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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[x] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended January 31, 2005 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ___ to ___.
Commission file number 1-13437
SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 20-2428299
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
27500 RIVERVIEW CENTER BLVD., SUITE 400
BONITA SPRINGS, FLORIDA 34134
(Address of Principal Executive Offices) (Zip Code)
(239) 949-4450
(Registrant's Telephone Number, Including Area Code)
Securities to be registered pursuant to Section 12(b) of the Act: NONE
Securities to be registered pursuant to Section 12(g) of the Act:
COMMON STOCK $0.01 PAR VALUE
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [X] No [ ]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of April 13, 2005 was approximately $297.6
million computed by reference to the price at which the common equity was sold
on July 31, 2004, the last day of the registrant's most recently completed
second fiscal quarter, as reported by The Nasdaq National Market
At April 13, 2005, the Company had 51,007,714 shares of common stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Source Interlink Companies, Inc. Annual
Meeting of Stockholders to be held on July 12, 2005 are incorporated by
reference into Part III of this Annual Report to the extent described in Part
III hereof.
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Business 2
ITEM 2. Properties 18
ITEM 3. Legal Proceedings 19
ITEM 4. Submission of Matters to a Vote of Security Holders 19
PART II
ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters 20
and Issuer Purchases of Equity Securities
ITEM 6. Selected Financial Data 20
ITEM 7. Management's Discussion and Analysis of Financial Condition 22
and Results of Operations
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 40
ITEM 8. Financial Statements and Supplementary Data 41
ITEM 9. Changes In and Disagreements with Accountants on 41
Accounting and Financial Disclosure
ITEM 9A. Controls and Procedures 41
ITEM 9B. Other Information 43
PART III
ITEM 10. Directors and Executive Officers of the Registrant 43
ITEM 11. Executive Compensation 43
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 43
And Related Stockholder Matters
ITEM 13. Certain Relationships and Related Transactions 43
ITEM 14. Principal Accountant Fees and Services 43
PART IV
ITEM 15. Exhibits and Financial Statement Schedules 44
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Some of the information contained in this Annual Report on Form 10-K
including, but not limited to, those contained in Item 1. "Business" and Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," along with statements in other reports filed with the Securities
and Exchange Commission (the "SEC"), external documents and oral presentations,
which are not historical facts are considered to be "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"believe," "expect," "anticipate,' "estimate," "project," and similar
expressions often characterize forward-looking statements. These statements may
include, but are not limited to, projections of collections, revenues, income or
loss, cash flow, estimates of capital expenditures, plans for future operations,
products or services, and financing needs or plans, as well as assumptions
relating to these matters. These statements are only predictions and you should
not unduly rely on them. Our actual results will differ, perhaps materially,
from those anticipated in these forward-looking statements as a result of a
number of factors, including the risks and uncertainties faced by us described
below and those set forth below under the heading "Risk Factors that Might
Affect Future Operating Results and Financial Condition":
- market acceptance of and continuing demand for magazines, DVDs, CDs and
other home entertainment products;
- the impact of competitive products and technologies;
- the pricing and payment policies of magazine publishers, film studios,
record labels and other key vendors;
- our ability to obtain additional financing to support our operations;
- changing market conditions and opportunities;
- our ability to realize operating efficiencies, cost savings and other
benefits from recent and pending acquisitions; and,
- retention of key management and employees.
We believe it is important to communicate our expectations to our
investors. However, there may be events in the future that we are not able to
predict accurately or over which we have no control. The factors listed above
provide examples of risks, uncertainties and events that may cause our actual
results to differ materially from the expectations we describe in our
forward-looking statements. Before you make an investment decision relating to
our common stock, you should be aware that the occurrence of the events
described in these risk factors and those set forth below under ITEM 1 --
"Business--Risk Factors that Might Affect Future Operating Results and Financial
Condition" could have a material adverse effect on our business, operating
results and financial condition. You should read and interpret any
forward-looking statement in conjunction with our consolidated financial
statements, the notes to our consolidated financial statements and "ITEM
7--Management's Discussion and Analysis of Financial Condition and Results of
Operations." Any forward-looking statement speaks only as of the date on which
that statement is made. Unless required by U.S. federal securities laws, we will
not update any forward-looking statement to reflect events or circumstances that
occur after the date on which the statement is made.
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PART I
ITEM 1. BUSINESS.
OVERVIEW
On February 28, 2005, we completed our merger with Alliance Entertainment
Corp: a logistics and supply chain management services company for the home
entertainment product market, principally selling CDs and DVDs. Following the
merger, we organized the combined company into two operating business units:
Supply Chain Management and In Store Services. For a discussion of Alliance and
the merger, see "Recent Developments" discussed below. The discussion of our
business includes the operations of the post-merger combined company.
In conjunction with the merger, the company is re-assessing its business
segments. These segments will be included in one of two principal business
units, In-Store Services and Supply Chain Management.
We provide supply chain management and/or related value-added products and
services to most national regional retailers, magazine publishers and other
providers of home entertainment content.
Our clients include:
- Mainstream retailers, such as The Kroger Company, Target Corporation,
Walgreen Company, Ahold USA, Inc., Kmart Corporation, Sear Roebuck &
Co., and Meijers;
- Specialty retailers, such as Barnes & Noble, Inc., Borders Group, Inc.,
The Musicland Group, Inc., Hastings Entertainment, Inc., Fry's
Electronics, Inc. and Circuit City Stores, Inc.;
- e-commerce retailers, such as amazon.com, barnesandnoble.com,
circuitcity.com and bestbuy.com;
Our suppliers include:
- Record labels, such as Vivendi Universal S.A., Sony BMG Music
Entertainment Company, WEA Distribution and Thorn-EMI;
- Film studios, such as The Walt Disney Company, Time-Warner Inc., Sony
Corp., The News Corporation, Viacom Inc. and General Electric Company;
and,
- Magazine Distributors, such as COMAG Marketing Group, LLC., Time Warner
Retail Sales & Marketing, Inc., Curtis circulation Company and Kable
Distribution Services, Inc.;
Our business model is designed to deliver a complete array of products and
value-added services developed to assist retailers and manufacturers of digital
versatile disks (DVDs), audio compact disks (CDs), magazines, confections and
general merchandise in efficiently and effectively marketing their products to
consumers visiting the more than 110,000 store fronts we serve.
CORPORATE GOVERNANCE
Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and all amendments to those reports are available,
as soon as practicable after filing with the SEC, free of charge on our website,
www.sourceinterlink.com. Our Code of Business Conduct and Ethics is also
available on our website, together with the charters for the Audit Committee,
Compensation Committee, Nominating and Corporate Governance Committee and
Capital Markets Committee of our Board of Directors. Written requests for copies
of these documents may be directed to Investor Relations at our principal
executive offices.
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INDUSTRY OVERVIEW
HOME ENTERTAINMENT CONTENT
According to industry sources, including the Motion Picture Association,
the Recording Industry Association of America, and Harrington Associates, LLC,
the total retail market in calendar year 2003 for DVDs, prerecorded music and
single-copy magazines was approximately $37.1 billion. Retail sales of DVDs
increased nearly 50% between 2002 and 2003.
The structure of the distribution channel for single-copy magazines has
changed little over the past several decades. Publishers each generally engage a
single national distributor, which acts as its representative to regional and
local wholesalers and furnishes billing, collecting and marketing services
throughout the United States or other territories. These national distributors
then secure distribution to retailers directly, or more typically, through a
number of regional and local wholesalers. The wholesalers maintain direct vendor
relationships with the retailers. Retailers in the mainstream retail market
require these wholesalers to provide extensive in-store services including
receiving, verifying, stocking new issues and removing out-of-date issues.
However, this traditional structure is not economically viable in the specialty
retail market. Thus, wholesalers servicing the specialty retail market typically
do not provide these in-store services.
In contrast, the distribution channel for prerecorded video and music
products is dominated by the major film studios and record labels, which
through their respective distribution units increasingly compete with
intermediaries by seeking to establish direct trading relationships with high
volume retailers. This disintermediation strategy has limited appeal to
retailers that demand a variety of value-added services, including e-commerce
support, inventory management, return logistics, advertising and marketing
assistance, information services, and in store merchandising services. Some
retailers have sought to maintain a duel supply chain by establishing a direct
trading relationship with the major studios and labels for high volume product,
primarily newly released titles, and a more expansive procurement and service
relationship with intermediaries to secure lower volume, higher margin product
and value-added services.
IN-STORE SERVICES
Front-End Management
The retail sale of single-copy magazines is largely an impulse purchase
decision by the consumer, and the retail sale of other home entertainment
content is becoming increasingly so. As a result, film studios, record labels,
publishers and manufacturers of other impulse merchandise such as confections
and general merchandise (i.e., razor blades, film, batteries, etc.) consider it
important for their products to be on prominent display in those areas of a
store where they will be seen by the largest number of shoppers in order to
increase the likelihood that their products will be sold. Retailers typically
display DVDs, CDs, magazines, confections and general merchandise in specific
aisles, or the "mainline," and the checkout area, or the "front-end." Product
visibility is highest in the front-end because every shopper making a purchase
must pass through this area.
Due to the higher visibility and resulting perception of increased sales
potential, vendors compete vigorously for favorable display space in the
front-end. To secure the desired display space, vendors offer rebate and other
incentive payments to retailers, such as:
- initial fees to rearrange front-end display fixtures to ensure the desired
placement of their products;
- periodic placement fees based on the location and size of their products'
display; and
- cash rebates based on the total sales volume of their products.
Due to the high volume of sales transactions and great variety of
incentive programs offered, there is a significant administrative burden
associated with front-end management. As a result, most retailers have
historically outsourced the information gathering and administration of rebate
claims collection to third parties such as our
3
company. This relieves retailers of the administrative burdens, such as
monitoring thousands of titles each with a distinct incentive arrangement.
Information Services
Prompt delivery of information regarding sales activity, including timing
of the redesign of front-end space, changes in display positions or the
discontinuance of a vendor's product, is important to vendors of front-end
products. This information allows vendors to make important strategic decisions
in advance of re-configurations and other changes implemented by retailers to
the front-end. Conversely, timely delivery of information about price changes,
special promotions, new product introductions and other plans is important to
retailers because it enables them to enhance the revenue potential of the
front-end. Historically, information available to vendors regarding retail
activity at the front-end and information available to retailers about vendors
has been fragmented and out-of-date. We believe that there is an increasing
demand on the part of vendors of front-end products for more frequent and
detailed information regarding front-end retail activity. Through our operating
units we have access to a significant amount of information regarding retail
front-end and mainline sales activity.
OUR BUSINESS
Our business consists of two strategic business units:
- Our Supply Chain Management unit distributes DVDs, CDs, domestic and
foreign titled magazines, confections and general merchandise to specialty
and mainstream retailers, renders fulfillment services for DVDs and CDs
sold by eCommerce retailers and provides a comprehensive category
management solution to its clients' home entertainment department. This
unit also exports domestic titled magazines from more than 100 publishers
to foreign markets worldwide.
- Our In-Store Services unit assists its clients with the design and
implementation of display fixture programs, collects rebate and other
incentive payments and provides access to real-time sales information
enabling its clients to make more informed decisions regarding their
product placement and marketing strategies.
SUPPLY CHAIN MANAGEMENT
In the spring of 2001, we acquired a group of affiliated specialty magazine
distributors to establish a platform from which to offer an expanding list of
merchandise and services to retailers. From 2002 through 2004, we continued to
expand our magazine product offerings by licensing and then purchasing
international distribution rights to a series of domestic magazine titles. In
February 2005, we further expanded our product offering beyond magazine
fulfillment to include DVDs, CDs and other home entertainment content products
through our merger with Alliance. On March 18, 2005, we signed a letter of
intent to acquire Chas. Levy Circulating Co., one of the principal magazine
wholesalers in the United States, for the purpose of strengthening our position
in the mainstream market. For a more complete discussion of the Alliance merger
and the proposed acquisition of Chas. Levy Circulating Co., see "Recent
Developments."
Currently, our Supply Chain Management unit offers a broad array of products
and services including the following:
Product Procurement. Through our extensive relationships with record
labels, film studios, magazine publishers and other producers of home
entertainment content, we can offer our retail clients the ability to display
virtually every domestic DVD, CD and magazine title and a significant selection
of foreign titled magazines. To maintain the high order fill rate demanded by
our clients, we have established an in stock catalogue of approximately 300,000
CD titles and approximately 100,000 DVD titles. We purchase home entertainment
content from every major record label, film studio and magazine publisher,
typically on a fully returnable basis.
Product is received at strategically located distribution centers. The
principal distribution centers are located in Harrisburg, Pennsylvania, Coral
Springs, Florida, Shepherdsville, Kentucky, Dallas, Texas and Carson City,
Nevada. At each of these distribution points, we process merchandise orders
using sophisticated warehouse
4
management systems. Once filled, orders are shipped to our retailers by a
combination of third party freight carriers and, in certain high volume
locations, in-house truck delivery. Given our broad distribution infrastructure,
we are capable of delivering home entertainment content overnight to virtually
any location within the continental United States.
Fulfillment Services. Our sophisticated warehouse management systems,
just-in-time replenishment and order regulation techniques enable us to offer
value-added fulfillment services including next day order delivery, ready for
shelf inventory preparation (such as price labeling and security device
placement) and a wide variety of electronic data interchange tools.
Most customers utilizing our fulfillment services are brick and mortar
retailers seeking support for their e-commerce initiatives in the DVD and CD
markets. For these clients, which include barnesandnoble.com, amazon.com and
bestbuy.com, we offer a comprehensive e-commerce platform, which includes direct
customer product delivery, real-time inventory querying and commitment
capabilities, credit card processing and settlement services, custom packaging,
promotional inserts and customer care services. Other fulfillment services
clients furnish magazines to us, rather than purchasing the product from us,
which we then package into individual orders and ship directly to individual
retail outlets.
Category Management Services. For retailers seeking a total merchandising
solution, we offer category management services that include product selection
and preparation, fixturing, in-store stocking and replenishment, marketing and
promotional program development, and inventory control.
IN-STORE SERVICES
The In-Store Services group provides rebate and other incentive payment
collection, information services and display fixture design and manufacture.
Claim Submission Services. Claim submission services have been the historical
core of our business. U.S. and Canadian retailers engage our In-Store Services
group to accurately monitor, document, claim and collect publisher rebate and
other incentive payments. Our services are designed to relieve our clients of
the substantial administrative burden associated with documenting, verifying and
collecting their payment claims, and to collect a larger percentage of the
potential incentive payments available to the retailers.
We established our Advance Pay Program as an enhancement to our claim
submission services. Typically, retailers are required to wait a significant
period of time to receive payments on their claims for incentive rebates. We
improve the retailer's cash flow by advancing the claims for rebates and other
incentive payments filed by us on their behalf, less our commission, within a
contractually agreed upon period after the end of each quarter.
Information Services. In connection with our claim submission services, we
gather extensive information on magazine sales, pricing, new titles,
discontinued titles and display configurations on a chain-by-chain and
store-by-store basis. As a result, we are able to furnish our clients with
reports of total sales, sales by class of trade and sales by retailer, as well
as reports of unsold magazines and total sales ranking. One of our products, the
Cover Analyzer, permits subscribers to determine the effectiveness of particular
magazine covers on sales for 300 top selling titles in the United States. Our
website gives subscribers the capability to react more quickly to market
changes, including the ability to reorder copies of specific issues, track
pricing information, to introduce new titles, and act on promotions offered by
publishers. Publishers also use the website to promote special incentives and
advertise and display special editions, new publications and upcoming covers. We
have supplemented our own data with data obtained under agreements with Barnes &
Noble, Inc., Walgreen Company and The Kroger Company.
Front-End and Point-of-Purchase Display Fixtures. To enhance retailers'
marketing efficiency, we developed the capacity to design, manufacture, deliver
and dispose of custom front-end and point-of-purchase displays for both retail
store chains and product manufacturers. Retailers perceive our experience in
developing and implementing product display strategies supported by our
information services as helpful in improving the revenue they generated from the
sale of home entertainment content merchandise. In addition, we believe that our
influence on the design and manufacture of display fixtures enhances our ability
to incorporate features that facilitate the gathering of information. Our
services in this regard frequently include designing front-end display fixtures,
supervising fixture
5
installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. We frequently assist our retailer clients in
the development of specialized marketing and promotional programs, which include
special mainline or front-end displays and cross-promotions of magazines and
products of interest to the readers of these magazines. Raw materials used in
manufacturing our fixtures include wire, wood, powder coating, paints and
stains, metal tubing and paneling, wood veneer and laminates, all of which are
readily available from multiple sources.
CUSTOMERS
Our customers in the specialty retail market consist of bookstore chains,
music stores and other specialty retailers. Our customers in the mainstream
retail market consist primarily of grocery stores, drug stores and mass
merchandise retailers. Two customers account for a large percentage of our total
revenues. Barnes & Noble, Inc. accounted for 28.7%, 28.3% and 30.0% in the
fiscal years ended January 31, 2005, 2004 and 2003 respectively. Borders Group,
Inc. accounted for 24.5%, 25.1% and 27.9% of total revenues in the fiscal years
ended January 31, 2005, 2004 and 2003, respectively. Prior to the consummation
of the merger Alliance's customers included specialty retailers, mainstream
retailers, and e-commerce retailers. Alliance's largest customer was Barnes &
Noble, Inc., which historically had accounted for approximately 30% of
Alliance's net sales. Based on historical trends, sales to Barnes & Noble, Inc.
would have represented approximately 30% of the combined company's total
revenues for the fiscal year ended January 31, 2005.
MARKETING AND SALES
Our target market includes magazine publishers, film studios, record labels,
magazine distributors and retailers. We specialize in providing nationwide home
entertainment product distribution to retailers with a national or regional
scope. We believe that our distribution centers differentiate us from our
national competitors and are a key element in our marketing program. Our
distribution centers focus on our just-in-time replenishment and our ability to
deliver product, particularly magazines published on a weekly basis, overnight
to virtually any location within the continental United States.
While we frequently attend trade shows and advertise in trade publications,
we emphasize personal interaction between our sales force and customers so that
our customers are encouraged to rely on our dependability and responsiveness.
Sales of our magazine products are not particularly seasonal; however, sales of
DVDs, CDs and other home entertainment content is highly concentrated in the
fourth fiscal quarter. Historically, prior to its merger with us, approximately
30% of Alliance's net sales were generated in the fourth quarter coinciding with
the holiday shopping season.
To enhance the frequency of contact between our sales force and our
customers, we have organized our direct sales force into a unified marketing
group responsible for soliciting sales of all products and services available
from each of our operating groups. We believe this combined marketing approach
will enhance cross-selling opportunities and lower the cost of customer
acquisition.
COMPETITION
Each of our business units faces significant competition. Our Supply Chain
Management group distributes home entertainment product in competition with a
number of national and regional companies, including Anderson News Company,
Anderson Merchandisers, L.P., Hudson News Company, News Group, Ingram Book
Group, Inc., Ingram Entertainment, Inc., Handleman Company, and Baker & Taylor,
Inc. Major record labels and film studios increasingly compete with us by
establishing direct trading relationships with the larger retail chains and it
is possible that magazine publishers and printers could seek to enter the
magazine distribution business.
Our In-Store Services group has a limited number of direct competitors for
its claims submission program, and it competes in a highly fragmented industry
with other manufacturers for wood and wire display fixture business. In
addition, some of this group's information and management services may be
performed directly by publishers and other vendors, retailers or distributors.
Other information service providers, including A.C. Nielsen Company, Information
Resources and Audit Bureau of Circulations, also collect sales data from retail
stores. If these service
6
providers were to compete with us, given their expertise in collecting
information and their industry reputations, they could be formidable
competitors.
The principal competitive factors faced by each of our business units are price,
financial stability, breath of products and services and reputation.
MANAGEMENT INFORMATION SYSTEMS
The efficiency of our business units are supported by our information systems
that combine traditional outbound product counts with real-time register
activity. Our ability to access real-time register data enables us to quickly
adjust individual store merchandise allocations in response to variation in
consumer demand. This increases the probability that any particular merchandise
allotment will be sold rather than returned for credit. In addition, we have
developed sophisticated database management systems designed to track various
on-sale and off-sale dates for the numerous issues and regional versions of the
magazine titles that we distribute.
Our primary operating systems are built on an open architecture platform and
provide the high level of scalability and performance required to manage our
large and complex business operations. We acquired certain of these systems in
connection with our acquisition of Alliance, including proprietary, real-time,
fully integrated enterprise planning, warehouse management and retail inventory
management systems.
We also deploy a variety of additional hardware and software to manage our
business, including a complete suite of electronic data interchange tools that
enable us to take client orders, transmit advanced shipping notifications, and
place orders with our manufacturing trading partners. We also use an automated
e-mail response system and automated call distribution system to manage our call
center and conduct customer care services.
Software used in connection with our claims submission program and in
connection with our subscriber information website was developed specifically
for our use by a combination of in-house software engineers and outside
consultants. We believe that certain elements of these software systems are
proprietary to us. Other portions of these systems are licensed from a third
party that assisted in the design of the system. We also receive systems service
and upgrades under the license. We believe that we have obtained all necessary
licenses to support our information systems.
We employ various security measures and backup systems designed to protect
against unauthorized use or failure of our information systems. Access to our
information systems is controlled through firewalls and passwords, and we
utilize additional security measures to safeguard sensitive information.
Additionally, we have backup power sources for blackouts and other emergency
situations. Although we have never experienced any material failures or downtime
with respect to any systems operations, any systems failure or material downtime
could prevent us from taking orders and/or shipping product.
We have made strategic investments in material handling automation. Such
investments include computer-controlled order selection systems that provide
labor efficiencies and increase productivity and handling efficiencies. We have
also invested in specialized equipment for our rapidly growing e-commerce
accounts. We believe that in order to remain competitive, it will be necessary
to invest and upgrade from time to time all of our information systems.
EMPLOYEES
As of March 31, 2005, we had 2,473 employees, of whom 2,227 were full-time
employees. Approximately 164 of our employees are covered by collective
bargaining agreements. We believe our relations with our employees are good.
RECENT DEVELOPMENTS
Merger of Source Interlink with Alliance
7
On February 28, 2005, we completed the merger with Alliance Entertainment
Corp, a logistics and supply chain management services company for the home
entertainment product market. In connection with the merger we issued
approximately 26.9 million shares of our common stock to the former Alliance
stockholders and assumed options, warrants and other obligations to issue
approximately 0.9 shares of our common stock.
Alliance historically operated two business segments: the Distribution and
Fulfillment Services Group and the Digital Media Infrastructure Services Group.
Prior to the merger, on December 31, 2004, Alliance disposed of all of the
operations conducted by the Digital Media segment. Consequently, in completing
the merger, we acquired only the Distribution and Fulfillment business, but
retained access to the Digital Media technology through a 5-year licensing
agreement. The Digital Media business represented approximately 1.8% and 1.4% of
Alliance's consolidated sales for the years ended December 31, 2004 and 2003,
respectively.
We consummated the merger with Alliance to further our objective of creating
the premier provider of information, supply chain management and logistics
services to retailers and producers of home entertainment content products. We
expect to benefit from substantial cost savings in the areas of procurement,
marketing, information technology and administration and from other operational
efficiencies, particularly in the distribution and fulfillment functions, where
we plan to consolidate some distribution operations, reorganize others and
leverage our best practices across all of our distribution operations.
Reincorporation from Missouri into Delaware
Also, on February 28, 2005, we reincorporated our company from Missouri into
Delaware (the "Reincorporation"). The Reincorporation was adopted and approved
at a special meeting of our shareholders. Each stock certificate representing
our issued and outstanding shares prior to the Reincorporation will continue to
represent the same number of our shares after the Reincorporation. The
Reincorporation did not result in any change in our name, headquarters,
business, jobs, management, location of offices or facilities, number of
employees, assets, liabilities or net worth. Our common stock continues to be
traded on the Nasdaq National Market under the symbol "SORC."
As a result of the Reincorporation, the rights of our stockholders became
subject to and are now governed by Delaware law, a new certificate of
incorporation and new bylaws. Certain differences in the rights of stockholders
arise from distinctions between Missouri law and Delaware law, as well as from
differences between the charter instruments of our Company. These differences
are described in the section entitled "Comparison of Stockholder Rights and
Corporate Governance Matters" on pages 149-165 of the Registrant's Registration
Statement on Form S-4/A filed on January 18, 2005, which section is incorporated
herein by reference.
Letter of Intent to Acquire Chas. Levy Circulating Co.
On March 18, 2005, we signed a non-binding letter of intent to acquire all of
the outstanding equity interests of Chas. Levy Circulating Co., LLC from its
sole member, Chas. Levy Company, LLC, for a purchase price of approximately $30
million, subject to certain adjustments. Chas. Levy Circulating Co. is one of
the principal magazine wholesalers in the United States and distributes
magazines from all leading publishers to more than 9,000 store fronts operated
by leading retail chains throughout the midwest, east and west coasts. In its
fiscal year ended September 30, 2004, Chas. Levy Circulating Co. reported
revenues of approximately $370 million. Completion of the proposed transaction
is conditioned on satisfactory completion of due diligence and approval of each
company's board of directors
Concurrent with the proposed acquisition, we intend to enter into a separate
10-year marketing and service agreement with Levy Home Entertainment, LLC., a
Chas Levy company not included in the transaction. Levy Home Entertainment is a
full line book distributor.
RISK FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS AND FINANCIAL CONDITION.
8
Set forth below and elsewhere in this Annual Report on Form 10-K and in other
documents we file with the SEC are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the forward
looking statements contained in this Annual Report on Form 10-K.
RISKS RELATING TO THE BUSINESS
WE HAVE A CONCENTRATED CUSTOMER BASE AND OUR REVENUES COULD BE ADVERSELY
AFFECTED IF IT LOSES ANY OF ITS LARGEST CUSTOMERS OR IF THESE CUSTOMERS ARE
UNABLE TO PAY AMOUNTS DUE TO US.
A significant percentage of our sales are derived from a limited number of
customers. In particular, for the year ended January 31, 2005, Barnes & Noble,
Inc. and Borders Group, Inc. accounted for approximately 28.7% and 24.5% of our
total revenues, respectively.
Alliance also has a significant concentration of revenues from its largest
customers. Historically, Barnes & Noble, Inc. accounted for more than 30% of
Alliance's total net revenues. We believe that as a result of the merger our
customer base may become even more highly concentrated as sales to Barnes &
Noble, Inc. increase as a percentage of our total revenues. Based on historical
trends, sales to Barnes & Noble, Inc. would have represented approximately 30%
of our total revenues for the fiscal year ended January 31, 2005.
As a result of this customer concentration, we expect to be dependent on a
small number of customers for a substantial portion of our revenues. If any of
these customers were to terminate their relationship with us, significantly
reduce their purchases from us or experience problems in paying amounts due to
us, it would result in a material reduction in our revenues and operating
profits.
WE DEPEND ON ACCESS TO CREDIT.
We will have significant working capital requirements principally to finance
inventory and accounts receivables. We are currently a party to a revolving
credit facility and term loan with Wells Fargo Foothill, Inc. In addition, we
are extended trade credit by our suppliers.
Our business will depend on the availability of a credit facility and
continued extension of credit by suppliers to support our working capital
requirements. To maintain the right to borrow revolving loans and avoid a
default under a credit facility, we will be required to comply with various
financial and operating covenants and maintain sufficient eligible assets to
support revolving loans pursuant to a specified borrowing base. Our ability to
comply with these covenants or maintain sufficient eligible assets may be
affected by events beyond our control, including prevailing economic, financial
and industry conditions, and we may be unable to comply with these covenants or
maintain sufficient eligible assets in the future. A breach of any of these
covenants or the failure to maintain sufficient eligible assets could result in
a default under these credit facilities. If we default, our revolving lender
will no longer be obligated to extend revolving loans to us and could declare
all amounts outstanding under our credit facility, together with accrued
interest, to be immediately due and payable. If we were unable to repay those
amounts, our lender could proceed against the collateral granted to it to secure
that indebtedness. The results of such actions would have a significant negative
impact on our results of operations and financial condition.
A DISRUPTION IN THE OPERATIONS OF OUR KEY SHIPPERS COULD CAUSE A DECLINE IN
OUR SALES OR A REDUCTION IN OUR EARNINGS.
We are dependent on commercial freight carriers, primarily Federal Express
and UPS, to deliver our products. If the operations of these carriers are
disrupted for any reason, we may be unable to deliver our products to our
customers on a timely basis. If we cannot deliver our products in an efficient
and timely manner, our revenues and operating profits could suffer.
For the year ended January 31, 2005, our freight cost represented
approximately 5.9% of our revenue. Alliance's freight costs have historically
been approximately 3.0% of its revenue. If freight costs were to increase and we
were unable to pass that increase along to our customers due to competition
within our industry, our financial results could materially suffer.
9
OUR STRATEGY WILL INCLUDE MAKING ADDITIONAL ACQUISITIONS THAT MAY PRESENT
RISKS TO THE BUSINESS.
Making additional strategic acquisitions, such as that of Chas. Levy
Circulating Co., is part of our strategy. The ability to make acquisitions will
depend upon identifying attractive acquisition candidates and, if necessary,
obtaining financing on satisfactory terms. Acquisitions, including those that we
have already made, may pose certain risks to us. These include the following:
- we may be entering markets in which we have limited experience;
- the acquisitions may be potential distractions to management and may
divert company resources and managerial time;
- it may be difficult or costly to integrate an acquired business'
financial, computer, payroll and other systems into our own;
- we may have difficulty implementing additional controls and information
systems appropriate for a growing company;
- some of the acquired businesses may not achieve anticipated revenues,
earnings or cash flow;
- we may have unanticipated liabilities or contingencies from an acquired
business;
- we may have reduced earnings due to amortization expenses, goodwill
impairment charges, increased interest costs and costs related to the
acquisition and its integration;
- we may finance future acquisitions by issuing common stock for some or all
of the purchase price which could dilute the ownership interests of the
stockholders;
- acquired companies will have to become, within one year of their
acquisition, compliant with SEC rules relating to internal control over
financial reporting adopted pursuant to the Sarbanes-Oxley Act of 2002;
- we may be unable to retain management and other key personnel of an
acquired company; and
- we may impair relationships with an acquired company's employees,
suppliers or customers by changing management.
To the extent that the value of the assets acquired in any prior or future
acquisitions, including goodwill or intangible assets with indefinite lives,
becomes impaired, our company would be required to incur impairment charges that
would affect earnings. Such impairment charges could reduce our earnings and
have a material adverse effect on the market value of our common stock. For
example, in connection with our fiscal 2002 acquisition of a magazine
distribution company, we recorded an asset impairment charge totaling $78.1
million.
If we are unsuccessful in meeting the challenges arising out of our
acquisitions, our business, financial condition and future results could be
materially harmed.
WE DEPEND ON ACCESS TO ACCURATE INFORMATION ON RETAIL SALES OF MAGAZINES IN
ORDER TO OFFER CERTAIN SERVICES TO OUR CUSTOMERS, AND WE COULD LOSE A
SIGNIFICANT COMPETITIVE ADVANTAGE IF OUR ACCESS TO SUCH INFORMATION WERE
DIMINISHED.
We use information concerning the retail sales of single copy magazines to:
- compare the revenue potential of various front-end fixture designs to
assist our customers in selecting designs intended to maximize sales in
the front-end;
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- identify sales trends at individual store locations permitting us to
provide just-in-time inventory replenishment and prevent stock outs;
and
- offer both retailers and publishers information services, such as
ICN and Cover Analyzer, and customized sales reporting.
As a result of the merger, we expect to provide similar services with
respect to home entertainment content products which would require us to obtain
and use information regarding these products. We gain access to this information
principally through relationships with A.C. Nielsen & Company and Barnes &
Noble, Inc. We do not currently have written agreements with these providers. We
also obtain a significant amount of information in connection with our rebate
claim submission services. Our access to information could be restricted as a
result of the inability of any of our data partners to supply information to us
or as a result of the discontinuation or substantial modification of the current
incentive payment programs for magazines. If our access to information were
reduced, the value of our information and design services could materially
diminish and our publisher and retailer relationships could be negatively
impacted.
OUR REVENUE FROM THE SALES OF DVDS AND CDS MAY SUFFER DUE TO A SHIFT IN
CONSUMER DEMAND AWAY FROM PHYSICAL MEDIA AND TOWARD DIGITAL DOWNLOADING AND
OTHER DELIVERY METHODS.
Current technology allows consumers to buy music digitally from many
providers such as Apple Computer (through iTunes), Music Match, Rhapsody,
Microsoft (through MSN) and others. The sale of digital music has grown
significantly in the past year, and the recording industry saw sales for CDs
decline significantly from 2001 to 2003. As this method of selling music
increases in popularity and gains consumer acceptance, it may adversely impact
our sales and profitability. The recording industry also continues to face
difficulties as a result of illegal online file-sharing and downloading. While
industry associations and manufacturers have launched legal action against
downloaders and file sharers to stop this practice, there can be no assurance of
the outcome or effect of these lawsuits. File sharing and downloading, both
legitimate and illegal, could continue to exert pressure on the recording
industry and the demand for CDs. Additionally, as other forms of media become
available for digital download, our sales and profitability attributable to our
CDs may be adversely affected.
Recent advances in the technologies to deliver movies to viewers may
adversely affect public demand for DVDs offered by us. For example, some digital
cable providers and internet companies offer movies "on demand" with interactive
capabilities such as start, stop and rewind. Direct broadcast satellite and
digital cable providers have been able to enhance their on-demand offerings as a
result of their ability to transmit over numerous channels. Apart from on-demand
technology, the recent development and enhancement of personal video recorder
technology with "time-shifting" technology (such as that used by TiVo and
certain cable companies) has given viewers greater interactive control over
broadcasted movies and other program types. Also, companies such as Blockbuster
Entertainment and NetFlix are now offering subscription services which provide
consumers the ability to rent VHS cassettes and DVDs for indefinite periods of
time without being subject to late fees. If these methods of watching filmed
entertainment increase in popularity and gain consumer acceptance, they may
adversely impact sales and profits.
WE PARTICIPATE IN HIGHLY COMPETITIVE INDUSTRIES AND COMPETITIVE PRESSURES
MAY RESULT IN A DECREASE IN OUR REVENUES AND PROFITABILITY.
Each of our business units faces significant competition. Our Supply Chain
Management group distributes home entertainment product in competition with a
number of national and regional companies, including Anderson News Company,
Anderson Merchandisers, L.P., Hudson News Company, News Group, Ingram Book
Group, Inc., Ingram Entertainment, Inc., Handleman Company, and Baker & Taylor,
Inc. Major record labels and film studios increasingly compete with us by
establishing direct trading relationships with the larger retail chains and it
is possible that magazine publishers and printers could seek to enter the
magazine distribution business.
Our In-Store Services group has a limited number of direct competitors for
its claims submission program, and it competes in a highly fragmented industry
with other manufacturers for wood and wire display fixture business. In
addition, some of this group's information and management services may be
performed directly by publishers and other vendors, retailers or distributors.
Other information service providers, including A.C. Nielsen Company,
11
Information Resources and Audit Bureau of Circulations, also collect sales data
from retail stores. If these service providers were to compete with us, given
their expertise in collecting information and their industry reputations, they
could be formidable competitors.
Some of our existing and potential competitors have substantially greater
resources and greater name recognition than we do with respect to the market or
market segments they serve. Because of each of these competitive factors, we may
not be able to compete successfully in these markets with existing or new
competitors. Competitive pressures may result in a decrease in the number of
customers it serves, a decrease in its revenues or a decrease in its operating
profits.
WE CONDUCT A GROWING PORTION OF OUR BUSINESS INTERNATIONALLY, WHICH
PRESENTS ADDITIONAL RISKS TO US OVER AND ABOVE THOSE ASSOCIATED WITH ITS
DOMESTIC OPERATIONS.
Approximately 10.8% of our total revenues for the year ended January 31,
2005 were derived from the export of U.S. publications to overseas markets,
primarily to the United Kingdom and Australia. In addition, approximately 17.9%
of our gross domestic distribution for the year ended January 31, 2005,
consisted of the domestic distribution of foreign publications imported for sale
to U.S. markets. A growing portion of Alliance's revenues were also derived from
international sales. Historically, approximately 13% of Alliance's total net
revenues were derived from international customers.
The conduct of business internationally presents additional inherent risks
including:
- unexpected changes in regulatory requirements;
- import and export restrictions;
- tariffs and other trade barriers;
- differing technology standards;
- resistance from retailers to our business practices;
- employment laws and practices in foreign countries;
- political instability;
- fluctuations in currency exchange rates;
- imposition of currency exchange controls; and
- potentially adverse tax consequences.
Any of these risks could adversely affect revenue and operating profits of
our international operations.
Certain suppliers have adopted policies restricting the export of DVDs and
CDs by domestic distributors. However, consistent with industry practice, we
distribute our merchandise internationally. We would be adversely affected if a
substantial portion of our suppliers enforced any restriction on our ability to
sell our home entertainment content products outside the United States.
A SUBSTANTIAL MAJORITY OF MAGAZINES DISTRIBUTED BY US ARE PURCHASED FROM
FOUR SUPPLIERS AND OUR REVENUES COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO
RECEIVE MAGAZINE ALLOTMENTS FROM THESE SUPPLIERS.
Substantially all of the magazines distributed in the United States are
supplied by or through one of four national distributors, Comag Marketing Group,
LLC, Curtis Circulation Company, Kable Distribution Services, Inc. and Warner
Publisher Services, Inc. Each title is supplied by one of these national
distributors to us and cannot be purchased from any alternative source. Our
success is largely dependent on our ability to obtain product in sufficient
12
quantities on competitive terms and conditions from each of the national
distributors. In order to qualify to receive copy allotments, we are required to
comply with certain operating conditions, which differ between the specialty
retail market and the mainstream market. Our ability to economically satisfy
these conditions may be affected by events beyond our control, including the
cooperation and assistance of our customers. A failure to satisfy these
conditions could result in a breach of our purchase arrangements with our
suppliers and entitle our suppliers to reduce our copy allotment or discontinue
our right to receive product for distribution to our customers. If our supply of
magazines were reduced, interrupted or discontinued, customer service would be
disrupted and existing customers may reduce or cease doing business with us
altogether, thereby causing our revenue and operating income to decline and
result in failure to meet expectations.
IF WE WERE UNABLE TO RECEIVE OUR PRODUCTS FROM OUR TOP SUPPLIERS, OUR
SALES AND PROFITABILITY COULD BE ADVERSELY AFFECTED.
A substantial portion of the DVD and CD products distributed by us are
supplied by 5 film studios and 4 record labels. These products are proprietary
to individual suppliers and may not be obtained from any alternative source. Our
success depends upon our ability to obtain product in sufficient quantities on
competitive terms and conditions from each of these major home entertainment
labels and studios. If our supply of products were interrupted or discontinued,
then customer service could be adversely affected and customers may reduce or
cease doing business with us causing our sales and profitability to decline.
VIRTUALLY ALL OF OUR SALES WILL BE MADE ON A "SALE OR RETURN" BASIS AND
HIGHER THAN EXPECTED RETURNS COULD CAUSE US TO OVERSTATE REVENUE FOR THE PERIOD
AFFECTED.
As is customary in the home entertainment content product industry,
virtually all of our sales will be made on a "sale or return" basis. During the
year ended January 31, 2005, approximately 55 out of every 100 magazine copies
distributed domestically by Source Interlink and between approximately 15 and 18
out of every 100 DVDs and CDs, respectively, distributed domestically by
Alliance were returned unsold by their customers for credit; however, the
sell-through rate has historically varied from period to period. Revenues from
the sale of merchandise that we distribute are recognized at the time of
delivery, less a reserve for estimated returns. The amount of the return reserve
is estimated based on historical sell-through rates. If sell-through rates in
any period are significantly less than historical averages, this return reserve
could be inadequate. If the return reserve proved inadequate, it would indicate
that actual revenue in prior periods was less than accrued revenue for such
periods. This would require an increase in the amount of the return reserve for
subsequent periods which may result in a reduction in operating income for such
periods.
SALES OF DVDS AND CDS ARE HIGHLY SEASONAL, AND FINANCIAL RESULTS COULD BE
NEGATIVELY IMPACTED IF ITS FOURTH QUARTER'S SALES ARE WEAK.
Alliance has historically generated approximately 33% of its total net
sales in the fourth calendar quarter of 2004 coinciding with the holiday
shopping season. Factors that could adversely affect sales and profitability in
the fourth quarter include:
- unavailability of, and low customer demand for, particular products;
- unfavorable economic conditions;
- inability to hire adequate temporary personnel;
- inability to anticipate consumer trends; and
- inability to maintain adequate inventory levels.
WE DEPEND ON THE EFFORTS OF CERTAIN KEY PERSONNEL, THE LOSS OF WHOSE
SERVICES COULD ADVERSELY AFFECT OUR BUSINESS.
We depend upon the services of our chief executive officer and chief
operating officer and their relationships with customers and other third
parties. The loss of these services or relationships could adversely affect our
business
13
and the implementation of our growth strategy. This in turn could materially
harm our financial condition and future results. Although we have employment
agreements with each of our chief executive officer and chief operating officer,
the services of these individuals may not continue to be available to the
combined company. We carry key person life insurance on the lives of both our
chief executive officer and chief operating officer.
OUR MANAGEMENT AND INTERNAL SYSTEMS MIGHT BE INADEQUATE TO HANDLE OUR
POTENTIAL GROWTH.
To manage future growth, including growth resulting from the merger, our
management must continue to improve operational and financial systems and
expand, train, retain and manage its employee base. We will likely be required
to manage an increasing number of relationships with various customers and other
parties. Our management may not be able to manage the company's growth
effectively. If our systems, procedures and controls are inadequate to support
our operations, our expansion could be halted and we could lose opportunities to
gain significant market share. Any inability to manage growth effectively may
harm our business.
OUR OPERATIONS COULD BE DISRUPTED IF OUR INFORMATION SYSTEMS FAIL, CAUSING
INCREASED EXPENSES AND LOSS OF SALES.
Our business depends on the efficient and uninterrupted operation of our
computer and communications software and hardware systems, including our
replenishment and order regulation systems, and other information technology. If
we were to fail for any reason or if we were to experience any unscheduled down
times, even for only a short period, its operations and financial results could
be adversely affected. We and Alliance have in the past experienced performance
problems and unscheduled down times, and these problems could recur. Our systems
could be damaged or interrupted by fire, flood, hurricanes, power loss,
telecommunications failure, break-ins or similar events. We have formal disaster
recovery plans in place. However, these plans may not be entirely successful in
preventing delays or other complications that could arise from information
systems failure, and, if they are not successful, our business interruption
insurance may not adequately compensate it for losses that may occur.
WE DEPEND ON THE INTERNET TO DELIVER SOME OF OUR SERVICES, AND THE USE OF
THE INTERNET MAY EXPOSE US TO INCREASED RISKS.
Many of our operations and services, including replenishment and order
regulation systems, PIN, ICN, customer direct fulfillment and other information
technology, involve the transmission of information over the Internet. Our
business therefore will be subject to any factors that adversely affect Internet
usage including the reliability of Internet service providers, which from time
to time have operational problems and experience service outages.
In addition, one of the requirements of the continued growth over the
Internet is the secure transmission of confidential information over public
networks. Failure to prevent security breaches of our networks or those of our
customers or well-publicized security breaches affecting the Internet in general
could significantly harm our growth and revenue. Advances in computer
capabilities, new discoveries in the field of cryptography or other developments
may result in a compromise or breach of the algorithms we use to protect content
and transactions or our customers' proprietary information in its databases.
Anyone who is able to circumvent our security measures could misappropriate
proprietary and confidential information or could cause interruptions in our
operations. We may be required to expend significant capital and other resources
to protect against such security breaches or to address problems caused by
security breaches.
14
IF OUR ACCOUNTING CONTROLS AND PROCEDURES ARE CIRCUMVENTED OR OTHERWISE
FAIL TO ACHIEVE THEIR INTENDED PURPOSES, OUR BUSINESS COULD BE SERIOUSLY HARMED.
Although we evaluate our internal control over financial reporting and
disclosure controls and procedures as of the end of each fiscal quarter, we may
not be able to prevent all instances of accounting errors or fraud in the
future. Controls and procedures do not provide absolute assurance that all
deficiencies in design or operation of these control systems, or all instances
of errors or fraud, will be prevented or detected. These control systems are
designed to provide reasonable assurance of achieving the goals of these systems
in light of legal requirements, company resources and the nature of our business
operations. These control systems remain subject to risks of human error and the
risk that controls can be circumvented for wrongful purposes by one or more
individuals in management or non-management positions. Our business could be
seriously harmed by any material failure of these control systems.
THE DVD AND CD BUSINESS DEPENDS IN PART ON THE CURRENT ADVERTISING
ALLOWANCES, VOLUME DISCOUNTS AND OTHER SALES INCENTIVE PROGRAMS, AND ITS RESULTS
OF OPERATION COULD BE ADVERSELY AFFECTED IF THESE PROGRAMS WERE DISCONTINUED OR
MATERIALLY MODIFIED.
Under terms of purchase prevailing in its industry, the profitability of
the DVD and CD are enhanced by advertising allowances, volume discounts and
other sales incentive programs offered by record labels and movie studios. Such
content providers are not under long-term contractual obligations to continue
these programs, and in 2003 one major record label eliminated advertising
allowances and volume discounts on a limited number of stock keeping units. If
record labels or movie studios, or both, decide to discontinue these programs,
we would experience a significant reduction in operating profits.
RISKS RELATING TO THE MERGER BETWEEN SOURCE INTERLINK AND ALLIANCE ENTERTAINMENT
CORP.
WE MAY NOT REALIZE SOME OF THE EXPECTED BENEFITS OF THE MERGER OF SOURCE
INTERLINK AND ALLIANCE.
We believe that the merger provides significant market opportunities to
take advantage of the customer bases and distribution channels of the formerly
separate businesses of Source Interlink and Alliance Entertainment in order to
promote and sell the products and services of one company to the existing
customers and business partners of the other company. However, we may be unable
to take advantage of these cross-selling opportunities and other revenue
synergies for several reasons. Difficulties in integrating the two companies
could result in disruption of customer services, which could cause existing
customers to reduce or cease doing business with the combined company
altogether. Moreover, the salespersons of one company may not be successful in
marketing the products and services of the other company or the existing
customers and business partners of either company may not be receptive to the
products and services of the other.
We also expect to benefit from substantial cost savings in the areas of
procurement, marketing, information technology and administration and from other
operational efficiencies. We may not realize these savings within the time
periods contemplated, or at all. If the benefits of the merger do not exceed the
associated costs, or if costs related to the merger exceed estimates, our
business and financial results could be materially harmed.
WE MAY BE UNABLE TO INTEGRATE THE OPERATIONS OF SOURCE INTERLINK AND
ALLIANCE SUCCESSFULLY.
We are in the process of integrating two companies that previously have
operated independently, which is a complex, costly and time-consuming process.
The difficulties of combining the companies' operations include, among other
things:
- the necessity of coordinating geographically disparate
organizations, systems and facilities;
- integrating personnel with diverse business backgrounds;
- consolidating corporate and administrative functions;
- limiting the diversion of management resources necessary to
facilitate the integration;
15
- implementing compatible information and communication systems, as
well as common operating procedures;
- creating compatible financial controls and comparable human
resources practices;
- coordinating sales and marketing functions;
- maintaining customer care services and retaining key customers;
- retaining key management and employees; and
- preserving the collaboration, distribution, marketing, promotion and
other important relationships of each company.
The process of integrating operations could cause an interruption of, or
loss of momentum in, the activities of our business and the loss of key
personnel. The diversion of management's attention, any delays or difficulties
encountered in connection with the merger and the integration of the two
companies' operations or the costs associated with these activities could harm
our business, results of operations, financial condition or prospects.
THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE AS A RESULT OF THE
MERGER.
The market price of our common stock may decline as a result of the merger
for a number of reasons, including if:
- the integration of our company and Alliance is not completed in a
timely and efficient manner;
- the costs associated with the merger or the integration of our
company and Alliance are higher than anticipated;
- we do not achieve the perceived benefits of the merger as rapidly or
to the extent anticipated by financial or industry analysts or
investors; or
- the effect of the merger on our financial results is not consistent
with the expectations of financial or industry analysts or
investors.
THERE MAY BE SALES OF A LARGE NUMBER OF SHARES OF OUR COMMON STOCK AFTER
THE MERGER THAT COULD CAUSE OUR STOCK PRICE TO FALL.
A large number of shares of our common stock may be sold into the public
market within short periods of time at various dates following the closing of
the merger. As a result, our stock price could fall. Of the approximately 26.9
million shares of our common stock issued in connection with the merger,
approximately 18.8% of such shares are immediately available for resale by
former stockholders of Alliance and approximately 81.2% of such shares are
subject to "lock-up agreements" that restrict the timing of the resale of these
shares. Under the lock-up agreements, shares will be released and available for
sale in the public market as follows:
- up to 33 1/3% of the shares subject to lock-up agreements may be
sold in the public market after May 28, 2005;
- up to a further 33 1/3% of the shares subject to lock-up agreements
may be sold in the public market after August 28, 2005; and
- the remaining shares subject to lock-up agreements may be sold in
the public market after November 28, 2005.
Any disposition of our common stock by former Alliance stockholders are
also subject to compliance with the Securities Act, including Rules 144 and 145
thereunder. While Rule 145 under the Securities Act may impose some
16
limitations on the number of shares certain Alliance stockholders may sell,
including AEC Associates, sales of a large number of newly released shares of
our common stock could occur and that could result in a sharp decline in our
stock price. In addition, the sale of these shares could impair the combined
company's ability to raise capital through the sale of additional stock.
RISKS RELATED TO YOUR OWNERSHIP OF OUR STOCK
WE HAVE A SIGNIFICANT STOCKHOLDER WHOSE INTERESTS MAY CONFLICT WITH YOURS.
Our largest stockholder, AEC Associates, L.L.C. beneficially owned
approximately 34.7% of our outstanding voting power as of April 13, 2005. AEC
Associates also has the right to designate three nominees for election to the
eleven member board which it is expected to exercise for our 2005 annual
meeting. In addition, for as long as AEC Associates (together with its members
and affiliates acting as a group) owns an aggregate of at least 10% of our
outstanding common stock, AEC Associates will have certain additional director
designation rights as further described in the risk factor entitled "We have
limitations on changes of control that could reduce your ability to sell our
shares at a premium." For example, for actions that require a supermajority of
the board, such as a change of control, AEC Associates designated directors may
effectively have enough votes to prevent any such action from being taken by us.
As a result, AEC Associates will have the ability through its ownership of our
common stock and its representation on the board to exercise significant
influence over our major decisions and over all matters requiring stockholder
approval. AEC Associates may have interests that differ from those of our
stockholders.
OUR BYLAWS WILL REQUIRE SUPERMAJORITY APPROVAL OF OUR BOARD BEFORE WE CAN
TAKE CERTAIN ACTIONS. THIS REQUIREMENT MAY RESTRICT STRATEGIC TRANSACTIONS
INVOLVING US.
Our bylaws provide that the affirmative vote of at least 75% of its entire
board will be required to (i) approve or recommend a reorganization or merger of
our company in a transaction that will result in our stockholders immediately
prior to such transaction not holding, as a result of such transaction, at least
50% of the voting power of the surviving or continuing entity, (ii) a sale of
all or substantially all of our assets which would result in its stockholders
immediately prior to such transaction not holding, as a result of such sale, at
least 50% of the voting power of the purchasing entity, or (iii) a change in our
bylaws. This requirement may prevent us from making changes and taking other
actions that are subject to this supermajority approval requirement. This
requirement may limit our ability to pursue strategies or enter into strategic
transactions for which the supermajority approval of the board cannot be
obtained.
WE HAVE LIMITATIONS ON CHANGES OF CONTROL THAT COULD REDUCE YOUR ABILITY
TO SELL OUR SHARES AT A PREMIUM.
Our certificate of incorporation and bylaws currently contain provisions
that could reduce the likelihood of a change of control or acquisition of our
company, which could limit your ability to sell our shares at a premium or
otherwise affect the price of our common stock. These provisions include the
following:
- permit our board to issue up to 2,000,000 shares of preferred stock
and to determine the price, rights, preferences, privileges and
restrictions of that preferred stock;
- permit our board to issue up to 100,000,000 shares of common stock;
- require that a change of control of the company be approved by a
supermajority of at least 75% of the members of the board;
- provide for a classified board of directors;
- provide that, for as long as AEC Associates (together with its
members and affiliates acting as a group) owns an aggregate of at
least 10% of the combined company's common stock, AEC Associates
will have the right to designate an individual (or individuals) of
its choice for election by the board for any seat that is last
occupied or vacated by a director designated by Alliance or AEC
Associates, except if such designation would result in the directors
designated by AEC Associates having a disproportionate board
representation
17
to AEC Associates' (together with its members and affiliates acting
as a group) ownership of our common stock;
- permit the board to increase its own size and fill the resulting
vacancies;
- limit the persons who may call special meetings of stockholders; and
- establish advance notice requirements for nominations for election
to the board or for proposing matters that can be acted on by
stockholders at stockholders meetings.
OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN
SUBSTANTIAL LOSSES FOR STOCKHOLDERS.
Our common stock is currently traded on the Nasdaq National Market. Our
average daily trading volume for the three month period ending April 13, 2005
was approximately 150,000 shares. In the future, we may experience more limited
daily trading volume. The trading price of our common stock has been and may
continue to be volatile. The closing sale prices of our common stock, as
reported by the Nasdaq National Market, have ranged from a high of $13.58 to a
low of $8.39 for the 52-week period ending January 31, 2005. Broad market and
industry fluctuations may significantly affect the trading price of our common
stock, regardless of our actual operating performance. The trading price of our
common stock could be affected by a number of factors, including, but not
limited to, announcements of new services, additions or departures of key
personnel, quarterly fluctuations in our financial results, changes in analysts'
estimates of our financial performance, general conditions in our industry and
conditions in the financial markets and a variety of other risk factors,
including the ones described elsewhere in this Annual Report on Form 10-K.
Periods of volatility in the market price of a company's securities sometimes
result in securities class action litigation. If this were to happen to us, such
litigation would be expensive and would divert management's attention. In
addition, if we needed to raise equity funds under adverse conditions, it would
be difficult to sell a significant amount of our stock without causing a
significant decline in the trading price of our stock.
ITEM 2. PROPERTIES
Our principal corporate offices are located at 27500 Riverview Center
Boulevard, Bonita Springs, Florida. As of April 13, 2005, we owned or leased
approximately 1.1 million square feet of manufacturing facilities, 1.0 million
square feet of distribution centers and 90,000 square feet of office space. The
following table presents information concerning our principal properties:
LOCATION DESCRIPTION SEGMENT SIZE (sq. ft.) OWNED/ LEASED
- --------------------------- -------------------------- ----------------------- ---------------- -------------
Bonita Springs, FL......... Office Worldwide 62,000 Leased
Headquarters
New York, NY............... Office Supply Chain Management 3,500 Leased
Coral Springs, FL.......... Distribution Center/office Supply Chain Management 250,000 Owned
Shepherdsville, KY......... Distribution Center Supply Chain Management 169,000 Leased
Rockford, IL............... Manufacturing/ Supply Chain 300,000/10,500 Owned
Distribution Center Management/In-store
Services
Brooklyn, NY............... Manufacturing In-Store Services 90,000 Leased
Philadelphia, PA........... Warehouse In-Store Services 110,000 Owned
Vancouver, B.C. ........... Manufacturing In-Store Services 51,000 Leased
Quincy, IL................. Manufacturing In-Store Services 258,000 Owned
Albemarle, NC.............. Manufacturing In-Store Services 190,000 Leased
Dallas, TX................. Distribution Center Supply Chain Management 48,000 Leased
Harrisburg, PA............. Distribution Center Supply Chain Management 142,000 Leased
18
Carson City, NV............ Distribution Center Supply Chain Management 135,000 Leased
Coral Springs, FL.......... Warehouse Supply Chain Management 46,000 Leased
Dayton, NJ................. Distribution.Center Supply Chain Management 42,000 Leased
We believe our facilities are adequate for our current level of operations
and that all of our facilities are adequately insured.
ITEM 3. LEGAL PROCEEDINGS
We are party to routine legal proceedings arising out of the normal course
of business. Although it is not possible to predict with certainty the outcome
of these unresolved legal actions or the range of possible loss, we believe that
none of these actions, individually or in the aggregate, will have a material
adverse effect on our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of stockholders during the fourth
quarter of fiscal 2005.
19
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
PRICE RANGE OF COMMON STOCK
Our common stock is quoted on the Nasdaq National Market under the symbol SORC.
The following table sets forth, for the periods indicated, the range of high and
low bid prices for our common stock as reported by the Nasdaq National Market
during the fiscal year shown. All such quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
HIGH LOW
Year ended January 31, 2004
First Quarter $ 5.51 $ 4.33
Second Quarter 8.59 5.50
Third Quarter 9.82 7.70
Fourth Quarter 14.30 8.10
Year ended January 31, 2005
First Quarter $13.58 $10.31
Second Quarter 11.39 8.89
Third Quarter 10.73 8.39
Fourth Quarter 13.32 10.20
As of April 13, 2005, there were approximately 195 holders of record of the
common stock.
DIVIDEND POLICY
We have never declared or paid dividends on our common stock. Our board of
directors presently intends to retain all of our earnings, if any, for the
development of our business for the foreseeable future. The declaration and
payment of cash dividends in the future will be at the discretion of our board
of directors and will depend upon a number of factors, including, among others,
any restrictions contained in our credit facilities and our future earnings,
operations, capital requirements and general financial condition and such other
factors that our board of directors may deem relevant. Currently, our credit
facilities prohibit the payment of cash dividends or other distributions on our
capital stock or payments in connection with the purchase, redemption,
retirement or acquisition of our capital stock.
REPURCHASES OF EQUITY SECURITIES
We did not make any repurchases of our equity securities in the fourth quarter
of 2004.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data are only a summary and
should be read in conjunction with our financial statements and related notes
thereto and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in this Annual Report on Form 10-K. The
consolidated statement of operations data for the years ended January 31, 2003,
2004 and 2005 and the balance sheet data as of January 31, 2004 and 2005, which
have been prepared in accordance with accounting principles generally accepted
in the U.S., are derived from our financial statements audited by BDO Seidman,
LLP, an independent registered public accounting firm, which are included
elsewhere in this Annual Report on Form 10-K. The consolidated statements of
income data for the years ended January 31, 2001 and 2002 and the balance sheet
data as of January 31, 2001, 2002 and 2003, which have been prepared in
accordance with accounting principles generally accepted in the U.S., are
derived from our audited financial statements which are not included in this
Annual Report on Form 10-K. On February 28, 2005, we consummated our merger with
Alliance Entertainment Corp. The results of operations of
20
Alliance are not included in the selected financial data presented below. For a
description of the merger of Source Interlink and Alliance, please see the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations." Historical operating results are not necessarily
indicative of the results that may be expected for any future period.
YEAR ENDED JANUARY 31,
--------------------------------------------------------------
2001(3) 2002(3) 2003(3) 2004(3) 2005
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues $ 92,423 $ 218,697 $ 269,191 $ 315,791 $ 356,644
Cost of revenues 53,792 159,660 197,431 229,748 258,851
--------- --------- --------- --------- ---------
Gross profit 38,631 59,037 71,760 86,043 97,793
Selling, general and administrative expenses 23,279 36,464 43,710 50,538 55,130
Fulfillment freight - 7,931 14,721 16,381 21,067
Relocation expenses (1) - - 1,926 1,730 2,450
Amortization of goodwill 2,994 5,424 - - -
Goodwill impairment charge (2) - 48,993 - - -
Loss on sale of land and building - - - - (1,122)
--------- --------- --------- --------- ---------
Operating income (loss) 12,358 (39,775) 11,403 17,394 18,024
Other income (expense):
Interest expense (2,312) (2,650) (3,473) (3,427) (1,575)
Interest income - - 277 358 175
Deferred loan costs - - - (865) (1,495)
Other 36 (2,390) 445 393 161
--------- --------- --------- --------- ---------
Total other expense (2,276) (5,040) (2,751) (3,541) (2,734)
--------- --------- --------- --------- ---------
Income from continuing operations before income
taxes and discontinued operation 10,082 (44,815) 8,652 13,853 15,290
Income tax expense (benefit) 3,965 (969) 893 3,690 2,228
--------- --------- --------- --------- ---------
Income from continuing operations before
discontinued operation 6,117 (43,846) 7,759 10,163 13,062
Loss from discontinued operation, net of tax - (29,019) (421) (115) (980)
--------- --------- --------- --------- ---------
Net income (loss) $ 6,117 $ (72,865) $ 7,338 $ 10,048 $ 12,082
========= ========= ========= ========= =========
Earnings (loss) per share - basic
Continuing operations $ 0.35 $ (2.45) $ 0.42 $ 0.55 0.57
Discontinued operations - (1.62) (0.02) (0.01) (0.04)
--------- --------- --------- --------- ---------
Total 0.35 (4.07) 0.40 $ 0.54 0.53
========= ========= ========= ========= =========
Earnings (loss) per share - diluted
Continuing operations 0.33 (2.45) 0.42 0.52 0.53
Discontinued operations - (1.62) (0.02) (0.01) (0.04)
--------- --------- --------- --------- ---------
Total 0.33 (4.07) 0.40 0.51 0.49
========= ========= ========= ========= =========
Weighted average of shares outstanding in computing
Basic net income per share 17,591 17,915 18,229 18,476 22,963
Diluted net income per share 18,348 17,915 18,478 19,866 24,833
========= ========= ========= ========= =========
AT JANUARY 31,
--------------------------------------------------------------
2001 2002 2003 2004 2005
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash 1,085 2,943 5,570 4,963 1,387
Working capital 60,277 (9,424) (3,519) 19,418 41,186
Total assets 158,448 164,430 157,239 164,101 197,753
Current maturities of debt 116 42,097 29,215 4,059 5,630
Debt, less current maturities 31,780 15,578 17,026 31,541 34,139
Total liabilities 48,658 120,887 106,320 97,027 70,070
Total equity 109,790 43,543 50,919 67,074 127,683
========= ========= ========= ========= =========
(1) Relocation costs relate to the consolidation of our prior offices from St.
Louis, Missouri, High Point, North Carolina and San Diego, California to
our new offices in Bonita Springs, Florida. In addition, during fiscal
2005, the company relocated distribution centers from Milan, OH, San
Diego, CA and Kent, WA to Harrisburg, PA and Carson City, NV.
(2) Charge related to the impairment of the goodwill attributed to our
Magazine Distribution and Wood Manufacturing businesses.
(3) Restated for the discontinued operations as discussed in note 8.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
Prior to our merger with Alliance as discussed below, our business
consisted of four business segments: Magazine Fulfillment, In-Store Services,
Wood Manufacturing and Shared Services. Our segment reporting is structured
based on the reporting of senior management to our chief executive officer.
- Our Magazine Fulfillment group provides domestic and foreign titled
magazines to specialty retailers, such as bookstores and music
stores, and to mainstream retailers, such as supermarkets, discount
stores, drug stores, convenience stores and newsstands. This group
also exports domestic titled magazines from more than 100 publishers
to foreign markets worldwide. We provide fulfillment services to
more than 26,000 retail stores, 7,300 of which also benefit from our
selection and logistical procurement services.
- Our In-Store Services group assists retailers with the design and
implementation of their front-end area merchandise programs, which
generally have a three-year life cycle. We also provide other
value-added services to retailers, publishers and other vendors.
These services include assisting retailers with the filing of claims
for publisher incentive payments, which are based on display
location or total retail sales, and providing publishers with access
to real-time sales information on more than 10,000 magazine titles,
thereby enabling them to make more informed decisions regarding
their product placement, cover treatments and distribution efforts.
- Our Wood Manufacturing group designs and manufactures wood display
and store fixtures for leading specialty retailers.
- Our Shared Services group consists of overhead functions not
allocated to the other groups. These functions include corporate
finance, human resource, management information systems and
executive management that are not allocated to the three operating
groups. Upon completion of the consolidation of our administrative
operations, we restructured our accounts to separately identify
corporate expenses that are not attributable to any of our three
main operating groups. Prior to fiscal year 2004, these expenses
were included within our In-Store Services group.
On February 28, 2005, we completed the merger with Alliance Entertainment
Corp, a logistics and supply chain management services company for the home
entertainment product market pursuant to the terms and conditions of the
Agreement and Plan of Merger Agreement dated as of November 18, 2004 (the
"Merger Agreement").
Alliance historically operated two business segments: the Distribution and
Fulfillment Services Group ("DFSG") and the Digital Medial Infrastructure
Services Group (the "DMISG"). Prior to the merger, on December 31, 2004,
Alliance disposed of all of the operations conducted by the DMISG business lines
through a spin-off to its existing stockholders. Consequently, in connection
with the merger, we acquired only the DFSG business and not the DMISG business.
The DMISG business represented approximately 1.8% and 1.4% of Alliance's
consolidated sales for the years ended December 31, 2004 and 2003, respectively.
We consummated the merger with Alliance to further our objective of
creating the premier provider of information, supply chain management and
logistics services to retailers and producers of home entertainment content
products. We believe that the merger provides significant market opportunities
to take advantage of our strong retailer relationships and experience in
marketing our products by expanding product offerings beyond our existing
magazine fulfillment business to DVDs, CDs, video games and related home
entertainment products and accessories. In addition, we believe that our
in-store merchandising capabilities will be strengthened. We also believe this
transaction will position us as the distribution channel of choice for film
studios, record labels, publishers and other producers of home entertainment
content products. We expect to benefit from substantial cost savings in the
areas of procurement, marketing, information technology and administration and
from other operational efficiencies, particularly in the distribution and
fulfillment functions, where we plan to consolidate some distribution
operations, reorganize others and leverage our best practices across all of our
distribution operations. As
22
a result, we believe the merger will enhance our financial strength, increase
our visibility in the investor community and strengthen our ability to pursue
further strategic acquisitions.
The total purchase price of approximately $317.0 million consisted of
$304.7 million in Source Interlink common stock, representing approximately 26.9
million shares, $9.3 million related to the exchange of approximately 0.9
million shares of common stock on exercise of outstanding stock options,
warrants and other rights to acquire Alliance common stock and direct
transaction costs of $3.0 million. The value of the common stock was determined
based on the average market price of Source Interlink common stock over the
5-day period prior to and after the announcement of the merger in November 2004.
The value of the stock options was determined using the Black-Scholes option
valuation model.
DISCONTINUED OPERATION
In November 2004, the Company sold and disposed of its secondary wholesale
distribution operation for $1.4 million, in order to focus more fully on its
domestic and export distribution. All rights owned under the secondary wholesale
distribution contracts were assigned, delivered, conveyed and transferred to the
buyer, an unrelated third party. All assets and liabilities relating to our
secondary wholesale distribution operation were not assumed by the buyer. We
recognized a gain on sale of this business of $1.4 million ($0.8 net of tax) in
the fourth quarter of fiscal year 2005.
The following amounts related to our Magazine Fulfillment segment's discontinued
operation (secondary wholesale distribution business) have been segregated from
continuing operations and reflected as discontinued operations in each period's
consolidated statement of income (in thousands):
2003 2004 2005
---- ---- ----
Revenue $ 21,704 $ 17,343 $ 13,380
======== ======== ========
Loss before income taxes $ (702) $ (191) $ (3,033)
Income tax benefit 281 76 1,213
-------- -------- --------
Loss from discontinued operation, net of tax (421) (115) (1,820)
-------- -------- --------
Pre-tax gain on sale of discontinued business - - 1,400
Income tax expense - - (560)
-------- -------- --------
Gain on sale of business, net of tax - - 840
-------- -------- --------
Discontinued operations, net of tax $ (421) $ (115) $ (980)
======== ======== ========
23
REVENUES
The Magazine Fulfillment group derives revenues from:
- selling and distributing magazines, including domestic and foreign
titles, to specialty and mainstream retailers throughout the United
States and Canada;
- exporting domestic titles internationally to foreign wholesalers or
through domestic brokers;
- providing return processing services for major specialty retail book
chains; and
- serving as an outsourced fulfillment agent and backroom operator for
publishers.
The In-Store Services group derives revenues from:
- designing, manufacturing and invoicing participants in front-end
merchandising programs;
- providing claim filing services related to rebates owed to retailers
from publishers or their designated agents;
- storing, shipping, installing, and removing front-end fixtures; and
- providing information and management services relating to magazine
sales to retailers and publishers throughout the United States and
Canada.
The Wood Manufacturing group derives revenues from designing,
manufacturing and installing custom wood fixtures primarily for retailers.
COST OF REVENUES
Our cost of revenues for the Magazine Fulfillment group consists of the
costs of magazines purchased for resale less all applicable publisher discounts
and rebates.
Our cost of revenues for the In-Store Services and the Wood Manufacturing
groups includes:
- raw materials consumed in the production of display fixtures,
primarily steel, wood and plastic components;
- production labor; and
- manufacturing overhead.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for each of the operating
groups include:
- non-production labor;
- rent and office overhead;
- insurance;
- professional fees; and
- management information systems.
Expenses associated with corporate finance, human resources, management
information systems and executive offices are included within the Shared
Services group and are not allocated to the other groups.
24
FULFILLMENT FREIGHT
Fulfillment freight consists of our direct costs of distributing magazines
by third-party freight carriers, primarily Federal Express ground service.
Freight rates are driven primarily by the weight of the copies being shipped and
the distance between origination and destination.
Fulfillment freight is not disclosed as a component of cost of revenues,
and, as a result, gross profit and gross profit margins are not comparable to
other companies that include shipping and handling costs in cost of revenues.
Fulfillment freight has increased proportionately as the amount of product
we distribute has increased. We anticipate the continued growth in our Magazine
Fulfillment group will result in an increase in fulfillment freight. Generally,
as pounds shipped increase, the cost per pound charged by third party carriers
decreases. As a result, fulfillment freight as a percent of the Magazine
Fulfillment group's gross revenues should decline slightly in the future.
RELOCATION EXPENSES
During fiscal 2005, the Company incurred $2.5 million of expenses related
to distribution center relocations and a plant conversion. The Company began
expansion into the mainstream retail market which resulted in distribution
fulfillment centers in Milan, OH, San Diego, CA and Kent, WA being moved to
Harrisburg, PA and Carson City, NV.
During fiscal 2004, the Company incurred $1.7 million of expenses related
to relocating its claims submission and fixture billing center, its Corporate
Headquarters, and its Magazine Fulfillment administrative offices to its
facility in Bonita Springs, FL.
25
RESULTS OF OPERATIONS
The following table sets forth, for the periods presented, information
relating to our continuing operations (in thousands):
YEAR ENDED JANUARY 31
------------------------------------------------------------------
2003 2004 2005
------------------- ------------------ --------------------
MARGIN MARGIN MARGIN
$ % $ % $ %
--------- ------ --------- ------ --------- ------
MAGAZINE FULFILLMENT
Revenues...................... $ 189,960 $ 238,471 $ 280,171
Cost of Revenues.............. 145,650 179,460 210,639
Gross Profit.................. 44,310 23.3% 59,011 24.7% 69,532 24.8%
Operating Expenses(1)......... 37,046 44,585 53,030
Operating Income ............. 7,264 3.8% 14,426 6.0% 16,502 5.9%
IN-STORE SERVICES(2)
Revenues...................... $ 61,754 $ 58,601 $ 54,103
Cost of Revenues.............. 35,391 33,931 29,368
Gross Profit.................. 26,363 42.7% 24,670 42.1% 24,735 45.7%
Operating Expenses(1)......... 21,512 8,245 8,777
Operating Income.............. 4,851 7.9% 16,425 28.0% 15,958 29.5%
WOOD MANUFACTURING
Revenues...................... $ 17,477 $ 18,719 $ 22,370
Cost of Revenues.............. 16,390 16,357 18,844
Gross Profit.................. 1,087 6.2% 2,362 12.6% 3,526 15.8%
Operating Expenses(1)......... 1,799 1,373 1,241
Operating Income (Loss)....... (712) (4.1)% 989 5.3% 2,285 10.2%
SHARED SERVICES(2)
Revenues...................... $ - $ - $ -
Cost of Revenues.............. - - -
Gross Profit.................. - - - - - -
Operating Expenses(1)......... - 14,446 16,721
Operating (Loss).............. - - (14,446) - (16,721) -
TOTAL
Revenues...................... $ 269,191 $ 315,791 $ 356,644
Cost of Revenues.............. 197,431 229,748 258,851
Gross Profit.................. 71,760 26.7% 86,043 27.2% 97,793 27.4%
Operating Expenses(1)......... 60,357 68,649 79,769
Operating Income ............. 11,403 4.2% 17,394 5.5% 18,024 5.4%
- ------------
(1) Operating expenses include selling, general and administrative expenses,
fulfillment freight, relocation expenses, loss on sale of land and
building and amortization of intangibles.
(2) Prior to fiscal year 2004 amounts currently reported as Shared Services
were reported as a component of In-Store Services.
26
RESULTS FOR THE FISCAL YEAR ENDED JANUARY 31, 2005 COMPARED TO THE FISCAL
YEAR ENDED JANUARY 31, 2004
Revenues
Overall revenues for the fiscal year ended January 31, 2005 increased
$40.9 million, or 12.3% from the prior year due primarily to an increase in
revenue in our Magazine Fulfillment group as described below.
Our Magazine Fulfillment group's revenues were $280.2 million, an increase
of $41.7 million or 17.5% as compared to the prior fiscal year.
The group's revenues for fiscal year 2005 and 2004 are comprised of the
following components (in thousands):
2005 2004 CHANGE
--------- --------- --------
Domestic distribution......................... $ 238.9 $ 204.6 $ 34.3
Export distribution........................... 38.5 32.0 6.5
Other......................................... 3.8 3.4 0.4
Intra-segment sales........................... (1.0) (1.5) 0.5
--------- --------- --------
Total......................................... $ 280.2 $ 238.5 $ 41.7
========= ========= ========
Domestic distribution consists of the gross amount of magazines (both
domestic and imported titles) distributed to domestic retailers and wholesalers,
less actual returns received, less an estimate of future returns and customer
discounts. The $34.3 million increase in domestic distribution relates primarily
to an $80.0 million increase in gross distribution partially offset by higher
returns and estimated return reserve at year-end. The increase in gross
distribution related both to an increase in copies distributed as well as an
increase in the amount billed per copy to specialty retailers as well as the
expansion of our distribution network to traditional retailers via internal
marketing efforts as well as the acquisition of Empire News, a traditional
wholesaler servicing the western New York and northern Pennsylvania markets.
Gross domestic distribution to our two largest customers increased $36.6
million. Gross distribution to traditional retailers increased from $10.9
million to $43.1 million, an increase of $32.2 million. Estimated sell-through
for the period was lowered from 46.7% to 45.9%. The decreased estimated
sell-through relates primarily to the increase in the percent of our
distribution related to traditional retailers who generally have lower
sell-through percentages than specialty retailers.
Our export distribution began operations in March 2003. Export
distribution increased $6.5 million compared to the prior fiscal year due
primarily to an additional month of distribution in the current fiscal year.
Our In-Store Services group's revenues for fiscal year ended January 31,
2005 were $54.1 million, a decrease of $4.5 million or 7.7% over the prior year.
The group's revenues for the fiscal year ended January 31, 2005 and 2004
are comprised of the following components (in thousands):
2005 2004 CHANGE
-------- -------- ------
Claim filing and information.................. $ 17.3 $ 14.0 $ 3.3
Wire manufacturing............................ 36.8 44.6 (7.8)
-------- -------- ------
Total......................................... $ 54.1 $ 58.6 $ (4.5)
======== ======== ======
Our claim filing revenues are recognized at the time the claim is paid.
The increase in revenues in the fiscal year ended January 31, 2005 relate to the
timing of the cash payments received on the claims. In addition, we acquired
Promag Retail Services, LLC in August 2004 which also contributed to the
increased revenues for the fiscal year ended January 31, 2005. Information
services revenue increased by approximately $0.5 million over the prior year
relating to additional information product contracts being entered into in the
current year.
Our front end wire and services revenues declined due to the cyclical
nature of the industry. Major chains typically purchase new front-end fixtures
every three years; however, the use of the front end fixtures has been extending
beyond this life cycle.
27
Our Wood Manufacturing group's revenues for the fiscal year ended January
31, 2005 were $22.4 million, an increase of approximately $3.7 million or 19.5%
over the prior year. The increase for the fiscal year ended January 31, 2005
relates to an increase in the number of store openings and remodelings performed
by our customers.
Gross Profit
Gross profit for the fiscal year ended January 31, 2005 increased $11.8
million, or 13.7 %, over the prior fiscal year primarily due to an increase in
sales volume in our Magazine Fulfillment group and our Wood Manufacturing Group.
Our Magazine Fulfillment gross profits were $69.5 million, an increase of
$10.5 million or 17.8%, compared to the prior fiscal year. The increase related
primarily to the increased distribution revenue as described above and the
improvement in gross profit margins from 24.7% to 24.8%. The gross profit
margins in our domestic distribution businesses are generally higher than our
export distribution and, as a result, overall gross profit margins improve as
the portion of total revenues is weighted more toward our domestic operations.
In addition, we receive certain supplier rebates on gross distribution and as
estimated sell-through decreases those rebates become a greater portion of the
overall gross profit contribution yielding higher gross profit margins.
Gross profit in our In-Store Services group for the fiscal year period
ended January 31, 2005 increased $0.1 million, or 0.03%, over the prior year.
The increase in gross profit is primarily due to a larger percentage of our
sales occurring in claim filing and information which is a significantly higher
margin business than our front end wire and services.
Gross profit in our Wood Manufacturing group for the fiscal year ended
January 31, 2005 increased $1.2 million, or 49.3%, over the prior year. The
increase relates primarily to operational efficiencies at our manufacturing
facilities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the fiscal year ended
January 31, 2005 increased $4.6 million, or 9.1%, over the prior year. Selling,
general, and administrative expenses as a percent of revenues declined from
16.0% to 15.5% in those same periods.
The Magazine Fulfillment group's selling, general, and administrative
expenses were $29.9 million, an increase of $3.3 million, or 12.5% over the
prior fiscal year. As a percentage of sales, selling, general and administrative
expenses have decreased from 11.1% to 10.7% compared to the prior year same
period due to our ability to leverage existing infrastructure over a larger base
of distribution and the consolidation of our distribution centers in Harrisburg,
Pennsylvania and Carson City, Nevada. Overall expenses have increased due to the
increase in our traditional distribution business and the related merchandising
and distribution labor in our distribution centers and the expansion of our
marketing efforts in the United Kingdom.
The selling, general, and administrative expenses of In-Store Services in
the fiscal year ended January 31, 2005 increased $0.2 million, or 2.1%, compared
to the fiscal year ended January 31, 2004. The increase relates to an increase
in general operating expenses offset by a reduction in executive salary expense
in the fiscal year ended January 31, 2005 compared to the fiscal year ended
January 31, 2004.
The selling, general, and administrative expenses of Shared Services for
the fiscal year ended January 31, 2005 increased $1.2 million, or 8.6%, compared
to the fiscal year ended January 31, 2004. The overall increase is primarily due
to Sarbanes-Oxley compliance charges and increased depreciation expense due to
increased capital expenditures.
The Wood Manufacturing group's selling, general, and administrative
expenses in the fiscal year ended January 31, 2005 decreased $0.1 million, or
9.6%, compared to the fiscal year ended January 31, 2004. The decrease was
attributable primarily to a head count reduction.
28
Fulfillment Freight
Fulfillment freight represents the outbound freight costs of domestic
distribution. It consists primarily of payments to third party carriers to
provide delivery service from our distribution centers to our customer's retail
stores.
Our Magazine Fulfillment group's freight expense was $21.1 million, an
increase of $4.7 million or 28.6% compared to the prior fiscal year. Freight
expense as a percentage of gross domestic distribution increased from 3.7% to
4.0%. The increase was primarily attributable to expansion of our fulfillment
business where we receive a per pound fee to ship other distributors product.
Relocation Expenses
During fiscal 2005, the Company incurred $2.5 million of expenses related
to distribution center relocations and a plant conversion. The Company began
expansion into the mainstream retail market which resulted in distribution
fulfillment centers in Milan, OH, San Diego, CA and Kent, WA being moved to
Harrisburg, PA and Carson City, NV.
During fiscal 2004, the Company incurred $1.7 million of expenses related
to relocating its claims submission and fixture billing center, its Corporate
Headquarters, and its Magazine Fulfillment administrative offices to its new
facility in Bonita Springs, FL.
Loss on sale of land and building
For the fiscal year ended January 31, 2005, the Company recognized a
loss on the sale of land and building of approximately $1.1 million for a vacant
property located in Highpoint, NC.
Operating Income
Operating income for the fiscal year ended January 31, 2005 increased $0.6
million or 3.6%, compared to the fiscal year ended January 31, 2004 due to the
factors described above.
Operating profit margins for the fiscal year ended January 31, 2005
decreased from 5.5% to 5.0% as compared to the prior year due to the relocation
costs and loss on sale of land and building discussed above.
Interest Expense
Interest expense includes the interest and fees on our significant debt
instruments and outstanding letters of credit.
Interest expense decreased $1.9 million, or 54%, for the fiscal year ended
January 31, 2005 compared to the fiscal ye