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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 2, 1998 Commission File No. 1-7923
HANDLEMAN COMPANY
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1242806
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
500 Kirts Boulevard, Troy, Michigan 48084 - 4142
(Address of principal executive offices) (Zip Code)
248-362-4400
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
COMMON STOCK $.01 PAR VALUE
Name of each exchange which registered
NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
NONE
(Title of Class)
Indicate by checkmark 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 at least the past 90 days.
YES X NO_____
-----
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. The aggregate market value shall be computed by reference to the
price at which the stock was sold, or the average bid and asked prices of such
stock, as of a specified date within 60 days prior to the date of filing. The
aggregate market value as of July 14, 1998 was $318,211,000.
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date. The number of shares of common
stock outstanding as of July 14, 1998 was 31,657,480.
Item 14(a) 3. on page 40 describes the exhibits filed with the Securities and
Exchange Commission.
Certain sections of the definitive Proxy Statement to be filed for the 1998
Annual Meeting of Shareholders are incorporated by reference into Part III.
1
PART 1
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.
2
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:
Year Ended
(Amounts in Millions)
-------------------------------------------------
May 2, 1998 May 3, 1997 April 27, 1996
(52 weeks) (53 weeks) (52 weeks)
--------------- --------------- ---------------
Handleman Entertainment Resources
Music $ 684.1 $ 595.6 $ 560.9
% of Total 61.9 50.4 49.5
Video 95.0 266.4 293.4
% of Total 8.6 22.6 25.9
Book 54.1 55.6 53.7
% of Total 4.9 4.7 4.8
Personal Computer Software 37.5 41.7 50.2
% Total 3.4 3.5 4.4
-------- -------- --------
Sub-Total 870.7 959.3 958.2
% of Total 78.8 81.2 84.6
-------- -------- --------
North Coast Entertainment 131.3 134.4 101.5
% of Total 11.9 11.4 9.0
International 124.5 117.0 72.2
% of Total 11.3 9.9 6.4
Eliminations, principally
NCE sales to H.E.R. (22.0) (29.7) (18.1)
% of Total (2.0) (2.5) (1.6)
Closed Operation --- --- 18.8
% of Total --- --- 1.6
-------- -------- --------
TOTAL $1,104.5 $1,181.0 $1,132.6
======== ======== ========
3
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.
Dollar Amounts in Thousands
----------------------------------------------------------------
1998 1997 1996
---------------- ------------------ ------------------
Net sales:
United States $ 971,346 $1,053,358 $1,050,545
Other 133,176 127,679 82,062
---------- ---------- ----------
Total net sales $1,104,522 $1,181,037 $1,132,607
========== ========== ==========
Operating income (loss):
United States 26,743 20,051 $ (18,562)
Other (14,153) 3,921 (5,130)
Interest expense, net (12,319) (10,967) (12,039)
---------- ---------- ----------
Income (loss) before income taxes
and minority interest $ 271 $ 13,005 $ (35,731)
========== ========== ==========
Identifiable assets:
United States $ 537,811 $ 619,548 $ 658,323
Other 75,245 48,338 35,591
---------- ---------- ----------
Total assets $ 613,056 $ 667,886 $ 693,914
========== ========== ==========
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.
4
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.
5
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.
6
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.
7
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.
8
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.
9
* * * * *
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.
10
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. 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. SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS
Not applicable.
11
PART II
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:
Fiscal Year Ended
-----------------------------------
May 2, 1998 May 3, 1997
----------- -----------
Quarter Low High Low High
------- ------------------------------------
First.............. 5 15/16 7 1/8 4 3/4 7 3/8
Second............. 5 1/8 7 5/16 4 5/8 7
Third.............. 5 13/16 7 3/8 6 3/8 9
Fourth............. 5 15/16 11 1/4 6 1/8 9
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.
12
Item 6.
SELECTED FINANCIAL DATA
HANDLEMAN COMPANY
FIVE YEAR REVIEW
(amounts in thousands except per share data and ratios)
1998 % 1997 % 1996 % 1995 % 1994 %
---------- ----- ---------- ----- ---------- ----- ---------- ----- ---------- -----
SUMMARY OF OPERATIONS:
Revenues $1,104,522 100.0 $1,181,037 100.0 $1,132,607 100.0 $1,226,062 100.0 $1,066,566 100.0
Gross profit, after direct product
costs* 270,052 24.4 274,258 23.2 244,685 21.6 278,464 22.7 249,049 23.4
Selling, general and
administrative expenses 243,778 22.1 250,286 21.2 252,377 22.3 220,511 18.0 195,199 18.3
Depreciation and amortization;
included in selling, general &
administrative expenses 32,733 3.0 35,330 3.0 36,884 3.3 31,801 2.6 31,725 3.0
Nonrecurring and repositioning
related charges 13,684 1.2 --- 16,000 1.4 5,500 .4 2,000 .2
Interest expense, net 12,319 1.1 10,967 .9 12,039 1.1 8,024 .7 6,211 .6
Income (loss) before income taxes
and minority interest 271 ** 13,005 1.1 (35,731) ** 44,429 3.6 45,639 4.3
Income tax expense (benefit) 2,800 .3 4,909 .4 (12,738) ** 17,809 1.4 17,983 1.7
Net income (loss) 312 ** 5,352 .5 (22,476) ** 28,023 2.3 27,656 2.6
Dividends --- --- 9,070 14,755 14,701
Average number of shares outstanding 32,868 33,481 33,576 33,518 33,389
PER SHARE DATA:
Earnings (loss) per share - basic
and diluted $ .01 $ .16 $ (.67) $ .84 $ .83
Dividends per share --- --- .27 .44 .44
FINANCIAL DATA:
Cash and receivables $ 268,007 $ 302,520 $ 277,764 $ 283,043 $ 237,846
Inventories 187,173 188,215 212,700 276,109 234,594
Current assets 466,014 500,378 509,813 560,931 477,376
Additions to property and equipment 21,369 22,635 33,596 40,675 28,737
Total assets 613,056 667,886 693,914 754,076 640,998
Debt, current 18,913 15,000 4,000 --- 32,200
Current liabilities 219,098 239,442 264,484 289,961 261,227
Debt, non-current 114,768 135,520 143,600 146,200 76,364
Working capital 246,916 260,936 245,329 270,970 216,149
Shareholders' equity 273,807 283,653 279,560 311,652 299,493
FINANCIAL RATIOS:
Quick ratio
(Cash and receivables/current
liabilities) 1.2 1.3 1.1 1.0 .9
Working capital ratio
(Current assets/current liabilities) 2.1 2.1 1.9 1.9 1.8
Inventory turns
(Direct product costs/average
inventories throughout year) 3.9 4.1 3.4 3.5 3.2
Debt to total capitalization ratio
(Debt, non-current/debt,
non-current plus shareholders'
equity) 29.5% 32.3% 33.9% 31.9% 20.3%
Return on assets
(Net income/average assets) ** .8% ** 4.0% 4.3%
Return on beginning shareholders'
equity
(Net income/beginning shareholders
equity) .1% 1.9% ** 9.4% 9.6%
* - Fiscal 1996 amount is before inventory reduction provision of $14,500.
** - Not meaningful
Note 1: See Item 7., Management's Discussion and Analysis of Financial Condition
and Results of Operations, for additional information regarding the
Company's activities.
Note 2: The Company's fiscal year ends on the Saturday closest to April 30th.
Fiscal 1998 and fiscal years 1994-1996 consisted of 52 weeks, whereas
fiscal 1997 consisted of 53 weeks.
13
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.
14
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.
15
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:
Year Ended
(Dollar Amounts in Millions)
--------------------------------------------------------------------
May 2, 1998 May 3, 1997 April 27, 1996
(52 weeks) (53 weeks) (52 weeks)
------------- --------------- ----------------
Handleman Entertainment Resources
Music $ 684.1 $ 595.6 $ 560.9
% of Total 61.9 50.4 49.5
Video 95.0 266.4 293.4
% of Total 8.6 22.6 25.9
Book 54.1 55.6 53.7
% of Total 4.9 4.7 4.8
Personal Computer Software 37.5 41.7 50.2
% Total 3.4 3.5 4.4
-------- -------- --------
Sub-Total 870.7 959.3 958.2
% of Total 78.8 81.2 84.6
-------- -------- --------
North Coast Entertainment 131.3 134.4 101.5
% of Total 11.9 11.4 9.0
International 124.5 117.0 72.2
% of Total 11.3 9.9 6.4
Eliminations, principally NCE sales to H.E.R. (22.0) (29.7) (18.1)
% of Total (2.0) (2.5) (1.6)
Closed Operation --- --- 18.8
% of Total --- --- 1.6
-------- -------- --------
TOTAL $1,104.5 $1,181.0 $1,132.6
======== ======== ========
16
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.
17
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.
18
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.
19
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.
20
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.
21
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
22
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
23
HANDLEMAN COMPANY
CONSOLIDATED BALANCE SHEET
MAY 2, 1998, MAY 3, 1997 AND APRIL 27, 1996
(amounts in thousands except share data)
ASSETS 1998 1997 1996
---- ---- ----
Current assets:
Cash and cash equivalents $ 25,562 $ 12,449 $ 19,936
Accounts receivable, less allowance of
$17,339 in 1998, $21,834 in 1997 and
$22,141 in 1996 for gross profit impact
of estimated future returns 242,445 290,071 257,828
Merchandise inventories 187,173 188,215 212,700
Other current assets 10,834 9,643 19,349
---------- ---------- ----------
Total current assets 466,014 500,378 509,813
Property and equipment, net 78,711 95,719 111,355
Other assets, net of allowances 68,331 71,789 72,746
---------- ---------- ----------
Total assets $ 613,056 $ 667,886 $ 693,914
========== ========== ==========
LIABILITIES
Current liabilities:
Accounts payable $ 179,227 $ 197,301 $ 223,023
Accrued and other liabilities 39,871 42,141 41,461
---------- ---------- ----------
Total current liabilities 219,098 239,442 264,484
Debt, non-current 114,768 135,520 143,600
Other liabilities 5,383 9,271 6,270
SHAREHOLDERS' EQUITY
Preferred stock, par value $1.00; 1,000,000 --- --- ---
shares authorized; none issued
Common stock, $.01 par value; 60,000,000
shares authorized: 31,977,000 33,373,000
and 33,498,000 shares issued in 1998,
1997 and 1996 320 334 335
Paid-in capital 20,710 30,800 32,089
Foreign currency translation adjustment and other (7,600) (7,546) (7,577)
Retained earnings 260,377 260,065 254,713
---------- ---------- ----------
Total shareholders' equity 273,807 283,653 279,560
---------- ---------- ----------
Total liabilities and shareholders' equity $ 613,056 $ 667,886 $ 693,914
========== ========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
24
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)
1998 1997 1996
---------- ---------- ----------
Revenues $1,104,522 $1,181,037 $1,132,607
Costs and expenses:
Direct product costs 834,470 906,779 887,922
Selling, general and administrative
expenses 243,778 250,286 252,377
Interest expense, net 12,319 10,967 12,039
Nonrecurring and repositioning related
charges 13,684 --- 16,000
---------- ---------- ----------
Income (loss) before income taxes
and minority interest 271 13,005 (35,731)
Income tax (expense) benefit (2,800) (4,909) 12,738
Minority interest 2,841 (2,744) 517
---------- ---------- ----------
Net income (loss) $ 312 $ 5,352 $ (22,476)
========== ========== ==========
Earnings (loss) per common share
- basic and diluted $ .01 $ .16 $ (.67)
========== ========== ==========
Weighted average number of common shares
outstanding during the year - basic 32,868 33,481 33,576
========== ========== ==========
The accompanying notes are an integral part of the
consolidated financial statements.
25
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)
Foreign
Common Stock Currency
------------------ Translation Total
Shares Paid-In Adjustment Retained Shareholders'
Issued Amount Capital and Other Earnings Equity
------ ------ ------- ----------- -------- -------------
April 29, 1995 33,533 $335 $33,188 $(8,130) $286,259 $311,652
Net loss (22,476) (22,476)
Cash dividends, $.27
per share (9,070) (9,070)
Common stock issuancess and forfeitures
in connection with employee benefit plans (35) (1,099) 1,000 (99)
Adjustment for foreign
currency translation (447) (447)
------ ---- ------- ------- -------- --------
April 27, 1996 33,498 335 32,089 (7,577) 254,713 279,560
Net income 5,352 5,352
Common stock issuances and forfeitures
in connection with employee benefit plans (125) (1) (1,289) 1,290 ---
Adjustment for foreign
currency translation (1,259) (1,259)
------ ---- ------- ------- -------- --------
May 3, 1997 33,373 334 30,800 (7,546) 260,065 283,653
Net income 312 312
Common stock issuances and forfeitures
in connection with employee benefit plans (101) (1) (1,258) 1,395 136
Common stock repurchased (1,295) (13) (8,832) (8,845)
Adjustment for foreign
currency translation (1,449) (1,449)
------ ---- ------- ------- -------- --------
May 2, 1998 31,977 $320 $20,710 $(7,600) $260,377 $273,807
====== ==== ======= ======= ======== ========
The accompanying notes are an integral part of the
consolidated financial statements.
26
HANDLEMAN COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED MAY 2, 1998, MAY 3, 1997 AND APRIL 27, 1996
(amounts in thousands)
----------------------
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 312 $ 5,352 $ (22,476)
---------- ------------ ------------
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 27,440 29,205 28,919
Amortization of acquisition costs 5,293 6,125 7,965
Recoupment of license advances 13,103 9,123 7,496
(Increase) decrease in assets from operating activities:
Accounts receivable 47,626 (32,243) 823
Merchandise inventories 1,042 24,485 63,409
Other assets 2,179 10,167 (22,400)
Increase (decrease) in liabilities from operating activities:
Accounts payable (18,074) (25,722) (20,115)
Accrued and other liabilities (9,735) (5,216) (1,138)
---------- ------------ ------------
Total adjustments 68,874 15,924 64,959
---------- ------------ ------------
Net cash provided from operating activities 69,186 21,276 42,483
---------- ------------ ------------
Cash flows from investing activities:
Additions to property and equipment (21,369) (22,635) (33,596)
Retirements of property and equipment 10,937 3,963 11,033
License advances (18,308) (11,752) (12,160)
---------- ------------ ------------
Net cash used by investing activities (28,740) (30,424) (34,723)
---------- ------------ ------------
Cash flows from financing activities:
Issuances of debt 1,811,205 1,363,311 2,053,087
Payments of debt (1,828,380) (1,360,391) (2,055,687)
Cash dividends --- --- (9,070)
Repurchase of common stock (8,845) --- ---
Other changes in shareholders' equity, net (1,313) (1,259) (546)
---------- ------------ ------------
Net cash provided from (used by)
financing activities (27,333) 1,661 (12,216)
---------- ------------ ------------
Net increase (decrease) in cash and
cash equivalents 13,113 (7,487) (4,456)
Cash and cash equivalents at
beginning of year 12,449 19,936 24,392
---------- ------------ ------------
Cash and cash equivalents at
end of year $ 25,562 $ 12,449 $ 19,936
========== ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
27
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.
28
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.
29
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:
Adjustments of assets to net
realizable value $65,000,000 - $ 80,000,000
Employee severance and related
benefit costs 5,000,000
Intangibles write-off 11,000,000
Repositioning related costs including
debt restructuring and
advisory fees 9,000,000 - 14,000,000
--------------------------
$90,000,000 - $110,000,000
==========================
30
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.
31
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:
1998 1997 1996
------------- ------------ ------------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including
vested benefits of $18,266,000, $14,339,000 and
$12,783,000 in 1998, 1997 and 1996,
respectively $19,080,000 $15,403,000 $13,769,000
=========== =========== ===========
Projected benefit obligation $22,748,000 $18,158,000 $16,918,000
Plan assets at fair value 20,413,000 16,492,000 15,627,000
----------- ----------- -----------
Projected benefit obligation in excess of plan assets (2,335,000) (1,666,000) (1,291,000)
Unrecognized net loss from past experience different
from that assumed 346,000 188,000 503,000
Unrecognized net gain from excess funding, being
amortized over 18 years (609,000) (728,000) (847,000)
Unrecognized prior service cost 235,000 246,000 257,000
----------- ----------- -----------
Accrued pension liability included in accrued and
other liabilities $(2,363,000) $(1,960,000) $(1,378,000)
=========== =========== ===========
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.
1998 1997 1996
----------- ----------- -----------
Net pension expense included the
following components:
Service cost $ 887,000 $ 886,000 $ 869,000
Interest cost 1,365,000 1,321,000 1,182,000
Actual return on plan assets (4,494,000) (2,046,000) (2,149,000)
Net amortization and deferral 3,005,000 626,000 926,000
----------- ----------- -----------
Net pension expense $ 763,000 $ 787,000 $ 828,000
=========== =========== ===========
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.
32
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.
33
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:
1998 1997 1996
------------- ------------ -------------
Domestic $ 12,378,000 $10,896,000 $(33,663,000)
Foreign (12,107,000) 2,109,000 (2,068,000)
------------ ----------- ------------
Income (loss) before income
taxes and minority interest $ 271,000 $13,005,000 $(35,731,000)
============ =========== ============
Provisions for income taxes for the years ended May 2, 1998, May 3, 1997 and
April 27, 1996 consist of the following:
1998 1997 1996
---------- ----------- ------------
Currently payable:
Federal $1,995,000 $ 9,054,000 $(11,059,000)
Foreign 483,000 477,000 1,049,000
State and other 531,000 794,000 (2,560,000)
Deferred, net:
Federal 291,000 (4,646,000) 87,000
Foreign (221,000) 326,000 (190,000)
State and other (279,000) (1,096,000) (65,000)
---------- ----------- ------------
$2,800,000 $ 4,909,000 $(12,738,000)
========== =========== ============
The following table provides a reconciliation of the Company's resulting income
tax to the statutory federal income tax:
1998 1997 1996
----------- ---------- ------------
Federal statutory tax $ 95,000 $4,552,000 $(12,506,000)
State and local income taxes 164,000 (234,000) (1,822,000)
Effect of foreign tax losses with no
tax benefit 6,386,000 --- 1,465,000
Prior years' tax accruals no longer
necessary (3,335,000) --- ---
Other (510,000) 591,000 125,000
----------- ---------- ------------
Resulting tax $ 2,800,000 $4,909,000 $(12,738,000)
=========== ========== ============
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:
May 2, 1998 May 3, 1997 April 27, 1996
-------------------------- -------------------------- --------------------------
Deferred Tax Deferred Tax Deferred Tax Deferred Tax Deferred Tax Deferred Tax
Tax Assets Liabilities Assets Liabilities Assets Liabilities
- ------------------------------------------------------------------------------------------------------------------------------
Allowances $ 9,294,000 $ 5,919,000 $10,612,000 $ 6,503,000 $ 6,807,000 $ 5,228,000
Foreign net operating losses
including net temporary differences 7,700,000 --- 3,200,000 --- 3,100,000 ---
Employee benefits 2,675,000 458,000 2,139,000 10,000 1,585,000 122,000
Property and equipment 1,759,000 7,875,000 738,000 8,190,000 1,462,000 8,076,000
Inventory 474,000 2,223,000 906,000 2,053,000 278,000 4,513,000
Other 588,000 325,000 550,000 408,000 172,000 ---
----------- ----------- ----------- ----------- ----------- -----------
22,490,000 16,800,000 18,145,000 17,164,000 13,404,000 17,939,000
Valuation allowance (7,700,000) --- (3,200,000) --- (3,100,000) ---
----------- ----------- ----------- ----------- ----------- -----------
Net $14,790,000 $16,800,000 $14,945,000 $17,164,000 $10,304,000 $17,939,000
=========== =========== =========== =========== =========== ===========
34
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
============ ============ ============
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
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.
Number Weighted
of Shares Average Price
---------- -------------
Balance, April 29, 1995 1,222,829 $14.45
Granted 336,000 10.06
Terminated (256,145) 13.65
Exercised --- ---
--------- ------
Balance, April 27, 1996 1,302,684 13.48
Granted 350,000 6.80
Repriced 56,975 7.03
Terminated, including repriced options (396,744) 12.93
Exercised --- ---
--------- ------
Balance, May 3, 1997 1,312,915 13.48
Granted 322,850 6.53
Repriced 66,575 6.95
Terminated, including repriced options (277,171) 11.70
Exercised (17,750) 6.55
--------- ------
Balance, May 2, 1998 1,407,419 $10.24
========= ======
Number of shares exercisable
at May 2, 1998 883,819 $12.37
========= ======
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.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
----------------
9. Quarterly Financial Summary (Unaudited):
---------------------------------------
(amounts in thousands except per share data)
FOR THE THREE MONTHS ENDED
--------------------------
Aug. 2, Nov. 1, Jan. 31, May 2,
Fiscal Year 1998 1997 1997 1998 1998
- ---------------- ---- ---- ---- ----
Revenues $209,037 $315,285 $308,202 $271,998
Income (loss) before income taxes
and minority interest (9,733) 10,969 9,897 (10,862)
Net income (loss) (6,470) 8,320 6,954 (8,492)
Earnings (loss) per share - basic and diluted (.19) .25 .21 (.26)*
July 27, Oct. 26, Jan. 31, May 3,
Fiscal Year 1997 1996 1996 1997 1997
- ---------------- ---- ---- ---- ----
Revenues $225,026 $347,080 $330,532 $278,399
Income (loss) before income taxes
and minority interest (11,967) 11,897 12,076 999
Net income (loss) (8,181) 6,822 6,527 184
Earnings (loss) per share - basic and diluted (.24) .20 .19 .01*
July 29, Oct. 28, Jan. 31, April 27,
Fiscal Year 1996 1995 1995 1996 1996
- ---------------- ---- ---- ---- ----
Revenues $230,789 $295,170 $345,605 $261,043
Income (loss) before income taxes
and minority interest (9,727) 4,662 1,543 (32,209)
Net income (loss) (6,469) 3,365 1,097 (20,469)
Earnings (loss) per share - basic and diluted (.19) .10 .03* (.61)*
Dividends per share .11 .11 .05 ---
*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.
37
Item 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
Not applicable
PART III.
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.
EXECUTIVE OFFICERS OF THE REGISTRANT
Name and Age Office and Year First Elected
- ---------------------------------------------------------------------
Stephen Strome 53 (1) President (1990), Chief Executive Officer (1991) and Director (1989)
Peter J. Cline 51 (2) Executive Vice President/President of H.E.R. (1994)
Stephen Nadelberg 57 (3) Senior Vice President/President of NCE (1997)
Arnold Gross 57 (4) Senior Vice President/President of Handleman International (1997)
Leonard A. Brams 47 (5) Senior Vice President/Finance, Chief Financial Officer and Secretary (1997)
Thomas C. Braum, Jr. 43 (6) Vice President (1992) and Corporate Controller (1988)
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.
38
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. 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. 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. 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
39
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.
40
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.
41
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
42
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
YEARS ENDED APRIL 27, 1996, MAY 3, 1997 AND MAY 2, 1998
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
----------- ----------- ----------- ------------- -------------
Deductions:
Balance at Additions: Adjustments
Beginning Charged to of, or Charge Balance at
Description of Period Expense to, Reserve end of Period
----------- ----------- ----------- ------------- -------------
Year ended April 27, 1996:
Accounts receivable,
allowance for gross
profit impact of estimated
future returns $24,053,000 $13,972,000 $15,884,000 $22,141,000
=========== =========== =========== ===========
Other assets, collectability
allowance for receivables
from bankrupt customers $13,176,000 $ 4,687,000 $ 3,913,000 $13,950,000
=========== =========== =========== ===========
Year ended May 3, 1997:
Accounts receivable,
allowance for gross
profit impact of estimated
future returns $22,141,000 $ 7,959,000 $ 8,266,000 $21,834,000
=========== =========== =========== ===========
Other assets, collectability
allowance for receivables
from bankrupt customers $13,950,000 $ 3,805,000 $ 4,754,000 $13,001,000
=========== =========== =========== ===========
Year ended May 2, 1998:
Accounts receivable,
allowance for gross
profit impact of estimated
future returns $21,834,000 $ 8,873,000 $13,368,000 $17,339,000
=========== =========== =========== ===========
Other assets, collectability
allowance for receivables
from bankrupt customers $13,001,000 $ 1,895,000 $ 9,555,000 $ 5,341,000
=========== =========== =========== ===========
43
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
44