UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended July 31, 2004
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________ to _________
Commission file number 1-13437
SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
MISSOURI 43-1710906
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
27500 RIVERVIEW CENTER BLVD., SUITE 400
BONITA SPRINGS, FLORIDA 34134
- ---------------------------------------- ----------------------
(Address of Principal Executive Offices) (Zip Code)
(239) 949-4450
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date.
Class Outstanding on September 08, 2004
----- ---------------------------------
Common Stock, $.01 Par Value 23,424,051
SOURCE INTERLINK COMPANIES, INC.
INDEX
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of
July 31, 2004 and January 31, 2004 1
Consolidated Statements of Income for the three months
and six months ended July 31, 2004 and 2003 3
Consolidated Statement of Stockholders'
Equity for the six months ended July 31, 2004 4
Consolidated Statements of Cash Flows for the
six months ended July 31, 2004 and 2003 5
Notes to Consolidated Financial Statements 6-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 27
ITEM 4. CONTROLS AND PROCEDURES 28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 29
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 29
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29
ITEM 5. OTHER INFORMATION 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 29
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
July 31, January 31,
2004 2004
------------ -----------
ASSETS
CURRENT
Cash $ 8,547 $ 4,963
Trade receivables (Note 2) 56,657 41,834
Purchased claims receivable 2,641 5,958
Inventories (Note 3) 15,748 17,241
Income taxes receivable 2,397 2,067
Deferred tax asset 3,405 2,915
Advances under magazine export agreement 3,769 6,830
Other 2,936 2,536
--------- ---------
TOTAL CURRENT ASSETS 96,100 84,344
========= =========
Property, Plants and Equipment 32,248 29,145
Less accumulated depreciation and amortization (12,411) (10,582)
--------- ---------
NET PROPERTY, PLANTS AND EQUIPMENT 19,837 18,563
========= =========
OTHER ASSETS
Goodwill, net 45,312 45,307
Intangibles, net 9,018 7,931
Deferred tax asset 658 908
Other 6,354 7,048
--------- ---------
TOTAL OTHER ASSETS 61,342 61,194
========= =========
$ 177,279 $ 164,101
========= =========
See accompanying notes to
Consolidated Financial Statements
1
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
July 31, January 31,
2004 2004
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future advances on revolving credit facility $ 5,328 $ 14,129
Accounts payable and accrued expenses, net of allowance for returns
of $48,455 and $57,842 at July 31 and January 31, 2004 respectively 48,000 44,741
Deferred revenue 1,519 1,680
Current maturities of long-term debt (Note 4) 2,032 4,059
Other current liabilities 79 317
--------- ---------
TOTAL CURRENT LIABILITIES 56,958 64,926
Debt, less current maturities (Note 4) 3,159 31,541
Other long-term liabilities 567 560
--------- ---------
TOTAL LIABILITIES 60,684 97,027
========= =========
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Contributed Capital:
Preferred Stock, $0.01 par (2,000 shares authorized; none issued) - -
Common Stock, $0.01 par (40,000 shares authorized; 23,416 and 18,991 shares issued) 234 190
Additional paid-in-capital 147,279 102,297
--------- ---------
Total contributed capital 147,513 102,487
Accumulated deficit (31,143) (35,778)
Accumulated other comprehensive income:
Foreign currency translation 792 932
--------- ---------
117,162 67,641
Less: Treasury Stock (100 at cost) (567) (567)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 116,595 67,074
========= =========
$ 177,279 $ 164,101
========= =========
See accompanying notes to
Consolidated Financial Statements
2
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three Months Ended July 31, Six Months Ended July 31,
2004 2003(1) 2004 2003(1)
-------------------------- -------------------------
Revenues $ 91,441 $ 85,475 $ 177,128 $ 166,458
Costs of Revenues 67,034 62,471 130,200 122,695
--------- --------- --------- ---------
Gross Profit 24,407 23,004 46,928 43,763
Selling, General and Administrative Expense 13,543 13,853 26,739 26,735
Fulfillment Freight 4,759 3,947 9,632 8,479
Relocation Expenses - - 1,552 1,730
--------- --------- --------- ---------
Operating Income 6,105 5,204 9,005 6,819
--------- --------- --------- ---------
Other Income (Expense)
Write off of deferred financing costs and original issue
discount (Note 4) - - (1,494) -
Interest expense (233) (1,106) (877) (2,071)
Interest income 39 73 106 160
Other 165 9 67 133
--------- --------- --------- ---------
Total Other Income (Expense) (29) (1,024) (2,198) (1,778)
--------- --------- --------- ---------
Income Before Income Taxes 6,076 4,180 6,807 5,041
Income Tax Expense 1,938 1,188 2,172 1,420
--------- --------- --------- ---------
Net Income $ 4,138 $ 2,992 $ 4,635 $ 3,621
========= ========= ========= =========
Earnings per Share - Basic $ 0.18 $ 0.16 $ 0.21 $ 0.20
Earnings per Share - Diluted 0.17 0.15 0.19 0.19
Weighted Average of Shares Outstanding - Basic (Note 7) 23,241 18,323 22,398 18,292
Weighted Average of Shares Outstanding - Diluted (Note 7) 25,026 19,679 24,466 19,074
========= ========= ========= =========
(1) July 31, 2003 results have been restated to reflect a change in our
revenue recognition policy related to our claim filing services of the
In-Store Services Division (see Note 11).
See accompanying notes to
Consolidated Financial Statements
3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands)
Other
Common Stock Additional Comprehensive Treasury Stock Total
----------------- Paid - in Accumulated Income ----------------------- Stockholders'
Shares Amount Capital Deficit (Loss) Shares Amount Equity
------ ------ ---------- ----------- ------------- ------ ------ --------------
Balance, January 31, 2004 18,991 $ 190 $ 102,297 $ (35,778) $ 932 (100) $ (567) $ 67,074
Net income - - - 4,635 - - - 4,635
Foreign currency translation - - - - (140) - - (140)
---------
Comprehensive income 71,569
---------
Sale of stock, $11.50 per
share (net of offering costs
of $3,226) 3,800 38 40,436 40,474
Exercise of stock options 625 6 3,322 - - - - 3,328
Tax benefit of stock options
exercised - - 1,224 - - 1,224
------ --------- --------- --------- --------- ---- --------- ---------
Balance, July 31, 2004 23,416 $ 234 $ 147,279 $ (31,143) $ 792 (100) $ (567) $ 116,595
====== ========= ========= ========= ========= ==== ========= =========
</Table>
See accompanying notes to
Consolidated Financial Statements
4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six months ended July 31, 2004 2003(1)
- ------------------------- ---- -------
OPERATING ACTIVITIES
Net income $ 4,635 $ 3,621
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 2,560 2,013
Provision for losses on accounts receivable 404 1,082
Write off of deferred financing costs and original issue
discount 1,494 -
Deferred income taxes (240) (2,165)
Other (303) 606
Changes in assets and liabilities (excluding business
acquisitions):
Increase in accounts receivable (15,228) (16,354)
Decrease (increase) in inventories 1,494 (781)
Decrease in other assets 285 3,186
Increase in accounts payable and accrued expenses 3,028 5,916
-------- --------
CASH USED IN OPERATING ACTIVITIES (1,871) (2,876)
======== ========
INVESTMENT ACTIVITIES
Capital expenditures (3,156) (915)
Purchase of claims (43,599) (37,432)
Payments received on purchased claims 46,915 37,010
Collections under magazine export agreement 3,061 4,738
Payments under import agreement (1,500) (1,000)
Payments under magazine export agreement - (1,400)
-------- --------
CASH PROVIDED BY INVESTING ACTIVITIES 1,721 1,001
======== ========
FINANCING ACTIVITIES
Decrease in checks issued against revolving credit facilities (8,801) (3,508)
(Repayments) Borrowings under credit facilities (9,757) 8,305
Payments of notes payable (21,510) (633)
Proceeds from the issuance of common stock 43,802 551
-------- --------
CASH PROVIDED BY FINANCING ACTIVITIES 3,734 4,715
======== ========
INCREASE IN CASH 3,584 2,840
CASH, beginning of period 4,963 5,570
-------- --------
CASH, end of period $ 8,547 $ 8,410
======== ========
(1) Cash flows for the six months ended July 31, 2003 have been restated to
reflect a change in our revenue recognition policy related to our claim
filing services of the In-Store Services Division (see Note 11).
See accompanying notes to
Consolidated Financial Statements
5
1. BASIS OF PRESENTATION
The consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. In the opinion of management, all adjustments
(consisting of normal recurring adjustments and reclassifications) necessary to
present fairly the financial position at July 31, 2004, and the results of
operations and cash flows for the three months and six months ended July 31,
2004, have been included.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. We suggest that these consolidated financial
statements be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's Form 10-K for the year ended January 31,
2004. The results of operations for such interim periods are not necessarily
indicative of the operating results to be expected for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. TRADE RECEIVABLES
Trade receivables consist of the following (in thousands):
July 31, 2004 January 31, 2004
------------- ----------------
Accounts Receivable $ 116,261 $ 112,504
Allowance:
Sales returns and other 55,564 66,102
Doubtful accounts 4,040 4,568
------------ -----------
59,604 70,670
------------ -----------
$ 56,657 $ 41,834
============ ===========
3. INVENTORIES
Inventories consist of the following (in thousands):
July 31, 2004 January 31, 2004
------------- ----------------
Raw materials $ 2,158 $ 2,278
Work-in-process 1,929 1,973
Finished goods:
Fixtures 1,295 761
Magazine inventory 10,366 12,229
------------ ---------
$ 15,748 $ 17,241
============ =========
In the event of non-sale, magazine inventories are generally returnable to the
publishers for full credit.
See accompanying notes to
Consolidated Financial Statements
6
4. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of (in thousands):
July 31, January 31,
2004 2004
-------- -----------
Revolving Credit facility - Wells Fargo Foothill $ 1,978 $ 11,735
Note payable - Wells Fargo Foothill - 4,083
Note payable - Hilco Capital, net of original
issuance discount 1 14,142
Guaranteed payments under magazine export
agreement (Note 6) 3,063 3,850
Notes payable to former owners of acquired company - 1,613
Other 149 177
---------- ----------
Debt 5,191 35,600
Less current maturities 2,032 4,059
---------- ----------
Debt, less current maturities $ 3,159 $ 31,541
========== ==========
Wells Fargo Foothill Credit Facility
On October 30, 2003, the Company entered into a credit agreement with Wells
Fargo Foothill. The credit agreement enables the Company to borrow up to $45.0
million under a revolving credit facility and provided a $5.0 million term note
payable. The credit agreement is secured by all of the assets of the Company.
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.25% at July 31, 2004) plus a margin up to 0.5% (the applicable
margin was 0.0% at July 31, 2004) based on an availability calculation and
carries a facility fee of 1/4% per annum on the difference between $45 million
and the average principal amount outstanding under the facility including
advances under the revolving credit facility and letter of credits.
The term note payable bears interest at a rate equal to the prime rate (4.25% at
July 31, 2004) plus 2.5%. The note was payable in equal principal installments
of $0.1 million per month plus current interest. The balance on the note payable
was paid in full during the quarter ended April 30, 2004 (See Note 5).
Under the credit agreement, the Company is limited in its ability to declare
dividends or other distributions on capital stock or make payments in connection
with the purchase, redemption, retirement or acquisition of capital stock. There
are also limitations on capital expenditures and the Company is required to
maintain certain financial ratios. The Company was in compliance with these
ratios at July 31, 2004.
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in unused
availability, after consideration of outstanding letters of credit, of $20.3
million at July 31, 2004.
Hilco Capital Note Payable
On October 30, 2003, the Company entered into a credit agreement with Hilco
Capital. The note bore a value at maturity of $15.0 million and was recorded net
of the original issuance discount. Upon the closing of the agreement, Hilco
received a five year warrant to purchase up to 400,000 shares of the Company's
common stock at $8.04 per share. The warrants were valued at $.9 million using a
Black Scholes option pricing model. The value of these warrants was recorded as
an original issuance discount to the term loan and was to be amortized over the
term of the loan using the effective interest method. The credit agreement was
secured by a subordinated interest in the assets of the Company. The note is
payable October 30, 2006 and can be prepaid without penalty at any earlier date.
All but a nominal amount on the term loan was paid during the quarter ended
April 30, 2004. As a result of this prepayment of the term loan, the remaining
original issue discount of approximately $858,000 and $636,000 of deferred
financing costs were written off in March 2004.
See accompanying notes to
Consolidated Financial Statements
7
The note payable bears current interest at a rate equal to the greater of the
prime rate (4.25% at July 31, 2004) plus 7.75% or 12% and deferred interest of
2% due at the termination of the agreement.
Note Payable to Former Owner of Acquired Company
In connection with the acquisition of Interlink, the Company assumed debt to the
former owners of International Periodical Distributors, Inc. ("IPD").
Previously, the Company was disputing the remaining amounts owed and commenced
legal action requesting the court release the Company of any further obligation
under these arrangements. The notes were due in fiscal 2003 and bore interest of
12%, which the Company continued to accrue pending the outcome of the
litigation. In March 2004, the Company and the former owners settled the notes
payable, interest accrued thereon, and the indemnification claim by the Company
paying a total of $1.6 million.
The aggregate amount of long-term debt maturing in each of the next four fiscal
years is as follows (in thousands):
Amount
- ------------------------------------------
2005 $ 894
2006 2,228
2007 2,022
2008 47
- ------------------------------------------
$ 5,191
- ------------------------------------------
5. SHAREHOLDERS' EQUITY
In March 2004, the Company completed the sale of 3.8 million shares of common
stock at $11.50 per share, excluding underwriting discounts and expenses. Net
proceeds to the Company of approximately $40.5 million, after costs of issuance
of $3.2 million, were utilized to repay the Wells Fargo Foothill note payable
and revolving credit facility and all but a nominal amount on the Hilco Capital
note payable in March 2004.
6. ACQUISITION AND BUSINESS COMBINATIONS
Magazine Import Agreement
In May, 2002, the Company entered into an agreement giving the Company the right
to distribute domestically a group of foreign magazine titles. The agreement
calls for an initial payment of $2.0 million, $1.0 million in fiscal 2004 and
additional contingent payments up to $2.5 million spread over the two years
ended May 2005 based on the overall gross profit generated from the sale of
these titles. Guaranteed payments and earned contingent payments under this
agreement are included in intangible assets and are being amortized over ten
years, the term of the agreement.
Magazine Export Agreement
In March, 2003, the Company entered into an agreement giving the Company the
right to distribute internationally a group of domestic magazine titles. The
agreement calls for an initial payment of $1.4 million, guaranteed payments
totaling $4.2 million spread over the next four fiscal years, and additional
contingent payments up to $5.6 million based on the overall gross profit
generated from the Company's international sales of these titles. Guaranteed
payments under this agreement were capitalized at inception and are included in
intangible assets and are being amortized over fifteen years, the term of the
agreement. The remaining guaranteed balances due under the agreement are
included in Debt. Under the agreement, the Company agreed to pay the prior
owner's outstanding trade payables out of the collections of the prior owner's
outstanding receivables. Amounts collected in excess of payments made or
payments in excess of collection are to be settled at a future date. At July 31,
2004 payments in excess of collections amounted to approximately $3.8 million.
See accompanying notes to
Consolidated Financial Statements
8
7. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows (in thousands):
Three Months Ended Six Months Ended
July 31, July 31,
2004 2003 2004 2003
- -------------------------------------------------------------------------------------------------
Basic weighted average number of common shares outstanding 23,241 18,323 22,398 18,292
Effect of dilutive securities:
Stock options and warrants 1,785 1,356 2,068 782
- -------------------------------------------------------------------------------------------------
Diluted weighted average number of common shares outstanding 25,026 19,679 24,466 19,074
=================================================================================================
For the quarter ended July 31, 2004, stock options to purchase 514 shares and
warrants convertible into 26 shares were excluded from the calculation of
diluted income per share because their exercise/conversion price exceeded the
average market price of the common shares during the period.
8. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Six Months Ended July 31, 2004 2003
- -------------------------------------------
Interest $ 881 1,861
Income Taxes $1,109 (1,691)
===========================================
9. STOCK OPTION PLANS
FAS No. 123, "Accounting for Stock-Based Compensation" defined a fair value
method of accounting for stock options and other equity instruments. Under the
fair value method, compensation cost is measured at the grant date based on the
fair value of the award and is recognized over the service period, which is
usually the vesting period. As provided in FAS No. 123, the Company elected to
apply Accounting Principles Board ("APB") Opinion No. 25 and related
interpretations in accounting for its stock-based compensation plans. No stock
based compensation was reflected in the period ended July 31, 2004 and 2003 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.
See accompanying notes to
Consolidated Financial Statements
9
The following is a reconciliation of net income per weighted average share had
the Company adopted FAS No. 123 (table in thousands except per share amounts):
Three Months Ended Six Months Ended
July 31, July 31,
2004 2003 2004 2003
===============================================================================================================================
Net income $ 4,138 $ 2,992 $ 4,635 $ 3,621
Stock compensation costs, net of tax (89) (320) (178) (640)
------------------ ---------------- ------------------ -------------------
Adjusted net income $ 4,049 $ 2,672 $ 4,457 $ 2,981
------------------ ---------------- ------------------ -------------------
Weighted average shares, basic 23,241 18,323 22,398 18,292
Weighted average shares, diluted 25,026 19,679 24,466 19,074
Basic earnings per share - as reported $ 0.18 $ 0.16 $ 0.21 $ 0.20
Diluted earnings per share - as reported $ 0.17 $ 0.15 $ 0.19 $ 0.19
Basic earnings per share - pro-forma $ 0.17 $ 0.15 $ 0.20 $ 0.16
Diluted earnings per share -pro-forma $ 0.16 $ 0.14 $ 0.18 $ 0.16
===============================================================================================================================
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
January 31, 2004 2003
- --------------------------------------------------------------------------
Dividend yield 0% 0%
Expected volatility 0.50 0.50
Risk-free interest rate 2.18-2.25% 2.16%
- --------------------------------------------------------------------------
10. SEGMENT FINANCIAL INFORMATION
The Company's segment reporting is based on the reporting of senior management
to the Chief Executive Officer. This reporting combines the Company's business
units in a logical way that identifies business concentrations and synergies.
The reportable segments of the Company are Magazine Distribution, In-Store
Services, Wood Manufacturing and Shared Services. The accounting policies of the
segments are materially the same as those described in the Summary of Accounting
Policies.
The Magazine Fulfillment segment derives revenues from (1) selling and
distributing magazines, including domestic and foreign titles, to major
specialty retailers and wholesalers throughout the United States and Canada, (2)
exporting domestic titles internationally to foreign wholesalers or through
domestic brokers, (3) serving as a secondary national distributor, (4) providing
return processing services for major specialty retail book chains and (5)
serving as an outsourced fulfillment agent.
See accompanying notes to
Consolidated Financial Statements
10
The In-Store Services segment derives revenues from (1) designing,
manufacturing, and invoicing participants in front-end fixture programs, (2)
providing claim filing services related to rebates owed retailers from
publishers or their designated agent, (3) shipping, installation and removal of
front-end fixtures, and (4) providing information and management services
relating to retail magazine sales to U.S. and Canadian retailers and magazine
publishers.
The Wood Manufacturing segment derives revenues from designing, manufacturing
and installing high-end wood store fixtures.
Shared Services consists of overhead functions not allocated to individual
operating segments. Segment results follow (in thousands):
Magazine In-Store Wood Other
Three Months Ended July 31, 2004 Distribution Services Manufacturing (Shared Services) Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $ 70,234 $ 13,455 $ 7,752 $ - $ 91,441
Cost of Revenue 53,094 7,721 6,219 - 67,034
------------------------------------------------------------------------------------------------
Gross Profit 17,140 5,734 1,533 - 24,407
Selling, General & Administrative 7,479 1,916 323 3,825 13,543
Freight Distribution 4,759 - - - 4,759
------------------------------------------------------------------------------------------------
Operating Income $ 4,902 $ 3,818 1,210 $ (3,825) $ 6,105
================================================================================================
Total Assets $ 61,873 $ 77,301 17,984 $ 20,121 $ 177,279
================================================================================================
Magazine In-Store Wood Other
Six Months Ended July 31, 2004 Distribution Services Manufacturing (Shared Services) Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $ 139,495 $ 25,982 $ 11,651 $ - $ 177,128
Cost of Revenue 106,520 14,290 9,390 - 130,200
------------------------------------------------------------------------------------------------
Gross Profit 32,975 11,692 2,261 - 46,928
Selling, General & Administrative 14,610 3,900 615 7,614 26,739
Freight Distribution 9,632 - - - 9,632
Relocation Expense 1,552 - - - 1,552
------------------------------------------------------------------------------------------------
Operating Income $ 7,181 $ 7,792 1,646 $ (7,614) $ 9,005
================================================================================================
Magazine In-Store Wood Other
Three Months Ended July 31, 2003 Distribution Services Manufacturing (Shared Services) Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $ 65,585 $ 15,876 $ 4,014 $ - $ 85,475
Cost of Revenue 49,760 9,165 3,546 - 62,471
------------------------------------------------------------------------------------------------
Gross Profit 15,825 6,711 468 - 23,004
Selling, General & Administrative 7,680 2,073 371 3,729 13,853
Freight Distribution 3,947 - - - 3,947
------------------------------------------------------------------------------------------------
Operating Income $ 4,198 $ 4,638 97 $ (3,729) $ 5,204
================================================================================================
Total Assets 55,975 $ 86,717 $ 16,246 $ 22,337 $ 181,275
================================================================================================
Magazine In-Store Wood Other
Six Months Ended July 31, 2003 Distribution Services Manufacturing (Shared Services) Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue $ 129,651 $ 28,936 $ 7,871 $ - $ 166,458
Cost of Revenue 99,260 16,588 6,847 - 122,695
------------------------------------------------------------------------------------------------
Gross Profit 30,391 12,348 1,024 - 43,763
Selling, General & Administrative 14,358 4,343 752 7,282 26,735
Freight Distribution 8,479 - - - 8,479
Relocation Expense 1,654 - - 76 1,730
------------------------------------------------------------------------------------------------
Operating Income $ 5,900 $ 8,005 272 $ (7,358) $ 6,819
================================================================================================
See accompanying notes to
Consolidated Financial Statements
11
11. RESTATEMENT
During March 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 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
activity. The following table details the effects of the restatement (in
thousands, except per share data):
Three Months Ended Six Months Ended
Income Statement Data: July 31, 2003 July 31, 2003
- --------------------------------------------------------------------------------------------------------------------------
As Previously Reported As Restated As Previously Reported As Restated
Net sales $ 85,155 85,475 $ 166,170 166,458
Gross profit 22,780 23,004 122,609 122,695
Net income 2,857 2,992 3,498 3,621
Basic net income per share 0.16 0.16 0.19 0.20
Diluted net income per share 0.15 0.15 0.18 0.19
Cash Flow Data:
Operating cash flow data $ -- -- $ 1,440 (2,876)
Investing cash flow -- -- (3,315) 1,001
- -------------------------------------------------------------------------------------------------------------------------
12. SUBSEQUENT EVENT
In August 2004, the Company acquired all of the contracts between customers and
publishers and related customer and retail lists of PROMAG Retail Services, LLC
("Promag") for $13.2 million ($12.45 million in cash and $0.75 million in a
promissory note payable over a four year period to Promag). Promag provides
claim filing services related to rebates owed retailers from publishers or their
designated agent manufactures throughout the United States.
In August 2004, the Company amended the credit facility with Wells Fargo
Foothill to finance the above transaction. The amended facility provides a $10
million term note payable that bears interest at the prime rate plus 2.0%. In
addition, the Company reduced the $45.0 million revolving credit facility to
$40.0 million however the total credit facility remains $50.0 million.
See accompanying notes to
Consolidated Financial Statements
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Some of the information in this report contains forward-looking statements that
involve risks and uncertainties. The words "believe," "expect," "anticipate,'
"estimate," "project," and similar expressions often characterize
forward-looking statements. These statements may include, but are not limited
to, projections of collections, revenues, income or loss, estimates of capital
expenditures, plans for future operations, products or services, and financing
needs or plans, as well as assumptions relating to these matters. These
statements are only predictions and you should not unduly rely on them. Our
actual results will differ, perhaps materially, from those anticipated in these
forward-looking statements as a result of a number of factors, including the
risks and uncertainties faced by us described below and elsewhere in this
report:
- market acceptance of and continuing demand for our services;
- the impact of competitive services;
- the pricing and reimbursement policies of magazine publishers;
- our ability to obtain additional financing to support our
operations;
- changing market conditions;
- demand for magazines at the retailers we service; and
- our ability to access retailers' point-of-sales information needed
to efficiently allocate distribution.
We believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to predict
accurately or over which we have no control. The factors listed above provide
examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking
statements. Before you make an investment decision relating to our common stock,
you should be aware that the occurrence of the events described in these risk
factors could have a material adverse effect on our business, operating results
and financial condition. You should read and interpret any forward-looking
statement in conjunction with our consolidated financial statements, the notes
to our consolidated financial statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Any forward-looking
statement speaks only as of the date on which that statement is made. Unless
required by U.S. federal securities laws, we will not update any forward-looking
statement to reflect events or circumstances that occur after the date on which
the statement is made.
Our business consists of four business segments: Magazine Fulfillment, In-Store
Services, Wood Manufacturing and Shared Services. Our segment reporting is
structured based on the reporting of senior management to the Chief Executive
Officer.
- Our Magazine Fulfillment group uses our proprietary order regulation
technology to manage the distribution of magazines to over 5,900
retail outlets. We assist retailers with the selection, logistical
procurement and fulfillment of approximately 4,000 monthly and 50
weekly magazine titles from over 560 publishers. The group was
established in May 2001 with the acquisition of The Interlink
Companies, Inc. or Interlink, and its two operating subsidiaries:
International Periodical Distributors, Inc. and David E. Young, Inc.
The scope of the group's operations was expanded through agreements
giving us the right to export domestic titles for sale
internationally and import foreign titles for sale domestically.
- Our In-Store Services group assists retailers with the design and
implementation of their front-end area merchandise programs, which
generally have a three-year life cycle. We also provide other
value-added services to retailers, publishers and other vendors.
These services include assisting retailers with the filing of claims
for publisher incentive payments, which are based on display
location or total retail sales, and providing publishers with access
to real-time sales information on more than 10,000 magazine titles,
thereby enabling them to make more informed decisions regarding
their product placement, cover treatments and distribution efforts.
- Our Wood Manufacturing group designs and manufactures wood display
and store fixtures for leading specialty retailers.
- Our Shared Services group consists of overhead functions not
allocated to the other groups. These functions include corporate
finance, human resource, management information systems and
executive management that are not allocated to the three operating
groups. Upon completion of our consolidation of our administrative
operations, we
13
restructured our accounts to separately identify corporate expenses
that are not attributable to any of our three main operating groups.
Prior to fiscal year 2004, these expenses were included within our
In-Store Services group.
REVENUES
The Magazine Fulfillment group derives revenues from:
- selling and distributing magazines, including domestic and foreign
titles, to major specialty retailers and wholesalers throughout the
United States and Canada,
- exporting domestic titles internationally to foreign wholesalers or
through domestic brokers,
- serving as a secondary national distributor,
- providing return processing services for major specialty retail book
chains, and
- serving as an outsourced fulfillment agent and backroom operator for
publishers.
The In-Store Services group derives revenues from:
- designing, manufacturing and invoicing participants in front-end
merchandising programs,
- providing claim filing services related to rebates owed retailers
from publishers or their designated agents,
- storing, shipping, installing, and removing front-end fixtures, and
- providing information and management services relating to magazine
sales to retailers and publishers throughout the United States and
Canada.
The Wood Manufacturing group derives revenues from designing, manufacturing and
installing custom wood fixtures primarily for retailers.
COST OF REVENUES
Our cost of revenues for the Magazine Fulfillment group consists of the costs of
magazines purchased for resale less all applicable publisher discounts and
rebates.
Our cost of revenues for the In-Store Services and the Wood Manufacturing groups
includes:
- raw materials consumed in the production of display fixtures,
primarily steel, wood and plastic components;
- production labor; and
- manufacturing overhead.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for each of the operating groups
include:
- non-production labor;
- rent and office overhead;
- insurance;
- professional fees; and
- management information systems.
Expenses associated with corporate finance, human resources, management
information systems and executive offices are included within the Shared
Services group and are not allocated to the other groups.
FULFILLMENT FREIGHT
Fulfillment freight consists of our direct costs of distributing magazines by
third-party freight carriers, primarily Federal Express ground service. Freight
rates are driven primarily by the weight of the copies being shipped and the
distance between origination and destination.
14
Fulfillment freight is not disclosed as a component of cost of revenues, and, as
a result, gross profit and gross profit margins are not comparable to other
companies that include shipping and handling costs in cost of revenues.
Fulfillment freight has increased proportionately as the amount of product we
distribute has increased. We anticipate the continued growth in our Magazine
Fulfillment group will result in an increase in fulfillment freight. Generally,
as pounds shipped increase, the cost per pound charged by third party carriers
decreases. As a result, fulfillment freight as a percent of Magazine Fulfillment
group revenue should decline slightly in the future.
RELOCATION EXPENSES
Relocation expenses in 2003 consisted primarily of the cost of transferring
existing employees and offices from their former locations in High Point, North
Carolina, St. Louis, Missouri, and San Diego, California, to our new offices in
Bonita Springs, Florida. In addition, during the six months ended July 31, 2004,
the Company began expansion into the mainstream retail market. The expansion
schedule required an acceleration of the relocation process from the
distribution fulfillment center in Milan, OH to Harrisburg, PA, which was
completed by the end of April 30, 2004.
15
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations (in thousands):
2004 2003(1)
MARGIN MARGIN
THREE MONTHS ENDED JULY 31, AMOUNT % AMOUNT %
- -----------------------------------------------------------------------------------
Magazine Fulfillment
Revenue $ 70,234 $ 65,585
Cost of revenue 53,094 49,760
Gross profit 17,140 24.4% 15,825 24.1%
Operating expense (2) 12,238 11,627
Operating income 4,902 7.0% 4,198 6.4%
In-Store Services
Revenue $ 13,455 $ 15,876
Cost of revenue 7,721 9,165
Gross profit 5,734 42.6% 6,711 42.3%
Operating expense (2) 1,916 2,073
Operating income 3,818 28.4% 4,638 29.2%
Wood Manufacturing
Revenue $ 7,752 $ 4,014
Cost of revenue 6,219 3,546
Gross profit 1,533 19.8% 468 11.7%
Operating expense (2) 323 371
Operating income 1,210 15.6% 97 2.4%
Shared Services
Revenue $ $
Cost of revenue
Gross profit
Operating expense (2) 3,825 3,729
Relocation expenses - -
Operating loss (3,825) n/a (3,729) n/a
Total
Revenue $ 91,441 $ 85,475
Cost of revenue 67,034 62,471
Gross profit 24,407 26.7% 23,004 26.9%
Operating expense (2) 18,302 17,800
============ ==== ============ ====
Operating income $ 6,105 6.7% $ 5,204 6.1%
============ ==== ============ ====
(1) July 31, 2003 results have been restated to reflect a change in our
revenue recognition policy related to our claim filing services of the
In-Store Services Division.
(2) Operating expenses include selling, general and administrative expenses,
fulfillment freight and amortization of goodwill.
16
2004 2003(1)
MARGIN MARGIN
SIX MONTHS ENDED JULY 31, AMOUNT % AMOUNT %
- -----------------------------------------------------------------------------------
Magazine Fulfillment
Revenue $ 139,495 $ 129,651
Cost of revenue 106,520 99,260
Gross profit 32,975 23.6% 30,391 23.4%
Operating expense (2) 24,242 22,837
Relocation expenses 1,552 1,654
Operating income 7,181 5.1% 5,900 4.6%
In-Store Services
Revenue $ 25,982 $ 28,936
Cost of revenue 14,290 16,588
Gross profit 11,692 45.0% 12,348 42.7%
Operating expense (2) 3,900 4,343
Operating income 7,792 30.0% 8,005 27.7%
Wood Manufacturing
Revenue $ 11,651 $ 7,871
Cost of revenue 9,390 6,847
Gross profit 2,261 19.4% 1,024 13.0%
Operating expense (2) 615 752
Operating income 1,646 14.1% 272 3.5%
Shared Services
Revenue $ $
Cost of revenue
Gross profit
Operating expense (2) 7,614 7,282
Relocation expenses - 76
Operating loss (7,614) n/a (7,358) n/a
Total
Revenue $ 177,128 $ 166,458
Cost of revenue 130,200 122,695
Gross profit 46,928 26.5% 43,763 26.3%
Operating expense (2) 36,371 35,214
Relocation expenses 1,552 1,730
============ ==== ============ ====
Operating income $ 9,005 5.1% $ 6,819 4.1%
============ ==== ============ ====
(1) Results for the six months ended July 31, 2003 have been restated to
reflect a change in our revenue recognition policy related to our claim
filing services of the In-Store Services Division.
(2) Operating expenses include selling, general and administrative expenses,
fulfillment freight and amortization of goodwill.
17
REVENUES
Total revenues for the quarter ended July 31, 2004 increased $6.0 million, or
7.0%, from the prior year due primarily to an increase in revenue in our
Magazine Fulfillment and Wood Manufacturing groups as described below.
Magazine Fulfillment group's revenues were $70.2 million, an increase of $4.7
million or 7.1% as compared to the quarter ended July 31, 2003. The group's
revenues for the three months ended July 31 are comprised of the following
components (in millions):
2004 2003 Change
- -----------------------------------------------------------------------------------
Domestic distribution $ 55,449 $ 51,767 $ 3,682
Export distribution 9,653 9,549 104
Secondary wholesale distribution 4,584 3,741 843
Other 888 865 23
Intra-segment sales (339) (338) (1)
---------- ----------- -----------
Total $ 70,235 $ 65,584 $ 4,651
========== =========== ===========
Domestic distribution consists of the gross amount of magazines (both domestic
and imported titles) distributed to domestic retailers and wholesalers, less
actual returns received, less an estimate of future returns and customer
discounts. The $3.7 million increase in domestic distribution relates primarily
to a $13.0 million increase in gross distribution partially offset by an
estimated higher return rate. The increase in gross distribution related both to
an increase in copies distributed as well as an increase in the amount billed
per copy. Gross domestic distribution to our two largest specialty retail
customers increased $11.9 million. Estimated sell-through for the quarter was
lowered from 48.2% to 46.1%.
Revenues from our secondary wholesale operations for the quarter ended July 31,
2004 increased approximately $0.8 million due to an increase in the number of
wholesale operations we serviced as compared to the quarter ended July 31, 2003.
Magazine Fulfillment group's revenues were $139.5 million, an increase of $9.8
million or 7.6% as compared to the six months ended July 31, 2003. The group's
revenues for the six months ended July 31 are comprised of the following
components (in millions):
2004 2003 Change
- -----------------------------------------------------------------------------------
Domestic distribution $ 110,135 $ 104,638 $ 5,497
Export distribution 20,155 15,741 4,414
Secondary wholesale distribution 8,089 8,284 (195)
Other 1,735 1,669 66
Intra-segment sales (620) (682) 62
---------- ----------- -----------
Total $ 139,494 $ 129,650 $ 9,844
========== =========== ===========
18
Domestic distribution consists of the gross amount of magazines (both domestic
and imported titles) distributed to domestic retailers and wholesalers, less
actual returns received, less an estimate of future returns and customer
discounts. The $5.5 million increase in domestic distribution relates primarily
to a $24.0 million increase in gross distribution partially offset by an
estimated higher return rate. The increase in gross distribution related both to
an increase in copies distributed as well as an increase in the amount billed
per copy. Gross domestic distribution to our two largest customers increased
$24.6 million. Estimated sell-through for the quarter was lowered from 48.5% to
46.1%.
Our export distribution began operation in March 2003. Export distribution
increased $4.4 million for the six month period ended July 31 over the
comparable period of the prior year due primarily to an additional month of
distribution in the current period.
Our In-Store Services group revenues were $13.4 million, a decrease of $2.4
million or 15.1%, for the three months ended July 31, 2004 as compared to the
comparable quarter of the prior year.
The group's revenues are comprised of the following components (in millions):
2004 2003 Change
- -----------------------------------------------------------------------------------
Claim filing and information $ 4,042 $ 3,079 $ 963
Front end wire and services 9,413 12,797 (3,384)
---------- ----------- -----------
Total $ 13,455 $ 15,876 $ (2,421)
========== =========== ===========
Our claim filing revenues are recognized at the time the claim is paid. The
increase in revenues in the current period relate primarily to the timing of the
cash payments received on the claims.
Our front end wire and services revenues declined due to the cyclical nature of
the industry (major chains purchase new front-end fixtures every three years).
In addition, there was a significant new customer in the quarter ended July 31,
2003 that did not recur in the quarter ended July 31, 2004.
Our In-Store Services group revenues were $26.0 million, a decrease of $2.9
million or 10.0%, for the six months ended July 31, 2004 as compared to the
comparable period of the prior year.
The group's revenues are comprised of the following components (in millions):
2004 2003 Change
- -----------------------------------------------------------------------------------
Claim filing and information $ 8,326 $ 6,776 $ 1,550
Front end wire and services 17,656 22,160 (4,504)
---------- ----------- -----------
Total $ 25,982 $ 28,936 $ (2,954)
========== =========== ===========
Our claim filing revenues are recognized at the time the claim is paid. The
increase in revenues in the current period relate primarily to the timing of the
cash payments received on the claims.
Our front end wire and services revenues declined due to the cyclical nature of
the industry (major chains purchase new front-end fixtures every three years).
19
Our Wood Manufacturing group's revenues were $7.8 million, an increase of $3.7
million or 93.1%, for the three months ended July 31, 2004 as compared to the
comparable period of the prior year. The Wood Manufacturing group's revenues
were $11.7 million, an increase of $3.8 million or 48.0%, for the six months
ended July 31, 2004 as compared to the comparable period of the prior year. The
increase for the quarter and the six month period relates to an increase in the
number of store openings and remodelings performed by our customers. In
addition, we have added a number of significant new customers in the second
quarter of the six month period.
GROSS PROFIT
Gross profit for the three months ended July 31, 2004 increased $1.4 million or
6.1%, over the same quarter in the prior fiscal year due primarily due to an
increase in sales volume in our Magazine Fulfillment group.
Gross Profit in our Magazine Fulfillment group increased approximately $1.3
million or 8.3% for the quarter ended July 31, 2004 as compared to the
comparable quarter of the prior year. The increase related primarily to the
increased distribution revenue as described above and the improvement in gross
profit margins from 24.1% to 24.4%. The gross profit margins in our domestic
distribution businesses are generally higher than our export distribution and
secondary wholesale businesses and, as a result, gross profit margins improve as
the portion of total revenues is weighted more toward our domestic operations.
We have also been able to utilize the working capital raised through our equity
offering and operating profits to improve selling and buying terms with some of
our major suppliers and customers. In addition, we receive certain supplier
rebates on gross distribution and as efficiency decreases those rebates become a
greater portion of the overall gross profit contribution yielding higher gross
profit margins.
Gross profit in our In-Store Services group decreased $1.0 million or 14.6% for
the three months ended July 31, 2004 as compared to the comparable quarter of
the prior year. The decrease in gross profit is primarily due to a decrease in
revenues as described above as the gross margin percentage remained consistent.
Gross profit in our Wood Manufacturing group increased $1.1 million or 227.6%
for the three months ended July 31, 2004 as compared to the comparable period of
the prior year. The increase related to the new business discussed above.
Gross profit for the six months ended July 31, 2004 increased $3.2 million or
7.2%, over the same period in the prior fiscal year due primarily due to an
increase in sales volume in our Magazine Fulfillment group and our Wood
Division. The increase was partially offset by decreases in our In-Store
Services group.
Gross Profit in our Magazine Fulfillment group increased approximately $2.6
million or 8.5% for the six month period ended July 31, 2004 as compared to the
comparable period of the prior year. The increase related primarily to the
increased distribution revenue as described above and the improvement in gross
profit margins from 23.4% to 23.6%. The improved gross profit amounts and margin
for the six-month period are related to the same items discussed in the above
analysis of the quarter.
Gross profit in our In-Store Services group decreased $0.7 million or 5.3% for
the six months ended July 31, 2004 as compared to the comparable period of the
prior year. The decrease in gross profit is primarily due to a decrease in
revenues as described above as the gross margin percentage remained consistent.
Gross profit in our Wood Manufacturing group increased $1.2 million or 120.8%
for the six months ended July 31, 2004 as compared to the comparable period of
the prior year. The increase related to the new business discussed above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the quarter ended July 31, 2004
decreased $0.3 million or 2.2%, compared to the quarter ended July 31, 2003.
Selling, general, and administrative expenses as a percent of revenues declined
from 16.2% to 14.8%.
20
The Magazine Fulfillment group's selling, general and administrative expenses
decreased $0.20 million, or 2.6% over the quarter ended July 31, 2003. As a
percentage of sales, selling, general and administrative expenses have decreased
from 11.7% to 10.6% compared to the prior year same period due to our ability to
leverage existing infrastructure over a larger base of distribution and the
consolidation of our distribution center in Milan, Ohio into Harrisburg,
Pennsylvania.
The selling, general, and administrative expenses of In-Store Services decreased
$0.16 million or 7.6% over the quarter ended July 31, 2003. The decrease relates
to a reduction in executive salary expense as compared to quarter ended July 31,
2003.
The selling, general, and administrative expenses of Shared Services increased
$0.10 million or 2.6%. The overall increase is primarily due to Sarbanes-Oxley
compliance charges and increased depreciation expense due to increased capital
expenditures.
The Wood Manufacturing group's selling, general, and administrative expenses
decreased $0.05 million or 12.9%. The decrease was attributable primarily to a
head count reduction.
Selling, general and administrative expenses for the six month period ended July
31, 2004 remained flat compared to the six month period ended July 31, 2003.
Selling, general, and administrative expenses as a percent of revenues declined
from 16.1% to 15.1%.
The Magazine Fulfillment group's selling, general, and administrative expenses
increased $0.25 million, or 1.7% over the six month period ended July 31, 2003.
As a percentage of sales, selling, general and administrative expenses have
decreased from 11.1% to 10.5%. Overall expenses have increased due to the
increase in overall distribution and the related labor in our distribution
centers to process the distribution and the expansion of our marketing efforts
in the United Kingdom.
The selling, general, and administrative expenses of In-Store Services decreased
$0.44 million or 10.2%. The decrease relates to a reduction in executive salary
expense as compared to the six month period ended July 31, 2003.
The selling, general, and administrative expenses of Shared Services increased
$0.33 million or 4.6% for the six month period ended July 31, 2004. The overall
increase is primarily due to Sarbanes-Oxley compliance charges, changes in
employee benefit programs and increased depreciation expense due to increased
capital expenditures.
The Wood Manufacturing group's selling, general, and administrative expenses
decreased $0.14 million or 18.2% compared to the six month period ended July 31,
2003. The decrease was attributable primarily to a head count reduction.
FULFILLMENT FREIGHT
Fulfillment freight expenses increased $0.81 million or 20.6%, compared to the
three months ended July 31, 2003 and $1.2 million or 13.6% compared to the six
months ended July 31, 2003. Freight as a percentage of the Magazine Fulfillment
group's revenues increased slightly from 6.5% for the six months ended July 31,
2003 to 6.9% for the six months ended July 31, 2004. Under our existing
contract, generally our freight rates per pound decrease as the number of pounds
shipped increases.
RELOCATION EXPENSES
During the six months ended July 31, 2004, the Company began expansion into the
mainstream retail market. The expansion schedule required an acceleration of the
relocation process from the distribution fulfillment center in Milan, OH to
Harrisburg, PA, which was completed by the end of April 30, 2004. Relocation
expenses recorded in the first quarter, including a lease termination charge and
the transfer of employees and equipment, were approximately $1.6 million.
During the six month period ended July 31, 2003, the company relocated the
magazine distribution back office from San Diego, California to Bonita Springs,
Florida. The total expense recorded related to this relocation was $1.7 million.
21
OPERATING INCOME
Operating income for the quarter ended July 31, 2004 increased $0.9 million or
17.3%, compared to the quarter ended July 31, 2003 due to the factors described
above.
Operating income for the six months ended July 31, 2004 increased $2.2 million
or 32.1%, compared to the six months ended July 31, 2003 due to the factors
described above
Operating profit margins improved from 6.1% to 6.7% for the quarters ended July
31 and from 4.1% to 5.1% for the six month period ended July 31 compared to the
prior fiscal year. The increase was due to the improvement in our gross profit
coupled with increased revenue from the Wood and Magazine Fulfillment Divisions
and a decrease in our selling, general, and administrative expenses as a percent
of revenues.
INTEREST EXPENSE
Interest expense includes the interest and fees on our significant debt
instruments and outstanding letters of credit.
Interest expense decreased $0.88 million or 78.9% from the quarter ended July
31, 2004 and $1.2 million or 57.7% for the six month period ended July 31, 2004.
Interest expense decreased from the prior year quarter and six month period due
to significantly lower borrowings. The lower borrowing levels are due to the
raising of proceeds from the sale of 3.8 million shares of common stock.
OTHER INCOME (EXPENSE)
Other income (expense) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
For the six month period ended July 31, 2004, the Company recorded a charge of
approximately $1.5 million related to the write off of deferred financing
charges as a result of paying off certain debt instruments, as described below
in Liquidity and Capital Resources.
INCOME TAX EXPENSE
The effective income tax rates were 32.0% and 28.4% for the quarters ended July
31, 2004 and 2003, respectively.
The effective income tax rates were 32.0% and 28.2% for the six months ended
July 31, 2004 and 2003, respectively.
The difference between the statutory rate and effective tax rates relates
primarily to the realization of a portion of the net operating loss
carry-forward acquired with our acquisition of Interlink.
22
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Our primary sources of cash include receipts from our customers and borrowings
under our credit facilities and from time to time the proceeds from the sale of
common stock.
Our primary cash requirements for the Magazine Fulfillment group consist of the
cost of magazines and the cost of freight, labor and facility expense associated
with our distribution centers.
Our primary cash requirements for the In-Store Services group consist of the
cost of raw materials, labor, and factory overhead incurred in the production of
front-end displays, the cost of labor incurred in providing our claiming, design
and information services and cash advances funding our Advance Pay program. Our
Advance Pay program allows retailers to accelerate collections of their rebate
claims through payments from us in exchange for the transfer to us of the right
to collect the claim. We then collect the claims when paid by publishers for our
own account.
Our primary cash requirements for the Wood Manufacturing group consist of the
cost of raw materials, the cost of labor, and factory overhead incurred in the
manufacturing process.
Our primary cash requirements for the Shared Services group consist of salaries,
professional fees and insurance not allocated to the operating groups.
The following table presents a summary of our significant obligations and
commitments to make future payments under debt obligations and lease agreements
due by fiscal year as of July 31, 2004 (in thousands).
Payments Due by Period
--------------------------------------------------------------
Less
Than 1-3 4-5 After 5
Total 1 year Years Years Years
- -------------------------------------------------------------------------------------------
Debt obligations $ 5,191 $ 894 $ 4,297 $ - $ -
Operating leases 35,938 2,654 8,597 6,499 18,188
----------- --------- --------- --------- --------
Total contractual cash
obligations $ 41,129 $ 3,548 $ 12,894 $ 6,499 $ 18,188
=========== ========= ========= ========= ========
The following table presents a summary of our commercial commitments and the
notional amount expiration by period (in thousands):
Notional amount expiration by period
--------------------------------------------------------------
Less
Than 1-3 4-5 After 5
Total 1 year Years Years Years
Financial standby letters
of credit $ 3,750 $ 3,750 $ - $ - $ -
----------- --------- --------- --------- --------
Total commercial
commitments 3,750 3,750 - - -
=========== ========= ========= ========= ========
OPERATING CASH FLOW
Net cash used in operating activities was $1.9 and $2.9 million for the six
months ended July 31, 2004 and 2003, respectively.
Operating cash flows for the six months ended July 31, 2004 were primarily from
net income ($4.6 million), plus non-cash charges including depreciation and
amortization ($2.6 million) and provisions for losses on accounts receivable
($0.4 million), a write off of deferred financing costs and original issue
discount ($1.5 million), a decrease in inventories, a decrease in other assets
and an increase in accounts payable accrued expenses ($1.5 million, $0.3 million
and $3.0 million, respectively). These cash providing activities were offset by
an increase in accounts receivable ($15.2 million).
23
The increase in accounts receivable for the six months ended July 31, 2004 was
primarily due to the increased revenues of the Magazine Fulfillment group
coupled with a decrease in the sales returns reserve for the six month period
ended July 31, 2004 ($10.2 million). Increased revenues of approximately $4.0
million over the first quarter in the Wood Division increased accounts
receivable by approximately $3.0 million for the six months ended July 31, 2004.
In addition, the In-Store Division had an increase in accounts receivable of
approximately $2.0 million due primarily to the timing of an advanced payment to
a retailer.
The increase in accounts payable and accrued expenses in the current period of
$3.0 million relates primarily to the timing of vendor payments in the current
period as compared to the quarter ended January 31, 2004.
Operating cash flows in the first six months of fiscal year 2004 were primarily
from net income ($3.6 million), adding back non-cash charges such as
depreciation and amortization ($2.0 million) and provisions for losses on
accounts receivable ($1.1 million), and a significant increase in accounts
payable ($5.9 million). These cash providing activities were offset by a
significant increase in accounts receivable ($16.4 million).
The increase in accounts receivable and accounts payable related primarily to
the magazine export agreement and the inception of that business. The first six
months of the year includes five months of operations from this business and
only two months of cash collections due to the standard payment terms of 90
days, which is typical for this segment of the industry.
INVESTING CASH FLOW
Net cash provided by investing activities was $1.7 and $1.0 million for the six
months ended July 31, 2004 and 2003, respectively.
For the six months ended July 31, 2004, cash provided by investing activities
was reduced by capital expenditures of $3.2 million, which in part related to
our expansion of our distribution facility in Harrisburg, Pennsylvania. Our
advance pay program generated net cash flow of $3.3 million in the current
period. In addition, the Company advanced to the prior operator of our export
distribution business $6.8 million at January 31, 2004. The advances were made
as part of the agreement to collect the prior operator's receivables and pay
outstanding payables so as to create a seamless transition for both the
customers and suppliers. The company collected $3.1 million of the advances
during the six months ended July 31, 2004.
For the six months ended July 31, 2003, cash provided by investing activities
related to capital expenditures of $0.9 million, which related primarily to our
relocation to Florida, and $1.4 million of payments made related to the
acquisition of customer lists under the export agreement and a contingent
payment of $1.0 million under the magazine import agreement. Our advance pay
program used net cash flow of $0.4 million. Finally, in connection with the
magazine export agreement discussed in the paragraph above, the company had
collected $4.7 million during the six months ended July 31, 2003.
Our borrowing agreements limit the amount of our capital expenditures in any
fiscal year.
FINANCING CASH FLOW
Outstanding balances on our credit facility fluctuate partially due to the
timing of the retailer rebate claiming process and our Advance Pay program, the
seasonality of our front end wire and services business and the payment cycle of
the magazine distribution business. Because the magazine distribution business
and Advance Pay program cash requirements peak at our fiscal quarter ends, the
reported bank debt levels usually are the maximum level outstanding during the
quarter.
Payments under our Advance Pay program generally occur just prior to our fiscal
quarter end. The related claims are not generally collected by us until 30-60
days after the advance is made. As a result, our funding requirements peak at
the time of the initial advances and decrease over this period as the cash is
collected on the related claims.
The front end wire and services business is seasonal because most retailers
prefer initiating new programs before the holiday shopping season begins, which
concentrates revenues in the second and third quarter. Receivables from these
fixture
24
programs are generally collected from all participants within 180 days. We are
usually required to tender payment on the costs of these programs (raw material
and labor) within a shorter period. As a result, our funding requirements peak
in the second and third fiscal quarters when we manufacture the wire fixtures
and decrease significantly in the fourth and first fiscal quarters as the
related receivable are collected and significantly less manufacturing activity
is occurring.
Within our magazine distribution business, our significant customers pay weekly,
and we pay our suppliers monthly. As a result, funding requirements peak at the
end of the month when supplier payments are made and decrease over the course of
the next month as our receivables are collected.
Net cash provided by financing activities was $3.7 and $4.7 million for the six
months ended July 31, 2004 and 2003, respectively.
Financing activities in the first six months of fiscal year 2005 consisted of
proceeds from the sale of 3.8 million shares of common stock. The proceeds of
$40.5 million (net of underwriting and related expenses) from the sale were
utilized to repay the Wells Fargo Foothill term loan, the Hilco Capital note
payable and the notes payable to former owners ($20.7 million) as well the net
pay down of the revolving credit facility ($9.8 million). Additional payments on
note payables were made of approximately $0.8 million. In addition, the cash
provided by the activities noted above were offset by an $8.8 million decrease
in checks issued and outstanding at July 31, 2004. Finally, the exercise of
employee stock options in the period generated approximately $3.3 million.
Financing activities for the first six months of fiscal year 2004 consisted
primarily of borrowings on our credit facilities ($8.3 million) to pay for the
acquisition of a customer list and working capital needs. These borrowings were
partially offset by a $3.5 million reduction of checks issued and outstanding at
July 31, 2003.
DEBT
At July 31, 2004, our total debt obligations were $5.2 million, excluding
outstanding letters of credit. Debt consists primarily of our amounts owed under
the Revolving Credit facility and the magazine export agreement.
On October 30, 2003, we entered into a credit agreement with Wells Fargo
Foothill. The credit agreement enables us to borrow up to $45.0 million under a
revolving credit facility. The credit agreement expires on October 30, 2006 and
is secured by all of the assets of the Company.
Borrowings under the revolving credit facility bear interest at a rate equal to
the prime rate (4.25% at July 31, 2004) plus up to 0.5% based on an availability
calculation and carries a facility fee of -1/4% per annum on the difference
between $45.0 million and the average principal amount outstanding under the
facility including advances under the revolving credit facility and letters of
credit. The balance on the credit facility at July 31, 2004 was $1.98 million.
The term note was paid in full during the quarter ended April 30, 2004.
In August 2004, the Company amended the credit facility with Wells Fargo
Foothill. The amended facility provides a $10 million term note payable that
bears interest at the prime rate plus 2.0%. In addition, the Company reduced the
$45.0 million revolving credit facility to $40.0 million however the total
credit facility remains $50.0 million.
Availability under the revolving facility is limited by a borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability of $20.3 million at July 31, 2004.
On October 30, 2003, we entered into a credit agreement with Hilco Capital. The
note payable had a face value of $15.0 million and was recorded net of the
original issuance discount related to the fair value of warrants issued
concurrently with the note. The note payable bears current interest at a rate
equal to the greater of the prime rate (4.25% at April 30, 2004) plus 7.75% or
12% and deferred interest of 2% due at the termination of the agreement on
October 30, 2006. The Company repaid all but a nominal amount of the note
payable during the six month period ended July 31, 2004.
Under the credit agreements, we are required to maintain a specified minimum
level of EBITDA and compliance with specified fixed charge coverage and debt to
EBITDA ratios. In addition, we are prohibited, without consent from our lenders,
from:
25
- incurring or suffering to exist additional indebtedness or liens on
our assets,
- engaging in any merger, consolidation, acquisition or disposition of
assets or other fundamental corporate change,
- permitting a change of control of our company,
- paying any dividends or making any other distribution on capital
stock or other payments in connection with the purchase, redemption,
retirement or acquisition of capital stock,
- changing our fiscal year or methods of accounting, and
- making capital expenditures in excess of $3.8 million during fiscal
year 2005 and $3.4 million during fiscal year 2006 and each
subsequent fiscal year.
We were in compliance with each of these financial and operating covenants at
July 31, 2004.
Amounts owed related to the magazine export agreement consist of 9 quarterly
payments of approximately $.4 million beginning in January 2004. The balance
outstanding under this agreement at July 31, 2004 was $3.1 million
A note payable, due in fiscal 2003, in the principal amount of $1.6 million to
the previous owner of an acquired company was being disputed by the Company
under the conditions of the acquisition agreement. The Company received a
favorable arbitration ruling during the fourth quarter of fiscal 2004, and in
March 2004, we settled the remaining note payable, interest accrued thereon and
the indemnification claim by the Company for $1.6 million.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability.
Our debt relates to credit facilities with Wells Fargo Foothill and a note
payable to Hilco Capital. See "--- Liquidity and Capital Resources --- Debt"
The revolving credit facility with Wells Fargo Foothill has an outstanding
principal balance of approximately $1.98 million at July 31, 2004. Interest on
the outstanding balance is charged based on a variable interest rate related to
the prime rate (4.25% at July 31, 2004) plus a margin specified in the credit
agreement (0.00% at July 31, 2004).
The term note payable with Wells Fargo Foothill was paid in full in March 2004.
The note payable with Hilco Capital was, except for a nominal amount, repaid in
March 2004. Interest on the outstanding balance is charged based on a variable
interest rate related to the prime rate (4.25% at July 31, 2004) plus 7.75% as
specified in the credit agreement.
Interest expense from these credit facilities is subject to market risk in the
form of fluctuations in interest rates.
In March 2004, we utilized the proceeds from a sale of our common stock to
pay-down all but a nominal amount of the Hilco Capital Note Payable, repay the
term note portion of the Wells Fargo Foothill credit facility, and repaid all
outstanding balances owed under the revolving credit partition of the Wells
Fargo Foothill credit facility.
We do not perform any interest rate hedging activities related to these two
facilities.
We have exposure to foreign currency fluctuations through our operations in
Canada. These operations accounted for approximately $1.4 million, which
represented 1.5% of our revenues for the quarter ended July 31, 2004. We
generally pay the operating expenses related to these revenues in the
corresponding local currency. We will be subject to any risk for exchange rate
fluctuations between such local currency and the dollar.
Additionally, we have exposure to foreign currency fluctuation through our
exporting of foreign magazines and the purchased of foreign magazine for
domestic distribution.
Revenues derived from the export of foreign titles (or sale to domestic brokers
who facilitate the export) totaled $9.7 million for the quarter ended July 31,
2004 or 10.6% of total revenues. For the most part, our export revenues are
denominated in dollars and the foreign wholesaler is subject to foreign currency
risks. We have the availability to control foreign currency risk via increasing
or decreasing the local cover price paid in the foreign markets. There is a risk
that a substantial increase in local cover price due to a decline in the local
currency relative to the dollar could decrease demand for these magazines at
retail and negatively impact our results of operations.
Domestic gross distribution of imported titles totaled approximately $47.0
million (of a total $242.7 million or 19.4%). Foreign publications are purchased
in both dollars and the local currency of the foreign publisher, primarily Euros
and pound sterling. In the instances where we buy in the foreign currency, we
generally have the ability to set the domestic cover price, which allows us to
control the foreign currency risk. Foreign titles generally have significantly
higher cover prices then comparable domestic titles, are considered somewhat of
a luxury item, are sold only at select retail locations, and sales do not appear
to be highly impacted by cover price increases. However, a significant negative
change in the relative strength of the dollar to these foreign currencies could
result in higher domestic cover prices and result in lower sales of these titles
at retail, which would negatively impact our results of operations.
We do not conduct any significant hedging activities related to foreign
currency.
27
ITEM 4. 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 (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the
Securities Exchange Act of 1934) as of the end of the period covered by this
report (the "Evaluation Date"). Based on this evaluation, our management,
including our principal executive officer and principal financial officer,
concluded that as of the Evaluation Date our disclosure controls and procedures
were effective to provide assurance that the information concerning us and our
consolidated subsidiaries, which is required to be included in our reports and
statements filed or submitted under the Securities Exchange Act of 1934, as
amended, (i) is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate to
allow timely decisions required disclosure and (ii) is recorded, processed,
summarized and reported within the time periods specified in rules and forms of
the Securities and Exchange Commission
In addition, there were no changes in our internal controls over financial
reporting identified in connection with the above-mentioned evaluation that
occurred during our most recent fiscal quarter that has materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting. In addition, we have not identified any significant deficiencies or
material weaknesses in the design or operation of internal controls over
financial reporting which are reasonably likely to adversely affect our ability
to record, process, summarize and report financial information.
28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are party to routine legal proceedings arising out of the normal course of
business. Although it is not possible to predict with certainty the outcome of
these unresolved legal actions or the range of possible loss, we believe that
none of these actions, individually or in the aggregate, will have a material
adverse effect on our financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of the Shareholders of the Company was held on
July 14, 2004. Of the 23,077,968 shares entitled to vote at such meeting,
19,839,562 shares were present at the meeting in person or by proxy.
(b) Each of the management nominees for election as Class III directors
was duly elected to serve an additional term of three years expiring in
2007. These individuals joined the directors James R. Gillis, Aron S.
Katzman, Randall S. Minix, Harry L. "Terry" Franc, III, Kenneth F.
Teasdale and Allan R. Lyons whose terms of office continued after the
Company's 2004 Annual Meeting of Shareholders. The number of shares voted
for and against/withheld were as follows:
Against/
For Withheld
--- --------
S. Leslie Flegel 18,227,107 1,612,455
A. Clinton Allen 19,100,163 739,399
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
See Exhibit Index
(b) Reports on Form 8-K.
During the quarter ended July 31, 2004, the Company filed two
Reports on Form 8-K as described below:
DATE FILED ITEM REPORTED FINANCIAL STATEMENTS FILED
---------- ------------- --------------------------
May 21, 2004 Item 9 Announced estimate of revenue recorded in first
fiscal quarter of the 2005 fiscal year
June 10, 2004 Item 12 Condensed Consolidated Balance Sheets and
Statements of Operations at April 30, 2004 and
January 31, 2004 and for the fiscal quarter ended
April 30, 2004 and 2003
29
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: September 09, 2004
SOURCE INTERLINK COMPANIES, INC.
/s/ Marc Fierman
---------------------------------------
Marc Fierman
Chief Financial Officer
30
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Executive
Officer
31.1 Rule 13a-14(a)/15d-14(a) Certification of Principal Financial
Officer
32.1 Section 1350 Certification of Principal Executive Officer and
Principal Financial Officer