** **

**UNITEDSTATESSECURITIES 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 March 31, 2006**                                                                                                                                                                            |
|                                                                                                                                                                                                                          |       |                                                                                          |
| **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 registrantas specified in its charter)

 

| **Washington**                                                  | ** ** | **91-1432133**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **16220  Wood-Red Road, N.E., Woodinville, Washington**         | ** ** | **98072**                             |
| (Address of principal  executive offices)                       |       | (Zip Code)                            |
|                                                            |       |                                  |
| **(425)  487-4333**                                             |
| (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 Act of1934 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**

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act (Checkone):

Large accelerated filer** ****o**          Acceleratedfiler o          Non-acceleratedfiler ý

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the ExchangeAct.):  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** | ** ** | **4,566,202**                                         |
|---------------------------------|------------|-------------------------------------------------------|
| Class                           |       | Number of Shares  Outstanding  (as of April 28, 2006) |

 

 

----

 

**LOUDTECHNOLOGIES INC.**

 

**FORM10-Q**

**For thequarter ended March 31, 2006**

 

**INDEX**

 
| **PART  I.**   | **FINANCIAL INFORMATION**                                                                                      |   |
|----------------|----------------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                           |   |
| Item 1.        | Financial Statements (Unaudited)                                                                               |   |
|           |                                                                                                           |   |
|           | Condensed  Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005                              |   |
|           |                                                                                                           |   |
|           | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2006 and March 31, 2005 |   |
|           |                                                                                                           |   |
|           | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  2006 and March 31, 2005 |   |
|           |                                                                                                           |   |
|           | Condensed  Consolidated Statement of Shareholders’ Equity for the three months ended  March 31, 2006      |   |
|           |                                                                                                           |   |
|           | 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 1A.       | Risk Factors                                                                                                   |   |
|           |                                                                                                           |   |
| Item 2.        | Unregistered  Sales of Equity 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                                                                                                       |   |
|           |                                                                                                           |   |
| **SIGNATURES** |                                                                                                           |

 

2

----

 

**LOUD TECHNOLOGIES INC.CONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)**

 

*(Inthousands, except share amounts)*

 
| ** **                                                                                                                                       | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                       | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                  |       |                |       |                   |       |
| Cash and cash  equivalents                                                                                                                       |       | $                   | 1,017      |                   | $          | 468 |   |
| Accounts  receivable, net of allowances of $2,222 and $2,224 respectively                                                                        |       | 30,848              |       | 28,224                 |       |
| Inventories                                                                                                                                      |       | 39,383              |       | 39,290                 |       |
| Prepaid expenses  and other current assets                                                                                                       |       | 1,509               |       | 1,859                  |       |
| Total current  assets                                                                                                                            |       | 72,757              |       | 69,841                 |       |
|                                                                                                                                             |       |                |       |                   |       |
| Property, plant and equipment, net                                                                                                               |       | 7,645               |       | 7,863                  |       |
| Goodwill                                                                                                                                         |       | 2,248               |       | 2,248                  |       |
| Other intangible assets, net                                                                                                                     |       | 11,978              |       | 12,198                 |       |
| Deferred financing costs                                                                                                                         |       | 3,206               |       | 3,378                  |       |
| Other assets, net                                                                                                                                |       | 17                  |       | 17                     |       |
| Total assets                                                                                                                                     |       | $                   | 97,851     |                   | $          | 95,545 |   |
|                                                                                                                                             |       |                |       |                   |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                    | ** ** | ** **          | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                             |       |                |       |                   |       |
| Short-term  borrowings                                                                                                                           |       | $                   | 12,565     |                   | $          | 9,595 |   |
| Accounts payable                                                                                                                                 |       | 16,512              |       | 16,133                 |       |
| Accrued  liabilities                                                                                                                             |       | 10,703              |       | 10,009                 |       |
| Taxes payable                                                                                                                                    |       | 1,274               |       | 1,293                  |       |
| Current portion  of long-term debt                                                                                                               |       | 2,645               |       | 3,306                  |       |
| Current portion  of payable to former Italian subsidiary                                                                                         |       | 2,200               |       | 2,200                  |       |
| Other current  liabilities                                                                                                                       |       | 2,990               |       | —                 |       |
| Total current  liabilities                                                                                                                       |       | 48,889              |       | 42,536                 |       |
|                                                                                                                                             |       |                |       |                   |       |
| Long-term debt, excluding current portion                                                                                                        |       | 40,283              |       | 40,944                 |       |
| Deferred tax liabilities                                                                                                                         |       | 53                  |       | 40                     |       |
| Other liabilities                                                                                                                                |       | —              |       | 2,938                  |       |
| Total  liabilities                                                                                                                               |       | 89,225              |       | 86,458                 |       |
|                                                                                                                                             |       |                |       |                   |       |
| Commitments and contingencies (Note 10)                                                                                                          |       |                |       |                   |       |
|                                                                                                                                             |       |                |       |                   |       |
| 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  4,566,202 shares at March 31, 2006 and December 31, 2005 |       | 40,922              |       | 40,788                 |       |
| Accumulated deficit                                                                                                                              |       | (32,296             | )          | (31,701                | )          |
| Total  shareholders’ equity                                                                                                                 |       | 8,626               |       | 9,087                  |       |
| Total  liabilities and shareholders’ equity                                                                                                 |       | $                   | 97,851     |                   | $          | 95,545 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

3

----

 

**LOUD TECHNOLOGIES INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

 

*(Inthousands, except per share data)*

 
| ** **                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                    | ** ** | **2006**                          | ** ** | **2005** | ** ** |
|                                                                          |       |                              |       |   |   |
| Net sales                                                                     |       | $                                 | 58,564     |   | $ | 39,945 |   |
| Cost of sales                                                                 |       | 38,935                            |       | 26,610 |   |
| Gross profit                                                                  |       | 19,629                            |       | 13,335 |   |
|                                                                          |       |                              |       |   |   |
| Operating expenses:                                                           |       |                              |       |   |   |
| Selling, general and administrative                                           |       | 14,760                            |       | 9,545 |   |
| Research and development                                                      |       | 3,256                             |       | 1,955 |   |
| Restructuring costs (Note 5)                                                  |       | 150                               |       | — |   |
| Total operating expenses                                                      |       | 18,166                            |       | 11,500 |   |
|                                                                          |       |                              |       |   |   |
| Operating income                                                              |       | 1,463                             |       | 1,835 |   |
|                                                                          |       |                              |       |   |   |
| Other income (expense):                                                       |       |                              |       |   |   |
| Interest income                                                               |       | 86                                |       | 29 |   |
| Interest expense                                                              |       | (1,644                            | )          | (862 | ) |
| Management fee                                                                |       | (262                              | )          | (328 | ) |
| Other                                                                         |       | (178                              | )          | (152 | ) |
| Total other (expense)                                                         |       | (1,998                            | )          | (1,313 | ) |
|                                                                          |       |                              |       |   |   |
| Income (loss) before income taxes and discontinued  operations                |       | (535                              | )          | 522 |   |
|                                                                          |       |                              |       |   |   |
| Provision for income taxes                                                    |       | 60                                |       | 26 |   |
|                                                                          |       |                              |       |   |   |
| Income (loss) from continuing operations                                      |       | (595                              | )          | 496 |   |
|                                                                          |       |                              |       |   |   |
| Recognized gain on discontinued operations, net of  income tax expense of $58 |       | —                            |       | 2,827 |   |
|                                                                          |       |                              |       |   |   |
| Net income (loss)                                                             |       | $                                 | (595       | ) | $ | 3,323 |   |
|                                                                          |       |                              |       |   |   |
| Basic net income (loss) per share:                                            |       |                              |       |   |   |
| Net income  (loss) from continuing operations                                 |       | $                                 | (0.12      | ) | $ | 0.11 |   |
| Net income from  discontinued operations                                      |       | —                            |       | 0.60 |   |
| Net income  (loss) per share                                                  |       | $                                 | (0.12      | ) | $ | 0.71 |   |
|                                                                          |       |                              |       |   |   |
| Diluted net income (loss) per share                                           |       |                              |       |   |   |
| Net income  (loss) from continuing operations                                 |       | $                                 | (0.12      | ) | $ | 0.10 |   |
| Net income from  discontinued operations                                      |       | —                            |       | 0.58 |   |
| Net income  (loss) per share                                                  |       | $                                 | (0.12      | ) | $ | 0.68 |   |
|                                                                          |       |                              |       |   |   |
| Shares used in computing basic and diluted net  income (loss) per share:      |       |                              |       |   |   |
| Basic                                                                         |       | 4,806                             |       | 4,699 |   |
| Diluted                                                                       |       | 4,806                             |       | 4,853 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

4

----

 

**LOUD TECHNOLOGIES INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

 

*(Inthousands)*

* *
| ** **                                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| **Operating activities**                                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                 | (595       | ) | $ | 3,323 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                              |       |   |   |
| Depreciation and amortization                                                             |       | 1,126                             |       | 883 |   |
| Amortization of deferred financing costs                                                  |       | 172                               |       | — |   |
| Stock based compensation                                                                  |       | 134                               |       | 15 |   |
| Gain on discontinued operations                                                           |       | —                            |       | (2,887 | ) |
| Non-cash interest expense                                                                 |       | —                            |       | 57 |   |
| Changes in operating assets and liabilities:                                              |       |                              |       |   |   |
| Accounts receivable                                                                       |       | (2,624                            | )          | (667 | ) |
| Inventories                                                                               |       | (93                               | )          | 1,516 |   |
| Prepaid expenses and other current assets                                                 |       | 350                               |       | 735 |   |
| Other assets                                                                              |       | —                            |       | 141 |   |
| Accounts payable and accrued expenses                                                     |       | 1,073                             |       | (8,039 | ) |
| Taxes payable                                                                             |       | (6                                | )          | 55 |   |
| Other liabilities                                                                         |       | 52                                |       | 2,967 |   |
| Net cash used in operating activities                                                     |       | (411                              | )          | (1,901 | ) |
|                                                                                      |       |                              |       |   |   |
| **Investing activities**                                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Purchases of property, plant and equipment                                                |       | (688                              | )          | (463 | ) |
| Acquisition of St. Louis Music, Inc., including  transaction fees paid                    |       | —                            |       | (34,565 | ) |
| Net cash used in investing activities                                                     |       | (688                              | )          | (35,028 | ) |
|                                                                                      |       |                              |       |   |   |
| **Financing activities**                                                                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| Payments on long-term debt                                                                |       | (1,322                            | )          | (75 | ) |
| Net proceeds on bank line of credit and short-term  borrowings                            |       | 2,970                             |       | 37,326 |   |
| Net cash provided by financing activities                                                 |       | 1,648                             |       | 37,251 |   |
|                                                                                      |       |                              |       |   |   |
| Increase in cash and cash equivalents                                                     |       | 549                               |       | 322 |   |
|                                                                                      |       |                              |       |   |   |
| Cash and cash equivalents at beginning of period                                          |       | 468                               |       | 450 |   |
| Cash and cash equivalents at end of period                                                |       | $                                 | 1,017      |   | $ | 772 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

5

----

 

**LOUD TECHNOLOGIES INC.CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITYThree months ended March 31, 2006**(unaudited)

 

*(Inthousands)*

 
| ** **                   | ** ** | **Common Stock** | ** ** | **Accumulated  Deficit** | ** ** | **Total** | ** ** |
|------------------------------|------------|------------------|------------|--------------------------|------------|-----------|------------|
| **Shares**                   | ** ** | **Amount**       |
|                         |       |             |       |                     |       |      |       |   |   |
| Balance at December 31, 2005 |       | 4,566            |       | $                        | 40,788     |      | $          | (31,701 | ) | $ | 9,087 |   |
| Stock based compensation     |       | —           |       | 134                      |       | —    |       | 134 |   |
| Net income                   |       | —           |       | —                   |       | (595      | )          | (595 | ) |
| Balance at March 31, 2006    |       | 4,566            |       | $                        | 40,922     |      | $          | (32,296 | ) | $ | 8,626 |   |

 

*See accompanying notes to condensedconsolidated financial statements.*

 

6

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**LOUD TECHNOLOGIES INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSMarch 31, 2006(Unaudited)**

 

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

 

We develop, manufacture and sell high-quality, affordable digital andanalog audio mixers, speakers, guitar and bass amplifiers, branded musicalinstruments and related accessories, and other professional audio equipment ona worldwide basis. Our products are used by professional and amateur musicians;school music programs; sound installation contractors and broadcastprofessionals in sound recordings, live presentations systems and installedsound systems. We distribute our products primarily through retail dealers,mail order outlets and installed sound contractors.  We have our primary operations in the UnitedStates with smaller operations in the United Kingdom, Canada, China and Japan.

 

**2.****             Summaryof Significant Accounting Policies**

 

**Basis of Presentation**

 

The accompanying unaudited condensed consolidated financial statementshave been prepared by LOUD Technologies Inc. (“LOUD” or the “Company”) inaccordance with U.S. generally accepted accounting principles for interimfinancial statements and includes the accounts of the Company and itssubsidiaries. They do not include all of the information and disclosuresrequired by generally accepted accounting principles for complete financialstatements and should be read in conjunction with the financial statementsincluded in our Annual Report on Form 10-K for the year ended December 31,2005.  In our opinion, all adjustments,consisting of normal recurring adjustments necessary for the fair presentationof the results of the interim periods are reflected herein. Operating resultsfor the three-month period ended March 31, 2006, are not necessarily indicativeof future financial results.

 

***Business Combinations***

 

On March 4, 2005, we acquired all of the shares of St. Louis Music,Inc. (“St. Louis”), a Missouri-based manufacturer, distributor and importer ofbranded musical instruments and professional audio products.  The Company believes the acquisition of St.Louis Music, Inc. will further diversify the Company’s product offerings tohelp acquire, retain and extend relationships with customers.  Our total purchase price was approximately$43.7 million, consisting of $33.7 million in cash; a commitment to pay $3.0million plus interest in two years, the present value of which as of theacquisition date was $2.8 million, 79,358 shares of the Company’s common stock,assumed liabilities of $4.4 million and transaction costs of $1.6 million.  The $3.0 million future commitment plusaccrued interest is secured by a standby letter of credit issued in September2005.  The St. Louis Music acquisitionwas conducted through SLM Merger Corp., an indirect wholly owned subsidiary ofthe Company.  Included in the Company’sresults of operations are the operations of St. Louis Music for the periodJanuary 1 through March 31, 2006 and March 5 through March 31, 2005.

 

***Use of Estimates***

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  Significant items subject to such estimatesand assumptions include the allocation of purchase costs to assets acquired andliabilities assumed, the carrying amount of property and equipment andintangibles; valuation allowances for receivables, inventories, and deferredincome tax assets and liabilities. Actual results may differ from those estimates.

 

***Revenue Recognition***

 

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. We do have somedealers who finance their purchases through finance companies.  We have manufacturer’s repurchase agreementswith the finance companies and defer the revenue and related cost of goods soldof these sales at the time of the sale. We then recognize the revenue and related cost of goods sold from thesesales when the repurchase obligation no longer exists.  Sales with contingencies, such as rights ofreturn, rotation rights, conditional acceptance provisions and price protection,are deferred until the contingencies have been satisfied or the contingentperiod has lapsed. We generally warrant our products against defects inmaterials and workmanship for periods of between one and six years, with theexception of Alvarez Yairi guitars, which have a limited lifetime warranty. Theestimated cost of warranty obligations, sales returns and other allowances arerecognized at the time of revenue recognition based on contract terms and priorclaims experience.

 

7

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**Stock-Based Compensation**

 

During July 2003, our board of directors adopted the 2003 Stock OptionPlan (the 2003 Plan), authorizing options to purchase 345,600 shares of commonstock.  The 2003 Plan calls for optionsto be non-qualified stock options with exercise prices equal to the fair marketvalue of the stock on the date granted. Options generally vest over a five-year period and expire the earlier often years from grant date or three months from termination.  If an option holder is terminated for Cause,as defined in the 2003 Plan, the options would terminate a day prior totermination.  At March 31, 2006, 61,000shares of common stock were available for future grants under the 2003 Plan.

 

The Company also has a 1995 Stock Option Plan (the 1995 Plan), whichauthorized 1.3 million shares of common stock for grants.  The exercise price of incentive stock optionsgranted under the 1995 Plan may not be less than the fair market value of thecommon stock on the date of grant.  Theexercise price of nonqualified stock options granted under the plan may begreater or less than the fair market value of the common stock on the date ofgrant, as determined by the stock option committee of the board of directors atits discretion. Options generally vest over a four to five-year period andexpire no later than ten years after the date of grant.  At March 31, 2006, 822,000 shares of commonstock were available for future grants under the 1995 Plan.

 

The Company’s policy is to issue new shares for stock optionexercises.  Shares issued under the 2003Plan are also subject to a Shareholder’s Agreement governing restrictions ontransfer and voting rights for shares issued under the plan.  No significant share repurchases are plannedin 2006.

 

The Company adopted SFAS 123R, “Share Based Payment: An Amendment ofSFAS Nos. 123 and 95”, on January 1, 2006, using the Modified ProspectiveApplication Method whereby previously awarded but unvested equity awards areaccounted for in accordance with SFAS No. 123R and prospective amounts arerecognized in the income statement instead of simply being disclosed. Prior tothe adoption of SFAS No. 123R, the Company followed the intrinsic-value methodprescribed in Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations including SFAS Interpretation No. 44,*Accounting for Certain Transactions Involving StockCompensation, an Interpretation of APB Opinion No. 25*to account forits stock options granted under its employee option plans.  Under this method, compensation expense wasrecorded on the date of grant only if the current market price of theunderlying stock exceeded the exercise price or if options were issued tonon-employees.  The adoption of SFAS No.123R primarily resulted in a change in the Company’s method of recognizing thefair value of share-based compensation for all unvested awards.  Specifically, the adoption of SFAS No. 123Rresulted in the Company recording compensation expense of approximately$124,000 for the three months ended March 31, 2006.  The following table shows the effects ofadopting SFAS No. 123R on selected reported items (“As Reported”) and whatthose items would have been under previous guidance under APB No. 25 (in thousandsexcept per share data):

 
| ** **                           | ** ** | **Three months ended  March 31, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **As Reported**                        | ** ** | **Under APB No. 25** | ** ** |
|                                 |       |                                   |       |   |   |
| Loss from continuing operations      |       | $                                      | (535       | ) | $ | (411 | ) |
| Net loss                             |       | $                                      | (595       | ) | $ | (471 | ) |
| Basic and diluted net loss per share |       | $                                      | (0.12      | ) | $ | (0.10 | ) |

 

Results for the three months ended March 31, 2005 have not beenrestated.  Had compensation expense foremployee stock options granted under the Company’s stock incentive plans beendetermined based on SFAS No. 123R’s Modified Prospective Application Method, theCompany’s Income from continuing operations, net income, and basic and dilutedper share amounts would have been reduced to the pro forma amounts as indicatedbelow (in thousands except per share data):

 
| ** **                         | ** ** | **Three months ended  March 31, 2005** | ** ** |
|------------------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | **As Reported**                        | ** ** | **Pro Forma** | ** ** |
|                               |       |                                   |       |   |   |
| Income from continuing operations  |       | $                                      | 496        |   | $ | 380 |   |
| Net income                         |       | $                                      | 3,323      |   | $ | 3,207 |   |
|                               |       |                                   |       |   |   |
| Basic net income per share:        |       |                                   |       |   |   |
| Income from  continuing operations |       | $                                      | 0.11       |   | $ | 0.08 |   |
| Net income                         |       | $                                      | 0.71       |   | $ | 0.68 |   |
| Diluted net income per share:      |       |                                   |       |   |   |
| Income from  continuing operations |       | $                                      | 0.10       |   | $ | 0.08 |   |
| Net income                         |       | $                                      | 0.68       |   | $ | 0.66 |   |

 

8

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The following table summarizes the stock option activity for the threemonths ended March 31, 2006:

 
| ** **                               | ** ** | **Shares subject to  exercise** | ** ** | **Weighted average  exercise price** | ** ** |
|------------------------------------------|------------|---------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **(in thousands)**              | ** ** | ** **                           | ** ** |
|                                     |       |                            |       |                                 |       |
| Options outstanding at December 31, 2005 |       | 629                             |       | $                                    | 15.27      |   |
| Granted                                  |       | —                          |       | —                               |       |
| Exercised                                |       | —                          |       | —                               |       |
| Forfeited                                |       | —                          |       | —                               |       |
| Expired                                  |       | (13                             | )          | 43.75                                |       |
| Options outstanding at March 31, 2006    |       | 616                             |       | $                                    | 14.67      |   |
|                                     |       |                            |       |                                 |       |
| Options exercisable at March 31, 2006    |       | 418                             |       | $                                    | 17.40      |   |

 

The aggregate intrinsic value of options outstandingand exercisable at March 31, 2006 was $1.6 million and $0 respectively.  The aggregate intrinsic value represents thedifference between the Company’s closing stock price on the last day of tradingduring the quarter, which was $17.25 per share as of March 31, 2006, and theexercise price multiplied by the number of applicable options.  The total intrinsic value of optionsexercised during the quarter ended March 31, 2005 was $0.1 million.  There were no options exercised during thequarter ended March 31, 2006.

 

The following table summarizes information about options outstandingand exercisable at March 31, 2006:

 
| ** **                   | ** ** | **Options outstanding** | ** ** | **Options exercisable**                                     | ** ** |
|------------------------------|------------|-------------------------|------------|-------------------------------------------------------------|------------|
| **Range of exercise  price** | ** ** | **Number  outstanding** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Weighted  average  exercise  price** | ** ** | **Number  exercisable** | ** ** | **Weighted  average  remaining  contractual  life (years)** | ** ** | **Weighted  average  exercise  price** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** | ** **                                                  | ** ** | ** ** | ** ** | **(in thousands****)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| $ 5.10 – 8.85      |       | 305                     |       | 6.2                                                         |       | $ | 5.27 |   | 186 |   | 5.4 |   | $ | 5.22 |   |
| $ 11.30 – 23.75    |       | 130                     |       | 7.6                                                         |       | 16.22 |   | 51 |   | 5.7 |   | 19.18 |   |
| $ 25.30 – 32.50    |       | 155                     |       | 2.7                                                         |       | 28.61 |   | 155 |   | 2.7 |   | 28.61 |   |
| $ 33.44 – 43.75    |       | 26                      |       | 2.8                                                         |       | 34.05 |   | 26 |   | 2.8 |   | 34.05 |   |
|                         |       | 616                     |       | 5.5                                                         |       | $ | 14.67 |   | 418 |   | 4.3 |   | $ | 17.40 |   |

 

Other information pertaining to options was as follows:

 
| ** **                                                       | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                       | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Weighted average grant-date fair value of stock  options granted |       | N/A                               |       | $ | 10.56 |   |
|                                                                  |            |                                   |            |  |  |  |

 

The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model with the following weightedaverage assumptions:

 
| ** **               | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------|------------|-----------------------------------|------------|
| ** **               | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Expected life (in years) |       | N/A                               |       | 5.0 |   |
| Risk-free interest rate  |       | N/A                               |       | 4.17 | % |
| Expected volatility      |       | N/A                               |       | 85 | % |
| Expected dividend yield  |       | N/A                               |       | 0 | % |

 

The Company has total compensation cost related to nonvested awards notyet recognized of approximately $1.2 million with the weighted average periodover which it is expected to be recognized of 1.7 years.

 

9

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**Significant Risks and Uncertainties**

 

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 credit risk,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 months ended March 31, 2006 and 2005, we had sales to one customer of$9.5 million and $5.4 million, or 16.2% and 13.5%, respectively of consolidatednet sales.

 

Many of our products are currently being manufactured exclusively bycontract manufacturers on our behalf. For the three months ended March 31, 2006, net sales of productsmanufactured by one manufacturer were $19.0 million, or 32.4%, of consolidatednet sales, and net sales from another manufacturer were $6.5 million, or 11.1%,of consolidated net sales.  Net sales forthe three months ended March 31, 2005 for the same manufacturers were $14.4million, or 36.1%, and $5.6 million, or 14.0%, respectively.

 

At March 31, 2006, we had approximately 700 full-time equivalentemployees of which less than 5% were members of an organized labor union.

 

##### **Recent AccountingPronouncements**

 

In November 2005, the FASB issued Staff Position No. SFAS 123R-3, *Transition Election Related to Accounting for the TaxEffect of Share-Based Payment Awards* (“FSP 123R-3”).  This pronouncement provides an alternativemethod of calculating the excess tax benefits available to absorb any taxdeficiencies recognized subsequent to the adoption of SFAS No. 123R.  We have up to one year from the effectivedate of FSP 123R-3 to make a one-time election to adopt the transitionmethod.  We are currently evaluatingthese alternative methods.

 

**Reclassifications**

 

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

 

**3.****             DiscontinuedOperations**

 

In December 2003, we placed our wholly owned Italian subsidiary, MackieDesigns (Italy) S.p.A. (“Mackie Italy”), into an Italian form ofcourt-supervised liquidation and sold all of the shares of Mackie Italy.  Mackie Italy was a manufacturer of many ofour speaker products, which were purchased by the Company for subsequent saleoutside of Italy.  At the time of the sale,the Company owed Mackie Italy approximately $9.2 million related to the purchaseof goods in the normal course of business. During 2004, we made payments to Mackie Italy of approximately $1.6million, lowering our liability to $7.6 million at December 31, 2004.  Additionally, Mackie Italy has a payable to aseparate wholly owned subsidiary of the Company for approximately $2.7 million,which was fully reserved at the date of sale in 2003.

 

In February 2005, we made an offer to Mackie Italy to settle anyoutstanding amounts owed by the Company to Mackie Italy for $4.7 million.  This proposal was accepted by the Italiancourt appointed trustee on behalf of Mackie Italy in May 2005.  Under the terms of the settlement agreement,we made additional payments of $2.5 million during 2005.  We also committed to pay $2.2 million during2006.  We recognized a gain, net ofincome tax, on discontinued operations of $2.8 million in the first quarter of2005 related to this settlement.

 

10

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**4.****             NetIncome (Loss) Per Share**

 

The following table sets forth the computation of basic and diluted netloss per share for the three months ended March 31, 2006 and 2005. Stockoptions to purchase 616,000 and 502,000 shares in 2006 and 2005, respectively,were excluded from the calculation of diluted per share amounts because theyare antidilutive in 2006 and out of the money in 2005.

 
| ** **                                                              | ** ** | **Three months ended  March 31,**          | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| ** **                                                              | ** ** | **(in thousands, except  per share data)** | ** ** |
| Numerator:                                                              |       |                                       |       |   |   |
| Net income (loss) from continuing operations                            |       | $                                          | (595       | ) | $ | 496 |   |
| Net income from discontinued operations                                 |       | —                                     |       | 2,827 |   |
| Numerator for basic and diluted net income (loss)  per share            |       | $                                          | (595       | ) | $ | 3,323 |   |
|                                                                    |       |                                       |       |   |   |
| Denominator:                                                            |       |                                       |       |   |   |
| Denominator for basic net income (loss) per share                       |       | 4,806                                      |       | 4,699 |   |
| Dilutive potential common shares from outstanding  warrants and options |       | —                                     |       | 154 |   |
| Denominator for diluted net income (loss) per share                     |       | 4,806                                      |       | 4,853 |   |
|                                                                    |       |                                       |       |   |   |
| Basic net income (loss) per share:                                      |       |                                       |       |   |   |
| Continuing operations                                                   |       | $                                          | (0.12      | ) | $ | 0.11 |   |
| Discontinued operations                                                 |       | —                                     |       | 0.60 |   |
| Basic net income (loss) per share                                       |       | $                                          | (0.12      | ) | $ | 0.71 |   |
|                                                                    |       |                                       |       |   |   |
| Diluted net income (loss) per share:                                    |       |                                       |       |   |   |
| Continuing operations                                                   |       | $                                          | (0.12      | ) | $ | 0.10 |   |
| Discontinued operations                                                 |       | —                                     |       | 0.58 |   |
| Diluted net income (loss) per share                                     |       | $                                          | (0.12      | ) | $ | 0.68 |   |

 

**5.****             RestructuringCosts**

 

During the first quarter of 2006, management approvedand began implementing a restructuring plan. Actions primarily involved a reduction of workforce due to our decisionto outsource more of our products overseas and also reduce our engineeringresources.  We incurred $150,000 inrestructuring costs during the three months ended March 31, 2006, primarilyrepresenting employee severance and related costs for approximately 28displaced employees.  We had $31,000 ofthese restructuring amounts remaining in accrued liabilities at March 31,2006.  This amount was paid in cash inApril 2006.

 

**6.****             Inventories**

 

Inventories consist of the following:

 
| ** **      | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------|------------|---------------------|------------|------------------------|------------|
| ** **      | ** ** | **(in thousands)**  | ** ** |
|            |       |                |       |                   |       |
| Raw materials   |       | $                   | 4,851      |                   | $          | 5,531 |   |
| Work in process |       | 992                 |       | 976                    |       |
| Finished goods  |       | 33,540              |       | 32,783                 |       |
|            |       | $                   | 39,383     |                   | $          | 39,290 |   |

 

11

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**7.****             Intangible Assets**

 

Intangible assets consist of the following:

 
| ** **                    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                    | ** ** | **(in thousands)**  | ** ** |
| Developed technology          |       | $                   | 5,470      |                   | $          | 5,470 |   |
| Customer relationships        |       | 3,080               |       | 3,080                  |       |
| Trademark                     |       | 5,930               |       | 5,930                  |       |
| Non-compete agreement         |       | 285                 |       | 285                    |       |
|                          |       | 14,765              |       | 14,765                 |       |
| Less accumulated amortization |       | (2,787              | )          | (2,567                 | )          |
|                          |       | $                   | 11,978     |                   | $          | 12,198 |   |

 

Amortization expense for intangible assets was $220,000 and $147,000for the three month periods ended March 31, 2006 and 2005, respectively.

 

Expected future amortization expense related to identifiable intangibleassets for the next five years is as follows (in thousands):

 
| **Twelve months ending March 31:** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2007                               |       | $          | 816        |   |
| 2008                               |       | 816        |       |
| 2009                               |       | 816        |       |
| 2010                               |       | 811        |       |
| 2011                               |       | 762        |       |
|                                    |            |            |            |  |

 

**8.****             Financing**

 

The Company has a $69.5 million secured loan facility and a $14.8million senior subordinated note payable. The senior secured loan facility consists of a $40.0 million revolvingloan, a $15.0 million Term Loan A, and a $14.5 million Term Loan B.  The Company’s obligations under the CreditAgreement and the Subordinated Note Agreements are automatically acceleratedupon certain bankruptcy or insolvency events, and may be accelerated upon theoccurrence of other events of default under the Credit Agreement and theSubordinated Note Agreement, such as non-payment of principal, interest or feeswhen due, or failure to comply with affirmative and negative covenants, subjectto any applicable grace periods.

 

As of March 31, 2006, the Company was in compliance with all financialcovenants.

 

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

 

The Company has a line of credit where we can borrow up to $40.0million, subject to certain restrictions, including available borrowingcapacity.  At March 31, 2006, theoutstanding balance on our line of credit was $12.6 million.  At March 31, 2006, we had the ability toborrow an additional $22.0 million on this line of credit.  Interest is due monthly or at the end of aLIBOR period (but in such case no greater than 3 months) and is based onBloomberg’s prime rate or LIBOR, both plus a specified margin.  Under the terms of the line of credit andrelated subordinated loan agreements, we are required to maintain certainfinancial ratios, such as measuring our EBITDA to our total debt and seniordebt, and maintaining a certain fixed charge coverage ratio.  The agreement also provides, among othermatters, restrictions on additional financing, dividends, mergers,acquisitions, and an annual capital expenditure limit.  The weighted average interest rate on ourline of credit was 8.34% at March 31, 2006.

 

12

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**(b)****           Long-termdebt**

 

At March 31, 2006 and December 31, 2005, our long-term debt consistedof the following:

 
| ** **                | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------|------------|---------------------|------------|------------------------|------------|
| ** **                | ** ** | **(In thousands)**  | ** ** |
|                      |       |                |       |                   |       |
| Term Loan A               |       | $                   | 13,750     |                   | $          | 15,000 |   |
| Term Loan B               |       | 14,428              |       | 14,500                 |       |
| Subordinated note payable |       | 14,750              |       | 14,750                 |       |
|                      |       | 42,928              |       | 44,250                 |       |
| Less: current portion     |       | (2,645              | )          | (3,306                 | )          |
| Long-term portion of debt |       | $                   | 40,283     |                   | $          | 40,944 |   |

 

Principal payments on the $29.5 million Term Loan A and Term Loan B,under the Credit Agreement, are paid quarterly. The term loans bear interest at the Bloomberg’s prime rate or LIBOR,both plus a specified margin.  This ratefor Term Loan A was 8.08% and Term Loan B was 8.58% at March 31, 2006.  Interest is due monthly on each term loan.  The final Term Loan A principal payment isdue August 29, 2010.  The final Term LoanB principal payment is due August 29, 2011. The term loans and the line of credit are both secured by substantiallyall of the assets of the Company and its subsidiaries, and are both senior toother long-term debt.  The $14.8 millionin senior subordinated notes issued is subordinate to all amounts due under theCredit Agreement and to any refinancing thereof.  Interest accrues on the senior subordinatednotes at a rate of 14% and is due quarterly. Of the 14% interest rate, up to two percent may be capitalized on eachinterest payment date.  The principalunder the Senior Subordinated Note Agreements is due February 29, 2012.

 

In addition, we have a future commitment to pay the former owners ofSt. Louis Music $3.0 million plus interest of 3%.  This commitment is due two years after thedate of the acquisition and was secured by a standby letter of credit inSeptember 2005.

 

**9.****             Guarantees**

 

In the ordinary course of business, we are not subject to potential obligationsunder guarantees that fall within the scope of FIN No. 45,*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*exceptfor standard indemnification and warranty provisions and give rise only to thedisclosure requirements prescribed by FIN No. 45.

 

Indemnification and warranty provisions contained within our salesagreements are generally consistent with those prevalent in our industry. Theduration of product warranties is generally one to six years following deliveryof products, with the exception of Alvarez Yairi guitars, which have a limitedlifetime warranty.

 

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

 
| ** **                   | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                         |       |                             |       |   |   |
| Balance, beginning of period |       | $                                | 980        |   | $ | 978 |   |
| Charged to cost of sales     |       | 713                              |       | 568 |   |
| Increase from acquisition    |       | —                           |       | 290 |   |
| Applied to liability         |       | (703                             | )          | (606 | ) |
| Balance, end of period       |       | $                                | 990        |   | $ | 1,230 |   |

 

**10.****          Contingencies**

 

We are a defendant in a lawsuit filed in the Southern District ofFlorida on November 29, 2005 by Ace Pro Sound and Recording, L.L.C.  The lawsuit alleges various federal and stateantitrust violations, as well as common-law (misrepresentation) claims.  We believe the claims are without merit andwe intend vigorously to defend the lawsuit.

 

In addition to the case noted above, we are also involved in variouslegal proceedings and claims that arise in the ordinary course ofbusiness.  We currently believe thatthese matters will not have a material adverse impact on our financialposition, liquidity or results of operations.

 

13

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**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

*The following discussion andanalysis should be read in conjunction with our financial statements includedin our Annual Report on Form 10-K for the year ended December 31, 2005. Thisdiscussion contains certain “forward-looking statements” within the meaning ofSection 21D of the Securities Exchange Act of 1934, as amended, which involverisks and uncertainties, such as statements of our plans, objectives,expectations and intentions. Actual results may differ materially from thosediscussed herein. The cautionary statements made in this Quarterly Report onForm 10-Q and the Annual Report on Form 10-K may apply to all forward-lookingstatements wherever they appear. We undertake no obligation to publicly releaseany revisions to these forward-looking statements that may be required toreflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events. Forward-looking statements include, withoutlimitation, any statement that may predict, forecast, indicate, or imply futureresults, performance, or achievements, and may contain the words “believe,” “anticipate,”“expect,” “estimate,” “project,” “will be,” “will continue,” “will likelyresult,” or words or phrases of similar meaning.*

 

**Overview**

 

LOUD Technologies Inc., was founded in 1988 and incorporated inWashington under the name Mackie Designs Inc., and changed its name to LOUDTechnologies Inc., on September 13, 2003. LOUD is one of the world’s largest dedicated pro audio and musicproducts companies.  As the corporateparent for world-recognized brands Alvarez®, Ampeg®, Crate®, EAW®, Knilling®,Mackie®, SIA® and Tapco®, LOUD engineers, manufactures, markets and distributesa wide range of professional audio and musical instrument products worldwide.  Additionally, LOUD is one of the largestdistributors of branded professional audio and music accessories through itsSLM Marketplace catalog.

 

We develop, manufacture, and sell high-quality,affordable sound reinforcement speakers, analog mixers, guitar and bassamplifiers, professional loudspeaker systems, violins and other stringedinstruments, and digital mixers on a worldwide basis.  Our products are used by both professionaland amateur musicians; school music programs; sound installation contractorsand broadcast professionals in sound recordings, live presentations systems andinstalled sound systems.  We distributeour products primarily through retail dealers, mail order outlets and installedsound contractors.  We have our primaryoperations in the United States with smaller operations in the United Kingdom,Canada, China and Japan.

 

The Company voluntarily delisted from the Nasdaq Small Cap MarketTM onFebruary 7, 2003 because of ongoing difficulties in satisfying certain of theNasdaq continuing listing requirements. The Company’s stock traded on the NASD OTC Bulletin Board from February11, 2003 until we were listed on the Nasdaq Capital MarketTM on March 1,2006.  Our stock is listed on the NasdaqCapital MarketTM under the symbol “LTEC”.

 

“MACKIE,” the running man figure, “TAPCO,” “EAW,” and “SIA” areregistered trademarks of LOUD Technologies Inc. “Alvarez”, “Ampeg”, “Crate”, and “Knilling” are registered trademarks ofour wholly owned subsidiary, St. Louis Music, Inc.  To the extent our trademarks areunregistered, we are unaware of any conflicts with trademarks owned by thirdparties.  This document also containsnames and marks of other companies, and we claim no rights in the trademarks,service marks and trade names of entities other than those in which we have afinancial interest or licensing right.

 

**Critical Accounting Policies andJudgments**

 

The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying notes.  Actual results coulddiffer from these estimates.

 

We believe there have been no additional significant changes in ourcritical accounting policies during the three months ended March 31, 2006 ascompared to what was previously disclosed in our Form 10-K for the year endedDecember 31, 2005.

 

14

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**Estimates and Assumptions Related toFinancial Statements**

 

The discussion and analysis of our financial condition and results ofoperations is based upon our unaudited condensed consolidated financialstatements, which have been prepared in accordance with U.S. generally acceptedaccounting principles for interim financial statements. The preparation ofthese condensed consolidated financial statements requires us to make estimatesand judgments that affect the reported amounts of assets, liabilities, revenueand expenses, and related disclosure of contingent assets and liabilities. Onan on-going basis, we evaluate our estimates, including those affecting revenuerecognition, the allowance for doubtful accounts, inventory valuation,intangible assets, income taxes and general business contingencies. We base ourestimates on historical experience and on various other assumptions that webelieve to be reasonable under the circumstances, the results of which form ourbasis for making judgments about the carrying values of assets and liabilitiesthat are not readily apparent from other sources. Actual results may differfrom these estimates under different assumptions or conditions.

 

**Results of Operations**

 
| ** **                                 | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------|------------|-----------------------------------|------------|
| ** **                                 | ** ** | **2006**                          | ** ** | **2005** | ** ** |
| Net sales                                  |       | $                                 | 58,564     |   | $ | 39,945 |   |
| Gross profit                               |       | 19,629                            |       | 13,335 |   |
|                                       |       |                              |       |   |   |
| Selling, general and administrative        |       | 14,760                            |       | 9,545 |   |
| Research and development                   |       | 3,256                             |       | 1,955 |   |
| Restructuring costs                        |       | 150                               |       | — |   |
| Total operating  expenses                  |       | 18,166                            |       | 11,500 |   |
|                                       |       |                              |       |   |   |
| Other expense                              |       | (1,998                            | )          | (1,313 | ) |
| Provision for income taxes                 |       | 60                                |       | 26 |   |
| Income (loss) from continuing operations   |       | (595                              | )          | 496 |   |
| Recognized gain on discontinued operations |       | —                            |       | 2,827 |   |
| Net income (loss)                          |       | $                                 | (595       | ) | $ | 3,323 |   |

 

***Three Months Ended March 31, 2006 vs. Three MonthsEnded March 31, 2005***

 

*Net Income (Loss)*

 

Results of operations in the first quarter of 2006 showed a net loss of$0.6 million, a decrease of $3.9 million from net income of $3.3 million in thefirst quarter of 2005.  The net income inthe first quarter of 2005 included a gain, net of tax, from the discontinuedoperations of our former Italian subsidiary of $2.8 million.  Operating income for the first quarter of2006 was $1.5 million compared to $1.8 million in the first quarter of2005.  The decrease results primarilyfrom a $6.7 million increase in operating expenses in the first quarter of 2006primarily reflecting a full quarter of St. Louis Music costs, higher tradeshowcosts, one-time costs associated with the shift to direct sales distribution ofMackie products in North America, restructuring costs related to reductions inworkforce in engineering and manufacturing, and compensation expense related tothe adoption of SFAS No. 123R. Finally, our interest expense was $0.8 millionhigher in the first quarter of 2006 than in the corresponding period of 2005,due primarily to an increase in the amount of outstanding debt in connectionwith the acquisition of St. Louis Music.

 

*Net Sales*

 

Net sales from continuing operations increased by 46.6% to $58.6million during the three months ended March 31, 2006 from $39.9 million in thecomparable period in 2005, due in part to the inclusion of a full quarter ofrevenues from historical St. Louis Music brands in 2006, which we acquired onMarch 4, 2005.  Sales of historical LOUDbrand products increased 16.0% to $39.2 million for the three months endedMarch 31, 2006, from $33.8 million for the comparable period in 2005.  This increase primarily relates to increasedproduct availability from our contract manufacturers and the introduction ofnew products.  Sales of historical St.Louis Music brand products increased to $19.4 million for the three monthsended March 31, 2006, from $6.1 million for the comparable period in 2005,primarily relating to having a full quarter of historical St. Louis Music brandsales in 2006.

 

15

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We anticipate introducing and shipping new products during theremainder of 2006, resulting in increased revenues the second half of 2006 ascompared to 2005.  Future quarterlycomparisons will also include a full quarter of historical St. Louis Musicbrands in each year.

 

*Gross Profit*

 

Gross profit increased to $19.6 million, or 33.5% of net sales, in thethree months ended March 31, 2006 from $13.3 million, or 33.4% of net sales, inthe three months ended March 31, 2005.   The increase in gross profitis attributable to the increase in sales volume.  The limited change in gross profit percentageresulted primarily from increases in the gross margin percentages of historicalLOUD brand products due to the continuing benefit of outsourcing our productionoverseas, offset by a larger percentage of lower margin historical St. LouisMusic brand sales.

 

We expect our gross margin percentage to remain in the 32% - 35% rangein future quarters.

 

*Selling, General and Administrative*

 

Selling, general and administrative expenses increased by $5.3 millionto $14.8 million in the three months ended March 31, 2006 from $9.5 million inthe comparable period in 2005.  The 54.6%increase was primarily attributable to a full quarter of St. Louis Musicexpenses, higher tradeshow costs stemming from the timing of major events in2006, and one-time costs associated with the shift to direct sales distributionof Mackie products in North America.

 

We expect our selling, general and administrative expenses to decreasein future quarters due to lower tradeshow costs and a reduction in salescommission costs.  The reduction in salescommission costs will be primarily caused by our decision to eliminate ourrelationship with independent sales representatives who sell Mackie and Tapcobrands in the United States and Canada, and instead use an existing domesticemployee sales force that had sold, and will continue to, sell existing St.Louis Music brands.

 

*Research and Development*

 

Research and development expenses increased by $1.3 million to $3.3million in the three months ended March 31, 2006 from $2.0 million in the comparableperiod in 2005.  The increase wasprimarily attributable to a full quarter of St. Louis Music costs with theprimary increase in personnel costs.  Wehave and will continue to invest in new products and improvements to existingproducts.  Accordingly, we anticipate ourresearch and development costs will be higher the remainder of 2006 compared to2005.

 

*Restructuring Costs*

 

Restructuring costs were $0.2 million in thethree months ended March 31, 2006.  Thesecosts were primarily severance payments related to reductions in work force inour engineering and manufacturing areas. We anticipate there to be additional restructuring costs in futurequarters.

 

*Other Income (Expense)*

 

Net other expense was $2.0 million for the three months ended March 31,2006 as compared to $1.3 million for the three months ended March 31,2005.  The primary causes of thisincrease was an increase in interest expense of $0.8 million caused by anincrease in the total amount of debt primarily attributable to the acquisition ofSt. Louis Music, Inc. and an increase in the variable interest rates comparedto the first three months of 2005.

 

The majority of our debt has variable interest rates, and the interestexpense component of other income (expense) in future quarters will be affectedby changing interest rates.

 

*Income Taxes*

 

Income tax expense for the first quarter of 2006 was $60,000 comparedto $26,000 for the comparable period in 2005. The 2006 taxes primarily relate to our non-U.S. subsidiaries. No benefitwas recognized in connection with our 2006 losses as recognition of suchbenefits depended on future profits, which are not assured.   The primary component of the 2005 tax isfrom our U.S. entities.  The 2005 amountis computed by applying the Alternative Minimum Tax rate to the taxable incomewe are unable to apply towards our NOLs.

 

*Recognized Gain on DiscontinuedOperations*

 

In March 2005, we recognized a $2.8 million gain from the discontinuedoperations of our former Italian subsidiary, net of tax of $0.1 million.   This gain was a result of a settlementagreement with Mackie Italy to settle any net outstanding amounts owed by theCompany.

 

16

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**Liquidity and Capital Resources**

 

In February 2005, we made an offer to Mackie Italy to settle anyoutstanding amounts owed by the Company to Mackie Italy for $4.7 million.  This proposal was accepted by the Italiancourt appointed trustee on behalf of Mackie Italy in May 2005.  Under the terms of the settlement agreement,we made additional payments of $2.5 million during 2005.  We also committed to pay $2.2 million during2006.  We recognized a pre-tax gain ondiscontinued operations of $2.9 million in the first quarter of 2005 related tothis settlement.

 

As of March 31, 2006, we had cash and cash equivalents of $1.0 millionand total debt and short-term borrowings of $57.7 million, including $2.2million payable to our former Italian subsidiary.  At March 31, 2006 wehad availability of $22.0 million on our revolving line of credit, net of a$3.2 million standby letter of credit issued to secure the commitment to paythe former shareholders of St. Louis Music, Inc.

 

*Net Cash Used in OperatingActivities*

 

Cash used in operating activities was $0.4 million in the three monthsended March 31, 2006, compared to $1.9 million for the comparable period in2005. Net loss for the first three months of 2006 was $0.6 million thatincluded $1.1 million in depreciation and amortization and $0.2 million inamortization of deferred financing fees. In the first three months of 2006, an increase of our accountsreceivable used cash of $2.6 million, while a decrease to prepaid expenses andother current assets and an increase to accounts payable and accrued expensesof $0.4 million and $1.1 million, respectively, provided cash.  Net cash used by operating activities in thefirst three months of 2005 was primarily attributable to decreases in accountspayable and other accrued expenses of $8.0 million, and the recognized gain ondiscontinued operations of Mackie Italy of $2.9 million, partially offset bydecreases in inventories and prepaid and other current assets and increases inother liabilities of $1.5 million, $0.7 million and $3.0 million, respectively.

 

*Net Cash Used in InvestingActivities*

 

Cash used in investing activities was $0.7 million for the first threemonths of 2006 and $35.0 million for the first three months of 2005. The cashused in investing activities for the first three months of 2006 related to thepurchases of capital expenditures.  Thecash used in investing activities in 2005 was primarily related to theacquisition of St. Louis Music, Inc. of $34.6 million.

 

*Net Cash Provided by FinancingActivities*

 

Cash provided by financing activities was $1.6 million during the firstthree months of 2006, compared to $37.3 million during the first three monthsof 2005.  Cash provided in the first three months of 2006 is primarilyattributable to an increase in our borrowings from our bank line of credit of$3.0 million partially offset by payments made on our long-term debt of $1.3million.  Financing activities during thefirst quarter of 2005 related primarily to the acquisition of St. Louis Music,Inc. resulting in a new demand credit facility of $35.1 million.  In addition, this increase was due to netborrowings on our line of credit of $2.2 million.

 

*Ability to stay in compliance withdebt covenants*

 

Under the terms of the line of credit and subordinated loan agreements,we are required to maintain certain financial ratios, such as measuring ourEBITDA to our total debt and senior debt, and maintaining a certain fixedcharge coverage ratio.  The agreementalso provides, among other matters, restrictions on additional financing,dividends, mergers, acquisitions, and an annual capital expenditure limit.  As of March 31, 2006, we met all of ourcovenant requirements and we believe we will continue to meet theserequirements each quarter thereafter in 2006.

 

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*Commitments*

 

We had the following material contractual commitments related tooperating leases for equipment facilities at March 31, 2006.  Inaddition, we had material obligations related to short-term and long-term debtarrangements, excluding our accounts payable, accrued liabilities and taxespayable of $28.5 million at March 31, 2006:

 
| ** **                                                                                    | ** ** | **Payments due by period (dollars in thousands)** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **Total**                                         | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5+ years** | ** ** |
|                                                                                          |       |                                              |       |   |   |   |   |   |   |   |   |
| Operating leases                                                                              |       | $                                                 | 9,069      |   | $ | 2,293 |   | $ | 3,682 |   | $ | 2,428 |   | $ | 666 |   |
| Lines of credit                                                                               |       | 12,565                                            |       | 12,565 |   | — |   | — |   | — |   |
| Payable to former Italian subsidiary                                                          |       | 2,200                                             |       | 2,200 |   | — |   | — |   | — |   |
| Future  commitment to pay  former shareholders of  St. Louis Music, Inc.,  including interest |       | 3,188                                             |       | 3,188 |   | — |   | — |   | — |   |
| Short-term and long-term debt                                                                 |       | 42,928                                            |       | 2,645 |   | 5,790 |   | 12,855 |   | 21,638 |   |
| Total                                                                                         |       | $                                                 | 69,950     |   | $ | 22,891 |   | $ | 9,472 |   | $ | 15,283 |   | $ | 22,304 |   |

 

We believe we have adequate resources to meet our obligations as theycome due through December 31, 2006.

 

**Item3.  Quantitative and Qualitative Disclosures About Market Risk**

 

We are exposed to various market risks, including fluctuations inforeign currency rates and interest rates. We may enter into various derivativetransactions to manage certain of these exposures; however, we did not have anyderivative financial instruments as of March 31, 2006.

 

At March 31, 2006, we had variable rate lines of credit withoutstanding balances of $12.6 million. In addition, our $28.2 million termloans also had variable interest rates. As such, changes in U.S. interest rates affect interest paid on debt andwe are exposed to interest rate risk. For the quarter ended March 31, 2006, anincrease in the average interest rate of 10%, i.e. from 8.26% to 9.09%, wouldhave resulted in an approximately $84,000 increase in net loss before incometaxes.  The fair value of such debt approximates the carrying amount onthe consolidated balance sheet at March 31, 2006.

 

A substantial majority of our revenues are denominated in U.S. Dollars,and during the three months ended March 31, 2006 approximately 10% of ourrevenues were denominated in foreign currencies.  We ordinarily do not engage in hedging, rateswaps, or other derivatives as a means to minimize our foreign currency riskand, instead, mitigate that exposure by limiting the portion of our sales thatare denominated in other than U.S. Dollars. Assuming the same level of foreign currency denominated sales as in thefirst three months of 2006, a 10% decline in the average exchange rates for allthese currencies would have caused a decline of approximately $547,000, or 1%,of our revenues.

 

**Item4.  Controls and Procedures**

 

The Company maintains disclosure controls and procedures (as defined inRules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, asamended, (the “Exchange Act”)) that are designed to ensure that informationrequired to be disclosed in the Company’s reports under the Exchange Act, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure.

 

The Company carried out an evaluation, under the supervision and withthe participation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of theCompany’s “disclosure controls and procedures” as of the end of the periodcovered by this report, pursuant to Rules 13a-15(b) and 15d-15(e) under theExchange Act.  Based on that evaluation,the Company’s Chief Executive Officer and Chief Financial Officer haveconcluded that the Company’s disclosure controls and procedures, as of the endof the period covered by this report, were effective in timely alerting them tomaterial information relating to the Company required to be included in theCompany’s periodic SEC filings.

 

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There has been no change in the Company’s internal control overfinancial reporting (as defined in Rules 13(a)-15(f) and 15(d)-15(f) under theExchange Act) during the period covered by this report that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**PARTII.  OTHER INFORMATION**

 

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

 

We are a defendant in a lawsuit filed in the Southern District ofFlorida on November 29, 2005 by Ace Pro Sound and Recording, L.L.C.  The lawsuit alleges various federal and stateantitrust violations, as well as common-law (misrepresentation) claims.  We believe the claims are without merit andwe intend vigorously to defend the lawsuit.

 

In addition to the case noted above, we are also involved in variouslegal proceedings and claims that arise in the ordinary course ofbusiness.  We currently believe thatthese matters will not have a material adverse impact on our financialposition, liquidity or results of operations.

 

##### **Item 1A.  Risk Factors**

 

Information regarding risk factors appears in the first paragraph inPart I – Item 2 of this Form 10-Q and in Part I – Item 1A of our Report on Form10-K for the fiscal year ended December 31, 2005 (the “2005 10-K”).  There have been no material changes from therisk factors previously disclosed in the 2005 Form 10-K.

 

**Item2.  Unregistered Sales of Equity Securities and Use of Proceeds**

 

None.

 

**Item3.  Defaults upon Senior Securities**

 

None.

 

**Item4.  Submission of Matters to a Vote of Security Holders**

 

None.

 

**Item 5. Other Information**

 

None.

 

**Item6.  Exhibits**

 

Exhibits

 

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

 

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

 

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

 

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**SIGNATURES**

 

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

 

 
|                      | ** ** | **LOUD Technologies Inc.**                                                                                                 |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|
|                      |       | (Registrant)                                                                                                               |
|                      |       |                                                                                                                       |
| Dated:  May 15, 2006 | By:        | /s/ James T. Engen                                                                                                         |
|                      |       | James T. Engen                                                                                                             |
|                      | * *   | *Chairman, President and Chief  Executive  Officer*                                                                        |
|                      |       |                                                                                                                       |
| Dated:  May 15, 2006 | By:        | /s/ Timothy P. O’Neil                                                                                                 |
|                      |       | Timothy P. O’Neil                                                                                                     |
|                      | * *   | *Chief Financial Officer, Senior  Vice  President, Secretary and**Treasurer (Principal Financial and**Accounting Officer)* |

 

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**EXHIBITINDEX**

 
| **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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