Source Interlink Companies, Inc. Q3 2009 (Qtr End 10/31/08) Earnings Call Transcript

Dec.10.08 | About: Source Interlink (SORC)

Source Interlink Companies, Inc. (SORC) Q3 2009 Earnings Call December 10, 2008 4:30 PM ET

Executives

Robert Carl – VP IR

Greg Mays – CEO

Marc Fierman - CFO

Analysts

Mark Cooper – Wells Capital

Operator

Good afternoon ladies and gentlemen, and welcome to Source Interlink Companies fiscal 2009 third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Robert Carl, Vice President of Investor Relations for Source Interlink Companies; please go ahead Mr. Carl.

Robert Carl

I would like to welcome everyone to Source Interlink’s third quarter fiscal 2009 conference call. I’m joined this afternoon by Greg Mays, Source Interlink’s Chairman and CEO and Marc Fierman, our Chief Financial Officer.

We issued a press release earlier this afternoon which detailed Source Interlink’s financial performance for the third fiscal quarter of 2009 which ended October 31, 2008. This release and Form 10-Q which will be filed later today can be accessed on the Investor Relations website at www.sourceinterlink.com.

Before we begin the call today, I would like to remind you that this conference call contains certain forward-looking statements within the meaning of Section 21-E of the Securities Exchange Act of 1934 and the US Private Securities Litigation Reform Act of 1995, including statements relating to among other things acquisition related cost savings, future business plans, strategies and financial results and growth opportunities.

These forward-looking statements reflects Source Interlink’s current views about future events and are subject to risks, uncertainties, assumptions and changes in circumstances that may cause future events, achievements or results to differ materially from those views expressed today.

Factors that may cause actual results to differ include; adverse trends in advertising spending, interest rate volatility and the consequences of significantly increased debt obligations, price volatility in fuel, paper and other raw materials used in our businesses, market acceptance of and continuing retail demand of physical copies of magazines, books, DVDs, and CDs and other home entertainment products, or our ability to realize additional operating efficiencies, cost savings and other benefits from recent acquisitions, evolving markets for entertainment media, the ability to obtain product in sufficient quantities, adverse changes in general economic or market conditions, the ability to attract and retain employees, intense competition in the market place and other events and other important factors disclosed previously and from time-to-time in Source Interlink’s fillings with the Securities and Exchange Commission, including its amended Annual Report on Form 10-K A filed with the SEC on May 30th 2008.

The company presents financial results on a GAAP and non-GAAP basis. The non-GAAP presentation is intended to reflect the manner in which management views the business which for example, excludes items such as amortization of acquired intangible assets, impairment charges, certain reserves for Circuit City Chapter 11 bankruptcy filings, charges incurred to consolidate and integrate distribution facilities of recently acquired businesses, and non-cash stock-based compensation that may have a material effect on the company’s net income and that income per share calculated in accordance with GAAP.

For a detailed review of the company’s quarterly results as well as the reconciliation of our GAAP and adjusted results, please refer to the press release issued earlier today and the reconciliations posted on the company’s website at www.sourceinterlink.com.

The company does not intend and disclaims any duty or obligation to update or revise any forward-looking statements or industry information set forth in this presentation to reflect any new information, future events or otherwise.

With that I will turn the call over to Greg.

Greg Mays

Thanks Robert and good afternoon everyone. My history with Source Interlink Company is as follows. I’ve been a Board member and Director for the last three years and three months prior to joining the company as CEO I did an on the ground business assessment visiting many of our operations located in 25 states and almost met with most of the decision making management team.

I then joined the company as CEO in late October. The reason I make reference to this is I know the company, I know the management team, and I understand what the opportunity drivers are for us. My observations are I believe there is real opportunity to significantly lower operating cost, to improve our market share within our business sector, and as we demonstrate success, it will translate to greater enterprise value and benefit all stakeholders.

I would like to start today by briefly underscoring what I believe are some of Source’s key strengths and opportunities, then Marc will cover the financials.

In the last four years Source has made four significant acquisitions; Levy, Anderson, Alliance, and a little over a year ago, Primedia Publication business. While the company might have realized most of the model synergies, in my view a real management and cost structure integration has not occurred.

For instance as a company we have not really integrated the back office functions effectively. By this I mean accounting, IT, and general administrative areas.

There is a real opportunity for us to become much more administratively effective and operationally stronger while significantly lowering costs; something I have done throughout my career.

Another example is the opportunity that exists in cross marketing within the segments of our business. As an organization we are not realizing the myriad of cross marketing benefits that exist between the portfolio of nearly 80 magazine titles and over 100 websites.

Or between our magazine distribution merchandising services including RDA [claiming] services and wire rack manufacturing. Or between MagNet LLC a partnership for database scan information or Alliance’s DVD/CD wholesale business which includes NCircle, a licensed content provider of children’s entertainment and educational DVDs.

I see significant potential in front of us on multiple fronts and believe myself and this management team can capitalize on the many opportunities that are before us. To illustrate this point in late third quarter we completed the integration of both our distribution and our sales organizations.

In doing so we are now realizing greater operational efficiencies, capitalizing on the benefit of best practices and at the same time we’ve lowered the cost of marketing and operational expenses. Some detail here is worth mentioning.

At the end of the third quarter we completed the distribution consolidation with the closing of three more DCs now leaving five main locations; three for magazine and two for DVD/CD distribution.

These locations are strategically placed in key service regions of the country. In late October we appointed Alan Tuchman to be President of the Source Interlink Division, a leadership position responsible for all of our distribution operations, regardless of product category.

At the time we merged the two distribution organizations into one with a much more efficient structure. And the new distribution management team has moved swiftly to right size our operation and reduce overhead which due to the timing of the reorganization only provided minimal benefits in the third quarter but will provide real results in the fourth quarter and the following fiscal year.

Just as we realigned our distribution operations, we did the same with our sales and support organizations. As our retail customer base evolves our selling approach must too. We are no longer just selling to brick and mortar single media retailers.

In the past we had separate sales teams for magazines, CD, DVD, rack fixtures, etc. calling on the same customers selling different services and items. Now we are selling to retailers handling all varieties of media with many also adding e-commerce to their channel strategy utilizing one marketing team.

I would also like to take a minute and discuss another key strength, our publication business. With SIM we have successfully combined the years of brand strength, of well-recognized titles, new forms of engagement for enthusiasts who are using the web.

In our SIM publishing business we have taken aggressive actions to position our core print assets to withstand the current softness in advertising. Our focus has been on identifying and managing ways to effectively streamline the SIM operation during this challenging economic period.

In doing so we have decided to consolidate eight magazine titles into other titles of our portfolio bringing the total number of titles to 69. This streamlining will be completed by the end of the fiscal year and will reduce run rate expenses.

In late third quarter and early fourth quarter we also realigned our organizational structure at Source Interlink Media and in several other parts of the publishing organization effectively reducing overhead expense. Marc will provide more color on this in a moment.

These changes will deliver a significant fourth quarter and subsequent year savings. We also made operating changes at SIM by renegotiating key vendor contracts that will have an even greater benefit in reducing year-over-year costs.

So just to wrap up, positive adjustments to cost structure which by the way will continue, and execution in the face of soft economic times is how we would characterize this past quarter. Our management team is focused on achieving further cost reductions across the company including the accelerated consolidation of operations and the right sizing of the company’s departments for their present and forecasted business levels.

While performing these necessary actions we have also remained focused on maintaining profitable growth in our key businesses. This includes progress in the online digital areas of the company and adding new distribution customers for magazines, DVDs and CDs when we continue to grow market share.

We believe that the measures we have implemented within each of the major segments will establish sound financial footing for the company and benefit all stakeholders. And with that I’ll now turn this over to Marc.

Marc Fierman

Thank you Greg and good afternoon everyone. I will briefly review our third quarter operating results for the company and its reporting segments. I will also comment on certain cash flow and balance sheet items.

As a reminder the company reports from four segments; periodical fulfillment services, DVD/CD fulfillment, Source Interlink Media known as SIM, and share services.

On a consolidated basis adjusted revenue decreased 7.4% to $593 million. For SIM our publishing segment, revenue declined 13.4% to $116 million. As you might be aware the overall magazine publishing industry is currently experienced the softest ad market in more then a decade.

PIV or the Publisher Information Bureau, has reported the automotive category has incurred declines in ad revenue and pages of 25% and 28% in Q3 versus the prior year. SIM’s automotive print titles continue to outperform the automotive category in terms of ad paging and revenue where we experienced decreases of only 15% and 14.5% respectively.

Combined revenue for our two fulfillment services businesses, decreased 6.3% to $483.6 million. The periodical fulfillment segments saw a revenue decrease of 3.4% to $244.5 million while revenue in our DVD/CD segment decreased 8.4% to $239.1 million.

DVD revenue increased 4.7% to $127 million driven by a more then doubling of Blu-Ray shipments year-over-year. For CDs we saw a revenue decrease 21.2% to $107 million, this against an overall industry decline of approximately 23%.

On a consolidated adjusted EBITDA in the third quarter decreased 8.8% to $47.9 million. Adjusted EBITDA for SIM decreased 17.7% to $24.7 million. I should note that the Q3 result included the benefit of a significant reduction in force of approximately 8% yielding annualized savings of over $11 million.

We also made operating changes and renegotiated key vendor contracts in the quarter that will result in an incremental $10 million in annualized savings beginning in fiscal year 2010. Combined adjusted EBITDA for our two fulfillment businesses decreased 1.1% to $26.1 million.

The periodical segment adjusted EBITDA decreased 12.3% to $11.4 million and the DVD/CD segment increased 9.4% to $14.7 million. The consolidation of our magazine distribution centers which was completed in the third quarter is expected to yield significant operating cost improvements beginning in the next quarter.

During the third quarter on a GAAP basis we generated $7.7 million in cash flow from operations and on a year-to-date basis $19.9 million. Q3 free cash flow on a GAAP basis was negative $1.9 million and negative $8.4 million for the year-to-date.

It should be noted that while inventory levels in Q3 increased $92.3 million compared with year-end, the build up is mostly attributable to the normal seasonal pre-holiday build up of CDs and DVDs. Those levels are expected to decrease to more normalized levels by the end of Q4.

It is also important to be aware that the vast majority of magazine, CD, and DVD inventories are fully returnable to our vendors for full credit.

CapEx in Q3 was $6.1 million and $25 million year-to-date. It is important to note that the current fiscal year has a historically high CapEx spend due to the distribution center integration. We do not expect this level of CapEx going forward and expect next year to be approximately one-third of this year’s anticipated spend of around $32 million.

Depreciation of property and equipment was $6.5 million in the quarter and $19.3 million for the year-to-date. Interest expense net of income in Q3 was $30.1 million, adjusted interest expense net of income for the nine-month period was $84.1 million, excluding approximately $3.7 million of non-cash amortization of bridge loan fees.

Q3 consolidated adjusted income from continuing operations was $9.7 million compared to $12.6 million last year. Third quarter adjusted earnings per share from continuing operations are $0.19 compared to $0.24 in Q3 of 2008.

On a GAAP basis in Q3 the company reported a loss from continuing operations of $36.6 million or $0.70 per share and that compares with a loss of $4.5 million or $0.09 in the year ago period. Our Q3 reported GAAP results were negatively impacted by a couple of items.

First we incurred $23.9 million of integration, consolidation, and relocation expenses most of which was associated with the integration of our distribution operations. Included in this amount were lease termination costs, write-offs of leasehold improvements, severance, and other conversion costs.

Additionally we recorded a $10.2 million reserve related to the recent Chapter 11 filing of Circuit City. Most of the reserve is related to the DVD/CD report segment. At this time the final settlement with Circuit City is unknown. We are represented on the unsecured creditors committee which positions us to closely monitor the situation.

Some balance sheet highlights as of October 31, 2008 are as follows. A cash on hand of $5.8 million, the average cash balance during the quarter was $11.1 million. Our revolving loan facility had a balance of $50.3 million and approximately $190 million of excess availability.

The average revolver balance during the quarter was $76 million. A couple of items worth noting, of the revolver balance in Q2 of this year we used $42 million of the line for the acquisition of the remaining minority interest of automotive.com and we used an additional $12 million to accomplish the successful placement of our senior unsecured notes.

Total debt at the end of the quarter including capital leases was $1.416 billion. In conclusion in Q3 we intensified our response to the current economic downturn with significant cost reductions to address headwinds we saw in some of our businesses.

The initiatives and plans we put in place contributed to the quarter’s results and we continue to evaluate cost savings opportunities. We have trimmed operating expenses across the board and made a number of operational changes.

In Q3 the company developed a plan that reduces headcount by approximately 300 full time and 100 part time employees. The majority of these reductions took place in the latter half of Q3 and early Q4 which we anticipate will result in significant savings beginning in Q4.

To sum up, in Q3 we trimmed $10.6 million on an annualized run rate basis in company wide expenses and in Q4 we have already trimmed an additional $17.1 million on an annualized run rate basis.

We expect total labor and overhead savings initiatives impacting financial performance in fiscal 2010 to be over $27 million. The initiatives and plans we put in place contributed to the quarter’s results and we will continue to evaluate additional cost savings opportunities.

And based on discussions with Greg, I can report that additional cost reduction opportunities will be forthcoming and discussed on future earnings calls.

With that I will hand the call over for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Cooper – Wells Capital

Mark Cooper – Wells Capital

My question has to do with the balance sheet structure of the company and any commentary you can give us on covenants and that sort, the obvious things that equity holders would want to know about here.

Marc Fierman

I guess you’re probably curious about our covenant in the third quarter we were able to make our covenant by a comfortable margin. Looking forward in this difficult economic environment I feel cautiously optimistic that we will comply with our covenants. Like I said in Q3 we passed with a comfortable margin and that was after Circuit City and the benefit of our some of cost cuts.

So we really feel comfortable, we have significant excess availability. Our revolver is a $300 million line. At the balance sheet date it was $190 million and that is actually at the time when we are at our highest level of inventory because we’re building up for the holiday season. So that I would expect that that inventory comes down, we could expect to see additional excess availability build up in our line.

Greg Mays

And I think its important to recognize in the third quarter that we had the unusual item of a $10 million provision for Circuit City and as Marc said we still made our covenants and in a comfortable range.

Mark Cooper – Wells Capital

Just from a, since you’ve been on the Board for awhile Greg, give us, what is the delta between what the company is doing today and what the expectations were because there’s no, its hard for me to fathom or at least come up with the math that says this debt can get paid off and so maybe we say, well you only have to pay off half of it and you can get the rest refinanced some years down the road. How does that happen given what appears to be some real structural deterioration in the core markets, DVDs, CDs, etc.

Greg Mays

The real difference obviously and its for all businesses when I joined the Board three years ago we certainly didn’t have this type of an economy and it’s a complete change in the credit markets. Certainly in the last six to nine months the reality of that has hit all of us, and Source is no different.

Companies that have the leverage ratios that we do all companies across the line, I think their equity prices or stock prices have reflected that. From my perspective as management and CEO the key here is timing and urgency. There is a lot of opportunity to reduce cost. This is not an environment that you get great revenue increases or if you do you pay for them and they’re not profitable and that’s not good business.

But we’re fortunate relative to say a lot of industries and a lot of companies is that as I outlined earlier there’s a lot of acquisitions historically if going back even prior to four years, for every year there’s and acquisition in this company and [inaudible] with integration, part of it might have been because there’s a comfort of growth.

That growth is gone and now we have the opportunity to seize and reduce cost. To deal with strategic debt issue is probably not our focus today. We make our interest payments in very comfortable fashion. Fortunately the company is not intensive capital requirements, so therefore our interest payment is somewhere in the line of $110 million to $115 million and a cash flow of the ranges that we’ve provided generates a lot of free cash or certainly significant free cash.

The task is to in the next year or two to realign our business so that as the economy does improve and I don’t suggest that’s quarters, but probably years, that we’re much stronger and I think that will allow all those stakeholders to come to the table and figure out how to deal with this capital structure.

Mark Cooper – Wells Capital

I think I heard you mention, you suggested $32 million of CapEx for next year, is that right?

Marc Fierman

No I said for the current fiscal year ended January 31, what I suggested was we would expect to see significantly less perhaps two-thirds less next year.

Mark Cooper – Wells Capital

So that would mean $10 million in that range?

Marc Fierman

Yes, that’s it.

Greg Mays

The reason for the significant capital this year is we build a new warehouse in Kentucky to better accommodate and give us [economies] on our DVD/CD business.

Mark Cooper – Wells Capital

And then so far to date, you’ve identified and are underway with $27 million of annual cost savings?

Marc Fierman

That is correct.

Greg Mays

Those cost savings that we outlined are events that took $10 million of it, took place right in the third quarter and the other $17 million was really in the first weeks or five weeks of this fiscal quarter so the $27 million is not a run rate but is in, a piece of that will be in the fourth quarter and more importantly the benefit of that will be next year.

Mark Cooper – Wells Capital

And I’m thinking to next year, this quarter, you much have a pretty good idea of what this looks like already.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Robert Carl

Thank you everybody for joining us on the conference call today and have a good day.

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