HANDLEMAN CO /MI/ - 10-K Annual Report

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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 April 29, 2000 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 Name of each exchange which registered
- ---------------------------------- --------------------------------------
COMMON STOCK $.01 PAR VALUE NEW YORK STOCK EXCHANGE

Securities registered pursuant to Section 12(g) of the Act:

NONE
--------------
(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for 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 10, 2000 was $307,810,000.

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 10, 2000 was 27,684,464.

Item 14(a) 3. on page 42 describes the exhibits filed with the Securities and
Exchange Commission.

Certain sections of the definitive Proxy Statement to be filed for the 2000
Annual Meeting of Shareholders are incorporated by reference into Part III.

PART 1

Item 1. BUSINESS

Handleman Company, a Michigan corporation (herein referred to as the "Company"
or "Handleman" or "Registrant"), which has its executive offices in Troy,
Michigan, is the successor to a proprietorship formed in 1934, and to a
partnership formed in 1937.

DESCRIPTION OF BUSINESS:

The Company has two business segments: Handleman Entertainment
Resources("H.E.R."), and North Coast Entertainment ("NCE"). H.E.R. is a category
manager and distributor of prerecorded music to mass merchants. NCE is
responsible for the Company's proprietary operations, which include music and
video products, as well as licensing operations. Handleman International (which
encompassed music category management and distribution operations in Mexico and
Brazil), was reported as a separate segment for fiscal 1999. Following a change
in responsibility for the segment effective at the beginning of fiscal 2000,
Handleman International has been included within H.E.R. for all years presented
herein.

The accounting policies of the segments are the same as those described in Note
1 of Notes to Consolidated Financial Statements, "Accounting Policies." Segment
data includes intersegment revenues, as well as a charge allocating all
corporate costs to the operating segments. The Company evaluates performance of
its segments and allocates resources to them based on income before interest,
income taxes, minority interest and repositioning and related charges.

See Note 2 of Notes to Consolidated Financial Statements for additional
information regarding segment activities.

On June 2, 1998, the Company's Board of Directors approved a comprehensive
strategic repositioning program designed to focus the Company on its core music
distribution business. The repositioning program resulted in a $110 million
charge to earnings in the first quarter of fiscal 1999, representing asset
adjustments and cost accruals directly related to the repositioning program,
other than those costs actually incurred and charged to earnings in fiscal 1998
of $13.7 million, and certain costs that were required to be expensed as
incurred in fiscal 1999. The repositioning activities, including employee
severance programs, were completed during fiscal 1999. Reference should be made
to the Company's Form 10-K for the year ended May 1, 1999 for additional
discussion regarding repositioning and related charges.

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 percentage contribution to
consolidated revenues, for the Company's two business segments for the fiscal
years ended April 29, 2000, May 1, 1999 and May 2, 1998.

Year Ended
(dollar amounts in millions)
-------------------------------------------------------------
April 29, 2000 May 1, 1999 May 2, 1998
(52 weeks) (52 weeks) (52 weeks)
------------------ ----------------- -----------------

Handleman Entertainment Resources $1,011.3 $ 888.4 $ 789.5
% of Total 88.9 83.9 71.5

North Coast Entertainment 142.0 139.0 93.9
% of Total 12.5 13.1 8.5

Eliminations, principally NCE sales to H.E.R. (15.7) (17.5) (22.0)
% of Total (1.4) (1.6) (2.0)

Exited Activities (1) -- 48.7 243.1
% of Total 4.6 22.0
-------- -------- --------

TOTAL $1,137.6 $1,058.6 $1,104.5
======== ======== ========

(1) Exited activities represent, within H.E.R., sales of the exited video, book
and software product lines and sales in Argentina where the operations were
sold in the fourth quarter of fiscal 1999, and within NCE, sales at
Sofsource, which was sold during the first quarter of fiscal 1999.

3

Handleman Entertainment Resources

The major business activity of H.E.R. is to actively manage the selection,
acquisition, display, sale and return of music product for unrelated mass
merchant chain stores. The following discussion pertains to these category
management activities of H.E.R. which comprises approximately 89% of the
Company's sales.

In November 1999 the Company acquired Lifetime Entertainment Limited, a category
manager in the United Kingdom, for approximately $6.5 million. Although this was
not a significant acquisition, it provides the Company entry into the
established Western European music distribution market.

The Company's vendors and customers use the services of H.E.R. for a variety of
reasons:

. Music is a local and national business requiring that products
selected for each individual store meet the unique demand of consumers who
frequent each store.

. Store service - the Company's field sales force visits each mass
merchant store to implement a variety of merchandising responsibilities,
including verifying that product has been placed on display, ensuring that
the department is neatly merchandised and that top-hit product is
available, setting up point of purchase displays, reordering product with
low inventory levels or required for local events, and ensuring that new
release product is displayed as close to the release date as possible.

. Direct store shipment - the Company bypasses mass merchant distribution
centers and ships directly to thousands of unique retail locations.

. Numerous small quantity shipments - to tailor each store inventory
to unique and changing consumer demand in each store, the Company must make
frequent shipments of less than case lot quantities to each store.

The Company distributes throughout vast geographic regions and adapts selections
to local tastes via a coordination of national and local purchasing
responsibility, both monitored by inventory control programs. In fiscal 2000,
approximately 95% of H.E.R.'s sales were in the U.S. and Canada.

Vendors

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 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-salable 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-salable 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.

4

Customers

H.E.R.'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. In addition, mass merchants utilize category managers due to the
complexity of managing the numerous SKUs required per department, the
variability of salable items among individual stores of a mass merchant chain,
the wide array of programs offered by the multitude of vendors, the "hits"
nature of the business and the high risk of inventory obsolescence. As a result,
customers avoid most of the risks inherent in product selection and the 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.

H.E.R. also offers 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.

Handleman 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 reduces gross sales and direct product costs for estimated
future returns at the time the merchandise is sold.

During the fiscal year ended April 29, 2000, one customer, Wal-Mart, accounted
for approximately 42% of the Company's consolidated sales, while a second
customer, Kmart, accounted for approximately 35%. Handleman generally does not
have contracts with its customers, and such relationships may be changed or
discontinued at any time by the customers or Handleman; the discontinuance or a
significant unfavorable change in the relationships with either of the two
largest customers would have a materially adverse effect upon the Company's
future sales and earnings.

Operations

The Company distributes products from facilities in the U.S., Canada, Mexico,
Brazil and the United Kingdom. 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 music
business, display of new releases close to authorized "street dates" is an
important driver of both retail sales and customer satisfaction.

5

Within its facilities, the Company operates return centers, including use of
automated return processing equipment in the United States and Canada, 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.

The Company has implemented high-technology automated distribution equipment in
Indianapolis, Indiana; Sparks, Nevada and Toronto, Canada, and will implement
such equipment in its Warrington, United Kingdom facility during fiscal 2001.

The Company also utilizes 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
directly to distributors or retailers. NCE has operations in the United States
and Canada, and to a minimal extent in Germany and the United Kingdom. In
addition, NCE products are available in Mexico and South America. In fiscal
2000, approximately 98% of NCE's sales were in the U.S. and Canada. Many NCE
products are categorized as budget, with many retailing for under $10. Such
products are designed to provide high margins to the retailer at prices that
generate impulse sales.

NCE 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 products. This enables H.E.R. 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.

6

NCE's current portfolio is comprised of the following entities:

. Anchor Bay Entertainment ("ABE") is one of the leading independent
distributors of home video products. ABE holds rights to a wide variety of
genres including classic theatrical films, family movies, children's
entertainment and chart-topping fitness lines. The award-winning children's
series, Thomas the Tank Engine & Friends has been a part of the ABE family
for many years. Anchor Bay Entertainment's fitness line, Crunch, is
consistently ranked on the top of fitness video charts annually.
Additionally, ABE is one of the largest rights holders within the horror
genre in the United States. Some of the company's most recent successes
have included Monte Hellman's classic Two-Lane Blacktop, Alfred Hitchcock's
Rebecca, the sci-fi classic The Black Hole, the thriller Halloween and
several of critically-acclaimed director Werner Herzog's films. Anchor Bay
has established itself as a haven for some of the world's great filmmakers
and studios. Producers, as well as many top directors, have found that the
company is one of the few interested in releasing outstanding films from
the finest elements possible. They have developed long-standing
relationships with such filmmakers as Werner Herzog, George A. Romero, John
Woo, Monte Hellman, Dario Argento and Max Baer.

. Madacy Entertainment Group ("Madacy"), in which NCE owns an 80%
share, controls the masters for more than 100,000 music recordings and has
over 650 video and DVD licensed titles. Madacy has the distinction of being
ranked the number one independent record label in the United States for
four years in a row (as ranked by "Music and Copyright Journal"). Madacy's
music catalog, which includes virtually every musical genre, features an
extensive classical library, romantic instrumental standards by the 101
Strings Orchestra, hits by the Orlando Pops Orchestra and the Countdown
Singers. Madacy has used this catalog to develop branded music for major
United States retailers.

. The itsy bitsy Entertainment Company ("TibECo") - NCE owns a 75%
share in TibECo, a firm dedicated to producing, licensing and marketing
entertainment properties for children and their caregivers. TibECo has the
exclusive right to license a number of childrens properties including
Ragdoll Productions' Teletubbies and Tots TV, Enid Blyton's Noddy and Kay
Thompson's Eloise. Day-to-day management of TibECo remains with its
continuing management team.

NCE's management will continue to focus its attention on growing the business
through licensing, acquiring or producing new products, as well as via new
markets, new customers, geographical growth, growth within the home
entertainment category and selective acquisitions and joint ventures.

7

Competition

Handleman is primarily a category manager of music products. The business of the
Company is highly competitive as to both price and alternative supply
arrangements. 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) record clubs, and (4) internet direct sales,
including direct to home shipment and direct downloading through a consumer's
home computer. Also, new methods of in-home delivery of entertainment software
products are continually being introduced. The Company competes directly for
sales to its customers with (1) manufacturers that bypass wholesalers and sell
directly to retailers, (2) independent distributors, and (3) other category
managers. In addition, some large mass merchants have "vertically integrated" so
as to provide their own category management. Some of these companies, however,
also purchase from independent category managers.

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.

* * * * * * * *

See Management's Discussion and Analysis of Financial Condition and Results of
Operations and Note 3, Repositioning and Related Charges, on page 31 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 39 under Item 8 discloses quarterly
results which indicate the seasonality of the Company's business.

The Company has approximately 2,500 employees. As of April 29, 2000, none were
unionized. The repositioning program resulted in a reduction of approximately
1,000 positions (about 30% of the Company's total workforce). This reduction
occurred predominately in the H.E.R. division and the Troy corporate
headquarters.

8

Item 2. PROPERTIES

As of April 29, 2000, the Company's H.E.R. division occupies six leased
warehouses located in the United States (2), Canada, the United Kingdom, Mexico
and Brazil. The leased warehouses are located in Indianapolis, Indiana; Reno,
Nevada; Toronto, Ontario; Warrington, United Kingdom; Mexico City, Mexico and
Sao Paulo, Brazil. The H.E.R. division also occupies nine leased satellite sales
offices which are located in the states of Maryland, Michigan, Missouri,
California, Georgia, Illinois and New York, as well as the Canadian provinces of
Alberta and Quebec. The vacant Company-owned warehouses in Baltimore, Maryland
and Tampa, Florida, which have a net book value of approximately $6.0 million,
are being sold. Sales proceeds are estimated to approximate net book value.

The Company's NCE unit leases one warehouse located in Quebec, Canada. NCE also
occupies leased office space within the United States in the states of Michigan,
California, New Jersey, New York and Minnesota, as well as in Canada and
Germany.

The Company owns its 130,000 square feet corporate office building located in
Troy, Michigan.

Item 3. LEGAL PROCEEDINGS

There are no pending legal proceedings to which the Registrant or any of its
subsidiaries is a party, other than routine litigation which are incidental to
the business and deemed immaterial to results of operations, financial position
and cash flows.

Item 4. SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS

Not applicable.

9

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 under the
symbol of "HDL."

Below is a summary of the market price of the Company's common stock:

Fiscal Year Ended

-----------------------------------------------------------------------
April 29, 2000 May 1, 1999

Quarter Low High Low High
------- -----------------------------------------------------------------------

First 10 3/4 14 1/2 8 3/4 12 15/16

Second 9 3/8 16 3/8 5 13/16 10 1/8

Third 9 3/4 17 9 3/4 15

Fourth 8 1/2 12 7/8 9 15/16 14 13/16

As of July 10, 2000, the Company had 3,240 shareholders of record.

The Company has not declared or paid dividends during the past two fiscal years.

10

Item 6. SELECTED FINANCIAL DATA
HANDLEMAN COMPANY
FIVE-YEAR REVIEW
(amounts in thousands except per share data and ratios)

2000 % 1999 % 1998 % 1997 % 1996 %
---- - ---- - ---- - ---- - ---- -

SUMMARY OF OPERATIONS:

Revenues $1,137,605 100.0 $1,058,553 100.0 $1,104,522 100.0 $1,181,037 100.0 $1,132,607 100.0
Gross profit, after direct product
costs* 288,776 25.4 266,870 25.2 270,052 24.4 274,258 23.2 230,185 20.3
Selling, general & administrative
expenses 219,625 19.3 211,682 20.0 243,778 22.1 250,286 21.2 252,377 22.3
Depreciation and amortization:
included in selling, general &
administrative expenses 20,109 1.8 20,488 1.9 32,733 3.0 35,330 3.0 36,884 3.3
Repositioning and related charges,
and other unusual charges*** -- 96,362 9.1 13,684 1.2 -- -- 1,500 .1
Interest expense, net 3,178 .3 8,088 0.8 12,319 1.1 10,967 .9 12,039 1.1
Income (loss) before income taxes
and minority interest 65,973 5.8 (49,262) ** 271 ** 13,005 1.1 (35,731) **
Income tax expense (benefit) 26,255 2.3 (16,449) ** 2,800 .3 4,909 .4 (12,738) **
Net income (loss) 38,648 3.4 (35,052) ** 312 ** 5,352 .5 (22,476) **
Dividends -- -- -- -- 9,070
Weighted average number of
shares outstanding
-- basic 29,425 31,568 32,868 33,481 33,576
-- diluted 29,692 31,818 32,886 33,500 33,576

PER SHARE DATA:

Earnings (loss) per share - basic $ 1.31 $ (1.11) $ .01 $ .16 $ (.67)
- diluted 1.30 (1.11) .01 .16 (.67)
Dividends per share -- -- -- -- .27

BALANCE SHEET DATA:

Cash and receivables $ 261,515 $ 245,373 $ 268,007 $ 302,520 $ 277,764
Inventories 100,298 102,589 187,173 188,215 212,700
Current assets 377,849 369,522 466,014 500,378 509,813
Additions to property and
equipment 20,335 17,054 21,369 22,635 33,596
Total assets 519,683 487,856 613,056 667,886 693,914
Debt, current 14,571 18,571 18,571 15,000 4,000
Current liabilities 248,128 216,801 219,098 239,442 264,484
Debt, non-current 33,986 39,857 114,768 135,520 143,600
Working capital 129,721 152,721 246,916 260,936 245,329
Shareholders' equity 223,282 225,686 273,807 283,653 279,560

FINANCIAL RATIOS:

Quick ratio
(Cash and receivables/current
liabilities) 1.1 1.1 1.2 1.3 1.1
Working capital ratio
(Current assets/current
liabilities) 1.5 1.7 2.1 2.1 1.9
Inventory turns
(Direct product costs/average
inventories throughout year) 6.6 5.5 3.9 4.1 3.4
Debt to total capitalization ratio
(Debt, non-current/debt,
non-current plus
shareholders' equity) 13.2% 15.0% 29.5% 32.3% 33.9%
Return on assets
(Net income/average assets) 7.7% ** ** .8% **
Return on beginning shareholders'
equity (Net income/beginning
shareholders' equity) 17.1% ** .1% 1.9% **

* - Amount in fiscal 1996 includes an inventory reduction provision of
$14,500.
** - Not meaningful
*** - Amount for fiscal 1999 is net of $31,000 gain on sale
of subsidiary.

Note: The Company's fiscal year ends on the Saturday closest to April 30th.
Fiscal years 2000, 1999, 1998 and 1996 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.

11

Item 7. Management's Discussion and
Analysis of Financial Condition
and Results of Operations

The Company has two business segments: Handleman Entertainment Resources
("H.E.R.") and North Coast Entertainment ("NCE"). H.E.R. consists of music
distribution and category management operations in the U.S., Canada, Mexico,
Brazil and the United Kingdom. Handleman International (which encompassed music
category management and distribution operations in Mexico and Brazil), was
previously reported as a separate segment for fiscal 1999. Due to a change in
responsibility for the segment effective at the beginning of fiscal 2000,
Handleman International is now included within the H.E.R. segment for all three
years presented herein. NCE encompasses the Company's proprietary operations,
which include music and video products, as well as licensing operations. All
references herein to NCE exclude Sofsource, which was sold during the first
quarter of fiscal 1999. Business segment sales discussed herein include
intercompany sales which are eliminated in consolidation.

The following table sets forth net sales, and the percentage contribution to
consolidated revenues, for the Company's two business segments for the fiscal
years ended April 29, 2000, May 1, 1999 and May 2, 1998.

Year Ended
(dollar amounts in millions)
-----------------------------------------------------------------
April 29, 2000 May 1, 1999 May 2, 1998
(52 weeks) (52 weeks) (52 weeks)
-------------------- ---------------- -----------------

Handleman Entertainment Resources $1,011.3 $ 888.4 $ 789.5
% of Total 88.9 83.9 71.5

North Coast Entertainment 142.0 139.0 93.9
% of Total 12.5 13.1 8.5

Eliminations, principally NCE sales to H.E.R. (15.7) (17.5) (22.0)
% of Total (1.4) (1.6) (2.0)

Exited Activities (1) -- 48.7 243.1
% of Total 4.6 22.0
-------- -------- --------

TOTAL $1,137.6 $1,058.6 $1,104.5
======== ======== ========

(1) Exited activities represent, within H.E.R., sales of the exited video, book
and software product lines and sales in Argentina where the operations were
sold in the fourth quarter of fiscal 1999, and, within NCE, sales at
Sofsource which was sold during the first quarter of fiscal 1999. See later
discussion regarding the Company's strategic repositioning program adopted
on June 2, 1998.

12

COMPARISON OF FISCAL 2000 WITH FISCAL 1999

For the fiscal year ended April 29, 2000 ("fiscal 2000"), revenues increased 7%
to $1.14 billion from $1.06 billion for the fiscal year ended May 1, 1999
("fiscal 1999"). This increase in revenues was primarily the result of increased
music sales at H.E.R. Fiscal 1999 net sales included $48.7 million attributable
to product lines and activities exited pursuant to the repositioning program
discussed later herein.

Net income for fiscal 2000 was $38.6 million or $1.30 per diluted share,
compared to a net loss of $(35.1) million or $(1.11) per share for fiscal 1999.
The Company's fiscal 1999 results included pre-tax repositioning and related
charges of $127.4 million and a pre-tax gain on the sale of subsidiary of $31
million.

H.E.R. net sales increased 14% to $1.01 billion for fiscal 2000 from $888.4
million for fiscal 1999. This increase in net sales was principally due to
strong music sales by H.E.R.'s customers. Management believes this was mainly
due to the Company's mass merchant customers outperforming, in regards to music
sales, other mass merchants as a group, as well as exceeding the overall music
industry growth rate.

NCE net sales for fiscal 2000 were $142.0 million, compared to $139.0 million
for the comparable period last year.

Direct product costs as a percentage of revenues was 74.6% for fiscal 2000,
compared to 74.8% for fiscal 1999. The slight decrease in direct product costs
as a percentage of revenues was primarily attributable to the inclusion of
higher direct product costs related to product lines exited during fiscal 1999,
which had a dampening effect on the prior year's gross profit margin percentage.

In the first quarter of fiscal 1999, the Company's Board of Directors approved a
repositioning program which resulted in a $110 million charge during that
quarter, representing asset adjustments and cost accruals directly related to
the repositioning program. A component of the $110 million charge was a $31.6
million provision for merchandise inventory write-downs required to liquidate
inventory through non-traditional channels as a result of the Company exiting
certain product lines (video, book and software) and no longer servicing certain
customers. The table below displays the proforma presentation of operations for
the fiscal years ended April 29, 2000 and May 1, 1999 as if the inventory
write-downs had been included in direct product costs (dollar amounts in
millions):

Fiscal Year Ended
-----------------------------------------------------
April 29, 2000
As Reported and May 1, 1999 May 1, 1999
Proforma As Reported Proforma
-------- ----------- --------

Revenues $1,137.6 $1,058.6 $1,058.6
Direct product costs 848.8 791.7 823.3
Repositioning and related costs -- 127.4 95.8
Direct product costs as a
percentage of revenues 74.6% 74.8% 77.8%

Selling, general and administrative ("SG&A") expenses for fiscal 2000 were
$219.6 million or 19.3% of revenues, compared to $211.7 million or 20.0% of
revenues for fiscal 1999. H.E.R. SG&A expenses for fiscal 2000 approximated
fiscal 1999 levels. NCE SG&A expenses increased 18% for fiscal 2000, compared to
the prior fiscal year, primarily due to incremental expenses incurred for
investments in future revenue producing projects.

Income before interest, income taxes, minority interest, repositioning and
related charges and gain on sale of subsidiary ("operating income") for fiscal
2000 increased to $69.2 million from $55.2 million for fiscal 1999. H.E.R.
operating income increased 52% to $54.8 million for fiscal 2000 from $36.1
million for the comparable prior year period. This increase was attributable to
the higher sales level. NCE operating income was $14.2

13

million for fiscal 2000, compared to $20.0 million for fiscal 1999. The decrease
in NCE operating income was principally related to increased SG&A expenses
discussed above.

Net interest expense for fiscal 2000 was $3.2 million, compared to $8.1 million
for fiscal 1999. This decrease in net interest expense was attributable to lower
borrowing levels.

Minority interest recognized in the statement of operations represents the
minority shareholders' portion of the income or loss for less than wholly-owned
subsidiaries. Minority interest expense was $1.1 million for fiscal 2000,
compared to $2.2 million for fiscal 1999.

Accounts receivable was $234.0 million at April 29, 2000, compared to $218.0
million at May 1, 1999. This increase was primarily due to the higher level of
sales in the fourth quarter of fiscal 2000, compared to the fourth quarter of
fiscal 1999.

The decrease in other current assets to $16.0 million at April 29, 2000 from
$21.6 million at May 1, 1999 was mainly attributable to the collection of income
taxes receivable related to a net operating loss carryback arising from the
repositioning charges in fiscal 1999.

Other assets, net was $90.0 million at April 29, 2000, compared to $64.9 million
at May 1, 1999. This increase was primarily attributable to the cost of license
advances and acquired rights of $30.0 million.

Accounts payable increased to $202.3 million at April 29, 2000 from $156.3
million at May 1, 1999. This increase was principally the result of the timing
of payments to vendors and increased merchandise purchases during the fourth
quarter of fiscal 2000, compared to the fourth quarter of the prior fiscal year.

Accrued and other liabilities decreased to $31.2 million at April 29, 2000 from
$41.9 million at May 1, 1999. This decrease was chiefly due to decreases in
accrued royalties and other payroll related items.

Other liabilities were $14.3 million at April 29, 2000, compared to $5.5 million
at May 1, 1999. This increase was primarily the result of an increase in
deferred revenues, which related to cash received for future revenue recognition
on certain new investments at The itsy bitsy Entertainment Company ("TibECo").

During fiscal 2000, the Company repurchased 3,538,000 shares of its common stock
at a cost of $42.0 million, leaving 27,691,000 shares outstanding as of April
29, 2000. Since September 1997, the Company has repurchased 6,576,000 shares of
its common stock, representing 20% of its outstanding shares (prior to
initiating the stock repurchase programs), at a cost of $71.8 million. Under the
current Board authorization (which expires in December 2000), the Company can
repurchase up to $6 million in additional shares of stock.

COMPARISON OF FISCAL 1999 WITH FISCAL 1998

For the fiscal year ended May 1, 1999 ("fiscal 1999"), revenues decreased 4% to
$1.06 billion from $1.10 billion for the fiscal year ended May 2, 1998 ("fiscal
1998"). This decrease in revenues was primarily the result of lower sales in the
video, book and software product lines which H.E.R. exited during fiscal 1999 in
connection with the Company's repositioning program.

Net loss for fiscal 1999 was $(35.1) million or $(1.11) per share, compared to
net income for fiscal 1998 of approximately $300,000 or $.01 per share. The
Company's fiscal 1999 results included pre-tax repositioning and related charges
of $127.4 million and a pre-tax gain on sale of subsidiary of $31 million. The
Company's fiscal 1998 results included pre-tax repositioning and related charges
of $13.7 million.

H.E.R.'s net sales grew 13% to $888.4 million for fiscal 1999, from $789.5
million for fiscal 1998. The increase in net sales was primarily due to the
Company's customers building market share by achieving music sales growth rates
that outpaced the overall industry sales.

14

NCE net sales increased 48.0% to $139.0 million for fiscal 1999, from $93.9
million for fiscal 1998. The NCE sales increase was primarily attributable to
the Anchor Bay and Madacy units, where the sales increases were driven by the
release of new titles.

Net sales for fiscal 1999 and fiscal 1998 included $48.7 million and $243.1
million, respectively, attributable to product lines and activities exited
pursuant to the repositioning program.

Direct product costs as a percentage of reported revenues was 74.8% for fiscal
1999, compared to 75.6% for fiscal 1998. The year-over-year reduction in direct
product costs as a percentage of revenues was primarily attributable to H.E.R.,
which experienced a reduction in low-margin video, book and software sales and
an increase in music sales. Music products have a cost to revenue relationship
lower than the cost to revenue relationship for the exited video, book and
software product lines.

SG&A expenses for fiscal 1999 were $211.7 million, or 20.0% of revenues,
compared to $243.8 million, or 22.1% of revenues in fiscal 1998. The $32.1
million decrease in SG&A expenses was attributable to H.E.R., which reduced
year-over-year SG&A expenses by $34.8 million, or by 17.2%, primarily as a
result of the repositioning program.

Operating income for fiscal 1999 increased to $55.2 million, from $26.3 million
for fiscal 1998. H.E.R.'s operating income improved to $36.1 million, from $12.3
million for fiscal 1998. NCE's operating income improved to $20.0 million, from
$11.2 million for fiscal 1998.

Repositioning and related charges were $127.4 million in fiscal 1999, and $13.7
million in fiscal 1998. Further discussion follows regarding the Company's
strategic repositioning program.

Net interest expense for fiscal 1999 was $8.1 million, compared to $12.3 million
for fiscal 1998. This decrease in interest expense was attributable to lower
borrowing levels.

Minority interest recognized in the statement of operations represents the
minority shareholders' portion of the income or loss for less than wholly-owned
subsidiaries. The Mexican unit's losses during fiscal 1998 were mitigated to
some extent by the sharing of the losses with the Company's joint venture
partner. During the fourth quarter of fiscal 1998, the Company acquired the
interest of its partner in Mexico. During the fourth quarter of fiscal 1999, the
Company sold a 21% interest in its Mexican operations to a new joint venture
partner. Minority interest was expense of $2.2 million in fiscal 1999 and income
of $2.8 million in fiscal 1998.

Accounts receivable were $218.0 million at May 1, 1999, compared to $242.4
million at May 2, 1998. This decrease was primarily attributable to the lower
level of sales in the fourth quarter of fiscal 1999 compared to the fourth
quarter of fiscal 1998.

Merchandise inventories were $102.6 million at May 1, 1999, compared to $187.2
million at May 2, 1998. The decrease in merchandise inventories was primarily
attributable to the H.E.R. video, book and software inventories, which were
reduced in connection with exiting these product lines.

The increase in other current assets to $21.6 million at May 1, 1999 from $10.8
million at May 2, 1998 was attributable to an increase in income tax receivable
related to a net operating loss carryback arising from the repositioning charges
in fiscal 1999.

15

The decrease in property and equipment, net to $53.4 million at May 1, 1999 from
$78.7 million at May 2, 1998 was caused by the write-off of certain fixed assets
in connection with the Company's repositioning program, principally video, book
and software display fixtures, as well as the sale of certain Company-owned
facilities.

The decrease in accounts payable to $156.3 million at May 1, 1999 from $179.2
million at May 2, 1998 was directly related to the decrease in merchandise
inventories during the comparable time period.

The increase in other current liabilities to $41.9 million at May 1, 1999 from
$21.3 million at May 2, 1998 was chiefly due to an $8 million increase in
accrued royalties within NCE and an increase of $4 million in accrued employee
compensation.

The decrease in debt, non-current to $39.9 million at May 1, 1999 from $114.8
million at May 2, 1998 was substantially attributable to cash generated in
connection with the Company's repositioning program (including $45 million from
the sale of stock received in connection with the sale of the Sofsource
subsidiary), reclassification of $18.6 million of senior notes to debt, current
portion and reduced working capital requirements attributable to the
repositioning program. This decrease in debt was achieved even though the
Company spent approximately $21.0 million in connection with its share
repurchase program.

During the first quarter of fiscal 1999, NCE purchased additional shares of
TibECo. As a result, NCE owns a 75% share in TibECo. The inclusion of TibECo's
results of operations in fiscal 1999 did not have a material effect on reported
consolidated revenues or consolidated results of operations.

THE FOLLOWING COMMENTS RELATE TO THE COMPANY'S STRATEGIC REPOSITIONING PROGRAM.

On June 2, 1998, the Company's Board of Directors approved a comprehensive
strategic repositioning program designed to focus the Company on its core music
distribution business. The program had four major components:

. Exit the H.E.R. video, book and software distribution and service
operations;
. Reduce the number of customers serviced in the music distribution
business within H.E.R. to a select group of strategic partners who could
best benefit from Handleman's category management and systems investments;
. Sell Sofsource, the Company's software publishing subsidiary; and
. Implement a common stock repurchase program.

The operational repositioning activities, including employee severance programs,
were completed during fiscal 1999.

During the first quarter of fiscal 1999, the Company sold its book distribution
business to Levy Home Entertainment at a pre-tax loss of approximately $1.3
million, and its Sofsource subsidiary to The Learning Company at a pre-tax gain
of $31 million.

H.E.R. has exited the video and software distribution business activities, as
well as ceased providing services to a number of music customers. 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
did not have the potential for sustainable growth and profitability.

The repositioning program resulted in a $110 million charge to earnings in the
first quarter of fiscal 1999, representing asset adjustments and cost accruals
directly related to the repositioning program, other than those costs actually
incurred and charged to earnings in fiscal 1998 and certain costs that were
incurred in the last three quarters of fiscal 1999 that were required to be
expensed as incurred.

16

A summary of the components of the $127.4 million (pre-tax) repositioning and
related charge recognized in fiscal 1999 is as follows (in millions):

First Second Third Fourth
Quarter Quarter Quarter Quarter Fiscal 1999
------- ------- ------- ------- -----------

Adjustments of assets to net realizable $ 84.5 $ 84.5
value

Intangibles write-off 13.0 13.0

Other repositioning related costs 12.5 7.0 6.9 3.5 29.9
------ ---- ---- ---- ------

Total $110.0 $7.0 $6.9 $3.5 $127.4
====== ==== ==== ==== ======

Adjustments of assets to net realizable value included adjustments to reflect
the estimated recovery amount of assets disposed of during fiscal 1999 that were
directly related to exited businesses or customers no longer serviced. The
components of the provision were, principally, inventory of $31.6 million and
property and equipment of $11.8 million, as well as certain adjustments to the
carrying value of receivables of $27.2 million, payables of $4.1 million and
investments, including international investments, of $9.2 million. Intangibles
related to either businesses exited, or customers no longer serviced, were
included in the intangibles write-off. Other repositioning related costs
recorded in the first quarter of fiscal 1999 were principally employee severance
costs of $3.5 million, advisory fees of $3.0 million, debt restructuring costs
of $2.0 million and inventory handling costs of $2.0 million. Other
repositioning related costs recognized in subsequent quarters were primarily
employee stay bonus costs and advisory fees, which were not accruable as part of
the initial repositioning charge, and therefore, were expensed as incurred.

The amount of each element of the overall repositioning charge was determined
based upon the actual cost of the asset and management estimates of
recoverability. In the case of receivables, the fact that certain accounts would
be settled with customer product returns rather than cash, which resulted in a
reversal of gross margin, was taken into consideration, as well as liquidation
value of the inventory returned since ongoing relationships with certain vendors
no longer existed and, therefore, return authorizations would be difficult to
obtain. In the case of property and equipment, which was principally display
fixtures in customer stores, the charge represented the net book value of such
abandoned display fixtures.

There were no adjustments necessary to the original estimated repositioning
provision of $110 million recognized in the first quarter of fiscal 1999.

The repositioning program resulted in a reduction of approximately 1,000
positions (approximately 30% of the Company's total workforce). This reduction
occurred predominantly in the H.E.R. division. For the most part the reductions
were in the following areas: field sales representatives; distribution facility
employees; and the corporate headquarters. Employee severance amounts were
determined based upon an employee's length of service, salary grade level and
compensation. Total employee severance paid in fiscal 2000 and fiscal 1999 in
connection with the repositioning program was approximately $.3 and $3.5
million, respectively.

As a result of the repositioning actions, the Company expected to realize an
improvement in operating income in excess of $25 million (pre-tax). The savings
were to result from a reduction in operating costs at a rate greater than the
projected decrease in revenues, because both average customer size and average
sales volume of departments serviced increased significantly. Benefits of the
repositioning program began to occur in the second quarter of fiscal 1999 as the
program was implemented.

Also on June 2, 1998, the Board of Directors approved an 18-month common stock
repurchase program, subject to the generation of cash from the sale of assets
and reduced working capital needs, as well as the requirements of the Company's
credit agreements. During fiscal 1999, the Company purchased 1,742,000

17

shares at a cost of approximately $21.0 million under the repurchase program.
These repurchases are in addition to the 1,295,000 shares repurchased in fiscal
1998 under a repurchase program which was replaced by this new authorization.

LIQUIDITY AND CAPITAL RESOURCES

Working capital at April 29, 2000 was $129.7 million, compared to $152.7 million
at May 1, 1999. The working capital ratio was 1.5 to 1 at April 29, 2000,
compared to 1.7 to 1 at May 1, 1999.

Property and equipment consist primarily of display fixtures, warehouse
equipment and facilities. The Company also acquires or licenses video and music
products which it markets. Purchases of these assets are expected to be funded
primarily by cash flow from operations.

The Company has an unsecured, five-year, $150,000,000 credit agreement, as
amended, with a consortium of banks that expires in September 2002. No
borrowings were outstanding under the credit agreement as of April 29, 2000. The
Company also has $39,857,000 outstanding as of April 29, 2000 under a senior
note agreement with a group of insurance companies. See Note 5 of Notes to
Consolidated Financial Statements for additional information regarding the
senior notes, including scheduled maturities.

TibECo has an $8,750,000 uncommitted credit facility with a certain bank. The
Company has guaranteed repayment of amounts borrowed under this facility and is
required to maintain availability under its $150,000,000 line of credit. As of
April 29, 2000, $8,700,000 was outstanding under this facility.

Net cash provided from operating activities included in the Consolidated
Statement of Cash Flows increased to $106,615,000 for the fiscal year ended
April 29, 2000 from $65,368,000 for fiscal 1999, primarily due to increased net
income for the year.

Net cash used by investing activities was $55,587,000 for the fiscal year ended
April 29, 2000, compared to net cash provided by investing activities of
$27,278,000 for the fiscal year ended May 1, 1999. This change was mainly
attributable to an increase in license advances and acquired rights of $16.5
million in fiscal 2000 and the proceeds of $45.0 million from sale of subsidiary
in fiscal 1999.

Net cash used by financing activities decreased to $50,923,000 for the fiscal
year ended April 29, 2000 from $90,803,000 for the fiscal year ended May 1,
1999. This decrease was principally due to lower net payments of debt during the
year.

In connection with the repositioning program discussed previously, the Company
amended its bank credit agreement and senior note agreement to effect compliance
with existing restrictions and covenants of the agreements. Management believes
that the amended credit agreement, and the amended senior note agreement, will
provide sufficient amounts to fund day-to-day operations and higher peak
seasonal demands. For further information, reference should be made to Note 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.

18

As a result of the Company's Year2000 efforts and the timely completion of all
related projects, the Company has not experienced any disruption in its business
operations. In addition, the Company was not adversely affected by any of its
key business vendors, customers or other partners not being Year 2000 ready.

* * * * * * *

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, conditions in the music industry, customer
requirements, continuation of satisfactory relationships with existing customers
and suppliers, nature and extent of new product releases, retail environment,
effects of electronic commerce, relationships with the Company's lenders,
pricing and competitive pressures, 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. The Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date of
this document.

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 April 29, 2000, May 1, 1999 and May 2, 1998

Consolidated Statement of Operations - Years Ended April 29, 2000, May 1, 1999
and May 2, 1998

Consolidated Statement of Shareholders' Equity - Years Ended April 29, 2000,
May 1, 1999 and May 2, 1998

Consolidated Statement of Cash Flows - Years Ended April 29, 2000, May 1, 1999
and May 2, 1998

Notes to Consolidated Financial Statements

19

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 (the "Company") at April 29, 2000, May 1,
1999 and May 2, 1998, and the results of their operations and their cash
flows for each of the three years in the period ended April 29, 2000, in
conformity with accounting principles generally accepted in the United
States. In addition, in our opinion, the financial statement schedule listed
in Item 14(a) 2 of this Annual Report on Form 10-K presents fairly, in all
material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These
financial statements and financial statement schedule 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 auditing standards generally accepted in
the United States, 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.

PricewaterhouseCoopers LLP

Detroit, Michigan
June 6, 2000

20

HANDLEMAN COMPANY
CONSOLIDATED BALANCE SHEET
YEARS ENDED APRIL 29, 2000, MAY 1, 1999 AND MAY 2, 1998
(amounts in thousands except share data)
----------------------------------------

ASSETS 2000 1999 1998
- ------ ---- ---- ----

Current assets:
Cash and cash equivalents $ 27,510 $ 27,405 $ 25,562
Accounts receivable, less allowance of $17,383 in
2000, $13,760 in 1999 and $17,339 in 1998 for
gross profit impact of estimated future returns 234,005 217,968 242,445
Merchandise inventories 100,298 102,589 187,173
Other current assets 16,036 21,560 10,834
--------- --------- ---------
Total current assets 377,849 369,522 466,014
Property and equipment, net 51,852 53,419 78,711
Other assets, net 89,982 64,915 68,331
--------- --------- ---------
Total assets $ 519,683 $ 487,856 $ 613,056
========= ========= =========

LIABILITIES
- -----------

Current liabilties:
Accounts payable $ 202,339 $ 156,300 $ 179,227
Debt, current portion 14,571 18,571 18,571
Accrued and other liabilities 31,218 41,930 21,300
--------- --------- ---------
Total current liabilities 248,128 216,801 219,098
Debt, non-current 33,986 39,857 114,768
Other liabilities 14,287 5,512 5,383

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: 27,691,000, 31,049,000
and 31,977,000 shares issued in 2000, 1999
and 1998, respectively 277 310 320
Paid-in capital -- 6,828 20,710
Foreign currency translation adjustment (6,449) (5,220) (7,600)
Unearned compensation (443) (1,557) --
Retained earnings 229,897 225,325 260,377
--------- --------- ---------
Total shareholders' equity 223,282 225,686 273,807
--------- --------- ---------
Total liabilities and shareholders' equity $ 519,683 $ 487,856 $ 613,056
========= ========= =========

The accompanying notes are an integral part of the
consolidated financial statements.

21

HANDLEMAN COMPANY
CONSOLIDATED STATEMENT OF OPERATIONS
YEARS ENDED APRIL 29, 2000, MAY 1, 1999 AND MAY 2, 1998
(amounts in thousands except per share data)
--------------------------------------------

2000 1999 1998
---- ---- ----

Revenues $ 1,137,605 $ 1,058,553 $ 1,104,522

Costs and expenses:

Direct product costs 848,829 791,683 834,470
Selling, general and administrative expenses 219,625 211,682 243,778
Interest expense, net 3,178 8,088 12,319
Repositioning and related charges -- 127,362 13,684

Gain on sale of subsidiary -- (31,000) --

----------- ----------- -----------
Income (loss) before income taxes
and minority interest 65,973 (49,262) 271

Income tax (expense) benefit (26,255) 16,449 (2,800)

Minority interest (1,070) (2,239) 2,841
----------- ----------- -----------

Net income (loss) $ 38,648 $ (35,052) $ 312
=========== =========== ===========

Earnings (loss) per common share
Basic $ 1.31 $ (1.11) $ 0.01
=========== =========== ===========
Diluted $ 1.30 $ (1.11) $ 0.01
=========== =========== ===========

Weighted average number of common shares
outstanding during the year
Basic 29,425 31,568 32,868
=========== =========== ===========
Diluted 29,692 31,818 32,886
=========== =========== ===========

The accompanying notes are an integral part of the
consolidated financial statements.

22

HANDLEMAN COMPANY
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
YEARS ENDED APRIL 29, 2000, MAY 1, 1999 AND MAY 2, 1998
(amounts in thousands)
--------------------

Common Stock Foreign Total
----------------------- Currency Unearned Share-
Shares Paid-In Translation Compen- Retained holders'
Issued Amount Capital Adjustment sation Earnings Equity
----------- ---------- ---------- -------------- ---------- ---------- --------------

May 3, 1997 33,373 $ 334 $ 30,800 $ (6,151) $ (1,395) $ 260,065 $ 283,653

Net income 312 312
Adjustment for foreign
currency translation (1,449) (1,449)
---------
Comprehensive loss, net of tax (1,137)
---------
Common stock forfeitures, net
of issuances,in connection
with employee benefit plans (101) (1) (1,258) 1,395 136
Common stock repurchased (1295) (13) (8,832) (8,845)
--------- --------- --------- --------- --------- --------- ---------

May 2, 1998 31,977 320 20,710 (7,600) -- 260,377 273,807

Net loss (35,052) (35,052)
Adjustment for foreign
currency translation 2,380 2,380
---------

Comprehensive loss, net of tax (32,672)
---------

Common stock issuances, net of
forfeitures, in connection
with employee benefit plans 368 4 4,290 (1,557) 2,737
Common stock repurchased (1,742) (18) (20,991) (21,009)
Additional investment in The
itsy bitsy Entertainment
Company, Inc. 446 4 2,819 2,823
--------- --------- --------- --------- --------- --------- ---------

May 1, 1999 31,049 310 6,828 (5,220) (1,557) 225,325 225,686

Net income 38,648 38,648
Adjustment for foreign
currency translation (1,229) (1,229)
---------
Comprehensive income, net of tax 37,419
---------
Common stock issuances, net
of forfeitures, in connection
with employee benefit plans 181 2 1,559 1,114 (515) 2,160
Common stock repurchased (3,539) (35) (8,387) (33,561) (41,983)
--------- --------- --------- --------- --------- --------- ---------

April 29, 2000 27,691 $ 277 $ -- $ (6,449) $ (443) $ 229,897 $ 223,282
========= ========= ========= ========= ========= ========= =========

The accompanying notes are an integral part of the
consolidated financial statements.

23

HANDLEMAN COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED APRIL 29, 2000, MAY 1, 1999 AND MAY 2, 1998
(amounts in thousands)
--------------------

2000 1999 1998
---- ---- ----
Cash flows from operating activities:

Net income (loss) $ 38,648 $ (35,052) $ 312
----------- ----------- -----------
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 15,962 16,526 27,440
Amortization of acquisition costs 4,147 3,962 5,293
Recoupment of license advances 10,793 9,478 13,103
Repositioning charge -- 110,000 --
Gain on sale of subsidiary -- (31,000) --
Loss on sale of book business -- 1,291 --
(Increase) decrease in accounts receivable (8,424) 12,101 47,626
Decrease in inventory 5,817 79,285 1,042
(Increase) decrease in other operating assets 5,829 (4,073) 2,179
Increase (decrease) in accounts payable 36,113 (20,795) (18,074)
Decrease in other operating liabilities (2,270) (76,355) (9,735)
----------- ----------- -----------
Total adjustments 67,967 100,420 68,874
----------- ----------- -----------
Net cash provided from operating activities 106,615 65,368 69,186
----------- ----------- -----------

Cash flows from investing activities:
Additions to property and equipment (20,335) (17,054) (21,369)
Retirements of property and equipment 1,222 14,339 10,937
License advances and acquired rights (30,042) (13,561) (18,308)
Cash investment in Lifetime Entertainment Limited (6,432) -- --
Cash investment in The itsy bitsy Entertainment
Company, Inc. -- (4,754) --
Proceeds from sale of subsidiary -- 45,000 --
Proceeds from sale of book business and other -- 3,308 --
----------- ----------- -----------
Net cash provided from (used by) investing activities (55,587) 27,278 (28,740)
----------- ----------- -----------

Cash flows from financing activities:
Issuances of debt 1,363,621 2,142,705 1,811,205
Payments of debt (1,373,492) (2,217,616) (1,828,380)
Repurchase of common stock (41,983) (21,009) (8,845)
Other changes in shareholders' equity, net 931 5,117 (1,313)
----------- ----------- -----------
Net cash used by financing activities (50,923) (90,803) (27,333)
----------- ----------- -----------

Net increase in cash and cash equivalents 105 1,843 13,113
Cash and cash equivalents at beginning of year 27,405 25,562 12,449
----------- ----------- -----------
Cash and cash equivalents at end of year $ 27,510 $ 27,405 $ 25,562
=========== =========== ===========

The accompanying notes are an integral part of the
consolidated financial statements.

24

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
----------------

1. Accounting Policies:

Business

The Company is comprised of two business segments. Handleman Entertainment
Resources is a category manager and distributor of prerecorded music to
mass merchants, principally in North America. North Coast Entertainment is
responsible for the Company's proprietary operations, which include music
and video products, as well as licensing operations. (see "Segment
Information" note)

Fiscal Year

The Company's fiscal year ends on the Saturday closest to April 30th.
Fiscal years 2000, 1999 and 1998 consisted of 52 weeks.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company
and all subsidiaries where the Company has voting control. All 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 $5,000,000, $5,244,000 and $1,119,000 as of April 29, 2000,
May 1, 1999 and May 2, 1998, respectively, is included in other liabilities
in the accompanying consolidated balance sheet. The Company does not have
any material equity investments other than in companies they have voting
control.

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 amounts 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) included in the statement of
operations were $383,000, $(162,000) and $(643,000) for the years ended
April 29, 2000, May 1, 1999 and May 2, 1998, 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. Staff Accounting Bulletin No. 101
issued by the Securities and Exchange Commission regarding revenue
recognition will not have an impact on the Company's revenue recognition
policy when the Bulletin becomes effective in fiscal 2001.

25

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
----------------

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 $11,178,000, $10,980,000 and
$14,157,000 were incurred during the years ended April 29, 2000, May 1,
1999 and May 2, 1998, respectively. Merchandise inventories as of April 29,
2000, May 1, 1999 and May 2, 1998 include $843,000, $892,000 and
$2,096,000, respectively, of such costs.

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 5 years
Equipment, furniture and other 3-10 years

License Advances and Acquired Rights

The Company, principally in its proprietary product business, acquires
video and audio licenses or rights giving it the exclusive privilege to
manufacture and distribute such products. The cost of license advances and
acquired rights 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 agreement or the products estimated useful life. The effective lives of
the licenses and rights tend to range from three to five years. As of April
29, 2000, May 1, 1999 and May 2, 1998, licenses and acquired rights, net of
amortization, amounted to $61,390,000, $31,654,000 and $33,738,000,
respectively.

Intangible Assets

Intangible assets, included in other assets in the consolidated balance
sheet and aggregating $24,575,000, $24,624,000 and $31,684,000, net of
amortization of $10,900,000, $7,894,000 and $24,232,000 as of April 29,
2000, May 1, 1999 and May 2, 1998, respectively, 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 ranging from four to 15 years. As of April 29, 2000,
May 1, 1999 and May 2, 1998, the weighted average period remaining to be
amortized was approximately six years, seven years and ten years,
respectively.

26

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
----------------

Long-Lived Assets

At each balance sheet date, management evaluates the carrying value and
remaining estimated lives of long-lived assets, including intangible
assets, for potential impairment by considering several factors, including
management's plans for future operations, recent operating results, market
trends and other economic factors relating to the operation to which the
assets apply. Recoverability of these assets is measured by a comparison of
the carrying amount of such assets to the future undiscounted net cash
flows expected to be generated by the assets. If such assets were deemed to
be impaired as a result of this measurement, the impairment that would be
recognized is measured by the amount by which the carrying amount of the
asset exceeds the fair value of the asset as determined on a discounted
basis.

Cash Equivalents

The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents. Cash and cash
equivalents are net of issued and outstanding checks in excess of
disbursing bank account balances, which checks are routinely funded on a
daily basis from the Company's main bank account with another bank.

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 April 29, 2000, May 1, 1999 and May 2,
1998. Fair values have been determined through information obtained from
market sources and management estimates.

Earnings Per Share

For computing diluted earnings per share in accordance with SFAS No. 128,
"Earnings Per Share," additional weighted average shares attributable to
outstanding stock options were 267,000, 250,000 and 18,000 for the years
ended April 29, 2000, May 1, 1999 and May 2, 1998, respectively.

2. Segment Information:

The Company has determined, using the management approach, that it operates
in two business segments: Handleman Entertainment Resources (H.E.R.)
provides category management and distribution services of music products to
select mass merchants; and North Coast Entertainment (NCE) encompasses the
Company's proprietary activities, which include music and video products,
as well as licensing operations. Effective May 1999, the Company integrated
its International category management operations with the H.E.R. business
operations.

The accounting policies of the segments are the same as those described in
Note 1, "Accounting Policies." Segment data includes intersegment revenues,
as well as a charge allocating all corporate costs to the operating
segments. The Company evaluates performance of its segments and allocates
resources to them based on income before interest, income taxes, minority
interest and repositioning and related charges ("segment income").

27

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
----------------

The tables below present information about reported segments for the years
ended April 29, 2000, May 1, 1999 and May 2, 1998 (in thousands of
dollars):

Fiscal 2000: H.E.R. NCE Total
------ --- -----

Revenues, external customers $1,011,323 $ 126,282 $1,137,605
Intersegment revenues -- 15,716 15,716
Segment income 54,811 14,182 68,993
Total assets 425,743 175,468 601,211
Capital expenditures 14,016 6,319 20,335

Fiscal 1999: H.E.R. NCE Total
------ --- -----

Revenues, external customers $ 884,670 $ 124,560 $1,009,230
Intersegment revenues 3,737 14,408 18,145
Segment income 36,099 19,973 56,072
Total assets 377,869 152,246 530,115
Capital expenditures 13,004 4,050 17,054

Fiscal 1998: H.E.R. NCE Total
------ --- -----

Revenues, external customers $ 782,084 $ 81,169 $ 863,253
Intersegment revenues 7,430 12,707 20,137
Segment income 12,348 11,160 23,508
Total assets 573,573 115,136 688,709
Capital expenditures 20,008 1,361 21,369

28

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
----------------

A reconciliation of total segment revenues to consolidated revenues, total
segment income to total consolidated income before income taxes and total
segment assets to total consolidated assets for the years ended April 29,
2000, May 1, 1999 and May 2, 1998 is as follows (in thousands of dollars):

2000 1999 1998
---- ---- ----
Revenues

Total segment revenue $ 1,153,321 $ 1,027,375 $ 883,390
Revenue from exited activities -- 48,684 243,160
Elimination of intersegment revenue (15,716) (17,506) (22,028)
----------- ----------- -----------
Consolidated revenue $ 1,137,605 $ 1,058,553 $ 1,104,522
=========== =========== ===========

Income Before Income Taxes

Total segment income for reportable segments $ 68,993 $ 56,072 $ 23,508
Segment income (loss) for sold operation (Sofsource) -- (135) 1,990
Interest revenue 2,195 1,392 274
Interest expense (5,373) (9,480) (12,593)
Repositioning and related charges -- (127,362) (13,684)
Gain on sale of subsidiary -- 31,000 --
Intersegment profit elimination 158 (749) 776
----------- ----------- -----------
Consolidated income (loss) before income taxes $ 65,973 $ (49,262) $ 271
=========== =========== ===========

Assets

Total segment assets $ 601,211 $ 530,115 $ 688,709
Elimination of intercompany receivables
and payables (81,528) (42,259) (75,653)
----------- ----------- -----------
Total consolidated assets $ 519,683 $ 487,856 $ 613,056
=========== =========== ===========

29

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

The following is revenue and long-lived asset information by geographic
area as of and for the years ended April 29, 2000, May 1, 1999 and May 2,
1998:

Revenues
-----------------------------------------

2000 1999 1998
---- ---- ----

United States $ 997,238 $ 926,573 $ 970,107
Canada 92,200 76,994 69,065
Other foreign 48,167 54,986 65,350
---------- ---------- -----------
$1,137,605 $1,058,553 $ 1,104,522
========== ========== ===========

Long-Lived Assets
----------------------------------------

2000 1999 1998
---- ---- ----

United States $130,248 $107,103 $135,731
Canada 4,012 3,888 3,755
Other foreign 7,056 3,320 7,258
-------- -------- --------
$141,316 $114,311 $146,744
======== ======== ========

Foreign revenue is based upon the country in which the legal subsidiary is
domiciled. Revenue from no single foreign country other than Canada was
material to the consolidated revenues of the Company.

For the years ended April 29, 2000, May 1, 1999 and May 2, 1998, one
customer accounted for approximately 35 percent, 31 percent and 33 percent
of the Company's net sales, respectively, and a second customer accounted
for approximately 42 percent, 39 percent and 32 percent of the Company's
net sales, respectively. Approximately 98 percent, 96 percent and 95
percent of the combined revenues for these two customers are included in
the H.E.R. segment for the years ended April 29, 2000, May 1, 1999 and May
2, 1998, respectively. Collectively, these customers accounted for
approximately 63 percent, 66 percent and 45 percent of accounts receivable
at April 29, 2000, May 1, 1999 and May 2, 1998, respectively.

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

3. Repositioning and Related Charges:

On June 2, 1998 the Board of Directors approved a comprehensive strategic
repositioning program designed to focus the Company on its core music
distribution business. The repositioning program resulted in a $110 million
charge to earnings in the first quarter of fiscal 1999, representing asset
adjustments and cost accruals directly related to the repositioning
program, other than those costs actually incurred and charged to earnings
in fiscal 1998 and certain costs, totaling $17.4 million, that were
expensed as incurred in the last three quarters of fiscal 1999. The
repositioning activities, including employee severance programs, were
completed during fiscal 1999.

The repositioning program was in addition to the 1998 consolidation of the
Albany, Atlanta and Baltimore distribution centers into the Indianapolis
automated distribution center. The $13,684,000 repositioning and related
charge recognized in the fourth quarter of fiscal 1998 included costs
associated with the closing of the distribution centers, the abandonment of
certain investments, as well as already incurred repositioning related
costs.

The $127.4 million (pre-tax) repositioning and related charge recognized in
fiscal 1999 was comprised of adjustments of assets to net realizable value
of $84.5 million, intangibles write-off of $13.0 million and other
repositioning related costs of $29.9 million. Adjustments of assets to net
realizable value included adjustments to reflect the estimated recovery
amount of assets disposed of during fiscal 1999. The components of the
provision were, principally, inventory of $31.6 million and property and
equipment of $11.8 million, as well as certain adjustments to the carrying
value of receivables of $27.2 million, payables of $4.1 million and
investments of $9.2 million. Intangibles related to either businesses
exited, or customers no longer serviced, are included in the intangibles
write-off. Other repositioning related costs were principally employee
severance costs of $3.8 million, advisory fees of $17.2 million, debt
restructuring costs of $2.0 million and inventory handling costs of $2.0
million.

The amount of each element of the overall repositioning charge was
determined based upon estimated costs at the time, or the actual cost of
assets compared to management estimates of recoverability. No adjustments
were subsequently necessary to adjust the initial overall repositioning
provision of $110 million.

The repositioning program resulted in a reduction of approximately 1,000
positions (approximately 30% of the Company's total workforce at the time).
This reduction occurred predominantly in the H.E.R. division. For the most
part, the reductions were in the following areas: field sales
representatives; distribution facility employees; and the corporate
headquarters. Employee severance amounts were determined based upon an
employee's length of service, salary grade level and compensation. Total
employee severance paid in fiscal 2000 and fiscal 1999 in connection with
the repositioning program was approximately $.3 million and $3.5 million,
respectively.

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

A reconciliation of the provisions for repositioning and related charges and
the remaining liability balance follows (in thousands):

Other
Adjustment of Repositioning
Assets to Net Related Costs, Accrued
Realizable Intangibles Including Exit Liability
Value Write-off Costs Account
-------------- ----------- -------------- ----------

Amount provided during the
fourth quarter ended May 2, 1998 $ 10,208 $ -- $ 3,476 $ 13,684

Charges resulting from asset write-
offs and cash expenditures (9,455) -- (1,336) (10,791)
--------- --------- --------- ---------

Remaining balance as of
May 2, 1998 753 -- 2,140 2,893

Amount provided during the first
quarter ended August 1, 1998 84,500 13,000 12,500 110,000

Charges resulting from asset
write-offs and cash expenditures (85,253) (13,334) (14,075) (112,662)

Reclassify residual intangibles
write-off -- 334 (334) --
--------- --------- --------- ---------

Remaining balance as of
May 1, 1999 $ -- $ -- 231 231
========= =========

Charges resulting from cash
expenditures (231) (231)
--------- ---------

Remaining balance as of
April 29, 2000 $ -- $ --
========= =========

The remaining liability balance as of May 1, 1999 and May 2, 1998 is included in
accrued and other liabilities in the consolidated balance sheet.

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

4. Pension Plan:

The Handleman Company Pension Plan's benefit obligation, plan assets, funded
status, net periodic benefit cost and the amount which is recorded in the
Company's consolidated balance sheet at April 29, 2000, May 1, 1999 and May 2,
1998 are as follows:

2000 1999 1998
---- ---- ----

Change in projected benefit obligation:
Benefit obligation at beginning of year $ 24,341,000 $ 22,748,000 $ 18,158,000
Service cost 1,069,000 981,000 887,000
Interest cost 1,672,000 1,518,000 1,365,000
Actuarial (gain)/loss (3,174,000) 454,000 3,271,000
Benefits paid (1,322,000) (1,360,000) (933,000)
------------ ------------ ------------
Benefit obligation at end of year $ 22,586,000 $ 24,341,000 $ 22,748,000
------------ ------------ ------------

Change in plan assets:
Fair value of plan assets at beginning of year $ 20,373,000 $ 20,413,000 $ 16,492,000
Actual return on plan assets 1,385,000 1,422,000 639,000
Net realized gain on the sale of assets 1,295,000 1,462,000 1,163,000
Unrealized appreciation (depreciation) (1,557,000) (1,564,000) 2,692,000
Company contribution -- -- 360,000
Benefits paid (1,322,000) (1,360,000) (933,000)
------------ ------------ ------------
Fair value of plan assets at end of year $ 20,174,000 $ 20,373,000 $ 20,413,000
------------ ------------ ------------

Funded status at end of year $ (2,412,000) $ (3,968,000) $ (2,335,000)
Unrecognized net (gain)/loss from past experience
different from that assumed (1,095,000) 1,506,000 346,000
Unrecognized net gain from excess funding (371,000) (490,000) (609,000)
Unrecognized prior service cost 146,000 154,000 235,000
------------ ------------ ------------
Accrued benefit cost included in
accrued and other liabilities $ (3,732,000) $ (2,798,000) $ (2,363,000)
============ ============ ============

Assumptions used in determining the actuarial present value of the projected
benefit obligation included a weighted average discount rate of 7.75% for 2000,
6.75% for 1999 and 6.75% for 1998, and a rate of increase in future compensation
levels of 5% for all years.

2000 1999 1998
---- ---- ----

Components of net periodic benefit cost:
Service cost $ 1,069,000 $ 981,000 $ 887,000
Interest cost 1,672,000 1,518,000 1,365,000
Expected return on plan assets (1,696,000) (1,701,000) (1,381,000)
Amortization of unrecognized transition
asset, prior service cost and actuarial gain (111,000) (39,000) (108,000)
----------- ----------- -----------
Net periodic benefit cost $ 934,000 $ 759,000 $ 763,000
=========== =========== ===========

The expected long-term rate of return on assets was 8.5% for all years. Plan
assets are invested in various pooled investment funds and mutual funds
maintained by the Plan trustee, as well as Handleman Company common stock valued
at $888,000 at April 29, 2000, $1,040,000 at May 1, 1999 and $786,000 at May 2,
1998.

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------------

5. Debt:

The Company has an unsecured, $150,000,000 line of credit with a consortium
of banks, which is scheduled to expire in September 2002. At April 29,
2000, borrowings available under the credit agreement, after $5,111,000 of
outstanding letters of credit, were $144,889,000 of which no borrowings
were 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
April 29, 2000, the interest rate was 6.69%. The weighted average amount of
borrowings outstanding under the credit agreement was $6,694,000,
$32,494,000 and $56,612,000 for the years ended April 29, 2000, May 1, 1999
and May 2, 1998, respectively, and the weighted average interest rate under
the credit agreement was 6.74% for the year ended April 29, 2000 and 6.8%
for the years ended May 1, 1999 and May 2, 1998.

In fiscal 1995, the Company entered into a $100,000,000 senior note
agreement, as amended, with a group of insurance companies. The balance
outstanding as of April 29, 2000 was $39,857,000 of which $14,571,000 is
classified as a current liability. These notes bear interest at rates of
8.51% or 8.84%.

Scheduled maturities for the senior note agreement are as follows:

2001 $14,571,000
2002 14,570,000
2003 3,572,000
2004 3,572,000
2005 3,572,000
-----------
$39,857,000
===========

The senior note and the credit agreements contain certain restrictions and
covenants, relating to, among others, interest coverage ratio, working
capital, debt and net worth. As of April 29, 2000, the Company was in
compliance with these various provisions.

In fiscal 1999, a subsidiary entered into an $8,750,000 uncommitted credit
facility with a certain bank. The Company has guaranteed repayment of
amounts borrowed under the facility, and is required to maintain
availability under its $150,000,000 line of credit to refinance any
outstanding balances. As of April 29, 2000, $8,700,000 was outstanding and
was classified as non-current debt. There were no borrowings under this
credit facility during fiscal 1999. As of April 29, 2000, the interest rate
was 9.0%.

Interest expense for the years ended April 29, 2000, May 1, 1999 and May 2,
1998 was $5,373,000, $9,480,000 and $12,593,000, respectively. Interest
paid for the years ended April 29, 2000, May 1, 1999 and May 2, 1998 was
$5,039,000, $9,526,000 and $12,796,000, respectively.

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

6. Income Taxes:

The domestic and foreign components of income (loss) before income taxes and
minority interest for the years ended April 29, 2000, May 1, 1999 and May 2,
1998 are as follows:

2000 1999 1998
---- ---- ----

Domestic $ 63,372,000 $(44,121,000) $ 12,378,000
Foreign 2,601,000 (5,141,000) (12,107,000)
------------ ------------ ------------

Income (loss) before income
taxes and minority interest $ 65,973,000 $(49,262,000) $ 271,000
============ ============ ============

Provisions for income taxes for the years ended April 29, 2000, May 1, 1999 and
May 2, 1998 consist of the following:

2000 1999 1998
---- ---- ----

Currently payable:
Federal $ 19,749,000 $ (2,686,000) $ 1,995,000
Foreign 2,195,000 814,000 483,000
State and other 2,845,000 (392,000) 531,000

Deferred, net:
Federal 1,545,000 (12,180,000) 291,000
Foreign (209,000) (996,000) (221,000)
State and other 130,000 (1,009,000) (279,000)
------------ ------------ ------------
$ 26,255,000 $(16,449,000) $ 2,800,000
============ ============ ============

The following table provides a reconciliation of the Company's resulting income
tax to the statutory federal income tax:

2000 1999 1998
---- ---- ----

Federal statutory tax $ 23,092,000 $(17,241,000) $ 95,000
State and local income taxes 1,940,000 (911,000) 164,000
Effect of foreign losses with no
tax benefit 1,076,000 1,617,000 6,386,000
Write-off of intangible assets -- 1,914,000 --
Prior years' tax accruals no
longer necessary -- (1,846,000) (3,335,000)
Other 147,000 18,000 (510,000)
------------ ------------ ------------
Resulting tax $ 26,255,000 $(16,449,000) $ 2,800,000
============ ============ ============

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
------------------

Items that gave rise to significant portions of the deferred tax accounts at
April 29, 2000, May 1, 1999 and May 2, 1998 are as follows:

April 29, 2000 May 1, 1999 May 2, 1998
----------------------------------------------------------------------------------------------------
Deferred Deferred Tax Deferred Tax Deferred Tax Deferred Tax Deferred Tax
Tax Assets Liabilities Assets Liabilities Assets Liabilities
- ---------------------------------------------------------------------------------------------------------------------------------

Allowances $ 13,585,000 $ 6,618,000 $ 13,615,000 $ 8,783,000 $ 9,294,000 $ 5,919,000
Foreign carryforward
losses including net
temporary differences 10,600,000 -- 8,300,000 -- 7,700,000 --
Employee benefits 2,251,000 95,000 4,788,000 -- 2,675,000 458,000
Property and equipment 2,802,000 6,075,000 8,327,000 6,656,000 1,759,000 7,875,000
Inventory 271,000 374,000 366,000 1,587,000 474,000 2,223,000
Other 1,531,000 83,000 1,734,000 -- 588,000 325,000
------------ ------------ ------------ ------------ ------------ ------------

31,040,000 13,245,000 37,130,000 17,026,000 22,490,000 16,800,000
Valuation allowance (8,600,000) -- (6,300,000) -- (7,700,000) --
------------ ------------ ------------ ------------ ------------ ------------

Net $ 22,440,000 $ 13,245,000 $ 30,830,000 $ 17,026,000 $ 14,790,000 $ 16,800,000
============ ============ ============ ============ ============ ============

The Company reinvests the majority of its undistributed Canadian earnings.
Accordingly, the potential withholding tax of approximately $750,000 on these
undistributed earnings has not been recorded as of April 29, 2000. The Company
has net operating loss carryforwards in certain of its foreign subsidiaries for
tax purposes of approximately $24,000,000 which expire predominantly in 2001 to
2008. 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 valuation allowances related to its foreign net operating loss
carryforwards.

Income taxes paid in 2000, 1999 and 1998 were approximately $26,311,000,
$5,203,000 and $9,824,000, respectively.

7. Property and Equipment:

Property and equipment consists of the following:

2000 1999 1998
---- ---- ----

Land $ 3,078,000 $ 3,354,000 $ 4,012,000
Buildings and improvements 17,126,000 16,227,000 20,544,000
Display fixtures 52,362,000 45,486,000 89,954,000
Equipment, furniture and other 49,682,000 43,830,000 72,366,000
------------ ------------ ------------
122,248,000 108,897,000 186,876,000
Less accumulated depreciation and
amortization 70,396,000 55,478,000 108,165,000
------------ ------------ ------------
$ 51,852,000 $ 53,419,000 $ 78,711,000
============ ============ ============

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
-----------------

8. Stock Plans:

The Company's shareholders approved the adoption of the Handleman Company
1998 Performance Incentive Plan (the "Plan"), which authorizes the granting
of stock options, stock appreciation rights and restricted stock. The
maximum number of shares of stock which may be issued under the Plan is
1,500,000 shares. After deducting restricted stock, options and awards
issued or granted under the Plan since adoption in September 1998,
1,042,800 shares of the Company's stock are available for use under the
Plan as of April 29, 2000.

During fiscal 2000, 49,970 shares of previously issued restricted stock
vested with recipients, and 153,532 shares, net of forfeitures, remain to
vest based upon pre-determined periods of continued employment.
Compensation expense recorded in fiscal 2000 and fiscal 1999 related to the
restricted stock awards was $526,000 and $1,293,000, respectively.

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 May 2, 1998, May 1, 1999 and April 29, 2000
is set forth below. Options were granted during such years at no less than
fair market value at the date of grant.

Weighted
Number Average
of Shares Price
--------------- --------------

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
Granted 292,100 12.06
Terminated (278,919) 11.60
Exercised (257,962) 9.61
---------- ---------

Balance, May 1, 1999 1,162,638 10.53
Granted 450,200 11.30
Terminated (88,597) 16.42
Exercised (117,214) 8.89
---------- ---------

Balance April 29, 2000 1,407,027 $ 10.55
========== =========

Number of shares exercisable
at April 29, 2000 601,163 $ 11.29
========== =========

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
-----------------

The exercise price range of outstanding options as of May 2, 1998, May 1,
1999 and April 29, 2000 was $5.75-$21.83, $6.00-$21.83 and $6.00-$15.87,
respectively. Approximately 69% of outstanding options as of April 29, 2000
had exercise prices of $10.00 per share or more. The average remaining
exercise period for shares exercisable at April 29, 2000 was five years.

The Company applies the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," in determining stock
option compensation expense. The following table presents the proforma
effects on the Company's earnings and earnings per share in fiscal years
2000, 1999 and 1998 had stock option compensation expense been determined
pursuant to the methodology of Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation," including amortization
to expense the estimated fair value of the granted options over the
options' vesting periods.

2000 1999 1998
---- ---- ----

Net income (loss):
As reported $38,648,000 $(35,052,000) $312,000
Proforma 37,901,000 (35,655,000) (162,000)
Earnings (loss) per share:
As reported - basic $ 1.31 $ (1.11) $ .01
- diluted 1.30 (1.11) .01

Proforma - basic 1.29 (1.13) --
- diluted 1.28 (1.12) --

The fair value of each option grant was estimated as of the date of grant using the Black-Scholes
option-pricing model using the following weighted average assumptions for fiscal years 2000,
1999 and 1998:

2000 1999 1998
---- ---- ----

Expected life (in years) 5.0 5.0 5.0
Risk free interest rate 5.84% 5.57% 6.22%
Volatility 42.17% 39.16% 34.31%
Dividend yield -- -- --

The weighted average estimated fair value of stock options granted during
fiscal years 2000, 1999 and 1998 was $5.16, $5.21 and $2.67, respectively.

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)
-----------------

9. Quarterly Financial Summary (unaudited):
(amounts in thousands except per share data)

For the Three Months Ended
--------------------------

July 31, Oct. 30, Jan. 31, April 29,
Fiscal Year 2000 1999 1999 2000 2000
- ---------------- ---- ---- ---- ----

Revenues $226,357 $288,855 $343,246 $279,147
Income before income taxes
and minority interest 1,686 23,487 25,131 15,669
Net income 682 13,479 14,660 9,828
Earnings per share - basic and diluted .02 .45 .50 .35

Aug. 1, Oct. 31, Jan. 31, May 1,
Fiscal Year 1999 1998 1998 1999 1999
- ---------------- ---- ---- ---- ----

Revenues $221,877 289,565 $290,115 $256,996
Income (loss) before income taxes
and minority interest (83,894) 11,550 10,153 12,929
Net income (loss) (59,038) 6,085 5,628 12,273*
Earnings (loss) per share - basic and diluted (1.86) .19 .18 .39

*The low effective tax rate in the fourth quarter of fiscal 1999
resulted from an increase in the estimated tax benefit to be realized on the
full-year repositioning and related charges. See note 3 to the consolidated
financial statements for further information regarding repositioning and
related charges.

39

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 2000 Annual Meeting of Shareholders
to be filed on or before August 25, 2000 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 55 (1) President (1990), Chief Executive Officer (1991) and Director (1989)
Peter J. Cline 53 (2) Executive Vice President (1994) and Chief Operating Officer (2000),
Stephen Nadelberg 59 (3) Senior Vice President/President of NCE (1997)
Leonard A. Brams 49 (4) Senior Vice President/Finance, Chief Financial Officer and Secretary (1997)
Samuel Milicia 58 (5) Senior Vice President/Music Purchasing, Handleman Entertainment Resources (1998)
Thomas C. Braum, Jr. 45 (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 was named Chief Operating Officer in May 2000, and has
served as Executive Vice President/President of Handleman Entertainment
Resources since joining the Company in April 1994.

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. 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.

5. Samuel Milicia has served as Senior Vice President/Music
Purchasing since January 1998. Mr. Milicia served as Vice
President/Operations for Handleman Entertainment Resources since
June 1990 and was elected to Senior Vice President in April 1996.

6. Thomas C. Braum, Jr. has served as Corporate Controller since June 1988.
In February 1992, Mr. Braum was elected Vice President.

40

Item 11. EXECUTIVE COMPENSATION

Information required by this item is contained in the Handleman
Company definitive Proxy Statement for its 2000 Annual Meeting of Shareholders,
to be filed on or before August 25, 2000 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 2000 Annual Meeting of Shareholders,
to be filed on or before August 25, 2000 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 2000 Annual Meeting of Shareholders,
to be filed on or before August 25, 2000 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 April 29, 2000, May 1, 1999 and
May 2, 1998

Consolidated Statement of Operations - Years Ended April 29,
2000, May 1, 1999 and May 2, 1998

Consolidated Statement of Shareholders' Equity - Years Ended
April 29, 2000, May 1, 1999 and May 2, 1998

Consolidated Statement of Cash Flows - Years Ended April 29,
2000, May 1, 1999 and May 2, 1998

Notes to Consolidated Financial Statements

41

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 Registrant's 1998 Stock Option and Incentive Plan was
filed with the Commission in Form S-8, dated December 21,
1998, File No. 333-69389.

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
was filed with the Form 10-K for the year ended May 2, 1998.

The change in control agreements dated March 17, 1997 and
October 30 and 31, 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 and Form 10-K for the year
ended May 2, 1998, respectively.

42

S-K Item 601 (21) - Subsidiaries of the Registrant:

Handleman Company of Canada, Limited, an Ontario Corporation
Hanley Advertising Company, a Michigan Corporation
Handleman de Mexico 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
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 do Brasil Commercial Ltd.
Madacy Entertainment (U.K.) Limited
Bosco Music, Inc., a Michigan Corporation
HGV Video Productions, Inc., an Ontario Corporation
H.E.R. Internet Company, a Michigan Corporation
The itsy bitsy Entertainment Company, a Delaware Corporation
Lifetime Entertainment Limited, a United Kingdom Corporation
Lifetime Holding, Inc., a Michigan Corporation
Oasis Merchandisers Limited, a United Kingdom Corporation
ABE R2 Communications, Inc., a California Corporation
ABE R2 Video Ltd., a California Limited Partnership
Anchor Bay International, Limited, a Private Limited (U.K.)
Corporation
Anchor Bay Entertainment, GmbH, a German Corporation
A teeny weeny Production Company, a Delaware Corporation
The itsy bitsy Entertainment Company (Canada) Ltd., a
Canadian Corporation
Eloise Production Company, a Delaware Corporation
TibECo Productions, Inc., a New York Corporation
The itsy bitsy Music Publishing Company, Inc., a New York
Corporation
The itsy bitsy Melody Company, Inc., a New York Corporation
HOORAY! Inc., a New York Corporation

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: Exhibits, if any, 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.

43

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,
33-69030, 333-69389 and 333-60205) of our report dated June 6, 2000 on
our audits of the consolidated financial statements and financial
statement schedule of Handleman Company and subsidiaries as of April
29, 2000, May 1, 1999, and May 2, 1998 and for the years then ended,
which report is included in this Annual Report on Form 10-K.

PricewaterhouseCoopers LLP

Detroit, Michigan
July 14, 2000

44

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
YEARS ENDED MAY 2, 1998, MAY 1, 1999 AND APRIL 29, 2000

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 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
=========== =========== =========== ===========

Year ended May 1, 1999:

Accounts receivable,
allowance for gross
profit impact of estimated
future returns $17,339,000 $ 7,260,000 $10,839,000 $13,760,000
=========== =========== =========== ===========

Other assets, collectability
allowance for receivables
from bankrupt customers $ 5,341,000 $ 875,000 $ 269,000 $ 5,947,000
=========== =========== =========== ===========

Year ended April 29, 2000:

Accounts receivable,
allowance for gross
profit impact of estimated
future returns $13,760,000 $ 6,750,000 $ 3,127,000 $17,383,000
=========== =========== =========== ===========

Other assets, collectability
allowance for receivables
from bankrupt customers $ 5,947,000 $ 1,515,000 $ 476,000 $ 6,986,000
=========== =========== =========== ===========

45

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: 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 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, Senior Vice President, Thomas C. Braum, Jr., Vice President,
Finance and Chief Financial Officer Corporate Controller
(Principal Financial Officer) (Principal Accounting Officer)

- ---------------------------------------- --------------------------------------------
DATE DATE

/s/ David Handleman /s/ John M. Barth
- ---------------------------------------- --------------------------------------------
David Handleman, Director John M. Barth, Director
(Chairman of the Board)

- ---------------------------------------- --------------------------------------------
DATE DATE

/s/ Elizabeth A. Chappell /s/ Richard H. Cummings
- ---------------------------------------- --------------------------------------------
Elizabeth A. Chappell, Director Richard H. Cummings, Director

- ---------------------------------------- --------------------------------------------
DATE DATE

/s/ James B. Nicholson /s/ Lloyd E. Reuss
- ---------------------------------------- --------------------------------------------
James B. Nicholson, Director Lloyd E. Reuss, Director

- ---------------------------------------- --------------------------------------------
DATE DATE

/s/ Alan E. Schwartz
- ----------------------------------------
Alan E. Schwartz, Director

- ----------------------------------------
DATE

46