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 June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ -------------
Commission file number 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)
(612) 931-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
--- ---
The number of shares outstanding of the Registrant's common stock as of
July 27, 1999 was 36,143,889 shares.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements.
Consolidated Statements of Earnings 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
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 13
PART II - OTHER INFORMATION
Item 2. Changes in Securities. 14
Item 4. Submission of Matters to a Vote of Security Holders. 14
Item 5. Other Information. 14
Item 6. Exhibits and Reports on Form 8-K. 15
Signature 16
2
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
1999 1998 1999 1998
---------- --------- --------- ----------
Sales............................ $ 381,059 $ 367,203 $ 782,856 $ 759,608
Cost of sales.................... 237,931 231,398 496,151 487,050
---------- --------- --------- ----------
Gross profit.................. 143,128 135,805 286,705 272,558
Selling, general and
administrative expenses......... 124,551 124,377 250,946 249,444
Depreciation and amortization.... 10,082 9,818 19,892 19,645
---------- --------- --------- ----------
Operating income.............. 8,495 1,610 15,867 3,469
Interest expense................. 6,354 8,270 11,763 15,202
---------- --------- --------- ----------
Earnings (loss) before
income taxes................. 2,141 (6,660) 4,104 (11,733)
Income taxes..................... 642 (1,998) 1,231 (3,520)
---------- --------- --------- ----------
Net earnings (loss)........... $ 1,499 $ (4,662) $ 2,873 $ (8,213)
========== ========= ========= ==========
Basic earnings (loss) per
common share.................... $ 0.04 $ (0.14) $ 0.08 $ (0.24)
========== ========= ========= ==========
Diluted earnings (loss) per
common share.................... $ 0.04 $ (0.14) $ 0.08 $ (0.24)
========== ========= ========= ==========
See accompanying Notes to Consolidated Financial Statements.
3
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
June 30,
--------------------- December 31,
1999 1998 1998
--------- --------- ----------
ASSETS
Current assets:
Cash and cash equivalents............... $ 61,657 $ 8,455 $ 257,218
Inventories............................. 399,188 399,307 446,710
Deferred income taxes................... 16,200 9,400 15,800
Other current assets.................... 8,282 8,960 10,395
---------- --------- ----------
Total current assets.................. 485,327 426,122 730,123
Property, at cost.......................... 439,467 424,611 437,349
Accumulated depreciation and amortization.. (215,353) (189,744) (203,925)
---------- --------- ----------
Property, net........................... 224,114 234,867 233,424
Deferred income taxes...................... - 3,000 -
Other assets............................... 9,638 10,960 10,093
---------- --------- ----------
Total Assets.......................... $ 719,079 $ 674,949 $ 973,640
========== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt.... $ - $ 50,000 $ -
Accounts payable........................ 258,415 226,647 452,410
Other current liabilities............... 91,253 78,290 154,743
---------- --------- -----------
Total current liabilities............. 349,668 354,937 607,153
Long-term debt............................. 258,909 258,834 258,871
Other long-term liabilities................ 42,482 46,516 43,634
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: June 30, 1999,
36,142,986; December 31, 1998,
36,041,934; June 30, 1998, 35,372,793). 361 354 360
Additional paid-in capital.............. 261,526 258,060 260,608
Accumulated deficit..................... (183,772) (232,891) (186,645)
Deferred compensation................... (5,792) (6,498) (5,998)
Common stock subscriptions.............. (4,303) (4,363) (4,343)
---------- ---------- -----------
Total stockholders' equity............ 68,020 14,662 63,982
---------- ---------- -----------
Total Liabilities and Stockholders'
Equity............................... $ 719,079 $ 674,949 $ 973,640
========== ========== ===========
See accompanying Notes to Consolidated Financial Statements.
4
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Six Months Ended
June 30,
------------------------
1999 1998
---------- -----------
OPERATING ACTIVITIES:
Net earnings (loss)............................... $ 2,873 $ (8,213)
Adjustments to reconcile net earnings (loss)
to net cash used in operating activities:
Depreciation and amortization................... 21,472 21,430
Disposal of property............................ 1,905 1,977
Deferred income taxes........................... (400) 600
Changes in operating assets and liabilities:
Inventories..................................... 47,522 50,951
Other current assets............................ 2,113 838
Accounts payable................................ (193,995) (118,475)
Other current liabilities....................... (63,326) (37,219)
Other assets.................................... (332) (61)
Other long-term liabilities..................... (1,152) (2,674)
---------- ----------
Net cash used in operating activities.......... (183,320) (90,846)
---------- ----------
INVESTING ACTIVITIES:
Capital expenditures.............................. (12,485) (6,464)
---------- ----------
FINANCING ACTIVITIES:
Decrease in outstanding checks in excess of cash
balances......................................... - (12,061)
Net proceeds from issuance of long-term debt...... - 144,317
Principal payments on long-term debt.............. - (32,933)
Proceeds from sale of common stock................ 244 2,500
---------- ----------
Net cash provided by financing activities...... 244 101,823
---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (195,561) 4,513
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.... 257,218 3,942
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......... $ 61,657 $ 8,455
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest......................................... $ 12,950 $ 10,643
Income taxes, net................................ 21,226 689
See accompanying Notes to Consolidated Financial Statements.
5
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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 a single operating segment. The Company's e-commerce
operations, which commenced online retailing in the second quarter of 1999, were
not material.
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. Income Taxes
The effective income tax rates for the three months and six months
ended June 30, 1999 and 1998 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.
3. Weighted Average Common Shares Outstanding
A reconciliation of weighted average common shares used in the
computation of basic and diluted earnings (loss) per common share is as follows:
Three Six
Months Ended Months Ended
June 30, June 30,
--------------- ----------------
1999 1998 1999 1998
------ ------- ------- -------
Weighted average common shares
outstanding - basic................ 35,517 34,064 35,480 33,896
Dilutive effect of stock options.... 676 N/A 711 N/A
Dilutive effect of warrants......... 448 N/A 459 N/A
------ ------- ------- -------
Weighted average common shares
outstanding - diluted.............. 36,641 34,064 36,650 33,896
====== ======= ======= =======
Antidilutive stock options.......... 1,797 2,631 1,568 2,747
====== ======= ======= =======
6
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands)
3. Weighted Average Common Shares Outstanding (Continued)
Antidilutive stock options outstanding during the three months and six
months ended June 30, 1999 had an exercise price greater than the average market
price during the period. All stock options and warrants outstanding during the
three months and six months ended June 30, 1998 were antidilutive due to the net
loss in each period.
7
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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 June 30, 1999
and 1998, and the related consolidated statements of earnings for the
three-month and six-month periods ended June 30, 1999 and 1998, and the
consolidated statements of cash flows for the six-month periods ended June 30,
1999 and 1998. 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, 1998, and, in our report dated January 18, 1999,
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, 1998, 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,
July 29, 1999
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
Results of Operations
The Company's stores operate in one segment 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 (the
"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 a single operating segment. The
following table presents certain unaudited sales and store data for the periods
indicated.
Three Months Ended June 30,
-----------------------------------------------------
Percent of Total
Percent -----------------
1999 1998 Incr.(Decr.) 1999 1998
--------- ---------- ----------- -------- -------
(Dollars in millions)
Sales:
Mall Stores.......... $ 248.9 $ 241.8 3.0 % 65.3% 65.8%
Superstores.......... 132.1 123.1 7.3 34.7 33.5
Total (1).......... 381.1 367.2 3.8 100.0 100.0
Comparable store
sales increase (2):
Mall Stores.......... 3.7% 10.5% N/A N/A N/A
Superstores.......... 5.7 7.6 N/A N/A N/A
Total (1).......... 4.4 9.5 N/A N/A N/A
Six Months Ended June 30,
-----------------------------------------------------
Percent of Total
Percent -----------------
1999 1998 Incr.(Decr.) 1999 1998
--------- ---------- ----------- -------- -------
(Dollars and square footage in millions)
Sales:
Mall Stores.......... $ 506.1 $ 498.3 1.6 % 64.7% 65.6%
Superstores.......... 275.6 256.5 7.4 35.2 33.8
Total (1).......... 782.9 759.6 3.1 100.0 100.0
Comparable store
sales increase (2):
Mall Stores.......... 2.7% 10.0% N/A N/A N/A
Superstores.......... 6.0 7.6 N/A N/A N/A
Total (1).......... 3.8 9.2 N/A N/A N/A
Number of stores open
at end of period:
Mall Stores.......... 1,093 1,102 (0.8) 82.5 82.2
Superstores.......... 232 224 3.6 17.5 16.7
Total (1).......... 1,325 1,341 (1.2) 100.0 100.0
Total store square
footage at end of
period:
Mall Stores.......... 4.0 4.0 0.5 48.2 48.2
Superstores.......... 4.3 4.2 1.5 51.8 51.3
Total (1).......... 8.3 8.2 0.6 100.0 100.0
----------------------------------------------
(1) The totals include other retail strategies.
(2) Comparable store sales percentages are computed for stores open for a full
year during each period.
9
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Net earnings for the second quarter of 1999 improved to $1.5 million,
or $0.04 per share, from a net loss of $4.7 million, or $0.14 per share, for the
second quarter of 1998. For the first half of 1999, net earnings were $2.9
million, or $0.08 per share, versus a net loss of $8.2 million, or $0.24 per
share, in 1998. Comparable store sales growth, reflecting the overall health of
the retail entertainment sector, continued improvements in gross margin and
reduced interest expense were the principal factors contributing to the strong
financial performance in 1999.
Sales. The comparable store sales growth in 1999, achieved on top of
strong comparable store sales results in 1998, led to the increases in total
sales for the 1999 periods. Comparable store sales gains in the music product
category were led by new music releases from popular artists, especially with
teen-agers, while the continued strength of DVD sales offset declines in
consumer demand for video cassettes. DVD sales, which reached 20% of total video
sales in the second quarter, are expected to be in excess of $100 million for
the year ended December 31, 1999. The books, electronics and video games product
categories also had comparable store sales increases during the 1999 periods.
Music and video, the Company's principal product categories, account
for approximately 80% of total sales. The following table shows the comparable
store sales percentage increase (decrease) attributable to these product
categories for the periods indicated.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
1999 1998 1999 1998
------------ ----------- ---------- ------------
Music.......... 4.5 % 8.1 % 2.8 % 10.2 %
Video.......... (2.1) 12.9 0.6 7.9
Gross Profit. Gross profit as a percentage of sales was 37.6% in the
second quarter of 1999 compared with 37.0% in the second quarter of 1998, an
increase of 0.6%. For the first half of 1999, gross margin improved 0.7% to
36.6% from 35.9% in 1998. The gross margin improvements in 1999 were
attributable to selective price increases and less promotional pricing.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of sales for the second quarter were
32.7% in 1999 compared with 33.9% in 1998 and for the first half of 1999 were
32.1% compared with 32.8% in 1998. The percentage rate decreases resulted from
the comparable store sales increases. Selling, general and administrative
expenses in the second quarter of 1999 included expenses related to the
e-commerce sites, launched in June of 1999, of $1.2 million, or $0.02 per share.
This incremental expense in 1999 was offset by a decrease in the provision for
store closings due to lower estimated closing costs, as most closings are
expected to occur after the lease expiration. See "- Liquidity and Capital
Resources - Investing Activities."
Depreciation and Amortization. Depreciation and amortization in the
second quarter and first half of 1999 increased slightly over the same periods
in 1998. The increases related to capital spending for new stores and upgrades
to existing stores over the last year, partially offset by decreases to
depreciation and amortization as a result of the closing of stores.
Interest Expense. Interest expense, net of interest income, for the
three months and six months ended June 30, 1999 decreased by $1.9 million and
$3.4 million, respectively, from the same periods in 1998. The decreases were
primarily the result of no revolver borrowing activity during 1999 and the
repayment of mortgage notes payable and a term loan in 1998. Higher average cash
balances during 1999 led to increases in interest income of $0.5 million and
$1.9 million for the second quarter and first half of 1999, respectively, and
contributed to the reduction in net interest expense for the periods. The
decreases in 1999 were partially offset by the increase to interest expense
related to the 9 7/8% senior subordinated notes issued in April 1998. See
"Liquidity and Capital Resources."
Income Taxes. The effective income tax rates for the three months and
six months ended June 30, 1999 and 1998 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.
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Liquidity and Capital Resources
The Company's financial position has strengthened in recent years as a
result of improvements in results of operations and the completion in April 1998
of an offering of $150 million of 9 7/8% senior subordinated notes due in 2008.
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 outstanding mortgage notes payable and the
remaining $112.2 million of net proceeds and $0.8 million of additional cash to
repay outstanding revolver borrowings. A $50 million term loan was repaid in
December 1998. The Company had no revolver borrowing activity during the first
half of 1999 and had minimal revolver borrowing activity during the second half
of 1998. At June 30, 1999 and 1998 and December 31, 1998, the Company had no
outstanding revolver borrowings and had cash and cash equivalents of $61.7
million, $8.5 million and $257.2 million, respectively. As a result of the
reduced reliance on revolver borrowings, the Company has periodically reduced
the maximum available under the revolving credit facility from $182 million in
December 1998 to $50 million as of August 11, 1999. Management expects that
internally generated cash will continue to be the Company's primary source of
capital in 1999. See "- Financing Activities."
The Company's revolving credit facility is subject to a credit
agreement that contains financial covenants and covenants that limit additional
indebtedness, liens, capital expenditures and cash dividends. The indentures
related to the 9% and 9 7/8% senior subordinated notes also contain certain
covenants, including limitations on the ability of the Company to make certain
payments, to incur additional indebtedness and to issue certain types of
preferred stock. The Company was in compliance with all covenants at June 30,
1999.
Operating Activities. Net cash used in operating activities (including
in 1998 the decrease in outstanding checks in excess of cash balances which
primarily related to vendor payments) during the six months ended June 30, 1999
and 1998 was $183.3 million and $102.9 million, respectively. The reduction in
accounts payable, the most significant use of cash in each period, reflects the
effect of payments for inventory purchases for the Christmas season, typically
due near the beginning of the following year, as well as nonseasonal inventory
purchases on normal credit terms. Cash used for inventory related activities, as
reflected by the aggregate net changes in inventories, accounts payable and
outstanding checks in excess of cash balances, was $146.5 million in 1999
compared with $79.6 million in 1998. The Company made income tax payments, net
of refunds, of $21.2 million in 1999, compared with $0.7 million in 1998. 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 Six Months Twelve Months
Ended June 30, Ended June 30, Ended June 30,
----------------- -------------- -----------------
1999 1998 1999 1998 1999 1998
-------- ------- ------ ------ ------- --------
Openings:
Mall Stores.......... 2 - 4 - 11 2
Superstores.......... 3 - 3 - 10 1
Total (1).......... 5 - 7 - 21 3
Closings:
Mall Stores.......... (4) (8) (12) (20) (20) (37)
Superstores.......... (2) - (2) (1) (2) (1)
Total (1).......... (7) (9) (28) (22) (37) (42)
Net increase (decrease):
Mall Stores.......... (2) (8) (8) (20) (9) (35)
Superstores.......... 1 - 1 (1) 8 -
Total (1).......... (2) (9) (21) (22) (16) (39)
- -----------------------------------------------------------
(1) The totals include other retail strategies.
11
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The Company plans to add approximately 45 to 50 new stores in 1999.
Media Play and On Cue stores will account for the majority of the total new
store square footage and store count, respectively. In addition to store
expansion, the Company plans to make upgrades to existing stores and has
developed four e-commerce sites launched in June of 1999. Capital expenditures
in 1999 for these programs and other capital projects are expected to be
approximately $45 million. Management expects that these capital expenditures
will be financed primarily by internally generated cash. The Company will
continue to assess the profitability of its stores and will close a limited
number of underperforming stores in future periods, primarily after the leases
expire. Most of the Company's capital expenditures in 1998 related to the
remodeling, relocation and general upkeep of existing stores.
Financing Activities. The Company had no revolver borrowings or other
significant financing activities during the six months ended June 30, 1999. The
Company's source of financing for the six months ended June 30, 1999 was
internally generated cash, which accounted for the net decrease in cash and cash
equivalents since December 31, 1998 of $195.6 million. For the six months ended
June 30, 1998, cash provided by financing activities (excluding the decrease in
outstanding checks in excess of cash balances which related to vendor payments)
was $113.9 million and related primarily to the offering of senior subordinated
notes discussed previously.
The revolving credit facility expires in October 1999. Maturities of
the senior subordinated notes are $110 million in 2003 and $150 million in 2008.
The $110 million senior subordinated notes may be redeemed prior to maturity, at
the Company's option, at 102.25% of par on and after June 15, 1999 and
thereafter at prices declining annually to 100% of par on and after June 15,
2001. The $150 million senior subordinated notes may be redeemed prior to
maturity, at the Company's option, at 104.938% of par on and after March 15,
2003 and thereafter at prices declining annually to 100% of par on and after
March 15, 2006. Management does not anticipate an immediate need to replace the
revolving credit facility and believes it will be able to secure adequate
financing to repay the senior subordinated notes when they mature.
Other Matters
Seasonality. The Company's business is highly seasonal, with nearly
40% of the annual revenues and most 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 Company's 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 is being 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
has primarily utilized internal resources for the installation of maintenance
updates and completion of modifications to existing computer systems. Costs of
addressing the Year 2000 issue have totaled approximately $2 million through
June 30, 1999. Management estimates the Company's total cost through completion
of all required Year 2000 modifications, based on currently available
information, to be approximately $3 million. The Company plans to capitalize the
cost of new systems in accordance with SOP 98-1. Other incremental costs
associated with the Year 2000 remediation effort are being charged to expense as
incurred.
The Company's Year 2000 readiness process consists of the following
phases: Awareness, Assessment, Renovation, Validation and Implementation. The
Company's evaluation process involves review of information technology ("IT")
systems and systems containing embedded technology such as
12
<PAGE>
microcontrollers ("Non-IT" systems), which include communication systems and
certain equipment. The Company has completed the Implementation phase for
nearly all of its IT and Non-IT systems. Year 2000 readiness for the remaining
systems is targeted for completion in the third quarter of 1999; however, the
Company plans to continue to perform tests on various completed systems through
the end of the year.
The Company has formed a task force which is corresponding with the
Company's business partners and service providers to determine their state of
Year 2000 readiness. The Company has confirmed with vendors representing 93% of
its purchase volume that their systems are Year 2000 ready. Management generally
believes the remaining 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.
The Company plans to devote the necessary resources to resolve all
significant Year 2000 issues in a timely manner. 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. In the most reasonably
likely worst case scenarios the Company could experience delays in receiving
product from vendors, shipping product to stores, accessing various types of
information or communicating effectively with financial institutions or vendors.
The Company is developing contingency plans which could include alternate
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, as well as strategies to address other unidentified issues.
The Company intends to finalize contingency plans in the third and fourth
quarters of 1999.
Forward-Looking Statements. This quarterly report on Form 10-Q contains
certain forward-looking statements, as defined in the Private Securities
Litigation Reform Act of 1995, and information relating to the Company that are
based on the beliefs of the management of the Company as well as assumptions
made by and information currently available to the management of the Company.
Forward-looking statements can be identified by, among other things, the use of
forward-looking terminology such as "believes," "expects," "may," "will,"
"should," "seeks," "anticipates," "intends" or the negative of any thereof, or
other variations thereon or comparable terminology, or by discussions of
strategies or intentions. A number of factors could cause actual results,
performance, achievements of the Company, or industry results to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. These factors include, but are not
limited to: general economic and market conditions; changes in consumer demand
and demographics; possible disruptions in the Company's computer or telephone
systems; increased or unanticipated costs or other effects associated with Year
2000 compliance by the Company or its service or supply providers; increases in
labor costs; the ability to attract and retain qualified personnel; effects of
competition, especially in the retailing of music and video products; possible
disruptions or delays in the opening of new stores or the inability to obtain
suitable sites for new stores; higher than anticipated store closing or
relocation costs; unanticipated increases in merchandise or occupancy costs; the
performance of the Company's e-commerce sites; possible increases in shipping
rates or interruptions in shipping service; changes in prevailing interest rates
and the availability of and terms of financing to fund the anticipated growth of
the Company's business and other factors which may be outside of the Company's
control. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results or outcomes may
vary materially from those described therein as anticipated, believed,
estimated, expected, intended or planned. Accordingly, any forward-looking
statements included herein do not purport to be predictions of future events or
circumstances and may not be realized. Subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by the cautionary statements in
this paragraph.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company holds no derivative instruments and does not engage in
hedging activities.
13
<PAGE>
PART II - OTHER INFORMATION
Item 2. Changes in Securities.
(c) During the quarterly period ended June 30, 1999, 24,293 shares of common
stock were issued for aggregate cash proceeds of $37,957.81 in connection with
the exercise of warrants on May 26, 1999 by ING Barings (U.S.) Capital LLC. In
connection with the warrant exercise, 0.97 warrants were canceled in lieu of
issuance of fractional shares. These shares 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 originally 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 4. Submission of Matters to a Vote of Security Holders.
(a) The Company held its Annual Stockholders' meeting on May 10, 1999.
(c) (1) The stockholders voted for three directors for three-year terms. The
vote was as follows for each of the nominees:
Affirmative Voting Authority
Name Votes Withheld
------------------ ----------- ----------------
Kenneth F. Gorman 30,796,830 630,643
Josiah O. Low, III 30,872,649 554,824
Terry T. Saario 30,874,290 553,183
There were no abstentions and no broker non-votes.
Continuing as directors were Jack W. Eugster, Keith A. Benson,
Gilbert L. Wachsman, William A. Hodder, Tom F. Weyl and Michael W.
Wright.
(2) The Alternate Incentive Plan for Designated Senior Officers was
voted on and approved. There were 29,841,108 votes for, 1,426,268
votes against, 160,096 abstentions and no broker non-votes.
(3) The appointment by the Board of Directors of Arthur Andersen LLP,
independent public accountants, as independent auditors of the
Company for the year ending December 31, 1999, was voted on and
approved. There were 31,218,042 votes for, 156,337 votes against,
53,093 abstentions and no broker non-votes.
Item 5. Other Information.
Jonathan T.M. Reckford was appointed to the position of President,
Mall Stores Division on May 17, 1999. He will have responsibility for
stores management, operational and merchandising support, visual
merchandising, leasing, store design and construction. Mr. Reckford had
previously held the position of Senior Vice President of Corporate
Planning and Communications for Circuit City Stores, Inc. Prior to that,
he worked for The Walt Disney Co. in a variety of planning and new
business roles. Before his service at Disney, he worked with Marriott
Corporation, Goldman, Sachs & Co. and the Seoul Olympic Organizing
Committee.
14
<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
- ----------- ----------------------------------------------------------
11. Statement re computation of per share earnings *
15. Letter re unaudited interim financial information -----
27. Financial Data Schedules -----
* The requirements of this exhibit are met by Note 3 of Notes to
Consolidated Financial Statements.
The following are filed as exhibits to Part II of this Form 10-Q:
Exhibit No. Description
- ----------- ---------------------------------------------------------
10.8(b) Alternate Incentive Plan for Designated Senior Officers
15
<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: August 12, 1999
---------------
16
THE MUSICLAND GROUP
ALTERNATE INCENTIVE PLAN
FOR DESIGNATED SENIOR OFFICERS
EFFECTIVE: JANUARY 1, 1999
Board Approval - March 19, 1999
Shareholder Approval - May 10, 1999
I. PURPOSE
The Alternate Incentive Plan for Designated Senior Officers (the
"Plan") is designed to provide the annual and long-term incentive
bonuses to those senior officers of the Company whose compensation may
be affected by Section 162(m) of the Internal Revenue Code (the
"Code"). The Plan is intended to qualify such compensation as
"qualified performance based compensation" within the meaning of
Section 162(m) of the Code. Participants in the Plan will not receive
bonuses for the same periods under the Company's existing Management
Incentive Plan and Long Term Incentive Plan.
II. ADMINISTRATION
A. The Plan is administered by the Compensation Committee of the
Company's Board of Directors (the "Compensation Committee")
which will consist of not less than two directors (all of whom
meet the Code definition of "outside director").
B. 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, provided that the Plan will be interpreted and
administered in such a manner that all bonus payments under
the Plan will qualify as performance-based compensation under
Section 162(m) of the Code.
III. PARTICIPATION
A. The Compensation Committee will designate the participants in
the Plan each fiscal year to be the CEO and up to four other
senior officers of the Company who are likely to be "covered
employees" (within the meaning of Section 162(m) ) for the
relevant fiscal year.
B. Participation in the Plan will preclude participation in the
Company's Management Incentive Plan and Long Term Incentive
Plan covering the same periods.
1
ALTERNATIVE INCENTIVE PLAN
FOR DESIGNATED SENIOR OFFICERS
<PAGE>
IV. MAXIMUM PERFORMANCE AWARDS
A. Each fiscal year will constitute a performance period for the
annual portion of the bonus payable under the Plan. For the
long-term portion of the bonus payable under the Plan, three
consecutive fiscal year periods, beginning with 1999 to 2001,
will constitute the performance period with a new three-year
period beginning each year.
B. The performance goal for each annual performance period will
be based on achieving a pre-tax return on net assets employed
("RONAE") of 10%. The performance goal for each long term
performance period will be based on achieving an average
annual pre-tax RONAE of 10% for the three-year period. If the
performance goal is not achieved, the bonus pool amount for
the corresponding performance period will not fund and no
bonuses for that period will be paid.
C. After the end of each performance period, the Compensation
Committee will certify that the performance goal has been
achieved.
D. The bonus pool for each annual performance period will be an
amount equal to 4.9% of the Company's operating income for the
fiscal year. The bonus pool for each long term performance
period will be an amount equal to 1% of the Company's
cumulative operating income for the three-year performance
period. For purposes of determining operating income,
extraordinary items, discontinued operations and restructuring
charges as reported by the Company in its financial statements
will not be taken into account.
E. The maximum bonus that can be paid to the CEO for any annual
or long term performance period will equal 40% of the bonus
pool for the applicable period. The maximum bonus that can be
paid to any other participant for any annual or long term
performance period will equal 15% of the bonus pool for the
applicable period.
V. NEGATIVE DISCRETION
The Compensation Committee is not obligated to pay out the maximum
bonuses determined pursuant to the above formulas and will retain sole
negative discretion to reduce the amount of any bonus otherwise payable
under the Plan. In determining whether the share of any participant in
the applicable bonus pool will be reduced, the Compensation Committee
will consider such factors as Company performance compared to target
business goals and individual contributions compared to established
individual performance objectives as the Committee determines to be
appropriate and in line with the Company's executive compensation
philosophy, other incentive plans and past practices.
2
ALTERNATIVE INCENTIVE PLAN
FOR DESIGNATED SENIOR OFFICERS
<PAGE>
VI. PAYMENT OF AWARDS
Awards will be paid in cash, less applicable tax and FICA withholding,
in such amounts (consistent with the terms of this Plan) and at such
times after the end of each performance period as determined by the
Compensation Committee.
VII. AWARD CONDITIONS
A. A participant whose employment ends prior to the completion of
any performance period due to retirement, disability, death,
or disposition of part of the business may be eligible for a
pro-rated award for that performance period as determined by
the Compensation Committee in its discretion.
B. A participant whose employment terminates prior to the
completion of any performance period for reasons other than
those listed in A above will not be eligible for any award for
that performance period.
C. A participant whose employment terminates for any reason after
the end of a performance period, but prior to the payment of
awards, may be eligible for an award for that performance
period as determined by the Compensation Committee in its
discretion.
D. A participant who is on an approved unpaid leave of absence
during a performance period may be eligible for a pro-rated or
full award for that performance period as determined by the
Compensation Committee in its discretion.
VIII. GENERAL PROVISIONS
A. This Plan does not guarantee, explicitly or implicitly, the
right to continued employment for participants.
B. This Plan may be terminated or its provisions changed at any
time and for any reason by the Compensation Committee without
notice to any participant. No amendment to the Plan will
require shareholder approval unless such approval is required
by Section 162(m) of the Code.
3
ALTERNATIVE INCENTIVE PLAN
FOR DESIGNATED SENIOR OFFICERS
Exhibit 15
Letter re unaudited interim financial information
August 12, 1999
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, 333-51401 and 333-68275, its Form 10-Q for the quarter ended June 30,
1999, which includes our report dated July 29, 1999, 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
<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 June 30, 1999, and the related consolidated statement of earnings
for the six-month period ended June 30, 1999, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1999
<PERIOD-END> Jun-30-1999
<CASH> 61,657
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 399,188
<CURRENT-ASSETS> 485,327
<PP&E> 439,467
<DEPRECIATION> 215,353
<TOTAL-ASSETS> 719,079
<CURRENT-LIABILITIES> 349,668
<BONDS> 258,909
0
0
<COMMON> 361
<OTHER-SE> 67,659
<TOTAL-LIABILITY-AND-EQUITY> 719,079
<SALES> 782,856
<TOTAL-REVENUES> 782,856
<CGS> 496,151
<TOTAL-COSTS> 496,151
<OTHER-EXPENSES> 270,838
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,763
<INCOME-PRETAX> 4,104
<INCOME-TAX> 1,231
<INCOME-CONTINUING> 2,873
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,873
<EPS-BASIC> .08
<EPS-DILUTED> .08
</TABLE>
