SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual report under Section 13 or 15(d) of the Securities Exchange Act
of 1934. For the fiscal year ended January 31, 2002.
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the transition period from _____________ to
______________.
Commission file number 1-13437
SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
MISSOURI 43-1710906
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
TWO CITY PLACE DRIVE, SUITE 380
ST. LOUIS, MISSOURI 63141
(Address of Principal Executive Offices) (Zip Code)
(314) 995-9040
(Registrant's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- ---------------------
Securities registered under Section 12(g) of the Act: COMMON STOCK $0.01 PAR
VALUE
Indicate by check mark whether the registrant: (1) 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 if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
At March 31, 2002 the aggregate market value of the voting and non-voting stock
held by non-affiliates of Source Interlink Companies, Inc. (the "Company") was
approximately $62,634,028 based on the last sale price of the Common Stock
reported by the Nasdaq National Market on March 31, 2002. At March 31, 2002, the
Company had outstanding 18,288,679 shares of Common Stock.
TABLE OF CONTENTS
PART I
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Page
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ITEM 1. Description of Business 1
ITEM 2. Description of Property 8
ITEM 3. Legal Proceedings 8
ITEM 4. Submission of Matters to a Vote of Security Holders 8
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 9
ITEM 6. Selected Financial Data 10
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 18
ITEM 8. Financial Statements 19
ITEM 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure 19
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 20
ITEM 11. Executive Compensation 23
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 27
ITEM 13. Certain Relationships and Related Transactions 28
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 29
</Table>
SOME OF THE INFORMATION CONTAINED IN THIS FORM 10-K CONTAINS FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE FEDERAL SECURITIES LAWS. WHEN USED IN THIS
REPORT, THE WORDS "MAY," "WILL," "BELIEVES," "ANTICIPATES," "INTENDS,"
"EXPECTS," AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. BECAUSE SUCH FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND
UNCERTAINTIES, OUR ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: (I) OUR DEPENDENCE ON THE
MARKETING AND DISTRIBUTION STRATEGIES OF PUBLISHERS AND OTHER VENDORS; (II) OUR
ABILITY TO ACCESS CHECKOUT AREA INFORMATION; (III) RISKS ASSOCIATED WITH OUR
ADVANCE PAY PROGRAM, INCLUDING PROBLEMS COLLECTING INCENTIVE PAYMENTS FROM
PUBLISHERS; (IV) DEMAND FOR OUR DISPLAY STORE FIXTURES; (V) OUR ABILITY TO
SUCCESSFULLY IMPLEMENT OUR GROWTH STRATEGY; (VI) COMPETITION; (VII) OUR ABILITY
TO EFFECTIVELY MANAGE OUR EXPANSION; (VIII) GENERAL ECONOMIC AND BUSINESS
CONDITIONS NATIONALLY, IN OUR MARKETS AND IN OUR INDUSTRY; (IX) OUR ABILITY TO
MAINTAIN ADEQUATE FINANCING ON ACCEPTABLE TERMS SUFFICIENT TO ACHIEVE OUR
BUSINESS PLAN; (X) OUR ABILITY TO SUCCESSFULLY INTEGRATE ACQUIRED COMPANIES WITH
AND INTO OUR CORPORATE ORGANIZATION, AND (XI) OUR ABILITY TO ATTRACT AND/OR
RETAIN SKILLED MANAGEMENT. INVESTORS ARE ALSO DIRECTED TO CONSIDER OTHER RISKS
AND UNCERTAINTIES DISCUSSED IN OTHER REPORTS PREVIOUSLY AND SUBSEQUENTLY FILED
BY US WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE
DATE HEREOF. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS, WHICH MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS.
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
We are a leading provider of information and management services for retail
magazine sales to U.S. and Canadian retailers and magazine publishers. We are
also a leading manufacturer of display and store fixtures used by retailers. On
May 31, 2001, we acquired The Interlink Companies, Inc. ("Interlink") and its
operating companies, including International Periodical Distributors, Inc.
("IPD"), a distributor of magazines to bookstore chains, record stores, computer
stores and independent retailers, and David E. Young, Inc. ("Deyco"), a national
distributor to secondary wholesalers who supply magazines to independent
retailers and specialty chains. Interlink represents a new business segment,
magazine distribution. Through this strategic acquisition, we have become a
leading direct distributor of magazines to bookstore chains, computer stores and
independent retailers.
Through our information services, we provide sales data and product placement
and other related information in various user-friendly formats, including print,
CD-ROM and over the Internet. This information helps users to formulate
marketing, distribution and advertising plans and to react more quickly to
changing market conditions. Our information services cover over 10,000 magazine
titles and are provided to approximately 1,000 retail chains with approximately
80,000 stores and 400,000 checkout counters. We believe we maintain the most
comprehensive information database available for retail magazine sales and
magazine placement at checkout counters. We have expanded upon our experience
with retail magazine sales to provide similar information and services to
confectioners and vendors of general merchandise sold at checkout counters.
We assist retailers in increasing sales and incentive payment revenues by
reconfiguring and designing front-end display fixtures, supervising
installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. Historically, as part of our services, we
arranged for the manufacture of display fixtures for many of our customers.
Since January 1999, we acquired five display fixture manufacturers.
Manufacturing display fixtures in our own facilities allows us to be a
full-service provider of management services for the checkout area, or
"front-end," of a customer's store. We also can integrate the design and
manufacturing processes with our clients' merchandising strategies and better
manage the timing of display fixture delivery and installation.
The Company's segment reporting has been restructured based on the reporting of
senior management to the Chief Executive Officer. This restructuring combines
the Company's business units in a logical way that more easily identifies
business concentrations and synergies for both analysis of results and real-time
control by management. The reportable segments of the Company are in-store
services, manufacturing and magazine distribution.
We believe that we are well positioned to use our existing relationships with
retailers and vendors to cross-sell our products and services.
1
INDUSTRY OVERVIEW
In-Store Services and Manufacturing
A substantial portion of the products sold in retail stores are bought on
impulse. It is therefore important to vendors that their products be on
prominent display in those areas of a store where they will be seen by the
largest number of shoppers. There are usually two such areas in a store. One is
a dedicated area called a mainline display; the other is the checkout area which
is sometimes referred to as the front-end. The front-end is visited by virtually
every shopper in a store. Shoppers typically must wait to complete the checkout
process and are more likely to see products on display in the front-end, which
increases the likelihood that these products will be bought on impulse. Products
suited to front-end display include magazines, confections and certain general
merchandise such as razor blades, film and batteries.
Vendors of front-end products compete for favorable spaces on display fixtures,
which we refer to as "pockets". Some vendors make incentive payments to
retailers for favorable product locations. These payments may include up-front
fees to have display fixtures configured to provide for a vendor's desired
product placements, recurring placement rental fees based on the location and
size or rebate payments on a product's sales volume.
Timely delivery of information about retailer activity at the front-end,
including timing of reconfigurations, changes in display position or the
discontinuance of a vendor's products, is important to vendors of front-end
products. Timely delivery of information about price changes, special
promotions, new product introductions and other vendor plans is important to
retailers. We believe that there is an increasing demand on the part of
front-end product vendors for more frequent and detailed information on sales
and other front-end activity.
Our in-store service segment and manufacturing segment also operate in the
in-store development industry which is comprised of suppliers who offer products
and services to retailers for the build-out of their store interiors and
suppliers of products and services related to the promotion and display of
merchandise that is offered to consumer products manufacturers.
Magazine Distribution
According to industry statistics, the newsstand magazine sales industry totals
approximately $4.4 billion in retail sales.
The distribution of magazines is generally described on the following levels:
Publishers: Publishers range from large, well-financed publishers of high volume
periodicals and books to independent publishers of low circulation specialty
titles.
National Distributors: National distributors represent publishers in
distributing their products nationwide to Local Distributors, who in turn
deliver the product to a wide variety of classes of trade, including major
retail chains, superstores, computer stores, specialty retailers and independent
retailers. National distributors do not physically handle product, but rather
direct and bill product to the local distributors on behalf of their publisher
clients.
Local Distributors: Local distributors, also referred to as "Wholesalers", take
physical delivery of publications, warehouse them, deliver them to retail
outlets, service magazine displays and initiate the returns process. They are
billed by National Distributors, and, in turn, invoice the retailer. There are
currently three types of Local Distributors, or Wholesalers, within the magazine
industry:
Primary Wholesalers: Primary wholesalers generally service the stores of
national and regional retail chains including transportation outlets,
supermarkets, convenience food stores, and drug stores. This class of
trade is also commonly referred to as Traditional Retailers. Although
there are currently only four major primary wholesaler companies, they
continue to operate from several hundred local distribution points.
Secondary Wholesalers: There are hundreds of secondary wholesalers in the
United States. Secondary wholesalers generally handle special interest
magazines, and distribute to smaller retail chains and independents.
Deyco is a national distributor who primarily represents publishers to
this group of wholesalers.
2
Specialty Distributors: This is the newest class of distributors; these
are the principal suppliers to the rapidly developing "Specialty Market",
which consists of bookstores, record stores and other niche oriented
classes of trade such as crafts and hardware. This segment has recently
developed into a significant component of newsstand sales within the last
five years. While Specialty Distributors are billed by national
distributors, invoice retailers, and warehouse product, they
fundamentally differ from the primary and secondary wholesalers in other
regards. Rather than delivering product via company owned trucks and
labor, they outsource the actual delivery of product to a third party
carrier. This enables these companies to supply retail locations
throughout, and even beyond, the United States from only a handful, as
opposed to hundreds, of locations. Specialty distributors also differ in
that because they do not actually deliver the product to their retail
customers with their own labor force, they lack the capability to
physically service the fixtures within their retailers' stores. This is
generally acceptable to these types of retailers as they are able to
adequately service the display fixtures with their own in-store labor.
IPD is an example of a Specialty Distributor.
Historically, Local Distributors were comprised of a geographically specific
series of local family-owned "monopolies". In 1995, the historical structure was
disrupted when the traditional major retailers began bidding out their magazine
business to a single distribution company nationwide. This resulted in the
consolidation to create what is currently recognized as the four Primary
Wholesalers. While Secondary Wholesalers have always existed, the Primary
Wholesalers' concentration and focus upon the major Traditional retail chains
have afforded these Secondary Wholesalers new opportunities with the smaller
retailer chains and independents. In many instances Secondary wholesalers are
solicited by some of the tens of thousands of smaller retailers whose
distribution from the Primary Wholesalers has been discontinued.
In contrast, much of the Specialty Market's emergence has occurred since 1995,
and because they were able to employ the Specialty Distributors as their
preferred alternative, they are the only retail class of trade to not have been
greatly affected by the Primary Wholesalers' consolidation.
This consolidation continues to affect all other distribution channels of the
publishing industry, limiting the business prospects for distributors that
cannot provide the geographic reach or level of service required by customers.
As a result, periodical wholesaling is being transformed from a low-cost,
low-risk, local or regional industry into an industry that is more capital
intensive, more reliant on technology and in many instances national in scope.
BUSINESS SEGMENTS
Our claims submission services for magazine retailers were established over 20
years ago. Our experience in providing these services is the foundation for our
other services. Set forth below are descriptions of our services and products in
each of our segments: in-store services (26.9% of our fiscal 2002 revenues)
manufacturing (7.5% of our fiscal 2002 revenues), and magazine distribution
(65.6% of our fiscal 2002 revenues). See Note 18 in our "Notes to Consolidated
Financial Statements" for certain financial information of each of our segments.
In-Store Services
Claim Submission Program. Through our information gathering capabilities, we
assist U.S. and Canadian retailers to accurately monitor, document, claim and
collect magazine publisher incentive and pocket rental payments. Incentive
payments consist of cash rebates offered to retailers by magazine publishers
equal to a percentage of magazine sales. Pocket rental payments are made by
magazine publishers for providing a specific pocket size and location on a
display fixture. Our claim submission program relieves our retailer customers of
the substantial administrative burden of documenting their claims and we believe
increases the amount of claims they collect.
The claim submission process begins at the end of each calendar quarter. Local
distributors detail the titles and number of copies sold by our retailer clients
during that quarter. Display fixture manufacturers and our retailer clients
provide us with information about magazine pocket placements. Based on this
information, we prepare claim forms and submit the documented claims to the
appropriate national distributor. After verification of the claim, the national
distributor, on behalf of the publisher, remits to us payment for the retailer.
We then record the payment and forward it to the retailer. We charge the
retailer a negotiated percentage of the amount collected.
Retailer customers who use our traditional claim submission program include
Fleming, Southland 7-Eleven and Walgreens.
3
Advance Pay Program. As an extension of our claim submission program, we have
established our Advance Pay Program for magazine sales. Under this program, we
advance to participating retailers a negotiated fixed percentage of the total
quarterly incentive payments and pocket rental fees otherwise due the retailer.
We generally make these payments within 90 days after the end of the quarter. We
then collect the payments for our own account. This service provides the
retailer with improved cash flow and relief from the burdensome administrative
task of processing a large number of small checks from publishers. Payments
collected from publishers under the Advance Pay Program as a percentage of all
incentive payments collected from publishers grew from 32.6% during fiscal 2000
to 47.4% during fiscal 2001 to 50.4% during fiscal 2002.
Our payments to the retailer precede our collections from the publisher. In
order to make these payments to retailers, we use funds generated from
operations and funds borrowed under our revolving credit facility. We generally
assume the risk of uncollectibility of the incentive and pocket rental payments.
Customers of our Advance Pay Program include A&P, Ahold USA, Food Lion, Kmart,
Target and W.H. Smith.
ICN, PIN and Store Level Data. In response to the business communications
opportunities presented by the internet, we have developed our ICN website. The
ICN website enables subscribing magazine publishers to access information
regarding pricing, new titles, discontinued titles and display fixture
configuration changes on a chain-by-chain basis. This information is important
to publishers because discontinuation and placement of their titles on the
display fixture can have a significant impact on sales. We believe that, prior
to ICN, publishers could not react as quickly to these changes. Publishers also
can use ICN to promote special incentives and advertise and display special
editions, new publications and upcoming covers, all of which can increase their
sales. We have an agreement with Barnes & Noble, Inc. to jointly offer their
store-by-store daily sales data to magazine publishers. We also have agreements
with AC Nielsen, the world's leading market research firm, and Efficient Market
Services ("EMS"), a privately held consumer-information company, to market and
sell store-level point-of-sale data. We believe the more timely, store-by-store
information has increased the attractiveness of our ICN website to publishers.
Retailers can use ICN to order new magazine titles and take advantage of
promotions by publishers. They also can download frequently changing price
information, including Uniform Product Codes, which change often because of
price changes and new title introductions.
The ICN website is configured so that publishers cannot access the strategically
sensitive information of other publishers and retailers. Retailers and
publishers can also exchange information and conduct transactions on the
Internet site without compromising their sensitive, proprietary information.
We market to magazine publishers our database of magazine-related industry
information (referred to as "PIN") that we gather through our claims submission
program. This information assists them in formulating their publishing and
distribution strategies. PIN subscribers have access to a historical database of
sales information for publications, as well as quarterly updates. PIN can
generate reports of total sales, sales by class of trade and sales by retailer.
Each report also provides other sales related information, including returns of
unsold magazines and total sales ranking. We believe that PIN is the most
extensive database available for single-copy retail magazine sales information.
Store Level Data provides publishers with daily insight into magazine sales
performance and information regarding their own titles' performance compared to
their competitors' sales performance on a daily, weekly or issue basis store by
store.
We receive annual fees, paid quarterly or monthly, from each publisher and
general merchandiser that subscribes to ICN, PIN or Store Level Data. For a fee,
publishers may advertise and run promotions and special programs on ICN. We have
approximately 150 retailer subscribers, including Ames Department Stores,
Eckerd, Kmart, Southland 7-Eleven, W.H. Smith and Wegman's Food Markets, and
approximately 20 publishers, including Comag, Murdoch Magazines, Time
Distribution Services and Times Mirror.
Front-End Management. We help retailers to increase sales and incentive payment
revenues by reconfiguring and designing front-end display fixtures, supervising
fixture installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. We also help our retailer clients to develop
specialized marketing and promotional programs, which may include, for example,
special mainline or checkout displays and cross-promotions of magazines and
products of interest to the readers of these magazines.
4
Front-End and Point-of-Purchase Displays. We design, manufacture, deliver and
dispose of custom front-end and point-of-purchase displays for both retail store
chains and product manufacturers, including Kmart, Food Lion, Kroger, Target,
Home Depot and Hershey Food Corporation. For many of our retail store accounts,
we also invoice vendors for fixture costs and coordinate the collection of
payments on these invoices. We believe that manufacturing display fixtures
increases our access to information about sales of magazines and other products
from retail checkout areas, which enhances our ability to provide PIN and ICN.
Our manufacturing process typically begins when a retail store chain requests us
to design a display for its stores. We create a computer model of the display
based on the retailer's specifications, from which a prototype is created and
presented to the retailer for its examination. We then work together with the
retailer to finalize the design of the display and negotiate a price per
display. All of our front-end display fixtures are manufactured to customer
specifications.
We design, manufacture and powder-coat each pocket, shelf and other component of
a display unit separately and then assemble these components to create the
finished display. We believe that our component-oriented manufacturing process
enables us to produce our displays more quickly and efficiently and with a
higher standard of quality than if we used a unit-oriented process.
Materials used in manufacturing our fixtures include wire, metal tubing and
paneling. At our four manufacturing locations, we cut, shape, bend and weld
wire, tubing and metal paneling and powder coat and assemble the finished
product. We use a just-in-time inventory practice. This reduces our requirements
to carry inventories of raw materials, which in turn improves our cash flow.
Manufacturing
In September 1999, we acquired Huck, a major manufacturer and supplier of custom
wood displays and fixtures to national retailers. Also, in September, we
acquired Arrowood, another manufacturer of wooden display fixtures. These
acquisitions enable us to meet demands for customized wooden display fixtures
from our major retail customers. This strategic broadening of our base business
provides access to new markets, solidifies existing relationships, and further
strengthens our leading position as the front-end one-stop shop for retailers.
Current customers for wooden store fixtures include bookstore chains, discount
stores, department stores, convenience stores, pizza delivery stores and other
niche retailers. Our fixtures are primarily made from wood veneers or laminated
wood. Other raw materials used include paints and varnishes and hardware such as
hinges, drawer slides, aluminum and other metals to support and assemble the
wood product. Our production process includes cutting, machining, assembly and
finish. Virtually all product is shipped assembled ready to place in service at
a retailer's store.
All wooden store fixtures are custom made and as such we do not manufacture
product without a customer commitment for the product. Engineering and design
teams work closely with retailers to create product to meet specific
requirements. The process includes use of computer assisted drawings ("CAD") and
"photo rendering" that allow a retailer to see an image of the product from
various angles and make changes. Once the CAD drawing is finalized, a prototype
is typically manufactured for approval prior to large scale manufacturing.
Products we make for retailers are check out counters, service desks, fitting
rooms, customized room kits, bookshelves, magazine racks and other merchandise
display fixtures.
To meet seasonal demands for product, customers will typically provide
commitments well in advance of needing the product in its stores so that enough
product is available for shipment when needed. As such, our inventory levels
increase during seasonal periods when customers are not opening or remodeling
stores, typically November through April. Inventory levels decrease during
periods when the majority of store openings and remodelings occur, typically
July through October.
Magazine Distribution
On May 31, 2001, we acquired Interlink and its operating companies, including
IPD, a distributor of magazines to the Specialty Market, including bookstore
chains, record stores, computer stores and independent retailers, and Deyco, a
national distributor to the secondary wholesalers. This established our magazine
distribution segment.
5
Through our magazine distribution segment, we distribute approximately 5,000
titles for publishers and national distributors. IPD arranges for copies of each
issue to be shipped from the supplier to our seven geographically dispersed
distribution centers, at which point the magazine copies are repackaged for
shipment by third party carriers to approximately 7,000 retail outlets. In
contrast, Deyco arranges for shipments of magazines to be made directly by the
supplier to secondary magazine wholesalers located throughout the country.
Almost all magazines are distributed on a fully returnable basis. Within a
specified period, which could be as much as 180 days, after the publisher
specified off-sale date, the retailers and secondary distributors are entitled
to return to our magazine distribution segment all unsold copies for full credit
of the price payable by such customers. Periodically, we report to our suppliers
the amount of returns received and obtain full credit of the price we paid for
such copies.
Payment for delivered copies is made by our customers under a wide variety of
terms, which may include regular payments, net payment and delayed payment. We
endeavor to match the terms of payment received from our suppliers with the
terms of payment offered to our customers, and thereby reduce our working
capital requirements.
Deyco recognizes revenue from sales to wholesalers based on the on-sale date of
each periodical, net of provisions for estimated returns. IPD recognizes revenue
at the time of shipment to the retailer customer, net of estimated returns.
Retailer customers of IPD include Barnes & Noble, B. Dalton Booksellers,
Borders, Waldenbooks, Babbages, Hastings Book, Music & Video and Tower
Magazines/MTS, Inc.
MAJOR CUSTOMERS
For fiscal 2002, two customers accounted for approximately 43% of revenues.
Barnes & Noble accounted for approximately 26% and Borders accounted for
approximately 17%. For fiscal 2001, two customers accounted for approximately
29% of revenues. Borders accounted for approximately 15% of revenues and Kmart
accounted for approximately 14% of revenues. For fiscal 2000, two customers
accounted for approximately 26% of revenues. Winn Dixie accounted for
approximately 15% of revenues and Ahold USA accounted for approximately 11% of
revenues.
MARKETING AND SALES
We market our services and display fixtures through our own direct sales force.
Our sales group consists of three divisional vice presidents and 11 regional
managers. We have integrated our marketing efforts for our traditional
information and management services with our display fixture manufacturing. We
market our services primarily through direct contact with clients and
prospective clients. We also market our services at industry trade shows and
through trade publications.
Each of our managers is assigned to a specific geographic territory and is
responsible for the preparation of quotations, program presentations and the
general development of sales, as well as maintenance of existing accounts,
within his or her territory. Our regional managers maintain frequent contact
with our clients in order to provide them with a high level of service and react
quickly to their needs.
Our magazine distribution segment is engaged in a two-pronged marketing and
sales effort. The first prong targets publishers and national distributors from
whom we acquire magazines for distribution. Our publisher services department
maintains direct contact with publishers and national distributors to secure
additional titles and a greater copy allocation of titles currently distributed.
The second prong targets retailers and distribution agents with a direct sales
force dedicated to securing new outlets for sale of magazines distributed by the
Company. The primary means of locating new retail outlets and distribution
agents is direct sales presentation, although the Company frequently attends
trade shows and industry gatherings to promote its business and make contacts
with potential customers.
COMPETITION
We face significant competition for many of our services. For example, we have a
number of direct competitors for our claims submission program, all of which are
closely-held private companies. We also compete with approximately five other
manufacturers for front-end display fixture manufacturing business. There also
are a substantial number of competitors for our
6
point-of-purchase fixture business, many of which are national in scope. Any of
these competitors could also compete for our front-end display fixture business.
In addition, some of our information and management services may be performed
directly by our retailer customers or by vendors, distributors or other
information service providers. Other organizations, including ACNielsen,
Information Resources and Audit Bureau of Circulations, also collect sales data
from retail stores. While none of these organizations currently compete with us,
any one of them could do so. If any of them were to compete with us, given their
experience in collecting information and their industry reputation, they could
be a formidable competitor.
The environment in our magazine distribution segment continues to evolve. Deyco
and IPD face competition from such organizations as Curtis Circulation Company
and Time Distribution Services, each of which are divisions of national
distributors targeting the secondary market. In addition, Deyco and IPD compete
with specialty distributors such as Retail Vision and Ingram. It is possible
that our magazine distribution segment, Deyco in particular, will face increased
competition from national distributors entering the secondary market.
Our competitors also may introduce services that are perceived by our clients to
be more attractive than those we provide. In addition, many of our current and
possible competitors have substantially greater financial resources than we do.
We believe that the principal competitive factors in the retail information
industry include access to information, technological support, accuracy, system
flexibility, financial stability, customer service and reputation. In addition
to financial stability, customer service and reputation, we believe that product
quality, timeliness of delivery and, to a lesser extent, price are competitive
factors in the display fixture manufacturing business. We believe we compete
effectively with respect to each of the above factors.
Competitive pressures may result in a decrease in the number of clients we serve
and a decrease in our revenues. Either of these could materially harm our
business, financial condition and future results.
INFORMATION SYSTEMS; INTELLECTUAL PROPERTY
Software used in connection with our claims submission program and in connection
with PIN and ICN was developed specifically for our use by a combination of
in-house software engineers and outside consultants. We believe that certain
elements of these software systems are proprietary to The Source. Other portions
of these systems are licensed from the third party, MJ Systems, that helped to
design the system. We also receive systems service and upgrades under the
license.
We have filed applications with the U.S. Patent Office for patent protection for
our ICN and PIN innovations. Certain aspects of our ICN and PIN innovations also
have copyright protection.
Software used in connection with our magazine distribution program was developed
specifically for our use by a combination of in-house software engineers and
outside consultants. We believe that certain elements of these software systems
are proprietary to The Source. Other portions of these systems are licensed from
the third party, Data Processing Services, that helped to design the system. We
also receive systems service and upgrades under the license.
EMPLOYEES
As of March 31, 2002, we employed approximately 1,200 persons. Of the employees
at our Brooklyn, New York facility, 108 are represented by Local 810 of the
Steel, Metal, Alloys and Hardware Fabricators of the International Brotherhood
of Teamsters under a collective bargaining agreement expiring on September 30,
2004. Of the employees at our Philadelphia, Pennsylvania facility, 70 are
represented by Local 837 of the Teamsters Union under a collective bargaining
agreement expiring on December 31, 2005. We consider our employee relations to
be satisfactory.
7
ITEM 2. DESCRIPTION OF PROPERTY.
We conduct our business from over twenty manufacturing, data processing, office
and warehouse facilities.
<Table>
<Caption>
LOCATION DESCRIPTION SEGMENT SIZE SQ. FT. OWNED/LEASED
---------------- ------------------- ----------- ------------ ------------
St. Louis, MO Office In-Store 5,100 Leased
Manhattan, NY Office In-Store 3,500 Leased
High Point, NC Data Processing/Office In-Store 24,000 Owned
Don Mills, Ontario Office In-Store 3,900 Leased
Rockford, IL Manufacturing/Office In-Store 310,500 Owned
Jacksonville, FL Manufacturing/Office In-Store 55,000 Leased
Brooklyn, NY Manufacturing/Office In-Store 92,000 Leased
Philadelphia, PA Manufacturing/Office In-Store 110,000 Owned
Vancouver, British Columbia Manufacturing/Office In-Store 20,000 Leased
Quincy, IL Manufacturing/Office Manufacturing 260,000 Owned
Carson City, NV Manufacturing/Office Manufacturing 135,000 Leased
Norwood, NC Manufacturing/Office Manufacturing 52,000 Leased
San Diego, CA Office Magazine Distribution 24,000 Leased
San Diego, CA Office/Warehouse (2) Magazine Distribution 43,000 Leased
Forest Park, GA Office/Warehouse Magazine Distribution 11,000 Leased
Nashville, TN Office/Warehouse Magazine Distribution 60,000 Leased
Elk Grove, IL Office/Warehouse Magazine Distribution 35,000 Leased
Kent, WA Office/Warehouse Magazine Distribution 15,000 Leased
Dallas, TX Office/Warehouse Magazine Distribution 48,000 Leased
Milan, OH Office/Warehouse Magazine Distribution 83,000 Leased
</Table>
In addition, we have warehouse facilities in Florida and New Jersey and small
offices in Pennsylvania, Ohio, Oklahoma, California, Washington, Arkansas,
Massachusetts, Wisconsin, Alberta and Ontario. We believe our facilities are
adequate for our current level of operations and that all of our facilities are
adequately insured.
ITEM 3. LEGAL PROCEEDINGS.
We are from time to time parties to various legal proceedings arising out of our
businesses. We believe that there are no proceedings pending or threatened
against us which, if determined adversely, would have a material adverse effect
on our business, financial condition, results of operations or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Annual Meeting of the Shareholders of the Company was held on November
19, 2001. Of the 18,231,299 shares entitled to vote at such meeting, 14,857,334
shares were present at the meeting in person or by proxy.
(b) The proposal to amend the Company's Article of Incorporation to change the
name of the Company to Source Interlink Companies, Inc. was approved The number
of shares voted for, against and withheld were as follows:
<Table>
<Caption>
For Against Withheld Non-Vote
--- ------- -------- --------
14,823,023 25,077 9,234 -0-
</Table>
Each of the management nominees for director was duly elected to serve an
additional term of three years. The number of shares voted for and withheld were
as follows:
<Table>
<Caption>
For Withheld
--- --------
S. Leslie Flegel 14,296,990 560,344
Robert O. Aders 14,655,084 202,250
</Table>
8
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our Common Stock is quoted on the Nasdaq National Market under the symbol
"SORC." The following table sets forth, for the periods indicated, the high and
low closing sale prices for the Common Stock as reported on the Nasdaq National
Market.
<Table>
<Caption>
Fiscal 2001 High Low
- ----------- ------ -------
First Quarter $22.81 $ 14.00
Second Quarter $15.25 $ 10.69
Third Quarter $11.06 $ 4.97
Fourth Quarter $ 7.13 $ 3.66
</Table>
<Table>
<Caption>
Fiscal 2002 High Low
- ----------- ------ -------
First Quarter $6.13 $3.44
Second Quarter $6.31 $3.95
Third Quarter $5.60 $3.37
Fourth Quarter $6.54 $3.70
</Table>
As of April 22, 2002, there were approximately 124 holders of record of the
Common Stock.
We have never paid dividends on our Common Stock. The Board of Directors
presently intends to retain all of its earnings, if any, for the development of
our business for the foreseeable future. The declaration and payment of cash
dividends in the future will be at the discretion of our Board of Directors and
will depend upon a number of factors, including among others, future earnings,
operations, capital requirements, the general financial condition of the Company
and such other factors that the Board of Directors may deem relevant. Currently,
the credit agreement with Bank of America, N.A., prohibits the payment of cash
dividends or other distributions on capital stock or payments in connection with
the purchase, redemption, retirement or acquisition of capital stock.
SALES OF UNREGISTERED SHARES
In May, 2001, we issued an aggregate of 980,025 shares of our common stock to
the former shareholders of Deyco Acquisition Corporation ("DAC") in exchange for
their shares of common stock of DAC. DAC, now Source Interlink Companies, Inc.,
is the parent corporation of IPD and Deyco. Each of the DAC shareholders
represented to us in writing that he or she as acquiring the shares for
investment and agreed that the shares could not be sold or otherwise transferred
unless they were first registered under the Act except in a transaction which is
exempt from the registration requirement. The certificates for the shares bear
appropriate restrictive legends and stop-transfer instructions with respect to
such shares have been given to our transfer agent. Based upon representations
made by each of the former DAC shareholders, we believe each was an accredited
investor as defined in Regulation D promulgated under the Act. We believe that
the issuance of these shares was exempt from the registration requirements of
the Act pursuant to Section 4(2) thereof and Regulation D.
In July, 2001, we issued warrants to Richard Cohen as consideration for
consulting services. The warrants are exercisable for 20,000 shares of our
common stock at an exercise price of $5.34 per share. The warrants vested in
February of 2002 and expire on January 31, 2003. Mr. Cohen represented to us in
writing that he was acquiring the warrant for investment, and, upon exercise,
would acquire shares of our common stock for investment and agreed that neither
the warrant nor the shares could be sold or otherwise transferred unless they
were first registered under the Act except in a transaction which is exempt from
the registration requirement. The warrant bears, and the certificate for shares
issued upon exercise of the warrant will bear, appropriate restrictive legends.
A stop-transfer instruction will be placed with our transfer agent for the
shares, should Mr. Cohen exercise the warrant. Based upon representations made
by Mr. Cohen, we believe that he is an accredited investor as defined in
Regulation D. We believe that the issuance of the warrant was, and the issuance
of shares upon exercise of the warrant will be, exempt from the registration
requirements of the Act pursuant to Section 4(2) thereof and Regulation D.
9
ITEM 6. SELECTED FINANCIAL DATA
<Table>
<Caption>
Fiscal Year Ended January 31,
----------------------------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(in thousands, except for per share data)
STATEMENT OF OPERATIONS INFORMATION:
Revenues $ 11,804 $ 21,100 $ 82,488 $ 91,748 $238,005
Cost of revenues 5,861 11,268 48,869 59,830 191,779
-------- -------- -------- -------- --------
Gross profit 5,943 9,832 33,619 31,918 46,226
Selling, general and administrative expense 2,173 2,551 12,162 17,038 32,022
Amortization 178 398 2,718 2,994 5,424
Asset Impairment Charge -- -- -- -- 78,126
-------- -------- -------- -------- --------
Operating income (loss) 3,592 6,883 18,739 11,886 (69,346)
Interest expense (714) (331) (1,033) (2,356) (3,521)
Interest income 21 28 114 44 183
Other income (expense) (79) (47) (152) 36 (1,741)
-------- -------- -------- -------- --------
Income (loss) before income taxes 2,820 6,533 17,668 9,610 (74,425)
Income tax (provision) benefit (1,231) (2,667) (7,557) (3,776) 1,047
-------- -------- -------- -------- --------
Net income (loss) $ 1,589 $ 3,866 $ 10,111 $ 5,834 $(73,378)
======== ======== ======== ======== ========
Earnings (loss) per share
Basic $ 0.23 $ 0.42 $ 0.66 $ 0.33 $ (4.10)
Diluted 0.22 0.40 0.60 0.32 (4.10)
Weighted average outstanding shares
Basic 6,562 9,132 15,332 17,591 17,915
Diluted 6,694 9,776 16,815 18,303 17,915
</Table>
<Table>
<Caption>
At January 31,
------------------------------------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(in thousands)
BALANCE SHEET INFORMATION:
Working capital (deficit) $ 16,988 $ 22,014 $ 61,455 $ 62,288 $ (7,926)
Total assets 23,808 65,878 156,759 157,108 166,514
Total debt 8,635 3,508 32,389 31,896 57,675
Stockholders' equity 12,495 52,310 107,414 111,801 45,041
</Table>
For a discussion on acquisitions and impairment that affect comparability of
results, see Notes 5 and 8 in the "Notes to the Consolidated Financial
Statements."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
On May 31, 2001 we acquired Interlink, which has various operating companies,
including IPD, a distributor of magazines to bookstore chains, record stores,
computer stores and independent retailers, and Deyco, a national distributor to
secondary wholesalers. Interlink represents a new business segment, magazine
distribution. The Company's segment reporting has been restructured based on the
reporting of senior management to the Chief Executive Officer. This
restructuring combines the Company's business units in a logical way that more
easily identifies business concentrations and synergies for both analysis of
results and real-time control by management. The reportable segments of the
Company are in-store services, manufacturing and magazine distribution.
Formerly, the segments were services, display rack and store fixture
manufacturing and magazine distribution.
10
Magazine Distribution. We derive our revenues from distributing magazines to
major bookstore chains, independent retailers and secondary wholesalers.
Magazine distribution revenue is recognized at the time of shipment to the
retailer, net of estimated returns. We recognize magazine distribution revenue
from sales made to wholesalers based on the on-sale date of each periodical, net
of provisions for estimated returns.
Cost of revenues for magazine distribution includes the price paid for magazines
sold plus costs associated with the shipping and handling of magazines sold.
In-Store Services. We derive our revenues from in-store services from (1)
providing information and management services relating to retail magazine sales
to U.S. and Canadian retailers, magazine publishers, confectioners and vendors
of gum and general merchandise sold at checkout counters and (2) designing,
manufacturing, shipping and salvaging display fixtures used by retailers at
checkout counters as well as at other points of purchase throughout their
stores.
In-store services include configuring, designing and manufacturing front-end
display fixtures, supervising installation, and billing and collecting incentive
payments from vendors for product placement. Revenues are recognized as fixtures
are shipped.
We also earn fees in connection with the collection of incentive payments under
our Traditional Claim Submission and Advance Pay Programs. Most incentive
payment programs offer the retailer a cash rebate, equal to a percentage of the
retailer's net sales of the publisher's titles, which is payable quarterly upon
submission of a properly documented claim. Under our Traditional Claim
Submission Program, we submit claims for incentive payments on behalf of the
retailer and receive a fee based on the amounts collected. Under the Advance Pay
Program, we advance participating retailers a negotiated fixed percentage of
total quarterly incentive payments and pocket rental fees and then collect the
payments from the publishers for our own account.
Under both the Traditional Claim Submission Program and the Advance Pay Program,
revenues are recognized at the time claims for incentive payments are
substantially completed for submission to the publishers. We believe our
allowance for doubtful accounts will be adequate to satisfy losses from
uncollectible accounts receivable. Under the Advance Pay Program, the revenues
we recognize represent the difference between the amount advanced to the
retailer customer and the amount claimed against the publisher.
Cost of revenues includes the cost of labor, materials and supplies directly
used in the provision of the in-store services as well as overhead costs which
include indirect material, indirect labor, and such items as depreciation,
taxes, insurance, heat and electricity.
Manufacturing. We derive our manufacturing revenues from designing,
manufacturing and installing primarily wooden store fixtures. We generally
recognize manufacturing revenues as products are shipped to customers. When we
receive payment prior to shipment, we record the amount as a liability and
recognize the amount as revenues when products are shipped.
Cost of goods sold includes the cost of labor, materials and supplies directly
used in the completion of store fixtures as well as manufacturing overhead costs
which include indirect material, indirect labor, and such items as depreciation,
taxes, insurance, heat and electricity incurred in the manufacturing process.
See Note 18 in the "Notes to Consolidated Financial Statements" for certain
financial information on our three business segments.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. On an ongoing basis, management evaluates its estimates, including
those that relate to magazine sales returns, magazine purchase returns, bad
debts, intangible assets, income tax contingencies, accruals and litigation.
Management bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other
11
sources. Actual results may differ from these estimates under different
assumptions and conditions. If actual results significantly differ from
management's estimates, the Company's financial condition and results of
operations could be materially impacted.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. The Company records a reduction in revenue for estimated
magazine sales returns and a reduction in cost of sales for estimated magazine
purchase returns. These estimates are based on historical sales returns,
historical purchase returns and other known factors. If the historical data the
Company uses to calculate these estimates does not properly reflect future
returns, revenue and/or cost of sales may be misstated.
The Company provides for potential uncollectible accounts receivable based on
customer specific information and historical collection experience. If market
conditions decline, actual collection experience may not meet expectations and
may result in increased bad debt expenses.
The carrying value of the Company's net deferred tax assets assumes that the
Company will be able to generate sufficient future taxable income in certain tax
jurisdictions, based on estimates and assumptions. If these estimates and
assumptions change in the future, the Company may be required to increase or
decrease valuation allowances against its deferred tax assets resulting in
additional income tax expenses or benefits.
In assessing the recoverability of the Company's goodwill and other intangible
assets, the Company must make estimates of expected future cash flows and other
factors to determine the fair value of the respective assets. If these estimates
and their related assumptions change in the future, the Company may be required
to record impairment charges. The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, on
February 1, 2002 and will be required to analyze its goodwill for impairment on
an annual basis. The Company does not expect to record any impairment charges as
a result of the adoption of this statement.
Deyco's costs of sales represents 8.7% of our total cost of sales and 12.3% of
our magazine distribution segment's cost of sales. Due to the complexities of
the many combinations and permutations of thousands of magazines and hundreds of
customers and publishers as well as the fact that payment for issues sold can
take up to a year and in some cases more to be finally settled, management
accrues a cost of sales for Deyco based on estimates derived from historical
analysis of product cost as a percent of sales. The basis of this estimate is
reviewed and updated on a regular basis. The cost accrual for each month's
billing is kept segregated in the general ledger and as payments are made, they
are charged to the same account. In this way management can track over time the
amount actually paid in settlement for a particular month's sales and
continuously hone the estimate. If the historical data the Company uses to
calculate these estimates does not properly reflect actual cost of sales, cost
of sales for Deyco may be misstated.
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations expressed as a percentage of Total Revenues:
<Table>
<Caption>
Fiscal Year Ended January 31,
--------------------------------
2002 2001 2000
------ ------ ------
Revenues 100.0% 100.0% 100.0%
Cost of Revenues 80.6% 65.2% 59.3%
------ ------ ------
Gross Profit 19.4% 34.8% 40.7%
Selling, General and Administrative Expense 13.4% 18.6% 14.7%
Amortization 2.3% 3.2% 3.3%
Asset Impairment Charges 32.8% --% --%
------ ------ ------
Operating Income (Loss) (29.1)% 13.0% 22.7%
Interest, Net (1.4)% (2.5)% (1.1)%
Other Income (Expense), Net (0.8)% --% (0.2)%
------ ------ ------
Income (Loss) Before Income Taxes (31.3)% 10.5% 21.4%
------ ------ ------
Net Income (Loss) (30.8)% 6.4% 12.3%
====== ====== ======
</Table>
12
FISCAL 2002 COMPARED TO FISCAL 2001
Revenues
Magazine Distribution. On May 31, 2001, we acquired Interlink. Interlink's
results of operations have been included in our consolidated financial
statements since the date of acquisition. Magazine distribution accounted for
approximately 65.6% of our revenues for the year ended January 31, 2002. There
were no magazine distribution revenues in the year ended January 31, 2001.
In-Store Services. In-store services accounted for approximately 26.9% (78.1%
excluding revenues from our newly acquired magazine distribution companies) and
73.3% of our revenues for the years ended January 31, 2002 and 2001,
respectively. In-store services revenues of $63.9 million decreased only $3.3
million compared to the year ended January 31, 2001 despite the inclusion in the
prior year of approximately $4.0 million of non-recurring revenue from the sale
of software associated with our information products.
Manufacturing. Manufacturing accounted for approximately 7.5% (21.9% excluding
revenues from our newly acquired magazine distribution companies) and 26.7% of
our revenues for the year ended January 31, 2002 and 2001, respectively.
Revenues of $18.0 million in the year ended January 31, 2002 decreased $6.5
million compared to the year ended January 31, 2001 due to reduced volume in
store fixture manufacturing caused by a major customer decreasing its new store
openings compared to last year. Sales to this major customer decreased
approximately $5.8 million compared to the prior year. Significant efforts were
made to establish relationships with new customers to replace this business. One
new customer accounted for over $2.0 million in revenues.
Gross Profit
Magazine Distribution. Gross profit was $20.1 million with a gross margin of
12.9%. We did not distribute magazines during the year ended January 31, 2001.
In-Store Services. Gross profit decreased approximately $2.0 million for the
year ended January 31, 2002 compared to the prior year despite approximately
$4.0 million of non-recurring revenue in the prior year. An insignificant amount
of costs were associated with such non-recurring revenue, thus the gross margin
decreased only slightly from 39.2% to 38.0%. Excluding the non-recurring
revenue, the gross margin was approximately 33.1% for the year ended January 31,
2001. The dramatic improvement was partially due to the fixed cost components of
the cost of revenue which do not increase with increased volume. More
importantly, however, was that we were able to produce more volume with
approximately the same amount of labor dollars. We attribute this to the efforts
of our employees and to the management of our production facilities. Further, we
believe that an indiscrete portion of our gross margin is related to our
ability, which is enhanced by our information products, to attract and retain
good customers.
Manufacturing. Gross profit decreased $3.8 million compared to the year ended
January 31, 2001. The gross margin also decreased from 22.8% to 10.1% partly
because of the decrease in volume. The margins on production for new customers
tend to be low due to start-up costs such as prototype production. Additionally,
some of the new business involved numerous short production runs as well as
services beyond those traditionally provided.
Selling, General & Administrative Expense ("SG&A")
Magazine Distribution. SG&A expenses were $19.9 million or 12.8% of revenues. We
did not distribute magazines during the year ended January 31, 2001.
In-Store Services. SG&A expenses decreased from $15.6 million to $12.9 million
($10.4 million after allocation of costs to the magazine distribution segment)
primarily as a result of write-offs of receivables being approximately $2.0
million higher last year. Excluding the write-offs of receivables, SG&A as a
percentage of revenue decreased slightly from 17.1% to 16.9%.
Manufacturing. SG&A expenses increased approximately $200,000 over the prior
year. Approximately $150,000 of this increase resulted from an increase in
administrative salaries which included the addition of three employees.
13
Goodwill Impairment. Following are the events and/or changes in circumstances
that indicated that the recoverability of the carrying amount of our goodwill
should be assessed:
A valuation analysis was commissioned in preparation for adopting SFAS 142
effective February 1, 2002. The initial phases of this analysis revealed
that we had experienced significant decreases in the market value of our
subsidiaries, Interlink and Huck. Early adoption of SFAS 142 is prohibited,
however, it did serve to alert us that we have experienced a significant
decrease in the market value of our assets.
Our manufacturing segment, Huck, experienced a substantial scale back in
sales to its most significant customer resulting in a net operating loss
for the segment.
The accumulation of costs to acquire Interlink were significantly in excess
of the amounts originally expected. This was because the net liabilities
acquired far exceeded the amount originally projected. Management does not
believe that it was practicable to determine the magnitude of this excess
during due diligence. The Company is seeking recourse from the sellers of
Interlink.
Interlink experienced a significant cash flow loss and has had a history of
operating and cash flow losses.
According to SFAS 121 estimates of future cash flows shall be the best estimate
based on reasonable and supportable assumptions and projections. The weight
given to the evidence in support of the estimated cash flows should be
commensurate with the extent of which the evidence can be verified objectively.
Management's reasonable and supportable estimates of expected future cash flows
from Interlink and Huck, weighted commensurately with the extent of which the
evidence for such estimates can be verified objectively, for the purpose of
complying with SFAS 121, are less than the carrying amount of the goodwill.
Accordingly, we reduced the carrying value of the goodwill for Interlink and
Huck to fair value. Our estimate of fair value was determined by independent
appraisal using customary valuation methodologies (including discounted cash
flow and fundamental analysis). The valuation concluded that the fair values of
these segments were less than the carrying amount of the assets associated with
these segments by approximately $78.1 million.
The following table shows, by segment, the original goodwill net of accumulated
amortization, the impairment charge and the resulting goodwill at January 31,
2002 (in thousands):
<Table>
<Caption>
Original Impairment Resulting
Segment Goodwill Charge Goodwill
---------------------- -------- ---------- ---------
In-Store 42,769 -- 42,769
Manufacturing 9,539 9,539 --
Magazine Distribution 68,587 68,587 --
</Table>
Interest Expense. Interest expense for the year ended January 31, 2002 increased
$1.2 million compared to the year ended January 31, 2001 principally due to the
borrowings by the newly acquired magazine distribution companies. A significant
portion of such borrowings were used to acquire the magazine distribution
companies.
Other Income (Expense). Other expense resulting from a loss on the sale of a
security of $3.5 million and an unrealized loss on an interest rate swap
agreement of $0.7 million was offset by other income of $2.0 million resulting
from life insurance proceeds.
Income Tax Expense. The effective income tax rates for fiscal years 2002 and
2001 were 1.4% and 39.3%, respectively. The effective income tax rate for the
year ended January 31, 2002 varied significantly from the federal statutory rate
due to the non-taxable life insurance proceeds received during the period and
due to the portion of the asset impairment charge which is not deductible for
income tax purposes. The rate for the year ended January 31, 2001 varied from
the federal statutory rate
14
due to state income taxes and expenses not deductible for income tax purposes.
These non-deductible expenses include goodwill amortization, meals and
entertainment and officers' life insurance premiums.
FISCAL 2001 COMPARED TO FISCAL 2000
Revenues
In-Store Services. In-store services accounted for approximately 73.3% and 88.4%
of our revenues for the years ended January 31, 2001 and 2000, respectively.
In-store revenue of $67.2 million decreased $5.7 million compared to the year
ended January 31, 2000. Although we had approximately $4.0 million of
non-recurring revenue from the sale of software associated with our information
products, we experienced an overall decrease in sales of $9.7 million primarily
related to volume, and to a small degree, pricing. Volume was impacted by
customer postponements. Although we enjoy a significant market share which we
believe in excess of 60%, we have experienced a limited degree of pricing
pressure.
Manufacturing. In September 1999, we acquired Huck and Arrowood. Results of
operations for these companies have been included in our consolidated financial
statements since their respective dates of acquisition. Manufacturing accounted
for approximately 26.7% and 11.6% of our revenues for the years ended January
31, 2001 and 2000, respectively.
Gross Profit
In-Store Services. Gross profit decreased to $26.3 million in fiscal 2001 from
$31.3 million in fiscal 2000, a decrease of approximately of approximately $5.0
million. Included in the gross margin of fiscal 2001 is approximately $4.0
million of non-recurring revenue that had an insignificant amount of costs
associated with it. Excluding that non-recurring revenue, the gross margin
decreased from 42.8% to 39.2%, primarily as a result of lower volume and pricing
pressure experienced during the third and fourth quarters of fiscal 2001.
Manufacturing. In September 1999, we acquired Huck and Arrowood. Results of
operations for these companies have been included in our consolidated financial
statements since their respective dates of acquisition. The gross profit
increased from $2.4 million to $5.6 million.
Selling, General and Administrative Expense)
In-Store Services. SG&A expense increased $4.2 million from $11.4 million in
fiscal 2000. The majority of the increase is due to a charge of $4.1 million to
write-off accounts receivable. Excluding the charge, SG&A as a percentage of
revenues increased slightly from 15.6% in fiscal 2000 to 17.1% in fiscal 2001.
Manufacturing. SG&A expense increased $0.7 million. The increase was merely the
result of the inclusion of Huck's operating results for a full year in fiscal
2001 versus four months in fiscal 2000.
Interest Expense. Interest expense for fiscal 2001 increased $1.3 million
compared to fiscal 2000 principally due to the increase in the average balance
outstanding on our credit facility from approximately $9.6 million during the
year ended January 31, 2000 to $26.8 million for the year ended January 31,
2001.
Income Tax Expense. The effective income tax rates for fiscal years 2001 and
2000 were 39.3% and 42.8%, respectively. These rates varied from the federal
statutory rate due to state income taxes and expenses not deductible for income
tax purposes. These non-deductible expenses include goodwill amortization, meals
and entertainment and officers' life insurance premiums.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements for the in-store services segment are for funding
the Advance Pay Program, for purchasing materials and the cost of labor incurred
in the provision of the in-store services. Our primary cash requirements for the
manufacturing segment are for purchasing materials and the cost of labor
incurred in the manufacturing process. Our primary cash requirements for the
magazine distribution segment are for the cost of the periodicals and for
meeting general working capital requirements. Historically, we have financed our
business activities through cash flows from operations, borrowings under
available lines of credit and through the issuance of equity securities.
15
During fiscal 2002, 2001 and 2000, we advanced approximately $81.5 million,
$84.8 million and $68.9 million, respectively, under the Advance Pay Program.
Generally, the primary source of funding the advances is our credit facility,
which is discussed below. During fiscal 2002, the Program was funded by
borrowings under the revolving credit facility and cash flows from operations.
Collections under the Advance Pay Program are used to pay down any outstanding
balance under the credit facility. Thus, the credit facility is primarily used
to manage the timing of payments and collections under the Advance Pay Program.
Growth of the Advance Pay Program will be monitored and controlled to ensure
that funding will be available either through cash provided by operations or
borrowings under our credit facility.
Net cash provided by operating activities of $14.4 million for fiscal 2002 was
primarily from the increase in accounts payable and accrued expenses and the non
cash items of depreciation and amortization, the loss on sale of the marketable
security and the asset impairment charge offset by the net loss and the increase
in accounts receivable. Net cash provided by operating activities of $8.7
million for fiscal 2001 was primarily from net income, non cash items of
depreciation and amortization and the decrease in inventories offset by the
decrease in accounts payable and accrued expenses and the increase in other
assets. Net cash used by operating activities of $16.4 million for fiscal 2000
was primarily from the increase in accounts receivable, increase in other assets
and decrease in accounts payable and accrued expenses offset by net income and
non cash items of depreciation and amortization. The average collection period
for 2002 was approximately 168 days, 129 days and 42 days for the in-store
services segment, the manufacturing segment and the magazine distribution
segment, respectively (all considered to be within an acceptable range by
management based on the nature of our business and historical experience).
Net cash used in investing activities was $13.7 million, $8.8 million and $42.1
million in fiscal year 2002, 2001 and 2000, respectively. The cash used in
fiscal year 2002 was primarily for the acquisition of the magazine distribution
companies. Net cash provided by financing activities was $1.2 million in fiscal
2002 compared to net cash used in financing activities of $0.5 million in fiscal
2001 and net cash provided by financing activities of $ $59.4 million in fiscal
2000.
At January 31, 2002, we anticipate capital expenditures during fiscal 2003 of
approximately $2.5 million of which approximately $1.5 million is allocated to
company-wide upgrades and maintenance of computers, software, and telecom
equipment and approximately $1.0 million is allocated to manufacturing plant
equipment upgrades and maintenance.
During fiscal 2003, we are undertaking the first phase of a consolidation of
company-wide administrative offices to new worldwide headquarters in Bonita
Springs, Florida. At January 31, 2002, we anticipate additional capital
expenditures relating to the move of approximately $1.8 million allocated to
furniture, leasehold improvements, computer equipment, and telecom equipment at
the new headquarters.
At January 31, 2002, our total long-term debt obligations were approximately
$57.7 million. In December 1999, we entered into an unsecured credit agreement
with Bank of America, N.A. which provides for a $46.0 million revolving credit
facility. The revolving credit facility bears interest at a rate equal to the
London Interbank Offered Rate ("LIBOR") plus a percentage ranging from 1.0% to
2.1% depending on our ratio of funded debt to earnings before interest, taxes,
depreciation and amortization (2.1% at January 31, 2002) and carries a facility
fee of 1/4 % per annum on the difference between $25 million and the average
principal amount outstanding under the loan (if less than $25 million) plus 3/8%
per annum of the difference between the maximum amount of the loan and the
greater of (i) $25 million or (ii) the average principal amount outstanding
under this loan. The availability at January 31, 2002 on the revolving credit
facility was approximately $9.9 million.
Under the Credit Agreement, we are subject to various financial and operating
covenants. These include (i) requirements that we satisfy various financial
ratios and (ii) limitations on the payment of cash dividends or other
distributions on capital stock or payments in connection with the purchase,
redemption, retirement or acquisition of capital stock.
Under the credit agreement, we are required to maintain certain financial
ratios. We were in compliance with all such ratios at January 31, 2002 other
than ratios driven by earnings before interest, taxes, depreciation and
amortization ("EBITDA"). We incurred a $3.5 million charge to EBITDA from the
loss on the sale of a security we acquired in July 2000 (the prior fiscal year).
While Bank of America did not raise the issue, we were unable to obtain
confirmation from Bank of America certifying for our auditors that the loss on
the sale of a security totaling $3.5 million is an allowable addition to net
income in the calculation of EBITDA. We believe that this amount should be an
allowable addition since Bank of America approved the investment, in writing,
and the investment has been carried on the balance sheet at its market value
since July 2000. The market value at October 31, 2001 was $63,000, at which
point, such decline in the market value of the security had not affected net
income or EBITDA. However, the actual sale of the security in January 2002
resulted in a charge to EBITDA of $3.5 million.
The existing revolving credit facility terminates on December 31, 2002. We are
currently in the process of negotiating an extension with Bank of America
including modifications to the agreement that would clearly allow the add-back
of the loss on the sale of the security for purposes of calculating EBITDA. We
have received from Bank of America a proposed term sheet for discussion purposes
which indicates that we will be required to offer collateral and possibly accept
a rate increase due to the change in the banking climate since our original loan
was negotiated. In addition to negotiating an extension with Bank of America, we
are also examining opportunities with other banks, one of which has provided a
proposed term sheet, not a commitment, which is subject to the completion of due
diligence with results satisfactory to the bank.
16
In connection with the acquisition of MYCO, Inc., we assumed MYCO's Industrial
Revenue Bonds ("IRB"). On January 30, 1995, the City of Rockford issued $4
million of its Industrial Project Revenue Bonds, Series 1995, and the proceeds
were deposited with the Amalgamated Bank of Chicago, as trustee. Bank of America
("the Bank") has issued an unsecured letter of credit for $4.1 million in
connection with the IRB with an initial expiration date of April 20, 2001. As
provided in the reimbursement agreement, the expiration date shall automatically
extend for successive additional periods of one calendar month until the
twentieth day of the thirteenth month following receipt of a notice of
non-extension from the Bank. To date, no such notice of non-extension has been
received and management does not expect such notice to be given by the Bank in
the foreseeable future. The bonds are secured by the trustee's indenture and the
$4.1 million letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.
On February 22, 2001, IPD and Deyco (now our wholly-owned subsidiaries) entered
into a credit agreement with Congress Financial Corporation ("Congress"). The
credit agreement includes a $4,000,000 term loan to be repaid in 36 equal
monthly installments, as well as a revolving credit facility secured by IPD and
Deyco's accounts receivable, inventories, equipment and other intangibles.
Borrowings under the term loan portion of the credit facility bear interest at a
rate equal to 0.5% in excess of the prime rate. Borrowings under the revolving
credit portion of the facility bear interest at a rate equal to 0.25% in excess
of the prime rate. Under the credit agreement, IPD and Deyco are required to
maintain certain financial ratios. IPD and Deyco were not in compliance with all
such ratios at January 31, 2002, and received a waiver from Congress of its
right to enforce compliance. In addition, IPD, Deyco and Congress have entered
into an amendment to the credit facility that will have the effect of easing the
ability of IPD and Deyco to maintain the financial ratios.
Summarized below are our obligations and commitments to make future payments
under debt obligations and lease agreements based on obligations at January 31,
2002.
<Table>
<Caption>
Payments Due By Period
Less than 1 - 3 4 - 5 After
(in thousands) Total 1 Year Years Years 5 Years
-------------- -------- -------- -------- -------- --------
Debt Obligations $ 57,675 $ 42,097 $ 379 $ 11,151 $ 4,048
Capital Lease Obligations 313 68 99 98 48
Operating Leases 34,989 4,907 8,206 4,722 17,154
-------- -------- -------- -------- --------
Total Contractual Cash Obligations $ 92,977 $ 47,072 $ 8,684 $ 15,971 $ 21,250
======== ======== ======== ======== ========
</Table>
In June 1999, we purchased our facility in High Point, North Carolina for $1.8
million. We financed this purchase through available borrowings under our
revolving credit facility.
We believe that our cash flow from operations together with our revolving credit
facilities will be sufficient to fund our working capital needs and capital
expenditures for the foreseeable future.
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when
17
those assets were initially recognized. SFAS 142 requires the Company to
complete a transitional goodwill impairment test six months from the date of
adoption. The Company is also required to reassess the useful lives of other
intangible assets within the first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using the
purchase method. Amortization expense arising from goodwill that will no longer
be amortized under the provision of the new rules was approximately $5.4
million, $3.0 million and $2.7 million in fiscal year 2002, 2001 and 2000,
respectively. Other than the impact on amortization expense, the Company does
not expect the adoption of this statement will have a material impact on the
Company's financial position, results of operations or cash flows.
In October 2001, the Financial Accounting Standards Board issued SFAS 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
This statement addresses financial accounting and reporting for the impairment
and disposal of long-lived assets. This Statement supercedes FASB Statement 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of", and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effect of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of a segment of a business. The
provisions of SFAS 144 will be effective for fiscal years beginning after
December 15, 2001.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability. Our debt relates primarily to credit facilities with Bank of
America, N.A. and IPD and Deyco's facility with Congress Financial Corporation.
The credit facility with Bank of America is a three-year credit agreement with
an outstanding principal balance of approximately $36.1 million as of January
31, 2002. Interest on the outstanding balance is charged based on a variable
interest rate related to LIBOR plus a margin specified in the credit agreement.
The credit facility with Congress includes a $4.0 million term loan to be repaid
in 36 equal monthly installments, as well as a revolving credit facility secured
by IPD and Deyco's accounts receivable, inventories, equipment and other
intangibles. The outstanding principal balance under the term loan at January
31, 2002 is approximately $2.8 million. The revolving credit facility had an
outstanding principal balance of approximately $11.1 million at January 31,
2002. Borrowings under the term loan portion of the credit facility bear
interest at a rate equal to 3.0% in excess of the adjusted eurodollar rate or
0.5% in excess of the prime rate. Borrowings under the revolving credit portion
of the facility bear interest at a rate equal to 2.5% in excess of the adjusted
eurodollar rate or 0.25% in excess of the prime rate. Interest on the
outstanding balances is subject to market risk in the form of fluctuations in
interest rates.
In order to better manage its exposure to interest rate risk, in February 2001
we entered into an interest rate swap agreement. The swap agreement, with a
notional amount of $15.0 million converts the floating interest rate on the Bank
of America credit facility to a fixed rate. At January 31, 2002 the fair value
of the swap is not material and is recorded in accrued expenses.
We also conduct operations in Canada. For the year ended January 31, 2002,
approximately 1.4% of our revenues were earned in Canada and collected in local
currency. In addition, we generally pay operating expenses in the corresponding
local currency and will be subject to increased risk for exchange rate
fluctuations between such local currency and the dollar. We do not conduct any
significant hedging activities.
18
<Table>
<Caption>
12% Notes
Due
Variable February
Rate IRB 2002 and Other
and Bank August Variable
As of January 31, 2002 (in thousands): Debt 2002 Debt
---------------------------------------------- -------- ---------- --------
Estimated cash inflow (outflow) by year of
principal maturity-
2003 $ 38,850 $ 2,500 $ 747
2004 -- -- 342
2005 -- -- 37
2006 11,068 -- 40
2007 -- -- 43
2008 and thereafter 4,000 -- 48
-------- ---------- --------
Total $ 53,918 $ 2,500 $ 1,257
-------- ---------- --------
Estimated fair value $ 53,918 $ 2,495 $ 1,200
-------- ---------- --------
Carrying value $ 53,918 $ 2,500 $ 1,257
======== ========== ========
</Table>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS.
The consolidated financial statements of the Company are included herein as a
separate section of this statement which begins on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES.
Not applicable.
19
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The following table sets forth certain information concerning the directors and
executive officers of the Company:
<Table>
<Caption>
Name Age Position
- ---- --- --------
S. Leslie Flegel 64 Director, Chairman and Chief Executive Officer
James R. Gillis 49 Director, Chief Operating Officer and President
W. Brian Rodgers 36 Secretary and Chief Financial Officer
Jason S. Flegel 36 Executive Vice President
Monte Weiner 52 President & Chief Executive Officer - Source Display
Frank Bishop 51 Senior Vice President - North American Sales
John D'Aloia 47 Executive Vice President, Chief Marketing Officer
Robert O. Aders 75 Director
Harry L. "Terry" Franc, III 66 Director
Aron Katzman 64 Director
Randall S. Minix 52 Director
Kenneth F. Teasdale 67 Director
</Table>
The Board consists of seven members, each of whom serves in that capacity for a
three year term or until a successor has been elected and qualified, subject to
earlier resignation, removal or death. The number of directors comprising the
Board may be increased or decreased by resolution adopted by the affirmative
vote of a majority of the Board. Our Articles of Incorporation and By-Laws
provide for three classes of directorships serving staggered three year terms
such that one class of the directors is elected at each annual meeting of
stockholders. The terms of Messrs. Katzman, Minix and Gillis will continue until
the 2002 annual meeting of stockholders, the terms of Messrs. Franc and Teasdale
will continue until the 2003 annual meeting of stockholders and the terms of
Messrs. Aders and Flegel will continue until the 2004 annual meeting of
stockholders.
Each of the executive officers is a full-time employee of The Source.
Non-employee directors of The Source devote such time to the affairs of The
Source as is necessary and appropriate. Set forth below are descriptions of the
backgrounds of the executive officers and directors of The Source:
S. Leslie Flegel has been the Chairman of the Board of Directors and Chief
Executive Officer of The Source since its inception in March 1995. For more than
14 years prior thereto, Mr. Flegel was the principal owner and Chief Executive
Officer of Display Information Systems Company ("DISC"), a predecessor of The
Source. S. Leslie Flegel is the father of Jason S. Flegel, The Source's
Executive Vice President, Information Services. Mr. Flegel is a director of
eRoomSystem Technologies, Inc.
James R. Gillis became President of The Source in December 1998, was appointed
as a director of The Source in March 2000 and became President and Chief
Operating Officer in August 2000. Prior thereto, he served as the President and
Chief Executive Officer of Brand Manufacturing Corporation.
20
W. Brian Rodgers has served as Secretary and Chief Financial Officer since
October 1996. Prior to joining The Source, Mr. Rodgers practiced for seven years
as a Certified Public Accountant with BDO Seidman, LLP.
Jason S. Flegel has served as Executive Vice President, Information Services
since June 1996. Prior thereto, and since the Company's inception in March 1995,
he served as Vice President-- Western Region. For more than two years prior
thereto, Mr. Flegel was an owner and the Chief Financial Officer of DISC. Jason
S. Flegel is the son of S. Leslie Flegel.
Monte Weiner has served as President and Chief Executive Officer - Source
Display since August 2000. Prior thereto, Mr. Weiner served as Executive Vice
President and Chief Executive Officer - Source Display from September 1999 until
May 2000. For more than 15 years prior thereto, Mr. Weiner served as President
of TCE Corporation and Secretary and Treasurer of Brand Manufacturing
Corporation.
Frank Bishop has served the Company since 1995, most recently as Senior Vice
President, Sales. Prior to joining the Company, Mr. Bishop served as the
Director of Sales & Marketing for Triangle News Co, a wholesale distributor of
books and magazines.
John D'Aloia joined the Company as Executive Vice President, Chief Marketing
Officer in February 2002. Prior to joining the Company, Mr. D'Aloia worked for
Hearst Distribution Corporation where he held the office of Executive Vice
President for Hearst Distribution Group since 1990, and simultaneously served as
Senior Vice President of COMAG Marketing Group. Prior to that, he worked for
Time Inc. Magazine Division of AOL Time Warner for 14 years where he held a
variety of positions including New York Regional Sales Director for People
Magazine.
Robert O. Aders was appointed as a director in March 1999. He is Chairman and
Chief Executive Officer of the Advisory Board, Inc. (an international consulting
organization) and a member of the Board of Directors of Food Marketing
Institute, where he served as President and CEO from its founding in 1976 until
his retirement in 1993. Mr. Aders was the Acting Secretary of Labor in the Ford
administration, is a former advisor to the White House Office of Emergency
Preparedness and has served on the U.S. Wage and Price Commission and as a Vice
Chairman of the National Business Council for Consumer Affairs. From 1970 to
1974, Mr. Aders was Chairman of the Board of the Kroger Company, where he served
in various executive positions beginning in 1957. Mr. Aders is also a member of
the Board of Directors of Coinstar, Inc., Spar Group, Inc. and Telepanel
Systems, Inc.
Harry L. "Terry" Franc, III, has been a director of The Source since it
commenced operations in May 1995. Mr. Franc is one of the founders of Bridge
Information Systems, Inc. ("BIS"), a global provider of information services to
the securities industry and of BIS's subsidiary, Bridge Trading Company ("BTC"),
a registered broker-dealer and member of the New York Stock Exchange. Mr. Franc
has been Executive Vice President of BTC for more than 20 years and for more
than 20 years prior to 1995, served as a director and an Executive Vice
President of BIS. Mr. Franc is a member of the National Organization of
Investment Professionals. He is a director of TV House, Inc. and of the St.
Louis Community Foundation.
Aron Katzman has served as a director of The Source since it commenced
operations in May 1995. Mr. Katzman was a founder of Medicine Shoppe
International, Inc. (Nasdaq) and served on its Board of Directors until it was
purchased by Cardinal Health (NYSE) in 1994. Until its sale in May 1994, Mr.
Katzman served as the Chairman and Chief Executive Officer of Roman Company, a
manufacturer and distributor of fashion custom jewelry. Mr. Katzman is a member
of the board of directors of Foto, Inc. Presently, Mr. Katzman is Chairman and
Chief Executive Officer of Decorating Den of Missouri.
Randall S. Minix has served as a director of The Source since it commenced
operations in May 1995. As of March 1, 2001, Mr. Minix became the Chief
Financial Officer of South Atlantic Lumber Industries in Greensboro, North
Carolina. For more than five years prior thereto, Mr. Minix had been the
managing partner of Minix, Morgan & Company, L.L.P., an independent accounting
firm headquartered in Greensboro, North Carolina.
Kenneth F. Teasdale was appointed as a director of The Source in March 2000. Mr.
Teasdale has been the Chairman of Armstrong Teasdale LLP, a law firm, since 1993
and before that was Managing Partner from 1986 to 1993. He has been associated
with Armstrong Teasdale since 1964. Prior thereto, Mr. Teasdale served as
General Counsel to the Democratic Policy Committee of the United States Senate
beginning in 1962. In that position, he also served for three years as Legal
Assistant to the Majority Leader of the United States Senate. Mr. Teasdale is
Chairman of the Board of Regents for St. Louis University, Member of the Board
of Trustees for the St. Louis Science Center, member of the Board of Directors
for the United Way of Greater St. Louis, member of the Board of Trustees for St.
Louis University and member of the Board of Trustees for the St. Louis Art
Museum.
21
COMMITTEES OF THE BOARD OF DIRECTORS
The Board has established an Audit Committee, a Compensation Committee, a
Finance Committee and an Acquisition Committee. The duties and members of each
of these committees are indicated below.
o The Audit Committee is comprised of three non-employee directors, presently
Messrs. Minix, Katzman and Franc. The audit committee assists the board in
fulfilling its financial oversight responsibilities by reviewing all audit
processes and fees, the financial information that will be provided to our
stockholders and our systems of internal controls. The audit committee
shares with the board the authority and responsibility to select, evaluate
and, where appropriate, replace the independent public accountants.
o The Compensation Committee is comprised of three non-employee directors,
presently Messrs. Aders, Katzman and Minix, and has been given the
responsibility of reviewing our financial records to determine overall
compensation and benefits for executive officers and to establish and
administer the policies which govern employee salaries and benefit plans.
o The Finance Committee is comprised of two directors, Messrs. Franc and
Katzman. The Finance Committee has been given the responsibility of
monitoring our capital structure, reviewing available alternatives to
satisfy our liquidity and capital requirements and recommending the firm or
firms which will provide investment banking and financial advisory services
to us.
o The Acquisition Committee is comprised of four directors, presently Messrs.
Katzman, Aders, Franc and Minix, and has been given the responsibility of
monitoring our search for attractive acquisition opportunities, consulting
with members of management to review plans and strategies for the
achievement of our external growth objectives and recommending the firm or
firms that will serve as advisors to us in connection with the evaluation of
potential business combinations.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to
the Company during its most recent fiscal year and Form 5 and amendments
thereto, or written representations that no Form 5 is required, all executive
officers and directors of the Company timely filed with the Securities and
Exchange Commission all reports required by Section 16(a) of the Securities
Exchange Act of 1934 except that Messrs. Teasdale, Weiner, Aders and Minix
failed to timely file a Form 4, Statement of Changes in Beneficial Ownership.
All such reports have since been filed.
22
ITEM 11. EXECUTIVE COMPENSATION.
The following table summarizes information concerning cash and non-cash
compensation paid to or accrued for the benefit of the named executive officers
for all services rendered in all capacities to the Company and its predecessors.
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
LONG-TERM
COMPENSATION
SECURITIES
NAME OF PRINCIPAL FISCAL UNDERLYING ALL OTHER
POSITION YEAR SALARY ($) BONUS ($) OPTIONS (#) COMPENSATION(1)($)
- -------------------- ------ ---------- --------- ------------ ------------------
S. Leslie Flegel 2002 $ 455,000 $ 200,000 450,000 $ 5,450
Chief Executive Officer 2001 455,000 359,217 -- 5,450
2000 330,000 140,000 525,000 5,450
James R. Gillis 2002 $ 350,000 $ 250,000 250,000 $ 970
President 2001 300,000 250,000 200,000 970
2000 250,000 250,000(2) -- 2,860
Monte Weiner 2002 $ 300,000 $ 150,000 200,000 --
Executive Vice President & 2001 241,000 250,000 200,000 --
CEO - Source Display 2000 150,000 100,000 25,000 --
Jason S. Flegel 2002 $ 204,000 $ -- 131,000 $ 981
Executive Vice President 2001 155,000 50,000 50,000 381
2000 125,000 16,000 50,000 381
Frank Bishop 2002 $ 204,000 $ -- 20,000 --
Executive Vice President, Sales 2001 185,000 -- 50,000 --
2000 120,000 5,000 30,000 --
</Table>
- --------
(1) In fiscal 2002, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $970, $0, $981 and $0, respectively. In
fiscal 2001, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $970, $0, $381 and $0, respectively. In
fiscal 2000, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $2,860, $0, $381 and $0, respectively.
(2) Includes $100,000 bonus accrued in fiscal year 2000, but paid in fiscal
year 2001, which was inadvertently not included in the proxy statement
dated September 22, 2000.
23
OPTIONS GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
Potential Realizable Value at
Number of % of Total Assumed Annual Rates of
Securities Options Stock Price Appreciation
Underlying Granted to Exercise or for Option Term
Options Employees in Base Price Expiration -----------------------------------
Name Granted # Fiscal Year ($/Sh) Date 5%($) 10%($)
- ---------------------- ------------ ------------ ----------- ---------- --------- ----------
S. L. Flegel 300,000(1) 13% 5.00 02-05-11 943,342 2,390,614
S. L. Flegel 150,000(2) 6% 4.35 07-11-11 410,354 1,039,917
James R. Gillis 100,000(3) 4% 5.00 02-05-11 314,447 796,871
James R. Gillis 100,000(3) 4% 4.35 07-11-11 273,569 693,278
James R. Gillis 50,000(4) 2% 4.21 12-05-11 132,382 335,483
Monte Weiner 50,000(1) 2% 5.00 02-05-11 157,224 398,436
Monte Weiner 50,000(3) 2% 4.35 07-11-11 136,785 346,639
Monte Weiner 100,000(4) 4% 4.21 12-05-11 264,765 670,966
Jason Flegel 50,000(1) 2% 5.00 02-05-11 157,224 398,436
Jason Flegel 50,000(2) 2% 4.35 07-11-11 136,785 346,639
Jason Flegel 31,000(5) 1% 4.21 12-05-11 82,077 207,999
Frank Bishop 20,000(1) 1% 5.00 02-05-11 62,889 159,374
------------ ------------ ----------- ---------- --------- ----------
</Table>
(1) Options were granted February 6, 2001 and are exercisable as to 100,000
shares immediately, another 100,000 shares on February 6, 2002 and the final
100,000 shares on February 6, 2003.
(2) Options were granted July 12, 2001 and vest in three equal annual
installments.
(3) Options were granted February 6, 2001 and vest 33.33% immediately, 33.33% on
August 1, 2001 and the remainder on August 1, 2002.
(4) Options were granted July 12, 2001 and vest 33.33% immediately, 33.33% on
August 1, 2002 and the remainder on August 1, 2003.
(5) Options were granted December 6, 2001 and vest in three equal annual
installments.
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
- --------------------------------------------------------------------------------
<Table>
<Caption>
Number of Value of Unexercised
Unexercised Options at In-the-Money Options(1)
Shares Fiscal Year End (#) at Fiscal Year End ($)
Acquired on Value Exercisable/ Exercisable/
Name Exercise(#) Realized($) Unexercisable Unexercisable
- ------------------- ----------- ----------- ---------------------- -----------------------
S. Leslie Flegel 0 0 1,003,006 / 421,250 448,292 / 170,300
James R. Gillis 0 0 418,667 / 166,000 101,501 / 77,999
Monte Weiner 0 0 283,334 / 183,333 73,000 / 98,500
Jason Flegel 0 0 90,758 / 159,333 60,679 / 145,418
Frank Bishop 0 0 36,485 / 45,333 9,636 / 4,600
- ------------------- ----------- ----------- ---------------------- -----------------------
</Table>
(1) "In-the-Money" options are options whose exercise price was less than the
market price of Common Stock at January 31, 2002.
24
DIRECTOR COMPENSATION.
Under the Company's present policy, each director of the Company who is
not also an employee receives $15,000 annually payable quarterly in either cash
or shares of Common Stock valued at 90% of market on the date of grant as of the
payment date. Directors also annually receive options to purchase 10,000 shares
of Common Stock at an exercise price equal to market on the date of grant.
Directors are also entitled to be reimbursed for expenses incurred by them in
attending meetings of the Board and its committees.
EMPLOYMENT AGREEMENTS WITH NAMED EXECUTIVE OFFICERS.
In February 2001, we entered into an employment agreement with S. Leslie Flegel,
which expires January 31, 2004. Under the agreement, Mr. Flegel serves as the
Chairman of the Board and Chief Executive Officer of The Source for an initial
annual base rate of compensation (the "Base Compensation") of $425,000. For the
fiscal years beginning February 1, 2002 and February 1, 2003, the Base
Compensation shall be increased to $500,000. Mr. Flegel will also be entitled to
receive a bonus ("Annual Bonus") each year of up to 100% of his Base
Compensation for such year if certain performance goals are met. The Company
granted to Mr. Flegel options to purchase an aggregate of 300,000 shares of our
common stock (the "Option") at an exercise price of $5.00. The options vest
100,000 immediately upon the granting of the options, another 100,000 shares on
February 6, 2002 and as to 100,000 shares on February 5, 2003. In the event the
employment of Mr. Flegel with The Source is terminated for reasons other than
for cause, permanent disability or death or there occurs a significant reduction
in the position, duties or responsibilities thereof (a "Termination") following
a "Hostile Change of Control" (as defined in the employment agreement), Mr.
Flegel will be entitled to a Severance Bonus equal to the sum of (i) the
aggregate of the Base Compensation that would be earned by Mr. Flegel had he
remained in The Source's employ from the date of such termination until January
31, 2004 (the "Remaining Term") and (ii) an amount equal to the aggregate Annual
Bonus Mr. Flegel would have earned for the Remaining Term if all criteria for
payment of the Annual Bonus were achieved at maximum levels for each of the
periods within the Remaining Term. Mr. Flegel also will agree to refrain from
disclosing information confidential to The Source or engaging, directly or
indirectly, in the rendering of services competitive with those offered by The
Source during the term of his employment and for one year thereafter, without
the prior written consent of The Source and will receive $250,000 in
consideration.
In August 2000, we entered into an employment agreement with James R. Gillis,
which expires July 31, 2003 (subject to renewal). The employment agreement
provides that Mr. Gillis serves as President of The Source and receives annual
base compensation of $350,000. In addition, Mr. Gillis is entitled to receive a
guaranteed bonus of $250,000 for each of fiscal 2001, 2002 and 2003, as long as
he is an employee of The Source at the agreed upon date of payment. Mr. Gillis
may also receive a discretionary bonus of $100,000 for each of fiscal 2001, 2002
and 2003 at the discretion of the Compensation Committee of the Board of
Directors. The Company will also grant Mr. Gillis options to purchase an
aggregate of 200,000 shares of our common stock at an exercise price of $7.84.
The options shall vest as to 66,667 shares immediately upon the granting of the
options, another 66,666 shares on August 1, 2001, and as to 66,666 shares on
August 1, 2002. In the event the employment of Mr. Gillis is terminated for
reasons other than cause, permanent disability or death, Mr. Gillis will be
entitled to receive the remainder of his base salary and benefits for the
balance of the term of the agreement. Mr. Gillis agreed to refrain from
disclosing information confidential to The Source during the term of the
employment agreement and agreed not to engage, directly or indirectly, in the
rendering of services competitive with those offered by The Source during the
term of his employment and for two years thereafter.
In August 2000, we entered into an employment agreement with Monte Weiner, which
expires July 31, 2003 (subject to renewal). The employment agreement provides
that Mr. Weiner serves as President/Chief Executive Officer of Source Display
and receives annual base compensation of $300,000. Also, as an inducement to
accept employment, Mr. Weiner received a signing bonus of $100,000 upon
execution of his employment agreement. In addition, Mr. Weiner is entitled to
receive a guaranteed bonus of $150,000 for each of fiscal 2001, 2002 and 2003,
as long as he is an employee of The Source at the agreed upon date of payment.
Mr. Weiner may also receive a discretionary bonus of $100,000 for each of fiscal
2001, 2002 and 2003 at the discretion of the Compensation Committee of the Board
of Directors. The Company will also grant Mr. Weiner options to purchase an
aggregate of 200,000 shares of our common stock at an exercise price of $7.84.
The options shall vest as to 66,666 shares immediately upon the granting of the
options, another 66,666 shares on August 1, 2001, and as to 66,667 shares on
August 1, 2002. In the event the employment of Mr. Weiner is terminated for
reasons other than cause, permanent disability or death, Mr. Weiner will be
entitled to receive the remainder of his base salary and benefits for the
balance of the term of the agreement. Mr. Weiner agreed to refrain from
disclosing information confidential to The Source
25
during the term of the employment agreement and agreed not to engage, directly
or indirectly, in the rendering of services competitive with those offered by
The Source during the term of his employment and for two years thereafter.
In January 2001, we entered into an employment agreement with Jason S. Flegel,
which expires January 31, 2004, and thereafter automatically continues for
additional one year terms unless terminated by either the executive or us. The
employment agreement provides that Mr. Flegel serves as Executive
Vice-President, Information Services of The Source and receives annual base
compensation of $204,000, subject to annual adjustment by the Board. In
addition, Mr. Flegel may also receive a discretionary bonus of up to $100,000 at
the discretion of the Compensation Committee of the Board of Directors. The
Company will also grant Mr. Flegel stock options to purchase 50,000 shares of
our common stock at $3.6875. Such options shall vest with respect to 16,667
shares on each of February 1, 2002 and 2003 and 16,666 shares on February 1,
2004. Mr. Flegel agreed to refrain from disclosing information confidential to
The Source during the term of the employment agreement and agreed not to engage,
directly or indirectly, in the rendering of services competitive with those
offered by The Source during the term of his employment and for two years
thereafter.
In June 2001, the Company and Frank Bishop agreed upon an arrangement under
which Mr. Bishop will serve as Senior Vice President North American Sales of The
Source in exchange for annual base compensation of $204,000. In addition, Mr.
Bishop will also be entitled to receive a bonus based upon the performance of
booked sales of certain divisions of our business, not to exceed 50% of his
salary. Also, subject to approval by the Compensation Committee of the Board,
20,000 options will be granted at market value each year if sales in those
divisions meet budget and an additional 20,000 options will be issued at market
value if budget is exceeded by 20%.
26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth certain information as of March 31, 2002
concerning the beneficial ownership of the Company's Common Stock by: (i) each
person known by the Company to be the beneficial owner of more than five percent
of the outstanding Common Stock, (ii) each executive officer named in the
Summary Compensation Table contained in this Form 10-K, (iii) each director of
the Company and (iv) all directors and executive officers of the Company as a
group. Each person named has sole voting and investment power with respect to
the shares indicated, except as otherwise stated in the notes to the table:
<Table>
<Caption>
Beneficial Ownership (1)
------------------------
Name and Address
of Beneficial Owner Number of Shares Percent
- ------------------- ---------------- -------
Jonathon J. Ledecky 2,640,000 14.4%
800 Connecticut Avenue NW, Suite 1111
Washington, D.C 20006
FMR Corporation 2,298,800(2) 12.6
82 Devonshire Street
Boston, Massachusetts, 02109
S. Leslie Flegel 2,106,226(3) 10.8
Two City Place Drive, Suite 380
St. Louis, Missouri 63141
James R. Gillis 426,501(3) 2.3
10 East 40th Street, Suite 3110
New York, New York 10016
Aron Katzman 327,309(3) 1.8
10 Layton Terrace
St. Louis, Missouri 63124
Monte Weiner 311,918(3) 1.7
10 East 40th Street, Suite 3110
New York, New York 10016
Jason S. Flegel 237,860(3) 1.3
10 East 40th Street, Suite 3110
New York, New York 10016
Harry L. Franc, III 118,505(3) *
19 Briarcliff
St. Louis, Missouri 63124
Robert O. Aders 90,000(3) *
132 S. Delancey Place
Atlantic City, New Jersey 08401
Randall S. Minix 77,974(3) *
5502 White Blossom Drive
Greensboro, North Carolina 27410
Kenneth F. Teasdale 65,573(3) *
33 Kingsbury Place
St. Louis, Missouri 63112
Frank Bishop 54,485(3) *
10 East 40th Street, Suite 3110
New York, New York 10016
All directors and executive 3,875,193(4) 19.0
officers as a group (12 persons)
</Table>
27
- -------
*Less than 1%
(1) Under the rules of the Commission, shares of the Company's common stock
which a person has the right to acquire within 60 days after March 31,
2002 in connection with the exercise of stock options and warrants are
deemed to be outstanding for the purpose of computing beneficial
ownership and the percentage of ownership of that person.
(2) This amount, as reflected on Schedule 13G filed with the Securities and
Exchange Commission on February 14, 2002, consists of sole dispositive
power with respect to 1,230,900 shares and no voting power.
(3) Includes exercisable options to acquire shares of common stock in the
following amounts per beneficial owner: S. Leslie Flegel - 1,224,256
shares; James R. Gillis - 418,000 shares; Monte Weiner - 293,250
shares; Aron Katzman -50,000 shares; Jason S. Flegel - 124,091 shares;
Harry L. Franc, III - 60,000 shares; Robert O. Aders - 60,000 shares;
Randall S. Minix - 60,000 shares; Kenneth Teasdale - 30,000 shares;
Frank Bishop - 54,485 shares.
(4) Includes options and warrants to acquire 137,242 shares of common
stock, excluded in the names indicated in the footnotes above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Kenneth F. Teasdale, a director and stockholder of the Company, is a partner in
the law firm of Armstrong Teasdale, LLP, counsel to the Company.
28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial statements:
Report of Independent Certified Public Accountants
Consolidated balance sheets - January 31, 2002 and 2001
Consolidated statements of operations - years ended January 31, 2002,
2001 and 2000
Consolidated statements of comprehensive income (loss) - years ended
January 31, 2002, 2001 and 2000
Consolidated statements of stockholders' equity - years ended January
31, 2002, 2001 and 2000
Consolidated statements of cash flows - years ended January 31, 2002,
2001 and 2000
Notes to consolidated financial statements
2. Financial statement schedules. The following consolidated financial
statement schedule of Source Interlink Companies, Inc. and subsidiaries
is included herein:
Report of Independent Certified Public Accountants S-1
Schedule II Valuation and qualifying accounts S-2
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and
therefore have been omitted.
3. Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K.
There were no Current Reports on Form 8-K filed during the quarter
ended January 31, 2002.
29
INDEX TO FINANCIAL STATEMENTS
<Table>
<Caption>
AUDITED CONSOLIDATED FINANCIAL STATEMENT OF SOURCE INTERLINK COMPANIES, INC. PAGE
The Report of the Independent Certified Public Accountants F-2
Consolidated Balance Sheets of January 31, 2002 and 2001 F-3
Consolidated Statements of Operations for the fiscal years ended January 31, 2002, 2001 and 2000 F-5
Consolidated Statements of Comprehensive Income (Loss) for the fiscal years ended January 31, 2002, F-5
2001 and 2000
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows for the fiscal years ended January 31, 2002, 2001 and 2000 F-7
Notes to Consolidated Financial Statements F-8
</Table>
F-1
The Report of the Independent Certified Public Accountants
Board of Directors
Source Interlink Companies, Inc.
St. Louis, Missouri
We have audited the consolidated balance sheets of Source Interlink Companies,
Inc. as of January 31, 2002 and 2001 and the related consolidated statements of
operations, comprehensive income (loss), stockholders' equity and cash flows for
each of the three years in the period ended January 31, 2002. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Source Interlink
Companies, Inc. at January 31, 2002 and 2001 and the results of its operations
and its cash flows for each of the three years in the period ended January 31,
2002 in conformity with generally accepted accounting principles in the United
States of America.
/s/ BDO Seidman, LLP
Chicago, Illinois
May 10, 2002
F-2
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<Table>
<Caption>
January 31, 2002 2001
-------- --------
ASSETS
CURRENT
Cash $ 2,943 $ 1,085
Trade receivables, net of allowance for doubtful accounts of $6,142 and
$1,398 at January 31, 2002 and 2001, respectively and net of allowance for
returns of $40,077 and $0 at January 31, 2002 and 2001, respectively 66,515 63,453
Income taxes receivable 6,085 3,648
Inventories (Note 4) 19,147 6,294
Other current assets 2,950 1,247
-------- --------
TOTAL CURRENT ASSETS 97,640 75,727
======== ========
Land 1,423 2,233
Plants and buildings 8,584 11,990
Office equipment and furniture 17,554 13,155
-------- --------
Property, Plants and Equipment 27,561 27,378
Less accumulated depreciation and amortization 7,184 5,246
-------- --------
NET PROPERTY, PLANTS AND EQUIPMENT 20,377 22,132
======== ========
OTHER ASSETS
Goodwill, net of accumulated amortization of $8,592 and $6,350 at January 31,
2002 and 2001, respectively (Note 5 and Note 8) 42,769 55,716
Marketable Securities -- 1,269
Deferred tax asset (Note 9) 2,065 --
Other 3,663 2,264
-------- --------
TOTAL OTHER ASSETS 48,497 59,249
-------- --------
$166,514 $157,108
======== ========
</Table>
See accompanying notes to
consolidated financial statements.
F-3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
<Table>
<Caption>
January 31, 2002 2001
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future deposits $ -- $ 3,818
Accounts payable and accrued expenses, net of allowance for returns of
$38,527 and $0 at January 31, 2002 and 2001, respectively 59,393 6,097
Due to retailers (Note 6) 3,099 2,693
Deferred income taxes (Note 9) 953 715
Current maturities of long-term debt (Note 7) 42,097 116
Other current liabilities 24 --
---------- ----------
TOTAL CURRENT LIABILITIES 105,566 13,439
---------- ----------
LONG-TERM DEBT, LESS CURRENT MATURITIES (Note 7) 15,578 31,780
---------- ----------
DEFERRED INCOME TAXES (Note 9) -- 88
---------- ----------
OTHER LONG-TERM LIABILITIES 329 --
---------- ----------
TOTAL LIABILITIES 121,473 45,307
---------- ----------
COMMITMENTS (Note 10)
STOCKHOLDERS' EQUITY
Contributed Capital:
Common Stock, $.01 par - shares authorized, 40,000,000; 19,414,799 issued,
of which 1,126,120 are being held as Treasury Stock at January 31, 2002 and
18,372,332 issued, of which 1,116,720 are being held as
Treasury Stock at January 31, 2001 194 183
Preferred Stock, $.01 par - shares authorized, 2,000,000; -0- issued and
outstanding at January 31, 2002 and 2001 (Note 12) -- --
Additional paid-in-capital 103,386 97,773
---------- ----------
Total contributed capital 103,580 97,956
Accumulated other comprehensive loss:
Available for sale securities -- (1,339)
Foreign currency translation (387) (81)
Retained (deficit) earnings (51,666) 21,712
---------- ----------
51,527 118,248
Less: Treasury Stock (1,126,120 and 1,116,720 shares at cost at January 31,
2002 and 2001, respectively) (6,486) (6,447)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 45,041 111,801
========== ==========
$ 166,514 $ 157,108
========== ==========
</Table>
See accompanying notes to
consolidated financial statements.
F-4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<Table>
<Caption>
Years Ended January 31, 2002 2001 2000
---------- ---------- ----------
Revenues $ 238,005 $ 91,748 $ 82,488
Costs of Revenues 191,779 59,830 48,869
---------- ---------- ----------
46,226 31,918 33,619
Selling, General and Administrative Expense 32,022 17,038 12,162
Amortization 5,424 2,994 2,718
Goodwill Impairment (Note 8) 78,126 -- --
---------- ---------- ----------
Operating Income (Loss) (69,346) 11,886 18,739
---------- ---------- ----------
Other Income (Expense)
Interest income 183 44 114
Interest expense (3,521) (2,356) (1,033)
Other (1,741) 36 (152)
---------- ---------- ----------
Total Other Income (Expense) (5,079) (2,276) (1,071)
---------- ---------- ----------
Income (Loss) Before Income Taxes (74,425) 9,610 17,668
Income Tax Expense (Benefit) (Note 9) (1,047) 3,776 7,557
---------- ---------- ----------
Net Income (Loss) $ (73,378) $ 5,834 $ 10,111
---------- ---------- ----------
Earnings (Loss) per Share - Basic $ (4.10) $ 0.33 $ 0.66
---------- ---------- ----------
Weighted Average of Shares Outstanding - Basic (Note 13) 17,915 17,591 15,332
---------- ---------- ----------
Earnings (Loss) per Share - Diluted $ (4.10) $ 0.32 $ 0.60
---------- ---------- ----------
Weighted Average of Shares Outstanding - Diluted (Note 13) 17,915 18,348 16,815
========== ========== ==========
</Table>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
<Table>
<Caption>
Years Ended January 31, 2002 2001 2000
---------- ---------- ----------
Net Income (Loss) $ (73,378) $ 5,834 $ 10,111
Unrealized Loss on Available-for-Sale Securities, net
of tax of $893 1,339 (1,339) --
Foreign Currency Translation Adjustment (306) (161) 80
---------- ---------- ----------
Comprehensive Income (Loss) $ (72,345) $ 4,334 $ 10,191
========== ========== ==========
</Table>
See accompanying notes to
consolidated financial statements.
F-5
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except per share data)
<Table>
<Caption>
Other
Preferred Stock Common Stock Additional Retained Compre-
------------------------- --------------------------- Paid - in Earnings hensive
Shares Amount Shares Amount Capital (Deficit) Income
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, January 31, 1999 1,473,281 $ 15 11,751,425 $ 117 $ 46,452 $ 5,767 $ --
Conversion of (1,473,281) (15) 1,473,281 15
Preferred Stock to
Common Stock
Issuance of Common
Stock 3,000,000 30 35,694
Exercise of stock options 88,020 1 452
Exercise of warrants 242,047 2 1,082
Vesting of warrants 27
issued for consulting
services
Warrants issued for 15
consulting services
Purchase of treasury
stock
Acquisitions 788,212 8 8,030
Foreign currency $ 80
translation adjustment
Other 2,086 18
Net income for the year 10,111
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, January 31, 2000 -- $ -- 17,345,071 $ 173 $ 91,770 $ 15,878 $ 80
Exercise of stock options 109,965 1 860
Exercise of warrants 499,109 5 2,542
Issuance of common 40,000 180
stock for payment of note
payable
Vesting of warrants issued 23
for consulting services
Purchase of treasury
stock
Acquisitions 373,382 4 2,103
Foreign currency (161)
translation adjustment
Net unrealized holding loss (1,339)
on available-for-sale
securities
Tax benefit of stock 292
options exercised
Other 4,805 3
Net income for the year 5,834
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, January 31, 2001 -- $ -- 18,372,332 $ 183 $ 97,773 $ 21,712 $ (1,420)
Exercise of stock options 56,364 1 147
Purchase of treasury stock
Acquisitions 980,025 10 5,439
Foreign currency (306)
translation adjustment
Reclassification 1,339
adjustment for net
realized losses
included in net
income, net of taxes
Other 6,078 27
Net loss for the year (73,378)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, January 31, 2002 -- $ -- 19,414,799 $ 194 $ 103,386 $ (51,666) $ (387)
=========== =========== =========== =========== =========== =========== ===========
<Caption>
Treasury Stock Total
---------------------------- Stockholders'
Shares Amount Equity
----------- ----------- -------------
Balance, January 31, 1999 8,000 $ (41) $ 52,310
Conversion of --
Preferred Stock to
Common Stock
Issuance of Common
Stock 35,724
Exercise of stock options 453
Exercise of warrants 1,084
Vesting of warrants 27
issued for consulting
services
Warrants issued for 15
consulting services
Purchase of treasury 34,250 (446) (446)
stock
Acquisitions 8,038
Foreign currency 80
translation adjustment
Other 18
Net income for the year 10,111
----------- ----------- -------------
Balance, January 31, 2000 42,250 $ (487) $ 107,414
Exercise of stock options 861
Exercise of warrants 2,547
Issuance of common 180
stock for payment of note
payable
Vesting of warrants issued 23
for consulting services
Purchase of treasury 1,074,470 (5,960) (5,960)
stock
Acquisitions 2,107
Foreign currency (161)
translation adjustment
Net unrealized holding loss (1,339)
on available-for-sale
securities
Tax benefit of stock 292
options exercised
Other 3
Net income for the year 5,834
----------- ----------- -------------
Balance, January 31, 2001 1,116,720 $ (6,447) $ 111,801
Exercise of stock options 148
Purchase of treasury stock 9,400 (39) (39)
Acquisitions 5,449
Foreign currency (306)
translation adjustment
Reclassification 1,339
adjustment for net
realized losses
included in net
income, net of taxes
Other 27
Net loss for the year (73,378)
----------- ----------- -------------
Balance, January 31, 2002 1,126,120 $ (6,486) $ 45,041
=========== =========== =============
</Table>
See accompanying notes to
consolidated financial statements.
F-6
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<Table>
<Caption>
Years Ended January 31, 2002 2001 2000
---------- ---------- ----------
OPERATING ACTIVITIES
Net income (loss) $ (73,378) $ 5,834 $ 10,111
Adjustments (net of effects of acquisitions) to
reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 7,815 4,957 3,981
Provision for losses on accounts receivable 2,824 1,477 5
Loss on disposition of equipment 264 80 50
Write-off of deferred loan costs -- -- 217
Loss on sale of security 3,500 -- --
Asset impairment charge 78,126 -- --
Tax benefit of stock option exercised -- 292 --
Deferred income taxes (2,663) 26 570
Other 317 126 1
Changes in assets and liabilities:
Increase in accounts receivable (20,947) (256) (27,715)
(Increase) decrease in inventories (1,003) 3,700 (53)
Increase in other assets (1,476) (3,021) (2,295)
Increase (decrease) in accounts payable and 20,611 (3,467) (2,210)
accrued expenses
Increase (decrease) in amounts due to retailers 406 (1,030) 986
---------- ---------- ----------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 14,396 8,718 (16,352)
========== ========== ==========
INVESTING ACTIVITIES
Acquisitions, net of cash acquired (13,677) (3,517) (37,348)
Capital expenditures (3,711) (2,544) (3,772)
Loans to officers -- -- (975)
Collection on officers notes receivable 66 748 --
Proceeds from sale of fixed assets 3,495 9 5
Investment in available-for-sale marketable securities -- (3,500) --
Other 99 (35) 24
---------- ---------- ----------
CASH USED IN INVESTING ACTIVITIES (13,728) (8,839) (42,066)
========== ========== ==========
FINANCING ACTIVITIES
Increase (decrease) in checks issued against future (4,575) 2,601 (1,660)
deposits
Proceeds from issuance of Common Stock 148 3,408 37,261
Borrowings under credit facilities 176,196 89,587 99,548
Principal payments on credit facilities (170,540) (90,080) (74,928)
Deferred loan costs -- (57) (373)
Common Stock reacquired (39) (5,960) (445)
Other -- (31) --
---------- ---------- ----------
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,190 (532) 59,403
========== ========== ==========
INCREASE (DECREASE) IN CASH 1,858 (653) 985
CASH, beginning of period 1,085 1,738 753
---------- ---------- ----------
CASH, end of period $ 2,943 $ 1,085 $ 1,738
========== ========== ==========
</Table>
See accompanying notes to
consolidated financial statements.
F-7
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Source Interlink Companies, Inc. (the Company) is a provider of merchandise
management information and related services primarily in connection with the
display and marketing of magazines and other periodicals throughout the United
States and Canada. The Company assists retailers in monitoring, documenting,
claiming and collecting incentive payments, primarily from publishers of
periodicals, and performs consulting and other services in exchange for
commissions. The Company also obtains revenues from consulting and other
services rendered to clients on other than a commission basis.
The Company also designs and manufactures custom-designed product display units
that are categorized as front-end merchandisers or point-of-purchase displays
used by retailers and consumer product manufacturers throughout the United
States and Canada. In September 1999, the Company acquired two manufacturers of
custom wood displays and fixtures used by national retailers.
The Company also engages in the distribution of magazines to retail stores and
wholesalers throughout the United States and Canada.
Principles of Consolidation
The consolidated financial statements include the accounts of Source Interlink
Companies, Inc. and its wholly-owned subsidiaries (collectively, the Company).
The results of operations of Source-Canada Corp. and its subsidiary,
Source-Yeager Industries, Inc., Source-U.S. Marketing Services, Inc. and its
subsidiaries, Source-MYCO, Inc., Source-Chestnut Display Systems, Inc.,
Source-Huck Store Fixture Company and its subsidiary and The Interlink
Companies, Inc. and its subsidiaries are included in the accompanying financial
statements as of the date of acquisition. All material intercompany accounts and
transactions have been eliminated in consolidation.
Concentrations of Credit Risk
During fiscal 2002 approximately 4.1% of the Company's revenues were derived
from the services provided in connection with the collection of payments owed to
the Company's retailer clients from magazine publishers under programs designed
by the publishers to provide incentives to increase single copy magazine sales
(referred to as claim submission program services). The incentive programs,
although part of the publishers' marketing strategy for over 20 years, are
governed by short-term contracts. If magazine publishers discontinue or
significantly modify the incentive programs in such a manner which makes the
Company's services incompatible with the modified programs, the Company's
results of operations and financial condition may be materially and adversely
affected.
In the Advance Pay Program, the Company assumes the risk otherwise borne by the
retailer that magazine publishers will refuse or be unable to pay the amount of
incentive payments claimed. Based on historical experience, the Company
maintains a reserve for claims submitted but subject to such a refusal or
inability to pay. However, if a prominent magazine publisher files a petition in
bankruptcy, seeks other protection from its creditors or otherwise refuses to
pay, this reserve may be inadequate. The results of operations and the financial
condition of the Company could be materially affected.
In the manufacturing and magazine distribution segments, the Company does have
significant client concentration. Substantially all of the Company's services
are performed under short-term contracts or agreements, thus permitting the
Company's clients to obtain services from other providers without further
obligation to the Company. If the Company experiences a significant reduction in
business from its clients, the Company's results of operations and financial
condition may be materially and adversely affected.
F-8
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
For fiscal 2002, two customers accounted for approximately 43% of revenues.
Barnes & Noble accounted for approximately 26% of revenues and Borders accounted
for approximately 17% of revenues. For fiscal 2001, two customers accounted for
approximately 29% of revenues. Borders accounted for approximately 15% of
revenues and Kmart accounted for approximately 14% of revenues. For fiscal 2000,
two customers accounted for approximately 26% of revenues. Winn Dixie accounted
for approximately 15% of revenues and Ahold USA accounted for approximately 11%
of revenues.
Revenue Recognition
Under both the standard arrangement and the Advance Pay Program, revenues are
recognized at the time claims for incentive payments are substantially completed
for submission to the publishers. The revenues recognized are based on the
amount claimed multiplied by a commission rate. Under the standard arrangement,
invoices for claim processing services are not issued until the Company receives
settlement of the claim. However, under the Advance Pay Program, the customer is
not invoiced for the commission, which is the difference between the claim and
the advance amount.
Revenues from annual ICN, PIN and Store Level Data contracts are recognized
ratably over the subscription term, generally one year.
Front-end management revenues are recognized as services are performed.
The Company generally recognizes manufacturing revenues when products are
shipped. Upon request from a customer, the product can be stored for future
delivery for the convenience of the customer. This only occurs when the
manufacturing and earnings processes are complete, the customer accepts title in
writing, the product is invoiced with payment due in the normal course of
business, the delivery schedule is fixed and the product is segregated from
other goods. In our in store services segment, we also receive trucking revenues
for transporting fixtures and warehousing revenues for storing fixtures. We
generally recognize trucking revenues as shipments are completed. Warehousing
revenues are recognized when services are rendered.
Revenues from magazine distribution to retailers are recognized at the time of
shipment to the customer, net of estimated returns. For sales made to
wholesalers, revenues are recognized based on the on-sale date of each
periodical, net of estimated returns.
Inventories
Inventories for in-store and manufacturing segments are valued at the lower of
cost or market. Cost is determined by the first-in, first-out ("FIFO") method.
Inventories for the magazine distribution segment are valued at lower of cost or
market. For the majority of the magazine inventory, cost is determined by the
last-in, first-out ("LIFO") method. The effect of the LIFO reserve at January
31, 2002 on the balance sheet and the income statement is insignificant.
Equipment and Furniture
Equipment and furniture are stated at cost. Depreciation is computed using the
straight-line method for financial reporting and accelerated methods for income
tax purposes over the estimated useful lives of 5 to 7 years.
F-9
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Marketable Securities
Marketable securities are stated at fair market value or historical cost in
accordance with Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities", and consists of an
investment in an equity security. Available-for-sale securities, which include
any security for which the Company has no immediate plan to sell but which may
be sold in the future, are valued at fair value. Unrealized gains and losses are
recorded, net of related income tax effects, as a separate component of equity.
To date, the basis on which cost has been determined for the purpose of
determining realized gains and losses has been specific identification.
Income Taxes
The Company accounts for income taxes under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the Company's
financial statements or tax returns. In estimating future tax consequences, the
Company generally considers all expected future events other than enactments of
changes in the tax laws or rates.
Goodwill
Goodwill represents the excess of the cost of a company acquired over the fair
value of the net assets acquired which is amortized over 15 to 20 years.
Deferred Loan Costs
Deferred loan costs represent the costs incurred relating to the Company's
revolving credit facility. These costs are being amortized by use of the
interest method over the life of the debt.
Stock-Based Compensation
The Company grants stock options for a fixed number of shares to employees with
an exercise price greater than or equal to the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25"). That Opinion requires that compensation cost
related to fixed stock option plans be recognized only to the extent that the
fair value of the shares at the grant date exceeds the exercise price.
Accordingly, the Company recognizes no compensation expense for its stock option
grants.
In October 1995, the Financial Accounting Standards Board, issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 allows companies to continue to account for
their stock option plans in accordance with APB Opinion No. 25, but encourages
the adoption of a new accounting method based on the estimated fair value of
employee stock options. Pro forma net income and earnings per share, determined
as if the Company had applied the new method, are disclosed within Note 14.
Accounting Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Long-Lived Assets
In March 1995, SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets Disposed Of" (SFAS 121) was issued. SFAS 121 requires
that long-lived assets and certain identifiable intangibles to be held and used
or disposed of by an entity be reviewed for impairment whenever events or
changes in circumstances
F-10
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
indicate that the carrying amount of an asset may not be recoverable. Management
periodically reviews the carrying value of property and equipment and
intangibles in relation to the operating performance and future undiscounted
cash flows of the underlying business to determine whether impairment exists.
Impairment loss is determined by the excess of carrying value over fair value.
During the year ended January 31, 2002, goodwill impairment was recognized. See
Note 8 for further discussions of the impairment loss. (See "New Accounting
Standards" below for the issuance of SFAS 144, "Accounting for the Impairment or
Disposal of Long-lived Assets" for changes in fiscal year 2003.)
Foreign Currency Translation and Transactions
The financial position and results of operations of the Company's foreign
subsidiaries are determined using local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year-end. Income statement accounts are translated at the
average rate of exchange prevailing during the year. Translation adjustments
arising from the use of differing exchange rates from period to period are
included in the other comprehensive income account in stockholders' equity.
Gains and losses resulting from foreign currency transactions are included in
the Consolidated Statements of Operations.
Comprehensive Income
Comprehensive income is defined to include all changes in equity except those
resulting from investments by owners and distributions to owners. The Company's
two items of comprehensive income are foreign currency translation adjustments
and a net unrealized holding loss on available-for-sale securities.
Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued SFAS No. 128,
"Earnings per Share," which requires the presentation of "basic" earnings per
share, computed by dividing net income available to common shareholders by the
weighted average number of common shares outstanding for the period, and
"diluted" earnings per share, which reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.
At January 31, 2002, options and warrants to purchase 4,587,752 shares of common
stock were not included in the computation of diluted earnings per share because
they were anti-dilutive due to the Company's net loss position and because the
options' exercise prices of some options were greater than the average market
price of the Company's common stock. At January 31, 2001 and 2000, options and
warrants to purchase 1,373,274 and 681,740 shares of common stock, respectively,
were not included in the computation of diluted earnings per share because the
options' exercise prices were greater than the average market price of the
Company's common stock for , 2001 and 2000, respectively.
Software Capitalization Policy
The Company capitalizes software in accordance with Statement of Position 98-1
("SOP 98-1"). The SOP allows capitalization of costs of computer software
developed or obtained for internal use only for (i) external direct costs of
materials and services incurred in developing or obtaining internal-use computer
software, (ii) payroll and payroll-related costs for employees who are directly
associated with and devote time to the internal-use computer software project,
to the extent of the time spent directly on the project, or (iii) interest costs
incurred while developing internal-use computer software. Depreciation is
computed using the straight-line method for financial reporting and accelerated
methods for income tax purposes over the estimated useful lives of 3 to 5 years.
F-11
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
presentation.
New Accounting Standards
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interest method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company's previous business combinations were accounted for using the
purchase method. Amortization expense arising from goodwill that will no longer
be amortized under the provision of the new rules was approximately $5.4
million, $3.0 million and $2.7 million in fiscal year 2002, 2001 and 2000,
respectively. Other than the impact on amortization expense, the Company does
not expect the adoption of this statement will have a material impact on the
Company's financial position, results of operations or cash flows.
In October 2001, the Financial Accounting Standards Board issued SFAS 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
This statement addresses financial accounting and reporting for the impairment
and disposal of long-lived assets. This Statement supercedes FASB Statement
121,"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of", and the accounting and reporting provisions of APB
Opinion No. 30,"Reporting the Results of Operations - Reporting the Effect of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions", for the disposal of a segment of a business.
The provisions of SFAS 144 will be effective for fiscal years beginning after
December 15, 2001.
2. RELATED PARTY TRANSACTIONS
In connection with his employment as Chief Operating Officer of the Company,
Richard Jacobsen received two loans in the amounts of $600,000 ("Loan 1") and
$375,000 ("Loan 2"). Loan 1, including interest, was to be forgiven over a
5-year term and Loan 2, including interest, was to be forgiven over a 7-year
term, provided, in each case, that he remained an employee of the Company. The
loans bear interest at 5% per annum. Mr. Jacobsen resigned in August 2000 and
repaid the outstanding balance on the loans in January 2001.
The Company leased certain office space from partnerships controlled by
stockholders of the Company. Amounts paid for the office space were
approximately $0, $6,000 and $114,000 for 2002, 2001 and 2000, respectively. In
May
F-12
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1999, the Company purchased its facility in High Point, North Carolina for $1.8
million. The facility was owned by a partnership in which stockholders of the
Company were partners. The Board of Directors appointed Timothy Braswell, an
independent director who has since resigned from the Board, to negotiate the
transaction on the Company's behalf and, based on Mr. Braswell's recommendation,
the Board believes the terms of the purchase were fair to the Company.
The Company paid Armstrong Teasdale LLP approximately $800,000 and $510,000 for
the years ended January 31, 2002 and 2001, respectively for legal services. Mr.
Kenneth Teasdale is Chairman of Armstrong Teasdale LLP and has served as a
director on the Company's Board of Directors since March 2000.
3. ADVANCE PAY PROGRAM
The Company has established an Advance Pay Program. Under this program the
Company advances an agreed upon percentage of the incentive payments otherwise
due the retailer from magazine publishers upon quarterly submission of claims
for such payments. The claims otherwise due the retailer become due the Company.
Revenues associated with the Advance Pay Program include only the difference
between what the Company advances the retailer and what is due from the
publisher. The receivable equals the amount due from the publisher, not the
amount of revenue recorded.
4. INVENTORIES
Inventories consist of the following (in thousands):
<Table>
<Caption>
January 31, 2002 2001
----------- -------- --------
Raw materials $ 2,559 $ 3,072
Work-in-process 1,754 1,470
Finished goods:
Fixtures 1,790 1,752
Magazine inventory 13,044 --
-------- --------
$ 19,147 $ 6,294
======== ========
</Table>
Magazine and periodical inventories are returnable to the publishers for full
credit in the event of non-sale.
5. BUSINESS COMBINATIONS
Acquisition of Chestnut Display Systems, Inc.
On February 1, 1999 the Company acquired the net assets of Chestnut Display
Systems, Inc. and its affiliate Chestnut Display Systems (North), Inc. for $3.6
million in cash and 285,714 shares of the Company's Common Stock, valued at the
time of acquisition at $1.8 million. The purchase price was increased by an
additional 130,000 shares of the Company's Common Stock issued in August 2000
and November 2000 based upon Chestnut meeting certain performance goals during
fiscal 2000 and 2001. Chestnut manufactures front-end display fixtures from its
facility in Jacksonville, Florida.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$7,178,000 and is being amortized straight line over 20 years.
F-13
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Acquisition of MYCO, Inc.
On February 26, 1999 the Company acquired the net assets of MYCO, Inc. for $12
million in cash and 134,615 shares of the Company's Common Stock, valued at the
time of acquisition at $875,000. The Company also assumed MYCO's industrial
revenue bond indebtedness of $4 million and repaid MYCO's indebtedness of $1.5
million. The purchase price was increased by an additional 100,000 shares of the
Company's Common Stock issued in October 2000 based on MYCO's' performance in
the twelve months following the acquisition. MYCO is a Rockford, Illinois
manufacturer of front-end display fixtures.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$12,616,000 and is being amortized straight line over 20 years.
Acquisition of 132127 Canada, Inc.
On March 23, 1999 the Company purchased the net assets of 132127 Canada, Inc.,
known as ProMark, for $1.5 million Canadian. ProMark is a Canadian corporation
headquartered in Toronto which provides rebate and information services to
retail customers throughout Canada.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$682,000 and is being amortized straight line over 20 years.
Acquisition of Aaron Wire and Metal Products, Ltd.
On July 1, 1999 the Company acquired all of the stock of Aaron Wire and Metal
Products, Ltd. for $2.4 million Canadian. Aaron Wire manufactures front-end
display fixtures from manufacturing facilities in Vancouver, British Columbia.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$1,519,000 and is being amortized straight line over 20 years.
Acquisition of Huck Store Fixture Company
On September 21, 1999 the Company purchased the net assets of Huck Store Fixture
Company for $3.0 million in cash and 100,000 shares of the Company's common
stock, valued at the time of acquisition at approximately $1.5 million. The
Company also repaid Huck Store Fixture Company's indebtedness of approximately
$6.8 million. The sellers received a second payment, based on performance, which
was calculated and paid in January, 2000 in the amount of $6.8 million in cash
and 267,883 shares of the Company's common stock, valued at the time of issuance
at $3.8 million. In January 2001 an additional payment of approximately $3.5
million in cash and 130,395 shares of the Company's Common Stock was made to the
sellers based on Huck's performance for its year ended November 4, 2000. Huck
manufactures wood store fixtures from its facilities in Quincy, Illinois and
Carson City, Nevada.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded fair market value of the assets acquired by
approximately $9,856,000.
F-14
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Acquisition of Arrowood, Inc.
On September 27, 1999 the Company acquired the net assets of Arrowood, Inc. for
$939,000 in cash and two separate notes for a total of $380,000. Arrowood
manufactures wood store fixtures from its facility in Norwood, North Carolina.
Huck Store Fixture Company had entered into a letter of intent to purchase
Arrowood prior to the Company acquisition of Huck. With the North Carolina
facility, the Company has wooden store fixture manufacturing facilities to
service accounts on the East Coast, the Midwest and the West Coast.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded fair market value of the assets acquired by
approximately $449,000.
Acquisition of The Interlink Companies, Inc.
In a series of transactions occurring between February 21, 2001 and June 1,
2001, the Company acquired all of the stock of The Interlink Companies, Inc.
("Interlink") for cash totaling $13,677,000 (including professional fees and net
of cash acquired) and 980,025 shares of the Company's common stock, valued at
the time of acquisition at $5.4 million. Interlink has various operating
companies, including International Periodical Distributors, Inc. ("IPD"), a
direct distributor of magazines, and Deyco, a specialty national magazine
distributor.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$70.9 million.
Unaudited Pro Forma Results of Operations
Unaudited pro forma results of operations for 2002 and 2001 for the Company and
Interlink, assuming the acquisition took place on February 1, 2000, are listed
below (in thousands):
<Table>
<Caption>
Year Ended January 31, 2002 2001
------------------------------ ------------- ---------- ---------
Total Revenues As reported $ 238,005 $ 91,748
Pro forma 298,627 271,766
Net Income (loss) As reported (73,378) 5,834
Pro forma (85,035) (1,505)
Earnings (loss) Per Share
Basic As reported $ (4.10) $ 0.33
Diluted As reported (4.10) 0.32
Basic Pro forma (4.66) (0.08)
Diluted Pro forma (4.66) (0.08)
------------------------------ ------------- ---------- ---------
</Table>
6. DUE TO RETAILERS
The Company has arrangements with certain of its customers whereby the Company
is authorized to collect and deposit in its own accounts, checks payable to its
customers for incentive payments and front end fixture programs. Due to
Retailers represents these funds collected on behalf of the retailers and not
yet remitted to the retailer.
F-15
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
7. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt consists of (in thousands):
<Table>
<Caption>
January 31, 2002 2001
----------- -------- --------
Revolving Credit Facility - Bank of America $ 36,073 $ 27,761
Revolving Credit Facility - Congress Financial Corporation 11,068 --
Term loan - Congress Financial Corporation 2,778 --
Industrial Revenue Bonds 4,000 4,000
Notes payable to former owner of acquired company, 12% annual interest
payable quarterly; two equal remaining
installments due February 2002 and August 2002 2,500 --
Note payable to former owner of acquired company, 12% annual interest,
payable in four quarterly installments beginning
May 2001 250 --
Note payable to former owner of acquired company, interest at prime
(4.75% at January 31, 2002) plus 1% compounded semi-annually, payable
in two remaining installments in May
2002 and May 2003 400 --
Unsecured note payable to former owner of acquired company, 7% annual
interest, payable in two annual
installments beginning in September 2000 -- 100
Other 606 35
-------- --------
Total Long-term Debt 57,675 31,896
Less current maturities 42,097 116
-------- --------
Long-term Debt $ 15,578 $ 31,780
======== ========
</Table>
Annual maturities of long-term debt are as follows: 2003 - $42.1 million; 2004 -
$0.4 million; 2005 - $37,000; 2006 - $11.1 million; 2007 - $43,000; thereafter -
$4.0 million.
On December 22, 1999, the Company entered into an unsecured credit agreement
with Bank of America, N.A. The credit agreement enables the Company to borrow up
to $46.0 million under a revolving credit facility that terminates December 31,
2002. Borrowings under the credit facility bear interest at a rate equal to the
monthly LIBOR rate (1.83% at January 31, 2002) plus a percentage ranging from
1.0% to 2.1% (2.1% at January 31, 2002) depending on the Company's ratio of
funded debt to earnings before interest, taxes, depreciation and amortization
and carries a facility fee of 1/4 % per annum
F-16
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
on the difference between $25 million and the average principal amount
outstanding under the loan (if less than $25 million) plus 3/8% per annum of the
difference between the maximum amount of the loan and the greater of (i) $25
million or (ii) the average principal amount outstanding under this loan. Under
the credit agreement, the Company is limited in its ability to declare dividends
or other distributions on capital stock or payments in connection with the
purchase, redemption, retirement or acquisition of capital stock and is required
to maintain certain financial ratios. The Company was in compliance with such
ratios at January 31, 2002 other than ratios driven by earnings before
interest, taxes, depreciation and amortization ("EBITDA"). We incurred a $3.5
million charge to EBITDA from the loss on the sale of a security we acquired in
July 2000 (the prior fiscal year). While Bank of America did not raise the
issue, we were unable to obtain confirmation from Bank of America certifying
for our auditors that the loss on the sale of a security totaling $3.5 million
is an allowable addition to net income in the calculation of EBITDA. We believe
that this amount should be an allowable addition since Bank of America approved
the investment, in writing, and the investment has been carried on the balance
sheet at its market value since July 2000. The market value at October 31, 2001
was $63,000, at which point, such decline in the market value of the security
had not effected net income or EBITDA. However, the actual sale of the security
in January 2002 resulted in a charge to EBITDA of $3.5 million. The availability
at January 31, 2002 on the revolving credit facility was approximately
$9.9 million.
In connection with the acquisition of MYCO, Inc., the Company assumed the
liabilities of MYCO's Industrial Revenue Bonds. On January 30, 1995, the City of
Rockford issued $4.0 million of its Industrial Project Revenue Bonds, Series
1995, and the proceeds were deposited with the Amalgamated Bank of Chicago, as
trustee. Bank of America, N.A. has issued an unsecured letter of credit for $4.1
million in connection with the bonds with an initial expiration date of April
20, 2001. As provided in the reimbursement agreement, the expiration date shall
automatically extend for successive additional periods of one calendar month
until the twentieth day of the thirteenth month following receipt of a notice of
non-extension from the Bank. To date, no such notice of non-extension has been
received and management does not expect such notice to be given by the Bank in
the foreseeable future. The bonds are secured by the trustee's indenture and the
$4.1 million letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.
In connection with the acquisition of Interlink, the Company assumed IPD and
Deyco's secured credit facility with Congress Financial Corporation
("Congress"). On February 22, 2001, IPD and Deyco entered into the credit
facility with Congress which expires on February 21, 2005. The credit agreement
includes a $4,000,000 term loan to be repaid in 36 equal monthly installments,
as well as a revolving credit facility secured by the IPD and Deyco's accounts
receivable, inventories, equipment and other intangibles. Borrowings under the
term loan portion of the credit facility bear interest at a rate equal to 0.5%
in excess of the prime rate (4.75% at January 31, 2002). Borrowings under the
revolving credit portion of the facility bear interest at a rate equal to 0.25%
in excess of the prime rate. Under the credit agreement, IPD and Deyco are
required to maintain certain financial ratios. IPD and Deyco were not in
compliance with all such ratios at January 31, 2002, and received a waiver from
Congress of its right to enforce compliance. In addition, IPD, Deyco and
Congress have entered into an amendment to the credit facility that will have
the effect of easing the ability of IPD and Deyco to maintain the financial
ratios.
8. GOODWILL IMPAIRMENT
Following are the events and/or changes in circumstances that indicated that the
recoverability of the carrying amount of our goodwill should be assessed:
A valuation analysis was commissioned in preparation for adopting SFAS 142
effective February 1, 2002. The initial phases of this analysis revealed
that we had experienced significant decreases in the market value of our
subsidiaries, Interlink and Huck. Early adoption of SFAS 142 is prohibited,
however, it did serve to alert us that we have experienced a significant
decrease in the market value of our assets.
Our manufacturing segment, Huck, experienced a substantial scale back in
sales to its most significant customer resulting in a net operating loss
for the segment.
The accumulation of costs to acquire Interlink were significantly in excess
of the amounts originally expected. This was because the net liabilities
acquired far exceeded the amount originally projected. Management does not
believe that it was practicable to determine the magnitude of this excess
during due diligence. The Company is seeking recourse from the sellers of
Interlink.
F-17
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Interlink experienced a significant cash flow loss and has had a history of
operating and cash flow losses.
According to SFAS 121 estimates of future cash flows shall be the best estimate
based on reasonable and supportable assumptions and projections. The weight
given to the evidence in support of the estimated cash flows should be
commensurate with the extent of which the evidence can be verified objectively.
Management's reasonable and supportable estimates of expected future cash flows
from Interlink and Huck, weighted commensurately with the extent of which the
evidence for such estimates can be verified objectively, for the purpose of
complying with SFAS 121, are less than the carrying amount of the goodwill.
Accordingly, we reduced the carrying value of the goodwill for Interlink and
Huck to fair value. Our estimate of fair value was determined by independent
appraisal using customary valuation methodologies (including discounted cash
flow and fundamental analysis). The valuation concluded that the fair values of
these segments were less than the carrying amount of the assets associated with
these segments by approximately $78.1 million.
The following table shows, by segment, the original goodwill net of accumulated
amortization, the impairment charge and the resulting goodwill at January 31,
2002 (in thousands):
<Table>
<Caption>
Original Impairment Resulting
Segment Goodwill Charge Goodwill
--------------------------- -------- ---------- ---------
In-Store 42,769 -- 42,769
Manufacturing 9,539 9,539 --
Magazine Distribution 68,587 68,587 --
--------------------------- -------- ---------- ---------
</Table>
F-18
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. INCOME TAXES
Components of earnings (loss) before income taxes are as follows:
<Table>
Year Ended January 31, 2002 2001 2000
---------------------- -------- -------- --------
United States $(75,160) $ 8,761 $ 17,330
Other nations 735 849 338
-------- -------- --------
$(74,425) $ 9,610 $ 17,668
======== ======== ========
</Table>
Provision (benefit) for federal and state income taxes in the consolidated
statements of operations consist of the following components (in thousands):
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- -------- -------- --------
Current
Federal $ 969 $ 2,875 $ 5,590
State 216 636 1,397
Foreign 431 239 --
-------- -------- --------
Total Current 1,616 3,750 6,987
-------- -------- --------
Deferred
Federal (2,143) 97 456
State (474) 21 114
Foreign (46) (92) --
-------- -------- --------
Total Deferred (2,663) 26 570
-------- -------- --------
Total Income Tax (Benefit)
Expense $ (1,047) $ 3,776 $ 7,557
======== ======== ========
</Table>
F-19
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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):
<Table>
<Caption>
January 31, 2002 2001
----------- -------- --------
Deferred Tax Assets
Net operating loss carryforward 5,658 285
Cost-based investment mark-to-market -- 893
Allowance for doubtful accounts 2,372 526
Goodwill 2,890 --
Self insurance 160 80
Deferred compensation 62 89
Accrued vacation 370 199
-------- --------
11,512 2,072
Less: Valuation allowance (8,255) (285)
-------- --------
Deferred Tax Asset, Net 3,257 1,787
-------- --------
Deferred Tax Liabilities
Book/tax difference in accounts receivable 1,259 1,447
Income not previously taxed under cash
basis of accounting for income tax purposes -- 16
Book/tax difference in property and equipment 806 496
Goodwill -- 573
Other 80 58
-------- --------
Total Deferred Tax Liabilities 2,145 2,590
-------- --------
Net Deferred Tax Asset (Liability) 1,112 (803)
-------- --------
Classified as:
Current asset (liability) (953) (715)
Long-term asset (liability) 2,065 (88)
-------- --------
Net Deferred Tax Asset (Liability) 1,112 (803)
======== ========
</Table>
The deferred tax asset in the accounts of Source-U.S. Marketing Services, Inc.
("Source-U.S. Marketing") totaling $0 and $285,000 for the years ended January
31, 2002 and 2001, respectively, is fully offset by a valuation allowance of the
same amount due to uncertainty regarding its ultimate utilization. At January
31, 2002 and 2001, Source-U.S. Marketing had net operating loss ("NOL")
carryforwards of approximately $0 and $737,000, respectively, expiring through
2018. As a result of the utilization of the NOL in 2002 and 2001, goodwill
related to the acquisition of Source-U.S. Marketing was reduced by $285,000 and
$767,000, respectively. The deferred tax asset in the accounts of Interlink
totaling $8,255,000 for the year ended January 31, 2002 is fully offset by a
valuation allowance of the same amount due to uncertainty regarding its ultimate
utilization. At January 31, 2002, Interlink had NOL carryforwards of
approximately $6,050,000 and IPD, a wholly owned subsidiary of Interlink, had
NOL carryforwards of approximately $8,600,000 expiring through 2016.
F-20
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following summary reconciles income taxes at the maximum federal statutory
rate with the effective rates for 2002, 2001 and 2000 (in thousands):
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- ---------- ---------- ----------
Income tax expense (benefit) at statutory rate $ (25,305) $ 3,267 $ 6,007
Non-deductible goodwill amortization 1,266 478 510
Non-deductible goodwill impairment 23,320 -- --
Non-taxable life insurance proceeds (714) -- --
State income tax expense (benefit), net of
federal income tax benefit (207) 444 887
Difference in foreign tax rates 134 (142) 50
Other, net 459 (271) 103
---------- ---------- ----------
Income Tax (Benefit) Expense $ (1,047) $ 3,776 $ 7,557
========== ========== ==========
</Table>
10. COMMITMENTS
Leases
The Company leases office and manufacturing space, an apartment, computer
equipment, and vehicles under leases that expire over the next five years.
Management expects that in the normal course of business, leases will be renewed
or replaced with other leases. Rent expense was approximately $3,553,000
$1,785,000 and $1,734,000 for the years ended January 31, 2002, 2001 and 2000,
respectively. Amounts paid to related parties included in total rent expense
were approximately $0, $6,000 and $114,000 for 2002, 2001 and 2000,
respectively.
Future minimum payments, by year and in the aggregate, under noncancelable
operating leases with initial or remaining terms of one year or more consisted
of the following at January 31, 2002 (in thousands):
<Table>
<Caption>
Capital Operating
Year Ending January 31, Leases leases
----------------------- ---------- ---------
2003 $ 68 $ 4,907
2004 50 4,473
2005 49 3,733
2006 49 2,616
2007 49 2,106
Thereafter 48 17,154
---------- ---------
Total minimum lease payments 313 $ 34,989
=========
Amount representing interest 60
----------
Present Value of Net Minimum Lease Payments $ 253
==========
</Table>
F-21
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Litigation
The Company has pending certain legal actions and claims incurred in the normal
course of business and is actively pursuing the defense thereof. In the opinion
of management, these actions and claims are either without merit or are covered
by insurance and will not have a material adverse effect on the Company's
financial condition, results of operations or liquidity.
Employment agreements
The Company has entered into employment agreements with certain officers and key
employees. These agreements expire at dates ranging from May 2002 to January
2005, are subject to annual renewal, and require annual salary levels and
termination benefits, should a termination occur. Annual requirements in
connection with the employment agreements are approximately as follows: 2003 -
$2,924,000; 2004 - $1,891,000; 2005 - $673,000.
Union Contracts
At January 31, 2002, approximately 180 of the Company's 1,200 employees were
members of a collective bargaining unit. The Company is party to two collective
bargaining agreements, which expire on December 31, 2005 and September 30, 2004.
Company contributions to the Union funds charged to operations were
approximately $440,000, $440,000 and $435,000 for the years ended January 31,
2002, 2001 and 2000, respectively.
11. WARRANTS
The following table summarizes information about the warrants for common stock
outstanding at January 31, 2002:
<Table>
<Caption>
Exercise Price Number Outstanding Date Exercisable Date of Expiration
---------------------- ------------------ ---------------- ------------------
3.00 10,709 July 1, 1997 July 1, 2002
5.34 20,000 February 1, 2002 January 31, 2003
7.84 2,500 August 2, 2001 January 31, 2003
7.84 2,500 August 2, 2002 January 31, 2003
8.40 200,000 June 15, 1999 June 15, 2003
14.00 8,548 August 31, 2000 August 31, 2003
14.00 8,548 August 31, 2001 August 31, 2003
14.00 8,548 August 31, 2002 August 31, 2003
</Table>
12. PREFERRED STOCK
The Company has authorized 2,000,000 shares of $.01 par Preferred Stock. On
March 13, 1996, 65,000 shares were designated as 1996 Series 7% Convertible
Preferred Stock. Rights and restrictions on the remaining shares will be
established if, and when, any shares are issued.
Each share of the 1996 Series 7% Convertible Preferred Stock entitles its holder
to receive an annual dividend, when and as declared by the Board of Directors,
of $7 per share payable in shares of the Company's Common Stock; to convert it
into shares of Common Stock; to receive $100 per share in the event of
dissolution, liquidation, or winding up of the Company, whether voluntary or
involuntary; and subject to certain conditions in the Certificate of
Designations, Preferences and Relative Rights of 1996 Series 7% Convertible
Preferred Stock, may be redeemed at the option of the Company at a price of $100
per share within 30 days following the effective date of a merger or
consolidation in which the Company is not the surviving entity.
F-22
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Each share of the 1996 Series 7% Convertible Preferred Stock shall be
convertible, at the option of the holder thereof, into shares of the Common
Stock of the Company, at the conversion price equal to 80% of the current market
price of the Common Stock, provided, however, the conversion price shall not be
less than $4.24 nor more than $6.66 per share of Common Stock. For purposes of
such conversion, each share of the 1996 Series 7% Convertible Preferred Stock
shall be accepted by the Company for surrender at its Liquidation Amount of $100
per share.
On January 6, 1999, 1,500,000 shares of Preferred Stock were designated as Class
A Convertible Preferred Stock. On January 7, 1999, 1,473,281 shares of Class A
Convertible Preferred Stock were issued in connection with the acquisition of
U.S. Marketing Services, Inc. On March 30, 1999 the Preferred Stock was
converted to 1,473,281 shares of Common Stock.
13. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows (in thousands):
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- -------- -------- --------
Weighted average number of common shares outstanding 17,915 17,591 15,332
-------- -------- --------
Effect of dilutive securities:
Stock options and warrants -- 757 1,249
Incremental shares from assumed conversion of
preferred stock -- -- 234
-------- -------- --------
Total effect of dilutive securities -- 757 1,483
-------- -------- --------
Weighted average number of common shares outstanding
- as adjusted 17,915 18,348 16,815
======== ======== ========
</Table>
14. EMPLOYEE BENEFIT PLANS
Profit Sharing and 401(k) Plan
The Company has a combined profit sharing and 401(k) Plan. Annual contributions
to the profit sharing portion of the Plan are determined by the Board of
Directors and may not exceed the amount that may be deducted for federal income
tax purposes. There were no profit sharing contributions charged against
operations for the years ended January 31, 2002, 2001, and 2000.
Under the 401(k) portion of the Plan, all eligible employees may elect to
contribute 2% to 20% of their compensation up to the maximum allowed under the
Internal Revenue Code. The Company matches one half of an employee's
contribution, not to exceed 5% of the employee's salary. The amounts matched by
the Company during the years ended January 31, 2002, 2001, and 2000 pursuant to
this Plan were approximately $413,000, $283,000 and $214,000, respectively.
Deferred Compensation Plan
During fiscal year 1997, the Company established an unfunded deferred
compensation plan for certain officers, who elect to defer a percentage of their
current compensation. The Company does not make contributions to the plan and is
responsible only for the administrative costs associated with the plan. Benefits
are payable to the participating officers
F-23
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
upon their death or termination of employment. From the deferred funds, the
Company has purchased certain life insurance policies. However, the proceeds and
surrender value of these policies are not restricted to pay deferred
compensation benefits when they are due.
Stock Option Plans
Under the Company's stock option plans, options to acquire shares of Common
Stock have been made available for grant to certain employees and non-employee
directors. Each option granted has an exercise price of not less than 100% of
the market value of the Common Stock on the date of grant. The contractual life
of each option is generally 10 years. The exercisability of the grants vary
according to the individual options granted.
<Table>
<Caption>
Weighted
Range of Average
Number of Exercise Exercise
Options Prices Price
----------- ------------- ---------
Options outstanding at
January 31, 1999 1,275,058 1.66 -10.88 6.26
Options granted 1,797,640 9.75 - 21.60 13.93
Options expired 20,883 2.42 - 13.94 6.13
Options exercised 88,020 2.42 - 7.38 5.14
----------- ------------- ---------
Options outstanding at
January 31, 2000 2,963,795 1.66 - 21.60 10.95
Options granted 757,000 3.69 - 18.31 8.28
Options expired 544,782 2.42 - 16.63 11.55
Options exercised 109,965 2.42 - 16.63 7.83
----------- ------------- ---------
Options outstanding at
January 31, 2001 3,066,048 1.66 - 21.60 10.29
Options granted 2,349,416 3.92 - 6.31 5.11
Options expired 1,032,701 4.00 - 16.63 10.77
Options exercised 56,364 2.42 - 2.66 2.63
----------- -------------- ---------
Options outstanding at
January 31, 2002 4,326,399 1.66 - 21.60 7.46
=========== ============== =========
</Table>
F-24
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following table summarizes information about the stock options outstanding
at January 31, 2002:
<Table>
<Caption>
Number Remaining Contractual Options
Exercise Price Outstanding Life (Months) Exercisable
-------------- ----------- --------------------- -----------
1.66 89,256 4 89,256
2.42 38,788 65 38,788
3.69 50,000 107 0
3.88 20,000 107 8,000
3.92 25,000 110 8,333
4.21 207,000 118 69,000
4.35 400,000 114 183,333
4.53 20,000 119 4,000
5.00 100,432 80 94,432
5.00 954,719 108 378,240
5.13 370,000 72 280,000
5.34 5,000 113 1,000
5.35 48,500 120 16,167
5.56 13,000 115 4,333
5.56 30,000 108 30,000
5.59 25,000 105 10,000
5.63 50,000 108 50,000
5.94 10,000 106 4,000
6.13 455 77 455
6.31 305,000 112 18,333
6.63 455 75 455
7.38 2,000 82 1,000
7.81 134,667 82 134,667
7.84 490,000 102 303,333
9.75 5,000 84 5,000
10.38 12,000 86 12,000
10.88 71,667 83 70,667
11.41 125,000 26 93,750
13.25 269,000 91 212,200
14.88 5,000 100 2,000
15.00 100,000 90 100,000
16.25 50,000 96 50,000
16.63 89,460 94 65,300
18.00 100,000 90 100,000
18.31 10,000 98 10,000
21.60 100,000 90 100,000
----------- -----------
4,326,399 2,548,042
=========== ===========
</Table>
Options exercisable at January 31, 2002 totaled 2,548,042 with a weighted
average exercise price of $8.56. Options exercisable at January 31, 2001 totaled
1,540,008 with a weighted average exercise price of $10.17. Options exercisable
at January 31, 2000 totaled 831,919 with a weighted average exercise price of
$9.72. The weighted
F-25
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
average fair value of each option granted during the year was $2.23, $3.47 and
$4.17 (at grant date) in 2002, 2001 and 2000, respectively.
The options above were issued at exercise prices which were equal to or exceeded
quoted market price at the date of grant. At January 31, 2002, 439,189 shares
were available for grant under the plans. However, 390,173 shares are reserved
for directors fees, directors options and options repriced pursuant to Schedule
TO filed October 22, 2001.
As discussed in the Summary of Accounting Policies, the Company applies APB
Opinion No. 25 and related interpretations in accounting for this plan.
Accordingly, no compensation cost has been recognized for its stock option
plans. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant dates for awards under the plan
consistent with the method of SFAS No. 123, the Company's consolidated net
income and consolidated income per share would have been reduced to the pro
forma amounts indicated below:
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- --------- ------- --------
Net income As reported $ (73,378) $ 5,834 $ 10,111
Pro forma (75,166) 4,431 9,134
Basic earnings per share As reported (4.10) 0.33 0.66
Pro forma (4.20) 0.25 0.60
Diluted earnings per share As reported (4.10) 0.32 0.60
Pro forma (4.20) 0.24 0.54
</Table>
The pro forma amounts reflected above are not representative of the effects on
reported net income in future years because in general, the options granted
typically do not vest for several years and additional awards are made each
year. The fair value of each option grant is estimated on the grant date using
the Black-Scholes option pricing model with the following assumptions:
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- -------------- -------------- --------------
Dividend yield 0% 0% 0%
Range of expected lives (years) 3.0 3.0 1.5 - 3.0
Range of expected volatility 0.60 0.5552 0.49
Risk-free interest rate 3.27% - 4.78% 4.92% - 6.82% 4.65% - 6.00%
</Table>
Stock Award Plan
In September 1996, the Company adopted its Stock Award Plan for all employees
and reserved 41,322 shares of Common Stock for such plan. Under the plan, the
Stock Award Committee, appointed by the Board of Directors of the Company, shall
determine the employees to whom awards shall be granted. No awards were granted
during the years ended January 31, 2002, 2001 or 2000.
F-26
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
15. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on the approximate amount of interest and income taxes
paid is as follows (in thousands):
<Table>
<Caption>
Year Ended January 31, 2002 2001 2000
---------------------- -------- -------- --------
Interest $ 3,590 $ 2,241 $ 999
Income Taxes $ 2,565 $ 7,433 $ 5,653
</Table>
In connection with the acquisitions in February 1999, the Company issued 420,329
shares of Common Stock during fiscal year 2000 and 230,000 shares of Common
Stock during fiscal year 2001.
In connection with the acquisition in September 1999, the Company issued 367,883
shares of Common Stock during fiscal year 2000 and 130,395 shares of Common
Stock during fiscal year 2001.
In December 2000, the Company issued 40,000 shares of Common Stock as payment
for the remaining balance of $180,000 on the unsecured note payable to former
owners of acquired company. The number of shares was determined based on the
quoted market price at the time of the exchange.
In connection with the acquisition in May 2001, the Company issued 980,025
shares of Common Stock.
In conjunction with business acquisitions, the Company used cash as follows (in
thousands):
<Table>
<Caption>
Year Ended January 31,
2002 2001 2000
-------- -------- --------
Fair Value of assets acquired, excluding cash $ 77,435 $ -- $ 59,612
Less: Liabilities assumed and created upon acquisition 58,309 -- 14,226
Less: Stock issued 5,449 -- 8,038
-------- -------- --------
Net cash paid $ 13,677 $ -- $ 37,348
-------- -------- --------
</Table>
16. DERIVATIVE FINANCIAL INSTRUMENTS
In order to manage its exposure to interest rate risk, in February 2001 the
Company entered into an interest rate swap agreement with a notional amount of
$15.0 million that expires in January 2004. The swap converts the floating rate
return on certain of the Company's credit facilities to a fixed interest rate.
At January 31, 2002 the fair value of the swap is not material and is recorded
in accrued expenses in the accompanying consolidated financial statements. As of
January 31, 2002, the Company had a loss associated with the interest rate swap
of approximately $0.7 million.
17. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair values of
each class of financial instruments for which it is practicable to estimate that
value:
F-27
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Trade Receivables and Income Taxes Receivable
The carrying amounts approximate fair value because of the short maturity of
those instruments.
Marketable Securities
Fair value is based on quoted market prices.
Accounts Payable and Accrued Expenses and Amounts
Due to Retailers
Carrying amounts are reasonable estimates of fair value due to the relatively
short period between origination and expected repayment of these instruments.
Long-term Debt and Revolving Credit Facility
It is presumed that the carrying amounts of the long-term debt and revolving
credit facilities are a reasonable estimate of fair value because the financial
instruments primarily bear variable interest rates.
Rates estimated to be currently available to the Company for debt with similar
terms and remaining maturities are used to estimate fair value of existing debt.
The estimated fair values of the Company's financial instruments are as follows:
<Table>
<Caption>
Carrying Fair
January 31, 2002 value value
- ---------------- -------- --------
Financial Assets
Trade receivables $ 66,515 $ 66,515
Income taxes receivable $ 6,085 $ 6,085
Financial Liabilities
Accounts payable and accrued expenses $ 59,393 $ 59,393
Due to retailers $ 3,099 $ 3,099
Long-term debt $ 57,675 $ 57,613
-------- --------
January 31, 2001
Financial Assets
Trade receivables $ 63,453 $ 63,453
Income taxes receivable 3,648 3,648
Marketable securities $ 1,269 $ 1,269
Financial Liabilities
Accounts payable and accrued expenses $ 6,097 $ 6,097
Due to retailers $ 2,963 $ 2,963
Long-term debt $ 31,896 $ 31,888
======== ========
</Table>
F-28
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
18. SEGMENT FINANCIAL INFORMATION
Effective the quarter ended October 31, 2001, the Company's segment reporting
has been restructured based on the reporting of senior management to the Chief
Executive Officer. This restructuring combines the Company's business units in a
logical way that more easily identifies business concentrations and synergies
for both analysis of results and real-time control by management. The reportable
segments of the Company are in-store services, manufacturing and magazine
distribution. In-store services derives revenues from (1) providing information
and management services relating to retail magazine sales to U.S. and Canadian
retailers, magazine publishers, confectioners and vendors of gum and general
merchandise sold at checkout counters and (2) designing, manufacturing, shipping
and salvaging display fixtures used by retailers at checkout counters as well as
at other points of purchase throughout their stores. The manufacturing segment
derives revenues from designing, manufacturing and installing primarily wooden
store fixtures. The magazine distribution segment derives revenues from
distributing magazines to major book chains, independent retailers and secondary
wholesalers. Formerly, the segments were services, display rack and store
fixture manufacturing and magazine distribution. The accounting policies of the
segments are the same as those described in the Summary of Accounting Policies.
All intersegment sales during the years ended January 31, 2002, 2001 or 2000
have been eliminated.
<Table>
<Caption>
(in thousands) In-Store Magazine
Year ended January 31, 2002 Services Manufacturing Distribution Consolidated
--------------------------- --------- ------------- ------------ ------------
Revenue $ 63,927 $ 17,971 $ 156,107 $ 238,005
Cost of Revenue 39,603 16,163 136,013 191,779
--------- ------------- ------------ ------------
Gross Profit 24,324 1,808 20,094 46,226
Selling, General & Administrative 10,366 1,709 19,947 32,022
Amortization of Goodwill 2,723 342 2,359 5,424
Asset Impairment Charge -- 9,539 68,587 78,126
--------- ------------- ------------ ------------
Operating Income (Loss) 11,235 (9,782) (70,799) (69,346)
Other Income (Expenses), net (4,612) (54) (413) (5,079)
--------- ------------- ------------ ------------
Income (Loss) Before Income Taxes 6,623 (9,836) (71,212) (74,425)
--------- ------------- ------------ ------------
Total Assets $ 109,997 $ 17,426 $ 39,091 $ 166,514
========= ============= ============ ============
</Table>
<Table>
<Caption>
(in thousands) In-Store Magazine
Year ended January 31, 2001 Services Manufacturing Distribution Consolidated
--------------------------- --------- ------------- ------------ ------------
Revenue $ 67,239 $ 24,509 $ -- $ 91,748
Cost of Revenue 40,910 18,920 -- 59,830
--------- ------------- ------------ ------------
Gross Profit 26,329 5,589 -- 31,918
Selling, General & Administrative 15,567 1,471 -- 17,038
Amortization of Goodwill 2,677 317 -- 2,994
--------- ------------- ------------ ------------
Operating Income 8,085 3,801 -- 11,886
Other Income (Expenses), net (2,341) 65 -- (2,276)
--------- ------------- ------------ ------------
Income Before Income Taxes 5,744 3,866 -- 9,610
--------- ------------- ------------ ------------
Total Assets $ 128,495 $ 28,613 $ -- $ 157,108
========= ============= ============ ============
</Table>
F-29
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
(in thousands) In-Store Magazine
Year ended January 31, 2000 Services Manufacturing Distribution Consolidated
--------------------------- --------- ------------- ------------ ------------
Revenue $ 72,951 $ 9,537 $- $ 82,488
Cost of Revenue 41,687 7,182 -- 48,869
--------- ------------- ------------ ------------
Gross Profit 31,264 2,355 -- 33,619
Selling, General & Administrative 11,367 795 -- 12,162
Amortization of Goodwill 2,610 108 -- 2,718
--------- ------------- ------------ ------------
Operating Income 17,287 1,452 -- 18,739
Other Income (Expenses), net (1,099) 28 -- (1,071)
--------- ------------- ------------ ------------
Income Before Income Taxes 16,188 1,480 -- 17,668
--------- ------------- ------------ ------------
Total Assets $ 130,179 $ 26,580 $ -- $ 156,759
========= ============= ============ ============
</Table>
19. QUARTERLY INFORMATION (Unaudited) (in thousands, except per share data)
<Table>
<Caption>
Quarter ended
April 30 July 31 October 31 January 31
-------- -------- ---------- ----------
2002
Total Revenue $ 18,257 $ 57,402 $ 82,076 $ 80,270
Gross Profit 5,616 12,241 17,121 11,248
Net Income (Loss) 2,525 1,176 2,551 (79,630)
EPS - Diluted $ 0.15 $ 0.07 $ 0.14 $ (4.37)
2001
Total Revenue $ 24,861 $ 22,304 $ 26,259 $ 18,324
Gross Profit 9,733 7,582 9,970 4,633
Net Income 2,974 1,767 652 441
EPS - Diluted $ 0.16 $ 0.10 $ 0.04 $ 0.03
</Table>
As discussed in Note 8, the Company recorded a goodwill impairment loss in the
fourth quarter of fiscal 2002 of $78.1 million.
F-30
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SOURCE INTERLINK COMPANIES, INC.
Date: May 16, 2002 /s/ W. BRIAN RODGERS
--------------------
W. Brian Rodgers
Secretary and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant in
the capacities and on the dates indicated.
<Table>
May 16, 2002 /s/ S. LESLIE FLEGEL
--------------------
S. Leslie Flegel
Chairman of the Board, Chief Executive
Officer and Director
(Principal Executive Officer)
May 16, 2002 /s/ W. BRIAN RODGERS
--------------------
W. Brian Rodgers
Secretary and Chief Financial Officer
(Principal Financial and Accounting Officer)
May 16, 2002 /s/ JAMES R. GILLIS
-------------------
James R. Gillis
President and Chief Operating Officer
Director
May 16, 2002 /s/ ROBERT O. ADERS
-------------------
Robert O. Aders
Director
May 16, 2002 /s/ HARRY L. "TERRY" FRANC, III
-------------------------------
Harry L. "Terry" Franc, III
Director
May 16, 2002 /s/ ARON KATZMAN
----------------
Aron Katzman
Director
May 16, 2002 /s/ RANDALL S. MINIX
--------------------
Randall S. Minix
Director
May 16, 2002 /s/ KENNETH F. TEASDALE
-----------------------
Kenneth F. Teasdale
Director
</Table>
Report of Independent Certified Public Accountants
Board of Directors
Source Interlink Companies, Inc.
St. Louis, Missouri
The audits referred to in our report dated May 10, 2002, relating to the
consolidated financial statements of Source Interlink Companies, Inc., which are
referred to in Item 8 of this Form 10-K, included the audit of the accompanying
financial statement schedule. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based upon our audits. In our
opinion, such financial statement schedule presents fairly, in all material
respects, the information set forth therein.
/s/ BDO Seidman, LLP
Chicago, Illinois
May 10, 2002
S-1
SCHEDULE II
Source Interlink Companies, Inc.
Valuation and Qualifying Accounts Schedule
January 31, 2002
<Table>
<Caption>
Column A Column B Column C Column D Column E
----------------------------
Charged to
Balance at Charged to other
beginning of costs and accounts - Balance at
Description period expenses describe(1) Deductions end of period
- ------------------------------- ------------ ------------ ----------- ------------ -------------
Year ended January 31, 2002:
Allowance for doubtful accounts 1,397,582 2,823,813 7,205,994 5,284,974 6,142,415
Year ended January 31, 2001:
Allowance for doubtful accounts 1,122,734 1,477,411 -- 1,202,563 1,397,582
Year ended January 31, 2000:
Allowance for doubtful accounts 469,658 4,830 648,246 -- 1,122,734
Year ended January 31, 2002:
Allowance for sales returns -- 152,220,077 33,591,947 145,735,683 40,076,341
Year ended January 31, 2002:
Allowance for purchase returns -- 144,924,401 31,665,101 138,062,311 38,527,191
</Table>
(1) Additions due to acquisitions
S-2
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- ---------------------------------------------
3.1 Articles of Incorporation(1)
3.2 Bylaws(1)
3.3 Amendment to Articles of Incorporation(2)
3.4 Amendments to Bylaws(2)
3.5 Amendment to Articles of Incorporation(3)
3.6 Amendment to Articles of Incorporation(4)
3.7 Amendment to Articles of Incorporation*
4.1 Form of Common Stock Certificate(2)
4.2 Form of Representative's Warrants(2)
4.3 Form of Privately Issued Warrant(2)
9.1 Voting Agreement dated January 7, 1999 between S. Leslie Flegel and Jonathan J. Ledecky(4)
10.1 Form of Indemnity Agreement with Officers and Directors(1)
10.2 Credit Agreement between The Source Information Management Company and Bank of America,
N.A. dated December 22, 1999(12)
10.2.1 Amendment to Credit Agreement between The Source Information Management Company and Bank of
America, N.A. dated December 22, 1999*
10.3 The Source Information Management Company Amended and Restated 1995 Incentive Stock
Option Plan (14)
10.4 The Source Information Management Company Stock Award Plan(6)
10.5 Form of Employment Agreement with W. Brian Rodgers(2)
10.6 Employment and Non-Competition Agreement with James R. Gillis dated as of December
14, 1998(10)
10.6.1 Amendment to Employment and Non-Competition Agreement with James R. Gillis dated as of
August 3, 2000(15)
10.8 Agreement with Dwight L. DeGolia(2)
10.9 Form of Financial Consulting Agreement with Donald & Co. Securities Inc.(2)
10.10 Agreement and Plan of Merger dated as of January 7, 1999 by and among The Source
Information Management Company, Source-U.S. Marketing Services, Inc., U.S. Marketing
Services, Inc. and U.S. Marketing Shareholders(8)
10.11 Asset Purchase Agreement dated as January 7, 1999 by and among The Source
Information Management Company and Yeager Industries, Inc.(8)
10.12 Asset Purchase Agreement dated as of February 1, 1999 by and among The Source
Information Management Company, Chestnut Display Systems, Inc. and Chestnut Display
Systems (North), Inc.(9)
10.13 Asset Purchase Agreement dated as of February 26, 1999 by and among The Source
Information Management Company, MYCO, Inc. and RY, Inc.(9)
10.14 Amendment to Asset Purchase Agreement dated as of February 26, 1999 by and among The
Source Information Management Company, MYCO, Inc. and RY, Inc.(9)
10.15 Asset Purchase Agreement dated March 19, 1999 between The Source Information
Management Company, The Source-Canada Corp. and 132127 Canada Inc.(4)
10.16 Real Estate Sale Contract dated as of April 20, 1999 by and between 711 Gallimore
Partnership and The Source Information Management Company (4)
10.17 Consulting agreement dated August 31, 1998 between Herbert A. Hardt and The Source
Information Management Company(2)
10.18 Asset Purchase Agreement dated as of September 21, 1999 by and among Huck Store Fixture
Company of North Carolina, Source-Huck Store Fixture Company, Arrowood, Inc., Bryce
Russell, Jr. and Sybil Russell (11)
10.19 Irrevocable Letter of Credit No. 3022930 dated February 8, 2000, issued by Bank of America,
N.A. in the amount of $4,073,973 upon the request of Source-Myco, Inc., a Delaware
corporation, and The Source Information Management Company, a Missouri corporation, in
respect to the Industrial Project Revenue Bonds, Series 1995, issued pursuant to the
Indenture of Trust dated as of January 1, 1995 between the City of Rockford, Illinois and
Amalgamated Bank of Chicago, as trustee(13)
10.20 The Source Information Management Company Amended and Restated 1998 Omnibus Plan(14)
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10.21 Employment Agreement Between The Source Information Management Company and S. Leslie Flegel
dated February 6, 2001(15)
10.22 Employment Agreement Between The Source Information Management Company and Jason S. Flegel
dated January 3, 2001(15)
10.23 Employment and Non-Competition Agreement Between The Source Information Management Company
and Monte Weiner dated August 3, 2000(15)
10.24 Agreement and Plan of Merger, dated as of May 31, 2001, by and among The Source Information
Management Company, Source-Interlink Acquisition, Inc., The InterLink Companies, Inc. and
the Shareholders and Option Holders of the InterLink Companies, Inc. (16)
10.25 Loan and Security Agreement by and between Congress Financial Corporation (Western) and
David E. Young, Inc. dated February 22, 2001*
10.25.1 First Amendment to Loan and Security Agreement and Waiver dated as of April 30, 2002, by
and between Congress Financial Corporation (Western) and David E. Young, Inc.*
10.26 Loan and Security Agreement by and between Congress Financial Corporation (Western) and
International Periodical Distributors, Inc. dated February 22, 2001*
10.26.1 First Amendment to Loan and Security Agreement and
Waiver dated as of April 30, 2002, by and between
Congress Financial Corporation (Western) and
International Periodical Distributors, Inc.*
10.27 Purchase and Sale Agreement by and between Source-Myco, Inc, Source-Yeager Industries,
Inc., Source-Huck Store Fixture Company, The Source Information Management Company and BFG
Holdings 2001 dated August 8, 2001 and Amendments 1 through 4, thereto*
10.28 Standard Lease Agreement between SINV II, LLC as Landlord and Source-Huck Store Fixture
Company as Tenant dated October 31, 2001*
10.29 Standard Lease Agreement between SINV, LLC as Landlord and Source-Huck Store Fixture
Company as Tenant dated October 31, 2001*
10.30 Employment Agreement Between Source Interlink Companies, Inc. and John D'Aloia dated
January 21, 2002*
10.31 Lease Agreement by and between Riverview Associates Limited Partnership and Source
Interlink Companies, Inc. dated August 9, 2001*
21.1 Subsidiaries of the Company*
23.1 Consent of BDO Seidman, LLP*
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* Filed herewith.
(1) Incorporated by reference to Registration Statement on Form 10-SB (File no.
0-26238)
(2) Incorporated by reference to Registration Statement on Form SB-2 (File no.
333-32733)
(3) Incorporated by reference to Form 10-KSB for the fiscal year ended January
31, 1996
(4) Incorporated by reference to Registration Statement on Form S-2 (File no.
333-76979)
(5) Incorporated by reference to Schedule 14A filed on March 9, 1999
(6) Incorporated by reference to Form S-8 (File no. 333-16059) filed on November
13, 1996
(7) Incorporated by reference to Current Report on Form 8-K filed on August 10,
1998
(8) Incorporated by reference to Current Report on Form 8-K filed on January 22,
1999
(9) Incorporated by reference to Current Report on Form 8-K filed on March 12,
1999
(10) Incorporated by reference to Form 10-KSB for the fiscal year ended January
31, 1999
(11) Incorporated by reference to Current Report on Form 8-K filed on October 6,
1999
(12) Incorporated by reference to Form 10-K for the fiscal year ended January
31, 2000
(13) Incorporated by reference to Form 10-Q for the fiscal quarter ended April
30, 2000
(14) Incorporated by reference to Form 10-Q for the fiscal quarter ended October
31, 2000
(15) Incorporated by reference to Form 10-K for the fiscal year ended January
31, 2001
(16) Incorporated by reference to Current Report on Form 8-K filed on June 12,
2001