Description

AMS stock price is currently sitting 46% off its 52 week high and at 52 week lows. The stock price has dropped a whopping 75% from a high in June 2002. The company has been raided by the FBI, hasn’t released financials since YE 2003 and numerous class action lawsuits have been filed. Yet, I believe that the future for AMS will be brighter and that a double is within reach due to the following:

1) New Management is in place to steer company truthfully forward.

2) The eventual submission of seven years restated financial statements (1997-2003) as well as reporting of YE 2004 & 2005 (ending in March) will provide clarity and assurance of earnings quality and financial stability.

3) Refocusing business on profitable business and the resumption of normalized margins FYE 2006

4) FYE 2006 Year over Year results should easily beat previous years numbers.

5) Reduction of cap-ex from investment to maintenance cap-ex will provide company excess FCF to reduce any existing debt, continue growth through acquisitions and give company the potential to reinstate share repurchases and dividends.


Key Statistics

Date: 2-24-2005
Price: 7.14
52-Week Range - 7.05 - 13.39
Ave. Daily Volume: 41,045
Shares O/S: 19.1
Market Cap: 136.4 mil.
Net Debt (Best Guess?) 25 mill.
Enterprise Value: 161.37
Est. Revenues: 945 mill
EV/Revenues: 17%


AMS was written up in VIC on January 27, 2003 by smitty818. At that time the stock price was $10.67. Please review smitty818’s write-up for a detailed summary about the business. I’ll concentrate on what has changed since the last write-up over two years ago.

Subsequent to smitty’s write-up, AMS has filed only one SEC financial report, the 10K for year ending March 31, 2003. Two years of non-filing is due to investigations on the company’s revenue reporting regarding their advertising services department, and seven years of re-auditing (1997 - 2003). Without audited financial statements, uncertainty remains and the stock price has suffered. Uncovering what AMS could look like in the future reveals some promising upside.

Here’s a brief timeline of events as reported through the company’s press department:

July 23, 2003 - AMS disclosed that a search warrant and related subpoena was issued by the U.S. District Court for the Southern District of California seeking records limited to the company's advertising services.
Aug. 18, 2003 - AMS announces delay in 10Q to investigate violations of federal law pertaining to announced government investigation of its advertising services.
Jan. 14, 2004 - AMS expects earnings reduction between 3 and 9 million over 5 year period prior to 2003.
Jan. 14, 2004 - AMS announces closing of one distribution facility at expense of 3 million dollars, yet expects to save 2 million annually.
Jan. 14, 2004 - AMS announces expected annual revenues of 1.0 to 1.1 billion
April 12, 2004 - AMS announces resignation of Michael Nicita, President & CEO, and Edward Leonard, CFO. Founder Charles Tillinghast named President and CEO, Bruce Myers, CFO.
April 29, 2004 - AMS signs $60 million credit facility with Wells Fargo
June 14,2004 - AMS announces net income reduction of $10 million over 7 year period (1997-2003).
Sept. 13, 2004 - AMS announces expected EPS for fiscal year 2004 of $.10-$.15 versus previous guidance of $.30-.$40 primarily due to increase in inventory reserves.
Oct. 18, 2004 - AMS announces resignation of Kevan M. Lyon, EVP Wholesale Merchandising/Distribution
Oct. 27, 2004 - AMS announces appointment of new CEO, Bruce Myers and retirement of Charles Tillinghast as company’s President, CEO and from the AMS Board of Directors.
Nov. 24, 2004 - AMS announces promotion of Adam Zoldan as new Executive VP and Chief Marketing Officer
Dec. 14, 2004 - AMS announces Curtis Smith as new EVP and Chief Financial Officer
Jan. 10, 2005- AMS announces business arrangement with Borders will end in March 2005. Borders accounted for 10% of total revenue. Borders mass-market book business will generate a loss in the fiscal year ending March 31, 2005.
Jan. 10, 2005 - AMS announced the cumulative effect of restatements on the seven years ended March 31, 2003 to be $11 million (previously $10 million).
Feb. 15, 2005 - AMS announces appointment of Michael Molina as EVP of Human Resources.

On October 4, 2004, Publishers Weekly ran a story about AMS and the investigation. Here’s what they had to say: “Marcy Roke, AMS Advertising Dir for Creative Services pleads guilty to two counts of conspiracy in connection with her participation in a scheme to defraud AMS customers. Roke admitted that she conspired with several employees at AMS, including the VP of Advertising and Dir. Of Adv, in a plan to increase the profitability of the advertising department by inducing publishers to pay for promotions that the company never provided. Roke admitted that circulation figures of magazines that publishers advertised in were inflated. Roke allegedly cheated publishers and misled retailers. According to the charges, Roke told AMS sales and advertising personnel that instead of contacting retailers about credit due them for providing certain advertising and promotional services, they should hide the discrepancies from the accounts, a move that decreased AMS’s advertising expenses. According to the SEC, Roke helped to overstate AMS’s pretax earnings by 9% in fiscal 2001, 10% in fiscal 2002 and 19% in fiscal 2003.”

Plugging in the above reduction of pretax earnings from years 2001 to 2003 (remember there are filings through year-end 2003) and using a 39% corporate tax for all three years yields an adjusted after tax net income reduction of $6.3 million for years 2001 through 2003. The 19% overstatement in 2003 appears to be an aberration from previous fraud in the 9 - 10 percent range. Therefore with 10% reductions to pre-tax income for the years 1997 through 2000 I get adjusted net income numbers that are $10.8 million dollars lower than reported net income. It appears that the company‘s public statements regarding the reduction of net income for the seven year period of $11.0 million seems reasonable.

Working with revised downward earnings for the years 1997 through 2003, and throwing in an extra non-adjusted year, 1996, for good luck, I argue that there’s some clarity to a very cloudy situation with regards to actual normalized margins. Again, using a 39% tax rate, over an eight year span I estimate AMS normalized and adjusted net margins to be 2%. AMS expected YE2004 revenues of between 1.0 and 1.1 billion dollars (see press release dated January 14, 2004). On Jan. 10, 2005, AMS released that company will cease doing business with Borders which was 10% of revenues. Backing out the Borders business nets revenues going forward YE 2006 to 945 million. With 2% normalized net margin, AMS is capable of earning .99 per share. This rough calculation doesn’t account for any interest expense. AMS recently signed a new credit facility with Wells Fargo (that incidentally was INCREASED by 33% from the previous facility from 45 mil to 60 mil). Historically, the company has used credit for holiday season cash needs and ended YE balances with no debt. It’s hard to say where debt currently stands, but conversation with a company source stated that the line is for “flexibility” and is nowhere near fully used.

Another valuation is to use pre-Borders margins. The Borders business that was canceled was initiated in fiscal year 2001. At the end of 2003 the Borders business accounted for 13 percent of revenues. During this period, AMS Distribution and Administration costs skyrocketed from 8.5% of revenues to over 14%. The Borders business was mostly low priced paperback wholesale distribution which required extensive labor costs. AMS did right in letting this business go. Past eight year average COGS expense is 87.5% . Average pre-Borders D&A expense was 7.95%.

Here’s what YE 2006 could look like:

YE 2006 (estimated)

Rev: 945,000
COGS 826,875 (@87.5%)
D&A 75,127 (@7.95%)

Operating Income: 42,998

Adjusted Operating Income: 38,698 (Adjusted downward 10% for previous fraudulent financials)
Taxes: 15,092 (Tax rate: 39%)
Net Income: 23,606
EPS: 1.24
PE: 5.75 ($7.14/1.24)


Est. Depreciation 8,000 (Last reported YE 2003. Could currently be closer to 10 mil.)

EBITDA: 46,698
EV/EBITDA: 3.46

Comparing EBITDA multiples to comp business Handleman (HDL) currently trading at a 5.8 ttm EBITDA (Yahoo site), AMS is cheap.

Year over year earnings going forward beginning YE2006 should be easy to beat. YE ‘04 and ‘05 will have hefty non-recurring expenses, such as realigning their distribution facilities (Jan. 14 press release) to the tune of 3 million and a big bath inventory write-down reducing after tax earnings by about $.25 per share or 8 million pre-tax (see press release dated Sept. 13, 2004). Not to mention all the legal and auditing expenses that the company has been incurring due to the restatements.

Cap-ex investment spending was 18.8 million greater than depreciation over years 2001 through 2003 due to implementation of new Oracle MIS system and expansion of distribution capacity. Anticipation of primarily maintenance cap-ex going forward should equalize spending to depreciation freeing up cash for debt reduction, acquisitions or reinstatement of dividend and share repurchase programs. Prior to accounting problem, AMS actually paid a dividend and had a share repurchase program.

CAP-EX DEPRECIATION
YE 2003 9.6 7.8
YE 2002 14.9 4.6
YE 2001 10.6 3.9

TOTAL 35.1 16.3

With a handful of new hires in the executive suite, AMS is ready to focus resources on running future business. I view the new Wells Fargo credit facility which increased credit 33% from $45 million to $60 million as a vote of confidence. The company’s ability to maintain their two biggest clients, Costco and Sam’s Club during this turbulent period also suggests the “stickiness” of relationship and valued services they provide. Additionally new management jettisoning unprofitable business as evidenced by discontinuation of the Borders business implies new management’s concern for profitability versus growing revenues.

Lastly, the well respected value investor Kahn Brothers have increased their holdings three times since the last proxy statement filed July 11, 2003 from 5.2% to 15.35% of the company. AMS also happens to be one of the Kahn’s largest current positions.

AMS stock price is now in the clearance bin. I believe that at current prices risk is minimized and the probability of future positive news and stock price appreciation is good.

Catalyst

1) New Management

2) Submission of financial statements

3) Refocusing business on profitable business and return to normalized margins

4) Positive year over year results beginning in FYE 2006

5) Reduction of cap-ex from investment to maintenance cap-ex will provide company excess FCF to reduce any existing debt, continue growth through acquisitions and give company the potential to reinstate share repurchases and dividends.