Valley Amplifies Web Ventures

NEW YORK-The merger of Valley Media's Internet fulfillment business with Amplified.com (BillboardBulletin, Feb. 16) allows the giant wholesaler to more fully realize Internet opportunities without incurring any of the costly start-up expenditures associated with such Web-based ventures on its income statement.
Valley's costs in preparing for the digital world had been a drag on earnings in the financial results just announced Feb. 15. In those results, the company posted a net income of $1.1 million, or 12 cents per share on a diluted basis, on revenue of $294.5 million for the quarter that ended Jan. 1. This was down considerably from the $4.8 million, or 85 cents per share, that Valley posted last year, when sales were $287.8 million.
Investors reacted to the company's financial performance rather than to the Amplified deal, and consequently Valley stock was driven down to $7.50 from the previous day's closing of $9, and on Feb. 16 it fell further, closing at $6.875.
By combining the assets of Valley and Amplified, "we are creating the dominant Internet business-to-business entertainment distribution company," Valley CEO Rob Cain said Feb. 15 in a conference call with analysts. "[The merger] is consistent with the strategy for unlocking shareholder value."
The two partners have agreed in principle on the new company, and the deal is expected to close in March. The new company will retain Amplified's name and privately held status and will be half-owned by Valley shareholders and half-owned by Amplified shareholders.
It will combine Valley's i.FILL division, which includes the Internet-fulfillment business, with Amplified's digital-rights-management systems, which allow for digital downloading, hold digital rights to more than 200,000 songs, and enable the creation of custom CDs.
In 1999 the proposed company had revenue of about $275 million, of which Valley's Internet-fulfillment business did $266.5 million and Amplified did $8.5 million, according to an estimate provided in the announcement.
If Amplified decides to go public, the deal allows Valley shareholders a free ride, says one Wall Street analyst, who predicts that in an initial public offering, the Internet company shares will command a price higher than the value that the Valley shares currently carry.
The deal allows Amplified to offer a full array of distribution services, for product both physically and digitally delivered, to labels and retailers. Amplified's digital-download capabilities move about 120,000 units per week, according to Cain. Most of those downloads are promotional in nature.
The deal also allows Amplified to sell additional services to Valley's Internet accounts. "Amplified will be able to offer more integrated services to retailers and will be able to grow the physical-fulfillment business faster," says Cain.
Amplified retail customers include Wherehouse Entertainment, Tower Records/Video/Books, the Musicland Group, Trans World Entertainment Corp., National Record Mart, Hastings Entertainment, Best Buy, Borders Books & Music, and Barnes & Noble (Billboard, Jan. 8).
In addition to the Internet-fulfillment division, Amplified will assume responsibility for audiofile, Valley's catalog product database of audio, video, and accessories, and for the company's new DVD content and artwork database, as well as others still in development. Amplified will co-manage those databases with Valley's information-systems personnel.
Valley is not alone in positioning itself as a turnkey solution to retailers and labels for physical product and digital downloads over the Internet. Recently Alliance Entertainment Corp., based in Coral Springs, Fla., announced that it was creating separate divisions, one for physical product and one for digital product, in an attempt to maximize Internet opportunities (Billboard, Feb. 19).
Amplified executives did not return calls seeking comment on the deal. But in announcing the deal, Amplified reported that Christopher Melton, previously in senior management for IBM Global Services, had joined the company as CEO. Also, Nora Moore Jimenez, who headed Valley's i.FILL division, will move over to Amplified with her team, holding the position of director of new media.
In addition to retail and independent labels, Cain says he foresees a role for Amplified with the major labels on the digital-rights-management and digital-fulfillment side of the business.
In the meantime, Valley management conceded that it expects to post a loss in its fiscal fourth quarter and for the year and will take a number of steps to reduce costs during that time period, by scaling back its Boston video warehouse from a full-service facility to carrying only hits and by reducing inventory by $40 million, which it will partially accomplish through product returns to vendors.
In fact, Valley has so far made partial payments to vendors for Christmas product and has claimed deductions for anticipated product returns, label and distribution sources say.
At the end of the Christmas selling season, Valley apparently was stuck with hit product when retailers, whether through better buying or due to a poorer selling season, didn't rely on the Woodland, Calif., wholesaler as much as they had in previous holiday selling seasons. Moreover, Valley executives acknowledged that it overbought DVD, which enjoyed tremendous growth but not as much as anticipated.
Nonetheless, DVD sales are about 45% ahead of last year and 61% ahead of last quarter, reported Randy Cerf, senior VP of business development and CFO of Valley, to analysts on the conference call.
By reducing inventory in the fourth quarter and in the first quarter of the new fiscal year, Valley will realize savings in interest expense, Cain stated. In the quarter that ended Jan. 1, interest expense was $3.6 million, up from $2.75 million in the same quarter last year.
While sales for the company were up 8.6% overall, full-line distribution, which consists of the one-stop business and video distribution, was down 10%, to $193.1 million from the $214.7 million generated in the third quarter last year. Cain attributed the drop largely to Wherehouse Entertainment assuming distribution of the Blockbuster Music chain it acquired in 1998. Initially, when the deal was first completed, Valley was acting as the fulfillment agent for those outlets.
New-media sales increased 47.3%, to $92.1 million, for the third quarter, bringing that division's total sales in Valley's current fiscal year to $207 million. By contributing that business to Amplified, "we believe we are creating a very valuable company," says Cain. "Also, we will be able to concentrate on earnings improvements."
Indie distribution sales were up slightly for the quarter, to $15.5 million, but up 19%, to $48.9 million, for the first nine months of the year.
For the quarter, gross profit decreased by 9.4%, to $29.8 million, vs. $32 million in the corresponding period last year. Part of that decrease was attributed to new two-year contracts signed with Amazon and CDnow that provide for greater volume discounts, according to Cerf.
Meanwhile, selling, general, and administrative (SG&A) expenses jumped by 11.3%, to $24.3 million from $21.6 million last year. Cain noted in the conference call that Valley's problems have not been with customer service but with cost containment.
"Our financial results were completely inadequate," Cain says. "We thought costs due to our warehouse move were over with," but that proved to be untrue. The company's costs in the new Woodland facility, he says, did "flatten out at a level well above the historical rate" of the old facility, which has since been converted to office space for the company.
Cain says that Valley has unacceptable inventory levels, labor productivity issues, and unforeseen problems with moving. "We can and will fix these problems."
Cerf told analysts on the conference call that the company has put in place programs to achieve cost improvement. "We are targeting SG&A improvements of 1% to 1.5% next year," he says.
For the nine-month period that ended Jan. 1, Valley's net income was $636,000, or 7 cents per share on a diluted basis, on sales of $685.5 million, vs. a net income of $3.2 million, or 70 cents per share on a diluted basis, on sales of $631.1 million in the first nine months of 1998.
Cerf acknowledged that the company will incur "significant fourth-quarter losses," which will include costs from putting together the Amplified merger. "We expect [the cost-containment] programs will have a significant impact early next year," he says. "We are targeting a recovery in the June quarter."