Item 1. BUSINESS
Handleman Company, a Michigan corporation (herein referred to as the "Company" or "Handleman" or "Registrant"), which has its executive office in Troy, Michigan, is the successor to a proprietorship formed in 1934, and to a partnership formed in 1937.
DESCRIPTION OF BUSINESS: - ------------------------
Handleman Company is engaged in the sale and distribution of music, video, book and personal computer software products primarily to mass merchants throughout the United States, Canada, Mexico, Argentina and Brazil. The operations of the Company are divided into three operating units: Handleman Entertainment Resources ("H.E.R."), North Coast Entertainment ("NCE") and Handleman International ("International"). The Company's H.E.R. and International operating units provide additional services as a category manager (rackjobber) to their accounts. The Company's H.E.R. division provides such products and services in the United States, while the International division provides such services in Canada, Mexico, Argentina and Brazil. NCE is in the business of acquiring or licensing video, music and software products, giving it exclusive rights to manufacture and distribute such products.
On June 2, 1998, Handleman's Board of Directors approved a comprehensive strategic repositioning program designed to focus on the Company's core music distribution business and product line. The repositioning program has four major components:
. Exiting the domestic video, book and software distribution and service operations.
. Sale of NCE's Sofsource software publishing subsidiary.
. Significant reduction of the number of customers serviced in the music business.
. Repurchase in the open market of up to $70 million of the outstanding common stock of the Company over 18 months. This repurchase program is subject to the realization of cash from asset sales and reduced working capital needs, as well as renegotiation of existing credit facilities.
During the first quarter of fiscal 1999, the Company sold its book distribution business and Sofsource, its software publishing subsidiary. The book distribution business was sold at approximately net book value and the Sofsource sale will generate a pre-tax gain in excess of $30 million.
In addition to the businesses being exited, the Company is reviewing its operations in Argentina, Brazil and Mexico to determine how best to maximize shareholder value from these entities. Decisions will be made with respect to each of these markets, and announced by the end of August 1998.
This repositioning program will result in a reduction of 900-1,000 positions (approximately 30% of the Company's total workforce). This reduction will occur predominantly in the H.E.R. division and the Troy corporate headquarters.
Handleman will operate NCE as a holding company. At this time there are no plans to divest any NCE businesses other than the completed sale of Sofsource.
See Note 3 of Notes to Consolidated Financial Statements, as well as Management's Discussion and Analysis of Financial Condition and Results of Operations, for additional information regarding the Company's repositioning program.
The following table sets forth net sales, and the approximate percentage contribution to consolidated sales, for the fiscal years ended May 2, 1998, May 3, 1997 and April 27, 1996, for the Company's three operating divisions:
Business Segments -----------------
The Company operates in one business segment, selling home entertainment software to mass merchants and also to specialty chain stores, drugstores and supermarkets. The Company has United States, Canadian, Mexican, Brazilian and Argentine operations. All operations outside of the U.S. are included in "Other" which is displayed separately below.
General -------
The Company's major business activity is to act as a link between manufacturers of home entertainment software products and mass merchant chain stores. Customers purchase from Handleman due to the value-added benefits the Company adds to the basic product, and due to the benefit of only dealing with one vendor for each product line. Manufacturers utilize the Company's services to avoid the necessity of distributing to thousands of individual stores throughout a vast geographic range.
Handleman Entertainment Resources and Handleman International -------------------------------------------------------------
The following discussion pertains to the category management (rackjobbing) activities of the H.E.R. and International divisions, which together comprise approximately 90% of the Company's sales.
Vendors
An important reason customers utilize H.E.R.'s and International's services is due to the multitude of manufacturers and suppliers offering products for-sale, the complexity of programs offered by those vendors, the "hits" nature of the business, and the high risk of inventory obsolescence.
The Company must anticipate consumer demand for individual titles. In order to maximize sales, the Company must be able to immediately react to "breakout" titles, while simultaneously minimizing inventory exposure for artists or titles which do not sell. In addition, because the Company distributes throughout vast geographic regions (U.S., Canada, Mexico, Argentina and Brazil) it must adapt selections it offers to local tastes. This is accomplished via a coordination of national and local purchasing responsibility, both monitored by inventory control programs.
The Company purchases from many different vendors. The volume of purchases from individual vendors fluctuates from year-to-year based upon the salability of selections being offered by such vendors. Though within each product line a small number of major, financially sound vendors account for a high percentage of purchases, product must be selected from a variety of additional vendors in order to maintain an adequate selection for consumers. The Company must closely monitor its inventory exposure and accounts payable balances with smaller vendors which may not have the financial resources to honor their return commitments.
Since the public's taste for the products the Company supplies is broad and varied, Handleman is required to maintain sufficient inventories to satisfy diverse tastes. The Company minimizes the effect of obsolescence through planned purchasing methods and computerized inventory controls. Since substantially all vendors from which the Company purchases product offer some level of return allowances and price protection, the Company's exposure to markdown risk is limited unless vendors are unable to fulfill their return obligations or non- saleable product purchases exceed vendor return limitations. Vendors offer a variety of return programs, ranging from 100% returns to zero return allowance. Other vendors offer incentive and penalty arrangements to restrict returns. Accordingly, the Company may possess in its inventories non-saleable product that can only be returned to vendors with cost penalties or may be non- returnable until the Company can comply with the provisions of the vendor's return policies.
Handleman generally does not have distribution contracts with manufacturers or suppliers; consequently, its relationships with them may be discontinued at any time by such manufacturers or suppliers, or by Handleman.
Customers - ---------
H.E.R.'s and International's customers utilize their services for a variety of reasons. Products must be selected from a multitude of vendors offering numerous titles, different formats (e.g., compact discs, cassettes) and different payment and return arrangements. As a result, customers avoid most of the risks inherent in product selection and the risk of inventory obsolescence.
H.E.R. and International also offer their customers a variety of "value-added" services:
Store Service: Sales representatives visit individual retail stores and meet with store management to discuss upcoming promotions, special merchandising efforts, department changes, current programs, or breaking releases which will increase sales. They also monitor inventory levels, check merchandise displays and install point-of-purchase advertising materials.
Advertising: Handleman supplies point-of-purchase materials and assists customers in preparing radio, television and print advertisements.
Fixturing: Handleman provides specially designed fixtures that emphasize product visibility and accessibility.
Freight: Handleman coordinates delivery of product to each store.
Product Exchange: Handleman protects its continuing customers against product markdowns by offering the privilege of exchanging slower-selling product for newer product.
The nature of the Company's business lends itself to computerized ordering, distribution and store inventory management techniques. The Company is able to tailor the inventories of individual stores to reflect the customer profile of each store and to adjust inventory levels, product mix and selections according to seasonal and current selling trends.
The Company determines the selections to be offered in its customers' retail stores, and ships these selections to the stores from one of its distribution centers. Slow-selling items are removed from the stores by the Company and are recycled for redistribution or return to the manufacturers. Returns from customer stores occur for a variety of reasons, including new releases which did not achieve their expected sales potential, ad product to be returned after the ad has run, regularly scheduled realignment pick-ups and customer directed returns. The Company provides a reserve for the gross profit margin impact of estimated customer returns.
During the fiscal year ended May 2, 1998 one customer, Kmart Corporation, accounted for approximately 33% of the Company's consolidated sales, while a second customer, Wal-Mart, accounted for approximately 32%. Handleman generally does not have contracts with its customers, and such relationships may be changed or discontinued at any time by the customers or Handleman; the discontinuance or a significant unfavorable change in the relationships with either of the two largest customers would have a materially adverse effect upon the Company's future sales and earnings.
Operations ----------
The Company distributes products from facilities in the U.S., Canada, Mexico, Brazil and Argentina. Besides economies of scale and through-put considerations in determining the number of facilities it operates, the Company must also consider freight costs to and from customers' stores and the importance of timely delivery of new releases. Due to the nature of the home entertainment software business, display of new releases close to authorized "street dates" is an important driver of both retail sales and customer satisfaction.
The Company also operates regional return centers in the United States and Canada as a means to expedite the processing of customer returns. In order to minimize inventory investment, customer returns must be sorted and identified for either redistribution or return to vendors as expeditiously as possible. An item returned from one store may be required for shipment to another store. Therefore, timely recycling prevents purchasing duplicate product for a store whose order could be filled from returns from other stores.
During fiscal 1996, the Company opened its second high-technology automated distribution center ("ADC") in Indianapolis, Indiana. The Company had previously realigned its Western region by replacing certain distribution centers with its first ADC located in Sparks, Nevada. The Company has decided to consolidate the distribution and return processing activities currently at the Albany, Atlanta and Baltimore warehouses into the Company's ADC in Indianapolis, Indiana. This consolidation will be completed by the end of calendar 1998.
Due to the opening of the two ADCs, the Company has been able to transfer the operations of 13 music/video/software shipping branches, 4 book shipping branches and 4 product return centers to the ADCs. Management expects that transitioning additional warehouse activities into the Company's two ADCs will further reduce operating costs and decrease inventory levels, while improving the Company's speed and reliability in supplying products to its customers.
The Company also has a proprietary inventory management system ("PRISM"). PRISM automates and integrates the functions of ordering product, receiving, warehousing, order fulfillment, ticket printing and perpetual inventory maintenance. PRISM also provides the basis to develop title specific billing to allow the Company to better serve its customers.
North Coast Entertainment -------------------------
NCE, a subsidiary of Handleman Company, includes the Company's proprietary product operations. NCE is the umbrella company for subsidiaries which acquire or develop master recordings, exclusive licensing and distribution agreements, and original productions. Such items are manufactured and then distributed to either rackjobbers, including H.E.R. and International, distributors or directly to retailers. NCE has operations in the United States and Canada, and to a lesser extent in Germany and the United Kingdom. In addition, NCE products are available in Mexico and South America. Most NCE products are categorized as budget, with many retailing for under $10. Products are designed to provide high margins to the retailer at prices that generate impulse sales.
NCE, the proprietary products group of the Company, provides the following opportunities:
. NCE enables the Company to take a more active, and more profitable, role in the production of home entertainment products. This enhances the Company's profit potential.
. NCE provides the Company with a wide array of product development and licensing opportunities for music and video products. This enables the Company to offer a broader range of more profitable products to its customers.
. NCE gives the Company access to new distribution channels, new markets and new customers. For example, the Company can cross-sell music and video to new or existing customers through any NCE subsidiary sales organization.
NCE is currently comprised of a group of enterprises operating under different names:
. Anchor Bay Entertainment markets a wide selection of video titles ranging from children's programs such as Thomas the Tank Engine, Tots TV, family movies like Huckleberry Finn, the Mobil Masterpiece Theater line, a popular Collector's Edition Series, holiday titles, best-selling horror/sci-fi movies and original fitness videos. Anchor Bay's film library encompasses several thousand titles and includes such classics as David O. Selznick's "Duel in the Sun" and Alfred Hitchcock's "Rebecca," as well as modern thrillers such as George Romero's "Dawn of the Dead" and John Carpenter's "Halloween." Its fitness programs include the popular series Crunch and a brand new line of Paula Abdul dance theme exercise videos. Anchor Bay provides films on the digital video disk format, the fastest growing segment of the video market. Anchor Bay supplies products to rackjobbers, specialty stores, mass merchants and distributors, as well as via direct response and catalog channels.
. Madacy Entertainment Group packages and markets music and video products. In addition, the company owns the masters to more than 2,000 classical recordings. Its diverse offerings include a wide selection of pop, classical, contemporary and dance titles. Madacy has created a special expertise in compilation albums and recently signed an agreement with Time Inc. to package, promote and distribute for retail sale a number of Time/Life's musical collections, previously only available through direct channels. As a value-added service, Madacy also supplies private label products to major retailers. Mediphon GmbH, a German-based subsidiary, distributes audio products throughout Germany and the rest of Europe.
. Sellthrough Entertainment markets special holiday music and video products. While Sellthrough's business is focused primarily on its Christmas catalog, the company is expanding its sales to include Halloween and other holidays. In addition to H.E.R., its customers include mass merchants, drug stores, grocery stores and specialty stores.
On May 18, 1998, NCE and The itsy bitsy Entertainment Company, Inc. ("itsy bitsy") entered into an agreement for the purchase of shares of itsy bitsy. As a result, NCE owns a 75% share in itsy bitsy. Managerial and operating control of itsy bitsy will remain with its current management, who are retaining a meaningful minority interest in the company.
itsy bitsy is an entertainment marketing firm with exclusive rights to a number of childrens properties, including Teletubbies, Tots TV and Noddy. Under the terms of the agreement, itsy bitsy will establish a childrens unit with responsibility for the acquisition, development and marketing of future childrens entertainment properties and concepts for NCE.
This transaction advances a long-standing relationship among NCE, its subsidiary Anchor Bay Entertainment Inc., itsy bitsy and itsy bitsy management. Anchor Bay has worked with itsy bitsy or its management team on Tots TV, Teletubbies and expansion of the video label for Thomas The Tank Engine. Anchor Bay continues to hold the video rights to Thomas The Tank Engine, Tots TV and other successful properties.
The Company sold Sofsource, its software publishing subsidiary, to The Learning Company at a pre-tax gain in excess of $30 million. The transaction closed during the first quarter of fiscal 1999. Sofsource has been a profitable growth business within Handleman's NCE subsidiary. However, the software industry is going through significant consolidation. Sofsource is at a point where the resources necessary for growth are best provided by another investor that has the critical mass and commitment to focus on the industry.
NCE's management will continue to focus its attention on growing the business through licensing and acquiring or producing new products, as well as via new markets, geographical growth, growth within the home entertainment and educational categories, and selective acquisitions and joint ventures.
Competition -----------
Handleman is primarily a category manager (rackjobber) of music products. The business of the Company is highly competitive as to both price and alternative supply arrangements in all of its product lines. Besides competition among the Company's mass merchant customers, the Company's customers compete with alternative sources from which consumers could purchase the same product, such as (1) specialty retail outlets, (2) electronic specialty stores, (3) video rental outlets, and (4) record clubs. The Company competes directly for sales to its customers with (1) manufacturers which bypass wholesalers and sell directly to retailers, (2) independent distributors, and (3) other rackjobbers. In addition, some large mass merchants have "vertically integrated" so as to provide their own rackjobbing. Some of these companies, however, also purchase from independent rackjobbers. Also, new methods of in-home delivery of entertainment software products are being introduced.
The Company believes that the distribution of home entertainment software will remain highly competitive. The Company believes that customer service and continual progress in operational efficiencies are the keys to growth and profitability in this competitive environment.
Industry Outlook ----------------
Information regarding industry outlook by product line follows (all years cited herein are calendar years):
Music - -----
According to the Recording Industry Association of America, the U.S. music industry posted sales, at list price, of $12.2 billion in calendar 1997, declining 2% from calendar 1996. According to Veronis, Suhler & Associates ("Veronis"), an entertainment industry investment banker, the U.S. market is expected to grow at a 5.6% compound annual rate through 2001. According to SoundScan, mass merchant sales accounted for 27% of music unit sales in calendar 1997 compared to 24% in calendar 1996.
Compact discs ("CDs") accounted for over 83% of music industry net revenues in 1997. Despite the growing dominance of CDs, cassettes still remain a popular format. Industry-wide sales of cassettes, including cassette singles, still represent sales of over $1.6 billion. Car stereos and portable systems, two areas where CDs have had less impact, still rely principally on the cassette. The size, cost and convenience of cassettes are also important factors in the continuing market for this music format.
Video - -----
According to VideoScan, the U.S. sellthrough video industry experienced a decrease in unit sales for 1997. In 1997, approximately 267 million units were sold compared to 281 million units in 1996. Veronis projects industry video sales to grow at an 11.2% compound annual rate through 2001.
* * * * *
See Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 3, Nonrecurring and Repositioning Charges, on page 30 under Item 8, for additional information regarding the Company's activities.
The Company's sales and earnings are of a seasonal nature. Note 9, Quarterly Financial Summary (Unaudited), on page 37 under Item 8 discloses quarterly results which indicate the seasonality of the Company's business.
The Company has approximately 3,400 employees as of May 2, 1998, of which none are unionized. The repositioning program will result in a reduction of 900-1,000 positions (approximately 30% of the Company's total workforce). This reduction will occur predominantly in the H.E.R. division and the Troy corporate headquarters. The Company believes it can continue to attract and retain adequate staff to support its ongoing business activities.
Item 2.
Item 2. PROPERTIES
The Company's H.E.R. division occupies four leased warehouses, two owned warehouses and nine leased satellite sales offices, all in the United States. The leased warehouses are located in Indianapolis, Indiana (3) and Reno, Nevada. The owned warehouses are located in Atlanta, Georgia and Baltimore, Maryland. The satellite sales offices are located in the states of Massachusetts, Ohio, Missouri, Arkansas, California, Oregon, Illinois and New York. The Company-owned warehouses in Atlanta, Georgia and Baltimore, Maryland are being sold in connection with the Company's repositioning program.
The Company's NCE division owns one warehouse located in Tampa, Florida and leases four warehouses located in Columbus, Ohio, Quebec, Canada (2), and Ontario, Canada. The warehouse in Tampa, Florida will be sold and leased-back in a transaction expected to close in the first quarter of fiscal 1999. NCE also occupies leased office space within the United States in the states of Texas, New Mexico, New Jersey and Missouri, as well as in Canada, Germany and the United Kingdom.
The Company's International division has leased warehouses in Montreal and Toronto, Canada, Buenos Aires, Argentina, Sao Paulo, Brazil and Mexico City, Mexico. The International division also has a leased satellite sales office in Calgary, Canada.
The Company owns its 130,000 square feet corporate office building located in Troy, Michigan. H.E.R.'s Atlanta building is encumbered by Economic Development Corporation Revenue Bonds, as explained in Note 5 to Handleman's Consolidated Financial Statements under Item 8. The bonds were issued in connection with the construction of the building.
Item 3.
Item 3. LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Registrant or any of its subsidiaries is a party, other than ordinary routine litigation incidental to the business.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange.
Below is a summary of the market price of the Company's common stock as traded on the New York Stock Exchange:
As of July 14, 1998, the Company had 3,922 shareholders of record.
The Company has not declared or paid dividends during the past two fiscal years.
Item 6.
Item 6. SELECTED FINANCIAL DATA HANDLEMAN COMPANY FIVE YEAR REVIEW (amounts in thousands except per share data and ratios)
* - Fiscal 1996 amount is before inventory reduction provision of $14,500.
** - Not meaningful
Note 1: See Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company operates principally in one business segment: selling music, video, book and personal computer software products primarily to mass merchants, and also to specialty chain stores, drugstores and supermarkets.
On June 2, 1998, Handleman's Board of Directors approved a comprehensive strategic repositioning program designed to focus on the Company's core music distribution business and product line. The repositioning program has four major components:
. Exiting the domestic video, book and software distribution and service operations.
. Sale of Sofsource, North Coast Entertainment's software publishing subsidiary.
. Significant reduction in the number of customers serviced in the music business.
. Repurchase in the open market of up to $70 million of the outstanding common stock of Handleman Company over 18 months. This repurchase program is subject to the realization of cash from asset sales and reduced working capital needs, as well as renegotiation of existing credit facilities.
During the first quarter of fiscal 1999, the Company sold its book distribution business and Sofsource. The book distribution business was sold at approximately net book value and the Sofsource sale generated a pre-tax gain in excess of $30 million.
Handleman plans to exit its domestic video and software distribution business activities, as well as to cease providing services to smaller customers in the music distribution business. This is in addition to the sale of the book distribution business noted above. The decision was made to exit these activities, as well as to reduce the number of customers serviced in the music distribution business, because these businesses or customers either did not provide an appropriate and consistent rate of return or do not have the potential for sustainable growth and profitability.
In addition to the business activities being exited, the Company is reviewing its operations in Argentina, Brazil and Mexico to determine how best to maximize shareholder value from these entities. Decisions will be made with respect to each of these markets and announced by the end of August 1998.
Management expects the repositioning activities to be substantially completed during fiscal 1999. The program is expected to generate cash flow exceeding $150 million from the sale of assets and a reduction in working capital. Upon completion of the repositioning actions, the Company expects to realize annual ongoing cost savings in excess of $25 million (pre-tax). The expected savings will result from a reduction in operating costs at a rate that is greater than the projected decrease in revenues, because both average customer size and average sales volume of departments serviced increase significantly.
During the fourth quarter of fiscal 1998, the Company recognized a $13.7 million (pre-tax) charge representing principally costs associated with closing the Albany and Atlanta warehouses (which were consolidated into the Indianapolis automated distribution center) and the impairment of certain investments, as well as already incurred repositioning related costs.
In the first quarter of fiscal 1999, the Company expects to recognize additional nonrecurring charges of $90 million to $110 million (pre-tax) for the following items:
. Severance and related benefit costs for employees being terminated.
. Reduction to net realizable value of assets in those business activities being exited.
. Write-off of intangibles related to business activities being exited.
. Costs related to restructuring the Company's debt financing arrangements and other costs related to repositioning activities.
These charges will result in the Company incurring a substantial loss in the first quarter and for all of fiscal 1999. Repositioning related charges after the first quarter are expected to not exceed $15 million (pre-tax). Benefits are expected to begin in the second fiscal quarter as the program is implemented.
This repositioning program will result in a reduction of 900-1,000 positions (approximately 30% of the Company's total workforce). This reduction will occur predominantly in the Handleman Entertainment Resources division and the Troy corporate headquarters.
Handleman will continue to operate its North Coast Entertainment subsidiary. The Company is confident about the prospects at North Coast Entertainment and is committed to growing the business, as evidenced by the May 1998 acquisition of a majority interest in The itsy bitsy Entertainment Company, Inc., an entertainment marketing firm with exclusive rights to a number of childrens properties. At this time there are no plans to divest any North Coast businesses other than the completed sale of Sofsource.
In connection with the repositioning program, the Board of Directors approved the repurchase in the open market of up to $70 million of the Company's common stock over 18 months. This repurchase program will be subject to the generation of cash from the sale of assets and reduced working capital needs, as well as the renegotiation of the Company's existing credit agreements. In September 1997 the Board authorized a program to repurchase up to 2 million shares, of which 1.3 million shares had been acquired as of May 2, 1998 at a cost of approximately $9 million. This program has been replaced by the new repurchase program.
See Note 3 of Notes to Consolidated Financial Statements for further information on the repositioning program.
Comparison of 1998 with 1997 - ----------------------------
For the fiscal year ended May 2, 1998 ("fiscal 1998"), revenues decreased 6% to $1.10 billion from $1.18 billion for the fiscal year ended May 3, 1997 ("fiscal 1997"), primarily as a result of lower sales in the video distribution business. Net income for fiscal 1998 was $.3 million or $.01 per share, compared to $5.4 million or $.16 per share for fiscal 1997.
Since the repositioning program was approved and announced in the first quarter of fiscal 1999, the principal portion of the estimated repositioning costs will be charged to earnings in the first quarter of fiscal 1999. Net earnings for fiscal 1998 include after-tax nonrecurring charges of $11.2 million ($.34 per share), representing costs already incurred to facilitate the repositioning, as well as costs associated with closing the Albany and Atlanta warehouses and the impairment of certain investments.
The Company's fiscal year ends on the Saturday closest to April 30th. Fiscal 1998 consisted of 52 weeks, whereas fiscal 1997 consisted of 53 weeks. Management believes the inclusion of one additional week in fiscal 1997 did not have a material effect on results of operations for fiscal 1997.
The Company has three operating units: Handleman Entertainment Resources ("H.E.R."), North Coast Entertainment ("NCE") and Handleman International ("International"). H.E.R. is a category manager of music, video, book and personal computer software products to mass merchants in the United States. NCE, which includes the Company's proprietary operations, sells music, video and personal computer software products to retailers and category managers (including H.E.R. and International). International provides category management services in Canada, Mexico, Brazil and Argentina.
The following table sets forth net sales, and the approximate percentage contribution to consolidated revenues, for the Company's three operating divisions for the fiscal years ended May 2, 1998, May 3, 1997 and April 27, 1996:
H.E.R. had net sales of $870.7 million for fiscal 1998, compared to $959.3 million for fiscal 1997, a decrease of 9%. A discussion of H.E.R. sales by product line follows:
Fiscal year 1998 music sales grew 15% to $684.1 million from $595.6 million for fiscal 1997, due to increased sales of compact discs, increased market share with mass merchants and more "hit" albums in fiscal 1998 by artists such as Celine Dion, Garth Brooks, Spice Girls, Chumbawumba and LeAnn Rimes. CD sales for fiscal year 1998 were $562.8 million or 82% of H.E.R.'s music sales, compared to $460.7 million or 77% of H.E.R.'s music sales for fiscal year 1997. According to the Recording Industry Association of America, music industry CD dollar sales reached 83% of total music revenues for calendar 1997 versus 81% for calendar 1996.
Video sales declined 64% to $95.0 million for fiscal 1998 from $266.4 million for fiscal 1997, substantially attributable to customers buying direct from the major video studios. Book sales decreased 3% to $54.1 million for fiscal 1998 from $55.6 million for fiscal 1997, principally resulting from fewer hit titles. Personal computer software sales decreased 10% to $37.5 million this year from $41.7 million last year, primarily the result of two major customers exiting the product line.
NCE is responsible for the Company's proprietary operations, which include music, video and personal computer software products. NCE had net sales of $131.3 million for fiscal 1998, compared to $134.4 million last year, a decrease of 2%. This decrease was driven by a decrease in video sales which followed industry trends, as well as a slight decline in computer software product sales due to delayed releases of new titles. NCE sales to other divisions within the Company were $20.9 million for fiscal 1998 and $29.2 million for fiscal 1997.
International includes category management operations in Canada, Mexico, Brazil and Argentina. International had net sales of $124.5 million for fiscal 1998, compared to $117.0 million for fiscal 1997, an increase of 6%. The increase in International sales was principally from operations in Brazil and Argentina, where year-over-year net sales increased by $8.0 million and $4.4 million, respectively. These increases were offset, to some extent, by the loss of two major customers in Canada: The Bay, which exited the music and video businesses, and the Canadian Kmart stores which were acquired by Zellers. (During the first quarter of fiscal 1999, Zellers retained the Company to provide rackjobbing services for all of its stores.) Sales in International were also impacted by pressure from Mexican retailers to reduce store inventories which limited shipments and increased returns. The growth of the International operating unit and expansion to additional foreign countries has introduced operating risks (e.g., currency fluctuation, political and economic instability) that could have an effect on results of operations.
Direct product costs as a percentage of revenues declined to 75.6% in fiscal 1998 from 76.8% in fiscal 1997. The improvement in direct product costs as a percentage of revenues was substantially attributable to H.E.R., which experienced a reduction in low-margin, mega-hit video sales and an increase in music sales. Music products have a cost to revenue relationship lower than H.E.R.'s overall relationship of direct product costs to revenues.
Selling, general and administrative ("SG&A") expenses were $243.8 million (22.1% of revenues) for fiscal 1998, compared to $250.3 million (21.2% of revenues) for fiscal 1997. The decrease in SG&A expenses was attributable to improvements in the H.E.R. operating unit. The lower H.E.R. SG&A expense level was driven by the impact of the various initiatives that have been implemented to improve operational efficiency. The decrease in H.E.R. SG&A expenses was somewhat offset by increased SG&A expenses within the NCE and International operating units.
NCE fiscal 1998 SG&A expenses increased by $3.8 million over the fiscal 1997 SG&A expense level, primarily related to new product introductions. SG&A expenses in International increased by $5.6 million over the fiscal 1997 expense level as a result of the increased product returns in Mexico and the growth of the Brazilian and Argentine operations. Despite the increases in International and NCE, consolidated SG&A expenses declined $6.5 million for fiscal 1998 as a result of continued cost reductions in H.E.R., as discussed above.
Net interest expense for fiscal 1998 was $12.3 million, compared to $11.0 million for fiscal 1997. The increase was primarily attributable to higher interest rates.
Income before income taxes and minority interest in fiscal 1998 was $271,000, compared to $13.0 million in fiscal 1997. This decrease was primarily attributable to the $13.7 million provision for nonrecurring and repositioning related charges recorded in the fourth quarter of fiscal 1998.
Improvement in income before income taxes within H.E.R. was offset by deterioration in income before income taxes and minority interest within International. The improvement in H.E.R. was driven by the aforementioned reductions in both direct product costs as a percentage of revenues and SG&A expenses. The deterioration within International was primarily attributable to Mexico, which experienced an $8.8 million year-over-year decrease in income before taxes and minority interest. The resultant loss in Mexico was caused by the combination of lower customer shipments, increased product returns and higher SG&A expenses, as discussed above. Decreases in income before income taxes and minority interest in Brazil and Argentina of $1.3 million and $1.0 million, respectively, and an increase in corporate costs to support International activities, also contributed to the overall operating loss in International.
Mexican losses during the first three quarters of fiscal 1998 were mitigated to some extent by a sharing of the losses with the Company's joint venture partner. During the fourth quarter, Handleman acquired the interest of its partner in Mexico and, therefore, minority interest was not recorded. The minority interest was income of $2.8 million for fiscal 1998 and expense of $2.7 million for fiscal 1997.
Accounts receivable were $242.4 million at the end of fiscal 1998, compared to $290.1 million at the end of fiscal 1997, a decrease of 16%. The lower receivable balance was attributable to the lower level of sales during the fourth quarter this year compared to the fourth quarter last year, as well as a concerted multi-discipline, ongoing collection effort which reduced days sales outstanding in accounts receivable by seven days.
Merchandise inventories were $187.2 million as of May 2, 1998, compared to $188.2 million as of May 3, 1997, a decrease of $1.0 million. A substantial decrease in H.E.R. inventory levels, resulting from the Company's inventory reduction program, was mostly offset by increases in NCE and International inventory levels.
The decrease in net property and equipment for fiscal 1998 from fiscal 1997 was due to the disposal of video display fixtures, related to customers buying direct from the major studios, as well as the sale of certain Company owned facilities resulting from the transition to the automated distribution center ("ADC") system.
Debt, noncurrent was reduced by $20.7 million from $135.5 million as of May 3, 1997 to $114.8 million as of May 2, 1998. This decrease was achieved despite spending approximately $9.0 million in connection with the Company's share repurchase program.
Comparison of 1997 with 1996 - ----------------------------
Revenues for the fiscal year ended May 3, 1997 ("fiscal 1997") were $1.18 billion, compared to $1.13 billion for the fiscal year ended April 27, 1996 ("fiscal 1996"), an increase of 4%. Net income for fiscal 1997 was $5.4 million or $.16 per share, compared to a net loss of $22.5 million or $.67 per share for fiscal 1996. The operating results for fiscal 1996 included a $14.5 million pre- tax provision ($.26 per share) recorded for markdowns and other costs incurred in connection with the Company's inventory reduction program, and a $1.5 million pre-tax charge ($.03 per share) in connection with closing Entertainment Zone, a subsidiary which sold music, video and book products in departments leased from certain retailers.
Fiscal 1997 consisted of 53 weeks, whereas fiscal 1996 consisted of 52 weeks. Management believes the inclusion of one additional week in fiscal 1997 did not have a material effect on results of operations for fiscal 1997.
H.E.R. net sales for fiscal 1997 were $959.3 million, approximately equal to fiscal 1996 net sales of $958.2 million. Following is a discussion of sales for each of H.E.R.'s four major product lines:
Music sales for fiscal 1997 increased 6% to $595.6 million from $560.9 million for fiscal 1996, mainly due to increased sales of compact discs. Compact disc ("CD") sales for fiscal 1997 were $ 460.7 million or 77% of H.E.R.'s music sales, compared to $401.1 million or 72% of H.E.R's music sales for fiscal 1996.
Video sales for fiscal 1997 were $ 266.4 million, a decline of 9% from $293.4 million for fiscal 1996, substantially attributable to a $17.8 million decline in sales of mega-hit titles. Book sales increased 4% to $55.6 million for fiscal 1997 from $53.7 million for fiscal 1996, principally resulting from an increase in the number of departments shipped. Personal computer software sales decreased 17% to $41.7 million for fiscal 1997 from $50.2 million for fiscal 1996, primarily the result of an $8.3 million sales decline from a major customer which exited the product line during the third quarter of fiscal 1997.
NCE net sales were $134.4 million for fiscal 1997, compared to $101.5 million for fiscal 1996, an increase of 32%. This increase was driven by sales growth ranging from $7.9 million to $12.6 million in each of NCE's three primary operating units. NCE net sales for fiscal 1996 exclude $18.8 million of sales from NCE's Entertainment Zone subsidiary, which closed during fiscal 1996. NCE sales to other divisions within the Company were $29.2 million in fiscal 1997 and $18.0 million in fiscal 1996.
International net sales for fiscal 1997 were $117.0 million, compared to $72.2 million for fiscal 1996, an increase of 62%. Approximately 68% of the increase in International net sales was driven by the addition of new customers to the account base in Mexico. In addition, approximately 23% of the increase in International net sales resulted from expansion of operations in Brazil and Argentina.
Direct product costs as a percentage of revenues for fiscal 1997 was 76.8%, compared to 78.4% for fiscal 1996. The year-over-year improvement in direct product costs as a percentage of revenues resulted from a number of factors including an increase in the proportion of NCE sales in the overall sales mix. This positively impacted the overall percentage since sales of NCE products carry lower product cost percentages than the overall direct product cost percentage. A significant portion of the decrease in the direct product cost to revenue percentage as compared to last year resulted from lower product cost percentages at each operating unit. The improvement within H.E.R. was substantially the result of music sales becoming a larger proportion of the H.E.R. sales mix and a reduction in sales of low margin mega-hit video titles. Approximately 80% of the 1.6 percentage point decrease in the direct product cost percentage from 78.4% for fiscal 1996 to 76.8% for fiscal 1997 could be attributed to the increase in NCE sales in the overall sales mix and the improved direct product cost percentage within H.E.R.
Selling, general and administrative ("SG&A") expenses were $250.3 million (21.2% of revenues) for fiscal 1997, compared to $252.4 million (22.3% of revenues) for fiscal 1996. The decrease in SG&A expenses as a percentage of revenues was attributable to improvements in the International and H.E.R. operating units. Within the International operating unit, which accounted for approximately 60% of the reduction in the SG&A expenses to revenue percentage, the improvement principally resulted from the spreading of fixed costs over the higher sales level and the inclusion of costs in fiscal 1996 related to the start-up of operations in Brazil and Argentina. The lower SG&A expenses to revenue percentage at H.E.R., which accounted for approximately 40% of the overall improvement, was driven by the impact of the various initiatives implemented to improve operational efficiency, such as implementing best practices at the warehouse and distribution facilities. These improvements were partially offset by higher SG&A expenses related to proprietary product activities in the NCE operating unit.
Interest expense decreased to $11.0 million for fiscal 1997 from $12.0 million for fiscal 1996. The decrease in interest expense was primarily attributable to lower borrowing levels.
Income before income taxes and minority interest was $13.0 million in fiscal 1997, compared to a loss of $35.7 million in fiscal 1996. Fiscal 1996 included a $16.0 million (pre-tax) provision for nonrecurring and repositioning related charges. The remainder of the $48.7 million improvement in income before income taxes was due to the aforementioned improvements in sales and costs.
Accounts receivable were $290.1 million at the end of fiscal 1997, compared to $257.8 million at the end of fiscal 1996, an increase of 13%. The increase in accounts receivable was partially the result of the higher level of sales during the fourth quarter of fiscal 1997 compared to the fourth quarter of fiscal 1996; in addition, the impact of customers immediately reducing payments for product returns also contributed to the increase in accounts receivable. Over 50% of the year-over-year increase in accounts receivable can be attributed to these factors.
Merchandise inventories were $188.2 million as of May 3, 1997, compared to $212.7 million as of April 27, 1996, a decrease of $24.5 million or 12%. The decrease was substantially the result of the Company's inventory reduction program and ADC implementation.
The decrease in other current assets at May 3, 1997 compared to April 27, 1996 was primarily due to a decrease in income taxes receivable.
The decrease in property and equipment from fiscal 1996 to fiscal 1997 was due to the disposal of certain Company owned facilities resulting from the transition to the ADC distribution system.
The accounts payable balance at the end of fiscal 1997 was $197.3 million, compared to $223.0 million last year. Net inventory investment (inventory less accounts payable) was a negative $9.1 million as of May 3, 1997, compared to a negative $10.3 million as of April 27, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at May 2, 1998 was $246.9 million, compared to $260.9 million at May 3, 1997, a decrease of $14.0 million or 5%. The decrease in working capital primarily resulted from improved collections and a lower accounts receivable balance at May 2, 1998. The working capital ratio of 2.1 to 1 at May 2, 1998 remains unchanged from May 3, 1997. For fiscal 1998, net cash provided from operating activities primarily resulted from non-cash charges for depreciation, amortization and recoupment of license advances.
Capital assets consist primarily of display fixtures, warehouse equipment and facilities. The Company also acquires or licenses video, music and software products which it markets. Purchases of these assets are expected to be funded primarily by cash flow from operations.
The Company has an unsecured, five-year, $150,000,000 credit agreement with a consortium of banks, that expires in September 2002. The Company also has $77,000,000 outstanding as of May 2, 1998 under a senior note agreement with a group of insurance companies. See Note 5 of Notes to Consolidated Financial Statements for scheduled maturities of the credit agreement, senior notes and $3,200,000 of Economic Development Corporation limited obligation revenue bonds.
In connection with the repositioning program discussed previously, the Company amended its bank credit agreement to effect compliance with existing restrictions and covenants of the credit agreement. The Company is currently having discussions with the holders of the senior notes to acquire waivers or amendments which may be necessitated by recording, in the first quarter of fiscal 1999, the charges contemplated by the repositioning program. Management believes that the required waivers or amendments will be obtained from the senior note holders. In the event that the required waivers or amendments are not obtained, management believes that the amended credit agreement, supplemented by cash proceeds from the repositioning program, will provide sufficient amounts to repay the senior note holders and fund day-to-day operations and higher peak seasonal demands. For further information, reference should be made to Notes 3 and 5 of Notes to Consolidated Financial Statements.
OTHER INFORMATION
The Company's financial statements have reported amounts based on historical costs which represent dollars of varying purchasing power and do not measure the effects of inflation. If the financial statements had been restated for inflation, net income would have been lower because depreciation expense would have to be increased to reflect the most current costs.
Inflation within the economies in which the Company does business has not had a material effect on the Company's results of operations.
The Company developed a project plan to address the information systems issue commonly referred to as "year 2000." The project plan calls for completion of all required actions, including testing, prior to the year 2000 issue having any impact on the Company's information systems. Work on the project plan is proceeding on schedule. Costs of modifying information systems to address the year 2000 issue are not expected to have a material impact on the Company's financial position, results of operations or cash flows.
* * * * *
This document contains forward-looking statements which are not historical facts and involve risk and uncertainties. Actual results, events and performance could differ materially from those contemplated by these forward-looking statements, including, without limitations, the Company's ability to effectively divest certain assets, the cost and timing of implementing repositioning actions, success in implementing actions contemplated by the repositioning program, conditions in the music industry, relationships with the Company's lenders, certain global and regional economic conditions, and other factors discussed in this Form 10-K and those detailed from time to time in the Company's other filings with the Securities and Exchange Commission. Handleman undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date of this document.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and supplementary data are filed as a part of this report:
Report of Independent Accountants
Consolidated Balance Sheet at May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Operations - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Shareholders' Equity - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Cash Flows - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Notes to Consolidated Financial Statements
Report of Independent Accountants
To the Board of Directors and Shareholders of Handleman Company:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders' equity, and of cash flows present fairly, in all material respects, the financial position of Handleman Company and subsidiaries at May 2, 1998, May 3, 1997, and April 27, 1996, and the results of their operations and their cash flows for each of the three years in the period ended May 2, 1998, in conformity with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. In addition, in our opinion, the financial statement schedule listed in Item 14(a)2 of this Annual Report on Form 10-K when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.
PricewaterhouseCoopers LLP
Detroit, Michigan June 2, 1998
The accompanying notes are an integral part of the consolidated financial statements.
HANDLEMAN COMPANY CONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED MAY 2, 1998, MAY 3, 1997 AND APRIL 27, 1996 (amounts in thousands except per share data)
The accompanying notes are an integral part of the consolidated financial statements.
HANDLEMAN COMPANY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY YEARS ENDED MAY 2, 1998, MAY 3, 1997 AND APRIL 27, 1996 (amounts in thousands except per share data)
The accompanying notes are an integral part of the consolidated financial statements.
HANDLEMAN COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED MAY 2, 1998, MAY 3, 1997 AND APRIL 27, 1996 (amounts in thousands) ----------------------
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
----------------
1. Accounting Policies:
Business
The Company operates principally in one business segment: selling music, video, book and personal computer software products primarily to mass merchants, and also to specialty chain stores, drugstores and supermarkets.
Annual Closing Date
The Company's fiscal year ends on the Saturday closest to April 30th. Fiscal year 1997 consisted of 53 weeks, whereas fiscal years 1998 and 1996 consisted of 52 weeks.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries where the Company has voting or contractual control. All material intercompany accounts and transactions have been eliminated. Minority interest recognized in the statement of operations represents the minority shareholders' portion of the income (loss) for less than wholly-owned subsidiaries. The minority interest share of the net assets of these subsidiaries of $1,119,000, $2,343,000 and $584,000 as of May 2, 1998, May 3, 1997 and April 27, 1996, respectively, are included in other liabilities in the accompanying consolidated balance sheet.
Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Foreign Currency Translation
The Company utilizes the policies outlined in Statement of Financial Accounting Standards No. 52, "Foreign Currency Translation," to convert the balance sheet and operations of its foreign subsidiaries to United States dollars. Net transaction gains (losses), and net translation gains (losses) resulting from translating results of operations in foreign countries deemed highly inflationary, included in the statement of operations were $(643,000), $(40,000) and $(235,000) for the years ended May 2, 1998, May 3, 1997 and April 27, 1996, respectively.
Recognition of Revenue and Future Returns
Revenues are recognized upon shipment of the merchandise. The Company reduces gross sales and direct product costs for estimated future returns at the time the merchandise is sold.
Pension Plan
The Company has a noncontributory defined benefit pension plan covering substantially all hourly and salaried employees. Pension benefits are generally based upon length of service and average annual compensation for the five highest years of compensation in the last 10 years of employment. Net periodic pension cost is accrued on a current basis, and funded as permitted or required by applicable regulations.
Inventory Valuation
Merchandise inventories are recorded at the lower of cost (first-in, first- out method) or market. The Company accounts for inventories using the full cost method which includes costs associated with acquiring and preparing inventory for distribution. Costs associated with acquiring and preparing inventory for distribution of $14,157,000, $15,946,000 and $17,582,000 were incurred during the years ended May 2, 1998, May 3, 1997 and April 27, 1996, respectively. Merchandise inventories as of May 2, 1998, May 3, 1997 and April 27, 1996 include $2,096,000, $3,078,000 and $3,056,000, respectively, of such costs.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
1. Accounting Policies: (continued)
Property and Equipment
Property and equipment are recorded at cost. Upon retirement or disposal, the asset cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in the consolidated statement of operations for the period. Repair costs are charged to expense as incurred.
Depreciation
Depreciation is computed using primarily the straight-line method based on the following estimated useful lives:
Buildings and improvements 10-40 years Display fixtures 3-5 years Equipment, furniture and other 3-10 years
Licenses
The Company acquires video, audio and software licenses giving it exclusive rights to manufacture and distribute such products. The cost of license advances are included in other assets in the consolidated balance sheet and are amortized over a period which is the lesser of the term of the license agreement or its estimated useful life. The effective lives of the licenses tend to range from three to five years. As of May 2, 1998, May 3, 1997 and April 27, 1996, licenses, net of amortization, amounted to $33,738,000, $30,570,000 and $26,744,000, respectively.
Intangible Assets
Intangible assets, included in other assets in the consolidated balance sheet and aggregating $31,684,000, net of amortization, consists primarily of the excess of consideration paid over the estimated fair values of net assets of businesses acquired. These assets are amortized using the straight-line method over periods predominantly ranging from five to 15 years. As of May 2, 1998, the weighted average period remaining to be amortized was approximately ten years.
Cash Equivalents
The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
Financial Instruments
The Company has evaluated the fair value of those assets and liabilities identified as financial instruments under Statement of Financial Accounting Standards No. 107. The Company estimates that fair values generally approximated carrying values at May 2, 1998, May 3, 1997 and April 27, 1996. Fair values have been determined through information obtained from market sources and management estimates.
Earnings Per Share
Statement of Financial Accounting Standards No. 128, "Earnings Per Share," established an updated standard for computing and presenting earnings per share. This standard was effective for the year ended May 2, 1998, and did not result in a different reported earnings per share amount for any reporting period. For diluted earnings per share, additional weighted average shares for the years ended May 2, 1998, May 3, 1997 and April 27, 1996 were 18,000, 19,000 and zero, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
Reclassifications
The 1997 and 1996 consolidated statement of operations have been conformed to the presentation adopted in 1998.
2. Sales and Accounts Receivable:
The Company's customers are comprised mainly of mass merchant retail chains located predominantly in North America. For the years ended May 2, 1998, May 3, 1997 and April 27, 1996, one customer accounted for approximately 33 percent, 38 percent and 40 percent of the Company's net sales, respectively, and a second customer accounted for approximately 32 percent, 23 percent and 21 percent of the Company's net sales, respectively. Collectively, these customers accounted for approximately 59 percent, 45 percent and 54 percent of accounts receivable at May 2, 1998, May 3, 1997 and April 27, 1996, respectively.
3. Nonrecurring and Repositioning Charges:
On June 2, 1998 the Board of Directors approved a comprehensive strategic repositioning program designed to focus on the Company's core business and product lines. The program has four major components:
. Exiting the domestic video, book and software service and distribution activities.
. Reduction of the number of customers serviced in the music distribution activity.
. Sale of North Coast Entertainment's Sofsource software publishing subsidiary.
. Repurchase of up to $70,000,000 of the Company's common stock.
The repositioning program is in addition to the consolidation of the Albany and Atlanta distribution centers into the Indianapolis automated distribution center which was announced in the fourth quarter of fiscal 1998. The $13,684,000 nonrecurring charge recognized in the fourth quarter of 1998 represents principally the costs associated with the closing of the Albany and Atlanta warehouses, the impairment of certain investments, as well as already incurred repositioning related costs.
Current accounting standards requires that repositioning charges be recognized in the period in which they are approved and announced. Although the repositioning program was approved and announced prior to the issuance of the fiscal 1998 financial statements, the asset adjustments and cost accruals with respect to the repositioning, other than those costs actually incurred in fiscal 1998, will be charged to earnings in the first quarter of fiscal 1999. The fiscal 1999 information is presented to aid the readers of the financial statements in understanding the magnitude of the costs included.
The following table summarizes the estimated range of nonrecurring and repositioning program charges to be recognized in the first quarter of fiscal 1999:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
3. Nonrecurring and Repositioning Charges: (continued)
The fiscal 1999 repositioning charge includes severance costs for employees to be terminated, as well as other items such as consulting fees incurred solely with respect to exiting the aforementioned activities. Other consulting fees incurred in connection with the repositioning, but benefiting the ongoing business, will be included in repositioning related charges as incurred. Adjustments of assets to net realizable value includes adjustments to reflect the estimated recovery amount of assets to be disposed of, principally inventory and property and equipment, as well as certain adjustments to the carrying value of receivables and payables. Intangibles related to either businesses to be exited, or customers no longer to be serviced, are included in the intangibles write-off.
It is estimated that the ongoing (after the first quarter) related charges will not exceed $15,000,000 and will be incurred during the time-frame of the repositioning activities. It is anticipated that the majority of the repositioning activities will be completed during fiscal 1999, but that some costs will be incurred during fiscal 2000.
The Company has entered into a definitive agreement to sell, at approximately net book value, its book distribution business and expects to close the transaction during the first quarter of fiscal 1999. The Company has also signed a definitive agreement to sell the software publishing subsidiary at a gain in excess of $30,000,000 during the first quarter of fiscal 1999. This gain has not been included in the above summarized nonrecurring charges to be incurred in fiscal 1999.
The Company has also announced that it is reviewing its subsidiaries in Argentina, Brazil and Mexico to determine how to best improve shareholder value. A decision is expected to be made in August 1998.
The Board has authorized management to repurchase up to $70,000,000 of the Company's common stock over the next 18 months subject to realization of projected proceeds from the sale of assets, and the renegotiation of the Company's credit arrangements.
During the fourth quarter of fiscal 1996, the Company recorded a $14,500,000 pre-tax provision related to markdowns and other costs to be incurred in connection with an inventory reduction program. In connection with closing its Entertainment Zone subsidiary, the Company recognized a $1,500,000 pre-tax charge in the third quarter of fiscal 1996, primarily related to write-offs of display fixtures and other equipment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
--------------
4. Pension Plan:
The Handleman Company Pension Plan's funded status, the components of net pension expense, and the amount which is recorded in the Company's consolidated balance sheet at May 2, 1998, May 3, 1997 and April 27, 1996 are as follows:
Assumptions used in determining the actuarial present value of the projected benefit obligation included a weighted average discount rate of 6.75 percent for 1998 and 7.75 percent for 1997 and 1996, and a rate of increase in future compensation levels of 5 percent for all periods.
The assumed long-term rate of return on assets was 8.5 percent for all periods. Plan assets are invested in various pooled investment funds and mutual funds maintained by the Plan trustee and common stock of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
--------------
5. Debt:
The Company has a contractually committed, unsecured, five-year, $150,000,000 credit agreement with a consortium of banks, which is scheduled to expire in September 2002. Under the agreement, the Company may borrow to the extent of eligible accounts receivable less outstanding senior indebtedness, principally the senior notes discussed below. At May 2, 1998, the maximum borrowings available under the credit agreement were approximately $69,000,000 of which $52,900,000 was outstanding at that date. The Company may elect to pay interest under a variety of formulae tied principally to either prime or "LIBOR." As of May 2, 1998, the interest rate on the borrowings outstanding was 6.53%.
In November 1994, the Company entered into a $100,000,000 senior note agreement with a group of insurance companies. The balance outstanding as of May 2, 1998 was $77,000,000 of which $18,571,000 is classified as current and included in accrued and other liabilities in the accompanying consolidated balance sheet. These notes bear interest at rates of 7.81% to 8.59%.
Scheduled maturities for the senior note, credit agreement, and $3,200,000 of Economic Development Corporation (EDC) limited obligation revenue bonds are as follows:
2000.................................$18,811,000 2001.................................$14,571,000 2002.................................$14,571,000 2003.................................$56,472,000 After 2003...........................$10,343,000
The EDC bonds, senior note and the credit agreement contain certain restrictions and covenants, relating to, among others, interest coverage ratio, working capital, debt and net worth. As of May 2, 1998, the Company was in compliance with these various provisions. In connection with the repositioning program, the Company amended its bank credit agreement to effect compliance with existing restrictions and covenants.
Interest expense for the years ended May 2, 1998, May 3, 1997 and April 27, 1996, was $12,593,000, $12,099,000 and $13,119,000, respectively. Interest paid for the years ended May 2, 1998, May 3, 1997 and April 27, 1996 was $12,796,000, $11,770,000 and $13,178,000, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
--------------
6. Income Taxes:
The domestic and foreign components of income (loss) before income taxes and minority interests for the years ended May 2, 1998, May 3, 1997 and April 27, 1996 are as follows:
Provisions for income taxes for the years ended May 2, 1998, May 3, 1997 and April 27, 1996 consist of the following:
The following table provides a reconciliation of the Company's resulting income tax to the statutory federal income tax:
Items that gave rise to significant portions of the deferred tax accounts at May 2, 1998, May 3, 1997 and April 27, 1996 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
The Company intends to reinvest indefinitely the undistributed earnings of its foreign subsidiaries. Accordingly, the potential withholding tax of approximately $1,300,000 on undistributed earnings of foreign subsidiaries that have accumulated earnings, totaling approximately $26,500,000, has not been recorded as of May 2, 1998. The Company has net operating loss carryforwards in certain of its foreign subsidiaries for tax purposes of approximately $12,000,000 which expire predominantly in 2001 to 2007. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has established valuation allowances for its foreign net operating loss carryforwards.
The financial reporting basis of investments in certain foreign subsidiaries is less than their tax basis, accordingly, in accordance with SFAS No. 109, a deferred tax asset has not been recognized for the excess basis because the investments are deemed permanent.
Income taxes paid in 1998, 1997 and 1996 were approximately $9,824,000, $8,833,000 and $1,865,000, respectively.
7. Property and Equipment:
Property and equipment consists of the following:
1998 1997 1996 ---- ---- ----
Land $ 4,012,000 $ 4,238,000 $ 4,877,000 Buildings and improvements 20,544,000 24,564,000 31,793,000 Display fixtures 89,954,000 96,721,000 112,207,000 Equipment, furniture and other 72,366,000 67,450,000 60,983,000 ------------ ------------ ------------ 186,876,000 192,973,000 209,860,000 Less accumulated depreciation and amortization 108,165,000 97,254,000 98,505,000 ------------ ------------ ------------ $ 78,711,000 $ 95,719,000 $111,355,000 ============ ============ ============
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
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8. Stock Plans:
The Company's shareholders approved the adoption of the Handleman Company 1992 Performance Incentive Plan (the "Plan"), which authorizes the granting of stock options, stock appreciation rights and restricted stock. At any given time, the maximum number of shares of stock which may be issued pursuant to restricted stock awards or granted pursuant to stock options or stock appreciation rights shall not exceed 5% of the number of shares of the Company's common stock outstanding as of the immediately preceding fiscal year end. After deducting restricted stock, options and awards issued or granted under the Plan since adoption in September 1992, 579,302 shares of the Company's stock are available for use under the Plan as of May 2, 1998.
Pursuant to the restricted stock provisions of the Plan, 121,952 shares of common stock were forfeited during the year ended May 2, 1998. Through 1998, the Company has not recorded any net compensation expense related to the restricted stock because minimum performance goals have not been achieved. As of May 2, 1998, there were no outstanding restricted shares.
Information with respect to options outstanding under the previous and current stock option plans, which have various terms and vesting periods as approved by the Compensation and Stock Option Committee of the Board of Directors, for the years ended April 27, 1996, May 3, 1997 and May 2, 1998 is set forth below. Options were granted during such years at no less than fair market value at the date of grant.
The exercise price range of outstanding options as of April 27, 1996, May 3, 1997 and May 2, 1998 was $10.06-$22.17, $6.38-$21.83 and $5.75-$21.83, respectively. Approximately 55% of outstanding options as of May 2, 1998 had exercise prices of $10 per share or more. The average remaining exercise period for shares exercisable at May 2, 1998 was five years.
The Company has elected to continue to apply the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly, no stock option compensation expense is included in the determination of net income in the statement of operations. Had stock option compensation expense been determined pursuant to the methodology of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the pro forma effects on the Company's earnings and earnings per share in fiscal years 1998, 1997 and 1996 would not have been material.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
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9. Quarterly Financial Summary (Unaudited): --------------------------------------- (amounts in thousands except per share data)
*Earnings per common share were improved by $.06 for the fourth quarters of both fiscal 1998 and fiscal 1997, resulting from various year-end adjustments to previous accrual estimates. Income before income taxes and minority interest for the quarter ended April 27, 1996 includes the effect of a $14,500,000 pre- tax inventory reduction provision ($.26 per share after tax). Income before income taxes and minority interest for the quarters ended May 2, 1998 and January 31, 1996 include the effect of a pre-tax provision for nonrecurring costs of $13,684,000 ($.34 per share after tax) and $1,500,000 ($.03 per share after tax), respectively. See note 3 to the consolidated financial statements for further information regarding these costs.
Item 9.
Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Not applicable
PART III.
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Item 10, with the exception of the following information regarding executive officers of the Registrant required by Item 10, is contained in the Handleman Company definitive Proxy Statement for its 1998 Annual Meeting of Shareholders to be filed on or before August 27, 1998 and such information is incorporated herein by reference. All officers serve at the discretion of the Board of Directors.
1. Stephen Strome has served as President since March 1990. On May 1, 1991, Mr. Strome was named Chief Executive Officer.
2. Peter J. Cline has served as Executive Vice President/President of Handleman Entertainment Resources since joining the Company in April 1994. Prior to joining Handleman Company, Mr. Cline was employed by the Snacks and International Consumer Products Division of Borden, Inc. from August 1990 until April 1994 where he served in various executive positions, most recently as Group Vice President - North American Snacks.
3. Stephen Nadelberg has served as Senior Vice President/President of North Coast Entertainment since joining the Company in February 1997. Prior to joining Handleman Company, Mr. Nadelberg was employed from 1974 to 1996 by Allied Domecq Spirits & Wines, parent company of Hiram Walker, Inc., where he held various positions most recently as Vice President and General Manager of global product development.
4. Arnold Gross has served as Senior Vice President/International since 1996. In June of 1997, Mr. Gross was elected Senior Vice President/President of Handleman International. From 1994 to 1995, Mr. Gross served as Director General of Rackjobbing, S.A. de C.V., the Company's joint venture in Mexico. Prior to joining Handleman Company, Mr. Gross served from 1983 to 1993 as President of A&M Development.
5. Leonard A. Brams has served as Senior Vice President/Finance, Chief Financial Officer and Secretary since joining the Company in June 1997. Prior to joining Handleman Company, Mr. Brams was Vice President/Administration and Chief Financial Officer for Talon LLC from 1995 until 1997, and Vice President Finance of United Technologies Automotive from 1990 until 1994.
6. Thomas C. Braum, Jr. has served as Corporate Controller since June 1988. In February 1992, Mr. Braum was elected Vice President.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Information required by this item is contained in the Handleman Company definitive Proxy Statement for its 1998 Annual Meeting of Shareholders, to be filed on or before August 27, 1998 and such information is incorporated herein by reference.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this item is contained in the Handleman Company definitive Proxy Statement for its 1998 Annual Meeting of Shareholders, to be filed on or before August 27, 1998 and such information is incorporated herein by reference.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this item is contained in the Handleman Company definitive Proxy Statement for its 1998 Annual Meeting of Shareholders, to be filed on or before August 27, 1998 and such information is incorporated herein by reference.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. The following financial statements and supplementary data are filed as a part of this report under Item 8.:
Report of Independent Accountants
Consolidated Balance Sheet at May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Operations - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Shareholders' Equity - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Consolidated Statement of Cash Flows - Years Ended May 2, 1998, May 3, 1997 and April 27, 1996.
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
II. Valuation and Qualifying Accounts and Reserves
All other schedules for Handleman Company have been omitted since the required information is not present or not present in an amount sufficient to require submission of the schedule, or because the information required is included in the financial statements or the notes thereto.
3. Exhibits as required by Item 601 of Regulation S-K.
S-K Item 601 (3)
The Registrant's Restated Articles of Incorporation dated June 30, 1989 were filed with the Form 10-K dated May 1, 1993, and are incorporated herein by reference. The Registrant's Bylaws adopted March 7, 1990, as amended June 16, 1993 and further amended December 6, 1995, were filed with the Form 10-K dated May 3, 1997, and are incorporated herein by reference.
S-K Item 601 (10)
The Registrant's 1983 Stock Option Plan was filed with the Commission in Form S-8 dated January 18, 1985, File No. 2-95421. The first amendment to the 1983 Stock Option Plan, adopted on March 11, 1987, was filed with the Commission with the Form 10-K for the year ended May 2, 1987.
The Registrant's 1992 Performance Incentive Plan was filed with the Commission in Form S-8, dated March 5, 1993, File No. 33-59100.
The advisory agreement with David Handleman was filed with the Form 10-K for the year ended April 28, 1990.
The Note Agreement dated as of November 1, 1994 was filed with the Form 10-K for the year ended April 28, 1995.
The Credit Agreement among Handleman Company, the Banks named therein and NBD Bank, N.A., as Agent, dated September 3, 1997 is filed as Exhibit A to this Form 10-K.
The change in control agreements dated March 17, 1997 between Handleman Company and certain executive officers of the Company were filed with the Form 10-K for the year ended May 3, 1997.
The change in control agreements dated October 30 and 31, 1997 between Handleman Company and certain executive officers of the Company are filed as Exhibit B to this Form 10-K.
S-K Item 601 (21) - Subsidiaries of the Registrant: Handleman Company of Canada, Limited, an Ontario Corporation Scorpio Productions, Inc., a Texas Corporation Hanley Advertising Company, a Michigan Corporation Rackjobbing, S.A. de C.V. Rackjobbing Services, S.A. de C.V. Michigan Property and Risk Management Company, a Michigan Corporation North Coast Entertainment, Inc., a Michigan Corporation Anchor Bay Entertainment, Inc., a Michigan Corporation Sellthrough Entertainment, Inc., a Michigan Corporation North Coast Entertainment, Ltd., a Canadian Corporation Sofsource, Inc., a Michigan Corporation Madacy Entertainment Group, Inc., a Michigan Corporation Mediaphon, Gmbh, a German Corporation Madacy Entertainment Group, Ltd., a Canadian Corporation American Sterling Corp., a Delaware Corporation Handleman de Argentina S.A. Handleman do Brasil Commercial Ltd. Sellthrough Entertainment, Limited, a Canadian Corporation Madacy Entertainment (U.K.) Limited Bosco Music, Inc., a Michigan Corporation HGV Video Productions, Inc., an Ontario Corporation The itsy bitsy Entertainment Company
S-K Item 601 (23) - Consent of Independent Accountants: Filed with this report.
(b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report.
Note: The Exhibits attached to this report will be furnished to requesting security holders upon payment of a reasonable fee to reimburse the Registrant for expenses incurred by Registrant in furnishing such Exhibits.
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of Handleman Company and Subsidiaries on Form S-3 (File No. 33-42018) and Form S-8 (File Nos. 2-95421, 33-59100, 33-16637 and 33-69030) of our report dated June 2, 1998, on our audits of the consolidated financial statements and financial statement schedule of Handleman Company and Subsidiaries as of May 2, 1998, May 3, 1997 and April 27, 1996 and for the years then ended, which report is included in this Annual Report on Form 10-K.
PricewaterhouseCoopers LLP
Detroit, Michigan July 28, 1998
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED APRIL 27, 1996, MAY 3, 1997 AND MAY 2, 1998
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.
HANDLEMAN COMPANY
DATE: July 29, 1998 BY: /s/ Stephen Strome ----------------- ------------------------------------- Stephen Strome, President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities and 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.
/s/ Leonard A. Brams /s/ Thomas C. Braum, Jr. - ------------------------------------ ---------------------------------------- Leonard A. Brams, Thomas C. Braum, Jr., Senior Vice President, Vice President, Corporate Controller Finance and Chief Financial Officer (Principal Accounting Officer) (Principal Financial Officer)
July 29, 1998 July 29, 1998 - ------------------------------------ ---------------------------------------- DATE DATE
/s/ David Handleman /s/ Richard H. Cummings - ------------------------------------ ---------------------------------------- David Handleman, Director Richard H. Cummings, Director (Chairman of the Board)
July 29, 1998 July 29, 1998 - ------------------------------------ ---------------------------------------- DATE DATE
/s/ James B. Nicholson /s/ Alan E. Schwartz - ------------------------------------ ---------------------------------------- James B. Nicholson, Director Alan E. Schwartz, Director
July 29, 1998 July 29, 1998 - ------------------------------------ ---------------------------------------- DATE DATE
/s/ Lloyd E. Reuss /s/ Gilbert R. Whitaker, Jr. - ------------------------------------ ---------------------------------------- Lloyd E. Reuss, Director Gilbert R. Whitaker, Jr., Director
July 29, 1998 July 29, 1998 - ------------------------------------ ---------------------------------------- DATE DATE
/s/ John M. Barth - ------------------------------------ John M. Barth, Director
July 29, 1998 - ------------------------------------ DATE