Post of the Day
May 26, 1998

From our Board

Subject: Re: Frank Sinatra featured
Author: privatequity

"However, it is still true that nearly all the bearish arguments posted here refer to (beyond the debate about the company's competitive advantage or lack thereof) the firm's balance sheet, cash flow statement, income statement and financial ratios, while a significant portion of the long postings -- if they refer to financial statements at all -- try to explain away the relevance of ANY traditional financial ratios, metrics or time series analysis. That IMHO is surely a new paradigm v. old paradigm debate. Let's call it what it is, but keep it going strong (as I, for one, have learned a ton, by following it here)"

O.K., this one's for you, puumbaa.

The high point of my life was living behind the Iron Curtain for three years and working in the American Embassy in Moscow. Gathering information on the Soviets was in some ways like trying to pierce the information veil of US public companies which play their hand close to the vest, issue periodic optimistic pronouncements, and publish quarterly numbers much like the Soviets. One trick the Embassy Economics officers told me about was to analyze changes over time.

Instead of back issues of Pravda, let's take a look at back 10Q's since we know any changes in the boilerplate are usually related to CEO concerns forced public by securities lawyers (lawyers are soimpassionately objective and logical-don't they just make you want to retch?). Friday's 10Q release vsNovember 14, 1997 10Q:


Gross margins were alluded to under Managements Discussion earlier but now received a dedicated line item,

"Factors that may adversely affect the Company's quarterly operating results include...(iii) the Company's ability to maintain gross margins in its existing business and in future product lines and markets..."

and also new but somewhat expected

"(x) the Company's ability to manage effectively its development of new business segments and markets, (xi) the Company's ability to successfully manage the integration of operations and technology of acquisitions and other business combinations."

Under Results of Operations, the percentage of international sales continued its slide. I view this as a point for the bulls, since international sales are problematical (IMHO) for the company and when you crunch the numbers, the slide is due to the [healthier] domestic sales growing faster than international. More worrisome for the Bulls was was a new discount popping up beyond the 20 and 30% discounts discussed earlier in which the company now offers "certain 'special value' editions discounted up to 89%". This then leads to the insertion of a new [happy, happy, happy for Bears] paragraph

"The Company over time intends to expand its operations by promoting new or complementary products or sales formats and by expanding the breadth and depth of its product or service offerings. Gross margins attributable to new business areas may be lower than those associated with the Company's existing business activities. In particular, the Company has announced plans to offer music to customers, and anticipates that music product gross margin, which is expected to be lower than book gross margin, will affect overall gross margin proportionately to its impact on product mix."


New additions under Additional Factors That May Affect Future Results: after speaking of the intensely competitive nature of the retail book and music business, the company says

"The Company's current or potential competitors include...(iii) publishers, distributors and retail vendors of books, music and other products, including Barnes & Noble, Inc., Bertelsmann AG and other large specialty booksellers and integrated media corporations, many of which possess significant brand awareness, sales volume and customer bases."

[never before had the company mentioned competitors by name]. Another new paragraph states,

"The Company believes that the principal competitive factors in its market are brand recognition, selection, personalized services, convenience, price, accessibility, customer service, quality of search tools, quality of editorial and other site content, and reliability and speed of fulfillment. Many of the Company's competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than the Company."

Since buying power directly impacts gross margins, the company returns to the gross profit issue with another new paragraph:

"Certain of the Company's competitors may be able to secure merchandise from vendors on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing or inventory availability policies and devote substantially more resources to Web site and systems development than the Company. Increased competition may result in reduced operating margins, loss of market share and a diminished brand franchise. There can be no assurance that the Company will be able to compete successfully against current and future competitors."


New verbage:

"There can be no assurance that the Company will be able to improve its earnings before fixed charges or that the Company will be able to meet its debt service obligations, including its obligations under the Senior Discount Notes. In the event the Company's cash flow is inadequate to meet its obligations, the Company could face substantial liquidity problems. If the Company is unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, or if the Company otherwise fails to comply with the various covenants in its indebtedness, it would be in default under the terms thereof, which would permit the holders of such indebtedness to accelerate the maturity of such indebtedness and could cause defaults under other indebtedness of the Company. Any such default could have a material adverse effect on the Company's business, prospects, financial condition and results of operations."

Finally, the international risk section was all new and negative but has been partially addressed in previous messages. Lots of new warnings here to shareholders. I don't know about the rest of you, but it seems to me, after examining the changes in the 10Q tea leaves, the General Secretary of the Communist Party of the USSR may have just caught a head cold.

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