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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 April 30, 2005
[ ] 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)
DELAWARE 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 June 6, 2005
----- ---------------------------
Common Stock, $.01 Par Value 51,017,562
SOURCE INTERLINK COMPANIES, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets at
April 30, 2005 and January 31, 2005 1
Consolidated Statements of Income for the three months
ended April 30, 2005 and 2004 3
Consolidated Statement of Stockholders'
Equity for the three months ended April 30, 2005 4
Consolidated Statements of Cash Flows for the
three months ended April 30, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 28
ITEM 4. CONTROLS AND PROCEDURES 29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 31
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS
AND ISSUER PURCHASES OF EQUITY SECURITIES 31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 31
ITEM 5. OTHER INFORMATION 31
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 31
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
April 30, 2005 January 31, 2005
-------------- ----------------
ASSETS
CURRENT ASSETS
Cash $ 1,394 $ 1,387
Trade receivables, net 87,997 48,078
Purchased claims receivable 14,671 2,006
Inventories 134,906 16,868
Income tax receivable 3,697 2,275
Deferred tax asset 11,202 2,302
Prepaid expenses and other 8,129 3,349
-------------- ----------------
TOTAL CURRENT ASSETS 261,996 76,265
-------------- ----------------
Property and equipment 82,690 36,706
Less accumulated depreciation and amortization (16,165) (14,375)
-------------- ----------------
Property and equipment, net 66,525 22,331
-------------- ----------------
OTHER ASSETS
Goodwill, net 121,450 71,600
Intangibles, net 228,369 16,126
Deferred tax asset 5,205 2,903
Other 8,535 8,528
-------------- ----------------
TOTAL OTHER ASSETS 363,559 99,157
-------------- ----------------
$ 692,080 $ 197,753
============== ================
1
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
April 30, 2005 January 31, 2005
-------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Checks issued against future advances on revolving credit facility $ 5,486 $ 1,951
Accounts payable and accrued expenses, net of allowances for returns of
$111,677 and $70,292, respectively 164,073 25,274
Deferred revenue 2,631 2,205
Other 1,752 19
Current maturities of long-term debt 12,873 5,630
Current portion of obligations under capital leases 321 -
-------------- ----------------
TOTAL CURRENT LIABILITIES 187,136 35,079
Long-term debt, less current maturities 57,604 34,139
Obligations under capital leases 144
Other 4,853 852
-------------- ----------------
TOTAL LIABILITIES 249,737 70,070
-------------- ----------------
COMMITMENTS AND CONTINGENCIES (NOTE 8)
STOCKHOLDERS' EQUITY
Contributed Capital:
Preferred Stock, $.01 par; 2,000 shares authorized; none issued - -
Common Stock, $.01 par; 100,000 and 40,000 shares authorized, respectively;
50,972 and 23,849 shares issued, respectively 509 238
Additional paid-in-capital 462,566 150,269
-------------- ----------------
Total contributed capital 463,075 150,507
Accumulated deficit (22,025) (23,696)
Accumulated other comprehensive income:
Foreign currency translation 1,293 1,439
-------------- ----------------
442,343 128,250
Less: Treasury Stock (100 shares at cost) - (567)
-------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 442,343 127,683
-------------- ----------------
$ 692,080 $ 197,753
============== ================
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 April 30, 2005 2004
- ---------------------------- -------------- ----------------
Revenues $ 234,421 $ 82,181
Cost of revenues 183,876 60,102
-------------- ----------------
Gross profit 50,545 22,079
Selling, general and administrative expenses 29,674 11,949
Fulfillment freight 10,336 4,874
Depreciation and amortization 3,103 677
Merger and acquisition charges 3,094 -
Relocation expenses - 1,552
-------------- ----------------
Operating income 4,338 3,027
-------------- ----------------
Other income (expense)
Interest expense (935) (536)
Interest income 46 67
Write off of deferred financing costs and original issue discount - (1,494)
Other 74 (108)
-------------- ----------------
Total other income (expense) (815) (2,071)
-------------- ----------------
Income from continuing operations before income taxes and discontinued operation 3,523 956
Income tax expense 1,852 324
-------------- ----------------
Income from continuing operations before discontinued operation 1,671 632
Loss from discontinued operation, net of tax - (135)
-------------- ----------------
Net income $ 1,671 $ 497
============== ================
Earnings (loss) per share - basic
Continuing operations $ 0.04 $ 0.03
Discontinued operation - (0.01)
-------------- ----------------
Total 0.04 0.02
============== ================
Earnings (loss) per share - diluted
Continuing operations 0.04 0.03
Discontinued operation - (0.01)
-------------- ----------------
Total $ 0.04 $ 0.02
============== ================
Weighted Average of Shares Outstanding - Basic 42,314 21,506
Weighted Average of Shares Outstanding - Diluted 44,395 23,857
============== ================
See accompanying notes to consolidated financial statements
3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands)
Accumulated
Other
Common Stock Additional Comprehensive Treasury Stock Total
------------ Paid - in Accumulated Income -------------- Stockholders'
Shares Amount Capital Deficit (Loss) Shares Amount Equity
------ ------ ---------- ----------- ------------- ------ ------ -------------
Balance, January 31, 2005 23,849 $ 238 $ 150,269 $ (23,696) $ 1,439 100 $ (567) $ 127,683
Net income - - - 1,671 - - - 1,671
Foreign currency translation - - - - (146) - - (146)
-------------
Comprehensive income 1,525
-------------
Exercise of stock options 281 3 1,239 - - - - 1,242
Tax benefit from stock
options exercised - - 679 - - - - 679
Stock issued in Alliance
acquisition 26,942 269 304,445 - - - - 304,714
Exchange of stock options and
warrants to acquire Alliance
common stock - - 6,500 - - - - 6,500
Retirement of treasury stock (100) (1) (566) (100) 567 -
------ ------ ---------- ----------- ------------- --- ------ -------------
Balance, April 30, 2005 50,972 $ 509 $ 462,566 $ (22,025) $ 1,293 0 $ 0 $ 442,343
====== ====== ========== =========== ============= === ====== =============
See accompanying notes to consolidated financial statements
4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Three months ended April 30, 2005 2004
- ---------------------------- ----------- --------------
OPERATING ACTIVITIES
Net income $ 1,671 $ 497
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 3,571 1,003
Provision for losses on accounts receivable 240 381
Deferred income taxes - (247)
Tax benefit from stock options exercised 679 889
Deferred revenue 402 -
Write off of deferred financing costs and original issue discount - 1,494
Other (70) (273)
Changes in assets and liabilities (excluding business acquisitions):
Decrease (increase) in accounts receivable 7,647 (5,536)
(Increase) decrease in inventories (15,605) 708
Increase in other assets (1,106) (1,433)
Decrease in accounts payable and other liabilities (8,041) (7,604)
----------- -----------
CASH USED IN OPERATING ACTIVITIES (10,612) (10,121)
----------- -----------
INVESTMENT ACTIVITIES
Capital expenditures (2,355) (1,946)
Purchase of claims (31,384) (22,056)
Payments received on purchased claims 18,720 23,042
Collections (advances) under magazine export agreement - 2,930
Net cash from Alliance Entertainment Corp. acquisition 16,879 -
Acquisition of distribution rights (2,300) -
Other (41) -
----------- -----------
CASH (USED IN)PROVIDED BY INVESTING ACTIVITIES (481) 1,970
----------- -----------
FINANCING ACTIVITIES
Decrease in checks issued against revolving credit facilities (8,041) (5,875)
Net borrowings (repayments) under credit facilities 28,709 (11,735)
Payments on debt and capital leases (9,910) (20,714)
Net proceeds from the issuance of common stock 1,241 42,264
Deferred financing costs (899) -
----------- -----------
CASH PROVIDED BY FINANCING ACTIVITIES 11,100 3,940
----------- -----------
INCREASE (DECREASE) IN CASH 7 (4,211)
CASH, beginning of period 1,387 4,963
----------- -----------
CASH, end of period $ 1,394 $ 752
=========== ===========
See accompanying notes to consolidated financial statements
5
BASIS OF PRESENTATION
The unaudited consolidated financial statements include the accounts of Source
Interlink Companies, Inc. and its subsidiaries (collectively, the Company). In
the opinion of the Company's management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of normal recurring
adjustments and reclassifications) necessary to present fairly its consolidated
financial position as of April 30, 2005 and 2004 and the results of its
operations and its cash flows for the three months then ended, respectively.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These consolidated financial statements should
be read in conjunction with the Company's Annual Report on Form 10-K for the
year ended January 31, 2005. The Company follows the same accounting policies in
preparation of interim reports. The results of operations for such interim
periods are not necessarily indicative of the operating results to be expected
for the full year.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
The income tax provisions for the three months ended April 30, 2005 and 2004 are
based upon management's estimate of the Company's annualized effective tax rate.
1. BUSINESS COMBINATION
ALLIANCE ENTERTAINMENT CORP. ACQUISITION
On February 28, 2005, the Company completed its acquisition of Alliance
Entertainment Corp. ("Alliance") pursuant to the terms and conditions of the
Agreement and Plan of Merger Agreement dated November 18, 2004 (the
"Agreement"). Alliance provides full-service distribution of home entertainment
products. They provide product and commerce solutions to "brick-and-mortar" and
e-commerce retailers, while maintaining trading relationships with major
manufacturers in the home entertainment industry.
The purchase price of approximately $315.5 million consisted of $304.7 million
in the Company's common stock, representing approximately 26.9 million shares,
$6.5 million related to the exchange of approximately 0.9 million options to
acquire shares of common stock on exercise of outstanding stock options,
warrants and other rights to acquire Alliance common stock and direct
transaction costs of approximately $4.3 million. The value of the common stock
was determined based on the average market price of Source Interlink common
stock over the 5-day period prior to and after the announcement of the
acquisition in November 2004. The value of the stock options were determined
using the Black-Scholes option valuation model.
The total cost of the acquisition was allocated to the assets acquired and
liabilities assumed based on their respective fair values in accordance with FAS
141, Business Combinations. Goodwill and other intangible assets, none of which
is deductible for tax purposes, recorded in connection with the transaction
totaled $50.5 million and $211.5 million, respectively. These amounts will be
tested at least annually for impairment in accordance with FAS No. 142, Goodwill
and Other Intangible Assets.
6
The assets acquired and liabilities assumed in the acquisition are summarized
below (in thousands):
Cash $ 18,567
Trade receivables, net 47,806
Inventories 102,434
Property and equipment 43,696
Goodwill 50,520
Intangible assets 211,525
Other assets 17,465
Accounts payable and accrued
liabilities (160,156)
Obligations under capital leases (563)
Long-term debt (11,811)
Other long-term liabilities (4,000)
------------
Total consideration $ 315,483
------------
The acquisition was accounted for by the purchase method and, accordingly, the
results of Alliance operations have been included in our consolidated statements
of income since March 1, 2005. The following table summarizes pro forma
operating results as if the Company had completed the acquisition on February 1,
2004 (in thousands, except per share data):
Three months ended April 30, 2005 2004
- ----------------------------- ------------ -------------
Revenues $ 307,615 $ 308,173
Net income 2,668 3,820
Earnings per share - basic
Continuing operations 0.05 0.08
Discontinued operation - -
------------ -------------
Total 0.05 0.08
============ =============
Earnings per share -- diluted
Continuing operations 0.05 0.08
Discontinued operation - -
Total 0.05 0.08
============ =============
This information has been prepared for comparative purposes only and does not
purport to be indicative of the results of operations which actually would have
resulted had the acquisition occurred on February 1, 2004, nor is it indicative
of future results.
Merger charges related to acquisitions recorded as expenses by the Company
through April 30, 2005 totaled $3.1 million. These expenses represented
severance and personnel-related charges, charges to exit certain merchandiser
contracts and a success fee paid to certain Company executives. These expenses
were not capitalized as they did not represent costs that provide future
economic benefits to the Company.
7
2. TRADE RECEIVABLES
Trade receivables consist of the following (in thousands):
April 30, 2005 January 31, 2005
--------------- -----------------
Trade receivables $ 234,243 $ 129,031
Allowances:
Sales returns and other (128,172) (78,404)
Doubtful accounts (18,074) (2,549)
--------------- -----------------
(146,246) (80,953)
--------------- -----------------
Net trade receivables $ 87,997 $ 48,078
=============== =================
3. INVENTORIES
Inventories consist of the following (in thousands):
April 30, 2005 January 31, 2005
-------------- ----------------
Raw materials $ 2,559 $ 2,657
Work-in-process 2,299 1,459
Finished goods:
Fixtures 1,810 1,407
Magazine 12,208 11,345
Pre-recorded music and video 116,030 -
-------------- ----------------
Inventories $ 134,906 $ 16,868
============== ================
In the event of non-sale, magazine and pre-recorded music and video inventories
are generally returnable to the supplier for full credit.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
APRIL 30, JANUARY 31,
2005 2005
---------- -----------
Land $ 8,218 $ 870
Buildings 18,804 8,809
Leasehold improvements 4,384 2,566
Machinery and equipment 30,338 10,806
Vehicles 437 354
Furniture and fixtures 7,510 3,855
Computers 10,560 9,446
Construction in progress 2,439 -
---------- -----------
Property and equipment $ 82,690 $ 36,706
========== ===========
Depreciation expense from property and equipment was $1.8 million and $0.8
million for the quarters ended April 30, 2005 and 2004, respectively.
8
5. GOODWILL AND INTANGIBLE ASSETS
A summary of the Company's intangible assets is as follows (in thousands):
April 30, January 31,
2005 2005
------------- ------------
Amortized intangible assets:
Customer lists $ 97,125 $ 16,025
Non-compete agreements 1,775 1,000
Software 12,948 -
Unamortized intangible assets including vendor lists 119,000 -
------------- ------------
230,848 17,025
Accumulated amortization (2,479) ( 899)
------------- ------------
Intangibles, net $ 228,369 $ 16,126
------------- ------------
Amortization expense from intangible assets was $1.6 million and $0.2 million
for the three months ended April 30, 2005 and 2004, respectively. Amortization
expense will approximate $8.0 million for each of the next five fiscal years.
The changes in the carrying amount of goodwill for the three months ended April
30, 2005, are as follows:
Foreign currency
January 31, Goodwill translation Purchase Price April 30,
2005 additions adjustments adjustments 2005
------------- ---------- ----------------- --------------- ----------
Goodwill $ 71,600 50,520 (64) (606) $ 121,450
---------- ------ ----------------- --------------- ----------
6. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of (in thousands):
April 30, January 31,
2005 2005
---------- ------------
Revolving Credit facility - Wells Fargo Foothill $ 47,998 $ 19,289
Note payable - Wells Fargo Foothill - 8,766
Note payable - magazine import and export 9,219 9,879
Notes payable - former owner of Empire 1,200 1,200
Mortgage loan - SunTrust Bank 7,432 -
Equipment loans - SunTrust Leasing 4,112 -
Other 516 635
---------- ------------
Debt 70,477 39,769
Less current maturities 12,873 5,630
---------- ------------
Debt, less current maturities $ 57,604 $ 34,139
========== ============
WELLS FARGO FOOTHILL CREDIT FACILITY
On February 28th 2005, the Company modified its existing credit facility with
Wells Fargo Foothill ("WFF") as a result of its acquisition of Alliance
Entertainment Corp. The primary changes from the original line of credit were to
(1) increase the maximum allowed advances under the line of credit from $45
million to $250 million and extend the maturity date from October 2009 to
October 2010. In addition, in conjunction with the modification of the existing
credit facility, the Company repaid the balance of its $10 million WFF term
loan. WFF, as arranger and administrative agent for each of the lenders that may
become a participant in such arrangement and their successors ("Lenders") will
make revolving loans to us and our subsidiaries of up to $250 million including
the issuance of letters of credit. The terms and conditions of the arrangement
are governed primarily by the Amended and Restated Loan Agreement dated February
28, 2005 by and among us, our subsidiaries, and WFF.
9
Outstanding borrowings bear interest at a variable annual rate equal to the
prime rate announced by Wells Fargo Bank, National Association's San Francisco
office, plus a margin of between 0.0% and 1.00% (applicable margin was 0.0% at
April 30, 2005) based upon a ratio of the Company's EBITDA to interest expense
("Interest Coverage Ratio"). At April 30, 2005 the prime rate was 5.75%. We also
have the option of selecting up to five traunches of at least $1 million each to
bear interest at LIBOR plus a margin of between 2.00% and 3.00% based upon our
Interest Coverage Ratio. The Company has one LIBOR contract outstanding at April
30, 2005 (expiring July 27, 2005) and bears interest at 5.18%. To secure
repayment of the borrowings and other obligations of ours to the Lenders, we and
our subsidiaries granted a security interest in all of the personal property
assets to WFF, for the benefit of the Lenders. These loans mature on October 31,
2010.
Under the credit agreement, the Company is limited in its ability to declare
dividends or other distributions on capital stock or make payments in connection
with the purchase, redemption, retirement or acquisition of capital stock. There
are also limitations on capital expenditures and the Company is required to
maintain certain financial ratios. The Company was in compliance with these
ratios at April 30, 2005
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability, after consideration of outstanding letters of credit, of $102.5
million at April 30, 2005.
MORTGAGE LOAN
Through the acquisition of Alliance, the Company assumed an $8.5 million
conventional mortgage loan through SunTrust Bank (the "SunTrust Mortgage"). The
SunTrust Mortgage is collateralized by land and building. The SunTrust Mortgage
matures on June 1, 2005 and has monthly principal payments of approximately
$0.03 million plus interest at a rate of LIBOR plus 2 1/2%. The principal
payments were determined based on a 15-year amortization of the outstanding
principal amount of the SunTrust Mortgage. On the maturity date, the aggregate
unpaid principal balance of the mortgage, accrued and unpaid interest and all
costs and expenses due under the SunTrust Mortgage terms shall be due and
payable. The total principal balance of $7.4 million is classified as current at
April 30, 2005.
EQUIPMENT LOAN
Through the acquisition of Alliance, the Company assumed a loan agreement
with SunTrust Leasing Corporation (the "SunTrust Loan") for the purchase of
equipment to be used at various locations. A credit line of $6.8 million was
approved under the SunTrust Loan, with repayment terms for five promissory notes
ranging from three to five years. The total principal balance of the SunTrust
Loan outstanding as of April 30, 2005 was $4.1 million.
The maturity schedule of the Company's long-term debt is as follows (in
thousands):
Fiscal year Amount
- ----------------------------- -----------------
2006 $ 12,873
2007 4,631
2008 4,209
2009 650
2010 106
Thereafter 48,008
-----------------
70,477
Less current maturities 12,873
-----------------
Debt, less current maturities $ 57,604
=================
10
7. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of the assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The sources of
the temporary differences and their effect on deferred taxes are as follows (in
thousands):
APRIL 30, JANUARY 31,
2005 2005
--------- -----------
Deferred tax assets
Net operating loss carryforwards $ 7,836 $ 4,576
Allowance for doubtful accounts 6,933 1,025
Goodwill 3,156 456
Deferred revenue 882 882
Inventory reserves 2,921 -
Other 2,964 918
--------- -----------
Deferred tax asset 24,692 7,857
--------- -----------
Deferred tax liabilities
Book/tax difference in capital assets 7,424 1,791
Prepaid expenses 861 861
--------- -----------
Total deferred tax liabilities 8,285 2,652
--------- -----------
Net deferred tax assets $ 16,407 $ 5,205
========= ===========
Classified as:
Current asset $ 11,202 $ 2,302
Long-term asset 5,205 2,903
--------- -----------
Net deferred tax assets $ 16,407 $ 5,205
========= ===========
At April 30, 2005, the Company had net operating loss carryforwards of
approximately $21.7 expiring as follows (in thousands):
FISCAL YEAR AMOUNT
- ------------ ---------
2019 $ 1,834
2020 17,444
2021 1,124
2022 507
2023 $ 759
The effective income tax rates were 52.6% and 33.9% for the quarters ended April
30, 2005 and 2004, respectively.
The difference between the statutory rate and effective tax rates for the
quarter ended April 30, 2005 primarily relates to the amortization of the
intangible assets acquired in the Alliance Entertainment Corp. not being
deductible for tax purposes.
The difference between the statutory rate and effective tax rates for the
quarter ended April 30, 2004 relates primarily to the realization of a portion
of the net operating loss carry-forward acquired with our acquisition of
Interlink.
11
8. COMMITMENTS AND CONTINGENCIES
The Company leases facilities, vehicles, an aircraft, computer and other
equipment under various capital and operating leases. Future minimum payments
under capital and noncancelable operating leases with terms of one year or more
at April 30, 2005 consist of the following (dollars in thousands):
OPERATING CAPITAL
Fiscal Year LEASES LEASES
- -------------- ---------- ---------
2006 $ 6,943 $ 335
2007 7,610 147
2008 6,724 4
2009 6,314 -
2010 5,684 -
Thereafter 20,638 -
---------- ---------
$ 53,913 486
========== ---------
Less: Amounts representing interest 21
---------
Present value of net minimum lease payments 465
Less: Current portion of obligations under capital leases 321
---------
Long-term portion of obligations under capital leases $ 144
=========
9. DISCONTINUED OPERATION
In November 2004, the Company sold and disposed of its secondary wholesale
distribution operation for $1.4 million, in order to focus more fully on its
domestic and export distribution. All rights owned under the secondary wholesale
distribution contracts were assigned, delivered, conveyed and transferred to the
buyer, an unrelated third party. All assets and liabilities of the secondary
wholesale distribution operation were not assumed by the buyer. The Company
recognized a gain on sale of this business of $1.4 million ($0.8 net of tax) in
the fourth quarter of fiscal year 2005.
The following amounts related to the Company's discontinued operation have been
segregated from continuing operations and reflected as discontinued operations
(in thousands):
THREE MONTHS ENDED APRIL 30, 2005 2004
- ----------------------------- -------- -------
Revenue $ - $ 3,506
======== =======
Loss before income taxes - (225)
Income tax benefit - 90
-------- -------
Loss from discontinued operation, net of tax $ - $ (135)
======== =======
10. 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
April 30,
2005 2004
------- ---------
Basic weighted average number of common shares outstanding 42,314 21,506
Effect of dilutive securities:
Stock options and warrants 2,081 2,351
------- ---------
Diluted weighted average number of common shares outstanding 44,395 23,857
======= =========
12
For the quarters ended April 30, 2005 and 2004, stock options to purchase
0.2 million shares and warrants convertible into 0.03 million shares,
respectively, 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.
11. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Three Months Ended April 30, 2005 2004
- ---------------------------- ---------- ----------
Interest $ 853 $ 652
Income Taxes $ 2,457 $ 664
========== ==========
On February 28, 2005, as discussed in Note 1, the Company acquired Alliance
Entertainment Corp. for the total consideration of $315.5 million as follows (in
thousands):
- --------------------------------------------------------------------------------
Fair value of common stock issued to Alliance shareholders $ 304,714
Fair value of options to purchase common stock issued to Alliance
shareholders 6,500
Cash paid for direct acquisition costs (of which $1.7 million
were paid during the three months ended April 30, 2005) 4,269
- --------------------------------------------------------------------------------
Total purchase price for allocation of Alliance $ 315,483
================================================================================
The total purchase price was allocated to the assets and liabilities of Alliance
Entertainment Corp. as disclosed in Note 1.
12. STOCK-BASED COMPENSATION
FAS No. 123, "Accounting for Stock-Based Compensation" ("FAS No. 123") 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 Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans. No stock
based compensation was reflected in the periods ended April 30, 2005 and 2004 as
all options granted in those periods had an exercise price equal to or greater
than the market value of the underlying stock on the date of grant.
The following is a reconciliation of net income per weighted average share had
the Company adopted FAS No. 123 (table in thousands except per share amounts):
Three Months Ended April 30, 2005 2004
- ---------------------------- ---------- ----------
Net income $ 1,671 $ 497
Stock compensation costs, net of tax (670) (89)
---------- ----------
Adjusted net income $ 1,001 $ 408
---------- ----------
Weighted average shares, basic 42,314 21,506
Weighted average shares, diluted 44,395 23,857
Basic earnings per share - as reported $ 0.04 $ 0.02
Diluted earnings per share - as reported 0.04 0.02
Basic earnings per share - pro-forma $ 0.02 $ 0.02
Diluted earnings per share - pro-forma 0.02 0.02
========== ==========
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
Three Months ended April 30, 2005 2004
- --------------------------- ---- ----------
Dividend yield 0% 0%
Expected volatility 0.50 0.50
Risk-free interest rate 3.75% 2.18- 2.25%
13
13. 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 Fulfillment, CD and DVD
Fulfillment, In-Store Services, and Shared Services. The accounting policies of
the segments are materially the same as those described in the Summary of
Accounting Policies. As a result of the acquisition of Alliance on February 28,
2005, the Company created a CD and DVD Fulfillment reporting segment and, based
on the reporting of the senior management, has included the previous Wood
Manufacturing group's results in In-Store Services group. The results of fiscal
year 2005 have been restated to conform to this presentation.
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) providing return processing services for major specialty
retail book chains and (4) serving as an outsourced fulfillment agent.
The CD and DVD Fulfillment segment derives revenues from (1) selling and
distributing pre-recorded music, videos, video games and related products to
retailers, (2) providing product and commerce solutions to "brick-and-mortar"
and e-commerce retailers, and (3) providing consumer-direct fulfillment and
vendor managed inventory services to its customers.
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) designing, manufacturing, shipping,
installation and removal of front-end fixtures, including high end wood and wire
and (4) providing information and management services relating to retail
magazine sales to U.S. and Canadian retailers and magazine publishers.
Shared Services consists of overhead functions not allocated to individual
operating segments.
14
Segment results from continuing operations follow (in thousands):
Magazine CD and DVD In-Store Other
Three Months Ended April 30, 2005 Fulfillment Fulfillment Services (Shared Services) Consolidated
- --------------------------------- ------------ ------------ ----------- ----------------- ------------
Revenue $ 71,653 $ 148,462 $ 14,306 $ - $ 234,421
Cost of revenue 52,740 121,136 10,000 - 183,876
------------ ------------ ----------- ----------- ------------
Gross profit 18,913 27,326 4,306 - 50,545
Selling, general & administrative 9,046 13,360 2,155 5,113 29,674
Fulfillment freight 5,669 4,667 - - 10,336
Depreciation and amortization 403 2,066 146 488 3,103
Merger and acquisition charges - - 227 2,867 3,094
------------ ------------ ----------- ----------- ------------
Operating income (loss) $ 3,795 $ 7,233 $ 1,778 $ (8,468) $ 4,338
============ ============ =========== =========== ============
Total Assets $ 66,282 $ 468,923 $ 110,333 $ 46,542 $ 692,080
Goodwill, net 16,652 50,520 50,139 4,139 121,450
Intangibles, net 13,891 210,268 4,210 - 228,369
Capital expenditures $ 53 $ 1,554 $ 158 $ 590 $ 2,355
Magazine CD and DVD In-Store Other
Three Months Ended April 30, 2004 Fulfillment Fulfillment Services (Shared Services) Consolidated
- ------------------------------ ------------ ------------ ----------- ----------------- ------------
Revenue $ 65,755 $ - $ 16,426 $ - $ 82,181
Cost of revenue 50,362 - 9,740 - 60,102
------------ ------------ ----------- ----------- ------------
Gross profit 15,393 - 6,686 - 22,079
Selling, general & administrative 6,339 - 2,243 3,367 11,949
Fulfillment freight 4,874 - - - 4,874
Depreciation and amortization 296 - 34 347 677
Relocation expense 1,552 - - - 1,552
------------ ------------ ----------- ----------- ------------
Operating income (loss) $ 2,332 $ $ 4,409 $ (3,714) $ 3,027
============ ============ =========== =========== ============
Total Assets $ 50,448 $ - $ 89,819 $ 21,997 $ 162,264
Goodwill, net - - 41,040 4,139 45,179
Intangibles, net 7,653 - 95 - 7,748
Capital expenditures $ 1,000 $ - $ 66 $ 880 $ 1,946
15
14. RELATED PARTY TRANSACTIONS
Pursuant to an agreement through August 2007, the Company conducts significant
business with one customer distributing magazines, music and DVDs. The Chairman
and major stockholder of this customer is a minority investor of AEC Associates,
the Company's largest shareholder. For the period subsequent to the acquisition,
the Company had revenues of $71.5 million to this customer and this customer's
subsidiaries.
15. SUBSEQUENT EVENTS
On May 10, 2005, the Company and Chas. Levy Company LLC ("Levy") entered into a
Unit Purchase Agreement (the "Purchase Agreement"). Under the terms of the
Purchase Agreement, the Company purchased all of the issued and outstanding
membership interests in Chas. Levy Circulating Co. LLC ("CLCC") from Levy for a
purchase price of approximately $30 million, subject to adjustment based on CLCC
net worth as of May 10, 2005, the closing date of the transaction. Levy was the
sole member of CLCC.
On May 10, 2005, as contemplated by the terms of the Purchase Agreement, the
Company and Levy Home Entertainment LLC ("LHE") entered into a Distribution and
Supply Agreement (the "Distribution Agreement"). Under the terms of the
Distribution Agreement, LHE appointed the Company as its sole and exclusive
subdistributor of book products to all supermarkets (excluding supermarkets
combined with general merchandise stores), drug stores, convenience stores,
newsstands and terminals within the geographic territory in which the Registrant
currently distributes DVDs, CDs and/or magazines. The initial term of the
Distribution Agreement begins on May 10, 2005 and expires on June 30, 2015. The
parties may renew the agreement thereafter for successive one year periods.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Some of the information contained in this report, which are not historical
facts, are considered to be "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities and Exchange Act of 1934, as amended. The words "believe," "expect,"
"anticipate,' "estimate," "project," and similar expressions often characterize
forward-looking statements. These statements may include, but are not limited
to, projections of collections, revenues, income or loss, cash flow, estimates
of capital expenditures, plans for future operations, products or services, and
financing needs or plans, as well as assumptions relating to these matters.
These statements are only predictions and you should not unduly rely on them.
Our actual results will differ, perhaps materially, from those anticipated in
these forward-looking statements as a result of a number of factors, including
the risks and uncertainties faced by us described below and those set forth
under the heading and those set forth under the heading "Risk Factors that Might
Affect Future Operating Results and Financial Condition" contained in our Annual
Report on Form 10-K for this fiscal year ended January 31, 2005.
- market acceptance of and continuing demand for magazines, DVDs, CDs
and other home entertainment products;
- the impact of competitive products and technologies;
- the pricing and payment policies of magazine publishers, film
studios, record labels and other key vendors;
- our ability to obtain additional financing to support our
operations;
- changing market conditions and opportunities;
- our ability to realize operating efficiencies, costs savings and
other benefits from recent and pending acquisitions; and,
- retention of key management and employees.
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 and those set forth under the heading "Risk Factors that Might Affect
Future Operating Results and Financial Condition" contained in our Annual Report
on Form 10-K for this fiscal year ended January 31, 2005 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.
Overview
We provide supply chain management and/or related value-added products and
services to most national/regional retailers, magazine publishers and other
providers of home entertainment content. On February 28, 2005, we completed our
merger with Alliance Entertainment Corp., a logistics and supply chain
management services company for the home entertainment product market
principally selling CDs and DVDs. Following the merger, we organized the
combined company into three operating business units: CD and DVD Fulfillment,
Magazine Fulfillment and In Store Services.
Acquisition of Alliance Entertainment
On February 28, 2005, we completed the merger with Alliance Entertainment Corp,
a logistics and supply chain management services company for the home
entertainment product market pursuant to the terms and conditions of the
Agreement and Plan of Merger Agreement dated as of November 18, 2004 (the
"Merger Agreement").
Alliance historically operated two business segments: the Distribution and
Fulfillment Services Group ("DFSG") and the Digital Medial Infrastructure
Services Group (the "DMISG"). Prior to the merger, on December 31, 2004,
Alliance disposed of all of the operations conducted by the DMISG business lines
through a spin-off to its existing stockholders. Consequently, in connection
with the merger, we acquired only the DFSG business and not the DMISG business.
The DMISG business represented approximately 1.8% and 1.4% of Alliance's
consolidated sales for the years ended December 31, 2004 and 2003, respectively.
We consummated the merger with Alliance to further our objective of creating the
premier provider of information, supply chain management and logistics services
to retailers and producers of home entertainment content products. We believe
that the merger provides significant market opportunities to take advantage of
our strong retailer relationships and experience in marketing our products by
expanding product offerings beyond our existing magazine fulfillment business to
DVDs, CDs, video games and related home entertainment products and accessories.
In addition, we believe that our in-store merchandising capabilities will be
strengthened. We also believe this transaction will position us as the
distribution channel of choice for film studios, record labels, publishers and
other producers of home entertainment content products. We expect to benefit
from substantial cost savings in the areas of procurement, marketing,
information technology and administration and from other operational
efficiencies, particularly in the distribution and fulfillment functions, where
we plan to consolidate some distribution operations, reorganize others and
leverage our best practices across all of our distribution operations. As a
result, we believe the merger will enhance our financial strength, increase our
visibility in the investor community and
17
strengthen our ability to pursue further strategic acquisitions.
SOURCE INTERLINK BUSINESS
Our business provides supply chain management and/or related value-added
products and services to most national regional retailers, magazine publishers
and other providers of home entertainment content.
Our clients include:
- Mainstream retailers, such as The Kroger Company, Target
Corporation, Walgreen Company, Ahold USA, Inc., Kmart Corporation,
Sear Roebuck & Co., and Meijers;
- Specialty retailers, such as Barnes & Noble, Inc., Borders Group,
Inc., The Musicland Group, Inc., Hastings Entertainment, Inc., Fry's
Electronics, Inc. and Circuit City Stores, Inc.; and,
- e-commerce retailers, such as amazon.com, barnesandnoble.com,
circuitcity.com and bestbuy.com.
Our suppliers include:
- Record labels, such as Vivendi Universal S.A., Sony BMG Music
Entertainment Company, WEA Distribution and Thorn-EMI;
- Film studios, such as The Walt Disney Company, Time-Warner Inc.,
Sony Corp., The News Corporation, Viacom Inc. and General Electric
Company; and,
- Magazine Distributors, such as COMAG Marketing Group, LLC., Time
Warner Retail Sales & Marketing, Inc., Curtis Circulation Company
and Kable Distribution Services, Inc..
Our business model is designed to deliver a complete array of products and
value-added services developed to assist retailers and manufacturers of digital
versatile disks ("DVDs"), audio compact disks ("CDs"), magazines, confections
and general merchandise in efficiently and effectively marketing their products
to consumers visiting the more than 110,000 store fronts we serve.
Our business consists of four business segments: Magazine Fulfillment, CD and
DVD Fulfillment, In-Store Services 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 26,000 retail stores, 7,300 of which also benefit from our
selection and logistical procurement services.
- Our CD and DVD Fulfillment group was established upon the
acquisition of Alliance Entertainment Corp. effective February 28,
2005. The group provides full-service distribution of pre-recorded
music, videos, video games and related accessories and merchandise
to retailers and other customers primarily in North America. The
group provides product and commerce solutions to "brick-and-mortar"
and e-commerce retailers, while maintaining trading relationships
with major manufacturers of pre-recorded music, video, and related
products. As part of the traditional distribution services, and as
an integral part of its service offering, the group also provides
consumer-direct fulfillment ("CDF"), and vendor managed inventory
("VMI") solutions to its customers.
- 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
18
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 Shared Services group consists of overhead functions not
allocated to the other operating groups. These functions include
corporate finance, human resources, management information systems
and executive management. 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.
19
REVENUES
The Magazine Fulfillment group derives revenues from:
- selling and distributing magazines, including domestic and foreign
titles, to major specialty retailers and wholesalers throughout the
United States and Canada;
- exporting domestic titles internationally to foreign wholesalers or
through domestic brokers;
- providing return processing services for major specialty retail book
chains; and
- serving as an outsourced fulfillment agent and backroom operator for
publishers.
The CD and DVD Fulfillment group derives revenues from:
- selling and distributing pre-recorded music, videos, video games and
related products to retailers;
- providing product and commerce solutions to "brick-and-mortar" and
e-commerce retailers; and
- providing consumer-direct fulfillment and vendor managed inventory
services to its customers.
The In-Store Services group derives revenues from:
- designing, manufacturing and invoicing participants in front-end
merchandising programs;
- providing claim filing services related to rebates owed retailers
from publishers or their designated agents;
- shipping, installing and removing front-end fixtures;
- designing, manufacturing and installing custom wood fixtures
primarily for retailers; and
- providing information and management services relating to magazine
sales to retailers and publishers throughout the United States and
Canada.
COST OF REVENUES
Our cost of revenues for the Magazine Fulfillment and the CD and DVD Fulfillment
groups consist of the costs of products purchased for resale less all applicable
supplier discounts and rebates.
Our cost of revenues for the In-Store Services group 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, certain 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, DVDs
and CDs by third-party freight carriers, primarily Federal Express and UPS.
Freight rates are driven primarily by the weight of the being shipped and the
distance between origination and destination.
20
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 and our CD and DVD Fulfillment groups will result in an increase in
fulfillment freight.
RELOCATION EXPENSES
The Company completed expansion into the mainstream retail market during the
first quarter of fiscal 2005. The expansion schedule required relocation from
the distribution fulfillment center in Milan, OH to Harrisburg, PA. The Company
did not incur similar costs in the period ended April 30, 2005.
RECENT DEVELOPMENTS
On May 10, 2005, the Company and Chas. Levy Company LLC ("Levy") entered into a
Unit Purchase Agreement (the "Purchase Agreement"). Under the terms of the
Purchase Agreement, the Company purchased all of the issued and outstanding
membership interests in Chas. Levy Circulating Co. LLC ("CLCC") from Levy for a
purchase price of approximately $30 million, subject to adjustment based on CLCC
net worth as of May 10, 2005, the closing date of the transaction. Levy was the
sole member of CLCC.
On May 10, 2005, as contemplated by the terms of the Purchase Agreement, the
Company and Levy Home Entertainment LLC ("LHE") entered into a Distribution and
Supply Agreement (the "Distribution Agreement"). Under the terms of the
Distribution Agreement, LHE appointed the Company as its sole and exclusive
subdistributor of book products to all supermarkets (excluding supermarkets
combined with general merchandise stores), drug stores, convenience stores,
newsstands and terminals within the geographic territory in which the Registrant
currently distributes DVDs, CDs and/or magazines. The initial term of the
Distribution Agreement begins on May 10, 2005 and expires on June 30, 2015. The
parties may renew the agreement thereafter for successive one year periods.
21
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our continuing operations (in thousands):
2005 2004
Period ended April 30, Amount Margin % Amount Margin %
- -------------------------------- -------------- --------- ---------- --------
MAGAZINE FULFILLMENT
Revenue $ 71,653 $ 65,755
Cost of revenues 52,740 50,362
Gross profit 18,913 26.4% 15,393 23.4%
Operating expenses (1) 15,118 11,509
Relocation expenses - 1,552
-------------- --------- ---------- --------
Operating income $ 3,795 5.3% $ 2,332 3.5%
CD AND DVD FULFILLMENT
Revenue $ 148,462 $ -
Cost of revenues 121,136 -
Gross profit 27,326 18.4% - n/a
Operating expenses (1) 20,093 -
-------------- --------- ---------- --------
Operating income $ 7,233 4.9% $ - n/a
IN-STORE SERVICES
Revenue $ 14,306 $ 16,426
Cost of revenues 10,000 9,740
Gross profit 4,306 30.1% 6,686 40.7%
Operating expenses (1) 2,528 2,277
-------------- --------- ---------- --------
Operating income $ 1,778 12.4% $ 4,409 26.8%
SHARED SERVICES
Revenue $ - $ -
Cost of revenues - -
Gross profit - n/a - n/a
Operating expenses (1) 8,468 3,714
-------------- --------- ---------- --------
Operating loss $ (8,468) n/a $ (3,714) n/a
TOTAL FROM CONTINUING OPERATIONS
Revenue $ 234,421 $ 82,181
Cost of revenues 183,876 60,102
Gross profit 50,545 21.6% 22,079 26.9%
Operating expenses (1) 46,207 17,500
Relocation expenses - 1,552
-------------- --------- ---------- --------
Operating income $ 4,338 1.9% $ 3,027 3.7%
============== ========= ========== ========
(1) Operating expenses include selling, general and administrative expenses,
fulfillment freight, merger and acquisition charges, depreciation and
amortization of intangibles.
22
Revenues
Total revenues for the quarter ended April 30, 2005 increased $152.2 million, or
185.2%, from the prior year due primarily to the acquisition of Alliance
Entertainment Corp. as discussed below.
MAGAZINE FULFILLMENT- Magazine Fulfillment group's revenues were $71.7 million,
an increase of $5.9 million or 9.0% as compared to the quarter ended April 30,
2004. The group's revenues for the three months ended April 30 are comprised of
the following components (in thousands):
2005 2004 Change
-------- -------- ---------
Domestic distribution $ 62,334 $ 54,680 $ 7,654
Export distribution 8,268 10,502 (2,234)
Other 1,051 573 478
-------- -------- ---------
Total $ 71,653 $ 65,755 $ 5,898
======== ======== =========
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 $7.7 million increase in domestic distribution relates primarily
to a $32.2 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 to our two largest specialty retail customers
and the increase in our traditional retail distribution channel. Gross domestic
distribution to our two largest specialty retail customers increased 11.3%.
Gross domestic distribution to the traditional retail distribution channel
increased $21.5 million. The increase was attributable to both the acquisition
of Empire News as well as an increase in the number of stores serviced through
organic growth. Estimated sell-through for the quarter was lowered from 46.0% to
41.2%. The lowered sell-through is related to the expansion of our distribution
into the mainstream market, which generally has lower efficiencies then the
specialty retail distribution channel.
The decrease in export distribution's revenue of $2.2 million relates primarily
to the timing of when certain issues are billed, which can vary from quarter to
quarter for international editions.
CD AND DVD FULFILLMENT - On February 28, 2005, we acquired Alliance
Entertainment Corp. Results of operations for Alliance have been included in our
consolidated financial statements since the date of acquisition. CD and DVD
Fulfillment accounted for approximately 63.3% of our revenues for the quarter
ended April 30, 2005. There were no CD and DVD Fulfillment revenues in the first
quarter of fiscal 2005.
IN-STORE SERVICES - Our In-Store Services group revenues were $14.3 million, a
decrease of $2.1 million or 12.9%.
The group's revenues are comprised of the following components (in thousands):
Three months ended April 30, 2005 2004 Change
- ---------------------------- -------- -------- ---------
Claim filing and information $ 3,544 $ 4,284 $ (740)
Front end wire and services 5,072 8,243 (3,171)
Wood 5,690 3,899 1,791
-------- -------- ---------
Total $ 14,306 $ 16,426 $ (2,120)
======== ======== =========
Our claim filing revenues are recognized at the time the claim is paid. The
decrease in revenues in the current period relates exclusively to the timing of
the cash payments received on the claims.
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.
Wood revenues increased $1.8 million, an increase of 45.9% over the quarter
ending April 30, 2004. The increase is primarily driven by an increase in the
number of store openings and remodelings performed by our customers.
Gross Profit
23
Gross profit for the period increased $28.5 million or 128.9%, over the first
quarter of fiscal 2005 primarily due to the acquisition of Alliance
Entertainment Corp.
Overall gross profit margins decreased 5.3 percentage points in the current
period over the comparable period of the prior fiscal year. Margins decreased
overall due to the acquisition of Alliance Entertainment Corp. in the current
quarter as the gross profit margins on CDs and DVDs are generally lower than the
remainder of our product mix while they are a substantial percentage of our
sales.
MAGAZINE FULFILLMENT - Gross profit in our Magazine Fulfillment group increased
approximately $3.5 million or 22.9% for the quarter ended April 30, 2005 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 23.4% to 26.4%. The gross profit
margins in our domestic distribution businesses are generally higher than our
export distribution businesses and, as a result, overall gross profit margins
improve as the portion of total revenues is weighted more toward our domestic
operations. 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.
Finally, the discount, which is used to calculate selling price based on the
cover price, offered in the traditional distribution channel are generally lower
than the discounts offered in the specialty retail distribution channel. The
revenue and gross profit contribution from these lower discounts are off-set by
higher selling, general and administrative costs associated with the in-store
merchandising that is prevalent in this distribution channel (specialty
retailers generally provide their own in-store merchandising in exchange for
better purchasing discounts).
CD AND DVD FULFILLMENT - Gross profit was $27.3 million with a gross margin of
18.4%. We did not distribute CDs and DVDs during the first quarter of fiscal
2005.
IN-STORE SERVICES - Gross profit in our In-Store Services group decreased $2.4
million or 35.6%. The decrease in gross profit and gross profit margin is being
driven by the decrease in sales volume in the front end wire and services
coupled with the decrease in claiming revenues due to timing of cash collections
in the first quarter of fiscal 2006.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, including depreciation and
amortization, for the quarter ended April 30, 2005 increased $20.1 million or
159.6%, compared to the prior fiscal year. Selling, general, and administrative
expenses as a percent of revenues declined significantly from 15.4% to 14.0%.
MAGAZINE FULFILLMENT - The Magazine Fulfillment group's selling, general, and
administrative expenses increased $2.8 million, or 42.4% over the quarter ended
April 30, 2004. As a percentage of sales, selling, general and administrative
expenses have increased from 10.1% to 13.2% compared to the same period of the
prior year. Overall expenses have increased due to the increase in overall
distribution and the related labor in our distribution centers to process the
distribution and the expansion of our in-store merchandising costs associated
with the traditional distribution channel. The increase in costs as a percent of
revenue also relates to the in-store merchandising costs, which is discussed in
greater detail above.
CD AND DVD FULFILLMENT - The CD and DVD Fulfillment group's selling, general,
and administrative expenses were $15.4 million, of which approximately $1.2
million relates to amortization of intangibles. We did not distribute CDs and
DVDs during the first quarter of fiscal 2005.
IN-STORE SERVICES - The selling, general, and administrative expenses of the
In-Store Services group remained flat at approximately $2.3 million compared to
the first quarter of fiscal 2005.
SHARED SERVICES - The selling, general, and administrative expenses of Shared
Services increased $1.9 million or 50.8%. The overall increase is primarily due
to incurring additional expenses to properly manage the expanded role of shared
services after the acquisition of Alliance Entertainment Corp. As noted above,
as a percentage of sales, shared services costs decreased from 4.5 % to 2.4 % as
a percentage of revenues.
24
Fulfillment Freight
Fulfillment freight expenses increased $5.5 million or 112.1%, compared to the
prior fiscal year. The CD and DVD Fulfillment group incurred $4.7 million during
the quarter just ended and we did not distribute CDs and DVDs during the first
quarter of fiscal 2005. The Magazine Fulfillment group's freight expense
increased $0.8 million, or 16.3%, over the quarter ended April 30, 2004. Freight
expense as a percent of gross domestic distribution decreased from 4.1% to 3.7%.
The decrease is attributable to the expansion of our distribution into the
traditional retail distribution channel via utilization of a hybrid delivery
method to leverage both route deliveries to service high volume store via
proprietary trucks and third party delivery for low volume and geographically
dispersed stores.
Relocation Expenses
During the quarter ended April 30, 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 the end of April 30, 2004. Relocation
expenses recorded in quarter ended April 30, 2004, including a lease termination
charge and the transfer of employees and equipment, were approximately $1.6
million.
Merger and Acquisition Changes
Merger charges related to acquisitions recorded as expenses by the Company
through April 30, 2005 totaled $3.1 million. These expenses represented
severance and personnel-related charges, charges to exit certain merchandiser
contracts and a success fee paid to certain Company executives. These expenses
were not capitalized as they did not represent costs that provide future
economic benefits to the Company.
Operating Income
Operating income for the quarter ended April 30, 2005 increased $1.3 million or
43.3%, compared to the prior fiscal year due to the factors described above.
Operating profit margins decreased from 3.7% to 1.9% in the current fiscal year
as compared to the prior fiscal year. The decrease was primarily due to the
merger and acquisition charges incurred in the quarter ended April 30, 2005.
Interest Expense
Interest expense includes the interest and fees on our significant debt
instruments and outstanding letters of credit. The increase of $0.4 million as
compared to the prior year first quarter relates to the increased borrowing
levels in the first quarter ended April 30, 2005 as discussed in Liquidity and
Capital Resources below.
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 quarter ended April 30, 2004, the Company recorded a charge of
approximately $1.5 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 52.6% and 33.9% for the quarters ended April
30, 2005 and 2004, respectively.
The difference between the statutory rate and effective tax rates for the
quarter ended April 30, 2005 primarily relates to the amortization of the
intangible assets acquired in the Alliance Entertainment Corp. not being
deductible for tax purposes.
The difference between the statutory rate and effective tax rates for the
quarter ended April 30, 2004 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
25
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 and CD and DVD
Fulfillment groups consist of the cost of home entertainment products 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 wood and wire 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 Shared Services group consist of salaries,
professional fees and insurance not allocated to the operating groups.
The following table presents a summary of our significant obligations and
commitments to make future payments under debt obligations and lease agreements
due by period as of April 30, 2005 (in thousands).
Payments Due by Period
-------------------------------------------------
Less
Than 1-3 3-5 After 5
Total 1 year Years Years Years
--------- -------- -------- -------- --------
Debt obligations $ 70,477 $ 12,873 $ 8,840 $ 756 $ 48,008
Operating leases 53,913 6,943 14,334 11,998 20,638
--------- -------- -------- -------- --------
Total contractual cash
obligations $ 124,390 $ 19,816 $ 23,174 $ 12,754 $ 68,646
========= ======== ======== ======== ========
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 3-5 After 5
Total 1 year Years Years Years
------- ------- ----- ----- -------
Financial standby letters
of credit $ 5,935 $ 5,935 $ - $ - $ -
------- ------- ----- ----- -------
Total commercial
commitments 5,935 5,935 - - -
======= ======= ===== ===== =======
OPERATING CASH FLOW
Net cash used in operating activities was $10.6 and $10.1 million for the
quarter ended April 30, 2005 and 2004, respectively.
Operating cash flows for the three months ended April 30, 2005 were comprised of
net income of $1.7 million, plus non-cash charges including depreciation and
amortization of $3.6 million and provisions for losses on accounts receivable of
$0.2 million, a tax benefit received on stock options exercised of $0.7 million
and an increase of $0.4 million in deferred revenue. A decrease in accounts
receivable of $7.6 million also provided cash for the quarter ended April 30,
2005. These cash providing activities were offset by an increase in inventories
of $15.6 million, a decrease in accounts payable and other liabilities $8.0
million and an increase in other assets of $1.1 million.
The decrease in accounts receivable for the three months ended April 30, 2005
was primarily due to a decrease in accounts receivable of $10.8 million from the
CD and DVD Fulfillment group due to collections subsequent to the date of
acquisition.
26
In addition, the In-Store Services division decreased accounts receivable by
$2.4 million due to significant cash collections in the current period and lower
sales volume. This decrease is consistent with prior first quarter activity. The
decreases in accounts receivable noted above were offset by an increase in the
Magazine Fulfillment group of approximately $6.2 million primarily due to a
decrease in the sales returns reserve from January 31, 2005 to April 30, 2005 of
$5.7 million which is consistent with prior first quarter sales returns activity
in the Magazine Fulfillment Division.
The decrease in accounts payable and other current and non-current liabilities
in the current period of $8.0 million relates primarily to the timing of vendor
payments in the current period as compared to January 31, 2005.
The increase in inventories of $15.6 million for the three months ended April
30, 2005 was primarily due to the acquisition of the CD and DVD Fulfillment
group on February 28, 2005, as approximately $13.6 million of the increase was
attributable to their purchases subsequent to the date of acquisition.
Operating cash flows for the three months ended April 30, 2004 were primarily
from net income of $0.5 million, plus non-cash charges including depreciation
and amortization of $1.0 million and provisions for losses on accounts
receivable of $0.4 million, a write off of deferred financing costs and original
issue discount of $1.5 million, a tax benefit received on stock options
exercised of $0.9 million and a decrease in inventory of $0.7 million. These
cash providing activities were offset by an increase in accounts receivable of
$5.5 million, and a decrease in accounts payable and other quarter ended
April 30, 2004 non-current liabilities of $7.6 million.
The increase in accounts receivable for the three months ended April 30, 2004
was primarily due to a decrease in the sales returns reserve from January 31,
2004 to April 30, 2004 of $4.8 million which is consistent with prior first
quarter sales returns activity in the Magazine Fulfillment Division. In
addition, increased distribution in the Magazine Fulfillment Division increased
accounts receivable by approximately $1.4 million. This increase in accounts
receivable was offset by the decrease in accounts receivable ($1.6 million) in
the In-Store Division due to significant cash collections in the quarter ended
April 30, 2004 and lower sales volume.
The decrease in accounts payable and other current and non-current liabilities
in the current period of $7.6 million relates primarily to the timing of vendor
payments in the current period as compared to January 31, 2004.
INVESTING CASH FLOW
Net cash (used in) provided by investing activities was $(0.5) and $2.0 million
for the quarter ended April 30, 2005, and 2004, respectively.
For the quarter ended April 30 2005, cash used in investing activities was
reduced by capital expenditures of $2.4 million, of which $1.6 million relates
to equipment purchases made by the CD and DVD Fulfillment group in anticipation
of new business. Our advance pay program used $12.7 million in the current
period. We also invested $2.3 million for the rights to distribute certain
titles over a period of three to fifteen years. Finally, as part of the
acquisition of the CD and DVD Fulfillment group, we acquired cash of $16.9
million after direct acquisition costs.
For the quarter ended April 30 2004, cash provided by investing activities was
reduced by capital expenditures of $2.0 million, which primarily related to our
expansion of our distribution facility in Harrisburg, Pennsylvania. Our advance
pay program generated net cash flow of $1.0 million in the 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 $2.9 million of the advances during the quarter
ended April 30, 2004.
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 wood, wire and services business and the payment
cycles of the CD and DVD and magazine distribution businesses. Because the
magazine distribution business and Advance Pay program cash requirement peak at
our fiscal quarter ends, the reported bank debt levels usually are the maximum
level outstanding during
27
the quarter. Alliance has historically generated approximately 33% of its total
net sales in the fourth calendar quarter coinciding with the holiday shopping
season and therefore should have greater borrowings in the third quarter to
finance the buildup of inventory.
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 wood, 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 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 fixtures and decrease significantly in the fourth and first fiscal quarters
as the related receivable are collected and significantly less manufacturing
activity is occurring.
Net cash provided by financing activities was $11.1 and $3.9 million for the
quarter ended April 30, 2005 and 2004, respectively.
Financing activities in the first quarter ended April 30, 2005 consisted of
borrowings under the credit facilities of $28.7 million. These amounts were
offset by repayments of $9.9 million in debt and capital leases, of which
approximately $8.8 million relates to the repayment of the Wells Fargo Foothill
term loan in connection with the modification of the revolving credit facility
and a decrease of $8.0 million in checks issued and outstanding at April 30,
2005. Finally, the exercise of employee stock options in the quarter generated
approximately $1.2 million.
Financing activities in the first quarter ended April 30, 2004 consisted
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 term loan, the Hilco Capital note
payable and the notes payable to former owners ($20.7 million) as well the pay
down of the revolving credit facility ($11.74 million). In addition, the cash
provided by the activities noted above were offset by a $5.9 million decrease in
checks issued and outstanding at April 30, 2004. Finally, the exercise of
employee stock options in the quarter generated approximately $1.7 million .
DEBT
At April 30, 2005, our total debt obligations were $70.5 million, excluding
outstanding letters of credit. Debt consists primarily of our amounts owed under
a revolving credit facility, the notes payable related to the acquisition of
magazine import and export businesses and a mortgage loan.
On February 28th 2005, the Company modified its existing credit facility with
Wells Fargo Foothill ("WFF") as a result of its acquisition of Alliance
Entertainment Corp. WFF, as arranger and administrative agent for each of the
lenders that may become a participant in such arrangement and their successors
("Lenders") will make revolving loans to us and our subsidiaries of up to $250
million and provide for the issuance of letters of credit. The terms and
conditions of the arrangement are governed primarily by the Amended and Restated
Loan Agreement dated February 28, 2005 by and among us, our subsidiaries, and
WFF.
Outstanding borrowings bear interest at a variable annual rate equal to the
prime rate announced by Wells Fargo Bank, National Association's San Francisco
office, plus a margin of between 0.0% and 1.00% (applicable margin was 0.0% at
April 30, 2005) based upon a ratio of the Company's EBITDA to interest expense
("Interest Coverage Ratio"). At April 30, 2005 the prime rate was 5.75%. We also
have the option of selecting up to five traunches of at least $1 million each to
bear interest at LIBOR plus a margin of between 2.00% and 3.00% based upon our
Interest Coverage Ratio. The Company has one LIBOR contract outstanding at April
30, 2005 (expiring July 27, 2005) and bears interest at 5.18%. To secure
repayment of the borrowings and other obligations of ours to the Lenders, we and
our subsidiaries granted a security interest in all of the personal property
assets to WFF, for the benefit of the Lenders. These loans mature on October 31,
2010.
Under the credit facility, 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
28
on capital expenditures and the Company is required to maintain certain
financial ratios. The Company was in compliance with these ratios at April 30,
2005
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability, after consideration of outstanding letters of credit, of $102.5
million at April 30, 2005.
In connection with our acquisition of the magazine import and export businesses
leased by us since May 2002 and March 2003, respectively, we agreed to make
thirteen quarterly principal payments of approximately $0.7 million beginning in
January 2004 and a payment of $1.0 million is payable in May 2005. The balance
outstanding under these notes payable at April 30, 2005 was $9.2 million.
Through the acquisition of Alliance, the Company assumed an $8.5 million
conventional mortgage loan through SunTrust Bank (the "SunTrust Mortgage"). The
SunTrust Mortgage is collateralized by land and building. The SunTrust Mortgage
matures on June 1, 2005 and has monthly principal payments of approximately
$0.03 million plus interest at a rate of LIBOR plus 2 1/2%. The principal
payments were determined based on a 15-year amortization of the outstanding
principal amount of the SunTrust Mortgage. On the maturity date, the aggregate
unpaid principal balance of the mortgage, accrued and unpaid interest and all
costs and expenses due under the SunTrust Mortgage terms shall be due and
payable. The total principal balance of $7.4 million is classified as current at
April 30, 2005.
Through the acquisition of Alliance, the Company assumed a loan agreement
with SunTrust Leasing Corporation (the "SunTrust Loan") for the purchase of
equipment to be used at various locations. A credit line of $6.8 million was
approved under the SunTrust Loan, with repayment terms for five promissory notes
ranging from three to five years. The total principal balance of the SunTrust
Loan outstanding as of April 30, 2005 was $4.1 million.
OFF-BALANCE SHEET ARRANGEMENTS
We do not engage in transactions or arrangements with unconsolidated or other
special purpose entities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability.
The amended revolving credit facility with Wells Fargo Foothill had an
outstanding principal balance of approximately $48.0 million at April 30, 2005.
Outstanding borrowings bear interest at a variable annual rate equal to the
prime rate announced by Wells Fargo Bank, National Association's San Francisco
office, plus a margin of between 0.0% and 1.00% (applicable margin was 0.0% at
April 30, 2005) based upon a ratio of the Company's EBITDA to interest expense
("Interest Coverage Ratio"). At April 30, 2005 the prime rate was 5.75%. We also
have the option of selecting up to five traunches of at least $1 million each to
bear interest at LIBOR plus a margin of between 2.00% and 3.00% based upon our
Interest Coverage Ratio. The Company has one LIBOR contract outstanding at April
30, 2005 (expiring July 27, 2005) and bears interest at 5.18%. To secure
repayment of the borrowings and other obligations of ours to the Lenders, we and
our subsidiaries granted a security interest in all of the personal property
assets to WFF, for the benefit of the Lenders. These loans mature on October 31,
2010.
As a result of the above, our primary market risks relate to fluctuations in
interest rates. We do not perform any interest rate hedging activities related
to the facility noted above. Therefore, if the prime rate of interest were to
increase one percentage point based on the Company's current borrowings under
its credit facility, interest expense would increase approximately $0.5 million
on an annual basis.
In connection with the SunTrust Mortgage discussed above, Alliance entered into
interest rate swap and cap agreements to manage the interest rate risk exposures
of its variable-rate debt portfolio. These instruments are not designated as
hedges, and, accordingly, are recorded at fair value as an asset or liability in
the consolidated balance sheets and interest income/expense in the consolidated
statements of income.
We have exposure to foreign currency fluctuations through our operations in
Canada. These operations accounted for approximately $1.9 million in revenues,
which represented less than 1.0% of our revenues for the quarter ended April 30,
2005. 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 $8.3 million for the
quarter ended April 30, 2005 or 3.5% 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
29
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 $22.8
million (of a total $152.9 million or 15.0%) for the quarter ended April 30,
2005. 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.
30
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 principal
executive officer and principal 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.
CONCLUSIONS
31
Based on this evaluation, our chief executive officer and our chief financial
officer, have concluded that, subject to the limitations noted above, as of the
end of the period covered by this report, our disclosure controls and procedures
were effective to ensure that information we are required to disclose in reports
that we file or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms and include controls and
procedures designed to ensure that information required to be disclosed by the
Company in such reports is accumulated and communicated to the Company's
management, including the Chief Executive Officer and the Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in the Company's internal controls over financial
reporting (as defined in Rule (13a-15(f) under the Securities Exchange Act of
1934) that occurred during the fiscal quarter ended April 30, 2005 that have
materially affected, or are reasonably likely to materially affect these
controls.
32
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. CHANGES IN SECURITIES
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
See Exhibit Index
33
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: June 08, 2004
SOURCE INTERLINK COMPANIES, INC.
/s/ Marc Fierman
-----------------------
Marc Fierman
Chief Financial Officer
34
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
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 Certifications of Principal Executive Officer
32.2 Section 1350 Certifications of Principal Financial Officer