**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q/A**

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

**For the quarterly periodended April 30, 2007**

**or**

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

**For the transition periodfrom                 to                 **

**Commission file number 001-13437**

****

**SOURCEINTERLINK COMPANIES, INC.**

(Exact name of registrant as specified in its charter)

| **Delaware**                                                              | ** ** | **20-2428299**                        |
|---------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)          |       | (I.R.S. Employer  Identification No.) |
| **27500 Riverview Center Blvd., Suite 400  Bonita Springs, Florida** | ** ** | **34134**                             |
| (Address of  principal executive offices)                                 |       | (Zip Code)                            |

 

**(239) 949-4450**

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(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 for thepast 90 days.

x Yes      o No

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

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

 

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

o Yes      x No

As ofJune 4, 2007, there were 52,310,837 shares of the Company’s common stockoutstanding.

 

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**EXPLANATORY NOTE**

This Amendment No. 1on Form 10-Q/A (this “Amendment”) amends our Quarterly Report onForm 10-Q for the fiscal quarter ended April 30, 2007, originallyfiled on June 11, 2007 (the “Original Filing”). We are filing thisAmendment solely to correct a typographical error within the column headings onpage 5 of the Original Filing. No other changes have been made to theOriginal Filing. The Original Filing continues to speak as of the date of theOriginal Filing, and we have not updated the disclosures contained therein toreflect any events which occurred at a date subsequent to the filing of theOriginal Filing.

**TABLEOF CONTENTS**
|                                             | ** **                                                                                       | **Page**   | ** ** |
|---------------------------------------------|--------------------------------------------------------------------------------------------------|------------|------------|
| **PART I—FINANCIAL  INFORMATION** | ** **                                                                                       |
| ITEM 1.                                     | FINANCIAL STATEMENTS                                                                             | 3          |       |
| ITEM 2.                                     | MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 19         |       |
| ITEM 3.                                     | QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET  RISK                                     | 28         |       |
| ITEM 4.                                     | CONTROLS AND PROCEDURES                                                                          | 29         |       |
| **PART II—OTHER  INFORMATION**    | ** **                                                                                       | ** ** |
| ITEM 1.                                     | LEGAL PROCEEDINGS                                                                                | 31         |       |
| ITEM 1A.                                    | RISK FACTORS                                                                                     | 31         |       |
| ITEM 2.                                     | UNREGISTERED SALES OF EQUITY  SECURITIES AND USE OF   PROCEEDS                                   | 31         |       |
| ITEM 3.                                     | DEFAULTS UPON SENIOR  SECURITIES                                                                 | 31         |       |
| ITEM 4.                                     | SUBMISSION OF MATTERS TO A  VOTE OF SECURITY HOLDERS                                             | 31         |       |
| ITEM 5.                                     | OTHER INFORMATION                                                                                | 31         |       |
| ITEM 6.                                     | EXHIBITS                                                                                         | 31         |       |
|                                             |                                                                                                  |            |            |  |  |

 

2

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**PART I—FINANCIALINFORMATION**

**ITEM 1. FINANCIAL STATEMENTS.**

**INDEXOF FINANCIAL STATEMENTS**
|                                                                                                                  | ** ** | ** ** | **Page** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------|----------|------------|------------|
| Consolidated Balance Sheets as of  April 30, 2007 (unaudited) and January 31, 2007                     |       | 4          |     |       |
| Consolidated Statements of  Income for the three months ended April 30, 2007 and 2006   (unaudited)         |       | 6          |     |       |
| Consolidated Statement of  Stockholders’ Equity for the three months ended April 30, 2007  (unaudited) |       | 7          |     |       |
| Consolidates Statements of  Cash Flows for the three months ended April 30, 2007 and 2006  (unaudited)      |       | 8          |     |       |
| Notes  to Consolidated Financial Statements                                                                      |       | 9          |     |       |
|                                                                                                                  |            |            |          |            |            |  |

 

3

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**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED BALANCE SHEETS**(in thousands)

| ** **                                     | ** ** | **April 30,  2007** | ** ** | **January 31,  2007** | ** ** |
|------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                     | ** ** | **(unaudited)**          | ** ** | ** **                 | ** ** |
| **Assets**                                     | ** ** | ** **               |       | ** **                 |       |
| Current assets                                 |       |                     |       |                       |       |
| Cash                                           |       | $                        | 14,514     |                       | $          | — |   |
| Trade receivables, net                         |       | 92,608                   |       | 102,658                    |       |
| Purchased claims receivable                    |       | 12,668                   |       | 16,983                     |       |
| Inventories                                    |       | 257,500                  |       | 248,941                    |       |
| Income tax receivable                          |       | 9,316                    |       | 9,932                      |       |
| Deferred tax asset                             |       | 29,809                   |       | 29,531                     |       |
| Other                                          |       | 8,080                    |       | 5,440                      |       |
| Total current assets                           |       | 424,495                  |       | 413,485                    |       |
| Property, plants and equipment                 |       | 94,116                   |       | 98,812                     |       |
| Less accumulated depreciation and amortization |       | (29,532                  | )          | (30,897                    | )          |
| Net property, plants and equipment             |       | 64,584                   |       | 67,915                     |       |
| Other assets                                   |       |                     |       |                       |       |
| Goodwill, net                                  |       | 396,330                  |       | 395,902                    |       |
| Intangibles, net                               |       | 115,960                  |       | 118,971                    |       |
| Other                                          |       | 17,249                   |       | 13,758                     |       |
| Total other assets                             |       | 529,539                  |       | 528,631                    |       |
| Total assets                                   |       | $                        | 1,018,618  |                       | $          | 1,010,031 |   |

 

See accompanying notes to Consolidated Financial Statements.

4

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**SOURCE INTERLINKCOMPANIES, INC.CONSOLIDATED BALANCE SHEETS (CONCLUDED)**(in thousands, exceptper share amounts)

| ** **                                                                                                                                | ** ** | **April 30,  2007** | ** ** | **January 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                | ** ** | **(unaudited)**          | ** ** | ** **                 | ** ** |
| **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  $145,764 and $164,069 at April 30, 2007 and January 31, 2007,  respectively) |       | 312,508                  |       | 308,184                    |       |
| Accrued expenses                                                                                                                          |       | 68,434                   |       | 62,838                     |       |
| Deferred revenue                                                                                                                          |       | 2,612                    |       | 2,630                      |       |
| Current portion of obligations under capital leases                                                                                       |       | 1,033                    |       | 995                        |       |
| Current maturities of debt                                                                                                                |       | 8,930                    |       | 7,850                      |       |
| Total current liabilities                                                                                                                 |       | 393,517                  |       | 383,962                    |       |
| Deferred tax liability                                                                                                                    |       | 32,470                   |       | 32,500                     |       |
| Obligations under capital leases                                                                                                          |       | 860                      |       | 1,069                      |       |
| Debt, less current maturities                                                                                                             |       | 143,766                  |       | 146,534                    |       |
| Other                                                                                                                                     |       | 5,233                    |       | 6,519                      |       |
| Total liabilities                                                                                                                         |       | 575,846                  |       | 570,584                    |       |
| Commitments and contingencies                                                                                                             |       |                     |       |                       |       |
| Stockholders’ equity                                                                                                                 |       |                     |       |                       |       |
| Contributed capital:                                                                                                                      |       |                     |       |                       |       |
| Preferred stock, $0.01 par (2,000 shares authorized;  none issued)                                                                        |       | —                   |       | —                     |       |
| Common stock, $0.01 par (100,000 shares authorized;  52,224 and 52,064 shares issued)                                                |       | 522                      |       | 521                        |       |
| Additional paid-in-capital                                                                                                                |       | 475,541                  |       | 474,796                    |       |
| Total contributed capital                                                                                                                 |       | 476,063                  |       | 475,317                    |       |
| Accumulated deficit                                                                                                                       |       | (35,938                  | )          | (37,766                    | )          |
| Accumulated other comprehensive income:                                                                                                   |       |                     |       |                       |       |
| Foreign currency translation                                                                                                              |       | 2,647                    |       | 1,896                      |       |
| Total stockholders’ equity                                                                                                           |       | 442,772                  |       | 439,447                    |       |
| Total liabilities and stockholders’ equity                                                                                           |       | $                        | 1,018,618  |                       | $          | 1,010,031 |   |

 

See accompanying notes to Consolidated Financial Statements.

5

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**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENTS OF INCOME**(in thousands, exceptper share amounts)(unaudited)

| ** **                                                                             | ** ** | **Three months ended  April 30,**                                 | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **      2007      ** | ** ** | **      2006      ** | ** ** |
| Revenues                                                                               |       |                                                                             | $          | 475,405 |   |   |   | $ | 447,894 |   |   |
| Cost of revenues  (including depreciation of $217 and $154)                            |       |                                                                             | 375,911    |   |   |   | 358,924 |   |   |
| Gross profit                                                                           |       |                                                                             | 99,494     |   |   |   | 88,970 |   |   |
| Selling, general and administrative expense                                            |       |                                                                             | 58,091     |   |   |   | 54,068 |   |   |
| Fulfillment  freight                                                                   |       |                                                                             | 25,755     |   |   |   | 21,935 |   |   |
| Depreciation and  amortization                                                         |       |                                                                             | 6,836      |   |   |   | 5,804 |   |   |
| Impairment of  land and building held for sale                                         |       |                                                                             | —     |   |   |   | 529 |   |   |
| Operating income                                                                       |       |                                                                             | 8,812      |   |   |   | 6,634 |   |   |
| Other income  (expense):                                                               |       |                                                                             |       |   |   |   |   |   |   |
| Interest expense (including amortization of deferred  financing fees of $146 and $157) |       |                                                                             | (3,567     | ) |   |   | (2,267 | ) |   |
| Interest income                                                                        |       |                                                                             | 41         |   |   |   | 68 |   |   |
| Other                                                                                  |       |                                                                             | 71         |   |   |   | 19 |   |   |
| Total other expense                                                                    |       |                                                                             | (3,455     | ) |   |   | (2,180 | ) |   |
| Income from continuing operations, before income  taxes                                |       |                                                                             | 5,357      |   |   |   | 4,454 |   |   |
| Income tax  expense                                                                    |       |                                                                             | 2,143      |   |   |   | 1,592 |   |   |
| Income from continuing operations                                                      |       |                                                                             | 3,214      |   |   |   | 2,862 |   |   |
| Discontinued  operation, net of income taxes                                           |       |                                                                             | (1,386     | ) |   |   | 397 |   |   |
| Net income                                                                             |       |                                                                             | $          | 1,828 |   |   |   | $ | 3,259 |   |   |
| Earnings per  share—basic                                                         |       |                                                                             |       |   |   |   |   |   |   |
| Continuing operations                                                                  |       |                                                                             | $          | 0.06 |   |   |   | $ | 0.05 |   |   |
| Discontinued operation                                                                 |       |                                                                             | (0.02      | ) |   |   | 0.01 |   |   |
| Total                                                                                  |       |                                                                             | $          | 0.04 |   |   |   | $ | 0.06 |   |   |
| Earnings per  share—diluted                                                       |       |                                                                             |       |   |   |   |   |   |   |
| Continuing operations                                                                  |       |                                                                             | $          | 0.06 |   |   |   | $ | 0.05 |   |   |
| Discontinued operation                                                                 |       |                                                                             | (0.03      | ) |   |   | 0.01 |   |   |
| Total                                                                                  |       |                                                                             | $          | 0.03 |   |   |   | $ | 0.06 |   |   |
| Weighted average common shares outstanding—basic                                  |       |                                                                             | 52,153     |   |   |   | 51,708 |   |   |
| Weighted average common  shares outstanding—diluted                               |       |                                                                             | 52,632     |   |   |   | 53,154 |   |   |

 

See accompanying notes to Consolidated Financial Statements.

6

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**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**(in thousands)(unaudited)

| ** **                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated ** | ** ** | **Accumulated  Other  Comprehensive  Income ** | ** ** | **Total  Stockholders’ ** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**           | ** ** | **Deficit**                                         | ** ** | **(Loss)**                          | ** ** | **Equity** | ** ** |
| Balance,  January 31, 2007                  |       | 52,064                |       |                    | $          | 521                   |       |                                                | $          | 474,796                             |       |   | $ | (37,766 | ) |   |   | $ | 1,896 |   |   |   | $ | 439,447 |   |   |
| Net income                                       |       | —                |       |                    | —     |                  |       | —                                              |       |                                | 1,828      |   |   |   | — |   |   |   | 1,828 |   |   |
| Foreign currency  translation                    |       | —                |       |                    | —     |                  |       | —                                              |       |                                | —     |   |   |   | 751 |   |   |   | 751 |   |   |
| Comprehensive income                             |       | —                |       |                    | —     |                  |       | —                                              |       |                                | —     |   |   |   | — |   |   |   | 2,579 |   |   |
| Stock compensation expense                       |       | —                |       |                    | —     |                  |       | 179                                                 |       |                                | —     |   |   |   | — |   |   |   | 179 |   |   |
| Exercise of stock  options                       |       | 160                   |       |                    | 1          |                  |       | 229                                                 |       |                                | —     |   |   |   | — |   |   |   | 230 |   |   |
| Excess tax  benefit from stock options exercised |       | —                |       |                    | —     |                  |       | 337                                                 |       |                                | —     |   |   |   | — |   |   |   | 337 |   |   |
| Balance,  April 30, 2007                    |       | 52,224                |       |                    | $          | 522                   |       |                                                | $          | 475,541                             |       |   | $ | (35,938 | ) |   |   | $ | 2,647 |   |   |   | $ | 442,772 |   |   |

 

See accompanying notes to Consolidated Financial Statements.

7

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**SOURCE INTERLINK COMPANIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**(in thousands)(unaudited)

| ** **                                                                                   | ** ** | **Three months ended  April 30,**                                                         | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **        2007        ** | ** ** | **        2006        ** | ** ** |
| **Operating Activities**                                                                     |       |                                                                                                     |       |   |   |   |   |   |   |
| Net income                                                                                   |       |                                                                                                     | $          | 1,828 |   |   |   | $ | 3,259 |   |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                                                                                                     |       |   |   |   |   |   |   |
| Depreciation and amortization                                                                |       |                                                                                                     | 7,339      |   |   |   | 6,240 |   |   |
| Provision for losses on accounts receivable                                                  |       |                                                                                                     | 1,106      |   |   |   | 1,728 |   |   |
| Deferred revenue                                                                             |       |                                                                                                     | 18         |   |   |   | (360 | ) |   |
| Stock compensation expense                                                                   |       |                                                                                                     | 179        |   |   |   | 400 |   |   |
| Loss on sale of discontinued operation                                                       |       |                                                                                                     | 508        |   |   |   | — |   |   |
| Impairment of land and building held for sale                                                |       |                                                                                                     | —     |   |   |   | 529 |   |   |
| Other                                                                                        |       |                                                                                                     | 490        |   |   |   | (259 | ) |   |
| Changes in assets  and liabilities (excluding business acquisitions):                        |       |                                                                                                     |       |   |   |   |   |   |   |
| Decrease (increase) in accounts receivable                                                   |       |                                                                                                     | 5,733      |   |   |   | (8,220 | ) |   |
| Increase in inventories                                                                      |       |                                                                                                     | (14,264    | ) |   |   | (9,816 | ) |   |
| Increase in other current and non-current assets                                             |       |                                                                                                     | (3,093     | ) |   |   | (1,654 | ) |   |
| Increase (decrease) in accounts payable and other  liabilities                               |       |                                                                                                     | 7,043      |   |   |   | (48,775 | ) |   |
| Cash provided by  (used in) operating activities                                             |       |                                                                                                     | 6,887      |   |   |   | (56,928 | ) |   |
| **Investment  Activities**                                                                   |       |                                                                                                     |       |   |   |   |   |   |   |
| Capital expenditures                                                                         |       |                                                                                                     | (4,027     | ) |   |   | (1,955 | ) |   |
| Purchase of claims                                                                           |       |                                                                                                     | (23,756    | ) |   |   | (27,902 | ) |   |
| Payments received on purchased claims                                                        |       |                                                                                                     | 28,071     |   |   |   | 27,655 |   |   |
| Proceeds from sale of wood manufacturing division,  net of cash transferred             |       |                                                                                                     | 9,970      |   |   |   | — |   |   |
| Acquisition of Anderson Mid-Atlantic News, LLC, net  of cash acquired                        |       |                                                                                                     | —     |   |   |   | (13,620 | ) |   |
| Acquisition of Anderson SCN Services, LLC, net of  cash acquired                             |       |                                                                                                     | —     |   |   |   | (25,990 | ) |   |
| Other                                                                                        |       |                                                                                                     | 44         |   |   |   | (1,017 | ) |   |
| Cash provided by  (used in) investing activities                                             |       |                                                                                                     | 10,302     |   |   |   | (42,829 | ) |   |
| **Financing  Activities**                                                                    |       |                                                                                                     |       |   |   |   |   |   |   |
| (Decrease) increase in checks issued against  revolving credit facilities                    |       |                                                                                                     | (1,383     | ) |   |   | 5,965 |   |   |
| (Repayments) borrowings under credit facilities                                              |       |                                                                                                     | (3,811     | ) |   |   | 69,793 |   |   |
| Net (payments) borrowings on notes payable and  capital leases                               |       |                                                                                                     | 1,952      |   |   |   | 692 |   |   |
| Proceeds from the issuance of common stock                                                   |       |                                                                                                     | 230        |   |   |   | 54 |   |   |
| Excess tax benefit from exercise of stock options                                            |       |                                                                                                     | 337        |   |   |   | 14 |   |   |
| Cash (used in)  provided by financing activities                                             |       |                                                                                                     | (2,675     | ) |   |   | 76,518 |   |   |
| Increase (decrease) in cash                                                                  |       |                                                                                                     | 14,514     |   |   |   | (23,239 | ) |   |
| Cash, beginning  of period                                                                   |       |                                                                                                     | —     |   |   |   | 23,239 |   |   |
| Cash, end of period                                                                          |       |                                                                                                     | $          | 14,514 |   |   |   | $ | — |   |   |

 

See accompanying notes to Consolidated Financial Statements.

8

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**(unaudited)

**1.**                 Natureof Business and Basis of Presentation

Source InterlinkCompanies, Inc. (the “Company”) is a leading marketing, merchandising andfulfillment company of entertainment products including DVDs, music CDs,magazines, books and related items. The Company’s fully integrated businessesinclude:

·       Distributionand fulfillment of entertainment products to major retail chains throughoutNorth America and directly to consumers of entertainment products orderedthrough the Internet;

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

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

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

·       Design,manufacture and installation of wire fixtures in major retail chains.

Source Interlink serves approximately 110,000 retailstore locations throughout North America. Supply chain relationships includemovie studios, record labels, magazine and newspaper publishers, confectionarycompanies and manufacturers of general merchandise.

The consolidated financial statements included hereinhave been prepared by the Company, without audit, pursuant to the rules andregulations of the Securities and Exchange Commission. In the opinion of theCompany’s management, all adjustments (consisting only of normal recurringadjustments and reclassifications) necessary to present fairly our results ofoperations and cash flows for the three months ended April 30, 2007 and2006 and our financial position as of April 30, 2007, respectively havebeen made. The results of operations for such interim periods are notnecessarily indicative of the operating results to be expected for the fullyear.

Certain information and disclosures normally includedin the notes to the annual consolidated financial statements have beencondensed or omitted from these interim consolidated financial statements.Accordingly, these interim consolidated financial statements should be read inconjunction with the consolidated financial statements and notes theretoincluded in our Annual Report on Form 10-K (the “Annual Report”) forthe fiscal year ended January 31, 2007, as filed with the Securities andExchange Commission (“SEC”) on April 25, 2007, as amended on May 31,2007.

Certain reclassificationshave been made to conform to the current period presentation. Thesereclassifications had no effect on the results of operations or stockholders’equity.

***Adoption of FIN-48***

In July 2006, the Financial Accounting Standards Board(“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty inIncome Taxes, an interpretation of FASB No. 109. Effective February 1,2007, the Company adopted the provisions of Financial Standards AccountingBoard Interpretation FIN 48. This interpretation clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with SFAS 109 and prescribes a recognitionthreshold of more-likely-than-not to be sustained upon examination. As a resultof the implementation of FIN 48, no adjustment was required.

9

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

The Company’s policy is to include interest andpenalties related to gross unrecognized tax benefits within our provision forincome taxes. Such interest and penalties are not material in the periodspresented.

The Company and its subsidiaries file income taxreturns in various tax jurisdictions, including the United States and severalUS states. The Company has substantially concluded all US Federal and Stateincome tax matters for years up to and including 2002.

**2.**                 TradeReceivables

Tradereceivables consist of the following: 

| ** **              | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|-------------------------|------------|--------------------|------------|----------------------|------------|
| **(in thousands)** | ** ** | ** **         | ** ** | **2007**             | ** ** | **2007** | ** ** |
| ** **              | ** ** | **(unaudited)**    | ** ** | ** **           | ** ** |
| Trade receivables       |       |               | $          | 278,784              |       |   |   | $ | 312,116 |   |   |
| Less allowances  for:   |       |               |       |                 |       |   |   |   |   |
| Sales returns and other |       |               | 168,518    |                 |       |   | 192,328 |   |   |
| Doubtful accounts       |       |               | 17,658     |                 |       |   | 17,130 |   |   |
| Total allowances        |       |               | 186,176    |                 |       |   | 209,458 |   |   |
| Trade  receivables, net |       |               | $          | 92,608               |       |   |   | $ | 102,658 |   |   |
|                         |            |                    |            |                      |            |  |  |  |  |  |  |  |  |

 

**3.**                 Inventories

Inventoriesconsist of the following:

| ** **                   | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|------------------------------|------------|--------------------|------------|----------------------|------------|
| **(in thousands)**      | ** ** | ** **         | ** ** | **2007**             | ** ** | **2007** | ** ** |
| ** **                   | ** ** | **(unaudited)**    | ** ** | ** **           | ** ** |
| Raw materials                |       |               | $          | 510                  |       |   |   | $ | 3,048 |   |   |
| Work-in-process              |       |               | 1,083      |                 |       |   | 2,519 |   |   |
| Finished goods:              |       |               |       |                 |       |   |   |   |   |
| Pre-recorded music and video |       |               | 138,878    |                 |       |   | 133,193 |   |   |
| Magazines and books          |       |               | 116,576    |                 |       |   | 107,449 |   |   |
| Fixtures                     |       |               | 453        |                 |       |   | 2,732 |   |   |
| Inventories                  |       |               | $          | 257,500              |       |   |   | $ | 248,941 |   |   |
|                              |            |                    |            |                      |            |  |  |  |  |  |  |  |  |

 

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

10

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

**4.**                 Debtand Revolving Credit Facility

Debt consists of:

| ** **                                           | ** ** | **April 30,** | ** ** | **January 31,** | ** ** |
|------------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| **(in thousands)**                              | ** ** | ** **         | ** ** | **2007**             | ** ** | **2007** | ** ** |
| ** **                                           | ** ** | **(unaudited)**    | ** ** | ** **           | ** ** |
| Revolving credit  facility—Wells Fargo Foothill |       |               | $          | 112,648              |       |   |   | $ | 116,459 |   |   |
| Note  payable—Magazine import and export        |       |               | 2,808      |                 |       |   | 3,500 |   |   |
| Note  payable—Former owner of Empire            |       |               | 233        |                 |       |   | 233 |   |   |
| Note  payable—Arrangements with suppliers       |       |               | 9,553      |                 |       |   | 10,180 |   |   |
| Mortgage  loan—Wachovia Bank                    |       |               | 19,500     |                 |       |   | 19,750 |   |   |
| Equipment loans                                      |       |               | 7,954      |                 |       |   | 4,262 |   |   |
| Total debt                                           |       |               | 152,696    |                 |       |   | 154,384 |   |   |
| Less current  maturities                             |       |               | 8,930      |                 |       |   | 7,850 |   |   |
| Debt, less current  maturities                       |       |               | $          | 143,766              |       |   |   | $ | 146,534 |   |   |
|                                                      |            |                    |            |                      |            |  |  |  |  |  |  |  |  |

 

***Wells Fargo Foothill Credit Facility***

On February 28, 2005, the Company modified itsexisting credit facility with Wells Fargo Foothill (“WFF”) as a result of itsacquisition of Alliance. The primary changes from the original line of creditwere to (1) increase the maximum allowed advances under the line of creditfrom $45.0 million to $250.0 million and (2) extend the maturity date fromOctober 2009 to October 2010. In addition, in conjunction with themodification of the existing credit facility, the Company repaid the balance ofits $10.0 million WFF term loan. WFF, as arranger and administrative agent foreach of the parties that may become a participant in such arrangement and theirsuccessors (“Lenders”) will make revolving loans to us and our subsidiaries ofup to $250.0 million including the issuance of letters of credit. The terms andconditions of the arrangement are governed primarily by the Amended and RestatedLoan 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 April 30, 2007) based upon a ratio of theCompany’s EBITDA to interest expense (“Interest Coverage Ratio”). At April 30,2007 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 3 LIBOR contracts outstanding at April 30, 2007 (expiring through June 2007)that bear interest at a weighted average rate of approximately 7.3%. To securerepayment of the borrowings and other obligations of ours to the Lenders, weand our subsidiaries granted a security interest in all of the personalproperty assets to 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 April 30, 2007.

11

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

Availability under thefacility is limited by the Company’s borrowing base calculation, as defined inthe agreement. The calculation resulted in excess availability, afterconsideration of outstanding letters of credit, of $85.5 million at April 30,2007.

***Equipment Loans***

Through the acquisition of Alliance, the Companyentered into a loan agreement with SunTrust Leasing Corporation (the “SunTrustLoan”) for the purchase of equipment to be used at various locations. A creditline of $6.8 million was approved under the SunTrust Loan, with repayment termsfor five promissory notes ranging from three to five years. The total principalbalance of the SunTrust Loan outstanding as of April 30, 2007 was $3.7million.

During the first quarterof fiscal 2008, the Company entered into a loan agreement with Wachovia Bank,N.A. (the “Wachovia Loan”) for the purchase of equipment to be used at variouslocations. The total principal balance of the Wachovia Loan outstanding as ofApril 30, 2007 was $4.2 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 notes range betweenMarch 2007 and August 2014 and bear interest at 5%. Principalrepayments range from $1.0 to $2.0 million per fiscal year with $1.6 millionand $1.7 million due to be repaid in fiscal year 2007 and 2008, respectively.The total principal balance of the Supplier Loans as of April 30, 2007 was$9.6 million.

***Mortgage Loan***

The Company obtained a 10year, $20.0 million conventional mortgage loan through Wachovia Bank (the“Wachovia Mortgage”). The Wachovia Mortgage is collateralized by land andbuilding located in Coral Springs, FL. The Wachovia Mortgage monthly principalpayments are approximately $0.08 million plus interest at a rate of LIBOR plusa margin of 1.60%. At the end of the 10 year term, a balloon payment in theamount of $11.1 million is due and payable. The total principal balance of theWachovia Mortgage as of April 30, 2007 was $19.5 million.

***Magazine Import and Export Notes***

Concurrent with themagazine import and export acquisition in November 2004, the Companyissued an additional $7.7 million in notes payable. At April 30, 2007, thebalance on all magazine import and export notes was $2.8 million. These notesbear interest at a rate of 2.37% and require quarterly payments throughFebruary, 2008.

12

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

Theaggregate amount of debt maturing through January 31, 2012 is as follows:

| **(in thousands)** | ** ** | ** ** | ** ** | **Amount** | ** ** |
|-------------------------|------------|------------|------------|------------|------------|
| Fiscal year:            |       |       |       |
| Remainder of 2008       |       | $          | 6,633      |       |
| 2009                    |       | 6,302      |       |
| 2010                    |       | 3,948      |       |
| 2011                    |       | 115,148    |       |
| 2012                    |       | 2,515      |       |
| Thereafter              |       | 18,150     |       |
| Total                   |       | $          | 152,696    |       |

 

At April 30, 2007 andJanuary 31, 2007, unamortized deferred financing fees were approximately$1.5 million and $1.7 million, respectively.

**5.**                 Earningsper Share

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

| ** **                                               | ** ** | **Three months ended  April 30,** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(in thousands)**                                  | ** ** | ** **                                       | ** ** | **        2007        ** | ** ** | **        2006        ** | ** ** |
| Weighted average  common shares outstanding—Basic   |       |                                             | 52,153     |   |   |   | 51,708 |   |   |
| Dilutive effect  of stock options and warrants           |       |                                             | 479        |   |   |   | 1,446 |   |   |
| Weighted average common  shares outstanding—Diluted |       |                                             | 52,632     |   |   |   | 53,154 |   |   |
|                                                          |            |                                                  |            |  |  |  |  |  |  |  |  |

 

For the three months endedApril 30, 2007 and 2006, stock options to purchase 1.8 million and0.2 million stock options and warrants, respectively, were excluded fromthe calculation of diluted income per share because their exercise priceexceeded the average market price of the common shares during the period.

13

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

**6.**                 DiscontinuedOperation

On April 30,2007, the Company disposed of substantially all of the assets and liabilitiesof its Wood Manufacturing division. The Company sold the assets and liabilitiesof its Wood Manufacturing division to a purchaser in which S. Leslie Flegel,the Company’s former Chairman of the Board and Chief Executive Officer has aninterest. The Wood Manufacturing division was formerly reported as part of ourIn-Store Services segment. The book value of the net assets sold on the closingdate was $11.6 million. The assets and liabilities of the Wood Manufacturingdivision were sold for $10.0 million cash, subject to adjustment based upon theworking capital transferred to the buyer, and the issuance of a note payable tothe Company in the face amount of $3.5 million, which bears interest at the3-month LIBOR plus a margin of 2.00%. The Company has determined that the notedoes not bear an interest rate equivalent to a market rate for the borrower. Therefore,the Company has discounted the note to fair value using its estimation of amarket rate for the note. This discount was approximately $1.0 million. For thethree months ended April 30, 2007 and 2006, the summary results for theWood Manufacturing division are as follows:

| ** **                                                      | ** ** | **Three months ended  April 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(in thousands)**                                         | ** ** | ** **                                       | ** ** | **        2007        ** | ** ** | **        2006        ** | ** ** |
| Revenues                                                        |       |                                             | $          | 2,551 |   |   |   | $ | 6,706 |   |   |
| (Loss) income  from discontinued operation, before income taxes |       |                                             | $          | (1,463 | ) |   |   | $ | 711 |   |   |
| Income tax  (benefit) expense                                   |       |                                             | (585       | ) |   |   | 314 |   |   |
| (Loss) income from discontinued operation                       |       |                                             | (878       | ) |   |   | 397 |   |   |
| Loss on sale of  discontinued operation, before income taxes    |       |                                             | (847       | ) |   |   | — |   |   |
| Income tax  benefit                                             |       |                                             | (339       | ) |   |   | — |   |   |
| Loss on sale of discontinued operation                          |       |                                             | (508       | ) |   |   | — |   |   |
| Discontinued operation,  net                                    |       |                                             | $          | (1,386 | ) |   |   | $ | 397 |   |   |
|                                                                 |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

**7.**                 SupplementalCash Flow Information

Supplementalinformation on interest and income taxes paid is as follows:

| ** **                                     | ** ** | **Three months ended  April 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|
| **(in thousands)**                        | ** ** | ** **                                       | ** ** | **        2007        ** | ** ** | **        2006        ** | ** ** |
| Interest                                       |       |                                             | $          | 2,850 |   |   |   | $ | 2,054 |   |   |
| Income taxes (net of  receipts of $27 in 2007) |       |                                             | $          | 241 |   |   |   | $ | 2,501 |   |   |
|                                                |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

As discussed in Note 9, the Company disposed of itsWood Manufacturing division for the total consideration of $13.5 million,including $3.5 million in the form of a note receivable.

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 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.

14

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

**8.**                 Stock-BasedCompensation

On February 1, 2006, the Company adopted FAS No. 123(R),*Share-Based Payment*, and chose totransition using the modified prospective method. On February 1, 2007, theCompany granted approximately 0.1 million options to non-executive members ofits board of directors. The Company recognized stock compensation expense ofapproximately $0.2 million associated with this grant. 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.

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

| ** **                                | ** ** | **Three months ended  April 30,**                                                         | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **        2007        ** | ** ** | **        2006        ** | ** ** |
| Weighted average  dividend yield          |       |                                                                                                     | 0.0%       |   |   |   | 0.0% |   |   |
| Weighted average  expected volatility     |       |                                                                                                     | 36.9%      |   |   |   | 41.4% |   |   |
| Weighted average  expected life           |       |                                                                                                     | 3.1  years |   |   |   | 3.1  years |   |   |
| Weighted average  risk-free interest rate |       |                                                                                                     | 4.8%       |   |   |   | 4.5% |   |   |

 

**9.**                 SegmentFinancial Reporting

The Company’s segment reporting is based on thereporting of senior management to the chief operating decision maker. 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 SharedServices. The accounting policies of the segments are materially the same asthose described in the Summary of Accounting Policies.

Based on the comparability of the operations,Mid-Atlantic and SCN’s results are included in the Magazine Fulfillment group.

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 throughoutthe United States and Canada, (2) exporting domestic titlesinternationally to foreign wholesalers or through domestic brokers, (3) providingreturn processing services for major specialty retail book chains and (4) servingas 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 

15

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

management servicesrelating to retail magazine sales to U.S. and Canadian retailers and magazinepublishers.

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

Thesegment results are as follows: 

| **(in thousands)**                     | ** ** | ** ** | ** ** | **CD and DVD  Fulfillment** | ** ** | **Magazine  Fulfillment** | ** ** | **In-Store  Services** | ** ** | **Shared  Services** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------|------------|------------|------------|---------------------------------------|------------|---------------------------|------------|------------------------|------------|----------------------|------------|------------------|------------|
| **Three months ended  April 30, 2007** |       |       |       |                                  |       |                      |       |                   |       |                 |       |             |       |   |   |   |   |
| Revenues                                    |       |       | $          | 230,816                               |       |                      |       | $                      | 233,935    |                 |       | $                | 10,654     |   | $ | — |   |   | $ | 475,405 |   |   |
| Cost of revenues                            |       |       | 190,875    |                                  |       |                      | 178,866    |                   |       | 6,170                |       | —           |       |   | 375,911 |   |   |
| Gross profit                                |       |       | 39,941     |                                  |       |                      | 55,069     |                   |       | 4,484                |       | —           |       |   | 99,494 |   |   |
| Selling, general and administrative expense |       |       | 21,613     |                                  |       |                      | 30,315     |                   |       | 1,980                |       | 4,183            |       |   | 58,091 |   |   |
| Fulfillment freight                         |       |       | 7,701      |                                  |       |                      | 18,054     |                   |       | —               |       | —           |       |   | 25,755 |   |   |
| Depreciation and amortization               |       |       | 4,035      |                                  |       |                      | 2,103      |                   |       | 121                  |       | 577              |       |   | 6,836 |   |   |
| Operating income                            |       |       | $          | 6,592                                 |       |                      |       | $                      | 4,597      |                 |       | $                | 2,383      |   | $ | (4,760 | ) |   | $ | 8,812 |   |   |
| Capital Expenditures                        |       |       | $          | 1,683                                 |       |                      |       | $                      | 1,292      |                 |       | $                | 230        |   | $ | 822 |   |   | $ | 4,027 |   |   |
| **As of  April 30, 2007**              |       |       |       |                                  |       |                      |       |                   |       |                 |       |             |       |   |   |   |   |
| Total assets                                |       |       | $          | 522,166                               |       |                      |       | $                      | 341,187    |                 |       | $                | 83,883     |   | $ | 71,382 |   |   | $ | 1,018,618 |   |   |
| Goodwill, net                               |       |       | $          | 201,532                               |       |                      |       | $                      | 169,875    |                 |       | $                | 24,923     |   | $ | — |   |   | $ | 396,330 |   |   |
| Intangibles, net                            |       |       | $          | 78,351                                |       |                      |       | $                      | 36,425     |                 |       | $                | 1,184      |   | $ | — |   |   | $ | 115,960 |   |   |

 

| **(in thousands)**                        | ** ** | ** ** | ** ** | **CD and DVD  Fulfillment** | ** ** | **Magazine  Fulfillment** | ** ** | **In-Store  Services** | ** ** | **Shared  Services** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------|------------|------------|------------|---------------------------------------|------------|---------------------------|------------|------------------------|------------|----------------------|------------|------------------|------------|
| **Three months ended April 30,  2006**    | ** ** |       | ** ** | ** **                            |       |                      | ** ** | ** **             |       | ** **           | ** ** | ** **       | ** ** |   | ** ** | ** ** |   |
| Revenues                                       |       |       | $          | 240,690                               | ** ** |                      |       | $                      | 194,979    | ** **           |       | $                | 12,225     |   | $ | — |   |   | $ | 447,894 | ** ** |   |
| Cost of revenues                               |       |       | 199,504    | ** **                            |       |                      | 152,125    | ** **             |       | 7,295                |       | —           |       |   | 358,924 | ** ** |   |
| Gross profit                                   |       |       | 41,186     | ** **                            |       |                      | 42,854     | ** **             |       | 4,930                |       | —           |       |   | 88,970 | ** ** |   |
| Selling, general and  administrative expense   |       |       | 21,805     | ** **                            |       |                      | 24,106     | ** **             |       | 1,984                |       | 6,173            |       |   | 54,068 | ** ** |   |
| Fulfillment freight                            |       |       | 8,744      | ** **                            |       |                      | 13,191     | ** **             |       | —               |       | —           |       |   | 21,935 | ** ** |   |
| Depreciation and  amortization                 |       |       | 3,458      | ** **                            |       |                      | 1,651      | ** **             |       | 145                  |       | 550              |       |   | 5,804 | ** ** |   |
| Impairment of land and  building held for sale |       |       | —     | ** **                            |       |                      | —     | ** **             |       | —               |       | 529              |       |   | 529 | ** ** |   |
| Operating income                               |       |       | $          | 7,179                                 | ** ** |                      |       | $                      | 3,906      | ** **           |       | $                | 2,801      |   | $ | (7,252 | ) |   | $ | 6,634 | ** ** |   |
| Capital Expenditures                           |       |       | $          | 941                                   | ** ** |                      |       | $                      | 444        | ** **           |       | $                | 79         |   | $ | 491 |   |   | $ | 1,955 | ** ** |   |
| **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 | ** ** |   |

 

Approximately $12.7million and $8.9 million of the Company’s total revenues in the MagazineFulfillment segment for the three months ended April 30, 2007 and 2006,respectively, were derived from the export of U.S. publications to overseasmarkets. At April 30, 2007 and January 31, 2007, identifiable assetsattributable to the export of U.S. publications were $32.6 million and $27.2million.

16

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**SOURCE INTERLINK COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**(unaudited)

**10.**          SubsequentEvent

On May 13, 2007, Source Interlink Companies, Inc.(“Source”), Consumer Source, Inc. (“Consumer”) a wholly owned subsidiaryof Primedia, Inc. and (“Primedia”) entered into a Stock Purchase Agreement(the “Purchase Agreement”) governing the purchase by Source of all of theissued and outstanding capital stock of Primedia Enthusiast Media, Inc. (“PEM”).Under the terms of the Purchase Agreement, Source would acquire 100% of theoutstanding capital stock of PEM from Consumer for $ 1,177.9 million in cash,subject to adjustment for changes in working capital. The Company expects tofinance the acquisition by issuing approximately $1.3 billion in debt. Theparties anticipate the closing of the transaction contemplated by the PurchaseAgreement (the “Transaction”) will occur in mid-summer 2007. Source andConsumer have made customary representations, warranties and covenants in thePurchase Agreement. Source and Consumer have agreed to make an election under Section 338(h)(10) ofthe Internal Revenue Code of 1986, as amended.

Consummation of the Transaction is subject to variousconditions, including, among other things, the expiration of applicable waitingperiods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. Inconnection with the Transaction, The Yucaipa Companies, LLC (“Yucaipa”)delivered to Source a commitment letter (the “Commitment Letter”) thatcontemplates Yucaipa making an additional investment in Source’s securities ofup to $100 million under certain circumstances. The terms of the securities tobe purchased will be established by a committee of independent directors. Theobligations of Source and Yucaipa under the Commitment Letter terminate at theclosing of the Transaction or the termination of the Purchase Agreement,whichever occurs first. Primedia and Consumer are third party beneficiaries ofthe Commitment Letter.

17

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

Some of theinformation contained in this Quarterly Report on Form 10-Q/Aincluding, but not limited to, those contained in Item 2 of Part I“Management’s Discussion and Analysis of Financial Condition and Results ofOperations,” along with statements in other reports filed with the Securitiesand Exchange Commission (the “SEC”), external documents and oral presentations,which are not historical facts are considered to be “forward-lookingstatements” within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. The words “believe,” “expect,” “anticipate,” “estimate,” “project,”and similar expressions often characterize forward-looking statements. Thesestatements may include, but are not limited to, projections of collections,revenues, income or loss, cash flow, estimates of capital expenditures, plans forfuture operations, products or services, and financing needs or plans, as wellas assumptions relating to these matters. These statements are only predictionsand you should not unduly rely on them. Our actual results will differ, perhapsmaterially, from those anticipated in these forward-looking statements as aresult of a number of factors, including the risks and uncertainties faced byus described below and those set forth below under  “Risk Factors” in our Annual Report for thefiscal year ended January 31, 2007 on Form 10-K filed with theSEC on April 25, 2007, as amended on May 31, 2007:

·       marketacceptance of and continuing demand for magazines, DVDs, CDs and other homeentertainment 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 ourexpectations to our investors. However, there may be events in the future thatwe are not able to predict accurately or over which we have no control. Thefactors listed above provide examples of risks, uncertainties and events thatmay cause our actual results to differ materially from the expectations wedescribe in our forward-looking statements. Before you make an investmentdecision relating to our common stock, you should be aware that the occurrenceof the events described in these risk factors and those set forth below under“Risk Factors” in our Annual Report for the fiscal year ended January 31,2007 filed with the SEC on April 25, 2007, as amended on May 31, 2007could have a material adverse effect on our business, operating results andfinancial condition. You should read and interpret any forward-lookingstatement in conjunction with our consolidated financial statements, the notesto our consolidated financial statements and Item 2 of Part I“Management’s Discussion and Analysis of Financial Condition and Results ofOperation.” Any forward-looking statement speaks only as of the date on whichthat statement is made. Unless required by U.S. federal securities laws, wewill not update any forward-looking statement to reflect events orcircumstances that occur after the date on which the statement is made.

18

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

We are a premiermarketing, merchandising and fulfillment company of entertainment productsincluding DVDs, music CDs, magazines, books and related items serving about110,000 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; and

·       Design,manufacture and installation of wire fixtures in major retail chains.

Our clientsinclude:

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

·       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 andbestbuy.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, Viacom Inc. and General 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 our merger with Alliance Entertainment Corp, a logistics andsupply chain management services company for the home entertainment productmarket, principally selling CDs and DVDs. Following the merger, we organizedthe combined company into three operating business units:

·       MagazineFulfillment—The magazine fulfillment segment sells and distributes magazines tomajor retailers and wholesalers, imports foreign titles for domestic retailersand wholesalers, exports domestic titles to foreign wholesalers, providesreturn processing services, serves as an outsource fulfillment agent andprovides 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-Store Services—Thein-store services segment designs, manufactures and invoices participants infront-end fixture programs, provides claim filing services for rebates owedretailers from publishers and their agents, designs, manufactures, ships,installs and removes front-end fixtures and provides 

19

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information andmanagement services relating to retail magazine sales to U.S. and Canadianretailers and magazine publishers.

**Overview**

Significant events thatoccurred during the three months ended April 30, 2007 and 2006 include:

***Sale of Wood Manufacturing Division***

On April 30, 2007, wesold substantially all of the assets of our Wood Manufacturing Division. Thisdiscontinued operation has been excluded from current and prior year results aspresented herein. See Note 9—*Discontinued Operation*.

***Acquisition of Anderson Mid-Atlantic News, LLC***

On March 30, 2006, weacquired 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 the negativenet worth as of the closing date of the transaction. In addition, we providedapproximately $9.6 million on the date of acquisition to Mid-Atlantic to repaya portion of their outstanding intercompany debt. The remaining outstandingintercompany debt of Mid-Atlantic was satisfied by issuance of a promissorynote totaling $4.1 million. The purchase price and the intercompany debtrepayment were funded by borrowings against our revolving line of credit. Mid-Atlantic’sresults of operations have been included in our Consolidated FinancialStatements since the date of acquisition. The allocation of purchase price ispresented in Note 2 to our Consolidated Financial Statements.

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

On March 30, 2006, weacquired all of the issued and outstanding membership interests of Anderson-SCNServices, LLC (“SCN”) from Anderson News, LLC for a purchase price ofapproximately $9.0 million, subject to adjustment based on the negative networth as of the closing date of the transaction. In addition, we providedapproximately $17.0 million on the date of acquisition to SCN to repay aportion of their outstanding intercompany debt. The remaining outstandingintercompany debt of SCN was satisfied by issuance of a promissory note totaling$10.2 million. The purchase price and the intercompany debt repayment werefunded by borrowings against our revolving line of credit. SCN’s results ofoperations have been included in our Consolidated Financial Statements sincethe date of acquisition. The allocation of purchase price is presented in Note2 to our Consolidated Financial Statements.

**Results ofoperations**

*Please see our Annual Report on Form 10-Kfor the fiscal year ended January 31, 2007 and filed with the SEC on April 25,2007, as amended on May 31, 2007, for more information on the types ofrevenues and expenses included within the specific line-items in our financialstatements.*

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***CD and DVD Fulfillment***

Thefollowing table sets forth, for the periods presented, information relating toour CD and DVD Fulfillment segment:

| ** **                                                             | ** ** | **Three months ended  April 30,**                                             | ** ** | **Change**                                                                                   | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **       2007       ** | ** ** | **       2006       ** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenues                                                               |       |                                                                                         | $          | 230,816                                                                                      |       |   |   | $ | 240,690 |   |   | $ | (9,874 | ) |   | (4.1 | )% |   |
| Cost of revenues                                                       |       |                                                                                         | 190,875    |                                                                                         |       |   | 199,504 |   |   | (8,629 | ) |   | (4.3 | )% |   |
| Gross profit                                                           |       |                                                                                         | 39,941     |                                                                                         |       |   | 41,186 |   |   | (1,245 | ) |   | (3.0 | )% |   |
| Selling, general  and administrative expenses                          |       |                                                                                         | 21,613     |                                                                                         |       |   | 21,805 |   |   | (192 | ) |   | (0.9 | )% |   |
| Fulfillment  freight                                                   |       |                                                                                         | 7,701      |                                                                                         |       |   | 8,744 |   |   | (1,043 | ) |   | (11.9 | )% |   |
| Depreciation and  amortization                                         |       |                                                                                         | 4,035      |                                                                                         |       |   | 3,458 |   |   | 577 |   |   | 16.7 | % |   |
| Operating income                                                       |       |                                                                                         | $          | 6,592                                                                                        |       |   |   | $ | 7,179 |   |   | $ | (587 | ) |   | (8.2 | )% |   |
| **Key operating measures:**                                            | ** ** |                                                                                         |       |                                                                                         |       |   |   |   | ** ** | ** ** | ** ** |   |   |   |   |
| Gross profit margin                                                    |       |                                                                                         | 17.3       | %                                                                                            |       |   | 17.1 | % |   | 0.2 | % |   |   |   |   |
| Operating income margin                                                |       |                                                                                         | 2.9        | %                                                                                            |       |   | 3.0 | % |   | (0.1 | )% |   |   |   |   |
| Fulfillment freight as a percent of revenues                           |       |                                                                                         | 3.3        | %                                                                                            |       |   | 3.6 | % |   | (0.3 | )% |   |   |   |   |
| Selling, general  and administrative expenses as a percent of revenues |       |                                                                                         | 9.4        | %                                                                                            |       |   | 9.1 | % |   | 0.3 | % |   |   |   |   |

 

Revenues decrease primarily due to industry trendswithin the CD and recorded music industry. Gross profit margin increasedprimarily due to improved pricing and vendor rebates.

Fulfillment freight decreased primarily due todecreased shipments. Fulfillment freight as a percent of revenues decreasedprimarily due to a shift of a larger portion of shipments to certain customersto ground versus air.

Selling, general and administrative expenses decreasedprimarily due to a change in the method of allocation of costs formerlyaccumulated in the Shared Services segment. Under the current methodology,approximately $0.2 million less selling, general and administrative expenseswould have been recorded in the same period of the prior year.

Depreciation and amortization increased primarily dueto capital expenditures in the three final quarters of fiscal 2007.

Operating income decreasedprimarily due the factors listed above.

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***Magazine Fulfillment***

Thefollowing table sets forth, for the periods presented, information relating toour Magazine Fulfillment segment:

| ** **                                                             | ** ** | **Three months ended  April 30,**                                 | ** ** | **Change** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|------------|------------|
| ** **                                                             | ** ** | **      2007      ** | ** ** | **2006**   | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenues                                                               |       |                                                                             | $          | 233,935    |       |   | $ | 194,979 |   | $ | 38,956 |   |   | 20.0 | % |   |
| Cost of revenues                                                       |       |                                                                             | 178,866    |       |       | 152,125 |   | 26,741 |   |   | 17.6 | % |   |
| Gross profit                                                           |       |                                                                             | 55,069     |       |       | 42,854 |   | 12,215 |   |   | 28.5 | % |   |
| Selling, general  and administrative expenses                          |       |                                                                             | 30,315     |       |       | 24,106 |   | 6,209 |   |   | 25.8 | % |   |
| Fulfillment  freight                                                   |       |                                                                             | 18,054     |       |       | 13,191 |   | 4,863 |   |   | 36.9 | % |   |
| Depreciation and  amortization                                         |       |                                                                             | 2,103      |       |       | 1,651 |   | 452 |   |   | 27.4 | % |   |
| Operating income                                                       |       |                                                                             | $          | 4,597      |       |   | $ | 3,906 |   | $ | 691 |   |   | 17.7 | % |   |
| **Key operating measures:**                                            | ** ** |                                                                             |       |       | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Gross profit margin                                                    |       |                                                                             | 23.5       | %          |       | 22.0 | % | 1.5 | % |   |   |   |   |
| Operating income margin                                                |       |                                                                             | 2.0        | %          |       | 2.0 | % | (0.0 | )% |   |   |   |   |
| Fulfillment freight as a percent of  revenues                          |       |                                                                             | 7.7        | %          |       | 6.8 | % | 0.9 | % |   |   |   |   |
| Selling, general and administrative expenses as a  percent of revenues |       |                                                                             | 13.0       | %          |       | 12.4 | % | 0.6 | % |   |   |   |   |
| **Revenues from:**                                                     | ** ** |                                                                             |       |       | ** ** | ** ** | ** ** | ** ** | ** ** |   |   |   |   |
| Domestic distribution                                                  |       |                                                                             | $          | 221,241    |       |   | $ | 186,076 |   | $ | 35,165 |   |   | 18.9 | % |   |
| International  distribution                                            |       |                                                                             | $          | 12,694     |       |   | $ | 8,903 |   | $ | 3,791 |   |   | 42.6 | % |   |

 

On March 30, 2007 we acquired Mid-Atlantic andSCN. Increases in individual income statement line items within our MagazineFulfillment group are primarily related to the impact of the inclusion of threemonths of results in the first quarter of fiscal 2008 versus one in the sameperiod of fiscal 2007.

Gross profit margin increased primarily due toimproved pricing from publishers.

Fulfillment freight as a percent of revenues increasedprimarily due to decreased efficiencies within the mainstream market.

Selling, general andadministrative expenses as a percent of revenues increased primarily due toincreased overhead related to the acquisition of Mid-Atlantic and SCN, and as apercent of revenues primarily due to a change in the method of allocation ofcosts formerly accumulated in the Shared Services segment. Under the currentmethodology, approximately $1.7 million of additional selling, general andadministrative expenses would have been recorded in the same period of theprior year. This increased allocation was partially offset by synergiesrealized from the integration of recent acquisitions.

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***In-Store Services***

Thefollowing table sets forth, for the periods presented, information relating toour In-Store Services segment (results for fiscal 2007 have been revised toeliminate the results of our Wood Manufacturing Division which was sold in April 2007):

| ** **                                                             | ** ** | **Three months ended  April 30,**                     | ** ** | **Change**                                                           | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **     2007     ** | ** ** | **     2006     ** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Revenues                                                               |       |                                                                 | $          | 10,654                                                               |       |   |   | $ | 12,225 |   |   | $ | (1,571 | ) |   | (12.9 | )% |   |
| Cost of revenues                                                       |       |                                                                 | 6,170      |                                                                 |       |   | 7,295 |   |   | (1,125 | ) |   | (15.4 | )% |   |
| Gross profit                                                           |       |                                                                 | 4,484      |                                                                 |       |   | 4,930 |   |   | (446 | ) |   | (9.1 | )% |   |
| Selling, general  and administrative expenses                          |       |                                                                 | 1,980      |                                                                 |       |   | 1,984 |   |   | (4 | ) |   | (0.2 | )% |   |
| Depreciation and  amortization                                         |       |                                                                 | 121        |                                                                 |       |   | 145 |   |   | (24 | ) |   | (16.6 | )% |   |
| Operating income                                                       |       |                                                                 | $          | 2,383                                                                |       |   |   | $ | 2,801 |   |   | $ | (418 | ) |   | (14.9 | )% |   |
| **Key operating measures:**                                            | ** ** |                                                                 |       |                                                                 |       |   |   |   | ** ** | ** ** | ** ** |   |   |   |   |
| Gross profit margin                                                    |       |                                                                 | 42.1       | %                                                                    |       |   | 40.3 | % |   | 1.8 | % |   |   |   |   |
| Operating income margin                                                |       |                                                                 | 22.4       | %                                                                    |       |   | 22.9 | % |   | (0.5 | )% |   |   |   |   |
| Selling, general and administrative expenses as a  percent of revenues |       |                                                                 | 18.6       | %                                                                    |       |   | 16.2 | % |   | 2.4 | % |   |   |   |   |
| **Revenues from:**                                                     | ** ** |                                                                 |       |                                                                 |       |   |   |   | ** ** | ** ** | ** ** |   |   |   |   |
| Claim filing and information                                           |       |                                                                 | $          | 3,500                                                                |       |   |   | $ | 4,548 |   |   | $ | (1,048 | ) |   | (23.0 | )% |   |
| Wire  manufacturing                                                    |       |                                                                 | $          | 7,154                                                                |       |   |   | $ | 7,677 |   |   | $ | (523 | ) |   | (6.8 | )% |   |

 

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

Gross profit decreased primarily due to lower revenue,while gross profit margin increased primarily due to higher profit margin jobswithin the wire manufacturing group.

Selling, general andadministrative expenses increased due in part to a change in the method ofallocation of costs formerly accumulated in the Shared Services segment. Underthe current methodology, approximately $0.1 million of additional selling,general and administrative expenses would have been recorded in the same periodof the prior year.

***Shared Services***

Thefollowing table sets forth, for the periods presented, information relating toour Shared services segment:

| ** **                                                                             | ** ** | **Three months ended  April 30,** | ** ** | **Change** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------|------------|
| ** **                                                                             | ** ** | **2007**                                    | ** ** | **2006**   | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| Selling, general  and administrative expenses                                          |       | 4,183                                       |       | 6,173      |       | (1,990 | ) | (32.2 | )% |
| Depreciation and  amortization                                                         |       | 577                                         |       | 550        |       | 27 |   | 4.9 | % |
| Impairment of  land and building held for sale                                         |       | —                                      |       | 529        |       | (529 | ) | (100.0 | )% |
| Operating loss                                                                         |       | $                                           | (4,760     | )          | $          | (7,252 | ) | $ | 2,492 |   | (34.4 | )% |
| **Key operating measures:**                                                            | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling, general  and administrative expenses as a percent of total revenues |       | 0.9                                         | %          | 1.4        | %          | (0.5 | )% |   |   |
|                                                                                        |            |                                             |            |            |            |  |  |  |  |  |  |  |

 

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Selling, general and administrative expenses decreasedprimarily due to a change in the method of allocation of costs formerlyaccumulated in the Shared Services segment. Under the current methodology,approximately $1.6 million more selling, general and administrative expenseswould have been allocated to the operating segments in the same period of theprior year. Selling, general and administrative expenses also decreased $0.4million due in part to the elimination of the corporate aircraft lease.

In the first quarter offiscal 2007, we recorded an impairment related to land and building held forsale that was sold after the balance sheet date to record the assets at their fairvalue.

***Interest Expense***

Interest expense includesthe interest and fees on our significant debt instruments and outstandingletters of credit. The increase of $1.3 million relates primarily tosignificantly higher borrowings during the current quarter due primarily to theacquisition of Mid-Atlantic and SCN and increased interest rates on debt.

***Other Income (Expense)***

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

***Income Tax Expense***

The effective tax rates were40.0% and 36.9% for the current quarter and the same quarter of the prior year,respectively. The increase in effective tax rates relates primarily to thetreatment of certain taxable differences that occurred in the first quarter offiscal 2007. We anticipate our effective tax rate to approximate 40% for theremainder of the year.

**Liquidity andCapital Resources**

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

Our primary cash requirements for the MagazineFulfillment and CD and DVD Fulfillment groups consist of the cost of homeentertainment products and the cost of freight, labor and facility expenseassociated with our 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 wood and wire 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 to collectthe claim. We then collect the claims when paid by publishers for our ownaccount.

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

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Thefollowing table presents a summary of our significant obligations andcommitments to make future payments under debt obligations and lease agreementsdue by period as of April 30, 2007:

| ** **                         | ** ** | **Payments due during the year ending January 31,** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------------------------|------------|------------|------------|
| ** **                         | ** ** | **Remainder  of 2008**                                                            | ** ** | **2009**   | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total** | ** ** |
| Debt obligations                   |       |                                                                                   | $          | 6,633      |       |   | $ | 6,302 |   | $ | 3,948 |   | $ | 115,148 |   |   | $ | 20,665 |   |   | $ | 152,696 |   |
| Interest payments(a)               |       |                                                                                   | 8,950      |       |       | 11,550 |   | 11,220 |   | 6,221 |   |   | 4,688 |   |   | 42,629 |   |
| Capital leases                     |       |                                                                                   | 843        |       |       | 791 |   | 259 |   | — |   |   | — |   |   | 1,893 |   |
| Operating leases                   |       |                                                                                   | 11,732     |       |       | 12,297 |   | 10,404 |   | 6,933 |   |   | 18,557 |   |   | 59,923 |   |
| Total contractual cash obligations |       |                                                                                   | $          | 28,158     |       |   | $ | 30,940 |   | $ | 25,831 |   | $ | 128,302 |   |   | $ | 43,910 |   |   | $ | 257,141 |   |

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(a)           Interest is calculatedusing the prevailing weighted average rate on our outstanding debt atApril 30, 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,** | ** ** | ** **                  | ** ** |
|--------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| **(in thousands)**              | ** ** | ** **                                                                                           | ** ** | **Remainder  of 2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012 and  thereafter** | ** ** | **Total** | ** ** |
| Financial standby  letters of credit |       |                                                                                                 | $          | 4,825                       |       |   | $ | 2,095 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 6,920 |   |
|                                      |            |                                                                                                      |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Operating Cash Flow***

Net cash provided byoperating activities was $6.9 million for the quarter ended April 30, 2007versus cash used in operating activities of $56.9 million for the quarter endedApril 30, 2006.

Operatingcash flows for the three months ended April 30, 2007 were comprised of:

·       Netincome of $1.8 million,

·       Plusnon-cash charges and positive changes in operating assets and liabilitiesincluding:

·        Depreciationand amortization of $7.3 million,

·        Provisionsfor losses on accounts receivable of $1.1 million,

·        Losson sale of discontinued operation of $0.5 million,

·        Decreasesin accounts receivable of $5.7 million, and

·        Increasesin accounts payable and other liabilities of $7.0 million.

·       Cashwas used for:

·        Increasesin inventories of $14.3 million and

·        Increasesin other current and non-current assets of $3.1 million.

The decrease in accountsreceivable of $5.7 million relates primarily to a decrease in accountsreceivable within our CD and DVD Fulfillment group of $18.6 million related tothe timing of customer payments, offset by an increase within our MagazineFulfillment group of $15.0 million related primarily to the timing of customerpayments and decreased expected returns during the second quarter of fiscal2008 versus the first quarter of fiscal 2008.

The increase in accounts payable and other liabilitiesof $7.0 million relates primarily to an increase in accounts payable within ourMagazine fulfillment group of $14.4 million primarily related to the timing ofvendor payments, offset by a decrease in accounts payable and other liabilitieswithin our CD and DVD Fulfillment group of $8.5 million primarily related tothe timing of vendor payments.

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The increase in inventories of $14.3 million relatesprimarily to an increase in inventories of $9.1 million related primarilyto the timing of shipments and increased consignment inventory as well as anincrease within our CD and DVD Fulfillment group of $5.7 million relatedprimarily to the timing of purchases and shipments.

Operating cashflows for the three months ended April 30, 2006 were comprised of:

·       Netincome of $3.3 million,

·       Plusnon-cash charges including:

·        depreciation andamortization of $6.2 million,

·        provisions for losses onaccounts receivable of $1.7 million,

·        stock compensation expenseof $0.4 million, and

·        impairment of land andbuilding held for sale of $0.5 million.

·       Cashwas used for:

·        a decrease in deferredrevenue of $0.4 million,

·        an increase in accountsreceivable of $8.2 million,

·        an increase in inventoriesof $9.8 million,

·        an increase in otherassets of $1.7 million, and

·        a decrease in accountspayable and other liabilities of $48.8 million.

The increase in accounts receivable was primarily dueto a $30.7 million increase in accounts receivable in our Magazine Fulfillmentgroup. $6.2 million of this increase results from the timing of the acquisitionof Mid-Atlantic and SCN, approximately $10.5 million in new receivables as aresult of bringing in new customers and locations, and $6.2 million associatedwith increased domestic specialty distribution and timing receipts from majorcustomers. Additionally, increased production within our In-Store Servicesgroup during the first quarter of fiscal 2007, versus fourth quarter fiscal2006 resulted in $3.2 million in additional receivables. These increases inaccounts receivable were partially offset by a decrease in accounts receivableof $25.1 million within our CD and DVD Fulfillment group, primarily related tothe timing of receipts from major customers.

The increase in inventories was primarily due to a$5.6 million increase in inventories within our Magazine Fulfillment group,resulting from an increase of $7.8 million associated with bringing in newcustomers and locations, partially offset by other insignificant changes withinthe Magazine Fulfillment group of $2.2 million. Changes in inventory in ourother groups were insignificant in size and accounted for the rest of theincrease.

The decrease in accountspayable was primarily due to a decrease in accounts payable within our MagazineFulfillment group of $31.5 million. $20.4 million of this increase results fromthe timing of the acquisition of Mid-Atlantic and SCN, with the remainderattributable to the timing of vendor payments within the first quarter offiscal 2007. Additionally, our CD and DVD Fulfillment group had a decrease inaccounts payable of $25.7 million associated with payments on accounts payableoriginated under extended holiday season payment terms in the fourth quarter offiscal 2006.

***Investing Cash Flow***

Net cash provided by investing activities was $10.3million for the quarter ended April 30, 2007 versus cash used in investingactivities of $42.8 million for the quarter ended April 30, 2006.

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For the quarter ended April 30, 2007, cashprovided by investing activities consisted primarily of $10.0 millionreceived from the sale of our Wood Manufacturing group and $4.3 millionreceived from net collections of advance pay claims, offset by $4.0 million incapital expenditures.

For the quarter ended April 30,2006 cash used in investing activities consisted primarily of $13.6 millionpaid to acquire Mid-Atlantic and $25.9 million paid to acquire SCN. Additionally,we incurred capital expenditures of $2.0 million and other investingexpenditures of $1.0 million.

***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 front end wire and servicesbusiness and the payment cycles of the CD and DVD and magazine distributionbusinesses. 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. Alliance hashistorically generated approximately 33% of its total net sales in the fourthcalendar quarter coinciding with the holiday shopping season and thereforeshould have greater borrowings in the third quarter to finance the buildup ofinventory.

Payments under our Advance Pay program generally occurjust prior to our fiscal quarter end. The related claims are not generallycollected by us until 30-60 days after the advance is made. As a result, ourfunding requirements peak at the time of the initial advances and decrease overthis period as the cash is collected on the related claims.

The front end wire and services business is seasonalbecause most retailers prefer initiating new programs before the holidayshopping season begins, which concentrates revenues in the second and thirdquarter. Receivables from these 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 fixtures and decrease significantly in the fourth andfirst fiscal quarters as the related receivable are collected and significantlyless manufacturing activity is occurring.

Net cash used in financing activities was $2.7 millionfor the quarter ended April 30, 2007 versus cash provided by financingactivities of $76.5 million for the quarter ended April 30, 2006.

Financing activities in the quarter ended April 30,2007 consisted primarily of repayments under our revolving credit facility of$3.8 million and a decrease in checks issued against future borrowings underthe revolving credit facility of $1.4 million, offset by borrowings under notespayable of $2.0 million

Financing activities inthe quarter ended April 30, 2006 consisted primarily of borrowings underour revolving credit facility of $69.8 million and an increase in checks issuedagainst future borrowings under the revolving credit facility of $6.0 million. Thesignificant borrowings under the revolving credit facility were primarily forthe purpose of acquiring Mid-Atlantic and SCN.

***Debt***

For a detailed description of the terms of oursignificant debt instruments, please see Note 7 to our Consolidated FinancialStatements.

In connection with our expected acquisition ofPrimedia Enthusiast Media, Inc., we expect to issue approximately $1.3billion in debt. Interest associated with this debt will significantly impactour liquidity and capital resources. We expect to pay interest with cash flowgenerated from operations.

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Significant debttransactions during the three months ended April 30, 2006 are as follows:

·       Inconnection with the acquisition of Mid-Atlantic on March 30, 2006, weissued a promissory note to its former owner in the amount of $4.1 million. Itwas repaid during the remainder of fiscal 2007. The remainder of the purchaseprice, $13.6 million, was funded by borrowings on our revolving creditfacility.

·       In connection with theacquisition of SCN on March 30, 2006, we issued a promissory note to itsformer owner in the amount of $10.2 million. It was repaid during the remainderof fiscal 2007. The remainder of the purchase price, $26.0 million, was fundedby borrowings on our revolving credit facility.

***Off-Balance Sheet Arrangements***

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

**ITEM 3.**                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 Note 7 to our Consolidated Financial Statements.

The revolving credit facility with Wells FargoFoothill had an outstanding principal balance of $112.6 million atApril 30, 2007. Interest on the outstanding balance is charge based on avariable interest rate related to the prime rate (8.25% at April 30, 2007)plus a margin specified in the credit agreement based on an availabilitycalculation (0.25% at April 30, 2007).

A 1.0% increase in the prevailing interest rate on ourdebt at April 30, 2007 is estimated to cause an increase of $1.0 millionin the interest expense for the remainder of the year ending January 31,2008.

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

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

Revenues derived from the export of foreign titles (orsales to domestic brokers who facilitate the export) totaled $12.7 million forthe quarter ended April 30, 2007 or 2.7% of total revenues. For the mostpart, 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 titles totaled approximately $24.4 million (of a total$613.8 million or 4.0%). 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 tocontrol the foreign currency risk. Foreign titles generally have significantlyhigher cover prices than comparable domestic titles, are considered somewhat ofa luxury item, are sold only at select retail locations, and sales do notappear to be highly impacted by cover price increases. However, a significantnegative change in the relative strength of the dollar to these foreigncurrencies could result in higher domestic cover prices and result in lowersales of these titles at retail, which would negatively impact our results ofoperations.

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**ITEM 4.**                CONTROLSAND PROCEDURES

Under the supervision and with the participation ofour management, including our principal executive officer and principalfinancial officer, 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 report (the “Evaluation Date”).

Attached as exhibits tothis Quarterly Report are certifications of our principal executive officer andchief financial officer, which are required in accordance with Rule 13a-14of the Securities Exchange Act of 1934, as amended (“Exchange Act”). Theinformation appearing below should be read in conjunction with thecertifications for a more complete understanding of the topics presented.

***About Disclosure Controls***

Disclosure controls andprocedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) ofthe Exchange Act) are designed to provide assurance that the informationconcerning us and our consolidated subsidiaries, which is required to be includedin our reports and statements filed or submitted under the Exchange Act, asamended, (i) is accumulated and communicated to our management, includingour principal executive officer and principal financial officer, as appropriateto allow timely decisions required disclosure and (ii) is recorded,processed, summarized and reported within the time periods specified in rules andforms of the SEC.

***Limitations On The Effectiveness Of Controls***

Our management, includingour principal executive officer and chief financial officer, do not expect thatour disclosure controls and procedures will prevent all error and all fraud. Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the control system’s objectives willbe met. Further, the design of a control system must reflect the fact thatthere are resource constraints, and the benefits of controls must be consideredrelative to their costs. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the company have beendetected. These inherent limitations include the realities that judgments indecision-making can be faulty and that breakdowns can occur because of simpleerror or mistake. Controls can also be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe controls. The design of any system of controls is based in part on certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Over time, controls may become inadequate becauseof changes in conditions or deterioration in the degree of compliance withpolicies or procedures. Because of the inherent limitations in a cost-effectivecontrol system, misstatements due to error or fraud may occur and not bedetected.

***Scope Of The Controls Evaluation***

The evaluation of ourdisclosure controls and procedures included a review of the controls’objectives and design, the company’s implementation of the controls and theeffect of the controls on the information generated for use in this QuarterlyReport. In the course of the controls evaluation, we sought to identify dataerrors, control problems or acts of fraud and confirm that appropriatecorrective action, including process improvements, were being undertaken. Thistype of evaluation is performed on a quarterly basis so that the conclusions ofmanagement, including the chief executive officer and the chief financialofficer, concerning the effectiveness of the controls can be reported in ourQuarterly Reports on Form 10-Q and to supplement our disclosures made inour Annual Report on Form 10-K. Many of the components of our disclosurecontrols and procedures are also evaluated on an ongoing basis by our InternalAudit Department and by other personnel in our finance organization. Theoverall goals of these various 

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evaluationactivities are to monitor our disclosure controls and procedures, and to modifythem as necessary. Our intent is to maintain the disclosure controls andprocedures as dynamic systems that change as conditions warrant.

***Conclusions***

Based on this evaluation,our principal executive officer and our chief financial officer, have concludedthat, subject to the limitations noted above, as of the end of the periodcovered by this report, our disclosure controls and procedures were effectiveto ensure that information we are required to disclose in reports that we fileor submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms andinclude controls and procedures designed to ensure that information required tobe disclosed by the Company in such reports is accumulated and communicated tothe Company’s management, including the Principal Executive Officer and theChief Financial Officer, as appropriate to allow timely decisions regardingrequired disclosure.

***Changes in Internal Controls Over Financial Reporting***

Except as set forth in this paragraph, there were nochanges in the Company’s internal controls over financial reporting (as definedin Rule 13a-15f of the Exchange Act that occurred during the fiscalquarter ended April 30, 2007 that have materially affected, or arereasonably likely to materially affect those controls.

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**PART II—OTHERINFORMATION**

**ITEM 1.**                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 of the range of possible loss, we believe that none of these actions,individually or in the aggregate, will have a material adverse effect on ourfinancial condition or results of operations.

**ITEM 1A.**        RISKFACTORS.

There were no materialchanges, additions or deletions from our risk factors as presented in thesection entitled “Risk Factors” in our Annual Report on Form 10-Kfor the year ended January 31, 2007 as filed with the SEC on April 25,2007, as amended May 31, 2007.

**ITEM 2.**                UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

Not Applicable.

**ITEM 3.**                DEFAULTSUPON SENIOR SECURITIES.

Not Applicable.

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

Not Applicable.

**ITEM 5.**                OTHERINFORMATION.

Not Applicable.

**ITEM 6.**                EXHIBITS.

See Exhibit Index.

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**SIGNATURES**

Pusuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                     | **SOURCE INTERLINK COMPANIES,  INC.** |
|---------------------|---------------------------------------|
| June 13,  2007 | By:                                   | /s/ MARC FIERMAN |
|                | * *                              | Marc Fierman |
|                | * *                              | *Chief Financial Officer  (principal financial officer)* |

 

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**EXHIBITINDEX**
| Exhibit No. | ** ** | ** **                                                                                       | ** ** | **Description** |
|------------------|------------|--------------------------------------------------------------------------------------------------|------------|-----------------|
| 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. |

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*                    Filedherewith.

 

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