UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------- -------
Commission file number 1-11014
MUSICLAND STORES CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 41-1623376
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
10400 Yellow Circle Drive, Minnetonka, MN 55343
(Address of principal executive offices) (Zip Code)
(952) 931-8000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X . No .
--- ---
The Registrant had 32,096,959 shares of common stock outstanding on
October 29, 2000.
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TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Statements of Earnings 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Report of Independent Public Accountants 9
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 6. Exhibits and Reports on Form 8-K 16
Signature 17
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ----------------------
2000 1999 2000 1999
--------- --------- ---------- ----------
Sales.............................. $ 389,393 $ 386,337 $1,207,700 $1,169,193
Cost of sales...................... 236,427 240,366 749,712 736,517
--------- --------- ---------- ----------
Gross profit.................... 152,966 145,971 457,988 432,676
Selling, general and administrative
expenses.......................... 135,773 128,485 404,457 379,431
Depreciation and amortization...... 11,527 10,586 32,894 30,478
--------- --------- ---------- ----------
Operating income................ 5,666 6,900 20,637 22,767
Interest expense................... 5,564 5,860 14,374 17,623
--------- --------- ---------- ----------
Earnings before income taxes.... 102 1,040 6,263 5,144
Income taxes....................... 40 312 2,443 1,543
--------- --------- ---------- ----------
Net earnings.................... $ 62 $ 728 $ 3,820 $ 3,601
========= ========= ========== ==========
Basic earnings per common share.... $ 0.00 $ 0.02 $ 0.12 $ 0.10
========= ========= ========== ==========
Diluted earnings per common share.. $ 0.00 $ 0.02 $ 0.12 $ 0.10
========= ========= ========== ==========
See accompanying Notes to Consolidated Financial Statements.
3
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
September 30,
--------------------- December 31,
2000 1999 1999
---------- ---------- ------------
ASSETS
Current assets:
Cash and cash equivalents............... $ 38,476 $ 65,961 $ 335,693
Inventories............................. 443,137 420,059 444,792
Deferred income taxes................... 27,237 16,300 27,300
Other current assets.................... 10,540 12,717 9,162
---------- ---------- ------------
Total current assets.................. 519,390 515,037 816,947
Property, at cost.......................... 500,687 451,473 467,526
Accumulated depreciation and amortization.. (252,140) (224,243) (230,976)
---------- ---------- ------------
Property, net........................... 248,547 227,230 236,550
Other assets............................... 11,052 9,583 10,077
---------- ---------- ------------
Total Assets.......................... $ 778,989 $ 751,850 $ 1,063,574
========== ========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................ $ 293,205 $ 294,205 $ 476,191
Other current liabilities............... 94,698 89,519 179,171
---------- ---------- ------------
Total current liabilities............. 387,903 383,724 655,362
Long-term debt............................. 258,515 258,929 258,950
Other long-term liabilities................ 37,683 40,152 39,904
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: September 30, 2000,
36,710,505; September 30, 1999,
36,167,762; December 31, 1999,
36,187,454)........................... 367 362 362
Additional paid-in capital.............. 261,867 261,545 261,534
Accumulated deficit..................... (124,710) (183,044) (128,265)
Deferred compensation................... (4,429) (5,515) (5,237)
Common stock subscriptions.............. (4,253) (4,303) (4,303)
Treasury stock, at cost
(September 30, 2000, 4,620,716 shares;
December 31, 1999, 2,015,700 shares).. (33,954) - (14,733)
---------- ---------- ------------
Total stockholders' equity............ 94,888 69,045 109,358
---------- ---------- ------------
Total Liabilities and Stockholders'
Equity............................... $ 778,989 $ 751,850 $ 1,063,574
========== ========== ============
See accompanying Notes to Consolidated Financial Statements.
4
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine Months Ended
September 30,
----------------------
2000 1999
---------- ----------
OPERATING ACTIVITIES:
Net earnings......................................... $ 3,820 $ 3,601
Adjustments to reconcile net earnings to net cash
used in operating activities:
Depreciation and amortization...................... 34,264 32,583
Disposal of property............................... 1,457 2,290
Deferred income taxes.............................. (125) (500)
Other.............................................. (50) -
Changes in operating assets and liabilities:
Inventories....................................... 1,655 26,651
Other current assets.............................. (1,378) (2,090)
Accounts payable.................................. (182,986) (158,205)
Other current liabilities......................... (84,147) (65,224)
Other assets...................................... (1,370) (631)
Other long-term liabilities....................... (2,221) (3,482)
---------- ----------
Net cash used in operating activities........... (231,081) (165,007)
---------- ----------
INVESTING ACTIVITIES:
Capital expenditures................................. (46,348) (26,571)
---------- ----------
FINANCING ACTIVITIES:
Principal payments on long-term debt................. (450) -
Proceeds from sale of common stock................... 592 321
Purchase of treasury stock........................... (19,930) -
---------- ----------
Net cash provided by (used in) financing
activities....................................... (19,788) 321
---------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS.............. (297,217) (191,257)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD....... 335,693 257,218
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD............. $ 38,476 $ 65,961
========== ==========
CASH PAID DURING THE PERIOD FOR:
Interest............................................ $ 19,944 $ 20,527
Income taxes, net................................... 33,031 22,562
See accompanying Notes to Consolidated Financial Statements.
5
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands)
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts
of Musicland Stores Corporation ("MSC") and its wholly-owned subsidiary, The
Musicland Group, Inc. ("MGI") and MGI's wholly-owned subsidiaries, after
elimination of all material intercompany balances and transactions. MSC and MGI
are collectively referred to as the "Company." The Company operates principally
in the United States as a specialty retailer of home entertainment products,
including prerecorded music and video, books, computer software, video games and
related products.
The interim consolidated financial statements of the Company are
unaudited; however, in the opinion of management, all adjustments necessary for
a fair presentation of such consolidated financial statements have been
reflected in the interim periods presented. Such adjustments consisted only of
normal recurring items. The Company has no significant items of other
comprehensive income. The Company's business is seasonal and, accordingly,
interim results are not indicative of results for a full year. The significant
accounting policies and certain financial information which are normally
included in financial statements prepared in accordance with generally accepted
accounting principles, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying consolidated
financial statements of the Company should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K.
2. Income Taxes
Income taxes for the three months and nine months ended September 30,
2000 and 1999 were based on the estimated annual effective tax rates for each
year. The annual effective tax rate is estimated using the federal statutory
income tax rate, increased for the effect of state income taxes, net of federal
benefit, and estimated earnings before income taxes for the full year.
3. Weighted Average Common Shares Outstanding
A reconciliation of weighted average common shares used in the
computation of basic and diluted earnings per common share is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
-------- -------- -------- --------
Weighted average common shares
outstanding - basic.............. 31,641 35,597 32,240 35,520
Dilutive effect of stock options.. 479 676 500 699
Dilutive effect of warrants....... - 435 17 451
-------- -------- -------- --------
Weighted average common shares
outstanding - diluted............ 32,120 36,708 32,757 36,670
======== ======== ======== ========
Antidilutive stock options........ 2,777 1,837 2,691 1,658
======== ======== ======== ========
Antidilutive stock options outstanding had an exercise price greater than
the average market price during the period.
6
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands)
4. Segment Information
The Company's two reportable segments, stores and E-commerce, have been
identified based on their method of retail distribution - stores and
direct-to-consumer. The Company's stores operate under two principal strategies:
(i) mall based music and video stores ("Mall Stores"), operating predominantly
under the trade names Sam Goody and Suncoast Motion Picture Company, and (ii)
non-mall based full-media superstores ("Superstores"), operating under the trade
names Media Play and On Cue. The stores are supported by centralized corporate
services and have similar economic characteristics, products and customers. In
June of 1999, the Company launched four e-commerce sites ("E-commerce")
operating under the names SamGoody.com, Suncoast.com, MediaPlay.com and
OnCue.com.
Three Months Ended September 30,
------------------------------------------------------------
2000 1999
----------------------------- -----------------------------
Stores Stores
and Other E-commerce Total and Other E-commerce Total
--------- ---------- -------- --------- ---------- --------
Sales (1)......... $ 387,933 $ 1,460 $389,393 $ 386,173 $ 164 $386,337
Operating income
(loss)........... 9,126 (3,460) 5,666 8,458 (1,558) 6,900
Depreciation and
amortization..... 10,937 590 11,527 10,364 222 10,586
Income taxes...... 1,386 (1,346) 40 918 (606) 312
Net earnings
(loss)........... 2,176 (2,114) 62 1,680 (952) 728
Nine Months Ended September 30,
------------------------------------------------------------------
2000 1999
-------------------------------- --------------------------------
Stores Stores
and Other E-commerce Total and Other E-commerce Total
---------- ---------- ---------- ---------- ---------- ----------
Sales (1).....$1,202,653 $ 5,047 $1,207,700 $1,169,001 $ 192 $1,169,193
Operating
income
(loss)....... 29,708 (9,071) 20,637 25,819 (3,052) 22,767
Depreciation
and
amortization. 31,711 1,183 32,894 30,195 283 30,478
Income taxes.. 5,972 (3,529) 2,443 2,730 (1,187) 1,543
Net earnings
(loss)....... 9,362 (5,542) 3,820 5,466 (1,865) 3,601
------------------
(1) Sales for E-commerce in 2000 include shipping and handling charges to
customers of $246 and $847 for the respective three months and nine months ended
September 30, 2000.
The Company's management utilizes various measurements to assess
segment performance. Corporate administration, certain other indirect expenses
and interest expense, none of which are allocated to E-commerce, are identified
as "other" and are combined with the segment information for stores. Segment
information for E-commerce includes an allocation of certain corporate expenses
directly associated with the E-commerce operation.
5. Litigation
On August 8, 2000, 30 Attorneys General served a complaint against the
Company, five major record distributors and two other music specialty retailers
in the U.S. District Court for the Southern District of New York ("AG's suit").
An amended complaint was filed on September 19, 2000 naming additional Attorneys
General as plaintiffs. The AG's suit alleges that the distributors and retailers
conspired to violate the anti-trust laws and to fix prices by adopting and/or
adhering to the labels' Minimum Advertised Pricing Policies. The complaint
alleges that consumers were damaged in an unspecified amount and seeks treble
damages and civil penalties. Following the service of the AG's
7
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MUSICLAND STORES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(In thousands)
5. Litigation (Continued)
suit, these same defendants, as well as certain other retailers, were named as
defendants in four private class action suits, each with similar allegations as
in the AG's suit. As of this date, the Company has been served with private
class actions suits in the U.S. District Court in the Eastern District of
Tennessee, the District of New Jersey, and the District of Alabama. It has also
been named in a suit filed in the Parish of East Baton Rouge, Louisiana, which
the Company will seek to remove to U.S. District Court. The Company anticipates
that it will be named in several more such lawsuits. The Company denies
liability and plans to undertake a vigorous defense. The AG's suit, the private
class actions described above and other similar private actions filed against
the labels and other retailers, are being consolidated in the U.S. District
Court in Maine under the Multidistrict Litigation Rules.
At this time, management is unable to make a prediction as to the
potential damages or costs that the Company would incur if it did not prevail in
this litigation. Accordingly, the Company has not recorded any contingent
liability in its financial statements in connection with this litigation. Legal
costs are being charged to expense as they are incurred.
8
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Musicland Stores Corporation:
We have reviewed the accompanying consolidated balance sheets of Musicland
Stores Corporation (a Delaware corporation) and Subsidiaries as of September 30,
2000 and 1999, and the related consolidated statements of earnings for the
three-month and nine-month periods ended September 30, 2000 and 1999, and the
consolidated statements of cash flows for the nine-month periods ended September
30, 2000 and 1999. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States, the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Musicland
Stores Corporation and Subsidiaries as of December 31, 1999, and, in our report
dated January 21, 2000, we expressed an unqualified opinion on that statement.
In our opinion, the information set forth in the accompanying consolidated
balance sheet as of December 31, 1999, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
October 25, 2000
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF
OPERATIONS AND FINANCIAL CONDITION
Results of Operations
Third quarter 2000 net earnings were $0.1 million, or $0.00 on a per
share basis, compared with net earnings of $0.7 million, or $0.02 per share, in
the third quarter last year. For the first nine months of 2000, net earnings
were $3.8 million, or $0.12 per share, compared with net earnings of $3.6
million, or $0.10 per share, for the same period last year. Continued
improvements in gross margin and lower interest expense offset increased
expenditures for the Company's E-commerce operations in both the third quarter
and first nine months of 2000. Earnings for the third quarter of 2000 were also
impacted by weak music sales.
The loss from E-commerce operations in the third quarter, including
certain corporate expenses related to E-commerce and net of income tax benefit,
reduced net earnings in 2000 by $2.1 million, or $0.07 per share, versus a
reduction of $1.0 million, or $0.03 per share, in 1999. The loss from E-commerce
operations for the nine months ended September 30, 2000 and 1999 was $5.5
million and $1.9 million, respectively, or a loss of $0.17 and $0.05,
respectively, on a per share basis. Expenditures to enhance the sites and build
market share were a significant factor in the higher E-commerce losses in 2000.
For the year ending December 31, 2000, the Company expects the E-commerce loss,
including certain corporate expenses and net of income tax benefit, to reduce
earnings per share by up to $0.30. See Note 4 of Notes to Consolidated Financial
Statements.
Sales. The following tables present certain unaudited sales and store
data for Mall Stores, Superstores, E-commerce and in total for the Company for
the periods indicated. The Company's E-commerce operation was formed in 1998 and
began online retailing in June of 1999.
Three Months Ended September 30,
-----------------------------------------------
Percent of Total
Percent ----------------
2000 1999 Incr.(Decr.) 2000 1999
-------- -------- ------------ -------- -------
(Dollars in millions)
Sales:
Mall Stores................ $246.6 $252.7 (2.4)% 63.3% 65.4%
Superstores................ 141.3 133.5 5.9 36.3 34.6
E-commerce (1)............. 1.5 0.2 790.2 0.4 -
Total.................... 389.4 386.3 0.8 100.0 100.0
Comparable store sales
increase (decrease) (2):
Mall Stores................ (0.8)% (0.7)% N/A N/A N/A
Superstores................ (1.9) 1.1 N/A N/A N/A
E-commerce (1)............. 636.1 N/A N/A N/A N/A
Total.................... (0.9) (0.1) N/A N/A N/A
10
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Nine Months Ended September 30,
-------------------------------------------------
Percent of Total
Percent -----------------
2000 1999 Incr.(Decr.) 2000 1999
-------- -------- ------------ -------- --------
(Dollars and square footage in millions)
Sales:
Mall Stores.............. $ 764.3 $ 758.8 0.7 % 63.3 % 64.9 %
Superstores.............. 438.4 409.1 7.2 36.3 35.0
E-commerce (1)........... 5.0 0.2 2,528.6 0.4 -
Total (3).............. 1,207.7 1,169.2 3.3 100.0 100.0
Comparable store sales
increase (2):
Mall Stores.............. 2.3% 1.6% N/A N/A N/A
Superstores.............. 0.9 4.4 N/A N/A N/A
E-commerce............... 763.2 N/A N/A N/A N/A
Total (3).............. 1.9 2.5 N/A N/A N/A
Number of stores open at
end of period:
Mall Stores.............. 1,062 1,093 (2.8)% 79.8 % 82.1 %
Superstores.............. 269 239 12.6 20.2 17.9
Total.................. 1,331 1,332 (0.1) 100.0 100.0
Total store square footage
at end of period:
Mall Stores.............. 4.1 4.0 1.3 % 46.3 % 47.8 %
Superstores.............. 4.7 4.4 7.4 53.7 52.2
Total.................. 8.8 8.4 4.5 100.0 100.0
Mall stores include Sam Goody/Musicland and Suncoast stores.
Superstores include Media Play and On Cue stores.
----------------------------------------------
(1) E-commerce sales in 2000 include shipping and handling revenues of $0.2
million and $0.8 million for the respective three months and nine months
ended September 30, 2000.
(2) Comparable store sales percentages are computed for stores open for a full
year during each period.
(3) The 1999 totals include United Kingdom stores.
The increases in total Company sales for the three months and nine
months ended September 30, 2000 were driven primarily by the incremental sales
generated by the additional square footage from new stores and expansion of
existing stores since September 30, 1999. Mall Store sales performance has been
impacted by store closings since September 30, 1999 and in the third quarter of
2000 by weak comparable store sales.
Comparable store sales results in both the third quarter and first nine
months of 2000 were led by strong growth in video sales. DVD sales continue to
benefit from the rapid growth in the installed base of DVD hardware and expanded
DVD product offerings from the release of new movie titles on DVD as well as the
re-release of movie classics on DVD. Comparable store sales in the third quarter
of 2000 were negatively impacted by a weak new release schedule for music
product. The weak music sales have continued early into the fourth quarter,
while DVD sales remain strong. The comparable store sales percentage increase
(decrease) and the percentage of total sales attributable to the Company's music
and video product categories are presented below.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
-------- -------- -------- -------
Music, including music video........ (8.5)% 2.2 % (1.6)% 2.5 %
Video, excluding music video........ 15.3 (13.8) 8.9 (4.2)
Music as a percentage of total
sales............................. 49.8 54.5 51.8 54.3
Video as a percentage of total
sales............................. 28.0 24.2 27.5 25.7
DVD sales as a percentage of total
video sales....................... 34.2 22.7 33.0 20.4
11
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The decline in music sales as a percentage of total sales is the result
of the sales growth in other product categories, such as books, electronics and
entertainment products, as well as a more rapid decline in sales of
audiocassettes. The sales growth in books has been driven by the widely
popular Harry Potter books while sales growth in the electronics and
entertainment product categories has been driven by strong consumer demand and
expanded product selections.
Gross Profit. Gross profit as a percentage of sales was 39.3% in the
third quarter of 2000 compared with 37.8% in the third quarter of 1999, an
increase of 1.5%. A decrease in inventory shrinkage, primarily related to
security enhancements in the stores, added 0.7% to gross margin in the third
quarter of 2000. Weak sales of new music releases, which are typically offered
at promotional prices, resulted in fewer markdowns during the quarter and were
the principle factor in the balance of the gross margin improvement for the
quarter. For the nine months ended September 30, 2000, gross margin improved
0.9% to 37.9% from 37.0% in 1999. A decrease in inventory shrinkage increased
gross margin by 0.4% in the first nine months of 2000. The balance of the gross
margin improvement was driven by selective price increases over the last twelve
months.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of sales for the third quarter were
34.9% in 2000 compared with 33.3% in 1999 and for the first nine months were
33.5% in 2000 compared with 32.5% in 1999. The percentage rate increases were
primarily attributable to store expenses and expenditures for the Company's
E-commerce operations. Store expenses, excluding depreciation and amortization,
increased by $3.6 million and $14.1 million for the respective three-month and
nine-month periods ended September 30, 2000 over the same periods in 1999. The
higher level of store expenses in 2000 reflects the impact of annual increases
in payroll and occupancy costs, current market lease rates for lease renewals
and new stores and additional store expense associated with the increase in
square footage from new and remodeled stores. Expenditures for E-commerce
operations, inclusive of corporate expenses related to E-commerce, were $1.9
million and $6.2 million higher in the third quarter and first nine months of
2000, respectively, than in the same periods in 1999.
Depreciation and Amortization. Depreciation and amortization for the
third quarter and first nine months of 2000 increased $0.9 million and $2.4
million, respectively, over the same periods in 1999. The increases were
attributable primarily to capital expenditures over the last twelve months for
the remodel and relocation of existing stores, new stores and the new E-commerce
sites.
Interest Expense. Interest expense was reduced by interest income in
each period. The decrease in interest expense in 2000 was the result of higher
interest income and lower revolver facility costs. The increase in interest
income was the result of higher levels of cash available for investment during
the nine months ended September 30, 2000 as well as higher interest rates earned
on investments during both the third quarter and first nine months of 2000.
Components of interest expense were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
-------- -------- -------- --------
(in millions)
Revolver facility costs.................. $ - $ 0.1 $ 0.1 $ 0.6
Interest on senior subordinated notes.... 6.2 6.2 18.5 18.5
Debt issuance costs, discount and
other interest......................... 0.3 0.4 0.8 1.4
Interest income.......................... (0.9) (0.8) (5.0) (2.9)
-------- -------- -------- --------
Total................................ $ 5.6 $ 5.9 $ 14.4 $ 17.6
======== ======== ======== ========
Monthly average total cash and cash
equivalents and short-term investments. $ 42.1 $ 63.4 $101.1 $ 80.6
======== ======== ======== ========
Income Taxes. Income taxes for the three months and nine months ended
September 30, 2000 and 1999 were based on the estimated annual effective tax
rates for each year. The annual effective tax
12
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rate is estimated using the federal statutory income tax rate, increased for the
effect of state income taxes, net of federal benefit, and estimated earnings
before income taxes for the full year.
Recently Issued Accounting Standards. In June 1998, the Financial
Accounting Standards Board issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("Statement No. 133"). Statement No. 133, as
amended by Statement No. 138 issued in June 2000, establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. As amended
in June 1999 by Statement No. 137, Statement No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000. Adoption of
Statement No. 133 as of January 1, 2001 is not expected to have a material
impact on the Company's financial position or results of operations.
Liquidity and Capital Resources
The Company's primary source of capital in both 2000 and 1999 was
internally generated cash. At September 30, 2000, the Company had cash and cash
equivalents of $38.5 million. The Company has a standby $25 million secured
revolving credit facility with an initial term expiring in 2002. Management
currently intends to have minimal use of this revolving credit facility and
expects that internally generated cash will continue to be the Company's primary
source of capital in 2000 and for the foreseeable future.
Operating Activities. Net cash used in operating activities during the
nine months ended September 30, 2000 and 1999 was $231.1 million and $165.0
million, respectively. The most significant use of cash in each period related
to payments for both seasonal and nonseasonal inventory purchases, as evidenced
by the net decrease in accounts payable during each period of $183.0 million and
$158.2 million, respectively. Seasonal inventory purchases typically begin
during the third quarter and continue into the fourth quarter, while payment is
typically due near the beginning of the following year. Nonseasonal inventory
purchases are made throughout the year and fluctuate with the timing and
strength of new releases, store count and store square footage. Inventories at
September 30, 2000 of $443.1 million increased $23.1 million over inventories of
$420.1 million at September 30, 1999. The higher inventory levels are primarily
a result of additional investments in DVD inventory in response to the rapid
growth in popularity of the format and the 0.4 million increase in store square
footage over the last twelve months.
The decreases in income taxes and deferred gift certificate revenue at
September 30, 2000 and 1999 from the respective December 31 of the previous year
accounted for the majority of the decrease in other current liabilities in each
period. For the nine months ended September 30, 2000 and 1999, the Company made
income tax payments, net of refunds, of $33.0 million and $22.6 million,
respectively. The increase in the amount of payments in 2000 was due to the
increase in earnings for the year ended December 31, 1999 over 1998 and higher
estimated tax payments for 2000. Redemptions of gift certificates, net of new
gift certificates issued, were $20.8 million in the first nine months of 2000
compared with $16.7 million in the first nine months of 1999. The majority of
gift certificate sales occur during the Christmas holiday season, while the
majority of gift certificate redemptions occur early in the following year.
Other operating assets and liabilities, such as payroll and related taxes and
benefits and sales taxes payable, fluctuate with the seasonality of the business
and the timing of store openings and closings.
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Investing Activities. Store expansion and closings were as follows for
the periods indicated:
Three Months Ended Nine Months Ended Twelve Months Ended
September 30, September 30, September 30,
------------------ ----------------- -------------------
2000 1999 2000 1999 2000 1999
-------- -------- -------- -------- -------- ---------
Openings:
Mall Stores..... 6 3 13 7 20 13
Superstores..... 6 7 16 10 31 17
Total......... 12 10 29 17 51 30
Closings:
Mall Stores..... (9) (3) (42) (15) (51) (19)
Superstores..... - - (1) (2) (1) (2)
Total (1)..... (9) (3) (43) (31) (52) (35)
Net increase (decrease):
Mall Stores..... (3) - (29) (8) (31) (6)
Superstores..... 6 7 15 8 30 15
Total (1)..... 3 7 (14) (14) (1) (5)
-----------------------------
(1) The 1999 totals include United Kingdom stores.
The Company's planned capital expenditures for the year ending December
31, 2000 are expected to be approximately $60 million, the majority of which
will include expenditures for existing stores as well as 54 new stores. The
Company's expenditures for existing stores include the remodel or relocation of
over 100 stores as well as the general upkeep of both Mall Stores and
Superstores. The Company's current plans for new store openings in 2000 include
six music stores, 13 Suncoast stores, five Media Play stores and 30 On Cue
stores. In addition, capital expenditures are planned for the improvement of the
Company's E-commerce sites, the first phase in the development of new
web-enabled store systems and enhancements to the Company's distribution
facilities in Franklin, Indiana. Management plans to use primarily internally
generated cash to finance these capital expenditures. The Company currently
plans to close a total of approximately 60 or more stores in 2000, primarily
when the leases expire, as part of management's ongoing review of store
profitability.
In addition to capital expenditures, the Company occasionally invests a
portion of excess cash in short-term investments and may also make other
investments. At September 30, 2000, the Company had no short-term investments
other than cash equivalents. In October 2000, the Company used excess cash to
acquire a minority interest in a golf specialty retailer for $9.4 million. As
the Company's interest represents less than 20% of the voting rights, the
investment will be accounted for on the cost basis.
For the nine months ended September 30, 1999, the most significant
portion of the Company's capital expenditures related to the remodeling,
relocation and general upkeep of existing stores. The closings in 1999 resulted
from the Company's ongoing monitoring of store performance in conjunction with
lease expirations.
Financing Activities. The Company's predominant source of financing for
the nine months ended September 30, 2000 and 1999 was internally generated cash.
There was no revolver borrowing activity during either period. During the first
nine months of 2000, the Company used internally generated cash to purchase
2,701,600 shares of its common stock at a cost of $19.9 million. The stock
purchase is part of a program authorized by the Company's board of directors to
use excess cash to repurchase up to six million shares of common stock on the
open market. From inception of the program in the fourth quarter of 1999 through
September 30, 2000, the Company has repurchased a total of 4,717,300 shares for
an aggregate cost of $34.7 million. The shares repurchased are being used for
stock issued in connection with awards under the Company's stock option and
incentive plans.
The initial term of the $25 million standby revolving credit facility
expires in September 2002 and is renewable annually thereafter. 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 101.125% of par up to June 15, 2001 and at 100% of par
on and
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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. The Company's board of directors has authorized the
repurchase of up to $25 million of either of its outstanding issues of senior
subordinated notes by redemption or through the market maker. During the first
nine months of 2000, the Company used internally generated cash to purchase
through a market maker $0.5 million of the $110 million senior subordinated
notes at 90% of par. The timing and amount of any additional purchases will
depend primarily on market conditions. Management expects to use internally
generated cash for any such repurchases and believes it will be able to secure
adequate financing to repay the senior subordinated notes when they mature.
Other Matters
Seasonality. The Company's business is highly seasonal, with sales
peaking during the Christmas holiday season. Because of the higher sales volume
and extended payment terms generally provided by most product vendors for
seasonal inventory purchases, the Company's cash position is generally highest
at the end of December. For the year ended December 31, 1999, 38.2% of the
Company's sales and 93.8% of the Company's net earnings were 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.
Forward-Looking Statements. This quarterly report on Form 10-Q contains
certain forward-looking statements relating to the Company's operations that are
based on management's current expectations, estimates and projections about the
Company and the home entertainment industry. Words such as "believes,"
"expects," "may," "will," "intends" or "plans," either in the positive or
negative, or discussions of strategy or intentions are used to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve risks, uncertainties and assumptions that are difficult
to predict. Further, some forward-looking statements are based upon assumptions
as to future events that may not prove to be accurate. Examples of factors that
could cause actual outcomes and results to differ materially from any future
results, performance or achievements expressed or implied by such
forward-looking statements are: changes in consumer demand and demographics;
increases in labor costs; the ability to attract and retain qualified personnel;
effects of competitive business practices and new technology, 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; the Company's ability to integrate enhancements to its
existing systems and to implement new technologies; 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 that may be
outside of the Company's control. The Company's repurchase of its common stock
and senior subordinated notes is also dependent on the availability of excess
cash, the attractiveness of prevailing market prices and restrictive covenants
by which the Company is bound. The outcome of any litigation involving the
Company is dependent upon the results of discovery, court rulings, and where
applicable, the decision of a jury. Therefore, actual outcomes and results may
differ materially from what is expressed or forecasted in such forward-looking
statements. Management undertakes no obligation to update publicly any
forward-looking statement for any reason, even if new information becomes
available or other events occur in the future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has not entered into any transactions using derivative
financial instruments or derivative commodity instruments and believes that its
exposure to market risk associated with other financial instruments (such as
cash equivalents and short-term investments) and interest rate risk is not
material.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On August 8, 2000, 30 Attorneys General served a complaint against the
Company, five major record distributors and two other music specialty retailers
in the U.S. District Court for the Southern District of New York ("AG's suit").
An amended complaint was filed on September 19, 2000 naming additional Attorneys
General as plaintiffs. The AG's suit alleges that the distributors and retailers
conspired to violate the anti-trust laws and to fix prices by adopting and/or
adhering to the labels' Minimum Advertised Pricing Policies. The complaint
alleges that consumers were damaged in an unspecified amount and seeks treble
damages and civil penalties. Following the service of the AG's suit, these same
defendants, as well as certain other retailers, were named as defendants in four
private class action suits, each with similar allegations as in the AG's suit.
As of this date, the Company has been served with private class actions suits in
the U.S. District Court in the Eastern District of Tennessee, the District of
New Jersey, and the District of Alabama. It has also been named in a suit filed
in the Parish of East Baton Rouge, Louisiana, which the Company will seek to
remove to U.S. District Court. The Company anticipates that it will be named in
several more such lawsuits. The Company denies liability and plans to undertake
a vigorous defense. The AG's suit, the private class actions described above and
other similar private actions filed against the labels and other retailers, are
being consolidated in the U.S. District Court in Maine under the Multidistrict
Litigation Rules.
At this time, management is unable to make a prediction as to the
potential damages or costs that the Company would incur if it did not prevail in
this litigation.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following are filed as exhibits to Part I of this Form 10-Q:
Exhibit No. Description
----------- -----------------------------------------------------------------
11. Statement re computation of per share earnings (the requirements
of this exhibit are met by Note 3 of Notes to Consolidated
Financial Statements)
15. Letter re unaudited interim financial information
27. Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
September 30, 2000.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MUSICLAND STORES CORPORATION
(Registrant)
By: /s/ Keith A. Benson
----------------------------------
Keith A. Benson
Vice Chairman, Chief Financial
Officer and Director
(authorized officer, principal
financial and accounting officer)
Date: November 10, 2000
-------------------------------
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