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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the quarterly period ended July 31, 2002
[ ] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from _________ to _________
Commission file number 1-13437
SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
MISSOURI 43-1710906
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
TWO CITY PLACE DRIVE, SUITE 380
ST. LOUIS, MISSOURI 63141
(Address of Principal Executive Offices)
(314) 995-9040
(Registrant's Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date.
Class Outstanding on September 10, 2002
Common Stock, $.01 Par Value 18,202,845
SOURCE INTERLINK COMPANIES, INC.
INDEX
PART I - FINANCIAL INFORMATION
Page
----
ITEM 1. Financial Statements
Consolidated Balance Sheets as of
July 31, 2002 and January 31, 2002
Consolidated Statements of Income for the three months
and six months ended July, 2002 and 2001
Consolidated Statements of Comprehensive Income for the three
months and six months ended July 31, 2002 and 2001
Consolidated Statement of Stockholders'
Equity for the six months ended July 31, 2002
Consolidated Statements of Cash Flows for the
six months ended July 31, 2002 and 2001
Notes to Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
ITEM 2. Changes in Securities
ITEM 3. Defaults Upon Senior Securities
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
July 31, 2002 January 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT
Cash $ 5,993 $ 2,943
Trade receivables, net of allowance for doubtful accounts of $4,840 and
$6,142 at July 31, 2002 and January 31, 2002, respectively and net of
allowance for returns of $31,502 and $40,077 at July 31, 2002 and January 31,
2002, respectively 56,568 66,609
Income taxes receivable 6,413 6,085
Inventories (Note 2) 17,371 16,923
Other current assets 2,484 2,950
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 88,829 95,510
- -----------------------------------------------------------------------------------------------------------------------------
Land 1,423 1,423
Plants and buildings 8,715 8,584
Office equipment and furniture 20,294 17,554
- -----------------------------------------------------------------------------------------------------------------------------
Property, Plants and Equipment 30,432 27,561
Less accumulated depreciation and amortization 8,455 7,184
- -----------------------------------------------------------------------------------------------------------------------------
NET PROPERTY, PLANTS AND EQUIPMENT 21,977 20,377
- -----------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS
Intangibles, net (Note 3) 47,084 43,069
Deferred tax asset 2,198 2,065
Other 3,459 3,363
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL OTHER ASSETS 52,741 48,497
- -----------------------------------------------------------------------------------------------------------------------------
$ 163,547 $ 164,384
- -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
1
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
July 31, 2002 January 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Checks issued against future deposits $ 3,561 $ -
Accounts payable and accrued expenses, net of allowance for returns of
$31,557 and $38,527 at July 31, 2002 and January 31, 2002, respectively 45,982 57,263
Due to retailers 5,022 3,099
Deferred income taxes 1,356 953
Current maturities of long-term debt (Note 5) 3,587 42,097
Other current liabilities 24 24
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 59,532 103,436
- -----------------------------------------------------------------------------------------------------------------------------
LONG-TERM DEBT, LESS CURRENT MATURITIES (NOTE 5) 56,072 15,578
- -----------------------------------------------------------------------------------------------------------------------------
OTHER LONG-TERM LIABILITIES 544 329
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 116,148 119,343
- -----------------------------------------------------------------------------------------------------------------------------
COMMITMENTS
- -----------------------------------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Contributed Capital:
Common Stock, $.01 par - shares authorized, 40,000,000; 19,426,295 issued
and 18,200,175 outstanding at July 31, 2002 and 19,414,799 issued and
18,288,679 outstanding at January 31, 2002 194 194
Preferred Stock, $.01 par - shares authorized, 2,000,000; -0- issued and
outstanding at July 31, 2002 and January 31, 2002 - -
Additional paid-in-capital 103,421 103,386
- -----------------------------------------------------------------------------------------------------------------------------
Total contributed capital 103,615 103,580
Accumulated other comprehensive (loss):
Foreign currency translation (262) (387)
Accumulated deficit (49,003) (51,666)
- -----------------------------------------------------------------------------------------------------------------------------
54,350 51,527
Less: Treasury Stock (1,226,120 and 1,126,120 shares at cost at July 31, 2002
and January 31, 2002, respectively) (6,951) (6,486)
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 47,399 45,041
- -----------------------------------------------------------------------------------------------------------------------------
$ 163,547 $ 164,384
- -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
2
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three Months Ended July 31, Six Months Ended July 31,
--------------------------- --------------------------
2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------
Revenues $ 71,577 $ 57,402 $ 137,890 $ 75,659
Costs of Revenues 57,622 43,590 109,369 54,909
- ---------------------------------------------------------------------------------------------------------------------
Gross Profit 13,955 13,812 28,521 20,750
Selling, General and Administrative Expense 10,522 9,169 21,720 13,784
Amortization of Goodwill (Note 3) - 1,297 - 2,052
Relocation Expenses 729 - 1,025 -
- ---------------------------------------------------------------------------------------------------------------------
Operating Income 2,704 3,346 5,776 4,914
- ---------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Interest income 66 43 98 123
Interest expense (822) (878) (1,664) (1,491)
Other (24) 140 499 2,115
- ---------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) (780) (695) (1,067) 747
- ---------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 1,924 2,651 4,709 5,661
Income Tax Expense 859 1,475 2,046 1,960
- ---------------------------------------------------------------------------------------------------------------------
Net Income $ 1,065 $ 1,176 $ 2,663 $ 3,701
- ---------------------------------------------------------------------------------------------------------------------
Earnings per Share - Basic $ .06 $ .07 $ .15 $ .21
- ---------------------------------------------------------------------------------------------------------------------
Weighted Average of Shares Outstanding - Basic (Note 6) 18,193 17,907 18,224 17,587
- ---------------------------------------------------------------------------------------------------------------------
Earnings per Share - Diluted $ .06 $ .07 $ .14 $ .21
- ---------------------------------------------------------------------------------------------------------------------
Weighted Average of Shares Outstanding - Diluted (Note 6) 18,389 18,088 18,410 17,741
- ---------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)
Three Months Ended July 31, Six Months Ended July 31,
------------------------------- -----------------------------
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Net Income $ 1,065 $ 1,176 $ 2,663 $ 3,701
Unrealized Loss on Available-for-Sale Securities, net
of tax - (134) - (200)
Foreign Currency Translation Adjustment 26 (51) 125 (488)
- -------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 1,091 $ 991 $ 2,788 $ 3,013
- -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands, except shares)
Other
Common Stock Additional Compre- Treasury Stock Total
---------------------- Paid - in Accumulated hensive -------------------- Stockholders'
Shares Amount Capital Deficit (Loss) Shares Amount Equity
- --------------------------------------------------------------------------------------------------------------------------------
Balance, January 31,
2002 19,414,799 $ 194 $ 103,386 $ (51,666) $(387) 1,126,120 $ (6,486) $ 45,041
Purchase of treasury
stock 100,000 (465) (465)
Foreign currency
translation adjustment 125 125
Other 11,496 - 35 35
Net income 2,663 2,663
- --------------------------------------------------------------------------------------------------------------------------------
Balance, July 31, 2002 19,426,295 $ 194 $ 103,421 $ (49,003) $(262) 1,226,120 $ (6,951) $ 47,399
- --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Six Months Ended July 31, 2002 2001
- -----------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 2,663 $ 3,701
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,465 3,271
Provision for losses on accounts receivable 264 121
Loss on disposition of equipment 68 164
Deferred income taxes 749 665
Other 5 82
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 10,243 (11,074)
(Increase) decrease in inventories (260) 782
(Increase) decrease in other assets (932) 742
(Decrease) increase in accounts payable and accrued
expenses (11,306) 1,461
Increase in amounts due to retailers 1,923 883
- -----------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY OPERATING ACTIVITIES 4,882 798
- -----------------------------------------------------------------------------------------------------------------------
INVESTMENT ACTIVITIES
Capital expenditures (2,787) (1,607)
Acquisition of The Interlink Companies, Inc., net of cash acquired - (13,679)
Acquisition of Innovative Metal Fixtures, Inc. (2,014) -
Acquisition of customer list (2,000) -
Other 85 82
- -----------------------------------------------------------------------------------------------------------------------
CASH USED IN INVESTING ACTIVITIES (6,716) (15,204)
- -----------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Increase in checks issued against future deposits 3,561 2,713
Borrowings under credit facility 145,745 78,804
Principal payments on credit facility (144,364) (66,245)
Common Stock reacquired - (21)
Other (58) -
- -----------------------------------------------------------------------------------------------------------------------
CASH PROVIDED BY FINANCING ACTIVITIES 4,884 15,251
- -----------------------------------------------------------------------------------------------------------------------
INCREASE IN CASH 3,050 845
CASH, beginning of period 2,943 1,085
- -----------------------------------------------------------------------------------------------------------------------
CASH, end of period $ 5,993 $ 1,930
- -----------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
5
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. BASIS OF PRESENTATION
The consolidated financial statements as of July 31, 2002 and for the three
month and six month periods ended July 31, 2002 and 2001, include, in the
opinion of management, all adjustments (consisting of normal recurring
adjustments and reclassifications) necessary to present fairly the financial
position, results of operations and cash flows at July 31, 2002 and for all
periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these consolidated
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Form 10-K for the year
ended January 31, 2002. The results of operations for the three month and six
month periods ended July 31, 2002 are not necessarily indicative of the
operating results to be expected for the full year.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
2. INVENTORIES
Inventories consist of the following (in thousands):
July 31, 2002 January 31, 2002
-------------------------------------------------------------------------------------------------
Raw materials $ 2,930 $ 2,559
Work-in-process 2,428 1,754
Finished goods:
Fixtures 2,323 1,790
Magazine inventory 9,690 10,820
-------------------------------------------------------------------------------------------------
$ 17,371 $ 16,923
-------------------------------------------------------------------------------------------------
Magazine and periodical inventories are returnable to the publishers for full
credit in the event of non-sale.
3. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"),
and SFAS 142, Goodwill and Other Intangible Assets. SFAS 141 eliminates the
pooling of interests method of accounting for all business combinations
initiated after June 30, 2001 and addresses the initial recognition and
measurement of goodwill and other intangible assets acquired in a business
combination. The Company adopted SFAS 141 as of July 1, 2001.
As of February 1, 2002, the Company adopted SFAS 142, which addresses the
financial accounting and reporting standards for the acquisition of intangible
assets outside of a business combination and for goodwill and other intangible
assets subsequent to their acquisition. This accounting standard requires that
goodwill and indefinite-lived intangible assets are no longer amortized but
tested for impairment on an annual basis, or more frequently if circumstances
warrant. The provisions of the standard also require the completion of a
transitional impairment test in the year of adoption, with any impairments
identified upon initial implementation treated as a cumulative effect of a
6
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
change in accounting principle. In connection with the adoption of SFAS 142, the
Company has determined that there are no indications of goodwill impairment.
In accordance with SFAS 142, goodwill associated with acquisitions consummated
after June 30, 2001 is not amortized and the amortization of goodwill from
business combinations consummated before June 30, 2001 ceased on February 1,
2002.
A summary of the Company's intangible assets is as follows:
July 31, 2002 January 31, 2002
-------------------------------------------------------------------------------------------------
Indefinite-lived Intangible Assets
Goodwill $ 44,816 $ 42,769
Amortizable Intangible Assets
Other 2,755 658
Accumulated Amortization 487 358
-------------------------------------------------------------------------------------------------
Net Intangibles $ 47,084 $ 43,069
-------------------------------------------------------------------------------------------------
Goodwill increased $2,037,000 from January 31, 2002 to July 31, 2002 due to the
acquisition of Innovative Metal Fixtures, Inc. in May 2002 and $10,000 due to
fluctuations in the foreign currency exchange rates.
Amortization expense for the three months and six months ended July 31, 2002 was
$95,000 and $129,000, respectively. Amortization expense for each of the five
succeeding years is estimated to be approximately $335,000.
4. BUSINESS COMBINATIONS
In a series of transactions occurring between February 21, 2001 and June 1,
2001, the Company acquired all of the stock of The Interlink Companies, Inc.
("Interlink") for cash totaling $13,677,000 (including professional fees and net
of cash acquired) and 880,025 shares (net of 100,000 shares returned by sellers
of Interlink) of the Company's common stock, valued at the time of acquisition
at $5.4 million. Interlink has various operating companies, including
International Periodical Distributors, Inc. ("IPD"), a direct distributor of
magazines, and Deyco, a specialty national magazine distributor.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$70.9 million.
On July 1, 1999 the Company acquired all of the stock of Innovative Metal
Fixtures, Inc. for $2.6 million. Innovative Metal Fixtures, Inc. manufactures
wire and metal fixture displays from manufacturing facilities in Vancouver,
British Columbia.
This transaction has been accounted for as a purchase, and accordingly, the
assets and liabilities have been recorded at fair market value. Results of
operations have been included as of the effective date of the transaction. The
purchase price exceeded the fair value of the assets acquired by approximately
$2.0 million.
7
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Unaudited pro forma results of operations for the six months ended July 31, 2001
for the Company and The Interlink Companies, Inc. are listed below (in
thousands):
Six months ended
July 31, 2001
--------------------------------------------------------------------------------
Total Revenues As reported $ 75,659
Pro forma 136,331
Net Income (Loss) As reported 3,701
Pro forma (6,667)
Earnings Per Share
Basic As reported $ 0.21
Diluted As reported 0.21
Basic Pro forma (0.36)
Diluted Pro forma (0.36)
--------------------------------------------------------------------------------
8
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
5. LONG-TERM DEBT AND REVOLVING CREDIT FACILITY
Long-term debt consists of (in thousands):
July 31, January 31,
2002 2002
---------------------------------------------------------------------------------------------------
Revolving Credit Facility - Bank of America $ 37,847 $ 36,073
Revolving Credit Facility - Congress Financial Corporation 13,974 11,068
Term loan - Congress Financial Corporation - 2,778
Industrial Revenue Bonds 4,000 4,000
Notes payable to former owner of acquired company, 12%
annual interest payable quarterly; two equal remaining
installments due February 2002 and August 2002 2,500 2,500
Note payable to former owner of acquired company, 12%
annual interest, payable in four quarterly installments
beginning May 2001 - 250
Note payable to former owner of acquired company,
interest prime plus 1% compounded semi-annually, payable in two
remaining installments in March 2002 and March 2003 200 400
Other 1,138 606
---------------------------------------------------------------------------------------------------
Total Long-term Debt 59,659 57,675
Less current maturities 3,587 42,097
---------------------------------------------------------------------------------------------------
Long-term Debt $ 56,072 $ 15,578
---------------------------------------------------------------------------------------------------
On December 22, 1999, the Company entered into a credit agreement with Bank of
America, N.A., which was amended on August 30, 2002 to extend the termination
date to August 1, 2003 and to grant Bank of America, N.A. a first-priority
perfected security interest in all real and personal property of the Company
excluding the capital stock and assets of The Interlink Companies, Inc.,
International Periodical Distributors, Inc. and David E. Young, Inc. The credit
agreement enables the Company to borrow up to $46.0 million under a revolving
credit facility. Borrowings under the credit facility bear interest at a rate
equal to the 90-day LIBOR rate (1.823% at July 31, 2002) plus 4.85% and carries
a facility fee of 1/4 % per annum on the difference between $25 million and the
average principal amount outstanding under the loan (if less than $25 million)
plus 3/8% per annum of the difference between the maximum amount of the loan and
the greater of (i) $25 million or (ii) the average principal amount outstanding
under this loan. Under the credit agreement, the Company is limited in its
ability to declare dividends or other distributions on capital stock or make
payments in connection with the purchase, redemption, retirement or acquisition
of capital stock. There are also limitations on capital expenditures and
9
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
the Company is required to maintain certain financial ratios. The Company was in
compliance with such ratios at July 31, 2002. The availability at July 31, 2002
on the revolving credit facility was approximately $1.1 million.
The Company has Industrial Revenue Bonds (IRB). On January 30, 1995, the City of
Rockford issued $4.0 million of its Industrial Project Revenue Bonds, Series
1995, and the proceeds were deposited with the Amalgamated Bank of Chicago, as
trustee. Bank of America ("the Bank") has issued an unsecured letter of credit
for $4.1 million in connection with the IRB with an initial expiration date of
April 20, 2001. As provided in the reimbursement agreement, the expiration date
shall automatically extend for successive additional periods of one calendar
month until the twentieth day of the thirteenth month following receipt of a
notice of non-extension from the Bank. To date, no such notice of non-extension
has been received and management does not expect such notice to be given by the
Bank in the foreseeable future. The bonds are secured by the trustee's indenture
and the $4.1 million letter of credit. The bonds bear interest at a variable
weekly rate (approximately 80% of the Treasury Rate) not to exceed 15% per
annum. The bonds mature on January 1, 2030. Fees related to the letter of credit
are .75% per annum of the outstanding bond principal plus accrued interest.
In connection with the acquisition of Interlink, the Company assumed IPD and
Deyco's secured $25.0 million credit facility with Congress Financial
Corporation ("Congress"). On February 22, 2001, IPD and Deyco entered into the
credit facility with Congress which expires on February 21, 2005. The credit
agreement includes a $4,000,000 term loan, which was repaid in May, 2002, as
well as a revolving credit facility secured by the Company's accounts
receivable, inventories, equipment and other intangibles. Borrowings under the
term loan portion of the credit facility bear interest at a rate equal to 0.5%
in excess of the prime rate. Borrowings under the revolving credit portion of
the facility bear interest at a rate equal 0.25% in excess of the prime rate.
Under the credit agreement, IPD and Deyco are required to maintain certain
financial ratios. IPD and Deyco were in compliance with all such ratios at July
31, 2002.
6. EARNINGS PER SHARE
A reconciliation of the denominators of the basic and diluted earnings per share
computations are as follows (in thousands):
Three Months Ended Six Months Ended
July 31, July 31,
--------------------- ---------------------
2002 2001 2002 2001
--------------------------------------------------------------------------------------------------------
Basic weighted average number of common shares
outstanding 18,193 17,907 18,224 17,587
Effect of dilutive securities:
Stock options and warrants 196 181 186 154
--------------------------------------------------------------------------------------------------------
Diluted weighted average number of common shares
outstanding 18,389 18,088 18,410 17,741
--------------------------------------------------------------------------------------------------------
10
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
7. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Six Months Ended July 31, 2002 2001
----------------------------------------------------------------------------------------------------
Interest $ 1,647 $ 1,536
Income Taxes $ 2,462 $ 512
----------------------------------------------------------------------------------------------------
8. SEGMENT FINANCIAL INFORMATION
Effective the quarter ended October 31, 2001, the Company's segment reporting
has been restructured based on the reporting of senior management to the Chief
Executive Officer. This restructuring combines the Company's business units in a
logical way that more easily identifies business concentrations and synergies
for both analysis of results and real-time control by management. The reportable
segments of the Company are in-store services, manufacturing and magazine
distribution. In-store services derives revenues from (1) providing information
and management services relating to retail magazine sales to U.S. and Canadian
retailers, magazine publishers, confectioners and vendors of gum and general
merchandise sold at checkout counters and (2) designing, manufacturing, shipping
and salvaging display racks used by retailers at checkout counters as well as at
other points of purchase throughout their stores. The manufacturing segment
derives revenues from designing, manufacturing and installing primarily wooden
store fixtures. The magazine distribution segment derives revenues from
distributing magazines to major book chains, independent retailers and secondary
wholesalers. Formerly, the segments were services, display rack and store
fixture manufacturing and magazine distribution. The accounting policies of the
segments are the same as those described in the Summary of Accounting Policies.
All intersegment sales during the quarters or six month periods ended July 31,
2002 or 2001 have been eliminated.
(in thousands) In-Store Magazine
Three Months Ended July 31, 2002 Services Manufacturing Distribution Consolidated
-----------------------------------------------------------------------------------------------------------
Revenue $13,706 $4,090 $53,781 $71,577
Cost of Revenue 7,979 3,526 46,117 57,622
---------------------------------------------------------------
Gross Profit 5,727 564 7,664 13,955
Selling, General & Administrative 4,634 376 5,512 10,522
Relocation Expense 729 - - 729
---------------------------------------------------------------
Operating Income (Loss) 364 188 2,152 2,704
Other Income (Expenses), net (822) (5) 47 (780)
---------------------------------------------------------------
Income (Loss) Before Income Taxes (458) 183 2,199 1,924
---------------------------------------------------------------
Total Assets $110,218 $19,282 $34,047 $163,547
---------------------------------------------------------------
11
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(in thousands) In-Store Magazine
Three Months Ended July 31, 2001 Services Manufacturing Distribution Consolidated
-----------------------------------------------------------------------------------------------------------
Revenue $16,999 $4,233 $36,170 $57,402
Cost of Revenue 8,450 3,459 31,681 43,590
---------------------------------------------------------------
Gross Profit 8,549 774 4,489 13,812
Selling, General & Administrative 4,293 305 4,571 9,169
Amortization of Goodwill 652 85 560 1,297
---------------------------------------------------------------
Operating Income (Loss) 3,604 384 (642) 3,346
Other Income (Expenses), net (578) 25 (142) (695)
---------------------------------------------------------------
Income Before Income Taxes 3,026 409 (784) 2,651
---------------------------------------------------------------
Total Assets $127,337 $31,575 $81,432 $240,344
===============================================================
(in thousands) In-Store Magazine
Six Months Ended July 31, 2002 Services Manufacturing Distribution Consolidated
-----------------------------------------------------------------------------------------------------------
Revenue $27,070 $9,938 $100,882 $137,890
Cost of Revenue 14,496 7,876 86,997 109,369
---------------------------------------------------------------
Gross Profit 12,574 2,062 13,885 28,521
Selling, General & Administrative 9,394 861 11,465 21,720
Relocation Expense 1,025 - - 1,025
---------------------------------------------------------------
Operating Income (Loss) 2,155 1,201 2,420 5,776
Other Income (Expenses), net (1,254) (8) 195 (1,067)
---------------------------------------------------------------
Income (Loss) Before Income Taxes 901 1,193 2,615 4,709
---------------------------------------------------------------
Total Assets $110,218 $19,282 $34,047 $163,547
===============================================================
Six Months Ended July 31, 2001
-----------------------------------------------------------------------------------------------------------
Revenue $31,078 $8,411 $36,170 $75,659
Cost of Revenue 15,968 7,260 31,681 54,909
---------------------------------------------------------------
Gross Profit 15,110 1,151 4,489 20,750
Selling, General & Administrative 8,460 753 4,571 13,784
Amortization of Goodwill 1,321 171 560 2,052
---------------------------------------------------------------
Operating Income (Loss) 5,329 227 (642) 4,914
Other Income (Expenses), net 858 31 (142) 747
---------------------------------------------------------------
Income Before Income Taxes 6,187 258 (784) 5,661
---------------------------------------------------------------
Total Assets $127,337 $31,575 $81,432 $240,344
===============================================================
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the
12
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
purchase method of accounting and prohibits the use of the pooling-of-interest
method of accounting for business combinations initiated after June 30, 2001.
SFAS 141 also requires that the Company recognize acquired intangible assets
apart from goodwill if the acquired intangible assets meet certain criteria.
SFAS 141 applies to all business combinations initiated after June 30, 2001 and
for purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test six months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
The Company adopted SFAS 142 effective February 1, 2002 and has determined that
there are no indications of goodwill impairment.
For comparative purposes, the following schedule is a reconciliation of reported
net income to adjusted net income for the three months and six months ended July
31, 2001, adjusted to exclude goodwill amortization, along with comparative
information for the three months and six months ended July 31, 2002 (in
thousands).
Three Months Ended Six Months Ended
July 31, July 31,
------------------------ -----------------------
2002 2001 2002 2001
----------------------------------------------------------------------------------------------------------
Reported Net Income $ 1,065 $ 1,176 $ 2,663 $ 3,701
Add Back: Goodwill Amortization, net of tax - 1,160 - 1,755
Adjusted Net Income 1,065 2,336 2,663 5,456
Reported Earnings Per Share - Basic $ .06 $ .07 $ .15 $ .21
Reported Earnings Per Share - Diluted $ .06 $ .07 $ .14 $ .21
Adjusted Earnings Per Share - Basic $ .06 $ .13 $ .15 $ .31
Adjusted Earnings Per Share - Diluted $ .06 $ .13 $ .14 $ .31
----------------------------------------------------------------------------------------------------------
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
SOME OF THE INFORMATION CONTAINED IN THIS FORM 10-Q CONTAINS FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE FEDERAL SECURITIES LAWS. WHEN USED IN THIS
REPORT, THE WORDS "MAY," "WILL," "BELIEVES," "ANTICIPATES," "INTENDS,"
"EXPECTS," AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. BECAUSE SUCH FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND
UNCERTAINTIES, OUR ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: (I) OUR DEPENDENCE ON THE
MARKETING AND DISTRIBUTION STRATEGIES OF PUBLISHERS AND OTHER VENDORS; (II) OUR
ABILITY TO ACCESS CHECKOUT AREA INFORMATION; (III) RISKS ASSOCIATED WITH OUR
ADVANCE PAY PROGRAM, INCLUDING PROBLEMS COLLECTING INCENTIVE PAYMENTS FROM
PUBLISHERS; (IV) DEMAND FOR OUR DISPLAY RACKS AND STORE FIXTURES; (V) OUR
ABILITY TO SUCCESSFULLY IMPLEMENT OUR GROWTH STRATEGY; (VI) COMPETITION; (VII)
OUR ABILITY TO EFFECTIVELY MANAGE OUR EXPANSION; (VIII) GENERAL ECONOMIC AND
BUSINESS CONDITIONS NATIONALLY, IN OUR MARKETS AND IN OUR INDUSTRY; (IX) OUR
ABILITY TO MAINTAIN ADEQUATE FINANCING ON ACCEPTABLE TERMS SUFFICIENT TO ACHIEVE
OUR BUSINESS PLANS (X) OUR ABILITY TO SUCCESSFULLY INTEGRATE ACQUIRED COMPANIES
WITH AND INTO OUR CORPORATE ORGANIZATION, AND (XI) OUR ABILITY TO ATTRACT AND/OR
RETAIN SKILLED MANAGEMENT. INVESTORS ARE ALSO DIRECTED TO CONSIDER OTHER RISKS
AND UNCERTAINTIES DISCUSSED IN OTHER REPORTS PREVIOUSLY AND SUBSEQUENTLY FILED
BY US WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE
DATE HEREOF. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS, WHICH MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS.
OVERVIEW
We are a leading provider of information and management services for retail
magazine sales to U.S. and Canadian retailers and magazine publishers. We are
also a leading manufacturer of display and store fixtures used by retailers. On
May 31, 2001, we acquired The Interlink Companies, Inc. ("Interlink") and its
operating companies, including International Periodical Distributors, Inc.
("IPD"), a distributor of magazines to bookstore chains, record stores, computer
stores and independent retailers, and David E. Young, Inc. ("Deyco"), a national
distributor to secondary wholesalers who supply magazines to independent
retailers and specialty chains. Interlink represents a new business segment,
magazine distribution. Through this strategic acquisition, we have become a
leading direct distributor of magazines to bookstore chains, computer stores and
independent retailers.
Through our information services, we provide sales data and product placement
and other related information in various user-friendly formats, including print,
CD-ROM and over the Internet. This information helps users to formulate
marketing, distribution and advertising plans and to react more quickly to
changing market conditions. Our information services cover over 10,000 magazine
titles and are provided to approximately 1,000 retail chains with approximately
80,000 stores and 400,000 checkout counters. We believe we maintain the most
comprehensive information database available for retail magazine sales and
magazine placement at checkout counters. We have expanded upon our experience
with retail magazine sales to provide similar information and services to
confectioners and vendors of general merchandise sold at checkout counters.
We assist retailers in increasing sales and incentive payment revenues by
reconfiguring and designing front-end display fixtures, supervising
installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. Historically, as part of our services, we
arranged for the manufacture of display fixtures for many of our customers.
Since January 1999, we acquired five display fixture manufacturers.
Manufacturing display fixtures in our own facilities allows us to be a
full-service provider of management services for the checkout area, or
"front-end," of a customer's store. We also can integrate the design and
manufacturing processes with our clients' merchandising strategies and better
manage the timing of display fixture delivery and installation.
Our segment reporting has been restructured based on the reporting of senior
management to the Chief Executive Officer. This restructuring combines our
business units in a logical way that more easily identifies business
concentrations and synergies for both analysis of results and real-time control
by management. Our reportable segments are in-store services, manufacturing and
magazine distribution.
We believe that we are well positioned to use our existing relationships with
retailers and vendors to cross-sell our products and services.
14
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations expressed by segment (in thousands):
MAGAZINE DISTRIBUTION
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues 53,781 36,170 100,882 36,170
Cost of Revenues 46,117 31,681 86,997 31,681
--------- --------- --------- ---------
Gross Profit 7,664 4,489 13,885 4,489
Selling, General and Administrative Expense 5,512 4,571 11,465 4,571
Amortization of Goodwill - 560 - 560
Relocation Expenses - - - -
--------- --------- --------- ---------
Operating Income (Loss) 2,152 (642) 2,420 (642)
Other Income (Expense), Net 47 (142) 195 (142)
--------- --------- --------- ---------
Income (Loss) Before Income Taxes 2,199 (784) 2,615 (784)
--------- --------- --------- ---------
IN-STORE SERVICES
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues 13,706 16,999 27,070 31,078
Cost of Revenues 7,979 8,450 14,496 15,968
--------- --------- --------- ---------
Gross Profit 5,727 8,549 12,574 15,110
Selling, General and Administrative Expense 4,634 4,293 9,394 8,460
Amortization of Goodwill - 652 - 1,321
Relocation Expenses 729 - 1,025 -
--------- --------- --------- ---------
Operating Income 364 3,604 2,155 5,329
Other Income (Expense), Net (822) (578) (1,254) 858
--------- --------- --------- ---------
Income Before Income Taxes (458) 3,026 901 6,187
--------- --------- --------- ---------
MANUFACTURING
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues 4,090 4,233 9,938 8,411
Cost of Revenues 3,526 3,459 7,876 7,260
--------- --------- --------- ---------
Gross Profit 564 774 2,062 1,151
Selling, General and Administrative Expense 376 305 861 753
Amortization of Goodwill - 85 - 171
Relocation Expenses - - - -
--------- --------- --------- ---------
Operating Income 188 384 1,201 227
Other Income (Expense), Net (5) 25 (8) 31
--------- --------- --------- ---------
Income Before Income Taxes 183 409 1,193 258
--------- --------- --------- ---------
MAGAZINE DISTRIBUTION
On May 31, 2001 we acquired Interlink. Results of operations for the quarter
ended July 31, 2001 contain only two months of operations. Therefore, the
sections following this section of Management's Discussion and Analysis of
Financial Condition and Results of Operations which compare the quarter and six
months ended July 31, 2002 to the quarter and six months ended July 31, 2001
generally exclude comparisons relating to our magazine distribution segment.
Magazine distribution includes both our sales to retailers we serve as a primary
wholesaler and revenues we generate as a national distributor for specialty
titles. Sales to retailers are driven primarily by our ability to obtain new
retail customers or more efficiently manage our existing retail customers we
service as the primary wholesaler or contract with to serve as the
15
exclusive wholesaler for specialty titles. The recently announced deal with
Hudson News whereby we became the United States wholesaler for a basket of
European titles is an example of this opportunity. We also believe we have an
opportunity to expand our retail customer base beyond specialty retailers to
include grocery store chains, mass merchandisers, drug stores and convenience
store chains with whom we have existing relationships through our other
operating segments who are currently being served by more traditional magazine
wholesalers. Other than increasing distribution of magazines, the other key
component impacting our net revenues is the sell-through of those magazines at
retail. While we have some control over the ultimate sell-through of magazines
at the retail level by carefully managing initial distribution and replenishment
during the on-sale period at individual stores, the ultimate sell-through of
titles is more closely related to the publishers' ability to generate buying
interest in their titles at the retail level. Additionally, sales at the retail
level of weekly titles improve dramatically when major world or national events
occur.
Since acquiring the Interlink business, we have put in place systems to more
closely manage distribution at the individual store level. We have decreased
allocations of titles that historically had poor sell-throughs, and obtained
access to daily point-of-sale data at major customers. We use this data to
monitor inventory levels and ship replenishment magazines to avoid sell-outs.
These factors have significantly improved our internal sell-through and resulted
in increased revenues.
The increased revenues we have seen from improvement in our retail business have
been partially offset by a decrease in sales to secondary wholesalers where we
serve as the national distributor. The decrease in sales is primarily the result
of our decision to cutoff certain specialty retailers through the tightening of
our credit procedures as the business transitioned from a privately held company
to a subsidiary of a publicly-traded company and our decision to focus on the
distribution business to retailers where we feel the opportunity is greatest to
generate significant growth. The quarter's revenue was also slightly impacted
due to the timing of certain significant titles having two April on-sale issues
and no May issues.
Gross profit is impacted primarily by the mix of the magazines distributed
during the quarter (we receive a higher discount from cover price on some titles
compared to others) and our ability to maximize sell-through, which minimizes
the cost of shipping and handling magazines that are not sold at retail and do
not generate revenue for us.
Gross profit increased during the quarter compared to the corresponding period
of the prior year primarily due to the factors discussed above.
SG&A expenses decreased as a percentage of sales and overall, even when adjusted
for the effect of the shorter prior year period. The decrease is primarily
attributable to our decision to consolidate the management of our magazine
distribution business in one location (San Diego). The consolidation of
operations allowed for a decrease in the number of employees, especially
executive level employees, and overhead. The decrease was also impacted by our
ability to lease new office space in San Diego under more favorable lease terms.
QUARTER ENDED JULY 31, 2002 COMPARED TO QUARTER ENDED JULY 31, 2001
Revenues
In-Store Services. In-store services accounted for approximately 19.1% and 29.6%
of our revenues for the quarters ended July 31, 2002 and 2001, respectively.
In-store service revenues of $13.7 million in second quarter of fiscal 2003
decreased $3.3 compared to the second quarter of fiscal 2002. Approximately $2.5
million of the decrease related to less production and lower pricing of our
display fixtures. Claims revenue accounted for the remaining decrease of
approximately $.8 million.
Manufacturing. Manufacturing accounted for approximately 5.7% and 7.4% of our
revenues for the quarters ended July 31, 2002 and 2001, respectively. Revenues
of $4.1 million in the second quarter of fiscal 2003 were flat compared to $4.2
million in the second quarter of fiscal 2002.
Gross Profit
In-Store Services. Gross profit decreased $2.8 million compared to the second
quarter of fiscal 2002. The gross margin decreased from 50.3% to 41.2%. We
estimate that the gross margin on the sale of display fixtures decreased due to
lower volume and, to a lesser extent, pricing. Additionally, the decrease in
claims revenue accounted for a significant portion of the decrease in the gross
margin.
16
Manufacturing. Gross profit decreased $.2 million compared to the second quarter
of fiscal 2002. The gross margin also decreased from 18.3% to 13.8% primarily
due to increases in rent expense. Subsequent to the prior year period, we sold
one of our production plants in a sale/leaseback transaction which significantly
increased our rent expense.
Selling, General and Administrative Expense ("SG&A")
In-Store Services. SG&A expenses increased from $4.3 million during the quarter
ended July 31, 2001 to $4.6 million during the quarter ended July 31, 2002.
Increases in accounting fees, workers' compensation insurance, consulting fees
and health insurance accounted for a $.3 million increase. Several other
categories of expenses increased also, but were offset by a bad debt recovery of
approximately $.1 million.
Manufacturing. SG&A expenses increased less than $.1 million, all of which was
due to increases in selling and administrative salaries, compared to the
corresponding quarter of the prior year. Such expenses associated with the
manufacturing segment are essentially fixed in that they do not vary directly
with the volume of production.
Relocation Expenses. During fiscal 2003, we began the first phase of a
consolidation of company-wide administrative offices to new worldwide
headquarters in Bonita Springs, Florida. The consolidation is expected to be
completed within the next 9 to 12 months.
Interest Expense. Interest expense for the quarter ended July 31, 2002 decreased
by less than $.1 million compared to the quarter ended July 31, 2001. The
primary reason for the decrease was due to the pay-off of our term loan with
Congress Financial Corporation.
Other Income (Expense). We experienced an unfavorable variance on other income
(expense) of under $.2 million primarily resulting from an unrealized loss on an
interest rate swap agreement.
Income Tax Expense. The effective income tax rates for the quarters ended July
31, 2002 and 2001 were 44.6% and 55.6%, respectively. The effective income tax
rate for the quarters ended July 31, 2002 and 2001 varied from the federal
statutory rate due to state income taxes and expenses not deductible for income
tax purposes. These non-deductible expenses include goodwill amortization, meals
and entertainment and officers' life insurance premiums.
SIX MONTHS ENDED JULY 31, 2002 COMPARED TO SIX MONTHS ENDED JULY 31, 2001
Revenues
In-Store Services. In-store services accounted for approximately 19.6% and 41.1%
of our revenues for the six months ended July 31, 2002 and 2001, respectively.
In-store service revenues of $27.1 million in the six months ended July 31, 2002
decreased $4.0 million compared to the six months ended July 31, 2001.
Approximately $2.7 million of the decrease related to less production and lower
pricing of our display fixtures. Additionally, claims revenue decreased
approximately $1.1 million and revenue from information related services
decreased approximately $.2 million.
Manufacturing. Manufacturing accounted for approximately 7.2% and 11.1% of our
revenues for the six months ended July 31, 2002 and 2001, respectively. Revenues
of $9.9 million in the six months ended July 31, 2002 increased $1.5 million
compared to the six months ended July 31, 2001. This increase resulted primarily
from a major customer undertaking more store openings compared to the first six
months of the prior year.
Gross Profit
In-Store Services. Gross profit decreased $2.5 million from the six months ended
July 31, 2001 to the six months ended July 31, 2002. The gross margin decreased
slightly from 48.6% to 46.4%. We estimate that the gross margin on the sale of
display fixtures decreased due to lower volume and, to a lesser extent, pricing.
Additionally, the decrease in claims revenue accounted for a significant portion
of the decrease in the gross margin.
Manufacturing. Gross profit increased $.9 million from the six months ended July
31, 2001 to the six months ended July 31,
17
2002. The gross margin also increased from 13.7% to 20.7%. The increase was
primarily due to efficiencies realized as a result of higher production levels.
To a lesser degree, gross profit was adversely affected by an increase in rent
expense. Subsequent to the prior year period, we sold one of our production
plants in a sale/leaseback transaction which significantly increased our rent
expense.
Selling, General and Administrative Expense ("SG&A")
In-Store Services. SG&A expenses increased from $8.5 million during the six
months ended July 31, 2001 to $9.4 million during the six months ended July 31,
2002. The increase is made up primarily of increases in professional fees,
including accounting, consulting, legal and marketing. Although we continue to
acquire companies, such as Interlink, these types of corporate expenses are
generally absorbed by the in-store services segment and not allocated to the
other segments. As a result, SG&A as a percentage of revenues increased from
27.2% for the six months ended July 31, 2001 to 34.7% for the six months ended
July 31, 2002.
Manufacturing. SG&A expenses increased $.1 million compared to the corresponding
quarter of the prior year due to increases in selling and administrative
salaries. Such expenses associated with the manufacturing segment are
essentially fixed in that they do not vary directly with the volume of
production.
Relocation Expenses. During fiscal 2003, we began the first phase of a
consolidation of company-wide administrative offices to new worldwide
headquarters in Bonita Springs, Florida. The consolidation is expected to be
completed within the next 9 to 12 months.
Interest Expense. Interest expense for the six months ended July 31, 2002
increased $.2 million compared to the six months ended July 31, 2001.
Interlink's interest expense was $.4 million higher during the six months ended
July 31, 2002 compared to the six months ended July 31, 2001 since their prior
period included only two months of activity. This increase was offset by a
decrease in interest expense of the In-store and Manufacturing segments of
approximately $.2 million.
Other Income (Expense). Other income decreased approximately $1.6 million
resulting from the inclusion in the prior year period of $2.1 million in life
insurance proceeds and an unrealized loss on an interest rate swap agreement
included in the current year period of $.1 million. These were offset by the
inclusion in the current year period of a full six months of other income of IPD
totaling $.8 million compared to only two months of activity in the prior year
period totaling only $.2 million. Other income of IPD is generally from charges
to third parties for processing magazine returns.
Income Tax Expense. The effective income tax rates for the six months ended July
31, 2002 and 2001 were 43.4% and 34.6%, respectively. The effective income tax
rate for the six months ended July 31, 2001 varied from the federal statutory
rate due to state income taxes and expenses not deductible for income tax
purposes. These non-deductible expenses include goodwill amortization, meals and
entertainment and officers' life insurance premiums.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements for the in-store services segment are for funding
the Advance Pay Program, for purchasing materials and the cost of labor incurred
in the provision of the in-store services. Our primary cash requirements for the
manufacturing segment are for purchasing materials and the cost of labor
incurred in the manufacturing process. Our primary cash requirements for the
magazine distribution segment are for the cost of the periodicals and for
meeting general working capital requirements. Historically, we have financed our
business activities through cash flows from operations, borrowings under
available lines of credit and through the issuance of equity securities.
During the six months ended July 31, 2002, we advanced approximately $41.4
million under the Advance Pay Program. During fiscal 2002, 2001 and 2000, we
advanced approximately $81.5 million, $84.8 million and $68.9 million,
respectively, under the Advance Pay Program. During the six months ended July
31, 2002, the Program was funded by borrowings under the revolving credit
facility and cash flows from operations. Collections under the Advance Pay
Program are used to pay down any outstanding balance under the credit facility.
Thus, the credit facility is primarily used to manage the timing of payments and
collections under the Advance Pay Program. Growth of the Advance Pay Program
will be monitored and controlled to ensure that funding will be available either
through cash provided by operations or borrowings under our credit facility.
18
Net cash provided by operating activities of $4.9 million for the six months
ended July 31, 2002 was primarily from net income and the decrease in accounts
receivable offset by a decrease in accounts payable and accrued expenses. The
average collection period for the twelve months ended July 31, 2002 was 151
days, 144 days and 38 days for the in-store services segment, the manufacturing
segment and the magazine distribution segment, respectively (all considered to
be within an acceptable range by management based on the nature of our business
and historical experience). Net cash provided by operating activities of
$800,000 for the six months ended July 31, 2001 was primarily from net income,
non cash items of depreciation and amortization and the increase in accounts
payable and accrued expenses offset by increases in accounts receivable.
At July 31, 2002, we anticipate capital expenditures (exclusive of capital
expenditures related to the relocation) during the remainder of fiscal 2003 of
approximately $1.1 million of which approximately $500,000 is allocated to
company-wide upgrades and maintenance of computers, software and telecom
equipment and approximately $600,000 is allocated to manufacturing plant
equipment upgrades and maintenance.
During fiscal 2003, we are undertaking the first phase of a consolidation of
company-wide administrative offices to new worldwide headquarters in Bonita
Springs, Florida. At July 31, 2002, we anticipate additional capital expenditure
relating to the move of approximately $500,000 allocated to furniture, leasehold
improvements, computer equipment, and telecom equipment at the new headquarters.
At July 31, 2002, our total long-term debt obligations were approximately $56.1
million. On December 22, 1999, we entered into a credit agreement with Bank of
America, N.A., which was amended on August 30, 2002 to extend the termination
date to August 1, 2003 and to grant Bank of America, N.A. a first-priority
perfected security interest in all of our real and personal property excluding
the capital stock and assets of The Interlink Companies, Inc., International
Periodical Distributors, Inc. and David E. Young, Inc. The credit agreement
enables us to borrow up to $46.0 million under a revolving credit facility.
Borrowings under the credit facility bear interest at a rate equal to the 90-day
LIBOR rate (1.823% at July 31, 2002) plus 4.85% and carries a facility fee of
1/4 % per annum on the difference between $25 million and the average principal
amount outstanding under the loan (if less than $25 million) plus 3/8% per annum
of the difference between the maximum amount of the loan and the greater of (i)
$25 million or (ii) the average principal amount outstanding under this loan.
The availability at July 31, 2002 on the revolving credit facility was
approximately $1.1 million.
Under the credit agreement, we are subject to various financial and operating
covenants. These include (i) requirements that we satisfy various financial
ratios, (ii) limitations on the payment of cash dividends or other distributions
on capital stock or payments in connection with the purchase, redemption,
retirement or acquisition of capital stock and (iii) limitations on capital
expenditures.
Under the credit agreement, we are required to maintain certain financial
ratios. We were in compliance with all such ratios at July 31, 2002.
In connection with the acquisition of MYCO, Inc., the Company assumed MYCO's
Industrial Revenue Bonds (IRB). On January 30, 1995, the City of Rockford issued
$4.0 million of its Industrial Project Revenue Bonds, Series 1995, and the
proceeds were deposited with the Amalgamated Bank of Chicago, as trustee. Bank
of America, N.A. ("the Bank") has issued an unsecured letter of credit for $4.1
million in connection with the IRB with an initial expiration date of April 20,
2001. As provided in the reimbursement agreement, the expiration date shall
automatically extend for successive additional periods of one calendar month
until the twentieth day of the thirteenth month following receipt of a notice of
non-extension from the Bank. To date, no such notice of non-extension has been
received and management does not expect such notice to be given by the Bank in
the foreseeable future. The bonds are secured by the trustee's indenture and the
$4.1 million letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.
On February 22, 2001, IPD and Deyco (now our wholly-owned subsidiaries) entered
into a $25.0 million credit agreement with Congress Financial Corporation
("Congress"). The credit agreement includes a $4.0 million term loan which was
repaid in May, 2002, as well as a revolving credit facility secured by IPD and
Deyco's accounts receivable. Borrowings under the term loan portion of the
credit facility bear interest at a rate equal to 0.5% in excess of the prime
rate. Borrowings under the revolving credit portion of the facility bear
interest at a rate equal to 0.25% in excess of the prime rate. Under the credit
agreement, IPD and Deyco are required to maintain certain financial ratios. IPD
and Deyco were in compliance with all such ratios at July 31, 2002.
19
We believe that our cash flow from operations together with our revolving credit
facilities will be sufficient to fund our working capital needs and capital
expenditures for the foreseeable future.
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that we recognize acquired intangible assets apart from goodwill
if the acquired intangible assets meet certain criteria. SFAS 141 applies to all
business combinations initiated after June 30, 2001 and for purchase business
combinations completed on or after July 1, 2001. It also requires, upon adoption
of SFAS 142, that we reclassify the carrying amounts of intangible assets and
goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that we identify reporting units for the purposes of
assessing potential future impairments of goodwill, reassess the useful lives of
other existing recognized intangible assets, and cease amortization of
intangible assets with an indefinite useful life. An intangible asset with an
indefinite useful life should be tested for impairment in accordance with the
guidance in SFAS 142. SFAS 142 is required to be applied in fiscal years
beginning after December 15, 2001 to all goodwill and other intangible assets
recognized at that date, regardless of when those assets were initially
recognized. SFAS 142 requires us to complete a transitional goodwill impairment
test six months from the date of adoption. We are also required to reassess the
useful lives of other intangible assets within the first interim quarter after
adoption of SFAS 142.
We adopted SFAS 142 effective February 1, 2002 and have determined that there
are no indications of goodwill impairment.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability. Our debt relates primarily to credit facilities with Bank of
America, N.A. and IPD and Deyco's facility with Congress Financial Corporation.
The credit facility with Bank of America is a three-year credit agreement with
an outstanding principal balance of approximately $37.8 million as of July 31,
2002. Interest on the outstanding balance is charged based on a variable
interest rate related to LIBOR plus a margin specified in the credit agreement.
The credit facility with Congress includes a revolving credit facility secured
by IPD and Deyco's accounts receivable, inventories, equipment and other
intangibles. The revolving credit facility had an outstanding principal balance
of approximately $14.0 million at July 31, 2002. Borrowings under the revolving
credit portion of the facility bear interest at a rate equal to 0.25% in excess
of the prime rate. Interest on the outstanding balances is subject to market
risk in the form of fluctuations in interest rates.
In order to better manage our exposure to interest rate risk, in February 2001
we entered into an interest rate swap agreement. The swap agreement, with a
notional amount of $15.0 million converts the floating interest rate on the Bank
of America credit facility to a fixed rate. At July 31, 2002 the fair value of
the swap is not material and is recorded in accrued expenses.
We also conduct operations in Canada. For the three months and six months ended
July 31, 2002, approximately 1.8% and 1.5%, respectively, of our revenues were
earned in Canada and collected in local currency. In addition, we generally pay
operating expenses in the corresponding local currency and will be subject to
increased risk for exchange rate fluctuations between such local currency and
the dollar. We do not conduct any significant hedging activities.
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders in the
quarter ended July 31, 2002.
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(b) The were no Current Reports on Form 8-K filed during the
quarter ended July 31, 2002.
21
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.
Date: September 16, 2002 /s/ W. BRIAN RODGERS
-----------------------
W. Brian Rodgers
Chief Financial Officer
22
CERTIFICATIONS
I, S. Leslie Flegel, certify that:
1. I have reviewed this Form 10-Q for the Quarter ended July 31,
2002 of Source-Interlink Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report.
Date: September 16, 2002
/s/ S. Leslie Flegel
------------------------------------
S. Leslie Flegel
Chairman and Chief Executive Officer
23
CERTIFICATIONS
I, W. Brian Rodgers, certify that:
1. I have reviewed this Form 10-Q for the Quarter ended July 31,
2002 of Source-Interlink Companies, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report; and
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report.
Date: September 16, 2002
/s/ W. Brian Rodgers
-----------------------------------
W. Brian Rodgers
Chief Financial Officer
24
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
10.6.2 Amendment to Employment and Non-Competition Agreement with
James R. Gillis dated as of July 5, 2002
25