<PAGE>   1

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   -----------
                                    FORM 10-Q

(MARK ONE)

[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934

                  FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2001

                                       OR

[ ]    Transition Report Pursuant to Section 13 or 15(d) of the Securities
       Exchange Act of 1934

                            For the Transition Period
                                      from

                                       to

                             COMMISSION FILE NUMBER
                                    333-54035
                                MTS, INCORPORATED
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                                <C>
                  CALIFORNIA                           94-1500342
       (State or other jurisdiction of              (I.R.S. Employer
        incorporation or organization)             Identification No.)
</TABLE>

                   2500 DEL MONTE, WEST SACRAMENTO, CA 95691
                    (Address of principal executive office)

                                  916-373-2500
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.   Yes [X]     No [ ]

Shares outstanding of the Registrant's common stock:

<TABLE>
<S>                                             <C>
               Class                            Outstanding at April 30, 2001
 Class B Common Stock, no par value                      1,000 shares
</TABLE>


<PAGE>   2

                                MTS, INCORPORATED
                                TABLE OF CONTENTS


<TABLE>
<CAPTION>
                                                                                                           PAGE
                                                                                                           ----
<S>                                                                                                        <C>
Part I. Financial Information.......................................................................
   Item 1. Consolidated Financial Statements........................................................
         Consolidated Balance Sheets as of April 30, 2001 and 2000 and July 31, 2000................          3
         Consolidated Statements of Income for the three months ended April 30, 2001 and
           2000 and the nine months ended April 30, 2001 and 2000...................................          4
         Consolidated Statements of Cash Flows for the nine months ended April 30, 2001 and 2000....          5
         Consolidated Statements of Comprehensive Income for the nine months ended
           April 30, 2001 and 2000..................................................................          6
         Notes to Consolidated Financial Statements.................................................        7-8
   Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....       9-15
   Item 3. Quantitative and Qualitative Disclosures about Market Risk...............................      15-16
Part II. Other Information .........................................................................
   Item 5. Other Information........................................................................         17
   Item 6. Exhibits and Reports on Form 8-K.........................................................         17
Signature...........................................................................................         18
</TABLE>


                                       2
<PAGE>   3

                          PART I--FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                                MTS, INCORPORATED
                           CONSOLIDATED BALANCE SHEETS
                  AS OF APRIL 30, 2001, 2000 AND JULY 31, 2000
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                   UNAUDITED      UNAUDITED
                                                                   ---------      ---------
                                                                   APRIL 30,      APRIL 30,       JULY 31,
                                                                     2001           2000            2000
                                                                   --------       --------        -------
<S>                                                                <C>            <C>             <C>
                                 Assets
Current Assets:
    Cash and cash equivalents                                        36,653         22,290         21,486
    Receivables, net                                                 33,162         30,118         31,457
    Merchandising inventories                                       275,655        288,996        293,429
    Prepaid expenses                                                  8,561         13,317         12,728
    Deferred tax assets                                              14,377          8,397         12,694
                                                                    -------        -------        -------
        Total current assets                                        368,408        363,118        371,794
Fixed assets, net                                                   185,499        208,389        207,440
Deferred tax assets                                                  10,456          9,794          9,648
Other assets                                                         38,975         37,971         38,396
                                                                    -------        -------        -------
        Total assets                                                603,338        619,272        627,278
                                                                    =======        =======        =======

                  Liabilities and Shareholder's Equity
 Current Liabilities:
    Current maturities of long-term debt                            204,611        180,558        191,325
    Accounts payable                                                161,906        161,365        165,701
    Reserve for restructuring costs                                   3,318             --             --
    Accrued liabilities                                              40,267         40,723         39,456
    Income taxes payable                                                 91          1,808             95
    Deferred revenue, current portion                                 2,593          2,409          2,959
                                                                    -------        -------        -------
        Total current liabilities                                   412,786        386,863        399,536
Long-term Liabilities:
    Long-term debt, less current maturities                         118,466        120,123        120,238
    Deferred revenue, less current portion                              134            148            144
                                                                    -------        -------        -------
        Total liabilities                                           531,386        507,134        519,918
                                                                    -------        -------        -------

Shareholder's Equity:
    Common stock:
    Class B, no par value; 10,000,000 shares authorized;
       1,000 shares issued and outstanding at April 30, 2001,
       April 30, 2000 and July 31, 2000                                   6              6              6
    Retained earnings                                                85,566        132,603        126,138

    Accumulated other comprehensive income                          (13,620)       (20,471)       (18,784)
                                                                    -------        -------        -------
        Total shareholder's equity                                   71,952        112,138        107,360
                                                                    -------        -------        -------
        Total liabilities and shareholder's equity                  603,338        619,272        627,278
                                                                    =======        =======        =======
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       3
<PAGE>   4

                                MTS, INCORPORATED
                        CONSOLIDATED STATEMENTS OF INCOME
               FOR THE THREE MONTHS ENDED APRIL 30, 2001 AND 2000
                AND THE NINE MONTHS ENDED APRIL 30, 2001 AND 2000
              (DOLLARS IN THOUSANDS, EXCEPTS PER SHARE INFORMATION)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                        THREE MONTHS ENDED            NINE MONTHS ENDED
                                                             APRIL 30,                    APRIL 30,
                                                    -------------------------     -------------------------
                                                       2001            2000          2001           2000
                                                    ----------      ---------     ----------      ---------
<S>                                                 <C>             <C>           <C>             <C>
Net revenue                                            255,098        255,042        833,474        842,151

Cost of sales (a)                                      184,175        169,601        583,369        573,141
                                                    ----------      ---------     ----------      ---------

    Gross Profit                                        70,923         85,441        250,105        269,010



Selling, general and administrative expenses (b)        70,901         74,004        226,152        226,013


Restructuring and asset impairment costs                17,789             --         17,789             --

Depreciation and amortization                            7,353          6,783         23,017         19,523
                                                    ----------      ---------     ----------      ---------

    (Loss)/income from operations                      (25,120)         4,654        (16,853)        23,474

Other expenses:

    Interest Expense                                    (6,291)        (5,549)       (18,601)       (14,832)

    Foreign currency translation loss                   (2,123)        (1,547)        (5,542)        (7,409)


    Other expenses                                        (844)        (1,873)        (1,044)        (3,011)
                                                    ----------      ---------     ----------      ---------

    Loss before taxes                                  (34,378)        (4,315)       (42,040)        (1,778)

    (Benefit)/provision for income taxes                    --            (62)        (1,468)         1,897
                                                    ----------      ---------     ----------      ---------

    Net loss                                           (34,378)        (4,253)       (40,572)        (3,675)
                                                    ==========      =========     ==========      =========

Basic and diluted loss per share:

    On net loss                                     (34,377.57)     (4,253.50)    (40,572.07)     (3,675.34)
                                                    ==========      =========     ==========      =========
</TABLE>


(a)    Includes $4.4 million of inventory write downs related to restructuring
       in 2001 (see note 4).

(b)    Includes $1.6 million of professional fees related to restructuring
       charges in 2001 (see note 4).

        The accompanying notes are an integral part of these statements.


                                       4
<PAGE>   5

                                MTS, INCORPORATED
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                FOR THE NINE MONTHS ENDED APRIL 30, 2001 AND 2000
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                   UNAUDITED
                                                                                   APRIL 30,
                                                                             ---------------------
                                                                               2001         2000
                                                                             -------       -------
<S>                                                                          <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:

    Net loss                                                                 (40,572)       (3,675)
    Adjustments to reconcile net loss to net cash provided by operating
    activities:
    Depreciation and amortization                                             25,226        22,977
    Restructuring and asset impairment costs                                  21,438            --
    Provision for losses on accounts receivable                                   57           114
    Loss on disposal of depreciable assets                                     3,573         5,126
    Exchange loss                                                              7,393         6,063
    Other non-cash expense                                                       320           197
    Provision for deferred taxes                                               1,554           767
    (Decrease) increase in cash resulting from changes in:
      Accounts receivable                                                     (1,705)       (3,740)
      Inventories                                                             13,369       (17,283)
      Prepaid expenses                                                         4,167        (2,105)
      Accounts payable                                                        (3,795)       11,033
      Accrued liabilities and taxes payable                                      807         8,803
      Deferred revenue                                                          (376)         (698)
                                                                             -------       -------
           Net cash provided by operating activities                          31,456        27,579
                                                                             -------       -------

CASH FLOWS FROM INVESTING ACTIVITIES:

      Acquisition of fixed assets                                            (23,213)      (27,798)
      Acquisition of investments                                              (1,710)       (1,327)
      Increase in deposits                                                      (262)         (169)
      Refunds of deposits                                                         38            29
      Increase in intangibles                                                 (2,092)         (358)
                                                                             -------       -------
           Net cash used in investing activities                             (27,239)      (29,623)
                                                                             -------       -------

CASH FLOWS FROM FINANCING ACTIVITIES:

      Loans to shareholder, officers and employees                                --          (334)
      Proceeds from employee loan payments                                        93           378
      Principal payments under long-term financing agreements                (35,803)      (60,550)
      Proceeds from issuance of long-term financing agreements                60,482        67,000
                                                                             -------       -------
           Net cash provided by financing activities                          24,772         6,494
                                                                             -------       -------
Effect of exchange rate changes on cash                                      (13,822)       (6,865)
                                                                             -------       -------
           Net increase/(decrease) in cash and cash equivalents               15,167        (2,415)
Cash and cash equivalents, beginning of period                                21,486        24,705
                                                                             -------       -------
Cash and cash equivalents, end of period                                      36,653        22,290
                                                                             =======       =======
Cash paid for interest                                                        16,250        12,508
                                                                             =======       =======
Cash paid for income taxes                                                     2,010         8,139
                                                                             =======       =======
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       5
<PAGE>   6

                                MTS, INCORPORATED
                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
                FOR THE NINE MONTHS ENDED APRIL 30, 2001 AND 2000
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                        UNAUDITED
                                                -------------------------
                                                  2001              2000
                                                -------            ------
<S>                                             <C>                <C>
Net Loss                                        (40,572)           (3,675)

Other comprehensive income, net of tax

      Foreign currency translation                5,164               111
                                                -------            ------
Comprehensive Loss                              (35,408)           (3,564)
                                                =======            ======
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       6
<PAGE>   7

                                MTS, INCORPORATED
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


NOTE 1 - BASIS OF PRESENTATION

The unaudited consolidated financial statements include the accounts of MTS,
Incorporated and its majority and wholly owned subsidiaries (Company). In the
opinion of the Company's management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only normal
recurring adjustments and restructuring and asset impairment charges) necessary
to present fairly its consolidated financial position as of April 30, 2001 and
the results of its operations and cash flows for the nine months then ended. The
significant accounting policies and certain financial information which are
normally included in financial statements prepared in accordance with generally
accepted accounting principals, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying unaudited
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the fiscal year ended July 31, 2000.

NOTE 2 - TRANSLATION OF FOREIGN CURRENCY

The value of the U.S. dollar rises and falls day-to-day on foreign currency
exchanges. Since the Company does business in several foreign countries, these
fluctuations affect the Company's financial position and results of operations.
In accordance with SFAS No. 52, Foreign Currency Translation, all foreign assets
and liabilities have been translated at the exchange rates prevailing at the
respective balance sheets dates, and all income statement items have been
translated using the weighted average exchange rates during the respective
years. The net gain or loss resulting from translation upon consolidation into
the financial statements is reported as a separate component of shareholder's
equity. Some transactions of the Company and its foreign subsidiaries are made
in currencies different from their functional currency. Translation gains and
losses from these transactions are included in income as they occur. The Company
recorded net transaction losses of $5.5 million and $7.4 million for the nine
months ended April 30, 2001 and 2000, respectively. These amounts primarily
represent unrealized losses on the Company's yen-denominated debt in 2000 and
the volatility of currencies in international countries in which the Company
does business.

NOTE 3 - INCOME TAXES

The effective income tax rates for the nine months ended April 30, 2001 and 2000
are based on the federal statutory income tax rate, increased for the effect of
state income taxes, net of federal benefit and foreign taxes and decreased due
to the creation of a valuation account related to the net operating loss and
certain deferred tax assets.

NOTE 4 - RESTRUCTURING AND ASSET IMPAIRMENT CHARGES

In the third quarter, the Company recorded pre-tax restructuring and asset
impairment charges of $23.8 million, as a result of steps the Company is taking
that are intended to improve the Company's operations and improve cash flows. Of
the $23.8 million in total pre-tax restructuring and asset impairment charges,
$4.4 million related to inventory write downs was recorded in cost of sales and
$1.6 million related to professional fees was recorded in selling, general and
administrative expenses. The remaining $17.8 million of the total pre-tax
restructuring and asset impairment charges were reported separately. Included in
the $17.8 million is $13.6 million for the write down of leasehold improvements
and various other property in stores to be closed, $3.2 million for accrual of
lease termination and other costs, and $1.0 million of involuntary termination
and benefits. The involuntary termination benefits include amounts that have
been either paid or accrued for and cover


                                       7
<PAGE>   8

                                MTS, INCORPORATED
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


approximately 250 employees at both the retail and corporate level, from clerks
to management.


NOTE 5 - DEBT

In April 2001, the Company amended and restated on a short-term basis its
outstanding obligations under its senior revolving credit facility (Credit
Facility). The Credit Facility now provides for initial maximum borrowings of up
to $225.0 million, consisting of two sub-facilities (one for an initial maximum
of $98.4 million and one for an initial maximum Japanese yen of
(Yen)15,596,828,718, which was equivalent to $126.6 million at inception), and
it matures in April 2002. Maximum borrowings under the Credit Facility will
decline during its one year term by $15 million in each of July and October 2001
and an additional $95 million in December 2001. Maximum borrowings under the
Credit Facility are also subject to a borrowing base formula, maximum leverage
ratio tests and maintaining a minimum rolling quarterly EBITDA. Borrowings are
collateralized by substantially all of the Company's assets and the capital
stock of its subsidiaries. The Credit Facility bears interest at various
variable rates, including (as defined in the agreements) a Money Market Rate,
ABR Rate, Yen Base Rate and Euro Rate, plus an annual facility fee payable by
the Company. There are various restrictive terms and covenants relating to the
occurrence of material adverse financial operating conditions, balance sheet
coverage ratio, certain debt and certain limitations on additional indebtedness,
sale-leaseback transactions, liens or encumbrances on substantially all of the
Company's assets, cash management arrangements, long-term transactions, capital
expenditures, investments, acquisitions and new retail locations, mandatory
commitment reductions and issuance of capital stock.


                                       8
<PAGE>   9

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following information should be read in conjunction with the unaudited
interim consolidated financial statements and the notes thereto included in Item
1 of this Quarterly Report on Form 10-Q in addition to the consolidated
financial statements and notes thereto for the fiscal year ended July 31, 2000
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission.

FORWARD-LOOKING STATEMENTS

The following discussion should be read in conjunction with historical
consolidated financial information and the unaudited consolidated financial
statements of the Company and the notes thereto included elsewhere in this Form
10-Q. The results shown herein are not necessarily indicative of the results to
be expected in any future period. The following discussion contains
forward-looking statements that involve known and unknown risks and
uncertainties. Use of the words "anticipates," "believes," "estimates,"
"expects," "intends," "plans" and similar expressions is intended to identify
forward-looking statements. A variety of factors could cause the Company's
actual results to differ materially from the anticipated results expressed in
such forward-looking statements, including among other things: (i) consumer
demand for the Company's products, which is believed to be related to a number
of factors, including overall consumer spending patterns, weather conditions and
new releases available from suppliers; (ii) an unexpected increase in
competition, including Internet competition and competition resulting from
electronic or other alternative methods of delivery of music and other products
to consumers, or unanticipated margin or other disadvantages relative to our
competitors; (iii) the continued availability and cost of adequate capital to
fund the Company's operations; (iv) higher than anticipated interest, occupancy,
labor, distribution and inventory shrinkage costs; (v) unanticipated adverse
litigation expenses or results; (vi) higher than anticipated costs associated
with the implementation of the Company's restructuring plan and/or lower than
anticipated resulting operations and cash flow benefits; (vii) unanticipated
increases in the cost of merchandise sold by the Company; (viii) changes in
foreign currency exchange rates and economic and political country risk; (ix)
the ability of the Company to comply with the ongoing monthly affirmative and
negative covenants as prescribed by the Company's Amended and Restated Credit
Agreement; (x) the ability of the Company to arrange for alternative debt or
equity financing commitments as required under the terms of the Company's
Amended and Restated Credit Agreement; (xi) the ability of the Company to raise
the cash necessary to meet the mandatory commitment reductions under the
Company's Amended and Restated Credit Agreement; and (xii) the ability of the
Company to successfully defend itself in ongoing and future litigation. All
forward-looking statements included in this Form 10-Q are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. Please refer to the
Risk Factors section of the Company's Annual Report on Form 10-K for further
information on other factors, which could affect the financial results of the
Company and such forward-looking statements.


RESULTS OF OPERATIONS

THREE MONTHS ENDED APRIL 30, 2001 COMPARED TO THREE MONTHS ENDED APRIL 30, 2000

REVENUES

For the three months ended April 30, 2001, the Company's consolidated net
revenues were stable at $255.1 million versus $255.0 million, an increase of $.1
million (or an increase of $10.3 million excluding the effects of U.S. dollar
foreign translation fluctuations). The Company's net revenues were derived from
U.S. revenues of $148.7 million and international revenues of $106.4 million for
the three months ended April 30, 2001 compared to $148.5 million in the U.S. and
$106.5 million internationally for the three months ended April 30, 2000. The
overall increase in total Company revenues for the three months ended April 30,
2001 was driven


                                       9
<PAGE>   10

primarily by new store revenues and improving comparable store performance
offset by the adverse fluctuations in foreign currency exchange rates, the loss
of one operating day in 2001 due to 2000 being a leap year and the closing of
under performing stores. During the three months ended April 30, 2001, the
Company opened one store and closed ten stores, bringing its total number of
owned and operated retail stores to 185.

GROSS PROFIT

For the three months ended April 30, 2001, gross profit decreased $14.5 million
to $70.9 million from $85.4 million for the three months ended April 30, 2000
(or a decrease of $11.7 million excluding the effects of the U.S. dollar foreign
translation fluctuations). Management attributes the decline in gross profit,
excluding the effect of inventory write downs related to the restructuring
charge (see note 4), principally to weaker domestic margins associated with the
liquidation of inventory from closed stores, adverse fluctuations in foreign
currency exchange rates and the reconciliation of the perpetual inventory
records of the Company's foreign subsidiaries. Improved margins from the
Company's domestic core music operations were impacted by higher product costs
associated with international operations due to the strengthening of the U.S.
dollar against international currencies. Gross profit as a percentage of net
revenues decreased to 27.8% for the three months ended April 30, 2001 as
compared to 33.5% for the three months ended April 30, 2000. Management
attributes the percentage decrease primarily to liquidation of inventory
associated with certain store closures in connection with the Company's
restructuring efforts and the reconciliation of international inventories as
discussed above.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses, excluding depreciation and
amortization, decreased by $3.1 million to $70.9 million during the three months
ended April 30, 2001 from $74.0 million for the three months ended April 30,
2000. Excluding the effect of professional fees related to the restructuring
charge (see note 4), decreases in personnel, occupancy, advertising and other
cost savings initiatives resulting from the Company's restructuring program
contributed primarily to the reduction in overall operating costs. As a
percentage of net revenues, selling, general and administrative expenses
decreased to 27.8% for the three months ended April 30, 2001 as compared to
29.0% for the three months ended April 30, 2000. Management attributes the
percentage decrease excluding the effect of professional fees related to the
restructuring charge (see note 4) primarily to the overall reductions in
operating costs as previously discussed.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense was $7.4 million for the three months
ended April 30, 2001 compared to $6.8 million for the three months ended April
30, 2000, an increase of $0.6 million. This increase was primarily due to
reducing the useful lives of the Company's technology and intangible assets and
ongoing investments in depreciable assets.

LOSS FROM OPERATIONS

The Company's consolidated operating loss during the three months ended April
30, 2001 was $25.1 million compared with consolidated operating income of $4.7
million during the three-month period ended April 30, 2000, a decrease of $29.8
million. Excluding the effects of the $23.8 million in total restructuring and
asset impairment costs incurred during the three months ended April 30, 2001,
this decrease reflects primarily the decrease in gross profit and increase in
depreciation offset by the reduction in selling, general and


                                       10
<PAGE>   11

administrative expenses as previously discussed.

INTEREST EXPENSE

Net interest expense was $6.3 million for the three months ended April 30, 2001
compared to $5.5 million for the three months ended April 30, 2000, an increase
of 14.6%. The increase was due primarily to increased amounts outstanding under
the Company's senior credit facility.

FOREIGN CURRENCY TRANSLATION LOSS

A foreign currency translation loss of $2.1 million was recognized for the three
months ended April 30, 2001 compared to a foreign currency translation loss of
$1.5 million for the three months ended April 30, 2000. The account primarily
represents the volatility of foreign currency fluctuations against the U.S.
dollar in foreign countries in which the Company does business.

INCOME TAXES

Pre-tax losses resulted in an income tax benefit for the three months ended
April 30, 2001 of $0 million compared with an income tax benefit of $0.1 million
for the three months ended April 30, 2000. Tax provisions and benefits are based
upon management's estimate of the Company's annualized effective tax rates.


NINE MONTHS ENDED APRIL 30, 2001 COMPARED TO NINE MONTHS ENDED APRIL 30, 2000

REVENUES

For the nine months ended April 30, 2001, the Company's consolidated net
revenues were $833.5 million compared to $842.2 million for the nine months
ended April 30, 2000, a decrease of $8.7 million (or an increase of $12.6
million excluding the effects of U.S. dollar foreign translation fluctuations).
The Company's net revenues were derived from U.S. revenues of $489.7 million and
international revenues of $343.8 million for the nine months ended April 30,
2001 compared to $498.9 million in the U.S. and $343.3 million internationally
for the nine months ended April 30, 2000. The overall decrease in total revenues
for the nine months ended April 30, 2001 was driven primarily by the adverse
fluctuations in foreign currency exchange rates and a decrease in domestic same
store sales of 3.6% generally associated with weak new releases and diminishing
consumer demand for compact disc singles and cassettes. During the nine months
ended April 30, 2001, the Company opened 12 stores and closed 15 stores,
bringing its total number of owned and operated retail stores to 185.

GROSS PROFIT

For the nine months ended April 30, 2001, gross profit was $250.1 million
compared to $269.0 million for the nine months ended April 30, 2000, a decrease
of $18.9 million (or a decrease of $12.3 million excluding the negative effects
of U.S. dollar foreign translation fluctuations). Management attributes the
decrease in gross profit, excluding the effects of inventory write downs related
to the restructuring charge (see note 4), principally to the decrease in
domestic same store sales, weaker domestic margins associated with the
liquidation of inventory from closed stores and the impact of foreign currency
fluctuations on international purchases and margins. Gross profit as a
percentage of net revenues decreased to 30.0% for the nine months ended April
30, 2001 compared to 31.9% for the nine months ended April 30, 2000. Management
believes that the primary factors contributing to the decrease in gross profit
as a percentage of net revenues was due to ongoing industry pricing pressures,
the liquidation of closed stores associated with the Company's restructuring
initiatives and the reconciliation of the perpetual


                                       11
<PAGE>   12

inventory records of the Company's foreign subsidiaries.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSE

Selling, general and administrative expenses, excluding depreciation and
amortization, were $226.2 million for the nine months ended April 30, 2001
compared to $226.0 million for the nine months ended April 30, 2000, an increase
of $.2 million. Excluding the effects of professional fees related to the
restructuring charge (see note 4), decreases in personnel and other cost savings
resulting from the Company's restructuring program were offset by increases in
distribution, store occupancy, and advertising and marketing costs. As a
percentage of net revenues, selling, general and administrative expenses
increased to 27.1% for the nine months ended April 30, 2001 compared to 26.8%
for the nine months ended April 30, 2000. Excluding the effects of professional
fees related to the restructuring charge (see note 4), management attributes the
percentage increase primarily to the decrease in net revenues.

DEPRECIATION AND AMORTIZATION

Depreciation and amortization expense was $23.0 million for the nine months
ended April 30, 2001 compared to $19.5 million for the nine months ended April
30, 2000, an increase of $3.5 million. The increase was primarily due to
reducing the useful lives of technology and intangible assets and ongoing
investments in depreciable assets.

LOSS FROM OPERATIONS

The Company's consolidated operating loss for the nine months ended April 30,
2001 was $16.9 million compared with consolidated operating income of $23.5
million for the nine-month period ended April 30, 2000, a decrease of $40.4
million. This decrease (excluding the effects of $23.8 million in restructuring
and asset impairment costs) reflects primarily the decrease in gross profit and
the increase in depreciation offset by the reduction in selling, general and
administrative expenses as discussed above.

INTEREST EXPENSE

Net interest expense was $18.6 million for the nine months ended April 30, 2001
compared to $14.8 million for the nine months ended April 30, 2000, an increase
of $3.8 million or 25.7%. The increase was due primarily to increased amounts
outstanding under the Company's senior credit facility combined with higher
borrowing costs.

FOREIGN CURRENCY TRANSLATION LOSS

The Company recognized a foreign currency translation loss of $5.5 million for
the nine months ended April 30, 2001 compared to a foreign currency translation
loss of $7.4 million for the nine months ended April 30, 2000. The account
primarily represents non-cash losses due to outstanding yen denominated bank
debt in 2000 and the volatility of currencies in international countries in
which the Company does business.

INCOME TAXES

A pre-tax operating loss resulted in an income tax benefit for the nine months
ended April 30, 2001 of $1.5 million compared with an income tax expense of $1.9
million for the nine months ended April 30, 2000. Tax benefits and provisions
are based upon management's estimate of the Company's annualized effective tax
rates.


                                       12
<PAGE>   13

RESTRUCTURING AND ASSET IMPAIRMENT COSTS

During the third quarter of the Company's 2001 fiscal year, the Company
commenced a business plan and restructuring process and retained a consulting
firm to assist the Company in its efforts. These efforts produced a three-year
restructuring plan that was adopted by the Company in February 2001.

The restructuring plan contains several initiatives designed to improve the
Company's operations, including closing and liquidating most stand-alone and
combination bookstores, canceling nearly all future commitments for bookstores
and book departments, entering into a joint venture relationship for the
Company's Hong Kong and Singapore operations, selling or closing the Company's
Canadian and Argentinean operations, closing up to nine under performing
domestic record, outlet and frame/gallery stores, and monitoring an additional
nine stores for possible future closure. The restructuring plan also contains
several initiatives intended to improve cash flow, including substantially
eliminating new store openings and remodeling plans, reducing capital
expenditures until internally generated cash flow will support further growth,
and reducing working capital.

The Company began implementing its restructuring plan shortly after its
adoption. Since the plan was implemented, the Company has closed all but one of
its stand-alone book stores identified in the plan and has liquidated most of
its book inventories. The Company has also closed several of its under
performing record and outlet stores and had arranged for the sale of two of its
frame/gallery stores. Consistent with the restructuring plan, the Company is
still monitoring additional stores for possible future closure.

In the third quarter, the Company recorded pre-tax restructuring and asset
impairment charges of $23.8 million, as a result of steps the Company is taking
that are intended to improve the Company's operations and improve cash flows. Of
the $23.8 million in total pre-tax restructuring and asset impairment charges,
$4.4 million related to inventory write downs was recorded in cost of sales and
$1.6 million related to professional fees was recorded in selling, general and
administrative expenses. The remaining $17.8 million of the total pre-tax
restructuring and asset impairment charges were reported separately. Included in
the $17.8 million is $13.6 million for the write down of leasehold improvements
and various other property in stores to be closed, $3.2 million for accrual of
lease termination costs, and $1.0 million of involuntary termination and
benefits. The involuntary termination benefits include amounts that have been
either paid or accrued for and cover approximately 250 employees at both the
retail and corporate level, from clerks to management.

The Company expects to substantially complete implementation of the remainder of
its restructuring initiatives by the end of the first quarter of the Company's
2002 fiscal year. The Company will continue to record charges to operations for
restructuring costs, asset impairments and inventory reserves in the future. Due
to these additional restructuring charges, the Company anticipates that net
income for the fourth quarter of fiscal 2001 will be lower than previously
anticipated.

LIQUIDITY AND CAPITAL RESOURCES

The Company's principal capital requirements are to fund working capital needs,
the refurbishment and expansion of existing stores, and continued development of
the Company's technological infrastructure.

Net cash provided by operating activities was $31.4 million and $27.6 million
for the nine months ended April 30, 2001 and 2000, respectively. For the nine
months ended April 30, 2001, net cash provided by working capital was $12.4
million versus $4.0 million applied to working capital for the nine months ended
April 30, 2000, and was primarily related to changes in inventories, prepaids,
payables and accruals. The increase in cash flow from operations for the nine
months ended April 30, 2001 versus the nine months ended April 30, 2000 was
primarily due to increases in cash provided from operating activities and
reductions in working capital requirements.


                                       13
<PAGE>   14

Net cash used for investing activities was primarily geared to capital
expenditures on stores, including the opening of five stores in the United
States, seven stores internationally along with store relocations,
refurbishments and technology investments totaling approximately $21.3 million
with an additional $1.9 million used for video rental acquisitions.

Cash provided by financing activities for the nine months ended April 30, 2001
was $60.5 million, resulting principally from borrowings under the Company's
credit facility. Cash expended for financing activities for the nine months
ended April 30, 2001 was $35.8 million, which resulted primarily from reductions
under the Company's credit facility.

Interest payments and required debt reduction on the senior subordinated notes
and on the credit facility will continue to impose significant liquidity demands
upon the Company. In addition to its debt service obligations, the Company will
require liquidity for capital expenditures, lease obligations and general
working capital needs. Total capital expenditures for fiscal 2001 are expected
to be approximately $29.0 million, of which approximately $15.0 million will be
related to maintenance and required technological capital improvements.

The Company entered into an amended and restated credit agreement in April 2001
pursuant to which the Company's senior credit facility will be extended for one
year. The amended revolving credit facility initially provides the Company with
available borrowings up to an aggregate amount of $225.0 million, of which
approximately $126.6 million can be borrowed in Japanese yen, subject to
compliance with the borrowing base formula and a maximum leverage test. The
amount available under the facility will decline to $210 million in July 2001,
$195 million in October 2001 and $100 million in December 2001. As of April 30,
2001, the Company had drawn $202.3 million on the credit facility, net of a
$13.2 million translation gain on yen debt translated in U.S. dollars at the
spot rate on April 30, 2001.

The Company believes that it will require further external financing to fund the
mandatory commitment reductions together with the Company's lease obligations,
working capital requirements, operating expenses and other debt service
obligations. Adverse foreign currency fluctuations could also increase the cash
needed by the Company to reduce its borrowings under the credit facility. In
addition, the Company is required under the terms of the credit facility to
deliver to its lenders by October 1, 2001 firm commitments from financial
institutions for debt or equity financings necessary to meet the December 2001
mandatory reduction under the credit facility. There can be no assurance that
the Company will be able to obtain firm financing commitments by that date, if
at all, or that the terms of those financing commitments will be favorable to
the Company or its debt or equity holders. If the Company is unable to satisfy
its obligations under the credit facility, the Company will be in default under
the terms of the amended and restated credit agreement.

The credit facility and the senior subordinated notes impose certain
restrictions on the Company's ability to make capital expenditures and limit the
Company's ability to incur additional indebtedness. Such restrictions could
limit the Company's ability to respond to market conditions, to provide for
unanticipated capital investments or to take advantage of business or
acquisition opportunities. The amended covenants contained in the credit
facility and the senior subordinated notes also, among other things, limit the
ability of the Company to dispose of assets, repay indebtedness or amend other
debt instruments, pay distributions, create liens on substantially all of the
Company's assets, enter into sale and leaseback transactions, make investments,
loans or advances and make acquisitions. Substantially all of the Company's
tangible and intangible assets have been collateralized against the credit
facility.

The Company's future operating performance and the Company's ability to service
or refinance the debt outstanding under its senior subordinated notes and its
credit facility will be subject to the Company's ability to extend the credit
facility, future economic conditions and financial, business and other factors,
many of which


                                       14
<PAGE>   15

are beyond the Company's control.

SEASONALITY

Retail music sales in the United States are typically higher during the calendar
fourth quarter as a result of consumer purchasing patterns due to increased
store traffic and impulse buying by holiday shoppers. As a result, the majority
of U.S. music retailers and, more specifically, the mall-based retailers rely
heavily on the calendar fourth quarter to achieve annual sales and profitability
results. The Company's deep-catalog approach to prerecorded music appeals to
customers who purchase music on a year-round basis. Consequently, the Company
has historically had reduced seasonal reliance. In addition, international
markets exhibit less fourth quarter seasonality than U.S. markets and the
Company's international presence has historically further reduced this reliance
on the U.S. holiday shopping season.

INFLATION

The Company believes that the recent low rates of inflation in the United
States, Japan and the United Kingdom, where it primarily operates, have not had
a significant effect on its net sales or operating results. The Company attempts
to offset the effects of inflation through the management of controllable
expenses. However, there can be no assurance that during a period of significant
inflation, the Company's results of operations would not be adversely affected.

FOREIGN EXCHANGE MANAGEMENT

The Company has substantial operations and assets located outside the United
States, primarily in the United Kingdom and Japan. With respect to international
operations, principally all of the Company's revenues and costs (including
borrowing costs) are incurred in the local currency, except that certain
inventory purchases are tied to U.S. dollars. The Company's financial
performance on a U.S. dollar-denominated basis has historically been
significantly affected by changes in currency exchange rates. The Company
believes that the matching of revenues and expenses in local currency, as well
as its foreign exchange hedging activities and borrowings in foreign currencies,
mitigate the effect of fluctuating currency exchange rates. Nonetheless, changes
in certain exchange rates could adversely affect the Company's business,
financial condition and results of operations. See "Quantitative and Qualitative
Disclosures about Market Risk."

ACCOUNTING POLICIES

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS)133, "Accounting for Derivative Instruments
and Hedging Activities." The provisions of SFAS 133, require all derivative
instruments to be recognized on the balance sheet as assets or liabilities at
fair value. The Company adopted SFAS 133, as amended, on August 1, 2000.
Commencing in fiscal 2001, the Company records its derivatives on the balance
sheet at fair value and reported adjustments to fair value through income. Given
the Company's limited use of derivatives, the cumulative effect of adopting SFAS
133 was not material.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to the impact of interest-rate changes and foreign
currency fluctuations. The Company does not enter into market risk sensitive
instruments for trading purposes. In the ordinary course of its business, the
Company enters into debt instruments, including instruments with short-term
maturities. The Company could be exposed to a higher interest rate at the time
such debt instruments are renewed or refinanced. Certain of the Company's debt
instruments contain terms that permit the Company to cap the interest rate at a
maximum rate.


                                       15
<PAGE>   16
In the past, the Company has purchased interest rate hedges to manage the risk
associated with interest rate variations.

Of the Company's current long-term debt, $110 million bears a fixed interest
rate and is payable in 2005. The Company prepared sensitivity analyses of the
balance of its financial instruments to determine the impact of hypothetical
changes in interest rates on the Company's results of operations, cash flows,
and the fair value of its financial instruments. The interest-rate analysis
assumed a one hundred basis point adverse change in interest rates on all
variable rate financial instruments but did not consider the effects of the
reduced level of economic activity that could exist in such an environment.
Based on the results of such analysis, the Company concluded that a one hundred
basis point adverse change in interest rates from year-end 2000 levels would not
materially affect the Company's results of operations, cash flows, or the fair
value of its financial instruments.

A substantial majority of the Company's revenues, expenses and capital
purchasing activities are transacted in U.S. dollars. However, the Company does
enter into these transactions in other foreign currencies, primarily Japanese
yen. The Company uses forward exchange contracts to hedge intercompany
transactions with foreign subsidiaries and affiliates, and in connection with
certain of its Japanese subsidiary's purchases of product from third parties.
Such instruments are short-term instruments entered into in the ordinary course
of the Company's business, in order to reduce the impact of fluctuating foreign
currencies on net income and shareholders' equity.

To finance expansion and operations in Japanese markets, the Company has entered
into yen-denominated borrowing arrangements. Unrealized gains and losses
resulting from the impact of currency exchange rate movements on these debt
instruments are recognized as other income or expense in the period in which the
exchange rates change. Historically, the Company has not entered into foreign
exchange contracts to manage the risk associated with such currency
fluctuations, but it may do so from time to time in the future.

The Company prepared sensitivity analyses of its yen-denominated financial
instruments to determine the impact of hypothetical changes in foreign exchange
rates on the Company's results of operations, cash flows and the fair value of
its financial instruments. The analysis assumed a 10% adverse change in exchange
rates on such financial instruments but did not consider other effects on
economic activity that could exist in such an environment. Based on the results
of such analysis, the Company concluded such an adverse change in exchange rates
from year-end levels would not materially affect the Company's results of
operations, cash flows or the fair value of its financial instruments.


                                       16
<PAGE>   17

                           PART II. OTHER INFORMATION


ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

       (a)    Exhibits

<TABLE>
<CAPTION>
          Exhibit No.                         Description
<S>                        <C>
             10.5          Amended and Restated Credit Agreement, dated as of
                           April 27, 2001, between the Company and The Chase
                           Manhattan Bank.
</TABLE>

       (b)    Reports on Form 8-K.

           None


                                       17
<PAGE>   18

                                   SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                        MTS, INCORPORATED

                        By:             /s/ DeVaughn D. Searson
                           ----------------------------------------------------
                                            DeVaughn D. Searson
                            Executive Vice President and Chief Financial Officer
                               (Principal Financial and Accounting Officer)


                        Dated: June 14, 2001


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