UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
- --- OF 1934
For the fiscal year ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
------ -------
Commission file number 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer
incorporation organization) Identification No.)
10400 Yellow Circle Drive,
Minnetonka, Minnesota 55343
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (612) 931-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information state-
ments incorporated by reference in Part III of this Form 10-K or any amendment
to this Form 10-K. X
---
The aggregate market value of the voting stock held by nonaffiliates of
the Registrant on December 31, 1997 was approximately $225,235,947 based on the
closing stock price of $7 5/16 on the New York Stock Exchange on such date (only
members of the Management Investors Group are considered affiliates for this
calculation).
The number of shares outstanding of the Registrant's common stock on
February 10, 1998 was 34,458,037.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 12, 1998 (the "Proxy Statement") are incorporated by
reference into Part III.
<PAGE>
PART I
ITEM 1. 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
(earnings before interest, income taxes, depreciation and amortization) of $85.4
million.
During 1997, the Company completed restructuring programs that had been
initiated by management in 1996 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, 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. See "Management's Discussion and Analysis of Results of
Operations and Financial Condition."
The Company closed 106 stores in 1997 and has closed a total of 236 stores
over the last three years, including 114 stores closed in 1997 and 1996 under
the restructuring programs and other underperforming stores,the majority of
which were near the end of their lease terms. The consolidation of distribution
facilities into a single facility in Franklin, Indiana was completed in January
1997 with the closing of the distribution facility in Minneapolis, Minnesota.
The Company opened three new stores during 1997. The Company intends to limit
store growth in 1998 and will focus on making improvements to existing stores.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition - Liquidity and Capital Resources - Investing Activities."
Musicland Stores Corporation ("MSC") was incorporated in Delaware in 1988
and acquired The Musicland Group, Inc. ("MGI") on August 25, 1988. MGI was
incorporated in Delaware in 1977 as a successor corporation to a number of
companies that participated in the music business as early as 1956. The
principal asset of Musicland Stores Corporation is 100% of the outstanding
common stock of MGI, and, since its formation, MSC has engaged in no independent
business operations. MSC and MGI, together with MGI's subsidiaries, are
collectively referred to herein as the "Company."
1
<PAGE>
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, emphasizing 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, digital video discs ("DVD"), 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 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.
2
<PAGE>
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.
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.
3
<PAGE>
Products
The following table shows the sales and percentage of total sales
attributable to each product group.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------
1997 1996 1995
------------------- -------------------- -----------------
Sales % Sales % Sales %
--------- ------- --------- -------- -------- -------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Music ..................................... $ 930.0 52.6 % $ 931.1 51.1 % $ 895.0 51.9 %
Video ..................................... 509.1 28.8 531.2 29.2 505.9 29.4
Books, computer software and other products 329.2 18.6 359.3 19.7 321.9 18.7
-------- ------- -------- ------- -------- -------
Total ............................... $1,768.3 100.0 % $1,821.6 100.0 % $1,722.8 100.0 %
======== ======= ======== ======== ======== =======
</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.
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 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.
4
<PAGE>
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 "Management's Discussion and Analysis of Results of
Operations and Financial Condition - General."
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
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.
5
<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 - General and
- - Results of Operations."
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.
ITEM 2. 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 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.
6
<PAGE>
1998........................ 157 2003......................... 141
1999........................ 203 2004......................... 127
2000........................ 208 2005......................... 107
2001........................ 185 2006......................... 43
2002........................ 117 2007 and thereafter.......... 72
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.
ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders by MSC during
the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of MSC is traded on the New York Stock Exchange under
the symbol MLG. For common stock price information, see Note 16 of Notes to
Consolidated Financial Statements. As of February 10, 1998, MSC had
approximately 578 holders of record of its common stock.
MSC has never paid cash dividends on its capital stock and does not
plan to pay cash dividends in the foreseeable future. The current policy of the
Board of Directors of MSC is to reinvest in the business of the Company. The
terms of the Company's credit agreement and the indenture for the 9% senior
subordinated notes restrict the amount of cash dividends that may be paid by
MSC. See Note 4 of Notes to Consolidated Financial Statements.
7
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the years
indicated. This information should be read in conjunction with the Consolidated
Financial Statements and related notes contained in Item 14 herein and
"Management's Discussion and Analysis of Results of Operations and Financial
Condition" contained in Item 7 herein.
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share amounts and store data)
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Sales...................................... $ 1,768,312 $ 1,821,594 $ 1,722,572 $ 1,478,842 $ 1,181,658
Gross profit............................... 614,829 611,759 606,070 542,199 470,951
Selling, general and administrative
expenses................................ 529,427 576,658 525,213 450,919 365,311
Depreciation and amortization.............. 39,411 44,819 45,531 37,243 29,057
Goodwill write-down........................ - 95,253 138,000 - -
Restructuring charges...................... - 75,000 - - -
Operating income (loss).................... 45,991 (179,971) (102,674) 54,037 76,583
Interest expense........................... 31,720 32,967 27,881 19,555 19,831
Earnings (loss) before income taxes and
extraordinary charge.................... 14,271 (212,938) (130,555) 34,482 56,752
Income taxes............................... 300 (19,200) 5,195 17,100 25,400
Earnings (loss) before extraordinary
charge (1).............................. 13,971 (193,738) (135,750) 17,382 31,352
Earnings (loss) per common share: (1)
Basic................................... $ .42 $ (5.80) $ (4.00) $ 0.51 $ 1.03
Diluted................................. .41 (5.80) (4.00) 0.51 1.03
<CAPTION>
December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
------------- ------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total assets............................... $ 733,895 $ 996,915 $ 996,957 $ 1,079,632 $ 905,682
Long-term debt, including current
maturities.............................. 193,087 396,599 163,000 110,000 135,000
Stockholders' equity....................... 18,770 2,619 195,811 340,276 322,594
Store Data:
Total store square footage (in millions)... 8.3 9.5 9.9 7.2 4.9
Store count:
Sam Goody stores........................ 713 777 820 869 875
Suncoast stores......................... 409 422 412 378 320
Media Play stores....................... 68 87 89 46 13
On Cue stores........................... 157 158 153 77 32
United Kingdom and other stores......... 16 22 22 16 11
------------- ------------- ------------ ------------- -------------
Total................................ 1,363 1,466 1,496 1,386 1,251
============= ============= ============ ============= =============
</TABLE>
- ----------------------------------------------
(1) Amounts for the year ended December 31, 1993 are before an extraordinary
charge from early redemption of debt, net of income tax benefit, of
$3,900, or $0.13 per basic and diluted share. Net earnings for the year
ended December 31, 1993 were $27,452, or $0.90 per basic and diluted
share.
8
<PAGE>
ITEM 7. 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, 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
earnings before interest expense, income taxes, depreciation and amortization,
goodwill write-down and restructuring charges 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 credit agreement in June 1997 that
modified and provided additional flexibility in financial covenants and allowed
a $50 million term loan. The Company previously obtained waivers of certain
financial covenants and technical defaults under the credit 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."
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.
9
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------
1997 1996 1995
----------- ------------ ------------
(dollars and square footage in millions)
<S> <C> <C> <C>
Sales:
Mall Stores ............................... $ 1,165.0 $ 1,160.0 $ 1,187.0
Superstores ............................... 589.5 643.8 516.7
Total (1) .............................. 1,768.3 1,821.6 1,722.6
Percentage change from prior year:
Mall Stores ............................... 0.4 % (2.3)% (2.5)%
Superstores ............................... (8.4) 24.6 108.5
Total (1) .............................. (2.9) 5.7 16.5
Comparable store sales change from prior year:
Mall Stores ............................... 4.7 % (1.7)% (4.9)%
Superstores ............................... 4.1 2.0 4.8
Total (1) .............................. 4.5 (0.6) (3.2)
Number of stores open at year end:
Mall Stores ............................... 1,122 1,199 1,232
Superstores ............................... 225 245 242
Total (1) .............................. 1,363 1,466 1,496
Total store square footage at year end:
Mall Stores ............................... 4.0 4.3 4.5
Superstores ............................... 4.2 5.2 5.3
Total (1) .............................. 8.3 9.5 9.9
</TABLE>
(1) The totals include United Kingdom and other stores.
Sales. 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.
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.
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.
Years Ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- --------
Music.......... 7.5 % 0.9 % (6.9)%
Video.......... 0.2 (0.8) 4.7
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 "Business - Products -
Video."
10
<PAGE>
Components of Earnings. The following table sets forth certain
operating results as a percentage of sales for the last three years.
Years Ended December 31,
------------------------
1997 1996 1995
------- ------ ------
Sales .............................................. 100.0% 100.0% 100.0%
Gross profit ....................................... 34.8 33.6 35.2
Selling, general and administrative expenses ....... 29.9 31.7 30.5
Operating income before depreciation, amortization
and restructuring charges ....................... 4.8 1.9 4.7
Operating income (loss) ............................ 2.6 (9.9) (6.0)
Gross Profit. 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 Company
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%.
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.
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 $1.5 million and $1.6 million in
1996 and 1995, respectively. Because of the Company's limited store expansion in
1997 and 1996, costs incurred related to store openings were minimal in 1997 and
were approximately $4 million in 1996 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
credit agreement, totaled approximately $2.9 million in 1997 and $3.8 million in
1996. 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.
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. 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."
Depreciation and Amortization. The goodwill write-downs in 1996 and
1995 eliminated goodwill amortization in 1997 while goodwill amortization was
$3.0 million, or $0.09 per share, in 1996 and $5.8 million, or $0.17 per share,
in 1995. Other depreciation and amortization was $39.4 million, $41.8 million
and $39.7 million in 1997, 1996 and 1995, respectively, and primarily related to
stores.
11
<PAGE>
The decrease in 1997 from 1996 was due to store closings. The
increase in 1996 over 1995 was attributable to store expansion, net of the
decrease related to store closings. See "-Liquidity and Capital Resources -
Investing Activities."
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 9% subordinated debt. Other interest consists
primarily of amortization of debt issuance costs. Components of interest expense
for the last three years are as follows:
Years Ended December 31,
-------------------------------
1997 1996 1995
------- ------- -------
(in millions)
Interest on revolver.................... $ 19.0 $ 21.9 $ 17.0
Interest on term loan................... 1.2 - -
Interest on subordinated debt........... 9.9 9.9 9.9
Other interest, net..................... 1.6 1.2 1.0
------- ------- -------
$ 31.7 $ 33.0 $ 27.9
======= ======= =======
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 revolving credit facility were as follows:
Years Ended December 31,
----------------------------------
1997 1996 1995
-------- -------- --------
(dollars in millions)
Average daily revolver borrowings...... $238.5 $289.7 $254.0
Highest level of revolver borrowings... 273.0 333.0 350.0
Weighted average interest rate......... 8.0 % 7.6 % 7.1 %
12
<PAGE>
Lower outstanding revolver borrowings 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. Higher outstanding revolver borrowings increased
interest expense by $2.4 million in 1996. Increases in the weighted average
interest rates increased revolver interest by $1.1 million in 1997 and $1.2
million in 1996. Most of the increase in interest rates in 1997 and 1996 was the
result of amendments to the Company's credit 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 2.1% in 1997, 9.0% in
1996 and (4.0)% in 1995 vary from the federal statutory rate as a result of
deferred tax valuation allowances in 1997 and 1996, goodwill amortization and
write-downs in 1996 and 1995, 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 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. 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.
In June 1997, the Company completed agreements with its banks to amend
the credit agreement and to allow a $50 million term loan. Pursuant to the
amendment, the maximum available borrowings under the revolving credit facility
are the lesser of: (i) 60% of eligible inventory or (ii) $245.0 million through
the expiration of the credit 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 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,
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 credit agreement that had been
extended through June 30, 1997 to allow for adequate time to complete all of the
necessary financing agreements and related
13
<PAGE>
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 senior
subordinated notes, as amended, also contain certain financial covenants. The
Company was in compliance with all covenants at December 31, 1997.
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 $86.7 million in 1997,
$(52.6) million in 1996 and $7.2 million in 1995. 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. In 1997, the aggregate net changes in inventories,
accounts payable and outstanding checks in excess of cash balances contributed
$6.4 million to net cash provided by operating activities. In 1996 and 1995,
cash used for inventory purchases, as reflected by the aggregate net changes in
these inventory related items, was $38.9 million and $31.8 million,
respectively. 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 Company received income tax refunds, net of payments, of $22.9
million in 1997 from the carryback of the 1996 taxable loss while tax payments
of $9.0 million and $17.9 million were made in 1996 and 1995, respectively. Cash
expenditures related to store closings under the Company's restructuring
programs were $12.2 million and $24.1 million in 1997 and 1996, respectively.
Investing Activities. Capital expenditures and store data for the last
three years are as follows:
Years Ended December 31,
------------------------
1997 1996 1995
--------- ------- ------
Capital expenditures, net of sale/leasebacks
and other property sales (in millions) .... $10.9 $6.4 $87.0
Store openings:
Mall Stores ............................... 2 14 49
Superstores ............................... 1 19 119
Total (1) .............................. 3 35 175
Store closings:
Mall Stores ............................... (79) (47) (64)
Superstores ............................... (21) (16) --
Total (1) .............................. (106) (65) (65)
Net increase (decrease) in store count:
Mall Stores ............................... (77) (33) (15)
Superstores ............................... (20) 3 119
Total (1) .............................. (103) (30) 110
(1) The totals include United Kingdom and other stores.
Most of the Company's capital expenditures in 1997 consisted of
improvements to existing stores, while in 1996 and 1995, capital expenditures
were primarily for store expansion, the majority of which were new Media Play
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 Company's
restructuring programs were 61 stores and 53 stores in 1997 and 1996,
respectively. See "-Results of Operations - Restructuring Charges."
14
<PAGE>
Financing of capital expenditures has generally been provided by
borrowings under the revolving credit facility 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 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 revolver borrowings 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.
Financing Activities. The Company's financing activities principally
consist of borrowings and repayments under its revolving credit facility. Cash
provided by (used in) financing activities (excluding the increase (decrease) in
outstanding checks in excess of cash balances which relate to vendor payments)
was $(233.8) million, $219.0 million and $43.2 million during the years ended
December 31, 1997, 1996 and 1995, respectively. 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. 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.
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 revolving credit facility expires in October 1999. The Company
expects to enter into a new financing arrangement on or before this expiration
date. 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 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
$21.0 million and $10.3 million to March 2000 and May 2001, respectively. The
Company believes it will be able to secure adequate financing to meet these
obligations when they become due.
15
<PAGE>
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.
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.
16
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and related notes are included in
Item 14 of this report. See Index to Consolidated Financial Statements contained
in Item 14 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by these items of Part III will be set forth
in the Proxy Statement under similar captions and is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
(a) Documents filed as part of this report:
(1) Consolidated Financial Statements
See Index to Consolidated Financial Statements on page 19.
(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they
are not required or are not applicable, or because the
information required to be set forth therein either is not
material or is included in the Consolidated Financial
Statements or related notes.
(3) Exhibits
See Exhibit Index on pages 38 through 41.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
fourth quarter of the year ended December 31, 1997.
(c) Exhibits
See Exhibit Index on pages 38 through 41.
(d) Other Financial Statements
Not applicable.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ Jack W. Eugster
---------------------
Jack W. Eugster, Chairman of the Board,
President and Chief Executive Officer
Date: March 12, 1998
---------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Capacity Date
Chairman of the Board, President
and Chief Executive Officer
/s/ Jack W. Eugster (principal executive officer) March 12, 1998
- ------------------
Jack W. Eugster
Vice Chairman, Chief Financial
Officer and Director
(principal financial and
/s/ Keith A. Benson accounting officer) March 12, 1998
- -------------------
Keith A. Benson
/s/ Gilbert L. Wachsman Vice Chairman and Director March 12, 1998
- -----------------------
Gilbert L. Wachsman
/s/ Kenneth F. Gorman Director March 12, 1998
- ---------------------
Kenneth F. Gorman
/s/ William A. Hodder Director March 12, 1998
- ---------------------
William A. Hodder
/s/ Josiah O. Low III Director March 12, 1998
- ---------------------
Josiah O. Low III
/s/ Terry T. Saario Director March 12, 1998
- -------------------
Terry T. Saario
/s/ Tom F. Weyl Director March 12, 1998
- -------------------
Tom F. Weyl
/s/ Michael W. Wright Director March 12, 1998
- ---------------------
Michael W. Wright
18
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants 20
Consolidated Statements of Operations 21
Consolidated Balance Sheets 22
Consolidated Statements of Cash Flows 23
Consolidated Statements of Stockholders' Equity 24
Notes to Consolidated Financial Statements 25
19
<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, 1997 and 1996, 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, 1997 and 1996, 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
20
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Sales ...................................... $ 1,768,312 $ 1,821,594 $ 1,722,572
Cost of sales .............................. 1,153,483 1,209,835 1,116,502
----------- ----------- -----------
Gross profit ............................ 614,829 611,759 606,070
Selling, general and administrative expenses 529,427 576,658 525,213
Depreciation and amortization .............. 39,411 44,819 45,531
Goodwill write-down ........................ -- 95,253 138,000
Restructuring charges ...................... -- 75,000 --
----------- ----------- -----------
Operating income (loss) ................. 45,991 (179,971) (102,674)
Interest expense ........................... 31,720 32,967 27,881
----------- ----------- -----------
Earnings (loss) before income taxes ..... 14,271 (212,938) (130,555)
Income taxes ............................... 300 (19,200) 5,195
----------- ----------- -----------
Net earnings (loss) ..................... $ 13,971 $ (193,738) $ (135,750)
=========== =========== ===========
Basic earnings (loss) per common share ..... $ 0.42 $ (5.80) $ (4.00)
=========== =========== ===========
Diluted earnings (loss) per common share ... $ 0.41 $ (5.80) $ (4.00)
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
21
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
December 31,
-------------------------
1997 1996
------------ ----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................................... $ 3,942 $ 161,976
Inventories ................................................................. 450,258 506,093
Deferred income taxes ....................................................... 10,600 11,800
Other current assets ........................................................ 8,768 31,492
--------- ---------
Total current assets ...................................................... 473,568 711,361
Property, net .................................................................. 250,021 277,996
Deferred income taxes .......................................................... 2,400 1,200
Other assets ................................................................... 7,906 6,358
--------- ---------
Total Assets .............................................................. $ 733,895 $ 996,915
========= =========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Current maturities of long-term debt ........................................ $ 26,657 $ 2,060
Accounts payable ............................................................ 357,183 406,642
Restructuring reserve ....................................................... -- 33,963
Other current liabilities ................................................... 115,660 100,866
--------- ---------
Total current liabilities ................................................. 499,500 543,531
Long-term debt ................................................................. 166,430 394,539
Other long-term liabilities .................................................... 49,195 56,226
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, 1997, 34,372,592; December 31, 1996,34,301,956) . 344 343
Additional paid-in capital .................................................. 255,075 253,896
Accumulated deficit ......................................................... (224,678) (238,649)
Deferred compensation ....................................................... (6,998) (7,998)
Common stock subscriptions .................................................. (4,973) (4,973)
--------- ---------
Total stockholders' equity ................................................ 18,770 2,619
--------- ---------
Total Liabilities and Stockholders' Equity ................................ $ 733,895 $ 996,915
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
22
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------
1997 1996 1995
--------- ---------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net earnings (loss) ................................................. $ 13,971 $(193,738) $(135,750)
Adjustments to reconcile net earnings (loss) to net cash provided by
(used in)operating activities:
Depreciation and amortization ..................................... 39,411 44,819 45,531
Disposal of property .............................................. 4,112 1,733 7,587
Goodwill write-down ............................................... -- 95,253 138,000
Amortization of debt issuance costs and other ..................... 1,234 658 516
Other amortization ................................................ 1,022 234 364
Restructuring charges ............................................. -- 75,000 --
Deferred income taxes ............................................. -- 500 (3,400)
Changes in operating assets and liabilities:
Inventories ....................................................... 55,835 27,601 (41,866)
Other current assets .............................................. 22,724 (10,353) (11,172)
Accounts payable .................................................. (61,520) 2,794 (53,388)
Restructuring reserve ............................................. (12,231) (24,092) --
Other current liabilities ......................................... 14,843 (6,767) (11,445)
Other assets ...................................................... (1,483) (590) (1,079)
Other long-term liabilities ....................................... (3,305) 3,637 9,875
-------- -------- --------
Net cash provided by (used in) operating activities ............. 74,613 16,689 (56,227)
-------- -------- --------
INVESTING ACTIVITIES:
Capital expenditures ................................................ (10,940) (17,970) (113,983)
Sale/leasebacks and other property sales ............................ -- 11,594 26,969
-------- -------- --------
Net cash used in investing activities ........................... (10,940) (6,376) (87,014)
-------- -------- --------
FINANCING ACTIVITIES:
Increase (decrease) in outstanding checks in excess of cash balances 12,061 (69,321) 63,435
Borrowings (repayments) under revolver .............................. (272,000) 219,000 53,000
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 .................................. 219 13 196
-------- -------- --------
Net cash provided by (used in) financing activities ............. (221,707) 149,692 106,634
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS ...................................................... (158,034) 160,005 (36,607)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR ........................ 161,976 1,971 38,578
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR............................... $ 3,942 $161,976 $ 1,971
======== ======== ========
CASH PAID (RECEIVED) DURING THE YEAR FOR:
Interest............................................................ $ 33,035 $ 31,677 $ 27,268
Income taxes, net .................................................. (22,908) 9,010 17,884
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
23
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings Common Total
--------------- Paid-in (Accumulated Deferred 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.
24
<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
25
<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)
adversely impacted if the 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. 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 $39,370, $41,763 and $39,653 for the years ended December 31,
1997, 1996 and 1995, 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.
26
<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)
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 33,528,000, 33,414,000 and
33,898,000 in 1997, 1996 and 1995, 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 the exercise of stock options
and warrants. Stock options were excluded from diluted computations for the net
losses for the years ended December 31, 1996 and 1995 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,
1996 and 1995 was $3,005 and $5,793, 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 store 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.
27
<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,
-------------------
1997 1996
-------- --------
<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 .................................... 33,087 14,599
9% senior subordinated notes, unsecured, due 2003 ....... 110,000 110,000
-------- --------
Total ................................................ 193,087 396,599
Less current maturities ................................. 26,657 2,060
-------- --------
Total long-term debt .................................... $166,430 $394,539
======== ========
</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,
-------------------------------
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Revolver data is as follows:
Average daily outstanding revolver borrowings $238,500 $289,700 $254,000
Highest outstanding revolver borrowings ..... 273,000 333,000 350,000
Weighted average interest rates:
Based on average daily borrowings ........ 8.03 % 7.56% 7.13 %
At year end, excluding facility fee rate . N/A 7.26 7.12
</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,
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
28
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
4. Long-term Debt (Continued)
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,
-----------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Income taxes consist of:
Current:
Federal ..................................... $ 100 $(18,300) $ 7,395
State, local and other ...................... 200 (1,400) 1,200
------ -------- -------
300 (19,700) 8,595
------ -------- -------
Deferred:
Federal ..................................... 1,400 (1,000) (3,200)
State, local and other ...................... (1,400) 1,500 (200)
------ -------- -------
-- 500 (3,400)
------ -------- -------
Total ....................................... $ 300 $(19,200) $ 5,195
====== ======== =======
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 ..................... 5.2 16.7 38.5
State and local income taxes, net of federal
benefit.................................... (5.5) -- 0.5
Valuation allowance ............................ (32.6) 9.3 --
------ -------- -------
Effective income tax rate ................... 2.1% (9.0)% 4.0%
====== ======== =======
</TABLE>
29
<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,
----------------------
1997 1996
---------- ---------
<S> <C> <C>
Components of deferred income taxes are as
follows:
Net current deferred tax asset:
Capitalized inventory costs .............. $ 5,360 $ 5,880
Inventory valuation ...................... 8,266 5,564
Compensation related ..................... 2,504 2,601
Restructuring charges .................... -- 14,388
Store closings ........................... 2,586 1,883
Other accruals ........................... 2,303 2,103
Other, net ............................... 681 581
-------- --------
Total current deferred income taxes ... 21,700 33,000
Valuation allowance ...................... (11,100) (21,200)
-------- --------
Net current deferred income taxes ..... $ 10,600 $ 11,800
======== ========
Net noncurrent deferred tax asset:
Depreciation ............................. $(15,263) $(20,901)
Rent expense ............................. 18,279 17,651
Amortization of intangible assets ........ (2,011) (2,011)
Net pension liability .................... 960 881
Other, net ............................... 489 (49)
Alternative minimum tax credits .......... 5,846 8,929
-------- --------
Total noncurrent deferred income taxes 8,300 4,500
Valuation allowance ...................... (5,900) (3,300)
-------- --------
Net noncurrent deferred income taxes ..... $ 2,400 $ 1,200
======== ========
</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 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, 1997 and 1996.
30
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
6. Employee Benefit Plans (Continued)
<TABLE>
<CAPTION>
December 31,
-----------------------
1997 1996
---------- ----------
<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................ $ 9,604 $ 9,330
Service cost........................................... 411 446
Interest cost.......................................... 748 715
Effect of assumption change............................ 448 (456)
Actuarial loss (gain) ................................. 257 (13)
Benefits paid.......................................... (1,011) (418)
---------- ----------
Benefit obligation at end of year...................... 10,457 9,604
---------- ----------
Change in plan assets:
Fair value of plan assets at beginning of year......... 9,468 9,289
Actual return on plan assets........................... 2,468 597
Benefits paid.......................................... (1,011) (418)
---------- ----------
Fair value of plan assets at end of year............... 10,925 9,468
---------- ----------
Funded status.......................................... 468 (136)
Unrecognized gains..................................... (3,277) (2,273)
---------- ----------
Accrued pension cost................................... $ (2,809) $ (2,409)
========== ==========
Assumptions used in computing pension data are
as follows:
Discount rate for benefit obligations.................. 7.50 % 7.75 %
Expected long-term rate of return on plan assets....... 8.50 8.50
</TABLE>
Years Ended December 31,
------------------------
1997 1996 1995
------- ------ ------
The components of net pension expense are as follows:
Service cost ........................................ $ 411 $ 446 $ 260
Interest cost ....................................... 748 715 631
Expected return on plan assets ...................... (754) (771) (672)
Amortization of prior service cost and gain ......... (5) (5) (12)
----- ----- -----
Net pension expense .............................. $ 400 $ 385 $ 207
===== ===== =====
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
31
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
6. Employee Benefit Plans (Continued)
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, 1997 and 1996. At December 31, 1997 and
1996, the number of shares held in suspense was 730,030 and 834,320,
respectively, and the market value of the shares held in suspense was $5,338 and
$1,251, respectively.
Expenses for the defined contribution and 401(k) plans for the years
ended December 31, 1997, 1996 and 1995 totaled $1,749, $354 and $570,
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:
1997 1996 1995
--------- ----------- ----------
Net earnings (loss): As reported..... $ 13,971 $(193,738) $(135,750)
Pro forma....... $ 13,168 $(194,394) $(135,850)
Net earnings (loss) per
common share: As reported
Basic........ $ .42 $ (5.80) $ (4.00)
Diluted...... $ .41 $ (5.80) $ (4.00)
Pro forma
Basic........ $ .39 $ (5.82) $ (4.01)
Diluted...... $ .39 $ (5.82) $ (4.01)
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 1997, 1996 and 1995, respectively:
risk-free interest rates of 6.27%, 6.17% and 6.31%; expected volatility of 56%,
49% and 45%; 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.
32
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
7. Stock Plans (Continued)
Stock option activity for the last three years was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------- ------------------------ -------------------------
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... 2,681,294 $ 7.33 1,892,984 $ 10.52 1,748,916 $ 11.90
Granted............... 734,650 3.16 1,023,973 2.30 398,350 7.84
Exercised............. (70,636) 3.10 (5,000) 2.50 (50,100) 3.93
Canceled.............. (409,400) 8.67 (230,663) 11.26 (204,182) 18.73
----------- ---------- ------------
Outstanding at
end of year......... 2,935,908 6.20 2,681,294 7.33 1,892,984 10.52
=========== ========== ============
Options exercisable
at year end......... 1,084,642 1,003,916 840,838
=========== ========== ============
Options available
for future grant.... 341,500 666,750 1,460,060
=========== ========== ============
Weighted average
fair value of
options granted
during the year..... $ 2.00 $ 1.32 $ 4.38
=========== ========== ============
</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>
33
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
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 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.
34
<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,
----------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Total rent expense consists of the following:
Minimum cash rents .......................... $ 152,343 $ 166,308 $ 148,736
Straight-line recognition of leases with
scheduled rent increases ................. (910) 3,152 7,304
Percentage rents ............................ 2,143 1,733 2,000
--------- --------- ---------
Total rent expense ....................... $ 153,576 $ 171,193 $ 158,040
========= ========= =========
</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.
35
<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,
----------------------
1997 1996
--------- ---------
<S> <C> <C>
Property consists of the following, at cost:
Land and land improvements ..................................... $ 10,003 $ 9,283
Buildings ...................................................... 32,055 10,408
Leasehold improvements ......................................... 231,831 248,077
Store fixtures and other property .............................. 149,973 162,348
--------- ---------
423,862 430,116
Less accumulated depreciation and amortization.................. (173,841) (152,120)
--------- ---------
Property, net .................................................. $ 250,021 $ 277,996
========= =========
<CAPTION>
December 31,
----------------------
1997 1996
--------- ---------
<S> <C> <C>
Other current liabilities consist of the following:
Payroll and related taxes and benefits .......................... $ 24,963 $ 19,598
Gift certificates payable ....................................... 38,224 32,792
Sales taxes payable ............................................. 18,764 19,924
Accrued store expenses and other ................................ 33,709 28,552
--------- ---------
Total ........................................................... $ 115,660 $ 100,866
========= =========
Other long-term liabilities consist of the following:
Straight-line recognition of leases with scheduled rent increases $ 32,457 $ 36,442
Deferred rent credits ........................................... 12,508 14,651
Other ........................................................... 4,230 5,133
--------- ---------
Total ........................................................... $ 49,195 $ 56,226
========= =========
</TABLE>
15. Supplemental Cash Flow Information
The land, building and certain equipment related to the Company's
distribution facility in Franklin, Indiana and the land, buildings and certain
fixtures related to three of the Company's Media Play stores were financed under
operating leases with special purpose entities that had been formed for the
purpose of purchasing the land, equipment and fixtures and constructing the
facilities using secured financing. 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. 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.
36
<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
Net (Loss)per (Loss)per Common Stock Price
Gross Earnings Common Common -----------------------
Sales Profit (Loss) Share Share High Low
-------------- ------------ ------------- ------------- ------------ ----------- -----------
1997:
<S> <C> <C> <C> <C> <C> <C> <C>
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
============== ============ ============= ============= ============
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)
============== ============ ============= ============= ============
</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.
37
<PAGE>
EXHIBIT INDEX
The following documents are filed as part of this Annual Report on Form
10-K for the year ended December 31, 1997.
<TABLE>
<CAPTION>
Exhibit Sequential
No. Description Page No.
-------- --------------------------------------------------------------- ----------
<S> <C> <C>
3.1 - Restated Certificate of Incorporation of MSC, as amended [i]
3.2 - By-laws of MSC, as amended [ii]
4.1 - Senior Subordinated Note Indenture, including form of Note,
dated as of June 15, 1993 among MGI, MSC and Bank One Columbus,
N.A. as Successor Trustee to Harris Trust and Savings Bank [iii]
4.1(a) - First Supplemental Indenture dated as of June 13, 1997 to the
Senior Subordinated Note Indenture [xv]
4.2(a) - Credit Agreement dated as of October 7, 1994 (the "Credit
Agreement") among MGI, MSC, the banks listed therein and Morgan
Guaranty Trust Company of New York, as agent [iv]
4.2(b) - Amendment No.1 dated as of February 28, 1995 to the Credit Agreement [viii]
4.2(c) - Amendment No. 2 dated as of April 9, 1996 to the Credit Agreement [xi]
4.2(d) - Amendment No. 3 dated as of October 18, 1996 to the Credit Agreement [xii]
4.2(e) - Waivers and Agreements under Credit Agreement dated as of March 7,
1997 to the Credit Agreement [xiii]
4.2(f) - Waivers and Agreements under Credit Agreement dated as of May 19,
1997 to the Credit Agreement [xv]
4.2(g) - Amendment No. 4 and Waiver dated as of June 16, 1997 to the Credit
Agreement [xv]
4.3 - Term Loan Agreement dated as of June 16, 1997 (the "Term Loan")
among MGI, MSC, the banks listed therein and Morgan Guaranty Trust
Company of New York, as agent [xv]
4.3(a) - Security Agreement dated as of June 16, 1997 among MGI and the
subsidiaries listed therein, the Debtors listed therein, and Morgan
Guaranty Trust Company of New York, as agent [xv]
4.3(b) - Warrant and Registration Rights Agreement dated as of June 16, 1997
among MSC and the Investors listed therein
4.4 - Rights Agreement dated as of March 14, 1995, between MSC and Norwest
Bank Minnesota, National Association, as Rights Agent. [v]
9 - Voting Trust Agreement among DLJ, certain of its affiliates, the
Equitable Investors and Meridian Trust Company [i]
10.1(a) - Lease Agreement dated as of March 31, 1994 between Shawmut Bank
Connecticut, N.A. as Owner Trustee and Musicland Retail,Inc.,
as Lessee [viii]
10.1(b) - Participation Agreement dated as of March 31, 1994 among Musicland
Retail, Inc., as Lessee, Shawmut Bank Connecticut, N.A. as Owner
Trustee, Kleinwort Benson Limited, as Owner Participant, Lender and
Agent and The Long-Term Credit Bank of Japan, Ltd. Chicago Branch,
Credit Lyonnais Cayman Island Branch, The Fuji Bank, Limited,
as Lenders [viii]
10.1(c) - Guaranty of MGI dated March 31, 1994 [viii]
10.1(d) - Amendment No. 1 dated as of June 16, 1997 to the Lease Agreement [xv]
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequential
No. Description Page No.
-------- --------------------------------------------------------------- ----------
<S> <C> <C>
10.1(e) - Amendment No. 1 dated as of June 16, 1997 to the Participation
Agreement [xv]
10.1(f) - Amendment No. 1 dated as of June 16, 1997 to the Guaranty [xv]
10.2(a) - Master Lease dated as of May 12, 1995 between Media Play Trust,
as Landlord, and Media Play, Inc., as Tenant [ix]
10.2(b) - Participation Agreement dated as of May 12, 1995 among Natwest
Leasing Corporation, as Owner Participant, Media Play Trust, As
Trust, Yasuda Bank and Trust Company (U.S.A.), as Owner Trustee,
National Westminster Bank PLC, as Agent and Lender, Media Play,
Inc., as Tenant and the Long-Term Credit Bank of Japan, Ltd.
Chicago Branch and The Yasuda Trust & Banking Company, Ltd.,
Chicago Branch, as Other Lenders [ix]
10.2(c) - Amendment No. 1 dated as of April 9, 1996 to the Participation
Agreement [xi]
10.2(d) - Lease Guaranty dated as of May 12, 1995 between MGI, as Guarantor,
and Media Play Trust, as Landlord [ix]
10.2(e) - Amendment No. 1 dated as of April 9, 1996 to the Lease Guaranty [xi]
10.2(f) - Second Limited Waiver and Amendment dated as of June 16, 1997 of
Certain Loan Documents and Key Agreements [xv]
*10.3(a) - Subscription Agreement among MSC and the Management Investors [vi]
*10.3(b) - Form of amendment to Management Subscription Agreement [i]
*10.4 - Form of Registration Rights Agreement among MSC, DLJ and the
Management Investors [vii]
*10.5(a) - Employment Agreement with Mr. Eugster [vi]
*10.5(b) - Form of amendment to Employment Agreement with Mr. Eugster [i]
*10.5(c) - Amendment No. 2 to Employment Agreement with Mr. Eugster [x]
*10.6(a) - Form of Employment Agreement with Messrs. Benson and Ross [vi]
*10.6(b) - Amendment to Employment Agreement with Mr. Benson [xiii]
*10.6(c) - Amendment to Employment Agreement with Mr. Ross [xiii]
*10.7(a) - Form of Employment Agreement with Messrs. Bausman and Henderson [vi]
*10.7(b) - Form of amendment to Employment Agreements with Messrs. Bausman
and Henderson [i]
*10.7(c) - Amendment No. 2 to Employment Agreement with Mr. Bausman [x]
*10.7(d) - Amendment No. 2 to Employment Agreement with Mr. Henderson [x]
*10.8(a) - Change of Control Agreement with Mr. Eugster [vi]
*10.8(b) - Form of amendment to Change of Control Agreement with Mr. Eugster [i]
*10.8(c) - Amendment No. 2 to Change of Control Agreement with Mr. Eugster [x]
*10.8(d) - Amendment No. 3 to Change of Control Agreement with Mr. Eugster [xiii]
*10.9 - Management Incentive Plan dated as of January 1, 1997 ---
*10.10 - 1988 Stock Option Plan, as amended [i]
*10.11 - Stock Option Plan for Unaffiliated Directors of MSC, as amended
on June 12, 1997 [xv]
*10.12 - 1992 Stock Option Plan [i]
*10.13 - Musicland Stores Corporation 1994 Employee Stock Option Plan [viii]
*10.14 - Employment Letter Agreement with Mr. Johnson [viii]
*10.15(a) - Change of Control Agreement with Mr. Johnson [x]
*10.15(b) - Amendment No. 1 to Change of Control Agreement with Mr. Johnson [xiii]
*10.16(a - Change of Control Agreement with Messrs. Benson and Ross [vi]
*10.16(b) - Amendment No. 1 to Change of Control Agreement with Mr. Benson [xiii]
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
Exhibit Sequential
No. Description Page No.
-------- --------------------------------------------------------------- ----------
<S> <C> <C>
*10.16(c) - Amendment No. 1 to Change of Control Agreement with Mr. Ross [xiii]
*10.17 - Form of Executive Severance Agreement with Mr. Wachsman [xiii]
*10.18 - Change of Control Agreement with Mr. Wachsman [xiv]
*10.19 - Long Term Incentive Plan dated as of January 1, 1996 [xiii]
*10.20 - Executive Officer Short Term Incentive Plan dated as of November
15, 1996 [xiii]
*10.21 - Executive Officer Salary Continuation Plan dated as of March 10,
1997 [xiv]
11 - Statement re computation of per share earnings [xvi]
21 - Subsidiaries of MSC [ii]
23 - Consent of Arthur Andersen LLP ---
27 - Financial Data Schedules ---
99 - Form 11-K for The Musicland Group's Capital Accumulation Plan [xvii]
</TABLE>
------------------------------------------
[i] Incorporated by reference to MSC's Form S-1 Registration Statement
covering common stock initially filed with the Commission on July 6,
1990 (Commission File No. 33-35774).
[ii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1992 filed with the Commission on March 2, 1993
(Commission File No. 1-11014).
[iii] Incorporated by reference to MGI's Registration Statement covering 9%
Senior Subordinated Notes initially filed with the Commission on May
19, 1993 (Commission File No. 33-62928).
[iv] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1994 filed with the Commission
on November 11, 1994 (Commission File No. 1-11014).
[v] Incorporated by reference to MSC's Form 8-A Exchange Act Registration
Statement covering Preferred Share Purchase Rights filed with the
Commission on March 16, 1995.
[vi] Incorporated by reference to MSC's Form S-1 Registration Statement
covering Senior Subordinated Notes initially filed with the Commission
on May 20, 1988 (Commission File No. 33-22058).
[vii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1993 filed with the Commission on March 25,
1994 (Commission File No. 1-11014).
[viii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1994 filed with the Commission on March 27,
1995 (Commission File No. 1-11014).
[ix] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarter period ended June 30, 1995 filed with the Commission on
August 11, 1995 (Commission File No. 1-11014).
[x] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1995 filed with the Commission on April 12,
1996 (Commission File No. 1-11014.
[xi] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarter period ended March 31, 1996 filed with the Commission on
May 10, 1996 (Commission File No. 1-11014).
[xii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarter period ended September 30, 1996 filed with the Commission
on November 13, 1996 (Commission File No. 1-11014).
40
<PAGE>
[xiii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1996 filed with the Commission on April 11,
1997 (Commission File No. 1-11014.
[xiv] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarter period ended March 31, 1997 filed with the Commission on
May 14, 1997 (Commission File No. 1-11014).
[xv] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarter period ended June 30, 1997 filed with the Commission on
August 13, 1997 (Commission File No. 1-11014).
[xvi] Earnings (loss) per common share amounts are computed by dividing net
earnings (loss) by the weighted average number of common shares
outstanding. 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. Common stock
equivalents related to stock options are anti-dilutive in 1996 and
1995 due to the net losses. Common stock equivalents related to stock
options which would have a dilutive effect based upon current market
prices had no material effect on net earnings per common share in 1994.
Accordingly, this exhibit is not applicable to the Company.
[xvii] To be filed by amendment.
* Indicates Management Contract or Compensatory Plan or Agreement
required to be filed as an Exhibit to this form.
41
THE MUSICLAND GROUP
MANAGEMENT INCENTIVE PLAN
JANUARY 1, 1997
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"). 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.
The percentage funding is a separate and distinct calculation from the
determination of individual awards (see V. below).
<PAGE>
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 by the Chief Financial Officer. The
Compensation Committee may approve adjustments to actual business
results to reflect 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/or 2) individual
performance compared to the individual's objectives. 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.
Individual awards may be less or greater than the percent funding since
awards are directly related to individual contributions. 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 bonuses will be equal
to the Plan funding percentage.
VI. PAYMENT OF AWARDS
Awards will be paid in cash less applicable tax and FICA withholding,
and will be considered income in the year paid out.
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.
<PAGE>
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
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.
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated January 21, 1998, included in this form 10-K, into the Company's
previously filed Registration Statement File Nos. 33-50520, 33-50522,
33-50524, 33-82130 and 33-99146.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
March 13, 1998
<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 DECEMBER 31, 1997, AND THE RELATED CONSOLIDATED STATEMENT OF OPERATIONS FOR
THE YEAR THEN ENDED, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,942
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 450,258
<CURRENT-ASSETS> 473,568
<PP&E> 423,862
<DEPRECIATION> 173,841
<TOTAL-ASSETS> 733,895
<CURRENT-LIABILITIES> 499,500
<BONDS> 166,430
0
0
<COMMON> 344
<OTHER-SE> 18,426
<TOTAL-LIABILITY-AND-EQUITY> 733,895
<SALES> 1,768,312
<TOTAL-REVENUES> 1,768,312
<CGS> 1,153,483
<TOTAL-COSTS> 1,153,483
<OTHER-EXPENSES> 568,838
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31,720
<INCOME-PRETAX> 14,271
<INCOME-TAX> 300
<INCOME-CONTINUING> 13,971
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,971
<EPS-PRIMARY> .42
<EPS-DILUTED> .41
</TABLE>
