MUSICLAND STORES CORP, 10-Q, 1997-05-14

MUSICLAND STORES CORP
10-Q, 1997-05-14
RADIO, TV & CONSUMER ELECTRONICS STORES

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<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 March 31, 1997

[ ] 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 (I.R.S. Employer
of 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 April
30, 1997 was 34,301,956 shares.

<PAGE>

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION PAGE

Item 1. Financial Statements.

Consolidated Statements of Operations 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. 17

Signature 18

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

THREE MONTHS ENDED
MARCH 31,
-----------------------
1997 1996
---------- ----------
(AS ADJUSTED)
(NOTE 5)

Sales $ 376,080 $ 383,570
Cost of sales 249,617 253,737
---------- ----------

Gross profit 126,463 129,833

Selling, general and administrative expenses 129,946 139,489
Depreciation and amortization 9,852 11,559
Restructuring charge - 35,000
---------- ----------

Operating loss (13,335) (56,215)

Interest expense 7,648 6,672
---------- ----------

Loss before income taxes (20,983) (62,887)

Income taxes - (10,251)
---------- ----------

Net loss $ (20,983) $ (52,636)
---------- ----------
---------- ----------

Net loss per common share $ (0.63) $ (1.58)
---------- ----------
---------- ----------

Weighted average number of common shares outstanding 33,481 33,371
---------- ----------
---------- ----------

See accompanying Notes to Consolidated Financial Statements.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

ASSETS

<TABLE>
<CAPTION>
MARCH 31,
------------------------ DECEMBER 31,
1997 1996 1996
---------- ----------- ------------
(AS ADJUSTED)
(NOTE 5)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents $ 78,968 $ 1,393 $ 161,976
Inventories 464,031 567,605 506,093
Deferred income taxes 11,800 16,187 11,800
Other current assets 11,181 33,179 31,492
---------- ----------- ----------
Total current assets 565,980 618,364 711,361

Property, at cost 401,639 441,876 430,116
Accumulated depreciation and amortization (151,785) (136,344) (152,120)
---------- ----------- ----------
Property, net 249,854 305,532 277,996

Goodwill - 97,507 -
Deferred income taxes 1,200 - 1,200
Other assets 6,217 6,022 6,358
---------- ----------- ----------
Total Assets $ 823,251 $ 1,027,425 $ 996,915
---------- ----------- ----------
---------- ----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
Checks drawn in excess of bank balances $ - $ 4,229 $ -
Current maturities of long-term debt - - 2,060
Revolver 273,000 296,000 272,000
Accounts payable 315,254 312,157 406,642
Restructuring reserve 10,735 31,391 33,963
Other current liabilities 66,725 68,371 100,866
---------- ----------- ----------
Total current liabilities 665,714 712,148 815,531

Long-term debt 122,774 110,000 122,539
Other long-term liabilities 53,174 55,266 56,226
Deferred income taxes - 6,836 -

Stockholders' equity (deficit):
Preferred stock ($.01 par value; authorized: 5,000,000 shares;
issued and outstanding: none) - - -
Common stock ($.01 par value; shares authorized: 75,000,000;
shares issued and outstanding: March 31, 1997 and
December 31, 1996, 34,301,956; March 31, 1996, 34,296,956) 343 343 343
Additional paid-in capital 253,849 254,350 253,896
Accumulated deficit (259,632) (97,547) (238,649)
Deferred compensation (7,998) (8,998) (7,998)
Common stock subscriptions (4,973) (4,973) (4,973)
---------- ----------- ----------
Total stockholders' equity (deficit) (18,411) 143,175 2,619
---------- ----------- ----------
Total Liabilities and Stockholders' Equity (Deficit) $ 823,251 $ 1,027,425 $ 996,915
---------- ----------- ----------
---------- ----------- ----------
</TABLE>

See accompanying Notes to Consolidated Financial Statements.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------
1997 1996
----------- -----------
(AS ADJUSTED)
(NOTE 5)
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (20,983) $ (52,636)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 10,028 11,693
Disposal of property 357 57
Restructuring charge - 35,000
Deferred income taxes - 4,149
Changes in operating assets and liabilities:
Inventories 42,062 (33,911)
Other current assets 20,311 (12,339)
Accounts payable (91,388) (91,691)
Restructuring reserve (5,405) (440)
Other current liabilities (34,188) (40,084)
Other assets (43) 308
Other long-term liabilities (960) 3,404
----------- -----------
Net cash used in operating activities (80,209) (176,490)
----------- -----------

INVESTING ACTIVITIES:
Capital expenditures (1,962) (1,996)
----------- -----------
FINANCING ACTIVITIES:
Decrease in checks drawn in excess of bank balances - (65,092)
Principal payments on long-term debt (1,837) -
Borrowings under revolver 1,000 243,000
----------- -----------
Net cash provided by (used in) financing activities (837) 177,908
----------- -----------

NET DECREASE IN CASH AND CASH EQUIVALENTS (83,008) (578)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 161,976 1,971
----------- -----------

CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 78,968 $ 1,393
----------- -----------
----------- -----------
CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Interest $ 5,536 $ 3,186
Income taxes, net (19,682) 9,358
</TABLE>

See accompanying Notes to Consolidated Financial Statements.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS)

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. SUMMARY OF SIGNIFICANT RISKS AND UNCERTAINTIES AND GOING CONCERN ASSESSMENT

The Company's stores continue to face increased competition from non-mall
discount stores, consumer electronics superstores and other mall based music,
video and book specialty retailers expanding into non-mall multimedia
superstores of their own. The low prices offered by these non-mall stores
create intense price competition and adversely affect the performance of both
the Company's non-mall and mall stores. The Company anticipates that the
challenging retail sales environment will continue into the foreseeable future.

The Company has experienced diminishing liquidity as a result of the
challenging retail sales environment and the negative impact of underperforming
existing stores and new Media Play stores opened in 1995 and 1996, particularly
those performing below expectations. Management implemented programs during
1996 to improve profitability, reduce inventory levels and increase inventory
turnover. More focused marketing and advertising programs were instituted in
late 1996. The Company slowed store expansion to focus on improving performance
in its existing stores and recorded pretax restructuring charges totaling
$75,000 to reflect estimated costs associated with the closing of 115
underperforming stores and the Company's distribution facility in Minneapolis,
Minnesota. The goodwill write-downs taken in 1995 and 1996 following
evaluations of goodwill for impairment have eliminated goodwill from the
Company's balance sheet. In addition, during the first quarter of 1997, the
Company reached voluntary agreements with the majority of its vendors to
temporarily defer existing trade payables and provide continued product supply,
subject to payment terms reduced to 10 days or less on new purchases. While the
actions taken by management contributed to improved performance in the first
quarter of 1997, improved borrowing flexibility and capacity and uninterrupted
shipments from vendors are essential to the Company's ability to continue as a
going concern.

In March 1997, the Company obtained waivers of financial covenants and
technical defaults under its credit agreement through May 29, 1997. The Company
is currently in negotiations with its banks to obtain an amendment to its credit
agreement that will modify or provide additional flexibility in the covenants
and provide additional financing under a term facility. If an amendment is not
obtained by May 29, 1997, when the waivers under the credit agreement expire,
the Company will be in default and the banks could demand repayment of all
amounts outstanding under the revolver. There can be no assurance that debt or
equity to repay the revolver, if necessary, will be available or can be arranged
on

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(IN THOUSANDS)

2. SUMMARY OF SIGNIFICANT RISKS AND UNCERTAINTIES AND GOING CONCERN ASSESSMENT
(CONTINUED)

acceptable terms. The consolidated financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result
should the Company be unable to continue as a going concern.

3. REVOLVING CREDIT FACILITY

The Company's bank credit agreement for the revolving credit facility
contains covenants that limit additional indebtedness, liens, capital
expenditures and cash dividends. Additionally, the Company must meet
financial covenants relating to fixed charge coverage, consolidated tangible
net worth, to total capitalization, debt and trade payables to eligible
inventory and a one day clean-down of revolver borrowings. An amendment to
the credit agreement in October 1996 waived certain financial covenants and
further modified other financial covenants through March 30, 1997. In March
1997, the Company obtained an agreement from its banks to waive financial
covenants and technical defaults through May 29, 1997. Without the waivers
in October 1996 and March 1997, the Company would have been in default of the
financial covenants related to the fixed charge coverage ratio, consolidated
tangible net worth, debt and trade payables to eligible inventory ratio and
the annual one day clean-down requirement during the first quarter of 1997.
Additionally, the Company would have been in technical default of the
financial covenant restricting additional debt and the related lien on March
31, 1997 due to the consolidation of a special purpose entity that holds
property and a mortgage note payable.

The Company is currently in negotiations with its banks to obtain an
amendment to its credit agreement that will modify or provide additional
flexibility in the covenants and provide additional financing under a term
facility. If an amendment is not obtained by May 29, 1997, when the waivers
under the credit agreement expire, the Company will be in default and the banks
could demand repayment of all amounts outstanding under the revolver. The
Company had been in negotiations with a potential equity investor; however,
those negotiations have terminated. There can be no assurance that debt or
equity to repay the revolver, if necessary, will be available or can be arranged
on acceptable terms.

4. RESTRUCTURING CHARGE

During 1996, the Company implemented programs designed to improve
profitability and increase inventory turnover. Pretax restructuring charges
of $35,000 and $40,000 were recorded in the first and fourth quarters of
1996, respectively, to reflect estimated costs associated with the closing of
115 underperforming stores and the Company's distribution facility in
Minneapolis, Minnesota. The store closings include 79 mall stores and 36
non-mall stores. Through March 31, 1997, the Company closed the distribution
facility and 114 stores, including 79 mall stores and 35 non-mall stores. As
of March 31, 1997, $64,265 of the restructuring reserve had been utilized,
consisting of $29,497 of cash payments, related primarily to payments to
landlords for the early termination of operating leases and legal and
consulting fees, and $34,768 of non-cash charges related to write-downs of
leasehold improvements and certain equipment, net of unamortized lease
credits. The reserve balance of $10,735 relates primarily to estimated costs
for the one remaining non-mall store closing and remaining lease obligations
on nine previously closed non-mall stores without termination agreements, net
of sublease income on certain stores.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED)
(IN THOUSANDS)

5. INCOME TAXES

The income tax benefit and the effective income tax rate in the first
quarter of 1996 have been adjusted from $22,400 and 35.6%, respectively, to
$10,251 and 16.3%, respectively, and the net current deferred tax asset and net
noncurrent deferred tax liability were increased (decreased) by ($10,513) and
$1,636, respectively, to reflect the effect of the deferred tax valuation
allowances recorded in the fourth quarter of 1996. The valuation allowances
were required because of the uncertainty of future earnings and reduced the
deferred income tax balances at December 31, 1996 to approximate the remaining
recoverable income taxes after carryback of the taxable loss for the year ended
December 31, 1996. Accordingly, the Company expects its tax provision for the
year ending December 31, 1997 to be minimal and no tax provision (benefit) will
be recorded on pretax earnings (loss) in interim periods during 1997. The
effective income tax rate for the three months ended March 31, 1996, before
consideration of the adjustment for valuation allowances, varies from the
federal statutory rate principally as a result of nondeductible goodwill
amortization and state income taxes.

6. LOSS PER COMMON SHARE

Loss per common share amounts are computed by dividing net loss by the
weighted average number of common shares outstanding. For purposes of loss per
share computations, shares of common stock under the Company's employee stock
ownership plan, established 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.

7. RECENTLY ISSUED ACCOUNTING STANDARDS

Financial Accounting Standards Board Statement No. 128, "Earnings per
Share" ("Statement No. 128"), issued in February 1997 and effective for
fiscal years ending after December 15, 1997, establishes and simplifies
standards for computing and presenting earnings per share ("EPS").
Implementation of this statement will not have a material impact on the
Company's computation or presentation of EPS, as the Company's common stock
equivalents either have had no material effect on earnings per share amounts
or have been anti-dilutive with respect to losses.

<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 March 31,
1997 and 1996, and the related consolidated statements of operations and cash
flows for the three-month periods then ended. 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, 1996, and, in our report dated February 25,
1997, we expressed an unqualified opinion on that statement with an explanatory
fourth paragraph regarding the Company's ability to continue as a going concern.
In our opinion, the information set forth in the accompanying consolidated
balance sheet as of December 31, 1996, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to
the consolidated financial statements, the Company has experienced declining
operating results and liquidity constraints that raise substantial doubt about
its ability to continue as a going concern. Management's plans in regard to
these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amount and classification of
liabilities that might result should the Company be unable to continue as a
going concern.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,
April 22, 1997

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION

GENERAL

The Company has experienced diminishing liquidity as a result of the
challenging retail sales environment and the negative impact of underperforming
existing stores and new Media Play stores opened in 1995 and 1996, particularly
those performing below expectations. Management implemented programs during
1996 to improve profitability, reduce inventory levels and increase inventory
turnover. More focused marketing and advertising programs were instituted in
late 1996. The Company slowed store expansion to focus on improving performance
in its existing stores and recorded pretax restructuring charges totaling $75
million to reflect estimated costs associated with the closing of 115
underperforming stores and the Company's distribution facility in Minneapolis,
Minnesota. The goodwill write-downs taken in 1995 and 1996 following
evaluations of goodwill for impairment have eliminated goodwill from the
Company's balance sheet. In addition, during the first quarter of 1997, the
Company reached voluntary agreements with the majority of its vendors to
temporarily defer existing trade payables and provide continued product supply,
subject to payment terms reduced to 10 days or less on new purchases. While the
actions taken by management contributed to improved performance in the first
quarter of 1997, improved borrowing flexibility and capacity and uninterrupted
shipments from vendors are essential to the Company's ability to continue as a
going concern.

<PAGE>

RESULTS OF OPERATIONS

The following table presents certain sales and store data for the non-mall
based full-media superstores (Media Play and On Cue), the mall based music and
video sell-through stores (Sam Goody, Musicland and Suncoast Motion Picture
Company) and in total for the Company for the three months ended March 31, 1997
and 1996.

<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------
PERCENT OF TOTAL
-------------------
1997 1996 % CHANGE 1997 1996
-------- -------- --------- -------- ---------
(DOLLARS AND SQUARE FOOTAGE IN MILLIONS)
<S> <C> <C> <C> <C> <C>
SALES:
Non-mall stores $ 130.2 $ 133.9 (2.7)% 34.6% 34.9%
Mall stores 243.1 246.4 (1.3) 64.6 64.2
Total (1) 376.1 383.6 (2.0) 100.0 100.0
COMPARABLE STORE SALES % CHANGE:
Non-mall stores 5.6% (4.8)% N/A N/A N/A
Mall stores 1.8 (2.3) N/A N/A N/A
Total (1) 2.9 (2.9) N/A N/A N/A

STORE COUNT AT END OF PERIOD:
Non-mall stores 224 248 (9.7)% 16.1% 16.6%
Mall stores 1,147 1,224 (6.3) 82.4 81.9
Total (1) 1,392 1,494 (6.8) 100.0 100.0
STORE SQUARE FOOTAGE AT END OF
PERIOD:
Non-mall stores 4.3 5.4 (21.4)% 50.4% 54.8%
Mall stores 4.1 4.4 (6.5) 48.9 44.6
Total (1) 8.4 9.9 (14.6) 100.0 100.0
</TABLE>

- -----------------------
(1) The totals include other divisions which individually are not significant.

SALES. Comparable store sales gains in the first quarter of 1997 reflect
sales growth in prerecorded music and video. First quarter comparable store
sales growth in prerecorded music increased 4.9% in 1997 compared to an
increase of 0.9% in 1996. In prerecorded video, first quarter comparable
store sales increased 1.7% in 1997 compared to a decrease of 5.9% in 1996.
The relatively weak comparable store sales results in the first quarter of
1996 were impacted by the lack of strong product releases in both music and
video and the effects of bad weather, particularly early in the quarter. For
the second quarter of 1997, the Company does not anticipate that sales from
prerecorded music and video releases will be as strong as those released in
the second quarter of 1996 and, accordingly, the Company does not anticipate
that the comparable store sales results achieved in the first quarter of 1997
will continue into the second quarter. Sales in the second quarter of 1996
benefited from the sales volume generated by prerecorded music releases from
Hootie and the Blowfish and Metallica and prerecorded video titles including
"Waiting to Exhale" and "Aristocats." The decreases in total sales in the
first quarter of 1997 resulted primarily from the net decrease in store count
of 102 stores since March 31, 1996. The expansion of non-mall stores
accounted for most of the increase in total sales in the first quarter of
1996. See "- Liquidity and Capital Resources - Investing Activities."

During the second half of 1996, the Company experienced difficulty in
obtaining shipments from certain vendors in the books, computer software, video
games and trend product categories, primarily due to concerns about the
Company's liquidity. In the first quarter of 1997, the Company's largest
vendors

11
<PAGE>

and a substantial majority of the remaining vendors agreed to temporarily defer
existing trade payables and provide continued product supply, subject to payment
terms reduced to 10 days or less on new purchases. Because these understandings
are voluntary on the part of the vendors and will continue at their sole
discretion, there can be no assurance that the Company will continue to receive
adequate product from its vendors on acceptable credit terms. See "- Liquidity
and Capital Resources."

GROSS PROFIT. Gross profit as a percentage of sales was 33.6% in the first
quarter of 1997 compared with 33.8% in the first quarter of 1996, a decrease of
0.2%. Inventory shrinkage in the first quarter increased to 1.3% in 1997 from
1.0% in 1996. Because the low-price, non-mall superstores have a lower gross
margin than mall stores, the expansion of non-mall stores in previous periods
negatively impacted total Company gross margin as their sales increased in
proportion to total Company sales. The proportion of sales from the non-mall
stores relative to total sales decreased in the first quarter of 1997 due to
store closings and resulted in an improvement to gross margin of 0.1%. The
Company expects a reduced impact on gross margin from the non-mall stores
because of the non-mall store closings and the curtailment of non-mall store
expansion. The Company may also potentially benefit from the continued
compliance by certain non-mall competitors with the more strictly enforced
minimum advertised price ("MAP") policies of certain of the largest prerecorded
music suppliers and the continued closing of stores by certain mall
competitors.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease in selling,
general and administrative expenses in the first quarter of 1997 compared with
the first quarter of 1996 was primarily due to the store closings over the past
twelve months. The Company also achieved cost savings in the first quarter of
1997 from less expensive but more efficient advertising and, to a lesser extent,
the closing of the Minneapolis distribution facility. Financial and legal
advisory services and related expenses, most of which were required or incurred
in conjunction with the Company's credit agreement, totaled approximately $2.1
million in 1997. Selling, general and administrative expenses as a percentage
of sales were 34.6% in the first quarter of 1997 compared with 36.4% in the
first quarter of 1996, a decrease of 1.8%. This rate decrease was primarily
attributable to the comparable store sales increase in the first quarter of
1997.

Management believes that the closing of underperforming stores, the
consolidation of distribution facilities into a single facility in Franklin,
Indiana and other streamlining and profit improvement actions taken in 1996 and
1997 will reduce expenses in 1997. Additionally, store opening costs in 1997
will be minimal due to very limited store expansion plans. These reductions may
be offset by contingent rentals on the Franklin distribution facility, which
fluctuate based upon changes in certain interest rates. The Company also
anticipates improvements in expenses as a percentage of sales from the lower
cost structure of the non-mall stores as the existing, streamlined base of
stores matures and realizes comparable store sales growth; however, these
improvements may not be fully realized until the fourth quarter due to
seasonality.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$1.7 million in the first quarter of 1997 compared to the first quarter of 1996.
Goodwill amortization, eliminated after the write-down of the remaining goodwill
balance in the fourth quarter of 1996, was $0.8 million for the three months
ended March 31, 1996. Other depreciation and amortization was $9.9 million and
$10.8 million in the first quarters of 1997 and 1996, respectively, and
related primarily to stores. The decrease in 1997 was primarily attributable
to store closings.

RESTRUCTURING CHARGES. During 1996, the Company implemented programs
designed to improve profitability and increase inventory turnover. Pretax
restructuring charges of $35 million and $40 million were recorded in the first
and fourth quarters of 1996, respectively, to reflect estimated costs
associated with the closing of 115 underperforming stores and the Company's
distribution facility in Minneapolis, Minnesota. The store closings include 79
mall stores and 36 non-mall stores. Through March 31, 1997, the Company closed
the distribution facility and 114 stores, including 79 mall stores and 35
non-mall stores. As of March 31, 1997, $64.3 million of the restructuring
reserve had been utilized, consisting of $29.5 million of cash payments,
related primarily to payments to landlords for the early termination of
operating leases and legal and consulting fees, and $34.8 million of non-cash
charges related to write-downs of leasehold improvements and certain equipment,
net of unamortized lease credits. The reserve

<PAGE>

balance of $10.7 million relates primarily to estimated costs for the one
remaining non-mall store closing and remaining lease obligations on nine
previously closed non-mall stores without termination agreements, net of
sublease income on certain stores. See "- Liquidity and Capital Resources -
Investing Activities."

INTEREST EXPENSE. Interest expense in the first quarter of 1997 increased
$1.0 million over the first quarter of 1996, of which $0.7 million was due to an
increase in the weighted average interest rate on the revolver and the remainder
was due to higher outstanding borrowings on the revolver. For the three months
ended March 31, 1997 and 1996, the average daily revolver balances were $263.6
million and $232.5 million, respectively, and the weighted average interest
rates on the revolver, based upon the average daily balances, were 8.0% and
7.0%, respectively.

During 1996 and in January 1997, Moody's Investor's Service, Inc. and
Standard & Poor's Corporation issued downgrades to the ratings of the Company's
revolving credit facility and its $110 million senior subordinated notes. These
downgrades occurred as a result of a number of factors including the continued
weak retailing environment, increased competition from nontraditional music
retailers, declining mall traffic and fundamental changes in the way recorded
music is distributed, which, along with high fixed costs from poorly performing
stores and aggressive store expansion in previous years, have negatively
impacted the Company's financial performance and limited the Company's financial
flexibility. The downgrades issued in January 1997 also cited diminishing
liquidity due to the Company's reliance upon waivers to continue access to its
revolving credit facility. As a result of the lower credit ratings and an
amendment to the Company's credit agreement in April 1996, the annual facility
fee rate increased from 0.30% to 0.50% and the margin added to variable interest
rates on revolver borrowings increased by 0.93%. See "- Liquidity and Capital
Resources."

INCOME TAXES. The income tax benefit and the effective income tax rate in
the first quarter of 1996 have been adjusted from $22.4 million and 35.6%,
respectively, to $10.3 million and 16.3%, respectively, to reflect the effect of
the deferred tax valuation allowances recorded in the fourth quarter of 1996.
The valuation allowances were required because of the uncertainty of future
earnings and reduced the deferred income tax balances at December 31, 1996 to
approximate the remaining recoverable income taxes after carryback of the
taxable loss for the year ended December 31, 1996. Accordingly, the Company
expects its tax provision for the year ending December 31, 1997 to be minimal
and no tax provision (benefit) will be recorded on pretax earnings (loss) in
interim periods during 1997. The effective income tax rate for the three months
ended March 31, 1996, before consideration of the adjustment for valuation
allowances, varies from the federal statutory rate principally as a result of
nondeductible goodwill amortization and state income taxes. See Note 5 of Notes
to Consolidated Financial Statements.

SEASONALITY. The Company's business is highly seasonal, with nearly 40% of
the annual revenues and all of the net earnings generated in the fourth quarter.

RECENTLY ISSUED ACCOUNTING STANDARDS. Financial Accounting Standards
Board Statement No. 128, "Earnings per Share" ("Statement No. 128"), issued
in February 1997 and effective for fiscal years ending after December 15,
1997, establishes and simplifies standards for computing and presenting
earnings per share ("EPS"). Implementation of this statement will not have a
material impact on the Company's computation or presentation of EPS, as the
Company's common stock equivalents either have had no material effect on
earnings per share amounts or have been anti-dilutive with respect to losses.

LIQUIDITY AND CAPITAL RESOURCES

The Company's primary sources of capital are borrowings under the revolving
credit facility pursuant to the terms of its bank credit agreement and
internally generated cash. The credit agreement, in the absence of any default,
provides for a revolving credit facility and expires in October 1999.
Borrowings under the revolving credit facility are available up to $275 million
(subject to certain limitations) during the period from December 20, 1996
through September 11, 1997, and up to $300 million (subject to certain
limitations) thereafter. At March 31, 1997, the maximum permitted borrowings
under the revolver, based upon the lesser of a percentage of inventory or the
maximum available for the period, were $275 million. The Company had
borrowings under the revolver of $273.0

13
<PAGE>

million at March 31, 1997; however cash and cash equivalents at March 31, 1997
were $79.0 million. See "-- Financing Activities" and Note 3 of Notes to
Consolidated Financial Statements.

The credit agreement contains covenants that limit additional
indebtedness, liens, capital expenditures and cash dividends. Additionally,
the Company must meet financial covenants relating to fixed charge coverage,
consolidated tangible net worth, debt to total capitalization, debt and trade
payables to eligible inventory and a one day clean-down of revolver
borrowings. An amendment to the credit agreement in October 1996 waived
certain financial covenants and further modified other financial covenants
through March 30, 1997. In March 1997, the Company obtained an agreement from
its banks to waive financial covenants and technical defaults through May 29,
1997. Without the waivers in October 1996 and March 1997, the Company would
have been in default of the financial covenants related to the fixed charge
coverage ratio, consolidated tangible net worth, debt and trade payables to
eligible inventory ratio and the annual one day clean-down requirement during
the first quarter of 1997. Additionally, the Company would have been in
technical default of the financial covenant restricting additional debt and
the related lien on March 31, 1997 due to the consolidation of a special
purpose entity that holds property and a mortgage note payable.

During the first quarter of 1997, the Company's largest vendors and a
substantial majority of the remaining vendors agreed to temporarily defer
existing trade payables and provide continued product supply, subject to payment
terms reduced to 10 days or less on new purchases. Because these understandings
are voluntary on the part of the vendors and will continue at their sole
discretion, there can be no assurance that the Company will continue to receive
adequate product from its vendors on acceptable credit terms. Should any or all
of these vendors demand payment of the deferred balances, there can be no
assurance that the Company will be able to obtain adequate financing to make
such payment.

The Company's Franklin distribution facility is under an operating lease
with a special purpose entity that contains certain financial covenants. The
write-down of goodwill in 1995 followed by an additional write-down of the
remaining goodwill balance on December 31, 1996 caused the Company to be in
default of the financial covenant related to the maximum total liabilities to
total stockholders' equity ratio on December 31, 1996. This covenant ratio
did not anticipate the impact on stockholders' equity of any goodwill
write-down. The Company is working with the parties to the operating lease to
obtain a waiver of this financial covenant for December 31, 1996. However,
there can be no assurance that the Company will be able to obtain such a
waiver or that alternative sources of financing for the distribution facility
would be available if the waiver is not obtained.

The Company's stores operate in a retail environment in which many factors
that are difficult to predict and outside the Company's control can have a
significant impact on store and Company sales and profits. These factors
include the timing and strength of new product offerings, pricing strategies of
competitors, openings and closings of competitors' stores, the Company's ability
to continue to receive adequate product from its vendors on acceptable credit
terms and to obtain sufficient financing to meet its liquidity needs, effects of
weather and overall economic conditions, including inflation, consumer
confidence, spending habits and disposable income. Any of these factors, alone
or in combination, could affect the Company's ability to meet its financial
covenants and to continue as a going concern.

OPERATING ACTIVITIES. Net cash used in operating activities (including, in
1996, the decrease in checks drawn in excess of bank balances which relate to
vendor payments) during the three months ended March 31, 1997 and 1996 was $80.2
million and $241.6 million, respectively. The lower level of cash used in the
first three months of 1997 was primarily due to lower inventory levels as a
result of the

14
<PAGE>

consolidation of distribution centers into a single facility, store closings
and other initiatives designed by management to increase inventory turnover.
Cash used for inventory purchases, as reflected by the aggregate net changes
in inventories, accounts payable and checks drawn in excess of bank balances,
was $49.3 million in 1997 compared to $190.7 million in 1996. Restructuring
reserve utilization in the first three months of 1997 included $5.4 million
of cash expenditures and $17.8 million of non-cash charges. Changes in other
operating assets and liabilities are related primarily to the seasonal nature
of the business and also reflect the effect of store closings and the
curtailment of store expansion.

The Company received income tax refunds in the first quarter of 1997
totaling approximately $20 million from the carryback of the taxable loss for
the year ended December 31, 1996, while taxes paid in the first three months of
1996 on taxable income in 1995 were approximately $9 million. Changes in the
deferred income tax balances and most of the increase in other current assets
during the first three months of 1996 from December 31, 1995 were due to the
tax provision (benefit) recorded on the loss in the first quarter of 1996.
The net current deferred tax asset and net noncurrent deferred tax liability
were increased (decreased) by ($10.5) million and $1.6 million, respectively, to
reflect the effect of the deferred tax valuation allowances established in the
fourth quarter of 1996. See Note 5 of Notes to Consolidated Financial
Statements.

INVESTING ACTIVITIES. Store expansion and closings were as follows for the
periods indicated:

THREE MONTHS ENDED TWELVE MONTHS ENDED
MARCH 31, MARCH 31,
------------------- -------------------
1997 1996 1997 1996
-------- -------- -------- --------
OPENINGS:
Non-mall stores - 9 10 108
Mall stores - 2 12 43
Total (1) - 11 24 158
CLOSINGS:
Non-mall stores (21) (3) (34) (3)
Mall stores (52) (10) (89) (57)
Total (1) (74) (13) (126) (60)
NET INCREASE (DECREASE):
Non-mall stores (21) 6 (24) 105
Mall stores (52) (8) (77) (14)
Total (1) (74) (2) (102) 98

- -----------------------
(1) The totals include other divisions which individually are not significant.

Through March 31, 1997, the Company has closed 114 stores, including 79
mall stores and 35 non-mall stores, under restructuring programs which include
closing a total of 115 stores. The Company is closely monitoring other
nonproductive stores and may close additional stores, the majority of which are
at or near the end of their lease terms. Inventories from closed stores will be
either redeployed to existing stores that are more profitable, returned to
vendors or sold in preclosing liquidation sales.

Capital expenditures in 1997 will be limited to approximately $20 million
and will consist primarily of improvements to existing stores. Plans for a
portion of the capital spending include the downsizing of Media Play stores
from approximately 50,000 square feet to approximately 35,000 to 40,000
square feet. The Company anticipates that these capital expenditures will be
financed by borrowings under its credit agreement and internally generated
cash. Since 1995, capital expenditures have been significantly lower than in
previous years because of the challenging retail environment, which is
expected to continue into the foreseeable future. Historically, most of the
Company's capital

<PAGE>

expenditures have been for store expansion, and the majority of the store
expansion in recent years has consisted of new Media Play stores.

FINANCING ACTIVITIES. The Company's financing activities principally
consist of borrowings and repayments under its revolving credit facility. Cash
provided by (used in) financing activities (excluding the decrease in checks
drawn in excess of bank balances which relate to vendor payments) was ($0.8)
million and $243.0 million during the three months ended March 31, 1997 and
1996, respectively. At March 31, 1997, outstanding revolver borrowings were
$273.0 million while cash and cash equivalents were $79.0 million. The Company
had $296.0 million of revolver borrowings and checks drawn in excess of bank
balances of $4.2 million outstanding at March 31, 1996.

The Company has maintained higher revolver and cash balances since the
fourth quarter of 1996 because the financial covenants related to the annual
one day clean-down requirement during the period from December 15, 1996 to
February 15, 1997 and the debt and trade payables to eligible inventory ratio
were waived. Accordingly, outstanding revolver borrowings at March 31, 1997,
for purposes of comparison to the $296.0 million of outstanding revolver
borrowings at March 31, 1996, would have been $194.0 million when netted with
the balance of cash and cash equivalents. The lower level of net revolver
borrowings at March 31, 1997 is due primarily to the closing of
underperforming stores, reduced inventory levels and expense reductions.

The Company's revolving credit facility expires in October 1999. The
Company made a principal payment on its mortgage note payable of $1.8 million
in March 1997 with the balance due at the end of either the original term in
May 2000 or the one year renewal term in May 2001. The operating lease for
the distribution facility in Franklin, Indiana contains a residual value
guarantee in an amount not to exceed approximately $25 million at the end of
either the original lease term in March 1999 or the one year renewal term in
March 2000. The lease also contains a purchase option at the end of either
the original or renewal period. The Company plans to either sell and lease
back these properties or seek other sources of financing. As the challenging
retail environment is expected to continue into the foreseeable future, there
can be no assurance that the Company will be able to obtain adequate or
alternative sources of financing to meet its obligations under these
agreements.

FORWARD-LOOKING STATEMENTS

Forward-looking statements herein are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. There are
certain important factors that could cause results to differ materially from
those anticipated by some of the statements made herein. Investors are cautioned
that all forward-looking statements involve risks and uncertainty. In addition
to the factors discussed above, among the factors that could cause actual
results to differ materially are the following: the timing and strength of new
product offerings, pricing strategies of competitors, openings and closings of
competitors' stores, the Company's ability to continue to receive adequate
product from its vendors on acceptable credit terms and to obtain sufficient
financing to meet its liquidity needs, effects of weather and overall economic
conditions, including inflation, consumer confidence, spending habits and
disposable income.

<PAGE>

PART II - OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits:

<TABLE>
<CAPTION>
<S> <C> <C>
10.18 Change of Control Agreement with Mr. Wachsman __________

10.21 Executive Officer Salary Continuation Plan dated as of March 10, 1997 __________

15. Letter re unaudited interim financial information __________

27. Financial Data Schedules __________
</TABLE>

(b) Reports on Form 8-K:

There were no reports on Form 8-K filed during the quarter ended
March 31, 1997.

Omitted from this Part II are items which are not applicable or to which the
answer is negative for the period covered.

<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: May 14, 1997

<PAGE>

CHANGE OF CONTROL AGREEMENT

BETWEEN

THE MUSICLAND GROUP, INC.,

MUSICLAND STORES CORPORATION

AND

GILBERT L. WACHSMAN

DATED AS OF MARCH 10, 1997

<PAGE>

TABLE OF CONTENTS
Page
----

1. Operation of Agreement. . . . . . . . . . . . . . . . . . . . . . . . 1
2. Employment; Period of Employment. . . . . . . . . . . . . . . . . . . 4
3. Position, Duties, Responsibilities. . . . . . . . . . . . . . . . . . 5
4. Compensation, Compensation Plans, Perquisites . . . . . . . . . . . . 6
5. Employee Benefit Plans. . . . . . . . . . . . . . . . . . . . . . . . 9
6. Retirement Program. . . . . . . . . . . . . . . . . . . . . . . . . . 9
7. Effect of Death or Disability . . . . . . . . . . . . . . . . . . . .10
8. Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
9. Offset of Compensation and Benefits from Subsequent Employment. . . .16
10. Minimum Severance Payment . . . . . . . . . . . . . . . . . . . . . .17
11. Joint and Several Liability; Trust Agreement. . . . . . . . . . . . .19
12. Discount Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . .20
13. Potential Excise Taxes. . . . . . . . . . . . . . . . . . . . . . . .20
14. Indemnification and Insurance; Legal Expenses . . . . . . . . . . . .22
15. Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
16. General Provisions. . . . . . . . . . . . . . . . . . . . . . . . . .24

<PAGE>

CHANGE OF CONTROL AGREEMENT

CHANGE OF CONTROL AGREEMENT ("Agreement"), dated as of March 10,
1997 among THE MUSICLAND GROUP, INC., a Delaware corporation (the "Company"),
MUSICLAND STORES CORPORATION, a Delaware corporation (the "Parent") and
GILBERT L. WACHSMAN (the "Executive").

W I T N E S E T H :

WHEREAS:

A. The Executive is one of the principal officers of the Company
and an integral part of its management.

B. The Company wishes to assure itself and the Executive of
continuity of management in the event of any actual or threatened Change in
Control of the Company as hereafter defined.

C. This Agreement is not intended to alter materially the
compensation and benefits that the Executive could reasonably expect in the
absence of a Change in Control of the Company or the Parent (as hereinafter
defined) and, accordingly, this Agreement, though taking effect upon
execution hereof, will be operative only upon a Change in Control and as set
forth in paragraph 1.01 of this Agreement.

NOW, THEREFORE, it is hereby agreed by and between the parties as
follows:

1. OPERATION OF AGREEMENT

1.01 (a) This Agreement shall be effective immediately but shall
not be operative unless and until there has been a Change in Control, as
defined in Paragraph 1.02,

- 1 -

<PAGE>

while the Executive is in the employ of the Company. Upon the date of a
Change in Control, this Agreement shall become operative immediately and
Executive's Severance Agreement effective as of July 17, 1996 (the "Prior
Agreement") shall terminate.

1.02 "Change in Control" shall mean, except as provided in
subparagraph (e) below, a change in control of the Company or the Parent that
shall be deemed to have occurred if and when:

(a) while the Company or the Parent maintains a class or series of
equity securities that are registered under the Securities Exchange Act of
1934, any person (as such term is defined in Sections 13(d) and 14(d) of the
Securities Exchange Act of 1934) shall become the beneficial owner, directly
or indirectly, of 20% or more of the common stock of the Company or the
Parent, or

(b) a majority of the directors of the Company or the Parent are
persons other than persons (i) for whose election proxies have been solicited
by the Board of Directors of the Company or the Parent, or (ii) who are then
serving as directors appointed by the Board of Directors of the Company or
the Parent to fill vacancies on the applicable Board of Directors caused by
death or resignation (but not by removal) or to fill newly-created
directorships, but excluding for purposes of this clause (ii) any such
individual whose initial assumption of office occurs as a result of either an
actual or threatened election contest (as such terms are used in Rule 14a-11
of Regulation 14A promulgated under the Securities Exchange Act of 1934) or
other actual or threatened solicitation of proxies or consents, or

(c) the Company's or the Parent's, or at least 70% of the
Company's or the Parent's, assets are sold and transferred to another
corporation or other enterprise that is not a

- 2 -

<PAGE>

subsidiary, direct or indirect, or other affiliate of the Company or the
Parent, if such other enterprise does not make arrangements with the
Executive satisfactory to the Executive for his employment by such other
enterprise, or

(d) the Board of Directors of the Company or the Parent
determines, by a vote of a majority of its entire membership, that a tender
offer initiated by any person (as defined in subparagraph l.02(a) above)
indicates an intention on the part of such person to acquire control of the
Company or the Parent and there is a substantial likelihood that such tender
offer will result in a Change in Control. Should any tender offer for shares
of the Company or the Parent be initiated, the Board of Directors of the
Company or the Parent, as the case may be, shall vote upon whether, in the
good faith judgment of the Board, a substantial likelihood exists that such
tender offer will result in a Change in Control.

(e) No Change in Control shall be deemed to have occurred under
subparagraph 1.02(c) or (d) above if:

(i) the Company or the Parent is a debtor pursuant to a written loan
agreement of the person so described in such subparagraph and

(ii) either:

(A) the right to nominate or elect directors by such person
results from an event of default under a then operative provision of
such loan agreement, or

(B) the acquisition of securities described in such
subparagraphs by such person results from a foreclosure by such
person under a then operative provision of such loan agreement
following an event of default, or

(C) the acquisition of securities described in such
subparagraphs by such person is pursuant to a plan of reorganization
under the bankruptcy laws of the United States.

- 3 -

<PAGE>

For a period of 60 days following the date on which a Change in Control
occurs, the Executive agrees to perform for the Company each and every one of
his duties in effect immediately prior to the Change in Control as described
in paragraph 3.01.

1.03 If there is a Change in Control of the type described in
paragraph l.02(c), the Executive may elect to terminate the Period of
Employment hereunder by giving written notice to the Company of his decision
to terminate pursuant to this paragraph 1.03 within 30 days following the
applicable sale or transfer, which termination shall be effective as of the
90th day following the date such notice is given or such earlier date as the
Company may specify in a written notice given to the Executive. Any
termination of the Period of Employment pursuant to this paragraph 1.03 shall
be treated as a termination without Cause pursuant to the Executive's "Prior
Agreement", as the same may have been amended to the date of such termination
and the obligation set forth therein shall be and remain those of the Company
(i.e., The Musicland Group, Inc.) and the Parent (i.e., Musicland Stores
Corporation) prior to such sale or transfer and shall not be otherwise
assignable.

2. EMPLOYMENT; PERIOD OF EMPLOYMENT.

2.01 The Company shall employ the Executive, and the Executive
shall serve the Company, for the period set forth in paragraph 2.02 (the
"Period of Employment"), in the position and with the duties and
responsibilities set forth in Section 3, and upon the other terms and
conditions hereinafter stated. Employment by a subsidiary or affiliate of
the Company at the Company's request and with the Executive's consent shall
constitute employment by the Company within the terms of this Agreement.

- 4 -

<PAGE>

2.02 The Period of Employment shall commence on the date of a
Change in Control and, subject only to the provisions of Section 7 relating
to death or Disability and of paragraph 8.04 relating to termination for
Cause, shall continue until the close of business on the last business day of
the 24th calendar month following such Change in Control; provided, that on
the last business day of the 12th calendar month following such Change in
Control and on each anniversary of such date thereafter, the Period of
Employment shall be automatically extended by one additional year (to the
second subsequent such anniversary, but in no event shall the Period of
Employment extend beyond the first day of the month next succeeding the month
in which the Executive shall attain his 65th birthday) unless prior to the
last business day of the 6th calendar month following such Change in Control,
or any subsequent 12-month anniversary of such date thereafter, the Company
shall deliver to the Executive or the Executive shall deliver to the Company
written notice that the Period of Employment will not be extended, in which
case the Period of Employment will end at the expiration of the then-existing
Period of Employment hereunder, including any previous extension, and shall
not be further extended except by agreement by the Company and the Executive.

3. POSITION, DUTIES, RESPONSIBILITIES

3.01 (a) It is contemplated that during the Period of Employment
the Executive shall serve in the position and have the duties and
responsibilities as Vice Chairman or such other senior executive capacity
with substantially the same nature and quality as those of the position of
Vice Chairman, as the Company may from time to time determine.

(b) During the Period of Employment, the Executive

(i) shall hold a position of responsibility, importance and scope
at least equal to his position referred to in subparagraph 3.01(a),

- 5 -

<PAGE>

(ii) shall, without compensation other than that provided, serve, if
and when elected or reelected, as a member of the Board of Directors
and/or Executive Committee of the Company or the Parent,

(iii) shall, without compensation other than that herein provided,
serve as an officer and director of any subsidiary or affiliate, provided
the Executive has determined in his sole discretion that such service
does not entail undue risk to the Executive in light of the financial
condition of such subsidiary or affiliate and the extent of officers' and
directors' liability insurance applicable to such service, and

(iv) shall devote substantially all of his time, best efforts and
undivided attention during normal business hours to the business and
affairs of the Company and its subsidiaries except for reasonable
vacations and except for illness or incapacity, but nothing in this
Agreement shall preclude the Executive from devoting reasonable periods
required for

(A) serving as a director or member of a committee of any
organization or company involving no conflict of interest with the
Company,

(B) delivering lectures, fulfilling speaking engagements,
teaching at educational institutions,

(D) managing his personal investments;
provided that such activities do not materially interfere with the
performance of his duties hereunder.

3.02 The Executive's office shall be located in the Minneapolis,
Minnesota metropolitan area. He shall not be required, without his written
consent, to locate his office more than 20 miles distant by public highway
from his office immediately prior to the Change in Control or to be absent
therefrom on business more than 60 working days in any year or more than 14
consecutive days at any one time.

4. COMPENSATION, COMPENSATION PLANS, PERQUISITES

4.01 For all services rendered during the Period of Employment,
the Executive shall receive:

(i) a salary, payable no less often than monthly, at the annual
rate of $431,600 or the rate of monthly salary of the Executive paid
prior to the Change in Control, whichever is higher, subject to such
periodic increases as shall be awarded in

- 6 -

<PAGE>

accordance with the Company's regular administrative practices of salary
increases applicable to executives in effect prior to the Change in
Control, and

(ii) an annual award under the Company's Management Incentive
Plan, or a plan with substantially equivalent incentives and benefits that
may be adopted by the Company, for each calendar year, or portion thereof,
during the Period of Employment, which shall be payable as soon as
practicable after the end of such calendar year and shall be equal to a
percentage of the annual salary payable to the Executive for such calendar
year determined on the basis of the monthly salary payable to the
Executive as of the beginning of such calendar year under clause (i) of
this paragraph (after adjustment to reflect any increase therein awarded
by the Company under clause (i)). Such percentage shall be the lesser of
(A) 35% or (B) the average of the percentages, for each of the three
preceding calendar years (or such lesser number of years that the
Executive has been a participant in the plan), that result from dividing
the Executive's annual award under the Management Incentive Plan (or its
successor) for such year by the Executive's annual salary for that year.

Increases in salary and annual awards under this Agreement or otherwise shall
not diminish any other obligation of the Company hereunder.

4.02 (a) During the Period of Employment, the Executive shall
continue to be a full participant in the performance awards and stock
incentive aspects of the Company's Long-Term Incentive Plan and any other
long-term incentive plans of the Company (provided that Executive was a
participant in such plan or plans immediately prior to the Change in
Control), and shall also be a participant in any and all other executive
incentive plans in which executives of the Company participate that are in
effect for Executive immediately prior to a Change in Control, or any amended
or successor plans with at least as favorable terms that may be substituted
and that may hereafter be adopted, including, without limitation, any plan
relating to stock options, stock appreciation rights, restricted stock and
deferred stock awards, or equivalent successor plans that may be adopted by
the Company with at least the same reward opportunities that have heretofore
been provided and with such

- 7 -

<PAGE>

improvements in such plans or other plans as may from time to time be made in
accordance with the present practices of the Company.

(b) Upon a Change in Control, the right to exercise any and all
stock options to purchase shares of the Company's or Parent's stock and any
stock appreciation rights held by the Executive shall, to the extent that
such options and rights shall not theretofore have been exercised, become
fully vested and exercisable immediately, all restrictions upon any
restricted stock previously granted to the Executive shall be deemed to have
lapsed, the deferral period and all conditions pertaining to any deferred
stock awards previously granted to the Executive shall be deemed to have
expired or have been satisfied, as the case may be, and the Executive shall
be entitled to receive all such shares of restricted or deferred stock. All
restricted stock and all deferred stock awards granted to the Executive on or
after the date hereof shall be awarded subject to the conditions described in
the immediately preceding sentence. All options issued or awarded to the
Executive on or after the date hereof shall contain adequate provisions to
effect the foregoing.

4.03 During the Period of Employment the Executive shall be
entitled to perquisites and to fringe benefits in each case at least equal to
those attached to his office immediately prior to a Change in Control, as
well as to reimbursement, upon proper accounting of reasonable expenses and
disbursements incurred by him in the course of his duties.

4.04 The compensation provided for in this Section 4, together
with other matters therein set forth, is in addition to the benefits provided
for in Sections 5 and 6.

- 8 -

<PAGE>

5. EMPLOYEE BENEFIT PLANS

5.01 The Executive shall be entitled to all payments, benefits and
service credit for benefits during the Period of Employment to which Company
officers are entitled, immediately prior to a Change in Control, as a result
of their employment under the terms of employee plans and practices of the
Company, other than the Retirement Program, for which specific provision is
made in Section 6, but including, without limitation,

(i) the Company's Capital Accumulation Plan,

(ii) its death benefit plans (consisting of its Group Life Insurance
Plan and accidental death and dismemberment insurance),

(iii) its disability benefit plans (consisting of its short-term
salary continuation, short-term disability and long-term disability
plans),

(iv) its senior officer medical, dental, health and welfare plans,
and

(v) other present or equivalent successor plans and practices of
the Company for which officers are eligible, and to all payments or other
benefits under any such plan or practice subsequent to the Period of
Employment as a result of participation in such plan or practice during
the Period of Employment.

5.02 Nothing in this Agreement shall preclude the Company from
amending or terminating any particular employee benefit plan or practice,
provided that the Executive shall continue to be entitled during the Period
of Employment to perquisites as set forth in paragraph 4.03 and to benefits
and service credit for benefits under paragraph 5.01 at least as favorable to
the Executive as those to which he is entitled immediately prior to a Change
in Control. If and to the extent that such perquisites, benefits and service
credits are not payable or provided under any such plans or practices by
reason of such amendment or termination thereof, the Company itself shall pay
or provide therefor.

6. RETIREMENT PROGRAM. The term "Retirement Program" shall mean
the Company's Employees' Retirement Plan. Executive shall not be eligible for
benefits under the

- 9 -

<PAGE>

Retirement Program, except that the Executive shall be eligible to
participate in the Musicland Group's Capital Accumulation Plan upon
satisfying the eligibility requirements of that Plan and in any retirement
plans that may become applicable to Executives employed by the Company after
the date of this Agreement.

7. EFFECT OF DEATH OR DISABILITY

7.01 If the Executive should die during the Period of Employment,
his legal representative shall be entitled to the compensation provided for
in paragraph 4.01 for the month in which death shall have occurred, and the
Period of Employment shall end on the last day of such month without
prejudice to any other payments due in respect of the Executive's death.

7.02 (a) The word "Disability" shall mean an illness or accident
which prevents the Executive from performing his duties under this Agreement
for a period of six consecutive months. The Period of Employment shall end
on the last day of such six months' period but without prejudice to any
payments due the Executive in respect of Disability.

(b) In the event of the Executive's Disability during the Period
of Employment, the Executive shall be entitled to the compensation provided
for in paragraph 4.01 for the period of such Disability but not in excess of
six months.

(c) The amount of any payments due under this paragraph shall be
reduced by any payments to which the Executive may be entitled for the same
period because of disability under any disability or pension plan of the
Company.

- 10 -

<PAGE>

8. TERMINATION

8.01 In the event of a Termination, as defined in paragraph 8.03,
during the Period of Employment, the provisions of this Section 8 shall apply.

8.02 In the event of a Termination, the Company shall, as
liquidated damages or severance pay, or both, pay to the Executive and
provide him, his dependents, beneficiaries and estate, in lieu of all other
remedies, damages or relief to which he might otherwise be entitled under
this Agreement, with the following:

(a) A lump sum equal to the total of the following future
payments, discounted to present value at the Discount Rate as defined in
Section 12 applied to each such future payment, that would have been made for
the remainder of the Period of Employment, as if such Termination had not
occurred:

(i) the salary provided in subparagraph 4.01(i) at the time of such
termination, at the times therein stated, for the month in which the
Termination shall have occurred and for each month thereafter during the
Period of Employment, less in respect of each such month the amounts, if
any, the Executive would have paid in cash in respect of employee
benefits provided for in subparagraphs 5.01 (ii), (iii) and (iv) if the
Executive were still employed, and (ii) the annual awards provided in
subparagraph 4.01(ii), at the times therein stated, for the year in which
the Termination shall have occurred and for each year thereafter during
the Period of Employment; provided that, for the purpose of calculating
the lump sum due under this subparagraph 8.02(a)(ii), the annual awards
for the remainder of the Period of Employment shall be calculated pursuant
to subparagraph 4.01(ii) using an annual salary at the time of such
Termination.

(b) In full substitution for any awards under the Long Term
Incentive Plan, a lump sum equal to 35% of the annual rate of salary payable
to the Executive in accordance with subparagraph 4.01(i) at the time of such
Termination, for the year in which the

- 11 -

<PAGE>

Termination shall have occurred and for each year thereafter during the
Period of Employment, as if such Termination had not occurred.

(d) The Executive shall continue to be entitled to all employee
benefits provided for in subparagraphs 5.01(ii), (iii) and (iv), relating to
death benefit, disability benefit, and senior officer medical, dental, health
and welfare plans and all other present or equivalent successor plans and
practices of the Company for which officers are eligible, until the Executive
shall attain age 65, as if the Executive were still employed during such
period under this Agreement, with benefits based upon the compensation
provided in paragraph 4.01 at the time of such Termination as if the
Executive continued to be employed until age 65, and if and to the extent
that such benefits shall not be payable or provided under any such plan by
reason of the Executive no longer being an employee of the Company as a
result of Termination, the Company itself shall pay or provide therefor.

(e) The payments made and benefits provided to the Executive, his
beneficiaries, or estate pursuant to this paragraph 8.02 shall be in lieu of,
and not in addition to, any and all benefits to which the Executive is
otherwise entitled upon termination of employment with the Company,
including, but not limited to, any other Company policies, procedures, or
practices, oral or written, now or hereafter established, and shall be in
lieu of all other remedies, damages, or relief to which he might otherwise be
entitled under this Agreement.

- 12 -

<PAGE>

8.03 The word "Termination" shall mean:

(a) Termination by the Company of the Executive's employment for
any reason other than for Cause as defined in paragraph 8.04 or for
Disability; or

(b) Termination by the Executive of his employment upon the
occurrence of any of the following events:

(i) A significant change in the nature or scope of the authorities,
powers, functions, duties or responsibilities attached to the position
referred to in paragraph 3.01(a) or a position of comparable authorities,
powers, functions, duties or responsibilities to that of senior officers
generally or a reduction in compensation, which in either event is not
remedied within 30 days after receipt by the Company of written notice
from the Executive;

(ii) A breach by the Company of any provision of this Agreement not
embraced within the foregoing clause (i) which is not remedied within 30
days after receipt by the Company of written notice from the Executive;

(iii) The liquidation, dissolution, consolidation or merger of the
Company or transfer of 70% or more of its assets unless a successor or
successors (by merger, consolidation or otherwise) to which all or 70% or
more of its assets has been transferred shall have assumed all duties and
obligations of the Company under this Agreement;

provided that, in any event set forth in this subparagraph, the Executive
shall have elected to terminate his employment under this Agreement upon not
less than 30 and not more than 90 days' advance written notice to the Board
of Directors of the Company, attention of the Chief Executive Officer, given,
except in the case of a continuing breach, within three calendar months after
(A) expiration of the 30-day cure period with respect to such event, or (B)
the closing date of such liquidation, dissolution, consolidation, merger or
transfer of assets.

An election by the Executive to terminate his employment under the
provisions of this subparagraph shall not be deemed a voluntary termination
of employment by the Executive for the purpose of this Agreement or any plan
or practice of the Company.

- 13 -

<PAGE>

8.04 The Company shall have the right, by not less than 60 days'
notice in writing, to terminate for Cause the employment of the Executive and
the Period of Employment. The termination of the Executive's employment
shall be deemed to have been for Cause only

(i) if termination of his employment shall have been the result of
an act or acts of dishonesty by him or an act or acts resulting or
intended to result directly or indirectly in gain to or personal
enrichment of the Executive at the Company's expense; or

(ii) if there has been a deliberate and intentional refusal by the
Executive during the Period of Employment (except by reason of incapacity
due to illness or accident) to comply with the provisions of subparagraph
3.01(b), relating to the time and best efforts to be devoted to the
affairs of the Company, and such breach results in demonstrably material
injury to the Company, and the Executive shall have either failed to
remedy such alleged breach within 30 days from his receipt of written
notice from the Secretary of the Company demanding that he remedy such
alleged breach, or shall have failed to take all reasonable steps to that
end during such 30-day period and thereafter; or

(iii) if there has been a determination by the Chief Executive
Officer or an affirmative vote (as described below) of the Board of
Directors of the Company at a meeting called and held for that purpose and
at which the Executive is given an opportunity to be heard, that, in the
judgment of the Chief Executive Officer or the Board, the Executive has,
over an extended period of time, consistently failed to satisfactorily
perform the material duties of his office assigned to him and such failure
has had an adverse impact upon the Company; provided that such
determination may be made only after at least two formal reviews of the
Executive's performance by the Chief Executive Officer conducted at an
interval of at least six months at which the Executive shall be informed
of the most significant deficiencies in performance and during such
interval and a period of at least ninety days from and after the most
recent such review, the Executive shall have failed to correct or failed
to take all reasonable steps to correct such significant deficiencies;

provided that there shall have been delivered to the Executive with the
above-mentioned 60-day notice a certified copy of a resolution of the Board
of Directors of the Company adopted by the affirmative vote of at least a
majority of the entire membership (whether or not present) of the Board of
Directors (other than the Executive) of the Company at a meeting called and
held for that purpose and at which the Executive was given an opportunity to
be heard, finding

- 14 -

<PAGE>

that the Executive was guilty of conduct set forth in clause (i), (ii) or
(iii) above, specifying the particulars thereof in detail. For purposes of
the minimum number of directors required for the affirmative vote described
in the next preceding sentence, any fraction shall be rounded to the next
higher whole number of directors.

Anything herein to the contrary notwithstanding, the employment of
the Executive shall not be considered to have been terminated by the Company
for Cause if termination of his employment took place

(i) as the result of bad judgment or negligence on the part of the
Executive, or

(ii) as the result of an act or omission without intent of gaining
therefrom directly or indirectly a profit to which the Executive was not
legally entitled, or

(iii) because of an act or omission believed by the Executive in
good faith to have been in or not opposed to the interests of the Company.

8.05 If the Executive's employment shall be terminated by the
Company during the Period of Employment and such termination is alleged to be
for Cause, or the Executive's right to terminate his employment under
subparagraph 8.03(b) shall be questioned by the Company, the Executive shall
have the right, in addition to all other rights and remedies provided by law,
at his election, either to seek arbitration in Minneapolis, Minnesota, under
the rules of The American Arbitration Association, by serving a notice to
arbitrate upon the Company, or to institute a judicial proceeding, in either
case within 90 days after having received notice of termination of his
employment or notice in any form that the termination of his employment under
subparagraph 8.03(b) is subject to question or within such longer period as
may reasonably be necessary for the Executive to take action in the

- 15 -

<PAGE>

event that his illness or incapacity should preclude his taking such action
within such 90-day period.

9. OFFSET OF COMPENSATION AND BENEFITS FROM SUBSEQUENT EMPLOYMENT

9.01 In the event of a termination of his employment, the
Executive shall not be required to minimize damages or severance payment
under Sections 8 or 10 by seeking or accepting other employment or consulting
position.

9.02 If the Executive obtains other employment or a consulting
position subsequent to a Termination and prior to the end of the Period of
Employment, the Executive shall pay to the Company on a quarterly basis the
Subsequent Compensation, as defined below, that he receives for such other
employment through the last day of the Period of Employment, provided,
however, that the amount of such quarterly payments shall be reduced by any
liability with respect to such Subsequent Compensation that the Executive
incurs for income taxes (after taking into account any income tax benefit
available as a result of such quarterly payments) and payroll deductions
required by law, and provided further that no such payments shall be made
unless the Executive received a lump sum payment pursuant to and in
accordance with subparagraphs 8.02(a) and (b). Subsequent Compensation for
each calendar quarter during which the Executive engages in such other
employment or consulting position shall equal the lesser of (i) the cash or
other compensation that is payable to the Executive for such employment or
consulting position during that particular quarter, or (ii) the figure
obtained by multiplying the total amount of salary plus annual and prorated
performance awards used in calculating a lump sum payment for the Executive
under subparagraphs 8.02(a) and (b) (prior to discounting to present value as
of the Termination) by a fraction, the numerator of which is 3 and the
denominator of which is the number of months remaining in

- 16 -

<PAGE>

the Period of Employment after Termination. Notwithstanding the foregoing,
the Executive shall not be required to minimize payments or benefits under
this Agreement by seeking or accepting other employment or a consulting
position.

9.03 The benefits to be provided by the Company under the
provisions of subparagraph 8.02(d) shall be reduced to the extent of the
death, disability, medical, dental, health and welfare benefits received by
the Executive from any other employment or consulting position he obtains
subsequent to a Termination and prior to his attaining age 65.

10. MINIMUM SEVERANCE PAYMENT

10.01 If the employment of the Executive shall be terminated by the
Company for any reason other than Cause at a time prior to the attainment by
the Executive of 65 years of age and when there are fewer than 12 months
remaining in the Period of Employment, the Company shall pay the Executive a
lump sum severance payment, in addition to any payment under Section 8, equal
to the total of the following future payments, discounted to present value at
the Discount Rate as defined in Section 12 applied to each such payment, for
each month of the Severance Period (as defined below): the sum of (i) the
monthly salary of the Executive in effect for the month immediately preceding
the month in which termination of his employment shall have taken place, (ii)
the average of the highest annual incentive awards paid to the Executive
under the Management Incentive Plan for any three calendar years (or the
actual number of years if fewer) during the last ten years of his employment
by the Company (or the actual number of years if fewer) divided by 12, and
(iii) the average of the highest incentive awards, if any, paid to the
Executive under the Long-Term Incentive Plan for any three performance
periods (or the actual number of performance periods if fewer) during the
last ten years of his employment by the Company (or the actual number of

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<PAGE>

years if fewer) divided by 12. The Severance Period shall (i) commence upon
the first calendar month after the completion of the Period of Employment,
and (ii) end upon the earliest of (A) 12 calendar months after the
termination of his employment, or (B) the month in which the Executive shall
attain 65 years of age.

The payments made and benefits provided to the Executive, his
beneficiaries, or estate pursuant to this paragraph 10.01 shall be in lieu
of, and not in addition to, any and all benefits to which the Executive is
otherwise entitled upon termination of employment with the Company,
including, but not limited to, any other Company policies, procedures, or
practices, oral or written, now or hereafter established, and shall be in
lieu of all other remedies, damages, or relief to which he might otherwise be
entitled under this Agreement.

10.02 If the Executive receives payment under paragraph 10.01 and
obtains other employment or consulting position within the Severance Period,
the Executive shall pay to the Company on a quarterly basis the
Post-Severance Compensation, as defined below, that he receives for such
other employment or consulting position through the last day of the Severance
Period, provided, however, that the amount of such quarterly payments shall
be reduced by any liability with respect to such Post-Severance Compensation
that the Executive incurs for income taxes (after taking into account any
income tax benefit available as a result of such quarterly payments) and
payroll deductions required by law. Post-Severance Compensation for each
calendar quarter during which the Executive engages in such other employment
or consulting position shall equal the lesser of (i) the cash or other
compensation that is payable to the Executive for such employment or
consulting position during that particular quarter, or (ii) the figure
obtained by multiplying the total amount of salary plus annual awards used in
calculating a lump-sum payment for the Executive under paragraph

- 18 -

<PAGE>

10.01 (prior to discounting to present value as of the termination) by a
fraction the numerator of which is 3 and the denominator of which is the
number of months in the Severance Period. Notwithstanding the foregoing, the
Executive shall not be required to minimize payments or benefits under this
Agreement by seeking or accepting other employment or a consulting position.

11. JOINT AND SEVERAL LIABILITY; TRUST AGREEMENT

11.01 All duties, undertakings, obligations, and liabilities of the
Company or the Parent arising under this Agreement shall be the joint and
several liability of the Company and the Parent.

11.02 To assure the performance by the Company and the Parent of
its obligations under this Agreement in the event of a Change in Control, the
Company or the Parent shall, upon the request of the Executive immediately
prior to a Change in Control, or at any time on or after the date a Change in
Control occurs and prior to the date all amounts to which Executive is or may
become entitled hereunder have been paid to Executive, deposit in an
irrevocable trust with a trustee designated by the Executive, an amount of
liquid assets equal to the present value based on the Discount Rate defined
in Section 12 of the maximum amount of all lump sum amounts which could be
paid to Executive in the event of a Termination of the Executive (as defined
in paragraph 8.03) following a Change in Control. Such trust shall be
established and funded only if and to the extent that the establishment of
such trust does not contravene the provisions of any loan agreement under
which the Company or the Parent is obligated; provided, however, that the
Company and Parent (as opposed to the lender under any such loan agreement)
may not seek to preclude the establishment of such trust by initiating the
entering into, renegotiating or amending of any such loan agreement, a

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<PAGE>

principal purpose of which entering into, renegotiation, or amendment is such
preclusion. The trust shall be reasonably satisfactory in form and substance
to the Executive, with no greater rights in the Executive than an unsecured
creditor of the Company and Parent. To the extent there are not amounts in
trust sufficient to pay all amounts due to Executive under this Agreement,
the Company and Parent shall be and remain liable therefore.

12. DISCOUNT RATE

For purposes of determining the present value of any payment or
benefit under this Agreement, the term "Discount Rate" shall mean 10%;
provided, that if the average of the prime rate (or its equivalent) charged
by Morgan Guaranty Trust Company of New York during the 30 day Period which
ends 15 days after the date of the Executive's Termination is 8% or less, the
Discount Rate shall be 8%.

13. POTENTIAL EXCISE TAXES

In the event that any excise tax is payable by the Executive by
reason of section 4999 of the Internal Revenue Code of 1986, as that section
may be amended, or any successor or similar provision thereto, or comparable
state or local tax laws, as a direct or indirect result of the receipt of any
payment, right or benefit received after July 17, 1996 by the Executive from
the Company or from any interested person which is in the nature of
compensation in connection with his employment with the Company, Parent, or
any subsidiary of either of them, the Company shall pay to the Executive such
additional compensation as is necessary (after taking into account all
Federal, state and local taxes, including income and excise taxes, payable by
the Executive as a result of the receipt of such additional compensation) to
place the Executive in the same after-tax position he would have been in had
no such excise tax (and

- 20 -

<PAGE>

any interest and penalties thereon) been paid or incurred. The Company shall
pay such additional compensation upon the earlier of (A) the time at which
the Company withholds such excise tax from any payments to the Executive, or
(B) 30 days after the Executive notifies the Company that the Executive has
filed a tax return which takes the position that such excise tax is due and
payable in reliance on a written opinion of the Executive's tax counsel that
it is more likely than not that such excise tax is due and payable.

If the Executive makes any payment with respect to any such excise
tax as a result of an adjustment to the Executive's tax liability by any
Federal, state or local authority, the Company will pay such additional
compensation within 30 days after the Executive notifies the Company of such
payment. Without limiting the obligation of the Company hereunder, the
Executive agrees, in the event the Executive makes any payment pursuant to
the preceding sentence, to negotiate with the Company in good faith with
respect to procedures reasonably requested by the Company which would afford
the Company the ability to contest the imposition of such excise tax;
provided, however, that the Executive will not be required to afford the
Company any right to contest the applicability of any such excise tax to the
extent that the Executive reasonably determines that such contest is
inconsistent with the overall tax interests of the Executive.

The Company agrees to hold in confidence and not to disclose,
without the Executive's prior written consent, any information with regard to
the Executive's tax position which the Company obtains pursuant to this
Section 13.

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<PAGE>

14. INDEMNIFICATION AND INSURANCE; LEGAL EXPENSES

14.01 The Company will indemnify the Executive (and his legal
representatives or other successors) to the fullest extent permitted
(including payment of expenses in advance of final disposition of the
proceeding) by the laws of the State of Delaware, as in effect at the time of
the subject act or omission, or by the Restated Certificate of Incorporation
and By-Laws of the Company as in effect at such time or on the date of this
Agreement, or by the terms of any indemnification agreement between the
Company and the Executive, whichever affords or afforded greater protection
to the Executive; and the Executive shall be entitled to the protection of
any insurance policies the Company may elect to maintain generally for the
benefit of its directors and officers (and to the extent the Company
maintains such an insurance policy or policies, the Executive shall be
covered by such policy or policies, in accordance with its or their terms, to
the maximum extent of the coverage available for any Company officer or
director), against all costs, charges and expenses whatsoever incurred or
sustained by him or his legal representatives in connection with any action,
suit or proceeding to which he (or his legal representatives or other
successors) may be made a party by reason of his being or having been a
director, officer or employee of the Company or any of its subsidiaries or
his serving or having served any other enterprise as a director, officer or
employee at the request of the Company, provided that the Company shall cause
to be maintained in effect for not less than six years from the date of a
Change in Control (to the extent available) policies of directors' and
officers' liability insurance of at least the same coverage as those
maintained by the Company at any time within 180 days after the date of this
Agreement and containing terms and conditions which are no less advantageous
than such policies.

- 22 -

<PAGE>

14.02 In the event of any litigation, arbitration or other
proceeding between the Company and the Executive with respect to the subject
matter of this Agreement or the enforcement of his rights hereunder, the
Company shall periodically reimburse the Executive, regardless of the
outcome, for all of his reasonable costs and expenses relating to such
litigation, arbitration or other proceeding, including, without limitation,
his reasonable attorneys' fees and expenses. In no event shall the Executive
be required to reimburse the Company for any of the costs or expenses
relating to such litigation, arbitration or other proceeding.

15. NOTICES

All notices, requests, demands and other communications provided
for by this Agreement shall be in writing and shall be sufficiently given if
personally delivered or if actually received by mail, return receipt
requested and postage prepaid, addressed to the party entitled thereto at the
address stated below or to such changed address as the addressee may have
given by a similar notice to the other:

To the Company: The Musicland Group, Inc.
10400 Yellow Circle Drive
Minnetonka, MN 55343
Attention: Chief Executive Officer

To the Executive: The Musicland Group, Inc.
10400 Yellow Circle Drive
Minnetonka, MN 55343
Attention: Gilbert L. Wachsman

With an additional copy to: Gilbert L. Wachsman

---------------------------------------

Receipt by mail shall be established by a duly executed return
receipt.

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<PAGE>

16. GENERAL PROVISIONS

16.01 Whenever, under this Agreement, it is necessary to determine
whether one benefit is less than, equal to, or larger than another in value,
whether or not such benefits are provided under this Agreement, such
determination shall be made using mortality, interest and any other
assumptions no less favorable to the Executive than those normally used as of
the date of such determination in determining actuarial equivalents for the
purpose of the Retirement Program.

16.02 This Agreement shall not confer any right or impose any
obligation on the Executive to continue in the employ of the Company, or
limit the right of the Company or the Executive to terminate his employment,
at any time prior to a Change in Control.

16.03 The Company shall have no right of set-off or counterclaim in
respect of any claim, debt or obligation against any payments provided for in
this Agreement, except as otherwise provided in paragraphs 9.02 and 10.02.

16.04 No right to or interest in any payments shall be assignable
by the Executive; provided, however, that this provision shall not preclude
him from designating one or more beneficiaries to receive any amount that may
be payable after his death and shall not preclude his executor or
administrator from assigning any right hereunder to the person or persons
entitled thereto.

16.05 No provision of this Agreement may be amended, modified or
waived unless such amendment, modification or waiver shall be agreed to in
writing signed by the Executive and by a duly authorized Company officer.

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<PAGE>

16.06 If any provision of this Agreement shall be determined to be
invalid or unenforceable by a court of competent jurisdiction, the remaining
provisions of this Agreement shall remain in full force and effect to the
fullest extent permitted by law.

16.07 When this Agreement becomes operative, the obligations of the
Company under paragraphs 11 (joint and several liability; trust agreement),
13 (potential excise taxes) and 14 (indemnification and insurance; legal
expenses) shall survive the termination for any reason of this Agreement
(whether such termination is by the Company, by the Executive, upon the
expiration of this Agreement or otherwise).

16.08 This Agreement shall be binding upon and inure to the benefit
of the Company and any successor of the Company including, without
limitation, any corporation or corporations acquiring directly or indirectly
all or substantially all of the assets of the Company, whether by merger,
consolidation, sale or otherwise (and such successor shall thereafter be
deemed "the Company" for the purposes of this Agreement), but shall not
otherwise be assignable by the Company.

16.09 The word "Executive" shall wherever appropriate include his
dependents, beneficiaries and legal representatives.

16.10 All payments required to be made by the Company hereunder to
the Executive or his estate or beneficiaries shall be subject to the
withholding of such amounts, if any, relating to tax and other payroll
deductions as the Company may reasonably determine it should withhold
pursuant to any applicable law or regulation.

- 25 -

<PAGE>

16.11 The validity, interpretation, performance and enforcement of
this Agreement shall be governed by the laws of the State of Minnesota,
without giving effect to the principles of conflict of laws thereof. IN
WITNESS WHEREOF, the parties hereto have executed this Change of Control
Agreement as of the day and year first above written to be effective and
operative as set forth in Section 1.01.

THE MUSICLAND GROUP, INC.

By /s/ Jack W. Eugster
---------------------------------------
Its Chief Executive Officer

MUSICLAND STORES CORPORATION

By /s/ Jack W. Eugster
---------------------------------------
Its Chief Executive Officer

GILBERT L. WACHSMAN

/s/ Gilbert L. Wachsman
---------------------------------------

- 26 -

<PAGE>
- -------------------------------------------------------------------------------
| PROCEDURE NUMBER: 253C
HUMAN RESOURCES |----------------------------------------
POLICIES AND PROCEDURES | EFFECTIVE DATE: 03/10/97
- --------------------------------------|----------------------------------------
TITLE: EXECUTIVE SALARY CONTINUATION | REVISED DATE:
BENEFIT - OFFICERS |----------------------------------------
| PAGE: 1 OF 1
- -------------------------------------------------------------------------------

I. POLICY

Under certain circumstances, the Company will grant separation pay (salary
continuation benefits and/or pay in lieu of notice) in instances where the
Company eliminates an employee's position.

II. SCOPE

This policy applies to any Executive Committee member who is NOT party to
an individual employment contract.

III. BASIC PROVISIONS

1. Such employees will be eligible to receive salary continuation
benefits if they are laid off from the Company due to:

A. Transfer of or elimination of a function, department or facility due
to reductions in work force, realignment, sale or closing of
operations, or;

B. Discontinuation of or restructuring of a position or function to
improve productivity or meet changed business needs.

The determination of whether the termination is due to either of
the above situations will be made solely at the discretion of the
Company.

2. Any Executive Officer level employee who is part of a lay-off is
eligible for 12 months salary continuation.

3. Eligible Executive Officers will be required as a condition of their
receipt of salary continuation benefits to actively seek and accept
other employment or consulting arrangements at a similar level of
management. To the extent that the Executive receives cash or other
compensation in respect of such other employment or consulting position
during the 12 month period following the Executive's termination, the
salary continuation benefits under this policy shall be correspondingly
reduced dollar for dollar.

4. The Company will only offer this salary continuation benefit in
exchange for an executed unqualified release, which will be given to
the employee upon notice of termination.

5. The Company will pay the employee all earned, unused vacation as of the
date of the lay-off. This does NOT include sick time, floating
holidays or personal days, and personal days or floating holidays may
not be used by the employee after notice of the lay-off has been given.
In the event an employee does not receive prior advance notice, they
will receive 2 weeks pay in lieu of notice (in addition to the amount of
salary continuation described above).

<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, 33-50522, 33-50524, 33-82130
and 33-99146, its Form 10-Q for the quarter ended March 31, 1997, which
includes our report dated April 22, 1997, 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

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET OF MUSICLAND STORES CORPORATION AND SUBSIDIARIES AS
OF MARCH 31, 1997 AND THE RELATED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE
THREE-MONTH PERIOD ENDED MARCH 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 78,968
<SECURITIES> 0
<RECEIVABLES> 0
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0
0
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</TABLE>