UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 (I.R.S. Employer Identification No.)
of incorporation or organization)
10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)
(612) 931-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
--- ---
The number of shares outstanding of the Registrant's common stock as of
April 27, 1999 was 36,069,891 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 6. Exhibits and Reports on Form 8-K. 14
Signature 15
2
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended
March 31,
-----------------------
1999 1998
--------- ---------
Sales ............................................. $ 401,797 $ 392,405
Cost of sales ..................................... 258,220 255,652
--------- ---------
Gross profit ................................... 143,577 136,753
Selling, general and administrative expenses ...... 126,395 125,067
Depreciation and amortization ..................... 9,810 9,827
--------- ---------
Operating income ............................... 7,372 1,859
Interest expense .................................. 5,409 6,932
--------- ---------
Earnings (loss) before income taxes ............ 1,963 (5,073)
Income taxes ...................................... 589 (1,522)
--------- ---------
Net earnings (loss) ............................ $ 1,374 $ (3,551)
========= =========
Basis earnings (loss) per common share ............ $ 0.04 $ (0.11)
========= =========
Diluted earnings (loss) per common share .......... $ 0.04 $ (0.11)
========= =========
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)
March 31,
----------------------- December 31,
1999 1998 1998
----------- ---------- -----------
ASSETS
Current assets:
Cash and cash equivalents.............. $ 55,856 $ 8,852 $ 257,218
Inventories............................ 405,868 423,940 446,710
Deferred income taxes.................. 16,012 10,600 15,800
Other current assets................... 8,176 7,849 10,395
----------- ---------- -----------
Total current assets................. 485,912 451,241 730,123
Property, at cost......................... 435,050 424,122 437,349
Accumulated depreciation and
amortization............................. (207,338) (182,187) (203,925)
----------- ---------- -----------
Property, net.......................... 227,712 241,935 233,424
Deferred income taxes..................... - 2,400 -
Other assets.............................. 9,535 7,416 10,093
----------- ---------- -----------
Total Assets......................... $ 723,159 $ 702,992 $ 973,640
=========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt... $ - $ 50,800 $ -
Accounts payable....................... 258,997 226,705 452,410
Other current liabilities.............. 96,637 78,903 154,743
----------- ---------- -----------
Total current liabilities............ 355,634 356,408 607,153
Long-term debt............................ 258,890 282,417 258,871
Other long-term liabilities............... 42,627 48,023 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: March 31,
1999, 36,065,705; December 31,1998,
36,041,934; March 31, 1998,
34,489,174)......................... 361 345 360
Additional paid-in capital............. 260,970 255,750 260,608
Accumulated deficit.................... (185,271) (228,229) (186,645)
Deferred compensation.................. (5,749) (6,749) (5,998)
Common stock subscriptions............. (4,303) (4,973) (4,343)
----------- ---------- -----------
Total stockholders' equity........... 66,008 16,144 63,982
----------- ---------- -----------
Total Liabilities and Stockholders'
Equity.............................. $ 723,159 $ 702,992 $ 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)
Three Months Ended
March 31,
----------------------------
1999 1998
------------ ------------
OPERATING ACTIVITIES:
Net earnings (loss).............................. $ 1,374 $ (3,551)
Adjustments to reconcile net earnings (loss)
to net cash used in operating activities:
Depreciation and amortization.................. 10,652 10,646
Disposal of property........................... 1,543 684
Deferred income taxes.......................... (212) -
Changes in operating assets and liabilities:
Inventories.................................... 40,842 26,318
Other current assets........................... 2,219 919
Accounts payable............................... (193,413) (118,417)
Other current liabilities...................... (58,004) (36,512)
Other assets................................... 164 (85)
Other long-term liabilities.................... (1,007) (1,166)
------------ ------------
Net cash used in operating activities......... (195,842) (121,164)
------------ ------------
INVESTING ACTIVITIES:
Capital expenditures............................. (5,640) (2,426)
------------ ------------
FINANCING ACTIVITIES:
Increase (decrease) in outstanding checks in
excess of cash balances......................... - (12,061)
Borrowings under revolver........................ - 141,000
Principal payments on long-term debt............. - (857)
Proceeds from sale of common stock............... 120 418
------------ ------------
Net cash provided by financing activities..... 120 128,500
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS....................................... (201,362) 4,910
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD............................................ 257,218 3,942
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD......... $ 55,856 $ 8,852
============ ============
CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Interest........................................ $ 7,746 $ 3,441
Income taxes, net............................... 15,011 (125)
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 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. Income Taxes
The effective income tax rates for the three months ended March 31,
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 Months Ended
March 31,
--------------------------
1999 1998
------------ ------------
Weighted average common shares
outstanding - basic.................... 35,443 33,727
Dilutive effect of stock options........ 746 N/A
Dilutive effect of warrants............. 470 N/A
------------ ------------
Weighted average common shares
outstanding - diluted.................. 36,659 33,727
============ ============
Antidilutive stock options.............. 1,325 744
============ ============
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 ended
March 31, 1999 had an exercise price greater than the average market price
during the period. All stock options and warrants outstanding during the three
months ended March 31, 1998 were antidilutive due to the net loss.
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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 March 31,
1999 and 1998, and the related consolidated statements of earnings and cash
flows for the three-month periods then ended. These financial statements are the
responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Musicland Stores Corporation and
Subsidiaries as of December 31, 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,
April 27, 1999
8
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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 March 31,
-------------------------------------------------------
Percent of Total
Percent -------------------
1999 1998 Incr.(Decr.) 1999 1998
------- ------- ----------- -------- --------
(Dollars and square footage in millions)
Sales:
Mall Stores........ $ 257.2 $ 256.6 0.3 % 64.0% 65.4%
Superstores........ 143.5 133.4 7.5 35.7 34.0
Total (1)........ 401.8 392.4 2.4 100.0 100.0
Comparable store
sales increase:
Mall Stores........ 1.9% 9.6% N/A N/A N/A
Superstores........ 6.3 7.6 N/A N/A N/A
Total (1)........ 3.4 8.9 N/A N/A N/A
Number of stores
open at end of
period:
Mall Stores........ 1,095 1,110 (1.4)% 82.5% 82.2%
Superstores........ 231 224 3.1 17.4 16.6
Total (1)........ 1,327 1,350 (1.7) 100.0 100.0
Total store square
footage at end of
period:
Mall Stores........ 4.0 4.0 (0.1)% 48.2% 48.4%
Superstores........ 4.3 4.2 1.4 51.8 51.1
Total (1)........ 8.2 8.2 0.2 100.0 100.0
--------------------------------------------------------
(1) The totals include other retail strategies.
Net earnings for the first quarter of 1999 improved to $1.4 million, or
$0.04 per share, compared with a net loss of $3.6 million, or $0.11 per share
for the first quarter of 1998. The earnings improvement resulted primarily from
comparable store sales increases, gross margin improvements and a decrease in
interest expense.
Sales. The increases in total sales for the three months ended March
31, 1999 were attributable primarily to the comparable store sales increases, as
shown in the table above. The comparable store sales increases in 1999 were
achieved on top of strong comparable store sales increases in 1998, which were
led by the soundtrack from the movie "Titanic." The Easter holiday fell in the
second calendar quarter in both 1999 and 1998. The following table shows the
comparable store sales percentage increase attributable to the Company's two
principal product categories for each period.
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Three Months Ended
March 31,
-------------------------------
1999 1998
-------------- --------------
Music................................ 1.2 % 11.8 %
Video................................ 3.0 3.7
The sales growth in video was led by the continued momentum of DVD
sales, which rose to 19% of total video sales in the first three months of 1999
compared with 9% of total video sales for the first three months of 1998. In
addition to the sales increases in music and video, which account for
approximately 80% of the Company's total sales, the video game and electronics
product categories also had significant sales gains in 1999.
Gross Profit. Gross profit as a percentage of sales was 35.7% in the
first quarter of 1999 compared with 34.8% in the first quarter of 1998, an
increase of 0.9%. Most of the gross margin improvement in 1999 was attributable
to less promotional pricing and, to a lesser extent, the cumulative effect of
selective price increases beginning in the second half of 1997 and continuing
through the first quarter of 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of sales were 31.5% in the first quarter
of 1999 compared with 31.9% in the first quarter of 1998, a decrease of 0.4%.
The percentage rate decrease resulted primarily from the comparable store sales
increases previously discussed. Selling, general and administrative expenses in
the first quarter of 1999 increased $1.3 million from the first quarter of 1998,
reflecting the impact of annual increases in payroll and occupancy costs and
current market lease rates for new stores and lease renewals.
Depreciation and Amortization. Depreciation and amortization in the
first quarter of 1999 was comparable to the prior year period. Increases to
depreciation and amortization resulting from new stores and other capital
expenditures were offset by decreases to depreciation and amortization resulting
from store closings.
Interest Expense. Interest expense in the first quarter of 1999 was net
of interest income of $1.5 million, resulting from higher cash balances during
the period and accounting for the decrease in interest expense from the first
quarter of 1998. The increase to interest expense from the 9 7/8% senior
subordinated notes issued in April 1998 was offset by decreases to interest
expense resulting from the repayment of the term loan and mortgage notes payable
in 1998 and no revolver borrowing activity during the first three months of
1999. See "Liquidity and Capital Resources."
Income Taxes. The effective income tax rates for the three months ended
March 31, 1999 and 1998 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.
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. The Company's
cash position is generally highest at the end of December because of the higher
sales volume during the Christmas season and extended payment terms typically
provided by most vendors for seasonal inventory purchases. The Company's cash
needs build during the first quarter as inventories are replenished following
the Christmas season and payments for seasonal inventory purchases become due.
The Company's practice has generally been to use the excess cash generated from
operations in the fourth quarter to repay all or a portion of the outstanding
revolver borrowings. The Company's cash position and any seasonal borrowings
outstanding at year end depend upon the sales performance during the Christmas
season, the timing of vendor payments and other cash flow requirements.
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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 of the 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. The $50 million term loan was repaid
in December 1998. At March 31, 1999 and December 31, 1998, the Company had no
outstanding revolver borrowings and had cash and cash equivalents of $55.9
million and $257.2 million, respectively. Borrowings under the revolving credit
facility are available up to a maximum of the lesser of (i) 60% of eligible
inventory or (ii) $125 million through the expiration of the credit agreement in
October 1999. Management expects that internally generated cash will be the
Company's primary source of capital in 1999. See "- Financing Activities."
The credit agreement 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 restrictions 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
March 31, 1999.
Operating Activities. Net cash used in operating activities (including
in 1998 the decrease in outstanding checks in excess of cash balances which
primarily relate to vendor payments) during the three months ended March 31,
1999 and 1998 was $195.8 million and $133.2 million, respectively. The reduction
in accounts payable, the most significant use of cash in each period, reflects
the effect of 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 $152.6 million in 1999 compared with
$104.2 million in 1998. The Company made income tax payments, net of refunds,
of $15.0 million in 1999 and received income tax refunds, net of payments, of
$0.1 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 Ended Twelve Months Ended
March 31, March 31,
--------------------- ----------------------
1999 1998 1999 1998
--------- --------- ---------- -----------
Openings:
Mall Stores................ 2 - 9 2
Superstores................ - - 7 1
Total (1)................ 2 - 16 3
Closings:
Mall Stores................ (8) (12) (24) (39)
Superstores................ - (1) - (1)
Total (1)................ (21) (13) (39) (45)
Net increase (decrease):
Mall Stores................ (6) (12) (15) (37)
Superstores................ - (1) 7 -
Total (1)................ (19) (13) (23) (42)
- ------------------------------------------------------
(1) The totals include other retail strategies.
The Company plans to add approximately 50 new stores in 1999. On Cue
and Media Play stores will account for the majority of the total new store
square footage and store count. In addition to store expansion, the Company also
plans to make upgrades to existing stores and to develop four e-commerce sites
targeted for launch 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
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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. Most of the Company's capital expenditures in 1998 related to the
remodeling, relocation and general upkeep of existing stores.
Financing Activities. Cash provided by financing activities (excluding
in 1998 the decrease in outstanding checks in excess of cash balances which
relate to vendor payments) was $0.1 million and $140.6 million during the three
months ended March 31, 1999 and 1998, respectively. The Company's primary source
of financing for the three months ended March 31, 1999 was internally generated
cash, which accounted for the decrease in cash and cash equivalents since
December 31, 1998 of $201.4 million. The Company had no revolver borrowing
activity during the three months ended March 31, 1999. The financing activities
in 1998 primarily related to revolver borrowings. The $141.0 million of revolver
borrowings for the three months ended March 31, 1998 were primarily used to
finance payments to vendors for seasonal inventory purchases and for purchases
to replenish inventories following the Christmas season.
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 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 $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 $1 million through
March 31, 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 microcontrollers
("Non-IT" systems), which include communication systems and certain equipment.
The Company has completed the Awareness and Assessment phases for all IT and
Non-IT systems and has completed the Implementation phase for nearly all of its
purchasing and store IT systems and its Non-IT
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systems and for the majority of its other IT systems. Year 2000 readiness for
substantially all IT and Non-IT systems is targeted for completion in the first
half 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 90% of
its purchase volume that their systems are Year 2000 compliant. 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.
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 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
- ---------- -----------------------------------------------------
10.9 Management Incentive Plan dated as of January 1, 1999
-------
10.20 Long Term Incentive Plan dated as of January 1, 1999
-------
- ----------------------------
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended March
31, 1999.
14
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MUSICLAND STORES CORPORATION
(Registrant)
By: /s/ Keith A. Benson
-------------------------------
Keith A. Benson
Vice Chairman, Chief Financial
Officer and Director
(authorized officer, principal
financial and accounting
officer)
Date: May 12, 1999
-------------------------------
15
THE MUSICLAND GROUP
MANAGEMENT INCENTIVE PLAN
*JANUARY 1, 1999
I. PURPOSE
The Management Incentive Plan (the "Plan") is designed to reward
participants who make significant contributions to the success of The
Musicland Group (the "Company"). The Plan recognizes the importance of
individual contributions to Company performance. Awards under this Plan
take into consideration such factors as the importance and impact of
each participant's accomplishments, the relative difficulty and the
degree of risk involved in those accomplishments, as well as Company
performance.
II. ADMINISTRATION
The Plan is administered by the Compensation Committee of the Company's
Board of Directors (the "Compensation Committee") who may delegate to
any other person or persons any ministerial duties of the Plan. In the
absence of a designated Compensation Committee, the Board as a whole
will act as the Compensation Committee. The Chief Executive Officer of
the Company (the "CEO") shall make recommendations to the Compensation
Committee regarding participation, level of awards, changes to the
Plan, annual funding percentages, and other aspects of the Plan's
administration.
The Compensation Committee has the authority to interpret the Plan,
and, subject to the Plan's provisions, to make and amend rules and to
make all other decisions necessary for the Plan's administration.
Specifically, the Compensation Committee has the authority to approve
funding percentages and to approve individual awards for participants
whose base salary is equal to or greater than an amount to be
designated by the Compensation Committee. The CEO has the authority to
approve individual awards for participants whose base salary is less
than the designated amount.
Each Plan Year will run from January 1 through the following December
31 (the "Plan Year").
III. PARTICIPATION
The CEO will recommend for approval by the Compensation Committee the
individuals who are eligible to participate in the Plan, and their
level of participation. All eligible participants will be given the
funding for their participation level and upon request a copy of this
Plan.
*The Plan is for Plan Year 1999 and each succeeding Plan Year and will
not be reissued unless there is a material change.
Page 1 of 6
<PAGE>
IV. INCENTIVE COMPENSATION MEASURES
Early each year the Compensation Committee will approve the business
goals on which incentive funds (the funding pool) will be made
available for awards to participants for such year, as well as a
performance range above and below such goals, and the amounts to be
made available for such awards at each level of business performance.
The percentage funding is a separate and distinct calculation from the
determination of individual awards (see V. below).
Actual business results for the year and their relation to such
pre-established ranges shall determine the amounts, if any, to be made
available for awards to designated participants. The actual business
results will be provided to the Compensation Committee by the Chief
Financial Officer. The Compensation Committee may approve adjustments
to actual business results to reflect non-recurring organizational,
operational, or other changes which have occurred during the year,
e.g., acquisitions, dispositions, expansions, contractions, material
non-recurring items of income or loss, or events which might create
unwarranted hardships or windfalls to participants.
The Compensation Committee will also determine the discretionary
incentive funds, if any, to be made available for awards to
participants based on their individual performance, such awards not to
be contingent upon the attainment of business goals.
V. DISTRIBUTION OF THE FUNDING POOL
The Compensation Committee approves the percentage of the funding pool
to be distributed each year. Up to, but no more than, 100% of the
funding pool can be approved for distribution.
Individual awards for participants whose base salary is equal to or
greater than an amount to be designated by the Compensation Committee
will be recommended by the CEO to the Compensation Committee for final
approval. Individual awards for participants whose base salary is below
the designated amount will be approved by the CEO.
Individual awards will be determined on the basis of 1) actual Company
performance compared to target business goals and if so designated by
the CFO, by 2) performance on their established objectives. For
participants assigned individual performance goals, up to 25% of their
individual award may be measured by their performance on individual
objectives. However, no payments shall be made based on individual
objectives until and unless the Company meets its threshold for
financial performance goals. Awards will be directly related to each
participant's contribution, considering such factors as importance and
impact of accomplishments as well as the difficulty and degree of risk
involved in those accomplishments.
Page 2 of 6
<PAGE>
Eligible salary is the employee's cumulative base salary earned while a
participant in the Plan during the Plan Year. In determining the base
salary earned during the Plan Year any delay in the receipt of a salary
increase from the customary date of increase will be ignored, and the
Participant will be deemed to have received the increase on the
customary date. No minimum award amount is guaranteed, as the Plan is
not intended to provide awards for marginally satisfactory performance
and the Plan makes no guarantee that individual awards will be equal to
the Plan funding percentage.
VI. PAYMENT OF AWARDS
Awards will consist of two parts, a cash payment and a deferred award,
as follows:
A. Eighty percent (80%) of the award will be paid in cash, less
applicable tax and FICA withholding, during the quarter
following the close of the plan year. It will be paid as soon
as 1) the Company performance results are available, 2)
individual achievements against objectives have been
determined and 3) all approvals have been obtained.
B. Twenty percent (20%) of the award will be made in the form of
a growth participation deferral which will increase or
decrease in value over a three year deferral period as
described below, proportionately to the increase or decrease
in Earnings Per Share (EPS) of The Musicland Group. However,
in no case shall the deferral be worth less than the original
amount.
For example: a participant whose total bonus for the 1999 Plan
Year is $10,000 will receive in the first quarter of 2000 a
cash payment of $8,000 (less applicable tax and FICA
withholding) and will receive a deferral award with a total
value of $2,000.
All deferral awards must be held to maturity before payment is
made in accordance with the following schedule and rules:
1. Maturity of the Award - Your deferral award will
mature in three equal annual increments with the
first increment maturing on the first anniversary
date of the end of the Plan Year for which the award
is made and subsequent increments maturing on the two
succeeding anniversary dates (said three year period
being the "Deferral Period"). Each matured portion of
the deferred award will be paid out during the first
quarter following the date maturity is reached, as
soon as the then current EPS has been calculated and
approved.
Page 3 of 6
<PAGE>
For example: if a participant receives a deferred
bonus award for the Plan Year ending 12-31-99, the
award will mature and be paid out in increments of
thirty-three and one third percent (33.3%) as
follows:
Date % Matured
Matured and Paid Out
-------- ------------
12-31-99 None
12-31-00 33.3% of the deferral award in 1st Q 2001
12-31-01 33.3% of the deferral award in 1st Q 2002
12-31-02 33.3% of the deferral award in 1st Q 2003
2. Eligibility of Receipt - If employment is terminated
for any reason during the Deferral Period (and even
if the participant is later re-employed prior to the
end of the Deferral Period), all non-matured portions
of the original deferral amount at the time of
termination are forfeited; except that in the event
termination is due to retirement, disability, death,
disposition of a portion of the business or transfer
to an ineligible position, payout may continue
according to the original schedule or may be made on
an accelerated basis, either at the discretion of the
CEO. In both cases the CEO shall determine the method
of valuation of such matured or non-matured portions
of the deferral award prior to pay out.
3. Calculation of each Matured Award - The value of your
deferral award will be determined on an annual basis
during the Deferral Period based upon changes in EPS.
The amount of each matured increment will be
calculated based on the Company's increase or
decrease in EPS at the end of each year during the
deferral period. For the purposes of determining each
deferral payout, we will establish a growth ratio by
comparing the then current EPS with the base EPS of
$1.04. However, in no case shall the deferral be
worth less than the original amount. This calculation
will occur three times during the deferral period as
each third of your performance deferral matures:
Calculation:
------------
Current EPS
Original X ----------- X .333 = payout
Deferral Amount $1.04
For example: for Plan Year 1999 the deferred portion
of a participant's award is $2,000. For the year end
12-31-2000 (the first time a portion of your award
matures) the EPS of the Company is $1.20. The growth
in EPS is 15.4%. Therefore, the value of your
original deferral for purposes of calculating a
payout on 12-31-2000 is $2,308. Your subsequent
payout would be $768 (33.3% of $2,308).
Page 4 of 6
<PAGE>
Continuing the example, the EPS of the Company at
year end 12-31-2001 is now $1.40. The growth in EPS
is 35% and therefore the value of your original
deferral is $2,692. Your payout would be $897
(33.3%). If in this example EPS had fallen to $.99
your deferred award would have a value of $2000,
since in no case will your award be less than the
original amount.
4. There is no guarantee of the value of your deferral,
as the value will fluctuate in accordance with the
Company's performance, or even that any award will be
paid since deferred compensation is subordinate to
the claims of creditors in the event of bankruptcy.
5. The Company reserves the right to cancel deferred
payment awards at any time after they have been
granted and for any reason. At the time of
cancellation, the value of any non-matured deferral
increments will be updated based upon the prior
rolling twelve months EPS for the period ending with
the most recently announced quarter end results. The
current value of the remaining increments, or the
value of remaining increments at the previous year
end, whichever is higher, will then be paid out
whether such increments have matured or not.
6. All payments under the deferral program will be made
in cash, less applicable tax and FICA withholding,
and will be considered income in the year paid out.
As an exception to the foregoing, and at the
Company's option, at the time of maturity any unpaid
deferral increments could be converted into an
appropriate number of shares of the publicly traded
stock which would be issued to the participant. The
conversion formula for such an exchange would be
recommended by the Chief Financial Officer, reviewed
by the Company's outside auditors, and approved by
the Board of Directors. Once a conversion formula is
approved, it cannot be challenged.
VII. AWARD CONDITIONS
A. Employees hired or promoted into eligible positions on or
before September 30 of the Plan Year will be eligible to
participate in the Plan. Employees hired or promoted into
eligible positions after September 30 may be eligible to
participate upon approval by the CEO. In both cases,
participation in the Annual Plan will be on a pro-rated basis,
determined by the number of full weeks of employment in an
eligible position.
B. A participant who is promoted, at any time other than at the
beginning of a Plan Year, into a position which calls for a
higher participation level will be eligible to receive an
award for that Plan Year which is a combination of pro-rated
awards calculated at the two participation levels.
Page 5 of 6
<PAGE>
C. A participant whose employment ends prior to December 31st of
a Plan Year due to retirement, disability, death, or
disposition of part of the business, or who is transferred to
an ineligible position prior to December 31st of a Plan Year,
may be eligible for a pro-rated annual award for that Plan
year, determined by the number of full weeks of employment in
an eligible position, upon approval by the CEO.
D. A participant whose employment terminates prior to December
31st of a Plan Year for reasons other than those listed in C
above will not be eligible for any award for that Plan Year.
E. A participant whose employment terminates after December 31st
of a Plan Year, but prior to the payment of awards, may be
eligible for an award for that Plan Year upon approval by the
CEO.
F. A participant who is on an approved unpaid leave of absence
during a Plan Year may be eligible for a pro-rated award for
that Plan Year upon approval by the CEO. A participant who is
on an approved paid medical leave of absence during a Plan
Year may be eligible for either a pro-rated or full award for
that Plan Year upon approval by the CEO.
G. Wherever in this Plan the CEO is given the authority to
approve a participant's eligibility for a full or partial
award, or to approve the pay out of any matured deferral
increment, such approvals may be made at his sole discretion.
VIII. GENERAL PROVISIONS
A. This Plan does not guarantee, explicitly or implicitly, the
right to continued employment for participants.
B. MIP awards will be pensionable earnings under the 1989 pension
plan. Legislation in effect at the time the award is approved
will govern how much of the MIP awards are pensionable or
non-pensionable earnings. Awards will be included in
pensionable earnings in the year they are paid.
C. This Plan can be terminated or its provisions changed at any
time by the Compensation Committee of the Board of Directors
acting upon the recommendation of the CEO.
Page 6 of 6
THE MUSICLAND GROUP
THREE-YEAR CYCLE
LONG TERM INCENTIVE PLAN
I. PURPOSE
The Long Term Incentive Plan (the "Plan") is designed to reward
participants who over time make significant contributions to the
success of The Musicland Group (the "Company"). The Plan recognizes the
importance of individual contributions to Company performance.
II. ADMINISTRATION
The Plan is administered by the Compensation Committee of the Company's
Board of Directors (the "Compensation Committee") who may delegate to
any other person or persons any ministerial duties of the Plan. In the
absence of a designated Compensation Committee, the Board as a whole
will act as the Compensation Committee. The Chief Executive Officer of
the Company (the "CEO") shall make recommendations to the Compensation
Committee regarding participation, level of awards, changes to the
Plan, annual funding percentages, and other aspects of the Plan's
administration.
The Compensation Committee has the authority to interpret the Plan,
and, subject to the Plan's provisions, to make and amend rules and to
make all other decisions necessary for the Plan's administration.
Plan Period will run from January 1st through December 31st of a
three-year period (the "Plan Period"). The three-year cycles overlap,
with a new three-year cycle beginning each year until the Plan is
terminated. 1998-2000 was the first three-year cycle of the Plan.
III. PARTICIPATION
Participation is limited to members of the Executive Committee. All
eligible participants will be given a copy of this Plan as well as the
funding for their participation level.
IV. INCENTIVE COMPENSATION MEASURES
At the beginning of the Plan Period the Compensation Committee will
approve the three year business goals as well as the performance range
above and below such goals, and the amount of award at each level of
business performance.
Actual business results for the three year Plan Period and their
relation to such pre-established ranges shall determine the amounts, if
any, of awards to designated participants. The actual business results
will be provided by the Chief Financial Officer. The Compensation
Committee may approve adjustments to actual business results to reflect
non-recurring organizational, operational, or other changes which have
occurred during the year, (e.g., acquisitions, dispositions,
expansions, contractions, material non-recurring items of income or
loss, or events which might create unwarranted hardships or windfalls
to participants.)
Page 1 of 3
<PAGE>
V. PAYMENT OF AWARDS
A. If the company achieves performance which is within the
established performance range for the three year Plan Period,
as adjusted by the Compensation Committee when appropriate,
participants earn the corresponding award. Dependent on the
performance measurement, awards are calculated using the total
of each of the three years of the Plan Period, or in the case
of percentages, the simple average of the three individual
years.
B. Awards are determined as a percentage of average annual base
earnings over the Plan Period and are paid after the final
year performance is determined and approved. Awards are paid
in cash, less applicable tax and FICA withholdings.
VI. AWARD CONDITIONS
A. Employees hired or promoted into eligible positions during the
Plan Period may be eligible to participate in the Plan upon
approval of the Compensation Committee. Participation for the
Plan Period in which the employee becomes eligible will be on
a pro-rated basis, determined by the number of full weeks of
employment in an eligible position.
B. A participant who is promoted, at any time other than at the
beginning of a Plan Period, into a position which calls for a
higher participation level will be eligible to receive an
award for that Plan Period which is a combination of pro-rated
awards calculated at the two participation levels.
C. A participant whose employment ends prior to the end of the
Plan Period due to retirement at age 55 or over, disability,
death, or disposition of part of the business, or who is
transferred to an ineligible position, may be eligible for a
pro-rated award, determined by the number of full weeks of
employment in an eligible position, upon approval by the
Compensation Committee.
D. A participant whose employment terminates prior to the end of
a Plan Period for reasons other than those listed in C above
will not be eligible for any award for that Plan Period except
as may be defined in a separate executed Employment Contract
or Change of Control Agreement.
E. A participant whose employment terminates after the last day
of the Plan Period, but prior to the payment of awards for
that Plan Period, may be eligible for an award for that Plan
Period upon approval by the Compensation Committee.
F. A participant who is on an approved unpaid leave of absence
during a Plan Period may be eligible for a pro-rated award for
that Plan Period upon approval by the Compensation Committee.
A participant who is on an approved paid medical leave of
absence during a Plan Period may be eligible for either a
pro-rated or full award for that Plan Period also upon
approval by the Compensation Committee.
Page 2 of 3
<PAGE>
G. Wherever in this Plan the Compensation Committee is given the
authority to approve a participant's eligibility for a full or
partial award, such approvals may be made at its sole
discretion.
VIII. GENERAL PROVISIONS
A. This Plan does not guarantee, explicitly or implicitly, the
right to continued employment for participants.
B. This Plan can be terminated or its provisions changed at any
time by the Compensation Committee of the Board of Directors.
Page 3 of 3
Exhibit 15
Letter re unaudited interim financial information
May 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 March 31,
1999, which includes our report dated April 27, 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 a report prepared
or certified by our firm within the meaning of Sections 7 and 11 of the Act.
Very truly yours,
ARTHUR ANDERSEN LLP
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet of Musicland Stores Corporation and subsidiaries
as of March 31, 1999, and the related consolidated statement of earnings
for the three-month period ended March 31, 1999, and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1999
<PERIOD-END> Mar-31-1999
<CASH> 55,856
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 405,868
<CURRENT-ASSETS> 485,912
<PP&E> 435,050
<DEPRECIATION> 207,338
<TOTAL-ASSETS> 723,159
<CURRENT-LIABILITIES> 355,634
<BONDS> 258,890
0
0
<COMMON> 361
<OTHER-SE> 65,647
<TOTAL-LIABILITY-AND-EQUITY> 723,159
<SALES> 401,797
<TOTAL-REVENUES> 401,797
<CGS> 258,220
<TOTAL-COSTS> 258,220
<OTHER-EXPENSES> 136,205
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,409
<INCOME-PRETAX> 1,963
<INCOME-TAX> 589
<INCOME-CONTINUING> 1,374
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,374
<EPS-PRIMARY> .04
<EPS-DILUTED> .04
</TABLE>
