<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 12, 1999
REGISTRATION NO. 333-69329
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
------------------------
VALLEY MEDIA, INC.
(Exact name of registrant as specified in its charter)
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<S> <C> <C>
DELAWARE 5190 94-2556440
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) Number)
</TABLE>
------------------------
1280 SANTA ANITA COURT
WOODLAND, CALIFORNIA 95776
(530) 661-6600
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
------------------------
J. RANDOLPH CERF
CHIEF FINANCIAL OFFICER
VALLEY MEDIA, INC.
1280 SANTA ANITA COURT
WOODLAND, CALIFORNIA 95776
(530) 661-6600
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
------------------------
COPIES TO:
DANIEL J. WINNIKE ALAN C. MENDELSON
PAUL A. REINER COOLEY GODWARD LLP
HOWARD, RICE, NEMEROVSKI, CANADY, 5 PALO ALTO SQUARE
FALK & RABKIN, A PROFESSIONAL 3000 EL CAMINO ROAD
CORPORATION PALO ALTO, CA 94306
THREE EMBARCADERO CENTER, SUITE 700 (650) 843-5000
SAN FRANCISCO, CA 94111
(415) 434-1600
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, check the following box. / /
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE(2)
<S> <C> <C>
COMMON STOCK, .001 PAR VALUE.......................................... $56,350,000 $15,665
</TABLE>
(1) Estimated solely for the purpose of computing the amount of the registration
fee pursuant to Rule 457 under the Securities Act.
(2) An amount of $12,788 of the registration fee has been previously paid.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY
DETERMINE.
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- --------------------------------------------------------------------------------
<PAGE>
The information in this preliminary prospectus is not complete and may be
changed. These securities may not be sold until the registration statement filed
with the Securities and Exchange Commission is effective. This preliminary
prospectus is not an offer to sell nor does it seek an offer to buy these
securities in any jurisdiction where the offer or sale is not permitted.
<PAGE>
PROSPECTUS SUBJECT TO COMPLETION
DATED FEBRUARY 12, 1999
3,500,000 SHARES
[LOGO]
VALLEY MEDIA, INC.
COMMON STOCK
(PAR VALUE $0.001 PER SHARE)
This is an initial public offering of shares of common stock of Valley Media,
Inc. Valley is offering all of these shares and will receive all of the proceeds
from this offering. There is currently no public market for the common stock. We
estimate that the initial public offering price will be between $12.00 and
$14.00 per share.
Valley has applied to list the common stock on the Nasdaq National Market under
the symbol "VMIX."
INVESTING IN THE COMMON STOCK INVOLVES CERTAIN RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 8.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT COMPANY
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------
Per Share $ $ $
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Total $ $ $
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</TABLE>
To cover over-allotments, the underwriters may purchase up to an additional
525,000 shares from certain stockholders at the initial public offering price
less the underwriting discount.
J.P. MORGAN & CO. BANCBOSTON ROBERTSON STEPHENS
, 1999
<PAGE>
VALLEY MEDIA'S BUSINESS GROUPS
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<S> <C> <C>
NEW MEDIA
Serving Internet
Retailers
INDEPENDENT
FULL-LINE DISTRIBUTION DISTRIBUTION
Serving music, video
and other retailers Serving independent
nationwide labels and studios
</TABLE>
[LOGO]
VALLEY MEDIA, INC.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Prospectus Summary............................. 4
Risk Factors................................... 8
Intense Competition in Each of Valley's
Business Groups............................. 8
Dependence on Major Labels, Major Studios and
Largest DNA Labels.......................... 9
Uncertainty of Growth in Internet Retail
Market...................................... 9
Dependence on a Few National Retailers....... 9
Risks of Integration and Enhancement of
Information Systems......................... 9
Effects of Year 2000 on Information
Systems..................................... 10
Uncertainties Relating to Video Rental
Market...................................... 10
Impact of Changes in Physical Format......... 10
Emergence of New Delivery Technologies....... 10
Integrating Operations into New Facilities... 11
Potential Inability to Return Products to
Labels or Studios........................... 11
Reliance on Suppliers for Copyright
Compliance.................................. 11
Uncertainty of International Music Sales..... 12
Substantial Leverage and Related Restrictive
Covenants................................... 12
<CAPTION>
PAGE
<S> <C>
Fluctuations in Quarterly Operating Results
Due to Fluctuations in Music and Video
Industries.................................. 13
Risk of No Active Public Market or Stock
Price Volatility............................ 13
Control By Founder and Anti-Takeover
Considerations.............................. 14
Significant Number of Shares Eligible For
Future Sale May Decrease Stock Price........ 14
Forward-looking Statements..................... 16
Use of Proceeds................................ 16
Dividend Policy................................ 16
Capitalization................................. 17
Dilution....................................... 18
Selected Consolidated Financial Data........... 19
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 22
Business....................................... 35
Management..................................... 52
Certain Transactions........................... 61
Principal Stockholders......................... 63
Description of Capital Stock................... 64
Shares Eligible for Future Sale................ 66
Underwriting................................... 68
Legal Matters.................................. 69
Experts........................................ 70
Additional Information......................... 70
Index to Financial Statements.................. F-1
</TABLE>
3
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS CERTAIN INFORMATION CONTAINED ELSEWHERE IN THIS
PROSPECTUS. TO UNDERSTAND THIS OFFERING FULLY, YOU SHOULD READ THE ENTIRE
PROSPECTUS CAREFULLY, INCLUDING THE RISK FACTORS AND THE FINANCIAL STATEMENTS.
VALLEY MEDIA, INC.
Valley is the largest independent full-line distributor of music and video
entertainment products in the United States. Our retail customers include Best
Buy, CVS, Toys R Us and Wherehouse Entertainment, Inc. In 1998, we distributed
product to more than 6,500 retailers operating over 36,000 traditional
storefronts. We also provide product, data and value-added services to
approximately 100 Internet music and video retailers including Amazon.com,
CDnow, Inc., DVD Express and N2K Inc. As an aggregator of product from thousands
of labels and studios and as a provider of a range of value-added services, we
help retailers reduce costs and increase sales. Selling through Valley allows
our suppliers to more effectively reach the fragmented retail market.
We differentiate ourselves with our large selection of music and video titles,
our reliability, our systems, our data and our value-added services. We stock
more than 250,000 items including CDs, video cassettes and DVDs.
SERVING INTERNET RETAILERS
New Media, our Internet sales, support and data division, is our fastest growing
business. Its revenues increased 542%, from $17.6 million in the nine months
ended December 1997 to $113.0 million in the corresponding period of 1998.
Access to our extensive catalog is particularly valuable to on-line retailers as
their customers tend to buy higher proportions of deep catalog titles relative
to hits than do traditional shoppers. We have developed databases that serve as
an integral part of Internet retailers' product information and ordering
systems. Our value-added services enable Internet retailers to outsource
operating capabilities instead of making the substantial investment to build
their own inventories and infrastructure.
SERVING STOREFRONT RETAILERS
As a full-line distributor to storefront retailers, we play a key role in the
traditional delivery of music and video. Full-line distribution sales increased
27%, from $385.5 million in the nine months ended December 1997 to $489.6
million in the corresponding period of 1998. We serve customers ranging from
independent stores to specialty chains to retailers who sell music and video as
an ancillary product line. For independent stores, we are usually their primary
or secondary supplier. Some national retailers outsource some or most of their
music and video distribution function to us. More typically, chains have their
own distribution centers to acquire product directly from many labels and
studios, but they generally stock only the higher velocity titles. We serve
their special needs for deep catalog product, independent product, special
orders and emergency replenishment.
4
<PAGE>
SERVING INDEPENDENT LABELS AND STUDIOS
Our Independent Distribution Group provides marketing and logistical support to
independent music label customers through Distribution North America, an
independent music distribution company. Sales of our Independent Distribution
group increased 23%, from $33.4 million in the nine months ended December 1997
to $41.0 million in the corresponding period of 1998.
OUR OPPORTUNITY
We intend to continue to grow by exploiting the following opportunities:
- continued rapid growth of music and video sales over the Internet
- expected growth of DVD
- increased demand for deep catalog music and video
- cross-selling of music and video
- industry consolidation
THE OFFERING
<TABLE>
<S> <C>
COMMON STOCK OFFERED.................... 3,500,000 shares
COMMON STOCK OUTSTANDING AFTER THE
OFFERING............................... 8,448,268 shares
USE OF PROCEEDS......................... For repayment of debt and working capital
and general corporate purposes. See "Use
of Proceeds."
PROPOSED NASDAQ NATIONAL MARKET
SYMBOL................................. "VMIX"
DIVIDEND POLICY......................... Valley intends to retain its earnings for
working capital and does not anticipate
paying cash dividends in the foreseeable
future. See "Dividend Policy."
</TABLE>
- ---------------------
Unless otherwise indicated, references to numbers and percentages of shares of
common stock (a) assume that the underwriters' over-allotment option is not
exercised and (b) have been adjusted to give effect to a 8.04 to 1 split of the
common stock anticipated to occur prior to this offering.
Our fiscal year is a 52 or 53 week period ending on the Saturday nearest to
March 31. Our fiscal quarter is a 13 week period ending on the Saturday of the
13th week. However, in a 53 week fiscal year, the fourth quarter is a 14 week
period. For convenience, at times in this prospectus we refer to our fiscal year
end as March 31 and our quarters ended as of March, June, September and
December.
Our executive offices are at: 1280 Santa Anita Court
Woodland, California 95776
(530) 661-6600
www.valley-media.com
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
The data set forth below should be read in conjunction with Valley's
consolidated financial statements, including the notes thereto, included
elsewhere in this prospectus. Fiscal 1998 and the nine months ended December 27,
1997 and December 26, 1998 include results of operations of the video business
we acquired on May 20, 1997. The "as adjusted" balance sheet data reflects
adjustments to our December 26, 1998 balance sheet as though the offering of
3,500,000 shares at an assumed public offering price of $13.00 per share had
been completed on that date and the net proceeds used to repay outstanding
balances under our credit facility.
The Supplemental Operating Data includes earnings before interest, income taxes,
depreciation and amortization, or EBITDA, for the periods presented. 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. Further, our calculation of EBITDA may be different from
the calculation used by other companies and, therefore, comparability may be
limited.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
FISCAL YEARS NINE MONTHS ENDED
DOLLARS IN THOUSANDS, ------------------------------------------------------- ----------------------------------
EXCEPT PER SHARE DATA 1994 1995 1996 1997 1998 DEC. 26, 1998
----------- --------- --------- --------- --------- ----------------
DEC. 27, 1997
----------------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA
Net sales............... $ 100,172 $ 140,916 $ 156,557 $ 199,231 $ 583,492 $ 427,280 $ 631,102
Gross profit............ 13,578 14,331 18,710 23,525 66,865 46,867 69,990
Operating income........ 2,139 4,830 4,677 2,973 11,682 7,945 13,963
Equity in net loss of
joint venture......... - 162 903 207 - - -
Interest expense........ 524 735 1,305 1,745 6,627 4,511 7,518
Income before income
taxes................. 1,615 3,933 2,469 1,021 5,055 3,434 6,445
Income before
extraordinary loss.... 954 2,317 1,453 611 3,021 2,054 3,988
Extraordinary loss (net
of income taxes of
$477)................. -- -- -- -- -- -- (723)
Net income.............. $ 954 $ 2,317 $ 1,453 $ 611 $ 3,021 $ 2,054 $ 3,265
Net income per share:
Basic:
Income before
extraordinary loss... $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.82
Extraordinary loss.... -- -- -- -- -- -- (0.15)
----------- --------- --------- --------- --------- ---------------- ----------------
Basic net income per
share................ $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.67
----------- --------- --------- --------- --------- ---------------- ----------------
----------- --------- --------- --------- --------- ---------------- ----------------
Diluted:
Income before
extraordinary loss... $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.72
Extraordinary loss.... -- -- -- -- -- -- (0.13)
----------- --------- --------- --------- --------- ---------------- ----------------
Diluted net income per
share................ $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.59
----------- --------- --------- --------- --------- ---------------- ----------------
----------- --------- --------- --------- --------- ---------------- ----------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
Weighted average
shares used in the
calculation:
Basic............. 4,867,891 4,917,393 4,965,375 4,797,193 4,791,864 4,782,447 4,838,413
Diluted........... 4,926,263 4,984,626 5,224,040 5,131,341 5,263,870 5,245,245 5,554,715
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------
FISCAL YEARS NINE MONTHS ENDED
DOLLARS IN THOUSANDS, EXCEPT --------------------------------------------------------- ----------------------------------
PER SHARE DATA 1994 1995 1996 1997 1998 DEC. 26, 1998
----------- --------- --------- --------- ----------- ----------------
DEC. 27, 1997
----------------
<S> <C> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL DATA
EBITDA........................ $ 2,655 $ 5,322 $ 5,070 $ 4,615 $ 15,794 $10,875 $18,121
Net cash provided by (used in)
operating activities........ (1,607) (1,384) (5,460) 12,855 (13,086) (23,263) (45,499)
Net cash used in investing
activities.................. (550) (3,072) (1,762) (12,330) (37,554) (34,911) (6,227)
Net cash provided by (used in)
financing activities........ 2,061 4,443 7,290 (359) 50,724 58,088 52,051
</TABLE>
<TABLE>
<CAPTION>
---------------------
AT DEC. 26, 1998
---------------------
DOLLARS IN THOUSANDS ACTUAL AS ADJUSTED
-------- -----------
<S> <C> <C>
BALANCE SHEET DATA
Working capital (deficit)............................................................................. $(15,272) $ 27,043
Total assets.......................................................................................... 487,929 487,929
Total long-term obligations........................................................................... 4,347 4,347
Total short-term borrowings........................................................................... 126,542 84,227
Stockholders' equity.................................................................................. 14,242 56,557
</TABLE>
7
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS AND OTHER INFORMATION
CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING THE COMMON STOCK.
INTENSE COMPETITION IN EACH OF VALLEY'S BUSINESS GROUPS
FULL-LINE DISTRIBUTION
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 and 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.
NEW MEDIA
Our existing 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 services, such as direct-to-consumer fulfillment and
data, our financial results could also be adversely affected.
INDEPENDENT DISTRIBUTION
Our independent distribution arm, Distribution North America, competes with
several other independent distribution companies. Some of these competitors
conduct distribution operations equal or larger than Distribution North America
and others operate in niche markets. We also compete with several of the major
labels' own independent distribution arms. 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. See
"Business - Competition."
8
<PAGE>
DEPENDENCE ON MAJOR LABELS, MAJOR STUDIOS AND LARGEST DNA LABELS
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 do not have long term contracts
with any supplier for our full-line distribution or New Media businesses. If we
cannot obtain sufficient quantities of product 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.
Distribution North America's largest label group accounted for approximately 11%
of Distribution North America's net sales for the first nine months of fiscal
1999. If Distribution North America were unable to maintain its distribution
relationship with any of its large customers, our financial results would be
adversely affected. See "Business - Suppliers."
UNCERTAINTY OF GROWTH IN INTERNET RETAIL MARKET
Our New Media 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. The growth projections for Internet music and video sales that we
have cited in this prospectus are only estimates by an industry analyst and may
not prove to be accurate. 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 traditional full-line distribution
business.
DEPENDENCE ON A FEW NATIONAL RETAILERS
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 nine months
of fiscal 1999, our top three customers accounted for an aggregate of 18.3% of
our sales. We believe our percentage of sales from these customers, as well as
from a few of our other large customers, will increase as a percentage of sales
during the remaining three months of fiscal 1999 and potentially thereafter. In
October 1998, under a contract that expires in June 1999, we began providing a
significant distribution function for the Blockbuster Music stores purchased by
Wherehouse Entertainment. For the quarter ended December 26, 1998, approximately
15% of our net sales were to Wherehouse. After June 1999, we anticipate that
sales to Wherehouse will decline as it handles more of its distribution
functions internally. See "Business - Customers."
RISKS OF INTEGRATION AND ENHANCEMENT OF INFORMATION SYSTEMS
Over the next two years, we intend to integrate certain of our separate
information systems. In addition, we are constantly upgrading our systems and
developing new applications. 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
9
<PAGE>
systems, or difficulties in integration of these systems, could have a material
adverse impact on our financial results. See "Business - Full-Line Distribution
- - Operations and Technology."
EFFECTS OF YEAR 2000 ON INFORMATION SYSTEMS
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. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Year 2000 Matters."
UNCERTAINTIES RELATING TO VIDEO RENTAL MARKET
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. See "Business - Suppliers."
IMPACT OF CHANGES IN PHYSICAL FORMAT
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.
Even more recently, Divx-enhanced DVD players have been introduced to play Divx
discs and DVDs. Divx discs are disposable DVDs and are an alternative to
returnable video rental products. Customers can play Divx discs for a short
period or electronically pay an additional fee to continue using the Divx disc.
Currently, we do not distribute Divx discs. Our financial results could be
adversely affected if Divx products become widely accepted and displace
significant demand for the formats we sell and we are unable to participate in
their distribution.
EMERGENCE OF NEW DELIVERY TECHNOLOGIES
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
10
<PAGE>
delivered by labels or studios directly to stores or homes through electronic
downloading or streaming, current methods of wholesale and retail distribution
could decrease or be eliminated. Real Networks 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 copying
of any digital audio product.
Today, much of this type of digital distribution is unauthorized and lacks
copyright protection. However, the major studios have recently announced a plan
to develop a universal standard for the electronic delivery of music and have
announced their intention to make this delivery method 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 television companies, 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.
INTEGRATING OPERATIONS INTO NEW FACILITIES
After eight months of operation at our Louisville distribution center, which we
refer to as the LDC, we continue to experience operating and inventory
inefficiencies. Such inefficiencies could have a material adverse effect on our
financial results. In addition, as the LDC has increased our fixed costs
substantially, a lack of growth or decline in sales would adversely affect our
earnings. Integration of operations into this new distribution center has and
will continue to absorb a substantial amount of management attention during a
period when our ability to manage our growth and development is critical.
Continued growth of our business will likely cause us to add new facilities or
expand or move our current facilities. As with any such facility changes, we may
experience operational disruptions, inventory inefficiencies and other
difficulties due to such changes.
POTENTIAL INABILITY TO RETURN PRODUCTS TO LABELS OR STUDIOS
We bear inventory risk associated with the financial viability of our
independent labels and studios. 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.
RELIANCE ON SUPPLIERS FOR COPYRIGHT COMPLIANCE
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
11
<PAGE>
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 violations, we
could be damaged in the future by copyright violations by someone in our
distribution channel.
UNCERTAINTY OF INTERNATIONAL MUSIC SALES
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 fiscal 1998 were approximately $43.2
million and for the first nine months of fiscal 1999 were approximately $34.3
million. We would be adversely affected if a major label enforced any
restriction on our ability to sell music outside the United States.
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. In addition, our credit risk with international customers
could increase with such appreciation. Other risks to which international
operations are subject include:
- imposition of governmental controls
- export license requirements
- restrictions on the export of certain technology
- political instability
- trade restrictions
- tariff changes
- impact of local economic conditions and practices
Our success will be dependent, in part, on our ability to anticipate and
effectively manage these and other risks.
SUBSTANTIAL LEVERAGE AND RELATED RESTRICTIVE COVENANTS
We have a revolving credit facility that is secured by substantially all of our
assets. As of December 26, 1998, borrowings of approximately $124.8 million were
outstanding under the credit facility. The credit facility will remain in place
following this offering and will be used for general working capital purposes.
See "Use of Proceeds."
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
12
<PAGE>
- 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
- 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. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS DUE TO FLUCTUATIONS IN MUSIC AND
VIDEO INDUSTRIES
We anticipate significant fluctuations in future quarterly sales and operating
results due to a number of factors outside our control, including:
- seasonal variations in the demand for music and video
- infrequent new releases of extremely popular hit video titles in a given
quarter
- the proportion in which retailers buy their music and videos directly from
major labels or studios as opposed to through full-line distributors
- the percentage of returns in a given quarter
- the general economic condition in the music and video industries
As a result, we believe period-to-period comparisons of our results of
operations are not, and will not necessarily be, meaningful and should not be
relied upon as an indication of future performance. Due to the foregoing
factors, it is possible that in some future quarters our operating results will
be below the expectations of analysts and investors. In such event, the price of
the common stock may be adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Seasonality in
Operating Results."
RISK OF NO ACTIVE PUBLIC MARKET OR STOCK PRICE VOLATILITY
Prior to this offering, there has been no public market for the common stock. We
have applied to list the common stock for trading on the Nasdaq National Market.
The initial public offering price will be determined by negotiations between the
underwriters and us and may not be
13
<PAGE>
indicative of the market price for the common stock after this offering. We do
not know the extent to which investor interest will lead to the development of
an active public market. Investors may not be able to resell the common stock at
or above the initial public offering price. Many factors could cause the market
price of the common stock to fluctuate substantially including:
- future announcements concerning us or our competitors
- variations in operating results
- loss of a key supplier or customer
- technological innovations such as changes in physical product formats or
delivery technologies
- changes in product pricing policies by us, our suppliers or competitors
- changes in earnings estimates by securities analysts
These fluctuations, as well as general economic, political and market
conditions, may have a material adverse effect on the market price of the common
stock. See "Underwriting."
CONTROL BY FOUNDER AND ANTI-TAKEOVER CONSIDERATIONS
After giving effect to this offering, Barnet Cohen, the founder and Chairman of
the board, will beneficially own approximately 51.7% of the common stock, and
the executive officers and directors, including Mr. Cohen, will own, in the
aggregate, approximately 55.9% of the common stock, assuming no exercise of
outstanding options. As a result, Mr. Cohen will be able to exercise control
over all matters requiring stockholder approval, including election of directors
and approval of significant corporate transactions. Future sales by Mr. Cohen or
the other members of management of substantial amounts of common stock, or the
potential for such sales, could adversely affect the prevailing market price of
the common stock.
Certain provisions of our Amended and Restated Certificate of Incorporation and
Amended and Restated Bylaws could make it more difficult for a third party to
acquire control of us without the consent of our board of directors, even if
such change were favored by the stockholders. See "Principal Stockholders" and
"Description of Capital Stock."
SIGNIFICANT NUMBER OF SHARES ELIGIBLE FOR FUTURE SALE MAY DECREASE STOCK PRICE
The market price of the common stock could drop as a result of sales of a large
number of shares of common stock in the market after this offering, or the
perception that such sales could occur. These factors could also make it more
difficult for us to raise funds through future offerings of common stock.
There will be 8,448,268 shares of common stock outstanding immediately after
this offering. All of the shares sold in this offering will be freely
transferable without restriction or further registration under the Securities
Act of 1933, as amended, except for shares purchased by "affiliates" of Valley,
as defined in Rule 144 under the Securities Act. The remaining 4,948,268 shares
of common stock that will be outstanding upon completion of this offering are
"restricted securities" as defined in Rule 144. These restricted securities may
be sold in
14
<PAGE>
the future without registration under the Securities Act to the extent permitted
under Rule 144, Rule 701 or an exemption under the Securities Act. In connection
with this offering, all holders of restricted securities have agreed not to sell
their shares without the prior written consent of J.P. Morgan & Co. for a period
of 180 days from the date of this prospectus.
As of January 30, 1999, 1,159,791 shares of common stock were issuable upon
exercise of currently outstanding options, all of which are subject to the
lock-up agreements described above. Of those options, options to purchase
957,067 shares will be vested and fully exercisable 180 days after commencement
of this offering. See "Shares Eligible for Future Sale."
15
<PAGE>
FORWARD-LOOKING STATEMENTS
Certain statements contained or incorporated in this prospectus are
forward-looking statements concerning our operations, economic performance and
financial condition. Forward-looking statements are included, for example, in
the discussions about:
- the market for music and video sales
- our strategy
- future technology
- our information systems
- year 2000 issues
- growth of Internet music and video sales
Those forward-looking statements involve risks and uncertainties and actual
results may differ materially from those expressed or implied in those
statements. Factors that could cause differences include, but are not limited
to, those discussed under "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
USE OF PROCEEDS
Our net proceeds from the sale of the 3,500,000 shares of common stock we are
offering are estimated to be approximately $42,315,000 at an assumed initial
public offering price of $13.00 per share (approximately $48,662,250 if the
underwriters' over-allotment option is exercised in full). We intend to use all
of the net proceeds to repay a portion of the outstanding balance under our
revolving credit facility, which we expect will provide additional borrowing
capacity for working capital and general corporate purposes. At December 26,
1998, the outstanding balance under the credit facility was approximately $124.8
million. Outstanding balances under the credit facility bear interest, at our
election, of either the prime rate plus a margin ranging from 0% to 0.5% or the
Euro Dollar Rate (as defined in the credit facility) plus a margin ranging from
2% to 2.75%. At December 26, 1998, the average interest rate on outstanding
borrowings under the credit facility was approximately 7.59%. The credit
facility expires in May 2001, unless extended by the parties, and upon such
expiration all outstanding amounts are then due.
DIVIDEND POLICY
The holders of common stock are entitled to share ratably in any dividends we
declare on the common stock. We did not declare any dividends on the common
stock during fiscal 1996, 1997, 1998 or during the nine months ended December
26, 1998 and do not anticipate paying any dividends in the foreseeable future.
In addition, the credit facility contains certain limitations on our ability to
pay cash dividends.
16
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of December 26, 1998 and as
adjusted to reflect the sale of the 3,500,000 shares of common stock we are
offering (at an assumed initial public offering price of $13.00 per share) and
application of the estimated net proceeds from the offering. This table should
be read in conjunction with our consolidated financial statements and notes
thereto appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
----------------------
AT DEC. 26, 1998
----------------------
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA ACTUAL AS ADJUSTED
--------- -----------
<S> <C> <C>
Short-term debt (including current portion of long-term debt).......... $ 126,542 $ 84,227
Long-term debt (excluding current portion)............................. 4,347 4,347
Stockholders' equity:
Preferred stock, $.001 par value, 2,000,000 shares authorized; no
shares issued and outstanding; no shares issued and outstanding as
adjusted............................................................ - -
Common stock, $.001 par value, 20,000,000 shares authorized;
4,900,109 shares issued and outstanding; and 8,400,109 shares issued
and outstanding as adjusted (1)..................................... 5 8
Additional paid-in capital........................................... 1,077 43,389
Stockholder notes receivable......................................... (232) (232)
Retained earnings.................................................... 13,392 13,392
--------- -----------
Total stockholders' equity......................................... 14,242 56,557
--------- -----------
Total capitalization............................................. $ 145,131 $ 145,131
--------- -----------
--------- -----------
</TABLE>
- ------------------------
(1) Excludes 1,214,487 shares of common stock issuable upon exercise of
outstanding options and 786,352 shares reserved for future issuance under our
1994 Stock Option Plan and 1997 Stock Option Plan.
17
<PAGE>
DILUTION
Our net tangible book value as of December 26, 1998 was approximately $(822,000)
or $(0.17) per share of common stock. "Net tangible book value" per share
represents the amount of total assets less goodwill and other intangibles
reduced by the amount of total liabilities and divided by the total number of
shares of common stock outstanding. After giving effect to the sale of the
3,500,000 shares of common stock we are offering at an assumed initial public
offering price of $13.00 per share, and deducting estimated underwriting
discounts and commissions and offering expenses, the pro forma net tangible book
value at December 26, 1998 would have been approximately $41,493,000 or $4.94
per share. This represents an immediate increase in net tangible book value of
$5.11 per share to existing stockholders and an immediate dilution of $8.06 per
share to new investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
--------------------
Assumed initial public offering price per share............................. $ 13.00
---------
Net tangible book value per share before this offering...................... $ (0.17)
Increase attributable to new investors...................................... 5.11
---------
Pro forma net tangible book value per share after this offering............. 4.94
---------
Dilution per share to new investors......................................... $ 8.06
---------
---------
</TABLE>
The following table summarizes on a pro forma basis as of December 26, 1998, the
differences between the existing stockholders and the new investors with respect
to the number of shares of common stock purchased from us, the total
consideration paid to us and the average price per share paid:
<TABLE>
<CAPTION>
------------------------------------------------------------
TOTAL CONSIDERATION
------------------------------------
SHARES PURCHASED AVERAGE
---------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing stockholders....................... 4,900,109 58.3% $1,082,000 2.3% $ 0.22
New investors............................... 3,500,000 41.7 45,500,000 97.7 13.00
----- -----
Total....................................... 8,400,109 100.0% $46,582,000 100.0%
--------- ----- ---------- -----
--------- ----- ---------- -----
</TABLE>
18
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
Our fiscal year is a 52 or 53 week period ending on the Saturday nearest to
March 31. The 1994, 1995, 1996, 1997 and 1998 fiscal years each contained a 52
week period. Our consolidated statements of operations data for fiscal 1996,
1997, 1998 and the first nine months of fiscal 1999 and the consolidated balance
sheet data as of fiscal year end 1997 and 1998 and as of December 26, 1998 have
been derived from the consolidated financial statements included elsewhere in
this prospectus that have been audited by Deloitte & Touche LLP, independent
auditors. The consolidated statement of operations data for fiscal 1995 and the
consolidated balance sheet data as of fiscal year end 1995 and 1996 have been
derived from audited consolidated financial statements not included in this
prospectus. The consolidated statement of operations data for fiscal 1994 and
the consolidated balance sheet data as of fiscal year end 1994 have been derived
from unaudited consolidated financial statements not included in this
prospectus. The results of operations for the nine months ended December 1998
are not necessarily indicative of the results expected for the full fiscal year.
The data set forth below should be read in conjunction with our consolidated
financial statements, including the notes thereto, included elsewhere in this
prospectus.
The fiscal years and nine month periods ending after May 20, 1997 include
results of operations of the video business we acquired at that time. The
Supplemental Operating Data includes earnings before interest, income taxes,
depreciation and amortization, or EBITDA, for the periods presented. 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. Further, our calculation of EBITDA may be different from
the calculation used by other companies, which may limit comparability.
19
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------
NINE MONTHS ENDED
FISCAL YEARS --------------------
----------------------------------------------------- DEC. 27, DEC. 26,
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA 1994 1995 1996 1997 1998 1997 1998
--------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF DATA
Net sales..................................... $100,172 $140,916 $156,557 $199,231 $583,492 $427,280 $631,102
Cost of goods sold............................ 86,594 126,585 137,847 175,706 516,627 380,413 561,112
--------- --------- --------- --------- --------- --------- ---------
Gross profit.................................. 13,578 14,331 18,710 23,525 66,865 46,867 69,990
Selling, general and administrative
expenses.................................... 11,439 9,501 14,033 20,552 55,183 38,922 56,027
--------- --------- --------- --------- --------- --------- ---------
Operating income.............................. 2,139 4,830 4,677 2,973 11,682 7,945 13,963
Equity in net loss of joint venture........... - 162 903 207 - - -
Interest expense.............................. 524 735 1,305 1,745 6,627 4,511 7,518
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes.................... 1,615 3,933 2,469 1,021 5,055 3,434 6,445
Income taxes.................................. 661 1,616 1,016 410 2,034 1,380 2,457
--------- --------- --------- --------- --------- --------- ---------
Income before extraordinary loss.............. 954 2,317 1,453 611 3,021 2,054 3,988
Extraordinary loss (net of income taxes of
$477)....................................... -- -- -- -- -- -- (723)
--------- --------- --------- --------- --------- --------- ---------
Net income.................................... $ 954 $ 2,317 $ 1,453 $ 611 $ 3,021 $ 2,054 $ 3,265
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Net income per share:
Basic:
Income before extraordinary loss............ $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.82
Extraordinary loss.......................... -- -- -- -- -- -- (0.15)
--------- --------- --------- --------- --------- --------- ---------
Basic net income per share.................. $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.67
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Diluted:
Income before extraordinary loss............ $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.72
Extraordinary loss.......................... -- -- -- -- -- -- (0.13)
--------- --------- --------- --------- --------- --------- ---------
Diluted net income per share................ $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.59
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------
Weighted average shares used in the
calculation:
Basic....................................... 4,867,891 4,917,393 4,965,375 4,797,193 4,791,864 4,782,447 4,838,413
Diluted..................................... 4,926,263 4,984,626 5,224,040 5,131,341 5,263,870 5,245,245 5,554,715
SUPPLEMENTAL OPERATING DATA
EBITDA........................................ $ 2,655 $ 5,322 $ 5,070 $ 4,615 $ 15,794 $ 10,875 $ 18,121
Net cash provided by (used in) operating
activities.................................. (1,607) (1,384) (5,460) 12,855 (13,086) (23,263) (45,499)
Net cash used in investing activities......... (550) (3,072) (1,762) (12,330) (37,554) (34,911) (6,227)
Net cash provided by (used in) financing
activities.................................. 2,061 4,443 7,290 (359) 50,724 58,088 52,051
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------------
AT FISCAL YEAR END
----------------------------------------------------- AT DEC. 26,
DOLLARS IN THOUSANDS 1994 1995 1996 1997 1998 1998
--------- --------- --------- --------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital (deficit)......................... $ 3,073 $ 3,762 $ 4,397 $ (200) $ (17,612) $ (15,272)
Total assets...................................... 32,171 48,648 58,114 94,591 245,062 487,929
Total long-term obligations....................... 873 961 3,157 2,257 3,166 4,347
Total short-term borrowings....................... 7,292 11,703 20,280 21,705 75,715 126,542
Stockholders' equity.............................. 3,930 6,333 7,716 7,773 10,977 14,242
</TABLE>
20
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The table below sets forth our quarterly operating data, including such data as
a percentage of net sales, for fiscal 1998 and the first three quarters of
fiscal 1999. This quarterly information is unaudited, but in our opinion
reflects all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the information for the periods presented
when read in conjunction with the audited consolidated financial statements and
notes thereto. Operating results for any quarter are not necessarily indicative
of results for any future period. See "Risk Factors - Fluctuations in Quarterly
Operating Results Due to Fluctuations in Music and Video Industries."
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
FISCAL QUARTERS ENDED
-------------------------------------------------------------------------------
DOLLARS IN THOUSANDS, EXCEPT PER JUNE 28, SEPT. 27, DEC. 27, MARCH 28, JUNE 27, SEPT. 26, DEC. 26,
SHARE DATA 1997 1997 1997 1998 1998(1) 1998 1998
----------- --------- --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales........................... $ 89,793 $ 144,654 $ 192,833 $ 156,212 $ 154,373 $ 188,978 $ 287,751
Gross profit........................ 10,690 16,118 20,059 19,998 16,950 20,996 32,044
Selling, general and administrative
expenses.......................... 9,670 14,168 15,084 16,260 17,181 17,029 21,817
Total operating income (loss)....... $ 1,020 $ 1,950 $ 4,975 $ 3,738 $ (231) $ 3,967 $ 10,227
Net income (loss)................... $ (11) $ 180 $ 1,885 $ 967 $ (2,189) $ 800 $ 4,654
Basic net income (loss) per share: - $ 0.04 $ 0.39 $ 0.20 $ (0.45) $ 0.17 $ 0.96
Diluted net income (loss) per
share............................. - $ 0.03 $ 0.36 $ 0.18 $ (0.45) $ 0.14 $ 0.83
SUPPLEMENTAL DATA
EBITDA............................ $ 1,763 $ 3,023 $ 6,089 $ 4,919 $ 984 $ 5,307 $ 11,830
</TABLE>
- ------------------------------
(1) Includes extraordinary loss of $723,000 or $0.15 per share.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
FISCAL QUARTERS ENDED
-----------------------------------------------------------------------------------------
JUNE 28, SEPT. 27, DEC. 27, MARCH 28, JUNE 27, SEPT. 26, DEC. 26,
1997 1997 1997 1998 1998 1998 1998
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales........................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit..................... 11.9 11.1 10.4 12.8 11.0 11.1 11.1
Selling, general and
administrative expenses........ 10.8 9.8 7.8 10.4 11.1 9.0 7.6
Total operating income (loss).... 1.1 1.3 2.6 2.4 (0.1) 2.1 3.5
Net income (loss)................ - 0.1 1.0 0.6 (1.4) 0.4 1.6
</TABLE>
The following table sets forth quarterly net sales of each of our three
principal business groups for fiscal 1998 and the first three quarters of fiscal
1999. Intercompany sales consist primarily of sales of music by the Independent
Distribution Group to full-line distribution and the New Media Group.
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
FISCAL QUARTERS ENDED
-------------------------------------------------------------------------------
JUNE 28, SEPT. 27, DEC. 27, MARCH 28, JUNE 27, SEPT. 26, DEC. 26,
DOLLARS IN THOUSANDS 1997 1997 1997 1998 1998 1998 1998
----------- --------- --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Full-line distribution........ $ 80,004 $ 131,816 $ 173,645 $ 135,000 $ 124,796 $ 150,117 $ 214,733
New Media..................... 3,266 4,981 9,396 12,673 21,650 29,481 61,881
Independent Distribution...... 8,877 11,198 13,341 12,269 12,583 13,252 15,191
Intercompany sales............ (2,354) (3,341) (3,549) (3,730) (4,656) (3,872) (4,054)
----------- --------- --------- ----------- --------- --------- ---------
Total net sales............. $ 89,793 $ 144,654 $ 192,833 $ 156,212 $ 154,373 $ 188,978 $ 287,751
----------- --------- --------- ----------- --------- --------- ---------
----------- --------- --------- ----------- --------- --------- ---------
</TABLE>
21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
"SELECTED CONSOLIDATED FINANCIAL DATA" AND OUR CONSOLIDATED FINANCIAL
STATEMENTS, AND THE RESPECTIVE NOTES THERETO INCLUDED ELSEWHERE IN THIS
PROSPECTUS. THE DISCUSSION IN THIS PROSPECTUS INCLUDES CERTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF OUR
PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS. THE CAUTIONARY STATEMENTS MADE
IN THIS PROSPECTUS SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD
LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS PROSPECTUS. OUR ACTUAL RESULTS
COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED IN "RISK FACTORS" AS WELL
AS THOSE DISCUSSED ELSEWHERE HEREIN.
OVERVIEW
We have been engaged in the full-line distribution of music since 1985 and
expanded our operations to include the full-line distribution of video with the
acquisition of substantially all of the assets of Star Video Entertainment, L.P.
in May 1997. In addition to our core full-line distribution business, we conduct
our music and video distribution business through two other operating divisions,
our New Media Group and our Independent Distribution Group. The New Media Group
provides product, data and direct-to-consumer fulfillment services for Internet
retailers and currently represents our fastest growing business group. In
September 1994, we entered into a joint venture, Distribution North America,
which is known in the industry as DNA, to provide marketing, distribution and
related services for independent record labels. In January 1997, we acquired our
joint venture partner's interest in DNA, which now forms the largest component
of our Independent Distribution Group.
We generate most of our revenue from the sale of music and video. We also
receive revenue from providing certain services to customers such as
direct-to-consumer fulfillment and licensing our proprietary databases of
product information. Incremental revenues, which represent under two percent of
our net sales, include direct-to-consumer fulfillment fees, sales of
publications, fees for applying retailers' customized stickers, preparation of
videos for rental and restocking fees. Our direct-to-consumer fulfillment
customers reimburse us for our shipping costs. Sales are recorded net of
estimated returns and allowances. See "Business - Suppliers" and "Business -
Customers."
Our fiscal year is a 52 or 53 week period ending on the Saturday nearest to
March 31. Our three most recently completed fiscal years ended March 30, 1996,
March 29, 1997 and March 28, 1998. Each such fiscal year contained a 52 week
period. Fiscal 1999 will be a 53 week period. The following table sets forth net
sales of each of our three principal business
22
<PAGE>
groups for fiscal 1996, 1997 and 1998 and for the nine months ended December
1997 and 1998. Intercompany sales consist primarily of sales of music by the
Independent Distribution Group to full-line distribution and the New Media
Group.
<TABLE>
<CAPTION>
---------------------------------------------------------
NINE MONTHS ENDED
FISCAL YEARS ------------------------
------------------------------- DEC. 27, DEC. 26,
DOLLARS IN THOUSANDS 1996 1997 1998 1997 1998
--------- --------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Full-line distribution.............. $ 152,235 $ 184,721 $ 520,465 $385,465 $489,645
New Media........................... 4,322 8,319 30,316 17,642 113,013
Independent Distribution............ - 6,626 45,685 33,415 41,026
Intercompany sales.................. - (435) (12,974) (9,242) (12,582)
--------- --------- --------- ----------- -----------
Total net sales................... $ 156,557 $ 199,231 $ 583,492 $427,280 $631,102
--------- --------- --------- ----------- -----------
--------- --------- --------- ----------- -----------
</TABLE>
Revenue growth through the periods presented has been due primarily to increases
in unit volumes sold rather than price increases. Cost of goods is comprised of
the average cost of product purchased, supplier incentives (including cash
discounts, returns incentives, rebates and net advertising support), freight
expense and inventory carrying costs. Gross margins are subject to both
quarterly fluctuations and long term trends. The mix of product sales among
higher margin sales relative to lower margin sales is the most significant
factor affecting gross margins. The video distribution business typically
generates lower gross margins than the music business. Factors that can
contribute to gross margin fluctuations on a quarterly basis also include:
- the percentage of New Media customers for which we perform
direct-to-customer fulfillment
- the percentage of lower margin, higher volume hits versus catalog product
sold in a given quarter
- competitive pricing conditions
- the level of product discounts, rebates and advertising support from our
vendors
- changes in freight costs
In the mid-1990's, our music distribution business was hurt by our largest
competitor pursuing an aggressive pricing strategy to gain market share. This
price competition negatively impacted both margins and sales. Simultaneously, we
recognized that to compete effectively in a competitive pricing environment we
needed to increase our scale, efficiencies and capabilities. Beginning late in
fiscal 1995, we undertook several actions to support future growth:
- significant investments were made to develop and install advanced
information systems and automated equipment in our California distribution
center
- senior executives were added in key areas, and sales and marketing,
information systems and administrative support staffs were expanded
- we enhanced our product information databases
As a result, selling, general and administrative expenses increased at a faster
rate than revenues in fiscal 1996 and 1997. We believe this infrastructure
development, along with the investment in the LDC, provides the capacity for
growth in all lines of our business. In
23
<PAGE>
addition, while the pricing environment for music and video remains competitive,
we believe that market conditions in our business have stabilized in the last
year except video full-line distribution.
Our selling, general and administrative expenses are comprised primarily of
salaries and benefits, operating supplies, outside services, bad debts and
occupancy costs. Such expenses have increased with our growth in net sales and
are expected to continue to do so. Over time we would expect the increase in
selling expenses generally to be proportionate to the increase in net sales.
However, the infrastructure represented by these expenses is not added or
reduced in a linear proportion to changes in net sales. These expenses can be
expected to increase as a percentage of sales in periods immediately following
the building of our infrastructure. We will seek to produce revenue growth at a
faster rate than selling, general and administrative expenses, but we may not be
successful in doing so.
Operating income increases are greater than net sales increases in years when no
additional investments in infrastructure are necessary to support increased
volumes.
RESULTS OF OPERATIONS
The following discussion is based on the historical results of operations for
fiscal 1996, 1997 and 1998 and the nine months ended December 1997 and 1998. We
engaged in a number of acquisitions during this period that enabled us to
achieve scale efficiencies, add product lines, acquire data and strengthen our
relationship with certain customer segments and suppliers. Because each
acquisition was accounted for as a purchase, the results of the acquired
companies are included in our results of operations from the date of
acquisition. These acquisitions included:
- certain assets of four regional full-line music distributors in
Indianapolis, Omaha, Baltimore and Connecticut in June, July and November
1996 and December 1997, respectively
- a music database and the rights to publish two music publications from
Stereophile, Inc. in December 1996
- the remaining 50% interest in DNA in January 1997 (the original investment
in the DNA joint venture was made in September 1994 and was accounted for
on the equity method)
- the Star acquisition in May 1997
24
<PAGE>
The following table sets forth certain operating data as a percentage of net
sales for fiscal 1996, 1997 and 1998 and the nine months ended December 1997 and
1998.
<TABLE>
<CAPTION>
-----------------------------------------------------------
NINE MONTHS ENDED
FISCAL YEARS --------------------------
------------------------------- DEC. 27, DEC. 26,
1996 1997 1998 1997 1998
--------- --------- --------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Net sales................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Gross profit............................. 12.0 11.8 11.5 11.0 11.1
Selling, general and administrative
expenses............................... 9.0 10.3 9.5 9.1 8.9
Operating income......................... 3.0 1.5 2.0 1.9 2.2
Net income............................... 0.9% 0.3% 0.5% 0.5% 0.5%
SUPPLEMENTAL DATA
EBITDA................................... 3.2% 2.3% 2.7% 2.5% 2.9%
</TABLE>
NINE MONTHS ENDED DECEMBER 1998 COMPARED TO NINE MONTHS ENDED DECEMBER 1997
Our net sales increased $203.8 million, or 48%, from $427.3 million in the nine
months ended December 1997 to $631.1 million in the nine months ended December
1998.
Full-line distribution sales increased $104.1 million, or 27%, from $385.5
million to $489.6 million. Approximately $32.5 million of this increase was
attributable to the inclusion of nine months of video sales in 1998 compared to
seven months in 1997 as a result of the Star acquisition. In addition, the
release of the TITANIC video and growth of DVD sales increased video sales in
1998. Net sales of TITANIC were approximately $21 million in 1998. The balance
of the growth was attributable to increased sales to existing and new full-line
distribution customers.
New Media sales increased $95.4 million, or 542%, from $17.6 million to $113.0
million due to (a) the addition of Amazon.com as a new customer, (b) increased
sales by our on-line customers and (c) the addition of other new customers.
Independent Distribution sales increased $7.6 million, or 23%, from $33.4
million to $41.0 million due to (a) the acquisition of new labels, (b) increased
sales to our full-line distribution and New Media divisions and (c) successful
marketing of existing labels and artists.
Our gross profit increased $23.1 million, from $46.9 million to $70.0 million,
with gross margin increasing from 11.0% to 11.1%. Margins were affected by a
number of factors including:
- the relatively faster growth rate in New Media sales, which have higher
margins than full-line distribution sales
- the inclusion of nine months as opposed to seven months of video sales,
which have lower margins than music sales
- increases in freight and inventory carrying costs associated with the
startup of the LDC
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<PAGE>
Selling, general and administrative expenses increased $17.1 million, or 44%,
from $38.9 million to $56.0 million primarily as a result of sales growth.
Selling, general and administrative expenses declined as a percentage of sales
from 9.1% to 8.9% due primarily to:
- lower general and administrative costs as a percentage of sales for
full-line video distribution as compared to full-line music
- our ability to increase full-line music distribution and New Media sales
with a less than proportionate increase in selling, general and
administrative expenses
Partially offsetting these cost reductions were the following unusual items:
- costs associated with opening the LDC
- costs associated with consolidating video sales offices and distribution
centers
- a write off of deferred offering costs of $587,000 that were no longer
considered specific incremental costs directly attributable to the
proposed offering
- increases in depreciation and amortization as a result of the Star
acquisition and infrastructure development
- increases in allowances for video customer bad debts
Interest expense increased $3.0 million, or 67%, from $4.5 million to $7.5
million due to (a) growth in working capital associated largely with increased
sales and the LDC, (b) the Star acquisition and (c) investment in systems and in
the LDC. Partially offsetting these factors was a reduction of our average
interest rate from 8.9% in 1997 to 7.6% in 1998.
Our effective tax rate decreased from 40.2% to 38.1% reflecting the effects of
adjustments to the purchase price of Star.
In May 1998, termination fees from refinancing our revolving credit facility
resulted in an extraordinary loss of $723,000 (net of income taxes).
Net income increased $1.2 million from $2.1 million to $3.3 million.
FISCAL 1998 COMPARED TO FISCAL 1997
Our net sales increased $384.3 million, or 193%, from $199.2 million in fiscal
1997 to $583.5 million in fiscal 1998.
Full-line distribution sales increased $335.7 million, or 182%, in fiscal 1998.
Approximately $234 million of this increase was attributable to the video
distribution business acquired from Star. Approximately $102 million was
attributable to growth in full-line music distribution, representing a 57%
growth rate in this business from fiscal 1997 to fiscal 1998. This growth was
due to increased sales to existing customers and the addition of new customers.
New Media sales increased $22.0 million, or 264%, in fiscal 1998 due to (a) the
overall growth of on-line sales to existing on-line customers and (b) the
addition of new customers.
Independent Distribution sales increased $39.1 million, or 589%, from $6.6
million in fiscal 1997 to $45.7 million in fiscal 1998. This growth primarily
was due to (a) the acquisition of
26
<PAGE>
the remaining 50% interest in DNA in the fourth quarter of fiscal 1997 (fiscal
1998 includes net sales for a full year versus two months in fiscal 1997) and
(b) successful marketing and new labels which provided strong growth in sales of
independent labels.
Our gross profit increased $43.4 million, from $23.5 million in fiscal 1997 to
$66.9 million in fiscal 1998, with gross margin declining slightly from 11.8% to
11.5%. The changes in margin were impacted by changes in product and customer
mix and increases in reserves for obsolete inventory. Margins in full-line music
distribution did not change meaningfully between fiscal 1997 and fiscal 1998.
The decline in gross margin was due primarily to our entry into the video
business, which more than offset the gross margin gains associated with the
growth in our New Media and Independent Distribution Groups. These groups
generally have higher margins than full-line distribution.
Selling, general and administrative expenses increased $34.6 million, or 168%,
from $20.6 million in fiscal 1997 to $55.2 million in fiscal 1998. Selling,
general and administrative expenses increased primarily as a result of the Star
acquisition and internal growth. Selling, general and administrative expenses
declined as a percentage of sales from 10.3% in fiscal 1997 to 9.5% in fiscal
1998 due primarily to:
- lower selling, general and administrative costs as a percentage of sales
for full-line video distribution, which commenced in the first quarter of
fiscal 1998 following the Star acquisition, as compared to full-line music
distribution
- operating leverage associated with the overall increase in sales,
particularly in full-line music distribution
Partially offsetting these factors were:
- increases in operating costs associated with the growth in newer
businesses that typically require higher selling, general and
administrative expenses (New Media and Independent Distribution)
- costs associated with the Star acquisition and consolidation of the Star
business
- costs associated with planning and preparing for the LDC
- increases in depreciation and amortization as a result of the recent
acquisitions and infrastructure development
- increases in allowances for video customer bad debts
The allowance for doubtful accounts increased primarily as a result of a number
of doubtful accounts receivable that we purchased as part of the Star
acquisition.
Interest expense increased from $1.7 million in fiscal 1997 to $6.6 million in
fiscal 1998, reflecting borrowings incurred to fund the Star acquisition, growth
in working capital and investments in systems and the LDC.
Net income increased by $2.4 million from $611,000 in fiscal 1997 to $3.0
million in fiscal 1998 as a result of these factors.
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<PAGE>
FISCAL 1997 COMPARED TO FISCAL 1996
Our net sales increased $42.6 million, or 27%, from $156.6 million in fiscal
1996 to $199.2 million in fiscal 1997.
Full-line distribution sales increased $32 million, or 21%, primarily due to (a)
the opening of an East Coast sales office and the hiring of additional sales and
marketing representatives and (b) the acquisition of customer lists from three
regional full-line distributors.
A reduction of approximately $29 million in sales to two of our largest
customers in fiscal 1997 partially offset these factors. We believe that sales
to these customers declined because we were unwilling to reduce our prices
enough to compete with the aggressive pricing strategy adopted by our
competitor, Alliance Entertainment.
New Media sales increased $4 million, or 92%, due to (a) the overall growth of
on-line sales to existing on-line customers and (b) the addition of new
customers.
Independent Distribution sales were $6.6 million in fiscal 1997 due to the
acquisition of the remaining 50% of the DNA business in January 1997.
Our gross profit increased $4.8 million, from $18.7 million for fiscal 1996 to
$23.5 million for fiscal 1997. However, gross margin decreased from 12.0% in
fiscal 1996 to 11.8% in fiscal 1997. This decline reflects the net impact of
several factors, including (a) sales discounts to full-line distribution
customers due to intense price competition and (b) higher freight costs due
primarily to a proportional increase in shipments to the Eastern United States.
These factors more than offset changes in our product mix that otherwise would
have improved gross margins, including (a) the effects of our January 1997
acquisition of the remaining 50% ownership interest in the DNA joint venture and
(b) growth in New Media sales.
Selling, general and administrative expenses increased $6.6 million, or 47%,
from $14.0 million for fiscal 1996 to $20.6 million for fiscal 1997. The
increase was attributable primarily to:
- a decrease in the reimbursement of selling, general and administrative
expenses under the DNA administrative agreement relative to the amount of
such expenses
- development of Schwann publications, Valley Entertainment, the LDC and the
East Coast sales office
- growth of other expenses due to increased sales
Interest expense increased from $1.3 million in fiscal 1996 to $1.7 million in
fiscal 1997 due to higher outstanding balances under our previous credit
facility. The higher outstanding balances are attributable to working capital
needs, capital investment and acquisitions associated with our growth.
Net income decreased from $1.5 million in fiscal 1996 to $611,000 in fiscal 1997
as a result primarily of the decline in operating income and the increase in
interest expense.
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<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Our capital requirements relate primarily to working capital, the expansion of
our operations to accommodate sales growth, and the funding of acquisitions. Our
working capital needs are seasonal and typically peak in the second and third
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 skus. Inventories generally can be returned to
suppliers. Historically, we have financed our cash requirements primarily from
short-term bank borrowings and cash from operations.
Net cash used in operating activities of $5.5 million in fiscal 1996 was
primarily attributable to increases of $4.0 million in accounts receivable and
$2.3 million in inventories and a decrease of $3.1 million in accounts payable.
Net cash provided by operating activities of $12.9 million in fiscal 1997 was
primarily attributable to an increase of $33.5 million in accounts payable,
partially offset by increases of $15.4 million in accounts receivable and $9.4
million in inventories.
Net cash used in operating activities of $13.1 million in fiscal 1998 was
primarily attributable to increases of $43.5 million in accounts receivable and
$31.4 million in inventories. These were partially offset by an increase in
accounts payable of $51.7 million.
Net cash used in operating activities of $23.3 million in the nine months ended
December 27, 1997 consisted primarily of increases of $88.3 million in accounts
receivable and $36.5 million in inventories. These were partially offset by an
increase in accounts payable of $93.6 million.
Net cash used in operating activities of $45.5 million in the nine months ended
December 26, 1998 consisted primarily of increases of $121.3 million in accounts
receivable and $123.7 million in inventories. These were partially offset by an
increase in accounts payable of $185.0 million.
The large increases in the components of working capital in fiscal 1997 and 1998
were a result of overall growth in sales. In fiscal 1998 and the nine month
period ended December 27, 1997, these increases were also a result of the Star
acquisition. Increases in receivables and inventories in the nine month periods
ended December 27, 1997 and December 26, 1998 were also due to high sales volume
occurring in the holiday period. In addition, for the nine month period ended
December 26, 1998, working capital was increased by sales to Wherehouse
Entertainment.
Net cash used in investing activities was $1.8 million, $12.3 million and $37.6
million for fiscal 1996, 1997 and 1998, respectively. Cash used in fiscal 1996
consisted primarily of $1.7 million of investments in property and equipment for
our California distribution center. Cash used in fiscal 1997 consisted of $9.3
million for business and net asset acquisitions completed during that year, and
$2.9 million for property and equipment acquisitions,
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<PAGE>
primarily for system enhancements. Cash used in fiscal 1998 consisted of $33.1
million for business and net asset acquisitions, primarily the Star acquisition,
and $4.3 million for property and equipment acquisitions.
Cash used in investing activities has increased in each of the past two fiscal
years because of increasing investments in fixed assets and technology required
to facilitate overall sales growth. Net cash used in investing activities was
$6.2 million in the nine months ended December 26, 1998, consisting primarily of
purchases of property and equipment at the LDC. We anticipate capital
expenditures in fiscal 1999 to be substantially above fiscal 1998 levels,
primarily as a result of the completion of the LDC and the continued integration
of Star's business.
Financing activities provided net cash of $7.3 million in fiscal 1996, used net
cash of $359,000 in fiscal 1997, and provided net cash of $50.7 million in
fiscal 1998. Cash provided from financing activities in fiscal 1996 consisted
primarily of additional borrowings under our previous credit facility to fund
increased working capital requirements. The fiscal 1997 amount was primarily a
result of the repurchase of common stock for $554,000. Cash provided from
financing activities in fiscal 1998 consisted primarily of additional borrowings
under our previous credit facility to fund the Star acquisition and working
capital requirements generated by our overall sales growth. Cash provided by
financing activities in the nine months ended December 26, 1998 was $52.0
million and consisted primarily of additional borrowings under our credit
facility to fund increased working capital requirements.
Our credit facility provides for borrowings up to the lesser of $200.0 million
or the amount of collateral availability. Collateral availability is limited to
certain percentages of eligible inventory and accounts receivable, subject to
certain limitations as to video and DNA inventories. The credit facility bears
interest, at our election, of either the prime rate plus a margin of 0% 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 eligible accounts
receivable, inventory, certain equipment and other tangible property. The credit
facility expires on May 21, 2001 and renews annually thereafter unless notice is
given by either party. The credit facility contains various covenants, including
among other things, compliance with:
- adjusted net worth requirements
- restrictions on sales of assets, consolidations, mergers, and dissolution
- limitations on encumbrances, indebtedness, loans, investments, and
guarantees
- limitations on payment of cash dividends and redemptions
We believe that our cash on hand, together with our cash flow from operations,
borrowing availability under the credit facility and the net proceeds from this
offering, will be sufficient to meet our operating and capital requirements
through fiscal 2000. We intend to use the net proceeds of the offering to repay
a portion of the outstanding balance under the credit facility.
30
<PAGE>
The Company's future operating and capital requirements, however, will depend on
numerous factors, including without limitations, 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 fiscal quarter.
NEW ACCOUNTING STANDARDS
See Note 2 to our consolidated financial statements for a discussion of the
impact of:
- Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income, and SFAS No. 131, Disclosures about Segment
Reporting of an Enterprise and Related Information, which we will adopt in
fiscal 1999
- SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, which will be adopted by us in fiscal 2001
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 ("IT Systems"), and
certain equipment that uses programmable logic chips to control aspects of their
operation ("embedded chip equipment"), may recognize "00" as a year other than
the year 2000. Some IT Systems and embedded chip equipment used by us and by
third parties who 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 causing disruptions of operations, including, among
other things, a temporary inability to process transactions or to engage in
other normal business activities. These projects generally relate to
improvements ranging from adding additional value-added services to cost saving
improvements.
READINESS FOR YEAR 2000
We are addressing year 2000 issues relating to:
- IT 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
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<PAGE>
We use a variety of IT Systems, internally developed and third-party provided
software and embedded chip equipment. For these IT Systems, software and
embedded chip equipment, we have divided our year 2000 efforts into four phases:
(1) identification and inventorying of IT 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 and
enterprise-wide basis
We have categorized as "mission critical" those IT Systems and embedded chip
equipment whose failure would cause 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 IT
Systems and embedded chip equipment are currently in phase (3) or (4). We will
conduct a comprehensive program of integration testing of internal systems in
order to ensure that all systems still work together properly and without year
2000 problems. This integration testing will occur in August 1999.
Our operations are also dependent on the year 2000 readiness of third parties
that do business with us. In particular, our IT 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 vendors 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 intends 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.
COSTS
We estimate that our IT Systems and embedded chip equipment will be year 2000
compliant by August 1999. Aggregate costs for work related to year 2000 efforts
currently are anticipated to total approximately $3.3 million. Costs of $364,000
and $253,000 were incurred and expensed in fiscal 1998 and in the nine months
ended December 26, 1998, respectively. These costs related entirely to
modifications of existing software and represented 5% and 3% of the IT budgets
for the respective periods.
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Of the remaining portion of our aggregate estimated year 2000 costs,
approximately $100,000 will be incurred in the fourth quarter of fiscal 1999 and
approximately $2.6 million will be incurred in fiscal 2000. Approximately $1.3
million of the remaining year 2000 costs are expected to be for capital
investments in new systems and applications. We anticipate that 10% of our
fiscal 2000 IT budget will be used for year 2000 remediation. We anticipate our
remaining year 2000 costs to be incurred in the following percentages among the
following types of remediation:
- 14% on modifications to existing software
- 16% on conversions to new software
- 70% on remediation of embedded chip equipment
Certain IT 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 IT 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
IT 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
IT 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 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.
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<PAGE>
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 its 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 communication
- 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
- 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 June
1999. However, there can be no assurance that we will be able to complete our
contingency planning on that schedule.
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<PAGE>
BUSINESS
We are the largest independent full-line distributor of music and video
entertainment products in the United States. Our retail customers include Best
Buy, CVS, Toys R Us and Wherehouse Entertainment as well as thousands of other
retailers. We distribute product to more than 6,500 retailers operating over
36,000 traditional storefronts. We also provide product, data and value-added
services to approximately 100 music and video Internet retailers, including
Amazon.com, Inc., CDnow, Inc., DVD Express, Inc. and N2K Inc. With our advanced
systems, technology and proprietary databases, we act as a partner to music and
video suppliers and retailers in the $28.8 billion domestic music and video
retail market. We enable music and video suppliers to more effectively reach a
fragmented retail market and provide value-added services to our customers and
suppliers. The National Association of Recording Merchandisers, commonly
referred to as NARM, recognized us as best in our class for each of the past
five years.
We have developed our proprietary databases, as well as our distribution and
data collection systems to handle a "deep catalog" of more than 250,000 stock
keeping units ("skus") efficiently. In addition, we have developed
state-of-the-art fulfillment centers to ship very small orders directly to
customers ordering via on-line music retailers as well as large, complex orders
from traditional retailers. Our advanced systems are the result of 13 years of
ongoing investments and operating refinements as well as the commitment of
approximately 130 technology professionals dedicated to maintaining and
enhancing these systems and databases. Further, we believe our systems and deep
catalog uniquely position us to capitalize on new growth opportunities.
We have benefited from retailers' efforts to outsource certain of their
distribution and purchasing functions. The music and video industries are
offering and consumers are demanding a growing product selection from thousands
of individual studios and labels. This demand for a larger variety of titles has
been particularly illustrated by Internet retailers who differentiate themselves
from traditional stores by advertising the breadth of their "virtual"
selections. It is inefficient for many retailers to manage the large number of
supplier relationships necessary to satisfy their customers. Accordingly,
retailers turn to product aggregators such as Valley to simplify their own
operations and reduce costs. We believe we differentiate ourselves by our
commitment to a deep selection of music and video skus and our ability to offer
value-added systems, data and other capabilities.
New Media, our Internet sales, support and data division, is our fastest growing
business and represents $61.9 million, or 22%, of net sales for the fiscal
quarter ended December 1998. New Media net sales grew from $17.6 million for the
nine months ended December 1997 to $113.0 million for the same period in 1998.
According to Forrester Research, Inc., domestic on-line sales of physical music
and video product (at retail) are expected to grow from approximately $338
million in 1998 to $3.8 billion in 2003. Through our proprietary systems,
technology and deep catalog commitment, we are positioned to offer a set of
value-added services that meet the specialized needs of this growing retail
channel.
We have partnered with on-line retailers by providing them with our proprietary
product databases. These databases contain data on title availability, trade
information, track
35
<PAGE>
information and other data enabling the on-line retailer to offer its customers
the ability to sort and search an extensive catalog for the items they wish to
purchase. This capability is particularly important for on-line retailers as
industry sources have observed that Internet customers buy a higher proportion
of deep catalog product relative to "hits" than do storefront shoppers. We
intend to further enhance and develop our capabilities and value-added services
for the on-line retail channel.
As a full-line distributor, we also play a key role in the delivery of music and
video to traditional retailers. In fiscal 1998, we aggregated and distributed
music and video product from all of the major, and many of the independent,
labels and studios. By partnering with us, a retailer can increase sales and
profitability while simultaneously reducing investment in inventory, facilities
and personnel. Our independent traditional storefront customers generally rely
on us to provide most, if not all, of their product requirements. On the other
hand, large chains frequently have their own distribution centers to acquire
product directly from the major labels and studios, but generally stock only
higher velocity skus. Accordingly, we serve the chains' special needs for deep
catalog product, independent product (as an aggregator of hundreds of small
suppliers), special orders and emergency replenishment.
After identifying an opportunity to apply our expertise in music distribution to
video, we entered the video distribution business through the Star acquisition.
We intend to capitalize on the growth in video product priced for sale to end
users (commonly referred to as "sell-through video") and the introduction of new
physical formats such as DVD. We are leveraging our technology, deep catalog,
and operational capabilities to provide value-added services to video customers
in order to differentiate ourselves in the market place and increase sales and
market share.
Our Independent Distribution Group leverages our full-line distribution
capabilities and gives us the opportunity for higher gross margin sales. The
Independent Distribution Group consists primarily of DNA, an independent
distribution company. It also includes Valley Entertainment, a music label. DNA
provides marketing and logistical support to independent music labels.
INDUSTRY OVERVIEW
The domestic music and video markets generated retail sales of approximately
$28.8 billion in 1997, of which $12.0 billion represented music sales, $7.6
billion represented video sales and $9.2 billion represented video rentals.
These markets feature a dynamic mix of products. For example, during fiscal
1998, we added 52,425 audio skus and deleted 33,095 audio skus from our
inventory. We believe that most of these additions and deletions represent skus
that have been added to or removed from the marketplace. The increase in sku
count adds inventory costs and amplifies the need for management and systems
sophistication. While retailers acquire music and video product through a
variety of direct channels, we estimate that more than 25% of the music and
video sold at retail each year reaches retailers through full-line distributors,
vendor managed inventory firms or other intermediaries.
Music and video are produced and supplied by a complex network of labels,
studios and distribution companies. Five large record companies and their
distribution companies, commonly referred to as the major labels, and six large
film studios and their distribution
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companies, commonly referred to as the major studios, produce and supply
products that represent approximately 85% of sales in the music industry and 70%
of sales in the video industry. The major labels (and their respective
distribution groups) are:
- Time Warner Inc. (WEA)
- The Seagram Company, Ltd. (Universal Music and Video Distribution)
- Bertelsmann AG (BMG Distribution)
- Sony Corp. (Sony Music Distribution)
- Thorne-EMI plc (EMI Distribution)
The major studios (and their respective distribution groups) are:
- The Walt Disney Company (Buena Vista Home Entertainment)
- Time Warner Inc. (Warner Home Video)
- Sony Corp. (Columbia Tri-Star Home Video)
- News Corporation (Twentieth Century Fox Home Entertainment)
- Viacom Inc. (Paramount Home Video)
- The Seagram Company, Ltd. (Universal Music and Video Distribution)
The balance of music and video is produced by thousands of independent labels
and studios that either sell their product directly or, in the case of music,
distribute through one of the major labels or an independent distribution
company, such as DNA.
Full-line distributors help music and video suppliers reach the full retail
spectrum without assuming the burden of entering into supplier relationships
with thousands of retailers. This retail network is diverse and evolving and
includes:
- sole proprietor music and video specialty stores
- national and regional specialty chains
- diversified consumer electronic, home entertainment, drug, grocery and toy
stores
- mass merchandisers
- on-line retailers offering music and video over the Internet
Full-line distributors actively market product to these retailers and assume a
substantial portion of the order processing, credit management, collections and
returns processing logistics that would otherwise be the responsibility of the
suppliers.
Most independent retailers rely on full-line distributors to supply the majority
of their product. Many large chains and some of the largest independent
retailers buy most of their higher volume products directly from the major
labels and major studios, collectively referred to as the majors, and the larger
independent labels and studios. They rely on full-line distributors for the
balance of their inventory. By outsourcing a portion of its distribution
function to a full-line distributor, a retailer can reduce its investment in
inventory, facilities and personnel while
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increasing sales with reliable, just-in-time delivery. We believe that a
full-line distributor that can make prompt deliveries of slower moving, but
often higher margin, skus is particularly valuable to retailers. The
sophisticated full-line distributor can also provide value-added services that
reduce costs and increase efficiency for retailers such as stickering, sorting,
box coding and providing current industry information and product data.
On-line retailers are currently the fastest growing retail channel. Following
the growth in sales of music over the Internet, many companies have started
selling videos over the Internet. Many of the largest music and video Internet
retailers have outsourced their customer fulfillment processes rather than
commit the capital and managerial resources required to develop this capability
internally. Internet retailers also generally have relied on accurate and
reliable data from third parties to build their product information and ordering
systems. We believe that a full-line distributor with deep catalog, strong
systems, value-added fulfillment services and data integrity is well positioned
to serve such retailers and participate in the growth of on-line music and video
retailing.
The current music and video retail industries are very competitive. Many
retailers are demanding a higher level of service from full-line distributors,
including extensive deep catalog (in stock), faster delivery standards and more
extensive value-added marketing services. We believe that these demands will
become more stringent and the number of items retailers will expect full-line
distributors to stock will continue to grow. These increased demands make it
ever more difficult for smaller competitors or new entrants in the full-line
distribution business to compete effectively. There has been substantial
consolidation among full-line distributors over the last decade.
STRATEGY
Our goal is to serve our customers and suppliers more effectively than our
competition by offering superior sales and marketing, catalog depth,
reliability, data, systems and service. Our strategy includes the following key
elements:
EXPAND LEADERSHIP IN SERVING NEW MEDIA MARKETS
We believe our past investment in our systems, data and facilities, as well as
the years we have spent developing and refining them, provide us a substantial
competitive advantage in serving Internet retailers. We intend to continually
improve our service to this market. We have employed a scaleable technology that
positions us for growth in the Internet retail market. We plan to add additional
data products, system enhancements, value-added services and increased product
selection to become an even more valuable partner to the on-line music and video
retailer.
STRENGTHEN PROFITABILITY
We intend to leverage our substantial investment in systems and facilities to
improve profitability. We plan to pursue further growth in all lines of our
business, through internal growth and acquisitions, to achieve greater scale
economies over our fixed cost base. We also expect to increase the efficiency of
our video distribution operations by continuing to integrate these operations
into the systems, technology and programs developed for music distribution.
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STRENGTHEN PARTNERSHIPS WITH SUPPLIERS AND CUSTOMERS
We intend to enhance our traditional distribution capabilities by offering a
broader range of cost reducing inventory management alternatives to our
customers and to improve the effectiveness of our marketing programs. We work
closely with our suppliers and customers to make the distribution channel more
effective. Further, we intend to expand our breadth of music and video skus,
providing our customers with greater selection.
BUILD INDUSTRY LEADING VIDEO DISTRIBUTION CAPABILITIES
We completed the Star acquisition to apply our expertise in music distribution
to video and to capitalize on the expected growth of video demand driven by the
Internet, sell-through and the introduction of DVD. We intend to apply our
advanced distribution systems and facilities to provide value-added services and
deep catalog to video customers to differentiate ourselves in the market and
increase sales and market share. Additionally, we intend to exploit cross-
selling opportunities of music and video to all segments of our business.
CONTINUE TO INCREASE MARKET SHARE
We intend to continue to grow market share, both through deeper penetration of
existing customers and markets and entering new markets. We will seek to
displace purchases that retailers currently make directly from the majors by
offering innovative programs that enable retailers to benefit from our deep
catalog, rapid product delivery and value-added services. We have completed
seven acquisitions since June 1996 and will continue to seek out attractive
acquisition candidates to build market share. We also will continue to take the
initiative in placing product with retailers that have not previously offered
music and video and that are offering music and video through new retailing
formats.
FULL-LINE DISTRIBUTION
We are the largest full-line music distributor, one of the two largest
sell-through video and DVD distributors and one of the nine largest video rental
distributors in terms of net sales in the United States. In fiscal 1998, we
distributed music and videos to more than 6,500 retailers operating over 36,000
traditional storefronts. Working with Valley, a retailer can increase sales by
improving in-stock position while reducing inventory, warehousing and other
costs. Suppliers benefit from Valley's ability to distribute their products
through the full variety of retail channels. Our competitive advantages among
full-line distributors include:
- advanced systems, databases, and processing technology
- deep catalog, operating efficiencies, geographical coverage, and economies
of scale
- reliability, knowledgable sales staff and service
We believe these capabilities have positioned us to capture additional market
share among full-line distributors in existing and emerging retail channels.
OPERATIONS AND TECHNOLOGY
By combining state-of-the-art information systems and customized distribution
center automation equipment, we believe we have developed the most efficient and
advanced distribution capabilities in the full-line music and video distribution
industry. These capabilities enable us to:
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- maintain a highly reliable inventory management system
- optimize product purchasing decisions
- minimize variable order processing costs
- increase accuracy and speed of order fulfillment
- provide other value-added services to both suppliers and retailers
Valley has designed its systems to be scaleable and has developed software that
can handle multiple warehouses and multiple sorters.
We have devoted substantial resources over the past four years to the
development, customization and integration of our advanced information and data
systems. Additionally, we employ approximately 130 people dedicated to
maintaining and further developing our systems, data and technology. Our fully
integrated operations system at our California and Kentucky distribution centers
provide us with the capacity to manage an inventory of more than 250,000 skus.
Our inventory system electronically accounts for, manages and maximizes
warehouse placement of more than 8.2 million units of inventory in its
California distribution center and 10.9 million units in the LDC. The accuracy
of the system enables us to rely upon it in place of a wall-to-wall physical
inventory count. To maximize distribution center space utilization, incoming
products are scanned and located "randomly" within the center utilizing "best
fit" logic that considers over 350,000 distinct potential locations in a single
distribution center. This logic considers, among other things, the size of the
incoming product and shipment as well as available locations within the center.
Using inventory information derived from our systems, we utilize customized
inventory replenishment software and purchasing systems to adjust our inventory
levels quickly and strategically in response to changes in demand. Our
integrated systems evaluate daily inventory levels on each sku and make
recommendations regarding the optimal order replenishment based on several
factors, including historical seasonal demand, supplier discounts, payment
terms, return dates, supplier characteristics, carrying costs and warehouse
processing costs. Employing the extensive industry knowledge of our product
managers, we manually order new releases and adjust the purchasing system's
recommendations to accommodate volatile-demand skus. Since the implementation of
our integrated purchasing systems, we have expanded the number of skus offered
by 122% while simultaneously optimizing use of the wide variety of discounts,
payment terms and other credits and promotions made available by our suppliers.
We have installed high capacity automated sorting equipment and order processing
systems in our California and Kentucky distribution centers that reduce labor
costs and freight upgrade expenses, increase peak capacity and accuracy and
enable us to provide certain automated value-added services that some of our
competitors may not be able to provide. For example, retailers can receive
shelf-ready product directly at their stores with advance shipping notification
of the contents of each box, custom stickers and genre labeling. Customer orders
are picked in batches of up to 100 or more, one batch representing one trip
through the
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distribution center. These batches are then placed in an advanced sorting
device, which uses high speed laser scanners to separate, sticker and stack
individual store orders at speeds of up to 10,000 units per hour. In the more
than two years since the implementation of our automated systems, we have
simultaneously:
- reduced operations labor as a percentage of net sales
- more than doubled the volume of orders filled on a daily basis
- developed a comprehensive database to manage our expanding inventory
breadth
- decreased reported order fulfillment error rate
Our information systems are an integral part of our operations. We are
constantly upgrading these systems and developing new applications. Our primary
information system is currently utilized for our audio and video operations in
our Woodland and Louisville distribution centers and certain of our smaller
facilities. We use an ancillary information system for our video facilities in
Massachusetts, New Jersey and Pennsylvania. In stages over the next two years,
we intend to integrate this ancillary information system into our primary
information system. In addition, we use a separate information system for our
vendor managed inventory operations. During 1999, we intend to license software
to replace our current vendor managed inventory system. We cannot be certain
that the integration or replacement of these systems will be completed as
scheduled or without unanticipated costs or operational difficulties.
DEEP CATALOG
We believe we differentiate ourselves with both retailers and suppliers by
stocking one of the deepest catalogs of music and video skus of any full-line
distributor. As of March 31, 1997, we had an inventory of 205,100 music skus.
Currently, our inventory has grown to more than 250,000 skus, 45,600 of which
are video skus. By managing deep catalog for many retailers, we believe we can
optimize the tradeoff between availability and inventory levels.
We believe marketing and stocking lower volume skus is a key competitive
advantage in developing and maintaining relationships with retailers and
suppliers. By providing customers an aggregated database describing all of our
products, we link suppliers and customers to the thousands of deep catalog skus.
Retailers are operating in an intensely competitive environment where their
margin on hit titles is constantly under pressure from competitors. On the other
hand, the margins attainable on lower volume, deep catalog skus, such as older
or less popular titles, are generally higher than the hits. Retailers who do not
have access to these skus miss out on the opportunity for higher margin sales.
Once a retailer has retained Valley as its supplier for lower volume skus, it is
often convenient for that retailer to satisfy other product needs through Valley
as well.
PROPRIETARY DATA
Besides serving as the foundation of our traditional distribution operations,
our systems also accurately capture, compile and update product data as
inventory moves in and out of our fulfillment centers. We utilize this data
collection capability to develop a proprietary database, which we license to
customers for a fee or as part of a package of services. The data is used by
SoundScan, Inc., a leading provider of music and video information, as a
backbone for its own systems. It contains over 30 distinct fields of information
(e.g., genre, title, suggested
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retail price, catalog code numbers, first sales date, vendor return dates and
parental advisory information), which can be sorted and analyzed by retailers to
help them better manage their purchasing and inventory requirements and service
their customers. Using SoundSearch, our electronic catalog system, a retailer
can access our data from a Windows-based platform and generate electronic data
interchange orders without an internal point-of-sale system. As of December 26,
1998, we were licensing our database to over 450 retailers, including most of
our New Media customers.
For most music retailers, the task of accurately compiling and updating data
regarding the broad range of music products they offer is prohibitively
time-consuming and expensive. On the other hand, pure data providers, which do
not handle physical music and video inventory daily, face inherent disadvantages
compared to full-line distributors in providing immediate and accurate data
reflecting changes in prices, suppliers, catalog numbers, UPC codes, deletion
information and other fields. Because we already compile and update this data
for our full-line distribution business, we maintain data accross a wider sku
count than retailers or pure data companies.
NEW MEDIA
Over the past four years, the New Media Group has been our fastest growing
business. Net sales grew from approximately $1.6 million in fiscal 1995 to $30.3
million in fiscal 1998. Sales in the quarter ended December 1998 were $61.9
million, which represents a 559% increase compared to the same quarter in 1997.
Our New Media Group provides product and data to the fastest growing segment of
the music retail industry, Internet retailers. We fulfill customer orders for
many of its Internet retailers by shipping product directly to the individual
customer. These retailers have effectively outsourced their inventory
procurement and management functions and stock little or no product on their
own. Other customers, including Amazon.com, fulfill their own orders, and we
provide product to their internal distribution centers on a just-in-time basis.
Our New Media Group currently has more than 100 customers, including specialty
Internet retailers, such as Amazon.com, CDnow, N2K and DVD Express, record clubs
and traditional retailers adding on-line capabilities.
The infrastructure, market channels and supplier relationships developed through
our core full-line distribution business are the foundation of our New Media
Group. See "Business - Full-Line Distribution." We believe our "First to Market"
position and strategic emphasis on data, catalog depth and systems enhancements
have enabled us to maintain our leadership position.
COMMITMENT TO DEEP CATALOG
Our deep catalog commitment enables Internet retailers to offer their customers
fast, reliable access to an extensive selection of product, without having to
take possession of the inventory. Furthermore, industry sources have observed
that Internet retail customers buy a higher proportion of deep catalog product
relative to hit titles than do shoppers at traditional storefronts. Our Internet
retailers rely on our extensive inventory of product offerings to supply the
breadth of product selection that Internet shoppers demand.
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SUPERIOR PRODUCT DATA
Most Internet retailers served by the New Media Group rely on our proprietary
product database to support their product information systems as well as the
ordering systems used by their customers. We believe our database is a key
building block for Internet retailers' websites because it would be
prohibitively expensive for most such retailers to build such a database
independently. To supplement this database, and for the greater convenience of
retailers and their customers, we recently have introduced two additional data
products:
- audioTRAX, which provides track-by-track information for music skus
- "stock-on-hand file," which provides current product-availability data for
music skus
We intend to continue adding additional data products and enhancements to
strengthen our role as an essential partner of Internet retailers, including
detailed customer oriented information on all DVD products.
ADVANCED SYSTEMS AND PROCESSING CAPABILITIES
Many Internet retailers require that their fulfillment partner fill a very large
number of small orders quickly and accurately and ship them in the name of such
retailers at the lowest cost possible. We developed our New Media Group's
fulfillment capabilities over a four-year period and incorporated the advanced
systems and equipment we had developed to support our full-line distribution
business. Furthermore, our New Media Group's systems are scaleable, allowing us
to support significant volume growth with low incremental costs.
COMPLETE PACKAGE OF SERVICES
Our New Media Group can provide Internet retailers with tailored services that
best meet their particular needs. Such services include:
- the provision of product data and order fulfillment
- marketing partnerships
- complete turn-key packages, encompassing product data, credit card
processing, custom labeling and packaging, order fulfillment and returns
management
- monitoring and updating order status several times a day
INDEPENDENT DISTRIBUTION
Our Independent Distribution Group consists of DNA, an independent music
distribution company, and Valley Entertainment, a label. Each business was built
to leverage our systems and markets. See "Business - Sales and Marketing."
DNA represents approximately 150 independent suppliers and their labels in the
United States. DNA assumes marketing responsibilities for these labels and
allows them to focus on their creative operations. DNA represents several Grammy
winning artists and has marketed and distributed many platinum titles.
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In seeking marketing services, independent labels may work with distribution
companies owned by major labels. However, many independent labels select
independent distributors instead of a distribution company owned by a major
label because:
- the label is too small to work with the major labels
- the label's product mix does not match the major labels' emphasis on
higher volume and lower overall sku count
- several larger independent labels seek to maintain greater control over
their distribution than the major labels allow
- labels are concerned that the major labels will not provide adequate
priority to their titles, which may sell in lower volume than the major
labels' proprietary hit titles
DNA serves the special needs of each client label and assists it in maximizing
its market penetration. In promoting a label's products among retailers and
full-line distributors, DNA utilizes its broad understanding of industry
activities and its intimate knowledge of the music wholesale and retail
marketplaces, developed through close relationships with product managers,
operational management and marketing coordinators of many music retailers. In
addition, DNA coordinates its sales and marketing efforts with retailers through
promotion and publicity of the labels themselves.
We believe DNA's affiliation with our full-line music distribution business
provides strategic advantages for DNA and its customers. DNA can capitalize on
our extensive network of contacts with music retailers throughout the country,
especially the independent retailers which are likely to be more receptive to
independent label product than the large chains. DNA also benefits from our
expansive knowledge of the music business, which can be important in designing a
label's marketing program. Finally, our substantial existing infrastructure
affords DNA a level of operational and processing efficiency that would be very
difficult for any independent distribution company not affiliated with a
full-line distributor to create on its own.
DNA complements our core full-line distribution business in a number of ways:
- DNA sales increase the volume that passes through Valley's facilities
- cross-selling DNA and full-line distribution products to their respective
retail customers enables us to capture both the independent distribution
and wholesale margins on a single sale
- by seeking out and promoting new and emerging labels, we are better able
to understand the trends in the emerging music industry and adjust our
full-line distribution business accordingly
Valley Entertainment is a two year old label developed to leverage our markets
and capabilities and bring new product to market effectively. Valley
Entertainment focuses on licensing and marketing existing product not currently
available in the United States. It typically offers relatively modest advances
with a greater revenue sharing than many labels.
We are evaluating the possible sale of a controlling interest in, or all of, the
Valley Entertainment business to Barnet J. Cohen, the Chairman of our board. Mr.
Cohen is the
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president of Valley Entertainment, which had net revenues in the nine months
ended December 26, 1998 of $1.1 million and resulted in a small net loss. Any
such sale would not proceed without the approval of the disinterested members of
the board, on terms that the board determines to be no less favorable to Valley
than could be obtained from independent third parties.
SALES AND MARKETING
A key element of our marketing strategy is the development and maintenance of
customer relationships with music and video retailers. This strategy is
implemented by a sales and marketing staff consisting of approximately 330
people. We organize our sales efforts around targeted customer groups.
Generally, sales to independently owned stores and small chains are serviced by
designated commission sales representatives. Smaller independent accounts are
serviced by a team of music and video specialists. We have established account
management teams to work with the large retail chains, which we refer to as
national accounts. New Media Group sales are also conducted through account
management teams equipped to meet the special needs of on-line retailers. Our
senior management also participates actively in sales and marketing activities.
Our marketing strategy employs the following customized programs and services to
further strengthen the partnerships we have developed with our customers and
suppliers:
- customized marketing initiatives
- new market development
- advanced vendor managed inventory services
MARKETING INITIATIVES
We employ a number of marketing initiatives to build demand for music and video,
both among retailers and end consumers. These initiatives are generally funded
by our suppliers to promote their products among retailers and consumers.
Marketing initiatives to the music and video retail community include the
following:
- financial incentives, such as product discounts and advertising support
- in-house publications and web page, containing information that helps
retailers stay abreast of current industry developments
- Schwann publications, which are the oldest and among the most popular
classical music reference guides in the United States
Additionally, we have designed marketing programs to increase demand for the
products of Valley's suppliers and customers. These include:
- co-op advertising support from suppliers for print and electronic media
advertisements
- listening stations that we place in certain stores, which allow consumers
to select and listen to songs from featured artists
- point of purchase displays
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- video promotions containing short descriptions and footage of selected
current and upcoming video releases, which retailers can play in monitors
throughout their stores.
NEW MARKET DEVELOPMENT
Our special markets group develops new markets and channels for its music and
video product. Special markets include non-music and video specialty retail
stores, libraries, insurance replacement, and public television and radio
stations.
ADVANCED VENDOR MANAGED INVENTORY SERVICES
We operate an advanced vendor managed inventory or "racking" service for video
retailers that wish to outsource a substantial portion of the inventory
management responsibility for their video products. Racking is typically
provided to mass merchandise, drug, toy, grocery or other stores not solely
dedicated to video. It involves managing the selection and manually stocking the
inventory in the retailer's dedicated video space. Racking requires
technological sophistication to select optimal product titles and quantities for
each storefront and generally entails the management of a substantially lower
sku count than is required of a full-line distributor. We are significantly
enhancing our vendor managed inventory capabilities and intend to complete the
upgrade by the end of 1999.
CUSTOMERS
Given the diversity in the size and operating philosophies of our customers, we
provide full-line distribution and New Media services under a range of programs
designed to best meet each customer's needs. We describe below our principal
dealings with our full-line distribution and New Media customers.
INDEPENDENT MUSIC RETAILERS
Independent music retailers typically do not have sufficient volume to deal
directly with the labels and studios, and therefore are supplied by a small
number of full-line distributors. For these customers, we are usually the
primary or secondary supply source for most or all of their inventory needs.
NATIONAL MUSIC RETAILERS
We have developed different programs to capture the opportunities that are
available to provide product to national music retail customers. Through our
catalog program, these larger retailers rely on us to provide a range of
product, from virtually all of their music selections to certain designated
categories of product. They use our special order program to fill customer
orders quickly for products that the retailer has elected not to stock. Using
our emergency fill program, the retailer can obtain product on a fast turnaround
basis. Through our just-in-time replacement program, retailers can outsource
some or all of their distribution needs.
SELL-THROUGH VIDEO ACCOUNTS
Our national video chain customers primarily use us to fill their needs for
sell-through video. Some of these stores buy product from us that is produced by
studios with which the stores have not established a supplier relationship.
Others may only carry video on a special promotional basis, such as during
holiday periods or to feature a selected hit, and rely on us to supply these
promotions. Other customers use our racking services, where we select product
mix and provide inventory management and in-store servicing.
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VIDEO RENTAL RETAILERS
We also sell video to independent video rental stores as well as chains. For the
independent video stores, we typically serve as the primary supplier. For the
video rental chains we typically serve as a secondary provider.
INTERNET RETAILERS
We provide Internet retailers with tailored packages of services from which they
can select to meet their individual needs. These services range from the
provision of product data and order fulfillment to complete turn-key packages.
Set forth below are our largest full-line distribution and New Media customers
for the first nine months of fiscal 1999.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
NATIONAL MUSIC, VIDEO, AND OTHER INDEPENDENT MUSIC AND VIDEO
SPECIALTY CHAINS SPECIALTY STORES
- -------------------------------- --------------------------------
<S> <C>
Best Buy Co., Inc. Amoeba
Camelot Blowout Entertainment
Hastings Easy Video
Wherehouse Entertainment, Inc. Fry's Electronics
The Wiz Joseph Beth Booksellers
<CAPTION>
- ------------------------------------------------------------------
DRUG, GROCERY AND TOY STORES DEPARTMENT STORES/MASS MERCHANTS
- -------------------------------- --------------------------------
<S> <C>
CVS/Revco BJ's Wholesale Club, Inc.
Pathmark Bradlees
RiteAid Kohl's
Shoprite Noodle Kidoodle
Toys R Us Sears
<CAPTION>
- ------------------------------------------------------------------
ON-LINE MUSIC RETAILERS ON-LINE VIDEO RETAILERS
- -------------------------------- --------------------------------
<S> <C>
Amazon.com Amazon.com
Best Buy Co., Inc. Digital Courier Technology, Inc.
CDnow DVD Express
CD World NetFlix
N2K Reel.com
</TABLE>
We believe customer service is an important factor in maintaining and expanding
our customer base. We have developed a sophisticated customer service department
with an experienced staff of approximately 20 customer service and support
professionals, and offer our customers toll-free telephone and facsimile
numbers. We have automated certain of the tools used by our customer service and
support team members. We intend to actively pursue enhancements and further
automate our customer service and support operations.
As is typical of the music and video businesses, we generally do not have long
term purchase and sale contracts with most of our full-line distribution
customers. We generally deal with these customers on a purchase order basis. We
permit our customers to return music and video product subject to certain time
limitations that vary based on a number of factors, including the product, price
and quantity ordered.
In October 1998, under a contract that expires in June 1999, we began providing
a significant distribution function for the Blockbuster Music stores purchased
by Wherehouse. Wherehouse
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was our largest customer for the nine months ended December 26, 1998. After June
1999, we anticipate that sales to Wherehouse will decline as it handles more of
its distribution functions internally. The completion of the publicly announced
merger of two of our largest New Media customers, CDnow and N2K, would make the
combined company our largest New Media customer for the first nine months of
fiscal 1999.
Our New Media Group has fulfillment agreements with most of its customers. These
agreements generally have terms of two or more years and contain provisions
regarding the level of exclusivity of the retailer's relationship with us and
other negotiated terms. The agreements generally do not contain minimum volume
requirements or other terms establishing required purchase and sale quantities.
DNA's fulfillment agreements with its customers specify such matters as the
term, DNA's level of exclusivity in distributing the product and inventory
ownership and management. These contracts generally do not specify any
particular volume of skus that will be purchased or sold.
SUPPLIERS
We purchase music and video product from each of the majors and from the leading
independent studios and labels. We believe we have good relationships with each
of the majors as well as with the leading independents. We have been recognized
as best in our class by NARM, which is comprised of the major labels,
independent distribution companies and retailers, for each of the past five
years. DNA was recognized as best in its class by NARM in 1997.
We enable independent labels to reach the independent retailers that are most
likely to promote their new talent and provide vital information to such
retailers regarding emerging artists. New artists are critical to the music
industry and independent music stores are more receptive than the chains to
promoting emerging artists, especially local or niche talent. Labels may also
hire us to manage targeted marketing efforts to break a new release. The major
labels generally have limited contact with the smaller independent stores most
likely to support emerging musicians.
The majors offer various financial incentives to distributors and retailers that
purchase their product, including timely payment discounts and advertising
revenues and allowances. In addition, extended payment terms, discounts and
volume rebates are sometimes available under seasonal and promotional plans.
Payment terms vary considerably among the independent labels and independent
studios. We are often able to negotiate favorable pricing, advertising and
discount programs with these suppliers. Consistent with other music and video
distributors, we do not have any long term contracts with suppliers. We purchase
our inventory from our suppliers through purchase orders. However, DNA maintains
contracts with most of its suppliers. DNA supplier contracts typically range in
length from one to three years, with varied payment terms.
In the past two years, studios and full-line distributors have initiated
programs to increase the quantity of copies of popular video titles stocked by
retailers. These programs include providing retailers the opportunity to avoid
purchasing product by sharing their rental revenue
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with the studio or full-line distributor. We believe that these programs have
accelerated a shift of the market share away from independent video rental
stores and small chains in favor of the larger chains.
Since full-line distributors generally play a larger role with independent
retailers than 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. For the time being, we have not
seen adequate demand from independent retailers to justify the expense. In doing
so, we risk losing market share to those distributors who adopt revenue sharing.
COMPETITION
FULL-LINE DISTRIBUTION
The full-line distribution of music and video is an intensely competitive
business. We face competition from national, regional and local full-line
distributors, vendor managed inventory firms, and from the majors and
independent distribution companies.
We believe the primary competitive factors in the full-line distribution of
music are:
- inventory breadth (actively stocked)
- fulfillment rate (the percentage of a customer's order that is filled on a
current basis)
- reliability
- accuracy, completeness and depth of data
- price
- delivery time
- information systems and electronic data interchange capabilities
- customer service
- vendor managed inventory capabilities
- advertising support
- financial strength
These factors are also the primary competitive factors in video, but because
video is more "hit" driven than music, with fewer skus and less demand for deep
catalog product, price is a relatively more important competitive factor.
The majors and the independent distribution companies sell substantial amounts
of their products directly to retailers and to date appear not to have focused,
to the same extent we have, on fulfilling the needs of smaller independent
stores or providing value-added services.
Several of our retail chain customers have chosen, from time to time, to buy a
substantial volume of product they had been purchasing through us directly from
the majors or the independent distribution companies. To the extent our
customers increase their direct purchasing from the majors or the independent
distribution companies, our business, financial condition and results of
operations could be adversely affected.
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Our largest direct competitor in full-line music distribution, Alliance, filed
for Chapter 11 bankruptcy protection in July 1997 and emerged from bankruptcy in
August 1998. In addition to Alliance, we face competition from dozens of other
full-line distributors. Some of these competitors generally sell to retailers
nationwide and others are particularly active in their respective geographic
regions or in certain niche areas. We believe our fiscal 1998 net sales of music
to our full-line distribution customers were greater than those of any of our
full-line distribution competitors. We believe we compete favorably with respect
to each of the leading competitive factors in music distribution relative to
other full-line distributors.
In our full-line video distribution business, we compete with eight companies of
greater or comparable size, the largest of which is Ingram Entertainment, Inc.
which has significantly greater sales than us. We believe we are one of the two
largest suppliers to retailers of video priced for sell-through.
In music and video full-line distribution, we also compete with two national
vendor managed inventory firms, Anderson Merchandising and Handleman Company, as
well as several smaller regional firms. Vendor managed inventory firms provide
their customers with inventory selection services for a limited selection of
high-volume product, management services and in-store servicing in addition to
order fulfillment. Such services involve more direct physical services for the
retailer, are more labor intensive than wholesale distribution, and generally
involve higher margins.
Record clubs also act as retailers for many labels. Record clubs license
selected titles directly from the major labels and independent labels and sell
them by mail order directly to consumers.
The delivery of music and video is subject to changes in market conditions and
to technological changes that can affect competitive conditions and give rise to
new forms of competition. Our business, financial condition and results of
operations could be adversely affected if such changes decrease suppliers' or
retailers' reliance on full-line distributors.
NEW MEDIA
The New Media Group competes to provide product and fulfillment services with
several other full-line distributors. A number of companies provide data to
Internet retailers. In direct-to-consumer fulfillment, the principle competitive
factors are similar to those for full-line distribution, although the ability to
provide accurate and complete product data, deep catalog and highly efficient
processing is of even greater importance.
INDEPENDENT DISTRIBUTION
There are a number of independent music distribution companies, certain of which
may conduct larger distribution operations than DNA. Several of the major labels
operate their own independent distribution arms which also compete with DNA. DNA
also faces competition from a number of smaller and niche independent
distribution companies. As a label or artist
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gains in popularity, DNA may face new competition from the major labels to
retain distribution rights for that label or artist. The principal competitive
factors in independent music distribution are:
- effectiveness in marketing and selling independent label product
- efficiency in managing distribution logistics
- price
- size and experience of sales staff
- financial strength
- industry relations and knowledge
- number and prestige of labels represented
FACILITIES
We lease all of the sites, including the buildings and improvements, where our
offices and distribution centers are located. Our business is operated
principally out of our executive offices and California distribution center,
both located in Woodland, California and the LDC, located in Louisville,
Kentucky. A portion of the approximately 281,440 square foot leased facilities
in Woodland expires in 2000 and the remaining portion of the Woodland facilities
lease expire in 2003. The LDC building consists of approximately 330,000 square
feet. Our lease on the LDC expires in 2008. We also maintain smaller sales or
distribution offices in Connecticut, Massachusetts, New Jersey, New Mexico, New
York and Pennsylvania.
EMPLOYEES
As of January 30, 1999, we had 1,503 employees, none of whom was represented by
an employee union. In addition, we regularly utilize the services of a number of
temporary and contract personnel. We believes that our relations with our
employees are good.
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MANAGEMENT
The following table sets forth certain information with respect to the directors
and executive officers of Valley as of January 30, 1999.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
NAME AGE POSITION AND OFFICE
<S> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------
Barnet J. Cohen (2)............................... 52 Chairman of the Board
Robert R. Cain (1)................................ 45 President, Chief Executive Officer and Director
Kenneth Alterwitz................................. 47 Senior Vice President, Sales and Marketing
J. Randolph Cerf.................................. 45 Senior Vice President, Chief Financial Officer and
Secretary
Melanie Cullen.................................... 47 Senior Vice President, Information Services
Paige S. Dickow................................... 38 Senior Vice President, Human Resources
John Kordic....................................... 39 Senior Vice President, Operations
Ronald A. Phillips................................ 40 Senior Vice President, Purchasing
Lawrence Archibald (2)............................ 53 Director
Christopher Mottern (1)(2)........................ 55 Director
Wendy Paskin-Jordan............................... 42 Director
James Sha (1)..................................... 48 Director
</TABLE>
- ---------------------
(1) Member of the audit committee
(2) Member of the compensation committee
BARNET J. COHEN is the founder of Valley and has been Chairman of the board from
its formation. He served as Chief Executive Officer from March 1979 until
December 1997. Mr. Cohen is a member of the compensation committee. Prior to
founding Valley, he owned and operated retail record stores. Mr. Cohen is
Past-Chairman of the Board of Directors of NARM. He is a graduate of Antioch
College and received an Executive M.B.A. from Harvard Business School.
ROBERT R. CAIN has served as Valley's President since January 1993, as its Chief
Executive Officer since December 1997 and as a member of the board of directors
since February 1995. He is also a member of the audit committee. Mr. Cain has
been employed by Valley since November 1991. He is a graduate of Oregon State
University with a B.S. in Food Science, and received an M.B.A. from the
University of California, Berkeley.
KENNETH ALTERWITZ has served as Valley's Senior Vice President, Sales and
Marketing since March 1998 and served as Vice President, Sales and Marketing
from January 1995 to March 1998. Prior to joining Valley, Mr. Alterwitz served
as Senior Vice President of Sales for Alliance Entertainment from November 1993
to August 1994. Mr. Alterwitz is a graduate of the New York Institute of
Technology with a B.A. in Communication Arts.
J. RANDOLPH CERF has served as Valley's Senior Vice President, Chief Financial
Officer and Secretary since March 1998 and served as Vice President and Chief
Financial Officer from October 1994 to March 1998. Prior to joining Valley, Mr.
Cerf was President of JRC Consulting, a financial and management consulting
firm, from July 1991 to October 1994. Mr. Cerf is a graduate of the University
of Colorado with a B.A. in Economics, Computer Science and Political Science,
and received an M.B.A. from Stanford University.
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MELANIE CULLEN has served as Valley's Senior Vice President, Information
Services since March 1998 and served as Vice President, Information Systems from
February 1995 to March 1998. Ms. Cullen has been employed by Valley since August
1993. Ms. Cullen is a graduate of California State University, Hayward with a
B.S. in Business Administration, and received an M.B.A. from Stanford
University.
PAIGE S. DICKOW has served as Valley's Senior Vice President, Human Resources
since March 1998 and served as Vice President, Human Resources, from February
1997 to March 1998. Prior to joining Valley, Ms. Dickow served as a consultant
with Hewitt Associates from August 1994 to February 1997, and with KPMG Peat
Marwick from February 1986 to July 1994. Ms. Dickow is a graduate of the
University of Georgia with a B.B.A. in Accounting.
JOHN KORDIC has served as Valley's Senior Vice President, Operations since March
1998 and served as Vice President, Operations from February 1995 to March 1998.
Mr. Kordic has been employed by Valley since November 1994. Prior to joining
Valley, Mr. Kordic served as Director of Distribution for Imaginarium, a San
Francisco-based distributor of creative toys, from November 1991 to November
1994. Mr. Kordic is a graduate of the University of California, Berkeley, with a
B.S. in Resource Economics.
RONALD A. PHILLIPS has served as Valley's Senior Vice President, Purchasing
since March 1998 and served as Vice President, Purchasing from February 1995 to
March 1998. Mr. Phillips has been employed by Valley since February 1993.
LAWRENCE ARCHIBALD is a member of the board of directors and chairman of the
compensation committee. He has been a member of the board since March 1997. Mr.
Archibald owned and operated Stereophile, Inc., which published a variety of
music reference magazines, from March 1982 to June 1998, when Stereophile sold
substantially all of its assets. Mr. Archibald is a graduate of Harvard College.
CHRISTOPHER MOTTERN is a member of the board of directors, chairman of the audit
committee and a member of the compensation committee. He has been a member of
the board since March 1997. Mr. Mottern has served as the President and Chief
Executive Officer of Peet's Coffee and Tea, Inc. since May 1997. Mr. Mottern
served as President of Heublein Wines from July 1992 to September 1996. Mr.
Mottern is a graduate of the University of Connecticut with a B.A. in Business
Administration.
WENDY PASKIN-JORDAN has been a member of the board since December 1998. Ms.
Paskin-Jordan has served as Principal of Paskin & Kahr Capital Management, an
investment management firm, since August 1998, and as Principal of Jordan &
Torres LLC, a consulting firm, since August 1998. From January 1995 to July 1998
she served as a Managing Director and Partner for Montgomery Asset Management,
and from September 1986 to December 1994 she served as National Sales Manager
and Vice President for Wells Fargo Bank. Ms. Paskin-Jordan holds an A.B. from
Stanford University, a J.D. from the Boalt Hall School of Law and an M.B.A. from
the Wharton School of the University of Pennsylvania.
JAMES SHA is a member of the board of directors and a member of the audit
committee. He has been a member of the Board since June 1998. Mr. Sha has
served as a general partner of
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Apogee Venture Group, LLC, an investment and management consulting firm, since
October 1998. He served as Senior Vice President of Commerce Applications for
Netscape Communications Corporation from August 1998 to October 1998, and as
Vice President, Unix Division, for Oracle Corporation from June 1990 to August
1998. Mr. Sha is a director of Abovenet Communications Inc. He holds an M.S.E.E.
from the University of California, Berkeley, an M.B.A. from Santa Clara
University, and a B.S.E.E. from Taiwan University.
COMMITTEES OF THE BOARD OF DIRECTORS
Valley's board of directors currently has two committees, the audit committee
and the compensation committee. The audit committee recommends the firm to be
appointed as independent accountants to audit Valley's financial statements,
discusses the scope and results of the audit with the independent accountants,
reviews Valley's interim and year-end operating results with management and the
independent accountants, considers the adequacy of the internal accounting
controls and audit procedures of Valley and reviews the non-audit services to be
performed by the independent accountants. The members of the audit committee are
Messrs. Mottern, Cain and Sha. Mr. Mottern is the chairman of the audit
committee. The compensation committee reviews and recommends the compensation
arrangements for management of Valley and administers Valley's stock option
plans. The members of the compensation committee are Messrs. Archibald, Cohen
and Mottern. Mr. Archibald is the chairman of the compensation committee.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee was formed in December 1998. Two of the committee
members, Mr. Archibald, who is the chairman of the committee, and Mr. Mottern,
are not and have never been officers or employees of Valley. Mr. Cohen, who is
the third member of the committee, has been Chairman of Valley since its
formation and served as Valley's Chief Executive Officer from March 1979 until
December 1997. Prior to the formation of the compensation committee, all
decisions regarding executive compensation, salaries and incentive compensation
for employees and consultants of Valley were made solely by the board of
directors.
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<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth information as to compensation paid or accrued by
Valley for fiscal 1998 to its Chief Executive Officer and each of its four other
most highly compensated executive officers (the "Named Executive Officers"). Mr.
Cain succeeded Mr. Cohen as Chief Executive Officer in December 1997.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
-----------------------------------------------------
ANNUAL COMPENSATION
-------------------- ALL OTHER COMPENSATION ($)
SALARY -------------------------------
NAME AND PRINCIPAL POSITION ($) BONUS ($) 401K ESOP OTHER
- -------------------------------------------------------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Barnet J. Cohen .......................................
Chairman of the Board $ 406,993 $ 166,263 $ 5,612 $ 1,600 --
Robert R. Cain ........................................
President and Chief Executive Officer 273,077 111,462 4,338 1,600 --
Kenneth Alterwitz .....................................
Senior Vice President, Sales and Marketing 192,712 62,860 4,137 1,600 $14,153(1)
J. Randolph Cerf ......................................
Senior Vice President, Chief Financial Officer and
Secretary 152,000 38,000 3,140 1,570 --
Melanie Cullen ........................................
Senior Vice President, Information Services 125,604 33,887 2,672 1,336 --
</TABLE>
- --------------------------
(1) Represents payment of sales commissions of $14,153.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information concerning the number and
value of stock options granted to each of the Named Executive Officers in fiscal
1998. Percentages of total options for individual grants are based on an
aggregate of options to purchase 368,577 shares of the common stock granted to
employees and directors of, and consultants to, Valley during fiscal 1998,
including the Named Executive Officers. The exercise price per share of each
option was equal to the fair market value of the common stock on the date of
grant as determined by the board of directors. Each such option vests with
respect to 1/48 of the shares of common stock underlying such option on the last
day of each calendar month, beginning August 1997. See "Management -
Compensation Plans."
Potential realizable value is based on the assumption that the common stock
appreciates at the annual rate shown (compounded annually) from the date of
grant until the expiration of the ten year term. These numbers are calculated
based on Securities and Exchange Commission requirements and do not reflect
Valley's estimates of future stock price growth.
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
------------------------------ ANNUAL RATES OF
NUMBER OF PERCENT OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM
OPTIONS EMPLOYEES IN PRICE EXPIRATION --------------------
NAME GRANTED FISCAL 1998 ($/SH) DATE 5% 10%
- -------------------------------------------- ----------- ----------------- ----------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Barnet J. Cohen............................. - - - - - -
Robert R. Cain.............................. - - - - - -
Kenneth Alterwitz........................... 8,040 2.2% $ 4.35 08/17/07 $ 21,995 $ 55,740
J. Randolph Cerf............................ 8,040 2.2 4.35 08/17/07 21,995 55,740
Melanie Cullen.............................. 8,040 2.2 4.35 08/17/07 21,995 55,740
</TABLE>
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<PAGE>
FISCAL YEAR-END OPTION VALUES
The following table sets forth certain information concerning the number and
value of unexercised stock options held as of March 28, 1998 by each of the
Named Executive Officers.
<TABLE>
<CAPTION>
--------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT AT
MARCH 28, 1998 MARCH 28, 1998 (1)
-------------------------- ----------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------------------------- ----------- ------------- --------- -----------
<S> <C> <C> <C> <C>
Barnet J. Cohen.............................. - - $ -- $ --
Robert R. Cain............................... 368,232 - 3,893,916 --
Kenneth Alterwitz............................ 49,075 17,921 516,467 176,220
J. Randolph Cerf............................. 77,385 17,752 817,959 174,759
Melanie Cullen............................... 60,130 6,866 633,591 59,369
</TABLE>
- ------------------------
(1) There was no public trading market for the common stock as of March 28,
1998. Accordingly, these values have been calculated based on the initial
offering price set forth on the cover page of this prospectus.
COMPENSATION PLANS
1994 STOCK OPTION PLAN
Valley's 1994 Stock Option Plan was adopted by the board of directors in
December 1994 and approved by the stockholders in February 1995. The plan
provides for the grant to employees (including officers and employee directors)
of incentive stock options within the meaning of Section 422 of the Internal
Revenue Code of 1986, as amended, and for the grant of nonstatutory stock
options to employees, directors and consultants. The plan is administered and
interpreted by the board of directors or a committee designated by the board.
The plan administrator has discretion, within the limits of the plan, to select
the optionees and to determine the number of shares to be subject to each option
and the exercise price and vesting schedule of each option.
The plan authorizes the issuance of up to 884,400 shares of common stock. As of
January 30, 1999, options to purchase 137,717 shares had been exercised pursuant
to the plan, options to purchase 724,949 shares were outstanding, and 21,734
shares remained available for future grants. The exercise price of incentive
stock options granted under the plan must be at least equal to the fair market
value per share of the common stock on the date of grant. The exercise price of
nonstatutory stock options granted under the plan must be at least 85% of the
fair market value of the common stock on the grant date. For any participant who
owns stock possessing more than 10% of the voting power of all classes of stock
of Valley, the per share exercise price of any stock option granted under the
plan must equal at least 110% of the fair market value of the common stock on
the grant date and the maximum term of the option must not exceed five years.
The term of all other options granted under the plan may not exceed ten years.
In the event of the occurrence of certain transactions deemed under the plan to
constitute a change in control of Valley, the plan provides that all options
issued under the plan that have
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not vested shall immediately become vested upon consummation of the change in
control transaction. In addition, the plan further authorizes the board to
cancel all outstanding options effective immediately prior to such transaction
and either allow all option holders an opportunity to exercise the portion of
their option that has vested prior to such transaction or make a payment to such
option holders in an amount equal to the difference between the fair-market
value of the shares of common stock underlying their options and the aggregate
exercise price of such options. Alternatively, upon a change in control, the
board may require that each outstanding option be assumed or an equivalent
option be substituted by the successor corporation or a parent or subsidiary of
the successor corporation. The plan will terminate in December 2004.
1997 STOCK OPTION PLAN
Valley's 1997 Stock Option Plan was adopted by the board of directors in June
1997 and approved by the stockholders in February 1998. The plan provides for
the grant to employees (including officers and employee directors) of incentive
stock options within the meaning of Section 422 of the Internal Revenue Code,
and for the grant of nonstatutory stock options to employees, directors,
consultants, independent contractors and advisers. The plan is administered and
interpreted by the board of directors or a committee designated by the board.
The plan administrator has discretion, within the limits of the plan, to select
the optionees and to determine the number of shares to be subject to each option
and the exercise price and vesting schedule of each option.
The plan authorizes the issuance of up to 1,206,000 shares of common stock. As
of January 30, 1999, no options had been exercised pursuant to the plan, options
to purchase 434,842 shares were outstanding, and 771,158 shares remained
available for future grants. The exercise price of incentive stock options
granted under the plan must at least be equal to the fair market value per share
of the common stock on the date of grant and the exercise price of nonstatutory
stock options granted under the plan must be greater than or equal to 85% of the
fair market value per share of the common stock on the date of the grant. With
respect to any participant who is a 10% stockholder, the per share exercise
price of any stock option granted under the plan must equal at least 110% of the
fair market value of the common stock on the grant date and the maximum term of
the option must not exceed five years. The term of all other options granted
under the plan may not exceed ten years.
In the event of the occurrence of certain transactions deemed under the plan to
constitute a change in control of Valley, the plan provides that all options
issued under the plan that have not vested shall immediately become vested upon
consummation of the change in control transaction and authorizes the board to
cancel all outstanding options effective immediately prior to such transaction
and allow all option holders an opportunity to exercise the portion of their
option that has vested prior to such transaction, or require the successor
entity to assume each outstanding option or substitute a comparable option of
such successor entity or a parent or subsidiary of the successor entity. The
plan will terminate in May 2007.
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EMPLOYEE STOCK OWNERSHIP PLAN
The ESOP was adopted effective as of November 1987 and subsequently amended in
January 1990, March 1990, January 1992, July 1994, December 1995 and February
1999. The ESOP is a combination of a stock bonus plan and a money purchase
pension plan, which together constitute an employee stock ownership plan under
section 4975(e)(7) of the Internal Revenue Code. All full-time employees who
have been employed by Valley for at least six months and have attained age 21
are eligible to participate in the ESOP.
The ESOP is administered by an administrative committee composed of individuals
appointed by the board of directors. The members of the committee are named
fiduciaries with authority to control and manage the operation and
administration of the ESOP. Shares of common stock allocated to participants'
accounts are voted in the manner directed by such participants, and the
committee directs the voting of unallocated shares and shares for which
participants do not provide voting instructions.
Each year Valley makes a fixed contribution to the ESOP in an amount equal to 1%
of the aggregate annual compensation of all ESOP participants. Valley is also
permitted to make a variable contribution to the ESOP each year in an amount
determined by the board. Valley's fixed and variable contributions may be in the
form of common stock or cash. ESOP participants are not permitted to make
contributions to the ESOP. Valley's fixed contributions to the ESOP are
allocated to the accounts of each ESOP participant in an amount equal to 1% of
the compensation of each such participant. Valley's variable contributions to
the ESOP are allocated to the accounts of each ESOP participant in proportion to
the ratio each participant's annual compensation bears to the total annual
compensation of all participants in the aggregate.
A participant's rights to his or her ESOP account become fully vested after he
or she has been employed by Valley for seven years or upon his or her death,
disability or retirement after attaining age 65. The ESOP trustees may use any
cash surplus in the ESOP to purchase additional shares of common stock or to
make other prudent investments. When an ESOP participant's employment with
Valley terminates, he or she receives a distribution from the ESOP in an amount
equal to the vested portion of his or her ESOP account. Such distributions can
be made in cash, common stock or a combination of the two, as determined by the
committee; provided, however, that any participant may demand that his or her
distribution be entirely in common stock, except to the extent such participant
has elected to "diversify" his or her ESOP account as provided in Section
401(a)(28)(B) of the Internal Revenue Code. The timing of a distribution upon a
participant's termination of employment with Valley is determined by the
committee. Valley has the right to terminate the ESOP, in whole or in part, at
any time; provided, however, that any such termination may not reduce the vested
rights of any participant.
401(k) PLAN
Valley sponsors a qualified defined contribution retirement plan that was
adopted effective as of April 1, 1995, under which eligible employees may elect
to defer their current compensation by up to certain statutorily prescribed
annual limits ($10,000 in 1998) and to contribute such amount to the 401(k)
plan. The 401(k) plan requires additional matching
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contributions by Valley on behalf of all participants of up to 2% of each such
participant's annual compensation. In fiscal 1998, Valley made matching
contributions of approximately $282,000. During the first eight months of fiscal
1999, Valley made matching contributions of $101,000 and has accrued an
additional $194,000. The 401(k) plan is intended to qualify under Section 401 of
the Internal Revenue Code, so that contributions by employees or by Valley to
the 401(k) plan, and income earned on such contributions, are not taxable to
employees until withdrawn, and so that contributions by Valley will be
deductible when made. The trustee for the 401(k) plan is Merrill Lynch Trust. At
the direction of each participant, the trustees invest the assets of the 401(k)
plan among a selection of eight designated mutual funds.
MANAGEMENT INCENTIVE PLAN
Valley has a management incentive plan for fiscal 1999. The incentive plan
provides variable cash bonuses for eligible executive and management employees
(including the Named Executive Officers). Cash bonuses will be based on a
percentage of each participant's base salary, with such percentages varying
depending on how closely Valley achieves specific financial objectives and the
employee achieves specific performance objectives. No bonuses will be paid
unless Valley's operating profit for fiscal 1999, less interest, taxes and
bonuses, is at least $3.8 million. Depending on the employee, cash bonuses will
range from 10% to 45% of base salary if the specified financial and performance
objectives are achieved. Valley has retained the discretion to modify such
bonuses as it deems appropriate. The board may modify or terminate the incentive
plan.
EMPLOYMENT AGREEMENTS
On April 6, 1998, Valley entered into severance and change in control agreements
with the following executive officers of the Company:
- Robert R. Cain, President and Chief Executive Officer
- Kenneth Alterwitz, Senior Vice President, Sales and Marketing
- J. Randolph Cerf, Senior Vice President and Chief Financial Officer
- Melanie Cullen, Senior Vice President, Information Services
- Paige S. Dickow, Senior Vice President, Human Resources
- John Kordic, Senior Vice President, Operations
- Ronald A. Phillips, Senior Vice President, Purchasing
Each severance agreement provides that the officer who is a party to that
agreement will be entitled to certain severance payments if his or her
employment is terminated constructively or without cause or he or she resigns
within 30 days after the first anniversary of a change in control of Valley.
Such severance payments could include payment of an amount equal to twice the
aggregate of the officer's annual salary immediately prior to the termination of
his or her employment and his or her target bonus for the year in which such
termination occurred.
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COMPENSATION OF DIRECTORS
Directors who are not currently employees of Valley receive (a) an annual
retainer of $5,000, payable quarterly, (b) $1,000 per board meeting attended and
(c) $500 per committee meeting attended, if such meeting is held separately from
the board meeting. In addition, non-employee directors are reimbursed for
certain reasonable expenses incurred in connection with attending each meeting
of the board of directors and are eligible to receive stock options under the
1997 Stock Option Plan.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
As permitted by the Delaware General Corporation Law, Valley's Amended and
Restated Certificate of Incorporation provides that no director will be
personally liable to Valley or its stockholders for monetary damages for breach
of fiduciary duty as a director, except for liability
- for any breach of the director's duty of loyalty to Valley or to its
stockholders
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law
- under Section 174 of the Delaware General Corporation Law
- for any transaction from which the director derived an improper personal
benefit
Valley's Amended and Restated Bylaws further provide that Valley must indemnify
its directors and executive officers and may indemnify its other officers and
employees and agents to the fullest extent permitted by Delaware law. Valley
believes that indemnification under its Certificate of Incorporation covers
negligence and gross negligence on the part of indemnified parties. Valley
currently maintains liability insurance for its officers and directors.
Valley has entered into indemnification agreements with each of its directors
and officers. These agreements require Valley to indemnify such directors and
officers for certain expenses (including attorneys' fees), judgments, fines,
penalties and settlement amounts incurred by any such person in any threatened,
pending or completed action, suit, proceeding or alternative dispute resolution
mechanism by reason of any event or occurrence arising out of such person's
services as a director or officer.
There is no pending litigation or proceeding involving any director, officer,
employee or agent of Valley as to which indemnification is being sought. Valley
is not aware of any pending or threatened litigation or proceeding that might
result in a claim for such indemnification.
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<PAGE>
CERTAIN TRANSACTIONS
In April 1996, Valley repurchased 139,777 shares of its common stock from Barnet
J. Cohen, who is Chairman of the board of directors, and was also the Chief
Executive Officer at that time, at a valuation of approximately $3.58 per share
for a total repurchase price of $500,000.
In December 1996, Valley entered into a Contribution and Shareholders Agreement
with Stereophile, Inc. Pursuant to the agreement, Valley and Stereophile formed
Schwann Acquisition Corp., a Delaware corporation. Valley owned 80% of the
outstanding shares of Schwann, while Stereophile owned the remaining 20%.
Lawrence Archibald owns 90% of the outstanding shares of Stereophile. In March
1997, Mr. Archibald was elected to the board of directors. In December 1997,
pursuant to the contribution agreement, Schwann was merged into Valley. In
connection with the merger, and pursuant to Section 4.3 of the contribution
agreement, Stereophile's 20% interest in Schwann was converted into 58,129
shares of common stock.
Bernard Herman and Arthur Bach, who were senior officers of Star, entered into
three year and one year employment agreements, respectively, with Valley in
connection with the Star transaction to serve as officers of the Valley's video
operations. In July 1997, Valley and Messrs. Herman and Bach agreed to terminate
those agreements and entered into severance agreements that provide for payments
of $21,875 per month to each individual. Mr. Herman's agreement expires in May
2000 and Mr. Bach's agreement expired in May 1998.
On April 6, 1998, the Company entered into severance agreements with the
following executive officers of the Company:
- Robert Cain
- Kenneth Alterwitz
- J. Randolph Cerf
- Melanie Cullen
- Paige Dickow
- John Kordic
- Ronald Phillips
Each severance agreement provides that the officer who is a party to that
agreement will be entitled to certain severance payments if his or her
employment is terminated constructively or without cause or he or she resigns
within 30 days after the first anniversary of a change in control of Valley.
Such severance payments could include payment of an amount equal to twice the
aggregate of the officer's annual salary immediately prior to the termination of
his or her employment and his or her target bonus for the year in which such
termination occurred.
In April 1998 and January 1999, Rob Cain, Valley's President and Chief Executive
Officer, exercised options granted to him under the 1994 Stock Option Plan to
purchase 52,260 shares of common stock at an exercise price of approximately
$2.43 per share. The aggregate exercise price paid by Mr. Cain was approximately
$127,000. As permitted under the plan, Mr. Cain
61
<PAGE>
paid the exercise price by delivering promissory notes in the aggregate
principal amount of approximately $127,000. These notes bear interest at a rate
of 8 1/2% per annum, with interest payable quarterly and outstanding principal
due three years from the date of issuance. Mr. Cain has pledged 52,260 shares of
common stock held by him to secure his obligations under the notes.
Valley has entered into indemnification agreements with each of its directors
and officers. These agreements require Valley to indemnify such directors and
officers for certain expenses (including attorneys' fees), judgments, fines,
penalties and settlement amounts incurred by any such person in any threatened,
pending or completed action, suit, proceeding or alternative dispute resolution
mechanism by reason of any event or occurrence arising out of such person's
services as a director or officer of Valley.
Valley believes that each of the foregoing transactions were in its best
interest. As a matter of policy, the transactions were, and all future
transactions between Valley and any of its officers, directors, or principal
stockholders will be, approved by a majority of the independent and
disinterested members of the board of directors, will be on terms no less
favorable to Valley than could be obtained from unaffiliated third parties and
will be in connection with bona fide business purposes of Valley.
62
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of Valley's common stock as of January 30, 1999, and as adjusted, to
reflect the sale by Valley of the shares offered by (a) each person who is known
by Valley to own beneficially more than five percent (5%) of the outstanding
shares of common stock, (b) each director, (c) each of the Named Executive
Officers, and (d) all directors and executive officers as a group. Except as
otherwise indicated, Valley believes that each individual or entity named has
sole investment and voting power of the shares of common stock beneficially
owned by them, except for applicable community property laws. The percentages
beneficially owned have been calculated pursuant to Rule 13d-3(d) of the
Securities Exchange Act of 1934, as amended. Under Rule 13d-3(d), shares not
outstanding which are subject to options, warrants, rights or conversion
privileges exercisable within 60 days as of January 30, 1999 are counted
outstanding for the purpose of calculating the number and percentage owned by
such person, but not counted outstanding for the purpose of calculating the
percentage owned by any other person listed. Percentages beneficially owned are
based on 4,948,268 shares of common stock outstanding as of January 30, 1999 and
8,448,268 shares outstanding after this offering. An asterisk indicates
beneficial ownership of less than 1.0% of the outstanding shares of common
stock.
<TABLE>
<CAPTION>
-------------------------------------
PERCENTAGE BENEFICIALLY
OWNED (1)
SHARES ------------------------
BENEFICIALLY BEFORE THE AFTER THE
NAME OWNED OFFERING OFFERING
- ------------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Barnet J. Cohen (1).......................................... 4,365,701 88.2% 51.7%
Robert R. Cain (2)........................................... 455,591 8.7 5.2
J. Randolph Cerf (3)......................................... 93,614 1.9 1.1
Melanie Cullen (4)........................................... 65,231 1.3 *
Kenneth Alterwitz (4)........................................ 60,229 1.2 *
Lawrence Archibald (5)....................................... 54,596 1.1 *
James Sha (5)................................................ 40,535 * *
Wendy Paskin-Jordan (5)...................................... 40,451 * *
Christopher Mottern (5)...................................... 26,046 * *
All Directors and Executive Officers as a Group (12 persons)
(6)........................................................ 5,349,286 95.9 58.9
</TABLE>
- ------------------------------
(1) Consists of 3,567,467 shares of common stock and 798,234 shares of common
stock held by the ESOP. Mr. Cohen and his wife Barbara Cohen are the trustees of
the ESOP. Mr. Cohen disclaims beneficial ownership of the ESOP shares except to
the extent of any pecuniary interest in such shares held by Mr. Cohen as an ESOP
participant. Mr. Cohen has granted to the underwriters a 30-day option to
purchase up to 472,500 shares solely to cover over-allotments, if any. If the
over-allotment option is exercised in full, Mr. Cohen would own 3,893,201
shares, representing 46.1% of the outstanding common stock.
(2) Consists of 126,228 shares of common stock, exercisable options to purchase
318,317 shares of common stock, and 11,046 shares of common stock allocated to
Mr. Cain's account under the ESOP. Mr. Cain has granted to the underwriters a
30-day option to purchase up to 52,500 shares solely to cover over-allotments,
if any. If the over-allotment option is exercised in full, Mr. Cain would own
403,091 shares, representing 4.6% of the outstanding common stock.
(3) Consists of 24,120 shares of common stock, exercisable options to purchase
68,674 shares of common stock and 820 shares of common stock allocated to Mr.
Cerf's account under the ESOP.
(4) Consists of less than 21,000 shares of common stock, exercisable options to
purchase less than 53,000 shares of common stock and less than 2,000 shares of
common stock allocated to such individual's account under the ESOP.
(5) Consists of less than 53,000 shares of common stock and exercisable options
to purchase less than 2,000 shares of common stock.
(6) Consists of 3,923,083 shares of common stock, 798,234 shares of common
stock held by the ESOP, for which Mr. Cohen serves as co-trustee, and
exercisable options to purchase 627,969 shares of common stock.
63
<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon completion of this offering, Valley will have authorized capital stock of
22,000,000 shares consisting of 20,000,000 shares of common stock, $0.001 par
value, and 2,000,000 shares of preferred stock, $0.001 par value. As of January
30, 1999, 4,948,268 shares of Common Stock were outstanding, held by 19 holders
of record.
COMMON STOCK
The holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of stockholders. The holders of common
stock are entitled to receive ratably such dividends, if any, as may be declared
from time to time by the board out of funds legally available therefor. Valley
does not anticipate paying dividends on the common stock in the foreseeable
future. See "Dividend Policy."
In the event of a liquidation, dissolution or winding up of Valley, the holders
of common stock are entitled to share ratably in all assets remaining after
payment of liabilities. Holders of common stock have no preemptive rights or
rights to convert their common stock into any other securities. There are no
redemption or sinking fund provisions applicable to the common stock. All shares
of common stock are, and the shares of common stock to be outstanding upon
completion of this offering will be, fully paid and non-assessable.
PREFERRED STOCK
The board is authorized, without further stockholder action, to issue up to two
million undesignated shares of preferred stock in one or more series and to fix
the voting rights, liquidation preferences, dividend rights, repurchase rights,
conversion rights, preemption rights, redemption rights and terms, including
sinking fund provisions, and certain other rights and preferences of such shares
of the preferred stock. The issuance of any series of preferred stock could
adversely affect the rights of the holders of common stock by restricting
dividends on, diluting the power of, or impairing the liquidation rights of
common stock, or delaying, deferring or preventing a change in control of
Valley. Valley has no present plans to issue any preferred stock.
TRANSFER AGENT
Valley's transfer agent and registrar for its common stock is Norwest Bank
Minnesota, N.A.
ANTI-TAKEOVER PROVISIONS IN CHARTER DOCUMENTS
Valley has adopted provisions in its Amended and Restated Certificate of
Incorporation and in its Amended and Restated Bylaws that do the following:
- eliminate the right of stockholders to call a special meeting of
stockholders
- require stockholders to give Valley advance notice of intent to nominate
directors or bring matters before a meeting of stockholders
- eliminate the ability of stockholders to take action by written consent
64
<PAGE>
- stagger the board into three classes so that only one third of the board
members are elected each year, and effectively provide that directors may
not be removed from office other than for cause
- provide that vacancies on the board resulting from increases in the size
of the board or from death, resignation, retirement or removal may only be
filled by the board
These provisions could adversely affect the rights of the holders of common
stock by delaying, deferring or preventing a change in control of Valley.
EFFECT OF DELAWARE ANTI-TAKEOVER STATUTE
Valley is subject to Section 203 of the Delaware General Corporation Law, which,
subject to certain exceptions, prohibits a publicly held Delaware corporation
from engaging in any "business combination" with any "interested stockholder"
for a period of three years following the date that such stockholder became an
interested stockholder, unless:
- prior to such date, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder
- upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced
- on or subsequent to such date, the business combination is approved by the
board of directors and authorized at an annual or special meeting of
stockholders, and not by written consent, by the affirmative vote of at
least 66 2/3% of the outstanding voting stock that is not owned by the
interested stockholder
Section 203 defines "business combination" to include:
- any merger or consolidation involving the corporation and the interested
stockholder
- any sale, transfer, pledge or other disposition of 10% or more of the
assets of the corporation involving the interested stockholder
- subject to certain exceptions, any transaction that results in the
issuance or transfer by the corporation of any stock of the corporation to
the interested stockholder
- any transaction involving the corporation that has the effect of
increasing the proportionate share of the stock of any class or series of
the corporation beneficially owned by the interested stockholder
- the receipt by the "interested stockholder" of the benefit of any loans,
advances, guarantees, pledges or other financial benefits provided by or
through the corporation
In general, Section 203 defines an interested stockholder as an entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
65
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, Valley will have 8,448,268 shares of common
stock outstanding, assuming no exercise of outstanding options and no
distributions of ESOP shares. Of these shares, the 3,500,000 shares sold in this
offering will be freely transferable without restriction under the Securities
Act unless they are held by "affiliates" of Valley as that term is defined in
Rule 144 under the Securities Act. The remaining 4,948,268 shares of common
stock held by officers, directors and other stockholders of Valley were sold by
Valley in reliance on exemptions from the registration requirements of the
Securities Act and are restricted securities within the meaning of Rule 144
under the Securities Act. These shares may not be sold publicly unless they are
registered under the Securities Act or are sold pursuant to Rule 144, Rule 701
or another exemption from registration.
The officers, directors and all stockholders of Valley have agreed not to sell
their shares without the prior written consent of J.P. Morgan Securities Inc.
for a period of 180 days from the date of this prospectus. Upon the expiration
of this lock-up period, 137,717 of the restricted shares will become eligible
for sale in the public market under Rule 701, and 4,012,317 of the restricted
shares will become eligible for sale subject to Rule 144. An additional 798,234
of the restricted shares are held by the ESOP and may not be sold without the
consent of the board. See "Management - Compensation Plans - Employee Stock
Ownership Plan."
In general, under Rule 144 as currently in effect, a person (or persons whose
shares are aggregated) who has beneficially owned restricted shares for at least
one year, including persons who may be deemed "affiliates" of Valley, is
entitled to sell, within any three month period commencing 90 days after this
offering, a number of shares that does not exceed the greater of 1% of the
number of shares of common stock then outstanding (approximately 84,483 shares
immediately after this offering, assuming no exercise of the underwriters' over-
allotment option) or the average weekly trading volume of the common stock as
reported through the Nasdaq National Market during the four calendar weeks
preceding the filing of a Form 144 with respect to such sale. Sales under Rule
144 are also subject to certain manner of sale provisions and notice
requirements and to the availability of current public information about Valley.
In addition, a person who is not deemed to have been an affiliate of Valley at
any time during the 90 days preceding a sale, and who has beneficially owned for
at least two years the shares proposed to be sold, would be entitled to sell
such shares under Rule 144(k) without regard to the requirements described
above.
As of January 30, 1999, 1,159,791 shares were issuable upon exercise of
currently outstanding options, all of which are subject to the lockup agreements
described above. Of those options, options to purchase 957,067 shares will be
vested and fully exercisable 180 days after commencement of this offering and
those shares will be eligible for sale, subject, in the case of sales by
affiliates, to the volume, manner of sale, notice and public information
requirements of Rule 144. In addition, as of January 30, 1999, 798,234 shares of
common stock had been allocated to the respective accounts of participants in
the ESOP. Under certain circumstances, including termination of a participant's
employment with Valley, shares of common stock allocated to the account of that
participant may be distributed to the participant
66
<PAGE>
and such shares may then be sold by the participant, subject to certain
restrictions on transfer, including Valley's right of first refusal. See
"Management - Compensation Plans" and "Management - Compensation of Directors."
Prior to this offering, there has been no public market for Valley's common
stock. No predictions can be made as to the effect, if any, that the sale or
availability for sale of shares of additional common stock will have on the
market price of the common stock. Nevertheless, sales of a substantial amount of
such shares by existing stockholders or by stockholders purchasing in this
offering could have a negative impact on the market price of the common stock.
67
<PAGE>
UNDERWRITING
Under the terms of, and subject to the conditions contained in the underwriting
agreement, each of the underwriters named below, for whom J.P. Morgan Securities
Inc. and BancBoston Robertson Stephens Inc. are acting as representatives, has
severally agreed to purchase, and Valley has agreed to sell to them, the
respective number of shares of common stock set forth opposite their names
below. Under the terms and conditions of the underwriting agreement, the
underwriters are obligated to take and pay for all such shares of common stock,
if any are taken. Under certain circumstances, the commitments of nondefaulting
underwriters may be increased as set forth in the underwriting agreement.
<TABLE>
<CAPTION>
-----------------
UNDERWRITERS NUMBER OF SHARES
- --------------------------------------------------------------------------- -----------------
<S> <C>
J.P. Morgan Securities Inc.................................................
BancBoston Robertson Stephens Inc..........................................
-----------------
Total.................................................................. 3,500,000
-----------------
-----------------
</TABLE>
Valley estimates that it will pay approximately $1.4 million in expenses for
this offering, exclusive of underwriting commissions and discounts.
The underwriters propose initially to offer the shares of common stock directly
to the public at the price set forth on the cover page of this prospectus, and
to certain dealers at such price less a selling concession not in excess of
$ per share. The underwriters may allow, and such dealers may reallow, a
concession not in excess of $ per share to certain other dealers. After the
initial public offering, the public offering price and such concessions may be
changed.
Messrs. Cohen and Cain collectively have granted to the underwriters an option
to purchase up to an additional 525,000 shares of common stock at the initial
public offering price to the public, less the aggregate underwriting discount,
solely to cover over-allotments. This option may be exercised at any time up to
30 days after the date of this prospectus. To the extent that the underwriters
exercise such option, each of the underwriters will have a firm commitment,
subject to certain conditions, to purchase a number of option shares
proportionate to such underwriter's initial commitment.
Valley's officers, directors and stockholders have agreed, subject to certain
exceptions, not to, directly or indirectly, sell, grant any option to purchase
or otherwise transfer or dispose of any shares of common stock or securities
convertible into or exchangeable or exercisable for shares of common stock or
file a registration statement under the Securities Act with respect to the
foregoing or enter into any swap or other agreement or transaction that
transfers, in whole or in part, the economic consequence of ownership of the
common stock, without the prior written consent of J.P. Morgan for a period of
180 days after the date of this prospectus. J.P. Morgan may, in its sole
discretion, at any time or from time to time, without notice, release all or any
portion of the shares subject to these lock-up agreements.
68
<PAGE>
Valley has agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, or to contribute to payments
that the underwriters may be required to make in respect thereof.
The representatives have informed Valley that the underwriters do not intend to
confirm sales of common stock offered hereby to any accounts over which they
exercise discretionary
authority.
Valley has applied to list the common stock on the Nasdaq National Market under
the trading symbol "VMIX."
To facilitate this offering, the underwriters may engage in transactions that
stabilize, maintain or otherwise affect the market price of the common stock.
Specifically, the underwriters may over-allot shares of the common stock in
connection with this offering, thereby creating a short position in the
underwriters' syndicate account. Additionally, to cover such over-allotments or
to stabilize the market price of the common stock, the underwriters may bid for,
and purchase, shares of the common stock in the open market. Any of these
activities may maintain the market price of the common stock at a level above
that which might otherwise prevail in the open market. The underwriters are not
required to engage in these activities, and, if commenced, any such activities
may be discontinued at any time. The representatives, on behalf of the
underwriters, also may reclaim selling concessions allowed to an underwriter or
dealer, if the syndicate repurchases shares distributed by that underwriter or
dealer.
Prior to this offering, there has been no public market for Valley's common
stock. There can be no assurance that an active trading market will develop for
shares of the common stock or that the common stock will trade in the public
market subsequent to this offering at or above the initial public offering
price. The initial public offering price will be determined by negotiation among
Valley and the representatives. Among the factors that will be considered in
determining the initial public offering price, in addition to prevailing market
conditions, are
- the financial and operating history and condition of Valley
- it's business and financial prospects
- the prospects for the industry in which Valley operates
- the recent market prices of securities of companies in businesses similar
to that of Valley and other relevant factors
From time to time in the ordinary course of their respective businesses, the
representatives and their respective affiliates may in the future provide
investment banking and other financial services to Valley and its affiliates.
LEGAL MATTERS
The validity of the shares of common stock being offered by Valley will be
passed upon for Valley by Howard, Rice, Nemerovski, Canady, Falk & Rabkin, a
Professional Corporation, San Francisco, California, which has acted as counsel
to Valley in connection with this offering. Certain legal matters in connection
with this offering will be passed upon for the underwriters by Cooley Godward
LLP, Palo Alto, California.
69
<PAGE>
EXPERTS
The consolidated financial statements of Valley as of March 29, 1997, March 28,
1998 and December 26, 1998 and for each of the three fiscal years in the period
ended March 28, 1998 and for the nine months ended December 26, 1998 included in
this prospectus and the related financial statement schedule included elsewhere
in the registration statement and the financial statements of Star for the years
ended December 31, 1995 and 1996 and for the period from January 1, 1997 to May
20, 1997 included in this prospectus, have been audited by Deloitte & Touche
LLP, independent auditors, as stated in their reports appearing herein and
elsewhere in the registration statement. Such financial statements and financial
statement schedule have been included in reliance upon the reports of such firm
given upon their authority as experts in accounting and auditing.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission a registration
statement on Form S-1 (together with all amendments, exhibits, schedules and
supplements thereto under the Securities Act with respect to the common stock
being offered. This prospectus, which forms a part of the registration
statement, does not contain all of the information set forth in the registration
statement. For further information with respect to Valley and the common stock,
reference is made to the registration statement. Statements contained in this
prospectus as to the contents of any contract or other document are not
necessarily complete, and, in each instance, reference is made to the copy of
such contract or document filed as an exhibit to the registration statement, and
each such statement is qualified in all respects by such reference. Copies of
the registration statement may be examined without charge at the Public
Reference Section of the Securities and Exchange Commission, 450 Fifth Street,
N.W., Room 1024, Washington, D.C. 20549, and the Securities and Exchange
Commission's Regional Offices located at Seven World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of all or any portion of the registration
statement can be obtained from the Public Reference Section of the Securities
and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, upon
payment of certain prescribed fees. The Securities and Exchange Commission
maintains a World Wide Web site that contains registration statements, reports,
proxy and information statements and other information regarding registrants
(including Valley) that file electronically. The address of such World Wide Web
site is http://www.sec.gov. Valley intends to distribute annual reports
containing audited financial statements and will make copies of quarterly
reports available for the first three quarters of each fiscal year containing
unaudited interim financial statements.
You should rely only on the information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. This prospectus is an offer to sell, or a
solicitation of offers to buy, shares of common stock only in jurisdictions
where offers and sales are permitted. The information contained in this
prospectus is accurate only as of the date of this prospectus, regardless of the
time of delivery of this prospectus or any sale of common stock.
70
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
VALLEY MEDIA, INC.:
Independent Auditors' Report....................................................... F-2
Consolidated Balance Sheets as of March 29, 1997, March 28, 1998 and December 26,
1998.............................................................................. F-3
Consolidated Statements of Operations for the Fiscal Years Ended March 30, 1996,
March 29, 1997 and March 28, 1998 and the Nine Months Ended December 27, 1997
(Unaudited) and December 26, 1998................................................. F-4
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended March
30, 1996, March 29, 1997 and March 28, 1998 and the Nine Months ended December 26,
1998.............................................................................. F-5
Consolidated Statements of Cash Flows for the Fiscal Years Ended March 30, 1996,
March 29, 1997 and March 28, 1998 and the Nine Months Ended December 27, 1997
(Unaudited) and December 26, 1998................................................. F-6
Notes to Consolidated Financial Statements......................................... F-7
STAR VIDEO:
Independent Auditors' Report....................................................... F-22
Statements of Operations and Changes in Net Assets Acquired for the Years Ended
December 31, 1995 and 1996 and the Period from January 1, 1997 to May 20, 1997.... F-23
Statements of Cash Flows for the Years Ended December 31, 1995 and 1996 and the
Period from January 1, 1997 to May 20, 1997....................................... F-24
Notes to Financial Statements...................................................... F-25
UNAUDITED PRO FORMA FINANCIAL INFORMATION OF VALLEY MEDIA, INC.:
Unaudited Pro Forma Financial Information of Valley Media, Inc..................... F-28
Unaudited Pro Forma Consolidated Statement of Operations for the Fiscal Year Ended
March 28, 1998.................................................................... F-29
Notes to Unaudited Pro Forma Consolidated Statement of Operations.................. F-30
</TABLE>
F-1
<PAGE>
THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS GIVE EFFECT TO THE
COMPLETION OF THE 8.04 FOR 1 SPLIT OF THE COMPANY'S COMMON STOCK WHICH WILL TAKE
PLACE ON FEBRUARY , 1999. THE FOLLOWING REPORT IS IN THE FORM WHICH WILL BE
FURNISHED BY DELOITTE & TOUCHE LLP UPON COMPLETION OF THE STOCK SPLIT OF THE
COMPANY'S COMMON STOCK DESCRIBED IN THE LAST PARAGRAPH OF NOTE 2 TO THE
CONSOLIDATED FINANCIAL STATEMENTS AND ASSUMING THAT FROM FEBRUARY 8, 1999 TO THE
DATE OF SUCH COMPLETION NO OTHER MATERIAL EVENTS HAVE OCCURRED THAT WOULD AFFECT
THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS OR REQUIRED DISCLOSURE
THEREIN.
INDEPENDENT AUDITORS' REPORT
"Board of Directors and Stockholders of
Valley Media, Inc.:
We have audited the accompanying consolidated balance sheets of Valley Media,
Inc. and its subsidiaries (the "Company") as of March 29, 1997, March 28, 1998
and December 26, 1998 and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the three fiscal years in the
period ended March 28, 1998 and for the nine months ended December 26, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Valley Media, Inc. and its
subsidiaries as of March 29, 1997, March 28, 1998, and December 26, 1998 and the
results of their operations and their cash flows for each of the three fiscal
years in the period ended March 28, 1998 and for the nine months ended December
26, 1998 in conformity with generally accepted accounting principles.
San Francisco, California
February 8, 1999 (February , 1999 as to the last paragraph of Note 2)"
/s/ Deloitte & Touche LLP
San Francisco, California
February 8, 1999
F-2
<PAGE>
VALLEY MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
-----------------------------------
MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS, EXCEPT SHARE DATA 1997 1998 1998
----------- ----------- ---------
<S> <C> <C> <C>
ASSETS
Current assets
Cash............................................................... $ 310 $ 394 $ 719
Accounts receivable, less allowance for doubtful accounts of $825
at March 29, 1997, $5,276 at March 28, 1998, and $9,326 at
December 26, 1998................................................. 36,075 108,429 225,676
Inventories, net of reserves of $392 at March 29, 1997, $1,587 at
March 28, 1998 and $2,403 at December 26, 1998.................... 44,351 95,365 219,034
Deferred income taxes.............................................. 1,136 1,903 4,643
Prepaid expenses and other......................................... 874 2,626 1,547
----------- ----------- ---------
Total............................................................ 82,746 208,717 451,619
Property and equipment, net.......................................... 9,085 15,681 19,130
Goodwill and other intangibles, net.................................. 2,626 19,040 15,064
Deferred income taxes................................................ 525 312
Other assets......................................................... 134 1,099 1,804
----------- ----------- ---------
Total assets......................................................... $ 94,591 $ 245,062 $ 487,929
----------- ----------- ---------
----------- ----------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable................................................... $ 58,428 $ 140,380 $ 323,919
Accrued expenses................................................... 1,594 7,180 8,577
Revolving line of credit........................................... 20,447 73,381 124,756
Current portion of long-term debt.................................. 1,258 2,334 1,786
Deferred income taxes.............................................. 908 3,383
Deferred revenue................................................... 1,219 2,146 4,470
----------- ----------- ---------
Total............................................................ 82,946 226,329 466,891
----------- ----------- ---------
Deferred income taxes................................................ 1,407 4,590 2,449
Long-term debt....................................................... 2,257 3,166 4,347
Minority interest.................................................... 208
Commitments and contingencies (Notes 7 and 9)
Stockholders' equity
Preferred stock, $.001 par value, 2,000,000 shares authorized, none
issued............................................................
Common stock, $.001 par value, 20,000,000 shares authorized,
4,784,865, 4,810,553 and 4,900,109 shares issued and
outstanding....................................................... 5 5 5
Additional paid-in capital......................................... 662 845 1,077
Stockholder notes receivable....................................... (232)
Retained earnings.................................................. 7,106 10,127 13,392
----------- ----------- ---------
Total stockholders' equity....................................... 7,773 10,977 14,242
----------- ----------- ---------
Total liabilities and stockholders' equity........................... $ 94,591 $ 245,062 $ 487,929
----------- ----------- ---------
----------- ----------- ---------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
VALLEY MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
-------------------------------------------------------
FISCAL YEARS ENDED NINE MONTHS ENDED
------------------------------- ----------------------
MARCH 30, MARCH 29, MARCH 28, DEC. 27, DEC. 26,
DOLLARS IN THOUSANDS, EXCEPT SHARE DATA 1996 1997 1998 1997 1998
--------- --------- --------- ----------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales............................... $156,557 $199,231 $583,492 $427,280 $631,102
Cost of goods sold...................... 137,847 175,706 516,627 380,413 561,112
--------- --------- --------- ----------- ---------
Gross profit............................ 18,710 23,525 66,865 46,867 69,990
Selling, general and administrative
expenses.............................. 14,033 20,552 55,183 38,922 56,027
--------- --------- --------- ----------- ---------
Operating income........................ 4,677 2,973 11,682 7,945 13,963
Equity in net loss of joint venture..... 903 207
Interest expense........................ 1,305 1,745 6,627 4,511 7,518
--------- --------- --------- ----------- ---------
Income before income taxes.............. 2,469 1,021 5,055 3,434 6,445
Income taxes............................ 1,016 410 2,034 1,380 2,457
--------- --------- --------- ----------- ---------
Income before extraordinary loss........ 1,453 611 3,021 2,054 3,988
Extraordinary loss (net of income taxes
of $477).............................. (723)
--------- --------- --------- ----------- ---------
Net income.............................. $ 1,453 $ 611 $ 3,021 $ 2,054 $ 3,265
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Net income per share:
Basic:
Income before extraordinary loss.... $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.82
Extraordinary loss.................. (0.15)
--------- --------- --------- ----------- ---------
Net income per share................ $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.67
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Diluted:
Income before extraordinary loss.... $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.72
Extraordinary loss.................. (0.13)
--------- --------- --------- ----------- ---------
Net income per share................ $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.59
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Weighted average shares used in the
calculation
Basic................................. 4,965,375 4,797,193 4,791,864 4,782,447 4,838,413
Diluted............................... 5,224,040 5,131,341 5,263,870 5,245,245 5,554,715
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
VALLEY MEDIA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
------------------------------------------------------------------
COMMON STOCK ADDITIONAL STOCKHOLDER
DOLLARS IN THOUSANDS, EXCEPT -------------------- PAID-IN NOTES RETAINED
SHARE DATA SHARES AMOUNT CAPITAL RECEIVABLE EARNINGS TOTAL
--------- --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at April 1, 1995........ 4,976,191 $5 $1,333 $ 5,042 $ 6,380
Repurchase of common stock...... (36,625) (117) (117)
Net income...................... 1,453 1,453
--------- --------- ----------- ---------
Balance at March 30, 1996....... 4,939,566 5 1,216 6,495 7,716
Repurchase of common stock...... (154,701) (554) (554)
Net income...................... 611 611
--------- --------- ----------- ---------
Balance at March 29, 1997....... 4,784,865 5 662 7,106 7,773
Repurchase of common stock...... (32,441) (143) (143)
Issuance of common stock in
connection with acquisition.... 58,129 326 326
Net income...................... 3,021 3,021
--------- --------- ----------- ---------
Balance at March 28, 1998....... 4,810,553 5 845 10,127 10,977
Exercise of stock option in
exchange for notes
receivable..................... 89,556 232 (232)
Net income...................... 3,265 3,265
--------- --------- ----------- --------- --------- ---------
Balance at December 26, 1998.... 4,900,109 $5 $1,077 $(232) $ 13,392 $ 14,242
--------- --------- ----------- --------- --------- ---------
--------- --------- ----------- --------- --------- ---------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
VALLEY MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
-------------------------------------------------------------
FISCAL YEARS ENDED NINE MONTHS ENDED
------------------------------------- ----------------------
MARCH 30, MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1996 1997 1998 1998
----------- ----------- ----------- ---------
DEC. 27,
1997
-----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income before extraordinary loss.............................. $ 1,453 $ 611 $ 3,021 $ 2,054 $ 3,988
Adjustments to reconcile income before extraordinary loss to
net cash provided by (used in) operating activities
Depreciation and amortization............................... 1,296 1,849 4,112 2,930 4,158
Bad debt expense............................................ 8 505 2,770 4,176 4,050
Deferred offering cost write-off............................ 587
Equity in net loss of joint venture......................... 903 207 2,799
Deferred income taxes....................................... 264 121 1,915 (2,193)
Extraordinary loss on debt refinancing (net of income taxes
of $477)................................................... (723)
Changes in assets and liabilities (net of acquisitions):
Accounts receivable....................................... (3,988) (15,401) (43,526) (88,285) (121,298)
Inventories............................................... (2,252) (9,412) (31,441) (36,484) (123,669)
Prepaid expenses and other................................ (255) (441) (1,213) (953) 245
Accounts payable.......................................... (3,066) 33,532 51,748 93,629 185,039
Accrued expenses.......................................... (261) 655 (2,283) (2,936) 1,993
Deferred revenue.......................................... 438 629 927 691 2,324
----------- ----------- ----------- ----------- ---------
Net cash provided by (used in) operating activities..... (5,460) 12,855 (13,086) (23,263) (45,499)
----------- ----------- ----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment........................... (1,728) (2,902) (4,346) (2,821) (6,227)
Business and net asset acquisitions, net of cash acquired..... (9,346) (33,147) (32,090)
Equipment deposit............................................. (34) (82) (61)
----------- ----------- ----------- ----------- ---------
Net cash used in investing activities................... (1,762) (12,330) (37,554) (34,911) (6,227)
----------- ----------- ----------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net short-term borrowings under revolving line of credit...... 7,926 1,502 52,934 59,445 51,375
Issuance of long-term debt.................................... 373 7 3 3 2,350
Repayment of long-term debt................................... (892) (1,314) (1,306) (1,003) (1,217)
Repurchase of common stock.................................... (117) (554) (142) (94)
Deferred offering costs....................................... (765) (263) (457)
----------- ----------- ----------- ----------- ---------
Net cash provided by (used in) financing activities..... 7,290 (359) 50,724 58,088 52,051
----------- ----------- ----------- ----------- ---------
NET INCREASE (DECREASE) IN CASH................................. 68 166 84 (86) 325
CASH, BEGINNING OF PERIOD....................................... 76 144 310 310 394
----------- ----------- ----------- ----------- ---------
CASH, END OF PERIOD............................................. $ 144 $ 310 $ 394 $ 224 $ 719
----------- ----------- ----------- ----------- ---------
----------- ----------- ----------- ----------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest........................................ $ 1,263 $ 1,676 $ 5,716 $ 4,134 $ 7,271
Cash paid for income taxes.................................... 730 85 6 22
NONCASH INVESTING AND FINANCING ACTIVITIES
Net liabilities assumed in connection with acquisition of
partnership
interest..................................................... 1,328
Noncompete agreement issued in connection with business
acquisition.................................................. 241
Net assets acquired........................................... 229
Purchase of equipment through capital leases.................. 820 231 2,788 391
Purchase of equipment through issuance of note payable........ 2,546
Payable to Star Video Entertainment, L.P. as a result of
acquisition.................................................. 3,144 3,144
Issuance of common stock in connection with acquisition....... 326 326
Notes receivable from stockholders............................ 232
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Valley Media, Inc. (a California corporation) and its subsidiaries (the
"Company") is a full-line distributor of prerecorded music and video
entertainment products. In July 1998, the Company was reincorporated as a
Delaware corporation. The Company has distribution facilities in California,
Kentucky, Pennsylvania and Massachusetts, and sells its products primarily to
retail stores throughout the United States and worldwide, as well as through
Internet music and video retailers. The Company also provides certain services
to customers such as direct-to-consumer fulfillment and licensing the Company's
proprietary products and databases of product information.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. Prior to January 1997, the Company owned a 50%
partnership interest in Distribution North America ("DNA"), which was accounted
for on the equity method. On January 31, 1997, the Company acquired the
remaining 50% partnership interest in DNA (see Note 4). Significant intercompany
balances and transactions are eliminated in consolidation.
FISCAL YEAR
The Company's fiscal year is a 52 or 53 week period ending on the Saturday
closest to March 31. The fiscal years ended March 30, 1996 ("fiscal 1996"),
March 29, 1997 ("fiscal 1997") and March 28, 1998 ("fiscal 1998") each contained
a 52 week period.
INTERIM FINANCIAL INFORMATION
The Company's consolidated financial statements as of December 27, 1997 and for
the nine months ended December 27, 1997 are unaudited and, in the opinion of
management, contain all adjustments that are of a normal and recurring nature
necessary to present fairly the financial position and results of operations for
such period. The results of operations for the nine months ended December 26,
1998 are not necessarily indicative of the results expected for the full year.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Significant estimates include allowances for doubtful accounts, vendor
receivables and customer returns. Actual results could differ from those
estimates.
INVENTORIES
Inventories are valued at the lower of cost or market and are accounted for on
the average cost basis. The Company performs periodic assessments to determine
the existence of obsolete, slow-moving and non-salable inventories and records
necessary provisions to reduce such inventories to net realizable value.
F-7
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated or amortized on a
straight-line basis over the estimated useful lives of the assets or the lease
term, whichever is shorter. Estimated useful lives range from three to ten
years.
CAPITALIZED COMPUTER SOFTWARE
Capitalized computer software included in property and equipment, reflects costs
related to internally developed or purchased software that are capitalized and
amortized on a straight-line basis over periods not exceeding five years.
Internally developed software costs are capitalized in accordance with Statement
of Position 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR
OBTAINED FOR INTERNAL USE. Amortization expense for fiscal 1996, fiscal 1997,
fiscal 1998 and the nine months ended December 26, 1998 was $195,000, $339,000,
$490,000 and $546,000, respectively.
GOODWILL AND OTHER INTANGIBLES
Goodwill is amortized on a straight-line basis over 15 years. Identifiable
intangible assets, consisting primarily of customer lists, are amortized on a
straight-line basis over five years.
OTHER ASSETS
Other assets include $764,000 at March 28, 1998 and $634,000 at December 26,
1998 of deferred offering costs, which the Company expects to offset against the
gross proceeds from an initial public offering. In June 1998, the Company
expensed $587,000 of deferred offering costs that were no longer considered
directly attributable to the proposed offering.
REVENUE RECOGNITION
Sales of prerecorded music, video, music accessories, and other related products
are recognized upon shipment of the product, net of estimated returns and
allowances, which are based on historical experience and adjusted for current
situations. Certain of the Company's sales are made to customers under
agreements permitting rights of return.
CONCENTRATION OF CREDIT RISK
The Company is subject to credit risk through sales and related trade
receivables to retailers. Approximately 27% and 33% of the Company's net sales
and accounts receivable was represented by four customers for the nine months
ended December 27, 1997 and as of December 26, 1998, respectively. The Company
routinely assesses the financial strength of significant customers and this
assessment, combined with the large number and geographic diversity of its
customers, limits the Company's concentration of risk with respect to trade
accounts receivable.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the intrinsic
value method in accordance with Accounting Principles Board No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES ("APB 25").
F-8
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company accounts for income taxes under the asset and liability approach
where deferred income tax assets and liabilities reflect the future tax
consequences, based on enacted tax laws, of the temporary differences between
financial and tax reporting at the balance sheet date.
ASSET IMPAIRMENT
Statement of Financial Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS TO BE DISPOSED OF, requires periodic review of
long-lived assets and certain identifiable intangibles for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Impairment, if any, would be determined from a
comparison of undiscounted net cash flows to the carrying value of the assets.
Implementation of SFAS No. 121 in fiscal 1997 had no effect on the Company's
financial statements.
NET INCOME PER SHARE
Basic net income per share is computed by dividing net income by the weighted
average of common shares outstanding for the period. Diluted net income per
share reflects the potential dilution that could occur if common stock was
issued through exercise of stock options.
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in a full set of general-purpose financial
statements. This statement requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. In addition, this statement requires that an
enterprise classify items of other comprehensive income by their nature in a
financial statement and display the accumulated balance of other comprehensive
income separately from the retained earnings and additional paid in capital in
the equity section of a statement of financial position. SFAS No. 130 is
effective for the Company's fiscal year ending April 3, 1999 ("fiscal 1999").
The Company has no items of other comprehensive income and therefore
comprehensive income is the same as net income for all periods presented.
SFAS No. 131, DISCLOSURES ABOUT SEGMENT REPORTING OF AN ENTERPRISE AND RELATED
INFORMATION, establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosure about products and services,
geographic areas, and major customers. SFAS No. 131 is effective for the
Company's fiscal 1999. The Company is currently evaluating what impact, if any,
SFAS No. 131 may have on its financial statement disclosures.
F-9
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 recognize all derivatives as either assets or
liabilities in the statement of financial position and measure these instruments
at fair value. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company is currently evaluating what impact,
if any, SFAS No. 133 may have on its financial statements.
STOCK SPLIT
On February , 1999, the Company effected a 8.04-for-1 split of its common
stock. All share and per share amounts in the accompanying consolidated
financial statements have been restated to give effect to the stock split.
3. ACQUISITION OF BUSINESS OF STAR VIDEO ENTERTAINMENT, L.P.
On May 20, 1997, the Company acquired certain of the assets and assumed certain
liabilities of Star Video Entertainment, L.P. ("Star Video"), a distributor of
prerecorded videocassettes. Consideration paid to the seller was $37,872,000, of
which $34,728,000 was paid in cash on May 20, 1997 and in August 1997 and the
remaining $3,144,000 was due in various installments over the next three years.
In connection with the acquisition, the Company incurred $1,080,000 of
transaction costs, comprised principally of legal fees.
As of May 20, 1997, the Company planned to (i) terminate certain Star Video
senior management in fiscal 1998, (ii) move virtually all Star Video
administrative functions to the Company's Woodland, California headquarters in
calendar 1998 and (iii) close three Star Video distribution facilities in fiscal
1998 and early fiscal 1999. Therefore, the Company recorded a liability of
$1,485,000 at May 20, 1997 for severance costs related to these planned
activities.
As of March 28, 1998, the Company had terminated certain Star Video senior
management and closed two distribution facilities. As a result, the Company
charged $606,000 against the severance liability in fiscal 1998 and at March 28,
1998 the remaining severance liability was $879,000.
In the nine months ended December 26, 1998, the Company moved the Star Video
administrative functions to Woodland, California and closed the third
distribution facility. As a result, the Company charged $507,000 against the
severance liability and at December 26, 1998 had a remaining severance liability
of $372,000, which will be paid on a monthly basis through May 2000.
F-10
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION OF BUSINESS OF STAR VIDEO ENTERTAINMENT, L.P. (CONTINUED)
The Company allocated the total purchase price of $40,437,000 to the fair value
of the net assets acquired as follows:
<TABLE>
<S> <C>
---------
DOLLARS IN THOUSANDS
Cash.............................................................................. $ 3,697
Accounts receivable............................................................... 58,025
Inventories....................................................................... 20,513
Property and equipment............................................................ 1,472
Goodwill.......................................................................... 15,540
Customer lists.................................................................... 2,300
Prepaid and other assets.......................................................... 812
Accounts payable.................................................................. (43,061)
Accrued expenses.................................................................. (1,722)
Short-term borrowings............................................................. (17,139)
---------
Total............................................................................. $ 40,437
---------
---------
</TABLE>
During November 1998, the Company and Star Video settled an arbitration
proceeding relating to the acquisition of Star Video regarding the valuation of
certain accounts receivables and payables. The settlement resulted in the
reduction of approximately $1,500,000 of accounts payable and $500,000 of notes
payable no longer due to the previous owners of Star Video and a $2,000,000
decrease in goodwill.
The following unaudited pro forma information has been presented as if the
acquisition of business of Star Video had occurred at the beginning of each
fiscal year presented. The unaudited pro forma information is based on
historical results of operations adjusted for purchase price adjustments and, in
the opinion of management, is not necessarily indicative of what results would
have been if the acquisition had occurred at the beginning of each fiscal year
presented.
<TABLE>
<CAPTION>
--------------------
FISCAL YEARS ENDED
--------------------
MARCH 29, MARCH 28,
1997(1) 1998
--------- ---------
(UNAUDITED)
<S> <C> <C>
DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA
Net sales............................................................... $ 500,353 $ 616,034
Net income.............................................................. 4,849 2,453
Net income per share:
Basic................................................................. $ 1.01 $ 0.51
Diluted............................................................... 0.94 0.47
</TABLE>
- ------------------------
(1) Includes results of operations of Star Video for the fiscal year ended
December 31, 1996
F-11
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. OTHER ACQUISITIONS
During fiscal 1998, the Company acquired inventories and accounts receivable
from a wholesale prerecorded music distributor for a purchase price of $798,000,
which was paid in cash.
In January 1997, the Company acquired the remaining 50% partnership interest in
DNA in exchange for assuming DNA's net liabilities of $1,328,000. Simultaneous
with the acquisition, the Company repaid DNA's line of credit balance of
$3,133,000 utilizing borrowings from the Company's line of credit. The
transaction resulted in goodwill of $747,000. The Company provided certain
services (including warehousing, data processing and order processing) to DNA
through January 1997. The Company received $3,606,000 and $2,403,000 from DNA
for such services during fiscal 1996 and fiscal 1997, respectively.
Additionally, the Company purchased products from DNA totaling $5,201,000, and
$4,274,000 during fiscal 1996 and fiscal 1997, respectively.
Summarized financial information for DNA is as follows:
<TABLE>
<CAPTION>
------------------------
FISCAL YEARS ENDED
------------------------
MARCH 30, MARCH 29,
1996 1997
----------- -----------
DOLLARS IN THOUSANDS
<S> <C> <C>
Net sales............................................................... $ 36,079 $ 23,540
Gross profit............................................................ 5,777 5,176
Operating income (loss)................................................. (1,248) 108
Net loss................................................................ (1,807) (414)
</TABLE>
During fiscal 1997, the Company acquired certain assets from three wholesale
prerecorded music distributors. The purchase prices totaled $9,346,000, paid in
cash. The purchases included inventory, accounts receivable, trademarks and
copyrights and a covenant not to compete, and resulted in goodwill and other
intangibles of $1,766,000.
In December 1996, the Company entered into an agreement to acquire certain
Stereophile, Inc. ("Stereophile") assets, a publisher of quarterly and annual
comprehensive classical music guides. Stereophile is owned by a Director of the
Company. The Company accounted for this transaction as an acquisition. The total
purchase price was $702,000, comprised of cash paid of $150,000, notes payable
and other liabilities assumed of $226,000 and common stock of $326,000 (58,129
shares of common stock which were issued in December 1997 at a fair value of
approximately $5.60 per share based upon an independent valuation of the
Company.) The Company allocated the total purchase price to the fair value of
the net assets acquired; $355,000 was allocated to identifiable intangible
assets (music databases based upon estimated costs to replicate the databases)
and $347,000 was allocated to goodwill.
F-12
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. OTHER ACQUISITIONS (CONTINUED)
The above acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the operations of these businesses and net assets
have been included in the Company's consolidated financial statements from their
respective dates of acquisition and were not material to the results of
operations of the Company.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
-------------------------------
MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1997 1998 1998
--------- --------- ---------
<S> <C> <C> <C>
Machinery and equipment........................................ $ 4,836 $ 9,682 $ 9,893
Office furniture and equipment................................. 4,953 6,733 9,817
Computer software.............................................. 2,765 5,045 6,252
Leasehold improvements......................................... 1,064 1,273 2,936
--------- --------- ---------
Total...................................................... 13,618 22,733 28,898
Less accumulated depreciation and amortization................. (4,533) (7,052) (9,768)
--------- --------- ---------
Property and equipment, net.................................... $ 9,085 $ 15,681 $ 19,130
--------- --------- ---------
--------- --------- ---------
</TABLE>
The Company leases some of its office furniture and equipment under capital
leases. At March 29, 1997, March 28, 1998 and December 26, 1998 property and
equipment recorded under capital leases was $1,051,000, $3,850,000, and
$4,361,000, respectively. Related accumulated amortization was $252,000,
$518,000 and $948,000, respectively.
6. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangibles consist of:
<TABLE>
<CAPTION>
-------------------------------
MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1997 1998 1998
--------- --------- ---------
<S> <C> <C> <C>
Goodwill....................................................... $2,508 $18,165 $15,569
Identifiable intangible assets, primarily customer lists....... 241 2,554 2,554
--------- --------- ---------
Total...................................................... 2,749 20,719 18,123
Less accumulated amortization.................................. (123) (1,679) (3,059)
--------- --------- ---------
Goodwill and other intangibles, net............................ $2,626 $19,040 $15,064
--------- --------- ---------
--------- --------- ---------
</TABLE>
7. REVOLVING LINE OF CREDIT
At December 26, 1998, the Company has a revolving line of credit agreement
("Credit Facility") that provides for borrowings up to the lesser of
$200,000,000 or the amount of collateral availability. Collateral availability
is limited to 77% of eligible accounts receivable plus the lesser of 62% of cost
or 91% of net realizable value of inventories (subject to certain limitations as
to video and DNA inventories, as defined in the Credit Facility). The Credit
Facility bears interest, at the Company's election, at prime plus a margin of 0%
to 0.5% or the Eurodollar Rate plus a margin of 2.0% to 2.75%, subject to
monthly adjustments and
F-13
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. REVOLVING LINE OF CREDIT (CONTINUED)
certain terms and conditions stated in the Credit Facility. At December 26,
1998, the average interest rate on outstanding borrowings was 7.59%. The Credit
Facility requires a monthly fee of 0.38% on the amount by which 80% of the
available borrowings exceeds the average daily principal balance of outstanding
loans and letters of credit (which were $16,075,000 at December 26, 1998).
Borrowings under the Credit Facility are secured by all eligible accounts
receivable, inventory, certain equipment, and other intangible property of the
Company. The Credit Facility contains various covenants, including among other
things, compliance with adjusted net worth requirements, restriction of
encumbrances, indebtedness, loans, investments and guarantees and restriction on
the payment of cash dividends. Dividends are restricted to 25% of fiscal year
net income, subject to certain borrowing availability requirements. At December
26, 1998, no dividends were allowable under the Credit Facility. The Credit
Facility expires on May 21, 2001 and renews annually thereafter unless notice is
given by either party.
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 (net of income tax
benefit of $477) or $0.13 per diluted share.
8. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
---------------------------------
MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1997 1998 1998
--------- --------- -----------
<S> <C> <C> <C>
Various notes payable in monthly installments of $50, interest
at 8.8% to 9.5%, due January and July 2002, secured by
equipment..................................................... $ 1,725
Note payable in monthly installments of $52, interest at the
treasury rate plus 3.2% (8.7% on December 26, 1998), due
November 2000, secured by equipment........................... $ 1,971 $ 1,494 1,152
Various notes payable in monthly installments totaling $16,
interest at 9.3% on March 28, 1998, due at various dates
through October 1998, secured by equipment.................... 595 79
10% unsecured promissory note due with accrued interest May
2000.......................................................... 500
10% unsecured promissory note due December 1998, interest due
quarterly beginning December 1997............................. 100 100
Capital lease obligations (see Note 9)......................... 786 3,260 3,256
Unsecured notes payable to related parties, interest at 8%,
payable monthly, due on demand................................ 63 67
--------- --------- -----------
Total........................................................ 3,515 5,500 6,133
Less current portion........................................... (1,258) (2,334) (1,786)
--------- --------- -----------
Total long-term debt........................................... $ 2,257 $ 3,166 $ 4,347
--------- --------- -----------
--------- --------- -----------
</TABLE>
F-14
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. LONG-TERM DEBT (CONTINUED)
Scheduled principal maturities as of December 26, 1998 for calendar years are as
follows:
<TABLE>
<S> <C>
---------
DOLLARS IN THOUSANDS
1999.............................................................................. $1,786
2000.............................................................................. 1,861
2001.............................................................................. 1,049
2002.............................................................................. 593
2003.............................................................................. 403
Thereafter........................................................................ 441
---------
Total........................................................................... $6,133
---------
---------
</TABLE>
9. COMMITMENTS AND CONTINGENCIES
The Company has several capital leases for office furniture and equipment. The
Company also leases computer equipment and office and warehouse facilities and
equipment under noncancelable operating leases. During fiscal 1996, fiscal 1997,
fiscal 1998 and the nine months ended December 26, 1998, total rent expense
under all operating leases was $1,217,000, $1,479,000, $3,125,000 and
$4,325,000, respectively. The Company was reimbursed $134,000 and $231,000 by
DNA related to these expenditures in fiscal 1996 and 1997, respectively.
As of December 26, 1998, the Company had commitments to purchase equipment of
approximately $332,000.
Future minimum payments under capital leases and noncancelable operating leases
with terms of one year or more at December 26, 1998 for calendar years consisted
of the following:
<TABLE>
<CAPTION>
---------------------
CAPITAL OPERATING
DOLLARS IN THOUSANDS LEASES LEASES
---------- ---------
<S> <C> <C>
1999.................................................................... $1,048 $6,084
2000................................................................... 952 5,039
2001................................................................... 575 3,129
2002................................................................... 466 2,377
2003................................................................... 462 2,554
Thereafter............................................................. 462 4,366
---------- ---------
Total lease payments................................................. 3,965 $23,549
---------
---------
Less amounts representing interest....................................... (709)
----------
Present value of net minimum lease payments.............................. $3,256
----------
----------
</TABLE>
In the ordinary course of its business the Company is a party to certain claims
and legal actions. After consulting with legal counsel, the management of the
Company believes that the ultimate resolution of these matters will not have a
material adverse effect on the consolidated financial statements of the Company
taken as a whole.
F-15
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
The income tax provision (benefit) consists of the following:
<TABLE>
<CAPTION>
--------------------------------------------------
NINE MONTHS
FISCAL YEARS ENDED ENDED
------------------------------------- -----------
MARCH 30, MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1996 1997 1998 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Income tax expense:
Current
Federal........................................ $ 551 $ 215 $ 98 $ 3,374
State.......................................... 201 74 3 764
----------- ----- ----------- -----------
Total........................................ 752 289 101 4,138
Deferred
Federal........................................ 244 102 1,417 (1,454)
State.......................................... 20 19 516 (227)
----------- ----- ----------- -----------
Total........................................ 264 121 1,933 (1,681)
----------- ----- ----------- -----------
Income tax provision (benefit)..................... $ 1,016 $ 410 $ 2,034 $ 2,457
----------- ----- ----------- -----------
----------- ----- ----------- -----------
</TABLE>
The Company's effective tax rate differs from the federal statutory rate of 34%
as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NINE MONTHS
FISCAL YEARS ENDED ENDED
------------------------------------------------------- ---------------
MARCH 30, 1996 MARCH 29, 1997 MARCH 28, 1998 DEC. 26, 1998
----------------- ----------------- ----------------- ---------------
Federal tax at statutory rate....... 34.0% 34.0% 34.0% 35.0%
State income taxes, net of Federal
benefit............................ 6.0 6.1 5.8 5.8
True-up of prior year tax returns... (2.1)
Other............................... 1.2 0.1 0.4 (0.6)
--- --- --- -----
Total............................... 41.2% 40.2% 40.2% 38.1%
--- --- --- -----
--- --- --- -----
</TABLE>
F-16
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The significant components of the Company's deferred tax assets (liabilities)
are as follows:
<TABLE>
<CAPTION>
-------------------------------------
<S> <C> <C> <C>
MARCH 29, MARCH 28, DEC. 26,
DOLLARS IN THOUSANDS 1997 1998 1998
----------- ----------- -----------
Deferred tax assets
Investment in joint venture.................................. $ 420
Allowance for doubtful accounts.............................. 235 $ 1,086 $ 2,361
Capitalized inventory costs.................................. 134 117 363
Accrued vacation............................................. 109 126 280
Nondeductible reserves....................................... 362 883
Deferred state taxes......................................... 182 288
ESOP contributions........................................... 70 105
Other........................................................ 238 485 675
----------- ----------- -----------
Total deferred tax assets................................ 1,136 2,428 4,955
----------- ----------- -----------
Deferred tax liabilities
Fair value adjustment on customer receivables................ (3,517) (3,061)
Capitalized software......................................... (807) (1,210) (1,005)
Depreciation and amortization................................ (554) (758) (1,442)
Other........................................................ (46) (13) (324)
----------- ----------- -----------
Total deferred tax liabilities........................... (1,407) (5,498) (5,832)
----------- ----------- -----------
Net deferred tax liability..................................... $ (271) $ (3,070) $ (877)
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS
During fiscal 1997, the Company repurchased 139,777 shares of common stock at
approximately $3.58 per share from the principal shareholder. The repurchase
price was based upon an independent valuation of the Company and no compensation
was recorded. In the nine months ended December 26, 1998, the Company's
principal shareholder sold approximately 111,756 shares of common stock at $9.95
per share to certain members of the Company's Board of Directors.
STOCK OWNERSHIP PLAN
The Company's employee stock ownership plan ("ESOP") is a defined contribution
plan covering substantially all full-time employees who meet minimum age and
length of service requirements. The ESOP requires annual Company contributions
of 1% of eligible employees' annual compensation in the form of common stock,
cash or any combination thereof. ESOP contribution expense, which represented 1%
of eligible compensation and was paid in cash, totaled $140,000, $164,000,
$216,000 and $196,000 for fiscal 1996, fiscal 1997, fiscal 1998 and nine months
ended December 26, 1998, respectively. Participant accounts become 20% vested
upon completion of three years service and vest an additional 20% in each
succeeding year. At March 30, 1996, March 29, 1997, March 28, 1998 and December
26, 1998, the
F-17
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS (CONTINUED)
ESOP held 845,598, 830,674, 798,234 and 798,234 shares, respectively, all of
which were allocated to participants. All ESOP shares are considered outstanding
for net income per share calculations.
Upon termination of employment or retirement, distributions to participants are
made based upon their vested account balances. Prior to the completion of the
Company's initial public offering, upon distribution of shares, participants
may, at their option, require the Company to repurchase ESOP shares distributed,
at fair value. The Company repurchased and retired 36,625, 14,930 and 32,441
ESOP shares during fiscal 1996, fiscal 1997 and fiscal 1998, respectively. The
purchase price in each period was based upon an independent valuation of the
Company. At March 28, 1998 and December 26, 1998, the fair value of allocated
shares which were subject to a repurchase obligation was approximately $4.6
million and $7.9 million respectively. As permitted by its terms, the ESOP has
suspended all distributions until after the completion of the Company's initial
public offering.
STOCK OPTION PLANS
Under the 1994 and 1997 Stock Option Plans, there were 2,090,400 shares of
common stock reserved for which the Company could grant options to eligible
employees, directors, and consultants at prices not less than the fair market
value at the date of grant for incentive stock options and not less than 85% of
the fair market value at the date of grant for nonqualified stock options.
Options granted under the Plans generally vest over four years, and expire 10
years from the date of grant.
All stock options have been granted at fair market value. The fair market values
were determined by the Company's Board of Directors based upon independent
valuations of the Company as of March 30, 1996, March 29, 1997 and March 28,
1998, adjusted for material changes in business circumstances, as appropriate.
No compensation expense has been recognized in connection with any stock option
grants or sales of common stock by the Company's principal shareholder.
F-18
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS (CONTINUED)
Outstanding options under both plans are summarized as follows:
<TABLE>
<CAPTION>
---------------------------------------------
<S> <C> <C> <C> <C>
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE OPTIONS EXERCISE
OPTIONS PRICE EXERCISABLE PRICE
--------- ---------- ---------- ----------
Outstanding, April 1, 1995 and March 30, 1996........ 751,447 $2.43
Granted (weighted average fair value of $8.34)....... 117,914 3.65
Forfeited............................................ (67,552) 3.33
---------
Outstanding, March 29, 1997.......................... 801,809 2.53 200,397 $2.43
Granted (weighted average fair value of $8.59)....... 368,577 4.48
Forfeited............................................ (22,753) 5.05
---------
Outstanding, March 28, 1998.......................... 1,147,633 3.11 759,386 2.54
Granted (weighted average fair value of $16.17)...... 219,291 9.54
Exercised............................................ (89,557) 2.59
Forfeited............................................ (62,880) 6.21
---------
Outstanding, December 26, 1998....................... 1,214,487 4.24 784,452 $2.81
---------
---------
</TABLE>
At December 26, 1998, there were 786,352 shares available for future grant under
both plans. Subsequent to December 26, 1998, the Company granted approximately
6,000 options to purchase the Company's common stock at $11.19 per share.
In the nine months ended December 26, 1998, certain officers exercised options
to purchase 89,556 shares of common stock. The exercise price was paid by
$232,000 in shareholder notes, with interest at 8.5%, due in three years.
Subsequent to December 26, 1998, certain officers exercised options to purchase
48,160 shares of common stock in exchange for shareholder notes of $125,000.
The following table summarizes information about both plans at December 26,
1998:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
WEIGHTED WEIGHTED
RANGE OF AVERAGE AVERAGE
EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
PRICES OUTSTANDING PRICE EXERCISABLE PRICE
- --------- --------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
$2.43 656,553 2.43 651,642 2.43
3.73 53,329 3.73 21,394 3.73
4.35 269,234 4.35 93,593 4.35
5.60 37,788 5.60 7,903 5.60
5.85 8,040 5.85 1,173 5.85
9.95 159,393 9.95 8,747 9.95
11.19 30,150 11.19 - 11.19
--------- ------ ----------- ------
1,214,487 $ 4.24 784,452 $ 2.82
--------- -----------
--------- -----------
</TABLE>
F-19
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS (CONTINUED)
ADDITIONAL STOCK PLAN INFORMATION
SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires the disclosure
of pro forma net income as if the Company had adopted the fair value method as
of the beginning of fiscal 1996. Under SFAS No. 123, the fair value of
stock-based awards to employees is calculated through the use of option pricing
models, even though such models were developed to estimate the fair value of
freely tradable, fully transferable options without vesting restrictions, which
significantly differ from the Company's stock option awards. These models also
require subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Company's calculations were made using the minimum value option pricing model
with the following weighted average assumptions: expected life, five years
following grant date; risk free interest rates, 5.6%-7.0%; and no dividends
during the expected term. The Company's calculations are based on a multiple
option valuation approach and forfeitures are recognized as they occur. If the
computed fair values of the fiscal 1997, fiscal 1998 and the nine months ended
December 26, 1998 awards had been amortized to expense over the vesting period
of the awards, pro forma net income would have been $610,000 or $0.12 per
diluted share in fiscal 1997, $2,979,000 or $0.57 per diluted share in fiscal
1998 and $3,200,000 or $0.58 per diluted share in the nine months ended December
26, 1998. As no awards were granted in fiscal 1996, pro forma net income does
not differ from the reported amounts. However, the impact of outstanding
nonvested stock options granted prior to fiscal 1996 has been excluded from the
pro forma calculation; accordingly, the fiscal 1997, fiscal 1998 and the nine
months ended December 26, 1998 pro forma adjustment is not indicative of future
period pro forma adjustments, when the calculation will apply to all applicable
stock options.
EMPLOYEE RETIREMENT PLAN
In April 1995, the Company adopted an employee retirement plan intended to be
qualified under Section 401(k) of the Internal Revenue Code. Participation in
the plan is available to substantially all employees. Generally, employees may
contribute up to 17% of their annual compensation to the plan on a pre-tax
basis. Under the plan, the Company makes matching contributions of 50% up to a
maximum of 4% of each participating employee's annual compensation. The
Company's contributions to the plan totaled $115,000, $164,000, $282,000 and
$264,000 in fiscal 1996, fiscal 1997, fiscal 1998 and the nine months ended
December 26, 1998, respectively.
F-20
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. NET INCOME PER SHARE
A reconciliation of basic to diluted weighted average shares used in the
calculation of net income per share is as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------
FISCAL YEARS ENDED NINE MONTHS ENDED
------------------------------- ----------------------
MARCH 30, MARCH 29, MARCH 28, DEC. 26,
1996 1997 1998 DEC. 27, 1998
--------- --------- --------- 1997 ---------
-----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Weighted average shares used in the
calculation-basic..................... 4,965,375 4,797,193 4,791,864 4,782,447 4,838,413
Effect of dilutive stock options....... 258,665 334,148 472,006 462,798 716,302
--------- --------- --------- ----------- ---------
Weighted average shares used in the
calculation-diluted................... 5,224,040 5,131,341 5,263,870 5,245,245 5,554,715
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
</TABLE>
F-21
<PAGE>
INDEPENDENT AUDITORS' REPORT
Valley Media, Inc.:
We have audited the accompanying statements of operations and changes in net
assets acquired and of cash flows of Star Video Entertainment, L.P. ("Star
Video") for the years ended December 31, 1995 and 1996 and for the period from
January 1, 1997 to May 20, 1997. These financial statements are the
responsibility of the management of Valley Media, Inc...........................
Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the results of operations and cash flows of Star Video for the years
ended December 31, 1995 and 1996 and for the period from January 1, 1997 to May
20, 1997 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California
July 22, 1998
F-22
<PAGE>
STAR VIDEO
STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS ACQUIRED
<TABLE>
<CAPTION>
-----------------------------------
PERIOD FROM
YEAR ENDED DECEMBER JANUARY 1,
31, 1997
-------------------- TO MAY 20,
DOLLARS IN THOUSANDS 1995 1996 1997
--------- --------- -------------
<S> <C> <C> <C>
Net sales................................................ $ 253,083 $ 301,122 $102,115
Cost of goods sold....................................... 227,520 272,870 93,006
--------- --------- -------------
Gross profit............................................. 25,563 28,252 9,109
Selling, general and administrative expenses............. 17,229 16,280 10,325
--------- --------- -------------
Operating income (loss).................................. 8,334 11,972 (1,216)
Interest expense......................................... 505 603 270
--------- --------- -------------
Net income (loss)........................................ 7,829 11,369 (1,486)
Net assets acquired, beginning of period................. 14,893 19,609 26,129
Distributions to partners................................ (3,113) (4,849) (1,803)
--------- --------- -------------
Net assets acquired, end of period....................... $ 19,609 $ 26,129 $ 22,840
--------- --------- -------------
--------- --------- -------------
</TABLE>
See notes to financial statements.
F-23
<PAGE>
STAR VIDEO
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
-----------------------------------
PERIOD FROM
YEAR ENDED JANUARY 1,
DECEMBER 31, 1997
-------------------- TO MAY 20,
DOLLARS IN THOUSANDS 1995 1996 1997
--------- --------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)....................................... $ 7,829 $ 11,369 $ (1,486)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 573 641 275
Bad debt expense........................................ 169 308 924
Changes in assets and liabilities:
Accounts receivables.................................. (25,841) (12,958) 28,931
Inventories........................................... (1,333) (1,957) (542)
Prepaid expenses and other............................ (440) 645 (5)
Accounts payable...................................... 6,896 9,440 (37,333)
Accrued expenses...................................... 156 382 (227)
--------- --------- -------------
Net cash provided by (used in) operating
activities......................................... (11,991) 7,870 (9,463)
--------- --------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment..................... (698) (862) (282)
--------- --------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net short-term borrowings (repayments).................. 3,791 (1,895) 15,243
Repayment of long-term debt............................. (144) (54)
Other................................................... (14) (138) (99)
Distributions to partners............................... (3,113) (4,849) (1,803)
--------- --------- -------------
Net cash provided by (used in) financing
activities......................................... 520 (6,936) 13,341
--------- --------- -------------
NET INCREASE (DECREASE) IN CASH........................... (12,169) 72 3,596
CASH, Beginning of period................................. 12,198 29 101
--------- --------- -------------
CASH, End of period....................................... $ 29 $ 101 $ 3,697
--------- --------- -------------
--------- --------- -------------
</TABLE>
See notes to financial statements.
F-24
<PAGE>
STAR VIDEO
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SALE OF BUSINESS TO VALLEY MEDIA, INC.
Star Video Entertainment, L.P. (the "Partnership") was engaged primarily in the
distribution of pre-recorded videocassettes, games and accessories and also
provided rental ready services as well as racking services for certain
customers. Distribution facilities were in New Jersey, Pennsylvania,
Massachusetts, New York and Indiana and products were sold primarily to retail
stores throughout the United States. The Partnership purchased approximately 30%
of video products from a single vendor.
On May 20, 1997, Valley Media, Inc. acquired substantially all of the
Partnership's assets and assumed certain Partnership liabilities. The total
purchase price was $37,872,000. The purchase price is subject to adjustment in
the future depending upon the ultimate resolution of an arbitration proceeding
between Valley Media, Inc. and the Partnership.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying financial statements present the results of operations and cash
flows of the net assets acquired by Valley Media, Inc. from the Partnership on
May 20, 1997. Such net assets acquired represent substantially all of the
business operations of the Partnership during the periods presented and are
referred to as "Star Video" in the accompanying financial statements and notes.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Significant estimates include allowances for doubtful accounts and vendor
receivables. Actual results could differ from those estimates.
REVENUE RECOGNITION
Sales are recognized upon shipment of pre-recorded videocassettes and other
related products net of returns and allowances. Net sales also include fees for
services.
CONCENTRATION OF CREDIT RISK
Star Video is subject to credit risk through sales and related trade accounts
receivable to retailers. Star Video routinely assesses the financial strength of
significant customers and this assessment, combined with the large number and
geographic diversity of its customers, limits Star Video's concentration of
credit risk with respect to trade accounts receivable.
F-25
<PAGE>
STAR VIDEO
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
No provision for income taxes has been recorded within Star Video's financial
statements since they were includable in the income tax returns of the partners
of the Partnership.
3. SHORT-TERM BORROWINGS
On December 26, 1991, Star Video entered into a revolving line of credit
agreement ("Agreement") with BTM Capital Corporation ("BTM") that provided for
borrowings up to the lesser of $30,000,000 or 75% of eligible accounts
receivable and 50% of eligible inventory. The line of credit bore interest at
prime plus 1% (9.5% at May 20, 1997). The Agreement provided for a commitment
fee of 0.38% on the unused portion of the line. Borrowings were secured by all
eligible accounts receivable, inventory, equipment and other tangible property
of Star Video. The Agreement was due to expire June 1, 1998.
Letters of credit of $200,000 and $7,940,000 were outstanding as of December 31,
1995 and 1996, respectively, which were issued to various vendors by BTM.
The Agreement contained various financial covenants, including among other
things, compliance with debt ratios, capital expenditure limits, net worth
limits and restrictions on the payment of amounts to the partners. As of
December 31, 1995 and 1996, Star Video was not in compliance with one of the
financial covenants of the Agreement. On March 7, 1996 and March 14, 1997, the
Company subsequently obtained from BTM a waiver of the respective defaults as of
December 31, 1995 and 1996, respectively.
On May 20, 1997, concurrent with the acquisition of the net assets of Star Video
by Valley Media, Inc., the outstanding loan balance of $14,529,000 and other
short-term borrowings of $2,610,000 were paid by Valley Media, Inc. Upon payment
of the outstanding balance, the Agreement was terminated.
4. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
Star Video leases office and warehouse facilities and equipment under
noncancelable operating leases. During 1995, 1996 and the period from January 1,
1997 to May 20, 1997, total rent expense under operating leases was
approximately $950,000, $1,023,000 and $439,000, respectively.
Star Video leases its executive offices and warehouse in New Jersey from an
affiliate of the Partnership under the terms of the lease expiring in 2000 and
requiring minimum annual rentals of $224,000. Star Video has deposited $90,000
with the affiliate as rent security and Star Video is paid interest at the rate
of 8% per annum.
F-26
<PAGE>
STAR VIDEO
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum payments under noncancelable operating leases with terms of one
year or more consisted of the following at May 20, 1997:
<TABLE>
<S> <C>
DOLLARS IN THOUSANDS
For the period ending December 31
1997.............................................................. $ 630
1998.............................................................. 726
1999.............................................................. 484
2000.............................................................. 279
---------
Total lease payments................................................ $ 2,119
---------
---------
</TABLE>
F-27
<PAGE>
UNAUDITED PRO FORMA FINANCIAL INFORMATION OF VALLEY MEDIA, INC.
The unaudited pro forma consolidated statement of income of Valley Media, Inc.
for the fiscal year ended March 28, 1998 gives effect to the May 20, 1997
acquisition of the net assets of Star Video Entertainment, L.P. ("Star Video"),
for approximately $37,900,000, as if it had occurred as of March 30, 1997, the
beginning of Valley Media, Inc.'s 1998 fiscal year. The acquisition of Star
Video was accounted for under the purchase method of accounting.
Unaudited pro forma adjustments are based upon historical information,
preliminary estimates and certain assumptions that Valley Media, Inc. deems
appropriate. The unaudited pro forma financial information presented herein is
not necessarily indicative of the results of Valley Media, Inc. that would have
been obtained had such acquisition of the net assets of Star Video occurred at
the beginning of the fiscal year, or of the future results of Valley Media, Inc.
The pro forma consolidated statement of income should be read in conjunction
with the consolidated financial statements of Valley Media, Inc. and Star Video
appearing elsewhere in this Prospectus.
F-28
<PAGE>
VALLEY MEDIA, INC.
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FISCAL YEAR ENDED MARCH 28, 1998(1)
<TABLE>
<CAPTION>
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PRO FORMA
VALLEY MEDIA, STAR VIDEO FISCAL
INC. APRIL 1, YEAR
FISCAL YEAR 1997- ENDED
DOLLARS IN THOUSANDS, EXCEPT PER ENDED MARCH MAY 20, PRO FORMA MARCH 28,
SHARE DATA 28, 1998 1997(2A) ADJUSTMENTS 1998
------------- ----------- ---------- ---------
Net sales........................ $583,492 $ 32,542 $ 616,034
Cost of goods sold............... 516,627 29,081 545,708
------------- ----------- ---------
Gross profit..................... 66,865 3,461 70,326
Selling, general and
administrative expenses......... 55,183 3,590 $ 193 (2b) 58,966
------------- ----------- ---------- ---------
Operating income................. 11,682 (129) (193) 11,360
Interest expense................. 6,627 86 396 (2c) 7,109
------------- ----------- ---------- ---------
Income (loss) before income
taxes........................... 5,055 (215) (589) 4,251
Income taxes..................... 2,034 (236) (2d) 1,798
------------- ----------- ---------- ---------
Net income (loss)................ $ 3,021 $ (215) $ (353) $ 2,453
------------- ----------- ---------- ---------
------------- ----------- ---------- ---------
Net income per share:
Basic.......................... $ 0.63 $ 0.51
------------- ---------
------------- ---------
Diluted........................ $ 0.57 $ 0.47
------------- ---------
------------- ---------
Weighted average number of shares
outstanding:
Basic.......................... 4,791,864 4,791,864
------------- ---------
------------- ---------
Diluted........................ 5,263,870 5,263,870
------------- ---------
------------- ---------
</TABLE>
See accompanying notes to unaudited pro forma consolidated statement of
operations.
F-29
<PAGE>
VALLEY MEDIA, INC.
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED
STATEMENT OF OPERATIONS
1. BASIS OF PRESENTATION
The accompanying unaudited pro forma consolidated statement of operations
presents the results of operations of Valley Media, Inc. for the fiscal year
ended March 28, 1998 as if the acquisition of the net assets of Star Video
Entertainment, L.P. ("Star Video") had occurred as of March 30, 1997 the
beginning of Valley Media, Inc.'s 1998 fiscal year.
2. PRO FORMA ADJUSTMENTS TO UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF
OPERATIONS
(a) To reflect the inclusion of the operating results of Star Video for the
period from March 30, 1997 (April 1, 1997 for accounting purposes) to May
20, 1997.
(b) To reflect the amortization of goodwill of $15,540,000, assuming a 15 year
amortization period and the amortization of customer lists of $2,300,000,
assuming a five year amortization period.
(c) To reflect additional interest expense, assuming an interest rate of 8.2%
(which represents the Company estimated incremental borrowing rate on its
revolving line of credit), as a result of additional borrowing of
$34,728,000 under the Company's revolving line of credit agreement utilized
to fund the acquisition of Star Video.
(d) To reflect the income tax effect (benefit of 40% based upon the Company's
actual effective income tax rate for the fiscal year ended March 28, 1998)
of the loss before income taxes of Star Video for the period from April 1,
1997 to May 20, 1997 and of adjustments (2b) and (2c) noted above.
F-30
<PAGE>
VALLEY MEDIA OFFERS A DEEP PRODUCT SELECTION BUTTRESSED WITH AN ARRAY OF DATA
PRODUCTS AND VALUE-ADDED SERVICES.
VALLEY STOCKS A SELECTION OF OVER 250,000 ITEMS.
<TABLE>
<S> <C>
[Pictures of videos and CDs] [Picture of inventory in Valley
California distribution facility]
[Picture of electronic sorter in Valley WE OFFER FULFILLMENT OF HIT PRODUCT AND
California distribution facility] DEEP CATALOG WITH AN ARRAY OF VALUE-ADDED
SERVICES TO TRADITIONAL AND INTERNET
RETAILERS ALIKE.
VALLEY'S STATE-OF-THE-ART DISTRIBUTION [Map of United States identifying
CENTERS ARE STRATEGICALLY PLACED TO location of Valley facilities]
IMPROVE DELIVERY TIMES, LOWER SHIPPING
COSTS AND IMPROVE PROFITABILITY FOR OUR
COMPANY AND FOR OUR CUSTOMERS.
[Picture of Valley employee using Valley VALLEY HAS BEEN SELECTED BEST IN CLASS
computerized database] SEVEN TIMES BY THE NATIONAL ASSOCIATION
OF RECORDING MERCHANDISERS.
</TABLE>
NARM
BEST IN CLASS AWARD WINNER
<PAGE>
[LOGO]
Until , 1999 (25 days after the date of this prospectus), all dealers
that effect transactions in the common stock, whether or not participating in
this offering, may be required to deliver a prospectus. This is in addition to
the dealer's obligation to deliver a prospectus when acting as an underwriter in
this offering and when selling unsold allotments or subscriptions.
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the costs and expenses payable by Valley in
connection with the sale of the common stock Valley is offering, other than
underwriting commissions and discounts. All amounts, except the SEC registration
fee, the NASD Filing Fee and the Nasdaq National Market listing fee, are
estimates.
<TABLE>
<CAPTION>
----------
ITEM AMOUNT
- ------------------------------------------------------ ----------
<S> <C>
SEC registration fee.................................. $ 15,665
NASD filing fee....................................... 5,100
Nasdaq National Market listing fee.................... 53,750
Blue Sky fees and expenses............................ 5,000
Printing and engraving expenses....................... 130,000
Legal fees and expenses............................... 600,000
Accounting fees and expenses.......................... 600,000
Transfer Agent and Registrar fees..................... 7,500
Miscellaneous expenses................................ 5,000
----------
Total............................................. $1,422,015
----------
----------
</TABLE>
- ---------------------
+ To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
As permitted by Delaware law, Valley's Amended and Restated Certificate of
Incorporation provides that no director will be personally liable to Valley or
its stockholders for monetary damages for breach of fiduciary duty as a
director, except for liability
- for any breach of duty of loyalty to Valley or to its stockholders
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law
- under Section 174 of the Delaware General Corporation Law
- for any transaction from which the director derived an improper personal
benefit
The Amended and Restated Certificate of Incorporation further provides that
Valley must indemnify its directors and executive officers and may indemnify its
other officers and employees and agents to the fullest extent permitted by
Delaware law. Valley believes that indemnification under its Amended and
Restated Certificate of Incorporation covers negligence and gross negligence on
the part of indemnified parties. The Amended and Restated Certificate of
Incorporation also permits Valley to secure insurance on behalf of any officer,
director, employee or other agent for any liability arising out of his or her
actions in such capacity, regardless of whether Delaware law would permit
indemnification.
II-1
<PAGE>
Valley has entered into indemnification agreements with each of its directors
and officers. These agreements, among other things, require Valley to indemnify
such directors and officers for certain expenses (including attorneys' fees),
judgments, fines and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of Valley, arising
out of such person's services as a director or officer of Valley, any subsidiary
of Valley or any other company or enterprise to which the person provides
services at the request of Valley.
The underwriting agreement (Exhibit 1.1) provides for indemnification by the
underwriters of Valley, its directors, its officers who sign the registration
statement, and Valley's controlling persons for certain liabilities, including
liabilities arising under the Securities Act, and affords certain rights of
contribution with respect thereto.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In July 1998, in connection with Valley's reincorporation in Delaware, Valley's
predecessor, a California corporation, was merged into Valley and each
outstanding share of the predecessor's common stock was exchanged for one share
of Valley's common stock. This issuance of securities was deemed exempt from
registration pursuant to Rule 145(a)(2) under the Securities Act.
Since December 1, 1995, Valley has issued and sold the following unregistered
securities:
(1) In December 1997, Valley issued 58,129 shares of its common stock to
Stereophile, 90% of the outstanding shares of which are owned by Lawrence
Archibald, a member of the board. The shares were issued by Valley in connection
with the merger of Schwann Acquisition Corp. into Valley. Prior to the merger,
Valley owned 80% of the outstanding shares of Schwann, while Stereophile owned
the remaining 20%. See "Certain Transactions." The sale and issuance of
securities in this transaction was deemed exempt from registration under Section
4(2) of the Securities Act.
(2) Since December 1, 1995, Valley has granted options to purchase 626,289
shares of common stock to a total of 60 employees, directors and consultants at
a weighted average exercise price of $5.96 per share pursuant to Valley's stock
option plans. These issuances of securities were deemed exempt from registration
under Rule 701 of the Securities Act.
(3) Since April 1, 1998, 9 employees of Valley have exercised options to
purchase a total of 137,715 shares of common stock under Valley's 1994 Stock
Option Plan at an average exercise price of $2.59 per share. These issuances of
securities were deemed exempt from registration under Rule 701 of the Securities
Act.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
EXHIBITS
NUMBER DESCRIPTION OF DOCUMENT
- --------- ---------------------------------------------------------------------
<S> <C>
1.1+ Form of Underwriting Agreement.
3.1* Amended and Restated Certificate of Incorporation.
3.2* Amended and Restated Bylaws.
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C>
4.1 Form of Common Stock Certificate.
4.2* Contribution and Shareholders Agreement, dated December 16, 1996,
between Valley and Stereophile, Inc.
4.3* Stockholder Agreement, dated January 15, 1995, between Valley and
Robert R. Cain.
4.4* Reference is made to Exhibits 3.1 and 3.2.
5.1 Opinion of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A
Professional Corporation, as to the validity of the issuance of the
securities registered hereby.
10.1* Loan and Security Agreement, dated May 21, 1998, between Valley,
Congress Financial Corporation (Northwest) and the institutions
named therein.
10.2* Asset Purchase Agreement, dated May 20, 1997, between Valley and Star
Video Entertainment, L.P.
10.3* Standard Industrial Lease - Net, dated October 6, 1988, between
Valley and Betty Kuhn.
10.4* Build-to-Suit Facility - Absolute Net Lease, dated October 3, 1989,
between Valley and Betty Kuhn.
10.5* Industrial Real Estate Lease, dated May 21, 1992, between Valley and
Panattoni Development Company.
10.6* Build to Suit Lease Agreement, dated October 1, 1997, between Valley
and Pizzuti Equities Inc.
10.7* Form of Indemnification Agreement between Valley and each of its
officers and directors.
10.8* 1994 Stock Option Plan and form of Option Agreement under Plan.
10.8.1* Amendment No. 1 to 1994 Stock Option Plan.
10.9* 1997 Stock Option Plan and form of Option Agreement under Plan.
10.9.1* Amendment No. 1 to 1997 Stock Option Plan.
10.10 Employee Stock Ownership Plan.
10.10.1 Amendment No. 4 to Employee Stock Ownership Plan.
10.10.2 Amendment No. 5 to Employee Stock Ownership Plan.
10.10.3+ Amendment No. 6 to Employee Stock Ownership Plan.
10.11* Form of Severance and Change in Control Agreement between Valley and
its executive officers.
10.12* Management Incentive Plan - Plan Summary.
11.1 Computation of Net Income Per Share.
23.1 Consent of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A
Professional Corporation (included in Exhibit 5.1).
23.2+ Independent Auditors' Consent and Report.
23.3 Independent Auditors' Consent.
24.1* Power of Attorney
27.1 Financial Data Schedule.
</TABLE>
II-3
<PAGE>
<TABLE>
<S> <C>
99.1 Consent of Forrester Research, Inc.
</TABLE>
- ---------------------
* Previously filed.
+ To be filed by amendment.
(b) Financial Statement Schedules
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
<S> <C>
SCHEDULE DESCRIPTION
- ----------- -----------------------------------------------------------------------
II Valuation and Qualifying Accounts
</TABLE>
All other schedules are omitted because they are inapplicable or the requested
information is shown in the consolidated financial statements of Valley or
related notes thereto.
ITEM 17. UNDERTAKINGS.
Valley hereby undertakes to provide to the underwriters at the closing specified
in the underwriting agreements certificates in such denominations and registered
in such names as required by the underwriters to permit prompt delivery to each
purchaser.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of Valley pursuant
to the foregoing provisions, or otherwise, Valley has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by Valley of expenses incurred or paid by a
director, officer or controlling person in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, Valley will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offerings of such securities at that time shall be
deemed to be the initial BONA FIDE offerings thereof.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, Valley has duly caused this
Amendment No. 1 to registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Woodland, State of
California, on the 12(th) day of February 1999.
VALLEY MEDIA, INC.
By: /s/ ROBERT R. CAIN
------------------------------------------
Robert R. Cain
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 1 to Registration Statement has been signed by the following
persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
/s/ BARNET J. COHEN*
- ------------------------------ Chairman of the Board February 12, 1999
Barnet J. Cohen
President, Chief Executive
/s/ ROBERT R. CAIN Officer and Director
- ------------------------------ (Principal Executive February 12, 1999
Robert R. Cain Officer)
/s/ J. RANDOLPH CERF Chief Financial Officer
- ------------------------------ (Principal Financial and February 12, 1999
J. Randolph Cerf Accounting Officer)
/s/ LAWRENCE ARCHIBALD*
- ------------------------------ Director February 12, 1999
Lawrence Archibald
/s/ CHRISTOPHER MOTTERN*
- ------------------------------ Director February 12, 1999
Christopher Mottern
/s/ WENDY PASKIN-JORDAN*
- ------------------------------ Director February 12, 1999
Wendy Paskin-Jordan
/s/ JAMES SHA*
- ------------------------------ Director February 12, 1999
James Sha
<TABLE>
<S> <C> <C> <C>
*By: /s/ J. RANDOLPH CERF
-------------------------
J. Randolph Cerf
ATTORNEY-IN-FACT
</TABLE>
II-5
<PAGE>
SCHEDULE II
VALLEY MEDIA, INC.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
---------------------------------------------------------
COLUMN B
--------- COLUMN C COLUMN E
BALANCE --------------------- ----------
AT CHARGED COLUMN D BALANCE AT
BEGINNING CHARGED TO TO OTHER ----------- END OF
COLUMN A OF PERIOD EXPENSE ACCOUNTS DEDUCTIONS PERIOD
- ------------------------------ --------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Fiscal year ended March 30, 1996:
Inventory reserves.......... $ - $ 428,414 $ - $ (378,014) $ 50,400
Allowance for doubtful
accounts receivable........ 312,800 108,342 - (100,642) 320,500
Customer returns reserve.... 248,433 1,567,061 - (1,529,757) 285,737
Vendor receivables
reserve.................... 18,727 306,988 325,715
--------- ---------- --------- ----------- ----------
Total......................... $ 579,960 $2,410,805 $ - $(2,008,413) $ 982,352
--------- ---------- --------- ----------- ----------
--------- ---------- --------- ----------- ----------
Fiscal year ended March 29, 1997:
Inventory reserves.......... $ 50,400 $ 788,140 $ 451,297 $ (897,913) $ 391,924
Allowance for doubtful
accounts receivable........ 320,500 408,012 194,550 (97,914) 825,148
Customer returns reserve.... 285,737 2,795,640 1,075,822 (2,548,576) 1,608,623
Vendor receivables
reserve.................... 325,715 77,191 44,564 (208,983) 238,487
--------- ---------- --------- ----------- ----------
Total......................... $ 982,352 $4,068,983 $1,766,233(1) $(3,753,386) $3,064,182
--------- ---------- --------- ----------- ----------
--------- ---------- --------- ----------- ----------
Fiscal year ended March 28, 1998:
Inventory reserves.......... $ 391,924 $1,273,409 $ 229,680 $ (308,177) $1,586,836
Allowance for doubtful
accounts receivable........ 825,148 6,077,164 1,833,357 (3,459,488) 5,276,181
Customer returns reserve.... 1,608,623 10,148,343 1,436,200 (9,471,891) 3,721,275
Vendor receivables
reserve.................... 238,487 - 1,695,326 (1,288,465) 645,348
--------- ---------- --------- ----------- ----------
Total......................... $3,064,182 $17,498,916 $5,194,563(2) $(14,528,021) $11,229,640
--------- ---------- --------- ----------- ----------
--------- ---------- --------- ----------- ----------
</TABLE>
- ------------------------
(1) Represents increases in reserves related to inventories and receivables
resulting from DNA acquisition in January 1997.
(2) Represents increases in reserves related to inventories and receivables
resulting from Star Video acquisition in May 1997.
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- --------- ----------------------------------------------------------------------------
1.1+ Form of Underwriting Agreement.
<S> <C>
3.1* Amended and Restated Certificate of Incorporation.
3.2* Amended and Restated Bylaws.
4.1 Form of Common Stock Certificate.
4.2* Contribution and Shareholders Agreement, dated December 16, 1996, between
Valley and Stereophile, Inc.
4.3* Stockholder Agreement, dated January 15, 1995, between Valley and Robert R.
Cain.
4.4* Reference is made to Exhibits 3.1 and 3.2.
5.1 Opinion of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A Professional
Corporation, as to the validity of the issuance of the securities
registered hereby.
10.1* Loan and Security Agreement, dated May 21, 1998, between Valley, Congress
Financial Corporation (Northwest) and the institutions named therein.
10.2* Asset Purchase Agreement, dated May 20, 1997, between Valley and Star Video
Entertainment, L.P.
10.3* Standard Industrial Lease - Net, dated October 6, 1988, between Valley and
Betty Kuhn.
10.4* Build-to-Suit Facility - Absolute Net Lease, dated October 3, 1989, between
Valley and Betty Kuhn.
10.5* Industrial Real Estate Lease, dated May 21, 1992, between Valley and
Panattoni Development Company.
10.6* Build to Suit Lease Agreement, dated October 1, 1997, between Valley and
Pizzuti Equities Inc.
10.7* Form of Indemnification Agreement between Valley and each of its officers
and directors.
10.8* 1994 Stock Option Plan and form of Option Agreement under Plan.
10.8.1* Amendment No. 1 to 1994 Stock Option Plan.
10.9* 1997 Stock Option Plan and form of Option Agreement under Plan.
10.9.1* Amendment No. 1 to 1997 Stock Option Plan.
10.10 Employee Stock Ownership Plan.
10.10.1 Amendment No. 4 to Employee Stock Ownership Plan.
10.10.2 Amendment No. 5 to Employee Stock Ownership Plan.
10.10.3+ Amendment No. 6 to Employee Stock Ownership Plan
10.11* Form of Severance and Change in Control Agreement between Valley and its
executive officers.
10.12* Management Incentive Plan - Plan Summary.
11.1 Computation of Net Income Per Share.
23.1 Consent of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, A Professional
Corporation (included in Exhibit 5.1).
23.2+ Independent Auditors' Consent and Report.
23.3 Independent Auditors' Consent.
24.1* Power of Attorney.
27.1 Financial Data Schedule.
99.1 Consent of Forrester Research, Inc.
</TABLE>
- ---------------------
* Previously filed.
+ To be filed by amendment.
<PAGE>
<TABLE>
<S><C>
NUMBER SHARES
VMI
COMMON STOCK [LOGO] COMMON STOCK
VALLEY MEDIA, INC. SEE REVERSE FOR CERTAIN DEFINITIONS
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE CUSIP 91972C 10 6
THIS CERTIFIES THAT
IS THE RECORD HOLDER OF
FULLY PAID AND NONASSESSABLE SHARES OF THE COMMON STOCK, $.001 PAR VALUE, OF
VALLEY MEDIA, INC.
transferable on the books of the Corporation by the holder hereof in person or by duly authorized attorney upon surrender of this
Certificate properly endorsed. This Certificate is not valid until countersigned and registered by the Transfer Agent and
Registrar.
WITNESS the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers.
Dated:
/s/ J. Randolph Cerf /s/ Robert R. Cain
SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER [SEAL] PRESIDENT AND CHIEF EXECUTIVE OFFICER
AND SECRETARY
COUNTERSIGNED AND REGISTERED:
NORWEST BANK MINNESOTA, N.A.
TRANSFER AGENT AND REGISTRAR
BY
AUTHORIZED SIGNATURE
<PAGE>
A statement of the powers, designations, preferences and relative, participating, optional or other special rights of each
class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights as
established, from time to time, by the Certificate of Incorporation of the Corporation and by any certificate of designation, and
the number of shares constituting each class and series and the designations thereof, may be obtained by the holder hereof upon
request and without charge from the Corporation at its principal office.
The following abbreviations, when used in the inscription on the face of this certificate, shall be construed as though they
were written out in full according to applicable laws or regulations:
TEN COM -- as tenants in common UNIF GIFT MIN ACT -- ......................... Custodian .......................
TEN ENT -- as tenants by the entireties (Cust) (Minor)
JT TEN -- as joint tenants with right of under Uniform Gifts to Minors
survivorship and not as tenants Act........................................................
in common (State)
UNIF TRF MIN ACT -- ................. Custodian (until age ...................)
(Cust)
............................ under Uniform Transfers
(Minor)
to Minors Act.............................................
(State)
Additional abbreviations may also be used though not in the above list.
FOR VALUE RECEIVED,______________________________________________________________________ hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
______________________________________
______________________________________
___________________________________________________________________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS, INCLUDING ZIP CODE, OF ASSIGNEE)
___________________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________ Shares
of the common stock represented by the within Certificate, and do hereby irrevocably constitute and appoint
__________________________________________________________________________________________________________________________ Attorney
to transfer the said stock on the books of the within named Corporation with full power of substitution in the premises.
Dated_______________________________
__________________________________________________________________
THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME AS
NOTICE: WRITTEN UPON THE FACE OF THE CERTIFICATE IN EVERY PARTICULAR,
WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATEVER.
Signature(s) Guaranteed
By_______________________________________________________________
THE SIGNATURE(S) MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR
INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS
AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE
GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15.
</TABLE>
<PAGE>
[HOWARD RICE LETTERHEAD]
February 12, 1999
Valley Media, Inc.
1280 Santa Anita Court
Woodland, California 95776
Re: 3,500,000 SHARES OF COMMON STOCK, PAR VALUE $0.001 PER SHARE
Ladies and Gentlemen:
You have requested our opinion of counsel for Valley Media, Inc., a
Delaware corporation (the "Company"), in connection with the registration
statement on Form S-1 (together with all amendments and exhibits thereto, the
"Registration Statement") filed with the Securities and Exchange Commission with
respect to the registration under the Securities Act of 1933, as amended (the
"Securities Act"), of 3,500,000 shares of Common Stock of the Company (the
"Offered Shares").
We have examined originals or copies certified or otherwise identified
to our satisfaction as authentic copies of the Registration Statement, the
Amended and Restated Certificate of Incorporation and Amended and Restated
Bylaws of the Company, resolutions and unanimous written consents of the Board
of Directors of the Company, certificates of one or more officers of the
Company, and such other corporate records of the Company and other documents of
which we are aware as we considered necessary for purposes of enabling us to
render the opinion set forth below.
In connection with this opinion we have assumed the following: (a)
the authenticity of original documents and the genuineness of all signatures;
(b) the conformity to the originals of all documents submitted to us as copies;
(c) the truth, accuracy and completeness of the information, representations and
warranties contained in the instruments, documents, records and certificates we
have reviewed; and (d) the due authorization, execution and delivery on behalf
of
<PAGE>
the respective parties thereto of the documents referred to herein. As to
matters of fact material to our opinions, we have relied on our review of the
documents referred to above and statements made to us by officers of the
Company. We have not independently verified any factual matters or any
assumptions made by us in this letter and disclaim any inference as to the
reasonableness of any such assumption.
Based upon the foregoing and subject to the exceptions, qualifications
and limitations set forth hereinafter, we are of the opinion that upon the
issuance and sale of the Offered Shares in accordance with the terms of the
Registration Statement, the Offered Shares will be legally issued, fully paid
and non-assessable.
We are members of the bar of the State of California and are not
admitted to practice in any other jurisdiction. The opinions set forth above
are limited in all respects to matters governed by the federal laws of the
United States of America and the General Corporation Law of the State of
Delaware.
The opinion set forth herein is given as of the date hereof and is
expressly limited to the matters stated. No opinion is implied or may be
inferred beyond what is explicitly stated in this letter. We disclaim any
obligation to notify you or any other person or entity after the date of this
letter if any change in fact or law should change our opinion with respect to
any matter on which we are expressing an opinion herein.
We are delivering this opinion to the Company solely to satisfy the
requirement of the Securities and Exchange Commission set forth in Item 601(a)
and Item 601(b)(5)(i) of Regulation S-K under the Securities Act and no other
person may rely on it. Copies of this letter may not be circulated or furnished
to any other person or entity, and this letter may not be referred to in any
report or document furnished to any other person or entity, without our prior
written consent.
<PAGE>
We consent to the use of this opinion as an exhibit to the
Registration Statement and to the use of our name under the heading "Legal
Matters" in the prospectus constituting part of the Registration Statement.
Very truly yours,
/s/ HOWARD, RICE, NEMEROVSKI, CANADY, FALK & RABKIN
A Professional Corporation
<PAGE>
VALLEY RECORD DISTRIBUTORS
EMPLOYEE STOCK OWNERSHIP PLAN
(As Conformed Through
Amendment No. 3 Dated January 31, 1992)
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Section Page
<S> <C>
1. Nature of the Plan . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2. Definitions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
3. Eligibility and Participation. . . . . . . . . . . . . . . . . . . . . 8
4. Employer Contributions . . . . . . . . . . . . . . . . . . . . . . . . 9
5. Investment of Trust Assets . . . . . . . . . . . . . . . . . . . . . . 10
6. Allocations to Participants' Accounts. . . . . . . . . . . . . . . . . 13
7. Allocation Limitations . . . . . . . . . . . . . . . . . . . . . . . . 18
8. Voting Company Stock . . . . . . . . . . . . . . . . . . . . . . . . . 21
9. Disclosure to Participants . . . . . . . . . . . . . . . . . . . . . . 22
10. Vesting and Forfeitures. . . . . . . . . . . . . . . . . . . . . . . . 23
11. Credited Service and Break in Service. . . . . . . . . . . . . . . . . 25
12. When Capital Accumulation Will Be Distributed. . . . . . . . . . . . . 27
13. Diversification. . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
14. How Capital Accumulation Will Be Distributed . . . . . . . . . . . . . 30
15. Rights, Options and Restrictions on Company Stock. . . . . . . . . . . 32
16. No Assignment of Benefits. . . . . . . . . . . . . . . . . . . . . . . 34
17. Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
18. Claims Procedure . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
19. Limitation on Participants' Rights . . . . . . . . . . . . . . . . . . 39
20. Future of the Plan . . . . . . . . . . . . . . . . . . . . . . . . . . 40
21. "Top-Heavy" Contingency Provisions . . . . . . . . . . . . . . . . . . 41
22. Governing Law. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
23. Execution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
</TABLE>
<PAGE>
VALLEY RECORD DISTRIBUTORS
EMPLOYEE STOCK OWNERSHIP PLAN
Section 1. NATURE OF THE PLAN.
The purpose of this Plan is to enable participating Employees to share
in the growth and prosperity of Valley Record Distributors, Inc. (the
"Company") and to provide Participants with an opportunity to accumulate
capital for their future economic security. The Plan is intended to do this
without any deductions from Participants' paychecks and without requiring
them to invest their personal savings. The primary purpose of the Plan is to
enable Participants to acquire stock ownership interests in the Company.
Therefore, the Trust established under the Plan is designed to invest
primarily in Company Stock.
The Plan, hereby adopted effective as of November 1, 1987, is a
combination of a stock bonus plan (the "Variable Contribution Portion") and a
money purchase pension plan (the "Fixed Contribution Portion") each of which
is qualified under Section 401(a) of the Internal Revenue Code (the "Code")
and which together constitute an employee stock ownership plan under Section
4975(e)(7) of the Code. The Plan was subsequently amended on August 21, 1990,
January 10, 1990 and January 31, 1992. This version conforms the Plan with
such amendments.
The Plan is also designed to be available as a technique of corporate
finance to the Company. Accordingly, it may be used to accomplish the
following objectives:
<PAGE>
(a) To meet general financing requirements of the Company, including
capital growth and transfers in the ownership of Company Stock;
(b) To provide Participants with beneficial ownership of Company
Stock, substantially in proportion to their relative
Compensation, without requiring any cash outlay, any reduction in
pay or other personal investment on the part of Participants; and
(c) To receive loans (or other extensions of credit) to finance the
acquisition of Company Stock, with such loans to be repaid by
Employer Contributions to the Trust and dividends received on
such Company Stock.
All Trust Assets held under the Plan will be administered, distributed,
forfeited and otherwise governed by the provisions of this Plan and the
related Trust Agreement. The Plan is administered by an Administrative
Committee for the exclusive benefit of Participants (and their Beneficiaries).
Section 2. DEFINITIONS.
In the text of the Plan, where a provision is intended to apply to the
entire Plan the term "Plan" is used. Where a provision is intended to apply
to one portion of the Plan but not the other, the term "Fixed Contribution
Portion" or "Variable Contribution Portion," as the case may be, is used.
In this Plan, whenever the context so indicates, the singular or plural
number and the masculine, feminine or neuter gender shall be deemed to
include the other, the terms "he," "his" and "him" shall refer to a
Participant, and the capitalized terms shall have the following meanings:
Account....................... One of two accounts maintained to record the
interest of a Participant under the Plan. See
Section 6.
2
<PAGE>
Acquisition Loan.............. A loan (or other extension of credit) used
by the Trust to finance the acquisition of
Company Stock, which loan may constitute an
extension of credit to the Trust from a party
in interest (as defined in ERISA). See
Section 5(b).
Allocation Date............... October 31 of each year; beginning in 1990,
the Allocation Date shall be the Saturday
closest to March 31 (the last day of each
Plan Year).
Approved Absence.............. A leave of absence granted to an Employee by
the Company under its established leave
policy.
Beneficiary................... The person (or persons) entitled to receive
any benefit under the Plan in the event of a
Participant's death. See Section 14(b).
Board of Directors............ The Board of Directors of the Company.
Break in Service.............. A period of time commencing with the date on
which an Employee's Service terminates and
ending on the date he resumes employment with
the Company. See Section 11(b).
Capital Accumulation.......... A Participant's vested, nonforfeitable
interest in his Accounts under the Plan. Each
Participant's Capital Accumulation shall be
determined in accordance with the provisions
of Section 10 and distributed as provided in
Sections 12, 13 and 14.
Code.......................... The Internal Revenue Code of 1986, as amended.
Committee..................... The Administrative Committee appointed by the
Board of Directors to administer the Plan.
See Section 16.
Company....................... Valley Record Distributors, Inc., a
California corporation.
3
<PAGE>
Company Stock................. Shares of capital stock issued by the
Company, which shares must be voting common
stock (or preferred stock convertible into
voting common stock) and which constitute
"employer securities" under Section 409(1)
of the Code.
Company Stock Account......... The Account which reflects each Participant's
interest in Company Stock held under the
Plan. See Section 6.
Compensation.................. The total salary, wages, overtime
compensation and bonuses accrued for an
Employee by the Company during the Plan Year;
provided, however, that any amount in excess
of $200,000 (as adjusted for increases in the
cost of living pursuant to Section 401(a)(17)
of the Code) shall be excluded.
Credited Service.............. The elapsed period of an Employee's Service,
excluding Service prior to November 1, 1987.
See Section 11(a).
Disability.................... The total and permanent inability of an
Employee to perform the usual duties of his
employment with the Company, determined by a
licensed physician approved by the Committee.
Employee...................... Any common-law employee of the Company. A
leased employee, as described in Section
414(n) of the Code, is not an Employee for
purposes of this Plan.
Employer Contributions........ Payments made to the Trust by the Company.
See Section 4.
ERISA......................... The Employee Retirement Income Security Act
of 1974, as amended.
Fair Market Value............. The fair market value of Company Stock, as
determined by the Committee for all purposes
under the Plan based upon a valuation by an
independent appraiser.
4
<PAGE>
Financed Shares .................... Shares of Company Stock acquired by
the Trust with the proceeds of an
Acquisition Loan.
Fixed Contributions ................ Employer Contributions under the Fixed
Contribution Portion of the Plan in
the amount set forth in Section 4(a).
Fixed Contribution Portion ......... The portion of the Plan which
constitutes a money purchase pension
plan under Section 401(a) of the Code.
Forfeiture ......................... Any portion of a Participant's Accounts
which does not become a part of his
Capital Accumulation and which is
forfeited under Section 10(b).
Highly Compensated Employee ........ An Employee who, during the year or
preceding year: (1) was a 5% owner of
the Company at any time during such
year by virtue of owning more than 5% of
the Company; (2) received Statutory
Compensation in excess of $75,000 (as
adjusted each Plan Year to take into
account any applicable cost of living
adjustment provided for that year)
from the Company; (3) received
Statutory Compensation in excess of
$50,000 (as adjusted each Plan Year
to take into account any applicable
cost of living adjustment provided
for that year) and was in the top 20%
of Employees when ranked on the basis
of Statutory Compensation for that year;
(4) was an officer of the Company at
any time during that year and
received Statutory Compensation of
more than 50% of the Code Section
415(b)(1)(A) limitation in effect for
that year; or (5) was the spouse,
lineal ascendant or descendant, or
spouse of a lineal ascendant or
descendant of an Employee who was a
5% owner or was one of the top 10 most
Highly Compensated Employees. A
former Employee will be considered a
member of the Highly Compensated Group,
if such
5
<PAGE>
former Employee was a Highly
Compensated Employee either when he
separated from service with the Company
or at any time after he attained age
55. The determination of whether an
Employee is a Highly Compensated
Employee will be made with reference to
definitions provided in Code Section
414(q) and any regulations issued by
the Secretary of the Treasury
thereunder (including any cost of
living adjustments). For purposes of
determining the Highly Compensated
Group, no more than 50 Employees or,
if lesser, the greater of 3 Employees
or 10% of Employees shall be considered
officers of the Company.
Hour of Service .................... Each hour of Service for which an
Employee is paid (or entitled to
payment) for the performance of duties.
Other Investments
Account ........................... The Account which reflects each
Participant's interest under the Plan
attributable to Trust Assets other than
Company Stock. See Section 6.
Participant ........................ Any Employee or former Employee who
has met the applicable eligibility
requirements of Section 3 and who has
not yet received a complete
distribution of his Capital
Accumulation.
Plan ............................... Valley Record Distributors Employee
Stock Ownership Plan, which includes
the Fixed Contribution Portion, the
Variable Contribution Portion and the
Trust Agreement.
Plan Year .......................... The twelve month period ending on
each Allocation Date and coinciding
with the Company's taxable year;
beginning November 1, 1989, the Plan
Year shall be the 52-53 week period
ending on each Allocation Date. The
Plan Year ending in the 1990 Allocation
Date shall be less than 52-53 weeks
long.
6
<PAGE>
Retirement ......................... Termination of Service on or after
attaining age 65.
Service ............................ Employment with the Company.
Statutory Compensation ............. The total remuneration paid to an
Employee by the Company during the Plan
Year for personal services rendered to
it, excluding employer contributions
to a plan of deferred compensation,
amounts realized in connection with
stock options and amounts which receive
special tax benefits; provided,
however, that any amount in excess of
$200,000 (as adjusted for increases in
the cost of living pursuant to Section
401(a)(17) of the Code) shall be
excluded.
Statutory Dollar Amount ............ For any Plan Year, $30,000, as may be
increased pursuant to Section
415(c)(1)(A) of the Code.
Trust .............................. Valley Record Distributors Employee
Stock Ownership Trust, created by the
Trust Agreement entered into between
the Company and the Trustee.
Trust Agreement .................... The Agreement between the Company and
the Trustee establishing the Trust and
specifying the duties of the Trustee.
Trust Assets ....................... The Company Stock (and other assets)
held in the Trust for the benefit of
Participants. See Section 5.
Trustee ............................ The Trustee (and any successor
Trustee) appointed by the Board of
Directors to hold the Trust Assets.
Variable Contributions ............. Employer Contributions under the
Variable Contribution Portion of the
Plan in amounts determined by the Board
of Directors. See Section 4(b).
7
<PAGE>
<TABLE>
<S> <C>
Variable Contribution
Portion..................... The portion of the Plan which constitutes a
stock bonus plan under Section 401(a) of
the Code.
</TABLE>
Section 3. ELIGIBILITY AND PARTICIPATION.
(a) Each Employee shall become a Participant in the Plan as of the date
which is first day of the month after the date on which he completes 90 days
of Credited Service.
(b) A Participant is entitled to share in the allocation of Employer
Contributions and Forfeitures under Section 6(a) for each Plan Year in which
he is an eligible Employee on the Allocation Date. A Participant is also
entitled to share in the allocation of Employer Contributions and Forfeitures
for the Plan Year of his Retirement, Disability or death.
(c) A former Participant who is reemployed by the Company shall become
a Participant as of the date of his reemployment. A former Employee who is
reemployed by the company and has previously satisfied the eligibility
requirements of Section 3(a) shall become a Participant as of the date of his
reemployment. An Employee who is on an Approved Absence shall not become a
Participant until the end of his Approved Absence, but a Participant who is
on an Approved Absence shall continue as a Participant during the period of
his Approved Absence.
8
<PAGE>
Section 4. EMPLOYER CONTRIBUTIONS.
(a) FIXED CONTRIBUTIONS -- Effective March 31, 1992, Employer
contributions under the Fixed Contribution Portion shall be paid to the
Trustee for each Plan Year in an amount equal to 1% of the Compensation of
all Participants entitled to share in the allocation of Employer
Contributions for that Plan Year.
(b) VARIABLE CONTRIBUTIONS -- Employer Contributions under the Variable
Contribution Portion shall be paid to the Trustee for each Plan Year in such
amounts (or under such formula) as may be determined by the Board of
Directors. Employer Contributions shall not be made for any Plan Year in
amounts which can be allocated to no Participant's Accounts by reason of the
allocation limitation described in Section 7(a) or in amounts which are not
deductible under Section 404(a) of the Code.
(c) PAYMENT OF EMPLOYER CONTRIBUTIONS -- Employer Contributions for
each Plan Year shall be paid to the Trustee not later than the due date
(including extensions) for filing the Company's Federal income tax return for
that Plan Year; provided, however, that Fixed Contributions shall be paid not
later than the date required by Section 412(c)(10) of the Code and the
regulations thereunder. Employer Contributions may be paid in cash and/or in
shares of Company Stock, as determined by the Board of Directors; provided,
however, that the Board of Directors may determine that Employer
Contributions may be paid as provided in Section 5(c) with notice to the
Committee and the Trustee.
9
<PAGE>
(d) ADDITIONAL PROVISIONS -- Any Employer Contributions which are not
deductible under Section 404(a) of the Code may be returned to the Company
by the Trustee (upon the direction of the Company) within one year after the
deduction is disallowed or after it is determined that the deduction is not
available. In the event that Employer Contributions are paid to the Trust by
reason of a mistake of fact, such Employer Contributions may be returned to
the Company by the Trustee (upon the direction of the Company) within one
year after the payment to the Trust.
(e) EMPLOYEE CONTRIBUTIONS -- No Participant shall be required or
permitted to make contributions to the Trust.
Section 5. INVESTMENT OF TRUST ASSETS.
(a) IN GENERAL -- Trust Assets will be invested by the Trustee
primarily (or exclusively) in Company Stock in accordance with directions
from the Committee. Employer Contributions (and other Trust Assets) may be
used to acquire shares of Company Stock from any Company shareholder or from
the Company. The Trustee may also invest Trust Assets in such other prudent
investments as the Committee deems to be desirable for the Trust, or Trust
Assets may be held temporarily in cash. All purchases of Company Stock by the
Trustee shall be made only as directed by the Committee and only at prices
which do not exceed Fair Market Value. The Committee may direct the Trustee
to invest and hold up to 100% of the Trust Assets in Company Stock.
10
<PAGE>
(b) ACQUISITION LOANS - The Committee may direct the Trustee to incur
Acquisition Loans from time to time to finance the acquisition of Company
Stock (Financed Shares) or to repay a prior Acquisition Loan. An installment
obligation incurred in connection with the purchase of Company Stock shall be
treated as an Acquisition Loan. An Acquisition Loan shall be for a specific
term, shall bear a reasonable rate of interest and shall not be payable on
demand except in the event of default. An Acquisition Loan may be secured by
a pledge of the Financed Shares so acquired (or acquired with the proceeds of
a prior Acquisition Loan which is being refinanced). No other Trust Assets
may be pledged as collateral for an Acquisition Loan, and no lender shall
have recourse against Trust Assets other than any Financed Shares remaining
subject to pledge. Any pledge of Financed Shares must provide for the release
of the shares so pledged as payments on the Acquisition Loan are made by the
Trustee and such Financed Shares are allocated to Participants' Company Stock
Accounts under Section 6. If the lender is a party in interest (as defined in
ERISA), the Acquisition Loan must provide for a transfer of Trust Assets to
the lender on default only upon and to the extent of the failure of the Trust
to meet the payment schedule of the Acquisition Loan.
(c) ACQUISITION LOAN PAYMENTS - Payments of principal and/or interest on
any Acquisition Loan shall be made by the Trustee (as directed by the
Committee) only from Employer Contributions paid in cash to enable the Trust
to repay such Ac-
11
<PAGE>
quisition Loan, from earnings attributable to such Employer Contributions and
from any cash dividends received by the Trust on the Financed Shares (whether
allocated or unallocated) purchased with the proceeds of such Acquisition
Loan; and the payments made with respect to an Acquisition Loan for a Plan
Year must not exceed the sum of such Employer Contributions, earnings and
dividends for that Plan Year (and prior Plan Years), less the amount of such
payments for prior Plan Years. If the Company is the lender with respect to
an Acquisition Loan, Employer Contributions may be paid in the form of
cancellation of indebtedness under the Acquisition Loan. If the Company is
not the lender with respect to an Acquisition Loan, the Company may elect to
make payments on the Acquisition Loan directly to the lender and to treat
such payments as Employer Contributions.
(d) SALES OF COMPANY STOCK - Subject to the approval of the Board of
Directors, the Committee may direct the Trustee to sell shares of Company
Stock to any person (including the Company), provided that any such sale must
be made at a price not less favorable to the Plan than Fair Market Value as
of the date of the sale. Notwithstanding the provisions of Section 5(c), the
Committee may direct the Trustee to apply the proceeds from the sale of
unallocated Financed Shares to repay the Acquisition Loan (incurred to
purchase the Financed Shares) in the event of the sale of the Company or the
termination of the Plan or if the Plan ceases to be an employee stock
ownership plan under Section 4975(a)(7) of the Code. If the Trustee is unable
to make payments of principal
12
<PAGE>
and/or interest on an Acquisition Loan when due, the Committee (with the
approval of the Board of Directors) may direct the Trustee to sell any
Financed Shares that have not yet been allocated to Participants' Company
Stock Accounts or to obtain an Acquisition Loan in an amount sufficient to
make such payments. Any Sale of Company Stock under this Section 5(d) must
comply with the fiduciary duties applicable to the Committee under Section
404(a)(1) of ERISA.
Section 6. ALLOCATIONS TO PARTICIPANTS' ACCOUNTS
A Company Stock Account and an Other Investments Account shall be
maintained to reflect the interest of each Participant under the Plan.
COMPANY STOCK ACCOUNT - The Company Stock Account maintained for each
Participant will be credited annually with his allocable share of Company
Stock (including fractional shares) purchased and paid for by the Trust or
contributed in kind to the Trust as an Employer Contribution, with any
Forfeitures of Company Stock and with any stock dividends on Company Stock
allocated to his Company Stock Account.
OTHER INVESTMENTS ACCOUNT - The Other Investments Account maintained for
each Participant will be credited annually with his allocable share of
Employer Contributions that are not in the form of Company Stock, with any
Forfeitures from Other Investments Accounts, with any cash dividends on
Company Stock allocated to his Company Stock Account (other than currently
distributed dividends)
13
<PAGE>
and any net income (or loss) of the Trust. Such Account will be debited for
the Participant's share of any cash payments made by the Trustee for the
acquisition of Company Stock or for the payment of any principal and/or
interest on an Acquisition Loan.
The allocations to Participants' Accounts for each Plan Year will be made
as follows:
(a) EMPLOYER CONTRIBUTIONS AND FORFEITURES - Fixed Contributions under
Section 4(a) for each Plan Year will be allocated as of the Allocation Date
among the Accounts of Participants so entitled under Section 3(b) in an
amount equal to 10% of the Compensation of each such Participant. Variable
Contributions under Section 4(b) and Forfeitures under Section 10(b) for each
Plan Year will be allocated as of the Allocation Date among the Accounts of
Participants so entitled under Section 3(b) in the ratio that the
Compensation of each such Participant bears to the total Compensation of all
such Participants, subject to the allocation limitations described in Section
7.
(b) FINANCED SHARES - Any Financed Shares acquired by the Trust shall
initially be credited to a "Loan Suspense Account" and will be allocated to
the Company Stock Accounts of Participants only as payments on the
Acquisition Loan are made by the Trustee. The number of Financed Shares to be
released from the Loan Suspense Account for allocation to Participants'
Company Stock Accounts for each Plan Year shall be determined by the
Committee (as of each Allocation Date) as follows:
14
<PAGE>
(1) PRINCIPAL/INTEREST METHOD - The number of Financed Shares held
in the Loan Suspense Account immediately before the release for the current
Plan Year shall be multiplied by a fraction. The numerator of the fraction
shall be the amount of principal and/or interest paid on the Acquisition Loan
for that Plan Year. The denominator of the fraction shall be the sum of the
numerator plus the total payments of principal and interest on that
Acquisition Loan projected to be paid for all future Plan Years. For this
purpose, the interest to be paid in future years is to be computed by using
the interest rate in effect as of the current Allocation Date.
(2) PRINCIPAL ONLY METHOD - The Committee may elect (as to each
Acquisition Loan) or the provisions of the Acquisition Loan may provide for
the release of Financed Shares from the Loan Suspense Account based solely on
the ratio that the payments of principal for each Plan Year bear to the total
principal amount of the Acquisition Loan. This method may be used only to the
extent that: (A) the Acquisition Loan provides for annual payments of
principal and interest at a cumulative rate that is not less rapid at any time
than level annual payments of such amounts for ten years; (B) interest
included in any payment on the Acquisition Loan is disregarded only to the
extent that it would be determined to be interest under standard loan
amortization tables; and (C) the entire duration of the Acquisition Loan
repayment period does not exceed ten years, even in the event of a renewal,
extension or refinancing of the Acquisition Loan.
15
<PAGE>
In each Plan Year in which Trust Assets are applied to make payments on
an Acquisition Loan, the Financed Shares released from the Loan Suspense
Account in accordance with the provisions of this Section 6(b) shall be
allocated among the Company Stock Accounts of Participants in the manner
determined by the Committee based upon the source of funds (Fixed
Contributions, Variable Contributions, earnings attributable to such Employer
Contributions and cash dividends) used to make the payments on the
Acquisition Loan. If cash dividends on Financed Shares allocated to a
Participant's Company Stock Account are used for payments on an Acquisition
Loan, Financed Shares (representing that portion of such payments) released
from the Loan Suspense Account shall be allocated to that Participant's
Company Stock Account.
(c) NET INCOME (OR LOSS) OF THE TRUST - The net income (or loss) of the
Trust for each Plan Year will be determined as of the Allocation Date. Prior
to the allocation of Employer Contributions and Forfeitures for the Plan
Year, each Participant's share of any net income (or loss) will be allocated
to his Other Investments Account in the ratio that the total balances of both
his Accounts on the preceding Allocation Date (reduced by any distribution of
Capital Accumulation during the Plan Year) bears to the sum of such Account
balances for all Participants as of that date. The net income (or loss) of
the Trust includes the increase (or decrease) in the fair market value of
Trust Assets (other than Company Stock), interest income, dividends and other
income and gains (or losses) attributable to Trust Assets (other than any
dividends on
16
<PAGE>
allocated Company Stock) since the preceding Allocation Date, reduced by any
expenses charged to the Trust Assets for that Plan Year. The determination of
the net income (or loss) of the Trust shall not take into account any
interest paid by the Trust under an Acquisition Loan.
(d) DIVIDENDS ON COMPANY STOCK - Any cash dividends received on shares
of Company Stock allocated to Participants' Company Stock Accounts will be
allocated to the respective Other Investments Accounts of such Participants.
Any cash dividends received on unallocated shares of Company Stock (including
any Financed Shares credited to the Loan Suspense Account) shall be included
in the computation of the net income (or loss) of the Trust. Any stock
dividends received on Company Stock shall be credited to the Accounts
(including the Loan Suspense Account) to which such Company Stock was
allocated.
(e) ACCOUNTING FOR ALLOCATIONS - The Committee shall establish
accounting procedures for the purpose of making the allocations to
Participants' Accounts provided for in this Section 6. The Committee shall
maintain adequate records of the aggregate cost basis of Company Stock
allocated to each Participant's Company Stock Account. The Committee shall
also keep separate records of Financed Shares and of Fixed Contributions,
Variable Contributions (and any earnings thereon) made for the purpose of
enabling the Trust to repay any Acquisition Loan. From time to time, the
Committee may modify the accounting procedures for the purposes of achieving
equitable and nondiscriminatory allocations among the
17
<PAGE>
Accounts of Participants in accordance with the general concepts of the Plan,
the provisions of this Section 6 and the requirements of the Code and ERISA.
Section 7. ALLOCATION LIMITATIONS.
(a) LIMITATION ON ANNUAL ADDITIONS - The Annual Additions for each Plan
Year with respect to any Participant may not exceed the lesser of:
(1) 25% of his Statutory Compensation; or
(2) the Statutory Dollar Amount.
For this purpose, Annual Additions shall be the total of all of the Employer
Contributions and Forfeitures (including any income attributable to
Forfeitures) allocated during the Plan Year to the Accounts of a
Participant in this Plan and any Employer Contributions, Forfeitures or
Employee Contributions allocated during the Plan Year to accounts in any
other defined contribution plan maintained by the Employer, except as
provided in Section 7(c). In determining such Annual Additions, Forfeitures
of Company Stock shall be included at the Fair Market Value as of the
Allocation Date.
Any Forfeitures which can be allocated to no Participant's Accounts by
reason of this limitation shall be credited to a "Forfeiture Suspense
Account" and allocated as Forfeitures under Section 6(a) for the next
succeeding Plan Year (prior to the allocation of Employer Contributions for
such succeeding Plan Year).
18
<PAGE>
(b) INCREASED DOLLAR LIMITATION - Under certain circumstances, the dollar
limitation set forth in Section 7(a)(2) may be increased. The increase will
occur only if not more than one-third of the Employer Contributions for the
Plan Year are allocated to the Accounts of Participants who are Highly
Compensated Employees. The amount of the increase will be the lesser of the
following: (A) the Statutory Dollar Amount otherwise applicable for the Plan
Year; or (B) the amount of Employer Contributions allocated to the
Participant's Company Stock Account (as of the Allocation Date of the Plan
Year) representing Company Stock which is -
(1) contributed to the Trust for that Plan Year;
(2) purchased with Employer Contributions (in cash) not later than
60 days after the due date (including extensions) for filing the
Company's Federal income tax return for that Plan Year; or
(3) released from the Loan Suspense Account by reason of payments
on an Acquisition Loan for that Plan Year.
(c) SPECIAL ACQUISITION LOAN RULES - Any Employer Contributions which
are used by the Trust (not later than the due date, including extensions, for
filing the Company's Federal income tax return for that Plan Year) to pay
interest on an Acquisition Loan, and any Financed Shares which are allocated
as Forfeitures, shall not be included as Annual Additions under Section 7(a);
provided, however, that the provisions of this Section 7(c) shall be
applicable for any Plan Year only if not more than one-third of the Employer
Contributions applied to pay principal and/or interest on
19
<PAGE>
an Acquisition Loan are allocated to Participants who are Highly Compensated
Employees; and the Committee shall reallocate such Employer Contributions to
the extent it deems it to be appropriate to satisfy this special rule.
(d) LIMITATION ON ELECTING OR DECEASED SHAREHOLDER - If a Company
shareholder sells Company Stock to the Trust and elects (with the consent of
the Company) nonrecognition of gain under Section 1042 of the Code, or if the
executor of the estate of a deceased Company shareholder sells Company Stock
to the Trust and claims (with the consent of the Company) an estate tax
deduction under Section 2057 of the Code, no portion of the Company Stock
purchased in any such transaction (or any dividends or other income
attributable thereto) may be allocated during the ten-year period following
the purchase (or, if an Acquisition Loan was incurred in connection with such
purchase, the period beginning on the date of such purchase and ending on the
tenth anniversary of the Allocation Date as of which shares are released from
the Loan Suspense Account as a result of the final payment on the Acquisition
Loan) to the Accounts of:
(1) the selling shareholder (in the case of a non-recognition
transaction under Section 1042 of the Code) or the decedent
(in the case of a sale to which Section 2057 of the Code
applies); or
(2) his spouse, brothers or sisters (whether by the whole or half
blood), ancestors or lineal descendants (except as to certain
lineal descendants, to the extent provided in Section 409(n)
(3) (A) of the Code), or any other person who bears a
relationship to him that is described in Section 267(b) of the
Code.
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<PAGE>
In addition, no portion of the Company Stock purchased in any such
transaction (or any dividends or other income attributable thereto) may
thereafter be allocated to the Accounts of any Participant owning (as
determined under Section 318(a) of the Code, without regard to Section
318(a)(2)(B)(i) of the Code), during the entire one-year period preceding the
purchase or on any Allocation Date, more than 25% of any class of outstanding
Company Stock or of the total value of any class of outstanding Company Stock.
To the extent that a Participant is subject to the allocation limitation
described in this Section 7(d) for a Plan Year, he shall not share in the
allocation of Employer Contributions and Forfeitures.
Section 8. VOTING COMPANY STOCK.
Shares of Company Stock in the Trust shall be voted by the Trustee in
such manner as it shall determine. With respect to any corporate matter which
involves the voting of such shares at a shareholder meeting and which
constitutes a merger, consolidation, recapitalization, reclassification,
liquidation, dissolution, sale of substantially all assets of a trade or
business or a similar transaction specified in regulations under Section
409(e)(3) of the Code, each Participant (or Beneficiary) will be entitled to
direct the voting of shares of Company Stock then allocated to his Company
Stock Account. In that event, any allocated Company Stock with respect to
which voting directions are not given shall not be voted, and shares of
Company Stock held by the Trust which are not
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<PAGE>
then allocated to Participants' Company Stock Accounts shall be voted in the
manner determined by the Trustee.
Section 9. DISCLOSURE TO PARTICIPANTS.
(a) SUMMARY PLAN DESCRIPTION - Each Participant shall be furnished
with the summary plan description of the Plan required by Sections 102(a)(1)
and 104(b)(1) of ERISA. Such summary plan description shall be updated from
time to time as required under ERISA and Department of Labor regulations
thereunder.
(b) SUMMARY ANNUAL REPORT - Within nine months after each Allocation
Date, each Participant shall be furnished with the summary annual report of
the Plan required by Section 104(b)(3) of ERISA, in the form prescribed in
regulations of the Department of Labor.
(c) ANNUAL STATEMENT - Following each Allocation Date, each
Participant shall be furnished with a statement reflecting the following
information:
(1) The balances (if any) in his Accounts as of the beginning of
the Plan Year.
(2) The amount of Fixed Contributions, Variable Contributions and
Forfeitures allocated to his Accounts for that Plan Year.
(3) The adjustments to his Accounts to reflect his share of
dividends (if any) on Company Stock and any net income (or
loss) of the Trust for that Plan Year.
(4) The new balances in his Accounts, including the number of
shares of Company Stock allocated to his Company Stock Account
and the Fair Market Value as of that Allocation Date.
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<PAGE>
(5) His number of years of Credited Service and his vested
percentage in his Account balances (under Sections 10 and
11) as of that Allocation Date.
(d) ADDITIONAL DISCLOSURE - The Company shall make available for
examination by any Participant copies of the Plan, the Trust Agreement and
the latest annual report of the Plan filed (on Form 5500) with the
Internal Revenue Service. Upon written request of any Participant, the
Company shall furnish copies of such documents and may make a reasonable
charge to cover the cost of furnishing such copies, as provided in
regulations of the Department of Labor.
Section 10. VESTING AND FORFEITURES.
(a) VESTING -
(1) A Participant's interest in his Accounts shall become 100%
vested and nonforfeitable without regard to his Credited Service if he (A) is
employed by the Company on or after his 65th birthday, (B) incurs a
Disability while employed by the Company or (C) dies while employed by the
company.
(2) Except as otherwise provided in Section 10(a)(1), the
interest of each Participant in his Accounts shall become vested and
nonforfeitable in accordance with the following schedule:
<TABLE>
<CAPTION>
Credited Service Nonforfeitable
Under Section 11 Percentage
---------------- --------------
<S> <C>
Less than Three Years 0%
Three Years 20%
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<PAGE>
Four Years 40%
Five Years 60%
Six Years 80%
Seven Years or More 100%
</TABLE>
(b) FORFEITURES - Any portion of the final balances in a
Participant's Accounts which is not vested (and does not become part of his
Capital Accumulation) will become a Forfeiture as of the Allocation Date of
the Plan Year in which he terminates Service. Forfeitures shall first be
charged against a Participant's Other Investments Account, with any balance
charged against his Company Stock Account (at Fair Market Value). Financed
Shares shall be forfeited only after other shares of Company Stock have been
forfeited. All Forfeitures will be reallocated to the Accounts of remaining
Participants, as provided in Section 6(a), as of the Allocation Date of the
Plan Year in which the Participant's Service terminates.
(c) RESTORATION OF FORFEITED AMOUNTS - If a participant is
reemployed prior to the occurrence of a five-consecutive-year Break in
Service, the portion of his Accounts (attributable to the prior period of
Service) that was forfeited upon his termination of Service shall be
restored as if there had been no Forfeiture. Such restoration shall be made
out of Forfeitures occurring in the Plan Year of reemployment (prior to
allocations under Section 6(a)). To the extent such Forfeitures are not
sufficient, the Company shall make a special contribution to the
Participant's restored
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<PAGE>
Accounts. Any amount so restored to a Participant shall not constitute an
Annual Addition under Section 7(a).
(d) VESTING UPON REEMPLOYMENT - If a Participant who is not 100%
vested receives a distribution of his Capital Accumulation prior to the
occurrence of a five-consecutive-year Break in Service and he is reemployed
prior to the occurrence of such a Break in Service, the portion of his
Accounts which was not vested (including any restored Accounts) shall be
maintained separately until he becomes 100% vested. His vested and
nonforfeitable percentage in such separate Accounts upon his subsequent
termination of Service shall be equal to:
X-Y
-------
100%-Y
For purposes of applying this formula, X is the vested percentage at the time
of the subsequent termination, and Y is the vested percentage at the time of
the prior termination.
Section 11. CREDITED SERVICE AND BREAK IN SERVICE.
(a) CREDITED SERVICE - An Employee's Credited Service shall include
each period of his Service, computed (in full years and days) from the date
he is first credited with an Hour of Service until the date on which his
Service terminates; provided, however, that Credited Service shall not
include Service prior to November 1, 1987. An Employee's Credited Service
shall be determined by aggregating all the periods required to be taken into
account under this Section 11. A Break in Service that does not
25
<PAGE>
exceed one year and the first year of an Approved Absence shall be included
in an Employee's Credited Service.
(b) BREAK IN SERVICE - A one-year Break in Service shall occur one
year after the date of an Employee's termination of Service. A five-year
Break in Service shall occur five years after the date of an Employee's
termination of Service. A Break in Service shall end in the event of an
Employee's reemployment. For purposes of determining the period of an
Employee's Break in Service, a period of absence for one year or less shall
not be treated as a Break-in-Service if the absence is caused on the account
of:
(i) the pregnancy of the Employee or Participant;
(ii) the birth of a child of the Employee or Participant;
(iii) the placement of a child with the Employee or Participant in
connection with the adoption of such child by such Employee
or Participant; or
(iv) caring for such child for a period beginning immediately
following such birth or placement.
(c) REEMPLOYMENT - If a former Employee is reemployed after a one-year
Break in Service, the following special rules shall apply in determining his
Credited Service:
(1) New Accounts will be established to reflect his interest in the
Plan attributable to Service after the Break in Service.
(2) After he completes one Plan Year of Credited Service following
reemployment, his Credited Service with respect to his new
Accounts will include his Credited Service accumulated prior to
the Break in Service.
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<PAGE>
(3) If he is reemployed after the occurrence of a five-consecutive-year
Break in Service, Credited Service after the Break in Service will
not increase his vested interest in his Accounts attributable to
Service prior to the Break in Service.
(4) If he is reemployed after the occurrence of a five-consecutive-year
Break in Service, and he had no vested interest under Section
10(a)(2), Service prior to the Break in Service shall not be
included in determining his Credited Service.
Section 12. WHEN CAPITAL ACCUMULATION WILL BE DISTRIBUTED.
(a) Except as otherwise provided in Sections 12(c) and 13, a
Participant's Capital Accumulation will be distributed following his
termination of Service, but only at the time and in the manner determined by
the Committee. If the value of a Participant's Capital Accumulation exceeds
$3,500, no portion of his Capital Accumulation may be distributed to him
before he attains age 65 without his consent.
(b) In the event of a Participant's Retirement, Disability or death,
distribution of his Capital Accumulation shall commence no later than the
Allocation Date of the Plan Year following the Plan Year in which his
Retirement, Disability or death occurs. If a Participant's Service terminates
for any other reason, distribution of his Capital Accumulation shall commence
no later than the Allocation Date of the sixth Plan Year following the Plan
Year in which his Service terminates. For this purpose, if a Participant's
Capital Accumulation includes Financed Shares, such shares shall not be
deemed to be a part of his Capital Accumulation until the
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<PAGE>
Allocation Date of the Plan Year in which the Acquisition Loan has been fully
repaid. The following alternative modes of distribution may be selected by
the Committee (after considering the available liquid assets of the Company
and the Trust):
(1) Distribution of a Participant's Capital Accumulation in a
single lump sum; or
(2) Distribution of a Participant's Capital Accumulation in
substantially equal, annual installments over a period not
exceeding five years (provided that the period over which
installments may be distributed may be extended an additional
year (up to an additional five years) for each $100,000 or
fraction thereof by which his Capital Accumulation exceeds
$500,000); or
(3) Any combination of the foregoing.
(c) Distribution of a Participant's Capital Accumulation shall commence
not later than 60 days after the Allocation Date coinciding with or next
following his 65th birthday (or his termination of Service, if later). The
distribution of the Capital Accumulation of any Participant who attains age
70-1/2 in a calendar year must commence not later than April 1 of the next
calendar year (even if he has not terminated Service) and must be made in
accordance with the regulations under Section 401(a)(9) of the Code,
including Section 1.401(a)(9)-2. If the amount of a Participant's Capital
Accumulation cannot be determined (by the Committee) by the date on which a
distribution is to commence, or if the Participant cannot be located,
distribution of his Capital Accumulation shall commence within 60 days after
the date on which his Capital Accumulation can be determined or after the
date on which the Committee locates the Participant.
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<PAGE>
(d) If any part of a Participant's Capital Accumulation is retained
in the Trust after his Service ends, his Accounts will continue to be
treated as described in Section 6. However, except as otherwise provided in
Section 3(b), such Accounts shall not be credited with any additional
Employer Contributions and Forfeitures. In addition, a Participant's entire
Capital Accumulation may be segregated and invested in assets other than
Company Stock (as determined by the Committee).
Section 13. DIVERSIFICATION.
Effective as of the 1997 Allocation Date, a Participant who has
attained age 55 and completed at least ten years of participation in the Plan
shall be notified of his right to elect to "diversify" a portion of the
balance in his Company Stock Account, as provided in Section 401(a)(28)(B)
of the Code. An election to "diversify" must be made on the prescribed form
and filed with the Committee within the 90-day period immediately following
the Allocation Date of a Plan Year in the Election Period. For purposes of
this Section 13 the "Election Period" means the period of six consecutive Plan
Years beginning with the Plan Year in which the Participant first becomes
eligible to make an election.
For each of the first five Plan Years in the Election Period, the
Participant may elect to "diversify" an amount which does not exceed 25% of
the balance in his Company Stock Account, less all amounts previously
"diversified" under this Section 13. In the case of the sixth Plan Year in
the Election Period, the Participant
29
<PAGE>
may elect to "diversify" an amount which does not exceed 50% of the balance
in his Company Stock Account, less all amounts previously "diversified" under
this Section 13. No "diversification" election shall be permitted if the
balance in a Participant's Company Stock Account as of the Allocation Date of
the first Plan Year in the Election Period has a Fair Market value of $500 or
less, unless and until the balance in his Company Stock Account as of a
subsequent Allocation Date in the Election Period exceeds $500.
The Committee shall determine whether "diversification" will be
effected by permitting the Participant to direct the investment or the
portion of his Company Stock Account with respect to which a
"diversification" election is made among at least three investment funds
(other than Company Stock) that the Committee shall cause to be made
available under the Trust or by distributing in cash to the Participant the
portion of such Account with respect to which a "diversification" election is
made. Any diversification of investments or distribution under this Section
13 shall occur within 90 days after the 90-day period in which the election
may be made, and any distribution shall be subject to the provisions of
Section 14(d).
Section 14. HOW CAPITAL ACCUMULATION WILL BE DISTRIBUTED.
(a) The Trustee will make distributions from the Trust only as
directed by the Committee. Distribution of a Participant's Capital
Accumulation will be made in whole shares of Company Stock,
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<PAGE>
cash or a combination of both, as determined by the Committee; provided,
however, that the Committee shall notify the Participant of his right to
demand distribution of his Capital Accumulation entirely in whole shares of
Company Stock (with only the value of any fractional share paid in cash). Any
portion of a Participant's Capital Accumulation which has been "diversified"
into investments other than Company Stock (as described in Section 13) shall
be distributed only in cash.
(b) If the charter or by-laws of the Company restrict the ownership
of substantially all outstanding shares of Company Stock to current Employees
and the Trust, the distribution of a Participant's Capital Accumulation may be
made entirely in cash without granting him the right to demand distribution
in Company Stock. Alternatively, Company Stock may be distributed subject to
the requirement that it be immediately resold to the Company.
(c) Distribution of a Participant's Capital Accumulation will be made
to the Participant if living, and if not, to his Beneficiary. In the event of
a Participant's death, his Beneficiary shall be his surviving spouse, or if
none, his estate. A Participant (with the notarized written consent of his
spouse, if any, acknowledging the effect of the consent) may designate a
different Beneficiary or Beneficiaries from time to time by filing a written
designation with the Committee. A deceased Participant's entire Capital
Accumulation shall be distributed to his Beneficiary within five years after
his death, except to the extent that
31
<PAGE>
distribution has previously commenced in accordance with Section 12(b)(2).
(d) The Company shall furnish the recipient of a distribution with the
tax consequences explanation required by Section 402(f) of the Code and shall
comply with the withholding requirements of Section 3405 of the Code and of
any applicable state law with respect to distributions from the Trust.
Section 15. RIGHTS, OPTIONS AND RESTRICTIONS ON COMPANY STOCK.
(a) Any shares of Company Stock distributed by the Trust shall be
subject to a "right of first refusal." The right of first refusal shall
provide that, prior to any subsequent transfer, the shares must first be
offered for purchase in writing to the Company, and then to the Trust, at the
then Fair Market Value. A bona fide written offer from an independent
prospective buyer shall be deemed to be the Fair Market Value for this
purpose. The Company and the Committee shall have a total of 14 days to
exercise the right of first refusal on the same terms offered by a
prospective buyer. The Company may require that a Participant entitled to a
distribution of Company Stock execute an appropriate stock transfer agreement
(evidencing the right of first refusal) prior to receiving a certificate for
Company Stock.
(b) The Company shall provide a "put option" to any Participant (or
Beneficiary) who receives a distribution of Company Stock. The put option
shall permit the Participant (or Beneficiary) to sell such Company Stock to
the Company at any time during
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<PAGE>
two option periods, at the then Fair Market Value. The first put option
period shall be for at least 60 days beginning on the date of distribution.
The second put option period shall be for at least 60 days beginning after
the new determination of Fair Market Value (and notice to the Participant
thereof) in the following Plan Year. The Company may allow the Committee to
purchase shares of Company Stock tendered to the Company under a put option.
The payment for any Company Stock sold under a put option shall be made
within 30 days if the shares are distributed as part of an installment
distribution. If the shares are distributed in a lump sum distribution,
payment shall commence within 30 days and may be made in a lump sum or in
substantially equal, annual installments over a period not exceeding five
years, with adequate security provided and interest payable at a reasonable
rate on any unpaid installment balance (as determined by the Company or the
Committee).
(c) Shares of Company Stock held or distributed by the Trustee may
include such legend restrictions on transferability as the Company may
reasonably require in order to assure compliance with applicable Federal and
state securities laws. Except as otherwise provided in this Section 15, no
shares of Company Stock held or distributed by the Trustee may be subject to
a put, call or other option, or buy-sell or similar arrangement. The
provisions of this Section 15 shall continue to be applicable to Company
Stock even if the Plan ceases to be an employee stock ownership plan under
Section 4975(e)(7) of the Code.
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<PAGE>
Section 16. NO ASSIGNMENT OF BENEFITS.
A Participant's Capital Accumulation may not be anticipated, assigned
(either at law or in equity), alienated or subject to attachment,
garnishment, levy, execution or other legal or equitable process, except in
accordance with a "qualified domestic relations order" (as defined in Section
414(p) of the Code).
Section 17. ADMINISTRATION.
(a) ADMINISTRATIVE COMMITTEE - The Plan will be administered by an
Administrative Committee composed of one or more individuals appointed by the
Board of Directors to serve at its pleasure and without compensation. The
members of the Committee shall be the named fiduciaries with authority to
control and manage the operation and administration of the Plan. Members of
the Committee need not be Employees or Participants. Any Committee member may
resign by giving notice, in writing, to the Board of Directors.
(b) COMMITTEE ACTION - Committee action will be by vote of a majority of
the members at a meeting or in writing without a meeting. A Committee member
who is a Participant shall not vote on any question relating specifically to
himself unless he is the sole member of the Committee.
The Committee members shall be authorized to execute any certificate or
other written direction on behalf of the Committee. The Committee shall keep
a record of its proceedings and of all
34
<PAGE>
dates, records and documents pertaining to the administration of the Plan.
(c) POWERS AND DUTIES OF THE COMMITTEE - The Committee shall have all
powers necessary to enable it to administer the Plan and the Trust Agreement
in accordance with their provisions, including without limitation the
following:
(1) resolving all questions relating to the eligibility of
Employees to become Participants;
(2) determining the appropriate allocations to Participants'
Accounts pursuant to Section 6;
(3) determining the amount of benefits payable to a
Participant (or Beneficiary), and the time and manner in
which such benefits are to be paid;
(4) authorizing and directing all disbursements of Trust
Assets by the Trustee;
(5) establishing procedures in accordance with Section
414(p) of the Code to determine the qualified status of
domestic relations orders and to administer distributions
under such qualified orders;
(6) engaging any administrative, legal, accounting, clerical
or other services that it may deem appropriate;
(7) construing and interpreting the Plan and the Trust
Agreement and adopting rules for administration of the
Plan that are consistent with the terms of the Plan
documents and of ERISA and the Code;
(8) compiling and maintaining all records it determines to
be necessary, appropriate or convenient in connection with
the administration of the Plan;
(9) reviewing the performance of the Trustee with respect to
the Trustee's administrative duties, responsibilities
and obligations under the Plan and Trust Agreement; and
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<PAGE>
(10) selecting an independent appraiser and determining the
Fair Market Value of Company Stock as of such dates as it
determines to be necessary or appropriate.
The Committee shall be responsible for directing the Trustee as to
the investment of Trust Assets. The Committee may delegate to the Trustee the
responsibility for investing Trust Assets other than Company Stock. The
Committee shall establish a funding policy and method for directing the
Trustee to acquire Company Stock (and for otherwise investing the Trust
Assets) in a manner that is consistent with the objectives of the Plan and
the requirements of ERISA.
The Committee shall perform its duties under the Plan and the Trust
Agreement solely in the interests of the Participants (and their
Beneficiaries). Any discretion granted to the Committee under any of the
provisions of the Plan or the Trust Agreement shall be exercised only in
accordance with rules and policies established by the Committee which shall
be applicable on a nondiscriminatory basis.
(d) EXPENSES - All reasonable expenses of administering the Plan and
Trust shall be charged to and paid out of the Trust Assets. The Company may,
however, pay all or any portion of such expenses directly, and payment of
expenses by the Company shall not be deemed to be Employer Contributions.
(e) INFORMATION TO BE SUBMITTED TO THE COMMITTEE - To enable the
Committee to perform its functions, the Company shall supply full and timely
information to the Committee on all matters as the Committee may require, and
shall maintain such other records
36
<PAGE>
as the Committee may determine are necessary or appropriate in order to
determine the benefits due or which may become due to Participants (or
Beneficiaries) under the Plan.
(f) DELEGATION OF FIDUCIARY RESPONSIBILITY - The Committee from time
to time may allocate to one or more of its members and/or may delegate to any
other persons or organizations any of its rights, powers, duties and
responsibilities with respect to the operation and administration of the Plan
that are permitted to be so delegated under ERISA; provided, however, that
responsibility for investment of the Trust Assets may not be allocated or
delegated. Any such allocation or delegation shall be made in writing, shall
be reviewed periodically by the Committee and shall be terminable upon such
notice as the Committee in its discretion deems reasonable and proper under
the circumstances.
(g) BONDING, INSURANCE AND INDEMNITY - To the extent required under
Section 412 of ERISA, the Company shall secure fidelity bonding for the
fiduciaries of the Plan.
The Company (in its discretion) or the Trustee (as directed by the
Committee) may obtain a policy or policies of insurance for the Committee
(and other fiduciaries of the Plan) to cover liability or loss occurring by
reason of the act or omission of a fiduciary. If such insurance is purchased
with Trust Assets, the policy must permit recourse by the insurer against
the fiduciary in the case of a breach of a fiduciary obligation by such
fiduciary. The Company shall indemnify each member of the Committee (to the
extent permitted by law) against any personal liability or
37
<PAGE>
expense resulting from his service on the Committee, except such liability
or expense as may result from his own willful misconduct.
(h) NOTICES, STATEMENTS AND REPORTS - The Company shall be the "Plan
Administrator" (as defined in Section 3(16)(A) of ERISA and Section 414(g) of
the Code) for purposes of the reporting and disclosure requirements of ERISA
and the Code. The Committee shall assist the Company, as requested, in
complying with such reporting and disclosure requirements. The Committee
shall be the designated agent of the Plan for the service of legal process.
Section 18. CLAIMS PROCEDURE.
A participant (or Beneficiary) who does not receive a distribution of
benefits to which he believes he is entitled may present a claim to the
Committee. The claim for benefits must be in writing and addressed to the
Committee or to the Company. If the claim for benefits is denied, the
Committee shall notify the Participant (or Beneficiary) in writing within 90
days after the Committee initially received the benefit claim. Any notice of
a denial of benefits shall advise the Participant (or Beneficiary) of the
basis for the denial, any additional material or information necessary for
the Participant (or Beneficiary) to perfect his claim and the steps which the
Participant (or Beneficiary) must take to have his claim for benefits
reviewed.
Each Participant (or Beneficiary) whose claim for benefits has been
denied may file a written request for a review of his claim by the Committee.
The request for review must be filed by
38
<PAGE>
the Participant (or Beneficiary) within 60 days after he receives the written
notice denying his claim. The decision of the Committee will be made within
60 days after receipt of a request for review and shall be communicated in
writing to the claimant. Such written notice shall set forth the basis for
the Committee's decision. If there are special circumstances (such as the
need to hold a hearing) which require an extension of time for completing the
review, the Committee's decision shall be rendered not later than 120 days
after receipt of a request for review.
Section 19. LIMITATION ON PARTICIPANTS' RIGHTS.
A Participant's Capital Accumulation will be based only on his
vested interest in his Accounts and will be paid only from the Trust Assets.
The Company, the Committee or the Trustee shall not have any duty or
liability to furnish the Trust with any funds, securities or other assets,
except as expressly provided in the Plan.
The adoption and maintenance of the Plan shall not be deemed to
constitute a contract of employment or otherwise between the Company and any
Employee, or to be a consideration for, or an inducement or condition of, any
employment. Nothing contained in this Plan shall be deemed to give an
Employee the right to be retained in the Service of the Company or to
interfere with the right of the Company to discharge, with or without cause,
any Employee at any time.
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<PAGE>
Section 20. FUTURE OF THE PLAN.
The Company reserves the right to amend or terminate the Plan (in
whole or in part) and the Trust Agreement at any time, by action of the
Board of Directors. Neither amendment nor termination of the Plan shall
retroactively reduce the vested rights of Participants or permit any part of
the Trust Assets to be diverted to or used for any purpose other than for the
exclusive benefit of the Participants (and their Beneficiaries).
The Company specifically reserves the right to amend the Plan and the
Trust Agreement retroactively in order to satisfy any applicable requirements
of the Code and ERISA.
The Company further reserves the right to terminate the Plan in the
event of a determination by the Internal Revenue Service (after a timely
Application for Determination is filed by the Company) that the Plan
initially fails to satisfy the applicable requirements of Sections 401(a) and
4975(e)(7) of the Code. In that event, all Trust Assets shall (upon written
direction of the Company) be returned to the Company, and the Plan shall
terminate.
If the Plan is terminated (or partially terminated), participation of
Participants affected by the termination will end. If Employer Contributions
are not replaced by contributions to a comparable plan which meets the
requirements of Section 401(a) of the Code, the Accounts of Employees
affected by the termination will become nonforfeitable as of the date of
termination. A complete discontinuance of Employer Contributions shall be
deemed to be a termination of the Plan for this purpose.
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<PAGE>
After termination of the Plan, the Trust will be maintained until the
Capital Accumulations of all Participants have been distributed. Capital
Accumulations may be distributed following termination of the Plan or
distributions may be deferred as provided in Section 12, as the Company shall
determine. In the event that Company Stock is sold in connection with the
termination of the Plan or the amendment of the Plan to become a qualified
employee plan that is not a stock bonus plan, all Capital Accumulations will
be distributed in cash.
In the event of the merger or consolidation of this Plan with another
plan, or the transfer of Trust Assets (or liabilities) to another plan, the
Account balances of each Participant immediately after such merger,
consolidation or transfer must be at least as great as immediately before
such merger, consolidation or transfer (as if the Plan had then terminated).
Section 21. "TOP-HEAVY" CONTINGENCY PROVISIONS.
(a) The provisions of this Section 21 are included in the Plan pursuant
to Section 401(a)(10)(B)(ii) of the Code and shall become applicable only if
the Plan becomes a "top-heavy plan" under Section 416(g) of the Code for any
Plan Year.
(b) The determination as to whether the Plan becomes "top-heavy" for any
Plan Year shall be made as of the Allocation Date of the immediately
preceding Plan Year (or as of October 31, 1988, for the Plan Year ending on
that date). The Plan shall be "top-heavy" only if the total of the Account
balances under the Plan
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<PAGE>
for "key employees" as of the determination date exceeds 60% of the total of
the Account balances for all Participants. For such purpose, Account Balances
shall be computed and adjusted pursuant to Section 416(g) of the Code, taking
into consideration plans which are considered part of the Aggregation Group.
The term 'Aggregation Group' shall include each plan of the Company or any
related company which includes a Key Employee and each plan of the Company or
any related company which allows the Plan to meet the requirements of
Sections 401(a) or 410(b) of the Code and may include any other Plan of the
Company or any related company, if the Aggregation Group would continue to
meet the requirements of Sections 401(a)(4) and 410(b) of the Code. "Key
employees" shall be certain Participants (who are officers or shareholders of
the Company) and Beneficiaries described in Section 416(i)(1) or (5) of the
Code; and in determining "key employees," the term "annual compensation" in
Section 416(i)(1)(A) of the Code shall mean Statutory Compensation.
(c) For any Plan Year in which the Plan is "top-heavy," each Participant
who is an Employee on the Allocation Date (and who is not a "key employee")
shall receive a minimum allocation of Employer Contributions and Forfeitures
which is equal to the lesser of:
(1) 3% of his Statutory Compensation; or
(2) the same percentage of his Statutory Compensation as the
allocation to the "key employee" for whom the percentage
is the highest for that Plan Year.
42
<PAGE>
(d) As of the first day of any Plan Year in which the Plan has become
"top-heavy," the vesting schedule in Section 10(a)(2) shall be amended (with
respect to any Employee who is credited with at least one Hour of Service
after the Plan has become "top-heavy") to read as follows:
<TABLE>
<CAPTION>
NONFORFEITABLE
CREDITED SERVICE PERCENTAGE
---------------- --------------
<S> <C>
Less than Two Years 0%
Two Years 20%
Three Years 40%
Four Years 60%
Five Years 80%
Six Years of More 100%
</TABLE>
If the Plan ceases to be "top-heavy," the Capital Accumulation of a
Participant who, at that time, has less than three years of Service shall
thereafter be determined under the vesting schedule in Section 10(a)(2),
instead of the vesting schedule in this Section 21(e), except that his
nonforfeitable percentage shall not be reduced below the nonforfeitable
percentage that he had at the time the Plan ceased to be "top-heavy." If the
Plan ceases to be "top-heavy," the Capital Accumulation of a Participant who,
at that time, has three or more years of Service shall continue to be
determined under the vesting schedule in this Section 21(e).
43
<PAGE>
Section 22. GOVERNING LAW.
The provisions of this Plan and the Trust Agreement shall be construed,
administered and enforced in accordance with the laws of the State of
California, to the extent such laws are not superseded by ERISA.
Section 23. EXECUTION.
To record the adoption of this Plan, the Company has caused this document
to be executed on this 13th day of December, 1993.
VALLEY RECORD DISTRIBUTORS, INC.
/s/ Barnet J. Cohen
--------------------------------
President
/s/ Barbara C. Cohen
--------------------------------
Secretary
44
<PAGE>
VALLEY RECORD DISTRIBUTORS
EMPLOYEE STOCK OWNERSHIP PLAN
Amendment No. 4
WHEREAS, Valley Record Distributors, Inc. (the "Company") adopted and
maintains the Employee Stock Ownership Plan ("Plan") for the exclusive
benefit of participating employees, effective November 1, 1987; and
WHEREAS, the Plan has been amended on three previous occasions; and
WHEREAS, the Internal Revenue Service has requested certain changes to
the Plan as a condition to the issuance of a favorable determination letter
under the Internal Revenue Code of 1986 ("Code").
NOW THEREFORE, the Plan is amended as follows:
1. Section 2 is amended by restating the definition of "Compensation,"
effective January 1, 1994, to read:
"The total salary, wages, overtime compensation and bonuses paid
to an Employee by the Company during the Plan Year, excluding
Compensation received by the Employee, his spouse and any lineal
descendants who have not attained age 19 in excess of $200,000
($150,000 for Plan Years beginning after December 31, 1993), as
adjusted for increases in the cost of living pursuant to
Section 401(a)(17) of the Code."
2. Section 7 is amended, effective January 1, 1990, by deleting
subsection (b) in its entirety and by designating subsections (c) and (d) as
"(b)" and "(c)".
3. Section 10 is amended by deleting subsection (c) in its entirety,
redesignating subsection (d) as subsection "(c)," and restating subsection
(b) to read:
"(b) FORFEITURES - Any portion of the final balances in a
Participant's Accounts which is not vested (and does not
become part of his Capital Accumulation) will become a
Forfeiture as of the Allocation Date on which he incurs a
five-consecutive-year Break in Service. Forfeitures shall
first be charged against a Participant's Cash Account, with
1
<PAGE>
any balance charged against his ESOP Account (at Fair Market
Value). Financed Shares shall be forfeited only after other
shares of Company Stock have been forfeited. All Forfeitures
will be reallocated to the Accounts of remaining Participants,
as provided in Section 6(a), as of the Allocation Date of the
Plan Year in which the Participant incurs a five-consecutive-year
Break in Service."
4. Section 11(b) is restated, effective November 1, 1987, to read:
"A one-year Break in Service shall occur in a Plan Year in which
an Employee is not credited with more than 500 Hours of Service.
A five-consecutive-year Break in Service shall be five-consecutive
one-year Breaks in Service. For purposes of determining whether a
Break in Service has occurred, if an Employee begins a maternity/
paternity absence described in Section 411(a)(6)(E)(i) of the Code,
the computation of his Hours of Service shall include the Hours of
Service that would have been credited if he had not been so absent (or
eight Hours of Service for each normal work day of such absence if the
actual Hours of Service cannot be determined). An Employee shall
be credited for such Hours of Service (up to a maximum of 501 Hours
of Service) in the Plan Year in which such absence begins (if such
crediting will prevent him from incurring a Break in Service in
such Plan Year) or in the next following Plan Year. For purposes
hereof, a maternity/paternity absence means an absence (1) by
reason of the pregnancy of the individual, (2) by reason of the
birth of a child of the individual, (3) by reason of the placement
of a child with the individual in connection with the adoption of
such child by such individual, or (4) for purposes of caring for
such child for a period beginning immediately following such birth
or placement."
5. Section 13 is amended, effective October 19, 1990, by deleting the
words "Effective as of the 1997 Allocation Date," and by capitalizing the
word "a" in the first sentence thereof.
2
<PAGE>
6. Section 14 is amended, effective January 1, 1993, by adding a new
subsection (e) to read:
"A distributee may elect, at the time and in the manner prescribed
by the Plan administrator, to have any portion of an eligible
rollover distribution paid directly to an eligible retirement
plan specified by the distributee in a direct rollover.
An eligible rollover distribution is any distribution of all or
any portion of the balance to the credit of the distributee, except
that an eligible rollover distribution does not include: any
distribution that is one of a series of substantially equal periodic
payments (not less frequently than annually) made for the life (or
life expectancy) of the distributee or the joint lives (or joint
life expectancies) of the distributee and the distributee's designated
Beneficiary, or for a specified period of ten years or more; any
distribution to the extent such distribution is required under
Section 401(a)(9) of the Code; and the portion of any distribution
that is not inclusive in gross income (determined without regard to
the exclusion for net unrealized appreciation with respect to employer
securities).
An eligible retirement plan is an individual retirement account
described in Section 408(a) of the Code, an individual retirement
annuity described in Section 408(b) of the Code, an annuity plan
described in Section 403(a) of the Code, or a qualified trust
described in Section 401(a) of the Code, that accepts the distributee's
eligible rollover distribution. However, in the case of an eligible
rollover distribution to the surviving spouse, an eligible retirement
plan is an individual retirement account or individual retirement
annuity.
A distributee includes an Employee or former Employee. In addition,
the Employee's or former Employee's surviving spouse and the
Employee's or former Employee's spouse or former spouse who is the
alternate payee under a "qualified domestic relations order," as
defined in Section 414(p) of the
3
<PAGE>
interest of the spouse or former spouse.
A direct rollover is a payment by the Plan to the eligible
retirement plan specified by the distributee.
If a distribution is one to which sections 401(a)(11) and 417
of the Internal Revenue Code do not apply, such distribution
may commence less than 30 days after the notice required under
section 1.411(a)-11(c) of the Income Tax Regulations is given,
provided that:
(1) the Plan administrator clearly informs the participant
that the Participant has a right to a period of at least 30 days
after receiving the notice to consider the decision of whether or
not to elect a distribution (and, if applicable, a particular
distribution option), and
(2) the Participant, after receiving the notice,
affirmatively elects a distribution."
8. Section 20 is amended, effective April 3, 1994, by adding a new
paragraph, to read:
"All actions by the Company under this Section 20 will be taken
by the Board of Directors."
9. Section 21 is amended, effective November 1, 1987, by changing the
reference to "Section 416(i)(1) and (5)" in subsection (b) to "Section
416(i)" and by changing the reference to "Section 21(e)" in subsection (d) to
"Section 21(d)".
To record the adoption of this Amendment No. 4, the Company has caused
this to be executed by the authorized corporate officers this 8 day of July,
1994.
VALLEY RECORD DISTRIBUTORS, INC.
By: /s/ BARNET J. COHEN
----------------------------
President
By: /s/ BARBARA C. COHEN
----------------------------
Secretary
4
<PAGE>
VALLEY RECORD DISTRIBUTORS
EMPLOYEE STOCK OWNERSHIP PLAN
Amendment No. 5
WHEREAS, Valley Record Distributors, Inc. ("Company") adopted and
maintains the Employee Stock Ownership Plan ("Plan") for the exclusive
benefit of participating employees, effective November 1, 1987; and
WHEREAS, the Plan has been amended on 4 previous occasions; and
WHEREAS, the Company wishes to further amend the Plan in certain respects.
NOW THEREFORE, the Plan is amended as follows:
1. Section 3(a) is amended, effective April 1, 1995, adding at the end
thereof:
"Effective December 15, 1995, each Employee who has not satisfied
the foregoing requirement shall become a Participant as of the
April 1 or October 1 coinciding with or next following the date
on which he attains age 21 and completes six consecutive months of
Service (in which is credited with at least 500 Hours of Service).
Any Employee who fails to satisfy the above Service requirement
will become a Participant as of the April 1 or October 1 coinciding
with or next following the date on which he completes one year of
Service (in which he is credited with at least 1,000 Hours of
Service); for purposes hereof, the eligibility computation shall be
the 12 month period following the date on which he is first credited
with at least one Hour of Service and each Plan Year commencing after
such date."
2. Section 4(a) is amended, effective December 28, 1995 by adding an
additional sentence to read:
"Such Fixed Contributions shall be reduced, however, by the amount
of any Forfeitures attributable to the Fixed Contribution Portion
for such Plan Year."
1
<PAGE>
To record the adoption of this Amendment No. 5, the Company has caused
this to be executed by the authorized corporate officers this 15 day of
December, 1995.
VALLEY RECORD DISTRIBUTORS, INC.
By: /s/ BARNET J. COHEN
----------------------------
By:
----------------------------
2
<PAGE>
EXHIBIT 11.1
VALLEY MEDIA, INC.
COMPUTATION OF NET INCOME PER SHARE
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NINE MONTHS ENDED
----------------------------------------- -----------------------
MARCH 30, MARCH 29, MARCH 28, DEC. 27, DEC. 26,
1996 1997 1998 1997 1998
--------- --------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Income before extraordinary loss ...................... 1,453 611 3,021 2,054 3,988
Extraordinary loss .................................... (723)
--------- --------- --------- --------- ---------
Net income ............................................ 1,453 611 3,021 2,054 3,265
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Weighted average common shares outstanding ............ 4,965,375 4,797,193 4,791,864 4,782,447 4,838,413
Dilutive Options ...................................... 258,665 334,148 472,006 462,798 716,302
--------- --------- --------- --------- ---------
Weighted average shares assuming dilution ............. 5,224,040 5,131,341 5,263,870 5,245,245 5,554,715
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings per share:
Basic:
Income before extraordinary loss .................... $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.82
Extraordinary loss .................................. (0.15)
--------- --------- --------- --------- ---------
Net income per share ................................ $ 0.29 $ 0.13 $ 0.63 $ 0.43 $ 0.67
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Diluted:
Income before extraordinary loss .................... $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.72
Extaordinary loss ................................... (0.13)
--------- --------- --------- --------- ---------
Net income per share ................................ $ 0.28 $ 0.12 $ 0.57 $ 0.39 $ 0.59
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
There is no difference between primarily and fully dilutive loss per share
for each period.
<PAGE>
EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 1 to Registration Statement No.
333-69329 of Valley Media, Inc. on Form S-1 of our report dated July 22, 1998 on
the consolidated financial statements of the net assets acquired from Star Video
Entertainment, L.P., appearing in the Prospectus, which is part of this
Registration Statement.
/s/ Deloitte & Touche LLP
San Francisco, California
February 11, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 9-MOS
<FISCAL-YEAR-END> MAR-29-1997 MAR-28-1998 APR-03-1999
<PERIOD-END> MAR-29-1997 MAR-28-1998 DEC-26-1998
<CASH> 310 394 719
<SECURITIES> 0 0 0
<RECEIVABLES> 36,900 113,705 235,002
<ALLOWANCES> (825) (5,276) (9,326)
<INVENTORY> 44,351 95,365 219,034
<CURRENT-ASSETS> 82,746 208,717 451,619
<PP&E> 13,618 22,733 28,898
<DEPRECIATION> (4,533) (7,052) 9,768
<TOTAL-ASSETS> 94,591 245,062 487,929
<CURRENT-LIABILITIES> 82,946 226,329 466,891
<BONDS> 2,257 3,166 4,347
0 0 0
0 0 0
<COMMON> 1 1 5
<OTHER-SE> 7,772 10,976 14,237
<TOTAL-LIABILITY-AND-EQUITY> 94,591 245,062 487,929
<SALES> 199,231 583,492 631,102
<TOTAL-REVENUES> 199,231 583,492 631,102
<CGS> 175,706 516,627 561,112
<TOTAL-COSTS> 175,706 516,627 561,112
<OTHER-EXPENSES> 19,902 51,511 52,862
<LOSS-PROVISION> 650 3,672 3,165
<INTEREST-EXPENSE> 1,745 6,627 7,518
<INCOME-PRETAX> 1,021 5,055 6,445
<INCOME-TAX> 410 2,034 2,457
<INCOME-CONTINUING> 611 3,021 3,988
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 (723)
<CHANGES> 0 0 0
<NET-INCOME> 611 3,021 3,265
<EPS-PRIMARY> 1.02 5.07 5.43
<EPS-DILUTED> 0.95 4.58 4.69
</TABLE>
<PAGE>
EXHIBIT 99.1
[LOGO]
February 9, 1999
Bill Cook
Valley Media, Inc.
1280 Santa Anita Court
Woodland, CA 95776
To Whom It May Concern:
Pursuant to our contract, Forrester Research, Inc. ("Forrester") consents to
the inclusion of our name and intellectual property in the Business section
of Valley Media, Inc.'s prospectus ("Prospectus") prepared in connection with
its initial public offering of securities. Forrester does not, however,
consent to the reference to Forrester in the Risk Factors section of the
Prospectus.
Forrester does not consent to be an expert in the registration statement or
as having prepared or certified any part of the registration statement.
Very truly yours,
/s/ Timothy J. Moynihan
Timothy J. Moynihan, Esq.
Corporate Counsel
