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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended October 31, 2004
[ ] 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 [X] No [ ]
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 9, 2004
- ---------------------------- --------------------------------
Common Stock, $.01 Par Value 23,735,173
SOURCE INTERLINK COMPANIES, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of
October 31, 2004 and January 31, 2004 1
Consolidated Statements of Income for the three months
and nine months ended October 31, 2004 and 2003 3
Consolidated Statement of Stockholders'
Equity for the nine months ended October 31, 2004 4
Consolidated Statements of Cash Flows for the
nine months ended October 31, 2004 and 2003 5
Notes to Consolidated Financial Statements 6-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 27
ITEM 4. CONTROLS AND PROCEDURES 28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 29
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 29
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29
ITEM 5. OTHER INFORMATION 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 29
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
October 31, January 31,
2004 2004
ASSETS
CURRENT
Cash $ 1,584 $ 4,963
Trade receivables 65,737 41,834
Purchased claims receivable 3,324 5,958
Inventories 14,114 17,241
Income taxes receivable 1,049 2,067
Deferred tax asset 3,405 2,915
Advances under magazine export agreement 1,525 6,830
Other 4,345 2,536
--------- ---------
TOTAL CURRENT ASSETS 95,083 84,344
========= =========
Property, Plants and Equipment 35,114 29,145
Less accumulated depreciation and amortization (13,382) (10,582)
--------- ---------
NET PROPERTY, PLANTS AND EQUIPMENT 21,732 18,563
========= =========
OTHER ASSETS
Goodwill, net 63,087 45,307
Intangibles, net 13,179 7,931
Deferred tax asset 652 908
Other 6,652 7,048
--------- ---------
TOTAL OTHER ASSETS 83,570 61,194
========= =========
$ 200,385 $ 164,101
========= =========
See accompanying notes to
Consolidated Financial Statements
1
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
October 31, January 31,
2004 2004
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future advances on revolving credit facility $ 2,951 $ 14,129
Accounts payable and accrued expenses, net of allowance for returns of
$53,076 and $57,842 at October 31 and January 31, 2004 respectively 35,994 44,741
Deferred revenue 1,738 1,680
Current maturities of long-term debt 2,491 4,059
Other current liabilities 82 317
----------- ---------
TOTAL CURRENT LIABILITIES 43,256 64,926
Debt, less current maturities 31,570 31,541
Other long-term liabilities 1,901 560
----------- ---------
TOTAL LIABILITIES 76,727 97,027
========== =========
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Contributed Capital:
Preferred Stock, $0.01 par (2,000 shares authorized; none issued) - -
Common Stock, $0.01 par (40,000 shares authorized; 23,663 and 18,991
shares issued) 237 190
Additional paid-in-capital 149,178 102,297
----------- ---------
Total contributed capital 149,415 102,487
Accumulated deficit (26,765) (35,778)
Accumulated other comprehensive income:
Foreign currency translation 1,575 932
----------- ---------
124,225 67,641
Less: Treasury Stock (100 at cost) (567) (567)
----------- ---------
TOTAL STOCKHOLDERS' EQUITY 123,658 67,074
========== =========
$ 200,385 $ 164,101
========== =========
See accompanying notes to
Consolidated Financial Statements
2
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three Months Ended Oct. 31, Nine Months Ended Oct. 31,
2004 2003 2004 2003
---------- ---------- --------- ----------
Revenues $ 96,045 $ 92,229 $ 273,175 $ 258,687
Costs of Revenues 69,621 67,291 199,822 189,986
---------- ---------- --------- ----------
Gross Profit 26,424 24,938 73,353 68,701
Selling, General and Administrative Expense 14,135 13,028 40,874 39,763
Fulfillment Freight 5,611 4,516 15,244 12,995
Relocation Expenses - - 1,552 1,730
---------- ---------- --------- ----------
Operating Income 6,678 7,394 15,683 14,213
---------- ---------- --------- ----------
Other Income (Expense)
Write off of deferred financing costs and
original issue discount - (865) (1,494) (865)
Interest expense (442) (844) (1,319) (2,915)
Interest income 34 69 140 230
Other 140 37 207 168
---------- ---------- --------- ----------
Total Other Income (Expense) (268) (1,603) (2,466) (3,382)
---------- ---------- --------- ----------
Income Before Income Taxes 6,410 5,791 13,217 10,831
Income Tax Expense 2,032 1,695 4,204 3,115
---------- ---------- --------- ----------
Net Income $ 4,378 $ 4,096 $ 9,013 $ 7,716
========== ========== ========= ==========
Earnings per Share - Basic $ 0.19 $ 0.22 $ 0.40 $ 0.42
Earnings per Share - Diluted 0.18 0.20 0.37 0.40
Weighted Average of Shares Outstanding - Basic 23,374 18,544 22,727 18,378
Weighted Average of Shares Outstanding - Diluted 24,924 20,285 24,606 19,487
========== ========== ========= ==========
See accompanying notes to
Consolidated Financial Statements
3
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, 2004 18,991 $ 190 $ 102,297 $ (35,778) $ 932 (100) $ (567) $ 67,074
Net income - - - 9,013 - - - 9,013
Foreign currency translation - - - - 643 - - 643
----------
Comprehensive income 9,656
----------
Sale of stock, $11.50 per
share (net of offering costs
of $3,226) 3,800 38 40,436 40,474
Exercise of stock options 872 9 4,929 - - - - 4,938
Tax benefit of stock options
exercised - - 1,516 - - 1,516
------ -------- ---------- --------- ------------ ---- ------- ----------
Balance, October 31, 2004 23,663 $ 237 $ 149,178 $ (26,765) $ 1,575 (100) $ (567) $ 123,658
====== ======== ========== ========= ============ ==== ======= ==========
See accompanying notes to
Consolidated Financial Statements
4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine months ended October 31, 2004 2003
- ----------------------------- ------------ -----------
OPERATING ACTIVITIES
Net income $ 9,013 $ 7,716
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 4,018 3,046
Provision for losses on accounts receivable 593 1,588
Write off of deferred financing costs and original issue discount 1,494 865
Deferred income taxes (234) (2,084)
Other 266 514
Changes in assets and liabilities (excluding business acquisitions):
Increase in accounts receivable (24,751) (20,555)
Decrease in inventories 3,364 67
Decrease in other assets 622 178
(Decrease) increase in accounts payable and accrued expenses (14,254) 11,261
------------ -----------
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (19,869) 2,596
------------ -----------
INVESTMENT ACTIVITIES
Capital expenditures (4,069) (1,434)
Purchase of claims (66,592) (51,347)
Payments received on purchased claims 69,227 56,665
Acquisition of claim filing contracts (12,915) -
Acquisition of net assets of wholesale magazine distributor (3,342) -
Collections (advances) under magazine export agreement 5,306 (4,677)
Payments under import agreement (1,500) (1,000)
Payments under magazine export agreement - (1,400)
Other (401) -
------------ -----------
CASH USED IN INVESTING ACTIVITIES (14,286) (3,193)
------------ -----------
FINANCING ACTIVITIES
Decrease in checks issued against revolving credit facilities (11,178) (5,528)
Borrowings (Repayments) under credit facilities 8,961 (15,667)
Proceeds from the issuance of notes payable 10,000 20,000
Payments of notes payable (22,419) (670)
Proceeds from the issuance of common stock 45,412 1,869
------------ -----------
CASH PROVIDED BY FINANCING ACTIVITIES 30,776 4
------------ -----------
DECREASE IN CASH (3,379) (593)
CASH, beginning of period 4,963 5,570
------------ -----------
CASH, end of period $ 1,584 $ 4,977
============ ===========
5
1. BASIS OF PRESENTATION
The consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. In the opinion of management, all adjustments
(consisting of normal recurring adjustments and reclassifications) necessary to
present fairly the financial position at October 31, 2004, and the results of
operations and cash flows for the three months and nine months ended October 31,
2004 and 2003, have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. We suggest 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,
2004. The results of operations for such interim periods 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. ACQUISITION AND BUSINESS COMBINATIONS
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, $1.0 million in fiscal 2004 and
additional contingent payments up to $2.5 million spread over the two years
ended May 2005 based on the overall gross profit generated from the sale of
these titles. Guaranteed payments and earned contingent payments under this
agreement are included in intangible assets and are being amortized over ten
years, the term of the agreement (See Note 12).
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. Under the agreement, the Company agreed to pay the prior
owner's outstanding trade payables out of the collections of the prior owner's
outstanding receivables. Amounts collected in excess of payments made or
payments in excess of collection are to be settled at a future date. At October
31, 2004 payments in excess of collections amounted to approximately $1.5
million (See Note 12).
PROMAG Retail Services, LLC Acquisition
In August 2004, the Company acquired all customer based intangibles (i.e., all
market composition, market share and other value) of the claiming and
information services of PROMAG Retail Services, LLC ("Promag") for approximately
$13.2 million. Of the $13.2 million purchase price, $10.0 million was funded
from the term loan described in footnote 5 and $0.75 million in a promissory
note payable over a three year period to Promag. Promag provides claim filing
services related to rebates owed retailers from publishers or their designated
agent throughout the United States and Canada. Goodwill and other intangible
assets recorded in connection with the transaction totaled $13.2 million. The
intangible assets are subject to amortization and consist primarily of customer
contracts and non-compete agreements that are amortized on a straight-line basis
over a weighted-average useful life of 12.77 years. Pro forma results have not
been shown due to the insignificance of the acquisition.
Goodwill and other intangible assets at the date of acquisition of Promag are
based on a preliminary independent valuation study, therefore reported amounts
may change based on finalization which is expected to occur during the fourth
quarter of 2005.
6
Empire State News Corp. Acquisition
In September 2004, the Company acquired substantially all of the operating
assets and liabilities of Empire State News Corp. ("Empire"), a magazine
wholesaler in northwest New York State for approximately $5.0 million. The
purchase price consisted of $3.3 million of cash paid and $1.6 million of
deferred consideration in the form of two notes payable (see footnote 4) and
deferred compensation, subject to finalization of working capital adjustments in
accordance with the purchase agreement. The results of Empire's operations have
been included in our consolidated statements of income since September 26, 2004.
The total cost of the acquisition was allocated to the assets acquired and
liabilities assumed based on their respective preliminary fair values in
accordance with FAS 141, Business Combinations ("FAS 141"). Goodwill recorded in
connection with the transaction totaled $8.7 million. Pro forma results have not
been shown due to the insignificance of the acquisition.
Estimated fair values of assets acquired and liabilities assumed at the date of
acquisition of Empire News are based on preliminary independent appraisals and
valuation studies, therefore reported amounts may change based on finalization
which is expected to occur during the fourth quarter of 2005.
3. TRADE RECEIVABLES
Trade receivables consist of the following (in thousands):
October 31, 2004 January 31, 2004
---------------- ----------------
Accounts Receivable $ 133,629 $ 112,504
Allowance:
Sales returns and other 63,765 66,102
Doubtful accounts 4,127 4,568
------------ ----------
67,892 70,670
------------ ----------
$ 65,737 $ 41,834
============ ==========
4. INVENTORIES
Inventories consist of the following (in thousands):
October 31, 2004 January 31, 2004
---------------- ----------------
Raw materials $ 2,250 $ 2,278
Work-in-process 1,789 1,973
Finished goods:
Fixtures 1,146 761
Magazine inventory 8,929 12,229
----------- ----------
$ 14,114 $ 17,241
=========== ==========
In the event of non-sale, magazine inventories are generally returnable to the
publishers for full credit.
7
5. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of (in thousands):
October 31, January 31,
2004 2004
----------- -----------
Revolving Credit facility - Wells Fargo Foothill $ 20,695 $ 11,735
Note payable - Wells Fargo Foothill 9,750 4,083
Note payable - Hilco Capital, net of original
issuance discount - 14,142
Guaranteed payments under magazine export
agreement (Note 2) 2,163 3,850
Notes payable to former owners of acquired company - 1,613
Notes payable to former owners of Empire 1,200 -
Other 253 177
----------- -----------
Debt 34,061 35,600
Less current maturities 2,491 4,059
----------- -----------
Debt, less current maturities $ 31,570 $ 31,541
=========== ===========
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 provided a $5.0 million term note
payable. The credit agreement is secured by all of the assets of the Company.
In August 2004, the Company amended the credit facility with Wells Fargo
Foothill. The amended facility now extends through October 31, 2009 and provides
for a $10 million term note payable that bears interest at the prime rate plus
2.0% (6.75% at October 31, 2004). In addition, the Company reduced the $45.0
million revolving credit facility to $40.0 million; however the total credit
facility remains $50.0 million. The term note is payable over five years with
initial quarterly installments of $0.25 million payable over four quarters
beginning October 31, 2004. The quarterly installments increase to $0.35, $0.50,
$0.65 and $0.75 million, respectively, over the subsequent four years.
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.75% at October 31, 2004) plus a margin up to 0.5% (the
applicable margin was 0.0% at October 31, 2004) based on an availability
calculation and carries a facility fee of 1/4% per annum on the difference
between $40 million and the average principal amount outstanding under the
facility including advances under the revolving credit facility and letter of
credits.
The original $5.0 million term note payable bore interest at a rate equal to the
prime rate plus 2.5%. The note was payable in equal principal installments of
$0.1 million per month plus current interest. The balance on the note payable
was paid in full during the quarter ended April 30, 2004.
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. At October 31, 2004, the impact of relocating
and consolidating certain distribution fulfillment centers resulted in
non-compliance with the Company's capital expenditure covenant. The Company
received a permanent waiver from its lender with respect to this non-compliance
and an amendment, which changed the financial covenant through January 31, 2005.
Management anticipates the Company being in compliance with the amended covenant
prospectively.
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in unused
availability, after consideration of outstanding letters of credit, of $11.4
million at October 31, 2004.
Hilco Capital Note Payable
8
On October 30, 2003, the Company entered into a credit agreement with Hilco
Capital. The note bore a value at maturity of $15.0 million and was 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 $.9 million using a
Black Scholes option pricing model. The value of these warrants was recorded as
an original issuance discount to the term loan and was to be amortized over the
term of the loan using the effective interest method. All but a nominal amount
of the term loan was paid during the quarter ended April 30, 2004 and the
balance was paid in full during the quarter ended October 31, 2004. In
conjunction with the prepayment of notes payable, the remaining original issue
discount of approximately $0.86 million and $0.64 million of deferred financing
costs were written off.
Notes Payable to Former Owners of Acquired Companies
In connection with the acquisition of the assets of Empire, the Company issued
notes payable totaling $1,200,000 to Empire and one of the former owners of
Empire. The notes payable bear interest at the lowest rate per annum allowable
under the Internal Revenue Service Code Section 1274, which was 2.35% as of
October 31, 2004 and are payable ratably over four fiscal years beginning with
the quarter ending January 31, 2005.
In connection with the acquisition of Interlink, the Company assumed debt to the
former owners of International Periodical Distributors, Inc. ("IPD").
Previously, the Company was disputing the remaining amounts owed and commenced
legal action requesting the court release the Company of any further obligation
under these arrangements. The notes were due in fiscal 2003 and bore interest of
12%, which the Company continued to accrue pending the outcome of the
litigation. In March 2004, the Company and the former owners settled the notes
payable, interest accrued thereon, and the indemnification claim by the Company
paying a total of $1.6 million.
The aggregate amount of debt maturing in each of the next five fiscal years is
as follows (in thousands):
Amount
--------
2005 $ 1,279
2006 3,067
2007 2,248
2008 2,466
2009 2,805
Thereafter 22,196
--------
$ 34,061
========
6. SHAREHOLDERS' EQUITY
In March 2004, the Company completed the sale of 3.8 million shares of common
stock at $11.50 per share, excluding underwriting discounts and expenses. Net
proceeds to the Company of approximately $40.5 million, after costs of issuance
of $3.2 million, were utilized to repay the Wells Fargo Foothill note payable
and revolving credit facility and all but a nominal amount on the Hilco Capital
note payable in March 2004.
7. 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,
2004 2003 2004 2003
------ ------ ------ ------
Basic weighted average number of common shares outstanding 23,374 18,544 22,727 18,378
Effect of dilutive securities:
Stock options and warrants 1,550 1,741 1,879 1,109
------ ------ ------ ------
Diluted weighted average number of common shares outstanding 24,924 20,285 24,606 19,487
====== ====== ====== ======
9
For the quarter ended October 31, 2004, stock options to purchase 524 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. All warrants convertible into shares were included in the
calculation above as their conversion price was less than the average market
price of the common shares during the period.
8. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Nine Months Ended October 31, 2004 2003
- ----------------------------- ----------- -----
Interest $ 1,334 2,524
Income Taxes $ 1,101 (875)
=========== =====
9. 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.
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,
2004 2003 2004 2003
-------- --------- -------- --------
Net income $ 4,378 $ 4,096 $ 9,013 $ 7,716
Stock compensation costs, net of tax (89) (320) (267) (960)
-------- --------- -------- --------
Adjusted net income $ 4,289 $ 3,776 $ 8,746 $ 6,756
-------- --------- -------- --------
Weighted average shares, basic 23,374 18,544 22,727 18,378
Weighted average shares, diluted 24,924 20,285 24,606 19,487
Basic earnings per share - as reported $ 0.19 $ 0.22 $ 0.40 $ 0.42
Diluted earnings per share - as reported $ 0.18 $ 0.20 $ 0.37 $ 0.40
Basic earnings per share - pro-forma $ 0.18 $ 0.21 $ 0.38 $ 0.37
Diluted earnings per share - pro-forma $ 0.17 $ 0.19 $ 0.36 $ 0.35
======== ========= ======== ========
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 0.50
Risk-free interest rate 2.18-2.25% 2.16%
========= ====
10
10. 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.
The reportable segments of the Company are Magazine Distribution, In-Store
Services, Wood Manufacturing and Shared Services. The accounting policies of the
segments are materially the same as those described in the Summary of Accounting
Policies.
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.
Shared Services consists of overhead functions not allocated to individual
operating segments. Segment results follow (in thousands):
Magazine In-Store Wood Other
Three Months Ended October 31, 2004 Distribution Services Manufacturing (Shared Services) Consolidated
- ----------------------------------- ------------ -------- ------------- ----------------- ------------
Revenue $ 75,226 $ 14,021 $ 6,798 $ - $ 96,045
Cost of Revenue 56,125 7,970 5,526 - 69,621
--------- -------- ------- -------- ---------
Gross Profit 19,101 6,051 1,272 - 26,424
Selling, General & Administrative 7,655 2,152 310 4,018 14,135
Freight Distribution 5,611 - - - 5,611
--------- -------- ------- -------- ---------
Operating Income $ 5,835 $ 3,899 962 $(4,018) $ 6,678
========= ======== ======= ======== =========
Total Assets $ 68,823 $ 93,074 $17,760 $ 20,728 $ 200,385
========= ======== ======= ======== =========
Magazine In-Store Wood Other
Nine Months Ended October 31, 2004 Distribution Services Manufacturing (Shared Services) Consolidated
- ---------------------------------- ------------ -------- ------------- ----------------- ------------
Revenue $ 214,723 $ 40,003 $18,449 $ - $273,175
Cost of Revenue 162,646 22,260 14,916 - 199,822
------------ -------- ------- ---------- --------
Gross Profit 52,077 17,743 3,533 - 73,353
Selling, General & Administrative 22,264 6,052 925 11,633 40,874
Freight Distribution 15,244 - - - 15,244
Relocation Expense 1,552 - - - 1,552
------------ -------- ------- ---------- --------
Operating Income $ 13,017 $ 11,691 $ 2,608 $ (11,633) $ 15,683
============ ======== ======= ========== ========
11
Magazine In-Store Wood Other
Three Months Ended October 31, 2003 Distribution Services Manufacturing (Shared Services) Consolidated
- ----------------------------------- ------------ -------- ------------- ----------------- ------------
Revenue $ 68,068 $ 17,417 $ 6,744 $ - $ 92,229
Cost of Revenue 52,008 9,522 5,761 - 67,291
-------- -------- -------- --------- ---------
Gross Profit 16,060 7,895 983 - 24,938
Selling, General & Administrative 7,026 2,061 322 3,619 13,028
Freight Distribution 4,516 - - - 4,516
-------- -------- -------- --------- ---------
Operating Income $ 4,518 $ 5,834 661 $ (3,619) $ 7,394
======== ======== ======== ========= =========
Total Assets 52,707 $ 83,722 $ 17,439 $ 27,715 $ 181,583
======== ======== ======== ========= =========
Magazine In-Store Wood Other
Nine Months Ended October 31, 2003 Distribution Services Manufacturing (Shared Services) Consolidated
- ---------------------------------- ------------ -------- ------------- ----------------- ------------
Revenue $ 197,719 $ 46,353 $14,615 $ - $258,687
Cost of Revenue 151,268 26,110 12,608 - 189,986
--------- -------- ------- --------- --------
Gross Profit 46,451 20,243 2,007 - 68,701
Selling, General & Administrative 21,384 6,404 1,074 10,901 39,763
Freight Distribution 12,995 - - - 12,995
Relocation Expense 1,654 - - 76 1,730
--------- -------- ------- --------- --------
Operating Income $ 10,418 $ 13,839 933 $ (10,977) $ 14,213
========= ======== ======= ========= ========
12. SUBSEQUENT EVENTS
Alliance Entertainment Corp. Acquisition
On November 18, 2004, Source Interlink Companies, Inc. ("Source"), Alliance
Entertainment Corp. ("Alliance") and Alligator Acquisition, LLC ("Merger Sub")
entered into an Agreement and Plan of Merger (the "Merger Agreement").
Concurrently, and in connection therewith, (i) Source and Alliance entered into
identical voting agreements (the "Source Voting Agreements") with each of
certain directors and officers of Source and (ii) Source, Alliance and AEC
Associates, LLC (the "Principal Alliance Stockholder") entered into a voting
agreement (the "Alliance Voting Agreement").
Source will issue to Alliance equityholders a number of shares of its common
stock (including shares reserved for issuance pursuant to outstanding options,
warrants and other rights assumed by Source) equal to Source's common stock
outstanding prior to the closing of the merger (including those shares issuable
for outstanding options, warrants and other rights). In addition, all
outstanding Alliance stock options, warrants and other rights would be assumed
by Source. As a condition to the merger, all shares of the preferred stock of
Alliance would be converted into shares of the common stock of Alliance. The
equityholders of Alliance and the equityholders of Source will each hold 50% of
the fully diluted capitalization of the combined company at the closing.
Source and Alliance have agreed that, immediately after the completion of the
merger, the board of directors of Source will consist of eleven directors,
including (i) six members designated by Source, three of whom will be
independent, and (ii) five members designated by Alliance, three of whom will be
independent.
Source and Alliance have made customary representations, warranties and
covenants in the Merger Agreement, including, among others, covenants (i) not to
(A) solicit proposals relating to alternative business combination transactions
or (B) subject to certain exceptions, enter into discussions concerning or
provide confidential information in connection with alternative business
combination transactions, (ii) to cause stockholder meetings to be held to
consider approval of the merger and related transactions, and (iii) subject to
certain exceptions, for their respective boards of directors to recommend
adoption and approval by its stockholders of the Merger Agreement and related
transactions.
Consummation of the merger is subject to various conditions, including, among
other things, the approval by the stockholders of Source and Alliance, no legal
impediment to the merger, the receipt of required regulatory approvals, receipt
of existing lender consent and completion of a distribution by Alliance of its
assets related to its "All Media Guide" and Digital On-
12
Demand" businesses. The Merger Agreement contains certain termination rights for
both Source and Alliance, and further provides that, upon termination of the
Merger Agreement under specified circumstances Source may be required to pay
Alliance a termination fee of $5 million.
Sale of Secondary Wholesale Distribution Operations
In November 2004, the Company sold its secondary wholesale distribution
operations and received net sales proceeds of approximately $1.4 million. The
sale of the business is not expected to result in a gain or loss for financial
reporting purposes.
Magazine Import and Export Acquisition Worldwide purchases
In November 2004, the Company entered into an agreement to terminate leases
under the magazine import and the magazine export agreements and acquire all
import and export assets, naming rights and other intangibles including a
non-compete by the seller. The purchase price of the import and export
businesses (after an allowed reduction of the purchase price for payments made
by the Company under the prior lease agreements) was approximately $14.1
million. The purchase price was comprised of $4.2 million paid in cash on the
last business day of November 2004 and notes payable in the amount of $9.9
million, payable over 13 quarters in equal installments of $0.7 million. In
addition, a second note payable in the amount of $0.99 million is payable in
full on May 1, 2005.
Since the Company has historically operated these magazine import and export
businesses under leases, results of operations for the import and export
businesses are included in the statement of operations for the nine month
periods ended October 31, 2004 and 2003, respectively.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
A CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
Some of the information in this report contain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements may be preceded by, followed by or include the words
"believe," "expect," "anticipate,' "estimate," "project," or similar
expressions. Other statements in this report that are not historical facts are
"forward-looking statements" for the purpose of the safe harbor provided by
Section 21E of the Securities Exchange Act of 1934 and Section 27A of the
Securities Act of 1933. 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 and other
possible or future actions. These statements involve estimates, assumptions and
predictions made by our management 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;
- demand for magazines at the retailers we service; and
- our ability to access retailers' point-of-sales information needed
to efficiently allocate distribution.
We believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to predict
accurately or over which we have no control. The factors listed above provide
examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking
statements. Before you make an investment decision relating to our common stock,
you should be aware that the occurrence of the events described in these risk
factors could have a material adverse effect on our business, operating results
and financial condition. You should read and interpret any forward-looking
statement in conjunction with our consolidated financial statements, the notes
to our consolidated financial statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Any forward-looking
statement speaks only as of the date on which that statement is made. Unless
required by U.S. federal securities laws, we will not update any forward-looking
statement to reflect events or circumstances that occur after the date on which
the statement is made.
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.
- Our Magazine Fulfillment group provides domestic and foreign titled
magazines to specialty retailers, such as bookstores and music
stores, and to mainstream retailers, such as supermarkets, discount
stores, drug stores, convenience stores and newsstands. This group
also exports domestic titled magazines from more than 100 publishers
to foreign markets worldwide. We provide fulfillment services to
more than 23,000 retail stores, 7,000 of which also benefit from our
selection and logistical procurement services.
- Our In-Store Services group assists retailers with the design and
implementation of their front-end area merchandise programs, which
generally have a three-year life cycle. We also provide other
value-added services to retailers, publishers and other vendors.
These services include assisting retailers with the filing of claims
for publisher incentive payments, which are based on display
location or total retail sales, 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.
- Our Wood Manufacturing group designs and manufactures wood display
and store fixtures for leading specialty retailers.
14
- Our Shared Services group consists of overhead functions not
allocated to the other groups. These functions include corporate
finance, human resource, management information systems and
executive management that are not allocated to the three operating
groups. Upon completion of our consolidation of our administrative
operations, we restructured our accounts to separately identify
corporate expenses that are not attributable to any of our three
main operating groups. Prior to fiscal year 2004, these expenses
were included within our In-Store Services group.
REVENUES
The Magazine Fulfillment group derives revenues from:
- selling and distributing magazines, including domestic and foreign
titles, to specialty and mainstream retailers 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 and backroom operator for
publishers.
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,
- storing, 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 less all applicable publisher discounts and
rebates.
Our cost of revenues for the In-Store Services and the Wood Manufacturing groups
includes:
- raw materials consumed in the production of display fixtures,
primarily steel, wood and plastic components;
- production labor; and
- manufacturing overhead.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for each of the operating groups
include:
- non-production labor;
- rent and office overhead;
- insurance;
- professional fees; and
- management information systems.
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 primarily by the weight of the copies being shipped and the
distance between origination and destination.
15
Fulfillment freight is not disclosed as a component of cost of revenues, and, as
a result, gross profit and gross profit margins are not comparable to other
companies that include shipping and handling costs in cost of revenues.
Fulfillment freight has increased proportionately as the amount of product we
distribute has increased. We anticipate the continued growth in our Magazine
Fulfillment group will result in an increase in fulfillment freight. Generally,
as pounds shipped increase, the cost per pound charged by third party carriers
decreases. As a result, fulfillment freight as a percent of Magazine Fulfillment
group revenue should decline slightly in the future.
RELOCATION EXPENSES
Relocation expenses in 2003 consisted primarily of the cost of transferring
existing employees and offices from their former locations in High Point, North
Carolina, St. Louis, Missouri, and San Diego, California, to our new offices in
Bonita Springs, Florida. In addition, during the nine months ended October 31,
2004, the Company began expansion into the mainstream retail market. The
expansion schedule required an acceleration of the relocation process from the
distribution fulfillment center in Milan, Ohio to Harrisburg, Pennsylvania,
which was completed by April 30, 2004.
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations (in thousands):
2004 2003
MARGIN MARGIN
THREE MONTHS ENDED OCTOBER 31, AMOUNT % AMOUNT %
- ------------------------------ -------- ------ ---------- ------
Magazine Fulfillment
Revenue $ 75,226 $ 68,068
Cost of revenue 56,125 52,008
Gross profit 19,101 25.4% 16,060 23.6%
Operating expense (1) 13,266 11,542
Operating income 5,835 7.8% 4,518 6.6%
In-Store Services
Revenue $ 14,021 $ 17,417
Cost of revenue 7,970 9,522
Gross profit 6,051 43.2% 7,895 45.3%
Operating expense (1) 2,152 2,061
Operating income 3,899 27.8% 5,834 33.4%
Wood Manufacturing
Revenue $ 6,798 $ 6,744
Cost of revenue 5,526 5,761
Gross profit 1,272 18.7% 983 14.6%
Operating expense (1) 310 322
Operating income 962 14.2% 661 9.8%
Shared Services
Revenue $ - $ -
Cost of revenue - -
Gross profit - -
Operating expense (1) 4,018 n/a 3,619 n/a
Relocation expenses - -
Operating loss (4,018) n/a (3,619) n/a
Total
Revenue $ 96,045 $ 92,229
Cost of revenue 69,621 67,291
16
Gross profit 26,424 27.5% 24,938 27.0%
Operating expense (1) 19,746 17,544
Operating income 6,678 7.0% 7,394 8.0%
====== ==== ====== ====
(1) Operating expenses include selling, general and administrative expenses,
fulfillment freight and amortization of goodwill.
2004 2003
MARGIN MARGIN
NINE MONTHS ENDED OCTOBER 31, AMOUNT % AMOUNT %
- ----------------------------- ---------- ------ ---------- ------
Magazine Fulfillment
Revenue $ 214,723 $ 197,719
Cost of revenue 162,646 151,268
Gross profit 52,077 24.3% 46,451 23.5%
Operating expense (1) 37,508 34,379
Relocation expenses 1,552 1,654
Operating income 13,017 6.1% 10,418 5.3%
In-Store Services
Revenue $ 40,003 $ 46,353
Cost of revenue 22,260 26,110
Gross profit 17,743 44.4% 20,243 43.7%
Operating expense (1) 6,052 6,404
Operating income 11,691 29.2% 13,839 29.9%
Wood Manufacturing
Revenue $ 18,449 $ 14,615
Cost of revenue 14,916 12,608
Gross profit 3,533 19.2% 2,007 13.7%
Operating expense (1) 925 1,074
Operating income 2,608 14.1% 933 6.4%
Shared Services
Revenue $ - $ -
Cost of revenue - -
Gross profit - -
Operating expense (1) 11,633 n/a 10,901 n/a
Relocation expenses - 76
Operating loss (11,633) n/a (10,977) n/a
Total
Revenue $ 273,175 $ 258,687
Cost of revenue 199,822 189,986
Gross profit 73,353 26.9% 68,701 26.6%
Operating expense (1) 56,118 52,758
Relocation expenses 1,552 1,730
Operating income 15,683 5.7% 14,213 5.5%
====== ==== ====== ====
(1) Operating expenses include selling, general and administrative expenses,
fulfillment freight and amortization of goodwill.
17
REVENUES
THREE MONTHS ENDED OCTOBER 31, 2004, AS COMPARED TO THE THREE MONTHS ENDED
OCTOBER 31, 2003
Revenues for the quarter ended October 31, 2004 increased $3.8 million, or 4.1%,
from the prior year due primarily to an increase in revenue in our Magazine
Fulfillment group as described below.
Magazine Fulfillment group's revenues were $75.2 million, an increase of $7.1
million or 10.5% as compared to the quarter ended October 31, 2003. The group's
revenues for the three months ended October 31 are comprised of the following
components (in thousands):
2004 2003 Change
--------- ------- -------
Domestic distribution $ 60,690 $54,025 $ 6,665
Export distribution 8,576 9,206 (630)
Secondary wholesale distribution 5,291 4,629 662
Other 1,047 613 434
Intra-segment sales (378) (405) 27
--------- ------- -------
Total $ 75,226 $68,068 $ 7,158
========= ======= =======
Domestic distribution consists of the gross amount of magazines (both domestic
and imported titles) distributed to domestic retailers and wholesalers, less
actual returns received, less an estimate of future returns and customer
discounts. The $6.7 million increase in domestic distribution relates primarily
to a $25.2 million increase in gross distribution partially offset by an
estimated higher return rate. The increase in gross distribution related both to
an increase in copies distributed as well as an increase in the amount billed
per copy. Gross domestic distribution to our two largest specialty retail
customers increased $9.2 million. Estimated sell-through for the quarter was
lowered from 48.5% to 45.4%.
Revenues from our secondary wholesale operations for the quarter ended October
31, 2004 increased approximately $0.7 million due to an increase in the number
of wholesale operations we serviced as compared to the quarter ended October 31,
2003. Subsequent to the period end, the Company sold its secondary wholesale
distribution operations.
Our In-Store Services group revenues were $14.0 million, a decrease of $3.4
million or 19.5%, for the three months ended October 31, 2004 as compared to the
comparable quarter of the prior year.
The group's revenues are comprised of the following components (in thousands):
2004 2003 Change
------- ------- --------
Claim filing and information $ 5,173 $ 3,106 $ 2,067
Front end wire and services 8,848 14,311 (5,463)
------- ------- --------
Total $14,021 $17,417 $ (3,396)
======= ======= ========
Our claim filing revenues are recognized at the time the claim is paid. The
increase in revenues in the current period relate primarily to the timing of the
cash payments received on the claims. In addition, the Company acquired Promag
Retail Services, LLC in August 2004 which also contributed to the increased
revenues for the quarter.
Our front end wire and services revenues declined due to the cyclical nature of
the industry. Major chains typically purchase new front-end fixtures every three
years however, the use of the front end fixtures has been extending beyond this
life cycle. In addition, there was a significant new customer in the quarter
ended October 31, 2003 that did not recur in the quarter ended October 31, 2004.
Our Wood Manufacturing group's revenues were $6.8 million for the three months
ended October 31, 2004 as compared to $6.7 million for the comparable period of
the prior year.
NINE MONTHS ENDED OCTOBER 31, 2004, AS COMPARED TO THE NINE MONTHS ENDED OCTOBER
31, 2003
Revenues for the nine month period ended October 31, 2004 increased $14.5
million, or 5.6%, from the prior year due primarily to an increase in revenue in
our Magazine Fulfillment and Wood Manufacturing groups as described below.
19
Magazine Fulfillment group's revenues were $214.7 million, an increase of $17.0
million or 8.5% as compared to the nine months ended October 31, 2003. The
group's revenues for the nine months ended October 31 are comprised of the
following components (in thousands):
2004 2003 Change
-------- -------- -------
Domestic distribution $170,805 $158,793 $12,012
Export distribution 28,731 24,947 3,784
Secondary wholesale distribution 13,380 12,913 467
Other 2,805 2,152 653
Intra-segment sales (998) (1,086) 88
-------- -------- -------
Total $214,723 $197,719 $17,004
======== ======== =======
Domestic distribution consists of the gross amount of magazines (both domestic
and imported titles) distributed to domestic retailers and wholesalers, less
actual returns received, less an estimate of future returns and customer
discounts. The $12.0 million increase in domestic distribution relates primarily
to a $49.2 million increase in gross distribution partially offset by an
estimated higher return rate. The increase in gross distribution related both to
an increase in copies distributed as well as an increase in the amount billed
per copy. Gross domestic distribution to our two largest customers increased
$30.8 million. Estimated sell-through for the period was lowered from 48.5% to
44.2%.
Our export distribution began operation in March 2003. Export distribution
increased $3.8 million for the nine month period ended October 31 over the
comparable period of the prior year due primarily to an additional month of
distribution in the current period.
Our In-Store Services group revenues were $40.0 million, a decrease of $6.3
million or 13.7%, for the nine months ended October 31, 2004 as compared to the
comparable period of the prior year.
The group's revenues are comprised of the following components (in thousands):
2004 2003 Change
------- ------- --------
Claim filing and information $13,499 $ 9,874 $ 3,625
Front end wire and services 26,504 36,479 (9,975)
------- ------- --------
Total $40,003 $46,353 $ (6,350)
======= ======= ========
Our claim filing revenues are recognized at the time the claim is paid. The
increase in revenues in the current period relate to the timing of the cash
payments received on the claims. In addition, the Company acquired Promag Retail
Services, LLC in August 2004 which also contributed to the increased revenues
for the nine month period ended October 31, 2004.
Our front end wire and services revenues declined due to the cyclical nature of
the industry. Major chains typically purchase new front-end fixtures every three
years however, the use of the front end fixtures has been extending beyond this
life cycle.
The Wood Manufacturing group's revenues were $18.4 million, an increase of $3.8
million or 26.2%, for the nine months ended October 31, 2004 as compared to the
comparable period of the prior year. The increase for the nine month period
relates to an increase in the number of store openings and remodelings performed
by our customers. In addition, we added a number of significant new customers in
the second quarter of the nine month period ended October 31, 2004.
GROSS PROFIT
THREE MONTHS ENDED OCTOBER 31, 2004, AS COMPARED TO THE THREE MONTHS ENDED
OCTOBER 31, 2003
Gross profit for the three months ended October 31, 2004 increased $1.5 million
or 6.0%, over the same quarter in the prior fiscal year due primarily due to an
increase in sales volume in our Magazine Fulfillment group.
Gross Profit in our Magazine Fulfillment group increased approximately $3.0
million or 18.9% for the quarter ended October 31, 2004 as compared to the
comparable quarter of the prior year. The increase related primarily to the
increased distribution revenue as described above and the improvement in gross
profit margins from 23.6% to 25.4%. The gross profit margins in
20
our domestic distribution businesses are generally higher than our export
distribution and secondary wholesale businesses and, as a result, overall gross
profit margins improve as the portion of total revenues is weighted more toward
our domestic operations. We have also been able to utilize the working capital
raised through our equity offering and operating profits to improve selling and
buying terms with some of our major suppliers and customers. In addition, we
receive certain supplier rebates on gross distribution and as efficiency
decreases those rebates become a greater portion of the overall gross profit
contribution yielding higher gross profit margins.
Gross profit in our In-Store Services group decreased $1.8 million or 23.4% for
the three months ended October 31, 2004 as compared to the comparable quarter of
the prior year. The decrease in gross profit is primarily due to a decrease in
revenues of the front end wire and services as described above as the gross
margin percentage remained consistent.
Gross profit in our Wood Manufacturing group increased $0.3 million or 29.4% for
the three months ended October 31, 2004 as compared to the comparable period of
the prior year. The increase related primarily to operational efficiencies at
the manufacturing facilities.
NINE MONTHS ENDED OCTOBER 31, 2004, AS COMPARED TO THE NINE MONTHS ENDED
OCTOBER 31, 2003
Gross profit for the nine months ended October 31, 2004 increased $4.7 million
or 6.8%, over the same period in the prior fiscal year due primarily due to an
increase in sales volume in our Magazine Fulfillment group and our Wood
Division. The increase was partially offset by decreases in our In-Store
Services group.
Gross Profit in our Magazine Fulfillment group increased approximately $5.6
million or 12.1% for the nine months ended October 31, 2004 as compared to the
comparable period of the prior year. The increase related primarily to the
increased distribution revenue as described above and the improvement in gross
profit margins from 23.5% to 24.3%. The improved gross profit amounts and margin
for the nine month period are related to the same items discussed in the above
analysis of the quarter.
Gross profit in our In-Store Services group decreased $2.5 million or 12.3% for
the nine month period ended October 31, 2004 as compared to the comparable
period of the prior year. The decrease in gross profit is primarily due to a
decrease in revenues as described above as the gross margin percentage remained
consistent.
Gross profit in our Wood Manufacturing group increased $1.5 million or 76.0% for
the nine month period ended October 31, 2004 as compared to the comparable
period of the prior year. The increase related to the new business discussed
above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the quarter ended October 31,
2004 increased $1.1 million or 8.5%, compared to the quarter ended October 31,
2003. Selling, general, and administrative expenses as a percent of revenues
increased from 14.1% to 14.7%.
The Magazine Fulfillment group's selling, general and administrative expenses
increased $0.63 million, or 9.0% over the quarter ended October 31, 2003. As a
percentage of sales, selling, general and administrative expenses have decreased
from 10.3% to 10.2% compared to the prior year same period due to our ability to
leverage existing infrastructure over a larger base of distribution and the
consolidation of our distribution center in Milan, Ohio into Harrisburg,
Pennsylvania.
The selling, general, and administrative expenses of In-Store Services increased
$0.09 million or 4.4%. This change is insignificant compared to the quarter
ended October 31, 2003.
The selling, general, and administrative expenses of Shared Services increased
$0.40 million or 11.0%. The overall increase is primarily due to Sarbanes-Oxley
compliance charges and increased depreciation expense due to increased capital
expenditures.
The Wood Manufacturing group's selling, general, and administrative expenses
decreased $0.01 million or 3.7%. This change is insignificant compared to the
quarter ended October 31, 2003.
21
Selling, general and administrative expenses for the nine month period ended
October 31, 2004 increased $1.1 million or 2.8% compared to the nine month
period ended October 31, 2003. Selling, general, and administrative expenses as
a percent of revenues declined from 15.4% to 15.0%.
The Magazine Fulfillment group's selling, general, and administrative expenses
increased $0.88 million, or 4.1% over the nine month period ended October 31,
2003. As a percentage of sales, selling, general and administrative expenses
have decreased from 10.8% to 10.4%. The increase in overall expenses and change
in those expenses as related to sales are related to the same items discussed in
the above analysis of the quarter.
The selling, general, and administrative expenses of In-Store Services decreased
$0.35 million or 5.5%. The decrease relates to a reduction in executive salary
expense as compared to the nine month period ended October 31, 2003.
The selling, general, and administrative expenses of Shared Services increased
$0.73 million or 6.7% for the nine month period ended October 31, 2004. The
overall increase is primarily due to Sarbanes-Oxley compliance charges and
increased depreciation expense due to increased capital expenditures.
The Wood Manufacturing group's selling, general, and administrative expenses
decreased $0.15 million or 13.9% compared to the nine month period ended October
31, 2003. The decrease was attributable primarily to a head count reduction.
FULFILLMENT FREIGHT
Fulfillment freight represents the outbound freight costs of domestic
distribution. It consists primarily of payments to third party carriers to
provide delivery service from our distribution centers to our customer's retail
stores.
Fulfillment freight expenses increased $1.1 million or 24.2%, compared to the
three months ended October 31, 2003 and $2.2 million or 17.3% compared to the
nine months ended October 31, 2003. Freight expense as a percent of gross
domestic distribution decreased from 4.3% to 4.1% for the quarter ended October
31, 2004 and 4.1% to 4.0% for the nine month period ended October 31, 2004. The
decrease is attributable to both the consolidation of our distribution center in
Milan, Ohio into Harrisburg, Pennsylvania and the decrease in cost per pound as
the weight increases in our freight providers pricing schedule.
RELOCATION EXPENSES
During the nine months ended October 31, 2004, the Company began expansion into
the mainstream retail market. The expansion schedule required an acceleration of
the relocation process from the distribution fulfillment center in Milan, OH to
Harrisburg, PA, which was completed by April 30, 2004. Relocation expenses
recorded in the first quarter, including a lease termination charge and the
transfer of employees and equipment, were approximately $1.6 million.
During the nine month period ended October 31, 2003, the company relocated the
magazine distribution back office from San Diego, California to Bonita Springs,
Florida. The total expense recorded related to this relocation was $1.7 million.
OPERATING INCOME
Operating income for the quarter ended October 31, 2004 decreased $0.7 million
or 9.7%, compared to the quarter ended October 31, 2003 due to the factors
described above.
Operating income for the nine months ended October 31, 2004 increased $1.5
million or 10.3%, compared to the nine months ended October 31, 2003 due to the
factors described above
Operating profit margins decreased from 8.0% for the quarter ended October 31,
2003 to 7.0% for the quarter ended October 31, 2004 and increased from 5.5% for
the nine month period ended October 31, 2003 to 5.7% for the nine month period
ended October 31, 2004. The increase for the nine month period was due to the
improvement in our gross profit coupled with increased revenue from the Wood and
Magazine Fulfillment Divisions and a decrease in our selling, general, and
administrative expenses as a percent of revenues.
INTEREST EXPENSE
22
Interest expense includes the interest and fees on our significant debt
instruments and outstanding letters of credit.
Interest expense decreased $0.4 million or 47.6% from the quarter ended October
31, 2004 and $1.6 million or 54.8% for the nine month period ended October 31,
2004. Interest expense decreased from the prior year quarter and nine month
period due to significantly lower borrowings. The lower borrowing levels are due
to the raising of proceeds from the sale of 3.8 million shares of common stock.
OTHER INCOME (EXPENSE)
Other income (expense) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
For the nine month periods ended October 31, 2004 and 2003, the Company recorded
charges of approximately $1.5 million and $0.86 million related to the write off
of deferred financing charges as a result of paying off certain debt
instruments, as described below in Liquidity and Capital Resources.
INCOME TAX EXPENSE
The effective income tax rates were 31.70% and 29.3% for the quarters ended
October 31, 2004 and 2003, respectively.
The effective income tax rates were 31.8% and 28.8% for the nine months ended
October 31, 2004 and 2003, respectively.
The difference between the statutory rate and effective tax rates relates
primarily to the realization of a portion of the net operating loss
carry-forward acquired with our acquisition of Interlink.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our primary sources of cash include receipts from our customers and borrowings
under our credit facilities and from time to time the proceeds from the sale of
common stock.
Our primary cash requirements for the Magazine Fulfillment group consist of 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 consist of 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 consist of the
cost of raw materials, the cost of labor, and factory overhead incurred in the
manufacturing process.
Our primary cash requirements for the Shared Services group consist of salaries,
professional fees and insurance not allocated to the operating groups.
23
The following table presents a summary of our significant obligations and
commitments to make future payments under debt obligations and lease agreements
due by fiscal year as of October 31, 2004 (in thousands).
Payments Due by Period
-----------------------------------------------------------------------------
Less
Than 1-3 4-5 After 5
Total 1 year Years Years Years
---------- --------- ---------- --------- ----------
Debt obligations $ 34,061 $ 1,279 $ 5,315 $ 5,271 $ 22,196
Operating leases 34,108 1,289 8,132 6,499 18,188
---------- --------- ---------- --------- ----------
Total contractual cash
obligations $ 68,169 $ 2,568 $ 13,447 $ 11,770 $ 40,384
========== ========= ========== ========= ==========
The following table presents a summary of our commercial commitments and the
notional amount expiration by period (in thousands):
Notional amount expiration by period
-----------------------------------------------------
Less
Than 1-3 4-5 After 5
Total 1 year Years Years Years
------- ------ ----- ----- ------
Financial standby letters
of credit $ 3,750 $3,750 $ - $ - $ -
------- ------ ----- ----- -----
Total commercial
commitments $ 3,750 $3,750 $ - $ - $ -
======= ====== ===== ===== =====
OPERATING CASH FLOW
Net cash used in and provided by operating activities was $19.9 and $2.6 million
for the nine months ended October 31, 2004 and 2003, respectively.
Operating cash flows for the nine months ended October 31, 2004 were primarily
from net income ($9.0 million), plus non-cash charges including depreciation and
amortization ($4.0 million) and provisions for losses on accounts receivable
($0.6 million), a write off of deferred financing costs and original issue
discount ($1.5 million), a decrease in inventories ($3.4 million), a decrease in
other assets ($0.6 million). These cash providing activities were offset by an
increase in accounts receivable ($24.7 million) and a decrease in accounts
payable and accrued expenses ($14.3 million).
24
The increase in accounts receivable for the nine months ended October 31, 2004
was primarily due to an increase in accounts receivable in our Magazine
Fulfillment group. The increase was due to an overall increase in distribution
levels, especially in the last month of the quarter, more lenient payment terms
offered to a significant customer in exchange for more favorable pricing, and
the increase in the sales return reserve from January 31, 2004. Receivables in
our Wood Manufacturing division increased by approximately $2.9 million, due to
additional revenues in the period of approximately $3.8 million. The In-Store
Division had an increase in accounts receivable of approximately $3.4 million
due primarily due to the seasonal nature of the wire manufacturing business,
which generally has the highest receivable balance in the third quarter. The
fourth quarter is generally our best collection and cash flow quarter of the
year as revenues from the third quarter are collected.
The decrease in accounts payable and accrued expenses in the current period of
$14.3 million relates to 1) a decrease in the accounts payable in our Magazine
Fulfillment group where we utilized available funds to pay vendors earlier in
order to generate additional margin 2) a reduction in customer deposits due to
change in payment terms and 3) timing of payments to vendors in the current
period.
Operating cash flows for the nine months ended October 31, 2003 were primarily
from net income ($7.7 million), adding back non-cash charges such as
depreciation and amortization ($3.0 million) and provisions for losses on
accounts receivable ($1.6 million), and a significant increase in accounts
payable ($11.3 million). These cash providing activities were offset by a
significant increase in accounts receivable ($20.5 million).
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.
INVESTING CASH FLOW
Net cash used in investing activities was $14.3 and $3.2 million for the nine
months ended October 31, 2004 and 2003, respectively.
For the nine months ended October 31, 2004, cash used in investing activities
included capital expenditures of $4.1 million, which in part related to our
expansion of our distribution facility in Harrisburg, Pennsylvania. Our advance
pay program generated net cash flow of $2.6 million in the current period. In
addition, the Company advanced to the prior operator of our export distribution
business $6.8 million at January 31, 2004. The advances were made as part of the
agreement to collect the prior operator's receivables and pay outstanding
payables so as to create a seamless transition for both the customers and
suppliers. The company collected $5.3 million of the advances during the nine
months ended October 31, 2004.
In August 2004, the Company acquired all customer-based intangibles (i.e., all
market composition, market share and other value) of the claiming and
information services of PROMAG Retail Services, LLC ("Promag") for approximately
$13.2 million. Of the $13.2 million purchase price, $10.0 million was funded
from a term loan discussed below and $0.75 million in a promissory note payable
over a three year period to Promag. Promag provides claim filing services
related to rebates owed retailers from publishers or their designated agent
throughout the United States and Canada.
In September 2004, the Company acquired substantially all of the assets and
liabilities of Empire State News Corp. ("Empire"), a magazine wholesaler in
northwest New York State for approximately $5.0 million. The purchase price
consisted of $3.3 million of cash paid and $1.6 million of deferred
consideration in the form of two notes payable ($1.2 million) and deferred
compensation, subject to finalization of working capital adjustments in
accordance with the purchase agreement.
For the nine months ended October 31, 2003, cash provided by investing
activities related to capital expenditures of $1.4 million, which related
primarily to our relocation to Florida, and $1.4 million of payments made
related to the acquisition of customer lists under the export agreement and a
contingent payment of $1.0 million under the magazine import agreement. Finally,
in connection with the magazine export agreement discussed in the paragraph
above, the company had advanced $4.7 million during the nine months ended
October 31, 2003.
25
Our borrowing agreements limit the amount of our capital expenditures in any
fiscal year.
FINANCING CASH FLOW
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 front end wire and services business and the payment cycle of
the magazine distribution business. Because the magazine distribution business
and Advance Pay program cash requirements peak at our fiscal quarter ends, the
reported bank debt levels usually are the maximum level outstanding during the
quarter.
Payments under our Advance Pay program generally occur just prior to our fiscal
quarter end. The related claims are not generally collected by us until 30-60
days after the advance is made. As a result, our funding requirements peak at
the time of the initial advances and decrease over this period as the cash is
collected on the related claims.
The front end wire and services business 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 180 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 decrease significantly in the fourth and first fiscal
quarters as the related receivable are collected and significantly less
manufacturing activity is occurring.
Within our magazine distribution business, 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.
Net cash provided by financing activities was $30.8 and $0.0 million for the
nine months ended October 31, 2004 and 2003, respectively.
Financing activities in the first nine months of fiscal year 2005 consisted of
proceeds from the sale of 3.8 million shares of common stock. The proceeds of
$40.5 million (net of underwriting and related expenses) from the sale were
utilized to repay the Wells Fargo Foothill original term loan, the Hilco Capital
note payable and the notes payable to former owners ($22.4 million through
October 31, 2004). For the nine month period ended October 31, 2004, borrowings
on the credit facilities totaled $8.9 million and a term loan in the amount of
$10.0 million was issued related to the Promag transaction. In addition, the
cash provided by the activities noted above were offset by an $11.1 million
decrease in checks issued and outstanding at October 31, 2004. Finally, the
exercise of employee stock options in the period generated approximately $4.9
million.
Financing activities for the first nine months of fiscal year 2004 consisted
primarily of repayments on our credit facilities ($15.7 million) and proceeds
from the issuance of notes payable ($20.0 million). These borrowings were offset
by a $5.5 million reduction of checks issued and outstanding at October 31,
2003. The exercise of employee stock options in the period generated
approximately $1.9 million.
DEBT
At October 31, 2004, our total debt obligations were $34.1 million, excluding
outstanding letters of credit. Debt consists primarily of our amounts owed under
the Revolving Credit facility, the term loan with Wells Fargo Foothill and the
magazine export agreement.
On October 30, 2003, we entered into a credit agreement with Wells Fargo
Foothill. The credit agreement enabled us to borrow up to $45.0 million under a
revolving credit facility. The credit agreement expired on October 30, 2006 and
was secured by all of the assets of the Company. In August 2004, the Company
amended the credit facility with Wells Fargo Foothill. The amended facility now
extends through October 31, 2009 and provides for a $10 million term note
payable that bears interest at the prime rate plus 2.0% (6.75% at October 31,
2004). In addition, the Company reduced the $45.0 million revolving credit
facility to $40.0 million however the total credit facility remains $50.0
million. The term note is payable over five years with initial quarterly
installments of $0.25 million payable over four quarters beginning October 31,
2004. The quarterly installments increase to $0.35, $0.50, $0.65 and $0.75
million, respectively, over the subsequent four years.
26
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.75% at October 31, 2004) plus up to 0.5% based on an
availability calculation and carries a facility fee of 1/4% per annum on the
difference between $40.0 million and the average principal amount outstanding
under the facility including advances under the revolving credit facility and
letters of credit. The balance on the credit facility at October 31, 2004 was
$20.7 million.
Availability under the revolving facility is limited by a borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability of $11.4 million at October 31, 2004.
On October 30, 2003, we entered into a credit agreement with Hilco Capital. The
note payable had a face value of $15.0 million and was recorded net of the
original issuance discount related to the fair value of warrants issued
concurrently with the note. The note payable bore interest at a rate equal to
the greater of the prime rate (4.75% at October 30, 2004) plus 7.75% or 12% and
deferred interest of 2% due at the termination of the agreement on October 30,
2006. The term loan was paid in full during the quarter ended October 31, 2004.
Under the credit agreements, we are required to maintain a specified minimum
level of EBITDA and compliance with specified fixed charge coverage and debt to
EBITDA ratios. In addition, we are prohibited, without consent from our lenders,
from:
- incurring or suffering to exist additional indebtedness or liens on
our assets,
- engaging in any merger, consolidation, acquisition or disposition of
assets or other fundamental corporate change,
- permitting a change of control of our company,
- paying any dividends or making any other distribution on capital
stock or other payments in connection with the purchase, redemption,
retirement or acquisition of capital stock,
- changing our fiscal year or methods of accounting, and
- making capital expenditures in excess of $7.15 million during fiscal
year 2005 and $3.4 million during fiscal year 2006 and each
subsequent fiscal year.
Amounts owed related to the magazine export agreement consist of 9 quarterly
payments of approximately $.4 million beginning in January 2004. The balance
outstanding under this agreement at October 31, 2004 was $2.16 million
In connection with the acquisition of the assets of Empire, the Company issued
notes payable totaling $1.2 million to Empire and one of the former owners of
Empire. The notes payable bear interest at the lowest rate per annum allowable
under the Internal Revenue Service Code Section 1274, which was 2.35% as of
October 31, 2004.
A note payable, due in fiscal 2003, in the principal amount of $1.6 million to
the previous owner of an acquired company was being disputed by the Company
under the conditions of the acquisition agreement. The Company received a
favorable arbitration ruling during the fourth quarter of fiscal 2004, and in
March 2004, we settled the remaining note payable, interest accrued thereon and
the indemnification claim by the Company for $1.6 million.
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
27
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 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.
INTERNAL CONTROLS OVER FINANCIAL REPORTING
The Company is currently undergoing the rigorous process to ensure compliance
with the new regulations under Section 404 of the Sarbanes-Oxley Act that take
effect for the Company's fiscal year ending January 31, 2005. In the course of
documenting and testing, certain aspects of our internal controls over financial
reporting have been identified that we believe require remediation. In these
instances, the company has implemented such remediation. While we continue to
dedicate substantial resources to this effort we can not be certain that all
remediation efforts will be timely completed and tested by us and our
independent auditor so that management and our independent auditor will be able
to express an unqualified opinion on the effectiveness of internal control for
our fiscal year ending January 31, 2005.
28
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 to credit facilities with Wells Fargo Foothill and a
note payable to Hilco Capital. See "--- Liquidity and Capital Resources
- --- Debt"
The revolving credit facility with Wells Fargo Foothill has an outstanding
principal balance of approximately $20.70 million at October 31, 2004. Interest
on the outstanding balance is charged based on a variable interest rate related
to the prime rate (4.75% at October 31, 2004) plus a margin specified in the
credit agreement (0.00% at October 31, 2004).
The amended credit facility provides for a $10 million term note payable that
bears interest at the prime rate plus 2.0% (6.75% at October 31, 2004). The term
note is payable over five years in installments of $0.25 million over four
quarters beginning October 31, 2004. The quarterly installments increase to
$0.35, $0.50, $0.65 and $0.75 million, respectively, over the subsequent four
years.
The original term note payable with Wells Fargo Foothill was paid in full in
March 2004.
The note payable with Hilco Capital was repaid in full during the quarter ended
October 31, 2004.
Interest expense from these credit facilities is subject to market risk in the
form of fluctuations in interest rates.
In March 2004, we utilized the proceeds from a sale of our common stock to
pay-down all but a nominal amount of the Hilco Capital Note Payable, repay the
term note portion of the Wells Fargo Foothill credit facility, and repaid all
outstanding balances owed under the revolving credit partition of the Wells
Fargo Foothill credit facility.
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 $2.0 million, which
represented 2.1% of our revenues for the quarter ended October 31, 2004. We
generally pay the operating expenses related to these revenues in the
corresponding local currency. We will be subject to any risk for exchange rate
fluctuations between such local currency and the dollar.
Additionally, we have exposure to foreign currency fluctuation through our
exporting of foreign magazines and the purchased of foreign magazine for
domestic distribution.
Revenues derived from the export of foreign titles (or sale to domestic brokers
who facilitate the export) totaled $28.7 million for the period ended October
31, 2004 or 13.4% of total revenues. For the most part, our export revenues are
denominated in dollars and the foreign wholesaler is subject to foreign currency
risks. We have the availability to control foreign currency risk via increasing
or decreasing the local cover price paid in the foreign markets. There is a risk
that a substantial increase in local cover price due to a decline in the local
currency relative to the dollar could decrease demand for these magazines at
retail and negatively impact our results of operations.
Domestic distribution (gross) of imported titles totaled approximately $68.4
million (of a total $381.1 million or 17.9%). Foreign publications are purchased
in both dollars and the local currency of the foreign publisher, primarily Euros
and pound sterling. In the instances where we buy in the foreign currency, we
generally have the ability to set the domestic cover price, which allows us to
control the foreign currency risk. Foreign titles generally have significantly
higher cover prices then comparable domestic titles, are considered somewhat of
a luxury item, are sold only at select retail locations, and sales do not appear
to be highly impacted by cover price increases. However, a significant negative
change in the relative strength of the dollar to these foreign currencies could
result in higher domestic cover prices and result in lower sales of these titles
at retail, which would negatively impact our results of operations.
We do not conduct any significant hedging activities related to foreign
currency.
29
ITEM 4. CONTROLS AND PROCEDURES
QUARTERLY CONTROLS EVALUATION AND RELATED CEO AND CFO CERTIFICATIONS
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report (the
"Evaluation Date").
Attached as exhibits to this Quarterly Report are certifications of our chief
executive officer and chief financial officer, which are required in accordance
with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (Exchange
Act). The information appearing below should be read in conjunction with the
certifications for a more complete understanding of the topics presented.
ABOUT DISCLOSURE CONTROLS
Disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule
15d-15(e) of the Securities Exchange Act of 1934) are designed to provide
assurance that the information concerning us and our consolidated subsidiaries,
which is required to be included in our reports and statements filed or
submitted under the Securities Exchange Act of 1934, as amended, (i) is
accumulated and communicated to our management, including our chief executive
officer and chief financial officer, as appropriate to allow timely decisions
required disclosure and (ii) is recorded, processed, summarized and reported
within the time periods specified in rules and forms of the Securities and
Exchange Commission.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our chief executive officer and chief financial
officer, do not expect that our disclosure controls and procedures will prevent
all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
system's objectives will be met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty and that breakdowns
can occur because of simple error or mistake. Controls can also be circumvented
by the individual acts of some persons, by collusion of two or more people, or
by management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
SCOPE OF THE CONTROLS EVALUATION
The evaluation of our disclosure controls and procedures included a review of
the controls' objectives and design, the company's implementation of the
controls and the effect of the controls on the information generated for use in
this Quarterly Report. In the course of the controls evaluation, we sought to
identify data errors, control problems or acts of fraud and confirm that
appropriate corrective action, including process improvements, were being
undertaken. This type of evaluation is performed on a quarterly basis so that
the conclusions of management, including the chief executive officer and the
chief financial officer, concerning the effectiveness of the controls can be
reported in our Quarterly Reports on Form 10-Q and to supplement our disclosures
made in our Annual Report on Form 10-K. Many of the components of our disclosure
controls and procedures are also evaluated on an ongoing basis by our Internal
Audit Department and by other personnel in our finance organization. The overall
goals of these various evaluation activities are to monitor our disclosure
controls and procedures, and to modify them as necessary. Our intent is to
maintain the disclosure controls and procedures as dynamic systems that change
as conditions warrant.
30
CONCLUSIONS
Based on this evaluation, our management, including our principal executive
officer and principal financial officer, concluded that, as of the Evaluation
Date and subject to the limitations noted above, our disclosure controls and
procedures were effective to provide reasonable assurance that material
information relating to the company is made known to management, including the
principal executive officer and principal financial officer, particularly during
the period when our periodic reports are being prepared.
In addition, there were no changes in our internal controls over financial
reporting identified in connection with the above-mentioned evaluation that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting. In addition, we have not identified any significant deficiencies or
material weaknesses in the design or operation of internal controls over
financial reporting which are reasonably likely to adversely affect our ability
to record, process, summarize and report financial information.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are 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, we believe that
none of these actions, individually or in the aggregate, will have a material
adverse effect on our financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not Applicable
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
See Exhibit Index
(b) Reports on Form 8-K.
During the quarter ended October 31, 2004, the Company filed three
Reports on Form 8-K as described below:
DATE FILED ITEM REPORTED FINANCIAL STATEMENTS FILED
---------- ------------- --------------------------
1.01, 2.03
September 9, 2004 and 9.01 none
Condensed Consolidated Balance
Sheets and Statements of
Operations at July 31, 2004 and January
31, 2004 and for the fiscal quarter ended
September 13, 2004 2.02 July 31, 2004 and 2003
1.02, 2.03
September 16, 2004 and 9.01 none
32
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.
Date: December 10, 2004
SOURCE INTERLINK COMPANIES, INC.
/s/ Marc Fierman
----------------------------
Marc Fierman
Chief Financial Officer
33
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
10.33.2 Second Amendment to Net Lease between Conewago Contractors, Inc. and
Pennsylvania International Distribution Services, Inc. effective
December 1, 2004
10.48* Retail Magazine Supply Agreement between Barnes & Noble, Inc. and
International Periodical Distributors, Inc. dated as of August 6,
2004
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 and
Principal Financial Officer
* Certain material has been omitted pursuant to a request for confidential
treatment and such material has been filed separately with the Commission.