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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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, 2003
[ ] 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 1-13437
SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
MISSOURI 43-1710906
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
27500 RIVERVIEW CENTER BLVD., SUITE 400
BONITA SPRINGS, FLORIDA 34134
- ---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
(239) 949-4450
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common equity, as of the latest practicable date.
Class Outstanding on December 2, 2003
----- -------------------------------
Common Stock, $.01 Par Value 18,722,700
SOURCE INTERLINK COMPANIES, INC.
INDEX
PART I - FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of
October 31, 2003 and January 31, 2003 1
Consolidated Statements of Income for the three and nine
months ended October 31, 2003 and 2002 3
Consolidated Statement of Stockholders'
Equity for the nine months ended October 31, 2003 4
Consolidated Statements of Cash Flows for the
nine months ended October 31, 2003 and 2002 5
Notes to Consolidated Financial Statements 6-14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 14-25
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 25
ITEM 4. CONTROLS AND PROCEDURES 26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 27
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES 27
OF EQUITY SECURITIES
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 27
ITEM 5. OTHER INFORMATION 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 28
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
October 31, January 31,
2003 2003
- -------------------------------------------------------------------------------------------
ASSETS
CURRENT
Cash $ 4,977 $ 5,570
Accounts receivables (Note 2) 69,506 51,869
Inventories (Note 2) 15,844 15,912
Income taxes receivable 2,448 6,883
Deferred tax asset 3,425 1,471
Other current assets 4,951 2,051
- ------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 101,151 83,756
==========================================================================================
Property, Plants and Equipment 28,775 27,671
Less accumulated depreciation and amortization (9,808) (7,532)
- ------------------------------------------------------------------------------------------
NET PROPERTY, PLANTS AND EQUIPMENT 18,967 20,139
==========================================================================================
OTHER ASSETS
Intangibles, net 50,830 46,797
Deferred tax asset 1,214 947
Other 8,688 4,729
- ------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 60,732 52,473
==========================================================================================
$ 180,850 $ 156,368
==========================================================================================
1 See accompanying notes to
Consolidated Financial Statements
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
October 31, January 31,
2003 2003
- ----------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future advances on revolving credit facility $ 1,083 $ 6,611
Accounts payable and accrued expenses, net of allowance for returns of
$55,944 and $31,543 at October 31 and January 31, 2003 respectively 61,941 50,119
Current maturities of debt (Note 3) 4,301 29,215
Other current liabilities 24 24
- ----------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 67,349 85,969
Debt, less current maturities (Note 3) 48,806 17,026
Other long-term liabilities 587 1,148
- ----------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 116,742 104,143
================================================================================================================
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Contributed Capital:
Preferred Stock, $.01 par (2,000 shares authorized; none issued) - -
Common Stock, $.01 par (40,000 shares authorized; 18,781 and 18,363 shares
issued at October 31, 2003 and January 31, 2003, respectively) 188 184
Additional paid-in-capital 100,467 97,338
- ----------------------------------------------------------------------------------------------------------------
Total contributed capital 100,655 97,522
Accumulated deficit (37,011) (44,520)
Accumulated other comprehensive income (loss):
Foreign currency translation 1,031 (210)
- ----------------------------------------------------------------------------------------------------------------
64,675 52,792
Less: Treasury Stock (100 shares at cost) (567) (567)
- ----------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 64,108 52,225
================================================================================================================
$ 180,850 $ 156,368
================================================================================================================
2 See accompanying notes to
Consolidated Financial Statements
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three Months Ended Nine Months Ended
October 31, October 31,
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
Revenues $ 92,024 $ 80,942 $ 258,195 $ 221,551
Costs of Revenues 67,229 60,748 189,839 164,936
- ------------------------------------------------------------------------------------------------------------------
Gross Profit 24,795 20,194 68,356 56,615
Selling, General and Administrative Expense 13,028 11,041 39,763 32,985
Fulfillment Freight 4,516 4,119 12,995 11,112
Relocation Expenses - 614 1,730 1,605
- ------------------------------------------------------------------------------------------------------------------
Operating Income 7,251 4,420 13,868 10,913
- ------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Interest expense, net (803) (1,028) (2,770) (2,581)
Other (800) 515 (612) 284
- ------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) (1,603) (513) (3,382) (2,297)
- ------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 5,648 3,907 10,486 8,616
Income Tax Expense 1,638 1,118 2,977 3,164
- ------------------------------------------------------------------------------------------------------------------
Net Income $ 4,010 $ 2,789 $ 7,509 $ 5,452
==================================================================================================================
Earnings per Share - Basic $ 0.22 $ 0.15 $ 0.41 $ 0.30
Weighted Average of Shares Outstanding - Basic
(Note 5) 18,544 18,212 18,378 18,220
Earnings per Share - Diluted $ 0.20 $ 0.15 $ 0.39 $ 0.29
Weighted Average of Shares Outstanding - Diluted
(Note 5) 20,285 18,672 19,487 18,497
==================================================================================================================
3 See accompanying notes to
Consolidated Financial Statements
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands)
Other
Common Stock Additional Comprehensive Treasury Stock Total
--------------- Paid - in Accumulated Income ---------------- Stockholders'
Shares Amount Capital Deficit (Loss) Shares Amount Equity
- ------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 2003 18,363 $ 184 $ 97,338 $ (44,520) $ (210) (100) $ (567) $ 52,225
Net income 7,509 7,509
Foreign currency translation 1,241 1,241
-----------
Comprehensive income 8,750
-----------
Exercise of stock options 418 4 1,865 1,869
Original issuance discount on
Note Payable 936 936
Other 328 328
- ----------------------------------------------------------------------------------------------------------------------
Balance, October 31, 2003 18,781 $ 188 $100,467 $ (37,011) $ 1,031 (100) $ (567) $ 64,108
======================================================================================================================
4 See accompanying notes to
Consolidated Financial Statements
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine months ended October 31, 2003 2002
- -----------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 7,509 $ 5,452
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,046 2,230
Provision for losses on accounts receivable 1,588 589
Deferred income taxes (2,222) (659)
Other 1,034 (216)
Changes in assets and liabilities (excluding business acquisitions):
(Increase) decrease in accounts receivable (19,224) 9,939
Decrease in inventories 67 269
Decrease in other assets 178 2,101
Increase (decrease) in accounts payable and accrued expenses 11,261 (6,395)
- -----------------------------------------------------------------------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES 3,237 13,310
===========================================================================================================
INVESTMENT ACTIVITIES
Capital expenditures (1,434) (3,809)
Payments under magazine export agreement (1,400) -
Acquisition of Innovative Metal Fixtures, Inc. - (2,014)
Payments under magazine import agreement (1,000) (2,000)
- -----------------------------------------------------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES (3,834) (7,823)
===========================================================================================================
FINANCING ACTIVITIES
Increase in checks issued against revolving credit facilities (5,528) -
Borrowings under credit facilities (15,667) 3,268
Proceeds from the issuance of notes payable 20,000 -
Payments of notes payable (670) (3,756)
Issuance of common stock upon the exercise of stock options 1,869 -
Other - (405)
- -----------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 4 (893)
===========================================================================================================
(DECREASE) INCREASE IN CASH (593) 4,594
CASH, beginning of period 5,570 2,943
- -----------------------------------------------------------------------------------------------------------
CASH, end of period $ 4,977 $ 7,537
===========================================================================================================
5 See accompanying notes to
Consolidated Financial Statements
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated financial statements as of October 31, 2003 and 2002, include,
in the opinion of management, all adjustments (consisting of normal recurring
adjustments and reclassifications) necessary to present fairly the financial
position, results of operations and cash flows at October 31, 2003 and for all
periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these consolidated
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the year
ended January 31, 2003. The results of operations for the nine month period
ended October 31, 2003 are not necessarily indicative of the operating results
to be expected for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. BALANCE SHEET ACCOUNTS
Accounts receivable consist of the following (in thousands):
October 31, 2003 January 31, 2003
- ---------------------------------------------------------------------------------------
Accounts Receivable $ 132,339 $ 96,083
Allowance:
Sales returns and other 58,213 38,289
Doubtful accounts 4,620 5,925
- ---------------------------------------------------------------------------------------
62,833 44,214
- ---------------------------------------------------------------------------------------
$ 69,506 $ 51,869
=======================================================================================
Inventories consist of the following (in thousands):
October 31, 2003 January 31, 2003
- ---------------------------------------------------------------------------------------
Raw materials $ 1,713 $ 2,413
Work-in-process 1,596 1,752
Finished goods:
Fixtures 1,603 1,174
Magazine 10,932 10,573
- ---------------------------------------------------------------------------------------
$ 15,844 $ 15,912
=======================================================================================
The Company receives full-credit from the publisher for all undistributed and
returned magazines.
6
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. DEBT
Debt consists of (in thousands):
October 31, January 31,
2003 2003
- -------------------------------------------------------------------------------------------------
Revolving Credit Facility - Wells Fargo Foothill $ 23,802 $ -
Term Note Payable - Hilco Capital 14,064 -
Term Note Payable - Wells Fargo Foothill 5,000 -
Revolving Credit Facility - Bank of America - 26,611
Revolving Credit Facilities - Congress Financial Corporation - 12,857
Guaranteed payments under magazine export agreement (Note 4) 4,200 -
Industrial Revenue Bonds 4,000 4,000
Notes payable to former owners of acquired company, currently
being disputed by Company 1,827 1,886
Note payable to former owner of acquired company - 200
Other 214 687
- -------------------------------------------------------------------------------------------------
Total Long-term Debt 53,107 46,241
Less current maturities 4,301 29,215
- -------------------------------------------------------------------------------------------------
Long-term Debt $ 48,806 $ 17,026
=================================================================================================
Wells Fargo Foothill Credit Facility
On October 30, 2003, the Company entered into a credit agreement with Wells
Fargo Foothill. The credit agreement enables the Company to borrow up to $45.0
million under a revolving credit facility and provides a $5.0 million note
payable. The credit facility in conjunction with the Hilco Capital term note
payable was utilized to repay the Company's former credit facilities with
Congress Financial and Bank of America. The credit agreement expires on October
30, 2006.
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.0% at October 31, 2003) plus a margin up to 0.5% (the
applicable margin was 0.25% at October 31, 2003) based on an availability
calculation and carries a facility fee of 1/4% per annum on the difference
between $45 million and the average principal amount outstanding under the
facility including advances under the revolving credit facility and letter of
credits.
7
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The term note payable bears interest at a rate equal to the prime rate (4.0% at
October 31, 2003) plus 2.5%. The note is payable in equal principal installments
of $83 per month plus current interest.
Under the credit agreement, the Company is limited in its ability to declare
dividends or other distributions on capital stock or make payments in connection
with the purchase, redemption, retirement or acquisition of capital stock. There
are also limitations on capital expenditures and the Company is required to
maintain certain financial ratios. The Company was in compliance with these
ratios at October 31, 2003.
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability of $16.3 million at October 31, 2003.
Hilco Capital Note Payable
On October 30, 2003, the Company entered into a credit agreement with Hilco
Capital. The note bears a value at maturity of $15.0 million and has been
recorded net of the original issuance discount. Upon the closing of the
agreement, Hilco received a five year warrant to purchase up to 400,000 shares
of the Company's common stock at $8.04 per share. The warrants were valued at
$936 using a Black Scholes option pricing model. The value of these warrants was
recorded as an original issuance discount to the term loan and will be amortized
over the term of the loan using the effective interest method.
The note payable bears current interest at a rate equal to the greater of the
prime rate (4.0% at October 31, 2003) plus 7.75% or 12% and deferred interest of
2% due at the termination of the agreement.
Under the note payable, the Company is limited in its ability to declare
dividends or other distributions on capital stock or make payments in connection
with the purchase, redemption, retirement or acquisition of capital stock. There
are also limitations on capital expenditures and the Company is required to
maintain certain financial ratios. The Company was in compliance with these
ratios at October 31, 2003.
All fees and expenses associated with the Company's refinancing have been
recorded as deferred financing costs and will be amortized over the three year
term of the credit agreements.
The aggregate amount of long-term debt maturing in each of the next five years
is as follows:
2004 $ 2,390
2005 2,437
2006 43,139
2007 1,093
2008 47
4. BUSINESS COMBINATIONS
Innovative Metal Fixtures, Inc.
In May, 2002, the Company, through its Source Interlink Canada, Inc. (f/k/a
Aaron Wire and Metal Products, Ltd.) subsidiary, acquired all of the assets of
Innovative Metal Fixtures, Inc. for $2.6 million ($2.0 million in cash and $0.6
million in a note payable to the former owner). Innovative Metal Fixtures, Inc.
manufactures wire and metal fixture displays from manufacturing facilities in
Vancouver, British Columbia.
8
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$2.0 million. The fair value of the assets acquired was allocated primarily to
goodwill. Pro-forma results have not been shown due to the insignificance of the
acquisition.
Magazine Import Agreement
In May, 2002, the Company entered into an agreement giving the Company the right
to distribute domestically a group of foreign magazine titles. The agreement
calls for an initial payment of $2.0 million and additional contingent payments
up to $3.5 million spread over the next three years based on the overall gross
profit generated from the sale of these titles. Payments under this agreement
are included in intangible assets and are being amortized over ten years, the
term of the agreement.
Magazine Export Agreement
In March, 2003, the Company entered into an agreement giving the Company the
right to distribute internationally a group of domestic magazine titles. The
agreement calls for an initial payment of $1.4 million, guaranteed payments
totaling $4.2 million spread over the next four fiscal years, and additional
contingent payments up to $5.6 million based on the overall gross profit
generated from the Company's international sales of these titles. Guaranteed
payments under this agreement were capitalized at inception and are included in
intangible assets and are being amortized over fifteen years, the term of the
agreement. The remaining guaranteed balances due under the agreement are
included in Debt.
5. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows (in thousands):
Three Months Ended Nine Months Ended
October 31, October 31,
2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------
Basic weighted average number of common shares
outstanding 18,544 18,212 18,378 18,220
Effect of dilutive securities:
Stock options and warrants 1,741 460 1,109 277
- ----------------------------------------------------------------------------------------------------
Diluted weighted average number of common shares
outstanding 20,285 18,672 19,487 18,497
====================================================================================================
For the quarter ended October 31, 2003, stock options to purchase 866 shares and
warrants convertible into 26 shares were excluded from the calculation of
diluted income per share because their exercise/conversion price exceeded the
average market price of the common shares during the period.
9
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Nine Months Ended October 31, 2003 2002
- -----------------------------------------------------------------------------
Interest $ 2,524 $ 2,420
Income Taxes $ (875) $ 2,548
=============================================================================
In connection with the magazine export agreement, discussed in Note 4, a
liability of $4.2 million was recognized for guaranteed payments owed under the
agreement.
In connection with the closing of the Wells Fargo Foothill credit facility, the
outstanding balances (including any accrued but unpaid interest and fees) with
Bank of America and Congress Financial were paid in full. Proceeds from the
closing of the facility were less certain third party expenses and closing fees.
The termination of our existing facilities resulted in a write-off of the
related deferred loan charges of $865.
The Hilco Financial note is recorded net of the original issuance discount
related to the 400,000 warrants (total value at $936) issued upon close.
7. STOCK OPTION PLANS
FAS No. 123, "Accounting for Stock-Based Compensation" defined a fair value
method of accounting for stock options and other equity instruments. Under the
fair value method, compensation cost is measured at the grant date based on the
fair value of the award and is recognized over the service period, which is
usually the vesting period. As provided in FAS No. 123, the Company elected to
apply Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans. No stock
based compensation was reflected in the period ended October 31, 2003 and 2002
as all options granted in those years had an exercise price equal to or greater
than the market value of the underlying stock on the date of grant.
The following is a reconciliation of net income per weighted average share had
the Company adopted FAS No. 123 (table in thousands except per share amounts):
Three Months Ended Nine Months Ended
October 31, October 31,
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------
Net income $ 4,010 $ 2,789 $ 7,509 $ 5,452
Stock compensation costs, net of tax (320) (548) (960) (1,644)
--------- ---------- --------- -----------
Adjusted net income $ 3,690 $ 2,241 $ 6,549 $ 3,808
--------- ---------- --------- -----------
Weighted average shares, basic 18,544 18,212 18,378 18,220
Weighted average shares, diluted 20,285 18,672 19,487 18,497
Basic earnings per share - as reported $ 0.22 $ 0.15 $ 0.41 $ 0.30
Diluted earnings per share - as reported $ 0.20 $ 0.15 $ 0.39 $ 0.29
10
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Basic earnings per share - pro-forma $ 0.20 $ 0.12 $ 0.36 $ 0.21
Diluted earnings per share - pro-forma $ 0.18 $ 0.12 $ 0.34 $ 0.21
=======================================================================================================
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
January 31, 2004 2003
- ----------------------------------------------------------------------------
Dividend yield 0% 0%
Expected volatility 0.50 0.60
Risk-free interest rate 2.16% 3.27% - 4.78%
===========================================================================
8. SEGMENT FINANCIAL INFORMATION
The Company's segment reporting is based on the reporting of senior management
to the Chief Executive Officer. This reporting combines the Company's business
units in a logical way that identifies business concentrations and synergies.
Presentation has been modified from the prior year from pre-tax income to
operating income to conform to how financial results are presented to the Chief
Executive Officer.
The reportable segments of the Company are Magazine Fulfillment, In-Store
Services, Wood Manufacturing and Shared Services.
The Magazine Fulfillment segment derives revenues from (1) selling and
distributing magazines, including domestic and foreign titles, to major
specialty retailers and wholesalers throughout the United States and Canada, (2)
exporting domestic titles internationally to foreign wholesalers or through
domestic brokers (3) serving as a secondary national distributor, (4) providing
return processing services for major specialty retail book chains and (5)
serving as an outsourced fulfillment agent.
The In-Store Services segment derives revenues from (1) designing,
manufacturing, and invoicing participants in front-end fixture programs, (2)
providing claim filing services related to rebates owed retailers from
publishers or their designated agent (3) shipping, installation and removal of
front-end fixtures, and (4) providing information and management services
relating to retail magazine sales to U.S. and Canadian retailers and magazine
publishers.
The Wood Manufacturing segment derives revenues from designing, manufacturing
and installing high-end wood store fixtures primarily for specialty retailers
and department stores.
Shared Services consists of overhead functions not allocated to individual
operating segments. Previously, the majority of these expenses were included in
the In-Store Services segment. Comparable information is not available and not
presented for the prior fiscal year.
11
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Segment results follow (in thousands):
Magazine In-Store Wood Other
Three Months Ended October 31, 2003 Fulfillment Services Manufacturing (Shared Services) Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Revenue $ 68,068 $ 17,212 $ 6,744 $ - $ 92,024
Cost of Revenue 52,008 9,460 5,761 - 67,229
-------------------------------------------------------------------------------
Gross Profit 16,060 7,752 983 - 24,795
Selling, General & Administrative 7,026 2,061 322 3,619 13,028
Fulfillment Freight 4,516 - - - 4,516
-------------------------------------------------------------------------------
Operating Income $ 4,518 $ 5,691 661 $ (3,619) $ 7,251
===============================================================================
Total Assets $ 52,707 $ 82,989 17,439 $ 27,715 $ 180,850
===============================================================================
Magazine In-Store Wood Other
Nine Months Ended October 31, 2003 Distribution Services Manufacturing (Shared Services) Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Revenue $ 197,719 $ 45,861 $ 14,615 $ - $ 258,195
Cost of Revenue 151,268 25,963 12,608 - 189,839
-------------------------------------------------------------------------------
Gross Profit 46,451 19,898 2,007 - 68,356
Selling, General & Administrative 21,384 6,404 1,074 10,901 39,763
Fulfillment Freight 12,995 - - - 12,995
Relocation Expense 1,654 - - 76 1,730
-------------------------------------------------------------------------------
Operating Income $ 10,418 $ 13,494 933 $ (10,977) $ 13,868
===============================================================================
12
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following segment results are reported under the segment reporting effective
for the prior year:
Magazine In-Store Wood
Three Months Ended October 31, 2003 Fulfillment Services Manufacturing Consolidated
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 68,068 $ 17,212 $ 6,744 $ 92,024
Cost of Revenue 52,008 9,460 5,761 67,229
-----------------------------------------------------------------------
Gross Profit 16,060 7,752 983 24,795
Selling, General & Administrative 7,026 5,680 322 13,028
Fulfillment Freight 4,516 - - 4,516
-----------------------------------------------------------------------
Operating Income $ 4,518 $ 2,072 $ 661 $ 7,251
=======================================================================
Total Assets $ 52,707 $ 110,704 $ 17,439 $ 180,850
=======================================================================
Magazine In-Store Wood
Three Months Ended October 31, 2002 Fulfillment Services Manufacturing Consolidated
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 57,562 $ 18,462 $ 4,918 $ 80,942
Cost of Revenue 44,613 11,664 4,471 60,748
-----------------------------------------------------------------------
Gross Profit 12,949 6,798 447 20,194
Selling, General & Administrative 6,012 4,630 399 11,041
Fulfillment Freight 4,119 - - 4,119
Relocation Expense 44 570 - 614
-----------------------------------------------------------------------
Operating Income $ 2,774 $ 1,598 $ 48 $ 4,420
=======================================================================
Total Assets $ 39,536 $ 102,910 $ 19,728 $ 162,174
=======================================================================
Magazine In-Store Wood
Nine Months Ended October 31, 2003 Fulfillment Services Manufacturing Consolidated
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 197,719 $ 45,861 $ 14,615 $ 258,195
Cost of Revenue 151,268 25,963 12,608 189,839
-----------------------------------------------------------------------
Gross Profit 46,451 19,898 2,007 68,356
Selling, General & Administrative 21,384 17,305 1,074 39,763
Fulfillment Freight 12,995 - - 12,995
Relocation Expense 1,654 76 - 1,730
-----------------------------------------------------------------------
Operating Income $ 10,418 $ 2,517 933 $ 13,868
=======================================================================
Magazine In-Store Wood
Nine Months Ended October 31, 2002 Fulfillment Services Manufacturing Consolidated
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 161,164 $ 45,531 $ 14,856 $ 221,551
Cost of Revenue 126,428 26,161 12,347 164,936
-----------------------------------------------------------------------
Gross Profit 34,736 19,370 2,509 56,615
Selling, General & Administrative 17,667 14,058 1,260 32,985
Fulfillment Freight 11,112 - - 11,112
Relocation Expense 43 1,562 - 1,605
-----------------------------------------------------------------------
Operating Income $ 5,914 $ 3,750 $ 1,249 $ 10,913
=======================================================================
13
9. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
requires that certain financial instruments, which under previous guidance were
accounted for as equity, must now be accounted for as liabilities. The financial
instruments affected include mandatory redeemable stock, certain financial
instruments that require or may require the issuer to buy back some of its
shares in exchange for cash or other assets and certain obligations that can be
settled with shares of stock. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of this standard did not have a material impact on our
consolidated financial statements.
In November 2002, the Emerging Issues Task Force ("EITF") reached consensus on
EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables",
which addresses how to account for arrangements that may involve the delivery or
performance of multiple products, services, and/or rights to use assets. The
final consensus of EITF 00-21 was applicable to agreements entered into in
fiscal periods beginning after June 15, 2003, with early adoption permitted.
Additionally, companies were permitted to apply the consensus guidance to all
existing arrangements as the cumulative effect of a change in accounting
principle in accordance with APB Opinion No. 20, "Accounting Changes." The
adoption of EITF No. 00-21 did not have a material impact on the Company's
results of operations or financial condition.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Some of the information in this quarterly report contains forward-looking
statements that involve risks and uncertainties within the meaning of Section
27A of the Securities Act of 1933. The words "believe," "expect," "anticipate,"
"estimate," "project," and similar expressions often characterize
forward-looking statements. These statements may include, but are not limited
to, projections of collections, revenues, income or loss, estimates of capital
expenditures, plans for future operations, products or services, and financing
needs or plans, as well as assumptions relating to these matters. These
statements are only predictions and you should not unduly rely on them. Our
actual results will differ, perhaps materially, from those anticipated in these
forward-looking statements as a result of a number of factors, including the
risks and uncertainties faced by us described below and elsewhere in this
report:
- market acceptance of and continuing demand for our services;
- the impact of competitive services;
- the pricing and reimbursement policies of magazine publishers;
- our ability to obtain additional financing to support our
operations;
- changing market conditions and other risks detailed below;
- demand for magazines at the retailers we service; and
- our ability to access retailer's point-of-sale information
needed to efficiently allocate distribution.
OVERVIEW
Our business consists of four business segments: Magazine Fulfillment, In-Store
Services, Wood Manufacturing and Shared Services. Our segment reporting is
structured based on the reporting of senior management to the Chief Executive
Officer.
- The Magazine Fulfillment group uses our proprietary order
regulation technology to manage the distribution of magazines
to 25 retail chains and 1,700 independent retailers with over
5,300 retail outlets in the specialty retail market. We assist
retailers with the selection, logistical procurement and
fulfillment of approximately 4,000 monthly and 50 weekly
magazine titles from over 560 publishers. The group was
established in May 2001 with the acquisition of the Interlink
Companies, Inc., or Interlink, and its two operating
subsidiaries: International Periodical Distributors, Inc., or
IPD, and David E. Young, Inc., or Deyco.
14
- The In-Store Services group assists retailers with the design
and implementation of their front-end area merchandising
programs. We provide other value-added services to retailers,
publishers and other vendors. These services include assisting
retailers with the filing of publisher rebates and other fee
collection efforts, and providing publishers with access to
real-time sales information on more than 10,000 magazine
titles, thereby enabling them to make more informed decisions
regarding their product placement, cover treatments and
distribution efforts.
- The Wood Manufacturing group designs and manufactures wood
display and store fixtures for leading specialty retailers.
- The Shared Services group consists of overhead functions not
allocated to the other groups. These functions include
Corporate Finance, Human Resource, MIS and Executive Offices
that are not allocated to the operating divisions. Prior to
fiscal 2004, the majority of the expenses relating to these
functions were included in the In-Store Services group.
Comparable information is not available and not presented for
prior fiscal years.
Revenues
The Magazine Fulfillment group derives revenues from:
- selling and distributing magazines, including domestic and
foreign titles, to major specialty retailers and wholesalers
throughout the United States and Canada;
- exporting domestic titles internationally to foreign
wholesalers or through domestic brokers;
- serving as a secondary national distributor;
- providing return processing services for major specialty
retail book chains; and
- serving as an outsourced fulfillment agent.
The In-Store Services group derives revenues from:
- designing, manufacturing and invoicing participants in
front-end merchandising programs;
- providing claim filing services related to rebates owed
retailers from publishers or their designated agents;
- shipping, installing and removing front-end fixtures; and
- providing information and management services relating to
magazine sales to retailers and publishers throughout the
United States and Canada.
The Wood Manufacturing group derives revenues from designing, manufacturing and
installing custom wood fixtures primarily for retailers.
Cost of Revenues
Our cost of revenues for the Magazine Fulfillment group consists of the costs of
magazines purchased for resale.
Our cost of revenues for the In-Store Services and the Wood Manufacturing groups
includes:
- raw materials consumed in the production of display fixtures;
- production labor; and
- manufacturing overhead.
15
Selling, general and administrative
Selling, general and administrative expenses for each of the operating groups
include:
- non-production labor;
- rent and office overhead;
- insurance;
- professional fees;
- computer related expenses.
Expenses associated with corporate finance, human resources, management
information systems and executive offices are included within the Shared
Services group and are not allocated to the other groups.
Fulfillment Freight
Fulfillment freight consists of our direct costs of distributing magazines by
third-party freight carriers, primarily Federal Express ground service. Freight
rates are driven by the weight of the copies being shipped and the distance
between origination and destination.
Relocation Expenses
Relocation expenses consist of the cost of transferring existing employees and
offices from their existing locations in High Point, North Carolina, St. Louis,
Missouri and San Diego, California to our new offices in Bonita Springs,
Florida. This relocation program began in fiscal 2003 and was completed in
fiscal 2004.
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations expressed by segment (all discussion of results express
dollars in thousands):
THREE MONTHS ENDED OCTOBER 31, 2003 2002
----------------------------------------
Revenues $ 92,024 $ 80,942
Cost of Revenues 67,229 60,748
----------------- ------------------
Gross Profit 24,795 20,194
Selling, General and Administrative Expense 13,028 11,041
Fulfillment Freight 4,516 4,119
Relocation Expenses - 614
----------------- ------------------
Operating Income 7,251 4,420
Interest Expense (803) (1,028)
Other (Expense) Income (800) 515
----------------- ------------------
Income Before Taxes 5,648 3,907
Income Tax Expense 1,638 1,118
----------------- ------------------
Net Income $ 4,010 $ 2,789
=============================================================================================================
Gross Profit Margin 26.9% 24.9%
Selling, General and Administrative Expense (% of Revenue) 14.2% 13.6%
Relocation Expenses (% of Revenue) 0.0% 0.8%
Operating Profit Margin 7.9% 5.5%
Operating Profit Margin (excluding Relocation) 7.9% 6.3%
=============================================================================================================
16
NINE MONTHS ENDED OCTOBER 31, 2003 2002
----------------------------------------
Revenues $ 258,195 $ 221,551
Cost of Revenues 189,839 164,936
----------------- ------------------
Gross Profit 68,356 56,615
Selling, General and Administrative Expense 39,763 32,985
Fulfillment Freight 12,995 11,112
Relocation Expenses 1,730 1,605
----------------- ------------------
Operating Income 13,868 10,913
Interest Expense (2,770) (2,581)
Other (Expense) Income (612) 284
----------------- ------------------
Income Before Taxes 10,486 8,616
Income Tax Expense 2,977 3,164
----------------- ------------------
Net Income $ 7,509 $ 5,452
=============================================================================================================
Gross Profit Margin 26.5% 25.6%
Selling, General and Administrative Expense (% of Revenue) 15.4% 14.9%
Relocation Expenses (% of Revenue) 0.7% 0.7%
Operating Profit Margin 5.4% 4.9%
Operating Profit Margin (excluding Relocation) 6.1% 5.6%
=============================================================================================================
THREE MONTH PERIOD ENDED OCTOBER 31, 2003 COMPARED TO THREE MONTH PERIOD ENDED
OCTOBER 31, 2002
Revenues
Revenues for the quarter increased $11,082 or, 13.7%, over the comparable
quarter of the prior year due primarily to an increase in revenue in our
Magazine Fulfillment group.
Revenues in our Magazine Fulfillment group increased $10,506, or 18.3%, due to
revenue from our magazine export group, which began operations in March 2003, an
increase in distribution of foreign titles, an increase in the number of
publishers whose titles we distribute to our specialty retail customers, an
increase in the number of retailers and retail outlets we service and an
increase in the level of retail sales at the outlets we service.
Revenues in our In-Store Services group decreased $1,250, or 6.8%, primarily due
to a decrease in our wire manufacturing revenues partially offset by a
significant increase in freight revenue as we shipped a large number of fixtures
being held for one of our significant customers.
Revenues in our Wood Manufacturing group increased $1,826, or 37.1%, due to an
increase in the expansion and remodel program of a significant customer and an
increase in the number of customers.
Gross profit
Gross profit for the quarter increased $4,601, or 22.8%, over the comparable
quarter of the prior year due primarily to an increase in gross profit in our
Magazine Fulfillment group.
Gross profit margins increased 2.0% in the current quarter over the comparable
period of the prior year. Margins improved in our Magazine Fulfillment, In-Store
Services, and Wood Manufacturing groups by 1.1%, 8.2%, and 5.5%, respectively.
17
Gross profit in our Magazine Fulfillment group increased due to both the
increase in revenue described above as well as improving margins. The increase
in margins in our Magazine Fulfillment group resulted from a shift in product
mix from low margin domestic titles to higher margin foreign titles.
Gross profit in our In-Store Services group increased despite the decrease in
revenue described above due to an increase in our profit margins. The improved
profit margins resulted from reductions in the cost of providing our claim
filing services due to system improvements implemented during our relocation to
Florida and a higher percentage of revenue derived from our higher margin
services rather than wire manufacturing.
Gross profit in our Wood Manufacturing group increased due to the increase in
revenue described above and an increase in our profit margins. The improved
profit margins resulted from reductions in costs due to the shifting of the
production and production capacity from our manufacturing facility in Nevada to
our manufacturing facility in North Carolina.
Selling, general and administrative expenses
Selling, general and administrative expenses increased $1,987, or 18.0%,
compared to the comparable three month period of the prior year. The increase
resulted from the growth in our Magazine Fulfillment group and an increase in
the expenses that are now accounted for under our Shared Services group.
The increase in these expenses for our Magazine Fulfillment group relates
primarily to the inception of our magazine export business, which occurred in
March 2003, and an overall increase in our back office operation to support our
increase in distribution.
The increase in our Shared Services resulted from the overall growth in our
businesses.
Fulfillment freight
Fulfillment freight expenses increased $397 or 9.6% compared to the comparable
quarter of the prior year due to growth in our Magazine Fulfillment group.
Freight as a percentage of the Magazine Fulfillment group revenues decreased
from 7.2% to 6.6% due to improvement in the efficiency of our distribution
model.
Relocation
During the three months ended October 31, 2003, we relocated our claim
submission and fixture billing center in High Point, North Carolina to Bonita
Springs, Florida. The total expense recorded for the three months ended October
31, 2003 related to this relocation was $614.
Operating income
Operating income in the quarter increased $2,831, or 64.1%, compared to the
prior year due to the factors described above.
Operating profit margins improved from 5.5% to 7.9% in the current quarter
compared to the comparable quarter of the prior year. The increase was due to
the improvement in our gross profit margins and the non-recurring relocation
expenses in the third quarter of the prior year, partially offset by the
increase in our selling, general, and administrative expenses as a percent of
revenues.
18
Interest Expense
Interest and related expenses relate primarily to our significant debt
instruments, which until October 31, 2003 consisted of our former revolving
line-of-credit with Bank of America, our credit facilities with Congress
Financial, our Industrial Revenue Bonds related to our Rockford, Illinois
manufacturing facility and debt to prior owners of an acquired company.
On October 30, 2003, the Company obtained new financing (see Note 3 to condensed
financial statements).
Other Expense (Income)
Other expense (income) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
Other expense during the current three month period included a charge of $865
related to the write-off of deferred financing fees associated with our former
credit facilities with Bank of America and Congress Financial in conjunction
with the Company's refinancing of this debt.
Income tax expense
The effective income tax rates were 29.0% and 28.6% for the quarter ended
October 31, 2003 and 2002, respectively.
The difference between the statutory rate and effective tax rate relates
primarily to the realization of a portion of the net operating loss carryforward
acquired as part of our acquisition of Interlink.
NINE MONTH PERIOD ENDED OCTOBER 31, 2003 COMPARED TO NINE MONTH PERIOD ENDED
OCTOBER 31, 2002
Revenues
Revenues for the period increased $36,644, or 16.5%, over the comparable nine
months of the prior year due primarily to an increase in revenue in our Magazine
Fulfillment group.
Revenues in our Magazine Fulfillment group increased $36,555, or 22.7%, due to
revenues from our magazine export group, which began operations in March 2003,
an increase in distribution of foreign titles, an increase in the number of
publishers (i.e., titles) we distribute to our specialty retail customers, an
increase in the number of retailers and retail outlets we service and an
increase in the level of retail sales at the outlets we service.
Revenues in our In-Store Services group and Wood Manufacturing group did not
change significantly compared to the comparable period of the prior year.
Gross profit
Gross profit for the period increased $11,741, or 20.7%, over the comparable
period of the prior year due primarily to an increase in gross profit in our
Magazine Fulfillment.
Gross profit margins increased 0.9% in the current period over the comparable
period of the prior year. Margins improved (declined) in our Magazine
Fulfillment, In-Store Services, and Wood Manufacturing by 1.9%, 0.8%, and
(3.2)%, respectively.
19
Gross profit in our Magazine Fulfillment group increased due to both the
increase in revenue described above as well as improving margins. The increase
in margins in our Magazine Fulfillment group resulted from a shift in product
mix from lower margin domestic titles to higher margin foreign titles.
Gross profit in our In-Store Services and Wood Manufacturing did not change
significantly compared to the comparable period of the prior year.
Selling, general and administrative expenses
Selling, general and administrative expenses increased $6,778, or 20.6%,
compared to the comparable period of the prior year. The increase resulted from
the growth in our Magazine Fulfillment group and an increase in the expenses
that now are accounted for under our Shared Services group.
The increase in our Magazine Fulfillment group relate primarily to the inception
of our magazine export business, which occurred in March 2003, and an overall
increase in our back office operation to support our increase in distribution.
The increase in our Shared Services resulted from the overall growth in our
businesses.
Fulfillment freight
Fulfillment freight expenses increased $1,883, or 17.0%, compared to the
comparable period of the prior year due to growth in our Magazine Fulfillment
group. Freight as a percentage of the Magazine Fulfillment groups revenues
decreased from 6.9% to 6.6% due to improvement in the efficiency of our
distribution model.
Relocation
During the nine month period ended October 31, 2003, we relocated our magazine
distribution back office from San Diego, California to Bonita Springs, Florida.
The total expense recorded in the period related to this relocation was $1,730.
During the nine month period ended October 31, 2002, we relocated our claim
submission and fixture billing center in High Point, North Carolina to Bonita
Springs, Florida. The total expense recorded in the period related to this
relocation was $1,605.
Operating income
Operating income in the nine month period increased $2,955, or 27.1%, compared
to the prior year due to the factors described above.
Operating profit margins improved from 4.9% to 5.4% in the current period
compared to the comparable period of the prior year. The increase was due to the
improvement in our gross profit margins partially offset by the increase in our
selling, general, and administrative expenses as a percent of revenues.
Interest Expense
Interest and related expenses relate primarily to our significant debt
instruments, which consist of our former revolving line-of-credit with Bank of
America, our credit facilities with Congress Financial, our Industrial Revenue
Bond related to our Rockford, Illinois manufacturing facility and debt to prior
owners of Interlink.
20
Other Expense (Income)
Other expense (income) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
Other expense in the current period includes a charge of $865 related to the
refinancing of our senior credit facilities.
Income tax expense
The effective income tax rates were 28.4% and 36.8% for the nine months ended
October 31, 2003 and 2002, respectively.
The difference between the statutory rate and effective tax rates relates
primarily to the realization of a portion of the net operating loss carryforward
acquired with our acquisition of Interlink.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of cash includes receipts from our customers and borrowings
under our credit facilities.
Our primary cash requirements for the Magazine Fulfillment group are the cost of
magazines and the cost of freight, labor and facility expense associated with
our distribution centers.
Our primary cash requirements for the In-Store Services group are the cost of
raw materials, labor, and factory overhead incurred in the production of
front-end displays, the cost of labor incurred in providing our claiming, design
and information services and cash advances funding our Advance Pay program. Our
Advance Pay program allows retailers to accelerate collections of their rebate
claims through payments from us in exchange for the transfer to us of the right
to collect the claim. We then collect the claims when paid by publishers for our
own account.
Our primary cash requirements for the Wood Manufacturing group are for
purchasing materials, the cost of labor, and factory overhead incurred in the
manufacturing process.
Our primary cash requirements for the Shared Services group are for salaries,
professional fees and insurance not allocated to the operating divisions.
Net cash provided by operating activities was $3,237 and $13,310 for the nine
month periods ended October 31, 2003 and 2002, respectively.
Operating cash flows in the first nine months of fiscal year 2004 were primarily
from net income ($7,509), adding back non-cash charges including depreciation
and amortization ($3,046), provisions for losses on accounts receivable
($1,588), and a significant increase in accounts payable ($11,261). These cash
providing activities were offset by a significant increase in accounts
receivable ($19,224).
The increase in accounts receivable and accounts payable related primarily to
the magazine export agreement and the inception of that business. The magazine
export agreement allowed us to become a leading exporter of domestic titles to
wholesalers overseas. Magazine are purchased directly from domestic publishers
and sold on extended terms to foreign distribution agents who distribute the
magazines to retailers in their geographic territories. The inception of this
business resulted in an increase in accounts receivable and an increase in
accounts payable. The first nine months of the current year includes eight
months of operations from this business and only five months of cash collections
due to standard payment terms of 90 days, which is typical for this segment of
the industry.
21
Operating cash flows in the first nine months of fiscal year 2003 were primarily
from net income ($5,452), adding back non-cash charges including depreciation
and amortization ($2,230), provisions for losses on accounts receivable ($589),
and a significant decrease in accounts receivable ($9,939). These cash providing
activities were offset by a significant decrease in accounts payable ($6,395).
The decrease in accounts receivable during the first nine months of fiscal 2003
related primarily to an unusually high level of accounts receivable as of the
beginning of the fiscal year returning to more normal levels. Improved cash
collections allowed us to significantly reduce payables.
Net cash used in investing activities was $3,834 and $7,823 for the nine month
period ended October 31, 2003 and 2002, respectively.
Investing activities in the first nine months of fiscal year 2004 consisted
primarily of the initial payment under the magazine export agreement, a
contingent payment under the magazine import agreement and capital expenditures.
Investing activities in the first nine months of fiscal year 2003 consisted of
capital expenditures, our acquisition of a wire manufacturing company in
Vancouver, British Columbia and our acquisition of a customer list of foreign
magazine publishers.
Our borrowing agreements limit the amount we can expend on capital expenditures
in any fiscal year.
Net cash provided by (used in) financing activities were $4 and $(893) for the
nine months ended October 31, 2003 and 2002, respectively.
Financing activities in the first nine months of fiscal year 2004 consisted
primarily of the refinancing or our existing credit facilities and proceeds from
the issuance of our equity securities under our employee stock option plans.
Financing activities in the first nine months of fiscal year 2003 consisted
primarily of borrowing against our credit facilities, payment under debt
obligations and the purchase of treasury stock.
Outstanding balances on our credit facility fluctuate partially due to the
timing of the retailer rebate claiming process and our Advance Pay program, the
seasonality of our wire manufacturing business, and the payment cycle of the
magazine distribution business.
Payments under our Advance Pay program generally occur just prior to our fiscal
quarter end. The related claims are not collected by us for the most part until
90 days after the advance is made. As a result, our funding requirement peak at
the time of the initial advances and decrease over the next 90 days as the cash
is collected on the related claims.
The wire manufacturing is seasonal because most retailers prefer initiating new
programs before the holiday shopping season begins, which concentrates revenues
in the second and third quarter. Receivables from these fixture programs are
generally collected from all participants within 120 days. We are usually
required to tender payment on the costs of these programs (raw material and
labor) within a shorter period. As a result, our funding requirements peak in
the second and third fiscal quarters when we manufacture the wire fixtures and
decreases significantly in the fourth and first fiscal quarters as the related
receivable are collected and significantly less manufacturing activity is
occurring.
22
Our magazine distribution business is unique in that our significant customers
pay weekly and we pay our suppliers monthly. As a result, funding requirements
peak at the end of the month when supplier payments are made and decrease over
the course of the next month as our receivables are collected.
At October 31, 2003, our total debt obligations were $53,107, excluding
outstanding letters of credit. Debt consists of our revolving credit facility
with Wells Fargo Foothill that we use to fund our short-term financing needs,
long-term notes to Wells Fargo Foothill and Hilco Capital, an Industrial Revenue
Bond connected to our manufacturing facility in Illinois, amounts owed related
to the magazine export agreement, and a note payable to the former owners of an
acquired company.
On October 30, 2003, we entered into a credit agreement with Wells Fargo
Foothill. The credit agreement enables us to borrow up to $45.0 million under a
revolving credit facility and provides a $5.0 million note payable. The credit
agreement expires on October 30, 2006.
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.0% at October 31, 2003) plus up to .5% based on an
availability calculation and carries a facility fee of 1/4% per annum on the
difference between $45 million and the average principal amount outstanding
under the facility including advances under the revolving credit facility and
letter of credits.
Availability under the revolving facility is limited by a borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability of $16.3 million at October 31, 2003.
The term note payable bears interest at a rate equal to the prime rate (4.0% at
October 31, 2003) plus 2.5%. The note is payable in equal principal installments
of $83 per month plus current interest.
Under the credit agreement, we are limited in our ability to declare dividends
or other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. There are also
limitations on capital expenditures and we are required to maintain certain
financial ratios. We were in compliance with these ratios at October 31, 2003.
On October 30, 2003, we entered into a credit agreement with Hilco Capital LP.
The notes has a face value of $15.0 million note payable and has been recorded
net of the original issuance discount ($963) related to the fair value of the
warrants issued concurrently with the issuance of the notes. The note payable
bears current interest at a rate equal to the greater of the prime rate (4.0% at
October 31, 2003) plus 7.75% or 12% and deferred interest of 2% due at the
termination of the agreement.
Under the note payable, we are limited in our ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. There are also
limitations on capital expenditures and we are required to maintain certain
financial ratios. We were in compliance with these ratios at October 31, 2003.
On January 30, 1995, the City of Rockford, Illinois issued $4.0 million of its
Industrial Project Revenue Bonds, Series 1995, and the proceeds were deposited
with the Amalgamated Bank of Chicago, as trustee. The proceeds of the issuance
were utilized to construct our manufacturing facility in Rockford, Illinois.
Bank of America ("the Bank") has issued an unsecured letter of credit for $4.1
million in connection with the Industrial Revenue Bond. The bonds are secured by
the trustee's indenture and the letter of credit. The bonds bear interest at a
variable weekly rate (approximately 80% of the Treasury Rate) not to exceed 15%
per annum. The bonds mature on January 1, 2030. Fees related to the letter of
credit are .75% per annum of the outstanding bond principal plus accrued
interest.
23
Amounts owed related to the magazine export agreement consist of 12 quarterly
payments of $350 beginning in January 2004.
A note payable in the principal amount of $1.9 million to the previous owner of
an acquired company is past due and is being disputed under the conditions of
the acquisition agreement.
We believe that our cash flow from operations together with our revolving credit
facilities will be sufficient to fund our working capital needs and capital
expenditures for the foreseeable future.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Senior Management has discussed the development, selection and
disclosure of these estimates with the Audit Committee of the Board of
Directors. Actual results may differ from these estimates under different
assumptions and conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.
Revenue Recognition
We record a reduction in revenue for estimated magazine sales returns and a
reduction in cost of sales for estimated magazine purchase returns. Estimated
sales returns are based on historical sales returns and daily point-of-sale data
from significant customers. The purchase return estimate is calculated from the
sales return reserve based on historical gross profit. If the historical data we
use to calculate these estimates does not properly reflect future results,
revenue and/or cost of sales may be misstated.
Allowance for Doubtful Accounts
We provide for potential uncollectible accounts receivable based on
customer-specific information and historical collection experience. If market
conditions decline, actual collection experience may not meet expectations and
may result in increased bad debt expenses.
Taxes on Earnings
The carrying value of our net deferred tax assets assumes that we will be able
to generate sufficient future taxable income in certain tax jurisdictions, based
on estimates and assumptions. If these estimates and assumptions change in the
future, we may be required to increase or decrease valuation allowances against
its deferred tax assets resulting in additional income tax expenses or benefits.
Valuation of Long-Lived Assets Including Goodwill and Purchased Intangible
Assets
We review property, plant and equipment, goodwill and purchased intangible
assets for impairment whenever events or changes in circumstances indicate the
carrying value of an asset may not be recoverable. Our asset
24
impairment review assesses the fair value of the assets based on the future cash
flows the assets are expected to generate. An impairment loss is recognized when
estimated discounted future cash flows expected to result from the use of the
asset plus net proceeds expected from the disposition of the asset (if any) are
less than the carrying value of the asset. This approach uses our estimates of
future market growth, forecasted revenue and costs, expected periods the asset
will be utilized and appropriate discount rates. Such evaluations of impairment
of long-lived assets including goodwill and purchased intangible assets are an
integral part of, but not limited to, our strategic reviews of our business and
operations. Deterioration of our business overall or within a business segment
in the future could also lead to impairment adjustments as such issues are
identified.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability.
Our debt relates primarily to credit facilities with Wells Fargo Foothill and a
note payable to Hilco Capital.
The revolving credit facility with Wells Fargo Foothill has an outstanding
principal balance of approximately $23.8 million as of October 31, 2003.
Interest on the outstanding balance is charged based on a variable interest rate
related to the prime rate (or LIBOR) plus a margin specified in the credit
agreement.
The term note payable with Wells Fargo Foothill has an outstanding principal
balance of $5.0 million as of October 31, 2003. Interest on the outstanding
balance is charged based on a variable interest rate related to prime rate plus
a margin specified in the credit agreement.
The term note payable with Hilco Capital has a principal amount payable at
maturity of $15.0 million as of October 31, 2003. Interest on the outstanding
balance is charged based on a variable interest rate related to the prime rate
plus a margin specified in the credit agreement.
Interest expense from these two facilities is subject to market risk in the form
of fluctuations in interest rates.
We do not perform any interest rate hedging activities related to these two
facilities.
We have exposure to foreign currency fluctuations through our operations in
Canada. These operations accounted for approximately $1.5 million or 1.6% of our
third quarter revenues. In addition, we generally pay operating expenses in the
corresponding local currency and will be subject to increased risk for exchange
rate fluctuations between such local currency and the dollar.
Additionally, we have exposure to foreign currency fluctuation through our
purchase of magazines from foreign publishers and sale of domestic magazine
titles to foreign wholesalers. Foreign magazines are purchased in foreign
currency (primarily Euros) and sold domestically in US$. Domestic magazines are
purchased in US$ and in some instances sold internationally in local currency. A
significant change in the relative strength of the US$ could have a significant
impact on the sales of these magazines at retail and on our results of
operations.
We do not conduct any significant hedging activities related to foreign
currency.
25
ITEM 4. CONTROLS AND PROCEDURES
Our principal executive officer and principal financial officer, with the
participation of management, evaluated our disclosure controls and procedures as
of October 31, 2003. Based on that evaluation, our principal executive officer
and principal financial officer concluded our disclosure controls and procedures
were, as of October 31, 2003, (i) designed to ensure that material information
relating to us, and our consolidated subsidiaries, is made known to our
principal executive officer and principal financial officer by others within
those entities, particularly during the period in which this report was being
prepared, and (2) effective, in that they provide reasonable assurance that
information required to be disclosed by us in the reports that we file or submit
under the Securities Exchange Act are recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. There
have not been changes in our internal control over financial reporting that
occurred during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
26
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to routine legal proceedings arising out of the normal
course of business. Although it is not possible to predict with certainty the
outcome of these unresolved legal actions or the range of possible loss, the
Company believes that none of these actions, individually or in the aggregate,
will have a material adverse affect on the financial condition or results of
operations of the Company.
ITEM 2. CHANGES IN SECURITIES
As of August 29, 2003, the Company issued to Phoenix Media Group, LLC a warrant
to acquire 75,000 shares of the Company's common stock for a purchase price of
$8.01 per share, the prevailing market price of the Company's common stock on
the date the warrant was issued. The warrant provides that it may be exercised
as to 25,000 shares immediately, as to an additional 25,000 shares after
September 1, 2004 and as to the remaining 25,000 shares after September 1, 2005.
The warrant expires on August 29, 2013, unless sooner terminated as the result
of the occurrence of certain specified events. The warrant was issued in
conjunction with the execution and delivery of a service agreement in reliance
on Section 4(2) of the Securities Act of 1933, as amended.
As of October 23, 2003, the Company issued to Melvyn Phillips, the Managing
Director of one of the Company's subsidiaries, a warrant to acquire 150,000
shares of the Company's common stock for a purchase price of $6.82 per share.
The warrant provides that it may be exercised as to 50,000 shares after October
1, 2004, as to an additional 50,000 shares after October 1, 2005 and as to the
remaining 50,000 shares after October 1, 2006. The warrant expires on October
23, 2013, unless sooner terminated as the result of the occurrence of certain
specified events. The warrant was issued as additional compensation for Mr.
Phillips services to the Company's subsidiary in reliance on Regulation S under
the Securities Act of 1933, as amended.
As of October 30, 2003, the Company issued to Hilco Capital, LP warrants (the
"Warrants") to purchase an aggregate of 400,000 shares of the Company's common
stock, $0.01 par value per share. The Warrants entitled the holder to purchase
shares of the Company's common stock for a purchase price of $8.04 per share at
any time after issuance and before October 30, 2008. The number of shares
issuable upon exercise of the Warrants and the applicable purchase price are
subject to adjustment upon the occurrence of certain dilutive and organic
events. The Warrants were issued in conjunction with the establishment of a
junior secured credit facility in reliance on Section 4(2) of the Securities Act
of 1933, as amended.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
See Exhibit Index
(b) Reports on Form 8-K.
On September 22, 2003, the Company filed a Current Report on
Form 8-K under Item 12 thereof disclosing the Company's public
announcement of the results of operation for the fiscal
quarter ended October 31, 2003 and the fiscal quarter then
ended.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
SOURCE INTERLINK COMPANIES, INC.
Date: December 15, 2003 /s/ Marc Fierman
---------------------------
Marc Fierman, Chief Financial Officer
29
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
10.33.1 First Amendment to Net Lease between Conewago Contractors, Inc. and
International Periodical Distributors, Inc. dated as of September 1, 2003.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer
32.1 Section 1350 Certification of Principal Executive Officer
32.2 Section 1350 Certification of Principal Financial Officer
30