<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 22, 1999
REGISTRATION NO. 333-69329
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
------------------------
VALLEY MEDIA, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<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
1755 EMBARCADERO ROAD, SUITE 200 (650) 843-5000
PALO ALTO, CALIFORNIA 94303
(650) 842-8500
------------------------
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. / /
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 MARCH 22, 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.
The shares Valley is offering have been approved for listing 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 $ $ $
- ---------------------------------------------------------------------------------
Total $ $ $
- ---------------------------------------------------------------------------------
</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
<TABLE>
<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
We May Be Unable to Compete with Other
Businesses that Offer Similar Products and
Services.................................... 8
We May Be Unable to Obtain Product from
Labels or Studios........................... 9
If the Internet Does Not Continue to Grow,
Our New Media Sales Will Not Grow........... 9
Our Sales Could Be Adversely Affected if We
Lose Any of Our Largest Customers........... 9
We May Be Unable to Integrate and Upgrade Our
Information Systems......................... 9
Our Information Systems Could Fail Because of
Problems Relating to the Year 2000.......... 10
Trends in the Video Rental Market Could Hurt
Our Sales................................... 10
New Product Formats Could Replace the Formats
We Distribute............................... 10
New Delivery Technologies Could Diminish Our
Role in the Distribution Process............ 11
We May Continue to Experience Inefficiencies
at Our New Facilities....................... 11
We Might Have Inventory Risk Due to an
Inability to Return Products................ 11
We May Be Liable if Our Suppliers Fail to
Comply with Copyright Laws.................. 12
We May Be Prevented from Distributing Music
Internationally............................. 12
<CAPTION>
PAGE
<S> <C>
We May Have Insufficient Access to Funds if
We Fail to Comply with the Terms of Our
Credit Facility............................. 13
The Fluctuations in Our Operating Results
Could Adversely Affect the Price of Our
Common Stock................................ 13
The Market Price of Our Common Stock Could
Fluctuate................................... 14
Insiders Could Preclude Actions Desired by
the Remaining Stockholders.................. 14
The Significant Number of Shares of Common
Stock Eligible for Future Sale Could
Adversely Affect the Price of Our Stock..... 15
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 a full-line distributor of music and video entertainment products. 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, 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 an 8.04 to 1 split of the
common stock effected by a stock dividend in March 1999 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. Each of the fiscal years ending in March 1994 through 1998 contained
52 weeks. Fiscal 1999 contains 53 weeks.
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>
---------------------------------------------------------------------------------------------
DOLLARS IN THOUSANDS, FISCAL YEARS
EXCEPT PER SHARE ---------------------------------------------------------
DATA 1994 1995 1996 1997
----------- --------- --------- --------- NINE MONTHS ENDED
----------------------------------
1998 DEC. 27, 1997 DEC. 26, 1998
----------- ---------------- ----------------
RESTATED RESTATED (1) RESTATED (1)
(1)
<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 10,917 7,684 14,242
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 4,290 3,173 6,724
Income before
extraordinary
loss................ 954 2,317 1,453 611 2,559 1,892 3,912
Extraordinary loss
(net of income taxes
of $477)............ -- -- -- -- -- -- (723)(2)
Net income............ $ 954 $ 2,317 $ 1,453 $ 611 $ 2,559 $ 1,892 $ 3,189
Net income per share:
Basic:
Income before
extraordinary
loss............... $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.81
Extraordinary
loss............... -- -- -- -- -- -- (0.15)(2)
----------- --------- --------- --------- ----------- ---------------- ----------------
Basic net income per
share.............. $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.66
----------- --------- --------- --------- ----------- ---------------- ----------------
----------- --------- --------- --------- ----------- ---------------- ----------------
Diluted:
Income before
extraordinary
loss............... $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.70
Extraordinary
loss............... -- -- -- -- -- -- (0.13)(2)
----------- --------- --------- --------- ----------- ---------------- ----------------
Diluted net income
per share.......... $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.57
----------- --------- --------- --------- ----------- ---------------- ----------------
----------- --------- --------- --------- ----------- ---------------- ----------------
</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 5,229,742 5,554,715
</TABLE>
- --------------------------
(1) Restated to write off deferred offering costs. See Note 13 to consolidated
financial statements.
(2) Represents an extraordinary loss comprised of termination fees and write off
of prepaid financing costs as a result of the termination of a prior line of
credit agreement.
6
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------
FISCAL YEARS
DOLLARS IN THOUSANDS, ---------------------------------------------------------
EXCEPT PER SHARE DATA 1994 1995 1996 1997
----------- --------- --------- --------- NINE MONTHS ENDED
----------------------------------
1998 DEC. 27, 1997 DEC. 26, 1998
----------- ---------------- ----------------
RESTATED RESTATED (1) RESTATED (1)
(1)
<S> <C> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL DATA
EBITDA..................... $ 2,655 $ 5,322 $ 5,070 $ 4,615 $ 15,030 $10,614 $18,400
Net cash provided by (used
in) operating
activities............... (1,607) (1,384) (5,460) 12,855 (13,851) (23,526) (45,809)
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) 51,489 58,351 52,361
</TABLE>
<TABLE>
<CAPTION>
---------------------
AT DEC. 26, 1998
---------------------
DOLLARS IN THOUSANDS AS ADJUSTED
-----------
ACTUAL
--------
RESTATED
(1)
<S> <C> <C>
BALANCE SHEET DATA
Working capital (deficit)............................................................................. $(15,325) $ 26,990
Total assets.......................................................................................... 487,444 487,444
Total long-term obligations........................................................................... 4,347 4,347
Total short-term borrowings........................................................................... 126,542 84,227
Stockholders' equity.................................................................................. 13,704 56,019
</TABLE>
- --------------------------
(1) Restated to write off deferred offering costs. See Note 13 to consolidated
financial statements.
7
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISKS AND OTHER INFORMATION
CONTAINED IN THIS PROSPECTUS BEFORE PURCHASING THE COMMON STOCK.
WE MAY BE UNABLE TO COMPETE WITH OTHER BUSINESSES THAT OFFER SIMILAR PRODUCTS
AND SERVICES
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.
8
<PAGE>
WE MAY BE UNABLE TO OBTAIN PRODUCT FROM LABELS OR STUDIOS
The major labels and studios produce most of the music and video product. Our
success depends upon our ability to obtain products in sufficient quantities on
competitive terms and conditions from each of the major labels and studios as
well as from thousands of smaller suppliers. We 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 12%
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.
IF THE INTERNET DOES NOT CONTINUE TO GROW, OUR NEW MEDIA SALES WILL NOT GROW
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.
OUR SALES COULD BE ADVERSELY AFFECTED IF WE LOSE ANY OF OUR LARGEST CUSTOMERS
If any of our largest customers were to stop or reduce their purchasing from us,
our financial results could be adversely affected. During the first nine months
of fiscal 1999, our top three customers accounted for an aggregate of 22.4% 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.
WE MAY BE UNABLE TO INTEGRATE AND UPGRADE OUR 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
9
<PAGE>
without unanticipated costs or operational difficulties. The failure or
inoperability of our systems, or difficulties in integration of these systems,
could have a material adverse impact on our financial results.
OUR INFORMATION SYSTEMS COULD FAIL BECAUSE OF PROBLEMS RELATING TO THE YEAR 2000
Our information systems could fail or provide erroneous output when referencing
dates subsequent to December 31, 1999 due to year 2000 processing problems. In
addition, as we provide electronic data interchange with our suppliers and
customers, difficulties with 21st century dates in our customers' or suppliers'
information systems could adversely affect our information systems, and vice
versa. Such failures or errors could occur prior to 2000. If we or our
electronic data interchange suppliers and customers are unable to update our
systems successfully to eliminate this problem, we may be prevented from using
some or all of our information systems or exchanging data with our customers or
suppliers. This, in turn, could disrupt our business and have a material adverse
impact on our financial results. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations - Year 2000 Matters."
TRENDS IN THE VIDEO RENTAL MARKET COULD HURT OUR SALES
Studios and full-line distributors recently have instituted programs to increase
the quantity of copies of popular video rental titles stocked by retailers. We
believe that these programs have accelerated a shift in the market away from
independent video rental stores and small chains in favor of the larger chains.
Since, in general, full-line distributors play a larger role with independent
retailers than with the larger chains, we believe that the market may contract
for full-line distribution of video rental product. In addition, while most
full-line video distributors have elected to participate in revenue sharing
distribution arrangements to help increase the quantity of copies of titles
available from the major studios, we have not. In doing so, we risk losing
market share to other distributors.
NEW PRODUCT FORMATS COULD REPLACE THE FORMATS WE DISTRIBUTE
The recent introductions of new product formats may cause consumers to exercise
caution in building their libraries of video cassettes and music CDs, thus
decreasing our video sell-through and music sales. Within the past two years,
studios started selling DVD, which currently is being marketed as a superior
alternative to the video cassette and may eventually be marketed as a superior
replacement for the music CD.
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.
10
<PAGE>
NEW DELIVERY TECHNOLOGIES COULD DIMINISH OUR ROLE IN THE DISTRIBUTION PROCESS
Music and video are currently marketed and distributed primarily on a physical
delivery basis through wholesale and retail distribution. In the future, if
products are marketed, sold and delivered by labels or studios directly to
stores or homes through electronic downloading or 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.
WE MAY CONTINUE TO EXPERIENCE INEFFICIENCIES AT OUR 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. Furthermore, we are planning to relocate our California distribution
center to a nearby facility in Woodland, California beginning in April 1999. Our
rent expense will increase and we expect to incur additional labor costs and
other expenses in the first and second quarters of fiscal 2000 in connection
with this relocation. In addition, we could incur unanticipated costs or
disruptions of our operations as a result of this move. Integration of
operations into these new distribution centers 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.
WE MIGHT HAVE INVENTORY RISK DUE TO AN INABILITY TO RETURN PRODUCTS
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
11
<PAGE>
return, we may be forced to expense such inventory costs. Further, we often
experience higher return rates for products of financially troubled labels and
studios. If we fail to manage our inventory to avoid accumulating substantial
product that cannot be returned, our financial results could be adversely
affected.
WE MAY BE LIABLE IF OUR SUPPLIERS FAIL TO COMPLY WITH COPYRIGHT LAWS
Substantially all of the music and video products we sell are subject to
copyright laws and licenses that limit the manner and geographic area in which
such products may be sold and provide royalties to the copyright owners. Any
sales of product in violation of such laws and licenses by anyone in the chain
of distribution may subject us to monetary damages or confiscation of such
product. We distribute thousands of titles from different artists over numerous
jurisdictions and rely primarily on our suppliers to ensure compliance with the
copyright laws, some of which may be conflicting or not clearly developed, and
payment of appropriate royalties. Although we have not experienced a material
loss due to copyright violations, we could be damaged in the future by copyright
violations by someone in our distribution channel.
WE MAY BE PREVENTED FROM DISTRIBUTING MUSIC INTERNATIONALLY
Most of the major labels have adopted policies restricting the export of their
merchandise by domestic distributors. However, consistent with industry
practice, we distribute music of the major labels internationally. Our
international net sales of music for 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.
12
<PAGE>
WE MAY HAVE INSUFFICIENT ACCESS TO FUNDS IF WE FAIL TO COMPLY WITH THE TERMS OF
OUR CREDIT FACILITY
We have a revolving credit facility that is secured by substantially all of our
assets. As of 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.
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
- 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.
THE FLUCTUATIONS IN OUR OPERATING RESULTS COULD ADVERSELY AFFECT THE PRICE OF
OUR COMMON STOCK
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
13
<PAGE>
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.
THE MARKET PRICE OF OUR COMMON STOCK COULD FLUCTUATE
Prior to this offering, there has been no public market for the common stock.
The shares we are offering have been approved 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 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.
INSIDERS COULD PRECLUDE ACTIONS DESIRED BY THE REMAINING STOCKHOLDERS
After giving effect to this offering, Barnet Cohen, our 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 55.8% 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.
14
<PAGE>
THE SIGNIFICANT NUMBER OF SHARES OF COMMON STOCK ELIGIBLE FOR FUTURE SALE COULD
ADVERSELY AFFECT THE PRICE OF OUR STOCK
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, 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
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
819,350 shares will be vested and fully exercisable 180 days after commencement
of this offering.
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. 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 as restated........................................ 12,854 12,854
--------- -----------
Total stockholders' equity......................................... 13,704 56,019
--------- -----------
Total capitalization............................................. $ 144,593 $ 144,593
--------- -----------
--------- -----------
</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
$(1,360,000) or $(0.28) 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, the pro forma net tangible book value at December 26,
1998 would have been approximately $40,955,000 or $4.88 per share. This
represents an immediate increase in net tangible book value of $5.16 per share
to existing stockholders and an immediate dilution of $8.12 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...................... $ (0.28)
Increase attributable to new investors...................................... 5.16
---------
Pro forma net tangible book value per share after this offering............. 4.88
---------
Dilution per share to new investors......................................... $ 8.12
---------
---------
</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 financial statements for the nine months ended
December 27, 1997 are unaudited, but include all adjustments (consisting of
normal recurring items) that management considers necessary for a fair
presentation of the financial statements. 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>
---------------------------------------------------------------------------------
FISCAL YEARS
DOLLARS IN THOUSANDS, EXCEPT PER SHARE -------------------------------------------------------
DATA 1994 1995 1996 1997
--------- --------- --------- --------- NINE MONTHS ENDED
------------------------
1998 DEC. 27, DEC. 26,
----------- 1997 1998
----------- -----------
RESTATED
(1) RESTATED RESTATED
(1) (1)
<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 55,948 39,183 55,748
--------- --------- --------- --------- ----------- ----------- -----------
Operating income....................... 2,139 4,830 4,677 2,973 10,917 7,684 14,242
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 4,290 3,173 6,724
Income taxes........................... 661 1,616 1,016 410 1,731 1,281 2,812
--------- --------- --------- --------- ----------- ----------- -----------
Income before extraordinary loss....... 954 2,317 1,453 611 2,559 1,892 3,912
Extraordinary loss (net of income taxes
of $477)............................. -- -- -- -- -- -- (723)(2)
--------- --------- --------- --------- ----------- ----------- -----------
Net income............................. $ 954 $ 2,317 $ 1,453 $ 611 $ 2,559 $ 1,892 $ 3,189
--------- --------- --------- --------- ----------- ----------- -----------
--------- --------- --------- --------- ----------- ----------- -----------
Net income per share:
Basic:
Income before extraordinary loss..... $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.81
Extraordinary loss................... -- -- -- -- -- -- (0.15)(2)
--------- --------- --------- --------- ----------- ----------- -----------
Basic net income per share........... $ 0.20 $ 0.47 $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.66
--------- --------- --------- --------- ----------- ----------- -----------
--------- --------- --------- --------- ----------- ----------- -----------
Diluted:
Income before extraordinary loss..... $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.70
Extraordinary loss................... -- -- -- -- -- -- (0.13)(2)
--------- --------- --------- --------- ----------- ----------- -----------
Diluted net income per share......... $ 0.19 $ 0.46 $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.57
--------- --------- --------- --------- ----------- ----------- -----------
--------- --------- --------- --------- ----------- ----------- -----------
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 5,229,742 5,554,715
SUPPLEMENTAL OPERATING DATA
EBITDA................................. $ 2,655 $ 5,322 $ 5,070 $ 4,615 $ 15,030 $ 10,614 $ 18,400
Net cash provided by (used in)
operating activities................. (1,607) (1,384) (5,460) 12,855 (13,851) (23,526) (45,809)
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) 51,489 58,351 52,361
</TABLE>
<TABLE>
<CAPTION>
--------------------------------------------------------------------
AT FISCAL YEAR END
-------------------------------------------------------
DOLLARS IN THOUSANDS 1994 1995 1996 1997
--------- --------- --------- --------- AT DEC. 26,
1998
1998 -----------
-----------
RESTATED
RESTATED (1)
(1)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital (deficit)...................... $ 3,073 $ 3,762 $ 4,397 $ (200) $ (17,310) $ (15,325)
Total assets................................... 32,171 48,648 58,114 94,591 244,298 487,444
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 10,515 13,704
</TABLE>
- ------------------------------
(1) Restated to write off deferred offering costs. See Note 13 to consolidated
financial statements.
(2) Represents an extraordinary loss comprised of termination fees and write off
of prepaid financing costs as a result of the termination of a prior line of
credit agreement.
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
---------------------------------------------------------------------------------------
DEC. 27, MARCH 28, JUNE 27, SEPT. 26, DEC. 26,
DOLLARS IN THOUSANDS, EXCEPT PER JUNE 28, SEPT. 27, 1997 1998 1998(1) 1998 1998
SHARE DATA 1997 1997 ----------- ----------- ----------- ----------- -----------
----------- ---------
RESTATED(2) RESTATED(2) RESTATED(2) RESTATED(2) RESTATED(2)
<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 15,346 16,765 16,734 17,409 21,605
Total operating income (loss)... $ 1,020 $ 1,950 $ 4,713 $ 3,233 $ 216 $ 3,587 $ 10,439
Net income (loss)............... $ (11) $ 180 $ 1,722 $ 669 $ (1,985) $ 415 $ 4,759
Basic net income (loss) per
share: - $ 0.04 $ 0.36 $ 0.14 $ (0.41) $ 0.09 $ 0.98
Diluted net income (loss) per
share......................... - $ 0.03 $ 0.33 $ 0.13 $ (0.37) $ 0.07 $ 0.85
SUPPLEMENTAL DATA
EBITDA........................ $ 1,763 $ 3,023 $ 5,829 $ 4,416 $ 1,430 $ 4,927 $ 12,043
</TABLE>
- ------------------------------
(1) Includes extraordinary loss of $723,000 or $0.15 per share.
(2) Restated to write off deferred offering costs.
<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 8.0 10.7 10.8 9.2 7.5
Total operating income (loss).... 1.1 1.3 2.4 2.1 0.1 1.9 3.6
Net income (loss)................ - 0.1 0.9 0.4 (1.3) 0.2 1.7
</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. Returns from our customers and to
our suppliers occur in the ordinary course of our business. Accordingly, sales
and cost of goods sold 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 sold is
comprised almost entirely 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 are included
in cost of goods sold, although in the aggregate these items represent a very
small portion of total cost of sales. 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 and the planned move of our
California distribution center to a larger
23
<PAGE>
nearby facility, provide the capacity for growth in all lines of our business.
In 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 for video full-line distribution.
Our selling, general and administrative expenses are comprised primarily of
salaries and benefits. They also include rent expense, depreciation,
amortization and other items. Such expenses have increased in absolute dollars
with our growth in net sales and are expected to continue to do so. Over time we
would expect the increase in selling, general and administrative expenses
generally to vary proportionally with the increase in net sales. These expenses
can be expected to increase as a percentage of sales in periods immediately
following the building of our infrastructure and to decrease as a percentage of
sales in periods in which we are growing faster than we are adding
infrastructure.
We intend to relocate our California distribution center to a nearby larger
facility this year. We expect to lease this new facility and to retain the
existing space. The move is expected to be completed in phases during the first
and second quarters of fiscal 2000. This move will increase our rent expense by
approximately $800,000 per year. We expect to incur additional labor costs and
other expenses in connection with this relocation.
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
24
<PAGE>
- 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
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 9.6 9.2 8.8
Operating income......................... 3.0 1.5 1.9 1.8 2.3
Net income............................... 0.9% 0.3% 0.4% 0.4% 0.5%
SUPPLEMENTAL DATA
EBITDA................................... 3.2% 2.3% 2.6% 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 $32.3 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 increased primarily
because of the relatively faster growth rate in New Media and full-line audio
sales, which have higher margins than full-line video sales.
In the nine months ended December 26, 1998, customer returns reserves,
representing the gross profit associated with product expected to be returned,
increased $2.8 million from $3.7 million to $6.5 million primarily due to
increased sales.
25
<PAGE>
Selling, general and administrative expenses increased $16.5 million, or 42%,
from $39.2 million to $55.7 million primarily as a result of sales growth.
Salaries and benefits increased during 1998 as this period included the full
nine months of the Star operations. In addition, we added employees with the
opening of the LDC, and also added staff in our California distribution center.
Our rent expense increased as a result of the Star acquisition and the opening
of the LDC, and we also incurred certain other costs in connection with the
LDC's opening. Depreciation and amortization also increased in 1998, primarily
due to the Star acquisition and further development of our infrastructure. Other
selling, general and administrative costs also grew as a result of costs
associated with closing designated video sales offices and distribution
facilities. Our bad debt reserve increased by approximately 0.6% of net sales
reflecting the increase in our bad debt reserve primarily for our video
customers prompted by the bankruptcies of a small number of these customers and
the deteriorating financial condition of some others. Selling, general and
administrative expenses for the nine months ending December 26, 1998 also
include approximately $600,000 for the write off of offering costs.
Selling, general and administrative expenses declined as a percentage of sales
from 9.2% to 8.8% 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 take advantage of our investment in our infrastructure to
grow full-line music distribution and New Media sales without the
requirement of proportionate increases in our personnel and facilities.
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 increased from 40.3% to 41.8% primarily due to the write
off of deferred offering costs for book purposes, which will not be deductible
for tax purposes, offset by the true-up of prior year tax returns which resulted
in a decrease in the tax provision of $135,000 in the nine months ended December
26, 1998.
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 $1.3 million from $1.9 million to $3.2 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
26
<PAGE>
Star. Approximately $102 million was attributable to growth in full-line music
distribution, representing a 55% 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 592%, from $6.6
million in fiscal 1997 to $45.7 million in fiscal 1998. This growth primarily
was due to (a) the acquisition of 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. The average cost of
product sold increased due to our entry into the video business with lower gross
margins. A portion of the video increase was offset by gross margin gains
associated with the growth in our New Media and Independent Distribution Groups.
Inventory reserves increased $1.2 million or 0.2% of net sales due to the
inclusion of DNA for twelve months in 1998 compared to two months in 1997.
Inventory obsolescence is typically higher in independent distribution than in
full line distribution as a function of the relative growth in the independent
distribution of smaller, less financially stable labels.
Customer returns reserves increased $2.1 million from $1.6 million to $3.7
million. This increase was primarily due to increased sales.
Selling, general and administrative expenses increased $35.3 million, or 171%,
from $20.6 million in fiscal 1997 to $55.9 million in fiscal 1998. Salaries and
benefits increased in fiscal 1998 primarily as a result of the Star acquisition
and personnel increases to support the growth in New Media and Independent
Distribution sales. Our rent expense increased as a result of the facilities we
acquired in the Star acquisition. Depreciation and amortization also increased
in fiscal 1998, primarily due to the Star acquisition and continued investment
in infrastructure. Selling, general and administrative costs also grew as a
result of costs associated with planning and preparing for the opening of the
LDC. Selling, general and administrative expenses also included $800,000 of
offering costs that were written off.
Our allowance for doubtful accounts and receivable reserves increased 0.5% of
net sales due primarily to the bankruptcy of three video customers, the
deteriorating financial conditions of other customers and collection
complications associated with the Star acquisition.
Selling, general and administrative expenses declined as a percentage of sales
from 10.3% in fiscal 1997 to 9.6% in fiscal 1998.
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.
27
<PAGE>
Net income increased by $2.0 million from $611,000 in fiscal 1997 to $2.6
million in fiscal 1998 as a result of these factors.
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 was primarily due to price
competition in full-line distribution.
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.
Customer returns reserves increased $1.3 million from $300,000 to $1.6 million
due primarily to the higher returns associated with DNA 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. Salaries
and benefits increased during fiscal 1997 primarily due to the development of
the Schwann publications, Valley Entertainment, the LDC and the East Coast sales
office. Our rent expense increased as we commenced leasing a large new computer
in July 1997. Depreciation and amortization increased due to amortization of
goodwill related to acquisitions completed in fiscal 1997.
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.
28
<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 $13.9 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 $23.5 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 $45.8 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,
29
<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 $50.5 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 $52.4
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>
Our 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 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, and certain
equipment that uses programmable logic chips to control aspects of their
operation, commonly referred to as embedded chip equipment, may recognize "00"
as a year other than the year 2000. Some information technology systems and
embedded chip equipment used by us and by third parties 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:
- information technology systems and embedded chip equipment used by us
- third parties who do business with us that are not prepared for the year
2000
- contingency planning
31
<PAGE>
We use a variety of information technology systems, internally developed and
third-party provided software and embedded chip equipment. For these information
technology systems, software and embedded chip equipment, we have divided our
year 2000 efforts into four phases:
(1) identification and inventorying of information technology systems and
embedded chip equipment with potential year 2000 problems
(2) evaluation of scope of year 2000 issues for, and assigning priorities
to, each item based on its importance to our operations
(3) remediation of year 2000 issues in accordance with assigned priorities,
by correction, upgrade, replacement or retirement
(4) testing for and validation of year 2000 compliance on an application and
enterprise-wide basis
We have categorized as "mission critical" those information technology 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 information technology 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 information technology systems
interact with commercial electronic transaction processing systems of customers.
In addition, we are dependent on third-party suppliers of infrastructure
elements such as telecommunications services, electric power, water and banking
facilities. We do not depend to any significant degree on any single merchandise
supplier or upon electronic transaction processing with individual 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 information technology 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
information technology budgets for the respective periods.
32
<PAGE>
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 information technology 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 information technology projects have been deferred and will continue to
be deferred as a result of the personnel we are devoting to our year 2000
remediation efforts. These projects relate to potential operational enhancements
such as additional value-added services and cost cutting projects. We do not
believe that the delay in these information technology projects will have a
material adverse affect on our financial condition or results of operations.
Our estimate of the costs of achieving year 2000 compliance and the date by
which year 2000 compliance will be achieved are based on our best estimates,
which were derived using numerous assumptions about future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no assurance that these estimates will be
achieved, and actual results could differ materially from these estimates.
Specific facts that might cause such material differences include the
availability and cost of personnel trained in year 2000 remediation work, the
ability to locate and correct all relevant computer codes, the success achieved
by our customers and suppliers in reaching year 2000-readiness, the timely
availability of necessary replacement items and similar uncertainties.
RISKS
We expect to implement the changes necessary to address the year 2000 issue for
information technology systems and embedded chip equipment we use. We presently
believe that, with modifications to existing software, conversions to new
software, and appropriate remediation of embedded chip equipment, the year 2000
issue with respect to our information technology systems and embedded chip
equipment is not reasonably likely to pose significant operational problems for
us. However, if unforeseen difficulties arise, such modifications, conversions
and replacements are not completed timely, or our customers' or suppliers'
systems 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.
33
<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.
34
<PAGE>
BUSINESS
We are a full-line distributor of music and video entertainment products. 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. NARM is a major music industry trade
organization comprised of more than 1,000 member companies, including all of the
major labels and a large number of independent labels, independent distributors
and retailers. NARM is the only industry organization that gives awards to music
distributors.
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, commonly referred to as 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.
35
<PAGE>
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 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 taking advantage of 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 approximately 52,425 audio skus and deleted approximately 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.
36
<PAGE>
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 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
37
<PAGE>
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 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.
38
<PAGE>
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:
- maintain a highly reliable inventory management system
39
<PAGE>
- 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 our
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 distribution center. These batches are then placed in an advanced
sorting device, which uses
40
<PAGE>
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 approximately 205,100
music skus. Currently, our inventory has grown to more than 250,000 skus,
approximately 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
41
<PAGE>
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.
42
<PAGE>
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.
43
<PAGE>
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
44
<PAGE>
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
45
<PAGE>
- 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 service, commonly referred to as
racking, 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.
46
<PAGE>
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
47
<PAGE>
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 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
48
<PAGE>
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.
49
<PAGE>
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
50
<PAGE>
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. We intend to relocate our California distribution center
to a nearby larger facility in phases during the first and second quarters of
fiscal 2000. We expect to lease this new facility and to retain the existing
space. The LDC building consists of approximately 330,000 square feet. Our lease
on the LDC expires in 2008. We also maintain smaller sales, distribution or
administrative offices in California, 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 believe that our relations with our
employees are good.
51
<PAGE>
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.
52
<PAGE>
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
53
<PAGE>
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.
54
<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 $ 406,923 $ 166,263 $ 5,612 $ 1,600 --
Robert R. Cain ........................................
President and Chief Executive Officer 273,077 111,462 4,366 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>
55
<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 19,095 817,959 186,371
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 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
56
<PAGE>
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.
57
<PAGE>
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. 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 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
58
<PAGE>
$282,000. During the first nine months of fiscal 1999, Valley made matching
contributions of $92,000 and has accrued an additional $172,000. 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:
- 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.
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-
59
<PAGE>
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.
60
<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, Valley entered into severance agreements with the following
executive officers:
- 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 an
average interest rate of 8.2% 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 was 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. 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
66
<PAGE>
common stock allocated to the account of that participant may be distributed to
the participant and such shares may then be sold by the participant. 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 of liabilities under
the Securities Act.
The representatives have informed Valley that the underwriters do not intend to
confirm sales of the common stock Valley is offering to any accounts over which
they exercise discretionary authority.
The shares Valley is offering have been approved for listing 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, which would create 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, Palo Alto, 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 and the financial statements of Distribution North America as of and
for the ten months ended January 31, 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.
The financial statements of Distribution North America as of and for the fiscal
year ended March 30, 1996 included in this prospectus have been audited by
PricewaterhouseCoopers LLP, independent accountants, as stated in this report
appearing herein. Such financial statements have been included in reliance upon
the report of such firm given upon their authority as experts in accounting and
auditing.
ADDITIONAL INFORMATION
Valley 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.
70
<PAGE>
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.
71
<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
DISTRIBUTION NORTH AMERICA:
Report of Independent Accountants.................................................. F-31
Independent Auditors' Report....................................................... F-32
Balance Sheets as of March 30, 1996 and January 31, 1997........................... F-33
Statements of Operations and Accumulated Deficit for the Fiscal Year Ended March
30, 1996 and the Ten Months Ended January 31, 1997................................ F-34
Statements of Cash Flows for the Fiscal Year Ended March 30, 1996 and the Ten
Months Ended January 31, 1997..................................................... F-35
Notes to Financial Statements...................................................... F-36
</TABLE>
F-1
<PAGE>
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.
As discussed in Note 13, the accompanying consolidated financial statements for
the fiscal year ended March 28, 1998 and for the nine months ended December 26,
1998 have been restated.
/s/ Deloitte & Touche LLP
San Francisco, California
February 8, 1999 (March 5, 1999 as to Note 13 and March 22, 1999 as to the last
paragraph of Note 2)
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
----------- ----------- ---------
AS RESTATED - SEE NOTE
13
<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......................................................... 134 335 1,319
----------- ----------- ---------
Total assets......................................................... $ 94,591 $ 244,298 $ 487,444
----------- ----------- ---------
----------- ----------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable................................................... $ 58,428 $ 140,380 $ 323,919
Accrued expenses................................................... 1,594 6,878 8,630
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............................................................ 82,946 226,027 466,944
----------- ----------- ---------
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 9,665 12,854
----------- ----------- ---------
Total stockholders' equity....................................... 7,773 10,515 13,704
----------- ----------- ---------
Total liabilities and stockholders' equity........................... $ 94,591 $ 244,298 $ 487,444
----------- ----------- ---------
----------- ----------- ---------
</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
--------- --------- --------- ----------- ---------
AS RESTATED - SEE NOTE 13
(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 55,948 39,183 55,748
--------- --------- --------- ----------- ---------
Operating income........................ 4,677 2,973 10,917 7,684 14,242
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 4,290 3,173 6,724
Income taxes............................ 1,016 410 1,731 1,281 2,812
--------- --------- --------- ----------- ---------
Income before extraordinary loss........ 1,453 611 2,559 1,892 3,912
Extraordinary loss (net of income taxes
of $477).............................. (723)
--------- --------- --------- ----------- ---------
Net income.............................. $ 1,453 $ 611 $ 2,559 $ 1,892 $ 3,189
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Net income per share:
Basic:
Income before extraordinary loss.... $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.81
Extraordinary loss.................. (0.15)
--------- --------- --------- ----------- ---------
Net income per share................ $ 0.29 $ 0.13 $ 0.53 $ 0.40 $ 0.66
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Diluted:
Income before extraordinary loss.... $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.70
Extraordinary loss.................. (0.13)
--------- --------- --------- ----------- ---------
Net income per share................ $ 0.28 $ 0.12 $ 0.49 $ 0.36 $ 0.57
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
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 5,229,742 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 as restated.......... 2,559 2,559
--------- --------- ----------- --------- ---------
Balance at March 28, 1998 as
restated....................... 4,810,553 5 845 9,665 10,515
Exercise of stock option in
exchange for notes
receivable..................... 89,556 232 $(232)
Net income as restated.......... 3,189 3,189
--------- --------- ----------- --------- --------- ---------
Balance at December 26, 1998 as
restated....................... 4,900,109 $5 $1,077 $(232) $ 12,854 $ 13,704
--------- --------- ----------- --------- --------- ---------
--------- --------- ----------- --------- --------- ---------
</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. 27, DEC. 26,
DOLLARS IN THOUSANDS 1996 1997 1998 1997 1998
----------- ----------- ----------- ----------- ---------
AS RESTATED - SEE NOTE 13
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income before extraordinary loss.............................. $ 1,453 $ 611 $ 2,559 $ 1,892 $ 3,912
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
Equity in net loss of joint venture......................... 903 207
Deferred income taxes....................................... 264 121 2,799 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 (2,586) (3,037) 2,346
Deferred revenue.......................................... 438 629 927 691 2,324
----------- ----------- ----------- ----------- ---------
Net cash provided by (used in) operating activities..... (5,460) 12,855 (13,851) (23,526) (45,809)
----------- ----------- ----------- ----------- ---------
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
Short-term borrowings under revolving line of credit.......... 163,068 195,748 632,004 444,452 581,191
Repayment of short-term borrowings............................ (155,142) (194,246) (579,070) (385,007) (529,816)
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....................................... (147)
----------- ----------- ----------- ----------- ---------
Net cash provided by (used in) financing activities..... 7,290 (359) 51,489 58,351 52,361
----------- ----------- ----------- ----------- ---------
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 $ 3,649 $ 7,108
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 $150,000 at December 26, 1998 of deferred offering costs,
which the Company expects to offset against the gross proceeds from an initial
public 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.
ADVERTISING EXPENSE AND REIMBURSEMENT
Advertising costs are expensed when incurred. Advertising reimbursements from
suppliers are recognized as earned. Net advertising reimbursements are included
in cost of goods sold and were $1,558,000 ($3,739,000 of advertising
reimbursements less $2,181,000 of advertising expenses), $1,688,000 ($4,510,000
of advertising reimbursements less $2,822,000 of advertising expenses),
$7,058,000 ($15,239,000 of advertising reimbursements less $8,181,000 of
advertising expenses), and $6,114,000 ($24,674,000 of advertising reimbursements
less $18,560,000 of advertising expenses) in fiscal 1996, fiscal 1997, fiscal
1998 and the nine months ended December 26, 1998, respectively.
CONCENTRATION OF CREDIT RISK
The Company is subject to credit risk through sales and related trade
receivables to retailers. Approximately 28% of the Company's net sales and 41%
of accounts receivable were represented by four customers for the nine months
ended December 26, 1998. The Company
F-8
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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").
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 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.
F-9
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 March 22, 1999, the Company effected a 8.04-for-1 split of its common stock
in the form of a stock dividend. 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.
F-10
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION OF BUSINESS OF STAR VIDEO ENTERTAINMENT, L.P. (CONTINUED)
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.
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
F-11
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. ACQUISITION OF BUSINESS OF STAR VIDEO ENTERTAINMENT, L.P. (CONTINUED)
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 1,991
Net income per share:
Basic................................................................. $ 1.01 $ 0.42
Diluted............................................................... 0.94 0.38
</TABLE>
- ------------------------
(1) Includes results of operations of Star Video for the fiscal year ended
December 31, 1996
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 YEAR TEN MONTHS
ENDED ENDED
MARCH 30, JANUARY 31,
1996 1997
----------- -----------
DOLLARS IN THOUSANDS
<S> <C> <C>
Net sales.............................................................. $ 36,079 $ 23,539
Gross profit........................................................... 5,846 5,176
Operating income (loss)................................................ (1,248) 108
Net loss............................................................... (1,807) (414)
</TABLE>
F-12
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. OTHER ACQUISITIONS (CONTINUED)
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
as of March 29, 1997, adjusted for changes in the Company's business.) 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.
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.
F-13
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 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.
F-14
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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>
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.
F-15
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
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 $ 3,663
State.......................................... 201 74 3 830
----------- ----- ----------- -----------
Total........................................ 752 289 101 4,493
Deferred
Federal........................................ 244 102 1,114 (1,454)
State.......................................... 20 19 516 (227)
----------- ----- ----------- -----------
Total........................................ 264 121 1,630 (1,681)
----------- ----- ----------- -----------
Income tax provision (benefit)..................... $ 1,016 $ 410 $ 1,731 $ 2,812
----------- ----- ----------- -----------
----------- ----- ----------- -----------
</TABLE>
F-16
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES (CONTINUED)
The Company's effective tax rate differs from the federal statutory rate 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)
Write off of deferred offering
costs.............................. 3.7
Other............................... 1.2 0.1 0.5 (0.6)
--- --- --- -----
Total............................... 41.2% 40.2% 40.3% 41.8%
--- --- --- -----
--- --- --- -----
</TABLE>
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
F-17
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS (CONTINUED)
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 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.
F-18
<PAGE>
VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCKHOLDERS' EQUITY AND EMPLOYEE BENEFIT PLANS (CONTINUED)
No compensation expense has been recognized in connection with any stock option
grants or sales of common stock by the Company's principal shareholder.
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 $1.04)....... 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 $1.07)....... 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 $2.01)....... 219,291 9.54
Exercised............................................ (89,556) 2.59
Forfeited............................................ (62,881) 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.
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
48,159 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 $ 2.81
--------- -----------
--------- -----------
</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, $2,517,000 or $0.48 per diluted share in fiscal
1998 and $3,124,000 or $0.56 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....... 258,665 334,148 472,006 447,295 716,302
--------- --------- --------- ----------- ---------
Weighted average shares used in the
calculation-diluted................... 5,224,040 5,131,341 5,263,870 5,229,742 5,554,715
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
</TABLE>
13. RESTATEMENT
Subsequent to the issuance of the Company's consolidated financial statements
for fiscal 1998 and the nine months ended December 26, 1998, the Company's
management determined that costs which had been reflected as deferred offering
costs should have been expensed, pursuant to the Securities and Exchange
Commission Staff Accounting Bulletin Topic 5A.1. As a result, such consolidated
financial statements have been restated from the amounts previously reported as
follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------
MARCH 28, 1998 DECEMBER 27, 1997 DECEMBER 26, 1998
------------------------ ------------------------ ------------------------
AS AS AS
PREVIOUSLY PREVIOUSLY PREVIOUSLY
DOLLARS IN THOUSANDS REPORTED AS RESTATED REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
At period end:
Other assets.................. $ 1,099 $ 335 $ 269 $ 8 $ 1,804 $ 1,319
Total stockholders' equity.... 10,977 10,515 10,057 9,895 14,242 13,704
For the period ended:
Selling, general and
administrative expenses...... 55,183 55,948 38,922 39,183 56,027 55,748
Income before income taxes.... 5,055 4,290 3,434 3,173 6,445 6,724
Income taxes.................. 2,034 1,731 1,380 1,281 2,457 2,812
Income before extraordinary
loss......................... 3,021 2,559 2,054 1,892 3,988 3,912
Net income.................... 3,021 2,559 2,054 1,892 3,265 3,189
Net income per share:
Basic:
Income before extraordinary
loss....................... $ 0.63 $ 0.53 $ 0.43 $ 0.40 $ 0.82 $ 0.81
Extraordinary Loss.......... -- -- -- -- (0.15) (0.15)
----------- ----------- ----------- ----------- ----------- -----------
Net income per share........ $ 0.63 $ 0.53 $ 0.43 $ 0.40 $ 0.67 $ 0.66
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Diluted:
Income before extraordinary
loss....................... $ 0.57 $ 0.49 $ 0.39 $ 0.36 $ 0.72 $ 0.70
Extraordinary loss.......... -- -- (0.13) (0.13)
----------- ----------- ----------- ----------- ----------- -----------
Net income per share........ $ 0.57 $ 0.49 $ 0.39 $ 0.36 $ 0.59 $ 0.57
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
</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......... 55,948 3,590 $ 193 (2b) 59,731
------------- ----------- ---------- ---------
Operating income................. 10,917 (129) (193) 10,595
Interest expense................. 6,627 86 396 (2c) 7,109
------------- ----------- ---------- ---------
Income (loss) before income
taxes........................... 4,290 (215) (589) 3,486
Income taxes..................... 1,731 (236) (2d) 1,495
------------- ----------- ---------- ---------
Net income (loss)................ $ 2,559 $ (215) $ (353) $ 1,991
------------- ----------- ---------- ---------
------------- ----------- ---------- ---------
Net income per share:
Basic.......................... $ 0.53 $ 0.42
------------- ---------
------------- ---------
Diluted........................ $ 0.49 $ 0.38
------------- ---------
------------- ---------
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>
REPORT OF INDEPENDENT ACCOUNTANTS
June 18, 1997
To the Partners of
Distribution North America
In our opinion, the accompanying balance sheet at March 30, 1996 and the related
statement of operations and accumulated deficit and of cash flows for the year
ended March 30, 1996 present fairly, in all material respects, the financial
position of Distribution North America at March 30, 1996, and the results of its
operations and its cash flows for the year then ended in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Partnership's management; our responsibility is to express
an opinion on these financial statements based on our audit. We conducted our
audit of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
Distribution North America is a partnership of two companies and, as disclosed
in Note 3 of the financial statements, has extensive transactions and
relationships with affiliates of the partners. Because of these relationships,
it is possible that the terms of these transactions are not the same as those
that would result from transactions among wholly unrelated parties. In January
1997, one partner acquired the interest of the other partner and, as discussed
in Note 1, terminated the partnership.
/s/ PricewaterhouseCoopers LLP
Sacramento, California
F-31
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors of
Distribution North America
We have audited the accompanying balance sheet of Distribution North America
(the Partnership) as of January 31, 1997, and the related statements of
operations and accumulated deficit, and cash flows for the ten months then
ended. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Distribution North America as of January 31,
1997, and the results of its operations and its cash flows for the ten month
period then ended in conformity with generally accepted accounting principles.
As described in Note 1, immediately subsequent to January 31, 1997, a partner
acquired 100% ownership of the Partnership.
As described in Note 3, the Partnership has significant related party
transactions.
/s/ Deloitte & Touche LLP
San Francisco, California
June 18, 1997
F-32
<PAGE>
DISTRIBUTION NORTH AMERICA
BALANCE SHEETS
<TABLE>
<CAPTION>
------------------------
<S> <C> <C>
MARCH 30, JANUARY 31,
DOLLARS IN THOUSANDS 1996 1997
----------- -----------
ASSETS
CURRENT ASSETS:
Cash................................................................................... $ 451 $ 296
Accounts receivable (less allowance for doubtful accounts of $223 and $275)............ 5,140 5,521
Inventories............................................................................ 4,698 3,383
Prepaid expenses....................................................................... 82 63
Receivables from affiliates............................................................ 517 106
----------- -----------
Total................................................................................ 10,888 9,369
PROPERTY AND EQUIPMENT, net.............................................................. 57 44
OTHER.................................................................................... 11 8
----------- -----------
TOTAL ASSETS............................................................................. $ 10,956 $ 9,421
----------- -----------
----------- -----------
LIABILITIES AND PARTNERS' DEFICIT
CURRENT LIABILITIES:
Bank line of credit.................................................................... $ 6,240
Accounts payable:
Trade................................................................................ 3,101 $ 4,951
Affiliates........................................................................... 2,255 5,120
Accrued expenses....................................................................... 195 62
Other.................................................................................. 537
----------- -----------
Total.............................................................................. 11,791 10,670
----------- -----------
COMMITMENTS AND CONTINGENCIES, (Note 5)
PARTNERS' DEFICIT:
Partners' capital...................................................................... 1,200 1,200
Accumulated deficit.................................................................... (2,035) (2,449)
----------- -----------
Total partners' deficit............................................................ (835) (1,249)
----------- -----------
TOTAL LIABILITIES AND PARTNERS' DEFICIT.................................................. $ 10,956 $ 9,421
----------- -----------
----------- -----------
</TABLE>
See notes to financial statements.
F-33
<PAGE>
DISTRIBUTION NORTH AMERICA
STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT
<TABLE>
<CAPTION>
-----------------------------------
<S> <C> <C>
FISCAL YEAR
ENDED TEN MONTHS ENDED
DOLLARS IN THOUSANDS MARCH 30, 1996 JANUARY 31, 1997
---------------- -----------------
NET SALES (includes net sales to affiliates of $5,201 and $4,274)........... $ 36,079 $ 23,539
COST OF GOODS SOLD (includes cost of goods sold from sales to affiliates of
$4,358 and $3,334)........................................................ 30,233 18,363
------- -------
GROSS PROFIT................................................................ 5,846 5,176
EXPENSES:
Distribution.............................................................. 2,987 2,222
Selling, general and administrative....................................... 4,074 2,791
Other..................................................................... 33 55
------- -------
Total operating expenses................................................ 7,094 5,068
------- -------
OPERATING INCOME (LOSS)..................................................... (1,248) 108
INTEREST EXPENSE............................................................ 559 522
------- -------
NET LOSS.................................................................... (1,807) (414)
ACCUMULATED DEFICIT, BEGINNING OF PERIOD.................................... (228) (2,035)
------- -------
ACCUMULATED DEFICIT, END OF PERIOD.......................................... $ (2,035) $ (2,449)
------- -------
------- -------
</TABLE>
See notes to financial statements.
F-34
<PAGE>
DISTRIBUTION NORTH AMERICA
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
-----------------------------------
<S> <C> <C>
FISCAL YEAR
ENDED TEN MONTHS ENDED
MARCH 30, 1996 JANUARY 31, 1997
---------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................... $ (1,807) $ (414)
Adjustments to reconcile net loss to net cash provided (used) by operating
activities:
Depreciation and amortization............................................. 33 16
Provision for doubtful accounts receivable................................ 166 52
Provision for writedown of inventories.................................... 952 250
Changes in operating assets and liabilities:
Accounts receivable..................................................... 877 (22)
Receivable from affliate................................................ 661
Inventories............................................................. (1,980) 1,065
Prepaid expenses........................................................ 7 18
Accounts payable:
Trade................................................................. 170 1,849
Affiliates............................................................ (763) (267)
Accrued expenses........................................................ 21 (132)
Other liabilities....................................................... 538
------- -------
Net cash provided (used) by operating activities............................ (1,663) 2,953
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................................... (34) (1)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net line-of-credit borrowings (repayments).................................. 1,995 (6,240)
Increase in amounts due affiliate........................................... 3,133
------- -------
Net cash provided (used) by financing activities............................ 1,995 (3,107)
NET INCREASE (DECREASE) IN CASH............................................. 298 (155)
------- -------
CASH, beginning of period................................................... 153 451
------- -------
CASH, end of period......................................................... $ 451 $ 296
------- -------
------- -------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.................................... $ 559 $ 522
------- -------
------- -------
</TABLE>
See notes to financial statements.
F-35
<PAGE>
DISTRIBUTION NORTH AMERICA
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Distribution North American (DNA or the Partnership) was formed in September
1994 as a Delaware general partnership between Valley Venturer, Inc., a
wholly-owned subsidiary of Valley Record Distributors, Inc. (Valley), and
Distribution North America, Inc., (DNA Inc.) a corporation owned by the members
of the ILN Group (ILN), an affiliate of Rounder Records Corporation (Rounder).
The Partnership is a distributor of independent label compact disks and
cassettes sold primarily in North America from Valley's distribution facility
located in Woodland, California.
Immediately subsequent to January 31, 1997, Valley Venturer, Inc., acquired
Rounder's partnership interest for a nominal amount and assumed the liabilities
of the Partnership. Subsequently, DNA is operated as a part of the independent
distribution group of Valley.
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 at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
INVENTORIES, which consist principally of compact discs and cassettes, are
stated at the lower of average cost or market.
PROPERTY AND EQUIPMENT, which consists primarily of computer 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 five years.
OTHER CURRENT LIABILITIES consist principally of an obligation due to a
significant customer that resulted from inventory which was returned to the
Partnership.
REVENUE RECOGNITION -- Revenue from the sale and distribution of pre-recorded
music, music accessories and other related products is recognized upon shipment
of the product. A reduction from sales is provided for estimated future customer
returns. At March 30, 1996 and January 31, 1997, the allowance for customer
returns totaled $904,346 and $1,068,375, respectively.
ADVERTISING costs are expensed when incurred and totaled $207,649 and $93,230
for the fiscal year ended March 30, 1996 and the ten months ended January 31,
1997, respectively.
CONCENTRATION OF CREDIT RISK -- In addition to sales to Valley, as discussed in
Note 3, the Partnership had sales to a significant customer which represented
14% and 12.5% of total sales for the fiscal year ended March 30, 1996 and the
ten months ended January 31, 1997, respectively. At March 30, 1996 and January
31, 1997, the amount due the Partnership from this customer totaled $1,152,785
and $904,557.
F-36
<PAGE>
DISTRIBUTION NORTH AMERICA
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Partnership is subject to credit risk through trade receivables. The
Partnership routinely assesses the financial strength of significant customers
and this assessment, combined with the large number and geographic diversity of
its customers, limits the Partnership's concentration of risk with respect to
trade accounts receivable.
INCOME TAXES -- The Partnership is not subject to income taxes. Taxable income
or loss from the Partnership's operations is recognized in the tax returns of
the partners. Accordingly, income taxes are not provided for in the accompanying
financial statements. Differences between the tax and book bases of the
Partnership's assets and liabilities exist due primarily to the deductability of
allowances for doubtful accounts and sales returns and inventory valuation
reserves. This difference results in net assets for tax purposes being
$2,080,000 and $2,545,000 greater than net assets for book purposes at March 30,
1996 and January 31, 1997.
2. BANK LINE OF CREDIT
The Partnership had a revolving line of credit agreement with Fleet Bank of
Massachusetts, N.A. that provided for borrowings up to the lesser of $10,000,000
or the sum of 75% of eligible accounts receivable and 25% of eligible inventory.
The line of credit bore interest at either Fleet Bank prime rate or at LIBOR
plus 2.5% and was due to expire on September 1, 1997. The line of credit was
secured by all eligible accounts receivable, inventory, equipment and other
tangible property of the Partnership and guarantees from the partners and their
affiliates. Under the line of credit agreement, the Partnership was required to
maintain certain working capital and minimum tangible net worth ratios. As of
March 30, 1996, the Partnership was out of compliance with these financial
covenants.
Subsequent to Valley Venturer, Inc.'s acquisition of DNA, Inc.'s ownership
interest in the Partnership, Valley repaid the amount due under the line of
credit.
3. RELATED PARTY TRANSACTIONS
The Partnership is charged certain operating expenses by Valley and Rounder in
accordance with operating agreements between the partners. The Partnership's
administrative offices are located within Valley's corporate headquarters. The
Partnership also utilizes Valley's warehouse distribution facilities. Valley
charges the Partnership a monthly fulfillment fee, typically 4% to 5% of net
sales revenue, primarily for shipping and receiving costs incurred in the
handling of Partnership inventory based on the terms of the operating
agreements. Fulfillment fees totaled $1,641,000 and $1,006,000 for the fiscal
year ended March 30, 1996 and the ten months ended January 31, 1997,
respectively. Valley charges other distribution expenses such as information
services, depreciation, other shipping and receiving costs, and operating
supplies to the Partnership based on the terms of the operating agreements
(primarily predetermined percentages and actual costs incurred). Other
distribution expenses totaled $1,602,000 and
F-37
<PAGE>
DISTRIBUTION NORTH AMERICA
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
$999,000 for the fiscal year ended March 30, 1996 and the ten months ended
January 31, 1997, respectively. Valley also charges administrative expenses,
including payroll and benefits of shared employees and insurance expense, to the
Partnership based on the terms of the operating agreements (primarily actual
costs incurred). Administrative expenses totaled $363,000 and $398,000 for the
fiscal year ended March 30, 1996 and the ten months ended January 31, 1997,
respectively. Management believes the administrative and distribution charges
agreed to by the partners are reasonable; however, it is not practicable to
provide an estimate of what the Partnership's expenses would have been on a
stand-alone basis had it operated as an unaffiliated entity.
Valley was the Partnership's largest customer. During the fiscal year ended
March 30, 1996 and the ten months ended January 31, 1997, net sales to Valley
totaled approximately $5,201,000 and approximately $4,274,000. The related cost
of goods sold totaled approximately $4,358,000 for the fiscal year ended March
30, 1996, and approximately $3,334,000 for the ten months ended January 31,
1997. At March 30, 1996, accounts receivable from Valley totaled $517,361. At
January 31, 1997, accounts receivable from and accounts payable to Valley
totaled $106,490 and $3,454,143 respectively. Additionally, the Partnership
makes significant purchases from Rounder. Net purchases from Rounder totaled
$19,114,393 and $11,250,000 during the fiscal year ended March 30, 1996 and the
ten months ended January 31, 1997, respectively. At March 30, 1996 and January
31, 1997, accounts payable to Rounder totaled $2,057,071 and $1,228,461. The
Partnership also makes significant purchases from RAS Records (RAS), an
affiliate of Rounder. Net purchases from RAS totaled $2,106,440 and $595,102
during the fiscal year ended March 30, 1996 and the ten month period ended
January 31, 1997, respectively. Accounts payable to RAS totaled $198,196 and
$437,700 at March 30, 1996 and January 31, 1997.
It is not practicable to estimate the fair value of amounts receivable from
affiliates and amounts payable to affiliates, due to the fact that they are
related parties.
4. EMPLOYEE RETIREMENT PLAN
In April 1995, the Partnership 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 Partnership makes elective matching contributions of
up to 50% for a maximum of 4% of each participating employee's annual
compensation. The Partnership elected to make no matching contributions to the
plan for the fiscal year ended March 30, 1996 or the ten month period ended
January 31, 1997.
F-38
<PAGE>
DISTRIBUTION NORTH AMERICA
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Partnership is a party to certain claims
and legal actions. After consulting with legal counsel, the Partnership is of
the opinion that any liability that may ultimately be incurred as a result of
these claims or legal actions will not have a material adverse effect on the
financial statements of the Partnership taken as a whole.
F-39
<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....................................... 6,135
Nasdaq National Market listing fee.................... 72,875
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............................................. $1,442,175
----------
----------
</TABLE>
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.
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
II-1
<PAGE>
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 705,782
shares of common stock to a total of 60 employees, directors and consultants at
a weighted average exercise price of $5.91 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.
4.1* Form of Common Stock Certificate.
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C>
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.
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.
23.4 Independent Accountants' Consent.
24.1* Power of Attorney
27.1* Financial Data Schedule.
99.1* Consent of Forrester Research, Inc.
</TABLE>
- ---------------------
* Previously filed.
II-3
<PAGE>
(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 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 22nd day of March 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 to Registration Statement has been signed by the following persons in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
*
- ------------------------------ Chairman of the Board March 22, 1999
Barnet J. Cohen
President, Chief Executive
/s/ ROBERT R. CAIN Officer and Director
- ------------------------------ (Principal Executive March 22, 1999
Robert R. Cain Officer)
/s/ J. RANDOLPH CERF Chief Financial Officer
- ------------------------------ (Principal Financial and March 22, 1999
J. Randolph Cerf Accounting Officer)
*
- ------------------------------ Director March 22, 1999
Lawrence Archibald
*
- ------------------------------ Director March 22, 1999
Christopher Mottern
*
- ------------------------------ Director March 22, 1999
Wendy Paskin-Jordan
*
- ------------------------------ Director March 22, 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... 248,433 350,565 - (313,260) 285,737
Vendor receivables
reserve................... 18,727 406,188 424,915
---------- ---------- --------- ----------- ----------
Total........................ $ 579,960 $1,293,509 $ - $ (791,916) $1,081,552
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Fiscal year ended March 29, 1997:
Inventory reserves......... $ 50,400 $ 788,140 $ 451,297 $ (897,913) $ 391,924
Allowance for doubtful
accounts receivable....... 320,500 327,262 275,300 (97,914) 825,148
Customer returns reserve... 285,737 1,227,597 950,305 (855,016) 1,608,623
Vendor receivables
reserve................... 424,915 165,311 44,564 (346,303) 288,487
---------- ---------- --------- ----------- ----------
Total........................ $1,081,552 $2,508,311 $1,721,466(1) $(2,197,146) $3,114,182
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
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 12,369,496 1,436,200 (11,693,043) 3,721,276
Vendor receivables
reserve................... 288,487 152,680 1,695,326 (1,335,915) 800,579
---------- ---------- --------- ----------- ----------
Total........................ $3,114,182 $19,872,749 $5,194,563(2) $(16,796,622) $11,384,872
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
Nine months ended December
26, 1998:
Inventory reserves......... $1,586,836 $3,093,779 $ - $(2,277,218) $2,403,397
Allowance for doubtful
accounts
receivable............... 5,276,181 4,253,300 - (203,082) 9,326,399
Customer returns reserve... 3,721,276 22,753,984 - (19,927,864) 6,547,396
Vendor receivables
reserve................... 800,579 5,497,622 - (2,377,454) 3,920,747
---------- ---------- --------- ----------- ----------
Total........................ $11,384,872 $35,598,685 $ - $(24,785,618) $22,197,940
---------- ---------- --------- ----------- ----------
---------- ---------- --------- ----------- ----------
</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.
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.
23.4 Independent Accountants' Consent.
24.1* Power of Attorney.
27.1* Financial Data Schedule.
99.1* Consent of Forrester Research, Inc.
</TABLE>
- ---------------------
* Previously filed.
<PAGE>
Exhibit 1.1
UNDERWRITING AGREEMENT
VALLEY MEDIA, INC.
[ ] Shares of Common Stock
Underwriting Agreement
, 1999
J.P. Morgan Securities Inc.
BancBoston Robertson Stephens
As Representatives of several underwriters
listed in Schedule I hereto
c/o J.P. Morgan Securities Inc.
60 Wall Street
New York, New York 10260
Ladies and Gentlemen:
Valley Media, Inc., a Delaware corporation (the "Company"), proposes to
issue and sell to the several Underwriters listed in Schedule I hereto (the
"Underwriters"), for whom you are acting as representatives (the
"Representatives"), an aggregate of 3,500,000 shares of Common Stock, $.001 par
value, of the Company (the "Underwritten Shares") and, for the sole purpose of
covering over-allotments in connection with the sale of the Underwritten Shares,
at the option of the Underwriters, certain stockholders of the Company named in
Schedule II hereto ("Selling Stockholders") propose to sell to the Underwriters
up to an additional 525,000 shares of Common Stock of the Company (the "Option
Shares"). The Underwritten Shares and the Option Shares are herein collectively
referred to as the "Shares." The shares of Common Stock of the Company to be
outstanding after giving effect to the sale of the Shares are herein referred to
as the "Stock." The Company is a successor by merger to Valley Media, Inc., a
California corporation (the "Predecessor"), as a result of a reincorporation
transaction that became effective in July 1998 (the "Reincorporation").
The Company has prepared and filed with the Securities and Exchange
Commission (the "Commission") in accordance with the provisions of the
Securities Act of 1933, as amended, and the rules and regulations of the
Commission thereunder (collectively, the "Securities Act"), a registration
statement, including a prospectus, relating to the Shares. The registration
statement as amended at the time when it shall become effective including
information (if any) deemed to be part of the registration statement at the time
of effectiveness pursuant to Rule 430A under the Securities Act, is referred to
in this Agreement as the "Registration Statement," and the prospectus in the
form first used to confirm sales of Shares is referred to in this Agreement as
the "Prospectus." If the Company has filed an abbreviated registration
statement pursuant to Rule 462(b) under the Securities Act (the "Rule 462
Registration Statement"), then any reference
<PAGE>
herein to the term "Registration Statement" shall be deemed to include such
Rule 462 Registration Statement.
The Company hereby agrees with the Underwriters as follows:
1. The Company agrees to issue and sell the Underwritten Shares to the
several Underwriters as hereinafter provided, and each Underwriter, upon the
basis of the representations and warranties herein contained, but subject to the
conditions hereinafter stated, agrees to purchase, severally and not jointly,
from the Company the respective number of Underwritten Shares set forth opposite
such Underwriter's name in Schedule I hereto at a purchase price per share the
("Purchase Price") of $____________.
In addition, each of the Selling Stockholders, as and to the extent
indicated in Schedule II hereto, agrees to issue and sell the Option Shares to
the several Underwriters as hereinafter provided, and the Underwriters on the
basis of the representations and warranties herein contained, but subject to the
conditions hereinafter stated, shall have the option to purchase, severally and
not jointly, from the Selling Stockholders up to an aggregate of 525,000 Option
Shares at the Purchase Price, for the sole purpose of covering over-allotments
(if any) in the sale of Underwritten Shares by the several Underwriters.
If any Option Shares are to be purchased, the number of Option Shares to be
purchased by each Underwriter shall be the number of Option Shares which bears
the same ratio to the aggregate number of Option Shares being purchased as the
number of Underwritten Shares set forth opposite the name of such Underwriter in
Schedule I hereto (or such number increased as set forth in Section 9 hereof)
bears to the aggregate number of Underwritten Shares being purchased from the
Company by the several Underwriters, subject, however, to such adjustments to
eliminate any fractional Shares as the Representatives in their sole discretion
shall make. Any such election to purchase Options Shares shall be made in
proportion to the maximum number of Option Shares to be sold by each Selling
Stockholder as set forth in Schedule II hereto.
The Underwriters may exercise the option to purchase the Option Shares at
any time (but not more than once) on or before the thirtieth day following the
date of this Agreement, by written notice from the Representatives to the
Attorney-in-Fact (defined below). Such notice shall set forth the aggregate
number of Option Shares as to which the option is being exercised and the date
and time when the Option Shares are to be delivered and paid for, which may be
the same date and time as the Closing Date (as hereinafter defined) but shall
not be earlier than the Closing Date nor later than the tenth full Business Day
(as hereinafter defined) after the date of such notice (unless such time and
date are postponed in accordance with the provisions of Section 9 hereof). Any
such notice shall be given at least two Business Days prior to the date and time
of delivery specified therein.
2. The Company and the Selling Stockholders understand that the
Underwriters intend (i) to make a public offering of the Shares as soon after
(A) the Registration Statement has become effective and (B) the parties hereto
have executed and delivered this Agreement, as in the judgment of the
Representatives is advisable and (ii) initially to offer the Shares upon the
terms set forth in the Prospectus.
2
<PAGE>
3. Payment for the Shares shall be made by wire transfer in immediately
available funds to the account specified to the Representatives by the Company
with regard to payment to the Company and by the Attorneys-in-Fact (as defined
below), or any of them, with regard to payment to the Selling Stockholders, in
the case of the Underwritten Shares, on __________________, 1999, or at such
other time on the same or such other date, not later than the fifth Business Day
thereafter, as the Representatives and the Company may agree upon in writing or,
in the case of the Option Shares, on the date and time specified by the
Representatives in the written notice of the Underwriters' election to purchase
such Option Shares. The time and date of such payment for the Underwritten
Shares are referred to herein as the "Closing Date" and the time and date for
such payment for the Option Shares, if other than the Closing Date, are referred
to herein as the "Additional Closing Date." As used herein, the term "Business
Day" means any day other than a day on which banks are permitted or required to
be closed in New York City.
Payment for the Shares to be purchased on the Closing Date or the
Additional Closing Date, as the case may be, shall be made against delivery to
the Representatives for the respective accounts of the several Underwriters of
the Shares to be purchased on such date registered in such names and in such
denominations as the Representatives shall request in writing not later than two
full Business Days prior to the Closing Date or the Additional Closing Date, as
the case may be, with any transfer taxes payable in connection with the transfer
to the Underwriters of the Shares duly paid by the Company or the Selling
Stockholders, as the case may be. The certificates for the Shares will be made
available for inspection and packaging by the Representatives at the office of
J.P. Morgan Securities Inc. set forth above not later than 1:00 P.M., New York
City time, on the Business Day prior to the Closing Date or the Additional
Closing Date, as the case may be.
4. (A) The Company represents and warrants to each Underwriter and the
Selling Stockholders that:
(a) no order preventing or suspending the use of any preliminary
prospectus has been issued by the Commission, and each preliminary prospectus
filed as part of the Registration Statement as originally filed or as part of
any amendment thereto, or filed pursuant to Rule 424 under the Securities Act,
complied when so filed in all material respects with the Securities Act, and did
not contain an untrue statement of a material fact or omit to state a material
fact required to be stated therein or necessary to make the statements therein,
in the light of the circumstances under which they were made, not misleading;
provided that this representation and warranty shall not apply to any statements
or omissions made in reliance upon and in conformity with information relating
to any Underwriter furnished to the Company in writing by such Underwriter
through the Representatives expressly for use therein;
(b) no stop order suspending the effectiveness of the
Registration Statement has been issued and no proceeding for that purpose has
been instituted or, to the knowledge of the Company, threatened by the
Commission; and the Registration Statement and Prospectus (as amended or
supplemented if the Company shall have furnished any amendments or supplements
thereto) comply, or will comply, as the case may be, in all material respects
with the Securities Act and do not and will not, as of the applicable effective
date as to the Registration Statement and any amendment thereto and as of the
date of the Prospectus and any
3
<PAGE>
amendment or supplement thereto, contain any untrue statement of a material
fact or omit to state any material fact required to be stated therein or
necessary to make the statements therein not misleading, and the Prospectus,
as amended or supplemented, if applicable, at the Closing Date or Additional
Closing Date, as the case may be, will not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading; except that the foregoing representations and warranties
shall not apply to statements or omissions in the Registration Statement or
the Prospectus made in reliance upon and in conformity with information
relating to any Underwriter furnished to the Company in writing by such
Underwriter through the Representatives expressly for use therein;
(c) the financial statements, and the related notes thereto,
included in the Registration Statement and the Prospectus present fairly the
consolidated financial position of the Company and its consolidated subsidiaries
as of the dates indicated and the results of their operations and changes in
their consolidated cash flows for the periods specified; said financial
statements have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis, and the supporting schedules included
in the Registration Statement present fairly the information required to be
stated therein; and the pro forma financial information, and the related notes
thereto, included in the Registration Statement and the Prospectus have been
prepared in accordance with the applicable requirements of the Securities Act
and are based upon good faith estimates and assumptions believed by the Company
to be reasonable;
(d) since the respective dates as of which information is given
in the Registration Statement and the Prospectus, (i) there has not been any
change in the capital stock or long-term debt of the Company or any of its
subsidiaries, or any material adverse change, or any development involving a
prospective material adverse change, in or affecting the general affairs,
business, management, financial position, stockholders' equity or results of
operations of the Company and its subsidiaries, taken as a whole, otherwise than
as set forth or contemplated in the Prospectus; and (ii) except as set forth or
generally described in the Prospectus neither the Company nor any of its
subsidiaries has entered into any transaction or agreement material to the
Company and its subsidiaries taken as a whole;
(e) the Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of its jurisdiction of
incorporation, with power and authority (corporate and other) to own its
properties and conduct its business as described in the Prospectus, and has been
duly qualified as a foreign corporation for the transaction of business and is
in good standing under the laws of Kentucky, Maine, Massachusetts, Minnesota,
New Jersey, New York and Pennsylvania, the only jurisdictions in which it owns
or leases properties, or conducts any business, so as to require such
qualification;
(f) the Company has only one subsidiary which has been duly
incorporated and is validly existing as a corporation under the laws of its
jurisdiction of incorporation, with power and authority (corporate and other) to
own its properties and conduct its business as described in the Prospectus, and
has been duly qualified as a foreign corporation for the transaction of business
and is in good standing under the laws of each jurisdiction in which it owns or
leases properties, or conducts any business, so as to require such
qualification,
4
<PAGE>
other than where the failure to be so qualified or in good standing would not
have a material adverse effect on the Company and its subsidiaries taken as a
whole; all the outstanding shares of capital stock of such subsidiary of the
Company have been duly authorized and validly issued, are fully-paid and
non-assessable, and (except, in the case of foreign subsidiaries, for
directors' qualifying shares) are owned by the Company, directly or
indirectly, free and clear of all liens, encumbrances, security interests and
claims;
(g) this Agreement has been duly authorized, executed and
delivered by the Company;
(h) the Company has an authorized capitalization as set forth in
the Prospectus and such authorized capital stock conforms as to legal matters to
the description thereof set forth in the Prospectus, and all of the outstanding
shares of capital stock of the Company (including the Shares to be sold by the
Selling Stockholders) have been duly authorized and validly issued, are
fully-paid and non-assessable and are not subject to any preemptive or similar
rights; and, except as described in or expressly contemplated by the Prospectus,
there are no outstanding rights (including, without limitation, preemptive
rights), warrants or options to acquire, or instruments convertible into or
exchangeable for, any shares of capital stock or other equity interest in the
Company or any of its subsidiaries, or any contract, commitment, agreement,
understanding or arrangement of any kind relating to the issuance of any capital
stock of the Company or any of its subsidiaries, any such convertible or
exchangeable securities or any such rights, warrants or options;
(i) the Shares to be issued and sold by the Company hereunder
have been duly authorized, and, when issued and delivered to and paid for by the
Underwriters in accordance with the terms of this Agreement, will be duly issued
and will be fully paid and non-assessable and will conform to the descriptions
thereof in the Prospectus; and the issuance of the Shares is not subject to any
preemptive or similar rights;
(j) neither the Company nor any of its subsidiaries is, or with
the giving of notice or lapse of time or both would be, in violation of or in
default under, its Certificate of Incorporation or By-Laws or any indenture,
mortgage, deed of trust, loan agreement or other agreement or instrument to
which the Company or any of its subsidiaries is a party or by which it or any of
them or any of their respective properties is bound, except for violations and
defaults which individually and in the aggregate are not material to the Company
and its subsidiaries taken as a whole; the issue and sale of the Shares and the
performance by the Company of its obligations under this Agreement and the
consummation of the transactions contemplated herein will not conflict with or
result in a breach of any of the terms or provisions of, or constitute a default
under, any indenture, mortgage, deed of trust, loan agreement or other agreement
or instrument to which the Company or any of its subsidiaries is a party or by
which the Company or any of its subsidiaries is bound or to which any of the
property or assets of the Company or any of its subsidiaries is the subject, nor
will any such action result in any violation of the provisions of the
Certificate of Incorporation or the By-Laws of the Company or any applicable law
or statute or any order, rule or regulation of any court or governmental agency
or body having jurisdiction over the Company, its subsidiaries or any of their
respective properties; and no consent, approval, authorization, order, license,
registration or qualification of or with any such court or governmental agency
or body is required for the issue and sale of the Shares or the
5
<PAGE>
consummation by the Company of the transactions contemplated by this
Agreement, except such consents, approvals, authorizations, orders, licenses,
registrations or qualifications as have been obtained under the Securities
Act and as may be required under state securities or Blue Sky Laws in
connection with the purchase and distribution of the Shares by the
Underwriters;
(k) other than as set forth or contemplated in the Prospectus,
there are no legal or governmental investigations, actions, suits or proceedings
pending or, to the knowledge of the Company, threatened against or affecting the
Company or any of its subsidiaries or any of their respective properties or to
which the Company or any of its subsidiaries is or may be a party or to which
any property of the Company or any of its subsidiaries is or may be the subject
which, if determined adversely to the Company or any of its subsidiaries, could
individually or in the aggregate have, or reasonably be expected to have, a
material adverse effect on the general affairs, business, management, financial
position, stockholders' equity or results of operations of the Company and its
subsidiaries, taken as a whole, and, to the best knowledge of the Company, no
such proceedings are threatened or contemplated by governmental authorities or
threatened by others; and there are no statutes, regulations, contracts or other
documents that are required to be described in the Registration Statement or
Prospectus or to be filed as exhibits to the Registration Statement that are not
described or filed as required;
(l) the Company and its subsidiaries have good and marketable
title in fee simple to all items of real property and good and marketable title
to all personal property owned by them, in each case free and clear of all
liens, encumbrances and defects except such as are described or referred to in
the Prospectus or such as do not materially affect the value of such property
and do not interfere with the use made or proposed to be made of such property
by the Company and its subsidiaries; and any real property and buildings held
under lease by the Company and its subsidiaries are held by them under valid,
existing and enforceable leases with such exceptions as are not material and do
not interfere with the use made or proposed to be made of such property and
buildings by the Company or its subsidiaries;
(m) no relationship, direct or indirect, exists between or among
the Company or any or its subsidiaries on the one hand, and the directors,
officers, stockholders, customers or suppliers of the Company or any of its
subsidiaries on the other hand, which is required by the Securities Act to be
described in the Registration Statement and the Prospectus which is not so
described;
(n) no person has the right to require the Company to register
any securities for offering and sale under the Securities Act by reason of the
filing of the Registration Statement with the Commission or the issue and sale
of the Shares to be sold by the Company hereunder or, to the knowledge of the
Company, the sale of the Shares to be sold by the Selling Stockholders
hereunder;
(o) the Company is not and, after giving effect to the offering
and sale of the Shares, will not be an "investment company" or an entity
"controlled" by an "investment company", as such terms are defined in the
Investment Company Act of 1940, as amended (the "Investment Company Act");
6
<PAGE>
(p) the Company has complied, and prior to the Reincorporation
the Predecessor had complied, with all provisions of Section 517.075, Florida
Statutes (Chapter 92-198, Laws of Florida) relating to doing business with the
Government of Cuba or with any person or affiliate located in Cuba;
(q) Deloitte & Touche LLP who have certified certain financial
statements of the Company and its subsidiaries are independent public
accountants with respect to the Company and its subsidiaries as required by the
Securities Act;
(r) the Company and its subsidiaries have, and prior to the
Reincorporation the Predecessor and its subsidiaries had, filed all federal,
state, local and foreign tax returns which have been required to be filed and
have paid all taxes shown thereon and all assessments received by them or any of
them to the extent that such taxes have become due and are not being contested
in good faith; and, except as disclosed in the Registration Statement and the
Prospectus, there is no tax deficiency which has been or might reasonably be
expected to be asserted or threatened against the Company, the Predecessor or
any subsidiary;
(s) the Company has not taken nor will it take, directly or
indirectly, any action designed to, or that might be reasonably expected to,
cause or result in stabilization or manipulation of the price of the Common
Stock;
(t) each of the Company and its subsidiaries owns, possesses or
has obtained all licenses, permits, certificates, consents, orders, approvals
and other authorizations (collectively "Permits") from, and has made all
declarations and filings with, all federal, state, local and other governmental
authorities (including foreign regulatory agencies), all self-regulatory
organizations and all courts and other tribunals, domestic or foreign, necessary
to own or lease, as the case may be, and to operate its properties and to carry
on its business as conducted as of the date hereof, and neither the Company nor
any such subsidiary has received any actual notice of any proceeding relating to
revocation or modification of any such Permits, except as described in the
Registration Statement and the Prospectus or where the failure to own, possess
or have obtained such Permits, or where the revocation of such Permits, would
not, individually or in the aggregate, have a material adverse effect on the
Company and its subsidiaries taken as a whole; and each of the Company and its
subsidiaries is in compliance with all laws and regulations relating to the
conduct of its business as conducted as of the date hereof except where the
failure to be in compliance with such laws and regulations would not,
individually or in the aggregate, have a material adverse effect on the Company
and its subsidiaries taken as a whole;
(u) there are no existing or, to the best knowledge of the
Company, threatened labor disputes with the employees of the Company or any of
its subsidiaries which are likely to have a material adverse effect on the
Company and its subsidiaries taken as a whole;
(v) the Company and its subsidiaries (i) are in compliance with
any and all applicable foreign, federal, state and local laws and regulations
relating to the protection of human health and safety, the environment or
hazardous or toxic substances or wastes, pollutants or contaminants
("Environmental Laws"), (ii) have received all permits, licenses or other
approvals required of them under applicable Environmental Laws to conduct their
7
<PAGE>
respective businesses and (iii) are in compliance with all terms and
conditions of any such permit, license or approval, except where such
noncompliance with Environmental Laws, failure to receive required permits,
licenses or other approvals or failure to comply with the terms and
conditions of such permits, licenses or approvals would not, singly or in the
aggregate, have a material adverse effect on the Company and its
subsidiaries, taken as a whole;
(w) in the ordinary course of its business, the Company conducts
a periodic review of the effect of Environmental Laws on the business,
operations and properties of the Company and its subsidiaries, in the course of
which it identifies and evaluates associated costs and liabilities (including,
without limitation, any capital or operating expenditures required for clean-up,
closure of properties or compliance with Environmental Laws or any permit,
license or approval, any related constraints on operating activities and any
potential liabilities to third parties). On the basis of such reviews, the
Company has reasonably concluded that such associated costs and liabilities
would not, singly or in the aggregate, have a material adverse effect on the
Company and its subsidiaries, taken as a whole;
(x) each employee benefit plan, within the meaning of Section
3(3) of the Employee Retirement Income Security Act of 1974, as amended,
("ERISA") that is maintained, administered or contributed to by the Company or
any of its affiliates for employees or former employees of the Company and its
affiliates has been maintained in compliance with its terms and the requirements
of any applicable statutes, orders, rules and regulations, including but not
limited to ERISA and the Internal Revenue Code of 1986, as amended, ("Code").
No prohibited transaction, within the meaning of Section 406 of ERISA or Section
4975 of the Code has occurred with respect to any such plan excluding
transactions effected pursuant to a statutory or administrative exemption. For
each such plan which is subject to the funding rules of Section 412 of the Code
or Section 302 of ERISA no "accumulated funding deficiency" as defined in
Section 412 of the Code has been incurred, whether or not waived, and the fair
market value of the assets of each such plan (excluding for these purposes
accrued but unpaid contributions) exceeds the present value of all benefits
accrued under such plan determined using reasonable actuarial assumptions;
(y) except as described in the Registration Statement and
Prospectus, the Company and its subsidiaries have sufficient trademarks, trade
names, patent rights, copyrights, licenses, approvals and governmental
authorizations to conduct their businesses as now conducted; the expiration of
any trademarks, trade names, patent rights, copyrights, licenses, approvals or
governmental authorizations would not have a material adverse effect on the
general affairs, business, management, financial position, stockholders' equity
or results of operations of the Company and its subsidiaries taken as a whole;
8
<PAGE>
the Company has no knowledge of any infringement by the Company or its
subsidiaries of trademarks, trade name rights, patent rights, copyrights,
licenses, trade secrets or other similar rights of others which could have a
material adverse effect on the general affairs, business, management,
financial position, stockholders' equity or results of operations of the
Company and its subsidiaries taken as a whole; and no claims have been made
or are threatened against the Company or its subsidiaries regarding
trademark, trade name, patent, copyright, license, trade secret or other
infringement which could have a material adverse effect on the general
affairs, business, management, financial position, stockholders' equity or
results of operations of the Company and its subsidiaries taken as a whole;
(z) the merger of the Predecessor with and into the Company has
been consummated in compliance with applicable law; the Company has succeeded to
all of the rights, privileges, powers and franchises, and is subject to all of
the restrictions, disabilities and duties, of the Predecessor; the Company has
succeeded to all of the material contract rights of the Predecessor, and all
required consents with respect to such contracts have been obtained except where
the failure to obtain such contract rights or consents would not, individually
or in the aggregate, have a material adverse effect on the Company and its
subsidiaries take as a whole; all of the outstanding shares of capital stock of
the Predecessor have been converted into shares of capital stock of the Company
having the rights, preferences and privileges described in the Registration
Statement and Prospectus; all of the outstanding options of the Predecessor are
exercisable for shares of Common Stock of the Company as described in the
Registration Statement and Prospectus; the Reincorporation was duly authorized
by the Board of Directors and shareholders of the Predecessor and the Board of
Directors and stockholders of the Company; the consummation of the
Reincorporation does not and will not conflict with, or result in any breach of,
or constitute a default under (nor constitute any event which with notice, lapse
of time or both would constitute a breach of or default under), any provision of
any material license, indenture, lease, mortgage, deed of trust, bank loan or
credit agreement or other agreement or instrument to which the Company is, or
immediately prior to the Reincorporation the Predecessor was, a party or by
which the Company or its properties are, or immediately prior to the
Reincorporation the Predecessor or its properties were, bound or affected; the
consummation of the Reincorporation does not and will not conflict with, or
result in a violation of, any federal, state, local or foreign law, regulation
or rules or any decree, judgment or order applicable to the Company, or
immediately prior to the Reincorporation, the Predecessor, the result of which
could have a material adverse effect on the general affairs, business,
management, financial position, stockholders' equity or results of operations of
the Company and its subsidiaries taken as a whole; and the issuance of capital
stock by the Company in the Reincorporation was in compliance with all
applicable state securities or Blue Sky Laws and was exempt from registration
under the Securities Act;
(aa) except as disclosed in the Registration Statement and
Prospectus, to the knowledge of the Company and its subsidiaries, no customer
which accounted for more the 10% of the Company's net sales during the
nine-month period ended December 31, 1998 has notified the Company of its
intention to cease dealing with the Company or otherwise materially reduce the
volume of business transacted by such customer with the Company below historical
levels; and
(bb) except as disclosed in the Registration Statement and
Prospectus, to the knowledge of the Company and its subsidiaries, no supplier
which accounted for more than 10% of the Company's net sales during the
nine-month period ended December 31, 1998 has notified the Company of its
intention to cease dealing with the Company or otherwise materially reduce the
volume of business transacted by such supplier with the Company below historical
levels.
4. (B) Each of the Selling Stockholders severally represents and
warrants to, and agrees with, each of the Underwriters that:
9
<PAGE>
(a) all consents, approvals, authorizations and orders necessary
for the execution and delivery by such Selling Stockholder of this Agreement and
the Power of Attorney (the "Power of Attorney") and the Custody Agreement (the
"Custody Agreement") hereinafter referred to, and for the sale and delivery of
the Shares to be sold by such Selling Stockholder hereunder, have been obtained;
and such Selling Stockholder has full right, power and authority to enter into
this Agreement, the Power of Attorney and the Custody Agreement and to sell,
assign, transfer and deliver the Shares to be sold by such Selling Stockholder
hereunder; this Agreement, the Power of Attorney and the Custody Agreement have
each been duly authorized, executed and delivered by such Selling Stockholder;
(b) the sale of the Shares to be sold by such Selling
Stockholder hereunder and the compliance by such Selling Stockholder with all of
the provisions of this Agreement, the Power of Attorney and the Custody
Agreement and the consummation of the transactions herein and therein
contemplated will not conflict with or result in a breach or violation of any of
the terms or provisions of, or constitute a default under, any statute, any
indenture, mortgage, deed of trust, loan agreement or other agreement or
instrument to which such Selling Stockholder is a party or by which such Selling
Stockholder is bound or to which any of the property or assets of such Selling
Stockholder is subject, nor will such action result in any violation of any
statute or any order, rule or regulation of any court or governmental agency or
body having jurisdiction over such Selling Stockholder or the property of such
Selling Stockholder;
(c) such Selling Stockholder has good and valid title to the
Shares to be sold at the Additional Closing Date by such Selling Stockholder,
free and clear of all liens, encumbrances, equities or adverse claims; such
Selling Stockholder will have, immediately prior to the Additional Closing Date
good and valid title to the Shares to be sold at the Additional Closing Date by
such Selling Stockholder, free and clear of all liens, encumbrances, equities or
adverse claims; and, upon delivery of the certificates representing such Shares
and payment therefor pursuant hereto, good and valid title to such Shares, free
and clear of all liens, encumbrances, equities or adverse claims, will pass to
the several Underwriters;
(d) such Selling Stockholder has not taken and will not take,
directly or indirectly, any action which is designed to or which has constituted
or which might reasonably be expected to cause or result in stabilization or
manipulation of the price of any security of the Company to facilitate the sale
or resale of the Shares;
(e) each Selling Stockholder has signed a "lock-up" agreement in
substantially the form of Exhibit A hereto on or before the date hereof; and
(f) the Registration Statement and the Prospectus (as amended or
supplemented) comply or will comply, as the case may be, in all material
respects the Securities Act and do not and will not, as of the applicable
effective date of the Registration Statement and any amendment thereto and as of
the date of the Prospectus and any amendment or supplement thereto, contain any
untrue statement of a material fact or omit to state any material fact required
to be stated therein or necessary to make the statements therein not misleading,
and the Prospectus, as amended or supplemented, if applicable, at the Closing
Date or Additional Closing Date, as the case may be, will not contain any untrue
statement of a material fact or omit
10
<PAGE>
to state a material fact necessary to make the statements therein, in light
of the circumstances under which they were made, not misleading; except that
the foregoing representations and warranties shall not apply to statements or
omissions in the Registration Statement or the Prospectus made in reliance
upon and in conformity with information relating to any Underwriter furnished
to the Company in writing by such Underwriter through the Representatives
expressly for use therein.
Each of the Selling Stockholders represents and warrants that
certificates in negotiable form representing all of the Shares to be sold by
such Selling Stockholders hereunder have been placed in custody under a Custody
Agreement relating to such Shares, in the form heretofore furnished to you, duly
executed and delivered by such Selling Stockholder to Norwest Bank, as custodian
(the "Custodian"), and that such Selling Stockholder has duly executed and
delivered Powers of Attorney, in the form heretofore furnished to you,
appointing the person or persons indicated in Schedule II hereto, and each of
them, as such Selling Stockholder's Attorneys-in-fact (the "Attorneys-in-Fact"
or any one of them the "Attorney-in Fact") with authority to execute and deliver
this Agreement on behalf of such Selling Stockholder, to determine the purchase
price to be paid by the Underwriters to the Selling Stockholders as provided
herein, to authorize the delivery of the Shares to be sold by such Selling
Stockholder hereunder and otherwise to act on behalf of such Selling Stockholder
in connection with the transactions contemplated by this Agreement and the
Custody Agreement.
Each of the Selling Stockholders specifically agrees that the Shares
represented by the certificates held in custody for such Selling Stockholder
under the Custody Agreement, are subject to the interests of the Underwriters
hereunder, and that the arrangements made by such Selling Stockholder for such
custody, and the appointment by such Selling Stockholder of the
Attorneys-in-Fact by the Power of Attorney, are to that extent irrevocable. Each
of the Selling Stockholders specifically agrees that the obligations of such
Selling Stockholder hereunder shall not be terminated by operation of law,
whether by the death or incapacity of any individual Selling Stockholder, or, in
the case of an estate or trust, by the death or incapacity of any executor or
trustee or the termination of such estate or trust, or in the case of a
partnership or corporation, by the dissolution of such partnership or
corporation, or by the occurrence of any other event. If any individual Selling
Stockholder or any such executor or trustee should die or become incapacitated,
or if any such estate or trust should be terminated, or if any such partnership
or corporation should be dissolved, or if any other such event should occur,
before the delivery of the Shares hereunder, certificates representing such
Shares shall be delivered by or on behalf of such Selling Stockholder in
accordance with the terms and conditions of this Agreement and the Custody
Agreement, and actions taken by the Attorneys-in-Fact pursuant to the Powers of
Attorney shall be as valid as if such death, incapacity, termination,
dissolution or other event had not occurred, regardless of whether or not the
Custodian, the Attorneys-in-Fact, or any of them, shall have received notice of
such death, incapacity, termination, dissolution or other event.
5. (A) The Company covenants and agrees with each of the several
Underwriters as follows:
(a) to use its best efforts to cause the Registration Statement to
become effective at the earliest possible time and, if required, to file the
final Prospectus with the
11
<PAGE>
Commission within the time periods specified by Rule 424(b) and Rule 430A
under the Securities Act and to furnish copies of the Prospectus to the
Underwriters in New York City prior to 10:00 a.m., New York City time, on the
second Business Day next succeeding the date of this Agreement in such
quantities as the Representatives may reasonably request;
(b) to deliver, at the expense of the Company, to the Representatives
three (3) signed copies of the Registration Statement (as originally filed) and
each amendment thereto, in each case including exhibits, and to each other
Underwriter a conformed copy of the Registration Statement (as originally filed)
and each amendment thereto, in each case without exhibits and, during the period
mentioned in paragraph (e) below, to each of the Underwriters as many copies of
the Prospectus (including all amendments and supplements thereto) as the
Representatives may reasonably request;
(c) before filing any amendment or supplement to the Registration
Statement or the Prospectus, whether before or after the time the Registration
Statement becomes effective, to furnish to the Representatives a copy of the
proposed amendment or supplement for review and not to file any such proposed
amendment or supplement to which the Representatives reasonably object;
(d) to advise the Representatives promptly, and to confirm such
advice in writing (i) when the Registration Statement has become effective, (ii)
when any amendment to the Registration Statement has been filed or becomes
effective, (iii) when any supplement to the Prospectus or any amended Prospectus
has been filed and to furnish the Representatives with copies thereof, (iv) of
any request by the Commission for any amendment to the Registration Statement or
any amendment or supplement to the Prospectus or for any additional information,
(v) of the issuance by the Commission of any stop order suspending the
effectiveness of the Registration Statement or of any order preventing or
suspending the use of any preliminary prospectus or the Prospectus or the
initiation or threatening of any proceeding for that purpose, (vi) of the
occurrence of any event, within the period referenced in paragraph (e) below, as
a result of which the Prospectus as then amended or supplemented would include
an untrue statement of a material fact or omit to state any material fact
necessary in order to make the statements therein, in the light of the
circumstances when the Prospectus is delivered to a purchaser, not misleading,
and (vii) of the receipt by the Company of any notification with respect to any
suspension of the qualification of the Shares for offer and sale in any
jurisdiction or the initiation or threatening of any proceeding for such
purpose; and to use its best efforts to prevent the issuance of any such stop
order, or of any order preventing or suspending the use of any preliminary
prospectus or the Prospectus, or of any order suspending any such qualification
of the Shares, or notification of any such order thereof and, if issued, to
obtain as soon as possible the withdrawal thereof;
(e) if, during such period of time after the first date of the public
offering of the Shares as in the opinion of counsel for the Underwriters a
prospectus relating to the Shares is required by law to be delivered in
connection with sales by the Underwriters or any dealer, any event shall occur
as a result of which it is necessary to amend or supplement the Prospectus in
order to make the statements therein, in the light of the circumstances when the
Prospectus is delivered to a purchaser, not misleading, or if it is necessary to
amend or supplement the Prospectus to comply with law, forthwith to prepare and
furnish, at the expense of the Company,
12
<PAGE>
to the Underwriters and to the dealers (whose names and addresses the
Representatives will furnish to the Company) to which Shares may have been
sold by the Representatives on behalf of the Underwriters and to any other
dealers upon request, such amendments or supplements to the Prospectus as may
be necessary so that the statements in the Prospectus as so amended or
supplemented will not, in the light of the circumstances when the Prospectus
is delivered to a purchaser, be misleading or so that the Prospectus will
comply with law;
(f) to endeavor to qualify the Shares for offer and sale under the
securities or Blue Sky laws of such jurisdictions as the Representatives shall
reasonably request and to continue such qualification in effect so long as
reasonably required for distribution of the Shares; PROVIDED that the Company
shall not be required to file a general consent to service of process in any
jurisdiction;
(g) to make generally available to its security holders and to the
Representatives as soon as practicable an earnings statement covering a period
of at least twelve months beginning with the first fiscal quarter of the Company
occurring after the effective date of the Registration Statement, which shall
satisfy the provisions of Section 11(a) of the Securities Act and Rule 158 of
the Commission promulgated thereunder;
(h) for a period of five years after the Closing Date, to furnish to
the Representatives copies of all reports or other communications (financial or
other) furnished to holders of the Shares, and copies of any reports and
financial statements furnished to or filed with the Commission or any national
securities exchange;
(i) for a period of 180 days after the date of the initial public
offering of the Shares not to (i) offer, pledge, announce the intention to sell,
sell, contract to sell, sell any option or contract to purchase, purchase any
option or contract to sell, grant any option, right or warrant to purchase or
otherwise transfer or dispose of, directly or indirectly, any shares of Stock or
any securities convertible into or exercisable or exchangeable for Stock or (ii)
enter into any swap or other agreement that transfers, in whole or in part, any
of the economic consequences of ownership of the Stock, whether any such
transaction described in clause (i) or (ii) above is to be settled by delivery
of Stock or such other securities, in cash or otherwise without the prior
written consent of J.P. Morgan Securities Inc. on behalf of the Underwriters,
other than the Shares to be sold hereunder, any shares of Stock of the Company
issued upon the exercise of options outstanding as of the date hereof and
additional options granted under the Company's 1994 Stock Option Plan and 1997
Stock Option Plan, any shares of Stock of the Company issued pursuant to
distributions from the Company's Employee Stock Ownership Plan, options to
purchase shares of Stock or debt convertible into shares of Stock issued in
connection with the Company acquiring the stock or assets of a business;
(j) to use the net proceeds received by the Company from the sale of
the Shares pursuant to this Agreement in the manner specified in the Prospectus
under the caption "Use of Proceeds";
(k) to use its best efforts to list for quotation the Shares on the
National Association of Securities Dealers Automated Quotations National Market
(the "Nasdaq National Market");
13
<PAGE>
(l) whether or not the transactions contemplated in this Agreement
are consummated or this Agreement is terminated, to pay or cause to be paid all
costs and expenses incident to the performance of its obligations hereunder,
including without limiting the generality of the foregoing, all costs and
expenses (i) incident to the preparation, issuance, execution and delivery of
the Shares, (ii) incident to the preparation, printing and filing under the
Securities Act of the Registration Statement, the Prospectus and any preliminary
prospectus (including in each case all exhibits, amendments and supplements
thereto), (iii) incurred in connection with the registration or qualification of
the Shares under the laws of such jurisdictions as the Representatives may
designate (including fees of counsel for the Underwriters and its
disbursements), (iv) in connection with the listing of the Shares on the Nasdaq
National Market, (v) related to the filing with, and clearance of the offering
by, the National Association of Securities Dealers, Inc., (vi) in connection
with the printing (including word processing and duplication costs) and delivery
of this Agreement, the Preliminary and Supplemental Blue Sky Memoranda and the
furnishing to the Underwriters and dealers of copies of the Registration
Statement and the Prospectus, including mailing and shipping, as herein
provided, (vii) any expenses incurred by the Company in connection with a "road
show" presentation to potential investors, (viii) the cost of preparing stock
certificates and (ix) the cost and charges of any transfer agent and any
registrar.
5. (B) Each of the Selling Stockholders covenants and agrees with each
of the several Underwriters to deliver to the Representatives prior to or at the
Closing Date a properly completed and executed United States Treasury Department
Form W-9 (or other applicable form or statement specified by the Treasury
Department regulations in lieu thereof) in order to facilitate the Underwriters'
documentation of their compliance with the reporting and withholding provisions
of the Tax Equity and Fiscal Responsibility Act of 1982 with respect to the
transactions herein contemplated.
6. The several obligations of the Underwriters hereunder to purchase the
Shares on the Closing Date or the Additional Closing Date, as the case may be,
are subject to the performance by the Company of its obligations hereunder and
to the following additional conditions:
(a) the Registration Statement shall have become effective (or if a
post-effective amendment is required to be filed under the Securities Act, such
post-effective amendment shall have become effective) not later than 5:00 P.M.,
New York City time, on the date hereof; and no stop order suspending the
effectiveness of the Registration Statement or any post-effective amendment
shall be in effect, and no proceedings for such purpose shall be pending before
or threatened by the Commission; the Prospectus shall have been filed with the
Commission pursuant to Rule 424(b) within the applicable time period prescribed
for such filing by the rules and regulations under the Securities Act and in
accordance with Section 5(a) hereof; and all requests from the Commission or
other regulatory authorities for additional information shall have been complied
with to the satisfaction of the Representatives;
(b) the representations and warranties of the Company and the Selling
Stockholders contained herein are true and correct on and as of the Closing Date
or the Additional Closing Date, as the case may be, as if made on and as of the
Closing Date or the Additional Closing Date, as the case may be, and each of the
Company and the Selling
14
<PAGE>
Stockholders shall have complied with all agreements and all conditions on
its part to be performed or satisfied hereunder at or prior to the Closing
Date or the Additional Closing Date, as the case may be;
(c) since the respective dates as of which information is given in
the Prospectus there shall not have been any change in the capital stock or
long-term debt of the Company or any of its subsidiaries or any material adverse
change, or any development involving a prospective material adverse change, in
or affecting the general affairs, business, prospects, management, financial
position, stockholders' equity or results of operations of the Company and its
subsidiaries, taken as a whole, other than as set forth or contemplated in the
Prospectus, the effect of which in the judgment of the Representatives makes it
impracticable or inadvisable to proceed with the public offering or the delivery
of the Shares on the Closing Date or the Additional Closing Date, as the case
may be, on the terms and in the manner contemplated in the Prospectus; and
neither the Company nor any of its subsidiaries has sustained since the date of
the latest audited financial statements included in the Prospectus any material
loss or interference with its business from fire, explosion, flood or other
calamity, whether or not covered by insurance, or from any labor dispute or
court or governmental action, order or decree, otherwise than as set forth or
contemplated in the Prospectus;
(d) the Representatives shall have received on and as of the Closing
Date or the Additional Closing Date, as the case may be, (1) a certificate of an
executive officer of the Company, with specific knowledge about the Company's
financial matters, in his capacity as such, satisfactory to the Representatives
to the effect set forth in subsections (a) through (c) (with respect to the
respective representations, warranties, agreements and conditions of the
Company) of this Section and to the further effect that there has not occurred
any material adverse change, or any development involving a prospective material
adverse change, in or affecting the general affairs, business, management,
financial position, stockholders' equity or results of operations of the Company
and its subsidiaries taken as a whole from that set forth or contemplated in the
Registration Statement and (2) a certificate of the Selling Stockholders,
satisfactory to the Representatives to the effect set forth in subsection (b) of
this Section 6 (with respect to the respective representations, warranties,
agreements and conditions of the Selling Stockholders);
(e) Howard, Rice, Nemerovski, Canady, Falk & Rabkin, a
Professional Corporation, counsel for the Company, shall have furnished to
the Representatives their written opinion, dated the Closing Date or the
Additional Closing Date, as the case may be, in form and substance
satisfactory to the Representatives, to the effect that:
(i) the Company has been duly incorporated and is validly
existing as a corporation in good standing under the laws of its jurisdiction
of incorporation, with requisite corporate power and authority to own its
properties and conduct its business as described in the Prospectus;
(ii) the Company has been duly qualified as a foreign
corporation for the transaction of business and is in good standing under the
laws of Kentucky, Maine, Massachusetts, Minnesota, New Jersey, New York and
Pennsylvania;
15
<PAGE>
(iii) to our knowledge, the Company has only one subsidiary
incorporated under the laws of Bermuda; all of the outstanding shares of
capital stock of such subsidiary are owned of record by the Company, and to
counsel's knowledge are free and clear of all liens, encumbrances, equities
or claims;
(iv) other than as set forth or contemplated in the Prospectus,
to our knowledge, there are no legal or governmental investigations, actions,
suits or proceedings pending or threatened against the Company or any of its
subsidiaries or any of their respective properties or to which the Company or
any of its subsidiaries is or may be a party or to which any property of the
Company or its subsidiaries is or may be the subject which, if determined
adversely to the Company or any of its subsidiaries, could individually or in
the aggregate, reasonably be expected to have, a material adverse effect on
the general affairs, business, management, financial position, stockholders'
equity or results of operations of the Company and its subsidiaries taken as
a whole;
(v) such counsel does not know of any contracts or other
documents that are required to be described in the Registration Statement or
Prospectus or to be filed as exhibits to the Registration Statement that are
not described therein or filed as exhibits thereto;
(vi) this Agreement has been duly authorized, executed and
delivered by the Company;
(vii) the authorized capital stock of the Company conforms as
to legal matters to the description thereof contained in the Prospectus;
(viii) the shares of capital stock of the Company outstanding
prior to the issuance of the Shares to be sold by the Company have been duly
authorized and are validly issued, fully paid and non-assessable;
(ix) the Shares to be issued and sold by the Company
hereunder have been duly authorized, and when delivered to and paid for by
the Underwriters in accordance with the terms of this Agreement, will be
validly issued, fully paid and non-assessable and the issuance of the Shares
is not subject to any preemptive or similar rights under the Company's
Certificate of Incorporation, Bylaws or any agreement known to such counsel;
(x) the statements in the Prospectus under "Risk Factors -
We May Have Insufficient Access to Funds if We Fail to Comply with the Terms
of Our Credit," "Risk Factors - Insiders Could Preclude Actions Desired by
the Remaining Stockholders," "Risk Factors - The Significant Number of Shares
of Common Stock Eligible for Future Sale Could Adversely Affect the Price of
Our Stock," the eleventh and twelfth paragraphs of "Management's Discussion
and Analysis of Financial Condition and Results of Operation - Liquidity and
Capital Resources," "Business - Facilities," "Management - Compensation
Plans," "Management - Limitation of Liability and Indemnification Matters,"
"Certain Transactions," "Description of Capital Stock," "Shares Eligible for
Future Sale" and the fourth, fifth, sixth and eighth paragraphs of
"Underwriting", and in the Registration Statement in Items 14 and 15, insofar
as such statements constitute a summary of the terms of the Stock, legal
matters,
16
<PAGE>
documents or proceedings referred to therein, fairly present the information
called for with respect to such terms, legal matters, documents or
proceedings;
(xi) such counsel is of the opinion that the Registration
Statement and the Prospectus and any amendments and supplements thereto
(other than the financial statements and related schedules therein, as to
which such counsel need express no opinion) comply as to form in all material
respects with the requirements of the Securities Act and rules promulgated
thereunder by the Commission;
(xii) the Company is not, and with the giving of notice or
lapse of time or both would not be, in violation of or in default under, its
Certificate of Incorporation or Bylaws, except for violations and defaults
which individually and in the aggregate are not material to the Company and
its subsidiaries taken as a whole; the issue and sale of the Shares being
delivered on the Closing Date or the Additional Closing Date, as the case may
be, and the performance by the Company of its obligations under this
Agreement and the consummation of the transactions contemplated herein in
accordance with the terms hereof will not result in a breach of any of the
terms or provisions of, or constitute a default under, any agreement or
instrument set forth in Exhibit A to the opinion, nor will any such action
result in any violation of the provisions of the Certificate of Incorporation
or the Bylaws of the Company or any applicable federal, California or
Delaware corporate law, rule or statute or any order of any court or
governmental agency or body in which the Company is a named party;
(xiii) no consent, approval, authorization, order, license,
registration or qualification of or with any court or governmental agency or
body is required for the Company's issuance and sale of the Firm Shares or
the consummation of the other transactions contemplated by this Agreement,
except such consents, approvals, authorizations, orders, licenses,
registrations or qualifications as have been obtained under the Securities
Act and as may be required under state securities laws in connection with the
purchase and distribution of the Shares by the Underwriters;
(xiv) the Company is not and, after giving effect to the
offering and sale of the Shares, will not be an "investment company" or
entity "controlled" by an "investment company", as such terms are defined in
the Investment Company Act;
(xv) the merger of Valley Media Inc, a California
corporation (the "Predecessor"), with and into the Company (the
"Reincorporation") has been consummated in compliance with applicable law;
the Company has succeeded to all of the rights, privileges, powers and
franchises, and is subject to all of the restrictions, disabilities and
duties of the Predecessor as provided under Section 259 of the Delaware
General Corporation Law; and the issuance of capital stock by the Company in
the Reincorporation was in compliance with the laws of the State of
California and the General Corporation Law of Delaware and was exempt from
registration under the Securities Act.
In rendering such opinions, such counsel may rely (A) as to matters
involving the application of laws other than the laws of the United States and
the States of California and Delaware, to the extent such counsel deems proper
and to the extent specified in such opinion, if
17
<PAGE>
at all, upon an opinion or opinions (in form and substance reasonably
satisfactory to Underwriters' counsel) of other counsel reasonably acceptable
to the Underwriters' counsel, familiar with the applicable laws; (B) as to
matters of fact, to the extent such counsel deems proper, on certificates of
responsible officers of the Company and certificates or other written
statements of officials of jurisdictions having custody of documents
respecting the corporate existence or good standing of the Company. The
opinion of such counsel for the Company shall state that the opinion of any
such other counsel upon which they relied is in form satisfactory to such
counsel and, in such counsel's opinion, the Underwriters and they are
justified in relying thereon.
The opinion of Howard, Rice, Nemerovski, Canady, Falk & Rabkin, a
Professional Corporation, described above shall be rendered to the Underwriters
at the request of the Company and shall so state therein.
(f) Howard, Rice, Hemerovski, Canady, Falk & Rabkin, a Professional
Corporation, counsel for the Selling Stockholders, shall have furnished to the
Representatives their written opinion, dated the Closing Date or Additional
Closing Date, as the case may be, in form and substance satisfactory to the
Representatives, to the effect that:
(i) this Agreement has been duly executed and delivered by
or on behalf of each of the Selling Stockholders;
(ii) a Power of Attorney and a Custody Agreement have been
duly authorized, executed and delivered by each Selling Stockholder and
constitute valid and binding agreements of each Selling Stockholder in
accordance with their terms, except as may be limited by applicable
bankruptcy, insolvency, reorganization, arrangement, moratorium, or other
similar laws or court decisions relating to or affecting the rights of
creditors generally;
(iii) each Selling Stockholder is the record owner of all of
the Shares to be sold by such Selling Stockholder; upon payment for and
delivery of the Option Shares in accordance with this Agreement, assuming the
Underwriters are acquiring the Option Shares in good faith without notice of
any adverse claim, the Underwriters will acquire the Option Shares free and
clear of any adverse claim; and
(iv) the sale of the Shares and the execution and delivery by
each the Selling Stockholder of, and the performance by each Selling
Stockholder of his obligations under, this Agreement, and the consummation of
the transactions contemplated herein, will not (i) conflict with or result in
a breach of any of the terms or provisions of, or constitute a default under,
any indenture, mortgage, deed of trust, loan agreement or other material
agreement or instrument set forth in Exhibit B, or (ii) result in any
violation of any applicable law or statute or any order, rule or regulation
of any court or governmental agency or body having jurisdiction over either
of the Selling Stockholders; and
(v) no consent, approval, authorization, order,
registration or qualification of or with any such court or governmental
agency or body is required for the sale by the Selling Stockholders of the
Option Shares or the consummation by the Selling Stockholders of the
transactions contemplated by this Agreement, except such consents,
18
<PAGE>
approvals, authorizations, registrations or qualifications as have been
obtained under the Securities Act and as may be required under state
securities or Blue Sky laws in connection with the purchase and distribution
of the Shares by the Underwriters.
In rendering such opinions, such counsel may rely as to matters
involving the application of laws other than the laws of the United States and
the States of California and Delaware, to the extent such counsel deems proper
and to the extent specified in such opinion, if at all, upon an opinion or
opinions (in form and substance reasonably satisfactory to Underwriters'
counsel) of other counsel reasonably acceptable to the Underwriters' counsel,
familiar with the applicable laws. The opinion of such counsel for the Selling
Stockholders shall state that the opinion of any such other counsel is in form
satisfactory to such counsel and, in such counsel's opinion, the Underwriters
and they are justified in relying thereon.
(g) on the effective date of the Registration Statement and the
effective date of the most recently filed post-effective amendment to the
Registration Statement and also on the Closing Date or Additional Closing Date,
as the case may be, Deloitte & Touche LLP shall have furnished to you letters,
dated the respective dates of delivery thereof, in form and substance
satisfactory to you, containing statements and information of the type
customarily included in accountants' "comfort letters" to underwriters with
respect to the financial statements and certain financial information contained
in the Registration Statement and the Prospectus;
(h) the Representatives shall have received on and as of the Closing
Date or Additional Closing Date, as the case may be, an opinion of Cooley
Godward LLP, counsel to the Underwriters, with respect to the due authorization
and valid issuance of the Shares, the Registration Statement, the Prospectus and
other related matters as the Representatives may reasonably request, and such
counsel shall have received such papers and information as they may reasonably
request to enable them to pass upon such matters;
(i) the Shares to be delivered on the Closing Date or Additional
Closing Date, as the case may be, shall have been approved for listing on the
Nasdaq National Market;
(j) on or prior to the Closing Date or Additional Closing Date, as
the case may be, the Company shall have furnished to the Representatives such
further certificates and documents as the Representatives shall reasonably
request;
(k) the "lock-up" agreements, each substantially in the form of
Exhibit A hereto, between you and the Selling Stockholders, certain other
stockholders, officers and directors of the Company relating to sales and
certain other dispositions of shares of Stock or certain other securities,
delivered to you on or before the date hereof, shall be in full force and effect
on the Closing Date or Additional Closing Date, as the case may be.
7. The Company agrees to indemnify and hold harmless each Underwriter,
each affiliate of any Underwriter which assists such Underwriter in the
distribution of the Shares and each person, if any, who controls any Underwriter
within the meaning of either Section 15 of the Securities Act or Section 20 of
the Securities Exchange Act of 1934, as amended ("the Exchange Act"), from and
against any and all losses, claims, damages and liabilities (including, without
limitation, the legal fees and other expenses incurred in connection with any
suit, action or proceeding or any claim asserted) caused by any untrue statement
or alleged untrue statement of a material fact contained in the Registration
Statement or the Prospectus (as amended or supplemented if the Company shall
have furnished any amendments or supplements thereto) or any preliminary
prospectus, or caused by any omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading, except (i) insofar as such losses, claims, damages or
liabilities are caused by any untrue statement or omission or alleged untrue
statement or omission made in reliance upon and in conformity with information
relating to any Underwriter furnished to the Company in writing by such
Underwriter through the Representatives expressly for use therein or (ii) if
copies of the Prospectus were timely delivered to the Underwriter pursuant to
Section 5(a) and a copy of the Prospectus (as then amended or supplemented if
the Company shall have furnished any amendments or supplements thereto) was not
sent or given by or on behalf of such Underwriter to such person, and if the
Prospectus (as so amended or supplemented) would have cured the defect giving
rise to such loss, claim, damage, or liability.
Each of the Selling Stockholders severally in proportion to the number of
Shares actually sold by such Selling Stockholder to the total number of Shares
actually sold hereunder agrees to indemnify and hold harmless each Underwriter,
each affiliate of any Underwriter which assists such Underwriter in the
distribution of the Shares and each person, if any, who controls any Underwriter
within the meaning of either Section 15 of the Securities Act or Section 20 of
the Exchange Act, from and against any and all losses, claims, damages and
liabilities (including, without limitation, the legal fees and other expenses
incurred in connection with any suit, action or
19
<PAGE>
proceeding or any claim asserted) caused by any untrue statement or alleged
untrue statement of a material fact contained in the Registration Statement
or the Prospectus (as amended or supplemented if the Company shall have
furnished any amendments or supplements thereto) or any preliminary
prospectus, or caused by any omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the
statements therein not misleading, except (i) insofar as such losses, claims,
damages or liabilities are caused by any untrue statement or omission or
alleged untrue statement or omission made in reliance upon and in conformity
with information relating to any Underwriter furnished to the Company in
writing by such Underwriter through the Representatives expressly for use
therein or (ii) if copies of the Prospectus were timely delivered to the
Underwriter pursuant to Section 5(a) and a copy of the Prospectus (as then
amended or supplemented if the Company shall have furnished any amendments or
supplements thereto) was not sent or given by or on behalf of such
Underwriter to such person, and if the Prospectus (as so amended or
supplemented) would have cured the defect giving rise to such loss, claim,
damage, or liability.
Each Underwriter agrees, severally and not jointly, to indemnify and hold
harmless the Company, its directors, its officers who sign the Registration
Statement and each person who controls the Company within the meaning of Section
15 of the Securities Act and Section 20 of the Exchange Act and each of the
Selling Stockholders to the same extent as the foregoing indemnity from the
Company and the Selling Stockholders to each Underwriter, but only with
reference to information relating to such Underwriter furnished to the Company
in writing by such Underwriter through the Representatives expressly for use in
the Registration Statement, the Prospectus, any amendment or supplement thereto,
or any preliminary prospectus. The Company and the Underwriters acknowledge
that the information set forth in the first, third, seventh and ninth paragraphs
under "Underwriting" in the Registration Statement and Prospectus
20
<PAGE>
(insofar as such information relates to the Underwriters) constitutes the
only information furnished by the Underwriters to the Company for inclusion
in the Registration Statement and Prospectus.
If any suit, action, proceeding (including any governmental or regulatory
investigation), claim or demand shall be brought or asserted against any person
in respect of which indemnity may be sought pursuant to either of the three
preceding paragraphs, such person (the "Indemnified Person") shall promptly
notify the person against whom such indemnity may be sought (the "Indemnifying
Person") in writing, and the Indemnifying Person, upon request of the
Indemnified Person, may assume the defense thereof and in such case shall retain
counsel reasonably satisfactory to the Indemnified Person to represent the
Indemnified Person and any others the Indemnifying Person may designate in such
proceeding and shall pay the fees and expenses of such counsel related to such
proceeding. In any such proceeding, any Indemnified Person shall have the right
to retain its own counsel, but the fees and expenses of such counsel shall be at
the expense of such Indemnified Person unless (i) the Indemnifying Person and
the Indemnified Person shall have mutually agreed to the contrary, (ii) the
Indemnifying Person has failed within a reasonable time to retain counsel
reasonably satisfactory to the Indemnified Person or (iii) the named parties in
any such proceeding (including any impleaded parties) include both the
Indemnifying Person and the Indemnified Person and representation of both
parties by the same counsel would be inappropriate due to actual or potential
differing interests between them. It is understood that the Indemnifying Person
shall not, in connection with any proceeding or related proceeding in the same
jurisdiction, be liable for the fees and expenses of more than one separate firm
(in addition to any local counsel) for all Indemnified Persons, and that all
such fees and expenses shall be reimbursed as they are incurred. Any such
separate firm for the Underwriters, each affiliate of any Underwriter which
assists such Underwriter in the distribution of the Shares and such control
persons of Underwriters shall be designated in writing by J.P. Morgan Securities
Inc. and any such separate firm for the Company, its directors, its officers who
sign the Registration Statement and such control persons of the Company shall be
designated in writing by the Company and any such separate firm for the Selling
Stockholders shall be designated in writing by Barnet J. Cohen. The Indemnifying
Person shall not be liable for any settlement of any proceeding effected without
its written consent, but if settled with such consent or if there be a final
judgment for the plaintiff, the Indemnifying Person agrees to indemnify any
Indemnified Person from and against any loss or liability by reason of such
settlement or judgment. Notwithstanding the foregoing sentence, if at any time
an Indemnified Person shall have requested an Indemnifying Person to reimburse
the Indemnified Person for fees and expenses of counsel as contemplated by the
second and third sentences of this paragraph, the Indemnifying Person agrees
that it shall be liable for any settlement of any proceeding effected without
its written consent if (i) such settlement is entered into more than 30 days
after receipt by such Indemnifying Person of the aforesaid request and (ii) such
Indemnifying Person shall not have reimbursed the Indemnified Person in
accordance with such request prior to the date of such settlement. No
Indemnifying Person shall, without the prior written consent of the Indemnified
Person, effect any settlement of any pending or threatened proceeding in respect
of which any Indemnified Person is a party and indemnity could have been sought
hereunder by such Indemnified Person, unless such settlement includes an
unconditional release of such Indemnified Person from all liability on claims
that are the subject matter of such proceeding.
21
<PAGE>
If the indemnification provided for in the first, second and third
paragraphs of this Section 7 is unavailable to an Indemnified Person or
insufficient in respect of any losses, claims, damages or liabilities referred
to therein, then each Indemnifying Person under such paragraph, in lieu of
indemnifying such Indemnified Person thereunder, shall contribute to the amount
paid or payable by such Indemnified Person as a result of such losses, claims,
damages or liabilities (i) in such proportion as is appropriate to reflect the
relative benefits received by the Company and the Selling Stockholders on the
one hand and the Underwriters on the other hand from the offering of the Shares
or (ii) if the allocation provided by clause (i) above is not permitted by
applicable law, in such proportion as is appropriate to reflect not only the
relative benefits referred to in clause (i) above but also the relative fault of
the Company and the Selling Stockholders on the one hand and the Underwriters on
the other hand in connection with the statements or omissions that resulted in
such losses, claims, damages or liabilities, as well as any other relevant
equitable considerations. The relative benefits received by the Company and the
Selling Stockholders on the one hand and the Underwriters on the other hand
shall be deemed to be in the same respective proportions as the net proceeds
from the offering (before deducting expenses) received by the Company and the
Selling Stockholders and the total underwriting discounts and the commissions
received by the Underwriters, in each case as set forth in the table on the
cover of the Prospectus, bear to the aggregate public offering price of the
Shares. The relative fault of the Company and the Selling Stockholders on the
one hand and the Underwriters on the other hand shall be determined by reference
to, among other things, whether the untrue or alleged untrue statement of a
material fact or the omission or alleged omission to state a material fact
relates to information supplied by the Company or by the Underwriters and the
parties' relative intent, knowledge, access to information and opportunity to
correct or prevent such statement or omission.
The Company, the Selling Stockholders and the Underwriters agree that it
would not be just and equitable if contribution pursuant to this Section 7 were
determined by PRO RATA allocation (even if the Selling Stockholders or the
Underwriters were treated as one entity for such purposes) or by any other
method of allocation that does not take account of the equitable considerations
referred to in the immediately preceding paragraph. The amount paid or payable
by an Indemnified Person as a result of the losses, claims, damages and
liabilities referred to in the immediately preceding paragraph shall be deemed
to include, subject to the limitations set forth above, any legal or other
expenses incurred by such Indemnified Person in connection with investigating or
defending any such action or claim. Notwithstanding the provisions of this
Section 7, in no event shall an Underwriter be required to contribute any amount
in excess of the amount by which the total price at which the Shares
underwritten by it and distributed to the public were offered to the public
exceeds the amount of any damages that such Underwriter has otherwise been
required to pay by reason of such untrue or alleged untrue statement or omission
or alleged omission. No person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any person who was not guilty of such fraudulent
misrepresentation. The Underwriters' obligations to contribute pursuant to this
Section 7 are several in proportion to the respective number of Shares set forth
opposite their names in Schedule I hereto, and not joint.
The remedies provided for in this Section 7 are not exclusive and shall not
limit any rights or remedies which may otherwise be available to any indemnified
party at law or in equity.
22
<PAGE>
The indemnity and contribution agreements contained in this Section 7 and
the representations and warranties of the Company and the Selling Stockholders
set forth in this Agreement shall remain operative and in full force and effect
regardless of (i) any termination of this Agreement, (ii) any investigation made
by or on behalf of any Underwriter or any person controlling any Underwriter or
by or on behalf of the Company, its officers or directors or any other person
controlling the Company or the Selling Stockholders and (iii) acceptance of and
payment for any of the Shares.
8. Notwithstanding anything herein contained, this Agreement (or the
obligations of the several Underwriters with respect to the Option Shares)
may be terminated in the absolute discretion of the Representatives, by
notice given to the Company and the Selling Stockholders, if after the
execution and delivery of this Agreement and prior to the Closing Date (or,
in the case of the Option Shares, prior to the Additional Closing Date) (i)
trading generally shall have been suspended or materially limited on or by,
as the case may be, any of the New York Stock Exchange or the American Stock
Exchange, the Nasdaq Stock Market, the Chicago Board Options Exchange, the
Chicago Mercantile Exchange or the Chicago Board of Trade, (ii) trading of
any securities of or guaranteed by the Company shall have been suspended on
any exchange or in any over-the-counter market, (iii) a general moratorium on
commercial banking activities in New York shall have been declared by either
Federal or New York State authorities, or (iv) there shall have occurred any
outbreak or escalation of hostilities or any change in financial markets or
any calamity or crisis that, in the judgment of the Representatives, is
material and adverse and which, in the judgment of the Representatives, makes
it impracticable to market the Shares being delivered at the Closing Date or
the Additional Closing Date, as the case may be, on the terms and in the
manner contemplated in the Prospectus.
9. This Agreement shall become effective upon the later of (x) execution
and delivery hereof by the parties hereto and (y) release of notification of the
effectiveness of the Registration Statement (or, if applicable, any
post-effective amendment) by the Commission.
If on the Closing Date or the Additional Closing Date, as the case may be,
any one or more of the Underwriters shall fail or refuse to purchase Shares
which it or they have agreed to purchase hereunder on such date, and the
aggregate number of Shares which such defaulting Underwriter or Underwriters
agreed but failed or refused to purchase is not more than one-tenth of the
aggregate number of Shares to be purchased on such date, the other Underwriters
shall be obligated severally in the proportions that the number of Shares set
forth opposite their respective names in Schedule I bears to the aggregate
number of Underwritten Shares set forth opposite the names of all such
non-defaulting Underwriters, or in such other proportions as the Representatives
may specify, to purchase the Shares which such defaulting Underwriter or
Underwriters agreed but failed or refused to purchase on such date; PROVIDED
that in no event shall the number of Shares that any Underwriter has agreed to
purchase pursuant to Section 1 be increased pursuant to this Section 9 by an
amount in excess of one-tenth of such number of Shares without the written
consent of such Underwriter. If on the Closing Date or the Additional Closing
Date, as the case may be, any Underwriter or Underwriters shall fail or refuse
to purchase Shares which it or they have agreed to purchase hereunder on such
date, and the aggregate number of Shares with respect to which such default
occurs is more than one-tenth of the aggregate number of Shares to be purchased
on such date, and arrangements satisfactory to the Representatives, the Company
and the Selling Stockholders for the purchase of such Shares
23
<PAGE>
are not made within 36 hours after such default, this Agreement (or the
obligations of the several Underwriters to purchase the Option Shares, as the
case may be) shall terminate without liability on the part of any
non-defaulting Underwriter, the Company or the Selling Stockholder. In any
such case either you or the Company and the Selling Stockholders shall have
the right to postpone the Closing Date (or, in the case of the Option Shares,
the Additional Closing Date), but in no event for longer than seven days, in
order that the required changes, if any, in the Registration Statement and in
the Prospectus or in any other documents or arrangements may be effected. Any
action taken under this paragraph shall not relieve any defaulting
Underwriter from liability in respect of any default of such Underwriter
under this Agreement.
10. If this Agreement shall be terminated by the Underwriters, or any of
them, because of any failure or refusal on the part of the Company or the
Selling Stockholders to comply with the terms or to fulfill any of the
conditions of this Agreement, or if for any reason the Company or the Selling
Stockholders shall be unable to perform its obligations under this Agreement or
any condition of the Underwriters' obligations cannot be fulfilled, the Company
or the respective Selling Stockholder, as the case may be, agrees to reimburse
the Underwriters or such Underwriters as have so terminated this Agreement with
respect to themselves, severally, for all out-of-pocket expenses (including the
fees and expenses of its counsel) reasonably incurred by the Underwriter in
connection with this Agreement or the offering contemplated hereunder.
11. This Agreement shall inure to the benefit of and be binding upon the
Company, the Selling Stockholders, the Underwriters, each affiliate of any
Underwriter which assists such Underwriter in the distribution of the Shares,
any controlling persons referred to herein and their respective successors and
assigns. Nothing expressed or mentioned in this Agreement is intended or shall
be construed to give any other person, firm or corporation any legal or
equitable right, remedy or claim under or in respect of this Agreement or any
provision herein contained. No purchaser of Shares from any Underwriter shall be
deemed to be a successor by reason merely of such purchase.
12. Any action by the Underwriters hereunder may be taken by the
Representatives jointly or by J.P. Morgan Securities Inc. alone on behalf of the
Underwriters, and any such action taken by the Representatives jointly or by
J.P. Morgan Securities Inc. alone shall be binding upon the Underwriters. All
notices and other communications hereunder shall be in writing and shall be
deemed to have been duly given if mailed or transmitted by any standard form of
telecommunication. Notices to the Underwriters shall be given to the
Representatives, c/o J.P. Morgan Securities Inc., 60 Wall Street, New York, New
York 10260 (telefax: (212) 648-5705); Attention: Syndicate Department. Notices
to the Company shall be given to it at 1280 Santa Anita Court, Woodland,
California 95776 (telefax: (530) 406-5205); Attention: President. Notice to the
Selling Stockholders shall be given to the Attorneys-in-Fact at 1280 Santa Anita
Court, Woodland, California 95776 (telefax: (530) 406-5205) Attention:
President.
13. This Agreement may be signed in counterparts, each of which shall be
an original and all of which together shall constitute one and the same
instrument.
24
<PAGE>
14. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH
THE LAWS OF THE STATE OF NEW YORK, WITHOUT GIVING EFFECT TO THE CONFLICTS OF
LAWS PROVISIONS THEREOF.
25
<PAGE>
If the foregoing is in accordance with your understanding, please sign and
return four counterparts hereof.
Very truly yours,
VALLEY MEDIA, INC.
By:
------------------------------
Title:
SELLING STOCKHOLDERS:
---------------------------------
Barnet J. Cohen
---------------------------------
Robert R. Cain
Accepted:_________, 1999
J.P. Morgan Securities Inc.
BancBoston Robertson Stephens
Acting severally on behalf of
themselves and the several Underwriters
listed in Schedule I hereto.
By: J.P. Morgan Securities Inc.
Acting on behalf of itself and the
several Underwriters listed in
Schedule I hereto.
By:
------------------------------------
Name:
Title:
26
<PAGE>
SCHEDULE I
<TABLE>
<CAPTION>
Number of Shares
To Be Purchased
Underwriter ----------------
- -----------
<S> <C>
J.P. Morgan Securities Inc................
BancBoston Robertson Stephens.............
Total ---------------
</TABLE>
27
<PAGE>
SCHEDULE II
<TABLE>
<CAPTION>
Number of
Option Shares
Selling Stockholder -------------
- -------------------
<S> <C>
Barnet J. Cohen........................................ 472,500
Robert R. Cain......................................... 52,500
-------------
Total 525,000
</TABLE>
28
<PAGE>
EXHIBIT A
FORM OF LOCK-UP AGREEMENT
29
<PAGE>
[HOWARD RICE LETTERHEAD]
March 22, 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;
and (c) the truth, accuracy and completeness of the information, representations
and warranties contained in the instruments, documents, records and certificates
we have reviewed.
<PAGE>
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 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.
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>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE
We consent to the use in this Amendment No. 3 to Registration Statement No.
333-69329 of Valley Media, Inc. on Form S-1 of our report dated February 8, 1999
(March 5, 1999 as to Note 13 and March 22, 1999 as to the last paragraph of Note
2) on the consolidated financial statements of Valley Media, Inc., appearing in
the Prospectus, which is part of this Registration Statement, and to the
references to us under the headings "Selected Consolidated Financial Data" and
"Experts" in such Prospectus.
Our audits of the consolidated financial statements of Valley Media, Inc.
referred to in our aforementioned report also included the consolidated
financial statement schedule of Valley Media, Inc., listed in Item 16(b). This
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such financial statement schedule, when considered in relation to
the basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
/s/ Deloitte & Touche LLP
San Francisco, California
March 22, 1999
<PAGE>
EXHIBIT 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Amendment No. 3 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., and our report dated June 18, 1997 on the financial
statements of Distribution North America appearing in the Prospectus, which is
part of this Registration Statement.
/s/ Deloitte & Touche LLP
San Francisco, California
March 22, 1999
<PAGE>
EXHIBIT 23.4
INDEPENDENT ACCOUNTANTS' CONSENT
We consent to the use in this Amendment No. 3 to Registration Statement No.
333-69329 of Valley Media, Inc. on Form S-1 of our report dated June 18, 1997 on
the financial statements of Distribution North America, appearing in the
Prospectus, which is part of this Registration Statement. We also consent to the
reference to us under the heading "Experts" in such Prospectus.
/s/ PricewaterhouseCoopers LLP
Sacramento, California
March 19, 1999
