ITEM 1. BUSINESS
Introduction
Integrity Media, Inc. and Subsidiaries is a media/communications company
that produces, publishes and distributes Christian music, books and related
products. Integrity's music product formats include cassettes, compact discs,
videos, DVD's and printed music. The Company produces Praise and Worship music
in different musical styles for specific audiences such as children's music,
gospel music for the African-American audience, youth music and live worship
music for adult audiences. In July 2002, Integrity announced the purchase of INO
Records, LLC (formerly M2 Communications, L.L.C.), an artist-based independent
Christian music company headquartered in Nashville, Tennessee. The purchase of
INO Records, LLC allowed the Company to enter the Adult Contemporary/Rock
segment of Christian music. The Company's Integrity Publishers division, created
in 2001, produces and publishes Christian books. The first product offerings
were released in the third quarter of 2002. The Company first recorded sales
from the INO Records and Integrity Publishers divisions in the third quarter of
2002.
Integrity's recorded music products fall into two broad categories (i)
concept products which are centered on a specific theme, such as Praise and
Worship music and (ii) artist products, in which the artist is the focal point.
In addition to recorded music, Integrity produces Christian music video products
for certain Praise and Worship artists. Integrity's products also include
software and printed music, such as songbooks and sheet music, designed
primarily for distribution to churches and choral groups. Integrity's book
products are categorized in one of four categories: Inspirational, Christian
Living, Youth or Fiction.
Integrity's products are sold primarily through retail stores and
direct-to-consumer channels throughout the United States and in 168 other
countries worldwide. The Company has determined that its business is operated in
segments based on distribution channels. For specific information regarding the
financial performance of each segment, see Note 10 of the Notes to Consolidated
Financial Statements.
Integrity was organized as an Alabama corporation on May 1, 1987, and was
reincorporated in Delaware on October 1, 1993.
Products
Concept Products
Praise and Worship concept products are centered around a specific theme or
event rather than being focused on a specific artist. The Company's original
concept product series, Hosanna! Music®, consists of live recordings of Praise
and Worship music sung by an audience and worship leader rather than a
performing artist. The Company's Hosanna! Music® series has proven to be a
successful product line having just released its 121st recording in March 2004.
The Company's concept product line now includes: Hosanna! Music®, FairHope
Records®, Songs4Worship®, iWorship®, World's Best Praise and Worship®; and
Integrity Notes®, a series of greeting cards for general occasions and specialty
cards related to seasonal events, featuring verses from our Praise and Worship
songs.
Artist Products
In addition to concept products, the Company also produces artist
recordings in which the artist is the main focal point. These products have
recently included "Satisfy" with Kathryn Scott, "Bigger Than My Imagination"
with Michael Gungor and "Worship With Natalie Grant and Friends by Natalie
Grant. Some of the recent artist products released by the INO Records, LLC are
"Kiss of Heaven" with Darlene Zschech, "The Throne Room" with CeCe Winans and "A
Beautiful Glow" with Rock & Roll Worship Circus.
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Other Products
The Company has also produced a variety of other types of products, such as
musical video products featuring recordings of live performances by the
Company's artists, such as the Gold certified "Shalom Jerusalem" with Paul
Wilbur, and the children's music series, Just-For-Kids®, featuring the Donut
Man®, which includes multiple Gold and Platinum certified videos. Other videos
include the Gold certified Praise! Aerobics®, Praise and Worship music recorded
specifically for aerobic exercises. Other products include Integrity Music
Worship Software®, designed to assist music ministers in the selection of songs
(over 5,000 featured), planning rehearsals and services, and reviewing song
usage tracking. The Company, in partnership with two other Praise and Worship
music companies, has also produced the Double-Platinum certified "WoW Worship
(Blue)," the Platinum certified "WoW Worship (Orange)" and the Gold certified
"WoW Worship (Green)." The Company has also developed the Songs4Worship series
in conjunction with Time Life Music, which includes the Double-Platinum
certified "Songs4Worship - Shout To The Lord" and the Gold certified
"Songs4Worship - Holy Ground." In late 2002, the Company released the iWorship
series, featuring popular contemporary and emerging modern worship songs on CD,
along with DVDs that provide breathtaking visuals, sing-along lyrics and
click-tracks for musicians and worship leaders. The first release in the series
was certified Gold by the Recording Industry Association of America (RIAA) in
January 2003 and certified Platinum in October 2003.
Integrity's Christian music products also include printed music such as
songbooks and sheet music designed primarily for distribution to churches and
choral groups. The Company produced "God With Us," winner of the 1994 Gospel
Music Association Dove Award for best musical, which has remained on the best
sellers list on the non-seasonal musical charts for eight years running. Other
musicals include "God For Us," "Let Your Glory Fall," "God In Us," "We Believe"
and "Redeemer, Savior, Friend." Other printed music products include
orchestrations, octavos and "The Celebration Hymnal", a joint venture with Word
Entertainment ("Word"), featuring over 700 songs and hymns. Sales of this hymnal
had exceeded one million units by year-end 2003.
Integrity Publishers, Inc., the Company's book publishing division,
released its first Christian books into the market in the third quarter of 2002.
Product Creation
The Company's music product development process is based upon the creation
of new concept or artist products that are designed, scripted and marketed to
respond to a specific demand. Integrity Music and INO Records, LLC each conduct
planning processes for each new product in order to determine whether the final
product is likely to be successful in the market for which it is designed.
New product concepts for Integrity Music are based on responses to surveys
of the Company's current customer base as well as other market and product
research conducted by the Company and by independent consultants. Once a new
product concept has been identified, the concept is reviewed and discussed by
representatives of Integrity's creative, marketing and finance divisions. If the
product concept is approved by that group, then Integrity assembles a creative
team, which includes one or more artists and producers, generally employed on a
freelance or contract basis, and members of Integrity's creative division.
Following the development of the Integrity Music product concept, the
product is recorded in live settings at churches or civic auditoriums, in
independent studios in cities such as Los Angeles, California or Nashville,
Tennessee, or at Integrity's studio in Mobile, Alabama. A significant amount of
recording is done in independent studios. The studios in Mobile, Alabama are
mainly used as a post-production facility where the recordings are edited and
mixed. The manufacturers receive the master recordings from Integrity in digital
format and then produce a master to be used in the manufacturing process. The
Company reviews the final manufacturing master prior to production to ensure
that the quality of the recording has been maintained.
The Company's book product development process begins with the signing of a
contract with the author. The author and the Company negotiate on the concept
for the book. Once
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agreement has been reached on a concept, the author will create a manuscript for
submission to the Company for editorial changes. Design for the interior and
exterior of the book and marketing plans are formulated accordingly. The
Company's own editorial staff provides final approval before the book is
manufactured.
Distribution
The Company distributes its products domestically through two primary
channels: direct-to-consumer and retail markets. In addition, the Company has an
international distribution network that reaches markets in 168 countries.
Direct-To-Consumer
The Company's direct-to-consumer activities are based on a variety of
methods designed to reach the consumer directly. Among the methods are
continuity clubs, through which the member receives a new selection every six to
eight weeks and is billed for each product. Shipments continue until the Company
is instructed to cancel the membership. This differs from certain other music
clubs in which members have a "negative option" allowing them to decline monthly
selections before they are mailed and in which their only obligation is to
purchase a certain number of products over a stated period of time.
The Company rents mailing lists that include subscribers to Christian
magazines, purchasers of Christian mail order products and donors to Christian
ministries. When available, the Company obtains new mailing lists to conduct a
one-time solicitation in an approved direct mailing. Once a response is received
by Integrity, the customer's name is added to the Company's own mailing list.
Integrity also builds its direct-to-consumer database through space
advertisements in Christian magazines, television advertising and Internet
marketing.
The Company's first continuity club, Hosanna! Music®, released its 121st
recording in March 2004. Currently the Company operates several continuity
clubs, including the Songs4Worship and Integrity Notes® series. The clubs are
launched with a mailing of a new product announcement and solicitation to as
many as 500,000 people. After the initial mailing, the Company postpones further
direct mail solicitation campaigns for up to six months, utilizing the time to
study the response and evaluate the sustainability of the initial members. If
the initial membership proves to be sustainable based on product shipments, the
Company will roll out the club in an extensive direct mail effort to an average
of 900,000 people.
In addition to continuity clubs, the Company's direct-to-consumer program
includes mail order catalog sales, telemarketing, one-time offers to active
customers, television offers and sales through the Internet. The mail order
catalog and telemarketing programs are designed to increase sales to the
Company's current customers by increasing their awareness of Integrity's full
line of products, as well as to develop new customers for Integrity products.
The Company operates its Internet activity through integritymusic.com and
songs4worship.com. We have also expanded our marketing through direct response
television including the Songs4Worship series advertising with Time Life Music.
The Direct-to-Consumer segment also includes direct sales to churches of printed
products, including "The Celebration Hymnal," which features over 700 songs and
hymns and was introduced in 1997 in a joint venture with Word Entertainment.
Retail Markets
Integrity's music retail sales activities target two markets: the Christian
retail market ("CBA"), which includes sales of choral music products, and the
general retail market.
The Company currently utilizes Word Entertainment, a division of Warner
Music Group, to serve the CBA market. All CBA orders are fulfilled through Word,
which is responsible for warehousing Integrity Music and INO Records, LLC
products. Products are shipped and invoiced based on orders received directly
from Word's sales force through a computerized order entry system. Word services
the Company's customers from one warehouse located in Tennessee. Word is the
number two distributor in the CBA market according to SoundScan's Top 2003 CBA
Distribution Group Share chart.
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Distribution of our products to the general retail market (i.e., Walmart,
Target, etc.) is done through the Company's global marketing and distribution
agreement with Sony Music Entertainment and its subsidiary Epic Records.
Products released by INO Records, LLC prior to its acquisition by Integrity are
distributed by Warner Music Group for distribution to the general retail market.
The Company's Integrity Publishers subsidiary utilizes G. L. Services for
distribution of its products to CBA stores, the general market, and ABA stores
(i.e. Barnes & Noble, Books-a-Million, etc.). G.L. Services warehouses the
Company's book products in one warehouse located in Cincinnati, Ohio.
Retail sales efforts are overseen by an in-house sales staff and supported
by Integrity's own in-house staff for marketing, covering such things as
point-of-purchase advertising, radio promotion, and product publicity. The
Company also utilizes the marketing expertise of several outside marketing
firms.
International
The Company's international sales are made through a subsidiary located in
the United Kingdom (responsible for Europe), a subsidiary located in Australia
(responsible for Australia, New Zealand and the Solomon Islands), a subsidiary
located in Singapore (responsible for Singapore and Myanmar), a subsidiary
located in South Africa (responsible for South Africa) and an office located at
the Company's headquarters in Mobile, Alabama (responsible for Latin America).
Products are sold to more than 60 independent distributors who are licensed to
manufacture Integrity's music products from master recordings and distribute
them in a country or region and to approximately 18 importers to whom the
Company provides products. The Company's international distribution network
reaches markets in 168 countries. The Company continually evaluates ways to
expand into various markets through importers or through distributors licensed
to produce Integrity products from a master recording. For specific financial
information regarding the geographic areas that the Company's international
distribution network reaches, see Note 10 to Notes to Consolidated Financial
Statements.
The Company also develops music products specifically for certain markets.
This effort includes recording songs in indigenous languages as well as
utilizing local artists and local songs to produce the recordings. Integrity
currently produces music products in the Russian, Spanish, Mandarin Chinese,
French, German, Hindi, Portuguese and Indonesian languages. Some of Integrity's
artists are also involved in live performance tours to various countries.
Song Publishing
The Company's song catalog has accumulated ownership rights for over 2,800
songs and has generated a significant amount of royalty income from use by third
parties. A majority of the songs appearing on Integrity recordings are published
from the Company's song catalog.
Integrity emphasizes the development and maintenance of its song catalog.
Songs are selectively added to the song catalog based on the concept or theme of
a specific product design, or because the Company believes that the songs have
the potential to be a part of a future Integrity product. The Company believes
that its efforts have produced a distinctive Christian song catalog whose titles
are used not only on recorded media and radio and television programming, but
also in church services.
The Company licenses the use of its songs to churches through Christian
Copyright Licensing, Inc. ("CCLI"). Through CCLI, churches in the United States
are able to pay one licensing fee for the use of numerous Christian song
copyrights. The Company is paid a percentage of the licensing fees collected by
CCLI based on CCLI's estimates of the percentage of Integrity songs utilized by
the churches.
Warehousing and Fulfillment
The Company currently contracts with Word Entertainment, a division of
Warner Music Group, for its CBA retail market warehousing, physical inventory
and distribution functions of its
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music products. Word is one of several companies that provide this service in
the CBA market. All of the Company's music products are sold in the CBA retail
market by Word's sales force. Direct-to-consumer fulfillment services, including
order receipt and processing, data fulfillment services, database management and
payment processing, are handled by Integrity's own staff in Mobile. Integrity's
own distribution center located in Mobile is responsible for its
direct-to-consumer and international warehousing, physical inventory and
distribution functions. The Company's Integrity Publishers subsidiary utilizes
G.L. Services for warehousing and fulfillment of its products for the CBA, ABA
and general markets. Most of our products are sold on a returnable basis, which
is standard music and book publishing industry practice.
Copyrights and Royalty Agreements
The Company's music and book products are protected under applicable
domestic and international copyright laws. In addition, Integrity currently has
ownership rights to approximately 2,800 songs, which are also protected under
copyright law.
In general, works that are protected under copyright laws are proprietary,
which means that for a fixed period of time the copyright owner has the
exclusive right to control the publication (or other reproduction) of the
copyrighted work. Subject to the compulsory licensing provisions of the United
States Copyright Act covering audio recordings, a copyright owner may license
others to publish, reproduce, or otherwise use its copyrighted work, on an
exclusive or nonexclusive basis, subject to limitations (such as duration and
territory) and upon such other terms and conditions, including royalty payments,
as the copyright owner may require. Despite these protections, the Company's
revenues may be adversely affected by the unauthorized reproduction of
recordings for commercial sale, commonly referred to as "piracy," and by home
taping for personal use. See Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors.
Integrity pays music royalties in two different categories. The Integrity
songwriters are paid by Integrity's song publishing division when their songs
are used on an Integrity product, when used in public performances such as CCLI
use in churches and when used on third-party products. Artists, producers and
other song publishers are paid based on Integrity's sales of products containing
their works. Integrity owns the majority of the songs it produces, and does not
have to pay publisher royalties to third parties for those songs. Integrity's
book publishing division pays royalties to authors and literary agents based on
the number of units sold.
Seasonality
Retail sales for music and books are typically higher in the third and
fourth quarters because of holiday promotions. Direct-to-Consumer sales are
typically higher in the first quarter as a result of significant marketing
promotions in late December. Direct-to-Consumer promotions require a build up in
inventory in the fourth quarter and as a result, sales and accounts receivable
increase in the first quarter. It is important to note that sales from quarter
to quarter depend heavily on marketing promotions and new product releases.
Accordingly, results of operations in any one quarter may not be indicative of
results of operations for the entire year. See Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors.
Competition
The Company faces intense competition for discretionary consumer spending
from numerous other music companies, book publishers and entertainment companies
that utilize various formats, including audio recordings, film, video and other
media. Integrity competes directly with the products of other record companies,
book publishers and music publishers that distribute Christian music and books
to Christian bookstores, as well as with a number of secular companies. Many of
the Company's competitors have substantially greater financial resources than
Integrity. The Company competes on the basis of its ability to produce new
products that are attractive to consumers, sign established and new artists,
songwriters and authors and gain access to distribution channels.
Many of the Company's competitors have significantly longer operating
histories and greater revenues from their music and book product lines. The
Company's ability to continue to
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compete successfully will be largely dependent upon its ability to build and
maintain its reputation for quality Christian music and books, as well as other
communication products. See Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors.
Employees
As of December 31, 2003, the Company employed 218 individuals, 146 of whom
were located at the Company's Mobile, Alabama, headquarters and 21 were located
at the Tennessee offices of Integrity Publishers, Inc. and INO Records, LLC.
The Company has no collective bargaining agreements covering any of its
employees, has never experienced any material labor disruption and is unaware of
any efforts or plans to organize its employees. The Company considers relations
with its employees to be good.
Government Regulation
The Company's direct-to-consumer program is subject to federal regulations
governing unfair methods of competition and unfair or deceptive acts and
practices in or affecting commerce. These regulations generally prohibit the
solicitation of any order for sale of merchandise through the mail unless at the
time of solicitation the seller has a reasonable basis to expect that he will be
able to ship the merchandise within the time period indicated or within thirty
days if no time period is indicated. If there is any delay in the applicable
time period, the regulations require the seller to give the buyer the option to
cancel the order and receive a prompt refund or consent to a delay in shipment.
Management believes that the Company is in full compliance with the applicable
federal regulations governing its direct-to-consumer programs.
Privatization
On March 2, 2004, the Company issued a press release announcing the
execution of a merger agreement with Kona Acquisition Corp. that would have the
effect of taking the Company private. Kona Acquisition Corp. is wholly owned by
P. Michael Coleman, Integrity's principal stockholder, President and Chief
Executive Officer. The closing of this merger is contingent upon Kona's
financing and approval by a majority of Integrity's stockholders who are
unaffiliated with management.