Valley Media Inc. Business Information, Profile, and History

Company Perspectives:

Valley Media Inc. is a recognized leader in the distribution of music and video entertainment products, including CDs, cassettes, video, DVD and games. Through the Company's Full-line Distribution business group, Valley provides products and services to more than 6,600 retailers operating through more than 42,000 traditional storefronts. Through its New Media business group--the Company's fastest growing business segment--Valley serves more than 100 Internet music and video retailers. Through its Independent Distribution business group, the Company represents independent labels.

History of Valley Media Inc.

Valley Media Inc. grew from a single record store in the 1970s to the largest one-stop distributor of CDs, cassettes, videos, and DVDs. It fills orders from retailers through two warehouse facilities located in Woodland, California and in Louisville, Kentucky. At the beginning of 2000 the company carried 260,000 different products and had an inventory valued at some $250 million. It regularly wins the Wholesaler of the Year award for large distributors from the National Association of Recording Merchandisers for its high level of service. Although sales were approaching $1 billion in 2000, the company operates on razor-thin margins; a mishandled move into a new warehouse in Woodland in 1999 resulted in a loss for the company's 1999-2000 fiscal year as costs quickly escalated.

Record Store Origins in the 1970s

Valley Media was founded by Barney Cohen in a warehouse in Davis, California, in the 1970s. Cohen, a graduate of Antioch College in Yellow Springs, Ohio, moved to Woodland, California with his wife. In 1974 he started a music store, Barney's Goodtime Musicstore, with borrowed money. He then opened a second store in Davis, which was more successful. By 1979 he owned four stores and decided to switch from retail to wholesale, calling his new company Valley Record Distributors.

The company initially operated out of the back of one of the record stores in Davis. In 1984 it expanded into a 2,000-square-foot warehouse in Davis. Cohen sold the last of his record stores in 1985. In his first year as a wholesaler he had about 20 customers, all of them within 50 miles of the warehouse. He also helped people open record stores by advising them on what to stock. With two employees, Valley Record Distributors had $2 million in sales in its first year. With its Data General midlevel mainframe, Valley was the first one-stop to have a computerized system. It carried about 30,000 titles.

Steady Growth in the 1980s

Sales doubled every year for the first few years. In 1986 Valley added CDs to its inventory and moved its operations to Woodland. By the end of 1987 Valley's sales had reached $16 million and the company won its first Wholesaler of the Year award from the National Association of Recording Merchandisers (NARM). Valley distinguished itself from its competition by offering special order fulfillment and supplying deep catalog items. Valley also committed to carrying every classic title.

In 1989 Valley moved across the street to a new, 66,000-square-foot warehouse. Its customers included about 1,000 independent stores and 50 chain locations. Orders were taken and fulfilled through electronic data interchange (EDI) for the first time. Cohen told Billboard, 'We believe we were the first company to take an electronic order. We've been ahead of the curve with technology all along.'

Increased Competition in the 1990s

In the early 1990s Valley faced competition from other one-stop distributors. When Alliance Entertainment Corp. purchased one-stop Abbey Road, it became a $600 million company, compared with Valley's $100 million size. When Alliance offered Borders Books and Music a better deal, Valley lost one-third of its business. In response, Valley vowed never to let any single account become more than ten percent of its business, and it began acquiring small- to medium-sized one-stop distributors. When Alliance filed for Chapter 11 bankruptcy protection in 1997, all of the business that Valley lost came back.

Valley began distributing independent labels in 1994 through an agreement with Rounder Records of Cambridge, Massachusetts. Together they set up Distribution North America (DNA) as a 50-50 joint venture to distribute Rounder product. In December 1997 Valley bought out Rounder's interest in DNA. By 1999 DNA had 150 suppliers, including several multilabel groups.

In October 1995 Valley installed a new inventory control system that allowed it to ship 95 percent of its orders on the same day they came in. It was designed and built by the Cormer/PCC consortium, which had built hardware/software installations for Kodak and Timex. Called 'a perpetual-inventory system with a random locator,' the system did not require Valley to store its product in any order. When a new shipment arrives, it is put into the nearest open space, with only the computer keeping track of where the product is located. Orders are held until they total 10,000 units. The pickers are then given a summary of product to pull in the exact order of the items' floor locations, so that no one has to go through the warehouse more than once. The product is then piled into a sorter, which reads the bar codes, adds price stickers, and sorts it into individual orders. This system enables Valley to receive an order as late as 6:00 p.m. one day and get the product to the retailer by 9:00 a.m. the next day.

Online Retailers and Videos: 1995-2000

Valley was one of the first music distributors to supply Internet retailers. Valley became involved in supplying Internet retailers as early as 1994 through a personal relationship, when Cohen's son was a classmate of Internet retailer CDNow's cofounder Jason Olim. Supplying Internet-based retailers soon became a big enough part of Valley's business for it to warrant having its own manager. That business segment initially was called Sound Delivery, then became i.Fill in 1999. By 1999 CDNow was a leading online retailer and Valley was one of the leading Internet fulfillment companies with more than 20,000 orders from Internet retailers a day. As part of its service to Internet retailers, Valley would ship orders in client packaging and was able to reach nearly 70 percent of the United States via ground UPS in two days.

In May 1997 Valley acquired video distributor Star Video Entertainment, based in New Jersey, for $37.9 million. Valley wanted to get into video distribution because of growing demand from Internet retailers. The company also wanted to diversify to stay ahead of other one-stops, and it expected that DVD sales would explode over the next few years. Acquiring Star Video virtually doubled the size of the company, but integrating the culture of video distribution with that of music distribution took two years. Found Barney Cohen told Billboard in 1999, 'We had a lot of big integration issues, and one of the reasons that we delayed going public is we wanted to be able to tell the world that we are over the hump of integration, and we feel we are.'

Unlike other video distributors that concentrate on rentals, Valley intended to focus on sell-through, believing that videos were underrepresented and undersold. Valley was able to sell a lot of video to its music accounts and, eventually, its video accounts began taking music. After the acquisition of Star Video in 1997, Valley significantly increased its stock of video titles, carrying every single music video available, 40,000 theatrical videos, and more than 3,000 DVD titles. Valley did not distribute adult-oriented video or DVD product, however.

For fiscal 1998 ending March 30, Valley had sales of $583 million. Of that total, $234 million was from video sales resulting from the acquisition of Star Video. Net income was $2.6 million. In fiscal 1999 video sales accounted for about one-third of Valley's overall sales.

In September 1997 Valley broke ground on its second warehouse in Louisville, Kentucky. It began receiving product on May 1, 1998 and shipped its first order on June 1. The second warehouse gave Valley the capacity it needed to handle the sale of Blockbuster's music stores to Wherehouse Entertainment in 1998, which added 400 stores to Valley's customer base with just a week of preparation.

At the end of 1998 Valley was the top one-stop wholesaler of records, cassettes, and compact discs, and it was one of the top five video distributors in the United States. It carried about 275,000 music titles and 30,000-40,000 video titles. It had about 1,100 employees nationwide, including some 800 at its Woodland headquarters.

Toward the end of 1998 Valley announced plans for an initial public offering (IPO) in 1999. Proceeds were expected to be used to help Valley repay a loan used to finance its 1997 acquisition of Star Video. Valley hoped its New Media division would attract investors interested in electronic commerce. It changed the name of its online fulfillment business from Sound Delivery to i.Fill. Its online customers were retailers who sold over the Internet or through 800 telephone numbers advertised on television. By mid-1999 Valley was fulfilling more than 20,000 orders a day from online retailers. For fiscal 1999 sales to Internet retailers were about $130 million, and it was described by Valley as its fastest growing business.

Going Public: 1999-2000

Valley priced its IPO of 3.5 million shares at $16 a share. In the first day of trading, March 25, 1999, the stock price jumped nearly 26 percent to close at slightly more than $20. The IPO raised $56 million, with substantial trading volume indicating strong investor interest in the company.

After extending its contract with Amazon.com for two years, Valley announced that it had won a contract with Virgin Entertainment to fill all of its audio, video, and DVD orders as well as selected book titles for Virgin E-Commerce.

As part of its New Media initiative, Valley entered into a partnership with Atlanta-based Amplified.com to provide custom CD and downloadable music capabilities to retailers and labels. Under the terms of the agreement, Valley would take an ownership interest in Amplified.com, which would in turn build a custom CD manufacturing facility within Valley Media's warehouse. This capability would allow Valley to offer its suppliers' products in a new format.

Following the IPO, Valley announced that it would expand its operations into a new 260,000-square-foot distribution facility near its corporate headquarters in Woodland. The newly leased facility was about a mile away from the company's 170,000-square-foot distribution center, which would be converted to administrative office space. Another 330,000-square-foot distribution facility was located in Louisville, Kentucky.

Net sales for fiscal 1999 ending April 3 were $889 million, up from $583.5 million in fiscal 1998. Net income increased 69.2 percent from $2.6 million to $4.4 million. The company noted spectacular growth in its online customers. Sales to traditional retail accounts rose 32.4 percent to $178.7 million, and sales from independent distribution increased 20.4 percent to $55 million.

In mid-1999 Valley reported a net loss of $799,000 for the first quarter ending July 3 of its fiscal year 2000. The overall loss was attributed to higher than expected costs associated with opening its new warehouse in Woodland. As a result of problems associated with moving into the new facility, Valley was unable to fill orders on time, and some customers resorted to other distributors. Labor and freight costs rose as the company tried to make up for lost time.

Sales of $185.8 million during the first quarter were 20 percent higher than the $154.4 million of the previous year's first quarter. For the second quarter ending October 3, 1999, Valley reported net income of $335,000 on sales of $205.2 million. For the six months ending October 3, Valley reported a net loss of $464,000 on sales of $390.9 million, compared with the previous year's six-month loss of $847,000 on sales of $343.3 million.

The slide in profitability during the year resulted in a much lower stock price for Valley Media. In December the company created a new chief operating officer position and promoted senior vice-president Melanie Cullen to the position. The company realized that its senior management was being stretched too far, when earlier in the year the company's IPO and move into a new warehouse coincided. With president and CEO Robert Cain on the road talking to investors about the IPO, the move into the new warehouse ended up costing significantly more than expected. When the problems were revealed in June 1999, the company's stock fell 31 percent in one day, to less than $15 a share. At the beginning of December 1999 it was trading at less than $10 a share.

For fiscal 2000 Valley expected to post a loss as a result of problems associated with moving into its new warehouse and a downturn in its mainstream business. In an effort to cut costs, the company planned to trim its inventory from $250 million to $210 million to reduce borrowing costs. It also planned to merge its Internet division, i.Fill, with Atlanta-based Amplified.com, while retaining a 50 percent ownership in the business. Training issues and implementation of new systems continued to plague the new warehouse facility in early 2000. The company also lost $28 million worth of business from Wherehouse Entertainment when a special contract expired. Other cost-cutting measures included closing a Boston warehouse and trimming some positions at the company's headquarters.

Ultimately, the mishandled warehouse move cost Valley Media president and CEO Robert Cain his job. In May 2000 he resigned from Valley Media and was temporarily replaced by founder Barney Cohen. Cain had joined Valley Media in 1991 as a consultant and replaced Cohen as CEO at the end of 1997. At the time of Cain's resignation, Valley's stock had fallen to $4 a share.

2000 and Beyond

In addition to competition from other large one-stop distributors, Valley Media faced competition from areas such as revenue-sharing programs started by the movie studios. The company acknowledged that it risked losing market share to those distributors who adopted revenue-sharing. Valley decided not to participate in the studios' revenue-sharing programs and was the only major distributor not to participate.

The company also faced risks from retailers, including Amazon.com and Wherehouse Entertainment, who were beginning to buy direct and bypass the wholesale distribution channel. Wherehouse accounted for 15 percent of Valley's sales in 1999.

As a company that has employed the latest technology throughout its history to provide high levels of service, Valley has positioned itself to benefit from the growth of electronic commerce and Internet retailers. It has been supplying Internet merchants since the mid-1990s and was one of the first music distributors to do so. It also has developed new media initiatives and ventures involving the latest music downloading and custom CD technologies.

Principal Subsidiaries: i.Fill; Distribution North America.

Principal Operating Units: Full-line Distribution Group; New Media Group; Independent Distribution Group.

Principal Competitors: Alliance Entertainment Corp.; Anderson Merchandising; BMG Distribution Co.; Handleman Co.; Ingram Entertainment Inc.; Sony Music Distribution.

Chronology

• Key Dates:

• 1974: Barney Cohen starts Barney's Goodtime Musicstore in Woodland, California.
• 1979: After expanding to four retail stores, Cohen switches to wholesale and establishes Valley Record Distributors in Davis, California.
• 1987: Valley wins its first Wholesaler of the Year award from the National Association of Recording Merchandisers (NARM).
• 1989: Valley opens a new 66,000-square-foot warehouse.
• 1994: Valley begins distributing independent labels through Distribution North America.
• 1996: Valley begins fulfilling orders for online merchant CDNow.
• 1999: Valley becomes a public company through an initial public offering.