March 28, 2006
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0308
ATTN: Larry Spirgel, Assistant Director
Mail Stop: 3730
RE: Source Interlink Companies, Inc. (File No. 1-13437) Form 10-K for
Fiscal Year Ended January 31, 2005 (filed April 18, 2005) Form 10-Q
for Quarter Ended October 31, 2005 (filed December 12, 2005)
Dear Mr. Spirgel:
This letter is written in response to the Staff's letter of comment dated March
8, 2006 (the "Comment Letter") to Mr. Marc Fierman, Chief Financial Officer of
Source Interlink Companies, Inc. (the "Company") with respect to the
above-captioned reports filed by the Company under Section 13 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). For ease of reference,
the responses in this letter have been keyed to the numbers assigned to the
individual comments in the Comment Letter.
COMMENT 1:
As previously requested, please provide, in writing, a statement from the
company acknowledging that:
- the company is responsible for the adequacy and accuracy of the
disclosure in the filings;
- staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filings; and
- the company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
RESPONSE:
The Company is responsible for the adequacy and accuracy of disclosure contained
in its filings with the Securities and Exchange Commission. The Company
acknowledges that staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action with respect to
the filings. The Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
COMMENT 2:
Please refer to prior comment 10. Please tell us your consideration of the
fourth factor listed in paragraph 3 of EITF 99-19. In view of your capacity as
Levy Home Entertainment's "sole and exclusive subdistributor... within (your)
geographic territory," please tell us how you concluded that
- you are the primary obligor in the arrangement with your customers;
- you have general inventory risk (before customer order is placed or
after customer return);
- you have latitude in establishing prices;
- the amount you earn is not fixed on a per-transaction basis or as a
stated percentage of the amount billed to the customers (covered in
the arrangement); and
- you have discretion in supplier selection.
RESPONSE:
To aid understanding of the Levy Home Entertainment ("LHE") arrangement, we have
provided the following description of the general mechanics of our book
distribution business:
LHE is our exclusive supplier of book product. We order product from LHE based
on retailer orders for book product. LHE distributes the product to us at our
distribution center for consolidation with the retailer's magazine order, which
is our principle product line, or drop ships the books via third party carrier
directly to the retailer as directed by us.
We are responsible for negotiating the price each retailer pays for books, which
is generally described as a discount to the publisher set cover price.
Book product is generally sold on a returnable basis. We have the right to
return to LHE only that product that LHE can receive credit for.
We bear all inventory risk while the books are in our possession and all credit
risk based on the sale to the retailer.
The following analysis of the requirements of EITF 99-19 should be read in
conjunction with the above discussion and exhibit 10.62 to our current report on
Form 8-K filed with the SEC on May 16, 2005:
Item 4 of paragraph 3 of EITF 99-19: "Reporting Revenue Gross as a Principal
versus Net as an Agent" states that if an entity acts as an agent or broker
(including performing services, in substance, as an agent or broker) with
compensation on a commission or fee basis it should report revenue on a net
basis.
An agent or broker works in the best interests of the entity for which it is the
agent or broker. In our arrangement with LHE, we have retained the right to
negotiate prices with retailers, to sell to any and all retailers we see fit
(except certain retailers that we are prohibited from selling to under the terms
of the agreement), and to purchase any quantities we see fit to distribute to
our retailers. Using these rights we have retained, we work in our own best
interests, not in the best interests of LHE. We determine what retailers we will
sell to and at what prices. Any and all retailers with whom we cannot negotiate
acceptable pricing are rejected, regardless of whether the arrangement would be
beneficial to LHE.
Therefore we conclude that we do not act as an agent or broker for LHE.
The criteria for gross reporting contained in paragraphs 7-14 of EITF 99-19
apply to the LHE arrangement as follows:
- THE COMPANY IS THE PRIMARY OBLIGOR IN THE ARRANGEMENT. Our retailers
place orders for merchandise with us. It is our responsibility to
purchase sufficient quantities of the merchandise to fill their
orders.
- THE COMPANY HAS GENERAL INVENTORY RISK (BEFORE CUSTOMER ORDER IS
PLACED OR UPON
CUSTOMER RETURN). We receive book purchases from LHE at our
distribution center and delivery it to our retail accounts. While the
merchandise is in our possession, we have unmitigated general
inventory risk. Upon return, we have general inventory risk for
hardback inventory until the entire books is physically returned to
LHE and for paperback inventory until it is counted and submitted via
either front cover or affidavit returns.
- THE COMPANY HAS LATITUDE IN ESTABLISHING PRICE. We negotiate the
prices that retailers pay for merchandise directly with the retailer,
these prices can vary from one retailer to another.
- THE COMPANY CHANGES THE PRODUCT OR PERFORMS PART OF THE SERVICE. We
provide in-store merchandising services to the majority of our
retailers.
- THE COMPANY HAS DISCRETION IN SUPPLIER SELECTION. We only have
discretion in supplier selection to the extent that LHE is unable or
unwilling to provide the merchandise we order.
- THE COMPANY IS INVOLVED IN THE DETERMINATION OF PRODUCT OR SERVICE
SPECIFICATIONS. We work with our retail customers to determine optimum
distribution quantities.
- THE COMPANY HAS PHYSICAL LOSS INVENTORY RISK (AFTER CUSTOMER ORDER OR
DURING SHIPPING). We have physical loss inventory risk on orders we
instruct LHE to drop ship directly to retailers as well as inventory
received in our distribution centers but not yet distributed.
- THE COMPANY HAS CREDIT RISK. We retain the risk associated with
collection of amounts due from retailers.
Given the above analysis, we conclude that gross presentation of sales, less an
allowance for estimated returns and costs of sales is appropriate under the
guidance of EITF 99-19.
COMMENT 3:
Please refer to prior comment 12. After reviewing you response, we have the
following comments.
- Please tell us the amount of the publisher and vendor lists assets.
- Please confirm to us that you have no contracts with the major record
labels, film studios, and magazine publishers. Otherwise, please tell
us the terms of each contract.
- Your Form 10-K discloses that your business units face significant
competition. We note that the major record labels and film studios are
increasingly competing with you for the larger retail chains market
and the magazine publishers and printers may enter in the magazine
distribution business. It also appears that consumers are increasingly
using the Internet to download music and purchase products that you
are selling to your customers. Based on these factors, please tell us
in more detail how you considered paragraph 11(e) of FAS 142. Please
address you consideration of the following:
- The economic effect of competition and demand for you services
and for your publishers and vendors products;
- Any penalty on your publishers and vendors for terminating their
relationship with you; and
- Any prohibition on your publishers and vendors from selling their
products directly to your customers.
RESPONSE:
As reported in our Form 10-Q for the quarterly period ended October 31, 2005 and
filed with the Commission on December 12, 2005, the total amount of our
indefinite lived intangible assets, including publisher and vendor lists is
$126.1 million.
To aid in the understanding of our determination that our vendor and publisher
list assets have an indefinite life, we have provided the following discussion
and historical data:
We have long-standing relationships with four major record labels, ten major
film studios and the major magazine publishers/national distributors. The
relationships with these suppliers are essential to us continuing to provide our
retailers with a full-line of home entertainment products. Approximately 82% of
the revenue from our CD and DVD segment for the fiscal year ended January 31,
2005 was derived from products obtained from these major record labels and film
studios and approximately 90% of the revenue was derived from magazines obtained
from the four major magazine publishers/national distributors.
We have established trade and credit terms with our suppliers; however, as
common in this industry, we have not historically had contracts with any of our
major record labels, film studios or magazine publishers. As such, there are no
penalties on vendors or publishers for terminating their relationships with us,
nor any prohibition on them from selling their products directly to our
customers. Historically, the trade terms with our major record labels, film
studios, and magazine publishers have not materially changed.
The major record labels and films studios are increasingly competing with us in
the large retail chain market and it is conceivable that magazine publishers may
enter into the magazine distribution business. However, there are significant
barriers to any major record label, film studio or magazine publisher entering
our business. These include the establishment of distribution centers capable of
delivering orders to virtually any retailer overnight, the development of
information systems capable of tracking retailer inventory and managing returns,
and the creation of networks of personnel capable of performing in-store
services, such as merchandising, for retailers. In addition, it would not be
economically feasible to distribute only one publisher's titles without the
other major titles that make up the category and it seems unlikely that other
publishers would rely on a rival publisher for distribution services.
Overcoming these barriers would require significant capital investments and the
investment of talent by the major record labels, film studios and magazine
publishers. Therefore, major record labels and film studios only prefer to
establish direct relationships with retailers that have central distribution
systems and service networks capable of tracking and managing returns and
performing their own in-store service. Many of our suppliers have recognized the
importance of their relationships with us to the success of their business. Many
of our suppliers have granted us large amounts of credit in recognition of our
long-standing relationships with them.
The following analysis under the guidance of paragraph 11 of FAS 142 should be
read in conjunction with the above discussion:
a. THE EXPECTED USE OF THE ASSET BY THE ENTITY. We expect to use the
vendor and publisher list assets in our operations until such time as
our operations cease or the industry in which we operate changes so
drastically as to make the vendors and publishers no longer necessary.
b. THE EXPECTED USEFUL LIFE OF ANOTHER ASSET OR A GROUP OF ASSETS TO
WHICH THE USEFUL
LIFE OF THE ASSET MAY RELATE. The publisher and vendor lists are their
own group of assets that do not relate to any other assets for which
we have determined a definite useful life.
c. ANY LEGAL, REGULATORY, OR CONTRACTUAL PROVISIONS THAT MAY LIMIT THE
USEFUL LIFE. There are no legal, regulatory or contractual provisions
that limit the useful lives of the vendor and publisher lists.
d. ANY LEGAL, REGULATORY, OR CONTRACTUAL PROVISIONS THAT ENABLE RENEWAL
OR EXTENSION OF THE ASSET'S LEGAL OR CONTRACTUAL LIFE WITHOUT
SUBSTANTIAL COST (PROVIDED THERE IS EVIDENCE TO SUPPORT RENEWAL OR
EXTENSION AND RENEWAL OR EXTENSION CAN BE ACCOMPLISHED WITHOUT
MATERIAL MODIFICATIONS OF THE EXISTING TERMS AND CONDITIONS). Due to
the lack of provisions limiting the useful lives, this item does not
apply.
e. THE EFFECTS OF OBSOLESCENCE, DEMAND, COMPETITION, AND OTHER ECONOMIC
FACTORS (SUCH AS THE STABILITY OF THE INDUSTRY, KNOWN TECHNOLOGICAL
ADVANCES, LEGISLATIVE ACTION THAT RESULTS IN AN UNCERTAIN OR CHANGING
REGULATORY ENVIRONMENT, AND EXPECTED CHANGES IN DISTRIBUTION
CHANNELS). Magazine - The magazine industry saw unit and dollar sales
increase during the twelve months ended December 31, 2005 versus the
same period in 2004. Recent technological advances, such as the
Internet, are, as data suggests, not impacting unit sales of
magazines. We are not aware of any major retailer that has a direct
relationship with magazine publishers. This is largely due to the
sheer number of publishers with whom a relationship would have to be
established. Therefore, we do not believe that these factors indicate
a definite useful life for our publisher list assets.
CD and DVD - Legitimate and illegal downloading of music and movies
over the Internet has impacted the CD and DVD industry. However
industry wide CD sales remain flat while DVD unit sales increased for
the fiscal year ended January 31, 2006 versus the same period ended
January 2005. Recently, we have seen several retailers who currently
have direct relationships with the major record labels and film
studios express interest in our services. Additionally, our business
has seen 24% organic growth in sales over the past four years.
Therefore, we do not believe that these factors indicate a definite
useful life for our vendor list assets.
f. THE LEVEL OF MAINTENANCE EXPENDITURES REQUIRED TO OBTAIN THE EXPECTED
FUTURE CASH FLOWS FROM THE ASSET (FOR EXAMPLE, A MATERIAL LEVEL OF
REQUIRED MAINTENANCE IN RELATION TO THE CARRYING AMOUNT OF THE ASSET
MAY SUGGEST A VERY LIMITED USEFUL LIFE). No maintenance expenditures
are required to obtain the expected future cash flows from the vendor
and publisher list assets.
Given the above factors, we believe that the relationships with our major record
labels, film studios and publishers will continue for an indefinite period and
that the economic and competitive landscape does not indicate a definite useful
life for these assets. Our historical experience supports these conclusions.
Therefore, we conclude that the vendor and publisher list assets have an
indefinite useful life.
However, in the event that we become aware of the intent of a major record
label, film studio or magazine publisher to terminate its relationship with us,
or the economic or competitive landscape changes such that a basis for erosion
exists we would test the assets for impairment and then estimate a useful life
for the affected assets and begin amortizing them over their useful life.
The Company believes that the foregoing is responsive to the Comment Letter and
that to the extent adjustments to the Company's disclosure may be desirable, the
adjustments are immaterial to an investor's understanding of the Company's
business, prospects, results
of operation and financial condition. Accordingly, the Company does not believe
that amendment of its most recently filed Form 10-K and Form 10-Q is required
and undertakes to include such adjusted language in future reports.
Sincerely,
/s/ Douglas J. Bates
-------------------------------------
Douglas J. Bates, Esq.
General Counsel
Source Interlink Companies, Inc.