our overseas contract manufacturers ramped up to full production of our products. Our overseas manufacturers are supported by a team of our employees, located in China, who are responsible to audit quality procedures, manage and facilitate the transition of products from design to manufacturing and to ensure timely delivery of purchased product.

Employees

As of December 31, 2007, we had 533 full-time equivalent employees, including 111 in marketing, sales and customer support; 143 in research and development; 191 in manufacturing, manufacturing support and manufacturing engineering; and 88 in administration and finance. Of our employees as of December 31, 2007, 396 were located in the United States, 25 were located in Canada, 70 were located in Europe and 42 were located in Asia. Also as of December 31, 2007, 33 were members of an organized labor union. We laid off approximately 226 employees during 2007, primarily in the manufacturing and manufacturing support areas.

Website Access to Reports

Our website address is www.loudtechinc.com. The contents of our website are not incorporated into this report or into any of our filings with the Securities and Exchange Commission. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, the Forms 3, 4 and 5 filed by our executive officers, directors and certain shareholders pursuant to Section 16(a) of the Exchange Act, and any amendments to those reports are available free of charge on our website, as soon as is reasonably practicable, after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. The SEC also maintains a website, http://www.sec.gov , at which you may access all of our filings of other persons who are required to file reports with respect to the ownership, disposition, and voting of our equity securities.

CEO BACKGROUND

James T. Engen was appointed President, Chief Executive Officer, and a director in November 2000 and Chairman in May 2005. Prior to such appointment, Mr. Engen served as the Company’s Chief Operating Officer. From 1998 to 1999, Mr. Engen oversaw the European operations of the Company. From 1997 to 1998, Mr. Engen was a Senior Vice President of Price Waterhouse, a public accounting firm (now PricewaterhouseCoopers LLP), specializing in the restructuring and refinancing of companies. Prior to joining Price Waterhouse, Mr. Engen’s background included being the executive producer of a mini-series, which was sold to ESPN, and the producer/publisher of other sports-related productions. Mr. Engen has several years of experience as a chartered accountant for Price Waterhouse, and five years as a freelance sound consultant specializing in the design and equalization of large sound systems in stadiums, arenas, and convention centers. Mr. Engen holds the professional designation of Chartered Accountant, granted by the Institute of Chartered Accountants of British Columbia.

Jon W. Gacek was appointed director in September 2002. Mr. Gacek joined Quantum as Executive Vice President and Chief Financial Officer in August 2006, upon Quantum’s acquisition of Advanced Digital Information Corp. (ADIC). Previously, he served as the Chief Financial Officer at ADIC from 1999 to 2006. ADIC is a designer and manufacturer of automated high performance data storage hardware and software products used to backup and archive electronic data in client/server network computing environments. Prior to joining ADIC in 1999, he was a partner at PricewaterhouseCoopers LLP in charge of the office technology practice in Seattle, Washington. While at PricewaterhouseCoopers, Mr. Gacek assisted private equity investment firms in a number of merger, acquisition, leveraged buyout and other transactions. Mr. Gacek is also a director at HouseValues.com, which is traded on Nasdaq under the symbol SOLD. Mr. Gacek holds a B.A. in Accounting from Western Washington University.

R. Lynn Skillen was appointed director in February 2003. Mr. Skillen has served as Senior Vice President of Sun Capital Partners, Inc. since June 2006, and has more than 30 years of experience in finance and operations. Prior to joining Sun Capital as Vice President in November 2002, Mr. Skillen served as Chief Financial Officer of two Sun Capital portfolio companies (Catalina Lighting, Inc. and Celebrity, Inc.). He also served as Vice President-Finance of Dollar Car Rental from September 1997 to March 1998 and as Chief Financial Officer of Snappy Car Rental, Inc. from October 1994 to September 1997. Prior to 1994, Mr. Skillen spent 16 years at Safelite Auto Glass, serving in several finance and operations management positions. Mr. Skillen is also a director of Indalex Holdings Finance, Inc. and a number of private companies

Clarence E. (“Bud”) Terry , was appointed as a director and Vice President in February 2003. Mr. Terry has served as Managing Director of Sun Capital Partners, Inc. since September 1999, and has more than 30 years of operating experience. Prior to joining Sun Capital, Mr. Terry served as Vice President at Rain Bird Sprinkler Manufacturing, Inc., the largest manufacturer of irrigation products in the world. Mr. Terry has been responsible for all areas of operations, including manufacturing, foreign sourcing, sales and marketing, and general management. Mr. Terry is also a director of SAN Holdings, Inc., Indalex Holdings Finance, Inc., Real Mex Restaurants, Inc. and a number of private companies.

Jason H. Neimark , was appointed Vice President in February 2003 and a director in May 2005. Mr. Neimark is a Managing Director of Sun Capital Partners, Inc. Since joining Sun Capital Partners in 2001, Mr. Neimark has led more than 30 buyout and re-financing transactions on behalf of affiliates of Sun Capital Partners, Inc. After receiving his CPA designation in 1992, Mr. Neimark worked as a tax consultant and auditor for KPMG Peat Marwick until 1995 when he joined Midwest Mezzanine Funds, a provider of junior capital to middle market businesses, where he served until 2001 as a Principal and President of K&D Distributors, a national direct marketer and specialty distributor of optical products, and an affiliated company of Midwest Mezzanine. Mr. Neimark led K&D’s financial and operational turnaround in 2000. Mr. Neimark graduated from Indiana University with a Bachelor of Science degree in Accounting.

Kevin J. Calhoun , was appointed as a director in May 2006. Mr. Calhoun has been employed by Sun Capital Partners, Inc. since 2000, and currently serves as its Senior Vice President & Chief Financial Officer. Mr. Calhoun previously served as Chief Financial Officer of Sun Capital Partners, Inc.’s first affiliated portfolio company. Mr. Calhoun has over 24 years of operating, accounting and tax, management information systems, and risk management experience. Prior to joining Sun Capital Partners, Inc., he served as Chief Financial Officer of a publicly-held technology company and Controller for a privately-owned distribution business. Mr. Calhoun was also with Ernst & Young for ten years, most recently as a Senior Manager in its audit department. Currently, Mr. Calhoun is also a director of SAN Holdings, Inc. Mr. Calhoun received his Bachelor of Science degree in Accounting from the University of Florida.

Thomas V. Taylor was appointed as a director by the Board of Directors in April 2007. Mr. Taylor has had extensive operating and merchandising experience having spent twenty-three years with The Home Depot Companies, most recently serving as Executive Vice President, Merchandising and CMO. Mr. Taylor began his career with The Home Depot at age 16, working as a part-time Associate in the outside garden department of a store in Miami, Florida. He quickly rose through the organization assuming increasing levels of managerial and executive responsibility. From Department Head, he became Assistant Store Manager, Store Manager, and at age 26, District Manager. In 1996, he was named President of the Eastern Division, and in December 2001, he was elevated to President of the Eastern Division when the Southeast and Northern Divisions were combined to create the new Eastern Division, Home Depot’s largest division with over 650 stores. From December 2004 to August 2005, Mr. Taylor assumed the newly-created role of Executive Vice President, a position responsible for all U.S. and Mexican stores. In August 2005, he was appointed Executive Vice President of Merchandising and Marketing with direct reports in merchandising, marketing, advertising, logistics, and international global sourcing.

Mark E. Kuchenrither, was appointed director and Vice President and Assistant Secretary of the Company on July 13, 2007. Mr. Kuchenrither is a Vice President of Sun Capital Partners. Prior to joining the Company, Mr. Kuchenrither served as a Chief Financial Officer of Arch Aluminum & Glass Co. from 2003 to 2007. From 2000 to 2003 Mr. Kuchenrither served as Chief Financial Officer and Treasurer for Peavey Electronics Corporation. Prior to joining Peavey Electronics Corporation, Mr. Kuchenrither spent nine years in various financial and operating roles for other corporations.

C. Daryl Hollis was appointed as a director in April 2003. Mr. Hollis is a CPA and has been an independent business consultant since 1998. From 1996 to 1998, Mr. Hollis served as Executive Vice President and Chief Financial Officer of The Panda Project, Inc., a technology company. Mr. Hollis is also a director of Medical Staffing Network Holdings, Inc.

George R. Rea , was appointed as a director in April 2003. Mr. Rea has been an independent business consultant since 1994.

Other Executive Officers and Key Employees

Gerald Y. Ng was appointed Chief Financial Officer of the Company effective July 23, 2007. Mr. Ng served as Vice President of Finance and Business Development for Medtronic Physio-Control since 2001 with responsibility for Finance and Information Technology operations and Business Development and Planning activities. Prior to joining Medtronic, he was a Senior Manager with Ernst & Young’s Management Consulting practice for seven years focusing on operational improvement and system implementation initiatives for clients in the Life Science and High Technology industries.

Gary M. Reilly was appointed Senior Vice President of Engineering in July 2005. Mr. Reilly brings to the Company over 25 years experience in engineering and product development, most recently as Sr. Director of Product Development at Qualcomm, a leader in developing innovative digital wireless communications products and services, where he was responsible for driving alignment of product strategies, roadmaps and development plans. Mr. Reilly held various product development and engineering positions at Cubic, Spectrum Control, Advanced Technology Laboratories, Data I/O and Boeing Aerospace.

MANAGEMENT DISCUSSION FROM LATEST 10K

The following discussion and analysis should be read in conjunction with “Selected Consolidated Financial Data” and the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report. 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 here.

The cautionary statements made in this Annual Report should be read as being applicable to all forward-looking statements wherever they appear. Factors that could cause or contribute to such differences include those discussed in “Risk Factors,” as well as those discussed elsewhere herein. We undertake no obligation to publicly release the result of 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.

General

Our product lines include sound reinforcement speakers, analog mixers, guitar and bass amplifiers, professional loudspeaker systems, and branded musical instruments. These products can be found in professional and project recording studios, video and broadcast suites, post-production facilities, sound reinforcement applications including churches and nightclubs, retail locations, and on major musical concert tours. We distribute our products primarily through retail dealers, mail order outlets and installed sound contractors. We have our primary operations in the United States with other operations in the United Kingdom, Canada, China and Japan.

Operating results for 2007 were substantially impacted by restructuring costs incurred during the manufacturing transition to Asia and the general softening in the demand for most of our product lines. Although this softening was partially offset by the inclusion of results of Martin Audio of $1.3 million for the period April 11, 2007 through December 31, 2007, our operating results decreased $8.1 million when compared to 2006. For the twelve months ended December 31, 2007, net sales decreased 3.2% to $208.3 million from $215.0 million for 2006. The decrease in net sales is primarily related to the softening in the demand for our products. The decrease is partially offset by the inclusion of the results of Martin Audio of $20.9 million for the period April 11, 2007 through December 31, 2007. Our operating income for 2007 decreased by 92.2% to $0.7 million, representing 0.3% of sales, compared to the operating income for 2006, which was $8.8 million, representing 4.1% of net sales. Net loss declined to $12.6 million, or $2.60 per diluted share, compared to net income of $0.6 million, or $0.13 per diluted share, for 2006.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities.

We believe that the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, allowance for doubtful accounts, inventory valuation and income taxes. These policies require that we make estimates in the preparation of our financial statements as of a given date. However, since our business cycle is relatively short, actual results related to these estimates are generally known within the six-month period following the financial statement date. Thus, these policies generally affect only the timing of reported amounts.

Inventory Valuation. LOUD inventories are reported at the lower of standard cost, which approximates actual cost on a first-in, first-out method, or market. Demonstration products used by our sales representatives and marketing department (including finished goods that have been shipped to customers for evaluation) are included in our inventories. Market value adjustments are recorded for excess and obsolete material, slow-moving product, service and demonstration products. We base judgments regarding the carrying value of our inventory upon current market conditions. Current market conditions depend upon competitive product introductions, customer demand and other factors. In the event that the market changes related to products that have been previously released, we may be required to write down the cost of our inventory to reflect this change in the market.

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

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 business judgment is used to assess events and factors which might trigger impairment of long-lived assets, including significant underperformance relative to expected operating results, significant changes in the use of the assets or the strategy for our overall business, and/or 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.

Goodwill and Other Intangible Assets. We assess the impairment of goodwill on an annual basis during our fourth fiscal quarter, or upon the occurrence of events or changes in circumstances that indicate that the fair value of the reporting unit to which goodwill relates is less than the carrying value. A reporting unit is considered to be a brand or group of brands. Factors we consider important which could trigger an impairment review include the following:


• Poor economic performance relative to historical or projected future operating results;

• Significant negative industry, economic or company specific trends;

• Changes in the manner of our use of the assets or the plans for our business; and

• Loss of key personnel.

If we were to determine that the fair value of the reporting unit was less than its carrying value (including the value of goodwill) based upon the annual test or the existence of one or more of the above indicators of impairment, we would measure impairment based on a comparison of the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value following this allocation is the implied fair value of the goodwill of the reporting unit. To the extent the carrying amount of the reporting unit goodwill is greater than the implied fair value of the reporting unit goodwill, we would record an impairment charge of the difference. There were no impairments related to goodwill for the Fiscal Year ended December 31, 2007.

Revenue Recognition. Revenues from sales of products, net of sales discounts, returns and allowances, are generally recognized upon shipment under a customer agreement when the following have occurred: the 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. We do provide products to some dealers who finance their purchases through finance companies. We have a manufacturer’s repurchase agreement with the finance companies. We defer the revenue and related cost of goods sold of these sales at the time of the sale and recognize the revenue and related cost of goods sold of these sales when the right of return no longer exists. Sales with contingencies (such as rights of return, rotation rights, conditional acceptance provisions and price protection) are rare and not material. We generally warrant our products against defects in materials and workmanship for periods of between one and six years, with the exception of Alvarez Yairi guitars, which have a limited lifetime warranty. 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. In connection with 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.

Accounting for Acquisitions. Significant business judgment is required to estimate the fair value of purchased assets and liabilities at the date of acquisition, including estimating future cash flows from the acquired business, determining appropriate discount rates, asset lives and other assumptions. Our process to determine the fair value of trademarks, customer relationships, and developed technology includes the use of estimates such as:


• the potential impact on operating results of the revenue estimates for customers acquired through the acquisition based on an assumed customer attrition rate; and

• estimated costs to be incurred to purchase the capabilities gained through the developed technology and appropriate discount rates based on the particular business’s weighted average cost of capital.

Our process to determine the fair value of inventories acquired was to estimate the selling price of the inventories less the sum of costs to sell and a reasonable selling profit allowance.

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Sales

Net sales decreased by 3.2% to $208.3 million in 2007 from $215.0 million in 2006. We have experienced general softening in the demand for most of our product lines over the last 18 months. These trends are reflective of challenges facing our major customers and the industry as a whole. These trends were partially offset by the inclusion of sales of Martin Audio products from April 11, 2007 through December 31, 2007 of $20.9 million. We have one significant customer who represented approximately 16% and 19% of our total net sales in 2007 and 2006, respectively. U.S. sales represented approximately 53% of our net sales in 2007, compared to approximately 66% in 2006.

Gross Profit

Gross profit decreased by 16.0% to $60.0 million, or 28.8% of net sales, in 2007 from $71.5 million, or 33.2% of net sales, in 2006. Included in gross profit was $1.3 million related to Martin Audio for the period April 11, 2007 through December 31, 2007 which was negatively affected by $1.6 million due to recording Martin Audio’s inventories at fair value as a result of the purchase price allocation of Martin Audio. Gross profit was also reduced by the costs associated with the domestic factory shutdowns and additional sales discounting done in the first quarter of 2007 to reduce the carrying balances of our inventories at December 31, 2006. Excluding the $1.6 million fair value adjustment for Martin Audio’s inventory, gross profit percent for 2007 was 29.6%.

Selling, General and Administrative

Selling, general and administrative expenses decreased by 7.2% to $45.8 million, or 22.0% of net sales in 2007, from $49.3 million, or 22.9% of net sales in 2006. The decrease was primarily attributable to the effect of cost-cutting programs implemented in 2006 partially offset by costs related to Martin Audio of $4.2 million for the period April 11, 2007 through December 31, 2007.

Research and Development

Research and development expenses decreased by 1.7% to $11.6 million, or 5.6% of net sales in 2007, from $11.8 million, or 5.5% of net sales in 2006. The decrease was primarily attributable to the effect of cost-cutting programs implemented in late 2006 and continuing into 2007 partially offset by costs related to Martin Audio of $1.2 million for the period April 11, 2007 through December 31, 2007.

Other Expense

Net other expense increased by 77.4% to $13.7 million in 2007, from $7.7 million in 2006. This increase was attributable primarily to an increase to interest expense of $3.9 million and the write-off of $2.5 million of unamortized fees related to the prior debt facility as a result of the refinancing of our debt facilities in March 2007. The increase in interest expense is primarily attributable to increasing variable interest rates and increased debt as a result of the $112 million senior secured credit facility.

Management fees are paid quarterly to Sun Capital Partners Management, LLC, an affiliate of our principal shareholder, and are calculated as the greater of $0.4 million annually or 6% of EBITDA, not to exceed $1.0 million per year. Of the $0.9 million of management fees expensed during 2007, $0.8 million relates to the 2007 EBITDA calculation and $0.1 million is miscellaneous expenses incurred by Sun Capital Partners Management, LLC, for which they are entitled to reimbursement pursuant to our Management Services Agreement dated February 21, 2003. Of the $1.1 million of management fees expensed during 2006, $1.0 million relates to the 2006 EBITDA calculation and $0.1 million is miscellaneous expense incurred by Sun Capital Partners Management, LLC.

Income Tax Expense

The income tax benefit was $436,000 in 2007 compared to income tax expense of $431,000 in 2006. The primary components of the 2007 benefit is the deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability recorded as a result of the acquisition of Martin Audio. This deferred tax benefit was further impacted by the enactment of a U.K. tax law during 2007, which reduced the statutory tax rate. This deferred tax benefit was partially offset by current taxes due from our foreign subsidiaries and an increase to our income tax reserve. The primary components of the 2006 taxes are the Alternative Minimum Tax, changes in our income tax reserve, deferred tax expense recorded as a result of the goodwill that is amortized for tax purposes only from the St. Louis Music, Inc. acquisition, and foreign subsidiary tax expense.

As of December 31, 2007, we had net operating loss carryforwards for federal income tax purposes of approximately $32.6 million, which if not utilized would begin to expire in 2024. Approximately $31.0 million of these loss carryforwards relate to the United States and United Kingdom. Approximately $1.6 million of these loss carryforwards relate to our discontinued operation in France, which we believe we will not be able to realize. We have recorded a valuation allowance for all of the net deferred tax assets related to the United States as a result of uncertainties of future taxable income necessary for the realization of these net assets.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Net Sales

Net sales from continuing operations increased by 5.2% to $215.0 million in 2006, from $204.3 million in 2005, due to the inclusion of a full year of sales from historical St. Louis Music brands in 2006, which we acquired on March 4, 2005. We have one significant customer who represented approximately 19% and 17% of our total net sales in 2006 and 2005, respectively. U.S. sales represented approximately 66% of our net sales in 2006, compared to approximately 63% in 2005.

Gross Profit

Gross profit increased by 9.4% to $71.5 million, or 33.2% of net sales, in 2006 from $65.3 million, or 32.0% of net sales, in 2005. The increase in gross profit is primarily attributable to the increase in sales volume in 2006. The 2005 gross profit was impacted by the $2.4 million fair value adjustment for recording of St. Louis Music’s inventories at fair value as a result of the purchase price allocation of St. Louis Music. The remaining increase is due to the continuing benefit of outsourcing our production overseas, which is partially offset by a larger percentage of lower margin historical St. Louis Music brand sales.

Selling, General and Administrative

Selling, general and administrative expenses increased by 5.9% to $49.3 million in 2006, from $46.6 million in 2005. This increase is partially attributable to having a full twelve months of St. Louis Music expenses. The remaining increase is due to one-time costs associated with the shift to direct sales distribution of Mackie products in North America. These increases were partially offset by the consolidation of the St. Louis Music operations, the ongoing cost benefits of our direct sales program, and the cost-cutting programs implemented in June 2006.

Research and Development

Research and development expenses increased by 14.6% to $11.8 million in 2006, from $10.3 million in 2005. The increase was primarily attributable to a full year of St. Louis Music costs, an increase in new product development in 2006 when compared to 2005, and additional engineering resources required to transition our domestic manufacturing to our contract manufacturers.

Other Expense

Net other expense increased $0.2 million, or 2.6% from $7.5 million in 2005 to $7.7 million in 2006. This increase was related primarily to an increase in interest expense partially offset by decreases to management fees and other expenses.

Of the $1.1 million of management fees expensed during 2006, $1.0 million is attributable to the 2006 EBITDA calculation and $0.1 million is miscellaneous expenses incurred by Sun Capital Partners Management, LLC. Of the $1.2 million of management fees expensed during 2005, $1.0 million is attributable to the 2005 EBITDA calculation, $0.1 million is a correction to the management fee owed for the 2004 EBITDA calculation, and the remaining amount is miscellaneous expenses incurred by Sun Capital Partners Management, LLC.

Income Tax Expense

Income tax expense was $431,000 in 2006 compared to $47,000 in 2005. The primary components of the 2006 and the 2005 taxes are the Alternative Minimum Tax, changes in our income tax reserve, deferred tax expense recorded as a result of the goodwill that is amortized for tax purposes only from the St. Louis Music, Inc. acquisition, and foreign subsidiary tax expense.

As of December 31, 2006, we had net operating loss carryforwards for federal income tax purposes of approximately $22.1 million, which if not utilized would begin to expire in 2024. Approximately $20.7 million of these loss carryforwards relate to the United States and United Kingdom. Approximately $1.4 million of these loss carryforwards relate to our discontinued operation in France, which we believe we will not be able to realize. We have recorded a valuation allowance for all of the net deferred tax assets as a result of uncertainties of future taxable income necessary for the realization of these net assets.

Gain on Discontinued Operations

In March 2005, we recognized a $2.8 million gain from the discontinued operations of our former Italian subsidiary, net of tax of $58,000. This gain was a result of an agreement with Mackie Italy to settle the net outstanding amounts owed by the Company.

Liquidity and Capital Resources

As of December 31, 2007, we had cash and cash equivalents of $3.6 million and total debt and short-term borrowings of $101.7 million. At December 31, 2007 we had availability of $8.7 million on our revolving line of credit.

The following paragraphs describe transactions that affected our liquidity and capital resources.

On August 29, 2005, a credit facility was completed providing a $69.5 million senior secured loan facility and a $14.8 million senior subordinated note. The senior secured loan facility consists of a $40.0 million revolving loan (of which $14.2 million was outstanding as of December 31, 2006), a $15.0 million Term Loan A, and a $14.5 million Term Loan B. In connection with the senior subordinated note, the Company issued 51,547 shares of common stock to the subordinated lender at a per share price of $14.55.

LOUD was not in compliance with the Credit Agreement at February 14, 2007, because it did not meet the financial covenants set forth in the Credit Agreement for the period ending December 31, 2006. On March 5, 2007, the Company entered into a Forbearance and Consent Agreement, whereby the Lenders agreed to forbear from exercising certain of their rights and remedies with respect to certain events of default under the previous Credit Agreement dated August 29, 2005 and consented to the Martin Audio, Ltd. acquisition. The Forbearance Agreement covered the period commencing on March 5, 2007 and ending on March 30, 2007, when we closed on a new $112 million senior secured credit facility. The proceeds from this new credit facility were used to retire all amounts outstanding on the previous credit facility dated August 29, 2005, to fund the acquisition of Martin Audio, Ltd., and to provide for our future working capital needs. The $112 million senior secured credit facility consists of a $10.0 million revolving loan, a $20.0 million Term Loan A, a $40.0 million US Term Loan B, a $30.0 million UK Term Loan B, and a $12.0 million Term Loan C.

The $102.0 million term loans under the $112 million senior secured credit facility require quarterly principal payments. The term loans bear interest at the Chase Manhattan Bank’s prime rate or LIBOR, plus a specified margin. Interest is due quarterly on each term loan. Under the revolving line of credit, the Company can borrow up to $10.0 million, subject to certain restrictions. Interest is due quarterly and is based on Chase Manhattan Bank’s prime rate or LIBOR, plus a specified margin. The $112 million senior secured credit facility is secured by substantially all of the assets of the Company and its subsidiaries.

As of September 30, 2007 and December 31, 2007, we failed to meet our EBITDA targets, fixed charge coverage ratios, and consolidated leverage ratios. On October 17, 2007 we entered into a waiver agreement with the lenders effective as of September 30, 2007 with respect to the September 30, 2007 defaults. We paid the lenders a fee of $225,000 upon execution of the waiver and the interest rates on Term Loan A increased to Chase Manhattan Bank’s prime rate plus 0.85% or LIBOR plus 3.35% and the interest rate on Term Loans B increased to Chase Manhattan Bank’s prime rate plus 2.95% or LIBOR plus 5.2%. With respect to the December 31, 2007 default, we entered into a waiver agreement on March 6, 2008 with the lenders effective as of December 31, 2007. We paid the lenders a fee of $100,000 upon execution of the waiver.

On March 6, 2008, we entered into an Amendment related to the Ableco credit facility. The Amendment modifies certain definitions used in the Financing Agreement and requires us to reduce the balance outstanding under the Financing Agreement by $7.5 million. The Amendment modifies the definition of “Consolidated EBITDA” and “Consolidated Funded Indebtedness” to change the calculations pursuant to these terms, as well as other terms used in the Financing Agreement.

As a condition to entering into the Amendment, our lender has requested that we seek $7.5 million of subordinated financing. On March 18, 2008, we issued to our controlling stockholder, Sun Mackie a $7.5 million Convertible Senior Subordinated Secured Promissory Note due 2012 (the “Note”) that is secured by all of the assets of the Company now owned and thereafter acquired. The Note bears interest at a rate of 15.25% per annum, payable in kind until maturity, and is convertible into common stock at a conversion price of $5.00. We paid Sun Mackie a fee of $150,000 upon issuance of the Note.

In April 2007 we acquired all of the outstanding capital stock of Martin Audio, a UK based manufacturer of loudspeakers and related equipment for total cash consideration including transaction costs of $35.7 million and the assumption of certain liabilities of $15.3 million.

In March 2005, we acquired all of the shares of St. Louis Music, Inc., a Missouri-based manufacturer, distributor and importer of branded musical instruments and professional audio products for total cash consideration including transaction costs of $35.3 million and the assumption of certain liabilities of $7.2 million.

In February 2005, we made an offer to Mackie Italy to settle any outstanding amounts owed by the Company to Mackie Italy for $4.7 million. This proposal was accepted by the Italian court appointed trustee on behalf of Mackie Italy in May 2005. Under the terms of the settlement agreement, we made payments of $2.5 million in 2005. Additionally, we committed to pay $2.2 million in 2006, of which $1.5 million was paid in 2006 and the remaining $0.7 million was paid in January 2007. We recognized a gain on discontinued operations of $2.9 million in 2005 related to this settlement.

Net Cash Provided by Operating Activities

Cash provided by operations was $0.3 million in 2007, $0.3 million in 2006 and $10.0 million in 2005. The net loss for 2007 was $12.6 million that included $5.0 million in depreciation and amortization, $3.1 million in amortization and write off of deferred financing fees, a gain on asset dispositions of $0.5 million, stock based compensation expense of $0.3 million and $0.3 million of non-cash interest expense. In 2007 decreases to accounts receivable and inventories provided cash of $5.6 million and $4.1 million, respectively, while decreases to accounts payable, accrued liabilities, and payable to our former Italian subsidiary, and taxes payable used cash of $3.9 million and $1.4 million, respectively. Net income for 2006 was $0.6 million that included $4.6 million in depreciation and amortization, $0.7 million in amortization of deferred financing fees and $0.4 million in stock based compensation expense. In 2006, a decrease of our accounts receivable and prepaid expenses and an increase to accounts payable, accrued liabilities and payable to our former Italian subsidiary of $2.3 million and $6.6 million, respectively, provided cash, while an increase of our inventory levels used $15.6 million of cash. Net income for 2005 was $3.8 million which included $4.5 million in depreciation and amortization, $1.1 million in amortization and write off of deferred financing costs, a gain on discontinued operations of $2.9 million, stock based compensation expense of $0.1 million and non cash interest expense of $0.1 million. In 2005 decreases to our accounts receivable, inventories, and prepaid expenses and other current assets provided cash of $8.8 million while a decrease to our accounts payable, accrued liabilities and payable to our former Italian subsidiary used cash of $5.4 million.

Net Cash Used in Investing Activities

Cash used in investing activities was $36.3 million in 2007, $2.4 million in 2006 and $37.0 million in 2005. Cash used in investing activities during 2007 was primarily related to the acquisition of Martin Audio of $32.0 million, payment of $3.2 million related to our commitment to pay the former shareholders of St. Louis Music and purchases of $2.4 million of property, plant and equipment. Investing activities were partially offset by proceeds of $1.2 million from sales of property, plant and equipment. Cash used in investing activities of $2.4 million in 2006 related to purchases of property, plant and equipment. The cash used in investing activities in 2005 was primarily related to the acquisition of St. Louis Music, Inc. for $35.3 million, in addition to cash used of $1.7 million related to the purchase of property, plant and equipment.

Net Cash Provided by Financing Activities

Cash provided by financing activities was $39.7 million in 2007, $2.0 million in 2006, and $27.0 million in 2005. Cash provided by financing activities during 2007 related primarily to a new credit facility of $112.0 million consisting of a revolving loan facility of $10.0 million, of which $1.3 million was outstanding at December 31, 2007, a Term Loan A of $20.0 million, Term Loans B of $70.0 million and a Term Loan C of $12.0 million. Along with this refinancing, we paid $26.2 million of our existing Term Loans A and B, subordinated debt of $14.8 million, a revolving loan facility of $26.2 million, a debt and credit facility acquired in the acquisition of Martin Audio of $3.0 million, and we incurred $3.0 million in deferred financing costs. Cash provided by financing activities during 2006 was primarily attributable to an increase in our borrowings from our bank line of credit of $4.6 million, which was partially offset by payments made on our long-term debt of $2.6 million. Cash provided by financing activities during 2005 related primarily to the Company issuing a new senior credit facility of $69.5 million, which consisted of a revolving loan facility of $40.0 million, of which $9.6 million was outstanding at December 31, 2005, a Term Loan A of $15.0 million and a Term Loan B of $14.5 million. Also issued in 2005 was new subordinated debt of $14.8 million. Along with this refinancing, we paid off our existing $11.4 million note, a term loan of $0.6 million, a credit facility of $11.8 million, and we incurred $3.6 million in deferred financing costs.

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

Under the terms of the Company’s senior secured credit facility, we are required to maintain certain financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. We are also required to meet certain EBITDA targets and adhere to certain capital expenditure limits.

Our continued liquidity is dependent upon the following key factors:

Ability to stay in compliance with debt covenants

Under the terms of the Company’s senior secured credit facility, we are required to maintain certain financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. We are also required to meet certain EBITDA targets and adhere to certain expenditure limits. As of December 31, 2007, we failed to meet our EBITDA target, fixed charge coverage ratio, and consolidated leverage ratio. On March 6, 2008, we entered into a waiver agreement with the lenders effective as of December 31, 2007 with respect to the defaults. We paid a fee to the lenders of $100,000 upon execution of the waiver agreement.

On March 6, 2008, the Company entered into an Amendment related to the senior secured credit facility. The Amendment modifies certain definitions used in the Financing Agreement and requires the Company to reduce the balance outstanding on the senior secured credit facility by $7.5 million. The Amendment modifies the definition of “Consolidated EBITDA” and “Consolidated Funded Indebtedness” to change the calculations pursuant to these terms, as well as other terms used in the Financing Agreement. These transactions and the impact to our liquidity are explained in more detail in Notes 10 and 18 of the accompanying consolidated financial statements.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

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, 2007. This discussion contains certain “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Actual results may 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 may apply 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. was founded in 1988 and incorporated in Washington under the name Mackie Designs Inc., and subsequently changed its name to LOUD Technologies Inc. LOUD is one of the world’s largest dedicated pro audio and music products companies. As the corporate parent for world-recognized brands Alvarez ® , Ampeg ® , Crate ® , EAW ® , Knilling ® , Mackie ® , Martin Audio ® , SIA ® and Tapco ® , LOUD engineers, markets and distributes a wide range of professional audio and musical instrument products worldwide. Additionally, LOUD is one of the largest distributors of branded professional audio and music accessories through its SLM Marketplace catalog.
Our product lines include sound reinforcement speakers, analog mixers, guitar and bass amplifiers, professional loudspeaker systems, and branded musical instruments. These products can be found in professional and project recording studios, video and broadcast suites, post-production facilities, sound reinforcement applications including churches and nightclubs, retail locations, and on major musical concert tours. We distribute our products primarily through retail dealers, mail order outlets and installed sound contractors. We have our primary operations in the United States with smaller operations in the United Kingdom, Canada, China and Japan.
Our stock is listed on the Nasdaq Capital Market™ under the symbol “LTEC”.
“MACKIE,” the running man figure, “TAPCO,” “EAW,” and “SIA” are registered trademarks of LOUD Technologies Inc. “Alvarez”, “Ampeg”, “Crate”, and “Knilling” are registered trademarks of our wholly owned subsidiary, St. Louis Music, Inc. “Martin Audio” is a registered trademark of our wholly owned subsidiary, Martin Audio, Ltd. To the extent our trademarks are unregistered, we are unaware of any conflicts with trademarks owned by third parties. This document also contains names and marks of other companies, and we claim no rights in the trademarks, service marks and trade names of entities other than those in which we have a financial interest or licensing right.
The financial statements herein have been prepared assuming the Company continues as a going concern. While we were in compliance with applicable loan covenants as of June 30, 2008, we have not offered assurances that we will remain in compliance in future periods. Were we to fall out of compliance and fail to negotiate waivers or obtain additional sources of liquidity, our lenders could foreclose on our assets or take other steps that may impede our ability to continue as a going concern.
The Company is highly leveraged and maintains a number of credit arrangements that are critical to our growth and to our ongoing operations. These credit agreements include certain financial covenants and ratios and require that we maintain adequate levels of eligible collateral to support our borrowing level, among other restrictions. In previous quarters, we have been in breach of certain financial covenants in our senior credit facility, and we have received forbearances from the lender and entered into waiver agreements with respect to the defaults and amended our credit agreement. If future breaches of the covenants of our credit arrangements occur, there is no assurance that the lenders would grant waivers or agree to restructure our debt or that we would be able to obtain other financing. We are unable to offer assurances that we can remain in compliance with such covenants in the future. If we default on our debt, our lenders have a variety of remedies against us including accelerating all amounts so that they come due immediately and foreclosing on their security interests, which would allow the creditors to take possession of all of our assets.

Under the terms of the senior secured credit facility, we are required to maintain certain financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. We are also required to meet certain EBITDA targets and adhere to certain capital expenditure limits. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, and acquisitions. As of June 30, 2008, we met all of our covenant requirements. The Company is uncertain whether it will meet these covenants in third and fourth quarter 2008 and can offer no assurances that it will remain in compliance with the terms of the credit agreement.
During July 2008 the Company experienced lower than expected sales and margins due to a backlog of orders with a contract manufacturer. This decline, which we believe to be temporary, could negatively impact EBITDA calculations.
In previous quarters, we have been in breach of certain financial covenants in our senior credit facility and we have received forebearances from the lender and entered into waiver agreements with respect to the defaults and amended our credit agreement. If breaches of the covenants of our senior secured credit facility occur, there is no assurance that the lender would grant waivers or agree to restructure our debt or that we would be able to obtain other financing. If we default on our debt, the lender has a variety of remedies against us including accelerating all amounts so that they come due immediately and foreclosing on their security interests, which would allow the creditor to take possession of all of our assets. The accompanying financial statements do not reflect any adjustments that might be required should the Company default on debt agreements.
Critical Accounting Policies and Judgments
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
We believe there have been no additional significant changes in our critical accounting policies during the six months ended June 30, 2008 from that disclosed in our Form 10-K for the year ended December 31, 2007.
Estimates and Assumptions Related to Financial Statements
Our 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 U.S. generally accepted accounting principles for interim financial statements. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including 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.

Three Months Ended June 30, 2008 vs. Three Months Ended June 30, 2007
Net Loss
Results of operations for the three months ended June, 2008, showed a net loss of approximately $1.1 million, a decrease of $1.7 million from a net loss of $2.7 million for the comparable period in 2007. Operating income for the three months ended June 30, 2008 was $2.7 million compared to operating income of $0.1 million in the comparable period in 2007. The increase is a result primarily from new Mackie products of $4.4 million which carry a higher gross profit on the 2008 sales.
Net Sales
Net sales increased by 8.7% to $55.0 million during the three months ended June 30, 2008 from $50.6 million in the comparable period in 2007. The increase in sales compared to the prior year is related to strength in the core brands of Mackie, Ampeg, and EAW, as well as, strong international sales.
Gross Profit
Gross profit was $17.1 million, or 31.1% of net sales, in the three months ended June 30, 2008 compared to $14.5 million, or 28.7% of net sales, in the three months ended June 30, 2007. Excluding the Martin Audio acquisition and the write down of inventory associated with the factory shutdowns in 2007, gross profit was comparable to prior year results.
Selling, General and Administrative
Selling, general and administrative expenses increased by $0.5 million to $11.5 million in the three months ended June 30, 2008 from $11.0 million in the comparable period in 2007. The increase is primarily attributable to increased commissions and bonuses on higher sales volumes.
Research and Development
Research and development expenses decreased by $0.2 million to $2.6 million in the three months ended June 30, 2008 from $2.8 million in the comparable period in 2007. The $0.2 million decrease is due to a reduction in engineering projects and prototype costs.
Restructuring Costs
We incurred approximately $262,000 in restructuring costs during the three-month period ended June 30, 2008, primarily attributed to employee severance and related costs for 3 terminated employees. In the comparable period in 2007, approximately $536,000 in restructuring costs were incurred, primarily representing severance accruals related to the closure and overseas transfer of our domestic manufacturing plants and closure of our St. Louis Music engineering functions.
Other Expense
Other expense was $3.6 million for the three months ended June 30, 2008 as compared to $2.9 million in the comparable period last year. The increase in other expense of $0.7 million is primarily due to the cost associated with the Sun Mackie $7.5 million Convertible Senior Subordinated Secured Promissory Note due 2012 issued on March 18, 2008.
The majority of our debt has variable interest rates, and the interest expense component of other income (expense) in future quarters will be affected by changing interest rates.

Income Taxes
Income tax expense for the three months ended June 30, 2008 was $156,000 compared to a benefit of ($39,000) for the comparable period in 2007. The primary components of the 2008 income tax include income tax expense of $0.3 million related to Martin Audio, $0.3 million associated with the deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability recorded as a result of the acquisition of Martin Audio, and $0.1 million related to federal tax expense. The primary components of the 2007 benefit are current taxes due from our foreign subsidiaries and an increase to our income tax reserve offset by the deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability as a result of the acquisition of Martin Audio.
Six Months Ended June 30, 2008 vs. Six Months Ended June 30, 2007
Net Sales
Net sales from continuing operations increased by 7.5% to $109.1 million during the six months ended June 30, 2008 from $101.5 million in the comparable period in 2007. The majority of the increase in sales was related to new Mackie products of $6.6 million along with increased sales in our core brands, including Ampeg and EAW.
Gross Profit
Gross profit increased to $32.9 million, or 30.2% of net sales, in the six months ended June 30, 2008 from $28.1 million, or 27.7% of net sales, in the six months ended June 30, 2007. Excluding the Martin Audio acquisition and the write down of inventory associated with the factory shutdowns in 2007 gross profit, was comparable to prior year results.
Selling, General and Administrative
Selling, general and administrative expenses increased by $1.0 million to $23.5 million in the six months ended June 30, 2008 from $22.5 million in the comparable period in 2007. The increase was primarily attributable to the increased commissions and bonuses on higher sales volumes.
Research and Development
Research and development expenses in the six months ended June 30, 2008 were $6.5 million, comparable to the same period in 2007.
Restructuring Costs
Restructuring costs were $0.3 million in the six months ended June 30, 2008, primarily attributed to employee severance and related costs for 10 employees. Restructuring costs were $1.6 million in the six months ended June 30, 2007. The 2007 costs were primarily severance accruals related to the closure and overseas transfer of our domestic manufacturing plants and the closure of our St. Louis Music engineering functions.
Other Expense
Net other expense was $6.8 million for the six months ended June 30, 2008 as compared to $7.1 million in the six months ended June 30, 2007. The decrease in other expense of $0.3 million is primarily due to the cost associated with the write-off of $2.5 million of unamortized fees related to the prior debt facility as a result of the refinancing of the debt facility in 2007, which was offset by an increase of approximately $1.6 million in interest expense incurred for the Ableco and Sun Capital financing arrangements and a $0.1 million increase in management fees.
Income Taxes
Income tax expense for the first six months of 2008 was $229,000 compared to income tax benefit of $5,000 for the comparable period in 2007. The primary components of the 2008 expense are current taxes due from our foreign subsidiaries and an increase to our income tax reserve partially offset by the deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability recorded as a result of the acquisition of Martin Audio. The primary component of the 2007 benefit are current taxes due from our foreign subsidiaries and an increase to our income tax reserve offset by the deferred tax benefit recorded as a result of the partial amortization of the deferred tax liability recorded as a result of the acquisition of Martin Audio.

Liquidity and Capital Resources
As of June 30, 2008, we had cash and cash equivalents of $4.7 million and short-term borrowings of $3.7 million. At June 30, 2008 we had $6.3 million available on our revolving line of credit.
Net Cash Used in and Provided by Operating Activities
Cash used in operating activities was $1.3 million in the six months ended June 30, 2008, compared to cash provided by operating activities of $1.6 million for the comparable period in 2007. The net loss for the first six months of 2008 was $3.6 million including $2.6 million in depreciation and amortization, $0.3 million in amortization of deferred financing fees, $0.9 million in interest expense capitalized, and $0.1 million in stock based compensation expense. In the first six months of 2008, an increase in accounts receivable of $3.4 million and an increase prepaid other current assets of $1.8 million accompanied by a decrease in accounts payable and accrued liabilities of $6.3 million used cash, while a decrease to inventories of $10.2 million, provided cash. The net loss for the first six months of 2007 was $8.7 million including $2.3 million in depreciation and amortization, $2.8 million in amortization and write-off of deferred financing fees, $0.2 million in stock based compensation expense, and a gain on asset dispositions of $0.5 million. In the first six months of 2007, a decrease in accounts payable and accrued liabilities of $7.8 million and increases to inventories and accounts receivable of $11.8 million and $2.0 million, respectively, used cash.
Net Cash Used in Investing Activities
Cash used in investing activities was $0.8 million for the first six months of 2008, compared to $35.2 million for the first six months of 2007. The cash used in investing activities for the first six months of 2008 primarily related to purchases of new product tooling. The cash used in investing activities for the first six months of 2007 primarily related to the acquisition of Martin Audio and the payment of the St. Louis Music, Inc. future commitment to pay of $3.2 million.
Net Cash Provided by Financing Activities
Cash provided by financing activities was $3.1 million during the first six months of 2008, compared to $40.0 million during the first six months of 2007. Cash provided in the first three months of 2008 is primarily attributable to the Sun Mackie Convertible Debt of $7.5 million which was used to partially pay down the existing debt and line of credit. Cash provided in the first six months of 2007 is primarily attributable to a new credit facility of $102.0 million consisting of a Term Loan A of $20.0 million, a US Term Loan B of $40.0 million, a UK Term Loan B of $30.0 million and a Term Loan C of $12.1 million. Along with this refinance, we paid off our existing credit facility of $67.2 million as of March 30, 2007, which consisted of a revolving loan facility of $26.2 million, a Term Loan A of $11.9 million, a Term Loan B of $14.3 million and a senior subordinated note for $14.8 million. We also incurred $2.9 million in deferred financing costs.
Ability to Stay in Compliance With Debt Covenants
Under the terms of the senior secured credit facility, we are required to maintain certain financial ratios, such as a fixed charge coverage ratio and a consolidated leverage ratio. We are also required to meet certain EBITDA targets and adhere to certain capital expenditure limits. The agreement also provides, among other matters, restrictions on additional financing, dividends, mergers, and acquisitions. As of June 30, 2008, we met all of our covenant requirements. The Company is uncertain whether it will meet these covenants in third and fourth quarter 2008 and can offer no assurances that it will remain in compliance with the terms of the credit agreement.
During July 2008 the Company experienced lower than expected sales and margins due to a backlog of orders with a contract manufacturer. This decline, while we believe to be temporary, could negatively impact EBITDA calculations.
In previous quarters, we have been in breach of certain financial covenants in our senior credit facility and we have received forebearances from the lender and entered into waiver agreements with respect to the defaults and amended our credit agreement. If breaches of the covenants of our senior secured credit facility occur, there is no assurance that the lender would grant waivers or agree to restructure our debt or that we would be able to obtain other financing. If we default on our debt, the lender has a variety of remedies against us including accelerating all amounts so that they come due immediately and foreclosing on their security interests, which would allow the creditor to take possession of all of our assets. The accompanying financial statements do not reflect any adjustments that might be required should the Company default on debt agreements.

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