VALLEY MEDIA INC, 10-Q, 1999-08-13

VALLEY MEDIA INC
10-Q, 1999-08-13
HOUSEHOLD AUDIO & VIDEO EQUIPMENT

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended July 3, 1999

[ ] 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 000-25617

VALLEY MEDIA, INC.
(Exact name of registrant as specified in its charter)

Delaware 94-2556440
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)

------------------------

1280 Santa Anita Court, Woodland, California 95776
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (530) 661-6600

------------------------

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

Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

The number of shares outstanding of the Registrant's common stock as of July 30,
1999 was 8,451,509 shares.

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Valley Media, Inc.

INDEX

<TABLE>
<CAPTION>
Part 1 - Financial Information Page
----
Item 1. Financial Statements
<S> <C>
Consolidated Balance Sheets as of July 3, 1999 and April 3,
1999 2

Consolidated Statements of Operations for the thirteen weeks
ended July 3, 1999 and June 27, 1998 3

Consolidated Statements of Cash Flows for the thirteen weeks
ended July 3, 1999 and June 27, 1998 4

Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 8

Item 3. Quantitative and Qualitative Disclosure About Market Risk 20

Part II - Other Information

Item 1. Legal Proceedings 20

Item 2. Changes in Securities and Use of Proceeds 20

Item 3. Defaults Upon Senior Securities 20

Item 4. Submission of Matters to a Vote of Security Holders 20

Item 5. Other Information 20

Item 6. Exhibits and Reports on Form 8-K 21

Signatures 22
</TABLE>

<PAGE>

PART I - Financial Information

ITEM 1. Financial Statements

Valley Media, Inc.

Consolidated Balance Sheets

(Unaudited)

<TABLE>
<CAPTION>
July 3, April 3,
1999 1999
--------- ---------
<S> <C> <C>

Dollars in thousands, except share data
Assets
Current assets

Cash............................................................................................... $ 261 $ 1,433
Accounts receivable, less allowance for doubtful accounts of $9,157 at July 3, 1999 and $8,892
at April 3, 1999.................................................................................. 123,807 167,925
Inventories, net of reserves of $2,898 at July 3, 1999 and $2,823 at April 3, 1999................. 225,727 216,807
Deferred income taxes.............................................................................. 5,956 5,956
Prepaid expenses and other......................................................................... 1,683 1,551
-------- --------
Total.............................................................................................. 357,434 393,672

Property and equipment, net......................................................................... 26,012 20,913

Goodwill and other intangibles, net................................................................. 14,309 14,678

Deferred income taxes............................................................................... 399 399

Other assets........................................................................................ 1,403 1,063
-------- --------

Total assets........................................................................................ $399,557 $430,725
======== ========

Liabilities and stockholders' equity
Current liabilities
Accounts payable................................................................................. $157,956 $191,978
Accrued liabilities.............................................................................. 6,853 11,534
Revolving line of credit......................................................................... 154,352 148,730
Current portion of long-term debt................................................................ 2,595 1,905
Deferred income taxes............................................................................ 3,918 3,918
-------- --------
Total............................................................................................ 325,674 358,065
-------- --------

Deferred income taxes............................................................................... 2,855 2,855

Long-term debt...................................................................................... 5,814 3,918

Commitments and contingencies

Stockholders' equity
Preferred stock, $.001 par value, 2,000,000 shares authorized, none issued
Common stock, $.001 par value, 20,000,000 shares authorized, 8,449,009 shares issued and
outstanding..................................................................................... 8 8

Additional paid-in capital......................................................................... 52,145 52,145
Stockholders' notes receivable..................................................................... (234) (360)
Retained earnings.................................................................................. 13,295 14,094
-------- --------

Total stockholders' equity........................................................................ 65,214 65,887
-------- --------

Total liabilities and stockholders' equity.......................................................... $399,557 $430,725
======== ========

</TABLE>

See notes to consolidated financial statements.

2
<PAGE>

Valley Media, Inc.

Consolidated Statements of Operations

(Unaudited)

<TABLE>
<CAPTION>
-----------------------------------
Thirteen Weeks Ended
-----------------------------------
July 3, June 27,
Dollars in thousands, except share data 1999 1998
---- ----
<S> <C> <C>
Net sales...................................................... $ 185,766 $ 154,373
Cost of goods sold............................................. 163,895 137,423
---------- ----------

Gross profit................................................... 21,871 16,950
Selling, general and administrative expenses................... 20,073 16,734
---------- ----------

Operating income............................................... 1,798 216
Interest expense............................................... 3,164 2,085
---------- ----------

Loss before income taxes....................................... (1,366) (1,869)
Income tax benefit............................................. (567) (607)
---------- ----------

Loss before extraordinary loss................................. (799) (1,262)
Extraordinary loss (net of income taxes of $477)............... (723)
---------- ----------

Net loss....................................................... $ (799) $ (1,985)
========== ==========
Net loss per share:
Basic and diluted loss before extraordinary loss.......... $(0.09) $ (0.26)
Basic and diluted extraordinary loss...................... (0.15)
---------- ----------
Basic and diluted net loss per share...................... $(0.09) $ (0.41)
========== ==========

Weighted average shares used in the calculation:
Basic and diluted........................................... 8,449,009 4,822,211
========== ==========
</TABLE>

See notes to consolidated financial statements.

3
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Valley Media, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

<TABLE>
<CAPTION>
---------------------
Thirteen Weeks Ended
---------------------
July 3, June 27,
Dollars in thousands 1999 1998
---- ----
<S> <C> <C>

Cash flows from operating activities
Loss before extraordinary loss...................................................................... $ (799) $ (1,262)
Adjustments to reconcile loss before extraordinary loss to net cash used in operating activities:
Depreciation and amortization....................................................................... 1,565 1,214
Bad debt expense.................................................................................... 265 980
Extraordinary loss on debt refinancing.............................................................. (723)
Changes in assets and liabilities:
Accounts receivable................................................................................. 42,944 3,053
Inventories......................................................................................... (7,717) (37,893)
Prepaid expenses and other.......................................................................... (247) (567)
Accounts payable.................................................................................... (34,637) 8,505
Accrued liabilities................................................................................ (4,466) (1,867)
--------- ---------

Net cash used in operating activities............................................................. (3,092) (28,560)
--------- ---------

Cash flows from investing activities
Purchases of property and equipment................................................................. (6,454) (4,150)
Other............................................................................................... 40
--------- ---------
Net cash used in investing activities............................................................. (6,414) (4,150)
--------- ---------

Cash flows from financing activities
Short-term borrowings under revolving line of credit................................................ 221,964 180,558
Repayment of short-term borrowings.................................................................. (216,342) (147,859)
Issuance of long-term debt.......................................................................... 2,985 263
Repayment of long-term debt......................................................................... (399) (312)
Repayment of stockholder note receivable............................................................ 126
--------- ---------
Net cash provided by financing activities......................................................... 8,334 32,650
--------- ---------

NET DECREASE IN CASH................................................................................... (1,172) (60)
CASH, BEGINNING OF PERIOD.............................................................................. 1,433 394
--------- ---------
CASH, END OF PERIOD.................................................................................... $ 261 $ 334
========= =========
</TABLE>

See notes to consolidated financial statements.

4
<PAGE>

Valley Media, Inc.

Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

The accompanying consolidated financial statements of Valley Media, Inc.,
and its subsidiaries (the "Company"), are unaudited and reflect all normal,
recurring adjustments, which, in the opinion of management, are necessary for a
fair presentation of such financial statements. The Company's interim results
are not indicative of results for a full year.

These unaudited consolidated financial statements should be read in
conjunction with the audited financial statements included in the Company's
Annual Report on Form 10-K for the fiscal year ended April 3, 1999.

2. Related Party Transactions

On July 2, 1999, the Company, Valley Entertainment, Inc. ("VE"), and Barnet
J. Cohen, the Company's founder, largest stockholder and the Chairman of the
Company's Board of Directors, entered into a Contribution Agreement (the
"Contribution Agreement"). Pursuant to the Contribution Agreement, Mr. Cohen
who is the President and Chief Executive Officer of VE, contributed $1,320,000
in cash in exchange for 66 percent of VE's common stock. Other individuals
contributed $300,000 in cash in exchange for 15 percent of VE's common stock.
The Company assigned the net assets of its Valley Entertainment division to VE
in exchange for a cash payment of $486,000 and 19 percent of VE's common stock.
The Company did not recognize any gain or loss on the transaction.

3. Extraordinary Loss

As a result of terminating a prior line of credit agreement in the first
quarter of fiscal 1999, the Company incurred termination fees and wrote off
prepaid financing costs resulting in an extraordinary loss of $723,000 (net of
income tax benefit of $477,000) or $0.15 per diluted share.

4. Segment Information

Management has determined that there are three reportable segments based on
the customers served by each segment: Full-line Distribution, New Media and
Independent Distribution. Such determination was based on the level at which
executive management reviews the results of operations in order to make
decisions regarding performance assessment and resource allocation.

Full-line Distribution serves music, video and other retailers worldwide
with customers ranging from independent stores to specialty chains to retailers
who sell music and video as an ancillary product line. New Media provides
product and data to Internet retailers. Independent

5
<PAGE>

Distribution serves independent labels and studios. Independent Distribution
sells products to Full-line Distribution and New Media at market price, and
accordingly, the intersegment revenues are included in "intersegment
eliminations" in the reconciliation of operating income reported below.

Expenses of the advertising, distribution, information systems, finance and
administrative groups are not allocated to the operating segments and are
included in "other" in the reconciliation of operating income reported below.
The Company does not allocate equity in net loss of joint venture, interest
expense, income taxes or extraordinary items to operating segments. The Company
does not identify and allocate assets or depreciation by operating segment.

Information on reportable segments is as follows:

----------------------
Thirteen Weeks Ended
----------------------
July 3, June 27,
Dollars in thousands 1999 1998
----- -----
Full-line Distribution
Net sales............................ $116,256 $124,796
Operating income..................... $ 8,834 $ 8,110

New Media
Net sales............................ $ 59,145 $ 21,650
Operating income..................... $ 7,281 $ 3,463

Independent Distribution
Net sales............................ $ 13,991 $ 12,583
Operating income..................... $ 2,028 $ 1,341

Other
Unallocated expenses................. $(16,345) $(12,698)

Intersegment Eliminations
Net sales............................ $ (3,626) $ (4,656)

Total
Net sales............................ $185,766 $154,373
Operating income..................... $ 1,798 $ 216

5. Net Loss Per Share

Basic net loss per share has been computed by dividing net loss by the
weighted average number of shares outstanding during the period. Diluted net
loss per share is computed by adjusting the weighted average number of shares
outstanding during the period for all potentially dilutive shares outstanding
during the period. Net loss and weighted average shares outstanding used for
computing diluted loss per share were the same as that used for computing basic
loss per share for the thirteen weeks ended July 3, 1999 and June 27, 1998.
Stock options to purchase 809,856 and 564,785 shares of common stock outstanding
during the thirteen weeks ended July 3, 1999 and June 27, 1998, respectively,
were not included in the computation of diluted net loss per share since the
inclusion of such shares would be antidilutive.

6
<PAGE>

6. New Accounting Pronouncement

SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognizes all derivatives as either assets or
liabilities in the statement of financial position and measures these
instruments at fair value. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 2000. The Company is currently evaluating
what impact, if any, SFAS No. 133 may have on its financial statements.

7
<PAGE>

ITEM 2. Management's Discussion And Analysis Of Financial Condition And Results
Of Operations

Results of Operations
The following table sets forth certain operating data as a percentage of
net sales for the first quarter of fiscal year 2000 and 1999.

----------------------
Thirteen Weeks Ended
----------------------
July 3, June 27,
1999 1998
---- ----
Net sales....................................... 100.0% 100.0%
Gross profit.................................... 11.8 11.0
Selling, general and administrative expenses.... 10.8 10.8
Operating income................................ 1.0 0.1
Loss before extraordinary loss.................. (0.4) (0.8)
Net loss........................................ (0.4)% (1.3)%

The following table sets forth certain supplemental data for the first
quarter of fiscal year 2000 and 1999.

----------------------
Thirteen Weeks Ended
----------------------
Dollars in thousands July 3, June 27,
Supplemental Data 1999 1998
---- ----
EBITDA.......................................... $3,363 $1,430
EBITDA as a percentage of net sales............. 1.8% 0.9%

_______________
EBITDA represents earnings before interest, income taxes and depreciation
and amortization. We believe that EBITDA is a useful measure of our
financial performance. However, EBITDA should not be construed as an
alternative to operating income, net income or cash flows from operations
as determined in accordance with generally accepted accounting principles.

Thirteen Weeks Ended July 3, 1999 Compared with Thirteen Weeks Ended June
27, 1998

Our net sales increased $31.4 million, or 20%, from $154.4 million in the
thirteen weeks ended June 27, 1998 to $185.8 million in the thirteen weeks ended
July 3, 1999.

Full-line Distribution sales decreased $8.5 million, or 7%, from $124.8
million in the first quarter of fiscal 1999 to $116.3 million in the first
quarter of fiscal 2000. Increases in non-VHS formats, primarily CDs and DVDs of
$1.8 million, or 2%, including the large volume associated

8
<PAGE>

with supporting the transition of Blockbuster music stores from Viacom
Entertainment to Wherehouse Entertainment which was concluded in June 1999, were
offset by decreases in VHS sales of $15.0 million. The decrease in VHS sales was
due primarily to a weak new release schedule in the first quarter of fiscal 2000
compared to the first quarter of fiscal 1999. The decrease is also due to
inefficiencies experienced in moving the California distribution center to a
nearby facility in the first quarter of fiscal 2000, which adversely affected
our sales.

New Media sales increased $37.4 million, or 172%, from $21.7 million in the
first quarter of fiscal 1999 to $59.1 million in the first quarter of fiscal
2000 due to increased sales by our on-line customers in connection with the
general growth of e-commerce sales and the addition of new customers acquired by
the continuous outreach efforts of our New Media sales force. Our New Media
sales were also adversely affected by the California distribution center move.

Independent Distribution sales increased $1.4 million, or 11%, from $12.6
million in the first quarter of fiscal 1999 to $14.0 million in the first
quarter of fiscal 2000 due to the acquisition of new labels and successful
marketing of existing labels and artists.

Our gross profit increased $4.9 million, or 29%, from $17.0 million in the
first quarter of fiscal 1999 to $21.9 million in the first quarter of fiscal
2000, with gross margin increasing from 11.0% to 11.8%. Margins increased
primarily due to the shift in sales mix from full-line video distribution to
full-line music distribution and New Media.

Selling, general and administrative expenses increased $3.4 million, or
20%, from $16.7 million in the first quarter of fiscal 1999 to $20.1 million in
the first quarter of fiscal 2000, primarily as a result of:

. sales growth

. costs associated with the move of the Company's California distribution
facility to a new and larger warehouse

. increased rent expense as a result of the new California distribution
facility

. increased depreciation and amortization, primarily due to the further
development of our infrastructure

Selling, general and administrative expenses remained flat as a percentage
of sales at 10.8% in both the first quarters of fiscal 1999 and fiscal 2000.

Interest expense increased $1.1 million, or 52%, from $2.1 million in the
first quarter of fiscal 1999 to $3.2 million in the first quarter of fiscal 2000
primarily due to increases in working capital associated with higher sales
levels, a higher level of unprocessed customer returns due to issues related to
the California warehouse move, and investment in systems. Partially offsetting
these factors was a reduction of our average interest rate from 8.0% in first
quarter of fiscal 1999 to 7.0% in the first quarter of fiscal 2000.

9
<PAGE>

Our effective tax rate was 41.5% in the first quarter of fiscal 2000 based
upon our estimated annual rate expected for fiscal 2000. Our effective tax rate
was 32.5% in the first quarter of fiscal 1999 reflecting the effects of a true-
up of prior year tax returns.

In May 1998, termination fees from refinancing our revolving credit
facility resulted in an extraordinary loss of $723,000 (net of income taxes).

Net loss decreased $1.2 million from $(2.0) million in the first quarter of
fiscal 1999 to $(799,000) in the first quarter of fiscal 2000.

Liquidity and Capital Resources

Our capital requirements relate primarily to working capital, the expansion
of our infrastructure to accommodate sales growth, and the funding of
acquisitions. Our working capital needs are seasonal and typically peak in the
third and fourth fiscal quarters due to increases in inventories purchased for
the holiday selling season and extension of credit terms to certain customers.
We maintain significant inventory levels to fulfill our operating commitment to
carry a deep catalog of music and video stock keeping units. Inventories
generally can be returned to suppliers. Inventory levels increased from the
first quarter of fiscal 1999 to the first quarter of fiscal 2000 primarily due
to the addition of our new Louisville distribution center, which we refer to as
the LDC, delays in returning product to our vendors as a result of issues
associated with the California warehouse move and the growth in our deep catalog
New Media business. Historically, we have financed our cash requirements
primarily from short-term bank borrowings and cash from operations. In addition,
the proceeds from our March 1999 initial public offering were utilized to help
finance our cash requirements.

Net cash used in operating activities of $3.1 million in the first quarter
of fiscal 2000 consisted primarily of decreases of $34.6 million in accounts
payable and $4.5 million in accrued expenses and an increase of $7.7 million in
inventories, offset by a decrease in accounts receivable of $ 42.9 million. Net
cash used in operating activities of $28.6 million in the first quarter of
fiscal 1999 was primarily attributable to an increase of $37.9 million in
inventories offset by an increase in accounts payable of $8.5 million.

Net cash used in investing activities was $6.4 million and $4.2 million for
the first quarter of fiscal 2000 and 1999, respectively. Cash used in the first
quarter of fiscal 2000 consisted of expenditures for property and equipment
acquisitions, including $2.2 million related to the new California distribution
facility and investments in information systems technology. Cash used in the
first quarter of fiscal 1999 consisted of expenditures for property and
equipment acquisitions, primarily in connection with the opening of the LDC.
Cash used for the purchase of property and equipment has increased because of
increasing investments in equipment and technology required to facilitate
overall sales growth.

Financing activities provided net cash of $8.3 million in the first quarter
of fiscal 2000 and $32.7 million in the first quarter of fiscal 1999. Cash
provided by financing activities in the first quarter of fiscal 2000 and fiscal
1999 consisted primarily of additional borrowings under our credit facility to
fund increased working capital requirements. Cash provided by financing

10
<PAGE>

activities in the first quarter of fiscal 2000 also included $3.0 million
related to the issuance of a note payable for the purchase of certain equipment.

Our credit facility provides for borrowings up to the lesser of $200
million or the amount of collateral availability. Collateral availability is
limited to certain percentages of eligible inventory, accounts receivable and
equipment, subject to certain limitations as to video and DNA inventories and
equipment. The credit facility bears interest, at our election, at either the
prime rate plus a margin of (0.25)% to 0.5% or the Eurodollar Rate plus a margin
of 2.0% to 2.75%, subject to monthly adjustments and certain terms and
conditions as stated in the credit facility.

Borrowings under the credit facility are secured by all accounts
receivable, inventory, certain equipment and other intangible property. The
credit facility expires on May 21, 2001 and renews annually thereafter unless
notice of termination is given by either party. The credit facility contains
various financial covenants.

We believe that our borrowing availability under the credit facility will
be sufficient to meet our operating and capital requirements through fiscal
2000. Our future operating and capital requirements, however, will depend on
numerous factors, including growth of the business, additional infrastructure
needs, potential acquisitions and/or joint ventures and future results of
operations.

Seasonality in Operating Results

Our quarterly net sales and operating results have varied significantly in
the past and will likely continue to do so in the future as a result of seasonal
variations in the demand for music and video. Historically, our sales are
highest during the third fiscal quarter (the holiday season) and returns are
highest during the fourth fiscal quarter. Due to this seasonality, we typically
experience significant changes in cash flows and capacity needs during the year,
with the heaviest credit needs and highest capacity requirements typically
occurring during the third and fourth fiscal quarters.

Year 2000 Matters

The year 2000 issue has arisen as a result of computer programs being
written using two digits rather than four to define the applicable year. Certain
information technology systems and their associated software, and certain types
of equipment that use programmable logic chips to control aspects of their
operation, commonly referred to as embedded chip equipment, may recognize "00"
as a year other than the year 2000. Some information technology systems and
embedded chip equipment used by us and by third parties that do business with us
contain two-digit programming to define a year. The year 2000 issue could
result, for us and for others, in system failures or miscalculations, which
could cause disruptions of operations, including, among other things, a
temporary inability to process transactions or to engage in other normal
business activities.

11
<PAGE>

Readiness for Year 2000

We are addressing year 2000 issues relating to:

. information technology systems and embedded chip equipment used by us

. third parties who do business with us that are not prepared for the
year 2000

. contingency planning

We use a variety of information technology systems, internally developed
and third party provided software and embedded chip equipment. For these
information technology systems, software and embedded chip equipment, we have
divided our year 2000 efforts into four phases:

(1) identification and inventorying of information technology systems
and embedded chip equipment with potential year 2000 problems

(2) evaluation of scope of year 2000 issues for, and assigning
priorities to, each item based on its importance to our operations

(3) remediation of year 2000 issues in accordance with assigned
priorities, by correction, upgrade, replacement or retirement

(4) testing for and validation of year 2000 compliance on an
application basis

We have categorized as "mission critical" those information technology
systems and embedded chip equipment whose failure would result in cessation of
operations or significant detrimental financial impact on us. Phases (1) and (2)
are complete across all "mission critical" business functions and locations. All
mission critical information technology systems and embedded chip equipment are
currently in phases (3) or (4).

Our operations are also dependent on the year 2000 readiness of third
parties that do business with us. In particular, our information technology
systems interact with commercial electronic transaction processing systems of
customers. In addition, we are dependent on third-party suppliers of
infrastructure elements such as telecommunications services, electric power,
water and banking facilities. We do not depend to any significant degree on any
single merchandise supplier or upon electronic transaction processing with
individual suppliers for merchandise purchases.

We have identified and initiated formal communications with key third
parties to determine the extent to which we will be vulnerable to such parties'
failure to resolve their own year 2000 issues. As a follow-up, we plan to
determine whether our customers and suppliers are taking appropriate steps to
achieve year 2000 readiness and ensure continued functioning in accordance with
our business needs. We are assessing our risks with respect to failure by third
parties to be year 2000 compliant and intend to seek to mitigate those risks. We
are also developing contingency plans, discussed below, to address issues
related to third parties we determine are not making sufficient progress toward
becoming year 2000 compliant.

12
<PAGE>

Costs

We estimate that our information technology systems and embedded chip
equipment will be year 2000 compliant by October 1999. Aggregate costs for work
related to year 2000 efforts currently are anticipated to total approximately
$2.2 million. Costs of $76,000 and $121,000 were incurred and expensed in the
first quarter of fiscal 2000 and 1999, respectively.

Of the remaining portion of our aggregate estimated year 2000 costs,
approximately $1.3 million will be incurred in the remaining quarters of fiscal
2000. Approximately $390,000 of these costs is expected to be for capital
investments in new systems and applications. We anticipate that 5% of our
fiscal 2000 information technology budget will be used for year 2000
remediation. We anticipate our remaining year 2000 costs will be incurred in
the following estimated percentages among the following types of remediation:

. 30% on modifications to existing software

. 10% on conversions to new software

. 60% on remediation of embedded chip equipment

Certain information technology projects have been deferred and will
continue to be deferred as a result of the personnel we are devoting to our year
2000 remediation efforts. These projects relate to potential operational
enhancements such as additional value-added services and cost cutting projects.
We do not believe that the delay in these information technology projects will
have a material adverse affect on our financial condition or results of
operations.

Our estimate of the costs of achieving year 2000 compliance and the date by
which year 2000 compliance will be achieved are based on our best estimates,
which were derived using numerous assumptions about future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no assurance that these estimates will be
achieved, and actual results could differ materially from these estimates.
Specific facts that might cause such material differences include the
availability and cost of personnel trained in year 2000 remediation work, the
ability to locate and correct all relevant computer codes, the success achieved
by our customers and suppliers in reaching year 2000-readiness, the timely
availability of necessary replacement items and similar uncertainties.

Risks

We expect to implement the changes necessary to address the year 2000 issue
for information technology systems and embedded chip equipment we use. We
presently believe that, with modifications to existing software, conversions to
new software, and appropriate remediation of embedded chip equipment, the year
2000 issue with respect to our information technology systems and embedded chip
equipment is not reasonably likely to pose significant operational problems for
us. However, if unforeseen difficulties arise, such modifications, conversions
and replacements are not completed timely, or our customers' or suppliers'
systems

13
<PAGE>

are not modified to become year 2000 compliant, the year 2000 issue may have a
material impact on our results of operations and financial condition.

Presently, we are unable to assess the likelihood that we will experience
significant operational problems due to unresolved year 2000 problems of third
parties that do business with us. Although we have not been put on notice that
any known third party problem will not be timely resolved, we have limited
information. No assurance can be made concerning the year 2000 readiness of
third parties. The resulting risks to our business are very difficult to assess
due to the large number of variables involved.

If third parties fail to achieve year 2000 compliance, year 2000 problems
could have a material impact on our operations. Similarly, there can be no
assurance that we can timely mitigate the risks related to a third party's
failure to resolve its year 2000 issues. If such mitigation is not achievable,
year 2000 problems could have a material impact on our operations.

The worst case year 2000 scenarios that we believe are reasonably likely to
occur would involve:

. disruption in utilities, transportation and communications

. disruption to commerce between us and third parties

Contingency Plans

We presently believe that the most reasonably likely worst-case year 2000
scenarios would relate to the possible failure in one or more geographic regions
of third party systems over which we have no control and for which we have no
ready substitute, such as, but not limited to, power and telecommunications
services. We have in place a business resumption plan that addresses recovery
from various kinds of disasters, including recovery from significant
interruptions to data flows and distribution capabilities at our major data
systems centers and major distribution centers. We are using that plan as a
starting point for developing specific year 2000 contingency plans, which will
emphasize locating alternate sources of supply, methods of distribution and ways
of processing information.

We anticipate this contingency planning will prepare our business for
disruptions but will not protect us fully from commercial impact. We are
currently initiating the following efforts:

. prioritizing all hardware, software and services across the enterprise

. developing contingency plans for top priority items, including:

. building an inventory of hardware and spare parts

. procurement of generators

. identification of alternatives for transportation of product and
communications with business partners

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<PAGE>

. increasing staff on call and on the job at the end of 1999 and
beginning of 2000

We expect our year 2000 contingency plans will be substantially complete by
October 1999. However, there can be no assurance that we will be able to
complete our contingency planning on that schedule.

Factors Affecting Operating Results

This report contains forward-looking statements made pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995.
These statements are identified by words such as "will", "expects",
"anticipates", "plans", or "intends" and by other descriptions of future
circumstances or conditions. Actual results may differ materially from those
projected in these forward-looking statements. Factors that could cause
differences include, but are not limited to, those discussed below.

We May Be Unable to Compete with Other Businesses that Offer Similar
Products and Services

The full-line distribution of music and video is an intensely competitive
business. We compete with national, regional and local full-line distributors.
In addition, the major labels, major studios and independent distribution
companies sell substantial amounts of their products directly to retailers.
However, to date they have not focused, to the same extent we have, on
fulfilling the needs of smaller independent stores or providing value-added
services. If the major labels, major studios or independent distribution
companies start providing more responsive service to underserved retail segments
or value-added services at competitive costs, our financial results could be
adversely affected. We also compete with several vendor managed inventory
firms, including two national vendor managed inventory firms that we believe
have greater revenues than us.

From time to time, several of our retail chain customers have chosen to buy
a substantial volume of their inventory directly from the major labels and
studios that they had previously been purchasing from us. To the extent that our
customers increase their direct purchasing from the major labels and studios or
the independent distribution companies, our financial results could be adversely
affected.

In addition to competition from existing competitors, in the future we
could face competition from new competitors that may enter the business. If new
competitors enter the music and video distribution business, our financial
results could be adversely affected.

Our existing New Media competitors include Alliance Entertainment Corp.,
Baker & Taylor and Ingram Entertainment. Other distributors have announced an
interest in starting to service the on-line market. If one or more of the
leading on-line retailers that we service buys more of its inventory directly
from a label or studio or through an alternative distributor, our financial
results could be adversely affected. Amazon.com, one of our largest New Media
customers, has announced its intent to increase the proportion of product it
buys directly from the labels and studios. In addition, to the extent our
Internet customers utilize fewer value-added

15
<PAGE>

services, such as direct-to-consumer fulfillment and data, our financial results
could also be adversely affected.

Distribution North America competes with several other independent
distribution companies. Some of these competitors conduct distribution
operations equal to or larger than Distribution North America and others operate
in niche markets. We also compete with several of the major labels' own
independent distribution groups. In addition, as a label or artist gains in
popularity, Distribution North America faces new competition from the major
labels to retain distribution rights for that label or artist.

We May Be Unable to Obtain Product from Labels or Studios

The major labels and studios produce most of the music and video product.
Our success depends upon our ability to obtain products in sufficient quantities
on competitive terms and conditions from each of the major labels and studios as
well as from thousands of smaller suppliers. We are also dependent upon the
quality of new releases from our suppliers. We do not have long term contracts
with any supplier for our Full-line Distribution or New Media business groups.
If we cannot obtain sufficient quantities of product or quality new releases
from the major labels or studios or a significant number of other suppliers for
our Full-line Distribution and New Media operations, our financial results could
be adversely affected.

Distribution North America maintains contracts with most of the suppliers
it represents. These contracts typically range in length from one to three
years. If Distribution North America were unable to maintain its distribution
relationship with any of its large suppliers, our financial results would be
adversely affected.

If the Internet Does Not Continue to Grow, Our New Media Sales Will Not
Grow

Our New Media business group's growth will largely depend on the
development and widespread acceptance of the Internet as a medium for commerce.
Use of the Internet by consumers is at an early stage of development, and market
acceptance of the Internet as a medium for commerce is subject to a high level
of uncertainty. If use of the Internet stops growing, our financial results
could be adversely affected. Additionally, we are not certain that growth in on-
line music and video retail businesses will continue or that such growth will
not adversely affect our Full-line Distribution business group.

Our Sales Could Be Adversely Affected if We Lose Any of Our Largest
Customers

If any of our largest customers were to stop or reduce their purchasing
from us, our financial results could be adversely affected. During the first
quarter of fiscal 2000, our top three customers accounted for approximately 35%
of our net sales. In October 1998, under a contract that expired in June 1999,
we provided a significant distribution function for the Blockbuster Music stores
purchased by Wherehouse. For the thirteen weeks ended July 3, 1999,
approximately 8% of our net sales were to Wherehouse. We expect sales to
Wherehouse to decline subsequent to June 1999 as it handles more of its
distribution functions internally.

16
<PAGE>

We May Be Unable to Integrate and Upgrade Our Information Systems

We are continuously upgrading our systems and developing new applications
to meet the changing demands of our business. We cannot be certain that the
integration or replacement of our systems will be completed as scheduled without
unanticipated costs or operational difficulties. The failure or inoperability of
our systems, or difficulties in integration of these systems, could have a
material adverse impact on our financial results.

Our Information Systems Could Fail Because of Problems Relating to the Year
2000

Our information systems could fail or provide erroneous output when
referencing dates subsequent to December 31, 1999 due to year 2000 processing
problems. In addition, as we provide electronic data interchange with our
suppliers and customers, difficulties with 21st century dates in our customers'
or suppliers' information systems could adversely affect our information
systems, and vice versa. Such failures or errors could occur prior to 2000. If
we or our electronic data interchange suppliers and customers are unable to
update our systems successfully to eliminate this problem, we may be prevented
from using some or all of our information systems or exchanging data with our
customers or suppliers. This, in turn, could disrupt our business and have a
material adverse impact on our financial results.

Trends in the Video Rental Market Could Hurt Our Sales

Studios and full-line distributors recently have instituted programs to
increase the quantity of copies of popular video rental titles stocked by
retailers. We believe that these programs have accelerated a shift in the
market away from independent video rental stores and small chains in favor of
the larger chains. Since, in general, full-line distributors play a larger role
with independent retailers than with the larger chains, we believe that the
market may contract for full-line distribution of video rental product. In
addition, while most full-line video distributors have elected to participate in
revenue sharing distribution arrangements to help increase the quantity of
copies of titles available from the major studios, we have not. In doing so, we
risk losing market share to other distributors.

New Product Formats Could Replace the Formats We Distribute

The recent introductions of new product formats may cause consumers to
exercise caution in building their libraries of video cassettes and music CDs,
thus decreasing our video sell-through and music sales. Within the past two
years, studios started selling DVD, which currently is being marketed as a
superior alternative to the video cassette and may eventually be marketed as a
superior replacement for the music CD.

New Delivery Technologies Could Diminish Our Role in the Distribution
Process

Music and video are currently marketed and distributed primarily on a
physical delivery basis through wholesale and retail distribution. In the
future, if products are marketed, sold and delivered by labels or studios
directly to stores or homes through electronic downloading or live streaming,
current methods of wholesale and retail distribution could decrease or be
eliminated.

17
<PAGE>

Microsoft, RealNetworks and others offer streaming technology, which allows
users to listen to, but not record, audio and video. In addition, digital
distribution has begun on the Internet utilizing a technology called MP3, a
coding compression technology that allows downloading and replication of any
digital audio product.

Today, much of this digital distribution is unauthorized and lacks
copyright protection. However, the major labels have announced a plan to develop
a universal standard for the electronic delivery of music which they intend to
make available by the end of 1999. If electronic distribution of music or video
becomes widespread and displaces significant demand for the formats we sell and
we fail to play a significant role in the electronic distribution market, our
financial results would be adversely affected.

In addition, cable and satellite television companies and others are
beginning to offer movies on a "near-video-on-demand" or other basis that allows
subscribers to order selected videos for in-home viewing. To the extent that
these programs achieve a broad level of acceptance, the market for physical
video product sold or rented by retailers could decline. This would reduce our
sales of video product.

We Are Experiencing Inefficiencies in Moving to Our New Facility

We relocated our California distribution center to a nearby facility in
Woodland, California. This move caused us to incur additional labor and freight
costs as well as other expenses and adversely affected our sales. We could also
incur further unanticipated costs or disruptions of our operations as a result
of this move. Furthermore, this new distribution center and the LDC have
increased our fixed costs substantially. As a result, a lack of growth or
decline in sales would adversely affect our earnings.

We Might Have Inventory Risk Due to an Inability to Return Products

We bear inventory risk associated with the financial viability of the
independent labels and studios from which we purchase product. If a label or
studio cannot provide refunds in cash for the inventory we desire to return, we
may be forced to expense such inventory costs. Further, we often experience
higher return rates for products of financially troubled labels and studios. If
we fail to manage our inventory to avoid accumulating substantial product that
cannot be returned, our financial results could be adversely affected.

We May Be Liable if Our Suppliers Fail to Comply with Copyright Laws

Substantially all of the music and video products we sell are subject to
copyright laws and licenses that limit the manner and geographic area in which
such products may be sold and provide royalties to the copyright owners. Any
sales of product in violation of such laws and licenses by anyone in the chain
of distribution may subject us to monetary damages or confiscation of such
product. We distribute thousands of titles from different artists over numerous
jurisdictions and rely primarily on our suppliers to ensure compliance with the
copyright laws, some of which may be conflicting or not clearly developed, and
payment of appropriate royalties. Although we have not experienced a material
loss due to copyright

18
<PAGE>

violations, we could be damaged in the future by copyright violations by someone
in our distribution channel.

We May Be Prevented from Distributing Music Internationally

Most of the major labels have adopted policies restricting the export of
their merchandise by domestic distributors. However, consistent with industry
practice, we distribute music of the major labels internationally. Our
international net sales of music for the first quarter of fiscal 2000 were
approximately $8.3 million. We would be adversely affected if a major label
enforced any restriction on our ability to sell music outside the United States.
In addition, although our international sales are denominated in dollars, our
international sales volume can be adversely affected by appreciation of the
dollar relative to foreign currencies.

We May Have Insufficient Access to Funds if We Fail to Comply with the
Terms of Our Credit Facility

We have a revolving credit facility that is secured by substantially all of
our assets. As of July 3, 1999, borrowings of approximately $154.4 million were
outstanding under the credit facility. The credit facility is used for general
working capital purposes.

As a result of our substantial leverage we will incur significant interest
expense and principal repayment obligations, our ability to obtain additional
financing in the future may be limited, and our ability to compete through
expansion, capital improvements and flexibility in response to changing industry
conditions may be limited. The credit facility contains numerous restrictive
covenants, including limitations on our ability to acquire or invest in other
businesses and requirements that we comply with certain financial covenants.

If we fail to comply with the terms of the credit facility or other
agreements related to the credit facility, or obtain waivers from such
obligations, we could trigger an event of default under the credit facility or
related agreements. An event of default could permit acceleration of
indebtedness under the credit facility or related agreements that contain cross-
acceleration or cross-default provisions.

Our cash flow and capacity needs change significantly during the year, with
the heaviest credit needs and highest capacity requirements typically occurring
during the third fiscal quarter. If we do not have sufficient finances to
purchase the inventory required or the distribution capacity to distribute
product in a timely and accurate manner during such seasonal peak periods, our
financial results could be adversely affected.

The Market Price of Our Common Stock Could Fluctuate

Many factors could cause the market price of our common stock to fluctuate
substantially, including (i) future announcements concerning us or our
competitors, (ii) variations in operating results, (iii) loss of a key supplier
or customer, (iv) technological innovations such as changes in physical product
formats or delivery technologies, (v) changes in product pricing policies by us,
our suppliers or our competitors and (vi) changes in earnings estimates by
securities analysts.

19
<PAGE>

These fluctuations, as well as general economic, political and market
conditions, may have a material adverse effect on the market price of our common
stock.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

The Company is exposed to market risks primarily from changes in U.S.
interest rates. The Company does not engage in financial transactions for
trading or speculative purposes.

The interest payable on the Company's revolving line of credit is based on
variable interest rates and is therefore affected by changes in market interest
rates. If interest rates on variable rate debt rose 0.70 percentage points (a
10% change from the average interest rate as of July 3, 1999), assuming no
change in the Company's outstanding balance under the line of credit
(approximately $154.4 million as of July 3, 1999), the Company's income before
taxes and cash flows from operating activities would decline by approximately
$1.1 million.

PART II - Other Information

ITEM 1. Legal Proceedings

We are subject to various legal proceedings that arise in the ordinary
course of business. While the outcome of all of these proceedings cannot be
predicted with certainty, we believe that none of such proceedings, individually
or in the aggregate, will have a material adverse effect on our business or
financial condition.

ITEM 2. Changes in Securities and Use of Proceeds

Not applicable.

ITEM 3. Defaults Upon Senior Securities

Not applicable.

ITEM 4. Submission Of Matters To A Vote Of Security Holders

Not applicable

ITEM 5. Other Information

Not applicable.

20
<PAGE>

ITEM 6. Exhibits And Reports On Form 8-K

(a) Exhibits

<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
Exhibits Number Description of Document
- ------------------ -----------------------------------------------------------------------
<S> <C>
2.1(1) Contribution Agreement dated July 2, 1999, by and among the
Company, Valley Entertainment, Inc. and Barnet J. Cohen.
10.1.1 Amendment No. 1 to Loan and Security Agreement, dated May 21, 1998,
by and among the Company, Congress Financial Corporation (Norwest)
and the institutions named therein.
10.1.2 Amendment No. 2 to Loan and Security Agreement, dated May 21, 1998,
by and among the Company, Congress Financial Corporation (Norwest)
and the institutions named therein.
10.1.3 Amendment No. 3 to Loan and Security Agreement, dated May 21, 1998,
by and among the Company, Congress Financial Corporation (Norwest)
and the institutions named therein.
10.1.4 Amendment No. 4 to Loan and Security Agreement, dated May 21, 1998,
by and among the Company, Congress Financial Corporation (Norwest)
and the institutions named therein.
27.1 Financial Data Schedule.
</TABLE>
_______________________
(1) Incorporated by reference to corresponding Exhibit included with
Registrant's Form 8-K filed on July 16, 1999.

(b) Reports On Form 8
The following report on Form 8-K was filed during the thirteen weeks ended
July 3, 1999.

(1) Report on Form 8-K dated July 2, 1999, filed July 16, 1999, announcing
the assignment of the assets of the Company's Valley Entertainment
division to Valley Entertainment, Inc.

21
<PAGE>

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.

VALLEY MEDIA, INC.

By: /s/ Robert R. Cain
--------------------------------------
Robert R. Cain
President and Chief Executive Officer
Date: August 11, 1999

By: /s/ J. Randolph Cerf
--------------------------------------
J. Randolph Cerf
Chief Financial Officer and
Accounting Officer
Date: August 11, 1999

<PAGE>

Exhibit 10.1.1

AMENDMENT NO. 1 TO LOAN AGREEMENT
---------------------------------

September 15, 1998

Congress Financial Corporation (Northwest)
One Main Place
101 Southwest Main, Suite 725
Portland, Oregon 97204

Ladies and Gentlemen:

Congress Financial Corporation (Northwest) ("Lender") and Valley Media,
Inc. ("Borrower") have entered into certain financing arrangements pursuant to
the Loan and Security Agreement dated as of May 21, 1998 by and between Lender
and Borrower (the "Loan Agreement") and all other Financing Agreements at any
time executed and/or delivered in connection therewith or related thereto. All
capitalized terms used herein shall have the meaning assigned thereto in the
Loan Agreement, unless otherwise defined herein.

Borrower has requested that Lender amend the Loan Agreement by increasing
the Maximum Credit, and Lender is willing to agree to the foregoing, on and
subject to the terms and conditions contained in this Amendment No. 1 to Loan
Agreement (this "Amendment").

In consideration of the foregoing and for other good and valuable
consideration, the receipt and sufficiency of which are hereby acknowledged by
the parties hereto, the parties hereto hereby agree as follows:

1. Amendment of Definition of Maximum Credit. Section 1.33 of the Loan
-----------------------------------------
Agreement is hereby amended and restated in its entirety as follows:

"1.33 'Maximum Credit' shall mean the amount of $160,000,000."

2. Amendment Fee. In consideration of the increase in the Maximum Credit
-------------
provided for in this Amendment, Borrower shall on the date hereof pay to Lender
or Lender, at its option, may charge the account(s) of Borrower maintained by
Lender, an amendment fee in the amount of $225,000, which fee is fully earned as
of the date hereof and shall constitute part of the Obligations.

1
<PAGE>

warranties and covenants are continuing and shall survive the execution and
delivery hereof and shall be incorporated into and made a part of the Financing
Agreements):

(a) No Event of Default exists on the date of this Amendment (after
giving effect to the amendments to the Loan Agreement made by this Amendment);
and

(b) This Amendment has been duly executed and delivered by Borrower
and is in full force and effect as of the date hereof, and the agreements and
obligations of Borrower contained herein constitute its legal, valid and binding
obligations enforceable against Borrower in accordance with their respective
terms.

4. Conditions Precedent. This Amendment shall not become effective
--------------------
unless all of the following conditions precedent have been satisfied in full, as
determined by Lender:

(a) the receipt by Lender of an original of this Amendment, duly
authorized, executed and delivered by Borrower;

(b) the receipt by Lender of a Certificate of the Secretary of
Borrower, in form and substance satisfactory to Lender, certifying as to the
adoption by Borrower's Board of Directors and current effectiveness of
resolutions authorizing Borrower to enter into and execute this Amendment and to
borrow from Lender under the secured lending facility established under the Loan
Agreement, as amended hereby, the maximum aggregate principal amount of
$160,000,000; and

(c) as of the date of this Amendment, no Event of Default shall have
occurred and be continuing and no event shall have occurred or condition be
existing and continuing which, with notice or passage of time or both, would
constitute an Event of Default.

5. Effect of this Amendment. Except as modified pursuant hereto, no
------------------------
other changes or modifications to the Loan Agreement and the other Financing
Agreements are intended or implied and in all other respects the Loan Agreement
and the other Financing Agreements are hereby specifically ratified, restated
and confirmed by all parties hereto as of the effective date hereof. To the
extent of any conflict between the terms of this Amendment and any of the
Financing Agreements, the terms of this Amendment shall control. The Loan
Agreement and this Amendment shall be read and be construed as one agreement.

6. Further Assurances. At Lender's request, Borrower shall execute and
------------------
deliver such additional documents and take such additional actions as Lender
reasonably requests to effectuate the provisions and purposes of this Amendment
and to protect and/or maintain perfection of Lender's security interests in and
liens upon the Collateral.

7. Governing Law. The validity, interpretation and enforcement of this
-------------
Amendment and any dispute arising out of the relationship between the parties
hereto, whether in contract, tort, equity or otherwise, shall be governed by the
internal laws of the State of California (without giving effect to principles of
conflicts of law).

2
<PAGE>

8. Binding Effect. This Amendment shall be binding upon and inure to the
--------------
benefit of each of the parties hereto and their respective successors and
assigns.

9. Counterparts. This Amendment may be executed in any number of
------------
counterparts, but all of such counterparts when executed shall together
constitute but one and the same agreement. In making proof of this Amendment,
it shall not be necessary to produce or account for more than one counterpart
thereof signed by each of the parties hereto.

Very truly yours,

VALLEY MEDIA, INC.

By: /s/ Donald E. Rose
------------------

Title: Treasurer
----------------

CONGRESS FINANCIAL CORPORATION
(NORTHWEST)

By: /s/ Rodney S. Davis
-------------------

Title: First Vice President
--------------------

<PAGE>

Exhibit 10.1.2

AMENDMENT NO. 2 TO LOAN AGREEMENT
---------------------------------

as of November 30, 1998

CONGRESS FINANCIAL CORPORATION
(NORTHWEST)
One Main Place
101 Southwest Main, Suite 725
Portland, Oregon 97204

Ladies and Gentlemen:

CONGRESS FINANCIAL CORPORATION (NORTHWEST) ("Lender") and VALLEY MEDIA,
INC. ("Borrower") have entered into certain financing arrangements pursuant to
the Loan and Security Agreement dated as of May 21, 1998 by and between Lender
and Borrower (the "Loan Agreement") and all other Financing Agreements at any
time executed and/or delivered in connection therewith or related thereto. All
capitalized terms used herein shall have the meaning assigned thereto in the
Loan Agreement, unless otherwise defined herein.

Borrower has requested that Lender amend and modify certain provisions of
the Loan Agreement, and Lender is willing to agree to the foregoing, on and
subject to the terms and conditions contained in this Amendment No. 2 to Loan
Agreement (this "Amendment").

1. The Loan Agreement is hereby amended, effective as of November 30,
1998, as follows:

(a) Section 1.19 "Excess Availability" of the Loan Agreement is hereby
amended and restated in its entirety as follows:

""Excess Availability" shall mean the amount, as determined by Lender,
calculated at any time from and after the date of this Agreement,
equal to: (a) the amount of the Revolving Loans available to Borrower
as of such time (without regard to the Maximum Credit) based on the
applicable lending formulas multiplied by the Net Amount of Eligible
Accounts and the Value of Eligible Inventory, as determined by Lender,
and subject to the sublimits and Availability Reserves from time to
time established by Lender hereunder minus (b) the sum of: (i) the
-----
amount of all then outstanding and unpaid Revolving Loans and Letter
of Credit Accommodations, plus (ii) as reflected on the accounts
payable aging

1
<PAGE>

for the immediately preceding month end, the aggregate amount of all
trade payables of Borrower which are more than sixty (60) days past
due as of such time, only to the extent that such trade payables
exceed five (5%) of all of Borrower's trade payables, excluding,
however, trade payables in an amount not to exceed $2,000,000 incurred
by Borrower in the ordinary course of its business in connection with
"dollar day swap" programs maintained by Borrower from time to time
with certain of Borrower's vendors."

(b) Section 1.33 of the Loan Agreement is hereby amended and restated in
its entirety as follows:

""Maximum Credit" shall mean the amount of $200,000,000."

"(e) Notwithstanding anything to the contrary contained in
Section 2.1(a)(ii) above, the maximum aggregate amount of Revolving
Loans outstanding at any time (i) made in respect of the Value of
Eligible Inventory, shall not at any time exceed (x) $35,000,000 in
respect of Eligible Inventory consisting of Video Inventory and (y)
$10,000,000 in respect of Eligible Inventory relating to DNA."

(d) Section 3.1(b)(iv) of the Loan Agreement is hereby amended and restated
in its entirety as follows:

"(iv) no more than ten (10) Interest Periods may be in effect at
any one time,"

(e) Section 9.10(b)(ii)(B)(1)(x) of the Loan Agreement is hereby amended
and restated in its entirety as follows:

"(x) $10,000,000 on the date of such loan or advance, the
maximum aggregate amount of all loans or advances to any Designated
Vendor shall not exceed the aggregate amount of $2,000,000 outstanding
at any given time,"

2. Amendment Fee. In consideration of the amendments to the financing
-------------
arrangements as set forth herein, Borrower shall pay to Lender or Lender, at its
option, may charge the account(s) of Borrower maintained by Lender (a) an
amendment fee in the amount of $200,000, which fee is fully earned and payable
as of the date hereof and shall constitute part of the Obligations and (b) in
the event that Borrower fails to receive, on or prior to April 30, 1999, net
proceeds of not less than $25,000,000 from the consummation of an Equity
Offering or an unsecured subordinated bond, debenture or note offering, then
Borrower shall pay to Lender an additional amendment fee in the amount of
$100,000, which fee shall constitute part of the Obligations and shall be fully
earned and payable on May 3, 1999.

2
<PAGE>

3. Representations, Warranties and Covenants. In addition to the
-----------------------------------------
continuing representations, warranties and covenants heretofore or hereafter
made by Borrower to Lender pursuant to the Loan Agreement and the other
Financing Agreements, Borrower hereby represents, warrants and covenants with
and to Lender as follows (which representations, warranties and covenants are
continuing and shall survive the execution and delivery hereof and shall be
incorporated into and made a part of the Financing Agreements):

(a) No Event of Default exists on the date of this Amendment (after
giving effect to the amendments to the Loan Agreement made by this Amendment);
and

4. Conditions Precedent. This Amendment shall not become effective
--------------------
unless all of the following conditions precedent have been satisfied in full, as
determined by Lender:

(a) the receipt by Lender of an original of this Amendment, duly
authorized, executed and delivered by Borrower;

3
<PAGE>

8. Binding Effect. This Amendment shall be binding upon and inure to the
--------------
benefit of each of the parties hereto and their respective successors and
assigns.

Very truly yours,

VALLEY MEDIA, INC.

By: /s/ Donald E. Rose
------------------

Title: Treasurer
---------

CONGRESS FINANCIAL CORPORATION
(NORTHWEST)

By: /s/ Rodney S. Davis
-------------------

Title: First Vice President
--------------------

<PAGE>

Exhibit 10.1.3

AMENDMENT NO. 3 TO LOAN AGREEMENT
---------------------------------

as of March 15, 1999

CONGRESS FINANCIAL CORPORATION
(NORTHWEST)
One Main Place
101 Southwest Main, Suite 725
Portland, Oregon 97204

Ladies and Gentlemen:

CONGRESS FINANCIAL CORPORATION (NORTHWEST) ("Lender") and VALLEY MEDIA,
INC. ("Borrower") have entered into certain financing arrangements pursuant to
the Loan and Security Agreement dated as of May 21, 1998 by and between Lender
and Borrower (as amended, the "Loan Agreement") and all other Financing
Agreements at any time executed and/or delivered in connection therewith or
related thereto. All capitalized terms used herein shall have the meaning
assigned thereto in the Loan Agreement, unless otherwise defined herein.

1. The Loan Agreement is hereby amended, effective as of March 15, 1999,
as follows:

(a) Section 1.33 of the Loan Agreement is hereby amended and restated in
its entirety as follows:

""Maximum Credit" shall mean (i) the amount of $200,000,000 at
all times during the period through and including March 14, 1999, (ii)
$220,000,000 at all times during the period from and after March 15,
1999 through and including April 5, 1999 and (iii) $200,000,000 at all
times from and after April 6, 1999."

(b) Section 2.1(e) of the Loan Agreement is hereby amended and restated in
its entirety as follows:

1
<PAGE>

"(e) Notwithstanding anything to the contrary contained in
Section 2.1(a)(ii) above, the maximum aggregate amount of Revolving
Loans outstanding at any time made in respect of the Value of Eligible
Inventory, shall not at any time exceed (i) in respect of Eligible
Inventory consisting of Video Inventory, the lesser of (x)
$45,000,000 and (y) thirty (30%) percent of the aggregate maximum
amount of revolving Loans that would then be available with respect to
all Eligible Inventory, based on the lending formulas set forth in
Section 2.1(a)(ii) above, and (ii) $10,000,000 in respect of Eligible
Inventory relating to DNA."

(a) No Event of Default exists on the date of this Amendment (after
giving effect to the amendments to the Loan Agreement made by this Amendment);
and

4. Conditions Precedent. This Amendment shall not become effective
--------------------
unless all of the following conditions precedent have been satisfied in full, as
determined by Lender:

(a) the receipt by Lender of an original of this Amendment, duly
authorized, executed and delivered by Borrower;

2
<PAGE>

8. Binding Effect. This Amendment shall be binding upon and inure to the
--------------
benefit of each of the parties hereto and their respective successors and
assigns.

Very truly yours,

VALLEY MEDIA, INC.

By: /s/ Donald E. Rose
------------------

Title: Treasurer
---------

CONGRESS FINANCIAL CORPORATION
(NORTHWEST)

By: /s/ Rodney S. Davis
-------------------

Title: First Vice President
--------------------

<PAGE>

Exhibit 10.1.4

June 25, 1999

CONGRESS FINANCIAL CORPORATION (NORTHWEST)
One Main Place, 101 Southwest Main
Suite 725
Portland, Oregon 97204

Re: Amendment No. 4 to Loan and Security Agreement
----------------------------------------------

Ladies and Gentlemen:

CONGRESS FINANCIAL CORPORATION (NORTHWEST) ("Lender") and VALLEY MEDIA,
INC., a Delaware corporation ("Borrower"), have entered into certain financing
arrangements pursuant to the Loan and Security Agreement, dated as of May 21,
1998, by and between Lender and Borrower (as amended, the "Loan Agreement") and
all other Financing Agreements at any time executed and/or delivered in
connection therewith or related thereto. All capitalized terms used herein
shall have the meaning assigned thereto in the Loan Agreement, unless otherwise
defined herein.

Borrower has requested that Lender amend certain provisions of the Loan
Agreement (a) with respect to the Interest Rate, (b) with respect to the unused
line fee set forth in Section 3.4 of the Loan Agreement and (c) to provide for
certain Loans, within the Maximum Credit, the proceeds of which shall be used by
Borrower to purchase certain Equipment, and Lender is willing to agree to the
foregoing, on and subject to the terms and conditions contained in this
Amendment No. 4 to Loan and Security Agreement (this "Amendment").

1. Additional Definitions. Section 1 of the Loan Agreement is hereby
----------------------
amended by adding thereto the following defined terms having the following
subsection designation in Section 1:

"1.46 "Capex Line Loans" shall have the meaning set forth in Section
2.5 hereof."

"1.47 "Capex Line Sublimit" shall mean $8,000,000."

"1.48 "Eligible Equipment" shall mean Equipment that meets all of the
following criteria:

1
<PAGE>

(a) the Equipment shall be described by model, make, manufacturer,
serial number and/or such other identifying information as may be
appropriate, as determined by Lender, in a schedule to be submitted by
Borrower to Lender; (b) Lender shall have a perfected first-and-only
lien on and security interest in such Equipment; (c) such Equipment
shall be located at premises owned or leased by Borrower and which, in
the case of the premises owned by Borrower is not subject to a
mortgage in favor of any mortgagee other than Lender or is the subject
of a mortgagee's waiver in favor of, and satisfactory to, Lender, and,
in the case of premises leased by Borrower, is the subject of a
landlord's waiver in favor of, and satisfactory to, Lender; (d) such
Equipment is not a fixture; (e) such Equipment is acceptable to Lender
as Collateral; and (f) Borrower shall have delivered to Lender a copy
of a bill of sale, invoice or other instrument evidencing that the
vendor of such Equipment has transferred good and absolute title
thereto to Borrower for the Equipment Purchase Price set forth therein
and, if applicable, any deferred payment terms given to Borrower in
connection with such sale.

The criteria for Eligible Equipment shall be subject to Lender's continuing
satisfaction and may be revised by Lender from time-to-time in its sole
judgment. Any Equipment that is not Eligible Equipment shall nevertheless be
and remain at all times part of the Collateral (subject to the provisions of
Section 5 of this Agreement)."

"1.49 "Equipment Purchase Price" shall mean, with respect to the
purchase by Borrower of an item of Eligible Equipment, the net cash amount
actually paid to acquire title to such item, net of all incentives, trade-in
allowances, discounts and rebates, and exclusive of freight, delivery charges,
installation costs and charges, software costs, charges and fees, warranty
costs, taxes, insurance and other incidental costs or expenses and all indirect
costs or expenses of any kind."

2. Amendment of Definitions. (a) Clause (a) of the definition of
------------------------
"Interest Rate" set forth in Section 1.26 is hereby deleted in its entirety and
the following is hereby substituted therefor:

"(a) as to Prime Rate Loans, commencing as of the date hereof
through and including June 30, 1998, a rate equal to eight and one-
half (8-1/2%) percent; and thereafter, for any given month, (i) if the
Monthly Excess Availability for the immediately preceding calendar
month is equal to or greater than $50,000,000, a rate equal to one-
quarter (1/4%) percent per annum below the Prime Rate, (ii) if the
Monthly Excess Availability for the immediately preceding calendar
month is equal to or greater than $35,000,000, but less than
$50,000,000, a rate equal to the Prime Rate, (iii) if the Monthly
Excess Availability for the immediately preceding calendar month is
equal to or greater than $25,000,000, but less than

2
<PAGE>

$35,000,000, a rate equal to the Prime Rate, (iv) if the Monthly
Excess Availability for the immediately preceding month is equal to or
greater than $10,000,000, but less than $25,000,000, a rate equal to
one-quarter (1/4%) percent per annum in excess of the Prime Rate, and
(v) if the Monthly Excess Availability for the immediately preceding
calendar month is less than $10,000,000, a rate equal to one-half
(1/2%) percent per annum in excess of the Prime Rate, and ..."

(b) Section 1.30 of the Loan Agreement is hereby deleted in its
entirety and the following is hereby substituted therefor:

"1.30 "Loans" shall mean the Revolving Loans and the Capex
Loans."

3. Capex Loans. The following new Section is hereby added to the Loan
-----------
Agreement as Section 2.5 thereof:

"Section 2.5 Capex Line Loans. In addition to all other loans,
----------------
advances and other financial accommodations to be made by Lender to
Borrower pursuant to this Agreement and subject to the terms and
conditions of this Agreement, Lender agrees to make loans to Borrower,
upon Borrower's written request, for the purpose of purchasing
Eligible Equipment (each, a "Capex Loan"). Each Capex Loan requested
shall be in an amount of not less than $1,000,000 and shall not exceed
80% (or such lesser percentage as may be specified by Lender from time
to time by written notice to Borrower) of the Equipment Purchase Price
of the Eligible Equipment to be purchased with the proceeds of such
Capex Loan, provided that, (i) the aggregate cumulative amount of all
-------- ----
Capex Loans made hereunder shall not exceed the Capex Line Sublimit;
(ii) the Capex Loans, once repaid, may not be reborrowed hereunder;
and (iii) Lender shall not be obligated to fund any particular Capex
Loan to Borrower unless Lender is satisfied, in its sole judgment and
based on such actual and pro forma financial information as Lender may
request, that no Event of Default exists at the time of and after
giving effect to such Capex Loan. Borrower shall request each Capex
Loan by notice in writing to Lender's representative responsible for
Borrower's account not less than ten (10) Business Days prior to the
requested date of disbursement of such Capex Loan, and Borrower shall
provide Lender with such information and documents regarding such
Capex Loan and the Eligible Equipment to be financed thereby as Lender
may request. Each Capex Loan to Borrower shall be repaid in
successive equal monthly installments of principal based on a sixty
(60) month amortization, with the first such installment being due and
payable on the first day of the first calendar month immediately
following the calendar month in which such Capex Loan is made. The
entire unpaid principal balance of each Capex Loan shall, at the
option of Lender, be due and payable upon the occurrence of

3
<PAGE>

an Event of Default but in any event shall be immediately due and
payable upon the termination of this Agreement. Interest shall accrue
on the unpaid principal amount of each Capex Loan at the Interest Rate
and shall be paid in accordance with Section 3.1 hereof."

4. Reduction in Basis for Calculation of Unused Line Fee. Section 3.4 of
-----------------------------------------------------
the Loan Agreement is hereby deleted in its entirety and the following is
hereby substituted therefor:

"3.4 Unused Line Fee. Borrower shall pay to Lender monthly, while
---------------
this Agreement is in effect and for so long thereafter as any of the
Obligations are outstanding, an unused line fee at a rate equal to
three-eighths (3/8%) percent per annum calculated upon the amount by
which the amount equal to the Applicable Percentage (as defined below)
multiplied by the Maximum Credit exceeds the average daily principal
balance of the outstanding Revolving Loans and Letter of Credit
Accommodations during the immediately preceding such month (or part
thereof), which fee shall be payable on the first of each month in
arrears. For purposes of this Section 3.4, "Applicable Percentage"
means, for any month, (a) if the Monthly Excess Availability for the
month immediately preceding such month was at least $50,000,000,
seventy (70%) percent, and (b) if the Monthly Excess Availability for
the month immediately preceding such month was less than $50,000,000,
eighty (80%) percent."

5. Representations, Warranties and Covenants. In addition to the
-----------------------------------------
continuing representations, warranties and covenants heretofore made by Borrower
to Lender pursuant to the Loan Agreement and the other Financing Agreements,
Borrower hereby represents, warrants and covenants with and to Lender as follows
(which representations, warranties and covenants are continuing and shall
survive the execution and delivery of this Amendment and shall be incorporated
into and made a part of the Financing Agreements):

(a) No Event of Default exists on the date of this Amendment (after
giving effect to the Amendments to the Loan Agreement made by this
Amendment); and

(b) This Amendment has been duly executed and delivered by Borrower
and is in full force and effect as of the date hereof, and the
agreements and obligations of Borrower contained herein constitute its
legal, valid and binding obligations enforceable against Borrower in
accordance with their respective terms.

4
<PAGE>

6. Conditions Precedent. This Amendment shall not become effective
--------------------
unless all of the following conditions precedent have been satisfied in full, as
determined by Lender:

(a) The receipt by Lender of an original of this Amendment, duly
authorized, executed and delivered by Borrower; and

(b) as of the date of this Amendment, no Event of Default shall have
occurred and be continuing and no event shall have occurred or a
condition be existing and continuing which, with notice or passage of
time or both, would constitute an Event of Default.

7. Effect of this Amendment. Except as modified pursuant hereto, no
------------------------
other changes or modifications to the Loan Agreement and the other Financing
Agreements are intended or implied and in all other respects the Loan Agreement
and the other Financing Agreements are hereby specifically ratified, restated
and confirmed by all parties hereto as of the effective date hereof. To the
extent of any conflict between the terms of this Amendment and the Loan
Agreement or any of the other Financing Agreements, the terms of this Amendment
shall control. The Loan Agreement and this Amendment shall be read and
construed as one agreement.

8. Further Assurances. At Lender's request, Borrower shall execute and
------------------
deliver such additional documents and take such additional actions as Lender
reasonably requests to effectuate the provisions and purposes of this Amendment
and to protect and/or maintain perfection of Lender's security interests in and
liens upon the Collateral.

9. Governing Law. The validity, interpretation and enforcement of this
-------------
Amendment in any dispute arising out of the relationship between the parties
hereto, whether in contract, tort, equity or otherwise shall be governed by the
internal laws of the State of California (without giving effect to principles of
conflicts of law).

10. Binding Effect. This Amendment shall be binding upon and enure to the
--------------
benefit of each of the parties hereto and their respective successors and
assigns.

11. Counterparts. This Amendment may be executed in any number of
------------
counterparts, but all of such counterparts when executed shall together
constitute one and the same Agreement. In making proof of this Amendment, it
shall not be necessary

5
<PAGE>

to produce or account for more than one counterpart thereof signed by each of
the parties hereto.

Very truly yours,

VALLEY MEDIA, INC.

By: /s/ Donald E. Rose
------------------

Title: Treasurer
---------

AGREED:

CONGRESS FINANCIAL CORPORATION (NORTHWEST)

By: /s/ Rodney S. Davis
-------------------

Title: First Vice President
--------------------

<PAGE>
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