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PROSPECTUS
MAY 6, 1998
$150,000,000
[LOGO]
OFFER TO EXCHANGE 9 7/8% SERIES B SENIOR SUBORDINATED NOTES FOR ANY AND ALL
OUTSTANDING 9 7/8% SENIOR SUBORDINATED NOTES DUE 2008
Offer to Exchange 9 7/8% Series B Senior Subordinated Notes Due 2008, which
have been registered under the Securities Act of 1933, as amended, for any and
all of its outstanding 9 7/8% Senior Subordinated Notes Due 2008. The Exchange
Offer will expire at 5:00 p.m., New York City time, on June 5, 1998 (the
"Expiration Date") unless the Exchange Offer is extended.
The Musicland Group, Inc. ("MGI" or the "Issuer") hereby offers, upon the
terms and subject to the conditions set forth in this Prospectus and the
accompanying letters of transmittal (each a "Letter of Transmittal,"
collectively the "Letters of Transmittal" and, together with this Prospectus,
the "Exchange Offer"), to exchange its 9 7/8% Series B Senior Subordinated Notes
Due 2008 (the "New Notes") which have been registered under the Securities Act
of 1933, as amended (the "Securities Act"), pursuant to a Registration Statement
of which this Prospectus is a part, for an equal principal amount of its
outstanding 9 7/8% Series A Senior Subordinated Notes Due 2008 (the "Old Notes")
outstanding in the principal amount of $150,000,000 as of the date of this
Prospectus. The Old Notes were originally sold on April 6, 1998 (the "Issue
Date") to a limited number of qualified investors in reliance upon exemption
from registration under the Securities Act (the "Private Placement").
The Issuer will accept for exchange any and all Old Notes that are validly
tendered and not withdrawn on or prior to 5:00 p.m., New York City time, on June
5, 1998, unless extended. Tenders of Old Notes may be withdrawn at any time
prior to 5:00 p.m., New York City time, on the Expiration Date. The Exchange
Offer is not conditioned upon any minimum principal amount of Old Notes being
tendered for exchange. See "The Exchange Offer."
The New Notes will be obligations of the MGI evidencing the same
indebtedness as the Old Notes and will be entitled to the benefits of the
Indenture (as defined), which governs both the Old Notes and the New Notes, and
to the benefits of the Guarantee of Musicland Stores Corporation ("MSC" or the
"Guarantor"), which owns 100% of MGI. All references to the "Company" shall
include MSC, MGI, and MGI's subsidiaries. The principal asset of MSC is the
stock of MGI; MSC has no business operations other than those conducted by MGI.
The form and terms of the New Notes are in all material respects identical
to the form and terms of the Old Notes, except that the offer and issuance of
the New Notes will have been registered under the Securities Act and, therefore,
the New Notes will not bear legends restricting their transfer. The Old Notes
and the New Notes are collectively, and sometimes individually, referred to as
the "Notes." See "Description of the Notes."
The New Notes are being offered hereunder in order to satisfy certain
obligations of the Issuer and the Guarantor under the Registration Rights
Agreement, dated April 6, 1998 (the "Registration Rights Agreement"), among the
Issuer, the Guarantor and Donaldson Lufkin & Jenrette Securities Corporation, BT
Alex. Brown, and NationsBanc Montgomery Securities LLC (the "Initial
Purchasers"). Based on interpretations by the staff of the Securities and
Exchange Commission (the "Commission"), as set forth in no-action letters issued
to third parties, the Company believes that the New Notes issued pursuant to the
Exchange Offer may be offered for resale, resold or otherwise transferred by
holders thereof (other than any holder that is an "affiliate" of the Company, as
defined under Rule 405 of the Securities Act), provided that such New Notes are
acquired in the ordinary course of such holder's business and such holder is not
engaged in, and does not intend to engage in, a distribution of such New Notes
and has no arrangement with any person to participate in the distribution of
such New Notes. However, the staff of the Commission has not considered the
Exchange Offer in the context of a no-action letter and there can be no
assurance that the staff of the Commission would make a similar determination
with respect to the Exchange Offer. By tendering the Old Notes in exchange for
the New Notes, each holder, other than a broker-dealer, will represent to the
Company that (i) it is not an affiliate of the Company (as defined under Rule
405 of the Securities Act), (ii) any New Notes to be received by it were
acquired in its ordinary business and (iii) it is not engaged in, and does not
intend to engage in, a distribution of such New Notes and has no arrangement or
understanding to participate in a distribution of the New Notes. Each
broker-dealer that receives New Notes for its own account pursuant to the
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Offer must acknowledge that it will deliver a Prospectus in connection with any
resale of such New Notes. The Letters of Transmittal state that by so
acknowledging and by delivering a prospectus, a broker-dealer will not be deemed
to admit that it is an "underwriter" within the meaning of the Securities Act.
This Prospectus, as it may be amended or supplemented from time to time, may be
used by a broker-dealer in connection with resales of New Notes received in
exchange for Old Notes, where such Old Notes were acquired by such broker-dealer
as a result of market-making activities or other trading activities. The Company
has agreed that it will make this Prospectus available to any broker-dealer for
use in connection with resale for a period starting on the Expiration Date and
ending on the earlier of (i) the close of business 360 days after the Expiration
Date or (ii) the date when (A) all Old Notes have been exchanged for New Notes,
(B) all Old Notes have been sold pursuant to a Shelf Registration Statement (as
defined) or pursuant to Rule 144 under the Act, and (C) all New Notes have been
sold (as contemplated by "Plan of Distribution," herein) by any broker-dealer
who acquires such New Notes in exchange for Old Notes pursuant to this Exchange
Offer. In addition, until August 4, 1998 (90 days after the date of this
Prospectus), all dealers effecting transactions in the New Notes may be required
to deliver a prospectus. See "Plan of Distribution."
Prior to this Exchange Offer, there has been no public market for the Old
Notes or the New Notes. The Initial Purchasers have agreed that one or more of
them will act as market-makers for the New Notes. However, the Initial
Purchasers are not obligated to so act and they may discontinue any such
market-making at any time without notice. Moreover, the New Notes and Old Notes
could trade at prices that may be higher or lower than their principal amount if
a market were to develop for either of them. The Company does not intend to
apply for listing or quotation of the New Notes or Old Notes on any securities
exchange or stock market. Therefore, there can be no assurance as to the
liquidity of any trading market for the New Notes or Old Notes or that an active
public market for the New Notes or Old Notes will develop. See "Risk
Factors--Absence of Public Market."
The Company will not receive any proceeds from the Exchange Offer. The
Company will pay all the expenses incident to the Exchange Offer. No underwriter
is being used in connection with the Exchange Offer.
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS OF
OLD NOTES WHO TENDER THEIR OLD NOTES IN THE EXCHANGE OFFER, SEE "RISK FACTORS"
BEGINNING ON PAGE OF THIS PROSPECTUS.
THE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
THIS PROSPECTUS INCLUDES "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE SECURITIES EXCHANGE ACT
OF 1934, AS AMENDED. ALL STATEMENTS REGARDING THE COMPANY'S EXPECTED FINANCIAL
POSITION, BUSINESS AND FINANCING PLANS ARE FORWARD-LOOKING STATEMENTS. ALTHOUGH
THE COMPANY BELIEVES THAT THE EXPECTATIONS REFLECTED IN SUCH FORWARD-LOOKING
STATEMENTS ARE REASONABLE, IT CAN GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL
PROVE TO HAVE BEEN CORRECT. IMPORTANT
FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH
EXPECTATIONS ("CAUTIONARY STATEMENTS") ARE DISCLOSED IN THIS PROSPECTUS,
INCLUDING IN CONJUNCTION WITH THE FORWARD-LOOKING STATEMENTS INCLUDED IN THIS
PROSPECTUS AND UNDER THE HEADING "RISK FACTORS." ALL SUBSEQUENT WRITTEN AND ORAL
FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS ACTING ON THE
COMPANY'S BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY
STATEMENTS.
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PROSPECTUS SUMMARY
THE FOLLOWING IS A SUMMARY OF CERTAIN INFORMATION CONTAINED ELSEWHERE IN
THIS PROSPECTUS AND IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND THE RELATED NOTES THERETO APPEARING
ELSEWHERE IN THIS PROSPECTUS. ALL REFERENCES IN THIS PROSPECTUS TO THE "COMPANY"
SHALL INCLUDE MSC AND MGI AND ITS SUBSIDIARIES. THE PRINCIPAL ASSET OF MSC IS
100% OF THE OUTSTANDING COMMON STOCK OF MGI AND MSC ENGAGES IN NO INDEPENDENT
BUSINESS OPERATIONS. THE INDUSTRY DATA REFERRED TO IN THIS OFFERING MEMORANDUM
ARE DERIVED FROM INFORMATION BY VERONIS, SUHLER AND ASSOCIATES, AN INDUSTRY
RESEARCH ORGANIZATION AND STRATEGIC RECORD RESEARCH, A MARKET RESEARCH
ORGANIZATION. WHILE THE COMPANY BELIEVES THAT THE INFORMATION CONTAINED THEREIN
HAS BEEN OBTAINED FROM RELIABLE SOURCES, THERE CAN BE NO ASSURANCE THAT SUCH
INFORMATION IS ACCURATE AND COMPLETE. THIS PROSPECTUS CONTAINS FORWARD-LOOKING
INFORMATION THAT INVOLVES RISKS AND UNCERTAINTIES AND SUCH INFORMATION IS
SUBJECT TO THE ASSUMPTIONS SET FORTH IN CONNECTION THEREWITH AND THE INFORMATION
CONTAINED HEREIN. SEE "RISK FACTORS--FORWARD-LOOKING STATEMENTS."
THE COMPANY
The Company is the leading specialty retailer of prerecorded music in the
United States and is one of the largest national full-media retailers of music,
video sell-through, books, computer software and related products. The Company's
stores operate under two principal strategies: (i) mall based music and video
sell-through stores (the "Mall Stores"), operating under the principal trade
names Sam Goody and Suncoast Motion Picture Company ("Suncoast"), and (ii)
non-mall based full-media superstores (the "Superstores"), operating under the
trade names Media Play and On Cue. At December 31, 1997, the Company operated
1,363 stores in 49 states, the District of Columbia, the Commonwealth of Puerto
Rico, the Virgin Islands and the United Kingdom. For the year ended December 31,
1997, the Company had consolidated revenues of $1.8 billion, including $1.2
billion from the Mall Stores and $0.6 billion from the Superstores, and EBITDA
(as defined) of $85.4 million.
MALL STORES
SAM GOODY. Sam Goody is a well established music retailer that provides a
broad selection in an exciting, customer friendly shopping environment. Sam
Goody stores offer a full line of music, along with video and related products,
and typically carry from 4,500 to 8,500 compact disc titles, depending upon
store size and location, with the largest stores carrying up to 45,000 titles.
The music stores are predominantly found in mall locations and range in size
from 1,000 to 30,000 square feet, averaging 4,300 square feet. Many of the music
stores previously operated under the Musicland name have been converted to the
Sam Goody name. At December 31, 1997, the Company operated 713 Sam Goody music
stores with total square footage of approximately three million square feet or
37% of the Company's total store square footage.
SUNCOAST. Suncoast is the dominant mall based video sell-through retailer
in the United States offering a broad selection and excellent customer service
in an entertaining atmosphere. The typical Suncoast store is 2,400 square feet
in size and features 8,000 to 10,000 video titles along with movie and video
related apparel, digital video discs ("DVD"), special order video and other
related products. At December 31, 1997, the Company operated 409 Suncoast stores
with total square footage of approximately one million square feet or 12% of the
Company's total store square footage.
SUPERSTORES
MEDIA PLAY. Media Play is a full-media, superstore retailer of
entertainment software products providing a superior assortment at competitive
prices in a fun and exciting family oriented environment. Media Play stores
average 48,000 square feet and are in freestanding and strip mall locations
primarily in urban and suburban areas. The extensive merchandise assortment,
including up to 50,000 compact disc titles, 50,000 book titles, 15,000 video
titles and 2,000 computer software programs, complemented by
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other media and related products including magazines, video games, educational
toys, greeting cards and apparel, appeals to customers of all ages and
encourages browsing. The non-mall locations and largely self-service environment
lower operating costs and enable Media Play to offer products at competitive
prices. At December 31, 1997, the Company operated 68 Media Play stores with
total square footage of approximately three million square feet or 39% of the
Company's total store square footage.
ON CUE. On Cue is a full-media retailer in small towns, generally with
populations between 8,000 and 20,000 people, providing a wide assortment of
entertainment software products at competitive prices. On Cue stores offer
customers a convenient local store to shop for music, books, video, computer
software and related products with superior customer service to encourage repeat
business. On Cue stores average 6,200 square feet in size and carry
approximately 5,000 compact disc titles, 6,500 book titles and 2,000 video
titles. On Cue customers also have access to over 100,000 home entertainment
titles through the Company's special order program. At December 31, 1997, the
Company operated 157 On Cue stores with total square footage of approximately
one million square feet or 12% of the Company's total store square footage.
Beginning in 1995, the Company's financial results began to deteriorate as a
result of: (i) aggressive expansion of product offerings and new store openings
by most of the Company's non-mall competitors; (ii) severe price discounting of
music products by certain non-mall competitors; (iii) a lack of strong selling
hits in the music industry, which depressed sales throughout the industry; and
(iv) the Company's own rapid expansion of Media Play stores in response to
encouraging initial results. In 1996 management initiated restructuring programs
designed to improve the Company's cash flow and profitability. The major
components of the restructuring programs included: (i) closing 114
underperforming stores, which in the last full year of their operations lost an
aggregate of $17.7 million on an operating contribution basis; (ii) closing one
of the Company's two distribution centers, which reduced the Company's working
capital investment by approximately $20 million and contributed to a $6.9
million reduction in distribution costs in 1997; and (iii) improving inventory
management techniques, which increased the Company's inventory turnover from 1.8
times during 1996 to 2.1 times during 1997. Inventory levels at year-end 1997
were $55.8 million below those of the prior year with approximately $30 million
of the reduction due to store closings and the remainder attributable to
distribution efficiencies and improved inventory management. The Company reduced
Media Play advertising expense by $7.9 million in 1997 from the prior year as a
result of closing stores in entire markets and the introduction of a less
costly, but more targeted, program of newspaper advertising inserts. In
addition, in 1997 the Company began to benefit from positive trends in the music
retailing industry, including a retreat from severe price discounting and an
increase in unit sales. As a result, the Company's EBITDA increased from $35.1
million in 1996 to $85.4 million in 1997, and comparable store sales improved
from a decrease of 0.6% in 1996 to an increase of 4.5% in 1997.
The Company's principal executive offices are located at 10400 Yellow Circle
Drive, Minnetonka, Minnesota 55343, and its telephone number is (612) 931-8000.
COMPETITIVE STRENGTHS
The Company believes that it benefits from the following competitive
advantages:
LARGEST NATIONAL MUSIC RETAILER. The Company is the largest specialty
retailer of music in the United States, with music available in all 1,363
stores. The Company's leading market presence allows the Company to: (i) spread
its fixed operating costs over a large revenue base; (ii) realize distribution
savings through freight consolidation; (iii) take advantage of vendor discounts
and cooperative advertising programs; (iv) negotiate more effectively with
national landlords; (v) use national advertising media; and (vi) benefit from
market clustering. A national distribution of stores also minimizes the impact
on the Company of regional business trends. In recent years, as a result of
adverse industry conditions, a number of mall based music chains have closed
hundreds of stores. Although the Company has also closed
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underperforming stores, the Company was the single music retailer in 285 malls
at the end of 1997 compared to 274 malls at the end of 1996.
SOPHISTICATED INVENTORY MANAGEMENT AND DISTRIBUTION SYSTEMS. Management
believes that the Company's proprietary retail inventory management ("RIM") and
distribution systems are the most sophisticated in the industry, allowing the
Company to manage its inventory more effectively than its competitors. The RIM
system performs comprehensive merchandise control functions on both an
individual store and a company wide basis. It maintains an inventory profile for
every store, incorporates an "intelligent" new release allocation system and
adjusts and monitors store inventory on a daily basis. The RIM system allows the
Company to meet demand for fast selling titles and carry a broad range of
current hits and catalog titles while avoiding excess inventory and substantial
returns. In January 1997, the Company consolidated its distribution operations
into its state-of-the-art, centrally located facility in Franklin, Indiana, that
contains 715,000 square feet. This facility incorporates computerized processing
and laser technology for receiving, storing, sorting and shipping new product
and returns. This technology has enabled the Company to implement "just-in-time"
inventory management with certain vendors, which reduces working capital.
STRONG BRAND NAME RECOGNITION. The Company benefits from strong national
brand name recognition and continually markets to strengthen the brand images
for each of its retail concepts. A 1997 national survey by Strategic Record
Research determined that more music consumers preferred shopping at the
Company's stores than at other music stores. Strong brand name recognition
offers advantages in advertising, in-store events and marketing partnerships.
The Company is able to attract large corporate partners such as Pepsi-Cola,
Sears, VISA, MasterCard and L'Oreal for cross promotions, events and sweepstakes
that the Company believes are attractive to shoppers. The Company's monthly
REQUEST magazine, with an annual audited circulation of 6 million copies, is an
award winning, cutting edge music publication. REQUEST offers numerous cross
marketing opportunities with Sam Goody and the Company's other concepts and
reinforces the Company's brand names with consumers.
LONG-STANDING VENDOR RELATIONSHIPS. The Company believes its relationships
with major music and video vendors are among the best in the industry. Strong
vendor relations allow the Company to be creative in its marketing programs and
business operations. The Company's long-standing relationships with vendors are
further enhanced because: (i) the Company's large selection of products provides
vendors with a needed outlet for their catalog product, which is generally more
profitable than hit product; and (ii) the Company's RIM system allows the
Company to manage product returns at rates below the industry average, which is
an economic benefit to the vendors. Management believes that the continued
support of its vendors in 1996 and 1997 is a testament to the strength of its
vendor relationships.
BUSINESS STRATEGY
The Company's objective is to continue to increase revenue, cash flow and
profitability. Management believes that the Company's recent operating results
have begun to reflect the successful implementation of its business strategy.
The key elements of the Company's business strategy are as follows:
STRENGTHEN STORE BASE. After closing 236 underperforming stores over the
past three years, management believes that its current store base is well
positioned for future growth. Management intends to improve sales by enhancing
brand name awareness and increasing store traffic through creative advertising
and marketing programs. Management also intends to remodel certain stores in
order to enhance their appeal to customers. While management does not currently
intend to significantly expand its store base, the Company will open selected
new stores in order to fill out existing markets or capitalize on attractive
leasing opportunities. The Company will continue to assess the profitability of
its stores and will close a limited number of underperforming stores in the
coming years, if the closings can be accomplished economically.
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CAPITALIZE ON FAVORABLE INDUSTRY DYNAMICS. The Company expects sales of its
products to increase due to: (i) increased consumer spending; (ii) favorable
demographic trends; and (iii) the advent of new technologies. Through 2001,
consumer spending on pre-recorded music, video sell-through and trade books is
projected to grow at compounded annual growth rates of 5.6%, 11.2% and 5.8%,
respectively (according to Veronis, Suhler & Associates). Demographic shifts
over the next few years are expected to contribute to sales growth. The 15 to 24
age group, whose members are known to be mall-shoppers and strong music buyers,
is projected to be 4.1% larger in the year 2000 than its size in 1995. The
principal book buying population, between 35 and 54 years of age, is projected
to grow in the same period by 12.3%. Children's music, video, books and toys
should benefit by a growth of 6.4% in the 5 to 14 age group in the same period
(source: U.S. Bureau of Census 1996). Historically, the introduction of new
technology, such as compact discs, has had a positive impact on the Company's
business, and the most encouraging new technology today is DVD. Veronis, Suhler
& Associates projects that by 2001 annual consumer spending on DVDs will be
approximately $1.2 billion. Most of the Company's stores carry DVD, and Suncoast
in particular is pursuing the early adopters of this new format.
INCREASE GROSS MARGIN. The Company believes the following initiatives will
benefit gross margin: (i) selective price decisions in response to the
competitive environment in various markets; (ii) adjustments to merchandise
assortment to include more higher margin products; and (iii) cross promotions on
product lines to increase sales of high margin ancillary products, such as
apparel.
REDUCE WORKING CAPITAL. The Company plans to continue reducing working
capital by: (i) expanding the "just in time" inventory program, which completely
eliminates backup inventory, to include more products and selective additional
vendors; (ii) implementing more precise buying rules to reduce returns; and
(iii) eliminating less profitable product lines.
IMPROVE MEDIA PLAY PROFITABILITY. The Company will concentrate on improving
profitability in all concepts, but particularly in Media Play. The Company's
efforts to increase sales, improve gross margin, increase customer traffic and
reduce operating costs in its Media Play stores include the following
initiatives: (i) introducing new merchandise assortments; (ii) altering
departmental and store layouts; and (iii) reducing operating costs through
improved store management, expense control and inventory management. Of the
Company's four concepts, Media Play showed the most significant profitability
improvement in 1997.
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THE EXCHANGE OFFER
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Registration Rights Agreement..... The Old Notes were sold by the Company on April 6, 1998
(the "Issue Date") in the Private Placement to
Donaldson, Lufkin & Jenrette, Securities Corporation, BT
Alex. Brown, and NationsBanc Montgomery Securities LLC
(the "Initial Purchasers"), who placed such Old Notes
with institutional investors. In connection therewith,
the Company executed and delivered for the benefit of
the holders of the Old Notes the Registration Rights
Agreement obligating the Company to file with the
Commission within 60 days after the date of issuance of
the Old Notes, a registration statement under the
Securities Act relating to an exchange offer for the Old
Notes (the "Exchange Offer") and to use its best efforts
to cause such registration statement to become effective
within 150 days after the Issue Date.
The Exchange Offer................ The New Notes are being offered in exchange for an equal
principal amount at maturity of Old Notes. As of the
date hereof, there was outstanding $150,000,000
principal amount of Old Notes. Because the New Notes
will be recorded in the Company's accounting records at
the same carrying value as the Old Notes, no gain or
loss will be recognized by the Company upon the
consummation of the Exchange Offer. See "The Exchange
Offer--Accounting Treatment." Holders of the Old Notes
do not have appraisal or dissenter's rights in
connection with the Exchange Offer under the Delaware
General Corporation Law (the "DGCL"), which is the law
of the state of incorporation of the Issuer and the
Guarantor.
Based on interpretations by the staff of the Commission,
as set forth in no-action letters issued to third
parties, the Company believes that the New Notes issued
pursuant to the Exchange Offer may be offered for
resale, resold or otherwise transferred by holders
thereof (other than any holder who is an "affiliate" of
the Company within the meaning of Rule 405 under the
Securities Act) without compliance with the registration
and prospectus delivery provisions of the Securities
Act; provided, however, that such New Notes are acquired
in the ordinary course of the holder's business and such
holder is not engaged in, and does not intend to engage
in, a distribution of such New Notes and has no
arrangement with any person to participate in a
distribution of such New Notes. The staff of the
Commission has not considered the Exchange Offer in the
context of a no action letter and there can be no
assurance that the staff of the Commission would make a
similar determination with respect to the Exchange
Offer. Each broker-dealer that receives New Notes for
its own account in exchange for Old Notes, where such
Old Notes were acquired by such broker-dealer as a
result of market-making activities or other trading
activities, must acknowledge that it will deliver a
prospectus in connection with any resale of such New
Notes. See "Plan of Distribution." To
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comply with the securities laws of certain
jurisdictions, it may be necessary to qualify for sale
or register the New Notes prior to offering or selling
such New Notes. The Company has agreed, pursuant to the
Registration Agreement and subject to certain specified
limitations therein, to register or qualify the New
Notes for offer or sale under the securities or "blue
sky" laws of such jurisdictions as may be necessary to
permit the holders of New Notes to trade such New Notes
without any restrictions or limitations under the
securities laws of the several states of the United
States. If a holder of Old Notes does not exchange such
Old Notes for New Notes pursuant to the Exchange Offer,
such Old Notes will continue to be subject to the
restrictions on transfer contained in the legend
thereon. In general, the Old Notes may not be offered or
sold, unless registered under the Securities Act, except
pursuant to an exemption from, or in a transaction not
subject to, the Securities Act and applicable state
securities laws. See "Risk Factors--Consequences of
Failure to Exchange."
Expiration Date................... 5:00 p.m. New York City time, on June 5, 1998, unless
the Exchange Offer is extended, in which case the term
"Expiration Date" means the latest date and time to
which the Exchange Offer is extended.
Conditions to the Exchange
Offer........................... The Exchange Offer is subject to certain customary
conditions, which may be waived by the Company. See "The
Exchange Offer--Conditions." Except for the requirements
of applicable Federal and state securities laws, there
are no Federal or state regulatory requirements to be
complied with or obtained by the Company in connection
with the Exchange Offer. NO VOTE OF THE SECURITY HOLDERS
OF MSC OR MGI IS REQUIRED TO EFFECT THE EXCHANGE OFFER
AND NO SUCH VOTE (OR PROXY THEREFOR) IS BEING REQUESTED
BY MEANS OF THIS PROSPECTUS OR OTHERWISE.
Procedures for Tendering Old
Notes........................... Each holder of Old Notes who wishes to accept the
Exchange Offer must complete, sign and date the Letter
of Transmittal (the "Letter of Transmittal"), or a
facsimile thereof, in accordance with the instructions
contained herein and therein, and mail or otherwise
deliver such Letter of Transmittal, or such facsimile
together with the Old Notes to be exchanged and any
other required documentation to the Exchange Agent (as
defined) at the address set forth herein and therein.
See "The Exchange Offer--Procedures for Tendering."
Withdrawal Rights................. Tenders of Old Notes may be withdrawn at any time prior
to 5:00 p.m., New York City time, on the Expiration
Date. To withdraw a tender of Old Notes, a written or
facsimile transmission notice of withdrawal must be
received by the Exchange Agent (as defined) at its
address set forth below under "Exchange Agent" prior to
5:00 p.m., New York City time, on the Expiration Date.
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Acceptance of Old Notes and
Delivery of New Notes........... Subject to certain conditions, the Company will accept
for exchange any and all Old Notes which are properly
tendered in the Exchange Offer prior to 5:00 p.m., on
the Expiration Date. The New Notes issued pursuant to
the Exchange Offer will be delivered promptly following
the Expiration Date. See "The Exchange Offer--Terms of
the Exchange Offer."
Exchange Agent.................... Bank One, N.A., the Trustee under the Indenture, is also
serving as exchange agent (the "Exchange Agent") in
connection with the Exchange Offer. The Exchange Agent
can be contacted by telephone at: (800) 346-5153; by
facsimile at: (614) 248-5088, or by mail at: Bank One,
N.A., 235 West Schrock Road, Westerville, OH 43081,
Attn: Corporate Trust Operations.
Use of Proceeds................... There will be no proceeds to the Company from the
Exchange Offer. The net proceeds to the Company from the
Private Placement were approximately $144 million (after
deduction of discounts and estimated offering expenses).
The Company has applied such proceeds to the repayment
of existing indebtedness.
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SUMMARY OF TERMS OF NEW NOTES
The Exchange Offer relates to the exchange of Old Notes for an equal
principal amount at maturity of New Notes. The New Notes will be obligations of
the Company evidencing the same indebtedness as the Old Notes and will be
entitled to the benefits of the same Indenture (as defined), which governs both
the Old Notes and the New Notes. In addition, the New Notes will be subject to
the benefits of the Guarantee. The form and terms of the New Notes are
substantially identical to the form and terms of the Old Notes except that the
offer of the New Notes will have been registered under the Securities Act and,
therefore, the New Notes will not bear legends restricting the transfer thereof.
Generally, the New Notes will be freely transferable under the Securities Act by
holders who are not affiliates of the Company. The New Notes otherwise will be
substantially identical in all material respects to the old Notes, as summarized
below.
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<S> <C>
Securities Offered................ $150.0 million in aggregate principal amount of 9 7/8%
Series B Senior Subordinated Notes due 2008.
Maturity Date..................... March 15, 2008.
Interest Rate..................... The Notes will bear interest at the rate of 9 7/8% per
annum, payable semi-annually on March 15 and September
15 of each year, commencing September 15, 1998.
Subordination..................... The Notes will be general unsecured obligations of MGI,
will rank subordinate in right of payment to all Senior
Debt and will rank senior or PARI PASSU in right of
payment to all existing and future subordinated
indebtedness of MGI. The Notes will be unconditionally
guaranteed on a senior subordinated basis by MSC. The
Guarantee will be a general unsecured obligation of MSC,
will rank subordinate in right of payment to all Senior
Debt of the Guarantor and will rank senior or PARI PASSU
in right of payment to all existing and future
subordinated indebtedness of MSC. As of March 1, 1998,
on a pro forma basis, after giving
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
effect to the issuance of the Notes and the application
of the net proceeds therefrom, the Notes would have been
subordinated to $83.0 million of Senior Debt of MGI. In
addition, on such date and pro forma basis, MGI could
have borrowed up to an additional $99.0 million under
the Revolver Agreement (as defined below) which would
also have constituted Senior Debt. See "Risk
Factors--Subordination" and "Description of Existing
Financing Arrangements."
Optional Redemption............... The Notes will be redeemable at the option of MGI, in
whole or in part, at any time on or after March 15, 2003
in cash, at the redemption prices set forth herein, plus
accrued and unpaid interest and Liquidated Damages, if
any, thereon to the date of redemption. In addition, at
any time prior to March 15, 2001, MGI may redeem up to
40% of the initially outstanding aggregate principal
amount of Notes at a redemption price equal to 109.875%
of the principal amount thereof, plus accrued and unpaid
interest and Liquidated Damages, if any, thereon to the
redemption date, with the net proceeds of a Public
Equity Offering; PROVIDED that, in each case, at least
60% of the initially outstanding aggregate principal
amount of Notes remains outstanding immediately after
the occurrence of any such redemption. See "Description
of Notes--Optional Redemption."
Change of Control................. Upon the occurrence of a Change of Control, each holder
of Notes will have the right to require MGI to
repurchase all or any part of such holder's Notes at an
offer price in cash equal to 101% of the aggregate
principal amount thereof, plus accrued and unpaid
interest thereon to the date of repurchase. See
"Description of Notes--Repurchase at the Option of
Holders-- Change of Control." There can be no assurance
that, in the event of a Change of Control, MGI would
have sufficient funds to repurchase all New Notes
tendered. See "Risk Factors-- Possible Inability to
Repurchase Notes Upon a Change of Control."
Guarantee......................... The New Notes will be unconditionally guaranteed on a
senior subordinated basis by MSC, the Guarantor.
Certain Covenants................. The Indenture contains certain covenants that limit,
among other things, the ability of MGI to: (i) pay
dividends, redeem capital stock or make certain other
restricted payments or investments; (ii) incur
additional indebtedness or issue preferred equity
interests; (iii) merge, consolidate or sell all or
substantially all of its assets; (iv) create liens on
assets; and (v) enter into certain transactions with
affiliates or related persons. See "Description of
Notes--Certain Covenants."
Use of Proceeds................... The Company will not receive any proceeds from the
issuance of the New Notes. See "Use of Proceeds."
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
Book-Entry; Delivery.............. The New Notes will not be certificated but will be
book-entry securities, and transfers will be effected
through the facilities of The Depository Trust Company
("DTC"). See "Description of Notes--Book-Entry; Delivery
and Form."
</TABLE>
EFFECT UPON OLD NOTES
The holders of Old Notes currently are entitled to certain registration
rights pursuant to the Registration Rights Agreement among the Issuer, the
Guarantor, and the Initial Purchasers. However, upon consummation of the
Exchange Offer, subject to certain exceptions, holders of Old Notes who do not
exchange their Old Notes for New Notes in the Exchange Offer will no longer be
entitled to registration rights and will not be able to offer or sell their Old
Notes, unless such Old Notes are subsequently registered under the Securities
Act (which, subject to certain limited exceptions, the Company will have no
obligation to do), except pursuant to an exemption from, or in a transaction not
subject to, the Securities Act and applicable state securities laws. See "Risk
Factors--Consequences of Failure to Exchange" and "The Exchange
Offer--Continuing Registration Rights." Old Notes which are not exchanged and
which remain outstanding will continue to be obligations of the Company and will
be entitled to the benefits of the Indenture and the Guarantee.
RISK FACTORS
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE
INVESTORS IN CONNECTION WITH AN INVESTMENT IN THE NOTES, SEE "RISK FACTORS."
9
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth summary consolidated financial data and
operating data for the years and dates indicated. The data presented below under
the captions "Pro Forma Data," "Operating Data" and "Store Data" for all years
presented, are unaudited. The unaudited summary pro forma financial and
operating data of the Company for the year ended December 31, 1997 do not
necessarily reflect the results of operations or financial position of the
Company that would have actually resulted had the events referred to in the
notes to the unaudited pro forma financial information been consummated as of
the dates indicated and are not intended to project the Company's financial
position or results of operations for any future period. This information should
be read in conjunction with the Consolidated Financial Statements and related
notes appearing elsewhere herein and "Management's Discussion and Analysis of
Results of Operations and Financial Condition."
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------
1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales......................... $1,181,658 $1,478,842 $1,722,572 $1,821,594 $1,768,312
Gross profit.................. 470,951 542,199 606,070 611,759 614,829
Selling, general and
administrative expenses..... 365,311 450,919 525,213 576,658 529,427
Depreciation and
amortization................ 29,057 37,243 45,531 44,819 39,411
Goodwill write-down(1)........ -- -- 138,000 95,253 --
Restructuring charges(2)...... -- -- -- 75,000 --
Operating income (loss)....... 76,583 54,037 (102,674) (179,971) 45,991
Interest expense.............. 19,831 19,555 27,881 32,967 31,720
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1997
(DOLLARS IN THOUSANDS)
-----------------------
<S> <C>
PRO FORMA DATA(3):
EBITDA(4)(5)....................... $86,520
Cash interest expense(6)........... 35,134
Ratio of net debt to EBITDA........ 2.2x
Ratio of EBITDA to cash interest
expense.......................... 2.5x
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
1993 1994 1995 1996 1997
--------- -------- ---------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
EBITDA(4)..................... $ 105,640 $ 91,280 $ 80,857 $ 35,101 $ 85,402
EBITDA margin................. 8.9% 6.2% 4.7% 1.9% 4.8%
Comparable store sales
increase (decrease)(7):
Mall Stores................. 4.5% 3.1% (4.9)% (1.7)% 4.7%
Superstores................. 27.6 33.3 4.8 2.0 4.1
Total(8).................. 4.6 4.6 (3.2) (0.6) 4.5
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
STORE DATA:
Total store square footage (in
millions)............................. 4.9 7.2 9.9 9.5 8.3
Store count:
Music stores.......................... 875 869 820 777 713
Suncoast stores....................... 320 378 412 422 409
Media Play stores..................... 13 46 89 87 68
On Cue stores......................... 32 77 153 158 157
United Kingdom and other stores....... 11 16 22 22 16
----- ----- ----- ----- -----
Total............................... 1,251 1,386 1,496 1,466 1,363
----- ----- ----- ----- -----
----- ----- ----- ----- -----
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
ACTUAL AS ADJUSTED(9)
-------- ---------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents(10)..................... $ 3,942 $115,326
Total assets(10).................................. 733,895 849,625
Long-term debt, including current maturities...... 193,087 308,817
Stockholders' equity.............................. 18,770 18,770
</TABLE>
- - ------------------------------
(1) The goodwill write-downs were taken following evaluations of goodwill for
impairment because of sales declines experienced by the music stores during
1995 and 1996. See Note 2 of Notes to Consolidated Financial Statements.
(2) The restructuring charges were recorded during 1996 for the estimated cost
of closing the Company's distribution facility in Minneapolis, Minnesota
and 114 underperforming stores. See Note 3 of Notes to Consolidated
Statements.
(3) Gives pro forma effect to the sale of the Notes offered hereby and the
anticipated application of the net proceeds therefrom as described under
the caption "Use of Proceeds" as of the first date of the stated period.
(4) EBITDA represents earnings (loss) before extraordinary charge plus interest
expense, income taxes, depreciation and amortization, goodwill write-down
and restructuring charges. While EBITDA should not be construed as a
substitute for income from operations, net earnings or cash flows from
operating activities (as defined by generally accepted accounting
principles) in analyzing the Company's operating performance, financial
position or cash flows, the Company has included EBITDA because it is
commonly used by certain investors and analysts to analyze and compare
companies on the basis of operating performance, leverage and liquidity and
to determine a company's ability to service debt. In addition, the method
of calculating EBITDA set forth above may be different from calculations of
EBITDA employed by other companies and, accordingly, may not be directly
comparable to such other calculations.
(5) Pro forma EBITDA represents EBITDA plus $1.1 million of rent expense
related to the financing agreements for the Company's distribution facility
prior to the recording of the mortgage notes payable on the Company's
Consolidated Balance Sheet in June 1997. See Note 15 of Notes to
Consolidated Financial Statements.
(6) For the purposes of Pro Forma Data, cash interest expense represents total
interest expense minus (i) amortization of debt issuance costs and (ii)
original issue discount on the Notes and plus deferred financing credits.
(7) Comparable store sales percentages are computed for stores open for a full
year during each year.
(8) The totals include United Kingdom and other stores.
(9) As Adjusted information gives pro forma effect to the sale of the Notes
offered hereby and the anticipated application of the net proceeds
therefrom as described under the caption "Use of Proceeds" as if they had
occurred on December 31, 1997. See "Capitalization."
(10) At December 31, 1997, outstanding checks in excess of cash balances of
$12.1 million were included in accounts payable. Cash and cash equivalents
and total assets, as adjusted to give effect to the Offering and the
application of the net proceeds therefrom, do not reflect the reduction of
$12.1 million for the outstanding checks in excess of cash balances that
would not have been included in accounts payable had the actual net amount
of cash and cash equivalents at December 31, 1997 exceeded this amount.
11
<PAGE>
RISK FACTORS
IN ADDITION TO THE OTHER INFORMATION SET FORTH ELSEWHERE IN THIS PROSPECTUS,
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS PRIOR
TO PURCHASING THE NOTES OFFERED HEREBY. THE COMPANY'S ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS
CONTAINED IN THIS PROSPECTUS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET
FORTH IN THE FOLLOWING RISK FACTORS AND ELSEWHERE IN THIS PROSPECTUS.
CONSEQUENCES OF FAILURE TO EXCHANGE
Holders of Old Notes who do not exchange their Old Notes for New Notes
pursuant to the Exchange Offer will continue to be subject to the restrictions
on transfer of such Old Notes as set forth in the legend thereon as a
consequence of the issuance of the Old Notes pursuant to exemptions from, or in
transactions not subject to, the registration requirements of the Securities Act
and applicable state securities laws. In general, the Old Notes may not be
offered or sold unless registered under the Securities Act, except pursuant to
an exemption from, or in a transaction not subject to, the Securities Act and
applicable state securities laws. The Company does not currently anticipate that
it will register the Old Notes under the Securities Act. Based on
interpretations by the staff of the Commission, as set forth in no-action
letters to third parties, the Company believes that the New Notes issued
pursuant to the Exchange Offer in exchange for Old Notes may be offered for
resale, resold or otherwise transferred by the holders thereof (other than any
such holder that is an "affiliate" of the Company within the meaning of Rule 405
under the Securities Act) without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that such New
Notes are acquired in the ordinary course of such holders' business and such
holders are not engaged in, and do not intend to engage in, a distribution of
such New Notes and have no arrangement or understanding with any person to
participate in the distribution of such New Notes. The staff of the Commission
has not considered the Exchange Offer in the context of a no-action letter and
there can be no assurance that the staff of the Commission would make a similar
determination with respect to the Exchange Offer. Each broker-dealer that
receives New Notes for its own account pursuant to the Exchange Offer must
acknowledge that it will deliver a prospectus in connection with any resale of
such New Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus a broker-dealer will not be deemed to admit that it is
an "underwriter" within the meaning or the Securities Act. This Prospectus, as
it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with resales of New Notes received in exchange for
Old Notes where such Old Notes were acquired by such broker-dealer as a result
of market-making activities or other trading activities. The Company has agreed
that, for a period of one year after the Expiration Date, it will make this
Prospectus available to any broker-dealer for use in connection with any such
resale. See "Plan of Distribution." However, to comply with the securities laws
of certain jurisdictions, if applicable, the New Notes may not be offered or
sold unless they have been registered or qualified for sale in such
jurisdictions or an exemption for registration or qualification is available and
is complied with. To the extent that Old Notes are tendered and accepted in the
Exchange Offer, the trading market for the untendered and the tendered but
unaccepted Old Notes could be adversely affected.
RISK ASSOCIATED WITH SUBSTANTIAL INDEBTEDNESS AND LIQUIDITY
The Company is highly leveraged. On a pro forma basis after giving effect to
the issuance of the Notes, the Company's long-term debt, including current
maturities, at December 31, 1997 was $308.8 million. In addition, on a pro forma
basis after giving effect to the issuance of the Notes, the Company's
consolidated ratio of long-term debt (including current maturities) to
stockholders' equity would have been 16.5:1 at December 31, 1997. At December
31, 1997, there were no borrowings outstanding under the Revolver Agreement, and
at March 1, 1998, the Company had borrowings of $146.0 million under the
Revolver Agreement. The highest balance outstanding under the Revolver Agreement
during the year ended December 31, 1997 was $273.0 million, and the average
daily balance was $238.5 million. However, in 1997 the Company maintained an
average month-end cash balance of $45.8 million and did not borrow the $50
million under the Term Loan until September 15, 1997. The net proceeds from the
sale of the
12
<PAGE>
Notes will be used to pay amounts outstanding under the Credit Facility and the
Mortgage Notes Payable. See "Use of Proceeds." The Company's indebtedness and
related financial covenants could significantly limit its ability to withstand
competitive pressures or adverse economic conditions, make acquisitions, obtain
future financing, or take advantage of business opportunities that may arise.
The indebtedness under the Revolver Agreement and the Term Loan Agreement bears
interest at floating rates, causing the Company to be sensitive to changes in
prevailing interest rates.
The Revolver Agreement will expire, and all amounts must be repaid
thereunder, on October 7, 1999. The Term Loan Agreement must be repaid in
installments of $25.0 million on each of December 14, 1998 and February 15,
1999. There is no assurance that the Company will be able to enter into new
credit arrangements or, if able to do so, that such arrangements will be on
favorable terms.
Beginning in 1995, the Company's financial results began to deteriorate as a
result of: (i) aggressive expansion of product offerings and new store openings
by most of the Company's non-mall competitors; (ii) severe price discounting;
(iii) a lack of strong selling hits in the music industry, which depressed sales
throughout the industry; and (iv) the Company's own rapid expansion of Media
Play stores in response to encouraging initial results. In 1996 the Company
initiated restructuring programs designed to improve the Company's cash flow and
profitability. The major components of the restructuring programs included: (i)
closing 114 underperforming stores; (ii) closing one of the Company's two
distribution centers; and (iii) improving inventory management techniques, which
increased the Company's inventory turnover. Because of the deterioration of the
Company's financial results and the incurrence of restructuring charges, the
Company would not have been in compliance with the financial covenants in the
Revolver Agreement without certain amendments and waivers to the Revolver
Agreement which were received throughout 1996 and in the first quarter of 1997.
In June 1997, the Company completed agreements with the Banks to amend the
Revolver Agreement and to provide additional financing under the Term Loan
Agreement. Also during the first quarter of 1997, the Company's largest vendors
and a substantial majority of its remaining vendors agreed to temporarily defer
existing trade payables and provide continued product supply, subject to payment
terms reduced to ten days or less on new purchases. During the third quarter of
1997, the Company completed individual agreements or understandings with most of
these vendors, including the ten largest, for the repayment of the deferred
trade payables balance and return to normal credit terms. The Company completed
repayment of deferred trade payables during the fourth quarter of 1997.
In addition to its obligations under the Notes, the Company is obligated to
make substantial principal and interest payments on indebtedness under the
Revolver Agreement and Term Loan Agreement and under the 9% Senior Subordinated
Notes due 2003 (the "2003 Notes"). See "Description of Existing Financing
Arrangements." The ability of the Company to make payments of principal and
interest on its indebtedness will be largely dependent upon its future
performance, which will be subject to factors affecting its business and
operations, many of which are beyond its control. There will be no sinking fund
established in connection with the Notes. There can be no assurance that the
Company will be able to generate sufficient cash flow, or that future borrowings
will be available in an amount sufficient to cover all required interest and
principal payments. See "Management's Discussion and Analysis of Results of
Operations and Financial Condition--Liquidity and Capital Resources."
SUBORDINATION
The right of holders to receive payment of principal and interest on the
Notes will be subordinate to the prior payment in full of all Senior Debt, which
consists of, among other things, amounts owing under the Revolver Agreement, the
Term Loan Agreement and any other debt of the Company not by its terms
subordinate to, or PARI PASSU with, the Notes. At December 31, 1997, on a pro
forma basis after giving effect to the Offering, the amount of Senior Debt was
$50.0 million, and at March 1, 1998, it was $83.0 million. At March 1, 1998, on
a pro forma basis after giving effect to the Offering and the application of the
net proceeds therefrom, the Company could have borrowed up to an additional
$99.0 million under the Revolver Agreement. No payment of principal or interest
on the Notes may be made during the
13
<PAGE>
continuance of a payment default under any Senior Debt. Further, the holders of
certain Senior Debt will be able to block payments on the Notes for up to 179
days during any 360-day period upon the occurrence of certain nonpayment events
of default under such Senior Debt. In addition, in the event of dissolution,
liquidation or the winding-up of the business of the Company, or upon
acceleration of the Notes prior to their stated maturity, all obligations with
respect to Senior Debt must first be paid in full before any payment may be made
with respect to the Notes, and the holders of the 2003 Notes would be entitled
to share ratably with the holders of the Notes. As a result, sufficient assets
may not exist to pay amounts due under the Notes. Subject to certain
restrictions contained in the Revolver Agreement and the Indentures related to
the 2003 Notes and the Notes, the Company is permitted to incur additional
Senior Debt. See "Description of Notes" and "Description of Existing Financing
Arrangements."
The principal asset of MSC is all of the outstanding stock of MGI and
substantially all MSC's operations are conducted through MGI. MSC is, and will
be, guaranteeing MGI's obligations under the Revolver Agreement, the Term Loan
Agreement, the 2003 Notes and the Notes. MSC's guarantee of the Notes is
subordinated in right of payment to MSC's guarantee of the Issuer's obligations
under the Revolver Agreement and Term Loan Agreement. MSC is restricted under
the terms of the Revolver Agreement from engaging in activities other than
ownership of MGI's stock and providing management and services to MGI.
MGI's indebtedness under the Revolver Agreement and the Term Loan Agreement
is secured by a pledge of the stock of MGI's consolidated wholly-owned
subsidiaries. Additionally, the Term Loan Agreement is secured by a
first-priority lien on all inventory of MGI and its consolidated wholly-owned
subsidiaries. In the event of defaults under the Revolver Agreement and Term
Loan Agreement, such lenders will have secured claims against such assets.
RECENT NET LOSSES
During the years ended December 31, 1995 and 1996, the Company incurred net
losses of $135.8 million and $193.7 million, respectively. These losses were the
result of many factors, primarily the write-down of goodwill and also included
restructuring charges, changes in the competitive environment, lack of hit music
product and the Company's rapid expansion of its Media Play concept. As a result
of these losses and the Company's liquidity problems, the Company's independent
auditors included a going concern qualification in their report for fiscal 1996.
During the years ended December 31, 1996 and December 31, 1997, the Company
implemented the restructuring programs described above under "--Risk Associated
with Substantial Indebtedness and Liquidity." In fiscal 1997, the Company had
net earnings of $14.0 million. This improvement was aided by the recent positive
trends in the music retailing industry, including a retreat from severe price
discounting and an increase in unit sales. There can be no assurance that the
restructuring programs will continue to result in positive financial results,
that the positive trend in the music industry will continue, that the negative
trend in the video industry will not worsen, or that the current competitive
environment will be sustained.
RISK OF COMPETITION
The Company operates in highly competitive markets, which are generally
local or individual in nature. The Company competes on the basis of service,
selection and price, with a broad range of specialty, discount and other
retailers, and certain national chains, some of whom have greater financial and
marketing resources than the Company. The number of stores and types of
competitors have increased significantly over recent years, including non-mall
discount stores, consumer electronic superstores, and mall based music, video
and book specialty retailers expanding into non-mall multimedia stores. The low
prices offered by these non-mall stores have created intense price competition
and adversely impacted the performance of both the Company's Superstores and
Mall Stores. Although deep discount pricing by many retailers of entertainment
products abated somewhat in 1997, there can be no assurance that if such
practice returns the Company will continue to achieve satisfactory gross margins
while remaining competitive.
14
<PAGE>
In addition, the Company competes for consumer time and spending with all
leisure time activities, such as movie theaters, television, home computing and
internet use, live theater, sporting facilities and spectator events, travel,
amusement parks, and other family entertainment centers. The Company's ability
to compete successfully depends on its ability to secure and maintain attractive
and convenient locations, market and manage merchandise attractively and
efficiently, offer an extensive product selection and knowledgeable customer
service and provide effective management. See "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Results of
Operations--Gross Profit" and "Business--Competition."
RISK OF RESTRICTIONS IMPOSED BY LENDERS
The Company's Revolver Agreement and, to a lesser extent, the Term Loan
Agreement and the indenture covering the 2003 Notes (the "2003 Indenture")
contain certain financial covenants which, among other things, limit the ability
of the Company to incur indebtedness, make investments, create or permit liens,
make capital expenditures, make guarantees and pay dividends. Additionally, the
Company is required to meet certain financial covenants under the Revolver
Agreement and Term Loan Agreement. Because of the highly competitive environment
and the decline in the Company's financial results, the Company experienced
difficulty meeting the financial covenants throughout 1996. As a result, the
Company obtained a series of amendments and waivers beginning in April 1996 and
ending with the amendment completed in June 1997. There can be no assurance
that, despite its recent improved results, the Company may not experience such
difficulty in the future and/or may require additional financing. If the Company
were unable to comply with the covenants under the Credit Facility or under the
2003 Notes, such indebtedness could be declared immediately due and payable. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Description of Existing
Financing Arrangements."
RISK OF AVAILABILITY OF HIT PRODUCTS
Entertainment product sales are dependent to some extent upon the
availability of hit products, which can create cyclical trends that do not
necessarily follow trends in the general economy. It is not possible to
determine the timing of these cycles or the future availability of hit products.
The availability of hit product is important for generating customer traffic in
the Company's stores. During recent years, industry growth and sales of music
and video products slowed due to the lack of strong new releases. Although the
situation in the music industry improved in fiscal 1997, the Company has no
control over the availability and strength of hit products and is dependent upon
the major music and movie producers continuing to produce a minimal number of
current hits. To the extent that current hits are not available, or not
available at prices attractive to consumers, the Company's business may be
adversely affected.
RISK FROM NEW TECHNOLOGIES
The Company believes that the introduction of new home entertainment
products, such as DVD, can help increase sales. This benefit, however, is
dependent upon acceptance by consumers of the new technology and availability of
product for consumer purchase. The switch of consumers from one format to
another, such as the shift from records to audio cassettes, and the later shift
from cassettes to compact discs, may also reduce sales of the existing format.
The Company intends to monitor carefully such technology shifts and to adjust as
necessary to respond to customer demand. Sales may be adversely affected and
product returns may be increased if the Company does not carry the right balance
of old and new formats. There can be no assurance that the Company will be
successful in interpreting the desires of consumers or predicting which of any
new technologies or formats will be accepted by consumers. Although the Company
believes DVD products may contribute to sales growth, there can be no assurance
that DVD will gain significant consumer acceptance generally or among the
Company's customers. Even if DVD is successful, any significant impact on sales
may not be seen for several years.
15
<PAGE>
In addition to the emergence of new technologies affecting product
offerings, emerging technologies are facilitating the offering by the internet,
cable companies, direct broadcast satellite companies, telephone companies and
other telecommunications companies of a wide selection of music and video
services to consumers. The Company expects this trend to continue. There is no
assurance that these new technologies will not have an adverse impact on sales.
UNCERTAINTY OF LEASE RENEWALS
All but three of the Company's stores are under operating leases with terms
ranging from 3 to 25 years. A total of 168 leases without renewal options will
expire in fiscal 1998 and 1999. Although the Company has historically been
successful in renewing most of its store leases when they have expired, there
can be no assurance that the Company will continue to be able to do so on
favorable terms or at all, particularly in light of the recent restructuring
programs. If the Company is unable to renew leases for its stores as they
expire, or find acceptable locations on favorable terms, there can be no
assurance that such failures will not have a material adverse effect on the
Company's financial condition or results of operations. See
"Business--Properties."
RELATIONSHIPS WITH VENDORS
The Company obtains approximately 68% of its product from the ten largest
vendors. Continued delivery of product to the Company by its vendors is critical
to the Company's operating results. During 1996, the Company experienced some
problems with delivery of product by vendors who were concerned about the
Company's financial viability. 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 ten days or less on new purchases. During
the third quarter of 1997, the Company completed individual agreements or
understandings with most of its vendors, including the ten largest, for the
repayment of trade payables balances and the return to normal credit terms. The
Company completed repayment of the deferred trade payables during the fourth
quarter of 1997. There can be no assurance that the Company may not experience
similar financial difficulties in the future or that the vendors would in such
case provide the Company with deferred or other favorable payment terms to allow
the Company to receive product.
SEASONALITY RISK
The Company's business is highly seasonal. During the years ended December
31, 1997 and 1996, nearly 40% of the Company's annual revenues and all of its
net income, if any, were generated during the fourth quarter. Quarterly results
are affected by the timing and strength of new releases, the timing of holidays,
new store openings and sales performance of existing stores. There can be no
assurance that economic conditions will not adversely affect the Company's sales
and earnings, particularly during the fourth quarter of the year. See
"Management's Discussion and Analysis of Results of Operations and Financial
Condition--Seasonality."
RISKS ASSOCIATED WITH FUTURE GROWTH
SALES AND EARNINGS GROWTH
The Company's sales and earnings growth is primarily dependent upon
increasing revenues in existing stores, which will be affected by various
industry and competitive factors discussed herein. In addition, the Company's
profitability is dependent on the economic environment in general and the level
of consumer spending. Many mall based specialty retailers have experienced weak
comparable store sales in recent periods. The Company experienced negative
comparable store sales in fiscal 1996. Comparable store sales of music product
were slightly up in fiscal 1996 and strongly up in fiscal 1997. However,
comparable store sales of video product were slightly negative in fiscal 1996
and increased only negligibly in fiscal 1997. There can be no assurance that
comparable sales of video product will improve or that they will not deteriorate
further. During fiscal 1995 and 1996, the Company's operating results were
affected by the high fixed cost of poorly performing stores, both mall stores
and non-mall stores. These results have been
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attributed in part to the growth of non-mall superstores and power shopping
centers that have attracted the mall customer base. In an effort to improve
results, the Company closed 114 stores, including 30 Media Play stores, and, in
fiscal 1996, reported restructuring charges totaling $75 million to reflect the
cost of these closings and other steps taken. During 1997, the Company initiated
certain changes in the size, design, and merchandise offerings of Media Play in
an attempt to improve the operating results of this concept. In 1997, after
implementing the restructuring programs, the Media Play concept became
profitable, on an operating contribution basis, for the first time. The
improvement efforts are continuing during 1998. There can be no assurance that
these efforts will be successful. Although the Company's operating results
improved in fiscal 1997, there can be no assurance that such results will
continue. There can also be no assurance that a deterioration in economic
conditions would not adversely affect the Company's business.
GROWTH THROUGH NEW STORES OPENINGS; AVAILABILITY OF CAPITAL FOR STORE
EXPANSION
The Company may also increase revenues by opening or acquiring stores. The
opening of new stores is contingent upon the availability of desirable locations
and the negotiation of suitable lease terms, and the acquisition of stores is
dependent upon the availability of desirable stores at acceptable prices. Any
expansion will depend on business conditions, the availability of desirable
sites obtainable on an acceptable economic basis, the ability to attract and
retain qualified managers and sales associates and the availability of
sufficient capital. There can be no assurance that the Company will be able to
open any new stores, or open them on a timely basis, or that they can be
operated profitably. To the extent the Company's rate of expansion is slower
than historical levels, the Company's sales growth may be adversely affected. In
addition, the success of new stores is dependent upon acceptance by customers.
During 1997, the Company initiated certain changes in the size, design, and
merchandise offerings of Media Play in an attempt to improve operating results.
These efforts are continuing during 1998. There can be no assurance that these
efforts will be successful.
In 1998, the Company anticipates spending approximately $20 million to
remodel and expand existing stores. The Company expects that substantially all
future capital expenditures will be funded by net cash provided by operating
activities. The amount of any additional capital needed will depend upon the
profitability of the Company's existing stores. There can be no assurance that
any needed capital will be available on terms acceptable to the Company. See
"Management's Discussion and Analysis of Results of Operations and Financial
Condition--Liquidity and Capital Resources."
RISK OF DEPENDENCE ON KEY PERSONNEL
The Company is dependent on the active participation of certain key
personnel, the loss of whom could have a material adverse effect on the Company.
The Company has taken certain steps to minimize these risks by executing
employment agreements with Messrs. Eugster, Benson, Wachsman and Ross.
CORPORATE STRUCTURE
MSC is a holding company and does not have any material operations or assets
other than its ownership of 100% of the outstanding stock of MGI. MGI holds 100%
of the outstanding stock of its subsidiaries. MSC and MGI are dependent on the
cash flow of MGI's subsidiaries and distributions from such subsidiaries in
order to meet their debt service obligations.
Any right of MSC and MGI to participate in any distribution of the assets of
any of MGI's subsidiaries upon liquidation, reorganization or insolvency of any
such subsidiary (and the consequent right of the holders of the Notes to
participate in distribution of those assets) will be subject to the prior claims
of such subsidiary's creditors.
RISK OF FAILURE TO ACHIEVE YEAR 2000 COMPLIANCE
The Company has assessed its systems and equipment with respect to Year 2000
compliance and has developed a project plan. Many of the Year 2000 issues,
including the processing of credit card transactions, have been addressed. The
remaining Year 2000 issues will either be addressed with scheduled system
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upgrades or through the Company's internal systems development staff. The
incremental costs will be charged to expense as incurred and are not expected to
have a material impact on the financial position or results of operations of the
Company. However, the Company could be adversely impacted if Year 2000
modifications are not properly completed by either the Company or its vendors,
banks or any other entity with whom the Company conducts business.
FRAUDULENT TRANSFER CONSIDERATIONS
Various laws enacted for the protection of creditors may apply to the
Company's incurrence of indebtedness in connection with the issuance of the
Notes. If a court were to find in a lawsuit by an unpaid creditor or
representative of unpaid creditors of the Company that the Company did not
receive fair consideration or reasonably equivalent value for incurring such
indebtedness or obligation and, at the time of such incurrence, the Company (i)
was insolvent, (ii) was rendered insolvent by reason of such incurrence, (iii)
was engaged in a business or transaction for which the assets remaining in the
Company constituted unreasonably small capital, or (iv) intended to incur or
believed it would incur debts beyond its ability to pay such debts as they
mature, such court, subject to applicable statutes of limitation, could
determine to invalidate, in whole or in part, such indebtedness and obligations
as fraudulent conveyances or subordinate such indebtedness and obligations to
existing or future creditors of the Company. If a court were to find that the
Company satisfied the measures of insolvency described in (i) through (iv)
above, such court could avoid a distribution and order that it be returned to
the Company or to a fund for the benefit of the Company's creditors. Further, if
a court were to find that, at the time the Company granted security interests to
or for the benefit of the Banks, the Company did not receive fair consideration
or reasonably equivalent value for the grant of such security interests and came
within any of the foregoing clauses (i) through (iv), a creditor or
representative of creditors could seek to avoid the grant of such security
interests. This could result in an event of default with respect to the Revolver
Agreement that, under the terms thereof (subject to applicable law), would allow
the lenders thereunder to accelerate such debt.
The measure of insolvency for purposes of the foregoing will vary depending
on the law of the jurisdiction being applied. Generally, however, either MSC or
MGI would be considered insolvent at a particular time if the sum of its debts
was then greater than all of its property at a fair valuation or if the present
fair salable value of its assets was then less than the amount that would be
required to pay its probable liabilities on its existing debts as they become
absolute and matured. On the basis of its financial information, its recent
operating history as discussed in "Management's Discussion and Analysis of
Results of Operations and Financial Condition," and other factors, the Company
believes that, after giving effect to the issuance of the Notes, it is not
rendered insolvent, it has sufficient capital for the businesses in which it is
engaged and it is able to pay its debts as they mature. There can be no
assurance, however, as to what standard a court would apply in making any such
determinations.
ABSENCE OF PUBLIC MARKET
The Notes have no established trading market and may not be widely
distributed. The Initial Purchasers have informed the Company that they
currently intend to make a market in the Notes to the extent permitted by
applicable laws and regulations; however, the Initial Purchasers are not
obligated do so and the Initial Purchasers may discontinue market making at any
time without notice. In addition, any such market-making activity will be
subject to the limits imposed by the Securities Act and the Exchange Act and may
be limited during the pendency of the Exchange Offer or any Shelf Registration
Statement.
Although the Old Notes have been accepted for trading on the PORTAL market,
the Company does not intend to list the Old Notes or the New Notes on any
national securities exchange or stock market. Accordingly, there can be no
assurance as to the development of any market or the liquidity of any market
that may develop for the Notes. If a market for the Notes does not develop,
holders may be unable to resell such securities for an extended period of time,
if at all. If a market for the Notes does develop, the price of the Notes may
fluctuate and liquidity may be limited. If such a market for the Notes were to
exist, the
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Notes could trade at prices lower than the initial offering price thereof
depending on many factors, including, among others, prevailing interest rates,
the market for similar securities, the ability to locate a willing buyer,
general economic conditions and the financial condition and performance of, and
prospects for, the Company.
Historically, the market for non-investment grade debt, such as the Notes,
has been subject to disruptions that have caused substantial volatility in the
prices of such securities. There can be no assurance that the market for the
Notes will not be subject to similar disruptions. Any such disruption may have
an adverse effect on holders of the Notes.
POSSIBLE INABILITY TO REPURCHASE NOTES UPON A CHANGE OF CONTROL
In the event of a Change of Control (as defined in the Indenture), the
Company will be required to offer to purchase the Notes at 101% of the principal
amount thereof plus accrued and unpaid interest and Liquidated Damages thereon,
if any, to the date of repurchase. However, the Revolver Agreement prohibits the
Company from repurchasing the Notes and also provides that certain change of
control events with respect to the Company will constitute a default thereunder.
Any future credit agreements or other agreements relating to Senior Debt to
which the Company becomes a party may contain similar restrictions and
provisions. In the event that a Change of Control occurs at a time when the
Company is prohibited from purchasing the Notes, the Company could seek the
consent of lenders to the purchase of the Notes or could attempt to refinance
the borrowings that contain such prohibition. If the Company does not obtain
such consent or repay such borrowings, the Company will remain prohibited from
purchasing the Notes by the relevant Senior Debt. In such case, the Company's
failure to purchase the tendered Notes would constitute an event of default
under the Indenture which would, in turn, constitute a default under the
Revolver Agreement and could constitute a default under other Senior Debt. In
such circumstances, the subordination provisions in the Indenture would likely
restrict payments to the holders of the Notes. Further, no assurance can be
given that the Company will have sufficient resources to satisfy its repurchase
obligations with respect to the Notes following a Change of Control.
FORWARD-LOOKING STATEMENTS
The information herein contains forward-looking statements that involve a
number of risks and uncertainties. A number of factors could cause actual
results, performance, achievements of the Company, or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. These factors include,
but are not limited to, the competitive environment in the entertainment
industry, especially for music and video product, inflation, changes in costs of
goods and services, economic conditions in general and in the Company's
business, demographic changes, changes in prevailing interest rates and the
availability of and terms of financing to fund the anticipated growth of the
Company's business, the ability to attract and retain qualified personnel, the
significant indebtedness of the Company, changes in the Company's acquisition
and capital expenditure plans, and other factors referenced herein and in the
Company's filings with the Commission. In addition, such forward-looking
statements are necessarily dependent upon assumptions, estimates and dates that
may be incorrect or imprecise and involve known and unknown risks, uncertainties
and other factors. Accordingly, any forward-looking statements included herein
do not purport to be predictions of future events or circumstances and may not
be realized. Forward-looking statements can be identified by, among other
things, the use of forward-looking terminology such as "believes," "expects,"
"may," "will," "should," "seeks," "pro forma," "anticipates," "intends" or the
negative of any thereof, or other variations thereon or comparable terminology,
or by discussions of strategy or intentions. Given these uncertainties,
prospective investors are cautioned not to place undue reliance on such
forward-looking statements. The Company disclaims any obligation to update any
such factors or to announce publicly the results of any revisions to any of the
forward-looking statements contained herein to reflect future events or
developments.
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THE EXCHANGE OFFER
GENERAL
Under the Registration Rights Agreement, the Company is obligated (i) to
file the Registration Statement of which this Prospectus is a part for a
registered exchange offer with respect to an issue of New Notes with terms
identical in all material respects to the Old Notes (except that such New Notes
will not contain transfer restrictions) within 60 days after the Issue Date and
(ii) to use its best efforts to cause the Registration Statement to be declared
effective within 150 days after the Issue Date. For each Old Note surrendered
pursuant to the Exchange Offer, the holder of such Old Note will receive a New
Note having a principal amount at maturity equal to that of the surrendered Old
Note. The Exchange Offer being made hereby if commenced and consummated within
such applicable time periods will satisfy those requirements under the
Registration Rights Agreement. See "Description of the New Notes--Exchange
Offer, Registration Rights."
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal (which together constitute the Exchange Offer),
the Company will accept for exchange all Old Notes validly tendered and not
withdrawn prior to 5:00 p.m., New York City time, on the Expiration Date. The
Company will issue New Notes in exchange for an equal principal amount at
maturity of outstanding Old Notes accepted in the Exchange Offer. As of the date
of this Prospectus, there was outstanding $150,000,000 aggregate principal
amount at maturity of Old Notes. This Prospectus, together with the Letters of
Transmittal, is being sent to all registered holders as of May 6, 1998.
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering holders
of Old Notes for the purposes of receiving the New Notes from the Company and
delivering New Notes to such holders.
In the event the Exchange Offer is consummated, subject to certain limited
exceptions, the Company will not be required to register the Old Notes. In such
event, holders of Old Notes seeking liquidity in their investment would have to
rely on exemptions to registration requirements under the U.S. securities laws.
See "Risk Factors--Consequences of Failure to Exchange."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean June 5, 1998, unless the Company, in
its sole discretion, extends the Exchange Offer, in which case the term
'Expiration Date" shall mean the latest date to which the Exchange Offer is
extended. In order to extend the Expiration Date, the Company will notify the
Exchange Agent of any extension by oral or written notice and will mail to the
record holders of Old Notes an announcement thereof, each prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
Expiration Date. Such announcement may state that the Company is extending the
Exchange Offer for a specified period of time.
The Company reserves the right (i) to delay accepting any Old Notes, to
extend the Exchange Offer or to terminate the Exchange Offer and not accept Old
Notes not previously accepted if any of the conditions set forth herein under
shall have occurred and shall not have been waived by the Company (see the
subcaption "Conditions for Exchange", below), by giving oral or written notice
of such delay, extension or termination to the Exchange Agent or (ii) to amend
the terms of the Exchange Offer in any manner deemed by it to be advantageous to
the holders of the Old Notes. Any such delay in acceptance, extension,
termination or amendment will be followed as promptly as practicable by oral or
written notice thereof. If the Exchange Offer is amended in a manner determined
by the Company to constitute a material change, the Company will promptly
disclose such amendment in a manner reasonably calculated to inform the holders
of the Old Notes of such amendment and the Company will extend the Exchange
Offer for a period of five to ten business days, depending upon the significance
of the amendment and the manner of
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<PAGE>
disclosure to holders of the Old Notes, if the Exchange Offer would otherwise
expire during such five to ten business day period.
Without limiting the manner in which the Company may choose to make public
announcement of any delay, extension, amendment or termination of the Exchange
Offer, the Company shall have no obligations to publish, advertise, or otherwise
communicate any such public announcement, other than by making a timely release
to an appropriate news agency.
NO VOTE OF SECURITY HOLDERS IS REQUIRED UNDER APPLICABLE LAW TO EFFECT THE
EXCHANGE OFFER AND NO SUCH VOTE (OR PROXY THEREFOR) IS BEING REQUESTED BY MEANS
OF THIS PROSPECTUS OR OTHERWISE.
Holders of Old Notes do not have any appraisal or dissenters' rights in
connection with the Exchange Offer under the Delaware General Corporation Law,
the law of the state of incorporation of the Issuer and the Guarantor.
CONTINUING REGISTRATION RIGHTS
If (a) the Exchange Offer is not consummated before June 17, 1998 (the
"Completion Deadline") or (b) a holder of Old Notes advises the Company within
twenty (20) business days following the Completion Deadline that (i) such holder
was prohibited by law from participating in the Exchange Offer, (ii) such holder
may not resell New Notes acquired in the Exchange Offer without delivery of a
prospectus other than this Prospectus, or (iii) such holder is an Initial
Purchaser or otherwise acquired Old Notes directly from the Company or an
affiliate of the Company, then the Company will, at its expense, (x) within 60
days, file a shelf registration statement covering resales of the Old Notes (a
"Shelf Registration Statement"), (y) use its best efforts to cause a Shelf
Registration Statement to be declared effective under the Securities Act within
90 days after filing and (z) keep the Shelf Registration Statement effective
until the earlier of 24 months following the Issue Date or such time as all of
the Old Notes have been sold thereunder, or otherwise can be sold pursuant to
Rule 144 without any limitations under clauses (c), (e), (f) and (h) of Rule
144. In the event a Shelf Registration Statement is filed, the Company will (i)
provide to each holder for whom such Shelf Registration Statement was filed,
copies of the prospectus which is a part of such Shelf Registration Statement,
(ii) notify each such holder when such Shelf Registration Statement has become
effective, and (iii) take certain other actions as are required to permit
unrestricted resales of the Old Notes. A holder selling Old Notes pursuant to
the Shelf Registration Statement generally will be required to be named as a
selling security holder in the related prospectus and to deliver a prospectus to
purchasers, will be subject to certain of the civil liability provisions under
the Securities Act in connection with such sales, and will be bound by the
provisions of the Registration Rights Agreement which are applicable to such a
holder (including certain indemnification obligations).
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a holder must complete, sign and date the
Letter of Transmittal or a facsimile thereof, have the signatures thereon
guaranteed if required by such Letter of Transmittal, and mail or otherwise
deliver such Letter of Transmittal or such facsimile, together with any other
required documents, to the Exchange Agent prior to 5:00 p.m. New York City time,
on the Expiration Date. In addition, either (i) certificates for such tendered
Old Notes must be received by the Exchange Agent along with the Letter of
Transmittal, (ii) a timely confirmation of a book-entry transfer (a "Book-Entry
Confirmation") of such Old Notes, if such procedure is available, into the
Exchange Agent's account at the Depository Trust Company (the "Book-Entry
Transfer Facility") pursuant to the procedure for book-entry transfer described
below, must be received by the Exchange Agent prior to the Expiration Date or
(iii) the holder must comply with the guaranteed delivery procedures described
below. THE METHOD OF DELIVERY OF OLD NOTES, LETTERS OF TRANSMITTAL AND ALL OTHER
REQUIRED DOCUMENTS IS AT THE ELECTION AND RISK OF THE HOLDERS. IF SUCH DELIVERY
IS BY
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MAIL, IT IS RECOMMENDED THAT REGISTERED MAIL, PROPERLY INSURED, WITH RETURN
RECEIPT REQUESTED, BE USED. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO
ASSURE TIMELY DELIVERY. NO LETTERS OF TRANSMITTAL OR OLD NOTES SHOULD BE SENT TO
THE COMPANY. To be tendered effectively, the Old Notes, the Letter of
Transmittal and all other required documents must be received by the appropriate
Exchange Agent prior to 5:00 p.m., New York City time, on the Expiration Date.
Delivery of all documents must be made to the appropriate Exchange Agent at the
addresses set forth herein. Holders may also request their respective brokers,
dealers, commercial banks, trust companies or nominees to effect such tender for
such holders.
The tender by a holder of Old Notes will constitute an agreement between
such holder and the Company in accordance with the terms and subject to the
conditions set forth therein and in the Letter of Transmittal.
Only a holder of Old Notes may tender such Old Notes in the Exchange Offer.
The term "holder" with respect to the Exchange Offer means any person in whose
name Old Notes are registered on the books of the Company or any other person
who has obtained a properly completed bond power from the registered holder.
Any beneficial owner whose Old Notes are registered in the name of a broker,
dealer, commercial bank, trust company or other nominee and who wishes to tender
shall contact such registered holder promptly and instruct such registered
holder to tender on his behalf. If such beneficial owner wishes to tender on his
own behalf, such beneficial owner must, prior to completing and executing the
Letter of Transmittal and delivering his Old Notes, either make appropriate
arrangements to register ownership of the Old Notes in such owner's name or
obtain a properly completed bond power from the registered holder. The transfer
of registered ownership may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by any member firm of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.
or a commercial bank or trust company having an office or correspondent in the
U.S. (an "Eligible Institution") unless the Old Notes tendered pursuant thereto
are tendered (i) by a registered holder who has not completed the box entitled
"Special Issuance Instructions" or "Special Delivery Instructions" on the Letter
of Transmittal or (ii) for the account of an Eligible Institution. In the event
that signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, are required to be guaranteed, such guarantee must be by an
Eligible Institution.
If the Letter of Transmittal is signed by a person other than the registered
holder of any Old Notes listed therein, such Old Notes must be endorsed or
accompanied by bond powers, and a proxy which authorizes such person to tender
the Old Notes on behalf of the registered holder, in each case as the name of
the registered holder or holders appears on the Old Notes.
If the Letter of Transmittal of any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
person should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
All questions as the validity, form, eligibility (including time of receipt)
and withdrawal of the tendered Old Notes will be determined by the Company in
its sole discretion, which determination will be final and binding. The Company
reserves the absolute right to reject any and all Old Notes not properly
tendered or any Old Notes which, if accepted by the Company, would, in the
opinion of counsel for the Company, be unlawful. The Company also reserves the
right to waive any irregularities or conditions of tender as to particular Old
Notes. The Company's interpretation of the terms and conditions of the Exchange
Offer (including the instructions in the Letters of Transmittal) will be final
and binding on all
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<PAGE>
parties. Unless waived, any defects or irregularities in connection with tenders
of Old Notes must be cured within such time as the Company shall determine. None
of the Company, the Exchange Agent, or any other person shall be under any duty
to give notification of defects or irregularities with respect to tenders of Old
Notes, nor shall any of them incur any liability for failure to give such
notification. Tenders of Old Notes will not be deemed to have been made until
such irregularities have been cured or waived. Any Old Notes received by the
Exchange Agent that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned without cost to
such holder by the Exchange Agent to the tendering holders of such Old Notes,
unless otherwise provided in the Letter of Transmittal, as soon as practicable
following the Expiration Date.
In addition, the Company reserves the right in its sole discretion, subject
to the provisions of the Indenture, to (i) purchase or make offers for any Old
Notes that remain outstanding subsequent to the Expiration Date or, (see the
subcaption "Conditions for Exchange", below), to terminate the Exchange Offer in
accordance with the terms of the Registration Rights Agreement and (ii) to the
extent permitted by applicable law and the Indenture, purchase Old Notes in the
open market, in privately negotiated transactions or otherwise, before, during,
and after the Exchange Offer. The terms of any such purchase or offers could
differ from the terms of the Exchange Offer.
By tendering, each holder will represent to the Company that (i) it is not
an affiliate of the Company (as defined under Rule 405 of the Securities Act),
(ii) any New Notes to be received by it were acquired in the ordinary course of
its business and (iii) at the time of commencement of the Exchange Offer, it was
not engaged in, and did not intend to engage in, a distribution of such New
Notes and had no arrangement or understanding with any person to participate in
a distribution (within the meaning of the Securities Act) of the New Notes. If a
holder of Old Notes is an affiliate of the Company, and is engaged in or intends
to engage in a distribution of the New Notes or has any arrangement or
understanding with respect to the distribution of the New Notes to be acquired
pursuant to the Exchange offer, such holder cannot rely on the applicable
interpretations of the staff of the Commission and must comply with the
registration and prospectus delivery requirement of the Securities Act in
connection with any secondary resale transaction. Each broker or dealer that
receives New Notes for its own account in exchange for Old Notes, where such Old
Notes were acquired by such broker or dealer as a result of market-making
activities, or other trading activities, must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. See "Plan of
Distribution."
ACCEPTANCE OF OLD NOTES FOR EXCHANGE; DELIVERY OF NEW NOTES
Upon satisfaction or waiver of all of the conditions to the Exchange Offer,
the Company will accept, promptly after the Expiration Date, all Old Notes
properly tendered and will issue the New Notes promptly after acceptance of the
Old Notes. For purposes of the Exchange Offer, the Company shall be deemed to
have accepted validly tendered Old Notes for exchange when, as and if the
Company has given oral or written notice thereof to the Exchange Agent.
For each Old Note for exchanged, the holder of such Old Note will receive a
New Note having a principal amount at maturity equal to that of the surrendered
Old Note.
If (i) by June 17, 1998 (the Completion Deadline), the Exchange Offer is not
consummated, or (ii) a Shelf Registration Statement is not filed and declared
effective within the time frame required, if a Shelf Registration Statement is
required to be filed, or (iii) after either the Exchange Offer Registration
Statement or the Shelf Registration Statement is declared effective, such
Registration Statement thereafter ceases to be effective or usable (subject to
certain exceptions) in connection with resales of Old Notes or New Notes, as
applicable, in accordance with and during the periods specified in the
Registration Rights Agreement (each such event referred to in clauses (i)
through (iii) a "Registration Default"), Liquidated Damages will accrue or
accumulate on the applicable Old Notes and New Notes, from and including the
date on which any such Registration Default shall occur to but excluding the
date on which all Registration
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Defaults have been cured, at the rate of $.05 per week per $1,000 in principal
amount of New Notes or Old Notes affected by such Registration Default for the
first 90-day period immediately following the occurrence of such Registration
Default. The amount of Liquidated Damages shall increase by an additional $.05
per week per $1,000 for each subsequent 90-day period until all Registration
Defaults have been cured, up to a maximum of $.50 per week per $1,000. Such
Liquidated Damages will be payable in cash and will be in addition to any other
interest payable with respect to the Old Notes and the New Notes. No holder of
New Notes or Old Notes shall be entitled to any Liquidated Damages if such
holder has failed to provide the Company with the information required by
applicable regulations of the Commission to be included with respect to such
holder in the Registration Statement and Prospectus pursuant to which the holder
seeks to sell his Old Notes or New Notes.
In all cases, issuance of New Notes for Old Notes that are accepted for
exchange pursuant to the Exchange Offer will be made only after timely receipt
by the Exchange Agent of certificates for such Old Notes or a timely Book-Entry
Confirmation of such Old Notes into the Exchange Agent's account at the
Book-Entry Transfer Facility, a properly completed and duly executed Letter of
Transmittal and all other required documents. If any tendered Old Notes are not
accepted for any reason set forth in the terms and conditions of the Exchange
Offer or if Old Notes are submitted for a greater principal amount than the
holder desires to exchange, such unaccepted or nonexchanged Old Notes will be
returned without expense to the tendering holder thereof (or, in the case of Old
Notes tendered by book-entry transfer procedures described below, such
nonexchanged Old Notes will be credited to an account maintained with such Book-
Entry Transfer Facility) as promptly as practicable after the expiration or
termination of the Exchange Offer.
BOOK-ENTRY TRANSFER
The Exchange Agent will establish an account with respect to the Old Notes,
respectively, at the Book-Entry Transfer facility for purposes of the Exchange
Offer within two business days after the date of the Prospectus. Any financial
institution that is a participant in the Book-Entry Transfer Facility's systems
may make book-entry delivery of Old Notes by causing the Book-Entry Transfer
Facility to transfer such Old Notes into the Exchange Agent's account at the
Book-Entry Transfer Facility in accordance with such Book-Entry Transfer
Facility's procedures for transfer. Although delivery of Old Notes may be
effected through book-entry transfer at the Book-Entry Transfer Facility, the
Letter of Transmittal or facsimile thereof with any required signature
guarantees and any other required documents must, in any case, be transmitted to
and received by the Exchange Agent on or prior to the Expiration Date, or the
guaranteed delivery procedures described below must be complied with.
GUARANTEED DELIVERY PROCEDURES
If a registered holder of the Old Notes desires to tender such Old Notes,
but the Old Notes are not immediately available, or time will not permit such
holder's Old Notes or other required documents to reach the Exchange Agent
before the Expiration Date, or the procedures for book-entry transfer cannot be
completed on a timely basis, a tender may be effected if (i) the tender is made
through an Eligible Institution, (ii) prior to the Expiration Date, the Exchange
Agent receives from such Eligible Institution a properly completed and duly
executed Letter of Transmittal (or a facsimile thereof) and Notice of Guaranteed
Delivery, substantially in the form provided by the Company (by facsimile
transmission, mail or hand delivery), setting forth the name and address of the
holder of such Old Notes and the amount of Old Notes tendered, stating that the
tender is being made thereby and guaranteeing that within five (5) business days
after the date of execution of the Notice of Guaranteed Delivery, the
certificates for all physically tendered Old Notes, in proper form to transfer,
or a Book-Entry Confirmation, as the case may be, and any other documents
required by the Letter of Transmittal will be deposited by the Eligible
Institution with the appropriate Exchange Agent and (iii) the certificate for
all physically tendered Old Notes, in proper form for transfer, or a Book-Entry
Confirmation, as the case may be, and all other
24
<PAGE>
documents required by the Letter of Transmittal are received by the Exchange
Agent within five (5) business days after the date of execution of the Notice of
Guaranteed Delivery.
WITHDRAWAL OF TENDERS
Tenders of Old Notes may be withdrawn at any time prior to 5:00 p.m. New
York City time, on the Expiration Date. For a withdrawal to be effective, a
written notice of withdrawal must be received by the Exchange Agent prior to
5:00 p.m. New York City time on the Expiration Date. Any such notice of
withdrawal must specify the name of the person having tendered the Old Notes to
be withdrawn, identify the Old Notes to be withdrawn (including the principal
amount of such Old Notes and (where certificates for Old Notes have been
transmitted) specify the name in which such Old Notes are registered, if
different from that of the withdrawing holder. If certificates for the Old Notes
have been delivered or otherwise identified to the Exchange Agent, then, prior
to the release of such certificates, the withdrawing holder must also submit the
serial numbers of the particular certificates to be withdrawn and a signed
notice of withdrawal with signatures guaranteed by an Eligible Institution,
unless such holder is an Eligible Institution. If Old Notes have been tendered
pursuant to the procedures of book-entry transfer described above, any notice of
withdrawal must specify the name and number of the account at the Book-Entry
Transfer Facility to be credited with the withdrawn Old Notes and must otherwise
comply with the procedures of such facility. All questions as to the validity,
form and eligibility (including time of receipt) of such notices will be
determined by the Company, whose determination shall be final and binding on all
parties. Any Old Notes so withdrawn will be deemed not to have been validly
tendered for exchange for purposes of the Exchange Offer. Any Old Notes which
have been tendered for exchange but which are not exchanged for any reason will
be returned to the holder thereof without cost to such holder (or, in the case
of Old Notes tendered by book-entry transfer into the Exchange Agent's account
at the Book-Entry Transfer Facility pursuant to the book-entry transfer
procedures described above, such Old Notes will be credited to an account
maintained with such Book-Entry Transfer Facility for the Old Notes) as soon as
practicable after withdrawal, rejection of tender or termination of the Exchange
Offer. Properly withdrawn Old Notes may be retendered by following one of the
procedures described under the subcaption "Procedures for Tendering" above at
any time on or prior to the Expiration Date.
CONDITIONS FOR EXCHANGE
Notwithstanding any other term of the Exchange Offer, the Company will not
be required to accept for exchange, or to issue New Notes in exchange for, any
Old Notes and may terminate or amend the Exchange Offer as provided herein
before the acceptance of such Old Notes, if because of any changes in law, or
applicable interpretations thereof by the Commission, the Company determines
that it is not permitted to effect the Exchange Offer. In addition, the Company
has no obligation to, and will not knowingly, accept tenders of Old Notes from
affiliates of the Company (within the meaning of Rule 405 under the Securities
Act) or from any other holder or holders who are not eligible to participate in
the Exchange Offer under applicable law or interpretations thereof by the
Commission, or if the New Notes to be received by such holder or holders of Old
Notes in the Exchange Offer, upon receipt, will not be tradeable by such holder
without restriction under the Securities Act and the Exchange Act and without
material restriction under the "blue sky" or securities law of substantially all
of the states.
EXCHANGE AGENT
Bank One, N.A. has been appointed as Exchange Agent in connection with the
Exchange Offer. Questions and requests for assistance in connection with the
Exchange Offer and requests for additional
25
<PAGE>
copies of this Prospectus or of the Letter of Transmittal should be directed to
the Exchange Agent addressed as follows:
By Registered or Certified Mail;
By Overnight Courier; or By Hand:
235 West Schrock Road
Westerville, Ohio 43081
Attention: Corporate Trust Operations
By Facsimile: (614) 248-5088
Telephone: (800) 346-5153
FEES AND EXPENSES
The expenses to be incurred in connection with the Exchange Offer will be
paid by the Company, including fees and expenses of each Exchange Agent, the
Trustee (as hereinafter defined), the Transfer Agent (as hereinafter defined)
and accounting, legal printing and related fees and expenses.
The expenses of soliciting tenders pursuant to the Exchange Offer will also
be borne by the Company. The principal solicitation for tender pursuant to the
Exchange Offer is being made by mail; however, additional solicitations may be
made by telegraph, telephone, telecopy or in person by officers and regular
employees of the Company.
The Company will not make any payments to brokers, dealers or other persons
soliciting acceptances of the Exchange Offer. The Company, however, will pay
each Exchange Agent reasonable and customary fees for its services and will
reimburse the Exchange Agent for its reasonable out-of-pocket expenses in
connection therewith. The Company may also pay brokerage houses and other
custodians, nominees and fiduciaries the reasonable out-of-pocket expenses
incurred by them in forwarding copies of the Prospectus and related documents to
the beneficial owners of the Old Notes, and in handling or forwarding tenders
for exchange.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Notes pursuant to the Exchange Offer. If, however, certificates
representing New Notes or Old Notes for principal amounts not tendered or
accepted for exchange are to be delivered to, or are to be registered or issued
in the name of, any person other than the registered holder of the Old Notes
tendered, or if tendered Old Notes are registered in the name of any person
other than the person signing the Letter of Transmittal, or if a transfer tax is
imposed for any reason other than exchange of Old Notes pursuant to the Exchange
Offer, then the amount of any such transfer taxes (whether imposed on the
registered holder or any other persons) will be payable by the tendering holder.
If satisfactory evidence of payment of such taxes or exemption therefrom is not
submitted with the Letter of Transmittal, the amount of such transfer taxes will
be billed directly to such tendering holder.
ACCOUNTING TREATMENT
The New will be recorded in the Company's accounting records at the same
carrying values as the Old Notes, respectively, as reflected in the Company's
accounting records on the date of the exchange. Accordingly, no gain or loss for
accounting purposes will be recognized upon the consummation of the Exchange
Offer. The expense of the Exchange Offer will be amortized by the Company over
the term of the New Notes in accordance with generally accepted accounting
principles.
26
<PAGE>
USE OF PROCEEDS
The Company will not receive any proceeds from the issuance of the New Notes
offered hereby. In consideration for issuing the New Notes as contemplated in
this Prospectus, the Company will receive in exchange Old Notes in like
principal amount, the term and form of which are identical in all material
respects to the New Notes. The Old Notes surrendered in exchange for New Notes
will be retired and cancelled and cannot be reissued. Accordingly, issuance of
the New Notes will not result in any increase in the indebtedness of the
Company. The net proceeds to the Company from the sale of the Old Notes (after
deducting discounts and commissions and estimated expenses of the Offering) were
approximately $144.3 million. The Company used such net proceeds to repay (i)
$112.2 million under the Credit Facility; and (ii) $32.1 million of mortgage
notes payable pertaining to the financing of the Franklin distribution center
and three Media Play stores (the "Mortgage Notes Payable"). After the paydown on
the Credit Facility, the combined aggregate available commitments under the
Credit Facility were reduced from $295.0 million to $182.0 million. As long as
indebtedness of $50.0 million is outstanding under the Term Loan Agreement, the
aggregate borrowings available under the Revolver Agreement will be $132.0
million. If the indebtedness under the Term Loan Agreement is paid when due, or
prepaid, the aggregate borrowings available under the Revolver Agreement will be
$182.0 million. The weighted average interest rate under the Revolver Agreement
for 1997 was 8.0%. As of December 31, 1997, the interest rate under the Term
Loan Agreement was 8.13%. See "Description of Existing Financing Arrangements."
The interest rates on the Mortgage Notes Payable as of December 31, 1997 ranged
from 8.24% to 8.37%. The Mortgage Notes Payable matured in March 1999 and May
2000. See "Management's Discussion and Analysis of Results of Operations and
Financial Condition--Liquidity and Capital Resources--Financing Activities."
27
<PAGE>
CAPITALIZATION
The following table, which should be read in conjunction with the
Consolidated Financial Statements of the Company and related notes included
elsewhere in this Prospectus, sets forth the capitalization of the Company as of
December 31, 1997 and as adjusted to reflect the issuance of the Notes. See "Use
of Proceeds."
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------
ACTUAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents(1)(2).......................................................... $ 3,942 $ 115,326
---------- -----------
---------- -----------
Long-term debt (including current maturities):
Revolver............................................................................... $ -- $ -- (1)
Term Loan.............................................................................. 50,000 50,000
Mortgage Notes Payable................................................................. 33,087 --
9% Senior Subordinated Notes due 2003.................................................. 110,000 110,000
9 7/8% Senior Subordinated Notes due 2008.............................................. -- 148,817(3)
---------- -----------
Total long-term debt................................................................. 193,087 308,817
---------- -----------
Stockholders' equity:
Preferred stock........................................................................ -- --
Common stock........................................................................... 344 344
Additional paid-in capital............................................................. 255,075 255,075
Accumulated deficit.................................................................... (224,678) (224,678)
Deferred compensation.................................................................. (6,998) (6,998)
Common stock subscriptions............................................................. (4,973) (4,973)
---------- -----------
Total stockholders' equity........................................................... 18,770 18,770
---------- -----------
Total capitalization............................................................... $ 211,857 $ 327,587
---------- -----------
---------- -----------
</TABLE>
- - ------------------------
(1) At December 31, 1997, there were no borrowings under the Revolver Agreement.
Borrowings under the Revolver Agreement at March 1, 1998 were $146.0
million. Assuming the Offering of the Old Notes had closed on March 1, 1998,
the Company would have used $112.2 million of net proceeds from such
Offering and $0.8 million of cash to repay borrowings under the Revolver
Agreement.
(2) At December 31, 1997, outstanding checks in excess of cash balances of $12.1
million were included in accounts payable. Cash and cash equivalents, as
adjusted to give effect to the Offering of the Old Notes and the application
of the net proceeds therefrom, do not reflect the reduction of $12.1 million
for the outstanding checks in excess of cash balances that would not have
been included in accounts payable had the actual net amount of cash and cash
equivalents at December 31, 1997 exceeded this amount.
(3) The Old Notes were issued with original issue discount of $1.2 million which
will be amortized as noncash interest expense over the term of the Notes.
28
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The following table sets forth selected consolidated financial data for the
years indicated. This information should be read in conjunction with the
Consolidated Financial Statements and related notes appearing elsewhere herein
and "Management's Discussion and Analysis of Results of Operations and Financial
Condition."
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ------------ ------------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales................................... $ 1,181,658 $ 1,478,842 $ 1,722,572 $ 1,821,594 $ 1,768,312
Cost of sales........................... 710,707 936,643 1,116,502 1,209,835 1,153,483
Gross profit............................ 470,951 542,199 606,070 611,759 614,829
Selling, general and administrative
expenses.............................. 365,311 450,919 525,213 576,658 529,427
Depreciation and amortization........... 29,057 37,243 45,531 44,819 39,411
Goodwill write-down(1).................. -- -- 138,000 95,253 --
Restructuring charges(2)................ -- -- -- 75,000 --
Operating income (loss)................. 76,583 54,037 (102,674) (179,971) 45,991
Interest expense........................ 19,831 19,555 27,881 32,967 31,720
Earnings (loss) before income taxes and
extraordinary charge.................. 56,752 34,482 (130,555) (212,938) 14,271
Income taxes............................ 25,400 17,100 5,195 (19,200) 300
Earnings (loss) before extraordinary
charge(3)............................. 31,352 17,382 (135,750) (193,738) 13,971
Ratio of earnings to fixed charges(4)... 2.05x 1.56x -- -- 1.17x
Pro forma ratio of earnings to fixed
charges(5)............................ 1.11
STATEMENT OF CASH FLOWS DATA:
Net cash provided by (used in) operating
activities............................ $ 61,662 $ 71,462 $ (56,227) $ 16,689 $ 74,613
Net cash used in investing activities... (77,139) (109,608) (87,014) (6,376) (10,940)
Net cash provided by (used in) financing
activities............................ 95,159 (19,042) 106,634 149,692 (221,707)
OPERATING DATA:
EBITDA(6)............................... $ 105,640 $ 91,280 $ 80,857 $ 35,101 $ 85,402
EBITDA as a percentage of sales......... 8.9% 6.2% 4.7% 1.9% 4.8%
Comparable store sales increase
(decrease)(7):
Mall Stores........................... 4.5% 3.1% (4.9)% (1.7)% 4.7%
Superstores........................... 27.6 33.3 4.8 2.0 4.1
Total(8)............................ 4.6 4.6 (3.2) (0.6) 4.5
BALANCE SHEET DATA (AT END OF YEAR):
Cash and cash equivalents(9)............ $ 95,766 $ 38,578 $ 1,971 $ 161,976 $ 3,942
Total assets............................ 905,682 1,079,632 996,957 996,915 733,895
Long-term debt, including current
maturities............................ 135,000 110,000 163,000 396,599 193,087
Stockholders' equity(1)(2).............. 322,594 340,276 195,811 2,619 18,770
STORE DATA (AT END OF YEAR):
Total store square footage (in
millions)............................. 4.9 7.2 9.9 9.5 8.3
Store count:
Music stores.......................... 875 869 820 777 713
Suncoast stores....................... 320 378 412 422 409
Media Play stores..................... 13 46 89 87 68
On Cue stores......................... 32 77 153 158 157
United Kingdom and other stores....... 11 16 22 22 16
----------- ----------- ------------ ------------ -----------
Total............................... 1,251 1,386 1,496 1,466 1,363
----------- ----------- ------------ ------------ -----------
----------- ----------- ------------ ------------ -----------
</TABLE>
- - --------------------------
(1) The goodwill write-downs were taken following evaluations of goodwill for
impairment because of sales declines experienced by the music stores during
1995 and 1996. See Note 2 of Notes to Consolidated Financial Statements.
(2) The restructuring charges were recorded during 1996 for the estimated cost
of closing the Company's distribution facility in Minneapolis, Minnesota and
114 underperforming stores. See Note 3 of Notes to Consolidated Statements.
(3) Amounts for the year ended December 31, 1993 are before an extraordinary
charge from early redemption of debt, net of income tax benefit, of $3.9
million. Net earnings for the year ended December 31, 1993 were $27.5
million.
29
<PAGE>
(4) Ratio of earnings to fixed charges is computed by dividing (x) pre-tax
earnings before extraordinary charge and before fixed charges by (y) fixed
charges (consisting of cash interest expense on debt, amortization of debt
issuance costs and deferred financing credits plus one-third of total rent
expense exclusive of contingent rentals, the portion considered to be
representative of the interest factor). For the years ended December 31,
1995 and 1996, earnings (loss) before fixed charges were insufficient to
cover fixed charges by $130.6 million and $212.9 million, respectively.
(5) On a pro forma basis, after giving effect to the Offering.
(6) EBITDA represents earnings (loss) before extraordinary charge plus, interest
expense, income taxes, depreciation and amortization, goodwill write-down
and restructuring charges. While EBITDA should not be construed as a
substitute for income from operations, net earnings or cash flows from
operating activities (as defined by generally accepted accounting
principles) in analyzing the Company's operating performance, financial
position or cash flows, the Company has included EBITDA because it is
commonly used by certain investors and analysts to analyze and compare
companies on the basis of operating performance, leverage and liquidity and
to determine a company's ability to service debt. In addition, the method of
calculating EBITDA set forth above may be different from calculations of
EBITDA employed by other companies and, accordingly, may not be directly
comparable to such other calculations.
(7) Comparable store sales percentages are computed for stores open for a full
year during each year.
(8) The totals include United Kingdom and other stores.
(9) At December 31, 1994, 1995 and 1997, outstanding checks in excess of cash
balances of $5.9 million, $69.3 million and $12.1 million, respectively,
were included in current liabilities.
30
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
GENERAL
Beginning in 1995, the Company's financial results began to deteriorate as a
result of: (i) aggressive expansion of product offerings and new store openings
by most of the Company's non-mall competitors; (ii) severe price discounting of
music products by certain non-mall competitors; (iii) a lack of strong selling
hits in the music industry, which depressed sales throughout the industry; and
(iv) the Company's own rapid expansion of Media Play stores in response to
encouraging initial results. In 1996 management initiated restructuring programs
designed to improve the Company's cash flow and profitability. The major
components of the restructuring programs included: (i) closing 114
underperforming stores, which in the last full year of their operations lost an
aggregate of $17.7 million on an operating contribution basis; (ii) closing one
of the Company's two distribution centers, which reduced the Company's working
capital investment by approximately $20 million and contributed to a $6.9
million reduction in distribution costs in 1997; and (iii) improving inventory
management techniques, which increased the Company's inventory turnover from 1.8
times during 1996 to 2.1 times during 1997. Inventory levels at year-end 1997
were $55.8 million below those of the prior year with approximately $30 million
of the reduction due to store closings and the remainder attributable to
distribution efficiencies and improved inventory management. The Company reduced
Media Play advertising expense by $7.9 million in 1997 from the prior year as a
result of closing stores in entire markets and the introduction of a less
costly, but more targeted, program of newspaper advertising inserts. In
addition, in 1997 the Company began to benefit from positive trends in the music
retailing industry, including a retreat from severe price discounting and an
increase in unit sales. As a result, the Company's EBITDA increased from $35.1
million in 1996 to $85.4 million in 1997, and comparable store sales improved
from a decrease of 0.6% in 1996 to an increase of 4.5% in 1997.
In the first quarter of 1997, the Company's largest vendors and a
substantial majority of its remaining vendors agreed to temporarily defer
existing trade payables and provide continued product supply, subject to payment
terms reduced to ten days or less on new purchases. The Company completed
repayment of the deferred trade payables during the fourth quarter of 1997. The
Company also obtained an amendment to its Revolver Agreement in June 1997 that
modified and provided additional flexibility in financial covenants and allowed
the $50 million Term Loan. The Company previously obtained waivers of certain
financial covenants and technical defaults under the Revolver Agreement that had
been extended to allow for adequate time to complete all of the necessary
financing agreements and related amendments. See "--Liquidity and Capital
Resources."
31
<PAGE>
RESULTS OF OPERATIONS
The following table presents certain sales and store data for Mall Stores,
Superstores and in total for the Company for the last three years. Because both
Mall Stores and Superstores are supported by centralized corporate services and
have similar economic characteristics, products, customers and retail
distribution methods, the stores are reported as one industry segment.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
----------- ----------- -----------
(DOLLARS AND SQUARE FOOTAGE IN MILLIONS)
<S> <C> <C> <C>
SALES:
Mall Stores................................ $ 1,187.0 $ 1,160.0 $ 1,165.0
Superstores................................ 516.7 643.8 589.5
Total(1)................................. 1,722.6 1,821.6 1,768.3
PERCENTAGE CHANGE FROM PRIOR YEAR:
Mall Stores................................ (2.5)% (2.3)% 0.4%
Superstores................................ 108.5 24.6 (8.4)
Total(1)................................. 16.5 5.7 (2.9)
COMPARABLE STORE SALES CHANGE FROM PRIOR
YEAR:
Mall Stores................................ (4.9)% (1.7)% 4.7%
Superstores................................ 4.8 2.0 4.1
Total(1)................................. (3.2) (0.6) 4.5
NUMBER OF STORES OPEN AT YEAR END:
Mall Stores................................ 1,232 1,199 1,122
Superstores................................ 242 245 225
Total(1)................................. 1,496 1,466 1,363
TOTAL STORE SQUARE FOOTAGE AT YEAR END:
Mall Stores................................ 4.5 4.3 4.0
Superstores................................ 5.3 5.2 4.2
Total(1)................................. 9.9 9.5 8.3
</TABLE>
- - ------------------------
(1) The totals include United Kingdom and other stores.
SALES. Comparable store sales in 1996 were adversely impacted by the lack
of strong product releases in music and video and the challenging retail sales
environment. Sales from new Superstores and comparable store sales increases in
Superstores open for one year or more accounted for most of the increases in
total sales in 1996.
Comparable store sales growth in 1997 was led by significant gains in music,
driven by strong sales of new releases. Gains were also achieved in educational
toys, apparel and video games. These gains were partially offset by flat
comparable store sales in video and a decline in book sales, due in part to a
reduction in the number of book titles offered by the Superstores. Comparable
store sales in video were slowed by the lack of depth in new releases other than
strong sales of the Star Wars Trilogy Special Edition video set released during
the third quarter of 1997. The Company benefited from a less competitive
environment due to the closing of stores by certain mall competitors and less
near or below cost pricing of music product by certain non-mall competitors. The
reductions in total sales in 1997 resulted from the decreased store count and
square footage from closing stores.
32
<PAGE>
The following table shows the comparable store sales percentage increase
(decrease) attributable to the Company's two principal product categories for
the last three years.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Music................................... (6.9)% 0.9% 7.5%
Video................................... 4.7 (0.8) 0.2
</TABLE>
The Company's DVD sales in 1997, the year of DVD introduction, were 1.8% of
total video sales. DVD sales accelerated in the months of December 1997 and
January 1998 to 3.4% and 8.2%, respectively, of total video sales. Sales of DVD
are expected to continue to build during 1998. See "Risk Factors--Risk from New
Technologies" and "Business--Products--Video."
COMPONENTS OF EARNINGS. The following table sets forth certain operating
results as a percentage of sales for the last three years.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Sales............................................................. 100.0% 100.0% 100.0%
Gross profit...................................................... 35.2 33.6 34.8
Selling, general and administrative expenses...................... 30.5 31.7 29.9
Operating income before depreciation, amortization and
restructuring charges........................................... 4.7 1.9 4.8
Operating income (loss)........................................... (6.0) (9.9) 2.6
</TABLE>
GROSS PROFIT. In 1996, the increase in sales from the lower margin
Superstores relative to total Company sales lowered total Company gross margin
by 0.5%. An increase in inventory shrinkage negatively impacted gross margin by
0.4%. The balance of the gross margin decrease in 1996 was primarily
attributable to increased promotional pricing in both Mall Stores and
Superstores and lower prices in Mall Stores in 1996 as compared to 1995.
Approximately 1.3% of the gross margin improvement in 1997 was attributable
to price increases and less promotional pricing. The proportion of sales from
the lower margin Superstores relative to total sales decreased during 1997 due
to store closings and resulted in an improvement in total Company gross margin
of 0.3%. An increase in inventory shrinkage reduced gross margin by 0.4%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The decrease in selling,
general and administrative expenses in 1997 compared with 1996 was primarily due
to store closings, a reduction in advertising and efficiencies gained from the
consolidation of the Company's distribution facilities into a single facility in
1997. The Company's distribution facility in Franklin, Indiana has more than
double the combined capacity of the Company's former facilities in Minneapolis,
Minnesota and Edison, New Jersey. The Minneapolis facility closed in January
1997 while the Edison facility closed in May 1995. The Company incurred expenses
related to the consolidation of approximately $1.6 million and $1.5 million in
1995 and 1996, respectively. Because of the Company's limited store expansion in
1996 and 1997, costs incurred related to store openings were approximately $4
million in 1996 and were minimal in 1997 compared with $13 million in 1995.
Financial and legal advisory services and related expenses, most of which
were incurred in conjunction with obtaining amendments to the Company's Revolver
Agreement, totaled approximately $3.8 million in 1996 and $2.9 million in 1997.
Selling, general and administrative expenses in 1995 are net of nonrecurring
items consisting of income of $8.8 million from the termination of certain
service and business development agreements and a charge of $5.4 million for the
closing of 35 mall based Sam Goody stores.
33
<PAGE>
The higher expense rate in 1996 compared with 1997 and 1995 was attributable
to the effect of the unusual items previously discussed and the negative impact
of fixed costs, principally occupancy costs, in both underperforming existing
stores and new Media Play stores opened in 1995 and 1996. Many of these
underperforming stores were closed under the Company's restructuring programs.
See "--Restructuring Charges." The decrease in selling, general and
administrative expenses as a percentage of sales in 1997 was mainly due to the
cost savings discussed above. The comparable store sales gains in 1997 also
contributed to the rate improvements.
DEPRECIATION AND AMORTIZATION. The goodwill write-downs in 1995 and 1996
eliminated goodwill amortization in 1997 while goodwill amortization was $5.8
million, or $0.17 per share, in 1995 and $3.0 million, or $0.09 per share, in
1996. Other depreciation and amortization was $39.7 million, $41.8 million and
$39.4 million in 1995, 1996 and 1997, respectively, and primarily related to
stores. The increases over the prior years in 1996 and 1997 were attributable to
store expansion, net of the decreases related to store closings.
GOODWILL WRITE-DOWN. In August 1995, the Company recorded a goodwill
write-down of $138.0 million, or $4.07 per share, for the year ended December
31, 1995. An additional goodwill write-down of $95.3 million, or $2.85 per
share, was recorded in December 1996, eliminating the remaining goodwill balance
and goodwill amortization for years after 1996.
Most of the goodwill was established in conjunction with the 1988 leveraged
buyout of MGI by MSC. At that time, nearly all of the Company's stores were mall
based music stores. The carrying values of long-lived assets, primarily goodwill
and property, of the music stores were reviewed for recoverability and possible
impairment in both 1995 and 1996 because of sales declines that began in 1995
and continued during 1996. These sales declines resulted from a general decrease
in customer traffic in malls, an increase in high-volume, low-price non-mall
superstores and a lack of strong music product releases. See Note 2 of Notes to
Consolidated Financial Statements.
RESTRUCTURING CHARGES. During 1996, the Company recorded pretax
restructuring charges of $75.0 million for the estimated cost of programs
designed to improve profitability and increase inventory turnover. The
restructuring programs included the closing of the Company's distribution
facility in Minneapolis, Minnesota and 115 underperforming stores, including 79
Mall Stores and 36 Superstores. The Company closed 53 of these stores in 1996
and completed the restructuring programs in 1997 with the closing of the
distribution facility and another 61 stores. The Company removed one Superstore
from the closing list after exercising an option in the termination agreement
for that store to reinstate the lease. The restructuring charges included $36.3
million of cash payments, primarily related to payments to landlords for the
early termination of operating leases and estimated legal and consulting fees,
and $38.7 million for non-cash charges related to write-downs of leasehold
improvements and certain equipment, net of unamortized lease credits. See
"--Liquidity and Capital Resources--Investing Activities."
INTEREST EXPENSE. Interest expense consists primarily of interest on
Revolver borrowings and the 2003 Notes. Other interest consists primarily of
amortization of debt issuance costs. Components of interest expense for the last
three years are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
Interest on Revolver.............................................. $ 17.0 $ 21.9 $ 19.0
Interest on Term Loan............................................. -- -- 1.2
Interest on 2003 Notes............................................ 9.9 9.9 9.9
Other interest, net............................................... 1.0 1.2 1.6
--------- --------- ---------
$ 27.9 $ 33.0 $ 31.7
--------- --------- ---------
--------- --------- ---------
</TABLE>
34
<PAGE>
Interest expense on Revolver borrowings is impacted by the level of
outstanding borrowings during the year, interest rates, the Company's credit
rating and the number of days borrowings are outstanding during the year.
Average daily Revolver borrowings outstanding, weighted average interest rates
on the Revolver, based on the average daily borrowings, and the highest balances
outstanding under the Revolver were as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C>
Average daily Revolver borrowings................................ $ 254.0 $ 289.7 $ 238.5
Highest level of Revolver borrowings............................. 350.0 333.0 273.0
Weighted average interest rate................................... 7.1% 7.6% 8.0%
</TABLE>
Higher outstanding Revolver borrowings increased interest expense by $2.4
million in 1996. Lower outstanding borrowings on the Revolver decreased interest
expense by $3.9 million in 1997, or $2.7 million when netted with interest
expense on the Term Loan. The Term Loan proceeds received in September 1997,
used to reduce outstanding Revolver borrowings, lowered the average daily
Revolver borrowings for the year by $13 million. Increases in the weighted
average interest rates increased Revolver interest by $1.2 million in 1996 and
$1.1 million in 1997. Most of the increase in interest rates in 1996 and 1997
was the result of amendments to the Company's Revolver Agreement. An amendment
in June 1997 increased the margin added to variable interest rates on Revolver
borrowings by 0.25% through April 1998 and by 0.50% thereafter. A previous
amendment in April 1996 and lower credit ratings had increased the interest rate
margin by 0.93% and the annual facility fee rate by 0.2%.
INCOME TAXES. The effective income tax rates of (4.0)% in 1995, 9.0% in
1996 and 2.1% in 1997 vary from the federal statutory rate as a result of
deferred tax valuation allowances in 1996 and 1997, goodwill amortization and
write-downs in 1995 and 1996, which are nondeductible, and state income taxes.
Deferred tax valuation allowances of $24.5 million were established in 1996
because of the uncertainty of future earnings and reduced the deferred income
tax balances at December 31, 1996 to the approximate amount of remaining
recoverable income taxes after carryback of the 1996 taxable loss. The valuation
allowances were reduced by $7.5 million in 1997 based on revised estimates of
future earnings. See Note 5 of Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are Revolver borrowings pursuant to
the terms of the Revolver Agreement and internally generated cash. Because of
the seasonality of the retail industry, the Company's cash needs fluctuate
throughout the year and typically peak in November as inventory levels build in
anticipation of the Christmas selling season. The Company's cash position is
generally highest at the end of December because of the higher sales volume
during the Christmas season and extended payment terms typically provided by
most vendors for seasonal inventory purchases. The Company's cash needs build
during the first quarter as inventories are replenished following the Christmas
season and payments for seasonal inventory purchases become due. The Company's
practice has generally been to use the excess cash generated from operations in
the fourth quarter to repay all or a portion of the outstanding Revolver
borrowings. The amount of Revolver borrowings, if any, outstanding at year end
depends upon the sales performance during the Christmas season, the timing of
vendor payments and other cash flow requirements. Following the Offering and the
use of proceeds therefrom, the Company believes that, based on current levels of
operations and anticipated growth, cash flow from operating activities, together
with cash flow from financing activities, including borrowings under the
Revolver, as amended, will be adequate for at least the next two years to make
required payments of principal and interest on the Company's indebtedness
(including the Notes), to fund anticipated capital expenditures and working
capital requirements and to comply with the terms of its debt agreements.
35
<PAGE>
In June 1997, the Company completed agreements with its banks to amend the
Revolver Agreement and to allow the Term Loan Agreement. Pursuant to the
amendment, the maximum available Revolver borrowings are the lesser of: (i) 60%
of eligible inventory or (ii) $245.0 million through the expiration of the
Revolver Agreement in October 1999. However, for any Revolver borrowings which
result in a net increase in total outstanding Revolver borrowings, total trade
accounts payable must be equal to or greater than the total outstanding Revolver
borrowings. Outstanding Revolver borrowings in excess of $245.0 million and the
Term Loan are secured by inventory. The Company had no outstanding Revolver
borrowings at December 31, 1997. See "--Financing Activities" and Note 4 of
Notes to Consolidated Financial Statements. The Company has received approval
for an amendment to the Revolver Agreement from the Banks which permits the
issuance of the Notes, reduces the combined aggregate commitments, under the
Revolver Agreement and Term Loan Agreement, to $182.0 million, and amends
certain other items in the Revolver Agreement. See "Description of Existing
Financing Arrangements--Credit Facility."
The Revolver Agreement contains financial covenants and covenants that limit
additional indebtedness, liens, capital expenditures and cash dividends. The
amendment to the Revolver Agreement in June 1997 modified and provided
additional flexibility in financial covenants related to fixed charge coverage,
consolidated tangible net worth and debt to total capitalization and removed
financial covenants related to the maximum debt and trade payables to eligible
inventory ratio and the annual one day clean-down requirement of revolver
borrowings. The Company had previously obtained waivers of certain financial
covenants and technical defaults under the Revolver Agreement that had been
extended through June 30, 1997 to allow for adequate time to complete all of the
necessary financing agreements and related amendments. Covenants of the Term
Loan Agreement require a minimum inventory of $150 million and a minimum
operating cash flow and limit additional liens. The agreements related to the
Mortgage Notes Payable and 2003 Notes, as amended, also contain certain
financial covenants. The Company was in compliance with all covenants at
December 31, 1997.
The Company used the net proceeds from the Offering of the Old Notes to
repay indebtedness. See "Use of Proceeds."
OPERATING ACTIVITIES. Net cash provided by (used in) operating activities
(including the increase (decrease) in outstanding checks in excess of cash
balances which relate to vendor payments) was $7.2 million in 1995, $(52.6)
million in 1996 and $86.7 million in 1997. Cash used for inventory purchases, as
reflected by the aggregate net changes in inventories, accounts payable and
outstanding checks in excess of cash balances, was $31.8 million in 1995 and
$38.9 million in 1996. In 1997, the aggregate net changes in these inventory
related items contributed $6.4 million to net cash provided by operating
activities. Although inventories at December 31, 1996 of $506.1 million
decreased $27.6 million from December 31, 1995, the amount of cash used for
inventory purchases increased because of early payments made to certain vendors
to obtain discounts and to ensure continued availability of product. The
significant positive cash flow in 1997 compared with prior years was achieved
primarily through a reduced investment in inventory and improvements in
operating performance. The consolidation of distribution centers into a single
facility, store closings and initiatives designed by management to increase
inventory turnover, including better in-stock positions and more frequent
purchases closer to the time of sale, enabled the Company to maintain lower
inventory levels during 1997, which decreased inventories at December 31, 1997
to $450.3 million from $506.1 million at December 31, 1996.
The Company made tax payments of $17.9 million and $9.0 million in 1995 and
1996, respectively, while income tax refunds, net of payments, of $22.9 million
were received in 1997 from the carryback of the 1996 taxable loss. Cash
expenditures related to store closings under the Company's restructuring
programs were $24.1 million and $12.2 million in 1996 and 1997, respectively.
36
<PAGE>
INVESTING ACTIVITIES. Capital expenditures and store data for the last
three years are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
Capital expenditures, net of sale/leasebacks and other property sales (in millions)...... $ 87.0 $ 6.4 $ 10.9
Store openings:
Mall Stores............................................................................ 49 14 2
Superstores............................................................................ 119 19 1
Total(1)............................................................................. 175 35 3
Store closings:
Mall Stores............................................................................ (64) (47) (79)
Superstores............................................................................ -- (16) (21)
Total(1)............................................................................. (65) (65) (106)
Net increase (decrease) in store count:
Mall Stores............................................................................ (15) (33) (77)
Superstores............................................................................ 119 3 (20)
Total(1)............................................................................. 110 (30) (103)
</TABLE>
- - ------------------------
(1) The totals include United Kingdom and other stores.
In 1995 and 1996, capital expenditures were primarily for store expansion,
the majority of which were new Media Play stores, while in 1997, most of the
Company's capital expenditures consisted of improvements to existing stores.
Capital expenditures since 1995 have been significantly lower than in previous
years as the Company has shifted its focus to improving profitability in
existing stores. The number of stores closed under the restructuring programs
were 53 stores and 61 stores in 1996 and 1997, respectively. See "--Results of
Operations--Restructuring Charges."
Financing of capital expenditures has generally been provided by borrowings
under the Revolver Agreement and internally generated cash. The Company
typically receives financing from landlords in the form of contributions and
rent abatements for a portion of the capital expenditures, primarily related to
new stores and relocations of existing stores. In the third quarter of 1996, net
proceeds of $11.6 million were received from the sale of the building containing
the Company's distribution facilities and certain corporate office facilities in
Minneapolis, Minnesota. The Company leased back the entire building through
January 1997 and since then leases a portion of the office facilities. A portion
of the Media Play capital expenditures in 1995 were financed with proceeds from
sale/leaseback transactions totaling $26.2 million.
Capital expenditures of approximately $14 million for three new Media Play
stores opened in 1996 and $30.0 million for the new Franklin distribution
facility and most of the related equipment were financed through special purpose
entities. The property and related Mortgage Notes Payable were recorded on the
Company's Consolidated Balance Sheet after terms of amendments to the operating
leases required consolidation of the special purpose entities as of October 1996
and June 1997, the dates of the respective amendments. See Note 15 of Notes to
Consolidated Financial Statements.
While management does not currently intend to significantly expand its store
base, the Company plans to open selected new stores in order to fill out
existing markets or capitalize on attractive leasing opportunities. The Company
anticipates capital expenditures in 1998 of approximately $20 million,
consisting primarily of improvements to existing stores. The Company anticipates
that these capital expenditures will be financed by borrowings under the
Revolver and internally generated cash. The Company will continue to assess the
profitability of its stores and will close a limited number of underperforming
stores in the coming years, if the closings can be accomplished economically.
37
<PAGE>
FINANCING ACTIVITIES. The Company's financing activities principally
consist of borrowings and repayments under its Revolver. Cash provided by (used
in) financing activities (excluding the increase (decrease) in outstanding
checks in excess of cash balances which relate to vendor payments) was $43.2
million, $219.0 million and $(233.8) million during the years ended December 31,
1995, 1996 and 1997, respectively. At December 31, 1996, the Company had
Revolver borrowings of $272.0 million, or $110.0 million when netted with $162.0
million of cash and cash equivalents. The higher level of Revolver borrowings in
1996 as compared to 1995 was primarily due to diminished liquidity that had
resulted from the challenging retail sales environment experienced by the
Company and the negative impact of underperforming stores. The $49.5 million of
net Term Loan proceeds received in September 1997 were used to reduce Revolver
borrowings. Excess cash generated from strong Christmas season sales in 1997 was
used to repay all outstanding Revolver borrowings by year end.
During the third quarter of 1995, the Company loaned $10.0 million to its
401(k) trust to finance the purchase of 1,042,900 shares of common stock of the
Company in the open market. The stock is used for a "KSOP" plan, which combines
features of a 401(k) plan and an employee stock ownership plan. See Note 6 of
Notes to Consolidated Financial Statements.
The Revolver expires in October 1999. The Company expects to enter into a
new financing arrangement on or before the expiration date of the Revolver.
Maturities of other long-term debt are $26.7 million in 1998, $46.0 million in
1999, $10.3 million in 2000 and $110.0 million in 2003. The Company may, at its
option, redeem the 2003 Notes prior to maturity at 103.375% of par on and after
June 15, 1998 and thereafter at prices declining annually to 100% of par on and
after June 15, 2001. The Mortgage Notes Payable agreements contain one year
renewal options which would extend maturities of $21.0 million and $10.3 million
to March 2000 and May 2001, respectively.
OTHER MATTERS
INFLATION, ECONOMIC TRENDS AND SEASONALITY. Although its operations are
affected by general economic trends, the Company does not believe that inflation
has had a material effect on the results of its operations during the past three
fiscal years. 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. See
Note 16 of Notes to Consolidated Financial Statements for quarterly financial
data.
YEAR 2000 COMPLIANCE. The Company has assessed its systems and equipment
with respect to Year 2000 compliance and has developed a project plan. Many of
the Year 2000 issues, including the processing of credit card transactions, have
been addressed. The remaining Year 2000 issues will either be addressed with
scheduled system upgrades or through the Company's internal systems development
staff. The incremental costs will be charged to expense as incurred and are not
expected to have a material impact on the financial position or results of
operations of the Company. However, the Company could be adversely impacted if
Year 2000 modifications are not properly completed by either the Company or its
vendors, banks or any other entity with whom the Company conducts business.
Accordingly, the Company plans to devote the necessary resources to resolve all
significant Year 2000 issues in a timely manner.
38
<PAGE>
BUSINESS
GENERAL
The Company is the leading specialty retailer of prerecorded music in the
United States and is one of the largest national full-media retailers of music,
video sell-through, books, computer software and related products. The Company's
stores operate under two principal strategies: (i) mall based music and video
sell-through stores (the "Mall Stores"), operating under the principal trade
names Sam Goody and Suncoast Motion Picture Company ("Suncoast"), and (ii)
non-mall based full-media superstores (the "Superstores"), operating under the
trade names Media Play and On Cue. At December 31, 1997, the Company operated
1,363 stores in 49 states, the District of Columbia, the Commonwealth of Puerto
Rico, the Virgin Islands and the United Kingdom. For the year ended December 31,
1997, the Company had consolidated revenues of $1.8 billion, including $1.2
billion from the Mall stores and $0.6 billion from the Superstores, and EBITDA
of $85.4 million.
MALL STORES
SAM GOODY. Sam Goody is a well established music retailer that provides a
broad selection in an exciting, customer friendly shopping environment. Sam
Goody stores offer a full line of music, along with video and related products.
The music stores are predominantly found in mall locations and range in size
from 1,000 to 30,000 square feet, averaging 4,300 square feet. The larger music
stores are in more prominent mall or downtown locations and carry a broader
inventory of catalog product, including substantial classical offerings and
video sell-through, to appeal to the high volume purchaser. Many of the music
stores previously operated under the Musicland name have been converted to the
Sam Goody name.
More than 400,000 Sam Goody store customers participate in the REPLAY
program, a frequent shopper program designed to promote customer loyalty and
enable targeted marketing. An increased emphasis has been placed on Latin music
and other niche music categories as part of efforts to broaden the music store
customer base.
During 1997, the Company opened two new stores and closed 66 stores,
including 33 closings under the Company's restructuring programs and 33 other
underperforming stores, most of which were near the end of their lease terms. At
December 31, 1997, the Company operated 713 music stores in 49 states, the
District of Columbia, the Commonwealth of Puerto Rico and the Virgin Islands.
The total square footage of music stores was approximately three million square
feet, or 37% of the Company's total store square footage at December 31, 1997.
SUNCOAST. Suncoast is the dominant mall based video sell-through retailer
in the United States, offering a broad selection and excellent customer service
in an entertaining atmosphere. Suncoast stores average 2,400 square feet in size
and typically feature 8,000 to 10,000 video titles along with movie and video
related apparel, DVDs, special order video and other related products. The video
categories include adventure, comedy, drama, family, animated, musicals, music
video, instructional and other special interest. Most of the movies are priced
at less than $20 and more than half sell for less than $15. Each store also
offers a wide selection of feature films and videos for less than $10.
Management plans to establish Suncoast stores as a primary retailer of DVD by
offering a broad assortment of titles and developing marketing programs to
encourage repeat visits. Suncoast stores currently carry an average of 500
titles on the new DVD format, which will be increased as more titles become
available and as the number of homes with DVD players increases. Most of the DVD
titles are priced at $20 to $30.
Suncoast's marketing programs include sweepstakes, instant rebates and
exclusive merchandise events promoting recent video releases. Suncoast stores
utilize theme and cross-promotional merchandising that coordinates the display
and sale of licensed merchandise with the related movie or genre to maximize
total sales. Niche marketing, such as product offerings related to Japanese
animation, or "Anime," was recently
39
<PAGE>
added in Suncoast stores. Beginning in 1998, new audiences will also be targeted
through the expansion of advertising to radio and cable television.
At December 31, 1997, there were 409 Suncoast stores in 46 states, the
District of Columbia and the Commonwealth of Puerto Rico. The Company opened no
new Suncoast stores during 1997 and closed a total of 13 stores, including nine
closings under the Company's restructuring programs and four other
underperforming stores. The total square footage of Suncoast stores was
approximately one million square feet, or 12% of the Company's total store
square footage at December 31, 1997.
SUPERSTORES
MEDIA PLAY STORES. Media Play is a full-media superstore retailer of
entertainment software products providing a superior assortment at competitive
prices. Media Play stores average 48,000 square feet in size and are in
freestanding and strip mall locations primarily in urban and suburban areas. The
extensive merchandise assortment of compact discs, books, video and computer
software, complemented by other media and related products including magazines,
video games, educational toys, greeting cards and apparel appeals to customers
of all ages. Media Play stores provide a family oriented and exciting shopping
environment featuring easy access to all merchandise categories, lounge areas
for relaxed browsing, convenient customer service areas, live performances and
other entertainment activities, children's play areas, coffee carts and popcorn
stands. A variety of in-store events, such as musician appearances, book clubs
and drawing events, are held throughout the year to attract customers. The
non-mall locations and largely self-service environment lower operating costs
and enable Media Play stores to offer products at competitive prices. See
"Business Strategy--Improve Media Play Profitability."
The first Media Play store opened in Rockford, Illinois in November 1992.
During 1997, 19 Media Play stores were closed under the Company's restructuring
programs. At December 31, 1997, the Company operated 68 Media Play stores in 19
states with total square footage of approximately three million square feet, or
39% of the Company's total store square footage.
ON CUE STORES. On Cue is a full-media retailer in small towns, generally
with populations between 8,000 and 20,000 people, providing a wide assortment of
entertainment software products at competitive prices. On Cue stores average
6,200 square feet in size and offer customers a convenient local store to shop
for music, books, video, computer software and related products with superior
customer service to encourage repeat business. On Cue customers also have access
to over 100,000 home entertainment titles through the Company's special order
program. Customer loyalty is rewarded through such programs as in-store
sweepstakes and unadvertised in-store specials. On Cue stores are promoted
through highway billboards, direct mail, cable television and local print and
radio.
The first On Cue store opened in February 1992. The Company opened one On
Cue store and closed two stores in 1997. At December 31, 1997, the Company
operated 157 On Cue stores in 28 states with total square footage of
approximately one million square feet, or 12% of the Company's total store
square footage.
INTERNATIONAL STORES
The Company operates music stores in the United Kingdom under the name Sam
Goody. During 1997, the Company focused on improving the profitability of its
United Kingdom stores, closing six underperforming stores while opening no new
stores. At December 31, 1997, the Company had 16 stores in operation averaging
approximately 2,800 square feet in size. The United Kingdom stores provide for
their own corporate services, including purchasing and distribution.
Beginning in 1995, the Company's financial results began to deteriorate as a
result of: (i) aggressive expansion of product offerings and new store openings
by most of the Company's non-mall competitors; (ii) severe price discounting of
music products by certain non-mall competitors; (iii) a lack of strong selling
40
<PAGE>
hits in the music industry, which depressed sales throughout the industry; and
(iv) the Company's own rapid expansion of Media Play stores in response to
encouraging initial results. In 1996 management initiated restructuring programs
designed to improve the Company's cash flow and profitability. The major
components of the restructuring programs included: (i) closing 114
underperforming stores, which in the last full year of their operations lost an
aggregate of $17.7 million on an operating contribution basis; (ii) closing one
of the Company's two distribution centers, which reduced the Company's working
capital investment by approximately $20 million and contributed to a $6.9
million reduction in distribution costs in 1997; and (iii) improving inventory
management techniques, which increased the Company's inventory turnover from 1.8
times during 1996 to 2.1 times during 1997. Inventory levels at year-end 1997
were $55.8 million below those of the prior year with approximately $30 million
of the reduction due to store closings and the remainder attributable to
distribution efficiencies and improved inventory management. The Company reduced
Media Play advertising expense by $7.9 million in 1997 from the prior year as a
result of closing stores in entire markets and the introduction of a less
costly, but more targeted, program of newspaper advertising inserts. In
addition, in 1997 the Company began to benefit from positive trends in the music
retailing industry, including a retreat from severe price discounting and an
increase in unit sales. As a result, the Company's EBITDA increased from $35.1
million in 1996 to $85.4 million in 1997, and comparable store sales improved
from a decrease of 0.6% in 1996 to an increase of 4.5% in 1997.
COMPETITIVE STRENGTHS
The Company believes that it benefits from the following competitive
advantages:
LARGEST NATIONAL MUSIC RETAILER. The Company is the largest specialty
retailer of music in the United States, with music available in all 1,363
stores. The Company's leading market presence allows the Company to: (i) spread
its fixed operating costs over a large revenue base; (ii) realize distribution
savings through freight consolidation; (iii) take advantage of vendor discounts
and cooperative advertising programs; (iv) negotiate more effectively with
national landlords; (v) use national advertising media; and (vi) benefit from
market clustering. A national distribution of stores also minimizes the impact
on the Company of regional business trends. In recent years, as a result of
adverse industry conditions, a number of mall based music chains have closed
hundreds of stores. Although the Company has also closed underperforming stores,
the Company was the single music retailer in 285 malls at the end of 1997
compared to 274 malls at the end of 1996.
SOPHISTICATED INVENTORY MANAGEMENT AND DISTRIBUTION SYSTEMS. Management
believes that the Company's proprietary retail inventory management ("RIM") and
distribution systems are the most sophisticated in the industry, allowing the
Company to manage its inventory more effectively than its competitors. The RIM
system performs comprehensive merchandise control functions on both an
individual store and a company wide basis. It maintains an inventory profile for
every store, incorporates an "intelligent" new release allocation system and
adjusts and monitors store inventory on a daily basis. The RIM system allows the
Company to meet demand for fast selling titles and carry a broad range of
current hits and catalog titles while avoiding excess inventory and substantial
returns. In January 1997, the Company consolidated its distribution operations
into its state-of-the-art, centrally located facility in Franklin, Indiana, that
contains 715,000 square feet. This facility incorporates computerized processing
and laser technology for receiving, storing, sorting and shipping new product
and returns. This technology has enabled the Company to implement "just-in-time"
inventory management with certain vendors, which reduces working capital.
STRONG BRAND NAME RECOGNITION. The Company benefits from strong national
brand name recognition and continually markets to strengthen the brand images
for each of its retail concepts. Strong brand name recognition offers advantages
in advertising, in-store events and marketing partnerships. A 1997 national
survey by Strategic Record Research determined that more music consumers
preferred shopping at the Company's stores than at other music stores. The
Company is able to attract large corporate
41
<PAGE>
partners such as Pepsi-Cola, Sears, VISA, MasterCard and L'Oreal for cross
promotions, events and sweepstakes that the Company believes are attractive to
shoppers. The Company's monthly REQUEST magazine, with an annual audited
circulation of 6 million copies, is an award winning, cutting edge music
publication. REQUEST offers numerous cross marketing opportunities with Sam
Goody and the Company's other concepts and reinforces the Company's brand names
with consumers.
LONG-STANDING VENDOR RELATIONSHIPS. The Company believes its relationships
with major music and video vendors are among the best in the industry. Strong
vendor relations allow the Company to be creative in its marketing programs and
business operations. The Company's long-standing relationships with vendors are
further enhanced because: (i) the Company's large selection of products provides
vendors with a needed outlet for their catalog product, which is generally more
profitable than hit product; and (ii) the Company's RIM system allows the
Company to manage product returns at rates below the industry average, which is
an economic benefit to the vendors. Management believes that the continued
support of its vendors in 1996 and 1997 is a testament to the strength of its
vendor relationships.
BUSINESS STRATEGY
The Company's objective is to continue to increase revenue, cash flow and
profitability. Management believes that the Company's recent operating results
have begun to reflect the successful implementation of its business strategy.
The key elements of the Company's business strategy are as follows:
STRENGTHEN STORE BASE. After closing 236 underperforming stores over the
past three years, management believes that its current store base is well
positioned for future growth. Management intends to improve sales by enhancing
brand name awareness and increasing store traffic through creative advertising
and marketing programs. Management also intends to remodel certain stores in
order to enhance their appeal to customers. While management does not currently
intend to significantly expand its store base, the Company will open selected
new stores in order to fill out existing markets or capitalize on attractive
leasing opportunities. The Company will continue to assess the profitability of
its stores and will close a limited number of underperforming stores in the
coming years, if the closings can be accomplished economically.
CAPITALIZE ON FAVORABLE INDUSTRY DYNAMICS. The Company expects sales of its
products to increase due to: (i) increased consumer spending; (ii) favorable
demographic trends; and (iii) the advent of new technologies. Through 2001,
consumer spending on pre-recorded music, video sell-through and trade books is
projected to grow at compounded annual growth rates of 5.6%, 11.2% and 5.8%,
respectively (according to Veronis, Suhler & Associates). Demographic shifts
over the next few years are expected to contribute to sales growth. The 15 to 24
age group, whose members are known to be mall-shoppers and strong music buyers,
is projected to be 4.1% larger in the year 2000 than its size in 1995. The
principal book buying population, between 35 and 54 years of age, is projected
to grow in the same period by 12.3%. Children's music, video, books and toys
should benefit by a growth of 6.4% in the 5 to 14 age group in the same period
(source: U.S. Bureau of Census 1996). Historically, the introduction of new
technology, such as compact discs, has had a positive impact on the Company's
business, and the most encouraging new technology today is DVD. Veronis, Suhler
& Associates projects that by 2001 annual consumer spending on DVDs will be
approximately $1.2 billion. Most of the Company's stores carry DVD, and Suncoast
in particular is pursuing the early adopters of this new format.
INCREASE GROSS MARGIN. The Company believes the following initiatives will
benefit gross margin: (i) selective price decisions in response to the
competitive environment in various markets; (ii) adjustments to merchandise
assortment to include more higher margin products; and (iii) cross promotions on
product lines to increase sales of high margin ancillary products, such as
apparel.
REDUCE WORKING CAPITAL. The Company plans to continue reducing working
capital by: (i) expanding the "just in time" inventory program, which completely
eliminates backup inventory, to include more
42
<PAGE>
products and selective additional vendors; (ii) implementing more precise buying
rules to reduce returns; and (iii) eliminating less profitable product lines.
IMPROVE MEDIA PLAY PROFITABILITY. The Company will concentrate on improving
profitability in all concepts, but particularly in Media Play. The Company's
efforts to increase sales, improve gross margin, increase customer traffic and
reduce operating costs in its Media Play stores includes the following
initiatives: (i) introducing new merchandise assortments; (ii) altering
departmental and store layouts; and (iii) reducing operating costs through
improved store management, expense control and inventory management. Of the
Company's four concepts, Media Play showed the most significant profitability
improvement in 1997.
PRODUCTS
The following table shows the sales and percentage of total sales
attributable to each product group.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
1995 1996 1997
-------------------- -------------------- --------------------
SALES % SALES % SALES %
--------- --------- --------- --------- --------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Music................................................ $ 895.0 51.9% $ 931.1 51.1% $ 930.0 52.6%
Video................................................ 505.9 29.4 531.2 29.2 509.1 28.8
Books, computer software and other products.......... 321.9 18.7 359.3 19.7 329.2 18.6
--------- --------- --------- --------- --------- ---------
Total.............................................. $ 1,722.8 100.0% $ 1,821.6 100.0% $ 1,768.3 100.0%
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
MUSIC. Sales of compact discs are expected to continue to grow and become a
larger portion of total music sales while sales of audio cassettes are expected
to continue to decline, although at a slower rate than in recent years. Sam
Goody stores typically carry 4,500 to 8,500 compact disc titles, depending upon
store size and location, while the largest Sam Goody stores carry up to 45,000
compact disc titles. Media Play and On Cue stores carry up to 50,000 and 5,000
compact disc titles, respectively. These titles include "hits," which are the
best selling newer releases, and "catalog" items, which are older but still
popular releases that customers purchase to build their collections. The Company
also produces and sells music under its "Excelsior" label, which include
compilations of public domain classical, jazz, big band and reggae music.
VIDEO. Video cassettes are for sale at all of the Company's stores.
Suncoast stores feature up to 15,000 video titles. Media Play stores carry up to
16,000 titles. Sam Goody stores typically carry 2,000 titles, while the largest
Sam Goody stores carry up to 14,000 titles. On Cue stores carry up to 4,500
titles.
Merchandising of DVD, a new video technology, began in 1997. DVD offers the
consumer laser technology in a smaller disc format with superior picture quality
and audio fidelity. The Company believes that in the next few years, sales of
DVD players will begin to replace sales of laserdisc players and video cassette
recorders as the new technology becomes widely available. DVD is currently
available in Sam Goody, Suncoast and Media Play stores and selected On Cue
stores. The Company's DVD sales in 1997 were 1.8% of total video sales, but
accelerated in the months of December 1997 and January 1998 to 3.4% and 8.2%,
respectively, of total video sales. DVD is expected to grow rapidly and, if
successful, to become an important part of the video industry by the year 2000.
However, DVD demand could accelerate faster or slower depending upon how
consumers react to its technical superiority over the VHS format and the
introductory price points of the hardware and software. See "Risk Factors--Risk
from New Technologies."
BOOKS, COMPUTER SOFTWARE AND OTHER PRODUCTS. Media Play and On Cue stores
carry up to 50,000 and 6,500 titles of books, respectively. Computer software is
available primarily in Media Play stores, which offer 2,000 computer software
programs. "Other Products" refers to video games, brand name blank audio and
video tapes, storage containers, carrying cases and sheet music, as well as
entertainment related
43
<PAGE>
apparel, posters and various other items. Movie and artist related accessories
and apparel are highly influenced by the trends and fads surrounding popular
movies, actors and artists. The Company's stores also carry a limited variety of
portable electronic equipment such as audio cassette players, radios and stereo
audio cassette/radios, generally sold at retail prices of approximately $200 or
less.
SUPPLIERS
Substantially all of the home entertainment products (other than computer
software) sold by the Company are purchased directly from manufacturers. The
Company purchases inventory for its stores from approximately 2,400 suppliers.
Approximately 68% of purchases in 1997 were made from the ten largest suppliers.
The Company has no long-term contracts with its suppliers and transacts business
principally on an order-by-order basis as is typical throughout the industry.
See "Risk Factors--Relationships with Vendors."
MARKETING
The Company uses a high level of advertising and promotions in marketing its
products. Marketing and advertising programs include special events, advertising
partnerships with vendors and corporate partnerships with nationally known
names. Additionally, frequent buyer programs in the Company's mall stores and
certain product specific programs in On Cue stores are designed to build
customer loyalty and encourage repeat visits. The Company has been sponsoring
nationally televised/advertised events such as ESPN's Xtreme Games and the
"UnVailed" battle of the bands, which appeal to its target customers. Other
advertising programs which are being created in conjunction with vendors include
television and billboard ads featuring specific albums or movies. In addition,
the Company publishes REQUEST, a cutting-edge music and video entertainment news
magazine for younger customers. REQUEST is distributed in the music stores as
well as Media Play and On Cue stores and also at limited magazine stand outlets.
The magazine has an annual audited circulation of six million copies and an
estimated readership in the millions.
The Company's major suppliers offer cooperative advertising support and
provide funds for the placement and position of product. A significant portion
of the Company's total advertising costs have been funded by suppliers through
these programs. The Company advertises principally through newspaper inserts.
Because of the high concentration of its mall stores in major metropolitan areas
such as New York, Chicago and Los Angeles, the Company has been able to expand
its radio and local television advertising in those areas. The national
distribution of the Company's mall stores has made it practical to advertise in
certain national magazines and on nationally syndicated radio programs and cable
television, including MTV.
STORE OPERATIONS
Sam Goody, Suncoast and On Cue stores are typically managed by a store
manager and an assistant manager. Media Play stores typically are managed by a
general manager, an assistant general manager and three to five department
managers. Most stores are open up to 80 hours per week, seven days a week. The
Company does not extend credit to customers, but most major credit cards are
accepted.
COMPETITION
The Company operates in highly competitive markets which are generally local
or individual in nature. The Company competes on the basis of service, selection
and price, with a broad range of specialty, discount and other retailers, and
certain national chains, some of whom have greater financial and marketing
resources than the Company. The number of stores and types of competitors have
increased significantly over recent years, including non-mall discount stores,
consumer electronic superstores, and mall based music, video and book specialty
retailers expanding into non-mall multimedia stores. The low
44
<PAGE>
prices offered by these non-mall stores have created intense price competition
and adversely impacted the performance of both the Company's non-mall and mall
stores. Although deep discount pricing by many retailers of entertainment
products abated somewhat in 1997, there can be no assurance that if such
practice returns the Company will continue to achieve satisfactory gross margins
while remaining competitive.
In addition, the Company competes for consumer time and spending with all
leisure time activities, such as movie theaters, television, home computing and
internet use, live theater, sporting facilities and spectator events, travel,
amusement parks and other family entertainment centers. The Company's ability to
compete successfully depends on its ability to secure and maintain attractive
and convenient locations, market and manage merchandise attractively and
efficiently, offer an extensive product selection and knowledgeable customer
service and provide effective management. See "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Results of
Operations--Gross Profits."
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. Quarterly
results are affected by, among other things, the timing of holidays, new product
offerings and new store openings and sales performance of existing stores. See
Note 16 of Notes to Consolidated Financial Statements.
TRADEMARKS AND SERVICE MARKS
The Company operates its stores under various names, including "Sam Goody,"
"Musicland," "Suncoast Motion Picture Company," "Media Play" and "On Cue," which
have become important to the Company's business as a result of its advertising
and promotional activities. These names, along with a number of others,
including "REQUEST," "REPLAY," "Excelsior" and "Channel 1000," have been
registered with the U.S. Patent and Trademark Office. The Company intends to
continue to use these names and marks and may use new names for specific stores
depending on the type of store and its location.
PERSONNEL
As of January 26, 1998, the Company employed approximately 5,800 full-time
employees, 9,600 part-time employees and 1,000 temporary employees. Hourly
employees at 15 of the Company's stores are represented by unions. All other
facilities are non-union and the Company believes that its employee relations
are good.
PROPERTIES
CORPORATE HEADQUARTERS AND DISTRIBUTION FACILITIES. The Company owns its
corporate headquarters facility in Minneapolis, Minnesota, consisting of an
office building with approximately 94,000 square feet of space on approximately
5.4 acres of land. Approximately 73,000 square feet of office and storage space
in Minneapolis, Minnesota is under an operating lease that expires in January
2002. The Company's distribution facilities are located in Franklin, Indiana and
consist of a 715,000 square foot building on approximately 66.6 acres of land,
with options on approximately 33.4 acres of land. See Note 4 and Note 15 of
Notes to Consolidated Financial Statements.
STORE LEASES. Most of the Company's stores are under operating leases with
various remaining terms through the year 2017. The Company owns three Media Play
stores. The leases have terms ranging from 3 to 25 years. Certain store leases
contain provisions restricting assignment, merger, change of control or
transfer. In most instances, the Company pays, in addition to minimum rent, real
estate taxes, utilities, common area maintenance costs and percentage rents
which are based upon sales volume. Certain store leases provide the Company with
an early cancellation option if sales for a designated period do not reach
45
<PAGE>
a specified level as defined in the lease. The following table lists the number
of leases due to expire or terminate in each fiscal year based on the fixed
lease term, giving effect to early cancellation options and excluding renewal
options.
<TABLE>
<S> <C> <C> <C>
1998......................... 157 2003......................... 141
1999......................... 203 2004......................... 127
2000......................... 208 2005......................... 107
2001......................... 185 2006......................... 43
2002......................... 117 2007 and thereafter.......... 72
</TABLE>
A total of 168 leases without renewal options will expire in the years 1998
and 1999. Although the Company has historically been successful in renewing most
of its store leases when they have expired, there can be no assurance that the
Company will continue to be able to do so on acceptable terms or at all in light
of the recent restructuring programs. If the Company is unable to renew leases
for its stores as they expire, or find favorable locations on acceptable terms,
there can be no assurance that such failures will not have a material adverse
effect on the Company's financial condition or results of operations.
LEGAL PROCEEDINGS
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business. It is the opinion of management that
the ultimate resolution of these matters will not have a material adverse effect
on the financial position or results of operations of the Company.
46
<PAGE>
MANAGEMENT
The following table sets forth certain information with respect to each
person who is an executive officer or director of the Company. All directors and
executive officers serve in the same capacities for both MSC and MGI:
<TABLE>
<CAPTION>
NAME AGE TITLE
- - --------------------------------------------- --- ------------------------------------------------------------
<S> <C> <C>
Jack W. Eugster.............................. 52 Chairman of the Board, President and Chief Executive Officer
Keith A. Benson.............................. 53 Vice Chairman, Chief Financial Officer and Director
Gilbert L. Wachsman.......................... 50 Vice Chairman and Director
Gary A. Ross................................. 51 President, Superstores Division
Douglas M. Tracey............................ 44 Senior Vice President of Distribution
Marcia F. Appel.............................. 47 Senior Vice President of Corporate Advertising, Partnership
Marketing and Communications
Richard J. Odette............................ 54 Senior Vice President of Prerecorded Audio
Kenneth F. Gorman............................ 58 Director
William A. Hodder............................ 66 Director
Josiah O. Low, III........................... 58 Director
Terry T. Saario.............................. 56 Director
Thomas F. Weyl............................... 54 Director
Michael W. Wright............................ 59 Director
</TABLE>
JACK W. EUGSTER. Mr. Eugster has been Chairman of the Board of the Company
since August 1988. He has been the Chairman of the Board, President and Chief
Executive Officer of MGI since August 1986 and has served MSC in the same
capacity since its acquisition of MGI in August 1988. Mr. Eugster joined MGI in
1980 as Executive Vice President and has held the positions of General Manager,
President and Chairman of the Retail Division. Previously, he was with The Gap
Stores and Target Stores. Mr. Eugster is also a director of Damark
International, Inc., Donaldson Company, Inc., MidAmerican Energy Company, ShopKo
Stores, Inc. and Jostens, Inc. He is a director and past president of the
National Association of Recording Merchandisers and a past chairman of the
Country Music Association.
KEITH A. BENSON. Mr. Benson has been a director of the Company since
January 1992 and served a prior term as a director from August 1988 until
December 1989. Mr. Benson was elected Vice Chairman and Chief Financial Officer
on August 4, 1997. Mr. Benson has been an executive officer of the Company since
1988. For the year prior, since August 1996, Mr. Benson was President of the
Mall Stores Division. Previously, Mr. Benson had served as President of the
Music Stores Division since August 1994. From May 1992 through July 1994, he
filled the position of Vice Chairman and Chief Financial Officer for both the
Company and MGI. Prior to that he was Executive Vice President and Chief
Financial Officer from 1988 through April 1992. Mr. Benson joined MGI in 1980 as
its Controller and also served successively as its Senior Vice President and
Chief Financial Officer, Senior Vice President and Chief Financial Officer for
the Retail Division and Senior Vice President of Finance and Administration for
the Retail Division. Previously he was with The May Company and Dayton Hudson
Corporation. Mr. Benson is also a director of Premium Wear, Inc.
47
<PAGE>
GILBERT L. WACHSMAN. Mr. Wachsman has been a director of the Company since
May 1997. He became the Vice Chairman of the Company on July 17, 1996. Prior to
joining the Company, Mr. Wachsman held the position of Senior Vice President
Hardlines at Kmart Corporation from 1995 to 1996. From 1990 to 1995 Mr. Wachsman
was a management consultant for major retail, distribution and manufacturing
companies. Prior to that he was Chief Executive Officer at Lieberman
Enterprises, Inc., President and Chief Executive Officer for Child World Inc.
and Senior Vice President of Marketing/ Merchandising for Target Stores.
GARY A. ROSS. Mr. Ross has been President, Superstores Division since
August 1996. Prior to that he served in the position of President of the
Suncoast Division since 1990. Since joining MGI in 1984, he has served in the
positions of Executive Vice President of Marketing and Merchandising, Senior
Vice President of Marketing and Merchandising, Senior Vice President of
Marketing and Merchandising of the Retail Division and Senior Vice President of
Planning and Administration of the Retail Division. Mr. Ross served as a
director of the Company from January 1, 1990 to December 31, 1990. Mr. Ross is a
past chairman and currently a director of the Video Software Dealers
Association. Prior to joining MGI, he was with The Gap Stores and Target Stores.
DOUGLAS M. TRACEY. Mr. Ross has been Senior Vice President of Distribution
since August 1994. He was first appointed a senior vice president in April 1992
and has served in the positions of General Manager of the On Cue Division,
Senior Vice President of Marketing Services and Senior Vice President of
Administration and Distribution. Previously, from 1986 through April 1992, he
served as Vice President, Distribution. Mr. Tracey joined MGI in 1971 and has
held the positions of Managing Director of National Distribution, General
Manager Minneapolis Distribution Center, Manager of Policies and Procedures,
National Store Operations Manager, District Supervisor and Store Manager.
MARCIA F. APPEL. Ms. Appel has been Senior Vice President of Corporate
Advertising, Partnership Marketing and Communications since October 1996.
Previously, she had served as Vice President, Communications and Music Stores
Marketing since February 1996. Ms. Appel joined the Company in April of 1993 as
Vice President, Communications and Publications. Prior to joining MGI, Ms. Appel
was Executive Director of the National Association of Area Business
Publications, and she has also worked for Control Data Corporation and Dorn
Communications. Ms. Appel is deputy to the Chief Executive Officer of the
Minnesota Business Partnership and sits on the Minnesota Women's Press Advisory
Board.
RICHARD J. ODETTE. Mr. Odette was elected Senior Vice President,
Prerecorded Audio on January 4, 1998. Previously, Mr. Odette had served as Vice
President, Prerecorded Audio since 1988. Mr. Odette joined MGI in 1982 and has
held the positions of Managing Director of Software, Director of Software
Merchandising, National Merchandising Manager of Software, and Zone
Merchandising Manager for the Retail Division. Prior to joining MGI, Mr. Odette
was with Richard's Inc. and Target Stores, Inc.
KENNETH F. GORMAN. Mr. Gorman has been a director of the Company since
November 1988. He has been in the merchant banking and private investment fields
since 1987 as an owner and Managing Director of Apollo Partners L.L.C. From 1970
until 1987 he was in the communications/entertainment business as a director and
Executive Vice President of Viacom International Inc. Mr. Gorman is also a
director of Dove Audio, Doane Farm Management Co., and IDC Services, Inc.
48
<PAGE>
WILLIAM A. HODDER. Mr. Hodder has been a director of the Company since July
1995. He is the retired Chairman and Chief Executive Officer of Donaldson
Company, Inc., a manufacturer of filtration devices. Mr. Hodder joined Donaldson
Company in 1973 as its President. Previously, he spent seven years in retailing
with Dayton Hudson Corporation including such positions as Senior Vice President
and Corporate Group Executive, President of Target Stores and Vice President of
Organization Planning and Development. Mr. Hodder is a director of Norwest
Corporation, ReliaStar Financial, SUPERVALU INC., and Tennant Company.
JOSIAH O. LOW, III. Mr. Low has been a director of the Company since July
1995. He has been an investment banker with Donaldson, Lufkin & Jenrette
Securities Corporation since 1985, where he is currently a Managing Director.
Previously he spent 24 years with Merrill Lynch, Pierce, Fenner and Smith. Mr.
Low is also a director of Centex Development Corporation and St. Laurent
Paperboard Inc.
TERRY T. SAARIO. Dr. Saario was elected a director of the Company on
February 3, 1998. From 1984 to 1996 Dr. Saario served as President of the
Northwest Area Foundation, an eight state regional organization. Previously she
held the positions of Vice President of Community Relations at the Pillsbury
Company, Deputy Assistant Secretary in the Department of Education and Program
Officer at the Ford Foundation. Dr. Saario was a director of Cowles Media
Company until its recent sale and is a current director of Minnesota Mutual
Insurance Company.
TOM F. WEYL. Mr. Weyl has been a director of the Company since December
1992. He is the President/ Chief Creative Officer at Martin/Williams
Advertising, Minneapolis and has been with that company since 1973. Mr. Weyl is
a past Chairman of the Board of Directors of the Twin Cities Council of the
American Association of Advertising Agencies.
MICHAEL W. WRIGHT. Mr. Wright has been a director of the Company since
January 1989. He has been in the food distribution and retail business since
1977 when he joined SUPERVALU INC. as Senior Vice President. He was elected
President and Chief Operating Officer of SUPERVALU INC. in 1978 and became its
Chief Executive Officer in June 1981. He assumed the additional responsibilities
of Chairman of the Board in October 1982. In addition to SUPERVALU INC., Mr.
Wright is a director of Cargill, Incorporated, Honeywell Inc., and Norwest
Corporation. He also serves as Chairman of the Food Marketing Institute.
49
<PAGE>
DESCRIPTION OF NOTES
GENERAL
The Old Notes have been, and the New Notes will be issued pursuant to an
indenture (the "Indenture") among the Issuer, the Issuer's parent corporation,
Musicland Stores Corporation (the "Guarantor" or "MSC") and Bank One, NA, as
trustee (the "Trustee"). The terms of the Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Notes are
subject to all such terms, and holders of Notes are referred to the Indenture
and the Trust Indenture Act for a statement thereof. The following summary of
the material provisions of the Indenture does not purport to be complete and is
qualified in its entirety by reference to the Indenture, including the
definitions therein of certain terms used below. Copies of the Indenture and
Registration Rights Agreement are available as set forth below under
"--Additional Information." The definitions of certain terms used in the
following summary are set forth below under "--Certain Definitions."
The Notes will be general unsecured obligations of the Issuer, subordinated
in right of payment to all existing and future Senior Debt of the Issuer,
including Indebtedness pursuant to the Credit Facility. The Issuer's obligations
under the Notes will be guaranteed (the "Guarantee") on a senior subordinated
basis by the Guarantor. See "--Guarantee." As of March 1, 1998, on a pro forma
basis giving effect to the issuance of the Notes and the application of the
proceeds therefrom, the Issuer would have had $83.0 million of Senior Debt. In
addition, on such date and pro forma basis, the Issuer could have borrowed up to
an additional $99.0 million under the Revolver Agreement which would also have
constituted Senior Debt. In addition, all existing and future liabilities of the
Subsidiaries of the Issuer will be effectively senior to the Notes. See "Risk
Factors--Subordination" and "Description of Existing Financing Arrangements."
The operations of the Issuer are conducted in part through its Subsidiaries,
and the Issuer may, therefore, be dependent upon the cash flow of its
Subsidiaries to meet its debt obligations, including its obligations under the
Notes. See "Risk Factors--Corporate Structure." As of the date of the Indenture,
all of the Issuer's Subsidiaries will be Restricted Subsidiaries. However, under
certain circumstances, the Issuer will be able to designate current or future
Subsidiaries as Unrestricted Subsidiaries. Unrestricted Subsidiaries will not be
subject to many of the restrictive covenants set forth in the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Notes will be limited in aggregate principal amount to $150 million and
will mature on March 15, 2008. Interest on the Notes will accrue at the rate of
9 7/8% per annum and will be payable semi-annually in arrears on March 15 and
September 15 of each year, commencing on September 15, 1998, to holders of
record on the immediately preceding March 1 and September 1. Interest on the
Notes will accrue from the most recent date to which interest has been paid or,
if no interest has been paid, from the date of original issuance. Interest will
be computed on the basis of a 360-day year comprised of twelve 30-day months.
Principal, premium and Liquidated Damages, if any, and interest on the Notes
will be payable at the office or agency of the Issuer maintained for such
purpose within the City and State of New York or, at the option of the Issuer,
payment of interest and Liquidated Damages, if any, may be made by check mailed
to the holders of the Notes at their respective addresses set forth in the
register of holders of Notes; provided that all payments of principal, premium
and Liquidated Damages, if any, and interest with respect to Notes the holders
of which have given wire transfer instructions to the Issuer will be required to
be made by wire transfer of immediately available funds to the accounts
specified by the holders thereof. Until otherwise designated by the Issuer, the
Issuer's office or agency in New York will be the office of the Trustee
maintained for such purpose. The Notes will be issued in denominations of $1,000
and integral multiples thereof.
50
<PAGE>
SUBORDINATION
The payment of principal of, premium and Liquidated Damages, if any, and
interest on the Notes will be subordinated in right of payment, as set forth in
the Indenture, to the prior payment in full of all Senior Debt in cash, whether
outstanding on the date of the Indenture or thereafter created, incurred or
assumed and all permissible renewals, extensions, refundings or refinancings
thereof. Except to the extent set forth under "--Repurchase at the Option of the
Holders--Asset Sales", the Notes will be PARI PASSU in right of payment with the
2003 Notes.
The Indenture will provide that, upon any payment or distribution of assets
of the Issuer of any kind or character, whether in cash, property or securities,
to creditors in any Insolvency or Liquidation Proceeding with respect to the
Issuer all amounts due or to become due under or with respect to all Senior Debt
will first be paid in full in cash before any payment is made on account of the
Notes. Upon any such Insolvency or Liquidation Proceeding, any payment or
distribution of assets of the Issuer of any kind or character, whether in cash,
property or securities, to which the holders of the Notes or the Trustee would
be entitled will be paid by the Issuer or by any receiver, trustee in
bankruptcy, liquidating trustee, agent or other person making such payment or
distribution, or by the holders of the Notes or by the Trustee if received by
them, directly to the holders of Senior Debt (pro rata to such holders on the
basis of the amounts of Senior Debt held by such holders) or their
Representative or Representatives, as their interests may appear, for
application to the payment of the Senior Debt remaining unpaid until all such
Senior Debt has been paid in full in cash, after giving effect to any concurrent
payment, distribution or provision therefor to or for the holders of Senior
Debt.
The Indenture will provide that (a) in the event of and during the
continuation of any default in the payment of principal of, interest or premium,
if any, on any Senior Debt, or any Obligation owing from time to time under or
in respect of Senior Debt, or in the event that any event of default (other than
a payment default) with respect to any Senior Debt will have occurred and be
continuing and will have resulted in such Senior Debt becoming or being declared
due and payable prior to the date on which it would otherwise have become due
and payable, or (b) if any event of default other than as described in clause
(a) above with respect to any Designated Senior Debt will have occurred and be
continuing permitting the holders of such Designated Senior Debt (or their
Representative or Representatives) to declare such Designated Senior Debt due
and payable prior to the date on which it would otherwise have become due and
payable, then no payment will be made by or on behalf of the Issuer on account
of the Notes (x) in case of any payment or nonpayment default specified in (a),
unless and until such default will have been cured or waived in writing in
accordance with the instruments governing such Senior Debt or such acceleration
will have been rescinded or annulled, or (y) in case of any nonpayment event of
default specified in (b), during the period (a "Payment Blockage Period")
commencing on the date the Issuer or the Trustee receives written notice (a
"Payment Notice") of such event of default (which notice will be binding on the
Trustee and the holders of Notes as to the occurrence of such nonpayment event
of default) from the Credit Agent (or other holders of Designated Senior Debt or
their Representative or Representatives) and ending on the earliest of (A) 179
days after such date, (B) the date, if any, on which such Designated Senior Debt
to which such default relates is paid in full in cash or such default is cured
or waived in writing in accordance with the instruments governing such
Designated Senior Debt by the holders of such Designated Senior Debt and (C) the
date on which the Trustee receives written notice from the Credit Agent (or
other holders of Designated Senior Debt or their Representative or
Representatives), as the case may be, terminating the Payment Blockage Period.
During any consecutive 360-day period, the aggregate of all Payment Blockage
Periods shall not exceed 179 days and there shall be a period of at least 181
consecutive days in each consecutive 360-day period when no Payment Blockage
Period is in effect. No event of default which existed or was continuing with
respect to the Senior Debt for which notice commencing a Payment Blockage Period
was given on the date such Payment Blockage Period commenced shall be or be made
the basis for the commencement of any subsequent Payment Blockage Period unless
such event of default is cured or waived for a period of not less than 90
consecutive days.
51
<PAGE>
As a result of the subordination provisions described above, in the event of
the Issuer's liquidation, dissolution, bankruptcy, reorganization, insolvency,
receivership or similar proceeding or in an assignment for the benefit of the
creditors or a marshaling of the assets and liabilities of the Issuer, holders
of Notes may recover less ratably than creditors of the Issuer who are holders
of Senior Debt. See "Risk Factors-- Subordination." The Indenture will limit,
subject to certain financial tests, the amount of additional Indebtedness,
including Senior Debt, that the Issuer and its Subsidiaries can incur. See
"--Certain Covenants--Incurrence of Indebtedness and Issuance of Preferred
Stock."
GUARANTEE
MSC will unconditionally guarantee the due and punctual payment of the
principal of, premium, and Liquidated Damages, if any, and interest on the
Notes, when and as the same shall become due and payable, whether at maturity,
upon redemption or by declaration or otherwise. The guarantee will represent an
unsecured general obligation of MSC, subordinate in right of payment to all
Guarantor Senior Debt (as defined in the Indenture), including MSC's obligations
under its guarantee of the Issuer's obligations under the Credit Facility. The
guarantee will be subordinate to the same extent and on the same terms and
conditions as set forth above. See "Subordination." The guarantee will be PARI
PASSU in right of payment to MSC's guarantee of the 2003 Notes. The obligations
of MSC under its guarantee will be limited so as not to constitute a fraudulent
conveyance under applicable law.
OPTIONAL REDEMPTION
The Notes will not be redeemable at the Issuer's option prior to March 15,
2003. Thereafter, the Notes will be subject to redemption at any time at the
option of the Issuer, in whole or in part, upon not less than 30 nor more than
60 days' notice, at the redemption prices (expressed as percentages of principal
amount) set forth below plus accrued and unpaid interest and Liquidated Damages
thereon, if any, to the applicable redemption date, if redeemed during the
twelve-month period beginning on March 15 of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- - ---------------------------------------------------------------------------------- -----------
<S> <C>
2003.............................................................................. 104.938%
2004.............................................................................. 103.292
2005.............................................................................. 101.646
2006 and thereafter............................................................... 100.000%
</TABLE>
Notwithstanding the foregoing, at any time prior to March 15, 2001, the
Issuer may redeem up to 40% of the original aggregate principal amount of Notes
at a redemption price of 109.875% of the principal amount thereof, plus accrued
and unpaid interest and Liquidated Damages thereon, if any, to the redemption
date, with the net cash proceeds of a Public Equity Offering; provided that at
least 60% of the original aggregate principal amount of Notes remains
outstanding immediately after the occurrence of each such redemption; and
provided, further, that such redemption shall occur within 45 days of the date
of the closing of such Public Equity Offering.
SELECTION AND NOTICE
If less than all of the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange, if any, on which the
Notes are listed, or, if the Notes are not so listed, on a pro rata basis or by
lot; provided that no Notes of $1,000 or less shall be redeemed in part. Notices
of redemption shall be mailed by first class mail at least 30 but not more than
60 days before the redemption date to each holder of Notes to be redeemed at its
registered address. Notices of redemption may not be conditional. If any Note is
to be redeemed in part only, the notice of redemption that relates to such Note
shall state the portion of the principal amount thereof to be redeemed. A new
Note in principal amount equal to the unredeemed portion thereof will be issued
in the name of the holder thereof upon cancellation of the original Note.
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Notes called for redemption become due on the date fixed for redemption. On and
after the redemption date, interest ceases to accrue on Notes or portions of
them called for redemption.
MANDATORY REDEMPTION
Except as set forth below under "Repurchase at the Option of Holders," the
Issuer is not required to make mandatory redemption or sinking fund payments
with respect to the Notes.
REPURCHASE AT THE OPTION OF HOLDERS
CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each holder of Notes will have
the right to require the Issuer to repurchase all or any part (equal to $1,000
or an integral multiple thereof) of such holder's Notes pursuant to the offer
described below (the "Change of Control Offer") at an offer price in cash equal
to 101% of the aggregate principal amount thereof plus accrued and unpaid
interest and Liquidated Damages thereon, if any, to the date of purchase (the
"Change of Control Payment"). Within 30 days following any Change of Control,
the Issuer will mail a notice to each holder describing the transaction or
transactions that constitute the Change of Control and offering to repurchase
Notes on the date specified in such notice, which date shall be no earlier than
30 days and no later than 60 days from the date such notice is mailed (the
"Change of Control Payment Date"), pursuant to the procedures required by the
Indenture and described in such notice. The Issuer will comply with the
requirements of Rule 14e-1 under the Exchange Act and any other securities laws
and regulations thereunder to the extent such laws and regulations are
applicable in connection with the repurchase of the Notes as a result of a
Change of Control.
On the Change of Control Payment Date, the Issuer will, to the extent
lawful, (1) accept for payment all Notes or portions thereof properly tendered
pursuant to the Change of Control Offer, (2) deposit with the Paying Agent an
amount equal to the Change of Control Payment in respect of all Notes or
portions thereof so tendered and (3) deliver or cause to be delivered to the
Trustee the Notes so accepted together with an Officers' Certificate stating the
aggregate principal amount of Notes or portions thereof being purchased by the
Issuer. The Paying Agent will promptly mail to each holder of Notes so tendered
the Change of Control Payment for such Notes, and the Trustee will promptly
authenticate and mail (or cause to be transferred by book entry) to each holder
a new Note equal in principal amount to any unpurchased portion of the Notes
surrendered, if any; provided that each such new Note will be in a principal
amount of $1,000 or an integral multiple thereof. The Indenture will provide
that, prior to complying with the provisions of this covenant, but in any event
within 30 days following a Change of Control, the Issuer will either repay all
outstanding Indebtedness under the Credit Facility and terminate the commitments
thereunder or obtain the requisite consents under the Credit Facility to permit
the repurchase of Notes required by this covenant. The Issuer will publicly
announce the results of the Change of Control Offer on or as soon as practicable
after the Change of Control Payment Date.
Except as described above with respect to a Change of Control, the Indenture
does not contain provisions that permit the holders of the Notes to require that
the Issuer repurchase or redeem the Notes in the event of a takeover,
recapitalization or similar transaction.
Any future credit agreements or other agreements relating to Senior Debt to
which the Issuer becomes a party may contain certain change of control
restrictions and provisions. In the event a Change of Control occurs at a time
when the Issuer is prohibited from purchasing Notes, the Issuer could seek the
consent of its lenders to purchase the Notes or could attempt to refinance the
borrowings that contain such prohibition. If the Issuer does not obtain such
consent or repay such borrowings, the Issuer will remain prohibited from
purchasing Notes. In such case, the Issuer's failure to purchase tendered Notes
would constitute an Event of Default under the Indenture which would, in turn,
constitute a default under the Credit Facility. In such circumstances, the
subordination provisions in the Indenture would likely restrict
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payments to the holders of Notes. See "Risk Factors--Change of Control" and
"--Description of Existing Financing Arrangements."
The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the assets of the Issuer and its Subsidiaries taken as a whole. Although
there is a developing body of case law interpreting the phrase "substantially
all," there is no precise established definition of the phrase under applicable
law. Accordingly, the ability of a holder of Notes to require the Issuer to
repurchase such Notes as a result of a sale, lease, transfer, conveyance or
other disposition of less than all of the assets of the Issuer and its
Subsidiaries taken as a whole to another Person or group may be uncertain.
ASSET SALES
The Indenture will provide that the Issuer will not, and will not permit any
of its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the
Issuer (or the Restricted Subsidiary, as the case may be) receives consideration
at the time of such Asset Sale at least equal to the fair market value
(evidenced by a resolution of the Board of Directors set forth in an Officers'
Certificate delivered to the Trustee) of the assets or Equity Interests issued
or sold or otherwise disposed of and (ii) at least 80% of the consideration
therefor received by the Issuer or such Restricted Subsidiary is in the form of
cash; provided that the amount of (x) any liabilities (as shown on the Issuer's
or such Restricted Subsidiary's most recent balance sheet) of the Issuer or any
Restricted Subsidiary (other than contingent liabilities and liabilities that
are by their terms subordinated to the Notes or any Guarantee thereof) that are
assumed by the transferee of any such assets pursuant to a customary novation
agreement that releases the Issuer or such Restricted Subsidiary from further
liability and (y) any securities, notes or other obligations received by the
Issuer or any such Restricted Subsidiary from such transferee that are converted
by the Issuer or such Restricted Subsidiary into cash within 90 days (to the
extent of the cash received), shall be deemed to be cash for purposes of this
provision.
Within 360 days after the receipt of any Net Proceeds from an Asset Sale,
the Issuer may apply such Net Proceeds, at its option, (a) to permanently repay
Senior Debt (and to correspondingly reduce commitments with respect thereto in
the case of revolving borrowings) or existing 2003 Notes or (b) to the
acquisition of a controlling interest in another business, the making of a
capital expenditure or the acquisition of other long-term assets, in each case,
in a Permitted Business. Pending the final application of any such Net Proceeds,
the Issuer may temporarily reduce the revolving Indebtedness under the Credit
Facility or otherwise invest such Net Proceeds in any manner that is not
prohibited by the Indenture. Any Net Proceeds from Asset Sales that are not
applied or invested as provided in the first sentence of this paragraph will be
deemed to constitute "Excess Proceeds." When the aggregate amount of Excess
Proceeds exceeds $5.0 million, the Issuer will be required to make an offer to
all holders of Notes (an "Asset Sale Offer") to purchase the maximum principal
amount of Notes that may be purchased out of the Excess Proceeds, at an offer
price in cash in an amount equal to 100% of the principal amount thereof plus
accrued and unpaid interest and Liquidated Damages thereon, if any, to the date
of purchase, in accordance with the procedures set forth in the Indenture. To
the extent that the aggregate amount of Notes tendered pursuant to an Asset Sale
Offer is less than the Excess Proceeds, the Issuer may use any remaining Excess
Proceeds for general corporate purposes. If the aggregate principal amount of
Notes surrendered by holders thereof exceeds the amount of Excess Proceeds, the
Trustee shall select the Notes to be purchased on a pro rata basis. Upon
completion of such offer to purchase, the amount of Excess Proceeds shall be
reset at zero.
CERTAIN COVENANTS
RESTRICTED PAYMENTS
The Indenture will provide that from and after the date of the Indenture the
Issuer will not, and will not permit any of its Subsidiaries to, directly or
indirectly: (i) declare or pay any dividend or make any
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other payment or distribution on account of the Issuer's or any of its
Restricted Subsidiaries' Equity Interests or to the direct or indirect holders
of the Issuer's or any of its Restricted Subsidiaries' Equity Interests in their
capacity as such (other than dividends or distributions payable in Equity
Interests (other than Disqualified Stock) of the Issuer); (ii) purchase, redeem
or otherwise acquire or retire for value any Equity Interests of the Issuer or
any direct or indirect parent of the Issuer; (iii) make any payment on or with
respect to, or purchase, redeem, defease or otherwise acquire or retire for
value any Indebtedness that is PARI PASSU with or subordinated to the Notes
(other than the Notes and the 2003 Notes), except a payment of interest or
principal at Stated Maturity; or (iv) make any Restricted Investment (all such
payments and other actions set forth in clauses (i) through (iv) above being
collectively referred to as "Restricted Payments"), unless, at the time of and
after giving effect to such Restricted Payment:
(a) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof; and
(b) the Issuer would, at the time of such Restricted Payment and after
giving pro forma effect thereto as if such Restricted Payment had been made
at the beginning of the applicable four-quarter period, have been permitted
to incur at least $1.00 of additional Indebtedness pursuant to the Cash Flow
Coverage Ratio test set forth in the first paragraph of the covenant
described below under caption "--Incurrence of Indebtedness and Issuance of
Preferred Stock"; and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Issuer and its Subsidiaries after the
date of the Indenture (excluding Restricted Payments permitted by clauses
(ii) and (iii) of the next succeeding paragraph), is less than the sum of
(i) 50% of the Consolidated Net Income of the Issuer for the period (taken
as one accounting period) from the beginning of the first fiscal quarter
commencing after the date of the Indenture to the end of the Issuer's most
recently ended fiscal quarter for which internal financial statements are
available at the time of such Restricted Payment (or, if such Consolidated
Net Income for such period is a deficit, less 100% of such deficit), plus
(ii) 100% of the aggregate net cash proceeds received by the Issuer from the
issue or sale since the date of the Indenture of Equity Interests of the
Issuer or MSC (other than Disqualified Stock) or of Disqualified Stock or
debt securities of the Issuer or MSC that have been converted into such
Equity Interests (other than Equity Interests (or Disqualified Stock or
convertible debt securities) sold to a Subsidiary of the Issuer and other
than Disqualified Stock or convertible debt securities that have been
converted into Disqualified Stock), plus (iii) to the extent that any
Restricted Investment that was made after the date of the Indenture is sold
for cash or otherwise liquidated or repaid for cash, the lesser of (A) the
cash return of capital with respect to such Restricted Investment (less the
cost of disposition, if any) and (B) the initial amount of such Restricted
Investment plus (iv) if any Unrestricted Subsidiary (A) is redesignated as a
Restricted Subsidiary, the fair market value of such redesignated Subsidiary
(as determined in good faith by the Board of Directors) as of the date of
its redesignation or (B) pays any cash dividends or cash distributions to
the Issuer or any of its Restricted Subsidiaries, 50% of any such cash
dividends or cash distributions made after the date of the Indenture.
The foregoing provisions will not prohibit (i) the payment of any dividend
within 60 days after the date of declaration thereof, if at said date of
declaration such payment would have complied with the provisions of the
Indenture; (ii) the redemption, repurchase, retirement, defeasance or other
acquisition of any PARI PASSU or subordinated Indebtedness or Equity Interests
of the Issuer or MSC in exchange for, or out of the net cash proceeds of the
substantially concurrent sale or issuance (other than to a Restricted Subsidiary
of the Issuer) of, other Equity Interests of the Issuer or MSC (other than any
Disqualified Stock); provided that the amount of any such net cash proceeds that
are utilized for any such redemption, repurchase, retirement, defeasance or
other acquisition shall be excluded from clause (c) (ii) of the preceding
paragraph; (iii) the defeasance, redemption, repurchase or other acquisition of
PARI PASSU or subordinated Indebtedness with the net cash proceeds from an
incurrence of Permitted Refinancing Indebtedness; (iv) the payment of any
dividend by a Restricted Subsidiary of the Issuer to the holders of its
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Equity Interests on a pro rata basis; (v) any repurchase of Equity Interests of
the Issuer or MSC from present and former employees and directors of the Issuer
or its Subsidiaries or MSC in an aggregate amount not to exceed $5 million; (vi)
Permitted Investments; or (vii) other Restricted Payments in an aggregate amount
not to exceed $5 million.
The Board of Directors may designate any Restricted Subsidiary to be an
Unrestricted Subsidiary if such designation would not cause a Default. For
purposes of making such determination, all outstanding Investments by the Issuer
and its Restricted Subsidiaries (except to the extent repaid in cash) in the
Subsidiary so designated will be deemed to be Restricted Payments at the time of
such designation and will reduce the amount available for Restricted Payments
under the first paragraph of this covenant. All such outstanding Investments
will be deemed to constitute Investments in an amount equal to the fair market
value of such Investments at the time of such designation (as determined in good
faith by the Board of Directors). Such designation will only be permitted if
such Restricted Payment would be permitted at such time and if such Restricted
Subsidiary otherwise meets the definition of an Unrestricted Subsidiary.
The amount of all Restricted Payments (other than cash) shall be the fair
market value on the date of the Restricted Payment of the asset(s) or securities
proposed to be transferred or issued by the Issuer or such Subsidiary, as the
case may be, pursuant to the Restricted Payment. The fair market value of any
non-cash Restricted Payment shall be determined in good faith by the Board of
Directors whose resolution with respect thereto shall be delivered to the
Trustee, such determination to be based upon an opinion or appraisal issued by
an accounting, appraisal or investment banking firm of national standing if such
fair market value exceeds $10.0 million. Not later than the date of making any
Restricted Payment, the Issuer shall deliver to the Trustee an Officers'
Certificate stating that such Restricted Payment is permitted and setting forth
the basis upon which the calculations required by the covenant "Restricted
Payments" were computed, together with a copy of any fairness opinion or
appraisal required by the Indenture.
INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK
The Indenture will provide that the Issuer will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, incur, issue, assume,
guarantee or otherwise become directly or indirectly liable, contingently or
otherwise, with respect to (collectively, "incur") any Indebtedness (including
Acquired Debt) and that the Issuer will not issue any Disqualified Stock and
will not permit any of its Subsidiaries to issue any shares of preferred stock;
provided, however, that the Issuer may incur Indebtedness (including Acquired
Debt) or issue shares of Disqualified Stock if the Cash Flow Coverage Ratio for
the Issuer's most recently ended four full fiscal quarters for which internal
financial statements are available immediately preceding the date on which such
additional Indebtedness is incurred or such Disqualified Stock is issued would
have been at least 2.0 to 1, determined on a Pro Forma Basis.
The provisions of the first paragraph of this covenant will not apply to the
incurrence of any of the following items of Indebtedness (collectively,
"Permitted Indebtedness"):
(i) the incurrence by the Issuer of Indebtedness under the Credit
Facility in an aggregate principal amount not to exceed $182.0 million
outstanding at any time;
(ii) the incurrence by the Issuer and its Restricted Subsidiaries of the
Existing Indebtedness;
(iii) the incurrence by the Issuer of Indebtedness represented by the
Notes;
(iv) the incurrence by the Issuer or any of its Restricted Subsidiaries
of Indebtedness represented by Capital Lease Obligations, mortgage
financings, purchase money obligations and Attributable Debt in an aggregate
principal amount not to exceed $15 million in any one year;
(v) the incurrence by the Issuer or any of its Restricted Subsidiaries
of Indebtedness in connection with the acquisition of assets or a new
Restricted Subsidiary; provided that such Indebtedness was incurred by the
prior owner of such assets or such Restricted Subsidiary prior to such
acquisition by the Issuer or one of its Subsidiaries and was not incurred in
connection with, or in
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contemplation of, such acquisition by the Issuer or one of its Subsidiaries;
provided further that the principal amount (or accreted value, as
applicable) of such Indebtedness, together with any other outstanding
Indebtedness incurred pursuant to this clause (v), does not exceed $5
million;
(vi) the incurrence by the Issuer or any of its Restricted Subsidiaries
of Permitted Refinancing Indebtedness in exchange for, or the net proceeds
of which are used to refund, refinance or replace Indebtedness that was
permitted by the Indenture to be incurred;
(vii) the incurrence by the Issuer or any of its Restricted Subsidiaries
of intercompany Indebtedness between or among the Issuer and any of its
Wholly Owned Restricted Subsidiaries; provided, however, that (i) if the
Issuer is the obligor on such Indebtedness, such Indebtedness is expressly
subordinated to the prior payment in full in cash of all Obligations with
respect to the Notes and (ii)(A) any subsequent issuance or transfer of
Equity Interests that results in any such Indebtedness being held by a
Person other than the Issuer or a Wholly Owned Restricted Subsidiary and (B)
any sale or other transfer of any such Indebtedness to a Person that is not
either the Issuer or a Wholly Owned Restricted Subsidiary shall be deemed,
in each case, to constitute an incurrence of such Indebtedness by the Issuer
or such Restricted Subsidiary, as the case may be;
(viii) the incurrence by the Issuer or any of its Restricted Subsidiaries
of Hedging Obligations that are incurred for the purpose of fixing or
hedging currency risk or interest rate risk with respect to any floating
rate Indebtedness that is permitted by the terms of this Indenture to be
outstanding;
(ix) the guarantee by the Issuer or any of its Restricted Subsidiaries
of Indebtedness of a Restricted Subsidiary of the Issuer that was permitted
to be incurred by another provision of this covenant and the guarantee by
Subsidiaries of Senior Debt of the Issuer;
(x) the incurrence by the Issuer's Unrestricted Subsidiaries of
Non-Recourse Debt, provided, however, that if any such Indebtedness ceases
to be Non-Recourse Debt of an Unrestricted Subsidiary, such event shall be
deemed to constitute an incurrence of Indebtedness by a Restricted
Subsidiary of the Issuer;
(xi) Indebtedness incurred by the Issuer or any of its Restricted
Subsidiaries constituting reimbursement obligations with respect to letters
of credit issued in the ordinary course of business, including without
limitation letters of credit in respect to workers' compensation claims or
self-insurance, or other Indebtedness with respect to reimbursement type
obligations regarding workers' compensation claims; provided, however, that
upon the drawing of such letters of credit or the incurrence of such
Indebtedness, such obligations are reimbursed within 30 days following such
drawing or incurrence;
(xii) obligations in respect of performance and surety bonds and
completion guarantees provided by the Issuer or any Restricted Subsidiary in
the ordinary course of business; and
(xiii) the incurrence by the Issuer or any of its Restricted Subsidiaries
of additional Indebtedness, including Attributable Debt incurred after the
date of the Indenture, in an aggregate principal amount (or accreted value,
as applicable) at any time outstanding, including all Permitted Refinancing
Indebtedness incurred to refund, refinance or replace any other Indebtedness
incurred pursuant to this clause (xiii), not to exceed $5 million.
For purposes of determining compliance with this covenant, in the event that
an item of Indebtedness meets the criteria of more than one of the categories of
Permitted Debt described in clauses (i) through (xiii) above or is entitled to
be incurred pursuant to the first paragraph of this covenant, the Issuer shall,
in its sole discretion, classify such item of Indebtedness in any manner that
complies with this covenant and such item of Indebtedness will be treated as
having been incurred pursuant to only one of such clauses or pursuant to the
first paragraph hereof. The amount of Indebtedness issued at a price which is
less than the principal amount thereof shall be equal to the amount of the
liability in respect thereof determined in
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accordance with GAAP. Neither the accrual of interest nor the issuance of
additional Indebtedness in the form of additional promissory notes or otherwise
in lieu of the payment of interest nor the accretion of accreted value will be
deemed to be an incurrence of Indebtedness for purposes of this covenant.
LIENS
The Indenture will provide that the Issuer will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, incur, assume or suffer
to exist any Lien that secures obligations under any PARI PASSU Indebtedness or
subordinated Indebtedness on any asset or property now owned or hereafter
acquired by the Issuer or any of its Subsidiaries, or any income or profits
therefrom or assign or convey any right to receive income therefrom, unless the
Notes are equally and ratably secured with the obligations so secured until such
time as such obligations are no longer secured by a Lien; provided, that in any
case involving a Lien securing subordinated Indebtedness, such Lien is
subordinated to the Lien securing the Notes to the same extent that such
subordinated Indebtedness is subordinated to the Notes.
DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED SUBSIDIARIES
The Indenture will provide that the Issuer will not, and will not permit any
of its Restricted Subsidiaries to, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Restricted Subsidiary to (i)(a) pay dividends or make any
other distributions to the Issuer or any of its Restricted Subsidiaries (1) on
its Capital Stock or (2) with respect to any other interest or participation in,
or measured by, its profits, or (b) pay any indebtedness owed to the Issuer or
any of its Restricted Subsidiaries, (ii) make loans or advances to the Issuer or
any of its Restricted Subsidiaries or (iii) transfer any of its properties or
assets to the Issuer or any of its Restricted Subsidiaries, except for such
encumbrances or restrictions existing under or by reason of (a) Existing
Indebtedness as in effect on the date of the Indenture, (b) the Credit Facility
as in effect as of the date of the Indenture, and any amendments, modifications,
restatements, renewals, increases, supplements, refundings, replacements or
refinancings thereof, provided that such amendments, modifications,
restatements, renewals, increases, supplements, refundings, replacement or
refinancings are no more restrictive in the aggregate (as determined by the
Board of Directors in good faith) with respect to such dividend and other
payment restrictions than those contained in the Credit Facility as in effect on
the date of the Indenture, (c) the Indenture and the Notes and the 2003
Indenture and the 2003 Notes, (d) any applicable law, rule, regulation or order,
(e) any instrument governing Indebtedness or Capital Stock of a Person acquired
by the Issuer or any of its Restricted Subsidiaries as in effect at the time of
such acquisition (except to the extent such Indebtedness was incurred in
connection with or in contemplation of such acquisition), which encumbrance or
restriction is not applicable to any Person, or the properties or assets of any
Person, other than the Person, or the property or assets of the Person, so
acquired, provided that, in the case of Indebtedness, such Indebtedness was
permitted by the terms of the Indenture to be incurred, (f) by reason of
customary non-assignment provisions in leases entered into in the ordinary
course of business and consistent with past practices, (g) Capital Lease
Obligations, mortgage financings and purchase money obligations for property
acquired in the ordinary course of business that impose restrictions of the
nature described in clause (iii) above on the property so acquired, (h)
Permitted Refinancing Indebtedness, provided that the material restrictions
contained in the agreements governing such Permitted Refinancing Indebtedness
are no more restrictive than those contained in the agreements governing the
Indebtedness being refinanced, (i) contracts for the sale of assets, including
without limitation customary restrictions with respect to a Subsidiary pursuant
to an agreement that has been entered into for the sale or disposition of all or
substantially all of the Capital Stock or assets of such Subsidiary, and (j) any
other agreement or instrument evidencing or relating to secured Indebtedness of
the Issuer or any Restricted Subsidiary otherwise permitted to be issued
pursuant to the provisions of the covenants described under the captions
"--Certain Covenants--Incurrence of Indebtedness and Issuance of Preferred
Stock" and "--Certain Covenants--Liens" that limit the right of the debtor to
dispose of the property or assets securing such Indebtedness.
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MERGER, CONSOLIDATION, OR SALE OF ASSETS
The Indenture will provide that the Issuer may not consolidate or merge with
or into (whether or not the Issuer is the surviving corporation), or sell,
assign, transfer, lease, convey or otherwise dispose of all or substantially all
of its properties or assets in one or more related transactions, to another
corporation, Person or entity unless (i) the Issuer is the surviving corporation
or the entity or the Person formed by or surviving any such consolidation or
merger (if other than the Issuer) or to which such sale, assignment, transfer,
lease, conveyance or other disposition shall have been made is a corporation
organized or existing under the laws of the United States, any state thereof or
the District of Columbia; (ii) the entity or Person formed by or surviving any
such consolidation or merger (if other than the Issuer) or the entity or Person
to which such sale, assignment, transfer, lease, conveyance or other disposition
shall have been made assumes all the obligations of the Issuer under the Notes
and the Indenture pursuant to a supplemental indenture in a form reasonably
satisfactory to the Trustee; (iii) immediately after such transaction no Default
or Event of Default exists; and (iv) except in the case of a merger of the
Issuer with or into MSC or a Wholly Owned Restricted Subsidiary of the Issuer,
the Issuer or the entity or Person formed by or surviving any such consolidation
or merger (if other than the Issuer), or to which such sale, assignment,
transfer, lease, conveyance or other disposition shall have been made will, at
the time of such transaction and determined on a Pro Forma Basis, be permitted
to incur at least $1.00 of additional Indebtedness pursuant to the Cash Flow
Coverage Ratio test set forth in the first paragraph of the covenant described
above under the caption "--Incurrence of Indebtedness and Issuance of Preferred
Stock."
TRANSACTIONS WITH AFFILIATES
The Indenture will provide that the Issuer will not, and will not permit any
of its Subsidiaries to, make any payment to, or sell, lease, transfer or
otherwise dispose of any of its properties or assets to, or purchase any
property or assets from, or enter into or make or amend any transaction,
contract, agreement, understanding, loan, advance or guarantee with, or for the
benefit of, any Affiliate (each of the foregoing, an "Affiliate Transaction")
unless (i) such Affiliate Transaction is entered into in good faith and on terms
that are no less favorable to the Issuer or the relevant Restricted Subsidiary
than those that would have been obtained in a comparable transaction by the
Issuer or such Restricted Subsidiary with an unrelated Person and (ii) the
Issuer delivers to the Trustee (a) with respect to any Affiliate Transaction or
series of related Affiliate Transactions involving aggregate consideration in
excess of $5 million, a resolution of the Board of Directors set forth in an
Officers' Certificate certifying that such Affiliate Transaction complies with
clause (i) above and that such Affiliate Transaction has been approved by a
majority of the disinterested members of the Board of Directors and (b) with
respect to any Affiliate Transaction or series of related Affiliate Transactions
involving aggregate consideration in excess of $10 million, an opinion as to the
fairness to the holders of such Affiliate Transaction from a financial point of
view issued by an accounting, appraisal or investment banking firm of national
standing; provided that the following shall not be deemed Affiliate
Transactions: (q) any employment agreement entered into by the Issuer or any of
its Restricted Subsidiaries in the ordinary course of business and consistent
with the past practice of the Issuer or such Restricted Subsidiary, (r)
transactions between or among the Issuer and/or its Restricted Subsidiaries, (s)
Permitted Investments and Restricted Payments that are permitted by the
provisions of the Indenture described above under the caption "--Restricted
Payments," (t) customary loans, advances, fees and compensation paid to, and
indemnity provided on behalf of, officers, directors, employees or consultants
of the Issuer or any of its Restricted Subsidiaries, (u) consulting and other
advisory fees paid to MSC not to exceed $250,000 in any one year and (v)
transactions pursuant to any contract or agreement in effect on the date of the
Indenture as the same may be amended, modified or replaced from time to time so
long as any such amendment, modification or replacement is no less favorable to
the Issuer and its Restricted Subsidiaries than the contract or agreement as in
effect on the date of the original issuance of the Notes or is approved by a
majority of the disinterested directors of the Issuer.
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ANTI-LAYERING
The Indenture will provide that (i) the Issuer will not, and the Issuer will
not permit any of its Subsidiaries to, incur, create, issue, assume, guarantee
or otherwise become liable for any Indebtedness that is both (a) subordinate or
junior in right of payment to any Senior Debt and (b) senior in any respect in
right of payment to the Notes; and (ii) the Guarantor will not incur, create,
issue, assume, guarantee or otherwise become liable for any Indebtedness that is
both (a) subordinate or junior in right of payment to its Guarantor Senior Debt
and (b) senior in right of payment to its Guarantee of the Notes.
SALE AND LEASEBACK TRANSACTIONS
The Indenture will provide that the Issuer will not, and will not permit any
of its Restricted Subsidiaries to, enter into any sale and leaseback
transaction; provided that the Issuer may enter into a sale and leaseback
transaction if (i) the Issuer could have (a) incurred Indebtedness in an amount
equal to the Attributable Debt relating to such sale and leaseback transaction
pursuant to the covenant described above under the caption "--Incurrence of
Indebtedness and Issuance of Preferred Stock" and (b) incurred a Lien to secure
such Indebtedness pursuant to the covenant described above under the caption
"--Liens," (ii) the gross cash proceeds of such sale and leaseback transaction
are at least equal to the fair market value (as determined in good faith by the
Board of Directors and set forth in an Officers' Certificate delivered to the
Trustee) of the property that is the subject of such sale and leaseback
transaction and (iii) the transfer of assets in such sale and leaseback
transaction is permitted by, and the Issuer applies the proceeds of such
transaction in compliance with, the covenant described above under the caption
"--Asset Sales."
LIMITATION ON ISSUANCES AND SALES OF CAPITAL STOCK OF WHOLLY OWNED
RESTRICTED SUBSIDIARIES
The Indenture will provide that the Issuer (i) will not, and will not permit
any Wholly Owned Restricted Subsidiary of the Issuer to, transfer, convey, sell,
lease or otherwise dispose of any Capital Stock of any Wholly Owned Subsidiary
of the Issuer to any Person (other than the Issuer or a Wholly Owned Restricted
Subsidiary of the Issuer), unless (a) such transfer, conveyance, sale, lease or
other disposition is of all the Capital Stock of such Wholly Owned Restricted
Subsidiary and (b) the cash Net Proceeds from such transfer, conveyance, sale,
lease or other disposition are applied in accordance with the covenant described
above under the caption "Repurchase at the Option of Holders--Asset Sales," and
(ii) will not permit any Wholly Owned Restricted Subsidiary of the Issuer to
issue any of its Equity Interests (other than, if necessary, shares of its
Capital Stock constituting directors' qualifying shares) to any Person other
than to the Issuer or a Wholly Owned Restricted Subsidiary of the Issuer except
that a Wholly Owned Restricted Subsidiary of the Issuer may issue shares of
common stock with no preferences or special rights or privileges and with no
redemption or prepayment provisions provided the cash Net Proceeds from such
issuance of such common stock are applied in accordance with the covenant
described under the caption "Repurchase at the Option of Holders--Asset Sales."
LIMITATIONS ON ISSUANCES OF GUARANTEES OF INDEBTEDNESS
The Issuer will not permit any Restricted Subsidiary, directly or
indirectly, to Guarantee any Indebtedness of the Issuer which is PARI PASSU with
or subordinate in right of payment to the Notes ("Guaranteed Indebtedness"),
unless (i) such Restricted Subsidiary simultaneously executes and delivers a
supplemental indenture to the Indenture providing for a Guarantee (a "Subsidiary
Guarantee") of payment of the Notes by such Restricted Subsidiary and (ii) such
Restricted Subsidiary waives and will not in any manner whatsoever claim or take
the benefit or advantage of, any rights of reimbursement, indemnity or
subrogation or any other rights against the Issuer or any other Restricted
Subsidiary as a result of any payment by such Restricted Subsidiary under its
Subsidiary Guarantee; provided that this paragraph shall not be applicable to
any Guarantee of any Restricted Subsidiary that existed at the time such Person
became a Restricted Subsidiary and was not incurred in connection with, or in
contemplation
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of, such Person becoming a Restricted Subsidiary. If the Guaranteed Indebtedness
is (A) PARI PASSU with the Notes, then the Guarantee of such Guaranteed
Indebtedness shall be PARI PASSU with, or subordinated to, the Subsidiary
Guarantee or (B) subordinated to the Notes, then the Guarantee of such
Guaranteed Indebtedness shall be subordinated to the Subsidiary Guarantee at
least to the extent that the Guaranteed Indebtedness is subordinated to the
Notes.
Notwithstanding the foregoing, any Subsidiary Guarantee by a Restricted
Subsidiary may provide by its terms that it shall be automatically and
unconditionally released and discharged upon (i) any sale, exchange or transfer,
to any Person not an Affiliate of the Issuer, of all of the Issuer's and each
Restricted Subsidiary's Capital Stock in, or all or substantially all the assets
of, such Restricted Subsidiary (which sale, exchange or transfer is not
prohibited by the Indenture) or (ii) the release or discharge of the Guarantee
which resulted in the creation of such Subsidiary Guarantee, except a discharge
or release by or as a result of payment under such Guarantee.
BUSINESS ACTIVITIES
The Issuer will not, and will not permit any Restricted Subsidiary to,
engage in any business other than Permitted Businesses, except to such extent as
would not be material to the Issuer and its Restricted Subsidiaries taken as a
whole.
REPORTS
The Indenture will provide that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the Issuer
(or MSC, as the case may be) will furnish to the holders of Notes (i) all
quarterly and annual financial information that would be required to be
contained in a filing with the Commission on Forms 10-Q and 10-K if the Issuer
(or MSC, as the case may be) were required to file such Forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, a report thereon
from certified independent accountants and (ii) all current reports that would
be required to be filed with the Commission on Form 8-K if the Issuer (or MSC,
as the case may be) were required to file such reports. In addition, whether or
not required by the rules and regulations of the Commission, the Issuer (or MSC,
as the case may be) will file a copy of all such information and reports with
the Commission for public availability (unless the Commission will not accept
such a filing) and make such information available to securities analysts and
prospective investors upon request. In addition, the Issuer and MSC have agreed
that, for so long as any Notes remain outstanding, they will furnish to the
holders and to securities analysts and prospective investors, upon their
request, the information required to be delivered pursuant to Rule 144A(d)(4)
under the Securities Act.
RESTRICTIVE COVENANT OF MSC
MSC will covenant and agree that it will not engage in any activities other
than holding 100% of the capital stock of the Issuer and providing services to
and management of the Issuer and it will not incur any liabilities other than
any liabilities relating to the Guarantee of the Issuer's obligations pursuant
to the Credit Facility, the Guarantee of the Notes, the Guarantee of the 2003
Notes, the Guarantee of any Indebtedness permitted by the covenant "--Incurrence
of Indebtedness and Issuance of Preferred Stock" and any other obligations or
liabilities incidental to holding 100% of the capital stock of the Issuer.
EVENTS OF DEFAULT AND REMEDIES
The Indenture will provide that each of the following constitutes an Event
of Default: (i) default for 30 days in the payment when due of interest on, or
Liquidated Damages with respect to, the Notes (whether or not prohibited by the
subordination provisions of the Indenture); (ii) default in payment when due of
the principal of or premium, if any, on the Notes (whether or not prohibited by
the subordination
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provisions of the Indenture); (iii) failure by the Issuer to comply with the
provisions described under the captions "--Change of Control," "--Asset Sales,"
or "Merger, Consolidation, or Sale of Assets;" (iv) failure by the Issuer for 30
days after notice from the Trustee or at least 25% in principal amount of the
Notes then outstanding to comply with the provisions described under the
captions "--Restricted Payments" or "--Incurrence of Indebtedness and Issuance
of Preferred Stock;" (v) failure by the Issuer for 60 days after notice from the
Trustee or at least 25% in principal amount of the Notes then outstanding to
comply with any of its other agreements in the Indenture or the Notes; (vi)
default under any mortgage, indenture or instrument under which there may be
issued or by which there may be secured or evidenced any Indebtedness for money
borrowed by the Issuer or any of its Restricted Subsidiaries (or the payment of
which is guaranteed by the Issuer or any of its Restricted Subsidiaries) whether
such Indebtedness or Guarantee now exists, or is created after the date of the
Indenture, which default (a) is caused by a failure to pay principal of or
premium, if any, or interest on such Indebtedness prior to the expiration of the
grace period provided in such Indebtedness on the date of such default (a
"Payment Default") or (b) results in the acceleration of such Indebtedness prior
to its express maturity and, in each case, the principal amount of any such
Indebtedness, together with the principal amount of any other such Indebtedness
under which there has been a Payment Default or the maturity of which has been
so accelerated, aggregates $15.0 million or more; (vii) failure by the Issuer or
any of its Restricted Subsidiaries to pay final judgments aggregating in excess
of $15.0 million, which judgments are not paid, discharged or stayed for a
period of 60 days; and (viii) certain events of bankruptcy or insolvency with
respect to the Issuer or any of its Significant Subsidiaries.
If any Event of Default occurs and is continuing, the Trustee or the holders
of at least 25% in principal amount of the then outstanding Notes may declare
all the Notes to be due and payable immediately; provided, however, that if any
Indebtedness or Obligation is outstanding pursuant to the Credit Facility, upon
a declaration of acceleration by the holders of the Notes or the Trustee, all
principal and interest under the Indenture shall be due and payable upon the
earlier of (x) the day which is five Business Days after the provision to the
Issuer, the Credit Agent and the Trustee of such written notice of acceleration
or (y) the date of acceleration of any Indebtedness under the Credit Facility;
and provided, further, that in the event of an acceleration based upon an Event
of Default set forth in clause (vi) above, such declaration of acceleration
shall be automatically annulled if the holders of Indebtedness which is the
subject of such acceleration have rescinded their declaration of acceleration in
respect of such Indebtedness or such Payment Default shall have been cured or
waived within 30 days thereof and no other Event of Default has occurred during
such 30-day period which has not been cured, paid or waived. Notwithstanding the
foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Issuer or any of its Significant
Subsidiaries all outstanding Notes will become due and payable without further
action or notice. Holders of the Notes may not enforce the Indenture or the
Notes except as provided in the Indenture. Subject to certain limitations,
holders of a majority in principal amount of the then outstanding Notes may
direct the Trustee in its exercise of any trust or power. The Trustee may
withhold from holders of the Notes notice of any continuing Default or Event of
Default (except a Default or Event of Default relating to the payment of
principal or interest) if it determines that withholding notice is in their
interest.
In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Issuer with the
intention of avoiding payment of the premium that the Issuer would have had to
pay if the Issuer then had elected to redeem the Notes pursuant to the optional
redemption provisions of the Indenture, an equivalent premium shall also become
and be immediately due and payable to the extent permitted by law upon the
acceleration of the Notes. If an Event of Default occurs prior to March 15, 2003
by reason of any willful action (or inaction) taken (or not taken) by or on
behalf of the Issuer with the intention of avoiding the prohibition on
redemption of the Notes prior to March 15, 2003, then the premium specified in
the Indenture shall also become immediately due and payable to the extent
permitted by law upon the acceleration of the Notes.
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The holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the holders of all of the
Notes waive any existing Default or Event of Default and its consequences under
the Indenture except a continuing Default or Event of Default in the payment of
interest on, or the principal of, the Notes.
The Issuer is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Issuer is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Issuer
(other than the Guarantor) or the Guarantor, as such, shall have any liability
for any obligations of the Issuer or the Guarantor under the Notes, the
Indenture, the Guarantee or for any claim based on, in respect of, or by reason
of, such obligations or their creation. Each holder of Notes by accepting a Note
waives and releases all such liability. The waiver and release are part of the
consideration for issuance of the Notes. Such waiver may not be effective to
waive liabilities under the federal securities laws and it is the view of the
Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Issuer may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding Notes and all obligations
of the Guarantor under the Guarantee ("Legal Defeasance") except for (i) the
rights of holders of outstanding Notes to receive payments in respect of the
principal of, premium and Liquidated Damages, if any, and interest on such Notes
when such payments are due from the trust referred to below, (ii) the Issuer's
obligations with respect to the Notes concerning issuing temporary Notes,
registration of Notes, mutilated, destroyed, lost or stolen Notes and the
maintenance of an office or agency for payment and money for security payments
held in trust, (iii) the rights, powers, trusts, duties and immunities of the
Trustee, and the Issuer's obligations in connection therewith and (iv) the Legal
Defeasance provisions of the Indenture. In addition, the Issuer may, at its
option and at any time, elect to have the obligations of the Issuer and the
Guarantor released with respect to certain covenants that are described in the
Indenture ("Covenant Defeasance") and thereafter any omission to comply with
such obligations shall not constitute a Default or Event of Default with respect
to the Notes. In the event Covenant Defeasance occurs, certain events (not
including non-payment, bankruptcy, receivership, rehabilitation and insolvency
events) described under "Events of Default" will no longer constitute an Event
of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Issuer must irrevocably deposit with the Trustee, in trust, for the benefit of
the holders of the Notes, cash in U.S. dollars, non-callable Government
Securities, or a combination thereof, in such amounts as will be sufficient, in
the opinion of a nationally recognized firm of independent public accountants,
to pay the principal of, premium and Liquidated Damages, if any, and interest on
the outstanding Notes on the stated maturity or on the applicable redemption
date, as the case may be, and the Issuer must specify whether the Notes are
being defeased to maturity or to a particular redemption date; (ii) in the case
of Legal Defeasance, the Issuer shall have delivered to the Trustee an opinion
of counsel in the United States reasonably acceptable to the Trustee confirming
that (A) the Issuer has received from, or there has been published by, the
Internal Revenue Service a ruling or (B) since the date of the Indenture, there
has been a change in the applicable federal income tax law, in either case to
the effect that, and based thereon such opinion of counsel shall confirm that,
the holders of the outstanding Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such Legal Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at the
same times as would have been the case if such Legal Defeasance had not
occurred; (iii) in the case of Covenant Defeasance, the Issuer shall have
delivered to the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that
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the holders of the outstanding Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such Covenant Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at the
same times as would have been the case if such Covenant Defeasance had not
occurred; (iv) no Default or Event of Default shall have occurred and be
continuing on the date of such deposit (other than a Default or Event of Default
resulting from the borrowing of funds to be applied to such deposit) or insofar
as Events of Default from bankruptcy or insolvency events are concerned, at any
time in the period ending on the 91st day after the date of deposit; (v) such
Legal Defeasance or Covenant Defeasance will not result in a breach or violation
of, or constitute a default under any material agreement or instrument (other
than the Indenture) to which the Issuer or any of its Subsidiaries is a party or
by which the Issuer or any of its Subsidiaries is bound; (vi) the Issuer must
have delivered to the Trustee an opinion of counsel to the effect that after the
91st day following the deposit, the trust funds will not be subject to the
effect of any applicable bankruptcy, insolvency, reorganization or similar laws
affecting creditors' rights generally; (vii) the Issuer must deliver to the
Trustee an Officers' Certificate stating that the deposit was not made by the
Issuer with the intent of preferring the holders of Notes over the other
creditors of the Issuer with the intent of defeating, hindering, delaying or
defrauding creditors of the Issuer or others; and (viii) the Issuer must deliver
to the Trustee an Officers' Certificate and an opinion of counsel, each stating
that all conditions precedent provided for relating to the Legal Defeasance or
the Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a holder, among other things, to
furnish appropriate endorsements and transfer documents and the Issuer may
require a holder to pay any taxes and fees required by law or permitted by the
Indenture. The Issuer is not required to transfer or exchange any Note selected
for redemption. Also, the Issuer is not required to transfer or exchange any
Note for a period of 15 days before a selection of Notes to be redeemed.
The registered holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the Indenture or
the Notes may be amended or supplemented with the consent of the holders of at
least a majority in principal amount of the Notes then outstanding (including,
without limitation, consents obtained in connection with a purchase of, or
tender offer or exchange offer for, Notes), and any existing Default or Event of
Default or compliance with any provision of the Indenture or the Notes may be
waived with the consent of the holders of a majority in principal amount of the
then outstanding Notes (including consents obtained in connection with a tender
offer or exchange offer for Notes).
Without the consent of each holder affected, an amendment or waiver may not
(with respect to any Notes held by a non-consenting holder): (i) reduce the
principal amount of Notes whose holders must consent to an amendment, supplement
or waiver, (ii) reduce the principal of or change the fixed maturity of any Note
or alter the provisions with respect to the redemption of the Notes (other than
provisions relating to the covenants described above under the caption
"--Repurchase at the Option of holders"), (iii) reduce the rate of or change the
time for payment of interest on any Note, (iv) waive a Default or Event of
Default in the payment of principal of or premium, if any, or interest on the
Notes (except a rescission of acceleration of the Notes by the holders of at
least a majority in aggregate principal amount of the Notes and a waiver of the
payment default that resulted from such acceleration), (v) make any Note payable
in money other than that stated in the Notes, (vi) make any change in the
provisions of the Indenture relating to waivers of past Defaults or the rights
of holders of Notes to receive payments of principal of or premium, if any, or
interest on the Notes, (vii) waive a redemption payment with respect to any Note
(other than a payment required by one of the covenants described above under the
caption
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"--Repurchase at the Option of Holders") or (viii) make any change in the
foregoing amendment and waiver provisions. In addition, any amendment to the
provisions of Article 10 of the Indenture (which relate to subordination) will
require the consent of the holders of at least 75% in aggregate principal amount
of the Notes then outstanding if such amendment would adversely affect the
rights of holders of Notes.
Notwithstanding the foregoing, without the consent of any holder of Notes,
the Issuer, the Guarantor and the Trustee may amend or supplement the Indenture
or the Notes to cure any ambiguity, defect or inconsistency, to provide for
uncertificated Notes in addition to or in place of certificated Notes, to
provide for the assumption of the Issuer's and the Guarantor's obligations to
holders of Notes in the case of a merger or consolidation, to make any change
that would provide any additional rights or benefits to the holders of Notes or
that does not adversely affect the legal rights under the Indenture of any such
holder, or to comply with requirements of the Commission in order to effect or
maintain the qualification of the Indenture under the Trust Indenture Act.
CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Issuer, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any such
claim as security or otherwise. The Trustee will be permitted to engage in other
transactions; however, if it acquires any conflicting interest it must eliminate
such conflict within 90 days, apply to the Commission for permission to continue
or resign.
The holders of a majority in principal amount of the then outstanding Notes
will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the conduct
of his own affairs. Subject to such provisions, the Trustee will be under no
obligation to exercise any of its rights or powers under the Indenture at the
request of any holder of Notes, unless such holder shall have offered to the
Trustee security and indemnity satisfactory to it against any loss, liability or
expense.
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Indenture and
Registration Rights Agreement without charge by writing to The Musicland Group,
Inc., 10400 Yellow Circle Drive, Minnetonka, Minnesota 55343-9143; Attention:
General Counsel.
BOOK-ENTRY, DELIVERY AND FORM
The New Notes initially will be represented by one or more New Notes in
registered, global form without interest coupons (collectively, the "Global
Notes") and will be deposited upon issuance with the Trustee as custodian for
The Depository Trust Company ("DTC"), in New York, New York, and registered in
the name of DTC or its nominee, in each case for credit to an account of a
direct or indirect participant as described below. Except in the limited
circumstances described below, under "Exchange of Book-Entry Notes for
Certificated Notes," owners of beneficial interests in a Global Note will not be
entitled to receive delivery of certificated Notes.
Except as set forth below, the Global Notes may be transferred, in whole and
not in part, only to another nominee of DTC or to a successor of DTC or its
nominee. Beneficial interests in the Global Notes may not be exchanged for Notes
in certificated form except in the limited circumstances described below. See
"Exchange of Book-Entry Notes for Certificated Notes."
The Notes may be presented for registration of transfer and exchange at the
offices of the Registrar.
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DEPOSITORY PROCEDURES
DTC has advised the Issuer that DTC is a limited-purpose trust company
created to hold securities for its participating organizations (collectively,
the "Participants") and to facilitate the clearance and settlement of
transactions in those securities between Participants through electronic
book-entry changes in accounts of Participants. The Participants include
securities brokers and dealers (including the Initial Purchasers), banks, trust
companies, clearing corporations and certain other organization. Access to DTC's
system is also available to other entities such as banks, brokers, dealers and
trust companies that clear through or maintain a custodial relationship with a
Participant, either directly or indirectly (collectively, the "Indirect
Participants"). Persons who are not Participants may beneficially own securities
held by or on behalf of DTC only through the Participants or Indirect
Participants. The ownership interest and transfer of ownership interest of each
actual purchaser of each security held by or on behalf of DTC are recorded on
the records of the Participants and Indirect Participants.
DTC has also advised the Issuer that pursuant to procedures established by
it, (i) upon deposit of the Global Notes, DTC will credit the accounts of
Participants designated by the Initial Purchaser with portions of the principal
amount of Global Notes and (ii) ownership of such interests in the Global Notes
will be shown on, and the transfer of ownership thereof will be effected only
through records maintained by DTC (with respect to Participants) or by
Participants and the Indirect Participants (with respect to other owners of
beneficial interests in the Global Notes).
Investors in the Global Notes may hold their interests therein directly
through DTC, if they are Participants in such system, or indirectly through
organizations (including Euroclear and Cedel Bank) that are Participants in such
system. Euroclear and Cedel Bank will hold interests in the Global Notes on
behalf of their Participants through customers' securities accounts in their
respective names on the books of their respective depositaries, which are Morgan
Guaranty Trust Company of New York, Brussels office, as operator of Euroclear,
and Citibank, N.A. as operator of Cedel. The depositaries, in turn, will hold
such interests in the Global Notes in customers' securities accounts in the
depositaries' names on the books of DTC. All interests in a Global Note,
including those held through Euroclear or Cedel Bank, may be subject to the
procedures and requirements of DTC. Those interests held by Euroclear or Cedel
Bank may be also be subject to the procedures and requirements of such system.
The laws of some states require that certain persons take physical delivery
in definitive form of securities that they own. Consequently, the ability to
transfer beneficial interest in a Global Note to such persons may be limited to
that extent. Because DTC can act only on behalf of Participants, which in turn
act on behalf of Indirect Participants and certain banks, the ability of a
person having a beneficial interest in a Global Note to pledge such interest to
persons or entities that do not participate in the DTC system, or otherwise take
actions in respect of such interest, may be affected by the lack of physical
certificate evidencing such interest. For certain other restrictions on the
transferability of the Notes, see "Exchange of Book-Entry Notes for Certificated
Notes."
EXCEPT AS DESCRIBED BELOW, OWNERS OF INTERESTS IN THE GLOBAL NOTES WILL NOT
HAVE NOTES REGISTERED IN THEIR NAMES, WILL NOT RECEIVE PHYSICAL DELIVERY OF
NOTES IN CERTIFICATED FORM AND WILL NOT BE CONSIDERED THE REGISTERED OWNERS OR
HOLDERS THEREOF UNDER THE INDENTURE FOR ANY PURPOSE.
Payments in respect of the principal and premium and Liquidated Damages, if
any, and interest on a Global Note registered in the name of DTC or its nominee
will be payable by the Trustee to DTC or its nominee in its capacity as the
registered holder under the Indenture. Under the terms of the Indenture, the
Issuer and the Trustee will treat the persons in whose names the Notes,
including the Global Notes, are registered as the owners thereof for the purpose
of receiving such payments and for any and all other purposes whatsoever.
Consequently, neither the Issuer, the Trustee nor any agent of the Issuer or the
Trustee has or will have any responsibility or liability for (i) any aspect of
DTC's records or any Participant's or Indirect Participant's records relating to
or payments made on account of beneficial ownership interests in the Global
Notes, or for maintaining, supervising or reviewing any of DTC's records
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or any Participant's or Indirect Participant's records relating to the
beneficial ownership interests in the Global Notes or (ii) any other matter
relating to the actions and practices of DTC or any of its Participants or
Indirect Participants.
DTC has advised the Issuer that its current practice, upon receipt of any
payment in respect of securities such as the Notes (including principal and
interest), is to credit the accounts of the relevant Participants with the
payment on the payment date, in amounts proportionate to their respective
holdings in principal amount of beneficial interests in the relevant security
such as the Global Notes as shown on the records of DTC. Payments by
Participants and the Indirect Participants to the beneficial owners of Notes
will be governed by standing instructions and customary practices and will not
be the responsibility of DTC, the Trustee or the Issuer. Neither the Issuer nor
the Trustee will be liable for any delay by DTC or its Participants in
identifying the beneficial owners of the Notes, and the Issuer and the Trustee
may conclusively rely on and will be protected in relying on instructions from
DTC or its nominee as the registered owner of the Notes for all purposes. Except
for trades involving only Euroclear and Cedel Bank participants, interests in
the Global Notes will trade in DTC's Same-Day Funds Settlement System and
secondary market trading activity in such interests will therefore settle in
immediately available funds, subject in all cases to the rules and procedures of
DTC and its participants.
Transfers between Participants in DTC will be effected in accordance with
DTC's procedures, and will be settled in same-day funds. Transfers between
participants in Euroclear and Cedel Bank will be effected in the ordinary way in
accordance with their respective rules and operating procedures.
Subject to compliance with the transfer restrictions applicable to the Notes
described herein, cross-market transfers between Participants in DTC, on the one
hand, and Euroclear or Cedel Bank participants, on the other hand, will be
effected through DTC in accordance with DTC's rules on behalf of Euroclear or
Cedel Bank, as the case may be, by its respective depositary; however, such
cross-market transactions will require delivery of instructions to Euroclear or
Cedel Bank, as the case may be, by the counterparty in such system in accordance
with the rules and procedures and within the established deadlines (Brussels
time) of such system. Euroclear or Cedel Bank, as the case may be, will, if the
transaction meets its settlement requirements, deliver instructions to its
respective depositary to take action to effect final settlement on its behalf by
delivering or receiving interests in the relevant Global Note in DTC, and making
or receiving payment in accordance with normal procedures for same-day fund
settlement applicable to DTC. Euroclear participants and Cedel Bank participants
may not deliver instructions directly to the depositaries for Euroclear or Cedel
Bank.
Because of time zone differences, the securities accounts of a Euroclear or
Cedel Bank participant purchasing an interest in a Global Note from a
Participant in DTC will be credited, and any such crediting will be reported to
the relevant Euroclear or Cedel Bank participant, during the securities
settlement processing day (which must be a business day for Euroclear or Cedel
Bank) immediately following the settlement date of DTC. Cash received in
Euroclear or Cedel Bank as a result of sales of interests in a Global Note by or
through a Euroclear or Cedel Bank participant to a Participant in DTC will be
received with value on the settlement date of DTC but will be available in the
relevant Euroclear or Cedel Bank cash account only as of the business day for
Euroclear or Cedel Bank following DTC's settlement date.
DTC has advised the Issuer that it will take any action permitted to be
taken by a holder of Notes only at the direction of one or more Participants to
whose account DTC interests in the Global Notes are credited and only in respect
of such portion of the aggregate principal amount of the Notes as to which such
Participant or Participants has or have given direction. However, if there is an
Event of Default under the Notes, DTC reserves the right to exchange Global
Notes for legended Notes in certificated form, and to distribute such Notes to
its Participants.
The information in this section concerning DTC, Euroclear and Cedel Bank and
their book-entry systems has been obtained from sources that the Issuer believes
to be reliable, but the Issuer takes no responsibility for the accuracy thereof.
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Although DTC, Euroclear and Cedel have agreed to the foregoing procedures to
facilitate transfers of interests in the Global Notes among participants in DTC,
Euroclear and Cedel Bank, they are under no obligation to perform or to continue
to perform such procedures, and such procedures may be discontinued at any time.
Neither the Issuer or the Trustee will have any responsibility for the
performance by DTC, Euroclear or Cedel Bank or their respective participants or
indirect participants of their respective obligations under the rules and
procedures governing their operations.
EXCHANGE OF BOOK-ENTRY NOTES FOR CERTIFICATED NOTES
A Global Note is exchangeable for definitive Notes in registered
certificated form if (i) DTC (x) notifies the Issuer that it is unwilling or
unable to continue as depositary for the Global Note and the Issuer thereupon
fails to appoint a successor depositary or (y) has ceased to be a clearing
agency registered under the Exchange Act, (ii) the Issuer, at its option,
notifies the Trustee in writing that it elects to cause the issuance of the
Notes in certificated form or (iii) there shall have occurred and be continuing
to occur a Default or an Event of Default with respect to the Notes. In
addition, beneficial interests in a Global Note may be exchanged for
certificated Notes upon request but only upon at least 20 days prior written
notice given to the Trustee by or on behalf of DTC in accordance with customary
procedures. In all cases, certificated Notes delivered in exchange for any
Global Note or beneficial interest therein will be registered in the names, and
issued in any approved denominations, requested by or on behalf of the
depositary (in accordance with its customary procedures).
SAME DAY SETTLEMENT AND PAYMENT
The Indenture will require that payments in respect of the Notes represented
by the Global Note (including principal, premium, if any, interest and
Liquidated Damages, if any) be made by wire transfer of immediately available
next day funds to the accounts specified by the Global Note Holder. With respect
to Certificated Notes, the Issuer will make all payments of principal, premium,
if any, interest and Liquidated Damages, if any, by wire transfer of immediately
available funds to the accounts specified by the holders thereof or, if no such
account is specified, by mailing a check to each such holder's registered
address. The Issuer expects that secondary trading in the Certificated Notes
will also be settled in immediately available funds.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"ACQUIRED DEBT" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Subsidiary of such specified Person, including,
without limitation, Indebtedness incurred in connection with, or in
contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, and (ii) Indebtedness secured by a Lien
encumbering any asset acquired by such specified Person.
"AFFILIATE" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise; provided that
beneficial ownership of 10% or more of the voting securities of a Person shall
be deemed to be control.
"ASSET SALE" means (i) the sale, lease, conveyance or other disposition of
any assets or rights (including, without limitation, by way of a sale and
leaseback) other than sales of inventory in the ordinary
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course of business consistent with past practices (provided that the sale,
lease, conveyance or other disposition of all or substantially all of the assets
of the Issuer and its Restricted Subsidiaries taken as a whole will be governed
by the provisions of the Indenture described above under the caption "--Change
of Control" and/or the provisions described above under the caption "--Merger,
Consolidation or Sale of Assets" and not by the provisions of the Asset Sale
covenant), and (ii) the issue or sale by the Issuer or any of its Restricted
Subsidiaries of Equity Interests of any of the Issuer's Restricted Subsidiaries,
in the case of either clause (i) or (ii), whether in a single transaction or a
series of related transactions (a) that have a fair market value in excess of
$2.0 million or (b) for net proceeds in excess of $2.0 million. Notwithstanding
the foregoing, the following will not be deemed to be Asset Sales: (i) a
transfer of assets by the Issuer to a Wholly Owned Restricted Subsidiary or by a
Wholly Owned Restricted Subsidiary to the Issuer or to another Wholly Owned
Restricted Subsidiary, (ii) an issuance of Equity Interests by a Wholly Owned
Restricted Subsidiary to the Issuer or to another Wholly Owned Restricted
Subsidiary, and (iii) a Restricted Payment that is permitted by the covenant
described above under the caption "--Restricted Payments."
"ATTRIBUTABLE DEBT" in respect of a sale and leaseback transaction means, at
the time of determination, the present value (discounted at the rate of interest
implicit in such transaction, determined in accordance with GAAP) of the
obligation of the lessee for net rental payments during the remaining term of
the lease included in such sale and leaseback transaction (including any period
for which such lease has been extended or may, at the option of the lessor, be
extended).
"CAPITAL LEASE OBLIGATION" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be required to be capitalized on a balance sheet in accordance with
GAAP.
"CAPITAL STOCK" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership or limited liability
company, partnership or membership interests (whether general or limited) and
(iv) any other interest or participation that confers on a Person the right to
receive a share of the profits and losses of, or distributions of assets of, the
issuing Person.
"CASH FLOW COVERAGE RATIO" means, for any given period and person, the ratio
of (i) Consolidated Cash Flow divided by (ii) Consolidated Interest Expense
(except dividends paid or payable in additional shares of Capital Stock (other
than Disqualified Stock)) in each case, without duplication; provided, however,
that if an acquisition or sale of a person, business or asset or the issuance or
repayment of Indebtedness occurred during the given period or subsequent to such
period on or prior to the date of calculation, then such calculation for such
period shall be made on a Pro Forma Basis.
"CASH EQUIVALENTS" means (a) United States dollars, (b) securities issued or
directly and fully guaranteed or insured by the United States government or any
agency or instrumentality thereof having maturities of not more than six months
from the date of acquisition, (c) certificates of deposit and eurodollar time
deposits with maturities of six months or less from the date of acquisition,
bankers' acceptances with maturities not exceeding six months and overnight bank
deposits, in each case with any domestic commercial bank having capital and
surplus in excess of $500.0 million, (d) repurchase obligations with a term of
not more than seven days for underlying securities of the types described in
clauses (b) and (c) above entered into with any financial institution meeting
the qualifications specified in clause (c) above, (e) commercial paper having
the highest rating obtainable from Moody's Investors Service, Inc. or Standard &
Poor's Ratings Group and in each case maturing within six months after the date
of acquisition and (f) any fund investing exclusively in investments of the
types described in clauses (a) through (e) above.
"CHANGE OF CONTROL" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by way of
merger or consolidation), in one or a series of related transactions, of all or
substantially all of the assets of MSC taken as a whole to any "person" (as
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such term is used in Section 13(d)(3) of the Exchange Act) other than the
Principals or their Related Parties (as defined below), (ii) the adoption of a
plan relating to the liquidation or dissolution of MSC, (iii) the consummation
of any transaction (including, without limitation, any merger or consolidation)
the result of which is that any "person" (as defined above), other than the
Principals and their Related Parties, becomes the "beneficial owner" (as such
term is defined in Rule 13d-3 and Rule 13d-5 under the Exchange Act, except that
a person shall be deemed to have "beneficial ownership" of all securities that
such person has the right to acquire, whether such right is currently
exercisable or is exercisable only upon the occurrence of a subsequent
condition), directly or indirectly, of more than 50% of the Voting Stock of MSC
(measured by voting power rather than number of shares), (iv) the first day on
which a majority of the members of the Board of Directors of MSC are not
Continuing Directors or (v) MSC consolidates with, or merges with or into, any
Person or sells, assigns, conveys, transfers, leases or otherwise disposes of
all or substantially all of its assets to any Person, or any Person consolidates
with, or merges with or into, MSC, in any such event pursuant to a transaction
in which any of the outstanding Voting Stock of MSC is converted into or
exchanged for cash, securities or other property, other than any such
transaction where the Voting Stock of MSC outstanding immediately prior to such
transaction is converted into or exchanged for Voting Stock (other than
Disqualified Stock) of the surviving or transferee Person constituting a
majority of the outstanding shares of such Voting Stock of such surviving or
transferee Person (immediately after giving effect to such issuance).
"CONSOLIDATED CASH FLOW" means, with respect to any Person for any period,
the Consolidated Net Income of such Person for such period plus (i) an amount
equal to any extraordinary loss plus any net loss realized in connection with an
Asset Sale (to the extent such losses were deducted in computing such
Consolidated Net Income), plus (ii) provision for taxes based on income or
profits of such Person and its Subsidiaries for such period, to the extent that
such provision for taxes was included in computing such Consolidated Net Income,
plus (iii) Consolidated Interest Expense of such Person and its Subsidiaries for
such period, to the extent deducted in computing such Consolidated Net Income,
plus (iv) depreciation, amortization (including amortization of goodwill and
other intangibles but excluding amortization of prepaid cash expenses that were
paid in a prior period) and other non-cash expenses (excluding any such non-cash
expense to the extent that it represents an accrual of or reserve for cash
expenses in any future period or amortization of a prepaid cash expense that was
paid in a prior period) of such Person and its Subsidiaries for such period to
the extent that such depreciation, amortization and other non-cash expenses were
deducted in computing such Consolidated Net Income, minus (v) non-cash items
increasing such Consolidated Net Income for such period; provided, however, that
if an acquisition or sale of a person, business or asset or the incurrence or
repayment of Indebtedness occurred during the given period or subsequent to such
period and on or prior to the date of calculation, then such calculation shall
be made on a Pro Forma Basis. Notwithstanding the foregoing, the provision for
taxes on the income or profits of, and the depreciation and amortization and
other non-cash charges of, a Subsidiary of the referent Person shall be added to
Consolidated Net Income to compute Consolidated Cash Flow only to the extent
that a corresponding amount would be permitted at the date of determination to
be dividended to the Issuer by such Subsidiary without prior governmental
approval (that has not been obtained), and without direct or indirect
restriction pursuant to the terms of its charter and all agreements,
instruments, judgments, decrees, orders, statutes, rules and governmental
regulations applicable to that Subsidiary or its stockholders.
"CONSOLIDATED INTEREST EXPENSE" means, for any given period and Person, the
aggregate of (i) the interest expense in respect of all Indebtedness of such
person and its Restricted Subsidiaries for such period, on a consolidated basis,
determined in accordance with GAAP (including, without duplication, amortization
of original issue discount on any such Indebtedness, all non-cash interest
payments, the interest portion of any deferred payment obligation, the interest
component of Capital Lease Obligations, and amortization of deferred financing
fees) and (ii) the product of (a) all cash dividend payments (and, in the case
of a Person that is a Restricted Subsidiary, dividends paid or payable in
additional shares of Disqualified Stock) on any series of preferred stock of
such Person and its Restricted Subsidiaries payable
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to a party other than the Issuer or a wholly owned Subsidiary, times (b) a
fraction, the numerator of which is one and the denominator of which is one
minus the then current combined federal, state and local statutory tax rate of
such Person, expressed as a decimal, on a consolidated basis and in accordance
with GAAP; provided, however, that for the purpose of the Cash Flow Coverage
Ratio, Consolidated Interest Expense shall be calculated on a Pro Forma Basis.
"CONSOLIDATED NET INCOME" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Restricted Subsidiaries
for such period, on a consolidated basis, determined in accordance with GAAP;
provided that (i) the Net Income (but not loss) of any Person that is not a
Restricted Subsidiary or that is accounted for by the equity method of
accounting shall be included only to the extent of the amount of dividends or
distributions paid in cash to the referent Person or a Wholly Owned Restricted
Subsidiary thereof, (ii) the Net Income of any Restricted Subsidiary shall be
excluded to the extent that the declaration or payment of dividends or similar
distributions by that Restricted Subsidiary of that Net Income is not at the
date of determination permitted without any prior governmental approval (that
has not been obtained) or, directly or indirectly, by operation of the terms of
its charter or any agreement, instrument, judgment, decree, order, statute, rule
or governmental regulation applicable to that Subsidiary or its stockholders,
(iii) the Net Income of any Person acquired in a pooling of interests
transaction for any period prior to the date of such acquisition shall be
excluded, (iv) the cumulative effect of a change in accounting principles shall
be excluded and (v) the Net Income of any Unrestricted Subsidiary shall be
excluded, whether or not distributed to the Issuer or one of its Restricted
Subsidiaries for purposes of the covenant described under the covenant
"Incurrence of Indebtedness and Issuance of Preferred Stock."
"CONTINUING DIRECTORS" means, as of any date of determination, any member of
the Board of Directors of MSC who (i) was a member of such Board of Directors on
the date of the original issuance of the Notes or (ii) was nominated for
election to such Board of Directors with the approval of, or whose election to
the Board of Directors of MSC was ratified by, at least a majority of the
Continuing Directors who were members of such Board of Directors at the time of
such nomination or election.
"CREDIT AGENT" means Morgan Guaranty Trust Company of New York, in its
capacity as Agent for the lenders party to the Credit Facility or any successor
thereto or any person otherwise appointed.
"CREDIT FACILITY" means (i) the Credit Agreement dated October 7, 1994 among
the Issuer, MSC, the various lenders party thereto from time to time and Morgan
Guaranty Trust Company of New York, as Agent, as amended by an Amendment No. 1
dated as of February 24, 1995, an Amendment No. 2 dated as of April 9, 1996, an
Amendment No. 3 dated as of October 18, 1996, an Amendment No. 4 dated as of
June 16, 1997 and an Amendment No. 5 effective as of the Closing of the
Offering, together with the related documents thereto (including any guarantee
agreement and securing documents), and (ii) the Term Loan Agreement dated as of
June 16, 1997 among the Issuer, MSC, various financial institutions and Morgan
Guaranty Trust Company of New York, as agent, together with the related
documents thereto (including any guarantee agreement and securing documents), in
each case, as such agreements may be amended (including any amendment and
restatement thereof), supplemented or otherwise modified or replaced (including
with other lenders) from time to time and including any agreement extending the
maturity of, refinancing, modifying, increasing, substituting for or otherwise
restructuring (including, but not limited to, the inclusion of additional or
different or substitute lenders or bank agents thereunder) all or any portion of
the Indebtedness, including changing the borrowing limits, under such agreement
or any successor or replacement agreement, regardless of whether the Credit
Facility or any portion thereof was outstanding or in effect at the time of such
replacement, refinancing, increase, substitution, extension, restructuring,
supplement or modification.
"DEFAULT" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
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"DESIGNATED SENIOR DEBT" means (i) any Indebtedness outstanding under the
Credit Facility and (ii) any other Senior Debt permitted under the Indenture the
principal amount of which is $25 million or more and that has been designated by
the Issuer as "Designated Senior Debt".
"DISQUALIFIED STOCK" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable at
the option of the holder thereof, in whole or in part, on or prior to the date
that is 91 days after the date on which the Notes mature; provided, however,
that any Capital Stock that would not qualify as Disqualified Stock but for
change of control provisions shall not constitute Disqualified Stock if the
provisions are not more favorable to the holders of such Capital Stock than the
provisions described under "--Change of Control" applicable to the holders of
the Notes.
"EQUITY INTERESTS" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"EXISTING INDEBTEDNESS" means Indebtedness of the Issuer and its
Subsidiaries (other than Indebtedness under the Credit Facility) in existence on
the date of the Indenture, until such amounts are repaid.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect from time to time set forth in the opinions and
pronouncements of the Accounting Principles Board and the American Institute of
Certified Public Accountants and the statements and pronouncements of the
Financial Accounting Standards Board, or in such other statements by such other
entity as may be in general use by significant segments of the accounting
profession, which are applicable to the circumstances as of the date of
determination; provided, however, that except as otherwise provided, all
calculations made for purposes of determining compliance with the terms of the
covenants set forth in "--Certain Covenants" and other provisions of the
Indenture shall utilize GAAP in effect at the date of the Indenture.
"GOVERNMENT SECURITIES" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which guarantee
or obligations the full faith and credit of the United States is pledged.
"GUARANTEE" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.
"HEDGING OBLIGATIONS" means, with respect to any Person, the obligations of
such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements and (ii) other agreements or
arrangements designed to protect such Person against fluctuations in interest
rates or currency rates.
"INDEBTEDNESS" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced by
bonds, notes, debentures or similar instruments or letters of credit (or
reimbursement agreements in respect thereof) or banker's acceptances or
representing Capital Lease Obligations or the balance deferred and unpaid of the
purchase price of any property or representing any Hedging Obligations, except
any such balance that constitutes an accrued expense or trade payable or
obligations with respect to consigned inventory, if and to the extent any of the
foregoing indebtedness (other than letters of credit and Hedging Obligations)
would appear as a liability upon a balance sheet of such Person prepared in
accordance with GAAP, as well as all indebtedness of others secured by a Lien on
any asset of such Person (whether or not such indebtedness is assumed by such
Person) and, to the extent not otherwise included, the Guarantee by such Person
of any indebtedness of any other Person. The amount of any Indebtedness
outstanding as of any date shall be (i) the accreted value thereof, in the case
of any Indebtedness that does not require current payments of interest, and (ii)
the principal amount thereof, together with any interest thereon that is more
than 30 days past due, in the case of any other Indebtedness.
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"INSOLVENCY OR LIQUIDATION PROCEEDING" means (i) any insolvency or
bankruptcy case or proceeding, or any receivership, liquidation, reorganization
or other similar case or proceeding, relative to the Issuer or to the creditors
of the Issuer, as such, or to the assets of the Issuer, or (ii) any liquidation,
dissolution, reorganization or winding up of the Issuer, whether voluntary or
involuntary and involving insolvency or bankruptcy, or (iii) any assignment for
the benefit of creditors or any other marshaling of assets and liabilities of
the Issuer.
"INVESTMENTS" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the forms of direct or
indirect loans (including guarantees of Indebtedness or other obligations),
advances or capital contributions (excluding commission, travel and similar
advances to officers and employees made in the ordinary course of business),
purchases or other acquisitions for consideration of Indebtedness, Equity
Interests or other securities, together with all items that are or would be
classified as investments on a balance sheet prepared in accordance with GAAP.
If the Issuer or any Restricted Subsidiary of the Issuer sells or otherwise
disposes of any Equity Interests of any direct or indirect Restricted Subsidiary
of the Issuer such that, after giving effect to any such sale or disposition,
such Person is no longer a Restricted Subsidiary of the Issuer, the Issuer shall
be deemed to have made an Investment on the date of any such sale or disposition
equal to the fair market value of the Equity Interests of such Restricted
Subsidiary not sold or disposed of in an amount determined as provided in the
final paragraph of the covenant described above under the caption "--Restricted
Payments."
"LIEN" means, with respect to any asset, any mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset, whether
or not filed, recorded or otherwise perfected under applicable law (including
any conditional sale or other title retention agreement, any lease in the nature
thereof, any option or other agreement to sell or give a security interest in
and any filing of or agreement to give any financing statement under the Uniform
Commercial Code (or equivalent statutes) of any jurisdiction).
"NET INCOME" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain (but not
loss), together with any related provision for taxes on such gain (but not
loss), realized in connection with (a) any Asset Sale (including, without
limitation, dispositions pursuant to sale and leaseback transactions) or (b) the
disposition of any securities by such Person or any of its Restricted
Subsidiaries or the extinguishment of any Indebtedness of such Person or any of
its Restricted Subsidiaries and (ii) any extraordinary or nonrecurring gain (but
not loss), together with any related provision for taxes on such extraordinary
or nonrecurring gain (but not loss).
"NET PROCEEDS" means the aggregate cash proceeds received by the Issuer or
any of its Restricted Subsidiaries in respect of any Asset Sale (including,
without limitation, any cash received upon the sale or other disposition of any
non-cash consideration received in any Asset Sale), net of the direct costs
relating to such Asset Sale (including, without limitation, legal, accounting
and investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof, taxes paid or payable as a result thereof (after
taking into account any available tax credits or deductions and any tax sharing
arrangements), and any reserve for adjustment in respect of the sale price of
such asset or assets established in accordance with GAAP.
"NON-RECOURSE DEBT" means Indebtedness (i) as to which neither the Issuer
nor any of its Restricted Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), (b) is directly or indirectly liable (as a guarantor or
otherwise), or (c) constitutes the lender; (ii) no default with respect to which
(including any rights that the holders thereof may have to take enforcement
action against an Unrestricted Subsidiary) would permit (upon notice, lapse of
time or both) any holder of any other Indebtedness (other than holders of the
Notes being offered hereby and lenders under the Credit Facility) of the Issuer
or any of its Restricted Subsidiaries to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable
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prior to its stated maturity; and (iii) as to which the lenders have been
notified in writing that they will not have any recourse to the stock or assets
of the Issuer or any of its Restricted Subsidiaries.
"OBLIGATIONS" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"PERMITTED BUSINESS" means any of the businesses and any other businesses
related to the businesses engaged in by the Issuer and its respective Restricted
Subsidiaries on the date of the Indenture.
"PERMITTED INVESTMENTS" means (a) any Investment in the Issuer or in a
Wholly Owned Restricted Subsidiary of the Issuer that is engaged in a Permitted
Business; (b) any Investment in Cash Equivalents; (c) any Investment by the
Issuer or any Restricted Subsidiary of the Issuer in a Person, if as a result of
such Investment (i) such Person becomes a Wholly Owned Restricted Subsidiary of
the Issuer that is engaged in a Permitted Business or (ii) such Person is
merged, consolidated or amalgamated with or into, or transfers or conveys
substantially all of its assets to, or is liquidated into, the Issuer or a
Wholly Owned Restricted Subsidiary of the Issuer that is engaged in a Permitted
Business; (d) any Restricted Investment made as a result of the receipt of
non-cash consideration from an Asset Sale that was made pursuant to and in
compliance with the covenant described above under the caption "--Repurchase at
the Option of holders--Asset Sales"; (e) any acquisition of assets solely in
exchange for the issuance of Equity Interests (other than Disqualified Stock) of
the Issuer or MSC; (f) stock, obligations or securities received in satisfaction
of judgment and (g) Hedging Obligations entered into in the ordinary course of
business and otherwise permitted under the Indenture.
"PERMITTED REFINANCING INDEBTEDNESS" means any Indebtedness of the Issuer or
any of its Restricted Subsidiaries issued in exchange for, or the net proceeds
of which are used to extend, refinance, renew, replace, defease or refund other
Indebtedness of the Issuer or any of its Restricted Subsidiaries; provided that:
(i) the principal amount (or accreted value, if applicable) of such Permitted
Refinancing Indebtedness does not exceed the principal amount of (or accreted
value, if applicable), plus accrued interest on, the Indebtedness so extended,
refinanced, renewed, replaced, defeased or refunded (plus the amount of
reasonable expenses incurred in connection therewith); (ii) such Permitted
Refinancing Indebtedness has a final maturity date later than the final maturity
date of, and has a Weighted Average Life to Maturity equal to or greater than
the Weighted Average Life to Maturity of, the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded; (iii) if the Indebtedness
being extended, refinanced, renewed, replaced, defeased or refunded is
subordinated in right of payment to the Notes, such Permitted Refinancing
Indebtedness has a final maturity date later than the final maturity date of,
and is subordinated in right of payment to, the Notes on terms at least as
favorable to the holders of Notes as those contained in the documentation
governing the Indebtedness being extended, refinanced, renewed, replaced,
defeased or refunded; and (iv) such Indebtedness is incurred either by the
Restricted Subsidiary who is the obligor on the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded or by the Issuer.
"PRINCIPALS" means Messrs. Eugster, Benson, Wachsman and Ross.
"PRO FORMA BASIS" means, for purposes of determining Consolidated Net Income
in connection with the Cash Flow Coverage Ratio (including in connection with
the covenants described above under the captions "--Certain
Covenants--Restricted Payments" and "--Merger, Consolation, or Sale of Assets"
and the incurrence of Indebtedness pursuant to the first sentence of the
covenant described above under the caption "--Certain Covenants--Incurrence of
Indebtedness and Issuance of Preferred Stock"), giving pro forma effect to (x)
any acquisition, by way of merger, consolidation or otherwise, or sale of a
person, business or asset, related incurrence, repayment or financing of
Indebtedness or other related transactions, including any Restructuring Charges
which would otherwise be accounted for as an adjustment permitted by Regulation
S-X under the Securities Act or on a pro forma basis under GAAP, or (y) any
incurrence, repayment or refinancing of any Indebtedness and the application of
the proceeds therefrom; in each case, which occurred during the relevant period
or subsequent to such period and on or prior to the date of
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calculation, as if such acquisition or sale and related transactions and any
Restructuring Charges, incurrence, repayment or refinancing were realized on the
first day of the relevant period permitted by Regulation S-X under the
Securities Act or on a pro forma basis under GAAP. For purposes of this
definition, whenever pro forma effect is to be given to an acquisition of a
person, business or asset, the amount of income or earnings relating thereto,
and the amount of Consolidated Interest Expense associated with any Indebtedness
issued in connection therewith, the pro forma calculations will be determined in
good faith by the chief financial officer of the Issuer as specified in an
Officers' Certificate of the Issuer delivered to the Trustee. Furthermore, in
calculating the Cash Flow Coverage Ratio, (1) interest on outstanding
Indebtedness determined on a fluctuating basis as of the determination date and
which will continue to be so determined thereafter shall be deemed to have
accrued at a fixed rate per annum equal to the rate of interest on such
Indebtedness in effect on the determination date; (2) if interest on any
Indebtedness actually incurred on the determination date may optionally be
determined at an interest rate based upon a factor of a prime or similar rate, a
eurocurrency interbank offered rate, or other rates, then the interest rate in
effect on the determination date will be deemed to have been in effect during
the relevant period; and (3) notwithstanding clause (1) above, interest on
Indebtedness determined on a fluctuating basis, to the extent such interest is
covered by agreements relating to interest rate swaps or similar interest rate
protection Hedging Obligations, shall be deemed to accrue at the rate per annum
resulting after giving effect to the operation of such agreements.
"PUBLIC EQUITY OFFERING" means a public offering of Equity Interests (other
than Disqualified Stock) of (i) the Issuer; or (ii) MSC to the extent the net
proceeds thereof are contributed to the Issuer as a capital contribution, that,
in each case, results in the net proceeds to the Issuer of at least $25.0
million.
"RELATED PARTY" with respect to any Principal means any spouse or immediate
family member or any controlled Affiliate of any such Principal, any trusts for
the benefit of any such Principal or such Principal's spouse or immediate family
or, in the event of the incompetence or death of any such Principal, such
Principal's estate, executor, administrator, committee or other personal
representative, in each case who will beneficially own or have the right to
acquire, directly or indirectly, Voting Stock of MSC.
"REPRESENTATIVE" means the trustee, agent or representative for any Senior
Debt.
"RESTRICTED INVESTMENT" means an Investment other than a Permitted
Investment.
"RESTRICTED SUBSIDIARY" of a Person means any Subsidiary of the referent
Person that is not an Unrestricted Subsidiary.
"RESTRUCTURING CHARGES" means any charges or expenses in respect of
restructuring or consolidating any business, operations or facilities, any
compensation or headcount reduction, or any other cost savings, of any persons
or businesses either alone or together with the Issuer or any Restricted
Subsidiary, as permitted by GAAP or Regulation S-X under the Securities Act;
provided that any cost savings of less than $10.0 million, shall be evidenced by
an Officers' Certificate delivered to the Trustee and any cost savings of $10.0
million or more shall be evidenced by a resolution of the Board of Directors set
forth in an Officers' Certificate delivered to the Trustee.
"SENIOR DEBT" means (i) all Indebtedness outstanding under the Credit
Facility, including any Guarantee thereof and all Hedging Obligations with
respect thereto, (ii) any other Indebtedness permitted to be incurred by the
Issuer under the terms of the Indenture, unless the instrument under which such
Indebtedness is incurred expressly provides that it is on a parity with or
subordinated in right of payment to the Notes, (iii) all Obligations with
respect to the foregoing, and (iv) all interest with respect to the foregoing
clauses (i) and (ii) accruing during the pendency of an Insolvency or
Liquidation Proceeding, whether or not allowed or allowable thereunder.
Notwithstanding anything to the contrary in the foregoing, Senior Debt will not
include (w) any liability for federal, state, local or other taxes owed or owing
by the Issuer, (x) any Indebtedness of the Issuer to any of its Subsidiaries or
other Affiliates, (y) any trade payables or liability to trade creditors or
obligations with respect to consigned inventory arising in the
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ordinary course of business (including guarantees thereof or instruments
evidencing such liabilities) or (z) any Indebtedness that is incurred in
violation of the Indenture.
"SIGNIFICANT SUBSIDIARY" means any Subsidiary that would be a "significant
subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated
pursuant to the Securities Act, as such Regulation is in effect on the date
hereof.
"STATED MATURITY" means, with respect to any installment of interest or
principal on any series of Indebtedness, the date on which such payment of
interest or principal was scheduled to be paid in the original documentation
governing such Indebtedness, and shall not include any contingent obligations to
repay, redeem or repurchase any such interest or principal prior to the date
originally scheduled for the payment thereof.
"SUBSIDIARY" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a combination
thereof) and (ii) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such Person or (b)
the only general partners of which are such Person or one or more Subsidiaries
of such Person (or any combination thereof).
"UNRESTRICTED SUBSIDIARY" means any Subsidiary that is designated by the
Board of Directors as an Unrestricted Subsidiary pursuant to a resolution of the
Board of Directors; but only to the extent that such Subsidiary: (a) has no
Indebtedness other than Non-Recourse Debt; (b) is not party to any agreement,
contract, arrangement or understanding with the Issuer or any Restricted
Subsidiary of the Issuer unless the terms of any such agreement, contract,
arrangement or understanding are no less favorable to the Issuer or such
Restricted Subsidiary than those that might be obtained at the time from Persons
who are not Affiliates of the Issuer; (c) is a Person with respect to which
neither the Issuer nor any of its Restricted Subsidiaries has any direct or
indirect obligation (x) to subscribe for additional Equity Interests or (y) to
maintain or preserve such Person's financial condition or to cause such Person
to achieve any specified levels of operating results; (d) has not guaranteed or
otherwise directly or indirectly provided credit support for any Indebtedness of
the Issuer or any of its Restricted Subsidiaries; and (e) has at least one
director on its board of directors that is not a director or executive officer
of the Issuer or any of its Restricted Subsidiaries and has at least one
executive officer that is not a director or executive officer of the Issuer or
any of its Restricted Subsidiaries. Any such designation by the Board of
Directors shall be evidenced to the Trustee by filing with the Trustee a
certified copy of the Board Resolution giving effect to such designation and an
Officers' Certificate certifying that such designation complied with the
foregoing conditions and was permitted by the covenant described above under the
caption "Certain Covenants-- Restricted Payments." If, at any time, any
Unrestricted Subsidiary would fail to meet the foregoing requirements as an
Unrestricted Subsidiary, it shall thereafter cease to be an Unrestricted
Subsidiary for purposes of the Indenture and any Indebtedness of such Subsidiary
shall be deemed to be incurred by a Restricted Subsidiary of the Issuer as of
such date (and, if such Indebtedness is not permitted to be incurred as of such
date under the covenant described under the caption "Incurrence of Indebtedness
and Issuance of Preferred Stock," the Issuer shall be in default of such
covenant). The Board of Directors of the Issuer may at any time designate any
Unrestricted Subsidiary to be a Restricted Subsidiary; provided that such
designation shall be deemed to be an incurrence of Indebtedness by a Restricted
Subsidiary of the Issuer of any outstanding Indebtedness of such Unrestricted
Subsidiary and such designation shall only be permitted if (i) such Indebtedness
is permitted under the covenant described under the caption "Certain
Covenants--Incurrence of Indebtedness and Issuance of Preferred Stock," and (ii)
no Default or Event of Default would be in existence following such designation.
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"VOTING STOCK" of any Person as of any date means the Capital Stock of such
Person that is at the time entitled to vote in the election of the Board of
Directors of such Person.
"WEIGHTED AVERAGE LIFE TO MATURITY" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the
products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse between
such date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.
"WHOLLY OWNED SUBSIDIARY" of any Person means a Subsidiary of such Person
all of the outstanding Capital Stock or other ownership interests of which
(other than directors' qualifying shares) shall at the time be owned by such
Person and/or by one or more Wholly Owned Subsidiaries of such Person.
"2003 INDENTURE" means the Indenture dated as of June 17, 1993, among the
Issuer, MSC and Harris Trust Savings Bank, as Trustee, relating to the 2003
Notes, as amended from time to time.
"2003 NOTES" means the 9% Senior Subordinated Notes due 2003 of the Issuer
issued pursuant to the 2003 Indenture.
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DESCRIPTION OF EXISTING FINANCING ARRANGEMENTS
The following is a summary of certain indebtedness incurred by the Company,
as such indebtedness exists on the date hereof. This summary is qualified in its
entirety by reference to the definitive agreements and instruments governing the
indebtedness.
CREDIT FACILITY
REVOLVER AGREEMENT
The Revolver Agreement Amendment, which became effective upon the closing of
the sale of the Old Notes, reduces the combined aggregate commitments available
under the Credit Facility from $295.0 million to $182.0 million (assuming net
proceeds from the Offering of $144.3 million). As long as indebtedness of $50.0
million is outstanding under the Term Loan Agreement, the aggregate borrowings
available under the Revolver Agreement, as amended, will be $132.0 million or,
if less, 60% of the eligible inventory as of the last day of the most recent
fiscal month. If the indebtedness under the Term Loan Agreement is paid when
due, or prepaid, the aggregate borrowings available under the Revolver
Agreement, as amended, increases to $182.0 million or, if less, 60% of the
eligible inventory. "Eligible Inventory" is defined to include readily
marketable assets of MGI of the type sold in the ordinary course of its
business, provided that the Banks may exclude certain types of inventory that
are determined not to be readily marketable or returnable to a vendor. If at any
time the amount outstanding under the Revolver Agreement exceeds the amount
available under the Eligible Inventory limit, MGI must repay the amount of such
excess. Up to $50.0 million of the aggregate available commitments may be
borrowed in the form of letters of credit. MGI had no borrowings under the
Revolver Agreement at December 31, 1997 and had borrowings of $146.0 million at
March 1, 1998. The highest balance outstanding under the Revolver Agreement
during the year ended December 31, 1997 was $273.0 million and the average daily
balance was $238.5 million. However, in 1997 the Company maintained an average
month-end cash balance of $45.8 million and did not borrow the $50 million under
the Term Loan Agreement until September 15, 1997. The weighted average interest
rate of the Revolver, based on the average daily balance, was 8.0%. The Revolver
Agreement will expire, and all amounts outstanding thereunder must be repaid, on
October 7, 1999. MGI may borrow and repay amounts under the Revolver Agreement
from time to time before such date.
Interest is payable monthly on borrowings under the Revolver Agreement at
rates based on, at the option of MGI, (i) Morgan's prime lending rate or (ii)
the one, two or three months London Interbank Offered Rate for U.S. dollar
deposits ("LIBOR"). In each case, MGI has a specified additional margin that is
currently 0.25% for loans based on Morgan's prime rate, increasing to 0.5% on
April 30, 1998, and 1.75% for loans based on LIBOR, increasing to 2.0% on April
30, 1998. The default interest rate is Morgan's prime rate plus 2.25%,
increasing to 2.5% on April 30, 1998.
The Revolver Agreement contains covenants that, subject to certain
exceptions, restrict the Company's ability to: (i) make investments and capital
expenditures; (ii) incur debt and issue guarantees; (iii) pay dividends on or
make other distributions with respect to its capital stock or redeem or purchase
any capital stock; (iv) make any principal payments on or redeem or purchase any
subordinated debt; (v) sell assets; (vi) create, assume or suffer to exist liens
on its assets; (vii) engage in transactions with affiliates; (viii) amend the
Company's certificates of incorporation; and (ix) engage in mergers or sell,
lease or otherwise transfer all or any substantial part of its assets to any
other person. The Revolver Agreement Amendment does permit use of proceeds of
the Offering to repay the Mortgage Notes Payable and redeem the 2003 Notes in
certain circumstances. The Revolver Agreement prohibits MSC from engaging in any
activity other than owning MGI and providing services to and management of MGI
and prohibits MGI from primarily engaging in any business other than a business
of the same general type conducted on the date of the Revolver Agreement.
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The Revolver Agreement also requires that the Company satisfy certain
financial tests and maintain certain financial ratios. In addition, for any
borrowings which result in a net increase in total outstanding borrowings, total
trade accounts payable must be equal to or greater than the total outstanding
borrowings. The Company would not have been in compliance with the financial
covenants in the Revolver Agreement without certain amendments and waivers which
were received throughout 1996 and 1997, with the last such amendment completed
in June 1997 concurrent with entering into the Term Loan Agreement. As amended
or waived, all covenants and financial tests were complied with for all quarters
through December 31, 1997.
Upon the occurrence of an event of default under the Revolver Agreement, the
Banks may cease making loans and terminate the Revolver Agreement and declare
all amounts outstanding under the Revolver Agreement immediately due and
payable. The Revolver Agreement specifies a number of "events of default"
including, among others, the failure to make timely principal and interest
payments or to perform the covenants or to meet the financial tests or maintain
the financial ratios contained therein.
MGI's obligations under the Revolver Agreement are guaranteed by MSC and the
wholly-owned subsidiaries of MGI and secured by a pledge by MGI of all the
capital stock of its wholly-owned consolidated subsidiaries.
TERM LOAN AGREEMENT
The Term Loan Agreement provides for a loan of $50 million, which amount was
borrowed on September 15, 1997 and must be repaid in installments of $25 million
on each of December 14, 1998 and February 15, 1999. Interest is payable monthly
at rates equal to, at the option of MGI, (i) Morgan's prime lending rate plus
1.0% or (ii) one month LIBOR plus 2.0%. The default interest rate is Morgan's
prime rate plus 3.0%. All obligations under the Term Loan are guaranteed by MSC
and MGI's wholly-owned consolidated subsidiaries and are secured by a
first-priority lien on all inventory of MGI and its wholly-owned consolidated
subsidiaries.
The Term Loan Agreement contains a trailing four quarters EBITDA test of $25
million and requires that the aggregate value of all inventory of MGI and its
wholly-owned consolidated subsidiaries be at all times equal to or greater than
$150 million. The Term Loan Agreement prohibits MSC from engaging in any
activity other than owning MGI and providing services to and management of MGI
and prohibits MGI from primarily engaging in any business other than a business
of the same general type conducted on the date of the Term Loan Agreement. In
addition, the Term Loan Agreement contains a covenant that, subject to certain
exceptions, restricts the Company's ability to create, assume or suffer to exist
liens on its assets. All covenants and financial tests have been complied with
for all quarters through December 31, 1997.
Upon the occurrence of an event of default under the Term Loan Agreement,
the Banks may terminate the Term Loan Agreement and declare all amounts
outstanding immediately due and payable. The Term Loan Agreement specifies a
number of "events of default" including, among others, an acceleration of the
Revolver Agreement (but not an event of default under the Revolver Agreement
without acceleration) and the failure to make timely principal and interest
payments or to perform the covenants or to meet the financial tests contained
therein.
9% SENIOR SUBORDINATED NOTES DUE 2003
In 1993 MGI issued $110 million principal amount of 2003 Notes. The 2003
Notes bear interest at the rate of 9%, payable semi-annually. The 2003 Notes
beginning on June 15, 1998 may be redeemed, at the option of MSC, at a
redemption price of 103.375% of their principal amount. The indenture for the
2003 Notes (the "2003 Indenture") specifies that the redemption price declines
annually at June 15th, from 103.375% at June 15, 1998, to 102.250% at June 15,
1999, to 101.125% at June 15, 2000 and to 100% of the principal amount on or
after June 15, 2001. The payment of the principal of, and premium, if any, and
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interest on, the 2003 Notes (other than credit for previously acquired or
redeemed 2003 Notes) is subordinated in right of payment as set forth in the
2003 Indenture, to the payment when due of all Senior Debt (as defined in the
2003 Indenture) of the Company.
The 2003 Indenture contains certain restrictions with respect to the conduct
of the Company's business and certain restrictive covenants, including among
others, limitations on the Company's ability to incur additional indebtedness,
pay dividends or make other distributions on MSC's capital stock, make
investments in, or loans to, any person, dispose of assets, create liens or
incur any indebtedness which is subordinate in right of payment to Senior Debt,
unless such indebtedness is subordinate in right of payment to, or ranks PARI
PASSU with, the 2003 Notes. In addition, MSC may not effect a merger or
consolidation unless certain financial tests are met.
The 2003 Indenture specifies a number of "events of default" including,
among others, a failure to make timely principal or interest payments or to
perform the covenants contained therein. If an event of default occurs and is
continuing, the Trustee under the 2003 Indenture or the holders of a specified
principal amount of the outstanding 2003 Notes may declare the principal of and
accrued but unpaid interest on all the 2003 Notes to be due and payable on the
date provided for in accordance with the 2003 Indenture. An acceleration of the
2003 Notes may, under certain circumstances, be rescinded by the holders of a
majority of the aggregate principal amount of the then outstanding 2003 Notes.
In June 1997, the holders of a majority of the aggregate principal amount of
the 2003 Notes approved an amendment to the 2003 Indenture which allowed the
lien on the Company's inventory required by the Revolver Agreement and the Term
Loan Agreement.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following is a general discussion of material United States federal
income tax considerations applicable to the initial holders of the Notes. This
summary is based upon provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), regulations, rulings and decisions currently in effect,
all of which are subject to change (possibly with retroactive effect). The
discussion does not purport to deal with all aspects of the United States
federal taxation that may be relevant to particular investors in light of their
particular circumstances (for example, to persons holding Notes as part of a
conversion transaction or as part of a hedge or hedging transaction, or as a
position in a straddle for tax purposes), nor does it discuss the United States
federal income tax considerations applicable to certain types of investors
subject to special treatment under the federal income tax laws (for example,
insurance companies, tax-exempt organizations, financial institutions and
persons who are not United States Holders or United States Alien Holders (each
as defined below)). In addition, the discussion does not consider the effect of
any foreign, state, local or other tax laws that may be applicable to a
particular investor. The discussion assumes that investors hold the Notes as
"capital assets" within the meaning of Section 1221 of the Code.
The Issuer intends to treat the Notes as indebtedness and not as equity for
United States federal income tax purposes, and the United States federal income
tax considerations described below are based on that characterization. Such
treatment, however, is not binding on the Internal Revenue Service ("IRS") (or
the Courts), and there can be no assurance that the IRS would not argue (or that
a court would not hold) that the Notes should be treated as equity for federal
income tax purposes.
HOLDERS OF THE NOTES SHOULD CONSULT THEIR TAX ADVISORS WITH REGARD TO THE
APPLICATION OF THE UNITED STATES FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR
SITUATIONS AS WELL AS ANY TAX CONSEQUENCES ARISING UNDER THE LAWS OF ANY STATE,
LOCAL OR FOREIGN TAXING JURISDICTION.
As used herein, the term "United States Holder" means an owner of a Note
that is, for United States federal income tax purposes, (i) a citizen or
resident of the United States, (ii) a corporation created or organized in or
under the laws of the United States or of any political subdivision thereof, or
(iii) an estate or trust the income of which is subject to United States federal
income taxation regardless of its source. The term also includes certain former
citizens and certain former long-term residents of the United States.
As used herein, the term "United States Alien Holder" means an owner of a
Note that is, for United States federal income tax purposes, (i) a nonresident
alien individual, (ii) a foreign corporation, (iii) a nonresident alien
fiduciary of a foreign estate or trust or (iv) a foreign partnership one or more
of the members of which is, for United States federal income tax purposes, a
nonresident alien individual, a foreign corporation or a nonresident alien
fiduciary of a foreign estate or trust.
TAX CONSEQUENCES TO UNITED STATES HOLDERS
INTEREST ON A NOTE
The Notes were not issued with original issue discount for United States
federal income tax purposes. Accordingly, interest and Liquidated Damages, if
any, on a Note will generally be taxable to a United States Holder as ordinary
interest income at the time it accrues or is received in accordance with the
United States Holder's method of accounting for United States federal income tax
purposes.
SALE OR RETIREMENT OF A NOTE
Upon the sale or retirement of a Note, a United States Holder will recognize
taxable gain or loss equal to the difference between the amount realized on the
sale or retirement and such Holders adjusted tax basis in the Note.
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EXCHANGE OFFER
The exchange of Old Notes for New Notes pursuant to the Exchange Offer will
not result in any United States federal income tax consequences to the United
States Holders. When a United States Holder exchanges an Old Note for a New Note
pursuant to the Exchange Offer, the Holder will have the same adjusted tax basis
and holding period in the New Note as in the Old Note immediately before the
exchange.
BACKUP WITHHOLDING AND INFORMATION REPORTING
Certain noncorporate United States Holders may be subject to backup
withholding at a rate of 31% on payments of principal, premium and interest
(including Liquidated Damages and/or original issue discount, if any) on, and
the proceeds of disposition of, a Note. Backup withholding will apply only if
the United States Holder (i) fails to furnish its Taxpayer Identification Number
("TIN") which, for an individual, would be his Social Security number, (ii)
furnishes an incorrect TIN, (iii) is notified by the IRS that it has failed to
properly report payments of interest or dividends or (iv) under certain
circumstances, fails to certify, under penalties of perjury, that it has
furnished a correct TIN and has not been notified by the IRS that it is subject
to backup withholding for failure to report interest and dividend payments.
United States Holders should consult their tax advisors regarding their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption if applicable.
The amount of any backup withholding from a payment to a United States
Holder will be allowed as a credit against such Holders United States federal
income tax liability and may entitle such Holder to a refund, provided that the
required information is furnished to the IRS.
TAX CONSEQUENCES TO UNITED STATES ALIEN HOLDERS
Under present United States federal law, and subject to the discussion below
concerning backup withholding, payments of principal, interest (including
Liquidated Damages, if any) and premium on the Notes by the Issuer or any paying
agent to any United States Alien Holder, and gain realized on the sale, exchange
or other disposition of such Note, will not be subject to United States federal
income or withholding tax, provided that: (i) such Holder does not own, actually
or constructively, 10 percent or more of the total combined voting power of all
classes of stock of the Issuer entitled to vote, is not a controlled foreign
corporation related, directly or indirectly, to the Issuer through stock
ownership, and is not a bank receiving interest described in Section
881(c)(3)(A) of the Code; (ii) the statement requirement set forth in Section
871(h) or Section 881(c) of the Code has been fulfilled with respect to the
beneficial owner, as discussed below; (iii) such Holder is not an individual who
is present in the United States for 183 days or more in the taxable year of
disposition, or such individual does not have a "tax home" (as defined in
Section 911(d)(3) of the Code) or an office or other fixed place of business in
the United States; and (iv) such payments and gain are not effectively connected
with the conduct by such Holder of a trade or business in the United States.
As noted above, the Issuer intends to treat the Notes as indebtedness for
United States federal income tax purposes. No assurance can be given, however,
that the Issuer's treatment will not be challenged by the IRS. If the Notes were
ultimately treated as equity rather than debt for United States federal income
tax purposes, the portfolio interest exception would not apply and withholding
tax at a flat rate of 30% (or a lower rate under an applicable income tax
treaty) would be imposed on the payments of interest and Liquidated Damages, if
any, on Notes to the extent of the Issuer's current or accumulated earnings and
profits or on the entire amounts of such payments if the withholding agent does
not know or cannot reasonably estimate the amount of such earnings and profits.
Further, any such withholding could commence when the IRS first asserted that
the Notes constituted equity; in such event, if the IRS did not ultimately
prevail, the United States Alien Holders would be able to recover the tax
withheld by filing a claim for refund with the IRS.
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CERTAIN CERTIFICATION REQUIREMENTS
Sections 871(h) and 881(c) of the Code require that, in order to obtain the
portfolio interest exemption from the withholding tax described in the
paragraphs above, either the beneficial owner of the Note, or a securities
clearing organization, bank or other financial institution that holds customers
securities in the ordinary course of its trade or business (a "Financial
Institution") and that is holding the Note on behalf of such beneficial owner,
file a statement with the withholding agent to the effect that the beneficial
owner of the Note is not a United States Holder. Under current United States
Treasury Regulations, such requirement will be fulfilled if the beneficial owner
of a Note certifies on IRS Form W-8, under penalties of perjury, that it is not
a United States Holder and provides its name and address, and any Financial
Institution holding the Note on behalf of the beneficial owner files a statement
with the withholding agent to the effect that it has received such a statement
from the Holder (and furnishes the withholding agent with a copy thereof). Under
recently finalized United States Treasury Regulations, which are generally
applicable to payments made after December 31, 1998, certain United States Alien
Holders would also need to provide their United States taxpayer identification
numbers on such forms in order to fulfill such requirement.
If a United States Alien Holder of a Note is engaged in a trade or business
in the United States, and if interest on the Note is effectively connected with
the conduct of such trade or business, the United States Alien Holder, although
exempt from the withholding tax discussed in the preceding paragraphs, will
generally be subject to regular United States income tax on interest and on any
gain realized on the sale, exchange or other disposition of a Note in the same
manner as if it were a United States Holder. In lieu of the certificate
described in the preceding paragraph, such a Holder will be required to provide
to the withholding agent a properly executed IRS Form 4224 (or the successor W-8
Form), in order to claim an exemption from withholding tax. Under recently
finalized United States Treasury Regulations, a United States Alien Holder may
also need to provide a United States taxpayer identification number on such form
in order to fulfill such requirement. In addition, if such United States Alien
Holder is a foreign corporation, it may be subject to a branch profits tax equal
to 30% (or such lower rate provided by an applicable treaty) of its effectively
connected earnings and profits for the taxable year, subject to certain
adjustments. For purposes of the branch profits tax, interest on and any gain
recognized on the sale, exchange or other disposition of a Note will be included
in the effectively connected earnings and profits of such United States Alien
Holder if such interest or gain, as the case may be, is effectively connected
with the conduct by the United States Alien Holder of a trade or business in the
United States.
ESTATE TAXES
Under Section 2105(b) of the Code, a Note held by an individual who is not a
citizen or resident of the United States at the time of his death will not be
subject to United States federal estate tax as a result of such individual's
death, provided that the individual does not own, actually or constructively, 10
percent or more of the total combined voting power of all classes of stock of
the Issuer entitled to vote and, at the time of such individual's death,
payments with respect to such Note would not have been effectively connected to
the conduct by such individual of a trade or business in the United States.
As noted above, the Issuer intends to treat the Notes as indebtedness for
United States federal income tax purposes. No assurance can be given, however,
that the Issuer's treatment will not be challenged by the IRS. If the Notes were
ultimately treated as equity rather than debt for United States federal income
tax purposes, a United States Alien Holder who is treated as the owner of, or
has made certain lifetime transfers of, an interest in the Notes will be
required to include the value thereof in his or her gross estate for United
States federal estate tax purposes, and may be subject to United States federal
estate tax unless an applicable estate tax treaty provides otherwise.
83
<PAGE>
BACKUP WITHHOLDING AND INFORMATION REPORTING
Under current Treasury Regulations, backup withholding (31%) will not apply
to payments by the Issuer made on a Note if the certifications required by
Sections 871(h) and 881(c) of the Code are received, provided in each case that
the Issuer or such paying agent, as the case may be, does not have actual
knowledge that the payee is a United States person.
Under current Treasury Regulations, payments on the sale, exchange or other
disposition of a Note made to or through a foreign office of a broker generally
will not be subject to backup withholding. However, if such broker is a United
States person, a controlled foreign corporation for United States tax purposes,
a foreign person 50 percent or more of whose gross income is effectively
connected with a United States trade or business for a specified three-year
period or another United States related person described in Section
1.6049-5(c)(5) of the Treasury Regulations, information reporting will be
required unless the broker has in its records documentary evidence that the
beneficial owner is not a United States person and certain other conditions are
met or the beneficial owner otherwise establishes an exemption. Under recently
finalized Treasury Regulations, backup withholding may apply to any payment made
after December 31, 1998 which such broker is required to report if such broker
has actual knowledge that the payee is a United States person. Payments to or
through the United States office of a broker will be subject to backup
withholding and information reporting unless the Holder certifies, under
penalties of perjury, that it is not a United States person or otherwise
establishes an exemption.
United States Alien Holders of Notes should consult their tax advisors
regarding the application of information reporting and backup withholding in
their particular situations, the availability of an exemption therefrom, and the
procedure for obtaining such an exemption, if available. Any amounts withheld
from a payment to a United States Alien Holder under the backup withholding
rules will be allowed as a credit against such Holder's United States federal
income tax liability and may entitle such Holder to a refund, provided that the
required information is furnished to the IRS.
84
<PAGE>
PLAN OF DISTRIBUTION
Each broker-dealer that receives New Notes for its own account pursuant to
the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. This Prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with the resale of New Notes received in exchange for Old Notes where
such Old Notes were acquired as a result of market-making activities or other
trading activities. The Company has agreed that, starting on the Expiration Date
and ending on the close of business one year after the Expiration Date, it will
make this Prospectus, as amended or supplemented, available to any broker-dealer
for use in connection with any such resale. In addition, until August 4, 1998
(90 days after the date of this Prospectus), all dealers effecting transactions
in the New Notes may be required to deliver a prospectus.
The Company will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the Exchange Offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the New Notes or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer or the purchasers of any such New Notes. Any broker-dealer that
resells New Notes that were received by it for its own account pursuant to the
Exchange Offer and any broker or dealer that participates in a distribution of
such New Notes may be deemed to be an "underwriter" within the meaning of the
Securities Act and any profit of any such resale of New Notes and any
commissions or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that, by acknowledging that it will deliver and by delivering a
prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
For a period of one year after the Expiration Date, the Company will
promptly send additional copies of this Prospectus and any amendment or
supplement to this Prospectus to any broker-dealer that requests such documents
in a Letter of Transmittal. The Company has agreed to pay all expenses incident
to the Exchange Offer (including the reasonable fees and expenses, if any, of
one counsel for the Initial Purchasers of the Old Notes) other than commissions
or concessions of any brokers or dealers and will indemnify the Holders of the
Notes (including any broker-dealers) against certain liabilities, including
liabilities under the Securities Act.
LEGAL MATTERS
The validity of the Notes being offered hereby and certain other legal
matters relating to the Exchange Offer will be passed upon for the Company by
Moss & Barnett, a Professional Association, Minneapolis, Minnesota.
EXPERTS
The consolidated financial statements of the Company as of December 31, 1996
and 1997 and for each of the three years ended December 31, 1997, have been
audited by Arthur Andersen LLP, independent public accountants, as indicated in
their report with respect thereto, and are included here in reliance upon the
authority of said firm as experts in giving said report.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The Company hereby incorporates into this Prospectus and the related
Registration Statement the following documents:
(a) Annual Report on Form 10-K for the year ended December 31, 1997
filed with the Commission (File No. 1-11014); and
85
<PAGE>
(b) The Company's Proxy Statement for the Annual Meeting of Shareholders
held on May 11, 1998.
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934 subsequent to the date of this
Offering Memorandum and prior to the termination of the Exchange Offer shall be
deemed to be incorporated by reference into this Prospectus from the date of
filing such documents. Any statement contained herein or in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained in any subsequently filed document which also is or is
deemed to be incorporated by reference herein modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
Copies of these documents may be obtained from the Company upon request.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. 20549, a Registration Statement on Form S-4
(including all amendments thereto, the "Registration Statement") under the
Securities Act of 1933, with respect to the New Notes offered in connection with
the Exchange Offer. As permitted by the rules and regulations of the Commission,
this Prospectus omits certain information contained in the Registration
Statement. For further information with respect to the Company and the New Notes
offered in connection with the Exchange Offer, reference is made to the
Registration Statement and the exhibits and schedules filed therewith.
Statements contained in this Prospectus concerning the contents of any contract
or any other document referred to are not necessarily complete; reference is
made in each instance to the copy of such contract or document filed as an
exhibit to the Registration Statement. Each such statement is qualified in all
respects by such reference to such exhibits. The Registration Statement,
including exhibits and schedules thereto, may be inspected without charge at the
Commission's principal office in Washington, D.C., and copies of all or any part
thereof may be obtained from such office after payment of fees prescribed by the
Commission. The Commission also maintains a Web site that contains reports,
proxy statements and other information regarding registrants, including the
Company, that file such information electronically with the Commission. The
address of the Commission's Web site is http://www.sec.gov.
86
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENTS OF MUSICLAND STORES CORPORATION
AND THE MUSICLAND GROUP, INC. AND SUBSIDIARIES
Separate financial statements of Musicland Stores Corporation ("MSC") and
The Musicland Group, Inc. and Subsidiaries ("MGI") have not been presented.
Since its formation, MSC has engaged in no independent business operations from
MGI. The separate financial statements of MGI would be substantially the same as
the consolidated financial statements of MSC, as all of the debt of MSC is
guaranteed by MGI and would be "pushed down" to the financial statements of MGI.
CONSOLIDATED FINANCIAL STATEMENTS
OF MUSICLAND STORES CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Report of Independent Public Accountants................................................................... F-2
Consolidated Statements of Operations...................................................................... F-3
Consolidated Balance Sheets................................................................................ F-4
Consolidated Statements of Cash Flows...................................................................... F-5
Consolidated Statements of Stockholders' Equity............................................................ F-6
Notes to Consolidated Financial Statements................................................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Musicland Stores Corporation:
We have audited the accompanying consolidated balance sheets of Musicland
Stores Corporation (a Delaware Corporation) and Subsidiaries as of December 31,
1996 and 1997, and the related consolidated statements of operations, cash flows
and stockholders' equity for each of the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Musicland Stores Corporation
and Subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
January 21, 1998
F-2
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Sales................................................................... $ 1,722,572 $ 1,821,594 $ 1,768,312
Cost of sales........................................................... 1,116,502 1,209,835 1,153,483
------------ ------------ ------------
Gross profit.......................................................... 606,070 611,759 614,829
Selling, general and administrative expenses............................ 525,213 576,658 529,427
Depreciation and amortization........................................... 45,531 44,819 39,411
Goodwill write-down..................................................... 138,000 95,253 --
Restructuring charges................................................... -- 75,000 --
------------ ------------ ------------
Operating income (loss)............................................... (102,674) (179,971) 45,991
Interest expense........................................................ 27,881 32,967 31,720
------------ ------------ ------------
Earnings (loss) before income taxes................................... (130,555) (212,938) 14,271
Income taxes............................................................ 5,195 (19,200) 300
------------ ------------ ------------
Net earnings (loss)................................................... $ (135,750) $ (193,738) $ 13,971
------------ ------------ ------------
------------ ------------ ------------
Basic earnings (loss) per common share.................................. $ (4.00) $ (5.80) $ 0.42
------------ ------------ ------------
------------ ------------ ------------
Diluted earnings (loss) per common share................................ $ (4.00) $ (5.80) $ 0.41
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-3
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1996 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................. $ 161,976 $ 3,942
Inventories........................................................................... 506,093 450,258
Deferred income taxes................................................................. 11,800 10,600
Other current assets.................................................................. 31,492 8,768
----------- -----------
Total current assets................................................................ 711,361 473,568
Property, net......................................................................... 277,996 250,021
Deferred income taxes................................................................. 1,200 2,400
Other assets.......................................................................... 6,358 7,906
----------- -----------
Total Assets........................................................................ $ 996,915 $ 733,895
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt.................................................. $ 2,060 $ 26,657
Accounts payable...................................................................... 406,642 357,183
Restructuring reserve................................................................. 33,963 --
Other current liabilities............................................................. 100,866 115,660
----------- -----------
Total current liabilities........................................................... 543,531 499,500
Long-term debt........................................................................ 394,539 166,430
Other long-term liabilities........................................................... 56,226 49,195
Commitments and contingent liabilities................................................
Stockholders' equity:
Preferred stock ($.01 par value; shares authorized: 5,000,000; shares issued and
outstanding: none).................................................................. -- --
Common stock ($.01 par value; shares authorized: 75,000,000; shares issued and
outstanding: December 31, 1996, 34,301,956; December 31, 1997, 34,372,592).......... 343 344
Additional paid-in capital............................................................ 253,896 255,075
Accumulated deficit................................................................... (238,649) (224,678)
Deferred compensation................................................................. (7,998) (6,998)
Common stock subscriptions............................................................ (4,973) (4,973)
----------- -----------
Total stockholders' equity.......................................................... 2,619 18,770
----------- -----------
Total Liabilities and Stockholders' Equity.......................................... $ 996,915 $ 733,895
----------- -----------
----------- -----------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-4
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net earnings (loss)...................................................... $ (135,750) $ (193,738) $ 13,971
Adjustments to reconcile net earnings (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization.......................................... 45,531 44,819 39,411
Disposal of property................................................... 7,587 1,733 4,112
Goodwill write-down.................................................... 138,000 95,253 --
Amortization of debt issuance costs and other.......................... 516 658 1,234
Other amortization..................................................... 364 234 1,022
Restructuring charges.................................................. -- 75,000 --
Deferred income taxes.................................................. (3,400) 500 --
Changes in operating assets and liabilities:
Inventories............................................................ (41,866) 27,601 55,835
Other current assets................................................... (11,172) (10,353) 22,724
Accounts payable....................................................... (53,388) 2,794 (61,520)
Restructuring reserve.................................................. -- (24,092) (12,231)
Other current liabilities.............................................. (11,445) (6,767) 14,843
Other assets........................................................... (1,079) (590) (1,483)
Other long-term liabilities............................................ 9,875 3,637 (3,305)
----------- ----------- -----------
Net cash provided by (used in) operating activities.................. (56,227) 16,689 74,613
----------- ----------- -----------
INVESTING ACTIVITIES:
Capital expenditures..................................................... (113,983) (17,970) (10,940)
Sale/leasebacks and other property sales................................. 26,969 11,594 --
----------- ----------- -----------
Net cash used in investing activities................................ (87,014) (6,376) (10,940)
----------- ----------- -----------
FINANCING ACTIVITIES:
Increase (decrease) in outstanding checks in excess of cash balances..... 63,435 (69,321) 12,061
Borrowings (repayments) under revolver................................... 53,000 219,000 (272,000)
Net proceeds from issuance of long-term debt............................. -- -- 49,500
Principal payments on long-term debt..................................... -- -- (11,487)
Loan to KSOP............................................................. (9,997) -- --
Proceeds from sale of common stock....................................... 196 13 219
----------- ----------- -----------
Net cash provided by (used in) financing activities.................. 106,634 149,692 (221,707)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................... (36,607) 160,005 (158,034)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR............................. 38,578 1,971 161,976
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR................................... $ 1,971 $ 161,976 $ 3,942
----------- ----------- -----------
----------- ----------- -----------
CASH PAID (RECEIVED) DURING THE YEAR FOR:..................................
Interest................................................................. $ 27,268 $ 31,677 $ 33,035
Income taxes, net........................................................ 17,884 9,010 (22,908)
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-5
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL EARNINGS TOTAL
---------------------- PAID-IN (ACCUMULATED DEFERRED COMMON STOCK STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT) COMPENSATION SUBSCRIPTIONS EQUITY
--------- ----------- ---------- ------------ ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1995.................... 34,247 $ 342 $ 254,068 $ 90,839 $ $ (4,973) $ 340,276
Net loss........................... (135,750) (135,750)
Other, including exercise of stock
options and related tax
benefit.......................... 50 1 670 671
Loan to KSOP....................... (9,997) (9,997)
Amortization of deferred
compensation and adjustment to
fair market value of KSOP shares,
net of tax benefit............... (388) 999 611
--------- ----- ---------- ------------ ------------- ------------- ------------
December 31, 1995.................. 34,297 343 254,350 (44,911) (8,998) (4,973) 195,811
Net loss........................... (193,738) (193,738)
Other, including exercise of stock
options and related tax
benefit.......................... 5 -- 13 13
Amortization of deferred
compensation and adjustment to
fair market value of KSOP shares,
net of tax benefit............... (467) 1,000 533
--------- ----- ---------- ------------ ------------- ------------- ------------
December 31, 1996.................. 34,302 343 253,896 (238,649) (7,998) (4,973) 2,619
Net earnings....................... 13,971 13,971
Other, including exercise of stock
options and related tax
benefit.......................... 71 1 275 276
Issuance of warrants............... 890 890
Amortization of deferred
compensation and adjustment to
fair market value of KSOP shares,
net of tax....................... 14 1,000 1,014
--------- ----- ---------- ------------ ------------- ------------- ------------
December 31, 1997.................. 34,373 $ 344 $ 255,075 $ (224,678) $ (6,998) $ (4,973) $ 18,770
--------- ----- ---------- ------------ ------------- ------------- ------------
--------- ----- ---------- ------------ ------------- ------------- ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-6
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements include the
accounts of Musicland Stores Corporation ("MSC") and its wholly-owned
subsidiary, The Musicland Group, Inc. ("MGI") and MGI's wholly-owned
subsidiaries, after elimination of all material intercompany balances and
transactions. MSC and MGI are collectively referred to as the "Company." The
Company's foreign operations in the United Kingdom and resulting foreign
currency translation adjustments have not been material. The preparation of the
accompanying consolidated financial statements required management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Actual results could differ from those
estimates.
BUSINESS. The Company operates principally in the United States as a
specialty retailer of home entertainment products, including prerecorded music,
video sell-through, books, computer software and related products. The Company's
stores operate under two principal strategies: (i) mall based music and video
sell-through stores (the "Mall Stores"), operating under the principal trade
names Sam Goody and Suncoast Motion Picture Company, and (ii) non-mall based
full-media superstores ("Superstores"), operating under the trade names Media
Play and On Cue. Because both Mall Stores and Superstores are supported by
centralized corporate services and have similar economic characteristics,
products, customers and retail distribution methods, the stores are reported as
one industry segment. At December 31, 1997, the store count included 1,122 Mall
Stores and 225 Superstores, with 4.0 million total store square footage in Mall
Stores and 4.2 million total store square footage in Superstores. The Company
operated 1,363 stores in 49 states, the District of Columbia, the Commonwealth
of Puerto Rico, the Virgin Islands and the United Kingdom at December 31, 1997.
SUMMARY OF SIGNIFICANT RISKS AND UNCERTAINTIES. Over the past few years,
the number of stores and types of competitors faced by the Company's stores
increased significantly, including 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
intense competitive environment and pricing pressure created by the high-volume
low-price superstores eased in 1997 as a result of the closing of stores by
certain mall competitors as well as the narrowing of entertainment software
product offerings, downsizing of store selling space devoted to media products
and less near or below cost pricing by certain non-mall competitors. 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 and technology, 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.
The Company has assessed its systems and equipment with respect to Year 2000
compliance and has developed a project plan. Many of the Year 2000 issues,
including the processing of credit card transactions, have been addressed. The
remaining Year 2000 issues will either be addressed with scheduled system
upgrades or through the Company's internal systems development staff. The
incremental costs will be charged to expense as incurred and are not expected to
have a material impact on the financial position or results of operations of the
Company. However, the Company could be adversely impacted if the Year 2000
modifications are not properly completed by either the Company or its vendors,
banks or any other
F-7
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
entity with whom the Company conducts business. The Company is devoting and
plans to continue to devote the necessary resources to resolve all significant
Year 2000 issues in a timely manner.
CASH AND CASH EQUIVALENTS. Cash equivalents consist principally of
short-term investments with original maturities of three months or less and are
recorded at cost, which approximates market value. Restricted cash amounts are
not material. The Company uses controlled disbursement banking arrangements
under its cash management program which provide for the reimbursement of major
bank disbursement accounts on a daily basis. At December 31, 1997, outstanding
checks in excess of cash balances of $12,061 were included in accounts payable.
INVENTORIES. Inventories are valued at the lower of cost or market. Cost is
determined using the retail inventory method, on the first-in, first-out (FIFO)
basis.
PROPERTY. Buildings and improvements, store fixtures and other property are
depreciated using the straight-line method over the estimated useful lives of
the respective assets. Leasehold improvements are amortized on a straight-line
basis over an estimated useful life of ten years, which is generally equal to or
less than the lease term. Accelerated depreciation methods are used for income
tax purposes. When assets are sold or retired, the costs and related accumulated
depreciation are removed from the accounts and the resulting gain or loss is
included in operations. Depreciation and amortization expense for property was
$39,653, $41,763 and $39,370 for the years ended December 31, 1995, 1996 and
1997, respectively. In the event that facts and circumstances indicate that the
carrying amount of property may not be recoverable, an evaluation would be
performed using such factors as recent operating results, projected cash flows
and management's plans for future operations.
DEBT ISSUANCE COSTS. Debt issuance costs are amortized over the terms of
the related financing using the interest method.
STORE OPENING AND ADVERTISING COSTS. Store opening and advertising costs
are charged to expense as they are incurred.
STOCK-BASED COMPENSATION. Compensation expense for employee and director
stock options is measured based on the excess, if any, of the quoted market
price of the Company's stock on the date of grant over the amount that must be
paid to acquire the stock.
INCOME TAXES. Deferred income taxes are provided for temporary differences
between the financial reporting and tax basis of assets and liabilities at
currently enacted tax rates. A valuation allowance for deferred income tax
assets is recorded when it is more likely than not that some portion or all of
the deferred income tax assets will not be realized.
OTHER COMPREHENSIVE INCOME. The Company has no significant items of other
comprehensive income.
EARNINGS (LOSS) PER COMMON SHARE. Basic earnings (loss) per common share is
computed by dividing net earnings (loss) by the weighted average number of
common shares outstanding during each year of 33,898,000, 33,414,000 and
33,528,000 in 1995, 1996 and 1997, respectively. Diluted earnings (loss) per
common share is computed by dividing net earnings (loss) by the weighted average
number of common shares outstanding during each year, adjusted in 1997 for
641,000 of incremental shares assumed issued on
F-8
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the exercise of stock options and warrants. Stock options were excluded from
diluted computations for the net losses for the years ended December 31, 1995
and 1996 as the effect would be anti-dilutive. For purposes of earnings (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.
2. WRITE-DOWN OF GOODWILL
In connection with the Company's adoption of Financial Accounting Standards
Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" ("Statement No. 121"), in 1995, the
carrying values of long-lived assets, primarily goodwill and property, of the
music stores were reviewed for recoverability and possible impairment in light
of recent developments. Goodwill primarily resulted from the acquisition of MGI
by MSC in a leveraged buyout in 1988, when nearly all of the Company's stores
were mall based music stores. During 1995 and 1996, the music stores experienced
sales declines which were a result of a general decrease in customer traffic in
malls, an increase in high-volume, low-price non-mall superstores and a lack of
strong music product releases.
The Company updated its operating projections for the music stores in the
third quarter of 1995 and again in the fourth quarter of 1996 to reflect the
continued weak retail environment and competitive pricing. An analysis of the
projected undiscounted future cash flows indicated impairment had occurred. A
goodwill write-down of $138,000 was recorded in August 1995 and a write-down of
the remaining goodwill of $95,253 was recorded in December 1996 based on
estimates of fair value of the music stores determined primarily from operating
projections, future discounted cash flows and other significant market factors
related to the Company. Goodwill amortization for the years ended December 31,
1995 and 1996 was $5,793 and $3,005, respectively.
3. RESTRUCTURING CHARGES
During 1996, the Company recorded pretax restructuring charges of $75,000
for the estimated cost of programs designed to improve profitability and
increase inventory turnover. The restructuring programs included the closing of
the Company's distribution facility in Minneapolis, Minnesota and 115
underperforming stores, including 79 Mall Stores and 36 Superstores. The Company
closed 53 of these stores in 1996 and completed the restructuring programs in
1997 with the closing of the distribution facility and another 61 stores. The
Company removed one Superstore from the closing list after exercising an option
in the termination agreement for that store to reinstate the lease. The
restructuring charges included $36,300 of cash payments, primarily related to
payments to landlords for the early termination of operating leases and
estimated legal and consulting fees, and $38,700 for non-cash charges related to
write-downs of leasehold improvements and certain equipment, net of unamortized
lease credits.
F-9
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. LONG-TERM DEBT
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
<S> <C> <C>
LONG-TERM DEBT CONSISTS OF THE FOLLOWING:
Revolver borrowings, variable rates............................... $ 272,000 $ --
Term loan, variable rate, 8.13% at December 31, 1997.............. -- 50,000
Mortgage notes payable, variable rates, 8.24% to 8.37% at December
31, 1997........................................................ 14,599 33,087
9% senior subordinated notes, unsecured, due 2003................. 110,000 110,000
---------- ----------
Total........................................................... 396,599 193,087
Less current maturities........................................... 2,060 26,657
---------- ----------
Total long-term debt.............................................. $ 394,539 $ 166,430
---------- ----------
---------- ----------
</TABLE>
The Company's bank credit agreement, as amended in June 1997, provides for a
revolving credit facility and expires in October 1999. Borrowings under the
revolving credit facility are available up to a maximum of the lesser of 60% of
eligible inventory or $255,000 through February 15, 1998 and $245,000
thereafter. However, for any borrowings which result in a net increase in total
outstanding revolver borrowings, total trade accounts payable must be equal to
or greater than the total outstanding revolver borrowings. Facility fees at an
annual rate of up to 0.50% are assessed on the maximum credit amount available.
Revolver borrowings at December 31, 1996 have been reclassified to long-term
debt because of the waiver and subsequent removal in 1997 of the annual one day
clean-down requirement of revolver borrowings.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
REVOLVER DATA IS AS FOLLOWS:
Average daily outstanding revolver borrowings........ $ 254,000 $ 289,700 $ 238,500
Highest outstanding revolver borrowings.............. 350,000 333,000 273,000
Weighted average interest rates:
Based on average daily borrowings.................. 7.13% 7.56% 8.03%
At year end, excluding facility fee rate........... 7.12 7.26 N/A
</TABLE>
The Company has pledged the common stock of certain of its wholly owned
subsidiaries as collateral for borrowings under the revolving credit facility.
Outstanding revolver borrowings in excess of $245,000 and the term loan are
secured by the Company's inventory. The mortgage notes payable are
collateralized by land, buildings and certain fixtures and equipment of three of
the Company's Media Play stores and the Franklin, Indiana distribution facility
with an aggregate carrying value, including additional building improvements, of
$43,965 at December 31, 1997.
The credit agreement contains financial covenants and covenants that limit
additional indebtedness, liens, capital expenditures and cash dividends. The
amendment to the credit agreement in June 1997 modified and provided additional
flexibility in financial covenants related to fixed charge coverage,
F-10
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
4. LONG-TERM DEBT (CONTINUED)
consolidated tangible net worth and debt to total capitalization and removed
financial covenants related to the maximum debt and trade payables to eligible
inventory ratio and the annual one day clean-down requirement of revolver
borrowings. Covenants of the term loan agreement require a minimum inventory of
$150,000 and a minimum operating cash flow and limit additional liens. The
agreements related to the mortgage notes payable and senior subordinated notes,
as amended, also contain certain financial covenants. The Company was in
compliance with all covenants at December 31, 1997.
Maturities of long-term debt are: 1998, $26,657; 1999, $46,000; 2000,
$10,276; and 2003, $110,000. The Company may, at its option, redeem the senior
subordinated notes prior to maturity at 103.375% of par on and after June 15,
1998 and thereafter at prices declining annually to 100% of par on and after
June 15, 2001. The mortgage notes payable agreements contain one year renewal
options which would extend maturities of $21,000 and $10,276 to March 2000 and
May 2001, respectively. The mortgage notes payable balance at December 31, 1997
includes deferred financing credits of $154 that are being amortized over the
term of the related debt.
5. INCOME TAXES
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
INCOME TAXES CONSIST OF:
Current:
Federal............................... $ 7,395 $ (18,300) $ 100
State, local and other................ 1,200 (1,400) 200
----------- ----------- -----------
8,595 (19,700) 300
----------- ----------- -----------
Deferred:
Federal............................... (3,200) (1,000) 1,400
State, local and other................ (200) 1,500 (1,400)
----------- ----------- -----------
(3,400) 500 --
----------- ----------- -----------
Total................................. $ 5,195 $ (19,200) $ 300
----------- ----------- -----------
----------- ----------- -----------
THE COMPANY'S EFFECTIVE INCOME TAX RATES
DIFFER FROM THE FEDERAL STATUTORY RATE
AS FOLLOWS:
Federal statutory tax rate.............. (35.0)% (35.0)% 35.0%
Goodwill amortization and write-down and
other permanent differences........... 38.5 16.7 5.2
State and local income taxes, net of
federal benefit....................... 0.5 -- (5.5)
Valuation allowance..................... -- 9.3 (32.6)
----------- ----------- -----------
Effective income tax rate............. 4.0% (9.0)% 2.1%
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
F-11
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. INCOME TAXES (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
<S> <C> <C>
COMPONENTS OF DEFERRED INCOME TAXES ARE AS FOLLOWS:
Net current deferred tax asset:
Capitalized inventory costs....................................... $ 5,880 $ 5,360
Inventory valuation............................................... 5,564 8,266
Compensation related.............................................. 2,601 2,504
Restructuring charges............................................. 14,388 --
Store closings.................................................... 1,883 2,586
Other accruals.................................................... 2,103 2,303
Other, net........................................................ 581 681
---------- ----------
Total current deferred income taxes............................. 33,000 21,700
Valuation allowance............................................... (21,200) (11,100)
---------- ----------
Net current deferred income taxes............................... $ 11,800 $ 10,600
---------- ----------
---------- ----------
Net noncurrent deferred tax asset:
Depreciation...................................................... $ (20,901) $ (15,263)
Rent expense...................................................... 17,651 18,279
Amortization of intangible assets................................. (2,011) (2,011)
Net pension liability............................................. 881 960
Other, net........................................................ (49) 489
Alternative minimum tax credits................................... 8,929 5,846
---------- ----------
Total noncurrent deferred income taxes.......................... 4,500 8,300
Valuation allowance............................................... (3,300) (5,900)
---------- ----------
Net noncurrent deferred income taxes.............................. $ 1,200 $ 2,400
---------- ----------
---------- ----------
</TABLE>
The Company's management believes it is more likely than not that the
deferred income tax assets, net of valuation allowances, will be realized based
on current income tax laws and estimates of future earnings. However, the amount
of deferred tax assets considered realizable could be adjusted in the future if
estimates of taxable income are revised.
6. EMPLOYEE BENEFIT PLANS
The Company has a non-contributory, defined benefit pension plan covering
certain employees. Retirement benefits are a function of both years of service
and the level of compensation. The Company's funding policy is to make an annual
contribution equal to or exceeding the minimum required by the Employee
Retirement Income Security Act of 1974. Effective December 31, 1991,
participation in the pension plan was frozen for employees hired on or after
July 1, 1990. The Company has been evaluating on
F-12
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. EMPLOYEE BENEFIT PLANS (CONTINUED)
a year to year basis the continuation of benefit accruals under the pension
plan. Accordingly, the projected benefit obligation approximated the accumulated
benefit obligation at December 31, 1996 and 1997.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
THE FUNDED STATUS OF THE PENSION PLAN AND THE RELATED ACCRUED PENSION
COST ARE AS FOLLOWS:
Change in benefit obligation:
Benefit obligation at beginning of year.............................. $ 9,330 $ 9,604
Service cost......................................................... 446 411
Interest cost........................................................ 715 748
Effect of assumption change.......................................... (456) 448
Actuarial loss (gain)................................................ (13) 257
Benefits paid........................................................ (418) (1,011)
--------- ---------
Benefit obligation at end of year.................................... 9,604 10,457
--------- ---------
Change in plan assets:
Fair value of plan assets at beginning of year....................... 9,289 9,468
Actual return on plan assets......................................... 597 2,468
Benefits paid........................................................ (418) (1,011)
--------- ---------
Fair value of plan assets at end of year............................. 9,468 10,925
--------- ---------
Funded status........................................................ (136) 468
Unrecognized gains................................................... (2,273) (3,277)
--------- ---------
Accrued pension cost................................................. $ (2,409) $ (2,809)
--------- ---------
--------- ---------
ASSUMPTIONS USED IN COMPUTING PENSION DATA ARE AS FOLLOWS:
Discount rate for benefit obligations................................ 7.75% 7.50%
Expected long-term rate of return on plan assets..................... 8.50 8.50
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
THE COMPONENTS OF NET PENSION EXPENSE ARE AS FOLLOWS:
Service cost.................................................... $ 260 $ 446 $ 411
Interest cost................................................... 631 715 748
Expected return on plan assets.................................. (672) (771) (754)
Amortization of prior service cost and gain..................... (12) (5) (5)
--------- --------- ---------
Net pension expense........................................... $ 207 $ 385 $ 400
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-13
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The Company established a defined contribution plan in 1992 for employees
not covered by the pension plan. The Company has a 401(k) plan, which is based
on contributions made through payroll deductions and partially matched by the
Company, covering substantially all employees. The Company's matching
contribution to the 401(k) plan is paid in stock of MSC under an employee stock
ownership plan ("KSOP"). The Company may also, at its discretion, make a
supplemental cash matching contribution. In 1995, to establish the KSOP, the
Company made a loan to the KSOP trust for the purchase of 1,042,900 shares of
the Company's common stock in the open market. In exchange, the Company received
a note, the balance of which is recorded as deferred compensation and is
reflected as a reduction of stockholders' equity. The Company recognizes
compensation expense during the period the match is earned equal to the expected
market value of the shares to be released to settle the match liability. The
number of KSOP shares committed to be released was 104,290 at December 31, 1996
and 1997. At December 31, 1996 and 1997, the number of shares held in suspense
was 834,320 and 730,030, respectively, and the market value of the shares held
in suspense was $1,251 and $5,338, respectively.
Expenses for the defined contribution and 401(k) plans for the years ended
December 31, 1995, 1996 and 1997 totaled $570, $354 and $1,749, respectively.
Expenses for postemployment benefits were not material. The Company does not
offer or provide postretirement benefits other than pensions to its employees.
7. STOCK PLANS
The Company's 1994, 1992 and 1988 Stock Option Plans authorize the grant of
stock options and stock appreciation rights to officers and other key employees.
The Company's Directors Stock Option Plan authorizes the grant of stock options
to its directors who are not employees of the Company or its affiliates. The
number of shares of common stock that may be issued to employees and directors
under each of these plans is 950,000 shares, 1,500,000 shares, 1,000,000 shares
and 200,000 shares, respectively. The stock options become exercisable over a
period not to exceed ten years after the date they are granted. Stock options
are granted at option prices not less than the fair market value of the
Company's common stock on the date of the grant. Accordingly, no compensation
expense has been recognized for stock options granted. The Company has not
granted any stock appreciation rights.
PRO FORMA DISCLOSURES OF NET EARNINGS (LOSS) AND NET EARNINGS (LOSS) PER
COMMON SHARE AS IF THE FAIR VALUE BASED METHOD OF ACCOUNTING FOR STOCK OPTIONS
HAD BEEN APPLIED ARE AS FOLLOWS:
<TABLE>
<CAPTION>
1995 1996 1997
----------- ----------- ---------
<S> <C> <C> <C> <C>
Net earnings (loss): As reported........ $ (135,750) $ (193,738) $ 13,971
Pro forma.......... $ (135,850) $ (194,394) $ 13,168
Net earnings (loss) per common share: As reported
Basic............ $ (4.00) $ (5.80) $ .42
Diluted.......... $ (4.00) $ (5.80) $ .41
Pro forma
Basic............ $ (4.01) $ (5.82) $ .39
Diluted.......... $ (4.01) $ (5.82) $ .39
</TABLE>
The fair value of each employee and director stock option has been estimated
on the date of grant using the Black-Scholes option pricing model with the
following assumptions used for grants in 1995, 1996
F-14
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. STOCK PLANS (CONTINUED)
and 1997, respectively: risk-free interest rates of 6.31%, 6.17% and 6.27%;
expected volatility of 45%, 49% and 56%; expected life of seven years; and no
dividend yields. The pro forma disclosures may not be representative of the
effects on net earnings in future years because they do not take into
consideration pro forma compensation expense related to grants made prior to
1996, the vesting of stock options over several years and the possible grant of
additional stock options in the future.
STOCK OPTION ACTIVITY FOR THE LAST THREE YEARS WAS AS FOLLOWS:
<TABLE>
<CAPTION>
1995 1996 1997
----------------------- ----------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year........... 1,748,916 $ 11.90 1,892,984 $ 10.52 2,681,294 $ 7.33
Granted.................................... 398,350 7.84 1,023,973 2.30 734,650 3.16
Exercised.................................. (50,100) 3.93 (5,000) 2.50 (70,636) 3.10
Canceled................................... (204,182) 18.73 (230,663) 11.26 (409,400) 8.67
---------- ---------- ----------
Outstanding at end of year................. 1,892,984 10.52 2,681,294 7.33 2,935,908 6.20
---------- ---------- ----------
---------- ---------- ----------
Options exercisable at year end............ 840,838 1,003,916 1,084,642
---------- ---------- ----------
---------- ---------- ----------
Options available for future grant......... 1,460,060 666,750 341,500
---------- ---------- ----------
---------- ---------- ----------
Weighted average fair value of options
granted during the year.................. $ 4.38 $ 1.32 $ 2.00
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
THE FOLLOWING TABLE SUMMARIZES INFORMATION CONCERNING OUTSTANDING AND
EXERCISABLE STOCK OPTIONS AT DECEMBER 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------- OPTIONS EXERCISABLE
WEIGHTED ---------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- - ---------------------------------------------------- ----------- --------------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C>
$ 1.5000 to $ 2.5625................................ 1,171,459 7.59 $ 2.000 271,503 $ 2.465
3.0000 to 4.5000................................ 592,016 6.42 3.485 228,600 4.500
6.0625 to 6.7500................................ 422,883 8.98 6.402 28,739 6.625
9.3750 to 14.5000................................ 594,700 5.35 12.992 452,567 13.462
21.7500 to 21.7500................................ 154,850 5.83 21.750 103,233 21.750
----------- ----------
2,935,908 1,084,642
----------- ----------
----------- ----------
</TABLE>
8. COMMON STOCK
Certain members of current and former management of the Company own
1,991,308 shares of common stock with restrictions ("Restricted Stock") at
$0.0025 per share. Although holders of Restricted
F-15
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. COMMON STOCK (CONTINUED)
Stock have voting and dividend rights, no Restricted Stock is transferable until
the Company is paid the balance of the subscription price of $2.4975 or $4.4975
per share. After August 25, 2003, the Company may, at its option, buy back the
Restricted Shares for $0.0025 per share. The amount of subscriptions due from
the holders of Restricted Stock upon transfer is reflected as a reduction of
stockholders' equity.
In connection with the term loan agreement completed in June 1997, the
Company issued warrants for the purchase of 1,822,087.16 shares of common stock
at $1.5625 per share. The warrants can be traded, are exercisable over a period
of five years and expire in 2002. The fair value of the warrants at the time of
issuance of $890 was recorded as additional debt issuance costs and an increase
to additional paid-in capital.
9. PREFERRED STOCK PURCHASE RIGHTS
In March 1995, the Company's Board of Directors adopted a stockholder rights
plan and declared a dividend of one preferred share purchase right ("Right") per
share for each outstanding share of common stock. The Rights will be distributed
20 days after a person or group (an "Acquiring Person") either acquires
beneficial ownership of, or commences a tender or exchange offer for, 17.5% or
more of the Company's outstanding common stock.
Each Right then may be exercised to purchase one one-hundredth of a share of
Series A Junior Participating Preferred Stock, $0.01 par value (the "Preferred
Shares"), at an exercise price of $70.00 per one-hundredth Preferred Share.
Thereafter, upon the occurrence of certain events, the Rights entitle holders
other than the Acquiring Person to acquire common stock having a value of twice
the exercise price of the Rights. Alternatively, upon the occurrence of certain
other events, the rights would entitle holders other than the Acquiring Person
to acquire common stock of the Acquiring Person having a value of twice the
exercise price of the Rights.
The Rights may be redeemed by the Company at a redemption price of $.001 per
Right at any time until the 20th day after a public announcement of an
acquisition of 17.5% or more of the common stock of the Company. The Rights
expire on March 20, 2005.
10. COMMITMENTS
The Company leases most of its retail stores and certain office and storage
facilities under operating leases for terms that typically range from three to
twenty-five years. Certain store leases provide the Company with an early
cancellation option if sales for a designated period do not reach a specified
level as defined in the lease. In most instances, the Company pays, in addition
to minimum rent, real estate taxes, utilities, common area maintenance costs and
percentage rents which are based upon sales volume. Certain store leases contain
provisions restricting assignment, merger, change of control or transfer. The
Company also leases certain store fixtures and equipment, computers and
automobiles under operating leases.
F-16
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
10. COMMITMENTS (CONTINUED)
Minimum payments under operating leases with noncancelable terms in excess
of one year at December 31, 1997 are: 1998, $137,183; 1999, $131,751; 2000,
$111,399; 2001, $85,060; 2002, $70,527; and thereafter, $268,219.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
TOTAL RENT EXPENSE CONSISTS OF THE FOLLOWING:
Minimum cash rents................................... $ 148,736 $ 166,308 $ 152,343
Straight-line recognition of leases with scheduled
rent increases..................................... 7,304 3,152 (910)
Percentage rents..................................... 2,000 1,733 2,143
---------- ---------- ----------
Total rent expense................................. $ 158,040 $ 171,193 $ 153,576
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
11. LITIGATION
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business. It is the opinion of management that
the ultimate resolution of these matters will not have a material adverse effect
on the financial position or results of operations of the Company.
12. RELATED PARTY TRANSACTIONS
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJSC"), a wholly
owned subsidiary of Donaldson, Lufkin & Jenrette, Inc. ("DLJ"), acts as a market
maker in the Company's senior subordinated notes. A Managing Director of DLJSC
is a member of the Company's board of directors. DLJ and certain of its
affiliates, excluding DLJ employees, owned approximately 6.9% of the Company's
common stock at December 31, 1996. During 1997, DLJ sold its ownership in the
Company's common stock.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reported in the consolidated balance sheets at December
31, 1996 and 1997 for cash and cash equivalents, other current assets, accounts
payable and other current liabilities approximate fair value because of the
immediate or short-term maturity of these financial instruments. The fair value
of the outstanding revolver borrowings at December 31, 1996, based on current
market rates, was $217,600. As the interest rates on the term loan and mortgage
notes payable are reset monthly based on current market rates and the debt is
secured, the carrying values approximate fair value. The fair value of the
senior subordinated notes at December 31, 1996 and 1997, based on the last
quoted price on those dates, was $50,600 and $101,750, respectively.
F-17
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
14. SUPPLEMENTAL BALANCE SHEET INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
<S> <C> <C>
PROPERTY CONSISTS OF THE FOLLOWING, AT COST:
Land and land improvements........................................ $ 9,283 $ 10,003
Buildings......................................................... 10,408 32,055
Leasehold improvements............................................ 248,077 231,831
Store fixtures and other property................................. 162,348 149,973
---------- ----------
430,116 423,862
Less accumulated depreciation and amortization.................... (152,120) (173,841)
---------- ----------
Property, net..................................................... $ 277,996 $ 250,021
---------- ----------
---------- ----------
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
<S> <C> <C>
OTHER CURRENT LIABILITIES CONSIST OF THE FOLLOWING:
Payroll and related taxes and benefits............................ $ 19,598 $ 24,963
Gift certificates payable......................................... 32,792 38,224
Sales taxes payable............................................... 19,924 18,764
Accrued store expenses and other.................................. 28,552 33,709
---------- ----------
Total............................................................. $ 100,866 $ 115,660
---------- ----------
---------- ----------
OTHER LONG-TERM LIABILITIES CONSIST OF THE FOLLOWING:
Straight-line recognition of leases with scheduled rent
increases....................................................... $ 36,442 $ 32,457
Deferred rent credits............................................. 14,651 12,508
Other............................................................. 5,133 4,230
---------- ----------
Total............................................................. $ 56,226 $ 49,195
---------- ----------
---------- ----------
</TABLE>
15. SUPPLEMENTAL CASH FLOW INFORMATION
The land, buildings and certain fixtures related to three of the Company's
Media Play stores and the land, building and certain equipment related to the
Company's distribution facility in Franklin, Indiana were financed under
operating leases with special purpose entities that had been formed for the
purpose of purchasing the land, fixtures and equipment and constructing the
facilities using secured financing. The three Media Play stores, which had an
aggregate cost of $14,395, together with the related mortgage note payable and
deferred financing credits totaling $14,599, were recorded on the Company's
Consolidated Balance Sheet after the terms of an amendment to the operating
lease required consolidation of the special purpose entity as of October 1996,
the date of the amendment. The financed distribution facility property, which
had an original cost of approximately $30,000, and the mortgage note payable
were recorded on the Company's Consolidated Balance Sheet after the terms of an
amendment to the operating lease required consolidation of the special purpose
entity as of June 1997, the date of the amendment.
F-18
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
BASIC DILUTED
EARNINGS EARNINGS
(LOSS) (LOSS) COMMON STOCK PRICE
NET PER PER
GROSS EARNINGS COMMON COMMON ---------------------
SALES PROFIT (LOSS) SHARE SHARE HIGH LOW
------------ ---------- ----------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
1996:
First......................... $ 383,570 $ 129,833 $ (52,636) $ (1.58) $ (1.58) $ 4 3/4 $ 2
Second........................ 372,410 126,582 (24,080) (0.72) (0.72) 5 1/4 3 1/8
Third......................... 366,634 127,702 (24,201) (0.72) (0.72) 3 5/8 1 3/8
Fourth........................ 698,980 227,642 (92,821) (2.77) (2.77) 2 1 1/4
------------ ---------- ----------- -------- --------
Total....................... $ 1,821,594 $ 611,759 $ (193,738) $ (5.80) $ (5.80)
------------ ---------- ----------- -------- --------
------------ ---------- ----------- -------- --------
1997:
First......................... $ 376,080 $ 126,463 $ (20,983) $ (0.63) $ (0.63) $ 1 3/4 $ 11/16
Second........................ 342,746 120,428 (18,325) (0.55) (0.55) 2 7/8 15/16
Third......................... 373,283 129,070 (12,384) (0.37) (0.37) 8 1/4 2 1/4
Fourth........................ 676,203 238,868 65,663 1.95 1.89 8 1/2 4 5/8
------------ ---------- ----------- -------- --------
Total....................... $ 1,768,312 $ 614,829 $ 13,971 $ .42 $ .41
------------ ---------- ----------- -------- --------
------------ ---------- ----------- -------- --------
</TABLE>
The three months ended December 31, 1996 include a goodwill write-down of
$95,253, or $2.85 per share.
The three months ended March 31, 1996 and December 31, 1996 include pretax
restructuring charges of $35,000 and $40,000, respectively.
The totals of basic and diluted earnings (loss) per common share by quarter
may not equal the totals for the year as there are changes in the weighted
average number of common shares outstanding each quarter and basic and diluted
earnings (loss) per common share are calculated independently for each quarter.
F-19
<PAGE>
- - -------------------------------------------
-------------------------------------------
- - -------------------------------------------
-------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATION, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, IN CONNECTION
WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR ANY OTHER PERSON. NEITHER THE DELIVER OF THIS PROSPECTUS NOR ANY SALE MADE
HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITIES OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER
OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION.
--------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 12
The Exchange Offer........................................................ 20
Use of Proceeds........................................................... 27
Capitalization............................................................ 28
Selected Consolidated Financial and Operating Data........................ 29
Management's Discussion and Analysis of Results of Operations and
Financial Condition..................................................... 31
Business.................................................................. 39
Management................................................................ 47
Description of Notes...................................................... 50
Description of Other Financing Arrangements............................... 78
Certain Federal Income Tax Considerations................................. 81
Plan of Distribution...................................................... 85
Legal Matters............................................................. 85
Experts................................................................... 85
Incorporation of Certain Documents by Reference........................... 85
Additional Information.................................................... 86
Index to Consolidated Financial Statements................................ F-1
</TABLE>
$150,000,000
[LOGO]
9 7/8% SENIOR SUBORDINATED
NOTES DUE 2008
--------------
PROSPECTUS
--------------
MAY 6, 1998
- - -------------------------------------------
-------------------------------------------
- - -------------------------------------------
-------------------------------------------
<PAGE>
INSTRUCTION TO REGISTERED HOLDER AND/OR
BOOK-ENTRY TRANSFER FACILITY PARTICIPANT FROM OWNER
OF
THE MUSICLAND GROUP, INC.
9 7/8% SERIES A SENIOR SUBORDINATED NOTES DUE 2008
(CUSIP #627578 AB 3)
(CINS #U61809 AA 4)
To: Registered Holder and/or Participant of the Book-Entry Transfer Facility:
The undersigned hereby acknowledges receipt of the Prospectus dated May 6,
1998 (the "Prospectus") of The Musicland Group, Inc., a Delaware corporation
(the "Company"), and the accompanying Letter of Transmittal (the "Letter of
Transmittal"), that together constitute the Company's offer (the "Exchange
Offer") to exchange its registered 9 7/8% Series B Senior Subordinated Notes Due
2008 (the "New Notes") for any outstanding 9 7/8% Series A Senior Subordinated
Notes Due 2008 (the "Old Notes"). Capitalized terms used but not defined herein
have the meaning as ascribed to them in the Prospectus.
This will instruct you, the registered holder and/or book-entry transfer
facility participant, as to the action to be taken by you relating to the
Exchange Offer with respect to the Old Notes held by you for the account of the
undersigned.
The aggregate face amount of the Old Notes held by you for the account of
the undersigned is (fill in amount) :
$ of the 9 7/8% Series A Senior Subordinated Notes due 2008
(CUSIP #627578 AB 3 or CINS #U61809 AA 4).
With respect to the Exchange Offer, the undersigned hereby instructs you
(check appropriate box):
[ ] To TENDER the following Old Notes held by you for the account of the
undersigned (insert principal amount of Old Notes to be tendered, if any)
$ of the 9 7/8% Series A Senior Subordinated Notes Due 2008
(CUSIP #627578 AB 3 or CINS #U61809 AA 4).
[ ] NOT to TENDER any Old Notes held by you for the account of the
undersigned.
If the undersigned instructs you to tender the Old Notes held by you for the
account of the undersigned, it is understood that you are authorized to make, on
behalf of the undersigned (and the undersigned, by its signature below, hereby
makes to you), the representations and warranties contained in the Letter of
Transmittal that are to be made with respect to the undersigned as a beneficial
owner, including but not limited to the representations, that (i) the holder is
not an "affiliate" of the Company, (ii) any New Notes acquired pursuant to the
Exchange Offer are being acquired in the ordinary course of business of the
person receiving such New Notes, whether or not such person is the holder and
(iii) neither the holder nor any such other person has an arrangement or
understanding with any person to participate in the distribution of such New
Notes. If the undersigned is a broker-dealer that will receive New Notes for its
own account in exchange for Old Notes, it represents that such Old Notes were
acquired as a result of market-making activities or other trading activities,
and it acknowledges that it will deliver a prospectus meeting the requirements
of the Securities Act in connection with any resale of such New Notes. By
acknowledging that it will deliver and by delivering a prospectus meeting the
requirements of the Securities Act in connection with any resale of such New
Notes, such broker-dealer is not deemed to admit that it is an "underwriter"
within the meaning of the Securities Act of 1933, as amended.
<PAGE>
SIGN HERE
NAME OF BENEFICIAL OWNER(S): _________________________
SIGNATURE(S): ________________________________________
NAME (S) (PLEASE PRINT) ______________________________
ADDRESS: _____________________________________________
TELEPHONE NUMBER _____________________________________
TAXPAYER IDENTIFICATION OR SOCIAL SECURITY NUMBER: ___
_______________________________________________________
DATE: ________________________________________________
2
<PAGE>
FORM OF
THE MUSICLAND GROUP, INC.
OFFER TO EXCHANGE ITS REGISTERED
9 7/8% SERIES B SENIOR SUBORDINATED NOTES DUE 2008
FOR ANY AND ALL OF ITS OUTSTANDING UNREGISTERED
9 7/8% SERIES A SENIOR SUBORDINATED NOTES DUE 2008
To: Our Clients
Enclosed for your consideration is a Prospectus, dated May 6, 1998 (the
"Prospectus"), and the enclosed Letter of Transmittal (the "Letter of
Transmittal"), relating to the offer (the "Exchange Offer") of The Musicland
Group, Inc. (the "Company") to exchange its registered 9 7/8% Series B Senior
Subordinated Notes Due 2008 (the "New Notes") for any and all of its outstanding
9 7/8% Series A Senior Subordinated Notes Due 2008 (the "Old Notes"), upon the
terms and subject to the conditions described in the Prospectus. The Exchange
Offer is being made in order to satisfy certain obligations of the Company
contained in the Registration Rights Agreement dated as of April 6, 1998,
between the Company and the Initial Purchasers thereto.
This material is being forwarded to you as the beneficial owner of the Old
Notes carried by us in your account but not registered in your name. A tender of
such Old Notes may only be made by us as the holder of record and pursuant to
your instructions.
Accordingly, we request instructions as to whether you wish us to tender on
your behalf the Old Notes held by us for your account, pursuant to the terms and
conditions set forth in the enclosed Prospectus and Letter of Transmittal.
Your instructions should be forwarded to us as promptly as possible in order
to permit us to tender the Old Notes on your behalf in accordance with the
provisions of the Exchange Offer. The Exchange Offer will expire at 5:00 p.m.,
New York City time, on June 5, 1998 (the "Expiration Date") unless extended by
the Company. Any Old Notes tendered pursuant to the Exchange Offer may be
withdrawn at any time before 5:00 p.m., New York City time, on the Expiration
Date.
Your attention is directed to the following:
1. The Exchange Offer is for any and all Old Notes.
2. The Exchange Offer is subject to certain conditions set forth in the
Prospectus in the section captioned "The Exchange Offer--Conditions."
3. Any transfer taxes incident to the transfer of Old Notes from the holder
to the Company will be paid by the Company, except as otherwise provided
in the Instructions in the Letter of Transmittal.
4. The Exchange Offer expires at 5:00 p.m., New York City time, on the
Expiration Date, unless extended by the Company.
If you wish to have us tender your Old Notes, please so instruct us by
completing, executing and returning to us the instruction form on the back of
this letter. The Letter of Transmittal is furnished to you for your information
only and may not be used directly by you to tender Old Notes.
<PAGE>
INSTRUCTIONS WITH RESPECT TO
EXCHANGE OFFER
The undersigned acknowledges receipt of your letter and the enclosed
material referred to therein relating to the Exchange Offer made by the Company
with respect to the Old Notes.
This will instruct you to tender the Old Notes held by you for the account
of the undersigned, upon and subject to the terms and conditions set forth in
the Prospectus and the related Letter of Transmittal.
<TABLE>
<S> <C>
Aggregate Principal Amount of Old Notes
9 7/8% Series A Senior Notes Due 2008
-------------------------------------------
Please do not tender any Old Notes held by
you for my account
-------------------------------------------
Dated: --------------, 1998 -------------------------------------------------------------
--------------------------------Signature(s)
- - ----------------------------------------------------------------------------------------
- - -------------------------------------------
Please print name(s) here
-------------------------------------------
--------------------------------Address(es)
---------------------------Area Code(s) and
Telephone Number(s)
-------------------------------------------
Tax Identification or Social Security No(s).
</TABLE>
None of the Old Notes held by us for your account will be tendered unless we
receive written instructions from you to do so. Unless a specific contrary
instruction is given in the space provided, your signatures) hereon shall
constitute an instruction to us to tender all the Old Notes held by us for your
account.
2
<PAGE>
FORM OF
THE MUSICLAND GROUP, INC.
OFFER TO EXCHANGE ITS REGISTERED
9 7/8% SERIES B SENIOR SUBORDINATED NOTES DUE 2008
FOR ANY AND ALL OF ITS OUTSTANDING UNREGISTERED
9 7/8% SERIES A SENIOR SUBORDINATED NOTES DUE 2008
To: Brokers, Dealers, Commercial Banks, Trust Companies and Other Nominees:
The Musicland Group, Inc. (the "Company") is offering to exchange (the
"Exchange Offer"), upon and subject to the terms and conditions set forth in the
Prospectus, dated May 6, 1998 (the "Prospectus"), and the enclosed Letter of
Transmittal (the "Letter of Transmittal"), its registered 9 7/8% Series B Senior
Discount Notes Due 2008 (the "New Notes") for any and all of its outstanding
9 7/8% Series A Senior Discount Notes Due 2008 (the "Old Notes"). The Exchange
Offer is being made in order to satisfy certain obligations of the Company
contained in the Registration Rights Agreement dated as of April 6, 1998,
between the Company and the Initial Purchasers.
We are requesting that you contact your clients for whom you hold Old Notes
regarding the Exchange Offer. For your information and for forwarding to your
clients for whom you hold Old Notes registered in your name or in the name of
your nominee, or who hold Old Notes registered in their own names, we are
enclosing the following documents:
1. Prospectus dated May 6, 1998;
2. The Letter of Transmittal for your use and for the information of your
clients;
3. A Notice of Guaranteed Delivery to be used to accept the Exchange Offer
if certificates for Old Notes are not immediately available or time will
not permit all required documents to reach the Exchange Agent prior to
the Expiration Date (as defined below) or if the procedure for book-entry
transfer cannot be completed on a timely basis;
4. A form of letter which may be sent to your clients for whose account you
hold Old Notes registered in your name or the name of your nominee, with
space provided for obtaining such clients' instructions with regard to
the Exchange Offer;
5. Guidelines for Certification of Taxpayer Identification Number on
Substitute Form W-9; and
6. Return envelopes addressed to Bank One, N.A., the Exchange Agent for the
Old Notes.
Your prompt action is requested. The Exchange Offer will expire at 5:00
p.m., New York City time, on June 5, 1998 (the "Expiration Date"), unless
extended by the Company. The Old Notes tendered pursuant to the Exchange Offer
may be withdrawn at any time before 5:00 p.m., New York City time, on the
Expiration Date.
To participate in the Exchange Offer, a duly executed and properly completed
Letter of Transmittal (or facsimile thereof), with any required signature
guarantees and any other required documents, should be sent to the Exchange
Agent and certificates representing the Old Notes should be delivered to the
Exchange Agent, all in accordance with the instructions set forth in the Letter
of Transmittal and the Prospectus.
If holders of Old Notes wish to tender, but it is impracticable for them to
forward their certificates for Old Notes prior to the expiration of the Exchange
Offer or to comply with the book-entry transfer procedures on a timely basis, a
tender may be effected by following guaranteed delivery procedures described in
the Prospectus under "The Exchange Offer--Guaranteed Delivery Procedures."
The Company will, upon request, reimburse brokers, dealers, commercial banks
and trust companies for reasonable and necessary costs and expenses incurred by
them in forwarding the Prospectus and the related documents to the beneficial
owners of Old Notes held by them as nominee or in a fiduciary
<PAGE>
capacity. The Company will pay or cause to be paid all stock transfer taxes
applicable to the exchange of Old Notes pursuant to the Exchange Offer, except
as set forth in Instruction 6 of the Letter of Transmittal.
Any inquiries you may have with respect to the Exchange Offer, or requests
for additional copies of the enclosed materials, should be directed to the
Exchange Agent for the Old Notes, at its address and telephone number set forth
on the front of the Letter of Transmittal.
Very truly yours,
THE MUSICLAND GROUP, INC.
NOTHING HEREIN OR IN THE ENCLOSED DOCUMENTS SHALL CONSTITUTE YOU OR ANY OTHER
PERSON AS AN AGENT OF THE COMPANY OR THE EXCHANGE AGENT, OR AUTHORIZE YOU OR ANY
OTHER PERSON TO USE ANY DOCUMENT OR MAKE ANY STATEMENTS ON BEHALF OF EITHER OF
THEM WITH RESPECT TO THE EXCHANGE OFFER, EXCEPT FOR STATEMENTS EXPRESSLY MADE IN
THE PROSPECTUS OR THE LETTER OF TRANSMITTAL.
2
<PAGE>
FORM OF
NOTICE OF GUARANTEED DELIVERY FOR
THE MUSICLAND GROUP, INC.
This form or one substantially equivalent thereto must be used to accept the
Exchange Offer of The Musicland Group, Inc. (the "Company") made pursuant to the
Prospectus, dated May 6, 1998 (the "Prospectus") , and the enclosed Letter of
Transmittal (the "Letter of Transmittal") if certificates for Old Notes of the
Company are not immediately available or if the procedure for book-entry
transfer cannot be completed on a timely basis or time will not permit all
required documents to reach the Company prior to 5:00 P.M., New York City time,
on the Expiration Date of the Exchange Offer. Such form may be delivered or
transmitted by facsimile transmission, mail or hand delivery to Bank One, NA
(the "Exchange Agent") as set forth below. In addition, in order to utilize the
guaranteed delivery procedure to tender Old Notes pursuant to the Exchange
Offer, a completed signed and dated Letter of Transmittal (or facsimile thereof)
must also be received by the Exchange Agent prior to 5:00 P.M., New York City
time, on the Expiration Date. Capitalized terms not defined herein are defined
in the Prospectus.
By Registered or Certified Mail,
By Overnight Courier, or By Hand:
Bank One, NA
235 West Schrock Road
Westerville, Ohio 43081
Attention: Corporate Trust Operations
By Facsimile: (614) 248-5088
Telephone: (800) 346-5153
Delivery of this instrument to an address other than as set forth above, or
transmission of instructions via facsimile other than as set forth above, will
not constitute a valid delivery.
Ladies and Gentlemen:
Upon the terms and conditions set forth in the Prospectus and the
accompanying Letter of Transmittal, the undersigned hereby tenders to the
Company the principal amount of Old Notes set forth below, pursuant to the
guaranteed delivery procedure described in "The Exchange Offer Guaranteed
Delivery Procedures" section of the Prospectus.
<TABLE>
<S> <C>
Principal Amount of Old Notes Tendered:
$ If Old Notes will be delivered by book entry
transfer to The Depository Trust Company,
provide account number.
Certificate Nos. (if available)
Total Principal Amount Represented by old
Notes Certificate (s):
$ Account Number
</TABLE>
<PAGE>
All authority herein conferred or agreed to be conferred shall survive the
death or incapacity of the undersigned any every obligation of the undersigned
hereunder shall be binding upon the heirs, personal representatives, successors
and assigns of the undersigned.
<TABLE>
<S> <C>
PLEASE SIGN HERE
Signature(s) of Owner(s)
or Authorized Signatory
Area Code and Telephone Number:
</TABLE>
Must be signed by the holder(s) of Old Notes as the name(s) of such
holder(s) appear(s) on the Old Notes certificates or on a security position
listing, or by person(s) authorized to become registered holder(s) by
endorsement and documents transmitted with this Notice of Guaranteed Delivery.
If any signature is by a trustee, executor, administrator, guardian,
attorney-in-fact, officer or other person acting in a fiduciary or
representative capacity, such person must set forth his or her full title below.
<TABLE>
<S> <C>
Please print name(s) and address(s)
Name(s):
Capacity: Address(es)
</TABLE>
2
<PAGE>
GUARANTEE
The undersigned, a member of a registered national securities exchange, or a
member of the National Association of Securities Dealers, Inc., or a commercial
bank or trust company having an office or correspondent in the United States,
hereby guarantees that the certificates representing the principal amount of Old
Notes tendered hereby in proper form for transfer, or timely confirmation of the
book-entry transfer of such Old Notes into the Exchange Agent's account at The
Depository Trust Company pursuant to the procedures set forth in "The Exchange
Offer--Guaranteed Delivery Procedures" section of the Prospectus, together with
a properly completed and duly executed Letter of Transmittal (or facsimile
thereof) with any required signature guarantee and any other documents required
by the Letter of Transmittal, will be received by the Exchange Agent at the
address set forth above, no later than five business days after the date of
execution hereof.
________________________________________________________________________________
<TABLE>
<S> <C>
Name of Firm Authorized Signature
Address Title
Zip Code (Please Type or Print)
Area Code and Tel. No. Dated:
</TABLE>
NOTE: DO NOT SEND CERTIFICATES FOR OLD NOTES WITH THIS FORM. CERTIFICATES FOR
OLD NOTES SHOULD ONLY BE SENT WITH YOUR LETTER OF TRANSMITTAL
3
<PAGE>
LETTER OF TRANSMITTAL
THE MUSICLAND GROUP, INC.
OFFER TO EXCHANGE ITS REGISTERED 9 7/8% SERIES B
SENIOR SUBORDINATED NOTES DUE 2008
FOR ANY AND ALL OF ITS UNREGISTERED 9 7/8% SERIES A OUTSTANDING
SENIOR SUBORDINATED NOTES DUE 2008
PURSUANT TO THE PROSPECTUS, DATED MAY 6, 1998.
- - --------------------------------------------------------------------------------
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M. ON JUNE 5, 1998 UNLESS EXTENDED
(THE "EXPIRATION DATE"). TENDERS SHALL BE MADE TO THE EXCHANGE AGENT AT THE
ADDRESS STATED BELOW. TENDERS MAY BE WITHDRAWN PRIOR TO 5:00 P.M. ON THE
EXPIRATION DATE.
- - --------------------------------------------------------------------------------
By Registered or Certified Mail,
By Overnight Courier, or By Hand:
Bank One, N.A.
235 West Schrock Road
Westerville, Ohio 43081
Attention: Corporate Trust Operations
By Facsimile: (614) 248-5088
Telephone: (800) 346-5153
Delivery of this Letter of Transmittal to an address other than as set forth
above, or transmission of instructions via a facsimile number other than the one
listed above will not constitute a valid delivery. The instructions accompanying
this Letter of Transmittal should be read carefully before this Letter of
Transmittal is completed.
The undersigned acknowledges that he or she has received the Prospectus,
dated May 6, 1998 (the "Prospectus"), of The Musicland Group, Inc., a Delaware
corporation (the "Company"), and this Letter of Transmittal (this "Letter")
which, together with the Prospectus, constitute the Company's offer (the
"Exchange Offer") to exchange an aggregate principal amount at maturity of
$150,000,000 of 9 7/8% Series B Senior Subordinated Notes Due 2008 (the "New
Notes") which have been registered under the Securities Act of 1933, as amended
(the "Securities Act"), pursuant to a Registration Statement of which the
Prospectus is a part, for an equal principal amount of the Company's outstanding
9 7/8% Series A Senior Subordinated Notes Due 2008 (the "Old Notes").
For each Old Note accepted for exchange, the holder of such Old Note will
receive a New Note having a principal amount at maturity equal to that of the
surrendered Old Note. The Company reserves the right, at anytime or from time to
time, to extend the Exchange Offer at its discretion, in which event the term
"Expiration Date" shall mean the latest time and date to which the Exchange
Offer is extended. In order to extend the Expiration Date, the Company will
notify the Exchange Agent of any extension by oral or written notice and will
mail to the record holders of Old Notes an announcement thereof, each prior to
9:00 a.m., New York City time, on the next business day after the previously
scheduled Expiration Date. Such announcement may state that the Company is
extending the Exchange Offer for a specified period of time.
This Letter is to be completed by holders of Old Notes if (i) certificates
of the Old Notes are to be forwarded herewith or (ii) delivery of Old Notes is
to be made by book-entry transfer to the account maintained by the Exchange
Agent at The Depository Trust Company (the "Book-Entry Transfer Facility")
<PAGE>
pursuant to the procedures set forth in "The Exchange Offer" section of the
Prospectus. Holders of Old Notes whose certificates are not immediately
available, or who are unable to deliver their certificates or confirmation of
the book-entry tender of their Old Notes into the Exchange Agent's account at
the Book-Entry Transfer Facility (a "Book-Entry Confirmation") and all other
documents required by this Letter to the Exchange Agent on or prior to the
Expiration Date, must tender their Old Notes in accordance with the guaranteed
delivery procedures set forth in "The Exchange Offer--Guaranteed Delivery
Procedures" section of the Prospectus. See Instruction 1. Delivery of documents
to the Book-Entry Transfer Facility does not constitute delivery to the Exchange
Agent.
The undersigned has completed the appropriate boxes below and signed this
Letter to indicate the action the undersigned desires to take with respect to
the Exchange Offer. Holders who wish to tender their Old Notes must complete
this Letter of Transmittal in its entirety.
List below the Old Notes to which this Letter relates. If the space below is
inadequate, the certificate numbers and principal amount of Old Notes should be
listed on a separate signed schedule affixed hereto.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
DESCRIPTION OF OLD NOTES
-------------------------------------------------------------------------------------------
AGGREGATE
PRINCIPAL PRINCIPAL
NAME(S) AND ADDRESSES OF REGISTERED CERTIFICATE AMOUNT AMOUNT
HOLDER(S) (PLEASE FILL IN, IF BLANK) NUMBER(S)(1) OF OLD NOTE(S) TENDERED (2)
<S> <C> <C> <C>
- - ---------------------------------------------------------------------------------------------
----------------------------------------------
----------------------------------------------
----------------------------------------------
----------------------------------------------
TOTAL
- - ---------------------------------------------------------------------------------------------
</TABLE>
(1) Need not be completed if Old Notes are being tendered by book-entry
transfer.
(2) Unless otherwise indicated in this column, a holder will be deemed to have
tendered ALL of the Old Notes represented by the Old Notes indicated in
column 2. See Instruction 2. Old Notes tendered hereby must be in
denominations of principal amount of $1,000 and any integral multiple
thereof.
See Instruction 1.
/ / CHECK HERE IF TENDERED OLD NOTES ARE ENCLOSED HEREWITH.
/ / CHECK HERE IF TENDERED OLD NOTES ARE BEING DELIVERED BY BOOK-ENTRY TRANSFER
MADE TO THE ACCOUNT MAINTAINED BY THE EXCHANGE AGENT WITH THE BOOK-ENTRY
TRANSFER FACILITY AND COMPLETE THE FOLLOWING:
Name of Tendering Institution ______________________________________________
Account Number _________________ Transaction Code Number ________________
/ / CHECK HERE IF TENDERED OLD NOTES ARE BEING DELIVERED PURSUANT TO A NOTICE
OF GUARANTEED DELIVERY ENCLOSED HEREWITH AND COMPLETE THE FOLLOWING (For use
by Eligible Institutions Only)
Name(s) of Registered Old Note Holder(s) ___________________________________
Window Ticket Number (if any) ______________________________________________
Date of Execution of Note of Guaranteed Delivery ___________________________
Name of Institution which guaranteed delivery ______________________________
If Delivered by Book-Entry Transfer, Complete the Following:
Account Number _________________ Transaction Code Number ________________
<PAGE>
/ / CHECK HERE IF YOU ARE A BROKER-DEALER AND WISH TO RECEIVE 10 ADDITIONAL
COPIES OF THE PROSPECTUS AND 10 COPIES OF ANY AMENDMENT OR SUPPLEMENTS
THERETO:
Name: ______________________________________________________________________
Address: ___________________________________________________________________
PLEASE READ THE ACCOMPANYING INSTRUCTIONS CAREFULLY
Ladies and Gentlemen:
Upon the terms and conditions of the Exchange Offer, the undersigned hereby
tenders to the Company the aggregate principal amount of Old Notes indicated
above. Subject to, and effective upon, the acceptance for exchange of the Old
Notes tendered in accordance with this Letter of Transmittal, the undersigned
sells, assigns and transfers to, or upon the order of, the Company all rights,
title and interest in and to the Old Notes tendered hereby.
The undersigned hereby represents and warrants that (i) the undersigned is
the owner of the Old Notes tendered hereby, (ii) the undersigned has full power
and authority to tender, exchange, sell, assign and transfer the Old Notes
tendered hereby and (iii) the Company will acquire good and unencumbered title
thereto, free and clear of all liens, restrictions, charges and encumbrances and
not subject to any adverse claim when the same are accepted by the Company. The
undersigned hereby further represents to the Company that (i) any New Notes
acquired in exchange for Old Notes tendered hereby will have been acquired in
the ordinary course of business of the undersigned or such other person
receiving such New Notes, (ii) neither the holder of such Old Notes nor any such
other person is engaged in, or intends to engage in a distribution of such New
Notes, or has an arrangement or understanding with any person to participate in
the distribution of such New Notes, and (iii) neither the holder of such old
Notes nor any such other person is an "affiliate," as defined in Rule 405 under
the Securities Act of 1933, as amended (the "Securities Act"), of the Company.
The undersigned also acknowledges that this Exchange Offer is being made by
the Company based upon the Company's understanding of an interpretation by the
staff of the Securities and Exchange Commission (the "Commission") as set forth
in no-action letters issued to third parties, that the New Notes issued in
exchange for the Old Notes pursuant to the Exchange Offer may be offered for
resale, resold and otherwise transferred by holders thereof (other than any such
holder that is an "affiliate" of the Company within the meaning of Rule 405
under the Securities Act), without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that: (1) such
holders are not affiliates of the Company within the meaning of Rule 405 under
the Securities Act; (2) such New Notes are acquired in the ordinary course of
such holders' business; and (3) such holders are not engaged in, and do not
intend to engage in, a distribution of such New Notes and have no arrangement or
understanding with any person to participate in the distribution of such New
Notes. However, the staff of the Commission has not considered the Exchange
Offer in the context of a no-action letter and there can be no assurance that
the staff of the Commission would make a similar determination with respect to
the Exchange Offer. If a holder of Old Notes is an affiliate of the Company, or
is engaged in or intends to engage in a distribution of the New Notes or has any
arrangement or understanding with respect to the distribution of the New Notes
to be acquired pursuant to the Exchange Offer, such holder cannot rely on the
applicable interpretations of the staff of the Commission and must comply with
the registration and prospectus delivery requirements of the Securities Act in
connection with any secondary resale transaction. If the undersigned is a
broker-dealer that will receive New Notes for its own account in exchange for
Old Notes, it represents that the Old Notes to be exchanged for the New Notes
were acquired by it as a result of market-making activities or other trading
activities and acknowledges that it will deliver a prospectus in connection with
any resale of such New Notes; however, by so acknowledging and by delivering a
prospectus, the undersigned will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
<PAGE>
The undersigned will, upon request, execute and deliver any additional
documents deemed by the Company to be necessary or desirable to complete the
sale, assignment and transfer of the Old Notes tendered hereby. All authority
conferred or agreed to be conferred in this Letter and every obligation of the
undersigned hereunder shall be binding upon the successors, assigns, heirs,
executors, administrators, trustees in bankruptcy and legal representatives of
the undersigned and shall not be affected by, and shall survive, the death or
incapacity of the undersigned. This tender may be withdrawn only in accordance
with the procedures set forth in "The Exchange Offer--Withdrawal of Tenders"
section of the Prospectus.
Unless otherwise indicated herein in the box entitled "Special Issuance
Instructions" below, please deliver the New Notes (and, if applicable,
substitute certificates representing Old Notes for any Old Notes not exchanged)
in the name of the undersigned or, in the case of a book-entry delivery of Old
Notes, please credit the account indicated above maintained at the Book-Entry
Transfer Facility. Similarly, unless otherwise indicated under the box entitled
"Special Delivery Instructions" below, please send the New Notes (and, if
applicable, substitute certificates representing Old Notes for any old Notes not
exchanged) to the undersigned at the address shown above in the box entitled
"Description of Old Notes."
THE UNDERSIGNED, BY COMPLETING THE BOX ENTITLED "DESCRIPTION OF OLD NOTES"
ABOVE AND SIGNING THIS LETTER OF TRANSMITTAL, WILL BE DEEMED TO HAVE TENDERED
THE OLD NOTES AS SET FORTH IN SUCH BOX ABOVE.
- - -------------------------------------------
SPECIAL ISSUANCE INSTRUCTIONS
(SEE INSTRUCTIONS 3 AND 4)
To be completed ONLY if certificates for Old Notes not exchanged and/or
New Notes are to be issued in the name of and sent to someone other than the
person(s) whose signatures) appear(s) on this Letter above, or if Old Notes
delivered by book-entry transfer which are not accepted for exchange are to
be returned by credit to an account maintained at the Book-Entry Transfer
Facility other than the account indicated above.
Issue New Notes and/or Old Notes to:
Name(s) ____________________________________________________________________
(PLEASE TYPE OR PRINT)
__________________________________________________________________________
(PLEASE TYPE OR PRINT)
Address: ___________________________________________________________________
(INCLUDING ZIP CODE)
(COMPLETE ACCOMPANYING SUBSTITUTE FORM W-9)*
/ / Credit unexchanged Old Notes delivered by book-entry transfer to the
Book-Entry Transfer Facility account set forth below.
BOOK-ENTRY TRANSFER FACILITY
ACCOUNT NUMBER, IF APPLICABLE)
- - ------------------------------------------------------
- - ------------------------------------------------------
SPECIAL DELIVERY INSTRUCTIONS
(SEE INSTRUCTIONS 3 AND 4)
To be completed ONLY if certificates for Old Notes not exchanged and/or
New Notes are to be sent to someone other than the person(s) whose
signatures) appear(s) on this Letter above, or to such person(s) at an
address other than shown in the box entitled "Description of Old Notes" on
this Letter above.
Mail New Notes and/or Old Notes to:
Name(s) ____________________________________________________________________
(PLEASE TYPE OR PRINT)
__________________________________________________________________________
(PLEASE TYPE OR PRINT)
Address: ___________________________________________________________________
(INCLUDING ZIP CODE)
-----------------------------------------------------------
<PAGE>
IMPORTANT: THIS LETTER OR A FACSIMILE HEREOF (TOGETHER WITH THE CERTIFICATES
FOR OLD NOTES OR A BOOK-ENTRY CONFIRMATION AND ALL OTHER REQUIRED DOCUMENTS OR
THE NOTICE OF GUARANTEED DELIVERY) MUST BE RECEIVED BY THE EXCHANGE AGENT PRIOR
TO 5:00 P.M., NEW YORK CITY TIME, ON THE EXPIRATION DATE.
PLEASE READ THIS ENTIRE LETTER OF TRANSMITTAL
CAREFULLY BEFORE COMPLETING ANY BOX ABOVE.
- - --------------------------------------------------------------------------------
PLEASE SIGN HERE
(TO BE COMPLETED BY ALL TENDERING HOLDERS)
(COMPLETE ACCOMPANYING SUBSTITUTE FORM W-9 ON REVERSE SIDE)
Dated: ______________________________________________________________ , 1998
__________________________________ , 1998
_____________________ _____________________ , 1998
(SIGNATURE OF OWNER) (DATE)
Area Code and Telephone Number: ____________________________________________
If a holder is tendering any Old Notes, this Letter of Transmittal must
be signed by the registered holder(s) as the name(s) appear(s) on the
certificates for the Old Notes or by an Persons) authorized to become
registered holder(s) by endorsements and documents transmitted herewith. If
signature is by a trustee, executor, administrator, guardian, officer or
other person acting in a fiduciary or representative capacity, please set
forth full title. See Instruction 3.
Name(s): ___________________________________________________________________
____________________________________________________________________________
(PLEASE TYPE OR PRINT)
Capacity: __________________________________________________________________
Address: ___________________________________________________________________
(INCLUDING ZIP CODE)
SIGNATURE GUARANTEE
(IF REQUIRED BY INSTRUCTION 3)
Signature(s) Guaranteed
by an Eligible Institution: ________________________________________________
(AUTHORIZED SIGNATURE)
__________________________________________________________________________
(TITLE)
__________________________________________________________________________
(NAME AND FIRM)
Dated _______________________________________________________________ , 1998
- - --------------------------------------------------------------------------------
INSTRUCTIONS
Forming Part of the Terms and Conditions of the Offer to Exchange Registered
9 7/8% Series B Senior Subordinated Notes Due 2008 for any and all Outstanding
Unregistered 9 7/8% Series A Senior Subordinated Notes Due 2008 of The Musicland
Group, Inc.
1. DELIVERY OF THIS LETTER AND OLD NOTES; GUARANTEED DELIVERY PROCEDURES.
This Letter is to be completed by holders of Old Notes either if
certificates are to be forwarded herewith or if tenders are to be made pursuant
to the procedures for delivery by book-entry set forth in "The Exchange
Offer--Book-Entry Transfer" section of the Prospectus. Certificates for all
physically
<PAGE>
tendered Old Notes, or Book-Entry Confirmation, as the case may be, as well as a
properly completed and duly executed Letter of Transmittal (or facsimile
thereof) and any other documents required by this Letter, must be received by
the Exchange Agent at the address set forth herein on or prior to the Expiration
Date, or the tendering holder must comply with the guaranteed delivery
procedures set forth below. Old Notes tendered hereby must be in denominations
of principal amount of maturity of $1,000 and any integral multiple thereof.
Holders of Old Notes whose certificates for Old Notes are not immediately
available or who cannot deliver their certificates and all other required
documents to the Exchange Agent on or prior to the Expiration Date, or who
cannot complete the procedure for book-entry transfer on a timely basis, may
tender their Old Notes pursuant to the guaranteed delivery procedures set forth
in "The Exchange Offer-- Guaranteed Delivery Procedures" section of the
Prospectus. Pursuant to such procedures, (i) such tender must be made through an
Eligible Institution (as defined below), (ii) prior to the Expiration Date, the
Exchange Agent must receive from such Eligible Institution a properly completed
and duly executed Letter of Transmittal (or facsimile thereof) and Notice of
Guaranteed Delivery, substantially in the form provided by the Company (by
facsimile transmission, mail or hand delivery), setting forth the name and
address of the holder of Old Notes and the amount of Old Notes tendered, stating
that the tender is being made thereby and guaranteeing that within five business
days after the date of execution of the Notice of Guaranteed Delivery, the
certificates for all physically tendered Old Notes, or a Book-Entry
Confirmation, as the case may be, and any other documents required by this
Letter will be deposited by the Eligible Institution with the Exchange Agent,
and (iii) the certificates for all physically tendered Old Notes, in proper form
for transfer, or Book-Entry Confirmation, as the case may be, and all other
documents required by this Letter, are received by the Exchange Agent within
five business days after the date of execution of the Notice of Guaranteed
Delivery.
The method of delivery of this Letter, the Old Notes and all other required
documents is at the election and risk of tendering holders, but the delivery
will be deemed made only when actually received or confirmed by the Exchange
Agent. If Old Notes are sent by mail, it is suggested that the mailing be made
sufficiently in advance of the Expiration Date to permit delivery to the
Exchange Agent prior to 5:00 p.m., New York City time, on the Expiration Date.
See "The Exchange Offer" section of the Prospectus.
2. PARTIAL TENDERS (NOT APPLICABLE TO HOLDERS OF OLD NOTES WHO TENDER BY BOOK
ENTRY TRANSFER).
If less than all of the Old Notes evidenced by a submitted certificate are
to be tendered, the tendering holder(s) should fill in the aggregate principal
amount of Old Notes to be tendered in the box above entitled "Description of Old
Notes--Principal Amount Tendered." A reissued certificate representing the
balance of nontendered Old Notes will be sent to such tendering holder, unless
otherwise provided in the appropriate box on this Letter, promptly after the
Expiration Date. All of the Old Notes delivered to the Exchange Agent will be
deemed to have been tendered unless otherwise indicated.
3. SIGNATURES ON THIS LETTER; BOND POWERS AND ENDORSEMENTS; GUARANTEE OF
SIGNATURES.
If this Letter is signed by the registered holder of the Old Notes tendered
hereby, the signature must correspond with the name as written on the face of
the certificates without any change whatsoever.
If any tendered Old Notes are owned of record by two or more joint owners,
all such owners must sign this Letter.
If any tendered Old Notes are registered in different names on several
certificates, it will be necessary to complete, sign and submit as many separate
copies of this Letter as there are different registrations of certificates.
When this Letter is signed by the registered holder of the Old Notes
specified herein and tendered hereby, no endorsements of certificates or
separate bond powers are required. If, however, the New Notes are to be issued,
or any untendered Old Notes are to be reissued, to a person other than the
registered
<PAGE>
holder, then endorsements of any certificates transmitted hereby or separate
bond powers are required. Signatures on such certificates must be guaranteed by
an Eligible Institution.
If this Letter is signed by a person other than the registered holder of any
certificates specified herein, such certificates must be endorsed or accompanied
by appropriate bond powers, in either case signed exactly as the name of the
registered holder appears on the certificates and the signatures on such
certificates must be guaranteed by an Eligible Institution.
If this Letter or any certificates or bond powers are signed by trustees,
executors, administrators, guardians, attorney-in-fact, officers of corporations
or others acting in a fiduciary or representative capacity, such persons should
so indicate when signing, and, unless waived by the Company, proper evidence
satisfactory to the Company of their authority to so act must be submitted.
Endorsements on certificates for Old Notes or signatures on bond powers
required by this Instruction 3 must be guaranteed by a firm which is a member of
a registered national securities exchange or a member of the National
Association of Securities Dealers, Inc. or by a commercial bank or trust company
having an office or correspondent in the United States (an "Eligible
Institution").
Signatures on this Letter need not be guaranteed by an Eligible Institution,
provided the Old Notes are tendered: (i) by a registered holder of Old Notes
(which term, for purposes of the Exchange Offer, includes any participant in the
Book-Entry Transfer Facility system whose name appears on a security position
listing as the holder of such Old Notes) tendered who has not completed the box
entitled "Special Issuance Instructions" or "Special Delivery Instructions" on
this Letter, or (ii) for the account of an Eligible Institution.
4. SPECIAL ISSUANCE AND DELIVERY INSTRUCTIONS.
Tendering holders of Old Notes should indicate in the applicable box the
name and address to which New Notes issued pursuant to the Exchange Offer and/or
substitute certificates evidencing Old Notes not exchanged are to be issued or
sent, if different from the name or address of the person signing this Letter.
In the case of issuance in a different name, the employer identification or
social security number of the person named must also be indicated. A holder of
Old Notes tendering Old Notes by book-entry transfer may request that Old Notes
not exchanged be credited to such account maintained at the Book-Entry Transfer
Facility as such holder of Old Notes may designate hereon. If no such
instructions are given, such Old Notes not exchanged will be returned to the
name and address of the person signing this Letter.
5. TAX IDENTIFICATION NUMBER.
Federal income tax law generally requires that a tendering holder whose Old
Notes are accepted for exchange must provide the Company (as payor) with such
holder's correct Taxpayer Identification Number ("TIN") on Substitute Form W-9
below, which, in the case of a tendering holder who is an individual, is his or
her social security number. If the Company is not provided with the current TIN
or an adequate basis for an exemption, such tendering holder may be subject to a
$50 penalty imposed by the Internal Revenue Service. In addition, delivery of
New Notes to such tendering holder may be subject to backup withholding in an
amount equal to 31% of all reportable payments made after the exchange. If
withholding results in an overpayment of taxes, a refund may be obtained.
Exempt holders of Old Notes (including, among others, all corporations and
certain foreign individuals) are not subject to these backup withholding and
reporting requirements. See the enclosed Guidelines of Certification of Taxpayer
Identification Number on Substitute Form W-9 (the "W-9 Guidelines") for
additional instructions.
To prevent backup withholding, each tendering holder of Old Notes must
provide its correct TIN by completing the "Substitute Form W-9" set forth below,
certifying that the TIN provided is correct (or that such holder is awaiting a
TIN) and that (i) the holder is exempt from backup withholding, (ii) the holder
has not been notified by the Internal Revenue Service that such holder is
subject to a backup withholding as a result of a failure to report all interest
or dividends or (iii) the Internal Revenue Service has notified the holder that
such holder is no longer subject to backup withholding. If the tendering holder
of Old
<PAGE>
Notes is a nonresident, alien or foreign entity not subject to backup
withholding, such holder must give the Company a completed Form W-8, Certificate
of Foreign Status. These forms may be obtained from the Exchange Agent. If the
Old Notes are in more than one name or are not in the name of the actual owner,
such holder should consult the W-9 Guidelines for information on which TIN to
report. If such holder does not have a TIN, such holder should consult the W-9
Guidelines for instructions on applying for a TIN, check the box in Part 2 of
the Substitute Form W-9 and write "applied for" in lieu of its TIN. Note:
checking this box and writing "applied for" on the form means that such holder
has already applied for a TIN or that such holder intends to apply for one in
the near future. If such holder does not provide its TIN to the Company within
60 days, backup withholding will begin and continue until such holder furnishes
its TIN to the Company.
6. TRANSFER TAXES.
The Company will pay all transfer taxes, if any, applicable to the transfer
of Old Notes to it or its order pursuant to the Exchange Offer. If, however, New
Notes and/or substitute Old Notes not exchanged are to be delivered to, or are
to be registered or issued in the name of, any person other than the registered
holder of the old Notes tendered hereby, or if tendered Old Notes are registered
in the name of any person other than the person signing this Letter, or if a
transfer tax is imposed for any reason other than the transfer of Old Notes to
the Company or its order pursuant to the Exchange Offer, the amount of any such
transfer taxes (whether imposed on the registered holder or any other persons)
will be payable by the tendering holder. If satisfactory evidence of payment of
such taxes or exemption therefrom is not submitted herewith, the amount of such
transfer taxes will be billed directly to such tendering holder.
Except as provided in this Instruction 6, it not be necessary for transfer
tax stamps to be affixed to the Old Notes specified in this Letter.
7. WAIVER OF CONDITIONS.
The Company reserves the absolute right to waive satisfaction of any or all
conditions enumerated in the Prospectus.
8. NO CONDITIONAL TENDERS.
No alternative, conditional, irregular or contingent tenders will be
accepted. All tendering holders of Old Notes, by execution of this Letter, shall
waive any right to receive notice of the acceptance of their Old Notes for
exchange.
Neither the Company, the Exchange Agent nor any other person is obligated to
give notice of any defect or irregularity with respect to any tender of Old
Notes nor shall any of them incur any liability for failure to give any such
notice.
9. MUTILATED, LOST, STOLEN OR DESTROYED OLD NOTES.
Any holder whose Old Notes have been mutilated, lost, stolen or destroyed
should contact the Exchange Agent at the address indicated above for further
instructions.
10. REQUESTS FOR ASSISTANCE OR ADDITIONAL COPIES.
Questions relating to the procedure for tendering, as well as requests for
additional copies of the Prospectus and this Letter, may be directed to the
Exchange Agent, at the address and telephone number indicated above.
<PAGE>
TO BE COMPLETED BY ALL TENDERING HOLDERS
(SEE INSTRUCTION 5)
PAYOR'S NAME: THE MUSICLAND GROUP, INC.
<TABLE>
<C> <S> <C>
- - -----------------------------------------------------------------------------------------
SUBSTITUTE Part 1-PLEASE PROVIDE TIN: -------------------
FORM W-9 YOUR TIN IN THE BOX Social Security Number OR
Department of the Treasury AT RIGHT AND CERTIFY Employer Identification Number
Internal Revenue Service BY SIGNING AND DATING
BELOW
- - -------------------------------------------------------
Payer's Request for Taxpayer Part 2 TIN Applied For [ ]
Identification Number (TIN)
and Certification
-------------------------------------------------------
CERTIFICATION: UNDER THE PENALTIES OF PERJURY, I CERTIFY THAT:
(1) the number shown on this form is my correct Taxpayer Identification Number (or I am
waiting for a number to be issued to me);
(2) I am not subject to backup withholding either because: (a) I am (exempt from backup
withholding, (b) I have not been notified by the Internal Revenue Service (the "IRS")
that I am subject to backup withholding as a result of a failure to report all interests
or dividends, or (c) the IRS has notified me that I am no longer subject to backup
withholding; and
(3) any other information provided on this form is true and correct.
</TABLE>
Signature ________________________________ Date _______________
<TABLE>
<C> <S> <C>
You must cross out item (2) of the above certification if you have been notified by the
IRS that you are subject to backup withholding because of underreporting of interest or
dividends on your tax return and you have not been notified by the IRS that you are no
longer subject to backup withholding.
---------------------------------------------------------------------------------------
</TABLE>
YOU MUST COMPLETE THE FOLLOWING CERTIFICATE IF YOU CHECKED
THE BOX IN PART 2 OF SUBSTITUTE FORM W-9
CERTIFICATE OF AWAITING TAXPAYER IDENTIFICATION NUMBER
- - --------------------------------------------------------------------------------
I certify under penalties of perjury that a taxpayer identification number has
not been issued to me, and either (a) I have mailed or delivered an
application to receive a taxpayer identification number to the appropriate
Internal Revenue Service Center or Social Security Administration Office or
(b) I intend to mail or deliver an application in the near future. I
understand that if I do not provide a taxpayer identification number by the
time of the exchange, 31 percent of all reportable payments made to me
thereafter will be withheld until I provide a number.
Signature ________________________________ Date _______________
- - --------------------------------------------------------------------------------
