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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended April 30, 2006
or
[ ] 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 001-13437
(SOURCE INTERLINK COMPANIES LOGO)
SOURCE INTERLINK COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 20-2428299
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
27500 Riverview Center Blvd., Suite 400 34134
Bonita Springs, Florida (Zip Code)
(Address of principal executive offices)
(239) 949-4450
(Registrant's telephone number, including area code)
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 from the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerate filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
[ ] Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. (Check one)
[ ] Yes [X] No
As of June 2, 2006, there were 51,783,364 shares of the Company's common stock
outstanding.
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Cover Page
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS. 3
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. 22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 34
ITEM 4. CONTROLS AND PROCEDURES. 35
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. 37
ITEM 1A. RISK FACTORS. 37
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. 37
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. 37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 37
ITEM 5. OTHER INFORMATION. 37
ITEM 6. EXHIBITS. 37
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
INDEX OF FINANCIAL STATEMENTS
PAGE
----
Consolidated Balance Sheets as of April 30, 2006 (unaudited) and
January 31, 2006. 4
Consolidated Statements of Income for the three months ended
April 30, 2006 and 2005 (unaudited). 6
Consolidated Statement of Stockholders' Equity for the three months ended
April 30, 2006 (unaudited). 7
Consolidates Statements of Cash Flows for the three months ended
April 30, 2006 and 2005 (unaudited). 8
Notes to Consolidated Financial Statements 9
Page 3 of 39
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
April 30,
2006 January 31,
(unaudited) 2006
----------- -----------
ASSETS
Current assets
Cash $ -- $ 23,239
Trade receivables, net 137,657 129,782
Purchased claims receivable 10,169 9,922
Inventories 233,505 198,483
Income tax receivable 2,686 2,180
Deferred tax asset 16,563 16,403
Other 7,644 6,058
---------- --------
Total current assets 408,224 386,067
---------- --------
Property, plants and equipment 92,977 89,971
Less accumulated depreciation and amortization (23,808) (23,255)
---------- --------
Net property, plants and equipment 69,169 66,716
---------- --------
Other assets
Goodwill, net 420,298 302,293
Intangibles, net 130,375 118,988
Other 9,873 10,408
---------- --------
Total other assets 560,546 431,689
---------- --------
Total assets $1,037,939 $884,472
========== ========
See accompanying notes to Consolidated Financial Statements.
Page 4 of 39
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS (CONCLUDED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
April 30,
2006 January 31,
(unaudited) 2006
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Checks issued against future advances on revolving credit facility $ 5,965 $ --
Accounts payable and accrued expenses (net of allowance for returns of
$169,693 and $167,423 at April 30, 2006 and January 31, 2006, respectively) 343,994 321,074
Deferred revenue 2,606 3,226
Current portion of obligations under capital leases 884 476
Current maturities of debt 21,849 6,508
---------- --------
Total current liabilities 375,298 331,284
Deferred tax liability 39,624 4,526
Obligations under capital leases 1,721 1,118
Debt, less current maturities 150,634 80,727
Other 7,083 7,224
---------- --------
Total liabilities 574,360 424,879
---------- --------
Commitments and contingencies
Stockholders' equity
Contributed capital:
Preferred stock, $0.01 par (2,000 shares authorized; none issued) -- --
Common stock, $0.01 par (100,000 and 40,000 shares authorized; 51,712 and
51,704 shares issued) 517 517
Additional paid-in-capital 468,011 467,543
---------- --------
Total contributed capital 468,528 468,060
Accumulated deficit (7,558) (10,817)
Accumulated other comprehensive income:
Foreign currency translation 2,609 2,350
---------- --------
Total stockholders' equity 463,579 459,593
---------- --------
Total liabilities and stockholders' equity $1,037,939 $884,472
========== ========
See accompanying notes to Consolidated Financial Statements.
Page 5 of 39
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three months ended
April 30,
-------------------
2006 2005
-------- --------
Revenues $454,600 $234,421
Cost of revenues (including depreciation of $278 and $193) 364,660 183,876
-------- --------
Gross profit 89,940 50,545
Selling, general and administrative expense 54,320 29,674
Fulfillment freight 21,935 10,336
Depreciation and amortization 5,805 3,103
Merger and acquisition charges -- 3,094
Impairment of land and building held for sale 529 --
-------- --------
Operating income 7,351 4,338
-------- --------
Other income (expense):
Interest expense (including amortization of deferred
financing fees of $157 and $275) (2,268) (935)
Interest income 68 46
Other 14 74
-------- --------
Total other expense (2,186) (815)
-------- --------
Income before income taxes 5,165 3,523
Income tax expense 1,906 1,852
-------- --------
Net income $ 3,259 $ 1,671
======== ========
Earnings per share - basic $ 0.06 $ 0.04
Earnings per share - diluted $ 0.06 $ 0.04
Weighted average common shares outstanding - basic 51,708 42,314
Weighted average common shares outstanding - diluted 53,154 44,395
See accompanying notes to Consolidated Financial Statements.
Page 6 of 39
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
(UNAUDITED)
Accumulated
Common Stock Additional Other Total
--------------- Paid-in Accumulated Comprehensive Stockholders'
Shares Amount Capital Deficit Income (Loss) Equity
------ ------ ---------- ----------- ------------- -------------
Balance, January 31, 2006 51,704 $517 $467,543 $(10,817) $2,350 $459,593
Net income -- -- -- 3,259 -- 3,259
Foreign currency translation -- -- -- -- 259 259
------ ---- -------- -------- ------ --------
Comprehensive income -- -- -- 3,259 259 3,518
------ ---- -------- -------- ------ --------
Stock compensation expense -- -- 400 -- -- 400
Exercise of stock options 8 -- 54 -- -- 54
Excess tax benefit from stock options
exercised -- -- 14 -- -- 14
------ ---- -------- -------- ------ --------
Balance, April 30, 2006 51,712 $517 $468,011 $ (7,558) $2,609 $463,579
====== ==== ======== ======== ====== ========
See accompanying notes to Consolidated Financial Statements.
Page 7 of 39
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Three months ended
April 30,
-------------------
2006 2005
-------- --------
OPERATING ACTIVITIES
Net income $ 3,259 $ 1,671
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation and amortization 6,240 3,571
Provision for losses on accounts receivable 1,728 240
Deferred income taxes -- --
Deferred revenue (360) 402
Stock compensation expense 400 --
Excess tax benefit from exercise of stock options 14 679
Impairment of land and building held for sale 529 --
Other (259) (70)
Changes in assets and liabilities (excluding business acquisitions):
(Increase) decrease in accounts receivable (8,220) 7,647
Increase in inventories (9,816) (15,605)
Increase in other current and non-current assets (1,654) (1,106)
Decrease in accounts payable and other liabilities (48,775) (8,041)
-------- --------
Cash used in operating activities (56,914) (10,612)
-------- --------
INVESTMENT ACTIVITIES
Capital expenditures (1,955) (2,355)
Purchase of claims (27,902) (31,384)
Payments received on purchased claims 27,655 18,720
Net cash from Alliance Entertainment Corp. acquisition -- 16,879
Acquisition of Anderson Mid-Atlantic News, LLC, net of cash acquired (13,620) --
Acquisition of Anderson SCN Services, LLC, net of cash acquired (25,990) --
Acquisition of distribution rights -- (2,300)
Other (1,017) (41)
-------- --------
Cash used in investing activities (42,829) (481)
-------- --------
FINANCING ACTIVITIES
Increase (decrease) in checks issued against revolving credit facilities 5,965 (8,041)
Borrowings under credit facilities 69,793 28,709
Net borrowings (payments) on notes payable and capital leases 692 (9,910)
Proceeds from the issuance of common stock 54 1,241
Deferred financing cost -- (899)
-------- --------
Cash provided by financing activities 76,504 11,100
-------- --------
(Decrease) increase in cash (23,239) 7
Cash, beginning of period 23,239 1,387
-------- --------
Cash, end of period $ -- $ 1,394
======== ========
See accompanying notes to Consolidated Financial Statements.
Page 8 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Source Interlink Companies, Inc. (the "Company") is a leading marketing,
merchandising and fulfillment company of entertainment products including DVDs,
music CDs, magazines, books and related items. The Company's fully integrated
businesses include:
- Distribution and fulfillment of entertainment products to major retail
chains throughout North America and directly to consumers of
entertainment products ordered through the Internet;
- Import and export of periodicals sold in more than 100 markets
worldwide;
- Coordination of product selection and placement of impulse items sold
at checkout counters;
- Processing and collection of rebate claims as well as management of
sales data obtained at the point-of-purchase; and
- Design, manufacture and installation of wire fixtures and custom wood
displays in major retail chains.
Source Interlink serves approximately 110,000 retail store locations throughout
North America. Supply chain relationships include movie studios, record labels,
magazine and newspaper publishers, confectionary companies and manufacturers of
general merchandise.
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 the Company's management, all
adjustments (consisting only of normal recurring adjustments and
reclassifications) necessary to present fairly our results of operations and
cash flows for the three months ended April 30, 2006 and 2005 and our financial
position as of April 30, 2006, respectively have been made. The results of
operations for such interim periods are not necessarily indicative of the
operating results to be expected for the full year.
Certain information and disclosures normally included in the notes to the annual
consolidated financial statements have been condensed or omitted from these
interim consolidated financial statements. Accordingly, these interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K (the "Annual Report") for the fiscal year ended January 31,
2006, as filed with the Securities and Exchange Commission ("SEC") on April 17,
2006.
Certain reclassifications have been made to conform to the current period
presentation. These reclassifications had no effect on the results of operations
or stockholders' equity.
Page 9 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
2. BUSINESS COMBINATIONS
ACQUISITION OF ANDERSON MID-ATLANTIC NEWS, LLC
On March 30, 2006, the Company and Anderson News, LLC entered into a Unit
Purchase Agreement pursuant to which the Company purchased all of the issued and
outstanding membership interests of Anderson Mid-Atlantic News, LLC
("Mid-Atlantic") from Anderson News, LLC for a purchase price of approximately
$4.0 million, subject to adjustment based on the negative net worth as of the
closing date of the transaction. In addition, approximately $9.6 million was
also provided on the date of acquisition to Mid-Atlantic to repay a portion of
its outstanding intercompany debt. The remaining outstanding intercompany debt
of Mid-Atlantic was satisfied by issuance of a promissory note totaling $4.1
million. The promissory note will be repaid by the Company over a six month
period beginning June 2006 and bears interest at LIBOR minus one (4.02% at April
30, 2006). The purchase price and the intercompany debt repayment were funded
from the Company's revolving line of credit.
The total cost of the acquisition was allocated to the assets acquired and
liabilities assumed based on their estimated respective fair values in
accordance with FAS 141, Business Combinations. Goodwill, which is deductible
for tax purposes, recorded in connection with the transaction is estimated to
total $26.4 million. These amounts will be tested at least annually for
impairment in accordance with FAS 142, Goodwill and Other Intangible Assets.
The assets acquired and liabilities assumed in the acquisition were recorded in
the quarter ended April 30, 2006. The acquisition was accounted for by the
purchase method and, accordingly, the results of Mid-Atlantic's operations have
been included in our consolidated statements of income since March 31, 2006. The
pro-forma operating results as if the Company had completed the acquisition at
the beginning of the periods presented are not significant to the Company's
consolidated financial statements and are not presented.
Goodwill at the date of the acquisition of Mid-Atlantic is based on a
preliminary internal valuation study, therefore reported amounts may change
based on finalization which is expected to occur during the second quarter of
fiscal 2007.
The assets acquired and liabilities assumed, based on the preliminary internal
valuation, are summarized below:
(IN THOUSANDS) Amount
- -------------- --------
Cash $ 4
Inventories 7,526
Property and equipment 396
Goodwill 26,417
Intangible assets 4,728
Other assets 63
Accounts payable and accrued liabilities (21,391)
Long-term debt (20)
--------
Total consideration $ 17,723
========
ACQUISITION OF ANDERSON SCN SERVICES, LLC
On March 30, 2006, the Company and Anderson News, LLC entered into a Unit
Purchase Agreement pursuant to which the Company purchased all of the issued and
outstanding membership interests of Anderson-SCN Services, LLC ("SCN") from
Anderson News, LLC for a purchase price of approximately $9.0 million, subject
to adjustment based on the negative net worth as of the closing date of the
transaction. In addition, approximately $17.0 million was also provided on the
date of acquisition to SCN to repay a portion of its outstanding intercompany
debt. The
Page 10 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
remaining outstanding intercompany debt of SCN was satisfied by issuance of a
promissory note totaling $10.2 million. The promissory note will be repaid by
the Company over a six month period beginning June 2006 and bears interest at
LIBOR minus one (4.02% at April 30, 2006). The purchase price and the
intercompany debt repayment were funded from the revolving line of credit.
The total cost of the acquisition was allocated to the assets acquired and
liabilities assumed based on their estimated respective fair values in
accordance with FAS 141, Business Combinations. Goodwill, which is deductible
for tax purposes, recorded in connection with the transaction is estimated to
total $55.5 million. These amounts will be tested at least annually for
impairment in accordance with FAS 142, Goodwill and Other Intangible Assets.
The assets acquired and liabilities assumed in the acquisition were recorded in
the quarter ended April 30, 2006. The acquisition was accounted for by the
purchase method and, accordingly, the results of SCN's operations have been
included in our consolidated statements of income since March 31, 2006. The
pro-forma operating results as if the Company had completed the acquisition at
the beginning of the periods presented are not significant to the Company's
consolidated financial statements and are not presented.
Goodwill at the date of the acquisition of SCN is based on a preliminary
internal valuation study, therefore reported amounts may change based on
finalization which is expected to occur during the second quarter of fiscal
2007.
The assets acquired and liabilities assumed, based on the preliminary internal
valuation, are summarized below:
(IN THOUSANDS) Amount
- -------------- --------
Cash $ 8
Trade receivables, net 3,241
Inventories 17,950
Property and equipment 2,691
Goodwill 55,460
Intangible assets 9,687
Other assets 54
Accounts payable and accrued liabilities (51,882)
Obligations under capital leases (1,010)
--------
Total consideration $ 36,199
========
3. INVENTORIES
Inventories consist of the following:
April 30,
2006 January 31,
(IN THOUSANDS) (unaudited) 2006
- -------------- ----------- -----------
Raw materials $ 2,846 $ 2,652
Work-in-process 3,369 3,458
Finished goods:
Pre-recorded music and video 135,541 131,601
Magazines and books 88,873 57,827
Fixtures 2,876 2,945
-------- --------
Inventories $233,505 $198,483
======== ========
Page 11 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
In the event of non-sale, pre-recorded music and video, magazine and book
inventories are generally returnable to the suppliers thereof for full credit.
4. GOODWILL AND INTANGIBLE ASSETS
A summary of the Company's intangible assets is as follows:
April 30,
2006 January 31,
(IN THOUSANDS) (unaudited) 2006
- -------------- ----------- -----------
Amortized intangible assets:
Customer lists $125,742 $111,320
Non-compete agreements 2,250 2,250
Software 16,492 16,492
-------- --------
Total intangibles 144,484 130,062
Accumulated amortization:
Customer lists (10,354) (8,133)
Non-compete agreements (691) (556)
Software (3,064) (2,385)
-------- --------
Total accumulated amortization (14,109) (11,074)
-------- --------
Intangibles, net $130,375 $118,988
======== ========
Amortization expense from intangible assets was $3.0 million and $1.6 million
for the three months ended April 30, 2006 and 2005, respectively. Amortization
expense is expected to approximate $12.2 million for each of the next five
fiscal years.
The changes in the carrying amount of goodwill for the three months ended April
30, 2006, are as follows:
CD and DVD Magazine In-Store
(IN THOUSANDS) Fulfillment Fulfillment Services Consolidated
- -------------- ----------- ----------- -------- ------------
Balance, January 31, 2006 $168,898 $ 78,601 $54,794 $302,293
Additions 35,097 82,068 738 117,903
Foreign currency translation adjustments -- -- 102 102
-------- -------- ------- --------
Balance, April 30, 2006 $203,995 $160,669 $55,634 $420,298
======== ======== ======= ========
5. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of:
April 30,
2006 January 31,
(IN THOUSANDS) (unaudited) 2006
- -------------- ----------- -----------
Revolving credit facility - Wells Fargo Foothill $114,793 $45,001
Note payable - Magazine import and export 5,551 6,227
Page 12 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Note payable - Former owner of Empire 717 717
Note payable - Former owner of Anderson Mid-Atlantic News, LLC 4,100 --
Note payable - Former owner of Anderson-SCN Services, LLC 10,200 --
Note payable - Arrangements with suppliers 11,218 11,815
Mortgage loan - Wachovia Bank 20,000 20,000
Equipment loans - Suntrust Leasing 5,761 3,216
Other 143 259
-------- -------
Total debt 172,483 87,235
Less current maturities 21,849 6,508
-------- -------
Debt, less current maturities $150,634 $80,727
======== =======
WELLS FARGO FOOTHILL CREDIT FACILITY
On February 28, 2005, the Company modified its existing credit facility with
Wells Fargo Foothill ("WFF") as a result of its acquisition of Alliance. The
primary changes from the original line of credit were to (1) increase the
maximum allowed advances under the line of credit from $45.0 million to $250.0
million and (2) extend the maturity date from October 2009 to October 2010. In
addition, in conjunction with the modification of the existing credit facility,
the Company repaid the balance of its $10.0 million WFF term loan. WFF, as
arranger and administrative agent for each of the parties that may become a
participant in such arrangement and their successors ("Lenders") will make
revolving loans to us and our subsidiaries of up to $250.0 million including the
issuance of letters of credit. The terms and conditions of the arrangement are
governed primarily by the Amended and Restated Loan Agreement dated February 28,
2005 by and among us, our subsidiaries, and WFF.
Outstanding borrowings bear interest at a variable annual rate equal to the
prime rate announced by Wells Fargo Bank, National Association's San Francisco
office, plus a margin of between 0.0% and 1.00% (applicable margin was 0.0% at
April 30, 2006) based upon a ratio of the Company's EBITDA to interest expense
("Interest Coverage Ratio"). At April 30, 2006 the prime rate was 7.75%. We also
have the option of selecting up to five traunches of at least $1 million each to
bear interest at LIBOR plus a margin of between 2.00% and 3.00% based upon our
Interest Coverage Ratio. The Company had 2 LIBOR contracts outstanding at April
30, 2006 (expiring through July 2006) that bear interest at a weighted average
rate of approximately 7.0%. To secure repayment of the borrowings and other
obligations of ours to the Lenders, we and our subsidiaries granted a security
interest in all of the personal property assets to WFF, for the benefit of the
Lenders. These loans mature on October 31, 2010.
Under the credit agreement, the Company is limited in its ability to declare
dividends or other distributions on capital stock or make payments in connection
with the purchase, redemption, retirement or acquisition of capital stock. There
are also limitations on capital expenditures and the Company is required to
maintain certain financial ratios. The Company was in compliance with these
ratios at April 30, 2006.
Availability under the facility is limited by the Company's borrowing base
calculation, as defined in the agreement. The calculation resulted in excess
availability, after consideration of outstanding letters of credit, of $45.7
million at April 30, 2006.
EQUIPMENT LOANS
Through the acquisition of Alliance, the Company entered into a loan agreement
with SunTrust Leasing Corporation (the "SunTrust Loan") for the purchase of
equipment to be used at various locations. A credit line of $6.8 million was
approved under the SunTrust Loan, with repayment terms for five promissory notes
ranging from three to five years. The total principal balance of the SunTrust
Loan outstanding as of April 30, 2006 was $5.8 million.
Page 13 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
SUPPLIER LOANS
Through the acquisition of Levy, the Company assumed four notes payable with
suppliers (the "Supplier Loans") totaling $14.0 million. The maturity dates of
the notes range between March 2007 and August 2014 and bear interest at 5%.
Principal repayments range from $1.0 to $2.0 million per fiscal year with $1.6
million and $1.7 million due to be repaid in fiscal year 2007 and 2008,
respectively. The total principal balance of the Supplier Loans as of April 30,
2006 is $11.2 million.
MORTGAGE LOAN
The Company obtained a 10 year, $20.0 million conventional mortgage loan through
Wachovia Bank (the "Wachovia Mortgage"). The Wachovia Mortgage is collateralized
by land and building located in Coral Springs, FL. The Wachovia Mortgage monthly
principal payments are approximately $0.08 million beginning in October 2006
plus interest at a rate of LIBOR plus a margin of 1.60%. At the end of the 10
year term, a balloon payment in the amount of $11.1 million is due and payable.
MAGAZINE IMPORT AND EXPORT NOTES
Concurrent with the magazine import and export acquisition in November 2004, the
Company issued an additional $7.7 million in notes payable. At April 30, 2006,
the balance on all magazine import and export notes was $5.6 million. These
notes bear interest at a rate of 2.37% and require quarterly payments through
February, 2008.
NOTE TO FORMER OWNER OF MID-ATLANTIC
Concurrent with the acquisition of Mid-Atlantic, the Company issued a note
payable to its former owner for $4.1 million. The note bears interest at LIBOR
minus 1.0%, beginning in June 2006, and requires repayment in the amount of $0.5
million in the second fiscal quarter of 2006 and the remainder in the third
fiscal quarter of 2006.
NOTE TO FORMER OWNER OF SCN
Concurrent with the acquisition of SCN, the Company issued a note payable to its
former owner for $10.2 million. The note bears interest at LIBOR minus 1.0%,
beginning in June 2006, and requires repayment in the amount of $1.3 million in
the second fiscal quarter of 2006 and the remainder in the third fiscal quarter
of 2006.
The aggregate amount of debt maturing through January 31, 2011 is as follows:
(IN THOUSANDS) Amount
- -------------- --------
Fiscal year:
Remainder of 2007 $ 20,457
2008 7,866
2009 4,577
2010 2,781
2011 116,744
Thereafter 20,058
--------
Total $172,483
========
Page 14 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
At April 30, 2006 and January 31, 2006, unamortized deferred financing fees were
approximately $2.0 million and $2.2 million, respectively.
6. COMMITMENTS AND CONTINGENCIES
The Company leases facilities, vehicles, an aircraft, computer and other
equipment under various capital and operating leases. Future minimum lease
payments under non-cancelable operating leases with terms of one year or more at
April 30, 2006 consist of the following:
(IN THOUSANDS) Amount
- -------------- -------
Fiscal year:
Remainder of 2007 $11,691
2008 12,760
2009 10,803
2010 8,829
2011 5,646
Thereafter 15,795
-------
Total $65,524
=======
7. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows:
Three months ended
April 30,
------------------
(IN THOUSANDS) 2006 2005
- -------------- ------ ------
Weighted average common shares outstanding - Basic 51,708 42,314
Dilutive effect of stock options and warrants 1,446 2,081
------ ------
Weighted average common shares outstanding - Diluted 53,154 44,395
====== ======
For the three months ended April 30, 2006 and 2005, stock options to purchase
0.4 million and 0.2 million stock options, respectively, were excluded from the
calculation of diluted income per share because their exercise 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:
Three months ended
April 30,
------------------
(IN THOUSANDS) 2006 2005
- -------------- ------ ------
Interest $2,054 $ 853
Income taxes (net of receipts of $119 in 2006) $2,501 $2,457
Page 15 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
As discussed in Note 2, the Company acquired Mid-Atlantic on March 30, 2006 for
the total consideration of $17.7 million, including $13.6 million in cash and
$4.1 million in the form of a note payable.
As discussed in Note 2, the Company acquired SCN on March 30, 2006 for the total
consideration of $36.2 million, including $26.0 million in cash and $10.2
million in the form of a note payable.
9. STOCK-BASED COMPENSATION
On February 1, 2006, the Company adopted FAS No. 123(R), Share-Based Payment,
and chose to transition using the modified prospective method. Also on February
1, 2006, the Company granted approximately 0.1 million options to non-executive
members of its board of directors. The Company recognized stock compensation
expense of approximately $0.3 million associated with this grant. Total stock
compensation expense recognized during the three months ended April 30, 2006 was
$0.4 million.
Prior to adoption of FAS No. 123(R), Share-Based Payment, the Company had
elected to apply Accounting Principles Board Opinion No. 25 to account for its
stock-based compensation plans, as permitted under FAS No. 123, Accounting for
Stock-Based Compensation (FAS No. 123). No stock compensation expense was
recognized during the three months ended April 30, 2005 as all options granted
in those periods had an exercise price equal or greater than the market value of
the underlying stock on the date of grant.
The following is a reconciliation of the net income per weighted average share
had the Company adopted the fair-value provisions of FAS No. 123:
Three months
ended April
(IN THOUSANDS, EXCEPT PER SHARE DATA) 30, 2005
- ------------------------------------- ------------
Net income - as reported $ 1,671
Add stock compensation expense included in net income, net of tax --
Less pro-forma stock compensation expense, net of tax (670)
-------
Pro-forma net income $ 1,001
=======
Weighted average common shares outstanding - Basic 42,314
Weighted average common shares outstanding - Diluted 44,395
Earnings per share (as reported):
Basic $ 0.04
Diluted $ 0.04
Earnings per share (pro-forma):
Basic $ 0.02
Diluted $ 0.02
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:
Three months ended
April 30,
---------------------
2006 2005
--------- ---------
Weighted average dividend yield 0.0% 0.0%
Weighted average expected volatility 41.4% 50.0%
Page 16 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Weighted average expected life 3.1 years 3.0 years
Weighted average risk-free interest rate 4.5% 3.8%
Under the Company's stock option plans, options to acquire shares of Common
Stock have been made available for grant to certain employees and non-employee
directors. Each option granted has an exercise price of not less than 100% of
the market value of the Common Stock on the date of grant. The contractual life
of each option is generally 10 years. The vesting of the grants varies according
to the individual options granted.
Range of Weighted
Exercise Prices Average
Number of --------------- Exercise
Options Low High Price
--------- ------ ------ --------
Options outstanding at January 31, 2006 3,927,190 $ 2.30 $18.31 $ 7.64
Options granted 71,712 11.39 11.39 11.39
Options forfeited or expired (3,100) 10.60 14.88 14.05
Options exercised (8,125) 4.21 10.60 6.28
--------- ------ ------ ------
Options outstanding at April 30, 2006 3,987,677 $ 2.30 $18.31 $ 7.70
========= ====== ====== ======
The following table summarizes information about the stock options outstanding
at April 30, 2006:
Options Outstanding Options Exercisable
-------------------------------------- ----------------------
Weighted Weighted
Average Remaining Average
Number Exercise Contractual Number Exercise
Outstanding Price Life (Months) Exercisable Price
----------- -------- ------------- ----------- --------
Range of exercise prices:
$2.30 - $5.00 1,166,108 $ 4.52 14 - 81 1,166,108 $ 4.52
$5.01 - $7.50 691,250 5.31 21 - 79 691,250 5.31
$7.51 - $10.00 1,041,207 8.55 32 - 79 1,011,873 8.58
$10.01 - $15.00 981,212 11.29 35 - 117 981,212 11.29
$15.01 - $18.31 107,900 16.61 43 - 47 107,900 16.61
--------- ------ -------- --------- ------
Total 3,987,677 $ 7.70 14 - 117 3,958,343 $ 7.70
========= ====== ======== ========= ======
10. SEGMENT FINANCIAL REPORTING
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 CD and DVD Fulfillment, Magazine
Fulfillment, In-Store Services, and Shared Services. The accounting policies of
the segments are materially the same as those described in the Summary of
Accounting Policies.
Based on the comparability of the operations, Mid-Atlantic and SCN's results are
included in the Magazine Fulfillment group.
The CD and DVD Fulfillment segment derives revenues from (1) selling and
distributing pre-recorded music, videos, video games and related products to
retailers, (2) providing product and commerce solutions to "brick-and-mortar"
Page 17 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
and e-commerce retailers, and (3) providing consumer-direct fulfillment and
vendor managed inventory services to its customers.
The Magazine Fulfillment segment derives revenues from (1) selling and
distributing magazines, including domestic and foreign titles, to major
specialty and mainstream retailers and wholesalers throughout the United States
and Canada, (2) exporting domestic titles internationally to foreign wholesalers
or through domestic brokers, (3) providing return processing services for major
specialty retail book chains and (4) serving as an outsourced fulfillment agent.
The In-Store Services segment derives revenues from (1) designing,
manufacturing, and invoicing participants in front-end fixture programs, (2)
providing claim filing services related to rebates owed retailers from
publishers or their designated agent, (3) designing, manufacturing, shipping,
installation and removal of front-end fixtures, including high end wood and wire
and (4) providing information and management services relating to retail
magazine sales to U.S. and Canadian retailers and magazine publishers.
Shared Services consists of overhead functions not allocated to individual
operating segments.
The segment results are as follows:
CD and DVD Magazine In-Store Shared
(IN THOUSANDS) Fulfillment Fulfillment Services Services Consolidated
- -------------- ----------- ----------- -------- -------- ------------
THREE MONTHS ENDED APRIL 30, 2006
Revenues $240,690 $194,979 $ 18,931 $ -- $ 454,600
Cost of revenues 199,504 152,125 13,031 -- 364,660
-------- -------- -------- ------- ----------
Gross profit 41,186 42,854 5,900 -- 89,940
Selling, general and administrative
expense 21,805 24,106 2,236 6,173 54,320
Fulfillment freight 8,744 13,191 -- -- 21,935
Depreciation and amortization 3,458 1,651 146 550 5,805
Impairment of land and building
held for sale -- -- -- 529 529
-------- -------- -------- ------- ----------
Operating income $ 7,179 $ 3,906 $ 3,518 $(7,252) $ 7,351
======== ======== ======== ======= ==========
Capital Expenditures $ 941 $ 444 $ 79 $ 491 $ 1,955
AS OF APRIL 30, 2006
Total assets $527,684 $372,590 $114,540 $23,125 $1,037,939
Goodwill, net $203,995 $160,669 $ 55,634 $ -- $ 420,298
Intangibles, net $ 85,866 $ 40,750 $ 3,759 $ -- $ 130,375
CD and DVD Magazine In-Store Shared
(IN THOUSANDS) Fulfillment Fulfillment Services Services Consolidated
- -------------- ----------- ----------- -------- -------- ------------
THREE MONTHS ENDED APRIL 30, 2005
Revenues $148,462 $ 71,653 $ 14,306 $ -- $ 234,421
Cost of revenues 121,136 52,740 10,000 -- 183,876
-------- -------- -------- ------- ----------
Gross profit 27,326 18,913 4,306 -- 50,545
Selling, general and administrative
expense 13,360 9,046 2,155 5,113 29,674
Fulfillment freight 4,667 5,669 -- -- 10,336
Depreciation and amortization 2,066 403 146 488 3,103
Merger and acquisition charges -- -- 227 2,867 3,094
-------- -------- -------- ------- ----------
Page 18 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Operating income $ 7,233 $ 3,795 $ 1,778 $(8,468) $ 4,338
======== ======== ======== ======= ==========
Capital Expenditures $ 1,554 $ 53 $ 158 $ 590 $ 2,355
AS OF JANUARY 31, 2006
Total assets $507,546 $205,782 $109,762 $57,525 $ 884,472
Goodwill, net $168,898 $ 78,601 $ 54,794 $ -- $ 302,293
Intangibles, net $ 87,742 $ 27,374 $ 3,872 $ -- $ 118,988
Approximately $8.9 million and $8.3 million of the Company's total revenues in
the Magazine Fulfillment segment for the three months ended April 30, 2006 and
2005, respectively, were derived from the export of U.S. publications to
overseas markets. At April 30, 2006 and January 31, 2006, identifiable assets
attributable to the export of U.S. publications were $29.3 million and $14.3
million.
Page 19 of 39
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
(UNAUDITED)
11. SUBSEQUENT EVENT
In June 2006, the Company determined that the book value of a building it owned
and held for sale at April 30, 2006 exceeded its fair market value. Therefore,
the Company recognized an impairment charge of $0.5 million for the difference
between the book value of the building and its fair market value. The impairment
charge is included in the Company's consolidated results of operations for the
three months ended April 30, 2006.
Page 20 of 39
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Some of the information contained in this Quarterly Report on Form 10-Q
including, but not limited to, those contained in Item 2 of Part I "Management's
Discussion and Analysis of Financial Condition and Results of Operations," along
with statements in other reports filed with the Securities and Exchange
Commission (the "SEC"), external documents and oral presentations, which are not
historical facts are considered to be "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The words "believe,"
"expect," "anticipate," "estimate," "project," and similar expressions often
characterize forward-looking statements. These statements may include, but are
not limited to, projections of collections, revenues, income or loss, cash flow,
estimates of capital expenditures, plans for future operations, products or
services, and financing needs or plans, as well as assumptions relating to these
matters. These statements are only predictions and you should not unduly rely on
them. Our actual results will differ, perhaps materially, from those anticipated
in these forward-looking statements as a result of a number of factors,
including the risks and uncertainties faced by us described below and those set
forth below under "Risk Factors" in our Annual Report for the fiscal year ended
January 31, 2006 on Form 10-K filed with the SEC on April 17, 2006:
- market acceptance of and continuing demand for magazines, DVDs, CDs
and other home entertainment products;
- the impact of competitive products and technologies;
- the pricing and payment policies of magazine publishers, film studios,
record labels and other key vendors;
- changing market conditions and opportunities;
- our ability to realize operating efficiencies, cost savings and other
benefits from recent acquisitions; and
- retention of key management and employees.
We believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to predict
accurately or over which we have no control. The factors listed above provide
examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking
statements. Before you make an investment decision relating to our common stock,
you should be aware that the occurrence of the events described in these risk
factors and those set forth below under "Risk Factors" in our Annual Report for
the fiscal year ended January 31, 2006 filed with the SEC on April 17, 2006
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 Item 2 of Part I "Management's Discussion
and Analysis of Financial Condition and Results of Operation." 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.
Page 21 of 39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
We are a premier marketing, merchandising and fulfillment company of
entertainment products including DVDs, music CDs, magazines, books and related
items serving about 110,000 retail store locations throughout North America. Our
fully integrated businesses include:
- Distribution and fulfillment of entertainment products to major retail
chains throughout North America and direct-to-consumers via the
Internet;
- Import and export of periodicals sold in more than 100 markets
worldwide;
- Coordination of product selection and placement for impulse items sold
at checkout counters;
- Processing and collection of rebate claims as well as management of
sales data obtained at the point-of-purchase; and
- Design, manufacture and installation of wire fixtures and custom wood
displays in major retail chains.
Our clients include:
- Mainstream retailers, such as Wal-Mart Stores, Inc., The Kroger
Company, Target Corporation, Walgreen Company, Ahold USA, Inc., Sears
Holdings Corporation., and Meijer, Inc.;
- Specialty retailers, such as Barnes & Noble, Inc., Borders Group,
Inc., Hastings Entertainment, Inc., Fry's Electronics, Inc. and
Circuit City Stores, Inc.; and
- e-commerce retailers, such as amazon.com, barnesandnoble.com,
circuitcity.com and bestbuy.com.
Our suppliers include:
- Record labels, such as Vivendi Universal S.A., Sony BMG Music
Entertainment Company, WEA Distribution and Thorn-EMI;
- Film studios, such as The Walt Disney Company, Time Warner Inc., Sony
Corp., The News Corporation, Viacom Inc. and General Electric Company;
and
- Magazine Distributors, such as COMAG Marketing Group, LLC, Time Warner
Retail Sales & Marketing, Inc., Curtis Circulation Company and Kable
Distribution Services, Inc.
On February 28, 2005, we completed our merger with Alliance Entertainment Corp,
a logistics and supply chain management services company for the home
entertainment product market, principally selling CDs and DVDs. Following the
merger, we organized the combined company into three operating business units:
- Magazine Fulfillment - The magazine fulfillment segment sells and
distributes magazines to major retailers and wholesalers, imports
foreign titles for domestic retailers and wholesalers, exports
domestic titles to foreign wholesalers, provides return processing
services, serves as an outsource fulfillment agent and provides
customer-direct fulfillment.
- CD and DVD Fulfillment - The CD and DVD fulfillment segment sells and
distributes pre-recorded music, videos, video games and related
products to retailers, provides product and commerce solutions to
retailers and provides customer-direct fulfillment and vendor managed
inventory.
- In-Store Services - The in-store services segment designs,
manufactures and invoices participants in front-end fixture programs,
provides claim filing services for rebates owed retailers from
publishers and their
Page 22 of 39
agents, designs, manufactures, ships, installs and removes front-end
fixtures and provides information and management services relating to
retail magazine sales to U.S. and Canadian retailers and magazine
publishers.
OVERVIEW
Significant events that occurred during the three months ended April 30, 2006
and 2005 include:
ACQUISITION OF ANDERSON MID-ATLANTIC NEWS, LLC
On March 30, 2006, we acquired all of the issued and outstanding membership
interests of Anderson Mid-Atlantic News, LLC ("Mid-Atlantic") from Anderson
News, LLC for a purchase price of approximately $4.0 million, subject to
adjustment based on the negative net worth as of the closing date of the
transaction. In addition, we provided approximately $9.6 million on the date of
acquisition to Mid-Atlantic to repay a portion of their outstanding intercompany
debt. The remaining outstanding intercompany debt of Mid-Atlantic was satisfied
by issuance of a promissory note totaling $4.1 million. The purchase price and
the intercompany debt repayment were funded by borrowings against our revolving
line of credit. Mid-Atlantic's results of operations have been included in our
Consolidated Financial Statements since the date of acquisition. The preliminary
allocation of purchase price is presented in Note 2 to our Consolidated
Financial Statements.
ACQUISITION OF ANDERSON-SCN SERVICES, LLC
On March 30, 2006, we acquired all of the issued and outstanding membership
interests of Anderson-SCN Services, LLC ("SCN") from Anderson News, LLC for a
purchase price of approximately $9.0 million, subject to adjustment based on the
negative net worth as of the closing date of the transaction. In addition, we
provided approximately $17.0 million on the date of acquisition to SCN to repay
a portion of their outstanding intercompany debt. The remaining outstanding
intercompany debt of SCN was satisfied by issuance of a promissory note totaling
$10.2 million. The purchase price and the intercompany debt repayment were
funded by borrowings against our revolving line of credit. SCN's results of
operations have been included in our Consolidated Financial Statements since the
date of acquisition. The preliminary allocation of purchase price is presented
in Note 2 to our Consolidated Financial Statements.
ACQUISITION OF ALLIANCE ENTERTAINMENT CORP.
On February 28, 2005, we completed the acquisition of Alliance Entertainment
Corp. ("Alliance"), a logistics and supply chain management services company for
the home entertainment product market pursuant to the terms and conditions of
the Agreement and Plan of Merger Agreement dated as of November 18, 2004 (the
"Merger Agreement").
Alliance historically operated two business segments: the Distribution and
Fulfillment Services Group ("DFSG") and the Digital Medial Infrastructure
Services Group (the "DMISG"). Prior to the merger, on December 31, 2004,
Alliance disposed of all of the operations conducted by the DMISG business lines
through a spin-off to its existing stockholders. Consequently, in connection
with the merger, we acquired only the DFSG business and not the DMISG business.
The DMISG business represented approximately 1.8% and 1.4% of Alliance's
consolidated sales for the years ended December 31, 2004 and 2003, respectively.
We consummated the merger with Alliance to further our objective of creating the
premier provider of information, supply chain management and logistics services
to retailers and producers of home entertainment content products. We believe
that the merger has provided significant market opportunities to take advantage
of our strong retailer relationships and experience in marketing our products by
expanding product offerings beyond our existing magazine fulfillment business to
DVDs, CDs, video games and related home entertainment products and accessories.
In addition, we believe that our in-store merchandising capabilities have been
strengthened. We also believe this transaction has positioned us as the
distribution channel of choice for film studios, record labels,
Page 23 of 39
publishers and other producers of home entertainment content products. We have
benefited from substantial cost savings in the areas of procurement, marketing,
information technology and administration and from other operational
efficiencies, particularly in the distribution and fulfillment functions, where
we have consolidated some distribution operations, reorganized others and
leveraged our best practices across all of our distribution operations. As a
result, we believe the merger has enhanced our financial strength, increased our
visibility in the investor community and strengthened our ability to pursue
further strategic acquisitions.
The total purchase price of approximately $315.5 million consisted of $304.7
million in Source Interlink common stock, representing approximately 26.9
million shares, $6.5 million related to the exchange of approximately 0.9
million shares of common stock on exercise of outstanding stock options,
warrants and other rights to acquire Alliance common stock and direct
transaction costs of $4.3 million. The value of the common stock was determined
based on the average market price of Source Interlink common stock over the
5-day period prior to and after the announcement of the merger in November 2004.
The value of the stock options was determined using the Black-Scholes option
valuation model.
Page 24 of 39
RESULTS OF OPERATIONS
Please see our Annual Report on Form 10-K for the fiscal year ended January 31,
2006 and filed with the SEC on April 17, 2006 for more information on the types
of revenues and expenses included within the specific line-items in our
financial statements.
The following table sets forth, for the periods presented, information relating
to our continuing operations, by segment:
Three months ended April 30,
-----------------------------------------
2006 2005
------------------- -------------------
(IN THOUSANDS) Amount Margin % Amount Margin %
- -------------- -------- -------- -------- --------
CD AND DVD FULFILLMENT
Revenues $240,690 $148,462
Cost of revenues 199,504 121,136
-------- --------
Gross profit 41,186 17.1% 27,326 18.4%
Operating expenses(a) 34,007 20,093
-------- ---- -------- ----
Operating income $ 7,179 3.0% $ 7,233 4.9%
======== ==== ======== ====
MAGAZINE FULFILLMENT
Revenues $194,979 $ 71,653
Cost of revenues 152,125 52,740
-------- --------
Gross profit 42,854 22.0% 18,913 26.4%
Operating expenses(a) 38,948 15,118
-------- ---- -------- ----
Operating income $ 3,906 2.0% $ 3,795 5.3%
======== ==== ======== ====
IN-STORE SERVICES
Revenues $ 18,931 $ 14,306
Cost of revenues 13,031 10,000
-------- --------
Gross profit 5,900 31.2% 4,306 30.1%
Operating expenses(a) 2,382 2,528
-------- ---- -------- ----
Operating income $ 3,518 18.6% $ 1,778 12.4%
======== ==== ======== ====
SHARED SERVICES
Revenues $ -- $ --
Cost of revenues -- --
-------- --------
Gross profit -- n/a -- n/a
Operating expenses(a) 7,252 8,468
-------- ---- -------- ----
Operating income (7,252) n/a (8,468) n/a
======== ==== ======== ====
TOTAL
Revenues $454,600 $234,421
Cost of revenues 364,660 183,876
-------- --------
Gross profit 89,940 19.8% 50,545 21.6%
Operating expenses(a) 82,589 46,207
-------- ---- -------- ----
Operating income 7,351 1.6% 4,338 1.9%
======== ==== ======== ====
(a) Operating expenses include selling, general and administrative expenses,
fulfillment freight, merger and acquisition charges, relocation expenses,
impairment of land and building held for sale, depreciation and
amortization of intangibles.
Page 25 of 39
REVENUES
Total revenues for the quarter ended April 30, 2006 increased $220.2 million, or
93.9%, from the same quarter of the prior year due primarily the following
factors:
- The acquisition of Chas. Levy Circulating Co., LLC ("Levy") in May
2005,
- The acquisition of Mid-Atlantic and SCN in the current quarter, and
- The inclusion of three months of results of operations from Alliance
in the current quarter compared to two months in the prior year.
CD and DVD Fulfillment
Our CD and DVD Fulfillment group's revenues were $240.7 million, an increase of
$92.2 million, or 62.1%, from the same quarter of the prior year. The increase
is due primarily to inclusion of three months of revenues from the group in
results of operations for the current quarter compared to two months in the
prior year. Additionally, the group experience increases in sales to major
customers and large new customers of $11.1 million and increases in customer
direct fulfillment of $8.5 million.
Magazine Fulfillment
Our Magazine Fulfillment group's revenues were $195.0 million, an increase of
$123.3 million, or 172.1%, from the same quarter of the prior year.
The group's revenues for the three months ended April, 30 2006 and 2005 are
comprised of the following components:
Three months ended
April 30,
------------------
(IN THOUSANDS) 2006 2005 Change
- -------------- -------- ------- --------
Domestic Mainstream $126,444 $ 7,598 $118,846
Domestic Specialty 59,632 55,787 3,845
Export 8,903 8,268 635
-------- ------- --------
Total $194,979 $71,653 $123,326
======== ======= ========
Revenue consists of the gross amount of books and 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.
Revenues also consists of fees earned for the picking of third party product,
return processing and wastepaper revenue.
Domestic mainstream revenues originate from sales to "mainstream" retailers,
which consist of Grocery, Discount, Transportation Terminals, Convenient Stores
and Drug Stores. The mainstream distribution channel's revenues include book and
magazine distribution. The increase in sales of $118.9 is primarily attributable
to two recent acquisitions and a major new customer and existing customer
expansion. In May 2005, the group significantly increased its presence in the
mainstream market with the acquisition of Levy, a leading magazine wholesaler
based in Chicago, IL, with distribution centers in Chicago, IL, Lancaster, PA,
Brainerd, MN, and City of Industry, CA. In March 2006, the group acquired
additional distribution territories in Southern California and Washington
DC/Baltimore markets, through the acquisition of Mid-Atlantic and SCN.
Domestic specialty revenues originate from magazine sales to "specialty"
retailers, which consist of Bookstores, Music outlets, Office Supply stores and
Computer stores. The increase in sales relates to increased distribution to our
two major bookstore chains.
Page 26 of 39
Export revenues originate from the sale of domestic titles to foreign
wholesalers and brokers for distribution to foreign markets.
Sales efficiencies expressed as a percentage of net distribution to gross
distribution were 31.5%, 42.0% and 40.5% for the mainstream, specialty and
export groups, respectively. The prior year comparable period efficiencies were
31.2%, 43.1% and 36.1%.
In-Store Services
Our In-Store Services group's revenues were $18.9 million, an increase of $4.6
million, or 32.3%, from the same quarter of the prior year.
The group's revenues are comprised of the following components:
Three months ended
April 30,
------------------
(IN THOUSANDS) 2006 2005 Change
- -------------- -------- ------- ------
Claim filing and information $ 4,548 $ 3,544 $1,004
Front end wire and services 7,676 5,072 2,604
Wood 6,707 5,690 1,017
------- ------- ------
Total $18,931 $14,306 $4,625
======= ======= ======
Our claim filing revenues are recognized at the time the claim is paid. The $1.0
million increase in claim filing and information is attributable to the timing
of the receipt of quarterly claim payments.
Our front end wire and services revenue increased $2.6 million due to increased
production for several large jobs for large chain retailers, compared to
relatively few large jobs during the same quarter of the prior year.
Our wood revenues increased $1.0 million due to increased store openings and
remodels performed by our major customers.
GROSS PROFIT
Gross profit for the period increased $39.4 million, or 77.9%, over the same
quarter of the prior year primarily due to the following factors:
- The acquisition of Levy in May 2005,
- The Mid-Atlantic and SCN in the current quarter, and
- The inclusion of three months of results of operations from Alliance
in the current quarter compared to two months in the prior year.
Overall gross profit margins decreased 1.8 percentage points in the current
quarter compared the same quarter of the prior year.
CD and DVD Fulfillment
Gross profit for our CD and DVD Fulfillment group was $41.2 million, an increase
of $13.9 million, or 50.7%, over the prior year. The increase relates primarily
to the inclusion of three months of results of operations from the group
Page 27 of 39
in the current quarter compared to two months in the prior year. Gross profit
margins for the group decreased from 18.4% in the prior year to 17.1% in the
current quarter, primarily due to increased DVD sales, which have lower gross
profit margins, over the same quarter of the prior year. In addition, there were
increased customer direct fulfillment sales, in which our CD and DVD Fulfillment
group sells directly to consumers via retailer websites. These sales have
generally lower gross profit margins than sales to retailers for resale to
consumers.
Magazine Fulfillment
Our Magazine Fulfillment group's gross profit was $42.9 million for the quarter
ended April 30, 2006. Compared to the comparable prior fiscal year period, gross
profit increased $23.9 million or 126.6%. Gross profit margin decreased from
26.4% to 22.0%.
The decrease in gross profit margins is attributable to the change in sales mix
due to the increase in revenues in the mainstream distribution channel, as a
result of the acquisition of Levy, Mid-Atlantic and SCN. The mainstream
distribution channel generally has lower gross margins then the specialty
distribution channel due to certain publisher rebates that are available to the
specialty distribution channel that are not available in the domestic
distribution channel. Gross margins were 23.2% and 21.3% in the current quarter
for the specialty and mainstream groups, respectively.
In-Store Services
Our In-Store Services group's gross profit was $5.9 million in the current
quarter, an increase of $1.6 million, or 37.0%, compared to the same quarter of
the prior year. The group's gross profit margin increased from 30.1% to 31.2%.
The increase in gross profit is attributed primarily to the increase in revenues
discussed above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the current quarter were $54.3
million, an increase of $24.6 million, or 83.1%, compared to the prior year.
Selling, general and administrative expenses as a percent of revenues declined
from 12.7% to 11.9%.
CD and DVD Fulfillment
Selling, general and administrative expenses for our CD and DVD Fulfillment
group were $21.8 million, an increase of $8.4 million, or 63.2%, compared to the
prior year. The increase is primarily due to the inclusion in the current
quarter of three months of the group's results of operations, compared to two
months in the prior year. Selling, general and administrative expenses as a
percentage of the group's revenues increased from 9.0% to 9.1%.
Magazine Fulfillment
The Magazine Fulfillment group's selling, general and administrative expenses
include the costs of operating the group's distribution centers, the in-store
merchandising field force and the backroom operations.
Selling, general and administrative expenses increased $15.1 million, or 166.5%,
from $9.0 million to $24.1 million. The increase relates primarily to the
expansion of the group's mainstream distribution backroom operations and
in-store merchandising field force via the acquisitions described above.
Selling, general and administrative expenses as a percentage of the group's
revenues decreased from 12.6% to 12.4%.
In-Store Services
Page 28 of 39
The In-Store Services group's selling, general and administrative expenses
remained relatively flat at $2.2 million.
Shared Services
The selling, general and administrative expenses of the Shared Services group
increased $1.1 million, or 20.7% over the same quarter of the prior year. The
increase is primarily due to increased operating expenses to support our
significant growth and a charge of $0.4 million taken in the current quarter
related to non-cash stock compensation expense associated with our adoption of
FAS 123(r). As noted above, shared services selling, general, and administrative
expenses declined as a percentage of total revenues from 2.2% to 1.4%.
FULFILLMENT FREIGHT
Our fulfillment freight expenses were $21.9 million, an increase of $11.6
million, or 112.2%, compared to the prior year. The increase is primarily
attributable to significantly higher distribution due to the acquisition of
Chas. Levy Circulating Co., LLC in May 2005, the acquisition of Anderson
Mid-Atlantic News, LLC and Anderson SCN Services, LLC and the inclusion of three
months of the results of operations of Alliance Entertainment Corp. in the
current quarter compared to two months in the same quarter of the prior year,
coupled with significantly higher fuel costs in the current quarter compared
with the same quarter of the prior year.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization was $5.8 million, an increase of $2.7 million, or
87.1%, compared to the prior year. The increase is primarily attributable to the
acquisition of Levy in May 2005, the acquisition of Mid-Atlantic and SCN and the
inclusion of three months of the results of operations of Alliance the current
quarter compared to two months in the prior year.
IMPAIRMENT OF LAND AND BUILDING HELD FOR SALE
In May 2006, we entered into a contract to sell land and a building that we
owned during the second quarter of fiscal 2007. As such, we recorded an
impairment charge in the three months ended April 30, 2006 for the difference
between the estimated realizable value and the carrying amount of the land and
building.
MERGER AND ACQUISITION CHARGES
Merger charges related to acquisition recorded as expense by the Company through
April 30, 2005 totaled $3.1 million. These expenses represented severance and
personnel-related charges, charges to exit certain merchandiser contracts and a
success fee paid to certain Company executives. These expenses were not
capitalized as they did not represent costs that provide future economic
benefits to the Company.
OPERATING INCOME
Operating income for the quarter ended April 30, 2006 increased $3.0 million, or
69.5%, compared to the prior year due to the factors described above.
Operating profit margins decreased from 1.9% to 1.6%, primarily due to decreases
in gross profit margins discussed above.
INTEREST EXPENSE
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Interest expense includes the interest and fees on our significant debt
instruments and outstanding letters of credit. The increase of $1.3 million
relates primarily to significantly higher borrowings during the current quarter
due primarily to the acquisition of Mid-Atlantic and SCN and increased interest
rates on debt.
OTHER INCOME (EXPENSE)
Other income (expense) consists of items outside the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful.
INCOME TAX EXPENSE
The effective tax rates were 36.9% and 52.6% for the current quarter and the
same quarter of the prior year, respectively. The decrease in the effective tax
rate is due to a revision of the treatment of certain timing differences. We
anticipate our effective tax rate to approximate 40% for the remainder of the
year.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of cash include receipts from our customers and borrowings
under our credit facilities and from time to time the proceeds from the sale of
common stock.
Our primary cash requirements for the Magazine Fulfillment and CD and DVD
Fulfillment groups consist of the cost of home entertainment products and the
cost of freight, labor and facility expense associated with our distribution
centers.
Our primary cash requirements for the In-Store Services group consist of the
cost of raw materials, labor, and factory overhead incurred in the production of
front-end wood and wire displays, the cost of labor incurred in providing our
claiming, design and information services and cash advances funding our Advance
Pay program. Our Advance Pay program allows retailers to accelerate collections
of their rebate claims through payments from us in exchange for the transfer to
us of the right to collect the claim. We then collect the claims when paid by
publishers for our own account.
Our primary cash requirements for the Shared Services group consist of salaries,
professional fees and insurance not allocated to the operation groups.
The following table presents a summary of our significant obligations and
commitments to make future payments under debt obligations and lease agreements
due by period as of April 30, 2006:
Payments due during the year ending January 31,
----------------------------------------------------
Remainder 2011 and
of 2007 2008 2009 2010 thereafter Total
--------- ------- ------- ------- ---------- --------
Debt obligations $20,457 $ 7,866 $ 4,577 $ 2,781 $136,802 $172,483
Interest payments(a) 8,599 10,464 10,025 9,765 10,573 49,426
Capital leases 801 888 704 212 -- 2,605
Operating leases 11,691 12,760 10,803 8,829 21,441 65,524
------- ------- ------- ------- -------- --------
Total contractual cash obligations $41,548 $31,978 $26,109 $21,587 $168,816 $290,038
======= ======= ======= ======= ======== ========
(a) Interest is calculated using the prevailing weighted average rate on our
outstanding debt at April 30, 2006, using the required payment schedule.
The following table presents a summary of our commercial commitments and the
notional amount expiration by period:
Page 30 of 39
Notional amounts expiring during the
year ending January 31,
-----------------------------------------
2011 and
(IN THOUSANDS) 2007 2008 2009 2010 thereafter Total
- -------------- ------- ---- ---- ---- ---------- -------
Financial standby letters of credit $11,625 $664 $-- $-- $-- $12,289
OPERATING CASH FLOW
Net cash used in operating activities was $56.9 million and $10.6 million for
the quarters ended April 30, 2006 and 2005, respectively.
Operating cash flows for the three months ended April 30, 2006 were comprised
of:
- Net income of $3.3 million,
- Plus non-cash charges including:
- depreciation and amortization of $6.2 million,
- provisions or losses on accounts receivable of $1.7 million,
- stock compensation expense of $0.4 million, and
- impairment of land and building held for sale of $0.5 million.
- Cash was used for:
- a decrease in deferred revenue of $0.4 million,
- an increase in accounts receivable of $8.2 million,
- an increase in inventories of $9.8 million,
- an increase in other assets of $1.7 million, and
- a decrease in accounts payable and other liabilities of $48.8
million.
The increase in accounts receivable was primarily due to a $30.7 million
increase in accounts receivable in our Magazine Fulfillment group. $6.2 million
of this increase results from the timing of the acquisition of Mid-Atlantic and
SCN, approximately $10.5 million in new receivables as a result of bringing in
new customers and locations, and $6.2 million associated with increased domestic
specialty distribution and the timing of receipts from major customers.
Additionally, increased production within our In-Store Services group during the
first quarter of fiscal 2007, versus fourth quarter fiscal 2006 resulted in $3.2
million in additional receivables. These increases in accounts receivable were
partially offset by a decrease in accounts receivable of $25.1 million within
our CD and DVD Fulfillment group, primarily related to the timing of receipts
from major customers.
The increase in inventories was primarily due to a $5.6 million increase in
inventories within our Magazine Fulfillment group, resulting from an increase of
$7.8 million associated with bringing in new customers and locations, partially
offset by other insignificant changes within the Magazine Fulfillment group of
$2.2 million. Changes in inventory in our other groups were insignificant in
size and accounted for the rest of the increase.
The decrease in accounts payable was primarily due to a decrease in accounts
payable within our Magazine Fulfillment group of $31.5 million. $20.4 million of
this increase results from the timing of the acquisition of Mid-Atlantic and
SCN, with the remainder attributable to the timing of vendor payments within the
first quarter of fiscal 2007. Additionally, our CD and DVD Fulfillment group had
a decrease in accounts payable of $25.7 million associated with payments on
accounts payable originated under extended holiday season payment terms in the
fourth quarter of fiscal 2006.
Operating cash flows for the three months ended April 30, 2005 were comprised
of:
- Net income of $1.7 million,
Page 31 of 39
- Plus non-cash charges including:
- depreciation and amortization of $3.6 million,
- provisions for losses on accounts receivable of $0.2 million,
- a tax benefit received on stock options exercised of $0.7
million, and
- an increase of $0.4 million in deferred revenue.
- $7.6 million cash was also provided by a decrease in accounts
receivable.
- Cash was used for:
- an increase in inventories of $15.6 million,
- a decrease in accounts payable and other liabilities of $8.0
million, and
- an increase in other assets of $1.1 million.
The decrease in accounts receivable for the three months ended April 30, 2005
was primarily due to a decrease in accounts receivable of $10.8 million from the
CD and DVD Fulfillment group due to collections subsequent to the date of
acquisition.
In addition, the In-Store Services division decreased accounts receivable by
$2.4 million due to significant cash collections in the current period and lower
sales volume. This decrease is consistent with prior first quarter activity. The
decreases in accounts receivable noted above were offset by an increase in the
Magazine Fulfillment group of approximately $6.2 million primarily due to a
decrease in the sales returns reserve from January 31, 2005 to April 30, 2005 of
$5.7 million which is consistent with prior first quarter sales returns activity
in the Magazine Fulfillment Division.
The decrease in accounts payable and other current and non-current liabilities
in the current period of $8.0 million relates primarily to the timing of vendor
payments in the current period as compared to January 31, 2005.
The increase in inventories of $15.6 million for the three months ended April
30, 2005 was primarily due to the acquisition of the CD and DVD Fulfillment
group on February 28, 2005, as approximately $13.6 million of the increase was
attributable to their purchases subsequent to the date of acquisition.
INVESTING CASH FLOW
Net cash used in investing activities was $42.8 million and $0.5 million for the
quarters ended April 30, 2006 and 2005, respectively.
For the quarter ended April 30, 2006 cash used in investing activities consisted
primarily of $13.6 million paid to acquire Mid-Atlantic and $25.9 million paid
to acquire SCN. Additionally, we incurred capital expenditures of $2.0 million
and other investing expenditures of $1.0 million.
For the quarter ended April 30, 2005, cash used in investing activities was
reduced by capital expenditures of $2.4 million, of which $1.6 million relates
to equipment purchases made by the CD and DVD Fulfillment group in anticipation
of new business. Our advance pay program used $12.7 million in the first quarter
of 2006. We also invested $2.3 million for the rights to distribute certain
titles over a period of three to fifteen years. Finally, as part of the
acquisition of the CD and DVD Fulfillment group, we acquired cash of $16.9
million after direct acquisition costs.
FINANCING CASH FLOW
Outstanding balances on our credit facility fluctuate partially due to the
timing of the retailer rebate claiming process and our Advance Pay program, the
seasonality of our front end wood, wire and services business and the payment
cycles of the CD and DVD and magazine distribution businesses. Because the
magazine distribution business and Advance Pay program cash requirement peak at
our fiscal quarter ends, the reported bank debt levels usually are the maximum
level outstanding during the quarter. Alliance has historically generated
approximately 33% of its total
Page 32 of 39
net sales in the fourth calendar quarter coinciding with the holiday shopping
season and therefore should have greater borrowings in the third quarter to
finance the buildup of inventory.
Payments under our Advance Pay program generally occur just prior to our fiscal
quarter end. The related claims are not generally collected by us until 30-60
days after the advance is made. As a result, our funding requirements peak at
the time of the initial advances and decrease over this period as the cash is
collected on the related claims.
The front end wood, wire and services business is seasonal because most
retailers prefer initiating new programs before the holiday shopping season
begins, which concentrates revenues in the second and third quarter. Receivables
from these programs are generally collected from all participants within 180
days. We are usually required to tender payment on the costs of these programs
(raw material and labor) within a shorter period. As a result, our funding
requirements peak in the second and third fiscal quarters when we manufacture
the fixtures and decrease significantly in the fourth and first fiscal quarters
as the related receivable are collected and significantly less manufacturing
activity is occurring.
Net cash provided by financing activities was $76.5 million and $11.1 million
for the quarters ended April 30, 2006 and 2005, respectively.
Financing activities in the quarter ended April 30, 2006 consisted primarily of
borrowings under our revolving credit facility of $69.8 million and an increase
in checks issued against future borrowings under the revolving credit facility
of $6.0 million. The significant borrowings under the revolving credit facility
were primarily for the purpose of acquiring Mid-Atlantic and SCN.
Financing activities in the first quarter ended April 30, 2005 consisted of
borrowings under the credit facilities of $28.7 million. These amounts were
offset by repayments of $9.9 million in debt and capital leases, of which
approximately $8.8 million relates to the repayment of the Wells Fargo Foothill
term loan in connection with the modification of the revolving credit facility
and a decrease of $8.0 million in checks issued and outstanding at April 30,
2005. Finally, the exercise of employee stock options in the quarter generated
approximately $1.2 million.
DEBT
For a detailed description of the terms of our significant debt instruments,
please see Note 7 to our Consolidated Financial Statements.
Significant debt transactions during the three months ended April 30, 2006 are
as follows:
- In connection with the acquisition of Mid-Atlantic on March 30, 2006,
we issued a promissory note to its former owner in the amount of $4.1
million. It is to be repaid in the amount of $0.5 million in the
second quarter of fiscal 2007, and the remainder in the third quarter
of fiscal 2007. It bears interest beginning in June 2007 at the rate
of LIBOR minus 1.0%. The remainder of the purchase price, $13.6
million, was funded by borrowings on our revolving credit facility.
- In connection with the acquisition of SCN on March 30, 2006, we issued
a promissory note to its former owner in the amount of $10.2 million.
It is to be repaid in the amount of $1.3 million in the second quarter
of fiscal 2007, and the remainder in the third quarter of fiscal 2007.
It bears interest beginning in June 2007 at the rate of LIBOR minus
1.0%. The remainder of the purchase price, $26.0 million, was funded
by borrowings on our revolving credit facility.
OFF-BALANCE SHEET ARRANGEMENTS
We do not engage in transactions or arrangements with unconsolidated or other
special purpose entities.
Page 33 of 39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability.
Our debt primarily relates to credit facilities with Wells Fargo Foothill. See
Note 7 to our Consolidated Financial Statements.
The revolving credit facility with Wells Fargo Foothill had an outstanding
principal balance of $114.8 million at April 30, 2006. Interest on the
outstanding balance is charge based on a variable interest rate related to the
prime rate (7.75% at April 30, 2006) plus a margin specified in the credit
agreement based on an availability calculation (0.0% at April 30, 2006).
A 1.0% increase in the prevailing interest rate on our debt at April 30, 2006 is
estimated to cause an increase of $1.2 million in the interest expense for the
remainder of the year ending January 31, 2007.
We do not perform any interest rate hedging activities related to this facility.
We have exposure to foreign currency fluctuation through our exporting of
foreign magazines and the purchase of foreign magazines for domestic
distribution.
Revenues derived from the export of foreign titles (or sales to domestic brokers
who facilitate the export) totaled $8.9 million for the quarter ended April 30,
2006 or 4.6% 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 distribution (gross) of imported titles totaled approximately $25.6
million (of a total $513.7 million or 5.0%). Foreign publications are purchased
in both dollars and the local currency of the foreign publisher, primarily Euros
and pounds 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 than 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.
Page 34 of 39
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 of the end of the period covered by this report (the
"Evaluation Date").
Attached as exhibits to this Quarterly Report are certifications of our chief
executive officer and chief financial officer, which are required in accordance
with Rule 13a-14 of the Securities Exchange Act of 1934, as amended ("Exchange
Act"). The information appearing below should be read in conjunction with the
certifications for a more complete understanding of the topics presented.
ABOUT DISCLOSURE CONTROLS
Disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule
15d-15(e) of the Exchange Act) are designed to provide assurance that the
information concerning us and our consolidated subsidiaries, which is required
to be included in our reports and statements filed or submitted under the
Exchange Act, 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 SEC.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Our management, including our chief executive officer and chief financial
officer, do not expect that our disclosure controls and procedures will prevent
all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
system's objectives will be met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty and that breakdowns
can occur because of simple error or mistake. Controls can also be circumvented
by the individual acts of some persons, by collusion of two or more people, or
by management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
SCOPE OF THE CONTROLS EVALUATION
The evaluation of our disclosure controls and procedures included a review of
the controls' objectives and design, the company's implementation of the
controls and the effect of the controls on the information generated for use in
this Quarterly Report. In the course of the controls evaluation, we sought to
identify data errors, control problems or acts of fraud and confirm that
appropriate corrective action, including process improvements, were being
undertaken. This type of evaluation is performed on a quarterly basis so that
the conclusions of management, including the chief executive officer and the
chief financial officer, concerning the effectiveness of the controls can be
reported in our Quarterly Reports on Form 10-Q and to supplement our disclosures
made in our Annual Report on Form 10-K. Many of the components of our disclosure
controls and procedures are also evaluated on an ongoing basis by our Internal
Audit Department and by other personnel in our finance organization. The overall
goals of these various evaluation activities are to monitor our disclosure
controls and procedures, and to modify them as necessary. Our intent is to
maintain the disclosure controls and procedures as dynamic systems that change
as conditions warrant.
Page 35 of 39
CONCLUSIONS
Based on this evaluation, our chief executive officer and our chief financial
officer, have concluded that, subject to the limitations noted above, as of the
end of the period covered by this report, our disclosure controls and procedures
were effective to ensure that information we are required to disclose in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in SEC rules and forms and
include controls and procedures designed to ensure that information required to
be disclosed by the Company in such reports is accumulated and communicated to
the Company's management, including the Chief Executive Officer and the Chief
Financial Officer, as appropriate to allow timely decisions regarding required
disclosure.
CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING
Except as set forth in this paragraph, there were no changes in the Company's
internal controls over financial reporting (as defined in Rule 13a-15f of the
Exchange Act that occurred during the fiscal quarter ended April 30, 2006 that
have materially affected, or are reasonably likely to materially affect those
controls. During the first quarter of fiscal 2007, we transitioned certain
Magazine Fulfillment Accounts Receivable functions to an application acquired as
part of the Chas. Levy Circulating Co., LLC transaction. We implemented the
change to leverage our technological infrastructure and improve the efficiency
of transaction processing, not in response to an identified internal control
deficiency. This system migration will likely have a material effect on our
internal controls over financial reporting and will require testing for
effectiveness.
Page 36 of 39
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 of 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 1A. RISK FACTORS.
There were no material changes, additions or deletions from our risk factors as
presented in the section entitled "Risk Factors" in our Annual Report on Form
10-K for the year ended January 31, 2006 as filed with the SEC on April 17,
2006.
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.
Not Applicable.
ITEM 5. OTHER INFORMATION.
Not Applicable.
ITEM 6. EXHIBITS.
See Exhibit Index.
Page 37 of 39
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.
SOURCE INTERLINK COMPANIES, INC.
June 9, 2006 By: /s/ Marc Fierman
------------------------------------
Marc Fierman
Chief Financial Officer
Page 38 of 39
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
31.1* Rule 13a-14(a)/15d-14(a) Certification of Principal Executive
Officer.
31.2* Rule 13a-14(a)/15d-14(a) Certification of Principal Financial
Officer.
32.1* Section 1350 Certification of Principal Executive Officer and
Principal Financial Officer.
Page 39 of 39