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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JANUARY 1, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NUMBER 000-25617
VALLEY MEDIA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE
(State or other jurisdiction 94-2556440
of incorporation or organization) (I.R.S. Employer Identification No.)
------------------------
1280 SANTA ANITA COURT, WOODLAND, CALIFORNIA
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
95776
(ZIP CODE)
(530) 661-6600
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __.
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
The number of shares outstanding of the Registrant's common stock as of January
28, 2000 was 8,464,707 shares.
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VALLEY MEDIA, INC.
INDEX
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<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets as of January 1, 2000 and April 3,
1999 2
Consolidated Statements of Operations for the thirteen and thirty-nine weeks
ended January 1, 2000 and December 26, 1998 3
Consolidated Statements of Cash Flows for the thirty-nine weeks
ended January 1, 2000 and December 26, 1998 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 8
Item 3. Quantitative and Qualitative Disclosure About Market Risk 16
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities and Use of Proceeds 16
Item 3. Defaults Upon Senior Securities 16
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
1
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VALLEY MEDIA, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
JANUARY 1, APRIL 3,
2000 1999
---- ----
DOLLARS IN THOUSANDS, EXCEPT SHARE DATA
ASSETS
Current assets
<S> <C> <C>
Cash ...................................................................... $ 3,620 $ 1,433
Accounts receivable, less allowance for doubtful accounts of $9,736 at
January 1, 2000 and $8,892 at April 3, 1999 ............................ 261,437 167,925
Inventories, net of reserves of $3,513 at January 1, 2000 and $2,823 at
April 3, 1999 .......................................................... 264,905 216,807
Deferred income taxes ..................................................... 5,956 5,956
Prepaid expenses and other ................................................ 1,836 1,551
--------- ---------
Total ..................................................................... 537,754 393,672
Property and equipment, net .................................................. 27,501 20,913
Goodwill and other intangibles, net .......................................... 13,574 14,678
Deferred income taxes ........................................................ 399 399
Other assets ................................................................. 1,068 1,063
--------- ---------
Total assets ................................................................. $ 580,296 $ 430,725
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable .......................................................... $ 310,514 $ 191,978
Accrued liabilities ....................................................... 7,707 11,534
Revolving line of credit .................................................. 176,597 148,730
Current portion of long-term debt ......................................... 3,933 1,905
Deferred income taxes ..................................................... 3,918 3,918
--------- ---------
Total .................................................................. 502,669 358,065
--------- ---------
Deferred income taxes ........................................................ 2,855 2,855
Long-term debt ............................................................... 8,083 3,918
Commitments and contingencies
Stockholders' equity
Preferred stock, $.001 par value, 2,000,000 shares authorized, none issued
Common stock, $.001 par value, 20,000,000 shares authorized, 8,464,707
and 8,449,009 shares issued and outstanding ........................... 8 8
Additional paid-in capital ................................................ 52,194 52,145
Stockholders' notes receivable ............................................ (243) (360)
Retained earnings ......................................................... 14,730 14,094
--------- ---------
Total stockholders' equity ............................................. 66,689 65,887
--------- ---------
Total liabilities and stockholders' equity ................................... $ 580,296 $ 430,725
========= =========
</TABLE>
See notes to consolidated financial statements.
2
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VALLEY MEDIA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
------------------------------- --------------------------------
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
------------------------------- --------------------------------
JANUARY 1, DECEMBER 26, JANUARY 1, DECEMBER 26,
DOLLARS IN THOUSANDS, EXCEPT SHARE DATA 2000 1998 2000 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales ....................................... $ 294,514 $ 287,751 $ 685,466 $ 631,102
Cost of goods sold .............................. 264,685 255,707 609,227 561,112
----------- ----------- ----------- -----------
Gross profit .................................... 29,829 32,044 76,239 69,990
Selling, general and administrative expenses .... 24,345 21,605 65,226 55,748
----------- ----------- ----------- -----------
Operating income ................................ 5,484 10,439 11,013 14,242
Interest expense ................................ 3,604 2,751 9,926 7,518
----------- ----------- ----------- -----------
Income before income taxes ...................... 1,880 7,688 1,087 6,724
Income tax provision ............................ 780 2,929 451 2,812
----------- ----------- ----------- -----------
Income before extraordinary loss ................ 1,100 4,759 636 3,912
Extraordinary loss (net of income taxes of $477) (723)
------------- ------------ ----------- -----------
Net income ...................................... $ 1,100 $ 4,759 $ 636 $ 3,189
=========== =========== =========== ===========
Net income per share:
Basic:
Income before extraordinary loss ........... $ 0.13 0.98 $ 0.08 $ 0.81
Extraordinary loss ......................... (0.15)
------------ ----------- ----------- -----------
Net income per share ....................... $ 0.13 0.98 $ 0.08 $ 0.66
=========== =========== =========== ===========
Diluted:
Income before extraordinary loss .......... $ 0.12 0.85 $ 0.07 $ 0.70
Extraordinary loss ........................ (0.13)
------------ ----------- ----------- -----------
Net income per share ...................... $ 0.12 0.85 $ 0.07 $ 0.57
=========== =========== =========== ===========
Weighted average shares used in the calculation:
Basic ........................................ 8,455,037 4,850,319 8,451,983 4,838,413
=========== =========== =========== ===========
Diluted ...................................... 8,990,299 5,624,266 9,185,987 5,554,715
=========== =========== =========== ===========
</TABLE>
See notes to consolidated financial statements.
3
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VALLEY MEDIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
------------------------------
THIRTY-NINE WEEKS ENDED
------------------------------
JANUARY 1, DECEMBER 26,
DOLLARS IN THOUSANDS 2000 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Income before extraordinary loss ............................................ $ 636 $ 3,912
Adjustments to reconcile income before extraordinary loss to net cash used in
operating activities:
Depreciation and amortization ............................................... 5,164 4,158
Bad debt expense ............................................................ 844 4,050
Deferred income taxes ....................................................... (2,193)
Extraordinary loss on debt refinancing ...................................... (723)
Changes in assets and liabilities:
Accounts receivable ...................................................... (95,275) (121,298)
Inventories .............................................................. (46,895) (123,669)
Prepaid expenses and other ............................................... (400) 245
Accounts payable ......................................................... 117,921 185,039
Accrued liabilities ..................................................... (3,602) 4,670
--------- ---------
Net cash used in operating activities .................................. (21,607) (45,809)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment ......................................... (10,807) (6,227)
Other ....................................................................... 375
--------- ---------
Net cash used in investing activities .................................. (10,432) (6,227)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Short-term borrowings under revolving line of credit ........................ 621,947 581,191
Repayment of short-term borrowings .......................................... (594,080) (529,816)
Issuance of long-term debt .................................................. 8,335 2,350
Repayment of long-term debt ................................................. (2,142) (1,217)
Issuance of common stock .................................................... 49 (147)
Repayment of stockholder note receivable .................................... 117
--------- ---------
Net cash provided by financing activities .............................. 34,226 52,361
--------- ---------
NET INCREASE IN CASH ........................................................... 2,187 325
CASH, BEGINNING OF PERIOD ...................................................... 1,433 394
--------- ---------
CASH, END OF PERIOD ............................................................ $ 3,620 $ 719
========= =========
</TABLE>
See notes to consolidated financial statements.
4
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VALLEY MEDIA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements of Valley Media,
Inc. and its subsidiaries (the "Company") are unaudited and reflect all normal,
recurring adjustments that, in the opinion of management, are necessary for a
fair presentation of such financial statements. The Company's interim results
are not indicative of results for a full year.
These unaudited consolidated financial statements should be read in
conjunction with the audited financial statements included in the Company's
Annual Report on Form 10-K for the fiscal year ended April 3, 1999.
2. RELATED PARTY TRANSACTIONS
On July 2, 1999, the Company, Valley Entertainment, Inc. ("VE"), and
Barnet J. Cohen, the Company's founder, largest stockholder and the Chairman of
the Company's Board of Directors, entered into a Contribution Agreement (the
"Contribution Agreement"). Pursuant to the Contribution Agreement, Mr. Cohen,
who is the President and Chief Executive Officer of VE, contributed $1,320,000
in cash in exchange for 66 percent of VE's outstanding common stock. Other
individuals contributed $300,000 in cash in exchange for a total of 15 percent
of VE's outstanding common stock. The Company assigned the net assets of its
Valley Entertainment division to VE in exchange for a cash payment of $277,000
and 19 percent of VE's outstanding common stock. The Company did not recognize
any gain or loss on the transaction. The Company uses the equity method to
account for its investment in VE.
3. LONG-TERM DEBT
During the thirty-nine weeks ended January 1, 2000, the Company
entered into various credit agreements providing for equipment financing with
terms of 3 to 6 years and interest rates ranging from 8.1% to 9.1%. The
credit agreements are secured by various pieces of warehouse equipment,
office furniture, and computer equipment. The credit agreements contain
various covenants including, among other things, compliance with minimum
tangible net worth, minimum coverage ratio, and maximum total liabilities to
equity ratio requirements. As of January 1, 2000, the Company was in
compliance with all covenants, certain of which were amended during the
thirteen weeks ended January 1, 2000. During the thirty-nine weeks ended
January 1, 2000, approximately $8.3 million was funded under the credit
agreements. Funds were primarily used to refinance equipment previously
purchased using the Company's revolving line of credit.
5
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4. COMMITMENTS AND CONTINGENCIES
On December 17, 1999, the Company entered into an agreement
("Agreement") with Loudeye Technologies, Inc. ("Loudeye") for Loudeye to provide
certain services in connection with the creation of a digital music sampling
service ("Sampling Service") that will be part of a consumer database the
Company offers to its retail customers.
In connection with this Agreement, the Company has committed that
Loudeye will receive revenues from the Sampling Service of at least $1.5 million
during the first year after the Sampling Service becomes operational, as defined
in the Agreement. The Company received warrants to purchase 650,000 shares of
Loudeye's common stock at $10.00 per share expiring December 17, 2000.
5. EXTRAORDINARY LOSS
As a result of terminating a prior line of credit agreement in the
first quarter of fiscal 1999, the Company incurred termination fees and wrote
off prepaid financing costs resulting in an extraordinary loss of $723,000 (net
of income tax benefit of $477,000) or $0.13 per diluted share.
6. SEGMENT INFORMATION
Management has determined that there are three reportable segments
based on the customers served by each segment: Full-line Distribution, New Media
and Independent Distribution. Such determination was based on the level at which
executive management reviews the results of operations in order to make
decisions regarding performance assessment and resource allocation.
Full-line Distribution serves music, video and other retailers
worldwide with customers ranging from independent stores to specialty chains to
retailers who sell music and video as an ancillary product line. New Media
provides product, data, and value-added services to Internet retailers.
Independent Distribution serves independent labels and studios. Independent
Distribution sells products to Full-line Distribution and New Media at market
price, and accordingly, the intersegment revenues are included in "intersegment
eliminations" in the reconciliation of operating income reported below.
Expenses of the communications and marketing, distribution, information
systems, finance and administrative groups are not allocated to the operating
segments and are included in "other" in the reconciliation of operating income
reported below. The Company does not allocate interest expense, income taxes or
extraordinary items to operating segments. The Company does not identify and
allocate assets or depreciation by operating segment.
6
<PAGE>
Information on reportable segments is as follows:
<TABLE>
<CAPTION>
---------------------------- ------------------------------
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
---------------------------- ------------------------------
JANUARY 1, DECEMBER 26, JANUARY 1, DECEMBER 26,
DOLLARS IN THOUSANDS 2000 1998 2000 1998
---- ---- ---- ----
FULL-LINE DISTRIBUTION
<S> <C> <C> <C> <C>
Net sales .................................. $ 193,121 $ 214,733 $ 441,775 $ 489,646
Operating income ........................... $ 15,871 $ 17,986 $ 36,224 $ 37,697
NEW MEDIA
Net sales .................................. $ 91,174 $ 61,881 $ 207,046 $ 113,012
Operating income ........................... $ 9,551 $ 8,417 $ 23,819 $ 16,031
INDEPENDENT DISTRIBUTION
Net sales .................................. $ 15,511 $ 15,191 $ 48,871 $ 41,026
Operating income ........................... $ 1,309 $ 1,304 $ 5,944 $ 3,991
OTHER
Unallocated expenses ....................... $ (21,247) $ (17,268) $ (54,974) $ (43,477)
INTERSEGMENT ELIMINATIONS
Net sales .................................. $ (5,292) $ (4,054) $ (12,226) $ (12,582)
TOTAL
Net sales .................................. $ 294,514 $ 287,751 $ 685,466 $ 631,102
Operating income ........................... $ 5,484 $ 10,439 $ 11,013 $ 14,242
</TABLE>
7. EARNINGS PER SHARE
Basic earnings per share has been computed by dividing net income by
the weighted average number of shares outstanding during the period. Diluted net
income per share is computed by adjusting the weighted average number of shares
outstanding during the period for all potentially dilutive shares outstanding
during the period.
8. NEW ACCOUNTING PRONOUNCEMENT
SFAS NO. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognizes all derivatives as either assets or
liabilities in the statement of financial position and measures these
instruments at fair value. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 2000. The Company is currently evaluating
what impact, if any, SFAS No. 133 may have on its financial statements.
9. SUBSEQUENT EVENTS
Subsequent to January 1, 2000, the Company's revolving line of credit
was increased from $200 million to $210 million, the expiration date for the
line was extended from May 21, 2001 to May 21, 2002 and there was a minor change
in the calculation of the unused line fee. All other terms of the revolving line
of credit remain the same.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
net sales for the thirteen and thirty-nine weeks of fiscal year 2000 and 1999.
<TABLE>
<CAPTION>
----------------------------- ---------------------------
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
----------------------------- ---------------------------
JANUARY 1, DECEMBER 26, JANUARY 1, DECEMBER 26,
2000 1998 2000 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales..................................................... 100.0% 100.0% 100.0% 100.0%
Gross profit.................................................. 10.1 11.1 11.1 11.1
Selling, general and administrative expenses.................. 8.3 7.5 9.5 8.8
Operating income.............................................. 1.8 3.6 1.6 2.3
Income before extraordinary loss.............................. 0.4 1.7 0.1 0.6
Net income.................................................... 0.4% 1.7% 0.1% 0.5%
</TABLE>
The following table sets forth certain supplemental data for the
thirteen and thirty-nine weeks of fiscal year 2000 and 1999.
<TABLE>
<CAPTION>
---------------------------- ---------------------------
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
---------------------------- ---------------------------
DOLLARS IN THOUSANDS JANUARY 1, DECEMBER 26, JANUARY 1, DECEMBER 26,
SUPPLEMENTAL DATA 2000 1998 2000 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
EBITDA..................................................... $ 7,414 $ 12,043 $ 16,177 $ 18,400
EBITDA as a percentage of net sales........................ 2.5% 4.2% 2.4% 2.9%
</TABLE>
- ---------------
EBITDA represents earnings before interest, income taxes and depreciation and
amortization. We believe that EBITDA is a useful measure of our financial
performance. However, EBITDA should not be construed as an alternative to
operating income, net income or cash flows from operations as determined in
accordance with generally accepted accounting principles.
THIRTEEN WEEKS ENDED JANUARY 1, 2000 COMPARED WITH THIRTEEN WEEKS ENDED
DECEMBER 26, 1998
Our net sales increased $6.7 million, or 2%, from $287.8 million in the
thirteen weeks ended December 26, 1998 to $294.5 million in the thirteen weeks
ended January 1, 2000.
Full-line Distribution sales decreased $21.6 million, or 10%, from
$214.7 million in the third quarter of fiscal 1999 to $193.1 million in the
third quarter of fiscal 2000. Sales to Wherehouse Entertainment declined $28.3
million versus the same period last year primarily because the transitional
support we provided to Wherehouse Entertainment in connection with its
acquisition of Blockbuster Music stores was completed near the end of the first
quarter of our current fiscal year.
8
<PAGE>
New Media sales increased $29.3 million, or 47%, from $61.9 million in
the third quarter of fiscal 1999 to $91.2 million in the third quarter of fiscal
2000 due to growth with existing accounts and the addition of new accounts.
Independent Distribution sales increased $0.3 million, or 2%, from
$15.2 million in the third quarter of fiscal 1999 to $15.5 million in the third
quarter of fiscal 2000.
Our gross profit decreased $2.2 million, or 7%, from $32.0 million in
the third quarter of fiscal 1999 to $29.8 million in the third quarter of fiscal
2000, with gross margin decreasing from 11.1% to 10.1%. Margins decreased
primarily due to the lower prices established under recent agreements with our
two largest New Media customers. We expect the New Media gross margins to remain
lower than they had been in prior quarters.
Selling, general and administrative expenses increased $2.7 million, or
13%, from $21.6 million in the third quarter of fiscal 1999 to $24.3 million in
the third quarter of fiscal 2000. Selling, general and administrative expenses
as a percentage of sales increased from 7.5% in the third quarter of fiscal 1999
to 8.3% in the third quarter of fiscal 2000. These actual and percentage
increases were primarily a result of increased volume, particularly of
direct-to-consumer shipments, and operating cost increases consisting of higher
than anticipated labor costs as a percentage of sales in our Woodland
Distribution Center (WDC). We expect selling, general and administrative
expenses to remain higher than historical levels.
Interest expense increased $0.8 million, or 29%, from $2.8 million in
the third quarter of fiscal 1999 to $3.6 million in the third quarter of fiscal
2000 primarily due to increases in inventory levels. Our inventory levels
increased as a result of lower than anticipated sales and operational
inefficiencies in processing incoming inventory receipts. Accounts receivable
also increased primarily due to one large customer electing to pay on longer
terms, thus foregoing an early payment discount. We expect interest costs to
remain higher than historical levels.
Our effective tax rate was 41.5% in the third quarter of fiscal 2000
based upon our estimated annual rate for fiscal 2000. Our effective tax rate was
38.1% in the third quarter of fiscal 1999 reflecting the effects of a true-up of
prior year tax returns.
Net income decreased $3.7 million, or 77%, from $4.8 million in the
third quarter of fiscal 1999 to $1.1 million in the third quarter of fiscal
2000.
THIRTY-NINE WEEKS ENDED JANUARY 1, 2000 COMPARED WITH THIRTY-NINE WEEKS
ENDED DECEMBER 26, 1998
Our net sales increased $54.4 million, or 9%, from $631.1 million in the
thirty-nine weeks ended December 26, 1998 to $685.5 million in the thirty-nine
weeks ended January 1, 2000.
Full-line Distribution sales decreased $47.8 million, or 10%, from
$489.6 million in the first three quarters of fiscal 1999 to $441.8 million in
the first three quarters of fiscal 2000 primarily due to a weaker video sell
through release schedule and decreased sales to Wherehouse Entertainment offset
by increases in DVD sales.
New Media sales increased $94 million, or 83%, from $113.0 million in
the first three quarters of fiscal 1999 to $207.0 million in the first three
quarters of fiscal 2000 due to sales growth with existing customers and the
addition of new customers.
9
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Independent Distribution sales increased $7.9 million, or 19%, from
$41.0 million in the first three quarters of fiscal 1999 to $48.9 million in the
first three quarters of fiscal 2000 due to the addition of new labels and growth
with existing labels.
Our gross profit increased $6.2 million, or 9%, from $70.0 million in
the first three quarters of fiscal 1999 to $76.2 million in the first three
quarters of fiscal 2000, with gross margin remaining the same at 11.1%. A higher
margin sales mix early in the fiscal year largely offset the effect of lower
prices to two large customers in the third fiscal quarter.
Selling, general and administrative expenses increased $9.5 million, or
17%, from $55.7 million in the first three quarters of fiscal 1999 to $65.2
million in the first three quarters of fiscal 2000, primarily as a result of
costs associated with the relocation of the WDC and other increases in
operations costs. Selling, general and administrative expenses as a percentage
of sales increased from 8.8% in the first thirty-nine weeks of fiscal 1999 to
9.5% in the first thirty-nine weeks of fiscal 2000. Investments in
infrastructure were not offset by corresponding increases in sales volume.
Interest expense increased $2.4 million, or 32%, from $7.5 million in
the first three quarters of fiscal 1999 to $9.9 million in the first three
quarters of fiscal 2000 primarily due to higher inventory levels and increased
capital investment.
Our effective tax rate was 41.5% in the first three quarters of fiscal
2000 based upon our estimated annual rate for fiscal 2000.
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 decreased $2.6 million, or 81%, from $3.2 million in the
first three quarters of fiscal 1999 to $636,000 in the first three quarters of
fiscal 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our capital requirements relate primarily to working capital, the
expansion of our infrastructure to accommodate sales growth, and the funding of
acquisitions. Our working capital needs are seasonal and typically peak in the
third and fourth fiscal quarters due to increases in inventories purchased for
the holiday selling season and extension of credit terms to certain customers.
We maintain significant inventory levels to fulfill our operating commitment to
carry a deep catalog of music and video stock keeping units. Inventories
generally can be returned to suppliers.
Net cash used in operating activities of $21.6 million in the first
three quarters of fiscal 2000 consisted primarily of a $117.9 million increase
in accounts payable offset by increases in accounts receivable and inventories
of $95.3 million and $46.9 million, respectively. Net cash used in operating
activities of $45.8 million in the first three quarters of fiscal 1999 was
primarily attributable to an increase in accounts payable of $185.0 million
offset by increases in inventories and accounts receivable of $123.7 million and
$121.3 million, respectively.
Net cash used in investing activities was $10.4 million and $6.2 million
for the first three quarters of fiscal 2000 and 1999, respectively. Cash used in
the first three-quarters of fiscal 2000 consisted of expenditures for property
and equipment acquisitions, primarily related to the new
10
<PAGE>
Woodland distribution facility and investments in information systems
technology. Cash used in the first three-quarters of fiscal 1999 consisted of
expenditures for property and equipment acquisitions, primarily in connection
with the opening of the Louisville Distribution Center.
Financing activities provided net cash of $34.2 million in the first
three quarters of fiscal 2000 and $52.4 million in the first three quarters of
fiscal 1999. Cash provided by financing activities in the first three quarters
of fiscal 2000 and fiscal 1999 consisted primarily of additional borrowings
under our credit facility to fund increased working capital requirements. Cash
provided by financing activities in the first three quarters of fiscal 2000 also
included $8.3 million related to the issuance of notes payable for the purchase
of certain equipment.
Effective February 2000, our credit facility provides for borrowings up
to the lesser of $210 million or the amount of collateral availability.
Collateral availability is limited to certain percentages of eligible inventory,
accounts receivable and equipment, subject to certain limitations as to video
and DNA inventories and equipment. The credit facility bears interest, at our
election, at either the prime rate plus a margin of (0.25)% to 0.5% or the
Eurodollar Rate plus a margin of 2.0% to 2.75%, subject to monthly adjustments
and certain terms and conditions as stated in the credit facility.
Borrowings under the credit facility are secured by all accounts
receivable, inventory, certain equipment and other intangible property. The
credit facility expires on May 21, 2002 and renews annually thereafter unless
notice of termination is given by either party. The credit facility contains
various financial covenants, including limitations on payment of cash dividends
and redemptions.
We believe that our borrowing availability under the credit facility
will be sufficient to meet our operating and capital requirements through the
next year. Our future operating and capital requirements, however, will depend
on numerous factors, including growth of the business, additional infrastructure
needs, potential acquisitions and/or joint ventures and future results of
operations.
SEASONALITY IN OPERATING RESULTS
Our quarterly net sales and operating results have varied significantly
in the past and will likely continue to do so in the future as a result of
seasonal variations in the demand for music and video. Historically, our sales
are highest during the third fiscal quarter (the holiday season) and returns are
highest during the fourth fiscal quarter. Due to this seasonality, we typically
experience significant changes in cash flows and capacity needs during the year,
with the heaviest credit needs and highest capacity requirements typically
occurring during the third and fourth fiscal quarters.
YEAR 2000 MATTERS
The year 2000 issue arose as a result of computer programs being written
using two digits rather than four to define the applicable year. Certain
information technology systems and their associated software, and certain types
of equipment that use programmable logic chips to control aspects of their
operation, commonly referred to as embedded chip equipment, may recognize "00"
as a year other than the year 2000. We experienced no significant operational
problems to date as a result of year 2000 issues, and do not expect significant
operational problems in the future. We expect remaining costs related to year
2000 issues to be insignificant.
11
<PAGE>
FACTORS AFFECTING OPERATING RESULTS
This report contains forward-looking statements made pursuant to the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. These statements are identified by words such as "will", "expects",
"anticipates", "plans", or "intends" and by other descriptions of future
circumstances or conditions. Actual results may differ materially from those
projected in these forward-looking statements. Factors that could cause these
differences include, but are not limited to, those discussed below.
WE MAY BE UNABLE TO COMPETE WITH OTHER BUSINESSES THAT OFFER SIMILAR
PRODUCTS AND SERVICES
The full-line distribution of music and video is an intensely
competitive business. We compete with national, regional and local full-line
distributors, including Alliance Entertainment Corp. and Ingram Entertainment.
As a result of such competition, we could experience pricing pressures or lose
customers altogether. Either event would adversely affect our financial results.
In addition, the major labels, major studios and independent
distribution companies sell substantial amounts of their products directly to
retailers. However, to date they have not focused, to the same extent we have,
on fulfilling the needs of smaller independent stores or providing value-added
services. If the major labels, major studios or independent distribution
companies start providing more responsive service to underserved retail segments
or value-added services at competitive costs, our financial results could be
adversely affected. We also compete with several vendor managed inventory firms,
including two national vendor managed inventory firms that we believe have
revenues greater than ours.
From time to time, several of our retail chain customers have chosen to
buy a substantial volume of their inventory directly from the major labels and
studios that they had previously been purchasing from us. To the extent that our
customers increase their direct purchasing from the major labels and studios or
the independent distribution companies, our financial results could be adversely
affected.
In addition to competition from existing competitors, in the future we
could face competition from new competitors that may enter the business. If new
competitors enter the music and video distribution business, our financial
results could be adversely affected.
Our existing New Media competitors include Alliance Entertainment Corp.,
Baker & Taylor and Ingram Entertainment. Other distributors have announced an
interest in starting to service the on-line market. If one or more of the
leading on-line retailers that we service buys more of its inventory directly
from a label or studio or through an alternative distributor, our financial
results could be adversely affected. Amazon.com, one of our largest New Media
customers, has increased, and may continue 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.
Distribution North America competes with several other independent
distribution companies. Some of these competitors conduct distribution
operations equal to or larger than
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Distribution North America and others operate in niche markets. We also compete
with several of the major labels' own independent distribution groups. In
addition, as a label or artist gains in popularity, Distribution North America
faces new competition from the major labels to retain distribution rights for
that label or artist.
WE EXPECT THE GROWTH RATE OF OUR NEW MEDIA SALES TO CONTINUE TO DECLINE
Our New Media sales continue to grow at a substantial rate as compared
to prior periods. During our most recent fiscal quarter, however, the rate of
such growth declined as compared to those prior periods, primarily because our
growth rates for prior periods were based on comparisons against the relatively
small sales volumes we experienced before the Internet gained significant
acceptance as a medium for commerce. We expect the decline in the growth rate of
our New Media sales to continue.
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
three quarters of fiscal 2000, our top three customers accounted for
approximately 34% of our net sales and our top two New Media customers accounted
for approximately 83% of our New Media net sales.
WE HAVE SIGNIFICANTLY INCREASED OUR INFRASTRUCTURE
During the current fiscal year, we have significantly increased our
investment in infrastructure, primarily due to the relocation of the WDC. During
our most recent fiscal quarter, because our sales did not meet expected levels,
we were unable to gain the incremental efficiencies we anticipated would result
from this increased investment. Thus, because of the increase in fixed costs
that resulted from the expansion of our infrastructure, any continuing erosion
in sales versus current or expected levels could result in a further increase of
our selling, general and administrative expenses as a percentage of net sales.
TIGHT LABOR MARKETS REDUCE OUR ABILITY TO ATTRACT AN ADEQUATE NUMBER OF
EMPLOYEES OR FORCE US TO INCREASE OUR COMPENSATION LEVELS
Low unemployment levels in the markets in which we operate impede our
ability to attract adequate labor thus impeding operations. The tight labor
markets also lead to increased expenses for wages, benefits and employee
amenities with no offsetting gain in productivity.
WE MAY BE DELAYED IN FILLING CERTAIN KEY MANAGEMENT POSITIONS
During our most recent fiscal quarter, we announced our intention to
hire a new Chief Financial Officer and a new Senior Vice President, Sales and
Marketing. We have not yet filled these positions. Pending the completion of
these new hires, J. Randolph Cerf continues to serve as our Chief Financial
Officer and the responsibilities of the Senior Vice President, Sales and
Marketing are being shared among our senior sales executives. Although we intend
to fill these positions as soon as we are able to identify and hire the
appropriate persons, we may be unable to complete this process as quickly as we
would like. Delays in filling these positions could adversely affect our
financial condition and results of operations.
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WE MAY BE UNABLE TO OBTAIN PRODUCT FROM LABELS OR STUDIOS
The major labels and studios produce most of the music and video
product. Our success depends upon our ability to obtain products in sufficient
quantities on competitive terms and conditions from each of the major labels and
studios as well as from thousands of smaller suppliers. We are also dependent
upon the quality of new releases from our suppliers. We do not have long term
contracts with any supplier for our Full-line Distribution or New Media business
groups. If we cannot obtain sufficient quantities of product or quality new
releases from the major labels or studios or a significant number of other
suppliers for our Full-line Distribution and New Media operations, our financial
results could be adversely affected.
Distribution North America maintains contracts with most of the
suppliers it represents. These contracts typically range in length from one to
three years. If Distribution North America were unable to maintain its
distribution relationship with any of its large suppliers, our financial results
would be adversely affected.
TRENDS IN THE VIDEO RENTAL MARKET COULD HURT OUR SALES
Studios and full-line distributors 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 DELIVERY TECHNOLOGIES COULD DIMINISH OUR ROLE IN THE DISTRIBUTION
PROCESS
Music and video are currently marketed and distributed primarily on a
physical delivery basis through wholesale and retail distribution. In the
future, if products are marketed, sold and delivered by labels or studios
directly to stores or homes through electronic downloading or live streaming,
current methods of wholesale and retail distribution could decrease or be
eliminated. Microsoft, RealNetworks and others offer streaming technology, which
allows users to listen to, but not record, audio and video. In addition, digital
distribution has begun on the Internet utilizing various coding compression
technologies that allow downloading and replication of any digital audio
product.
The major labels and others have announced plans to develop a universal
standard for the electronic delivery of music with copyright protection. If
electronic distribution of music or video becomes widespread and displaces
significant demand for the formats we sell and we fail to play a significant
role in the electronic distribution market, our financial results would be
adversely affected.
In addition, cable and satellite television companies and others are
beginning to offer movies on a "near-video-on-demand" or other basis that allows
subscribers to order selected videos for in-home viewing. To the extent that
these programs achieve a broad level of acceptance, the market for physical
video product sold or rented by retailers could decline. This would reduce our
sales of video product.
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WE MIGHT HAVE INVENTORY RISK DUE TO AN INABILITY TO RETURN PRODUCTS
We bear inventory risk associated with the financial viability of the
independent labels and studios from which we purchase product. If a label or
studio cannot provide refunds in cash for the inventory we desire to return, we
may be forced to expense such inventory costs. Further, we often experience
higher return rates for products of financially troubled labels and studios. If
we fail to manage our inventory to avoid accumulating substantial product that
cannot be returned, our financial results could be adversely affected.
OUR ABILITY TO OBTAIN SUFFICIENT FINANCING MAY BE LIMITED
We have a revolving credit agreement and several equipment credit
agreements that are secured by substantially all of our assets. As of January 1,
2000, borrowings of approximately $176.6 million and $12.0 million were
outstanding under the revolving credit agreement and the equipment credit
agreements, respectively. The revolving credit agreement is used for general
working capital purposes while the equipment credit agreements provide financing
for specific fixed assets.
As a result of our substantial leverage we will incur significant
interest expense and principal repayment obligations, our ability to obtain
additional financing in the future may be limited, and our ability to compete
through expansion, capital improvements and flexibility in response to changing
industry conditions may be limited. The credit agreements contain numerous
restrictive covenants, including limitations on our ability to acquire or invest
in other businesses and requirements that we comply with certain financial
covenants.
If we fail to comply with the terms of the credit agreements or obtain
waivers from such obligations, we could trigger an event of default under the
credit agreements. An event of default could permit acceleration of indebtedness
under the credit 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.
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. Any sales of product in violation of such laws and
licenses by us could 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 that such titles
comply with the copyright laws, some of which may be conflicting or not clearly
developed. Although we have not experienced a material loss due to copyright
violations, we could be damaged in the future by copyright violations.
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WE MAY BE PREVENTED FROM DISTRIBUTING MUSIC INTERNATIONALLY
Most of the major labels have adopted policies restricting the export of
their merchandise by domestic distributors. However, consistent with industry
practice, we distribute music of the major labels internationally. Our
international net sales of music for the first three quarters of fiscal 2000
were approximately $29.6 million. We would be adversely affected if a major
label enforced any restriction on our ability to sell music outside the United
States. In addition, although our international sales are denominated in
dollars, our international sales volume can be adversely affected by
appreciation of the dollar relative to foreign currencies.
THE MARKET PRICE OF OUR COMMON STOCK COULD FLUCTUATE
Many factors could cause the market price of our common stock to
fluctuate substantially, including (i) future announcements concerning us or our
competitors, (ii) variations in operating results, (iii) loss of a key supplier
or customer, (iv) technological innovations such as changes in physical product
formats or delivery technologies, (v) changes in product pricing policies by us,
our suppliers or our competitors and (vi) changes in earnings estimates by
securities analysts. These fluctuations, as well as general economic, political
and market conditions, may have a material adverse effect on the market price of
our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks primarily from changes in U.S.
interest rates. The Company does not engage in financial transactions for
trading or speculative purposes.
The interest payable on the Company's revolving line of credit is based
on variable interest rates and is therefore affected by changes in market
interest rates. If interest rates on variable rate debt rose 0.79 percentage
points (a 10% change from the average interest rate as of January 1, 2000),
assuming no change in the Company's outstanding balance under the line of credit
(approximately $176.6 million as of January 1, 2000), the Company's annualized
income before taxes and cash flows from operating activities would decline by
approximately $1.4 million.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various legal proceedings that arise in the ordinary
course of business. While the outcome of our pending legal proceedings cannot be
predicted with certainty, we believe that none of such proceedings, individually
or in the aggregate, will have a material adverse effect on our business or
financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
<TABLE>
<CAPTION>
- -------------------------- -----------------------------------------------------
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
(b) REPORTS ON FORM 8
The following report on Form 8-K was filed during the thirteen weeks
ended January 1, 2000.
(1) Report on Form 8-K dated December 3, 1999, filed December 17, 1999,
announcing a senior management restructuring.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALLEY MEDIA, INC.
By: /s/ Robert R. Cain
--------------------------------------
Robert R. Cain
President and Chief Executive Officer
Date: February 11, 2000
By: /s/ J. Randolf Cerf
--------------------------------------
J. Randolph Cerf
Chief Financial Officer and
Accounting Officer
Date: February 11, 2000
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> APR-01-2000
<PERIOD-START> OCT-03-1999
<PERIOD-END> JAN-01-2000
<CASH> 3,620
<SECURITIES> 0
<RECEIVABLES> 271,173
<ALLOWANCES> (9,736)
<INVENTORY> 264,905
<CURRENT-ASSETS> 537,754
<PP&E> 42,260
<DEPRECIATION> (14,759)
<TOTAL-ASSETS> 580,296
<CURRENT-LIABILITIES> 502,669
<BONDS> 8,083
0
0
<COMMON> 8
<OTHER-SE> 66,681
<TOTAL-LIABILITY-AND-EQUITY> 580,296
<SALES> 294,514
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