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Rating Action:

Moody's revises Guitar Center's outlook to negative

12 Apr 2017

New York, April 12, 2017 -- Moody's Investors Service (Moody's) today revised Guitar Center, Inc.'s (GCI) rating outlook to negative from stable.

GCI's B2 Corporate Family Rating and B2-PD Probability of Default Rating were affirmed along with the B2 rating on the company's senior secured 1st lien notes and Caa1 on its senior unsecured notes.

"The outlook revision considers Moody's view that GCI, similar to other retailers, will continue to be challenged with respect to improving its consolidated revenue and earnings performance," stated Keith Foley, a Senior Vice President at Moody's.

GCI's growth challenge is coming from what Moody's believes is a secular shift in the broader retail industry towards the increasingly important and competitive e-commerce space that is affecting GCI along with many other retailers. As a result, Moody's does not expect that the company will generate enough free cash flow in the next 12-18 month period to materially reduce debt and improve leverage, most of which will depend on the success of GCI's strategic initiatives to generate more consistent and sustainable revenue and earnings. GCI's lease-adjusted debt/EBITDA for the fiscal year-ended Dec. 31, 2016 was about 6.3 times. While this leverage is still below Moody's stated 7.0 times debt/EBITDA downgrade trigger, limited revenue visibility regarding the retail environment for musical instruments and only very modest free cash flow potential makes the company vulnerable to an increase in leverage should the demand environment become less certain and/or working capital needs rise above norms for any reason.

"The negative rating outlook also considers that a substantial amount of GCI's debt matures within our two year rating horizon," added Foley.

GCI's growth challenge is coming from what Moody's believes is a secular shift in the broader retail industry towards the increasingly important and competitive e-commerce space that is affecting GCI along with many other retailers. As a result, Moody's does not expect that the company will generate enough free cash flow in the next 12-18 month period to materially reduce debt and improve leverage, most of which will depend on the success of GCI's strategic initiatives to generate more consistent and sustainable revenue and earnings. GCI's lease-adjusted debt/EBITDA for the fiscal year-ended Dec. 31, 2016 was about 6.3 times. While this leverage is still below Moody's stated 7.0 times debt/EBITDA downgrade trigger, limited revenue visibility regarding the retail environment for musical instruments and only very modest free cash flow potential makes the company vulnerable to an increase in leverage should the demand environment become less certain and/or working capital needs rise above norms for any reason.

Although Moody's does not see GCI's debt maturity profile as an immediate risk, the company would need to lengthen its debt maturity profile in the next two quarters as well as achieve some improvement in leverage and coverage to strengthen its position within its current B2 Corporate Family Rating. Failure to do so could result in a downgrade. From strictly a quantitative perspective, ratings could be lowered if lease-adjusted debt/EBITDA increases to at/near 7.0 times or EBIT/interest drops below 1.0 time. If GCI is able to extend its maturity profile as well as demonstrate some positive revenue and earnings momentum, the rating outlook could be revised back to stable.

Although not likely in the foreseeable future, a higher rating is possible over the long-term, but would require GCI materially improve its credit metrics -- achieve and maintain lease-adjusted debt/EBITDA of at least 4.5 times and EBIT/interest at or above 2.5 times.

Ratings affirmed:

Corporate Family Rating, at B2

Probability of Default Rating, at B2-PD

$615 mil 6.5% senior secured 1st lien notes due 2019, at B2 (LGD3)

$325 million 9.625% senior unsecured notes due 2020, at Caa1 (LGD5)

RATINGS RATIONALE

In addition to GCI's high financial risk and the increased amount of competition coming from the e-commerce space, key credit concerns include the very narrow retail segment that the company operates in, and the discretionary nature of its products. Also considered is the possibility that large, well-known musical equipment manufacturers will attempt to sell more directly to retail customers as part of their overall business model. Partly mitigating these risks are the benefits afforded to GCI by its leading market position and very strong brand awareness. GCI is also the largest customer for many musical instrument manufacturers, which helps it obtain favorable terms from its vendors.

The Caa1 rating on GCI's $325 million senior unsecured notes reflect their junior position in the capital structure behind the first lien notes and the company's $375 million first lien asset-backed credit facility (not-rated).

GCI is the largest retailer of music products in the United States based on revenues. GCI is a wholly-owned subsidiary of Guitar Center Holdings, Inc. The company has three reportable business segments, comprised of Guitar Center, Musician's Friend and Music & Arts. Sales for the fiscal year ended December 31, 2016 were $2.14 billion. GCI is a private company and does not publicly disclose detailed financial data.

The principal methodology used in these ratings was Retail Industry published in October 2015. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Keith Foley
Senior Vice President
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Janice Hofferber, CFA
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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