UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K/A
Amendment No. 2
[x] Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934. For the fiscal year ended January 31, 2003.
[ ] 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.)
27500 RIVERVIEW CENTER BLVD., SUITE 400
BONITA SPRINGS, FLORIDA 34134
(Address of Principal Executive Offices) (Zip Code)
(239) 949-4450
(Registrant's Telephone Number, Including Area Code)
Securities to be registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
Securities to be registered pursuant to Section 12(g) of the Act: COMMON STOCK
$0.01 PAR VALUE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark 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. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
The aggregate market value of the voting and non-voting stock held by
non-affiliates of Source Interlink Companies, Inc. (the "Company") was
approximately $61,919,572 based on the last sale price of the Common Stock
reported by the Nasdaq National Market on July 31, 2002 (the last day of the
Company's most recently completed second fiscal quarter). At April 18, 2003, the
Company had outstanding 18,261,966 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Source Interlink Companies, Inc. Annual
Meeting of Shareholders to be held on July 22, 2003 are incorporated by
reference into Part III of this Annual Report to the extent described in Part
III hereof.
EXPLANATORY NOTE
This report has been amended for the sole purpose of correcting a typographical
error in the text of the certifications made by our principal executive officer
and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Description of Business 1
ITEM 2. Description of Property 5
ITEM 3. Legal Proceedings 5
ITEM 4. Submission of Matters to a Vote of Security Holders 5
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 6
ITEM 6. Selected Financial Data 7
ITEM 7. Management's Discussion and Analysis of Financial Condition 7
and Results of Operations
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 19
ITEM 8. Consolidated Financial Statements 19
ITEM 9. Changes In and Disagreements with Accountants on 19
Accounting and Financial Disclosure
PART III
ITEM 10. Directors, Executive Officers, Promoters and Control Persons; 20
Compliance with Section 16(a) of the Exchange Act
ITEM 11. Executive Compensation 20
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 20
And Related Stockholder Matters
ITEM 13. Certain Relationships and Related Transactions 20
ITEM 14. Controls and Procedures 21
PART IV
ITEM 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 22
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,; (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 U.S. 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
1. DESCRIPTION OF THE BUSINESS
Our company is a leading provider of marketing services to producers,
distributors and retailers of magazines, confections and general merchandise,
and the largest direct-to-retail magazine distributor servicing specialty
retailers in North America. We are also a leading marketer of magazines,
confections and general merchandise sold at the front-end of retail stores.
Our business has been built on three complementary operating units. The Magazine
Distribution group distributes magazines to specialty retailers utilizing
proprietary information systems to assist retailers with magazine selection and
procurement. In addition, we provide fulfillment services to third parties for a
fee. Our fulfillment services consist of us providing shipping and handling
services to other wholesalers for either a per-unit or per-pound fee. Our
In-Store Service group combines display fixture design and production
capabilities, supported by standard-setting information services, to offer our
clients, both retailers and vendors, more efficient, profitable merchandising.
In addition, we provide critical sales information on more than 10,000 magazine
titles to assist our clients in making strategic marketing, distribution and
advertising decisions affecting some of the most valuable space in any retail
store, its checkout area. In-Store Services also assists retailers in claiming
rebates earned on the placement and sale of magazines. Our Wood Manufacturing
group designs and manufactures custom wood displays and store fixtures to
complement the wire and metal displays and store fixtures offered by our
In-Store Services group.
We believe that we derive synergistic benefits from the breadth of our product
and service offerings and our multi-faceted relationships with retailers and
product vendors. The following summarizes the various business groups.
MAGAZINE DISTRIBUTION
In Spring 2001, we established our Magazine Distribution group with the
acquisition of the Interlink Companies, a group of affiliated specialty magazine
distributors. This strategic acquisition provided a platform from which we
intend to offer an expanding list of merchandise and services to retailers,
including those currently served by our In-Store Services and Wood Manufacturing
groups, who are underserved by existing distribution channels and to merchandise
vendors who find it difficult to adequately service certain classes of
retailers.
The Magazine Distribution group accounted for approximately 72.8% of our fiscal
2003 revenues, 65.2% of our fiscal 2002 revenues and 0.0% of our fiscal 2001
revenues.
To meet the needs of our clients, our Magazine Distribution group presently
offers three levels of service.
Traditional Fulfillment
Our traditional fulfillment service functions in a manner similar to traditional
specialty distributors. We purchase magazines, from publishers of more than
3,500 titles, which are typically fully returnable. Merchandise is received in
bulk at our
1
regionally located distribution centers. Using our proprietary order management
and just-in-time replenishment system, our employees fulfill the merchandise
orders and ship the required merchandise by third party carrier directly to
individual retail outlets. To further enhance the efficiency and efficacy of our
fulfillment service, we upgraded our distribution centers with a
state-of-the-art order regulation system.
Wholesale Fulfillment
Developed to assist traditional distributors, our wholesale fulfillment service
facilitates the satisfaction of the magazine procurement needs of lower volume
or geographically isolated retailers by arranging for magazines to be shipped in
bulk from the publisher's printers directly to the wholesaler.
Back Room Management
We developed our back room management services as a means of permitting
publishers and traditional distributors to access our proprietary order
management and just-in-time replenishment system. In essence, we are engaged by
publishers and traditional distributors to act as their order fulfillment and
shipping agent. Rather than purchasing merchandise, our back room management
clients furnish merchandise to us that we then package into individual orders
and ship directly to individual retail outlets. We also serve as a returns
processor for many of our retailer customers. This service consists of counting
covers of unsold magazines and preparing return forms required by wholesalers to
obtain credit.
IN-STORE SERVICES
The In-Store Services group accounted for approximately 21.2% of our fiscal 2003
revenues, 27.3% of our fiscal 2002 revenues and 73.5% of our fiscal 2001
revenues, by providing a variety of services to the magazine retailing industry,
the more important of which are described below:
Claim Submission Services
Claim submission services have been the historical core of our business. U.S.
and Canadian retailers engage our In-Store Services group 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 to retailers for providing a specific
pocket size and location on a display fixture. Our services are designed to
relieve our clients of the substantial administrative burden associated with
documenting, verifying and collecting their payments claims, and to increase the
amounts recovered on the retailer's claims.
Advance Pay Program
We established our Advance Pay Program as an enhancement to our claim submission
services. Typically, retailers are required to wait for approximately nine
months to receive payments on their claims for incentive rebates and pocket
rental fees. We improve the retailer's cash flow by advancing a negotiated fixed
percentage of the incentive and pocket rental claims filed by us on their behalf
within a contractually agreed upon period after the end of each quarter.
Information Products
In connection with our claim submission services, we gather extensive
information on magazine sales, pricing, new titles, discontinued titles and
display configurations on chain-by-chain and even store-by-store basis. As a
result, we are able to furnish our clients with reports of total sales, sales by
class of trade and sales by retailer sales, as well as reports of unsold
magazines and total sales ranking. Our newest product, the Cover Analyzer,
permits subscribers to determine the effectiveness of particular magazine covers
on sales for the 300 top selling titles in the United States. Our ICN website
gives subscribers the capability to react more quickly to market changes,
including the ability to reorder copies of specific issues, track pricing
information, to introduce new titles, and act on promotions offered by
publishers. Publishers also use ICN to promote special incentives and advertise
and display special editions, new publications and upcoming covers. We have
supplemented our own data with data provided under agreements with Barnes &
Noble, Inc., AC Nielsen, the world's leading market research firm, and Efficient
Market Services, a privately held consumer-information company.
Front-End Management
2
Our extensive informational resources and experience in claim submission enable
us to assist retailers by managing the design and configuration of the checkout
area to increase sales and incentive payment revenues. Our services in this
regard frequently include designing front-end display fixtures, supervising
fixture installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. We may 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.
Front-End and Point-of-Purchase Display Fixtures
To provide our clients with greater efficiency during implementation of a
checkout area merchandising program, we acquired the capacity to design,
manufacture, deliver and dispose of custom front-end and point-of-purchase
displays for both retail store chains and product manufacturers. Clients seeking
to optimize revenue from the checkout area perceive our experience in managing
Front-End programs supported by our informational services as valuable. In
addition, we believe that our control over the design and manufacture of display
fixtures increases our ability to incorporate features that facilitate
information gathering supporting our information services. Raw materials used in
manufacturing our fixtures include wire, powder coating, metal tubing and
paneling, all of which are readily available from multiple sources.
The productivity of our In-Store Services group is partially dependent on
proprietary software programs developed by our staff programmers with the
assistance of outside consultants. Portions of the programs are licensed from an
unaffiliated third party that also participated in the design of our system. To
protect our rights, we have applied for patent and copyright protection in
connection with our ICN and PIN products.
WOOD MANUFACTURING
In the fall of 1999, our Wood Manufacturing group was established with the
acquisition of two manufacturers of custom wood store fixtures and displays
demanded by bookstore chains, discount stores, department stores and certain
niche retailers. The Wood Manufacturing group accounted for approximately 6.0%
of our fiscal 2003 revenues, 7.5% of our fiscal 2002 revenues and 26.5% of our
fiscal 2001 revenues.
All fixtures and displays are custom manufactured to customer specifications
upon receipt of order confirmations using common, available raw materials,
including wood veneers and laminates. Delivery of fixtures is highly
concentrated in our third fiscal quarter as a result of the demands of retailers
to be ready for the critical Holiday selling season. To assure that their
seasonal demands for delivery are met, retailers will typically provide
commitments well in advance of needing the product in its stores. Accordingly,
our inventory levels increase during seasonal periods when retailers are not
opening or remodeling stores, typically November through April.
MAJOR CUSTOMERS
During fiscal 2003, two customers accounted for 46.6% of the Company's
total revenues: Barnes & Noble, Inc. (27.7%) and Borders Group, Inc. (18.9%).
During fiscal 2002, two customers accounted for 49.0% of the Company's
total revenues: Barnes & Noble, Inc. (26.4%) and Borders Group, Inc. (22.6%).
During fiscal 2001, one customer, Kmart Corporation, accounted for 13.8% of
total revenues.
MARKETING AND SALES
The target market for the services and products of our Magazine Distribution
group include publishers, distributors and retailers. We specialize in providing
nationwide magazine distribution to specialty retailers with national or
regional scope. Unlike traditional magazine wholesalers, we do not provide
in-store servicing of the products.
3
Our In-Store Services group markets its products and services, together with
those of the Wood Manufacturing group through a direct sales staff. While we
frequently attend trade shows and advertise in trade publications, direct
contact between our sales personnel and representatives of our prospective
clients is the principal means used to achieve our sales objectives. Sales of
our services are not particularly seasonal, but delivery of new display fixtures
is highly concentrated in our third fiscal quarter as a result of the demands of
retailers to be ready for the critical Holiday selling season. As a result,
inventories of fixtures tend to be lowest during our fourth fiscal quarter and
increase throughout the first and second fiscal quarters in anticipation of the
delivery demands of retailers in the third fiscal quarter.
Marketing of our Wood Manufacturing group's services is integrated with those of
our In-Store Services group. As of March 31, 2003, and the comparable date in
2002, our Wood Manufacturing group maintained a backlog not considered to be
material to the Company as a whole.
COMPETITION
Our Magazine Distribution group faces a rapidly changing competitive landscape.
Traditional distribution channels for merchandise have evolved and are expected
to continue to evolve in response to the needs of retailers. As a result, we
compete with national distributors, secondary or local distributors and
specialty distributors. Competition is generally met on matters such as
reliability, value added service and price. We believe that we have built a
magazine distribution organization that competes effectively in all facets of
the business.
Our In-Store Services group primarily competes with privately held companies for
its claim filing services. There are a significant number of private and public
(both small and very large) companies that compete with our fixture
manufacturing group. Some of these competitors, or potential competitors, could
compete effectively with us particularly in the manufacture and installation of
display fixtures. In addition, we may face competition for our information
services from information providers such as Information Resources, Inc. The
principal competitive factors in our market include access to information,
technological support, accuracy, system flexibility, financial stability,
customer service and reputation. We believe that our products and services
compete effectively in each of the foregoing areas.
Our Wood Manufacturing group operates in a highly fragmented, intensely
competitive industry. We believe that the principal competitive factors include
price, reliability and quality. We believe that our Wood Manufacturing group
competes effectively with respect to each of these factors.
INFORMATION TECHNOLOGY; INTELLECTUAL PROPERTY
The efficiency and efficacy of our Magazine Distribution group is supported by
our proprietary information systems that combine traditional outbound and
inbound product counts with real-time register activity. The ability to access
real-time register data enables us to quickly adjust individual outlet
merchandise allocations in response to variation in consumer demand thereby
increasing the probability that any particular merchandise allotment will be
sold rather than returned for credit. In addition, we have developed
sophisticated database management systems designed to track various on-sale and
off-sale dates for the numerous issues and regional versions of the more than
3,500 titles we distribute.
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 Company. Other
portions of these systems are licensed from a third party, who helped 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.
EMPLOYEES
We employ approximately 1,300 persons. Of that total, approximately 240 are
represented by unions and are covered by collective bargaining agreements.
We consider our employee relations to be satisfactory.
4
ITEM 2. DESCRIPTION OF PROPERTY.
Our principal corporate offices are located at 27500 Riverview Center Blvd,
Bonita Springs, Florida. As of January 31, 2003, we owned or leased an
additional 1,149,500 square feet of manufacturing facilities, 316,200 square
feet of distribution centers and 74,600 square feet of office space.
SIZE SQ. OWNED/
LOCATION DESCRIPTION SEGMENT FT. LEASED
- ------------------------------------------------------------------------------------------------------
Bonita Springs, FL Office Corporate Headquarters 51,000 Leased
New York City, NY Sales Office Magazine Distribution 3,500 Leased
Rockford, IL Manufacturing/ In-Store Services/ 300,000/
Distribution Center Magazine Distribution 10,500 Owned
Brooklyn, NY Manufacturing In-Store Services 92,000 Leased
Philadelphia, PA Manufacturing In-Store Services 110,000 Owned
Vancouver, BC Manufacturing In-Store Services 51,000 Leased
Quincy, IL Manufacturing Wood Manufacturing 260,000 Owned
Carson City, NV Manufacturing Wood Manufacturing 135,000 Leased
Albermarle, NC Manufacturing Wood Manufacturing 52,000 Leased
Milan, OH Distribution Center Magazine Distribution 82,500 Leased
Dallas, TX Distribution Center Magazine Distribution 48,000 Leased
Harrisburg, PA Distribution Center Magazine Distribution 60,000 Leased
We believe our facilities are adequate for our current level of operations and
that all of our facilities are adequately insured.
We continue to identify ways to consolidate operations to maximize operating
efficiencies. As of April 18, 2003, leased space was expiring or we were
attempting to or had completed the sub-lease or sale of 105,000 square feet of
office and manufacturing space relating to our previously announced relocation
of operations to Bonita Springs, Florida, and consolidation of certain
manufacturing operations.
ITEM 3. LEGAL PROCEEDINGS.
The Company is a party to routine legal proceedings arising out of the normal
course of business. Although it is not possible to predict with certainty the
outcome of these unresolved legal actions or the range of possible loss, the
Company believes that none of these actions, individually or in the aggregate,
will have a material adverse affect on the financial condition or results of
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
(a) The Annual Meeting of the Shareholders of the Company was held on
November 12, 2002. Of the 18,209,445 shares entitled to vote at such meeting,
16,138,898 shares were present at the meeting in person or by proxy.
(b) Each of the management nominees for election as Class I directors was
duly elected to serve an additional term of three years expiring in 2005. These
individuals joined the directors Harry L. "Terry" Franc III, Kenneth F.
Teasdale, S. Leslie Flegel and Robert O. Aders , whose terms of office continued
after the Company's 2002 Annual Meeting of Shareholders. The number of shares
voted for and withheld were as follows:
For Withheld
--- --------
Aron Katzman 15,112,551 1,026,347
Randall S. Minix 15,114,151 1,024,747
James R. Gillis 14,222,190 1,916,708
5
(c) In addition to the election of directors, two other matters were
submitted for shareholder action at the Company's 2002 Annual Meeting of
Shareholders. The tabulation of votes for each matter is set forth below:
Against/ Abstentions/
Proposal For Withheld Non-votes
-------- --- -------- ---------
To increase the number of shares authorized for issuance 11,561,619 4,552,889 24,390
under the Company's 1995 Incentive Stock Option Plan
To increase the number of shares authorized for issuance 11,646,654 4,469,254 22,990
under the Company's 1998 Omnibus Plan
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock, par value $.01 per share, is quoted on the NASDAQ National
Market under the symbol SORC.
The following table sets forth the range of high and low closing prices for our
common stock as reported on the NASDAQ National Market for the past two years
during the fiscal year shown.
Fiscal 2003 High Low
----------- ---- ---
First Quarter $ 5.55 $ 4.26
Second Quarter 5.70 4.46
Third Quarter 6.37 4.50
Fourth Quarter 5.89 3.98
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
As of April 18, 2003, there were approximately 111 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 our 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,
our credit agreements prohibit 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.
6
ITEM 6. SELECTED FINANCIAL DATA (in thousands except per share data):
STATEMENT OF OPERATIONS INFORMATION:
(RESTATED)
------------------------------------------------------------------------
Fiscal Year Ended January 31,
2003 2002(1) 2001(1) 2000 1999
------------------------------------------------------------------------
Revenues $ 290,894 $ 238,923 $ 92,423 $ 82,279 $ 20,051
Cost of revenues 216,483 176,357 53,792 48,806 10,953
------------- ------------ ---------- ---------- -----------
Gross profit 74,411 62,566 38,631 33,473 9,098
Selling, general and administrative 61,285 46,909 23,279 12,162 2,551
Relocation 1,926 - - - -
Amortization of goodwill - 5,424 2,994 2,718 398
Asset impairment charge - 78,126 - - -
------------- ------------ ---------- ---------- -----------
Operating income (loss) 11,200 (67,893) 12,358 18,593 6,149
Interest expense, net (3,765) (3,338) (2,312) (919) (303)
Other income (expense) 514 (2,339) 36 (152) (47)
------------- ------------ ---------- ---------- -----------
Total other (3,251) (5,677) (2,276) (1,071) (350)
Income (loss) before income taxes 7,949 (73,570) 10,082 17,522 5,799
Income tax expense (benefit) 611 (705) 3,965 7,499 2,373
------------- ------------ ---------- ---------- -----------
Net income (loss) $ 7,338 $ (72,865) $ 6,117 $ 10,023 $ 3,426
============= ============ ========== ========== ===========
Earnings (loss) per share
Basic 0.40 $ (4.07) $ 0.35 $ 0.65 $ 0.38
Diluted 0.40 (4.07) 0.33 0.60 0.35
Weighted average outstanding shares
Basic 18,229 17,915 17,591 15,332 9,132
Diluted 18,478 17,915 18,348 16,815 9,776
BALANCE SHEET INFORMATION:
----------------------------------------------------------------------
At January 31,
2003 2002 2001 2000 1999
----------------------------------------------------------------------
Total assets $ 157,239 164,430 158,448 158,289 67,349
Total debt 46,241 57,675 31,896 32,389 3,508
Stockholders' equity 50,919 43,543 109,790 105,120 50,103
(1) Certain amounts from the prior years have been reclassified to conform to
current year presentation. The reclassifications included the reclass of
certain shipping and delivery expenses from cost of revenues to selling,
general and administrative expenses, the reclass of certain overhead
expenses from cost of revenues to selling, general and administrative
expenses, the reclass of certain sales discounts from selling, general and
administrative expenses to revenues and the reclass of our backroom services
revenues from other income to revenues. These reclassification adjustments
had no impact on income (loss) before income taxes.
For a discussion on acquisitions that affect comparability of results, see Note
2 in the "Notes to the Consolidated Financial Statements."
7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS (AMOUNTS IN THOUSANDS)
OVERVIEW
Acquisition of the Interlink Companies, Inc.
On May 31, 2001, we acquired the Interlink Companies, Inc (Interlink), a holding
company with two principal operating divisions: International Periodical
Distributors, Inc. (IPD) and David E. Young, Inc (Deyco).
IPD is the leading direct to retail distributor of magazines to specialty
retailers (e.g., bookstore chains, record stores, computer stores, independent
retailers, etc.). IPD distributes non-weekly titles under its own name and
weekly titles under the name Austin News.
Deyco is a national distributor of magazines to the secondary wholesale market.
Historical Results
The following discussion compares the historical results of operations on a GAAP
basis for the years ended January 31, 2003, 2002 and 2001. These results include
Interlink's results of operations from May 31, 2001 (the acquisition date).
The following tables set forth, for the periods presented, information relating
to our operations:
Fiscal Year Ended January 31,
-----------------------------------------
2003 2002 2001
-----------------------------------------
Revenues $ 290,894 $ 238,923 $ 92,423
Cost of Revenues 216,483 176,357 53,792
------------ ----------- ----------
Gross Profit 74,411 62,566 38,631
Selling, General and Administrative Expense 61,285 46,909 23,279
Relocation Expenses 1,926 - -
Amortization of Goodwill - 5,424 2,994
Asset Impairment Charge - 78,126 -
------------ ----------- ----------
Operating Income (loss) 11,200 (67,893) 12,358
Interest Expense (3,765) (3,338) (2,312)
Other Expense (Income) 514 (2,339) 36
------------ ----------- ----------
Income (Loss) before taxes 7,949 (73,570) 10,082
Income Tax Expense (Benefit) 611 (705) 3,965
------------ ----------- ----------
Net Income (loss) $ 7,338 $ (72,865) $ 6,117
- ------------------------------------------------------------------------------------------------------
Gross Profit Margin 25.6% 26.2% 41.8%
Selling, General and Administrative Expense (% of Revenue) 21.1% 19.6% 25.2%
- ------------------------------------------------------------------------------------------------------
8
REVENUES
Revenues increased $51,971 (21.8%) from 2002 to 2003. The increase relates
primarily to the acquisition of Interlink. The results of operations for 2002
include only eight months of operations of the acquired companies.
Revenues increased $146,500 (158.5%) from 2001 to 2002. The increase relates
primarily to the acquisition of Interlink. The results of operation for 2001
include no activity related to the acquired companies.
COST OF REVENUES
Cost of revenues increased $40,126 (22.8%) from 2002 to 2003. The increase
relates primarily to the acquisition of Interlink. The results of operations for
2002 include only eight months of operations of the acquired companies.
Gross profit margins declined 0.6% from 2002 to 2003. The decline relates
primarily to our acquisition of Interlink. The acquired companies operating
business are historically known as lower margin businesses than our
pre-acquisition businesses.
Cost of revenues increased $122,565 (227.8%) from 2001 to 2002. The increase
relates primarily to the acquisition of Interlink. The results of operation for
2001 include no activity related to the acquired companies.
Gross profit margins declined 15.6% from 2001 to 2002. The decline relates
primarily to our acquisition of Interlink. The acquired companies operating
business are historically known as lower margin businesses than our
pre-acquisition businesses.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $14,376 (30.6%) from 2002
to 2003. The increase relates primarily to the acquisition of Interlink. The
results of operations for 2002 include only eight months of operations of the
acquired companies.
Selling, general and administrative expenses increased $23,630 (101.5%) from
2001 to 2002. The increase relates primarily to the acquisition of Interlink.
The results of operation for 2001 include no activity related to the acquired
companies.
RELOCATION EXPENSES
During 2003, we relocated our claim submission and fixture billing center in
High Point, North Carolina and our Corporate Headquarters in St. Louis, Missouri
to our new Corporate Headquarters in Bonita Springs, Florida. The relocation was
completed in the fourth quarter of 2003. We also began a relocation of our
administrative operations from San Diego, California to our new Corporate
Headquarters in Bonita Springs, Florida. The relocation was completed in the
first quarter of fiscal 2004 at an additional cost of approximately $1,200.
We believe this relocation will result in significant cost saving due to an
increase in operating efficiencies and better integration with our other
operations.
AMORTIZATION OF GOODWILL
Prior to 2003, we amortized goodwill consistent with accounting literature in
effect at that time. Effective February 1, 2002, we adopted FAS 142 and ceased
amortizing goodwill.
Amortization expense increased $2,430 from 2001 to 2002 related entirely to the
acquisition of Interlink, which resulted in a significant amount of goodwill.
ASSET IMPAIRMENT CHARGE
In fiscal year 2002, pursuant to an independent valuation of our intangible
assets (goodwill) in accordance with FAS 121, it was determined an impairment
charge was required. The impairment charge reduced the carrying value of
goodwill on our balance sheet related to the Magazine Distribution and Wood
Manufacturing segments to zero.
9
INTEREST EXPENSE
Interest and related expenses relate primarily to our significant debt
instruments, which consist of our revolving line-of credit with Bank of America,
our credit facilities with Congress Financial, our IRB related to our Rockford,
IL manufacturing facility and debt to prior owners of Interlink.
Interest expense increased from 2002 to 2003 due to acquisition of the Interlink
Companies and the assumption of their related bank debt.
Interest expense increased from 2001 to 2002 as a result of the additional debt
assumed in the acquisition of Interlink.
OTHER INCOME (EXPENSE)
Other income (expense) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
Other income in 2003 related primarily to the favorable settlement of an
outstanding liability.
Other income in 2002 related to life insurance proceeds received upon the death
of one of our senior executives.
Other income was insignificant in 2001.
INCOME TAX EXPENSE (BENEFIT)
The effective income tax rates for 2003, 2002 and 2001 were 7.6%, 1.0%, and
39.3%, respectively. The difference in 2003 between the effective tax rates and
the statutory rates related to the realization of a portion of the NOL acquired
with our acquisition of Interlink that was fully reserved at the end of 2002.
The difference in 2002 between the effective tax rates and statutory rates
related to items that created permanent differences between book and tax income,
primarily the amortization and impairment charge associated with non-deductible
goodwill.
SEGMENT RESULTS
Due to the size of the Interlink acquisition, comparisons on an overall level
are deemed less meaningful than comparisons on the segment level. As a result,
we have included additional analysis on a segment level.
MAGAZINE DISTRIBUTION
The Magazine Distribution segment's financial performance was as follows:
Fiscal Year Ended January 31,
------------------------------------
2003 2002 2001
-------------- ------------- ----
Revenues $ 211,663 $ 155,804 $ -
Cost of Revenues 164,702 126,216 -
------------ ----------- ----
Gross Profit 46,961 29,588 -
Selling, General and Administrative Expense 39,515 26,352 -
Relocation Expenses 85 - -
Amortization of Goodwill - 2,359 -
Asset Impairment Charge - 68,587 -
------------ ----------- ----
Operating Income (Loss) $ 7,361 $ (67,710) $ -
- -------------------------------------------------------------------------------------------------
Gross Profit Margin 22.2% 19.0% -
Selling, General and Administrative Expense (% of Revenue) 18.7% 16.9% -
- -------------------------------------------------------------------------------------------------
10
The Magazine Distribution segment consists entirely of the Interlink companies,
which were acquired in May 2001. The segment consists of two principal
significant operating divisions: IPD and Deyco.
IPD operates strategically located distribution centers throughout the United
States providing fulfillment services to retailers utilizing common carrier
delivery of merchandise to retailers throughout North America. IPD also performs
fulfillment services on a per-pound or per-unit shipped basis. IPD accounted for
90.3% of the segments revenues in 2003. We anticipate this percentage will
increase due to the significant number of growth opportunities for the business
as we expand our customer base and the number of titles we distribute.
Deyco represents publishers to the secondary wholesale market. Deyco accounted
for 9.7% of the segment's revenues in 2003. Deyco does not perform physical
distribution of its product. Rather, it instructs printers to drop ship product
directly to wholesalers who perform the physical distribution.
Revenues
Revenues for the segment are driven by the level of gross distribution, the
estimated sell-through of that distribution at retail, and the amount of
fulfillment services performed for others. Revenues increased $55,859 (35.9%)
from 2002 to 2003.
Revenues increased over 2002 due to an increase in gross distribution and an
increase in the amount of fulfillment services performed for others. The
increase in gross distribution over the prior year was due primarily to the
short-year in 2002. Other factors contributing to the increase were an increase
in the number of publishers' magazines, particularly foreign, we distribute to
our retailer customers, an increase in the number of stores our retailer
customers operate and an increase in the number of retailers we service. These
increases were partially offset by the unusually high levels of distribution and
sell-through surrounding the events of September 11, 2001. The increase in the
amount of fulfillment services was related to the addition of a significant
customer during the fiscal year.
We anticipate significant revenues growth in our IPD division as we continue to
increase the number of publishers we distribute, growth in the number of stores
our retailer customers operates, the addition of the number of retailer
customers we service, and the addition of a significant export business through
a partnership with the leading exporter of domestic titles in February 2003.
Cost of Revenues
Cost of revenues for the distribution division consists entirely of the cost,
net of all discounts, of the merchandise we distribute. Discounts consist
primarily of various allowances and rebates based on gross distribution or the
amount of product ultimately sold at retail. Gross profit increased $17,373
(58.7%) from 2002 to 2003. Gross profit margin improved 3.2% from 2002 to 2003.
The increase in the gross profit from 2002 to 2003 was attributable to the
overall increase in revenues described above as well as an overall improvement
in gross profit margin.
Cost of revenues as a percentage of sales (or inverse gross profit margin) has
improved from 2002 due to our ability to negotiate better terms with publishers
than our predecessors, the addition of publishers with historically higher
margin titles (primarily foreign) and the increase of fulfillment services which
generally is higher margin business because we only recognize revenue for our
fee.
We anticipate slight improvement of our gross profit margin in the future due to
our ability to continue to negotiate improved terms with our publishers.
Selling, General and Administrative
Selling, general and administrative (SG&A) expenses consist primarily of
personnel costs (both administrative and distribution), direct freight costs,
and administrative overheads. SG&A expenses increased $13,163 (50.0%) from 2002
to 2003.
11
Selling, general and administrative costs increased over 2002 due to the
short-year partially offset by a shift of many of the overhead costs to our
corporate departments, which are reported herein as part of the In-Store
Services segment, and the consolidation of IPD and Deyco's selling and
administrative functions.
We anticipate higher S,G&A costs as our net revenues increase. However, these
costs should decrease as a percentage of revenues from efficiencies gained from
distributing additional product through our existing infrastructure and the
benefit of lower per-pound shipping rates as we increase the number of pounds
shipped.
IN-STORE SERVICES
The In-Store Services segment's financial performance was as follows:
Fiscal Year Ended January 31,
---------------------------------------
2003 2002 2001
---------------------------------------
Revenues $ 61,754 $ 65,148 $ 67,914
Cost of Revenues 35,391 33,978 34,872
------------ ---------- ----------
Gross Profit 26,363 31,170 33,042
Selling, General and Administrative Expense 19,971 18,848 21,808
Relocation Expenses 1,841 - -
Amortization of Goodwill - 2,723 2,677
------------ ---------- ----------
Operating Income $ 4,551 $ 9,599 $ 8,557
=====================================================================================================
Gross Profit Margin 42.7% 47.8% 48.7%
Selling, General and Administrative Expense (% of Revenue) 32.3% 28.9% 32.1%
- -----------------------------------------------------------------------------------------------------
Our In-Store Services segment consists primarily of our claim submission
services, our front-end fixture (commonly known as check-out display fixtures)
management services, which include design, manufacture and coordination of
shipping of front-end fixtures, and our information products. Currently, it also
includes our Corporate Departments.
Our claim submission services consist of the submission of claims for rebates
due from publishers on behalf of our retailer customers. Rebates are offered
based on either the number of copies of magazines sold at retail (typically 10%
of cover price) or the location of the title on the retailers' front-end fixture
(commonly known as a per pocket allowance). We charge a fee for these services,
generally based on a percent of the claims filed. In the case of rebates based
on sales, the claim submission process consists of us obtaining from the
individual retailer's magazine wholesalers a detail ledger by title and issue of
all copies sold. Our systems then compile these results for all wholesalers and
create a claim acceptable in form for each national distributor, who generally
represents multiple publishers. We also maintain a database of each display
fixture by retailer by store and the location of each title on those fixtures.
This database is utilized to create a claim for rebates offered by publisher
based on the location of their titles on the front-end fixture.
Our front-end fixture services consist of the design, manufacture, coordination
of shipping and salvaging of front-end fixtures for our retailer customers. We
utilize our custom design software to design these programs to maximize the
revenue potential of the front-end area of the retailers' store. Each program
generally lasts three years and includes leading publishers, confectioneries and
general merchandisers.
Our information products consist of databases of information pertaining to the
sale of magazines at retail. It utilizes a web-based platform to deliver daily
point-of sale and historical sales analysis to the retail and publishing
community.
12
Revenues
Revenues for the In-Store Services segment are driven primarily by the number of
large retailers who pursue a new front-end marketing program during the fiscal
year. Typically, retailers maintain a three year life cycle on their front-end
marketing program, which includes replacing their front-end fixtures with newly
designed ones, making year-over-year comparisons less meaningful. Revenues
decreased $3,394 (5.2%) from 2002 to 2003 and decreased $2,766 (4.1%) from 2001
to 2002.
The decline in revenues from 2002 to 2003 was primarily attributable to the
lowering of the price of display fixtures (mainly in the latter half of the
year) due to competition prevalent in the marketplace. This decline was
partially offset by an overall increase in revenues from our rebate claiming and
information products.
Revenues declined from 2001 to 2002 due to a large one-time order in 2001 for
one of our information products. Our front-end fixture and rebate claiming
business experienced consistent results.
Cost of Revenues
Cost of revenues for the In-Store segment consist of the cost of the
manufacturing wire fixtures (raw material, labor and factory overhead), the
personnel costs of providing our claiming services and the cost of information
we resell to our customers. Gross profit decreased $4,807 (15.4%) from 2002 to
2003. Gross profit margins decreased 5.1% from 2002 to 2003. Gross profit
decreased $1,872 (5.7%) from 2001 to 2002. Gross profit margins decreased 0.9%
from 2001 to 2002.
The decrease in gross profit from 2002 to 2003 related primarily to the pricing
we were able to obtain for our fixtures. The cost of revenue component per unit
remained relatively consistent from 2002 to 2003.
The decrease in gross profit from 2001 to 2002 related primarily to the one-time
order of one of our information products, which due to its nature has limited
cost of revenues associated with it.
Selling, General and Administrative
Selling, General and Administrative (SG&A) expenses include both the expenses
related to the In-Store segment as well as our corporate overhead departments.
SG&A increased $1,123 (6.0%) from 2002 to 2003 and decreased $2,960 (13.6%) from
2001 to 2002.
The increase in S,G&A from 2002 to 2003 is primarily attributable to the
increase in the size and scope of our corporate overhead departments consistent
with the significant growth we have experienced in the prior year.
The decrease in SG&A from 2001 to 2002 related to the benefits of consolidating
the administrative functions of our wire factories in 2001. The costs of this
consolidation were recorded in 2001 and the majority of the benefits from this
consolidation were derived in 2002.
13
WOOD MANUFACTURING
The Wood Manufacturing segment's financial performance was as follows:
Fiscal Year Ended January 31,
-----------------------------------------
2003 2002 2001
-----------------------------------------
Revenues $ 17,477 $ 17,971 $ 24,509
Cost of Revenues 16,390 16,163 18,920
----------- ---------- -----------
Gross Profit 1,087 1,808 5,589
Selling, General and Administrative Expense 1,799 1,709 1,471
Amortization of Goodwill - 342 317
Asset Impairment Charge - 9,539 -
----------- ---------- -----------
Operating Income (Loss) $ (712) $ (9,782) $ 3,801
- -----------------------------------------------------------------------------------------------------
Gross Profit Margin 6.2% 10.1% 22.8%
Selling, General and Administrative Expense (% of Revenue) 10.3% 9.5% 6.0%
- -----------------------------------------------------------------------------------------------------
Our Wood Manufacturing segment manufactures high-end custom wood retail display
fixtures.
Revenues
Revenues from the Wood Manufacturing segment are driven primarily by the number
of new store openings or remodels undertaken by our primary customers.
Historically, the segment relied heavily on two primary customers for its
revenues. As a result, significant changes in those customers' operating plans
have an immediate impact on the overall revenue growth of the segment. Revenues
decreased $494 (2.7%) from 2002 to 2003 and $6,538 (26.7%) from 2001 to 2002.
Revenues for 2003 and 2002 were comparable as new customer orders offset a
continued decline in revenues from the segment's major customers.
The decline in revenue from 2001 to 2002 related to the financial difficulties
of one of the segment's major customers.
During the last quarter of 2003 and first quarter of 2004, we have begun
manufacturing store fixtures for the largest operator of airport retail magazine
and bookstores in the United States.
Cost of Revenues
Cost of revenues includes the material, labor and factory overhead associated
with the manufacture of store fixtures. Cost of revenues is driven by the
quality of the fixture and the number of features requested by the customer.
Generally, we are able to improve gross profit for an individual customer's
program over their life-cycle through improved manufacturing efficiencies, which
results in less scrap, and the significant costs at the beginning of each
program allocated to design and tooling. Gross profit decreased $721 (39.9%)
from 2002 to 2003. Gross profit margins decreased 3.9% from 2002 to 2003. Gross
profit decreased $3,781 (67.7%) from 2001 to 2002. Gross profit margins
decreased 12.7% from 2001 to 2002.
The decrease in gross profit from 2002 to 2003 related primarily to higher costs
associated with implementing new customer programs, which generally have a
significant upfront investment in design and set-up costs. The decrease was
further impacted by the write-down of excess inventories.
The decrease in gross profit from 2001 to 2002 related to the loss of revenues
from one of the segment's major customers.
14
Selling, General and Administrative
Selling, General and Administrative (SG&A) consists of the administrative tasks
performed at the plant level. SG&A increased $90 (5.3%) from 2002 to 2003 and
$238 (16.2%) from 2001 to 2002.
The change in SG&A (excluding charges related to goodwill amortization and
relocation) was not significant to our overall operations in either year.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements for the Magazine Distribution segment are the cost
of the periodicals and the cost of freight, labor and overhead associated with
our distribution centers.
Our primary cash requirements for the In-Store Services segment are the cost of
raw materials, labor, and factory overhead incurred in the production of
front-end displays, funding corporate overhead, the cost of labor incurred in
providing our claiming, design and information services and cash advances
funding our Advance Pay program. Our Advance Pay program allows retailers to
receive a cash advance on future collections of their rebate claims, which is
repaid when those claims are paid by publishers.
Our primary cash requirements for the Wood Manufacturing segment are for
purchasing materials, the cost of labor, and factory overhead incurred in the
manufacturing process.
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.
Net cash provided by (used in) operating activities was $20,634, $(1,602) and
$7,295 for 2003, 2002 and 2001, respectively.
Operating cash flow from 2003 was primarily from net income ($7,338), adding
back non-cash charges such as depreciation and amortization ($3,301) and
provisions for losses on accounts receivable ($2,023) and a significant decrease
in accounts receivable ($17,619). These cash providing activities were offset by
a significant reduction in accounts payable ($9,675).
The decrease in accounts receivable relates to both faster collection of our
claim receivables and a significant decrease in receivables related to front-end
fixture programs.
The faster collection cycle for our claim receivables resulted from providing
publishers with the necessary information in an electronic format allowing for
quicker processing. As a result of this new process, claims outstanding related
to our Advance Pay program decreased compared to the prior fiscal year-end,
without a significant decrease in either the number or amount of claims filed.
Unpaid publisher claims related to our Advance Pay program and standard claim
program equal approximately one quarter's claim filings. However, this does not
equate to 90 days sale outstanding because the claims are not filed uniformly
over the quarter but almost entirely in the last month of the fiscal quarter.
The decrease in receivables related to front-end fixture programs relates
primarily to the timing of payments by significant participants of cost-shared
front-end fixture programs. Our year-end balance as of 2002 was inflated by the
significantly higher revenue in the third quarter of 2002 that was for the most
part collected in the first quarter of 2003.
Improved cash flow and profits in our Magazine Distribution segment allowed for
a significant reduction in accounts payable ($12,987 of the total decrease,
which was $9,675). We believe that we are now current with all our publishers,
which has significantly improved our relationship with the publishing community
and allowed us to expand our business with those publishers.
Cash used in operating activities in 2002 was $1,602 despite a net loss of
$72,865. Operating cash flow resulted from a significant non-cash charges
including depreciation and amortization, provisions for losses on accounts
receivable and an asset impairment charge. In addition to the non-cash charges
we also experience a significant increase in accounts payable, which increases
cash flow from operations. This increase related our recently purchased
Interlink subsidiaries increase in the average days outstanding to its vendors.
These increases were offset by a significant increase in accounts receivable.
The increase in accounts receivable was attributable to the high third quarter
revenues and the resulting accounts receivable that was not collected until the
first quarter of 2003.
Operating cash flow in 2001 was positive as a result of our net income and
increases related to non-cash charges such as depreciation and amortization and
provision for losses on accounts receivable. Increases caused by a overall
decrease in inventory were offset by decrease in other assets and accounts
payable and accrued expenses.
Net cash (used in) provided by investing activity was $(12,836), $2,270 and
$(7,416) in 2003, 2002 and 2001, respectively.
In 2003, cash used in investing activity related to capital expenditures of
$4,429, which related primarily to our relocation to Florida, an increase in our
advance pay receivable, the acquisition of Innovative Metal Fixtures ($2,014 of
a total purchase price of approximately $2,600; the remaining portion consisting
of a note payable to the former owner) and a customer list ($2,000) related to
the domestic distribution of foreign (primarily European) titles.
In 2002, cash provided by investing activities related primarily to a decrease
in our advance pay receivables partially offset by the acquisition of Interlink.
15
In 2001, cash used in investing activities related both to the initial
investment in Interlink as well as the acquisition of a marketable security.
Our borrowing agreements limit the amount we can expend on capital expenditures
in any fiscal year.
Net cash (used in) provided by financing activities was $(5,171), $1,190 and
$(532) in 2003, 2002 and 2001, respectively.
In 2003, cash used in financing activities related to repayments under our
credit facilities and note payables we assumed through our acquisition of
Interlink partially offset by a significant amount of checks outstanding at
year-end. The significant increase in outstanding checks relates to the timing
of our payments to retailers under the Advance Pay Program. At January 31, 2003,
we had completed the filing of the quarterly rebates and had just processed a
large number of payments, which was not the case at the end of 2002.
In 2002, cash provided by financing activities related to borrowing under our
credit facilities partially offset by the reduction of checks issued and
outstanding at January 31, 2002 compared to 2001.
In 2001, cash used in financing activities related to treasury stock purchases
partially offset by proceeds from the issuance of common stock.
At January 31, 2003, our total long-term debt obligations were $46,241,
excluding outstanding letters of credit. Long-term debt consists of our
revolving credit facility with Bank of America that we use to fund our In-Store
Services and Wood Manufacturing segments, our revolving credit facilities with
Congress Financial Corporation that we use to fund our Magazine Distribution
segment, and an Industrial Revenue Bond connected to our manufacturing facility
in Illinois.
The Bank of America credit agreement enables us to borrow up to $46 million
under a revolving credit facility subject to limits set by periodic borrowing
base calculation. Borrowings under the credit facility bear interest at a rate
equal to the 90-day LIBOR rate (1.3625% at January 31, 2003) plus 4.85% 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 excess availability at January 31, 2003, on the Bank of America revolving
credit facility was approximately $13,800 against which we had issued checks
totaling $6,611 that had not cleared the facility as of year-end. The checks
relate primarily to our Advance Pay Program and generally are issued at or near
our fiscal year-end depending upon the timing of our claiming processes. The
facility expires in August 2003 and as such is included in current maturities of
long-term debt.
Under the Bank of America credit agreement, we are subject to various financial
and operating covenants. These include (i) requirements that we satisfy various
financial ratios, (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 and (iii) limitations on
capital expenditures. The Company was not in compliance with the covenant
pertaining to maintaining a minimum EBITDA or the covenant pertaining to
maintaining a minimum debt to EBITDA ratio as defined by the agreement as of
January 31, 2003. The Company has requested and obtained a waiver from Bank of
America relating to these covenants through April 30, 2003. In addition, the
Company has obtained two options to extend the agreement through November 1,
2003, and February 1, 2004. The extensions lower the amount available under the
facility. We believe the Company could operate under the decreased facility.
In connection with the acquisition of Interlink, the Company assumed IPD and
Deyco's secured credit facilities 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 Congress agreements provide for maximum combined borrowings of $25,000
subject to limits set by periodic borrowing base calculations. Borrowings under
the revolving credit portion of the facility bear interest at a rate equal 0.25%
in excess of the prime rate (4.25% as of January 31, 2003). The credit facility
is secured by IPD and Deyco's accounts receivable and limited cross guarantees
between the two companies. Under the credit agreement, IPD and Deyco are
required to maintain certain financial ratios. IPD and Deyco were in compliance
with all such ratios at January 31, 2003.
16
Availability under the Congress facility is limited by the Company's borrowing
base calculation as defined in the agreement resulted in excess availability of
approximately $2,400 at January 31, 2003.
On January 30, 1995, the City of Rockford, Illinois issued $4,000 of its
Industrial Project Revenue Bonds, Series 1995, and the proceeds were deposited
with the Amalgamated Bank of Chicago, as trustee. The proceeds of the issuance
were utilized to construct our manufacturing facility in Rockford, Illinois.
Bank of America ("the Bank") has issued an unsecured letter of credit for $4,100
in connection with the IRB. The bonds are secured by the trustee's indenture and
the letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.
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. At this time, we believe we will be
able to replace the Bank of America credit facility with new bank financing at
terms consistent with or slightly less favorable than the existing facility
before the current agreement expires on August 1, 2003. If necessary, we can
avail ourselves of the offer to extend the facility an additional two three
month periods.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based on our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. Management bases its estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Senior Management has discussed the development, selection and
disclosure of these estimates with the Audit Committee of the Board of
Directors. Actual results may differ from these estimates under different
assumptions and conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.
Revenue Recognition
The Company records a reduction in revenue for estimated magazine sales returns
and a reduction in cost of sales for estimated magazine purchase returns.
Estimated sales returns are based on historical sales returns and daily point-of
sale data from significant customers. The purchase return estimate is based on
historical gross profit. If the historical data the Company uses to calculate
these estimates does not properly reflect future results, revenue and/or cost of
sales may be misstated.
Allowance for Doubtful Accounts
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.
Taxes on Earnings
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.
17
Valuation of Long-Lived Assets Including Goodwill and Purchased Intangible
Assets
We review property, plant and equipment, goodwill and purchased intangible
assets for impairment whenever events or changes in circumstances indicate the
carrying value of an asset may not be recoverable. Our asset impairment review
assesses the fair value of the assets based on the future cash flows the assets
are expected to generate. An impairment loss is recognized when estimated
undiscounted future cash flows expected to result from the use of the asset plus
net proceeds expected from the disposition of the asset (if any) are less than
the carrying value of the asset. This approach uses our estimates of future
market growth, forecasted revenue and costs, expected periods the asset will be
utilized and appropriate discount rates. Such evaluations of impairment of
long-lived assets including goodwill and purchased intangible assets are an
integral part of, but not limited to our strategic reviews of our business and
operations. Deterioration of our business overall or within a business segment
in the future could also lead to impairment adjustments as such issues are
identified.
Recent Accounting Pronouncements
In June 2002, the FASB issued FAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities." FAS No. 146 addresses the recognition,
measurement, and reporting of costs associated with exit and disposal
activities, including costs related to terminating a contract that is not a
capital lease and termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement that is not
an ongoing benefit arrangement or an individual deferred-compensation contract.
FAS No. 146 requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. This
statement will be effective for exit or disposal activities that are initiated
after December 31, 2002. The Company adopted FAS No. 146 and the pronouncement
did not have a material impact on the Company's results of operations or
financial position.
In December 2002, the FASB issued FAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." FAS No. 148 amends FAS No. 123, "Accounting for Stock-Based Compensation",
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, FAS No. 148 amends the disclosure requirements of FAS No. 123 to
require prominent disclosures in both the annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. As provided in FAS No.
123, the Company has elected to apply APB No. 25 "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its stock-based
compensation plans. APB No. 25 does not require options to be expenses when
granted with an exercise price equal to fair market value. The Company intends
to continue to apply the provisions of APB No. 25.
In November 2002, FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" was issued. FIN 45 elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The required disclosures and a roll-forward of
product warranty liabilities are effective for financial statements of interim
or annual periods ending after December 15, 2002. At this time, the Company does
not believe that the adoption of this interpretation will have a material effect
on its financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation
of Variable Interest Entities, an interpretation of ARB 51. The primary
objectives of FIN 46 are to provide guidance on the identification of entities
for which control is achieved through means other than through voting rights
("variable interest entities" or "VIEs") and how to determine when and which
business enterprise should consolidate the VIE (the "primary beneficiary"). This
new model for consolidation applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. The Company is currently evaluating the impact of FIN 46 on its
financial statements, but does not expect that there will be any material
impact.
18
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 facilities with Congress Financial Corporation.
The credit facility with Bank of America has an outstanding principal balance of
approximately $26,600 as of January 31, 2003. Interest on the outstanding
balance is charged based on a variable interest rate related to LIBOR plus a
margin specified in the credit agreement.
In order to better manage our 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, 2003, the fair value
of the swap is recorded in accrued expenses. The change in the fair value of the
swap is recorded in other income (expense).
The two credit facilities with Congress are secured by IPD and Deyco's accounts
receivable, inventories, equipment and other intangibles. The revolving credit
facilities had a combined outstanding principal balance of approximately $12,850
at January 31, 2003. Borrowings under the revolving credit portion of the
facility bear interest at a rate equal to 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.
We do not perform any interest rate hedging activities related to these two
facilities.
We have exposure to foreign currency fluctuations through our operations in
Canada. These operations accounted for approximately 1.8% of revenues. We
generally pay operating expenses in the corresponding local currency and will be
subject to increased risk for exchange rate fluctuations between such local
currency and the dollar.
Additionally, we have exposure to foreign currency fluctuation through our
purchase of magazines from foreign publishers. These magazines are purchased in
Euros and sold in the United States in local currency. A significant change in
the relative strength of the US $ could have an impact on the sales of these
magazines at retail.
We do not conduct any significant hedging activities related to foreign
currency.
Summarized below are our significant obligations and commitments to make future
payments under debt obligations and lease agreements based on obligations at
January 31, 2003.
Payments Due By Period
Less than 1 - 3 4 - 5 After 5
(in thousands) Total 1 Year Years Years Years
- -----------------------------------------------------------------------------------------------------------
Debt Obligations $ 46,241 $ 29,215 $ 12,936 $ 90 $ 4,000
Operating Leases 33,018 4,890 7,650 5,326 15,152
-----------------------------------------------------------------
Total Contractual Cash Obligations 79,259 34,105 20,586 5,416 19,152
- -----------------------------------------------------------------------------------------------------------
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.
None.
19
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 regarding the Company's directors is
incorporated by reference to the Company's 2003 Proxy Statement under the
captions "Nominees for Director-Class II," "Directors Continuing in Office-Class
I" and "Directors Continuing in Office-Class III." The information required by
Item 10 regarding the Company's executive officers is incorporated by reference
to the Company's 2003 Proxy Statement under the caption "Executive Officers."
The information required by Item 10 regarding compliance with Section 16(a) of
the Exchange Act is incorporated by reference to the Company's 2003 Proxy
Statement under the caption "Compliance with Section 16(a) of the Exchange Act."
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 is incorporated by reference to the
Company's 2003 Proxy Statement under the caption "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Except for the information concerning equity compensation plans, the information
required by Item 12 is incorporated by reference to the Company's 2003 Proxy
Statement under the caption "Security Ownership of Directors, Executive Officers
and Principal Stockholders."
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes our equity compensation plan information as of
January 31, 2003.
Number of securities
remaining available for
Number of securities to be future issuance under equity
issued upon exercise of Weighted-average exercise compensation plans
outstanding options, price of outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
- --------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- --------------------------------------------------------------------------------------------------------------------
Equity compensation
plans approved by
security holders 3,918,167 $ 7.36 603,430
- --------------------------------------------------------------------------------------------------------------------
Equity compensation
plans not approved by
security holders(1) 772,750 $ 6.22 -0-
- --------------------------------------------------------------------------------------------------------------------
Totals: 4,690,917 $ 7.07 603,430
- --------------------------------------------------------------------------------------------------------------------
(1) Represents options and warrants issued to executive and non-executive
employees as an inducement to accept employment with the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference to the
Company's 2003 Proxy Statement under the caption "Related Party Transactions"
and also appears in Note 10 of the Company's Notes to Consolidated Financial
Statements.
20
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures under the Securities Exchange Act of 1934, as of the
date of this report (the "Evaluation Date"). Based on this evaluation, our
principal executive officer and principal financial officer concluded as of the
Evaluation Date that our disclosure controls and procedures were effective such
that the material information required to be included in our Securities and
Exchange Commission ("SEC") reports is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms relating to
our company, including our consolidated subsidiaries, and was made known to them
by others within those entities, particularly during the period when this report
was being prepared.
In addition, there were no changes in our internal controls over financial
reporting that occurred during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting. In addition, we have not identified any
significant deficiencies or material weaknesses in the design or operation of
internal controls over financial reporting which are reasonably likely to
adversely affect our ability to record, process, summarize and report financial
information.
As described in Note 20 to our annual consolidated financial statements
contained herein, we have restated our financial statements to reflect
adjustments resulting from the revision of our accounting treatment of revenues
derived from our rebate claim filing services and cash flows from our Advance
Pay Program. In light of this restatement, we conducted a new evaluation of the
effectiveness of our disclosure controls and procedures as of the date of the
filing of this amended report. Based on this evaluation, our principal executive
officer and principal financial officer concluded that (a) the prior conclusion
was correct, and that our disclosure controls and procedures were effective, and
(b) the disclosure controls and procedures were not intended to elicit the type
of information that resulted in the restatement.
21
PART IV
ITEM 15. 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, 2003 and 2002
Consolidated statements of operations - years ended January 31, 2003,
2002 and 2001
Consolidated statements of stockholders' equity - years ended January
31, 2003, 2002 and 2001
Consolidated statements of cash flows - years ended January 31, 2003,
2002 and 2001
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.
On November 21, 2002, the Company filed a Current Report on Form 8-K
disclosing the appointment of Marc Fierman to the position of Chief
Financial Officer and attaching a copy of the press release announcing
such appointment.
22
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized,
March 3, 2004.
SOURCE INTERLINK COMPANIES, INC.
(registrant)
/s/ Marc Fierman
-----------------------------------
Marc Fierman
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities indicated March 3, 2004.
SIGNATURE TITLE
/s/ S. LESLIE FLEGEL Chairman, Chief Executive Officer
- ------------------------------------------ and Director (principal executive officer)
S. Leslie Flegel
/s/ JAMES R. GILLIS President, Chief Operating Officer
- ------------------------------------------ and Director
James R. Gillis
/s/ MARC FIERMAN Chief Financial Officer
- ------------------------------------------ (principal financial and accounting officer)
Marc Fierman
/s/ ROBERT O. ADERS Director
- ------------------------------------------
Robert O. Aders
/s/ HARRY L. FRANC III Director
- ------------------------------------------
Harry L. Franc III
/s/ ARON KATZMAN Director
- ------------------------------------------
Aron Katzman
/s/ ALLAN R. LYONS Director
- ------------------------------------------
Allan R. Lyons
/s/ RANDALL S. MINIX Director
- ------------------------------------------
Randall S. Minix
/s/ KENNETH F. TEASDALE Director
- ------------------------------------------
Kenneth F. Teasdale
23
INDEX TO FINANCIAL STATEMENTS
PAGE
Audited Consolidated Financial Statements of Source Interlink Companies, Inc.
The Report of the Independent Certified Public Accountants F-2
Consolidated Balance Sheets as of January 31, 2003 and 2002 F-3
Consolidated Statements of Operations for the fiscal years ended January 31, 2003, 2002 and 2001 F-5
Consolidated Statements of Stockholders' Equity F-6
Consolidated Statements of Cash Flows for the fiscal years ended January 31, 2003, 2002 and 2001 F-7
Notes to Consolidated Financial Statements F-8
F-1
THE REPORT OF THE INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Source Interlink Companies, Inc.
Bonita Springs, Florida
We have audited the consolidated balance sheets of Source Interlink
Companies, Inc. as of January 31, 2003 and 2002 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended January 31, 2003. 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 auditing standards generally
accepted 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, 2003 and 2002 and the results of its
operations and its cash flows for each of the three years in the period ended
January 31, 2003 in conformity with accounting principles generally accepted in
the United States of America.
As discussed in Note 20, the consolidated financial statements have been
restated to reflect the effect of a change in recognizing revenue for the
Company's rebate claim filing service. Also, as discussed in Note 1 to the
consolidated financial statements, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and other Intangible Assets," on
February 1, 2002.
/s/ BDO SEIDMAN, LLP
Chicago, Illinois
April 30, 2003, except for Note 20 which is as of March 1, 2004
F-2
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
January 31, 2003 2002
- ----------------------------------------------------------------------------------------------------------
(restated)
ASSETS
CURRENT
Cash $ 5,570 $ 2,943
Trade receivables (Note 3) 44,108 63,242
Claims purchased under advance pay program 7,761 3,368
Inventories (Note 4) 15,912 16,923
Income taxes receivable 6,883 6,085
Deferred tax asset (Note 9) 2,342 46
Other current assets 2,051 2,949
- ----------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 84,627 95,556
==========================================================================================================
Property, Plants and Equipment (Note 5) 27,671 27,561
Less accumulated depreciation and amortization (7,532) (7,184)
- ----------------------------------------------------------------------------------------------------------
NET PROPERTY, PLANTS AND EQUIPMENT 20,139 20,377
==========================================================================================================
OTHER ASSETS
Goodwill 44,750 42,769
Other intangibles, net (Note 6) 2,047 108
Deferred tax asset (Note 9) 947 2,065
Other 4,729 3,555
- ----------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 52,473 48,497
==========================================================================================================
$ 157,239 $ 164,430
==========================================================================================================
See accompanying notes to
Consolidated Financial Statements
F-3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
January 31, 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
(restated)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future advances on revolving credit facility $ 6,611 $ -
Accounts payable and accrued expenses, net of allowance for returns of $31,543
and $38,527 at January 31, 2003 and 2002, respectively 50,119 60,362
Current maturities of long-term debt (Note 7) 29,215 42,097
Deferred revenue 2,177 2,497
Other current liabilities 24 24
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 88,146 104,980
Debt, less current maturities (Note 7) 17,026 15,578
Other long-term liabilities 1,148 329
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 106,320 120,887
============================================================================================================================
COMMITMENTS AND CONTINGENCIES (Notes 11 and 12)
STOCKHOLDERS' EQUITY
Contributed Capital:
Preferred Stock, $.01 par (2,000 shares authorized; none issued) - -
Common Stock, $.01 par (40,000 shares authorized; 18,363 and 19,415 shares
issued) 184 194
Additional paid-in-capital 97,338 103,386
- ----------------------------------------------------------------------------------------------------------------------------
Total contributed capital 97,522 103,580
Accumulated deficit (45,826) (53,164)
Accumulated other comprehensive (loss):
Foreign currency translation (210) (387)
- ----------------------------------------------------------------------------------------------------------------------------
51,486 50,029
Less: Treasury Stock (100 and 1,126 shares at cost) (567) (6,486)
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 50,919 43,543
============================================================================================================================
$ 157,239 $ 164,430
============================================================================================================================
See accompanying notes to
Consolidated Financial Statements
F-4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
(restated)
Revenues $ 290,894 $ 238,923 $ 92,423
Costs of Revenues 216,483 176,357 53,792
- --------------------------------------------------------------------------------------------------------------------
Gross Profit 74,411 62,566 38,631
Selling, General and Administrative Expense 61,285 46,909 23,279
Relocation Expenses 1,926 - -
Amortization of Goodwill (Note 6) - 5,424 2,994
Goodwill Impairment Charge - 78,126 -
- --------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) 11,200 (67,893) 12,358
- --------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Interest expense, net (3,765) (3,338) (2,312)
Other 514 (2,339) 36
- --------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) (3,251) (5,677) (2,276)
- --------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 7,949 (73,570) 10,082
Income Tax Expense (Benefit) (Note 9) 611 (705) 3,965
====================================================================================================================
Net Income (Loss) $ 7,338 $ (72,865) $ 6,117
====================================================================================================================
Earnings per Share - Basic $ 0.40 $ (4.07) $ 0.35
Weighted Average of Shares Outstanding - Basic (Note 8) 18,229 17,915 17,591
Earnings per Share - Diluted $ 0.40 $ (4.07) $ 0.33
Weighted Average of Shares Outstanding - Diluted (Note 8) 18,478 17,915 18,348
====================================================================================================================
See accompanying notes to
Consolidated Financial Statements
F-5
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
(restated)
Retained
Common Stock Additional Earnings Other Treasury Stock Total
---------------- Paid - in (Accumulated Comprehensive ------------------ Stockholders'
Shares Amount Capital Deficit) (Loss) Shares Amount Equity
- --------------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 2000
(as previously reported) 17,345 $ 173 $ 91,770 $ 15,878 $ 80 42 $ (487) $ 107,414
Prior period adjustment -- -- -- (2,294) -- -- -- (2,294)
------ ------ ---------- --------- ----- ------- -------------
Balance January 31, 2000
(as restated) 17,345 173 91,770 13,584 80 42 (487) 105,120
Net income 6,117 6,117
Foreign Currency
Translation (161) (161)
Unrealized loss on
marketable security, net
of taxes (1,339) (1,339)
-------------
Comprehensive income 4,617
-------------
Issuance of common stock 413 4 2,283 2,287
Exercise of stock options 110 1 860 861
Exercise of warrants 499 5 2,542 2,547
Purchase of treasury stock 1,075 (5,960) (5,960)
Other 5 - 318 318
- -------------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 2001
(as restated) 18,372 183 97,773 19,701 (1,420) 1,117 (6,447) 109,790
Net loss (72,865) (72,865)
Foreign Currency Translation (306) (306)
Loss on marketable security
included in net income 1,339 1,339
-------------
Comprehensive loss (71,832)
-------------
Issuance of common stock 980 10 5,439 5,449
Exercise of stock options 57 1 147 148
Purchase of treasury stock 9 (39) (39)
Other 6 - 27 27
- -------------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 2002
(as restated) 19,415 $ 194 $ 103,386 $ (53,164) $ (387) 1,126 $(6,486) $ 43,543
Net income 7,338 7,338
Foreign Currency Translation 177 177
-------------
Comprehensive income 7,515
-------------
Issuance of common stock in
exchange for services 46 1 214 215
Exercise of stock options 17 - 77 77
Exercise of warrants 11 - 32 32
Purchase of treasury stock 100 (464) (464)
Retirement of treasury stock (1,126) (11) (6,372) (1,126) 6,383 -
Other 1 1
- -------------------------------------------------------------------------------------------------------------------------------
Balance, January 31, 2003
(as restated) 18,363 $ 184 $ 97,338 $ (45,826) $ (210) 100 $ (567) $ 50,919
===============================================================================================================================
See accompanying notes to
Consolidated Financial Statements
F-6
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(restated)
Years ended January 31, 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 7,338 $ (72,865) $ 6,117
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 3,301 7,815 4,957
Provision for losses on accounts receivable 2,023 2,824 1,477
Deferred income taxes (2,278) (2,321) 215
Deferred revenue (320) (855) (472)
Loss on sale of security - 3,500 -
Asset impairment charge - 78,126 -
Other (288) 581 498
Changes in assets and liabilities (excluding business
acquisitions):
Decrease (increase) in accounts receivable 17,619 (36,851) (1,679)
Decrease (increase) in inventories 1,200 (3,227) 3,700
Decrease (increase) in other assets 1,714 (1,476) (3,021)
(Decrease) increase in accounts payable and accrued expenses (9,675) 23,147 (4,497)
- --------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 20,634 (1,602) 7,295
- --------------------------------------------------------------------------------------------------------------------
INVESTMENT ACTIVITIES
Capital expenditures (4,429) (3,711) (3,517)
Purchase of claims under advance pay program (79,789) (85,888) (73,030)
Collections on claims under advance pay program 75,396 101,886 74,453
Acquisition of The Interlink Companies, Inc., net of cash acquired - (13,677) (2,544)
Acquisition of Innovative Metal Fixtures, Inc. (2,014) - -
Acquisition of customer list (2,000) -
Proceeds from the sale of fixed assets - 3,495 9
Investment in marketable security - - (3,500)
Other - 165 713
- --------------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (12,836) 2,270 (7,416)
- --------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase (decrease) in checks issued against revolving credit
facilities 6,611 (4,575) 2,601
(Repayments) Borrowings under credit facilities (7,667) 5,656 (493)
Payments of notes payable (3,758) - -
Proceeds from the issuance of common stock - 148 3,408
Purchase of treasury stock (465) (39) (5,960)
Other 108 - (88)
- --------------------------------------------------------------------------------------------------------------------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (5,171) 1,190 (532)
- --------------------------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN CASH 2,627 1,858 (653)
CASH, beginning of period 2,943 1,085 1,738
- --------------------------------------------------------------------------------------------------------------------
CASH, end of period $ 5,570 $ 2,943 $ 1,085
- --------------------------------------------------------------------------------------------------------------------
See accompanying notes to
Consolidated Financial Statements
F-7
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Source Interlink Companies, Inc. (the Company) and its subsidiaries distribute
magazines direct to specialty retailers, design, manufacture, install and remove
retail fixtures located at the check-out lane, manage retailers' claim for
rebates with magazine publishers, provides access to a comprehensive database of
point-of-sale data to retailers and product managers, and manufactures high-end
wood retail display fixtures.
Principles of Consolidation
The consolidated financial statements include the accounts of Source Interlink
Companies, Inc. and its wholly-owned subsidiaries (collectively, the Company) as
of the date they were acquired. All significant intercompany accounts and
transactions have been eliminated.
Use of Estimates
The preparation of financial statements in accordance with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Basis of Presentation
Certain amounts from the prior years have been reclassified to conform to
current year presentation. The reclassifications included the reclass of certain
shipping and delivery expenses from cost of revenues to selling, general and
administrative expenses, the reclass of certain sales discounts from selling,
general and administrative expenses to revenues and the reclass of our
fulfillment service revenues from other income to revenues. These
reclassification adjustments had no impact on income (loss) before income taxes.
Revenue Recognition
Magazine Distribution
Revenues from the sale of magazines the Company distributes are recognized at
the time of shipment less allowances for estimated returns. Revenues from the
sale of magazines to wholesalers that are not shipped through our distribution
centers are recognized at the later of notification from the shipping agent that
the product has been delivered or the on-sale date of the magazine. The Company
records a reduction in revenue for estimated magazine sales returns and a
reduction in cost of sales for estimated magazine purchase returns. Estimated
returns are based on historical sell-through rates.
Fulfillment & Return Processing Services
Revenues from performing fulfillment and return processing services are
recognized at the time the service is performed. The Company is generally
compensated on either a per-copy or per-pound basis based on a negotiated price
or a cost plus model.
Rebate Claim Filing
Revenues from the filing of rebate claims with publisher on behalf of retailers
are recognized at the time the claim is paid. The revenue recognized is based on
the amount paid multiplied by our commission rate. The Company has developed a
program (the "advance pay" program) whereby the Company will advance the claimed
amount less applicable commissions to the retailers and collect the entire
amount claimed from publishers for our own accounts. The Company accounts for
the advance as a purchase of a financial asset and records a receivable the time
of the purchase.
F-8
Information Products
Revenues from information product contracts are recognized ratably over the
subscription term, generally one year.
Custom Display Manufacturing
Revenues from the design and manufacture of custom display fixtures are
recognized when the retailer accepts title to the display. Transfer of title
usually occurs upon shipment. However, upon request from a customer, the product
can be stored for future delivery for the convenience of the customer. If this
occurs, we recognize revenue 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. Services related to the
manufacturing of displays such as freight, installation, warehousing and
salvage are recognized when the services are performed.
Marketable Securities
Marketable securities are stated at fair market value or historical cost in
accordance with Statement of Financial Accounting Standards (FAS) 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.
Inventories
Inventories for In-store Services and Wood 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 the lower of
cost or market. Magazine inventory cost is determined by the last-in, first-out
("LIFO") method. The effect of the LIFO reserve at January 31, 2003 on the
balance sheet and the income statement is insignificant.
Property, Plant & Equipment
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method for financial reporting over the estimated useful lives
ranging from 3 to 30 years.
Intangible Assets
On February 1, 2002, the Company adopted Statement of Financial Accounting
Standards FAS No. 142, "Goodwill and Other Intangible Assets" effective for
fiscal years beginning after December 15, 2001. In accordance with FAS No. 142,
the Company completed its transitional impairment testing of intangible assets
during the first quarter of fiscal 2003. The impairment testing was performed in
two steps: first, determining whether there was impairment, based upon the fair
value of a reporting unit as compared to its carrying value, and second, if
there was impairment, the determination of the impairment loss by comparing the
implied fair value of goodwill with the carrying amount of that goodwill.
Subsequent to the first quarter of fiscal 2003, with the assistance of a
third-party valuation firm, the Company finalized the testing of goodwill
subject to SFAS 142. Using conservative, but realistic assumptions to model its
In-Store segment, it determined that the derived fair value of the In-Store
segment was greater than the carrying value, indicating no impairment in the
recorded goodwill. To determine fair value, the Company relied on a discounted
cash flow analysis. For goodwill valuation purposes only, the revised fair value
of this unit was allocated to the assets and liabilities of the reporting unit
to arrive at an implied fair value of goodwill, based upon known facts and
circumstances, as if the acquisition occurred currently.
F-9
Intangible assets consist primarily of goodwill. Statement of Financial
Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets",
requires the Company to assess goodwill for impairment at least annually in the
absence of an indicator of possible impairment and immediately upon an indicator
of possible impairment. If it is determined that the fair values are less than
the carrying amount of goodwill recorded on its Consolidated Balance Sheet, the
Company must recognize an impairment in its financial statements (see summary of
accounting principal regarding impairment of long-live assets). With the
adoption of SFAS 142, goodwill is no longer amortized. Prior to the adoption we
amortized goodwill over 15 to 20 years using a straight-line method.
Impairment of Long-Lived Assets
The Company records impairment losses on long-lived assets used in operations
when events and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of those items. Our cash flow estimates are based on
historical results adjusted to reflect our best estimate of future market and
operating conditions. The net carrying value of assets not recoverable is
reduced to fair value. Our estimates of fair value represent our best estimate
based on industry trends and reference to market rates and transactions. The
Company had made acquisitions in the past that included a significant amount of
goodwill and other intangible assets. Under generally accepted accounting
principles in effect through December 31, 2001, these assets were amortized over
their estimated useful lives, and were tested periodically to determine if they
were recoverable from operating earnings on an undiscounted basis over their
useful lives. Effective in 2002, goodwill is no longer amortized but is subject
to an annual (or under certain circumstances more frequent) impairment test
based on its estimated fair value. Other intangible assets that meet certain
criteria will continue to be amortized over their useful lives and will also be
subject to an impairment test based on estimated fair value. Estimated fair
value is less than values based on undiscounted operating earnings because fair
value estimates include a discount factor in valuing future cash flows. There
are many assumptions and estimates underlying the determination of an impairment
loss. Another estimate using different, but still reasonable, assumptions could
produce a significantly different result
Derivative Financial Instruments
The Company uses a derivative to hedge variable interest rate exposure related
to its Bank of America credit facility. To achieve hedge accounting, the
criteria specified in FAS No. 133, "Accounting for Derivative Instrument and
Hedging Activities" must be met. FAS 133 requires all derivatives, whether
designated for hedging relationships or not, to be recorded on the balance sheet
at fair value. The accounting for changes in the value of a derivative depends
on whether the contract has been designated and qualifies for hedge accounting.
The Company's derivative did not qualify for hedge accounting and any changes in
fair value are recorded on the statement of operations.
Concentrations of Credit Risk
The Company has significant concentrations of credit risk in its Magazine
Distribution, In-Store Services and Wood Manufacturing segments. If the Company
experiences a significant reduction in business from its customers, the
Company's results of operations and financial condition may be materially and
adversely affected.
Major Customers
During fiscal 2003, two customers accounted for 46.6% (27.7% and 18.9%) of
total revenues.
During fiscal 2002, two customers accounted for 49.0% (26.4% and 22.6%) of
total revenues.
During fiscal 2001, one customer accounted for 13.8% of total revenues.
F-10
Allowance for Doubtful Accounts
The Company provides for potential uncollectible accounts receivable based on
customer specific information and historical collection experience.
Shipping and Handling Charges
Shipping and handling charges related to the distribution of magazines are
included in Selling, General and Administrative expenses. These costs amounted
to $14,720 and $9,797 in 2003 and 2002, respectively.
Relocation Expenses
The Company relocated its claims submission and fixture billing center, its
Corporate Headquarters, and its magazine distribution administrative offices to
its new facility in Bonita Springs, FL. The Company elected early adoption of
FAS 146, "Accounting for Costs Associated with Exit of Disposal Activities" and
accounted for the relocation in accordance with the guidance provided by FAS
146. FAS 146 requires recording costs associated with an exit or disposal
activity at their fair values when a liability has been incurred. During fiscal
2003, the Company incurred $1,926 of expenses related to the relocations. These
costs consist of reimbursement of moving expenses for relocating employees
($1,224), severance payments to non-relocation employees ($245) and other costs.
The Company completed the relocation in April, 2003 at an additional cost of
approximately $1,200. These expenses were recorded when incurred subsequent to
year-end.
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.
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.
Accounting for Stock-Based Compensation
FAS No. 123, "Accounting for Stock-Based Compensation" defined a fair value
method of accounting for stock options and other equity instruments. Under the
fair value method, compensation cost is measured at the grant date based on the
fair value of the award and is recognized over the service period, which is
usually the vesting period. As provided in FAS No. 123, the Company elected to
apply Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans. No stock
based compensation was reflected in the fiscal 2003, 2002 or 2001 net income
(loss) as all options granted in those years had an exercise price equal to or
greater than the market value of the underlying stock on the date of grant.
F-11
The following is a reconciliation of net income (loss) per weighted average
share had the Company adopted FAS No. 123 (table in thousands except per share
amounts):
2003 2002 2001
- ----------------------------------------------------------------------------------------------------
Net income (loss) $ 7,338 $ (72,865) $ 6,117
Stock compensation costs, net of tax (2,191) (1,788) (1,403)
------------- -------------- --------------
Adjusted net income (loss) $ 5,147 $ (74,653) $ 4,714
============= ============== ==============
Weighted average shares, basic 18,229 17,915 17,591
Weighted average shares, diluted 18,478 17,915 18,348
Basic earnings per share - as reported $ 0.40 $ (4.07) $ 0.35
============= ============== ==============
Diluted earnings per share - as reported $ 0.40 $ (4.07) $ 0.33
============= ============== ==============
Basic earnings per share - pro-forma $ 0.28 $ (4.17) $ 0.27
============= ============== ==============
Diluted earnings per share - pro-forma $ 0.28 $ (4.17) $ 0.26
============= ============== ==============
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
Year Ended January 31, 2003 2002 2001
- -------------------------------------------------------------------------------------------------
Dividend yield 0% 0% 0%
Expected volatility 0.50 0.60 0.56
Risk-free interest rate 2.21% - 4.32% 3.27% - 4.78% 4.92% - 6.82%
- -------------------------------------------------------------------------------------------------
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.
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.
F-12
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.
Recent Accounting Pronouncements
In June 2002, the FASB issued FAS No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities." FAS No. 146 addresses the recognition,
measurement, and reporting of costs associated with exit and disposal
activities, including costs related to terminating a contract that is not a
capital lease and termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement that is not
an ongoing benefit arrangement or an individual deferred-compensation contract.
FAS No. 146 requires recording costs associated with exit or disposal activities
at their fair values when a liability has been incurred. Under previous
guidance, certain exit costs were accrued upon management's commitment to an
exit plan, which is generally before an actual liability has been incurred. The
Company has adopted FAS No. 146 and the pronouncement did not have a material
impact on the Company's results of operations or financial position.
In December 2002, the FASB issued FAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FASB Statement No.
123." FAS No. 148 amends FAS No. 123, "Accounting for Stock-Based Compensation",
to provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, FAS No. 148 amends the disclosure requirements of FAS No. 123 to
require prominent disclosures in both the annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. As provided in FAS No.
123, the Company has elected to apply APB No. 25 "Accounting for Stock Issued to
Employees" and related interpretations in accounting for its stock-based
compensation plans. APB No. 25 does not require options to be expenses when
granted with an exercise price equal to fair market value. The Company intends
to continue to apply the provisions of APB No. 25.
In November 2002, FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" was issued. FIN 45 elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of this
Interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. The required disclosures and a roll-forward of
product warranty liabilities are effective for financial statements of interim
or annual periods ending after December 15, 2002. At this time, the Company does
not believe that the adoption of this interpretation will have a material effect
on its financial statements.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"), Consolidation
of Variable Interest Entities, an interpretation of ARB 51. The primary
objectives of FIN 46 are to provide guidance on the identification of entities
for which control is achieved through means other than through voting rights
("variable interest entities" or "VIEs") and how to determine when and which
business enterprise should consolidate the VIE (the "primary beneficiary"). This
new model for consolidation applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entity's activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46 requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE make additional
disclosures. The Company is currently evaluating the impact of FIN 46 on its
financial statements, but does not expect that there will be any material
impact.
F-13
2. BUSINESS COMBINATIONS AND ASSET ACQUISITIONS
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 million (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.
F-14
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, 2001 and 2000, are
listed below (in thousands):
2002 2001
- ----------------------------------------------------------------------------
Total Revenues As reported $ 238,923 $ 92,423
Pro forma 299,545 272,441
Net Income (loss) As reported (72,865) 6,117
Pro forma (84,522) (1,222)
Earnings (loss) Per Share
Basic As reported $ (4.07) $ 0.35
Diluted As reported (4.07) 0.33
Basic Pro forma (4.72) (0.07)
Diluted Pro forma (4.72) (0.07)
- ---------------------------------------------------------------------------
Innovative Metal Fixtures, Inc.
In May, 2002 the Company (through its Aaron Wire subsidiary) acquired all of the
assets of Innovative Metal Fixtures, Inc. for $2.6 million ($2.0 million in cash
and $0.6 million in a note payable to the former owner). Innovative Metal
Fixtures, Inc. manufactures wire and metal fixture displays from manufacturing
facilities in Vancouver, British Columbia.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$2.0 million. The fair value of the assets acquired was allocated primarily to
goodwill. Pro-forma results have not been shown due to the lack of significance
of the acquisition.
Foreign Title Customer List
In May, 2002, the Company acquired a customer (publisher) list giving the
Company the right to distribute domestically a group of foreign titles. The
agreement calls for an initial payment of $2.0 million and additional contingent
payments up to $3.5 million over the next three years based on the overall gross
profit generated from the sale of these titles. Payments under this agreement
are included in intangible assets and are being amortized over ten years.
Amortization expense of $150 thousand is included in Selling, General and
Administrative expenses.
F-15
3. ACCOUNTS RECEIVABLE
Accounts receivable consist of the following (in thousands):
2003 2002
- ------------------------------------------------------------------------
Accounts Receivable $ 88,322 $ 112,733
Allowance:
Sales returns and other 38,289 43,349
Doubtful accounts 5,925 6,142
- ------------------------------------------------------------------------
44,214 49,491
- ------------------------------------------------------------------------
$ 44,108 $ 63,242
========================================================================
4. INVENTORIES
Inventories consist of the following (in thousands):
2003 2002
- ------------------------------------------------------------------------
Raw materials $ 2,413 $ 2,559
Work-in-process 1,752 1,754
Finished goods:
Fixtures 1,174 1,790
Magazine inventory 10,573 10,820
- ------------------------------------------------------------------------
$ 15,912 $ 16,923
========================================================================
In the event of non-sale, magazine and periodical inventories are generally
returnable to the publishers for full credit.
5. PROPERTY, PLANTS AND EQUIPMENT
Property, Plants and Equipment consist of the following (in thousands):
2003 2002
- ------------------------------------------------------------------------
Land $ 911 $ 1,423
Buildings 7,222 8,584
Leasehold Improvements 1,190 1,048
Machinery & Equipment 8,746 8,946
Vehicles 344 584
Furniture and Fixtures 3,247 1,400
Computers 6,011 5,576
- ------------------------------------------------------------------------
Total Property, Plants and Equipment $ 27,671 $ 27,561
========================================================================
F-16
6. OTHER INTANGIBLE ASSETS
A summary of the Company's other intangible assets is as follows (in thousands):
2003 2002
- ------------------------------------------------------------------------
Amortizable Intangible Assets:
Other 2,483 300
Accumulated Amortization (436) (192)
- ------------------------------------------------------------------------
Intangibles, net $ 2,047 $ 108
- ------------------------------------------------------------------------
Amortization expense for each of the five succeeding years is estimated to be
approximately (in thousands) $200 in 2004 and $150 thereafter.
For comparative purposes, the following schedule is a reconciliation of reported
net income to adjusted net income for the three years ended January 31, 2003,
adjusted to exclude goodwill amortization.
(in thousands, except per share data) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------
Reported Net Income $ 7,338 $ (72,865) $ 6,117
Add back: Goodwill amortization, net of tax - 4,842 2,448
---------------- --------------- --------------
Adjusted Net Income $ 7,338 $ (68,023) $ 8,565
================ =============== ==============
Reported Earnings Per Share - Basic $ 0.40 $ (4.07) $ 0.35
================ =============== ==============
Reported Earnings Per Share -Diluted $ 0.40 $ (4.07) $ 0.33
================ =============== ==============
Adjusted Earnings Per Share - Basic $ 0.40 $ (3.80) $ 0.49
================ =============== ==============
Adjusted Earnings Per Share -Diluted $ 0.40 $ (3.80) $ 0.47
================ =============== ==============
In 2002, we recorded an asset impairment charge related to the carrying value of
goodwill. The events and/or changes in circumstances that indicated that the
recoverability of the carrying amount of our goodwill should be assessed are
described below:
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 was
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
F-17
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):
Original Impairment Resulting
Segment Goodwill Charge Goodwill
- --------------------------------------------------------------------
In-Store 42,769 - 42,769
Manufacturing 9,539 9,539 -
Magazine Distribution 68,587 68,587 -
====================================================================
F-18
7. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of (in thousands):
2003 2002
==================================================================================================
Revolving Credit Facility - Bank of America $ 26,611 $ 36,073
Revolving Credit Facilities - Congress Financial Corporation 12,857 11,068
Industrial Revenue Bonds 4,000 4,000
Notes payable to former owners of acquired company, currently
being disputed by Company 1,886 2,750
Term loan - Congress Financial Corporation - 2,778
Note payable to former owner of acquired company 200 400
Other 687 606
- --------------------------------------------------------------------------------------------------
Total Long-term Debt 46,241 57,675
Less current maturities 29,215 42,097
- --------------------------------------------------------------------------------------------------
Long-term Debt $ 17,026 $ 15,578
==================================================================================================
On December 22, 1999, the Company entered into a credit agreement with Bank of
America, N.A., which was amended on August 30, 2002 to extend the termination
date to August 1, 2003 and to grant Bank of America, N.A. a first-priority
perfected security interest in all real and personal property of the Company
excluding the capital stock and assets of The Interlink Companies, Inc.,
International Periodical Distributors, Inc. and David E. Young, Inc.
The Bank of America credit agreement enables the Company to borrow up to $46
million under a revolving credit facility. Borrowings under the credit facility
bear interest at a rate equal to the 90-day LIBOR rate (1.3625% at January 31,
2003) plus 4.85% 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. Under the credit
agreement, the Company is limited in its ability to declare dividends or other
distributions on capital stock or make payments in connection with the purchase,
redemption, retirement or acquisition of capital stock. There are also
limitations on capital expenditures and the Company is required to maintain
certain financial ratios. The Company was not in compliance with the covenant
pertaining to maintaining a minimum EBITDA or the covenant pertaining to
maintaining a minimum debt to EBITDA ratio as defined by the agreement as of
January 31, 2003. The Company has requested and obtained a waiver from Bank of
America relating to these covenants through April 30, 2003. In addition to this
waiver, the bank lowered certain financial ratio covenants for the period ended
April 30, 2003 and provided two three-month extensions that, if exercised, would
extend the maturity of the agreement through February 1, 2004.
Availability under the Bank of America facility is limited by the Company's
borrowing base calculation as defined in the agreement resulted in excess
availability of approximately $13.8 million at January 31, 2003.
F-19
In connection with the acquisition of Interlink, the Company assumed IPD and
Deyco's secured credit facilities 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 Congress agreements provide for maximum combined borrowings of $25.0 million
subject to limits set by periodic borrowing base calculations. Borrowings under
the revolving credit portion of the facility bear interest at a rate equal 0.25%
in excess of the prime rate (4.25% as of January 31, 2003). The credit facility
is secured by IPD and Deyco's accounts receivable and limited cross guarantees
between the two divisions. Under the credit agreement, IPD and Deyco are
required to maintain certain financial ratios. IPD and Deyco were in compliance
with all such ratios at January 31, 2003.
Availability under the Congress facility is limited by the Company's borrowing
base calculation as defined in the agreement resulted in excess availability of
approximately $2.4 million at January 31, 2003.
In connection with the acquisition of Interlink, the Company assumed debt to the
former owners of IPD. The Company is currently disputing the remaining amounts
owed and has commenced legal action requesting the court release the Company of
any further obligation under these arrangements. The notes were due in fiscal
2003 and bear interest of 12%, which the Company continues to accrue pending the
outcome of the pending litigation.
On January 30, 1995, the City of Rockford, Illinois issued $4,000 of its
Industrial Project Revenue Bonds, Series 1995, and the proceeds were deposited
with the Amalgamated Bank of Chicago, as trustee. The proceeds of the issuance
were utilized to construct our manufacturing facility in Rockford, Illinois.
Bank of America ("the Bank") has issued an unsecured letter of credit for $4,100
in connection with the IRB. The bonds are secured by the trustee's indenture and
the letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.
Annual maturities of long-term debt are as follows (in thousands): 2004 -
$29,215; 2005 - $38; 2006 - $12,898; 2007 - $43; 2008 - $47; thereafter -
$4,000.
8. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows (in thousands):
2003 2002 2001
=====================================================================================================
Weighted average number of common shares outstanding 18,229 17,915 17,591
- -----------------------------------------------------------------------------------------------------
Effect of dilutive securities:
Stock options and warrants 249 - 757
- -----------------------------------------------------------------------------------------------------
Total effect of dilutive securities 249 - 757
- -----------------------------------------------------------------------------------------------------
Weighted average number of common shares outstanding - as
adjusted 18,478 17,915 18,348
=====================================================================================================
Certain items were excluded from the dilution calculation for the following
reasons (shares in thousands):
F-20
At January 31, 2003, options and warrants to purchase 3,484 and 234 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 2003.
At January 31, 2002, options and warrants to purchase 4,326 and 262 shares of
common stock, respectively, were not included in the computation of diluted
earnings per share because they were anti-dilutive due to the Company's net
loss.
At January 31, 2001, options and warrants to purchase 1,373 and 682 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.
9. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of the assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The sources of
the temporary differences and their effect on deferred taxes are as follows (in
thousands):
2003 2002
- ------------------------------------------------------------------------------------------------------
Deferred Tax Assets
Net operating loss carryforwards $ 6,951 $ 7,391
Allowance for doubtful accounts 1,870 2,579
Goodwill 2,409 3,292
Other 1,898 1,329
- ------------------------------------------------------------------------------------------------------
13,128 14,591
Less: Valuation allowance (8,226) (10,335)
- ------------------------------------------------------------------------------------------------------
Deferred Tax Asset, Net 4,902 4,256
- ------------------------------------------------------------------------------------------------------
Deferred Tax Liabilities
Book/tax difference in capital assets 1,613 806
Book/tax difference in accounts receivable - 1,259
Other - 80
- ------------------------------------------------------------------------------------------------------
Total Deferred Tax Liabilities 1,613 2,145
- ------------------------------------------------------------------------------------------------------
Net Deferred Tax Asset (Liability) 3,289 2,111
======================================================================================================
Classified as:
Current asset (liability) 2,342 46
Long-term asset (liability) 947 2,065
- ------------------------------------------------------------------------------------------------------
Net Deferred Tax Asset (Liability) 3,289 2,111
======================================================================================================
At January 31, 2003, the Company had net operating loss ("NOL") carryforwards of
approximately $20,214 expiring through 2018.
Valuation allowances exist on assets where there is uncertainty as to their
eventual utilization. Valuation allowances relate primarily to NOL's whose usage
is limited by law.
F-21
Components of earnings (loss) before income taxes are as follows:
2003 2002 2001
- -------------------------------------------------------------------------------------------------------
United States $ 6,009 $ (74,305) $ 9,233
Foreign 1,940 735 849
- -------------------------------------------------------------------------------------------------------
$ 7,949 $ (73,570) $ 10,082
=======================================================================================================
Provision (benefit) for federal and state income taxes in the consolidated
statements of operations consist of the following components (in thousands):
2003 2002 2001
=======================================================================================================
Current
Federal $ 1,108 $ 969 $ 2,875
State 195 216 636
Foreign 485 431 239
- -------------------------------------------------------------------------------------------------------
Total Current 1,788 1,616 3,750
- -------------------------------------------------------------------------------------------------------
Deferred
Federal (1,028) (1,853) 257
State (181) (422) 50
Foreign 32 (46) (92)
- -------------------------------------------------------------------------------------------------------
Total Deferred (1,177) (2,321) 215
- -------------------------------------------------------------------------------------------------------
Total Income Tax (Benefit) Expense $ 611 $ (705) $ 3,965
=======================================================================================================
The following summary reconciles income taxes at the maximum federal statutory
rate with the effective rates for 2002, 2001 and 2000 (in thousands):
2003 2002 2001
- -------------------------------------------------------------------------------------------------------
Income tax expense (benefit) at statutory rate $ 2,703 $ (25,014) $ 3,428
Change in valuation allowance (2,109) - -
Non-deductible goodwill amortization - 1,266 478
Non-deductible goodwill impairment - 23,325 -
Non-taxable life insurance proceeds - (714) -
State income tax expense (benefit), net of
federal income tax benefit 403 (207) 444
Difference in foreign tax rates (142) 134 (142)
Other, net (244) 505 (243)
- -------------------------------------------------------------------------------------------------------
Income Tax (Benefit) Expense $ 611 $ (705) $ 3,965
=======================================================================================================
F-22
10 RELATED PARTY TRANSACTIONS
The Company paid Armstrong Teasdale LLP approximately $531, $800 and $510 for
the years ended January 31, 2003, 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.
11. 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 (in thousands) $4,870, $3,553 and $1,785 for the
years ended January 31, 2003, 2002 and 2001, respectively.
Future minimum payments, by year and in the aggregate, under non-cancelable
operating leases with initial or remaining terms of one year or more consisted
of the following at January 31, 2003 (in thousands):
Year Ending January 31, Leases
- ---------------------------------------------------------
2004 $ 4,890
2005 4,438
2006 3,212
2007 2,677
2008 2,649
Thereafter 15,152
- ---------------------------------------------------------
$ 33,018
=========================================================
12. LITIGATION AND CONTINGENCIES
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.
13. WARRANTS
The following table summarizes information about the warrants for common stock
outstanding at January 31, 2003:
Exercise Price Number Outstanding Date Exercisable Date of Expiration
- ---------------------------------------------------------------------------------
5.39 8,000 May 23, 2002 August 31, 2005
8.40 200,000 June 15, 1999 June 15, 2005
14.00 25,644 May 23, 2002 August 31, 2005
=================================================================================
F-23
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, 2003, 2002, and 2001.
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, 2003, 2002, and 2001 pursuant to
this Plan were approximately (in thousands) $343, $413, and $283, respectively.
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, 2003, 2002, or 2001.
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 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.
Union Plan
At January 31, 2003, approximately 240 of the Company's 1,300 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 $430, $440 and $440 for the years ended January 31, 2003, 2002,
and 2001, respectively.
F-24
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 vesting of the grants varies according
to the individual options granted.
Weighted
Range of Average
Number of Exercise Exercise
Options Prices Price
--------------------------------------------------
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 forfeited or 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 forfeited or 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
Options granted 926,750 4.27 - 6.00 4.83
Options forfeited or expired 545,633 1.66 - 16.63 6.26
Options exercised 16,599 2.42 - 5.00 4.63
--------------------------------------------------
Options outstanding at
January 31, 2003 4,690,917 2.42 - 21.60 7.07
==================================================================================
The following table summarizes information about the stock options outstanding
at January 31, 2003:
Options
Options Outstanding Exercisable
--------------------------------------------------------
Remaining
Number Contractual Numbers
Exercise Price Outstanding Life (Months) Exercisable
- ----------------------------------------------------------------------------
$ 2.42 - $ 5.00 2,147,128 53 - 112 1,552,179
5.01 - 7.50 1,042,955 36 - 118 833,288
7.51 - 10.00 629,667 70 - 90 593,667
10.01 - 15.00 552,667 71 - 88 527,467
15.01 - 21.60 318,500 78 - 86 309,420
--------- ---------
4,690,917 3,816,021
===========================================================================
Options exercisable at January 31, 2003 totaled 3,816,021 with a weighted
average exercise price of $7.58.
Options exercisable at January 31, 2002 totaled 2,548,042 with a weighted
average exercise price of $8.56.
F-25
Options exercisable at January 31, 2001 totaled 1,540,008 with a weighted
average exercise price of $10.17.
The weighted average fair value of each option granted during the year was
$1.80, $2.23, and $3.47 (at grant date) in 2003, 2002, and 2001, 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, 2003, 603,430 shares were available for grant under the plans.
15. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on the approximate amount of interest and income taxes
paid is as follows (in thousands):
Year Ended January 31, 2003 2002 2001
============================================================
Interest $ 3,545 $ 3,590 $ 2,241
Income Taxes $ 2,609 $ 2,565 $ 7,433
============================================================
Significant non-cash activities were as follows:
In connection with the Interlink acquisition in May 2001, the Company issued
980,025 shares of Common Stock.
During 2003, the company retired 1,126,120 shares of common stock held in
treasury which was recorded at a cost of $6,383.
As part of the relocation of our North Carolina claim submission and fixture
billing center to Bonita Springs, Florida, the assets related to the land and
building located in North Carolina totaling $1,841 was placed on the market for
sale. As a result, the related assets were removed from our capital asset
accounts and are recorded in other long-term assets.
In conjunction with business acquisitions, the Company used cash as follows (in
thousands):
Year ended January 31,
----------------------------
2003 2002 2001
- ---------------------------------------------------------------------------------------
Fair value of assets acquired, excluding cash $ 3,015 $ 77,435 $ -
Less: Liabilities assumed and created upon acquisition 397 58,309 -
Less: Note payable issued 604
Less: Stock issued - 5,449 -
- ---------------------------------------------------------------------------------------
Net Cash Paid $ 2,014 $ 13,677 $ -
=======================================================================================
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.
As of January 31, 2003, the fair value of the derivative was a liability of
approximately $670 thousand, which is recorded in accounts payable and accrued
expenses.
F-26
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:
Trade Receivables and Income Taxes Receivable
The carrying amounts approximate fair value because of the short maturity of
those instruments.
Accounts Payable and Accrued Expenses
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 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
long-term debt.
The estimated fair values of the Company's financial instruments are as follows
(in thousands):
Carrying Fair
January 31, 2003 Value Value
============================================================================
Financial Assets
Trade receivables $ 44,108 $ 44,108
Claims purchased under advance
pay program $ 7,761 $ 7,761
Income taxes receivable $ 6,883 $ 6,883
Financial Liabilities
Accounts payable and accrued expenses $ 50,119 $ 50,119
Long-term debt $ 46,241 $ 43,263
============================================================================
Carrying Fair
January 31, 2002 Value Value
============================================================================
Financial Assets
Trade receivables $ 63,242 $ 63,242
Claims purchased under advance
pay program $ 3,368 $ 3,368
Income taxes receivable $ 6,085 $ 6,085
Financial Liabilities
Accounts payable and accrued expenses $ 60,362 $ 60,362
Long-term debt $ 57,675 $ 57,613
============================================================================
F-27
18. SEGMENT FINANCIAL INFORMATION
The Company's segment reporting is based on the reporting of senior management
to the Chief Executive Officer. This reporting combines the Company's business
units in a logical way that identifies business concentrations and synergies.
Presentation has been modified from the prior year from pre-tax income to
operating income to conform to how financial results are presented to the Chief
Executive Officer.
The reportable segments of the Company are Magazine Distribution, In-Store
Services, and Wood Manufacturing.
The Magazine Distribution segment derives revenues from (1) selling and
distributing magazines to major book chains, independent retailers and secondary
wholesalers throughout North America, (2) serving as secondary national
distributor, (3) providing return processing services for major book chains and
(4) providing fulfillment services or other wholesalers.
The In-Store Services segment derives revenues from (1) providing information
and management services relating to retail magazine sales to U.S. and Canadian
retailers and magazine publishers, (2) providing claim filing services related
to rebates owed retailers from publishers or their designated agent, (3)
designing, manufacturing, and invoicing participants in front-end fixture
programs, and (4) shipping, installation and removal of front-end fixtures.
The Wood Manufacturing segment derives revenues from designing, manufacturing
and installing high-end wood store fixtures.
The accounting policies of the segments are materially the same as those
described in the Summary of Accounting Policies. The In-Store Services "Selling,
General & Administrative" segment includes the majority of corporate overhead
and the related corporate assets and expenditures.
Segment results follow (in thousands) (restated):
Magazine In-Store Wood
Year ended January 31, 2003 Distribution Services Manufacturing Consolidated
- ------------------------------------------------------------------------------------------------------------
Revenue $ 211,663 $ 61,754 $ 17,477 $ 290,894
Cost of Revenue 164,702 35,391 16,390 216,483
---------------------------------------------------------------
Gross Profit 46,961 26,363 1,087 74,411
Selling, General & Administrative 39,515 19,971 1,799 61,285
Relocation Expense 85 1,841 - 1,926
---------------------------------------------------------------
Operating Income $ 7,361 $ 4,551 $ (712) $ 11,200
===============================================================
Total Assets $ 32,862 $ 108,982 $ 15,395 $ 157,239
===============================================================
Magazine In-Store Wood
Year ended January 31, 2002 Distribution Services Manufacturing Consolidated
- ------------------------------------------------------------------------------------------------------------
Revenue $ 155,804 $ 65,148 $ $17,971 $ 238,923
Cost of Revenue 126,216 33,978 16,163 176,357
---------------------------------------------------------------
Gross Profit 29,588 31,170 1,808 62,566
Selling, General & Administrative 26,352 18,848 1,709 46,909
Amortization of Goodwill 2,359 2,723 342 5,424
Asset Impairment Charge 68,587 9,539 78,126
---------------------------------------------------------------
Operating Income $ (67,710) $ 9,599 $ (9,782) $ (67,893)
===============================================================
Total Assets $ 36,961 $ 110,043 $ 17,426 $ 164,430
===============================================================
F-28
Magazine In-Store Wood
Year ended January 31, 2001 Distribution Services Manufacturing Consolidated
- ------------------------------------------------------------------------------------------------------------
Revenue $ - $ 67,914 $ 24,509 $ 92,423
Cost of Revenue - 34,872 18,920 53,792
---------------------------------------------------------------
Gross Profit - 33,042 5,589 38,631
Selling, General & Administrative - 21,808 1,471 23,279
Amortization of Goodwill - 2,677 317 2,994
---------------------------------------------------------------
Operating Income $ - $ 8,557 $ 3,801 $ 12,358
===============================================================
Total Assets $ - $ 129,835 $ 28,613 $ 158,448
===============================================================
The Company derives essentially all its revenues inside the United States.
Revenues from operations outside the United States were not significant in 2003,
2002 or 2001.
19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (RESTATED)
Quarterly financial data for 2003 and 2002 is as follows (table in thousands,
except per share amounts):
Q1 Q2 Q3 Q4
-----------------------------------------------------
April 30 July 31 October 31 January 31
-----------------------------------------------------
2003
Total Revenue $ 67,066 $ 73,955 $ 81,214 $ 68,659
Gross Profit 18,902 17,809 20,384 17,317
Net Income 1,727 1,108 2,903 1,600
EPS - Diluted $ 0.09 $ 0.06 $ 0.16 $ 0.09
EPS - Basic 0.09 0.06 0.16 0.09
2002
Total Revenue $ 18,257 $ 57,347 $ 81,933 $ 81,386
Gross Profit 6,938 16,299 22,510 16,819
Net Income (loss) 2,525 1,176 2,551 (79,117)
EPS - Diluted $ 0.15 $ 0.07 $ 0.14 $ (4.29)
EPS - Basic 0.15 0.07 0.14 (4.29)
During the fourth quarter, the Company reclassified certain shipping and
handling costs previously reported in Cost of Revenues to Selling, General and
Administrative expenses, which increased reported gross profit. The reclassified
amounts were as follows: $3,675, $3,318 and $4,118 for the periods ended April,
30, 2002, July 31, 2002 and October 31, 2002, respectively. This
reclassification adjustment also impacted the previously reported results from
fiscal year 2002 as follows: $-, $2,542 and $3,880 for the periods ended April
30, 2001, July 31, 2001 and October 31, 2001, respectively.
Quarterly financial data for the fourth quarter of 2002 includes a goodwill
impairment charge of $78,126.
F-29
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
AS ORIGINALLY AS
REPORTED ADJUSTMENTS(1) RESTATED
------------- -------------- --------
QUARTER ENDED APRIL 30, 2002
Revenue.................................................. $66,755 $ 311 $67,066
Gross Profit............................................. 18,684 218 18,902
Net income (loss)........................................ 1,598 129 1,727
Earnings per share -- basic.............................. 0.09 -- 0.09
Earnings per share -- diluted............................ 0.09 -- 0.09
QUARTER ENDED JULY 31, 2002
Revenue.................................................. $73,854 $ 101 $73,955
Gross Profit............................................. 17,738 71 17,809
Net income (loss)........................................ 1,065 43 1,108
Earnings per share -- basic.............................. 0.06 -- 0.06
Earnings per share -- diluted............................ 0.06 -- 0.06
QUARTER ENDED OCTOBER 31, 2002
Revenue.................................................. $80,942 $ 272 $81,214
Gross Profit............................................. 20,194 190 20,384
Net income (loss)........................................ 2,789 114 2,903
Earnings per share -- basic.............................. 0.15 0.01 0.16
Earnings per share -- diluted............................ 0.15 0.01 0.16
QUARTER ENDED JANUARY 31, 2003
Revenue.................................................. $68,885 $ (226) $68,659
Gross Profit............................................. 17,476 (159) 17,317
Net income (loss)........................................ 1,694 (94) 1,600
Earnings per share -- basic.............................. 0.09 -- 0.09
Earnings per share -- diluted............................ 0.09 -- 0.09
QUARTER ENDED JANUARY 31, 2002
Revenue.................................................. $80,165 $1,221 $81,386
Gross Profit............................................. 15,964 855 16,819
Net income (loss)........................................ (79,630) 513 (79,117)
Earnings per share -- basic.............................. (4.37) 0.08 (4.29)
Earnings per share -- diluted............................ (4.37) 0.08 (4.29)
</Table>
- ---------------
(1) During 2004, the Company restated historical financial statements to revise
the recognition of revenue for its rebate claim filing. See note 20. The
change had no impact on the first, second and third fiscal quarters of
fiscal 2002.
F-30
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
20. RESTATEMENT
During 2004, the Company restated its historical financial statements to
revise the accounting treatment for revenue recognition related to its rebate
claim filing. During a detailed review of the accounting treatment of its
claiming revenue recognition policies, the Company determined that certain
revisions to the accounting treatment of its revenue recognition for rebate
claim filing were appropriate. Previously, revenues from the filing of rebate
claims with publishers on behalf of retailers were recognized at the time the
claim was filed. The revenue recognized was previously based on the amount
claimed multiplied by the commission rate. The actual amount payable to the
Company for rebate claiming services is based on a percentage of the claim paid
by the publisher. Based on guidance in SEC Staff Accounting Bulletin 104,
management believes it is considered more appropriate for the Company to
recognize revenue upon collection (rather than filing) of the claim. The Company
has also restated its statement of cash flows to include the purchases and
collections under our advance pay program as an investing activities. The
accompanying financial statements and notes reflect the restated amounts. The
following tables detail the effects of the restatement (in thousands, except per
share data):
<Table>
<Caption>
FOR THE YEAR ENDED,
---------------------------------------------------------------------
JANUARY 31, 2003 JANUARY 31, 2002 JANUARY 31, 2001
--------------------- --------------------- ---------------------
AS AS AS
PREVIOUSLY AS PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
---------- -------- ---------- -------- ---------- --------
Income Statement Data:
Net sales.................... $290,436 $290,894 $237,702 $238,923 91,748 92,423
Gross profit................. 74,091 74,411 61,711 62,566 38,159 38,631
Net income................... 7,146 7,338 (73,378) (72,865) 5,834 6,117
Basic net income per share... 0.39 0.40 (4.10) (4.07) 0.33 0.35
Diluted net income per
share...................... 0.39 0.40 (4.10) (4.07) 0.32 0.33
Cash Flow Data:
Operating cash flow.......... 16,241 20,634 14,396 (1,602) 8,718 7,295
Investing cash flow.......... (8,443) (12,836) (13,728) 2,270 (8,839) (7,416)
</Table>
<Table>
<Caption>
AT
---------------------------------------------
JANUARY 31, 2003 JANUARY 31, 2002
--------------------- ---------------------
AS AS
PREVIOUSLY AS PREVIOUSLY AS
REPORTED RESTATED REPORTED RESTATED
---------- -------- ---------- --------
Balance Sheet Data:
Current assets................................ 83,756 84,627 95,510 95,556
Total assets.................................. 156,368 157,239 164,384 164,430
Current liabilities........................... 85,969 88,146 103,436 104,980
Total liabilities............................. 104,143 106,320 119,343 120,887
Shareholders' equity.......................... 52,225 50,919 45,041 43,543
</Table>
The following table details unaudited quarterly financial data as
previously reported (refer to Note 19).
F-31
Report of Independent Certified Public Accountants
Board of Directors
Source Interlink Companies, Inc.
Bonita Springs, Florida
The audits referred to in our report dated April 30, 2003, except for Note 20
which is as of March 1, 2004 relating to the consolidated financial statements
of Source Interlink Companies, Inc., which are referred to in Item 8 of this
Form 10-K/A, 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
April 30, 2003
S-1
SCHEDULE II
SOURCE INTERLINK COMPANIES, INC.
Valuation and Qualifying Accounts Schedule
January 31, 2003
(in thousands)
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, 2003: 6,142 2,023 - 3,340 5,005
Allowance for doubtful accounts
Year ended January 31, 2002: 1,398 2,823 7,206 5,285 6,142
Allowance for doubtful accounts
Year ended January 31, 2001: 1,123 1,477 - 1,203 1,398
Allowance for doubtful accounts
Year ended January 31, 2003: 40,076 232,706 - 235,788 36,994
Allowance for sales return
Year ended January 31, 2002: - 152,220 33,592 145,736 40,076
Allowance for sales return
- ---------------------------------------------------------------------------------------------------------------
(1) Additions due to acquisitions
S-2
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------------------------------------------------------------------------------
3.1(a) Articles of Incorporation
3.2(a) Bylaws
3.3(b) Amendment to Articles of Incorporation
3.4(c) Amendments to Bylaws
3.5(c) Amendment to Articles of Incorporation
3.6(d) Amendment to Articles of Incorporation
3.7(e) Amendment to Articles of Incorporation
4.1(b) Form of Common Stock Certificate
10.1(a) Form of Indemnity Agreement with Officers and Directors
10.2(f) Credit Agreement between The Source Information Management Company and Bank of
America, N.A. dated December 22, 1999
10.2.1(e) Amendment to Credit Agreement between The Source Information Management Company and
Bank of America, N.A. dated December 22, 1999
10.2.2(g) Second Amendment and Waiver Agreement between Source Interlink Companies, Inc. and
Bank of America, N.A. dated May 1, 2003
10.3(h)(z) The Source Information Management Company Amended and Restated 1995 Incentive Stock
Option Plan
10.6(f)(z) Employment and Non-Competition Agreement with James R. Gillis dated as of December
14, 1998
10.6.1(h)(z) Amendment to Employment and Non-Competition Agreement with James R. Gillis dated as
of August 3, 2000
10.19(i) 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
10.20(h)(z) The Source Information Management Company Amended and Restated 1998 Omnibus Plan
10.21(j)(z) Employment Agreement Between The Source Information Management Company and S.
Leslie Flegel dated February 6, 2001
10.22(h)(z) Employment Agreement Between The Source Information Management Company and Jason S.
Flegel dated January 3, 2001
10.23(h)(z) Employment and Non-Competition Agreement Between The Source Information Management
Company and Monte Weiner dated August 3, 2000
10.24(k) 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.
10.25(e) Loan and Security Agreement by and between Congress Financial Corporation (Western)
and David E. Young, Inc. dated February 22, 2001
10.25.1(e) 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(e) Loan and Security Agreement by and between Congress Financial Corporation (Western)
and International Periodical Distributors, Inc. dated February 22, 2001
10.26.1(e) 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(e) 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(e) Standard Lease Agreement between SINV II, LLC as Landlord and Source-Huck Store Fixture Company
as Tenant dated October 31, 2001
10.29(e) Standard Lease Agreement between SINV, LLC as Landlord and Source-Huck Store Fixture Company
as Tenant dated October 31, 2001
10.31(e) Lease Agreement by and between Riverview Associates Limited Partnership and Source
Interlink Companies, Inc. dated August 9, 2001
10.32(g) Industrial Lease between Broadway Properties LTD and Innovative Metal Fixtures,
Inc. dated for reference June 1, 2001 and Assignment and Assumption Agreement
between Innovative Metal Fixtures, Inc., Aaron Wire & Metal Products LTD and
Broadway Properties LTD dated May 3, 2002
10.33(g) Net Lease between Conewago Contractors, Inc. and Pennsylvania International
Distribution Services, Inc. dated as of May 1, 2000
10.34(g) Lease Agreement between Regal Business Center, Inc and Publisher Distribution
Services, Inc. dated as of September 1, 1998, as amended by Modification and
Ratification of Lease Agreement dated as of October __, 1998 and Second
Modification and Ratification of Lease Agreement dated as of October __, 2001
(dates omitted in original)
10.35(g) Lease Agreement between Milan Industrial Park and Eastern News Distributors, Inc.
dated as of September __, 1995 (date omitted in original), as assigned by Assignment
and Assumption of Lease between COMAG Marketing Group, Inc. and International
Periodical Distributors, Inc. dated as of April 27, 2001
10.36(g) Commercial Lease Agreement between NCSC Properties LLC and Huck Store Fixture
Company of North Carolina dated July 1, 2002
10.37(g) Agreement between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen, Anna
Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing Corp. dated June
1, 1989, as amended by Extension of Lease dated October 22, 1999
10.38(g) Agreement between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen,
Steven Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing
Corporation dated November 1, 1995, as amended by Extension of Lease dated October
22, 1999
10.39(g) Agreement between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen, Anna
Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing Corp. dated
September 1, 1984, as amended by Extension of Lease dated October 22, 1999
21.1(g) Subsidiaries of the Company
23.1* Consent of BDO Seidman, LLP
31.1* Rule 13a-14(a)/15d-14(a) Certification of principal executive officer
31.2* Rule 13a-14(a)/15d-14(a) Certification of principal financial officer
32.1* Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- ----------
(a) Incorporated by reference to Registration Statement on Form S-B, as filed
with the SEC on June 12, 1995 (File No. 0-26238)
(b) Incorporated by reference to Registration Statement on Form SB-2, as filed
with the SEC on August 4, 1997 (File No. 333-32733)
(c) Incorporated by reference to Pre-Effective Amendment No. 3 to Registration
Statement on Form SB-2, as filed with the SEC on October 7, 1997 (File No.
333-32733)
(d) Incorporated by reference to Annual Report on Form 10-KSB, as filed with the
SEC on May 5, 1999 (File No. 001-13437)
(e) Incorporated by reference to Annual Report on Form 10-K, as filed with the
SEC on May 16, 2002 (File No. 001-13437)
(f) Incorporated by reference to Annual Report on Form 10-K, as filed with the
SEC on May 1, 2000 (File No. 001-13437)
(g) Incorporated by reference to Annual Report on Form 10-K, as filed with the
SEC on May 1, 2003 (File No. 001-13437)
(h) Incorporated by reference to Annual Report on Form 10-K, as filed with the
SEC on May 1, 2001 (File No. 001-13437)
(i) Incorporated by reference to Quarterly Report on Form 10-Q, as filed with
the SEC on June 14, 2000 (File No. 001-13437)
(j) Incorporated by reference to Quarterly Report on Form 10-Q, as filed with
the SEC on June 16, 2003 (File No. 001-13437)
(k) Incorporated by reference to Current Report on Form 8-K, as filed with the
SEC on June 12, 2001 (File No. 001-13437)
(z) Indicates management contract or compensatory plan or arrangement
* Filed herewith