UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-K





R
            ANNUAL REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the fiscal year ended January 31, 2008





or





£
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the transition period from _______________to______________





Commission
file number 001-13437








SOURCE
INTERLINK COMPANIES, INC.


(Exact
name of registrant as specified in its charter)





Delaware
            20-2428299(State
      or other jurisdiction of
            (I.R.S.
      Employer Identification No.)incorporation
      or organization)27500
      Riverview Center Blvd.,Suite
      400, Bonita Springs, Florida
            34134(Address
      of principal executive offices)
            (Zip
      Code)incorporation
      or organization)(239)
      949-4450(Registrant’s
      telephone number, including area code)Securities
      registered pursuant to section 12(b) of the Act:Title
      of each class
            Name
      of exchange on which registeredCOMMON
      STOCK $0.01 PAR VALUE
            Nasdaq
      Global Select Market





Securities
registered pursuant to section 12(g) of the Act:





NONE





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as
      defined in Rule 405 of the Securities
Act.


£ Yes
      R
      No





Indicate
      by check mark if the registrant is not required to file reports pursuant
      to Section 13 or Section 15(d) of the
Act.


£ Yes
      R
      No





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.


R Yes £
No





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. £





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer or a smaller reporting company.
      See definition of “accelerated filer, large accelerated filer, and smaller
      reporting company” in Rule 12b-2 of the Exchange Act. (Check
      one):





£ Large
      accelerated filer
            R
      Accelerated filer
              £ Smaller
      reporting company
            £
      Non-accelerated filer





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Act).


£ Yes
      R
      No





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of July 31, 2007 was approximately $78.0
million computed by reference to the price at which the common equity was sold
on July 31, 2007, the last day of the registrant’s most recently completed
second fiscal quarter, as reported by The Nasdaq National Market.





At
      April 8, 2008 the Company had 52,320,837 shares of common stock $0.01 par
      value outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE


Portions
of the Registrant’s definitive Proxy Statement for the 2008 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Form
10-K.








TABLE OF
CONTENTS





PAGEPART
      IITEM
      1.BUSINESS.
            3ITEM
      1A.RISK FACTORS.
            9ITEM
      1B.UNRESOLVED STAFF COMMENTS.
            16ITEM
      2.PROPERTIES.
            17ITEM
      3.LEGAL PROCEEDINGS.
            17ITEM
      4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
            17PART
      IIITEM
      5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
      ISSUER PURCHASES OF EQUITY SECURITIES.
            17ITEM
      6.SELECTED FINANCIAL DATA.
            18ITEM
      7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF OPERATIONS.
            19ITEM
      7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
    RISK.
            40ITEM
      8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
            41ITEM
      9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
      FINANCIAL DISCLOSURE.
            41ITEM
      9A.CONTROLS AND PROCEDURES.
            41ITEM
      9B.OTHER INFORMATION.
            43PART
      IIIITEM
      10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
            44ITEM
      11.EXECUTIVE COMPENSATION.
            44ITEM
      12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
      RELATED STOCKHOLDER MATTERS.
            44ITEM
      13.CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR
      INDEPENDENCE.
            44ITEM
      14.PRINCIPAL ACCOUNTANT FEES AND SERVICES.
            44PART
      IVITEM
      15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
            45SIGNATURES
            46EXHIBIT
      INDEX
            47








1


CAUTIONARY
      STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE
      SECURITIES LITIGATION REFORM ACT OF
1995





Some of
the information contained in this Annual Report on Form 10-K including, but not
limited to, those contained in Item 1 “Business” and Item 7 “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” along
with statements in other reports filed with the Securities and Exchange
Commission (the “SEC”), external documents and oral presentations, which are not
historical facts are considered to be “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The words “believe,”
“expect,” “anticipate,” “estimate,” “project,” and similar expressions often
characterize forward-looking statements. These statements may include, but are
not limited to, projections of collections, revenues, income or loss, cash flow,
estimates of capital expenditures, plans for future operations, products or
services, and financing needs or plans, as well as assumptions relating to these
matters. These statements are only predictions and you should not unduly rely on
them. Our actual results will differ, perhaps materially, from those anticipated
in these forward-looking statements as a result of a number of factors,
including the risks and uncertainties faced by us described below and those set
forth below under Item 1A “Risk Factors”:





-
            changes
      in advertising spending trends;





-
            changes
      in interest rates;





-
            volatility
      in fuel and paper prices;





-
            market
      acceptance of and continuing demand for physical copies of magazines,
      DVDs, CDs and other home entertainment
products;





-
            the
      impact of competitive products and
technologies;





-
            the
      pricing and payment policies of magazine publishers, motion picture
      studios, record labels and other key
vendors;





-
            changing
      market conditions and
opportunities;





-
            our
      ability to realize operating efficiencies, cost savings and other benefits
      from recent acquisitions; and





-
            retention
      of key management and employees.





We
believe it is important to communicate our expectations to our investors.
However, there may be events in the future that we are not able to predict
accurately or over which we have no control. The factors listed above provide
examples of risks, uncertainties and events that may cause our actual results to
differ materially from the expectations we describe in our forward-looking
statements. Before you make an investment decision relating to our common stock,
you should be aware that the occurrence of the events described in these risk
factors and those set forth below under Item 1A. “Risk Factors” could have a
material adverse effect on our business, operating results and financial
condition. You should read and interpret any forward-looking statement in
conjunction with our consolidated financial statements, the notes to our
consolidated financial statements and Item 7 “Management’s Discussion and
Analysis of Financial Condition and Results of Operation.” Any forward-looking
statement speaks only as of the date on which that statement is made. Unless
required by U.S. federal securities laws, we will not update any forward-looking
statement to reflect events or circumstances that occur after the date on which
the statement is made.





2


PART
I





ITEM 1.
BUSINESS.





OVERVIEW





We are a
premier marketing, publishing, merchandising and fulfillment company of
entertainment products including DVDs, music CDs, magazines, books and related
items serving about 110,000 retail store locations throughout North America. Our
fully integrated businesses include:




-
            Publication
      of print and digital content to the enthusiast community in the United
      States via:




-
            76
      publications





-
            90
      websites, and





-
            over
      65 events;




-
            Distribution
      and fulfillment of entertainment products to major retail chains
      throughout North America and direct-to-consumers via the
      Internet;





-
            Import
      and export of periodicals sold in more than 100 markets
      worldwide;





-
            Production
      and distribution content through magazines and via the internet to
      consumers in various niche and enthusiast markets.  Trade,
      Retail and Consumer events further enhance customer
      continuity.





-
            Coordination
      of product selection and placement for impulse items sold at checkout
      counters;





-
            Processing
      and collection of rebate claims;
and





-
            Design,
      manufacture and installation of metal wire display fixtures in major
      retail chains.




Our
clients include:




-
            Major
      automobile manufacturers and part suppliers, as well as enthusiast product
      manufacturers, wholesalers and
retailers;





-
            Major
      magazine national distributors such as Time Warner Retail Sales &
      Marketing, Inc. and Curtis Circulation Company, as well as a significant
      base of individual magazine
subscribers;





-
            Retailers,
      such as Wal-Mart Stores, Inc., The Kroger Company, Target Corporation,
      Walgreen Company, Ahold USA, Inc., Sears Holdings Corporation, Meijer,
      Inc., Barnes & Noble, Inc., Borders Group, Inc., Hastings
      Entertainment, Inc., Fry’s Electronics, Inc. and Circuit City Stores,
      Inc.; and





-
            e-commerce
      retailers, such as amazon.com, barnesandnoble.com, circuitcity.com and
      bestbuy.com.




Our
suppliers include:




-
            Major
      paper mills and printing press outsource
  providers;





-
            Record
      labels, such as Vivendi Universal S.A., Sony BMG Music Entertainment
      Company, WEA Distribution and
Thorn-EMI;





-
            Motion
      picture studios, such as The Walt Disney Company, Warner Home Video, Sony
      Corp., The News Corporation, and Viacom Inc.;
  and





-
            Magazine
      National Distributors, such as COMAG Marketing Group, LLC, Time Warner
      Retail Sales & Marketing, Inc., Curtis Circulation Company and Kable
      Distribution Services, Inc.




On August
1, 2007, the Company completed its acquisition of Primedia Enthusiast Media,
Inc. (“EM”) pursuant to the terms and conditions of the Stock Purchase Agreement
dated May 13, 2007 (the “Agreement”). EM is one of the largest providers of
print and digital content to the enthusiast community in the United
States.  EM’s business was comprised of 76 publications, 90 websites and
over 65 events.  In addition, its portfolio of strong brands afforded EM
several different licensing opportunities for consumer goods products,
television and radio shows.  EM’s print titles include Motor Trend,
Automobile, Hot Rod, Lowrider, Power & Motoryacht, Surfer, Surfing,
Snowboarder, Soap Opera Digest and Soap Opera Weekly.  Its web properties
include automotive.com, equine.com and motortrend.com.





3




Following
the acquisition, we organized the combined company into four operating business
units:





-
            Media
      – The Media segment sells print advertising space in its enthusiast
      publications, sells enthusiast publications via newsstand and
      subscription, and sells online advertising and lead generation
      services.





-
            Magazine
      Fulfillment – The magazine fulfillment segment sells and distributes
      magazines to major retailers and wholesalers, imports foreign titles for
      domestic retailers and wholesalers, exports domestic titles to foreign
      wholesalers, provides return processing services, serves as an outsource
      fulfillment agent and provides customer-direct
  fulfillment.





-
            DVD
      and CD Fulfillment – The DVD and CD fulfillment segment sells and
      distributes pre-recorded music, videos, video games and related products
      to retailers, provides product and commerce solutions to retailers and
      provides customer-direct fulfillment and vendor managed
      inventory.





-
            In-Store
      Services – The in-store services segment designs, manufactures and
      invoices participants for front-end display fixture programs
      and provides claim filing
services.




See
      Note 17 to the Consolidated Financial
  Statements.







STRATEGIC
ALTERNATIVES PROCESS





In 2008,
our Board of Directors, in consultation with its strategic advisor, The Yucaipa
Companies, LLC (“Yucaipa”), hired Deutsche Bank Securities Inc. to act as its
exclusive financial advisor in its process of evaluating strategic alternatives
to enhance stockholder value, including but not limited to, a recapitalization,
strategic acquisitions, and the combination, sale or merger of the Company with
another entity.





Yucaipa
is an affiliate of AEC Associates, LLC, our largest shareholder.





On May
13, 2007, the Company completed its evaluation of strategic alternatives by
announcing the acquisition of Primedia Enthusiast Media, Inc.  As a
result, the Company paid Yucaipa $12.7 million in connection with its advisory
services.





CORPORATE
GOVERNANCE





Copies of
our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports
on Form 8-K and all amendments to those reports are available, as soon as
practicable after filing with the SEC, free of charge on our website,
www.sourceinterlink.com. Our Code of Business Conduct and Ethics is also
available on our website, together with the charters for the Audit Committee,
Compensation Committee, Nominating and Corporate Governance Committee and
Capital Markets Committee of our Board of Directors. Written requests for copies
of these documents may be directed to Investor Relations at our principal
executive offices.





REINCORPORATION
FROM MISSOURI INTO DELAWARE





On
February 28, 2005, we reincorporated our company from Missouri into Delaware
(the “Reincorporation”). The Reincorporation was adopted and approved at a
special meeting of our shareholders.





INDUSTRY
OVERVIEWS





HOME
ENTERTAINMENT CONTENT





According
to industry sources, including the Motion Picture Association, the Recording
Industry Association of America, Harrington Associates, LLC, and the American
Booksellers Association, the total retail market in calendar year 2006 for DVDs,
prerecorded music, single-copy magazines and books was approximately $59.4
billion.





The
structure of the distribution channel for single-copy magazines is that
publishers each generally engage a single national distributor, which acts as
its representative to regional and local wholesalers and furnishes billing,
collecting and marketing services throughout the United States or other
territories. These national distributors then secure distribution to retailers
typically through a number of regional and local wholesalers. The wholesalers
maintain direct vendor relationships with the retailers. Retailers in the
mainstream retail market, which consists primarily of grocery stores, drug
stores and mass merchandise retailers require these wholesalers to provide
extensive in-store services including, for traditional trading terms accounts,
receiving and verifying shipments, and for scan-based and traditional trading
terms accounts, stocking new issues and removing out-of-date issues. However,
this structure is not economically viable in the specialty retail market, which
consists of bookstore chains, music stores and other specialty retailers. Thus,
wholesalers servicing the specialty retail market typically do not provide these
in-store services.




4





In
contrast, the distribution channel for prerecorded video and music products is
dominated by the major motion picture studios and record labels, which through
their respective distribution units periodically compete with intermediaries by
seeking to establish direct trading relationships with high volume retailers.
This disintermediation strategy has limited appeal to retailers that demand a
variety of value-added services, including e-commerce support, inventory
management, return logistics, advertising and marketing assistance, information
services, and in store merchandising services to manage these increasingly
volatile categories. Some retailers have sought to maintain a dual supply chain
by establishing a direct trading relationship with the major studios and record
labels for high volume product, primarily newly released titles, and a more
expansive procurement and service relationship with intermediaries to secure
lower volume, higher margin product and value-added services.





IN-STORE
SERVICES





Front-End
Management





The
retail sale of single-copy magazines is largely an impulse purchase decision by
the consumer, and the retail sale of other home entertainment content is
becoming increasingly so. As a result, motion picture studios, record labels,
publishers and manufacturers of other impulse merchandise such as confections
and general merchandise (i.e., razor blades, film, batteries, etc.) consider it
important for their products to be on prominent display in those areas of a
store where they will be seen by the largest number of shoppers in order to
increase the likelihood that their products will be sold. Retailers typically
display DVDs, CDs, magazines, confections and general merchandise in specific
aisles, or the “mainline,” and the checkout area, or the “front-end.” Product
visibility is highest in the front-end because every shopper making a purchase
must pass through this area.





Due to
the higher visibility and resulting perception of increased sales potential,
vendors compete vigorously for favorable display space in the front-end. To
secure the desired display space, vendors offer rebate and other incentive
payments to retailers, such as:





-
            initial
      fees to rearrange front-end display fixtures to ensure the desired
      placement of their products;





-
            periodic
      placement fees based on the location and size of their products’ display;
      and





-
            cash
      rebates based on the total sales volume of their
  products.





Due to
the high volume of sales transactions and great variety of incentive programs
offered, there is a significant administrative burden associated with front-end
management. As a result, most retailers have historically outsourced the
information gathering and administration of rebate claims collection to third
parties such as our company. This relieves retailers of the administrative
burdens, such as monitoring thousands of titles each with a distinct incentive
arrangement.





OUR
BUSINESS





Our
business consists of four operating segments, as discussed above. Due to the
similar operating characteristics of the Magazine Fulfillment and DVD and CD
Fulfillment, they are discussed in aggregate, as the Fulfillment business unit
below.





MEDIA





Source
Interlink Media encompasses the Company’s publication of consumer publications,
the Internet, events, licensing and merchandising.  Readers value
enthusiast publications for their targeted editorial content and also rely on
them as primary sources of information in their topic areas. This aspect makes
the enthusiast properties important media buys for advertisers. Advertising
sales for the Company’s enthusiast publications are generated largely by
in-house sales forces.




Brands




The
Company publishes 56 automotive titles, including consumer automotive
publications such as Automobile and Motor Trend which cater to the high-end and
new car automotive market, as well as highly specialized enthusiast titles such
as Hot Rod, Truckin’, Super Street, Lowrider, Motorcyclist, 4Wheel &
Off-Road and Four Wheeler. The Company’s automotive magazines represent the
largest portfolio of magazines in the automotive category. Automotive print
publications are supplemented by our strong internet presence and co-branded
websites.




The
Company is a publisher for other enthusiast markets with such titles as
Stereophile, Power & Motoryacht and EQUUS. The Company also publishes
numerous magazines targeting action sports enthusiasts such as Surfing,
Skateboarder and Snowboarder. The Company’s major competition in the enthusiast
market includes the titles comprising the Time4Media division of Time
Warner Inc., which are under contract for sale to the Bonnier Group. We
publish two soap opera magazines, Soap Opera Digest and Soap Opera Weekly, which
compete with Bauer Publishing.




5




The
Company is focused on building multiple online revenue streams, including
subscriber acquisition, transactions that connect buyers and sellers, lead
generation and pay-per-click and other online advertising.




Automotive.com,
incorporated in 1999, has proven expertise in car sales lead generation, search
engine marketing, search engine optimization and a technology platform that can
drive increased traffic and ultimately monetize that traffic into high quality
lead generation. As automakers divert marketing dollars to the Internet and as
auto dealers seek increased car sale leads, the combination of Automotive.com
and the automotive Internet sites provides a platform for maximizing advertising
and lead generation revenues across all those sites.







FULFILLMENT





In the
spring of 2001, we acquired a group of affiliated domestic magazine distributors
to establish a platform from which to offer an expanding list of merchandise and
services to retailers. From 2002 through 2004, we continued to expand our
magazine product offerings by licensing and then purchasing international
distribution rights to a series of domestic magazine titles. In February 2005,
we further expanded our product offering beyond magazine fulfillment to include
DVDs, CDs and other home entertainment content products through our merger with
Alliance. In May 2005, we acquired Chas. Levy Circulating Co., one of the
principal magazine wholesalers in the United States, for the purpose of
strengthening our position in the domestic retail market. In March 2006, we
acquired Anderson Mid-Atlantic News, LLC and Anderson-SCN Services, LLC, major
distributors of magazines in the mid-Atlantic and Southern California regions,
respectively. For a more complete discussion of the Alliance merger, the
acquisition of Chas. Levy Circulating Co., and the acquisitions of Anderson
Mid-Atlantic News, LLC and Anderson-SCN Services, LLC, see “Recent
Developments.”





Currently,
our Fulfillment segments offer a broad array of products and services including
the following:





Product
Procurement





Through
our extensive relationships with record labels, motion picture studios, magazine
publishers and other producers of home entertainment content, we can offer our
retail clients the ability to display virtually every domestic DVD, CD and
magazine title and a significant selection of foreign titled magazines. To
maintain the high order fill rate demanded by our clients, we have established
an in stock catalogue of approximately 300,000 CD titles and approximately
100,000 DVD titles. We purchase home entertainment content from every major
record label, motion picture studio and magazine publisher, typically on a fully
returnable basis.





Product
is received at strategically located distribution centers. The principal
distribution centers are located in Harrisburg, Pennsylvania, Coral Springs,
Florida, Shepherdsville, Kentucky, Dallas, Texas, Lancaster, Pennsylvania,
Ontario, California, and McCook, Illinois. At each of these distribution points,
we process merchandise orders using sophisticated warehouse management systems.
Once filled, orders are shipped to our retailers by a combination of third party
freight carriers and, in certain high volume locations, in-house truck delivery.
Given our broad distribution infrastructure, we are capable of delivering home
entertainment content overnight to virtually any location within the continental
United States.





Fulfillment
Services





Our
sophisticated warehouse management systems, just-in-time replenishment and order
regulation techniques enable us to offer value-added fulfillment services
including next day order delivery, ready for shelf inventory preparation (such
as price labeling and security device placement) and a wide variety of
electronic data interchange tools.





Most
customers utilizing our fulfillment services are brick and mortar retailers some
of which seek support for their e-commerce initiatives in the DVD and CD
markets. For these clients, which include barnesandnoble.com, amazon.com and
bestbuy.com, we offer a comprehensive e-commerce platform, which includes direct
customer product delivery, real-time inventory querying and commitment
capabilities, credit card processing and settlement services, custom packaging,
promotional inserts and customer care services.





6




Category
Management Services





For
retailers seeking a total merchandising solution, we offer category management
services that include product selection and preparation, fixturing, in-store
stocking and replenishment, marketing and promotional program development, and
inventory control.





IN-STORE
SERVICES





The
In-Store Services group provides rebate and other incentive payment collection
and display fixture design and manufacture.





Claim
Submission Services





Claim
submission services related to the display and sale of magazines have been the
historical core of our business. U.S. retailers engage our In-Store Services
group to accurately monitor, document, claim and collect publisher rebate and
other incentive payments. Our services are designed to relieve our clients of
the substantial administrative burden associated with documenting, verifying and
collecting their payment claims, and to collect a larger percentage of the
potential incentive payments available to the retailers.





We
established our Advance Pay Program as an enhancement to our claim submission
services. Typically, retailers are required to wait a significant period of time
to receive payments on their claims for incentive rebates. We improve the
retailer’s cash flow by advancing the claims for rebates and other incentive
payments filed by us on their behalf, less our commission, within a
contractually agreed upon period after the end of each quarter.





Front-End
and Point-of-Purchase Display Fixtures





To
enhance retailers’ marketing efficiency, we developed the capacity to design,
manufacture, deliver and dispose of custom front-end and point-of-purchase
displays for both retail store chains and product manufacturers. Retailers
perceive our experience in developing and implementing product display
strategies as helpful in improving the revenue they generated from the sale of
home entertainment content merchandise. In addition, we believe that our
influence on the design and manufacture of display fixtures enhances our ability
to incorporate features that facilitate the gathering of information. Our
services in this regard frequently include designing front-end display fixtures,
supervising fixture installation, selecting products and negotiating, billing
and collecting incentive payments from vendors. We frequently assist our
retailer clients in the development of specialized marketing and promotional
programs, which include special mainline or front-end displays and
cross-promotions of magazines and products of interest to the readers of these
magazines. Raw materials used in manufacturing our fixtures include wire, powder
coating, metal tubing and paneling, wood veneer and laminates, all of which are
readily available from multiple sources.




CUSTOMERS





Our
customers in the retail market consist of bookstore chains, music stores and
other retailers, as well as, grocery stores, drug stores and mass merchandise
retailers. One customer accounts for a large percentage of our total revenues.
Barnes & Noble, Inc. accounted for 21.6%, 19.6% and 27.5%in the fiscal years
ended January 31, 2008, 2007 and 2006 respectively.





MARKETING
AND SALES





Our
target market includes advertisers, magazine publishers, motion picture studios,
record labels, magazine distributors and retailers. We specialize in providing
nationwide home entertainment product distribution to retailers with a national
or regional scope. We believe that our distribution centers differentiate us
from our national competitors and are a key element in our marketing program.
Our distribution centers focus on our just-in-time replenishment and our ability
to deliver product, particularly magazines published on a weekly basis,
overnight to virtually any location within the United States and Puerto
Rico.





While we
frequently attend trade shows and advertise in trade publications, we emphasize
personal interaction between our sales force and customers so that our customers
are encouraged to rely on our dependability and responsiveness. To enhance the
frequency of contact between our sales force and our customers, we have
organized our direct sales force into a unified marketing group responsible for
soliciting sales of all products and services available from each of our
operating groups. We believe this combined marketing approach will enhance
cross-selling opportunities and lower the cost of customer
acquisition.





SEASONALITY
AND INFLATION





Our DVD
and CD Fulfillment segment is highly seasonal. The fiscal fourth quarter is
typically the largest revenue producing quarter due to increased distribution of
pre-recorded music, videos, and video games during the year end holiday shopping
season.





Our
Magazine Fulfillment segment is generally not impacted by a significant amount
of seasonality. The fiscal third quarter is typically the largest revenue
quarter due to increased distribution of certain monthly titles, such as fashion
titles and sports titles, and various quarterly, semi-annual and annual titles
that are only produced and distributed in the third quarter to be in retail
stores during the year end holiday shopping season.




7





Our
In-Store Services segment is also highly seasonal. Historically, the largest
revenue producing fiscal quarter for this segment is the third. This is
primarily due to the fact that most retailers for which we design, manufacture
and deliver product want their goods in their retail stores prior to the year
end holiday shopping season, which is our fourth quarter.





Generally,
during the last three years personnel and supplies costs have increase at a
moderate rate of inflation.  However, the retail price of magazines
and DVDs and CDs has remained static or declined.  As such we have
experience declining profit margins due to these macro-economic
factors.





COMPETITION





Each of
our business units faces significant competition.





Our Media
group competes for advertising on the basis of circulation and the niche markets
they serve. Each of the Company’s enthusiast publications faces competition in
its subject area from a variety of publishers and competes for readers on the
basis of the high quality of its targeted editorial, which is provided by
in-house and freelance writers.  In the high-end and new car markets,
our publications compete primarily against Car and Driver and Road and Track,
both owned by Hachette Filipacchi Media U.S. Inc.  The Company also
competes in individual enthusiast markets with a number of smaller,
privately-owned or regionally-based magazine publishers.





Our
Fulfillment groups distribute home entertainment product in competition with a
number of national and regional companies, including Anderson News LLC, Anderson
Merchandisers, L.P., Hudson News Company, The News Group, Ingram Book Group,
Inc., Ingram Entertainment, Inc., Handleman Company, and Baker & Taylor,
Inc. Major record labels and motion picture studios compete with us by
establishing direct trading relationships with the larger retail
chains.





Our
In-Store Services group has a very limited number of direct competitors for its
claims submission program, and it competes in a highly fragmented industry with
other manufacturers for wire display fixture business. In addition, some of this
group’s information and management services may be performed directly by
publishers and other vendors, retailers or distributors.





The
principal competitive factors faced by each of our business units are price,
financial stability, breadth of products and services, and
reputation.





MANAGEMENT
INFORMATION SYSTEMS





The
efficiency of our business units are supported by our information systems that
combine traditional outbound product counts with real-time checkout register
activity. Our ability to access real-time checkout register data enables us to
quickly adjust individual store merchandise allocations in response to variation
in consumer demand. This increases the probability that any particular
merchandise allotment will be sold rather than returned for credit. In addition,
we have developed sophisticated database management systems designed to track
various on-sale and off-sale dates for the numerous issues and regional versions
of the magazine titles that we distribute.





Our
primary operating systems are built on an open architecture platform and provide
the high level of scalability and performance required to manage our large and
complex business operations. We acquired certain of these systems in connection
with our acquisition of Alliance, including proprietary, real-time, fully
integrated enterprise planning, warehouse management and retail inventory
management systems.





We also
deploy a variety of additional hardware and software to manage our business,
including a complete suite of electronic data interchange tools that enable us
to take client orders, transmit advanced shipping notifications and place orders
with our manufacturing trading partners. We also use an automated e-mail
response system and automated call distribution system to manage our call center
and conduct customer care services.





Software
used in connection with our claims submission program and in connection with our
subscriber information website was developed specifically for our use by a
combination of in-house software engineers and outside consultants. We believe
that certain elements of these software systems are proprietary to us. Other
portions of these systems are licensed from a third party that assisted in the
design of the system. We also receive systems service and upgrades under the
license. We believe that we have obtained all necessary licenses to support our
information systems.





We employ
various security measures and backup systems designed to protect against
unauthorized use or failure of our information systems. Access to our
information systems is controlled through firewalls and passwords and we utilize
additional security measures to safeguard sensitive information. Additionally,
we have backup power sources for blackouts and other emergency situations.
Although we have never experienced any material failures or downtime with
respect to any management information systems operations, any systems failure or
material downtime could prevent us from taking orders and/or shipping
product.




8





We have
made strategic investments in material handling automation. Such investments
include computer-controlled order selection systems that provide labor
efficiencies and increase productivity and handling efficiencies. We have also
invested in specialized equipment for our rapidly growing e-commerce accounts.
We believe that in order to remain competitive, it will be necessary to invest
in and upgrade from time to time all of our information systems.





EMPLOYEES





As of
March 31, 2008, we had approximately 8,500 employees, of whom approximately
4,400 were full-time employees. Approximately 550 of our employees are covered
by collective bargaining agreements that expire at various times through August
31, 2009. We believe our relations with our employees are good.





RECENT
DEVELOPMENTS





Included
below is a summary of event(s) occurring after the end of the most recently
complete fiscal year, but prior to the filing of this Form 10-K:





On April
11, 2008, the Company entered into an interest rate swap agreement with Wachovia
Bank, N.A.  The interest rate swap is intended to hedge the Company’s
exposure to fluctuations in LIBOR on $210.0 million of 1-month LIBOR based debt
through April 29, 2011.  The Company expects that this swap agreement
will qualify for hedge accounting treatment in accordance with SFAS
133.





ITEM 1A.
RISK FACTORS.





Set forth
below and elsewhere in this Annual Report on Form 10-K and in other documents we
file with the SEC are risks and uncertainties that could cause actual results to
differ materially from the results contemplated by the forward looking
statements contained in this Annual Report on Form 10-K.





RISKS
RELATING TO THE BUSINESS





WE HAVE A
CONCENTRATED CUSTOMER BASE AND OUR REVENUES COULD BE ADVERSELY AFFECTED IF WE
LOSE ANY OF OUR LARGEST CUSTOMERS OR THESE CUSTOMERS ARE UNABLE TO PAY AMOUNTS
DUE TO US.





A
significant percentage of our sales are derived from a limited number of
customers. In particular, for the year ended January 31, 2008, Barnes &
Noble, Inc. accounted for approximately 21.6% of our total
revenues.





We expect
to continue to be dependent on a small number of customers for a substantial
portion of our revenues. If any of these customers were to terminate their
relationship with us, significantly reduce their purchases from us or experience
problems in paying amounts due to us, it would result in a material reduction in
our revenues, operating profits and cash flows.





WE DEPEND
ON ACCESS TO CREDIT.





We will
have significant working capital requirements principally to finance inventory,
accounts receivable and new acquisitions. We are currently a party to a
revolving credit facility with a syndicate of lenders arranged by Citicorp North
America. In addition, we are extended trade credit by our
suppliers.





Our
business will depend on the availability of a credit facility and continued
extension of credit by suppliers to support our working capital requirements. To
maintain the right to borrow revolving loans and avoid a default under a credit
facility, we will be required to comply with various financial and operating
covenants and maintain sufficient eligible assets to support revolving loans
pursuant to a specified borrowing base. Our ability to comply with these
covenants or maintain sufficient eligible assets may be affected by events
beyond our control, including prevailing economic, financial and industry
conditions, and we may be unable to comply with these covenants or maintain
sufficient eligible assets in the future. A breach of any of these covenants or
the failure to maintain sufficient eligible assets could result in a default
under these credit facilities. If we default, our lenders will no longer be
obligated to extend revolving loans to us and could declare all amounts
outstanding under our credit facilities, together with accrued interest, to be
immediately due and payable. If we were unable to repay those amounts, our
lenders could proceed against the collateral interest granted to them to secure
that indebtedness. The results of such actions would have a significant negative
impact on our results of operations and financial condition.





A
DISRUPTION IN THE OPERATIONS OF OUR KEY SHIPPER OR SHARPLY HIGHER COSTS COULD
CAUSE A DECLINE IN OUR REVENUES OR A REDUCTION IN OUR EARNINGS.





We are
dependent on commercial freight carriers, primarily UPS, to deliver our
products. If the operations of these carriers are disrupted for any reason, we
may be unable to deliver our products to our customers on a timely basis. If we
cannot deliver our products in an efficient and timely manner, our customers may
reduce their orders from us and our revenues and operating profits could
materially decline.




9





For the
year ended January 31, 2008, our freight cost represented approximately 5.6% of
our revenue. If freight costs were to materially increase and we were unable to
pass that increase along to our customers due to competition within our
industry, our financial results could materially suffer.





In a
rising fuel cost environment, our freight costs will increase. If we are unable
to pass the increased costs along to our customers, our results of operation may
materially decline.





OUR
STRATEGY WILL INCLUDE MAKING ADDITIONAL ACQUISITIONS THAT MAY PRESENT RISKS TO
THE BUSINESS.





Making
additional strategic acquisitions is part of our strategy. The ability to make
acquisitions will depend upon identifying attractive acquisition candidates and,
if necessary, obtaining financing on satisfactory terms. Acquisitions, including
those that we have already made, may pose certain risks to us. These include the
following:





-
            we
      may be entering markets in which we have limited
    experience;





-
            the
      acquisitions may be potential distractions to management and may divert
      company resources and managerial
time;





-
            it
      may be difficult or costly to integrate an acquired business’ financial,
      computer, payroll and other systems into our
  own;





-
            we
      may have difficulty implementing additional controls and information
      systems appropriate for a growing
company;





-
            some
      of the acquired businesses may not achieve anticipated revenues, earnings
      or cash flow;





-
            we
      may not achieve the expected benefits of the transactions including
      increased market opportunities, revenue synergies and cost savings from
      operating efficiencies;





-
            difficulties
      in integrating the acquired businesses could disrupt client service and
      cause us to lose customers;





-
            we
      may have unanticipated liabilities or contingencies from an acquired
      business;





-
            we
      may assume indebtedness of the acquired company that may leave the Company
      more leveraged;





-
            we
      may be required to invest a significant amount into working capital of the
      acquired company;





-
            we
      may have reduced earnings due to amortization expenses, goodwill or
      intangible asset impairment charges, increased interest costs and costs
      related to the acquisition and its
integration;





-
            we
      may finance future acquisitions by issuing common stock for some or all of
      the purchase price which could dilute the ownership interests of the
      existing stockholders;





-
            acquired
      companies will have to become, within one year of their acquisition,
      compliant with SEC rules relating to internal control over financial
      reporting adopted pursuant to the Sarbanes-Oxley Act of
    2002;





-
            we
      may be unable to retain management and other key personnel of an acquired
      company; and





-
            we
      may impair relationships with an acquired company’s, or our own,
      employees, suppliers or customers by changing
  management.





To the
extent that the value of the assets acquired in any prior or future
acquisitions, including goodwill or other identifiable intangible assets,
becomes impaired, we would be required to incur impairment charges that would
result in a material charge against our earnings. Such impairment charges could
reduce our earnings and have a material adverse effect on the market value of
our common stock.  At the end of fiscal year 2008, the net book value of
our goodwill and other identifiable intangibles was approximately $1,706.9
million.  At the end of fiscal year 2008, certain customer lists related to
our DVD and CD Fulfillment segment were evaluated and determined to be
impaired.  The impairment charge recorded in the fourth quarter of fiscal
2008 was approximately $35.3 million.  At the end of fiscal year 2007,
certain customer lists, non-compete agreements and goodwill related to our
In-Store Services segment were revalued and determined to be impaired.  The
impairment charges recorded in the fourth quarter of fiscal 2007 were
approximately $30.5 million.





If we are
unsuccessful in meeting the challenges arising out of our acquisitions, our
business, financial condition and future results could be materially
harmed.




10





WE DEPEND
ON ACCESS TO ACCURATE INFORMATION ON RETAIL SALES OF MAGAZINES IN ORDER TO OFFER
CERTAIN SERVICES TO OUR CUSTOMERS, AND WE COULD LOSE A SIGNIFICANT COMPETITIVE
ADVANTAGE IF OUR ACCESS TO SUCH INFORMATION WERE DIMINISHED.





We use
information concerning the retail sales of single copy magazines
to:





-
            compare
      the revenue potential of various front-end fixture designs to assist our
      customers in selecting designs intended to maximize sales in the
      front-end;





-
            identify
      sales trends at individual store locations permitting us to provide
      just-in-time inventory replenishment and prevent stock outs;
      and





We gain
access to this information principally through relationships with A.C. Nielsen
& Company, Barnes & Noble, Inc, Walgreen Company and The Kroger Company.
We do not currently have written agreements with all of these providers. We also
obtain a significant amount of information in connection with our rebate claim
submission services. Our access to information could be restricted as a result
of the inability of any of our data partners to supply information to us or as a
result of the discontinuation or substantial modification of the current
incentive payment programs for magazines. If our access to information were
reduced, the value of our information and design services could materially
diminish and our publisher and retailer relationships could be negatively
impacted.





OUR
REVENUE FROM THE SALES OF DVDS AND CDS MAY SUFFER DUE TO A SHIFT IN CONSUMER
DEMAND AWAY FROM THE PHYSICAL MEDIA AND TOWARD DIGITAL DOWNLOADING AND OTHER
DELIVERY METHODS.





Current
technology allows consumers to buy music digitally from many providers such as
Apple Computer (through iTunes), Music Match, Rhapsody, Microsoft (through MSN)
and others. The sale of digital music has grown significantly in the past few
years, and the recording industry saw sales revenue for CDs decline
significantly from calendar years 2001 to 2007. As this method of selling music
increases in popularity and gains consumer acceptance, it may adversely impact
our sales and profitability. The recording industry also continues to face
difficulties as a result of illegal online file-sharing and downloading. While
industry associations and manufacturers have successfully launched legal action
against downloaders and file sharers to stop this practice, there can be no
assurance of the effect of these lawsuits. File sharing and downloading, both
legitimate and illegal, could continue to exert pressure on the recording
industry and the demand for CDs. Additionally, as other forms of media become
available for digital download, our revenues and profitability attributable to
CDs and DVDs may be adversely affected.





Recent
advances in the technologies to deliver movies to viewers may adversely affect
public demand for DVDs offered by us. For example, some digital cable providers
and internet companies offer movies “on demand” with interactive capabilities
such as start, stop and rewind. Direct broadcast satellite and digital cable
providers have been able to enhance their on-demand offerings as a result of
their ability to transmit over numerous channels. Although not as advanced as
the digital distribution of music, Apple Computer (through iTunes) and others
have begun to offer video content digitally. Apart from on-demand technology,
the recent development and enhancement of personal video recorder technology
with “time-shifting” technology (such as that used by TiVo and certain cable
companies) has given viewers greater interactive control over broadcasted movies
and other program types. Also, companies such as Blockbuster Entertainment and
NetFlix are now offering subscription services which provide consumers the
ability to rent VHS cassettes and DVDs for indefinite periods of time without
being subject to late fees. If these methods of watching filmed entertainment
increase in popularity and gain consumer acceptance, they may adversely impact
revenues and profits.





WE
PARTICIPATE IN HIGHLY COMPETITIVE INDUSTRIES AND COMPETITIVE PRESSURES MAY
RESULT IN A DECREASE IN OUR REVENUES AND PROFITABILITY.





Each of
our business units faces significant competition.





Our Media
group competes for advertising on the basis of circulation and the niche markets
they serve. Each of the Company’s enthusiast publications faces competition in
its subject area from a variety of publishers and competes for readers on the
basis of the high quality of its targeted editorial, which is provided by
in-house and freelance writers.  In the high-end and new car markets,
our publications compete primarily against Car and Driver and Road and Track,
both owned by Hachette Filipacchi Media U.S. Inc.  The Company also
competes in individual enthusiast markets with a number of smaller,
privately-owned or regionally-based magazine publishers.





Our
Fulfillment group distributes home entertainment product in competition with a
number of national and regional companies, including Anderson News Company,
Anderson Merchandisers, L.P., Hudson News Company, News Group, Ingram Book
Group, Inc., Ingram Entertainment, Inc., Handleman Company, and Baker &
Taylor, Inc. Major record labels and motion picture studios periodically compete
with us by establishing direct trading relationships with the larger retail
chains.




11





Our
In-Store Services group competes in a highly fragmented industry with other
manufacturers for wire display fixture business. In addition, some of this
group’s information and management services may be performed directly by
publishers and other vendors, retailers or distributors. Other information
service providers, including A.C. Nielsen Company, Information Resources and
Audit Bureau of Circulations, also collect sales data from retail stores. If
these service providers were to compete with us, given their expertise in
collecting information and their industry reputations, they could be formidable
competitors.





Some of
our existing and potential competitors have substantially greater resources and
greater name recognition than we do with respect to the market or market
segments they serve. Because of each of these competitive factors, we may not be
able to compete successfully in these markets with existing or new competitors.
Competitive pressures may result in a decrease in the number of customers it
serves, a decrease in its revenues or a decrease in its operating
profits.





WE
CONDUCT A GROWING PORTION OF OUR BUSINESS INTERNATIONALLY, WHICH PRESENTS
ADDITIONAL RISKS TO US OVER AND ABOVE THOSE ASSOCIATED WITH OUR DOMESTIC
OPERATIONS.





Approximately
6.1% of our total revenues from magazine distribution for the year ended January
31, 2008 were derived from the export of U.S. publications to overseas markets,
primarily to the United Kingdom and Australia. In addition, approximately 4.7%
of our gross domestic distribution of magazines for the year ended January 31,
2008, consisted of the domestic distribution of foreign publications imported
for sale to U.S. markets.





The
conduct of business internationally presents additional inherent risks
including:





-
            unexpected
      changes in regulatory requirements;





-
            import
      and export restrictions;





-
            tariffs
      and other trade barriers;





-
            differing
      technology standards;





-
            resistance
      from retailers to our business
practices;





-
            employment
      laws and practices in foreign
countries;





-
            political
      instability;





-
            fluctuations
      in currency exchange rates;





-
            imposition
      of currency exchange controls; and





-
            potentially
      adverse tax consequences.





Any of
these risks could adversely affect revenue and operating profits of our
international operations.





Certain
suppliers have adopted policies restricting the export of DVDs and CDs by
domestic distributors. However, consistent with industry practice, we distribute
our merchandise internationally. We would be adversely affected if a substantial
portion of our suppliers enforced any restriction on our ability to sell our
home entertainment content products outside the United States.





SUBSTANTIALLY
ALL OF THE MAGAZINES DISTRIBUTED BY US ARE PURCHASED FROM FOUR SUPPLIERS AND OUR
REVENUES COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO RECEIVE MAGAZINE
ALLOTMENTS FROM THESE SUPPLIERS.





Substantially
all of the magazines distributed in the United States are supplied by or through
one of four national distributors, Comag Marketing Group, LLC, Curtis
Circulation Company, Kable Distribution Services, Inc. and Time Warner Retail
Sales and Marketing, Inc. Each title is generally supplied by one of these
national distributors to us and generally cannot be purchased from any
alternative source. Our success is largely dependent on our ability to obtain
product in sufficient quantities on competitive terms and conditions from each
of the national distributors. In order to qualify to receive copy allotments, we
are required to comply with certain operating conditions, which differ between
the specialty retail market and the mainstream market. Our ability to
economically satisfy these conditions may be affected by events beyond our
control, including the cooperation and assistance of our customers. A failure to
satisfy these conditions could result in a breach of our purchase arrangements
with our suppliers and entitle our suppliers to reduce our copy allotment or
discontinue our right to receive product for distribution to our customers. If
our supply of magazines were reduced, interrupted or discontinued, customer
service would be disrupted and existing customers may reduce or cease doing
business with us altogether, thereby causing our revenue and operating income to
decline and result in failure to meet expectations.




12





IF WE
WERE UNABLE TO RECEIVE OUR DVD AND CD PRODUCTS FROM OUR TOP SUPPLIERS, OUR
REVENUE AND PROFITABILITY COULD BE ADVERSELY AFFECTED.





A
substantial portion of the DVD and CD products distributed by us are supplied by
5 motion picture studios and 4 record labels. These products are proprietary to
individual suppliers and may not be obtained from any alternative source. Our
success depends upon our ability to obtain product in sufficient quantities on
competitive terms and conditions from each of these major home entertainment
labels and studios. If our supply of products were interrupted or discontinued,
then customer service could be adversely affected and customers may reduce or
cease doing business with us causing our sales and profitability to
decline.





VIRTUALLY
ALL OF OUR SALES ARE MADE ON A “SALE OR RETURN” BASIS AND HIGHER THAN EXPECTED
RETURNS COULD CAUSE US TO OVERSTATE REVENUE FOR THE PERIOD
AFFECTED.





As is
customary in the home entertainment content product industry, virtually all of
our sales will be made on a “sale or return” basis. During the year ended
January 31, 2008, approximately 60 out of every 100 magazine copies distributed
domestically by Source Interlink and approximately 22 and 20 out of every 100
DVDs and CDs, respectively, distributed domestically by Alliance were returned
unsold by their customers for credit; however, the sell-through rate can vary
from period to period. Revenues from the sale of merchandise that we distribute
are recognized at the time of delivery, less a reserve for estimated returns.
The amount of the return reserve is estimated based on historical sell-through
rates. If sell-through rates in any period are significantly less than
historical averages, this return reserve could be inadequate. If the return
reserve proved inadequate, it would indicate that actual revenue in prior
periods was less than accrued revenue for such periods. This would require an
increase in the amount of the return reserve for subsequent periods which may
result in a reduction in operating income for such periods.





SALES OF
DVDS AND CDS ARE HIGHLY SEASONAL AND OUR FINANCIAL RESULTS COULD BE NEGATIVELY
IMPACTED IF THE FOURTH QUARTER SALES OF DVDS AND CDS ARE WEAK.





Our DVD
and CD Fulfillment segment generated 32.7% of its total net revenues in the
fourth quarter of fiscal 2008 coinciding with the year end holiday shopping
season. Factors that could adversely affect sales and profitability in the
fourth quarter include:





-
            unavailability
      of, and low customer demand for, particular
  products;





-
            unfavorable
      economic and geopolitical
conditions;





-
            inability
      to hire adequate temporary
personnel;





-
            weather
      conditions;





-
            inability
      to anticipate consumer trends;





-
            weak
      new release schedules;





-
            inability
      to obtain favorable trade credit terms;
and





-
            inability
      to maintain adequate inventory
levels.





WE DEPEND
ON THE EFFORTS OF CERTAIN KEY PERSONNEL, THE LOSS OF WHOSE SERVICES COULD
ADVERSELY AFFECT OUR BUSINESS.





We depend
upon the services of our interim co-chief executive officers and their
relationships with customers and other third parties. The loss of these services
or relationships could adversely affect our business and the implementation of
our growth strategy. This in turn could materially harm our financial condition
and future results. Although we have employment agreements with each of our
interim co-chief executive officers, the services of these individuals may not
continue to be available to the combined company.





OUR
MANAGEMENT AND INTERNAL SYSTEMS MIGHT BE INADEQUATE TO HANDLE OUR POTENTIAL
GROWTH.





To manage
future growth, our management must continue to improve operational and financial
systems and expand, train, retain and manage its employee base. We will likely
be required to manage an increasing number of relationships with various
customers and other parties. Our management may not be able to manage the
company’s growth effectively. If our systems, procedures and controls are
inadequate to support our operations, our expansion could be halted and we could
lose opportunities to gain significant market share. Any inability to manage
growth effectively may harm our business.





OUR
OPERATIONS COULD BE DISRUPTED IF OUR INFORMATION SYSTEMS FAIL, CAUSING INCREASED
EXPENSES AND LOSS OF REVENUES.




13





Our
business depends on the efficient and uninterrupted operation of our computer
and communications software and hardware systems, including our replenishment
and order regulation systems, and other information technology. If we were to
fail for any reason or if we were to experience any unscheduled down times, even
for only a short period, its operations and financial results could be adversely
affected. We have in the past experienced performance problems and unscheduled
down times, and these problems could recur. Our systems could be damaged or
interrupted by fire, flood, hurricanes, earthquakes, power loss,
telecommunications failure, break-ins or similar events. We have formal disaster
recovery plans in place. However, these plans may not be entirely successful in
preventing delays or other complications that could arise from information
systems failure, and, if they are not successful, our business interruption
insurance may not adequately compensate for losses that may occur.





WE DEPEND
ON THE INTERNET TO DELIVER SOME OF OUR SERVICES, AND THE USE OF THE INTERNET MAY
EXPOSE US TO INCREASED RISKS.





Many of
our operations and services, including replenishment and order regulation
systems, customer direct fulfillment and other information technology, involve
the transmission of information over the Internet. Our business therefore will
be subject to any factors that adversely affect Internet usage including the
reliability of Internet service providers, which from time to time have
operational problems and experience service outages.





In
addition, one of the requirements of the continued growth over the Internet is
the secure transmission of confidential information over public networks.
Failure to prevent security breaches of our networks or those of our customers
or well-publicized security breaches affecting the Internet in general could
significantly harm our growth and revenue. Advances in computer capabilities,
new discoveries in the field of cryptography or other developments may result in
a compromise or breach of the algorithms we use to protect content and
transactions or our customers’ proprietary information in its databases. Anyone
who is able to circumvent our security measures could misappropriate proprietary
and confidential information or could cause interruptions in our operations. We
may be required to expend significant capital and other resources to protect
against such security breaches or to address problems caused by security
breaches.





IF OUR
ACCOUNTING CONTROLS AND PROCEDURES ARE CIRCUMVENTED OR OTHERWISE FAIL TO ACHIEVE
THEIR INTENDED PURPOSES, OUR BUSINESS COULD BE SERIOUSLY HARMED.





Although
we evaluate our internal control over financial reporting and disclosure
controls and procedures as of the end of each fiscal quarter, we may not be able
to prevent all instances of accounting errors or fraud in the future. Controls
and procedures do not provide absolute assurance that all deficiencies in design
or operation of these control systems, or all instances of errors or fraud, will
be prevented or detected. These control systems are designed to provide
reasonable assurance of achieving the goals of these systems in light of legal
requirements, company resources and the nature of our business operations. These
control systems remain subject to risks of human error and the risk that
controls can be circumvented for wrongful purposes by one or more individuals in
management or non-management positions. Our business could be seriously harmed
by any material failure of these control systems.





THE DVD
AND CD BUSINESS DEPENDS IN PART ON THE CURRENT ADVERTISING ALLOWANCES, VOLUME
DISCOUNTS AND OTHER SALES INCENTIVE PROGRAMS, AND OUR RESULTS OF OPERATION COULD
BE ADVERSELY AFFECTED IF THESE PROGRAMS WERE DISCONTINUED OR MATERIALLY
MODIFIED.





Under
terms of purchase prevailing in its industry, the profitability of the DVD and
CD are enhanced by advertising allowances, volume discounts and other sales
incentive programs offered by record labels and motion picture studios. Such
content providers are not under long-term contractual obligations to continue
these programs, and in 2003 one major record label eliminated advertising
allowances and volume discounts on a limited number of stock keeping units
(“SKUs”). If record labels or motion picture studios, or both, decide to
discontinue these programs, we would experience a significant reduction in
operating profits.





TRENDS IN
ADVERTISING SPENDING MAY REDUCE OUR REVENUES.




Our
advertising revenues are subject to the risks arising from possible shifting of
advertising spending amongst media. A decline in the level of business activity
of certain of our advertisers, particularly U.S. and non-U.S. automobile
manufacturers, could have an adverse effect on our revenues and profit
margins.




WE HAVE
SUBSTANTIAL INDEBTEDNESS, WHICH WILL CONSUME A SIGNIFICANT PORTION OF THE CASH
FLOW THAT WE GENERATE.




A
significant portion of our cash flow will be dedicated to the payment of
interest on indebtedness which will reduce funds available for capital
expenditures and business opportunities and may limit our ability to respond to
adverse developments in our business or in the economy.




OUR DEBT
INSTRUMENTS LIMIT OUR BUSINESS FLEXIBILITY BY IMPOSING OPERATING AND FINANCIAL
RESTRICTIONS ON OUR OPERATIONS.




14




The
agreements governing our indebtedness impose specific operating and financial
restrictions on us. These restrictions impose conditions or limitations on our
ability to, among other things:





-
      change the nature of our business;





-
      incur additional indebtedness;





-
      create liens on our assets;





-
      sell assets;





-
      issue stock;





-
      engage in mergers, consolidations or transactions with our
      affiliates;





-
      make investments in or loans to specific subsidiaries;
  and





-
      declare or make dividend payments on our common
  stock.




Our
failure to comply with the terms and covenants in our indebtedness could lead to
a default under the terms of those documents, which would entitle the lenders to
accelerate the indebtedness and declare all amounts owed due and payable.
Moreover, the instruments governing almost all of our indebtedness contain
cross-default provisions so that a default under any of our indebtedness may
result in a default under our other indebtedness. If a cross-default occurs, the
maturity of almost all of our indebtedness could be accelerated and become
immediately due and payable. If that happens, we might not be able to satisfy
our debt obligations, which could have a substantial adverse effect on our
ability to continue as a going concern.  We may not be able to comply
with these restrictions in the future or, in order to comply with these
restrictions, we may have to forego opportunities that might otherwise be
beneficial to us.





INCREASES
IN PAPER AND POSTAGE COSTS MAY HAVE AN ADVERSE IMPACT ON OUR FUTURE FINANCIAL
RESULTS.





The price
of paper is a significant expense relating to our print products and direct mail
solicitations. Worldwide demand, strikes and extraordinary weather conditions
could result in higher prices in fiscal 2009. We use the U.S. Postal Service for
distribution of many of our products and marketing materials. Paper and postage
cost increases may have an adverse effect on our future results. We may not be
able to pass these cost increases through to our customers.








RISKS
RELATED TO YOUR OWNERSHIP OF OUR STOCK





WE HAVE A
SIGNIFICANT STOCKHOLDER WHOSE INTERESTS MAY CONFLICT WITH YOURS.





Our
largest stockholder, AEC Associates, L.L.C. beneficially owned approximately 34%
of our outstanding voting power as of April 9, 2008. For as long as AEC
Associates (together with its members and affiliates acting as a group) owns an
aggregate of at least 10% of our outstanding common stock, AEC Associates will
have certain additional director designation rights as further described in the
risk factor entitled “We have limitations on changes of control that could
reduce your ability to sell our shares at a premium.” For example, for actions
that require a supermajority of the board, such as a change of control, AEC
Associates designated directors may effectively have enough votes to prevent any
such action from being taken by us. As a result, AEC Associates will have the
ability through its ownership of our common stock and its representation on the
board to exercise significant influence over our major decisions and over all
matters requiring stockholder approval. AEC Associates may have interests that
differ from those of our stockholders.





OUR
BYLAWS WILL REQUIRE SUPERMAJORITY APPROVAL OF OUR BOARD BEFORE WE CAN TAKE
CERTAIN ACTIONS. THIS REQUIREMENT MAY RESTRICT STRATEGIC TRANSACTIONS INVOLVING
US.





Our
bylaws provide that the affirmative vote of at least 75% of its entire board
will be required to (i) approve or recommend a reorganization or merger of our
company in a transaction that will result in our stockholders immediately prior
to such transaction not holding, as a result of such transaction, at least 50%
of the voting power of the surviving or continuing entity, (ii) a sale of all or
substantially all of our assets which would result in its stockholders
immediately prior to such transaction not holding, as a result of such sale, at
least 50% of the voting power of the purchasing entity, or (iii) a change in our
bylaws. This requirement may prevent us from making changes and taking other
actions that are subject to this supermajority approval requirement. This
requirement may limit our ability to pursue strategies or enter into strategic
transactions for which the supermajority approval of the board cannot be
obtained.




15





WE HAVE
LIMITATIONS ON CHANGES OF CONTROL THAT COULD REDUCE YOUR ABILITY TO SELL OUR
SHARES AT A PREMIUM.





Our
certificate of incorporation and bylaws currently contain provisions that could
reduce the likelihood of a change of control or acquisition of our company,
which could limit your ability to sell our shares at a premium or otherwise
affect the price of our common stock. These provisions include the
following:





-
            permit
      our board to issue up to 2,000,000 shares of preferred stock and to
      determine the price, rights, preferences, privileges and restrictions of
      that preferred stock;





-
            permit
      our board to issue up to 100,000,000 shares of common
    stock;





-
            require
      that a change of control of the company be approved by a supermajority of
      at least 75% of the members of the
board;





-
            provide
      for a classified board of
directors;





-
            permit
      the board to increase its own size and fill the resulting
      vacancies;





-
            limit
      the persons who may call special meetings of stockholders;
    and





-
            establish
      advance notice requirements for nominations for election to the board or
      for proposing matters that can be acted on by stockholders at stockholders
      meetings.





OUR
COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES
FOR STOCKHOLDERS.





Our
common stock is currently traded on the Nasdaq National Market. Our average
daily trading volume for the three month period ending April 9, 2008 was
approximately 281,000 shares. In the future, we may experience more limited
daily trading volume. The trading price of our common stock has been and may
continue to be volatile. The closing sale prices of our common stock, as
reported by the Nasdaq National Market, have ranged from a high of $7.92 to a
low of $1.75 for the 52-week period ending January 31, 2008. The closing sale
price of our common stock, as reported by the Nasdaq National Market on April 9,
2008 was $1.52.  Broad market and industry fluctuations may
significantly affect the trading price of our common stock, regardless of our
actual operating performance. The trading price of our common stock could be
affected by a number of factors, including, but not limited to, announcements of
new services, additions or departures of key personnel, quarterly fluctuations
in our financial results, changes in analysts’ estimates of our financial
performance, general conditions in our industry and conditions in the financial
markets and a variety of other risk factors, including the ones described
elsewhere in this Annual Report on Form 10-K. Periods of volatility in the
market price of a company’s securities sometimes result in securities class
action litigation. If this were to happen to us, such litigation would be
expensive and would divert management’s attention. In addition, if we needed to
raise equity funds under adverse conditions, it would be difficult to sell a
significant amount of our stock without causing a significant decline in the
trading price of our stock.





ITEM 1B.
UNRESOLVED STAFF COMMENTS.





None.


16


ITEM 2.
PROPERTIES.





Our
principal executive offices are located at 27500 Riverview Center Boulevard,
Bonita Springs, Florida. As of April 3, 2008, we owned or leased
approximately 0.5 million square feet of manufacturing facilities, 2.6 million
square feet of distribution centers, warehouses and depots, and 0.7 million
square feet of office space. The following table presents information concerning
our principal properties:





Location
            Description
            Segment
            
            Size
      (square feet)
            
            Owned/LeasedBonita Springs,
      FL
            Office
            Worldwide
      headquarters
            
            
            95,000
            
            LeasedCoral
      Springs, FL
            Distribution
      center/Office
            DVD
      and CD fulfillment
            
            
            244,000
            
            OwnedShepherdsville,
      KY
            Distribution
      center
            DVD
      and CD fulfillment
            
            
            404,000
            
            LeasedShepherdsville,
      KY
            Distribution
      center
            DVD
      and CD fulfillment
            
            
            167,000
            
            LeasedOntario,
      CA
            Distribution
      center
            Magazine
      fulfillment
            
            
            160,000
            
            LeasedMcCook,
      IL
            Distribution
      center
            Magazine
      fulfillment
            
            
            210,000
            
            LeasedLancaster,
      PA
            Distribution
      center
            Magazine
      fulfillment
            
            
            106,000
            
            LeasedDallas,
      TX
            Distribution
      center
            Magazine
      fulfillment
            
            
            48,000
            
            LeasedHarrisburg,
      PA
            Distribution
      center
            Magazine
      fulfillment
            
            
            142,000
            
            LeasedRockford,
      IL
            Manufacturing/Distribution
      center
            In-store
      services
            
            
            300,000/9,000
            
            OwnedBrooklyn,
      NY
            Manufacturing
            In-store
      services
            
            
            92,000
            
            LeasedVancouver,
      B.C.
            Manufacturing
            In-store
      services
            
            
            51,000
            
            LeasedLos
      Angeles, CA
            Office
            Media
            
            
            207,000
            
            LeasedNew
      York, NY
            Office
            Media
            
            
            95,000
            
            LeasedHarrisburg,
      PA
            Office
            Media
            
            
            50,000
            
            Leased





We
believe our facilities are adequate for our current level of operations and that
all of our facilities are adequately insured.





ITEM 3.
LEGAL PROCEEDINGS.





We are
party to routine legal proceedings arising out of the normal course of business.
Although it is not possible to predict with certainty the outcome of these
unresolved legal actions or the range of possible loss, we believe that none of
these actions, individually or the in the aggregate, will have a material
adverse effect on our financial condition, results of operations or
liquidity.





ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.





On
November 27, 2007, the Company held its 2008 annual meeting.  The following
are the results of questions submitted to votes of shareholders:




Votes
      Cast
              VotesFor
              Against
              AbstainedWith
      regard to election of directors:Michael
      R. Duckworth
              44,318,172
              -
              526,172Ariel
      Z. Emanuel
              35,671,987
              -
              9,172,737Terrence
      Wallock
              43,847,740
              -
              996,984With
      regard to approval of the 2007 OmnibusLong-Term
      Compensation Plan
              35,886,115
              2,413,666
              13,125With
      regard to ratification of BDO Seidman, LLPas
      the Company's external auditors
              44,697,809
              121,779
              25,138







PART
II





ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.





MARKET
INFORMATION





Our
common stock is quoted on the Nasdaq Global Select Market under the symbol
SORC.





The
following table sets forth, for the periods indicated, the range of high and low
bid prices for our common stock as reported by the Nasdaq National Market during
the fiscal year shown. All such quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent actual
transactions.







High
            
            
            LowYear
      ended January 31, 2007First
      quarter
            
            $
            12.00
            
            
            $
            9.87Second
      quarter
            
            $
            12.89
            
            
            $
            10.55Third
      quarter
            
            $
            11.92
            
            
            $
            8.99Fourth
      quarter
            
            $
            9.62
            
            
            $
            7.10Year
      ended January 31, 2008First
      quarter
            
            $
            7.92
            
            
            $
            6.41Second
      quarter
            
            $
            6.91
            
            
            $
            4.33Third
      quarter
            
            $
            4.89
            
            
            $
            3.16Fourth
      quarter
            
            $
            3.74
            
            
            $
            1.75





17




HOLDERS





As of
April 10, 2008, there were approximately 126 holders of record of our common
stock.





DIVIDENDS





We have
never declared or paid dividends on our common stock. Our board of directors
presently intends to retain all of our earnings, if any, for the development of
our business for the foreseeable future. The declaration and payment of cash
dividends in the future will be at the discretion of our board of directors and
will depend upon a number of factors, including, among others, any restrictions
contained in our credit facilities and our future earnings, operations, capital
requirements and general financial condition and such other factors that our
board of directors may deem relevant. Currently, our credit facilities prohibit
the payment of cash dividends or other distributions on our capital stock or
payments in connection with the purchase, redemption, retirement or acquisition
of our capital stock.





SECURITIES
AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





RECENT
SALES OF UNREGISTERED SECURITIES; USE OF PROCEEDS FROM REGISTERED
SECURITIES





None.





PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS





None.





ITEM 6.
SELECTED FINANCIAL DATA.





The
following selected consolidated financial data are only a summary and should be
read in conjunction with our financial statements and related notes thereto and
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” included in this Annual Report on Form 10-K. The consolidated
statement of operations data for the years ended January 31, 2006, 2007 and 2008
and the balance sheet data as of January 31, 2007 and 2008, which have been
prepared in accordance with accounting principles generally accepted in the
U.S., are derived from our financial statements audited by BDO Seidman, LLP, an
independent registered public accounting firm, which are included elsewhere in
this Annual Report on Form 10-K. The consolidated statement of operations data
for the years ended January 31, 2004 and 2005 and the balance sheet data as of
January 31, 2004 and 2005, which have been prepared in accordance with
accounting principles generally accepted in the U.S., are derived from our
audited financial statements which are not included in this Annual Report on
Form 10-K. On August 1, 2007, we consummated our acquisition of Enthusiast Media
Inc. The results of operations of Enthusiast Media are included in the selected
financial data presented below for the period beginning August 1, 2007 only. On
February 28, 2005, we consummated our merger with Alliance Entertainment Corp.
The results of operations of Alliance are included in the selected financial
data presented below for the period beginning March 1, 2005 only. On May 10,
2005, we consummated our acquisition of Chas. Levy Circulating Co, LLC. The
results of operations of Levy are included in the selected financial data
presented below for the period beginning May 10, 2005 only. Also on March 30,
2006, we consummated our acquisitions of Anderson Mid-Atlantic News, LLC and
Anderson SCN Services, LLC.  The results of operations for
Mid-Atlantic and SCN are included in the selected financial data presented below
for the period beginning April 1, 2006 only. For a description of the merger of
Source Interlink and Alliance and the acquisitions of Levy, Mid-Atlantic and
SCN, please see the section entitled “Management’s Discussion and Analysis of
Financial Condition and Results of Operations.” Historical operating results are
not necessarily indicative of the results that may be expected for any future
period.





Year
      Ended January 31,(in
      thousands, except per share data)
            
            2008
            
            
            2007(a)
            
            
            2006(a)
            
            
            2005(a)
            
            
            2004(a)Income
      Statement data:Revenues
            
            $
            2,254,252
            
            
            $
            1,828,653
            
            
            $
            1,498,789
            
            
            $
            334,274
            
            
            $
            297,072Gross
      profit
            
            $
            598,071
            
            
            $
            382,729
            
            
            $
            302,669
            
            
            $
            94,267
            
            
            $
            83,681Operating
      income (loss)
            
            $
            36,709
            
            
            $
            (19,370
            )
            
            $
            32,540
            
            
            $
            16,239
            
            
            $
            16,905(Loss)
      income from continuing operations
            
            $
            (26,238
            )
            
            $
            (25,967
            )
            
            $
            12,989
            
            
            $
            11,277
            
            
            $
            9,674Net
      (loss) income available to common shareholders
            
            $
            (27,893
            )
            
            $
            (24,656
            )
            
            $
            12,879
            
            
            $
            12,082
            
            
            $
            10,048(Loss)
      income from continuing operations per share:Basic
            
            $
            (0.50
            )
            
            $
            (0.50
            )
            
            $
            0.26
            
            
            $
            0.49
            
            
            $
            0.52Diluted
            
            $
            (0.50
            )
            
            $
            (0.50
            )
            
            $
            0.25
            
            
            $
            0.45
            
            
            $
            0.49





(a)           Periods
are reclassified for the discontinued operations as discussed in Note
8.








As
      of January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004Balance
      sheet data:Cash
            
            $
            35,650
            
            
            $
            -
            
            
            $
            23,239
            
            
            $
            1,387
            
            
            $
            4,963Working
      capital (b)
            
            $
            (8,490
            )
            
            $
            38,368
            
            
            $
            61,767
            
            
            $
            46,816
            
            
            $
            23,477Total
      assets
            
            $
            2,436,005
            
            
            $
            1,010,031
            
            
            $
            884,472
            
            
            $
            197,753
            
            
            $
            164,101Current
      maturities of debt
            
            $
            15,369
            
            
            $
            7,850
            
            
            $
            6,508
            
            
            $
            5,630
            
            
            $
            4,059Debt,
      less current maturities
            
            $
            1,359,210
            
            
            $
            146,534
            
            
            $
            80,727
            
            
            $
            34,139
            
            
            $
            31,541Total
      liabilities
            
            $
            1,995,504
            
            
            $
            570,584
            
            
            $
            424,879
            
            
            $
            70,070
            
            
            $
            97,027Minority
      Interest
            
            $
            25,978
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Total
      stockholders' equity
            
            $
            414,523
            
            
            $
            439,447
            
            
            $
            459,593
            
            
            $
            127,683
            
            
            $
            67,074







18


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION.





Throughout
this section we discuss and refer to the following reportable
segments:





-
            Media
      – The Media segment sells print advertising space in its enthusiast
      publications, sells enthusiast publications via newsstand and
      subscription, and sells online advertising and lead generation
      services.





-
            Magazine
      Fulfillment Services - Our Magazine Fulfillment Services group provides
      domestic and foreign titled magazines to specialty retailers, such as
      bookstores and music stores, and to mainstream retailers, such as
      supermarkets, discount stores, drug stores, convenience stores and
      newsstands. This group also exports domestic titled magazines from more
      than 100 publishers to foreign markets
  worldwide.





-
            In-Store
      Services – Our In-Store Services group designs, manufactures, ships,
      installs, removes and invoices participants in front-end wire fixture
      display programs, provides claim filing services for rebates owed
      retailers from publishers.





-
            DVD
      and CD Fulfillment - Our DVD and CD Fulfillment group sells and
      distributes pre-recorded music, videos, video games and related products
      to retailers, provides product and commerce solutions to retailers and
      provides customer-direct fulfillment and vendor managed
      inventory.





-
            Shared
      Services - Our Shared Services group consists of overhead functions not
      allocated to the other groups. These functions include corporate finance,
      human resource, management information systems and executive management
      that are not allocated to the three operating groups. Upon completion of
      the consolidation of our administrative operations, we restructured our
      accounts to separately identify corporate expenses that are not
      attributable to any of our three main operating
  groups.





The
segment organization presented herein corresponds to the financial and other
reporting received by our chief operating decision maker. For additional
financial and geographic information regarding our segments and a discussion of
the change in organizational structure, see Note 17 “Segment Information” to our
Consolidated Financial Statements.








OVERVIEW





The
following events have occurred that have a material impact on the comparison of
our results of operations for the year ended January 31, 2008 and the prior
years:





We have
performed three acquisitions during the last two fiscal years.  The
results of operations from the following acquired business are included in
current year results of operations for a different number of months than they
were included in the prior year:





-
            Primedia
      Enthusiast Media, Inc. – Results from Enthusiast Media were included in
      fiscal 2008 earnings for 6 months while no results from Enthusiast Media
      were included in fiscal 2007.





-
            Anderson
      Mid-Atlantic News, LLC – Results from Mid-Atlantic were included in fiscal
      2007 earnings for 10 months while no results from Mid-Atlantic were
      included in fiscal 2006; and





-
            Anderson
      SCN Services, LLC – Results from SCN were included in fiscal 2007 earnings
      for 10 months while no results from SCN were included in fiscal
      2006.








For more
information on the above acquisitions, see Note 2 – Business Combinations and
Asset Acquisitions to our Consolidated Financial Statements.





As a
result of our fiscal year 2008 SFAS No. 144 fourth quarter impairment
analysis, we determined that certain of our customer lists of our DVD and CD
Fulfillment reporting unit were impaired and consequently recorded a charge of
approximately $35.3 million.  These determinations are based largely
on management’s projections regarding the revenues from and profitability of
customer relationships acquired on February 28, 2005.  The combination
of these factors had an adverse impact on the anticipated future cash flows used
in the impairment analysis performed during the fourth quarter of fiscal year
2008.  The net carrying amount of the customer list was $30.5 million at
the end of the fourth quarter of fiscal year 2008, after the impairment charge
was recorded.




19





Effective
November 10, 2006, S. Leslie Flegel, the Company's then Chairman of the Board of
Directors and Chief Executive Officer, resigned from the Company and its Board
of Directors pursuant to a Separation, Consulting and General Release Agreement
dated November 12, 2006 (the "Separation Agreement"). The Company's Board of
Directors has since named Michael R. Duckworth, a director of the Company,
Chairman of the Board of Directors. The Company's then President and Chief
Operating Officer, James R. Gillis, and the Company's then Executive Vice
President and President and Chief Operating Officer of the Company's Alliance
Entertainment Corporation subsidiary, Alan Tuchman, have since been named
interim co-Chief Executive Officers.  The Company recorded a charge to
earnings of $9.6 million in the fiscal year ended January 31, 2007 related to
Mr. Flegel’s separation from the Company.





As a
result of our fiscal year 2007 SFAS No. 142 fourth quarter impairment
analysis, we determined that the customer list, non-compete agreement and
goodwill of our In-Store Services reporting unit was impaired and consequently
recorded a charge of  approximately $1.7 million, $0.5 million and $30.6
million, respectively.  These determinations were primarily the result of a
change in management’s expectations of the long-term outlook for that business
unit, including increased life cycle for certain products, as well as decreasing
operating profit margins.  The combination of these factors had an adverse
impact on the anticipated future cash flows of this reporting unit used in the
impairment analysis performed during the fourth quarter of fiscal year 2007.
 The net carrying amount of the customer list was $1.25 million and
goodwill $24.7 million at the end of the fourth quarter of fiscal year 2007,
after the impairment charge was recorded.





In the
fourth quarter of fiscal 2007, we amended our distribution agreement with a
major customer of our magazine distribution segment such that revenue is no
longer recognized upon the delivery of product less an allowance for returns but
rather revenue is recognized when the sale occurs at retail.  This
transition to a scan-based trading relationship resulted in a one-time
conversion charge, which had a negative impact on profitability of $16.2
million.  A large portion of this charge is the non-cash deferral of
profits as a result of this change.  Until the time of sale, the inventory
is being carried on the Company’s books at the product cost.  We are
optimistic that scan-based trading will ultimately reduce costs, result in a
reduction in working capital, maximize retail productivity and throughput, and
continue to enhance retailer relationships.





DISCONTINUED
OPERATION





The
following amounts related to our In-Store Services segment’s discontinued
operation (wood manufacturing business) have been segregated from continuing
operations and reflected as discontinued operations in each period’s
consolidated statement of income:





Year ended January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Revenue
            
            $
            2,551
            
            
            $
            26,193
            
            
            $
            28,627(Loss)
      income before income taxes
            
            $
            (1,912
            )
            
            $
            2,184
            
            
            $
            2,693Income
      tax benefit
            
            
            (765
            )
            
            
            873
            
            
            
            1,357(Loss)
      income from discontinued operations, net of tax
            
            
            (1,147
            )
            
            
            1,311
            
            
            
            1,336Pre-tax
      loss on sale of discontinued business
            
            
            (847
            )
            
            
            -
            
            
            
            -Income
      tax benefit
            
            
            (339
            )
            
            
            -
            
            
            
            -Loss
      on sale of business, net of tax
            
            
            (508
            )
            
            
            -
            
            
            
            -Discontinued
      operation, net of tax
            
            $
            (1,655
            )
            
            $
            1,311
            
            
            $
            1,336








EXPLANATION
OF FINANCIAL STATEMENT LINE ITEMS





REVENUES





The Media
segment derives revenues primarily from:





-
            selling
      print advertising space in its enthusiast
  publications,





-
            selling
      enthusiast publications via single-copy sales and subscription,
      and





-
            selling
      online advertising and lead generation
services.





20




The
Magazine Fulfillment group derives revenues from:





-
            selling
      and distributing magazines, including domestic and foreign titles, to
      retailers throughout the United States and
  Canada;





-
            exporting
      domestic titles internationally to foreign wholesalers or through domestic
      brokers;





-
            providing
      return processing services for major specialty retail book chains;
      and





-
            serving
      as an outsourced fulfillment agent and backroom operator for
      publishers.





The
In-Store Services group derives revenues from:





-
            designing,
      manufacturing and invoicing participants in front-end merchandising
      programs;





-
            providing
      claim filing services related to rebates owed to retailers from publishers
      or their designated agents; and







The DVD
and CD Fulfillment group derives revenues from:





-
            selling
      and distributing pre-recorded music, movies, video games and related
      products primarily to retailers throughout the United
    States;





-
            serving
      as an outsourced fulfillment agent and backroom operator for motion
      picture studios and record labels.





COST OF
REVENUES





The cost
of revenues for the Media group consists of paper, outsourced printing services
and the cost of licensed products.





The cost
of revenues for the Magazine Fulfillment Services group consists of the costs of
magazines and books purchased for resale less all applicable publisher discounts
and rebates.





The cost
of revenues for the In-Store Services group consists of:





-
            raw
      materials consumed in the production of display fixtures, primarily steel
      and powder coatings;





-
            production
      labor; and





-
            manufacturing
      overhead.





The cost
of revenues for the DVD and CD Fulfillment group consists of the costs of CDs
and DVDs purchased for resale less all applicable discounts and
rebates.







SELLING,
GENERAL, AND ADMINISTRATIVE EXPENSES





Selling,
general and administrative expenses for each of the operating groups
include:





-
            non-production
      labor;





-
            rent
      and office overhead;





-
            insurance;





-
            professional
      fees; and





-
            management
      information systems.





Expenses
associated with corporate finance, human resources, certain management
information systems and executive offices are included within the Shared
Services group and are not fully allocated to the other groups.




21





DISTRIBUTION,
CIRULATION AND FULFILLMENT





Distribution,
circulation and fulfillment consists of our direct costs of distributing
magazines, books, CDs and DVDs by third-party freight carriers, primarily UPS
ground service, and the cost of delivery by company-leased trucks as well as
distribution center labor and overhead. Third party freight rates are driven
primarily by the weight of the copies being shipped and the distance between
origination and destination.





Freight
is not disclosed as a component of cost of revenues, and, as a result, gross
profit and gross profit margins are not comparable to other companies that
include shipping and handling costs in cost of revenues.





Distribution,
circulation and fulfillment has increased proportionately as the amount of
product we distribute has increased. We anticipate the continued growth in our
Magazine Fulfillment and DVD and CD Fulfillment groups will result in an
increase in distribution, circulation and fulfillment. Generally, as total
pounds shipped increase, the cost per pound charged by third party carriers
decreases.





INTEGRATION
AND RELOCATION EXPENSE





During
fiscal 2008, the Company incurred relocation expenses of $1.6 million related to
the relocation of its Chicago, IL distribution center to McCook,
IL.





During
fiscal 2007, the Company incurred $3.7 million of expenses related to the
planned consolidation of the backroom operations and marketing functions of the
domestic distribution group from Lisle, IL to Bonita Springs, FL and the planned
consolidation of one of its existing southern California distribution centers
into a facility acquired in connection with the acquisition of SCN.





22


RESULTS
OF OPERATIONS





RESULTS
FOR THE FISCAL YEAR ENDED JANUARY 1, 2008 COMPARED TO THE FISCAL YEAR ENDED
JANUARY 31, 2007





MEDIA





The
following table presents comparative operating results for our Media group for
the fiscal years ended January 31, 2008 and 2007:





Year
      ended January 31,
            
            
            Increase
      (decrease)(in
      thousands)
            
            2008
            
            
            2007
            
            
            Amount
            
            
            PercentRevenues,
      netDistribution
            
            $
            4,762
            
            
            $
            -
            
            
            $
            4,762
            
            
            
            NMAdvertising
            
            
            122,769
            
            
            
            -
            
            
            
            122,769
            
            
            NMCirculation
            
            
            78,532
            
            
            
            -
            
            
            
            78,532
            
            
            NMOther
            
            
            46,848
            
            
            
            -
            
            
            
            46,848
            
            
            NMTotal
      revenues, net
            
            
            252,911
            
            
            
            -
            
            
            
            252,911
            
            
            NMCost
      of revenues
            
            
            68,906
            
            
            
            -
            
            
            
            68,906
            
            
            NMGross
      profit
            
            
            184,005
            
            
            
            -
            
            
            
            184,005
            
            
            NMDistribution,
      circulation and fulfillment
            
            
            23,427
            
            
            
            -
            
            
            
            23,427
            
            
            NMSelling,
      general and administrative expense
            
            
            112,778
            
            
            
            -
            
            
            
            112,778
            
            
            NMDepreciation
      and amortization
            
            
            24,840
            
            
            
            -
            
            
            
            24,840
            
            
            NMMerger
      and acquisition costs
            
            
            252
            
            
            
            -
            
            
            
            252
            
            
            NMOperating
      income
            
            $
            22,708
            
            
            $
            -
            
            
            $
            22,708
            
            
            NMKey
      operating measures:Gross
      profit margin
            
            
            72.8
            %
            
            NM
            
            
            NMOperating
      margin
            
            
            9.0
            %
            
            NM
            
            
            NMDistribution,
      circulation and fulfillment as a percent of revenues
            
            
            9.3
            %
            
            NM
            
            
            NMSelling,
      general and administrative expenses as a percent of
      revenues
            
            
            44.6
            %
            
            NM
            
            
            NMNM
      - the result of the calculation is not meaningful





On
August 1, 2007 we acquired EM, which created our Media operating
segment.  All changes in income statement line items result from this
acquisition.





23


MAGAZINE
FULFILLMENT SERVICES





The
following table presents comparative operating results for our Magazine
Fulfillment services for the fiscal years ended January 31, 2008 and
2007:





Year
      ended January 31,
            
            
            Increase
      (decrease)(in
      thousands)
            
            2008
            
            
            2007
            
            
            Amount
            
            
            PercentRevenues,
      netDistribution
            
            $
            932,315
            
            
            $
            794,973
            
            
            $
            137,342
            
            
            
            17.3
            %Other
            
            
            17,972
            
            
            
            14,780
            
            
            
            3,192
            
            
            
            21.6
            %Total
      Revenues, net
            
            
            950,287
            
            
            
            809,753
            
            
            
            140,534
            
            
            
            17.4
            %Cost
      of revenues
            
            
            730,839
            
            
            
            621,786
            
            
            
            109,053
            
            
            
            17.5
            %Gross
      profit
            
            
            219,448
            
            
            
            187,967
            
            
            
            31,481
            
            
            
            16.7
            %Distribution,
      circulation, and fulfillment
            
            
            111,370
            
            
            
            113,444
            
            
            
            (2,074
            )
            
            
            -1.8
            %Selling,
      general and administrative expense
            
            
            74,818
            
            
            
            63,603
            
            
            
            11,215
            
            
            
            17.6
            %Depreciation
      and amortization
            
            
            9,208
            
            
            
            7,997
            
            
            
            1,211
            
            
            
            15.1
            %Integration
      and relocation expense
            
            
            1,072
            
            
            
            3,580
            
            
            
            (2,508
            )
            
            
            -70.1
            %Disposal
      of land, buildings and equipment, net
            
            
            -
            
            
            
            (154
            )
            
            
            154
            
            
            
            -100.0
            %Operating
      income
            
            $
            22,980
            
            
            $
            (503
            )
            
            $
            23,483
            
            
            
            -4668.6
            %Key
      operating measures:Gross
      profit margin
            
            
            23.1
            %
            
            
            23.2
            %
            
            
            -0.1
            %Operating
      margin
            
            
            2.4
            %
            
            
            -0.1
            %
            
            
            2.5
            %Distribution,
      circulation and fulfillment as apercent
      of revenues
            
            
            11.7
            %
            
            
            14.0
            %
            
            
            -2.3
            %Selling,
      general and administrative expenses asa
      percent of a percent of revenues
            
            
            7.9
            %
            
            
            7.9
            %
            
            
            0.0
            %NM
      - the result of the calculation is not meaningful





On
March 30, 2006 we acquired Mid-Atlantic and SCN.  Increases in
individual income statement line items within our Magazine Fulfillment group are
related to the impact of the inclusion of twelve months of results in the
current year period versus ten in the same period of fiscal 2007.




Revenues
increased primarily due the acquisition of Mid-Atlantic and SCN in addition to
the impact of a new exclusive contract with a major bookstore, significant sales
to new retailers and increased export distribution as a result of a new
exclusive export contract with a major domestic national distributor, partially
offset by approximately $6 million in lost sales due to the southern California
wild fires, as well as the impact of the conversion of a large customer to
scan-based trading during the fiscal 2007 period.




Gross
profit margin was consistent with the same period of the prior
year.




Distribution,
circulation and fulfillment as a percent of revenues decreased primarily due to
synergies achieved related to our acquisition of Mid-Atlantic and SCN as well as
increased revenue from our export distribution business that does not carry
freight costs.





Selling,
general and administrative expenses increased due in part to increased expenses
as a result of the addition of new customers and a change in the method of
allocation of costs formerly accumulated in the Shared Services segment. 
Under the current methodology, approximately $5.8 million of additional Selling,
general and administrative expenses would have been recorded in the prior
year.





24


DVD AND
CD FULFILLMENT GROUP





The
following table presents comparative operating results for our DVD and CD
Fulfillment group for the fiscal years ended January 31, 2008 and
2007:





Year
      ended January 31,
            
            
            Increase
      (decrease)(in
      thousands)
            
            2008
            
            
            2007
            
            
            Amount
            
            
            PercentRevenues,
      netDistribution
            
            $
            1,021,018
            
            
            $
            971,523
            
            
            $
            49,495
            
            
            
            5.1
            %Total
      revenues, net
            
            
            1,021,018
            
            
            
            971,523
            
            
            
            49,495
            
            
            
            5.1
            %Cost
      of revenues
            
            
            845,418
            
            
            
            797,348
            
            
            
            48,070
            
            
            
            6.0
            %Gross
      profit
            
            
            175,600
            
            
            
            174,175
            
            
            
            1,425
            
            
            
            0.8
            %Distribution,
      circulation and fulfillment
            
            
            62,220
            
            
            
            64,509
            
            
            
            (2,289
            )
            
            
            -3.5
            %Selling,
      general and administrative expenses
            
            
            61,612
            
            
            
            55,650
            
            
            
            5,962
            
            
            
            10.7
            %Depreciation
      and amortization
            
            
            16,739
            
            
            
            14,650
            
            
            
            2,089
            
            
            
            14.3
            %Impairment
      of intangibles
            
            
            35,310
            
            
            
            -
            
            
            
            35,310
            
            
            NMDisposal
      of land, buildings and equipment, net
            
            
            417
            
            
            
            287
            
            
            
            130
            
            
            
            45.3
            %Operating
      (loss) income
            
            $
            (698
            )
            
            $
            39,079
            
            
            $
            (39,777
            )
            
            
            -101.8
            %Key
      operating measures:Gross
      profit margin
            
            
            17.2
            %
            
            
            17.9
            %
            
            
            -0.7
            %Operating
      margin
            
            
            -0.1
            %
            
            
            4.0
            %
            
            
            -4.1
            %Distribution,
      circulation and fufillment as a percent of revenues
            
            
            6.1
            %
            
            
            6.6
            %
            
            
            -0.5
            %Selling,
      general and administrative expenses as apercent
      of revenues
            
            
            6.0
            %
            
            
            5.7
            %
            
            
            0.3
            %NM
      - the result of the calculation is not meaningful








Revenues
increased primarily due to the addition of a significant new customer during the
third quarter of fiscal 2008 and increased sales of DVDs in our large bookstore
customer, partially offset by decreased revenues as a result of certain retailer
programs in the prior year period not being renewed in the current year and
negative industry trends within the CD and recorded music industry.




Gross
profit margin decreased primarily due to a shift in mix away from CDs toward
lower-margin DVDs and the addition of a significant new customer that carries
lower gross margins.




Distribution,
circulation and fulfillment as a percent of revenues decreased primarily due to
a shift of a larger portion of shipments to certain customers to ground versus
air.




Selling,
general and administrative expenses increased primarily due to new vendor
managed inventory customers, where we provide in-store product
merchandising, and other new business ventures.





During
the fourth quarter of fiscal 2008, we recorded an impairment charge of $35.3
million related to the group’s acquired customer lists.





Operating
margin decreased primarily due to the factors discussed above.





25


IN-STORE
SERVICES GROUP





The
following table presents comparative operating results for our In-Store services
group for the fiscal years ended January 31, 2008 and 2007:





Year
      ended January 31,
            
            
            Increase
      (decrease)(in
      thousands)
            
            2008
            
            
            2007
            
            
            Amount
            
            
            PercentRevenues,
      netManufacturing
            
            $
            30,650
            
            
            $
            32,670
            
            
            $
            (2,020
            )
            
            $
            -6.2
            %Claiming
      and Information
            
            
            14,001
            
            
            
            14,707
            
            
            
            (706
            )
            
            
            -4.8
            %Total
      Revenues, net
            
            
            44,651
            
            
            
            47,377
            
            
            
            (2,726
            )
            
            
            -5.8
            %Cost
      of revenues
            
            
            25,633
            
            
            
            26,790
            
            
            
            (1,157
            )
            
            
            -4.3
            %Gross
      profit
            
            
            19,018
            
            
            
            20,587
            
            
            
            (1,569
            )
            
            
            -7.6
            %Selling,
      general and administrative expense
            
            
            7,879
            
            
            
            7,695
            
            
            
            184
            
            
            
            2.4
            %Depreciation
      and amortization
            
            
            490
            
            
            
            557
            
            
            
            (67
            )
            
            
            -12.0
            %Impairment
      of goodwill and intangible assets
            
            
            -
            
            
            
            32,742
            
            
            
            (32,742
            )
            
            
            -100.0
            %Disposal
      of land, buildings and equipment, net
            
            
            (174
            )
            
            
            (86
            )
            
            
            (88
            )
            
            
            102.3
            %Operating
      income
            
            $
            10,823
            
            
            $
            (20,321
            )
            
            $
            31,144
            
            
            
            -153.3
            %Key
      operating measures:Gross
      profit margin
            
            
            42.6
            %
            
            
            43.5
            %
            
            
            -0.9
            %Operating
      margin
            
            
            24.2
            %
            
            
            -42.9
            %
            
            
            67.1
            %NM
      - the result of the calculation is not meaningful





Revenues
from Claim filing and information decreased primarily due to the timing of
payments received on claims filed.  Revenues from Wire manufacturing
decreased primarily due to fewer jobs in the current period versus the same
period of the prior year.




Gross
profit decreased primarily due to lower revenue, while gross profit margin
remained relatively consistent.




Selling,
general and administrative expenses decreased over the prior year period. 
Components of selling, general and administrative expenses increased due to
changes in the method of allocating costs formerly accumulated in the Shared
Services segment, offset by reductions in selling, general and administrative
expenses due to cost cutting initiatives.




Operating
margin increased primarily due to the impairment of goodwill and intangible
assets discussed above.




26


SHARED
SERVICES GROUP





The
following table presents comparative operating results for our Shared Services
group for the fiscal years ended January 31, 2008 and 2007:





Year
      ended January 31,
            
            
            Increase
      (decrease)(in
      thousands)
            
            2008
            
            
            2007
            
            
            Amount
            
            
            PercentSelling,
      general and administrative expense
            
            $
            15,535
            
            
            $
            34,483
            
            
            $
            (18,948
            )
            
            
            -54.9
            %Depreciation
      and amortization
            
            
            2,161
            
            
            
            2,155
            
            
            
            6
            
            
            
            0.3
            %Integration
      and relocation expense
            
            
            495
            
            
            
            84
            
            
            
            411
            
            
            
            489.3
            %Disposal
      of land, buildings and equipment, net
            
            
            -
            
            
            
            903
            
            
            
            (903
            )
            
            
            -100.0
            %Merger
      and acquisition costs
            
            
            913
            
            
            
            -
            
            
            
            913
            
            
            NMOperating
      loss
            
            $
            (19,104
            )
            
            $
            (37,625
            )
            
            $
            18,521
            
            
            
            -49.2
            %Key
      operating measures:Selling,
      general and administrative expenses as apercent
      of revenues
            
            
            1.0
            %
            
            
            2.0
            %
            
            
            -1.0
            %NM
      - the result of the calculation is not meaningful








Selling,
general and administrative expenses decreased due to a change in the method of
allocation of costs formerly accumulated in the Shared Services segment. 
Under the current methodology, approximately $6.5 million of additional Selling,
general and administrative expenses would have been allocated in the prior
year.  In addition, fiscal 2007 selling general and administrative
costs include a charge of $9.6 million related to the resignation of our CEO
described above, $1.1 million in expenses associated with the Company’s
exploration of strategic alternatives and $0.4 million in expenses associated
with the Company’s adoption of FAS 123(R).





In fiscal
2008, Merger and acquisition costs include indirect costs associated with the
acquisition of Primedia Enthusiast Media, Inc (“EM”).





In fiscal
2007, disposal of land, buildings and equipment includes a $0.5 million loss
associated with the sale of a former manufacturing facility and a $0.4 million
loss associated with the termination of the Company’s aircraft
lease.








INTEREST
EXPENSE, NET





Interest
expense includes the interest and fees on our significant debt instruments and
outstanding letters of credit.  Interest expense increased from $12.5
million to $76.8 million.  The increase relates to the significant increase
in borrowings as a result of our acquisition of EM.





OTHER
INCOME





Other
income is comprised of items that are outside the normal course of
business.  Therefore, comparison between periods is not
meaningful.








INCOME
TAXES





For the
year ended January 31, 2008 we recognized an income tax benefit of $16.0 million
compared to $6.1 million for the year ended January 31, 2007.  Our
effective benefit rate was 38.5% in fiscal 2008 versus 18.9% in fiscal
2007.  The change in effective rate is due primarily to the
non-deductible nature of a large portion of the goodwill and intangible assets
impairment charge taken in fiscal 2007.




27


RESULTS
FOR THE FISCAL YEAR ENDED JANUARY 1, 2007 COMPARED TO THE FISCAL YEAR ENDED
JANUARY 31, 2006




DVD AND
CD FULFILLMENT GROUP




The
following table presents comparative operating results for our DVD and CD
Fulfillment group for the fiscal years ended January 31, 2007 and
2006:




Year ended January 31,
            
            
            Increase (decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percent(in thousands)Revenues
            
            $
            971,523
            
            
            $
            889,380
            
            
            $
            82,143
            
            
            
            9.2
            %Cost
      of revenues
            
            
            797,348
            
            
            
            733,173
            
            
            
            64,175
            
            
            
            8.8
            %Gross
      profit
            
            
            174,175
            
            
            
            156,207
            
            
            
            17,968
            
            
            
            11.5
            %Selling,
      general and administrative expense
            
            
            55,650
            
            
            
            53,962
            
            
            
            1,688
            
            
            
            3.1
            %Distribution,
      circulation and fulfillment
            
            
            64,509
            
            
            
            56,595
            
            
            
            7,914
            
            
            
            14.0
            %Depreciation
      and amortization
            
            
            14,650
            
            
            
            11,147
            
            
            
            3,503
            
            
            
            31.4
            %Disposal
      of land, buildings and equipment, net
            
            
            287
            
            
            
            —
            
            
            
            287
            
            
            NMOperating
      income
            
            $
            39,079
            
            
            $
            34,503
            
            
            $
            4,576
            
            
            
            13.3
            %Key
      operating measures:Gross
      profit margin
            
            
            17.9
            %
            
            
            17.6
            %
            
            
            0.3
            %Operating
      margin
            
            
            4.0
            %
            
            
            3.9
            %
            
            
            0.1
            %Distribution,
      circulation and fulfillment  percent of
      revenues
            
            
            6.6
            %
            
            
            6.4
            %
            
            
            0.2
            %




NM—the
result of the calculation is not meaningful




As
discussed above, we acquired Alliance Entertainment Corp. on February 28,
2005. As such, results of operations for the year ended January 31, 2006
include only 11 months of activity, compared to 12 months in the year ended
January 31, 2007. Increases in individual income statement line items for
the DVD and CD fulfillment group result primarily from the timing of the
acquisition during the year ended January 31, 2006.




Gross
profit margin increased over the prior year primarily due to increased volume
rebates and other vendor incentives.




Distribution,
circulation and fulfillment increased as a percentage of revenues primarily due
to increased fuel surcharges and a larger percentage of sales requiring
overnight air shipments.




Operating
margin increased primarily due to decreased bad-debt expense. During the fourth
quarter of fiscal 2007, we reached a final favorable settlement of certain
disputes with large customers that were reserved prior to the acquisition of
Alliance. As a result of this final settlement, we reversed $3.3 million of
bad-debt reserves and accrued expenses.




28


MAGAZINE
FULFILLMENT GROUP




The
following table presents comparative operating results for our Magazine
Fulfillment group for the fiscal years ended January 31, 2007 and
2006:




Year ended January 31,
            
            
            Increase (decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percent(in thousands)Revenues
            
            $
            809,753
            
            
            $
            566,436
            
            
            $
            243,317
            
            
            
            43.0
            %Cost
      of revenues
            
            
            621,786
            
            
            
            437,869
            
            
            
            183,917
            
            
            
            42.0
            %Gross
      profit
            
            
            187,967
            
            
            
            128,567
            
            
            
            59,400
            
            
            
            46.2
            %Selling,
      general and administrative expense
            
            
            63,603
            
            
            
            36,080
            
            
            
            27,523
            
            
            
            76.3
            %Distribution,
      circulation and fulfillment
            
            
            113,444
            
            
            
            74,221
            
            
            
            39,223
            
            
            
            52.8
            %Depreciation
      and amortization
            
            
            7,997
            
            
            
            4,446
            
            
            
            3,551
            
            
            
            79.9
            %Integration
      and relocation expense
            
            
            3,580
            
            
            
            —
            
            
            
            3,580
            
            
            NMDisposal
      of land, buildings and equipment, net
            
            
            (154
            )
            
            
            —
            
            
            
            (154
            )
            
            NMOperating
      (loss) income
            
            $
            (503
            )
            
            $
            13,820
            
            
            $
            (14,325
            )
            
            
            (103.6
            )%Key
      operating measures:Revenues
      from:Domestic
      specialty distribution
            
            $
            171,290
            
            
            $
            215,137
            
            
            $
            (43,847
            )
            
            
            (20.4
            )%Domestic
      mainstream distribution
            
            $
            603,021
            
            
            $
            319,631
            
            
            $
            283,390
            
            
            
            88.7
            %Export
      distribution
            
            $
            35,442
            
            
            $
            31,668
            
            
            $
            3,774
            
            
            
            11.9
            %Gross
      profit margin
            
            
            23.2
            %
            
            
            22.7
            %
            
            
            0.5
            %Distribution,
      circulation and fulfillment percent of revenues
            
            
            14.0
            %
            
            
            13.1
            %
            
            
            0.9
            %Operating
      margin
            
            
            (0.1
            )%
            
            
            2.4
            %
            
            
            (2.5
            )%




NM—the
result of the calculation is not meaningful




Revenues
from domestic specialty distribution decreased primarily due to the change in
revenue recognition discussed above.




As
discussed above, we acquired Levy in May 2005 and SCN and Mid-Atlantic in
March 2006. Therefore, fiscal 2006 results include only nine months of
results from Levy and no results from SCN and Mid-Atlantic and fiscal 2007
results include 12 months of results from Levy and ten months of results from
SCN and Mid-Atlantic. Increases in individual income statement line items for
the Magazine fulfillment group as well as revenues from domestic mainstream
distribution result primarily from the timing of the acquisitions during fiscal
2007 and fiscal 2006.




Gross
profit margin increased partly due to the benefit of certain industry-wide
pricing programs designed to compensate distributors for distributing
lower-priced titles.




Distribution,
circulation and fulfillment increased as a percentage of revenues and operating
margin decreased primarily due to the change in revenue recognition discussed
above, as all expenses associated with distributing magazines for this account
have been recorded as incurred while recognition of revenues has been deferred
until the magazines scan. Distribution, circulation and fulfillment as a
percentage of revenues was also impacted by higher fuel surcharges. In addition,
operating margin was reduced by of the integration and relocation expenses
discussed above.







29


IN-STORE
SERVICES GROUP




The
following table presents comparative operating results for our In-Store Services
group for the fiscal years ended January 31, 2007 and 2006:




Year ended January 31,
            
            
            Increase (decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percent(in thousands)Revenues
            
            $
            47,377
            
            
            $
            42,973
            
            
            $
            4,404
            
            
            
            10.2
            %Cost
      of revenues
            
            
            26,790
            
            
            
            25,078
            
            
            
            1,712
            
            
            
            6.8
            %Gross
      profit
            
            
            20,587
            
            
            
            17,895
            
            
            
            2,692
            
            
            
            6.9
            %Selling,
      general and administrative expense
            
            
            7,695
            
            
            
            6,452
            
            
            
            1,243
            
            
            
            19.3
            %Fulfillment
      freight
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            NMDepreciation
      and amortization
            
            
            557
            
            
            
            588
            
            
            
            (31
            )
            
            
            (5.3
            )%Impairment
      of goodwill and intangible assets
            
            
            32,742
            
            
            
            —
            
            
            
            32,742
            
            
            NMIntegration
      and relocation expense
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            NMDisposal
      of land, buildings and equipment, net
            
            
            (86
            )
            
            
            —
            
            
            
            (86
            )
            
            NMMerger
      and acquisition charges
            
            
            —
            
            
            
            344
            
            
            
            (344
            )
            
            
            (100.0
            )%Operating
      (loss) income
            
            $
            (20,321
            )
            
            $
            10,511
            
            
            $
            (30,832
            )
            
            
            (293.3
            )%Key
      operating measures:Revenue
      from:Claim
      filing and information
            
            $
            14,707
            
            
            $
            16,172
            
            
            $
            (1,465
            )
            
            
            (9.0
            )%Wire
      manufacturing
            
            $
            32,670
            
            
            $
            26,801
            
            
            $
            5,869
            
            
            
            21.9
            %Gross
      profit margin
            
            
            43.5
            %
            
            
            41.6
            %
            
            
            1.9
            %Operating
      margin
            
            
            (42.9
            )%
            
            
            24.5
            %
            
            
            (67.4
            )%




NM—the
result of the calculation is not meaningful




Revenues
from claim filing are recognized at the time the claim is paid. Claim filing
revenues decreased primarily due to the timing of the cash payments received on
claims. Information services revenue increased $0.1 million over the prior year
to $2.0 million.




Revenues
from wire manufacturing increased primarily due to an increased number of
front-end fixture purchases as certain retailers replaced their aging
fixtures.




Gross
profit margin increased primarily due to the increase in wire manufacturing
revenues discussed above.




Operating
margin decreased primarily due to the impairment of goodwill and intangible
assets discussed above, partially offset by increased operating margins related
to increased wire manufacturing revenues discussed above.




30


SHARED
SERVICES GROUP




The
following table presents comparative operating results for our Shared Services
group for the fiscal years ended January 31, 2007 and 2006:




Year ended January 31,
            
            
            Increase (decrease)2007
            
            
            2006
            
            
            Amount
            
            
            Percent(in thousands)Selling,
      general and administrative expense
            
            $
            34,483
            
            
            $
            21,300
            
            
            $
            13,183
            
            
            
            61.9
            %Depreciation
      and amortization
            
            
            2,155
            
            
            
            2,019
            
            
            
            136
            
            
            
            6.7
            %Integration
      and relocation expense
            
            
            84
            
            
            
            —
            
            
            
            84
            
            
            NMDisposal
      of land, buildings and equipment, net
            
            
            903
            
            
            
            —
            
            
            
            903
            
            
            NMMerger
      and acquisition charges
            
            
            —
            
            
            
            2,975
            
            
            
            (2,975
            )
            
            
            (100.0
            )%Operating
      loss
            
            $
            (37,625
            )
            
            $
            (26,294
            )
            
            $
            (11,331
            )
            
            
            43.1
            %Key
      operating measure:Operating
      expenses percent of revenues
            
            
            2.0
            %
            
            
            1.7
            %
            
            
            0.3
            %




NM—the
result of the calculation is not meaningful




Selling,
general and administrative expenses increased primarily due to a charge of $9.6
million related to the resignation of our CEO described above, $1.1 million in
expenses associated with the Company’s exploration of strategic alternatives and
$0.4 million in expenses associated with the Company’s adoption of FAS
123(R) and to support the growth of the business due to recent acquisitions
described above.




Disposal
of land, buildings and equipment includes a $0.5 million loss associated with
the sale of a former manufacturing facility and a $0.4 million loss associated
with the termination of the Company’s aircraft lease.










INTEREST
EXPENSE, NET




Interest
expense, net increased $5.9 million from $6.6 million to $12.5 million primarily
due to increased borrowings on our revolving credit facility due to the
acquisitions of SCN and Mid-Atlantic described above. Also contributing to the
increase are higher weighted average borrowing rates versus the prior
year.




OTHER
INCOME




Other
income is comprised of items that are outside the normal course of business.
Therefore, comparison between periods is not meaningful.




INCOME
TAXES




Income
tax expense decreased $19.3 million from $13.2 million to $(6.1) million
primarily due to a decrease in taxable income. Our effective benefit rate was
18.9% in the year ended January 31, 2007 compared to an effective tax rate
of 50.4% for the year ended January 31, 2006. The change in effective rate
is due primarily to the non-deductible nature of a large portion of the goodwill
and intangible assets impairment charge taken in fiscal 2007. The revision of
the treatment of certain timing differences also impacted our effective tax
rate.







31


LIQUIDITY
AND CAPITAL RESOURCES





OVERVIEW





Our
primary sources of cash include receipts from our customers, borrowings under
our credit facilities and from time to time the proceeds from the sale of common
stock.





Our
primary cash requirements for the DVD and CD Fulfillment and Magazine
Fulfillment group consist of the cost of CDs and DVDs, magazines and the cost of
freight, labor and facility expense associated with our distribution
centers.





Our
primary cash requirements for the In-Store Services group consist of the cost of
raw materials, labor, and factory overhead incurred in the production of
front-end displays, the cost of labor incurred in providing our claiming, design
and information services and cash advances funding our Advance Pay program. Our
Advance Pay program allows retailers to accelerate collections of their rebate
claims through payments from us in exchange for the transfer to us of the right
to collect the claim. We then collect the claims when paid by publishers for our
own account.





Our
primary cash requirements for the Shared Services group consist of salaries,
professional fees and insurance not allocated to the operating
groups.





The
following table presents a summary of our significant obligations and
commitments to make future payments under debt obligations and lease agreements
due by fiscal year as of January 31, 2008 (in thousands).





Payments
      due during the year ending January 31,2013
      and2009
            
            
            2010
            
            
            2011
            
            
            2012
            
            
            thereafter
            
            
            TotalDebt
      obligations
            
            $
            15,369
            
            
            $
            12,944
            
            
            $
            11,402
            
            
            $
            11,315
            
            
            $
            1,323,549
            
            
            $
            1,374,579Interest
      payments(a)
            
            
            106,685
            
            
            
            109,825
            
            
            
            109,070
            
            
            
            108,362
            
            
            
            425,430
            
            
            
            859,372Obligations
      under Automotive.com agreements
            
            
            7,573
            
            
            
            29,746
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            37,319Capital
      leases
            
            
            1,405
            
            
            
            1,130
            
            
            
            504
            
            
            
            193
            
            
            
            -
            
            
            
            3,232Operating
      leases
            
            
            25,489
            
            
            
            23,334
            
            
            
            15,271
            
            
            
            12,219
            
            
            
            25,912
            
            
            
            102,225Total
      contractual cash obligations
            
            $
            156,521
            
            
            $
            176,979
            
            
            $
            136,247
            
            
            $
            132,089
            
            
            $
            1,774,891
            
            
            $
            2,376,727








(a)
            Interest
      is calculated using the prevailing weighted average rate on our
      outstanding debt at January 31, 2008, using the required payment
      schedule.





The
following table presents a summary of our commercial commitments and the
notional amount expiration by period:





Notional
      amounts expiring during the year ending January 31,(IN
      THOUSANDS)
            
            2009
            
            
            2010
            
            
            2011
            
            
            2012
            
            
            2013
      and
              thereafter
            
            
            TotalFinancial
      standby letters of credit
            
            $
            20,511
            
            
            $
            1,800
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            22,311







32


OPERATING
CASH FLOW





The
following table shows comparative operating cash flow components for the years
ended January 31, 2008, 2007 and 2006:





Year
      ended January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Net
      (loss) income
            
            $
            (27,893
            )
            
            $
            (24,656
            )
            
            $
            12,879Minority
      interest in income of subsidiary
            
            
            731
            
            
            
            -
            
            
            
            -Depreciation
      and amortization
            
            
            61,243
            
            
            
            26,903
            
            
            
            20,089Provision
      for losses on accounts receivable
            
            
            4,325
            
            
            
            3,156
            
            
            
            6,100Deferred
      income taxes
            
            
            (16,028
            )
            
            
            (13,296
            )
            
            
            7,395Impairment
      of goodwill and intangible assets
            
            
            35,310
            
            
            
            32,742
            
            
            
            -Other
            
            
            7,951
            
            
            
            1,763
            
            
            
            3,563Working
      capital changes:Decrease
      (increase) in accounts receivable
            
            
            5,601
            
            
            
            15,681
            
            
            
            (33,295
            )(Increase)
      decrease in inventories
            
            
            (37,975
            )
            
            
            (30,134
            )
            
            
            (41,518
            )(Increase)
      decrease in income tax receivable or payable
            
            
            13,133
            
            
            
            (7,752
            )
            
            
            95(Increase)
      decrease in other current and non-current assets
            
            
            (16,766
            )
            
            
            (4,060
            )
            
            
            2,059(Decrease)
      increase in accounts payable and other liabilities
            
            
            47,495
            
            
            
            (21,091
            )
            
            
            81,463Cash
      (used in) provided by operating activities
            
            $
            77,127
            
            
            $
            (20,744
            )
            
            $
            58,830





In
addition to the non-cash add-backs to and (deductions from) net income required
to reconcile net income from cash used in operating activities, working capital
changes for the year ended January 31, 2008 are as follows:





The
increase in inventory was primarily related to an increase in inventory within
our Magazine Fulfillment group of $19.6 million related to increased consignment
inventory related to scan-based customers as well as an increase of $16.6
million within our DVD and CD Fulfillment group related to increased inventory
required to service a significant new customer gained during fiscal year
2008.





The
decrease in income tax receivable is due primarily to refunds received during
fiscal year 2008.





The
increase in other current and non-current assets results from an increase in
other current and non-current assets within our Media group primarily relating
to timing of payments related to direct response advertising programs as well as
an increase within our Shared Services group of $4.4 million related in part to
merger and acquisition costs capitalized.





The
increase in accounts payable and other liabilities relates to an increase in
accounts payable and other liabilities within our In-Store Services group of
$15.7 million related to the timing of payment of claims, an increase of $14.4
million within our Magazine Fulfillment group related to better payment terms
negotiated with vendors during the first half of fiscal year 2008, an increase
within our DVD and CD Fulfillment group of $13.6 million related to the timing
of vendor payments and an increase of $7.0 million within our Shared Services
group related primarily to the timing of interest payments.





In
addition to the non-cash add-backs to and (deductions from) net income required
to reconcile net income from cash used in operating activities, working capital
changes for the year ended January 31, 2007 are as follows:




The
overall increase in inventory was primarily due to an increase in inventories
within our Magazine Fulfillment group, due in part to the change in revenue
recognition discussed above, partially offset by a decrease in inventory within
our DVD and CD Fulfillment group of $1.6 million.




The
decrease in accounts payable and other liabilities was primarily due to a
decrease in accounts payable within our Magazine Fulfillment group of $20.1
million, primarily due to the timing of the acquisitions of SCN and Mid
Atlantic. A decrease in accounts payable of $15.0 million within our DVD and CD
Fulfillment group, related primarily to the timing of vendor payments and
shifting product mix toward more DVDs, which have historically had
less-favorable payment terms. These decreases are partially offset by an
increase in within our Shared Services group of $11.0 million, due primarily to
the accrual of charges associated with the resignation of our CEO in
November 2006.




The
increase in income tax receivable is primarily attributable to the accrual of
income tax refunds receivable during the year ended January 31,
2007.




The
overall decrease in accounts receivable is primarily attributable to a decrease
in accounts receivable within our Magazine fulfillment group of $16.5 million
related to the revenue recognition change described above, offset by the timing
of customer payments.




In
addition to the non-cash add-backs to and (deductions from) net income required
to reconcile net income from cash used in operating activities, working capital
changes for the year ended January 31, 2006 are as follows:




33




The
overall increase in accounts payable of $81.5 million for the fiscal year ended
January 31, 2006 was primarily due to the seasonality of DVD and CD
Fulfillment and Magazine Fulfillment groups. An increase in accounts payable in
our DVD and CD Fulfillment group of $56.3 million was due to holiday season
purchasing on extended terms provided by the major record labels and
studios.




The
Magazine Fulfillment Group had an increase in accounts payable of approximately
$36.5 million due primarily to the cyclical nature of the Mainstream Magazine
distribution business.




The
increase in accounts receivable for the fiscal year ended January 31, 2006
of $33.3 million and the increase in inventories of $41.5 million relates
primarily to increased distribution and sales levels in our DVD and CD
Fulfillment and Magazine Fulfillment, for the holiday season.




INVESTING
CASH FLOW





The
following table shows comparative investing cash flow components for the years
ended January 31, 2008, 2007 and 2006:





Year
      ended January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Capital
      expenditures
            
            $
            (30,047
            )
            
            $
            (13,379
            )
            
            $
            (13,069
            )Net
      (purchase of) payments received on purchased claims
            
            
            2,571
            
            
            
            (7,061
            )
            
            
            (7,916
            )Acquisitions
            
            
            (1,195,348
            )
            
            
            (39,800
            )
            
            
            (30,409
            )Divestitures
            
            
            9,828
            
            
            
            -
            
            
            
            -Other
            
            
            210
            
            
            
            1,362
            
            
            
            1,548Cash
      used in investing activities
            
            $
            (1,212,786
            )
            
            $
            (58,878
            )
            
            $
            (49,846
            )





Net cash
used in investing activities for the fiscal year ended January 31, 2008
consisted primarily of $1,195.3 million paid for the acquisition of Primedia
Enthusiast Media, Inc. and capital expenditures of $30.0 million.  The
expenditures were partially offset by $9.8 million received from the sale of our
Wood manufacturing group.  The increase in capital expenditures
relates to the addition of EM and to our continued integration projects inside
our Magazine Fulfillment group.





Net cash
used in investing activities for the fiscal year ended January 31, 2007
consisted primarily of cash paid to acquired SCN and Mid-Atlantic, capital
expenditures of $13.4 million related primarily to our DVD and CD Fulfillment
group’s ongoing effort to streamline its distribution process and our Shared
Services group’s ongoing effort to improve information technology
infrastructure. Net cash used by investing activities also included the net
acquisition of claims by our In-Store Services group of $7.1
million.




Net cash
used in investing activities for the fiscal year ended January 31, 2006
consisted primarily of cash paid to acquire Levy of $45.0 million, net of cash
acquired and capital expenditures of $13.1 million. Capital expenditures related
primarily to our DVD and CD Fulfillment group and its ongoing effort to
streamline its distribution process. Net cash used by investing activities also
included the net acquisition of claims by our In-Store Services group of $7.9
million. These cash consuming activities were partially offset by net cash
acquired of $16.8 million upon completion of our merger with
Alliance.




FINANCING
CASH FLOW





Outstanding
balances on our credit facility fluctuate partially due to the timing of the
retailer rebate claiming process and our Advance Pay program, the seasonality of
our DVD and CD Fulfillment and wire manufacturing business, and the payment
cycle of the magazine distribution business. Because the magazine distribution
business and Advance Pay program cash requirements peak at our fiscal quarter
ends, the reported bank debt levels usually are the maximum level outstanding
during the quarter.





Payments
under our Advance Pay program generally occur just prior to our fiscal quarter
end. The related claims are not generally collected by us until 90 days after
the advance is made. As a result, our funding requirements peak at the time of
the initial advances and decrease over the next 90 days as the cash is collected
on the related claims.





Sales of
CDs and DVDs are traditionally highest during our fourth quarter (the holiday
season), while returns are highest during our first quarter. Consequently,
working capital needs for the home entertainment products marketplace are
typically highest in our third quarter due to increases in inventories purchased
for the holiday selling season and extension of credit terms to certain
customers. Historically, the DVD and CD Fulfillment segment has financed their
working capital needs through cash generated from operations, extended terms
from suppliers and bank borrowings.





Within
our magazine distribution business, our significant customers pay weekly, and we
pay our suppliers monthly. As a result, funding requirements peak at the end of
the month when supplier payments are made and decrease over the course of the
next month as our receivables are collected.




34





The wire
manufacturing business is seasonal because most retailers prefer initiating new
programs before the holiday shopping season begins, which concentrates revenues
in the second and third quarter. Receivables from these fixture programs are
generally collected from all participants within 180 days. We are usually
required to tender payment on the costs of these programs (raw material and
labor) within a shorter period. As a result, our funding requirements peak in
the second and third fiscal quarters when we manufacture the wire fixtures and
decrease significantly in the fourth and first fiscal quarters as the related
receivable are collected and significantly less manufacturing activity is
occurring.





The
following table shows comparative financing cash flow components for the years
ended January 31, 2008, 2007 and 2006:





Year
      ended January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Increase
      (decrease) in checks issued against revolving credit
      facility
            
            $
            (12,854
            )
            
            $
            1,465
            
            
            $
            (13,529
            )(Repayments)
      borrowings under credit facilities
            
            
            (116,459
            )
            
            
            71,458
            
            
            
            25,712Borrowing
      under Citicorp Northamerica credit facilities
            
            
            1,345,000Net
      payments on notes payable and capital leases
            
            
            (8,723
            )
            
            
            (18,951
            )
            
            
            (3,279
            )Proceeds
      from the issuance of common stock
            
            
            715
            
            
            
            2,222
            
            
            
            5,040Excess
      tax benefit from exercise of stock options
            
            
            389
            
            
            
            189
            
            
            
            -Deferred
      financing costs and other
            
            
            (36,759
            )
            
            
            -
            
            
            
            (1,076
            )Cash
      provided by financing activities
            
            $
            1,171,309
            
            
            $
            56,383
            
            
            $
            12,868





Financing
activities in the fiscal year ended January 31, 2008 consisted primarily of
borrowings on our Citicorp North America facilities of $1,345 million, partially
offset by repayment of the Wells Fargo Foothill revolving credit facility of
$116.5 million, payment of deferred financing costs and other of $36.8 million
and net repayments of notes payable and capital leases of $8.7
million.





Financing
activities in the fiscal year ended January 31, 2007 consisted primarily of
borrowings on our revolving credit facility of $71.5 million, borrowings under
notes payable of $3.1 million and proceeds from issuance of common stock of $2.2
million, partially offset by payments on notes payable of $21.3 million.
Payments on notes payable are composed primarily of payments on notes issued to
the former owner of SCN and Mid-Atlantic.




Financing
activities in the fiscal year ended January 31, 2006 consisted primarily of
borrowings on our revolving credit facility of $25.7 million and borrowings
under notes payable of $20.6 million, including a mortgage of $20.0 million.
These cash providing activities were partially offset by the reduction in checks
issued against future borrowings on credit facilities of $13.5 million and
payments on notes payable of $23.4 million, primarily related to the
modification of the Wells Fargo Foothill credit facility and the repayment of a
mortgage loan. Finally, the exercise of employee stock options for the fiscal
year generated approximately $5.0 million.







Debt




For a
detailed description of the terms of our significant debt instruments, please
see Note 6 to our Consolidated Financial Statements.




In
connection with our acquisition of Primedia Enthusiast Media, Inc., we
issued three new credit facilities on August 1, 2007.  These
facilities consist of a $300 million asset-based revolving facility that was
undrawn at close of the transaction, a $880 million term loan facility that
amortizes 1.0% per year, and a $465 million bridge loan that will convert to
long-term financing if it is not refinanced within one year with the full amount
due upon maturity on August 1, 2017.  Upon conversion or refinancing,
the Company will pay Citicorp North America a conversion fee of $11.6
million.  Our debt facilities are subject to cross-default provisions
with our other material facilities.  See Note 6 – Debt and Revolving Credit
Facilities.  We expect to pay interest on these facilities with cash flow
generated from operations.  At January 31, 2008, we had $279.6 million
of excess availability under our revolving credit facility.




Significant
debt transactions during the nine months ended January 31, 2008, 2007 and 2006
are as follows:




-
            In
      connection with the acquisition of EM, we issued our new Citicorp North
      America credit facilities.  See Note 6 — Debt and Revolving Credit
      Facilities.





-
            In
      connection with the acquisition of Mid-Atlantic on March 30, 2006, we
      issued a promissory note to its former owner in the amount of $4.1
      million.  It was repaid during the remainder of fiscal 2007. 
      The remainder of the purchase price, $13.6 million, was funded by
      borrowings on our revolving credit
facility.





-
            In
      connection with the acquisition of SCN on March 30, 2006, we issued a
      promissory note to its former owner in the amount of $10.2 million. 
      It was repaid during the remainder of fiscal 2007.  The remainder of
      the purchase price, $26.0 million, was funded by borrowings on our
      revolving credit facility.





35




OFF-BALANCE
SHEET ARRANGEMENTS





We do not
engage in transactions or arrangements with unconsolidated or other special
purpose entities.





CRITICAL
ACCOUNTING POLICIES AND ESTIMATES





Management’s
Discussion and Analysis of Financial Condition and Results of Operations is
based on our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent liabilities.
Management bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Senior management has discussed the development, selection and disclosure of
these estimates with the audit committee of the board. Actual results may differ
from these estimates under different assumptions and conditions.





Management
believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of its consolidated financial
statements.





REVENUE
RECOGNITION





CD, DVD
and Magazine Fulfillment





Revenues
from the sale of CDs, DVDs and magazines the Company distributes are recognized
at the time of delivery (shipment for CDs and DVDs) less allowances for
estimated returns. Revenues from the sale of CDs, DVDs and magazines to
wholesalers that are not shipped through our distribution centers are recognized
at the later of notification from the shipping agent that the product has been
delivered or the on-sale date of the CD, DVD or magazine. The Company records a
reduction in revenue for estimated CD, DVD and magazine sales returns and a
reduction in cost of sales for estimated CD, DVD and magazine purchase returns.
Estimated returns are based on historical sell-through rates. A certain number
of retailers use scan-based trading terms, in which retailers are not obligated
to pay until the item sells at the retail store. In such arrangements, the
Company recognizes revenue upon the sale of the merchandise by the
retailer.





During
January 2007, the Company re-negotiated terms with its largest specialty
magazine distribution customer.  As a result, the Company began
billing this customer only for magazines that actually scan at their
checkouts.  In the past the Company had billed this customer for the
gross amount of magazines actually shipped to their locations and allowed them
to take credits for magazines returned.  This change resulted in a
change in the Company’s revenue recognition policy for this customer from
recognizing gross sales upon shipment with a reserve for returns to recognizing
revenues only when magazines scan through their checkouts.  As a
result, the Company reversed revenues and accounts receivable for all magazines
that it had shipped into their stores but that had not yet scanned through their
checkouts, reduced cost of revenues for those magazines and recorded those
magazines as inventory





Fulfillment
& Return Processing Services





Revenues
from performing fulfillment and return processing services are recognized at the
time the service is performed. The Company is generally compensated on either a
per-copy or per-pound basis based on a negotiated price or a cost plus
model.





Advertising
Revenues





Advertising
revenues for all consumer magazines are recognized as income at the on-sale
date, net of provisions for estimated rebates, adjustments and discounts. Other
advertising revenues are generally recognized based on the publications’ cover
dates. Online advertising is generally recognized as advertisements are run.
Newsstand sales are recognized as revenue at the on-sale date for all
publications, net of provisions for estimated returns. Subscriptions are
recorded as deferred revenue when received and recognized as revenue over the
term of the subscription. Sales of books and other items are recognized as
revenue upon shipment, net of an allowance for returns. In accordance with
Emerging Issues Task Force (“EITF”) No. 00-10, “Accounting for Shipping and
Handling Fees and Costs,” distribution costs charged to customers are recognized
as revenue when the related product is shipped. The Company also derives revenue
from various licensing agreements, which grant the licensee rights to use the
trademarks and brand names of the Company in connection with the manufacture and
sale of certain designated products. Licensing revenue is generally recognized
by the Company pro-rata over the life of the license agreement or as licensed
products are sold.




Rebate
Claim Filing





Revenues
from the filing of rebate claims with publishers on behalf of retailers are
recognized at the time the claim is paid. The revenue recognized is based on the
amount paid multiplied by our commission rate. The Company has developed a
program (the “advance pay” program) whereby the Company will advance the claimed
amount less applicable commissions to the retailers and collect the entire
amount claimed from publishers for our own accounts. The Company accounts for
the advance as a purchase of a financial asset and records a receivable at the
time of purchase.




36





Information
Products





Revenues
from information product contracts are recognized ratably over the subscription
term, generally one year.





Custom
Display Manufacturing





Revenues
from the design and manufacture of custom display fixtures are recognized when
the retailer accepts title to the display. Transfer of title usually occurs upon
shipment. However, upon request from a customer, the product can be stored for
future delivery for the convenience of the customer. If this occurs, we
recognize revenue when the manufacturing and earnings processes are complete,
the customer accepts title in writing, the product is invoiced with payment due
in the normal course of business, the delivery schedule is fixed and the product
is segregated from other goods. Services related to the manufacturing of
displays such as freight, installation, warehousing and salvage are recognized
when the services are performed.





Editorial
and Product Development Costs





Editorial
cost and product development cost are expensed as incurred. Product development
costs include the cost of artwork, graphics, prepress, plates and photography
for new products.




Advertising
and Subscription Acquisition Costs





Advertising
and subscription acquisition costs are expensed the first time the advertising
takes place, except for certain direct-response advertising, the primary purpose
of which is to elicit sales from customers who can be shown to have responded
specifically to the advertising and that results in probable future economic
benefits. Direct-response advertising consists of product promotional mailings,
catalogues, telemarketing and subscription promotions. These direct-response
advertising costs are capitalized as assets and amortized over the estimated
period of future benefit. The amortization periods range from one to two years
subsequent to the promotional event.





TAXES ON
EARNINGS





The
carrying value of our net deferred tax assets assumes that we will be able to
generate sufficient future taxable income in certain tax jurisdictions, based on
estimates and assumptions. If these estimates and assumptions change in the
future, we may be required to increase or decrease valuation allowances against
our deferred tax assets resulting in additional income tax expenses or
benefits.





GOODWILL
AND OTHER INTANGIBLE ASSETS


Goodwill
represents the excess of cost over the fair value of net assets acquired in
connection with business acquisitions. In accordance with SFAS 142, goodwill and
other intangible assets are tested for impairment at the reporting unit level,
which is defined as an operating segment or a component of an operating segment
that constitutes a business for which financial information is available and is
regularly reviewed by management. The Company assesses goodwill for impairment
at least annually in the absence of an indicator of possible impairment and
immediately upon an indicator of possible impairment. The annual impairment
review is completed in the first quarter of the fiscal year.





In
accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets,” we review finite-lived intangible assets for impairment
whenever an event occurs or circumstances change which indicates that the
carrying amount of such assets may not be fully recoverable. Determination of
recoverability is based on an estimate of undiscounted future cash flows
resulting from the use of the asset and its eventual disposition. Measurement of
an impairment loss is based on the fair value of the asset compared to its
carrying value. Impairment losses, if any, are reflected in operating income or
loss in the Consolidated Statements of Income (Loss).




In
assessing goodwill and finite-lived intangible assets for impairment, we make
estimates of fair value which are based on our projection of revenues, operating
costs, and cash flows of each reporting unit considering historical and
anticipated future results, general economic and market conditions as well as
the impact of planned strategies. The Company combines the discounted cash flow
fair value with publicly traded company multiples and acquisition multiples of
comparable businesses to determine fair value.  Generally, we engage third
party specialists to assist us with our valuations. Changes in our judgments and
projections could result in a significantly different estimate of the fair value
of the reporting units and could result in an impairment of goodwill or other
intangible assets.




37





If the
carrying amount of a reporting unit exceeds its fair value, the Company measures
the possible goodwill impairment based upon an allocation of the estimate of
fair value  to the underlying assets and liabilities of the reporting unit,
including any previously unrecognized intangible assets., based upon known facts
and circumstances as if the acquisition occurred currently. The excess of the
fair value of the reporting unit over the amounts assigned to its assets and
liabilities is the implied fair value of goodwill.  An impairment loss
would be recognized to the extent the carrying value of goodwill exceeds the
implied fair value of the goodwill.  This test performed in the fourth
quarter of fiscal year 2007 indicated that goodwill and other intangible assets
related to the In-Store Services reporting unit were
impaired.


The
Company has intangible assets (other than goodwill) with an indefinite useful
life. Such assets are not amortized until their useful life is determined to be
no longer indefinite at which point the asset would be amortized over its
estimated remaining useful life and be accounted for similar to other
identifiable amortizable intangible assets.
 An
intangible asset that is not subject to amortization shall be tested for
impairment annually, or more frequently, if events or changes in circumstances
indicate that the asset might be impaired. The impairment test shall consist of
a comparison of the fair value of an intangible asset with its carrying amount.
If the carrying amount of the intangible asset exceeds its fair value, an
impairment loss shall be recognized in an amount equal to that
excess.


As a
result of our fiscal year 2008 SFAS No. 144 fourth quarter impairment analysis,
we determined that the customer list of our DVD and CD Fulfillment reporting
unit was impaired and consequently recorded a charge of approximately $35.3
million.  These determinations were primarily the result of a change in
management’s expectations of the long-term outlook for that business unit,
including declining revenues from existing customer, as well as decreasing
operating profit margins.  The combination of these factors had an adverse
impact on the anticipated future cash flows of this reporting unit used in the
impairment analysis performed during the fourth quarter of fiscal year 2008.
 The net carrying amount of the customer list was $30.5 million at the end
of the fourth quarter of fiscal year 2008, after the impairment charge was
recorded.





As a
result of our fiscal year 2007 SFAS No. 142 and SFAS No. 144 fourth quarter
impairment analysis, we determined that the customer list, non-compete agreement
and goodwill of our In-Store Services reporting unit was impaired and
consequently recorded a charge of  approximately $1.7 million, $0.5 million
and $30.6 million, respectively.  These determinations were primarily the
result of a change in management’s expectations of the long-term outlook for
that business unit, including increased life cycle for certain products, as well
as decreasing operating profit margins.  The combination of these factors
had an adverse impact on the anticipated future cash flows of this reporting
unit used in the impairment analysis performed during the fourth quarter of
fiscal year 2007.  The net carrying amount of the customer list was $1.25
million and goodwill $24.7 million at the end of the fourth quarter of fiscal
year 2007, after the impairment charge was recorded.





Intangible
assets with finite useful lives are amortized over their estimated useful lives.
The Company evaluates the remaining useful lives of amortizable identifiable
intangible assets at each reporting period to determine whether events and
circumstances warrant a revision to the remaining periods of
amortization.





RECENT
ACCOUNTING PRONOUNCEMENTS







SFAS
No. 157


In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which provides guidance on how companies should measure fair value when they are
required to use a fair value measure for recognition or disclosure purposes
under GAAP. SFAS No. 157 creates a common definition of fair value to be
used throughout GAAP and prescribes methods for measuring fair value, which is
intended to make the measurement of fair value more consistent and comparable
across companies. This statement also expands the related disclosure
requirements in an effort to provide greater transparency around fair value
measures. SFAS No. 157 is effective as of the beginning of fiscal years
beginning after November 15, 2007.





In
February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which
delays the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years for all
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). Examples of items to which the deferral would apply
include, but are not limited to:





-
            Nonfinancial
      assets and nonfinancial liabilities initially measured at fair value in a
      business combination or other new basis event, but not measured at fair
      value in subsequent periods (nonrecurring fair value
      measurements);





-
            Reporting
      units measured at fair value in the first step of a goodwill impairment
      test and nonfinancial assets and nonfinancial liabilities measured at fair
      value in the second step of a goodwill impairment test (measured at fair
      value on a recurring basis, but not necessarily recognized or disclosed in
      the financial statements at fair
value);





-
            Indefinite-lived
      intangible assets measured at fair value for impairment assessment
      (measured at fair value on a recurring basis, but not necessarily
      recognized or disclosed in the financial statements at fair
      value);





-
            Long-lived
      assets (asset groups) measured at fair value for an impairment assessment
      (nonrecurring fair value measurements);
and





-
            Liabilities
      for exit or disposal activities initially measured at fair value
      (nonrecurring fair value
measurements).





The
Company does not expect the adoption of SFAS No. 157, excluding those items
deferred by FSP FAS 157-2, to have a material impact on its financial condition,
results of operations or cash flows. The Company is still evaluating the impact
of the items deferred by FSP FAS 157-2.




38




SFAS
No. 159


In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. This statement permits companies to
choose, at specified election dates, to measure eligible items, which include
most recognized financial assets and liabilities and firm commitments, at fair
value with unrealized gains and losses on items for which the fair value option
has been elected reported in earnings at each subsequent reporting date.
Generally, the decision about whether to elect the fair value option must
be:





-
            Applied
      instrument by instrument;





-
            Irrevocable;
      and





-
            Applied
      only to an entire instrument and not to only specified risks, specific
      cash flows or portions of that
instrument.





A company
may decide whether to elect the fair value option for each eligible item on its
election date. Alternatively, a company may elect the fair value option
according to a preexisting policy for specified types of eligible items. A
company may choose to elect the fair value option for an eligible item only on
the date that certain events occur, including when:





-
            A
      company first recognizes the eligible
item;





-
            A
      company enters into an eligible firm
commitment;





-
            Financial
      assets that have been reported at fair value with unrealized gains and
      losses included in earnings because of specialized accounting principles
      cease to qualify for that specialized accounting;
  or





-
            The
      accounting treatment for an investment in another entity
      changes.





This
statement is effective as of the beginning of fiscal years that begin after
November 15, 2007. The Company does not expect the adoption of this
statement to have a material impact on its financial condition, results of
operations or cash flows.




SFAS
No. 141(R)


In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations,
which establishes new principles and disclosure requirements pertaining to
business combinations. Primary changes to existing literature include
requirements for the acquirer to recognize:





-
            Assets
      acquired, liabilities assumed and any noncontrolling interest in the
      acquiree at the acquisition date, measured at their fair values as of that
      date;





-
            Identifiable
      assets and liabilities, as well as the noncontrolling interest in the
      acquiree, at the full amounts of their fair values, in a step
      acquisition;





-
            Assets
      acquired and liabilities assumed arising from contractual contingencies as
      of the acquisition date, measured at their acquisition-date fair
      values;





-
            Goodwill
      as of the acquisition date, measured as a residual, which in most types of
      business combinations will result in measuring goodwill as the excess of
      the consideration transferred plus the fair value of any noncontrolling
      interest in the acquiree at the acquisition date over the fair values of
      the identifiable net assets
acquired;





-
            Contingent
      consideration at the acquisition date, measured at its fair value at that
      date;





-
            The
      effect of a bargain purchase in earnings;
and





-
            Changes
      in the amount of its deferred tax benefits that are recognizable because
      of a business combination either in income from continuing operations in
      the period of the combination or directly in contributed capital,
      depending on the circumstances.




SFAS
No. 141(R) applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early adoption is not
permitted. The Company is still evaluating the impact that this statement will
have on its financial condition, results of operations and cash
flows.




SFAS
No. 160


In
December 2007, the FASB also issued a related statement, SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statements. This statement
establishes accounting and reporting standards that require:





-
            Ownership
      interests in subsidiaries held by parties other than the parent to be
      clearly identified, labeled and presented in the consolidated statement of
      financial position within equity, but separate from the parent’s
      equity;





-
            The
      amount of consolidated net income attributable to the parent and to the
      noncontrolling interest to be clearly identified and presented on the face
      of the consolidated statement of
operations;





39


-
            Changes
      in a parent’s ownership interest while the parent retains its controlling
      financial interest in its subsidiary to be accounted for
      consistently;





-
            When
      a subsidiary is deconsolidated, any retained noncontrolling equity
      investment in the former subsidiary be initially measured at fair
      value;





-
            Gains
      or losses on the deconsolidation of a subsidiary to be measured using the
      fair value of any noncontrolling equity investment rather than the
      carrying amount of the retained investment;
and





-
            Entities
      to provide sufficient disclosures that clearly identify and distinguish
      between the interests of the parent and the interests of the
      noncontrolling owners.




SFAS
No. 160 is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. Earlier adoption is
prohibited. The standard must be applied prospectively as of the beginning of
the year of adoption, except for the presentation and disclosure requirements,
which must be applied retrospectively for all periods presented. The Company is
still evaluating the impact on its financial condition, results of operations or
cash flows.







ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





Our
primary market risks include fluctuations in interest rates and exchange rate
variability.





Our debt
primarily relates to credit facilities with Citicorp North America. See “Debt”
in Item 7. Management’s Discussion and Analysis.





The
credit facilities with Citicorp North America had an outstanding principal
balance of approximately $1,340.6 million at January 31, 2008. Interest on the
outstanding balance is charged based on a variable interest rate related to
LIBOR (3.27% at January 31, 2008) plus a margin of 3.25% on the Term Loan B and
5.75% on the Bridge Loan.





As a
result of the above, our primary market risks relate to fluctuations in interest
rates. A 1% increase in the prevailing weighted average interest rate on our
debt at January 31, 2008, is estimated to cause an increase of $11.3 million in
interest expense for the year ending January 31, 2009.





We do not
currently perform any interest rate hedging activities related to these credit
facilities.





We have
exposure to foreign currency fluctuation through our exporting of foreign
magazines and the purchased of foreign magazine for domestic
distribution.





Revenues
derived from the export of domestic titles (or sales to domestic brokers who
facilitate the export) totaled $57.6 million for the fiscal year ended January
31, 2008 or 2.6% of total revenues. For the most part, our export revenues are
denominated in dollars, and the foreign wholesaler is subject to foreign
currency risks. We have the availability to control foreign currency risk via
increasing or decreasing the local cover price paid in the foreign markets.
There is a risk that a substantial increase in local cover price, due to a
decline in the local currency relative to the dollar, could decrease demand for
these magazines at retail and negatively impact our results of
operations.





Domestic
distribution (gross) of imported titles totaled approximately $106.8 million (of
a total $2,423.8 million in gross magazine distribution or 4.7%). Foreign
publications are purchased in both dollars and the local currency of the foreign
publisher, primarily Euros and pounds sterling. In the instances where we buy in
the foreign currency, we generally have the ability to set the domestic cover
price, which allows us to minimize if we so choose the foreign currency risk.
Foreign titles generally have significantly higher cover prices than comparable
domestic titles, are sold only at select retail locations, and sales do not
appear to be highly impacted by cover price increases. However, a significant
negative change in the relative strength of the dollar to these foreign
currencies could result in higher domestic cover prices and result in lower
sales of these titles at retail, which would negatively impact our results of
operations.





We do not
conduct any significant hedging activities related to foreign
currency.





40


ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.





Our
consolidated financial statements are included herein as a separate section of
this report which begins on page F-1.





ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.





None.





ITEM 9A.
CONTROLS AND PROCEDURES.





MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING





Our
management is responsible for establishing and maintaining adequate internal
control over our financial reporting, as such term is defined in Exchange Act
Rule 13a-15(f). Under the supervision and with the participation of management,
including our chief executive officer and chief financial officer, we conducted
an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Based on this evaluation, our management concluded that our internal control
over financial reporting was effective as of January 31, 2008.







Our
internal control over financial reporting as of January 31, 2008 has been
audited by BDO Seidman LLP, an independent registered public accounting firm
which also audited the Company’s consolidated financial statements included in
this Annual Report on Form 10-K. BDO Seidman LLP’s attestation report on the
Company’s internal control over financial reporting is included
below.




41


REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL
REPORTING




Board of
Directors


Source
Interlink Companies, Inc


Bonita Springs,
FL





We have
audited Source Interlink Companies, Inc internal control over financial
reporting as of January 31, 2008, based on criteria established in Internal
Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The Company’s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Item 9A,
Management’s Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the company’s internal control over
financial reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





As
indicated in the accompanying Item 9A, Management’s Report on Internal Control
over Financial Reporting, management’s assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include the
internal controls of Primedia Enthusiast Media, Inc, which was acquired on
August 1, 2007, and which is included in the consolidated balance sheet of
Source Interlink Companies, Inc as of January 31, 2008, and the related
consolidated statements of operations, stockholders’ equity, and cash flows for
the year then ended.  Primedia Enthusiast Media, Inc constituted 57%
of total assets, respectively, as of January 31, 2008, and 11% of revenues,
respectively, for the year then ended. Management did not assess the
effectiveness of internal control over financial reporting of Primedia
Enthusiast Media, Inc. because of the timing of the acquisition which was
completed on August 1, 2007. Our audit of internal control over financial
reporting of Source Interlink Companies, Inc. also did not include an evaluation
of the internal control over financial reporting of Primedia Enthusiast Media,
Inc.





In our
opinion, Source Interlink Companies, Inc maintained, in all material respects,
effective internal control over financial reporting as of January 31, 2008,
based on the COSO criteria.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Source
Interlink Companies, Inc as of January 31, 2008 and 2007, and the related
consolidated statements of income, stockholders’ equity, and cash flows for each
of the three years in the period ended January 31, 2008 and our report dated
April 14, 2008 expressed an unqualified opinion thereon.





/s/ BDO
Seidman, LLP


Chicago,
Illinois








42


CHANGES
IN INTERNAL CONTROL OVER FINANCIAL REPORTING





There was
no change in our internal control over financial reporting that occurred during
the quarter ended January 31, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.





EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES





We
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
Annual Report on Form 10-K. The controls evaluation was done under the
supervision and with the participation of management, including our chief
executive officer and chief financial officer.





Based on
this evaluation, our chief executive officer and our chief financial officer
have concluded that, subject to the limitations noted below, as of the end of
the period covered by this Annual Report on Form 10-K, our disclosure controls
and procedures were effective to ensure that information we are required to
disclose in reports that we file or submit under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.





Attached
as exhibits to this annual report are certifications of the chief executive
officer and the chief financial officer, which are required in accordance with
Rule 13a-14 of the Securities Exchange Act of 1934. This “Controls and
Procedures” section includes the information concerning the controls evaluation
referred to in the certifications, and it should be read in conjunction with the
certifications for a more complete understanding of the topics
presented.





SCOPE OF
THE EVALUATION





The
evaluation of our disclosure controls and procedures included a review of the
controls’ objectives and design, the company’s implementation of the controls
and the effect of the controls on the information generated for use in this
annual report. In the course of the controls evaluation, we sought to identify
data errors, control problems or acts of fraud and confirm that appropriate
corrective action, including process improvements, were being undertaken. This
type of evaluation is performed on a quarterly basis so that the conclusions of
management, including the Chief Executive Officer and Chief Financial Officer,
concerning the effectiveness of the controls can be reported in our quarterly
reports on Form 10-Q and to supplement our disclosures made in our Annual Report
on Form 10-K. Many of the components of our disclosure controls and procedures
are also evaluated on an ongoing basis by personnel in our finance department,
as well as our independent auditors who evaluate them in connection with
determining their auditing procedures related to their report on our annual
financial statements and not to provide assurance on our controls. The overall
goals of these various evaluation activities are to monitor our disclosure
controls and procedures, and to modify them as necessary.





Among
other matters, we also considered whether our evaluation identified any
“significant deficiencies” or “material weaknesses” in our internal control over
financial reporting, and whether the company had identified any acts of fraud
involving personnel with a significant role in our internal control over
financial reporting. We evaluated these matters using the definitions for these
terms found in professional auditing literature. We also sought to address other
controls matters in the controls evaluation, and in each case if a problem was
identified, we considered what revision, improvement and/or correction to make
in accordance with our ongoing procedures.





INHERENT
LIMITATIONS ON EFFECTIVENESS OF CONTROLS





The
company’s management, including the chief executive officer and chief financial
officer, does not expect that our disclosure controls or our internal control
over financial reporting will prevent all error and all fraud. A control system,
no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system’s objectives will be met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, within the company have been detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple error or mistake.
Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls is based in part on certain assumptions about
the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or
procedures. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be
detected.





ITEM 9B.
OTHER INFORMATION.





Not
applicable.





43


PART
III





ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





CODES OF
ETHICS





We have a
long-standing commitment to conduct our business in accordance with the highest
ethical principles. Our Code of Business Conduct and Ethics is applicable to all
representatives of our enterprise, including our executive officers and all
other employees and agents of our company and our subsidiary companies, as well
as to our directors. A copy of our Code of Business Conduct and Ethics is
available in the Corporate Governance section of the Investor Relations page of
our website. In addition, our board has adopted a Code of Ethics for the Chief
Executive Officer and Financial Executives and a Code of Conduct for Directors
and Executive Officers which supplement our Code of Business Conduct and Ethics.
A copy of each of these codes is available on the Corporate Governance section
of the Investor Relations page of our website. We will disclose any amendments
to, or waivers from, our Codes of Ethics on our website at
www.sourceinterlink.com.





ITEM 11.
EXECUTIVE COMPENSATION.





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





ITEM 13.
CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE.





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.





See the
Proxy Statement for the Company’s 2008 Annual Meeting of Stockholders, which
information is incorporated herein by reference.





44


PART
IV





ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES.





(A)
            1.
      FINANCIAL STATEMENTS:





Report of
Independent Registered Public Accounting Firm





Consolidated
balance sheets - January 31, 2008 and 2007





Consolidated
statements of operations - years ended January 31, 2008, 2007 and
2006





Consolidated
statements of stockholders’ equity - years ended January 31, 2008, 2007 and
2006





Consolidated
statements of cash flows - years ended January 31, 2008, 2007 and
2006





Notes to
consolidated financial statements





2.
FINANCIAL STATEMENT SCHEDULES





The
following consolidated financial statement schedule of Source Interlink
Companies, Inc. and subsidiaries is included herein:





Schedule
II - Valuation and qualifying accounts S-1





All other
schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related
instructions or are inapplicable, and therefore have been omitted.





3.
      EXHIBITS





See
Exhibit Index


45


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.





SOURCE
INTERLINK COMPANIES, INC.





April
      15, 2008
            By:
            /s/ Marc
      Fierman


Marc
      Fierman


Chief
      Financial Officer


(principal
      financial officer)





Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.





April
      15, 2008
            /s/ Michael R.
      Duckworth


Michael
      R. Duckworth


Chairman
      of the Board of Directors


(principal
      executive officer)





April
      15, 2008
            /s/ James R.
      Gillis


James
      R. Gillis


Co-Chief
      Executive Officer and Director





April
      15, 2008
            /s/ Gray
      Davis


Gray
      Davis


Director





April
      __, 2008


Ariel
      Z. Emanuel


Director





April
      15, 2008
            /s/ David R.
      Jessick


David
      R. Jessick


Director





April
      15, 2008
            /s/ Allan R.
      Lyons


Allan
      R. Lyons


Director





April
      15, 2008
            /s/ Gregory
      Mays


Gregory
      Mays


Director





April
      15, 2008
            /s/
      George A. Schnug


George
      A. Schnug


Director





April
      15, 2008
            /s/ Terrence J.
      Wallock


Terrence
      J. Wallock


Director


46


EXHIBIT
      INDEX





EXHIBIT
              NO.
            DESCRIPTION2.1
            Agreement
      and Plan of Merger, dated November 18, 2004, by and among Source Interlink
      Companies, Inc., Alliance Entertainment Corp. and Alligator Acquisition,
      LLC , incorporated by reference to Current Report on Form 8-K, as filed
      with the SEC on November 24, 2004 (File No. 001-13437).2.2
            Agreement
      and Plan of Merger dated February 28, 2005, between Source Interlink
      Companies, Inc., a Missouri corporation and Source Interlink Companies,
      Inc., a Delaware corporation, incorporated by reference to Current Report
      on Form 8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).2.3
            Unit
      Purchase Agreement dated May 10, 2005 between the Registrant and Chas.
      Levy Company LLC, incorporated by reference to Current Report on Form 8-K,
      as filed with the SEC on May 16, 2005 (File No.
  001-13437).2.4
            Unit
      Purchase Agreement dated March 30, 2006 between the Registrant and
      Anderson News, LLC, incorporated by reference to Current Report on Form
      8-K, as filed with the SEC on April 5, 2006 (File No.
      001-13437).2.5
            Unit
      Purchase Agreement dated March 30, 2006 between the Registrant and
      Anderson News, LLC, incorporated by reference to Current Report on Form
      8-K, as filed with the SEC on April 5, 2006 (File No.
      001-13437).3.9
            Certificate
      of Incorporation of Source Interlink Companies, Inc., a Delaware
      corporation, incorporated by reference to Current Report on Form 8-K, as
      filed with the SEC on March 4, 2005 (File No.
  001-13437).3.10
            Amended
      and Restated Bylaws of Source Interlink Companies, Inc., a Delaware
      corporation, incorporated by reference to Current Report on Form 8-K, as
      filed with the SEC on March 4, 2005 (File No.
  001-13437).4.1
            Form
      of Common Stock Certificate of Source Interlink Companies, Inc., a
      Delaware corporation, incorporated by reference to Current Report on Form
      8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).4.2
            Form
      of Warrant issued pursuant to a Loan Agreement dated as of October 30,
      2003, by and between Source Interlink Companies, Inc., its subsidiaries
      and Hilco Capital, LP, as agent, incorporated by reference to Current
      Report on Form 8-K, as filed with the SEC on November 5, 2003. (File No.
      001-13437).4.3
            Form
      of Warrant Agreement issued pursuant to a Loan Agreement dated as of
      October 30, 2003, by and between Source Interlink Companies, Inc., its
      subsidiaries and Hilco Capital, LP, as agent, as amended and restated,
      incorporated by reference to Registration Statement on Form S-3, as filed
      with the SEC on August 30, 2004 (File No. 333-118655).4.4
            Warrantholders
      Rights Agreement dated as of October 30, 2003 by and between Source
      Interlink Companies, Inc. and Hilco Capital LP, incorporated by reference
      to Current Report on Form 8-K, as filed with the SEC on November 5, 2003
      (File No. 001-13437).4.5
            Stockholder’s
      Agreement dated February 28, 2005, between the Registrant and AEC
      Associates, LLC, incorporated by reference to Current Report on Form 8-K,
      as filed with the SEC on March 4, 2005 (File No.
    001-13437).10.3**
            The
      Source Information Management Company Amended and Restated 1995 Incentive
      Stock Option Plan, incorporated by reference to Annual Report on Form
      10-K, as filed with the SEC on May 1, 2001 (File No.
      001-13437).10.6**
            Employment
      Agreement dated February 28, 2005 between the Registrant and James R.
      Gillis, incorporated by reference to Current Report on Form 8-K, as filed
      with the SEC on March 4, 2005 (File No. 001-13437).10.20**
            The
      Source Information Management Company Amended and Restated 1998 Omnibus
      Plan, incorporated by reference to Annual Report on Form 10-K, as filed
      with the SEC on May 1, 2001 (File No. 001-13437).10.22**
            Employment
      Agreement dated February 28, 2005 between the Registrant and Jason S.
      Flegel, incorporated by reference to Current Report on Form 8-K, as filed
      with the SEC on March 4, 2005 (File No. 001-13437).10.31
            Lease
      Agreement by and between Riverview Associates Limited Partnership and
      Source Interlink Companies, Inc. dated August 9, 2001, incorporated by
      reference to Annual Report on Form 10-K, as filed with the SEC on May 16,
      2002 (File No. 001-13437).10.31.1
            Lease
      Amendment by and between Riverview Associates Limited Partnership and
      Source Interlink Companies, Inc. dated August 27, 2003, incorporated by
      reference to Quarterly Report on Form 10-Q, as filed with the SEC on
      September 15, 2003 (File No. 001-13437).10.31.2
            Second
      Lease Amendment dated April 20, 2005 between Riverview Associates Limited
      Partnership and Source Interlink Companies, Inc. incorporated by reference
      to Quarterly Report on Form 8-K, as filed with the SEC on April 21, 2005
      (File No. 001-13437).10.32
            Industrial
      Lease between Broadway Properties LTD and Innovative Metal Fixtures, Inc.
      dated for reference June 1, 2001, and Assignment and Assumption Agreement
      between Innovative Metal Fixtures, Inc., Aaron Wire & Metal Products
      LTD and Broadway Properties LTD dated May 3, 2002, incorporated by
      reference to Annual Report on Form 10-K, as filed with the SEC on May 1,
      2003 (File No. 001-13437).10.33
            Net
      Lease between Conewago Contractors, Inc. and Pennsylvania International
      Distribution Services, Inc. dated as of May 1, 2000, incorporated by
      reference to Annual Report on Form 10-K, as filed with the SEC on May 1,
      2003 (File No. 001-13437).10.33.1
            First
      Amendment to Net Lease between Conewago Contractors, Inc. and
      International Periodical Distributors, Inc. effective September 1, 2003,
      incorporated by reference to Quarterly Report on Form 10-Q, as filed with
      the SEC on December 15, 2003 (File No. 001-13437).10.33.2
            Second
      Amendment to Net Lease between Conewago Contractors, Inc. and
      International Periodical Distributors, Inc. effective December 1, 2004,
      incorporated by reference to Quarterly Report on Form 10-Q, as filed with
      the SEC on December 10, 2004 (File No.
  001-13437).




47


10.34
            Lease
      Agreement between Regal Business Center, Inc and Publisher Distribution
      Services, Inc. dated as of September 1, 1998, as amended by First
      Modification and Ratification of Lease Agreement dated as of October __,
      1998 and Second Modification and Ratification of Lease Agreement dated as
      of October __, 2001 (dates omitted in original), incorporated by reference
      to Annual Report on Form 10-K, as filed with the SEC on May 1, 2003 (File
      No. 001-13437).10.36
            Commercial
      Lease Agreement between NCSC Properties LLC and Huck Store Fixture Company
      of North Carolina dated July 1, 2002, incorporated by reference to Annual
      Report on Form 10-K, as filed with the SEC on May 1, 2003 (File No.
      001-13437).10.37
            Agreement
      between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen, Anna
      Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing Corp.
      dated June 1, 1989, as amended by Extension of Lease dated October 22,
      1999, incorporated by reference to Annual Report on Form 10-K, as filed
      with the SEC on May 1, 2003 (File No. 001-13437).10.38
            Agreement
      between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen, Steven
      Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing
      Corporation dated November 1, 1995, as amended by Extension of Lease dated
      October 22, 1999, incorporated by reference to Annual Report on Form 10-K,
      as filed with the SEC on May 1, 2003 (File No.
  001-13437).10.39
            Agreement
      between Louis Nathan Wank, Irving Wank, Murray Wank, Sylvia Goshen, Anna
      Godel, Sylvia Thorne and/or Wank Brothers and Brand Manufacturing Corp.
      dated September 1, 1984, as amended by Extension of Lease dated October
      22, 1999, incorporated by reference to Annual Report on Form 10-K, as
      filed with the SEC on May 1, 2003 (File No. 001-13437).10.41**
            Employment
      Agreement dated February 28, 2005 between the Registrant and Marc Fierman,
      incorporated by reference to Current Report on Form 8-K, as filed with the
      SEC on March 4, 2005 (File No. 001-13437).10.44
            Amended
      and Restated Loan Agreement dated February 28, 2005 by and among the
      Registrant, its subsidiaries, and Wells Fargo Foothill, Inc., as arranger
      and administrative agent, incorporated by reference to Current Report on
      Form 8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).10.44.1
            First
      Amendment to Amended and Restated Loan Agreement dated April 18, 2005 by
      and among Source Interlink Companies, Inc., its subsidiaries, Wells Fargo
      Foothill, Inc., as arranger, administrative agent and collateral agent,
      and Wachovia Bank, N.A., as documentation agent, incorporated by reference
      to Quarterly Report on Form 8-K, as filed with the SEC on April 21, 2005
      (File No. 001-13437).10.48+
            Retail
      Magazine Supply Agreement between Barnes & Noble, Inc. and
      International Periodical Distributors, Inc. dated as of August 6, 2004,
      incorporated by reference to Quarterly Report on Form 10-Q, as filed with
      the SEC on December 10, 2004 (File No. 001-13437).10.48.1+
            First
      Amendment to Retail Magazine Supply Agreement effective as of April 1,
      2006 between Barnes & Noble, Inc. and International Periodical
      Distributors, Inc. , incorporated by reference to Current Report on Form
      8-K, as filed with the SEC on February 14, 2006 (File No.
      001-13437).10.49**
            Employment
      Agreement dated February 28, 2005 between the Registrant and Alan Tuchman,
      incorporated by reference to Current Report on Form 8-K, as filed with the
      SEC on March 4, 2005 (File No. 001-13437).10.50**
            The
      1999 Equity Participation Plan of Alliance Entertainment Corp.,
      incorporated by reference to Exhibit 10.2 to Amendment No. 1 to
      Registration Statement on Form S-4, as filed with the SEC on January 18,
      2005 (File No. 333-121656).10.51**
            The
      1999 Employee Equity Participation and Incentive Plan of Alliance
      Entertainment Corp., incorporated by reference to Exhibit 10.3 to
      Amendment No. 1 to Registration Statement on Form S-4, as filed with the
      SEC on January 18, 2005 (File No. 333-121656).10.52**
            Amended
      and Restated Digital On-Demand, Inc. 1998 Executive Stock Incentive Plan,
      incorporated by reference to Exhibit 10.4 to Amendment No. 1 to
      Registration Statement on Form S-4, as filed with the SEC on January 18,
      2005 (File No. 333-121656).10.53**
            Amended
      and Restated Digital On-Demand, Inc. 1998 General Stock Incentive Plan,
      incorporated by reference to Exhibit 10.5 to Amendment No. 1 to
      Registration Statement on Form S-4, as filed with the SEC on January 18,
      2005 (File No. 333-121656).10.54
            Multi-Tenant
      Industrial Triple Net Lease, dated as of September 5, 2003, between
      Catellus Development Corporation and AEC One Stop Group, Inc.,
      incorporated by reference to Exhibit 10.6 to Amendment No. 1 to
      Registration Statement on Form S-4, as filed with the SEC on January 18,
      2005 (File No. 333-121656).10.55**
            Source
      Interlink Companies, Inc. Supplemental Executive Retirement Plan,
      effective as of March 1, 2005, incorporated by reference to Current Report
      on Form 8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).10.56**
            Source
      Interlink Companies, Inc. Challenge Grant Program, incorporated by
      reference to Current Report on Form 8-K, as filed with the SEC on March 4,
      2005 (File No. 001-13437).10.57**
            Executive
      Participation Agreement dated February 28, 2005 between the Registrant and
      James R. Gillis, incorporated by reference to Current Report on Form 8-K,
      as filed with the SEC on March 4, 2005 (File No.
    001-13437).10.58**
            Form
      of Executive Participation Agreement, incorporated by reference to Current
      Report on Form 8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).10.59**
            Form
      of Split-Dollar Insurance Agreement, incorporated by reference to Current
      Report on Form 8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).




48




10.60
            Consulting
      Agreement dated February 28, 2005 between the Registrant and The Yucaipa
      Companies, LLC, incorporated by reference to Current Report on Form 8-K,
      as filed with the SEC on March 4, 2005 (File No.
    001-13437).10.61+
            Product
      Fulfillment Services Agreement dated as of March 17, 2004 between Barnes
      & Noble, Inc. and AEC One Stop Group, Inc., incorporated by reference
      to Annual Report on Form 10-K, as filed with the SEC on April 18, 2005
      (File No. 001-13437)10.62+
            Distribution
      and Supply Agreement dated May 10, 2005 between the Registrant and Levy
      Home Entertainment LLC, incorporated by reference to Current Report on
      Form 8-K, as filed with the SEC on May 16, 2005 (File No.
      001-13437)10.63
            Lease
      Agreement dated May 10, 2005 between Chas. Levy Company LLC and Chas. Levy
      Circulating Co. LLC concerning real estate located at 1140 North Branch
      Street, Chicago, Illinois, incorporated by reference to Current Report on
      Form 8-K, as filed with the SEC on May 16, 2005 (File No.
      001-13437)10.65
            Lease
      Agreement dated May 10, 2005 between Chas. Levy Company LLC and Chas. Levy
      Circulating Co. LLC concerning real estate located at 1006 Wright Street,
      Brainerd, Minnesota10.66
            Lease
      Agreement dated March 15, 2000 between High Properties and the Chas. Levy
      Circulating Company, LLC relating to 1850 Colonial Village Lane,
      Lancaster, Pennsylvania10.66.1
            Amendment
      #1 to the Lease dated December 3, 200310.67
            Industrial
      Real Estate Lease dated March 22, 1999 between MICO Archibald Partners,
      L.L.C. and Anderson News, LLC relating to 2590 East Lindsay Privado,
      Ontario, California.10.48.2+
            Second
      Amendment to Retail Magazine Supply Agreement made and entered into as of
      April 6, 2007 by and between Barnes & Noble, Inc. and International
      Periodical Distributors, Inc.10.68
            Letter
      dated May 13, 2007 from The Yucaipa Companies, LLC addressed to Source
      Interlink Companies, Inc.10.69
            Letter
      of Intent dated May 14, 2007 between The Yucaipa Companies, LLC and Source
      Interlink Companies, Inc.10.70
            Revolving
      Credit Agreement, dated as of August 1, 2007, by and among Source
      Interlink Companies, Inc., certain subsidiaries of Source Interlink
      Companies, Inc. as guarantors, Citicorp North America, Inc. as
      administrative agent and collateral agent, JP Morgan Chase Bank, N.A. as
      syndication agent, and the lenders from time to time party
      thereto.10.71
            Senior
      Subordinated Bridge Loan Agreement, dated as of August 1, 2007, by and
      among Source Interlink Companies, Inc., certain subsidiaries of Source
      Interlink Companies, Inc. as guarantors, Citicorp North America, Inc. as
      administrative agent and collateral agent, JP Morgan Chase Bank, N.A. as
      syndication agent, and the lenders from time to time party
      thereto.10.72
            Term
      Loan Agreement, dated as of August 1, 2007, by and among Source Interlink
      Companies, Inc., certain subsidiaries of Source Interlink Companies, Inc.
      as guarantors, Citicorp North America, Inc. as administrative agent and
      collateral agent, JP Morgan Chase Bank, N.A. as syndication agent, and the
      lenders from time to time party thereto.10.73
            Employment
      Agreement by and between Steven R. Parr and Source Interlink Companies,
      Inc., dated as of June 27, 200710.74
            Automotive.com,
      Inc. Stockholders Agreement, dated November 15, 2005, by and among
      PRIMEDIA Inc., Automotive.com, Inc. and certain holders of common stock
      and options of Automotive.com, Inc.10.75*
            Lease
      agreement dated July 31, 2007 by and between Primedia, Inc. and Primedia
      Enthusiast Media, Inc. concerning real estate located at 261 Madison
      Avenue, New York, NY.10.76*
            Lease
      agreement dated April 18, 2007 by and between MLRP Sergo, LLC and Chas
      Levy Circulating Company, LLC concerning real estate located at 9450 Sergo
      Drive, McCook, IL.10.77*
            Parties.
      This Lease, dated December 1, 1994, for reference purposes only, is made
      by and between Robert E. Petersen and Margaret McNally Petersen, Trustees
      of The R. E. and M. M. Petersen Living Trust Dated January 17, 1983, and
      Petersen Publishing Company, a Califomia corporation.14.1
            Code
      of Business Conduct and Ethics of Source Interlink Companies, Inc., a
      Delaware corporation, incorporated by reference to Current Report on Form
      8-K, as filed with the SEC on March 4, 2005 (File No.
      001-13437).14.2
            Code
      of Ethics for Chief Executive Officer and Financial Executives of Source
      Interlink Companies, Inc., a Delaware corporation, incorporated by
      reference to Current Report on Form 8-K, as filed with the SEC on March 4,
      2005 (File No. 001-13437).14.3
            Code
      of Conduct for Directors and Executive Officers of Source Interlink
      Companies, Inc., a Delaware corporation, incorporated by reference to
      Current Report on Form 8-K, as filed with the SEC on March 4, 2005 (File
      No. 001-13437).21.1*
            Subsidiaries
      of the Registrant.23.1*
            Consent
      of BDO Seidman, LLP.31.1*
            Rule
      13a-14(a)/15d-14(a) Certification of Principal Executive
      Officer.31.2*
            Rule
      13a-14(a)/15d-14(a) Certification of Principal Financial
      Officer.32.1*
            Section
      1350 Certification of Principal Executive Officer and Principal Financial
      Officer.


____________


*
            Filed
      herewith





**
            Indicates
      management contract or compensatory plan, contract or
      arrangement





+
            Certain
      material has been omitted pursuant a request for confidential treatment
      and such material has been filed separately with the
  SEC.


49


SOURCE
INTERLINK COMPANIES, INC.


INDEX OF
FINANCIAL STATEMENTS





AUDITED
      CONSOLIDATED FINANCIAL STATEMENTS OF SOURCE INTERLINK COMPANIES,
      INC.
            PAGEReport
      of Independent Registered Public Accounting Firm
            51Consolidated
      Balance Sheets at January 31,  2008 and 2007
            52Consolidated
      Statements of Operations for the fiscal years ended January 31,
       2008, 2007 and 2006
            54Consolidated
      Statements of Stockholders’ Equity for the fiscal years
      ended  January 31,  2008, 2007 and 2006
            55Consolidated
      Statements of Cash Flows for the fiscal years ended January 31,
       2008, 2007 and 2006
            56Notes
      to Consolidated Financial Statements
            57Financial
      Statement Schedule
            81





50




REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM









Board of
Directors


Source
Interlink Companies, Inc


Bonita Springs,
FL




We have
audited the accompanying consolidated balance sheets of Source Interlink
Companies, Inc as of January 31, 2008 and 2007 and the related consolidated
statements of operations, stockholders’ equity, and cash flows for each of the
three years ended January 31, 2008.  In connection with our audits of
the financial statements, we have also audited the financial statement schedule
listed in the accompanying index.  These financial statements and
schedule are the responsibility of the Company’s management.  Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall presentation of the financial statements and schedule.  We
believe that our audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Source Interlink Companies,
Inc at January 31, 2008 and 2007, and the results of its operations and its cash
flows for each of the three years in the period ended January 31, 2008, in conformity with
accounting principles generally accepted in the United States of
America.




Also, in
our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Source Interlink Companies, Inc internal
control over financial reporting as of January 31, 2008, based on criteria
established in Internal
Control – Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated April 14,
2008 expressed an unqualified opinion thereon.





/s/ BDO
Seidman, LLP


Chicago,
Illinois








51


SOURCE
INTERLINK COMPANIES, INC.


CONSOLIDATED
BALANCE SHEETS


(IN
THOUSANDS)





January
      31,2008
            
            
            2007ASSETSCurrent
      assetsCash
            
            $
            35,650
            
            
            $
            -Trade
      receivables, net
            
            
            183,475
            
            
            
            102,658Purchased
      claims receivable
            
            
            14,412
            
            
            
            16,983Inventories
            
            
            290,507
            
            
            
            248,941Income
      tax receivable
            
            
            -
            
            
            
            9,932Deferred
      tax asset
            
            
            23,107
            
            
            
            29,531Other
            
            
            20,679
            
            
            
            5,440Total
      current assets
            
            
            567,830
            
            
            
            413,485Property,
      plants and equipment
            
            
            150,612
            
            
            
            98,812Less
      accumulated depreciation and amortization
            
            
            (42,708
            )
            
            
            (30,897
            )Net
      property, plants and equipment
            
            
            107,904
            
            
            
            67,915Other
      assetsGoodwill,
      net
            
            
            1,069,835
            
            
            
            395,902Intangibles,
      net
            
            
            637,082
            
            
            
            118,971Other
            
            
            53,354
            
            
            
            13,758Total
      other assets
            
            
            1,760,271
            
            
            
            528,631Total
      assets
            
            $
            2,436,005
            
            
            $
            1,010,031








See
accompanying notes to Consolidated Financial Statements.





52


SOURCE
INTERLINK COMPANIES, INC.


CONSOLIDATED
BALANCE SHEETS (CONCLUDED)


(IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS)





January
      31,2008
            
            
            2007LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilitiesChecks
      issued against future advances on revolving credit
      facility
            
            $
            -
            
            
            $
            1,465Accounts
      payable (net of allowance for returns of $174,751$164,069,
      respectively)
            
            
            372,429
            
            
            
            308,184Accrued
      expenses
            
            
            123,973
            
            
            
            62,838Deferred
      revenue
            
            
            79,918
            
            
            
            2,630Current
      portion of obligations under capital leases
            
            
            1,406
            
            
            
            995Current
      maturities of debt
            
            
            15,369
            
            
            
            7,850Total
      current liabilities
            
            
            593,095
            
            
            
            383,962Other
      liabilitiesDeferred
      tax liability
            
            
            8,944
            
            
            
            32,500Obligations
      under capital leases
            
            
            1,826
            
            
            
            1,069Debt,
      less current maturities
            
            
            1,359,210
            
            
            
            146,534Other
            
            
            32,429
            
            
            
            6,519Total
      other liabilities
            
            
            1,402,409
            
            
            
            186,622Total
      liabilities
            
            
            1,995,504
            
            
            
            570,584MINORITY
      INTEREST
            
            
            25,978
            
            
            
            -COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITYContributed
      capitalPreferred
      stock, $0.01 par (2,000 shares authorized; none
    issued)
            
            
            -
            
            
            
            -Common
      stock, $0.01 par (100,000 shares authorized; 52,321
    and51,704
      shares issued)
            
            
            523
            
            
            
            521Additional
      paid-in capital
            
            
            476,099
            
            
            
            474,796Total
      contributed capital
            
            
            476,622
            
            
            
            475,317Accumulated
      deficit
            
            
            (65,659
            )
            
            
            (37,766
            )Accumulated
      other comprehensive incomeForeign
      currency translation
            
            
            3,560
            
            
            
            1,896Total
      stockholders' equity
            
            
            414,523
            
            
            
            439,447Total
      liabilities and stockholders' equity
            
            $
            2,436,005
            
            
            $
            1,010,031





See
accompanying notes to Consolidated Financial Statements.





53


SOURCE
INTERLINK COMPANIES, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(IN
THOUSANDS, EXCEPT PER SHARE AMOUNTS)





Year
      ended January 31,2008
            
            
            2007
            
            
            2006Revenues,
      net:Distribution
            
            $
            1,958,095
            
            
            $
            1,766,496
            
            
            $
            1,445,900Advertising
            
            
            122,769
            
            
            
            -
            
            
            
            -Circulation
            
            
            63,917
            
            
            
            -
            
            
            
            -Manufacturing
            
            
            30,650
            
            
            
            32,670
            
            
            
            26,801Claiming
      and information
            
            
            14,001
            
            
            
            14,707
            
            
            
            16,172Other
            
            
            64,820
            
            
            
            14,780
            
            
            
            9,916Total
      revenues, net
            
            
            2,254,252
            
            
            
            1,828,653
            
            
            
            1,498,789Cost
      of revenues (including depreciation and amortization of
      $992,$1,245
      and $1,225, respectively)
            
            
            1,656,181
            
            
            
            1,445,924
            
            
            
            1,196,120Gross
      profit
            
            
            598,071
            
            
            
            382,729
            
            
            
            302,669Selling,
      general and administrative expense
            
            
            272,622
            
            
            
            161,431
            
            
            
            117,794Distribution,
      circulation and fulfillment
            
            
            197,017
            
            
            
            177,953
            
            
            
            130,816Depreciation
      and amortization
            
            
            53,438
            
            
            
            25,359
            
            
            
            18,200Impairment
      of Goodwill and Intangible Assets
            
            
            35,310
            
            
            
            32,742
            
            
            
            -Integration
      and relocation expense
            
            
            1,567
            
            
            
            3,664
            
            
            
            -Disposal
      of land, buildings and equipment, net
            
            
            243
            
            
            
            950
            
            
            
            -Merger
      and acquisition charges
            
            
            1,165
            
            
            
            -
            
            
            
            3,319Operating
      income (loss)
            
            
            36,709
            
            
            
            (19,370
            )
            
            
            32,540Other
      income (expense):Interest
      expense (including amortization of deferred financing fees
      of$6,515,
      $631 and $471, respectively)
            
            
            (77,845
            )
            
            
            (12,724
            )
            
            
            (6,788
            )Interest
      income
            
            
            997
            
            
            
            193
            
            
            
            218Write
      off of deferred financing costs
            
            
            (1,313
            )
            
            
            -
            
            
            
            -Other
            
            
            (49
            )
            
            
            (134
            )
            
            
            215Total
      other expense
            
            
            (78,210
            )
            
            
            (12,665
            )
            
            
            (6,355
            )(Loss)
      income from continuing operations, beforeincome
      taxes and minority interest
            
            
            (41,501
            )
            
            
            (32,035
            )
            
            
            26,185Income
      tax (benefit) expense
            
            
            (15,994
            )
            
            
            (6,068
            )
            
            
            13,196Minority
      interest in income of subsidiary
            
            
            (731
            )
            
            
            -
            
            
            
            -(Loss)
      income from continuing operations
            
            
            (26,238
            )
            
            
            (25,967
            )
            
            
            12,989(Loss)
      income from discontinued operations, net of tax
            
            
            (1,655
            )
            
            
            1,311
            
            
            
            (110
            )Net
      (loss) income available to common shareholders
            
            $
            (27,893
            )
            
            $
            (24,656
            )
            
            $
            12,879Earnings
      per share - basic:Continuing
      operations
            
            $
            (0.50
            )
            
            $
            (0.50
            )
            
            $
            0.26Discontinued
      operations
            
            
            (0.03
            )
            
            
            0.02
            
            
            
            -Total
            
            $
            (0.53
            )
            
            $
            (0.48
            )
            
            $
            0.26Earnings
      per share - diluted:Continuing
      operations
            
            $
            (0.50
            )
            
            $
            (0.50
            )
            
            $
            0.25Discontinued
      operations
            
            
            (0.03
            )
            
            
            0.02
            
            
            
            -Total
            
            $
            (0.53
            )
            
            $
            (0.48
            )
            
            $
            0.25Weighted
      average common shares outstanding - basic
            
            
            52,276
            
            
            
            51,838
            
            
            
            49,097Weighted
      average common shares outstanding - diluted
            
            
            52,276
            
            
            
            51,838
            
            
            
            50,894





See
accompanying notes to Consolidated Financial Statements.


54


SOURCE
INTERLINK COMPANIES, INC.


CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY


(IN
THOUSANDS)





Additional
            
            
            
            
            
            Accumulated
      Other
            
            
            
            
            
            
            
            
            TotalCommon
      Stock
            
            
            Paid-in
            
            
            Accumulated
            
            
            Comprehensive
            
            
            Treasury
      Stock
            
            
            Stockholders'Shares
            
            
            Amount
            
            
            Capital
            
            
            Deficit
            
            
            Income
      (Loss)
            
            
            Shares
            
            
            Amount
            
            
            EquityBalance,
      January 31, 2005
            
            
            23,849
            
            
            $
            238
            
            
            $
            150,269
            
            
            $
            (23,696
            )
            
            $
            1,439
            
            
            $
            100
            
            
            $
            (567
            )
            
            $
            127,683Net
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            12,879
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            12,879Foreign
      currency translation
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            911
            
            
            
            
            
            
            
            
            
            
            
            911Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            13,790Exercise
      of stock options
            
            
            1,013
            
            
            
            11
            
            
            
            5,029
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5,040Tax
      benefit from stock optionsexercised
            
            
            -
            
            
            
            -
            
            
            
            1,866
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,866Stock
      issued in Allianceacquisition
            
            
            26,942
            
            
            
            269
            
            
            
            304,445
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            304,714Exchange
      of stock options andwarrants
      to acquire Alliancecommon
      stock
            
            
            -
            
            
            
            -
            
            
            
            6,500
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            6,500Retirement
      of treasury stock
            
            
            (100
            )
            
            
            (1
            )
            
            
            (566
            )
            
            
            -
            
            
            
            -
            
            
            
            (100
            )
            
            
            567
            
            
            
            -Balance,
      January 31, 2006as
      reported
            
            
            51,704
            
            
            
            517
            
            
            
            467,543
            
            
            
            (10,817
            )
            
            
            2,350
            
            
            
            -
            
            
            
            -
            
            
            
            459,593APB
      No. 25 cumulative effectadjustment
            
            
            -
            
            
            
            -
            
            
            
            2,996
            
            
            
            (2,293
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            703Balance,
      February 1, 2006
            
            
            51,704
            
            
            
            517
            
            
            
            470,539
            
            
            
            (13,110
            )
            
            
            2,350
            
            
            
            -
            
            
            
            -
            
            
            
            460,296Net
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (24,656
            )
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (24,656
            )Foreign
      currency translation
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (454
            )
            
            
            
            
            
            
            
            
            
            
            (454
            )Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (25,110
            )Stock
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            1,660
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,660Exercise
      of stock options andwarrants
            
            
            360
            
            
            
            4
            
            
            
            2,408
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,412Excess
      tax benefit from stockoptions
      exercised
            
            
            -
            
            
            
            -
            
            
            
            189
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            189Balance,
      January 31, 2007
            
            
            52,064
            
            
            $
            521
            
            
            $
            474,796
            
            
            $
            (37,766
            )
            
            $
            1,896
            
            
            
            -
            
            
            $
            -
            
            
            $
            439,447Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (27,893
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (27,893
            )Foreign
      currency translation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,664
            
            
            
            -
            
            
            
            -
            
            
            
            1,664Comprehensive
      income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (26,229
            )Stock
      compensation expense
            
            
            -
            
            
            
            -
            
            
            
            201
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            201Exercise
      of stock options andwarrants
            
            
            257
            
            
            
            2
            
            
            
            713
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            715Excess
      tax benefit from stockoptions
      exercised
            
            
            -
            
            
            
            -
            
            
            
            389
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            389Balance,
      January 31, 2008
            
            
            52,321
            
            
            $
            523
            
            
            $
            476,099
            
            
            $
            (65,659
            )
            
            $
            3,560
            
            
            
            -
            
            
            $
            -
            
            
            $
            414,523








See
accompanying notes to Consolidated Financial Statements.


55


SOURCE
INTERLINK COMPANIES, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(IN
THOUSANDS)





Year
      ended January 31,2008
            
            
            2007
            
            
            2006OPERATING
      ACTIVITIESNet
      (loss) income available to common shareholders
            
            $
            (27,893
            )
            
            $
            (24,656
            )
            
            $
            12,879Minority
      interest in income of subsidiary
            
            
            731
            
            
            
            -
            
            
            
            -Adjustments
      to reconcile net income to net cash provided by (used
      in)operating
      activities:Depreciation
      and amortization
            
            
            61,243
            
            
            
            26,903
            
            
            
            20,089Provision
      for losses on accounts receivable
            
            
            4,325
            
            
            
            3,156
            
            
            
            6,100Deferred
      income taxes
            
            
            (16,028
            )
            
            
            (13,296
            )
            
            
            7,395Deferred
      revenue
            
            
            2,112
            
            
            
            (1,050
            )
            
            
            997Impairment
      of goodwill and intangible Assets
            
            
            35,310
            
            
            
            32,742
            
            
            
            -Loss
      on sale of discontinued operations
            
            
            730
            
            
            
            950
            
            
            
            -Write
      off of deferred financing financing fees
            
            
            1,313
            
            
            
            -
            
            
            
            -Stock
      compensation expense
            
            
            201
            
            
            
            1,850
            
            
            
            -Excess
      tax benefit from exercise of stock options
            
            
            -
            
            
            
            -
            
            
            
            1,866Other
            
            
            3,595
            
            
            
            13
            
            
            
            700Changes
      in assets and liabilities (excluding business
      combinations):Decrease
      (increase) in accounts receivable
            
            
            5,601
            
            
            
            15,681
            
            
            
            (33,295
            )(Increase)
      in inventories
            
            
            (37,975
            )
            
            
            (30,134
            )
            
            
            (41,518
            )(Increase)
      decrease in income tax receivable
            
            
            13,133
            
            
            
            (7,752
            )
            
            
            95(Increase)
      decrease in other current and non-current assets
            
            
            (16,766
            )
            
            
            (4,060
            )
            
            
            2,059Increase
      (decrease) in accounts payable and other liabilities
            
            
            47,495
            
            
            
            (21,091
            )
            
            
            81,463Cash
      (used in) provided by operating activities
            
            
            77,127
            
            
            
            (20,744
            )
            
            
            58,830INVESTING
      ACTIVITIESCapital
      expenditures
            
            
            (30,047
            )
            
            
            (13,379
            )
            
            
            (13,069
            )Purchase
      of claims
            
            
            (102,939
            )
            
            
            (109,193
            )
            
            
            (109,095
            )Payments
      received on purchased claims
            
            
            105,510
            
            
            
            102,132
            
            
            
            101,179Proceeds
      from sale of wood manufacturing division, net of cash
      transferred
            
            
            9,828
            
            
            
            -
            
            
            
            -Acquisition
      of Primedia Enthusiast Media, Inc., net of cash
    acquired
            
            
            (1,195,348
            )
            
            
            -
            
            
            
            -Net
      cash from Alliance Entertainment Corp. acquisition
            
            
            -
            
            
            
            -
            
            
            
            16,882Acquisition
      of Anderson Mid-Atlantic News, LLC, net of cash
    acquired
            
            
            -
            
            
            
            (13,726
            )
            
            
            -Acquisition
      of Anderson SCN Services, LLC, net of cash acquired
            
            
            -
            
            
            
            (26,074
            )
            
            
            -Acquisition
      of Chas. Levy Circulating Company, LLC, net of cash
      acquired
            
            
            -
            
            
            
            -
            
            
            
            (44,991
            )Proceeds
      from sale of fixed assets
            
            
            -
            
            
            
            2,706
            
            
            
            1,548Acquisition
      of customer list
            
            
            -
            
            
            
            -
            
            
            
            (2,300
            )Other
            
            
            210
            
            
            
            (1,344
            )
            
            
            -Cash
      used in investing activities
            
            
            (1,212,786
            )
            
            
            (58,878
            )
            
            
            (49,846
            )FINANCING
      ACTIVITIESIncrease
      (decrease) in checks issued against revolving credit
      facility
            
            
            (12,854
            )
            
            
            1,465
            
            
            
            (13,529
            )(Repayments)
      borrowings under WFF credit facility
            
            
            (116,459
            )
            
            
            71,458
            
            
            
            25,712Payment
      of deferred purchase price liabilities
            
            
            (3,144
            )
            
            
            -
            
            
            
            -Payments
      of notes payable
            
            
            (13,257
            )
            
            
            (21,383
            )
            
            
            (23,357
            )Borrowings
      under notes payable
            
            
            1,349,911
            
            
            
            3,063
            
            
            
            20,605Proceeds
      from the issuance of common stock
            
            
            715
            
            
            
            2,222
            
            
            
            5,040Payments
      under capital leases
            
            
            (1,103
            )
            
            
            (631
            )
            
            
            (527
            )Borrowings
      under capital leases
            
            
            726Excess
      tax benefit from exercise of stock options
            
            
            389
            
            
            
            189
            
            
            
            -Deferred
      loan costs
            
            
            (33,581
            )
            
            
            -
            
            
            
            (1,076
            )Other
            
            
            (34
            )Cash
      provided by financing activities
            
            
            1,171,309
            
            
            
            56,383
            
            
            
            12,868(Decrease)
      increase in cash
            
            
            35,650
            
            
            
            (23,239
            )
            
            
            21,852Cash,
      beginning of period
            
            
            -
            
            
            
            23,239
            
            
            
            1,387Cash,
      end of period
            
            $
            35,650
            
            
            $
            -
            
            
            $
            23,239





See
accompanying notes to Consolidated Financial Statements.


56


SOURCE
INTERLINK COMPANIES, INC.


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS





1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





BUSINESS





Source
Interlink Companies, Inc (the “Company”) is a leading marketing, publishing,
merchandising and fulfillment company of entertainment products including DVDs,
music CDs, magazines, books and related items. The Company’s fully integrated
businesses include:




-
            Publication
      of print and digital content to the enthusiast community in the United
      States via:





-
            76
      publications





-
            90
      websites, and





-
            over
      65 events.





-
            Distribution
      and fulfillment of entertainment products to major retail chains
      throughout North America and directly to consumers of entertainment
      products ordered through the
Internet;





-
            Import
      and export of periodicals sold in more than 100 markets
      worldwide;





-
            Produce
      and distribute content through magazines and via the internet to consumers
      in various niche and enthusiast markets.  Trade, Retail and
      Consumer events further enhance customer
  continuity.





-
            Coordination
      of product selection and placement of impulse items sold at checkout
      counters at major retail chains throughout North
  America;





-
            Processing
      and collection of rebate claims;
and





-
            Design,
      manufacture and installation of wire display fixtures in major retail
      chains throughout North America.




Source
Interlink serves approximately 110,000 retail store locations throughout North
America. Supply chain relationships include motion picture studios, record
labels, magazine and newspaper publishers, confectionary companies and
manufacturers of general merchandise.




Source
Interlink’s Media business segment encompasses 76 magazines, 90 websites, over
65 events, two television programs, 400 branded products, and such well-known
brands as Motor Trend magazine, Automobile magazine, Automotive.com, Equine.com,
Power & Motoryacht magazine, Hot Rod magazine, Snowboarder magazine,
Surfer magazine, and Wavewatch.com.




PRINCIPLES
OF CONSOLIDATION





The
consolidated financial statements include the accounts of Source Interlink
Companies, Inc. and its wholly-owned subsidiaries (collectively, the Company) as
of the date they were acquired, as well as Automotive.com, of which the Company
owns 80.1%. All significant intercompany accounts and transactions have been
eliminated.





USE OF
ESTIMATES





The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.





REVENUE
RECOGNITION





CD, DVD
and Magazine Fulfillment





Revenues
from the sale of CDs, DVDs and magazines the Company distributes are recognized
at the time of delivery (shipment for CDs and DVDs) less allowances for
estimated returns. Revenues from the sale of CDs, DVDs and magazines to
wholesalers that are not shipped through our distribution centers are recognized
at the later of notification from the shipping agent that the product has been
delivered or the on-sale date of the CD, DVD or magazine. The Company records a
reduction in revenue for estimated CD, DVD and magazine sales returns and a
reduction in cost of sales for estimated CD, DVD and magazine purchase returns.
Estimated returns are based on historical sell-through rates. A certain number
of retailers use scan-based trading terms, in which retailers are not obligated
to pay until the item sells at the retail store. In such arrangements, the
Company recognizes revenue upon the sale of the merchandise by the
retailer.




57




During
January 2007, the Company re-negotiated terms with its largest specialty
magazine distribution customer.  As a result, the Company began
billing this customer only for magazines that actually scan at their
checkouts.  In the past, the Company had billed this customer for the
gross amount of magazines actually shipped to their locations and allowed them
to take credits for magazines returned.  This change resulted in a
change in the Company’s revenue recognition policy for this customer from
recognizing gross sales upon shipment with a reserve for returns to recognizing
revenues only when magazines scan through their checkouts.  As a
result, the Company reversed revenues and accounts receivable for all magazines
that it had shipped into their stores but that had not yet scanned through their
checkouts, reduced cost of revenues for those magazines and recorded those
magazines as inventory





Fulfillment
& Return Processing Services





Revenues
from performing fulfillment and return processing services are recognized at the
time the service is performed. The Company is generally compensated on either a
per-copy or per-pound basis based on a negotiated price or a cost plus
model.





Advertising
Revenues





Advertising
revenues for all consumer magazines are recognized as income at the on-sale
date, net of provisions for estimated rebates, adjustments and discounts. Other
advertising revenues are generally recognized based on the publications’ cover
dates. Online advertising is generally recognized as advertisements are run.
Newsstand sales are recognized as revenue at the on-sale date for all
publications, net of provisions for estimated returns. Subscriptions are
recorded as deferred revenue when received and recognized as revenue over the
term of the subscription. Sales of books and other items are recognized as
revenue upon shipment, net of an allowance for returns. In accordance with
Emerging Issues Task Force (“EITF”) No. 00-10, “Accounting for Shipping and
Handling Fees and Costs,” distribution costs charged to customers are recognized
as revenue when the related product is shipped. The Company also derives revenue
from various licensing agreements, which grant the licensee rights to use the
trademarks and brand names of the Company in connection with the manufacture and
sale of certain designated products. Licensing revenue is generally recognized
by the Company pro-rata over the life of the license agreement or as licensed
products are sold.





Rebate
Claim Filing





Revenues
from the filing of rebate claims with publishers on behalf of retailers are
recognized at the time the claim is paid. The revenue recognized is based on the
amount paid multiplied by our commission rate. The Company has developed a
program (the “advance pay” program) whereby the Company will advance the claimed
amount less applicable commissions to the retailers and collect the entire
amount claimed from publishers for our own accounts. The Company accounts for
the advance as a purchase of a financial asset and records a receivable at the
time of purchase.





Information
Products





Revenues
from information product contracts are recognized ratably over the subscription
term, generally one year.





Custom
Display Manufacturing





Revenues
from the design and manufacture of custom display fixtures are recognized when
the retailer accepts title to the display. Transfer of title usually occurs upon
shipment. However, upon request from a customer, the product can be stored for
future delivery for the convenience of the customer. If this occurs, we
recognize revenue when the manufacturing and earnings processes are complete,
the customer accepts title in writing, the product is invoiced with payment due
in the normal course of business, the delivery schedule is fixed and the product
is segregated from other goods. Services related to the manufacturing of
displays such as freight, installation, warehousing and salvage are recognized
when the services are performed.





Editorial
and Product Development Costs





Editorial
cost and product development cost are expensed as incurred. Product development
costs include the cost of artwork, graphics, prepress, plates and photography
for new products.




Advertising
and Subscription Acquisition Costs





Advertising
and subscription acquisition costs are expensed the first time the advertising
takes place, except for certain direct-response advertising, the primary purpose
of which is to elicit sales from customers who can be shown to have responded
specifically to the advertising and that results in probable future economic
benefits. Direct-response advertising consists of product promotional mailings,
catalogues, telemarketing and subscription promotions. These direct-response
advertising costs are capitalized as assets and amortized over the estimated
period of future benefit. The amortization periods range from one to two years
subsequent to the promotional event.




58







INVENTORIES





Inventories
are valued at the lower of cost or market. Costs within our Magazine Fulfillment
and In-Store Services groups are determined by the first-in, first-out (“FIFO”)
method.  Cost within our DVD and CD Fulfillment group is determined by
the average cost method.  Cost of paper inventories held within our
Media group is determined on the FIFO method.





PROPERTY,
PLANTS & EQUIPMENT





Property
and equipment are stated at cost. Depreciation is computed using the
straight-line method for financial reporting over the estimated useful lives as
follows:





LifeAsset
      Class:Buildings
            40
      yearsMachinery
      and equipment
            5-7
      yearsVehicles
            5-7
      yearsFurniture
      and fixtures
            5-7
      yearsComputers
            3-5
      years





Leasehold
improvements are amortized over the shorter of the useful life of the asset or
the life of the lease.





GOODWILL
AND OTHER INTANGIBLE ASSETS





Goodwill
represents the excess of cost over the fair value of net assets acquired in
connection with business acquisitions. In accordance with SFAS 142, goodwill is
reporting unit level, which is defined as an operating segment or a component of
an operating segment that constitutes a business for which financial information
is available and is regularly reviewed by management. The Company assesses
goodwill for impairment at least annually in the absence of an indicator of
possible impairment and immediately upon an indicator of possible impairment.
The annual impairment review is completed in the first quarter of the fiscal
year.





In
assessing goodwill and intangible assets for impairment, we make estimates of
fair value which are based on our projection of revenues, operating costs, and
cash flows of each reporting unit considering historical and anticipated future
results, general economic and market conditions as well as the impact of planned
strategies. The Company combines the discounted cash flow fair value with
publicly traded company multiples (market comparison approach) and acquisition
multiples of comparable businesses (industry acquisition approach) to determine
fair value.  Generally, we engage third party specialists to assist us with
our valuations. Changes in our judgments and projections could result in a
significantly different estimate of the fair value of the reporting units and
could result in an impairment of goodwill or other intangible
assets.





If the
carrying amount of a reporting unit exceeds its fair value, the Company measures
the possible goodwill impairment based upon an allocation of the estimate of
fair value  to the underlying assets and liabilities of the reporting unit,
including any previously unrecognized intangible assets, based upon known facts
and circumstances as if the acquisition occurred currently. The excess of the
fair value of the reporting unit over the amounts assigned to its assets and
liabilities is the implied fair value of goodwill.  An impairment loss
would be recognized to the extent the carrying value of goodwill exceeds the
implied fair value of the goodwill.  This test performed in the fourth
quarter of fiscal year 2007 indicated that goodwill related to the In-Store
Services reporting unit was impaired





Impairment
losses, if any, are reflected in operating income or loss in the Consolidated
Statements of Income (Loss). This test, performed in the fourth quarter of
fiscal year 2008, indicated that the acquired customer lists related to the DVD
and CD Fulfillment segment were impaired.





INTANGIBLE
ASSETS





The
Company currently amortizes intangible assets over the estimated useful life of
the asset ranging from 3 to 20 years (See Footnote 6). The weighted average
estimated useful life is approximately 5 years for amortized tradenames, 18
years for customer lists, 4 years for non-compete agreements, 10 years for
content, and 7 years for software.




The
Company has intangible assets (other than goodwill) with an indefinite useful
life. Such assets are not amortized until their useful life is determined to be
no longer indefinite at which point the asset would be amortized over its
estimated remaining useful life and be accounted for similar to other
identifiable amortizable intangible assets.
 An
intangible asset that is not subject to amortization shall be tested for
impairment annually, or more frequently, if events or changes in circumstances
indicate that the asset might be impaired. The impairment test shall consist of
a comparison of the fair value of an intangible asset with its carrying amount.
If the carrying amount of the intangible asset exceeds its fair value, an
impairment loss shall be recognized in an amount equal to that
excess.





59


DEFERRED
FINANCING FEES





Deferred
financing fees related to the Company’s term debt are capitalized and amortized
over the life of the debt using the effective interest method and are included
in other long-term assets.  Deferred financing fees related to the
Company’s revolving credit facilities are capitalized and amortized over the
life of the facility using the straight-line method.





IMPAIRMENT
OF LONG-LIVED ASSETS





The
Company accounts for long-live assets in accordance with FAS 144, “Accounting
for the Impairment or Disposal of Long Lived Assets.” This Statement applies to
long-lived assets other than goodwill, and prescribes a probability-weighted
cash flow estimation approach to evaluate the recoverability of the carrying
amount of long-lived assets such as property, plant and equipment. The Company
records impairment losses on long-lived assets used in operations, other than
goodwill, when events and circumstances indicate that the assets might be
impaired and the estimated cash flows (undiscounted and without interest
charges)  to be generated by those assets over the remaining lives of the
assets are less than the carrying amount of those items. Our cash flow estimates
are based on historical results adjusted to reflect our best estimate of future
market and operating conditions. The net carrying value of assets not
recoverable is reduced to fair value.





CONCENTRATIONS
OF CREDIT RISK





The
Company has significant concentrations of credit risk in its DVD and CD
Fulfillment, Magazine Fulfillment, Media and In-Store Services segments. If the
Company experiences a significant reduction in business from its clients, the
Company’s results of operations and financial condition may be materially and
adversely affected. The Company aggregates customers with a common parent when
calculating the applicable percentages. For CD, DVD and magazine distribution
the Company calculates contribution to revenue based on the actual distribution
and estimated sell-through based on the Company’s calculated sales return
reserve.





During
fiscal 2008, 2007, and 2006 one customer (Barnes and Noble, Inc.) accounted for
21.6%, 19.6% and 27.5%) of total revenues.





SHIPPING
AND HANDLING CHARGES





Shipping
and handling charges related to the distribution of magazines and CDs and DVDs
are not included in Cost of Revenues. Shipping and handling costs totaled
approximately $126.9 million, $103.9 million, and $72.8 million in 2008, 2007
and 2006, respectively.  The Company charges some customers for
shipping and handling, these amounts are included in revenues.





RELOCATION
EXPENSES





During
fiscal 2008, the Company incurred relocation expenses of $1.6 million related to
the relocation of its Chicago, IL distribution center to McCook,
IL.





During
fiscal 2007, the Company incurred $3.3 million of expenses related to the
consolidation of the backroom operations and marketing functions of the domestic
mainstream distribution group from Lisle, IL to Bonita Springs, FL and the
consolidation of one of its existing southern California distribution centers
into a facility acquired in connection with the acquisition of SCN.





The
Company accounted for the relocations in accordance with FAS 146, “Accounting
for Costs Associated with Exit or Disposal Activities”. FAS 146 requires
recording costs associated with an exit or disposal activity at their fair
values when a liability has been incurred.





INCOME
TAXES





The
Company accounts for income taxes under an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been recognized in the Company’s
financial statements or tax returns. In estimating future tax consequences, the
Company generally considers all expected future events other than enactments of
changes in the tax laws or rates. Valuation allowances are established as
necessary to reduce deferred tax assets to the amount more likely than not to be
realized.





FOREIGN
CURRENCY TRANSLATION AND TRANSACTIONS





The
financial position and results of operations of the Company’s foreign
subsidiaries are determined using local currency as the functional currency.
Assets and liabilities of these subsidiaries are translated at the exchange rate
in effect at each year-end. Income statement accounts are translated at the
average rate of exchange prevailing during the year. Translation adjustments
arising from the use of differing exchange rates from period to period are
included in the other comprehensive income account in stockholders’ equity.
Gains and losses resulting from foreign currency transactions, which are not
material, are included in the Consolidated Statements of
Operations.




60




COMPREHENSIVE
INCOME (LOSS)





Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. The Company’s comprehensive
income item is foreign currency translation adjustments.





EARNINGS
PER SHARE (LOSS)





In
February 1997, the Financial Accounting Standards Board issued FAS No. 128,
“Earnings per Share,” which requires the presentation of “basic” earnings per
share, computed by dividing net income available to common shareholders by the
weighted average number of common shares outstanding for the period, and
“diluted” earnings per share, which reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity.





FAIR
VALUE OF FINANCIAL INSTRUMENTS





The
carrying amounts of accounts receivable and accounts payable approximates fair
value due to their short-term nature. The carrying amount of debt including
credit facilities approximates fair value due to their stated interest rate
approximating a market rate. The fair value of the Company’s fixed-rate debt
approximates its carrying amount. These estimated fair value amounts have been
determined using available market information or other appropriate valuation
methodologies.





ACCOUNTING
FOR STOCK-BASED COMPENSATION





FAS No.
123, “Accounting for Stock-Based Compensation” defined a fair value method of
accounting for stock options and other equity instruments. Under the fair value
method, compensation cost is measured at the grant date based on the fair value
of the award and is recognized over the service period, which is usually the
vesting period. As provided in FAS No. 123, the Company elected to apply
Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations
in accounting for its stock-based compensation plans. No stock based
compensation was reflected in the fiscal 2006 net income related to our stock
option plans as all options granted in 2006 had an exercise price equal to or
greater than the market value of the underlying stock on the date of
grant.





On
December 15, 2004, the FASB issued a revision of the standard entitled SFAS No.
123(R), Share Based Payment, which requires all companies to measure
compensation cost for all share-based payments, including stock options, at fair
value. Publicly traded companies must apply this standard as of the beginning of
the first annual period that begins after December 15, 2005. This statement
applies to all awards granted after the required effective date and to awards
modified, repurchased, or cancelled after that date. The Company adopted FAS
123(R) during the year ended January 31, 2007, using the modified prospective
method.





The
following is a reconciliation of net income per weighted average share had the
Company adopted FAS No. 123 prior to 2007:




Year
      ended January 31,(IN
      THOUSANDS, EXCEPT PER SHARE AMOUNTS)
            
            2006Net
      income (as reported)
            
            $
            12,879Stock
      compensation costs, net of tax
            
            
            (1,742
            )Pro-forma
      net income
            
            $
            11,137Weighted
      average shares, basic
            
            
            49,097Weighted
      average shares, diluted
            
            
            50,894Basic
      earnings per share - as reported
            
            $
            0.26Diluted
      earnings per share - as reported
            
            $
            0.25Basic
      earnings per share - pro-forma
            
            $
            0.23Diluted
      earnings per share - pro-forma
            
            $
            0.22





The fair
value of each option grant is estimated on the grant date using the
Black-Scholes option pricing model with the following assumptions:





Year
      ended January 31,2008
            
            
            2007
            
            
            2006Dividend
      yield
            
            
            0
            %
            
            
            0
            %
            
            
            0
            %Expected
      volatility
            
            
            0.43
            
            
            
            0.28
            
            
            
            0.50Risk-free
      interest rate
            
            
            3.15-4.88
            %
            
            
            2.15-5.10
            %
            
            
            3.65-3.79
            %Expected
      life
            
            3
      years
            
            
            3
      years
            
            
            3
      years





The
Company estimates the expected volatility by evaluating the historical
volatility of the Company’s stock, implied volatility of the Company’s publicly
traded share options and the Company’s interpretation of historical events that
may cause future volatility to be different from historical
volatility.  For purposes of this assumption, the Company calculates
historical volatility for the period equal to the expected term of share options
at each grant date.




61







The
Company estimates the expected term by evaluating the historical share option
holding patterns of its identified groups of employees, taking into account
exercise and post-vesting forfeiture activity as well as management’s
expectations regarding the holding period of each grant recipient.





RECLASSIFICATIONS





Certain
prior year amounts have been reclassified in the consolidated financial
statements to conform with current year presentation.





RECENT
ACCOUNTING PRONOUNCEMENTS





SFAS
No. 157


In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which provides guidance on how companies should measure fair value when they are
required to use a fair value measure for recognition or disclosure purposes
under GAAP. SFAS No. 157 creates a common definition of fair value to be
used throughout GAAP and prescribes methods for measuring fair value, which is
intended to make the measurement of fair value more consistent and comparable
across companies. This statement also expands the related disclosure
requirements in an effort to provide greater transparency around fair value
measures. SFAS No. 157 is effective as of the beginning of fiscal years
beginning after November 15, 2007.





In
February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which
delays the effective date of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years for all
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually). Examples of items to which the deferral would apply
include, but are not limited to:





-
            Nonfinancial
      assets and nonfinancial liabilities initially measured at fair value in a
      business combination or other new basis event, but not measured at fair
      value in subsequent periods (nonrecurring fair value
      measurements);





-
            Reporting
      units measured at fair value in the first step of a goodwill impairment
      test and nonfinancial assets and nonfinancial liabilities measured at fair
      value in the second step of a goodwill impairment test (measured at fair
      value on a recurring basis, but not necessarily recognized or disclosed in
      the financial statements at fair
value);





-
            Indefinite-lived
      intangible assets measured at fair value for impairment assessment
      (measured at fair value on a recurring basis, but not necessarily
      recognized or disclosed in the financial statements at fair
      value);





-
            Long-lived
      assets (asset groups) measured at fair value for an impairment assessment
      (nonrecurring fair value measurements);
and





-
            Liabilities
      for exit or disposal activities initially measured at fair value
      (nonrecurring fair value
measurements).





The
Company does not expect the adoption of SFAS No. 157, excluding those items
deferred by FSP FAS 157-2, to have a material impact on its financial condition,
results of operations or cash flows. The Company is still evaluating the impact
of the items deferred by FSP FAS 157-2.




SFAS
No. 159


In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities. This statement permits companies to
choose, at specified election dates, to measure eligible items, which include
most recognized financial assets and liabilities and firm commitments, at fair
value with unrealized gains and losses on items for which the fair value option
has been elected reported in earnings at each subsequent reporting date.
Generally, the decision about whether to elect the fair value option must
be:





-
            Applied
      instrument by instrument;





-
            Irrevocable;
      and





-
            Applied
      only to an entire instrument and not to only specified risks, specific
      cash flows or portions of that
instrument.





A company
may decide whether to elect the fair value option for each eligible item on its
election date. Alternatively, a company may elect the fair value option
according to a preexisting policy for specified types of eligible items. A
company may choose to elect the fair value option for an eligible item only on
the date that certain events occur, including when:





-
            A
      company first recognizes the eligible
item;





-
            A
      company enters into an eligible firm
commitment;




62




-
            Financial
      assets that have been reported at fair value with unrealized gains and
      losses included in earnings because of specialized accounting principles
      cease to qualify for that specialized accounting;
  or





-
            The
      accounting treatment for an investment in another entity
      changes.





This
statement is effective as of the beginning of fiscal years that begin after
November 15, 2007. The Company does not expect the adoption of this
statement to have a material impact on its financial condition, results of
operations or cash flows.




SFAS
No. 141(R)


In
December 2007, the FASB issued SFAS No. 141(R), Business Combinations,
which establishes new principles and disclosure requirements pertaining to
business combinations. Primary changes to existing literature include
requirements for the acquirer to recognize:





-
            Assets
      acquired, liabilities assumed and any noncontrolling interest in the
      acquiree at the acquisition date, measured at their fair values as of that
      date;





-
            Identifiable
      assets and liabilities, as well as the noncontrolling interest in the
      acquiree, at the full amounts of their fair values, in a step
      acquisition;





-
            Assets
      acquired and liabilities assumed arising from contractual contingencies as
      of the acquisition date, measured at their acquisition-date fair
      values;





-
            Goodwill
      as of the acquisition date, measured as a residual, which in most types of
      business combinations will result in measuring goodwill as the excess of
      the consideration transferred plus the fair value of any noncontrolling
      interest in the acquiree at the acquisition date over the fair values of
      the identifiable net assets
acquired;





-
            Contingent
      consideration at the acquisition date, measured at its fair value at that
      date;





-
            The
      effect of a bargain purchase in earnings;
and





-
            Changes
      in the amount of its deferred tax benefits that are recognizable because
      of a business combination either in income from continuing operations in
      the period of the combination or directly in contributed capital,
      depending on the circumstances.




SFAS
No. 141(R) applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Early adoption is not
permitted.




SFAS
No. 160


In
December 2007, the FASB also issued a related statement, SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statements. This statement
establishes accounting and reporting standards that require:





-
            Ownership
      interests in subsidiaries held by parties other than the parent to be
      clearly identified, labeled and presented in the consolidated statement of
      financial position within equity, but separate from the parent’s
      equity;





-
            The
      amount of consolidated net income attributable to the parent and to the
      noncontrolling interest to be clearly identified and presented on the face
      of the consolidated statement of
operations;





-
            Changes
      in a parent’s ownership interest while the parent retains its controlling
      financial interest in its subsidiary to be accounted for
      consistently;





-
            When
      a subsidiary is deconsolidated, any retained noncontrolling equity
      investment in the former subsidiary be initially measured at fair
      value;





-
            Gains
      or losses on the deconsolidation of a subsidiary to be measured using the
      fair value of any noncontrolling equity investment rather than the
      carrying amount of the retained investment;
and





-
            Entities
      to provide sufficient disclosures that clearly identify and distinguish
      between the interests of the parent and the interests of the
      noncontrolling owners.




SFAS
No. 160 is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. Earlier adoption is
prohibited. The standard must be applied prospectively as of the beginning of
the year of adoption, except for the presentation and disclosure requirements,
which must be applied retrospectively for all periods presented. The Company is
still evaluating the impact on its financial condition, results of operations or
cash flows.




63





2.
BUSINESS COMBINATIONS AND ASSET ACQUISITIONS





PRIMEDIA
ENTHUSIAST MEDIA ACQUISITION




On
August 1, 2007, the Company completed its acquisition of Primedia
Enthusiast Media, Inc. (“EM”) pursuant to the terms and conditions of the
Stock Purchase Agreement dated May 13, 2007 (the “Agreement”). EM is one of
the largest providers of print and digital content to the enthusiast community
in the United States.  EM’s business is comprised of 76 publications, 90
websites and over 65 events.  In addition, its portfolio of strong brands
has afforded EM several different licensing opportunities for consumer goods
products, television and radio shows.  EM’s print titles include Motor
Trend, Automobile, Hot Rod, Lowrider, Power & Motoryacht, Surfer,
Surfing, Snowboarder, Soap Opera Digest and Soap Opera Weekly.  Its web
properties include automotive.com, equine.com and motortrend.com.




The
purchase price of $1,177.9 million consisted entirely of cash borrowed under the
Company’s Term Loan B and Bridge Facility issued on August 1, 2007. In
connection with the acquisition of EM, the Company paid a fee of $12.7 million
to Yucaipa. See Note 6 – Debt and Revolving Credit Facility.




The total
cost of the acquisition was allocated to the assets acquired and liabilities
assumed based on their respective fair values in accordance with FAS 141 -
Business Combinations. Goodwill and other intangible assets, which are
deductible for tax purposes, recorded in connection with the transaction totaled
$672.1 million and $581.2 million, respectively. These amounts will be tested at
least annually for impairment in accordance with FAS No. 142, Goodwill and
Other Intangible Assets.




The
assets acquired and liabilities assumed in the acquisition were recorded in the
quarter ended October 31, 2007, based on a preliminary valuation that is
expected to be finalized during the third quarter of fiscal 2009. The
acquisition was accounted for by the purchase method and, accordingly, the
results of EM’s operations have been included in our consolidated statements of
income since August 1, 2007.





(IN
      THOUSANDS)
            
            AmountTrade
      receivables, net
            
            $
            94,896Inventories
            
            9,332Property
      and equipment
            
            33,599Goodwill
            
            672,132Intangible
      assets
            
            581,241Other
      assets
            
            13,524Cash
      overdraft
            
            (11,471
            )Accounts
      payable and accrued liabilities
            
            (56,584
            )Deferred
      revenue
            
            (75,176
            )Other
      liabilities
            
            (41,292
            )Minority
      interest
            
            (24,853
            )Total
      consideration
            
            $
            1,195,348





The major
classes of intangible assets acquired and their respective weighted average
useful lives are as follows:





(in
      thousands)
            
            Fair
      Value Acquired
            
            
            Weighted
      Average Useful LivesTrade
      Names
            
            $
            2,400
            
            
            
            5.0Trade
      Names
            
            
            352,238
            
            
            IndefiniteSubscriber
      Relationships
            
            
            5,800
            
            
            
            4.7Advertiser
      Relationships
            
            
            153,298
            
            
            
            9.8Lead
      Generation Relationships
            
            
            34,123
            
            
            
            18.9Event
      Exhibitor & Sponsor Relationships
            
            
            4,700
            
            
            
            15.5Distribution
      Relationships
            
            
            8,300
            
            
            
            10.0Content
            
            
            20,382
            
            
            
            10.0Total
            
            $
            581,241
            
            
            
            11.1





As a
result of the acquisition, the Company acquired 80.1% of Automotive.com and a
contractual agreement to purchase the remaining 19.9% of
Automotive.com.  The Company has recorded the fair value of this
redeemable minority interest on its balance sheet as of January 31, 2008 in
accordance with EITF D-98.  EITF D-98 - Classification and Measurement of
Redeemable Securities - provides guidance regarding the measurement and
classification of minority interests whose redemption is not solely in the
control of the issuer.  Under this guidance, the Company has calculated the
fair value as of January 31, 2008 of the minority holders' put right.  The
earliest date the minority holders may put the shares to the Company is December
31, 2008.  At that time, the Company estimates the cash payment due to the
minority holders to be approximately $29.9 million.




ACQUISITION
OF ANDERSON MID-ATLANTIC NEWS, LLC





On March
30, 2006, the Company and Anderson News, LLC entered into a Unit Purchase
Agreement pursuant to which the Company purchased all of the issued and
outstanding membership interests of Anderson Mid-Atlantic News, LLC
("Mid-Atlantic") from Anderson News, LLC for a purchase price of approximately
$4.0 million, subject to adjustment based on the negative net worth as of the
closing date of the transaction. In addition, approximately $9.6 million was
also provided on the date of acquisition to Mid-Atlantic to repay a portion of
its outstanding intercompany debt. The remaining outstanding intercompany debt
of Mid-Atlantic was satisfied by issuance of a promissory note totaling $4.1
million. The promissory note was repaid by the Company during fiscal 2007. The
purchase price and the intercompany debt repayment were funded from the
Company's revolving line of credit.




64




The total
cost of the acquisition was allocated to the assets acquired and liabilities
assumed based on their estimated respective fair values in accordance with FAS
141, Business Combinations. Goodwill, which is deductible for tax purposes,
recorded in connection with the transaction is estimated to total $30.4
million.





The
assets acquired and liabilities assumed in the acquisition were recorded in the
quarter ended April 30, 2006. The acquisition was accounted for by the purchase
method and, accordingly, the results of Mid-Atlantic's operations have been
included in our consolidated statements of income since March 31, 2006. The
pro-forma operating results as if the Company had completed the acquisition at
the beginning of the periods presented are not significant to the Company's
consolidated financial statements and are not presented.





The
assets acquired and liabilities assumed, based on the valuation, are summarized
below:





(in
      thousands)
            
            AmountCash
            
            $
            4Inventories
            
            
            7,526Property
      and equipment
            
            
            516Goodwill
            
            
            30,417Intangible
      assets
            
            
            4,650Deferred
      tax assets
            
            
            1,642Other
      assets
            
            
            63Accounts
      payable and accrued liabilities
            
            
            (27,066
            )Total
      consideration
            
            $
            17,752





ACQUISITION
OF ANDERSON SCN SERVICES, LLC





On March
30, 2006, the Company and Anderson News, LLC entered into a Unit Purchase
Agreement pursuant to which the Company purchased all of the issued and
outstanding membership interests of Anderson-SCN Services, LLC (“SCN”) from
Anderson News, LLC for a purchase price of approximately $9.0 million, subject
to adjustment based on the negative net worth as of the closing date of the
transaction. In addition, approximately $17.0 million was also provided on the
date of acquisition to SCN to repay a portion of its outstanding intercompany
debt. The remaining outstanding intercompany debt of SCN was satisfied by
issuance of a promissory note totaling $10.2 million. The promissory note was
repaid by the Company during fiscal 2007. The purchase price and the
intercompany debt repayment were funded from the revolving line of
credit.





The total
cost of the acquisition was allocated to the assets acquired and liabilities
assumed based on their estimated respective fair values in accordance with FAS
141, Business Combinations.  Goodwill, which is deductible for tax
purposes, recorded in connection with the transaction is estimated to total
$59.9 million.





The
assets acquired and liabilities assumed in the acquisition were recorded in the
quarter ended April 30, 2006.  The acquisition was accounted for by
the purchase method and, accordingly, the results of SCN’s operations have been
included in our consolidated statements of income since March 31,
2006.  The pro-forma operating results as if the Company had completed
the acquisition at the beginning of the periods presented are not significant to
the Company’s consolidated financial statements and are not
presented.





The
assets acquired and liabilities assumed, based on the valuation, are summarized
below:





(in
      thousands)
            
            AmountCash
            
            $
            8Trade
      receivables, net
            
            
            581Inventories
            
            
            17,950Property
      and equipment
            
            
            1,690Goodwill
            
            
            59,927Intangible
      assets
            
            
            10,800Deferred
      tax assets
            
            
            1,573Other
      assets
            
            
            58Accounts
      payable and accrued liabilities
            
            
            (55,294
            )Obligations
      under capital leases
            
            
            (1,011
            )Total
      consideration
            
            $
            36,282





65





CHAS.
LEVY CIRCULATING COMPANY LLC ACQUISITION





On May
10, 2005, the Company and Chas. Levy Company LLC (“Seller”) entered into a Unit
Purchase Agreement (the “Purchase Agreement”). Under the terms of the Purchase
Agreement, the Company purchased all of the issued and outstanding membership
interests in Chas. Levy Circulating Co. LLC (“Levy”) from Seller for a purchase
price of approximately $30 million, subject to adjustment based on Levy’s net
worth as of the closing date of the transaction. Seller was the sole member of
Levy. In addition, approximately $19.3 million was also provided on the date of
acquisition to Seller to repay all outstanding intercompany debt of Levy. The
purchase price and the intercompany debt repayment were funded from the
revolving line of credit.





On May
10, 2005, as contemplated by the terms of the Purchase Agreement, the Company
and Levy Home Entertainment LLC (“LHE”) entered into a Distribution and Supply
Agreement (the “Distribution Agreement”). Under the terms of the Distribution
Agreement, LHE appointed the Company as its sole and exclusive subdistributor of
book products to all supermarkets (excluding supermarkets combined with general
merchandise stores), drug stores, convenience stores, newsstands and terminals
within the geographic territory in which the Registrant currently distributes
DVDs, CDs and/or magazines. The initial term of the Distribution Agreement
begins on May 10, 2005 and expires on June 30, 2015. The parties may renew the
agreement thereafter for successive one year periods.





The total
cost of the acquisition was allocated to the assets acquired and liabilities
assumed based on their respective fair values in accordance with FAS 141,
Business Combinations. Goodwill and other intangible assets, which is deductible
for tax purposes, recorded in connection with the transaction totaled $62.2
million and $15.9 million, respectively.





The
assets acquired and liabilities assumed in the acquisition were recorded in the
quarter ended July 31, 2005. The acquisition was accounted for by the purchase
method and, accordingly, the results of Levy’s operations have been included in
our consolidated statements of income since May 10, 2005.





The
assets acquired and liabilities assumed in the acquisition are summarized
below:





(IN
      THOUSANDS)
            
            AmountCash
            
            $
            4,276Trade
      receivables, net
            
            
            6,703Inventories
            
            
            37,664Income
      tax receivable
            
            
            4,619Property
      and equipment
            
            
            1,539Goodwill
            
            
            62,199Intangible
      assets
            
            
            15,865Other
      assets
            
            
            1,728Accounts
      payable and accrued liabilities
            
            
            (67,928
            )Long-term
      debt
            
            
            (13,359
            )Deferred
      tax liability
            
            
            (5,004
            )Other
      long-term liabilities
            
            
            (3,311
            )Total
      consideration
            
            $
            44,991








ALLIANCE
ENTERTAINMENT CORP. ACQUISITION





On
February 28, 2005, the Company completed its acquisition with Alliance
Entertainment Corp. (“Alliance”) pursuant to the terms and conditions of the
Agreement and Plan of Merger Agreement dated November 18, 2004 (the
“Agreement”). Alliance provides full-service distribution of home entertainment
products. They provide product and commerce solutions to “brick-and-mortar” and
e-commerce retailers, while maintaining trading relationships with major
manufacturers in the home entertainment industry. The Company consummated the
acquisition to further its objective of creating the premier provider of
information, supply chain management and logistics services to retailers and
producers of home entertainment content products.





The
purchase price of approximately $315.5 million consisted of $304.7 million in
the Company’s common stock, representing approximately 26.9 million shares, $6.5
million related to the exchange of approximately 0.9 million options to acquire
shares of common stock on exercise of outstanding stock options, warrants and
other rights to acquire Alliance common stock and direct transaction costs of
approximately $4.3 million. The value of the common stock was determined based
on the average market price of Source Interlink common stock over the 5-day
period prior to and after the announcement of the acquisition in November 2004.
The value of the stock options was determined using the Black-Scholes option
valuation model.





The total
cost of the acquisition was allocated to the assets acquired and liabilities
assumed based on their respective fair values in accordance with FAS 141,
Business Combinations. Goodwill and other intangible assets, none of which is
deductible for tax purposes, recorded in connection with the transaction totaled
$201.5 million and $94.2 million, respectively.




66


The
assets acquired and liabilities assumed in the acquisition were recorded in the
quarter ended April 30, 2005. The acquisition was accounted for by the purchase
method and, accordingly, the results of Alliance’s operations have been included
in our consolidated statements of income since March 1, 2005.





The
assets acquired and liabilities assumed in the acquisition are summarized
below:





(IN
      THOUSANDS)
            
            AmountCash
            
            $
            18,567Trade
      receivables, net
            
            
            48,216Inventories
            
            
            102,434Property
      and equipment
            
            
            41,881Goodwill
            
            
            201,532Intangible
      assets
            
            
            94,214Other
      assets
            
            
            16,326Accounts
      payable and accrued liabilities
            
            
            (158,264
            )Obligations
      under capital leases
            
            
            (563
            )Long-term
      debt
            
            
            (11,811
            )Non-current
      deferred tax liabilities
            
            
            (33,049
            )Other
      long-term liabilities
            
            
            (4,000
            )Total
      consideration
            
            $
            315,483





The
acquisition was accounted for by the purchase method and, accordingly, the
results of Alliance’s operations have been included in our consolidated
statements of income since March 1, 2005.





PRO-FORMA
OPERATING RESULTS (Unaudited)





The
following table summarizes pro forma operating results as if the Company had
completed the acquisition of (1) Enthusiast Media as of February 1, 2006 and (2)
Alliance and Levy on February 1, 2005:





Year
      ended January 31,(IN
      THOUSANDS, EXCEPT PER SHARE DATA)
            
            2008
            
            
            2007
            
            
            2006Revenues
            
            $
            2,510,740
            
            
            $
            2,315,190
            
            
            $
            1,697,794(Loss)
      income from continuing operations
            
            $
            (45,110
            )
            
            $
            (94,840
            )
            
            $
            11,268(Loss)
      income from continuing operations per share:Basic
            
            $
            (0.86
            )
            
            $
            (1.83
            )
            
            $
            0.25Diluted
            
            $
            (0.86
            )
            
            $
            (1.83
            )
            
            $
            0.24





This
information has been prepared for comparative purposes only and does not purport
to be indicative of the results of operations which actually would have resulted
had the acquisitions occurred on February 1, 2005, nor is it indicative of
future results.





Merger
charges related to the acquisition of Alliance and Levy recorded as expenses by
the Company through January 31, 2006 totaled $3.3 million. These expenses
represented severance and personnel-related charges, charges to exit certain
merchandiser contracts and a success fee paid to certain Company executives.
These expenses were not capitalized as they did not represent costs that provide
future economic benefits to the Company.





3. TRADE
RECEIVABLES





Trade
receivables consist of the following:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Trade
      receivables
            
            $
            411,968
            
            
            $
            312,116Less
      allowances for:Sales
      returns and other
            
            
            202,569
            
            
            
            192,328Doubtful
      accounts
            
            
            25,924
            
            
            
            17,130Total
      allowances
            
            
            228,493
            
            
            
            209,458Trade
      receivables, net
            
            $
            183,475
            
            
            $
            102,658





67


4.
INVENTORIES





Inventories
consist of the following:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Paper
            
            $
            8,225
            
            
            $
            -Raw
      materials
            
            
            629
            
            
            
            3,048Work-in-process
            
            
            1,322
            
            
            
            2,519Finished
      goods:Pre-recorded
      music and video
            
            
            149,765
            
            
            
            133,193Magazine
      and book
            
            
            127,067
            
            
            
            107,449Display
      Fixtures
            
            
            3,498
            
            
            
            2,732Total
      inventories
            
            $
            290,507
            
            
            $
            248,941





In the
event of non-sale, pre-recorded music and video, magazine and book inventories
are generally returnable to the suppliers thereof for full credit.





5.
PROPERTY, PLANTS AND EQUIPMENT





Property,
plants and equipment consist of the following:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Land
            
            $
            8,323
            
            
            $
            8,298Buildings
            
            
            18,495
            
            
            
            16,087Leasehold
      improvements
            
            
            10,289
            
            
            
            7,056Machinery
      and equipment
            
            
            38,434
            
            
            
            36,652Vehicles
            
            
            953
            
            
            
            593Furniture
      and fixtures
            
            
            9,005
            
            
            
            7,657Computers
            
            
            51,739
            
            
            
            19,476Construction
      in progress
            
            
            13,373
            
            
            
            2,993Total
      property, plants and equipment
            
            $
            150,612
            
            
            $
            98,812





Depreciation
expense from property, plants and equipment was $18.9 million $13.0 million, and
$8.9 million, for the fiscal years ended January 31, 2008, 2007 and 2006,
respectively.





6.
GOODWILL AND INTANGIBLE ASSETS





A summary
of the Company’s intangible assets are as follows:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Amortized
      intangible assets:Customer
      lists and relationships
            
            $
            298,924
            
            
            $
            122,406Trade
      names
            
            
            2,400
            
            
            
            -Content
            
            
            20,382
            
            
            
            -Non-compete
      agreements
            
            
            4,350
            
            
            
            4,350Software
            
            
            16,340
            
            
            
            16,340Total
      intangibles
            
            
            342,396
            
            
            
            143,096Accumulated
      amortization:Customer
      lists and relationships
            
            
            (45,565
            )
            
            
            (17,564
            )Trade
      names
            
            
            (250
            )
            
            
            -Content
            
            
            (1,019
            )
            
            
            -Non-compete
      agreements
            
            
            (2,518
            )
            
            
            (1,438
            )Software
            
            
            (8,317
            )
            
            
            (5,123
            )Total
      accumulated amortization
            
            
            (57,669
            )
            
            
            (24,125
            )Net
      Amortized intangible assets
            
            
            284,727
            
            
            
            118,971Indefinite
      lived trade names
            
            
            352,355
            
            
            
            -Intangibles,
      net
            
            $
            637,082
            
            
            $
            118,971





As a
result of our fiscal year 2008 SFAS No. 144 fourth quarter impairment
analysis, we determined that certain of our customer lists of our DVD and CD
Fulfillment reporting unit were impaired and consequently recorded a charge of
approximately $35.3 million.  These determinations are based largely
on management’s projections regarding the revenues from and profitability of
customer relationships acquired on February 28, 2005.  The combination
of these factors had an adverse impact on the anticipated future cash flows used
in the impairment analysis performed during the fourth quarter of fiscal year
2008.  The net carrying amount of the customer list was $30.5 million at
the end of the fourth quarter of fiscal year 2008, after the impairment charge
was recorded.




68





As a
result of our fiscal year 2007 SFAS No. 144 fourth quarter impairment
analysis, we determined that the customer list and non-compete agreement of our
In-Store Services reporting unit was impaired and consequently recorded a charge
of  approximately $1.7 million and $0.5 million, respectively.  These
determinations were primarily the result of a change in management’s
expectations of the long-term outlook for that business unit, including
increased life cycle for certain products, as well as decreasing operating
profit margins. The net carrying amount of the customer list was $1.25 million
at the end of the fourth quarter of fiscal year 2007, after the impairment
charge was recorded.





Amortization
expense from intangible assets was $35.5 million, $13.3 million, and $10.2
million for the fiscal years ended January 31, 2008, 2007 and 2006,
respectively.





Amortization
expense is estimated to be $78.2 million, $77.3 million, $62.8 million, $54.0
million and $45.2 million for the years ended January 31, 2009, 2010, 2011, 2012
and 2013, respectively.





Changes
in the carrying amount of goodwill for the year ended January 31, 2008 are as
follows:





Media
            
            
            Magazine
            
            
            CD
      and DVD
            
            
            In-Store(IN
      THOUSANDS)
            
            
            
            
            Fulfillment
            
            
            Fulfillment
            
            
            Services
            
            
            ConsolidatedBalance,
      January 31, 2007
            
            $
            -
            
            
            $
            169,600
            
            
            $
            201,532
            
            
            $
            24,770
            
            
            $
            395,902Additions
            
            
            673,654
            
            
            
            275
            
            
            
            -
            
            
            
            -
            
            
            
            673,929Foreign
      currency translation adjustments
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4
            
            
            
            4Balance,
      January 31, 2008
            
            $
            673,654
            
            
            $
            169,875
            
            
            $
            201,532
            
            
            $
            24,774
            
            
            $
            1,069,835





As a
result of our fiscal year 2007 SFAS No. 142 fourth quarter impairment
analysis, we determined that the goodwill of our In-Store Services reporting
unit was impaired and consequently recorded a charge of approximately $30.6
million.  These determinations were primarily the result of a change in
management’s expectations of the long-term outlook for that business unit,
including increased life cycle for certain products, as well as decreasing
operating profit margins.  The combination of these factors had an adverse
impact on the anticipated future cash flows of this reporting unit used in the
impairment analysis performed during the fourth quarter of fiscal year 2007.
 The net carrying amount of the goodwill was $24.8 million at the end of
the fourth quarter of fiscal year 2007, after the impairment charge was
recorded.





7. DEBT
AND REVOLVING CREDIT FACILITY





Debt
consists of:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Revolving
      credit facility - Wells Fargo Foothill
            
            $
            -
            
            
            $
            116,459Revolving
      credit facility - Citicorp North America
            
            
            -
            
            
            
            -Term
      Loan B - Citicorp North America
            
            
            875,600
            
            
            
            -Bridge
      Facility - Citicorp North America
            
            
            465,000
            
            
            
            -Note
      payable - Magazine import and export
            
            
            708
            
            
            
            3,500Note
      payable - Former owner of Empire
            
            
            -
            
            
            
            233Note
      payable - Arrangements with suppliers
            
            
            8,461
            
            
            
            10,180Mortgage
      loan - Wachovia Bank
            
            
            18,750
            
            
            
            19,750Equipment
      loans - SunTrust Leasing
            
            
            6,060
            
            
            
            4,262Total
      debt
            
            
            1,374,579
            
            
            
            154,384Less
      current maturities
            
            
            15,369
            
            
            
            7,850Debt,
      less current maturities
            
            $
            1,359,210
            
            
            $
            146,534







Citicorp
North America Credit Facilities




Revolving Credit
Facility




On August
1, 2007, the Company entered into a new $300.0 million asset-based revolving
credit facility as a result of its acquisition of EM. Citicorp North America,
Inc., as administrative agent for each of the parties that may become a
participant in such arrangement and their successors (“Lenders”) will make
revolving loans to us and our subsidiaries of up to $300.0 million including the
issuance of letters of credit. The terms and conditions of the arrangement are
governed primarily by the Revolving Credit Agreement dated August 1, 2007 by and
among us, our subsidiaries, and Citigroup Global Markets, Inc. and J.P. Morgan
Securities, Inc. as Joint Lead Arrangers and Joint Book Runners, Citicorp North
America, Inc. as Administrative Agent and Collateral Agent, JPMorgan Chase Bank,
N.A. as Syndication Agent, and Wachovia Bank, National Association and Wells
Fargo Foothill, LLC as Co-Documentation Agents.




69




Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 0.50%. At January
31, 2008 the prime rate was 6.00%. We also have the option of selecting up to
five traunches of at least $1 million each to bear interest at LIBOR plus a
margin of 1.50%. The Company had no LIBOR contracts outstanding at January 31,
2008. To secure repayment of the borrowings and other obligations of ours to the
Lenders, we and our subsidiaries granted a security interest in all of the
personal property assets to Citicorp North America, Inc., for the benefit of the
Lenders. These loans mature on August 1, 2013.




Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock.




Availability
under the facility is limited by the Company’s borrowing base calculation, as
defined in the agreement. The calculation resulted in excess availability, after
consideration of outstanding letters of credit, of $279.6 million at January 31,
2008.




Term Loan
B




On August
1, 2007, the Company entered into a new $880.0 million Term Loan B as a result
of its acquisition of EM. Citicorp North America, Inc., as administrative agent
for each of the parties that may become a participant in such arrangement and
their successors (“Lenders”) made loans to us and our subsidiaries of $880.0
million. The terms and conditions of the arrangement are governed primarily by
the Term Loan Agreement dated August 1, 2007 by and among us, our subsidiaries,
and Citigroup Global Markets, Inc. and J.P. Morgan Securities, Inc. as Joint
Lead Arrangers and Joint Book Runners, Citicorp North America, Inc. as
Administrative Agent and Collateral Agent and JPMorgan Chase Bank, N.A. as
Syndication Agent.




Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 2.25%. At January
31, 2008 the prime rate was 6.00%. We also have the option of selecting up to
five traunches of at least $1 million each to bear interest at LIBOR plus a
margin of 3.25%. The Company had one LIBOR contract outstanding at January 31,
2008 in the amount of $875.6 million and maturing in February 2008 and bearing
interest at a rate of 6.52%.  The Term Loan B requires the Company to
make principal payments of $2.2 million on the last day of each fiscal
quarter.  The Company made principal payments totaling $4.4 million
during fiscal year 2008.  To secure repayment of the borrowings and
other obligations of ours to the Lenders, we and our subsidiaries granted a
security interest in all of the personal property assets to Citicorp North
America, Inc., for the benefit of the Lenders. These loans mature on August 1,
2014.  At that time, a final principal payment of $820.6 million is
due.




Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. The Company is
also required to maintain a certain financial ratio. The Company is in
compliance with this requirement at January 31, 2008.




Bridge
Facility




On August
1, 2007, the Company issued a new $465.0 million Bridge Facility as a result of
its acquisition of EM. Citicorp North America, Inc., as administrative agent for
each of the parties that may become a participant in such arrangement and their
successors (“Lenders”) made loans to us and our subsidiaries of $465.0 million.
The terms and conditions of the arrangement are governed primarily by the Senior
Subordinated Bridge Loan Agreement dated August 1, 2007 by and among us, our
subsidiaries, and Citigroup Global Markets, Inc. and J.P. Morgan Securities,
Inc. as Joint Lead Arrangers and Joint Book Runners, Citicorp North America,
Inc. as Administrative Agent and JPMorgan Chase Bank, N.A. as Syndication
Agent.




Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 4.25% at January 31,
2008, which increases by 0.50% upon the expiration of each of the first four 90
day periods following original issuance. At January 31, 2008 the prime rate was
6.00%. We also have the option of selecting up to five tranches of at least $1
million each to bear interest at LIBOR plus a margin of 5.25% at January 31,
2008, which increases by 0.50% upon the expiration of each of the first four 90
day periods following original issuance. The interest rate on either base-rate
or LIBOR loans may not exceed 11.25%.  The Company had one LIBOR
contract outstanding at January 31, 2008 in the amount of $465.0 million and
maturing in February 2008 and bearing interest at a rate of
9.02%.  These loans mature on August 1, 2008 - the table below assumes
that the extended maturity date of these loans will be August 1,
2017.




On or
before August 1, 2008, the Company has the right to refinance the Bridge
Facility by paying an exchange fee of $11.6 million to Citicorp North America,
Inc.  If the Company does not refinance the loans on or before August
1, 2008, Citicorp North America, Inc. is required to allow the facility to
convert into a form of permanent financing.  At that time, the Company
must pay to Citicorp North America a conversion fee of $11.6
million.  The extended maturity date of these loans would be August 1,
2017.  These loans would carry interest not to exceed
11.25%.




70




Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. The Company is
also required to maintain a certain financial ratio




WELLS
FARGO FOOTHILL CREDIT FACILITY




On August
1, 2007, the Company repaid all amounts due under the former revolving credit
facility with proceeds from borrowings under the Citicorp North America Credit
Facilities.







MORTGAGE
LOAN





The
Company obtained a 10 year, $20.0 million conventional mortgage loan through
Wachovia Bank (the “Wachovia Mortgage”). The Wachovia Mortgage is collateralized
by land and building located in Coral Springs, FL. The Wachovia Mortgage monthly
principal payments are approximately $0.08 million beginning in October 2006
plus interest at a rate of LIBOR plus a margin of 1.60%. At the end of the 10
year term, a balloon payment in the amount of $11.1 million is due and
payable.








The
aggregate amount of debt maturing in each of the next five fiscal years is as
follows:





Fiscal
      year:
            
            Amount2009
            
            $
            15,3692010
            
            
            12,9442011
            
            
            11,4022012
            
            
            11,3152013
            
            
            10,938Thereafter
            
            
            1,312,611Total
            
            $
            1,374,579





At
January 31, 2008 and 2007, unamortized deferred financing fees were
approximately $29.0 million and $2.2 million, respectively and included in other
long term assets.





8.
DISCONTINUED OPERATION





On April
30, 2007, the Company disposed of substantially all of the assets and
liabilities of its Wood Manufacturing division.  The Company sold the
assets and liabilities of its Wood Manufacturing division to a purchaser in
which S. Leslie Flegel, the Company’s former Chairman of the Board and Chief
Executive Officer, has an interest.  The Wood Manufacturing division
was formerly reported as part of our In-Store Services segment.  The
book value of the net assets sold on the closing date was $11.6
million.  The assets and liabilities of the Wood Manufacturing
division were sold for $10.0 million cash, and the issuance of a note payable to
the Company in the face amount of $3.5 million, which bears interest at the
3-month LIBOR plus a margin of 2.00%.  The Company has determined that
the note does not bear an interest rate equivalent to a market rate for the
borrower.  Therefore, the Company has discounted the note to fair
value using its estimation of a market rate for the note.  This
discount was approximately $1.0 million.  Based upon the final
determination of working capital, the Company refunded to the buyer $1.9 million
in cash during the third quarter of fiscal 2008.  For the years ended
January 31, 2008, 2007 and 2006 the results of operations from the wood
manufacturing division are as follows:




Year ended January 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Revenue
            
            $
            2,551
            
            
            $
            26,193
            
            
            $
            28,627(Loss)
      income before income taxes
            
            $
            (1,912
            )
            
            $
            2,184
            
            
            $
            2,693Income
      tax (benefit) expense
            
            
            (765
            )
            
            
            874
            
            
            
            1,357(Loss)
      income from discontinued operations, net of tax
            
            
            (1,147
            )
            
            
            1,311
            
            
            
            1,336Pre-tax
      loss on sale of discontinued business
            
            
            (847
            )
            
            
            -
            
            
            
            -Income
      tax benefit
            
            
            (339
            )
            
            
            -
            
            
            
            -Loss
      on sale of business, net of tax
            
            
            (508
            )
            
            
            -
            
            
            
            -Discontinued
      operation, net of tax
            
            $
            (1,655
            )
            
            $
            1,311
            
            
            $
            1,336





In
November 2004, the Company sold and disposed of its secondary wholesale
distribution operation for $1.4 million, in order to focus more fully on its
domestic and export distribution. All rights owned under the secondary wholesale
distribution contracts were assigned, delivered, conveyed and transferred to the
buyer, an unrelated third party. All assets and liabilities of the secondary
wholesale distribution operation were not assumed by the buyer. The Company
recognized a gain on sale of this business of $1.4 million ($0.8 net of tax) in
the fourth quarter of fiscal year 2005.




71




The
following amounts related to the Company’s discontinued operation have been
segregated from continuing operations and reflected as discontinued
operations:




Year
      EndedJanuary
      31, 2006Revenue
            
            $
            -Loss
      before income taxes
            
            $
            (2,410
            )Income
      tax benefit
            
            
            964Loss
      from discontinued operation, net of tax
            
            
            (1,446
            )Pre-tax
      gain on sale of discontinued business
            
            
            -Income
      tax expense
            
            
            -Gain
      on sale of business, net of tax
            
            
            -Discontinued
      operations, net of tax
            
            $
            (1,446
            )




9.
EARNINGS PER SHARE





A
reconciliation of the denominators of the basic and diluted earnings per share
computation are as follows:





(IN
      THOUSANDS)
            
            2008
            
            
            2007
            
            
            2006Weighted
      average number of common shares outstanding - basic
            
            
            52,276
            
            
            
            51,838
            
            
            
            49,097Effect
      of dilutive securities:Stock
      options and warrants
            
            
            -
            
            
            
            -
            
            
            
            1,797Weighted
      average number of common shares outstanding -
diluted
            
            
            52,276
            
            
            
            51,838
            
            
            
            50,894The
      following securities were excluded because their effect would be
      anti-dilutive:Stock
      options and warrants
            
            
            3,247
            
            
            
            1,980
            
            
            
            864





10.
INCOME TAXES





Provision
(benefit) for federal and state income taxes in the consolidated statements of
income for the income from continuing operations before income taxes consists of
the following components:





Year
      ended January 31,(IN
      THOUSANDS)
            
            2008
            
            
            2007
            
            
            2006CurrentFederal
            
            $
            (605
            )
            
            $
            6,159
            
            
            $
            5,176State
            
            
            (166
            )
            
            
            809
            
            
            
            1,333Foreign
            
            
            805
            
            
            
            1,173
            
            
            
            1,192Total
      current
            
            
            34
            
            
            
            8,141
            
            
            
            7,701DeferredFederal
            
            
            (13,618
            )
            
            
            (11,518
            )
            
            
            4,430State
            
            
            (2,410
            )
            
            
            (2,186
            )
            
            
            1,065Foreign
            
            
            -
            
            
            
            (505
            )
            
            
            -Total
      deferred
            
            
            (16,028
            )
            
            
            (14,209
            )
            
            
            5,495Total
      income tax (benefit) expense
            
            $
            (15,994
            )
            
            $
            (6,068
            )
            
            $
            13,196





The
following summary reconciles income taxes for continuing operations at the
maximum federal statutory rate with the effective rates for 2008, 2007 and
2006:





Year
      ended January 31,(IN
      THOUSANDS)
            
            2008
            
            
            2007
            
            
            2006Income
      tax (benefit) expense at statutory rate
            
            $
            (14,499
            )
            
            $
            (11,212
            )
            
            $
            9,165Permanent
      difference relating to non-deductible amortization of
      intangibles
            
            
            -
            
            
            
            -
            
            
            
            2,263Permanent
      difference relating to non-deductible impairment
    charges
            
            
            -
            
            
            
            4,449
            
            
            
            -State
      income tax (benefit) expense, net of federal income tax
      benefit
            
            
            (1,674
            )
            
            
            (934
            )
            
            
            1,479Difference
      in foreign tax rates
            
            
            332
            
            
            
            36
            
            
            
            13Other,
      net
            
            
            (153
            )
            
            
            1,593
            
            
            
            276Income
      tax (benefit) expense
            
            $
            (15,994
            )
            
            $
            (6,068
            )
            
            $
            13,196





72


Components
of income from continuing operations before income taxes are as
follows:





Year
      ended January 31,(IN
      THOUSANDS)
            
            2008
            
            
            2007
            
            
            2006United
      States
            
            $
            (42,852
            )
            
            $
            (31,326
            )
            
            $
            24,139Foreign
            
            
            1,351
            
            
            
            (709
            )
            
            
            2,046Total
      (loss) income from continuing operations
            
            $
            (41,501
            )
            
            $
            (32,035
            )
            
            $
            26,185





Deferred
income taxes reflect the net tax effect of temporary differences between the
carrying amount of the assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. The sources of the temporary
differences and their effect on deferred taxes are as follows:





January
      31,(IN
      THOUSANDS)
            
            2008
            
            
            2007Deferred
      tax assetsNet
      operating loss carryforwards
            
            $
            27,141
            
            
            $
            13,303Allowance
      for doubtful accounts
            
            
            9,131
            
            
            
            6,910Payroll
      related items
            
            
            6,308
            
            
            
            4,483Deferred
      revenue
            
            
            2,684
            
            
            
            963Inventory
      related items
            
            
            4,428
            
            
            
            6,824Other
            
            
            3,239
            
            
            
            3,313Total
      deferred tax asset
            
            
            52,931
            
            
            
            35,796Deferred
      tax liabilitiesBook/tax
      difference in capital assets
            
            
            9,499
            
            
            
            8,965Goodwill
      and intangible assets
            
            
            28,492
            
            
            
            29,024Prepaid
      expenses
            
            
            777
            
            
            
            776Total
      deferred tax liabilities
            
            
            38,768
            
            
            
            38,765Net
      deferred tax (liability) asset
            
            $
            14,163
            
            
            $
            (2,969
            )Classified
      as:Current
      asset
            
            $
            23,107
            
            
            $
            29,531Long-term
      (liability) asset
            
            
            (8,944
            )
            
            
            (32,500
            )Net
      deferred tax (liability) asset
            
            $
            14,163
            
            
            $
            (2,969
            )





At
January 31, 2008, the Company had net operating loss (“NOL”) carryforwards of
approximately $70.6 million expiring through 2028.





The
Company has net operating losses of approximately $70 million as of January 31,
2008 which expire through 2028. Approximately $10 million of these net operating
losses are subject to Internal Revenue Service regulations which limit the
amount of such operating losses available for utilization to approximately $1.3
million per year. At January 31, 2008, the Company assessed the future
utilization of its deferred tax assets, including NOL carryforwards and
determined that it is more likely than not that the benefit of such deferred tax
assets will be realized and a valuation allowance is not necessary. This
determination was based on the Company’s expected future taxable income and in
the event the Company does not meet these expectations, a valuation allowance
might be required for these deferred tax assets in the future.
  In July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FASB No. 109. Effective February 1, 2007, the Company adopted
the provisions of Financial Standards Accounting Board Interpretation FIN 48.
This interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with SFAS 109
and prescribes a recognition threshold of more-likely-than-not to be sustained
upon examination. As a result of the implementation of FIN 48, no adjustment was
required.  Gross uncertain tax positions taken by the Company are
immaterial to the Company's financial statements.


11.
RELATED PARTY TRANSACTIONS





Pursuant
to an agreement through August 2007, the Company conducts significant business
with one customer distributing magazines, music and DVDs. The Chairman and major
stockholder of this customer is a passive minority investor of AEC Associates,
the Company’s largest shareholder. During the fiscal year ended January 31,
2008, 2007 and 2006, the Company had revenues of $488.0 million, $364.9 and
$421.0 million, respectively, related to this customer and this customer’s
subsidiaries.





AEC
Associates is the majority stockholder of Digital On-Demand, Inc. In connection
with the spin-off of certain assets by Alliance to Digital On-Demand, Inc. which
occurred prior to the merger, Alliance and Digital On-Demand, Inc. entered into
a number of agreements including a distribution and separation agreement,
licensing and co-marketing agreement, transition/shared services agreement and
tax-sharing and indemnification agreement. We assumed the rights and obligations
of Alliance under these agreements upon consummation of our merger with
Alliance.





In
connection with the Company’s acquisition of EM, the Company paid $12.7 million
to The Yucaipa Companies, LLC, an affiliate of AEC Associates.  In
addition, the Company paid Yucaipa approximately $1.0 million in each of the
years ended January 31, 2008, 2007 and 2006 in connection with its advisory
services.




73




Carol
Kloster, one of our former executive officers, was a director of Chas. Levy
Company, LLC during her service with the Company, formerly the sole member of
Chas. Levy Circulating Co. LLC. Concurrent with our acquisition of Chas. Levy
Circulating Co. LLC, we entered into an agreement with Levy Home Entertainment,
LLC, a wholly owned subsidiary of Chas. Levy Company, LLC to purchase book
product for distribution to our customers. During the year ended January 31,
2007, the Company purchased $39.5 million, net of returns. During the period
beginning in May 2005 and ending January 31, 2006, we purchased $23.1 million in
book product from Levy Home Entertainment, net of returns.





A former
director of the Company was a principal in Armstrong Teasdale
LLP.  The Company purchased legal services from Teasdale LLP totaling
approximately $0.1 year ended January 31, 2006.





12.
COMMITMENTS AND CONTINGENCIES





LEASES





The
Company leases office and manufacturing space, computer equipment and vehicles
under leases that expire over the next 15 years. Management expects that in the
normal course of business, leases will be renewed or replaced with other
leases.





Rent
expense was approximately $22.1 million, $20.8 million and $9.2 million for the
years ended January 31, 2008, 2007 and 2006, respectively.





Future
minimum payments, by year and in the aggregate, under non-cancelable operating
leases with initial or remaining terms of year or more consisted of the
following at January 31, 2008:








(IN
      THOUSANDS)
            
            AmountFiscal
      year:2009
            
            $
            25,4892010
            
            
            23,3342011
            
            
            15,2712012
            
            
            12,2192013
            
            
            11,065Thereafter
            
            
            14,847Total
            
            $
            102,225





LITIGATION





The
Company has pending certain legal actions and claims, which were incurred in the
normal course of business, and is actively pursuing the defense thereof. In the
opinion of management, these actions and claims are either without merit or are
covered by insurance and will not have a material adverse effect on the
Company’s financial condition, results of operations or liquidity.





13.
            EMPLOYEE
      BENEFIT PLANS





On
February 1, 2006, the Company adopted FAS No. 123(R), Share-Based Payment, and
chose to transition using the modified prospective method.  Also on
February 1, 2006, the Company granted approximately 0.1 million options to
non-executive members of its board of directors.  The Company
recognized stock compensation expense of approximately $0.3 million associated
with this grant.  On November 10, 2006, the Company modified certain
stock options granted to S. Leslie Flegel to extend the exercise period beyond
his resignation.  The Company recognized stock compensation expense of
approximately $1.3 million associated with this modification.  For the
fiscal year ended January 31, 2008 and 2007, the Company recorded $0.2 million,
and $1.7 million in stock compensation expense, respectively.





Under the
Company’s stock option plans, options to acquire shares of Common Stock have
been made available for grant to certain employees and non-employee directors.
Each option granted has an exercise price of not less than 100% of the market
value of the Common Stock on the date of grant. The contractual life of each
option is generally 10 years. The vesting of the grants varies according to the
individual options granted.


74





WeightedAverageNumber
      of
            
            
            Range
      of Exercise Prices
            
            
            ExerciseOptions
            
            
            Low
            
            
            High
            
            
            PriceOptions
      outstanding at January 31, 2005
            
            
            3,555,999
            
            
            $
            2.42
            
            
            $
            21.60
            
            
            $
            6.48Options
      granted
            
            
            587,500
            
            
            
            9.79
            
            
            
            11.00
            
            
            
            10.95Options
      acquired
            
            
            807,107
            
            
            
            1.77
            
            
            
            9.21
            
            
            
            7.07Options
      forfeited or expired
            
            
            (28,923
            )
            
            
            1.77
            
            
            
            16.63
            
            
            
            7.14Options
      exercised
            
            
            (994,493
            )
            
            
            1.77
            
            
            
            9.75
            
            
            
            4.85Options
      outstanding at January 31, 2006
            
            
            3,927,190
            
            
            $
            2.30
            
            
            $
            18.31
            
            
            $
            7.64Options
      granted
            
            
            84,575
            
            
            
            8.97
            
            
            
            11.15
            
            
            
            10.03Options
      forfeited or expired
            
            
            (188,275
            )
            
            
            10.60
            
            
            
            16.63
            
            
            
            11.33Options
      exercised
            
            
            (142,185
            )
            
            
            2.30
            
            
            
            10.78
            
            
            
            8.40Options
      outstanding at January 31, 2007
            
            
            3,681,305
            
            
            $
            2.30
            
            
            $
            18.31
            
            
            $
            7.48Options
      granted
            
            
            380,000
            
            
            
            2.54
            
            
            
            7.35
            
            
            
            3.53Options
      forfeited or expired
            
            
            (472,020
            )
            
            
            4.56
            
            
            
            16.63
            
            
            
            8.71Options
      exercised
            
            
            (416,985
            )
            
            
            2.42
            
            
            
            5.63
            
            
            
            3.94Options
      outstanding at January 31, 2008
            
            
            3,172,300
            
            
            $
            2.30
            
            
            $
            18.31
            
            
            $
            7.20








The
following table summarizes information about the stock options outstanding at
January 31, 2008:





Options
      Outstanding
            
            
            Options
      ExercisableRange
      of Exercise Prices
            
            
            Number
      Outstanding
            
            
            Weighted
      Average Exercise Price
            
            
            Remaining
      Contractual Life (months)
            
            
            Number
      Exercisable
            
            
            Weighted
      Average Exercise Price$
            2.30
      - $5.00
            
            
            
            1,001,136
            
            
            $
            3.92
            
            
            
            8 -
      60
            
            
            
            701,136
            
            
            $
            4.51$
            5.01
      - $7.50
            
            
            
            591,250
            
            
            $
            5.52
            
            
            
            1 -
      110
            
            
            
            591,250
            
            
            $
            5.52$
            7.51
      - $10.00
            
            
            
            909,289
            
            
            $
            8.46
            
            
            
            10
      - 106
            
            
            
            909,289
            
            
            $
            8.46$
            10.01
      - $15.00
            
            
            
            603,025
            
            
            $
            11.31
            
            
            
            13
      - 96
            
            
            
            603,025
            
            
            $
            11.31$
            15.01
      - $18.31
            
            
            
            67,600
            
            
            $
            16.65
            
            
            
            22
      - 26
            
            
            
            67,600
            
            
            $
            16.65Total
            
            
            
            3,172,300
            
            
            $
            7.20
            
            
            
            1 -
      110
            
            
            
            2,872,300
            
            
            $
            7.48





Options
exercisable at January 31, 2007 and 2006 totaled 3,804,190 and 2,894,983,
respectively and had weighted average exercise prices of $7.56 and $6.65,
respectively.  The weighted total intrinsic value of options
outstanding and exercisable at January 31, 2008 was less than
zero.  The total intrinsic value of options exercised during the year
ended January 31, 2008, 2007 and 2006 was $1.9 million, $0.5 million, and $6.3
million, respectively.  As of January 31, 2008, substantially all of
the Company’s employee stock options are vested.





The
weighted average fair value of each option granted during the year was $1.15,
$3.32, and $4.08 (at grant date) in 2008, 2007 and 2006, respectively. The
options were issued at exercise prices which were equal to or exceeded the
quoted market price of the Company’s Common Stock on the date of grant. At
January 31, 2008, there were 3,700,000 options remaining under the Company’s
stock option plans.





STOCK
OPTIONS REVIEW





The
Company, under the direction of the Audit Committee, undertook a review of
previously issued stock options.  The Company determined that there were
instances when the documentation of the Compensation Committee’s formal approval
of the grant differed from the grant date being used by the Company. 
However, the Company did not find any intent to defraud or fraudulent misconduct
by any individual or groups of individuals.  Furthermore, the Company found
that the dating and pricing practice for stock options was applied uniformly by
Company personnel to stock options granted and was not used selectively to
benefit any one group or individual within the Company.





The
Company has concluded that the charges are not material to the financial
statement in any of the periods to which such charges relate and therefore will
not restate its historic financial statements.  The Company has
recorded an adjustment of $0.1 million ($0.1 million after tax) to increase
non-cash compensation expense in the fourth quarter of fiscal 2007 to correctly
present compensation expense for fiscal 2007. The Company has recorded an
adjustment to increase accumulated deficit by $2.6 million, increase additional
paid in capital by $3.2 million and decrease non-current deferred tax
liabilities by $0.6 million to correct the consolidated balance sheet for the
cumulative impact of the misstated compensation expense in periods prior to
fiscal 2007.





The
Company is still examining its alternatives, including but not limited to
repricing options, relating to Section 16 officers and employees who are not
Section 16 officers who were issued incorrectly dated options.  All
decisions will be approved by the Board of Directors and at this time, there
have been no approved actions.  The Company can not estimate the aggregate
cost of such alternatives at this time and therefore any decisions will impact
the results of operations of future periods.




75




PROFIT
SHARING AND 401(k) PLAN





The
Company has a combined profit sharing and 401(k) Plan. Annual contributions to
the profit sharing portion of the Plan are determined by the Board of Directors
and may not exceed the amount that may be deducted for federal income tax
purposes. There were no profit sharing contributions charged against operations
for the years ended January 31, 2008, 2007 and 2006.





Under the
401(k) portion of the Plan, all eligible employees may elect to contribute 2% to
20% of their compensation up to the maximum allowed under the Internal Revenue
Code. The Company matches one half of an employee’s contribution, not to exceed
5% of the employee’s salary. The amounts matched by the Company during the years
ended January 31, 2008, 2007 and 2006 pursuant to this Plan were approximately
$1.7 million, $2.5 million, and $1.4 million, respectively.





UNION
PLAN





At
January 31, 2008, 570 of the Company’s 7,348 employees were members of a
collective bargaining unit. The Company is party to fourteen collective
bargaining agreements, which expire at various times through August 2009.
Contributions to the union funds were approximately $1.2 million, $1.4 million,
and $0.7 million for the years ended January 31, 2008, 2007, and 2006,
respectively.





SUPPLEMENTAL
EXECUTIVE RETIREMENT PLAN





The
Company also provides a Supplemental Executive Retirement Plan (“SERP”) that is
designed to supplement the retirement benefits available through the Company’s
other savings plans to certain of the Company’s executive officers. The minimum
SERP liability is measured at year-end.





The
accumulated year-end SERP benefit obligation, based on a discount rate of 7.00%,
was $2.7 million at January 31, 2008 and is reflected in the Consolidated
Balance Sheets as a liability. Benefits are funded by the Company through a
Rabbi Trust. The year-end balance included in Other Assets was $3.2 million at
January 31, 2008.





14.
WARRANTS





The
following table summarizes information about the warrants for common stock
outstanding at January 31, 2008:





Number
            Number
            
            ExpirationOutstanding
            Exercisable
            Grant
      Date
            DateExercise
      price:$8.04
            61,333
            61,333
            10/30/2003
            10/3/2008$8.58
            30,000
            30,000
            8/30/2004
            8/30/2014$11.62
            10,000
            10,000
            4/4/2005
            4/4/2015





15.
SUPPLEMENTAL CASH FLOW INFORMATION





Supplemental
information on the approximate amount of interest and income taxes paid
(refunded) is as follows:





Year
      ended January 31,(IN
      THOUSANDS)
            
            2008
            
            
            2007
            
            
            2006Interest
            
            $
            62,531
            
            
            $
            11,782
            
            
            $
            6,303Income
      taxes (net of refunds of $15,990 in 2008)
            
            $
            (14,258
            )
            
            $
            15,331
            
            
            $
            6,606





Significant
non-cash activities were as follows:





YEAR
ENDED JANUARY 31, 2008





As
discussed in Note 8, the Company disposed of its Wood Manufacturing division for
the total consideration of $13.5 million, including $3.5 million in the form of
a note receivable, of which the Company refunded $1.9 million to the buyer
during the third quarter of fiscal 2008, based on a working capital
adjustment.








YEAR
ENDED JANUARY 31, 2007





As
discussed in Note 2, the Company acquired Mid-Atlantic on March 30, 2006 for the
total consideration of $17.7 million, including $13.6 million in cash and $4.1
million in the form of a note payable.  As of January 31, 2008, this
note was repaid.




76





As
discussed in Note 2, the Company acquired SCN on March 30, 2006 for the total
consideration of $36.2 million, including $26.0 million in cash and $10.2
million in the form of a note payable.  As of January 31, 2008, this
note was repaid.





YEAR
ENDED JANUARY 31, 2006





On
February 28, 2005, as discussed in Note 2, the Company acquired Alliance
Entertainment Corp. for the total consideration of $315.5 million as
follows:





(IN
      THOUSANDS)
            
            AmountFair
      value of common stock issued to Alliance
shareholders
            
            $
            304,714Fair
      value of options to purchase common stock issued to Alliance
      shareholders
            
            
            6,500Cash
      paid for direct acquisition costs (of which, $1.7 million were paid during
      the year ended January 31, 2005)
            
            
            4,269Total
      purchase price for acquisition of Alliance
            
            $
            315,483








The total
purchase price was allocated to the assets and liabilities of Alliance
Entertainment Corp. as disclosed in Note 2.








16.
SHAREHOLDERS’ EQUITY





In
February 2005, the Company issued 26.9 million shares of common stock to the
former shareholders of Alliance Entertainment Corp. as partial consideration for
the Company’s acquisition of Alliance at a value of approximately $304.7
million, valued at the average market price over the 5 day period preceding and
following the announcement of the acquisition. The Company also exchanged 0.9
million Alliance stock options, which were valued using the Black-Scholes option
pricing model and assumptions substantially the same as those presented in Note
1.





Also in
February 2005, the Company reincorporated from Missouri into Delaware, and
retired 100,000 shares of stock it held in treasury.








17.
SEGMENT FINANCIAL REPORTING





The
Company’s segment reporting is based on the reporting of senior management to
the Chief Executive Officer. This reporting combines the Company’s business
units in a logical way that identifies business concentrations and
synergies.





The Media
segment derives revenues from (1) selling print advertising space in its
enthusiast publications, (2) sales of single-copy magazines to magazine national
distributors, (2) sales of subscription magazines to consumers, (3) online pay
per click advertising and lead generation services, (4) distribution of
magazines to small specialty retailers and (5) licensing its trade-names for use
in product promotions.





The DVD
and CD Fulfillment segment derives revenues from (1) selling and distributing
pre-recorded music, videos, video games and related products to retailers, (2)
providing product and commerce solutions to “brick-and-mortar” and e-commerce
retailers, and (3) providing consumer-direct fulfillment and vendor managed
inventory services to its customers.





The
Magazine Fulfillment Services segment derives revenues from (1) selling and
distributing magazines, including domestic and foreign titles, to major
specialty and mainstream retailers and wholesalers throughout the United States
and Canada, (2)  exporting domestic titles internationally to foreign
wholesalers or through domestic brokers, (3) providing return processing
services for  major specialty retail book chains and (4) serving as an
outsourced fulfillment agent





The
In-Store Services segment derives revenues from (1) designing, manufacturing,
and invoicing participants in front-end fixture programs and (2) providing
claim filing services related to rebates owed retailers from publishers or their
designated agent.




Shared
Services consists of overhead functions not allocated to individual operating
segments.





77


The
segment results are as follows:





Year
      ended January 31, 2008(in
      thousands)
            
            Media
            
            
            Magazine
      Fulfillment Services
            
            
            CD
      and DVD Fulfillment
            
            
            In-Store
      Services
            
            
            Shared
      Services
            
            
            Eliminations
            
            
            ConsolidatedRevenues,
      net:Distribution
            
            $
            4,762
            
            
            $
            932,315
            
            
            $
            1,021,018
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            1,958,095Advertising
            
            
            122,769
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            122,769Circulation
            
            
            78,532
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (14,615
            )
            
            
            63,917Manufacturing
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            30,650
            
            
            
            -
            
            
            
            -
            
            
            
            30,650Claiming
      and information
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14,001
            
            
            
            -
            
            
            
            -
            
            
            
            14,001Other
            
            
            46,848
            
            
            
            17,972
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            64,820Total
      revenues, net
            
            
            252,911
            
            
            
            950,287
            
            
            
            1,021,018
            
            
            
            44,651
            
            
            
            -
            
            
            
            (14,615
            )
            
            
            2,254,252Cost
      of revenues
            
            
            68,906
            
            
            
            730,839
            
            
            
            845,418
            
            
            
            25,633
            
            
            
            -
            
            
            
            (14,615
            )
            
            
            1,656,181Gross
      profit
            
            
            184,005
            
            
            
            219,448
            
            
            
            175,600
            
            
            
            19,018
            
            
            
            -
            
            
            
            -
            
            
            
            598,071Selling,
      general and administrative expense
            
            
            112,778
            
            
            
            74,818
            
            
            
            61,612
            
            
            
            7,879
            
            
            
            15,535
            
            
            
            -
            
            
            
            272,622Distribution,
      circulation and fulfillment
            
            
            23,427
            
            
            
            111,370
            
            
            
            62,220
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            197,017Depreciation
      and amortization
            
            
            24,840
            
            
            
            9,208
            
            
            
            16,739
            
            
            
            490
            
            
            
            2,161
            
            
            
            -
            
            
            
            53,438Impairment
      of Goodwill and Intangible Assets
            
            
            -
            
            
            
            -
            
            
            
            35,310
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            35,310Integration
      and relocation expense
            
            
            -
            
            
            
            1,072
            
            
            
            -
            
            
            
            -
            
            
            
            495
            
            
            
            -
            
            
            
            1,567Disposal
      of land, buildings and equipment, net
            
            
            -
            
            
            
            -
            
            
            
            417
            
            
            
            (174
            )
            
            
            -
            
            
            
            -
            
            
            
            243Merger
      and acquisition charges
            
            
            252
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            913
            
            
            
            -
            
            
            
            1,165Operating
      income (loss)
            
            $
            22,708
            
            
            
            22,980
            
            
            
            (698
            )
            
            
            10,823
            
            
            
            (19,104
            )
            
            
            -
            
            
            
            36,709Capital
      expenditures
            
            $
            3,876
            
            
            $
            8,890
            
            
            $
            11,435
            
            
            $
            215
            
            
            $
            5,631
            
            
            $
            -
            
            
            $
            30,047Year
      ended January 31, 2008(in
      thousands
            
            Media
            
            
            Magazine
      Fulfillment Services
            
            
            CD
      and DVD Fulfillment
            
            
            In-Store
      Services
            
            
            Shared
      Services
            
            
            Eliminations
            
            
            ConsolidatedTotal
      Assets
            
            $
            1,378,489
            
            
            $
            359,764
            
            
            $
            538,867
            
            
            $
            73,744
            
            
            $
            89,208
            
            
            $
            (4,067
            )
            
            $
            2,436,005Goodwill,
      net
            
            $
            673,654
            
            
            $
            169,875
            
            
            $
            201,532
            
            
            $
            24,774
            
            
            $
            -
            
            
            $
            -
            
            
            $
            1,069,835Intangibles,
      net
            
            $
            561,808
            
            
            $
            36,992
            
            
            $
            37,406
            
            
            $
            876
            
            
            $
            -
            
            
            $
            -
            
            
            $
            637,082





78





Year
      ended January 31, 2007(in
      thousands)
            
            Media
            
            
            Magazine
      Fulfillment Services
            
            
            CD
      and DVD Fulfillment
            
            
            In-Store
      Services
            
            
            Shared
      Services
            
            
            Eliminations
            
            
            ConsolidatedRevenues,
      net:Distribution
            
            $
            -
            
            
            $
            794,973
            
            
            $
            971,523
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            1,766,496Advertising
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Circulation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Manufacturing
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            32,670
            
            
            
            -
            
            
            
            -
            
            
            
            32,670Claiming
      and information
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14,707
            
            
            
            -
            
            
            
            -
            
            
            
            14,707Other
            
            
            -
            
            
            
            14,780
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14,780Total
      revenues, net
            
            
            -
            
            
            
            809,753
            
            
            
            971,523
            
            
            
            47,377
            
            
            
            -
            
            
            
            -
            
            
            
            1,828,653Cost
      of revenues
            
            
            -
            
            
            
            621,786
            
            
            
            797,348
            
            
            
            26,790
            
            
            
            -
            
            
            
            -
            
            
            
            1,445,924Gross
      profit
            
            
            -
            
            
            
            187,967
            
            
            
            174,175
            
            
            
            20,587
            
            
            
            -
            
            
            
            -
            
            
            
            382,729Selling,
      general and administrative expense
            
            
            -
            
            
            
            63,603
            
            
            
            55,650
            
            
            
            7,695
            
            
            
            34,483
            
            
            
            -
            
            
            
            161,431Distribution,
      circulation and fulfillment
            
            
            -
            
            
            
            113,444
            
            
            
            64,509
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            177,953Depreciation
      and amortization
            
            
            -
            
            
            
            7,997
            
            
            
            14,650
            
            
            
            557
            
            
            
            2,155
            
            
            
            -
            
            
            
            25,359Impairment
      of Goodwill and Intangible Assets
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            32,742
            
            
            
            -
            
            
            
            -
            
            
            
            32,742Integration
      and relocation expense
            
            
            -
            
            
            
            3,580
            
            
            
            -
            
            
            
            -
            
            
            
            84
            
            
            
            -
            
            
            
            3,664Disposal
      of land, buildings and equipment, net
            
            
            -
            
            
            
            (154
            )
            
            
            287
            
            
            
            (86
            )
            
            
            903
            
            
            
            -
            
            
            
            950Operating
      income (loss)
            
            $
            -
            
            
            
            (503
            )
            
            
            39,079
            
            
            
            (20,321
            )
            
            
            (37,625
            )
            
            
            -
            
            
            
            (19,370
            )Capital
      expenditures
            
            $
            -
            
            
            $
            1,375
            
            
            $
            6,983
            
            
            $
            286
            
            
            $
            4,735
            
            
            $
            -
            
            
            $
            13,379Year
      ended January 31, 2007(in
      thousands
            
            Media
            
            
            Magazine
      Fulfillment Services
            
            
            CD
      and DVD Fulfillment
            
            
            In-Store
      Services
            
            
            Shared
      Services
            
            
            Eliminations
            
            
            ConsolidatedTotal
      Assets
            
            $
            -
            
            
            $
            342,733
            
            
            $
            541,122
            
            
            
            89,524
            
            
            $
            36,652
            
            
            $
            -
            
            
            $
            1,010,031Goodwill,
      net
            
            $
            -
            
            
            $
            169,600
            
            
            $
            201,532
            
            
            
            24,770
            
            
            $
            -
            
            
            $
            -
            
            
            $
            395,902Intangibles,
      net
            
            $
            -
            
            
            $
            37,456
            
            
            $
            80,229
            
            
            
            1,286
            
            
            $
            -
            
            
            $
            -
            
            
            $
            118,971





Year
      ended January 31, 2006(in
      thousands)
            
            Media
            
            
            Magazine
      Fulfillment Services
            
            
            CD
      and DVD Fulfillment
            
            
            In-Store
      Services
            
            
            Shared
      Services
            
            
            Eliminations
            
            
            ConsolidatedRevenues,
      net:Distribution
            
            $
            -
            
            
            $
            556,520
            
            
            $
            889,380
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            1,445,900Advertising
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Circulation
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Manufacturing
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            26,801
            
            
            
            -
            
            
            
            -
            
            
            
            26,801Claiming
      and information
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            16,172
            
            
            
            -
            
            
            
            -
            
            
            
            16,172Other
            
            
            -
            
            
            
            9,916
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            9,916Total
      revenues, net
            
            
            -
            
            
            
            566,436
            
            
            
            889,380
            
            
            
            42,973
            
            
            
            -
            
            
            
            -
            
            
            
            1,498,789Cost
      of revenues
            
            
            -
            
            
            
            437,869
            
            
            
            733,173
            
            
            
            25,078
            
            
            
            -
            
            
            
            -
            
            
            
            1,196,120Gross
      profit
            
            
            -
            
            
            
            128,567
            
            
            
            156,207
            
            
            
            17,895
            
            
            
            -
            
            
            
            -
            
            
            
            302,669Selling,
      general and administrative expense
            
            
            -
            
            
            
            36,080
            
            
            
            53,962
            
            
            
            6,452
            
            
            
            21,300
            
            
            
            -
            
            
            
            117,794Distribution,
      circulation and fulfillment
            
            
            -
            
            
            
            74,221
            
            
            
            56,595
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            130,816Depreciation
      and amortization
            
            
            -
            
            
            
            4,446
            
            
            
            11,147
            
            
            
            588
            
            
            
            2,019
            
            
            
            -
            
            
            
            18,200Impairment
      of Goodwill and Intangible Assets
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Integration
      and relocation expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Disposal
      of land, buildings and equipment, net
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Merger
      and acquisition charges
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            344
            
            
            
            2,975
            
            
            
            -
            
            
            
            3,319Operating
      income
            
            $
            -
            
            
            
            13,820
            
            
            
            34,503
            
            
            
            10,511
            
            
            
            (26,294
            )
            
            
            -
            
            
            
            32,540Capital
      expenditures
            
            $
            -
            
            
            $
            1,576
            
            
            $
            8,469
            
            
            $
            623
            
            
            $
            2,401
            
            
            $
            -
            
            
            $
            13,069





Approximately
$57.6 million, $35.4 million and $31.7 million of our total revenues in the
Magazine Fulfillment Services segment for the years ended January 31, 2008, 2007
and 2006, respectively, were derived from the export of U.S. publications to
overseas markets. At January 31, 2008 and 2007, identifiable assets attributable
to the export of U.S. publications were $37.6 million and $27.2 million,
respectively.




79





18.
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)





Three
      months endedApril
      30,
            
            
            July
      31,
            
            
            October
      31,
            
            
            January
      31,2007
            
            
            2007
            
            
            2007
            
            
            2008Total
      revenues, net
            
            $
            475,405
            
            
            $
            434,147
            
            
            $
            639,149
            
            
            $
            705,551Gross
      profit
            
            $
            99,494
            
            
            $
            93,489
            
            
            $
            203,115
            
            
            $
            201,973(Loss)
      income from continuing operations
            
            $
            3,214
            
            
            $
            2,439
            
            
            $
            (4,461
            )
            
            $
            (27,430
            )Loss
      from discontinued operations, net of tax
            
            $
            (1,386
            )
            
            $
            (222
            )
            
            $
            -
            
            
            $
            (47
            )Net
      (loss) income available to common shareholders
            
            $
            1,828
            
            
            $
            2,217
            
            
            $
            (4,461
            )
            
            $
            (27,477
            )Earnings
      per share - basic:Continuing
      operations
            
            $
            0.06
            
            
            $
            0.04
            
            
            $
            (0.09
            )
            
            $
            (0.51
            )Discontinued
      operations
            
            
            (0.02
            )
            
            
            -
            
            
            
            -
            
            
            
            (0.01
            )Total
            
            $
            0.04
            
            
            $
            0.04
            
            
            $
            (0.09
            )
            
            $
            (0.52
            )Earnings
      per share - diluted:Continuing
      operations
            
            $
            0.06
            
            
            $
            0.04
            
            
            $
            (0.09
            )
            
            $
            (0.51
            )Discontinued
      operations
            
            
            (0.03
            )
            
            
            -
            
            
            
            -
            
            
            
            -Total
            
            $
            0.03
            
            
            $
            0.04
            
            
            $
            (0.09
            )
            
            $
            (0.51
            )Three
      months endedApril
      30,
            
            
            July
      31,
            
            
            October
      31,
            
            
            January
      31,2006
            
            
            2006
            
            
            2006
            
            
            2007Total
      revenues, net
            
            $
            447,894
            
            
            $
            433,308
            
            
            $
            467,890
            
            
            $
            479,561Gross
      profit
            
            $
            88,970
            
            
            $
            94,109
            
            
            $
            103,840
            
            
            $
            95,810(Loss)
      income from continuing operations
            
            $
            2,862
            
            
            $
            3,238
            
            
            $
            4,333
            
            
            $
            (36,400
            )Loss
      from discontinued operations, net of tax
            
            $
            397
            
            
            $
            856
            
            
            $
            498
            
            
            $
            (440
            )Net
      (loss) income available to common shareholders
            
            $
            3,259
            
            
            $
            4,094
            
            
            $
            4,831
            
            
            $
            (36,840
            )Earnings
      per share - basic:Continuing
      operations
            
            $
            0.05
            
            
            $
            0.06
            
            
            $
            0.08
            
            
            $
            (0.69
            )Discontinued
      operations
            
            
            0.01
            
            
            
            0.02
            
            
            
            0.01
            
            
            
            (0.02
            )Total
            
            $
            0.06
            
            
            $
            0.08
            
            
            $
            0.09
            
            
            $
            (0.71
            )Earnings
      per share - diluted:Continuing
      operations
            
            $
            0.05
            
            
            $
            0.06
            
            
            $
            0.08
            
            
            $
            (0.69
            )Discontinued
      operations
            
            
            0.01
            
            
            
            0.02
            
            
            
            0.01
            
            
            
            (0.02
            )Total
            
            $
            0.06
            
            
            $
            0.08
            
            
            $
            0.09
            
            
            $
            (0.71
            )





19.
SUBSEQUENT EVENT





On April
11, 2008, the Company entered into an interest rate swap agreement with Wachovia
Bank, N.A.  The interest rate swap is intended to hedge the Company’s
exposure to fluctuations in LIBOR on $210.0 million of 1-month LIBOR based debt
through April 29, 2011.  The Company expects that this swap agreement
will qualify for hedge accounting treatment in accordance with SFAS
133.











80


SOURCE
INTERLINK COMPANIES


SCHEDULE
II


VALUATION
AND QUALIFYING ACCOUNTS SCHEDULE


(IN
THOUSANDS)








Column
      A
            
            Column
      B
            
            
            Column
      C
            
            
            Column
      D
            
            
            Column
      EBalance
      at
            
            
            
            
            
            Charge
      tobeginning
      of
            
            
            Charged
      to
            
            
            other
            
            
            
            
            
            Balance
      atDescription
            
            period
            
            
            expense
            
            
            accounts
            
            
            Deductions
            
            
            end
      of periodYear
      ended January 31, 2008:Allowance
      for doubtful accounts
            
            $                  
      17,130
            
            
            $                     4,325
            
            
            $                    
      7,433
            
            
            $                     2,964
            
            
            $                  
      25,924Sales
      return reserves
            
            $                
      192,328
            
            
            $             
      1,714,869
            
            
            $                       
      543
            
            
            $              1,705,171
            
            
            $                 202,569Year
      ended January 31, 2007:Allowance
      for doubtful accounts
            
            $
            20,682
            
            
            $
            3,156
            
            
            $
            2,260
            
            
            $
            8,968
            
            
            $
            17,130Sales
      return reserves
            
            $
            193,418
            
            
            $
            1,775,707
            
            
            $
            28,791
            
            
            $
            1,805,588
            
            
            $
            192,328Year
      ended January 31, 2006:Allowance
      for doubtful accounts
            
            $
            2,126
            
            
            $
            6,100
            
            
            $
            18,833
            
            
            $
            6,377
            
            
            $
            20,682Sales
      return reserves
            
            $
            78,404
            
            
            $
            1,178,681
            
            
            $
            109,663
            
            
            $
            1,173,330
            
            
            $
            193,418








81