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, 2001
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 (I.R.S. Employer
incorporation or organization) Identification 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 [ ]
Shares outstanding of the Registrant's common stock:
Class Outstanding at October 31, 2001
Class B Common Stock, no par value 1,000 shares
MTS, INCORPORATED
TABLE OF CONTENTS
PAGE
Part I. Financial Information..........................................................................
Item 1. Consolidated Financial Statements...........................................................
Consolidated Balance Sheets as of October 31, 2001 and 2000 and July 31, 2001............... 3
Consolidated Statements of Income for the three months ended October 31, 2001
and 2000.................................................................................. 4
Consolidated Statements of Cash Flows for the three months ended October 31, 2001
and 2000.................................................................................. 5
Consolidated Statements of Comprehensive Income for the three months ended October 31, 2001
and 2000.................................................................................... 6
Notes to Consolidated Financial Statements.................................................. 7-9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 10-14
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................. 15
Part II. Other Information ............................................................................
Item 5. Other Information........................................................................... 16
Item 6. Exhibits and Reports on Form 8-K............................................................ 16
Signature.............................................................................................. 17
2
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MTS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
AS OF OCTOBER 31, 2001, 2000 AND JULY 31, 2001
(DOLLARS IN THOUSANDS)
UNAUDITED UNAUDITED
----------- -----------
OCTOBER 31, OCTOBER 31, JULY 31,
2001 2000 2001
----------- ----------- ---------
Assets
Current Assets:
Cash and cash equivalents $ 29,486 $ 19,347 $ 32,075
Receivables, net 30,090 35,577 31,805
Merchandising inventories 268,078 323,622 249,128
Prepaid expenses 10,507 14,462 8,970
Deferred tax assets -- 12,762 --
--------- --------- ---------
Total current assets 338,161 405,770 321,978
Fixed assets, net 173,816 208,032 178,021
Deferred tax assets -- 9,634 --
Other assets 22,651 39,153 26,976
--------- --------- ---------
Total assets $ 534,628 $ 662,589 $ 526,975
========= ========= =========
Liabilities and Shareholder's Equity
Current Liabilities:
Current maturities of long-term debt $ 189,487 $ 209,198 $ 179,374
Accounts payable 173,072 185,680 163,336
Reserve for restructuring costs 481 -- 2,225
Accrued liabilities 41,801 38,118 39,399
Income taxes payable -- 757 --
Deferred revenue, current portion 2,326 2,632 2,780
--------- --------- ---------
Total current liabilities 407,167 436,385 387,114
Long-term Liabilities:
Long-term debt, less current maturities 117,801 119,662 118,341
Deferred revenue, less current portion 128 141 131
--------- --------- ---------
Total liabilities 525,096 556,188 505,586
--------- --------- ---------
Shareholder's Equity:
Common stock:
Class B, no par value; 10,000,000 shares authorized;
1,000 shares issued and outstanding at October 31, 2001,
October 31, 2000 and July 31, 2001 6 6 6
Retained earnings 24,576 125,405 35,848
Accumulated other comprehensive income (15,050) (19,010) (14,465)
--------- --------- ---------
Total shareholder's equity 9,532 106,401 21,389
--------- --------- ---------
Total liabilities and shareholder's equity $ 534,628 $ 662,589 $ 526,975
========= ========= =========
The accompanying notes are an integral part of these statements.
3
MTS, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED OCTOBER 31, 2001 AND 2000
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
THREE MONTHS ENDED
----------------------
OCTOBER 31,
2001 2000
--------- ---------
Net revenue $ 226,694 $ 255,388
Cost of sales (a) 156,181 171,011
--------- ---------
Gross Profit 70,513 84,377
Selling, general and administrative expenses (b) 66,678 70,344
Restructuring and asset impairment costs 88 --
Depreciation and amortization 7,339 7,512
--------- ---------
(Loss)/income from operations (3,592) 6,521
Other expenses:
Interest Expense (7,663) (5,689)
Foreign currency translation loss (740) (704)
Other income /(expenses) 859 (175)
--------- ---------
Loss before taxes (11,136) (47)
Provision for income taxes 136 686
--------- ---------
Net loss $ (11,272) $ (733)
========= =========
Basic and diluted loss per share $(11,272.41) $ (732.78)
=========== =========
(a) Includes $1.5 million of inventory write-downs related to the
Restructuring Plan in fiscal year 2002.
(b) Includes $1.4 million in professional fees related to the
Restructuring Plan in fiscal year 2002.
The accompanying notes are an integral part of these statements.
4
MTS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED OCTOBER 31, 2001 AND 2000
(DOLLARS IN THOUSANDS)
UNAUDITED
OCTOBER 31,
----------------------
2001 2000
--------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(11,272) $ (733)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 7,665 8,162
Restructuring and asset impairment costs (381) --
(Recovery)/provision for losses on accounts receivable (72) 58
Loss on disposal of depreciable assets 301 389
Exchange (gain)/loss (603) 761
Other non-cash expense 228 35
Increase/(decrease) in cash resulting from changes in:
Accounts receivable 1,715 (4,120)
Inventories (20,422) (30,193)
Prepaid expenses (1,537) (1,734)
Accounts payable 9,736 19,979
Accrued liabilities and taxes payable 2,402 (676)
Deferred revenue (457) (330)
-------- --------
Net cash used in operating activities (12,697) (8,402)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of fixed assets (2,455) (8,072)
Acquisition of investments (140) (693)
Increase in deposits (121) (168)
Refunds of deposits 167 9
Increase in intangibles (963) (139)
-------- --------
Net cash used in investing activities (3,512) (9,063)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from life insurance loans 3,526 --
Proceeds from employee loan payments 105 6
Principal payments under long-term financing agreements (20,253) (884)
Proceeds from issuance of long-term financing agreements 30,607 17,734
-------- --------
Net cash provided by financing activities 13,985 16,856
-------- --------
Effect of exchange rate changes on cash (365) (1,530)
-------- --------
Net decrease in cash and cash equivalents (2,589) (2,139)
Cash and cash equivalents, beginning of period 32,075 21,486
-------- --------
Cash and cash equivalents, end of period $ 29,486 $ 19,347
======== ========
Cash paid for interest $ 5,244 $ 3,006
======== ========
Cash paid for income taxes $ -- $ 41
======== ========
The accompanying notes are an integral part of these statements.
5
MTS, INCORPORATED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED OCTOBER 31, 2001 AND 2000
(DOLLARS IN THOUSANDS)
UNAUDITED
----------------------
2001 2000
-------- ------
Net Loss $(11,272) $(733)
Other comprehensive income, net of tax
Foreign currency translation (585) (226)
-------- ------
Comprehensive Loss $(11,857) $(959)
======== =====
The accompanying notes are an integral part of these statements.
6
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 and restructuring and asset impairment charges) necessary
to present fairly its consolidated financial position as of October 31, 2001 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 principals, but which are not required for interim reporting
purposes, have been condensed or omitted. The accompanying unaudited
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, 2001.
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 rates 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 shareholder's
equity. 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 a net transaction loss of $0.7 million for the three months ended
October 31, 2001 and October 31, 2000. These amounts primarily represent the
volatility of currencies in international countries in which the Company does
business.
NOTE 3 -- INCOME TAXES
The effective income tax rates for the three months ended October 31, 2001 and
2000 are based on the federal statutory income tax rate, increased for the
effect of state income taxes, net of federal benefit and foreign taxes and
decreased due to the creation of a valuation account related to the net
operating loss and certain deferred tax assets.
NOTE 4 -- RESTRUCTURING AND ASSET IMPAIRMENT CHARGES
At July 31, 2001 the Company recorded pre-tax restructuring charges of $46.7
million as a result of steps the Company is taking that are intended to improve
the Company's operations and improve cash flows. For the three month period
ended October 31, 2001, the Company's pre-tax restructuring charges were an
additional $3.0 million.
At July 31, 2001 the Company had recorded a restructuring liability in the
amount of $2.2 million. For the three month period ended October 31, 2001, the
restructuring liability was $0.5 million. The change in the restructuring
liability is due to the following:
7
MTS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
INVENTORY LEASEHOLD LEASE EMPLOYEE
WRITE- PROFESSIONAL IMPROVEMENTS TERMINATION TERMINATION
(IN MILLIONS) DOWNS FEES WRITE-OFFS COSTS COSTS OTHER TOTAL
- -------------------------------------------------------------------------------------------------------------
RESTRUCTURING $ - $ - $ 1,023 $ 813 $ 225 $164 $ 2,225
LIABILITY AT
JULY 31, 2001
- -------------------------------------------------------------------------------------------------------------
CHANGES IN $ - $ - $(1,023) $(522) $(199) $ - $(1,744)
RESTRUCTURING
LIABILITY
ESTIMATES:
- -------------------------------------------------------------------------------------------------------------
TOTAL $ - $ - $ - $ 291 $ 26 $164 $ 481
RESTRUCTURING
LIABILITY AT
OCTOBER 31,
2001
- -------------------------------------------------------------------------------------------------------------
The change in the restructure reserve estimates is primarily due to the closure
of the last Canadian store in October 2001.
In connection with its restructuring plan, the Company continues to monitor
under performing stores and assets in addition to evaluating its ongoing working
capital commitments. As such, the Company anticipates that it will continue to
incur restructuring and asset impairment charges through fiscal year 2002.
NOTE 5 -- DEBT
In October 2001, the Company entered into an amendment (Amendment) to the Credit
Facility dated as of October 5, 2001, and effective September 30, 2001. Pursuant
to the Amendment, the maximum borrowings under the Credit Facility are required
to be reduced by $5 million in October 2001 and $10 million in December 2001,
instead of $15 million in October 2001 and $95 million in December 2001. The
Amendment also eliminates certain provisions of the Credit Facility,
specifically those requiring the Company to (1) provide firm commitments by
October 1, 2001 for financing or sale of assets that will reduce the commitments
to $100,000,000 by December 31, 2001 and (2) receiving proceeds of such
financing or sale that actually reduce the commitments to $100,000,000 by
December 31, 2001. In addition, the Amendment reduces the EBITDA and leverage
ratio amounts that the Company is required to meet. Pursuant to the Amendment,
the Company paid a 0.0375% amendment fee to the lenders. The recorded value of
the Credit Facility approximates fair value at October 31, 2001 due to the
variable nature of rates.
The Company's future operating performance and ability to service or refinance
its senior subordinated notes and the Credit Facility will be subject to the
Company's ability to refinance its Credit Facility maturing April 23, 2002,
future economic conditions and financial, business and other factors, many of
which are beyond the Company's control. There can be no assurance or guaranty
that the Company will be successful in refinancing the Credit Facility or that
any renewal will be on terms that are favorable to the Company. In the event the
Company is unable to refinance the Credit Facility, the Company's business,
financial condition and results of operations would be materially and adversely
affected.
8
MTS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Credit Facility and the senior subordinated notes impose certain
restrictions on the Company's ability to make capital expenditures and limit the
Company's ability to incur additional indebtedness. Such restrictions could
limit the Company's ability to respond to market conditions, to provide for
unanticipated capital investments or to take advantage of business or
acquisition opportunities. The covenants contained in the Credit Facility and
the senior subordinated notes also, among other things, limit the ability of the
Company to dispose of assets, repay indebtedness or amend other debt
instruments, pay distributions, create liens on assets, enter into sale and
leaseback transactions, make investments, loans or advances and make
acquisitions.
9
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 in addition to the consolidated
financial statements and notes thereto for the fiscal year ended July 31, 2001
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission.
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with historical
consolidated financial information and the consolidated financial statements of
the Company and the notes thereto included elsewhere in this Form 10-Q. The
results shown herein are not necessarily indicative of the results to be
expected in any future period. The following discussion contains forward-looking
statements that involve known and unknown risks and uncertainties. Use of the
words "anticipates," "believes," "estimates," "expects," "intends," "plans" and
similar expressions are intended to identify forward-looking statements. A
variety of factors could cause the Company's actual results to differ materially
from the anticipated results expressed in such forward-looking statements,
including among other things: (i) consumer demand for the Company's products,
which is believed to be related to a number of factors, including overall
consumer spending patterns, weather conditions and new releases available from
suppliers; (ii) an increase in competition, including Internet competition and
competition resulting from electronic or other alternative methods of delivery
of music and other products to consumers, or unanticipated margin or other
disadvantages relative to competitors; (iii) the continued availability and cost
of adequate capital to fund the Company's operations; (iv) higher than
anticipated interest, occupancy, labor, distribution and inventory shrinkage
costs; (v) unanticipated adverse litigation expenses or results; (vi) higher
than anticipated costs associated with the implementation of the Company's
Restructuring Plan and/or lower than anticipated resulting operations and cash
flow benefits; (vii) unanticipated increases in the cost of merchandise sold by
the Company; (viii) changes in foreign currency exchange rates and economic and
political risks; (ix) the adverse effects of acts or threats of war, terrorism
or other armed conflict on the United States and international economies; (x)
the ability of the Company to comply with the ongoing monthly affirmative and
negative covenants as prescribed by the Company's Amended and Restated Credit
Agreement, as amended; (xi) the ability of the Company to meet the mandatory
commitment reductions under the Company's Amended and Restated Credit Agreement,
as amended; (xii) the ability of the Company to refinance or extend its credit
facility prior to the maturity thereof; and (xiii) the ability of the Company to
successfully defend itself in ongoing and future litigation. All forward-looking
statements included in this Form 10-Q are based on information available to the
Company on the date hereof, and the Company assumes no obligation to update any
such forward-looking statements. Please refer to the Risk Factors section of the
Company's Annual Report Form 10-K for further information on other factors,
which could affect the financial results of the Company and such forward-looking
statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED OCTOBER 31, 2001 COMPARED TO THREE MONTHS ENDED OCTOBER 31,
2000
REVENUES
For the three months ended October 31, 2001, the Company's consolidated net
revenues were $226.7 million versus $255.4 million, a decrease of $28.7 million
(or a decrease of $19.3 million excluding the effects of U.S. dollar foreign
translation fluctuations). The Company's net revenues were derived from U.S.
revenues of $126.4 million and international revenues of $100.3 million for the
three months ended October 31, 2001 compared to $147.9 million in the U.S. and
$107.5 million internationally for the three months ended October 31, 2000. The
overall decrease in total Company revenues for the three months ended October
31, 2001 was driven primarily
10
by the closing of unprofitable stores associated with the Company's worldwide
restructuring efforts in fiscal 2001 and a decline in consumer spending
attributed to the events of September 11, 2001.
GROSS PROFIT
For the three months ended October 31, 2001, gross profit decreased $13.9
million to $70.5 million from $84.4 million for the three months ended October
31, 2000 (or a decrease of $9.1 million excluding the effects of the U.S. dollar
foreign translation fluctuations and the impact of the Company's Restructuring
Plan). Management attributes the decline in gross profit, excluding the effect
of inventory write downs related to the restructuring charge, principally to the
decrease in revenues as previously discussed, weaker margins associated with
competitive pricing pressure in the United States and Great Britain and adverse
fluctuations in foreign translation rates. Gross profit as a percentage of net
revenues decreased to 31.1% for the three months ended October 31, 2001, as
compared to 33.0% for the three months ended October 31, 2000. Management
attributes the percentage decrease primarily to liquidation of inventory
associated with certain store closures in connection with the Company's
restructuring efforts and industry pricing pressure in the United States and
Great Britain.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses, excluding the effects of the $1.4
million in professional fees related to the restructuring charge and
depreciation and amortization, decreased by $5.0 million to $65.3 million during
the three months ended October 31, 2001 from $70.3 million for the three months
ended October 31, 2000. Excluding the effect of professional fees related to the
restructuring charge, decreases in personnel, occupancy and other cost savings
initiatives resulting from the Company's restructuring plan contributed
primarily to the reduction in overall operating costs. As a percentage of net
revenues, selling, general and administrative expenses, excluding the effects of
the professional fees related to the restructuring charge and depreciation and
amortization, increased to 28.8% for the three months ended October 31, 2001 as
compared to 27.5% for the three months ended October 31, 2000. Management
attributes the percentage increase (excluding the effect of professional fees
related to the restructuring charge) primarily to the overall reduction in
revenues during the period.
RESTRUCTURING AND IMPAIRMENT COSTS
The Company recorded pre-tax restructuring and asset impairment charges of $3.0
million during the three months ended October 31, 2001, as related to the
implementation of the Restructuring Plan. Of the $3.0 million in total pre-tax
restructuring and asset impairment charges, $1.5 million related to inventory
write downs was recorded in cost of sales and $1.4 million related to
professional fees was recorded in selling, general and administrative expenses.
The remaining $0.1 million of total pre-tax restructuring and asset impairment
charges were reported separately.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expense was $7.3 million for the three months
ended October 31, 2001 compared to $7.5 million for the three months ended
October 31, 2000, a decrease of $0.2 million. The decrease was primarily due to
the closing of unprofitable stores associated with the Company's worldwide
restructuring efforts in fiscal 2001, offset by fiscal year 2001 asset
additions.
LOSS FROM OPERATIONS
The Company's consolidated operating loss during the three months ended October
31, 2001 was $3.6 million compared with consolidated operating income of $6.5
million during the three-month period ended October 31,
11
2000, for a decrease of $10.1 million. The decrease was primarily attributable
to the decreases in revenues and gross profit as discussed above.
INTEREST EXPENSE
Net interest expense increased to $7.7 million during the three months ended
October 31, 2001 from $5.7 million during the three months ended October 31,
2000. The increase was due primarily to higher borrowing costs.
FOREIGN CURRENCY TRANSLATION LOSS
A foreign currency translation loss of $0.7 million was recognized for the three
months ended October 31, 2001 and October 31, 2000. The account primarily
represents the volatility of foreign currency fluctuations against the U.S.
dollar in foreign countries in which the Company does business.
INCOME TAXES
Pre-tax losses resulted in an income tax provision for both the three months
ended October 31, 2001 and October 31, 2000. Tax provisions and benefits are
based upon management's estimate of the Company's annualized effective tax
rates.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital requirements are to fund working capital needs,
the opening of new stores, the refurbishment and expansion of existing stores,
and continued development of the Company's technological infrastructure.
Net cash used in operating activities was $12.7 million and $8.4 million for the
three months ended October 31, 2001 and 2000, respectively. For the three months
ended October 31, 2001, net increase in inventory was $20.4 million, which
included a $1.5 million write-down of inventory related to the Company's
restructuring plan. Net increase in inventory was $30.2 for the three months
ended October 31, 2000. The increase in inventory is due to the Company's
increased needs through the holiday season. The net decrease in cash flow from
operations for the three months ended October 31, 2001 compared to October 31,
2000 was primarily due to the net loss incurred.
Net cash used for investing activities was focused primarily on store
maintenance and capital expenditure requirements including store relocations,
refurbishment and technology investments totaling approximately $2.1 million
with an additional $0.3 million used for video rental acquisition. During the
three months ended October 31, 2001, the Company opened 1 store domestically.
Net cash provided by financing activities in 2001 was $14.0 million, resulting
principally from proceeds from life insurance loans and net borrowings under the
Company's credit facility. Net borrowings under the Company's credit facility
increased $10.1 million for the three months ended October 31, 2001, excluding
the effects of foreign currency exchange rates. Net cash provided by financing
for the three months ended October 31, 2000 was $16.9 million, which resulted
primarily from net borrowings under the Company's credit facility.
Total funded debt decreased to $307.3 million as of October 31, 2001 from $328.9
million as of October 31, 2000. Outstandings under the Company's senior
revolving credit facility were $187.2 million on October 31, 2001 compared to
$206.2 million on October 31, 2000. The decrease in bank outstandings was the
result of the effects of the restructuring plan implemented in fiscal year 2001.
12
Interest payments on the senior subordinated notes and on the credit facility
will continue to impose significant liquidity demands upon the Company. In
addition to its debt service obligations, the Company will require liquidity for
capital expenditures, lease obligations and general working capital needs. Total
capital expenditures for fiscal 2002 are expected to be approximately $15.0
million, of which approximately $11.9 million will be related to maintenance and
required technological and capital improvements.
The Company's Senior Credit Facility expires April 23, 2002. The Company intends
to refinance the credit facility prior to expiration and believes that the cash
flow generated from its operations, together with amounts available from other
financing alternatives, will be sufficient to fund its debt service
requirements, lease obligations, working capital needs, its currently expected
capital expenditures and other operating expenses for the next twelve months.
In April 2001, the Company extended and restated on a short-term basis its
outstanding obligations under its senior revolving credit facility. The Credit
Facility was further amended in October 2001. The Credit Facility provided for
initial maximum borrowings of up to $225.0 million, consisting of two
sub-facilities (one for an initial maximum of $98.4 million and one for an
initial maximum Japanese yen of (Yen)15,596,828,718, which was equivalent to
$126.6 million at inception), with a maturity date of April 23, 2002. Maximum
borrowings under the Credit Facility are scheduled to decline during its
one-year term by $15 million in July 2001, $5.0 million in October 2001, and
$10.0 million in December 2001.
Maximum borrowings under the Credit Facility are subject to a borrowing base
formula, maximum leverage ratio tests and maintaining a minimum rolling
quarterly EBITDA. As of October 31, 2001, approximately $205.0 million was
available under the Senior Credit Facility, of which $187.2 million had been
drawn. The $187.2 million includes a decrease of $14.2 million due to yen debt
translated back to U.S. dollars at the spot rate on October 31, 2001.
The Company's future operating performance and ability to service or refinance
its senior subordinated notes and the Credit Facility will be subject to the
Company's ability to refinance its Credit Facility maturing April 23, 2002,
future economic conditions and financial, business and other factors, many of
which are beyond the Company's control. There can be no assurance or guaranty
that the Company will be successful in refinancing the Credit Facility or that
any renewal will be on terms that are favorable to the Company. In the event the
Company is unable to refinance the Credit Facility, the Company's business,
financial condition and results of operations would be materially and adversely
affected.
The Credit Facility and the senior subordinated notes impose certain
restrictions on the Company's ability to make capital expenditures and limit the
Company's ability to incur additional indebtedness. Such restrictions could
limit the Company's ability to respond to market conditions, to provide for
unanticipated capital investments or to take advantage of business or
acquisition opportunities. The covenants contained in the Credit Facility and
the senior subordinated notes also, among other things, limit the ability of the
Company to dispose of assets, repay indebtedness or amend other debt
instruments, pay distributions, create liens on assets, enter into sale and
leaseback transactions, make investments, loans or advances and make
acquisitions.
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's deep-catalog approach to prerecorded music appeals to
customers who purchase music on a year-round basis. Consequently, the
13
Company has historically had reduced seasonal reliance. In addition,
international markets exhibit less fourth quarter seasonality than U.S. markets
and the Company's international presence has historically further reduced this
reliance on the U.S. holiday shopping season. Nevertheless, sales during the
Company's second fiscal quarter (November 1 through January 31) in 2001 and 2000
accounted for approximately 30% of annual sales.
INFLATION
The Company believes that the recent low rates of inflation in the United
States, Japan and the United Kingdom, where it primarily operates, has not had a
significant effect on its net sales or operating results. The Company attempts
to offset the effects of inflation through the management of controllable
expenses. However, there can be no assurance that during a period of significant
inflation, the Company's results of operations would not be adversely affected.
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 the Company'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
significantly affected by changes in currency exchange rates. The Company
believes that the matching of revenues and expenses in local currency, as well
as its foreign exchange hedging activities and borrowings in foreign currencies,
mitigate the effect of fluctuating currency exchange rates. Nonetheless, changes
in certain exchange rates could adversely affect the Company's business,
financial condition and results of operations. See "Quantitative and Qualitative
Disclosures about Market Risk."
NEW ACCOUNTING POLICIES
In July 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 142
changes the accounting for goodwill, including goodwill recorded in past
business combinations. SFAS 142 requires, among other things, that companies no
longer amortize goodwill, but instead periodically test goodwill for impairment.
The previous accounting principles governing goodwill generated from a business
combination will cease upon adoption of SFAS 142. Currently, the Company is
assessing but has not yet determined how the adoption of SFAS 141 and SFAS 142
will impact its financial position and results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments and Hedging Activities". The provisions of SFAS 133 require all
derivative instruments to be recognized on the balance sheet as assets or
liabilities at fair value. The Company adopted SFAS 133, as amended, on August
1, 2000. The Company records its derivatives on the balance sheet at fair value
and reported adjustments to fair value through income.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the impact of interest-rate changes and foreign
exchange rate fluctuations. The Company does not enter into market risk
sensitive instruments for trading purposes. In the ordinary course of its
business, the Company enters into debt instruments, including instruments with
short-term maturities. The Company could be exposed to a higher interest rate at
the time such debt instruments are renewed or refinanced. Certain of the
Company's debt instruments contain terms that permit the Company to cap the
interest rate at a maximum rate. In the past, the Company has purchased interest
rate hedges to manage the risk associated with interest rate variations.
The Company is subject to risks resulting from interest rate fluctuations
because interest on the Company's borrowings under its credit facility are based
on variable rates. If the base borrowing rates (primarily a combination of LIBOR
and TIBOR) were to increase 1% in fiscal 2002 as compared to the rate at July
31, 2001, the Company's interest expense related to its credit facility for
fiscal 2002 would increase approximately $1.9 million based on the outstanding
balance of the Company's credit facility at October 31, 2001. A substantial
majority of the Company's revenues, expenses and capital purchasing activities
are transacted in U.S. dollars. However, the Company does enter into these
transactions in other foreign currencies, primarily Japanese yen. The Company
uses forward exchange contracts to hedge intercompany transactions with foreign
subsidiaries and affiliates, and in connection with certain of its Japanese
subsidiary's purchases of product from third parties. Such instruments are
short-term instruments entered into in the ordinary course of the Company's
business, in order to reduce the impact of exchange rate fluctuation on net
income and shareholder's equity. At October 31, 2001, the Company had
outstanding forward exchange contracts maturing on dates through April 2002, to
buy approximately $3,000,000 in foreign currency (355 billion yen at the
contract rate). The fair value of the contracts as of October 31, 2001 was 367
billion yen.
To finance expansion and operations in Japanese markets, the Company has entered
into yen-denominated borrowing arrangements. Unrealized gains and losses
resulting from the impact of foreign exchange rate movements on these debt
instruments are recognized as other income or expense in the period in which the
exchange rates change. Historically, the Company has not entered into foreign
exchange contracts to manage the risk associated with such currency
fluctuations, but it may do so from time to time in the future.
The Company engaged a third party to analyze the sensitivity of the Company's
operations to fluctuations in the exchange rate between U.S. dollars and
Japanese yen. The analysis made various assumptions for exchange rates, and
assumed that the results of the Japanese operations would remain consistent with
recent history. According to this analysis, the Japanese operation provides a
natural hedge against any impact of changes in foreign exchange rates on the
company's yen denominated debt. Based on the results of this analysis, the
Company concluded that a change in exchange rates from year-end levels would not
materially affect the Company's results of operations.
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PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION
10.6 First Amendment, dated as of October 05, 2001, to the
Amended and Restated Credit Agreement, dated as of April 27,
2001, between the Company and The Chase Manhattan Bank.
(Previously filed with the Company's report on Form 8-K
filed October 10, 2001).
(b) Reports on Form 8-K.
FORM ITEM NO. DESCRIPTION FILING DATE
8-K 5 Report on Amendment October 10, 2001
of Credit Agreement among
the Company, Tower Records
Kabushiki Kaisha, the lenders
Party thereto and The Chase
Manhattan Bank
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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:
Dated: December 14, 2001 DeVaughn D. Searson
Executive Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer)
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