<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1995
OR
/ / 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 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)
(612) 931-8000
(Registrant's telephone number, including area code)
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 X . No .
---- -----
The number of shares outstanding of the Registrant's common stock as of October
25, 1995 was 34,296,956 shares.
Exhibit index on page 17
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
Item 1. Financial Statements.
Consolidated Statements of Earnings 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Report of Independent Public Accountants 9
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition. 10
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. 15
Signature 16
2
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ----------------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
Sales $ 357,585 $ 302,479 $ 1,035,665 $ 844,973
Cost of sales 226,268 185,155 658,732 516,419
-------- ------- --------- ---------
Gross profit 131,317 117,324 376,933 328,554
Selling, general and administrative
expenses 124,359 106,817 362,779 300,484
Depreciation and amortization 11,778 9,547 33,940 26,747
Goodwill write-down 138,000 - 138,000 -
------- ------- -------- -------
Operating income (loss) (142,820) 960 (157,786) 1,323
Interest expense 7,898 5,563 19,815 13,685
------- ------- -------- -------
Loss before income taxes (150,718) (4,603) (177,601) (12,362)
Income taxes (6,168) (2,049) (19,206) (5,502)
------- ------- -------- -------
Net loss $(144,550) $ (2,554) $ (158,395) $ (6,860)
------- ------- -------- -------
------- ------- -------- -------
Loss per common share $ (4.28) $ (0.07) $ (4.65) $ (0.20)
------- ------- -------- -------
------- ------- -------- -------
Weighted average number of shares
outstanding 33,766 34,239 34,092 34,235
------- ------- -------- -------
------- ------- -------- -------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
---------------------------
1995 1994 1994
----------- ----------- -----------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 1,302 $ 1,028 $ 38,578
Inventories 642,099 459,149 491,828
Deferred income taxes 13,935 13,067 15,600
Other current assets 43,235 15,748 9,574
----------- ----------- -----------
Total current assets 700,571 488,992 555,580
Property, at cost 438,779 336,512 374,620
Accumulated depreciation and amortization (121,059) (92,166) (98,586)
----------- ----------- -----------
Property, net 317,720 244,346 276,034
Goodwill 99,009 243,848 242,051
Deferred income taxes 3,530 - -
Other assets 6,042 5,090 5,967
----------- ----------- -----------
Total Assets $ 1,126,872 $ 982,276 $ 1,079,632
----------- ----------- -----------
----------- ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term notes payable $ 16,400 $ 5,000 $ -
Current maturities of long-term debt - 25,000 -
Accounts payable 381,462 263,896 463,122
Other current liabilities 61,997 44,902 120,148
----------- ----------- -----------
Total current liabilities 459,859 338,798 583,270
Long-term debt 446,000 281,000 110,000
Other liabilities 48,945 37,842 40,586
Deferred income taxes - 8,665 5,500
Stockholders' equity:
Preferred stock ($.01 par value; authorized: 5,000,000 shares;
issued and outstanding: none) - - -
Common stock ($.01 par value; authorized: 75,000,000 shares;
issued and outstanding: September 30, 1995, 34,276,456
shares; September 30, 1994, 34,239,356 shares;
December 31, 1994, 34,246,856 shares) 343 342 342
Additional paid-in capital 254,251 254,005 254,068
Retained earnings (accumulated deficit) (67,556) 66,597 90,839
Deferred KSOP expense (9,997) - -
Common stock subscriptions (4,973) (4,973) (4,973)
----------- ----------- -----------
Total stockholders' equity 172,068 315,971 340,276
----------- ----------- -----------
Total Liabilities and Stockholders' Equity $ 1,126,872 $ 982,276 $ 1,079,632
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1995 1994
------------ -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (158,395) $ (6,860)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 34,323 27,374
Goodwill write-down 138,000 -
Loss on disposal of property 3,729 3,074
Deferred income taxes (7,365) (402)
Changes in operating assets and liabilities:
Inventories (150,271) (122,347)
Other current assets (33,606) (8,165)
Accounts payable (81,660) (39,144)
Other current liabilities (58,151) (58,445)
Other assets (499) (179)
Other liabilities 7,090 3,841
------------ -----------
Net cash used in operating activities (306,805) (201,253)
------------ -----------
INVESTING ACTIVITIES:
Purchase of property (78,524) (69,528)
Proceeds from sale of property 5,538 -
------------ -----------
Net cash used in investing activities (72,986) (69,528)
------------ -----------
FINANCING ACTIVITIES:
Increase in short-term notes payable 16,400 5,000
Borrowings under revolver 336,000 171,000
Loan to KSOP (9,997) -
Proceeds from sale of common stock 112 43
------------ -----------
Net cash provided by financing activities 342,515 176,043
------------ -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (37,276) (94,738)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 38,578 95,766
------------ -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,302 $ 1,028
------------ -----------
------------ -----------
CASH PAID DURING THE PERIOD FOR:
Interest $ 15,835 $ 11,627
Income taxes 18,976 23,498
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Musicland Stores Corporation ("MSC" or the "Company") and its wholly owned
subsidiary, The Musicland Group, Inc. ("MGI") and MGI's wholly owned
subsidiaries. All material intercompany accounts and transactions have
been eliminated in consolidation.
The accompanying interim consolidated financial statements of the Company
are unaudited; however, in the opinion of management, all adjustments
necessary for a fair presentation of such consolidated financial statements
have been reflected in the interim periods presented. Such adjustments
consisted only of normal recurring items. The Company's business is
seasonal and, accordingly, interim results are not indicative of results
for a full year. The significant accounting policies and certain financial
information which are normally included in financial statements prepared in
accordance with generally accepted accounting principles, but which are not
required for interim reporting purposes, have been condensed or omitted.
The accompanying consolidated financial statements of the Company should be
read in conjunction with the consolidated financial statements and related
notes included in the Company's Annual Report on Form 10-K.
2. WRITE-DOWN OF GOODWILL AND OTHER NONRECURRING ITEMS
During the third quarter of 1995, the Company adopted Financial Accounting
Standards Board Statement No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement No.
121"), issued in March 1995. Goodwill primarily resulted from the
acquisition of MGI by MSC in a leveraged buyout in 1988, when nearly all of
the Company's stores were mall based music stores. In connection with the
adoption of Statement No. 121, the carrying values of long-lived assets,
primarily goodwill and property, of the music division were reviewed for
recoverability and possible impairment because of recent developments.
Since the beginning of 1995, the music division has been experiencing sales
declines. These sales declines are occurring in connection with a consumer
shift away from mall based stores to non-mall superstores that offer low
prices. While the Company's mall based music stores have responded with
increased promotional pricing and lower prices, they are at a
competitive disadvantage to non-mall stores because of their higher cost
structure, principally related to occupancy costs. The Company updated its
operating projections for the music division during the third quarter of
1995 to reflect the continued weak retail environment and competitive
pricing. The sum of the projected undiscounted future cash flows over the
remaining goodwill amortization period of 33 years was less than the
carrying amount of goodwill, which indicated impairment had occurred. An
estimated fair value of the music division was determined from a range of
valuations based on the operating projections and future discounted cash
flows. Based on this estimated fair value, a goodwill write-down of
$138,000 was recorded in August 1995.
6
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
2. WRITE-DOWN OF GOODWILL AND OTHER NONRECURRING ITEMS (CONTINUED)
Selling, general and administrative expenses were reduced by a net amount
of $3,400 for two nonrecurring items. The Company recorded other income of
$8,800 from the termination of certain service and business development
agreements and a charge of $5,400 for the closing of an additional 35 mall
music stores. Costs of store closings, principally lease termination
costs and nonrecoverable investments in property, net of the write-off of
any remaining liability from the straight-line recognition of rent expense,
are provided for in the period when the decision is made to close the
store.
3. INCOME TAXES
The effective income tax rates for the three month and nine month periods
ended September 30, 1995 and 1994 are higher than the federal statutory
rate principally as a result of goodwill amortization and write-down, both
of which are nondeductible, and state income taxes.
4. LOSS PER COMMON SHARE
Loss per common share amounts are computed by dividing the net loss by the
weighted average number of common shares outstanding. For purposes of
computing the loss per common share, the 1,042,900 shares of common stock
purchased for the Employee Stock Ownership Plan in the third quarter of
1995 are not considered outstanding until they are committed to be
released. Common stock equivalents related to stock options are anti-
dilutive due to the net loss in each period.
5. EMPLOYEE STOCK OWNERSHIP PLAN
On July 31, 1995, the Company's board of directors authorized the Company
to establish an employee stock ownership plan ("ESOP") and trust. The plan
combines the features of a 401(k) plan and an ESOP ("KSOP") and will
replace benefits under the Company's current defined benefit pension,
defined contribution and 401(k) plans. During the third quarter, the
Company made a loan to the KSOP trust for the purchase of 1,042,900 shares
of the Company's common stock in the open market. The shares will be
distributed to employee participants in the KSOP as employer matching
contributions over a period of ten years beginning in 1995.
6. RECENTLY ISSUED ACCOUNTING STANDARDS
Financial Accounting Standards Board Statement No. 123, "Accounting for
Stock-Based Compensation" ("Statement No. 123"), issued in October 1995 and
effective for fiscal years beginning after December 15, 1995, encourages,
but does not require, a fair value based method of accounting for employee
stock options or similar equity instruments. It also allows an entity to
elect to continue to measure compensation cost under Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No.
25"), but requires pro forma disclosures of net income and earnings per
share as if the fair value based method of accounting had been applied.
7
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
6. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)
The Company expects to adopt Statement No. 123 in 1996. While the Company
is still evaluating Statement No. 123, it currently expects to elect to
continue to measure compensation cost under APB No. 25 and comply with the
pro forma disclosure requirements. If the Company makes this election, this
statement will have no impact on the Company's results of operations or
financial position because the Company's plans are fixed stock option plans
which have no intrinsic value at the grant date under APB No. 25.
7. SUBSEQUENT EVENT
On November 9, 1995, the Company announced its intent to file a
registration statement for an initial public offering of up to 49% of a new
company to be created to contain the Suncoast Motion Picture Company
division, currently a division of MGI.
8
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Musicland Stores Corporation:
We have reviewed the accompanying consolidated balance sheets of Musicland
Stores Corporation (a Delaware corporation) and Subsidiaries as of September 30,
1995 and 1994, and the related consolidated statements of earnings for the
three-month and nine-month periods ended September 30, 1995 and 1994, and the
consolidated statements of cash flows for the nine-month periods ended September
30, 1995 and 1994. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Musicland Stores Corporation and
Subsidiaries as of December 31, 1994, and, in our report dated March 14, 1995,
we expressed an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1994, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
November 9, 1995
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
The following table presents certain sales and store data for the mall based
music and video sell-through stores (Sam Goody, Musicland and Suncoast Motion
Picture Company), the non-mall based full-media superstores (Media Play and On
Cue) and in total for the Company for the three months and nine months ended
September 30, 1995 and 1994.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------------
PERCENT OF TOTAL
-----------------------
1995 1994 % CHANGE 1995 1994
-------- -------- -------- -------- --------
(DOLLARS AND SQUARE FOOTAGE IN MILLIONS)
<S> <C> <C> <C> <C> <C>
SALES:
Superstores $ 105.3 $ 47.2 123.3% 29.5% 15.6%
Mall stores 248.9 252.8 (1.6) 69.6 83.6
Total (1) 357.6 302.5 18.2 100.0 100.0
COMPARABLE STORE SALES % CHANGE:
Superstores 9.1% 15.8% N/A N/A N/A
Mall stores (3.5) (0.7) N/A N/A N/A
Total (1) (1.4) (0.1) N/A N/A N/A
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------------------------
PERCENT OF TOTAL
-----------------------
1995 1994 % CHANGE 1995 1994
-------- -------- -------- -------- --------
(DOLLARS AND SQUARE FOOTAGE IN MILLIONS)
SALES:
Superstores $ 289.8 $109.1 165.6% 28.0% 12.9%
Mall stores 735.6 728.8 0.9 71.0 86.3
Total (1) 1,035.7 845.0 22.6 100.0 100.0
COMPARABLE STORE SALES % CHANGE:
Superstores 16.7% 19.7% N/A N/A N/A
Mall stores (2.1) 2.0 N/A N/A N/A
Total (1) 0.5 2.6 N/A N/A N/A
STORE COUNT AT END OF PERIOD:
Superstores 205 91 125.3 14.0 6.9
Mall stores 1,244 1,218 2.1 84.7 92.2
Total (1) 1,468 1,321 11.1 100.0 100.0
STORE SQUARE FOOTAGE AT END OF PERIOD:
Superstores 4.3 1.8 133.5 48.8 30.1
Mall stores 4.5 4.2 5.6 50.7 69.2
Total (1) 8.8 6.1 44.3 100.0 100.0
</TABLE>
- - - ------------------------------------
(1) The totals include other divisions which individually are not significant.
10
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SALES. The opening of new superstores and comparable store sales increases from
the maturation of existing superstores accounted for most of the Company's sales
growth for the third quarter and first nine months of 1995 compared to the same
periods in 1994. Comparable store sales results in the third quarter were
impacted by the relatively soft retail economy, particularly for mall based
specialty retailers, increased competition and a lack of strong product releases
in music and video. The Company faces increasing competition from non-mall
discount stores, consumer electronics superstores and other music, video and
book specialty retailers expanding into non-mall multimedia superstores of their
own. The low prices offered by these non-mall stores, including the Company's
Media Play stores, continue to adversely affect the performance of the Company's
mall stores. Because of these factors, the Company anticipates that the
challenging retail sales environment will continue into the fourth quarter and
for the foreseeable future.
GROSS PROFIT. Gross profit as a percentage of sales was 36.7% in the third
quarter of 1995 compared with 38.8% in the third quarter of 1994 . The gross
profit rate decreased to 36.4% in the first nine months of 1995 from 38.9% in
the first nine months of 1994. The sales increase in the low-price superstore
divisions relative to total Company sales accounted for substantially all of the
decline in the gross profit rate in the quarter and 2.1% of the decline in the
year to date period. The balance of the gross profit rate decrease in the first
nine months was primarily attributable to the increased promotional pricing and
the lowering of prices in mall based stores, most of which occurred during the
fourth quarter of 1994. However, the gross profit rate for the 1995 periods
improved from the fourth quarter 1994 gross profit rate of 33.7% because of
targeted price increases and fewer promotions.
The continued expansion of the superstore divisions will further reduce the
gross profit rate in the remainder of 1995 and in 1996 as their revenues
increase as a percentage of the Company's total sales. However, this decrease
is expected to be offset by lower operating expenses in the superstore
divisions, principally related to occupancy costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Increases in selling, general and
administrative expenses and depreciation and amortization in the third quarter
and first nine months of 1995, compared to the same periods last year, were
primarily due to store expansion. Selling, general and administrative expenses
as a percentage of sales were 34.8% in the third quarter of 1995, compared with
35.3% in the third quarter of 1994, and improved to 35.0% in the first nine
months of 1995 from 35.6% in the first nine months of 1994. The shift in the
mix of stores to superstores which have a lower cost structure than mall based
stores, principally related to occupancy costs, contributed to rate improvements
in the third quarter and first nine months of 1995 of 0.7% and 0.8%,
respectively. These rate improvements were offset by expense rate increases
from weak comparable store sales in the mall based music division. A net
reduction to expense in the third quarter of 1995 of $3.4 million, or 1.0% of
sales, was the result of two nonrecurring items. The Company recorded income
of $8.8 million from the termination of certain service and business development
agreements and a charge of $5.4 million for the closing of an additional 35 mall
based music stores. Expenses in 1995 were also impacted by start-up costs
associated with the new distribution center in Franklin, Indiana opened in March
1995.
Further improvements in expenses as a percentage of sales are expected from the
lower cost structures of Media Play and On Cue stores as the existing stores
mature and as these stores become a larger portion of the Company's total store
base. Start-up costs associated with new stores, primarily related to the Media
Play superstores, will partially offset expected expense rate improvements. The
incremental direct costs associated with store openings are amortized over
expected sales to the end of the fiscal year in which the store opens. This
results in the recognition of most of the start-up costs in the fourth quarter,
11
<PAGE>
when a larger percentage of the sales in a new store are realized. The Company
also expects to obtain cost reductions with the Franklin distribution center,
which has more than double the combined capacity of the Company's distribution
center in Minneapolis, Minnesota and the former facility in Edison, New Jersey,
which was closed in May 1995.
GOODWILL WRITE-DOWN AND ADOPTION OF NEW ACCOUNTING STANDARD. During the third
quarter of 1995, the Company adopted Financial Accounting Standards Board
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("Statement No. 121"), issued in March
1995. In connection with the adoption of Statement No. 121, the Company
recorded in August 1995 a goodwill write-down of $138 million, or $4.09 per
share and $4.05 per share for the three months and nine months ended September
30, 1995, respectively. This write-down reduced goodwill amortization by $0.3
million, or $0.01 per share, in the third quarter of 1995, and will reduce
future goodwill amortization by $1.0 million, or $0.03 per share, in the fourth
quarter of 1995 and $4.2 million, or $0.13 per share, annually.
Most of the goodwill was established in conjunction with the 1988 leveraged
buyout of The Musicland Group, Inc. by Musicland Stores Corporation. At that
time, nearly all of the Company's stores were mall based music stores. The
carrying values of long-lived assets, primarily goodwill and property, of the
music division were reviewed for recoverability and possible impairment because
of recent developments. Since the beginning of 1995, the music division has
been experiencing sales declines. These sales declines coincide with general
declines in customer traffic in malls and an increase in consumer traffic at
high-volume, low-price superstores. While the mall based music stores have
responded with increased promotional pricing and lower prices, they are at a
competitive disadvantage to non-mall stores because of their higher cost
structure, principally related to occupancy costs. The Company updated its
operating projections for the music division during the third quarter of 1995 to
reflect the continued weak retail environment and competitive pricing. The sum
of the projected undiscounted future cash flows over the remaining goodwill
amortization period was less than the carrying amount of goodwill, which
indicated impairment had occurred. The amount of goodwill impairment was
determined from a range of values of the music division developed from the
operating projections and future discounted cash flows. See Note 2 of Notes to
Consolidated Financial Statements.
INTEREST EXPENSE. Interest expense increased by $2.3 million and $6.1 million
in the third quarter and first nine months of 1995, respectively, over the same
periods in 1994. Higher average outstanding borrowings on the revolver, net of
interest savings on a term loan repaid in October 1995, added $1.8 million and
$4.1 million to interest expense in the third quarter and first nine months of
1995, respectively. The remainder of the increase in interest expense was
primarily caused by higher interest rates on the revolver. The weighted average
interest rates on the revolver were 6.9% and 6.3% for the three months ended
September 30, 1995 and 1994, respectively, and were 7.2% and 6.0% for the nine
months ended September 30, 1995 and 1994, respectively.
In October 1995, Standard & Poor's Corporation and Moody's Investor's Service,
Inc. placed the Company's $110 million senior subordinated notes under review
for possible downgrade. This action was taken because of several factors,
including the continued weak retail environment, competitive pricing and the
pressure on cash flow resulting from the superstore expansion. If a lowering of
the Company's credit rating were to occur, the Company would experience an
increase in its revolver interest rate of 0.625%.
12
<PAGE>
INCOME TAXES. The effective income tax rates for 1995 and 1994 are higher than
the Federal statutory rate as a result of goodwill amortization and write-down,
both of which are nondeductible, and state income taxes.
SEASONALITY. The Company's business is highly seasonal, with historically more
than 40% of the annual revenues and more than 100% of the net earnings generated
in the fourth quarter.
RECENTLY ISSUED ACCOUNTING STANDARDS. Financial Accounting Standards Board
Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement No.
123"), issued in October 1995 and effective for fiscal years beginning after
December 15, 1995, encourages, but does not require, a fair value based method
of accounting for employee stock options or similar equity instruments. It
also allows an entity to elect to continue to measure compensation cost under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"), but requires pro forma disclosures of net income and
earnings per share as if the fair value based method of accounting had been
applied. The Company expects to adopt Statement No. 123 in 1996. While the
Company is still evaluating Statement No. 123, it currently expects to elect to
continue to measure compensation cost under APB No. 25 and comply with the pro
forma disclosure requirements. If the Company makes this election, this
statement will have no impact on the Company's results of operations or
financial position because the Company's plans are fixed stock option plans
which have no intrinsic value at the grant date under APB No. 25.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. Net cash used in operating activities during the nine
months ended September 30, 1995 and 1994 was $306.8 million and $201.3 million,
respectively. The most significant operating uses of cash related to payments
after December 31 for seasonal merchandise purchases and inventory purchases for
store expansion, as reflected by the aggregate net changes in inventories and
accounts payable during these periods of $231.9 million and $161.5 million,
respectively. The inventory balances in September of each year reflect the
building of inventory levels for the Christmas season . Additionally, overall
inventory levels have increased from the shift to larger stores through the
expansion of the superstore divisions and the full line mall based music and
video stores, or combo stores, all of which have higher inventory levels than
traditional mall based stores.
Other current assets at September 30, 1995 reflect $7.3 million due from the
termination of certain service and business development agreements and $5.5
million due from an equipment sale leaseback completed in the third quarter of
1995. Because taxable income is expected for the full year, the Company records
an income tax benefit in interim periods due to the losses. This resulted in a
net current asset balance for income taxes of $10.8 million and $2.3 million at
September 30, 1995 and 1994, respectively. The changes in deferred income tax
balances were the result of the expected full year income tax rates based on
estimated taxable income applied to the losses in interim periods. Changes in
other operating assets and liabilities for the first nine months of 1995 and
1994 from the year end balances are primarily related to the seasonal nature of
the business and store expansion. Changes in other liabilities include non-cash
provisions for future rent increases of $5.0 million and $2.9 million for the
nine months ended September 30, 1995 and September 30, 1994, respectively.
CAPITAL EXPENDITURES. Most of the Company's capital expenditures are for store
expansion. Total capital expenditures in 1995 are projected to be approximately
$100 million. This amount may be reduced by
13
<PAGE>
equipment sale leasebacks of approximately $20 million, of which $5.5 million
was completed in the third quarter of 1995 and the balance is expected to be
completed in the fourth quarter of 1995. Approximately two-thirds of the
capital expenditures in 1995 are for the continued expansion of the Media Play
division. Preliminary plans for 1996 include estimated capital expenditures of
approximately $60 million. The Company's capital expenditure plan may be
adjusted based upon the availability of financing, future profitability, the
competitive environment and economic conditions. The Company anticipates that
these capital expenditures will be financed by internally generated cash,
borrowings under the revolving credit facility and equipment sale leasebacks.
The new Franklin distribution facility and most of the related equipment, which
together had an original cost of approximately $30 million, are financed under
an operating lease. The lease contains a residual value guarantee in an amount
not to exceed $24.9 million at the end of the original four year lease term and
$25.7 million at the end of the one year renewal term. The lease also contains
purchase options at the end of the original and renewal periods. The Company
expects that it will be able to obtain adequate financing to meet its
obligations under the lease agreement.
FINANCING ACTIVITIES. The majority of the Company's financing for store
expansion and working capital is obtained from internally generated cash and
borrowings under its revolving credit facility. Although the Company is not
required to pay down the revolver at year end, the revolver has been paid off at
year end when the Company's internally generated cash peaks following the
Christmas season. The revolver balance and the Company's cash needs typically
peak in November. The Company's ability to pay down the revolver at year end
and in future years will depend upon future profitability and the level of store
expansion.
During the third quarter of 1995, the Company loaned $10.0 million to its 401(k)
trust to finance the purchase of 1,042,900 shares of common stock of the Company
on the open market. The stock will be used for a "KSOP" plan, which combines
the features of a 401(k) plan and an employee stock ownership plan. See Note 5
of Notes to Consolidated Financial Statements.
The revolving credit facility allows the Company to borrow up to $350 million
(subject to certain limitations) and expires on October 7, 1999. As permitted
by the credit agreement for the revolver, the Company has available short-term
unsecured line of credit arrangements with two banks which provide for
borrowings in the aggregate of up to $23 million through October 1996. The
Company repaid in October 1995 the $16.4 million of short-term borrowings
outstanding at September 30, 1995. The lines of credit provide little
flexibility to the Company because these facilities are uncommitted. Borrowings
are permitted on a limited basis and the Company can be required to repay
outstanding borrowings at any time. The limited availability of short-term
borrowings combined with the financing requirements for store expansion and the
weak sales in the third quarter and into the fourth quarter will cause the
Company to be at or near the maximum on its revolver in October and until mid-
November when sales begin to rise with the holiday season. However, because
the Company obtains favorable payment terms from its major vendors for the
holiday season, it expects to have adequate financing for the fourth quarter of
1995.
On November 9, 1995, the Company announced its intent to file a registration
statement for an initial public offering of up to 49% of a new company to be
created to contain the Suncoast Motion Picture Company ("Suncoast") division,
currently a division of The Musicland Group, Inc. Proceeds to the Company from
the planned offering would initially be used to repay outstanding borrowings
under the revolver and ultimately for expansion of the superstore divisions and
of the Suncoast division.
14
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
15 Letter re unaudited interim financial information
------
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the quarter ended
September 30, 1995.
Omitted from this Part II are items which are not applicable or to which the
answer is negative for the period covered.
15
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MUSICLAND STORES CORPORATION
By: \s\Reid Johnson
-----------------------------
Reid Johnson
Executive Vice President and
Chief Financial Officer
(authorized officer, principal
financial and accounting officer)
Date: November 13, 1995
-----------------------
16
<PAGE>
EXHIBIT INDEX
Paper (P)
Exhibit or Electronic(E)
- - - ------- ----------------
15. Letter re unaudited interim financial information E
27. Financial Data Schedule E
17
<PAGE>
EXHIBIT 15
LETTER RE UNAUDITED INTERIM FINANCIAL INFORMATION
To Musicland Stores Corporation:
We are aware that Musicland Stores Corporation has incorporated by reference in
its Registration Statements Nos. 33-50520, 35-50522, 33-50524, 33-52322, 33-
82130 and Form S-8 filed on November 6, 1995, its Form 10-Q for the quarter
ended September 30, 1995, which includes our report dated November 9, 1995,
covering the unaudited interim financial information contained therein.
Pursuant to Regulation C of the Securities Act of 1933, that report is not
considered a part of those registration statements prepared or certified by our
firm or reports prepared or certified by our firm within the meaning of Sections
7 and 11 of the Act.
Very truly yours,
Arthur Andersen LLP
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET OF MUSICLAND STORES CORPORATION AND SUBSIDIARIES AS
OF SEPTEMBER 30, 1995, AND THE RELATED CONSOLIDATED STATEMENT OF EARNINGS FOR
THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 1995, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> SEP-30-1995
<CASH> 1,302
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 642,099
<CURRENT-ASSETS> 700,571
<PP&E> 438,779
<DEPRECIATION> 121,059
<TOTAL-ASSETS> 1,126,872
<CURRENT-LIABILITIES> 459,859
<BONDS> 0
<COMMON> 343
0
0
<OTHER-SE> 171,725
<TOTAL-LIABILITY-AND-EQUITY> 1,126,872
<SALES> 1,035,665
<TOTAL-REVENUES> 1,035,665
<CGS> 658,732
<TOTAL-COSTS> 658,732
<OTHER-EXPENSES> 534,719
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,815
<INCOME-PRETAX> (177,601)
<INCOME-TAX> (19,206)
<INCOME-CONTINUING> (158,395)
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<EXTRAORDINARY> 0
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<NET-INCOME> (158,395)
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