**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM10-Q**

 

**(Mark One)**

 

| **ý**                                                                                                                                                                               |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                     |
| **For the quarterly period ended  June 30, 2004**                                                                                                                                   |
|                                                                                                                                                                                     |
| **or**                                                                                                                                                                                   |
|                                                                                                                                                                                     |
| **o**                                                                                                                                                                                    |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                                                                     |
| **For the transition period from                to            ** |

 

**Commission File Number:  0-26524**

 

**LOUDTECHNOLOGIES INC.**

(Exact name of registrant as specified in itscharter)

 

| **Washington**                                                  |   | **91-1432133**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |   |                                 |
| **16220 Wood-Red Road, N.E., Woodinville,  Washington**         |   | **98072**                            |
| (Address of principal executive offices)                        |   | (Zip Code)                           |
|                                                            |
| **(425) 892-6500**                                              |
| (Registrant’s telephone number, including  area code)      |
|                                                            |
| **N/A**                                                         |
| (Former name or former address, if  changed since last report)  |

 

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

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

Yes   o   No   ý

 

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

 

| **Common Stock, no par value** |   | **19,624,703**                                           |
|--------------------------------|--------|----------------------------------------------------------|
| Class                          |   | Number of Shares Outstanding  (as of July 30, 2004) |

 

 

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**LOUD TECHNOLOGIES INC.**

 

**FORM 10-Q**

**For the quarter ended June 30, 2004**

 

**INDEX**

 
| **PART I.**    | **FINANCIAL INFORMATION**                                                                   |   |
|----------------|---------------------------------------------------------------------------------------------|--------|
|           |                                                                                        |   |
| Item 1.        | Financial Statements (Unaudited)                                                            |   |
|           |                                                                                        |   |
|           | Condensed Consolidated Balance Sheets                                                       |   |
|           |                                                                                        |   |
|           | Condensed Consolidated Statements of  Operations                                            |   |
|           |                                                                                        |   |
|           | Condensed Consolidated Statements of Cash  Flows                                            |   |
|           |                                                                                        |   |
|           | Condensed Consolidated Statements of  Shareholders’ Equity (Deficit)                   |   |
|           |                                                                                        |   |
|           | Notes to Condensed Consolidated Financial  Statements                                       |   |
|           |                                                                                        |   |
| Item 2.        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|           |                                                                                        |   |
| Item 3.        | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
|           |                                                                                        |   |
| Item 4.        | Controls  and Procedures                                                                    |   |
|           |                                                                                        |   |
| **PART II.**   | **OTHER INFORMATION**                                                                       |   |
|           |                                                                                        |   |
| Item 1.        | Legal Proceedings                                                                           |   |
|           |                                                                                        |   |
| Item 2.        | Changes in Securities and Use of Proceeds                                                   |   |
|           |                                                                                        |   |
| Item 3.        | Defaults Upon Senior Securities                                                             |   |
|           |                                                                                        |   |
| Item 4.        | Submission of Matters to a Vote of Security  Holders                                        |   |
|           |                                                                                        |   |
| Item 5.        | Other Information                                                                           |   |
|           |                                                                                        |   |
| Item 6.        | Exhibits and Reports on Form 8-K                                                            |   |
|           |                                                                                        |
| **SIGNATURES** |                                                                                        |

 

2

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**LOUD TECHNOLOGIES INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 

*(In thousands, except share amounts)*

 
|                                                                                                                                                                |   | **June 30,  2004** |   | **December  31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| **ASSETS**                                                                                                                                                          |   |               |   |                    |   |
| Current assets:                                                                                                                                                     |   |               |   |                    |   |
| Cash and cash equivalents                                                                                                                                           |   | $                  | 434    |                    | $      | 757 |   |
| Accounts receivable, net of allowances of  $1,805 and $2,163, respectively                                                                                          |   | 13,847             |   | 13,683                  |   |
| Income taxes receivable                                                                                                                                             |   | 191                |   | 188                     |   |
| Inventories                                                                                                                                                         |   | 16,486             |   | 18,930                  |   |
| Prepaid expenses and other current assets                                                                                                                           |   | 2,595              |   | 2,280                   |   |
| Total current assets                                                                                                                                                |   | 33,553             |   | 35,838                  |   |
|                                                                                                                                                                |   |               |   |                    |   |
| Property and equipment, net                                                                                                                                         |   | 8,224              |   | 8,381                   |   |
| Intangible assets, net                                                                                                                                              |   | 5,340              |   | 5,552                   |   |
| Other assets, net                                                                                                                                                   |   | 419                |   | 651                     |   |
| Total assets                                                                                                                                                        |   | $                  | 47,536 |                    | $      | 50,422 |   |
|                                                                                                                                                                |   |               |   |                    |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY  (DEFICIT)**                                                                                                            |   |               |   |                    |   |
| Current liabilities:                                                                                                                                                |   |               |   |                    |   |
| Short-term borrowings                                                                                                                                               |   | $                  | 7,930  |                    | $      | 7,868 |   |
| Accounts payable                                                                                                                                                    |   | 10,905             |   | 6,454                   |   |
| Accrued liabilities                                                                                                                                                 |   | 6,707              |   | 7,973                   |   |
| Income taxes payable                                                                                                                                                |   | 1,355              |   | 1,288                   |   |
| Current portion of long-term debt                                                                                                                                   |   | 500                |   | 500                     |   |
| Payable to former Italian subsidiary                                                                                                                                |   | 8,565              |   | 9,173                   |   |
| Total current liabilities                                                                                                                                           |   | 35,962             |   | 33,256                  |   |
|                                                                                                                                                                |   |               |   |                    |   |
| Long-term debt, excluding current portion                                                                                                                           |   | 15,687             |   | 16,262                  |   |
| Other liabilities                                                                                                                                                   |   | 52                 |   | 72                      |   |
| Total liabilities                                                                                                                                                   |   | 51,701             |   | 49,590                  |   |
|                                                                                                                                                                |   |               |   |                    |   |
| Commitments and contingencies                                                                                                                                       |   |               |   |                    |   |
|                                                                                                                                                                |   |               |   |                    |   |
| Shareholders’ equity:                                                                                                                                          |   |               |   |                    |   |
| Preferred stock, no par value. Authorized  5,000,000 shares, no shares issued and outstanding                                                                       |   | —             |   | —                  |   |
| Common stock, no par value. Authorized  40,000,000 shares, issued and outstanding   19,624,703 at June 30, 2004 and 19,608,036 at December 31,  2003 |   | 33,913             |   | 33,999                  |   |
| Accumulated deficit                                                                                                                                                 |   | (38,078            | )      | (33,167                 | )      |
| Total shareholders’ equity (deficit)                                                                                                                           |   | (4,165             | )      | 832                     |   |
| Total liabilities and shareholders’ equity  (deficit)                                                                                                          |   | $                  | 47,536 |                    | $      | 50,422 |   |

 

*See accompanying Notes to CondensedConsolidated Financial Statements.*

 

3

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**LOUD TECHNOLOGIES INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Unaudited)**

 

*In thousands, except for per share data*

 
|                                                                                                             |   | **Three  months ended  June 30,** |   | **Six months  ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                                             |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Net sales                                                                                                        |   | $                                 | 30,531 |                            | $      | 35,653 |   | $ | 56,212 |   | $ | 68,399 |   |
| Cost of sales                                                                                                    |   | 20,236                            |   | 26,919                          |   | 39,005 |   | 52,924 |   |
| Gross profit                                                                                                     |   | 10,295                            |   | 8,734                           |   | 17,207 |   | 15,475 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Operating expenses:                                                                                              |   |                              |   |                            |   |   |   |   |   |
| Selling, general and administrative                                                                              |   | 8,492                             |   | 9,103                           |   | 16,784 |   | 18,914 |   |
| Research and development                                                                                         |   | 1,832                             |   | 1,584                           |   | 3,804 |   | 3,906 |   |
| Restructuring costs                                                                                              |   | —                            |   | 6                               |   | — |   | 702 |   |
| Total operating expenses                                                                                         |   | 10,324                            |   | 10,693                          |   | 20,588 |   | 23,522 |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Operating loss                                                                                                   |   | (29                               | )      | (1,959                          | )      | (3,381 | ) | (8,047 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Other income (expense):                                                                                          |   |                              |   |                            |   |   |   |   |   |
| Interest income                                                                                                  |   | 11                                |   | 1                               |   | 11 |   | 16 |   |
| Interest expense                                                                                                 |   | (882                              | )      | (800                            | )      | (1,643 | ) | (1,318 | ) |
| Other                                                                                                            |   | (52                               | )      | (15                             | )      | 112 |   | 186 |   |
| Total other income (expense)                                                                                     |   | (923                              | )      | (814                            | )      | (1,520 | ) | (1,116 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Loss before income taxes and discontinued  operations                                                            |   | (952                              | )      | (2,773                          | )      | (4,901 | ) | (9,163 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Provision (benefit) for income taxes                                                                             |   | 5                                 |   | (356                            | )      | 10 |   | (344 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Loss from continuing operations                                                                                  |   | (957                              | )      | (2,417                          | )      | (4,911 | ) | (8,819 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Loss from discontinued operations, net of  income tax expense (benefit) of $0, ($180), $0 and $433, respectively |   | —                            |   | (1,835                          | )      | — |   | (3,827 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Net loss                                                                                                         |   | $                                 | (957   | )                               | $      | (4,252 | ) | $ | (4,911 | ) | $ | (12,646 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Basic and diluted net loss per share:                                                                            |   |                              |   |                            |   |   |   |   |   |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Net loss from continuing operations                                                                              |   | $                                 | (0.05  | )                               | $      | (0.12 | ) | $ | (0.24 | ) | $ | (0.48 | ) |
| Net loss from discontinued operations                                                                            |   | —                            |   | (0.09                           | )      | — |   | (0.21 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Basic and diluted net loss per share                                                                             |   | $                                 | (0.05  | )                               | $      | (0.21 | ) | $ | (0.24 | ) | $ | (0.69 | ) |
|                                                                                                             |   |                              |   |                            |   |   |   |   |   |
| Shares used in computing basic and diluted  net loss per share                                                   |   | 20,891                            |   | 20,280                          |   | 20,891 |   | 18,276 |   |

 

*See accompanying Notes to CondensedConsolidated Financial Statements.*

 

4

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**LOUD TECHNOLOGIES INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
|                                                                                       |   | **Six months  ended  June 30,** |   |
|--------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                       |   | **2004**                        |   | **2003** |   |
|                                                                                       |   | **(In  thousands)**             |   |
| **Operating activities**                                                                   |   |                            |   |   |   |
| Net loss                                                                                   |   | $                               | (4,911 | ) | $ | (12,646 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |                            |   |   |   |
| Depreciation and amortization                                                              |   | 1,562                           |   | 4,463 |   |
| Non-cash interest expense                                                                  |   | 75                              |   | — |   |
| (Gain) loss on asset dispositions                                                          |   | (187                            | )      | 114 |   |
| Deferred stock compensation                                                                |   | 29                              |   | 120 |   |
| Changes in operating assets and  liabilities:                                              |   |                            |   |   |   |
| Accounts receivable                                                                        |   | (164                            | )      | 2,302 |   |
| Inventories                                                                                |   | 2,444                           |   | 10,528 |   |
| Prepaid expenses and other current assets                                                  |   | (745                            | )      | 153 |   |
| Other assets                                                                               |   | 232                             |   | 766 |   |
| Accounts payable and accrued liabilities                                                   |   | 3,327                           |   | (1,147 | ) |
| Income taxes                                                                               |   | 67                              |   | 600 |   |
| Other long term liabilities                                                                |   | (20                             | )      | (56 | ) |
| Net cash provided by operating activities                                                  |   | 1,709                           |   | 5,197 |   |
|                                                                                       |   |                            |   |   |   |
| **Investing activities**                                                                   |   |                            |   |   |   |
| Purchases of property and equipment                                                        |   | (1,405                          | )      | (789 | ) |
| Proceeds from sales of property and  equipment                                             |   | 826                             |   | — |   |
| Net cash used in investing activities                                                      |   | (579                            | )      | (789 | ) |
|                                                                                       |   |                            |   |   |   |
| **Financing activities**                                                                   |   |                            |   |   |   |
| Proceeds from sale of stock and stock  options                                             |   | —                          |   | 3,515 |   |
| Proceeds from long-term debt and warrants                                                  |   | —                          |   | 17,500 |   |
| Payments on long-term debt                                                                 |   | (1,515                          | )      | (16,524 | ) |
| Proceeds from new short-term borrowing                                                     |   | —                          |   | 12,040 |   |
| Net borrowings (payments) on short-term  borrowings                                        |   | 62                              |   | (23,392 | ) |
| Net cash used in financing activities                                                      |   | (1,453                          | )      | (6,861 | ) |
|                                                                                       |   |                            |   |   |   |
| Effect of exchange rate changes on cash                                                    |   | —                          |   | 205 |   |
|                                                                                       |   |                            |   |   |   |
| Net decrease in cash and cash equivalents                                                  |   | (323                            | )      | (2,248 | ) |
|                                                                                       |   |                            |   |   |   |
| Cash and cash equivalents at beginning of  period                                          |   | 757                             |   | 3,062 |   |
| Cash and cash equivalents at end of period                                                 |   | $                               | 434    |   | $ | 814 |   |

 

*See accompanying Notes to CondensedConsolidated Financial Statements.*

 

5

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**LOUD TECHNOLOGIES INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ EQUITY (DEFICIT)**

**Six months ended June 30, 2004**

 

*(In thousands)*

 
|                                                         |   | **Common  Stock** |   | **Accumulated  Deficit** |   | **Total** |   |
|--------------------------------------------------------------|--------|-------------------|--------|--------------------------|--------|-----------|--------|
|                                                         |   | **Shares**        |   | **Amount**               |   |      |   |
|                                                         |   |              |   |                     |   |      |   |   |   |
| Balance at December 31, 2003                            |   | 19,608            |   | $                        | 33,999 |      | $      | (33,167 | ) | $ | 832 |   |
| Offering costs related to  February 2003 stock offering |   | —            |   | (115                     | )      | —    |   | (115 | ) |
| Amortization of deferred stock compensation                  |   | —            |   | 29                       |   | —    |   | 29 |   |
| Exercise of stock options                                    |   | 17                |   | —                   |   | —    |   | — |   |
| Net loss                                                     |   | —            |   | —                   |   | (4,911    | )      | (4,911 | ) |
| Balance at June 30, 2004                                |   | 19,625            |   | $                        | 33,913 |      | $      | (38,078 | ) | $ | (4,165 | ) |

 

*See accompanying Notes to CondensedConsolidated Financial Statements.*

 

6

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**LOUD TECHNOLOGIES INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**June 30, 2004**

**(Unaudited)**

 

**1.****                        Descriptionof Business**

 

We develop, manufacture and sell high-quality, affordable digital andanalog audio mixers, speakers, amplifiers and other professional audioequipment on a worldwide basis. Our products are used by professionalmusicians, sound installation contractors and broadcast professionals in soundrecordings, live presentations systems and installed sound systems. We have ourprimary operations in the United States and the United Kingdom.

 

**2.****                        Summary ofSignificant Accounting Policies**

 

**Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared by LOUD Technologies Inc. (“LOUD” or the “Company”) inaccordance with accounting principles generally accepted in the United Statesof America for interim financial statements and include the accounts of theCompany and its subsidiaries. They do not include all of the information anddisclosures required by generally accepted accounting principles for completefinancial statements and should be read in conjunction with the financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2003. In our opinion, all normal recurring adjustmentsnecessary for the fair presentation of the results of the interim periods arereflected herein. Operating results for the three or six-month periods endedJune 30, 2004, are not necessarily indicative of future financial results.

 

**RevenueRecognition**

 

Revenues from sales of products, net of sales discounts, returns andallowances, are generally recognized upon shipment under an agreement with acustomer when risk of loss has passed to the customer, all significantcontractual obligations have been satisfied, the fee is fixed or determinableand collection of the resulting receivable is considered probable. Products aregenerally shipped “FOB shipping point” with no right of return. Sales withcontingencies, such as rights of return, rotation rights, conditionalacceptance provisions and price protection, are rare and insignificant and aredeferred until the contingencies have been satisfied or the contingency periodhas lapsed. We generally warrant our products against defects in materials andworkmanship for periods of between one and six years. The estimated cost ofwarranty obligations, sales returns and other allowances are recognized at thetime of revenue recognition based on contract terms and prior claimsexperience. A provision for future warranty costs is recorded at the time ofsale of products.

 

**Stock-Based Compensation**

 

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

 

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

 

FAS No. 123, as amended, permits companies to recognize, asexpense over the vesting period, the fair value of all stock-based awards onthe date of grant. The Black-Scholes option valuation model was developed foruse in estimating the fair value of traded options, which have no vestingrestrictions and are fully transferable. Because our stock-based compensationplans have characteristics significantly different from those of traded optionsand because changes in the subjective input assumptions can materially affectthe fair value estimate, management believes that the existing option valuationmodels do not necessarily

 

7

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provide a reliable single measure of the fair value of awards from theplan. Therefore, as permitted, we apply the existing accounting rules under APBNo. 25 and provide pro forma net loss and pro forma loss per sharedisclosures for stock-based awards made as if the fair value method defined inFAS No. 123, as amended, had been applied.

 

The following table summarizes relevant information as to the reportedamounts under the Company’s intrinsic value method of accounting for stockawards, with supplemental information as if the fair value recognitionprovisions of FAS No. 123, as amended, had been applied:

 
|                                                                              |   | **Three  months ended  June 30,**     |   | **Six months  ended  June 30,** |   |
|-----------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------|--------|
|                                                                              |   | **2004**                                   |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                              |   | **(in  thousands, except per share data)** |   |
|                                                                              |   |                                       |   |                                 |   |   |   |   |   |
| Net loss:                                                                         |   |                                       |   |                                 |   |   |   |   |   |
| As reported                                                                       |   | $                                          | (957   | )                                    | $      | (4,252 | ) | $ | (4,911 | ) | $ | (12,646 | ) |
| Add: Stock-based employee compensation  included in reported net loss             |   | —                                     |   | —                               |   | — |   | 67 |   |
| Less: Stock-based employee compensation  determined under fair-value based method |   | (189                                       | )      | (281                                 | )      | (403 | ) | (633 | ) |
| Pro forma                                                                         |   | $                                          | (1,146 | )                                    | $      | (4,533 | ) | $ | (5,314 | ) | $ | (13,212 | ) |
|                                                                              |   |                                       |   |                                 |   |   |   |   |   |
| Basic and diluted net loss per share:                                             |   |                                       |   |                                 |   |   |   |   |   |
| As reported                                                                       |   | $                                          | (0.05  | )                                    | $      | (0.21 | ) | $ | (0.24 | ) | $ | (0.69 | ) |
| Pro forma                                                                         |   | $                                          | (0.05  | )                                    | $      | (0.22 | ) | $ | (0.25 | ) | $ | (0.72 | ) |

 

**Concentration of Credit and Supply Risk**

 

We sell products on a worldwide basis and a significant portion of ouraccounts receivable are due from customers outside of the U.S.  Where we are exposed to material creditrisk, we generally require letters of credit, advance payments, or carry foreigncredit insurance.  No individual countryoutside of the U.S. accounted for more than 10% of net sales from continuingoperations in any of the periods presented. Sales to U.S. customers are generally on open credit terms.  In the U.S., we primarily sell our productsthrough third-party resellers and experience individually significant annualsales volumes with major resellers.  Forthe three month periods ended June 30, 2004 and 2003, we had sales to onecustomer of $3.5 million and $3.8 million, or 11.5% and 10.6%, respectively ofconsolidated net sales from continuing operations.  For the six month periods ended June 30, 2004 and 2003, wehad sales to the same customer of $6.1 million and $7.3 million, or 10.9% and10.7%, respectively, of consolidated net sales from continuing operations.

 

Many of our products are currently being manufactured exclusively by afew manufacturers on our behalf.  Duringthe three and six month periods ended June 30, 2004, net sales of productsmanufactured by one manufacturer were $6.8 million and $13.6 million, or 22.3%and 24.2%, respectively, of consolidated net sales and net sales from anothermanufacturer were $3.2 million and $5.9 million, or 10.5% and 10.5%,respectively, of consolidated net sales.

 

**3.****                        DiscontinuedOperations**

 

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

 

Concurrent with the sale, Mackie Italy was placed into a ConcordatoPreventivo, an Italian form of court-supervised liquidation (the“Concordato”).  Knight Italia has made an irrevocable offer to the courtto lease or purchase the former Mackie Italy factory in Reggio Emilia, Italy,the RCF brand name and significant other Italian-based assets.  In December 2003,the Company fulfilled its obligation under the Concordato filing to purchaseapproximately $620,000 of finished inventory.  The Concordato filing issubject to approval by a majority of the creditors and then by an Italian courtfrom which approval is expected in 2004.  In the event the court deniesthe Concordato, Italian law may permit actions to be taken against the Companyincluding the demand of a refund of any payments made by Mackie Italy to theCompany in the prior two years. We believe this possibility to be remote.

 

8

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

 

The disposition of these operations is accounted for as a discontinuedoperation.  At June 30, 2004 and December 31, 2003, we do notshow any assets or liabilities of this entity on our consolidated balancesheet.  We have reclassified and condensed the results of discontinuedoperations on our consolidated statements of operations for three and sixmonths ended June 30, 2003.  Cash flows from these operations areincluded in our consolidated statements of cash flows for the six months endedJune 30, 2003.  Summarized operating results of the discontinuedoperations for the three and six months ended June 30, 2003 are asfollows:

 
|                              |   | **Three  Months  Ended****June 30,  2003** |   | **Six Months  Ended  June 30, 2003** |   |
|-----------------------------------|--------|--------------------------------------------|--------|--------------------------------------|--------|
|                              |   | **(in thousands)**                         |   |
| Revenues                          |   | $                                          | 7,756  |                                 | $      | 15,549 |   |
| Gross profit                      |   | 844                                        |   | 1,970                                |   |
| Operating loss                    |   | (1,700                                     | )      | (2,773                               | )      |
| Loss before income taxes          |   | (2,015                                     | )      | (3,394                               | )      |
| Income tax expense (benefit)      |   | (180                                       | )      | 433                                  |   |
| Loss from discontinued operations |   | (1,835                                     | )      | (3,827                               | )      |
|                                   |        |                                            |        |                                      |        |  |  |

 

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

 

**4.****                        Net LossPer Share**

 

The following table sets forth the computation of basic and diluted netloss per share for the three and six months ended June 30, 2004 and2003. Stock options to purchase 3,978,000 and 3,666,000 shares in 2004 and2003, respectively, were excluded from the calculation of diluted per shareamounts because they are antidilutive. The 1.2 million warrants issued inconnection with the debt to Sun Mackie LLC, an affiliate of Sun CapitalPartners Inc., a private investment firm, (see Note 8) and 83,333 vested stockoptions at an exercise price of $0.01 are considered outstanding common sharesand are included in the denominator for computation of basic and diluted netloss per share.

 
|                                                                                 |   | **Three  months ended  June 30,**     |   | **Six months  ended  June 30,** |   |
|--------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------|--------|
|                                                                                 |   | **2004**                                   |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                                 |   | **(in  thousands, except per share data)** |   |
| Numerator:                                                                           |   |                                       |   |                                 |   |   |   |   |   |
| Net loss from continuing operations                                                  |   | $                                          | (957   | )                                    | $      | (2,417 | ) | $ | (4,911 | ) | $ | (8,819 | ) |
| Net loss from discontinued operations                                                |   | —                                     |   | (1,835                               | )      | — |   | (3,827 | ) |
| Numerator for basic and diluted net loss  per share                                  |   | $                                          | (957   | )                                    | $      | (4,252 | ) | $ | (4,911 | ) | $ | (12,646 | ) |
|                                                                                 |   |                                       |   |                                 |   |   |   |   |   |
| Denominator:                                                                         |   |                                       |   |                                 |   |   |   |   |   |
| Weighted average shares outstanding                                                  |   | 19,622                                     |   | 20,280                               |   | 19,615 |   | 18,276 |   |
| Dilutive potential common shares from  outstanding stock option and warrants         |   | 1,269                                      |   | —                               |   | 1,276 |   | — |   |
| Denominator for basic and diluted net loss  per share – weighted average shares |   | 20,891                                     |   | 20,280                               |   | 20,891 |   | 18,276 |   |
|                                                                                 |   |                                       |   |                                 |   |   |   |   |   |
| Basic and diluted net loss per share:                                                |   |                                       |   |                                 |   |   |   |   |   |
| Continuing operations                                                                |   | $                                          | (0.05  | )                                    | $      | (0.12 | ) | $ | (0.24 | ) | $ | (0.48 | ) |
| Discontinued operations                                                              |   | —                                     |   | (0.09                                | )      | — |   | $ | (0.21 | ) |
| Basic and diluted net loss per share                                                 |   | $                                          | (0.05  | )                                    | $      | (0.21 | ) | $ | (0.24 | ) | $ | (0.69 | ) |

 

9

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**5.****                   Inventories**

 

Inventories consist of thefollowing:

 
| ** **      | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------|------------|--------------------|------------|------------------------|------------|
| ** **      | ** ** | **(in thousands)** | ** ** |
| ** **      | ** ** | ** **         | ** ** |
| Raw materials   |       | $                  | 5,109      |                   | $          | 4,383 |   |
| Work in process |       | 631                |       | 543                    |       |
| Finished goods  |       | 10,746             |       | 14,004                 |       |
|            |       | $                  | 16,486     |                   | $          | 18,930 |   |

 

**6.****                   Intangible Assets**

 

Intangible assets consist ofthe following:

 
| ** **                    | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                    | ** ** | **(in thousands)** | ** ** |
| Developed technology          |       | $                  | 5,200      |                   | $          | 5,200 |   |
| Trademark                     |       | 1,380              |       | 1,380                  |       |
| Covenant not to compete       |       | 285                |       | 285                    |       |
|                          |       | 6,865              |       | 6,865                  |       |
| Less accumulated amortization |       | (1,525             | )          | (1,313                 | )          |
|                          |       | $                  | 5,340      |                   | $          | 5,552 |   |

 

**7.****                   Restructuringcosts**

 

During 2003, managementapproved and implemented a restructuring plan in order to adjustoperations.  Major actions of the restructuring plan involved thereduction of workforce from the closure of certain manufacturing facilities. Weincurred $1.6 million in restructuring expenses, of which $6,000 and $702,000relate to the three and six months ended June 30, 2003, respectively, primarilyrepresenting employee severance and related costs for approximately 210displaced employees.  The restructuring accrual is summarized as follows:

 
| **Restructuring   Accrual at   December 31, 2003** | ** ** | **Amount Paid** | ** ** | **Restructuring  Accrual at  June 30, 2004** | ** ** |
|----------------------------------------------------|------------|-----------------|------------|----------------------------------------------|------------|
|                                               |       |            |       |                                         |       |
| $                                                  | 304,000    |            | $          | (183,000                                     | )          | $ | 121,000 |   |
|                                                    |            |                 |            |                                              |            |  |  |  |

 

We expect to pay the remainingliability by December 31, 2004.

 

**8.****                   Financing**

 

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

 

In April 2004, we received acommitment letter from Sun Capital Partners III QP, LP, an affiliate of SunCapital Partners, Inc., to provide up to $2.0 million, in the aggregate, indebt or equity financing to the Company through December 31, 2004 if

 

10

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necessary to enable the Companyto meet its obligations as they become due.  If the financing is in theform of debt financing, it is expected that the terms will be generally similarto the terms of the existing subordinated or senior debt arrangements, adjustedas necessary for market conditions.  If the financing is in the form ofequity financing, it is expected the terms will be at fair market value basedon the current market conditions.

 

**(a)****               Short-termborrowings**

 

At June 30, 2004, we had arevolving line of credit to borrow up to $26.0 million limited to a percentageof eligible collateral, which expires March 31, 2006.  In August 2004, we executed a Loan Amendmentreducing the maximum borrowing from $26.0 million to $25.0 million. Interest is due monthly and is based on the bank’s prime rate or LIBOR plus aspecified margin.  At June 30, 2004, the average interest rate was4.7%.  This revolving line of credit is secured by substantially all U.S.assets and accounts receivable of our U.K. subsidiary.  At June 30, 2004,we had an outstanding balance on our line of credit of $7.9 million andavailable excess borrowing capacity of $2.0 million.

 

**(b)****               Long-term debt**

 

At June 30, 2004 and December31, 2003, our long-term debt consisted of the following:

 
| ** **                                               | ** ** | **June 30,**

**2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **(in thousands)**     | ** ** |
|                                                     |       |                   |       |                   |       |
| U.S. term loans                                          |       | $                      | 735        |                   | $          | 2,250 |   |
| U.S. subordinated note payable                           |       | 11,264                 |       | 11,000                 |       |
| Note payable to related party (face value  $4.0 million) |       | 4,188                  |       | 3,512                  |       |
|                                                     |       | 16,187                 |       | 16,762                 |       |
| Less: current portion                                    |       | (500                   | )          | (500                   | )          |
| Long-term portion of debt                                |       | $                      | 15,687     |                   | $          | 16,262 |   |

 

*U.S. term loans*

 

Our U.S. term loan was amendedin August 2004 to reduce the monthly payments from $42,000 to $25,000, untilpaid in full.  In the first half of 2004, in addition to our monthlypayments, we paid $1.3 million on this loan from sales of equipment secured bythe loan due to our closure of manufacturing facilities in Woodinville,Washington.  This loan and the line of credit held by the same financialinstitution, are both secured by substantially all of the assets of the Company,and are both senior to other long-term debt.  The term loan bears interestat the bank’s prime rate plus a specified margin.  This rate was 5% atJune 30, 2004.

 

*U.S. subordinated note payable*

 

The U.S. subordinated notepayable accrues interest at 10% per annum.  Minimum interest payments aremade monthly at 8%, with the remaining 2% paid if certain available cash flowsare met, otherwise, the 2% is added back to principal. During the six monthperiod ended June 30, 2004, we added $264,000 to the principal balance of thisnote for these cumulative interest amounts. Principal payments on this notebegin in May 2005, and will be based on our 2004 earnings before interest,taxes, depreciation and amortization, less cash taxes paid, certain capitalexpenditures and certain debt repayments (adjusted EBITDA).  If the 2004adjusted EBITDA is positive, we would make payments during the twelve monthsbeginning May 2005 of 50% of adjusted EBITDA up to $1.7 million; no paymentswould be made if adjusted EBITDA and line of credit availability amounts failto meet a certain threshold.  The principal is due in May 2006.

 

*Note payable to related party*

 

In March 2003, our primaryshareholder, Sun Mackie LLC (“Sun Mackie”) provided $4.0 million for a notepayable and warrants to purchase 1.2 million shares of common stock at $0.01per share.  We valued the warrants issued in this transaction at $0.6million and the note payable at $3.4 million.  We have been increasing thevalue of the loan to its face value of $4.0 million over its 4-year lifethrough additional non-cash interest expense.  Interest accrued at 15% ofthe face value, payable annually on June 30 if a specified adjusted EBITDA ofthe prior year is achieved. As this threshold was not met, at March 31, 2004, theaccrued interest of $0.6 million was added to the principal balance.  Thenote was payable in full in March 2007.

 

11

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Subsequent to quarter end, inAugust 2004, we executed an Exchange Agreement whereby we exchanged our entiredebt to Sun Mackie for 2,480,155 shares of common stock valued at $1.95 pershare.  In August 2004, we recognized aloss on early extinguishment of debt with this transaction of $400,000 representingthe debt discount from the face value of the note to the carrying value.

 

**9.****                   Guarantees**

 

In November 2002, the FASBissued FIN No. 45,*Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*. FIN No. 45 provides expandedaccounting guidance surrounding liability recognition and disclosurerequirements related to guarantees, as defined by this Interpretation. Weadopted the disclosure provision requirements of FIN No. 45 during theyear ended December 31, 2002. In the ordinary course of business, we arenot subject to potential obligations under guarantees that fall within thescope of FIN No. 45 except for standard indemnification and warrantyprovisions and give rise only to the disclosure requirements prescribed by FINNo. 45.

 

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

 

The warranty liability issummarized as follows:

 
| ** **                   | ** ** | **Three  months ended June 30,** | ** ** | **Six  months ended June 30,** | ** ** |
|------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                   | ** ** | **(in thousands)**               | ** ** |
| Balance, beginning of period |       | $                                | 1,067      |                           | $          | 1,519 |   | $ | 1,081 |   | $ | 1,525 |   |
| Charged to cost of sales     |       | 641                              |       | 828                            |       | 1,323 |   | 1,732 |   |
| Applied to liability         |       | (730                             | )          | (844                           | )          | (1,426 | ) | (1,754 | ) |
| Balance, end of period       |       | $                                | 978        |                           | $          | 1,503 |   | $ | 978 |   | $ | 1,503 |   |

 

**10.****            Contingencies**

 

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

 

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

 

12

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

 
| ** **                        | ** ** | **2003**  | ** ** |
|-----------------------------------|------------|-----------|------------|
| ** **                        | ** ** | **First** | ** ** | **Second** | ** ** | **Third** | ** ** | **Fourth(a)** | ** ** |
| Net Sales                         |       | $         | 32,746     |   | $ | 35,653 |   | $ | 33,457 |   | $ | 28,910 |   |
| Gross profit                      |       | 6,741     |       | 8,734 |   | 6,665 |   | 7,170 |   |
| Loss from continuing operations   |       | (6,402    | )          | (2,417 | ) | (2,797 | ) | (3,796 | ) |
| Loss from discontinued operations |       | (1,992    | )          | (1,835 | ) | (507 | ) | (2,049 | ) |
| Net loss                          |       | (8,394    | )          | (4,252 | ) | (3,304 | ) | (5,845 | ) |
| Basic and diluted loss per share  |       | (0.54     | )          | (0.21 | ) | (0.16 | ) | (0.28 | ) |
|                                   |            |           |            |  |  |  |  |  |  |  |  |  |  |

 

----

(a)           Inventory adjustments of approximately $0.9 millionrelated to products no longer marketable and excess material were recorded inthe fourth quarter of 2003.

 

13

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

 

*The following discussion and analysis should be read in conjunctionwith our financial statements included in our Annual Report on Form 10-K forthe year ended December 31, 2003. This discussion contains certain“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995 that involve risks and uncertainties, such asstatements of our plans, objectives, expectations and intentions. Actualresults could differ materially from those discussed herein. The cautionarystatements made in this Quarterly Report on Form 10-Q and the Annual Report onForm 10-K should be read as being applicable to all forward-looking statementswherever they appear. We undertake no obligation to publicly release anyrevisions to these forward-looking statements that may be required to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated 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.*

 

**General**

 

LOUD Technologies Inc., aWashington corporation formed in 1988, engineers, manufactures and marketsprofessional audio reproduction and recording equipment and software under thebrand names Mackie, TAPCO, SIA, EAW and EAW Commercial.

 

Our primary products includeanalog mixers, sound reinforcement speakers, professional loudspeaker systems,installed paging and music distribution systems, preamplifiers, poweramplifiers, and A/V software control surfaces, digital mixers, i/o devices andacoustic test and measurement software.  These products are used in avariety of applications, including home and commercial recording studios, liveperformances and fixed installations of all sizes.

 

**CriticalAccounting Policies and Judgments**

 

The preparation of financial statements inconformity with general accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Actual results could differ fromthose estimates.

 

We believe there have been no significantchanges in our critical accounting policies during the six months ended June30, 2004 as compared to what was previously disclosed in our Form 10-K for theyear ended December 31, 2003.

 

**Estimatesand Assumptions Related to Financial Statements**

 

The discussion and analysis ofour financial condition and results of operations is based upon our unauditedcondensed consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these condensed consolidated financial statements requiresus to make estimates and judgments that affect the reported amounts of assets,liabilities, revenue and expenses, and related disclosure of contingent assetsand liabilities. On an on-going basis, we evaluate our estimates, includingthose affecting revenue recognition, the allowance for doubtful accounts, inventoryvaluation, intangible assets, income taxes and general business contingencies.We base our estimates on historical experience and on various other assumptionsthat we believe to be reasonable under the circumstances, the results of whichform our basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.

 

14

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**Results of Operations**

 
| ** **                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **2004**                         | ** ** | **2003**                       | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                            |       | $                                | 30,531     |                           | $          | 35,653 |   | $ | 56,212 |   | $ | 68,399 |   |
| Gross profit                         |       | 10,295                           |       | 8,734                          |       | 17,207 |   | 15,475 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Selling, general and administrative  |       | 8,492                            |       | 9,103                          |       | 16,784 |   | 18,914 |   |
| Research and development             |       | 1,832                            |       | 1,584                          |       | 3,804 |   | 3,906 |   |
| Restructuring costs                  |       | —                           |       | 6                              |       | — |   | 702 |   |
| Total operating expenses             |       | 10,324                           |       | 10,693                         |       | 20,588 |   | 23,522 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Other income (expense)               |       | (923                             | )          | (814                           | )          | (1,520 | ) | (1,116 | ) |
| Provision (benefit) for income taxes |       | 5                                |       | (356                           | )          | 10 |   | (344 | ) |
| Loss from continuing operations      |       | (957                             | )          | (2,417                         | )          | (4,911 | ) | (8,819 | ) |
| Loss from discontinued operations    |       | —                           |       | (1,835                         | )          | — |   | (3,827 | ) |
| Net loss                             |       | (957                             | )          | (4,252                         | )          | (4,911 | ) | (12,646 | ) |
|                                      |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

***Three Months Ended June 30, 2004 vs. Three MonthsEnded June 30, 2003***

*** ***

*Net Sales*

 

Net sales from continuingoperations decreased by 14.6% to $30.5 million during the three months endedJune 30, 2004 from $35.7 million in the comparable period in 2003.  Saleswere negatively affected during the latter part of 2003 and the beginning of2004, due primarily to our being out of stock of certain products,primarily our Mackie brand speakers and the discontinuation of low margin Mackieand RCF brand products.  These product shortages are due primarily to themigration of certain product manufacturing from Woodinville, Washington and ourformer Italian subsidiary to contract manufacturers.

 

We believe we will continue tohave product shortages during the third quarter of 2004, although the extent ofthese shortages is decreasing.  Throughout the remainder of 2004, weanticipate continuing to introduce and ship new products, resulting inincreased revenues in the second half of 2004 as compared to the firsthalf.  These new products will include introductions of more affordableproduct lines; entrance into the desktop recording line and feature-richadditions to our core analog mixer product lines. Orders placed but not shippedat the end of this quarter were significantly higher than at June 30,2003.  The bulk of these orders are forcurrent out of stock products.

 

*Gross Profit*

 

Gross profit increased to $10.3million, or 33.8% of net sales, in the three months ended June 30, 2004 from$8.7 million, or 24.4% of net sales, in the three months ended June 30,2003.   The improvement in gross profit is due primarily to reducedproduct costs due to offshore manufacturing, and charges taken in the 2003quarter related to the write-down of excess and obsolete inventory ofapproximately $0.7 million and charges of $0.2 million related to theobsolescence of manufacturing equipment in our former manufacturing facility.

 

We expect our gross profit toremain constant or slightly improve in the remainder of 2004 as we complete ourtransition plan.

 

*Selling, General and Administrative*

 

Selling, general andadministrative expenses decreased by $0.6 million, or 6.6%, to $8.5 million inthe three months ended June 30, 2004 from $9.1 million in the comparable periodin 2003. The decline in these expenses is due to reductions in the numberof employees through layoffs or attrition during 2003.  Additionally,included in selling costs are commissions paid to third parties, which werelower due to lower revenues during the three months ended June 30, 2004,compared to the three months ended June 30, 2003.  We anticipate selling,general and administrative costs to be lower during the remainder of 2004 thanin 2003, primarily due to cost reduction initiatives completed in 2003.

 

15

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*Research and Development*

 

Research and developmentexpenses increased by $0.2 million, or 12.5%, to $1.8 million in the threemonths ended June 30, 2004 from $1.6 million in the three months ended June 30,2003. This increase relates primarily to outsourcing certain productdevelopment to third parties.  We expect to continue to outsourceproducts, which could cause these expenses to be higher in some quarters thanothers, depending on when these activities occur.   We also expect tocontinue to invest in new products and improvements to existing products, whichwill increase R&D costs as our revenues increase.

 

*Restructuring Costs*

 

We incurred $6,000 inrestructuring expenses during the second quarter in 2003.  These costs primarily represented employeeseverance and related costs for displaced employees associated with the closingof our manufacturing facility in Woodinville, Washington, after production ofgoods had terminated.  The majority ofthis restructure occurred in the first quarter of 2003, with minor carryoverinto the second quarter of 2003.   Additionally, we may haveadditional restructuring expenses in 2004 related to minimum lease payments onunder-utilized warehouse space if we fully exit the space.

 

*Other Income (Expense)*

 

Net other expense was $0.9million for the three months ended June 30, 2004 as compared to $0.8 million inthe three months ended June 30, 2003, an increase of $0.1 million or 12.5%.Included in these amounts are interest and financing expenses which increasedto $0.9 million in the second quarter of 2004 from $0.8 million in thecorresponding period of 2003 due to higher financing fees.

 

*Income Taxes*

 

Income tax expense for thesecond quarter of 2004 was $5,000 compared to a benefit of $356,000 for thecomparable period in 2003. Tax expense primarily relates to our non-U.S.subsidiaries. No tax benefit is recognized in connection with our tax losses asrecognition of such benefit depends on future profits, which are not assured.We calculate the current tax rate based upon our estimate of the tax rate to beachieved for the full year.

 

*Discontinued Operations*

 

Discontinued operations relatesto our former subsidiary, Mackie Italy, which was sold in December 2003. We incurred a loss on discontinued operations of $1.8 million during the threemonths ended June 30, 2003.  During this period, the loss consisted of a$1.7 million loss from operations, $0.3 million net other expense offset by$0.2 million in tax benefit.

 

***Six Months Ended June 30, 2004 vs. Six MonthsEnded June 30, 2003***

 

*Net Sales*

 

Net sales from continuingoperations decreased by 17.8% to $56.2 million during the six months ended June30, 2004 from $68.4 million in the comparable period in 2003.  Sales werenegatively impacted during the latter part of 2003 and the beginning of 2004due primarily to our being out of stock of certain products.  Theseproduct shortages were due primarily to the migration of certain productmanufacturing from Woodinville, Washington and our former Italian subsidiary tocontract manufacturers.

 

*Gross Profit*

 

Gross profit increased to $17.2million, or 30.6% of net sales, in the six months ended June 30, 2004 from$15.5 million, or 22.7% of net sales, in the six months ended June 30,2003.  The improvement in gross profit is due primarily to reducedproduct costs due to offshore manufacturing; charges taken in the six monthsended June 30, 2003, related to the write-down of excess and obsolete inventoryof approximately $3.3 million compared to $0.3 million in the six month periodended June 30, 2004; and charges of $0.4 million related to the obsolescence ofmanufacturing equipment in our former manufacturing facility taken in the firsthalf of 2003.

 

We expect our gross profit toremain constant or slightly improve in the remainder of 2004 as we complete ourtransition plan.

 

16

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*Selling, General and Administrative*

 

Selling, general andadministrative expenses decreased by $2.1 million, or 11.1%, to $16.8 millionin the six months ended June 30, 2004 from $18.9 million in the comparableperiod in 2003. The decline in these expenses is primarily dueto reductions in the number of employees through layoffs or attritionduring 2003.  Additionally, included in selling costs are commissions paidto third parties, which were lower due to lower revenues during the six monthsended June 30, 2004, compared to the six months ended June 30, 2003. Expenses in the first quarter of 2003 included certain one-time items relatedto the equity investment by Sun Mackie, LLC including run-off policies fordirectors’ and officers’ liability insurance totaling approximately$500,000.  We anticipate selling, general and administrative costs to belower during the remainder of 2004 than in 2003, primarily due to costreduction initiatives completed in 2003.

 

*Research and Development*

 

Research and developmentexpenses decreased by $0.1 million, or 2.6%, to $3.8 million in the six monthsended June 30, 2004 from $3.9 million in the six months ended June 30, 2003.This decrease relates primarily to headcount reductions made during 2003 andthe closure of a research facility we had in Belgium during the first half of2003 offset by outsourcing certain development products to third parties. We expect to continue to outsource certain development products to thirdparties, which will cause these expenses to be higher in some quarters thanothers, depending on when these activities occur.   We expect tocontinue to invest in new products and improvements to existing products, whichwill increase R&D costs as our revenues increase.

 

*Restructuring Costs*

 

During 2003, we incurred $1.6million in restructuring expenses, of which $702,000 related to the six monthsended June 30, 2003, primarily representing employee severance and relatedcosts for displaced employees associated with the closing of our manufacturingfacility in Woodinville, Washington, after production of goods hadterminated.  We believe we will continue to recognize the benefits of thisrestructuring in the second half of 2004 in the form of higher product marginson goods previously manufactured in the U.S.  Additionally, we may haveadditional restructuring expenses in 2004 related to minimum lease payments onunder-utilized warehouse space when we fully exit the space.

 

*Other Income (Expense)*

 

Net other expense was $1.5million for the six months ended June 30, 2004 as compared to net other expenseof $1.1 million in the six months ended June 30, 2003, an increase of $0.4million or 36.4%. Included in these amounts are interest expense whichincreased to $1.6 million in the six months ended June 30, 2004 from $1.3million in the corresponding period of 2003 due to higher interest rates in thefirst quarter and higher financing fees in the second quarter.

 

*Income Taxes*

 

Income tax expense for thefirst six months of 2004 was $10,000 compared to a benefit of $344,000 for thecomparable period in 2003. Tax expense primarily relates to our non-U.S.subsidiaries. No tax benefit is recognized in connection with our tax losses asrecognition of such benefit depends on future profits, which are not assured.We calculate the current tax rate based upon our estimate of the tax rate to beachieved for the full year.

 

*Discontinued Operations*

 

Discontinued operations relatesto our former subsidiary, Mackie Designs Italy, which was sold in December2003.  We incurred a loss on discontinued operations of $3.8 millionduring the six months ended June 30, 2003.  During this period, the lossconsisted of a $2.8 million loss from operations, $0.6 million net otherexpense and $0.4 million in tax expense.

 

**Liquidityand Capital Resources**

 

On August 3, 2004, we enteredinto an Exchange Agreement, whereby Sun Mackie converted its subordinated debtand interest totaling $4.8 million into 2,480,155 shares of common stock.  This transaction will reduce our interestexpenses by approximately $0.2 million per quarter and increases our netequity.

 

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In August 2004, we executed aLoan Amendment on our line of credit increasing the amount of our availableborrowings by $1.0 million. Additionally, we reduced our maximum borrowing from $26.0 million to$25.0 million.  This agreement also reducedthe payments due on our term loan from $42,000 to $25,000 per month.

 

In April 2004, we received acommitment letter from Sun Capital Partners III QP, LP, an affiliate of SunCapital Partners, Inc., to provide up to $2.0 million, in the aggregate in debtor equity financing to the Company through December 31, 2004, if necessary toenable the Company to meet its obligations as they become due.  If thefinancing is in the form of debt financing, it is expected that the terms willbe generally similar to the terms of the existing subordinated or senior debtarrangements, adjusted as necessary for market conditions.  If thefinancing is in the form of equity financing, it is expected the terms will beat fair value based on the current market conditions.

 

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

 

As of June 30, 2004, we hadcash and cash equivalents of $434,000 and total current portion of long-termdebt and short-term borrowings of $8.4 million.  We had excess availabilityon our line of credit of $2.0 million at June 30, 2004.

 

*Net Cash from Operating Activities*

 

Cash provided by operatingactivities was $1.7 million in the six months ended June 30, 2004 and $5.2million for the comparable period in 2003. Net cash provided by operatingactivities in the first six months of 2004 was primarily attributable todecreases in inventories and other assets along with an increase to accountspayable and accrued liabilities offset by an increase in accounts receivableand prepaid expenses and other current assets. In the first six months of 2003,cash provided by operating activities was primarily attributable to a decreasein inventories and accounts receivable offset by decreases in accounts payableand accrued expenses.  During the remainder of 2004, we anticipate growingour inventory levels and accounts receivable as revenues and productavailability increase. These working capital needs will be partially offset byincreases to accounts payable.

 

*Net Cash Used in Investing Activities*

 

Cash used in investingactivities was $0.6 million for the first six months of 2004 and $0.8 millionfor the first six months of 2003. The cash flows used in investing activitiesin 2004 consisted primarily of purchases of capital expenditures for toolingused in manufacturing by our contract manufacturers offset by proceeds from thesale of manufacturing equipment.  Cash used in investing activities in thefirst quarter of 2003 primarily consisted of purchases of manufacturingequipment and office equipment.

 

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

 

*Net Cash Used in Financing Activities*

 

Cash used in financingactivities was $1.5 million during the first six months of 2004 and $6.9million during the first six months of 2003.  Financing activities duringthe six months ended June 30, 2004 relate primarily to payments on our termloan.  Financing activities in the first six months of 2003 included $3.5million in net proceeds from the sale of stock to Sun Mackie LLC, an affiliateof Sun Capital Partners, Inc., a private investment firm, $17.5 million ofborrowings on new term loans and notes payable, offset by $16.5 million inrepayments of debt and $11.4 million in net repayments on lines of credit.

 

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*Payments and Proceeds from Long-term Debt, Line of Credit and OtherShort-term Borrowings*

 

In addition to its equityinvestment, Sun Mackie provided $4.0 million in debt financing in March2003.  Interest accrued at 15%.  In addition to the loan from SunMackie, we issued warrants to purchase an additional 1.2 million common sharesat an exercise price of $0.01 per share.

 

In connection with thisagreement with Sun Mackie LLC in March 2003, we refinanced all of our debtobligations, paying down a net of $4.3 million.  We entered into a $2.5million term loan and a line of credit providing up to $25.0 million with a newU.S. lender.  Availability under this line of credit is limited toeligible collateral; initial funding was $11.6 million. Principal payments on theterm loan are due in equal monthly payments over five years, beginning in July2003. Interest is due monthly calculated at the bank’s prime rate plus 0.75% orEurodollar Rate plus 3.5%. Both the revolving line of credit and term loan aresecured by all U.S. based assets including, but not limited to, accountsreceivable, inventory, fixed assets, intangible assets and patents.Additionally, a portion of the revolving line of credit is provided in the U.K.and is secured by accounts receivable of LOUD Technologies (Europe) Plc.

 

Our previous U.S. lender hasprovided a loan totaling $11.0 million, which is subordinate to the Loan andSecurity Agreement with our new U.S. lender. Principal is due beginning in May2005 based upon our 2004 earnings before interest, taxes, depreciation andamortization, less cash taxes paid, certain capital expenditures and certaindebt repayments. Interest accrues at a rate of 10% per annum and is paidsubject to certain availability tests as we have availability under the Loanand Security Agreement.

 

Under the terms of the line ofcredit and subordinated loan agreements, we are required to maintain certainfinancial ratios, such as a cumulative EBITDA calculation. The agreement alsoprovides, among other matters, restrictions on additional financing, dividends,mergers, acquisitions, and an annual capital expenditure limit.

 

We have taken various actionsto improve results of operations and ensure our ongoing ability to coverscheduled debt servicing payments, including headcount reductions and othercost containment measures. Over the last two years, these measures included thefollowing items:

 

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

•                  sale andliquidation of Mackie Italy;

•                  bankruptcy andclosure of Mackie Belgium;

•                  closure ofcertain international sales offices;

•                  layoffs acrossall areas, primarily manufacturing related;

•                  reduction ofcapital expenditures;

•                  replacement ofdebt instruments with instruments with longer lives;

•                  reorganizationof our management team.

 

Our continued liquidity isdependent upon the following key factors:

 

*Delivery of new products*

 

We anticipate launching anumber of new products during 2004, which are expected to increase ourrevenues.  We anticipate sales from new products will become meaningful inthe third quarter.

 

*Ability to stay in compliance with debt covenants*

 

We have entered into anamendment of our line of credit and term loans, which have revised debtcovenants.  The key financial covenants are achievement of certain EBITDAtargets for the term of the agreement or, during the period until September 30,2004, maintenance of an average of $2.5 million in excess borrowingavailability.  The excess borrowingavailability at June 30, 2004, for the 60-day prior to monthly measurementdates was $3.5 million. As we are required to maintain $1.5 millionavailability at all times, the amount we could borrow at quarter-end was $2.0million.

 

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*Improvement in gross profit*

 

In order to achieve ourprojected results from operations, we anticipate realizing increases in ourgross profit as both a percentage of net sales and in whole dollaramounts.  Meeting these targets is contingent upon successful transitionof product manufacturing to more cost efficient sources offshore.  Webelieve the bulk of this transition has occurred and anticipate seeingcontinued efficiencies and improvements to gross profit throughout theremainder of 2004 and into the first half of 2005.

 

*Commitments*

 

At June 30, 2004, we had thefollowing material contractual commitments related to operating leases forequipment facilities and material obligations related to short-term and long-termdebt arrangements, excluding our line of credit of $7.9 million:

 
| ** **                    | ** ** | **Payments due by period****Less than 1** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | ** **                                |
| ** **                    | ** ** | **Total**                                 | ** ** | **year** | ** ** | **1-3  years** | ** ** |
|                          |       | **(in  thousands)**                       |       |
|                          |       | ** **                                |       |
| Operating Leases              |       | $                                         | 5,326      |   | $ | 2,084 |   | $ | 3,242 |   |
| Short-term and Long-term Debt |       | 16,599                                    |       | 500 |   | 16,099 |   |
| Total                         |       | $                                         | 21,925     |   | $ | 2,584 |   | $ | 19,341 |   |

 

In August 2004, we executed aLoan Amendment on our line of credit that reduces the monthly payment due onour term loan from $42,000 to $25,000, which will reduce the short-term portionof our debt to $300,000.

 

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

 

**Item 3.****  Quantitative and Qualitative Disclosures AboutMarket Risk**

 

We are exposed to variousmarket risks, including changes in foreign currency rates and interest rates.We may enter into various derivative transactions to manage certain of theseexposures; however, we did not have any derivative financial instruments as ofJune 30, 2004.

 

At June 30, 2004, we had avariable rate line of credit with an outstanding balance of $7.9 million. Assuch, changes in U.S. interest rates affect interest paid on debt and we areexposed to interest rate risk. For the quarter ended June 30, 2004, an increasein the average interest rate of 10%, i.e. from 4.34% to 4.77%, would haveresulted in an approximately $8,000 increase in net loss before income taxesand discontinued operations.  The fair value of such debt approximates thecarrying amount on the consolidated balance sheet at June 30, 2004.

 

Our non-U.S. subsidiaries havefunctional currencies of the U.S. Dollar and consequently we translatenon-monetary assets and liabilities at historical rates and remeasure monetaryassets and liabilities at exchange rates in effect at the balance sheet date.These subsidiaries are located in Western Europe and the U.K. income andexpense items are translated at the average exchange rates prevailing duringthe period. A 10% decrease in the value of the U.S. Dollar compared to thelocal currencies of our non U.S. subsidiaries, throughout the quarter endedJune 30, 2004, would have resulted in an approximately $42,000 increase to thenet loss before income taxes.

 

**Item 4.****  Controls and Procedures**

 

At June 30, 2004, we carriedout an evaluation, under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and our Chief FinancialOfficer, of the effectiveness of our “disclosure controls and procedures” (asdefined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of1934).  Based on this evaluation, our Chief Executive Officer and ourChief Financial Officer have concluded that, as of the date of the evaluation,our disclosure controls and procedures were effective.

 

There have been no significantchanges in our internal control or in other factors that could significantlyaffect these controls during our last fiscal quarter.

 

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**PART II.****  OTHER INFORMATION**

 

**Item 1.** **Legal Proceedings**

 

We sold our Italian subsidiaryduring 2003 and placed it in an Italian form of court-supervisedliquidation.  In the event the Italian court does not approve theliquidation plan, Italian law may permit actions to be taken against theCompany including demanding a refund of any payments made to the Company in theprior two years.  We believe this possibility to be remote.

 

**Item 2.  Changes in Securities and Use ofProceeds**

 

None.

 

**Item 3.  Defaults upon Senior Securities**

 

None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

 

(a)                                  Ourannual meeting of shareholders was held on May 21, 2004.

 

(b)                                 Atthe annual meeting, C. Daryl Hollis, George R. Rea and Clarence E. Terry wereelected to serve as Class 3 directors for a three-year term and T. Scott Kingwas elected to serve as a Class 2 director for a two-year term.

 

(c)                                  Theresults of voting for the election of directors at the annual meeting were asfollows:

 
| **Nominee**       | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-------------------|------------|------------|------------|--------------|------------|
|              |       |       |       |         |       |
| C. Daryl Hollis   |       | 14,142,521 |       | —       |       |
| George R. Rea     |       | 14,142,521 |       | —       |       |
| Clarence E. Terry |       | 14,127,421 |       | 15,100       |       |
| T. Scott King     |       | 14,142,521 |       | —       |       |

 

**Item 5.  OtherInformation**

 

None.

 

**Item 6.  Exhibits and Reports on Form 8-K**

 

(a)           Exhibits

 

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

 

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

 

32.1 Certification pursuant to18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

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**SIGNATURES**

 

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

 

 
|                          | ** ** | **LOUD Technologies Inc.**                                                                                         |
|-------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|
|                          |       | (Registrant)                                                                                                       |
|                          |       |                                                                                                               |
| Dated:   August 12, 2004 | By:        | /s/ James T.  Engen                                                                                                |
|                          |       | James T.  Engen                                                                                                    |
|                          | * *   | *President, Chief Executive Officer and  Director*                                                                 |
|                          |       |
|                          |       | * *                                                                                                           |
| Dated:   August 12, 2004 | By:        | /s/ Timothy  P. O’Neil                                                                                        |
|                          |       | Timothy P.  O’Neil                                                                                            |
|                          | * *   | *Chief Financial Officer, Vice**President, Secretary and**Treasurer (Principal Financial and**Accounting Officer)* |

 

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Document  Description**                                                                                                                        |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                             |
| 31.1                |       | Certification  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                       |
|                |       |                                                                                                                                             |
| 31.2                |       | Certification  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                       |
|                |       |                                                                                                                                             |
| 32.1                |       | Certification  Pursuant to Section 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |

 

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