MUSICLAND STORES CORP, 10-Q, 1998-11-13

MUSICLAND STORES CORP
10-Q, 1998-11-13
RADIO, TV & CONSUMER ELECTRONICS STORES

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 1998

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from to
---------- ----------

Commission file number 1-11014

MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)

Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)

(612) 931-8000
(Registrant's telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
--- ---
The number of shares outstanding of the Registrant's common stock as of
October 15, 1998 was 35,790,399 shares.

<PAGE>

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION Page

Item 1. Financial Statements.

Consolidated Statements of Operations 3

Consolidated Balance Sheets 4

Consolidated Statements of Cash Flows 5

Notes to Consolidated Financial Statements 6

Report of Independent Public Accountants 8

Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition. 9

PART II - OTHER INFORMATION

Item 2. Changes in Securities. 15

Item 5. Other Information. 15

Item 6. Exhibits and Reports on Form 8-K. 16

Signature 17

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share amounts)

Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -----------------------
1998 1997 1998 1997
--------- --------- ---------- -----------

Sales ......................... $ 387,368 $ 373,283 $1,146,976 $ 1,092,109
Cost of sales ................. 249,573 244,213 736,623 716,148
--------- --------- ---------- -----------

Gross profit ............... 137,795 129,070 410,353 375,961

Selling, general and
administrative expenses ...... 125,130 123,299 374,574 374,788

Depreciation and amortization . 9,951 10,048 29,596 29,527
--------- --------- ---------- -----------

Operating income (loss) .... 2,714 (4,277) 6,183 (28,354)

Interest expense .............. 8,113 8,107 23,315 23,338
--------- --------- ---------- -----------

Loss before income taxes ... (5,399) (12,384) (17,132) (51,692)

Income taxes .................. (1,620) -- (5,140) --
--------- --------- ---------- -----------

Net loss ................... $ (3,779) $ (12,384) $ (11,992) $ (51,692)
========= ========= ========== ===========

Loss per common share ...... $ (0.11) $ (0.37) $ (0.35) $ (1.54)
========= ========= ========== ===========

Weighted average number of
common shares outstanding .... 34,859 33,533 34,230 33,507
========= ========= ========== ===========

See accompanying Notes to Consolidated Financial Statements.

3
<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)

September 30,
------------------- December 31,
1998 1997 1997
---------- --------- ----------
ASSETS

Current assets:
Cash and cash equivalents............... $ 17,065 $ 12,958 $ 3,942
Inventories............................. 436,701 467,431 450,258
Deferred income taxes................... 8,900 11,800 10,600
Other current assets.................... 14,520 9,167 8,768
---------- --------- ----------
Total current assets.................. 477,186 501,356 473,568

Property, at cost.......................... 429,313 421,924 423,862
Accumulated depreciation
and amortization.......................... (197,790) (165,188) (173,841)
---------- --------- ----------
Property, net........................... 231,523 256,736 250,021

Deferred income taxes...................... 3,200 1,200 2,400
Other assets............................... 10,651 8,081 7,906
---------- --------- ----------

Total Assets.......................... $ 722,560 $ 767,373 $ 733,895
========== ========= ==========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities:
Current maturities of long-term debt.... $ 50,000 $ 3,571 $ 26,657
Accounts payable........................ 280,465 317,581 357,183
Restructuring reserve................... - 3,772 -
Other current liabilities............... 76,808 68,499 115,660
---------- --------- ----------
Total current liabilities............. 407,273 393,423 499,500

Long-term debt............................. 258,852 372,242 166,430
Other long-term liabilities................ 44,770 49,936 49,195

Stockholders' equity (deficit):
Preferred stock ($.01 par value; shares
authorized: 5,000,000; shares issued
and outstanding: none)................. - - -
Common stock ($.01 par value; shares
authorized: 75,000,000; shares issued
and outstanding: September 30, 1998,
35,790,399; September 30, 1997,
34,302,508; December 31, 1997,
34,372,592)............................ 358 343 344
Additional paid-in capital.............. 258,588 254,741 255,075
Accumulated deficit..................... (236,670) (290,341) (224,678)
Deferred compensation................... (6,248) (7,998) (6,998)
Common stock subscriptions.............. (4,363) (4,973) (4,973)
---------- --------- ----------
Total stockholders' equity (deficit).. 11,665 (48,228) 18,770
---------- --------- ----------

Total Liabilities and Stockholders'
Equity (Deficit)..................... $ 722,560 $ 767,373 $ 733,895
========== ========= ==========

See accompanying Notes to Consolidated Financial Statements.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

Nine Months Ended
September 30,
----------------------
1998 1997
--------- ---------
OPERATING ACTIVITIES:
Net loss .......................................... $ (11,992) $ (51,692)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ................... 32,316 30,114
Disposal of property ............................ 2,956 3,215
Deferred income taxes ........................... 900 --
Changes in operating assets and liabilities:
Inventories ..................................... 13,557 38,662
Other current assets ............................ (4,652) 22,325
Accounts payable ................................ (64,657) (89,061)
Restructuring reserve ........................... -- (8,872)
Other current liabilities ....................... (38,852) (32,336)
Other assets .................................... (258) (1,067)
Other long-term liabilities ..................... (4,421) (2,558)
--------- ---------
Net cash used in operating activities .......... (75,103) (91,270)
--------- ---------

INVESTING ACTIVITIES:
Capital expenditures .............................. (14,047) (6,477)
--------- ---------

FINANCING ACTIVITIES:
Decrease in outstanding checks in excess of
cash balances..................................... (12,061) --
Net borrowings (repayments) under revolver ........ -- (92,000)
Net proceeds from issuance of long-term debt ...... 144,317 49,500
Principal payments on long-term debt .............. (32,933) (8,773)
Proceeds from sale of common stock ................ 2,950 2
--------- ---------
Net cash provided by (used in) financing
activities .................................... 102,273 (51,271)
--------- ---------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 13,123 (149,018)

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD .... 3,942 161,976
--------- ---------

CASH AND CASH EQUIVALENTS AT END OF PERIOD .......... $ 17,065 $ 12,958
========= =========

CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Interest ......................................... $ 18,532 $ 22,051
Income taxes, net ................................ 1,048 (22,703)

See accompanying Notes to Consolidated Financial Statements.

<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands)

1. Basis of Presentation

The accompanying consolidated financial statements include the accounts
of Musicland Stores Corporation ("MSC") and its wholly-owned subsidiary, The
Musicland Group, Inc. ("MGI") and MGI's wholly-owned subsidiaries, after
elimination of all material intercompany balances and transactions. MSC and MGI
are collectively referred to as the "Company." The Company operates principally
in the United States as a specialty retailer of home entertainment products,
including prerecorded music, video sell-through, books, computer software and
related products. The Company's stores operate under two principal strategies:
(i) mall based music and video sell-through stores (the "Mall Stores"),
operating predominantly under the trade names Sam Goody and Suncoast Motion
Picture Company, and (ii) non-mall based full-media superstores ("Superstores"),
operating under the trade names Media Play and On Cue. Because both Mall Stores
and Superstores are supported by centralized corporate services and have similar
economic characteristics, products, customers and retail distribution methods,
the stores are reported as one industry segment.

The interim consolidated financial statements of the Company are
unaudited; however, in the opinion of management, all adjustments necessary for
a fair presentation of such consolidated financial statements have been
reflected in the interim periods presented. Such adjustments consisted only of
normal recurring items. The Company has no significant items of other
comprehensive income. The Company's business is seasonal and, accordingly,
interim results are not indicative of results for a full year. The significant
accounting policies and certain financial information which are normally
included in financial statements prepared in accordance with generally accepted
accounting principles, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying consolidated
financial statements of the Company should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K.

2. Long-term Debt

In April 1998, the Company completed an offering of $150,000 of 9 7/8%
senior subordinated notes due 2008 with an original issue discount of $1,183.
The net proceeds to the Company from the offering, after discounts, commissions
and other offering costs were $144,317 and were used to repay $32,076 of
outstanding mortgage notes payable and $112,241 of revolver borrowings. In 1998,
the effective interest rate on the mortgage notes payable ranged from 8.4% to
8.6%. The effective interest rate on the revolver, exclusive of fees, ranged
from 7.4% to 9.0% for the nine months ended September 30, 1998.

In connection with and effective upon completion of the offering, the
Company obtained an amendment to its credit agreement that permitted the
issuance of the senior subordinated notes and allowed the repayment of the
mortgage notes payable. The amendment reduces the maximum available borrowings
under the revolving credit facility to the lesser of: (i) 60% of eligible
inventory or (ii) $132,000 while the term loan is outstanding or $182,000 if the
term loan is repaid.

3. Income Taxes

The effective income tax rates for the three months and nine months
ended September 30, 1998 and 1997 were based on the federal statutory income tax
rate, increased for the effect of state income taxes, net of federal benefit,
and adjusted for anticipated changes to the deferred tax valuation allowance
based on estimates of future earnings.

6
<PAGE>

MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands)

4. Loss Per Common Share

Basic loss per common share amounts were computed by dividing net loss
by the weighted average number of common shares outstanding in each period.
Potential common shares related to outstanding stock options and warrants were
anti-dilutive due to the net loss in each of the three month and nine month
periods ended September 30, 1998 and 1997.

5. Recently Issued Accounting Standards

Accounting Standards Executive Committee Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"), issued in March 1998 and effective for fiscal years
beginning after December 15, 1998, provides guidance on accounting for the costs
of computer software developed or obtained for internal use. SOP 98-1 requires
all costs related to the development of internal-use software other than those
incurred during the application development stage to be expensed as incurred.
Costs incurred during the application development stage are required to be
capitalized and amortized over the estimated useful life of the software. The
Company plans to adopt SOP 98-1 effective with the first quarter of 1999.
Adoption is not expected to have a material effect on the Company's financial
position or results of operations.

Accounting Standards Executive Committee Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), issued in April
1998 and effective for fiscal years beginning after December 15, 1998, requires
an entity to expense all start-up activities, including preopening and
organization costs, as incurred. The Company is currently in compliance with the
provisions of SOP 98-5, and, accordingly, the adoption of SOP 98-5 will not
impact the Company's financial position or results of operations.

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Musicland Stores Corporation:

We have reviewed the accompanying consolidated balance sheets of Musicland
Stores Corporation (a Delaware corporation) and Subsidiaries as of September 30,
1998 and 1997, and the related consolidated statements of operations for the
three-month and nine-month periods ended September 30, 1998 and 1997, and the
consolidated statements of cash flows for the nine-month periods ended September
30, 1998 and 1997. These financial statements are the responsibility of the
Company's management.

We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.

We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Musicland Stores Corporation and
Subsidiaries as of December 31, 1997, and, in our report dated January 21, 1998,
we expressed an unqualified opinion on that statement. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1997, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,
October 28, 1998

8
<PAGE>

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

Results of Operations

The Company's stores operate under two principal strategies: (i) mall
based music and video sell-through stores (the "Mall Stores"), operating
predominantly under the trade names Sam Goody and Suncoast Motion Picture
Company ("Suncoast"), and (ii) non-mall based full-media superstores (the
"Superstores"), operating under the trade names Media Play and On Cue. The
following table presents certain unaudited sales and store data for Mall Stores,
Superstores and in total for the Company for the three months and nine months
ended September 30, 1998 and 1997. Because both Mall Stores and Superstores are
supported by centralized corporate services and have similar economic
characteristics, products, customers and retail distribution methods, the stores
are reported as one industry segment.

Three Months Ended September 30,
----------------------------------------------
Percent Percent of Total
Incr. -----------------
1998 1997 (Decr.) 1998 1997
-------- ------- ------- ------- --------
(Dollars in millions)

Sales:
Mall Stores ................ $ 255.8 $ 249.1 2.7 % 66.0% 66.7%
Superstores ................ 129.3 121.5 6.4 33.4 32.5
Total (1) ................ 387.4 373.3 3.8 100.0 100.0

Comparable store sales increase:
Mall Stores ................ 5.6% 11.7% N/A N/A N/A
Superstores ................ 6.4 5.8 N/A N/A N/A
Total (1) ................ 5.8 9.7 N/A N/A N/A

Nine Months Ended September 30,
----------------------------------------------
Percent Percent of Total
Incr. -----------------
1998 1997 (Decr.) 1998 1997
-------- -------- ------- ------- --------
(Dollars and square footage in millions)

Sales:
Mall Stores ................ $ 754.2 $ 717.8 5.1 % 65.8% 65.7%
Superstores ................ 385.8 366.2 5.4 33.6 33.5
Total (1) ................ 1,147.0 1,092.1 5.0 100.0 100.0

Comparable store sales increase:
Mall Stores ................ 8.5% 4.3% N/A N/A N/A
Superstores ................ 7.2 2.5 N/A N/A N/A
Total (1) ................ 8.0 3.6 N/A N/A N/A

Number of stores open at end of
period:
Mall Stores ................ 1,099 1,131 (2.8) 82.2 82.4
Superstores ................ 224 225 (0.4) 16.8 16.4
Total (1) ................ 1,337 1,372 (2.6) 100.0 100.0

Total store square footage at
end of period:
Mall Stores ................ 3.9 4.1 (2.8) 48.1 48.5
Superstores ................ 4.2 4.3 (1.1) 51.4 51.0
Total (1) ................ 8.2 8.4 (2.0) 100.0 100.0

- --------------------------------------------------------
(1) The totals include United Kingdom stores.

<PAGE>

Sales. The increases in total sales for the third quarter and first
nine months of 1998 compared to the same periods in 1997 were attributable to
the comparable store sales increases, partially offset by the decrease in sales
from the closing of stores. The comparable store sales increases were primarily
attributable to sales gains in video for the quarter and sales gains in both
music and video for the nine months. The movie "Titanic," released in September
1998, produced the strongest sales for a video title in the Company's history
and drove the double digit comparable store sales growth in video in the third
quarter of 1998 despite the strong sales of the "Star Wars Trilogy" released in
the third quarter of 1997. Music comparable store sales in the third quarter of
1998 were up only modestly due to the strong sales of music product in the third
quarter of 1997, led by Elton John's single "Candle in the Wind." Soundtracks
from popular movies contributed to the growth in music sales during the nine
month period.

The following table shows the comparable store sales percentage
increase attributable to the Company's two principal product categories for the
three months and nine months ended September 30, 1998 and 1997.

Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
1998 1997 1998 1997
----------- ---------- ----------- ----------

Music............... 1.2 % 12.3 % 6.8 % 7.1 %
Video............... 13.4 12.0 9.9 1.6

Digital video discs ("DVD") were first offered for sale in select
markets near the end of the first quarter of 1997 and were carried in most of
the Company's stores by the end of the third quarter of 1997. DVD sales were
10.2% and 9.9% of total movie sales in the third quarter and first nine months
of 1998, respectively, and are expected to continue to gain momentum as more
titles become available and more consumers purchase DVD players.

Gross Profit. Gross profit as a percentage of sales was 35.6% in the
third quarter of 1998 compared with 34.6% in the third quarter of 1997, an
increase of 1.0%. For the first nine months, gross margin improved 1.4% to 35.8%
in 1998 from 34.4% in 1997. Most of the gross margin improvements in 1998 were
attributable to less promotional pricing and selective price increases made
during the second half of 1997 and in 1998. Decreases in inventory shrinkage in
the third quarter and first nine months of 1998 also contributed to the gross
margin improvements.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of sales for the third quarter were
32.3% in 1998 compared with 33.0% in 1997 and for the first nine months were
32.7% in 1998 compared with 34.3% in 1997. The percentage rate decreases
resulted from the comparable store sales increases previously discussed.
Selling, general and administrative expenses in the third quarter and first nine
months of 1997 included financial and legal advisory services and related
expenses of approximately $0.3 million and $2.8 million, respectively, most of
which were incurred in conjunction with the Company's credit agreement.

Depreciation and Amortization. Depreciation and amortization in 1998
was comparable to the prior year. Increases to depreciation and amortization
resulting from capital expenditures and the Company's distribution facility in
Franklin, Indiana were offset by decreases to depreciation and amortization
resulting from store closings. Certain financed property related to the Franklin
distribution facility was capitalized at the end of the second quarter of 1997
when the operating lease with a special purpose entity was amended. See "-
Liquidity and Capital Resources - Investing Activities."

Interest Expense. The interest savings resulting from lower outstanding
revolver borrowings in 1998 were offset by increases to interest expense from
the term loan, the issuance of $150.0 million of 9 7/8% senior subordinated
notes and higher interest rates. For the third quarter of 1998 and 1997 and the
first nine months of 1998 and 1997, average daily revolver borrowings, based
upon the number of days with outstanding borrowings, were $5.1 million, $224.6
million, $57.8 million and $255.6 million, respectively. During the three months
and nine months ended September 30, 1998, the Company had outstanding revolver
borrowings for 29 days and 196 days, respectively, while revolver borrowings
were outstanding during the entire three month and nine month periods of 1997.
The Company received the

<PAGE>
net proceeds from the term loan in September 1997 and the senior subordinated
notes in April 1998. As all of the net proceeds from the senior subordinated
notes were used to reduce existing debt at lower interest rates, the Company
expects an increase to interest expense for the year ending December 31, 1998 of
approximately $3 million. This increase has been partially offset by the
interest savings from lower revolver borrowings due to improvements in the
Company's results of operations. See "- Liquidity and Capital Resources" and
Note 2 of Notes to Consolidated Financial Statements.

Income Taxes. The effective income tax rates for the three months and
nine months ended September 30, 1998 and 1997 are based on the federal statutory
income tax rate, increased for the effect of state income taxes, net of federal
benefit, and adjusted for anticipated changes to the deferred tax valuation
allowance based on estimates of future earnings.

Loss Per Common Share. Basic loss per common share amounts were
computed using the weighted average number of common shares outstanding during
each period. Potential common shares related to outstanding stock options and
warrants were anti-dilutive due to the net loss in each period. The Company
anticipates net earnings for the fourth quarter and year ending December 31,
1998. For purposes of diluted earnings per share computations for these periods,
the weighted average number of common shares will be increased by approximately
1.5 million and 2.0 million shares, respectively, for the dilutive effect of
shares assumed issued on the exercise of stock options and warrants, compared
with increases of 1.1 million shares and 0.6 million shares, respectively, for
the same periods in 1997. The higher number of incremental shares in 1998 is due
to the full year effect of warrants, issued in June 1997, for the purchase of
1.8 million shares and higher stock prices. The actual number of incremental
shares may vary from the estimate based upon movements in the Company's stock
price, actual exercises of stock options and warrants and new grants of stock
options. See Note 4 of Notes to Consolidated Financial Statements and "- Other
Matters - Seasonality."

Recently Issued Accounting Standards. Accounting Standards Executive
Committee Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), issued in March
1998 and effective for fiscal years beginning after December 15, 1998, provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. SOP 98-1 requires all costs related to the development of
internal-use software other than those incurred during the application
development stage to be expensed as incurred. Costs incurred during the
application development stage are required to be capitalized and amortized over
the estimated useful life of the software. The Company plans to adopt SOP 98-1
effective with the first quarter of 1999. Adoption is not expected to have a
material effect on the Company's financial position or results of operations.

Liquidity and Capital Resources

The Company's primary sources of working capital are internally
generated cash and borrowings under the revolving credit facility pursuant to
the terms of its credit agreement. Because of the seasonality of the retail
industry, the Company's cash needs fluctuate throughout the year and typically
peak in November as inventory levels build in anticipation of the Christmas
selling season. The Company's cash position is generally highest at the end of
December because of the higher sales volume during the Christmas season and
extended payment terms typically provided by most vendors for seasonal inventory
purchases. The Company's cash needs build during the first quarter as
inventories are replenished following the Christmas season and payments for
seasonal inventory purchases become due. In the first quarter of 1997, the
Company's largest vendors and most 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

<PAGE>

payables during the fourth quarter of 1997 and since then has been on normal
credit terms with its vendors.

In April 1998, the Company completed an offering of $150.0 million of 9
7/8% senior subordinated notes. The net proceeds to the Company from the
offering, after discounts, commissions and other offering expenses, were $144.3
million. The Company used $32.1 million of the net proceeds to repay all of the
outstanding mortgage notes payable and the remaining $112.2 million of net
proceeds and $0.8 million of additional cash to repay revolver borrowings. At
September 30, 1998, the Company had no revolver borrowings and had cash and cash
equivalents of $17.1 million. Effective with the completion of the offering, the
maximum available borrowings under the revolving credit facility are the lesser
of: (i) 60% of eligible inventory or (ii) $132.0 million while the $50 million
term loan is outstanding or $182.0 million if the term loan is repaid. See "-
Financing Activities" and Note 2 of Notes to Consolidated Financial Statements.

Operating Activities. Net cash used in operating activities (including
in 1998 the decrease in outstanding checks in excess of cash balances which
primarily relate to vendor payments) during the nine months ended September 30,
1998 and 1997 was $87.2 million and $91.3 million, respectively. The level of
cash used in each period primarily relates to the amount of inventory purchases,
income tax refunds and net loss. Cash used for inventory purchases, as reflected
by the aggregate net changes in inventories, accounts payable and outstanding
checks in excess of cash balances, was $63.2 million in 1998 compared with $50.4
million in 1997. Cash payments for inventory in the first nine months of 1998
reflect normal credit terms, while the deferral of trade payable balances in the
first nine months of 1997 increased accounts payable and reduced cash payments
during the first nine months of 1997 by approximately $20 million. Store
closings and more frequent inventory purchases closer to the time of sale
reduced cash payments for inventory during the first nine months of 1998 and
contributed to lower inventories at September 30, 1998 of $436.7 million, a
decrease of $30.7 million from inventories of $467.4 million at September 30,
1997. The Company had income tax payments, net of refunds, of $1.0 million in
the first nine months of 1998, compared to income tax refunds, net of payments,
of $22.7 million in the first nine months of 1997. The refunds in 1997 resulted
from the carryback of the taxable loss for the year ended December 31, 1996. The
net loss for the nine months ended September 30, 1998 was $12.0 million compared
with $51.7 million for the nine months ended September 30, 1997, an improvement
of $39.7 million.

Cash used in operating activities for the nine months ended September
30, 1997 includes $8.9 million related to restructuring programs initiated by
management in 1996 that included the closing of 114 underperforming stores and
one of the Company's two distribution centers. The restructuring programs were
completed in 1997. Other changes in operating assets and liabilities are
primarily related to the seasonal nature of the business and also reflect the
effect of store closings.

Investing Activities. Store expansion and closings were as follows for
the periods indicated:

Three Months Nine Months Twelve Months
Ended Ended Ended
September 30, September 30, September 30,
---------------- ---------------- ----------------
1998 1997 1998 1997 1998 1997
------- ------- ------- ------- ------- -------
Openings:
Mall Stores.......... 1 1 1 1 2 5
Superstores.......... - 1 - 1 - 4
Total (1).......... 1 2 1 2 2 10
Closings:
Mall Stores.......... (4) (7) (24) (69) (34) (86)
Superstores.......... - - (1) (21) (1) (22)
Total (1).......... (5) (10) (27) (96) (37) (114)
Net increase (decrease):
Mall Stores.......... (3) (6) (23) (68) (32) (81)
Superstores.......... - 1 (1) (20) (1) (18)
Total (1).......... (4) (8) (26) (94) (35) (104)

- ---------------------------------------
(1) The totals include United Kingdom stores.

<PAGE>

Most of the Company's capital expenditures in 1998 and 1997 consisted
of improvements to existing stores. The Company is also opening selected new
stores in order to fill in existing markets or capitalize on attractive leasing
opportunities. Management expects that total capital expenditures for 1998 will
approach $25 million. The Company anticipates that these capital expenditures
will be financed by internally generated cash and revolver borrowings. The
Company will continue to assess the profitability of its stores and will close a
limited number of underperforming stores in the coming years if the closings can
be accomplished economically. The number of stores closed during the nine months
and twelve months ended September 30, 1997 included stores closed under the
Company's restructuring programs of 61 stores and 75 stores, respectively.

Financing Activities. Cash provided by (used in) financing activities
(excluding in 1998 the decrease in outstanding checks in excess of cash balances
which relate to vendor payments) was $114.3 million and $(51.3) million during
the nine months ended September 30, 1998 and 1997, respectively. In April 1998,
the Company received net proceeds of $144.3 million from the offering of $150.0
million of 9 7/8% senior subordinated notes. The net proceeds were used to repay
$32.1 million of outstanding mortgage notes payable and to reduce outstanding
revolver borrowings. The Company had no outstanding revolver borrowings at
September 30, 1998 due to improvements in results of operations and the use of
the proceeds from the 9 7/8% senior subordinated notes to reduce revolver
borrowings. The Company had repaid all outstanding revolver borrowings by the
end of 1997 with excess cash generated from strong Christmas season sales.
Financing activities in 1997 principally consisted of revolver borrowings and
repayments.

The term loan is due in two installments of $25 million in each of
December 1998 and February 1999. The revolving credit facility expires in
October 1999. The 9% senior subordinated notes are due 2003 and the 9 7/8%
senior subordinated notes are due 2008. The Company may, at its option, redeem
the 9% senior subordinated notes prior to maturity at 103.375% of par on and
after June 15, 1998 and thereafter at prices declining annually to 100% of par
on and after June 15, 2001. The Company anticipates that the repayment of the
term loan will be financed with internally generated cash. Management believes
that it will be able to secure adequate financing to meet the Company's other
long-term debt obligations when they become due.

Other Matters

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

Year 2000. The Year 2000 issue is the result of computer programs being
written using two digits rather than four to define the applicable year.
Computer programs and computer hardware and electronic equipment with
date-sensitive software or computer chips may recognize a date using the last
two digits of "00", as the year 1900, rather than the year 2000. This could
result in system failures or miscalculations causing disruptions to various
activities and operations.

The Company has been aware of and understands the material nature of
the business issues surrounding computer processing of dates into and beyond the
year 2000. Many of the internally developed computer programs written over the
last several years have utilized four digits to define the year. Formal
assessments of existing computer systems were initiated by management as early
as 1996 to identify the requirements to achieve Year 2000 readiness. Year 2000
compliance will be achieved through: planned system replacements; installation
of maintenance updates conforming to the Year 2000 provided by vendors of
purchased packages; and modifications to existing computer systems. The Company
plans to capitalize the cost of new systems in accordance with SOP 98-1. The
Company has primarily utilized internal resources for the installation of
maintenance updates and completion of modifications to existing computer
systems. These costs are being charged to expense as incurred. Management
estimates the Company's total incremental cost through completion of all
required Year 2000 modifications, based on currently available information, to
be approximately $3 million.

<PAGE>

Management anticipates that most of the Year 2000 requirements will be
completed by the end of 1998 while the remainder are expected to be completed in
the first half of 1999. The Company has formed a task force to assess the Year
2000 readiness of other aspects of the business, including communication systems
and any equipment controlled by computer chips with date sensitive logic. The
task force is also corresponding with the Company's business partners and
service providers to determine their state of Year 2000 readiness. Management
generally believes that its largest vendors will be able to complete the
necessary Year 2000 modifications and that there is not likely to be a
significant disruption in product supply. However, there can be no absolute
assurance that there will not be a material adverse effect on the Company if
third parties do not convert their systems in a timely manner and in a way that
is compatible with the Company's systems. The Company plans to devote the
necessary resources to resolve all significant Year 2000 issues in a timely
manner. The Company intends to develop contingency plans which could include
alternative vendors, suppliers and service providers in the event current
vendors, suppliers or service providers suffer significant disruption as a
result of Year 2000 compliance failures and strategies to address other
unidentified issues.

Forward-Looking Statements. Forward-looking statements herein are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. Investors are cautioned that all forward-looking statements
involve risks and uncertainty. There are certain important conditions that could
cause actual results to differ materially from those anticipated by some of the
statements made herein. These include, but are not limited to: 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 obtain sufficient financing to meet its liquidity needs; effects of weather
and overall economic conditions, including inflation, consumer confidence,
spending habits and disposable income.

14
<PAGE>

PART II - OTHER INFORMATION

Item 2. Changes in Securities.

<TABLE>
<CAPTION>
Shares of Warrants Warrants
Common Aggregate Cancelled With Cancelled For
Stock Cash Cashless Fractional
Exercise Date Warrant Holder Issued Proceeds Exercise Shares
--------------- --------------------- --------- ------------ ---------------- ------------
<S> <C> <C> <C> <C> <C>
Aug. 4, 1998 Donaldson, Lufkin & 95,927 $149,881.89 N/A .21
Jenrette Securities

Aug. 18, 1998 Credit Lyonnais 68,547 N/A 9,541.72 .72

Sept. 3, 1998 Hour, L.L.C. 148,313 $231,738.25 N/A .08

Sept.28, 1998 First Trust Corporation 87,529 N/A 12,470.07 .93
TTEEFBO Rawson IRA
</TABLE>

The shares of common stock issued upon exercise of the warrants were
issued pursuant to an exemption from registration under Section 4(2) and/or
Regulation D of the General Rules and Regulations promulgated under the
Securities Act of 1933 as a sale by the issuer not involving a public offering.
The warrants were issued in June 1997 to 12 accredited investors and are
exercisable over a period of five years at a price of $1.5625 per share. No
underwriters were used for either the issuance or the exercise of the warrants.

Item 5. Other Information

As a result of a recent amendment by the Securities and Exchange
Commission to Commission Rule 14a-4, the Company has amended its By-laws to
provide that written notice of any proposal that a shareholder intends to make
at an annual shareholders meeting must be received ninety days prior to the
anniversary date of the prior year's annual meeting. For the 1999 Annual
Meeting, currently scheduled for May 10, 1999, that deadline is February 10,
1999. If a proposal is received by that deadline, the persons named in the proxy
solicited by the Company's Board of Directors may exercise discretionary
authority to vote on such proposal only if the proxy indicates that the proposal
is expected to be made and that discretionary voting authority will be used.

15
<PAGE>

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

The following are filed as exhibits to Part I of this Form 10-Q:

Exhibit No. Description
- ----------- --------------------------------------------------------
15. Letter re unaudited interim financial information
--------
27. Financial Data Schedules
--------

The following are filed as exhibits to Part II of this Form 10-Q:

Exhibit No. Description
- ----------- --------------------------------------------------------
3.2 By-laws of MSC, as amended
--------

(b) Reports on Form 8-K

There were no reports on Form 8-K filed during the quarter ended
September 30, 1998.

<PAGE>

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

MUSICLAND STORES CORPORATION
(Registrant)

By: /s/ Keith A. Benson
----------------------------------
Keith A. Benson
Vice Chairman, Chief Financial
Officer and Director
(authorized officer, principal
financial and accounting officer)

Date: November 13, 1998
-----------------

MUSICLAND STORES CORPORATION
(a Delaware corporation)

BY-LAWS

Adopted January 22, 1992
as Amended October 26, 1998

ARTICLE I

OFFICES

SECTION 1.01. Registered Office. The registered office of MUSICLAND STORES
CORPORATION (hereinafter called the "Corporation"), in the State of Delaware
shall be at 1209 Orange Street, Wilmington, Delaware 19801. The name of the
registered agent in charge thereof shall be The Corporation Trust Company.

SECTION 1.02. Other Offices. The Corporation may also have an office or offices
at such other place or places either within or without the State of Delaware as
the Board of Directors may from time to time determine or the business of the
Corporation may require.

ARTICLE II

MEETINGS OF STOCKHOLDERS

SECTION 2.01. Place of Meetings. Each meeting of the stockholders of the
Corporation shall be held at such place either within or without the State of
Delaware as shall be fixed by the Board of Directors and specified in the
respective notices or waivers of notice of said meeting.

SECTION 2.02. Annual Meetings. The annual meeting of the stockholders for the
election of directors and for the transaction of such other business as may
properly come before the meeting shall be held at such place, date and hour as
shall be designated in the notice thereof.

SECTION 2.03. Special Meetings. A special meeting of the stockholders for any
purposes, unless otherwise prescribed by statute or by the Restated Certificate
of Incorporation, may be called at any time by order of the Board of Directors,
the Chairman of the Board or the President.

1
<PAGE>

SECTION 2.04. Notice of Annual and Special Meetings. Written notice of the
annual and any special meetings of stockholders, stating the place, date and
hour of the meeting, and for special meetings, the purpose or purposes for which
the meeting is called, shall be given to each stockholder entitled to vote at
such meeting, either personally or by mail, not less than ten, nor more than
sixty days before the date of the meeting.

SECTION 2.05. Stockholder List. The officer who has charge of the stock ledger
of the Corporation shall prepare and make, at least ten days before every
meeting of stockholders, a complete list of the stockholders entitled to vote at
the meeting, arranged in alphabetical order, and showing the address of each
stockholder and the number of shares registered in the name of each stockholder.
Such a list shall be open to the examination of any stockholder, for any purpose
germane to the meeting, during ordinary business hours, for a period of at least
ten days prior to the meeting, either at a place within the city where the
meeting is to be held, which place shall be specified in the notice of the
meeting, or, if not so specified, at the place where the meeting is to be held.
The list shall also be produced and kept at the time and place of the meeting
during the whole time thereof, and may be inspected by any stockholder who is
present.

SECTION 2.06. Annual and Special Meetings - Business. The business to be
transacted at any annual or special meeting of stockholders shall be limited to
business which is properly brought before the meeting. For the purposes of these
By-Laws, "properly brought before the meeting" shall mean (i) the business which
is specified in the notice of the meeting, given by the Board of Directors, (ii)
otherwise brought before the meeting by the Board of Directors, or (iii)
otherwise properly brought before the meeting by a stockholder. In order for
business to be properly brought before the meeting by a stockholder, the
stockholder must give written notice, either by personal delivery, courier, or
by United States mail, postage pre-paid, to the Secretary of the Corporation not
later than (a) with respect to a proposal to be made at an annual meeting of
stockholders, ninety days prior to the anniversary date of the immediately
preceding annual meeting, and (b) with respect to a proposal to be made at a
special meeting of stockholders, the close of business on the tenth day
following the date on which notice of such meeting is first given to
stockholders. Each such notice shall set forth: (1) the name and address of the
stockholder proposing the business; (2) the number of shares in the Corporation
entitled to vote at such meeting held by the stockholder; (3) a description of
the business desired to be brought before the meeting and the reasons therefore;
(4) such other information regarding the business proposed by such stockholder
as would be required to be included in a proxy statement filed pursuant to the
proxy rules of the Securities and Exchange Commission; and (5) a representation
as to the stockholder's material interest in the business being proposed. The
presiding officer of the meeting may refuse to acknowledge any business
proposals not made in compliance with the foregoing procedure.

2
<PAGE>

SECTION 2.07. Quorum and Adjourned Meetings. The holders of a majority of the
stock issued and outstanding and entitled to vote thereat, present in person or
represented by proxy, shall constitute a quorum at all meetings of the
stockholders for the transaction of business, except as otherwise provided by
statue or by the Restated Certificate of Incorporation. If, however, such quorum
shall not be present or represented at any meeting of the stockholders, the
stockholders entitled to vote thereat, present in person or represented by
proxy, shall have the power to adjourn the meeting from time to time, without
notice other than announcement at the meeting, until a quorum shall be present
or represented. At such adjourned meeting, at which a quorum shall be present or
represented, any business may be transacted which might have been transacted at
the meeting as originally notified. If the adjournment is for more than thirty
days, or if after the adjournment, a new record date is fixed for the adjourned
meeting, a notice of the adjourned meeting shall be given to each stockholder of
record entitled to vote at the meeting.

SECTION 2.08. Required Vote. When a quorum is present at any meeting, the vote
of the holders of a majority of the stock having voting power present in person
or represented by proxy shall decide any question brought before such meeting,
unless the question is one upon which, by express provision of statute or by the
Restated Certificate of Incorporation, a different vote is required, in which
case such express provisions shall govern and control the decision of such
question.

SECTION 2.09. Voting. Each stockholder shall, at every meeting of the
stockholders be entitled to one vote in person or by proxy for each share of the
capital stock having voting power held by such stockholder. No proxy shall be
voted or acted upon after three years from its date, unless the proxy expressly
provides for a longer period.

ARTICLE III

BOARD OF DIRECTORS

SECTION 3.01. General Powers. The business, property and affairs of the
Corporation shall be managed by or under the direction of the Board of
Directors.

SECTION 3.02. Nomination of Directors. Except as to directors nominated and
elected pursuant to the rights of holders of Common Stock who are parties to the
Shareholders Agreement dated August 25, 1988, as amended, nominations for the
election of directors may be made by the Board of Directors or a committee
appointed by the Board of Directors or by any stockholder entitled to vote in
the election of directors generally. Any stockholder entitled to vote in the
election of

3
<PAGE>

directors generally may nominate one or more persons for election as directors
at a meeting only if written notice of such stockholder's intent to make such
nomination or nominations has been given, either by personal delivery or by
United States mail, postage prepaid, to the Secretary of the Corporation not
later than (i) with respect to an election to be held at an annual meeting of
stockholders, ninety days prior to the anniversary date of the immediately
preceding annual meeting, and (ii) with respect to an election to be held at a
special meeting of stockholders for the election of directors, the close of
business on the tenth day following the date on which notice of such meeting is
first given to stockholders. Each such notice shall set forth: (a) the name and
address of the stockholder who intends to make the nomination and of the person
or persons to be nominated; (b) a representation that the stockholder is a
holder of record of stock of the Corporation entitled to vote at such meeting
and intends to appear in person or by proxy at the meeting to nominate the
person or persons specified in the notice; (c) a description of all arrangements
or understandings between the stockholder and each nominee and any other person
or persons (naming such person or persons) pursuant to which the nomination or
nominations are to be made by the stockholder; (d) such other information
regarding each nominee proposed by such stockholder as would be required to be
included in a proxy statement filed pursuant to the proxy rules of the
Securities and Exchange Commission; and (e) the consent of each nominee to serve
as a director of the Corporation if so elected. The presiding officer of the
meeting may refuse to acknowledge the nomination of any person not made in
compliance with the foregoing procedure.

SECTION 3.03. Quorum and Manner of Acting. One half in number of the directors
in office at the time, but not less than three, shall constitute a quorum for
the transaction of business at any meeting. If the number of directors in office
at the time is not evenly divisible by two, any resulting fraction shall be
rounded upwards to the next whole number in calculation of the quorum number.
The affirmative vote of a majority of the directors present at any meeting at
which a quorum is present shall be required for the taking of any action by the
Board of Directors. In the absence of a quorum at any meeting of the Board, such
meeting, unless it be the first meeting of the Board, need not be held, or a
majority of the directors present thereat or, if no director be present, the
Secretary, may adjourn such meeting from time to time until a quorum shall be
present. Notice of any adjourned meeting need not be given.

SECTION 3.04. Offices; Place of Meetings. The Board of Directors may hold
meetings and have an office or offices at such place or places within or without
the State of Delaware, as the Board of Directors may from time to time
determine.

SECTION 3.05. Annual Meeting. The Board of Directors shall meet for the purpose
of organization, the election of officers and the transaction of other business,
as soon as practicable following each annual election of directors. Such meeting
shall be called and held at the place and time specified in the notice or waiver
of notice thereof as in the case of a special meeting of the Board of Directors.

4
<PAGE>

SECTION 3.06. Regular Meeting. Regular meetings of the Board of Directors shall
be held at such places and at such times as the Board of Directors shall from
time to time by resolution determine. Notice of regular meetings of the Board of
Directors need not be given.

SECTION 3.07. Special Meetings; Notice. Special meetings of the Board of
Directors shall be held whenever called by the Chairman of the Board, the
President or by any two of the directors. Notice of each such meeting shall be
mailed by the Secretary to each director, addressed to him at his residence or
usual place of business, at least two days before the day on which the meeting
is to be held, or shall be sent to him at his residence or at such place of
business by facsimile, telegraph, cable, radio, or similar means, or be
delivered personally or by telephone, not later than two days before the day on
which the meeting is to be held. Each such notice shall state the time and place
of the meeting but need not state the purposes thereof except as otherwise
herein expressly provided. Notice of any such meeting need not be given to any
director, however, if waived by him in writing or by facsimile, telegraph,
cable, radio, or similar means, or by mail, whether before or after such meeting
shall be held, or if he shall be present at such meeting; and any meeting of the
Board shall be a legal meeting without any notice thereof having been given, if
all of the directors shall be present thereat.

SECTION 3.08. Organization. At each meeting of the Board of Directors, the
Chairman of the Board, or in the absence of the Chairman of the Board, the
President, or in the absence of the President, any director chosen by a majority
of the directors present thereat, shall preside. The Secretary, or in his
absence an Assistant Secretary of the Corporation, or in the absence of the
Secretary and all Assistant Secretaries, a person whom the chairman of such
meeting shall appoint, shall act as secretary of such meeting and keep the
minutes thereof.

SECTION 3.09. Order of Business. At all meetings of the Board of Directors
business shall be transacted in the order determined by the Board of Directors.

SECTION 3.10. Action by Consent. Any action required or permitted to be taken at
any meeting of the Board of Directors or of any committee thereof may be taken
without a meeting if a written consent thereto is signed by all members of the
Board or of such committee, as the case may be, and such written consent is
filed with the minutes of the proceedings of the Board of Directors or such
committee.

SECTION 3.11. Telephone etc. Meetings. Members of the Board of Directors, or any
committee designated by the Board of Directors, may participate in a meeting of
the Board of Directors, or committee, by means of conference telephone or
similar communications equipment by means of which all persons participating in
the meeting can hear each other, and such participation shall constitute
presence in person at such meeting.

5
<PAGE>

SECTION 3.12. Resignation. Any director of the Corporation may resign at any
time by giving written notice of his resignation to the Chairman of the Board,
the President or the Secretary of the Corporation. Such resignation shall take
effect at the time specified therein, or, if the time when it shall become
effective shall not be specified therein, then it shall take effect when
received by the Board of Directors. Except as aforesaid, the acceptance of such
resignation shall not be necessary to make it effective.

SECTION 3.13. Compensation. Each director, in consideration of his serving as
such, shall be entitled to receive from the Corporation such fixed amount per
annum or such fees for attendance at directors' meetings, or both, as the Board
of Directors shall from time to time determine. The Board of Directors may
likewise provide that the Corporation shall reimburse each director or member of
a committee for any expenses incurred by him on account of his attendance at any
such meeting. Nothing herein contained shall be construed to preclude any
director from serving the Corporation in any other capacity and receiving proper
compensation therefor.

SECTION 3.14. Indemnification of Directors and Officers. The Corporation shall
indemnify its Directors and officers in the manner and to the extent provided in
the Restated Certificate of Incorporation.

SECTION 3.15. Removal. Any Director or the entire Board of Directors may be
removed at any time but only for cause.

SECTION 3.16. Super-majority. Subject to Article XI of the Restated Certificate
of Incorporation, without the approval of 66% (67% if the Board shall consist of
nine directors) of all "Disinterested Directors" (to the extent that the
application of such percentage results in a fractional number, rounded up to the
nearest whole number of directors) the Corporation shall not and it shall not
permit any Wholly-owned Subsidiary (as defined in the Restated Certificate of
Incorporation) of the Corporation to:

1. Acquire, consolidate with or merge into another person or entity, if
the aggregate consideration for such transaction exceeds $50 million,
except that any Subsidiary (as defined in the Restated Certificate of
Incorporation) may consolidate with, merge into or acquire the
Corporation or any Wholly-owned Subsidiary of the Corporation under the
provisions of Section 253 of Delaware Law.

2. Convey, transfer, lease or otherwise dispose of assets or properties of
the Corporation, or any of its Subsidiaries, having a book value in
excess of $50 million, except that any Subsidiary of the Corporation
may at any time, or from time to time, convey, transfer, lease or
otherwise dispose of all or any of its properties and assets to the
Corporation or any Wholly-owned Subsidiary of the Corporation.

6
<PAGE>
3. Make any recommendation to the shareholders with respect to a pending
tender offer.

4. Redeem, purchase or otherwise acquire any shares of the Corporation
unless pursuant to an offer to acquire Common Stock made pro rata and
on the same terms to the holders of all Common Stock, except that:

(a) shares of Senior Preferred Stock may be redeemed to the extent
required by the Restated Certificate of Incorporation;

(b) up to 500,000 shares of Common Stock may be redeemed,
repurchased or otherwise acquired at not more than Fair Market
Value (as defined in Article VIII of the Restated Certificate
of Incorporation):

(i) from any shareholder in any one year period, with the
cumulation of such purchases from such shareholder
not to exceed 1,000,000 shares;

(ii) from any group of shareholders selling in the same
transaction; or

(iii) pursuant to a stock repurchase plan approved by a
majority of the Directors voting at a meeting at
which a quorum is present; and

(c) shares of stock of the Corporation or any Subsidiary may be
acquired or redeemed under the terms of any consolidation,
merger or acquisition approved or permitted under the Restated
Certificate of Incorporation or this Section 3.16.

5. Issue, sell, assign, pledge or otherwise dispose of any shares of, or
any securities convertible into, Common Stock of the Corporation or any
Subsidiaries of the Corporation except that:

(a) the Corporation may issue up to 500,000 shares of Common Stock
in any one transaction or series of related transactions, for
any purpose authorized by the Board including acquisitions, at
not less than Fair Market Value (as defined in Article VIII of
the Restated Certificate of Incorporation);

(b) the Corporation may sell or assign to any Wholly-owned
Subsidiary of the Corporation, and any Subsidiary of the
Corporation may issue, sell, assign, pledge or otherwise
dispose of to the Corporation or any Wholly-owned Subsidiary
of the Corporation shares of or any

7
<PAGE>

warrants, rights or options to acquire any securities
convertible into, stock of any Subsidiary;

(c) the Corporation may issue shares in connection with the
exercise of stock options by directors or employees (under
stock option plans approved by the shareholders and
administered by the Board of Directors); and

(d) any Subsidiary may issue, sell, assign, pledge or otherwise
dispose of any

(i) Shares of, or any warrants, rights or options to
acquire any securities convertible into, stock of
such Subsidiary, or

(ii) any other assets or property of such Subsidiary,
provided the Fair Market Value (as defined in Article
VIII of the Restated Certificate of Incorporation) of
the consideration to be received by the Subsidiary or
by the Corporation is $5 million or less.

6. Increase the size of the Board of Directors.

7. File a petition under the Federal Bankruptcy Act or any other
insolvency law, or admit in writing its bankruptcy, insolvency or
general inability to pay its debts.

8. Agree to do any of the foregoing.

9. Amend this Section 3.16.

For purposes of this Section 3.16, a "Disinterested Director" shall mean any
director that does not have a financial interest in the outcome of such vote
(other than as a shareholder of the Corporation). Notwithstanding the foregoing,
the term Disinterested Director shall include any Director who has an interest
in the outcome of the vote if such Director is an employee of the Corporation
("Management Director"), and (i) the transaction giving rise to the vote is an
acquisition, merger or consolidation of the Corporation (or any Subsidiary) with
or by a person or entity which is not affiliated with such Management Director
(before completion of such transaction), (ii) such Management Director has not
initiated discussions concerning such transaction with such person or entity,
and (iii) such person or entity has not, at the time of such vote, entered into
management equity or employment arrangements with such Management Director
provided, however, the foregoing shall not be deemed to prohibit such Management
Director from entering into customary management equity and employment
arrangements after the vote to facilitate completion of such transaction.

8
<PAGE>

ARTICLE IV

COMMITTEES

The Board of Directors may, by resolution or resolutions passed by a majority of
the full Board of Directors, designate one or more committees, each such
committee to consist of one or more directors of the Corporation, which to the
extent provided in said resolution of resolutions shall have and may exercise
the powers of the Board of Directors in the management of the business and
affairs of the Corporation. Such committee or committees shall have such name or
names as may be determined from time to time by resolution adopted by the Board
of Directors. A majority of all the members of any such committee may determine
its actions and fix the time and place of its meetings, unless the Board of
Directors shall otherwise provide. The Board of Directors shall have power to
change the members of any such committee at any time, to fill vacancies and to
discharge any such committee, either with or without cause, at any time.

ARTICLE V

OFFICERS

SECTION 5.01. Number. The principal officers of the Corporation shall be chosen
by the Board of Directors and shall be a Chairman and Chief Executive Officer, a
President, one or more Vice Presidents (the number thereof to be determined by
the Board of Directors and one or more of whom may be designated as Executive or
Senior Vice Presidents), a Secretary and a Treasurer. The Board of Directors may
also elect a Chairman of the Board. In addition, there may be such subordinate
officers, agents and employees as may be appointed in accordance with the
provisions of Section 5.03. Any two or more offices may be held by the same
person. The offices of the Corporation for which officers may be elected shall
be set forth, from time to time, by resolution of the Board of Directors.

SECTION 5.02. Election, Qualifications and Term of Office. Each officer of the
Corporation, except such officers as may be appointed in accordance with the
provisions of Section 5.03, shall be elected by the Board of Directors from time
to time, and shall hold office until his successor shall have been duly elected
and qualified, or until his death, or until he shall have resigned or shall have
been removed in the manner herein provided.

SECTION 5.03. Other Officers. The Corporation may have such other subordinate
officers, agents and employees as the Chairman and Chief Executive Officer may
deem necessary, including one or more Assistant Secretaries, one or more
Assistant Treasurers, a Controller and one or more Assistant Controllers, each
of

9
<PAGE>

whom shall hold office for such period, have such authority, and perform such
duties as the Chairman and Chief Executive Officer may from time to time
determine.

SECTION 5.04. Removal. Any officer may be removed, either with or without cause,
by the vote of a majority of the full Board of Directors or, except in case of
any officer elected by the Board of Directors, by any officer upon whom the
power of removal may be conferred by the Board of Directors. Such removal from
office shall not affect any rights which such removed officer may have under any
employment or shareholder agreement.

SECTION 5.05. Resignation. Any officer may resign at any time by giving written
notice to the Board of Directors or to the Chairman of the Board or to the
President. Any such resignation shall take effect at the time specified therein
or, if the time when it shall become effective shall not be specified therein,
then it shall take effect when accepted by action of the Board of Directors.
Except as aforesaid, the acceptance of such resignation shall not be necessary
to make it effective.

SECTION 5.06. Vacancies. A vacancy in any office because of death, resignation,
removal, disqualification or any other cause shall be filled for the unexpired
portion of the term in the manner prescribed in these By-Laws for regular
election or appointment to such office.

SECTION 5.07. Chairman of the Board. The Chairman of the Board if elected, shall
preside at all meetings of the stockholders and of the Board of Directors and
shall perform such other duties and have such responsibilities as the Board of
Directors may from time to time determine.

SECTION 5.08. Chairman and Chief Executive Officer. The Chairman and Chief
Executive Officer shall have general supervisory management over the business of
the Corporation, shall report to the Board of Directors, and shall see that all
orders and resolutions of the Board of Directors are carried into effect, all
subject to the general control of the Board of Directors. In the absence of the
Chairman of the Board for any reason, including the failure of the Board of
Directors to elect the Chairman of the Board, or in the event of the Chairman's
inability or refusal to act, the Chief Executive Officer shall have all the
powers of, and be subject to all the restrictions upon, the Chairman of the
Board.

SECTION 5.09. President. The President shall be responsible for the active
management of the business of the Corporation, shall perform such other duties
as may be prescribed by the Board of Directors or the Chief Executive Officer
and shall have authority to execute such contracts and take such actions
required in connection therewith. In the absence of the Chief Executive Officer
for any reason, including the failure of the Board of Directors to elect a Chief
Executive Officer, or in the event of the Chief Executive Officer's inability or
refusal to act,

<PAGE>

the President or any Vice President designated by the Board shall have all the
powers of, and be subject to all the restrictions upon, the Chief Executive
Officer.

SECTION 5.10. Vice Presidents. The Vice President or, if there be more than one,
the Vice Presidents, in the order determined by the Board of Directors (or if
there is no such determination, then in the order of their election), shall, in
the absence of the President for any reason, including the failure of the Board
of Directors to elect a President or in the event of the President's inability
or refusal to act, perform the duties of the President, and, when so acting,
have all the powers of, and be subject to all of the restrictions upon, the
President. The Vice President shall perform such other duties and have such
other powers as the Board of Directors or President may from time to time
prescribe.

SECTION 5.11. Secretary. The Secretary shall record or cause to be recorded in
books provided for the purpose the minutes of the meetings of the stockholders,
the Board of Directors, and all committees of which a secretary shall not have
been appointed; shall see that all notices are duly given in accordance with the
provisions of these By-Laws and as required by law; shall be custodian of all
corporate records (other than financial); shall see that the books, reports,
statements, certificates and all other documents and records required by law are
properly kept and filed; and, in general, shall perform all duties as may, from
time to time, be assigned to him by the Board of Directors or the President or
the Chairman or the Board.

SECTION 5.12. Assistant Secretary. The Assistant Secretary, or if there be more
than one, the Assistant Secretaries, in the order determined by the Board of
Directors (or if there be no such determination, then in the order of their
election), shall, in the absence of the Secretary for any reason, including the
failure of the Board of Directors to elect a Secretary or in the event of the
Secretary's inability or refusal to act, perform the duties and exercise the
powers of the Secretary and perform such other duties and have such other powers
as the Board of Directors or President may from time to time prescribe. Any
Assistant Secretary shall have authority to attest by his signature to the same
extent as the Secretary.

SECTION 5.13. Treasurer. The Treasurer shall have charge and custody of, and be
responsible for, all funds and securities of the Corporation, and shall deposit
all such funds to the credit of the Corporation in such banks, trust companies
or other depositories as shall be selected in accordance with the provisions of
these By-Laws; he shall disburse the funds of the Corporation as may be ordered
by the Board of Directors, making proper vouchers for such disbursements, and
shall render to the Board of Directors, whenever the Board may require him so to
do, and shall present at the annual meeting of the stockholders a statement of
all his transactions as Treasurer; and, in general, he shall perform all the
duties incident to the office of Treasurer and such other duties as from time to
time may be assigned to him by the Board of Directors or the President or the
Chairman of the Board.

11
<PAGE>

SECTION 5.14. Assistant Treasurer. The Assistant Treasurer, or if there be more
than one, the Assistant Treasurers, in the order determined by the Board of
Directors (or if there be no such determination, then in the order of their
election), shall, in the absence of the Treasurer, for any reason, including the
failure of the Board of Directors to elect a Treasurer, or the Treasurer's
inability or refusal to act, perform the duties and exercise the powers of the
Treasurer, and perform such other duties and have such other powers as the Board
of Directors and President may from time to time prescribe.

SECTION 5.15. Compensation. The compensation of the officers shall be fixed from
time to time by or in the manner prescribed by the Board of Directors, and none
of such officers shall be prevented from receiving compensation by reason of the
fact that he is also a director of the Corporation. The application of this
Section 5.15 shall not affect the rights any officer may have regarding
compensation under an employment agreement.

ARTICLE VI

CONTRACTS, CHECKS, DRAFTS, BANK ACCOUNTS, ETC.

SECTION 6.01. Execution of Contracts. The Board of Directors may authorize any
officer or officers or agent or agents of the Corporation to enter into any
contract or execute and deliver any instrument in the name and on behalf of the
Corporation, and such authority may be general or confined to specific
instances, and, unless so authorized by the Board of Directors, no officer,
agent or employee shall have any power or authority to bind the Corporation by
any contract or engagement or to pledge its credit or to render it liable
pecuniarily for any purpose or to any amount.

SECTION 6.02. Loans. No loan shall be contracted on behalf of the Corporation,
and no evidence of indebtedness shall be issued, endorsed or accepted in its
name, unless authorized by the Board of Directors. Such authority may be general
or confined to specific instances. When so authorized the officer or officers
thereunto authorized may effect loans and advances at any time for the
Corporation from any bank, trust company or other institution, or from any firm,
corporation or individual, and for such loans and advances may make, execute and
deliver promissory notes or other evidences of indebtedness of the Corporation,
and, when authorized as aforesaid, as security for the payment of any and all
loans, advances, indebtedness and liabilities of the Corporation, may mortgage,
pledge, hypothecate or transfer any real or personal property at any time owned
or held by the Corporation and to that end execute instruments or mortgage or
pledge or otherwise transfer such property.

SECTION 6.03. Checks, Drafts, Etc. All checks, drafts, bills of exchange or
other orders for the payment of money, obligations, notes or other evidences of

12
<PAGE>

indebtedness, bills of lading, warehouse receipts and insurance certificates of
the Corporation, shall be signed or endorsed by such officer or officers, agent
or agents, attorney or attorneys, employee or employees, of the Corporation as
shall from time to time be determined by resolution of the Board of Directors.

SECTION 6.04. Deposits. All funds of the Corporation not otherwise employed
shall be deposited from time to time to the credit of the Corporation in such
banks, trust companies or other depositories as the Board of Directors may from
time to time designate, or as may be designated by an officer or officers, or
agent or agents of the Corporation to whom such power may be delegated by the
Board of Directors for the purpose of such deposit. For the purpose of
collection for the account of the Corporation all checks, drafts, and other
orders for the payment of money which are payable to the order of the
Corporation, may be endorsed, assigned and delivered by any officer of the
Corporation or in such other manner as may from time to time be determined by
resolution of the Board of Directors.

SECTION 6.05. Proxies in Respect of Securities of Other Corporations. Unless
otherwise provided by resolution of the Board of Directors, the Chairman of the
Board, the President or a Vice President may from time to time appoint an
attorney or attorneys, or agent or agents, of the Corporation, in the name and
on behalf of the Corporation to cast the votes which the Corporation may be
entitled to cast as the holder of stock or other securities in any other
corporation any of whose stock or other securities may be held by the
Corporation, at meetings of the holders of the stock or other securities of such
other corporation, or to consent in writing, in the name of the Corporation as
such holder, to any action by such other corporation, and may instruct the
person or persons so appointed as to the manner of casting such votes or giving
such consent, and may execute or cause to be executed in the name and on behalf
of the Corporation and under its corporate seal, or otherwise, all such written
proxies or other instruments as he may deem necessary or proper in the
circumstances.

ARTICLE VII

BOOKS AND RECORDS

SECTION 7.01. Place. The books and records of the Corporation may be kept at
such places within or without the State of Delaware, as the Board of Directors
may from time to time determine. The stock record books and the blank stock
certificate books shall be kept by the Secretary or by any other officer or
agent designated by the Board of Directors.

SECTION 7.02. Addresses of Stockholders. Each stockholder shall designate to the
Secretary of the Corporation an address at which notices of meetings and all
other corporate notices may be served upon or mailed to him, and if any
stockholder shall fail to designate such address, corporate notices may be
served

<PAGE>

upon him by mail, postage prepaid, to his post office address last known to the
Secretary of the Corporation or by transmitting a notice thereof to him at such
address by telegraph or cable.

ARTICLE VIII

SHARES AND THEIR TRANSFER

SECTION 8.01. Certificate of Stock. Every owner of stock of the Corporation
shall be entitled to have a certificate certifying the number of shares owned by
him in the Corporation and designating the class of stock to which such shares
belong, which shall otherwise be in such form as the Board of Directors shall
prescribe. Each such certificate shall be signed by, or in the name of the
Corporation by, the Chairman of the Board, the President or a Vice President and
the Treasurer or an Assistant Treasurer or the Secretary or an Assistant
Secretary of the Corporation.

Where a certificate is countersigned (i) by a transfer agent other than the
Corporation or its employees, or (ii) by a registrar other than the Corporation
or its employees, any other signature may be facsimile. In case any officer,
transfer agent or registrar who has signed, or whose facsimile signature has
been placed upon a certificate, shall have ceased to be such officer, transfer
agent or registrar before such certificate is issued, it may be issued by the
Corporation with the same effect as if he were such officer, transfer agent or
registrar at the date of issue.

SECTION 8.02. Record. A record shall be kept of the name of the person, firm or
corporation owning the stock represented by each certificate for stock of the
Corporation issued, the number of shares represented by each such certificate,
and the date thereof, and, in the case of cancellation, the date of
cancellation. The person in whose name shares of stock stand on the books of the
Corporation shall be deemed the owner thereof for all purposes as regards the
Corporation. The Corporation shall be entitled to treat the record holder of any
shares of the Corporation as the owner thereof for all purposes, including all
rights deriving from such shares, and shall not be bound to recognize any
equitable or other claim to, or interest in, such shares or rights deriving from
such shares, on the part of any other person, including, but without limiting
the generality thereof, a purchaser, assignee or transferee of such shares or
rights deriving from such shares, unless and until such purchaser, assignee,
transferee or other person becomes the record holder of such shares, whether or
not the Corporation shall have either actual or constructive notice of the
interest of such purchaser, assignee, transferee or other person. Any such
purchaser, assignee, transferee or other person shall not be entitled to receive
notice of the meetings of stockholders, to vote at such meetings, to examine a
complete list of the stockholders entitled to vote at meetings, or to own,
enjoy, and exercise any other property or rights deriving from

14
<PAGE>

such shares against the Corporation, until such purchaser, assignee, transferee
or other person has become the record holder of such shares.

SECTION 8.03. Transfer of Stock. Transfers of shares of the stock of the
Corporation shall be made only on the books of the Corporation by the registered
holder thereof, or by his attorney thereunto authorized by power of attorney
duly executed and filed with the Secretary of the Corporation, and on the
surrender of the certificate or certificates for such shares properly endorsed.

SECTION 8.04. Lost, Destroyed or Mutilated Certificates. In case of the alleged
loss or destruction or the mutilation of a certificate representing capital
stock of the Corporation, a new certificate may be issued in place thereof, in
the manner and upon such terms as the Board of Directors may prescribe. When
authorizing such issue of a new certificate or certificates, the Board of
Directors may, in its discretion and as a condition precedent to the issuance
thereof, require the owner of such lost, stolen or destroyed certificate or
certificates, or his legal representative, to advertise the same in such manner
as it shall require and/or to give the Corporation a bond in such sum as it may
direct as indemnity against any claim that may be made against the Corporation
with respect to the certificate alleged to have been lost, stolen or destroyed.

ARTICLE IX

DIVIDENDS AND RESERVES

The Board of Directors may declare and pay dividends upon the outstanding shares
of the Corporation, from time to time and to such extent as they deem advisable,
in the manner and upon the terms and conditions provided by statute and the
Restated Certificate of Incorporation. Before payment of any dividend there may
be set aside out of the funds of the Corporation available for the payment of
dividends such sum or sums as the Directors, from time to time, in their
absolute discretion, think proper as a reserve fund to meet contingencies, or
for equalizing dividends, or for repairing or maintaining any property of the
Corporation, or for such other purpose as the Directors shall think conducive to
the interest of the Corporation, and the Directors may abolish any such reserve
in the manner in which it was created.

ARTICLE X

SEAL

The Board shall provide a corporate seal, which shall be in the form of a circle
and shall bear the full name of the Corporation and the word "Delaware" and
figures

<PAGE>

representing the year of its incorporation. The use of the seal by the
Corporation on a document is not necessary and the use or non-use of the
corporate seal does not affect the validity, recordability or enforceability of
a document or act.

ARTICLE XI

FISCAL YEAR

The fiscal year of the Corporation shall be the calendar year unless the Board
of Directors shall otherwise determine.

ARTICLE XII

WAIVER OF NOTICE

Whenever any notice whatever is required to be given by statute, these By-Laws
or the Restated Certificate of Incorporation, a waiver thereof in writing,
signed by the person or persons entitled to said notice, whether before or after
the time stated therein, shall be deemed equivalent thereto. Attendance of a
person at a meeting shall constitute a waiver of such notice of such meeting,
except when the person attends a meeting for the express purpose of objecting,
at the beginning, to the transaction of any business because the meeting is not
lawfully called or convened. Neither the business to be transacted at, nor the
purpose of, any meeting need be specified in any written waiver of notice.

ARTICLE XIII

AMENDMENTS

Subject to the provisions of the Restated Certificate of Incorporation and the
provisions of Section 3.16 hereof, these By-Laws may be altered, amended or
repealed at any regular meeting of the stockholders (or at any special meeting
thereof duly called for that purpose) by a majority vote of the shares
represented and entitled to vote at such meeting; provided that in the notice of
any such special meeting, notice of such purpose shall be given. Subject to the
laws of the State of Delaware, the Restated Certificate of Incorporation and the
provisions of

16
<PAGE>

Section 3.16 hereof, the Board of Directors may, by majority vote of all
Directors, amend these By-Laws, or enact such other By-Laws as in their judgment
may be advisable for the regulation of the conduct of the affairs of the
Corporation.

Exhibit 15

Letter re unaudited interim financial information

November 13, 1998

To Musicland Stores Corporation:

We are aware that Musicland Stores Corporation has incorporated by reference in
its Registration Statements Nos. 33-50520, 33-50522, 33-50524, 33-82130,
33-99146 and 333-51401, its Form 10-Q for the quarter ended September 30, 1998,
which includes our report dated October 28, 1998, covering the unaudited interim
financial information contained therein. Pursuant to Regulation C of the
Securities Act of 1933, that report is not considered a part of those
registration statements prepared or certified by our firm or reports prepared or
certified by our firm within the meaning of Sections 7 and 11 of the Act.

Very truly yours,

Arthur Andersen LLP

<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet of Musicland Stores Corporation and subsidiaries
as of September 30, 1998, and the related consolidated statement of
operations for the nine-month period ended September 30, 1998, and is
qualified in its entirety by reference to such financial statements.
</LEGEND>

<MULTIPLIER> 1000

<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Sep-30-1998
<CASH> 17,065
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 436,701
<CURRENT-ASSETS> 477,186
<PP&E> 429,313
<DEPRECIATION> 197,790
<TOTAL-ASSETS> 722,560
<CURRENT-LIABILITIES> 407,273
<BONDS> 258,852
0
0
<COMMON> 358
<OTHER-SE> 11,307
<TOTAL-LIABILITY-AND-EQUITY> 722,560
<SALES> 1,146,976
<TOTAL-REVENUES> 1,146,976
<CGS> 736,623
<TOTAL-COSTS> 736,623
<OTHER-EXPENSES> 404,170
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 23,315
<INCOME-PRETAX> (17,132)
<INCOME-TAX> (5,140)
<INCOME-CONTINUING> (11,992)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,992)
<EPS-PRIMARY> (0.35)
<EPS-DILUTED> 0

</TABLE>