UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-KFOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

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

For the fiscal year ended December 31, 2003
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 000-22207

GUITAR CENTER, INC.

(Exact name of registrant as specified in charter)

Delaware(State or other jurisdiction of
incorporation or organization)

95-4600862(I.R.S. Employer Identification Number)5795 Lindero Canyon Road
Westlake Village, California

91362(Zip Code)(Address of principal executive offices)


Registrant's telephone number, including area code:(818) 735-8800

Securities
registered pursuant to 12(b) of the Act: None

Securities
registered pursuant to 12(g) of the Act: Common Stock, $.01 par value(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o

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

As of March 5, 2004, the aggregate market value of voting stock held by nonaffiliates of the Company was approximately
$689,800,000 (based upon the last business day of the Registrant's most recently completed second fiscal quarter sales price of the Common Stock as reported by the Nasdaq National Market). Shares of
Common Stock held by each executive officer, director and each person or entity known to the Registrant to be affiliates of the foregoing have been excluded in that such persons may be deemed to be
affiliates. This assumption regarding affiliate status is not necessarily a conclusive determination for other purposes.

As of March 5, 2004, there were 24,317,581 shares of Common Stock, par value $.01 per share, outstanding.

Portions of the Proxy Statement for the annual stockholders' meeting scheduled to be held on April 29, 2004 are incorporated by reference into Part III.

The
Exhibit Index appears on page 47.



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PART I

Item 1. BUSINESS

Company History

Guitar Center, Inc. was founded in 1964 in Hollywood, California. Our flagship Hollywood store currently is one of the nation's largest and
best-known retail stores of its kind with approximately 30,600 square feet of retail space. The Hollywood store features one of the largest used and vintage guitar collections in the
United States, attracting buyers and collectors from around the world. In front of the Hollywood store is the Rock Walk which memorializes over 200 famous musicians and music pioneers. The Rock Walk
attracts several tour buses daily and has helped to create international recognition of the Guitar Center name. In 1972, we opened our second store in San Francisco to capitalize on the emerging San
Francisco rock 'n roll scene. By this time, our inventory had been expanded to include drums, keyboards, accessories, and pro-audio and recording equipment.

Throughout
the 1980s, we expanded by opening nine stores in five major markets, including Chicago, Dallas and Minneapolis. Since 1990, we have continued our new store expansion and have
focused on building the infrastructure necessary to manage our strategically planned growth. As of December 31, 2003, we operated 122 Guitar Center stores. Among the 14 new stores we opened in
2003 were two large "flagship" stores located in Manhattan and Nashville with 50,000 square feet of retail space in aggregate. Current executive officers and key managers have been with our company
for an average of 11 years, and our two Co-Chief Executive Officers (Mr. Larry Thomas, our Chairman and Co-Chief Executive Officer, and Mr. Marty
Albertson, our President and Co-Chief Executive Officer) effectively assumed full operating control in 1992. Since then, we have focused on developing and realizing our
long-term goal of expanding our position as the leading music products retailer throughout the United States.

In
May of 1999, we merged with Musician's Friend, Inc. Musician's Friend, a separate business unit of our company, operates the largest direct response channel (catalog and
e-commerce) in the musical instruments industry in the United States. Robert Eastman, Chief Executive Officer of Musician's Friend, has been with the company for 20 years.

In
April of 2001, we acquired the assets of American Music Group, Ltd. and related companies, a leading musical instrument retailer specializing in the sale and rental of band
instruments and accessories. American Music operates as a retail business and serves the student and family market through its 19 band instrument retail stores. David Fleming is the President and
Chief Operating Officer of American Music and has been with the company for 28 years.

We
are a Delaware corporation with our principal executive offices located at 5795 Lindero Canyon Road, Westlake Village, California 91362, and our telephone number is
(818) 735-8800. We maintain several corporate websites, including www.guitarcenter.com, however none of the information contained on our websites is incorporated into this annual
report. Our periodic and current reports are available, free of charge, on the website noted above at a reasonable time following the filing with the SEC. Whenever we refer to the "Company" or to
"us," or use the terms "we" or "our" in this annual report, we are referring to Guitar Center, Inc. and its subsidiaries.

Industry Overview

The United States retail market for music products in 2002 was estimated in a study by the National Association of Music Merchants, or NAMM, to be approximately
$7.0 billion in net sales, representing a five-year compound annual growth rate of 2.1%. The broadly defined music products market, according to NAMM, includes retail sales of
string and fretted instruments, sound reinforcement and recording equipment, drums, keyboards, print music, pianos, organs, and school band and orchestral instruments. Products currently offered by us
include categories of products which

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account
for approximately $5.8 billion of the estimated $7.0 billion of this market's sales, representing a five-year compound annual growth rate of 6.2%. The music products
market, as currently defined by NAMM, however, does not include the significant used and vintage product markets or apparel markets in which we actively participate.

Included
in the $7.0 billion of estimated industry sales is the school music market estimated at $572 million in the United States and industry trends and positive
demographic trends suggest that the school music market will continue to grow. According to published reports, school band enrollments
have risen and publicity linking music making and improved academic performance has improved prevailing attitudes towards music and music education.

According
toThe Music Tradesmagazine, the industry is highly fragmented with the nation's five leading music products retailers, as
measured by the amount of sales generated by such retailers (i.e., Guitar Center, Brook Mays/H&H, Sam Ash Music Corp., Hermes Music and Victor's House of Music), accounting for approximately 25.8% of
the industry's estimated total sales in 2002. The list of leading retailers excludes Mars Music, which was liquidated in the fourth quarter of 2002. There are approximately 8,400 retailers in the
industry. According to Music USA 2003, a typical music products store averages approximately 5,500 square feet and generates an average of approximately $1.2 million in annual net sales. In
contrast, our standard large format Guitar Center stores generally range in size from 12,000 to 30,000 square feet, and in 2003 these stores generated an average of approximately $9.2 million
in annual net sales for stores open the full year.

Over
the past decade, technological advances in the industry have resulted in dramatic changes to the nature of music-related products. Manufacturers have combined computers and
microprocessor technologies with musical equipment to create a new generation of products capable of high grade sound processing and reproduction. Products featuring those technologies are available
in a variety of forms and have broad application across most of our music product categories. Most importantly, rapid technological advances have resulted in the continued introduction of higher
quality products offered at lower prices, and this trend is continuing. Today, an individual consumer can affordably create a home recording studio which interacts with personal computers and is
capable of producing high-quality digital recordings. Until recently, this type of powerful sound processing capability was expensive and was typically purchased primarily by professional
sound recording studios.

Business

Of the 122 Guitar Center stores we operated at December 31, 2003, 107 were located in 45 major U.S. markets, including, among others, areas in or near Los
Angeles, San Francisco, Chicago, Miami, Houston, Dallas, Detroit, Boston, Minneapolis, Seattle, Phoenix, Atlanta, New York, Denver and Cleveland, and 15 stores were located in secondary markets. We
also operated 19 American Music stores. From 1999 to 2003, our net sales grew at an annual compound growth rate of 19%, principally due to comparable store sales growth averaging 7% per year, the
opening of new stores, and a 31% increase in the direct response channel. We achieved comparable store sales growth of 7%, 6%, and 6% for the fiscal years ended December 31, 2003, 2002 and
2001, respectively. Comparable store sales are defined as sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of the reporting
period.

For
the fiscal years ended December 31, 2003, 2002 and 2001, we had net income of $36.9 million, $25.3 million and $17.0 million, respectively.



At our Guitar Center stores, we offer a unique retail concept in the music products industry, combining an interactive, hands-on shopping experience
with superior customer service and a broad selection of brand name, high-quality products at guaranteed low prices. We create an entertaining and

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exciting
atmosphere in our stores with bold and dramatic merchandise presentations, highlighted by bright, multi-colored lighting, high ceilings, music and videos. Based on market research conducted
by us, we believe approximately 73% of our Guitar Center store sales are to professional and aspiring musicians who generally view the purchase of music products as a career necessity. These
sophisticated customers rely on our knowledgeable and highly trained salespeople to answer technical questions and to assist in product demonstrations.

Our
standard large format Guitar Center store generally ranges in size from 12,000 to 30,000 square feet (as compared to a typical music products retail store which averages
approximately 5,500 square feet) and is designed to encourage customers to hold and play instruments. In late 2000, we opened our first smaller format store, and have since opened 14 additional small
format stores. We plan to continue to open additional stores using this format of approximately 8,000 to 10,000 square feet to serve secondary markets. Each large format store carries an average of
12,000 core stock keeping units, or SKUs, and each small format store carries an average of 7,000 core SKUs, which in each case our management believes is significantly greater than a typical music
products retail store. Our core SKUs represent our consistent and established product lines which are considered staple products for our customers. Our stores are organized into five departments, each
focused on one product category. These departments cater to a musician's specific product needs and are staffed by specialized salespeople, many of whom are practicing musicians. We believe this
retail concept differentiates us from our competitors and encourages repeat business.

We
opened a total of 14 Guitar Center stores in 2003, and presently expect to open approximately 16 to 18 additional Guitar Center stores in 2004. Approximately half of the stores
planned for 2004 are expected to be smaller format units designed for secondary markets.

The
following summarizes key operating statistics of our Guitar Center stores and is based upon the stores operated by us for the full year ended December 31:

2003

2002Number of stores operated for the full year


108


96Average net sales per square foot

$
560

$
546Average net sales per store

$
8,720,000

$
8,616,000Average store-level operating income

$
1,113,000

$
941,000Average store-level operating income margin


12.8
%

10.9
%


The
above key operating statistics are based upon results of Guitar Center retail stores in operation for at least 12 months as of December 31, 2003 and 2002, respectively.
Average net sales per square foot, which increased $14 in the current year, is a measure of sales efficiency based on square footage. Average net sales per store represents the average result of
stores open more than 12 months, and is typically affected by the opening of small format stores which generate lower levels of sales. Although small format stores generate lower levels of
sales, these stores cost less to build, stock and operate than our large format stores. Store-level operating income and margin includes individual store revenue and expenses plus allocated rebates,
cash discounts and purchasing department salaries (based upon individual store sales).

Our
Guitar Center retail growth strategy is to continue to increase our presence in our existing markets and to open new stores in strategically selected markets. We will continue to
pursue our strategy of clustering stores in major markets to take advantage of operating and advertising efficiencies and to build awareness of our name in new markets.

Our
distribution center in Indianapolis, Indiana supports our Guitar Center retail store operations. The facility commenced operations in July 2002. We have a 10-year
agreement to lease the facility and have agreements to lease equipment to support its operations. In 2003, nearly all product flowed through this distribution facility with the exception of special
orders which will continue, for the most

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part,
to be drop shipped to our stores. Completion of the migration from our former "drop-ship" model to a centralized distribution model is an important development in our operating
strategy and has required the allocation of significant financial and managerial resources. In accordance with generally accepted accounting principles, a portion of the costs of operating this
facility are absorbed into our Guitar Center merchandise inventories and recognized as an element of cost of goods sold when the related inventory is sold. This could result in a slight decrease in
reported gross margin depending on our success in defraying these additional costs, although we also hope to realize efficiencies involving other costs such as selling, general and administrative and
interest expense.

Our
American Music division operates family music stores, retailing band and orchestral instruments, introductory guitars, percussion instruments and keyboards, as well as the related
accessories. This division also rents its instruments on site and through "satellite stores" operated by third party musical instrument dealers. The principal market for American Music is the school
band market. During 2002, we added a significant number of guitar, percussion, pro audio, keyboard and accessory products to the American Music retail stores, as we repositioned American Music as a
family music store capable of fulfilling a wider array of consumer needs. As of December 31, 2003, American Music operated 19 stores located in New York, Maine, Florida, Massachusetts,
Illinois, Arizona, Nevada and Georgia. During 2002, we opened three American Music stores, and acquired five M&M Music stores which were rebranded as American Music stores. In 2003, we opened one and
closed two American Music stores. In 2004, we do not plan to open any additional American Music stores. We have slowed our planned growth of the American Music division because our infrastructure and
remerchandising projects at this business have to date required more time and resources than originally anticipated. We do, however, believe there exists a number of acquisition opportunities in the
relatively fragmented band instruments market that could be a good fit into our American Music platform and continue to pursue acquisition opportunities. AMG retail stores range from 1,400 to 10,000
square feet, with an average store size of approximately 4,800 square feet.



Our Musician's Friend subsidiary, which operates as a separate business unit, is an integrated e-commerce and catalog business. Musician's Friend
offers musicians a shopping experience that satisfies the need for technical product information, confirmation of needs by a live person, quick and efficient service, and a musician-based staff for
after-sale support. Our catalogs present a fresh assortment of products and promotions throughout the year, mixing big name products with unique and practical offerings. The Musician's
Friend website, www.musiciansfriend.com, offers all that is shown in our catalogs and more, supported by the same service and staff.

The
Musician's Friend business is based in Medford, Oregon and is supported by a customer contact center located in Salt Lake City, Utah and a distribution facility located in Kansas
City, Missouri.

Our
customer contact staff receives product and customer service training in the Salt Lake City call center facility. Extensive product information, including technical information,
product features and benefits, and real-time stocking information is available to the staff on their desktop systems via intranet and back-end information systems. A staff of
over 180 associates is trained and ready to respond to questions to help ensure that customers can purchase confidently. Website visitors are treated to a constantly updated and evolving, information
rich shopping experience that includes product availability and purchase recommendations generated through collaborative filtering processes. Questions regarding products can be submitted
electronically, or the musician can call the support center directly. Our customer service telephone staff for returns is located in the Kansas City distribution center where they can be closer to the
returns process while assisting customers.

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Orders,
whether taken electronically or by an associate in our customer contact center, are processed by our automated transaction system and generally ship within 24 hours. In
2002 our Kansas City distribution center was expanded by 100,000 square feet to its present 241,000 square feet. Initiatives were completed to improve inventory management and reduce outbound shipping
costs. We have implemented sophisticated inventory planning systems to help ensure that products are in-stock with the goal of maintaining a high initial line item fill rate. The initial
line item fill rate reflects the percentage of items ordered by our customers that we are able to supply in the initial shipment to that consumer. Split shipments of a single order impose additional
shipping, handling and materials costs on us when compared to being able to fulfill an entire order in a single shipment. The technology on our website also permits our customers to monitor their
orders online by accessing the UPS and FedEx tracking services.

The
focus of the Musician's Friend business strategy is to increase market share in the non-bricks and mortar retail segment of our industry. Our mailing and
e-mail lists give us a significant base from which to grow. Our catalog circulation, which is broader than any other direct-mail circulation in our industry, provides a unique
advertising and marketing platform for e-commerce.

Our
business plan is to continue to leverage our leading industry position and existing infrastructure, and to build on that base to support the continued growth in
e-commerce. We believe that our leadership position and established direct marketing model leverages both Internet and direct mail mechanics to provide a significant competitive advantage.
We also believe that there may be opportunities to acquire complementary direct response businesses and regularly investigate such opportunities.

Business Strategy



The goal in the retail stores business is to continue to expand our position as the leading music products retailer throughout the United States. The principal
elements of our business strategy are as follows:



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The goal of the e-commerce and catalog business unit is to capitalize and expand on our leadership position. Our extensive customer database is used
to design effective marketing campaigns. The presentation of an extensive selection of products and continual and informative contact with prospects and customers provides attention grabbing content
designed to generate results. In 2003 we circulated over 16 million catalogs and sent over 110 million e-mails to prospects and customers. The call center fielded over
1.9 million calls during 2003, and hosted over 64,000 live chat sessions.

Our
key business strategies include the following:



Retail Merchandising

Our merchandising concept differentiates us from most of our competitors. Guitar Center offers merchandise at guaranteed low prices and utilizes aggressive
marketing and advertising to attract new customers and maintain existing customer loyalty. American Music focuses on the family music market, particularly band instruments. The principal elements of
our merchandising philosophy are as follows:



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Retail Store Operations

To facilitate our strategy of accelerated but controlled growth, we have centralized many key aspects of Guitar Center store operations, including the development
of policies and procedures, accounting systems, training programs, store layouts, purchasing and replenishment, advertising and pricing. Such centralization utilizes the experience and resources of
our headquarters staff to establish a high level of consistency throughout all of our stores.

Our
Executive Vice President of Stores, 3 regional managers and 15 district sales managers manage the Guitar Center retail stores. Store management is normally comprised of a store
manager, a sales manager, an operations manager, two assistant store managers and five department managers. Each store also has a warehouse manager and a sales staff that ranges from 20 to 40
employees. Retail store operations for American Music are led by the Vice President of Retail and the educational sales are led by the Vice President of Education. Store management is comprised of a
store manager, assistant store manager, educational representative and related sales and support staff.

We
ensure that store managers are well trained and experienced individuals who will maintain our store concept and philosophy. Each manager completes an extensive training program that
instills the values of operating as a business owner, and only experienced store employees are promoted to the position of store manager. We seek to encourage responsiveness and entrepreneurship at
each store by providing store managers with a relatively high degree of autonomy relating to operations, personnel and merchandising. Managers play an integral role in the presentation of merchandise,
as well as the promotion of our reputation.

We
view our employees as long-term members of our team. We encourage employee development by providing the sales force with extensive training and the opportunity to increase
both compensation and responsibility level through increased product knowledge and performance. Our aggressive growth strategy provides employees with the ability to move into operations, sales and
store management positions, an opportunity which management believes is not available at most other music retailers. As we open new stores, the qualified and experienced employees from existing stores
primarily fill key in-store management positions. By adopting a "promotion from within" strategy, we maintain a well-trained, loyal and enthusiastic sales force that is
motivated by our strong opportunities for advancement. Larry Thomas and Marty Albertson, our Chairman and Co-Chief Executive Officer and President and Co-Chief Executive
Officer, respectively, each began their careers as salespersons at Guitar Center.

Marketing and Promotion

We maintain three unique and proprietary databases (Guitar Center, Musician's Friend and American Music) containing information on over 10 million
customers, including approximately 2 million customer names which were purchased in early 2003 from Mars Music at an auction conducted in connection with that company's bankruptcy proceedings.
We believe that these databases assist in identifying customer prospects and in generating repeat business by targeting consumers based on their purchasing history and by permitting us to establish
and maintain personal relationships with our customers.

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For the Guitar Center retail stores, our advertising and promotion strategy is designed to enhance the Guitar Center name and increase consumer awareness and
loyalty. The advertising and promotional campaigns are developed around "events" designed to attract significant store traffic and exposure. We regularly plan large promotional events including the
Green Tag Sale in March, the Anniversary Sale in August and the Guitar-a-thon in November. We believe that our special events have a broad reach as many of them have occurred
annually during the past 21 years. These events are often coordinated with product demonstrations, interactive displays, clinics and in-store artist appearances. Cooperative
advertising and in-store training from our major vendors ensures that our customers are kept current with trends presented by the latest music gear.

As
we enter new markets, we initiate an advertising program, including mail and radio promotions, television and Internet campaigns, and other special grand opening activities, designed
to accelerate sales volume for each new store. Radio advertising plays a significant part in our store-opening campaign to generate excitement and create customer awareness.

Generally,
all credit made available to retail customers and all extended payment arrangements are provided by third party consumer credit companies which are non-recourse to
us, meaning that the risk of non-payment is borne by the third party provider so long as we comply with its administrative and approval policies. These arrangements also give us the
flexibility to offer attractive payment options to our customers on a promotional basis, such as no interest periods, reduced interest rates or deferred payment options. These programs are also
non-recourse to us, but we pay the credit provider a fee reflecting the below-market, promotional benefit of the particular program.

For
the American Music retail stores, our advertising efforts are focused primarily on the school band market and community. For instrument rental the advertising and promotional
campaigns are developed around "rental nights" designed to display our orchestral and band instruments at elementary and high schools. These events attract band directors, music educators, parents and
students. Our key promotional events are held primarily from August through October. In addition to "rental nights," we also have education representatives that travel around the country to promote
and educate band directors on our instruments and our sales and rental programs. We maintain long-term relationships with educators in order to provide visibility to our products and
obtain access to student musicians.



We maintain a stream of communication in electronic and print media, presenting consumers with an optimized and refreshed mix of offers. Extensive analysis of
customer behavior and transactions along with the industry expertise of our merchandising staff provides our marketing staff with offers carefully targeted for optimal response. Cooperative
advertising and on-going training with key industry suppliers ensures that Musician's Friend customers are kept current with trends and the latest music gear.

The
same transactional databases that make accurate market targeting available for catalog and e-mail circulation are enhanced by the information archived from our website
traffic. With the use of an analytical engine developed by Net Perceptions, and continued development of additional tools, our merchandising and marketing departments are able to present relevant and
personalized product and promotional offerings to prospects.

Musician's
Friend also offers its customers private label credit card programs on non-recourse terms comparable to those offered by Guitar Center. These programs include the
Platinum Card offered by Musician's Friend and the new Clef Card offered for customers of the Giardinelli band

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instruments
catalog. These credit cards permit us to offer carefully tailored competitive promotional opportunities to our customers.

Our
plans for Musician's Friend include the development of catalogs targeted towards particular segments of the musician market. In 2002, Musician's Friend took over production of two
small catalogs from the American Music division. The LMI Catalog is oriented toward young, school-aged children and the Giardinelli Catalog is targeted to band and orchestra buyers. In
2003, we introduced the Musician's Friend keyboard catalog adding to our exiting percussion and DJ specialty catalogs.

We
believe that there may be opportunities to acquire complementary direct response businesses and are also examining opportunities to use the Internet to expand further the reach of our
brands. For example, in early 2003 we purchased the principal assets ofMarsmusic.com, including the URL address and hardware. New opportunities are
being created by the rapid development of auction, content and community sites oriented towards music and musicians.

Customer Service



Exceptional customer service is fundamental to our operating strategy. With the rapid changes in technology and continuous new product introductions, customers
depend on salespeople to offer expert advice and to assist with product demonstrations. We believe that our well-trained and knowledgeable sales force differentiates us from our
competitors and is critical to maintaining customer confidence and loyalty. Our employees are typically musicians trained to understand the needs of our customers. Guitar Center store salespeople
specialize in one of our six product categories and begin training on their first day of employment. Guitar Center store sales and management training programs are implemented on an ongoing basis to
maintain and continually improve the level of customer service and sales support in the stores. We believe that our employee testing program impresses upon our salespeople a sense of professionalism
and reduces employee turnover by providing salespeople with the opportunity to increase their salaries by advancing through the certification program. We believe that due to our emphasis on training,
we are able to attract and retain well-qualified, highly motivated salespeople committed to providing superior customer service.

Our
Guitar Center store customer base consists of the professional or aspiring musician who makes or hopes to make a living through music and the amateur musician or hobbyist who views
music as recreation. Management estimates that professional and aspiring musicians, who generally view the purchase of musical products as a career necessity, represent approximately 58% of our
customer base, and account for approximately 73% of our sales. These customers make frequent visits to a store and develop relationships with the sales force. We generate repeat business and are
successful in utilizing our unique and proprietary database to market selectively to these customers based on past buying patterns. In addition, we service touring professionals, providing customized
products for musical artists.

The
majority of our educational representative sales force at American Music is composed of music teachers who are experienced band instructors. With the introduction of the family music
store concept, we have added a limited retail sales force. The customer base of American Music has historically consisted of band directors, music educators, college professors who are involved in
music education and students of music education programs.



Musician's Friend maintains a staff of over 180 contact center customer service associates, staffing the contact center
24-hours-a-day, seven-days-a-week. Customers can contact agents via phone, e-mail, live chat or fax for questions
regarding products, technical information or the status of their orders. Most of the staff is comprised of musicians who are given extensive and ongoing product training. The

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Salt
Lake City contact center houses an extensive product demonstration area and training facility. In-house technical staff as well as manufacturers' representatives conduct weekly
product training.

We
maintain a database of product information for use by the agents in our contact center that is always available on our corporate intranet. The intranet also makes operational and
instructional information available to agents, minimizing their downtime and maximizing their ability to service customer needs effectively. All of this information, along with customer account
information, is available in real time, giving agents the ability to keep customers constantly up to date.

The
website is updated every 15 minutes with new product information so customers can work with the latest available data. As this is an area that is constantly evolving, customers are
continually presented with new and more extensive information. In addition, the collaborative filtering process results in customized product recommendation to customers browsing the website. The
website is continuously improved for customer ease and in 2003 Musician's Friend web site was named as one of the top 10 web sites in the country for customer service by E-Tailing Group.

To
provide the customer with a high degree of satisfaction, customers may return items for a full refund within 45 days of purchase. Additionally, if customers find a lower
advertised price within 45 days of purchase, we will match the competitor's advertised price.

For
customers that have registered e-mail addresses with us, we offer automated order and shipment verification. This provides customers with UPS or FedEx order tracking
information as soon as their shipment has been processed.

Direct Response Order Fulfillment

Musician's Friend orders are fulfilled out of the company-operated distribution center located in Kansas City, Missouri, which became fully operational in 2001.
In 2002, we expanded the facility to 241,000 square feet, adding another 100,000 square feet for bulk inventory storage.

Credit
card authorization and fraud management systems are automated, minimizing delays in processing. The distribution center processes orders taken before 5 p.m., Eastern Time,
for same-day shipping of in-stock items, minimizing delays in delivery to customers. Orders ship primarily by UPS and FedEx.

All
returns are routed to the Kansas City warehouse where repairs and quality evaluations are made. On site repair and customer service representatives assist our customers and reduce
the costs associated with returns. Returned and blemished products are sold through an outlet store located in the Kansas City facility and by offering such products at reduced prices on the
musiciansfriend.com website.

Purchasing, Distribution and Inventory Control

Purchasing.We believe that we have excellent relationships with our vendors and, in many instances,
are the vendor's largest customer. Given our high volume, we are generally able to receive prompt order fulfillment and access to our vendors' premium products. Both Guitar Center and Musician's
Friend maintain centralized buying groups. Our centralized buyers include merchandise managers, buyers, planners, replenishers and allocators. Merchandise managers and buyers are responsible for the
selection and development of product assortments and the negotiation of prices and terms. The planners, replenishers and allocators are responsible for maintaining inventory levels and allocating the
merchandise to the retail distribution center, stores and direct response fulfillment center. We use merchandise replenishment systems which automatically analyze and forecast sales trends for each
stock keeping unit, or SKU, using various statistical models, supporting the buyers by predicting merchandise requirements. This has resulted in limited "out of stock" positions while maintaining
satisfactory inventory levels.

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Our business and expansion plans are dependent to a significant degree upon our vendors. As we believe is customary in the industry, we do not have any long-term supply
contracts with our vendors. Please see "Risks Related to the BusinessWe depend on a relatively small number of manufacturers and suppliers who may not be able to or desire to
supply our requirements."

Distribution.Our distribution center in the Indianapolis, Indiana area supports our Guitar Center
retail store operations. The facility commenced operations in July 2002. We have a 10-year agreement to lease the facility. In 2003, nearly all products flowed through the
distribution facility, with the exception of special orders which will continue, for the most part, to be drop-shipped to our stores. Completion of the migration from our former
"drop-ship" model to a centralized distribution model is an important development in our operating strategy and has required the allocation of significant financial and managerial
resources. In accordance with generally accepted accounting principles, a portion of the costs of operating this facility are absorbed into our Guitar Center merchandise inventories and recognized as
an element of cost of goods sold when the related inventory is sold. This could result in a slight decrease in reported gross margin depending on our success in defraying these additional costs,
although we also hope to realize efficiencies involving other costs such as selling, general and administrative and interest expense.

We
are also evaluating additional capital and strategic requirements related to improving our fulfillment facilities and technology and pursuing new opportunities in the
e-commerce activities of Guitar Center, Musician's Friend, American Music and related businesses.

Inventory Control.We have invested significant time and resources in our inventory control system at
the Guitar Center retail stores and believe we have one of the most sophisticated systems in the music products retail industry. We believe the vast majority of music product retailers do not use a
computerized inventory management system. We perform inventory cycle counts daily, both to measure shrinkage and to update the perpetual inventory on a store-by-store basis. As
appropriate, we also stock balance inventory among stores to assure proper distribution of product and to control overall inventory levels. Our inventory shrinkage level has historically been low at
Guitar Center and Musician's Friend, which we attribute to our sophisticated system controls and strong corporate culture.

Retail Store Site Selection

We believe we have developed unique and, what historically have been, highly effective selection criteria to identify prospective store sites for our Guitar
Center units. In evaluating the suitability of a particular location, we concentrate on the demographics of our target customer as well as traffic patterns and specific site characteristics such as
visibility, accessibility, traffic volume, shopping patterns and availability of adequate parking. Stores are typically located in free-standing locations to maximize their outside
exposure and signage.

Management Information Systems



We have invested significant resources in management information systems that provide real-time information for the Guitar Center division. The
systems have been designed to integrate all major aspects of our business, including sales, gross margins, inventory levels, purchase order management, automated replenishment and merchandise
planning. Our sophisticated management information systems provide us with the ability to monitor all critical aspects of activity on a real-time basis. Our system capabilities include
inter-store transactions, vendor analysis, serial number tracking, inventory analysis and commission sales reporting. We believe that the system we have developed will enable us to continue to improve
customer service and operational efficiency and support our needs for the immediately foreseeable future.

14

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We
continue to invest significant resources in the development and implementation of the basic information systems for American Music. The systems have been designed to operate and
control fundamental business processes, including sales, rentals, store operations, inventory levels, purchase order management, and finance. The technology and architecture are consistent with the
overall enterprise IT strategy, and will be leveraged as we advance the existing management information systems at Guitar Center.



Musician's Friend maintains an extensive transaction processing system as well as systems supporting e-commerce, operations and marketing analysis,
and internal support information. All transaction and inventory information is available real-time. The e-commerce website is updated during the day through a firewall,
providing a high degree of security for our internal systems. Our direct response business does not have redundant Internet or operating systems and would be vulnerable to catastrophic events. In the
event of a disaster, our direct response business would most likely experience delays in processing and shipping orders until we executed our failure recovery plans. Dedicated systems are used for
inventory planning and for website analysis. In 2003, initiatives were completed to improve inventory management and reduce outbound shipping costs. Many of the systems which run our distribution
center operations function via wireless technology.

The
systems provide management with extensive marketing, merchandising and operational information, and provide call center and customer service staff with current inventory and customer
account information. The choice of platforms and databases provides us with a strong foundation for ongoing development of systems.

Competition

We are in direct competition with Sam Ash Music based in New York, New York, a major multi-unit retail chain in the music products industry. In
addition, we compete with various direct response companies such as American Music Supply (unrelated to our American Music division), Sam Ash Music, and Sweetwater Sound. As of December 31,
2003, we were in direct competition with Sam Ash in 24 of our markets. In recent years, Sam Ash has continued to open new or acquired stores, and various store openings are planned for 2004. One of
our primary competitors, Mars Music, Inc., or "Mars," filed for federal bankruptcy court protection on September 27, 2002 and has completed a liquidation resulting in the closure of all
of its stores. Of the Mars Music stores closed, Sam Ash acquired four of the locations from the bankruptcy court. The competitive landscape remains dynamic and we cannot predict what level of national
and local competition our retail store and direct response businesses will face in the future. Nonetheless, we continue to believe that there is room for further consolidation within the music
products retailing industry as the top five retailers, perThe Music Tradesmagazine (including Guitar Center and Sam Ash), only account for an
estimated 25.8% of the market in 2002.

We
believe that the ability to compete successfully in our markets is determined by several factors, including breadth and quality of product selection, pricing, effective merchandise
presentation, customer service, store location and proprietary database marketing programs. Customer satisfaction is paramount to our operating strategy and we believe that providing knowledgeable and
friendly customer service gives us a competitive advantage. The store environment is designed to be an entertaining and exciting environment in which to shop. In an effort to exceed customer
expectations, our stores provide a number of services not generally offered by most competitors, including the ability to hold and use merchandise, product demonstrations and extensive product
selection. Salespeople are highly trained and specialize in one of our five product areas. Salespeople are certified by an internal training team, based on extensive training and product knowledge
testing. We believe that this certification process has increased the professionalism of our employees while reducing turnover.

15

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Customers
are encouraged to help themselves to the displayed instruments and to seek the assistance of the professional salespeople.

Various
factors, however, could materially and adversely affect our ability to compete successfully in our markets, including, among others, the expansion by us into new markets in which
our competitors are already established, competitors' expansion into markets in which we are currently operating, the adoption by competitors of innovative store formats and retail sales methods or
the entry into our markets by competitors with substantial financial or other resources. See "Risks Related to the BusinessWe may be unable to meet our Guitar Center and
American Music retail growth strategy, which could adversely affect our results of operations" and "We face significant competition, and our efforts to increase our market share may be
inhibited by existing or new competitors also trying to execute national expansion strategies."

Employees

As of December 31, 2003, we employed 5,520 people, of whom 4,618 were hourly employees and 902 were salaried. None of our employees are covered by a
collective bargaining agreement. We believe that we enjoy good employee relations.

Brand Names and Service Marks

We operate our retail stores under the "Guitar Center" and "American Music" brands and our direct response business under the "Musician's Friend" brand.

We
have registered the GUITAR CENTER, ROCK WALK, MUSICIAN'S FRIEND, ROGUE, AXMAN, PULSE PERCUSSION, PARADISE, GUITAR MAN, RAM, MIDI BY MAIL, ALUMINATOR, MITCHELL GUITARS, THE MUSICIAN'S
CHOICE, AMERICAN MUSIC, DIGITAL REFERENCE and MUSICIAN'S FRIEND.COM service marks with the United States Patent and Trademark Office. We believe that these service marks have become important
components of our merchandising and marketing strategy. The loss of the GUITAR CENTER, MUSICIAN'S FRIEND or AMERICAN MUSIC service mark would likely have a material adverse effect on our business.

Risks Related to the Business

An investment in our securities involves a high degree of risk. Described below are some of the risks and uncertainties facing our company. There may be
additional risks that we do not presently know of or that we currently consider immaterial. Any of these risks could adversely affect our business, results of operations, liquidity and financial
position. A shortfall in comparative sales growth in any period will likely cause a shortfall in earnings, and result in financial performance below that for which we have planned or the investment
community expects.

We may be unable to meet our Guitar Center and American Music retail store growth strategy, which could adversely affect our results of operations.

Our retail store growth strategy includes opening new stores in new and existing markets and increasing sales at existing locations. As of December 31,
2003, we operated 122 Guitar Center stores and 19 American Music stores. We opened a total of 14 Guitar Center stores in 2003, and currently expect to open approximately 16 to 18 additional Guitar
Center stores in 2004. Approximately half of the Guitar Center stores planned for 2004 are expected to be smaller format units designed for secondary markets.

We
opened a total of eight American Music stores in 2002, five of which were acquired in connection with American Music's acquisition of M&M Music, a band instrument retailer. In 2003,
we

16

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opened
one American Music store and closed two. In 2004, we do not plan to open any additional American Music stores. We do, however, believe there exists a number of acquisition opportunities in the
relatively fragmented band instruments market that could be a good fit into our American Music platform. However, we have slowed our planned growth of the American Music division because our
infrastructure and remerchandising projects at this business have to date required more time and resources than originally anticipated. As a result of these factors, the American Music stores incurred
significant operating losses in 2003 and we presently expect this situation to continue in 2004.

The
success of our retail store expansion plans depend on many factors, including:



A
number of these factors are, to a significant extent, beyond our control. As a result, we do not know whether we will be able to continue to open and/or acquire additional Guitar
Center and American Music stores at the rates currently anticipated. If we are unable to achieve our retail store expansion goals, or the new stores underperform our expectations, our results of
operations could be adversely affected.

We face unique competitive and merchandising challenges in connection with our plans to open additional Guitar Center and American Music retail stores in new markets.

As part of our retail growth strategy, we plan to open and/or acquire additional Guitar Center and American Music stores in new markets. This expansion into new
markets will present unique competitive and merchandising challenges, including:



Any
of these factors may lead to a shortfall in revenues or an increase in costs with respect to the operation of these stores. If we are not able to operate these stores profitably, our
results of operations would be adversely affected.

17

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Our retail store expansion strategy, including our strategy of clustering retail stores, may adversely impact our comparable store sales.

Historically, we have achieved significant sales growth in existing stores. Our quarterly comparable stores sales results have fluctuated significantly in the
past. Sales growth for comparable periods, excluding net sales attributable to stores not open for 14 months, was as follows for our retail stores:

2003

2002

2001Quarter 1

4
%
5
%
7
%Quarter 2

5
%
8
%
5
%Quarter 3

7
%
5
%
3
%Quarter 4

10
%
7
%
6
%Full Year

7
%
6
%
6
%


We
do not know whether our new stores will achieve sales or profitability levels similar to our existing stores. Our expansion strategy includes clustering stores in existing markets.
Clustering has in the past and may in the future result in the transfer of sales to the new store and a reduction in the profitability of an existing store. In addition, a variety of factors affect
our comparable store sales results, including:



Our
management is presently anticipating comparable store sales growth of 5% to 7% for the first quarter of 2004. A shortfall in comparative sales growth in any period will likely cause
a shortfall in earnings, and result in financial performance below that for which we have planned or the investment community expects.

Our growth plans depend on our completion of acquisitions, and these transactions involve special risks.

We believe that our expansion may be accelerated by the acquisition of existing music product retailers. For example, in April 2001 we acquired the
business of American Music Group, a New York-based retailer of band instruments, a business in which we were not previously engaged. Our growth plans for the American Music business
contemplate a significant number of relatively small acquisitions. For example, in June 2002 American Music acquired M&M Music, a band instrument retailer. We also regularly investigate
acquisition opportunities complimentary to our Guitar Center and Musician's Friend businesses. Accordingly, in the ordinary course of our business, we regularly consider, evaluate and enter into
negotiations related to potential acquisition opportunities. We may pay for these acquisitions in cash or securities, including equity securities, or a combination of both. We cannot assure you that
attractive acquisition targets will be available at reasonable prices or
that we will be successful in any such transaction. Acquisitions involve a number of special risks, including:



18

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We depend on a relatively small number of manufacturers and suppliers who may not be able or desire to supply our requirements.

Brand recognition is of significant importance in the retail music products business. As a result, we depend on a relatively small number of manufacturers and
suppliers for both our existing stores and the direct response unit as well as our expansion goals for each of these units. We do not have any long-term contracts with our suppliers, and
any failure to maintain our relationships with our key brand name vendors would have a material adverse effect on our business. A number of the manufacturers of the products we sell are limited in
size and manufacturing capacity and have significant capital or other constraints. These manufacturers may not be able or willing to meet our increasing requirements for inventory, and we cannot
assure you that sufficient quantities or the appropriate mix of products will be available in the future to supply our existing stores and expansion plans. These capacity constraints could lead to
extended lead times and shortages of desirable products. The risk is especially prevalent in new markets where our vendors have existing agreements with other dealers and thereby may be unwilling or
unable for contractual or other reasons to meet our requirements. The efficient operation of our distribution center for the Guitar Center stores is also highly dependent upon compliance by our
vendors with precise requirements as to the timing, format and composition of shipments, which in many instances requires changes and upgrades to the operational procedures and logistics and supply
chain management capabilities of vendors, all of which are outside of our control. Additionally, many of our vendors receive product from overseas and depend on an extensive supply chain including
common carriers and port access to transport merchandise into the country. Foreign manufacturing is subject to a number of risks, including political and economic disruptions, the imposition of
tariffs, quotas and other import or export controls, and changes in governmental policies. We also rely on common carriers to transport product from our vendors to our central distribution center in
Indiana, and from the distribution facility to our Guitar Center stores. Any disruption in the services of common carriers due to employee strikes or other unforeseen events could impact our ability
to maintain sufficient quantities of inventory in our retail locations.

We face significant competition, and our efforts to increase our market share may be inhibited by existing or new competitors also trying to execute national expansion
strategies.

The retail music products industry is fragmented and highly competitive. We compete with many different types of music product retailers, including conventional
retailers, as well as other catalog and e-commerce retailers, who sell many or most of the items we sell. We believe that large format music product retailers such as our company will seek
to expand in part through the acquisition of small, independently owned stores or franchises, and we anticipate increased competition in our existing markets and planned new markets from these
consolidating retailers. These retailers may
identify target companies or execute their acquisition strategies more effectively than our company. In addition, these retailers may have greater financial resources or other competitive advantages
as compared to our company. Our expansion to new markets will be inhibited by these and other established competitors. In addition, one or more of our competitors may adopt a new, innovative store
format or retail selling method. If we are not able to compete effectively, we may fail to achieve market position gains or may lose market share.

Recently,
several large mass merchants, including Wal-Mart and Costco, have begun to sell musical instruments in categories that we compete in, including entry-level guitars,
electronic keyboards and band instruments, and thus could represent a significant source of future competition for our retail and direct response businesses, particularly if these retailers expand
their product lines beyond entry-level merchandise.

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We must efficiently integrate American Music and grow its family music business in order to earn an acceptable return on that investment.

In April 2001, we completed our acquisition of American Music Group, a New York-based retailer of band instruments. We had not previously
participated in the band instruments segment of the music products business and had no prior experience in this distribution channel. We intend to use the acquired American Music business as a
platform to develop and grow a family music store concept that will emphasize band instruments and also sell selected "combo" products sold by our Guitar Center stores, such as guitars, drums and the
like. Thus, we face the normal challenges of any acquisition, such as integration of personnel and systems as well as the need to learn, understand and further develop this business. We are installing
new management information systems, at American Music, which has proven to be a challenging project requiring more time and resources than originally anticipated. This implementation is an important
project to facilitate further integrating of American Music with our other businesses and to provide a systems backbone to permit growth of this division. In addition, in 2002 we started marketing
through the American Music stores some Guitar Center products not previously carried by American Music. This change in merchandising strategy from the historic focus of American Music on band
instruments is in process and is an important element of our family music store concept for this brand. This remerchandising strategy is not yet proven. Further, we have slowed our planned growth of
the American Music division because the challenges posed by our infrastructure and remerchandising projects. As a result of these factors, the American Music stores incurred significant operating
losses in 2003 and we presently expect this situation to continue in 2004. Failure to execute on the requirements and initiatives described above could result in a poor or no return on our investment,
constitute a distraction of the efforts of our management team from the core Guitar Center and Musician's Friend brands and potentially require us to recognize an impairment in the significant amount
of goodwill recorded in the acquisitions of American Music and M&M Music, which totaled $20.6 million at December 31, 2003.

We depend on key personnel including our senior management who are important to the success of our business.

Our success depends to a significant extent on the services of Larry Thomas, our Chairman and Co-CEO, Marty Albertson, our President and
Co-CEO, Robert Eastman, the CEO of our wholly-owned subsidiary, Musician's Friend, Inc., and David Fleming, President and Chief Operating Officer of American Music, as well as our
ability to attract and retain additional key personnel with the skills necessary to manage our existing business and growth plans. During 2001 we entered into a five year employment contract with each
of Mr. Thomas and Mr. Albertson and in 2003 entered into a three year employment agreement with Mr. Eastman. The loss of one or more of these individuals or other key personnel
could have a material adverse effect on our business, results of operations, liquidity and financial position.

Historically,
we have promoted employees from within our organization to fill senior operations, sales and store management positions. In order to achieve our growth plans, we will
depend upon our ability to retain and promote existing personnel to senior management, and we must attract and retain new personnel with the skills and expertise to manage our business. If we cannot
hire, retain and promote qualified personnel, our business, results of operations, financial condition and prospects could be adversely affected.

The implementation of our distribution center for the Guitar Center retail stores presents operational risks and represents a significant investment.

Our distribution center in the Indianapolis, Indiana area supports our Guitar Center retail store operations. The conveyor systems, the warehouse management
system, and all other technology systems and infrastructure commenced operations in July 2002. Migration from our former "drop-ship" model

20

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to
a centralized distribution model is an important development in our operating strategy. The efficient operation of the distribution center is also dependent upon the performance of third parties
that we do not control, such as vendors who must comply with new operating procedures and common carriers who must deliver product on time. This program involves financial and operating risks that
could include the need to expend greater funds than presently budgeted or disruptions in retail store operations and the loss of sales if inventory is not timely provided in the required quantities.
Further, one of the key underlying economic assumptions of our distribution center project is that this program will permit us to reduce overall inventory levels as a percentage of sales thereby
resulting in significantly reduced working capital requirements. Any failure to reach our inventory reduction targets will adversely affect our future financial performance and capital needs,
potentially in a material manner. Failure to execute on these requirements could result in a poor or no return on our investment, disruption of our retail store business and a distraction of the
efforts of our management team.

Our retail operations are concentrated in California, which ties our financial performance to events in that state.

As of December 31, 2003, our corporate headquarters as well as 23 of our 122 Guitar Center stores were located in California, and stores located in that
state generated 25.8% and 27.5% of our retail sales for 2003 and 2002, respectively. Although we have opened and acquired stores in other areas of the United States, a significant percentage of our
net sales and results of operations will likely remain concentrated in California for the foreseeable future. As a result, our results of operations and financial condition are heavily dependent upon
general consumer trends and other general economic conditions in California and are subject to other regional risks, including earthquakes. We do maintain earthquake insurance, but such policies carry
significant deductibles and other restrictions.

Economic conditions or changing consumer preferences could also adversely impact us.

Our business is sensitive to consumer spending patterns, which can be affected by prevailing economic conditions. A downturn in economic conditions in one or more
of our markets, such as occurred after September 11, 2001, could have a material adverse effect on our results of operations, financial condition, business and prospects. Although we attempt to
stay informed of consumer preferences for musical products and accessories typically offered for sale in our stores, any sustained failure on our part to identify and respond to trends would have a
material adverse effect on our results of operations, financial condition, business and prospects.

We may need to change the manner in which we conduct our business if government regulation or taxation imposes additional costs and adversely affects our financial results.

The adoption or modification of laws or regulations, or revised interpretations of existing laws, relating to the direct response industry could adversely affect
the manner in which we currently conduct our catalog and e-commerce business and the results of operations of that unit. For example, laws and enforcement practices related to the taxation
of catalog, telephone and online commercial activity, including direct response sales, remain in flux. In addition, the growth and development of the market for online commerce may lead to more
stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens on us. Laws and regulations directly applicable to communications or commerce over the
Internet are becoming more prevalent. The law of the Internet, however, remains largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether
and how existing laws such as those governing intellectual property, consumer privacy, sales-based and other taxation of e-commerce transactions and the like are interpreted and enforced.
Any adverse change in any of these laws or in the enforcement,

21

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interpretation
or scope of existing laws could have a material adverse effect on our results of operations, financial condition or prospects.

We face risks created by litigation, governmental proceedings, labor disputes or environmental matters.

We are involved in a number of litigation matters. Litigation may result in substantial costs and expenses and significantly divert the attention of our
management regardless of the outcome. In addition, current and future litigation, governmental proceedings, labor disputes or environmental matters could lead to increased costs or interruptions of
our normal business operations.

We must manage efficiently the expansion of our Direct Response business, including the musiciansfriend.com website, our systems that process orders in our Direct Response
business, and our fulfillment resources in order to service our customers properly.

Our direct response business, particularly our e-commerce business, will require significant investments to respond to anticipated growth and
competitive pressures. If we fail to rapidly upgrade our website in order to accommodate increased traffic, we may lose customers, which would reduce our net sales. Furthermore, if we fail to expand
the computer systems that we use to process and ship customer orders and process payments and the fulfillment facilities we use to manage and ship our inventory, we may not be able to successfully
distribute customer orders. We experienced some delays of this sort in 2001 in connection with the consolidation of our fulfillment centers. As a result, we could incur excessive shipping costs due to
the need to split delayed shipments, increased marketing costs in the form of special offers to affected customers or the loss of customers altogether. We may experience difficulty in improving and
maintaining such systems if our employees or contractors that develop or maintain our key systems become unavailable to us. We have experienced periodic service disruptions and interruptions, which we
believe will continue to occur, while enhancing and expanding these systems.

Net sales of our e-commerce business could decrease if our online security measures fail.

Our relationships with our e-commerce customers may be adversely affected if the security measures that we use to protect their personal information,
such as credit card numbers, are ineffective. If, as a result, we lose customers, our net sales could decrease. We rely on security and authentication technology that we license from third parties.
With this technology, we perform real-time credit card authorization and verification with our bank. We cannot predict whether events or developments will result in a compromise or breach
of the technology we use to protect a customer's personal information. Furthermore, our servers may be vulnerable to computer viruses, physical or electronic break-ins and similar
disruptions. We may need to expend significant additional capital and other resources to protect against a security breach or to alleviate problems caused by any breaches. We cannot assure that we can
prevent all security breaches.

If we do not respond to rapid technological changes, our services could become obsolete and we could lose customers.

If we face material delays in introducing new services, products and enhancements, our e-commerce customers may forego the use of our services and use
those of our competitors. To remain competitive, we must continue to enhance and improve the functionality and features of our online store. The Internet and the online commerce industry are rapidly
changing. If competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing website and proprietary technology and systems
may become obsolete. To develop our website and other proprietary technology entails significant technical and business risks. We may use new technologies ineffectively or we may fail to adapt our
website, our transaction processing systems and our computer network to meet customer requirements or emerging industry standards. In

22

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addition,
the success of e-commerce may result in greater efficiency and lower prices, which could have an adverse effect on selling prices and margins in our retail store business and in
our catalog business and generally constrain profitability in the specialty retail business.

Our hardware and software systems are vital to the efficient operation of our retail stores and Direct Response business, and damage to these systems could harm our business.

We rely on our computer hardware and software systems for the efficient operation of our retail stores and direct response business. Our information systems
provide our management with real-time inventory, sales and cost information that is essential to the operation of our business. Due to our number of stores, geographic diversity and other
factors, we would be unable to generate this information in a timely and accurate manner in the event our hardware or software systems were unavailable. These systems are vulnerable to damage or
interruption from a number of factors, including:



A
significant information systems failure could reduce the quality or quantity of operating data available to our management. If this information were unavailable for any extended period
of time, our management would be unable to efficiently run our business, which would result in a reduction in our net sales.

To
attempt to mitigate these risks we have contracted services from third parties to provide backup systems for our Guitar Center retail stores in the event of a disaster. These services
provide for our "mission critical" systems to be online within 48 hours following most disasters. Our direct response business does not have redundant Internet or operating systems and would be
vulnerable to catastrophic events. In the event of a disaster, our direct response business would most likely experience delays in processing and shipping orders.

Our stock price could be volatile.

The market price of our common stock has been subject to significant fluctuations in response to our operating results and other factors, including announcements
by our competitors, and those fluctuations will likely continue in the future. In addition, the stock market in recent years has experienced significant price and volume fluctuations that often have
been unrelated or disproportionate to the operating performance of particular companies. These fluctuations, as well as a shortfall in sales or earnings compared to public market analysts'
expectations, changes in analysts' expectations, changes in analysts' recommendations or projections, and general economic and market conditions, may adversely affect the market price of our common
stock.

Forward-looking statements contained in this annual report are subject to risks and other uncertainties.

This annual report contains forward-looking statements, relating to, among other things, future results of operations, growth plans (including, without
limitation, the number and timing of new store openings, comparable store sales growth and the growth of our e-commerce business), sales, gross margin and expense trends, capital
requirements and general industry and business conditions applicable to us. These statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Our
actual results could differ materially from these forward-looking statements. In addition to the other risks described elsewhere in this section, important factors to consider in evaluating these
statements include changes in external competitive market factors, changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the music products industry
or the economy in general, the emergence of new or growing specialty retailers

23

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of
music products and various other competitive factors that may prevent us from competing successfully in existing or future markets. In light of these risks and uncertainties, we can not assure you
that the forward-looking statements contained in this annual report will in fact be realized. Further, we do not undertake any duty to update the forward-looking statements contained in this annual
report, particularly those related to management's future estimates which are subject to revision due to changes in the business environment that we face.

Our actual operating results may differ significantly from our projections.

From time to time, we release projections regarding our future performance that represent our management's estimates as of the date of release. These projections,
which are forward looking-statements, are prepared by our management and are qualified by, and subject to, the assumptions and the other information contained or referred to in the release. Our
projections are not prepared with a view toward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our independent public accountants nor any
other independent expert or outside party compiles or examines the projections and, accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.

Projections
are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and
competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions with respect to future business decisions, some of which will change. We
generally state possible outcomes as high and low ranges which are intended to provide a sensitivity analysis as variables are changed but are not intended to represent that actual results could not
fall outside of the suggested ranges. The principal reason that we release this data is to provide a basis for our
management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by any such persons.

Projections
are necessarily speculative in nature, and it can be expected that some or all of the assumptions of the projections furnished by us will not materialize or will vary
significantly from actual results. Accordingly, our projections are only an estimate of what management believes is realizable as of the date of release. Actual results will vary from the projections
and the variations may be material. Investors should also recognize that the reliability of any forecasted financial data diminishes the farther in the future that the data is projected. In light of
the foregoing, investors are urged to put the projections in context and not to place undue reliance on them.

Any
failure to successfully implement our operating strategy or the occurrence of any of the events or circumstances set forth in this report could result in the actual operating results
being different than the projections, and such differences may be adverse and material.

Item 2. PROPERTIES

We lease our corporate offices of approximately 69,600 square feet, which are located at 5795 Lindero Canyon Road, Westlake Village, California 91362. We also
lease an adjoining office space of approximately 7,500 square feet at 5785 Lindero Canyon Road, Westlake Village, California 91362. These leases expire in April 2009. Our direct response
business is headquartered in a facility we own located at 931 Chevy Way, Medford, Oregon 97504 and the American Music division is headquartered in a facility we lease located at 7845 Maltage Drive,
Liverpool, New York 13090. The lease expires on June 30, 2005.

We
lease approximately 25,500 square feet of office space in Salt Lake City, Utah, for our direct response customer contact center facility. This lease expires in December 2008.
We lease approximately 241,000 square feet for use as a central distribution center for our direct response division, in Kansas City, Missouri. This lease expires in June 2007. We lease
approximately 505,000 square feet of

24

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warehouse
space near Indianapolis, Indiana for use as our Guitar Center retail distribution center. This lease expires in June 2012.

In
connection with our retail business, as of December 31, 2003, we leased approximately 1,896,000 square feet for our 122 Guitar Center stores and approximately 91,400 square
feet for our 19 American Music stores. Our retail stores' initial lease terms range from 10-15 years and typically
allow us to renew for two additional five-year terms. Most of the leases require us to pay property tax, utilities, normal repairs, common area maintenance and insurance expenses.

Store Locations

The table below sets forth information concerning our Guitar Center and American Music retail stores as of December 31, 2003:

|Store                |                  | Year
Opened |      | Gross
Square
Feet |        | Status
|-------------------- | ---------------- | ----------- | ---- | ----------------- | ------ | ------
|Guitar Center Stores |                  |            
|Alabama              |                  |             |      |                   |        |       
|                     | Mobile (1)       |             | 2004 |                   | 11,100 |       
|Arizona              |                  |             |      |                   |        |       
|                     | Phoenix          |             | 1997 |                   | 13,600 |       
|                     | Tempe            |             | 1997 |                   | 12,100 |       
|                     | Tucson           |             | 2001 |                   | 15,000 |       
|                     | Scottsdale       |             | 2003 |                   | 17,500 |       
|Arkansas             |                  |             |      |                   |        |       
|                     | Little Rock      |             | 2002 |                   | 8,700  |       
|Southern California  |                  |             |      |                   |        |       
|                     | Hollywood        |             | 1964 |                   | 30,600 |       
|                     | San Diego        |             | 1973 |                   | 15,100 |       
|                     | Fountain Valley  |             | 1980 |                   | 16,800 |       
|                     | Sherman Oaks     |             | 1982 |                   | 18,700 |       
|                     | Covina           |             | 1985 |                   | 15,400 |       
|                     | Southbay         |             | 1985 |                   | 14,500 |       
|                     | San Bernardino   |             | 1993 |                   | 15,000 |       
|                     | Brea             |             | 1995 |                   | 14,900 |       
|                     | San Marcos (2)   |             | 1996 |                   | 14,700 |       
|                     | Rancho Cucamonga |             | 1999 |                   | 15,000 |       
|                     | El Toro          |             | 1999 |                   | 16,300 |       
|                     | Oxnard           |             | 2000 |                   | 14,000 |       
|                     | Bakersfield      |             | 2000 |                   | 8,000  |       
|                     | Palmdale         |             | 2001 |                   | 12,000 |       
|                     | Pasadena         |             | 2002 |                   | 19,400 |       
|                     | Cerritos         |             | 2003 |                   | 15,300 |       
|Northern California  |                  |             |      |                   |        |       
|                     | San Francisco    |             | 1972 |                   | 11,900 |       
|                     | San Jose         |             | 1978 |                   | 14,200 |       
|                     | El Cerrito (3)   |             | 1983 |                   | 11,300 |       
|                     | Concord          |             | 1996 |                   | 15,800 |       
|                     | Fresno           |             | 2000 |                   | 15,500 |       
|                     | Sacramento       |             | 2000 |                   | 15,800 |       
|                     | Modesto          |             | 2001 |                   | 9,000  |       
|Colorado             |                  |             |      |                   |        |       
|                     | Denver           |             | 1998 |                   | 16,800 |       
|                     | Englewood        |             | 1998 |                   | 16,800 |       
|                     | Arvada           |             | 1999 |                   | 15,700 |       
|                     | Colorado Springs |             | 2002 |                   | 8,600  |       
|Connecticut          |                  |             |      |                   |        |       
|                     | Manchester       |             | 1999 |                   | 16,000 |       
|                     | Orange           |             | 2002 |                   | 15,500 |       
|Florida              |                  |             |      |                   |        |       
|                     | North Miami area |             | 1996 |                   | 20,900 |       
|                     | South Miami area |             | 1996 |                   | 14,700 |       
|                     | West Palm Beach  |             | 2001 |                   | 15,200 |       
|                     | Orlando          |             | 2002 |                   | 15,300 |       
|                     | Lakeland         |             | 2003 |                   | 13,000 |       
|                     | Tampa            |             | 2003 |                   | 15,000 |       
|                     | Ft. Myers (1)    |             | 2004 |                   | 13,300 |       
|Georgia              |                  |             |      |                   |        |       
|                     | Atlanta          |             | 1997 |                   | 23,600 |       
|                     | Marietta         |             | 1997 |                   | 22,800 |       
|Idaho                |                  |             |      |                   |        |       
|                     | Boise            |             | 2001 |                   | 10,800 |       
|Illinois             |                  |             |      |                   |        |       
|                     | South Chicago    |             | 1979 |                   | 13,800 |       
|                     | North Chicago    |             | 1981 |                   | 11,000 |       
|                     | Central Chicago  |             | 1988 |                   | 20,500 |       
|                     | Villa Park       |             | 1996 |                   | 15,000 |       
|                     | Highland Park    |             | 2001 |                   | 15,200 |       
|Indiana              |                  |             |      |                   |        |       
|                     | Indianapolis     |             | 2001 |                   | 15,600 |       
|                     | Hobart           |             | 2003 |                   | 12,000 |       
|Louisiana            |                  |             |      |                   |        |       
|                     | New Orleans      |             | 1999 |                   | 19,700 |       
|                     | Baton Rouge (1)  |             | 2004 |                   | 10,200 |       
|Maryland             |                  |             |      |                   |        |       
|                     | Towson           |             | 1998 |                   | 14,600 |       
|                     | Rockville (4)    |             | 2000 |                   | 24,000 |       
|                     |                  |             |      |                   |        |       

25

---

|Massachusetts  |                  |  |      |  |        | 
|-------------- | ---------------- |  | ---- |  | ------ | 
|               | Boston           |  | 1994 |  | 12,600 | 
|               | Danvers          |  | 1996 |  | 14,600 | 
|               | Natick           |  | 1997 |  | 15,100 | 
|               | N. Attleboro     |  | 1998 |  | 16,800 | 
|Michigan       |                  |  |      |  |        | 
|               | Detroit          |  | 1994 |  | 16,100 | 
|               | Southfield       |  | 1996 |  | 18,800 | 
|               | Canton           |  | 1998 |  | 16,800 | 
|               | Grand Rapids     |  | 2002 |  | 11,400 | 
|               | Saginaw          |  | 2003 |  | 13,800 | 
|               | Flint (1)        |  | 2004 |  | 10,020 | 
|Minnesota      |                  |  |      |  |        | 
|               | Twin Cities      |  | 1988 |  | 15,000 | 
|               | Edina            |  | 1997 |  | 15,700 | 
|Missouri       |                  |  |      |  |        | 
|               | N. St. Louis     |  | 1999 |  | 15,700 | 
|               | Bridgeton        |  | 1999 |  | 15,000 | 
|Nevada         |                  |  |      |  |        | 
|               | Las Vegas        |  | 1998 |  | 20,000 | 
|New Jersey     |                  |  |      |  |        | 
|               | Springfield      |  | 1998 |  | 20,000 | 
|               | E. Brunswick     |  | 1998 |  | 20,000 | 
|               | Totowa           |  | 1999 |  | 15,600 | 
|               | Paramus          |  | 1999 |  | 14,100 | 
|               | Cherry Hill      |  | 2001 |  | 15,800 | 
|               | Atlantic City    |  | 2002 |  | 10,300 | 
|New Mexico     |                  |  |      |  |        | 
|               | Albuquerque (1)  |  | 2004 |  | 11,600 | 
|New York       |                  |  |      |  |        | 
|               | Carle Place      |  | 1998 |  | 22,800 | 
|               | Queens           |  | 1999 |  | 19,000 | 
|               | Larchmont        |  | 1999 |  | 15,300 | 
|               | Commack          |  | 2000 |  | 16,000 | 
|               | Buffalo          |  | 2000 |  | 15,000 | 
|               | Rochester        |  | 2001 |  | 15,300 | 
|               | Albany           |  | 2003 |  | 14,000 | 
|               | Manhattan        |  | 2003 |  | 30,000 | 
|North Carolina |                  |  |      |  |        | 
|               | Charlotte        |  | 2002 |  | 15,200 | 
|               | Raleigh          |  | 2002 |  | 15,900 | 
|Ohio           |                  |  |      |  |        | 
|               | Cleveland        |  | 1997 |  | 15,600 | 
|               | Mayfield Heights |  | 1998 |  | 15,400 | 
|               | Cincinnati       |  | 1998 |  | 18,500 | 
|               | Columbus         |  | 2002 |  | 17,600 | 
|               | Toledo (1)       |  | 2004 |  | 12,000 | 
|Oklahoma       |                  |  |      |  |        | 
|               | Oklahoma City    |  | 2000 |  | 15,200 | 
|Oregon         |                  |  |      |  |        | 
|               | Eugene           |  | 1996 |  | 10,000 | 
|               | Medford          |  | 1987 |  | 11,900 | 
|               | Clackamas        |  | 2000 |  | 15,600 | 
|               | Beaverton        |  | 2000 |  | 15,300 | 
|Pennsylvania   |                  |  |      |  |        | 
|               | Philadelphia     |  | 2000 |  | 15,200 | 
|               | Plymouth Meeting |  | 2001 |  | 14,900 | 
|               | Monroeville      |  | 2001 |  | 14,000 | 
|               | Harrisburg       |  | 2003 |  | 10,000 | 
|Rhode Island   |                  |  |      |  |        | 
|               | Warwick          |  | 2003 |  | 14,000 | 
|Tennessee      |                  |  |      |  |        | 
|               | Knoxville        |  | 1998 |  | 15,000 | 
|               | Memphis          |  | 2003 |  | 15,500 | 
|               | Nashville        |  | 2003 |  | 20,000 | 
|Texas          |                  |  |      |  |        | 
|               | Dallas           |  | 1989 |  | 18,375 | 
|               | Arlington        |  | 1991 |  | 19,200 | 
|               | South Houston    |  | 1993 |  | 14,700 | 
|               | North Houston    |  | 1994 |  | 14,700 | 
|               | Central Dallas   |  | 1998 |  | 17,800 | 
|               | Clearlake        |  | 1998 |  | 15,000 | 
|               | Austin           |  | 2000 |  | 15,200 | 
|               | Plano            |  | 2000 |  | 15,500 | 
|               | Corpus Christi   |  | 2002 |  | 10,500 | 
|Utah           |                  |  |      |  |        | 
|               | Salt Lake City   |  | 1998 |  | 15,000 | 
|               | Ogden            |  | 2002 |  | 7,500  | 
|Virginia       |                  |  |      |  |        | 
|               | Fairfax          |  | 1999 |  | 15,600 | 
|               | Seven Corners    |  | 1999 |  | 15,400 | 
|               | Virginia Beach   |  | 2000 |  | 16,000 | 
|               | Fredericksburg   |  | 2003 |  | 9,000  | 
|               | Richmond         |  | 2003 |  | 14,000 | 
|Washington     |                  |  |      |  |        | 
|               | Tukwila          |  | 1997 |  | 18,000 | 
|               | Kirkland         |  | 1997 |  | 20,200 | 
|               | Seattle          |  | 1997 |  | 18,300 | 
|               | Lynnwood         |  | 1998 |  | 14,000 | 
|               | Tacoma           |  | 2001 |  | 15,600 | 
|               | Spokane          |  | 2001 |  | 12,800 | 
|Wisconsin      |                  |  |      |  |        | 
|               | Brookfield (1)   |  | 2004 |  | 15,000 | 
|               |                  |  |      |  |        | 

26

---

|American Music Stores |                | 
|--------------------- | -------------- | 
|Arizona               |                | 
|                      | Phoenix        | 
|                      | Mesa           | 
|                      | Tucson         | 
|Florida               |                | 
|                      | Longwood       | 
|                      | Ft. Myers      | 
|                      | Jupiter        | 
|                      | Jacksonville   | 
|Georgia               |                | 
|                      | Valdosta       | 
|                      | Stone Mountain | 
|                      | Albany         | 
|Illinois              |                | 
|                      | Carol Stream   | 
|                      | Naperville     | 
|Maine                 |                | 
|                      | W. Falmouth    | 
|Massachusetts         |                | 
|                      | Greenfield     | 
|Nevada                |                | 
|                      | Las Vegas      | 
|                      | Henderson      | 
|New York              |                | 
|                      | Syracuse       | 
|                      | Pittsford      | 
|                      | New York Mills | 

---

Item 3. LEGAL PROCEEDINGS

We are involved in various claims and legal actions arising in the ordinary course of our business and, while the results of the proceedings cannot be predicted
with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our consolidated financial position or results of operations.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fiscal quarter ended December 31, 2003.

27

---



PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is quoted on the Nasdaq National Market under the symbol "GTRC." The following table sets forth the high and low closing sale prices for the
common stock for the calendar quarters indicated:

2003

2002High

Low

High

LowFirst Quarter

$
21.55

$
16.12

$
17.52

$
12.67Second Quarter


29.39


19.62


20.20


16.75Third Quarter


35.56


27.71


18.78


14.30Fourth Quarter


36.53


27.37


20.95


15.66


As
of December 31, 2003, there were 467 stockholders of record, excluding the number of beneficial owners whose shares were held in street name. We believe that the number of
beneficial holders is significantly in excess of such amount based on the security position listings we obtain from time to time for the purpose of facilitating mailings to our stockholders.

Dividend Policy

We currently intend to retain any earnings to provide funds for the operation and expansion of our business and for the servicing and repayment of indebtedness,
and do not intend to pay cash dividends on our common stock in the foreseeable future. The terms of our credit facility with Wells Fargo Retail Finance, LLC and a syndicate of other lenders includes
specified covenants which, among other things, prohibit the payment of cash dividends on our capital stock. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of
OperationsLiquidity and Capital Resources." Any determination to pay cash dividends on the common stock in the future will be at the sole discretion of our Board of Directors.

28

---

Item 6. SELECTED FINANCIAL DATA

The selected data presented below under the captions "Income Statement Data" and "Balance Sheet and Other Data" for, and as of the end of, each of the years in
the five-year periods ended December 31, 2003, are derived from the consolidated financial statements of Guitar Center, Inc. and subsidiaries, which financial statements have
been audited by KPMG LLP, independent auditors. The consolidated financial statements as of December 31, 2003 and 2002, and for each of the years in the three-year period ended
December 31, 2003, and the report thereon, are included elsewhere in this annual report. The information presented below under the caption "Operating Data" is unaudited. The selected historical
financial data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations, our consolidated financial statements and the notes thereto
included elsewhere in this annual report.

|                                                                                                              |                       | Year Ended December 31, |          
|------------------------------------------------------------------------------------------------------------- | --------------------- | ----------------------- | ---------
|
|
|Income Statement Data:                                                                                        |                       |                         |          
|Net sales                                                                                                     |                       | $                       | 1,275,059
|Cost of goods sold                                                                                            |                       |                         | 931,014  
|                                                                                                              |                       |                         |          
|Gross profit                                                                                                  |                       |                         | 344,045  
|Selling, general and administrative expenses                                                                  |                       |                         | 271,996  
|Transaction and other costs                                                                                   |                       |                         |         
|                                                                                                              |                       |                         |          
|Operating income                                                                                              |                       |                         | 72,049   
|Other expense:                                                                                                |                       |                         |          
|                                                                                                              | Other expense         |                         |          
|                                                                                                              | Interest expense, net |                         |          
|                                                                                                              |                       |                         |          
|                                                                                                              |                       | Total other expense     |          
|                                                                                                              |                       |                         |          
|Income before income taxes (benefit), and cumulative effect of change in accounting principle                 |                       |                         | 59,509   
|Income taxes (benefit)                                                                                        |                       |                         | 22,649   
|                                                                                                              |                       |                         |          
|Income before cumulative effect of change in accounting principle                                             |                       |                         | 36,860   
|                                                                                                              |                       |                         |          
|Cumulative effect of change in accounting principle to write-off pre-opening costs, net of tax effect of $578 |                       |                         |         
|                                                                                                              |                       |                         |          
|Net income                                                                                                    |                       | $                       | 36,860   
|                                                                                                              |                       |                         |          
|Net income per share (diluted)                                                                                |                       | $                       | 1.50     
|                                                                                                              |                       |                         |          
|Weighted average shares outstanding (1)                                                                       |                       |                         | 24,561   
|                                                                                                              |                       |                         |          
|Operating Data:                                                                                               |                       |                         |          
|Guitar Center net sales per gross square foot (2)                                                             |                       | $                       | 560      
|Net sales growth                                                                                              |                       |                         | 16%      
|Increase in comparable store sales (3)                                                                        |                       |                         | 7%       
|Guitar Center stores open at end of period                                                                    |                       |                         | 122      
|Ratio of earnings to fixed charges (4)                                                                        |                       |                         | 3.5x     
|Net cash provided by operating activities (thousands)                                                         |                       | $                       | 58,005   
|EBITDA (thousands) (5)                                                                                        |                       | $                       | 92,669   
|Balance Sheet and Other Data:                                                                                 |                       |                         |          
|Net working capital                                                                                           |                       | $                       | 198,713  
|Property and equipment, net                                                                                   |                       |                         | 93,347   
|Total assets                                                                                                  |                       |                         | 460,871  
|Total long-term and revolving debt (including current portion)                                                |                       |                         | 100,000  
|Stockholders' equity                                                                                          |                       |                         | 214,171  
|Capital expenditures                                                                                          |                       |                         | 24,245   

Footnotes appear on following page.

29

---

Footnotes to table on previous page.

---

EBITDA

2003

2002

2001

2000

1999Net income as reported

$
36,860

$
25,256

$
17,033

$
22,454

$
18,276Income taxes


22,649


15,545


12,243


13,304


187Interest expense


12,540


13,077


13,411


12,466


11,235Depreciation and amortization


20,620


16,860


15,006


11,043


8,252EBITDA

$
92,669

$
70,738

$
57,693

$
59,267

$
37,950




30

---



Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

Guitar Center is the nation's leading retailer of guitars, amplifiers, percussion instruments, keyboards and pro-audio and recording equipment based
on annual revenue. As of December 31, 2003, we operated 122 Guitar Center stores, with 107 stores in 45 major markets and 15 stores in secondary markets. In addition, our American Music
division operates 19 family music stores specializing in band and orchestral instruments for sale and rental, serving teachers, band directors, college professors and students. We are also the largest
direct response retailer of musical instruments in the United States through our wholly owned subsidiary, Musician's Friend, Inc., and its catalog and web site, www.musiciansfriend.com.

During
2003, we opened 14 new stores and relocated one store which resulted in the addition of approximately 213,000 square feet of store space. The new store opening program for 2003
included nine large format Guitar Center stores, of which two were large flagship stores located in Manhattan and Nashville, and five small format stores. In the five year period from the beginning of
1999 to the end of 2003, we have grown from 48 Guitar Center stores to 122 Guitar Center stores, consisting of large flagship stores in Hollywood, Manhattan and Nashville, 104 other large format
stores and 15 small format stores. Total square footage grew from 794,000 square feet at the beginning of 1999 to 1,896,000 square feet at the end of 2003.

As
we enter new markets, we expect that we will initially incur higher administrative and promotional costs per store than is currently experienced in established markets. We expect
competition to continue to increase as other music product retailers attempt to execute national growth strategies. Our business strategy will also emphasize opportunities to continue to grow each of
our brands, including further acquisitions if attractive candidates can be located for reasonable prices.

From
1999 to 2003, our net sales grew at an annual compound growth rate of 19%, principally due to the comparable store sales growth of our retail stores averaging 7% per year, the
opening of new stores, and a 31% per year increase in the direct response channel. We believe such volume increases are the result of the continued success of the implementation of our business
strategy, continued growth in the music products industry and increasing consumer awareness of the Guitar Center, Musician's Friend and American Music brand names. We achieved comparable store sales
growth of 7%, 6%, and 6% for the fiscal years ended December 31, 2003, 2002 and 2001, respectively. We believe this growth reflects the strength of our merchandise selection, effective
advertising and promotion, and well-trained and committed personnel.

Executive Summary

During 2003, our Guitar Center stores generated 7% comparative store sales growth and a 13.9% increase in total net sales. Sales from new stores contributed
$60 million and accounted for 50.7% of the sales increase in our Guitar Center stores. Late in the year we increased our advertising expenditure, predominately focused on generating a greater
number of impressions through our mailing list, which resulted in higher traffic in our stores.

We
continue to encounter operational challenges in our American Music stores. The results of American Music continue to reflect investments in the systems and infrastructure for the
stores. Despite the challenges we are experiencing in this business, we generated an increase of 17.5% in net sales and achieved 10% comparable store sales for the year. We are repositioning our
American Music stores and establishing scalable infrastructure and systems for this area of our business. We have slowed our planned growth of the American Music division because of the challenges
posed by our infrastructure and remerchandising projects. As a result of these factors, the American Music stores

31

---

incurred
significant operating losses in 2003. Failure to execute on the requirements and initiatives described above could potentially require us to recognize an impairment in the significant amount
of goodwill recorded in the acquisitions of American Music and M&M Music, which totaled $20.6 million at December 31, 2003. No such impairment has been recorded through
December 31, 2003.

Our
direct response division generated a 23.5% increase in net sales and an 81.6% increase in operating income. For the year, we achieved an initial order fill rate of 91.7% and improved
inventory turn to 5.6 times on a trailing twelve-month basis compared to 4.1 times in 2002. Our return rate as a percentage of sales was 8.6% in 2003 compared to 11.6% in 2002. The improvements that
were made to the Musician's Friend web site over the last year, as well as to the infrastructure and systems at the direct response call center and fulfillment center, permitted us to capitalize on
high demand.

During
the fourth quarter, the direct response division changed its revenue recognition methodology, whereby we do not recognize revenue until the estimated date an order is received by
the customer, instead of the date shipped. This change resulted in a reduction of approximately $3.9 million in net sales, and of approximately $546,000 in net income, or $0.02 per diluted
share, for the fourth quarter. The impact of this change was immaterial to the prior quarters of 2003. The net effect of the change was to take several days' sales at the end of December and defer
recognition of that revenue to 2004. On a going forward basis, we do not expect this change to have a material effect on operating results because the amount of revenue deferred at the end of a given
quarter should be largely offset by revenue carried over from the prior period.

We
are focused on leveraging the infrastructure investments we have made to streamline inventory management and improve operating efficiencies across the company. Continued execution of
these initiatives will be necessary to meet our business objectives for 2004.

Discussion of Critical Accounting Policies

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition
in the preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those
estimates under different assumptions and conditions. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal
of our financial condition and results and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are
inherently uncertain. Additionally, the policy described below regarding credits and other vendor allowances is unique to our industry and deserves the attention of a reader of our financial
statements.



We value our inventories at the lower of cost or market using the first-in, first-out (FIFO) method. Rental inventories are valued at the
lower of cost or market using the specific identification method and are depreciated on a straight-line basis over the term of the associated rental agreement for
rent-to-own sales, or over the estimated useful life of the rented instrument for rental only items. We record adjustments to the value of inventory based upon obsolescence and
changes in market value. Applicable costs associated with bringing inventory through our Guitar Center retail distribution center are capitalized to inventory. The amounts are expensed to cost of
goods sold as the associated inventory is sold. Management has evaluated the current level of inventories considering future customer demand for our products, taking into account general economic
conditions, growth prospects within the marketplace, competition, market acceptance of current and upcoming products, and management initiatives. Based on this evaluation, we have recorded impairment
adjustments to cost of goods sold for estimated decreases in net realizable value. These judgments are made in the context of

32

---

our
customers' shifting needs, product and technological trends, and changes in the demographic mix of our customers. A misinterpretation or misunderstanding of these conditions and uncertainties in
the future outlook of our industry or the economy, or other failure to estimate correctly, could result in inventory valuation changes as of any given balance sheet date.



Long-lived assets such as property and equipment and identifiable intangibles are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Goodwill is required to be reviewed for impairment on an annual basis, or more frequently when triggering events occur. Factors we
consider important, which could trigger impairment, include, among other things:



For
long-lived assets other than goodwill and intangibles that are not amortized, the determination of whether impairment has occurred is based on an estimate of undiscounted
future cash flows attributable to the assets, as compared to the carrying value of the assets. Assumptions used in these cash flows are consistent with internal forecasts and consider current and
future expected sales volumes and related operating costs and any anticipated increases or declines based on expected market conditions and local business environment factors. If a potential
impairment is identified, the amount of the impairment loss recognized would be determined by estimating the fair value of the assets and recording a loss if the fair value was less than the book
value. Fair value will be determined based on appraisal values assessed by third parties, if deemed necessary, or a discounted future cash flows analysis. For goodwill and other intangibles that are
not amortized, impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the related assets of the underlying segment to which the
goodwill relates.

Our
assessment regarding the existence of impairment factors is based on market conditions and the operational performance of our business. Our review of factors present and the
resulting appropriate carrying value of our goodwill, intangibles and other long-lived assets are subject to judgments and estimates that management is required to make.



As part of our "satisfaction guaranteed" policy, we allow Guitar Center customers to return product generally within 30 days after the date of purchase,
and we allow Musician's Friend customers to return product within 45 days. American Music customers have ten business days from the date of purchase to return product. We regularly review and
revise, when deemed necessary, our estimates of sales returns based upon historical trends. While our estimates during the past few years have closely approximated actual results, actual returns may
differ significantly, either favorably or unfavorably, from estimates if factors such as economic conditions or the competitive environment differ from our expectations.



We receive cooperative advertising allowances (i.e., an allowance from the manufacturer to subsidize qualifying advertising and similar promotional expenditures
we make relating to the vendor's

33

---

products),
price protection credits (i.e., credits from vendors with respect to in-stock inventory if the vendor subsequently lowers their wholesale price for such products) and vendor
rebates (i.e., credits or rebates provided by vendors based on the purchase of specified products and paid at a later date). Cooperative advertising allowances are recognized as a reduction to
selling, general, and administrative expense when we incur the advertising expense eligible for the credit. We recognized cooperative advertising allowances of $5.1 million, $4.9 million
and $4.5 million for the years ended December 31, 2003, 2002 and 2001, respectively, recorded as an offset to selling, general and administrative expense. Price protection credits and
vendor rebates are accounted for as a reduction of the cost of merchandise inventory and are recorded at the time the credit or rebate is earned. The effect of price protection credits and vendor
rebates is recognized in the income statement at the time the related inventory is sold, as a reduction in cost of goods sold. None of these credits are recorded as revenue.

Results of Operations

The following table presents our consolidated statements of income, as a percentage of sales, for the periods indicated:

Fiscal Year Ended December 31,2003

2002

2001Net sales

100.0
%
100.0
%
100.0
%Gross profit

27.0

26.4

26.0Selling, general and administrative expenses

21.3

21.5

21.1Operating income

5.7

4.9

4.9Other expense:Write-off of investment in non-consolidated entity





0.4Interest expense, net

1.0

1.2

1.4Total other expense

1.0

1.2

1.8Income before income taxes

4.7

3.7

3.1Income taxes

1.8

1.4

1.3Net income

2.9
%
2.3
%
1.8
%


Fiscal 2003 Compared to Fiscal 2002

Net sales for the year ended December 31, 2003 increased 15.8% to $1.3 billion, compared with $1.1 billion last year. Comparable store sales
for the full year increased 7%. Comparable store sales are defined as sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of the
reporting period. We believe that comparable store sales are a more useful indicator of store performance than the change in total net sales, since comparable store sales exclude the effects of
changes in the number of stores open.

Net
sales from Guitar Center stores for fiscal 2003 totaled $979.0 million, a 13.9% increase from $859.6 million in fiscal 2002. Sales from new stores contributed
$60.0 million and represent 50.7% of the total increase in retail store sales. Comparable Guitar Center store sales for the full year increased 7%. The increase in comparable store sales was
due to good response to our advertising and marketing strategy for our Guitar Center stores. Total advertising and marketing expense increased from $23.9 million to $28.5 million in
2003. Our management is presently anticipating comparable store sales growth of 5% to 7% for the first quarter in 2004. The foregoing statement is a forward-looking statement and is subject to the
qualifications set forth below under "Forward-Looking Statements; Business Risks." Net sales from American Music stores for 2003 totaled $38.2 million, a 17.5% increase from
$32.5 million in 2002. Comparable American Music stores sales for the full year increased 10%.

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The
increase is due to improved retail traffic and sales in combo products not historically carried in these stores.

Net
sales from the direct response channel totaled $257.9 million in 2003, a $49.1 million, or 23.5%, increase from 2002. This increase primarily reflects the improved
performance of catalog circulation strategies. Sales from the contact center, which represents sales placed via phone, live chat, mail and e-mail, increased 8.4% to $118.4 million
from $109.2 million in 2003. Internet sales from orders placed via Musician's Friend and Giardinelli web sites increased 40.2% to $139.5 million from $99.5 million for the same
period last year. The growth of web-based sales reflects the continued trend of our catalog customers' preference in using the web to place their orders, the success of
web-based promotions, and that the web site includes a more complete inventory presentation than our catalogs. During the fourth quarter, the direct response division changed its revenue
recognition methodology, whereby we do not recognize revenue until the estimated date an order is received by the customer, instead of the date shipped. This change resulted in a reduction of
approximately $3.9 million in net sales, and of approximately $546,000 in net income, or $0.02 per diluted share, for the fourth quarter. The impact of this change was immaterial to the prior
quarters of 2003. On a going forward basis, we do not expect this change to have a material effect on operating results because the amount of revenue deferred at the end of a given quarter should be
largely offset by revenue carried over from the prior period.

Gross
profit for the year ended December 31, 2003 compared to 2002 increased 18.5% to $344.0 million from $290.4 million. Gross profit as a percentage of net sales
for the year ended December 31, 2003 compared to 2002 increased to 27.0% from 26.4%. Gross profit as a percentage of net sales for Guitar Center was 25.3% for both the year ended
December 31, 2003 and 2002. The unchanged percentage reflects improved selling margins (0.21%), leveraging of occupancy costs on higher sales (0.11%) and a reduction in shrink (0.07%), offset
by increased freight. The gross profit margin for the American Music stores was 35.7% compared to 34.1% for the same period last year. The gross margin percentage increased due to a reduction in
shrink (3.74%) offset by a decline in selling margins due to a change in product mix (1.57%) with the remainder primarily due to higher store depreciation. The gross profit margin for the direct
response division was 32.1% for 2003 compared to 29.7% in 2002. The increase is due to higher selling margin resulting from better buying performance and favorable product mix (1.6%) and better than
expected margins on the sell through of slow moving products (0.6%).

Selling,
general and administrative expenses for fiscal 2003 increased 15.0% to $272.0 million from $236.5 million in fiscal 2002. As a percentage of net sales, selling,
general and administrative expenses for fiscal 2003 decreased to 21.3% from 21.5% in fiscal 2002. Selling, general and administrative expenses for the Guitar Center stores in 2003 was 20.2% as a
percentage of net sales compared to 20.5% in fiscal 2002. The decrease reflects leveraging due to higher than expected sales, as indicated by lower payroll costs (0.2%), decrease in telephone expense
(0.02%) as a result of better negotiated rates, decrease in supplies expense (0.04%) and a decrease in entertainment costs (0.03%). Selling, general and administrative expenses for the American Music
stores were 48.0% of sales compared to 41.1% last year. The increase is primarily due to increased salary costs (3.0%), increase in bad debt expense (2.1%), advertising (0.8%), travel and
entertainment (0.6%) and profit sharing plan (0.4%).

Selling,
general and administrative expenses for the direct response division were 21.6% of sales compared to 22.6% last year. The improvement is primarily due to a reduction in
advertising costs (0.3%) as a result of leveraging of catalog and postage costs, decrease in bad debt (0.2%), decrease in credit card expense (0.2%) reflecting reduced fees and a decrease in computer
maintenance costs (0.1%).

Operating
income increased 33.7% to $72.0 million from $53.9 million in fiscal 2002. This increase reflects performance of the Guitar Center and Musician's Friend
businesses at or above expected levels,

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offset
somewhat by continued spending on systems and infrastructure build out and merchandising and operational challenges at the American Music stores resulting in an operating loss of approximately
$4.7 million for this segment for the year ended December 31, 2003.

Interest
expense, net for fiscal 2003 decreased to $12.5 million from $13.1 million in fiscal 2002. The decrease is due to lower rates and reduced borrowings, offset by a
one time charge to redeem our $66 million in Senior Notes. We issued $100 million of 4% Convertible Senior Notes in June of 2003 and redeemed our 11% Senior Notes in July of 2003.
Accordingly, included in interest expense for 2003 are the redemption premium of $1.2 million and the write-off of deferred financing costs of $0.7 million associated with
the Senior Notes redeemed in July 2003 for a total of $1.9 million.

Income
tax expense for fiscal 2003 was $22.6 million compared to $15.5 million for the same period last year, both based on an effective tax rate of approximately 38%.
There were no significant changes in the Company's operation that resulted in a change to the effective tax rate.

Net
income for fiscal 2003 increased to $36.9 million from $25.3 million in fiscal 2002 as a result of the combinations of factors described above.

One
of our competitors, Mars Music, Inc., filed for federal bankruptcy court protection on September 27, 2002 and has completed a liquidation resulting in the closure of
all of its stores. We believe that a portion of our sales growth during 2003 was attributable to the closure of Mars, but cannot quantify this benefit or predict whether or not we will retain these
former Mars customers.

Fiscal 2002 Compared to Fiscal 2001

Net sales for the year ended December 31, 2002 increased 16.0% to $1.1 billion, compared with $949.3 million last year. Comparable store
sales for the full year increased 6%. Comparable store sales are defined as sales for the comparable periods, excluding net sales attributable to stores not open for 14 months as of the end of
the reporting period. We believe that comparable store sales are a more useful indicator of store performance than the change in total net sales, since comparable store sales exclude the effects of
changes in the number of stores open. Net sales from Guitar Center stores for fiscal 2002 totaled $859.6 million, a 13.6% increase from $756.8 million in fiscal 2001. Sales from new
stores contributed $63.3 million and represent 57.0% of the total increase in retail store sales. Comparable store sales for Guitar Center increased 7%. The increase in comparable store sales
was due to good response to our advertising and marketing for our Guitar Center stores and the closure of a competitor, Mars Music, which was in markets also served by us. Total advertising and
marketing expense was $23.9 million in 2002 versus $22.2 million in 2001. Net sales for American Music stores for 2002 totaled $32.5 million, a 35.4% increase from
$24.0 million in 2001. Comparable store sales for American Music decreased 6%. Net sales from the direct response channel totaled $208.7 million in 2002, a $40.2 million, or
23.9%, increase from 2001, due primarily to increased orders driven by higher circulation and promotional targeting (15.0%) and an increase in the average order (8.9%). Although catalogs are mailed to
both Internet and catalog customers, we continue to see a shifting in customer preference towards placing orders via the Internet. Catalog sales, which consist of all orders placed through the contact
center, increased 16.2% to $109.2 million in 2002 from $94.0 million in 2001. Internet sales for the year, which represents orders placed via the Internet, increased 33.5% to
$99.5 million from $74.5 million last year.

During
the second quarter of 2002, we adopted a new accounting policy to conform withEITF 00-10, Accounting for Shipping and Handling Fees and
Costs. Prior to adopting EITF 00-10, shipping and handling fees paid by our customers to our direct response division were recognized as a reduction to cost of
goods sold. To conform with EITF 00-10, we now treat such fees as revenue. As a result, $13.0 million and $11.1 million of shipping and handling fees were recognized as
direct response division revenue in the years 2002 and 2001, respectively. The reclassification of these fees has no effect on operating income, net income or earnings per share for any period. We
have made a conforming

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reclassification
in all historical accounting periods to provide a comparable presentation. Please see our Current Report on Form 8-K dated July 25, 2002 for a schedule of
the reclassification amounts applied to our historical financial statements in order to implement this accounting policy.

Gross
profit for the year ended December 31, 2002 compared to 2001 increased 17.6% to $290.4 million from $247.0 million. Gross profit as a percentage of net sales
for the year ended December 31, 2002 compared to 2001 increased to 26.4% from 26.0%. Gross profit as a percentage of net sales for Guitar Center stores in 2002 was 25.3% compared to 25.2% in
2001. The slight increase reflects an increase in freight costs (0.2%). The gross profit margin for American Music was 34.1% compared to 38.6%. The decrease in retail gross margins is primarily due to
a change in product mix, which resulted in incrementally higher freight costs (0.4%), increased occupancy costs (2.5%), increase in shrink (3.5%), offset by improved selling margins (2.0%). The gross
profit margin for the direct response division was 29.7% for 2002 compared to 27.7% in 2001. The improvement in margin is attributed to better pricing and favorable market conditions compared to the
post-9/11 environment in 2001, as well as a shift towards Internet ordering which presents customers with a higher margin assortment of accessories and other low cost
products not carried in the catalogs (1.0%). Reduced shipping costs (1.0%) are due to efficiency improvements at the distribution center, including the implementation of marry-up shipping
techniques.

Selling,
general and administrative expenses for fiscal 2002 increased 17.8% to $236.5 million from $200.7 million in fiscal 2001. As a percentage of net sales, selling,
general and administrative expenses for fiscal 2002 increased to 21.5% from 21.1% in fiscal 2001. Selling, general and administrative expenses for the Guitar Center stores were 20.5% as a percentage
of sales for fiscal 2002 and 2001. Selling, general and administrative expenses for American Music stores were 41.1% in 2002 compared to 29.5% in 2001. The increase is primarily due to increased
salary costs (6.8%), insurance costs (1.3%), advertising costs (1.2%), computer maintenance expenses (1.1%), travel costs (0.4%), and supplies expense (0.8%). Selling, general and administrative
expenses for the direct response division were 22.6% of sales compared to 23.1% last year. The decrease primarily reflects reduced postage costs related to catalog mailings (0.2%) and improved
performance at the warehouse with reduced packing supplies (0.3%) due to the improvement in marry-up fill rate and reduction of split shipments.

Operating
income, for the reasons stated above, increased 16.6% to $53.9 million from $46.2 million in fiscal 2001. As a percentage of sales, operating income was 4.9% in
the years ended December 31, 2002 and 2001, respectively.

In
2001, we recorded a $3.5 million, non-cash charge to reflect the write-off of our minority interest in a non-consolidated entity. This
charge reflected our assessment of the likely future cash flows from the investment in light of the uncertainties regarding the ongoing business of this entity. No similar cost was incurred in 2002.

Interest
expense, net for fiscal 2002 decreased to $13.1 million from $13.4 million in fiscal 2001. The decrease is due to lower interest rates applicable to our line of
credit borrowings and a $592,000 non-recurring charge in 2001 related to the extension of our line of credit and replacement of one of our former lenders, offset by additional borrowings.

Income
tax expense for fiscal 2002 was $15.5 million compared to $12.2 million for the same period last year. In the prior year we did not recognize a tax benefit on the
$3.5 million write-off of the minority investment in a non-consolidated entity because of the capital nature of the write-down and the uncertainty that we
will have future capital gains to utilize the capital loss. Excluding the effect of the write-off of the minority investment, our effective tax rates for each of the years ending
December 31, 2002 and 2001 was 38%.

Net
income for fiscal 2002 increased to $25.3 million from $17.0 million in fiscal 2001 as a result of the combinations of factors described above.

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Liquidity and Capital Resources

Disclosures about Contractual Obligations and Commercial Commitments

The following table aggregates all material contractual obligations and commercial commitments that affect our financial condition and liquidity as of
December 31, 2003:

|                                                                                         |  | Payments Due by Period
(In thousands)
|---------------------------------------------------------------------------------------- |  | -------------------------------------
|
|Long-term obligations (1)                                                                |  | $                                    
|Operating lease obligations (2)                                                          |  |                                      
|Other long-term liabilities reflected on the registrant's balance sheet under "GAAP" (3) |  |                                      
|                                                                                         |  |                                      
|Total                                                                                    |  | $                                    
|                                                                                         |  |                                      

---

Our
need for liquidity will arise primarily from the funding of capital expenditures, working capital requirements and payments on our indebtedness, as well as possible acquisitions. We
have historically financed our operations primarily through internally generated funds and borrowings under our credit
facilities. Please see Item 1. Business"Risks Related to the Business" for a discussion of factors which could reasonably likely result in a decrease in the amount of internally generated
funds available to finance capital expenditures and working capital requirements. As of December 31, 2003, we had no borrowings under our credit facility and had available borrowings of
$111 million (net of $4.0 million of outstanding letters of credit).

The
terms of our significant financing agreements, including those related to our credit facility, the convertible notes and the equipment lease facilities described below are not
dependent on any change in our credit rating. We believe that the key company-specific factors affecting our ability to maintain our existing debt and lease financing relationships and to access such
capital in the future are our present and expected levels of profitability and cash flow from operations, our working capital and fixed asset collateral bases, our expected level of capital
expenditures, the level of equity capital of the company relative to the level of debt obligations and, in the case of convertible instruments, the related

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perceived
attractiveness of an investment in our common stock. In addition, as noted below, our existing agreements include significant restrictions on future financings, including, among others,
limits on the amount of indebtedness that we may incur and whether or not such indebtedness may be secured by any of our assets.

In
the fourth quarter of 2003, we amended our credit facility with a syndicate of banks led by Wells Fargo Retail Finance. The credit facility permits borrowings up to
$125 million, subject to borrowing base limitations ($115 million at December 31, 2003). The actual amount available is tied to our inventory and receivable base, and repayment
obligations under the credit facility are secured by liens on our principal assets. Borrowing options are prime rate (4.00% at December 31, 2003) plus applicable prime margin, or London
Interbank Offered Rate, or LIBOR (six month rate at December 31, 2003 was 1.22%) plus applicable LIBOR margin. The applicable prime and LIBOR margins are fixed for the first six months of the
agreement at 0.00% and 1.50%, respectively. After the initial six months, the applicable prime and LIBOR margins are based upon levels of excess availability and adjusted quarterly. If excess
availability is greater than $20 million, the applicable prime margin is 0.00% and applicable LIBOR margin is 1.50%. If excess availability is less than or equal to $20 million and
greater than $10 million, the applicable prime margin is 0.00% and the applicable LIBOR margin is 1.75%. If excess availability is less than or equal to $10 million, the applicable prime
margin is 0.25% and the applicable LIBOR margin is 2.00%. An unused fee is assessed on the unused portion of the credit facility based upon levels of excess availability. If excess availability is
greater than $10 million, the unused fee is 0.25%. If excess availability is less than or equal to $10 million, the unused fee is 0.375%. The agreement underlying the credit facility
includes significant restrictive negative covenants. Among other things, these covenants restrict our ability to incur debt and issue specified equity instruments, incur liens on our assets, make any
significant change in our corporate structure or the nature of our business, dispose of assets, make guaranties, prepay debt, engage in a change in control transaction, pay dividends, make investments
or acquisitions, engage in transactions with affiliates and incur capital expenditures, and also require that we satisfy a minimum availability test. The minimum availability test requires that we
maintain $10 million of reserved availability under the agreement based on its borrowing base limitations. The amount we disclose in our public reports from time to time as available to borrow
under the agreement ($111 million at December 31, 2003) is already reduced by this required reserve and outstanding letters of credit, and thus represents a net amount available under
the
agreement. The agreement also includes representations and warranties which must be true each time we borrow funds under the credit facility and affirmative covenants. The full text of the contractual
requirements imposed by this financing is set forth in the Amended and Restated Loan and Security Agreement which has been filed with the Securities and Exchange Commission. We were in compliance with
such requirements as of December 31, 2003. Subject to limited cure periods, the lenders under our credit facility may demand repayment of these borrowings prior to stated maturity upon the
occurrence of specified events, including if we breach the terms of the agreement, suffer a material adverse change, engage in a change in control transaction, suffer a significant adverse legal
judgment, default on other significant obligations, or in the event of specified events of insolvency. The credit agreement matures in December 2007.

On
June 16, 2003, we completed the issuance of $100 million principal amount of 4.00% Senior Convertible Notes due 2013. Of the net proceeds from the offering,
approximately $68.2 million was used in July 2003 to retire all outstanding Senior Notes and pay the related redemption premium, and the balance was used to reduce the amount outstanding
under our credit agreement and pay offering expenses. The Notes bear interest at the rate of 4.00% per annum, subject to the payment of contingent interest under certain circumstances, and are
convertible into shares of common stock at a conversion price of $34.58 per share, subject to adjustment under specified circumstances. Under the contingent conversion feature of the Notes, subject to
certain exceptions, they are not convertible into common stock unless and until the trading price of the common stock reaches at least $41.50 for a specified period or designated corporate events
occur. The final maturity of the Notes is July 2013,

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although
holders may require us to repurchase the Notes at their election in July 2008, July 2010 or upon the occurrence of a change in control, in each case for a purchase price equal
to the original principal amount plus accrued interest. We may call the Notes for redemption commencing in July 2006 subject to the payment of a redemption premium of 1.6% if redeemed prior to
July 2007 and 0.8% if redeemed prior to July 2008 (thereafter there is no redemption premium). The indenture governing the Notes does not limit our ability to incur indebtedness or
otherwise substantively restrict the operation of our business to any significant degree. Subject to limited cure periods, the holders of the Notes may demand repayment of these borrowings prior to
the stated maturity upon the occurrence of specified events, including if we fail to pay interest or principal when due, fail to satisfy our conversion obligation, if another obligation of ours having
an outstanding principal amount in excess of $15 million is accelerated prior to stated maturity and upon the occurrence of specified events of insolvency.

In
July 2003, we called for the redemption of $66.7 million of Senior Notes outstanding. Interest expense related to the redemption premium and the write-off of
deferred financing costs associated with the Senior Notes redeemed was $1.9 million ($1.2 million after-tax, or $0.05 per diluted share).

During
2002 we entered into master operating lease agreements with General Electric Capital Corporation and US Bank to lease equipment and other property primarily to support the
operations of the new central distribution center for our Guitar Center retail stores. Under these agreements, we leased a total of $10.5 million in equipment and other property. The agreement
calls for monthly payments of $138,000 for a term of 36 months through September 1, 2005 and monthly payments of
$48,000 for a term of 12 months through December 28, 2003. The leases have options to extend through September 30, 2009 and December 28, 2005, respectively.

As
is the case with most multi-unit retailers, substantially all of the real property used in our business is leased under operating lease agreements. Please see, Item 2.
Properties, "Disclosures About Contractual Obligations and Commercial Commitments" and Note 8 to our financial statements.

For
the year ended December 31, 2003, cash provided by operating activities was $58.0 million, most of which represented cash income from operations, net of depreciation
and amortization expense. Cash used in investing activities totaled $24.2 million, which primarily consisted of capital expenditures for retail store expansions ($14.1 million),
remodeling of existing stores ($1.2 million) and computer equipment purchases ($6.7 million). Cash used in financing activities totaled $34.3 million, which consisted principally
of repayments under our credit facility ($82.7 million) and redemption of our Senior Notes outstanding ($66.7 million), offset by net proceeds from the issuance of our
$100 million Senior Convertible Notes, less fees of $3.1 million ($96.9 million) and the proceeds from employee stock purchases and the exercise of stock options
($18.3 million).

Our
principal working capital need is to provide for the inventory levels necessary to support our sales activities, particularly the Guitar Center retail stores. Inventory decreased
from $292.1 million to $288.9 million, or 1.1%. Inventory per square foot at Guitar Center retail stores (Guitar Center store and distribution center inventories under GAAP divided by
total store retail square footage on a given date) was $121 at December 31, 2003 compared to $140 in 2002. Our ongoing objective is to improve inventory performance by refining our
replenishment processes and systems, utilizing a distribution center for our Guitar Center stores, and through improved planning, presentation and display of inventories in our retail stores.

We
generally do not provide credit to our retail customers but instead offer programs provided by third party consumer credit companies which are non-recourse to us, meaning
that the risk of non-payment is borne by the third party provider so long as we comply with its administrative and approval policies. From time to time we participate in programs that
provide our customers with below-market interest rates, deferred payments or similar benefits. These programs are also non-recourse to us but we pay the credit provider a fee which is
recognized as a component of selling, general and administrative expense at the time of the sale to the consumer.

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We
intend to pursue an aggressive growth strategy by opening additional stores in new and existing markets. During 2003, we opened 14 new Guitar Center stores. Each new large format
Guitar Center store typically has required approximately $1.6 to $1.8 million for gross inventory. Historically, our cost of capital improvements for a large format Guitar Center store has been
approximately $850,000,
consisting of leasehold improvements, fixtures and equipment. We incur higher costs in some geographic areas, particularly the Northeast, and when we build a larger flagship store. We have developed
smaller Guitar Center stores to build in secondary markets or sites that we do not believe will support our large format units. The first of these units was opened in late 2000 and 14 more had been
opened as of December 31, 2003. Our small format stores have typically incurred approximately $560,000 in capital expenditures and require approximately $1.1 million to
$1.2 million in inventory.

We
are also anticipating additional capital and strategic requirements related to improving our fulfillment facilities, upgrading our technology and systems, and pursuing new
opportunities in the e-commerce activities of our retail and direct response divisions as well as related businesses.

Our
distribution center in the Indianapolis, Indiana area supports our Guitar Center retail store operations. We have a 10-year agreement to lease the facility and we also
have numerous additional commitments necessary to support the operations of the facility. In 2003, nearly all products flowed through the distribution facility, with the exception of special orders
which will continue, for the most part, to be drop shipped to our stores. Migration from our former "drop-ship" model to a centralized distribution model is an important development in our
operating strategy and has required the allocation of significant financial and managerial resources. In accordance with generally accepted accounting principles, a portion of the costs of operating
this facility are absorbed into our Guitar Center merchandise inventories and recognized as an element of cost of goods sold when the related inventory is sold. This can result in a slight decrease in
reported gross margin depending on our success in defraying these additional costs, although we also expect to realize efficiencies involving other costs such as selling, general and administrative
expense and interest expense.

We
also continue to make significant investments in information technology across our businesses and to incur costs and make investments designed to expand the reach of our businesses on
the Internet. The costs of these initiatives and other investments related to our businesses will continue to be significant.

Our
expansion strategy is to continue to increase our market share in existing markets and to penetrate strategically selected new markets. We opened a total of 14 Guitar Center stores
in 2003 and 12 stores in 2002, and currently anticipate opening 16 to 18 Guitar Center stores in 2004. Approximately half of the stores planned for 2004 are smaller format units designed for secondary
markets. We opened a total of eight American Music stores in 2002, five of the eight by acquisition of M&M Music, a band instrument and retail merchandise retailer. In 2003, we opened one and closed
two American Music stores. As of December 31, 2003, we have 19 American Music stores. In 2004, we do not presently plan to open any American Music stores. We have slowed our planned growth of
the American Music division because our infrastructure and remerchandising projects at this business have to date required more time and resources than originally anticipated. We do, however, believe
there exists a number of acquisition opportunities in the relatively fragmented band instruments market that could be a good fit into our American Music platform and continue to pursue acquisition
opportunities.

We
also believe there may be attractive opportunities to expand by selectively acquiring existing music products retailers or other complimentary businesses, if attractive opportunities
can be identified. While we cannot provide assurance that we will complete any further acquisition transactions, in the ordinary course of our business we investigate and engage in negotiations
regarding such opportunities. Acquisitions will be financed with drawings under our existing credit facilities, expansion of our credit facilities, issuance of debt or equity securities, or a
combination, depending upon transaction size and market conditions, among other things.

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Our
additional capital resources and liquidity for 2004 are presently expected to be primarily provided by net cash flow from operations and borrowings under our credit facility.
Depending upon market conditions, we may also elect or be required to raise additional capital in the form of common or preferred equity, debt or convertible securities for the purpose of providing
additional capital to fund working capital needs or continued growth of our existing business, or to refinance existing obligations. Any such financing activity will be dependent upon many factors,
including our liquidity needs, market conditions and prevailing market terms, and we cannot assure you that future external financing for us will be available on attractive terms or at all.

New Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board issued Statement No. 143, "Accounting for Asset Retirement
Obligations" (SFAS No. 143). This new pronouncement establishes financial accounting and reporting standards for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The provisions of SFAS No. 143 apply to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for obligations of lessees. The standard was effective for
financial statements issued for fiscal years beginning after June 15, 2002. We adopted this standard effective January 1, 2003, and it did not have a material effect on our consolidated
financial statements.

In
January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, "Consolidation of Variable Interest
Entities" (FIN 46). This interpretation clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" (ARB 51), and requires companies to evaluate variable interest entities for specific characteristics to determine whether additional consolidation and disclosure
requirements apply. This interpretation is immediately applicable for variable interest entities created after January 31, 2003, and applies to the first fiscal year or interim period beginning
after June 15, 2003 for variable interest entities acquired prior to February 1, 2003. The adoption of this interpretation did not have any impact on our financial position or results of
operations. In December 2003, the FASB revised FIN 46 to exempt certain entities from its requirements and to clarify certain issues arising during the implementation of FIN 46. The adoption of
this revised interpretation in the first quarter of 2004 is not expected to have any impact on our consolidated financial statements.

EITF
Issue No. 02-16, "Accounting by a Reseller for Cash Consideration Received from a Vendor," provides that cash
consideration received from a vendor is presumed to be a reduction of the prices of the vendor's products or services and should, therefore, be characterized as a reduction in cost of sales unless it
is a payment for assets or services delivered to the vendor, in which case the cash consideration should be characterized as revenue, or unless it is a reimbursement of costs incurred to sell the
vendor's products, in which case the cash consideration should be characterized as a reduction of that cost. EITF No. 02-16 became effective for us in the first quarter of 2003, and
had no impact on our consolidated financial statements, as we have historically accounted for vendor payments in accordance with the provisions of this standard.

In
December 2002, the Financial Accounting Standards Board issued Statement No. 148, "Accounting for Stock-Based CompensationTransition
and Disclosure," (SFAS No. 148), an amendment of FASB Statement No. 123, which provides guidance for transition to the fair value based method of accounting for
stock-based employee compensation and the required financial statement disclosure. The adoption of SFAS No. 148 expanded the disclosure in our interim financial statements, and does not
significantly impact our annual disclosures of stock-based compensation in our consolidated financial statements.

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In
May 2003, the Financial Accounting Standards Board issued Statement No. 150, "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity" (SFAS No. 150). The statement establishes standards for how an issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective
for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted
this standard effective July 1, 2003, and it did not have a material effect on our consolidated financial statements.

Seasonality

Our operating results are not highly seasonal, except for the effect of the holiday selling season in November and December. Sales in the fourth quarter are
typically significantly higher on a per store basis and through the direct response unit than in any other quarter.

Inflation

We believe that the relatively moderate rates of inflation experienced in recent years have not had a significant impact on our net sales or profitability.

Forward-Looking Statements; Business Risks

This annual report contains forward-looking statements relating to, among other things, future results of operations, growth and investment plans, sales, trends
in gross margin, growth in the Internet business and other factors affecting growth in sales and earnings. Specific forward-looking statements are provided regarding our management's current views
regarding comparable store sales, new store openings, and capital expenditure levels. Statements regarding new store openings are based largely on our current expectations and are necessarily subject
to associated business risks related to, among other things, the identification of suitable sites or acquisition opportunities, the timely construction, staffing and merchandising of those stores and
other matters, some of which are outside of our control. Comparable store sales growth is highly dependent upon the state of the economy, the effectiveness of our sales and promotion strategies, and
the effect of competition, including other national operators of music products stores attempting to implement national growth strategies. The American Music business has in the past and may in the
future give rise to significant fluctuations from period to period as we reformat their store model and build-out the information technology and management structure. The American Music
stores have incurred significant operating losses in 2003 and we presently expect this situation to continue in 2004.

Sales
and earnings trends are also affected by many other factors including, among others, world and national political events, general economic conditions, the effectiveness of our
promotion and merchandising strategies, changes in the music products industry, retail sales trends and the emergence of new or growing specialty retailers of music products. In light of these risks,
there can be no assurance that the forward-looking statements contained in this report will in fact be realized. The statements made by us in this report represent our views as of the date of this
report, and it should not be assumed that the statements made herein remain accurate as of any future date. We do not presently intend to update these statements and undertake no duty to any person to
affect any such update under any circumstances.

For
further discussion of risks associated with our business, please see the discussion under the caption Item 1. Business"Risks Related to the Business."

43

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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not have any assets or liabilities which, in our view, impose upon us significant market risk except for our outstanding indebtedness represented by
$100 million principal amount of Senior Convertible Notes due 2013 with a fixed interest rate of 4% (subject to contingent interest) and our credit facility which has a variable rate of
interest generally consisting of stated premiums above LIBOR. At December 31, 2003, we had no outstanding borrowings under our credit facility. To the extent prevailing short-term
interest rates fluctuate, the interest expense we incur on our credit facility will change with a resulting effect (positive or negative) on our financial position, results of operations and cash
flows. We do not use derivative financial instruments in our investment portfolio. Historically, we have not carried significant cash balances and any cash in excess of our daily operating needs has
been used to reduce our borrowings. Excess cash is invested in short-term, high quality interest bearing investments.

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the index included at "Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K."

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable

ITEM 9A. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to our
management, including our Co-Chief Executive Officers and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired
control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As
required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Co-Chief
Executive Officers and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on
the foregoing, our Co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There
has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially
affect, our internal controls over financial reporting.

44

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PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

We have adopted a code of business conduct and ethics, or code of conduct, containing general guidelines for conducting our business consistent with the highest
standards of business ethics. The code of conduct is designed to qualify as a "code of ethics" within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules promulgated
thereunder as well as under applicable rules of the Nasdaq National Market to become effective in May 2004. The code is available on the investor relations section of our website
(www.guitarcenter.com), under subsection captioned "Corporate Governance." To the extent required by law or the rules of the Nasdaq National Market, any amendments to, or waivers from, any provision
of the code will be promptly disclosed publicly. To the extent permitted by such requirements, we intend to make such public disclosure by posting the relevant material on the corporate governance
page of the investor relations section of our website in accordance with SEC rules.

All
additional information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the Securities
Exchange Act of 1934, as amended, or Exchange Act, in connection with our annual meeting of stockholders.

Item 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Exchange Act in connection with our annual meeting of stockholders.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is incorporated by reference into our definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Exchange Act in connection with our annual meeting of stockholders.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Exchange Act in connection with our annual meeting of stockholders.

Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is incorporated by reference to our definitive Proxy Statement to be filed pursuant to Regulation 14A under the
Exchange Act in connection with our annual meeting of stockholders.

45

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PART IV

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

| |  |    |  |                                                                                                                                                                                                                                |  |          
| |  | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ---------
| |  | 1. |  | The following financial statements for the Company are included as part of this Report:                                                                                                                                        |  |          
| |  |    |  |                                                                                                                                                                                                                                |  |          
| |  |    |  | Index to Financial Statements                                                                                                                                                                                                  |  | Page 53  
| |  |    |  |                                                                                                                                                                                                                                |  |          
| |  | 2. |  | The following financial statement schedule for the Company is included as part of this Report:                                                                                                                                 |  |          
| |  |    |  |                                                                                                                                                                                                                                |  |          
| |  |    |  | Schedule IIValuation and Qualifying Accounts                                                                                                                                                                                  |  | Page II-1
| |  |    |  |                                                                                                                                                                                                                                |  |          
| |  |    |  | All other schedules have been omitted since the required information is not present in amounts sufficient to require submission of the schedules, or because the information required is included in the financial
statements. |  |          



46

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INDEX TO EXHIBITS

|Exhibit
Number |  | Description                                                                                                                                                                                                                                                                      
|-------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1            |  | The Company's Restated Certificate of Incorporation (Incorporated by reference to Exhibit 3.5 of the Company's Registration Statement on Form S-1; Registration No. 333-20931).                                                                                                  
|3.2            |  | The Company's Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2001).                                                                                               
|3.3            |  | Amendment to the Company's Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.3 of the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2001).                                                                              
|3.4            |  | Amendment to the Company's Amended and Restated Bylaws adopted February 25, 2003 (Filed herewith).                                                                                                                                                                               
|3.5            |  | Amendment to the Company's Amended and Restated Bylaws adopted July 21, 2003 (Filed herewith).                                                                                                                                                                                   
|4.1            |  | Indenture dated as of June 10, 2003 by and between the Company and BNY Western Trust Company as trustee (Filed herewith).                                                                                                                                                        
|4.2            |  | Form of Stock Certificate (Incorporated by reference to Exhibit 4.4 of the Company's Registration Statement on Form S-1; Registration No. 333-20931).                                                                                                                            
|4.3            |  | Form of Indenture (Incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-3; Registration No. 333-65220).                                                                                                                                    
|4.4            |  | Form of Officer's Certificate pursuant to Section 2.02 of the Indenture governing the Senior Convertible Notes due 2013 (Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K dated June 13,
2003).                                              
|4.5            |  | Form of Global Note relating to the Senior Convertible Notes due 2013 (Incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K dated June 13, 2003).                                                                                                
|10.1*          |  | The Company's Amended and Restated 1996 Performance Stock Option Plan (Incorporated by reference to Exhibit 10.5 of the Company's Registration Statement on Form S-1; Registration No. 333-20931).                                                                               
|10.2*          |  | Modification to Amended and Restated 1996 Performance Stock Option Plan (Incorporated by reference to Exhibit 10.28 of the Company's Registration Statement on Form S-1; Registration No. 333-20931).                                                                            
|10.3*          |  | Amendment No. 2 to the Amended and Restated 1996 Performance Stock Option Plan (Incorporated by reference to Exhibit 10.30 of the Company's Registration Statement on Form S-1; Registration No. 333-20931).                                                                     
|10.4*          |  | Amendment No. 3 to Amended and Restated 1996 Performance Stock Option Plan (Incorporated by reference to Exhibit 10.29 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998).                                                                 
|10.5*          |  | Amended 1997 Equity Participation Plan (Incorporated by reference to Exhibit 10.22 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998).                                                                                                     
|10.6*          |  | Amendment to the 1997 Equity Participation Plan of Guitar Center, Inc. approved by stockholders at the 2000 Annual Meeting of Stockholders. (Incorporated by reference to Exhibit 10.36 of the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999).
|               |  |                                                                                                                                                                                                                                                                                  

47

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|10.7*  |  | Amendment to the Company's 1997 Equity Participation Plan approved by stockholders at the 2001 Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the period ended
March 31, 2001).                             
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.8*  |  | Amendment to the Company's 1997 Equity Participation Plan approved July 26, 2001 (Incorporated by reference to Exhibit 10.42 to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 2001).                                                                      
|10.9*  |  | Amendment to the 1997 Equity Participation Plan of Guitar Center, Inc. adopted March 24, 2003 increasing the authorized shares under the plan to 4,000,000 (Incorporated by reference to Exhibit 10.40 to the Company's Quarterly Report on
Form 10-Q for the period ended March 31, 2003).
|10.10* |  | Form of Employee Stock Purchase Plan as approved by stockholders at the Annual Meeting of Stockholders (Incorporated by reference to Exhibit 10.38 to the Company's Quarterly Report Form 10-Q for the period ended March 31,
2001).                                                       
|10.11* |  | Form of Indemnification Agreement between the Company and each of its directors and executive officers (Incorporated by reference to Exhibit 10.11 of the Company's Registration Statement on Form S-1; Registration
No. 333-20931).                                                       
|10.12* |  | Management Stock Option agreement dated June 5, 1996 by and between the Company and Larry Thomas (Incorporated by reference to Exhibit 10.16 of the Company's Registration Statement on Form S-1; Registration No. 333-10491).                                                             
|10.13* |  | Amendment No. 1 to Management Stock Option Agreement dated as of October 15, 1996 between the Company and Larry Thomas (Incorporated by reference to Exhibit 10.21 contained in Registration Statement on Form S-1; File
No. 333-10491).                                                   
|10.14* |  | Management Stock Option agreement dated June 5, 1996 by and between the Company and Marty Albertson (Incorporated by reference to Exhibit 10.17 of the Company's Registration Statement on Form S-1; Registration
No. 333-10491).                                                          
|10.15* |  | Amendment No. 1 to Management Stock Option Agreement dated as of October 15, 1996 between the Company and Marty Albertson (Incorporated by reference to Exhibit 10.22 contained in Registration Statement on Form S-1; File
No. 333-10491).                                                
|10.16* |  | Amended and Restated Employment Agreement between the Company and Larry Thomas, effective as of June 6, 2001, with exhibits (Incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2001).                                 
|10.17* |  | Amendment to Amended and Restated Employment Agreement by and between Larry Thomas and Guitar Center, Inc. dated March 24, 2003 (Incorporated by reference to Exhibit 10.33 to the Company's Quarterly Report on Form 10-Q for the period ended
March 31, 2003).                           
|10.18* |  | Amendment No. 2 dated July 1, 2003 to Amended and Restated Employment Agreement between Guitar Center, Inc. and Larry Thomas (Incorporated by reference to Exhibit 10.43 to the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 2003).                          
|10.19* |  | Amended and Restated Employment Agreement between the Company and Marty Albertson, effective as of June 6, 2001, with exhibits (Incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2001).                              
|10.20* |  | Amendment to Amended and Restated Employment Agreement by and between Marty Albertson and Guitar Center, Inc. dated March 24, 2003 (Incorporated by reference to Exhibit 10.34 to the Company's Quarterly Report on Form 10-Q for the period ended
March 31, 2003).                        
|       |  |                                                                                                                                                                                                                                                                                            

48

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|10.21* |  | Amendment No. 2 dated July 1, 2003 to Amended and Restated Employment Agreement between Guitar Center, Inc. and Marty Albertson (Incorporated by reference to Exhibit 10.44 to the Company's Quarterly Report on Form 10-Q for the period
ended September 30, 2003).                                                                                                                                                                                                                                                                                                                                                      
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.22* |  | Third Amended and Restated Employment Agreement dated July 1, 2003 between Guitar Center, Inc. and Bruce Ross (Incorporated by reference to Exhibit 10.45 to the Company's Quarterly Report on Form 10-Q for the period ended
September 30, 2003).                                                                                                                                                                                                                                                                                                                                                                        
|10.23* |  | Employment Agreement made as of March 20, 2001 between Guitar Center Stores, Inc. and David Fleming (Incorporated by reference to Exhibit 10.41 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2001).                                                                                                                                                                                                                                                                                                                                                                                       
|10.24* |  | Amended and Restated Employment Agreement dated May 13, 1999 between Musician's Friend, Inc. and Robert Eastman (Incorporated by reference to Exhibit 10.31 of the Company's Quarterly Report on Form 10-Q for the period ending June 30,
1999).                                                                                                                                                                                                                                                                                                                                                                          
|10.25* |  | Amendment No. 2 dated June 1, 2003 to Amended and Restated Employment Agreement between Guitar Center, Inc. and Robert Eastman (Filed herewith).                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|10.26* |  | Guitar Center, Inc. Senior Executive Performance Bonus Plan (Incorporated by reference to Exhibit 10.35 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                              
|10.27* |  | Amended and Restated Registration Rights Agreement dated May 13, 1999 by and among the Company, Chase Venture Capital Associates, L.P., Weston Presidio Capital II, L.P., Wells Fargo Small Business Investment Company, Inc., Larry Thomas, Marty
Albertson, Amazing Grace Foundation, The Emmanuel Foundation, Midas Touch Investments Trust, Sterling Investments Trust, Syringa Investments Trust, Eiger Mountain Real Estate Trust, Promise Land Real Estate Development Trust and Musician's Friend
Trust (Incorporated by reference to Exhibit 2.2 of the Company's Current Report on Form 8-K dated May 28, 1999).
|10.28  |  | Lease Agreement, dated as of August 15, 2001, by and between Guitar Center Stores, Inc. and Eaglepoint Partners Two, LLC (Incorporated by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2001).                                                                                                                                                                                                                                                                                                                                                                   
|10.29  |  | Master Lease Agreement, dated as of March 4, 2002, between Guitar Center, Inc. and General Electric Capital Corporation (Incorporated by reference to Exhibit 10.31 to the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2002).                                                                                                                                                                                                                                                                                                                                                        
|10.30  |  | Standard Industrial/Commercial Single-Tenant Lease by and between The J. David Gladstone Institutes, a Charitable Trust, as lessor and Guitar Center, Inc. as lessee relating to 5795 Lindero Canyon Road, Westlake Village, California (Incorporated by
reference to Exhibit 10.36 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                  
|10.31  |  | Addendum to Industrial/Commercial Single-Tenant Lease by and between The J. David Gladstone Institutes, a Charitable Trust, as lessor and Guitar Center, Inc. as lessee relating to 5795 Lindero Canyon Road, Westlake Village, California (Incorporated
by reference to Exhibit 10.37 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                               
|10.32  |  | Standard Commercial Lease by and between Mid-West Terminal Warehouse Company as lessor and Musician's Friend, Inc. as lessee relating to 1491 North Universal Avenue, Kansas City, Missouri (Incorporated by reference to Exhibit 10.38 to the
Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                                              
|10.33  |  | Addendum to Commercial Lease Agreement by and between Mid-West Terminal Warehouse Company, Inc. as lessor and Musician's Friend, Inc. as lessee relating to 1491 North Universal Avenue, Kansas City, Missouri (Incorporated by reference to
Exhibit 10.39 to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2003).                                                                                                                                                                                                                                                                           
|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

49

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|10.34 |  | Second Amended and Restated Loan and Security Agreement entered into as of December 21, 2001, between and among the Company, Guitar Center Stores, Inc., Musician's Friend, Inc. and the lenders identified therein (Incorporated by reference to
Exhibit 10.30 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001).                                                
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.35 |  | Consent and Amendment, dated as of June 9, 2003, by and among, Wells Fargo Retail Finance, LLC, as the arranger and administrative agent, the lenders named therein, and Guitar Center, Inc., Guitar Center Stores, Inc. and Musician's Friend, Inc.,
as borrowers (Incorporated by reference to Exhibit 10.42 to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 2003).
|10.36 |  | Second Amendment to Second Amended and Restated Loan and Security Agreement between Guitar Center, Inc. and Wells Fargo Retail Finance, LLC. (Filed herewith).                                                                                                                                                                                                                                    
|12.1  |  | Ratio of Earnings to Fixed Charges (Filed herewith).                                                                                                                                                                                                                                                                                                                                              
|21.1  |  | Material subsidiaries of the Registrant as of December 31, 2003 (Filed herewith).                                                                                                                                                                                                                                                                                                                 
|23.1  |  | Consent of Independent Auditors (KPMG LLP) (Filed herewith).                                                                                                                                                                                                                                                                                                                                      
|24.1  |  | Power of Attorney (included on page 51).                                                                                                                                                                                                                                                                                                                                                          
|31    |  | Certification of the Company's Co-Chief Executive Officers and Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                                                                                                
|32    |  | Certification of the Company's Co-Chief Executive Officers and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                                                                                                

---

50

---



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized as of this 5th day of March 2004.

| | GUITAR CENTER, INC.                                                
| | -------------------------------------------------------------------
| | /s/LARRY THOMASLarry Thomas Chairman and Co-Chief Executive Officer

KNOW
ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Larry Thomas, Marty Albertson and Bruce Ross, as his
attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendment to this Report on Form 10-K, and to file the
same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.

Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|Name                              |  | Title                                                                                         |  | Date         
|--------------------------------- |  | --------------------------------------------------------------------------------------------- |  | -------------
|                                  |  |                                                                                               |  |              
|/s/LARRY THOMASLarry Thomas       |  | Chairman & Co-Chief Executive Officer and Director (Principal Executive Officer)              |  | March 5, 2004
|/s/MARTY ALBERTSONMarty Albertson |  | President & Co-Chief Executive Officer and Director                                           |  | March 5, 2004
|/s/BRUCE ROSSBruce Ross           |  | Executive Vice President, Chief Financial Officer and Secretary (Principal Financial Officer) |  | March 5, 2004
|/s/ERICK MASONErick Mason         |  | Executive Vice President, Chief Administrative Officer (Principal Accounting Officer)         |  | March 5, 2004
|/s/GEORGE JONESGeorge Jones       |  | Director                                                                                      |  | March 5, 2004
|/s/CHRIS GOROGChris Gorog         |  | Director                                                                                      |  | March 5, 2004
|                                  |  |                                                                                               |  |              

51

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|/s/WAYNE INOUYEWayne Inouye         |  | Director |  | March 5, 2004
|----------------------------------- |  | -------- |  | -------------
|/s/LARRY LIVINGSTONLarry Livingston |  | Director |  | March 5, 2004
|/s/GEORGE MRKONICGeorge Mrkonic     |  | Director |  | March 5, 2004
|/s/KENNETH REISSKenneth Reiss       |  | Director |  | March 5, 2004
|/s/WALTER ROSSIWalter Rossi         |  | Director |  | March 5, 2004
|/s/PETER STARRETTPeter Starrett     |  | Director |  | March 5, 2004

52

---



INDEX TO FINANCIAL STATEMENTS

|Management's Responsibility for Financial Statements                                                 |  | 54      
|---------------------------------------------------------------------------------------------------- |  | --------
|Independent Auditors' Report                                                                         |  | 55      
|Consolidated Balance Sheets as of December 31, 2003 and 2002                                         |  | 56      
|Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001               |  | 57      
|Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001 |  | 58      
|Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001           |  | 59      
|Notes to Consolidated Financial Statements                                                           |  | 60      
|                                                                                                     |  | Schedule
|Financial Statement Schedule:                                                                        |  |         
|Valuation and Qualifying Accounts                                                                    |  | II-1    

53

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MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS

We are responsible for the preparation of our consolidated financial statements and related information appearing in this Annual Report. We believe that the
consolidated financial statements fairly reflect the form and substance of transactions and that the financial statements reasonably present our financial position and results of operations in
conformity with accounting principles generally accepted in the United States of America. We also have included in our financial statements amounts that are based on estimates and judgments which we
believe are reasonable under the circumstances.

The
independent auditors audit our consolidated financial statements in accordance with auditing standards generally accepted in the United States of America and provide an objective,
independent review of the fairness of reported operating results and financial position.

The
Board of Directors of the Company has an Audit Committee composed of three independent Directors. The Committee meets periodically with financial management and the independent
auditors to review accounting, internal control, auditing and financial reporting matters.

|Larry Thomas Chairman &
Co-Chief Executive Officer |  | Marty Albertson President &
Co-Chief Executive Officer |  | Bruce Ross Executive Vice President &
Chief Financial Officer
|-------------------------------------------------- |  | ------------------------------------------------------ |  | -------------------------------------------------------------

Los
Angeles, California
February 26, 2004

54

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INDEPENDENT AUDITORS' REPORT

The
Board of Directors and Stockholders
Guitar Center, Inc.:

We
have audited the accompanying consolidated financial statements as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also
have audited the consolidated financial statement schedule as listed in the accompanying index. These consolidated financial statements and the consolidated financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the consolidated financial statement schedule based on our
audits.

We
conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Guitar Center, Inc. and subsidiaries as
of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As
discussed in Note 15 to the consolidated financial statements, effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 142,"Goodwill and Other Intangible Assets."

KPMG
LLP

Los
Angeles, California
February 4, 2004

55

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GUITAR CENTER, INC. AND SUBSIDIARIES  CONSOLIDATED BALANCE SHEETS  (In thousands, except per share data)

|                                     |                                                                                                                                             | December 31,
2003 |         | December 31,
2002 |  
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------- | ----------------- | ------- | ----------------- | -
|Assets                               |                                                                                                                                             |                   |         |                   |  
|Current assets:                      |                                                                                                                                             |                   |         |                   |  
|                                     | Cash and cash equivalents                                                                                                                   |                   | $       | 5,350             |  
|                                     | Accounts receivable, less allowance for doubtful accounts $1,708 and $1,083, respectively                                                   |                   |         | 23,814            |  
|                                     | Merchandise inventories                                                                                                                     |                   |         | 288,873           |  
|                                     | Prepaid expenses and deposits                                                                                                               |                   |         | 11,543            |  
|                                     | Deferred income taxes                                                                                                                       |                   |         | 5,631             |  
|                                     |                                                                                                                                             |                   |         |                   |  
|Total current assets                 |                                                                                                                                             |                   | 335,211 |                   |  
|Property and equipment, net          |                                                                                                                                             |                   | 93,347  |                   |  
|Goodwill                             |                                                                                                                                             |                   | 25,995  |                   |  
|Deposits and other assets, net       |                                                                                                                                             |                   | 6,318   |                   |  
|                                     |                                                                                                                                             |                   |         |                   |  
|                                     |                                                                                                                                             | $                 | 460,871 |                   | $
|                                     |                                                                                                                                             |                   |         |                   |  
|Liabilities and stockholders' equity |                                                                                                                                             |                   |         |                   |  
|Current liabilities:                 |                                                                                                                                             |                   |         |                   |  
|                                     | Accounts payable                                                                                                                            |                   | $       | 47,778            |  
|                                     | Accrued expenses and other current liabilities                                                                                              |                   |         | 71,616            |  
|                                     | Merchandise advances                                                                                                                        |                   |         | 17,104            |  
|                                     | Revolving line of credit                                                                                                                    |                   |         |                  |  
|                                     | Current portion of long-term debt                                                                                                           |                   |         |                  |  
|                                     |                                                                                                                                             |                   |         |                   |  
|Total current liabilities            |                                                                                                                                             |                   | 136,498 |                   |  
|Other long-term liabilities          |                                                                                                                                             |                   | 5,982   |                   |  
|Deferred income taxes                |                                                                                                                                             |                   | 4,220   |                   |  
|Long-term debt                       |                                                                                                                                             |                   | 100,000 |                   |  
|                                     |                                                                                                                                             |                   |         |                   |  
|Total liabilities                    |                                                                                                                                             |                   | 246,700 |                   |  
|Stockholders' equity:                |                                                                                                                                             |                   |         |                   |  
|                                     | Preferred stock; 5,000 authorized, none issued and outstanding                                                                              |                   |         |                  |  
|                                     | Common stock, $0.01 par value, authorized 55,000 shares, issued and outstanding 23,998 at December 31, 2003 and 22,746 at December 31, 2002 |                   |         | 240               |  
|                                     | Additional paid in capital                                                                                                                  |                   |         | 276,233           |  
|                                     | Accumulated deficit                                                                                                                         |                   |         | (62,302           | )
|                                     |                                                                                                                                             |                   |         |                   |  
|Stockholders' equity                 |                                                                                                                                             |                   | 214,171 |                   |  
|                                     |                                                                                                                                             |                   |         |                   |  
|                                     |                                                                                                                                             | $                 | 460,871 |                   | $
|                                     |                                                                                                                                             |                   |         |                   |  

See accompanying notes to consolidated financial statements.

56

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GUITAR CENTER, INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF INCOME  (In thousands, except per share data)

|                                             |                                                    | Year ended December 31,
|-------------------------------------------- | -------------------------------------------------- | -----------------------
|
|Net sales                                    |                                                    | $                      
|Cost of goods sold, buying and occupancy     |                                                    |                        
|                                             |                                                    |                        
|                                             | Gross profit                                       |                        
|Selling, general and administrative expenses |                                                    |                        
|                                             |                                                    |                        
|                                             | Operating income                                   |                        
|Other expense:                               |                                                    |                        
|                                             | Write-off of investment in non-consolidated entity |                        
|                                             | Interest expense, net                              |                        
|                                             |                                                    |                        
|                                             |                                                    | Total other expense    
|Income before income taxes                   |                                                    |                        
|                                             | Income taxes                                       |                        
|                                             |                                                    |                        
|Net income                                   |                                                    | $                      
|                                             |                                                    |                        
|Net income per share                         |                                                    |                        
|                                             | Basic                                              |                        
|                                             |                                                    |                        
|                                             | Diluted                                            |                        
|                                             |                                                    |                        
|Weighted average shares outstanding          |                                                    |                        
|                                             | Basic                                              |                        
|                                             |                                                    |                        
|                                             | Diluted                                            |                        
|                                             |                                                    |                        

See accompanying notes to consolidated financial statements.

57

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GUITAR CENTER, INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY  (In thousands)

|                             |                                                                     | Number of
Shares |       | Common
Stock |     | Additional
Paid in
Capital |   | Accumulated
Deficit |        | Total
|---------------------------- | ------------------------------------------------------------------- | ---------------- | ----- | ------------ | --- | -------------------------- | - | ------------------- | ------ | -----
|Balance at December 31, 2000 |                                                                     | 22,087           |       | $            | 221 |                            | $ | 244,693             |        | $    
|                             | Exercise of employee stock options                                  |                  | 113   |              |     | 1                          |   |                     | 1,279  |      
|                             | Issuance of stock for acquisition                                   |                  | 115   |              |     | 1                          |   |                     | 2,091  |      
|                             | Net income                                                          |                  |      |              |     |                           |   |                     |       |      
|                             |                                                                     |                  |       |              |     |                            |   |                     |        |      
|Balance at December 31, 2001 |                                                                     | 22,315           |       |              | 223 |                            |   | 248,063             |        |      
|                             | Exercise of employee stock options                                  |                  | 207   |              |     | 2                          |   |                     | 2,436  |      
|                             | Issuance of stock for acquisition                                   |                  | 145   |              |     | 1                          |   |                     | 2,347  |      
|                             | Stock issued under employee stock purchase plan                     |                  | 79    |              |     | 1                          |   |                     | 1,017  |      
|                             | Net income                                                          |                  |      |              |     |                           |   |                     |       |      
|                             |                                                                     |                  |       |              |     |                            |   |                     |        |      
|Balance at December 31, 2002 |                                                                     | 22,746           |       |              | 227 |                            |   | 253,863             |        |      
|                             | Exercise of employee stock options, including tax benefit of $4,091 |                  | 1,203 |              |     | 12                         |   |                     | 21,462 |      
|                             | Stock issued under employee stock purchase plan                     |                  | 49    |              |     | 1                          |   |                     | 908    |      
|                             | Net income                                                          |                  |      |              |     |                           |   |                     |       |      
|                             |                                                                     |                  |       |              |     |                            |   |                     |        |      
|Balance at December 31, 2003 |                                                                     | 23,998           |       | $            | 240 |                            | $ | 276,233             |        | $    
|                             |                                                                     |                  |       |              |     |                            |   |                     |        |      

See accompanying notes to consolidated financial statements.

58

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GUITAR CENTER, INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF CASH FLOWS  (In thousands)

|                                                                                              |                                                         | Year ended December 31, |        
|--------------------------------------------------------------------------------------------- | ------------------------------------------------------- | ----------------------- | -------
|
|Operating activities:                                                                         |                                                         |                         |        
|Net income                                                                                    |                                                         | $                       | 36,860 
|Adjustments to reconcile net income to net cash provided by operating activities:             |                                                         |                         |        
|                                                                                              | Depreciation and amortization                           |                         |        
|                                                                                              | Loss on sale and disposal of property and equipment     |                         |        
|                                                                                              | Amortization of deferred financing fees                 |                         |        
|                                                                                              | Write-off of deferred financing fees                    |                         |        
|                                                                                              | Deferred income taxes                                   |                         |        
|                                                                                              | Tax benefit from exercise of stock options              |                         |        
|                                                                                              | Write-off of investment in non-consolidated entity      |                         |        
|Changes in operating assets and liabilities:                                                  |                                                         |                         |        
|                                                                                              | Accounts receivable                                     |                         |        
|                                                                                              | Merchandise inventories                                 |                         |        
|                                                                                              | Prepaid expenses and deposits                           |                         |        
|                                                                                              | Deposits and other assets                               |                         |        
|                                                                                              | Accounts payable                                        |                         |        
|                                                                                              | Accrued expenses and other current liabilities          |                         |        
|                                                                                              | Other long-term liabilities                             |                         |        
|                                                                                              | Merchandise advances                                    |                         |        
|                                                                                              |                                                         |                         |        
|Net cash provided by operating activities                                                     |                                                         |                         | 58,005 
|Investing activities:                                                                         |                                                         |                         |        
|                                                                                              | Purchase of property and equipment                      |                         |        
|                                                                                              | Proceeds from sale of property and equipment            |                         |        
|                                                                                              | Investment in non-consolidated entity                   |                         |        
|                                                                                              | Acquisition of business, net of cash acquired           |                         |        
|                                                                                              |                                                         |                         |        
|Net cash used in investing activities                                                         |                                                         |                         | (24,245
|Financing activities:                                                                         |                                                         |                         |        
|                                                                                              | Net change in revolving debt facility                   |                         |        
|                                                                                              | Proceeds from exercise of stock options                 |                         |        
|                                                                                              | Proceeds from stock issued under employee purchase plan |                         |        
|                                                                                              | Net proceeds from Senior Convertible Note               |                         |        
|                                                                                              | Payments on Senior Note                                 |                         |        
|                                                                                              | Payments under capital lease                            |                         |        
|                                                                                              |                                                         |                         |        
|Net cash (used in) provided by financing activities                                           |                                                         |                         | (34,341
|Net (decrease) increase in cash                                                               |                                                         |                         | (581   
|Cash at beginning of year                                                                     |                                                         |                         | 5,931  
|                                                                                              |                                                         |                         |        
|Cash at end of period                                                                         |                                                         | $                       | 5,350  
|                                                                                              |                                                         |                         |        
|Non-cash investing activities:                                                                |                                                         |                         |        
|Borrowings under capital leases                                                               |                                                         | $                       |       
|Acquisition of businesses, in which the fair value of assets and liabilities were as follows: |                                                         |                         |        
|                                                                                              | Fair value of assets acquired                           |                         | $      
|                                                                                              | Liabilities assumed                                     |                         |        
|                                                                                              | Goodwill                                                |                         |        
|                                                                                              | Common stock issued                                     |                         |        
|                                                                                              |                                                         |                         |        
|                                                                                              | Cash paid for acquisition                               |                         |        
|                                                                                              | Cash acquired in acquisition                            |                         |        
|                                                                                              |                                                         |                         |        
|                                                                                              | Net cash paid for acquisition                           |                         | $      
|                                                                                              |                                                         |                         |        
|Non-cash financing activities:                                                                |                                                         |                         |        
|Issuance of Common stock in connection with business acquisitions                             |                                                         | $                       |       
|Supplemental disclosure of cash flow information:                                             |                                                         |                         |        
|                                                                                              | Cash paid during the year for:                          |                         |        
|                                                                                              |                                                         | Interest                |        
|                                                                                              |                                                         | Income taxes            |        

See accompanying notes to consolidated financial statements.

59

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GUITAR CENTER, INC. AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        December 31, 2003

1. Nature of Business and Significant Accounting Policies



Guitar Center, Inc. and subsidiaries (the "Company" or "we") operates a chain of retail stores and a direct response unit which sells musical instruments,
primarily guitars, amplifiers, percussion instruments, keyboards, pro-audio, recording equipment, and band and orchestral instruments. At December 31, 2003, we operated 122 Guitar
Center stores and 19 American Music stores in major cities throughout the United States, with 23 of the stores located in California.



The consolidated financial statements include the financial statements of Guitar Center, Inc. and our wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.



Reclassifications have been made to prior year amounts to conform with the current year's presentation.



Inventories, including used merchandise and vintage guitars, are valued at the lower of cost or market using the first-in, first-out
(FIFO) method. Applicable costs associated with bringing inventory through our Guitar Center retail distribution center are capitalized to inventory. The amounts are expensed to cost of goods sold as
the associated inventory is sold. Rental inventories are valued at the lower of cost or market using the specific identification method and are depreciated on a straight-line basis over
the term of the rental agreement for rent-to-own sales, or over the estimated useful life of the rented instrument for rental only sales. We receive price protection credits
and vendor rebates from vendors, which are accounted for as a component of merchandise inventory and are recorded at the time the credit or rebate is earned. The effect of price protection credits and
vendor rebates is recognized in the income statement as an effective reduction in cost of goods sold at the time the related item of inventory is sold. None of these credits are recorded as revenue.



Property and equipment is recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets;
generally five years for furniture and fixtures, computer equipment and vehicles, 15 years for buildings and 15 years or the life of the lease, whichever is less, for leasehold
improvements. Maintenance and repair costs are expensed as they are incurred, while renewals and betterments are capitalized.



Goodwill represents the excess of the purchase price over the fair value of the net assets acquired resulting from business acquisitions and was historically
amortized over a 20 to 30 year period using the straight-line method. In 2002, we adopted SFAS No. 142 which no longer requires the periodic amortization of goodwill. As of
December 31, 2003 we had unamortized goodwill in the amount of

60

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$26.0 million
and unamortized identifiable intangible assets in the amount of $325,000. We have tested goodwill and intangible assets for impairment under the provisions of SFAS No. 142
and these tests indicated that there was no impairment. Net income for the year ended December 31, 2001, had SFAS No. 142 been in effect, would have been $17.5 million, compared
to reported net income of $17.0 million. Basic and fully diluted earnings per share for the year ended December 31, 2001, if SFAS No. 142 had been in effect, would have both
improved by $0.02.



Long-lived assets and identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected
to be generated by said assets. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs. No impairment was identified for the years ended December 31, 2003, 2002 and
2001.



Merchandise advances represent layaway deposits which are recorded as a liability pending consummation of the sale when the full purchase price is received from
the customer, outstanding gift certificates which are recorded as a liability until redemption by the customer, and credit on account for customer returns and special orders.



We began to maintain a self-insurance program for workers' compensation and medical insurance in 2002 and 2003, respectively. Estimated costs under
these programs, including incurred but not reported claims, are recorded as expenses based upon actuarially determined historical experience and trends of paid and incurred claims. At
December 31, 2003, self-insurance reserves for workers' compensation and medical insurance amounted to $2.0 million and $0.8 million, respectively.
Self-insurance reserve for workers' compensation amounted to $0.8 million at December 31, 2002. The balances are included in accrued liabilities.



Retail sales are recognized at the time of sale, net of a provision for estimated returns. Band instrument rentals are recognized on a straight-line
basis over the term of the rental agreement. The terms of the majority of our rental agreements do not exceed 30 months. Direct response sales are recognized when the products are estimated to
be received by the customers, net of a provision for estimated returns. Direct response items sold to customers are received, on average, three days after shipment. Return allowances are estimated
using historical experience.

During
the fourth quarter of 2003, we changed our method of accounting for the direct response division whereby we do not recognize revenue until the estimated date an order is received
by the

61

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customer,
instead of the date shipped. This change resulted in a reduction of approximately $3.9 million in net sales, and of approximately $456,000 in net income, or $0.02 per diluted per
share, for the fourth quarter of 2003. The impact of this change was immaterial to the prior quarters of 2003.



We expense retail advertising as incurred. Advertising expense included in the consolidated statements of income for the years ended December 31, 2003,
2002 and 2001 is $29.6 million, $24.7 million, and $22.4 million, respectively. Mail order catalog costs are capitalized on a catalog by catalog basis and are
amortized over the expected period of future benefits, not to exceed five months, under the provisions of AICPA Statement of Position 93-7,"Reporting of
Advertising Costs."Capitalized mail order catalog costs at December 31, 2003, 2002 and 2001 were $3.1 million, $1.9 million and $1.7 million,
respectively. The realizability of the capitalized mail order catalog costs are evaluated at each balance sheet date by comparing the carrying amount of such assets on a
cost-pool-by-cost-pool basis to the probable remaining future net revenues expected to result directly from such advertising. If the carrying amounts of
such deferred mail order catalog costs exceed the remaining future net revenues that probably will be realized from such catalog, the excess capitalized amount is written down and expensed in the
current period. There was no write-down of capitalized mail order catalog costs for the years ended December 31, 2003, 2002 and 2001.

We
receive cooperative advertising allowances from manufacturers in order to subsidize qualifying advertising and similar promotional expenditures we make relating to the vendor's
products. These advertising allowances are recognized as a reduction to selling, general and administrative expense when we incur the advertising expense eligible for the credit. We recognized
cooperative advertising allowances of $5.1 million, $4.9 million and $4.5 million for the years ended December 31, 2003, 2002 and 2001, respectively.



We lease the majority of our store locations under operating leases that provide for monthly payments that increase over the life of the leases. The aggregate of
the minimum annual payments are expensed on a straight-line basis over the term of the related lease. The amount by which straight-line rent expense exceeds actual lease
payment requirements in the early years of the leases is accrued as deferred minimum rent and reduced in later years when the actual cash payment requirements exceed the straight-line
expense.



We account for income taxes under Statement of Financial Accounting Standards No. 109,"Accounting for Income
Taxes"(SFAS No. 109). Under the asset and liability method of SFAS No. 109, deferred income tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are
measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on
deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

62

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In
assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The
ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the
scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment.



We adopted SFAS No. 123,"Accounting for Stock-Based Compensation,"which permits entities to recognize as
expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of Accounting
Principles Board ("APB") Opinion No. 25"Accounting for Stock Issued to Employees,"and related
interpretations and provide pro forma net income and pro forma earnings per share disclosures for employee stock option as if the fair-value-based method defined in SFAS No. 123 had
been applied. We have elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. As such, compensation expense for
stock options issued to employees is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Had we determined compensation cost based upon
the fair value at the grant date for our stock options under SFAS No. 123 using the Black Scholes option pricing model, pro forma net income and pro forma net income per share, including the
following weighted average assumptions used in these calculations, would have been as follows:

December 31,2003

2002

2001($ in thousands, except per share dataunaudited)Net income, as reported

$
36,860

$
25,256

$
17,033Deduct:    Total stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects


5,800


4,329


3,904Pro forma net income

$
31,060

$
20,927

$
13,129Earnings per share:Basicas reported

$
1.59

$
1.12

$
0.77Basicpro forma

$
1.34

$
0.93

$
0.59Dilutedas reported

$
1.50

$
1.09

$
0.75Dilutedpro forma

$
1.26

$
0.90

$
0.58Risk free interest rate


3.8
%

3.6
%

4.9
%Expected lives


6.92


6.96


6.99Expected volatility


65.4
%

68.3
%

72.0
%Expected dividends











63

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The following table summarizes the reconciliation of Basic to Diluted Weighted Average Shares for the years ended December 31, 2003, 2002 and 2001:

2003

2002

2001(in thousands)Basic shares

23,255

22,491

22,229Common stock equivalentsdilutive effect of options outstanding

1,306

639

471Diluted shares

24,561

23,130

22,700


For
the years ended December 31, 2003, 2002 and 2001, the only common stock equivalents outstanding with the Company are stock options. During the years ended December 31,
2003, 2002 and 2001, options to purchase 223,000 shares, 1,201,000 shares and 1,313,000 shares of common stock, respectively, at prices ranging from $15.94 to $30.70, were outstanding but were not
included in the computation of diluted earnings per share because the exercise prices of these options were greater than the average market price of our common stock.

For
the year ended December 31, 2003, the 2.9 million shares of common stock issuable upon conversion of the 4% Senior Convertible Notes issued in June 2003
(reflecting an effective conversion price of $34.58) were not deemed to be common stock equivalents and thus not considered in the calculation of earnings per share. At such time that those Notes
become convertible (generally involving trading prices above $41.50 per share for a specified period and designated corporate events), the security will be treated under the as-if
converted method, whereby for earnings per share purposes the 2.9 million conversion shares will be deemed outstanding and the after-tax interest expense for the period will be
added back to net income.



Our deposits are with various high quality financial institutions. Customer purchases generally are transacted using cash or credit cards. In limited instances,
we grant credit for larger purchases, generally to professional musicians, under normal trade terms. Trade accounts receivable were approximately $7.6 million and $5.2 million at
December 31, 2003 and 2002, respectively. Credit losses have historically been within our expectations.



The fair value of our revolving line of credit reflects the fair value based upon current rates available to us for similar debt. As of December 31, 2003
the fair value of our 4% Senior Convertible Notes was $120 million, based on quoted market prices. As discussed at Note 7, a cost-based investment was written-off
at December 31, 2001 in consideration of the estimated future cash flows of the investment and the uncertainties regarding its ongoing business.

64

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The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from our estimates.



In August 2001, the Financial Accounting Standards Board issued Statement No. 143,"Accounting for Asset Retirement
Obligations"(SFAS No. 143). This new pronouncement establishes financial accounting and reporting standards for obligations associated with the retirement of tangible
long-lived assets and the associated asset retirement costs. The provisions of SFAS No. 143 apply to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for obligations of lessees. The standard was effective for
financial statements issued for fiscal years beginning after June 15, 2002. We adopted this standard effective January 1, 2003, and it did not have a material effect on our consolidated
financial statements.

In
January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46,"Consolidation of Variable Interest Entities" (FIN
46).This interpretation clarifies the application of Accounting Research Bulletin No. 51,"Consolidated Financial Statements" (ARB
51),and requires companies to evaluate variable interest entities for specific characteristics to determine whether additional consolidation and disclosure requirements apply.
This interpretation is immediately applicable for variable interest entities created after January 31, 2003, and applies to the first fiscal year
or interim period beginning after June 15, 2003 for variable interest entities acquired prior to February 1, 2003. The adoption of this interpretation did not have any impact on our
financial position or results of operations. In December 2003, the FASB revised FIN 46 to exempt certain entities from its requirements and to clarify certain issues arising during the
implementation of FIN 46. The adoption of this revised interpretation in the first quarter of 2004 is not expected to have any impact on our consolidated financial statements.

EITF
Issue No. 02-16,"Accounting by a Reseller for Cash Consideration Received from a Vendor,"provides that cash
consideration received from a vendor is presumed to be a reduction of the prices of the vendor's products or services and should, therefore, be characterized as a reduction in cost of sales unless it
is a payment for assets or services delivered to the vendor, in which case the cash consideration should be characterized as revenue, or unless it is a reimbursement of costs incurred to sell the
vendor's products, in which case the cash consideration should be characterized as a reduction of that cost. EITF No. 02-16 became effective for us in the first quarter of 2003, and
had no impact on our consolidated financial statements, as we have historically accounted for vendor payments in accordance with the provisions of this standard.

In
December 2002, the FASB issued SFAS No. 148"Accounting for Stock-Based CompensationTransition and
Disclosure,"an amendment of FASB Statement No. 123, which provides guidance for transition to the fair value based method of accounting for stock-based employee
compensation and the

65

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required
financial statement disclosure. The adoption of SFAS No. 148 expanded the disclosure in our interim financial statements, and does not significantly impact our annual disclosures of
stock-based compensation in our consolidated financial statements.

In
May 2003, the Financial Accounting Standards Board issued Statement No. 150,"Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity."The Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). It is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted this standard
effective July 1, 2003, and it did not have a material effect on our consolidated financial statements.

2. Acquisitions

In February 2002, we acquired the inventory and assumed the customer credit liabilities of Music Loft East, Inc., a single store located in Raleigh,
North Carolina. In connection with the purchase we paid
$488,000 in cash, acquired assets with a fair value of $369,000, and assumed liabilities of $146,000. Goodwill in the amount of $265,000 was recorded.

On
June 14, 2002, we acquired M&M Music, a five-store band instrument retailer headquartered in Valdosta, Georgia. Under the terms of the agreement, we acquired the
stock of M&M Music for total consideration of $6.0 million in cash and stock. We acquired assets with a fair value of $4.4 million and assumed liabilities and paid expenses of
$1.3 million. Goodwill in the amount of $2.9 million was recorded. Under the terms of the purchase agreement, during the second quarter of 2002 we paid $3.6 million in cash and
during the third quarter of 2002 we issued 90,602 shares of Guitar Center stock, representing $1.5 million. As part of the terms of the purchase agreement, there was a $0.9 million
holdback on the transaction, pending the M&M Music business meeting certain balance sheet requirements. During the fourth quarter of 2002, it was determined that the requirements subject to the
holdback were satisfied and we issued an additional 54,360 shares of common stock in consideration for the remaining $0.9 million of the purchase price.

The
results of operations and the assets of the Music Loft East, Inc. and M&M Music were not material to Guitar Center's previously presented consolidated financial statements
and, as such, pro-forma financial information is not presented. The results of operations for each of these entities are included in Guitar Center's consolidated financial statements from
the dates of the acquisition.

Goodwill
was recorded on Music Loft and M&M Music acquisitions in the amount of the total consideration paid in excess of the fair value of the identifiable assets acquired. In
accordance with SFAS 142, we no longer amortize goodwill and intangible assets with an indefinite useful life on a stated basis but rather do annual testing of the goodwill for impairment, with
no charge to income except to the extent of any such impairment.

66

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3. Merchandise Inventories

The major classes of merchandise inventories are as follows:

December 31,2003

2002(in thousands)Major goods

$
181,218

$
187,113Band instruments


22,199


20,247Associated accessories


56,265


55,153Vintage guitars


10,150


8,892Used merchandise


15,601


15,680General accessories


8,814


11,162294,247


298,247Less inventory reserves


5,374


6,172$
288,873

$
292,075


Major
goods include stringed merchandise, percussion, keyboards, pro-audio and recording equipment. Band instruments include horns, flutes, brass and woodwind instruments.
Associated accessories are comprised of accessories to major goods and band instruments. General accessories include other merchandise such as apparel, cables and books.

4. Property and Equipment

Property and equipment consists of the following:

December 31,2003

2002(in thousands)Land

$
2,946

$
2,946Buildings


9,426


9,365Furniture and fixtures


21,606


20,142Computer equipment


47,271


46,665Leasehold improvements


84,816


74,364Construction in progress


6,384


1,954172,449


155,436Less accumulated depreciation and amortization


79,102


65,734$
93,347

$
89,702


5. Revolving Line of Credit and Debt

In the fourth quarter of 2003, we amended our credit facility with a syndicate of banks led by Wells Fargo Retail Finance. The credit facility permits borrowings
up to $125 million, subject to borrowing base limitations ($115 million at December 31, 2003). The actual amount available is tied to our inventory and receivable base, and
repayment obligations under the credit facility are secured by

67

---

liens
on our principal assets. Borrowing options are prime rate (4.00% at December 31, 2003) plus applicable prime margin, or London Interbank Offered Rate, or LIBOR (six month rate at
December 31, 2003 was 1.22%) plus applicable LIBOR margin. The applicable prime and LIBOR margins are fixed for the first six months of the agreement at 0.00% and 1.50%, respectively. After the
initial six months, the applicable prime and LIBOR margins are based upon levels of excess availability and adjusted quarterly. If excess availability is greater than $20 million, the
applicable prime margin is 0.00% and applicable LIBOR margin is 1.50%. If excess availability is less than or equal to $20 million and greater than $10 million, the applicable prime
margin is 0.00% and the applicable LIBOR margin is 1.75%. If excess availability is less than or equal to $10 million, the applicable prime margin is 0.25% and the applicable LIBOR margin is
2.00%. An unused fee is assessed on the unused portion of the credit facility based upon levels of excess availability. If excess availability is greater than $10 million, the unused fee is
0.25%. If excess availability is less than or equal to $10 million, the unused fee is 0.375%. The agreement underlying the credit facility includes significant restrictive negative covenants.
Among other things, these covenants restrict our ability to incur debt and issue specified equity instruments, incur liens on our assets, make any significant change in our corporate structure or the
nature of our business, dispose of assets, make guaranties, prepay debt, engage in a change in control transaction, pay dividends, make investments or acquisitions, engage in transactions with
affiliates and incur capital expenditures, and also require that we satisfy a minimum availability test. The minimum availability test requires that we maintain $10 million of reserved
availability under the agreement based on its borrowing base limitations. The amount we disclose in our public reports from time to time as available to borrow under the agreement ($111 million
at December 31, 2003) is already reduced by this required reserve and outstanding letters of credit, and thus represents a net amount available under the agreement. The agreement also includes
representations and warranties which must be true each time we borrow funds under the credit facility and affirmative covenants. The full text of the contractual requirements imposed by this financing
is set forth in the Amended and Restated Loan and Security Agreement which has been filed with the Securities and Exchange Commission. We were in compliance with such requirements as of
December 31, 2003. Subject to limited cure periods, the lenders under our credit facility may demand repayment of these borrowings prior to stated maturity upon the occurrence of specified
events, including if we breach the terms of the agreement, suffer a material adverse change, engage in a change in control transaction, suffer a significant adverse legal judgment, default on other
significant obligations, or in the event of specified events of insolvency. The credit agreement matures in December 2007.

On
June 16, 2003, we completed the issuance of $100 million principal amount of 4.00% Senior Convertible Notes due 2013. Of the net proceeds from the offering,
approximately $68.2 million was used in July 2003 to retire all outstanding Senior Notes and pay the related redemption premium, and the balance was used to reduce the amount outstanding
under our credit agreement and pay offering expenses. The Notes bear interest at the rate of 4.00% per annum, subject to the payment of contingent interest under certain circumstances, and are
convertible into shares of common stock at a conversion price of $34.58 per share, subject to adjustment under specified circumstances. Under the contingent conversion feature of the Notes, subject to
certain exceptions, they are not convertible into common stock unless and until the trading price of the common stock reaches at least $41.50 for a specified period or designated corporate events
occur. The final maturity of the Notes is July 2013, although holders may require us to repurchase the Notes at their election in July 2008, July 2010 or

68

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upon
the occurrence of a change in control, in each case for a purchase price equal to the original principal amount plus accrued interest. We may call the Notes for redemption commencing in
July 2006 subject to the payment of a redemption premium of 1.6% if redeemed prior to July 2007 and 0.8% if redeemed prior to July 2008 (thereafter there is no redemption
premium). The indenture governing the Notes does not limit our ability to incur indebtedness or otherwise substantively restrict the operation of our business to any significant degree. Subject to
limited cure periods, the holders of the Notes may demand repayment of these borrowings prior to the stated maturity upon the occurrence of specified events, including if we fail to pay interest or
principal when due, fail to satisfy our conversion obligation, if another obligation of ours having an outstanding principal amount in excess of $15 million is accelerated prior to stated
maturity and upon the occurrence of specified events of insolvency.

In
July 2003, we called for the redemption of $66.7 million of Senior Notes outstanding. Interest expense related to the redemption premium and the write-off of
deferred financing costs associated with the Senior Notes redeemed was $1.9 million.

Assets
of our Company secure the credit facility and the actual amount available to borrow is tied to our inventory and receivable base.

The
agreements underlying the credit facility include restrictive covenants. We were in compliance with such requirements as of December 31, 2003.

For
the years ended December 31, 2003, 2002 and 2001, $938,000, $664,000 and $556,000 of amortization of deferred financing fees was included in interest expense. Capitalized
deferred financing fees at December 31, 2003 and 2002 were $4.6 million and $2.2 million and related accumulated amortization was $3.8 million and $2.1 million,
respectively.

6. Segment Information

Our reportable business segments are Guitar Center stores, American Music stores and direct response (Musician's Friend's catalog and Internet). Management
evaluates segment performance based primarily on net sales and income (loss) before income taxes. Accounting policies of the segments are the same as the accounting policies for the consolidated
Company. There are no differences between the measurements of profits or losses or assets of the reportable segments and those of the Company on a consolidated basis. The company business segments
under SFAS No. 131 are consistent with its reporting units under SFAS No. 142.

69

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Net sales, depreciation and amortization, income before income taxes, capital expenditures and total assets are summarized as follows for the years ended
December 31, 2003, 2002 and 2001 (in thousands):

|                                  |  | Guitar Center
2003 |         | American Music
2003 |   | Direct Response
2003 |   | Total
|--------------------------------- |  | ------------------ | ------- | ------------------- | - | -------------------- | - | -----
|Net sales                         |  | $                  | 978,962 |                     | $ | 38,225               |   | $    
|Depreciation and amortization     |  |                    | 16,721  |                     |   | 1,233                |   |      
|Income (loss) before income taxes |  |                    | 40,736  |                     |   | (7,894               | ) |      
|Capital expenditures              |  |                    | 20,710  |                     |   | 1,954                |   |      
|Total assets                      |  |                    | 355,668 |                     |   | 64,071               |   |      

|                                 |  | Guitar Center
2002 |         | American Music
2002 |   | Direct Response
2002 |   | Total
|-------------------------------- |  | ------------------ | ------- | ------------------- | - | -------------------- | - | -----
|Net sales                        |  | $                  | 859,618 |                     | $ | 32,525               |   | $    
|Depreciation and amortization    |  |                    | 14,071  |                     |   | 717                  |   |      
|Income(loss) before income taxes |  |                    | 31,730  |                     |   | (4,522               | ) |      
|Capital expenditures             |  |                    | 19,142  |                     |   | 4,051                |   |      
|Total assets                     |  |                    | 353,037 |                     |   | 57,240               |   |      

|                              |  | Guitar Center
2001 |         | American Music
2001 |   | Direct Response
2001 |  | Total
|----------------------------- |  | ------------------ | ------- | ------------------- | - | -------------------- |  | -----
|Net sales                     |  | $                  | 756,758 |                     | $ | 24,005               |  | $    
|Depreciation and amortization |  |                    | 12,508  |                     |   | 688                  |  |      
|Income before income taxes    |  |                    | 22,034  |                     |   | 937                  |  |      
|Capital expenditures          |  |                    | 22,138  |                     |   | 761                  |  |      
|Total assets                  |  |                    | 327,112 |                     |   | 38,074               |  |      

7. Investment in Non-Consolidated Entity

At
December 31, 2001, we had an investment through a wholly-owned subsidiary, Musician's Choice, Inc., of approximately $3.5 million, in a
non-consolidated entity, Musician.com Internet Network, Inc. ("Musician.com"). As of December 31, 2001, we owned approximately 14% of the voting stock of Musician.com. As of
this date we also owned additional shares of
non-voting common stock and non-voting preferred stock with a liquidation preference of $2.7 million. Musician.com operated community-based musician websites which went
out of business in 2002. We accounted for this investment under the cost method. During the fourth quarter of 2001, in consideration of the estimated future cash flows of Musician.com and the
uncertainties regarding its ongoing business, we recorded a $3.5 million charge representing the write-off of our investment in this company.

8. Lease Commitments

We lease offices, most of our retail store facilities, our distribution centers and various personal property used in our business under operating leases which
expire at varying dates through

70

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December 2018.
Generally, the agreements contain provisions which require us to pay for normal repairs and maintenance, property taxes and insurance.

The
total minimum lease commitment at December 31, 2003, under operating leases, is as follows:

Year ended December 31

Amount(in thousands)2004

$
34,2042005


32,3802006


29,1062007


27,3432008


25,078Thereafter


71,597$
219,708


Total
rent expense included in the consolidated statements of income for the years ended December 31, 2003, 2002 and 2001 is $31.7 million, $26.3 million and
$20.1 million, respectively.

9. Employee Benefit Plans

We have a defined contribution 401(k) plan with a 401(a) profit-sharing component (the "Plan") maintained for the exclusive benefit of eligible employees and
their beneficiaries. Eligible employees can contribute from one to fifteen percent of their compensation. At our discretion, we can make matching contributions to the Plan, which will be a uniform
percentage of the eligible employees' contributions. We may also, at our discretion, make profit-sharing contributions to the Plan. The profit-sharing contributions are allocated based on the relative
compensation of all eligible employees. Plan expense was $2.1 million, $1.2 million and $712,000 for the years ended December 31, 2003, 2002 and 2001, respectively.

10. Stock Option and Purchase Plans



In June 1996, we adopted the 1996 Performance Stock Option Plan (as amended, the "1996 Plan"), which provided for the granting of options to officers and
key employees. Under the 1996 Plan, the number of options available for grant was 713,782, with a maximum term of ten years and an exercise price equal to the fair market value ($10.89 per share) of
the underlying stock at the date of grant. The options generally vested ratably over three years. At December 31, 2003, options to purchase 81,427 shares of common stock were outstanding and
exercisable. No additional options are available for grant under the 1996 Plan.



In June 1996, we granted options to two officers to purchase 795,970 shares at an exercise price of $10.89 per share with a term of ten years. Under the
terms of the option agreements, the conditions

71

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for
full, accelerated vesting occurred during 1997. No additional options are available for grant under this plan. At December 31, 2003, all options granted were outstanding and exercisable.



In January 1997, the 1997 Equity Participation Plan (as amended, the "1997 Plan") was adopted. Under the 1997 Plan, we may grant options to purchase up to
4,000,000 shares of common stock; provided, however, that grants to any one individual may not exceed 250,000 shares of common stock in any calendar year. Options granted under the 1997 Plan vest
ratably over various terms with a maximum life of ten years. As of December 31, 2003, options to purchase 2,835,535 shares of common stock were outstanding under the 1997 Plan, and 1,640,244
shares were exercisable with exercise prices ranging from $8.34 to $28.56 and a weighted average exercise price of $16.50. At December 31, 2003, 177,669 shares were available for grant.

Included
in the options outstanding are outstanding options to purchase 88,489 shares of common stock that were assumed in 1999 in connection with the merger with Musician's Friend.



In April 2001, the Employee Stock Purchase Plan (the "ESPP Plan") was adopted. The ESPP Plan is a tax-qualified employee stock purchase plan
which authorizes 500,000 shares of our common stock, $0.01 par value, for issuance under the plan. Under the ESPP Plan, participants are granted options to purchase our common stock at a price which
is eighty-five percent of the stock's fair market value on either the first or last day of the offering period, whichever price is lower. The options are then automatically exercised on
the last business day of the offering period. The
participants purchase the shares through payroll deductions. As of December 31, 2003, 127,814 shares had been purchased under the ESPP Plan at a weighted-average price of $14.58 per share.

We
apply APB Opinion No. 25 in accounting for our plans. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the date of grant.

72

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Stock
option activity for all plans during the periods presented is as follows:

No. of Shares

Weighted Average
Exercise PriceBalance at December 31, 2000

3,476,621

$
14.14Granted

994,744


15.35Exercised

(113,856
)

11.24Forfeited

(124,649
)

16.52Balance at December 31, 2001

4,232,860


14.43Granted

559,869


16.94Exercised

(206,675
)

12.10Forfeited

(188,091
)

16.88Balance at December 31, 2002

4,397,963


14.75Granted

510,927


27.34Exercised

(1,203,087
)

14.45Forfeited

(92,871
)

20.02Balance at December 31, 2003

3,612,932

$
16.54


The
following is a summary of stock options outstanding and exercisable at December 31, 2003:

|                 |  | Outstanding |  | Exercisable
|---------------- |  | ----------- |  | -----------
|
|$8.34 to $10.89  |  | 1,154,907   |  | 3.68       
|$13.44 to $17.73 |  | 1,351,258   |  | 7.74       
|$18.25 to $20.75 |  | 580,592     |  | 4.56       
|$21.96 to $30.70 |  | 526,175     |  | 9.09       
|                 |  |             |  |            
|$8.34 to $30.70  |  | 3,612,932   |  | 6.13       
|                 |  |             |  |            

73

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11.Income Taxes

Total income taxes for the years ended December 31, 2003, 2002 and 2001 consist of:

2003

Current

Deferred

Total(in thousands)Federal

$
19,231

$
1,005

$
20,236State


2,104


309


2,413$
21,335

$
1,314

$
22,649


2002

Current

Deferred

Total(in thousands)Federal

$
15,066

$
(1,364
)
$
13,702State


2,043


(200
)

1,843$
17,109

$
(1,564
)
$
15,545


2001

Current

Deferred

Total(in thousands)Federal

$
9,022

$
1,921

$
10,943State


1,461


(161
)

1,300$
10,483

$
1,760

$
12,243


Actual
income taxes for 2003, 2002 and 2001 differ from the statutory tax rate of 35% as applied to income before income taxes as follows:

2003

2002

2001(in thousands)Expected income tax expense

$
20,827

$
14,280

$
10,247State income taxes, net of federal tax benefit


1,459


1,181


761Non deductible items


273


153


127Change in valuation allowance





19


1,120Other


90


(88
)

(12
)Actual income tax expense

$
22,649

$
15,545

$
12,243


74

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The
tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are presented below:

2003

2002(in thousands)Deferred tax assets:State net operating loss carryforwards

$
155

$
180Accrued liabilities


3,808


3,390Merchandise inventories


2,148


2,685Capital loss (Musician.com)


1,150


1,150Total gross deferred tax assets


7,261


7,405Deferred tax liabilities:Depreciation


3,559


2,812Other


1,152


729Total gross deferred liabilities


4,711


3,541Deferred tax assets, net of deferred tax liabilities


2,550


3,864Less valuation allowancecapital loss carryforward


(1,139
)

(1,139
)Net deferred tax assets

$
1,411

$
2,725


In
assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider
scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections
of future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible
differences. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward periods are reduced.

The
Company accounts for the tax benefit resulting the employee exercises of non-qualifying stock options or the disqualified disposition of incentive stock options as a
reduction in income tax payable and an increase to additional paid in capital in the accompanying consolidated financial statements. The Company recorded $4.1 million of a benefit in 2003. The
benefit derived from such exercises or dispositions in the prior years was not material.

75

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12. Accrued Expenses and Other Current Liabilities

December 31,2003

2002(in thousands)Wages, salaries and benefits

$
22,145

$
18,071Sales tax payable


10,290


8,565Accrued income taxes


6,988


5,675Provision for sales returns


6,430


3,613Accrued advertising


4,884


4,119Accrued insurance


2,847


788Unearned revenue


2,660


Accrued interest


2,200


4,127Accrued freight


1,993


227Accrued real estate tax


1,814


1,735Accrued catalog costs


1,696


591Accrued professional fees


742


270Accrued utilities


228


554Other


6,699


5,876$
71,616

$
54,211


13. Legal

We are involved in various claims and legal actions arising in the ordinary course of our business and, while the results of the proceedings cannot be predicted
with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our consolidated financial position or results of operations.

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14. Quarterly Financial Data (unaudited)

|                               |  | 2003
|------------------------------ |  | ----
|
|
|Net sales                      |  | $   
|Gross profit                   |  | $   
|Net income                     |  | $   
|Net income per share (diluted) |  | $   

|                               |  | 2002
|------------------------------ |  | ----
|
|
|Net sales                      |  | $   
|Gross profit                   |  | $   
|Net income                     |  | $   
|Net income per share (diluted) |  | $   

15.   Goodwill and Other Intangible Assets

Amortization expense related to goodwill and other intangible assets was $827,000 for the year ended December 31, 2001. The following table reconciles
previously reported net income as if the provisions of SFAS No. 142 were in effect at 2001:

(in thousands except earnings per share data)

2003

2002

2001Reported net income

$
36,860

$
25,256

$
17,033Add back: Goodwill amortization, net of tax








513Adjusted net income

$
36,860

$
25,256

$
17,546Reported basic earnings per share

$
1.59

$
1.12

$
0.77Goodwill amortization, net of tax








0.02Adjusted basic earnings per share

$
1.59

$
1.12

$
0.79Reported diluted earnings per share

$
1.50

$
1.09

$
0.75Goodwill amortization, net of tax








0.02Adjusted diluted earnings per share

$
1.50

$
1.09

$
0.77


77

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Schedule II

GUITAR CENTER, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2003 and 2002
(amounts in thousands)

|                  |                                    | Balance at
beginning
of year |   | Additions
charged to
operations |  | Deductions
from
Allowance |  | Balance
at end
of year
|----------------- | ---------------------------------- | ---------------------------- | - | ------------------------------- |  | ------------------------- |  | ----------------------
|December 31, 2003 |                                    |                              |   |                                 |  |                           |  |                       
|                  | Allowance for doubtful receivables |                              | $ | 1,083                           |  | 625                       |  |                      
|December 31, 2002 |                                    |                              |   |                                 |  |                           |  |                       
|                  | Allowance for doubtful receivables |                              | $ | 959                             |  | 124                       |  |                      

II-1

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