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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Quarterly Period Ended September 30, 1998 Commission File No. 0-24134
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INTEGRITY INCORPORATED
----------------------
(Exact name of registrant as specified in its charter)
Delaware 63-0952549
- -------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1000 Cody Road
Mobile, Alabama 36695
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(Address of principal executive offices, zip)
(334) 633-9000
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(Registrant's telephone number, including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 6, 1998
- ----- -------------------------------
Class A Common Stock, $0.01 par value 2,079,000
Class B Common Stock, $0.01 par value 3,435,000
<PAGE> 2
FINANCIAL INFORMATION
Item 1. Financial Statements
INTEGRITY INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
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<CAPTION>
Sep 30, 1998 Dec 31, 1997
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(Unaudited)
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ASSETS
Current Assets
Cash $ 939 $ 523
Trade receivables, less allowance for returns and doubtful accounts 5,446 4,258
of $746 and $812, respectively
Other receivables 1,859 2,033
Inventories 3,713 5,303
Other current assets 2,610 2,927
-------- --------
Total current assets 14,567 15,044
Property and equipment, net of accumulated depreciation 3,434 3,499
of $4,566 and $3,085, respectively
Product masters, net of accumulated amortization 8,411 8,618
of $10,173 and $7,537, respectively
Other assets 3,226 3,614
-------- --------
Total assets $ 29,638 $ 30,775
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of longterm debt $ 1,806 $ 1,838
Accounts payable and accrued expenses 1,861 2,156
Royalties payable 736 908
Other current liabilities 402 237
-------- --------
Total current liabilities 4,805 5,139
Long Term Debt 11,207 13,279
Deferred revenue 137 207
-------- --------
Total liabilities 16,149 18,625
-------- --------
Minority interest 1,250 954
-------- --------
Stockholders' Equity
Preferred stock, $.01 par value; 500,000 shares authorized, 0 0
none issued and outstanding
Class A common stock, $.01 par value; 7,500,000 shares authorized; 21 21
2,079,000 shares issued and outstanding
Class B common stock, $.01 par value; 10,500,000 shares authorized; 34 34
3,435,000 shares issued and outstanding
Additional paid-in capital 13,428 13,428
Accumulated deficit (1,231) (2,303)
Cumulative translation account (13) 16
-------- --------
Total stockholders' equity 12,239 11,196
-------- --------
Total liabilities and stockholders' equity $ 29,638 $ 30,775
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
1
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INTEGRITY INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
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<CAPTION>
Quarter Ended Nine Months
Sep 30 Ended Sep 30
1998 1997 1998 1997
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Net sales $ 9,358 $ 8,551 $ 27,146 $ 24,474
Cost of sales 5,257 4,188 13,282 11,398
------- ------- -------- --------
Gross profit 4,101 4,363 13,864 13,076
Marketing and fulfillment expenses 1,276 1,731 4,666 5,290
General and administrative expenses 1,910 1,749 6,656 5,990
------- ------- -------- --------
Income from operations 915 883 2,542 1,796
Other expenses
Interest expense, net 348 495 1,125 1,374
Other expenses 14 20 17 62
------- ------- -------- --------
Income before taxes and minority interest 553 368 1,400 360
Provision for income taxes 7 93 32 66
------- ------- -------- --------
Income from consolidated companies
before minority interest 546 275 1,368 294
Minority interest 103 0 296 0
------- ------- -------- --------
Net income 443 275 1,072 294
Adjustments to determine comprehensive
Income
Foreign currency translation
adjustments (35) (20) (29) 40
------- ------- -------- --------
Comprehensive income $ 408 $ 255 $ 1,043 $ 334
======= ======= ======== ========
BASIC AND DILUTED EARNINGS PER SHARE
Net income $ 0.08 $ 0.05 $ 0.19 $ 0.05
======= ======= ======== ========
Weighted average number of shares 5,514 5,514 5,514 5,514
outstanding ======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements
2
<PAGE> 4
INTEGRITY INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE DATA)
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<CAPTION>
Nine Months Ended
Sep 30, 1998 Sep 30, 1997
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,072 $ 294
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 701 834
Amortization of product masters 2,315 2,399
Allowance for returns and doubtful accounts (66) (379)
Minority interest 296 0
Changes in operating assets and liabilities
Increase in trade receivables (1,122) (909)
Decrease in other receivables 174 (1,071)
Decrease in inventories 1,590 740
Decrease in prepaid assets 317 1,242
Increase (decrease) in accounts payable and accrued expenses (295) 464
(Decrease) increase in royalties payable (172) 1,016
Increase in other current liabilities and deferred revenue 95 373
Equity adjustments from translation (29) 40
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Net cash provided by operating activities 4,876 5,043
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (251) (235)
Payments for product masters (2,108) (2,277)
Decrease (increase) in other non-current assets 3 (75)
-------- --------
Net cash used in investing activities (2,356) (2,587)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net repayments under line of credit (312) (1,690)
Principal payments on debt (1,792) (1,158)
-------- --------
Net cash (used) provided by financing activities (2,104) (2,848)
-------- --------
(Decrease) increase in cash 416 (392)
Cash beginning of period 523 1,131
-------- --------
Cash end of period $ 939 $ 739
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for
Interest $ 928 $ 1,091
======== ========
Income taxes $ 0 $ 0
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
<PAGE> 5
INTEGRITY INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
(UNAUDITED)
BASIS OF PRESENTATION AND SUMMARY OF ACCOUNTING POLICIES
Integrity Incorporated (the "Company" or "Integrity") is a producer
and publisher of Christian lifestyle products developed to facilitate worship,
entertainment and education. Product formats include cassettes, compact discs,
videos and print music. The Company produces Christian music ranging from
praise and worship music, its largest category, to other styles of adult
contemporary Christian music and children's music. Integrity sells its products
primarily through retail stores and direct to consumers throughout the United
States and in over 140 other countries worldwide.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements and should be read in conjunction with the
financial statements contained in the Company's Annual Report, dated December
31, 1997. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the quarter ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998. Certain amounts in the prior years' financial statements
have been reclassified to conform with the current year presentation.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the
Company and its subsidiaries, which include Integrity Music Pty. Ltd.,
Integrity Music Europe, Ltd., Integrity Media Asia Pte. Ltd. and Celebration
Hymnal LLP. All significant accounts and transactions have been eliminated in
consolidation.
REVENUE RECOGNITION
Revenue is recognized at the time of shipment. Provision is made for
sales returns and allowances in the period in which the related products are
shipped based on estimates derived from historical data. The full amount of the
returns allowance is shown, along with the allowance for doubtful accounts, as
a reduction of accounts receivable in the accompanying financial statements.
Generally, revenue derived from licensing the use of songs in the Company's
song catalogs is recognized as payments are received from licensees.
MARKETING COSTS
The Company incurs marketing costs utilizing various media to generate
direct sales to customers. Marketing expenditures that benefit future periods
are capitalized and charged to operations using the straight-line method over a
period of six months, which approximates the period during which the related
sales are expected to be realized. Other marketing costs are expensed the first
time advertising takes place. Prepaid marketing costs, including artwork,
printing and direct mail packages, are included in assets in the accompanying
financial statements. Marketing costs expensed for the nine months ended
September 30, 1998 and 1997 approximated $3.5 million and $3.8 million,
respectively.
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PRODUCT MASTERS
Product masters, which include sound recordings and print masters, are
amortized over their future estimated useful lives, using a method that
reasonably relates to the amount of net revenue expected to be realized. The
costs of producing a product master, including the cost of the musical talent,
the cost of the technical talent for engineering, directing and mixing, costs
for the use of the equipment to record and produce the master and studio
facility charges are capitalized.
EARNINGS PER SHARE OF COMMON STOCK
The Company adopted SFAS 128, "Earnings per Share" effective December
31, 1997. SFAS 128 requires that the Company earnings per share be presented as
(i) basic earnings per share, which is computed by dividing income available to
common stockholders by the weighted average of common shares outstanding for
the period and (ii) diluted earnings per share, which is calculated by dividing
income available to common stockholders by weighted average of common shares
outstanding assuming issuance of potential dilutive common shares related to
options, warrants, convertible debt, or other stock agreements.
LONG TERM DEBT
The Company has a $19 million credit agreement with a financial
institution, which includes a $6 million revolving credit facility and a $13
million term loan maturing on August 6, 2002. At the Company's option, the
credit agreement carries an interest rate of the bank's base rate plus 1 1/2%,
or LIBOR plus 3%. The lender holds warrants exercisable for up to 12.5% of the
Company's Class A common stock. The warrants have an exercise price of $1.875
and expire in 10 years. Under the terms of the financing agreement, the
warrants became exercisable in August 1998.
5
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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Total net revenue increased $2.7 million or 10.9% to $27.1 million for
the nine months ended September 30, 1998, from $24.4 million during the nine
months ended September 30, 1997. This increase in sales revenue is primarily
attributable to strong sales in church/choral and hymnal products. Sales of
church/choral products increased $907,000 or 47.6% to $2.8 million, compared to
$1.9 million in the same period in 1997, due to strong releases in the first
nine months of 1998 and increased market share through an expanded auto-release
program to targeted churches and church leaders. Sales of hymnal products
increased $1.6 million or 306% to $2.1 million compared to $526,000 in 1997, as
the Company did not launch hymnal products until April of 1997. Retail/Special
sales increased by $323,000 or 4.0% to $8.5 million, compared to $8.2 million
for the same period in 1997. Copyright revenue increased 10.8% to $3.4 million
from $3.1 million in the same period in 1997, and direct to consumer revenue
decreased 8.4% to $5.6 million versus $6.2 million in the same period in 1997.
New product sales in all divisions amounted to $7.1 million or 26.2% of net
revenue for the nine months ended September 30, 1998 versus $6.9 million or
28.2% of net revenue for the same period in 1997. For the quarter ended
September 30, 1998, total net revenue increased $807,000 or 9.4% to $9.4
million, from $8.6 million in the same period in 1997. The increase is due
mainly to increased sales of church/choral and hymnal products with continued
sales of the Celebration Hymnal and sales from newly released ancillary
products that accompany the Hymnal.
Gross profit increased to $13.9 million, or 51.1% of sales, as
compared to $13.1 million, or 53.4% of sales, for the nine month periods ended
September 30, 1998 and 1997, respectively. The gross profit for the third
quarter decreased to $4.1 million, or 43.8% of sales, as compared to $4.4
million, or 51.0% of sales, for the same period in 1997. The decrease in gross
profit as a percentage of sales in the quarter and the nine month periods is
due to a charge of $700,000 to masters amortization and a sale of excess
inventory of $395,000 at cost which occurred in the third quarter. The charge
against product masters was the result of management's periodic estimates of
the eventual realizability of certain production costs. The sale of excess
inventory at cost involved no longer saleable inventory that does not compete
with any other product, thereby reducing inventory levels and turning that into
available working capital.
Marketing and fulfillment expenses decreased 11.7% to $4.7 million or
17.2% of net sales for the nine months ended September 30, 1998, as compared
with $5.3 million or 21.6% of net sales for the same period in 1997. For the
quarter ended September 30, 1998, marketing and fulfillment expenses were $1.3
million or 13.6% of net sales, compared to $1.7 million or 20.3% of net sales
for the same period in 1997. The decrease in marketing and fulfillment expenses
is partly attributable to fewer but more productive and targeted marketing
expenses in the direct to consumer division.
General and administrative expenses increased to $6.7 million or 24.5%
of net sales for the nine months ended September 30, 1998 as compared to $6.0
million or 24.5% of net sales for the same period in 1997. For the quarter
ended September 30, 1998, general and administrative expenses were $1.9 million
or 20.4% of net sales, compared to $1.7 million or 20.5% of net sales for the
same period in 1997. The increase from the 1997 period is mainly attributable
to compensation expenses, as the Company continues to invest in its
infrastructure to support its growth plans.
Interest expense decreased to $1.1 million for the nine months ended
September 30, 1998 as compared with $1.4 million for the same period in 1997.
The decrease was the result of lower average debt levels in the first nine
months of 1998. The average interest rates for the nine months ended September
30, 1998 and 1997 were 9.58% and 9.75%, respectively.
6
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LIQUIDITY AND CAPITAL RESOURCES
The Company has historically and will continue to finance its
operations primarily through cash generated from operations, although such
funds have also been supplemented by borrowing under a line of credit and term
notes as needed. The Company believes that funds generated from operations,
together with existing cash and available borrowings under its Credit Agreement
will be sufficient to finance its current operations and planned capital
expenditure requirements and internal growth at least through the next twelve
months.
Cash generated from operations totaled $4.9 and $5.0 million in the
nine months ended September 30, 1998 and 1997, respectively. The use of cash
varies from quarter to quarter based on product releases and scheduled
marketing promotions.
In accordance with industry practice, the Company's music products are
sold on a returnable basis. The Company's allowance for returns and doubtful
accounts is based upon historical returns and collections of the Company. Due
to the nature of sales through direct mail and consumer continuity programs,
the Company has a somewhat higher product return and doubtful account exposure
than other music companies where the majority of sales are in traditional
retail markets. For the nine months ended September 30, 1998 and 1997, the
provision for returns and doubtful accounts were $4.1 million and $3.1 million,
respectively.
Capital expenditures totaled $251,000 and $235,000 for the nine month
periods ended September 30, 1998 and 1997, respectively. Capital expenditures
made during 1998 included computer equipment and capital improvements to
existing buildings.
Other significant uses of cash were $2.1 million and $2.3 million for
product master development for the nine months ended September 30, 1998 and
1997, respectively. Product masters, which include sound recordings, print
masters and video masters, both live action and animated, are amortized over
their future estimated useful lives, using a method that reasonably relates to
the amount of net revenue expected to be realized. The cost of producing a
product master includes the cost of the musical talent, the cost of the
technical talent for engineering, directing and mixing, cost for the use of the
equipment to record and produce the master and studio facility charges. Current
book value for product masters is $8.4 million. From time to time, the Company
analyzes the book value of its product masters and adjusts, as necessary, for
those product masters not expected to recoup recording costs. Write-downs to
the value of product masters for the nine month periods ended September 30,
1998 and 1997 were $700,000 and $0, respectively.
YEAR 2000
The Company has implemented a program to identify, evaluate and
address the impact of the Year 2000 on its information systems to insure that
its network and software will manage the data involving date sensitive fields.
The program includes evaluation and corrections to software, hardware,
telephones, suppliers and distribution relationships. The Company believes all
in-house software is Year 2000 compliant. All non-compliant hardware and
telephones will be replaced in 1999 at a cost approximating $36,000. All major
suppliers and distributors have made representations that they will be Year
2000 compliant in 1999.
The Company expects the impact of the Year 2000 will not materially or
adversely affect the Company's business or results of operations. No assurance
can be given, however, that unanticipated or undiscovered Year 2000 compliance
problems will not have a material adverse effect on the Company's business or
results of operations. In addition, if the Company's clients or significant
suppliers and contractors do not successfully achieve Year 2000 compliance, the
Company's business and results of operations could be materially and adversely
affected, resulting from, among other things, the Company's inability to
properly exchange and/or receive data with its clients.
7
<PAGE> 9
The Company has not yet established a contingency plan to handle Year
2000 issues. The Company's program to identify, evaluate and address the impact
of the Year 2000 on its information systems will also seek to establish such a
contingency plan by December 31, 1998.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 establishes standards for the reporting and display of comprehensive
income, requiring its components to be reported in a financial statement that
is displayed with the same prominence as other financial statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 establishes standards for reporting financial information about
operating segments in annual financial statements and requires reporting of
selected information about operating segments in financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customer. The Company is
required to disclose this information for the first time when it publishes its
1998 annual report. Management is in the process of evaluating the segment
disclosures for purposes of reporting under SFAS No. 131. Management has not
determined what impact the adoption of SFAS No. 131 will have on the
consolidated results of operations, financial condition or cash flows of the
Company.
8
<PAGE> 10
PART II OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
On the Company's Annual Report on Form 10-K for the year ended
December 31, 1997, the Company reported that it had failed to meet one of the
new requirements for maintenance of the listing of its shares on The Nasdaq
National Market. This new requirement states that the value of its publicly
traded shares be $5 million. The new listing and maintenance requirements went
into effect February 23, 1998. The Company further indicated it had elected to
transfer its listing to The Nasdaq SmallCap Market. The company was given 90
days to regain compliance with the new maintenance requirement, the 90-day
period ending on May 28, 1998. The Company did regain compliance for 11 days
during this period.
On April 24, 1998, the Company announced through a press release that
it would suspend the process for listing on The Nasdaq SmallCap Market and
would take advantage of any and all review and appeal processes available to
continue trading its stock on The Nasdaq National Market. On May 29, 1998,
Nasdaq issued a letter advising that unless the Company filed for an appeal,
the Company's stock would be delisted from The Nasdaq National Market. The
Company filed an appeal and attended a hearing on July 24, 1998. The Company's
appeal remained under consideration for two months following that hearing. On
September 29, 1998, The Nasdaq Stock Market notified the Company that the
Company's securities would be moved to The Nasdaq SmallCap Market effective
October 2, 1998.
9
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
3(i) Certificate of Incorporation of the Registrant, as amended
(incorporated by reference from Exhibit 4(a) to the
Registrant's Registration Statement on Form S-8 (File No.
33-84584) filed on September 29, 1994).
3(i).1 Certificate of Amendment to the Certificate of Incorporation
of the Registrant, dated July 21, 1995, (incorporated by
reference from Exhibit 3(i).1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30,
1995).
3(ii) Bylaws of the Registrant, as amended (incorporated by
reference from Exhibit 3(ii) to the Registrant's
Registration Statement on Form S-1 (File No. 33-78582), and
amendments thereto, originally filed on May 6, 1994).
27 Financial Data Schedule (for SEC use only).
(B) REPORT ON FORM 8-K
There were no reports on Form 8-K filed for the quarter
ended September 30, 1998.
10
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEGRITY INCORPORATED
Date: November 6, 1998 /s/ P. Michael Coleman
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P. Michael Coleman
Chairman, President and Chief
Executive Officer
Date: November 6, 1998 /s/ Alison S. Richardson
- ------------------------ -----------------------------
Alison S. Richardson
Senior Vice President,
Finance and Administration
11
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<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 939
<SECURITIES> 0
<RECEIVABLES> 6,192
<ALLOWANCES> 746
<INVENTORY> 3,713
<CURRENT-ASSETS> 14,567
<PP&E> 8,000
<DEPRECIATION> 4,566
<TOTAL-ASSETS> 29,638
<CURRENT-LIABILITIES> 4,805
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0
0
<COMMON> 5,514
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