U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(Mark One)
|X| Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended October 31, 1996
|_| Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from _________ to _________
Commission file number 0-26238
The Source Company
(Exact Name of Small Business Issuer as Specified in Its Charter)
Missouri 43-1710906
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
11644 Lilburn Park Road
St. Louis, Missouri 63146
(Address of Principal Executive Offices)
(314) 995-9040
(Issuer's Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year, if Changed
Since Last Report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: 7,041,478 (as of November 27,
1996)
Transitional Small Business Disclosure Format (check one):
Yes_________ No X
<PAGE>
THE SOURCE COMPANY
QUARTERLY REPORT TO THE SECURITIES AND EXCHANGE COMMISSION
FOR THE QUARTER ENDED
October 31, 1996
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements Page
Unaudited Balance Sheet as of October 31, 1996 3
Unaudited Statements of Income for the three
months ended October 31, 1996 and 1995 and for the
nine months ended October 31, 1996 and 1995 5
Unaudited Statements of Cash Flows for the nine
months ended October 31, 1996 and 1995 6
Notes to Financial Statements 7
ITEM 2. Management's Discussion and Analysis 14
PART II - OTHER INFORMATION
ITEM 5. Other Information 20
ITEM 6. Exhibits and Reports on Form 8-K 20
SIGNATURE PAGE 21
EXHIBIT INDEX 22
<PAGE>
THE SOURCE COMPANY
Unaudited Balance Sheet
October 31, 1996
- --------------------------------------------------------------------------
Assets
Current
Cash $ 176,866
Receivables:
Trade (net of allowance for doubtful accounts
of $196,836) 6,668,776
Income Taxes 334,200
Related Parties 31,171
Employees 8,045
Interest Receivable 14,032
Notes Receivable - Officers 58,395
Prepaid Expenses 129,542
Other current assets 62,934
- --------------------------------------------------------------------------
Total Current Assets 7,483,961
- --------------------------------------------------------------------------
Office Equipment and Furniture 1,709,834
Less Accumulated Depreciation and Amortization 1,132,833
- --------------------------------------------------------------------------
Net Office Equipment and Furniture 577,001
- --------------------------------------------------------------------------
Other Assets
Notes Receivable - Officers 175,183
Investment in limited partnership 52,956
Goodwill, net of accumulated amortization 77,579
Unallocated purchase price of acquisitions 973,413
Cash surrender value of life insurance 71,618
Other 67,478
- --------------------------------------------------------------------------
Total Other Assets 1,418,227
- --------------------------------------------------------------------------
TOTAL ASSETS $ 9,479,189
- --------------------------------------------------------------------------
<PAGE>
THE SOURCE COMPANY
Unaudited Balance Sheet
October 31, 1996
- ---------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current
Note payable - bank (Note 3) $ 4,272,715
Accounts payable 299,463
Due to Retailers (Note 9) 113,213
Accrued liabilities:
Compensation 140,167
Other 127,138
Deferred income taxes 72,000
Current maturities of long-term debt (Note 4) 152,834
- ---------------------------------------------------------------------------
Total Current Liabilities 5,177,530
- ---------------------------------------------------------------------------
Long-term Debt (Note 4) 342,507
Less current maturities 152,834
- ---------------------------------------------------------------------------
Total Long-term Debt 189,673
- ---------------------------------------------------------------------------
Deferred income taxes 210,000
- ---------------------------------------------------------------------------
Total Liabilities 5,577,203
- ---------------------------------------------------------------------------
Redeemable Common Stock
211,245 Shares Issued and Outstanding 753,820
- ---------------------------------------------------------------------------
Stockholders' Equity
Preferred stock (Note 7) 56
Common stock 70,314
Additional paid-in-capital 2,986,468
Retained Earnings 91,328
- ---------------------------------------------------------------------------
Total Stockholders' Equity 3,148,166
- ---------------------------------------------------------------------------
TOTAL LIABILITIES, REDEEMABLE COMMON
STOCK & STOCKHOLDERS' EQUITY $ 9,479,189
- ---------------------------------------------------------------------------
<PAGE>
<TABLE>
THE SOURCE COMPANY
Unaudited Statements of Income
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Three Months Ended October 31, Nine Months Ended October 31,
1996 1995 1996 1995
-------------------------------- ----------------------------------
<S> <C> <C> <C> <C>
Commission Revenues $ 2,004,343 $ 2,014,017 $ 4,750,601 $ 5,591,922
Merchandise Revenues 95,847 473,968 108,088 816,501
- ----------------------------------------------------------------------------------------------------------------------
2,100,190 2,487,985 4,858,689 6,408,423
- ----------------------------------------------------------------------------------------------------------------------
Cost of Commission Revenues 1,222,833 1,051,916 3,573,925 2,608,100
Cost of Merchandise Sold 81,967 371,538 93,221 547,680
- ----------------------------------------------------------------------------------------------------------------------
1,304,800 1,423,454 3,667,146 3,155,780
- ----------------------------------------------------------------------------------------------------------------------
Gross Profit 795,390 1,064,531 1,191,543 3,252,643
Selling, General and Administrative
Expense 649,027 728,324 2,320,529 2,300,802
- ----------------------------------------------------------------------------------------------------------------------
Operating Income (Loss) 146,363 336,207 (1,128,986) 951,841
- ----------------------------------------------------------------------------------------------------------------------
Other Income (Expense)
Interest income 10,158 6,356 26,398 14,337
Interest expense (88,276) (36,788) (202,454) (83,970)
Other (3,589) (2,082) (14,304) 2,200
- ----------------------------------------------------------------------------------------------------------------------
Total Other Income (Expense) (81,707) (32,514) (190,360) (67,433)
- ----------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 64,656 303,693 (1,319,346) 884,408
Provision for Income Taxes (2,246) (115,848) 476,217 (460,500)
- ----------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 62,410 $ 187,845 $ (843,129) $ 423,908
- ----------------------------------------------------------------------------------------------------------------------
Earnings (Loss) per Share - Primary $ 0.01 $ 0.03 $ (0.13) $ 0.07
- ----------------------------------------------------------------------------------------------------------------------
Weighted Average of Shares
Outstanding - Primary 7,008,518 6,324,389 6,611,849 6,307,722
- ----------------------------------------------------------------------------------------------------------------------
Earnings (Loss) per Share - Fully
Diluted $ 0.01 N/A $ (0.13) N/A
- ----------------------------------------------------------------------------------------------------------------------
Weighted Average of Shares
Outstanding - Fully Diluted 7,008,518 N/A 6,611,849 N/A
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
THE SOURCE COMPANY
Unaudited Statements of Cash Flows
- ----------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Nine Months Ended October 31,
------------------------------------------
1996 1995
<S> <C> <C>
Operating Activities
Net income (loss) $ (843,129) $ 423,908
Adjustments to reconcile net cash provided by
operating activities:
Depreciation and amortization 167,711 111,159
Provision for losses on accounts receivable 97,636 81,004
Impairment of investments in limited partnership 15,000 15,000
Write-off related party receivable 0 10,644
Shareholder Distribution 0 (27,000)
Deferred income taxes (195,191) (44,000)
Services received in exchange for common stock 21,600 0
Changes in assets and liabilities:
(Increase)/Decrease in accounts receivable (2,361,834) (2,112,973)
(Increase)/Decrease in other assets (519,834) (231,707)
Increase/(Decrease) in A/P and accrued expenses (545,734) 916,182
Increase/(Decrease) in amounts due customers 29,758 0
- ----------------------------------------------------------------------------------------------------------------------------
Cash Used in Operating Activities (4,134,017) (857,783)
- ----------------------------------------------------------------------------------------------------------------------------
Investment Activities
Acquisition of Magazine Marketing, Inc. (275,000) 0
Repayments on Notes Receivable 29,715 3,582
Repayments from related party 22,000 270,240
Advances to employees (1,005) (3,000)
Capital expenditures (176,780) (171,570)
- ----------------------------------------------------------------------------------------------------------------------------
Cash Provided by (Used in) Investing Activities (401,070) 99,252
- ----------------------------------------------------------------------------------------------------------------------------
Financing Activities
Issuance of Common Stock 30,000 268,500
Issuance of preferred convertible stock 1,922,075 0
Borrowings under long-term debt agreements 281,317 0
Principal payments on long-term debt (104,261) (97,652)
Borrowings under short-term debt agreements 3,206,000 417,474
Repayments under short-term debt agreements (647,000) 0
Preferred stock dividends (6) 0
- ----------------------------------------------------------------------------------------------------------------------------
Cash Provided by Financing Activities 4,688,125 588,322
- ----------------------------------------------------------------------------------------------------------------------------
Increase/(Decrease) in Cash 153,038 (170,209)
Cash, beginning of period 23,828 252,555
- ----------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 176,866 $ 82,346
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
THE SOURCE COMPANY
Notes to Financial Statements (Unaudited)
1. Related Party
Transactions The Company purchases data processing services from
an employment service company owned by certain
officers of the Company. There were $276,049 and
$226,817 of such purchases made during the nine
months ended October 31, 1996 and 1995 respectively.
At January 31, 1995, the Company was indebted to
director and stockholder Timothy A. Braswell in the
amount of $56,192. Such debt bore interest at 10.0%
and matured on January 1, 1996. The Company's
indebtedness under the promissory note was secured
by an interest in the accounts receivable of the
Company. This obligation was fully satisfied as the
final payment was made on December 29, 1995.
One of the Company's stockholders also owns a
majority of stock of FMG, Inc., primarily an
investing company. At October 31, 1996 the Company
had a receivable from FMG of $31,171 at prime plus
.5%. This receivable was collected in full on
November 5, 1996.
The Company currently leases certain office space
and has, in the past, leased an airplane from
partnerships controlled by stockholders of the
Company. Amounts paid for the office space were
$138,780 and $110,250 for the nine months ended
October 31, 1996 and 1995, respectively. Amounts
paid for the airplane were $0 and $57,926 for the
nine months ended October 31, 1996 and 1995
respectively.
Three officers of the Company, have from time to
time, received cash advances from the Company. The
officers executed promissory notes in favor of the
Company in the aggregate amounts of $233,578. Such
notes bear interest at the rate of 7.34% per annum
and are payable in five equal installments which
began April 1996.
2. Notes OFFICERS
Receivable
The notes receivable relate to advances to certain
officers of the Company. The notes bear interest at
7.34% and are payable in five equal, annual payments
of $69,489 which began April 1996. These notes are
current and the Company is unaware of any
circumstances that would negatively impact the
collectibility of these notes.
<PAGE>
OTHER
The Company had a $120,000 unsecured, non-interest
bearing note from a non-affiliated company which
required quarterly installments of $6,000 through
June 2000. The note was stated net of discount of
$27,454 which was computed using a 10% imputed
interest rate. On March 31, 1996, the debtor
defaulted on the note. Based on the financial
condition of the debtor, the note was written off
resulting in a charge to selling, general and
administrative expenses during the year ended
January 31, 1996 of $92,063.
3. Notes Payable The Company had a revolving loan credit facility
providing for aggregate borrowings of $5,000,000
that was scheduled to expire on July 1, 1997.
Borrowings under the loans bore interest at the
bank's prime plus 1% (effectively 9.25% at October
31, 1996) and were secured by an assignment of
interest in the limited partnership investment,
personal guarantees of certain of the stockholders
of the Company, and a security agreement including
equipment, fixtures, personal property, accounts
receivable, contract rights, notes and general
intangibles.
Borrowings under the revolving credit facility at
October 31, 1996 were $4,272,715.
The revolving credit facility required the Company
to maintain specified levels of working capital and
net worth, restricted capital additions and the
payment of dividends, and limited additional
indebtedness. At October 31, 1996, the Company was
not in compliance with certain of these
requirements. However, as discussed at Note 10, on
December 6, 1996 the outstanding balance, including
interest, was paid by the Company with the proceeds
from the initial funding under a new credit facility
with another bank. The credit facility which was in
place at October 31, 1996 was simultaneously
terminated.
<PAGE>
4. Long-term Long-term debt consists of:
Debt
Note payable to stockholder (former
owner of Magazine Marketing, Inc.),
non-interest bearing, payable in
eight quarterly installments of
$10,000, discounted based on the
Company's effective borrowing rate $ 55,428
Term note payable in monthly
installments of $7,639 plus interest
at the bank's corporate base rate plus
1%, due June 1, 1999 244,440
Obligations under capital lease 42,639
----------------------------------------------------
Total Long Term Debt 342,507
Less Current Maturities 152,834
----------------------------------------------------
Long Term Debt $ 189,673
----------------------------------------------------
5. Supplemental Supplemental information on interest and income
Cash Flow taxes paid is as follows:
Information
Nine Months Ended October 31, 1996 1995
----------------------------------------------------
Interest $200,000 $ 84,000
Income Taxes $264,000 $460,500
----------------------------------------------------
6. Business ACQUISITION OF THE COMPANY BY PERIODICO, INC.
Combination
On May 1, 1995, Periodico, Inc. (formerly Garner
Investments, Inc.) acquired the Company through an
exchange of stock. Periodico then changed its name
to The Source Company.
Since Periodico had no significant assets or
operations at the transaction date, the transaction
was accounted for as an issuance of 959,389 shares
of common stock by the Company in exchange for the
net assets of Periodico, which were recorded at
Periodico's cost basis and amounted to $-0- at the
transaction date. In addition, the pre-transaction
date financial statements of the combined entity are
those of the Company.
<PAGE>
ACQUISITION OF DIXON'S MODERN MARKETING CONCEPTS,
INC. AND TRI-STATE STORES, INC.
On June 15, 1995, the Company acquired the assets of
Dixon's Modern Marketing Concepts, Inc. and
Tri-State Stores, Inc. (MMC) in exchange for 300,000
shares of common stock of The Source Company and the
assumption by the Company of all the liabilities of
MMC. The transaction has been accounted for as a
pooling of interests and, accordingly, the Company's
financial statements have been restated for all
periods prior to the acquisition to include the
results of operations, financial position, and cash
flows of The Source Company and MMC.
The S corporation retained earnings of MMC totaling
approximately $225,000 representing undistributed
earnings on June 15, 1995 net of $27,000 distributed
in lieu of taxes to shareholders, has been credited
to additional paid-in capital.
ACQUISITION OF MAGAZINE MARKETING, INC.
On June 28, 1996, the Company acquired all of the
stock of Magazine Marketing, Inc. in exchange for
100,000 shares of common stock of The Source Company
and $275,000 in cash. In addition, the Company shall
pay $10,000 at the end of each quarter for a two
year period following the closing date (or a total
of $80,000). The first such payment was made on July
29, 1996.
The transaction has been accounted for as a purchase
and, accordingly, the assets and liabilities have
been recorded at fair market value. Results of
operations have been included as of the effective
date of the transaction. The purchase price of the
transaction exceeds the fair value of the assets
acquired in the amount of $762,368.
The following schedule reflects pro forma statements
of income:
Six Months Ended July 31,
1996 1995
---------------------------------------------
Revenue $ 2,995,433 $ 4,371,347
Net income (loss) $ (883,911) $ 278,188
Net income (loss) per share $ (0.14) $ (0.04)
ACQUISITION OF READERS CHOICE, INC.
On June 30, 1996, the Company acquired all of the
issued and outstanding shares of Readers Choice,
Inc., a wholly owned subsidiary of United Magazine
<PAGE>
Company, in exchange for 111,245 shares of common
stock of The Source Company. This transaction has
been accounted for as a purchase and accordingly,
the assets and liabilities have been recorded at
fair market value. Results of operations have been
included as of the effective date of the
transaction. This transaction did not meet any of
the conditions to be considered a significant
business combination. The purchase price of the
transaction exceeds the fair value of the assets
acquired in the amount of $233,169.
7. Preferred Stock The Company has authorized 2,000,000 shares of $.01
par preferred stock. On March 13, 1996, 65,000
shares were designated as 1996 Series 7% Convertible
Preferred Stock. Rights and restrictions on the
remaining shares will be established if, and when,
any shares are issued.
Each share of the 1996 Series 7% Convertible
Preferred Stock entitles its holder to receive an
annual dividend, when and as declared by the Board
of Directors, of $7 per share payable in shares of
the Company's common stock; to convert it into
shares of common stock subject to the conversion
rights described in the Certificates Designations,
Preferences and Relative Rights of 1996 Series 7%
Convertible Preferred Stock (the Certificate); to
receive $100 per share in the event of dissolution,
liquidation or winding up of the Company, whether
voluntary or involuntary; and, subject to certain
conditions in the Certificate, may be redeemed at
the option of the Company at a price of $100 per
share or at the option of the holder at a price of
$100 per share within 30 days following the
effective date of a merger or consolidation in which
the Company is not the surviving entity.
During March 1996, the Company issued 20,000 shares
of 1996 Series 7% Convertible Preferred Stock for
$100 per share. Brokers' fees totaling $120,000 were
incurred in connection with the stock issuance's of
which $60,000 was paid in cash and $60,000 was paid
by issuance of an additional 600 shares of preferred
stock.
On June 3, 1996, an investor converted 5,000 shares
of the Company's 1996 Series 7% Convertible
Preferred Stock into common stock of the Company.
The conversion price was $3.55 per share, which
resulted in the issuance of 140,714 shares of common
stock. This conversion also resulted in the issuance
to certain of the Company's financial advisors of
options to purchase an additional 2,814 shares of
the common stock of the Company. This option to
purchase is exercisable for a two year period at an
exercise price equal to $4.26 per share.
On July 29, 1996 two investors converted 2,250 and
500 shares of the Company's 1996 Series 7%
Convertible Preferred Stock into common stock of the
Company. The conversion price was $3.65 per share,
which resulted in the issuance of 61,643 and 13,698
shares, respectively, of common stock.
<PAGE>
On August 30, 1996, the Company issued a common
stock dividend to investors who held the Company's
1996 Series 7% Convertible Preferred Stock. At this
date there were 12,850 shares of such stock
outstanding. The 7% dividend resulted in a common
stock dividend of 9,515 shares based on an issuance
price of $4.46 per share.
On September 11, 1996, an investor converted 5,000
shares of the Company's 1996 Series 7% Convertible
Preferred Stock into common stock of the Company.
The conversion price was $3.50 per share, which
resulted in the issuance of 142,857 shares of common
stock. This conversion also resulted in the issuance
to certain of the Company's financial advisors of
options to purchase an additional 2,857 shares of
the common stock of the Company. This option to
purchase is exercisable for a two year period at an
exercise price equal to $4.20 per share.
On September 22, 1996, an investor converted 2,250
shares of the Company's 1996 Series 7% Convertible
Preferred Stock into common stock of the Company.
The conversion price was $3.50 per share, which
resulted in the issuance of 64,285 shares of common
stock.
8. Advance Pay Program The Company has established an Advance Pay Program.
Under this program the Company advances an agreed
upon percentage of the incentive payments otherwise
due the retailer from magazine publishers upon
quarterly submission and processing of claims for
such payments. The claims otherwise due the
retailer become due the Company. Included in trade
receivables at October 31, 1996 is $2,124,204 due
the Company under the advance pay program (net of
$3,455,125 due the program participants). Income
from the program was $731,482 during the nine
months ended October 31, 1996 and was not material
in 1995.
9. Due To Retailers The Company has arrangements with certain of its
customers whereby the Company is authorized to
collect and deposit in its own accounts, checks
payable to its customers for incentive payments. The
Company retains the commission related to such
payments and pays the customer the difference. The
Company owes retailers $113,213 at October 31, 1996
under such arrangements.
10. Subsequent Events BANK FINANCING
On December 6, 1996 the Company received its
initial funding under a new credit agreement dated
November 14, 1996. The initial funding of
$4,550,000 was used to pay the then outstanding
debt under the old credit agreement which was
simultaneously terminated.
<PAGE>
The new credit agreement provides for revolving
loans of up to $8,700,000. The bank has the right to
terminate the agreement upon not less than thirteen
months prior written notice. Borrowings bear
interest at a rate related to the monthly LIBOR
index rate plus a percentage ranging from 2.5% to
3.5% depending upon the ratio of funded debt to
earnings before interest, taxes, depreciation and
amortization. Borrowings are secured by personal
guarantees of certain stockholders of the Company
and by a security agreement including receivables,
inventory, equipment, goods and fixtures, software,
contract rights, notes, and general intangibles.
The credit agreement requires the Company to
maintain certain financial ratios and to maintain a
specified minimum tangible net worth. As of the date
of this filing, the Company was in compliance with
these requirements.
11. Unaudited Recently, the Company has discovered certain
Financial deviations from its accounting practices and
Statements policies which affected the Company's financial
reporting at July 31, 1996 and the interim fiscal
periods then ended. The Company subsequently made
correcting entries and has implemented stringent
initiatives designed to prevent a reoccurrance of
such deviations. After giving effect to the
correcting entries, the Company's total revenues,
operating loss, net loss and loss per share-primary
for the six months ended July 31, 1996 were
$2,758,499; $1,275,349; $905,539; and $0.14,
respectively. Shortly, the Company will file amended
Forms 10-QSB for the affected periods with the
Securities and Exchange Commission.
In the opinion of management, the unaudited
financial information as of October 31, 1996
contained herein reflects all adjustments
(consisting only of normal recurring adjustments)
necessary to fairly present such information in
accordance with generally accepted accounting
principles. The results of operations for the nine
months ended October 31, 1996 are not necessarily
indicative of the results to be expected for the
entire year.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Quarterly Report contains forward looking information that is
subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected. Among these risks, trends and
uncertainties are those related to the ability of the Company to attract
adequate capital resources to fund its growth, and the dependence of the Company
on the terms of incentive programs over which it has no control. For a more
complete discussion of these and other risks, trends and uncertainties,
investors are directed to Exhibit 99.1 attached to the Company's Annual Report
on Form 10-KSB, a copy of which may be obtained without charge by written
request to the Company.
Overview
The Company provides monitoring, documentation and collection services
required to obtain single copy magazine sales incentive payments available for
magazine publishers to magazine and periodical retailers. The Company has
developed a contractual relationship with approximately 50,000 mass merchandise,
grocery and pharmacy stores located throughout the United States and in eastern
Canada under which it provides such services and related merchandising services
on a frequent basis, in many cases daily, and holds power of attorney from its
retailer clients to collect incentive payments from publishers. To further
expand its presence in the upper midwest and increase the number of its
mid-sized chain retailer clients, in June of 1995 the Company acquired all of
the business and assets of Dixon's Modern Marketing Concepts, Inc. and Tri-State
Stores, Inc., both of Chicago Heights, Illinois, in exchange for the issuance of
an aggregate of 300,000 shares of Common Stock. The Company has continued to
expand its operations in the upper midwest through the acquisitions of Magazine
Marketing, Inc. and Readers Choice, Inc., a wholly owned subsidiary of United
Magazine Company.
The Company issued 100,000 shares of its common stock, cash of $275,000
and a note payable totaling $80,000 payable quarterly over a two year period, in
exchange for all the stock of Magazine Marketing, Inc. This transaction has been
accounted for as a purchase and, accordingly, the financial statements reflect
the combined results of operations as of June 28, 1996, the transaction date.
Assets have been recorded at fair value and the purchase price in excess of fair
value has been recorded as unallocated purchase price of acquisitions.
The Company issued 111,245 shares of its common stock in exchange for
all issued and outstanding stock of Readers Choice, Inc. This transaction has
been accounted for as a purchase and, accordingly, the assets have been recorded
at fair value and the results of operations reflect combined results of
operations from June 30, 1996, the transaction date. The purchase price in
excess of the fair value of the assets has been recorded as unallocated purchase
price of acquisitions.
A majority of the Company's revenues are derived from commissions
earned in connection with the collection of incentive payments owed to the
Company's retailer clients from magazine publishers. Most such incentive payment
programs offer the retailer a cash rebate equal to a percentage of the
retailer's actual net sales of the publisher's titles which is payable quarterly
upon submission of a properly documented claim. Under agreements with its
retailer clients, the Company gathers sales data, submits claims for payment,
collects payments and receives a percentage of the aggregate payments collected
on the retailers' behalf. Claims for incentive payments are generally submitted
to the publishers quarterly based on actual net sales of the publishers' titles
recorded in the previous calendar quarter. Except in connection with its
expanded Advance Pay Program, the Company does not guaranty to its retailer
clients any payments due to the client from magazine publishers, and
<PAGE>
accordingly, does not assume any credit risk associated with such incentive
payments.
Under both the standard arrangement and the Advance Pay Program,
commission revenue is recognized at the time claims for incentive payments are
substantially completed for submission to the publishers based on the amount
claimed, less an estimated reserve necessary to maintain an allowance for
doubtful accounts of approximately 2% of trade accounts receivable. However,
under the standard arrangement, invoices for services provided by the Company in
connection with the claim process are not issued until the Company receives
settlement of the claim. Under the Advance Pay Program, the customer is not
invoiced for the commission, which is the difference between the claim and the
advance amount.
Recently, the Company has discovered certain deviations from its
accounting practices and policies which affected the Company's financial
reporting at July 31, 1996 and the interim fiscal periods then ended. The
Company subsequently made correcting entries and has implemented stringent
initiatives designed to prevent a reoccurrance of such deviations. After giving
effect to the correcting entries, the Company's total revenues, operating loss,
net loss, and loss per share-primary for the six months ended July 31, 1996 were
$2,758,499; $1,275,349; $905,539; and $0.14, respectively.
Results of Operations
The following table sets forth, for the periods presented, certain
information relating to the operations of the Company expressed as a percentage
of Total Revenue:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended October 31, Ended October 31,
------------------ ------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Commission Revenues 95.4% 80.9% 97.8% 87.3%
Merchandise Revenues 4.6% 19.1% 2.2% 12.7%
Total Revenue 100.0% 100.0% 100.0% 100.0%
Cost of Commission Revenues 58.2% 42.3% 73.6% 40.7%
Cost of Merchandise Sold 3.9% 14.9% 1.9% 8.5%
Gross Profit 37.9% 42.8% 24.5% 50.8%
Selling, General &
Administrative Expenses 30.9% 29.3% 47.8% 35.9%
Operating Income 7.0% 13.5% (23.3)% 14.9%
Interest Expense, Net (3.7)% (1.2)% (3.6)% (1.1)%
Other Income/(Expense), Net (0.2)% (0.1)% (0.3)% (0.0)%
Earnings Before Income
Taxes 3.1% 12.2% (27.2)% 13.8%
Net Income 3.0% 7.6% (17.4)% 6.6%
</TABLE>
<PAGE>
Commission Revenues
Although Commission Revenues for the third fiscal quarters of 1996 and
1997 were comparable, Commission Revenues for the nine month period decreased
$841,000 from the comparable period of Fiscal 1996 primarily resulting from a
decrease in space design revenues of $571,000. Space design revenues are
recognized as front end display manufacturers ship the displays to the
retailers, the timing of which is not within the Company's control. Another
significant factor contributing to the decrease in Commission Revenues was
magazine wholesaler consolidation. During calendar year 1996 many wholesalers
were purchased by or merged with competing wholesalers. These consolidations
made it difficult, if not impossible, at times to gather sales data. Currently,
this unusual activity in the wholesaler industry has slowed considerably and
accurate sales data is being collected in a timely manner.
The decreases discussed above were mitigated by increased retailer
participation in the Advance Pay Program. Commission Revenues from this program
increased from $200,000 for the nine month period ended October 1995 to $700,000
for the same period in the current year. Advance pay revenues increased from
$70,000 for the prior year third quarter to $250,000 for the current year third
quarter.
Merchandise Revenues
Merchandise Revenues decreased by $378,121 and $708,413 for the three
months and nine months ended October 31, 1996, respectively, over the prior
period. Such decreases are expected to continue as a result of management's
decision to de-emphasize this portion of its business.
Cost of Commission Revenues
The Cost of Commission Revenues increased approximately $1,000,000 and
$170,000 for the nine month period compared to the same period in the prior year
and the three month period compared to the same period in the prior year,
respectively. These increases were primarily the result of the Company's effort
to more precisely identify and reclassify categories of costs as direct costs of
commission revenues. Costs of producing commission revenues are inelastic and,
therefore, are not directly proportional to revenue.
Selling, General and Administrative Expense
As discussed above, the Company has reclassified certain categories of
costs as direct costs of commission revenues. Thus, certain costs included in
selling, general and administrative expense during the prior periods are now
classified as direct costs of commission revenues.
Selling, General and Administrative Expense plus Costs of Commission
Revenue (or "total costs") for the nine month period increased $986,000 over the
comparable period in the prior year. Wages accounted for $650,000 of the
increase. New hires, including personnel formerly employed by Magazine
Marketing, Inc., comprised approximately $370,000 of this increase, while the
balance of the increase was the result of raises and bonuses. Rent, telephone
and utilities have increased $130,000 as a direct result of expanding the square
footage rented in North Carolina and adding regional offices in Canada, Arizona
and California. Computer hardware and software acquisitions combined with
equipment and furniture acquisitions related to the additional regional offices
<PAGE>
contributed to a $30,000 increase in depreciation expense. Lastly, bad debt
expense increased approximately $140,000 over the comparable prior nine month
period.
The total costs for the third quarter increased $90,000 over the third
quarter of the prior year. Wages, rent, telephone, utilities, and depreciation
combined to account for an increase of $213,000 over the prior year third
quarter for the reasons noted above. Also, marketing expense increased $29,000
primarily due to costs related to an advertising agreement with Financial Power
Network to increase awareness of the Company. Although professional fees,
including accounting, legal and data entry fees, were comparable for the nine
month periods, these expenses decreased $140,000 in the current year third
quarter as compared to the prior year third quarter.
Interest Expense
Interest expense for the third quarter and the nine month period
increased $51,000 and $118,000, respectively, over the comparable periods in the
prior year. This increase is due primarily to the increased borrowings from
approximately $1,100,000 at October 31, 1995 to approximately $4,300,000 at
October 31, 1996.
Provision for Income Taxes
The Provision for Income Taxes for all periods presented differs from
the statutory rate due to non-deductible meals and entertainment, officers' life
insurance, country club dues, and auto lease expense.
Liquidity and Capital Resources
The Company's primary cash requirements are for funding the Company's
Advance Pay Program and selling, general and administrative expenses
(particularly salaries, travel and data entry expenses) incurred in connection
with the solicitation of new clients and the maintenance of existing accounts.
Historically, the Company has financed its business activities through cash flow
from operations, short-term borrowings under available lines of credit and
through the issuance of equity securities.
Net cash used by operating activities was approximately $4,134,000 for
the nine months ended October 31, 1996 compared to approximately $858,000 for
the same period in 1995. Cash advanced under the Advance Pay Program during the
period was approximately $4,162,000. As a result of increased participation in
the Advance Pay Program, the Company's trade accounts receivable increased
$2,500,000 since January 31, 1996. Another factor contributing to the increased
accounts receivable balance was a delay in filing claims during the first two
quarters caused by wholesaler consolidation and by internal consolidation of
operations of the once separate entities that now comprise the Company. The
average collection period for the nine months ended October 31, 1996 was 304.6
days (calculated as follows: 365 days/(Revenues/Average A/R)) compared to 143.9
days for the nine month period ended October 31, 1995. However, the average
daily cash collections for the period August 1, 1996 through December 17, 1996
was $56,790. Based on this average daily cash collection amount it would take
182 days to collect the October 31, 1996 accounts receivable. Management does
not consider this collection period acceptable. However, wholesaler
consolidation and internal consolidation of operations contributed to the
increase in the average collection period. Management plans to increase
resources in the collection area with the goal of reducing this average
collection period to 90 to 150 days.
The Company is primarily engaged in the business of providing services
to its retailer clients; therefore, its capital expenditure requirements are
minimal. At October 31, 1996, the Company had no outstanding material
commitments for capital expenditures.
<PAGE>
In response to the increased cash requirements necessary to fund the
Advance Pay Program, the Company replaced its credit facility with Boatmen's
with a new credit agreement dated November 14, 1996 with Wachovia Bank of North
Carolina, N.A. The initial funding took place on December 6, 1996 in the amount
of $4,550,000 and was used to retire then outstanding balances under the former
credit facility.
The new credit agreement provides for revolving loans of up to
$8,700,000. The borrowing base calculation under this credit facility allows for
a higher percentage of the accounts receivable to be eligible than under the
Boatmen's agreement. The bank has the right to terminate the agreement upon not
less than thirteen months prior written notice. Borrowings bear interest at a
rate related to the monthly LIBOR index rate plus a percentage ranging from 2.5%
to 3.5% depending upon the ratio of funded debt to earnings before interest,
taxes, depreciation and amortization. Borrowings are secured by personal
guarantees of Messrs. S. Leslie Flegel and William H. Lee and their spouses and
by a security agreement including receivables, inventory, equipment, goods and
fixtures, software, contract rights, notes, and general intangibles.
During March 1996, the Company sold an aggregate of 20,000 of its 1996
Series 7% Convertible Preferred Stock, $0.01 par value per share (the "Preferred
Stock"), in a series of transactions exempt from the registration requirements
of the Securities Act of 1933, as amended. The Preferred Stock was sold for an
aggregate purchase price of $2,000,000, resulting in net proceeds to the Company
of $1,802,075 after deducting commissions and expenses totaling $137,925 of
which $77,925 has been paid in cash and $60,000 was paid through the issuance of
an additional 600 shares of Preferred Stock.
On February 28, 1996, the Company sold 8,000 shares of its Common Stock
in a private transaction in reliance on Section 4(2) of the Securities Act and
Regulation D promulgated thereunder. The transaction resulted in net proceeds to
the Company of $30,000.
From time to time, the Company has made cash advances to the Company's
Chief Executive Officer totaling $221,485 at October 31, 1996. The Company has
made similar advances to the Company's Executive Vice President totaling $12,093
at October 31, 1996. Such advances are evidenced by promissory notes, bear
interest at the rate of 7.34%, are payable in four remaining equal annual
installments. The Company also made advances to FMG, Inc., a North Carolina
corporation in which Company officers hold a controlling interest. Such advances
bore interest at an annual rate equal to prime plus one-half percent, had a
balance at October 31, 1996 of $31,571, and was paid in full on November 5,
1996. Each of the related parties including those described above, which are
indebted to the Company are current with respect to all payments of principal
and interest, and the Company is unaware of any circumstances which are
reasonably likely to negatively impact the collectibility of such indebtedness.
At October 31, 1996, the Company's total long-term debt obligations
were $342,507 which included a $244,440 note payable which was paid in full on
December 6, 1996 in connection with the initial funding of the Company's new
credit facility. The remaining long-term debt totals $98,607, of which $61,154
is due in the next twelve months. The Company anticipates that the funds
necessary to satisfy these obligations will be derived primarily from cash flows
from operations.
<PAGE>
During the nine months ended October 31, 1996, the Company experienced
an operating loss of $1,128,986. The Company's expenses were at a level that
anticipated revenues from space design commissions and merchandise revenues far
in excess of revenues realized for the period. The Company believes that its
expense reduction initiative began to impact results of operations in the third
quarter. Further reductions in wages, rents, travel and entertainment, and auto
leases are expected to impact future quarters. Additionally, commission revenues
from the Advance Pay Program are expected to exceed third quarter levels due to
the recent conversion of two large retailers to the program.
<PAGE>
PART II
OTHER INFORMATION
Item 5. Other Information
Recently, the Company has discovered certain deviations from its
accounting practices and policies which affected the Company's
financial reporting at July 31, 1996 and the interim fiscal periods
then ended. The Company subsequently made correcting entries and
has implemented stringent initiatives designed to prevent a
reoccurrance of such deviations. After giving effect to the
correcting entries, the Company's total revenues, operating loss,
net loss and loss per share-primary for the six months ended July
31, 1996 were $2,758,499; $1,275,349; $905,539; and $0.14,
respectively. Shortly, the Company will file amended Forms 10-QSB
for the affected periods with the Securities and Exchange
Commission.
In October, 1996, W. Brian Rodgers joined the Company as Chief
Financial Officer replacing Lance C. McCord. Prior to joining the
Company, Mr. Rodgers practiced for more than six years as a
certified public accountant with BDO Seidman, LLP.
Item 6. Exhibits and Reports on Form 8-K
(a) See Exhibit Index.
(b) A report on Form 8-K/A dated June 28, 1996 reporting the
acquisition of Magazine Marketing, Inc. was filed September
11, 1996.
FINANCIAL STATEMENTS FILED IN CONNECTION WITH FOREGOING
REPORT
Balance sheet of Magazine Marketing, Inc. as of December
31, 1995 and the related statements of income and retained
earnings and cash flows for the year then ended.
Balance sheet of Magazine Marketing, Inc. as of June 28,
1996 and the related statements of income and cash flows
for the period January 1, 1996 through June 28, 1996.
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
THE SOURCE COMPANY
Date December 20, 1996 /s/ W. Brian Rodgers
-----------------------
W. Brian Rodgers
Chief Financial Officer
<PAGE>
EXHIBIT INDEX
Exhibit No. Description Page
- ----------- ----------- ----
27 Financial Data Schedule 23
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Jan-31-1997
<PERIOD-START> Aug-01-1996
<PERIOD-END> Oct-31-1996
<CASH> 176,866
<SECURITIES> 7,250
<RECEIVABLES> 6,865,612
<ALLOWANCES> 196,836
<INVENTORY> 0
<CURRENT-ASSETS> 7,483,961
<PP&E> 1,709,834
<DEPRECIATION> (1,132,833)
<TOTAL-ASSETS> 9,479,189
<CURRENT-LIABILITIES> 5,177,530
<BONDS> 0
0
56
<COMMON> 70,314
<OTHER-SE> 3,077,796
<TOTAL-LIABILITY-AND-EQUITY> 9,479,189
<SALES> 4,858,689
<TOTAL-REVENUES> 4,858,689
<CGS> 3,667,146
<TOTAL-COSTS> 2,230,529
<OTHER-EXPENSES> 12,094
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 202,454
<INCOME-PRETAX> (1,319,346)
<INCOME-TAX> 476,217
<INCOME-CONTINUING> (843,129)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (843,129)
<EPS-PRIMARY> (.13)
<EPS-DILUTED> (.13)
</TABLE>
