-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FhLwwcS3rNgMTNLMFFPPNJ3MbyypXOHUIZH85fzP8s/iZU8c1ka12VSzgNg9gnxV EmDzn1Qo/qQ2r9Lrwcvh7A== 0000912057-97-012616.txt : 19970414 0000912057-97-012616.hdr.sgml : 19970414 ACCESSION NUMBER: 0000912057-97-012616 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970411 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MUSICLAND STORES CORP CENTRAL INDEX KEY: 0000832995 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-RADIO TV & CONSUMER ELECTRONICS STORES [5731] IRS NUMBER: 411623376 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-11014 FILM NUMBER: 97578471 BUSINESS ADDRESS: STREET 1: 10400 YELLOW CIRCLE DR CITY: MINNETONKA STATE: MN ZIP: 55343 BUSINESS PHONE: 6129318000 MAIL ADDRESS: STREET 1: 10400 YELLOW CIRCLE DR CITY: MINNETONKA STATE: MN ZIP: 55343 10-K405 1 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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, 1996 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 incorporation or organization) Identification No.) 10400 YELLOW CIRCLE DRIVE, MINNETONKA, MINNESOTA 55343 (Address of principal executive (Zip Code) offices)
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 26, 1997 was $38,371,268.75, based on the closing price of $1 1/4 per common share on the New York Stock Exchange on such date (only members of the Management Investors Group are considered affiliates for this calculation). The number of shares outstanding of the Registrant's common stock on March 26, 1997 was 34,301,956. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the 1997 Annual Meeting of Stockholders (the "Proxy Statement") are incorporated by reference into Part III. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS GENERAL The Company operates principally in the United States and is engaged in one industry segment as a specialty retailer of home entertainment products, including prerecorded music, prerecorded video, books, computer software and related accessories. The Company's two principal business categories are non-mall based full-media superstores operating under the names Media Play and On Cue and mall based music and video sell-through stores operating under the names Sam Goody, Musicland and Suncoast Motion Picture Company ("Suncoast"). At December 31, 1996, the Company operated 1,466 stores in 49 states, the District of Columbia, the Commonwealth of Puerto Rico, the Virgin Islands and the United Kingdom. For the year ended December 31, 1996, the Company had consolidated revenues of $1.8 billion, including $0.6 billion from non-mall stores and $1.2 billion from mall stores. The market for prerecorded music and video, books, computer software and related accessories continues to be highly competitive. The number of stores and types of competitors have increased significantly over the past few years, including non-mall discount stores, consumer electronics superstores and other mall based music, video and book specialty retailers expanding into non-mall multimedia superstores of their own. The low prices offered by these non-mall stores create intense price competition and adversely impact the performance of both the Company's non-mall and mall stores. Further, consumers have more home entertainment options available with the increasing penetration of personal computers into homes, while industry growth in prerecorded music sales has slowed due to the lack of strong product releases. The Company anticipates that the challenging retail sales environment will continue into the foreseeable future. Management implemented programs during 1996 to improve profitability, reduce inventory levels and increase inventory turnover. More focused marketing and advertising programs were instituted in late 1996. The Company slowed store expansion to focus on improving performance in its existing stores and recorded pretax restructuring charges totaling $75 million to reflect estimated costs associated with the closing of 115 underperforming stores and the Company's distribution facility in Minneapolis, Minnesota. The Company also evaluated goodwill for impairment in 1995 and 1996 and recorded a write-down of $138 million in 1995 and a write-down of the remaining balance of $95.3 million in 1996. See "Management's Discussion and Analysis of Results of Operations and Financial Condition." During the year ended December 31, 1996, the Company opened 35 stores and closed 65 stores, resulting in a net decrease in store count of 30 stores. At December 31, 1996, the Company operated 245 non-mall stores with total square footage of 5.2 million and 1,199 mall stores with total square footage of 4.3 million. After store closings under the restructuring programs are completed and before consideration of other changes to store counts in 1997, the Company will operate 225 non-mall stores with total square footage of 4.2 million and 1,157 mall stores with total square footage of 4.1 million. Store expansion in 1997 will be very limited. 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." 1 NON-MALL STORES MEDIA PLAY STORES. Media Play stores are full-media, low-price superstores in freestanding and regional strip mall locations averaging 48,000 square feet in size. These stores offer a broad merchandising assortment appealing to all ages. During 1996, the merchandising strategy of Media Play stores was revised to minimize slow-moving inventory and reduce working capital investment. The streamlined Media Play stores have approximately 100,000 SKU's of merchandise compared to 175,000 SKU's previously. In addition to prerecorded music, books and prerecorded video, Media Play stores carry approximately 2,000 computer software programs and video games and 1,500 magazine titles, as well as comic books, greeting cards, licensed music, movie and sports apparel and other media and related products. Media Play stores provide a family oriented and exciting shopping environment featuring easy access to all merchandise categories, lounge areas for relaxed browsing, convenient customer service areas, live performances and other entertainment activities, children's play areas, coffee carts and popcorn stands. In-store events, such as musician appearances, book clubs and drawing events, have been popular with customers and will be continued. In late 1996, advertising and merchandising programs were upgraded as part of the Company's strategy to increase store traffic and the average purchase per customer. The Company plans to continue in-store merchandising tests to identify additional product category opportunities. Currently, an expanded children's department is being tested that will provide an interactive learning environment for children. The first Media Play store opened in Rockford, Illinois in November 1992. The Company opened nine Media Play stores in 1996 and closed 11 under the restructuring programs. As part of the Company's effort to improve store productivity, the new stores were smaller in size, averaging approximately 44,000 square feet. At December 31, 1996, the Company operated 87 Media Play stores in 20 states with total square footage of approximately 4.2 million, or 44% of the Company's total store square footage. The Company plans to close an additional 20 underperforming Media Play stores during 1997 under its restructuring programs. After these closings are completed, the Company will operate 67 Media Play stores in 19 states with total square footage of 3.2 million. In other efforts to improve store productivity, 10 to 20 existing stores will be downsized to approximately 35,000 to 40,000 square feet. The Company plans to sublease the vacated space. ON CUE STORES. On Cue stores are full-media stores for smaller markets of between 5,000 and 20,000 people and average 6,200 square feet in size. The stores emphasize competitive prices on new releases and everyday low prices on catalog titles. On Cue stores are promoted through highway billboards, direct mail, cable television and local print and radio. Customer loyalty is rewarded through such programs as in-store sweepstakes and unadvertised in-store specials. The stores offer prerecorded music, books, prerecorded video, computer software, accessories and entertainment related licensed products, such as apparel and posters. Most stores carry approximately 25,000 SKU's of merchandise. On Cue customers have access to over 100,000 home entertainment titles through the Company's special order program. The first On Cue store opened in February 1992. The Company opened 10 On Cue stores in 1996 and closed five under the restructuring programs. At December 31, 1996, the Company operated 158 On Cue stores in 28 states with total square footage of approximately 1.0 million, or 10% of the Company's total store square footage. MALL STORES The Company's mall based music stores continue to experience increasing competition from non-mall discount stores, consumer electronics superstores and other mall based music, video and book specialty retailers that are expanding into non-mall multimedia superstores of their own. These non-mall competitors are expanding into new markets and offer low prices on prerecorded music and video products. MUSIC STORES. The majority of the mall based music stores are operated under the name Sam Goody. At December 31, 1996, there were 777 music stores in 49 states, the District of Columbia, the Commonwealth of Puerto Rico and the Virgin Islands. These stores offer a full line of music, video and home 2 entertainment products through stores averaging 4,200 square feet and ranging from 1,000 square feet to 30,000 square feet in size. The total square footage of music stores was approximately 3.3 million, or 34% of the Company's total store square footage at December 31, 1996. In recent years, the Company has opened combo stores, principally in malls and downtown locations. These combo stores combine a full line of both music and video products and offer computer and entertainment software. When compared to traditional mall based music stores, "combo" stores are larger and more prominent in the mall and carry a broader inventory of catalog product, including substantial classical offerings and sell-through video, to appeal to the high volume purchaser. The mall based music stores offer REPLAY, a frequent shopper program designed to promote customer loyalty and enable targeted marketing. More than 500,000 mall based music store customers participate in the REPLAY program. A music and video publication specially designed for adult REPLAY members was introduced in 1996. In addition, the Company publishes "REQUEST," a cutting-edge music and video entertainment news magazine for younger customers. "REQUEST" is distributed in the music stores and at limited magazine stand outlets. The magazine has an audited monthly circulation of 1,029,000 and an estimated monthly readership of 2.5 million. Expansion of mall based music stores has been curtailed in order to focus on streamlining the existing store base and improving profitability. In 1996, the Company opened three new stores and closed 46 stores. The closings included 36 stores under the restructuring programs and 10 stores that were generally non- productive and at or near the end of their lease terms. Additionally, the Company continued the conversion of store names from Musicland to Sam Goody and plans to convert additional stores in 1997. The Company plans to close an additional 33 underperforming music stores during 1997 under its restructuring programs. After these closings are completed, the Company will operate 744 music stores with total square footage of 3.1 million. The Company also plans to close other nonproductive stores during 1997, the majority of which are at or near the end of their lease terms. SUNCOAST MOTION PICTURE COMPANY STORES. The mall based Suncoast stores primarily offer sell-through video and average 2,440 square feet in size. The prerecorded video categories include adventure, comedy, drama, family, animated, musicals, music video, instructional and other special interest. The video selection ranges from 6,000 to 13,000 titles and is complemented by movie and Hollywood related apparel and gift products, accessories, blank video tapes, laser discs and special order prerecorded video cassettes and laser discs. Most of the movies 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's marketing programs include sweepstakes, instant rebates, phone card promotions and exclusive merchandise events promoting recent video releases. Suncoast stores utilize theme and cross-promotional merchandising that coordinates the display and sale of licensed merchandise with the related movie or genre to maximize total sales. "Producers' Club," a customer loyalty program, is being tested in key targeted markets. At December 31, 1996, there were 422 Suncoast stores in 46 states, the District of Columbia and the Commonwealth of Puerto Rico. In 1996, the Company opened 11 new Suncoast stores and closed one non-productive store. The total square footage of Suncoast stores was approximately 1.0 million, or 11% of the Company's total store square footage at December 31, 1996. The Company plans to close an additional nine underperforming Suncoast stores during 1997 under its restructuring programs. After these closings are completed, the Company will operate 413 Suncoast stores. INTERNATIONAL STORES The Company operates music stores in the United Kingdom under the name Sam Goody. The first two stores in the United Kingdom were opened in 1990. In 1996, the Company opened two new stores and closed one store. At December 31, 1996, the Company had 22 stores in operation averaging approximately 2,900 square feet in size. The United Kingdom stores provide for their own corporate services, including purchasing and distribution. 3 PRODUCTS The following table shows the sales and percentage of total sales attributable to each product group.
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------- 1996 1995 1994 -------------------- -------------------- -------------------- SALES % SALES % SALES % --------- --------- --------- --------- --------- --------- (DOLLARS IN MILLIONS) Prerecorded music: Compact discs...................................... $ 681.9 37.4% $ 610.1 35.4% $ 534.2 36.1% Audio cassettes and other.......................... 249.2 13.7 284.9 16.5 314.7 21.3 --------- --------- --------- --------- --------- --------- Total............................................ 931.1 51.1 895.0 51.9 848.9 57.4 Prerecorded video.................................... 531.2 29.2 505.9 29.4 413.5 28.0 Books................................................ 126.3 6.9 106.6 6.2 56.5 3.8 Computer software, accessories and apparel........... 233.0 12.8 215.1 12.5 159.9 10.8 --------- --------- --------- --------- --------- --------- Total............................................ $ 1,821.6 100.0% $ 1,722.6 100.0% $ 1,478.8 100.0% --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
PRERECORDED MUSIC. Sales of compact discs are expected to continue to grow and become a larger portion of total prerecorded music sales while sales of prerecorded audio cassettes are expected to continue to decline. The Company's non-mall based Media Play and On Cue stores and mall based music stores offer assortments of compact discs and prerecorded audio cassettes purchased from all major manufacturers. Media Play and On Cue stores typically carry approximately 30,000 and 5,000 titles of prerecorded music, respectively. Music stores typically carry 6,000 titles, while combo stores carry up to 30,000 titles, depending upon store size and location. 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. The Company also produces and sells prerecorded music under its "Excelsior" label. Product includes compilations of public domain classical, jazz, big band and reggae music. Several key suppliers of prerecorded music have more strictly enforced minimum advertised price ("MAP") programs. Under the terms of these programs, retailers which sell prerecorded music below the MAP lose the cooperative advertising funding which they would normally receive from the supplier. The severity of the penalty varies by supplier from losing advertising funding for the life of the title to losing it for 30 days or losing advertising support on the supplier's total offering. In the first quarter of 1997, two of the six largest prerecorded music suppliers raised the MAP by $1.00. These MAP policies are determined by the suppliers and compliance with them by retailers is at their discretion. See "--Competition" and "Management's Discussion and Analysis of Results of Operations and Financial Condition--Results of Operations--Sales" and "--Gross Profit." PRERECORDED VIDEO. The demand for movies and other prerecorded video has increased in direct response to the penetration of video cassette recorders into most homes in the United States, the lowering of prices and the growing consumer acceptance of owning videos. Prerecorded video cassettes are for sale at all of the Suncoast, Media Play and On Cue stores and at substantially all of the music stores. Suncoast stores typically carry 8,000 title selections. Media Play stores and On Cue stores typically carry 10,000 and 2,000 titles of prerecorded video cassettes, respectively. Music stores carry approximately 2,000 title selections; combo stores carry up to 11,000 title selections. Management, based on industry information, believes the demand for video will continue to increase, causing sales of prerecorded video to be a growing component of the Company's total revenues. Merchandising of digital video discs ("DVD"), a new video technology, is expected to begin in 1997. DVD offers the consumer laser technology in a smaller disc format with superior picture quality and audio fidelity. The Company believes that in the next few years, sales of DVD players will begin to replace sales of laserdisc players and video cassette recorders as the new technology becomes widely available. Management expects to capitalize on the release of DVD players by offering software as soon as it is available. However, DVD demand could accelerate faster or slower depending upon how consumers react 4 to its technical superiority over the VHS format and the introductory price points of the hardware and software. BOOKS. The Company began selling books with the introduction of the non-mall based full-media superstores in 1992. Media Play and On Cue stores typically carry 29,000 and 4,000 titles of books, respectively. COMPUTER SOFTWARE, ACCESSORIES AND APPAREL. This product category includes computer and entertainment software, brand name blank audio and video tapes, storage containers, carrying cases and guitar and piano sheet music, as well as entertainment related apparel, posters and various other items. Movie and artist related accessories and apparel are highly influenced by the trends and fads surrounding popular movies, actors and artists. The Company's stores also carry a limited variety of portable electronic equipment such as audio cassette players, radios and stereo audio cassette/radios, generally sold at retail prices of approximately $200 or less. 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 3,100 suppliers and has consignment arrangements with approximately 1,800 of these suppliers. Approximately 60% of purchases in 1996 were made from the eight 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. During 1996, the Company experienced difficulty in obtaining shipments from certain vendors in the books, computer software, video games and trend product categories, primarily due to concerns about the Company's liquidity. In the first quarter of 1997, the Company's largest vendors and a substantial majority of the 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. Because these understandings are voluntary on the part of the vendors and will continue at their sole discretion, there can be no assurance that the Company will continue to receive adequate product from its vendors on acceptable credit terms. See "Management's Discussion and Analysis of Results of Operations and Financial Condition--Liquidity and Capital Resources." MARKETING The Company uses a high level of advertising and promotions in marketing its products. Marketing and advertising programs include special events, advertising partnerships with vendors and corporate partnerships with nationally known names. Additionally, frequent buyer programs in the Company's mall stores and certain product specific programs in On Cue stores are designed to build customer loyalty and encourage repeat visits. The Company has been sponsoring nationally televised/advertised events such as ESPN's Xtreme Games and the "UnVailed" battle of the bands, which appeal to its target customers. Other advertising programs which are being created in conjunction with vendors include television and billboard ads featuring specific albums or movies. The Company's major suppliers offer cooperative advertising support and provide funds for the placement and position of product. A significant portion of the Company's total advertising costs have been funded by suppliers through these programs. The Company advertises principally through newspaper inserts. Because of the high concentration of its mall stores in major metropolitan areas such as New York, Chicago and Los Angeles, the Company has been able to expand its radio and local television advertising in those areas. The national distribution of the Company's mall stores has made it practical to advertise in certain national magazines and on nationally syndicated radio programs and cable television, including MTV. 5 STORE OPERATIONS Media Play stores typically are managed by a general manager, an operations manager and three to five department managers. On Cue, music and Suncoast stores are typically managed by a store manager and one to three assistant 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. COMPETITION The market for prerecorded music and video, books, computer software and related accessories continues to be highly competitive. Some or all of these home entertainment products can be purchased or rented through other mall retail chains, warehouse clubs, individual stores, video rental stores, grocery, convenience and drug stores, television, telephone or Internet mail order offers and mail order clubs. The number of stores and types of competitors have increased significantly over the past few years, including non-mall discount stores, consumer electronics superstores and other mall based music, video and book specialty retailers expanding into non-mall multimedia superstores of their own. The low prices offered by these non-mall stores create intense price competition and adversely impact the performance of both the Company's non-mall and mall stores. Further, consumers have more home entertainment options available with the increasing penetration of personal computers into homes, while industry growth in prerecorded music sales has slowed due to the lack of strong product releases. The Company anticipates that the challenging retail sales environment will continue into the foreseeable future. The Company believes that its ability to compete successfully depends on its ability to secure and maintain attractive and convenient locations, manage merchandise efficiently, offer broad product selections at competitive prices, provide effective management and control operating costs. See "Management's Discussion and Analysis of Results of Operations and Financial Condition." SEASONALITY The Company's business is highly seasonal, with nearly 40% of the annual revenues and all of the net earnings generated in the fourth quarter. Quarterly results are affected by, among other things, the timing of holidays, new product offerings and new store openings and sales performance of existing stores. See Note 16 of Notes to Consolidated Financial Statements. TRADEMARKS AND SERVICE MARKS The Company operates its stores under various names, including "Media Play," "On Cue," "Sam Goody," "Musicland," and "Suncoast Motion Picture Company," which have become important to the Company's business as a result of its advertising and promotional activities. These names, along with a number of others, including "Request," "REPLAY," "Excelsior" and "Channel 1000," have been or are being registered with the U.S. Patent and Trademark Office. The Company intends to continue to use these names and marks and may use new names for specific stores depending on the type of store and its location. PERSONNEL As of March 25, 1997, the Company employed approximately 6,100 full-time employees, 9,200 part-time employees and 600 temporary employees. Hourly employees at 17 of the Company's stores are represented by unions. 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. In the third quarter of 1996, net proceeds of $11.6 million were received from the sale of the 513,000 square foot building containing the Company's distribution facilities 6 and certain corporate office facilities in Minneapolis, Minnesota. The Company leased back the entire building through January 1997 and thereafter will continue to lease approximately 73,000 square feet of office and storage space in the building through January 2002. In January 1997, the Company completed the consolidation of its distribution facilities into one center in Franklin, Indiana. The distribution facility is in a 715,000 square foot building and is under an operating lease that expires in 1999 with a one year renewal option. The lease contains purchase options at the end of the original and renewal periods. See "Management's Discussion and Analysis of Results of Operations and Financial Condition--Liquidity and Capital Resources" and Note 10 of Notes to Consolidated Financial Statements . STORE LEASES. Most of the Company's stores are under operating leases with various remaining terms through the year 2017. The Company owns three Media Play stores. The leases have terms ranging from 3 to 25 years. Certain store leases contain provisions restricting assignment, merger, change of control or transfer. In most instances, the Company pays, in addition to minimum rent, real estate taxes, utilities, common area maintenance costs and percentage rentals which are based upon sales volume. 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. The following table lists the number of leases due to expire or terminate in each fiscal year, based on the fixed lease term and excluding renewal options. 1997 181 2002 108 1998 124 2003 137 1999 182 2004 124 2000 200 2005 111 2001 185 2006 and thereafter 111
The Company expects that, as these current leases expire, in most cases it should be able to obtain either renewal leases, if desired, or new leases at equivalent or better locations. ITEM 3. LEGAL PROCEEDINGS The Company is a party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, all such matters are without merit or involve such amounts that unfavorable disposition will not have a material impact on the financial position or results of operations of the Company. 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 fiscal year covered by this report. 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 16 of Notes to Consolidated Financial Statements. As of March 26, 1997, MSC had approximately 705 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 indenture for the 9% senior subordinated notes restrict the amount of cash dividends that may be paid by MSC. See Note 4 of Notes to Consolidated Financial Statements. 7 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and related notes contained in Item 14 herein and "Management's Discussion and Analysis of Results of Operations and Financial Condition" contained in Item 7 herein. No cash dividends have ever been declared on the common stock of MSC. SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND STORE DATA)
YEARS ENDED DECEMBER 31, -------------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------ ------------ ------------ ------------ ------------ STATEMENT OF EARNINGS DATA: Sales......................................... $ 1,821,594 $ 1,722,572 $ 1,478,842 $ 1,181,658 $ 1,020,508 Gross profit.................................. 611,759 606,070 542,199 470,951 414,167 Selling, general and administrative expenses.................................... 576,658 525,213 450,919 365,311 319,713 Depreciation and amortization................. 44,819 45,531 37,243 29,057 24,715 Goodwill write-down........................... 95,253 138,000 -- -- -- Restructuring charges......................... 75,000 -- -- -- -- Operating income (loss)....................... (179,971) (102,674) 54,037 76,583 69,739 Interest expense.............................. 32,967 27,881 19,555 19,831 24,418 Earnings (loss) before income taxes and extraordinary charges....................... (212,938) (130,555) 34,482 56,752 45,321 Income taxes.................................. (19,200) 5,195 17,100 25,400 21,100 Earnings (loss) before extraordinary charges(1).................................. (193,738) (135,750) 17,382 31,352 23,518 Earnings (loss) per common share(1)........... $ (5.80) $ (4.00) $ 0.51 $ 1.03 $ 0.83 Weighted average number of common shares outstanding................................. 33,414 33,898 34,238 30,548 28,398 DECEMBER 31, -------------------------------------------------------------------- 1996 1995 1994 1993 1992 ------------ ------------ ------------ ------------ ------------ BALANCE SHEET DATA: Total assets.................................. $ 996,915 $ 996,957 $ 1,079,632 $ 905,682 $ 689,349 Revolver...................................... 272,000 53,000 -- -- -- Long-term debt, including current maturities.................................. 124,599 110,000 110,000 135,000 103,541 Stockholders' equity.......................... 2,619 195,811 340,276 322,594 223,646 Book value per common share(2)................ 0.08 5.71 9.94 9.42 7.42 STORE DATA: Total store square footage (in millions)...... 9.5 9.9 7.2 4.9 3.8 Store count: Media Play stores........................... 87 89 46 13 1 On Cue stores............................... 158 153 77 32 13 Music stores................................ 777 820 869 875 861 Suncoast stores............................. 422 412 378 320 252 Readwell's store............................ -- 1 1 1 -- United Kingdom stores....................... 22 21 15 10 8 ------------ ------------ ------------ ------------ ------------ Total..................................... 1,466 1,496 1,386 1,251 1,135 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
- ------------------------ (1) Amounts for the year ended December 31, 1992 are after dividends on senior preferred stock of $703. Amounts for the years ended December 31, 1993 and 1992 are before extraordinary charges from early redemption of debt, net of income tax benefit, of $3,900, or $0.13 per share, and $8,440, or $0.30 per share, respectively. Net earnings applicable to common stockholders for the years ended December 31, 1993 and 1992 were $27,452, or $0.90 per share, and $15,078, or $0.53 per share, respectively. (2) Based on the number of common shares outstanding at year end. 8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL The Company is engaged in one industry segment as a specialty retailer of home entertainment products operating principally in two business categories: non-mall based full-media, low-price superstores under the names Media Play and On Cue and mall based music and video sell-through stores under the names Sam Goody, Musicland and Suncoast. The market for prerecorded music and video, books, computer software and related accessories continues to be highly competitive. The number of stores and types of competitors have increased significantly over the past few years, including non-mall discount stores, consumer electronics superstores and other mall based music, video and book specialty retailers expanding into non-mall multimedia superstores of their own. The low prices offered by these non-mall stores create intense price competition and adversely impact the performance of both the Company's non-mall and mall stores. Further, consumers have more home entertainment options available with the increasing penetration of personal computers into homes, while industry growth in prerecorded music sales has slowed due to the lack of strong product releases. The Company anticipates that the challenging retail sales environment will continue into the foreseeable future. The Company has experienced diminishing liquidity as a result of the challenging retail sales environment and the negative impact of underperforming existing stores and new Media Play stores opened in 1995 and 1996, particularly those performing below expectations. During 1996, the Company experienced difficulty in obtaining shipments from certain vendors, primarily due to concerns about the Company's liquidity. In the first quarter of 1997, the Company's largest vendors and a substantial majority of the remaining vendors agreed to temporarily defer existing trade payables and provide continued product supply, subject to reduced payment terms on new purchases. Because these understandings are voluntary on the part of the vendors and will continue at their sole discretion, there can be no assurance that the Company will continue to receive adequate product from its vendors on acceptable credit terms. Should any or all of these vendors demand payment of the deferred balances, there can be no assurance that the Company will be able to obtain adequate financing to make such payment. In April and October of 1996, the Company obtained amendments to its credit agreement. The April amendment modified certain existing covenants and added financial covenants while the October amendment waived the additional financial covenants and further modified certain existing covenants through March 30, 1997. In March 1997, the Company obtained waivers of certain financial covenants and technical defaults under the credit agreement through May 29, 1997. Without the waivers in October 1996 and March 1997, the Company would have been in default under the credit agreement in the fourth quarter of 1996 and the first quarter of 1997. The Company is currently in negotiations with its banks to obtain an amendment to its credit agreement that will modify or provide additional flexibility in the covenants and provide additional financing under a term facility. If an amendment is not obtained by May 29, 1997, when the waivers under the credit agreement expire, the Company will be in default and the banks could demand repayment of all amounts outstanding under the revolver. There can be no assurance that debt or equity to repay the revolver, if necessary, will be available or can be arranged on acceptable terms. Management implemented programs during 1996 to improve profitability, reduce inventory levels and increase inventory turnover. More focused marketing and advertising programs were instituted in late 1996. The Company slowed store expansion to focus on improving performance in its existing stores and recorded pretax restructuring charges totaling $75 million to reflect estimated costs associated with the closing of 115 underperforming stores and the Company's distribution facility in Minneapolis, Minnesota. The Company also evaluated goodwill for impairment in 1995 and 1996 and recorded a write-down of $138 million in 1995 and a write-down of the remaining balance of $95.3 million in 1996. The Company's stores operate in a retail environment in which many factors that are difficult to predict and outside the Company's control can have a significant impact on store and Company sales and 9 profits. These factors include the timing and strength of new product offerings, pricing strategies of competitors, openings and closings of competitors' stores, the Company's ability to continue to receive adequate product from its vendors on acceptable credit terms and to obtain sufficient financing to meet its liquidity needs, effects of weather and overall economic conditions, including inflation, consumer confidence, spending habits and disposable income. Any of these factors, alone or in combination, could affect the Company's ability to meet its financial covenants and to continue as a going concern. See Note 1 of Notes to Consolidated Financial Statements. RESULTS OF OPERATIONS The following table presents certain sales and store data for the Company's two principal business categories and in total for the Company for the last three years.
YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- (DOLLARS AND SQUARE FOOTAGE IN MILLIONS) SALES: Non-mall stores.................................................. $ 643.8 $ 516.7 $ 247.9 Mall stores...................................................... 1,160.0 1,187.0 1,217.0 Total(1)....................................................... 1,821.6 1,722.6 1,478.8 PERCENTAGE CHANGE FROM PRIOR YEAR: Non-mall stores.................................................. 24.6% 108.5% 355.6% Mall stores...................................................... (2.3) (2.5) 9.0 Total(1)....................................................... 5.7 16.5 25.1 COMPARABLE STORE SALES CHANGE FROM PRIOR YEAR: Non-mall stores.................................................. 2.0% 4.8% 33.3% Mall stores...................................................... (1.7) (4.9) 3.1 Total(1)....................................................... (0.6) (3.2) 4.6 NUMBER OF STORES OPEN AT YEAR END: Non-mall stores(2)............................................... 245 242 123 Mall stores(2)................................................... 1,199 1,232 1,247 Total(1)....................................................... 1,466 1,496 1,386 TOTAL STORE SQUARE FOOTAGE AT YEAR END: Non-mall stores.................................................. 5.2 5.3 2.7 Mall stores...................................................... 4.3 4.5 4.4 Total(1)....................................................... 9.5 9.9 7.2
- ------------------------ (1) The totals include other divisions which individually are not significant. (2) After the remaining store closings under the restructuring programs are completed in 1997, store counts will be 225 superstores and 1,157 mall stores. SALES. Sales from new non-mall stores opened since 1994 and comparable store sales increases in non-mall stores open for one year or more accounted for most of the sales increases in 1996 and 1995. Inventory liquidation sales held late in the fourth quarter of 1996 in anticipation of the closing of certain underperforming stores contributed approximately $9 million to the sales increase in 1996. Comparable store sales in 1996 were adversely impacted by the lack of strong product releases in music and video and the challenging retail sales environment. In 1995, comparable store sales in both non-mall and mall stores were adversely impacted by weak sales during the fourth quarter coupled with aggressive price competition. Comparable store sales of mall stores in 1995 also were negatively impacted by increased competition from non-mall stores and weak music sales. 10 The following table shows the comparable store sales percentage increase (decrease) attributable to the Company's two principal product categories for the last three years.
YEARS ENDED DECEMBER 31, ----------------------------- 1996 1995 1994 ----- -------- ------ Prerecorded music......................................................... 1% (7)% 3% Prerecorded video cassettes............................................... (1) 5 10
The low prerecorded music comparable store sales increase in 1996 is a reflection of the low overall sales volume in the music industry. According to SOUNDSCAN, which collects and compiles retail store and rack sales data, unit sales of music recordings in 1996 versus 1995 were flat. Sales of music product were particularly soft in 1995 due to a lack of strong releases in the latter part of the year. In prerecorded video, the top selling video titles in 1996 did not attain the same level of sales volume as those released in 1995. Video sales in 1995 benefited from the very successful LION KING video released in the first quarter, FORREST GUMP released in the second quarter and STAR WARS TRILOGY released in the third quarter. During 1996, the Company experienced difficulty in obtaining shipments from certain vendors in the books, computer software, video games and trend product categories, primarily due to concerns about the Company's liquidity. In the first quarter of 1997, the Company's largest vendors and a substantial majority of the 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. Because these understandings are voluntary on the part of the vendors and will continue at their sole discretion, there can be no assurance that the Company will continue to receive adequate product from its vendors on acceptable credit terms. See "--Liquidity and Capital Resources." 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, ------------------------------ 1996 1995 1994 ----- ------ ----- Gross profit............................................................. 33.6% 35.2% 36.7% Selling, general and administrative expenses............................. 31.7 30.5 30.5 Operating income before depreciation, amortization and non-recurring charges................................................................ 1.9 4.7 6.2 Operating income (loss).................................................. (9.9) (6.0) 3.7
GROSS PROFIT. The increase in sales from the low-price non-mall stores relative to total Company sales accounted for 0.5% of the decrease in gross margin in 1996 and substantially all of the decrease in 1995. Inventory shrinkage increased to 1.2% of sales in 1996 from 0.8% of sales in 1995, causing a gross margin decline of 0.4% in 1996. The balance of the gross margin decrease in 1996 was primarily attributable to increased promotional pricing in both mall and non-mall stores and lower prices in mall stores in 1996 compared to 1995. Sales in non-mall stores will further reduce gross margin in future periods if their revenues increase at a faster rate than the Company's total sales. The rate of decrease, however, is expected to slow because of the closing of non-mall stores under the restructuring program and the curtailment of store expansion. The Company may also potentially benefit from the continued compliance by certain non-mall competitors with the more strictly enforced minimum advertised price ("MAP") policies of certain of the largest prerecorded music suppliers and the continued closing of stores by certain mall competitors. See "Business--Products: Prerecorded Music" and "--Competition." SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses as a percentage of sales were 31.7% in 1996 compared to 30.5% in 1995 and 1994, an increase of 1.2%. Increased advertising in the Media Play stores accounted for 0.5% of the percentage increase. Financial and legal advisory services and related expenses, most of which were required or incurred in conjunction 11 with the Company's credit agreement, totaled approximately $4 million, or 0.2% of sales in 1996. The remainder of the increase in selling, general and administrative expenses as a percentage of sales in 1996 was attributable to the impact of fixed costs, principally occupancy costs, both in underperforming existing stores and in new Media Play stores opened in 1995 and 1996 that have not achieved the sales level of a mature store. Some of these new Media Play stores also performed below expectations in 1996, further impacting the expense percentage. Many of these existing and recently opened underperforming stores have been or will be closed under the Company's restructuring programs. During 1996 and 1995, the Company consolidated its distribution facilities into one center in Franklin, Indiana, which has more than double the combined capacity of the Company's former facilities in Minneapolis, Minnesota and Edison, New Jersey. The Minneapolis facility closed in January 1997 while the Edison facility closed in May 1995. The Company incurred expense in 1996 of approximately $1.5 million related to the closing of the Minneapolis facility and transfer of operations to the Franklin facility. Expenses in 1995 included approximately $1.6 million related to costs associated primarily with the start-up of the new distribution center in Franklin, Indiana opened in March 1995 and, to a lesser extent, the closing of the Edison distribution facility. Costs incurred related to store openings were approximately $4 million in 1996, $13 million in 1995 and $11 million in 1994. The lower level of expense in 1996 was due to the fewer number of store openings. Selling, general and administrative expenses in 1995 included a net reduction to expense of $3.4 million related to two nonrecurring items. Income of $8.8 million from the termination of certain service and business development agreements was partially offset by a charge of $5.4 million for the closing of 35 mall based music stores. Expenses in 1994 included a charge of approximately $3 million for the cost of closing facilities and changing the name of certain Musicland stores to Sam Goody. Management believes that the closing of underperforming stores, the consolidation of distribution facilities into a single facility in Franklin, Indiana and other streamlining and profit improvement actions taken in 1996 and 1997 will reduce expenses in 1997. Additionally, store opening costs in 1997 will be minimal due to very limited store expansion plans. The Company also anticipates improvements in expenses as a percentage of sales from the lower cost structure of the non-mall stores as the existing, streamlined base of stores matures and realizes comparable store sales growth. These reductions may be offset by contingent rentals on the Franklin distribution facility, which fluctuate based upon changes in certain interest rates. DEPRECIATION AND AMORTIZATION. Goodwill amortization in 1996 was $3.0 million, or $0.09 per share in 1996 compared to $5.8 million, or $0.17 per share in 1995, a decrease of $2.8 million. The write-down of goodwill in the third quarter of 1995 decreased goodwill amortization by $4.2 million, or $0.13 per share, in 1996 and by $1.4 million, or $0.04 per share, in 1995. Other depreciation and amortization was $41.8 million, $39.7 million and $30.1 million in 1996, 1995 and 1994, respectively, and primarily related to stores. The increases over the prior years in 1996 and 1995 were attributable to store expansion, net of the decreases related to store closings. GOODWILL WRITE-DOWN AND ADOPTION OF NEW ACCOUNTING STANDARD. During the third quarter of 1995, the Company adopted Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement No. 121"), issued in March 1995. In August 1995, in connection with the adoption of Statement No. 121, the Company recorded a goodwill write-down of $138 million, or $4.07 per share, for the year ended December 31, 1995. An additional goodwill write-down of $95.3 million, or $2.85 per share, was recorded in December 1996, eliminating the remaining goodwill balance and goodwill amortization for years after 1996. Most of the goodwill was established in conjunction with the 1988 leveraged buyout of MGI by MSC. At that time, nearly all of the Company's stores were mall based music stores. The carrying values of long-lived assets, primarily goodwill and property, of the music division were reviewed for recoverability and possible impairment in both 1995 and 1996 because of sales declines that began in 1995 and continued during 1996. These sales declines resulted from general declines in customer traffic in malls, the increase in 12 high-volume, low-price superstores and the lack of strong music product releases. While the Company's mall based music stores have responded with increased promotional pricing and lower prices, they are at a competitive disadvantage to non-mall stores because of their higher cost structure, principally related to occupancy costs. See "--Liquidity and Capital Resources" and Note 2 of Notes to Consolidated Financial Statements. RESTRUCTURING CHARGES. During 1996, the Company implemented programs designed to improve profitability and increase inventory turnover. Pretax restructuring charges of $75 million were recorded in 1996 to reflect estimated costs associated with the closing of 115 underperforming stores and the Company's distribution facility in Minneapolis, Minnesota. The store closings include 79 mall stores and 36 non-mall stores. The Company completed 53 of these store closings through December 31, 1996 and will have closed the distribution facility and an additional 61 stores by March 31, 1997. The restructuring charges include $41.1 million of estimated cash expenditures, primarily consisting of estimated payments to landlords for the early termination of operating leases and estimated legal and consulting fees, and $33.9 million for estimated non-cash write-downs of leasehold improvements and certain equipment, net of unamortized lease credits. In 1996, $41.0 million of the restructuring reserve had been utilized, consisting of $24.1 million of cash payments and $16.9 million of non-cash charges. See "--Liquidity and Capital Resources--Investing Activities." INTEREST EXPENSE. Components of interest expense for the last three years were as follows:
YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- (IN MILLIONS) Interest on revolver.................................................. $ 21.9 $ 17.0 $ 7.4 Interest on term loan................................................. -- -- 1.1 Interest on subordinated debt......................................... 9.9 9.9 9.9 Other interest, net................................................... 1.2 1.0 1.2 --------- --------- --------- $ 33.0 $ 27.9 $ 19.6 --------- --------- --------- --------- --------- ---------
Interest expense on the revolver is impacted by the level of outstanding borrowings during the year, interest rates, the Company's credit rating and the number of days borrowings are outstanding during the year. Average daily revolver borrowings outstanding, weighted average interest rates on the revolver, based on the average daily borrowings, and the highest balances outstanding under the revolving credit facility were as follows:
YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- (DOLLARS IN MILLIONS) Average daily revolver borrowings................................. $ 289.7 $ 254.0 $ 128.6 Highest level of revolver borrowings.............................. 333.0 350.0 216.0 Weighted average interest rate.................................... 7.6% 7.1% 6.4%
Higher outstanding borrowings on the revolver increased interest expense by $2.4 million in 1996 and in 1995 by $6.2 million, net of the decrease in term loan interest. Increases in the weighted average interest rates increased revolver interest by $1.2 million in 1996 and $1.7 million in 1995. The remainder of the increases in revolver interest in 1996 and 1995 were caused by an increase in the number of days borrowings were outstanding. The term loan was repaid in October 1994. Other interest expense consists primarily of amortization of debt issuance costs. During 1996 and in January 1997, Moody's Investor's Service, Inc. and Standard & Poor's Corporation issued downgrades to the ratings of the Company's revolving credit facility and its $110 million senior subordinated notes. These downgrades occurred as a result of a number of factors including the continued weak retailing environment, increased competition from nontraditional music retailers, declining mall 13 traffic and fundamental changes in the way recorded music is distributed, which, along with high fixed costs from poorly performing stores and aggressive store expansion in previous years, have negatively impacted the Company's financial performance and limited the Company's financial flexibility. The downgrades issued in January 1997 also cited diminishing liquidity due to the Company's reliance upon waivers to continue access to its revolving credit facility. As a result of the lower credit ratings and an amendment to the Company's credit agreement in April 1996, the annual facility fee rate increased from 0.30% to 0.50% and the margin added to variable interest rates on revolver borrowings increased by 0.93%. See "--Liquidity and Capital Resources." INCOME TAXES. The effective income tax rates of 9.0% in 1996, (4.0%) in 1995 and 49.6% in 1994 vary from the federal statutory rate principally as a result of goodwill amortization and write-downs, which are nondeductible, and state income taxes. The income tax benefit and the effective income tax rate in 1996 were also reduced by valuation allowances established in the fourth quarter of $24.5 million. The valuation allowances were required because of the uncertainty of future earnings and reduced the deferred income tax balances to approximate the remaining recoverable income taxes after carryback of the 1996 taxable loss. Accordingly, the Company expects its tax provision for the year ending December 31, 1997 to be minimal and no tax provision (benefit) will be recorded on pretax earnings (loss) in interim periods during 1997. See Note 5 and Note 16 of Notes to Consolidated Financial Statements. SEASONALITY. The Company's business is highly seasonal, with nearly 40% of the annual revenues and all of the net earnings generated in the fourth quarter. See Note 16 of Notes to Consolidated Financial Statements for quarterly financial data. RECENTLY ISSUED ACCOUNTING STANDARDS. Financial Accounting Standards Board Statement No. 128, "Earnings per Share" ("Statement No. 128"), issued in February 1997 and effective for fiscal years ending after December 15, 1997, establishes and simplifies standards for computing and presenting earnings per share ("EPS"). Implementation of this statement will not have a material impact on the Company's computation or presentation of EPS, as the Company's common stock equivalents have had no material effect on earnings per share amounts. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of capital are borrowings under the revolving credit facility pursuant to the terms of its bank credit agreement and internally generated cash. Because of the seasonality of the retail industry, the Company's cash needs fluctuate throughout the year and typically peak in November as inventory levels build in anticipation of the Christmas selling season. The Company's cash position is generally highest at the end of December because of the higher sales volume during the Christmas season and extended payment terms typically provided by most vendors for seasonal inventory purchases. The Company's cash needs build during the first quarter as inventories are replenished following the Christmas season and payments for seasonal inventory purchases become due. The credit agreement, as amended in October 1996 and in the absence of any default, provides for a revolving credit facility and expires in October 1999. Borrowings under the revolving credit facility are available up to $275 million (subject to certain limitations) during the period from December 20, 1996 through September 11, 1997, and up to $300 million (subject to certain limitations) thereafter. At December 31, 1996, the maximum permitted borrowings under the revolver, based upon the lesser of a percentage of inventory or the maximum available for the period, were $275 million. The Company had borrowings under the revolver of $272 million at December 31, 1996; however cash and cash equivalents at December 31, 1996 were $162.0 million. See "--Financing Activities" and Note 4 of Notes to Consolidated Financial Statements. The Company's credit agreement contains covenants that limit additional indebtedness, liens, capital expenditures and cash dividends. Additionally, the Company must meet financial covenants relating to fixed charge coverage, consolidated tangible net worth and debt to total capitalization. In April and 14 October of 1996, the Company obtained amendments to its credit agreement. The April amendment modified certain existing covenants and added financial covenants. The additional financial covenants required the Company to meet certain debt and trade payables to eligible inventory ratios and to make an annual one day clean-down of outstanding revolver borrowings. The October amendment waived these additional financial covenants and further modified certain existing covenants through March 30, 1997. In March 1997, the Company obtained an agreement from its banks to waive certain financial covenants and technical defaults through May 29, 1997. Without the waivers in October 1996 and March 1997, the Company would have been in default of the financial covenants related to the debt and trade payables to eligible inventory ratio and the annual one day clean-down requirement during the fourth quarter of 1996 and the first quarter of 1997. Additionally, the terms of an amendment to an operating lease with a special purpose entity formed for the purpose of purchasing land and constructing three of the Company's Media Play stores using secured financing required consolidation of that entity as of October 1996, the date of the amendment. This consolidation caused the Company to be in technical default of the covenants of the credit agreement restricting additional debt, liens and the amount of capital spending. The waiver in March 1997 permitted the additional debt and the related lien and capital spending. See "--Investing Activities." During the first quarter of 1997, the Company's largest vendors and a substantial majority of the remaining vendors agreed to temporarily defer existing trade payables and provide continued product supply, subject to reduced payment terms on new purchases. Because these understandings are voluntary on the part of the vendors and will continue at their sole discretion, there can be no assurance that the Company will continue to receive adequate product from its vendors on acceptable credit terms. Should any or all of these vendors demand payment of the deferred balances, there can be no assurance that the Company will be able to obtain adequate financing to make such payment. The Company's Franklin distribution facility is under an operating lease with a special purpose entity that contains certain financial covenants. The write-down of goodwill in 1995 followed by an additional write-down of the remaining goodwill balance on December 31, 1996 caused the Company to be in default of the financial covenant related to the maximum total liabilities to total stockholders' equity ratio on December 31, 1996. This covenant ratio did not anticipate the impact on stockholders' equity of any goodwill write-down. The Company is working with the parties to the operating lease to obtain a waiver to adjust the covenant ratio for the effect of the goodwill write-downs. However, there can be no assurance that the Company will be able to obtain such a waiver or that alternative sources of financing for the distribution facility would be available if the waiver is not obtained. The Company is currently in negotiations with its banks to obtain an amendment to its credit agreement that will modify or provide additional flexibility in the covenants and provide additional financing under a term facility. If an amendment is not obtained by May 29, 1997, when the waivers under the credit agreement expire, the Company will be in default and the banks could demand repayment of all amounts outstanding under the revolver. The Company had been in negotiations with a potential equity investor; however, those negotiations have terminated. There can be no assurance that debt or equity to repay the revolver, if necessary, will be available or can be arranged on acceptable terms. The Company's stores operate in a retail environment in which many factors that are difficult to predict and outside the Company's control can have a significant impact on store and Company sales and profits. These factors include the timing and strength of new product offerings, pricing strategies of competitors, openings and closings of competitors' stores, the Company's ability to continue to receive adequate product from its vendors on acceptable credit terms and to obtain sufficient financing to meet its liquidity needs, effects of weather and overall economic conditions, including inflation, consumer confidence, spending habits and disposable income. Any of these factors, alone or in combination, could affect the Company's ability to meet its financial covenants and to continue as a going concern. See Note 1 of Notes to Consolidated Financial Statements. OPERATING ACTIVITIES. Net cash provided by (used in) operating activities was $16.7 million in 1996, ($56.2) million in 1995 and $71.5 million in 1994. The amounts in 1996 and 1995 were impacted by early 15 payments made to certain vendors to obtain discounts. The payments near the end of 1995 caused the amount of checks issued but not presented to the Company's banks for payment to exceed the Company's bank balances by $69.3 million at December 31, 1995. When netted with checks drawn in excess of bank balances, cash provided by (used in) operating activities was ($52.6) million in 1996 and $7.2 million in 1995. Cash used in operating activities in 1996 included $24.1 million of cash expenditures related to store closings under the Company's restructuring programs. Cash used for inventory purchases, as reflected by the aggregate net changes in inventories, accounts payable and checks drawn in excess of bank balances, was $38.9 million in 1996 compared to $31.8 million in 1995. Although inventories at December 31, 1996 of $506.1 million decreased $27.6 million from $533.7 million at December 31, 1995, the amount of cash used for inventory purchases increased because of early payments made to certain vendors to obtain discounts and to ensure continued availability of product. Cash flow in 1997 will benefit from lower inventory levels as a result of the consolidation of distribution centers into a single facility, store closings and other initiatives designed by management to increase inventory turnover. Additionally, the Company will receive income tax refunds in the first quarter of 1997 totaling approximately $20 million from the carryback of the 1996 taxable loss. However, the cash expected to be generated in 1997 will be offset by approximately $17 million of expected cash expenditures to complete the restructuring programs. The reduction in cash provided by operating activities in 1995 compared to 1994 was attributable to the inventory purchased for store expansion and weak sales in the latter part of 1995. The Company reduced inventory levels at the end of 1995 in response to the weak retailing environment. INVESTING ACTIVITIES. Capital expenditures and store data for the last three years are as follows:
YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- Capital expenditures, net of sale/leasebacks and other property sales (in millions).......................................................................... $6.4 $87.0 $ 109.6 Store openings: Non-mall stores.................................................................... 19 119 78 Mall stores........................................................................ 14 49 92 Total(1)........................................................................... 35 175 175 Store closings: Non-mall stores.................................................................... (16) -- -- Mall stores........................................................................ (47) (64) (40) Total(1)........................................................................... (65) (65) (40) Net increase (decrease) in store count: Non-mall stores.................................................................... 3 119 78 Mall stores........................................................................ (33) (15) 52 Total(1)........................................................................... (30) 110 135
- ------------------------ (1) The totals include other divisions which individually are not significant. Most of the Company's capital expenditures are for store expansion, and the majority of the store expansion in the last three years consisted of new Media Play stores. Financing for 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. 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 thereafter will continue to lease a portion of the office facilities. Approximately $14 million of capital expenditures for three new Media Play stores opened in 1996 were financed under an operating lease with a special purpose entity formed for the purpose of purchasing the land and constructing the stores using secured long-term financing. The land, buildings and 16 certain fixtures, together with the related mortgage note payable, were recorded on the Company's books 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. A portion of the Media Play capital expenditures in 1995 and 1994 were financed with proceeds from sale/leaseback transactions totaling $26.2 million in 1995 and $10.0 million in 1994. The new Franklin distribution facility and most of the related equipment, which together had an original cost of approximately $30 million, were financed under an operating lease with a special purpose entity. The Company financed a significant portion of capital expenditures in 1994 with $70.7 million in net proceeds from a common stock offering completed in December 1993. The Company significantly reduced capital expenditures in 1996 in response to the challenging retail environment, which is expected to continue into the foreseeable future. Capital expenditures in 1997 will be limited to approximately $20 million and will consist primarily of improvements to existing stores. A portion of the capital spending is planned for the downsizing of Media Play stores from approximately 50,000 square feet to approximately 35,000 to 40,000 square feet. The Company anticipates that these capital expenditures will be financed by borrowings under its credit agreement and internally generated cash. During 1997, the Company plans to close the remaining 62 stores under its restructuring programs, of which 61 stores will have closed in the first quarter. The Company also plans to close other nonproductive stores, the majority of which are at or near the end of their lease terms. Inventories from closed stores will be either redeployed to existing stores that are more profitable, returned to vendors or sold in preclosing liquidation sales. FINANCING ACTIVITIES. The Company's financing activities principally consist of borrowings and repayments under its revolving credit facility. Cash provided by (used in) financing activities was $149.7 million, $106.6 million and ($19.0) million during the years ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996, outstanding revolver borrowings were $272.0 million while cash and cash equivalents were $162.0 million. The Company had $53.0 million of revolver borrowings and checks drawn in excess of bank balances of $69.3 million outstanding at December 31, 1995. There were no revolver borrowings outstanding at December 31, 1994 and checks drawn in excess of bank balances were $5.9 million. As the financial covenants related to the annual one day clean-down requirement during the period from December 15, 1996 to February 15, 1997 and the debt and trade payables to eligible inventory ratio were waived, the revolver borrowings were not required to be paid down at December 31, 1996. For purposes of comparison to the $53 million of outstanding revolver borrowings at December 31, 1995, the revolver borrowings at December 31, 1996 would have been $110 million when netted with the balance of cash and cash equivalents at year end. The higher level of net revolver borrowings at December 31, 1996 compared to December 31, 1995 is due primarily to the continued weak retailing environment and the cash used under the restructuring programs in 1996 to close underperforming stores. Because of the weak retailing environment in the latter part of 1995 which continued through the Christmas season, $53 million of borrowings remained outstanding under the revolving credit facility at December 31, 1995. Sufficient cash was generated from the Christmas season in 1994 to repay all outstanding revolver borrowings at year end. During the third quarter of 1995, the Company loaned $10.0 million to its 401(k) trust to finance the purchase of 1,042,900 shares of common stock of the Company in the open market. The stock is used for a "KSOP" plan, which combines features of a 401(k) plan and an employee stock ownership plan. See Note 6 of Notes to Consolidated Financial Statements. In October 1994, the Company replaced its $175 million revolving credit facility and term loan with its current revolving credit facility. Borrowings under the October 1994 revolving credit facility were used to repay all outstanding borrowings under the former revolving credit facility and to make the final $25 million principal payment on the term loan that was due on December 31, 1994. 17 The Company's revolving credit facility expires in October 1999. The mortgage note payable requires a principal payment of $2.1 million in March 1997 with the balance due at the end of either the original term in May 2000 or the one year renewal term in May 2001. The operating lease for the distribution facility in Franklin, Indiana contains a residual value guarantee in an amount not to exceed $24.9 million at the end of the original four year lease term in March 1999 and $25.7 million at the end of the one year renewal term in March 2000. The lease also contains purchase options at the end of the original and renewal periods. The Company plans to either sell and lease back these properties or seek other sources of financing. As the challenging retail environment is expected to continue into the foreseeable future, there can be no assurance that the Company will be able to obtain adequate or alternative sources of financing to meet its obligations under these agreements. INFLATION AND ECONOMIC TRENDS 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. Forward-looking statements herein are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made herein. Investors are cautioned that all forward-looking statements involve risks and uncertainty. In addition to the factors discussed above, among the factors that could cause actual results to differ materially are the following: the timing and strength of new product offerings, pricing strategies of competitors, openings and closings of competitors' stores, the Company's ability to continue to receive adequate product from its vendors on acceptable credit terms and to obtain sufficient financing to meet its liquidity needs, effects of weather and overall economic conditions, including inflation, consumer confidence, spending habits and disposable income. 18 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 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 notes thereto. (3) Exhibits See Exhibit Index on pages 42 through 44. (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, 1996. (c) Exhibits See Exhibit Index on pages 42 through 44. (d) Other Financial Statements Not applicable. 19 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: April 11, 1997 -------------------------------------------- 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, /s/ JACK W. EUGSTER President, Chief - ------------------------------ Executive Officer and April 11, 1997 Jack W. Eugster Director (principal executive officer) Executive Vice President /s/ REID JOHNSON and Chief Financial - ------------------------------ Officer (principal April 11, 1997 Reid Johnson financial and accounting officer) /s/ KEITH A. BENSON - ------------------------------ Director April 11, 1997 Keith A. Benson /s/ KENNETH F. GORMAN - ------------------------------ Director April 11, 1997 Kenneth F. Gorman /s/ WILLIAM A. HODDER - ------------------------------ Director April 11, 1997 William A. Hodder /s/ LLOYD P. JOHNSON - ------------------------------ Director April 8, 1997 Lloyd P. Johnson /s/ JOSIAH O. LOW, III - ------------------------------ Director April 11, 1997 Josiah O. Low, III /s/ TOM F. WEYL - ------------------------------ Director April 11, 1997 Tom F. Weyl /s/ MICHAEL W. WRIGHT - ------------------------------ Director April 11, 1997 Michael W. Wright 20 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 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, 1996 and 1995, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1996. 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, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has experienced declining operating results and liquidity constraints that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, February 25, 1997 22 MUSICLAND STORES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1996 1995 1994 ------------ ------------ ------------ Sales................................................................... $ 1,821,594 $ 1,722,572 $ 1,478,842 Cost of sales........................................................... 1,209,835 1,116,502 936,643 ------------ ------------ ------------ Gross profit.......................................................... 611,759 606,070 542,199 Selling, general and administrative expenses............................ 576,658 525,213 450,919 Depreciation and amortization........................................... 44,819 45,531 37,243 Goodwill write-down..................................................... 95,253 138,000 -- Restructuring charges................................................... 75,000 -- -- ------------ ------------ ------------ Operating income (loss)............................................... (179,971) (102,674) 54,037 Interest expense........................................................ 32,967 27,881 19,555 ------------ ------------ ------------ Earnings (loss) before income taxes................................... (212,938) (130,555) 34,482 Income taxes............................................................ (19,200) 5,195 17,100 ------------ ------------ ------------ Net earnings (loss)................................................... $ (193,738) $ (135,750) $ 17,382 ------------ ------------ ------------ ------------ ------------ ------------ Net earnings (loss) per common share.................................. $ (5.80) $ (4.00) $ 0.51 ------------ ------------ ------------ ------------ ------------ ------------ Weighted average number of common shares outstanding.................... 33,414 33,898 34,238 ------------ ------------ ------------ ------------ ------------ ------------
See accompanying Notes to Consolidated Financial Statements. 23 MUSICLAND STORES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- ASSETS Current assets: Cash and cash equivalents............................................................... $ 161,976 $ 1,971 Inventories............................................................................. 506,093 533,694 Deferred income taxes................................................................... 11,800 17,400 Other current assets.................................................................... 31,492 20,840 ---------- ---------- Total current assets.................................................................. 711,361 573,905 Property, at cost......................................................................... 430,116 446,100 Accumulated depreciation and amortization................................................. (152,120) (127,783) ---------- ---------- Property, net........................................................................... 277,996 318,317 Goodwill.................................................................................. -- 98,258 Deferred income taxes..................................................................... 1,200 -- Other assets.............................................................................. 6,358 6,477 ---------- ---------- Total Assets.......................................................................... $ 996,915 $ 996,957 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Checks drawn in excess of bank balances................................................. $ -- $ 69,321 Current maturities of long-term debt.................................................... 2,060 -- Revolver................................................................................ 272,000 53,000 Accounts payable........................................................................ 406,642 403,848 Restructuring reserve................................................................... 33,963 -- Other current liabilities............................................................... 100,866 108,455 ---------- ---------- Total current liabilities............................................................. 815,531 634,624 Long-term debt............................................................................ 122,539 110,000 Other long-term liabilities............................................................... 56,226 52,622 Deferred income taxes..................................................................... -- 3,900 Commitments and contingent liabilities Stockholders' equity: Preferred stock ($.01 par value; authorized: 5,000,000 shares; issued and outstanding: none)................................................................................. -- -- Common stock ($.01 par value; authorized: 75,000,000 shares; issued and outstanding: December 31, 1996, 34,301,956 shares; December 31, 1995, 34,296,956 shares)........... 343 343 Additional paid-in capital.............................................................. 253,896 254,350 Accumulated deficit..................................................................... (238,649) (44,911) Deferred compensation................................................................... (7,998) (8,998) Common stock subscriptions.............................................................. (4,973) (4,973) ---------- ---------- Total stockholders' equity............................................................ 2,619 195,811 ---------- ---------- Total Liabilities and Stockholders' Equity............................................ $ 996,915 $ 996,957 ---------- ---------- ---------- ----------
See accompanying Notes to Consolidated Financial Statements. 24 MUSICLAND STORES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, ------------------------------------- 1996 1995 1994 ----------- ----------- ----------- OPERATING ACTIVITIES: Net earnings (loss)...................................................... $ (193,738) $ (135,750) $ 17,382 Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.......................................... 44,819 45,531 37,243 Goodwill write-down.................................................... 95,253 138,000 -- Disposal of property................................................... 1,733 7,587 3,475 Amortization of debt issuance and other costs.......................... 658 516 872 Other amortization..................................................... 234 364 1 Restructuring charges.................................................. 75,000 -- -- Deferred income taxes.................................................. 500 (3,400) (6,100) Changes in operating assets and liabilities: Inventories............................................................ 27,601 (41,866) (155,026) Other current assets................................................... (10,353) (11,172) (1,991) Accounts payable....................................................... 2,794 (53,388) 154,196 Restructuring reserve.................................................. (24,092) -- -- Other current liabilities.............................................. (6,767) (11,445) 16,829 Other assets........................................................... (590) (1,079) (1,333) Other long-term liabilities............................................ 3,637 9,875 5,914 ----------- ----------- ----------- Net cash provided by (used in) operating activities.................. 16,689 (56,227) 71,462 ----------- ----------- ----------- INVESTING ACTIVITIES: Capital expenditures..................................................... (17,970) (113,983) (119,608) Sale/leasebacks and other property sales................................. 11,594 26,969 10,000 ----------- ----------- ----------- Net cash used in investing activities................................ (6,376) (87,014) (109,608) ----------- ----------- ----------- FINANCING ACTIVITIES: Increase (decrease) in checks drawn in excess of bank balances........... (69,321) 63,435 5,886 Borrowings under revolver................................................ 219,000 53,000 -- Principal payments on long-term debt..................................... -- -- (25,000) Loan to KSOP............................................................. -- (9,997) -- Net proceeds from sale of common stock................................... 13 196 72 ----------- ----------- ----------- Net cash provided by (used in) financing activities.................. 149,692 106,634 (19,042) ----------- ----------- ----------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS....................... 160,005 (36,607) (57,188) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR............................. 1,971 38,578 95,766 ----------- ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF YEAR................................... $ 161,976 $ 1,971 $ 38,578 ----------- ----------- ----------- ----------- ----------- ----------- CASH PAID DURING THE YEAR FOR: Interest................................................................. $ 31,677 $ 27,268 $ 19,666 Income taxes............................................................. 9,010 17,884 29,394
See accompanying Notes to Consolidated Financial Statements. 25 MUSICLAND STORES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
RETAINED COMMON STOCK ADDITIONAL EARNINGS COMMON TOTAL ---------------------- PAID-IN (ACCUMULATED DEFERRED STOCK STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT) COMPENSATION SUBSCRIPTIONS EQUITY --------- ----------- ---------- ------------ ------------- ------------- ------------ January 1, 1994.................... 34,230 $ 342 $ 253,768 $ 73,457 $ $ (4,973) $ 322,594 Net earnings....................... 17,382 17,382 Other, including exercise of stock options and related tax benefit.......................... 17 -- 300 300 --------- ----- ---------- ------------ ------------- ------------- ------------ December 31, 1994.................. 34,247 342 254,068 90,839 (4,973) 340,276 Net loss........................... (135,750) (135,750) Other, including exercise of stock options and related tax benefit.......................... 50 1 670 671 Loan to KSOP....................... (9,997) (9,997) Amortization of deferred compensation and adjustment to fair market value of KSOP shares, net of related tax benefit....... (388) 999 611 --------- ----- ---------- ------------ ------------- ------------- ------------ December 31, 1995.................. 34,297 343 254,350 (44,911) (8,998) (4,973) 195,811 Net loss........................... (193,738) (193,738) Other, including exercise of stock options and related tax benefit.......................... 5 -- 13 13 Amortization of deferred compensation and adjustment to fair market value of KSOP shares, net of related tax benefit....... (467) 1,000 533 --------- ----- ---------- ------------ ------------- ------------- ------------ December 31, 1996.................. 34,302 $ 343 $ 253,896 $ (238,649) $ (7,998) $ (4,973) $ 2,619 --------- ----- ---------- ------------ ------------- ------------- ------------ --------- ----- ---------- ------------ ------------- ------------- ------------
See accompanying Notes to Consolidated Financial Statements. 26 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 and is engaged in one industry segment as a specialty retailer of home entertainment products, including prerecorded music, prerecorded video, books, computer software and related accessories. The Company's two principal business categories are non-mall based full-media low-price superstores operating under the names Media Play and On Cue and mall based music and video sell-through stores operating under the names Sam Goody, Musicland and Suncoast Motion Picture Company. At December 31, 1996, the store count consisted of 245 non-mall stores and 1,199 mall stores, with 5.2 million total store square footage in non-mall stores and 4.3 million total store square footage in mall stores. The Company operated 1,466 stores in 49 states, the District of Columbia, the Commonwealth of Puerto Rico, the Virgin Islands and the United Kingdom at December 31, 1996. SUMMARY OF SIGNIFICANT RISKS AND UNCERTAINTIES AND GOING CONCERN ASSESSMENT. The market for prerecorded music and video, books, computer software and related accessories continues to be highly competitive. The number of stores and types of competitors have increased significantly over the past few years, including non-mall discount stores, consumer electronics superstores and other mall based music, video and book specialty retailers expanding into non-mall multimedia superstores of their own. The low prices offered by these non-mall stores create intense price competition and adversely impact the performance of both the Company's non-mall and mall stores. Further, consumers have more home entertainment options available with the increasing penetration of personal computers into homes, while industry growth in prerecorded music sales has slowed due to the lack of strong product releases. The Company anticipates that the challenging retail sales environment will continue into the foreseeable future. The Company has experienced diminishing liquidity as a result of the challenging retail sales environment and the negative impact of underperforming existing stores and new Media Play stores opened in 1995 and 1996, particularly those performing below expectations. During 1996, the Company experienced difficulty in obtaining shipments from certain vendors, primarily due to concerns about the Company's liquidity. In the first quarter of 1997, the Company's largest vendors and a substantial majority of the remaining vendors agreed to temporarily defer existing trade payables and provide continued product supply, subject to reduced payment terms on new purchases. Because these understandings are voluntary on the part of the vendors and will continue at their sole discretion, there can be no assurance that the Company will continue to receive adequate product from its vendors on acceptable credit terms. Should any or all of these vendors demand payment of the deferred balances, there can be no assurance that the Company will be able to obtain adequate financing to make such payment. In April and October of 1996, the Company obtained amendments to its credit agreement. The April amendment modified certain existing covenants and added financial covenants while the October amendment waived the additional financial covenants and further modified certain existing covenants 27 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) through March 30, 1997. In March 1997, the Company obtained waivers of certain financial covenants and technical defaults under the credit agreement through May 29, 1997. Without the waivers in October 1996 and March 1997, the Company would have been in default under the credit agreement in the fourth quarter of 1996 and the first quarter of 1997. See Note 4 and Note 10. The Company is currently in negotiations with its banks to obtain an amendment to its credit agreement that will modify or provide additional flexibility in the covenants and provide additional financing under a term facility. If an amendment is not obtained by May 29, 1997, when the waivers under the credit agreement expire, the Company will be in default and the banks could demand repayment of all amounts outstanding under the revolver. There can be no assurance that debt or equity to repay the revolver, if necessary, will be available or can be arranged on acceptable terms. Management implemented programs during 1996 to improve profitability, reduce inventory levels and increase inventory turnover. More focused marketing and advertising programs were instituted in late 1996. The Company slowed store expansion to focus on improving performance in its existing stores and recorded pretax restructuring charges totaling $75,000 to reflect estimated costs associated with the closing of 115 underperforming stores and the Company's distribution facility in Minneapolis, Minnesota. The Company also evaluated goodwill for impairment in 1995 and 1996 and recorded a write-down of $138,000 in 1995 and a write-down of the remaining balance of $95,253 in 1996. See Note 2 and Note 3. The Company's stores operate in a retail environment in which many factors that are difficult to predict and outside the Company's control can have a significant impact on store and Company sales and profits. These factors include the timing and strength of new product offerings, pricing strategies of competitors, openings and closings of competitors' stores, the Company's ability to continue to receive adequate product from its vendors on acceptable credit terms and to obtain sufficient financing to meet its liquidity needs, effects of weather and overall economic conditions, including inflation, consumer confidence, spending habits and disposable income. Any of these factors, alone or in combination, could affect the Company's ability to meet its financial covenants and to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. 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. CASH MANAGEMENT. The Company's cash management system provides for the reimbursement of all major bank disbursement accounts on a daily basis. Checks issued but not presented for payment to the bank are reflected as checks drawn in excess of bank balances in the accompanying consolidated financial statements. 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. Property consists principally of store leasehold improvements, fixtures and other equipment and is stated at cost. Leasehold improvements are amortized on a straight-line basis over an estimated useful life of ten years, which is generally equal to or less than the lease term. Store fixtures and other equipment are depreciated on a straight-line basis over their estimated useful lives. When assets are 28 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) 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 $41,763, $39,653 and $29,816 for the years ended December 31, 1996, 1995 and 1994, respectively. GOODWILL. Goodwill represents the cost in excess of fair value of net assets of businesses acquired and primarily resulted from the acquisition of MGI by MSC in 1988. The carrying amount of goodwill is evaluated if facts and circumstances indicate that it may be impaired. If an evaluation is required, the estimated future undiscounted cash flows of the entity acquired over the remaining amortization period would be compared to the carrying amount of goodwill to determine if a write-down is required. In December 1996, the Company recorded a write-down of $95,253, which represented the remaining carrying amount of goodwill. In August 1995, the Company recorded a write-down of $138,000. Prior to the August 1995 write-down, goodwill was amortized using the straight-line method over a forty year period. During 1996, goodwill was amortized using the straight-line method over the remaining life of 33 years. Accumulated amortization at December 31, 1995 was $1,002. DEBT ISSUANCE COSTS. Debt issuance costs are amortized over the terms of the related financing using the interest method. STORE OPENING AND ADVERTISING COSTS. Costs associated with store openings are amortized over expected sales to the end of the fiscal year in which the store opens. Advertising costs are charged to expense as they are incurred. STOCK-BASED COMPENSATION. Compensation for employee stock options is recognized based on the difference, if any, between the quoted market price of the stock on the date of grant and the amount an employee must pay to acquire the stock. The Company's plans are fixed stock option plans and, accordingly, the Company has not recognized compensation expense. See Note 7 for pro forma disclosures as if the fair value method of accounting for stock options had been used. INCOME TAXES. The provision for deferred income taxes represents the tax effects of differences in the timing of income and expense recognition for tax and financial reporting purposes under the liability method of accounting. A valuation allowance reduces deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. EARNINGS (LOSS) PER COMMON SHARE. Earnings (loss) per common share amounts are computed by dividing net earnings (loss) by the weighted average number of common shares outstanding. 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. Common stock equivalents related to stock options are anti-dilutive in 1996 and 1995 due to the net losses. Common stock equivalents related to stock options which would have a dilutive effect based upon current market prices had no material effect on net earnings per common share in 1994. RECENTLY ISSUED ACCOUNTING STANDARDS. Financial Accounting Standards Board Statement No. 128, "Earnings per Share" ("Statement No. 128"), issued in February 1997 and effective for fiscal years ending after December 15, 1997, establishes and simplifies standards for computing and presenting earnings per share ("EPS"). Implementation of this statement will not have a material impact on the Company's computation or presentation of EPS, as the Company's common stock equivalents have had no material effect on earnings per share amounts. 29 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2. WRITE-DOWN OF GOODWILL During the third quarter of 1995, the Company adopted Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("Statement No. 121"), issued in March 1995. 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. In connection with the adoption of Statement No. 121, the carrying values of long-lived assets, primarily goodwill and property, of the music division were reviewed for recoverability and possible impairment because of recent developments. Since the beginning of 1995, the music division has been experiencing sales declines. These sales declines resulted from general declines in customer traffic in malls, the increase in high-volume, low-price superstores and the lack of strong music product releases. While the Company's mall based music stores have responded with increased promotional pricing and lower prices, they are at a competitive disadvantage to non-mall stores because of their higher cost structure, principally related to occupancy costs. The Company updated its operating projections for the music division during the third quarter of 1995 and again in the fourth quarter of 1996 to reflect the continued weak retail environment and competitive pricing. An analysis of the projected undiscounted future cash flows indicated impairment had occurred. A goodwill write-down of $138,000 was recorded in August 1995 based on an estimated fair value of the music division determined primarily from a range of valuations based on the operating projections and future discounted cash flows. In December 1996, a write-down of the remaining goodwill of $95,253 was recorded and was based on an estimated fair value determined from updated future discounted cash flows of the music division and other significant market factors related to the Company. 3. RESTRUCTURING CHARGES During 1996, the Company implemented programs designed to improve profitability and increase inventory turnover. Pretax restructuring charges of $35,000 and $40,000 were recorded in the first and fourth quarters of 1996, respectively. These charges reflect estimated costs associated with the closing of 115 underperforming stores and the Company's distribution facility in Minneapolis, Minnesota. The store closings include 79 mall stores and 36 non-mall stores. The Company completed 53 of these store closings through December 31, 1996 and will have closed the distribution facility and an additional 61 stores by March 31, 1997. The restructuring charges include $41,100 of estimated cash expenditures, primarily consisting of estimated payments to landlords for the early termination of operating leases and estimated legal and consulting fees, and $33,900 for estimated non-cash write-downs of leasehold improvements and certain equipment, net of unamortized lease credits. In 1996, $41,000 of the restructuring reserve had been utilized, consisting of $24,100 of cash payments and $16,900 of non-cash charges. 30 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 4. REVOLVING CREDIT FACILITY AND LONG-TERM DEBT
YEARS ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---------- ---------- ---------- REVOLVER DATA IS AS FOLLOWS: Revolver borrowings at year end.................................... $ 272,000 $ 53,000 $ -- Average daily revolver borrowings.................................. 289,700 254,000 128,600 Highest total revolver borrowings.................................. 333,000 350,000 216,000 Weighted average interest rates: Based on average daily borrowings................................ 7.56% 7.13% 6.38% At year end, excluding facility fee rate......................... 7.26 7.12 N/A
The Company's bank credit agreement, as amended in October 1996 and in the absence of any default, provides for a revolving credit facility and expires in October 1999. Borrowings under the revolving credit facility are at variable interest rates and are available up to a maximum of the lesser of 50% to 60% of eligible inventory or $275,000 during the period from December 20, 1996 through September 11, 1997, or $300,000 thereafter. The credit agreement also requires payment of a facility fee at an annual rate of 0.15% to 0.50% on the maximum credit amount available, subject to adjustment based on the Company's credit rating. The Company is currently at the maximum facility fee rate of 0.50 % based on its current credit rating. The Company has pledged the common stock of certain of its wholly owned subsidiaries as collateral for borrowings under the credit agreement. The Company's credit agreement contains covenants that limit additional indebtedness, liens, capital expenditures and cash dividends. Additionally, the Company must meet financial covenants relating to fixed charge coverage, consolidated tangible net worth and debt to total capitalization. In April and October of 1996, the Company obtained amendments to its credit agreement. The April amendment modified certain existing covenants and added financial covenants. The additional financial covenants required the Company to meet certain debt and trade payables to eligible inventory ratios and to make an annual one day clean-down of outstanding revolver borrowings. The initial one day clean-down was to occur during the period from December 15, 1996 to February 15, 1997. The October amendment waived these additional financial covenants and further modified certain existing covenants through March 30, 1997. In March 1997, the Company obtained an agreement from its banks to waive certain financial covenants and technical defaults through May 29, 1997. Without the waivers in October 1996 and March 1997, the Company would have been in default of the financial covenants related to the debt and trade payables to eligible inventory ratio and the annual one day clean-down requirement during the fourth quarter of 1996 and the first quarter of 1997. Additionally, the terms of an amendment to an operating lease with a special purpose entity formed for the purpose of purchasing land and constructing three of the Company's Media Play stores using secured financing required consolidation of that entity as of October 1996, the date of the amendment. This consolidation caused the Company to be in technical default of the covenants of the credit agreement restricting additional debt, liens and the amount of capital spending. The waiver in March 1997 permitted the additional debt and the related lien and capital spending. The Company is currently in negotiations with its banks to obtain an amendment to its credit agreement that will modify or provide additional flexibility in the covenants and provide additional financing under a term facility. If an amendment is not obtained by May 29, 1997, when the waivers under 31 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 4. REVOLVING CREDIT FACILITY AND LONG-TERM DEBT (CONTINUED) the credit agreement expire, the Company will be in default and the banks could demand repayment of all amounts outstanding under the revolver. The Company had been in negotiations with a potential equity investor; however, those negotiations have terminated. There can be no assurance that debt or equity to repay the revolver, if necessary, will be available or can be arranged on acceptable terms.
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- LONG-TERM DEBT CONSISTS OF THE FOLLOWING: Mortgage note payable, variable interest rates.................................. $ 14,599 $ -- 9% senior subordinated notes, unsecured, due 2003............................... 110,000 110,000 ---------- ---------- Total......................................................................... 124,599 110,000 Less current maturities......................................................... 2,060 -- ---------- ---------- Total long-term debt.......................................................... $ 122,539 $ 110,000 ---------- ---------- ---------- ----------
The mortgage note payable is collateralized by land, buildings and certain fixtures of three of the Company's Media Play stores with an aggregate carrying value, including additional building improvements, of $14,537 at December 31, 1996. The mortgage note payable and related agreements, as amended in October 1996, require a principal payment of $2,060 in March 1997 with the balance due at the end of either the original term in May 2000 or the one year renewal term in May 2001. Interest and facility fees are payable monthly. The interest rate, inclusive of the facility fee rate, was 7.92% at December 31, 1996. The senior subordinated notes are subordinate to borrowings under the credit agreement, with interest payable semi-annually. The debt agreement for the senior subordinated notes contains financial covenants and the Company was in compliance with such covenants at December 31, 1996. 32 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 5. INCOME TAXES
YEARS ENDED DECEMBER 31, ------------------------------ 1996 1995 1994 -------- -------- -------- INCOME TAXES CONSIST OF: Current: Federal............................................................. $(18,300) $ 7,395 $ 18,900 State, local and other.............................................. (1,400) 1,200 4,300 -------- -------- -------- (19,700) 8,595 23,200 -------- -------- -------- Deferred: Federal............................................................. (1,000) (3,200) (5,000) State, local and other.............................................. 1,500 (200) (1,100) -------- -------- -------- 500 (3,400) (6,100) -------- -------- -------- Total............................................................. $(19,200) $ 5,195 $ 17,100 -------- -------- -------- -------- -------- -------- THE COMPANY'S EFFECTIVE INCOME TAX RATE DIFFERED FROM THE FEDERAL STATUTORY RATE AS FOLLOWS: Federal statutory tax rate............................................ (35.0)% (35.0)% 35.0% Goodwill amortization and write-down.................................. 16.2 38.5 7.3 State and local income taxes, net of federal benefit.................. -- 0.5 6.0 Valuation allowance................................................... 9.3 -- -- Other items, net*..................................................... 0.5 -- 1.3 -------- -------- -------- Effective income tax rate........................................... (9.0)% 4.0% 49.6% -------- -------- -------- -------- -------- --------
- -------------------------- * None of which individually exceeds 5% of federal tax at the statutory rate on earnings (loss) before income taxes.
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- COMPONENTS OF DEFERRED INCOME TAXES ARE AS FOLLOWS: Net current deferred tax asset: Capitalized inventory costs.................................................... $ 5,880 $ 5,877 Inventory valuation............................................................ 5,564 5,012 Compensation related........................................................... 2,601 2,264 Restructuring charges.......................................................... 14,388 -- Facility closings.............................................................. 1,883 2,251 Other accruals................................................................. 2,103 1,562 Other, net..................................................................... 581 434 ---------- ---------- Total current deferred income taxes.......................................... 33,000 17,400 Valuation allowance............................................................ (21,200) -- ---------- ---------- Net current deferred income taxes............................................ $ 11,800 $ 17,400 ---------- ---------- ---------- ----------
33 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 5. INCOME TAXES (CONTINUED)
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- Net noncurrent deferred tax asset (liability): Depreciation................................................................... $ (20,901) $ (25,096) Rent expense................................................................... 17,651 19,572 Amortization of intangible assets.............................................. (2,011) (2,034) Net pension liability.......................................................... 881 807 Other, net..................................................................... (49) 551 Alternative minimum tax credit................................................. 8,929 2,300 ---------- ---------- Total noncurrent deferred income taxes....................................... 4,500 (3,900) Valuation allowance............................................................ (3,300) -- ---------- ---------- Net noncurrent deferred income taxes......................................... $ 1,200 $ (3,900) ---------- ---------- ---------- ----------
Due to the loss incurred in 1996 and uncertainty of future earnings, current deferred income taxes and the noncurrent alternative minimum tax credit have been reduced by valuation allowances at December 31, 1996 to approximate the remaining recoverable income taxes after carryback of the 1996 taxable loss. 6. 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 established a defined contribution plan in 1992 for those employees.
DECEMBER 31, -------------------- 1996 1995 --------- --------- PENSION DATA HAVE BEEN COMPUTED BASED ON THE FOLLOWING ASSUMPTIONS: Discount rate for benefit obligations............................................... 7.75% 7.50% Rate of increase for future compensation levels..................................... 5.50 5.50 Expected long-term rate of return on plan assets.................................... 8.50 8.50 THE FUNDED STATUS OF THE PENSION PLAN AND THE RELATED AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS WERE AS FOLLOWS: Funded assets at fair value (primarily listed stocks and U.S. bonds)................ $ 9,468 $ 9,289 Projected benefit obligation: Vested benefits................................................................... (9,604) (9,141) Non-vested benefits............................................................... -- (142) --------- --------- Accumulated benefit obligation.................................................... (9,604) (9,283) Projected future salary increases................................................. -- (47) --------- --------- Projected benefit obligation...................................................... (9,604) (9,330) --------- --------- Projected benefit obligation in excess of assets.................................... (136) (41) Net unamortized gains............................................................... (2,273) (1,983) --------- --------- Net pension liability............................................................. $ (2,409) $ (2,024) --------- --------- --------- ---------
34 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 6. EMPLOYEE BENEFIT PLANS (CONTINUED) The increase in the discount rate at December 31, 1996 decreased the accumulated benefit obligation and the projected benefit obligation by $456. 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, 1996 and 1995.
YEARS ENDED DECEMBER 31, ------------------------------- 1996 1995 1994 --------- --------- --------- THE COMPONENTS OF NET PENSION EXPENSE WERE AS FOLLOWS: Service cost for benefits earned........................................ $ 446 $ 260 $ 407 Interest cost on projected benefit obligation........................... 715 631 648 Actual return on plan assets............................................ (597) (1,814) 512 Net amortization and deferred amounts................................... (179) 1,130 (1,225) --------- --------- --------- Net pension expense................................................... $ 385 $ 207 $ 342 --------- --------- --------- --------- --------- ---------
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. Beginning in 1996, the 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, 1996 and 1995. At December 31, 1996 and 1995, the number of shares held in suspense was 834,320 and 938,610, respectively, and the market value of the shares held in suspense was $1,251 and $3,989, respectively. Expenses for the 401(k) and defined contribution plans for the years ended December 31, 1996, 1995 and 1994 totalled $354, $570 and $591, respectively. Expenses for postemployment benefits were not material. The Company does not offer or provide postretirement benefits other than pensions to its employees. 7. STOCK PLANS The Company's 1994, 1992 and 1988 Stock Option Plans authorize the grant of stock options and stock appreciation rights to officers and other key employees. The Company's Directors Stock Option Plan authorizes the grant of stock options to its directors who are not employees of the Company or its affiliates. The number of shares of common stock that may be issued to employees and directors under each of these plans is 950,000 shares, 1,500,000 shares, 1,000,000 shares and 200,000 shares, respectively. The stock options become exercisable over a period not to exceed ten years after the date they are granted. Exercise prices are based upon the stock's market price at the grant date. The employee and director stock options generally vest over a period of four to five years. No stock appreciation rights were outstanding as of December 31, 1996. In 1996, the Company adopted Financial Accounting Standards board Statement No. 123, "Accounting for Stock-Based Compensation" ("Statement No. 123"), for disclosure purposes only. 35 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 7. STOCK PLANS (CONTINUED) A SUMMARY OF THE STATUS OF THE COMPANY'S EMPLOYEE STOCK OPTION PLANS AS OF DECEMBER 31, 1996, 1995 AND 1994 AND CHANGES DURING THE YEARS THEN ENDED IS PRESENTED BELOW:
1996 1995 1994 ------------------------- ------------------------- ------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------------ ----------- ------------ ----------- ------------ ----------- Outstanding at beginning of year.............................. 1,847,984 $ 10.49 1,708,916 $ 11.89 1,588,250 $ 11.65 Granted................................ 1,023,973 2.30 393,350 7.82 215,000 14.37 Exercised.............................. (5,000) 2.50 (50,100) 3.93 (17,206) 4.20 Cancelled.............................. (230,663) 11.26 (204,182) 18.73 (77,128) 15.41 ------------ ------------ ------------ Outstanding at end of year.............................. 2,636,294 7.25 1,847,984 10.49 1,708,916 11.89 ------------ ------------ ------------ ------------ ------------ ------------ Options exercisable at year end.......................... 958,916 800,838 605,762 ------------ ------------ ------------ ------------ ------------ ------------ Options available for future grant......................... 631,750 1,425,060 1,612,046 ------------ ------------ ------------ ------------ ------------ ------------ Weighted average fair value of options granted during the year...................... $ 1.32 $ 4.37 ------------ ------------ ------------ ------------
THE FOLLOWING TABLE SUMMARIZES INFORMATION ABOUT EMPLOYEE STOCK OPTIONS OUTSTANDING AT DECEMBER 31, 1996:
OPTIONS OUTSTANDING --------------------------------------- OPTIONS EXERCISABLE WEIGHTED ---------------------- AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE RANGE OF EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE - ------------------------------------------ ----------- --------------- --------- ----------- --------- $ 1.500 to $ 2.5625....................... 820,299 7.35 $ 2.073 287,384 $ 2.500 3.000 to 4.5000....................... 691,350 7.47 3.454 257,850 4.500 6.625 to 9.8750....................... 352,195 8.68 7.664 17,198 6.625 12.875 to 21.7500....................... 772,450 6.36 15.965 396,484 15.321 ----------- ----------- 2,636,294 958,916 ----------- ----------- ----------- -----------
36 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 7. STOCK PLANS (CONTINUED) A SUMMARY OF THE STATUS OF THE COMPANY'S DIRECTORS STOCK OPTION PLANS AS OF DECEMBER 31, 1996, 1995 AND 1994 AND CHANGES DURING THE YEARS THEN ENDED IS PRESENTED BELOW:
1996 1995 1994 ---------------------- ---------------------- ---------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE --------- ----------- --------- ----------- --------- ----------- Outstanding at beginning of year....................................... 45,000 $ 11.90 40,000 $ 12.22 40,000 $ 12.22 Granted......................................... -- 5,000 -- --------- --------- --------- Outstanding at end of year....................................... 45,000 11.90 45,000 11.90 40,000 12.22 --------- --------- --------- --------- --------- --------- Options exercisable at year end................................... 45,000 11.90 40,000 12.22 40,000 12.22 --------- --------- --------- --------- --------- --------- Options available for future grant.................................. 35,000 35,000 40,000 --------- --------- --------- --------- --------- ---------
Exercise prices under the director stock option plan range from $9.375 to $12.50 and the weighted average remaining contractual life of the outstanding options is 6.36 years. The weighted average fair value of options granted in 1995 was $5.34. PRO FORMA DISCLOSURES OF NET LOSS AND NET LOSS PER COMMON SHARE AS IF THE FAIR VALUE BASED METHOD OF ACCOUNTING FOR STOCK OPTIONS UNDER STATEMENT NO. 121 HAD BEEN APPLIED ARE AS FOLLOWS:
1996 1995 ----------- ----------- Net loss As reported............................... $ (193,738) $ (135,750) Pro forma................................. $ (194,394) $ (135,850) Net loss per common share As reported............................... $ (5.80) $ (4.00) Pro forma................................. $ (5.82) $ (4.01)
The fair value of the employee and director options granted was estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions for 1996 and 1995, respectively: risk-free interest rates of 6.17% and 6.31%; expected volatility of 45% and 49%; expected life of seven years for both years; and no dividend yields for either year. Statement No. 123 does not apply to option grants prior to 1995. Additionally, options vest over several years and additional stock option grants are anticipated in the future. Accordingly, the pro forma disclosures may not be representative of the effects on net earnings (loss) in future years. 37 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 8. COMMON STOCK SUBSCRIPTIONS Certain members of management of the Company own 1,991,308 shares of common stock with restrictions ("Restricted Stock") at $0.0025 per share. The Restricted Stock is not transferable until the Company is paid the balance of the subscription price of $2.4975 or $4.4975 per share. The amount of subscriptions due from the holders of Restricted Stock upon transfer is reflected as a reduction of stockholders' equity. 9. 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. 10. COMMITMENTS The Company leases most of its retail stores and certain office and warehouse facilities under operating leases for terms ranging from three to twenty-five years. 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. In most instances, the Company pays, in addition to minimum rent, real estate taxes, utilities, common area maintenance costs and percentage rentals which are based upon sales volume. Certain store leases contain provisions restricting assignment, merger, change of control or transfer. The Company also leases certain store fixtures and equipment, computers, and automobiles under operating leases. The Company's distribution facility in Franklin, Indiana is under an operating lease with a special purpose entity that contains an original term of four years, a one year renewal option and purchase options at the end of the original and renewal periods. The lease contains a residual value guarantee in an amount not to exceed $24,900 at the end of the original lease term in March 1999 and $25,650 at the end of the renewal term in March 2000. The lease also contains certain financial covenants. The write-down of goodwill in 1995 followed by an additional write-down of the remaining goodwill balance on December 31, 1996 caused the Company to be in default of the financial covenant related to the maximum total liabilities to total stockholders' equity ratio on December 31, 1996. The operating lease was executed in March 1994 and, accordingly, this covenant ratio did not anticipate the impact on stockholders' equity of any goodwill write-down. The Company is working with the parties to the operating lease to obtain a waiver to adjust the covenant ratio for the effect of the goodwill write-downs taken in 1996 and 1995. However, there can 38 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 10. COMMITMENTS (CONTINUED) be no assurance that the Company will be able to obtain such a waiver or that alternative sources of financing for the distribution facility would be available if the waiver is not obtained. AT DECEMBER 31, 1996, FUTURE ANNUAL MINIMUM RENTALS FOR NONCANCELLABLE OPERATING LEASES WITH REMAINING FIXED TERMS GREATER THAN ONE YEAR ARE: 1997..................................................... $ 145,525 1998..................................................... 142,907 1999..................................................... 155,748 2000..................................................... 116,400 2001..................................................... 93,075 Thereafter............................................... 343,609 --------- Total.................................................. $ 997,264 --------- ---------
YEARS ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---------- ---------- ---------- TOTAL RENT EXPENSE CONSISTS OF THE FOLLOWING: Minimum cash rents....................................... $ 166,308 $ 148,736 $ 120,118 Straight-line recognition of leases with scheduled rent increases.............................................. 3,152 7,304 4,892 Percentage rents......................................... 1,733 2,000 3,408 ---------- ---------- ---------- Total rent expense..................................... $ 171,193 $ 158,040 $ 128,418 ---------- ---------- ---------- ---------- ---------- ----------
11. RELATED PARTY TRANSACTIONS Donaldson, Lufkin & Jenrette, Inc. ("DLJ") and certain of its affiliates, excluding DLJ employees, owned approximately 6.9% of the Company's common stock at December 31, 1996. DLJ acts as a market maker in the Company's senior subordinated notes. 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts reported in the consolidated balance sheets at December 31, 1996 and 1995 for cash and cash equivalents, other current assets, checks drawn in excess of bank balances, accounts payable and other current liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments. As the interest rate on the long-term debt is reset monthly based on current market rates, the carrying value of the mortgage note payable approximates fair value. The fair value of the revolver at December 31, 1996 and 1995, based on current market rates, was $217,600 and $45,050, respectively. The fair value of the senior subordinated notes at December 31, 1996 and 1995, based on the last quoted price on those dates, was $50,600 and $66,000, respectively. 39 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 13. SUPPLEMENTARY BALANCE SHEET INFORMATION
DECEMBER 31, ---------------------- 1996 1995 ---------- ---------- OTHER CURRENT LIABILITIES CONSIST OF THE FOLLOWING: Income taxes(1)....................................................... $ -- $ 10,351 Payroll and related taxes and benefits................................ 19,598 18,183 Gift certificates payable............................................. 32,792 28,716 Sales taxes payable................................................... 19,924 19,694 Accrued store expenses and other...................................... 28,552 31,511 ---------- ---------- Total............................................................. $ 100,866 $ 108,455 ---------- ---------- ---------- ---------- OTHER LONG-TERM LIABILITIES CONSIST OF THE FOLLOWING: Straight-line recognition of leases with scheduled rent increases..... $ 36,442 $ 35,915 Deferred rent credits................................................. 14,651 11,882 Other................................................................. 5,133 4,825 ---------- ---------- Total............................................................. $ 56,226 $ 52,622 ---------- ---------- ---------- ----------
- ------------------------ (1) Other current assets at December 31, 1996 include net income taxes refundable of $18,657. 14. SUPPLEMENTAL CASH FLOW INFORMATION In May 1995, the Company entered into an operating lease with a special purpose entity for the purpose of purchasing land and constructing three of the Company's Media Play stores using secured long-term financing. The land, buildings and certain fixtures, which had an aggregate cost of $14,395 at December 31, 1996, together with the related mortgage note payable and deferred financing credits totaling $14,599 at December 31, 1996, were recorded on the Company's books 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. 15. LITIGATION The Company is a party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, all such matters are without merit or involve such amounts that unfavorable disposition will not have a material impact on the financial position or results of operations of the Company. 40 MUSICLAND STORES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 16. QUARTERLY FINANCIAL DATA (UNAUDITED)
EARNINGS COMMON STOCK PRICE NET (LOSS) PER GROSS EARNINGS COMMON -------------------- SALES PROFIT (LOSS) SHARE HIGH LOW ------------ ---------- ----------- ----------- --------- --------- 1996: First................... $ 383,570 $ 129,833 $ (52,636) $ (1.58) $ 4 3/4 $ 2 Second.................. 372,410 126,582 (24,080) (0.72) 5 1/4 3 1/8 Third................... 366,634 127,702 (24,201) (0.72) 3 5/8 1 3/8 Fourth.................. 698,980 227,642 (92,821) (2.77) 2 1 1/4 ------------ ---------- ----------- ----------- Total................. $ 1,821,594 $ 611,759 $ (193,738) $ (5.80) ------------ ---------- ----------- ----------- ------------ ---------- ----------- ----------- 1995: First................... $ 346,360 $ 122,244 $ (6,314) $ (0.18) $ 10 3/4 $ 6 3/4 Second.................. 331,720 123,372 (7,531) (0.22) 10 5/8 8 7/8 Third................... 357,585 131,317 (144,550) (4.28) 11 8 1/4 Fourth.................. 686,907 229,137 22,645 0.68 10 3 3/4 ------------ ---------- ----------- ----------- Total................. $ 1,722,572 $ 606,070 $ (135,750) $ (4.00) ------------ ---------- ----------- ----------- ------------ ---------- ----------- -----------
The three months ended December 31, 1996 and September 30, 1995 include goodwill write-downs of $95,253, or $2.85 per share, and $138,000, or $4.09 per share, respectively. The three months ended March 31, 1996 and December 31, 1996 include pretax restructuring charges of $35,000 and $40,000, respectively. The total of earnings (loss) per common share by quarter may not equal the total for the year as there are changes in the weighted average number of common shares outstanding each quarter and earnings (loss) per common share is calculated independently for each quarter. Quarterly financial data for 1996 has been adjusted to reflect the effect of the deferred tax valuation allowance in each quarter. See Note 5. 41 EXHIBIT INDEX The following documents are filed as part of this Annual Report on Form 10-K for the year ended December 31, 1996.
SEQUENTIAL EXHIBIT NO. DESCRIPTION PAGE NO. - ------------ ----------------------------------------------------------------------------------------- ------------- 3.1 Restated Certificate of Incorporation of MSC, as amended................................. [i] 3.2 By-laws of MSC, as amended............................................................... [ii] 4.1 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........................................................................... [iii] 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........... [iv] 4.2(b) Amendment No. 1 dated as of February 28, 1995 to the Credit Agreement.................... [viii] 4.2(c) Amendment No. 2 dated as of April 9, 1996 to the Credit Agreement........................ [xi] 4.2(d) Amendment No. 3 dated as of October 18, 1996 to the Credit Agreement..................... [xii] 4.2(e) Waiver and Agreements under Credit Agreement dated as of March 7, 1997 to the Credit Agreement.............................................................................. -- 4.3 Rights Agreement dated as of March 14, 1995, between MSC and Norwest Bank Minnesota, National Association, as Rights Agent.................................................. [v] 9 Voting Trust Agreement among DLJ, certain of its affiliates, the Equitable Investors and Meridian Trust Company................................................................. [i] 10.1(a) Lease Agreement dated March 31, 1994 between Shawmut Bank Connecticut, N.A. as Owner Trustee and Musicland Retail, Inc., as Lessee.......................................... [viii] 10.1(b) Participation Agreement dated March 31, 1994 among Musicland Retail, Inc., as Lessee, Shawmut Bank Connecticut, N.A. as Owner Trustee, Kleinwort Benson Limited, as Owner Participant, Lender and Agent and The Long-Term Credit Bank of Japan, Ltd. Chicago Branch, Credit Lyonnais Cayman Island Branch, The Fuji Bank, Limited, as Lenders....... [viii] 10.1(c) Guaranty of MGI dated March 31, 1994..................................................... [viii] 10.2(a) Master Lease dated May 12, 1995 between Media Play Trust, as Landlord, and Media Play, Inc., as Tenant........................................................................ [ix] 10.2(b) Participation Agreement dated May 12, 1995 among Natwest Leasing Corporation, as Owner Participant, Media Play Trust, As Trust, Yasuda Bank and Trust Company (U.S.A.), as Owner Trustee, National Westminster Bank PLC, as Agent and Lender, Media Play, Inc., as Tenant and the Long-Term Credit Bank of Japan, Ltd. Chicago Branch and The Yasuda Trust & Banking Company, Ltd., Chicago Branch, as Other Lenders.............................. [ix] 10.2(c) Amendment No. 1 dated as of April 9, 1996 to the Participation Agreement................. [xi] 10.2(d) Lease Guaranty dated May 12, 1995 between MGI, as Guarantor, and Media Play Trust, as Landlord............................................................................... [ix] 10.2(e) Amendment No. 1 dated as of April 9, 1996 to the Lease Guaranty.......................... [xi] *10.3(a) Subscription Agreement among MSC and the Management Investors............................ [vi] *10.3(b) Form of amendment to Management Subscription Agreement................................... [i]
42
SEQUENTIAL EXHIBIT NO. DESCRIPTION PAGE NO. - ------------ ----------------------------------------------------------------------------------------- ------------- *10.4 Form of Registration Rights Agreement among MSC, DLJ and the Management Investors........ [vii] *10.5(a) Employment Agreement with Mr. Eugster.................................................... [vi] *10.5(b) Form of amendment to Employment Agreement with Mr. Eugster............................... [i] *10.5(c) Amendment No. 2 to Employment Agreement with Mr. Eugster................................. [x] *10.6(a) Form of Employment Agreement with Messrs. Benson and Ross................................ [vi] *10.6(b) Amendment to Employment Agreement with Mr. Benson........................................ -- *10.6(c) Amendment to Employment Agreement with Mr. Ross.......................................... -- *10.7(a) Form of Employment Agreement with Messrs. Bausman and Henderson.......................... [vi] *10.7(b) Form of amendment to Employment Agreements with Messrs. Bausman and Henderson............ [i] *10.7(c) Amendment No. 2 to Employment Agreement with Mr. Bausman................................. [x] *10.7(d) Amendment No. 2 to Employment Agreement with Mr. Henderson............................... [x] *10.8(a) Change of Control Agreement with Mr. Eugster............................................. [vi] *10.8(b) Form of amendment to Change of Control Agreement with Mr. Eugster........................ [i] *10.8(c) Amendment No. 2 to Change of Control Agreement with Mr. Eugster.......................... [x] *10.8(d) Amendment No. 3 to Change of Control Agreement with Mr. Eugster.......................... -- *10.9 Management Incentive Plan dated as of January 1, 1996.................................... -- *10.10 1988 Stock Option Plan, as amended....................................................... [i] *10.11 Stock Option Plan for Unaffiliated Directors of MSC, as amended.......................... [i] *10.12 1992 Stock Option Plan................................................................... [i] *10.13 Musicland Stores Corporation 1994 Employee Stock Option Plan............................. [viii] *10.14 Employment Letter Agreement with Mr. Johnson............................................. [viii] *10.15 (a) Change of Control Agreement with Mr. Johnson............................................. [x] *10.15 (b) Amendment No. 1 to Change of Control Agreement with Mr. Johnson.......................... -- *10.16 (a) Change of Control Agreement with Messrs. Benson and Ross................................. [vi] *10.16 (b) Amendment No. 1 to Change of Control Agreement with Mr. Benson........................... -- *10.16 (c) Amendment No. 1 to Change of Control Agreement with Mr. Ross............................. -- *10.17 Form of Executive Severance Agreement with Mr. Wachsman.................................. -- *10.18 Long Term Incentive Plan dated as of January 1, 1996..................................... -- *10.19 Executive Officer Short Term Incentive Plan dated as of November 15, 1996................ -- 11 Statement re computation of per share earnings........................................... [xiii] 21 Subsidiaries of MSC...................................................................... [ii] 23 Consent of Arthur Andersen LLP........................................................... -- 27 Financial Data Schedules................................................................. -- 99 Form 11-K for The Musicland Group's Capital Accumulation Plan............................ [xiv]
- ------------------------ [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). 43 [ii] Incorporated by reference to MSC's Annual Report on Form 10-K for the year ended December 31, 1992 filed with the Commission on March 2, 1993 (Commission File No. 1-11014). [iii] 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). [iv] 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). [v] 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. [vi] 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). [vii] 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). [viii] 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). [ix] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for the quarter period ended June 30, 1995 filed with the Commission on August 11, 1995 (Commission File No. 1-11014). [x] 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. [xi] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for the quarter period ended March 31, 1996 filed with the Commission on May 10, 1996 (Commission File No. 1-11014). [xii] Incorporated by reference to MSC's Quarterly Report on Form 10-Q for the quarter period ended September 30, 1996 filed with the Commission on November 13, 1996 (Commission File No. 1-11014). [xiii] Earnings (loss) per common share amounts are computed by dividing net earnings (loss) by the weighted average number of common shares outstanding. 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. Common stock equivalents related to stock options are anti-dilutive in 1996 and 1995 due to the net losses. Common stock equivalents related to stock options which would have a dilutive effect based upon current market prices had no material effect on net earnings per common share in years prior to 1995. Accordingly, this exhibit is not applicable to the Company. [xiv] To be filed by amendment. * Indicates Management Contract or Compensatory Plan or Agreement required to be filed as an Exhibit to this form. 44 EX-4.2(E) 2 EXHIBIT 4.2(E) March 7, 1997 The Musicland Group, Inc. Musicland Stores Corporation 10400 Yellow Circle Drive Minnetonka, Minnesota 55343 Re: Waivers and Agreements under Credit Agreement Ladies/Gentlemen: Please refer to the Credit Agreement dated as of October 7, 1994 (as previously amended, the "Credit Agreement") among The Musicland Group, Inc., Musicland Stores Corporation, various financial institutions and Morgan Guaranty Trust Company of New York, as Agent. Terms defined in the Credit Agreement are, unless otherwise defined herein, used herein as so defined. Pursuant to the Borrower's request, the Required Banks agree as follows: 1. The Required Banks hereby waive through May 29, 1997 any Default or Event of Default which now or hereafter may exist under Section 5.7, 5.8, 5.9 or 5.23 of the Credit Agreement; it being understood that upon the expiration of such waiver on May 30, 1997, the Agent and the Banks may exercise any or all of their rights with respect to any such Default or Event of Default. 2. The Borrower and certain of its Subsidiaries have incurred obligations under (a) the Participation Agreement dated as of May 12, 1995 among NatWest Leasing Corporation, Media Play Trust, Yasuda Bank and Trust Company, National Westminster Bank Plc, various other lenders and Media Play, Inc., and the Master Lease and other documents referred to therein and (b) the Participation Agreement dated as of March 31, 1994 among Musicland Retail, Inc., Shawmut Bank Connecticut, National Association, Kleinwort Benson Limited, The Long Term Credit Bank of Japan, Ltd., Chicago Branch, Credit Lyonnais Cayman Island Branch and The Fuji Bank, Limited, and the Master Lease and other documents referred to therein. The transactions contemplated by the documents described in the foregoing sentence are Page 1 collectively called the "Synthetic Lease Transactions". As a result of certain payments which have been or may be made under the Synthetic Lease Transactions, the Synthetic Lease Transactions have been or may be required to be classified for accounting purposes as financing leases (rather than operating leases). Such reclassification would result in technical defaults under the Credit Agreement because the existing obligations of the Borrower and its Subsidiaries under the Synthetic Lease Transactions would be recharacterized as Debt, the existing interest of the lessors under the Synthetic Lease Transactions would be recharacterized as Liens and certain payments under the Synthetic Lease Transactions would be recharacterized as Capital Expenditures. Accordingly, the Required Banks hereby agree that (i) to the extent that the existing obligations of the Company and its Subsidiaries under the Synthetic Lease Transactions constitute Debt, such existing Debt shall be permitted under Section 5.11 of the Credit Agreement; (ii) to the extent that the property subject to the Synthetic Lease Transactions is deemed to be owned by the Company or any Subsidiary and subject to existing Liens arising under the Synthetic Lease Transactions, such existing Liens shall be permitted under Section 5.14 of the Credit Agreement; and (iii) for purposes of computing Capital Expenditures under Section 5.16 of the Credit Agreement, payments under the Synthetic Lease Transactions shall continue to be deemed to be operating lease payments and shall not constitute Capital Expenditures. Without limiting the foregoing, the Required Banks waive any Default or Event of Default arising solely from the recharacterization of the Synthetic Lease Transactions as financing leases. 3. The Required Banks further agree that subclauses (i) and (ii) of clause (b) of the definition of "Eligible Inventory Limit" set forth in the Credit Agreement are amended in their entirety to read as follows: "(i) during the fiscal months of May, June, July, August, September and October of each year, and during November and December of 1996 and January, February, March and April of 1997, 60%; (ii) during the fiscal months of March and April of 1996, 55%;". The waivers and agreements set forth above shall become effective when the Agent has received counterparts of this letter Page 2 executed by the Required Banks (it being understood that the Agent may rely upon facsimile confirmation of the execution of a counterpart hereof by any Bank for purposes of determining such effectiveness). This letter may be executed in any number of counterparts and by the different parties on separate counterparts, and each such counterpart shall be deemed to be an original but all such counterparts shall together constitute one and the same letter. This letter shall be a contract made under and governed by the internal laws of the State of New York applicable to contracts made and to be performed within such State. MORGAN GUARANTY TRUST COMPANY OF NEW YORK By ------------------------------- Title: FIRST BANK NATIONAL ASSOCIATION By ------------------------------- Title: THE BANK OF TOKYO - MITSUBISHI, LTD. By ------------------------------- Title: THE BANK OF NOVA SCOTIA By ------------------------------- Title: CITIBANK, N.A. By ------------------------------- Title: Page 3 CREDIT AGRICOLE By ------------------------------- Title: CREDIT LYONNAIS NEW YORK BRANCH By ------------------------------- Title: WELLS FARGO BANK By ------------------------------- Title: THE FUJI BANK, LIMITED By ------------------------------- Title: THE HOKKAIDO TAKUSHOKU BANK, LTD., NEW YORK BRANCH By ------------------------------- Title: THE LONG-TERM CREDIT BANK OF JAPAN, LTD., CHICAGO BRANCH By ------------------------------- Title: Page 4 NBD BANK, N.A. By ------------------------------- Title: PNC BANK, NATIONAL ASSOCIATION By ------------------------------- Title: THE SAKURA BANK, LIMITED By ------------------------------- Title: SOCIETE GENERALE By ------------------------------- Title: BANK AUSTRIA AKTIENGESELLSCHAFT By ------------------------------- Title: BEAR STEARNS GOVERNMENT SECURITIES, INC. By ------------------------------- Title: MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED By ------------------------------- Title: Page 5 BANK OF AMERICA ILLINOIS By ------------------------------- Title: DLJ CAPITAL FUNDING, INC. By ------------------------------- Title: MORGENS WATERFALL DOMESTIC PARTNERS, L.L.C. By ------------------------------- Title: NATIONSBANK, N.A. By ------------------------------- Title: MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as Agent By ------------------------------- Title: Page 6 EX-10.6B 3 AMENDMENT TO EMPLOYMENT AGMT W/ K. BENSON EXHIBIT 10.6(b) AMENDMENT TO EMPLOYMENT AGREEMENT WITH KEITH A. BENSON (formerly titled "Agreement") AMENDMENT dated December 3, 1996 to the Employment Agreement ("the Employment Agreement", formerly titled Agreement) dated as of August 25, 1988 by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporations, a Delaware corporation (the "Parent") and Keith A. Benson (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Employment Agreement in certain respects: NOW, THEREFORE, BE IT RESOLVED, that the Employment Agreement shall be amended as follows: 1. Section 1, TERM OF EMPLOYMENT; OFFICE AND DUTIES, is amended by deleting the title "Executive Vice President and Chief Financial Officer" as it appears in subparagraph (a) thereof, and inserting in its place "President, Mall Stores Division." 2. Section 3, COMPENSATION, is amended by deleting the salary of "$170,000" in subparagraph (a) and inserting in its place "$308,700. 3. Section 3, COMPENSATION, is further amended by adding to subparagraph (b)(iii) the words "and other subsequent Stock Plans" after the word "Plan." 4. Section 8 (c), TERMINATION OF EMPLOYMENT, is hereby deleted in its entirety and substituting in its place is the following: (c) By the Executive at any time for any other reason, in which event the Executive's employment and the Period of Employment hereunder shall be deemed terminated as of the 90th day following the giving of written notice by the Executive to the Company or such earlier date as the Company may specify on a written notice to the Executive. In the event of any termination by the Executive pursuant to this Section 8(c), the Executive shall receive all compensation and other benefits to which he was entitled under this Agreement through the termination date and thereafter the Company will have no further obligation to the Executive except for qualified benefits vested and accrued as of the termination date. 5. Section 9, REDUCTION FOR EQUITY APPRECIATION, is hereby deleted in its entirety and is no longer of any force or effect. 6. Section 19, NOTICES, is amended by deleting Keith A. Benson's home address of "6004 Luigi Circle, Bloomington, MN 55437" and inserting in its place "2523 Kelly Avenue, Excelsior, MN 55331." IN WITNESS WHEREOF, the undersigned have executed this Amendment of Employment Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: /s/ Jack W. Eugster --------------------------------------- Its: Jack W. Eugster, Chairman & CEO MUSICLAND STORES CORPORATION By:/s/ Jack W. Eugster --------------------------------------- Its: Jack W. Eugster, Chairman & CEO EXECUTIVE /s/ Keith A. Benson --------------------------------------- Keith A. Benson EX-10.6C 4 AMENDMENT TO EMPLOYMENT AGMT W/ G. ROSS EXHIBIT 10.6(c) AMENDMENT TO EMPLOYMENT AGREEMENT WITH GARY A. ROSS (formerly titled "Agreement") AMENDMENT dated December 3, 1996 to the Employment Agreement ("("the Employment Agreement," formerly titled Agreement) dated as of August 25, 1988 by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporations, a Delaware corporation (the "Parent") and Gary A. Ross (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Employment Agreement in certain respects: NOW, THEREFORE, BE IT RESOLVED, that the Employment Agreement shall be amended as follows: 1. Section 1, TERM OF EMPLOYMENT; OFFICE AND DUTIES, is amended by deleting the title "Executive Vice President of Marketing and Merchandising" as it appears in subparagraph (a) thereof, and inserting in its place "President, Superstores Division" 2. Section 3, COMPENSATION, is amended by deleting the salary of "$195,000" in subparagraph (a) and inserting in its place "$316,340." 3. Section 3, COMPENSATION, is further amended by adding to subparagraph (b)(iii) the words "and other subsequent Stock Plans" after the word "Plan." 4. Section 8 (c), TERMINATION OF EMPLOYMENT, is hereby deleted in its entirety and substituting in its place is the following: (c) By the Executive at any time for any other reason, in which event the Executive's employment and the Period of Employment hereunder shall be deemed terminated as of the 90th day following the giving of written notice by the Executive to the Company or such earlier date as the Company may specify on a written notice to the Executive. In the event of any termination by the Executive pursuant to this Section 8(c), the Executive shall receive all compensation and other benefits to which he was entitled under this Agreement through the termination date and thereafter the Company will have no further obligation to the Executive except for qualified benefits vested and accrued as of the termination date. 5. Section 9, REDUCTION FOR EQUITY APPRECIATION, is hereby deleted in its entirety and is no longer of any force or effect. 6. Section 19, NOTICES, is amended by deleting Gary A. Ross's home address of "4119 France Avenue South, Minneapolis, MN 55416" and inserting in its place "2608 Crosby Road, Wayzata, MN 55391." IN WITNESS WHEREOF, the undersigned have executed this Amendment of Employment Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: /s/ Jack W. Eugster -------------------------------- Its: Jack W. Eugster, Chairman & CEO MUSICLAND STORES CORPORATION By: /s/ Jack W. Eugster -------------------------------- Its: Jack W. Eugster, Chairman & CEO EXECUTIVE /s/ Gary A. Ross ------------------------------------ Gary A. Ross EX-10.8D 5 3RD AMENDMENT TO CHANGE IN CONTROL EXHIBIT 10.8(d) THIRD AMENDMENT TO CHANGE IN CONTROL AGREEMENT OF JACK W. EUGSTER AMENDMENT dated as of December 3, 1996 to the Change in Control Agreement (the "Change in Control Agreement" formerly called Employment Agreement) dated as of August 25, 1988 and as amended January 22, 1992 and November 27, 1995, by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporation, a Delaware corporation (the "Parent") and Jack W. Eugster of Excelsior, Minnesota (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Change in Control Agreement in certain respects; NOW, THEREFORE, BE IT RESOLVED, that the Change of Control Agreement shall be amended as follows: Paragraph 1.02, definition of "Change of Control," subparagraph (a) is hereby amended by deleting the phrase "and are publicly traded on a recognized securities exchange." IN WITNESS WHEREOF, the undersigned have executed this Third Amendment of Change in Control Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: /s/ Reid Johnson ------------------------------ Reid Johnson Its: Executive Vice President and CFO MUSICLAND STORES CORPORATION By: /s/ Reid Johnson ------------------------------ Reid Johnson Its: Executive Vice President and CFO EXECUTIVE /s/ Jack W. Eugster ------------------------------ Jack W. Eugster EX-10.9 6 MANAGEMENT INCENTIVE PLAN EXHIBIT 10.9 THE MUSICLAND GROUP MANAGEMENT INCENTIVE PLAN JANUARY 1, 1996 I. PURPOSE The Management Incentive Plan (the "Plan") is designed to reward participants who make significant contributions to the success of The Musicland Group (the "Company"). The Plan recognizes the importance of individual contributions to Company performance. Awards under this Plan take into consideration such factors as the importance and impact of each participant's accomplishments, the relative difficulty and the degree of risk involved in those accomplishments, as well as Company performance. II. ADMINISTRATION The Plan is administered by the Compensation Committee of the Company's Board of Directors (the "Compensation Committee"). In the absence of a designated Compensation Committee, the Board as a whole will act as the Compensation Committee. The Chief Executive Officer of the Company (the "CEO") shall make recommendations to the Compensation Committee regarding participation, level of awards, changes to the Plan, annual funding percentages, and other aspects of the Plan's administration. The Compensation Committee has the authority to interpret the Plan, and, subject to the Plan's provisions, to make and amend rules and to make all other decisions necessary for the Plan's administration. Specifically, the Compensation Committee has the authority to approve funding percentages and to approve individual awards for participants whose base salary is equal to or greater than an amount to be designated by the Compensation Committee. The CEO has the authority to approve individual awards for participants whose base salary is less than the designated amount. Each Plan Year will run from January 1 through the following December 31 (the "Plan Year"). III. PARTICIPATION The CEO will recommend for approval by the Compensation Committee the individuals who are eligible to participate in the Plan, and their level of participation. All eligible participants will be given the funding for their participation level and upon request a copy of this Plan. IV. INCENTIVE COMPENSATION MEASURES Early each year the Compensation Committee will approve the business goals on which incentive funds (the funding pool) will be made available for awards to participants for such year, as well as a performance range above and below such goals, and the amounts to be made available for such awards at each level of business performance. THE PERCENTAGE FUNDING IS A SEPARATE AND DISTINCT CALCULATION FROM THE DETERMINATION OF INDIVIDUAL AWARDS (SEE V. BELOW). 1996 Management Incentive Plan Actual business results for the year and their relation to such pre- established ranges shall determine the amounts, if any, to be made available for awards to designated participants. The actual business results will be provided by the Chief Financial Officer. The Compensation Committee may approve adjustments to actual business results to reflect organizational, operational, or other changes which have occurred during the year, e.g., acquisitions, dispositions, expansions, contractions, material non-recurring items of income or loss, or events which might create unwarranted hardships or windfalls to participants. The Compensation Committee will also determine the discretionary incentive funds, if any, to be made available for awards to participants based on their individual performance, such awards not to be contingent upon the attainment of business goals. V. DISTRIBUTION OF THE FUNDING POOL The Compensation Committee approves the percentage of the funding pool to be distributed each year. Up to, but no more than, 100% of the funding pool can be approved for distribution. Individual awards for participants whose base salary is equal to or greater than an amount to be designated by the Compensation Committee will be recommended by the CEO to the Compensation Committee for final approval. Individual awards for participants whose base salary is below the designated amount will be approved by the CEO. Individual awards will be determined on the basis of 1) actual Company performance compared to target business goals and/or 2) individual performance compared to the individual's objectives. Awards will be directly related to each participant's contribution, considering such factors as importance and impact of accomplishments as well as the difficulty and degree of risk involved in those accomplishments. INDIVIDUAL AWARDS MAY BE LESS OR GREATER THAN THE PERCENT FUNDING SINCE AWARDS ARE DIRECTLY RELATED TO INDIVIDUAL CONTRIBUTIONS. Eligible salary is the employee's cumulative base salary earned while a participant in the Plan during the Plan Year. In determining the base salary earned during the Plan Year any delay in the receipt of a salary increase from the customary date of increase will be ignored, and the Participant will be deemed to have received the increase on the customary date. No minimum award amount is guaranteed, as the Plan is not intended to provide awards for marginally satisfactory performance AND THE PLAN MAKES NO GUARANTEE THAT INDIVIDUAL BONUSES WILL BE EQUAL TO THE PLAN FUNDING PERCENTAGE. VI. PAYMENT OF AWARDS Awards will consist of two parts, a cash payment and a deferred award, as follows: A. Eighty percent (80%) of the award will be paid in cash, less applicable tax and FICA withholding, during the quarter following the close of the plan year. It will be paid as soon as 1) the Company performance results are available, 2) individual achievements against objectives have been determined and 3) all approvals have been obtained. B. Twenty percent (20%) of the award will be made in the form of a growth participation deferral which will increase or decrease in value over a four year deferral period as described below. (Note, this deferral is not the same as Page 2 of 6 1996 Management Incentive Plan ownership in TMG, Inc. but will grow proportionally with the growth of the company.) For example: a participant whose total bonus for the 1996 Plan Year is $10,000 will receive in the first quarter of 1997 a cash payment of $8,000 (less applicable tax and FICA withholding) and will receive a deferral award with a total value of $2,000 as of 1-1-96 (the beginning of the plan year). All deferral awards must be held to maturity before payment is made in accordance with the following schedule and rules: 1. MATURITY OF THE AWARD - Twenty five percent of your deferral award will mature in four equal annual increments with the first increment maturing on the first anniversary date of the end of the Plan Year for which the award is made and subsequent increments maturing on the three succeeding anniversary dates (said four year period being the "Deferral Period"). Each matured portion of the deferred award will be paid out during the first quarter following the date maturity is reached, as soon as the then current book value has been calculated and approved. For example: if a participant receives a deferred bonus award for the Plan Year ending 12-31-96, the award will mature and be paid out in increments of twenty five percent (25%) as follows: % Matured and Date Matured To Be Paid Out ------------ -------------- 12-31-96 None 12-31-97 25% of the deferral award in 1st Q 1998 12-31-98 25% of the deferral award in 1st Q 1999 12-31-99 25% of the deferral award in 1st Q 2000 12-31-2000 25% of the deferral award in 1st Q 2001 2. ELIGIBILITY OF RECEIPT - If employment is terminated for any reason during the Deferral Period (and even if the participant is later re-employed prior to the end of the Deferral Period), all non-matured portions of the original deferral amount at the time of termination are forfeited; except that in the event termination is due to retirement, disability, death, disposition of a portion of the business or transfer to an ineligible position, payout may continue according to the original schedule or may be made on an accelerated basis, either at the discretion of the CEO. In both cases the CEO shall determine the method of valuation of such matured or non-matured portions of the deferral award prior to pay out. 3. CALCULATION OF EACH MATURED AWARD - The value of your deferral award will be determined on an annual basis during the Deferral Period. The growth calculation used to determine the value of your deferral award is the cumulative net income from the respective plan year (before extraordinary charges) through the date of maturity divided by the stockholders' equity at the beginning of the plan year in which the deferral was earned. This calculation will be made for each of the four years of the deferral period. Page 3 of 6 1996 Management Incentive Plan The growth calculations will be approved by the Chief Financial Officer. Once the growth ratio has been approved, it cannot be challenged. For plan purposes, net income may be adjusted to exclude extraordinary events or extraneous accounting adjustments, and stockholders' equity may also be adjusted so as to prevent a hardship or windfall to participants. The amount of each matured increment will be calculated based on the growth ratio. Twenty-five percent of your original deferral will be paid out during the first quarter of the year following the date of maturity. This calculation will occur four times during the deferral period as each increment of your performance deferral matures. In any given year, and depending on the number of MIP bonus payouts received, deferrals from several bonus plan years may mature at the same time. 4. Treatment of the 1992 IPO - The 1992 public offering resulted in an extraordinary change in the Company's book value. Consequently, growth for all plan years will be calculated through 12/31/92 using interest and equity adjustments to factor out the effect of the IPO. Thereafter the calculation shall be as described in 3 above. 5. There is no guarantee of the value of your deferral, as the value will fluctuate in accordance with the Company's performance, or even that any award will be paid since deferred compensation is subordinate to the claims of creditors in the event of bankruptcy. 6. The Company reserves the right to cancel deferred payment awards at any time after they have been granted and for any reason. At the time of cancellation, the value of any non-matured deferral increments will be updated based upon the normal growth calculation described in 3 above performed at that time and seasonally adjusted for any partial year. The current value of the remaining increments, or the value of remaining increments at the previous year end, whichever is higher, will then be paid out whether such increments have matured or not. 7. All payments under the deferral program will be made in cash, less applicable tax and FICA withholding, and will be considered income in the year paid out. As an exception to the foregoing, and at the Company's option, at the time of maturity any unpaid deferral increments could be converted into an appropriate number of shares of the publicly traded stock which would be issued to the participant. The conversion formula for such an exchange would be recommended by the Chief Financial Officer, reviewed by the Company's outside auditors, and approved by the Board of Directors. Once a conversion formula is approved, it cannot be challenged. VII. AWARD CONDITIONS A. Employees hired or promoted into eligible positions on or before September 30 of the Plan Year will be eligible to participate in the Plan. Employees hired or promoted into eligible positions after September 30 may be eligible to participate upon approval by the CEO. In both cases, participation in the Annual Plan will be on a pro-rated basis, determined by the number of full weeks of employment in an eligible position. Page 4 of 6 1996 Management Incentive Plan B. A participant who is promoted, at any time other than at the beginning of a Plan Year, into a position which calls for a higher participation level will be eligible to receive an award for that Plan Year which is a combination of pro-rated awards calculated at the two participation levels. C. A participant whose employment ends prior to December 31st of a Plan Year due to retirement, disability, death, or disposition of part of the business, or who is transferred to an ineligible position prior to December 31st of a Plan Year, may be eligible for a pro-rated annual award for that Plan year, determined by the number of full weeks of employment in an eligible position, upon approval by the CEO. D. A participant whose employment terminates prior to December 31st of a Plan Year for reasons other than those listed in C above will not be eligible for any award for that Plan Year. E. A participant whose employment terminates after December 31st of a Plan Year, but prior to the payment of awards, may be eligible for an award for that Plan Year upon approval by the CEO. F. A participant who is on an approved unpaid leave of absence during a Plan Year may be eligible for a pro-rated award for that Plan Year upon approval by the CEO. A participant who is on an approved paid medical leave of absence during a Plan Year may be eligible for either a pro-rated or full award for that Plan Year upon approval by the CEO. G. Increase or decrease in deferral values during any period when an employee is on leave of absence (paid or unpaid) maybe adjusted at the CEO's sole discretion. H. Wherever in this Plan the CEO is given the authority to approve a participant's eligibility for a full or partial award, or to approve the pay out of any matured deferral increment, such approvals may be made at his sole discretion. VIII. GENERAL PROVISIONS A. This Plan does not guarantee, explicitly or implicitly, the right to continued employment for participants. B. MIP awards will be pensionable earnings under the 1989 pension plan. Legislation in effect at the time the award is approved will govern how much of the MIP awards are pensionable or non-pensionable earnings. Awards will be included in pensionable earnings in the year they are paid. C. This Plan can be terminated or its provisions changed at any time by the Compensation Committee of the Board of Directors acting upon the recommendation of the CEO. Page 5 of 6 1996 Management Incentive Plan XI. APPENDIX - SPECIAL RETENTION BONUS On March 11, 1996 a Special Retention Bonus for MIP participants was approved by the Compensation Committee of the Board of Directors. If the respective corporate performance goals adopted for 1996 are not met such that the plan participants are not entitled to receive a MIP bonus, a special retention bonus equal to twenty-five percent (25%) of the target bonus for each plan participant will be guaranteed. Such guaranteed retention bonus will be paid out in two equal installments on February 1, 1997 and February 1, 1998 provided the participant remains an active employee on each of those dates. These awards will not be subject to the provisions in the MIP plan with respect to deferral of twenty percent (20%) of each award. Page 6 of 6 EX-10.15B 7 FIRST AMENDMENT TO CHANGE EXHIBIT 10.15(b) FIRST AMENDMENT TO CHANGE IN CONTROL AGREEMENT OF REID JOHNSON AMENDMENT dated as of December 3, 1996 to the Change in Control Agreement (the "Change in Control Agreement") dated as of November 27, 1995, by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporation, a Delaware corporation (the "Parent") and Reid Johnson of Eden Prairie, Minnesota (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Change in Control Agreement in certain respects; NOW, THEREFORE, BE IT RESOLVED, that the Change of Control Agreement shall be amended as follows: Paragraph 1.02, definition of "Change of Control," subparagraph (a) is hereby amended by deleting the phrase "and are publicly traded on a recognized securities exchange." IN WITNESS WHEREOF, the undersigned have executed this First Amendment of Change in Control Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: \s\ Jack W. Eugster ------------------------------------- Jack W. Eugster Its: Chairman and CEO MUSICLAND STORES CORPORATION By: \s\ Jack W. Eugster ------------------------------------- Jack W. Eugster Its: Chairman and CEO EXECUTIVE \s\ Reid Johnson ---------------------------------------- Reid Johnson EX-10.16B 8 AMENDMENT TO CHANGE IN CONTROL AGMT OF K. BENSON EXHIBIT 10.16(b) AMENDMENT TO CHANGE OF CONTROL AGREEMENT OF KEITH A. BENSON AMENDMENT dated as of December 3, 1996 to the Change of Control Agreement (the "Change of Control Agreement" formerly titled Employment Agreement) dated as of August 25, 1988, by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporation, a Delaware corporation (the "Parent") and Keith A. Benson (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Change of Control Agreement in certain respects; NOW, THEREFORE, BE IT RESOLVED, that the Change of Control Agreement shall be amended as follows: 1. Section 1, OPERATION OF AGREEMENT, is amended by deleting the words "prior to September 1, 1991" in clause (i) of subparagraph (a) of Paragraph 1.01, by deleting clause (ii) of subparagraph (a) of Paragraph 1.01 and deleting the last sentence of 1.01(a) and inserting this sentence in its place: Upon the date of a change of control, this Agreement shall become operative immediately." and by deleting subparagraph (b) of Paragraph 1.01. 2. Paragraph 1.02, "Change of Control", subparagraph (a) the definition "Change of Control" is amended by deleting the phrase "and are publicly traded on a recognized securities exchange." and by deleting "30%" and inserting in its place "20%". 3. Paragraph 1.02, "Change in Control" is amended by deleting subparagraph (b) thereof and inserting in its place the following new subparagraph (b): "(b) a majority of the directors of the Company or the Parent are persons other than persons (i) for whose election proxies have been solicited by the Board of Directors of the Company or the Parent, or (ii) who are then serving as directors appointed by the Board of Directors of the Company or the Parent to fill vacancies on the applicable Board of Directors caused by death or resignation (but not by removal) or to fill newly-created directorships, but excluding for purposes of this clause (ii) any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Securities Exchange Act of 1934) or other actual or threatened solicitation of proxies or consents, or" 4. Paragraph 1.03 of Section 1 is amended by deleting the phrase "or within 30 days of the date Eugster is terminated within the meaning of clause (ii) of subparagraph 1.01(a), whichever is later," 5. Paragraph 2.01 of Section 2, EMPLOYMENT; PERIOD OF EMPLOYMENT, is amended by inserting, after the word, "subsidiary" the words "or affiliate." 6. Paragraph 2.02 of Section 2, EMPLOYMENT; PERIOD OF EMPLOYMENT, is amended by deleting "36th" and inserting in its place "24th," by deleting "24th" and inserting in its place "12th," and by deleting "18th" and inserting in its place "6th." 7. Paragraph 3.01 of Section 3, POSITION, DUTIES, RESPONSIBILITIES, is amended by deleting the title "Executive Vice President and Chief Financial Officer" in both places that it appears in subparagraph (a) thereof, and inserting in said places the title "President, Mall Stores Division." 8. Paragraph 4.01 of Section 4, COMPENSATION, COMPENSATION PLANS, PERQUISITES, is amended by deleting the salary of "$170,000" in clause (i) thereof and inserting in its place "$308,700"; and by deleting "30%" in clause (ii) thereof and inserting in its place "35%." 9. Paragraph 8.02 of Section 8, TERMINATION, is amended by deleting "30%" in subparagraph (b) thereof and inserting in its place "35%." 10. Paragraph 8.03 of Section 8, "TERMINATION" subparagraph 8.03(b)(ii) is hereby deleted, in its entirety, and is no longer of any force or effect. 11. Subparagraph 8.03(iii) is amended by deleting the words "clauses (i) and (ii)" and inserting in its place "clause (i)." 12. Paragraph 10.01 of Section 10, MINIMUM SEVERANCE PAYMENT, is amended by deleting in the first and last sentences of the first paragraph of this section the number "24" and inserting in both places the number "12." 13. Paragraph 10.01 is further amended by deleting subparagraph (ii)(C) of the definition of "Severance Period" in its entirety and is no longer of any force or effect. 14. Section 11, REDUCTION FOR EQUITY APPRECIATION, is hereby deleted in its entirety and is no longer of any force or effect. 15. Paragraph 12.02 of Section 12, JOINT AND SEVERAL LIABILITY; TRUST AGREEMENT, relating to establishment of a trust, is amended by adding the following words at the end of that paragraph: "; provided, however, that Executive may request that such trust be established at any time on or after the date a Change in Control occurs and prior to the date all amounts to which Executive is or may become entitled from such trust have been paid to Executive." IN WITNESS WHEREOF, the undersigned have executed this Amendment of Change of Control Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: /s/ Jack W. Eugster ------------------------------------- Its: Jack W. Eugster, Chairman & CEO MUSICLAND STORES CORPORATION By: /s/ Jack W. Eugster ------------------------------------- Its: Jack W. Eugster, Chairman & CEO EXECUTIVE /s/ Keith A. Benson ---------------------------------------- Keith A. Benson EX-10.16C 9 AMENDMENT TO CHANGE IN CONTROL AGMT W/ G. ROSS EXHIBIT 10.16(c) AMENDMENT TO CHANGE OF CONTROL AGREEMENT OF GARY A. ROSS AMENDMENT dated as of December 3, 1996 to the Change of Control Agreement (the "Change of Control Agreement" formerly titled Employment Agreement) dated as of August 25, 1988, by and among The Musicland Group, Inc., a Delaware corporation (the "Company"), Musicland Stores Corporation, a Delaware corporation (the "Parent") and Gary A. Ross (the "Executive"). WHEREAS, the Board of Directors, on behalf of the Company and the Parent, and the Executive have determined it to be in their mutual best interests to amend the Change of Control Agreement in certain respects; NOW, THEREFORE, BE IT RESOLVED, that the Change of Control Agreement shall be amended as follows: 1. Section 1, OPERATION OF AGREEMENT, is amended by deleting the words "prior to September 1, 1991" in clause (i) of subparagraph (a) of Paragraph 1.01, by deleting clause (ii) of subparagraph (a) of Paragraph 1.01 and deleting the last sentence of 1.01(a) and inserting this sentence in its place: Upon the date of a change of control, this Agreement shall become operative immediately." and by deleting subparagraph (b) of Paragraph 1.01. 2. Paragraph 1.02, "Change of Control", subparagraph (a) the definition "Change of Control" is amended by deleting the phrase "and are publicly traded on a recognized securities exchange." and by deleting "30%" and inserting in its place "20%". 3. Paragraph 1.02, "Change in Control" is amended by deleting subparagraph (b) thereof and inserting in its place the following new subparagraph (b): "(b) a majority of the directors of the Company or the Parent are persons other than persons (i) for whose election proxies have been solicited by the Board of Directors of the Company or the Parent, or (ii) who are then serving as directors appointed by the Board of Directors of the Company or the Parent to fill vacancies on the applicable Board of Directors caused by death or resignation (but not by removal) or to fill newly-created directorships, but excluding for purposes of this clause (ii) any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Securities Exchange Act of 1934) or other actual or threatened solicitation of proxies or consents, or" 4. Paragraph 1.03 of Section 1 is amended by deleting the phrase "or within 30 days of the date Eugster is terminated within the meaning of clause (ii) of subparagraph 1.01(a), whichever is later," 5. Paragraph 2.01 of Section 2, EMPLOYMENT; PERIOD OF EMPLOYMENT, is amended by inserting, after the word, "subsidiary" the words "or affiliate". 6. Paragraph 2.02 of Section 2, EMPLOYMENT; PERIOD OF EMPLOYMENT, is amended by deleting "36th" and inserting in its place "24th," by deleting "24th" and inserting in its place "12th," and by deleting "18th" and inserting in its place "6th." 7. Paragraph 3.01 of Section 3, POSITION, DUTIES, RESPONSIBILITIES, is amended by deleting the title "Executive Vice President of Marketing and Merchandising" in both places that it appears in subparagraph (a) thereof, and inserting in said places the title "President, Superstores Division." 8. Paragraph 4.01 of Section 4, COMPENSATION, COMPENSATION PLANS, PERQUISITES, is amended by deleting the salary of "$195,000" in clause (i) thereof and inserting in its place "$316,340"; and by deleting "30%" in clause (ii) thereof and inserting in its place "35%." 9. Paragraph 8.02 of Section 8, TERMINATION, is amended by deleting "30%" in subparagraph (b) thereof and inserting in its place "35%." 10. Paragraph 8.03 of Section 8, "TERMINATION" subparagraph 8.03(b)(ii) is hereby deleted, in its entirety, and is no longer of any force or effect. 11. Subparagraph 8.03(iii) is amended by deleting the words "clauses (i) and (ii)" and inserting in its place "clause (i)." 12. Paragraph 10.01 of Section 10, MINIMUM SEVERANCE PAYMENT, is amended by deleting in the first and last sentences of the first paragraph of this section the number "24" and inserting in both places the number "12." 13. Paragraph 10.01 is further amended by deleting subparagraph (ii)(C) of the definition of "Severance Period" in its entirety and is no longer of any force or effect. 14. Section 11, REDUCTION FOR EQUITY APPRECIATION, is hereby deleted in its entirety and is no longer of any force or effect. 15. Paragraph 12.02 of Section 12, JOINT AND SEVERAL LIABILITY; TRUST AGREEMENT, relating to establishment of a trust, is amended by adding the following words at the end of that paragraph: "; provided, however, that Executive may request that such trust be established at any time on or after the date a Change in Control occurs and prior to the date all amounts to which Executive is or may become entitled from such trust have been paid to Executive." IN WITNESS WHEREOF, the undersigned have executed this Amendment of Change of Control Agreement as of the date set forth above. THE MUSICLAND GROUP, INC. By: /s/ Jack W. Eugster ------------------------------------- Its: Jack W. Eugster, Chairman and CEO MUSICLAND STORES CORPORATION By: /s/ Jack W. Eugster ------------------------------------- Its: Jack W. Eugster, Chairman and CEO EXECUTIVE /s/ Gary A. Ross ------------------------------------- Gary A. Ross EX-10.17 10 EXECUTIVE SEVERENCE AGREEMENT EXECUTIVE SEVERANCE AGREEMENT This Agreement, dated as of July 17, 1996, is among THE MUSICLAND GROUP, INC. and its wholly-owned subsidiary, MUSICLAND RETAIL, INC., Delaware corporations (collectively referred to herein as the "Company"), and GILBERT L. WACHSMAN (the "Executive"). WITNESSETH WHEREAS, the Company wishes to be assured of the services of Executive for the period provided in this Agreement; and WHEREAS, Executive desires to serve in the employ of the Company on a full-time basis for a period provided in the Agreement as Vice Chairman, and upon the terms and conditions hereafter provided; NOW, THEREFORE, in consideration of the premises and of the respective representations and warranties set forth and of the mutual covenants herein contained, the parties hereby agree as follow: 1. EMPLOYMENT. The Company agrees to employ Executive, and Executive agrees to enter the employ of the Company, upon the terms and conditions provided herein. 2. TERM. Executive's employment under this Agreement shall be for a period of sixty (60) full months, beginning July 17, 1996, and shall end on July 31, 2001. The Company shall have the right to extend this Agreement for one or more additional successive one year terms by giving written notice of such extension to Executive at least three months prior to the expiration of the then current term. 3. POSITION. During the period of his employment hereunder, Executive shall be employed in the position of Vice Chairman, or in such other executive officer capacity as the Board of Directors of the Company may from time to time determine, and shall perform such services for the Company and for any parent, subsidiary or affiliate of the Company when and as directed by the Chairman and Chief Executive Officer of the Company. 1 4. SERVICES AND DUTIES. Executive shall devote substantially all of his time during normal business hours, attention, skill and efforts to the faithful performance of his duties as the Vice Chairman. Executive's primary job responsibilities shall include, but not be limited to: merchandising, buying, inventory management, advertising and distribution. Such responsibilities may be altered as the business needs of the Company require. Executive shall also sit as a member of the Executive Committee. The expenditure of reasonable amounts of time by the Executive for personal, charitable and professional activities shall not be deemed a breach of this Agreement, provided such activities do not materially interfere with the services required to be rendered by Executive under this Agreement, do not involve any conflict of interest (or the appearance of a conflict of interest), and are not contrary to the business or other interests of the Company or the Parent. 5. OBLIGATION OF LOYALTY TO THE COMPANY A. During the term of this Agreement and while employed by the Company, Executive agrees that he will not: (1) Make any statement or perform any act intended to advance an interest of any existing or prospective competitor of the Company in any way or that will or may injure the Company in its relationship and dealings with any existing or potential, supplier or creditor; (2) Solicit or encourage any other officer or employee of the Company to do any act that is disloyal to the Company, or inconsistent with the Company's interests or in violation of any provision of this Agreement; (3) Solicit any other officer or employee to participate in or assist with the formation or operation of any business intended to compete with the Company or with respect to the possible future employment of such other executive by any such business; (4) Inform any existing or potential customer, supplier or creditor of the Company that Executive intends to resign; or make any statement or do any act intended to cause any existing or potential customer, supplier or creditor of the Company to learn of Executive's intention to resign; 2 (5) Discuss with any existing or potential customer, supplier or creditor of the Company the present or future availability of services or products provided by a business that competes with services or products that the Company provides. B. If Executive during his employment with the Company has or expects to acquire a proprietary interest in, or is or expects to be made an owner, agent, consultant, executive, officer or director of, any existing or future business that provides or may provide services or products in competition with the Company, Executive agrees that he will furnish immediately to the Company all information that may reasonably be of assistance to the Company in protecting its relationships with any existing or potential customer, supplier or creditor with whom Executive may have had dealings on behalf of the Company. 6. COMPENSATION. As compensation for all services rendered by Executive under this Agreement, Executive shall be paid as follows: A. SALARY. As a minimum the Executive shall be paid the fixed base salary which was agreed to by the parties upon his hiring, said annual salary to be paid in twenty-six (26) bi-weekly installments and subject to such periodic merit increases as the Company shall deem appropriate in accordance with the Company's customary procedures and practices applicable to other similarly situated executives (the "Base Salary"). Such periodic increases, once granted, shall not be subject to revocation except pursuant to a program of salary reductions applicable to the Company's executive officers generally. B. INCENTIVE COMPENSATION. (1) Executive shall participate in the Company's Management Incentive Plan at a "target" level of 40% of Base Salary. (2) Executive shall be considered by the Compensation Committee along with other executive officers for selection of stock option awards pursuant to the Company's stock option plans. 3 (3) Executive shall be eligible to participate in The Musicland Group Capital Accumulation Plan (KSOP) upon meeting said plan's service requirements. (4) Executive may participate in successor or additional plans of the Company which may be adopted by the Company in it's sole discretion for the benefit of Company officers generally. (5) Nothing in this Agreement shall preclude any amendment or termination by the Company of any benefit plan, provided that such amendment or termination is applicable to all of the Company's executive officers generally. C. FRINGE BENEFITS. Executive shall participate in the full executive benefits package, as modified from time to time at the Company's sole discretion, including: (1) death benefit plans consisting of group life insurance and accidental death and dismemberment insurance; (2) disability benefit plans consisting of short-term salary continuation, short-term disability and long-term disability plans; (3) senior officer medical, dental, health and welfare plans; (4) senior officer leased car or car allowance (reviewed annually); (5) paid vacation, holidays and other leave pursuant to the Company's policies and practices; (6) all other fringe benefits and perquisites which the Company may in its sole discretion make available to its officers generally, provided that nothing in this Agreement shall preclude any amendment or termination by the Company of any insurance plans, fringe benefits or perquisites provided that such amendment or termination is applicable to all of the Company's executive officers generally. 4 7. BUSINESS RELATED EXPENSE. Executive shall be entitled to reimbursement of actual out-of-pocket expenses incurred in the conduct of the Company's business, which shall be limited to ordinary and necessary items, and which shall be supported by vouchers, receipts, or similar documentation in accordance with such procedures as the Company may from time to time establish. 8. DISABILITY. A. In the event the Executive becomes disabled, as such term is defined in the Company's then current disability benefit plans, the obligation of the Company to make salary payments pursuant to this Agreement shall cease as of the date the Executive begins receiving benefits under such disability plans. B. If the Executive is unable to perform the essential functions of his position, with or without reasonable accommodation, for six consecutive months, or for an aggregate of 180 days during nine consecutive months, this Agreement shall terminate as of the expiration date of such six-month period or the completion of the aggregation of such 180 days, as the case may be. 9. DEATH. If the Executive dies while this Agreement is in effect, this Agreement shall terminate as of the date of death. After payment of all amounts accrued to the Executive hereunder through the date of death, the Company shall have no obligation to make any further payments under this Agreement with the exception of any benefits payable under the Company's then current death benefit plans and any vested benefits the Executive may have under the Company's qualified benefit plans. 10. TERMINATION OF EMPLOYMENT BY THE COMPANY. A. This Agreement and the Executive's employment hereunder may be terminated by the Company upon not less than 30 days' notice for "Cause" as defined herein. After payment of all amounts accrued to the Executive hereunder through the date of such notice, the Company will have no further obligation to the Executive hereunder except any vested benefits the Executive may have under the Company's qualified benefit plans. B. Termination shall be deemed to have been for Cause if: 5 (1) Executive is convicted of or admits to committing a felony or any crime involving moral turpitude, or any other criminal activity or unethical conduct which, in the good faith opinion of the Company, would impair Executive's ability to perform his duties hereunder or would impair the business reputation of the Company; (2) Executive commits an intentional act of dishonesty or an act resulting in or intended to result directly or indirectly in gain to or personal enrichment of the Executive at the Company's expense; (3) Executive refuses or is unable (except by reason of incapacity due to illness, accident or disability) to comply with his obligations under this Agreement to devote his time and attention to the affairs of the Company or commits any other material breach of this Agreement, and the Executive shall have either failed to remedy such alleged breach within thirty (30) days from his receipt of written notice from the Secretary of the Company demanding that he remedy such alleged breach, or shall have failed to take all reasonable steps to that end during such thirty-day period and thereafter; or (4) There has been a determination by the Chief Executive Officer or an affirmative vote of at least a majority of the Company's entire Board of Directors (other than the Executive if also a director) at a meeting called and held for that purpose and at which the Executive is given an opportunity to be heard, that, in the judgment of the Chief Executive Officer or the Board, the Executive has over an extended period of time consistently failed to satisfactorily perform the material duties of his office assigned to him, and such failure has had an adverse impact upon the Company, provided that such determination may be made only after a period of at least ninety (90) days following the last of two formal reviews (which are at least six months apart) of the Executive's performance by the Chief Executive Officer at which the Executive shall be informed of the most significant deficiencies and during such ninety-day period the Executive shall have failed to correct, or failed to take all reasonable steps to correct, such significant deficiencies. 6 C. Anything herein to the contrary notwithstanding, termination of the employment of the Executive shall not be considered to have been for Cause if such termination took place as a result of (i) bad judgment or negligence (but not gross negligence) on the part of the Executive, (ii) an act or omission without intent of gaining therefrom directly of indirectly a profit or other benefit to which the Executive was not legally entitled, or (iii) an act or omission believed by the Executive in good faith to have been in, or at least not opposed to, the best interests of the Company and consistent with reasonable business practices. D. If the Executive's employment is terminated by the Company, while this Agreement is in effect for any reason other than for Cause, then Executive shall be due the severance payments described in Paragraph 12 below. 11. TERMINATION OF EMPLOYMENT BY THE EXECUTIVE. A. Executive may terminate his employment at any time and for any reason by giving written notice to the Company. Executive's employment and this Agreement shall terminate effective on the date specified in such notice or upon such earlier date as the Company may specify in a written notice given to the Executive. After payment of all amounts accrued to the Executive hereunder through the date of such notice (and unless subparagraph B below applies), the Company will have no further obligation to the Executive hereunder except any vested benefits the Executive may have under the Company's qualified benefit plans. B. If Executive determines in good faith that the nature and quality of the authorities, powers, functions, duties or responsibilities assigned to him are substantially and materially less than the nature and quality of the authorities, powers, functions, duties or responsibilities generally of executive vice presidents of the Company, which shall be deemed a continuing breach of this Agreement, or that the Company has committed any other material breach of the terms of this Agreement, Executive may terminate his employment for "Good Reason" by setting forth the reason for such termination in a written notice to the Company. Except in the case of a continuing breach, such notice must be received by the Company within thirty (30) days after the event giving rise to the 7 material breach. Unless the Company disputes the Executive's determination of Good Reason or cures the breach within thirty (30) days after receipt of such notice, this Agreement and the Executive's employment shall terminate at the end of the thirty-day period, or upon such earlier date as the Company may specify, and the Executive shall be due the severance payments described in Paragraph 12 below. If the Company disputes the Executive's determination of Good Reason, the matter shall be settled by arbitration pursuant to Paragraph 15 hereof. 12. SEVERANCE. In the event, while this Agreement is in effect, the Executive's employment is terminated by the Company for any reason other than Cause or by the Executive for Good Reason, the Company will pay executive the following as liquidated damages or severance pay, or both: A. Executive's Base Salary will continue to be paid in bi-weekly installments for a period of twelve (12) months following the date of termination of the Executive's employment, provided that in the event the termination occurs prior to July 17, 1997, Base Salary will be continued for such additional period so that the total Base Salary paid to the Executive both before and after the termination of employment aggregates to twenty-four (24) months. The applicable period during which Base Salary is continued shall be deemed the "Severance Period." B. For the calendar year in which termination occurred and for each subsequent calendar year (or portion thereof) in the Severance Period, in full substitution for Executive's rights under the Company's Management Incentive Plan, the Executive will be entitled to a substitute incentive award (pro-rated for any partial year) equal to 40% of the Executive's weighted average Base Salary for the twelve (12) months immediately preceding the date of termination. The substitute incentive award for the calendar year in which termination occurred shall be paid in a lump sum on the first day of February following such calendar year. The substitute incentive award for the remainder of the Severance Period shall be paid in a lump sum on last day of the Severance Period. C. Except for continuation rights under COBRA and any vested benefits under the Company's qualified plans, all other benefits and perquisites shall cease as of the termination of the Executive's employment. 8 13. CONFIDENTIAL INFORMATION. Executive agrees that he will not, during the period of his employment hereunder, or at any time thereafter, disclose to any unauthorized person, firm or corporation any trade secrets or confidential information relating to the Company, its subsidiaries or affiliates, or to any of the businesses operated by them; and Executive confirms that such information constitutes the exclusive property of the Company. For the purposes of this Agreement, the term "Confidential Information" shall mean information of any nature and in any form which at the time concerned is not generally known to those persons engaged in business similar to that conducted or contemplated by the Company. Executive shall return all tangible evidence of such Confidential Information to the Company anytime upon the Company's request or at the termination of Executive's employment. 14. INDEMNIFICATION. The Company will indemnify the Executive (and his legal representatives or other successors) to the fullest extent permitted (including payment of expenses in advance of final disposition of a proceeding) by the laws of the State of Delaware and the Restated Certificate of Incorporation and By-Laws of the Company, as in effect at the time of the subject act or omission. Executive shall also be entitled to the protection of any insurance policies the Company, in its sole discretion, may elect to maintain generally for the benefit of its directors and officers. The Executive shall be covered by any such policies in accordance with their terms to the maximum extent of the coverage available for any Company officer or director. The foregoing obligations of the Company to indemnify Executive shall survive the termination of this Agreement (whether such termination is by the Company, by the Executive, upon expiration or otherwise). 15. JOINT AND SEVERAL LIABILITY. All obligations and liabilities of the Company under this Agreement shall be the joint and several liability of The Musicland Group, Inc. and Musicland Retail, Inc. 16. REMEDY FOR BREACH. Executive understands that a breach of any one or more of the covenants contained herein will result in irreparable and continuing damage to the Company for which there will be no adequate remedy at law, and, in the event of any breach or threatened breach of Executive's obligations hereunder, the Company may in addition to any other remedies which may be 9 available to it (i) declare forfeited any sums representing accrued salary, other fringe benefits or severance otherwise due and payable to Executive, and, or alternatively, (ii) file suit to enjoin Executive from the breach or threatened breach of such covenants. 17. ARBITRATION. Any dispute or controversy arising under or in connection with this Agreement, or the breach thereof, or the termination of the employment relationship (including, without limitation, any claims of unlawful discrimination, harassment or wrongful discharge) shall be settled exclusively by binding arbitration in Minneapolis, Minnesota, in accordance with the Employment Dispute Resolution Rules of the American Arbitration Association then in effect. The arbitrator shall be an attorney with experience in employment disputes and shall be empowered to award counsel fees and expenses to the prevailing party. Judgment may be entered on the arbitration award in any court having jurisdiction. 18. CHOICE OF LAW. The validity of this Agreement, the construction of its terms and the determination of the rights and duties of the parties hereto shall be governed by and construed in accordance with the laws of the State of Minnesota. 19. WAIVER. The failure of either party to enforce any rights hereunder shall not be deemed to be a waiver of such rights, unless such waiver is an express written waiver which has been signed by the waiving party. Waiver of any one breach shall not be deemed to be a waiver of any other breach of the same or any other provision hereof. 20. AMENDMENTS. This Agreement may be amended or modified at any time in all respects, but only by an instrument in writing agreed upon and executed by or on behalf of the party against whom any amendment, waiver, change, modification or discharge is sought. Each party waives the future right to contend that this Agreement was modified by an oral agreement or waiver or course of conduct. 21. NOTICES. Any notice, communication, request, reply or advice given hereunder by either party to the other shall be in writing and may be effected by personal delivery or by certified mail postage prepaid with return receipt requested and addressed as follows: 10 If to the Company, to: Musicland Stores Corporation Attn: General Counsel and Secretary 10400 Yellow Circle Drive Minnetonka, Minnesota 55434 If to Executive, to: Gilbert L. Wachsman ------------------- ------------------- With a copy to: ------------------- ------------------- ------------------- or at such other address as either party may notify the other from time to time. Notices delivered personally shall be deemed given on actual receipt, and mailed notices shall be deemed given three (3) days after mailing by certified mail, return receipt requested. 22. SEVERABILITY. Each provision of this Agreement is intended to be severable. In the event that any one or more of the provisions contained in this Agreement shall be for any reason held to be invalid, illegal or unenforceable the same shall not affect the validity or enforceability of any other provision of this Agreement, but this Agreement shall be construed as if such invalid, illegal or unenforceable provisions had never been contained herein. 23. ASSIGNABILITY. Executive shall not assign or transfer any of his rights or obligations under this Agreement. Subject to the foregoing sentence, the rights and obligations of the parties shall inure to the benefit of and be binding upon their successors in interest, legal representatives and assigns. 25. ENTIRE AGREEMENT. This Agreement contains the entire agreement between the Company and Executive with respect to the subject matter contained herein. The parties rely on no representations or inducements not stated herein or in other written agreements between the parties. 11 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the day and year first above written. MUSICLAND RETAIL, INC. By-------------------- Jack W. Eugster Chief Executive Officer MUSICLAND STORES CORPORATION By-------------------- Jack W. Eugster Chief Executive Officer EXECUTIVE: ---------------------- GILBERT L. WACHSMAN 12 EX-10.18 11 LONG TERM INCENTIVE PLAN EXHIBIT 10.18 THE MUSICLAND GROUP LONG TERM INCENTIVE PLAN JANUARY 1, 1996 I. PURPOSE The Long Term Incentive Plan (the "Plan") is designed to reward participants who over time make significant contributions to the success of The Musicland Group (the "Company"). The Plan recognizes the importance of individual contributions to Company performance. II. ADMINISTRATION The Plan is administered by the Compensation Committee of the Company's Board of Directors (the "Compensation Committee"). In the absence of a designated Compensation Committee, the Board as a whole will act as the Compensation Committee. The Chief Executive Officer of the Company (the "CEO") shall make recommendations to the Compensation Committee regarding participation, level of awards, changes to the Plan, annual funding percentages, and other aspects of the Plan's administration. The Compensation Committee has the authority to interpret the Plan, and, subject to the Plan's provisions, to make and amend rules and to make all other decisions necessary for the Plan's administration. The Plan period will run from January 1, 1996 through the December 31, 1998 (the "Plan Period"). III. PARTICIPATION Participation is limited to members of the Executive Committee. All eligible participants will be given a copy of this Plan as well as the funding for their participation level. IV. INCENTIVE COMPENSATION MEASURES At the beginning of the Plan Period the Compensation Committee will approve the annual business goals as well as the performance range above and below such goals, and the amount of award at each level of business performance. Each year during the Performance Period represents a separate bonus opportunity. Failure to achieve performance goals in any given year does not prevent the participant from earning an award in any subsequent year provided the Company achieves the pre-established performance goals for that performance year. Actual business results for each year of the Plan Period and their relation to such pre-established ranges shall determine the amounts, if any, of awards to designated participants. The actual business results will be provided by the Chief Financial Officer. The Compensation Committee may approve adjustments to actual business results to reflect organizational, operational, or other changes which have occurred during the year, Page 1 of 3 e.g., acquisitions, dispositions, expansions, contractions, material non-recurring items of income or loss, or events which might create unwarranted hardships or windfalls to participants. If Company performance, as adjusted by the Compensation Committee when appropriate, falls within the pre-established performance ranges, participants earn the award for that year. Each earned award is restricted from payment for one year. For example, an award earned for 1996 is restricted from payment until January, 1998 and is subject to the terms of the plan. One specific condition of the plan is that the participant remains actively employed with the company through the restriction period and until such time as the award is paid. Participants who terminate employment for any reason, except as may be defined in a separate executed Employment Contract or Change of Control Agreement, forfeit any and all unpaid awards. V. PAYMENT OF AWARDS 1. Each year during the Performance Period has separate performance goals. If the company achieves performance which is within the established performance range, participants earn the corresponding award for that one year period. Awards are determined as a percentage of base earnings for the year in which they are earned and are restricted from payment for one calendar year. 2. Awards are paid in cash, less applicable tax and FICA withholdings, during January, after one calendar year following the end of the year in which the award was earned. VI. AWARD CONDITIONS A. Employees hired or promoted into eligible positions on or before September 30th of the Plan Period will be eligible to participate in the Plan. Employees hired or promoted into eligible positions after September 30th may be eligible to participate upon approval by the Compensation Committee. In both cases, participation for the year in which the employee becomes eligible will be on a pro-rated basis, determined by the number of full weeks of employment in an eligible position. B. A participant who is promoted, at any time other than at the beginning of a Plan Year, into a position which calls for a higher participation level will be eligible to receive an award for that Plan Year which is a combination of pro-rated awards calculated at the two participation levels. C. A participant whose employment ends prior to December 31st of a Plan Year due to retirement at age 55 or over, disability, death, or disposition of part of the business, or who is transferred to an ineligible position prior to December 31st of a Plan Year, may be eligible for a pro-rated annual award for that Plan year, Page 2 of 3 determined by the number of full weeks of employment in an eligible position, upon approval by the Compensation Committee. D. A participant whose employment terminates prior to December 31st of a Plan Year for reasons other than those listed in C above will not be eligible for any award for that Plan Year except as may be defined in a separate executed Employment Contract or Change of Control Agreement. E. A participant whose employment terminates after December 31st of a Plan Year, but prior to the payment of awards, may be eligible for an award for that Plan Year upon approval of the Compensation Committee. F. A participant who is on an approved unpaid leave of absence during a Plan Year may be eligible for a pro-rated award for that Plan Year upon approval by the Compensation Committee. A participant who is on an approved paid medical leave of absence during a Plan Year may be eligible for either a pro-rated or full award for that Plan Year also upon approval by the Compensation Committee . G. Wherever in this Plan the Compensation Committee is given the authority to approve a participant's eligibility for a full or partial award, or to approve the pay out of any matured deferral increment, such approvals may be made at its sole discretion. VIII. GENERAL PROVISIONS A. This Plan does not guarantee, explicitly or implicitly, the right to continued employment for participants. B. This Plan can be terminated or its provisions changed at any time by the Compensation Committee of the Board of Directors. Page 3 of 3 EX-10.19 12 EXECUTIVE OFFICER SHORT TERM INCENTIVE PLAN EXHIBIT 10.19 THE MUSICLAND GROUP 1996 EXECUTIVE OFFICER SHORT TERM INCENTIVE PLAN I. PURPOSE The 1996 Executive Officer Short Term Incentive Plan (the "Plan") is designed to incent the Executive Officers of The Musicland Group, Inc. (the "Company") to extraordinary performance during a particularly critical period for the Company by allowing these officers to earn a special bonus based upon aggressive earnings targets for the Company. II. TERM This Plan covers the fourth quarter of 1996 (October 1 - December 31, 1996) (the "Fourth Quarter") and the first quarter of 1997 (January 1 - March 31, 1997) (the "First Quarter"). III. ADMINISTRATION This Plan is administered by the Compensation Committee of the Company's Board of Directors (the "Compensation Committee"). IV. PARTICIPATION Participation in this Plan is limited to those officers who were designated by the Board of Directors as the Executive Officers of the Company on October 28, 1996 (the "Participants"). V. BONUS AWARDS Participants are eligible to earn an award for each quarter of the Plan period independently. If the threshold target for the quarter is met, participants will earn a bonus equal to 10% of their base salary. If the maximum target for the quarter is met or exceeded, participants will earn a bonus equal to 15% of their base salary. If Company performance falls between the threshold and maximum, the percentage of base salary earned will be interpolated between 10% and 15% on a straight line basis. Bonuses, if earned, will be paid out in a lump sum one week after the Company's books are closed for the applicable quarter. VI. TARGET COMPANY PERFORMANCE LEVELS Target levels for Company performance will be based upon the Company's earnings (or loss) before interest, taxes, depreciation and amortization but after taking into account payment of bonuses under this Plan ("EBITDA"), as follows: Threshold EBITDA Maximum EBITDA ---------------- ---------------- Fourth Quarter $70 million $77.5 million First Quarter ($5.5 million) ($2.9 million) VII. PLAN CONDITIONS A. Generally, Participants must be employed by the Company on the last day of the applicable quarter to be eligible to receive an award for that quarter. Participants whose employment terminates prior to the end of a quarter may receive a pro-rated award for that quarter in the sole discretion of the Compensation Committee, taking into account the reason for termination and the Participant's contribution to the Company's performance for the quarter. B. This Plan doe not guarantee, explicitly or implicitly, the right to continued employment for Participants. C. Awards under this Plan will be pensionable earnings under the Company's defined benefit pension plan. Legislation in effect at the time the award is paid will govern how much of the award is pensionable or non-pensionable earnings. Awards will be included in pensionable earnings in the year they are paid. D. This Plan may be terminated or its provisions changed at any time by the Board of Directors. EX-23 13 EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated February 25, 1997, included in this form 10-K, into the Company's previously filed Registration Statements, File Nos. 33-50520, 35-50522, 33-50524, 33-82130 and 33-99146. ARTHUR ANDERSEN LLP Minneapolis, Minnesota, April 11, 1997 EX-27 14 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET OF MUSICLAND STORES CORPORATION AND SUBSIDIARIES AS OF DECEMBER 31, 1996, AND THE RELATED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR THEN ENDED, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 161,976 0 0 0 506,093 711,361 430,116 152,120 996,915 815,531 122,539 0 0 343 2,276 996,915 1,821,594 1,821,594 1,209,835 1,209,835 791,730 0 32,967 (212,938) (19,200) (193,738) 0 0 0 (193,738) (5.80) 0 INCLUDES RESTRUCTURING CHARGES OF $75,000 AND A WRITE-DOWN OF THE REMAINING GOODWILL BALANCE OF $95,253.
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