UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------ ------
Commission file number 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)
(612) 931-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
--- ---
The number of shares outstanding of the Registrant's common stock as of
April 22, 1998 was 34,489,174 shares.
<PAGE>
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements.
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Report of Independent Public Accountants 8
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition. 9
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. 14
Signature 15
2
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1998 1997
--------- ---------
<S> <C> <C>
Sales .............................................. $ 392,405 $ 376,080
Cost of sales ...................................... 255,652 249,617
--------- ---------
Gross profit .................................... 136,753 126,463
Selling, general and administrative expenses ....... 125,067 129,946
Depreciation and amortization ...................... 9,827 9,852
--------- ---------
Operating income (loss) ......................... 1,859 (13,335)
Interest expense ................................... 6,932 7,648
--------- ---------
Loss before income taxes ........................ (5,073) (20,983)
Income taxes ....................................... (1,522) --
--------- ---------
Net loss ........................................ $ (3,551) $ (20,983)
========= =========
Loss per common share ........................... $ (0.11) $ (0.63)
========= =========
Weighted average number of common shares outstanding 33,727 33,481
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
March 31,
---------------------- December 31,
1998 1997 1997
--------- ---------- ----------
ASSETS
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents ............ $ 8,852 $ 78,968 $ 3,942
Inventories .......................... 423,940 464,031 450,258
Deferred income taxes ................ 10,600 11,800 10,600
Other current assets ................. 7,849 11,181 8,768
--------- --------- ---------
Total current assets ............... 451,241 565,980 473,568
Property, at cost ....................... 424,122 401,639 423,862
Accumulated depreciation and amortization (182,187) (151,785) (173,841)
--------- --------- ---------
Property, net ........................ 241,935 249,854 250,021
Deferred income taxes ................... 2,400 1,200 2,400
Other assets ............................ 7,416 6,217 7,906
--------- --------- ---------
Total Assets ....................... $ 702,992 $ 823,251 $ 733,895
========= ========= =========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<S> <C> <C> <C>
Current liabilities:
Current maturities of long-term debt .. $ 50,800 $ -- $ 26,657
Accounts payable ...................... 226,705 315,254 357,183
Restructuring reserve ................. -- 10,735 --
Other current liabilities ............. 78,903 66,725 115,660
--------- --------- ---------
Total current liabilities ........... 356,408 392,714 499,500
Long-term debt ........................... 282,417 395,774 166,430
Other long-term liabilities .............. 48,023 53,174 49,195
Stockholders' equity (deficit):
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: March 31, 1998,
34,489,174; December 31, 1997,
34,372,592; March 31, 1997, 34,301,956) 345 343 344
Additional paid-in capital ............. 255,750 253,849 255,075
Accumulated deficit .................... (228,229) (259,632) (224,678)
Deferred compensation .................. (6,749) (7,998) (6,998)
Common stock subscriptions ............. (4,973) (4,973) (4,973)
--------- --------- ---------
Total stockholders' equity (deficit) .. 16,144 (18,411) 18,770
--------- --------- ---------
Total Liabilities and Stockholders'
Equity (Deficit) .................. $ 702,992 $ 823,251 $ 733,895
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------------
1998 1997
--------- ----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ............................................ $ (3,551) $ (20,983)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ..................... 10,646 10,028
Disposal of property .............................. 684 357
Changes in operating assets and liabilities:
Inventories ....................................... 26,318 42,062
Other current assets .............................. 919 20,311
Accounts payable .................................. (118,417) (91,388)
Restructuring reserve ............................. -- (5,405)
Other current liabilities ......................... (36,512) (34,188)
Other assets ...................................... (85) (43)
Other long-term liabilities ....................... (1,166) (960)
--------- ---------
(121,164) (80,209)
--------- ---------
INVESTING ACTIVITIES:
Capital expenditures ................................ (2,426) (1,962)
--------- ---------
FINANCING ACTIVITIES:
Decrease in outstanding checks in excess of cash
balances ........................................... (12,061) --
Borrowings under revolver ........................... 141,000 1,000
Principal payments on long-term debt ................ (857) (1,837)
Proceeds from sale of common stock .................. 418 --
--------- ---------
Net cash provided by (used in) financing activities 128,500 (837)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .. 4,910 (83,008)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD ...... 3,942 161,976
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ............ $ 8,852 $ 78,968
========= =========
CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Interest ........................................... $ 3,441 $ 5,536
Income taxes, net .................................. (125) (19,682)
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands)
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts
of Musicland Stores Corporation ("MSC") 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 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.
The interim consolidated financial statements of the Company are
unaudited; however, in the opinion of management, all adjustments necessary for
a fair presentation of such consolidated financial statements have been
reflected in the interim periods presented. Such adjustments consisted only of
normal recurring items. The Company has no significant items of other
comprehensive income. The Company's business is seasonal and, accordingly,
interim results are not indicative of results for a full year. The significant
accounting policies and certain financial information which are normally
included in financial statements prepared in accordance with generally accepted
accounting principles, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying consolidated
financial statements of the Company should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K.
2. Long-term Debt
In April 1998, the Company completed an offering of $150,000 of 9 7/8%
senior subordinated notes due 2008 with an original issue discount of $1,183.
The net proceeds to the Company from the offering, after discounts, commissions
and other offering costs were $144,317 and were used to repay $32,076 of
outstanding mortgage notes payable and $112,241 of revolver borrowings. For the
three months ended March 31, 1998, the effective interest rate on the mortgage
notes payable ranged from 8.37% to 8.55% and the weighted average interest rate
on the revolver, based on average daily borrowings, was 9.01%. Had the offering
and repayment of debt occurred on January 1, 1998, interest expense for the
three months ended March 31, 1998 would have increased from $6,932 to $7,794.
In connection with and effective upon completion of the offering, the
Company obtained an amendment to its credit agreement that permitted the
issuance of the senior subordinated notes and allowed the repayment of the
mortgage notes payable. The amendment also allows the Company to seek to extend
the maturities of its $50,000 term loan and reduces the maximum available
borrowings under the revolving credit facility to the lesser of: (i) 60% of
eligible inventory or (ii) $132,000 while the term loan is outstanding or
$182,000 if the term loan is repaid.
6
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands)
3. Income Taxes
The effective income tax rates for the three months ended March 31,
1998 and 1997 are based on the federal statutory income tax rate, increased for
the effect of state income taxes, net of federal benefit, and adjusted for
anticipated changes to the deferred tax valuation allowance based on estimates
of future earnings.
4. Loss Per Common Share
Loss per common share amounts are computed by dividing net loss by the
weighted average number of common shares outstanding. Potential common shares
related to outstanding stock options and warrants are anti-dilutive due to the
net loss in each of the three months ended March 31, 1998 and 1997 and,
accordingly, only basic loss per share amounts have been presented.
7
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Musicland Stores Corporation:
We have reviewed the accompanying consolidated balance sheets of Musicland
Stores Corporation (a Delaware corporation) and Subsidiaries as of March 31,
1998 and 1997, and the related consolidated statements of operations and cash
flows for the three-month periods then ended. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Musicland Stores Corporation and
Subsidiaries as of December 31, 1997, and, in our report dated January 21, 1998,
we expressed an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1997, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
April 24, 1998
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Results of Operations
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. The
following table presents certain unaudited sales and store data for Mall Stores,
Superstores and in total for the Company for the three months ended March 31,
1998 and 1997. 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.
Three Months Ended March 31,
-----------------------------------------
Percent
Percent of Total
Incr. --------------
1998 1997 (Decr.) 1998 1997
-------- -------- ------- ------ ------
(Dollars and square footage in millions)
Sales:
Mall Stores .......................$ 256.6 $ 243.1 5.5 % 65.4% 64.6%
Superstores ....................... 133.4 130.2 2.5 34.0 34.6
Total (1) ....................... 392.4 376.1 4.3 100.0 100.0
Comparable store sales increase:
Mall Stores ....................... 9.6% 1.8% N/A N/A N/A
Superstores ....................... 7.6 5.6 N/A N/A N/A
Total (1) ....................... 8.9 2.9 N/A N/A N/A
Number of stores open at end of period:
Mall Stores ....................... 1,110 1,147 (3.2)% 82.2% 82.4%
Superstores ....................... 224 224 0.0 16.6 16.1
Total (1) ....................... 1,350 1,392 (3.0) 100.0 100.0
Total store square footage at end of
period:
Mall Stores ....................... 4.0 4.1 (3.5)% 48.4% 48.9%
Superstores ....................... 4.2 4.3 (1.1) 51.1 50.4
Total (1) ....................... 8.2 8.4 (2.4) 100.0 100.0
----------------------------------------------------------
(1) The totals include United Kingdom stores.
Sales. Sales growth during the first quarter of 1998 was driven by
strong comparable store sales in music, led by the soundtrack from the movie
"Titanic." The Company also had comparable store sales increases in video,
contemporary product and video games. These sales gains were achieved with an
average store base of approximately 4% fewer stores than in the first quarter of
1997 and a shift in the Easter holiday from March to April in 1998. The Company
continued to benefit 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 following table shows the
comparable store sales percentage increase attributable to the Company's two
principal product categories for the three months ended March 31, 1998 and 1997.
Three Months Ended
March 31,
------------------------------
1998 1997
-------------- -------------
Music................................... 11.8 % 4.9 %
Video................................... 3.7 1.7
9
<PAGE>
Digital video discs ("DVD") were first offered for sale in select
markets near the end of the first quarter of 1997 and were carried in most of
the Company's stores by the end of the third quarter of 1997. DVD sales were
8.7% of total movie sales in the first quarter of 1998 and are expected to
continue to gain momentum as more titles become available and more consumers
purchase DVD players.
Gross Profit. Gross profit as a percentage of sales was 34.8% in the
first quarter of 1998 compared with 33.6% in the first quarter of 1997, an
increase of 1.2%. Most of the gross margin improvement in 1998 was attributable
to less promotional pricing and, to a lesser extent, selective price increases
made during the second half of 1997 and the first quarter of 1998.
Selling, General and Administrative Expenses. The decrease in selling,
general and administrative expenses in the first quarter of 1998 compared with
the first quarter of 1997 was due to store closings and a reduction in
advertising. Selling, general and administrative expenses in the first quarter
of 1997 included financial and legal advisory services and related expenses of
approximately $2.1 million, most of which were incurred in conjunction with the
Company's credit agreement. Selling, general and administrative expenses as a
percentage of sales were 31.9% in the first quarter of 1998 compared with 34.6%
in the first quarter of 1997, a decrease of 2.7%. The percentage rate decrease
resulted from the expense reductions and comparable store sales increases
previously discussed.
Depreciation and Amortization. Store closings since the first quarter
of 1997 reduced depreciation and amortization by $0.6 million in the first
quarter of 1998. This decrease was offset by depreciation and amortization of
$0.5 million on certain financed property related to the Company's distribution
facility in Franklin, Indiana. This property was capitalized in the second
quarter of 1997 when the operating lease with a special purpose entity was
amended.
Interest Expense. Interest expense in the first quarter of 1998
decreased $0.7 million from the first quarter of 1997 primarily due to lower
outstanding revolver borrowings offset by an increase to interest expense from
the term loan. The term loan proceeds received by the Company in September 1997
were used to reduce outstanding revolver borrowings and lowered the average
daily revolver borrowings during the first quarter of 1998 by $43.9 million. For
the first quarters of 1998 and 1997, the average daily revolver balances, based
upon the number of days with outstanding borrowings, were $108.5 million and
$272.7 million, respectively. The weighted average interest rates on the
revolver during the periods, based upon the average daily balances, were 9.0%
and 7.7%, respectively.
In April 1998, the Company completed an offering of $150.0 million of 9
7/8% senior subordinated notes. As all of the net proceeds were used to reduce
existing debt at lower interest rates, the Company expects an increase to
interest expense for the year ending December 31, 1998 of approximately $3
million. See "- Liquidity and Capital Resources" and Note 2 of Notes to
Consolidated Financial Statements.
Income Taxes. The effective income tax rates for the three months ended
March 31, 1998 and 1997 are based on the federal statutory income tax rate,
increased for the effect of state income taxes, net of federal benefit, and
adjusted for anticipated changes to the deferred tax valuation allowance based
on estimates of future earnings.
Loss Per Common Share. Potential common shares related to outstanding
stock options and warrants are anti-dilutive due to the net loss in each of the
three months ended March 31, 1998 and 1997 and, accordingly, only basic loss per
share amounts have been presented. The Company anticipates net earnings for the
fourth quarter and year ending December 31, 1998. For purposes of diluted
earnings per share computations for these periods, the weighted average number
of common shares will be increased by approximately 2.4 million shares for the
incremental shares assumed issued on the exercise of stock options and warrants,
compared with increases of 1.1 million shares and 0.6 million shares,
respectively, for the same periods in 1997. The higher number of incremental
shares in 1998 is due to the full year effect of warrants, issued in June 1997,
for the purchase of 1.8 million shares and higher stock prices. The actual
number of incremental shares may vary from the estimate based upon movements in
the Company's stock price, actual exercises of stock options and warrants and
new grants of stock options. See Note 4 of Notes to Consolidated Financial
Statements and "Other Matters - Seasonality."
10
<PAGE>
Liquidity and Capital Resources
The Company's primary sources of working capital are borrowings under
the revolving credit facility pursuant to the terms of its credit 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. 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's purchases were on normal credit terms
during the first quarter of 1998.
In April 1998, the Company completed an offering of $150.0 million of 9
7/8% senior subordinated notes. The net proceeds to the Company from the
offering, after discounts, commissions and other offering expenses, were $144.3
million. The Company used $32.1 million of the net proceeds to repay all of the
outstanding mortgage notes payable and the remaining $112.2 million of net
proceeds and $0.8 million of additional cash to repay revolver borrowings. At
March 31, 1998, the Company had revolver borrowings of $141.0 million and had
cash and cash equivalents of $8.9 million. Effective with the completion of the
offering, the maximum available borrowings under the revolving credit facility
are the lesser of: (i) 60% of eligible inventory or (ii) $132.0 million while
the $50 million term loan is outstanding or $182.0 million if the term loan is
repaid. See "- Financing Activities" and Note 2 of Notes to Consolidated
Financial Statements.
Operating Activities. Net cash used in operating activities (including
in 1998 the decrease in outstanding checks in excess of cash balances which
primarily relate to vendor payments) during the three months ended March 31,
1998 and 1997 was $133.2 million and $80.2 million, respectively. The level of
cash used in each period primarily relates to the amount of inventory purchases,
income tax refunds and net loss. 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 $104.2 million in 1998 compared with
$49.3 million in 1997. Cash payments for inventory in the first three months of
1998 reflect normal credit terms, while the deferral of trade payable balances
in the first quarter of 1997 increased accounts payable and reduced cash
payments during the first three months of 1997 by approximately $60 million.
Store closings and more frequent purchases closer to the time of sale reduced
cash payments during the first three months of 1998 and contributed to lower
inventories at March 31, 1998 of $423.9 million, a decrease of $40.1 million
from inventories of $464.0 million at March 31, 1997. The Company received
income tax refunds, net of payments, of $0.1 million and $19.7 million in the
first three months of 1998 and 1997, respectively. The larger refund in 1997
resulted from the carryback of the taxable loss for the year ended December 31,
1996. The net loss for the three months ended March 31, 1998 was $3.6 million
compared with $21.0 million for the three months ended March 31, 1997, an
improvement of $17.4 million.
Cash used in operating activities for the three months ended March 31,
1997 include $5.4 million related to restructuring programs initiated by
management in 1996 that included the closing of 114 underperforming stores and
one of the Company's two distribution centers. The restructuring programs were
completed in 1997. Other changes in operating assets and liabilities are
primarily related to the seasonal nature of the business and also reflect the
effect of store closings.
11
<PAGE>
Investing Activities. Store expansion and closings were as follows for
the periods indicated:
Three Months Ended Twelve Months Ended
March 31, March 31,
----------------------- -----------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
Openings:
Mall Stores............... - - 2 12
Superstores............... - - 1 10
Total (1)............... - - 3 24
Closings:
Mall Stores............... (12) (52) (39) (89)
Superstores............... (1) (21) (1) (34)
Total (1)............... (13) (74) (45) (126)
Net increase (decrease):
Mall Stores............... (12) (52) (37) (77)
Superstores............... (1) (21) - (24)
Total (1)............... (13) (74) (42) (102)
- --------------------------------
(1) The totals include United Kingdom and other stores.
Most of the Company's capital expenditures in 1998 and 1997 consisted
of improvements to existing stores. 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 internally generated cash and revolver borrowings. 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. The number of stores closed during the three months and twelve
months ended March 31, 1997 included stores closed under the Company's
restructuring programs of 61 stores and 102 stores, respectively.
Financing Activities. Cash provided by (used in) financing activities
(excluding in 1998 the decrease in outstanding checks in excess of cash balances
which relate to vendor payments) was $140.6 million and $(0.8) million during
the three months ended March 31, 1998 and 1997, respectively. The financing
activities primarily relate to revolver borrowings. The Company had repaid all
outstanding revolver borrowings by the end of 1997 with excess cash generated
from strong Christmas season sales. The $141.0 million of revolver borrowings
for the three months ended March 31, 1998 were primarily used to finance
payments to vendors for seasonal inventory purchases and for inventory purchases
on normal credit terms to replenish inventories following the Christmas season.
During the three months ended March 31, 1997, revolver borrowings increased $1.0
million since December 31, 1996. Revolver borrowings and cash and cash
equivalents were $272.0 million and $162.0 million, respectively, at December
31, 1996 compared with $273.0 million and $79.0 million, respectively, at March
31, 1997. The higher revolver borrowings in those periods were due to the
diminished liquidity that had resulted from the challenging retail sales
environment experienced by the Company and the negative impact of
underperforming stores. Revolver borrowings are lower at March 31, 1998 due to
the improved performance of the Company and the use of proceeds received in
September 1997 from the $50.0 million term loan, net of $0.5 million of cash
debt issuance costs, to reduce revolver borrowings.
Long-term debt at March 31, 1998 includes $21.0 million of mortgage
notes payable related to financing from a special purpose entity that had been
treated as an operating lease at March 31, 1997. An amendment to the operating
lease in June 1997 required consolidation of the special purpose entity and
resulted in the recording of the financing as debt effective with the date of
the amendment. Principal payments on long-term debt for the three months ended
March 31, 1998 and 1997 of $0.9 million and $1.8 million, respectively, relate
to mortgage notes payable. The outstanding balance of mortgage notes payable at
March 31, 1998 of $32.1 million, including $0.8 million of current maturities,
was repaid in April 1998 with a portion of the $144.3 million of net proceeds
from the offering of $150.0 million of 9 7/8% senior subordinated notes. The
Company's existing 9% senior subordinated notes are due 2003
12
<PAGE>
and the 9 7/8% senior subordinated notes are due 2008. The Company may, at
its option, redeem the 9% 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 Company's revolving
credit facility expires in October 1999. The Company expects to enter into a new
financing arrangement on or before this expiration date. The term loan is due in
two installments of $25 million in each of December 1998 and February 1999;
however the amendment to the Company's credit agreement in April 1998 allows the
Company to seek to extend the maturities of the term loan.
Other Matters
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.
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.
Forward-Looking Statements. Forward-looking statements herein are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. There are certain important factors that could cause results
to differ materially from those anticipated by some of the statements made
herein. Investors are cautioned that all forward-looking statements involve
risks and uncertainty. In addition to the factors discussed above, among the
factors that could cause actual results to differ materially are the following:
the timing and strength of new product offerings 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.
13
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The following are filed as exhibits to Part I of this Form 10-Q:
Exhibit No. Description
- ----------- -------------------------------------------------------
15. Letter re unaudited interim financial information
-------
27. Financial Data Schedules
-------
The following are filed as exhibits to Part II of this Form 10-Q:
Exhibit No. Description
- ----------- -------------------------------------------------------
4.5 Indenture dated April 6, 1998 between the Company, as
Issuer, and Bank One, N.A., as Trustee, with respect
to the 9 7/8% Senior Subordinated Notes Due 2008 and
Form of Note [i]
4.5(a) Registration Rights Agreement dated as of April 6, 1998
by and among the Company and Donaldson, Lufkin &
Jenrette Securities Corporation, BT Alex. Brown, and
NationsBanc Montgomery Securities LLC, as Initial
Purchasers [i]
10.9 Management Incentive Plan dated as of January 1, 1998
-------
10.20 Long Term Incentive Plan dated as of January 1, 1998
-------
- ---------------------------------
[i] Incorporated by reference to MGI's Registration Statement covering 9 7/8%
Senior Subordinated Notes initially filed with the Commission on April 24,
1998 (Commission File No. 333-50951).
(b) Reports on Form 8-K:
On March 18, 1998, the Company filed a Form 8-K reporting under Item 5, Other
Events, that it had issued a notice of a certain proposed unregistered offering
of debt securities pursuant to Rule 135c of the Securities Act of 1933.
14
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MUSICLAND STORES CORPORATION
(Registrant)
By: /s/ Keith A. Benson
Keith A. Benson
Vice Chairman, Chief Financial
Officer and Director
(authorized officer, principal
financial and accounting officer)
Date: May 12, 1998
-------------
15
THE MUSICLAND GROUP
MANAGEMENT INCENTIVE PLAN
JANUARY 1, 1998
I. PURPOSE
The Management Incentive Plan (the "Plan") is designed to reward
participants who make significant contributions to the success of The
Musicland Group (the "Company"). The Plan recognizes the importance of
individual contributions to Company performance. Awards under this Plan
take into consideration such factors as the importance and impact of
each participant's accomplishments, the relative difficulty and the
degree of risk involved in those accomplishments, as well as Company
performance.
II. ADMINISTRATION
The Plan is administered by the Compensation Committee of the Company's
Board of Directors (the "Compensation Committee") who may delegate to
any other person or persons any ministerial duties of the Plan. In the
absence of a designated Compensation Committee, the Board as a whole
will act as the Compensation Committee. The Chief Executive Officer of
the Company (the "CEO") shall make recommendations to the Compensation
Committee regarding participation, level of awards, changes to the
Plan, annual funding percentages, and other aspects of the Plan's
administration.
The Compensation Committee has the authority to interpret the Plan,
and, subject to the Plan's provisions, to make and amend rules and to
make all other decisions necessary for the Plan's administration.
Specifically, the Compensation Committee has the authority to approve
funding percentages and to approve individual awards for participants
whose base salary is equal to or greater than an amount to be
designated by the Compensation Committee. The CEO has the authority to
approve individual awards for participants whose base salary is less
than the designated amount.
Each Plan Year will run from January 1 through the following December
31 (the "Plan Year").
III. PARTICIPATION
The CEO will recommend for approval by the Compensation Committee the
individuals who are eligible to participate in the Plan, and their
level of participation. All eligible participants will be given the
funding for their participation level and upon request a copy of this
Plan.
IV. INCENTIVE COMPENSATION MEASURES
Early each year the Compensation Committee will approve the business
goals on which incentive funds (the funding pool) will be made
available for awards to participants for such year, as well as a
performance range above and below such goals, and the amounts to be
made available for such awards at each level of business performance.
<PAGE>
The percentage funding is a separate and distinct calculation from the
determination of individual awards (see V. below).
Actual business results for the year and their relation to such
pre-established ranges shall determine the amounts, if any, to be made
available for awards to designated participants. The actual business
results will be provided to the Compensation Committee by the Chief
Financial Officer. The Compensation Committee may approve adjustments
to actual business results to reflect non-recurring organizational,
operational, or other changes which have occurred during the year,
e.g., acquisitions, dispositions, expansions, contractions, material
non-recurring items of income or loss, or events which might create
unwarranted hardships or windfalls to participants.
The Compensation Committee will also determine the discretionary
incentive funds, if any, to be made available for awards to
participants based on their individual performance, such awards not to
be contingent upon the attainment of business goals.
V. DISTRIBUTION OF THE FUNDING POOL
The Compensation Committee approves the percentage of the funding pool
to be distributed each year. Up to, but no more than, 100% of the
funding pool can be approved for distribution.
Individual awards for participants whose base salary is equal to or
greater than an amount to be designated by the Compensation Committee
will be recommended by the CEO to the Compensation Committee for final
approval. Individual awards for participants whose base salary is below
the designated amount will be approved by the CEO.
Individual awards will be determined on the basis of 1) actual Company
performance compared to target business goals and if so designated by
the CFO, by 2) performance on their established objectives. For
participants assigned individual performance goals, up to 25% of their
individual award may be measured by their performance on individual
objectives. However, no payments shall be made based on individual
objectives until and unless the Company meets its threshold for
financial performance goals. Awards will be directly related to each
participant's contribution, considering such factors as importance and
impact of accomplishments as well as the difficulty and degree of risk
involved in those accomplishments.
Eligible salary is the employee's cumulative base salary earned while a
participant in the Plan during the Plan Year. In determining the base
salary earned during the Plan Year any delay in the receipt of a salary
increase from the customary date of increase will be ignored, and the
Participant will be deemed to have received the increase on the
customary date. No minimum award amount is guaranteed, as the Plan is
not intended to provide awards for marginally satisfactory performance
and the Plan makes no guarantee that individual awards will be equal to
the Plan funding percentage.
<PAGE>
VI. PAYMENT OF AWARDS
Awards will consist of two parts, a cash payment and a deferred award,
as follows:
A. Eighty percent (80%) of the award will be paid in cash, less
applicable tax and FICA withholding, during the quarter
following the close of the plan year. It will be paid as soon
as 1) the Company performance results are available, 2)
individual achievements against objectives have been
determined and 3) all approvals have been obtained.
B. Twenty percent (20%) of the award will be made in the form of
a growth participation deferral which will increase or
decrease in value over a three year deferral period as
described below, proportionately to the increase or decrease
in Earnings Per Share (EPS) of The Musicland Group. However,
in no case shall the deferral be worth less than the original
amount.
For example: a participant whose total bonus for the 1998 Plan
Year is $10,000 will receive in the first quarter of 1999 a
cash payment of $8,000 (less applicable tax and FICA
withholding) and will receive a deferral award with a total
value of $2,000.
All deferral awards must be held to maturity before payment is
made in accordance with the following schedule and rules:
1. Maturity of the Award - Your deferral award will
mature in three equal annual increments with the
first increment maturing on the first anniversary
date of the end of the Plan Year for which the award
is made and subsequent increments maturing on the two
succeeding anniversary dates (said three year period
being the "Deferral Period"). Each matured portion of
the deferred award will be paid out during the first
quarter following the date maturity is reached, as
soon as the then current EPS has been calculated and
approved.
For example: if a participant receives a deferred
bonus award for the Plan Year ending 12-31-98, the
award will mature and be paid out in increments of
thirty-three and one third percent (33.3%) as
follows:
Date % Matured
Matured and Paid Out
------- ------------
12-31-98 None
12-31-99 33.3% of the deferral award in 1st Q 2000
12-31-00 33.3% of the deferral award in 1st Q 2001
12-31-01 33.3% of the deferral award in 1st Q 2002
2. Eligibility of Receipt - If employment is terminated
for any reason during the Deferral Period (and even
if the participant is later re-employed prior to the
end of the Deferral Period), all non-matured portions
<PAGE>
of the original deferral amount at the time of
termination are forfeited; except that in the event
termination is due to retirement, disability, death,
disposition of a portion of the business or transfer
to an ineligible position, payout may continue
according to the original schedule or may be made on
an accelerated basis, either at the discretion of the
CEO. In both cases the CEO shall determine the method
of valuation of such matured or non-matured portions
of the deferral award prior to pay out.
3. Calculation of each Matured Award - The value of your
deferral award will be determined on an annual basis
during the Deferral Period based upon changes in EPS.
The amount of each matured increment will be
calculated based on the Company's increase or
decrease in EPS at the end of each year during the
deferral period. For the purposes of determining each
deferral payout, we will establish a growth ratio by
comparing the then current EPS with the base EPS of
$.50. However, in no case shall the deferral be worth
less than the original amount. This calculation will
occur three times during the deferral period as each
third of your performance deferral matures:
Calculation: Current
EPS
-------
Original Deferral Amount X $.50 X .333 = payout
For example: for Plan Year 1998 the deferred portion
of a participant's award is $2,000. For the year
ending 12-31-2000 (the first time a portion of your
award matures) the EPS of the Company is $.61. The
ratio of change in EPS is 1.22 ($.61 divided by
$.50), and, therefore, the value of your original
deferral for purposes of calculating a payout for
12-31-2000 is $2,440. Your subsequent payout would be
$813 (33.3% of $2,440).
Continuing the example, the EPS of the Company at
year end 12-31-2001 is now $.75. The ratio of change
in EPS is now 1.50 ($.75 divided by $.50) and
therefore the value of your original deferral is
$3,000. Your payout would be $1000 (33.3%). If in
this example EPS had fallen to $.45 your deferred
award would have a value of $2000, since in no case
will your award be less than the original amount.
4. There is no guarantee of the value of your deferral,
as the value will fluctuate in accordance with the
Company's performance, or even that any award will be
paid since deferred compensation is subordinate to
the claims of creditors in the event of bankruptcy.
5. The Company reserves the right to cancel deferred
payment awards at any time after they have been
granted and for any reason. At the time of
cancellation, the value of any non-matured deferral
increments will be updated based upon the prior
<PAGE>
rolling twelve months EPS for the period ending with
the most recently announced quarter end results. The
current value of the remaining increments, or the
value of remaining increments at the previous year
end, whichever is higher, will then be paid out
whether such increments have matured or not.
6. All payments under the deferral program will be made
in cash, less applicable tax and FICA withholding,
and will be considered income in the year paid out.
As an exception to the foregoing,and at the Company's
option, at the time of maturity any unpaid deferral
increments could be converted into an appropriate
number of shares of the publicly traded stock which
would be issued to the participant. The conversion
formula for such an exchange would be recommended by
the Chief Financial Officer, reviewed by the
Company's outside auditors, and approved by the Board
of Directors. Once a conversion formula is approved,
it cannot be challenged.
VII. AWARD CONDITIONS
A. Employees hired or promoted into eligible positions on or
before September 30 of the Plan Year will be eligible to
participate in the Plan. Employees hired or promoted into
eligible positions after September 30 may be eligible to
participate upon approval by the CEO. In both cases,
participation in the Annual Plan will be on a pro-rated basis,
determined by the number of full weeks of employment in an
eligible position.
B. A participant who is promoted, at any time other than at the
beginning of a Plan Year, into a position which calls for a
higher participation level will be eligible to receive an
award for that Plan Year which is a combination of pro-rated
awards calculated at the two participation levels.
C. A participant whose employment ends prior to December 31st of
a Plan Year due to retirement, disability, death, or
disposition of part of the business, or who is transferred to
an ineligible position prior to December 31st of a Plan Year,
may be eligible for a pro-rated annual award for that Plan
year, determined by the number of full weeks of employment in
an eligible position, upon approval by the CEO.
D. A participant whose employment terminates prior to December
31st of a Plan Year for reasons other than those listed in C
above will not be eligible for any award for that Plan Year.
E. A participant whose employment terminates after December 31st
of a Plan Year, but prior to the payment of awards, may be
eligible for an award for that Plan Year upon approval by the
CEO.
F. A participant who is on an approved unpaid leave of absence
during a Plan Year may be eligible for a pro-rated award for
that Plan Year upon approval by the CEO. A participant who is
on an approved paid medical leave of absence during a Plan
<PAGE>
Year may be eligible for either a pro-rated or full award for
that Plan Year upon approval by the CEO.
G. Wherever in this Plan the CEO is given the authority to
approve a participant's eligibility for a full or partial
award, or to approve the pay out of any matured deferral
increment, such approvals may be made at his sole discretion.
VIII. GENERAL PROVISIONS
A. This Plan does not guarantee, explicitly or implicitly, the
right to continued employment for participants.
B. MIP awards will be pensionable earnings under the 1989 pension
plan. Legislation in effect at the time the award is approved
will govern how much of the MIP awards are pensionable or
non-pensionable earnings. Awards will be included in
pensionable earnings in the year they are paid.
C. This Plan can be terminated or its provisions changed at any
time by the Compensation Committee of the Board of Directors
acting upon the recommendation of the CEO.
THE MUSICLAND GROUP 1998-2000
LONG TERM INCENTIVE PLAN
JANUARY 1, 1998
I. PURPOSE
The Long Term Incentive Plan (the "Plan") is designed to reward
participants who over time make significant contributions to the
success of The Musicland Group (the "Company"). The Plan recognizes the
importance of individual contributions to Company performance.
II. ADMINISTRATION
The Plan is administered by the Compensation Committee of the Company's
Board of Directors (the "Compensation Committee") who may delegate to
any other person or persons any ministerial duties of the plan. In the
absence of a designated Compensation Committee, the Board as a whole
will act as the Compensation Committee. The Chief Executive Officer of
the Company (the "CEO") shall make recommendations to the Compensation
Committee regarding participation, level of awards, changes to the
Plan, annual funding percentages, and other aspects of the Plan's
administration.
The Compensation Committee has the authority to interpret the Plan,
and, subject to the Plan's provisions, to make and amend rules and to
make all other decisions necessary for the Plan's administration.
The Plan Period will run from January 1, 1998 through the December 31,
2000 (the "Plan Period").
III. PARTICIPATION
Participation is limited to members of the Executive Committee. All
eligible participants will be given a copy of this Plan as well as the
funding for their participation level.
IV. INCENTIVE COMPENSATION MEASURES
At the beginning of the Plan Period the Compensation Committee will
approve the three year business goals as well as the performance range
above and below such goals, and the amount of award at each level of
business performance.
Actual business results for the three year Plan Period and their
relation to such pre-established ranges shall determine the amounts, if
any, of awards to designated participants. The actual business results
will be provided by the Chief Financial Officer. The Compensation
Committee may approve adjustments to actual business results to reflect
non-recurring organizational, operational, or other changes which have
occurred during the year, (e.g., acquisitions, dispositions,
expansions, contractions, material non-recurring items of income or
loss, or events which might create unwarranted hardships or windfalls
to participants.)
<PAGE>
V. PAYMENT OF AWARDS
A. If the company achieves performance which is within the
established performance range for the three year Plan Period,
as adjusted by the Compensation Committee when appropriate,
participants earn the corresponding award. Dependent on the
performance measurement, awards are calculated using the total
of each of the three years of the Plan Period, or in the case
of percentages, the simple average of the three individual
years.
B. Awards are determined as a percentage of average annual base
earnings over the Plan Period and are paid after the final
year performance is determined and approved. Awards are paid
in cash, less applicable tax and FICA withholdings.
VI. AWARD CONDITIONS
A. Employees hired or promoted into eligible positions during the
Plan Period may be eligible to participate in the Plan upon
approval of the Compensation Committee. Participation for the
Plan Period in which the employee becomes eligible will be on
a pro-rated basis, determined by the number of full weeks of
employment in an eligible position.
B. A participant who is promoted, at any time other than at the
beginning of a Plan Period, into a position which calls for a
higher participation level will be eligible to receive an
award for that Plan Period which is a combination of pro-rated
awards calculated at the two participation levels.
C. A participant whose employment ends prior to the end of the
Plan Period due to retirement at age 55 or over, disability,
death, or disposition of part of the business, or who is
transferred to an ineligible position, may be eligible for a
pro-rated award, determined by the number of full weeks of
employment in an eligible position, upon approval by the
Compensation Committee.
D. A participant whose employment terminates prior to the end of
a Plan Period for reasons other than those listed in C above
will not be eligible for any award for that Plan Period except
as may be defined in a separate executed Employment Contract
or Change of Control Agreement.
E. A participant whose employment terminates after December 31st,
2000, but prior to the payment of awards, may be eligible for
an award for that Plan Period upon approval by the
Compensation Committee.
F. A participant who is on an approved unpaid leave of absence
during a Plan Period may be eligible for a pro-rated award for
that Plan Period upon approval by the Compensation Committee.
<PAGE>
A participant who is on an approved paid medical leave of
absence during a Plan Period may be eligible for either a
pro-rated or full award for that Plan Period also upon
approval by the Compensation Committee .
G. Wherever in this Plan the Compensation Committee is given the
authority to approve a participant's eligibility for a full or
partial award, such approvals may be made at its sole
discretion.
VIII. GENERAL PROVISIONS
A. This Plan does not guarantee, explicitly or implicitly, the
right to continued employment for participants.
B. This Plan can be terminated or its provisions changed at any
time by the Compensation Committee of the Board of Directors.
Exhibit 15
Letter re unaudited interim financial information
May 12, 1998
To Musicland Stores Corporation:
We are aware that Musicland Stores Corporation has incorporated by reference in
its Registration Statements Nos. 33-50520, 33-50522, 33-50524, 33-82130,
33-99146 and 333-51401, its Form 10-Q for the quarter ended March 31, 1998,
which includes our report dated April 24, 1998, covering the unaudited interim
financial information contained therein. Pursuant to Regulation C of the
Securities Act of 1933, that report is not considered a part of those
registration statements prepared or certified by our firm or a report prepared
or certified by our firm within the meaning of Sections 7 and 11 of the Act.
Very truly yours,
ARTHUR ANDERSEN LLP
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET OF MUSICLAND STORES CORPORATION AND SUBSIDIARIES AS
OF MARCH 31, 1998, AND THE RELATED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE
THREE-MONTH PERIOD ENDED MARCH 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 8,852
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 423,940
<CURRENT-ASSETS> 451,241
<PP&E> 424,122
<DEPRECIATION> 182,187
<TOTAL-ASSETS> 702,992
<CURRENT-LIABILITIES> 356,408
<BONDS> 282,417
0
0
<COMMON> 345
<OTHER-SE> 15,799
<TOTAL-LIABILITY-AND-EQUITY> 702,992
<SALES> 392,405
<TOTAL-REVENUES> 392,405
<CGS> 255,652
<TOTAL-COSTS> 255,652
<OTHER-EXPENSES> 134,894
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,932
<INCOME-PRETAX> (5,073)
<INCOME-TAX> (1,522)
<INCOME-CONTINUING> (3,551)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,551)
<EPS-PRIMARY> (.11)
<EPS-DILUTED> 0
</TABLE>
