**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

----

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the fiscal year ended January 31,2007**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the transition periodfrom                      to                       **

**Commission file number 001-13437**

----

**[SOURCE INTERLINKCOMPANIES LOGO]**

**SOURCE INTERLINK COMPANIES, INC.**

(Exact name of registrantas 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)                            |

 

**(239) 949-4450**

(Registrant’s telephonenumber, including area code)

Securities registered pursuant to section 12(b) ofthe Act:

**COMMONSTOCK $0.01 PAR VALUE**

Securities registered pursuant to section 12(g) ofthe Act:

**NONE**

----

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

| £ Yes |   | x No |
|------------|--------|------|

 

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

| £ Yes |   | x No |
|------------|--------|------|

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

| x Yes |   | o No |
|-------|--------|------|

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405of this chapter) is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. £

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

| o Large accelerated filer |   | x Accelerated filer |   | o Non-accelerated filer |
|---------------------------|--------|---------------------|--------|-------------------------|

 

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

|  Yes |   | x No |
|-----------|--------|------|

 

The aggregate market valueof the voting and non-voting common equity held by non-affiliates of theregistrant as of July 31, 2006 was approximately $374.6 million computedby reference to the price at which the common equity was sold on July 31,2006, the last day of the registrant’s most recently completed second fiscalquarter, as reported by The Nasdaq National Market.

At April 9, 2007 theCompany had 52,183,852 shares of common stock $0.01 par value outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

Portionsof the Registrant’s definitive Proxy Statement for the 2007 Annual Meeting ofStockholders are incorporated by reference in Part III of this Form 10-K.

 

----

**TABLEOF CONTENTS**
|                | ** **                                                                                                         | **PAGE** | ** ** |
|----------------|--------------------------------------------------------------------------------------------------------------------|----------|------------|
|           | PART I                                                                                                        |     |       |   |   |   |
| ITEM 1.        | BUSINESS                                                                                                           |     |       | 4 |   |   |
| ITEM  1A.      | RISK  FACTORS                                                                                                      |     |       | 13 |   |   |
| ITEM 1B.       | UNRESOLVED STAFF COMMENTS                                                                                          |     |       | 21 |   |   |
| ITEM 2.        | PROPERTIES                                                                                                         |     |       | 22 |   |   |
| ITEM  3.       | LEGAL  PROCEEDINGS                                                                                                 |     |       | 22 |   |   |
| ITEM 4.        | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |     |       | 22 |   |   |
|           | PART II                                                                                                       |     |       |   |   |   |
| ITEM 5.        | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |     |       | 22 |   |   |
| ITEM 6.        | SELECTED FINANCIAL DATA                                                                                            |     |       | 24 |   |   |
| ITEM 7.        | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS                        |     |       | 25 |   |   |
| ITEM 7A.       | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK.                              |     |       | 44 |   |   |
| ITEM 8.        | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.                                                                       |     |       | 45 |   |   |
| ITEM 9.        | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                              |     |       | 45 |   |   |
| ITEM 9A.       | CONTROLS AND PROCEDURES                                                                                            |     |       | 45 |   |   |
| ITEM  9B.      | OTHER  INFORMATION                                                                                                 |     |       | 48 |   |   |
|           | PART III                                                                                                      |     |       |   |   |   |
| ITEM 10.       | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                 |     |       | 48 |   |   |
| ITEM 11.       | EXECUTIVE COMPENSATION                                                                                             |     |       | 48 |   |   |
| ITEM 12.       | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                    |     |       | 48 |   |   |
| ITEM 13.       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                     |     |       | 49 |   |   |
| ITEM 14.       | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                             |     |       | 49 |   |   |
|           | PART IV                                                                                                       |     |       |   |   |   |
| ITEM 15.       | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                            |     |       | 49 |   |   |
| SIGNATURES     |                                                                                                               |     | 50         |   |   |
| EXHIBIT  INDEX |                                                                                                               |     | 51         |   |   |

 

2

----

**CAUTIONARYSTATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATESECURITIES LITIGATION REFORM ACT OF 1995**

Some of theinformation contained in this Annual Report on Form 10-K including,but not limited to, those contained in Item 1. “Business” and Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations,”along with statements in other reports filed with the Securities and ExchangeCommission (the “SEC”), external documents and oral presentations, which arenot historical facts are considered to be “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. The words “believe,” “expect,”“anticipate,” “estimate,” “project,” and similar expressions often characterizeforward-looking statements. These statements may include, but are not limitedto, projections of collections, revenues, income or loss, cash flow, estimatesof capital expenditures, plans for future operations, products or services, andfinancing 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 inthese forward-looking statements as a result of a number of factors, includingthe risks and uncertainties faced by us described below and those set forthbelow under Item 1A. “Risk Factors”:

·       marketacceptance of and continuing demand for physical copies of magazines, DVDs, CDsand other home entertainment products;

·       theimpact of competitive products and technologies;

·       thepricing and payment policies of magazine publishers, film studios, recordlabels and other key vendors;

·       changingmarket conditions and opportunities;

·       ourability to realize operating efficiencies, cost savings and other benefits fromrecent acquisitions; and

·       retentionof key management and employees.

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

3

----

**PART I**

**ITEM 1.**                BUSINESS.

**OVERVIEW**

We are a premiermarketing, merchandising and fulfillment company of entertainment productsincluding DVDs, music CDs, magazines, books and related items serving abhout110,000 retail store locations throughout North America. Our fully integratedbusinesses include:

·       Distributionand fulfillment of entertainment products to major retail chains throughoutNorth America and direct-to-consumers via the Internet;

·       Importand export of periodicals sold in more than 100 markets worldwide;

·       Coordinationof product selection and placement for impulse items sold at checkout counters;

·       Processingand collection of rebate claims as well as management of sales data obtained atthe point-of-purchase;

·       Design,manufacture and installation of wire fixtures and custom wood displays in majorretail chains.

Our clientsinclude:

·       Mainstreamretailers, such as Wal-Mart Stores, Inc., The Kroger Company, TargetCorporation, Walgreen Company, Ahold USA, Inc., Sears HoldingsCorporation, and Meijer;

·       Specialtyretailers, such as Barnes & Noble, Inc., Borders Group, Inc.,Hastings Entertainment, Inc., Fry’s Electronics, Inc. and CircuitCity Stores, Inc.; and

·       e-commerceretailers, such as amazon.com, barnesandnoble.com, circuitcity.com and bestbuy.com.

Our suppliersinclude:

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

·       Filmstudios, such as The Walt Disney Company, Time-Warner Inc., Sony Corp., TheNews Corporation, Paramount Home Entertainment, Inc., Viacom Inc. andGeneral Electric Company; and

·       MagazineDistributors, such as COMAG Marketing Group, LLC., Time Warner Retail Sales &Marketing, Inc., Curtis Circulation Company and Kable DistributionServices, Inc.

On February 28, 2005, we completed theacquisition of Alliance Entertainment Corp, a logistics and supply chainmanagement services company for the home entertainment product market pursuantto the terms and conditions of the Agreement and Plan of Merger Agreement datedas of November 18, 2004 (the “Merger Agreement”).

We consummated the merger with Alliance to further ourobjective of creating the premier provider of information, supply chainmanagement and logistics services to retailers and producers of home entertainmentcontent products. We believe that the merger has provided significant marketopportunities to take advantage of our strong retailer relationships andexperience in marketing our products by expanding product offerings beyond ourexisting magazine fulfillment business to DVDs, CDs, video games and relatedhome entertainment products and accessories. In addition, we believe that ourin-store merchandising capabilities have been strengthened. We also believethis transaction has positioned us as the distribution channel of choice forfilm studios, record labels, publishers and other producers of homeentertainment content products. We have benefited from substantial cost savingsin the areas of 

4

----

procurement, marketing,information technology and administration and from other operationalefficiencies, particularly in the distribution and fulfillment functions, wherewe have consolidated some distribution operations, reorganized others andleveraged our best practices across all of our distribution operations. As aresult, we believe the merger has enhanced our financial strength, increasedour visibility in the investor community and strengthened our ability to pursuefurther strategic acquisitions.

The total purchaseprice of approximately $315.5 million consisted of $304.7 million in SourceInterlink common stock, representing approximately 26.9 million shares, $6.5million related to the exchange of approximately 0.9 million shares of commonstock on exercise of outstanding stock options, warrants and other rights toacquire Alliance common stock and direct transaction costs of $4.3 million. Thevalue of the common stock was determined based on the average market price ofSource Interlink common stock over the 5-day period prior to and afterthe announcement of the merger in November 2004. The value of the stockoptions was determined using the Black-Scholes option valuation model.Following the merger, we organized the combined company into three operatingsegments:

·       MagazineFulfillment—The magazine fulfillment segment sells and distributes magazinesand books to major retailers and wholesalers, imports foreign titles fordomestic retailers and wholesalers, exports domestic titles to foreignwholesalers, provides return processing services, serves as an outsourcefulfillment agent and provides customer-direct fulfillment.

·       CDand DVD Fulfillment—The CD and DVD fulfillment segment sells and distributespre-recorded music, videos, video games and related products to retailers,provides product and commerce solutions to retailers and providescustomer-direct fulfillment and vendor managed inventory.

·       In-StoreServices—The in-store services segment designs, manufactures, ships, installs,removes and invoices participants in front-end wire fixture and custom wooddisplay programs, provides claim filing services for rebates owed retailersfrom publishers and their agents and provides information and managementservices relating to retail magazine sales to U.S. and Canadian retailers andmagazine publishers.

This segment structure represents a change instructure from that reported in Item 1. “Business” in our Form 10-Kfor the fiscal year ended January 31, 2005. The segment organizationpresented herein corresponds to the financial and other reporting received byour chief operating decision maker. For financial and geographic informationregarding our segments see Note 17 “Segment Information” to our ConsolidatedFinancial Statements.

Following ouracquisition of Alliance, we performed the following three acquisitions thathave strengthened our position in the mainstream magazine distributionbusiness:

·       OnMay 10, 2005, we entered into a Unit Purchase Agreement with Chas. LevyCompany, LLC. Under the terms of the agreement, we purchased all of the issuedand outstanding membership interests in Chas. Levy Circulating Co. LLC (“Levy”)from Seller for a purchase price of approximately $30 million, subject toadjustment based on Levy’s net worth as of the closing date of the transaction.In addition, approximately $19.3 million was also provided on the date ofacquisition to repay all outstanding intercompany debt of Levy. The purchaseprice and the intercompany debt repayment were funded from the revolving lineof credit.

·       OnMarch 30, 2006, we entered into a Unit Purchase Agreement, under which wepurchased all of the issued and outstanding membership interests of AndersonMid-Atlantic News, LLC (“Mid-Atlantic”) from Anderson News, LLC for a purchaseprice of approximately $4.0 million, subject to adjustment based on thenegative net worth as of the closing date of the transaction. In addition,approximately $9.6 million was also provided on the date of acquisition toMid-Atlantic to repay a portion of their outstanding intercompany debt. Theremaining outstanding intercompany debt of 

5

----

Mid-Atlantic was satisfiedby issuance of a promissory note totaling $4.1 million. The promissory note wasrepaid by the Company during the fiscal year ended January 31, 2007. Thepurchase price and the intercompany debt repayment were funded by borrowingsagainst our revolving line of credit.

·       On March 30, 2006, weentered into a Unit Purchase Agreement, under which we purchased all of theissued 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 ofthe transaction. In addition, approximately $17.0 million was also provided onthe date of acquisition to SCN to repay a portion of their outstandingintercompany debt. The remaining outstanding intercompany debt of SCN wassatisfied by issuance of a promissory note totaling $10.2 million. Thepromissory note was repaid by the Company during the fiscal year ended January 31,2007. The purchase price and the intercompany debt repayment were funded byborrowings against our revolving line of credit.

Also during the fourth quarter of Fiscal 2007, theCompany recorded a goodwill and intangible assets impairment of $32.7 million.See Item 7—Management’s Discussion and Analysis of Financial Condition andResults of Operations.

**STRATEGICALTERNATIVES PROCESS**

Our Board of Directors, in consultation with itsstrategic advisor, The Yucaipa Companies, LLC, hired Deutsche Bank SecuritiesInc. to act as its exclusive financial advisor in its process of evaluatingstrategic alternatives to enhance stockholder value, including but not limitedto, a recapitalization, strategic acquisitions, and the combination, sale ormerger of the Company with another entity.

In connection with this evaluation process, DeutscheBank Securities, Inc. has worked with an affiliate of The YucaipaCompanies, LLC, the Company’s consultant with respect to analyzing strategicalternatives. There can be no assurance that the exploration of strategicalternatives will result in a transaction. We do not intend to disclosedevelopments with respect to the exploration of strategic alternatives unlessand until our Board of Directors has approved a specific course of action.

The Yucaipa Companies, LLCis an affiliate of AEC Associates, LLC, our largest shareholder.

**CORPORATEGOVERNANCE**

Copies of our AnnualReports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and all amendments to those reports areavailable, as soon as practicable after filing with the SEC, free of charge onour website, www.sourceinterlink.com. Our Code of Business Conduct and Ethicsis also available on our website, together with the charters for the AuditCommittee, Compensation Committee, Nominating and Corporate GovernanceCommittee and Capital Markets Committee of our Board of Directors. Writtenrequests for copies of these documents may be directed to Investor Relations atour principal executive offices.

**REINCORPORATIONFROM MISSOURI INTO DELAWARE**

Also, on February 28, 2005, we reincorporated ourcompany from Missouri into Delaware (the “Reincorporation”). TheReincorporation was adopted and approved at a special meeting of ourshareholders. Each stock certificate representing our issued and outstandingshares prior to the Reincorporation will continue to represent the same numberof our shares after the Reincorporation. The Reincorporation did not result inany change in our name, headquarters, business, jobs, management, location ofoffices or facilities, number of employees, assets, liabilities or net worth.Our common stock continues to be traded on the Nasdaq National Market under thesymbol “SORC.”

6

----

As a result of theReincorporation, the rights of our stockholders became subject to and are nowgoverned by Delaware law, a new certificate of incorporation and new bylaws.Certain differences in the rights of stockholders arise from distinctionsbetween Missouri law and Delaware law, as well as from differences between thecharter instruments of our Company. These differences are described in thesection entitled “Comparison of Stockholder Rights and Corporate GovernanceMatters” on pages 149-165 of the Registrant’s Registration Statementon Form S-4/A filed on January 18, 2005, which section isincorporated herein by reference.

**INDUSTRY OVERVIEWS**

**HOME ENTERTAINMENTCONTENT**

According to industry sources, including the MotionPicture Association, the Recording Industry Association of America, HarringtonAssociates, LLC, and the American Booksellers Association, the total retailmarket in calendar year 2006 for DVDs, prerecorded music, single-copy magazinesand books was approximately $59.4 billion.

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

In contrast, thedistribution channel for prerecorded video and music products is dominated bythe major film studios and record labels, which through their respective distributionunits periodically compete with intermediaries by seeking to establish directtrading relationships with high volume retailers. This disintermediationstrategy has limited appeal to retailers that demand a variety of value-addedservices, including e-commerce support, inventory management, return logistics,advertising and marketing assistance, information services, and in storemerchandising services to manage these increasingly volatile categories. Someretailers have sought to maintain a dual supply chain by establishing a directtrading relationship with the major studios and labels for high volume product,primarily newly released titles, and a more expansive procurement and servicerelationship with intermediaries to secure lower volume, higher margin productand value-added services.

**IN-STORE SERVICES**

**Front-EndManagement**

The retail sale of single-copy magazines is largely animpulse purchase decision by the consumer, and the retail sale of other homeentertainment content is becoming increasingly so. As a result, film studios,record labels, publishers and manufacturers of other impulse merchandise suchas confections and general merchandise (i.e., razor blades, film, batteries,etc.) consider it important for their products to be on prominent display inthose areas of a store where they will be seen by the largest number ofshoppers in order to increase the likelihood that their products will be sold.Retailers typically display DVDs, CDs, magazines, confections and generalmerchandise in specific aisles, or the “mainline,” and the checkout 

7

----

area, or the “front-end.”Product visibility is highest in the front-end because every shopper making apurchase must pass through this area.

Due to the highervisibility and resulting perception of increased sales potential, vendorscompete vigorously for favorable display space in the front-end. To secure thedesired display space, vendors offer rebate and other incentive payments toretailers, such as:

·       initialfees to rearrange front-end display fixtures to ensure the desired placement oftheir products;

·       periodicplacement fees based on the location and size of their products’ display; and

·       cashrebates based on the total sales volume of their products.

Due to the high volume ofsales transactions and great variety of incentive programs offered, there is asignificant administrative burden associated with front-end management. As aresult, most retailers have historically outsourced the information gatheringand administration of rebate claims collection to third parties such as ourcompany. This relieves retailers of the administrative burdens, such asmonitoring thousands of titles each with a distinct incentive arrangement.

**InformationServices**

Prompt delivery ofinformation regarding sales activity, including timing of the redesign offront-end space, changes in display positions or the discontinuance of a vendor’sproduct, is important to vendors of front-end products. This information allowsvendors to make important strategic decisions in advance of re-configurationsand other changes implemented by retailers to the front-end. Conversely, timelydelivery of information about price changes, special promotions, new productintroductions and other plans is important to retailers because it enables themto enhance the revenue potential of the front-end. Historically, informationavailable to vendors regarding retail activity at the front-end and informationavailable to retailers about vendors has been fragmented and out-of-date. Webelieve that there is an increasing demand on the part of vendors of front-endproducts for more frequent and detailed information regarding front-end retailactivity. Through our operating units we have access to a significant amount ofinformation regarding retail front-end and mainline sales activity.

**OUR BUSINESS**

Our business consists ofthree operating segments, as discussed above. Due to the similar operatingcharacteristics of the Magazine Fulfillment and CD and DVD Fulfillment, theyare discussed in aggregate, as the Fulfillment business unit below.

**FULFILLMENT**

In the spring of 2001, we acquired a group ofaffiliated specialty magazine distributors to establish a platform from whichto offer an expanding list of merchandise and services to retailers. From 2002through 2004, we continued to expand our magazine product offerings bylicensing and then purchasing international distribution rights to a series ofdomestic magazine titles. In February 2005, we further expanded ourproduct offering beyond magazine fulfillment to include DVDs, CDs and otherhome entertainment content products through our merger with Alliance. In May 2005,we acquired Chas. Levy Circulating Co., one of the principal magazinewholesalers in the United States, for the purpose of strengthening our positionin the mainstream retail market. In March 2006, we acquired AndersonMid-Atlantic News, LLC and Anderson-SCN Services, LLC, major distributors ofmagazines 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, LLCand Anderson-SCN Services, LLC, see “Recent Developments.”

8

----

Currently,our Fulfillment unit offers a broad array of products and services includingthe following:

**Product Procurement**

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

Product is received atstrategically located distribution centers. The principal distribution centersare located in Harrisburg, Pennsylvania, Coral Springs, Florida,Shepherdsville, Kentucky, Dallas, Texas, Lancaster, Pennsylvania, Ontario,California, Chicago, Illinois, and Brainerd, Minnesota. At each of thesedistribution points, we process merchandise orders using sophisticatedwarehouse management systems. Once filled, orders are shipped to our retailersby a combination of third party freight carriers and, in certain high volumelocations, in-house truck delivery. Given our broad distributioninfrastructure, we are capable of delivering home entertainment contentovernight to virtually any location within the continental United States.

**FulfillmentServices**

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

Most customers utilizingour fulfillment services are brick and mortar retailers some of which seeksupport for their e-commerce initiatives in the DVD and CD markets. For theseclients, which include barnesandnoble.com, amazon.com and bestbuy.com, we offera comprehensive e-commerce platform, which includes direct customer productdelivery, real-time inventory querying and commitment capabilities, credit cardprocessing and settlement services, custom packaging, promotional inserts andcustomer care services. Other fulfillment services clients furnish magazines tous, rather than purchasing the product from us, which we then package intoindividual orders and ship directly to individual retail outlets.

**Category ManagementServices**

For retailers seeking atotal merchandising solution, we offer category management services thatinclude product selection and preparation, fixturing, in-store stocking andreplenishment, marketing and promotional program development, and inventorycontrol.

**IN-STORE SERVICES**

The In-Store Servicesgroup provides rebate and other incentive payment collection, informationservices and display fixture design and manufacture.

**Claim SubmissionServices**

Claim submission services related to the display andsale of magazines have been the historical core of our business. U.S. andCanadian retailers engage our In-Store Services group to accurately monitor,document, claim and collect publisher rebate and other incentive payments. Ourservices are designed to 

9

----

relieve our clients of thesubstantial administrative burden associated with documenting, verifying andcollecting their payment claims, and to collect a larger percentage of thepotential incentive payments available to the retailers.

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

**InformationServices**

In connection with ourclaim submission services, we gather extensive information on magazine sales,pricing, new titles, discontinued titles and display configurations on achain-by-chain and store-by-store basis. As a result, we are able to furnishour clients with reports of total sales, sales by class of trade and sales byretailer, as well as reports of unsold magazines and total sales ranking. Oneof our products, the Cover Analyzer, permits subscribers to determine theeffectiveness of particular magazine covers on sales for 300 top selling titlesin the United States. Our website gives subscribers the capability to reactmore quickly to market changes, including the ability to reorder copies ofspecific issues, track pricing information, introduce new titles, and act onpromotions offered by publishers. Publishers also use the website to promotespecial incentives and advertise and display special editions, new publicationsand upcoming covers. We have supplemented our own data with data obtained underagreements with Barnes & Noble, Inc., Walgreen Company and TheKroger Company.

**Front-End andPoint-of-Purchase Display Fixtures**

To enhance retailers’marketing efficiency, we developed the capacity to design, manufacture, deliverand dispose of custom front-end and point-of-purchase displays for both retailstore chains and product manufacturers. Retailers perceive our experience indeveloping and implementing product display strategies supported by ourinformation services as helpful in improving the revenue they generated fromthe sale of home entertainment content merchandise. In addition, we believethat our influence on the design and manufacture of display fixtures enhancesour ability to incorporate features that facilitate the gathering ofinformation. Our services in this regard frequently include designing front-enddisplay fixtures, supervising fixture installation, selecting products andnegotiating, billing and collecting incentive payments from vendors. Wefrequently assist our retailer clients in the development of specializedmarketing and promotional programs, which include special mainline or front-enddisplays and cross-promotions of magazines and products of interest to thereaders of these magazines. Raw materials used in manufacturing our fixturesinclude wire, wood, powder coating, paints and stains, metal tubing andpaneling, wood veneer and laminates, all of which are readily available frommultiple sources.

**Custom WoodManufacturing**

We manufacture custom woodstore fixtures and displays to customer specifications using wood veneers andlaminates. Delivery of fixtures is highly concentrated in our second and thirdfiscal quarters as a result of the demands of retailers to be ready for thecritical holiday selling season. To assure that their seasonal demands for thedelivery are met, retailers typically provide commitments well in advance ofanticipated product delivery. Accordingly, our inventory levels increase duringseasonal periods when retailers are not opening or remodeling stores, typicallyNovember through April.

10

----

**CUSTOMERS**

Our customers in thespecialty retail market consist of bookstore chains, music stores and otherspecialty retailers. Our customers in the mainstream retail market consistprimarily of grocery stores, drug stores and mass merchandise retailers. Twocustomers account for a large percentage of our total revenues. Barnes &Noble, Inc. accounted for 19.6%, 27.5% and 28.7% in the fiscal years endedJanuary 31, 2007, 2006 and 2005 respectively. Borders Group, Inc.accounted for 5.8%, 6.3% and 24.5% of total revenues in the fiscal years ended January 31,2007, 2006 and 2005, respectively. Revenues provided by Barnes & Noble, Inc.and Borders Group for the fiscal year ended January 31, 2006 includerevenues generated by Alliance from the date of acquisition.

**MARKETING AND SALES**

Our target market includes magazine publishers, filmstudios, record labels, magazine distributors and retailers. We specialize inproviding nationwide home entertainment product distribution to retailers witha national or regional scope. We believe that our distribution centers differentiateus from our national competitors and are a key element in our marketingprogram. Our distribution centers focus on our just-in-time replenishment andour ability to deliver product, particularly magazines published on a weeklybasis, overnight to virtually any location within the United States and PuertoRico.

While we frequently attendtrade shows and advertise in trade publications, we emphasize personalinteraction between our sales force and customers so that our customers areencouraged to rely on our dependability and responsiveness. To enhance thefrequency of contact between our sales force and our customers, we haveorganized our direct sales force into a unified marketing group responsible forsoliciting sales of all products and services available from each of ouroperating groups. We believe this combined marketing approach will enhancecross-selling opportunities and lower the cost of customer acquisition.

**SEASONALITY ANDINFLATION**

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

Our Magazine Fulfillment segment is generally notimpacted by a significant amount of seasonality. The fiscal third quarter istypically the largest revenue quarter due to increased distribution of certainmonthly titles, such as fashion titles and sports titles, and variousquarterly, semi-annual and annual titles that are only produced and distributedin the third quarter to be in retail stores during the holiday shopping season.

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

The moderate rate ofinflation over the past three years has not had a significant effect on ourrevenues or profitability.

**COMPETITION**

Each of our business units faces significantcompetition. Our Fulfillment group distributes home entertainment product incompetition with a number of national and regional companies, includingAnderson News LLC, Anderson Merchandisers, L.P., Hudson News Company, The NewsGroup, Ingram Book Group, Inc., Ingram Entertainment, Inc., HandlemanCompany, and Baker & Taylor, Inc. Major 

11

----

record labels and filmstudios compete with us by establishing direct trading relationships with thelarger retail chains.

Our In-Store Services group has a very limited numberof direct competitors for its claims submission program, and it competes in ahighly fragmented industry with other manufacturers for wood and wire displayfixture business. In addition, some of this group’s information and managementservices may be performed directly by publishers and other vendors, retailersor distributors. Other information service providers, including A.C. NielsenCompany, Information Resources and Audit Bureau of Circulations, also collectsales data from retail stores. If these service providers were to compete withus, given their expertise in collecting information and their industry reputations,they could be formidable competitors. In addition, some of this group’sinformation and management services may be performed directly by publishers andother vendors, retailers or distributors.

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

**MANAGEMENTINFORMATION SYSTEMS**

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

Our primary operating systems are built on an openarchitecture platform and provide the high level of scalability and performancerequired to manage our large and complex business operations. We acquiredcertain 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 andsoftware to manage our business, including a complete suite of electronic datainterchange tools that enable us to take client orders, transmit advancedshipping notifications, and place orders with our manufacturing tradingpartners. We also use an automated e-mail response system and automated calldistribution system to manage our call center and conduct customer careservices.

Software used in connection with our claims submissionprogram and in connection with our subscriber information website was developedspecifically for our use by a combination of in-house software engineers andoutside consultants. We believe that certain elements of these software systemsare proprietary to us. Other portions of these systems are licensed from athird party that assisted in the design of the system. We also receive systemsservice and upgrades under the license. We believe that we have obtained allnecessary licenses to support our information systems.

We employ various security measures and backup systemsdesigned to protect against unauthorized use or failure of our informationsystems. Access to our information systems is controlled through firewalls andpasswords, and we utilize additional security measures to safeguard sensitiveinformation. Additionally, we have backup power sources for blackouts and otheremergency situations. Although we have never experienced any material failuresor downtime with respect to any management information systems operations, anysystems failure or material downtime could prevent us from taking orders and/orshipping product.

12

----

We have made strategicinvestments in material handling automation. Such investments includecomputer-controlled order selection systems that provide labor efficiencies andincrease productivity and handling efficiencies. We have also invested inspecialized equipment for our rapidly growing e-commerce accounts. We believethat in order to remain competitive, it will be necessary to invest and upgradefrom time to time all of our information systems.

**EMPLOYEES**

As of March 31, 2007,we had approximately 7,500 employees, of whom approximately 3,400 werefull-time employees. Approximately 600 of our employees are covered bycollective bargaining agreements that expire at various times throughOctober 31, 2009. We believe our relations with our employees are good.

**RECENT DEVELOPMENTS**

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

**PROPOSED DISPOSALOF CUSTOM WOOD MANUFACTURING BUSINESS**

On February 14, 2007,our Board of Directors approved a plan to dispose of our custom woodmanufacturing division, in order to better focus on our distribution, claiming,information and wire manufacturing businesses. We are currently negotiatingwith a potential purchaser in which our former Chairman of the Board and ChiefExecutive Officer holds an interest, however no assurance can be made that atransaction will occur. This potential buyer has submitted to the Company aLetter of Intent which provides for a purchase price of $10.0 million incash, subject to a working capital adjustment, and a note for $3.5 millionmaturing over 10 years.

**ITEM 1A.**        RISKFACTORS.

Set forth below andelsewhere in this Annual Report on Form 10-K and in other documentswe file with the SEC are risks and uncertainties that could cause actualresults to differ materially from the results contemplated by the forwardlooking statements contained in this Annual Report on Form 10-K.

**RISKS RELATING TOTHE BUSINESS**

**WE HAVE ACONCENTRATED CUSTOMER BASE AND OUR REVENUES COULD BE ADVERSELY AFFECTED IF WELOSE ANY OF OUR LARGEST CUSTOMERS OR THESE CUSTOMERS ARE UNABLE TO PAY AMOUNTSDUE TO US.**

A significant percentage of our sales are derived froma limited number of customers. In particular, for the year ended January 31,2007, Barnes & Noble, Inc. accounted for approximately 19.6% ofour total revenues.

We expect to continue tobe dependent on a small number of customers for a substantial portion of ourrevenues. If any of these customers were to terminate their relationship withus, significantly reduce their purchases from us or experience problems inpaying amounts due to us, it would result in a material reduction in ourrevenues and operating profits.

**WE DEPEND ON ACCESSTO CREDIT.**

We will have significant working capital requirementsprincipally to finance inventory, accounts receivable and new acquisitions. Weare currently a party to a revolving credit facility with a syndicate oflenders arranged by Wells Fargo Foothill, Inc. In addition, we areextended trade credit by our suppliers.

13

----

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

**A DISRUPTION IN THEOPERATIONS OF OUR KEY SHIPPER OR SHARPLY HIGHER COSTS COULD CAUSE A DECLINE INOUR SALES 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 aredisrupted for any reason, we may be unable to deliver our products to ourcustomers on a timely basis. If we cannot deliver our products in an efficientand timely manner, our customers may reduce their orders from us and ourrevenues and operating profits could materially decline.

For the year ended January 31, 2007, our freightcost represented approximately 5.6% of our revenue. If freight costs were toincrease and we were unable to pass that increase along to our customers due tocompetition within our industry, our financial results could materially suffer.

In a rising fuel costenvironment, our freight costs may increase. If we are unable to pass theincreased costs along to our customers, our results of operation may materiallydecline.

**OUR STRATEGY WILLINCLUDE MAKING ADDITIONAL ACQUISITIONS THAT MAY PRESENT RISKS TO THEBUSINESS.**

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

·       wemay be entering markets in which we have limited experience;

·       theacquisitions may be potential distractions to management and may divert companyresources and managerial time;

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

·       wemay have difficulty implementing additional controls and information systemsappropriate for a growing company;

·       someof the acquired businesses may not achieve anticipated revenues, earnings orcash flow;

·       wemay not achieve the expected benefits of the transactions including increasedmarket opportunities, revenue synergies and cost savings from operatingefficiencies;

14

----

·       difficultiesin integrating the acquired businesses could disrupt client service and causeus to lose customers;

·       wemay have unanticipated liabilities or contingencies from an acquired business;

·       wemay assume indebtedness of the acquired company that may leave the Companyhighly leveraged;

·       wemay be required to invest a significant amount into working capital of theacquired company;

·       wemay have reduced earnings due to amortization expenses, goodwill impairmentcharges, increased interest costs and costs related to the acquisition and itsintegration;

·       wemay finance future acquisitions by issuing common stock for some or all of thepurchase price which could dilute the ownership interests of the stockholders;

·       acquiredcompanies will have to become, within one year of their acquisition, compliantwith SEC rules relating to internal control over financial reportingadopted pursuant to the Sarbanes-Oxley Act of 2002;

·       wemay be unable to retain management and other key personnel of an acquiredcompany; and

·       wemay 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 inany prior or future acquisitions, including goodwill or other identifiableintangible assets, becomes impaired, we would be required to incur impairmentcharges that would result in a material charge against our earnings. Suchimpairment charges could reduce our earnings and have a material adverse effecton the market value of our common stock. At the end of fiscal year 2007, thenet book value of our goodwill and other identifiable intangibles wasapproximately $511.0 million. At the end of fiscal year 2007, certain customerlists, non-compete agreements and goodwill related to our In-Store Servicessegment were revalued and determined to be impaired. The impairment chargesrecorded in the fourth quarter of fiscal 2007 were approximately $32.7 million.

If we are unsuccessful inmeeting the challenges arising out of our acquisitions, our business, financialcondition and future results could be materially harmed.

**WE DEPEND ON ACCESSTO ACCURATE INFORMATION ON RETAIL SALES OF MAGAZINES IN ORDER TO OFFER CERTAINSERVICES TO OUR CUSTOMERS, AND WE COULD LOSE A SIGNIFICANT COMPETITIVEADVANTAGE IF OUR ACCESS TO SUCH INFORMATION WERE DIMINISHED.**

We use informationconcerning the retail sales of single copy magazines to:

·       comparethe revenue potential of various front-end fixture designs to assist ourcustomers in selecting designs intended to maximize sales in the front-end;

·       identifysales trends at individual store locations permitting us to providejust-in-time inventory replenishment and prevent stock outs; and

·       offerboth retailers and publishers information services, such as ICN and CoverAnalyzer, and customized sales reporting.

We gain access to thisinformation 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. Wealso obtain a significant amount of information in connection 

15

----

with ourrebate claim submission services. Our access to information could be restrictedas a result of the inability of any of our data partners to supply informationto us or as a result of the discontinuation or substantial modification of thecurrent incentive payment programs for magazines. If our access to informationwere reduced, the value of our information and design services could materiallydiminish and our publisher and retailer relationships could be negativelyimpacted.

**OUR REVENUE FROMTHE SALES OF DVDS AND CDS MAY SUFFER DUE TO A SHIFT IN CONSUMER DEMANDAWAY FROM THE PHYSICAL MEDIA AND TOWARD DIGITAL DOWNLOADING AND OTHER DELIVERYMETHODS.**

Current technology allows consumers to buy musicdigitally from many providers such as Apple Computer (through iTunes), MusicMatch, Rhapsody, Microsoft (through MSN) and others. The sale of digital musichas grown significantly in the past year, and the recording industry saw salesrevenue for CDs decline significantly from 2001 to 2006. As this method ofselling music increases in popularity and gains consumer acceptance, it mayadversely impact our sales and profitability. The recording industry also continuesto face difficulties as a result of illegal online file-sharing anddownloading. While industry associations and manufacturers have successfullylaunched legal action against downloaders and file sharers to stop thispractice, there can be no assurance of the effect of these lawsuits. Filesharing and downloading, both legitimate and illegal, could continue to exertpressure on the recording industry and the demand for CDs. Additionally, asother forms of media become available for digital download, our sales andprofitability attributable to CDs and DVDs may be adversely affected.

Recent advances in thetechnologies to deliver movies to viewers may adversely affect public demandfor DVDs offered by us. For example, some digital cable providers and internetcompanies offer movies “on demand” with interactive capabilities such as start,stop and rewind. Direct broadcast satellite and digital cable providers havebeen able to enhance their on-demand offerings as a result of their ability totransmit over numerous channels. Although not as advanced as the digitaldistribution of music, Apple Computer (through iTunes) and others have begun tooffer video content digitally. Apart from on-demand technology, the recentdevelopment and enhancement of personal video recorder technology with “time-shifting”technology (such as that used by TiVo and certain cable companies) has givenviewers greater interactive control over broadcasted movies and other programtypes. Also, companies such as Blockbuster Entertainment and NetFlix are nowoffering subscription services which provide consumers the ability to rent VHScassettes and DVDs for indefinite periods of time without being subject to latefees. If these methods of watching filmed entertainment increase in popularity andgain consumer acceptance, they may adversely impact sales and profits.

**WE PARTICIPATE INHIGHLY COMPETITIVE INDUSTRIES AND COMPETITIVE PRESSURES MAY RESULT IN ADECREASE IN OUR REVENUES AND PROFITABILITY.**

Each of our business units faces significant competition.Our Fulfillment group distributes home entertainment product in competitionwith a number of national and regional companies, including Anderson NewsCompany, Anderson Merchandisers, L.P., Hudson News Company, News Group, IngramBook Group, Inc., Ingram Entertainment, Inc., Handleman Company, andBaker & Taylor, Inc. Major record labels and film studiosperiodically compete with us by establishing direct trading relationships withthe larger retail chains.

Our In-Store Services group competes in a highlyfragmented industry with other manufacturers for wood and wire display fixturebusiness. In addition, some of this group’s information and management servicesmay be performed directly by publishers and other vendors, retailers ordistributors. Other information service providers, including A.C. NielsenCompany, Information Resources and Audit Bureau of Circulations, also collectsales data from retail stores. If these service providers were to compete withus, 

16

----

given their expertise incollecting information and their industry reputations, they could be formidablecompetitors.

Some of our existing andpotential competitors have substantially greater resources and greater namerecognition 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 competesuccessfully in these markets with existing or new competitors. Competitivepressures may result in a decrease in the number of customers it serves, adecrease in its revenues or a decrease in its operating profits.

**WE CONDUCT AGROWING PORTION OF OUR BUSINESS INTERNATIONALLY, WHICH PRESENTS ADDITIONALRISKS TO US OVER AND ABOVE THOSE ASSOCIATED WITH OUR DOMESTIC OPERATIONS.**

Approximately 4.4% of our total revenues from magazinedistribution for the year ended January 31, 2007 were derived from theexport of U.S. publications to overseas markets, primarily to the UnitedKingdom and Australia. In addition, approximately 4.4% of our gross domesticdistribution of magazines for the year ended January 31, 2007, consistedof the domestic distribution of foreign publications imported for sale to U.S.markets.

The conduct ofbusiness internationally presents additional inherent risks including:

·       unexpectedchanges in regulatory requirements;

·       importand export restrictions;

·       tariffsand other trade barriers;

·       differingtechnology standards;

·       resistancefrom retailers to our business practices;

·       employmentlaws and practices in foreign countries;

·       politicalinstability;

·       fluctuationsin currency exchange rates;

·       impositionof currency exchange controls; and

·       potentiallyadverse tax consequences.

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

Certain suppliers haveadopted policies restricting the export of DVDs and CDs by domesticdistributors. However, consistent with industry practice, we distribute ourmerchandise internationally. We would be adversely affected if a substantialportion of our suppliers enforced any restriction on our ability to sell ourhome entertainment content products outside the United States.

**SUBSTANTIALLY ALLOF THE MAGAZINES DISTRIBUTED BY US ARE PURCHASED FROM FOUR SUPPLIERS AND OURREVENUES COULD BE ADVERSELY AFFECTED IF WE ARE UNABLE TO RECEIVE MAGAZINEALLOTMENTS FROM THESE SUPPLIERS.**

Substantially all of themagazines distributed in the United States are supplied by or through one offour national distributors, Comag Marketing Group, LLC, Curtis CirculationCompany, Kable Distribution Services, Inc. and Time Warner Retail Salesand Marketing, Inc. Each title is supplied by one of these nationaldistributors to us and cannot be purchased from any alternative source. Oursuccess is largely dependent on our ability to obtain product in sufficientquantities on competitive terms and conditions from each of the nationaldistributors. In order to qualify to receive copy allotments, we are requiredto 

17

----

complywith certain operating conditions, which differ between the specialty retailmarket and the mainstream market. Our ability to economically satisfy theseconditions may be affected by events beyond our control, including thecooperation and assistance of our customers. A failure to satisfy theseconditions could result in a breach of our purchase arrangements with oursuppliers and entitle our suppliers to reduce our copy allotment or discontinueour right to receive product for distribution to our customers. If our supplyof magazines were reduced, interrupted or discontinued, customer service wouldbe disrupted and existing customers may reduce or cease doing business with usaltogether, thereby causing our revenue and operating income to decline andresult in failure to meet expectations.

**IF WE WERE UNABLETO RECEIVE OUR CD AND DVD PRODUCTS FROM OUR TOP SUPPLIERS, OUR SALES ANDPROFITABILITY COULD BE ADVERSELY AFFECTED.**

A substantial portion ofthe DVD and CD products distributed by us are supplied by 5 film studios and 4record labels. These products are proprietary to individual suppliers and maynot be obtained from any alternative source. Our success depends upon ourability to obtain product in sufficient quantities on competitive terms andconditions from each of these major home entertainment labels and studios. Ifour supply of products were interrupted or discontinued, then customer servicecould be adversely affected and customers may reduce or cease doing businesswith us causing our sales and profitability to decline.

**VIRTUALLY ALL OFOUR SALES ARE MADE ON A “SALE OR RETURN” BASIS AND HIGHER THAN EXPECTED RETURNSCOULD CAUSE US TO OVERSTATE REVENUE FOR THE PERIOD AFFECTED.**

As is customary in thehome entertainment content product industry, virtually all of our sales will bemade on a “sale or return” basis. During the year ended January 31, 2007,approximately 60 out of every 100 magazine copies distributed domestically bySource Interlink and approximately 22 and 20 out of every 100 DVDs and CDs,respectively, distributed domestically by Alliance were returned unsold bytheir customers for credit; however, the sell-through rate can vary from periodto period. Revenues from the sale of merchandise that we distribute arerecognized at the time of delivery, less a reserve for estimated returns. Theamount of the return reserve is estimated based on historical sell-throughrates. If sell-through rates in any period are significantly less thanhistorical averages, this return reserve could be inadequate. If the returnreserve proved inadequate, it would indicate that actual revenue in prior periodswas less than accrued revenue for such periods. This would require an increasein the amount of the return reserve for subsequent periods which may result ina reduction in operating income for such periods.

**SALES OF DVDS ANDCDS ARE HIGHLY SEASONAL AND OUR FINANCIAL RESULTS COULD BE NEGATIVELY IMPACTEDIF THE FOURTH QUARTER SALES OF DVDS AND CDS ARE WEAK.**

Our CD and DVDFulfillment segment generated 30.8% of its total net sales in the fourthquarter of fiscal 2007 coinciding with the holiday shopping season. Factorsthat could adversely affect sales and profitability in the fourth quarterinclude:

·       unavailabilityof, and low customer demand for, particular products;

·       unfavorableeconomic and geopolitical conditions;

·       inabilityto hire adequate temporary personnel;

·       weatherconditions;

·       inabilityto anticipate consumer trends;

·       weaknew release schedules; and

·       inability to maintainadequate inventory levels.

18

----

**WE DEPEND ON THEEFFORTS OF CERTAIN KEY PERSONNEL, THE LOSS OF WHOSE SERVICES COULD ADVERSELYAFFECT OUR BUSINESS.**

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

**OUR MANAGEMENT ANDINTERNAL SYSTEMS MIGHT BE INADEQUATE TO HANDLE OUR POTENTIAL GROWTH.**

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

**OUR OPERATIONSCOULD BE DISRUPTED IF OUR INFORMATION SYSTEMS FAIL, CAUSING INCREASED EXPENSESAND LOSS OF SALES.**

Our business depends onthe efficient and uninterrupted operation of our computer and communicationssoftware and hardware systems, including our replenishment and order regulationsystems, and other information technology. If we were to fail for any reason orif we were to experience any unscheduled down times, even for only a shortperiod, its operations and financial results could be adversely affected. Wehave in the past experienced performance problems and unscheduled down times,and these problems could recur. Our systems could be damaged or interrupted byfire, flood, hurricanes, power loss, telecommunications failure, break-ins orsimilar events. We have formal disaster recovery plans in place. However, theseplans may not be entirely successful in preventing delays or othercomplications that could arise from information systems failure, and, if theyare not successful, our business interruption insurance may not adequatelycompensate it for losses that may occur.

**WE DEPEND ON THEINTERNET TO DELIVER SOME OF OUR SERVICES, AND THE USE OF THE INTERNET MAY EXPOSEUS TO INCREASED RISKS.**

Many of our operations and services, includingreplenishment and order regulation systems, PIN, ICN, customer directfulfillment and other information technology, involve the transmission ofinformation over the Internet. Our business therefore will be subject to anyfactors that adversely affect Internet usage including the reliability ofInternet service providers, which from time to time have operational problemsand experience service outages.

In addition, one of therequirements of the continued growth over the Internet is the securetransmission of confidential information over public networks. Failure to preventsecurity breaches of our networks or those of our customers or well-publicizedsecurity breaches affecting the Internet in general could significantly harmour growth and revenue. Advances in computer capabilities, new discoveries inthe field of cryptography or other developments may result in a compromise orbreach of the algorithms we use to protect content and transactions or ourcustomers’ proprietary information in its databases. Anyone who is able tocircumvent our security measures could misappropriate proprietary andconfidential information or could cause interruptions in our operations. We maybe required to expend significant capital and other resources to protectagainst such security breaches or to address problems caused by security breaches.

19

----

**IF OUR ACCOUNTINGCONTROLS AND PROCEDURES ARE CIRCUMVENTED OR OTHERWISE FAIL TO ACHIEVE THEIRINTENDED PURPOSES, OUR BUSINESS COULD BE SERIOUSLY HARMED.**

Although we evaluate ourinternal control over financial reporting and disclosure controls and proceduresas of the end of each fiscal quarter, we may not be able to prevent allinstances of accounting errors or fraud in the future. Controls and proceduresdo not provide absolute assurance that all deficiencies in design or operationof these control systems, or all instances of errors or fraud, will beprevented or detected. These control systems are designed to provide reasonableassurance of achieving the goals of these systems in light of legalrequirements, company resources and the nature of our business operations.These control systems remain subject to risks of human error and the risk thatcontrols can be circumvented for wrongful purposes by one or more individualsin management or non-management positions. Our business could be seriously harmedby any material failure of these control systems.

**THE DVD AND CDBUSINESS DEPENDS IN PART ON THE CURRENT ADVERTISING ALLOWANCES, VOLUMEDISCOUNTS AND OTHER SALES INCENTIVE PROGRAMS, AND OUR RESULTS OF OPERATIONCOULD BE ADVERSELY AFFECTED IF THESE PROGRAMS WERE DISCONTINUED OR MATERIALLYMODIFIED.**

Under terms of purchaseprevailing in its industry, the profitability of the DVD and CD are enhanced byadvertising allowances, volume discounts and other sales incentive programsoffered by record labels and movie studios. Such content providers are notunder long-term contractual obligations to continue these programs, and in 2003one major record label eliminated advertising allowances and volume discountson a limited number of stock keeping units. If record labels or movie studios,or both, decide to discontinue these programs, we would experience asignificant reduction in operating profits.

**RISKS RELATED TOYOUR OWNERSHIP OF OUR STOCK**

**WE HAVE ASIGNIFICANT STOCKHOLDER WHOSE INTERESTS MAY CONFLICT WITH YOURS.**

Our largest stockholder,AEC Associates, L.L.C. beneficially owned approximately 34% of our outstandingvoting power as of April 9, 2007. For as long as AEC Associates (togetherwith its members and affiliates acting as a group) owns an aggregate of atleast 10% of our outstanding common stock, AEC Associates will have certainadditional director designation rights as further described in the risk factorentitled “We have limitations on changes of control that could reduce yourability to sell our shares at a premium.” For example, for actions that requirea supermajority of the board, such as a change of control, AEC Associatesdesignated directors may effectively have enough votes to prevent any suchaction from being taken by us. As a result, AEC Associates will have theability through its ownership of our common stock and its representation on theboard to exercise significant influence over our major decisions and over allmatters requiring stockholder approval. AEC Associates may have interests thatdiffer from those of our stockholders.

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

Our bylaws provide thatthe affirmative vote of at least 75% of its entire board will be required to (i) approveor recommend a reorganization or merger of our company in a transaction thatwill result in our stockholders immediately prior to such transaction notholding, as a result of such transaction, at least 50% of the voting power ofthe surviving or continuing entity, (ii) a sale of all or substantiallyall of our assets which would result in its stockholders immediately prior tosuch transaction not holding, as a result of such sale, at least 50% of thevoting power of the purchasing entity, or (iii) a change in our bylaws.This requirement may prevent us from making changes and taking other actionsthat are subject to this 

20

----

supermajorityapproval requirement. This requirement may limit our ability to pursuestrategies or enter into strategic transactions for which the supermajorityapproval of the board cannot be obtained.

**WE HAVE LIMITATIONSON CHANGES OF CONTROL THAT COULD REDUCE YOUR ABILITY TO SELL OUR SHARES AT APREMIUM.**

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

·       permitour board to issue up to 2,000,000 shares of preferred stock and to determinethe price, rights, preferences, privileges and restrictions of that preferredstock;

·       permitour board to issue up to 100,000,000 shares of common stock;

·       requirethat a change of control of the company be approved by a supermajority of atleast 75% of the members of the board;

·       providefor a classified board of directors;

·       permitthe board to increase its own size and fill the resulting vacancies;

·       limitthe persons who may call special meetings of stockholders; and

·       establish advance noticerequirements for nominations for election to the board or for proposing mattersthat can be acted on by stockholders at stockholders meetings.

**OUR COMMON STOCKPRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FORSTOCKHOLDERS.**

Our common stock iscurrently traded on the Nasdaq National Market. Our average daily tradingvolume for the three month period ending April 13, 2007 was approximately279,000 shares. In the future, we may experience more limited daily tradingvolume. The trading price of our common stock has been and may continue to bevolatile. The closing sale prices of our common stock, as reported by theNasdaq National Market, have ranged from a high of $12.52 to a low of $7.16 forthe 52-week period ending January 31, 2007. The closing sale priceof our common stock, as reported by the Nasdaq National Market on April 13,2007 was $6.90. Broad market and industry fluctuations may significantly affectthe trading price of our common stock, regardless of our actual operatingperformance. The trading price of our common stock could be affected by anumber of factors, including, but not limited to, announcements of new services,additions or departures of key personnel, quarterly fluctuations in ourfinancial results, changes in analysts’ estimates of our financial performance,general conditions in our industry and conditions in the financial markets anda variety of other risk factors, including the ones described elsewhere in thisAnnual Report on Form 10-K. Periods of volatility in the marketprice of a company’s securities sometimes result in securities class actionlitigation. If this were to happen to us, such litigation would be expensiveand would divert management’s attention. In addition, if we needed to raiseequity funds under adverse conditions, it would be difficult to sell asignificant amount of our stock without causing a significant decline in thetrading price of our stock.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS.

None.

21

----

**ITEM 2.**                PROPERTIES.

Our principal executive offices are located at 27500Riverview Center Boulevard, Bonita Springs, Florida. As of April 3, 2007,we owned or leased approximately 1.1 million square feet of manufacturingfacilities, 1.1 million square feet of distribution centers, 0.5 million inwarehouses, and 0.1 million square feet of office space. The following tablepresents information concerning our principal properties:

| **Location**        | ** ** | ** **                          | ** ** | **Description**         | ** ** | **Segment** | ** **        | **Size  (square feet)** | ** ** | **Owned/  Leased** | ** ** |
|---------------------|------------|-------------------------------------|------------|-------------------------|------------|-------------|-------------------|------------------------------|------------|--------------------|------------|
| Bonita Springs,  FL |       | Office                              |       | Worldwide  headquarters |       |        | 95,000            |                         |       | Leased             |       |
| Coral Springs, FL   |       | Distribution  center/  Office       |       | CD  and DVD fulfillment |       |        | 244,000           |                         |       | Owned              |       |
| Shepherdsville,  KY |       | Distribution  center                |       | CD  and DVD fulfillment |       |        | 168,000           |                         |       | Leased             |       |
| Ontario, CA         |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 160,000           |                         |       | Leased             |       |
| Chicago, IL         |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 66,000            |                         |       | Leased             |       |
| Brainerd, MN        |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 29,000            |                         |       | Leased             |       |
| Lancaster, PA       |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 106,000           |                         |       | Leased             |       |
| Dallas, TX          |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 48,000            |                         |       | Leased             |       |
| Harrisburg, PA      |       | Distribution  center                |       | Magazine  fulfillment   |       |        | 142,000           |                         |       | Leased             |       |
| Rockford, IL        |       | Manufacturing/  Distribution center |       | In-store  services      |       |        | 300,000/  9,000   |                         |       | Owned              |       |
| Brooklyn, NY        |       | Manufacturing                       |       | In-store  services      |       |        | 92,000            |                         |       | Leased             |       |
| Vancouver, B.C.     |       | Manufacturing                       |       | In-store  services      |       |        | 51,000            |                         |       | Leased             |       |
| Quincy, IL          |       | Manufacturing/  Warehouse           |       | In-store  services      |       |        | 260,000/  160,000 |                         |       | Owned              |       |
| Albemarle, NC       |       | Manufacturing                       |       | In-store services       |       |        | 194,000           |                         |       | Leased             |       |

 

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

**ITEM 3.**                LEGALPROCEEDINGS.

We are party to routinelegal proceedings arising out of the normal course of business. Although it isnot possible to predict with certainty the outcome of these unresolved legalactions 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 onour financial condition, results of operations or liquidity.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submittedto a vote of stockholders during the fourth quarter of fiscal 2007.

**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES.

**MARKET INFORMATION**

Our common stock is quoted on the Nasdaq NationalMarket under the symbol SORC.

22

----

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

| ** **                        | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------|------------|----------|------------|---------|------------|
| Year ended  January 31, 2006 |       |     |       |    |       |
| First quarter                     |       | $        | 12.51      |    | $          | 10.36 |   |
| Second quarter                    |       | $        | 13.20      |    | $          | 9.20 |   |
| Third quarter                     |       | $        | 12.70      |    | $          | 9.36 |   |
| Fourth quarter                    |       | $        | 11.65      |    | $          | 9.66 |   |
| Year ended  January 31, 2007 |       |     |       |    |       |
| First quarter                     |       | $        | 12.00      |    | $          | 9.87 |   |
| Second quarter                    |       | $        | 12.89      |    | $          | 10.55 |   |
| Third quarter                     |       | $        | 11.92      |    | $          | 8.99 |   |
| Fourth quarter                    |       | $        | 9.62       |    | $          | 7.10 |   |

 

**HOLDERS**

As of April 5, 2007,there were approximately 130 holders of record of our common stock.

**DIVIDENDS**

We have never declared orpaid dividends on our common stock. Our board of directors presently intends toretain all of our earnings, if any, for the development of our business for theforeseeable future. The declaration and payment of cash dividends in the futurewill be at the discretion of our board of directors and will depend upon anumber of factors, including, among others, any restrictions contained in ourcredit facilities and out future earnings, operations, capital requirements andgeneral financial condition and such other factors that our board of directorsmay deem relevant. Currently, our credit facilities prohibit the payment ofcash dividends or other distributions on our capital stock or payments inconnection with the purchase, redemption, retirement or acquisition of ourcapital stock.

**SECURITIESAUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS**

Thefollowing table presents information about securities authorized for issuanceunder equity compensation plans as of January 31, 2007:

| **Plan category**                                  | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of outstanding  options, warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans(a)** | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders |       |       | 3,681,305  |                                                                                                                                                 |       |                                                                                                        | $          | 7.48                                                                                                                                           |       |   |   | 361,397 |   |   |
|                                                         |            |            |            |                                                                                                                                                      |            |                                                                                                             |            |                                                                                                                                                |            |  |  |  |  |  |  |  |

----

(a)           Excludessecurities to be issued upon exercise of outstanding options, warrants andrights.

**RECENT SALES OF UNREGISTEREDSECURITIES; USE OF PROCEEDS FROM REGISTERED SECURITIES**

None.

**PURCHASES OF EQUITYSECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS**

None.

23

----

**ITEM 6.**                SELECTEDFINANCIAL DATA.

Thefollowing selected consolidated financial data are only a summary and should beread in conjunction with our financial statements and related notes thereto and“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” included in this Annual Report on Form 10-K. Theconsolidated statement of operations data for the years ended January 31,2005, 2006 and 2007 and the balance sheet data as of January 31, 2006 and2007, which have been prepared in accordance with accounting principlesgenerally accepted in the U.S., are derived from our financial statementsaudited by BDO Seidman, LLP, an independent registered public accounting firm,which are included elsewhere in this Annual Report on Form 10-K. Theconsolidated statements of income data for the years ended January 31,2003 and 2004 and the balance sheet data as of January 31, 2003, 2004 and2005, which have been prepared in accordance with accounting principlesgenerally accepted in the U.S., are derived from our audited financialstatements which are not included in this Annual Report on Form 10-K.On February 28, 2005, we consummated our merger with AllianceEntertainment Corp. The results of operations of Alliance are included in theselected financial data presented below for the period beginning March 1,2005 only. On May 10, 2005, we consummated our acquisition of Chas. LevyCirculating Co, LLC. The results of operations of Levy are included in theselected financial data presented below for the period beginning May 10,2005 only. Also on March 30, 2006, we consummated our acquisitions of AndersonMid-Atlantic News, LLC and Anderson SCN Services, LLC. The results ofoperations for Mid-Atlantic and SCN are included in the selected financial datapresented below for the period beginning April 1, 2006 only. For adescription of the merger of Source Interlink and Alliance and the acquisitionsof Levy, Mid-Atlantic and SCN, please see the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”Historical operating results are not necessarily indicative of the results thatmay be expected for any future period.

| ** **                                    | ** ** | **Year ended January 31,**                          | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004(a)** | ** ** | **2003(a)** | ** ** |
| ** **                                    | ** ** | **(in thousands, except per share data)** | ** ** |
| **Income statement data:**                    |       |                                                               |       |   |   |   |   |   |   |   |   |
| Revenues                                      |       | $                                                                  | 1,854,845  |   | $ | 1,527,451 |   | $ | 356,644 |   | $ | 315,791 |   | $ | 269,191 |   |
| Gross profit                                  |       | $                                                                  | 386,057    |   | $ | 307,454 |   | $ | 97,793 |   | $ | 86,043 |   | $ | 71,760 |   |
| Operating income                              |       | $                                                                  | (17,180    | ) | $ | 35,249 |   | $ | 18,024 |   | $ | 17,394 |   | $ | 11,403 |   |
| Income from  continuing operations            |       | $                                                                  | (29,850    | ) | $ | 14,325 |   | $ | 13,062 |   | $ | 10,163 |   | $ | 7,759 |   |
| Net income                                    |       | $                                                                  | (24,656    | ) | $ | 12,879 |   | $ | 12,082 |   | $ | 10,048 |   | $ | 7,338 |   |
| Income from continuing  operations per share: |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic                                         |       | $                                                                  | (0.48      | ) | $ | 0.29 |   | $ | 0.57 |   | $ | 0.55 |   | $ | 0.42 |   |
| Diluted                                       |       | $                                                                  | (0.48      | ) | $ | 0.28 |   | $ | 0.53 |   | $ | 0.52 |   | $ | 0.42 |   |

----

(a)           2003and 2004 are restated for the discontinued operations as discussed in Note 8.

| ** **                       | ** ** | **As of January 31,** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|
| ** **                       | ** ** | **2007**                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                       | ** ** | **(in thousands)**              | ** ** |
| **Balance sheet data:**          |       |                                 |       |   |   |   |   |   |   |   |   |
| Cash                             |       | $                                    | —     |   | $ | 23,239 |   | $ | 1,387 |   | $ | 4,963 |   | $ | 5,570 |   |
| Working capital                  |       | $                                    | 29,523     |   | $ | 54,783 |   | $ | 41,186 |   | $ | 19,418 |   | $ | (3,519 | ) |
| Total assets                     |       | $                                    | 1,010,031  |   | $ | 884,472 |   | $ | 197,753 |   | $ | 164,101 |   | $ | 157,239 |   |
| Current  maturities of debt      |       | $                                    | 7,850      |   | $ | 6,508 |   | $ | 5,630 |   | $ | 4,059 |   | $ | 29,215 |   |
| Debt, less  current maturities   |       | $                                    | 146,534    |   | $ | 80,727 |   | $ | 34,139 |   | $ | 31,541 |   | $ | 17,026 |   |
| Total liabilities                |       | $                                    | 570,584    |   | $ | 424,879 |   | $ | 70,070 |   | $ | 97,027 |   | $ | 106,320 |   |
| Total stockholders’  equity |       | $                                    | 439,447    |   | $ | 459,593 |   | $ | 127,683 |   | $ | 67,074 |   | $ | 50,919 |   |

 

24

----

**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

Throughout thissection we discuss and refer to the following reportable segments:

·       MagazineFulfillment—Our Magazine Fulfillment group provides domestic and foreign titledmagazines to specialty retailers, such as bookstores and music stores, and tomainstream retailers, such as supermarkets, discount stores, drug stores,convenience stores and newsstands. This group also exports domestic titledmagazines from more than 100 publishers to foreign markets worldwide. Weprovide fulfillment services to more than 40,000 retail stores, 11,000 of whichalso benefit from our selection and logistical procurement services.

·       CDand DVD Fulfillment—Our CD and DVD Fulfillment group sells and distributespre-recorded music, videos, video games and related products to retailers,provides product and commerce solutions to retailers and providescustomer-direct fulfillment and vendor managed inventory.

·       In-StoreServices—The in-store services segment designs, manufactures, ships, installs,removes and invoices participants in front-end wire fixture and custom wooddisplay programs, provides claim filing services for rebates owed retailersfrom publishers and their agents and provides information and managementservices relating to retail magazine sales to U.S. and Canadian retailers andmagazine publishers.

·       SharedServices—Our Shared Services group consists of overhead functions not allocatedto the other groups. These functions include corporate finance, human resource,management information systems and executive management that are not allocatedto the three operating groups. Upon completion of the consolidation of ouradministrative operations, we restructured our accounts to separately identifycorporate expenses that are not attributable to any of our three main operatinggroups. Prior to fiscal year 2004, these expenses were included within ourIn-Store Services group.

This segment structurerepresents a change in organizational structure from that reported inItem 7. “Management’s Discussion and Analysis of Financial Condition andResults of Operations” in our Form 10-K for the fiscal year ended January 31,2005. The segment organization presented herein corresponds to the financialand other reporting received by our chief operating decision maker. Foradditional financial and geographic information regarding our segments and adiscussion of the change in organizational structure, see Note 17 “SegmentInformation” to our Consolidated Financial Statements.

**OVERVIEW**

The following events have occurred that have amaterial impact on the comparison of our results of operations for the yearended January 31, 2007 and the prior year:

We have performedfour acquisitions during the last two fiscal years. The results of operationsfrom the following acquired business are included in current year results ofoperations for a different number of months than they were included in theprior year:

·       AllianceEntertainment Corp.—Results from Alliance were included in fiscal 2007 earningsfor 12 months compared to 11 months in fiscal 2006;

·       Chas.Levy Circulating Co, LLC—Results from Levy were included in fiscal 2007earnings for 12 months compared to approximately nine months in fiscal2006;

·       AndersonMid-Atlantic News, LLC—Results from Mid-Atlantic were included in fiscal 2007earnings for 10 months while no results from Mid-Atlantic were included infiscal 2006; and

·       AndersonSCN Services, LLC—Results from SCN were included in fiscal 2007 earnings for 10 monthswhile no results from SCN were included in fiscal 2006.

25

----

For more information on the above acquisitions, seeNote 2—*Business Combinations and Asset Acquisitions*to our Consolidated Financial Statements.

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

In the fourth quarter of fiscal 2007, we amended ourdistribution agreement with a major customer of our magazine distributionsegment such that revenue is no longer recognized upon the delivery of productless an allowance for returns but rather revenue is recognized when the saleoccurs at retail. This transition to a scan-based trading relationship resultedin a one-time conversion charge, which had a negative impact on profitabilityof $16.2 million. The majority of this charge is the non-cash deferral ofprofits as a result of this change. Until the time of sale, the inventory isbeing carried on the Company’s books at the product cost. We are optimisticthat scan-based trading will ultimately reduce costs, result in a reduction inworking capital, maximize retail productivity and throughput, and continue toenhance retailer relationships.

As a result of indicationsof potential impairment, we performed SFAS No. 142 and SFAS No. 144impairment analyses, we determined that the customer list, non-competeagreement and goodwill of our In-Store Services reporting unit was impaired andconsequently recorded a charge of  approximately $1.7 million, $0.5million and $30.6 million, respectively. These determinations wereprimarily the result of a change in management’s expectations of the long-termoutlook for that business unit, including increased life cycle for certainproducts, as well as decreasing operating profit margins. The combination ofthese factors had an adverse impact on the anticipated future cash flows ofthis reporting unit used in the impairment analysis performed during the fourthquarter 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 quarterof fiscal year 2007, after the impairment charge was recorded.

**DISCONTINUEDOPERATION**

In November 2004, we sold and disposed of oursecondary wholesale distribution operation for $1.4 million, in order tofocus more fully on our domestic and export distribution. All rights ownedunder the secondary wholesale distribution contracts were assigned, delivered,conveyed and transferred to the buyer, an unrelated third party. All assets andliabilities relating to our secondary wholesale distribution operation were notassumed by the buyer. We recognized a gain on sale of this business of $1.4million ($0.8 net of tax) in the fourth quarter of fiscal year 2005.

26

----

Thefollowing amounts related to our Magazine Fulfillment segment’s discontinuedoperation (secondary wholesale distribution business) have been segregated fromcontinuing operations and reflected as discontinued operations in each period’sconsolidated statement of income:

| ** **                                    | ** ** | **Year ended January 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                   | ** ** |
| Revenue                                       |       |                                      | $          | — |   |   | $ | — |   | $ | 13,380 |   |
| Loss before income taxes                      |       |                                      | $          | — |   |   | $ | (2,410 | ) | $ | (3,033 | ) |
| Income tax  benefit                           |       |                                      | —     |   |   | 964 |   | 1,213 |   |
| Loss from discontinued operations, net of tax |       |                                      | —     |   |   | (1,446 | ) | (1,820 | ) |
| Pre-tax gain on sale of discontinued business |       |                                      | —     |   |   | — |   | 1,400 |   |
| Income tax  expense                           |       |                                      | —     |   |   | — |   | (560 | ) |
| Gain on sale of business, net of tax          |       |                                      | —     |   |   | — |   | 840 |   |
| Discontinued  operation, net of tax           |       |                                      | $          | — |   |   | $ | (1,446 | ) | $ | (980 | ) |

 

**EXPLANATION OFFINANCIAL STATEMENT LINE ITEMS**

**REVENUES**

The MagazineFulfillment group derives revenues from:

·       sellingand distributing magazines, including domestic and foreign titles, to specialtyand mainstream retailers throughout the United States and Canada;

·       exportingdomestic titles internationally to foreign wholesalers or through domesticbrokers;

·       providingreturn processing services for major specialty retail book chains; and

·       servingas an outsourced fulfillment agent and backroom operator for publishers.

The CD and DVDFulfillment group derives revenues from:

·       sellingand distributing pre-recorded music, movies, video games and related productsprimarily to specialty and mainstream retailers throughout the United States;

·       servingas an outsourced fulfillment agent and backroom operator for movie studios andrecord labels.

The In-StoreServices group derives revenues from:

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

·       providingclaim filing services related to rebates owed to retailers from publishers ortheir designated agents;

·       storing,shipping, installing, and removing front-end fixtures;

·       designing,manufacturing and installing custom wood fixtures primarily for retailers; and

·       providing information andmanagement services relating to magazine sales to retailers and publishersthroughout the United States and Canada.

**COST OF REVENUES**

The cost of revenues for the Magazine Fulfillmentgroup consists of the costs of magazines purchased for resale less allapplicable publisher discounts and rebates.

27

----

The cost of revenues for the CD and DVD Fulfillmentgroup consists of the costs of CDs and DVDs purchased for resale less allapplicable discounts and rebates.

The cost ofrevenues for the In-Store Services group includes:

·       rawmaterials consumed in the production of display fixtures, primarily steel, woodand plastic components;

·       productionlabor; and

·       manufacturing overhead.

**SELLING, GENERAL,AND ADMINISTRATIVE EXPENSES**

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

·       non-productionlabor;

·       rentand office overhead;

·       insurance;

·       professionalfees; and

·       managementinformation systems.

Expenses associated withcorporate finance, human resources, certain management information systems andexecutive offices are included within the Shared Services group and are notallocated to the other groups.

**FULFILLMENT FREIGHT**

Fulfillment freight consists of our direct costs ofdistributing magazines, CDs and DVDs by third-party freight carriers, primarilyUPS ground service, and the cost of delivery by company-owned trucks. Thirdparty freight rates are driven primarily by the weight of the copies beingshipped and the distance between origination and destination.

Fulfillment freight is not disclosed as a component ofcost of revenues, and, as a result, gross profit and gross profit margins arenot comparable to other companies that include shipping and handling costs incost of revenues.

Fulfillment freight hasincreased proportionately as the amount of product we distribute has increased.We anticipate the continued growth in our Magazine Fulfillment and CD and DVDFulfillment groups will result in an increase in fulfillment freight.Generally, as pounds shipped increase, the cost per pound charged by thirdparty carriers decreases.

**INTEGRATION ANDRELOCATION EXPENSE**

During fiscal 2007, the Company incurred $3.7 millionof expenses related to the planned consolidation of the backroom operations andmarketing functions of the domestic mainstream distribution group from Lisle,IL to Bonita Springs, FL and the planned consolidation of one of its existingsouthern California distribution centers into a facility acquired in connectionwith the acquisition of SCN.

During fiscal 2005, the Company incurred $2.5 millionof expenses related to distribution center relocations and a plant conversion.The Company began expansion into the mainstream retail market which resulted indistribution fulfillment centers in Milan, OH, San Diego, CA and Kent, WA beingmoved to Harrisburg, PA and Carson City, NV.

28

----

**RESULTS OFOPERATIONS**

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

**CD AND DVDFULFILLMENT GROUP**

Thefollowing table presents comparative operating results for our CD and DVDFulfillment 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    |       | 84,224                                    |       | 79,564                       |       | 4,660 |   |   | 5.9 | % |   |
| Fulfillment  freight                            |       | 35,935                                    |       | 30,993                       |       | 4,942 |   |   | 15.9 | % |   |
| Depreciation and  amortization                  |       | 14,650                                    |       | 11,147                       |       | 3,503 |   |   | 31.4 | % |   |
| Disposal of land,  buildings and equipment, net |       | 287                                       |       | —                       |       | 287 |   |   | NM |   |   |
| Operating 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 | % |   |   |   |   |
| Fulfillment freight  percent of revenues        |       | 3.7                                       | %          | 3.5                          | %          | 0.2 | % |   |   |   |   |

----

NM—the result of the calculation is not meaningful 

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

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

Fulfillment freight increased as a percentage ofrevenues primarily due to increased fuel surcharges and a larger percentage ofsales requiring overnight air shipments.

Operating margin increasedprimarily due to decreased bad-debt expense. During the fourth quarter offiscal 2007, we reached a final favorable settlement of certain disputes withlarge customers that were reserved prior to the acquisition of Alliance. As aresult of this final settlement, we reversed $3.3 million of bad-debt reservesand accrued expenses.

29

----

**MAGAZINEFULFILLMENT GROUP**

Thefollowing table presents comparative operating results for our Magazine Fulfillmentgroup 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    |                         | $          | 566,438 |   | $ | 243,315 |   | 43.0 | % |
| Cost of revenues                                |       | 621,786                                   |       | 437,869                      |       | 183,917 |   | 42.0 | % |
| Gross profit                                    |       | 187,967                                   |       | 128,569                      |       | 59,398 |   | 46.2 | % |
| Selling, general  and administrative expense    |       | 109,124                                   |       | 68,488                       |       | 40,636 |   | 59.3 | % |
| Fulfillment  freight                            |       | 67,923                                    |       | 41,813                       |       | 26,110 |   | 62.4 | % |
| Depreciation and  amortization                  |       | 7,997                                     |       | 4,446                        |       | 3,551 |   | 79.9 | % |
| Integration and  relocation expense             |       | 3,580                                     |       | —                       |       | 3,580 |   | NM |   |
| Disposal of land,  buildings and equipment, net |       | (154                                      | )          | —                       |       | (154 | ) | NM |   |
| Operating income                                |       | $                                         | (503       | )                            | $          | 13,822 |   | $ | (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    |                         | $          | 319,633 |   | $ | 283,388 |   | 88.7 | % |
| Export distribution                             |       | $                                         | 35,442     |                         | $          | 31,668 |   | $ | 3,774 |   | 11.9 | % |
| Gross profit margin                             |       | 23.2                                      | %          | 22.7                         | %          | 0.5 | % |   |   |
| Fulfillment freight percent of revenues         |       | 8.4                                       | %          | 7.4                          | %          | 1.0 | % |   |   |
| Operating margin                                |       | (0.1                                      | )%         | 2.4                          | %          | (2.5 | )% |   |   |

----

NM—the result of the calculation is not meaningful

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

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

Gross profit margin increased partly due to thebenefit of certain industry-wide pricing programs designed to compensatedistributors for distributing lower-priced titles.

Fulfillment freightincreased as a percentage of revenues and operating margin decreased primarilydue to the change in revenue recognition discussed above, as all expensesassociated with distributing magazines for this account have been recorded asincurred while recognition of revenues has been deferred until the magazinesscan. Fulfillment freight as a percentage of revenues was also impacted byhigher fuel surcharges. In addition, operating margin felt the impact of theintegration and relocation expenses discussed above.

30

----

**IN-STORE SERVICESGROUP**

Thefollowing table presents comparative operating results for our In-StoreServices group for the fiscal years ended January 31, 2007 and 2006:

| ** **                                      | ** ** | **Year ended January 31,** | ** ** | **Increase (decrease)** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **2007**                                  | ** ** | **2006**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                   | ** ** |
| Revenues                                        |       | $                                         | 73,569     |                         | $          | 71,633 |   | $ | 1,936 |   | 2.7 | % |
| Cost of revenues                                |       | 49,654                                    |       | 48,955                       |       | 699 |   | 1.4 | % |
| Gross profit                                    |       | 23,915                                    |       | 22,678                       |       | 1,237 |   | 5.5 | % |
| Selling, general  and administrative expense    |       | 8,824                                     |       | 8,515                        |       | 309 |   | 3.6 | % |
| Fulfillment  freight                            |       | —                                    |       | —                       |       | — |   | NM |   |
| Depreciation and  amortization                  |       | 566                                       |       | 601                          |       | (35 | ) | (5.8 | )% |
| Impairment of  goodwill and intangible assets   |       | 32,742                                    |       | —                       |       | 32,742 |   | NM |   |
| Integration and  relocation expense             |       | —                                    |       | —                       |       | — |   | NM |   |
| Disposal of land,  buildings and equipment, net |       | (86                                       | )          | —                       |       | (86 | ) | NM |   |
| Merger and  acquisition charges                 |       | —                                    |       | 344                          |       | (344 | ) | (100.0 | )% |
| Operating income                                |       | $                                         | (18,131    | )                            | $          | 13,218 |   | $ | (31,349 | ) | (237.2 | )% |
| **Key operating measures:**                     |       |                                      |       |                         |       |   |   |   |   |
| Revenue from:                                   |       |                                      |       |                         |       |   |   |   |   |
| Claim filing and information                    |       | $                                         | 14,707     |                         | $          | 16,170 |   | $ | (1,463 | ) | (9.0 | )% |
| Wire manufacturing                              |       | $                                         | 32,670     |                         | $          | 26,836 |   | $ | 5,834 |   | 21.7 | % |
| Wood manufacturing                              |       | $                                         | 26,192     |                         | $          | 28,627 |   | $ | (2,435 | ) | (8.5 | )% |
| Gross profit margin                             |       | 32.5                                      | %          | 31.7                         | %          | 0.8 | % |   |   |
| Operating margin                                |       | (24.6                                     | )%         | 18.5                         | %          | (43.1 | )% |   |   |

----

NM—the result of the calculation is not meaningful

Revenues from claim filing are recognized at the timethe claim is paid. Claim filing revenues decreased primarily due to the timingof 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 primarilydue to an increased number of front-end fixture purchases as certain retailersreplaced their aging fixtures.

Revenues from wood manufacturing decreased primarilydue fewer store openings and remodelings performed by our significantcustomers.

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

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

31

----

**SHARED SERVICESGROUP**

Thefollowing table presents comparative operating results for our Shared Servicesgroup 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 |   | NM |   |
| Disposal of land,  buildings and equipment, net      |       | 903                                       |       | —                       |       | 903 |   | NM |   |
| Merger and  acquisition charges                      |       | —                                    |       | 2,975                        |       | (2,975 | ) | (100.0 | )% |
| Operating income                                     |       | $                                         | (37,625    | )                            | $          | (26,294 | ) | $ | (11,331 | ) | 43.1 | % |
| **Key operating measure:**                           |       |                                      |       |                         |       |   |   |   |   |
| Operating  expenses percent of consolidated revenues |       | 2.0                                       | %          | 1.7                          | %          | 0.3 | % |   |   |
|                                                      |            |                                           |            |                              |            |  |  |  |  |  |  |  |

----

NM—the result of the calculation is not meaningful

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

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

**INTEREST EXPENSE,NET**

Interest expense, netincreased $5.9 million from $6.6 million to $12.5 million primarily due toincreased borrowings on our revolving credit facility due to the acquisitionsof SCN and Mid-Atlantic described above. Also contributing to the increase arehigher weighted average borrowing rates versus the prior year.

**OTHER INCOME**

Other income is comprisedof items that are outside the normal course of business. Therefore, comparisonbetween periods is not meaningful.

**INCOME TAXES**

Income tax expensedecreased $20.1 million from $14.6 million to $(5.2) million primarily due to adecrease in taxable income. Our effective benefit rate was 17.4% in the yearended January 31, 2007 compared to an effective tax rate of 50.4% for theyear ended January 31, 2006. The change in effective rate is due primarilyto the non-deductible nature of a large portion of the goodwill and intangibleassets impairment charge taken in fiscal 2007 and to the effects of certaincustomary permanent differences on our decreased income before income taxes. Therevision of the treatment of certain timing differences also impacted oureffective tax rate.

32

----

**RESULTS FOR THEFISCAL YEAR ENDED JANUARY 31, 2006 COMPARED TO THE FISCAL YEAR ENDED JANUARY31, 2005**

**CD AND DVDFULFILLMENT GROUP**

The following tablepresents comparative operating results for our CD and DVD Fulfillment group forthe fiscal years ended January 31, 2006 and 2005:

| ** **                                   | ** ** | **Year ended January 31,** | ** ** | **Increase (decrease)**                             | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                  | ** ** | **    2005    ** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                   | ** ** |
| Revenues                                     |       | $                                         | 889,380    |                                                     |       | $ | — |   |   | $ | 889,380 |   |   | NM |   |   |
| Cost of revenues                             |       | 733,173                                   |       |                                                     | —     |   |   | 733,173 |   |   | NM |   |   |
| Gross profit                                 |       | 156,207                                   |       |                                                     | —     |   |   | 156,207 |   |   | NM |   |   |
| Selling, general and  administrative expense |       | 79,564                                    |       |                                                     | —     |   |   | 79,564 |   |   | NM |   |   |
| Fulfillment freight                          |       | 30,993                                    |       |                                                     | —     |   |   | 30,993 |   |   | NM |   |   |
| Depreciation and  amortization               |       | 11,147                                    |       |                                                     | —     |   |   | 11,147 |   |   | NM |   |   |
| Operating income                             |       | $                                         | 34,503     |                                                     |       | $ | — |   |   | $ | 34,503 |   |   | NM |   |   |
| **Key operating measures:**                  |       |                                      |       |                                                     |       |   |   |   |   |   |   |   |   |
| Gross profit margin                          |       | 17.6                                      | %          |                                                     |       |   |   |   |   |   |   |   |   |
| Operating margin                             |       | 3.9                                       | %          |                                                     |       |   |   |   |   |   |   |   |   |
| Fulfillment freight percent of revenues      |       | 3.5                                       | %          |                                                     |       |   |   |   |   |   |   |   |   |

----

NM—theresult of the calculation is not meaningful

We acquired Alliance on February 28,2005. As such, no results of operations were recorded from our CD and DVDFulfillment group during fiscal 2005. Therefore, all increases in individualincome statement line items are attributable to the acquisition.

**MAGAZINEFULFILLMENT GROUP**

Thefollowing table presents comparative operating results for our Magazine Fulfillmentgroup for the fiscal years ended January 31, 2006 and 2005:

| ** **                                   | ** ** | **Year ended January 31,** | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **2006**                                  | ** ** | **2005**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                   | ** ** |
| Revenues                                     |       | $                                         | 566,438    |                         | $          | 280,171 |   | $ | 286,267 |   | 102.2 | % |
| Cost of revenues                             |       | 437,869                                   |       | 210,639                      |       | 227,230 |   | 107.9 | % |
| Gross profit                                 |       | 128,569                                   |       | 69,532                       |       | 59,037 |   | 84.9 | % |
| Selling, general and  administrative expense |       | 68,488                                    |       | 28,481                       |       | 40,007 |   | 140.5 | % |
| Fulfillment freight                          |       | 41,813                                    |       | 21,067                       |       | 20,746 |   | 98.5 | % |
| Depreciation and  amortization               |       | 4,446                                     |       | 1,392                        |       | 3,054 |   | 219.4 | % |
| Integration and  relocation expense          |       | —                                    |       | 2,090                        |       | (2,090 | ) | (100.0 | )% |
| Operating income                             |       | $                                         | 13,822     |                         | $          | 16,502 |   | $ | (2,680 | ) | (16.2 | )% |
| **Key operating measures:**                  |       |                                      |       |                         |       |   |   |   |   |
| Revenues from:                               |       |                                      |       |                         |       |   |   |   |   |
| Domestic specialty  distribution             |       | $                                         | 215,137    |                         | $          | 223,291 |   | $ | (8,154 | ) | (3.7 | )% |
| Domestic mainstream  distribution            |       | $                                         | 319,633    |                         | $          | 18,403 |   | $ | 301,230 |   | 1636.9 | % |
| Export distribution                          |       | $                                         | 31,668     |                         | $          | 38,477 |   | $ | (6,809 | ) | (17.7 | )% |
| Gross profit margin                          |       | 22.7                                      | %          | 24.8                         | %          | (2.1 | )% |   |   |
| Fulfillment freight  percent of revenues     |       | 7.4                                       | %          | 7.5                          | %          | (0.1 | )% |   |   |
| Operating margin                             |       | 2.4                                       | %          | 5.9                          | %          | (3.5 | )% |   |   |

----

NM—theresult of the calculation is not meaningful

33

----

Revenues from domestic specialty distributiondecreased primarily due to an overall decrease in efficiencies in our two majorbookstore chains.

Revenues from domestic mainstream distributionincreased primarily due to significantly increasing our presence in themainstream market in May 2005, with the acquisition of Chas. LevyCirculating Company, a leading magazine wholesaler based in Chicago, IL withdistribution centers in Chicago, Lancaster, PA, Brainerd, MN, and City ofIndustry, CA.

Revenues from export distribution decreased primarilydue to lower overall efficiencies.

Gross profit margins decreased primarily due to thechange in sales mix due to the increase in revenues in the mainstreamdistribution channel. The mainstream distribution channel generally has lowergross margins than the specialty distribution channel due to certain publisherrebates that are available to the specialty distribution channel that are notavailable in the domestic mainstream distribution channel.

Selling, general and administrative costs increasedprimarily due to the expansion of the group’s mainstream distributioninfrastructure. Expenses as a percentage of revenues increased from 10.2% to12.1%. The increase relates primarily to a high concentration of total salesbeing derived from mainstream accounts in fiscal 2006. As part of ourmainstream distribution channel we provide in-store merchandising services tothe majority of retailer accounts.

Fulfillment freightpercent of revenues decreased primarily due to the expansion of ourdistribution into the mainstream distribution channel, which overall has lowerfreight costs as a percent of distribution than the specialty market due toconcentration of retail accounts in a single marketing region and theutilization of our own fleet vs. servicing national accounts via third partydelivery.

**IN-STORE SERVICESGROUP**

Thefollowing table presents comparative operating results for our In-StoreServices group for the fiscal years ended January 31, 2006 and 2005:

| ** **                                   | ** ** | **Year ended January 31,** | ** ** | **Increase (decrease)** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|
| ** **                                   | ** ** | **2006**                                  | ** ** | **2005**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                   | ** ** |
| Revenues                                     |       | $                                         | 71,633     |                         | $          | 76,473 |   | $ | (4,840 | ) | (6.3 | )% |
| Cost of revenues                             |       | 48,955                                    |       | 48,212                       |       | 743 |   | 1.5 | % |
| Gross profit                                 |       | 22,678                                    |       | 28,261                       |       | (5,583 | ) | (19.8 | )% |
| Selling, general and  administrative expense |       | 8,515                                     |       | 9,154                        |       | (639 | ) | (7.0 | )% |
| Depreciation and  amortization               |       | 601                                       |       | 504                          |       | 97 |   | 19.2 | % |
| Integration and  relocation expense          |       | —                                    |       | 360                          |       | (360 | ) | (100.0 | )% |
| Merger and acquisition  charges              |       | 344                                       |       | —                       |       | 344 |   | NM |   |
| Operating income                             |       | $                                         | 13,218     |                         | $          | 18,243 |   | $ | (5,025 | ) | (27.5 | )% |
| **Key  operating measures:**                 |       |                                      |       |                         |       |   |   |   |   |
| Revenue from:                                |       |                                      |       |                         |       |   |   |   |   |
| Claim filing and  information                |       | $                                         | 16,170     |                         | $          | 17,336 |   | $ | (1,166 | ) | (6.7 | )% |
| Wire manufacturing                           |       | $                                         | 26,836     |                         | $          | 36,766 |   | $ | (9,930 | ) | (27.0 | )% |
| Wood manufacturing                           |       | $                                         | 28,627     |                         | $          | 22,371 |   | $ | 6,256 |   | 28.0 | % |
| Gross profit margin                          |       | 31.7                                      | %          | 37.0                         | %          | (5.3 | )% |   |   |
| Operating margin                             |       | 18.5                                      | %          | 23.9                         | %          | (5.4 | )% |   |   |

----

NM—the result of the calculation is not meaningful

Revenues from claim filing are recognized at the timethe claim is paid. The decrease in revenues in the fiscal year ended January 31,2006 relate to the timing of the cash payments received on the claims. 

34

----

Information servicesrevenue increased by approximately $1.0 million over the prior year relating toadditional information product contracts being entered into in the currentyear.

Revenues from wire manufacturing declined due to thecyclical nature of the industry and use of fixtures beyond the historical lifecycle. Major chains have historically purchased new front-end fixtures everythree years; however, the use of the front end fixtures has been extendingbeyond this life cycle.

Revenues from wood manufacturing increased due to anincrease in the number of store openings and remodelings performed by oursignificant customers.

Gross profit margin decreased primarily due todecreased revenues from the wire manufacturing business, coupled with anincrease in lower profit margin projects completed within the wiremanufacturing business versus the prior year.

Selling, general andadministrative expenses decreased primarily due to a decrease in generaloperating expenses.

**SHARED SERVICESGROUP**

Thefollowing table presents comparative operating results for our Shared Servicesgroup for the fiscal years ended January 31, 2006 and 2005:

| ** **                                           | ** ** | **Year ended January 31,** | ** ** | **Increase (decrease)** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **2006**                                  | ** ** | **2005**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Selling, general  and administrative expense         |       | 21,300                                    |       | 13,744                       |       | 7,556 |   | 55.0 | % |
| Depreciation and  amortization                       |       | 2,019                                     |       | 1,855                        |       | 164 |   | 8.8 | % |
| Disposal of land,  buildings and equipment, net      |       | —                                    |       | 1,122                        |       | (1,122 | ) | (100.0 | )% |
| Merger and  acquisition charges                      |       | 2,975                                     |       | —                       |       | 2,975 |   | NM |   |
| Operating income                                     |       | $                                         | (26,294    | )                            | $          | (16,721 | ) | $ | (9,573 | ) | 57.3 | % |
| **Key  operating measure:**                          |       |                                      |       |                         |       |   |   |   |   |
| Operating  expenses percent of consolidated revenues |       | 1.7                                       | %          | 4.7                          | %          | (3.0 | )% |   |   |
|                                                      |            |                                           |            |                              |            |  |  |  |  |  |  |  |

----

NM—the result of the calculation is not meaningful

Selling, general andadministrative expense increased primarily due to increases in corporateoverhead and compensation as a result of the merger with Alliance and theacquisition of Levy.

**INTEREST EXPENSE**

Interest expense increased$5.2 million, or 331.4%, for the fiscal year ended January 31, 2006compared to the fiscal year ended January 31, 2005. This increase was dueto significantly higher borrowings in the fiscal year ended January 31,2006, related to the Alliance and Levy acquisitions and higher average interestrates.

**OTHER INCOME(EXPENSE)**

Other income (expense)consists of items outside of the normal course of operations. Due to itsnature, comparability between periods is not generally meaningful.

**INCOME TAX EXPENSE**

The effective tax rates onincome from continuing operations for the years ended January 31, 2006 andJanuary 31, 2005 were 50.4% and 14.6%, respectively. The increase ineffective tax rates and differences from statutory rates relate primarily tocertain non-deductible charges, and gains associated 

35

----

with theAlliance merger and a reduction in a valuation allowance in the fiscal yearended January 31, 2005.

**LIQUIDITY ANDCAPITAL RESOURCES**

**OVERVIEW**

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

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

Our primary cash requirements for the In-StoreServices group consist of the cost of raw materials, labor, and factoryoverhead incurred in the production of front-end and custom wood displays, thecost of labor incurred in providing our claiming, design and informationservices and cash advances funding our Advance Pay program. Our Advance Payprogram allows retailers to accelerate collections of their rebate claimsthrough payments from us in exchange for the transfer to us of the right tocollect the claim. We then collect the claims when paid by publishers for ourown account.

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

Thefollowing table presents a summary of our significant obligations andcommitments to make future payments under debt obligations and lease agreementsdue by fiscal year as of January 31, 2007 (in thousands).

| ** **                          | ** ** | **Payments due during the year ending January 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                                               | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total** | ** ** |
| Debt obligations                    |       | $                                                                                      | 7,850      |   | $ | 5,284 |   | $ | 2,781 |   | $ | 118,409 |   |   | $ | 20,060 |   |   | $ | 154,384 |   |
| Interest  payments(a)               |       | 11,712                                                                                 |       | 11,355 |   | 11,114 |   | 6,168 |   |   | 4,250 |   |   | 44,599 |   |
| Capital leases                      |       | 1,056                                                                                  |       | 824 |   | 262 |   | — |   |   | — |   |   | 2,142 |   |
| Operating leases                    |       | 10,974                                                                                 |       | 11,929 |   | 9,620 |   | 8,253 |   |   | 17,512 |   |   | 58,288 |   |
| Total contractual cash  obligations |       | $                                                                                      | 31,540     |   | $ | 29,329 |   | $ | 23,609 |   | $ | 132,716 |   |   | $ | 41,769 |   |   | $ | 258,963 |   |

----

(a)           Interest is calculatedusing the prevailing weighted average rate on our outstanding debt at January 31,2007, using the required payment schedule.

Thefollowing table presents a summary of our commercial commitments and thenotional amount expiration by period:

| ** **                           | ** ** | **Notional amounts expiring during the year ending January 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                                                                                 | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total** | ** ** |
| ** **                           | ** ** | **(in thousands)**                                                                                  | ** ** |
| Financial standby  letters of credit |       | $                                                                                                        | 7,125      |   | $ | 464 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 7,589 |   |
|                                      |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

36

----

**OPERATING CASH FLOW**

Thefollowing table shows comparative operating cash flow components for the yearsended January 31, 2007, 2006 and 2005:

| ** **                                                     | ** ** | **Year ended January 31,** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                     | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**                   | ** ** |
| Net income                                                     |       | $                                         | (24,656    | ) | $ | 12,879 |   | $ | 12,082 |   |
| Depreciation and  amortization                                 |       | 26,903                                    |       | 20,089 |   | 5,447 |   |
| Provision for  losses on accounts receivable                   |       | 3,156                                     |       | 6,100 |   | 3,003 |   |
| Deferred income  taxes                                         |       | (13,296                                   | )          | 7,395 |   | (1,382 | ) |
| Impairment of  goodwill and intangible assets                  |       | 32,742                                    |       | — |   | — |   |
| Other                                                          |       | 1,763                                     |       | 3,563 |   | 3,174 |   |
| Working capital changes:                                       |       |                                      |       |   |   |   |   |
| Decrease (increase) in accounts receivable                     |       | 15,681                                    |       | (33,295 | ) | (10,256 | ) |
| (Increase) decrease in inventories                             |       | (30,134                                   | )          | (41,518 | ) | 610 |   |
| (Increase) decrease in income tax receivable                   |       | (7,752                                    | )          | 95 |   | (208 | ) |
| (Increase) decrease in other current and non-current  assets   |       | (4,060                                    | )          | 2,059 |   | 914 |   |
| (Decrease) increase in accounts payable and other  liabilities |       | (21,091                                   | )          | 81,463 |   | (24,845 | ) |
| Cash (used in)  provided by operating activities               |       | $                                         | (20,744    | ) | $ | 58,830 |   | $ | (11,461 | ) |

 

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

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

The decrease in accounts payable and other liabilitieswas primarily due to a decrease in accounts payable within our MagazineFulfillment group of $20.1 million, primarily due to the timing of theacquisitions of SCN and Mid Atlantic. A decrease in accounts payable of $15.0million within our CD and DVD Fulfillment group, related primarily to thetiming of vendor payments and shifting product mix toward more DVDs, which havehistorically had less-favorable payment terms. These decreases are partiallyoffset by an increase in within our Shared Services group of $11.0 million, dueprimarily to the accrual of charges associated with the resignation of our CEOin November 2006.

The increase in income tax receivable is primarilyattributable to the accrual of income tax refunds receivable during the yearended January 31, 2007.

The overall decrease in accounts receivable isprimarily attributable to a decrease in accounts payable within our Magazinefulfillment group of $16.5 million related to the revenue recognition changedescribed 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 inoperating activities, working capital changes for the year endedJanuary 31, 2006 are as follows:

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

37

----

The Magazine Fulfillment Group had an increase inaccounts payable of approximately $36.5 million due primarily to the cyclicalnature of the Mainstream Magazine distribution business.

The increase in accounts receivable for the fiscalyear ended January 31, 2006 of $33.3 million and the increase ininventories of $41.5 million relates primarily to increased distribution andsales levels in our CD and DVD Fulfillment and Magazine Fulfillment, for theholiday season.

In addition to the non-cash add-backs to and(deductions from) net income required to reconcile net income from cash used inoperating activities, working capital changes for the year ended January 31,2005 are as follows:

The increase in accounts receivable for the fiscalyear ended January 31, 2005 was primarily due to an increase in accountsreceivable in our Magazine Fulfillment group of $6.6 million. The increase wasdue to an overall increase in distribution levels, especially in the last monthof the quarter, more lenient payment terms offered to a significant customer inexchange for more favorable pricing, and partially offset by $13.8 millionincrease in the sales return reserve from the end of fiscal 2004.

The In-Store Services Group had an increase inaccounts receivable of approximately $2.2 million due primarily due to theseasonal nature of the wire manufacturing business, which generally has thehighest receivable balance in the third quarter, and increased revenues fromthe wood manufacturing business.

The decrease in accountspayable and accrued expenses for the fiscal year ended January 31, 2005 of$24.8 million relates primarily to a $12.5 million increase of purchase returnreserves in our Magazine Fulfillment group.

**INVESTING CASH FLOW**

Thefollowing table shows comparative investing cash flow components for the yearsended January 31, 2007, 2006 and 2005:

| ** **                                               | ** ** | **Year ended January 31,** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                               | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(in thousands)**                   | ** ** |
| Capital  expenditures                                    |       | $                                         | (13,379    | ) | $ | (13,069 | ) | $ | (7,146 | ) |
| Net (purchase of)  payments received on purchased claims |       | (7,061                                    | )          | (7,916 | ) | 3,951 |   |
| Acquisitions, net                                        |       | (37,094                                   | )          | (28,861 | ) | (16,557 | ) |
| Other                                                    |       | (1,344                                    | )          | — |   | — |   |
| Cash used in  investing activities                       |       | $                                         | (58,878    | ) | $ | (49,846 | ) | $ | (19,752 | ) |

 

Net cash used in investing activities for the fiscalyear ended January 31, 2007 consisted primarily of cash paid to acquiredSCN and Mid-Atlantic, capital expenditures of $13.4 million related primarilyto our CD and DVD Fulfillment group’s ongoing effort to streamline itsdistribution process and our Shared Services group’s ongoing effort to improveinformation technology infrastructure. Net cash used by investing activitiesalso included the net acquisition of claims by our In-Store Services group of$7.1 million.

Net cash used in investing activities for the fiscalyear ended January 31, 2006 consisted primarily of cash paid to acquireLevy of $45.0 million, net of cash acquired and capital expenditures of $13.1million. Capital expenditures related primarily to our CD and DVD Fulfillmentgroup and its ongoing effort to streamline its distribution process. Net cashused by investing activities also included the net acquisition of claims by ourIn-Store Services group of $7.9 million. These cash consuming activities werepartially offset by net cash acquired of $16.8 million upon completion of ourmerger with Alliance.

For the fiscal year ended January 31, 2005, cashused in investing activities included capital expenditures of $7.1 million,which in part related to our expansion of our distribution facilities in 

38

----

Harrisburg, Pennsylvaniaand Carson City, Nevada. Our advance pay program generated net cash flow of$4.0 million in the fiscal year ended January 31, 2005. In addition, wecollected $6.8 million from the prior operator of our export distributionbusiness during 2005. The initial advances were made as part of the agreementto collect the prior operator’s receivables and pay outstanding payables so asto create a seamless transition for both the customers and suppliers. Inaddition, we incurred approximately $2.6 million in acquisition costs relatedto the acquisition of Alliance Entertainment Corp.

In August 2004, we acquired all customer-basedintangibles (i.e., all market composition, market share and other value)respecting claiming and information services of PROMAG Retail Services, LLC (“Promag”)for approximately $13.2 million. Of the $13.2 million purchase price, $10.0million was funded from a term loan discussed below and $0.75 million in apromissory note payable over a three year period to Promag. Promag provides claimfiling services related to rebates owed retailers from publishers or theirdesignated agent throughout the United States and Canada.

In September 2004, we acquired substantially allof the assets and liabilities of Empire State News Corp. (“Empire”), a magazinewholesaler in northwest New York state, for approximately $5.0 million. Thepurchase price consisted of $3.4 million of cash paid and $1.6 million ofdeferred consideration in the form of two notes payable ($1.2 million) anddeferred compensation, subject to finalization of working capital adjustmentsin accordance with the purchase agreement.

In November 2004, the Company entered into anagreement to terminate the leases under the magazine import and the magazineexport agreements and acquire all import and export assets, naming rights andother intangibles including a non-compete by the seller. The purchase price ofthe import and export businesses was approximately $14.1 million (after anallowed reduction of the purchase price for the payments made by the Companyunder the prior leases agreements). The purchase price was comprised of $4.2million paid in cash on the last business day of November 2004 andadditional notes payable in the principal amount of $7.7 million.

Our borrowing agreementslimit the amount of our capital expenditures in any fiscal year.

**FINANCING CASH FLOW**

Outstanding balances on our credit facility fluctuatepartially due to the timing of the retailer rebate claiming process and ourAdvance Pay program, the seasonality of our CD and DVD Fulfillment and wiremanufacturing business, and the payment cycle of the magazine distributionbusiness. Because the magazine distribution business and Advance Pay programcash requirement peak at our fiscal quarter ends, the reported bank debt levelsusually are the maximum level outstanding during the quarter.

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

Sales of CDs and DVDs are traditionally highest duringour fourth quarter (the holiday season), while returns are highest during ourfirst quarter. Consequently, working capital needs for the home entertainmentproducts marketplace are typically highest in our third quarter due toincreases in inventories purchased for the holiday selling season and extensionof credit terms to certain customers. Historically, the CD and DVD Fulfillmentsegment has financed their working capital needs through cash generated fromoperations, extended terms from suppliers and bank borrowings.

Within our magazine distribution business, oursignificant customers pay weekly, and we pay our suppliers monthly. As aresult, funding requirements peak at the end of the month when supplierpayments are made and decrease over the course of the next month as ourreceivables are collected.

39

----

The wire manufacturing business is seasonal becausemost retailers prefer initiating new programs before the holiday shoppingseason begins, which concentrates revenues in the second and third quarter.Receivables from these fixture programs are generally collected from allparticipants within 180 days. We are usually required to tender payment on thecosts of these programs (raw material and labor) within a shorter period. As aresult, our funding requirements peak in the second and third fiscal quarterswhen we manufacture the wire fixtures and decrease significantly in the fourthand first fiscal quarters as the related receivable are collected andsignificantly less manufacturing activity is occurring.

Thefollowing table shows comparative investing cash flow components for the yearsended January 31, 2007, 2006 and 2005:

| ** **                                                              | ** ** | **Year ended January 31,** | ** ** |
|-------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                              | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                   | ** ** |
| Increase  (decrease) in checks issued against revolving credit facility |       | $                                         | 1,465      |   | $ | (13,529 | ) | $ | (12,178 | ) |
| Borrowings under  credit facilities                                     |       | 71,458                                    |       | 25,712 |   | 7,554 |   |
| Net payments on  notes payable and capital leases                       |       | (18,951                                   | )          | (3,279 | ) | (13,977 | ) |
| Proceeds from the  issuance of common stock                             |       | 2,222                                     |       | 5,040 |   | 46,399 |   |
| Excess tax  benefit from exercise of stock options                      |       | 189                                       |       | — |   | — |   |
| Deferred  financing costs                                               |       | —                                    |       | (1,076 | ) | (161 | ) |
| Cash provided by  financing activities                                  |       | $                                         | 56,383     |   | $ | 12,868 |   | $ | 27,637 |   |

 

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 fromissuance of common stock of $2.2 million, partially offset by payments on notespayable of $21.3 million. Payments on notes payable are composed primarily of paymentson 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 amortgage of $20.0 million. These cash providing activities were partiallyoffset by the reduction in checks issued against future borrowings on creditfacilities of $13.5 million and payments on notes payable of $23.4 million, primarilyrelated to the modification of the Wells Fargo Foothill credit facility and therepayment of a mortgage loan. Finally, the exercise of employee stock optionsfor the fiscal year generated approximately $5.0 million.

Financing activities inthe fiscal year ended January 31, 2005 consisted of proceeds from the saleof 3.8 million shares of common stock. The proceeds generated from the issuanceof common stock were approximately $40.5 million (net of underwriting andrelated expenses). We utilized a portion of these proceeds to repay the WellsFargo Foothill original term loan, the Hilco Capital note payable and the notespayable to former owners. Total payments on notes payable in the current yearwas $24.0 million. For the fiscal year ended January 31, 2005, borrowingson the credit facilities totaled $7.6 million and a term loan in the amount of$10.0 million was issued related to the Promag transaction. In addition, thecash provided by the activities noted above was offset by a $12.2 milliondecrease in checks issued and outstanding at January 31, 2005. Finally,the exercise of employee stock options for the fiscal year generatedapproximately $5.9 million.

**DEBT**

At January 31, 2007, our total debt obligationswere $154.4 million, excluding outstanding letters of credit. Debt consistsprimarily of our amounts owed under a revolving credit facility, a mortgageloan with Wachovia Bank, the notes payable related to the acquisitions of themagazine import and export businesses and Levy, and equipment loans.

40

----

On February 28, 2005, in conjunction with ourmerger with Alliance, we entered into an amended and restated secured financingarrangement with Wells Fargo Foothill, Inc., as arranger andadministrative agent (the “Working Capital Loan Agent”) for each of the lendersthat may become a participant in such arrangement, and their successors andassigns (the “Working Capital Lenders”) pursuant to which the Working CapitalLenders will make revolving loans (“Working Capital Loans”) to us and oursubsidiaries of up to $250 million (“Advances”) and provide for the issuance ofletters of credit. The terms and conditions of the arrangement are governedprimarily by the Amended and Restated Loan Agreement dated February 28,2005 by and among us, our subsidiaries, and Wells Fargo (the “Amended andRestated Loan Agreement”).

The proceeds of the Working Capital Loans were used to(i) finance transaction expenses incurred in connection with the merger ofSource Interlink and Alliance and the reincorporation of Source Interlink intoDelaware, (ii) repay certain existing indebtedness of Alliance and itssubsidiaries, (iii) repay certain existing indebtedness of SourceInterlink to Wells Fargo under our previous credit facility (including, withoutlimitation, a $10 million term loan) and (iv) for working capital andgeneral corporate purposes, including the financing of acquisitions.

Outstanding Advances bear interest at a variableannual rate equal to the prime rate announced by Wells Fargo Bank, NationalAssociation’s San Francisco office, plus a margin of between 0% and 1.00% basedupon a ratio of the Registrant’s EBITDA to interest expense (“Interest CoverageRatio”). 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 between 2.00% and3.00% based upon our Interest Coverage Ratio. To secure repayment of theWorking Capital Loans and other obligations of ours to the Working CapitalLenders, we and our subsidiaries granted a security interest in all of ourpersonal property assets to the Working Capital Loan Agent, for the benefit ofthe Working Capital Lenders. The Working Capital Loans mature on October 31,2010.

The commitment ofthe Working Capital Lenders to make Advances is subject to the existence ofsufficient eligible assets to support such Advances under a specified borrowingbase formula and compliance with, among other things, certain financialcovenants. Under the Amended and Restated Loan Agreement, we are required tomaintain a specified minimum level of EBITDA and compliance with specifiedfixed charge coverage and debt to EBITDA ratios. In addition, we areprohibited, without consent from the Working Capital Lenders, from:

           (i)  incurring additional indebtedness or liens onour personal property assets;

         (ii)  engaging in any merger, consolidation,acquisition or disposition of assets or other fundamental corporate change;

        (iii)  permitting a change of control of us;

         (iv)  paying any dividends or making any otherdistribution on capital stock or other payments in connection with thepurchase, redemption, retirement or acquisition of capital stock;

          (v)  changing our fiscal year or methods ofaccounting; and

         (vi)  making capital expenditures in excess of $19.3million during any fiscal year.

Additional eventsof default under the Amended and Restated Loan Agreement include, among others:

           (i)  failure to pay our obligations to the WorkingCapital Lenders or to otherwise observe its covenants under the Amended andRestated Loan Agreement and other loan documents,

         (ii)  any of our subsidiaries becomes insolvent orbankrupt or has any material portion of its assets seized or encumbered, and

41

----

        (iii)  a material breach or default under any of theRegistrant’s material contracts, including contracts for indebtedness.

The balance on the creditfacility at January 31, 2007 was $116.5 million. At January 31, 2007,the Company had availability of $92.7 million. We believe that availabilityunder this credit facility will be sufficient to finance our operation duringthe coming year.

**OFF-BALANCE SHEETARRANGEMENTS**

We do not engage intransactions or arrangements with unconsolidated or other special purposeentities.

**CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES**

Management’s Discussion and Analysis of Financial Conditionand Results of Operations is based on our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires management to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent liabilities. Management bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Senior management has discussed the development,selection and disclosure of these estimates with the audit committee of theboard. Actual results may differ from these estimates under differentassumptions and conditions.

Management believes thefollowing critical accounting policies affect its more significant judgmentsand estimates used in the preparation of its consolidated financial statements.

**REVENUE RECOGNITION**

For traditional accounts, we record a reduction inrevenue for estimated CD, DVD, and magazine sales returns and a reduction incost of sales for estimated purchase returns. Estimated sales returns are basedon historical sales returns and daily point-of-sale data from significantcustomers. The purchase return estimate is calculated from the sales returnreserve based on historical gross profit. If the historical data we use tocalculate these estimates does not properly reflect future results, revenueand/or cost of sales may be misstated.

We do not record areduction in revenue for estimated magazine sales returns or a reduction incost of sales for estimated purchase returns for scan-based accounts. Scan-basedaccounts are accounts which we bill retailers only for magazines that areultimately sold to their customers.

**ALLOWANCE FORDOUBTFUL ACCOUNTS**

We provide for potentialuncollectible accounts receivable based on customer-specific information andhistorical collection experience. If market conditions decline, actualcollection experience may not meet expectations and may result in increased baddebt expenses.

**TAXES ON EARNINGS**

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

42

----

**GOODWILL AND OTHERINTANGIBLE ASSETS**

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

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

In assessing goodwill and intangible assets forimpairment, we make estimates of fair value which are based on our projectionof revenues, operating costs, and cash flows of each reporting unit consideringhistorical and anticipated future results, general economic and marketconditions as well as the impact of planned strategies. The Company combinesthe discounted cash flow fair value with publicly traded company multiples andacquisition multiples of comparable businesses to determine fair value. Generally,we engage third party specialists to assist us with our valuations. Changes inour judgments and projections could result in a significantly differentestimate of the fair value of the reporting units and could result in animpairment of goodwill or other intangible assets.

If the carrying amount of a reporting unit exceeds itsfair value, the Company measures the possible goodwill impairment based upon anallocation of the estimate of fair value  to the underlying assets andliabilities of the reporting unit, including any previously unrecognizedintangible assets., based upon known facts and circumstances as if the acquisitionoccurred currently. The excess of the fair value of the reporting unit over theamounts assigned to its assets and liabilities is the implied fair value ofgoodwill. An impairment loss would be recognized to the extent the carryingvalue of goodwill exceeds the implied fair value of the goodwill. This testperformed in the fourth quarter of fiscal year 2007 indicated that goodwill andother intangible assets related to the In-Store Services reporting unit wereimpaired.

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

Intangible assets withfinite useful lives are amortized over their estimated useful lives. TheCompany evaluates the remaining useful lives of amortizable identifiableintangible assets at each reporting period to determine whether events andcircumstances warrant a revision to the remaining periods of amortization.

43

----

**RECENT ACCOUNTINGPRONOUNCEMENTS**

In February 2007, the FASB issued FAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities* (“FAS 159”). FAS 159 provides entities withthe option to mark certain financial assets and liabilities to market,recognizing unrealized gains and losses through earnings. FAS 159 is effectivefor the Company beginning February 1, 2008. The Company does not believethat adoption of FAS 159 will have a material impact on its results of operations,financial position or cash flows.

In September 2006, the FASB issued FAS No. 157,*Fair Value Measurements* (“FAS 157”). FAS157 provides entities with additional guidance on which to base fair valuemeasurements required in financial statements. FAS 157 is effective for theCompany beginning February 1, 2008. The Company is still assessing theimpact, if any, the adoption of FAS 157 will have on its results of operations,financial position or cash flows.

In June 2006, the FASB issued FIN No. 48, *Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109* (“FIN 48”). FIN 48 provides entities withadditional guidance on measuring the amount of tax benefits to recognize infinancial statements when the tax position from which those benefits arederived is uncertain. FIN 48 is effective for the Company beginning February 1,2007. The Company has not yet completed its evaluation of the impact theadoption of FIN 48 will have on its results of operations, financial positionor cash flows.

In September 2006, the SEC issued SAB No. 108.SAB 108 requires entities to use both a balance sheet and income statementapproach when evaluating the materiality of misstatements and providesregistrants with the opportunity to adopt SAB 108 by recording a cumulativeeffect adjustment to correct misstatements that were considered immaterialunder one of the approaches but are considered material under the other. TheCompany adopted SAB 108 in the fourth quarter of fiscal 2007 by recording acumulative effect adjustment discussed in Note 13.

In March 2006, theFASB issued FAS No. 156, *Accounting for Servicingof Financial Assets—and amendment of FASB Statement No. 140* (“FAS140”). FAS 156 requires that servicing assets and liabilities be initially measuredat fair value and subsequently amortized or re-measured at fair value. TheCompany does not believe that adoption of FAS 156 will have a material impacton its results of operations, financial position or cash flows.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

Our debt primarily relates to credit facilities withWells Fargo Foothill. See “Debt” in Item 7. Management’s Discussion and Analysis.

The revolving credit facility with Wells FargoFoothill had an outstanding principal balance of approximately $116.5 millionat January 31, 2007. Interest on the outstanding balance is charged basedon a variable interest rate related to the prime rate (8.25% at January 31,2007) plus a margin specified in the credit agreement based on an availabilitycalculation (0.0% at January 31, 2007).

As a result of the above, our primary market risksrelate to fluctuations in interest rates. A 1% increase in the prevailingweighted average interest rate on our debt at January 31, 2007, isestimated to cause an increase of $1.4 million in interest expense for the yearending January 31, 2008.

We do not perform any interest rate hedging activitiesrelated to the credit facility.

We have exposure to foreign currency fluctuationthrough our exporting of foreign magazines and the purchased of foreignmagazine for domestic distribution.

44

----

Revenues derived from the export of foreign titles (orsales to domestic brokers who facilitate the export) totaled $35.4 million forthe fiscal year ended January 31, 2007 or 1.9% of total revenues. For themost part, our export revenues are denominated in dollars, and the foreignwholesaler is subject to foreign currency risks. We have the availability tocontrol foreign currency risk via increasing or decreasing the local coverprice paid in the foreign markets. There is a risk that a substantial increasein 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 ourresults of operations.

Domestic distribution (gross) of imported titlestotaled approximately $104.5 million (of a total $2,363.4 million in grossmagazine distribution or 4.4%). Foreign publications are purchased in bothdollars and the local currency of the foreign publisher, primarily Euros andpounds sterling. In the instances where we buy in the foreign currency, wegenerally have the ability to set the domestic cover price, which allows us tominimize if we so choose the foreign currency risk. Foreign titles generallyhave significantly higher cover prices than comparable domestic titles, aresold only at select retail locations, and sales do not appear to be highly impactedby cover price increases. However, a significant negative change in therelative strength of the dollar to these foreign currencies could result inhigher domestic cover prices and result in lower sales of these titles atretail, which would negatively impact our results of operations.

We do not conduct anysignificant hedging activities related to foreign currency.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.

Our consolidated financialstatements are included herein as a separate section of this report whichbegins on page F-1.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES.

**MANAGEMENT’S REPORTON INTERNAL CONTROL OVER FINANCIAL REPORTING**

Our management is responsible for establishing andmaintaining adequate internal control over our financial reporting, as suchterm is defined in Exchange Act Rule 13a-15(f). Under thesupervision and with the participation of management, including our chiefexecutive officer and chief financial officer, we conducted an evaluation ofthe effectiveness of our internal control over financial reporting based on theframework in Internal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). Based on thisevaluation, our management concluded that our internal control over financialreporting was effective as of January 31, 2007.

Our management’s assessment of the effectiveness ofour internal control over financial reporting as of January 31, 2006 hasbeen audited by BDO Seidman LLP, an independent registered public accountingfirm which also audited the Company’s consolidated financial statementsincluded in this Annual Report on Form 10-K. BDO Seidman LLP’sattestation report on management’s assessment of the Company’s internal controlover financial reporting is included below.

45

----

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVERFINANCIAL REPORTING**

Board of DirectorsSource Interlink Companies, Inc.Bonita Springs, Florida

We have audited management’sassessment, included in the accompanying Management’s Report, that SourceInterlink Companies, Inc. maintained effective internal control overfinancial reporting as of January 31, 2007, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that the Company maintained effective internal control overfinancial reporting as of January 31, 2007, is fairly stated, in allmaterial respects, based on the COSO criteria. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of January 31, 2007, based on the COSO criteria.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheet of Source Interlink Companies, Inc.as of January 31, 2007 and 2006, and the related consolidated statementsof operations, stockholders’ equity and cash flows for each of the three yearsin the period ended January 31, 2007 and our report dated April 23,2007 expressed an unqualified opinion on those consolidated financialstatements.

Chicago, Illinois/s/ BDO Seidman, LLPApril 23, 2007

46

----

**CHANGES IN INTERNALCONTROL OVER FINANCIAL REPORTING**

There was no change in ourinternal control over financial reporting that occurred during the quarterended January 31, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

**EVALUATION OF DISCLOSURECONTROLS AND PROCEDURES**

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

Based on this evaluation, our chief executive officerand our chief financial officer have concluded that, subject to the limitationsnoted 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 thatinformation we are required to disclose in reports that we file or submit underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms.

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

**SCOPE OF THEEVALUATION**

The evaluation of our disclosure controls andprocedures included a review of the controls’ objectives and design, thecompany’s implementation of the controls and the effect of the controls on theinformation generated for use in this annual report. In the course of thecontrols evaluation, we sought to identify data errors, control problems oracts of fraud and confirm that appropriate corrective action, including processimprovements, were being undertaken. This type of evaluation is performed on aquarterly basis so that the conclusions of management, including the ChiefExecutive Officer and Chief Financial Officer, concerning the effectiveness ofthe controls can be reported in our quarterly reports on Form 10-Qand to supplement our disclosures made in our Annual Report on Form 10-K.Many of the components of our disclosure controls and procedures are alsoevaluated on an ongoing basis by personnel in our finance department, as wellas our independent auditors who evaluate them in connection with determiningtheir auditing procedures related to their report on our annual financialstatements and not to provide assurance on our controls. The overall goals ofthese various evaluation activities are to monitor our disclosure controls andprocedures, and to modify them as necessary.

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

47

----

**INHERENTLIMITATIONS ON EFFECTIVENESS OF CONTROLS**

The company’s management,including the chief executive officer and chief financial officer, does notexpect that our disclosure controls or our internal control over financialreporting will prevent all error and all fraud. A control system, no matter howwell designed and operated, can provide only reasonable, not absolute,assurance that the control system’s objectives will be met. Further, the designof 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 ofcontrols can provide absolute assurance that all control issues and instancesof fraud, if any, within the company have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Over time, controls may become inadequate because of changes inconditions or deterioration in the degree of compliance with policies orprocedures. Because of the inherent limitations in a cost-effective controlsystem, misstatements due to error or fraud may occur and not be detected.

**ITEM 9B.**       OTHERINFORMATION.

Not applicable.

**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

See the Proxy Statementfor the Company’s 2007 Annual Meeting of Stockholders, which information isincorporated herein by reference.

**CODES OF ETHICS**

We have a long-standingcommitment to conduct our business in accordance with the highest ethicalprinciples. Our Code of Business Conduct and Ethics is applicable to allrepresentatives of our enterprise, including our executive officers and allother employees and agents of our company and our subsidiary companies, as wellas to our directors. A copy of our Code of Business Conduct and Ethics isavailable in the Corporate Governance section of the Investor Relations page ofour website. In addition, our board has adopted a Code of Ethics for the ChiefExecutive Officer and Financial Executives and a Code of Conduct for Directorsand Executive Officers which supplement our Code of Business Conduct andEthics. A copy of each of these codes is available on the Corporate Governancesection of the Investor Relations page of our website. We will discloseany amendments to, or waivers from, our Codes of Ethics on our website atwww.sourceinterlink.com.

**ITEM 11.**         EXECUTIVECOMPENSATION.

See the Proxy Statementfor the Company’s 2007 Annual Meeting of Stockholders, which information isincorporated herein by reference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS.

See the Proxy Statementfor the Company’s 2007 Annual Meeting of Stockholders, which information isincorporated herein by reference.

48

----

**ITEM 13.**         CERTAINRELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.

See the Proxy Statementfor the Company’s 2007 Annual Meeting of Stockholders, which information isincorporated herein by reference.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES.

See the Proxy Statementfor the Company’s 2007 Annual Meeting of Stockholders, which information isincorporated herein by reference.

**PART IV**

**ITEM 15.**         EXHIBITS,FINANCIAL STATEMENT SCHEDULES.

(A)  1.   FINANCIALSTATEMENTS:

Report of Independent Registered Public AccountingFirm

Consolidated balance sheets—January 31, 2007 and2006

Consolidated statements of operations—years ended January 31,2007, 2006 and 2005

Consolidated statements of stockholders’ equity—yearsended January 31, 2007, 2006 and 2005

Consolidated statements of cash flows—years ended January 31,2007, 2006 and 2005

Notes to consolidated financial statements

2.   FINANCIAL STATEMENT SCHEDULES

The following consolidated financial statementschedule of Source Interlink Companies, Inc. and subsidiaries is includedherein:

Schedule II—Valuation and qualifying accounts S-1

All other schedules for which provision is made in theapplicable accounting regulations of the Securities and Exchange Commission arenot required under the related instructions or are inapplicable, and thereforehave been omitted.

3.   EXHIBITS

**See Exhibit Index**

49

----

**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, as amended, the registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.
|                     | SOURCE INTERLINK COMPANIES, INC. |
|---------------------|----------------------------------|
| April 25, 2007 | By:                              | /s/ MARC FIERMAN |
|                |                             | Marc Fierman |
|                |                             | Chief Financial Officer |
|                |                             | (principal financial officer) |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, thisreport has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.
| April 25, 2007          | /s/ MICHAEL R.  DUCKWORTH                       |
|------------------------------|-------------------------------------------------|
|                         | Michael R. Duckworth                            |
|                         | Chairman of the Board of Directors              |
|                         | (principal executive officer)                   |
| April 25, 2007          | /s/ JAMES R. GILLIS                             |
|                         | James R. Gillis                                 |
|                         | Interim Co-Chief Executive Officer and Director |
| April 25, 2007          | /s/ GRAY DAVIS                                  |
|                         | Gray Davis                                      |
|                         | Director                                        |
|                         |                                            |
|                         | Ariel Z. Emanuel                                |
|                         | Director                                        |
| April 25, 2007          | /s/ DAVID R. JESSICK                            |
|                         | David R. Jessick                                |
|                         | Director                                        |
| April 25, 2007          | /s/ ALLAN R. LYONS                              |
|                         | Allan R. Lyons                                  |
|                         | Director                                        |
| April 25, 2007          | /s/ GREGORY MAYS                                |
|                         | Gregory Mays                                    |
|                         | Director                                        |
| April 25, 2007          | /s/ GEORGE A. SCHNUG                            |
|                         | George A. Schnug                                |
|                         | Director                                        |
| April 25, 2007 * * | /s/ TERRENCE J. WALLOCK                         |
|                         | Terrence J. Wallock                             |
|                         | Director                                        |

 

50

----

**EXHIBITINDEX**
| EXHIBIT   NO. | ** ** | **DESCRIPTION**                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| 2.1           |       | 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).                                                                                                                                          |       |

51

----

 
| 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).                                                                                                                                                  |   |

52

----

 
| 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).                                                                                                                                                                                                                                    |   |

53

----

 
| 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.                                                                                                                                                |   |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.49**  |   | 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).                                                                                                                                                                       |   |
| 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)                                                                |   |

54

----

 
| 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, Minnesota                                                                                                                                           |   |
| 10.66   |   | Lease Agreement  dated March 15, 2000 between High Properties and the Chas. Levy  Circulating Company, LLC relating to 1850 Colonial Village Lane, Lancaster,  Pennsylvania                                                                                                                                                 |   |
| 10.66.1 |   | Amendment #1 to  the Lease dated December 3, 2003                                                                                                                                                                                                                                                                           |   |
| 10.67   |   | 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.                                                                                                                                             |   |
| 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.                                                                                                                                                                                                                                 |   |

----

*                    Filedherewith

**             Indicates managementcontract or compensatory plan, contract or arrangement

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

55

----

**SOURCEINTERLINK COMPANIES, INC.INDEX OF FINANCIAL STATEMENTS**
| AUDITED CONSOLIDATED FINANCIAL STATEMENTS OF SOURCE INTERLINK COMPANIES, INC.                               | ** ** | ** ** | ** ** | **PAGE** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                                            |       |       | F-2        |     |       |
| Consolidated  Balance Sheets at January 31,  2007 and 2006                                                                                |       |       | F-3        |     |       |
| Consolidated Statements of Operations for the fiscal  years ended January 31,  2007, 2006 and 2005                                        |       |       | F-4        |     |       |
| Consolidated Statements of Stockholders’ Equity for  the fiscal years ended January 31,  2007, 2006 and 2005     |       |       | F-5        |     |       |
| Consolidated Statements of Cash Flows for the fiscal  years ended January 31,  2007, 2006 and 2005                                        |       |       | F-6        |     |       |
| Notes to Consolidated Financial Statements                                                                                                          |       |       | F-7        |     |       |
| Financial  Statement Schedule                                                                                                                       |       |       | S-1        |     |       |

 

F-1

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

Board of DirectorsSource Interlink Companies, Inc.Bonita Springs, Florida

We have audited the accompanying consolidated balancesheets of Source Interlink Companies, Inc. as of January 31, 2007 and2006 and the related consolidated statements of operations, stockholders’equity and cash flows for each of the three years in the period ended January 31,2007. We have also audited the schedule listed in the accompanying index. Theseconsolidated financial statements and schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements and schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements and schedule are free ofmaterial misstatement. An audit also includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements andschedule, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall presentation of theconsolidated financial statements and schedule. We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements andschedule referred to above present fairly, in all material respects, thefinancial position of Source Interlink Companies, Inc. at January 31,2007 and 2006 and the results of its operations and its cash flows for each ofthe three years in the period ended January 31, 2007, in conformity withaccounting principles generally accepted in the United States of America.

Also, in our opinion, the information in the schedulepresents fairly, in all material respects, the information set forth therein.

As described in Note 13 to the consolidated financialstatements, effective February 1, 2006, the Company adopted the fair valuemethod of accounting provisions of Statement of Financial Accounting StandardNo. 123 (revised 2004), “Share Based Payment”.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Source Interlink Companies, Inc.’sinternal control over financial reporting as of January 31, 2007, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO) and ourreport dated April 23, 2007 expressed an unqualified opinion thereon.

/s/ BDO Seidman, LLPChicago, IllinoisApril 23, 2007

F-2

----

**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED BALANCE SHEETS(IN THOUSANDS)**

| ** **                                                                              | ** ** | **January 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                              | ** ** | **2007**             | ** ** | **2006** | ** ** |
| **ASSETS**                                                                              |       |                 |       |   |   |
| Current assets                                                                          |       |                 |       |   |   |
| Cash                                                                                    |       | $                    | —     |   | $ | 23,239 |   |
| Trade receivables, net                                                                  |       | 102,658              |       | 129,782 |   |
| Purchased claims receivable                                                             |       | 16,983               |       | 9,922 |   |
| Inventories                                                                             |       | 248,941              |       | 198,483 |   |
| Income tax receivable                                                                   |       | 9,932                |       | 2,180 |   |
| Deferred tax asset                                                                      |       | 29,531               |       | 16,403 |   |
| Other                                                                                   |       | 5,440                |       | 6,058 |   |
| Total current assets                                                                    |       | 413,485              |       | 386,067 |   |
| Property, plants and equipment                                                          |       | 98,812               |       | 89,971 |   |
| Less accumulated depreciation and amortization                                          |       | (30,897              | )          | (23,255 | ) |
| Net property, plants and equipment                                                      |       | 67,915               |       | 66,716 |   |
| Other assets                                                                            |       |                 |       |   |   |
| Goodwill, net                                                                           |       | 395,902              |       | 302,293 |   |
| Intangibles, net                                                                        |       | 118,971              |       | 118,988 |   |
| Other                                                                                   |       | 13,758               |       | 10,408 |   |
| Total other assets                                                                      |       | 528,631              |       | 431,689 |   |
| Total assets                                                                            |       | $                    | 1,010,031  |   | $ | 884,472 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                          |       |                 |       |   |   |
| Current liabilities                                                                     |       |                 |       |   |   |
| Checks issued against future advances on revolving  credit facility                     |       | $                    | 1,465      |   | $ | — |   |
| Accounts payable (net of allowance for returns of  $164,069 and $167,423, respectively) |       | 308,184              |       | 249,207 |   |
| Accrued expenses                                                                        |       | 62,838               |       | 71,867 |   |
| Deferred revenue                                                                        |       | 2,630                |       | 3,226 |   |
| Current portion of obligations under capital leases                                     |       | 995                  |       | 476 |   |
| Current maturities of debt                                                              |       | 7,850                |       | 6,508 |   |
| Total current liabilities                                                               |       | 383,962              |       | 331,284 |   |
| Other liabilities                                                                       |       |                 |       |   |   |
| Deferred tax liability                                                                  |       | 32,500               |       | 4,526 |   |
| Obligations under capital leases                                                        |       | 1,069                |       | 1,118 |   |
| Debt, less current maturities                                                           |       | 146,534              |       | 80,727 |   |
| Other                                                                                   |       | 6,519                |       | 7,224 |   |
| Total other liabilities                                                                 |       | 186,622              |       | 93,595 |   |
| Total liabilities                                                                       |       | 570,584              |       | 424,879 |   |
| **STOCKHOLDERS’  EQUITY**                                                          |       |                 |       |   |   |
| Contributed capital                                                                     |       |                 |       |   |   |
| Preferred stock, $0.01 par (2,000 shares authorized;  none issued)                      |       | —               |       | — |   |
| Common stock, $0.01 par (100,000 shares authorized;  52,064 and 51,704 shares issued)   |       | 521                  |       | 517 |   |
| Additional paid-in capital                                                              |       | 474,796              |       | 467,543 |   |
| Total contributed capital                                                               |       | 475,317              |       | 468,060 |   |
| Accumulated deficit                                                                     |       | (37,766              | )          | (10,817 | ) |
| Accumulated other  comprehensive income                                                 |       |                 |       |   |   |
| Foreign currency translation                                                            |       | 1,896                |       | 2,350 |   |
| Total stockholders’ equity                                                         |       | 439,447              |       | 459,593 |   |
| Total liabilities  and stockholders’ equity                                        |       | $                    | 1,010,031  |   | $ | 884,472 |   |

 

See accompanying notes to Consolidated Financial Statements.

F-3

----

**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)**

| ** **                                                                                                 | ** ** | **Year ended January 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues                                                                                                   |       | $                                         | 1,854,845  |   | $ | 1,527,451 |   | $ | 356,644 |   |
| Cost of revenues  (including depreciation and amortization of $928, $1,245 and $1,225,  respectively)      |       | 1,468,788                                 |       | 1,219,997 |   | 258,851 |   |
| Gross profit                                                                                               |       | 386,057                                   |       | 307,454 |   | 97,793 |   |
| Selling, general  and administrative expense                                                               |       | 236,655                                   |       | 177,867 |   | 51,379 |   |
| Fulfillment  freight                                                                                       |       | 103,858                                   |       | 72,806 |   | 21,067 |   |
| Depreciation and  amortization                                                                             |       | 25,368                                    |       | 18,213 |   | 3,751 |   |
| Impairment of  Goodwill and Intangible Assets                                                              |       | 32,742                                    |       |   |   |   |   |
| Integration and  relocation expense                                                                        |       | 3,664                                     |       | — |   | 2,450 |   |
| Disposal of land,  buildings and equipment, net                                                            |       | 950                                       |       | — |   | 1,122 |   |
| Merger and acquisition  charges                                                                            |       | —                                    |       | 3,319 |   | — |   |
| Operating (loss) income                                                                                    |       | (17,180                                   | )          | 35,249 |   | 18,024 |   |
| Other income  (expense):                                                                                   |       |                                      |       |   |   |   |   |
| Interest expense (including amortization of deferred  financing fees of $607, $631 and $471, respectively) |       | (12,729                                   | )          | (6,794 | ) | (1,575 | ) |
| Interest income                                                                                            |       | 193                                       |       | 220 |   | 175 |   |
| Write off of deferred financing costs and original  issue  discount                                        |       | —                                    |       | — |   | (1,495 | ) |
| Other                                                                                                      |       | (134                                      | )          | 203 |   | 161 |   |
| Total other expense                                                                                        |       | (12,670                                   | )          | (6,371 | ) | (2,734 | ) |
| (Loss) income from continuing operations, before income  taxes                                             |       | (29,850                                   | )          | 28,878 |   | 15,290 |   |
| Income tax (benefit)  expense                                                                              |       | (5,194                                    | )          | 14,553 |   | 2,228 |   |
| (Loss) income from continuing operations                                                                   |       | (24,656                                   | )          | 14,325 |   | 13,062 |   |
| Loss from  discontinued operations, net of tax                                                             |       | —                                    |       | (1,446 | ) | (980 | ) |
| Net (loss) income                                                                                          |       | $                                         | (24,656    | ) | $ | 12,879 |   | $ | 12,082 |   |
| Earnings (loss) per  share—basic:                                                                     |       |                                      |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                         | (0.48      | ) | $ | 0.29 |   | $ | 0.57 |   |
| Discontinued operations                                                                                    |       | —                                    |       | (0.03 | ) | (0.04 | ) |
| Total                                                                                                      |       | $                                         | (0.48      | ) | $ | 0.26 |   | $ | 0.53 |   |
| Earnings (loss) per  share—diluted:                                                                   |       |                                      |       |   |   |   |   |
| Continuing operations                                                                                      |       | $                                         | (0.48      | ) | $ | 0.28 |   | $ | 0.53 |   |
| Discontinued operations                                                                                    |       | —                                    |       | (0.03 | ) | (0.04 | ) |
| Total                                                                                                      |       | $                                         | (0.48      | ) | $ | 0.25 |   | $ | 0.49 |   |
| Weighted average common shares outstanding—basic                                                      |       | 51,838                                    |       | 49,097 |   | 22,963 |   |
| Weighted average common  shares outstanding—diluted                                                   |       | 51,838                                    |       | 50,894 |   | 24,833 |   |

 

See accompanying notes to Consolidated Financial Statements.

F-4

----

**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY(IN THOUSANDS)**
|                                                                                            | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Accumulated  Other**  | ** ** | ** **             | ** ** | ** ** | ** ** | **Total**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                                                                 | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **Treasury Stock** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                 | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income (Loss)**  | ** ** | **Shares**             | ** ** | **Amount** | ** ** | **Equity** | ** ** |
| Balance, January 31, 2004                                                             |       |                  | 18,991     |        |       |            | $          | 190               |       |                    |       | $                      | 102,297    |       |       |       | $          | (35,778 | ) |   |   | $ | 932 |   |   |   | 100 |   |   |   | $ | (567 | ) |   |   | $ | 67,074 |   |   |
| Net income                                                                                 |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       | 12,082     |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 12,082 |   |   |
| Foreign currency translation                                                               |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   | 507 |   |   |   |   |   |   |   |   |   |   |   | 507 |   |   |
| Comprehensive income                                                                       |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 12,589 |   |   |
| Exercise of stock options                                                                  |       |                  | 1,058      |        |       |            | 10         |              |       |                    | 5,915      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,925 |   |   |
| Tax benefit from stock options exercised                                                   |       |                  | —     |        |       |            | —     |              |       |                    | 1,621      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,621 |   |   |
| Public offer proceeds (net of offering costs of  $3,226)                                   |       |                  | 3,800      |        |       |            | 38         |              |       |                    | 40,436     |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 40,474 |   |   |
| Balance, January 31, 2005                                                             |       |                  | 23,849     |        |       |            | 238        |              |       |                    | 150,269    |                   |       |       | (23,696    | )          |       |   | 1,439 |   |   |   | 100 |   |   |   | (567 | ) |   |   | 127,683 |   |   |
| Net income                                                                                 |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       | 12,879     |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 12,879 |   |   |
| Foreign currency translation                                                               |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   | 911 |   |   |   |   |   |   |   |   |   |   |   | 911 |   |   |
| Comprehensive income                                                                       |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 13,790 |   |   |
| Exercise of stock options                                                                  |       |                  | 1,013      |        |       |            | 11         |              |       |                    | 5,029      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 5,040 |   |   |
| Tax benefit from stock options exercised                                                   |       |                  | —     |        |       |            | —     |              |       |                    | 1,866      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,866 |   |   |
| Stock issued in Alliance acquisition                                                       |       |                  | 26,942     |        |       |            | 269        |              |       |                    | 304,445    |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 304,714 |   |   |
| Exchange of stock options and warrants to acquire  Alliance common stock    |       |                  | —     |        |       |            | —     |              |       |                    | 6,500      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 6,500 |   |   |
| Retirement of treasury stock                                                               |       |                  | (100       | )           |       |            | (1         | )                 |       |                    | (566       | )                      |       |       | —     |       |       |   | — |   |   |   | (100 | ) |   |   | 567 |   |   |   | — |   |   |
| Balance, January 31, 2006 as reported                                            |       |                  | 51,704     |        |       |            | 517        |              |       |                    | 467,543    |                   |       |       | (10,817    | )          |       |   | 2,350 |   |   |   | — |   |   |   | — |   |   |   | 459,593 |   |   |
| APB No. 25 cumulative effect adjustment                                               |       |                  | —     |        |       |            | —     |              |       |                    | 2,996      |                   |       |       | (2,293     | )          |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 703 |   |   |
| Balance, February 1, 2006                                                             |       |                  | 51,704     |        |       |            | 517        |              |       |                    | 470,539    |                   |       |       | (13,110    | )          |       |   | 2,350 |   |   |   | — |   |   |   | — |   |   |   | 460,296 |   |   |
| Net loss                                                                                   |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       | (24,656    | )          |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (24,656 | ) |   |
| Foreign currency translation                                                               |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   | (454 | ) |   |   |   |   |   |   |   |   |   |   | (454 | ) |   |
| Comprehensive loss                                                                         |       |                  |       |        |       |            |       |              |       |                    |       |                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | (25,110 | ) |   |
| Stock compensation expense                                                                 |       |                  | —     |        |       |            | —     |              |       |                    | 1,850      |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 1,850 |   |   |
| Exercise of stock options and warrants                                                |       |                  | 360        |        |       |            | 4          |              |       |                    | 2,218      |                   |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   | 2,222 |   |   |
| Excess tax benefit from stock options exercised                                            |       |                  | —     |        |       |            | —     |              |       |                    | 189        |                   |       |       | —     |       |       |   | — |   |   |   | — |   |   |   | — |   |   |   | 189 |   |   |
| Balance,  January 31, 2007                                                            |       |                  | 52,064     |        |       |            | $          | 521               |       |                    |       | $                      | 474,796    |       |       |       | $          | (37,766 | ) |   |   | $ | 1,896 |   |   |   | — |   |   |   | $ | — |   |   |   | $ | 439,447 |   |   |

 

See accompanying notes to Consolidated Financial Statements.

F-5

----

**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)**
|                                                                                                     | ** ** | **Year ended January 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| **OPERATING ACTIVITIES**                                                                            |       |                                      |       |   |   |   |   |
| Net (loss) income                                                                                   |       | $                                         | (24,656    | ) | $ | 12,879 |   | $ | 12,082 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by (used in) operating activities: |       |                                      |       |   |   |   |   |
| Depreciation and  amortization                                                                      |       | 26,903                                    |       | 20,089 |   | 5,447 |   |
| Provision for  losses on accounts receivable                                                        |       | 3,156                                     |       | 6,100 |   | 3,003 |   |
| Deferred income  taxes                                                                              |       | (13,296                                   | )          | 7,395 |   | (1,382 | ) |
| Deferred revenue                                                                                    |       | (1,050                                    | )          | 997 |   | 525 |   |
| Impairment of  Goodwill and Intangible Assets                                                       |       | 32,742                                    |       |   |   |   |   |
| Disposal of land,  buildings and equipment, net                                                     |       | 950                                       |       | — |   | 1,122 |   |
| Write off of  deferred financing costs and original issue discount                                  |       | —                                    |       | — |   | 1,495 |   |
| Stock compensation  expense                                                                         |       | 1,850                                     |       | — |   | — |   |
| Excess tax benefit  from exercise of stock options                                                  |       | —                                    |       | 1,866 |   | 1,621 |   |
| Other                                                                                               |       | 13                                        |       | 700 |   | (1,589 | ) |
| Changes in assets and  liabilities (excluding business combinations):                               |       |                                      |       |   |   |   |   |
| Decrease  (increase) in accounts receivable                                                         |       | 15,681                                    |       | (33,295 | ) | (10,256 | ) |
| (Increase)  decrease in inventories                                                                 |       | (30,134                                   | )          | (41,518 | ) | 610 |   |
| (Increase)  decrease in income tax receivable                                                       |       | (7,752                                    | )          | 95 |   | (208 | ) |
| (Increase)  decrease in other current and non-current assets                                        |       | (4,060                                    | )          | 2,059 |   | 914 |   |
| (Decrease)  increase in accounts payable and other liabilities                                      |       | (21,091                                   | )          | 81,463 |   | (24,845 | ) |
| Cash (used in)  provided by operating activities                                                    |       | (20,744                                   | )          | 58,830 |   | (11,461 | ) |
| **INVESTING ACTIVITIES**                                                                            |       |                                      |       |   |   |   |   |
| Capital  expenditures                                                                               |       | (13,379                                   | )          | (13,069 | ) | (7,146 | ) |
| Purchase of claims                                                                                  |       | (109,193                                  | )          | (109,095 | ) | (87,230 | ) |
| Payments received  on purchased claims                                                              |       | 102,132                                   |       | 101,179 |   | 91,181 |   |
| Net cash from  Alliance Entertainment Corp. acquisition                                             |       | —                                    |       | 16,882 |   | (2,585 | ) |
| Acquisition 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                                     |       | 1,548 |   | 735 |   |
| Collections under  magazine export agreement                                                        |       | —                                    |       | — |   | 6,830 |   |
| Payments under  magazine import agreement                                                           |       | —                                    |       | — |   | (1,500 | ) |
| Acquisition of  Empire State News Corp.                                                             |       | —                                    |       | — |   | (3,352 | ) |
| Acquisition of  Worldwide agreements                                                                |       | —                                    |       | — |   | (4,212 | ) |
| Acquisition of  Promag Retail Services, LLC                                                         |       | —                                    |       | — |   | (12,473 | ) |
| Acquisition of  customer list                                                                       |       | —                                    |       | (2,300 | ) | — |   |
| Other                                                                                               |       | (1,344                                    | )          | — |   | — |   |
| Cash used in  investing activities                                                                  |       | (58,878                                   | )          | (49,846 | ) | (19,752 | ) |
| **FINANCING ACTIVITIES**                                                                            |       |                                      |       |   |   |   |   |
| Increase  (decrease) in checks issued against revolving credit facility                             |       | 1,465                                     |       | (13,529 | ) | (12,178 | ) |
| Borrowings under  credit facilities                                                                 |       | 71,458                                    |       | 25,712 |   | 7,554 |   |
| Payments of notes  payable                                                                          |       | (21,383                                   | )          | (23,357 | ) | (23,977 | ) |
| Borrowings under  notes payable                                                                     |       | 3,063                                     |       | 20,605 |   | 10,000 |   |
| Proceeds from the  issuance of common stock                                                         |       | 2,222                                     |       | 5,040 |   | 46,399 |   |
| Payments under  capital leases                                                                      |       | (631                                      | )          | (527 | ) | — |   |
| Excess tax benefit  from exercise of stock options                                                  |       | 189                                       |       | — |   | — |   |
| Deferred financing  costs                                                                           |       | —                                    |       | (1,076 | ) | (161 | ) |
| Cash provided by  financing activities                                                              |       | 56,383                                    |       | 12,868 |   | 27,637 |   |
| (Decrease)  increase in cash                                                                        |       | (23,239                                   | )          | 21,852 |   | (3,576 | ) |
| Cash, beginning of  period                                                                          |       | 23,239                                    |       | 1,387 |   | 4,963 |   |
| Cash, end of period                                                                                 |       | $                                         | —     |   | $ | 23,239 |   | $ | 1,387 |   |

 

See accompanying notes to Consolidated Financial Statements.

F-6

----

**SOURCE INTERLINKCOMPANIES, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.**                 SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

**BUSINESS**

Source Interlink Companies, Inc.(the “Company”) and its subsidiaries distribute home entertainment productsdirect to specialty and mainstream retailers, design, manufacture, install andremove retail fixtures located at the check-out lane, manage retailers’ claimsfor rebates with magazine publishers, provide access to a comprehensivedatabase of point-of-sale data to retailers and product managers, andmanufacture and install high-end wood retail display fixtures principally inthe United States.

**PRINCIPLES OFCONSOLIDATION**

The consolidated financialstatements include the accounts of Source Interlink Companies, Inc. andits wholly-owned subsidiaries (collectively, the Company) as of the date theywere acquired. All significant intercompany accounts and transactions have beeneliminated.

**USE OF ESTIMATES**

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

**REVENUE RECOGNITION**

**CD, DVD andMagazine Fulfillment**

Revenues from the sale of CDs, DVDs and magazines theCompany distributes are recognized at the time of delivery (shipment for CDsand DVDs) less allowances for estimated returns. Revenues from the sale of CDs,DVDs and magazines to wholesalers that are not shipped through our distributioncenters are recognized at the later of notification from the shipping agentthat the product has been delivered or the on-sale date of the CD, DVD ormagazine. The Company records a reduction in revenue for estimated CD, DVD andmagazine sales returns and a reduction in cost of sales for estimated CD, DVDand magazine purchase returns. Estimated returns are based on historicalsell-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 retailstore. In such arrangements, the Company recognizes revenue upon the sale ofthe merchandise by the retailer.

During January 2007,the Company re-negotiated terms with its largest specialty magazinedistribution customer. As a result, the Company began billing this customeronly for magazines that actually scan at their checkouts. In the past theCompany had billed this customer for the gross amount of magazines actuallyshipped to their locations and allowed them to take credits for magazinesreturned. This change resulted in a change in the Company’s revenue recognitionpolicy for this customer from recognizing gross sales upon shipment with areserve for returns to recognizing revenues only when magazines scan throughtheir checkouts. As a result, the Company reversed revenues and accountsreceivable for all magazines that it had shipped into their stores but that hadnot yet scanned through their checkouts, reduced cost of revenues for thosemagazines and recorded those magazines as inventory

F-7

----

**Fulfillment &Return Processing Services**

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

**Rebate Claim Filing**

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

**InformationProducts**

Revenues from informationproduct contracts are recognized ratably over the subscription term, generallyone year.

**Custom DisplayManufacturing**

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

**INVENTORIES**

Inventories are valued atthe lower of cost or market. Costs within our Magazine Fulfillment and In-StoreServices groups are determined by the first-in, first-out (“FIFO”) method. Costwithin our CD and DVD Fulfillment group is determined by the average costmethod.

**PROPERTY, PLANTS &EQUIPMENT**

Propertyand equipment are stated at cost. Depreciation is computed using thestraight-line method for financial reporting over the estimated useful lives asfollows:

| ** **              | ** ** | **Life**  | ** ** |
|-------------------------|------------|-----------|------------|
| Asset Class:            |       |      |       |
| Buildings               |       | 40 years  |       |
| Machinery and equipment |       | 5-7 years |       |
| Vehicles                |       | 5-7 years |       |
| Furniture and fixtures  |       | 5-7 years |       |
| Computers               |       | 3-5 years |       |

 

Leasehold improvements areamortized over the shorter of the useful life of the asset or the life of thelease.

F-8

----

**GOODWILL AND OTHERINTANGIBLE ASSETS**

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

In accordance with SFAS No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*,” we review finite-lived intangible assets forimpairment whenever an event occurs or circumstances change which indicatesthat the carrying amount of such assets may not be fully recoverable.Determination of recoverability is based on an estimate of undiscounted futurecash 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 assetcompared to its carrying value. Impairment losses, if any, are reflected inoperating income or loss in the Consolidated Statements of Income (Loss).

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 historicaland anticipated future results, general economic and market conditions as wellas the impact of planned strategies. The Company combines the discounted cashflow fair value with publicly traded company multiples (market comparisonapproach) and acquisition multiples of comparable businesses (industryacquisition approach) to determine fair value. Generally, we engage third partyspecialists to assist us with our valuations. Changes in our judgments andprojections could result in a significantly different estimate of the fairvalue of the reporting units and could result in an impairment of goodwill orother intangible assets.

If the carrying amount ofa reporting unit exceeds its fair value, the Company measures the possiblegoodwill impairment based upon an allocation of the estimate of fair value to the underlying assets and liabilities of the reporting unit, includingany previously unrecognized intangible assets, based upon known facts andcircumstances as if the acquisition occurred currently. The excess of the fairvalue of the reporting unit over the amounts assigned to its assets and liabilitiesis the implied fair value of goodwill. An impairment loss would be recognizedto the extent the carrying value of goodwill exceeds the implied fair value ofthe goodwill. This test performed in the fourth quarter of fiscal year 2007indicated that goodwill related to the In-Store Services business unit wasimpaired

**INTANGIBLE ASSETS**

The Company currentlyamortizes intangible assets over the estimated useful life of the asset rangingfrom 3 to 20 years (See Footnote 6). The weighted average estimated useful lifeis approximately 18 years for customer lists, 4 years for non-competeagreements, and 7 years for software.

**DEFERRED FINANCINGFEES**

Deferred financing fees are capitalized and amortizedover the life of the credit facility and are included in other long-termassets.

F-9

----

**IMPAIRMENT OFLONG-LIVED ASSETS**

The Company accounts forlong-live assets in accordance with FAS 144, “Accounting for the Impairment orDisposal of Long Lived Assets.” This Statement applies to long-lived assetsother than goodwill, and prescribes a probability-weighted cash flow estimationapproach to evaluate the recoverability of the carrying amount of long-livedassets such as property, plant and equipment. The Company records impairmentlosses on long-lived assets used in operations, other than goodwill, whenevents and circumstances indicate that the assets might be impaired and theestimated cash flows (undiscounted and without interest charges)  to begenerated by those assets over the remaining lives of the assets are less thanthe carrying amount of those items. Our cash flow estimates are based onhistorical results adjusted to reflect our best estimate of future market andoperating conditions. The net carrying value of assets not recoverable isreduced to fair value.

**CONCENTRATIONS OFCREDIT RISK**

The Company has significant concentrations of creditrisk in its CD and DVD Fulfillment, Magazine Fulfillment and In-Store Servicessegments. If the Company experiences a significant reduction in business fromits clients, the Company’s results of operations and financial condition may bematerially and adversely affected. The Company aggregates customers with acommon parent when calculating the applicable percentages. For CD, DVD andmagazine distribution the Company calculates contribution to revenue based onthe actual distribution and estimated sell-through based on the Company’scalculated sales return reserve.

During fiscal 2007, two customers (Barnes and Noble, Inc.and Borders Group, Inc.) accounted for 25.4% (19.6% and 5.8%) of totalrevenues.

During fiscal 2006, two customers accounted for 33.8%(27.5% and 6.3%) of total revenues.

During fiscal 2005, thesetwo customers accounted for 53.2% (28.7% and 24.5%) of total revenues.

**ALLOWANCE FORDOUBTFUL ACCOUNTS**

The Company provides forpotential uncollectible accounts receivable at a level management believes issufficient based on customer specific information and historical collectionexperience.

**SHIPPING ANDHANDLING CHARGES**

Shipping and handlingcharges related to the distribution of magazines and CDs and DVDs are notincluded in Cost of Revenues. Shipping and handling costs totaled approximately$103.9 million, $72.8 million, and $21.1 million in 2007, 2006 and 2005,respectively. The Company charges some customers for shipping and handling,these amounts are included in revenues.

**RELOCATION EXPENSES**

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

During fiscal 2005, the Company incurred $2.5 millionof expenses related principally to distribution center relocations. The Companybegan expansion into the mainstream retail market which resulted indistribution fulfillment centers in Milan, OH, San Diego, CA and Kent, WA beingmoved to Harrisburg, PA and Carson City, NV.

F-10

----

The Company accounted forthe relocations in accordance with FAS 146, “Accounting for Costs Associatedwith Exit or Disposal Activities”. FAS 146 requires recording costs associatedwith an exit or disposal activity at their fair values when a liability has beenincurred.

**INCOME TAXES**

The Company accounts forincome taxes under an asset and liability approach that requires therecognition of deferred tax assets and liabilities for the expected future taxconsequences of events that have been recognized in the Company’s financialstatements or tax returns. In estimating future tax consequences, the Companygenerally considers all expected future events other than enactments of changesin the tax laws or rates.

**FOREIGN CURRENCYTRANSLATION AND TRANSACTIONS**

The financial position andresults of operations of the Company’s foreign subsidiaries are determinedusing local currency as the functional currency. Assets and liabilities ofthese subsidiaries are translated at the exchange rate in effect at eachyear-end. Income statement accounts are translated at the average rate ofexchange prevailing during the year. Translation adjustments arising from theuse of differing exchange rates from period to period are included in the othercomprehensive income account in stockholders’ equity. Gains and lossesresulting from foreign currency transactions, which are not material, areincluded in the Consolidated Statements of Operations.

**COMPREHENSIVEINCOME**

Comprehensive income isdefined to include all changes in equity except those resulting frominvestments by owners and distributions to owners. The Company’s comprehensiveincome item is foreign currency translation adjustments.

**EARNINGS PER SHARE**

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

**FAIR VALUE OFFINANCIAL INSTRUMENTS**

The carrying amounts ofaccounts receivable and accounts payable approximates fair value due to theirshort-term nature. The carrying amount of debt including credit facilitiesapproximates fair value due to their stated interest rate approximating amarket rate. The fair value of the Company’s fixed-rate debt approximates itscarrying amount.

**ACCOUNTING FORSTOCK-BASED COMPENSATION**

FAS No. 123, “Accounting for Stock-BasedCompensation” defined a fair value method of accounting for stock options andother equity instruments. Under the fair value method, compensation cost ismeasured at the grant date based on the fair value of the award and isrecognized over the service period, which is usually the vesting period. Asprovided in FAS No. 123, the Company elected to apply AccountingPrinciples Board (“APB”) Opinion No. 25 and related interpretations inaccounting for its stock-based compensation plans. No stock based compensationwas reflected in the fiscal 2006, 2005 or 2004 net 

F-11

----

income related to ourstock option plans as all options granted in those years had an exercise priceequal to or greater than the market value of the underlying stock on the dateof grant.

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

Thefollowing is a reconciliation of net income per weighted average share had theCompany adopted FAS No. 123 prior to 2007:

| ** **                                   | ** ** | **Year ended January 31,**                         | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(in thousands, except per  share amounts)** | ** ** |
| Net (loss) income  (as reported)             |       | $(24,656                                                          | )          | $12,879 |   | $12,082 |   |
| Stock  compensation costs, net of tax        |       | —                                                            |       | (1,742 | ) | (423 | ) |
| Pro-forma net  (loss) income                 |       | $(24,656                                                          | )          | $11,137 |   | $11,659 |   |
| Weighted average  shares, basic              |       | 51,838                                                            |       | 49,097 |   | 22,963 |   |
| Weighted average  shares, diluted            |       | 51,838                                                            |       | 50,894 |   | 24,833 |   |
| Basic earnings  per share—as reported   |       | $                                                                 | (0.48      | ) | $ | 0.26 |   | $ | 0.53 |   |
| Diluted earnings  per share—as reported |       | $                                                                 | (0.48      | ) | $ | 0.25 |   | $ | 0.49 |   |
| Basic earnings  per share—pro-forma     |       | $                                                                 | (0.48      | ) | $ | 0.23 |   | $ | 0.51 |   |
| Diluted earnings per  share—pro-forma   |       | $                                                                 | (0.48      | ) | $ | 0.22 |   | $ | 0.47 |   |

 

Thefair value of each option grant is estimated on the grant date using theBlack-Scholes option pricing model with the following assumptions:

| ** **               | ** ** | **Year ended January 31,** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| ** **               | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| Dividend yield           |       | 0                                         | %          | 0 | % | 0 | % |
| Expected  volatility     |       | 0.28                                      |       | 0.50 |   | 0.50 |   |
| Risk-free  interest rate |       | 2.15 - 5.10                               | %          | 3.65 - 3.79 | % | 2.18 - 2.86 | % |
| Expected life            |       | 3 years                                   |       | 3 years |   | 3 years |   |

 

**RECLASSIFICATIONS**

Certain prior year amountshave been reclassified in the consolidated financial statements to conform withcurrent year presentation.

**RECENT ACCOUNTINGPRONOUNCEMENTS**

In February 2007, the FASB issued FAS No. 159,*The Fair Value Option for Financial Assets andFinancial Liabilities* (“FAS 159”). FAS 159 provides entities withthe option to mark certain financial assets and liabilities to market,recognizing unrealized gains and losses through earnings. FAS 159 is effectivefor the Company beginning February 1, 2008. The Company does not believethat adoption of FAS 159 will have a material impact on its results ofoperations, financial position or cash flows.

In September 2006, the FASB issued FAS No. 157,*Fair Value Measurements* (“FAS 157”). FAS157 provides entities with additional guidance on which to base fair valuemeasurements required in financial statements. FAS 157 is effective for theCompany beginning February 1, 2008. The Company is still 

F-12

----

evaluating the impact, ifany, that the adoption of FAS 157 will have on its results of operations,financial position or cash flows.

In June 2006, the FASB issued FIN No. 48, *Accounting for Uncertainty in Income Taxes—an interpretation of FASBStatement No. 109* (“FIN 48”). FIN 48 provides entities withadditional guidance on measuring the amount of tax benefits to recognize infinancial statements when the tax position from which those benefits arederived is uncertain. FIN 48 is effective for the Company beginning February 1,2007. The Company has not yet completed its evaluation of the impact theadoption of FIN 48 will have on its results of operations, financial positionor cash flows.

In September 2006, the SEC issued SAB No. 108.SAB 108 requires entities to use both a balance sheet and income statementapproach when evaluating the materiality of misstatements and providesregistrants with the opportunity to adopt SAB 108 by recording a cumulativeeffect adjustment to correct misstatements that were considered immaterialunder one of the approaches but are considered material under the other. TheCompany adopted SAB 108 in the fourth quarter of fiscal 2007 by recording acumulative effect adjustment discussed in Note 13.

In March 2006, theFASB issued FAS No. 156, *Accounting for Servicingof Financial Assets—and amendment of FASB Statement No. 140* (“FAS140”). FAS 156 requires that servicing assets and liabilities be initiallymeasured at fair value and subsequently amortized or re-measured at fair value.The Company does not believe that adoption of FAS 156 will have a materialimpact on its results of operations, financial position or cash flows.

**2.   BUSINESSCOMBINATIONS AND ASSET ACQUISITIONS**

**ACQUISITION OFANDERSON MID-ATLANTIC NEWS, LLC**

In order to strengthen its position in the mainstreammagazine distribution business, the Company and Anderson News, LLC entered intoa Unit Purchase Agreement, on March 30, 2006, pursuant to which theCompany purchased all of the issued and outstanding membership interests ofAnderson Mid-Atlantic News, LLC (“Mid-Atlantic”) from Anderson News, LLC for apurchase price of approximately $4.0 million, subject to adjustment based onthe 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 toMid-Atlantic to repay a portion of its outstanding intercompany debt. Theremaining outstanding intercompany debt of Mid-Atlantic was satisfied byissuance of a promissory note totaling $4.1 million. The promissory note wasrepaid by the Company during fiscal 2007. The purchase price and theintercompany debt repayment were funded from the Company’s revolving line ofcredit.

The total cost of the acquisition was allocated to theassets acquired and liabilities assumed based on their estimated respectivefair values in accordance with FAS 141, Business Combinations. Goodwill, whichis deductible for tax purposes, recorded in connection with the transaction isestimated to total $30.4 million. These amounts will be tested at leastannually for impairment in accordance with FAS 142, Goodwill and OtherIntangible Assets.

The assets acquired and liabilities assumed in theacquisition were recorded in the quarter ended April 30, 2006. Theacquisition was accounted for by the purchase method and, accordingly, theresults of Mid-Atlantic’s operations have been included in our consolidatedstatements of income since March 31, 2006. The pro-forma operating resultsas if the Company had completed the acquisition at the beginning of the periodspresented are not significant to the Company’s consolidated financialstatements and are not presented.

F-13

----

Theassets acquired and liabilities assumed, based on the preliminary internalvaluation, are summarized below:

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

 

***Acquisition of Anderson SCN Services, LLC***

In order to strengthen its position in the mainstreammagazine distribution business, the Company and Anderson News, LLC entered intoa Unit Purchase Agreement, on March 30, 2006,  pursuant to which the Company purchased all ofthe 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 ofthe transaction. In addition, approximately $17.0 million was also provided onthe date of acquisition to SCN to repay a portion of its outstanding intercompanydebt. The remaining outstanding intercompany debt of SCN was satisfied byissuance of a promissory note totaling $10.2 million. The promissory note wasrepaid by the Company during fiscal 2007. The purchase price and theintercompany debt repayment were funded from the revolving line of credit.

The total cost of the acquisition was allocated to theassets acquired and liabilities assumed based on their estimated respectivefair values in accordance with FAS 141, *Business Combinations*.Goodwill, which is deductible for tax purposes, recorded in connection with thetransaction is estimated to total $59.9 million. These amounts will be testedat least annually for impairment in accordance with FAS 142, *Goodwill and Other Intangible Assets*.

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

F-14

----

The assetsacquired and liabilities assumed, based on the preliminary internal valuation,are summarized below:

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

 

**CHAS. LEVYCIRCULATING COMPANY LLC ACQUISITION**

On May 10, 2005, the Company and Chas. LevyCompany LLC (“Seller”) entered into a Unit Purchase Agreement (the “PurchaseAgreement”). Under the terms of the Purchase Agreement, the Company purchasedall of the issued and outstanding membership interests in Chas. LevyCirculating 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 closingdate of the transaction. Seller was the sole member of Levy. In addition,approximately $19.3 million was also provided on the date of acquisition toSeller to repay all outstanding intercompany debt of Levy. The purchase priceand the intercompany debt repayment were funded from the revolving line ofcredit.

On May 10, 2005, as contemplated by the terms ofthe 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 itssole 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 inwhich the Registrant currently distributes DVDs, CDs and/or magazines. Theinitial term of the Distribution Agreement begins on May 10, 2005 andexpires on June 30, 2015. The parties may renew the agreement thereafterfor successive one year periods.

The total cost of the acquisition was allocated to theassets acquired and liabilities assumed based on their respective fair valuesin accordance with FAS 141, Business Combinations. Goodwill and otherintangible assets, which is deductible for tax purposes, recorded in connectionwith the transaction totaled $62.2 million and $15.9 million, respectively.These amounts will be tested at least annually for impairment in accordancewith FAS No. 142, Goodwill and Other Intangible Assets. Deferred taxamounts associated with the acquisition have not been finalized.

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

F-15

----

Theassets acquired and liabilities assumed in the acquisition are summarizedbelow:

| ** **                                | ** ** | **Amount**              | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Cash                                      |       |                    | $          | 4,276 |   |   |
| Trade  receivables, net                   |       |                    | 6,703      |   |   |
| Inventories                               |       |                    | 37,664     |   |   |
| Income tax  receivable                    |       |                    | 4,619      |   |   |
| Current deferred  tax asset               |       |                    | 379        |   |   |
| Property and  equipment                   |       |                    | 1,539      |   |   |
| Goodwill                                  |       |                    | 62,199     |   |   |
| Intangible assets                         |       |                    | 15,865     |   |   |
| Other assets                              |       |                    | 1,728      |   |   |
| Accounts payable  and accrued liabilities |       |                    | (67,928    | ) |   |
| Long-term debt                            |       |                    | (13,359    | ) |   |
| Non-current  deferred tax liability       |       |                    | (1,107     | ) |   |
| Other long-term  liabilities              |       |                    | (3,311     | ) |   |
| Total consideration                       |       |                    | $          | 49,267 |   |   |

 

**ALLIANCEENTERTAINMENT CORP. ACQUISITION**

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

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

The total cost of the acquisition was allocated to theassets acquired and liabilities assumed based on their respective fair valuesin accordance with FAS 141, Business Combinations. Goodwill and otherintangible assets, none of which is deductible for tax purposes, recorded inconnection with the transaction totaled $201.5 million and $94.2 million,respectively. These amounts will be tested at least annually for impairment inaccordance with FAS No. 142, Goodwill and Other Intangible Assets.

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

F-16

----

Theassets acquired and liabilities assumed in the acquisition are summarizedbelow:

| ** **                                | ** ** | **Amount**              | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **(in thousands)** | ** ** |
| Cash                                      |       |                    | $          | 18,567 |   |   |
| Trade  receivables, net                   |       |                    | 48,216     |   |   |
| Inventories                               |       |                    | 102,434    |   |   |
| Property and  equipment                   |       |                    | 41,881     |   |   |
| Goodwill                                  |       |                    | 201,532    |   |   |
| Intangible assets                         |       |                    | 94,214     |   |   |
| Other assets                              |       |                    | 16,326     |   |   |
| Accounts 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 wasaccounted for by the purchase method and, accordingly, the results of Alliance’soperations have been included in our consolidated statements of income since March 1,2005.

**PRO-FORMA OPERATINGRESULTS (Unaudited)**

Thefollowing table summarizes pro forma operating results as if the Company hadcompleted the acquisition of Alliance and Levy on February 1, 2003:

| ** **                              | ** ** | **Year ended January 31,**                     | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                              | ** ** | **(in thousands, except per share data)** | ** ** |
| Revenues                                |       | $                                                             | 1,854,845  |   | $ | 1,697,003 |   | $ | 1,674,794 |   |
| Net (loss) income                       |       | $                                                             | (24,656    | ) | $ | 12,604 |   | $ | 19,505 |   |
| (Loss) earnings per  share—basic   |       |                                                          |       |   |   |   |   |
| Continuing operations                   |       | $                                                             | (0.48      | ) | $ | 0.28 |   | $ | 0.40 |   |
| Discontinued operations                 |       | —                                                        |       | (0.03 | ) | (0.02 | ) |
| Total                                   |       | $                                                             | (0.48      | ) | $ | 0.25 |   | $ | 0.38 |   |
| (Loss) earnings per  share—diluted |       |                                                          |       |   |   |   |   |
| Continuing operations                   |       | $                                                             | (0.48      | ) | $ | 0.27 |   | $ | 0.39 |   |
| Discontinued operations                 |       | —                                                        |       | (0.03 | ) | (0.02 | ) |
| Total                                   |       | $                                                             | (0.48      | ) | $ | 0.24 |   | $ | 0.37 |   |

 

This information has been prepared for comparativepurposes only and does not purport to be indicative of the results ofoperations which actually would have resulted had the acquisitions occurred on February 1,2004, nor is it indicative of future results.

Merger charges related tothe acquisition of Alliance recorded as expenses by the Company through January 31,2006 totaled $3.3 million. These expenses represented severance andpersonnel-related charges, charges to exit certain merchandiser contracts and asuccess fee paid to certain Company executives. These expenses were notcapitalized as they did not represent costs that provide future economicbenefits to the Company.

F-17

----

**MAGAZINE IMPORT ANDEXPORT ACQUISITION**

In May, 2002, the Company entered into an agreementgiving the Company the right to distribute domestically a group of foreignmagazine titles. The agreement called for an initial payment of $2.0 million,$1.0 million in fiscal 2004 and additional contingent payments up to $2.5million spread over the two years ended May 2005 based on the overallgross profit generated from the sale of these titles.

In March, 2003, the Company entered into an agreementgiving the Company the right to distribute internationally a group of domesticmagazine titles. The agreement called for an initial payment of $1.4 million,guaranteed payments totaling $4.2 million spread over the next four fiscalyears, and additional contingent payments up to $5.6 million based on theoverall gross profit generated from the Company’s international sales of thesetitles. Guaranteed payments under both of these agreements were capitalized atinception and were included in intangible assets and were being amortized overfifteen years, the term of the agreements.

In November 2004, these distribution agreementswere terminated when the Company acquired all import and export assets, WMS, Inc.naming rights and other intangibles including a non-compete by the seller. Thepurchase price of the import and export businesses was approximately $14.1million (after an allowed reduction of the purchase price for the payments madeby the Company under the prior leases agreements). The purchase price wascomprised of $4.2 million paid in cash on the last business day of November 2004and additional notes payable in the principal amount of $7.7 million. The firstnote of $8.9 million is payable over 13 quarters in equal installments of $0.7million. In addition, a second note payable in the amount of $1.0 million waspaid in full on May 1, 2005.

Since the company has historically operated thesemagazine import and export businesses under leases, included in the magazinefulfillment segment, results of operations for the import and export businessesare included in the statement of operations for the years ended January 31,2006, 2005 and 2004 respectively. Thus, this acquisition was not material tothe Company’s operations.

Under the original export lease agreement, the Companyagreed to pay the prior owner’s outstanding trade payables out of thecollections of the prior owner’s outstanding receivables. Amounts collected inexcess of payments made or payments in excess of collection were to be settledat a future date. The balance was paid in full in November 2004.

Inconjunction with this acquisition, the assets liabilities were allocated asfollows (in thousands):

| Intangible  assets:                      |   |   |   |
|------------------------------------------|--------|--------|--------|
| Goodwill                                 |   | 8,529  |   |
| Customer lists and non-compete agreement |   | 3,400  |   |
| Total assets  acquired                   |   | 11,929 |   |
| Less: Additional  notes payable issued   |   | (7,717 | )      |
| Total cash paid                          |   | $      | 4,212  |   |
|                                          |        |        |        |  |

 

**PROMAG RETAILSERVICES, LLC ACQUISITION**

In August 2004, the Company acquired all customerbased intangibles (i.e., all market composition, market share and other value)of the claiming and information services of PROMAG Retail Services, LLC (“Promag”)for approximately $13.2 million. Of the $13.2 million purchase price, $10.0million was funded from a note payable with Wells Fargo Foothill noted inFootnote 7 and $0.75 million in a promissory note payable over a three yearperiod to Promag in quarterly installments of approximately $0.05. The resultsof Promag’s operations have been included in our consolidated statements ofoperations since August 1, 2004.

F-18

----

Promag provides claim filing services related torebates owed retailers from publishers or their designated agent throughout theUnited States and Canada. Goodwill and other intangible assets recorded inconnection with the transaction totaled $13.2 million. The intangible assetsare subject to amortization and consist primarily of customer contracts andnon-compete agreements that are amortized on a straight-line basis over aweighted-average useful life of 12.77 years. The fair value assigned tointangible assets and the related weighted-average useful life was based onvaluations prepared by an independent third party appraisal firm usingestimates and assumptions provided by management. The goodwill and intangibleassets were assigned entirely to our In-Store Services segment. Thisacquisition was not material to the Company’s operations.

Inconjunction with this acquisition, the assets liabilities were allocated asfollows (in thousands):

| Intangible  assets:                      |   |   |   |
|------------------------------------------|--------|--------|--------|
| Goodwill                                 |   | 8,723  |   |
| Customer lists and non-compete agreement |   | 4,500  |   |
| Total assets  acquired                   |   | 13,223 |   |
| Less: Note  payable issued               |   | (750   | )      |
| Total cash paid                          |   | $      | 12,473 |   |
|                                          |        |        |        |  |

 

**EMPIRE STATE NEWSCORP. ACQUISITION**

In September 2004, the Company acquiredsubstantially all of the operating assets and liabilities of Empire State NewsCorp. (“Empire”), a magazine wholesaler in northwest New York State forapproximately $5.0 million. The purchase price consisted of $3.4 million ofcash paid and $1.6 million of deferred consideration in the form of two notespayable (see Footnote 7) and deferred consideration, subject to finalization ofworking capital adjustments in accordance with the purchase agreement. Theresults of Empire’s operations have been included in our consolidatedstatements of operations since September 26, 2004. The total cost of theacquisition was allocated to the assets acquired and liabilities assumed basedon their respective fair values in accordance with FAS 141, BusinessCombinations (“FAS 141”). Goodwill recorded in connection with the transactiontotaled $8.7 million. The fair value assigned to goodwill was based onvaluations prepared by an independent third party appraisal firm usingestimates and assumptions provided by management. The goodwill was assignedentirely to our Magazine Fulfillment segment. This acquisition was not materialto the Company’s operations.

Inconjunction with this acquisition, the assets liabilities were allocated asfollows (in thousands):

| Current assets:                    |   | 485    |   |
|------------------------------------|--------|--------|--------|
| Fixed assets                       |   | 1,902  |   |
| Goodwill                           |   | 8,612  |   |
| Total assets  acquired             |   | 10,999 |   |
| Less: Current  liabilities         |   | (6,080 | )      |
| Less: Note  payable issued         |   | (1,200 | )      |
| Less: Other  long-term liabilities |   | (367   | )      |
| Total cash paid                    |   | $      | 3,352  |   |
|                                    |        |        |        |  |

 

F-19

----

**3.   TRADERECEIVABLES**

Tradereceivables consist of the following:

| ** **              | ** ** | **January 31,**    | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| Trade receivables       |       | $                       | 312,116    |   | $ | 343,882 |   |
| Less allowances  for:   |       |                    |       |   |   |
| Sales returns and other |       | 192,328                 |       | 193,418 |   |
| Doubtful accounts       |       | 17,130                  |       | 20,682 |   |
| Total allowances        |       | 209,458                 |       | 214,100 |   |
| Trade receivables, net  |       | $                       | 102,658    |   | $ | 129,782 |   |

 

**4.   INVENTORIES**

Inventoriesconsist of the following:

| ** **                   | ** ** | **January 31,**    | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Raw materials                |       | $                       | 3,048      |   | $ | 2,652 |   |
| Work-in-process              |       | 2,519                   |       | 3,458 |   |
| Finished goods:              |       |                    |       |   |   |
| Pre-recorded music and video |       | 133,193                 |       | 131,601 |   |
| Magazine and book            |       | 107,449                 |       | 57,827 |   |
| Fixtures                     |       | 2,732                   |       | 2,945 |   |
| Total inventories            |       | $                       | 248,941    |   | $ | 198,483 |   |

 

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

**5.   PROPERTY,PLANTS AND EQUIPMENT**

Property,plants and equipment consist of the following:

| ** **                            | ** ** | **January 31,**    | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Land                                  |       | $                       | 8,298      |   | $ | 8,418 |   |
| Buildings                             |       | 16,087                  |       | 17,206 |   |
| Leasehold  improvements               |       | 7,056                   |       | 5,768 |   |
| Machinery and  equipment              |       | 36,652                  |       | 31,649 |   |
| Vehicles                              |       | 593                     |       | 494 |   |
| Furniture and  fixtures               |       | 7,657                   |       | 6,809 |   |
| Computers                             |       | 19,476                  |       | 15,870 |   |
| Construction in  progress             |       | 2,993                   |       | 3,757 |   |
| Total property, plants  and equipment |       | $                       | 98,812     |   | $ | 89,971 |   |

 

Depreciation expense fromproperty, plants and equipment was $13.0 million, $8.9 million, and $3.8million for the fiscal years ended January 31, 2007, 2006 and 2005,respectively.

F-20

----

**6.   GOODWILLAND INTANGIBLE ASSETS**

Asummary of the Company’s intangible assets is as follows:

| ** **                      | ** ** | **January 31,**    | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Amortized  intangible assets:   |       |                    |       |   |   |
| Customer lists                  |       | $                       | 122,406    |   | $ | 111,320 |   |
| Non-compete agreements          |       | 4,350                   |       | 2,250 |   |
| Software                        |       | 16,340                  |       | 16,492 |   |
| Total intangibles               |       | 143,096                 |       | 130,062 |   |
| Accumulated  amortization:      |       |                    |       |   |   |
| Customer lists                  |       | (17,564                 | )          | (8,133 | ) |
| Non-compete agreements          |       | (1,438                  | )          | (556 | ) |
| Software                        |       | (5,123                  | )          | (2,385 | ) |
| Total accumulated  amortization |       | (24,125                 | )          | (11,074 | ) |
| Intangibles, net                |       | $                       | 118,971    |   | $ | 118,988 |   |

 

As a result of our fiscal year 2007 SFAS No. 144fourth quarter impairment analysis, we determined that the customer list andnon-compete agreement of our In-Store Services reporting unit was impaired andconsequently recorded a charge of  approximately $1.7 million and $0.5million, respectively. These determinations were primarily the result of achange in management’s expectations of the long-term outlook for that businessunit, including increased life cycle for certain products, as well asdecreasing operating profit margins. The net carrying amount of the customerlist 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 $13.3million, $10.2 million, and $1.2 million for the fiscal years ended January 31,2007, 2006 and 2005, respectively.

Amortization expense for each of the five succeedingyears is estimated to be approximately $15.6 million per year.

Changesin the carrying amount of goodwill for the year ended January 31, 2007 areas follows:

| ****                                      | ** ** | **CD and DVD  Fulfillment** | ** ** | **Magazine  Fulfillment** | ** ** | **In-Store  Services** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|------------------------|------------|------------------|------------|
| ** **                                | ** ** | **(in thousands)**               | ** ** |
| Balance,  January 31, 2006           |       |                                  | $          | 168,898                   |       |                   |       | $                | 78,601     |   |   | $ | 54,794 |   |   | $ | 302,293 |   |   |
| Additions                                 |       |                                  | 32,634     |                      |       |                   | 90,999     |             |       | 738 |   |   | 124,371 |   |   |
| Impairment charge                         |       |                                  | —     |                      |       |                   | —     |             |       | (30,611 | ) |   | (30,611 | ) |   |
| Foreign currency  translation adjustments |       |                                  | —     |                      |       |                   | —     |             |       | (151 | ) |   | (151 | ) |   |
| Working capital  adjustments              |       |                                  | —     |                      |       |                   | —     |             |       | — |   |   | — |   |   |
| Balance,  January 31, 2007           |       |                                  | $          | 201,532                   |       |                   |       | $                | 169,600    |   |   | $ | 24,770 |   |   | $ | 395,902 |   |   |

 

As a result of our fiscalyear 2007 SFAS No. 142 fourth quarter impairment analysis, we determinedthat the goodwill of our In-Store Services reporting unit was impaired andconsequently recorded a charge of  approximately $30.6 million. Thesedeterminations were primarily the result of a change in management’sexpectations of the long-term outlook for that business unit, includingincreased life cycle for certain products, as well as decreasing operatingprofit margins. The combination of these factors had an adverse impact on theanticipated future cash flows of this reporting unit used in the impairmentanalysis performed during the fourth quarter of fiscal year 2007. The netcarrying amount of the goodwill 

F-21

----

was $24.8million at the end of the fourth quarter of fiscal year 2007, after theimpairment charge was recorded.

**7.   DEBT ANDREVOLVING CREDIT FACILITY**

Debtconsists of: 

| ** **                                           | ** ** | **January 31,**    | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|
| ** **                                           | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** ** |
| Revolving credit  facility—Wells Fargo Foothill |       | $                       | 116,459    |   | $ | 45,001 |   |
| Note payable—Magazine  import and export        |       | 3,500                   |       | 6,227 |   |
| Note payable—Former  owner of Empire            |       | 233                     |       | 717 |   |
| Note payable—Arrangements  with suppliers       |       | 10,180                  |       | 11,815 |   |
| Mortgage loan—Wachovia  Bank                    |       | 19,750                  |       | 20,000 |   |
| Equipment loans—SunTrust  Leasing               |       | 4,262                   |       | 3,216 |   |
| Other                                                |       | —                  |       | 259 |   |
| Total debt                                           |       | 154,384                 |       | 87,235 |   |
| Less current  maturities                             |       | 7,850                   |       | 6,508 |   |
| Debt, less current  maturities                       |       | $                       | 146,534    |   | $ | 80,727 |   |

 

**WELLS FARGOFOOTHILL CREDIT FACILITY**

On February 28, 2005, the Company modified itsexisting credit facility with Wells Fargo Foothill (“WFF”) as a result of itsacquisition of Alliance Entertainment Corp. The primary changes from theoriginal line of credit were to (1) increase the maximum allowed advancesunder the line of credit from $45.0 million to $250.0 million and (2) extendthe maturity date from October 2009 to October 2010. In addition, inconjunction with the modification of the existing credit facility, the Companyrepaid the balance of its $10.0 million WFF term loan. WFF, as arranger andadministrative agent for each of the parties that may become a participant insuch arrangement and their successors (“Lenders”) will make revolving loans tous and our subsidiaries of up to $250.0 million including the issuance ofletters of credit. The terms and conditions of the arrangement are governedprimarily by the Amended and Restated Loan Agreement dated February 28,2005 by and among us, our subsidiaries, and WFF.

Outstanding borrowings bear interest at a variableannual rate equal to the prime rate announced by Wells Fargo Bank, NationalAssociation’s San Francisco office, plus a margin of between 0.0% and 1.00%(applicable margin was 0.0% at January 31, 2007) based upon a ratio of theCompany’s EBITDA to interest expense (“Interest Coverage Ratio”). At January 31,2007 the prime rate was 8.25%. We also have the option of selecting up to fivetraunches of at least $1 million each to bear interest at LIBOR plus a marginof between 2.00% and 3.00% based upon our Interest Coverage Ratio. The Companyhad 4 LIBOR contracts outstanding at January 31, 2007 with an aggregateprincipal amount of $101.0 million (expiring through March 2007) that boreinterest at a weighted average rate of approximately 7.3% To secure repaymentof the borrowings and other obligations of ours to the Lenders, we and oursubsidiaries granted a security interest in all of the personal property assetsto WFF, for the benefit of the Lenders. These loans mature on October 31,2010.

Under the credit agreement, the Company is limited inits ability to declare dividends or other distributions on capital stock ormake payments in connection with the purchase, redemption, retirement oracquisition of capital stock. There are also limitations on capitalexpenditures and the Company is required to maintain certain financial ratios.The Company was in compliance with these ratios at January 31, 2007

F-22

----

Availability under the facility is limited by theCompany’s borrowing base calculation, as defined in the agreement. Thecalculation resulted in excess availability, after consideration of outstandingletters of credit, of $92.7 million at January 31, 2007.

WFF and its affiliatestogether beneficially held 3,327823 shares, or 6.41%, of the Company’soutstanding common stock as of December 31, 2006. The Company did notengage in any material transactions with WFF during the year ended January 31,2007, other than those listed above.

**EQUIPMENT LOANS**

Through the acquisition ofAlliance, the Company entered into a loan agreement with SunTrust LeasingCorporation (the “SunTrust Loan”) for the purchase of equipment to be used atvarious locations. A credit line of $6.8 million was approved under theSunTrust Loan, with repayment terms for five promissory notes ranging fromthree to five years. The total principal balance of the SunTrust Loanoutstanding as of January 31, 2007 was $4.3 million.

**SUPPLIER LOANS**

Through the acquisition ofLevy, the Company assumed four notes payable with suppliers (the “SupplierLoans”) totaling $14.0 million. The maturity dates of the supplier notes rangebetween March 2007 and August 2014 and bear interest at 5%. Principalrepayments range from $1.0 to $2.0 million per fiscal year with $1.7 millionand $1.8 million due to be repaid in fiscal years 2008 and 2009, respectively.The total principal balance of the supplier loans as of January 31, 2007is $10.2 million.

**MORTGAGE LOAN**

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

**MAGAZINE IMPORT ANDEXPORT NOTES**

Concurrent with the magazine import and exportacquisition in November 2004, the Company issued an additional $7.7million in notes payable. At January 31, 2007, the balance on all magazineimport and export notes was $3.5 million. These notes bear interest at a rateof 2.37% and require quarterly payments of approximately $0.7 million throughFebruary, 2008.

F-23

----

Theaggregate amount of debt maturing in each of the next five fiscal years is asfollows:

| ** **   | ** ** | **Amount**              | ** ** |
|--------------|------------|-------------------------|------------|
| ** **   | ** ** | **(in thousands)** | ** ** |
| Fiscal year: |       |                    |       |   |   |
| 2008         |       |                    | $          | 7,850 |   |   |
| 2009         |       |                    | 5,284      |   |   |
| 2010         |       |                    | 2,781      |   |   |
| 2011         |       |                    | 118,409    |   |   |
| 2012         |       |                    | 1,998      |   |   |
| Thereafter   |       |                    | 18,062     |   |   |
| Total        |       |                    | $          | 154,384 |   |   |

 

At January 31, 2007and 2006, unamortized deferred financing fees were approximately $1.7 millionand $2.2 million, respectively.

**8.   DISCONTINUEDOPERATION**

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

Thefollowing amounts related to the Company’s discontinued operation have beensegregated from continuing operations and reflected as discontinued operations:

| ** **                                     | ** ** | **Year ended January 31,** | ** ** |
|------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                   | ** ** |
| Revenue                                        |       |                                      | $          | — |   |   | $ | — |   | $ | 13,380 |   |
| Loss before  income taxes                      |       |                                      | $          | — |   |   | $ | (2,410 | ) | $ | (3,033 | ) |
| Income tax  benefit                            |       |                                      | —     |   |   | 964 |   | 1,213 |   |
| Loss from  discontinued operation, net of tax  |       |                                      | —     |   |   | (1,446 | ) | (1,820 | ) |
| Pre-tax gain on  sale of discontinued business |       |                                      | —     |   |   | — |   | 1,400 |   |
| Income tax  expense                            |       |                                      | —     |   |   | — |   | (560 | ) |
| Gain on sale of  business, net of tax          |       |                                      | —     |   |   | — |   | 840 |   |
| Discontinued operations,  net of tax           |       |                                      | $          | — |   |   | $ | (1,446 | ) | $ | (980 | ) |

 

F-24

----

**9.   EARNINGSPER SHARE**

Areconciliation of the denominators of the basic and diluted earnings per sharecomputation are as follows:

| ** **                                                                           | ** ** | **Year ended January 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                           | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                   | ** ** |
| Weighted average  number of common shares outstanding—basic                     |       | 51,838                                    |       | 49,097 |   | 22,963 |   |
| Effect of dilutive  securities:                                                      |       |                                      |       |   |   |   |   |
| Stock options and warrants                                                           |       | —                                    |       | 1,797 |   | 1,870 |   |
| Weighted average  number of common shares outstanding—diluted                   |       | 51,838                                    |       | 50,894 |   | 24,833 |   |
| The following securities  were excluded because their effect would be anti-dilutive: |       |                                      |       |   |   |   |   |
| Stock options and  warrants                                                          |       | 1,980                                     |       | 864 |   | 251 |   |

 

**10.   INCOMETAXES**

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

| ** **                          | ** ** | **Year ended January 31,** | ** ** |
|-------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(in thousands)**                   | ** ** |
| Current                             |       |                                      |       |   |   |   |   |
| Federal                             |       | $                                         | 6,125      |   | $ | 4,701 |   | $ | 2,627 |   |
| State                               |       | 804                                       |       | 1,265 |   | 539 |   |
| Foreign                             |       | 1,173                                     |       | 1,192 |   | 444 |   |
| Total current                       |       | 8,102                                     |       | 7,158 |   | 3,610 |   |
| Deferred                            |       |                                      |       |   |   |   |   |
| Federal                             |       | (10,719                                   | )          | 5,916 |   | (1,608 | ) |
| State                               |       | (2,072                                    | )          | 1,479 |   | 466 |   |
| Foreign                             |       | (505                                      | )          | — |   | (240 | ) |
| Total deferred                      |       | (13,296                                   | )          | 7,395 |   | (1,382 | ) |
| Total income tax  (benefit) expense |       | $                                         | (5,194     | ) | $ | 14,553 |   | $ | 2,228 |   |

 

Thefollowing summary reconciles income taxes for continuing operations at themaximum federal statutory rate with the effective rates for 2007, 2006 and2005:

| ** **                                                                   | ** ** | **Year ended January 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                   | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **(in thousands)**                   | ** ** |
| Income tax (benefit)  expense at statutory rate                              |       | $                                         | (10,448    | ) | $ | 10,107 |   | $ | 5,351 |   |
| Permanent  difference relating to non-deductible amortization of intangibles |       | —                                    |       | 2,263 |   | — |   |
| Permanent  difference relating to non-deductible impairment charges          |       | 4,449                                     |       | — |   | — |   |
| Change in  valuation allowance                                               |       | —                                    |       | — |   | (4,104 | ) |
| State income tax  expense, net of federal income tax benefit                 |       | (824                                      | )          | 1,894 |   | 653 |   |
| Difference in foreign  tax rates                                             |       | 36                                        |       | 13 |   | (61 | ) |
| Prior year taxes                                                             |       | 640                                       |       | — |   | — |   |
| Other, net                                                                   |       | 953                                       |       | 276 |   | 389 |   |
| Income tax (benefit)  expense                                                |       | $                                         | (5,194     | ) | $ | 14,553 |   | $ | 2,228 |   |

 

F-25

----

Componentsof income from continuing operations before income taxes are as follows:

| ** **                                      | ** ** | **Year ended January 31,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(in thousands)**                   | ** ** |
| United States                                   |       | $                                         | (29,141    | ) | $ | 26,832 |   | $ | 14,259 |   |
| Foreign                                         |       | (709                                      | )          | 2,046 |   | 1,031 |   |
| Total (loss) income from  continuing operations |       | $                                         | (29,850    | ) | $ | 28,878 |   | $ | 15,290 |   |

 

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

| ** **                            | ** ** | **January 31,**    | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets                   |       |                    |       |   |   |
| Net operating loss carryforwards      |       | $                       | 13,303     |   | $ | 4,122 |   |
| Allowance for doubtful accounts       |       | 6,910                   |       | 8,056 |   |
| Payroll related items                 |       | 4,483                   |       | 2,222 |   |
| Deferred revenue                      |       | 963                     |       | 1,246 |   |
| Inventory related items               |       | 6,824                   |       | 2,456 |   |
| Other                                 |       | 3,313                   |       | 3,144 |   |
| Total deferred  tax asset             |       | 35,796                  |       | 21,246 |   |
| Deferred tax liabilities              |       |                    |       |   |   |
| Book/tax difference in capital assets |       | 8,965                   |       | 7,448 |   |
| Goodwill                              |       | 29,024                  |       | 1,149 |   |
| Prepaid expenses                      |       | 776                     |       | 772 |   |
| Total deferred  tax liabilities       |       | 38,765                  |       | 9,369 |   |
| Net deferred tax  (liability) asset   |       | $                       | (2,969     | ) | $ | 11,877 |   |
| Classified as:                        |       |                    |       |   |   |
| Current asset                         |       | $                       | 29,531     |   | $ | 16,403 |   |
| Long-term (liability) asset           |       | (32,500                 | )          | (4,526 | ) |
| Net deferred tax  (liability) asset   |       | $                       | (2,969     | ) | $ | 11,877 |   |

 

At January 31, 2007, the Company had netoperating loss (“NOL”) carryforwards of approximately $34.7 million expiring in2019.

Internal Revenue Serviceregulations limit the utilization of these operating losses to approximately$24.2 million for the year ended January 31, 2007 and $1.3 million foreach year thereafter. At January 31, 2007, the Company assessed the futureutilization of its deferred tax assets, including NOL carryforwards anddetermined that it is more likely than not that the benefit of such deferredtax assets will be realized and a valuation allowance is not necessary.

**11.   RELATEDPARTY TRANSACTIONS**

A former director of the Company was a principal inArmstrong Teasdale LLP. The Company purchased legal services from ArmstrongTeasdale LLP totaling approximately $0.1 and $0.3 for the years ended January 31,2006 and 2005, respectively.

Pursuant to an agreement through August 2007, theCompany conducts significant business with one customer distributing magazines,music and DVDs. The Chairman and major stockholder of this customer 

F-26

----

was a passive minorityinvestor of AEC Associates, the Company’s largest shareholder. During thefiscal year ended January 31, 2007 and 2006, the Company had revenues of$364.9 and $421.0 million, respectively, related to this customer and thiscustomer’s subsidiaries.

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

Carol Kloster, one of ourformer executive officers, was a director of Chas. Levy Company, LLC during herservice with the Company, formerly the sole member of Chas. Levy CirculatingCo. LLC. Concurrent with our acquisition of Chas. Levy Circulating Co. LLC, weentered into an agreement with Levy Home Entertainment, LLC, a wholly ownedsubsidiary of Chas. Levy Company, LLC to purchase book product for distributionto our customers. During the year ended January 31, 2007, the Companypurchased $39.5 million, net of returns. During the period beginning in May 2005and ending January 31, 2006, we purchased $23.1 million in book productfrom Levy Home Entertainment, net of returns.

The Company has anagreement with The Yucaipa Companies, LLC, an affiliate of AEC Associates underwhich the Company is entitled to consulting services for an annual fee of$1.0 million. In addition, the Company has engaged The Yucaipa Companies,LLC to act as its strategic advisor in connection with its strategicalternatives process.

**12.   COMMITMENTSAND CONTINGENCIES**

**LEASES**

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

Rent expense was approximately $20.8 million, $9.2million and $5.5 million for the years ended January 31, 2007, 2006 and2005, respectively.

Futureminimum payments, by year and in the aggregate, under non-cancelable operatingleases with initial or remaining terms of year or more consisted of thefollowing at January 31, 2007:

| ** **   | ** ** | **Amount**              | ** ** |
|--------------|------------|-------------------------|------------|
| ** **   | ** ** | **(in thousands)** | ** ** |
| Fiscal year: |       |                    |       |   |   |
| 2008         |       |                    | 10,974     |   |   |
| 2009         |       |                    | 11,929     |   |   |
| 2010         |       |                    | 9,620      |   |   |
| 2011         |       |                    | 8,253      |   |   |
| Thereafter   |       |                    | 17,512     |   |   |
| Total        |       |                    | $          | 58,288 |   |   |
|              |            |                         |            |  |  |  |

 

**CHALLENGE GRANTPROGRAM**

On March 1, 2005 the Company adopted theChallenge Grant Program (the “Program”) to incentivize key executive personnelto maximize shareholder value resulting from the Alliance Entertainment Corp.acquisition. The effective date of the Program is March 1, 2005 and is ineffect for the three year period commencing February 1, 2005 and ending January 31,2008.

F-27

----

TheAggregate Payout under the Program shall be equal to that amount set forth inthe following table opposite the applicable range which encompasses thecumulative operating income, as defined, over the three year period:

| **Greater Than** | ** ** | ** ** | ** ** | **Less Than or Equal to** | ** ** | **Aggregate Payout** | ** ** |
|-----------------------|------------|------------|------------|-----------------------------------------------|------------|---------------------------|------------|
| $0                    |       |       | $          | 195.2 million                                 |       |                      |       | $ | 0 |   |   |
| $195.2 million        |       |       | $          | 202.8 million                                 |       |                      |       | $ | 2.50 million |   |   |
| $202.8 million        |       |       | $          | 210.4 million                                 |       |                      |       | $ | 5.00 million |   |   |
| $210.4 million        |       |       | $          | 218.0 million                                 |       |                      |       | $ | 7.50 million |   |   |
| $218.0 million        |       |       | $          | 227.2 million                                 |       |                      |       | $ | 10.00 million |   |   |
| $227.2 million        |       |       | $          | 236.4 million                                 |       |                      |       | $ | 11.00 million |   |   |
| $236.4 million        |       |       | $          | 245.6 million                                 |       |                      |       | $ | 12.00 million |   |   |
| $245.6 million        |       |       | $          | 254.8 million                                 |       |                      |       | $ | 13.00 million |   |   |
| $254.8 million        |       |       | $          | 264.0 million                                 |       |                      |       | $ | 14.00 million |   |   |
| $264.0 million        |       |       | Unlimited  |                                          |       |                      | $          | 15.00 million |   |   |

 

The Aggregate Payout, if any, shall be allocated amongthe Executives in such amounts and proportions as may be determined by theChief Executive Officer with, in the case of Executives that are also officersof the Corporation subject to the reporting requirements of Section 16promulgated under the Securities Exchange Act of 1934, as amended, the approvalof the Compensation Committee of the Board of Directors; provided however that35% of the Aggregate Payout was to be allocated to S. Leslie Flegel, prior tohis resignation. Based on current performance and projected performance levels,the Company has not accrued any aggregate payout related to the Program at January 312007.

If aChange of Control, as defined, shall occur during the Challenge Period, theAggregate Payout under the Program shall be equal to that amount set forth inthe following table opposite the applicable period in which the Change ofControl occurs.

| **Twelve Month Period Ending** | ** ** | ** ** | ** ** | **Aggregate Payout** | ** ** |
|-----------------------------------------------|------------|------------|------------|---------------------------|------------|
| January 31,  2006                        |       |       | $          | 10.0 million              |       |   |
| January 31,  2007                        |       |       | $          | 12.5 million              |       |   |
| January 31, 2008                         |       |       | $          | 15.0 million              |       |   |

 

**LITIGATION**

The Company has pendingcertain legal actions and claims, which were incurred in the normal course ofbusiness, and is actively pursuing the defense thereof. In the opinion ofmanagement, these actions and claims are either without merit or are covered byinsurance and will not have a material adverse effect on the Company’sfinancial condition, results of operations or liquidity.

**13.   EMPLOYEEBENEFIT PLANS**

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

F-28

----

Underthe Company’s stock option plans, options to acquire shares of Common Stockhave been made available for grant to certain employees and non-employeedirectors. Each option granted has an exercise price of not less than 100% ofthe market value of the Common Stock on the date of grant. The contractual lifeof each option is generally 10 years. The vesting of the grants variesaccording to the individual options granted.

| ** **                                    | ** ** | ** **         | ** ** | ** **                                  | ** ** | ** **   | ** ** | **Weighted** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|---------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                    | ** ** | ** **         | ** ** | ** **                                  | ** ** | ** **   | ** ** | **Average**  | ** ** |
| ** **                                    | ** ** | **Number of** | ** ** | **Range of Exercise Prices** | ** ** | **Exercise** | ** ** |
| ** **                                    | ** ** | **Options**        | ** ** | **Low**                                     | ** ** | **High**     | ** ** | **Price**    | ** ** |
| Options  outstanding at January 31, 2004 |       | 4,901,034          |       | 2.42                                        |       | 21.60        |       |         | 7.07       |   |   |
| Options granted                               |       | 223,500            |       | 8.58                                        |       | 12.55        |       |         | 9.40       |   |   |
| Options forfeited  or expired                 |       | (586,089           | )          | 4.56                                        |       | 21.60        |       |         | 12.37      |   |   |
| Options exercised                             |       | (982,446           | )          | 2.42                                        |       | 8.04         |       |         | 5.53       |   |   |
| Options  outstanding at January 31, 2005 |       | 3,555,999          |       | 2.42                                        |       | 21.60        |       |         | 6.48       |   |   |
| Options granted                               |       | 587,500            |       | 9.79                                        |       | 11.00        |       |         | 10.95      |   |   |
| Options acquired                              |       | 807,107            |       | 1.77                                        |       | 9.21         |       |         | 7.07       |   |   |
| Options forfeited  or expired                 |       | (28,923            | )          | 1.77                                        |       | 16.63        |       |         | 7.14       |   |   |
| Options exercised                             |       | (994,493           | )          | 1.77                                        |       | 9.75         |       |         | 4.85       |   |   |
| Options  outstanding at January 31, 2006 |       | 3,927,190          |       | $                                           | 2.30       |         | $          | 18.31        |       |   | $ | 7.64 |   |   |
| Options granted                               |       | 84,575             |       | 8.97                                        |       | 11.15        |       |         | 10.03      |   |   |
| Options forfeited  or expired                 |       | (188,275           | )          | 10.60                                       |       | 16.63        |       |         | 11.33      |   |   |
| Options exercised                             |       | (142,185           | )          | 2.30                                        |       | 10.78        |       |         | 8.40       |   |   |
| Options outstanding at  January 31, 2006 |       | 3,681,305          |       | $                                           | 2.30       |         | $          | 18.31        |       |   | $ | 7.48 |   |   |
|                                               |            |                    |            |                                             |            |              |            |              |            |  |  |  |  |  |  |

 

Thefollowing table summarizes information about the stock options outstanding at January 31,2007:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Remaining  Contractual Life  (months)** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $2.42 - $5.00                               |       |                         | 1,149,631  |                         |       |   | $ | 4.54 |   |   |   | 17 -  84 |   |   | 1,149,631 |   |   | $ | 4.54 |   |   |
| $5.01 - $7.50                               |       |                         | 691,250    |                         |       |   | $ | 5.31 |   |   |   | 24 -  82 |   |   | 691,250 |   |   | $ | 5.31 |   |   |
| $7.51 - $10.00                              |       |                         | 972,024    |                         |       |   | $ | 8.49 |   |   |   |  46  - 130 |   |   | 972,024 |   |   | $ | 8.49 |   |   |
| $10.01 - $15.00                             |       |                         | 771,100    |                         |       |   | $ | 11.35 |   |   |   |  37  - 120 |   |   | 771,100 |   |   | $ | 11.35 |   |   |
| $15.01 - $18.31                             |       |                         | 97,300     |                         |       |   | $ | 16.65 |   |   |   | 46 -  50 |   |   | 97,300 |   |   | $ | 16.65 |   |   |
| Total                                       |       |                         | 3,681,305  |                         |       |   | $ | 7.48 |   |   |   |  17 - 130 |   |   | 3,681,305 |   |   | $ | 7.48 |   |   |
|                                             |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Options exercisable at January 31, 2006 and 2005totaled 3,804,190 and 2,894,983, respectively and had weighted average exerciseprices of $7.56 and $6.65, respectively. The weighted total intrinsic value ofoptions outstanding and exercisable at January 31, 2007 was less than zero.The total intrinsic value of options exercised during the year ended January 31,2007, 2006 and 2005 was $0.5 million, $6.3 million and $5.4 million,respectively. As of January 31, 2007, substantially all of the Company’semployee stock options are vested.

The weighted average fairvalue of each option granted during the year was $3.32, $4.08 and $3.40 (atgrant date) in 2007, 2006 and 2005, respectively. The options were issued atexercise prices which were equal to or exceeded the quoted market price of theCompany’s Common Stock on the date of grant. At January 31, 2007, therewere 361,397 options remaining, under the Company’s stock option plans.

F-29

----

**STOCK OPTIONSREVIEW**

The Company, under the direction of the AuditCommittee, undertook a review of previously issued stock options. The Companydetermined that there were instances when the documentation of the CompensationCommittee’s formal approval of the grant differed from the grant date beingused by the Company. However, the Company did not find any intent to defraud orfraudulent misconduct by any individual or groups of individuals. Furthermore,the Company found that the dating and pricing practice for stock options wasapplied uniformly by Company personnel to stock options granted and was notused selectively to benefit any one group or individual within the Company.

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

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

**PROFIT SHARING AND401(k) PLAN**

The Company has a combined profit sharing and 401(k) Plan.Annual contributions to the profit sharing portion of the Plan are determinedby the Board of Directors and may not exceed the amount that may be deductedfor federal income tax purposes. There were no profit sharing contributionscharged against operations for the years ended January 31, 2007, 2006 and2005.

Under the 401(k) portionof the Plan, all eligible employees may elect to contribute 2% to 20% of theircompensation up to the maximum allowed under the Internal Revenue Code. TheCompany matches one half of an employee’s contribution, not to exceed 5% of theemployee’s salary. The amounts matched by the Company during the years ended January 31,2007, 2006 and 2005 pursuant to this Plan were approximately $2.5 million, $1.4million and $0.3 million, respectively.

**UNION PLAN**

At January 31, 2007,586 of the Company’s 7,614 employees were members of a collective bargainingunit. The Company is party to fourteen collective bargaining agreements, whichexpire at various times through August 2009. Contributions to the unionfunds were approximately $1.4, $0.7 million and $0.3 million for the yearsended January 31, 2007, 2006, and 2005, respectively.

**SUPPLEMENTALEXECUTIVE RETIREMENT PLAN**

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

The accumulated year-endSERP benefit obligation, based on a discount rate of 7.00%, was $1.2 million atJanuary 31, 2007 and is reflected in the Consolidated Balance Sheets as aliability. Benefits are 

F-30

----

fundedby the Company through a Rabbi Trust. The year-end balance included in OtherAssets was $2.3 million at January 31, 2007.

**14.**          WARRANTS

Thefollowing table summarizes information about the warrants for common stockoutstanding at January 31, 2007:

| ** **      | ** ** | **Number  Outstanding** | ** ** | **Number  Exercisable** | ** ** | **Grant Date** | ** ** | **Expiration  Date** | ** ** |
|-----------------|------------|-------------------------|------------|-------------------------|------------|---------------------|------------|----------------------|------------|
| Exercise price: |       |                    |       |                    |       |                |       |                 |       |   |   |   |   |
| $8.04           |       |                    | 61,323     |                    |       |                | 61,323     |                 |       | 10/30/2003 |   | 10/3/2008 |   |
| $8.58           |       |                    | 35,000     |                    |       |                | 11,667     |                 |       | 8/30/2004 |   | 8/30/2014 |   |
| $11.62          |       |                    | 10,000     |                    |       |                | 10,000     |                 |       | 4/4/2005 |   | 4/4/2015 |   |

 

**15.**          SUPPLEMENTALCASH FLOW INFORMATION

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

| ** **                                       | ** ** | **Year ended January 31,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                   | ** ** |
| Interest                                         |       | $                                         | 11,782     |   | $ | 6,303 |   | $ | 2,168 |   |
| Income taxes (net of  refunds of $1,017 in 2007) |       | $                                         | 15,331     |   | $ | 6,606 |   | $ | 359 |   |

 

Significantnon-cash activities were as follows:

**YEAR ENDED JANUARY31, 2007**

As discussed in Note 2, the Company acquiredMid-Atlantic on March 30, 2006 for the total consideration of $17.7million, including $13.6 million in cash and $4.1 million in the form of a notepayable. As of January 31, 2007, this note was repaid.

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 ofa note payable. As of January 31, 2007, this note was repaid.

**YEAR ENDED JANUARY31, 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:

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

 

The total purchase pricewas allocated to the assets and liabilities of Alliance Entertainment Corp. asdisclosed in Note 2.

F-31

----

**YEAR ENDED JANUARY31, 2005**

In conjunction with the acquisition of Empire StateNews Corp., the Company incurred $1.6 million of deferred consideration in theform of two notes payable totaling $1.2 million (see Note 7) and deferredcompensation of $0.4 million, subject to finalization of working capitaladjustments in accordance with the purchase agreement.

In conjunction with the acquisition of WMS, Inc.,the Company issued an addition $7.7 million in notes payable to acquire allimport and export assets, naming rights and other intangibles, including anon-compete by the seller (see Note 7).

The Company paid in full anote payable it had with Hilco Capital and wrote off the original issuediscount of $0.9 million and the unamortized deferred financing fees of $0.64million.

**16.**          SHAREHOLDERS’EQUITY

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

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

In March 2004, theCompany completed the sale of 3.8 million shares of common stock at $11.50 pershare, excluding underwriting discounts and expenses. Net proceeds to theCompany of approximately $40.5 million, after costs of issuance of $3.2million, were utilized to repay the Wells Fargo Foothill note payable andrevolving credit facility and all but a nominal amount on the Hilco Capitalnote payable in March 2004.

**17.**          SEGMENTFINANCIAL REPORTING

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

The reportable segments of the Company are CD and DVDFulfillment, Magazine Fulfillment, In-Store Services, and Shared Services. Theaccounting policies of the segments are materially the same as those describedin the Summary of Accounting Policies.

Based on the comparability of the operations, Levy’sresults are included in the Magazine Fulfillment group. As a result of theacquisition of Alliance on February 28, 2005, the Company created a CD andDVD Fulfillment reporting segment. Based on the reporting of the seniormanagement, the previous Wood Manufacturing group’s results are included in theIn-Store Services group. The results for the years ended January 31, 2005and 2004 have been restated to conform to this presentation.

The CD and DVD Fulfillment segment derives revenuesfrom (1) selling and distributing pre-recorded music, videos, video gamesand related products to retailers, (2) providing product and commercesolutions to “brick-and-mortar” and e-commerce retailers, and (3) providingconsumer-direct fulfillment and vendor managed inventory services to itscustomers.

The Magazine Fulfillment segment derives revenues from(1) selling and distributing magazines, including domestic and foreigntitles, to major specialty and mainstream retailers and wholesalers 

F-32

----

throughout the UnitedStates and Canada, (2)  exporting domestic titles internationally toforeign wholesalers or through domestic brokers, (3) providing returnprocessing services for  major specialtyretail 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, (2) providingclaim filing services related to rebates owed retailers from publishers ortheir designated agent, (3) designing, manufacturing, shipping,installation and removal of front-end fixtures, including high end wood andwire and (4) providing information and management services relating toretail magazine sales to U.S. and Canadian retailers and magazine publishers.

Shared Services consists of overhead functions notallocated to individual operating segments.

Thesegment results are as follows:

| ** **                                      | ** ** | **CD and DVD** | ** ** | **Magazine**    | ** ** | **In-Store** | ** ** | **Shared**   | ** ** | ** **       | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|-----------------|------------|--------------|------------|--------------|------------|------------------|------------|
| ** **                                      | ** ** | **Fulfillment**          | ** ** | **Fulfillment** | ** ** | **Services** | ** ** | **Services** | ** ** | **Consolidated** | ** ** |
| **Year  ended January 31, 2007**           |       |                     |       |            |       |         |       |         |       |             |       |   |   |   |   |   |   |
| Revenues                                        |       |                     | $          | 971,523         |       |         |       | $            | 809,753    |             |       | $ | 73,569 |   | $ | — |   |   | $ | 1,854,845 |   |   |
| Cost of revenues                                |       |                     | 797,348    |            |       |         | 621,786    |         |       | 49,654           |       | — |   |   | 1,468,788 |   |   |
| Gross profit                                    |       |                     | 174,175    |            |       |         | 187,967    |         |       | 23,915           |       | — |   |   | 386,057 |   |   |
| Selling, general  and administrative expense    |       |                     | 84,224     |            |       |         | 109,124    |         |       | 8,824            |       | 34,483 |   |   | 236,655 |   |   |
| Fulfillment  freight                            |       |                     | 35,935     |            |       |         | 67,923     |         |       | —           |       | — |   |   | 103,858 |   |   |
| Depreciation and  amortization                  |       |                     | 14,650     |            |       |         | 7,997      |         |       | 566              |       | 2,155 |   |   | 25,368 |   |   |
| Impairment of  Goodwill and Intangible Assets   |       |                     | —     |            |       |         | —     |         |       | 32,742           |       | — |   |   | 32,742 |   |   |
| Integration and  relocation expense             |       |                     | —     |            |       |         | 3,580      |         |       | —           |       | 84 |   |   | 3,664 |   |   |
| Disposal of land,  buildings and equipment, net |       |                     | 287        |            |       |         | (154       | )            |       | (86              | )          | 903 |   |   | 950 |   |   |
| Merger and  acquisition charges                 |       |                     | —     |            |       |         | —     |         |       | —           |       | — |   |   | — |   |   |
| Operating income (loss)                         |       |                     | $          | 39,079          |       |         |       | $            | (503       | )                |       | $ | (18,131 | ) | $ | (37,625 | ) |   | $ | (17,180 | ) |   |
| Capital expenditures                            |       |                     | $          | 6,983           |       |         |       | $            | 1,375      |             |       | $ | 286 |   | $ | 4,735 |   |   | $ | 13,379 |   |   |
| **As of January 31, 2007**                 |       |                     |       |            |       |         |       |         |       |             |       |   |   |   |   |   |   |
| Total assets                                    |       |                     | $          | 541,122         |       |         |       | $            | 342,733    |             |       | $ | 89,524 |   | $ | 36,652 |   |   | $ | 1,010,031 |   |   |
| Goodwill, net                                   |       |                     | $          | 201,532         |       |         |       | $            | 169,600    |             |       | $ | 24,770 |   | $ | — |   |   | $ | 395,902 |   |   |
| Intangibles, net                                |       |                     | $          | 80,229          |       |         |       | $            | 37,456     |             |       | $ | 1,286 |   | $ | — |   |   | $ | 118,971 |   |   |

 

F-33

----

 

| ** **                                      | ** ** | **CD and DVD** | ** ** | **Magazine**    | ** ** | **In-Store** | ** ** | **Shared**   | ** ** | ** **       | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|-----------------|------------|--------------|------------|--------------|------------|------------------|------------|
| ** **                                      | ** ** | **Fulfillment**          | ** ** | **Fulfillment** | ** ** | **Services** | ** ** | **Services** | ** ** | **Consolidated** | ** ** |
| **Year ended January 31,  2006**           |       |                     |       |            |       |         |       |         |       |             |       |   |   |   |   |   |   |
| Revenues                                        |       |                     | $          | 889,380         |       |         |       | $            | 566,438    |             |       | $ | 71,633 |   | $ | — |   |   | $ | 1,527,451 |   |   |
| Cost of revenues                                |       |                     | 733,173    |            |       |         | 437,869    |         |       | 48,955           |       | — |   |   | 1,219,997 |   |   |
| Gross profit                                    |       |                     | 156,207    |            |       |         | 128,569    |         |       | 22,678           |       | — |   |   | 307,454 |   |   |
| Selling, general  and administrative expense    |       |                     | 79,564     |            |       |         | 68,488     |         |       | 8,515            |       | 21,300 |   |   | 177,867 |   |   |
| Fulfillment  freight                            |       |                     | 30,993     |            |       |         | 41,813     |         |       | —           |       | — |   |   | 72,806 |   |   |
| Depreciation and  amortization                  |       |                     | 11,147     |            |       |         | 4,446      |         |       | 601              |       | 2,019 |   |   | 18,213 |   |   |
| Integration and  relocation expense             |       |                     | —     |            |       |         | —     |         |       | —           |       | — |   |   | — |   |   |
| Disposal of land,  buildings and equipment, net |       |                     | —     |            |       |         | —     |         |       | —           |       | — |   |   | — |   |   |
| Merger and  acquisition charges                 |       |                     | —     |            |       |         | —     |         |       | 344              |       | 2,975 |   |   | 3,319 |   |   |
| Operating income (loss)                         |       |                     | $          | 34,503          |       |         |       | $            | 13,822     |             |       | $ | 13,218 |   | $ | (26,294 | ) |   | $ | 35,249 |   |   |
| Capital expenditures                            |       |                     | $          | 8,469           |       |         |       | $            | 1,576      |             |       | $ | 623 |   | $ | 2,401 |   |   | $ | 13,069 |   |   |
| **As of  January 31, 2006**                |       |                     |       |            |       |         |       |         |       |             |       |   |   |   |   |   |   |
| Total assets                                    |       |                     | $          | 508,620         |       |         |       | $            | 208,523    |             |       | $ | 114,355 |   | $ | 52,974 |   |   | $ | 884,472 |   |   |
| Goodwill, net                                   |       |                     | $          | 168,898         |       |         |       | $            | 78,601     |             |       | $ | 54,794 |   | $ | — |   |   | $ | 302,293 |   |   |
| Intangibles, net                                |       |                     | $          | 87,742          |       |         |       | $            | 27,374     |             |       | $ | 3,872 |   | $ | — |   |   | $ | 118,988 |   |   |

 

| ** **                                  | ** ** | **CD and DVD  Fulfillment** | ** ** | **Magazine  Fulfillment** | ** ** | **In-Store  Services** | ** ** | **Shared  Services** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|------------------------|------------|----------------------|------------|------------------|------------|
| ** **                                  | ** ** | **(in thousands)**               | ** ** |
| YEAR ENDED JANUARY 31,  2005                |       |                                  |       |                      |       |                   |       |                 |       |             |       |   |   |   |   |   |   |
| Revenues                                    |       |                                  | $          | —                    |       |                   |       | $                    | 280,171    |             |       | $ | 76,473 |   | $ | — |   |   | $ | 356,644 |   |   |
| Cost of revenues                            |       |                                  | —     |                      |       |                   | 210,639    |                 |       | 48,212           |       | — |   |   | 258,851 |   |   |
| Gross profit                                |       |                                  | —     |                      |       |                   | 69,532     |                 |       | 28,261           |       | — |   |   | 97,793 |   |   |
| Selling, general and administrative expense |       |                                  | —     |                      |       |                   | 28,481     |                 |       | 9,154            |       | 13,744 |   |   | 51,379 |   |   |
| Fulfillment freight                         |       |                                  | —     |                      |       |                   | 21,067     |                 |       | —           |       | — |   |   | 21,067 |   |   |
| Depreciation and amortization               |       |                                  | —     |                      |       |                   | 1,392      |                 |       | 504              |       | 1,855 |   |   | 3,751 |   |   |
| Relocation expense                          |       |                                  | —     |                      |       |                   | 2,090      |                 |       | 360              |       | — |   |   | 2,450 |   |   |
| Loss on sale of land and building           |       |                                  | —     |                      |       |                   | —     |                 |       | —           |       | 1,122 |   |   | 1,122 |   |   |
| Operating income (loss)                     |       |                                  | $          | —                    |       |                   |       | $                    | 16,502     |             |       | $ | 18,243 |   | $ | (16,721 | ) |   | $ | 18,024 |   |   |
| Capital  Expenditures                       |       |                                  | $          | —                    |       |                   |       | $                    | 2,379      |             |       | $ | 279 |   | $ | 4,488 |   |   | $ | 7,146 |   |   |

 

Approximately $35.4million, $31.7 million and $38.5 million of our total revenues in the MagazineFulfillment segment for the years ended January 31, 2007, 2006 and 2005,respectively, were derived from the export of U.S. publications to overseasmarkets. For the years ended January 31, 2007, 2006 and 2005, identifiableassets attributable to the export of U.S. publications were $27.2 million,$14.3million and $18.0 million, respectively.

F-34

----

**18.**          SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)

| ** **                              | ** ** | **Three months ended**                                   | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                              | ** ** | **April 30**                                                  | ** ** | **July 31** | ** ** | **October 31** | ** ** | **January 31** | ** ** |
| ** **                              | ** ** | **(in thousands, except per share data)** | ** ** |
| Revenues                                |       | $                                                                  | 454,600    |   | $ | 441,507 |   |   | $ | 475,775 |   |   |   | $ | 482,963 |   |   |
| Gross profit                            |       | $                                                                  | 89,940     |   | $ | 95,840 |   |   | $ | 104,923 |   |   |   | $ | 95,354 |   |   |
| Net income                              |       | $                                                                  | 3,259      |   | $ | 4,094 |   |   | $ | 4,831 |   |   |   | $ | (36,840 | ) |   |
| Earnings (loss) per  share—Basic   |       | $                                                                  | 0.06       |   | $ | 0.08 |   |   | $ | 0.09 |   |   |   | $ | (0.71 | ) |   |
| Earnings (loss) per  share—Diluted |       | $                                                                  | 0.06       |   | $ | 0.08 |   |   | $ | 0.09 |   |   |   | $ | (0.71 | ) |   |

 

| ** **                                | ** ** | **Three months ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **April 30**                | ** ** | **July 31** | ** ** | **October 31** | ** ** | **January 31** | ** ** |
| ** **                                | ** ** | **(in thousands)**          | ** ** |
| 2006                                      |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                  |       | $                                | 234,421    |   | $ | 393,790 |   |   | $ | 425,859 |   |   |   | $ | 473,381 |   |   |
| Gross profit                              |       | $                                | 50,545     |   | $ | 78,989 |   |   | $ | 86,084 |   |   |   | $ | 91,826 |   |   |
| Income from continuing operations         |       | $                                | 1,671      |   | $ | 4,076 |   |   | $ | 6,083 |   |   |   | $ | 2,495 |   |   |
| Income (loss) from discontinued operation |       | $                                | —     |   | $ | (1,446 | ) |   | $ | — |   |   |   | $ | — |   |   |
| Net income                                |       | $                                | 1,671      |   | $ | 2,630 |   |   | $ | 6,083 |   |   |   | $ | 2,495 |   |   |
| Earnings (loss)  per share—Basic     |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                     |       | $                                | 0.04       |   | $ | 0.08 |   |   | $ | 0.12 |   |   |   | $ | 0.05 |   |   |
| Discontinued operation                    |       | —                           |       | (0.03 | ) |   | — |   |   |   | — |   |   |
| Total                                     |       | $                                | 0.04       |   | $ | 0.05 |   |   | $ | 0.12 |   |   |   | $ | 0.05 |   |   |
| Earnings (loss)  per share—Diluted   |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                     |       | $                                | 0.04       |   | $ | 0.08 |   |   | $ | 0.11 |   |   |   | $ | 0.05 |   |   |
| Discontinued operation                    |       | —                           |       | (0.03 | ) |   | — |   |   |   | — |   |   |
| Total                                     |       | $                                | 0.04       |   | $ | 0.05 |   |   | $ | 0.11 |   |   |   | $ | 0.05 |   |   |

 

**19.**          SUBSEQUENTEVENTS

On February 14, 2007, the Company’s Board ofDirectors approved a plan to dispose of our custom wood manufacturing division.The Company has located a potential buyer in which our former Chairman of theBoard and Chief Executive Officer holds an interest and is in the process ofnegotiating the terms of a sale. This potential buyer has submitted a Letter ofIntent to the Company which provides for a purchase price of $10.0 millionin cash, subject to a working capital adjustment, and a note with aggregateprincipal of $3.5 million maturing over 10 years.

F-35

----

**SOURCE INTERLINK COMPANIESSCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS SCHEDULE(IN THOUSANDS)**
| Column A                      | ** ** | ** ** | **Column B** | ** **                                     | **Column C** | ** **                   | **Column D** | ** **                          | **Column E** | ** **     |
|------------------------------------|------------|------------|-------------------|------------------------------------------------|-------------------|------------------------------|-------------------|-------------------------------------|-------------------|----------------|
| **Description**                    | ** ** | ** ** | ** **        | **Balance at  beginning of  period** | ** **        | **Charged to  expense** | ** **        | **Charge to  other  accounts** | ** **        | **Deductions** | ** ** | **Balance at  end of period** | ** ** |
| Year ended  January 31, 2007: |       |       |              |                                           |              |                         |              |                                |              |           |   |   |   |   |   |
| Allowance for doubtful accounts    |       |       | 20,682            |                                           |              | 3,156                        |              | 2,260                               |              | 8,968          |   |   | 17,130 |   |   |
| Sales return reserves              |       |       | 193,418           |                                           |              | 1,775,707                    |              | 28,791                              |              | 1,805,588      |   |   | 192,328 |   |   |
| Year ended  January 31, 2006: |       |       |              |                                           |              |                         |              |                                |              |           |   |   |   |   |   |
| Allowance for doubtful accounts    |       |       | $                 | 2,126                                          |              |                         | $                 | 6,100                               |              | $              | 18,833 |   | $ | 6,377 |   |   | $ | 20,682 |   |   |
| Sales return reserves              |       |       | $                 | 78,404                                         |              |                         | $                 | 1,178,681                           |              | $              | 109,663 |   | $ | 1,173,330 |   |   | $ | 193,418 |   |   |
| Year ended  January 31, 2005: |       |       |              |                                           |              |                         |              |                                |              |           |   |   |   |   |   |
| Allowance for doubtful accounts    |       |       | $                 | 4,568                                          |              |                         | $                 | 3,003                               |              | $              | 200 |   | $ | 5,645 |   |   | $ | 2,126 |   |   |
| Sales return  reserves             |       |       | $                 | 64,566                                         |              |                         | $                 | 356,691                             |              | $              | 3,147 |   | $ | 346,000 |   |   | $ | 78,404 |   |   |
|                                    |            |            |                   |                                                |                   |                              |                   |                                     |                   |                |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

S-1

----