Source Interlink Companies, Inc. F1Q09 (Qtr End 04/30/2008) Earnings Call Transcript

Jun. 5.08 | About: Source Interlink (SORC)

Source Interlink Companies, Inc. (SORC) F1Q09 Earnings Call June 5, 2008 4:30 PM ET

Executives

Denise Roche - Brainerd Communicators

Michael Duckworth - Chairman

Mark Fierman - Chief Financial Officer

Alan Tuchman - Interim Co-Chief Executive Officer

Analysts

Brian Joseph - Golden Tree

Ben Michovac - Revana Capital

Robert Reddy - Violin capital Partners

Terry Frank - TF Trading and Company

Operator

Welcome to Source Interlink Company's fiscal 2009 first quarter earnings teleconference call. (Operator Instructions) At this time, I will turn the conference over to Denise Roche of Brainerd Communicators to read the forward-looking statements.

Denise Roche

I would like to remind you that this conference call and presentation 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 expressed by the forward-looking statements.

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 for physical copies of magazines, books, DVDs, CDs and other home entertainment products, our ability to realize additional operating efficiencies, cost savings and other benefits from recent acquisitions, evolving markets for entertainment media, the ability to obtain products 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 filings with the Securities and Exchange Commission including its amended annual report on Form 10-KA filed with the SEC on May 30, 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 eliminates certain non-cash items such as amortization of intangible assets resulting from acquisitions, non-cash income taxes as well as certain costs related to consolidating and integrating acquisitions.

For a detailed review of the company's quarterly as well as a reconciliation of our GAAP and adjusted results, please refer to the press release issued earlier today and the reconciliations posted on the company 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 new information, future events or otherwise. With that, I will turn the call over to, Mr. Duckworth. Please go ahead.

Michael Duckworth

Thank you, good afternoon everyone and thank you for joining us on our first quarter fiscal 2009 earnings call. We produced another solid quarter especially in light of the current economic environment and since we just reported a few weeks ago there is not a lot of new news today, however I do want to reinforce that we continue to make very good progress in executing our strategic plans across each of our businesses.

I will focus my comments today around that while giving some context to our financial performance and then I will ask Mark Fierman, to cover the specific numbers including this quarter’s non-cash charge related to the same intangibles. Jim Gillis, Alan Tuchman, and Steve Parr who head our divisions are also here with me today and available for Q-and-A at the end of our prepared remarks.

Execution in the phase of a tough economy is really the story for this quarter. We continue to gain share while consolidating operations and reducing costs particularly in our fulfillment businesses. We also remain focused on the growth in digital which highlights our strategy of being media-neutral to our readers and advertisers. In the first quarter, adjusted revenue was up 29% to $615 million compared to the prior year of 475 million. First quarter adjusted EBITDA up $44.4 million increased a 176% year-over-year. The majority of this increase came from our new SIM division which is in the mid of a challenging advertising cycle particularly in our dominant category of automotive.

Our Periodical Fulfillment Services Division delivered strong results. Performance here was driven by market share growth and the continued benefit of our consolidation and cost reduction efforts. While it is tough out there, we remain confident in our fiscal year guidance we provided on our last call. Now, let me provide more detail on the three major segments starting with Periodical Fulfillment Services.

Revenue in the first quarter increased by 10.2%, primarily due to the Borders exclusive magazine distribution deal and EBITDA for the division increased 39.6% to $13.2 million. EBITDA margins improved to 4.9% from 3.9% as we began to see the results from the continued integration of previously acquired assets and the ongoing rationalization of our infrastructure. Recent investments in our distribution center, logistics and in-store personnel have resulted in successive retail, where we are outperforming our competition in both same-store sales and percent of Weekly’s delivered prior to the weekend at key retailers.

On the cost side, the consolidation of our magazine distribution centers continues. In fiscal 2008, we went from nine distribution centers to seven. In the first quarter, we closed our distribution center in Brainerd, Minnesota bringing our total number of DCs to six. In addition we recently announced plans to close three additional distribution centers so that prior to the holiday season we will operate at of only three DCs. These closures and the associated adjustment of our logistics needs are part of our ongoing effort to lower costs and better serve our customers. We project savings from these consolidations of about $8 million annually.

We are also determined to drive the magazine distribution channel itself to becoming more efficient. Historically the number of copies distributed has been push down rather than determined by store level demand. We believe this supply driven model is the single biggest cause of inefficiency and the primary reason for the unnecessary and duplicative cost associated with what is clearly an antiquated model. We are driving the channel to become more demand driven as we expect these changes to benefit publishers, wholesalers and retailers alike.

Moving to our DVD/CD Fulfillment business, we continue to benefit from the trend of outsourcing the distribution of our products by retailers and our continued push to reduce cost. Although, net revenue for the quarter was relatively flat and EBITDA was down approximately $1.3 million compared to the prior year, we continue to gain market share and we still significantly are outperforming the industry in music.

DVD net revenue declined approximately 6% in the quarter, as a result of a one-time inventory return adjustment by one of our customers. We look for DVD sales to improve as the industry coalesces around the Blu-ray standard and we are encouraged to see that major retailers have announced plans to discount Blu-ray players. As we expect this trend will accelerate demand for high definition DVDs.

Led by strong Internet sales, first quarters CD revenue increased 2.8% versus the overall industry decline of almost 17%. Internet fulfillment continues to be a growth opportunity for us here. The distribution of our product is moving from the traditional brick and mortar channels to the Internet. As the distributor of DVDs and CDs to almost every major Internet retailer our market share online continues to growth.

Our E-commerce offerings are expanding and the net revenue generated from online sales in the first quarter was up 16.4% over the prior year quarter. As an example we recently announced the addition of Sears which will be utilizing our proprietary E-commerce engine to offer consumers a catalog of almost 400,000 music and movie tittles.

Video game service revenue continues to expand as well and we are now the fulfillment and services provider for over 7 million units of video games annually. We recently announced the opening of a new 404,000 square foot distribution center in Shepherdsville, Kentucky. This facility replaces as smaller warehouse there and we will begin processing outbound services this month and returns in October when fully operational next year. This new distribution center will be capable of processing and shipping nearly 200 million units each year.

Centralizing our facilities in Kentucky, it's inter goal to better serving our customers, positioning ourselves to take on new business and reducing cost. Kentucky is centrally located, UPS’s national air hub is nearby in Louisville and is also close to major DVD, CD and video games manufacturers which allow us a quicker re-supply of product. Source Interlink Media or publishing division saw a revenue decline of 7.7% or $10.3 million relative to the comparable period last year and adjusted EBITDA decreased of $4.8 million or 15.6%.

The critical driver here is the very challenging advertising environment particularly in automotive and marine segments. The Magazine industry is currently experiencing the softest overall advertising market in more than a decade. While economic factors create near term pressure on the segments results, SIM remains a fundamentally strong well positioned business and we fully expect improving results once the economic picture brightens and advertising returns to normalized level.

For the first quarter of fiscal 2009, our circulation revenue declined by $2.3 million or 5.8% largely, attributable to weaker news stand sales in automotive and in our soap category. We continue to exploit opportunities to improve efficiency in the news stand and expect to reduce draw by 11.6 million copies this year, an increase from our previous estimate of 7.4 million copies.

In advertising revenue was down $6.3 million or 8.6% versus the same period last year. Keep in mind however, that SIM is a resilient business and there are few factors to consider relative to the current market conditions. First, while automakers and large general advertisers that reduced marketing budgets near term are enthusiast verticals remain better projected relative to the general interest publications. By way of example PIB reported a first quarter decline of 21.3% in automotive advertising versus the prior year while SIMs automotive titles experienced a decline in print advertising of only 5.5% in the same period.

Second we are experiencing outstanding traction in our digital platform which posted a 49% increased in online advertising over the same period last year. We increased the number of unique visitors by approximately 23% and increased the number of page views by 20% over the last 12 months through continued product development and investment. In the first quarter of 2009 unique visitors were up 27% and page views climbed 24%.

Although it’s still representing less than 15% of our total revenue and EBITDA, the growth and earnings outlook in digital remains very compelling. What this growing base of users is really responding to is the enhanced features and more timely content on our sites. New features include a searchable database of road tests and reviews from all our titles. In addition Motor Trend now provides daily automotive news from around the globe as reported by our editors given our site up to maintain relevance for users.

The ability to provide this functionality is the product of our robust technology platform, which is now in place. Our focus going forward is on ramping the performance of our platform. Overall, despite a tough add sales environment, we feel good about SIMs progress and our outlook for the business particularly on the digital side. Let me wrap up my remarks, with some comments on our outlook and then hand the call back to Marc Fierman.

As provided in our April conference call, we anticipate year-end revenue of between $2.4 and $2.5 billion and adjusted combined EBITDA of between $190 million and $200 million. We expect our business will generate free cash flow in the range of $30 million to $45 million despite the higher than normal levels of investment to consolidate our infrastructure. As noted during our 2008 year-end call, we anticipate adjusted EPS in the range of $0.87 to $1.6 for fiscal 2009.

The overall economic outlook is uncertain and the advertising cycle very difficult, but our strategies remain intact, our business fundamentals remain strong and we expect to see improvement once we return to a more normalized economy. Source’s driving change in what historically has been an extremely inefficient business of magazine distribution and is capitalizing on changes in content particularity in digital.

We look forward to reporting our progress to you throughout the remainder of the year. With that I will turn it over to Marc.

Marc Fierman

Thank you Mike and good afternoon everyone. I will briefly review our first quarter consolidated operating results for the Company and for our operating segments. I will also comment on certain cash flow and balance sheet items. As the operator mentioned at the outside of the call we have also prepared a slide presentation that corresponds with some of our comments that can be accessed on the Investor Relations section of our website.

As a reminder and as discussed on our last call, the Company's reporting results from four segments: Periodical Fulfillment Services, DVD/CD performance, Source Interlink Media also referred to a SIM and Shared Service. The Periodical Fulfillment Service segment includes the former Magazine Fulfillment and In-Store Service segments. On a consolidated basis prior year periods only include legacy source, the reporting segments in place prior to the Source Interlink Media acquisition on August 1, 2007. Please note that our release and slide presentation provides some insight into SIM’s historical revenue and EBITDA as a stand-alone entity for the comparable period.

Consolidated first quarter adjusted revenue increased 29.4% to $615 million, of which $124 million came from the SIM acquisition. Revenue in our two fulfillment businesses increased 4.8% to $498 million. The periodical fulfillment segment saw an increase of 10.2% to $270 million while revenue in our DVD/CD segment declined 1% to $229 million. CD revenue increased approximately 2.8% to $111 million with DVD revenue declining approximately 6.1% to $112 million compared to the prior year quarter.

Consolidated adjusted EBITDA in the first quarter grew 176% to $44.4 million of which $25.8 million came from SIM. Q1 adjusted EBITDA for our two fulfillment businesses increased 13.6% to $22.5 million. The Periodical segment increased 43.5% to 13.2 million and the DVD/CD segment declined 12% to $9.3 million.

On a GAAP basis during the first quarter the company used $12.4 million of cash in operations, incurred $8.6 million of CapEx and generated $2.1 million of cash from purchases and receipts of rebate claims, all of which net to negative cash flow in the quarter of $18.9 million. Depreciation of propriety and equipment was $7.8 million in the quarter and adjusted interest expenses, net of interest income in Q1 was $26.6 million, and excludes approximately $2.3 million of non-cash amortization of bridge loan fees.

Q1 consolidated adjusted income from continuing operations was $9.6 million compared to $5.2 million last year and first quarter adjusted earnings per share from continuing operations are $0.18 compared to 0.10 last year. On a GAAP basis the company reported a loss from continuing operations of $280.8 million or $5.37 per share and that compares with income of $3.2 million or $0.06 per share in the year ago period. The reported GAAP net loss in the quarter includes the non-cash impairment charge of $270.8 million or $5.18 per share for goodwill and other intangible assets related to the SIM acquisition.

We will be providing a detailed discussion of the process we went through in determining the charge in our Form 10-Q that we expect to file shortly, so I won’t go through the details hear, but I can briefly inform you that this is a result of our annual FAS 142 assessment of goodwill and other intangibles and our conclusion that the net book value of goodwill and intangibles assets related to certain reporting units in our SIM business exceeds what we currently estimate as its fair value.

Some of the factors that droving the charge are managements projections of revenues and profitability of the SIM business units, the effects of the recent credit market changes, the continued economic downturn and the related effects on advertising and consumer discretionary spending. In managements view this non-cash charge does not reflects the long-term value of SIM or our long-term outlook for the business. GAAP earnings per share in the quarter excluding the impairment charges would have resulted in a loss of $0.19 per share.

Some balance sheet highlights as of April 30, are as follows. Cash on hand $3.3 million, average cash balance during the quarter $11.2 million. Our revolving loan facility was undrawn and had approximately $265 million of excess availability and the average monthly revolver balance during the quarter was $27.8 million and total debt was $1,370 billion. I will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Brian Joseph - Golden Tree.

Brian Joseph – Golden Tree

Can you give an update on the status of the synergies?

Mark Fierman

There were two sets of synergies that we had discussed previously on our last call that was $18 million related to previous magazine acquisitions and in fiscal year 2008 of the $18 million identified we had recognized nine. We expect to recognize 4 million in the current year and 5 million in fiscal year ’10. In regard to the SIM acquisition where we discussed $18 million of synergies identified on a run rate basis in the first 12 months, in last year in fiscal year ’08 on an actual basis we recognized 5 million. We expect on an actual basis this year, fiscal year ’09 to recognize 14 million and in fiscal year ‘10 next year we will have the full 18 million. At the current time the full 18 million has been identified, but it is not on a full run rate basis yet.

Brian Joseph – Golden Tree

So, that’s exactly it was last quarter right.

Mark Fierman

Yes, there is no change.

Brian Joseph – Golden Tree

Right, okay and then with regards to work in capital, obviously you’ve got some pretty big shifts there. So, what happened in terms of accrued and 80, looks like they were both down by $20 million.

Michael Duckworth

Yes, most of that is really due to the timing of certain payments, in particular in our CD/DVD business as you heard earlier we had a large return of inventory from one of our customers and those returns had not yet been processed by the end of the quarter, so that will slip into the following quarter. So from now on you’ll hear really from a working capital basis, it’s really a temporary timing difference.

Brian Joseph – Golden Tree

So, what does the cash balance look like now?

Michael Duckworth

I don’t know what it is today, but I think as Mike said, he reiterated our view on our free cash flow projection for the full-year and I think we are comfortable with that.

Brian Joseph – Golden Tree

Okay, but as of now that shift has not happened yet or I mean I guess post quarter has it shifted back.

Michael Duckworth

Its beginning to shift, yes it is.

Brian Joseph – Golden Tree

And so last time I guess on your full-year guidance you gave working capital is flat for the year, are you still comfortable with that?

Michael Duckworth

Yes.

Mark Fierman

Yes.

Brian Joseph – Golden Tree

I’m sorry, you said yes?

Michael Duckworth

Yes, correct, affirmative.

Operator

Our next question is from [Ben Michovac] of Revana Capital.

Ben Michovac - Revana Capital

The CapEx spent, is that a little heavy. We shouldn’t expect that to be annualized, do you have guidance for what’s going to be for the whole year?

Michael Duckworth

It is heavy this year primarily as a result of with significant investment in consolidating our Magazine Distribution Centers as well as the new facility on the DVD side. Another good chunk of it is our continued investment in the digital business there where we’re really growing the platform fairly dramatically. I would expect that a more normalized level of CapEx would be around the $25 million number and on a purely maintenance kind of basis would be around the $15 million, $17 million number.

Ben Michovac - Revana Capital

Okay and can you just repeat the interest expense; was it 26.6? It looks like there is some fees built in this of the bridge facility...

Michael Duckworth

Yes, there was an initial bridge facility that was paid at closing, that’s just really being amortized at the non-cash charge that’s included in our GAAP interest expense that we don’t count in our adjusted view of interest expense.

Ben Michovac - Revana Capital

Okay, and can you go over the debt one more time? You said that there was none of the…?

Michael Duckworth

At the close of the quarter there was no balance outstanding on a revolver and we have the term loan which was initially at 880, it’s paid down a few million dollars and then we have the Bridge loan outstanding of 465 and then we have some assorted mortgages and leases and that number is 316.

Ben Michovac - Revana Capital

Okay, and this is all floating right?

Michael Duckworth

The Bridge note is floating to a cap of a 11.25 which we would be at by August 1. The bank debt is a LIBOR spread; we have put an interest cap in place for a couple of $100 million and what’s our cap on that rate? 3.1; lock in LIBOR in at 3.1%. We have about half of our capitals; a little over half of our capital structure is fixed at this point.

Operator

Our next question is from Robert Reedy of Violin Capital Partners.

Robert Reddy – Violin capital Partners

Two questions, the first one is can you help explain fuel costs and how they impact the business and how you plan to mitigate those assuming that they continue to stay high.

Michael Duckworth

Well, fuel impacts the business in a number of ways. As you know in our magazine business we have a fleet of our own trucks as well as a third party carrier such as UPS. In our CD/DVD business we use UPS for most of our distribution and we use ground as well as air. So, all those different pieces have the different metric as to how fuel prices are passed through. In certain parts of our business we are able to pass those directly to our customers, in other parts of the business we have to absorb it and make other changes in order to become a deal with the reality of the higher fuel prices. So there is really not one answer on how we deal with it. We deal with it on a daily basis like a lot of other companies and we feel very comfortable that the changes that have occurred will not materially have a negative impact on our business overall for the full year.

Robert Reddy – Violin capital Partners

And roughly what percent of our costs could you primarily attribute to fuel on an income statement basis?

Michael Duckworth

I’d probably say, it’s probably 2% to 3% maybe less than that. It’s not significant

Robert Reddy – Violin capital Partners

That’s fair. That gets a little point, thank you and then second question is, on the free cash flow just so I understand as an earlier question; the negative $18.9 million, we shouldn’t think of that with any adjustments or anything of the source for the quarter and then following up to that, so if we have the negative 18 point now I would assume that Q2 should be I guess abnormally positive I guess?

Michael Duckworth

Yes Mark referred to this as timing. One of the big factors was a significant amount of returns from one particular customer. So, those returns to us and the associated accounting interests for them have happened to us, but we haven’t returned those tittles back to the ultimate publisher on the other side yet and so that’s the timing issue there and as we do that and run that through our system, you will see that come back inline and then again as Mark iterated as we get through to the end of the year we still I think we will be in a similar place as we provided the guidance for.

Robert Reddy – Violin capital Partners

Which is the $30 million to $45 million of free cash flow?

Michael Duckworth

That’s correct.

Operator

Our next question is from [Terry Frank] of TF Trading and Company.

Terry Frank - TF Trading and Company

It’s a couple of question; one is there still a good demand from our clients to collect and manage rebates of profitable amounts as they proceed and mange this whole process for the customer?

Michael Duckworth

Clearly it’s a very significant part of our business. We’ve continued to actually pickup share in that business from some of the other folks. It’s part of our core strategy Terry in terms being that total solutions provider for the retailer by doing, managing, just sliding around, just building the rack and providing the entire solution. So, that’s still a very big portion of our business in the Magazine segment. One of the reasons we have began to not talk about it specifically is because as you look at the larger entity we are today it’s really not relevant on a company of our size totally, but it’s critical to our magazine distribution segment.

Operator

This concludes today’s question-and-answer session. I would like to return the meeting back over to Mr. Duckworth.

Michael Duckworth

Thank you very much for spending time with us. We look forward to reporting next quarter.

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