UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the transition period from to
---- ----
Commission file number 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10400 Yellow Circle Drive,
Minnetonka, Minnesota 55343
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (612) 931-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
---
The aggregate market value of the voting stock held by nonaffiliates of
the Registrant on March 12, 1999 was approximately $340,250,739 based on the
closing stock price of $10 1/16 on the New York Stock Exchange on such date
(only directors and executive officers of the Registrant are considered
affiliates for this calculation).
The Registrant had 36,065,271 shares of common stock outstanding on
March 12, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held May 10, 1999 (the "Proxy Statement") are incorporated by
reference into Part III.
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PART I
ITEM 1. BUSINESS
General
The Company is the leading specialty retailer of prerecorded home
entertainment products in the United States and is one of the largest national
full-media retailers of music, video sell-through, books, computer software and
related products. The Company's stores operate 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 ("Suncoast"), and (ii) non-mall based full-media
superstores (the "Superstores"), operating under the trade names Media Play and
On Cue. At December 31, 1998, the Company operated 1,346 stores in 49 states,
the District of Columbia, the Commonwealth of Puerto Rico, the Virgin Islands
and the United Kingdom, with total store square footage of 8.3 million.
For the year ended December 31, 1998, the Company had consolidated
revenues of $1.8 billion and operating income, before depreciation and
amortization, of $124.3 million, both of which were records for the Company.
Net earnings in 1998 increased 172.2% to $38.0 million from $14.0 million in
1997. Diluted earnings per share were $1.04 in 1998 compared with $0.41 in
1997, an increase of 153.7%. The strong performance resulted primarily from
comparable store sales gains and gross margin improvements. Total comparable
store sales increased 6.7% in 1998 while gross margin improved to 35.5% from
34.8% in 1997. In April 1998, the Company completed an offering of $150 million
of 9 7/8% senior subordinated notes due in 2008, which, coupled with the
significant improvements in results of operations, enabled the Company to repay
all borrowings under its revolving credit and term loan facilities. Cash and
cash equivalents, which are generally highest at the end of December following
the Christmas season, reached $257.2 million by year end.
Capital expenditures of $27.2 million in 1998 were primarily for the
remodeling, relocation and general upkeep of existing stores. The relocated
stores typically involved moves to more prominent locations in the malls and
often replaced one or more smaller stores in the same mall. The Company monitors
store performance on an ongoing basis and closed a total of 31 stores during
1998. The Company opened 14 new stores in 1998. See "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Liquidity and
Capital Resources - Investing Activities."
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. In addition to store expansion, the Company also plans to make
upgrades to existing stores and to develop four e-commerce sites. The e-commerce
sites are targeted to launch late in the second quarter of 1999. Capital
expenditures in 1999 for these programs and other capital projects are expected
to be in the range of $40 million.
Musicland Stores Corporation ("MSC") was incorporated in Delaware in
1988 and acquired The Musicland Group, Inc. ("MGI") on August 25, 1988. MGI was
incorporated in Delaware in 1977 as a successor corporation to a number of
companies that participated in the music business as early as 1956. The
principal asset of Musicland Stores Corporation is 100% of the outstanding
common stock of MGI, and, since its formation, MSC has engaged in no independent
business operations. MSC and MGI, together with MGI's subsidiaries, are
collectively referred to herein as the "Company."
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Retail Strategies
The Company's management believes that its retail strategies are well
positioned to take advantage of favorable demographic and industry growth
trends. According to the Company's customer research, its retail stores appeal
to key demographic groups and are particularly popular with the "Echo-Boom"
generation. The number of young adults between the ages of 15 and 24 is expected
to grow by more than 8% over the next five years. To capitalize on the sales
growth potential of the new digital video disc technology ("DVD"), the Company's
stores carry the broadest available selection of DVD product. DVD has been
enthusiastically adopted by consumers and has become an accepted standard for
home theater.
Mall Stores
Sam Goody. Sam Goody is a well established music retailer offering a
broad product selection in an exciting, customer friendly shopping environment.
Sam Goody stores specialize in providing music entertainment products, including
compact discs, audio cassettes, music and movie videos, sheet music, musical
accessory items and music inspired apparel, posters and novelties. The music
stores are predominantly found in mall locations and range in size from 1,000 to
30,000 square feet, averaging 4,300 square feet. The larger music stores are
often in more prominent mall or downtown locations and carry a broader inventory
of catalog product, including substantial classical offerings and video
sell-through, to appeal to the high volume purchaser.
During 1998, the Company opened five new Sam Goody stores and closed 22
stores. In recent years, the Company has also relocated several stores. The
relocated stores typically involved moves to more prominent locations in the
malls and often replaced one or more smaller stores in the same mall. The moves
often provide Sam Goody with some exclusivity. A number of mall based music
chains have closed hundreds of stores as a result of adverse industry conditions
in the mid-1990s. Although the Company has also closed underperforming stores,
the Company was the single music retailer in 281 malls at the end of 1998. Most
of the music stores previously operated under the Musicland name have been
converted to the Sam Goody name.
At December 31, 1998, the Company operated 696 music stores in 49
states, the District of Columbia, the Commonwealth of Puerto Rico and the Virgin
Islands. The total square footage of music stores was approximately 3.0 million
square feet, or 36% of the Company's total store square footage, at December 31,
1998. The Company plans to open five to 10 new Sam Goody stores in 1999.
Suncoast. Suncoast is the dominant mall based video sell-through
retailer in the United States, emphasizing a broad product selection and
excellent customer service in an entertaining atmosphere. Suncoast stores
average 2,400 square feet in size and feature movies and special interest videos
complemented by Hollywood inspired apparel, posters and other products, as well
as blank video tapes, storage cases and other video related accessories. The
video categories include drama, adventure, family/animated, comedy and musicals,
as well as music video and instructional and other special interest videos. Most
movies on video cassette are priced at less than $20 and more than half sell for
less than $15. Each store also offers a wide selection of feature films and
videos for less than $10. Suncoast stores present DVD in a very visible display
in the front of its stores, with most of the DVD titles priced at $20 to $30.
At December 31, 1998, there were 405 Suncoast stores in 46 states, the
District of Columbia and the Commonwealth of Puerto Rico. The Company opened two
new Suncoast stores during 1998 and closed six stores. The total square footage
of Suncoast stores was approximately 1.0 million square feet, or 12% of the
Company's total store square footage, at December 31, 1998. The Company plans to
open five to 10 Suncoast stores in 1999.
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Superstores
Media Play Stores. Media Play is a full-media superstore retailer of
entertainment software products offering a superior assortment of home
entertainment products at competitive prices. Media Play stores operate
primarily in freestanding and regional strip mall locations in urban and
suburban areas. Media Play stores have achieved significant profitability
improvements in recent years through an expanded selection of higher margin
product categories, including entertainment related apparel and accessories,
musical instruments, children's merchandise and magazines, and a refined, more
efficient store prototype. Several existing stores have been downsized to the
current prototype, which is smaller by approximately 10,000 square feet from the
original prototype. Other factors contributing to Media Play's improvement
include tighter expense controls, increased emphasis on customer service and
employee training and upgraded operational logistics.
Media Play's extensive merchandise assortment provides customers with
one-stop shopping for music, books, movies and specialty videos, computer
software, computer games, storage products, personal/portable electronics and
licensed movie, music and sports apparel, as well as other media and related
products including magazines, trading cards, posters and toys. The stores
provide a family oriented and exciting shopping environment appealing to
customers of all ages and feature easy access to all merchandise categories,
lounge areas for relaxed browsing, convenient customer service areas, live
performances and an exciting M.P. Kids department. By early 1999, all Media Play
locations will have an expanded department called "Game Zone," where customers
can buy, sell and trade used video game software.
The Company opened one Media Play store in 1998 to fill in the Salt
Lake City market and plans to open three to five Media Play stores in 1999, all
of which will utilize the current store prototype. The Company also plans to
continue the downsizing of a select number of existing Media Play stores, which
currently average 47,000 square feet in size. At December 31, 1998, the Company
operated 69 Media Play stores in 19 states with total square footage of
approximately 3.3 million square feet, or 39% of the Company's total store
square footage.
On Cue Stores. On Cue is a full-media retailer located in small cities,
generally with populations between 10,000 and 30,000 people, providing a wide
assortment of entertainment products at competitive prices. On Cue stores
average 6,200 square feet in size and offer customers a convenient local store
to shop for music, books, videos, computer software, video games and related
products with superior customer service to encourage repeat business. On Cue
customers also have access to over 100,000 home entertainment titles through the
Company's special order program. Customer loyalty is rewarded through such
programs as in-store sweepstakes and unadvertised in-store specials.
The Company opened six On Cue stores and closed one store in 1998. At
December 31, 1998, the Company operated 162 On Cue stores in 28 states with
total square footage of approximately 1.0 million square feet, or 12% of the
Company's total store square footage. The Company plans to open 25 to 30 On Cue
stores in 1999.
Other Strategies
The Company plans to offer home entertainment products for sale on four
e-commerce sites beginning late in the second quarter of 1999. The sites will
offer a broad array and depth of entertainment products, including a full line
of music along with videos on both VHS and DVD, complemented by selected
licensed apparel, portable electronics, accessories, trend merchandise, sheet
music and music books, entertainment books, video games and entertainment soft-
ware, frequently cross-merchandised around entertainment personalities. The
e-commerce strategy will capitalize on the Company's existing strengths,
including strong store brands, nationwide presence, broad fashion-forward
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merchandise and state-of-the-art inventory and distribution systems. Most
e-commerce orders will be fulfilled from the Company's distribution facility in
Franklin, Indiana.
At December 31, 1998, the Company operated 14 music stores in the
United Kingdom under the name Sam Goody. The Company plans to close all stores
and cease operations in the United Kingdom by March 1999.
Products
Sales and percentage of total sales attributable to each product group
are as follows:
Years Ended December 31,
------------------------------------------------------
1998 1997 1996
--------------- ---------------- ---------------
Sales % Sales % Sales %
-------- ----- -------- ----- -------- -----
(dollars in millions)
Music............... $ 964.7 52.2 % $ 930.0 52.6 % $ 931.1 51.1 %
Video............... 531.0 28.8 509.1 28.8 531.2 29.2
Books, computer
software and
other products..... 351.2 19.0 329.2 18.6 359.3 19.7
-------- ----- -------- ----- -------- -----
Total......... $1,846.9 100.0 % $1,768.3 100.0 % $1,821.6 100.0 %
======== ===== ======== ===== ======== =====
Music. Sales of music, a market of approximately $13.7 billion in 1998,
are expected to grow at a compound annual rate of 5.5% through 2002, according
to the Recording Industry Association of America. The recent trend toward
greater diversity of available music product, particularly in the rap, rhythm
and blues, soundtrack, metal, Latin and alternative genres, appeals to the full
spectrum of music purchasers. Cross marketing between films and their
soundtracks, as well as the variety of music on the soundtrack, has increased
the popularity of and demand for movie soundtracks.
Sam Goody stores typically carry 4,500 to 8,500 compact disc titles,
depending upon store size and location, while the largest Sam Goody stores carry
up to 35,000 compact disc titles. Media Play and On Cue stores carry up to
40,000 and 7,000 compact disc titles, respectively. These titles include "hits,"
which are the best selling newer releases, and "catalog" items, which are older
but still popular releases that customers purchase to build their collections.
Video. The video sell-through market, including VHS and DVD, totaled an
estimated $8.9 billion in 1998. All of the Company's stores carry video titles
in DVD and video cassette formats. Suncoast and Media Play stores, in
particular, devote significant space and special displays to DVD product.
Suncoast stores feature up to 12,000 titles, including 1,800 in the DVD format.
Media Play stores carry up to 14,000 titles, including 1,800 DVD titles. Sam
Goody stores typically carry 500 DVD and 2,000 total titles, while the largest
Sam Goody stores carry up to 1,800 DVD and 10,000 total video titles. On Cue
stores carry up to 3,000 titles, including 500 DVD titles.
In 1998, the second year of DVD merchandising, the Company's DVD sales
increased to 11% of total video sales, from 2% in 1997, the year of DVD
introduction. The Company expects significant growth in DVD sales over the next
several years as more consumers purchase DVD players and more titles become
available on the DVD format. Prices for DVD players have reached affordable
price points, as low as $299 for some models, and are now available at many
large discount and mass market retailers. Paul Kagan Associates estimated that
as many as 1.1 million households would own a DVD player by the end of 1998 and
as many as 48 million households will own a DVD player by 2010. The Company's
stores do not offer Divx, a competing technology with a pay per play feature
incorporated into the current DVD technology.
Books, Computer Software and Other Products. Media Play and On Cue
stores carry up to 50,000 and 6,500 titles of books, respectively. Computer
software is available primarily in Media Play
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stores, which offer 2,000 computer software programs. "Other Products" include
video games, toys, brand name blank audio and video tapes, storage containers,
carrying cases and sheet music, as well as entertainment related apparel,
posters and various other items. Video games are offered in Media Play and On
Cue stores, while Media Play stores also allow customers to buy, sell and trade
used video games. Movie and artist related accessories and apparel products are
highly influenced by the trends and fads surrounding popular movies, TV shows,
actors and artists.
The Company's stores also carry a limited variety of electronic
equipment such as portable compact disc and audio cassette players, portable
stereo systems and kids' electronic products, all sold at retail prices under
$200. DVD players at retail prices of approximately $300 are currently offered
in a limited number of Media Play and On Cue stores and will be offered in all
On Cue stores by the second quarter of 1999. All On Cue and Media Play stores
now feature an area within each store where customers can purchase sheet music,
guitars, guitar strings and other related merchandise in an in-store boutique
called Jam Central.
Suppliers
Substantially all of the home entertainment products (other than
computer software) sold by the Company are purchased directly from
manufacturers. The Company purchases inventory for its stores from approximately
2,300 suppliers. Approximately 67% of purchases in 1998 were made from the 10
largest suppliers. The Company has no long-term contracts with its suppliers and
transacts business principally on an order-by-order basis as is typical
throughout the industry.
The Company has confirmed with vendors representing 86% its of
purchasing volume that their systems are Year 2000 compliant. Management
generally believes the remaining vendors will be able to complete the necessary
Year 2000 remediation efforts and that there is not likely to be a significant
disruption in product supply. See "Management's Discussion and Analysis of
Results of Operations and Financial Condition - Other Matters - Year 2000."
Marketing
The Company's marketing programs are designed to build each store's
brand image, encourage first time visits and reinforce store loyalty among
existing customers through a wide variety of traffic driving special events,
promotions and advertising partnerships with vendors and nationally recognized
corporations. Strong brand name recognition has enabled the Company to develop
marketing partnerships with such large corporate partners as Pepsi-Cola, Sears,
MasterCard, L'Oreal, Warner Lambert and Just Born Candies for cross promotions,
events and sweepstakes that the Company believes are attractive to shoppers. The
Company has been a co-sponsor of the nationally televised/advertised "UnVailed"
battle of the bands event, which appeals to its target customers. Specific
consumer segments are targeted through niche marketing concepts such as in-store
boutiques supported by signage and a customer information system. The Company's
major suppliers offer cooperative advertising support and provide funds for the
placement and position of product.
More than 500,000 Sam Goody store customers participate in the REPLAY
program, a frequent shopper program designed to promote customer loyalty and
encourage repeat visits through special offers, a bi-monthly membership
newsletter and targeted marketing. The Company publishes REQUEST, a cutting-edge
music and video entertainment news magazine for younger customers, distributed
in Sam Goody, Media Play and On Cue stores and also at limited magazine stand
outlets. The magazine has an annual audited circulation of six million copies
and an estimated readership in the millions. The REQUEST web site
requestmagazine.com offers downloadable sound clips of the music being reviewed
in the magazine.
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Store Operations
Sam Goody, Suncoast and On Cue stores are typically managed by a store
manager and an assistant manager. Media Play stores are typically managed by a
general manager, an assistant general manager and three to five department
managers. Most stores are open up to 80 hours per week, seven days a week. The
Company does not extend credit to customers, but most major credit cards are
accepted. The Company has completed and implemented the necessary Year 2000
remediations to nearly all of its store systems and has requested confirmation
of Year 2000 readiness from landlords and service providers to the stores.
Management generally believes that most third parties will have completed the
necessary Year 2000 remediation efforts and that there is not likely to be
significant disruptions in store operations. See "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Other Matters - Year
2000."
Industry and Competitive Environment
The retail home entertainment industry is highly competitive. The
Company's retail stores compete with large, established music and video chains,
such as those operated by Trans World Entertainment Corporation, The Wherehouse
and Tower Records, as well as consumer electronics superstores (Best Buy and
Circuit City), mass merchants (Wal-Mart, K-Mart and Target), other specialty
retail stores (Barnes & Noble and Borders), video rental stores, variety
discounters and warehouse clubs, some of which may have greater financial or
other resources than the Company. There has been a recent trend in the industry
of consolidation of competitors, such as the acquisition of the Blockbuster
Music chain by The Wherehouse, Inc. and the pending acquisition of the Camelot
chain by Trans World Entertainment Corporation.
In addition to retail stores, consumers receive television and mail
order offers and have access to mail order clubs. The largest mail order clubs
are affiliated with major manufacturers of pre-recorded music and video and may
have advantageous marketing relationships with their affiliates. In recent
years, the Internet has emerged as an avenue for retailing. In particular, the
retailing of music, video and books over the Internet is developing rapidly.
Competitors on the Internet include Amazon, Barnes & Noble, CDnow and others.
The Company does not believe that, to date, sales via the Internet have
materially affected its sales, but Internet sales are expected to become more
significant over time. The Company has announced that it will also sell on the
Internet beginning late in the second quarter of 1999.
It has been the practice in recent years for companies in the home
entertainment industry to announce various initiatives and innovations in
technology which are associated with alternative forms of distribution of both
music and video. While most of these technologies are not yet commercially
available, and it appears that significant technical, economic and other
obstacles to their introduction remain to be resolved, if and when these or
other new technologies are introduced, the Company's business could be impacted.
Seasonality
The Company's business is highly seasonal, with nearly 40% of annual
revenues and all of net earnings generated in the fourth quarter. Quarterly
results are affected by, among other things, the timing and strength of new
product offerings, the timing of holidays, new store openings and sales
performance of existing stores. See Note 17 of Notes to Consolidated Financial
Statements.
Trademarks and Service Marks
The Company operates its stores under various names, including "Sam
Goody," "Musicland," "Suncoast Motion Picture Company," "Media Play" and "On
Cue," which have become important to the Company's business as a result of its
advertising and promotional activities. These names, along with a
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number of others, including "REQUEST" and "REPLAY," have been registered with
the U.S. Patent and Trademark Office.
Personnel
As of February 22, 1999, the Company employed approximately 5,700
full-time employees and 9,900 part-time employees. Hourly employees at 15 of the
Company's stores are represented by a union. All other facilities are non-union
and the Company believes that its employee relations are good.
ITEM 2. PROPERTIES
Corporate Headquarters and Distribution Facilities. The Company owns
its corporate headquarters facility in Minneapolis, Minnesota, consisting of
an office building with approximately 94,000 square feet of space on
approximately 5.4 acres of land. Additional office, warehouse and storage space
located in Minneapolis, Minnesota totaling approximately 150,000 square feet are
under operating leases that expire at various dates through February 2002. The
Company owns its distribution facilities located in Franklin, Indiana,
consisting of a 715,000 square foot building on approximately 66.6 acres of
land, with options on approximately 33.4 additional acres of land. The Company
also has approximately 105,000 square feet of storage space in a building
located in Indianapolis, Indiana, under an operating lease expiring in January
2000.
Retail Stores. At December 31, 1998, the Company operated 1,346 retail
stores, including 1,323 stores in the United States, seven stores in Puerto
Rico, two stores in the Virgin Islands and 14 stores in the United Kingdom. The
Company owns three Media Play stores. All other stores are under operating
leases with various remaining terms through 2016. The leases have noncancelable
terms that generally range from three to 20 years and many include renewal
options for additional periods. Certain store leases provide the Company with an
early cancellation option if sales for a designated period do not reach a
specified level as defined in the lease. Most of the store leases contain
escalation clauses and require payment of real estate taxes, utilities, common
area maintenance costs and contingent rentals based on percentages of sales in
excess of specified minimums. Certain store leases contain provisions
restricting assignment, merger, change of control or transfer. The following
table lists the number of store leases due to expire or terminate in each fiscal
year based on the fixed lease term, giving effect to early cancellation options
and excluding renewal options.
1999....................... 246 2004...................... 144
2000....................... 234 2005...................... 111
2001....................... 191 2006...................... 44
2002....................... 120 2007...................... 13
2003....................... 166 2008 and thereafter....... 74
Of the 480 leases expiring in 1999 and 2000, 193 have renewal options.
The Company anticipates closing up to 30 stores and relocating 20 to 30 stores
that either are underperforming or are part of a strategy to open stores in more
prominent locations in the malls to replace one or more smaller locations in the
same mall. The Company expects that, as other leases expire, in most cases it
should be able either to obtain renewal leases, if desired, or to obtain leases
for other suitable locations.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business. It is the opinion of management
that the ultimate resolution of these matters will not have a material adverse
effect on the financial position or results of operations of the Company.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders by MSC during
the fourth quarter of the year ended December 31, 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of MSC is traded on the New York Stock Exchange under
the symbol MLG. For common stock price information, see Note 17 of Notes to
Consolidated Financial Statements. As of March 12, 1999, MSC had approximately
476 holders of record of its common stock.
MSC has never paid cash dividends on its capital stock and does not
plan to pay cash dividends in the foreseeable future. The current policy of the
Board of Directors of MSC is to reinvest in the business of the Company. The
terms of the Company's credit agreement and the indentures for the 9% and 9 7/8%
senior subordinated notes restrict the amount of cash dividends that may be paid
by MSC. See Note 5 of Notes to Consolidated Financial Statements.
Shares of common stock purchasable upon exercise of warrants were
issued pursuant to an exemption from registration under Section 4(2) and/or
Regulation D of the General Rules and Regulations promulgated under the
Securities Act of 1933 as a sale by the issuer not involving a public offering.
The warrants were issued in June 1997 to 12 accredited investors and are
exercisable over a period of five years at a price of $1.5625 per share. No
underwriters were used for either the issuance or the exercise of the warrants.
During the quarterly period ended December 31, 1998, 140,626 shares of common
stock were issued for the cashless exercise of warrants on December 1, 1998 by
The Long-Term Credit Bank of Japan, Ltd., Chicago Branch. Canceled in connection
with the warrant exercise were 14,250.77 warrants for the purchase of common
stock and 0.64 warrants for fractional shares.
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the years
indicated. This information should be read in conjunction with the Consolidated
Financial Statements and related notes contained in Item 14 and "Management's
Discussion and Analysis of Results of Operations and Financial Condition"
contained in Item 7.
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share amounts and store data)
Years Ended December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
Statement of
Operations Data:
Sales................ $1,846,882 $1,768,312 $1,821,594 $1,722,572 $1,478,842
Gross profit......... 656,300 614,829 611,759 606,070 542,199
Selling, general
and administrative
expenses............ 532,018 529,427 576,658 525,213 450,919
Depreciation and
amortization........ 39,471 39,411 44,819 45,531 37,243
Goodwill write-down.. - - 95,253 138,000 -
Restructuring
charges............. - - 75,000 - -
Operating income
(loss)............... 84,811 45,991 (179,971) (102,674) 54,037
Interest expense..... 30,478 31,720 32,967 27,881 19,555
Earnings (loss)
before income
taxes............... 54,333 14,271 (212,938) (130,555) 34,482
Income taxes......... 16,300 300 (19,200) 5,195 17,100
Net earnings
(loss).............. 38,033 13,971 (193,738) (135,750) 17,382
Earnings (loss) per
common share:
Basic............. $ 1.10 $ .42 $ (5.80) $ (4.00) $ 0.51
Diluted........... 1.04 .41 (5.80) (4.00) 0.51
December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
Balance Sheet Data:
Total assets......... $ 973,640 $ 733,895 $ 996,915 $ 996,957 $1,079,632
Long-term debt,
including current
maturities.......... 258,871 193,087 396,599 163,000 110,000
Stockholders'
equity.............. 63,982 18,770 2,619 195,811 340,276
Store Data:
Total store square
footage(in
millions).......... 8.3 8.3 9.5 9.9 7.2
Store count:
Sam Goody stores... 696 713 777 820 869
Suncoast stores.... 405 409 422 412 378
Media Play
stores............ 69 68 87 89 46
On Cue stores...... 162 157 158 153 77
United Kingdom and
other stores...... 14 16 22 22 16
---------- ---------- ---------- ---------- ----------
Total.......... 1,346 1,363 1,466 1,496 1,386
========== ========== ========== ========== ==========
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
Results of Operations
The following table presents certain operating and store data for Mall
Stores, Superstores and in total for the Company for the last three years.
Because both Mall Stores and Superstores are supported by centralized corporate
services and have similar economic characteristics, products, customers and
retail distribution methods, the stores are reported as a single operating
segment.
Years Ended December 31,
-----------------------------------------
1998 1997 1996
---------- ---------- ------------
(dollars and square footage in millions)
Operating Data:
Sales:
Mall Stores........................ $ 1,206.8 $ 1,165.0 $ 1,160.0
Superstores........................ 627.9 589.5 643.8
Total (1)....................... 1,846.9 1,768.3 1,821.6
Percentage change from
prior year:
Mall Stores........................ 3.6 % 0.4 % (2.3)%
Superstores........................ 6.5 (8.4) 24.6
Total (1)....................... 4.4 (2.9) 5.7
Comparable store sales
increase (decrease) (2):
Mall Stores........................ 6.5 % 4.7 % (1.7)%
Superstores........................ 7.2 4.1 2.0
Total (1)....................... 6.7 4.5 (0.6)
Operating income before
depreciation and amortization,
goodwill write-down and
restructuring charges................ $ 124.3 $ 85.4 $ 35.1
Store Data:
Number of stores open at
year end:
Mall Stores ....................... 1,101 1,122 1,199
Superstores........................ 231 225 245
Total (1)....................... 1,346 1,363 1,466
Total store square footage at
year end:
Mall Stores........................ 4.0 4.0 4.3
Superstores........................ 4.3 4.2 5.2
Total (1)....................... 8.3 8.3 9.5
- -------------------------------------
(1) The totals include United Kingdom and other stores.
(2) Comparable store sales percentages are computed for stores open for a full
year during each year.
The Company achieved record sales and earnings for the year ended
December 31, 1998. Net earnings for the year ended December 31, 1998 rose 172.2%
to $38.0 million compared with $14.0 million for the year ended December 31,
1997. Diluted earnings per share increased 153.7% to $1.04 in 1998 compared with
diluted earnings per share in 1997 of $0.41. The earnings improvements resulted
primarily from comparable store sales increases and gross margin improvements.
Sales. The increases in total sales for the year ended December 31,
1998 were attributable primarily to the comparable store sales increases,
partially offset by the decrease in sales from the closing of stores. The
comparable store sales gains were attributable primarily to sales increases in
music and video. Soundtracks from popular movies, led by the soundtrack from the
movie "Titanic," as well as the diverse popularity of music titles, contributed
to the growth in music sales. The movie "Titanic," released on video in
September 1998, produced the strongest sales for a video title in the Company's
history.
10
<PAGE>
Comparable store sales growth in 1997 was led by significant gains in
music, driven by strong sales of new releases. Gains were also achieved in toys,
apparel and video games. These gains were partially offset by flat comparable
store sales in video and a decline in book sales, due in part to a reduction in
the number of book titles offered by the Superstores. Comparable store sales in
video were slowed by the lack of depth in new releases other than strong sales
of the "Star Wars Trilogy Special Edition" video set released during the third
quarter of 1997. The Company benefited from a less competitive environment due
to the closing of stores by certain mall competitors and less near or below cost
pricing of music product by certain non-mall competitors. The reductions in
total sales in 1997 resulted from the decreased store count and square footage
from closing stores.
The following table shows the comparable store sales percentage
increase (decrease) attributable to each of the Company's two principal product
categories for the last three years.
Years Ended December 31,
-----------------------------------
1998 1997 1996
-------- -------- --------
Music......................... 6.4 % 7.5 % 0.9 %
Video......................... 5.7 0.2 (0.8)
Industry data and demographics indicate significant sales growth
opportunities in the music, video and video game product categories,
particularly in the new DVD format. DVD sales accelerated throughout 1998 at a
pace that exceeded management's expectations. The Company's DVD sales were in
excess of $50 million, or 11% of total video sales, for the year ended December
31, 1998, compared with 2% of total video sales in 1997, the year of DVD
introduction. See "Business - Products."
Components of Earnings. The following table sets forth certain
operating results as a percentage of sales for the last three years.
Years Ended December 31,
-----------------------------
1998 1997 1996
-------- -------- -------
Sales................................... 100.0% 100.0% 100.0%
Gross profit............................ 35.5 34.8 33.6
Selling, general and administrative
expenses............................... 28.8 29.9 31.7
Operating income before depreciation
and amortization, goodwill write-down
and restructuring charges.............. 6.7 4.8 1.9
Operating income (loss)................. 4.6 2.6 (9.9)
Gross Profit. Most of the gross margin improvement in 1998 was
attributable to less promotional pricing and selective price increases made
during the second half of 1997 and in 1998. Inventory shrinkage decreased in
1998 and accounted for 0.2% of the gross margin improvement.
Approximately 1.3% of the gross margin improvement in 1997 was
attributable to price increases and less promotional pricing. The proportion of
sales from the lower margin Superstores relative to total Company sales
decreased during 1997 due to store closings and resulted in an improvement in
total Company gross margin of 0.3%. Inventory shrinkage increased in 1997 and
reduced gross margin by 0.4%.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses in 1998 increased slightly over 1997, but decreased as a
percentage of sales by 1.1%. The decrease in the expense rate was attributable
to the comparable store sales increases and the continued benefit of cost saving
initiatives that began in 1997. The consolidation of distribution facilities
into a single facility, completed in January 1997, resulted in greater operating
efficiency and lower distribution costs. Advertising effectiveness was improved
while advertising expenditures were decreased by focusing resources on a wide
range of traffic driving events and promotions and by partnering with vendors
and nationally recognized corporations.
11
<PAGE>
The decrease in selling, general and administrative expenses in 1997
compared with 1996 was primarily due to store closings and the reductions in
distribution and advertising expenses discussed previously, which also reduced
selling, general and administrative expenses as a percentage of sales.
Comparable store sales gains in 1997 also contributed to the rate improvements.
The expense rate in 1996 was negatively impacted by the effect of fixed costs,
principally occupancy costs, in both underperforming existing stores and new
Media Play stores opened in 1995 and 1996. Many of these underperforming stores
were closed under the Company's restructuring programs. See "- Restructuring
Charges."
Depreciation and Amortization. Depreciation and amortization in 1998
was comparable to 1997. Increases to depreciation and amortization resulting
from capital expenditures and the Company's distribution facility in Franklin,
Indiana, were offset by decreases to depreciation and amortization resulting
from store closings. In 1997, depreciation and amortization decreased from 1996
due to store closings and the elimination of goodwill. Goodwill amortization was
$3.0 million, or $0.09 per share, in 1996. See "Liquidity and Capital Resources
- - Investing Activities."
Goodwill Write-down. In December 1996, the Company recorded a goodwill
write-down of $95.3 million, or $2.85 per share, eliminating the remaining
goodwill balance and goodwill amortization for years after 1996. See Note 2 of
Notes to Consolidated Financial Statements.
Restructuring Charges. During 1996, the Company recorded pretax
restructuring charges of $75.0 million for the estimated cost of programs
designed to improve profitability and increase inventory turnover. The
restructuring programs included the closing of the Company's distribution
facility in Minneapolis, Minnesota, and 114 underperforming stores, including 79
Mall Stores and 35 Superstores. The Company closed 53 of these stores in 1996
and completed the restructuring programs in 1997 with the closing of the
distribution facility and another 61 stores. See "- Liquidity and Capital
Resources - Investing Activities" and Note 3 of Notes to Consolidated Financial
Statements.
Interest Expense. Components of interest expense for the last three
years were as follows:
Years Ended December 31,
-----------------------------
1998 1997 1996
------ ------ ------
(in millions)
Interest on revolver borrowings......... $ 3.5 $ 19.0 $ 21.9
Interest on term loan................... 3.6 1.2 -
Interest on senior subordinated notes... 20.8 9.9 9.9
Other interest, net..................... 2.6 1.6 1.2
------ ------ ------
$ 30.5 $ 31.7 $ 33.0
====== ====== ======
The fluctuations in interest expense in 1998 and 1997 compared with
1996 resulted from improvements in operating performance, the issuance of $150
million of 9 7/8% senior subordinated notes in April 1998 and the term loan
proceeds received in September 1997, all of which have led to lower outstanding
revolver borrowings. See "Liquidity and Capital Resources." Average daily
revolver borrowings, based upon the number of days with outstanding borrowings,
weighted average interest rates, based on the average daily revolver borrowings,
and the highest balances outstanding under the revolving credit facility were as
follows:
12
<PAGE>
Years Ended December 31,
----------------------------
1998 1997 1996
------ ------- -------
(dollars in millions)
Average daily revolver borrowings...... $ 56.4 $238.5 $289.7
Number of days with outstanding
revolver borrowings................... 201 362 366
Weighted average interest rate,
excluding facility costs.............. 7.8% 7.4% 7.0%
Highest level of revolver borrowings... $152.0 $273.0 $333.0
Most of the increases in interest rates in 1998 and 1997 resulted from
amendments to the Company's credit agreement which increased the margin added to
variable interest rates on revolver borrowings. For the years ended December
31, 1998, 1997 and 1996, the Company incurred facility costs related to the
revolving credit facility of $1.1 million, $1.5 million and $1.7 million,
respectively. See Note 5 of Notes to Consolidated Financial Statements.
Income Taxes. The effective income tax rates of 30.0% in 1998, 2.1% in
1997 and 9.0% in 1996 vary from the federal statutory rate as a result of
deferred tax valuation allowances and state income taxes. The effective income
tax rate in 1996 was also impacted by the goodwill amortization and write-down,
which are nondeductible. Valuation allowances reduce deferred income tax
balances to the approximate amount of recoverable income taxes based on
assessments of taxable income within the carryback or carryforward periods for
each year. Valuation allowances of $24.5 million, established in 1996, were
reduced by $4.0 million and $7.5 million in 1998 and 1997, respectively. See
Note 6 of Notes to Consolidated Financial Statements.
Recently Issued Accounting Standards. Accounting Standards Executive
Committee Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), issued in March
1998 and effective for fiscal years beginning after December 15, 1998, provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. SOP 98-1 requires all costs related to the development of
internal-use software other than those incurred during the application
development stage to be expensed as incurred. Costs incurred during the
application development stage are required to be capitalized and amortized over
the estimated useful life of the software. The Company plans to adopt SOP 98-1
effective with the first quarter of 1999. Adoption is not expected to have a
material effect on the Company's financial position or results of operations.
Accounting Standards Executive Committee Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), issued in April
1998 and effective for fiscal years beginning after December 15, 1998, requires
an entity to expense all start-up activities, including preopening and
organization costs, as incurred. The Company is currently in compliance with the
provisions of SOP 98-5, and, accordingly, the adoption of SOP 98-5 will not
impact the Company's financial position or results of operations.
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.
13
<PAGE>
The Company's financial position has strengthened during both 1998 and
1997 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. At December 31, 1998
and 1997, the Company had no outstanding revolver borrowings and had cash and
cash equivalents of $257.2 million and $3.9 million, respectively. The Company
repaid the $50 million term loan in December 1998 with excess cash generated
from Christmas season sales. Effective with the repayment of the term loan,
borrowings under the revolving credit facility are available up to a maximum of
the lesser of (i) 60% of eligible inventory or (ii) $182 million through March
15, 1999 and $125 million from March 16, 1999 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" and Note 5 of Notes to Consolidated Financial Statements.
The credit agreement contains financial covenants and covenants that
limit additional indebtedness, liens, capital expenditures and cash dividends.
The 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
December 31, 1998.
Operating Activities. Net cash provided by (used in) operating
activities (including the increase (decrease) in outstanding checks in excess of
cash balances which relate to vendor payments) was $215.6 million in 1998, $86.7
million in 1997 and $(52.6) million in 1996. The significant increases in
operating cash flows in 1998 and 1997 over the previous years were attributable
to inventory purchasing activities and improvements in operating performance.
Inventory purchasing activities, as reflected by the aggregate net changes in
inventories, accounts payable and outstanding checks in excess of cash balances,
generated cash flows of $98.8 million and $6.4 million in 1998 and 1997,
respectively. At December 31, 1998, although inventories remained comparable to
the prior year, accounts payable increased by $107.3 million over December 31,
1997, reflecting normal extended payment terms for seasonal inventory purchases
as well as later purchases of seasonal inventory. Cash used for inventory
purchases in 1997 was more than offset by the savings resulting from reduced
inventory levels. The consolidation of distribution centers into a single
facility, store closings and initiatives designed by management to increase
inventory turnover, including better in-stock positions and more frequent
purchases closer to the time of sale, enabled the Company to maintain lower
inventory levels during 1997, which decreased inventories at December 31, 1997
to $450.3 million from $506.1 million at December 31, 1996. Cash used for
inventory purchasing activities in 1996 of $38.9 million was impacted by early
payments made to certain vendors to obtain discounts and to ensure continued
availability of product. In the first quarter of 1997, the Company's largest
vendors and most of its remaining vendors agreed to temporarily defer existing
trade payables and provide continued product supply, subject to payment terms
reduced to 10 days or less on new purchases. The Company completed repayment of
the deferred trade payables during the fourth quarter of 1997 and since then has
been on normal credit terms with its vendors.
The Company made income tax payments, net of refunds, of $0.9 million
and $9.0 million in 1998 and 1996, respectively. In 1997, the Company received
income tax refunds, net of payments, of $22.9 million from the carryback of the
1996 taxable loss. Cash expenditures related to store closings under the
Company's restructuring programs were $12.2 million and $24.1 million in 1997
and 1996, respectively.
14
<PAGE>
Investing Activities. Capital expenditures and store data for the last
three years are as follows:
Years Ended December 31,
--------------------------
1998 1997 1996
------ ------ ------
Capital expenditures, net of
sale/leasebacks (in millions) .......... $ 27.2 $ 10.9 $ 6.4
Store openings:
Mall Stores........................... 7 2 14
Superstores........................... 7 1 19
Total (1).......................... 14 3 35
Store closings:
Mall Stores........................... (28) (79) (47)
Superstores........................... (1) (21) (16)
Total (1).......................... (31) (106) (65)
Net increase (decrease) in store count:
Mall Stores........................... (21) (77) (33)
Superstores........................... 6 (20) 3
Total (1).......................... (17) (103) (30)
- ------------------------
(1) The totals include United Kingdom and other stores.
Most of the Company's capital expenditures in 1998 and 1997 related to
the remodeling, relocation and general upkeep of existing stores. In 1996, the
majority of capital expenditures were for new Media Play stores. The number of
stores closed under the Company's restructuring programs were 61 stores and 53
stores in 1997 and 1996, respectively. All other closings resulted from the
Company's ongoing monitoring of store performance. See "- Results of Operations
- - Restructuring Charges" and Note 3 of Notes to Consolidated Financial
Statements.
Financing of capital expenditures has generally been provided by
borrowings under the revolving credit facility and internally generated cash.
The Company typically receives financing from landlords in the form of
contributions and rent abatements for a portion of the capital expenditures,
primarily related to new stores and relocations of existing stores. In the third
quarter of 1996, net proceeds of $11.6 million were received from the sale of
the building containing the Company's distribution facilities and certain
corporate office facilities in Minneapolis, Minnesota. The Company leased back
the entire building through January 1997 and since then leases a portion of the
office facilities. Capital expenditures exclude approximately $14 million for
three new Media Play stores opened in 1996 and $30 million for the new Franklin
distribution facility and most of the related equipment, which were financed
through special purpose entities. See Note 16 of Notes to Consolidated Financial
Statements.
The Company's planned capital expenditures for 1999 are expected to be
in the range of $40 million and will include moderate store expansion and
improvements to existing stores. 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 the coming years, if the closings
can be accomplished economically.
Financing Activities. Cash provided by (used in) financing activities
(excluding the increase (decrease) in outstanding checks in excess of cash
balances which relate to vendor payments) was $64.8 million, $(233.8) million
and $219.0 million during the years ended December 31, 1998, 1997 and 1996,
respectively. Financing activities in 1998 include net proceeds of $144.3
million received by the Company from the offering of $150 million of 9 7/8%
senior subordinated notes. The net proceeds were used to repay $32.1 million of
outstanding mortgage notes payable and to reduce outstanding revolver
borrowings. Excess cash generated from strong Christmas season sales in 1998 and
1997 was used to repay the $50 million term loan in December 1998 and all
outstanding revolver borrowings by the end of each year. At December 31, 1996,
the Company had revolver borrowings of $272.0 million, or $110.0
15
<PAGE>
million when netted with $162.0 million of cash and cash equivalents. The
higher level of revolver borrowings in 1996 as compared to 1998 and 1997 was
primarily due to diminished liquidity that had resulted from the challenging
retail sales environment experienced by the Company and the negative impact of
underperforming stores.
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
Inflation, Economic Trends and Seasonality. Although its operations are
affected by general economic trends, the Company does not believe that inflation
has had a material effect on the results of its operations during the past three
fiscal years. The Company's business is highly seasonal, with nearly 40% of
annual revenues and all of net earnings generated in the fourth quarter. See
Note 17 of Notes to Consolidated Financial Statements for quarterly financial
data.
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
December 31, 1998. 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 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.
16
<PAGE>
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 86% 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 annual report on Form 10-K 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.
17
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company holds no derivative instruments and does not engage in
hedging activities. Information about fair value of financial instruments is
included in Note 14 of Notes to Consolidated Financial Statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and related notes are included in
Item 14 of this report. See Index to Consolidated Financial Statements contained
in Item 14 herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
.
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by these items of Part III will be set forth
in the Proxy Statement under similar captions and is incorporated herein by
reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K
(a) Documents filed as a part of this report:
(1) Consolidated Financial Statements
See Index to Consolidated Financial Statements on page 21.
(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they
are not required or are not applicable, or because the
information required to be set forth therein either is not
material or is included in the Consolidated Financial
Statements or related notes.
(3) Exhibits
See Exhibit Index on pages 40 through 42.
18
<PAGE>
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
fourth quarter of the year ended December 31, 1998.
(c) Exhibits
See Exhibit Index on pages 40 through 42.
(d) Other Financial Statements
Not applicable.
19
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MUSICLAND STORES CORPORATION
(Registrant)
By: /s/ Jack W. Eugster
----------------------------------------
Jack W. Eugster, Chairman of the Board,
President and Chief Executive Officer
Date: March 24, 1999
---------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Capacity Date
--------- -------- ----
Chairman of the Board, President
and Chief Executive Officer
/s/ Jack W. Eugster (principal executive officer) March 24, 1999
- ---------------------------
Jack W. Eugster
Vice Chairman, Chief Financial
Officer and Director
(principal financial and
/s/ Keith A. Benson accounting officer) March 24, 1999
- ---------------------------
Keith A. Benson
/s/ Gilbert L. Wachsman Vice Chairman and Director March 24, 1999
- ---------------------------
Gilbert L. Wachsman
/s/ Kenneth F. Gorman Director March 24, 1999
- ---------------------------
Kenneth F. Gorman
/s/ William A. Hodder Director March 24, 1999
- ---------------------------
William A. Hodder
/s/ Josiah O. Low III Director March 24, 1999
- ---------------------------
Josiah O. Low III
/s/ Terry T. Saario Director March 24, 1999
- ---------------------------
Terry T. Saario
/s/ Tom F. Weyl Director March 24, 1999
- ---------------------------
Tom F. Weyl
/s/ Michael W. Wright Director March 24, 1999
- ---------------------------
Michael W. Wright
20
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Report of Independent Public Accountants 22
Consolidated Statements of Operations 23
Consolidated Balance Sheets 24
Consolidated Statements of Cash Flows 25
Consolidated Statements of Stockholders' Equity 26
Notes to Consolidated Financial Statements 27
21
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Musicland Stores Corporation:
We have audited the accompanying consolidated balance sheets of
Musicland Stores Corporation (a Delaware Corporation) and Subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, cash flows and stockholders' equity for each of the three years in
the period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Musicland Stores
Corporation and Subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
January 18, 1999
22
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------
1998 1997 1996
------------- ------------- ------------
Sales............................. $ 1,846,882 $ 1,768,312 $ 1,821,594
Cost of sales..................... 1,190,582 1,153,483 1,209,835
------------- ------------- ------------
Gross profit.................. 656,300 614,829 611,759
Selling, general and
administrative expenses.......... 532,018 529,427 576,658
Depreciation and amortization..... 39,471 39,411 44,819
Goodwill write-down............... - - 95,253
Restructuring charges............. - - 75,000
------------- ------------- ------------
Operating income (loss)....... 84,811 45,991 (179,971)
Interest expense.................. 30,478 31,720 32,967
------------- ------------- ------------
Earnings (loss) before
income taxes................. 54,333 14,271 (212,938)
Income taxes ..................... 16,300 300 (19,200)
------------- ------------- ------------
Net earnings (loss) .......... $ 38,033 $ 13,971 $ (193,738)
============= ============= ============
Basic earnings (loss) per
common share..................... $ 1.10 $ 0.42 $ (5.80)
============= ============= ============
Diluted earnings (loss) per
common share..................... $ 1.04 $ 0.41 $ (5.80)
============= ============= ============
See accompanying Notes to Consolidated Financial Statements.
23
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
December 31,
---------------------------
1998 1997
-------------- ------------
ASSETS
Current assets:
Cash and cash equivalents...................... $ 257,218 $ 3,942
Inventories.................................... 446,710 450,258
Deferred income taxes.......................... 15,800 10,600
Other current assets........................... 10,395 8,768
------------ ------------
Total current assets......................... 730,123 473,568
Property, net..................................... 233,424 250,021
Deferred income taxes............................. - 2,400
Other assets...................................... 10,093 7,906
------------ ------------
Total Assets................................. $ 973,640 $ 733,895
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt........... $ - $ 26,657
Accounts payable............................... 452,410 357,183
Other current liabilities...................... 154,743 115,660
------------ ------------
Total current liabilities.................... 607,153 499,500
Long-term debt.................................... 258,871 166,430
Other long-term liabilities....................... 43,634 49,195
Commitments and contingent liabilities
Stockholders' equity:
Preferred stock ($.01 par value; shares
authorized: 5,000,000; shares issued
and outstanding: none)...................... - -
Common stock ($.01 par value; shares
authorized: 75,000,000; shares issued and
outstanding: December 31, 1998, 36,041,934;
December 31, 1997, 34,372,592)................ 360 344
Additional paid-in capital..................... 260,608 255,075
Accumulated deficit............................ (186,645) (224,678)
Deferred compensation.......................... (5,998) (6,998)
Common stock subscriptions..................... (4,343) (4,973)
------------ ------------
Total stockholders' equity................... 63,982 18,770
------------ ------------
Total Liabilities and Stockholders' Equity... $ 973,640 $ 733,895
============ ============
See accompanying Notes to Consolidated Financial Statements.
24
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
OPERATING ACTIVITIES:
Net earnings (loss)................. $ 38,033 $ 13,971 $ (193,738)
Adjustments to reconcile net
earnings (loss) to net cash
provided by operating activities:
Depreciation and amortization..... 39,471 39,411 44,819
Disposal of property.............. 4,287 4,112 1,733
Goodwill write-down............... - - 95,253
Amortization of debt issuance
costs and other.................. 2,630 1,234 658
Other amortization................ 986 1,022 234
Restructuring charges............. - - 75,000
Deferred income taxes............. (2,800) - 500
Changes in operating assets and
liabilities:
Inventories....................... 3,548 55,835 27,601
Other current assets.............. (1,627) 22,724 (10,353)
Accounts payable.................. 107,288 (61,520) 2,794
Restructuring reserve............. - (12,231) (24,092)
Other current liabilities......... 41,919 14,843 (6,767)
Other assets...................... (492) (1,483) (590)
Other long-term liabilities....... (5,557) (3,305) 3,637
------------ ------------ ------------
Net cash provided by
operating activities........... 227,686 74,613 16,689
------------ ------------ ------------
INVESTING ACTIVITIES:
Capital expenditures................ (27,153) (10,940) (17,970)
Sale/leasebacks and other
property sales..................... - - 11,594
------------ ------------ ------------
Net cash used in
investing activities........... (27,153) (10,940) (6,376)
------------ ------------ ------------
FINANCING ACTIVITIES:
Increase (decrease) in
outstanding checks in excess
of cash balances................... (12,061) 12,061 (69,321)
Net borrowings (repayments)
under revolver..................... - (272,000) 219,000
Net proceeds from issuance of
long-term debt..................... 144,317 49,500 -
Principal payments on long-term
debt............................... (82,933) (11,487) -
Proceeds from sale of common
stock.............................. 3,420 219 13
------------ ------------ ------------
Net cash provided by (used
in) financing activities...... 52,743 (221,707) 149,692
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS................. 253,276 (158,034) 160,005
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR.................... 3,942 161,976 1,971
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR.......................... $ 257,218 $ 3,942 $ 161,976
============ ============ ============
CASH PAID (RECEIVED) DURING
THE YEAR FOR:
Interest........................... $ 24,517 $ 33,035 $ 31,677
Income taxes, net.................. 855 (22,908) 9,010
See accompanying Notes to Consolidated Financial Statements.
25
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings Common Total
-------------- Paid-in (Accumulated Deferred Stock Stockholders'
Shares Amount Capital Deficit) Compensation Subscriptions Equity
------ ------ -------- --------- ------------ ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
January 1, 1996............ 34,297 $ 343 $254,350 $ (44,911) $ (8,998) $ (4,973) $ 195,811
Net loss................... (193,738) (193,738)
Stock options exercised and
related tax benefit..... 5 - 13 13
Amortization of deferred
compensation and
adjustment to fair
market value of KSOP
shares, net of tax...... (467) 1,000 533
------ ------ -------- --------- ------------ ----------- ----------
December 31, 1996.......... 34,302 343 253,896 (238,649) (7,998) (4,973) 2,619
Net earnings............... 13,971 13,971
Stock options exercised and
related tax benefit..... 71 1 275 276
Issuance of warrants....... 890 890
Amortization of deferred
compensation and
adjustment to fair
market value of KSOP
shares, net of tax...... 14 1,000 1,014
------ ------ -------- --------- ------------ ----------- ----------
December 31, 1997.......... 34,373 344 255,075 (224,678) (6,998) (4,973) 18,770
Net earnings............... 38,033 38,033
Stock options exercised and
related tax benefit..... 475 4 3,576 3,580
Net proceeds from exercise
of warrants............. 1,194 12 790 802
Common stock subscriptions
paid and related tax
benefit................. 1,176 630 1,806
Amortization of deferred
compensation and
adjustment to fair
market value of KSOP
shares, net of tax...... (9) 1,000 991
------ ------ -------- --------- ------------ ----------- ----------
December 31, 1998.......... 36,042 $ 360 $260,608 $(186,645) $ (5,998) $ (4,343) $ 63,982
====== ====== ======== ========= ============ =========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
26
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
1. Summary of Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include
the accounts of Musicland Stores Corporation ("MSC") and its wholly-owned
subsidiary, The Musicland Group, Inc. ("MGI") and MGI's wholly-owned
subsidiaries, after elimination of all material intercompany balances and
transactions. MSC and MGI are collectively referred to as the "Company." The
Company's foreign operations in the United Kingdom and resulting foreign
currency translation adjustments have not been material. The preparation of the
accompanying consolidated financial statements required management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Actual results could differ from those
estimates.
Business. The Company operates principally in the United States as a
specialty retailer of home entertainment products, including prerecorded music,
video sell-through, books, computer software and related products. The Company's
stores operate under two principal strategies: (i) mall based music and video
sell-through stores (the "Mall Stores"), operating under the principal trade
names Sam Goody and Suncoast Motion Picture Company, and (ii) non-mall based
full-media superstores ("Superstores"), operating under the trade names Media
Play and On Cue. Because both Mall Stores and Superstores are supported by
centralized corporate services and have similar economic characteristics,
products, customers and retail distribution methods, the stores are reported as
a single operating segment. At December 31, 1998, the store count included 1,101
Mall Stores and 231 Superstores, with 4.0 million total store square footage in
Mall Stores and 4.3 million total store square footage in Superstores. The
Company operated 1,346 stores in 49 states, the District of Columbia, the
Commonwealth of Puerto Rico, the Virgin Islands and the United Kingdom at
December 31, 1998.
Cash and Cash Equivalents. Cash equivalents consist principally of
short-term investments with original maturities of three months or less and are
recorded at cost, which approximates market value. Restricted cash amounts are
not material. The Company uses controlled disbursement banking arrangements
under its cash management program which provide for the reimbursement of major
bank disbursement accounts on a daily basis. At December 31, 1997, outstanding
checks in excess of cash balances of $12,061 were included in accounts payable.
Inventories. Inventories are valued at the lower of cost or market.
Cost is determined using the retail inventory method, on the first-in, first-out
(FIFO) basis.
Property. Buildings and improvements, store fixtures and other property
are depreciated using the straight-line method over the estimated useful lives
of the respective assets. Leasehold improvements are amortized on a
straight-line basis over an estimated useful life of 10 years, which is
generally equal to or less than the lease term. Accelerated depreciation methods
are used for income tax purposes. When assets are sold or retired, the costs and
related accumulated depreciation are removed from the accounts and the resulting
gain or loss is included in operations. Depreciation and amortization expense
for property was $39,459, $39,370 and $41,763 the years ended December 31, 1998,
1997 and 1996, respectively. In the event that facts and circumstances indicate
that the carrying amount of property may not be recoverable, an evaluation would
be performed using such factors as recent operating results, projected cash
flows and management's plans for future operations.
Debt Issuance Costs. Debt issuance costs are amortized over the terms
of the related financing using the interest method.
27
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
1. Summary of Significant Accounting Policies (Continued)
Store Opening and Advertising Costs. Store opening and advertising
costs are charged to expense as they are incurred.
Stock-Based Compensation. Compensation expense for employee and
director stock options is measured based on the excess, if any, of the quoted
market price of the Company's stock on the date of grant over the amount that
must be paid to acquire the stock.
Income Taxes. Deferred income taxes are provided for temporary
differences between the financial reporting and tax basis of assets and
liabilities at currently enacted tax rates. A valuation allowance for deferred
income tax assets is recorded when it is more likely than not that some portion
or all of the deferred income tax assets will not be realized.
Derivative Instruments, Hedging Activities and Other Comprehensive
Income. The Company holds no derivative instruments, engages in no hedging
activities and has no significant items of other comprehensive income.
Earnings (Loss) Per Common Share. Basic earnings (loss) per common
share is computed by dividing net earnings (loss) by the weighted average number
of common shares outstanding during each year. Diluted earnings (loss) per
common share is computed by dividing net earnings (loss) by the weighted average
number of common shares outstanding during each year, increased by the effect of
the assumed exercise of dilutive stock options and warrants. For purposes of
earnings (loss) per share computations, shares of common stock under the
Company's employee stock ownership plan, established in the third quarter of
1995, are not considered outstanding until they are committed to be released.
Recently Issued Accounting Standards. Accounting Standards Executive
Committee Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), issued in March
1998 and effective for fiscal years beginning after December 15, 1998, provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. SOP 98-1 requires all costs related to the development of
internal-use software other than those incurred during the application
development stage to be expensed as incurred. Costs incurred during the
application development stage are required to be capitalized and amortized over
the estimated useful life of the software. The Company plans to adopt SOP 98-1
effective with the first quarter of 1999. Adoption is not expected to have a
material effect on the Company's financial position or results of operations.
Accounting Standards Executive Committee Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities" ("SOP 98-5"), issued in April
1998 and effective for fiscal years beginning after December 15, 1998, requires
an entity to expense all start-up activities, including preopening and
organization costs, as incurred. The Company is currently in compliance with the
provisions of SOP 98-5, and, accordingly, the adoption of SOP 98-5 will not
impact the Company's financial position or results of operations.
28
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
2. Write-down of Goodwill
Goodwill primarily resulted from the acquisition of MGI by MSC in a
leveraged buyout in 1988, when nearly all of the Company's stores were mall
based music stores. During 1995 and 1996, the music stores experienced sales
declines which were a result of a general decrease in customer traffic in malls,
an increase in high-volume, low-price non-mall superstores and a lack of strong
music product releases. The Company updated its operating projections for the
music stores in the fourth quarter of 1996 to reflect the effect of sales
declines and competitive pricing. An analysis of the projected undiscounted
future cash flows indicated impairment had occurred. A write-down of the
remaining goodwill of $95,253 was recorded in December 1996 based on estimates
of fair value of the music stores determined primarily from operating
projections, future discounted cash flows and other significant market factors
related to the Company. Goodwill amortization for the year ended December 31,
1996 was $3,005.
3. Restructuring Charges
During 1996, the Company recorded pretax restructuring charges of
$75,000 for the estimated cost of programs designed to improve profitability and
increase inventory turnover. The restructuring programs included the closing of
the Company's distribution facility in Minneapolis, Minnesota, and 114
underperforming stores, including 79 Mall Stores and 35 Superstores. The Company
closed 53 of these stores in 1996 and completed the restructuring programs in
1997 with the closing of the distribution facility and another 61 stores. The
restructuring charges included $36,300 of cash payments, primarily related to
payments to landlords for the early termination of operating leases and
estimated legal and consulting fees, and $38,700 for non-cash charges related to
write-downs of leasehold improvements and certain equipment, net of unamortized
lease credits.
4. 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:
Years Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Weighted average common shares
outstanding - basic.......... 34,485,000 33,528,000 33,414,000
Dilutive effect of stock
options...................... 856,000 299,000 N/A
Dilutive effect of warrants... 1,105,000 342,000 N/A
------------ ------------ ------------
Weighted average common shares
outstanding - diluted........ 36,446,000 34,169,000 33,414,000
============ ============ ============
Antidilutive stock options.... 831,000 1,803,000 2,681,000
============ ============ ============
Antidilutive stock options outstanding during the years ended December
31, 1998 and 1997 had an exercise price greater than the average market price
during the year. All stock options outstanding during the year ended December
31, 1996 were antidilutive due to the net loss.
29
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
5. Long-term Debt
Long-term debt consists of the following:
December 31,
---------------------------
1998 1997
------------ ------------
Revolver borrowings, variable rates....... $ - $ -
Term loan, variable rate, 8.13% at
December 31, 1997...................... - 50,000
Mortgage notes payable, variable rates,
8.24% to 8.37% at December 31, 1997.... - 33,087
9% senior subordinated notes, unsecured,
due 2003............................... 110,000 110,000
9 7/8% senior subordinated notes,
unsecured, due 2008.................... 148,871 -
------------ ------------
Total long-term debt................... 258,871 193,087
Less current maturities................... - 26,657
------------ ------------
Long-term debt, net of current
maturities............................ $ 258,871 $ 166,430
============ ============
The Company's bank credit agreement, as amended in April 1998, provides
for a revolving credit facility and expires in October 1999. Borrowings under
the revolving credit facility are available up to a maximum of the lesser of:
(i) 60% of eligible inventory or (ii) $182,000 through March 15, 1999 and
$125,000 thereafter. The Company has pledged the common stock of certain of its
wholly owned subsidiaries as collateral for borrowings under the revolving
credit facility. Facility fees at an annual rate of up to 0.50% are assessed on
the maximum credit amount available. During the years ended December 31, 1998,
1997 and 1996, the weighted average interest rates, excluding facility costs, on
revolver borrowings were 7.78%, 7.37% and 6.98%, respectively, and total
facility costs incurred were $1,099, $1,549 and $1,691, respectively.
In April 1998, the Company completed an offering of $150,000 of 9 7/8%
senior subordinated notes with an original issue discount of $1,183. The net
proceeds to the Company from the offering, after discounts, commissions and
other offering costs were $144,317 and were used to repay $32,076 of outstanding
mortgage notes payable and $112,241 of outstanding revolver borrowings.
The credit agreement contains financial covenants related to fixed
charge coverage, consolidated tangible net worth and debt to total
capitalization, and covenants that limit additional indebtedness, liens, capital
expenditures, investments, sales of assets and cash dividends. The indentures
related to the senior subordinated notes also contain certain financial
covenants. The Company was in compliance with all covenants at December 31,
1998.
The Company has the option to redeem the senior subordinated notes
prior to maturity at 103.375% of par on and after June 15, 1998 and thereafter
at prices declining annually to 100% of par on and after June 15, 2001 for the
9% issue and 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 for the 9
7/8% issue.
30
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
6. Income Taxes
Income taxes consist of:
Years Ended December 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Current:
Federal................... $ 16,700 $ 100 $ (18,300)
State, local and other.... 2,400 200 (1,400)
----------- ----------- -----------
19,100 300 (19,700)
----------- ----------- -----------
Deferred:
Federal................... (1,800) 1,400 (1,000)
State, local and other.... (1,000) (1,400) 1,500
----------- ----------- -----------
(2,800) - 500
----------- ----------- -----------
Total income taxes........... $ 16,300 $ 300 $ (19,200)
=========== =========== ===========
The Company's effective income tax rates differ from the federal
statutory rate as follows:
Years Ended December 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Federal statutory tax rate.... 35.0% 35.0% (35.0)%
Goodwill amortization and
write-down and other
permanent differences...... .3 5.2 16.7
State and local income taxes,
net of federal benefit..... 1.7 (5.5) -
Valuation allowance........... (7.0) (32.6) 9.3
----------- ----------- -----------
Effective income tax rate.. 30.0% 2.1% (9.0)%
=========== =========== ===========
Components of deferred income taxes are as follows:
December 31,
---------------------------
1998 1997
------------ ------------
Net current deferred tax asset:
Capitalized inventory costs........... $ 5,540 $ 5,360
Inventory valuation................... 9,609 8,266
Compensation related.................. 3,542 2,504
Store closings........................ 3,877 2,586
Other accruals........................ 2,388 2,303
Other, net............................ 644 681
------------ ------------
Total current deferred income taxes...... 25,600 21,700
Valuation allowance................... (9,800) (11,100)
============ ============
Net current deferred income taxes........ $ 15,800 $ 10,600
============ ============
31
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
6. Income Taxes (Continued)
December 31,
---------------------------
1998 1997
------------ ------------
Net noncurrent deferred tax asset:
Depreciation........................... $ (12,453) $ (15,263)
Rent expense........................... 16,418 18,279
Amortization of intangible assets...... (2,010) (2,011)
Net pension liability.................. 1,042 960
Other, net............................. 203 489
Alternative minimum tax credits........ - 5,846
------------ ------------
Total noncurrent deferred income taxes.... 3,200 8,300
Valuation allowance.................... (3,200) (5,900)
============ ============
Net noncurrent deferred income taxes...... $ - $ 2,400
============ ============
The Company's management believes it is more likely than not that the
deferred income tax assets, net of valuation allowances, will be realized based
on current income tax laws and assessments of taxable income within the
carryback or carryforward periods for each year. However, the amount of deferred
tax assets considered realizable could be adjusted in the future if estimates of
taxable income are revised.
7. Employee Benefit Plans
The Company has a non-contributory, defined benefit pension plan
covering certain employees. Retirement benefits are a function of both years of
service and the level of compensation. The Company's funding policy is to make
an annual contribution equal to or exceeding the minimum required by the
Employee Retirement Income Security Act of 1974. Effective December 31, 1991,
participation in the pension plan was frozen for employees hired on or after
July 1, 1990. The Company has been evaluating on a year to year basis the
continuation of benefit accruals under the pension plan. Accordingly, the
projected benefit obligation approximated the accumulated benefit obligation at
December 31, 1998 and 1997.
In October 1998, the Company established a non-qualified, unfunded
Supplemental Executive Retirement Plan ("SERP") to provide certain executives
with pension benefits in excess of limits imposed by federal tax law. The annual
benefit amount is a function of both years of service and the level of
compensation. For the SERP in 1998, the benefit obligation at December 31 was
$1,366 and pension expense was $136.
The funded status of the pension plans and the related accrued pension
cost, using a measurement date of September 30, are as follows:
32
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
7. Employee Benefit Plans (Continued)
December 31,
----------------------
1998 1997
---------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year..... $ 10,457 $ 9,604
Service cost................................ 513 411
Interest cost............................... 847 748
Effect of assumption change................. 1,099 448
Unrecognized prior service cost from
inception of the SERP...................... 1,366 -
Actuarial loss.............................. 175 257
Benefits paid............................... (526) (1,011)
--------- ---------
Benefit obligation at end of year.............. 13,931 10,457
--------- ---------
Change in plan assets:
Fair value of plan assets at beginning
of year.................................... 10,925 9,468
Actual return on plan assets................ (972) 2,468
Employer contribution....................... 552 -
Benefits paid............................... (526) (1,011)
--------- ---------
Fair value of plan assets at end of year....... 9,979 10,925
--------- ---------
Funded status.................................. (3,952) 468
Unrecognized gains.......................... (22) (3,209)
Unrecognized prior service cost............. 1,278 (68)
--------- ---------
Accrued pension cost.......................... $ (2,696) $ (2,809)
========= =========
The components of net pension expense are as follows:
Years Ended December 31,
------------------------------------
1998 1997 1996
----------- ---------- ---------
Service cost..................... $ 513 $ 411 $ 446
Interest cost.................... 847 748 715
Expected return on plan assets... (916) (754) (771)
Amortization of prior service
cost and gain................... (6) (5) (5)
----------- ---------- ---------
Net pension expense........... $ 438 $ 400 $ 385
=========== ========== =========
Assumptions used in computing pension data are as follows:
December 31,
---------------
1998 1997
------- ------
Discount rate for benefit obligations.................. 7.00% 7.50%
Expected long-term rate of return on plan assets....... 8.50 8.50
Rate of compensation increase for the SERP obligation.. 5.50 -
The Company established a defined contribution plan in 1992 for
employees not covered by the pension plan. The Company has a 401(k) plan, which
is based on contributions made through payroll deductions and partially matched
by the Company, covering substantially all employees. The
33
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
7. Employee Benefit Plans (Continued)
Company's matching contribution to the 401(k) plan is paid in stock of MSC under
an employee stock ownership plan ("KSOP"). The Company may also, at its
discretion, make a supplemental cash matching contribution. In 1995, to
establish the KSOP, the Company made a loan to the KSOP trust for the purchase
of 1,042,900 shares of the Company's common stock in the open market. In
exchange, the Company received a note, the balance of which is recorded as
deferred compensation and is reflected as a reduction of stockholders' equity.
The Company recognizes compensation expense during the period the match is
earned equal to the expected market value of the shares to be released to settle
the match liability. The number of KSOP shares committed to be released was
104,290 at December 31, 1998 and 1997. At December 31, 1998 and 1997, the number
of shares held in suspense was 625,740 and 730,030, respectively, and the market
value of the shares held in suspense was $9,621 and $5,338, respectively.
Expenses for the defined contribution and 401(k) plans for the years
ended December 31, 1998, 1997 and 1996 totaled $1,332, $1,749 and $354,
respectively. Expenses for postemployment benefits were not material. The
Company does not offer or provide postretirement benefits other than pensions to
its employees.
8. Stock Plans
The Company's stock plans authorize the grant of stock options and
other stock awards to officers, other employees and outside directors. Stock
options are generally exercisable over a period not to exceed 10 years after the
grant date. As stock options have been granted at exercise prices not less than
the fair market value of the Company's common stock on the date of the grant, no
compensation expense has been recognized. No other awards have been granted
under the stock plans.
Stock option activity is as follows:
1998 1997 1996
-------------------- ------------------- ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- ------- ---------- -------- --------- --------
Outstanding at
beginning of
year............ 2,935,908 $ 6.20 2,681,294 $7.33 1,892,984 $ 10.52
Granted........... 1,193,775 13.65 734,650 3.16 1,023,973 2.30
Exercised......... (475,292) 4.19 (70,636) 3.10 (5,000) 2.50
Canceled.......... (140,977) 9.57 (409,400) 8.67 (230,663) 11.26
----------- ----------- ----------
Outstanding at
end of year..... 3,513,414 8.86 2,935,908 6.20 2,681,294 7.33
=========== =========== ==========
Options
exercisable
at year end..... 955,997 1,084,642 1,003,916
=========== =========== ==========
Options
available for
future grant.... 966,052 341,500 666,750
=========== =========== ==========
34
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
8. Stock Plans (Continued)
Stock options outstanding and exercisable at December 31, 1998 are as
follows:
Stock Options
Stock Options Outstanding Exercisable
------------------------------ ---------------------
Weighted
Average
Remaining Weighted Weighted
Contractual Average Average
Number Life Exercise Number Exercise
Range of Exercise Prices Outstanding (Years) Price Exercisable Price
- ------------------------- ----------- ------- -------- ----------- --------
$ 1.5000 to $ 2.5625..... 993,888 7.8 $ 1.956 111,008 $ 2.448
3.0000 to 4.5000..... 345,616 5.6 3.566 194,952 3.988
6.0625 to 10.3125..... 460,710 7.8 7.052 133,270 7.932
11.1875 to 14.8125..... 832,500 6.9 12.593 376,567 13.801
15.0625 to 21.7500..... 880,700 8.8 16.128 140,200 21.750
--------- --------
3,513,414 955,997
========= ========
Pro forma data using the fair value of stock options is as follows:
1998 1997 1996
------------------ ---------------- ----------------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
--------- -------- -------- ------- ---------- ----------
Net earnings (loss).. $38,033 $37,002 $13,971 $13,168 $(193,738) $(194,394)
Earnings(loss) per
common share:
Basic....... $ 1.10 $ 1.07 $ .42 $ .39 $ (5.80) $ (5.82)
Diluted..... 1.04 1.02 .41 .39 (5.80) (5.82)
The fair value of each stock option was estimated on the date of grant
using the Black-Scholes option pricing model. The pro forma data may not be
representative of the effects on net earnings in future years because pro forma
compensation expense related to grants made prior to 1996 is not considered,
stock options vest over several years and additional stock options may be
granted in the future.
Fair value and assumptions were as follows:
1998 1997 1996
----------- ----------- -----------
Weighted average fair value of
options granted..................... $9.53 $2.00 $1.32
Risk-free interest rate.............. 5.2% 6.3% 6.2%
Expected stock price volatility...... 69% 56% 49%
Expected dividend yield.............. - - -
Expected life of stock options....... 7 years 7 years 7 years
35
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
9. Common Stock
On August 25, 1988, certain members of current and former management of
the Company purchased common stock with restrictions ("Restricted Stock") at
$0.0025 per share. Although holders of Restricted Stock have voting and dividend
rights, no Restricted Stock is transferable until the holder has paid the
Company the balance of the subscription price of $2.4975 or $4.4975 per share.
After August 25, 2003, the Company may, at its option, buy back the outstanding
shares of Restricted Stock for $0.0025 per share. At December 31, 1998 and 1997,
the amount of subscriptions due for Restricted Stock outstanding of 1,740,204
shares and 1,991,308 shares, respectively, is reflected as a reduction of
stockholders' equity.
In connection with the term loan agreement completed in June 1997, the
Company issued warrants for the purchase of 1,822,087.16 shares of common stock
at $1.5625 per share. The warrants can be traded, are exercisable over a period
of five years and expire in 2002. The fair value of the warrants at the time of
issuance of $890 was recorded as additional debt issuance costs and an increase
to additional paid-in capital. During 1998, 1,194,050 shares of common stock
were issued in connection with the exercise of warrants and 84,660.70 warrants
were canceled for cashless exercises and fractional shares. At December 31,
1998, 543,376.46 warrants remained outstanding.
10. Preferred Stock Purchase Rights
In March 1995, the Company's Board of Directors adopted a stockholder
rights plan and declared a dividend of one preferred share purchase right
("Right") per share for each outstanding share of common stock. The Rights will
be distributed 20 days after a person or group (an "Acquiring Person") either
acquires beneficial ownership of, or commences a tender or exchange offer for,
17.5% or more of the Company's outstanding common stock.
Each Right then may be exercised to purchase one one-hundredth of a
share of Series A Junior Participating Preferred Stock, $0.01 par value (the
"Preferred Shares"), at an exercise price of $70.00 per one-hundredth Preferred
Share. Thereafter, upon the occurrence of certain events, the Rights entitle
holders other than the Acquiring Person to acquire common stock having a value
of twice the exercise price of the Rights. Alternatively, upon the occurrence of
certain other events, the rights would entitle holders other than the Acquiring
Person to acquire common stock of the Acquiring Person having a value of twice
the exercise price of the Rights.
The Rights may be redeemed by the Company at a redemption price of
$.001 per Right at any time until the 20th day after a public announcement of an
acquisition of 17.5% or more of the common stock of the Company. The Rights
expire on March 20, 2005.
11. Commitments
Most of the Company's retail stores are under operating leases with
various remaining terms through 2016. The leases have noncancelable terms that
generally range from three to 20 years and many include renewal options for
additional periods. Certain store leases provide the Company with an early
cancellation option if sales for a designated period do not reach a specified
level as defined in the lease. Most of the store leases contain escalation
clauses and require payment of real estate taxes, utilities,
36
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
11. Commitments (Continued)
common area maintenance costs and contingent rentals based on percentages of
sales in excess of specified minimums. Certain store leases contain provisions
restricting assignment, merger, change of control or transfer. The Company also
leases certain office and storage facilities, store fixtures and equipment,
computers and automobiles under operating leases.
Future minimum payments under operating leases with noncancelable terms
in excess of one year at December 31, 1998 are: 1999, $129,454; 2000, $119,102;
2001, $91,361; 2002, $77,652; 2003, $61,858 and thereafter, $226,521.
Total rent expense consists of the following:
Years Ended December 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
Minimum cash rents............ $ 149,432 $ 152,343 $ 166,308
Straight-line recognition of
leases with scheduled
rent increases............. (2,676) (910) 3,152
Percentage rents.............. 2,169 2,143 1,733
----------- ----------- -----------
Total rent expense......... $ 148,925 $ 153,576 $ 171,193
=========== =========== ===========
12. Litigation
The Company is a party to various claims, legal actions and complaints
arising in the ordinary course of business. It is the opinion of management that
the ultimate resolution of these matters will not have a material adverse effect
on the financial position or results of operations of the Company.
13. Related Party Transactions
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJSC"), a wholly
owned subsidiary of Donaldson, Lufkin & Jenrette, Inc. ("DLJ"), acts as a market
maker for the Company's senior subordinated notes. A Managing Director of DLJSC
is a member of the Company's board of directors. In 1998, DLJSC received
compensation as underwriter of approximately $2,322 in connection with the
Company's offering of the 9 7/8% senior subordinated notes. DLJ and certain of
its affiliates, excluding DLJ employees, owned approximately 6.9% of the
Company's common stock at December 31, 1996. During 1997, DLJ sold its ownership
in the Company's common stock.
14. Fair Value of Financial Instruments
The carrying amounts reported in the consolidated balance sheets at
December 31, 1998 and 1997 for cash and cash equivalents, other current assets,
accounts payable and other current liabilities approximate fair value because of
the immediate or short-term maturity of these financial instruments. As the
interest rates on the term loan and mortgage notes payable were reset monthly
based on current market rates and the debt was secured, the carrying amounts
approximated fair value at December 31, 1997. The fair value of the 9% senior
subordinated notes at December 31, 1998 and 1997, based on the last quoted
prices on those dates, was $104,885 and $101,750, respectively, versus the
carrying amount
37
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
14. Fair Value of Financial Instruments (Continued)
of $110,000. The fair value of the 9 7/8% senior subordinated notes at December
31, 1998, based on the last quoted price on that date, was $139,860, versus the
carrying amount of $148,871.
15. Supplemental Balance Sheet Information
Property consists of the following, at cost:
December 31,
---------------------------
1998 1997
------------ ------------
Land and land improvements............... $ 10,003 $ 10,003
Buildings................................ 32,242 32,055
Leasehold improvements................... 237,596 231,831
Store fixtures and other property........ 157,508 149,973
------------ ------------
437,349 423,862
Less accumulated depreciation and
amortization........................... (203,925) (173,841)
------------ ------------
Property, net........................ $ 233,424 $ 250,021
============ ============
Other current liabilities consist of the following:
December 31,
---------------------------
1998 1997
------------ ------------
Payroll and related taxes and benefits... $ 29,003 $ 24,963
Gift certificates payable................ 46,384 38,224
Sales taxes payable...................... 19,823 18,764
Accrued store expenses and other......... 39,559 29,207
Income taxes payable..................... 19,974 4,502
------------ ------------
Total other current liabilities..... $ 154,743 $ 115,660
============ ============
Other long-term liabilities consist of the following:
December 31,
---------------------------
1998 1997
------------ ------------
Straight-line recognition of leases with
scheduled rent increases................ $ 29,193 $ 32,457
Deferred rent credits.................... 11,165 12,508
Other.................................... 3,276 4,230
------------ ------------
Total other long-term liabilities... $ 43,634 $ 49,195
============ ============
16. Supplemental Cash Flow Information
The land, building and certain equipment related to the Company's
distribution facility in Franklin, Indiana, and the land, buildings and certain
fixtures related to three of the Company's Media Play stores were financed under
operating leases with special purpose entities that had been formed for the
purpose of purchasing the land, equipment and fixtures and constructing the
facilities using secured
38
<PAGE>
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)
16. Supplemental Cash Flow Information (Continued)
financing. The financed distribution facility property, which had an original
cost of approximately $30,000, and the mortgage note payable were recorded on
the Company's Consolidated Balance Sheet after the terms of an amendment to the
operating lease required consolidation of the special purpose entity as of June
1997, the date of the amendment. The three Media Play stores, which had an
aggregate cost of $14,395, together with the related mortgage note payable and
deferred financing credits totaling $14,599, were recorded on the Company's
Consolidated Balance Sheet after the terms of an amendment to the operating
lease required consolidation of the special purpose entity as of October 1996,
the date of the amendment.
17. Quarterly Financial Data (Unaudited)
Basic Diluted
Earnings Earnings
(Loss) (Loss)
Net per per Common Stock Price
Gross Earnings Common Common ------------------
Sales Profit (Loss) Share Share High Low
---------- --------- --------- -------- ------ ---------- -------
1998:
First.... $ 392,405 $ 136,753 $ (3,551) $(0.11) $(0.11) $12 1/16 $6 1/2
Second... 367,203 135,805 (4,662) (0.14) (0.14) 15 1/8 9 7/8
Third.... 387,368 137,795 (3,779) (0.11) (0.11) 16 3/16 9 1/8
Fourth... 699,906 245,947 50,025 1.42 1.36 18 8 1/2
---------- --------- --------- -------- -------
Total.. $1,846,882 $ 656,300 $ 38,033 $ 1.10 $ 1.04
========== ========= ========= ======== =======
1997:
First.... $ 376,080 $ 126,463 $(20,983) $(0.63) $(0.63) $ 1 3/4 $ 11/16
Second... 342,746 120,428 (18,325) (0.55) (0.55) 2 7/8 15/16
Third.... 373,283 129,070 (12,384) (0.37) (0.37) 8 1/4 2 1/4
Fourth... 676,203 238,868 65,663 1.95 1.89 8 1/2 4 5/8
---------- --------- --------- -------- -------
Total.. $1,768,312 $ 614,829 $ 13,971 $ .42 $ .41
========== ========= =-======= ======== =======
The totals of basic and diluted earnings (loss) per common share by
quarter may not equal the totals for the year as there are changes in the
weighted average number of common shares outstanding each quarter and basic and
diluted earnings (loss) per common share are calculated independently for each
quarter.
39
<PAGE>
EXHIBIT INDEX
The following documents are filed as part of this Annual Report on Form
10-K for the year ended December 31, 1998.
Exhibit Sequential
No. Description Page No.
------- ------------------------------------------------------- ---------
3.1 - Restated Certificate of Incorporation of MSC, as amended [i]
3.2 - By-laws of MSC, as amended [xvii]
4.1(a) - Senior Subordinated Note Indenture, including form
of Note, dated as of June 15, 1993 among MGI, MSC
and Bank One Columbus, N.A. as Successor Trustee to
Harris Trust and Savings Bank [ii]
4.1(b) - First Supplemental Indenture dated as of June 13,
1997 to the Senior Subordinated Note Indenture [xiii]
4.2(a) - Credit Agreement dated as of October 7, 1994 (the "Credit
Agreement") among MGI, MSC, the banks listed therein and
Morgan Guaranty Trust Company of New York, as agent [iii]
4.2(b) - Amendment No. 1 dated as of February 28, 1995 to the
Credit Agreement [vii]
4.2(c) - Amendment No. 2 dated as of April 9, 1996 to the Credit
Agreement [ix]
4.2(d) - Amendment No. 3 dated as of October 18, 1996 to the
Credit Agreement [x]
4.2(e) - Waivers and Agreements under Credit Agreement dated as
of March 7, 1997 to the Credit Agreement [xi]
4.2(f) - Waivers and Agreements under Credit Agreement dated as
of May 19, 1997 to the Credit Agreement [xiii]
4.2(g) - Amendment No. 4 and Waiver dated as of June 16, 1997
to the Credit Agreement [xiii]
4.2(h) - Amendment No. 5 dated as of March 17, 1998 to the Credit
Agreement [xvi]
4.3(a) - Term Loan Agreement dated as of June 16, 1997 (the
"Term Loan") among MGI, MSC, the banks listed therein
and Morgan Guaranty Trust Company of New York, as agent [xiii]
4.3(b) - Security Agreement dated as of June 16, 1997
among MGI and the subsidiaries listed therein, the
Debtors listed therein, and Morgan Guaranty Trust
Company of New York, as agent [xiii]
4.3(c) - Warrant and Registration Rights Agreement dated as of
June 16, 1997 among MSC and the Investors listed therein [xiii]
4.4 - Rights Agreement dated as of March 14, 1995, between MSC
and Norwest Bank Minnesota, National Association, as
Rights Agent [iv]
4.5(a) - Indenture including Form of Note dated as of April 6, 1998
between MGI, as Issuer, MSC, as Guarantor, and Bank One,
N.A., as Trustee [xiv]
4.5(b) - Registration Rights Agreement dated as of April 6, 1998
by and among MGI, MSC, as Guarantor, and Donaldson,
Lufkin & Jenrette Securities Corporation, BT Alex Brown
Incorporated, and NationsBanc Montgomery Securities LLC,
as Initial Purchasers [xiv]
*10.1(a) - Subscription Agreement among MSC and the Management
Investors [v]
*10.1(b) - Form of amendment to Management Subscription Agreement [i]
*10.2 - Form of Registration Rights Agreement among MSC, DLJ and
the Management Investors [vi]
*10.3 - 1988 Stock Option Plan, as amended [i]
*10.4 - Stock Option Plan for Unaffiliated Directors of MSC, as
amended [xiii]
*10.5 - 1992 Stock Option Plan [i]
40
<PAGE>
Exhibit Sequential
No. Description Page No.
------- --------------------------------------------------------- ----------
*10.6 - Musicland Stores Corporation 1994 Employee Stock Option
Plan [vii]
*10.7 - Musicland Stores Corporation 1998 Stock Incentive Plan [xvi]
*10.8 - Management Incentive Plan dated as of January 1, 1998 [xv]
*10.9(a) - Long Term Incentive Plan dated as of January 1, 1996 [xi]
*10.9(b) - Long Term Incentive Plan dated as of January 1, 1998 [xv]
*10.10 - Executive Officer Salary Continuation Plan dated as of
March 10, 1997 [xii]
*10.11 - The Musicland Group, Inc. Supplemental Executive
Retirement Plan adopted as of October 26, 1998 ---
*10.12(a)- Employment Agreement with Mr. Eugster [v]
*10.12(b)- Form of amendment to Employment Agreement with Mr. Eugster [i]
*10.12(c)- Amendment No. 2 to Employment Agreement with Mr. Eugster [viii]
*10.13(a)- Change of Control Agreement with Mr. Eugster [v]
*10.13(b)- Form of amendment to Change of Control Agreement with Mr.
Eugster [i]
*10.13(c)- Amendment No. 2 to Change of Control Agreement with Mr.
Eugster [viii]
*10.13(d)- Amendment No. 3 to Change of Control Agreement with Mr.
Eugster [xi]
*10.14 - Form of Executive Severance Agreement with Mr. Wachsman [xi]
*10.15 - Change of Control Agreement with Mr. Wachsman [xii]
*10.16(a)- Form of Employment Agreement with Messrs. Benson and Ross [v]
*10.16(b)- Amendment to Employment Agreement with Mr. Benson [xi]
*10.16(c)- Amendment to Employment Agreement with Mr. Ross [xi]
*10.17(a)- Change of Control Agreement with Messrs. Benson and Ross [v]
*10.17(b)- Amendment No. 1 to Change of Control Agreement with Mr.
Benson [xi]
*10.17(c)- Amendment No. 1 to Change of Control Agreement with Mr. Ross [xi]
11 - Statement re computation of per share earnings [xviii]
21 - Subsidiaries of MSC ---
23 - Consent of Arthur Andersen LLP ---
27 - Financial Data Schedules ---
99 - Form 11-K for The Musicland Group's Capital Accumulation Plan [xix]
- ----------------------------------------
[i] Incorporated by reference to MSC's Form S-1 Registration Statement
covering common stock initially filed with the Commission on July 6,
1990 (Commission File No. 33-35774).
[ii] Incorporated by reference to MGI's Registration Statement covering 9%
Senior Subordinated Notes initially filed with the Commission on May
19, 1993 (Commission File No. 33-62928).
[iii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1994 filed with the Commission
on November 11, 1994 (Commission File No. 1-11014).
[iv] Incorporated by reference to MSC's Form 8-A Exchange Act Registration
Statement covering Preferred Share Purchase Rights filed with the
Commission on March 16, 1995.
[v] Incorporated by reference to MSC's Form S-1 Registration Statement
covering Senior Subordinated Notes initially filed with the Commission
on May 20, 1988 (Commission File No. 33-22058).
[vi] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1993 filed with the Commission on March 25,
1994 (Commission File No. 1-11014).
[vii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1994 filed with the Commission on March 27,
1995 (Commission File No. 1-11014).
41
<PAGE>
[viii] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1995 filed with the Commission on April 12,
1996 (Commission File No. 1-11014).
[ix] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 1996 filed with the Commission on
May 10, 1996 (Commission File No. 1-11014).
[x] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1996 filed with the Commission
on November 13, 1996 (Commission File No. 1-11014).
[xi] Incorporated by reference to MSC's Annual Report on Form 10-K for the
year ended December 31, 1996 filed with the Commission on April 11,
1997 (Commission File No. 1-11014).
[xii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 1997 filed with the Commission on
May 14, 1997 (Commission File No. 1-11014).
[xiii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1997 filed with the Commission on
August 13, 1997 (Commission File No. 1-11014).
[xiv] Incorporated by reference to MGI's Registration Statement on Form S-4
covering 9 7/8% Senior Subordinated Notes initially filed with the
Commission on April 24, 1998 (Commission File No. 333-50951).
[xv] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 1998 filed with the Commission on
May 12, 1998 (Commission File No. 1-11014).
[xvi] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1998 filed with the Commission on
August 12, 1998 (Commission File No. 1-11014).
[xvii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1998 filed with the Commission
on November 13, 1998 (Commission File No. 1-11014).
[xviii] The requirements of this exhibit are met by Note 1 and Note 4 of Notes
to Consolidated Financial Statements.
[xix] To be filed by amendment.
* Indicates Management Contract or Compensatory Plan or Agreement
required to be filed as an Exhibit to this form.
42
THE MUSICLAND GROUP, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
(As Adopted Effective October 26, 1998)
<PAGE>
THE MUSICLAND GROUP, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
Table of Contents
Page
ARTICLE I GENERAL...................................................1
Sec. 1.1 Name of Plan..............................................1
Sec. 1.2 Purpose...................................................1
Sec. 1.3 Effective Date............................................1
Sec. 1.4 Company...................................................1
Sec. 1.5 Participating Employers...................................1
Sec. 1.6 Construction and Applicable Law...........................1
ARTICLE II DEFINITIONS...............................................1
Sec. 2.1 Actuarial Equivalent......................................1
Sec. 2.2 Board.....................................................2
Sec. 2.3 Cause.....................................................2
Sec. 2.4 Change In Control.........................................4
Sec. 2.5 Committee.................................................4
Sec. 2.6 Covered Compensation......................................4
Sec. 2.7 Final Average Compensation................................4
Sec. 2.8 Normal Retirement Age.....................................4
Sec. 2.9 Participant...............................................4
Sec. 2.10 Plan Year.................................................4
Sec. 2.11 Retirement Plan...........................................4
Sec. 2.12 Subsidiary................................................4
Sec. 2.13 Successor Employer........................................4
Sec. 2.14 Supplemental Accrual Years................................4
Sec. 2.15 Year of Participation.....................................4
ARTICLE III PARTICIPATION.............................................5
Sec. 3.1 Eligibility for Participation.............................5
Sec. 3.2 Cessation of Participation................................5
Sec. 3.3 No Guarantee of Employment................................5
ARTICLE IV BENEFIT ACCRUAL AND VESTING...............................5
Sec. 4.1 Supplemental Retirement Benefit...........................5
Sec. 4.2 Vesting of Benefit........................................7
ARTICLE V FORM OF PAYMENT AND COMMENCEMENT DATE.....................7
Sec. 5.1 Entitlement...............................................7
Sec. 5.2 Time of Payment...........................................7
Sec. 5.3 Form of Payment...........................................8
Sec. 5.4 Disability Before Retirement..............................9
Sec. 5.5 Death Prior to Commencement of Benefits...................9
Sec. 5.6 Death After Commencement of Benefits......................9
Sec. 5.7 Benefit Upon Change In Control...........................10
ARTICLE VI ADMINISTRATION...........................................10
Sec. 6.1 Administration by the Committee..........................10
Sec. 6.2 Withholding of Taxes.....................................10
Sec. 6.3 Unfunded and Unsecured Plan..............................10
i
<PAGE>
ARTICLE VII AMENDMENT AND TERMINATION................................11
Sec. 7.1 Amendment................................................11
Sec. 7.2 Termination of Plan......................................11
ARTICLE VIII MISCELLANEOUS............................................11
Sec. 8.1 Designation of Joint Annuitant or Beneficiary............11
Sec. 8.2 Benefits May Not Be Assigned or Alienated................11
Sec. 8.3 Headings.................................................11
Sec. 8.4 Capitalized Definitions..................................12
Sec. 8.5 Gender...................................................12
Sec. 8.6 Use of Compounds of Word "Here"..........................12
Sec. 8.7 Construed as a Whole.....................................12
ii
<PAGE>
THE MUSICLAND GROUP, INC.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
ARTICLE I
GENERAL ARTICLE I
GENERAL
Sec. 1.1 Name of Plan. The name of this plan is "The Musicland
Group, Inc. Supplemental Executive Retirement Plan" (referred to hereinafter as
the "Plan").
Sec. 1.2 Purpose. The Plan has been established to provide
supplemental retirement benefits and certain benefits upon disability or death
before retirement to certain select management or highly compensated employees
so that such employees may be retained and their productive efforts encouraged.
Sec. 1.3 Effective Date. The "Effective Date" of the Plan is
October 26, 1998.
Sec. 1.4 Company. For purposes of this Plan, "Company" means The
Musicland Group, Inc., a Delaware corporation, and any Successor Employer
thereof, and "Parent" means Musicland Stores Corporation, a Delaware
corporation, and any Successor Employer thereof.
Sec. 1.5 Participating Employers. The Parent and the Company
each is a "Participating Employer" in the Plan. Each other Subsidiary of the
Parent also shall be a Participating Employer in the Plan during the period it
is a Subsidiary.
Sec. 1.6 Construction and Applicable Law. The Plan is intended
to be an unfunded plan maintained primarily for the purpose of providing
deferred compensation for a select group of management or highly compensated
employees, within the meaning of Sections 201(2), 301(a)(3) and 401(a)(1) of
the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). The
Plan shall be administered and construed consistent with said intent. The Plan
also shall be governed and construed in accordance with the laws of the State
of Minnesota as applied to contracts executed and to be wholly performed within
said state to the extent that such laws are not preempted by the laws of the
United States of America.
ARTICLE II
DEFINITIONS ARTICLE II
DEFINITIONS
Sec. 2.1 Actuarial Equivalent. "Actuarial Equivalent" means a
benefit of equivalent value determined by the Committee upon advice of the
actuary for the Retirement Plan using the actuarial factors used for the
corresponding type of calculation under the Retirement Plan, or if no similar
benefit is payable under the Retirement Plan, using such actuarial factors as
are deemed reasonable by the Committee. For purposes of calculating any single
lump-sum payment under the Plan, the following actuarial factors shall be used
to determine the lump-sum amount:
<PAGE>
mortality - UP -1984 Mortality Table; interest - an annual rate equal to the
average of the annual rates of interest on 30-Year Treasury Securities for
November of the Plan Year preceding the Plan Year in which the single lump-sum
payment is made, as prescribed by the Internal Revenue Service for purposes of
Code section 417(e).
Sec. 2.2 Board. "Board" means the Board of Directors of the
Parent.
Sec. 2.3 Cause. "Cause" means the following:
(a) If the Participant is covered under an employment agreement in
effect between the Participant and any Participating Employer, and
that employment agreement contains a definition of "cause", then
"cause" as defined under such employment agreement (including any
notice and/or other procedural requirements contained therein).
(b) Otherwise, any one of the following:
(i) Indictment on or conviction of a felony;
(ii) Theft or embezzlement of property or commission of similar
acts involving moral turpitude;
(iii) The willful failure by the Participant to substantially
perform the material duties of his/her position (excluding
nonperformance resulting from disability), which willful
failure is not cured within thirty (30) days after written
notice from the Secretary of the Company specifying the act
of willful nonperformance.
If this paragraph (b) applies, a termination of employment shall
not be for Cause unless there shall be delivered to the
Participant with 60-day notice a certified copy of a resolution of
the Board, adopted by the affirmative vote of not less than that
number of directors equal to the greater of (A) 4 directors or (B)
two-thirds of the entire membership (whether or not present) of
the Board (other than the Participant and directors who are
employees of the Company or the Parent) at a meeting called and
held for that purpose and at which the Participant was given an
opportunity to be heard, finding that the Participant was guilty
of conduct set forth in clause (i), (ii) or (iii) above, and
specifying the particulars thereof in detail. For purposes of the
minimum number of directors required in the preceding sentence,
any fraction shall be rounded up to the next higher whole number
of directors.
If this paragraph (b) applies, then anything herein to the
contrary notwithstanding, the employment of the Participant shall
not be considered to have been terminated for Cause if his/her
termination of employment took place solely because of one or more
of the following:
(A) As a result of bad judgment or negligence on the part
of the Participant, or
(B) As the result of an act or omission without intent of
gaining therefrom directly or indirectly a profit to
which the Participant was
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<PAGE>
not legally entitled; provided, however, that this
subsection shall not apply to a termination pursuant
to clause (iii) above, or
(C) Because of an act or omission believed by the
Participant in good faith to have been in or not
opposed to the interests of the Company, or
(D) As the result of an act or omission which occurred
more than 12 calendar months prior to the
Participant's having been given notice of the
termination of his/her employment for such act or
omission unless the commission of such act or such
omission could not at the time of such commission or
omission have been known to a member of the Board
(other than the Participant), in which case more than
12 calendar months prior to the date that the
commission of such act or such omission was or could
reasonably have been so known; provided, however,
that this subsection shall not apply to a termination
pursuant to clause (iii) above, or
(E) As a result of a continuing course of action which
commenced and was or could reasonably have been known
to a member of the Board (other than the Participant)
more than 12 calendar months prior to notice having
been given to the Participant of the termination of
his employment; provided, however, that this
subsection shall not apply to a termination pursuant
to clause (iii) above.
Sec. 2.4 Change In Control. "Change in Control" means the
occurrence of any of the following:
(a) The acquisition by any person, entity or "group" within the
meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange
Act of 1934, as amended ("the 1934 Act"), other than the Parent or
any of its affiliates, or any employee benefit plan of the Parent
and/or its affiliates, of beneficial ownership (within the meaning
of Rule 13d-3 under the 1934 Act) of shares of stock of the Parent
having twenty-five percent (25%) or more of the total number of
votes that may be cast for election of the Board in a transaction
or series of transactions not approved in advance by a vote of at
least three-quarters of the Continuing Directors (as defined
below).
(b) A change in the composition of the Board such that at any time a
majority of the members of the Board are not Continuing Directors.
"Continuing Directors" refers to the individuals who serve on the
Board at the effective date of this Plan and any individual whose
term of office on the Board begins thereafter if the nomination or
election of such individual was approved in advance by a vote of
at least three-quarters of the then serving Continuing Directors
(other than a nomination of an individual whose initial assumption
of office is in connection with an actual or threatened
solicitation with respect to the election or removal of the
members of the Board, as such terms are used in Rule 14a-11 of
Regulation 14A under the 1934 Act).
(c) The approval by the shareholders of the Parent of a
reorganization, merger, consolidation, liquidation or dissolution
of the Parent or of the sale (in one transaction or a series of
transactions) of all or substantially all of the assets of the
Parent other than a reorganization, merger, consolidation,
liquidation,
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dissolution or sale approved in advance by a vote of at least
three-quarters of the Continuing Directors.
(d) Any other occurrence if at least a majority of the Continuing
Directors determine in their discretion that there has been a
Change in Control.
Sec. 2.5 Committee. "Committee" means the Compensation
Committee of the Board or such other committee as may be appointed by the Board
to administer the Plan. However, no member of the Committee who is also a
Participant in this Plan may participate in or vote on any matter involving the
Plan.
Sec. 2.6 Covered Compensation. "Covered Compensation" means
Covered Compensation as defined under the Retirement Plan (as said definition
may be amended from time to time).
Sec. 2.7 Final Average Compensation. "Final Average Compensation
means the average of the highest 5 calendar years of Compensation received by
the Participant from the Participating Employers during the 10 calendar year
period immediately preceding the calendar year in which the Participant's
termination of employment occurs (or the average of the calendar years during
such period in which the Participant received compensation if the Participant
received compensation in fewer than 5 such years). For this purpose, the
Participant's Compensation for a year is the Participant's base pay (determined
before any reductions for pre-tax contributions under The Musicland Group, Inc.
Capital Accumulation Plan, or any deferred compensation plan or other benefit
plan, and before withholding of taxes) plus bonuses received from the
Participating Employers.
Sec. 2.8 Normal Retirement Age. "Normal Retirement Age" means
age 65.
Sec. 2.9 Participant. "Participant" means an individual defined
as such in Sec. 3.1.
Sec. 2.10 Plan Year. "Plan Year" means the 12-consecutive-month
period commencing January 1 and ending December 31.
Sec. 2.11 Retirement Plan. "Retirement Plan" means The Musicland
Group, Inc. Employees' Retirement Plan, as it may be amended from time to time.
Sec. 2.12 Subsidiary. "Subsidiary" means any corporation 80% or
more of the voting stock of which is owned directly indirectly by the Parent.
Sec. 2.13 Successor Employer. "Successor Employer" means any
business entity that succeeds to the business of another business entity through
merger, consolidation, acquisition of all or substantially all of its assets, or
any other means.
Sec. 2.14 Supplemental Accrual Years. "Supplemental Accrual
Years" means the Participant's Years of Participation plus, in the case of a
Participant who has 5 or more Years of Participation, the period of time prior
to the date on which he/she became a Participant in this Plan and during which
he/she was a participant in the Retirement Plan or The Musicland Group, Inc.
Capital Accumulation Plan.
Sec. 2.15 Year of Participation. "Year of Participation" means
the period of time (expressed in completed years) that has elapsed from the
date on which an
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employee becomes a Participant in this Plan to the date on which he/she ceases
to be a Participant in this Plan (by reason of his/her termination of employment
or otherwise).
ARTICLE III
PARTICIPATION ARTICLE III
PARTICIPATION
Sec. 3.1 Eligibility for Participation. A select management or
highly compensated employee of the Company or another Participating Employer
shall become a Participant in the Plan upon being designated as such by the
Committee in a written notice issued by the Committee to the Participant at the
time of the designation, effective as of the date specified in the notice and
subject to any additional conditions or limitations specified in the notice.
Sec. 3.2 Cessation of Participation. An employee shall cease to
be a Participant on the earliest of (i) the date he or she ceases to be an
employee of the Participating Employers, (ii) the date he or she receives a
written notice from the Committee revoking his/her status as a Participant, or
(iii) the date he/she fails to meet the requirements of any regulations which
may be issued by the U.S. Department of Labor that define the phrase "select
group of management or highly compensated employees" under ERISA. Service
and compensation after the date the individual ceases to be a Participant shall
be disregarded for purposes of this Plan, but the individual shall remain
entitled to any benefits under this Plan which have become vested prior to that
date.
Sec. 3.3 No Guarantee of Employment. Participation in the Plan
does not constitute a guarantee or contract of employment with the
Participating Employers. Such participation shall in no way interfere with
any rights the Participating Employers would have in the absence of such
participation to determine the duration of the employee's employment with the
Participating Employers.
ARTICLE IV
BENEFIT ACCRUAL AND VESTING ARTICLE IV
BENEFIT ACCRUAL AND VESTING
Sec. 4.1 Supplemental Retirement Benefit. A Participant's
supplemental retirement benefit under the Plan as of any date of determination,
when expressed as a single life annuity starting as of the first day of the
month after the Participant attains Normal Retirement Age (or as of the first
day of the month after the date of determination, if such date is after Normal
Retirement Age) will equal an amount equal to "A" minus "B", where:
A = "A1" multiplied by "A2" and divided by 12, where
A1 = 1% of the Participant's Final Average Compensation,
plus .65% of the Participant's Final Average
Compensation in excess of Covered Compensation.
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<PAGE>
A2 = The Participant's Supplemental Accrual Years.
However, as of any date of determination after Normal Retirement
Age, the value of "A" will not be less than the value of "A"
measured as of the first day of the month after Normal Retirement
Age and increased by 1.5% per year for each subsequent year to the
date of determination.
B = "B1" plus "B2" plus "B3", where:
B1 = The monthly amount of the pension (if any) that the
Participant would be entitled to receive under the
Retirement Plan in the form of a single life annuity
starting as of the first day of the month after the
Participant attains Normal Retirement Age (or as of
the first day of the month after the date of
determination, if such date is after Normal
Retirement Age), irrespective of the actual pension
paid to the Participant under the Retirement Plan.
B2 = The monthly amount of a hypothetical annuity
calculated by converting his/her "hypothetical
balance" under The Musicland Group, Inc. Capital
Accumulation Plan to a single life annuity starting
as of the first day of the month after the
Participant attains Normal Retirement Age (or the
first day of the month after the date of
determination, if such date is after Normal
Retirement Age) using the following actuarial
factors: mortality - UP-1984 Mortality Table;
interest - an annual rate equal to the lesser of (i)
8%, or (ii) the average of the annual rates of
interest on 30-Year Treasury Securities for November
of the Plan Year preceding the Plan Year in which the
hypothetical annuity is to commence, as prescribed by
the Internal Revenue Service for purposes of Code
section 417(e).
For this purpose, a Participant's "hypothetical
balance" under The Musicland Group Capital
Accumulation Plan shall be equal to the sum of the
profit sharing contributions made thereunder on
behalf of the Participant, each credited with
interest at the rate of 8% per annum from the last
day of the plan year with respect to which such
contribution was made (irrespective of the date on
which such contribution was actually contributed to
the plan) to the last day of the month prior to the
month in which the hypothetical annuity is to
commence.
B3 = The monthly amount of a hypothetical annuity
calculated by converting the "excess value" under his
/her life insurance policy purchased under The
Musicland Group, Inc. Executive/Survivor Benefit
Split Dollar Life Insurance Agreement to a single
life annuity starting as of the first day of the
month after the Participant attains Normal Retirement
Age (or the first day of the month after the date of
determination, if such date is after Normal
Retirement Age) using the following actuarial
factors: mortality- UP-1984 Mortality Table; interest
- an annual rate equal to the lesser of (i) 8%, or
(ii) the average of the annual rates of interest on
30-year Treasury Securities for November of the Plan
Year preceding the Plan Year in
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which the hypothetical annuity is to commence, as
prescribed by the Internal Revenue Service for
purposes of Code section 417(e).
For this purpose, a Participant's "excess value"
under his/her life insurance policy is the excess of
the cash surrender value of such policy as of his/her
termination of employment over the premiums that have
been paid under such policy and that are subject to
recapture by the Company under the terms of The
Musicland Group, Inc. Executive/Survivor Benefit
Split Dollar Life Insurance Agreement. In the event a
life insurance policy is surrendered for its cash
value prior to termination of employment, the "excess
value" is the excess determined under the prior
sentence as of the date of surrender credited with
interest at the rate of 8% per annum from the date of
surrender to the last day of the month prior to the
month in which the hypothetical annuity is to
commence.
Sec. 4.2 Vesting of Benefit. A Participant will be vested in
a supplemental retirement benefit if his/her termination of employment with all
Participating Employers occurs:
(a) After he/she has completed at least 5 Years of Participation, or
(b) At his/her termination of employment prior to completion of 5
Years of Participation if such termination of employment occurs
for any reason other than for Cause.
Notwithstanding the foregoing, the Participant shall not be vested in a
supplemental retirement benefit under this Plan and the entire benefit shall be
forfeited if the Participant's employment is terminated by his/her Participating
Employer because of the Participant's fraud or dishonesty which has resulted in,
or is likely to result in, material economic damage to a Participating Employer,
as determined in good faith by the Committee. The determination of the Committee
with respect to the Participant's conduct shall be conclusive, whether or not
there are related judicial or other proceedings and without regard to the
outcome of any such proceeding. A Participant who is not vested under this
Section on the date his/her termination of employment occurs shall not be
eligible to receive any benefit under this Plan.
ARTICLE V
FORM OF PAYMENT AND COMMENCEMENT DATE ARTICLE V
FORM OF PAYMENT AND COMMENCEMENT DATE
Sec. 5.1 Entitlement. A Participant shall be entitled to a
supplemental retirement benefit under the Plan if he/she is vested in such a
benefit upon his/her termination of employment with all Participating Employers.
Sec. 5.2 Time of Payment. A supplemental retirement benefit
shall be paid commencing as of the first day of the month after the Participant
attains Normal Retirement Age (or as of the first day of the month after his/her
termination of employment if after Normal Retirement Age). However, in the event
the Participant's
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termination of employment occurs prior to Normal Retirement Age (except for
death), the supplemental retirement benefit shall be paid commencing as of the
following date:
(a) As of the first day of the following month:
If the Participant has completed
the following number of years of The first day of the month
service with the Parent after he/she has attained
or any Subsidiary the following age:
----------------- -----------------
15 55
14 56
13 57
13 58
11 59
10 60
(or as of the first day of the month after his/her termination of
employment, if after the age specified above).
(b) Otherwise, as of the first day of the month after the Participant
attains Normal Retirement Age.
The amount of the supplemental retirement benefit, when expressed as a single
life annuity, shall be reduced by 1/15th for each of the first 5 years, and
1/30th for each of the next 5 years, by which the commencement date precedes the
first day of the month following the date the Participant will attain Normal
Retirement Age.
Sec. 5.3 Form of Payment. The supplemental retirement benefit
shall be payable in the form of a single life annuity for the life of the
Participant; except that:
(a) Upon written election of a Participant made within 60 days after
notice of his/her participation in the Plan, or upon written
election of a Participant made at any time before commencement of
the benefit and with the specific consent of the Committee (which
shall be granted in its sole discretion), the supplemental
retirement benefit shall be payable in the form of any annuity
option permitted under the Retirement Plan (determined without
regard to any limitation resulting from Code section 401(a)(9)).
(b) Upon written election of a Participant made at any time before
commencement of the benefit and with the specific consent of the
Committee (which shall be granted in its sole discretion), the
supplemental retirement benefit shall be payable in the form of a
single lump-sum payment.
Any annuity or lump-sum payment shall be the Actuarial Equivalent of the life
annuity that would be payable as a supplemental retirement benefit starting as
of the same date.
Notwithstanding any contrary provision of this Plan, and notwithstanding the
election of a Participant, the supplemental retirement benefit shall be paid as
soon as administratively practicable after termination of employment in the form
of a single lump-sum payment that is the Actuarial Equivalent of the single life
annuity that the Participant would receive starting at Normal Retirement Age (or
as of the first day of the
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month after his/her termination of employment if after Normal Retirement Age) if
the amount of such single lump-sum payment does not exceed $5,000.
Sec. 5.4 Disability Before Retirement. If a Participant becomes
disabled while employed by a Participating Employer and his/her termination of
employment occurs as a result of such disability, at the request of the
Participant and with the specific consent of the Committee (to be granted in its
sole discretion), the supplemental retirement benefit shall be payable starting
as of the first day of any month following his/her termination of employment. If
payments start prior to the date specified in Sec. 5.2, the amount of the
supplemental retirement benefit shall be reduced to be the Actuarial Equivalent
of the supplemental retirement benefit payable starting as of the first day of
the month after the Participant will attain Normal Retirement Age. For this
purpose, "disabled" means that the Participant is mentally or physically unable
to perform his/her usual duties for the Participant Employer, as determined by
the Committee.
Sec. 5.5 Death Prior to Commencement of Benefits. If a
Participant dies after he/she is vested but prior to the payment or commencement
of his/her supplemental retirement benefit, and the Participant is survived by
his/her spouse, such spouse shall be entitled to a survivor benefit as follows:
(a) The survivor benefit shall be payable in the form of a single life
annuity for the life of the spouse starting as of the first day of
the month after the date of death of the Participant or, if later,
as of the earliest date on which the supplemental retirement
benefit could have commenced to the Participant under Sec. 5.2
(determined based upon his/her years of service as of his/her date
of death).
(b) The monthly payment under the survivor benefit shall equal the
amount which would have been paid to the spouse as a survivor
annuity if the Participant had survived to the date on which
payments start under (a), commenced his/her supplemental
retirement benefit in the form of a qualified joint and survivor
annuity (as defined under the Retirement Plan) and then died.
The Committee may, in its sole discretion, pay the survivor benefit to a spouse
in a single lump sum payment in lieu of the life annuity, with the single
lump-sum payment being the Actuarial Equivalent of the single life annuity that
would otherwise be paid to the spouse. Further, the Committee may, in its sole
discretion, provide for earlier payment of the survivor benefit that otherwise
provided under (a), with the survivor benefit being the Actuarial Equivalent of
the survivor benefit that would be payable as of the date specified in (a).
If a Participant dies prior to the payment or commencement of his/her
supplemental retirement benefit, and the Participant does not have a spouse on
the date of death (or such spouse does not survive the Participant), there shall
be no benefit payable under the Plan to any other beneficiary.
Sec. 5.6 Death After Commencement of Benefits. If a Participant
receives his/her supplemental retirement benefit in the form of an annuity and
dies after commencement of such annuity, the benefit (if any) payable after the
Participant dies shall be as appropriate for the form of annuity being received.
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Sec. 5.7 Benefit Upon Change In Control. Notwithstanding any
contrary provision of the Plan, in the event of a Change in Control, the Company
shall be obligated to establish a "rabbi" trust as a funding vehicle for the
Plan (if such a trust has not previously been established for this purpose) and
the Participating Employers shall be obligated to contribute to such trust the
amount determined by the actuaries for the Retirement Plan as being necessary to
fully fund all accrued benefits under this Plan as of the Change of Control (the
funding to equal the Actuarial Equivalent present value of all accrued benefits
under the Plan). If a Participant's termination of employment with all
Participating Employers occurs within 24 months after a Change In Control, the
Participant shall be fully vested in his/her supplemental retirement benefit,
and such benefit shall be paid within 30 days following his/her termination of
employment in a single lump sum payment that is the Actuarial Equivalent of the
benefit to which he/she was otherwise entitled under the Plan.
ARTICLE VI
ADMINISTRATION ARTICLE VI
ADMINISTRATION
Sec. 6.1 Administration by the Committee. The Committee shall
administer the Plan, establish, adopt, or revise such rules and regulations as
it may deem necessary or advisable for the administration of the Plan and
interpret the provisions of the Plan. The Committee shall have discretionary
authority to interpret the Plan, and the interpretations of the Committee shall
be conclusive.
Sec. 6.2 Withholding of Taxes. The benefits payable under this
Plan shall be subject to the deduction of any federal, state, or local income
taxes or other taxes which are required to be withheld from such payments by
applicable laws and regulations.
Sec. 6.3 Unfunded and Unsecured Plan. The Plan is an unfunded
and unsecured nonqualified plan for federal income tax, ERISA and Department of
Labor purposes. It is a condition of the Plan, and each Participant expressly
agrees, that the Participant and the Participant's spouse, joint annuitant or
beneficiary shall look solely to the Participating Employers for payment of
benefits under the Plan, whether such payments are made from the general funds
of the Participating Employers or otherwise. No Participant or Beneficiary shall
have any interest whatsoever in any specific asset of the Participating
Employers. Neither the trust that supports the Retirement Plan, nor the trust
that supports The Musicland Group Inc., Capital Accumulation Plan, nor any
split-dollar life insurance policy on the life of any Participant, nor any other
specific asset or fund shall in any way support the liabilities created under
this Plan, except as otherwise expressly provided in Sec. 5.7 (relating to a
"rabbi" trust). To the extent that any Participant or Beneficiary acquires a
right to receive payments under this Plan, such right shall be no greater than
the right of any unsecured general creditor of the Participating Employers.
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ARTICLE VII
AMENDMENT AND TERMINATION ARTICLE VII
AMENDMENT AND TERMINATION
Sec. 7.1 Amendment. The Board may amend the Plan at any time in
whole or in part for any reason. No amendment shall decrease the benefits that
have accrued under the Plan prior to the date of such amendment based on
earnings and service prior to such date, but the amendment may decrease or
eliminate future benefit accruals.
Sec. 7.2 Termination of Plan. The Board may terminate the Plan
at any time. After such termination, no employee shall become a Participant, no
further benefits shall accrue under the Plan, and each Participant shall become
100% vested in the benefit accrued prior to the date of termination. At the
discretion of the Committee, the benefits accrued prior to termination of the
Plan may be either distributed to Participants (or Beneficiaries in the event of
death) in a lump sum on an Actuarial Equivalent basis as of a date determined by
the Committee which is after the date of termination, or distributed in
accordance with Article V.
ARTICLE VIII
MISCELLANEOUS ARTICLE VIII
MISCELLANEOUS
Sec. 8.1 Designation of Joint Annuitant or Beneficiary. If a
Participant receives his/her supplemental retirement benefit in the form of a
joint and survivor annuity or life with term certain annuity, he/she may name
any joint annuitant or beneficiary with respect thereto; provided that, in the
absence of a designation or in the event that the designated joint annuitant or
beneficiary is not surviving on the annuity starting date, his/her spouse (if
any) as of the annuity starting date shall be the joint annuitant or
beneficiary. A designation of joint annuity or beneficiary shall be made with
the election of the payment form and shall not require consent of the spouse.
However, the Participant may change such designation (but not the payment form
election) at any time prior to the annuity starting date with the consent of the
Committee. If a Participant's payment form election cannot be affected because
the designated joint annuitant or beneficiary is not surviving on the annuity
starting date, and the Participant has no spouse on the annuity starting date,
the supplemental retirement benefit shall be paid as a single life annuity,
except as provided in Sec. 5.3(b).
Sec. 8.2 Benefits May Not Be Assigned or Alienated. Neither a
Participant nor any Beneficiary shall have the right to sell, assign, transfer,
encumber or otherwise convey any right to receive any payment hereunder. No
part of the amounts payable hereunder shall be subject to seizure or
sequestration for the payment of any debts or judgments owed by a Participant or
any other person.
Sec. 8.3 Headings. Headings at the beginning of articles and
sections hereof are for convenience of reference, shall not be considered a part
of the text of the Plan, and shall not influence its construction.
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Sec. 8.4 Capitalized Definitions. Capitalized terms used in the
Plan shall have their meaning as defined in the Plan unless the context clearly
indicates to the contrary.
Sec. 8.5 Gender. Any references to the masculine gender include
the feminine and vice versa.
Sec. 8.6 Use of Compounds of Word "Here". Use of the words
"hereof", "herein", "hereunder", or similar compounds of the word "here" shall
mean and refer to the entire Plan unless the context clearly indicates to the
contrary.
Sec. 8.7 Construed as a Whole. The provisions of the Plan shall
be construed as a whole in such manner as to carry out the provisions hereof and
shall not be construed separately without relation to the context.
IN WITNESS WHEREOF, the Company has caused this Plan to be
executed by its duly authorized officer this 23 day of December, 1998.
THE MUSICLAND GROUP, INC.
By Jack W. Eugster /s/ Jack W. Eugster
------------------------------------- ---------------------------------
Its Chief Executive Officer
M1:
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.
SUBSIDIARY INFORMATION EXHIBIT 21
UPDATED AS OF DECEMBER 31, 1998
I. SUBSIDIARIES OF MUSICLAND STORES CORPORATION
State Of Name(s) Under Which
Name Of Corporation Incorporation Corporation Does Business
- ------------------- ------------- -------------------------
The Musicland Group, Inc. Delaware Discount Records
Excelsior
Musicland
Musicland/Suncoast Motion
Picture Company
On Cue
Replay
Sam Goody
Sam Goody's Music & Video
Sam Goody's Musicland
Sam Goody/Suncoast Motion
Picture Company
II. SUBSIDIARIES OF THE MUSICLAND GROUP, INC.
State Of Name(s) Under Which
Name Of Corporation Incorporation Corporation Does Business
- ------------------- ------------- -------------------------
Media Play, Inc. Delaware Media Play
MG Financial Services, Inc. Delaware
MLG Internet, Inc. Delaware mediaplay.com
oncue.com
samgoody.com
suncoast.com
Musicland Retail, Inc. Delaware Musicland
Musicland/Suncoast Motion
Picture Company
Replay
Sam Goody
Sam Goody/Suncoast Motion
Picture Company
On Cue, Inc. Delaware On Cue
Request Media, Inc. Delaware Request
requestline.com
Suncoast Group, Inc. Delaware Producers Club
Suncoast Motion Picture Company
Suncoast Pictures
Suncoast Motion Picture
Company, Inc. Delaware
Suncoast Retail, Inc. Delaware Producers Club
Suncoast Motion Picture Company
TMG Caribbean, Inc. Delaware Musicland
Sam Goody
Suncoast Motion Picture Company
TMG-U.K. Delaware, Inc. Delaware Sam Goody
TMG-Virgin Islands, Inc. Delaware Sam Goody
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report dated January 18, 1999, included in this form 10-K, into the Company's
previously filed Registration Statement File Nos. 33-50520, 33-50522, 33-50524,
33-82130, 33-99146 and 333-51401.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
March 25, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet of Musicland Stores Corporation and subsidiaries
as of December 31, 1998, and the related consolidated statement of
operations for the year then ended, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<CASH> 257,218
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 446,710
<CURRENT-ASSETS> 730,123
<PP&E> 437,349
<DEPRECIATION> 203,925
<TOTAL-ASSETS> 973,640
<CURRENT-LIABILITIES> 607,153
<BONDS> 258,871
0
0
<COMMON> 360
<OTHER-SE> 63,622
<TOTAL-LIABILITY-AND-EQUITY> 973,640
<SALES> 1,846,882
<TOTAL-REVENUES> 1,846,882
<CGS> 1,190,582
<TOTAL-COSTS> 1,190,582
<OTHER-EXPENSES> 571,489
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 30,478
<INCOME-PRETAX> 54,333
<INCOME-TAX> 16,300
<INCOME-CONTINUING> 38,033
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 38,033
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.04
</TABLE>
