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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
(MARK ONE)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 1998
OR
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE TRANSITION PERIOD FROM
TO
COMMISSION FILE NUMBER
333-54035
MTS, INCORPORATED
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-1500342
(State or other jurisdiction of incorporation (I.R.S. Employer Identification
or organization) No.)
2500 DEL MONTE, WEST SACRAMENTO, CA 95691
(Address of principal executive office)
916-373-2500
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes /x/ No / /
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MTS, INCORPORATED
TABLE OF CONTENTS
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PAGE
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Part I. Financial Information............................................. 1
Item 1. Consolidated Financial Statements................................ 1
Consolidated Balance Sheets as of October 31, 1998 and 1997
and July 31, 1998.................................................... 1
Consolidated Statements of Income for the three months ended
October 31, 1998 and 1997 ........................................... 2
Consolidated Statements of Cash Flows for the three months ended
October 31, 1998 and 1997............................................ 3
Notes to Consolidated Financial Statements................................. 4-5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................... 5-7
Part II. Other Information ............................................... N/A
Signature................................................................. 8
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MTS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 1998, 1997 AND JULY 31, 1998
(DOLLARS IN THOUSANDS)
UNAUDITED
---------
OCTOBER 31, JULY 31,
------------------------------------- ----------------
1998 1997 1998
---------------- ----------------- ----------------
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ASSETS
Current Assets:
Cash and cash equivalents $31,002 $2,480 $14,609
Receivables, net 28,685 26,280 23,095
Merchandise inventories 291,486 304,268 261,003
Prepaid expenses 6,755 9,563 6,619
Deferred tax assets 8,221 1,319 4,184
---------------- ----------------- ----------------
Total current assets 366,149 343,910 309,510
Fixed assets, net 200,977 185,197 187,586
Deferred tax assets 15,950 7,821 15,076
Other assets 36,041 32,343 33,219
---------------- ----------------- ----------------
Total assets $619,117 $569,271 $545,391
---------------- ----------------- ----------------
---------------- ----------------- ----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $2,654 $8,354 $2,540
Accounts payable 159,783 159,466 157,443
Accrued liabilities 36,625 27,975 30,422
Income taxes payable 3,208 504 1,422
Deferred revenue, current portion 3,037 2,915 3,251
---------------- ----------------- ----------------
Total current liabilities 205,307 199,214 195,078
Long-term Liabilities:
Long-term debt, less current maturities 288,784 229,390 229,345
Deferred revenue, less current portion 167 180 170
---------------- ----------------- ----------------
Total liabilities 494,258 428,784 424,593
---------------- ----------------- ----------------
Minority equity in subsidiaries - 3,232 -
---------------- ----------------- ----------------
Commitments and contingencies
Shareholders' Equity:
Common stock:
Class A, no par value; 5,000,000 shares authorized;
500 shares issued and outstanding at October 31, 1997:
none at October 31, 1998 and July 31, 1998 - 3 -
Class B, no par value; 10,000,000 shares authorized;
500 shares issued and outstanding at October 31, 1997:
1,000 issued and outstanding at October 31,1998
and July 31, 1998 6 3 6
Additional paid-in capital - 780 -
Retained earnings 124,853 136,469 120,792
---------------- ----------------- ----------------
Total shareholders' equity 124,859 137,255 120,798
---------------- ----------------- ----------------
Total liabilities and shareholders' equity $619,117 $569,271 $545,391
---------------- ----------------- ----------------
---------------- ----------------- ----------------
</TABLE>
The accompanying notes are an integral part of these statements.
1
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MTS, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED OCTOBER 31, 1998 AND 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
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<CAPTION>
UNAUDITED
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1998 1997
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<S> <C> <C>
Net revenue $233,598 $239,329
Cost of sales 154,487 158,763
---------------------------- ---------------------------
Gross profit 79,111 80,566
Selling, general and administrative expenses 61,640 62,908
Depreciation and amortization 5,690 5,645
---------------------------- ---------------------------
Income from operations 11,781 12,013
Other income and (expenses):
Interest expense (4,587) (3,439)
Foreign currency translation loss (11,895) (93)
Other income and (expenses) 325 (543)
---------------------------- ---------------------------
(Loss) income before taxes and minority interest (4,376) 7,938
(Benefit) provision for income taxes (1,960) 3,337
---------------------------- ---------------------------
(Loss) income before minority interest (2,416) 4,601
Minority interest in net income of subsidiaries - 38
---------------------------- ---------------------------
Net (loss) income ($2,416) $4,563
---------------------------- ---------------------------
---------------------------- ---------------------------
Basic and diluted earnings per share:
On net (loss) income $2,415.80 $4,563.45
---------------------------- ---------------------------
---------------------------- ---------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
2
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MTS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED OCTOBER 31, 1998 AND 1997
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
UNAUDITED
---------------------------------------------------------
1998 1997
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income ($2,416) $4,563
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization 6,947 7,034
Provision (recovery) for losses on accounts receivable 146 (2)
Loss on disposal of depreciable assets 617 553
Exchange loss 10,973 115
Other non-cash expense 50 264
Provision for deferred taxes (5,067) 641
Minority interests in net income of subsidiaries - 37
(Decrease) increase in cash resulting from changes in:
Accounts receivable (5,590) (5,582)
Inventories (30,483) (22,253)
Prepaid expenses (136) (1,459)
Accounts payable 2,340 (4,490)
Accrued liabilities 7,989 (589)
Deferred revenue (217) 37
-------------------------- ---------------------------
Net cash used in operating activities (14,847) (21,131)
-------------------------- ---------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets (16,994) (5,806)
Acquisition of investments (844) (1,793)
Increase in deposits (57) (742)
Refunds of deposits 10 87
Increase in intangibles (747) (58)
-------------------------- ---------------------------
Net cash used in investing activities (18,632) (8,312)
-------------------------- ---------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loans to shareholders, officer and employees - (48)
Proceeds from employee loan repayments 78 69
Principal payments under long-term financing agreements (613) (5,523)
Proceeds from issuance of long-term financing agreements 40,413 32,000
-------------------------- ---------------------------
Net cash provided by financing activities 39,878 26,498
-------------------------- ---------------------------
Effect of exchange rate changes on cash 9,994 (1,182)
-------------------------- ---------------------------
Net increase (decrease) in cash and cash equivalents 16,393 (4,127)
Cash and cash equivalents, beginning of period 14,609 6,607
-------------------------- ---------------------------
Cash and cash equivalents, end of period $31,002 $2,480
-------------------------- ---------------------------
-------------------------- ---------------------------
Cash paid for interest expense $1,597 $4,333
-------------------------- ---------------------------
-------------------------- ---------------------------
Cash paid for income taxes $1,319 $1,490
-------------------------- ---------------------------
-------------------------- ---------------------------
</TABLE>
The accompanying notes are an integral part of these statements.
3
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MTS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1- BASIS OF PRESENTATION
The unaudited consolidated financial statements include the accounts of MTS,
Incorporated and its majority and wholly owned subsidiaries (Company).
In the opinion of the Company's management, the accompanying unaudited
consolidated financial statements contain all adjustments (consisting of only
normal recurring adjustments) necessary to present fairly its consolidated
financial position as of October 31, 1998 and the results of its operations
and cash flows for the three months then ended. The significant accounting
policies and certain financial information which are normally included in
financial statements prepared in accordance with generally accepted
accounting principles but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying consolidated
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the fiscal year ended July 31, 1998.
NOTE 2- TRANSLATION OF FOREIGN CURRENCY
The value of the U.S. dollar rises and falls day-to-day on foreign currency
exchanges. Since the Company does business in several foreign countries,
these fluctuations affect the Company's financial position and results of
operations. In accordance with SFAS No. 52, Foreign Currency Translation, all
foreign assets and liabilities have been translated at the exchange rates
prevailing at the respective balance sheets dates, and all income statement
items have been translated using the weighted average exchange rated during
the respective years. The net gain or loss resulting from translation upon
consolidation into the financial statements is reported as a separate
component of retained earnings. Some transactions of the Company and its
foreign subsidiaries are made in currencies different from their functional
currency. Translation gains and losses from these transactions are included
in income as they occur. The Company recorded net transaction losses of $11.9
million and $.1 million as of October 31, 1998 and 1997 respectively. These
amounts primarily represent unrealized losses on the Company's
yen-denominated debt and the strengthening of the yen versus the U.S. dollar.
NOTE 3- INCOME TAXES
The effective income tax rates for the three months ended October 31, 1998
and 1997 are based on the federal statutory income tax rate, increased for
the effect of state income taxes, net of federal benefit and foreign taxes.
NOTE 4- NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards (SFAS) No. 130, REPORTING
COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION, were issued in June 1997. The Company
will adopt both of the statements on their effective date, which will be in
the Company's fiscal year ending July 31, 1999.
On August 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). This
establishes standards for the reporting and display of comprehensive income
and its components in the financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. For
the Company, comprehensive income includes net income reported on the income
statement and changes in the cumulative transaction adjustment reported as a
separate component of shareholder's equity. The Company's total comprehensive
income for the period was $4.0 million and $3.3 million as of October 31,
1998 and 1997, respectively.
SFAS No. 131 requires that the Company report financial and descriptive
information about its reportable operating segments using the "management
approach" model. Under the management approach model, segments are defined
based on the way the Company's management internally evaluates segment
performance and decides how to allocate resources to segments.
4
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The Company is in the process of evaluating the impact of this pronouncement
on its segment disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.133, Accounting for Derivative Instruments
and Hedging Activities. The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
Statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Special accounting for qualifying hedges allows a derivative's gains and
losses to offset related results on the hedged item in the income statement,
and requires that a company must formally document, designate, and assess the
effectiveness of transactions that receive hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement the Statement as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). Statement 133 cannot be applied retroactively. Statement 133
must be applied to (a) derivative instruments and (b) certain derivative
instruments embedded in hybrid contracts that were issued, acquired, or
substantively modified after December 31, 1997 (and at the company's
election, before January 1, 1998).
The Company has not yet quantified the impacts of adopting Statement 133 on
its financial statements nor determined the timing of or method of our
adoption of Statement 133. However, the Statement could increase volatility
in earnings and other comprehensive income.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the unaudited
interim consolidated financial statements and the notes thereto included in
Item 1 of this Quarterly Report on Form 10-Q.
Forward-Looking Statements
This report contains forward-looking statements (as such term is defined in
the Private Securities Litigation Reform Act of 1995) that involve known and
unknown risks and uncertainties. The statements contained in this report that
are not purely historical are forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. Use of the words "anticipates," "believes,"
"estimates," "expects," "intends," "plans" and similar expressions, as they
relate to the Company or the management of the Company, identify
forward-looking statements. Such statements reflect the current views of the
Company with respect to future events, the outcome of which is subject to
certain risks, including among others general economic and market conditions,
significant leverage and debt service obligations, restrictive debt
covenants, changing economic conditions including decreased consumer
spending, risks relating to international operations, increased or
unanticipated costs or effects associated with year 2000 compliance by the
Company or its service or supply providers, effects of competition, higher
interest rates, and other factors which may be outside of the Company's
control. Actual results or outcomes may differ materially from those
expressed or implied by such forward-looking statements as a result of
certain factors described herein and in other documents. Readers are
cautioned that all forward-looking statements involve risks and uncertainty.
Readers should also carefully review the risk factors described in the other
documents the Company files from time to time with the Securities and
Exchange Commission and the Company assumes no obligation to update any such
forward-looking statements.
NET REVENUE
Net revenues were $233.6 million for the three months ended October 31, 1998,
a decrease of $5.7 million (or an increase of $7.0 million excluding the
unfavorable effects of the U.S. dollar-Japanese yen exchange rate movements),
from $239.3 million for the three months ended October 31, 1997. Management
attributed the flat sales growth to, among other things, a 1.2% decline in
same store sales growth and a decrease in the number of popular new releases.
GROSS PROFIT
Gross profit was $79.1 million for the three months ended October 31, 1998, a
decrease of $1.5 million or 1.2%, from $80.6 million for the three months
ended October 31, 1997. Gross profit as a percentage of net revenues
increased to 33.9% for the three months ended October 31, 1998 as compared to
33.7% for the three months ended October 31, 1997. The Company believes that
the primary factor contributing to the slight increase was the weakening
dollar relative to the yen and pricing in Japan keeping pace with the
decreased cost of dollar-sensitive product.
5
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SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses were $61.6 million for the three
months ended October 31, 1998, a decrease of $1.3 million or 2.1% from $62.9
million for the three months ended October 31, 1997. Selling, general and
administrative expense as a percentage of net revenues increased to 26.4% for
the three months ended October 31, 1998, as compared to 26.3% for the three
months ended October 31, 1997. Management believes the decrease in selling
and administrative costs was primarily attributed to the Company's continued
cost containment efforts.
INCOME FROM OPERATIONS
Income from operations was $11.8 million for the three months ended October
31, 1998, a decrease of $.2 million from $12.0 million for the three months
ended October 31, 1997. As a percentage of net revenues, income from
operations remained constant at 5.0 % for the three months ended October 31,
1998 as compared to October 31, 1997.
INTEREST EXPENSE
Interest expense was $4.6 million for the three months ended October 31,
1998, an increase of $1.2 million from $3.4 million for the three months
ended October 31, 1997. As a percentage of net revenues, interest expense
increased to 2.0% for the three months ended October 31, 1998 from 1.4% for
the three months ended October 31, 1997. Management attributes the increase
in interest expense to the higher borrowing costs associated with the Senior
Subordinated Debt Issuance on April 23, 1998.
FOREIGN CURRENCY TRANSLATION LOSS
Foreign currency translation loss totaled $11.9 million for the three months
ended October 31, 1998 versus $.1 million for the three months ended October
31, 1997. The increase in the account primarily represents an unrealized loss
due to yen denominated debt and the strengthening of the yen versus the U.S.
dollar.
BENEFIT PROVISION FOR INCOME TAXES
The benefit for income taxes for the three months ended October 31, 1998 was
$2.0 million compared with a provision for income taxes of $3.3 million for
the three months ended October 31, 1997. The tax benefit for the three months
ended October 31, 1998 was based upon management's estimate of the Company's
annualized effective tax rate.
NET LOSS
As a result of the factors discussed above, the Company reported a
consolidated net loss of $2.4 million for the three months ended October 31,
1998, a decrease of $7 million from $4.6 million for the three months ended
October 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of working capital are borrowings under its
senior credit facility, net cash flows from operating activities and
short-term vendor financing.
The Company's cash and cash equivalents were $31.0 million as of October 31,
1998 compared with $2.5 million as of October 31, 1997. Net cash used by
operating activities was $14.8 million and $21.1 million for the three months
ended October 31, 1998 and 1997, respectively with cash provided from
operations of $33.5 million in fiscal 1998 and $52.2 million in fiscal 1997.
For the three months ended October 31, 1998 inventory merchandise increased
$30.5 million as the Company positions itself for the holiday season compared
to a $22.3 million increase for the three months ended October 31, 1997. The
decrease in cash from operations for the three month period ended October 31,
1998 compared to the three month period ended October 31, 1997 was primarily
due to an increase in net operating liabilities.
6
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The Company's investing activities consist principally of capital
expenditures for new store construction, system enhancements and store
relocations/remodels. Capital expenditures totaled $17.0 million and $5.8
million during the three months ended October 31, 1998 and October 31, 1997,
respectively.
Total debt increased to $279.5 million as of October 31, 1998, from $237.8
million as of October 31, 1997. Borrowings under the Company's senior
revolving credit facility were $169.5 million for October 31, 1998. The
increased borrowings were largely due to translation of yen denominated debt
to U.S. dollars and financing operating activities. Unused availability under
the $275.0 million revolving senior credit facility as of October 31, 1998
was $58.2 million.
Based upon the Company's current operating levels and expansion plans,
management believes net cash flows from operating activities and the capacity
under its $275 million senior credit facility will be sufficient to meet the
Company's working capital and debt service requirements and support the
development of its short- and long-term strategies for at least the next
twelve months.
OTHER MATTERS
SEASONALITY
Retail music sales in the United States are typically higher during the
calendar fourth quarter as a result of consumer purchasing patterns due to
increased store traffic and impulse buying by holiday shoppers. As a result,
the majority of U.S. music retailers and, more specifically, the mall-based
retailers rely heavily on the calendar fourth quarter to achieve annual sales
and profitability results. The Company has had reduced seasonal reliance due
to its deep catalog merchandising approach. In addition, international
markets exhibit less fourth quarter seasonality than U.S. markets and the
Company's international presence has historically reduced this reliance on
the U.S. holiday shopping season.
FOREIGN EXCHANGE MANAGEMENT
The Company has substantial operations and assets located outside the United
States, primarily in the United Kingdom and Japan. With respect to
international operations, principally all of Tower's revenues and costs
(including borrowing costs) are incurred in the local currency, except that
certain inventory purchases are tied to U.S. dollars. The Company's financial
performance on a U.S. dollar-denominated basis has historically been affected
by changes in currency exchange rates. Changes in certain exchange rates
could adversely affect the Company's business, financial condition and
results of operations.
YEAR 2000 COMPLIANCE
Many currently installed information technology and non-information
technology systems and products are coded to accept only two digit entries in
the date code field. Beginning in the year 2000, these date code fields will
need to accept and recognize four digit entries to distinguish 21st century
dates from 20th century dates. As a result, within the next two years
computer systems and/or software used by many companies may need to be
upgraded to comply with such "Year 2000" requirements. The Company has
developed an overall plan to assist with the Year 2000 problem resolution
process. This plan is being used for both information technology (mainly
financial programs) and non-information technology programs (stereos, tv's,
vcr's, escalators, elevators, etc.). The main components of the plan are as
follows: awareness of the problem, preparation of an inventory check list,
assessment of complexity, remediation, validation testing and implementation.
With respect to information technology systems the Company has already
finished all phases through implementation for the majority of its financial
systems and expects to have 100% compliance by mid 1999. The non-information
technology systems and products have been completed through the assessment of
complexity phase and the Company expects to have 100% compliance by the
middle of 1999. The Company is still in the process of obtaining year 2000
compliance certificates from its third parties but due to the fact the
Company does not have a material relationship with any one vendor it does not
anticipate any possible business interruption due to non-compliance with
third parties. As of October 31, 1998, the Company has incurred $.2 million in
remediation cost and estimates it will require an additional $1.0 million to
complete all year 2000 compliance work. These costs include but are not
limited to costs directly related to fixing year 2000 issues, such as
modifying software and hiring year 2000 solution providers. Although it is
not certain what the worst case Year 2000 scenario would be, management
believes that any computer generated work, i.e. inventory tracking, point of
sale at cash register, could be done manually as had been the case before the
in-store processing programs were implemented in 1994. In the unlikely event
that a contingency plan is needed due to a year 2000 system failure, the
Company would revert back to manual "offline" processing of its sales and
inventory systems until the problem is resolved.
7
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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.
MTS, INCORPORATED
By: /s/ DeVaughn D. Searson
------------------------------------------------
DeVaughn D. Searson
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)
Dated: December 15, 1998
EXHIBIT INDEX
EXHIBIT NO. EXHIBIT
27. Financial Data Schedule.
8
<TABLE> <S> <C>
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<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-START> AUG-01-1998
<PERIOD-END> OCT-31-1998
<CASH> 31,002
<SECURITIES> 0
<RECEIVABLES> 28,685
<ALLOWANCES> 0
<INVENTORY> 291,486
<CURRENT-ASSETS> 366,149
<PP&E> 200,977
<DEPRECIATION> 0
<TOTAL-ASSETS> 619,117
<CURRENT-LIABILITIES> 205,307
<BONDS> 288,784
0
0
<COMMON> 6
<OTHER-SE> 124,853
<TOTAL-LIABILITY-AND-EQUITY> 619,117
<SALES> 233,598
<TOTAL-REVENUES> 233,598
<CGS> 154,487
<TOTAL-COSTS> 67,330
<OTHER-EXPENSES> 11,570
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<INCOME-PRETAX> (4,376)
<INCOME-TAX> (1,960)
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<NET-INCOME> (2,416)
<EPS-PRIMARY> (2,415.80)
<EPS-DILUTED> (2,415.80)
</TABLE>
