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UNTIED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended October 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 December 13, 2002
Common Stock, $.01 Par Value 18,251,967
SOURCE INTERLINK COMPANIES, INC.
INDEX
PART I - FINANCIAL INFORMATION
Page
----
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets as of
October 31, 2002 and January 31, 2002 1
Consolidated Statements of Income for the three months
and nine months ended October 31, 2002 and 2001 3
Consolidated Statements of Comprehensive Income for the
three months and nine months ended October 31, 2002 and 2001 3
Consolidated Statement of Stockholders'
Equity for the nine months ended October 31, 2002 4
Consolidated Statements of Cash Flows for the
nine months ended October 31, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS 14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK 23
ITEM 4. CONTROLS AND PROCEDURES 24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 25
ITEM 2. CHANGES IN SECURITIES 25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
ITEM 5. OTHER INFORMATION 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 25
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
October 31, 2002 January 31, 2002
---------------- ----------------
ASSETS
CURRENT
Cash $ 7,537 $ 2,943
Trade receivables, net of allowance for doubtful accounts of $4,067 and
$6,142 at October 31, 2002 and January 31, 2002, respectively and net of
allowance for returns of $36,410 and $40,077 at October 31, 2002 and January 56,590 66,609
31, 2002, respectively
Inventories (Note 2) 16,843 16,923
Income taxes receivable 4,310 6,085
Other current assets 2,259 2,950
---------------- ----------------
TOTAL CURRENT ASSETS 87,539 95,510
================ ================
Land 1,423 1,423
Plants and buildings 9,032 8,584
Office equipment and furniture 20,941 17,554
---------------- ----------------
Property, Plants and Equipment 31,396 27,561
Less accumulated depreciation and amortization 9,147 7,184
---------------- ----------------
NET PROPERTY, PLANTS AND EQUIPMENT 22,249 20,377
---------------- ----------------
OTHER ASSETS
Intangibles, net (Note 3) 46,802 42,877
Deferred tax asset 1,772 2,065
Other 3,812 3,555
---------------- ----------------
TOTAL OTHER ASSETS 52,386 48,497
---------------- ----------------
$ 162,174 $ 164,384
================ ================
See accompanying notes to consolidated financial statements.
1
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
October 31, 2002 January 31, 2002
---------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT
Accounts payable and accrued expenses, net of allowance for returns of $31,543
and $38,527 at October 31, 2002 and January 31, 2002, respectively $ 53,999 $ 60,362
Deferred income taxes -- 953
Current maturities of long-term debt (Note 4) 38,451 42,097
Other current liabilities 24 24
---------------- ----------------
TOTAL CURRENT LIABILITIES 92,474 103,436
DEBT, LESS CURRENT MATURITIES (NOTE 4) 18,727 15,578
OTHER LONG-TERM LIABILITIES 548 329
---------------- ----------------
TOTAL LIABILITIES 111,749 119,343
================ ================
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Contributed Capital:
Common Stock, $.01 par - shares authorized, 40,000,000; 18,349,445 issued
and 18,249,445 outstanding at October 31, 2002 and 19,414,799 issued and
18,288,679 outstanding at January 31, 2002 184 194
Preferred Stock, $.01 par - shares authorized, 2,000,000; -0- issued and
outstanding at October 31, 2002 and January 31, 2002 -- --
Additional paid-in-capital 97,277 103,386
---------------- ----------------
Total contributed capital 97,461 103,580
Accumulated other comprehensive (loss):
Foreign currency translation (255) (387)
Accumulated deficit (46,214) (51,666)
---------------- ----------------
50,992 51,527
Less: Treasury Stock (100,000 and 1,126,120 shares at cost at October 31, 2002 and
January 31, 2002, respectively) (567) (6,486)
---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 50,425 45,041
---------------- ----------------
$ 162,174 $ 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 October 31, Nine Months Ended October 31,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Revenues $ 80,942 $ 81,933 $ 221,551 $ 157,537
Costs of Revenues 64,867 62,970 176,048 117,624
---------- ---------- ---------- ----------
Gross Profit 16,075 18,963 45,503 39,913
Selling, General and Administrative Expense 11,041 11,251 33,281 25,125
Amortization of Goodwill (Note 3) -- 1,687 -- 3,739
Relocation Expenses 614 -- 1,309 --
---------- ---------- ---------- ----------
Operating Income 4,420 6,025 10,913 11,049
---------- ---------- ---------- ----------
Other Income (Expense)
Interest expense, net (1,028) (966) (2,581) (2,334)
Other 515 (78) 284 1,927
---------- ---------- ---------- ----------
Total Other Income (Expense) (513) (1,044) (2,297) (407)
---------- ---------- ---------- ----------
Income Before Income Taxes 3,907 4,981 8,616 10,642
Income Tax Expense 1,118 2,430 3,164 4,390
---------- ---------- ---------- ----------
Net Income $ 2,789 $ 2,551 $ 5,452 $ 6,252
========== ========== ========== ==========
Earnings per Share - Basic $ 0.15 $ 0.14 $ 0.30 $ 0.35
---------- ---------- ---------- ----------
Weighted Average of Shares Outstanding - Basic (Note 6) 18,212 18,234 18,220 17,805
---------- ---------- ---------- ----------
Earnings per Share - Diluted $ 0.15 $ 0.14 $ 0.29 $ 0.35
---------- ---------- ---------- ----------
Weighted Average of Shares Outstanding - Diluted (Note 6) 18,672 18,406 18,497 17,962
========== ========== ========== ==========
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)
Three Months Ended October 31, Nine Months Ended October 31,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net Income $ 2,789 $ 2,551 $ 5,452 $ 6,252
Unrealized Loss on Available-for-Sale Securities,
net of tax (235) (723)
Foreign Currency Translation Adjustment 7 (66) 132 (266)
---------- ---------- ---------- ----------
Comprehensive Income $ 2,796 $ 2,250 $ 5,584 $ 5,263
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
3
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited)
(in thousands)
Common Stock Additional Other Treasury Stock Total
--------------------- Paid - in Accumulated Comprehensive ------------------- Stockholders'
Shares Amount Capital Deficit (Loss) Shares Amount Equity
--------- --------- ---------- ----------- ------------- --------- --------- -------------
Balance, January 31, 2002 19,415 $ 194 $ 103,386 $ (51,666) $ (387) (1,126) $ (6,486) $ 45,041
Purchase of treasury stock (100) (465) (465)
Retirement of treasury stock (1,126) (11) (6,373) 1,126 6,384 --
Foreign currency
translation adjustment 132 132
Other 60 1 264 265
Net income 5,452 5,452
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, October 31, 2002 18,349 $ 184 $ 97,277 $ (46,214) $ (255) (100) $ (567) $ 50,425
========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements.
4
SOURCE INTERLINK COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Nine Months Ended October 31, 2002 2001
---------- ----------
OPERATING ACTIVITIES
Net income $ 5,452 $ 6,252
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,230 5,603
Provision for losses on accounts receivable 589 (397)
Deferred income taxes (659) 155
Other (216) 470
Changes in assets and liabilities:
Decrease (increase) in accounts receivable 9,939 (18,001)
Decrease in inventories 269 2,893
Decrease in other assets 2,101 4,306
(Decrease) increase in accounts payable and accrued expenses (6,395) 7,780
---------- ----------
CASH PROVIDED BY OPERATING ACTIVITIES 13,310 9,061
========== ==========
INVESTMENT ACTIVITIES
Capital expenditures (3,809) (2,582)
Acquisition of The Interlink Companies, Inc., net of cash -- (13,623)
acquired
Acquisition of Innovative Metal Fixtures, Inc. (2,014) --
Acquisition of intangible (2,000) --
Other -- 374
---------- ----------
CASH USED IN INVESTING ACTIVITIES (7,823) (15,831)
========== ==========
FINANCING ACTIVITIES
Increase in checks issued against revolving credit facility -- (895)
Borrowings under credit facility (3,268) 9,890
Payment of Notes Payable (3,756) --
Purchase of treasury stock (465) (39)
Other 60 --
---------- ----------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (893) 8,956
========== ==========
INCREASE IN CASH 4,594 2,186
CASH, beginning of period 2,943 1,085
---------- ----------
CASH, end of period $ 7,537 $ 3,271
========== ==========
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 October 31, 2002 and for the three
month and nine month periods ended October 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 October 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 nine
month periods ended October 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):
October 31, 2002 January 31, 2002
---------------- ----------------
Raw materials $ 2,672 $ 2,559
Work-in-process 2,749 1,754
Finished goods:
Fixtures 1,193 1,790
Magazine 10,229 10,820
---------- ----------
$ 16,843 $ 16,923
========== ==========
The Company receives full-credit from the publisher for all undistributed and
returned magazines.
3. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board ("FASB") issued the
Statement of Financial Accounting Standards (SFAS) No. 141, Business
Combinations, and SFAS No. 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 impairment
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:
October 31, 2002 January 31, 2002
---------------- ----------------
Indefinite-lived Intangible Assets:
Goodwill $ 44,839 $ 42,769
Amortizable Intangible Assets:
Other 2,300 300
Accumulated Amortization (337) (192)
---------- ----------
Intangibles, net $ 46,802 $ 42,877
========== ==========
For comparative purposes, the following schedule is a reconciliation of reported
net income to adjusted net income for the three months and nine months ended
October 31, 2001, adjusted to exclude goodwill amortization, along with
comparative information for the three months and nine months ended October 31,
2002 (in thousands).
Three Months Ended Nine Months Ended
October 31, October 31,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Reported Net Income $ 2,789 $ 2,551 $ 5,452 $ 6,252
Add Back: Goodwill Amortization, net of tax -- 1,519 -- 3,257
Adjusted Net Income 2,789 4,070 5,452 9,509
Reported Earnings Per Share - Basic $ 0.15 $ 0.14 $ 0.30 $ 0.35
Reported Earnings Per Share -Diluted 0.15 0.14 0.29 0.35
Adjusted Earnings Per Share - Basic $ 0.15 $ 0.22 $ 0.30 $ 0.48
Adjusted Earnings Per Share -Diluted 0.15 0.22 0.29 0.47
========== ========== ========== ==========
Amortization expense for the three months and nine months ended October 31, 2002
was $65 and $145 respectively. Amortization expense for each of the five
succeeding years is estimated to be approximately $260.
7
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
4. DEBT AND REVOLVING CREDIT FACILITY
Debt consists of (in thousands):
October 31, January 31,
2002 2002
----------- -----------
Revolving Credit Facility - Bank of America $ 35,872 $ 36,073
Revolving Credit Facilities - Congress Financial Corporation 14,512 11,068
Industrial Revenue Bonds 4,000 4,000
Notes payable to former owners of acquired company, currently
being disputed by Company 1,886 2,750
Term loan - Congress Financial Corporation -- 2,778
Note payable to former owner of acquired company 200 400
Other 708 606
---------- ----------
Total Long-term Debt 57,178 57,675
Less current maturities 38,451 42,097
---------- ----------
Long-term Debt $ 18,727 $ 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 (1.69% at October 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 the Company is required to maintain certain financial ratios. The Company
was in compliance with such ratios at October 31, 2002. Availability under the
facility is limited by the Company's borrowing base calculation as defined in
the agreement resulted in excess availability of $5.8 million at October 31,
2002.
The Company has Industrial Revenue Bonds (IRB). On January 30, 1995, the City of
Rockford, Illinois 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. The bonds are secured by
the trustee's indenture and the $4.1 million letter of credit. The bonds
8
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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 credit facilities with Congress Financial Corporation
("Congress"). On February 22, 2001, IPD and Deyco entered into two credit
facilities with Congress which expire on February 21, 2005. The agreements
provide for maximum combined borrowings of $25 million subject to limits set by
periodic borrowing base calculations. Borrowings under the revolving credit
portion of the facility bear interest at a rate equal to 0.25% in excess of the
prime rate. The credit facility is secured by IPD and Deyco's accounts
receivable and limited cross guarantees between the two divisions. Under the
credit agreement, IPD and Deyco are required to maintain certain financial
ratios. IPD and Deyco were in compliance with all such ratios at October 31,
2002. Availability under the facility is limited by the Company's borrowing base
as defined by the agreement resulted in excess availability of $.3 million at
October 31, 2002.
In connection with the acquisition of Interlink, the Company assumed debt to the
former owners of IPD. The Company is currently disputing the remaining amounts
owed and has commenced legal action requesting the court release the Company of
any further obligation under these arrangements.
5. BUSINESS COMBINATIONS
On May 14, 2002 the Company (through its Aaron Wire subsidiary) acquired all of
the assets 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.
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.
9
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Unaudited pro forma results of operations for the nine months ended October 31,
2001 for the Company and The Interlink Companies, Inc. are listed below (in
thousands):
Nine months ended
October 31, 2001
------------------
Total Revenues As reported $ 157,735
Pro forma 218,407
Net Income (Loss) As reported 6,252
Pro forma (4,116)
Earnings Per Share
Basic As reported $ 0.35
Diluted As reported 0.35
Basic Pro forma (0.23)
Diluted Pro forma (0.23)
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 Nine Months Ended
October 31, October 31,
2002 2001 2002 2001
--------- --------- --------- ---------
Basic weighted average number of common shares
outstanding 18,212 18,234 18,220 17,805
Effect of dilutive securities:
Stock options and warrants 460 172 277 157
--------- --------- --------- ---------
Diluted weighted average number of common shares
outstanding 18,672 18,406 18,497 17,962
========= ========= ========= =========
For the quarter ended October 31, 2002, stock options to purchase 2,373 shares
and warrants convertible into 231 shares were excluded from the calculation of
diluted income per share because their exercise/ conversion price exceeded the
average market price of the common shares during the period.
7. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental information on interest and income taxes paid is as follows (in
thousands):
Nine Months Ended October 31, 2002 2001
----------- -----------
Interest $ 2,420 $ 2,518
Income Taxes $ 2,548 $ 312
=========== ===========
Other non-cash operating activities include the favorable settlement of a
liability for approximately $600, which is included in other income (expense)
net of related expenses.
10
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
8. SEGMENT FINANCIAL INFORMATION
The Company's segment reporting is based on the reporting of senior management
to the Chief Executive Officer. This reporting combines the Company's business
units in a logical way that identifies business concentrations and synergies for
both analysis of results and real-time control by management.
The reportable segments of the Company are Magazine Distribution, In-Store
Services, and Wood Manufacturing.
The Magazine Distribution segment derives revenues from (1) selling and
distributing magazines to major book chains, independent retailers and secondary
wholesalers throughout North America, (2) serving as secondary national
distributor, and (3) providing return processing services to major book chains.
The In-Store Services segment derives revenues from (1) providing information
and management services relating to retail magazine sales to U.S. and Canadian
retailers and magazine publishers, (2) providing claim filing services related
to rebates owed retailers from publishers or their designated agent, (3)
designing, manufacturing, and invoicing participants in front-end fixture
programs, and (4) shipping, installation and removal of front-end fixtures.
The Wood Manufacturing segment derives revenues from designing, manufacturing
and installing high-end wood store fixtures.
The Company derives essentially all its revenues from North America. The Company
purchases a portion of its magazines outside of North America.
The accounting policies of the segments are materially the same as those
described in the Summary of Accounting Policies. All material inter-segment
sales during the quarters or nine month periods ended October 31, 2002 or 2001
have been eliminated. The In-Store Services segment's "Selling, General &
Administrative" expense includes the majority of corporate overhead and the
related corporate assets and expenditures.
11
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Segment data (in thousands):
Magazine In-Store Wood
Distribution Services Manufacturing Consolidated
------------ -------- ------------- ------------
Three Months Ended October 31, 2002
Revenue $ 57,562 $ 18,462 $ 4,918 $ 80,942
Cost of Revenue 48,732 11,664 4,471 64,867
--------- --------- --------- ---------
Gross Profit 8,830 6,798 447 16,075
Selling, General & Administrative 6,012 4,630 399 11,041
Relocation Expense 44 570 -- 614
--------- --------- --------- ---------
Operating Income $ 2,774 $ 1,598 $ 48 $ 4,420
========= ========= ========= =========
Total Assets $ 39,817 $ 102,630 $ 19,728 $ 162,175
========= ========= ========= =========
Magazine In-Store Wood
Distribution Services Manufacturing Consolidated
------------ -------- ------------- ------------
Three Months Ended October 31, 2001
Revenue $ 56,007 $ 19,893 $ 6,033 $ 81,933
Cost of Revenue 48,497 9,515 4,958 62,970
--------- --------- --------- ---------
Gross Profit 7,510 10,378 1,075 18,963
Selling, General & Administrative 6,407 4,484 360 11,251
Amortization of Goodwill 911 690 86 1,687
--------- --------- --------- ---------
Operating Income $ 192 $ 5,204 $ 629 $ 6,025
========= ========= ========= =========
Total Assets $ 81,900 $ 129,001 $ 30,511 $ 241,412
========= ========= ========= =========
Magazine In-Store Wood
Distribution Services Manufacturing Consolidated
------------ -------- ------------- ------------
Nine Months Ended October 31, 2002
Revenue $ 161,164 $ 45,531 $ 14,856 $ 221,551
Cost of Revenue 137,540 26,161 12,347 176,048
--------- --------- --------- ---------
Gross Profit 23,624 19,370 2,509 45,503
Selling, General & Administrative 17,667 14,354 1,260 33,281
Relocation Expense 43 1,266 -- 1,309
--------- --------- --------- ---------
Operating Income $ 5,913 $ 3,750 $ 1,249 $ 10,913
========= ========= ========= =========
Magazine In-Store Wood
Distribution Services Manufacturing Consolidated
------------ -------- ------------- ------------
Nine Months Ended October 31, 2001
Revenue $ 92,122 $ 50,971 $ 14,444 $ 157,537
Cost of Revenue 79,924 25,395 12,305 117,624
--------- --------- --------- ---------
Gross Profit 12,198 25,576 2,139 39,913
Selling, General & Administrative 11,066 12,945 1,114 25,125
Amortization of Goodwill 1,471 2,011 257 3,739
--------- --------- --------- ---------
Operating Income $ (339) $ 10,620 $ 768 $ 11,049
========= ========= ========= =========
12
SOURCE INTERLINK COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
9. RECENTLY ISSUED ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board (FASB) issued the
Statement of Financial Accounting Standards (SFAS) No. 143, Accounting for Asset
Retirement Obligations. SFAS 143 addresses financial accounting and reporting
obligations associated with the retirement of tangible, long-lived assets and
the associated asset retirement costs. This statement is effective for fiscal
years beginning after June 15, 2002. Management does not believe the adoption of
this statement will have a material impact on the results of operations or
financial position of the Company.
In August 2001, FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. It supercedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to be Disposed
Of, and certain provisions of Accounting Principles Board Opinion No. 30,
Reporting the Effects of the Disposal of a Segment of a Business and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, for
the disposal of a segment of a business. SFAS 144 establishes a single
accounting model, based on the framework established in SFAS 121, for long-lived
assets to be disposed of by sale and resolves other implementation issues
related to SFAS 121. This statement was adopted by the Company effective
February 1, 2002. The adoption of SFAS 144 did not have a material impact on the
Company's results of operations or financial position.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS 145 rescinds, amends, or makes various technical corrections to certain
existing authoritative pronouncements. SFAS 145 is effective of financial
statements issued on after May 15, 2002. The adoption of SFAS 145 did not have a
material impact on the Company's results of operations or financial position.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS 146 addresses the recognition, measurement,
and reporting of costs associated with exit and disposal activities, including
costs related to terminating a contract that is not a capital lease and
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS 146 requires
recording costs associated with exit or disposal activities at their fair values
when a liability has been incurred. Under previous guidance, certain exit costs
were accrued upon management's commitment to an exit plan, which is generally
before an actual liability has been incurred. This statement will be effective
for exit or disposal activities that are initiated after December 31, 2002.
Management is currently evaluating the impact this statement will have on the
Company's results of operations or financial position. Specifically, the impact
this pronouncement will have on the Company's decision to consolidate its
operations in Bonita Springs, Florida.
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 to U.S. and
Canadian retailers, magazine publishers and product manufacturers. Our products
focus primarily on the retail sale of magazines, especially at the check-out
lane.
We are the leading direct-to-retail distributor of magazines to bookstore
chains, record stores, computer stores and independent retailers, and a national
distributor to the secondary wholesale channel. We are unique in the magazine
industry in that we utilize express common carrier to deliver our products from
our nine strategically located distribution centers directly to retail. The
location of our distribution centers allows us to service national retailers
with next day or second day service anywhere in the North America. This model
allows us to serve national retailers without significant capital investment and
leverages our expertise of managing magazine inventory levels at retail with the
common carrier's expertise of managing logistics.
Through our information products, we provide retailers and publishers sales
data, product placement and other related information over the Internet. This
information helps users to formulate marketing, and distribution plans and to
react more quickly to changing market conditions. We believe we maintain the
most comprehensive information database available for retail magazine sales and
magazine placement at checkout counters including the only source of daily
point-of-sale data.
We are the leading designer and manufacturer of front-end display fixtures used
by retailers. We assist retailers in increasing sales and incentive payment
revenues by designing front-end display fixtures, supervising installation,
selecting products and negotiating, billing and collecting incentive payments
from vendors. We are a full-service provider of management services for the
checkout area, or "front-end," of a customer's store. We have the ability to
design, manufacture and install front-end fixtures which maximize our clients'
merchandising strategies and profit generated from the most valuable space in
their store.
Our segment reporting is structured based on the reporting of senior management
to the Chief Executive Officer. Our reportable segments are Magazine
Distribution, In-Store Services and Wood Manufacturing.
14
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information relating
to our operations expressed by segment (all discussion of results is in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MAGAZINE DISTRIBUTION OCTOBER 31, OCTOBER 31,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenues $ 57,562 $ 56,007 $161,164 $ 92,122
Cost of Revenues 48,732 48,497 137,540 79,924
-------- -------- -------- --------
Gross Profit 8,830 7,510 23,624 12,198
Selling, General and Administrative Expense 6,012 6,407 17,667 11,066
Amortization of Goodwill -- 911 -- 1,471
Relocation Expenses 44 -- 44 --
-------- -------- -------- --------
Operating Income (Loss) $ 2,774 $ 192 $ 5,913 $ (339)
======== ======== ======== ========
Gross Profit Margin 15.4% 13.4% 14.7% 13.2%
Operating Profit Margin 4.8% 0.3% 3.6% (0.4)%
======== ======== ======== ========
THREE MONTHS ENDED NINE MONTHS ENDED
IN-STORE SERVICES OCTOBER 31, OCTOBER 31,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenues $ 18,462 $ 19,893 $ 45,531 $ 50,971
Cost of Revenues 11,664 9,515 26,161 25,395
-------- -------- -------- --------
Gross Profit 6,798 10,378 19,370 25,576
Selling, General and Administrative Expense 4,630 4,484 14,354 12,945
Amortization of Goodwill -- 690 -- 2,011
Relocation Expenses 570 -- 1,265 --
-------- -------- -------- --------
Operating Income $ 1,598 $ 5,204 $ 3,751 $ 10,620
======== ======== ======== ========
Gross Profit Margin 36.8% 52.2% 42.5% 50.2%
Operating Profit Margin 8.7% 26.2% 8.2% 20.9%
======== ======== ======== ========
THREE MONTHS ENDED NINE MONTHS ENDED
WOOD MANUFACTURING OCTOBER 31, OCTOBER 31,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenues $ 4,918 $ 6,033 $ 14,856 $ 14,444
Cost of Revenues 4,471 4,958 12,347 12,305
-------- -------- -------- --------
Gross Profit 447 1,075 2,509 2,139
Selling, General and Administrative Expense 399 360 1,260 1,114
Amortization of Goodwill -- 86 -- 257
-------- -------- -------- --------
Operating Income $ 48 $ 629 $ 1,249 $ 768
======== ======== ======== ========
Gross Profit Margin 9.1% 17.8% 16.9% 14.8%
Operating Profit Margin 1.0% 10.4% 8.4% 5.3%
======== ======== ======== ========
15
MAGAZINE DISTRIBUTION
The Magazine Distribution segment consists of companies acquired in May 2001.
Our magazine distribution business is operated from our administrative offices
in San Diego, California. We operate 9 distribution centers strategically
located throughout the United States. We also serve as a secondary national
distributor, which is managed from both our San Diego and New York City offices.
The Magazine Distribution segment accounted for 62.8% of consolidated operating
income for the quarter-ended October 31, 2002 and 54.2% of consolidated
operating income for the nine month period ended October 31, 2002.
Revenues
Revenues for the quarter-ended October 31, 2002 increased $1,555 (2.8%) compared
to the third quarter of fiscal 2002.
The increase in revenues is primarily attributed to an increase in our direct
wholesale distribution division's gross distribution of $1,064 and an increase
in the estimated net sell-through (after reserving for returns) of 1.7%, which
translates into $1,197 of addition net revenues. This increase in gross
distribution resulted from an increase in the number of retail stores we service
and an increase in the number of publishers (i.e., titles) we distribute to our
customer base. Our customer base generally concentrates new store openings in
our third and fourth fiscal quarter. Store openings in 2002 included certain
stores delayed from 2001 due to uncertain economic conditions caused by the
events on September 11. The increase was partially offset by our decision to
decrease initial distribution into existing stores, which has the effect of
decreasing gross distribution but at the same time improving sell-through.
Our comparable quarter of the prior year also included special one-time
distribution related to the events of September 11, which for the most part
were not repeated in 2002.
The increase in our wholesale business was partially off-set by a decrease in
our national distribution business. The decrease is indicative of both an
overall decline in this market as well as a strategic decision to focus
management efforts on our direct wholesale distribution business.
Finally, we experienced a $600 increase in our magazine distribution services,
which consists of providing backroom return processing to retail chains and the
direct distribution of other company's products (primarily magazines) through
our distribution centers.
Revenues for the nine month period-ended October 31, 2002 increased $69,042
(75.0%) compared to the corresponding nine month period of the prior year.
The increase was attributable to both the factors described above and the
additional four months of operations.
Gross Profit
Gross profit for the third quarter improved $1,320 (17.6%) compared to the third
quarter of fiscal 2002. Gross profit percentage improved to 15.4% from 13.4%.
The increase resulted both from the increase in net revenues as well as an
improvement in our gross profit margin.
Gross profit is impacted 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 never sold and eventually returned to
us.
We increased the number of publishers (titles) including foreign publishers,
which generally have higher cover prices, sell-through and profit margins
resulting in higher gross profit than mainstream titles. In addition, we have
been able to negotiate more favorable terms from our suppliers and our increased
volume allows us to qualify for a lower freight rate from our common carrier.
Finally, we have reconfigured our magazine distribution network to maximize
shipping efficiency and minimize our freight costs, which has resulted in lower
per unit shipping costs. We continue to work closely with our common carrier to
create a magazine distribution network that interacts seamlessly with their
distribution system and anticipate continued progress in this area.
16
Gross profit for the nine month period-ended October 31, 2002 increased $11,426
compared to the comparable nine month period of the prior year. Gross profit
percentage improved to 14.7% from 13.2%.
The increase was attributable to both the factors described above and the
additional four-months of operations.
Selling, General and Administrative Expense ("SG&A")
SG&A expenses for the quarter-ended October 31, 2002 decreased $395 compared to
the third quarter of fiscal 2002.
The decrease is primarily attributable to our decision to consolidate the
management of our direct wholesale division and our secondary national
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 administrative overhead. The decrease was also
impacted by our ability to lease new office space in San Diego under favorable
leasing conditions.
SG&A expenses for the nine month period ended October 31, 2002 increased $6,601
compared to the comparable nine month period of the prior fiscal year due to the
additional four months of operations partially offset by the efficiencies
described above.
Relocation Expenses
We are in the process of consolidating certain operations in Bonita Springs,
Florida. Resulting costs consist of the costs of relocating employees and
closing existing facilities. The magazine distribution segment is the last to be
relocated and as a result expenses are not yet significant. We anticipate some
of these costs will be expensed in the fourth quarter and will have a
significant impact on the results of operations that quarter.
IN-STORE SERVICES
Our In-Store Services segment consists of our front-end management products
including our information products. Our front-end products are a suite of
products related to the front-end (or more commonly known as the checkout lane
of retail stores). These products range from the filing of rebate claims with
publishers of magazines who desire front-end placement to the design,
manufacture, removal of existing, and installation of the new front-end
fixtures. Our information products consist of multiple databases with
information related to the sale of products and the front-end. The segment also
includes most corporate overhead functions, which comprise the majority of the
segment's SG&A expenses.
In-Store Services accounted for 36.2% of consolidated operating income for the
quarter-ended October 31, 2002 and 34.4% of consolidated operating income for
the nine month period ended October 31, 2002.
Revenues
In-Store Services revenues for the third quarter decreased $1,431 (7.2%)
compared to the third quarter of fiscal 2002.
The decrease is primarily attributable to a significant decrease in revenue
generated from the design, manufacture and shipping of front-end fixtures in the
United States. The decrease in revenue occurred despite a significant increase
in the number of fixtures sold during the quarter compared to the prior year. We
attribute the overall decrease in price to an extremely competitive marketplace
and the decision we made to match our competitors pricing in order to maximize
our percentage of the overall market. Our primary competitor does not have the
same scope of products as we have and compete primarily on price. We consider
the pricing in this quarter to be an anomaly and anticipate pricing to return to
more normalized levels in the future.
The decrease in revenue from the design, manufacture, shipping and removal was
partially offset by an increase in revenues generated from installation, which
is a service that did not generate significant revenues in the third quarter of
the prior year. In addition, the decrease in revenue was partially offset by an
increase in Canadian manufacturing revenue as a result of our recent acquisition
and a small increase in revenues related to the sale of information and claim
filing.
17
In-Store Services revenues for the nine-months ended October 31, 2002 decreased
$5,440 (10.7%) compared to nine month period ended October 31, 2002.
The decrease is primarily attributable to the factors described above related to
the revenues generated from the design, manufacture and shipping of front-end
fixtures in the United States partially offset by a significant increase in
Canadian manufacturing revenue as a result of our recent acquisition and
revenues generated from our installation service.
We also experienced a decrease in claiming revenue due to a decrease in claims
filed under our Advance Pay program and a very small (approximately 1%) decrease
in our average commission generated from those claims. Both decreases were
caused by our acquisition of IPD, which is one of the Interlink Companies, and a
significant customer of our Advance Pay program before the acquisition. IPD
continues to file claims related to their sale of magazines but all revenue from
those claim filings is eliminated in consolidation.
Gross Profit
Gross profit in the third quarter decreased $3,580 compared to the third quarter
of fiscal 2002. The gross profit margin decreased to 36.8% from 52.2%.
The decrease is attributable to the decrease in the pricing of the fixtures
partially offset by spreading the overhead costs of our factories over a larger
number of fixtures. We also did not experience the efficiencies we had
anticipated from the greater volume due to overtime pay and the inefficiencies
and cost of manufacturing 24 hours a day/ 7 days a week in order to meet
customer delivery schedules (retailers generally desire delivery and
installation before the holiday season).
Gross profit for the nine months ended October 31, 2002 decreased $6,206
compared to the comparable nine month period of the prior fiscal year. The gross
profit margin decreased to 42.5% from 50.2%.
The decrease for the nine month period is not as significant as the decrease in
the third quarter because the issues impacting the third quarter were not
prevalent in the other six months.
Selling, General and Administrative Expense ("SG&A")
SG&A expenses for the quarter-ended October 31, 2002, excluding relocation costs
and amortization of goodwill, increased $146 (3.3%) compared to the third
quarter of fiscal 2002.
The increase in SG&A was due primarily to duplicative rents paid on facilities
in Bonita Springs, St. Louis, MO and New York City. As part of our relocation
process, we are currently evaluating possible scenarios with respect to facility
utilization.
SG&A expenses for the nine month period-ended October 31, 2002 increased $1,424
(11.1%) compared to the comparable nine month period of the prior fiscal year.
The increase is due to the factors described above as well as an increase in
corporate overheads (professional fees, insurance, etc.) and marketing expenses
consistent with the growth of the overall business. The prior nine-month period
only included four months of operations of our Magazine Distribution segment,
which gave rise to most of these costs.
Relocation Expenses
We are in the process of consolidating certain operations in Bonita Springs,
Florida. These costs consist of the costs of relocating employees and closing
existing facilities. The segment, which includes our corporate overhead
functions, was the first to be relocated. We anticipate some of these costs will
be expensed in the fourth quarter and will have a significant impact on the
results of that quarter.
18
WOOD MANUFACTURING
The Wood Manufacturing segment manufactures high-end wood retail display
fixtures from three manufacturing facilities located in Nevada, Illinois and
North Carolina. The location of the facilities provides the necessary coverage
to service national retailers. The majority of the segment's revenue is derived
from one large national bookstore chain. The segment's financial performance is
highly reliant on that customer's store opening and capital expenditure plans.
Wood Manufacturing accounted for 1.1% of consolidated operating income for the
quarter-ended October 31, 2002 and 11.4% of consolidated operating income for
the nine month period ended October 31, 2002.
Revenue
Wood Manufacturing revenues in the third quarter decreased $1,115 (18.5%)
compared to the third quarter of fiscal 2002.
The decrease in revenues is primarily attributable to the timing of production
of orders for our largest customer. Generally, we receive orders with
significant lead times, produce the fixtures to maximize the efficiencies of our
factories, and then store them for the customer until delivery is requested.
Wood Manufacturing revenues for the nine month period ended October 31, 2002
increased $412 (2.9%) compared to the comparable period of the prior fiscal
year. The increase for the nine month period was not significant.
Gross Profit
Gross profit in the third quarter decreased $628 compared to the third quarter
of fiscal 2002. The gross profit margin decreased to 9.1% from 17.8%.
The decrease in the gross profit margin resulted from the lower production,
which causes fixed factory expenses to be spread-out over fewer fixtures.
Gross profit for the nine month period ended October 31, 2002 increased $370
compared to the comparable period of fiscal 2002. The gross profit margin
increased to 8.4% from 5.3%.
Selling, General and Administrative Expense ("SG&A")
SG&A expenses for the quarter increased $39 (10.8%) compared to the third
quarter of fiscal 2002.
SG&A expenses for the nine month period-ended October 31, 2002 increased $146
(13.1%) compared to the comparable nine month period of the prior fiscal year.
Both the quarter and nine month increases relate primarily to an increase in
rent associated with our Nevada facility.
INTEREST EXPENSE
Interest expense for the quarter ended October 31, 2002 increased $62 compared
to the quarter ended October 31, 2001.
Interest expense for the nine month period ended October 31, 2002 increased $247
compared to the comparable period of the prior year.
The increase was primarily due to an increase in borrowings related to the
acquisition of Interlink, which affected only five of the nine months in the
comparable period. The increase was partially offset by an improving interest
rate environment for our variable rate loans.
19
OTHER INCOME (EXPENSE)
Other income (expense) consists of items outside of the normal course of
operations. Due to its nature, comparability between periods is not generally
meaningful. Other income in the current period related primarily to the
favorable settlement on an outstanding liability. Other income in the
corresponding nine month period of the prior year related to life insurance
proceeds.
INCOME TAX EXPENSE
The effective income tax rates for the quarters ended October 31, 2002 and 2001
were 28.6% and 48.8%, respectively. The effective income tax rates for the nine
months ended October 31, 2002 and 2001 were 36.7% and 41.3%, respectively.
The effective income tax rate varied from the federal statutory rate due to the
Company's effective state income taxes, expenses not deductible for income tax
purposes and income not included in taxable income. These non-deductible
expenses include a portion of meals and entertainment and officers' life
insurance premiums.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements for the Magazine Distribution segment are the cost
of the periodicals and the cost of labor and overhead associated with our
distribution centers.
Our primary cash requirements for the In-Store Product segment are for
purchasing materials and the cost of labor incurred in the production of
front-end displays, funding corporate overhead, the cost of labor incurred in
providing our claiming, design and information services and funding our Advance
Pay Program.
Our primary cash requirements for the Wood Manufacturing segment are for
purchasing materials and the cost of labor incurred in the manufacturing
process.
Historically, we have financed our business activities through cash flows from
operations, borrowings under available lines of credit and through the issuance
of equity securities.
Net cash provided by operating activities of $13,310 for the nine months ended
October 31, 2002 was primarily from net income, non-cash expenditures such as
depreciation, and a significant decrease in accounts receivable. These cash
providing activities were offset by a significant reduction in accounts payable.
The decrease in accounts receivable relates to our new procedures for filing
rebate claims with certain large publishers and the significant decrease in
receivables related to front-end fixture programs.
The new claim filing process provides the publishers with the necessary
information in an electronic format that allows for quicker processing. As a
result of this new process, claims outstanding related to our Advance Pay
program decreased compared to the prior fiscal year-end, without a significant
decrease in either the number or amount of claims filed. Unpaid Publisher claims
for our Advance Pay program and standard claim program equal approximately one
quarter's claim filings. However, this does not equate to 90 days sale
outstanding because the claims are not filed uniformly over the quarter but
almost entirely in the last month of the quarter.
The decrease in receivables related to front-end fixture programs relates
primarily to the timing of payments by significant participants of cost-shared
front-end fixture programs.
Improved cash flow in our Magazine Distribution segment allowed for a
significant reduction in accounts payable. We believe that we are now current
with all our publishers, which has significantly improved our relationship with
the publishing community and allowed us to expand our business with those
publishers.
At October 31, 2002, we anticipate capital expenditures during the remainder of
fiscal 2003 of less than $500. Our borrowing agreements limit the amount we can
expend in any fiscal year.
20
At October 31, 2002, our total long-term debt obligations were $57,178,
excluding outstanding letters of credit. Long-term debt consists of our
revolving credit facility with Bank of America that we use to fund our In-Store
Services and Wood Manufacturing segments, our revolving credit facilities with
Congress Financial Corporation that we use to fund our Magazine Distribution
segment, and a Industrial Revenue Bond connected to our front-end fixture
manufacturing facility in Illinois.
The credit agreement enables us to borrow up to $46 million under a revolving
credit facility subject to limits set by periodic borrowing base calculation.
Borrowings under the credit facility bear interest at a rate equal to the 90-day
LIBOR rate (1.69% at October 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 excess availability at October 31, 2002 on the revolving credit facility was
approximately $6 million. The facility expires in August 2003 and as such is
included in current maturities of long-term debt.
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 October 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 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
million in connection with the IRB with an initial expiration date of April 20,
2001. The letter of credit reduces our availability under our facility. 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 two credit agreements with Congress Financial Corporation ("Congress"). The
agreements provide for maximum combined borrowings of $25 million subject to
limits set by periodic borrowing base calculations. Borrowings under the
revolving credit facility bear interest at a rate equal to 0.25% in excess of
the prime rate. The credit facility is secured by IPD and Deyco's accounts
receivable and limited cross guarantees between the two divisions. The
facilities are not secured beyond the divisional level. The facilities require
the divisions to maintain certain combined financial ratios. The Company was in
compliance with all such ratios at October 31, 2002.
At October 31, 2002, we calculated our working capital, excluding our revolving
credit facility with Bank of America, to be $30,937 compared to $28,147 at
January 31, 2002.
We believe that our cash flow from operations together with our revolving credit
facilities will be sufficient to fund our working capital needs and capital
expenditures for the foreseeable future. At this time, we believe we will be
able to extend or replace the Bank of America credit facility, which expires
August 1, 2003, at terms consistent with the existing facility. However, there
are many factors that could have a significant impact on the overall credit
markets, which could have an adverse impact on the Company's financial
condition.
NEW ACCOUNTING STANDARDS
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
143, Accounting for Asset Retirement Obligations. SFAS 143 addresses financial
accounting and reporting obligations associated with the retirement of tangible,
long-lived assets and the associated asset retirement costs. This statement is
effective for fiscal years beginning after June 15, 2002. Management does not
believe the adoption of this statement will have a material impact on the
results of operations or financial position of the Company.
In August 2001, FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. It supercedes
SFAS No.
21
121, Accounting for the Impairment of Long-Lived Assets to be Disposed Of, and
certain provisions of Accounting Principles Board Opinion No. 30, Reporting the
Effects of the Disposal of a Segment of a Business and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions, for the disposal of a
segment of a business. SFAS 144 establishes a single accounting model, based on
the framework established in SFAS 121, for long-lived assets to be disposed of
by sale and resolves other implementation issues related to SFAS 121. This
statement was adopted by the Company effective February 1, 2002. The adoption of
SFAS 144 did not have a material impact on the Company's results of operations
or financial position.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS 145 rescinds, amends, or makes various technical corrections to certain
existing authoritative pronouncements. SFAS 145 is effective of financial
statements issued on after May 15, 2002. The adoption of SFAS 145 did not have a
material impact on the Company's results of operations or financial position.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS 146 addresses the recognition, measurement,
and reporting of costs associated with exit and disposal activities, including
costs related to terminating a contract that is not a capital lease and
termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS 146 requires
recording costs associated with exit or disposal activities at their fair values
when a liability has been incurred. Under previous guidance, certain exit costs
were accrued upon management's commitment to an exit plan, which is generally
before an actual liability has been incurred. This statement will be effective
for exit or disposal activities that are initiated after December 31, 2002.
Management is currently evaluating the impact this statement will have the
Company's results of operations or financial position. Specifically, the impact
this pronouncement will have on the Company's decision to consolidate its
operations in Bonita Springs, Florida.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary market risks include fluctuations in interest rates and exchange
rate variability.
Our debt relates primarily to credit facilities with Bank of America, N.A. and
IPD and Deyco's facilities with Congress Financial Corporation.
The credit facility with Bank of America has an outstanding principal balance of
approximately $35.9 million as of October 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.
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 October 31, 2002 the fair value
of the swap is recorded in accrued expenses. The change in the fair value of the
swap is recorded in other income (expense).
The two credit facilities with Congress are secured by IPD and Deyco's accounts
receivable, inventories, equipment and other intangibles. The revolving credit
facilities had a combined outstanding principal balance of approximately $14.5
million at October 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.
We do not perform any interest rate hedging activities related to these two
facilities.
We have exposure to foreign currency fluctuations through our operations in
Canada. These operations accounted for approximately 1.76% and 1.56% of our
quarter and nine month revenues, respectively. 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.
Additionally, we have exposure to foreign currency fluctuation through our
purchase of magazines from foreign publishers. These magazines are purchased in
Euros and sold in the United States in local currency. A significant change in
the relative strength of the US $ could have a significant impact on the sales
of these magazines at retail.
We do not conduct any significant hedging activities related to foreign
currency.
23
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer have
concluded that the Company's disclosure controls and procedures (as
defined in Rules 240.13a-14(c) and 15d-14(c) promulgated under the
Securities Exchange Act of 1934) are sufficiently effective to ensure
that the information required to be disclosed by the Company in the
reports it files under the Exchange Act is gathered, analyzed and
disclosed with adequate timeliness, accuracy and completeness, based on
the evaluation of such controls and procedures within 90 days prior to
the date thereof.
In reaching this conclusion, the Company's Chief Executive and Chief
Financial Officer considered the impact of the unexpected departure of
the Company's prior Chief Financial Officer and Corporate Controller
and the inability of the Company to perform comprehensive exit
interviews of these two employees who performed key internal control
functions. The Company does not believe that their departure was in any
way related to concerns regarding the accounting policies and
procedures of the Company.
In addition, the Company's Chief Executive Officer and Chief Financial
Officer considered the recommendations of the Company's external
auditors made during the prior fiscal year's audit, which identified
two material weaknesses in internal control. The Company has
implemented corrective actions to address the material weaknesses
identified.
(b) Changes in Internal Controls
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation referred to above,
nor were there any corrective actions with regard to significant
deficiencies or material weaknesses since that date.
24
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 October 31, 2002.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
See Exhibit Index.
(b) Reports on Form 8-K.
None
25
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: December 18, 2002 /s/ MARC FIERMAN
----------------
Marc Fierman
Chief Financial Officer
26
I, S. Leslie Flegel, certify that:
1. I have reviewed this Form 10-Q for the Quarter ended October 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.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidating subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"; and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 18, 2002
/s/ S. Leslie Flegel
-----------------------------------
S. Leslie Flegel
Chairman and Chief Executive Officer
27
I, Marc Fierman, certify that:
1. I have reviewed this Form 10-Q for the Quarter ended October 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.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidating subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"; and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a. All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. Any fraud, whether or not material, that involves management or
other employees who have a significant role in the internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: December 18, 2002
/s/ Marc Fierman
---------------------------
Marc Fierman
Chief Financial Officer
28
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
10.1 Bank of America Extension Amendment and Waiver Agreement dated
August 30, 2002.
99.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
29