UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
  FORM
10-Q
  x
              
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the quarterly period ended April 30, 2008oro
              
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the transition period from toCommission
      file number 001-13437
 
  
  SOURCE
INTERLINK COMPANIES, INC.
 (Exact
name of registrant as specified in its charter)
  Delaware
              
              20-2428299(State
      or other jurisdiction of
                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 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 x Yeso No
  Indicate
by check mark whether the registrant is a large accelerated filer, an accelerate
filer, a non-accelerated filer, or a smaller reporting company.See definition of
“large accelerated filer,” “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act.(Check one):
 o Large
      accelerated filer
              
              x Accelerated
      filer
              
              o Non-accelerated
      filero Smaller reporting
      company
 
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.
 o Yesx No
  As of
June 2, 2008, there were 52,320,837 shares of the Company’s common stock
outstanding.
  
  
  
 TABLE
OF CONTENTS
  PagePART I – FINANCIAL
      INFORMATIONITEM 1.
              
              FINANCIAL
      STATEMENTS
              
              2ITEM 2.
              
              MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
      CONDITION
                AND RESULTS OF OPERATIONS
              
              21ITEM 3.
              
              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
      MARKET RISK
              
              31ITEM 4.
              
              CONTROLS AND PROCEDURES
              
              31PART II – OTHER INFORMATIONITEM 1.
              
              LEGAL PROCEEDINGS
              
              33ITEM 1A.
              
              RISK FACTORS
              
              33ITEM 2.
              
              UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS
              
              33ITEM 3.
              
              DEFAULTS UPON SENIOR SECURITIES
              
              33ITEM 4.
              
              SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
              
              33ITEM 5.
              
              OTHER INFORMATION
              
              33ITEM 6.
              
              EXHIBITS
              
              33
 
   1
  PART
I – FINANCIAL INFORMATION
  ITEM 1.
FINANCIAL STATEMENTS
  INDEX
OF FINANCIAL STATEMENTS
  PageConsolidated Balance Sheets as of April 30, 2008
      (unaudited) and January 31, 2008
              
              3Consolidated Statements of Operations for the three
      months ended April 30, 2008 and 2007 (unaudited)
              
              5Consolidated Statement of Stockholders’ Equity for
      the three months ended April 30, 2008 (unaudited)
              
              6Consolidated Statements of Cash Flows for the three
      months ended April 30, 2008 and 2007 (unaudited)
              
              7Notes to Consolidated Financial
      Statements
              
              8
 
   2
  
 SOURCE
INTERLINK COMPANIES, INC.
 CONSOLIDATED
BALANCE SHEETS
 (in
thousands)
  April
      30,
              
              
              January 31,2008
              
              
              2008(unaudited)AssetsCurrent
      assetsCash
              
              $
              3,273
              
              
              $
              35,650Trade
      receivables, net
              
              
              162,624
              
              
              
              183,475Purchased
      claims receivable
              
              
              12,300
              
              
              
              14,412Inventories
              
              
              301,793
              
              
              
              290,507Deferred
      tax asset
              
              
              22,928
              
              
              
              23,107Other
              
              
              21,032
              
              
              
              20,679Total
      current assets
              
              
              523,950
              
              
              
              567,830Property,
      plants and equipment
              
              
              157,578
              
              
              
              150,612Less
      accumulated depreciation and amortization
              
              
              (49,092
              )
              
              
              (42,708
              )Net
      property, plants and equipment
              
              
              108,486
              
              
              
              107,904Other
      assetsGoodwill,
      net
              
              
              873,826
              
              
              
              1,069,835Intangibles,
      net
              
              
              550,634
              
              
              
              637,082Other
              
              
              51,235
              
              
              
              53,354Total
      other assets
              
              
              1,475,695
              
              
              
              1,760,271Total
      assets
              
              $
              2,108,131
              
              
              $
              2,436,005
 
  See
accompanying notes to Consolidated Financial Statements
   3
  SOURCE
INTERLINK COMPANIES, INC.
 CONSOLIDATED
BALANCE SHEETS (CONCLUDED)
 (in
thousands, except per share amounts)
  April
      30,
              
              
              January 31,2008
              
              
              2008(unaudited)Liabilities
      and Stockholders’ EquityCurrent
      liabilitiesAccounts
      payable (net of allowance for returns of $154,284 and $174,751 at April
      30, 2008 and January 31, 2008, respectively)
              
              $
              351,939
              
              
              $
              372,429Accrued
      expenses
              
              
              102,172
              
              
              
              123,973Deferred
      revenue
              
              
              80,768
              
              
              
              79,918Current
      portion of obligations under capital leases
              
              
              1,327
              
              
              
              1,406Current
      maturities of debt
              
              
              14,520
              
              
              
              15,369Total
      current liabilities
              
              
              550,726
              
              
              
              593,095Deferred
      tax liability
              
              
              8,573
              
              
              
              8,944Obligations
      under capital leases, less current portion
              
              
              1,514
              
              
              
              1,826Debt,
      less current maturities
              
              
              1,355,435
              
              
              
              1,359,210Other
              
              
              30,693
              
              
              
              32,429Total
      liabilities
              
              
              1,946,941
              
              
              
              1,995,504Minority
      interest
              
              
              26,803
              
              
              
              25,978Commitments
      and contingenciesStockholders’
      equityContributed
      capital:Preferred
      stock, $0.01 par (2,000 shares authorized; none issued)
              
              
              -
              
              
              
              -Common
      stock, $0.01 par (100,000 shares authorized; 52,321 shares issued and
      outstanding at April 30, 2008 and January 31, 2008)
              
              
              523
              
              
              
              523Additional
      paid-in-capital
              
              
              475,744
              
              
              
              476,099Total
      contributed capital
              
              
              476,267
              
              
              
              476,622Accumulated
      deficit
              
              
              (346,501
              )
              
              
              (65,659
              )Accumulated
      other comprehensive income
              
              
              4,621
              
              
              
              3,560Total
      stockholders’ equity
              
              
              134,387
              
              
              
              414,523Total
      liabilities and stockholders’ equity
              
              $
              2,108,131
              
              
              $
              2,436,005
 
 See
accompanying notes to Consolidated Financial Statements
  4
  SOURCE
INTERLINK COMPANIES, INC.
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except per share amounts)
 (unaudited)
  Three months ended April
      30,2008
              
              
              2007Revenues,
      net:Distribution
              
              $
              487,795
              
              
              $
              464,751Advertising
              
              
              61,633
              
              
              
              -Circulation
              
              
              30,162
              
              
              
              -Manufacturing
              
              
              8,629
              
              
              
              7,154Claiming
      and information
              
              
              3,762
              
              
              
              3,500Other
              
              
              22,380
              
              
              
              -Total
      revenues, net
              
              
              614,361
              
              
              
              475,405Cost
      of goods sold
              
              
              420,222
              
              
              
              375,911Gross
      profit
              
              
              194,139
              
              
              
              99,494Distribution,
      circulation and fulfillment
              
              
              55,003
              
              
              
              36,489Selling,
      general and administrative expenses
              
              
              96,632
              
              
              
              47,357Depreciation
      and amortization
              
              
              18,224
              
              
              
              6,836Integration,
      consolidation and relocation expense
              
              
              2,707
              
              
              
              -Write-off
      of capitalized acquisition costs
              
              
              1,900
              
              
              
              -Impairment
      of goodwill and intangible assets
              
              
              270,847
              
              
              
              -Operating
      (loss) income
              
              
              (251,174
              )
              
              
              8,812Other
      expense:Interest
      expense
              
              
              (29,009
              )
              
              
              (3,567
              )Interest
      income
              
              
              158
              
              
              
              41Other
      (expense) income:
              
              
              (412
              )
              
              
              71Total
      other expense
              
              
              (29,263
              )
              
              
              (3,455
              )(Loss)
      income from continuing operations, before income taxes
              
              
              (280,437
              )
              
              
              5,357Income
      tax expense
              
              
              -
              
              
              
              (2,143
              )Minority
      interest in income of subsidiary
              
              
              (405
              )
              
              
              -(Loss)
      income from continuing operations
              
              
              (280,842
              )
              
              
              3,214Loss
      from discontinued operations, net of taxes
              
              
              -
              
              
              
              (1,386
              )Net
      (loss) income
              
              $
              (280,842
              )
              
              $
              1,828(Loss)
      earnings per share – BasicContinuing
      operations
              
              $
              (5.37
              )
              
              $
              0.06Discontinued
      operations
              
              
              -
              
              
              
              (0.02
              )Total
              
              $
              (5.37
              )
              
              $
              0.04(Loss)
      earnings per share – DilutedContinuing
      operations
              
              $
              (5.37
              )
              
              $
              0.06Discontinued
      operations
              
              
              -
              
              
              
              (0.03
              )Total
              
              $
              (5.37
              )
              
              $
              0.03Weighted
      average shares outstanding – Basic
              
              
              52,321
              
              
              
              52,153Weighted
      average shares outstanding – Diluted
              
              
              52,321
              
              
              
              52,632
 
 See
accompanying notes to Consolidated Financial Statements
 5
 SOURCE
INTERLINK COMPANIES, INC.
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY
 (in
thousands)
 (unaudited)
  Common Stock
              
              
              Additional
      Paid-In Capital
              
              
              Accumulated
      Defecit
              
              
              Accumulated
      Other Comprehensive Income
              
              
              Total
      Stockholders EquityShares
              
              
              AmountBalance,
      January 31, 2008
              
              
              52,321
              
              
              $
              523
              
              
              $
              476,099
              
              
              $
              (65,659
              )
              
              $
              3,560
              
              
              $
              414,523Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (280,842
              )
              
              
              -
              
              
              
              (280,842
              )Foreign
      currency translation
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (55
              )
              
              
              (55
              )Unrealized
      gain on interest rate swaps
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,116
              
              
              
              1,116Comprehensive
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (280,842
              )
              
              
              1,061
              
              
              
              (279,781
              )Stock
      compensation expense
              
              
              -
              
              
              
              -
              
              
              
              65
              
              
              
              -
              
              
              
              -
              
              
              
              65Minority
      interest adjustment
              
              
              -
              
              
              
              -
              
              
              
              (420
              )
              
              
              -
              
              
              
              -
              
              
              
              (420
              )Balance,
      April 30, 2008
              
              
              52,321
              
              
              $
              523
              
              
              $
              475,744
              
              
              $
              (346,501
              )
              
              $
              4,621
              
              
              $
              134,387
  See
accompanying notes to Consolidated Financial Statements
   6
  SOURCE
INTERLINK COMPANIES, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
thousands)
 (unaudited)
  Three
      Months ended April 30,2008
              
              
              2007Operating
      ActivitiesNet
      (loss) income
              
              $
              (280,842
              )
              
              $
              1,828Minority
      interest in income of subsidiary
              
              
              405
              
              
              
              -Adjustments
      to reconcile net (loss) income to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
              
              
              19,653
              
              
              
              7,193Amortization
      of deferred financing costs
              
              
              3,278
              
              
              
              146Provision
      for losses on accounts receivable
              
              
              1,990
              
              
              
              1,106Stock
      compensation expense
              
              
              65
              
              
              
              179Loss
      on sale of discontinued operation
              
              
              -
              
              
              
              508Impairment
      of goodwill and intangible assets
              
              
              270,847
              
              
              
              -Other
              
              
              212
              
              
              
              490Changes
      in assets and liabilities (excluding business
    acquisitions):Decrease
      in accounts receivable
              
              
              18,860
              
              
              
              5,733Increase
      in inventories
              
              
              (11,338
              )
              
              
              (14,264
              )Increase
      in other current and non-current assets
              
              
              (1,237
              )
              
              
              (3,093
              )Increase
      in deferred revenue
              
              
              851
              
              
              
              18(Decrease)
      increase in accounts payable and other liabilities
              
              
              (35,154
              )
              
              
              7,043Cash
      (used in) provided by operating activities
              
              
              (12,410
              )
              
              
              6,887Investment
      ActivitiesCapital
      expenditures
              
              
              (8,572
              )
              
              
              (4,027
              )Purchase
      of claims
              
              
              (23,350
              )
              
              
              (23,756
              )Payments
      received on purchased claims
              
              
              25,463
              
              
              
              28,071Proceeds
      from sale of Wood Manufacturing division, net of cash
      transferred
              
              
              -
              
              
              
              9,970Payment
      of capitalized acquisition costs
              
              
              (1,900
              )
              
              
              -Other
              
              
              (50
              )
              
              
              44Cash
      (used in) provided by investing activities
              
              
              (8,409
              )
              
              
              10,302Financing
      ActivitiesDecrease
      in checks issued against revolving credit facility
              
              
              -
              
              
              
              (1,383
              )Repayments
      under credit facilities
              
              
              -
              
              
              
              (3,811
              )Payment
      of deferred purchase price liabilities
              
              
              (5,693
              )
              
              
              -Net
      (payments) borrowings on notes payable and capital leases
              
              
              (5,865
              )
              
              
              1,952Proceeds
      from the issuance of common stock
              
              
              -
              
              
              
              230Excess
      tax benefit from exercise of stock options
              
              
              -
              
              
              
              337Cash
      used in financing activities
              
              
              (11,558
              )
              
              
              (2,675
              )(Decrease)
      increase in cash
              
              
              (32,377
              )
              
              
              14,514Cash,
      beginning of period
              
              
              35,650
              
              
              
              -Cash,
      end of period
              
              $
              3,273
              
              
              $
              14,514
 See
accompanying notes to Consolidated Financial Statements
   7
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited)
  1.Nature
of Business and Basis of Presentation
  Source
Interlink Companies, Inc (“the Company”) is a premier publishing, marketing,
merchandising and fulfillment company of entertainment products including
magazines, DVDs, music CDs, books and related items, serving more than 100,000
retail locations throughout North America. It produces print and digital content
for consumers in North America through its enthusiast media division, Source
Interlink Media (“SIM”), which was acquired on August 1, 2007.The Company also
sells and distributes entertainment products to leading mass merchandise
retailers, grocery stores, bookstore chains, music stores, drug stores and other
specialty retailers, as well as e-commerce retailers. It offers customers an
array of value-added content and services including enthusiast media
publications and online content, category management, product procurement,
fulfillment services, claims submission, information services and in-store
display fixturing.
 
 The
Company directly produces and delivers magazine, Internet and home entertainment
content to consumers. With the addition of SIM, it transformed from a leading
home entertainment distributor into a significant content owner.This array of
products and services, in combination with our value added services and
geographic reach, positions us to service the needs of America’s leading
retailers and to capitalize on the rapidly changing distribution and fulfillment
landscape.
 
 The
Company is one of the largest independent wholesalers of DVDs and CDs in North
America. It effectively operates as an extension of its customers’ operations.
Between its fulfillment, category management and e-commerce solutions, it
provides our customers with a complete solution to maximize the sales and
profitability of their home entertainment content products.
 
 The
consolidated financial statements included herein have been prepared by the
Company, without audit, pursuant to and in conformity with the instructions to
Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange
Commission (“SEC”).Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States (“GAAP”).In the opinion of the Company’s management, these unaudited
consolidated financial statements reflect all adjustments (consisting only of
normal recurring adjustments and reclassifications) necessary to present fairly
our results of operations and cash flows for the three months ended April 30,
2008 and 2007 and our financial position as of April 30, 2008, respectively.All
significant intercompany accounts and transactions have been eliminated from
these statements.The preparation of unaudited consolidated financial statements
in conformity with GAAP requires management to make estimates and assumptions
that affect the reported amount of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting
period.Because of this and the seasonality of the Company’s business, the
results of operations for such interim periods will not necessarily be
indicative of the results of operations and cash flows for the full fiscal year
or subsequent quarters.
   8
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  Certain
information and disclosures normally included in the notes to the annual
consolidated financial statements have been condensed or omitted from these
interim consolidated financial statements. Accordingly, these interim
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in our Annual
Report on Form 10-K (the “Annual Report”) for the fiscal year ended
January 31, 2008, as filed with the SEC on April 15, 2008, as amended May
30, 2008.
  The
Company’s segment reporting combines the Company’s business units in a logical
way that identifies business concentrations and synergies.Accordingly, beginning
in fiscal 2009, management has restructured the presentation of the Company’s
segments to better reflect the change in management and financial reporting of
the applicable units.The Company’s segments are heretofore presented as follows:
Media, Periodical Fulfillment Services, DVD and CD Fulfillment and Shared
Services.Prior reporting periods have been reclassified to conform to current
presentation to make prior period comparisons meaningful.
 
 Other
revenue includes online revenues, licensing revenues, barter revenues and event
revenues within our Media segment.
  Derivative
Financial Instruments
 
 As part
of our risk management strategy, we enter into derivative transactions to
mitigate loss exposures.Our derivative instruments are currently limited to an
interest rate swap which is not exchange-traded and is an over-the-counter
customized transaction.Our derivative exposure is with a counterparty that has a
long-term credit rating of A-1.
 
 Derivatives
that are designated as hedges are documented and evaluated for effectiveness in
accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities(“FAS 133”).The effective portion of
changes in the fair value of cash flow hedges is deferred in accumulated other
comprehensive income.In the event hedge accounting no longer applies, the
Company recognizes all changes in fair value of derivative instruments in the
other income (expense) section of its Consolidated Statement of Operations.The
Company ceases hedge accounting treatment if its evaluation of effectiveness no
longer justifies deferral of changes in fair value in accumulated other
comprehensive income.At that time, a reclassification from accumulated other
comprehensive income to earnings would occur.
 
 On April
11, 2008, the Company entered into an interest rate swap agreement with Wachovia
Bank, N.A. to hedge the Company’s exposure to fluctuations in LIBOR on $210.0
million of 1-month LIBOR-based debt through April 29, 2011.This swap agreement
qualifies for hedge accounting treatment in accordance with FAS
133.
 
 Goodwill
and Other Intangible Assets
 
 Goodwill
represents the excess of cost over the fair value of net assets acquired in
connection with business acquisitions. In accordance with Statement of Financial
Accounting Standards No. 142, Goodwill and Other IntangibleAssets (“FAS 142”), goodwill is evaluated at the reporting unit level,
which is defined as an operating segment or a component of an operating segment
that constitutes a business for which financial information is available and is
regularly reviewed by management. The Company assesses goodwill for impairment
at least annually in the absence of an indicator of possible impairment and
immediately upon an indicator of possible impairment. The annual impairment
review is completed in the first quarter of the fiscal year.
 
 In
assessing goodwill and intangible assets for impairment, we make estimates of
fair value which are based on our projection of revenues, operating costs, and
cash flows of each reporting unit considering historical and anticipated future
results, general economic and market conditions as well as the impact of planned
strategies. The Company combines the discounted cash flow fair value with
publicly traded company multiples (market comparison approach) and acquisition
multiples of comparable businesses (industry acquisition approach) to determine
fair value.Generally, we engage third party specialists to assist us with our
valuations. Changes in our judgments and projections could result in a
significantly different estimate of the fair value of the reporting units and
could result in an impairment of goodwill or other intangible
assets.
 
 If the
carrying amount of a reporting unit exceeds its fair value, the Company measures
the possible goodwill impairment based upon an allocation of the estimate of
fair valueto the underlying assets and liabilities of the reporting unit,
including
  9
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  any
previously unrecognized intangible assets, based upon known facts and
circumstances as if the acquisition occurred currently. The excess of the fair
value of the reporting unit over the amounts assigned to its assets and
liabilities is the implied fair value of goodwill.An impairment loss would be
recognized to the extent the carrying value of goodwill exceeds the implied fair
value of the goodwill.This test, performed in the first quarter of fiscal year
2009, indicated that goodwill and indefinite-lived intangible assets related to
the Media reportable segment were impaired.
 
 Impairment
losses, if any, are reflected in operating income or loss in the Consolidated
Statements of Operations.
 
 As a
result of our fiscal year 2009 FAS 142 first quarter impairment
analysis, we determined that certain tradenames of our Media reportable
segment were impaired and consequently recorded a charge of approximately $74.3
million.This determination was based largely on management’s projections
regarding the revenues from and profitability of tradenames acquired on August
1, 2007.The combination of the analysis and other factors discussed below, had
an adverse impact on the anticipated future cash flows used in the impairment
analysis performed during the first quarter of fiscal year 2009.The net carrying
amount of the tradenames was $280.6 million at the end of the first quarter of
fiscal year 2009, after the impairment charge was recorded.
 
 As a
result of our fiscal year 2009 FAS 142 annual first quarter impairment analysis,
we determined that the goodwill of our Media reportable segment was impaired and
consequently recorded an impairment charge of $196.5 million. This determination
was based largely on management’s projections regarding the revenues and
profitability of the Media reportable segment as well as the effects of the
recent credit market changes, the continued economic downturn and the related
effects on customer discretionary spending and print advertising. The charge was
measured on the basis of comparison of estimated fair values with corresponding
book values and relates primarily to goodwill recorded in connection with our
acquisition of Primedia Enthusiast Media (“EM”). These fair values were
determined in accordance with Company policy discussed above as well as FAS 142
and other relevant guidance.
 
 Following
the impairment charges, goodwill totaled $873.8 million, of which $477.7 million
related to our Media reportable segment.Other intangible assets totaled $550.6
million, of which $478.3 million related to our Media reportable segment. Due to
uncertain market conditions and potential changes in our strategy and product
portfolio, it is possible that forecasts used to support our goodwill and
intangible assets may change in the future, which could result in additional
non-cash charges that would adversely affect our results of operations and
financial condition.
 
  Income
Taxes
  Statement
of Financial Accounting Standards No. 109 "Accounting for Income Taxes"
("FAS 109") requires that a valuation allowance be establishedwhen it is more likely
than not that all or a portion of deferred tax assetswill not be realized. A
review of all available positive and negative evidenceneeds to be considered,
including a company's performance, the marketenvironment in which
the company operates, the utilization of past tax credits,length of carryback and
carryforward periods, existing contracts or salesbacklog that will
result in future profits, etc.It further states that
forming a conclusion that a valuation allowance is notneeded is difficult
when there is negative evidence such as cumulative losses inrecent years.
Therefore, cumulative losses weigh heavily in the overall assessment. We
identified several significant developments which we considered in determining
the need to record a full valuation allowance in the current quarter, including
the continuing economic downturn and our projections regarding the near-term
revenues and profitability of our segments. As a result of our assessment, we
recorded a valuation allowance on deferred tax assets of approximately $108.7
million during the three months ended April 30, 2008.
 
  Recently
Issued Accounting Pronouncements
  FAS
No. 161
 In March
2008, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards No. 161, Disclosures about Derivative
Instruments and Hedging Activities,(“FAS 161”)–an amendment of FAS
133.FAS 161 requires
enhanced disclosures about how and why an entity uses derivative instruments,
how derivative instruments and related hedge items are accounted for under FAS
133 and its interpretations and how they affect an entity’s financial position,
financial
   10
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  performance
and cash flows.It is effective for financial statements issued for fiscal years
and interim periods beginning after November 15, 2008, with early application
encouraged. Since FAS 161 impacts disclosures and not the accounting treatment
for derivative instruments and hedged items, adoption will not impact our
results of operations or financial condition.
  FAS
No. 157
 On
February 1, 2008, the Company adopted Statement of Financial Accounting
Standards No. 157, Fair
Value Measurements (“FAS 157”).In conjunction with the guidance in FAS
133, the Company records its derivative instruments on its Consolidated Balance
Sheets.As of April 30, 2008, its derivative instruments were valued at $1.1
million and are recorded in other assets.This value is based upon significant
observable inputs in the form of publicly available interest rate
information.
   2.
Trade Receivables
  Trade
receivables consist of the following:
  (in thousands)
              
              April 30,
              
              
              January 31,2008
              
              
              2008(unaudited)Trade
      receivables
              
              $
              382,482
              
              
              $
              411,968Less
      allowances for:Sales
      returns and other
              
              
              194,848
              
              
              
              202,569Doubtful
      accounts
              
              
              25,010
              
              
              
              25,924Total
      allowances
              
              
              219,858
              
              
              
              228,493Trade
      receivables, net
              
              $
              162,624
              
              
              $
              183,475
 
  3.
Inventories
  Inventories
consist of the following:
  (in thousands)
              
              April 30,
              
              
              January 31,2008
              
              
              2008(unaudited)Raw
      materials
              
              $
              11,407
              
              
              $
              8,854Work-in-process
              
              
              2,396
              
              
              
              1,322Finished
      goods:Pre-recorded
      music and video
              
              
              147,849
              
              
              
              149,765Magazines
      and books
              
              
              139,711
              
              
              
              127,067Display
      fixtures
              
              
              253
              
              
              
              3,499Other
              
              
              177
              
              
              
              -Inventories
              
              $
              301,793
              
              
              $
              290,507
 
  11
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  4.
Goodwill and intangibles
  The
Company’s goodwill and intangibles consist of the following:
  (in thousands)
              
              April
      30,
              
              
              January 31,2008
              
              
              2008(unaudited)Amortized
      intangible assetsCustomer
      lists and relationships
              
              $
              285,345
              
              
              $
              285,345Trade
      names
              
              
              2,554
              
              
              
              2,400Content
              
              
              20,380
              
              
              
              20,382Non-compete
      agreements
              
              
              4,581
              
              
              
              4,350Software
              
              
              16,340
              
              
              
              16,340Total
      intangibles
              
              
              329,200
              
              
              
              328,817Accumulated
      amortizationCustomer
      lists and relationships
              
              
              (42,743
              )
              
              
              (31,986
              )Trade
      names
              
              
              (375
              )
              
              
              (250
              )Content
              
              
              (1,545
              )
              
              
              (1,019
              )Non-compete
      agreements
              
              
              (2,959
              )
              
              
              (2,518
              )Software
              
              
              (8,999
              )
              
              
              (8,317
              )Total
      accumulated amortization
              
              
              (56,621
              )
              
              
              (44,090
              )Net
      amortized intangible assets
              
              
              272,579
              
              
              
              284,727Indefinite
      lived trade names
              
              
              278,055
              
              
              
              352,355Intangibles,
      net
              
              $
              550,634
              
              
              $
              637,082
 
  As
discussed above, our fiscal year 2009 FAS 142 annual first quarter impairment
analysis determined that certain of our tradenames were impaired and
consequently we recorded a charge of approximately $73.4 million. See Note
1 – Nature of Business and Basis of Presentation.
 
 As a
result of our first quarter fiscal 2009 impairment test, we reassessed the
estimated remaining useful lives of our indefinite-lived tradenames and
shortened such as lives as required.As a result of our fourth fiscal 2008
quarter impairment test, we reassessed the estimate remaining useful lives of
our customer lists within our DVD and CD Fulfillment group and shortened such
lives as required.
 
 Amortization
of intangible assets was $11.8 million and $14.2 million for the three months
ended April 30, 2008 and 2007.
  Changes
in the carrying amount of goodwill for the three months ended April 30, 2008 are
as follows:
  (in
      thousands)
              
              Media
              
              
              Periodical
      Fulfillment Services
              
              
              CD
      and DVD Fulfillment
              
              
              ConsolidatedBalance,
      January 31, 2008
              
              $
              673,654
              
              
              $
              194,649
              
              
              $
              201,532
              
              
              $
              1,069,835Additions
              
              
              555
              
              
              
              —
              
              
              
              —
              
              
              
              555Foreign
      currency translation adjustments
              
              
              —
              
              
              
              (17
              )
              
              
              —
              
              
              
              (17
              )Impairment
              
              
              (196,547
              )
              
              
              —
              
              
              
              —
              
              
              
              (196,547
              )Balance,
      April 30, 2008
              
              $
              477,662
              
              
              $
              194,632
              
              
              $
              201,532
              
              
              $
              873,826
 
  As
discussed above, our fiscal year 2009 FAS 142 annual first quarter impairment
analysis determined that the goodwill attributable
to four reporting units within our Media reportable segment was impaired and
consequently we recorded a charge of approximately $196.5 million. See Note
1 – Nature of Business and Basis of Presentation.
  12
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  5.
Debt and Revolving Credit Facility
  Debt
consists of:
  (in thousands)
              
              April 30,
              
              
              January 31,2008
              
              
              2008(unaudited)Revolving
      credit facility – Citicorp North America
              
              $
              -
              
              
              $
              -Term
      Loan B – Citicorp North America
              
              
              873,400
              
              
              
              875,600Bridge
      Facility – Citicorp North America
              
              
              465,000
              
              
              
              465,000Note
      payable – Magazine import and export
              
              
              -
              
              
              
              708Note
      payable – Arrangements with suppliers
              
              
              7,803
              
              
              
              8,461Mortgage
      loan – Wachovia Bank
              
              
              18,500
              
              
              
              18,750Equipment
      loans
              
              
              5,252
              
              
              
              6,060Total
      debt
              
              
              1,369,955
              
              
              
              1,374,579Less
      current maturities
              
              
              14,520
              
              
              
              15,369Debt,
      less current maturities
              
              $
              1,355,435
              
              
              $
              1,359,210
 
  
 Citicorp
North America Credit Facilities
  Revolving Credit
Facility
  On August
1, 2007, the Company entered into a new $300.0 million asset-based revolving
credit facility as a result of its acquisition of EM. Citicorp North America,
Inc., as administrative agent for each of the parties that may become a
participant in such arrangement and their successors (“Lenders”) will make
revolving loans to us and our subsidiaries of up to $300.0 million including the
issuance of letters of credit. The terms and conditions of the arrangement are
governed primarily by the Revolving Credit Agreement dated August 1, 2007 by and
among us, our subsidiaries, and Citigroup Global Markets, Inc. and J.P. Morgan
Securities, Inc. as Joint Lead Arrangers and Joint Book Runners, Citicorp North
America, Inc. as Administrative Agent and Collateral Agent, JPMorgan Chase Bank,
N.A. as Syndication Agent, and Wachovia Bank, National Association and Wells
Fargo Foothill, LLC as Co-Documentation Agents.
  Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 0.50%. At April 30,
2008 the prime rate was 5.00%. We also have the option of selecting up to five
tranches of at least $1.0 million each to bear interest at LIBOR plus a margin
of 1.50%. The Company had no LIBOR contracts outstanding at April 30, 2008. To
secure repayment of the borrowings and other obligations of ours to the Lenders,
we and our subsidiaries granted a security interest in all of the personal
property assets to Citicorp North America, Inc., for the benefit of the Lenders.
These loans mature on August 1, 2013. As of April 30, 2008 and January 31, 2008,
the Company had no borrowings under this facility.
  Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock.
  Availability
under the facility is limited by the Company’s borrowing base calculation, as
defined in the agreement. The calculation resulted in excess availability, after
consideration of outstanding letters of credit, of $265.0 million at April 30,
2008.
   13
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  Term Loan
B
  On August
1, 2007, the Company entered into a $880.0 million Term Loan B as a result of
its acquisition of EM. Citicorp North America, Inc., as administrative agent for
each of the parties that may become a participant in such arrangement and their
successors (“Lenders”) made loans to us and our subsidiaries of $880.0 million.
The terms and conditions of the arrangement are governed primarily by the Term
Loan Agreement dated August 1, 2007 by and among us, our subsidiaries, and
Citigroup Global Markets, Inc. and J.P. Morgan Securities, Inc. as Joint Lead
Arrangers and Joint Book Runners, Citicorp North America, Inc. as Administrative
Agent and Collateral Agent and JPMorgan Chase Bank, N.A. as Syndication
Agent.
  Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 2.25%. At April 30,
2008 the prime rate was 5.00%. We also have the option of selecting up to five
tranches of at least $1.0 million each to bear interest at LIBOR plus a margin
of 3.25%. The Company had one LIBOR contract outstanding at April 30, 2008 in
the amount of $873.4 million, maturing in May 2008 and bearing interest at a
rate of 5.63%.The Term Loan B requires the Company to make principal payments of
$2.2 million on the last day of each fiscal quarter.The Company made principal
payments totaling $2.2 million during the three months ended April 30, 2008.To
secure repayment of the borrowings and other obligations of ours to the Lenders,
we and our subsidiaries granted a security interest in all of the personal
property assets to Citicorp North America, Inc., for the benefit of the Lenders.
These loans mature on August 1, 2014.At that time, a final principal payment of
$820.6 million is due.
  Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. The Company is
also required to maintain a certain financial ratio. The Company was in
compliance with this requirement at April 30, 2008.
  Bridge
Facility
  On August
1, 2007, the Company issued a $465.0 million Bridge Loan Agreement (the “Bridge
Facility”) as a result of its acquisition of EM. Citicorp North America, Inc.,
as administrative agent for each of the parties that may become a participant in
such arrangement and their successors (“Lenders”) made loans to us and our
subsidiaries of $465.0 million. The terms and conditions of the arrangement are
governed primarily by the Senior Subordinated Bridge Loan Agreement dated August
1, 2007 by and among us, our subsidiaries, and Citigroup Global Markets, Inc.
and J.P. Morgan Securities, Inc. as Joint Lead Arrangers and Joint Book Runners,
Citicorp North America, Inc. as Administrative Agent and JPMorgan Chase Bank,
N.A. as Syndication Agent.
  Outstanding
borrowings bear interest at a variable annual rate equal to the prime rate
announced by Citicorp North America, Inc., plus a margin of 4.75% at April 30,
2008, which increases by 0.50% upon the expiration of each of the first four 90
day periods following original issuance. At April 30, 2008 the prime rate was
5.00%. We also have the option of selecting up to five tranches of at least $1.0
million each to bear interest at LIBOR plus a margin of 5.75% at April 30, 2008,
which increases by 0.50% upon the expiration of each of the first four 90 day
periods following original issuance. The interest rate on either base-rate or
LIBOR loans may not exceed 11.25%.The Company had one LIBOR contract outstanding
at April 30, 2008 in the amount of $465.0 million, maturing in May 2008 and
bearing interest at a rate of 8.63%.These loans mature on August 1, 2008 - the
table below assumes that the extended maturity date of these loans will be
August 1, 2017.
  On or
before August 1, 2008, the Company has the right to refinance the Bridge
Facility by paying an exchange fee of $11.6 million to Citicorp North America,
Inc.If the Company does not refinance the loans on or before August 1, 2008,
Citicorp North America, Inc. is required to allow the facility to convert into a
form of permanent financing.At that time, the Company must pay to Citicorp North
America a conversion fee of $11.6 million.The extended maturity date of these
loans would be August 1, 2017.These loans would carry interest not to exceed
11.25%.See Note 13 Subsequent Events.
 
 Under the
credit agreement, the Company is limited in its ability to declare dividends or
other distributions on capital stock or make payments in connection with the
purchase, redemption, retirement or acquisition of capital stock. The Company is
also required to maintain a certain financial ratio.The Company was in
compliance with this requirement at April 30, 2008.
   14
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  
 
 The
aggregate amount of debt maturing in each of the next five fiscal years is as
follows:
 (in thousands)
              
              AmountFiscal
      year:Remainder
      of 2009
              
              $
              11,0172010
              
              
              12,6722011
              
              
              11,4022012
              
              
              11,3152013
              
              
              10,938Thereafter
              
              
              1,312,611Total
              
              $
              1,369,955
 
 At April
30, 2008 and January 31, 2008, unamortized deferred financing fees were
approximately $25.6 million and $29.0 million, respectively.
  
  6.
Earnings per Share
  A
reconciliation of the denominators of the basic and diluted earnings per share
computations is shown below:
  Three months ended April 30,2008
              
              
              2007Weighted
      average common shares outstanding – basic
              
              
              52,321
              
              
              
              52,153Dilutive
      effect of stock options and warrants outstanding
              
              
              —
              
              
              
              479Weighted
      average common shares outstanding – diluted
              
              
              52,321
              
              
              
              52,632The
      following were not included in weighted average common shares outstanding
      because they are antidilutive:Unvested
      restricted stock units
              
              
              243
              
              
              
              —Stock
      options
              
              
              2,577
              
              
              
              1,670Warrants
              
              
              101
              
              
              
              106Total
              
              
              2,921
              
              
              
              1,776
 
  15
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  7.
Discontinued Operation
 On April
30, 2007, the Company disposed of substantially all of the assets and
liabilities of its Wood Manufacturing division.The Company sold the assets and
liabilities of its Wood Manufacturing division to a purchaser in which the
Company’s former Chairman of the Board and Chief Executive Officer, has an
interest.The Wood Manufacturing division was formerly reported as part of our
Periodical Fulfillment Services segment.The book value of the net assets sold on
the closing date was $11.6 million.The assets and liabilities of the Wood
Manufacturing division were sold for $10.0 million in cash, and the issuance of
a note payable to the Company in the face amount of $3.5 million, which bears
interest at the 3-month LIBOR plus a margin of 2.00%.The Company has determined
that the note does not bear an interest rate equivalent to a market rate for the
borrower.Therefore, the Company has discounted the note to fair value using its
estimation of a market rate for the note.This discount was approximately $1.0
million.Based upon the final determination of working capital, the Company
refunded to the buyer $1.9 million in cash during the third quarter of fiscal
2008.For the three months ended April 30, 2007, the summary results for the Wood
Manufacturing division are as follows:
  (in thousands)
              
              Three months ended April 30,2007Revenues
              
              $
              2,551Loss
      from discontinued operation, before income taxes
              
              $
              (1,463
              )Income
      tax benefit
              
              
              585Loss
      from discontinued operation
              
              
              (878
              )Loss
      on sale of discontinued operation, before income taxes
              
              
              (847
              )Income
      tax benefit
              
              
              339Loss
      on sale of discontinued operation
              
              
              (508
              )Discontinued
      operation, net
              
              $
              (1,386
              )
 
  
  8.
Supplemental Cash Flow Information
  Supplemental
information on interest and income taxes paid is as follows:
  Three
      months ended April 30,(in thousands)
              
              2008
              
              
              2007Interest
              
              $
              29,005
              
              
              $
              2,850Income
      taxes (net of receipts of $270 in 2008)
              
              $
              549
              
              
              $
              241
 
  As
discussed in Note 7, the Company disposed of its Wood Manufacturing division for
the total consideration of $13.5 million, including $3.5 million in the form of
a note receivable, of which the Company refunded $1.9 million to the buyer
during the third quarter of fiscal 2008, based on a working capital
adjustment.
   16
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  9.
Stock-Based Compensation
  On
February 1, 2008, the Company authorized the issuance of 243,472 restricted
stock units (“the units”) to its Board of Directors as compensation for services
rendered (or 30,434 per Director).The units vest in one-third increments,
annually beginning one year from the grant date.
  10.
Derivative Financial Instruments and Hedging Activities
 
 The
aggregate fair value of derivative instruments in asset positions on
April 30, 2008, is $1.1 million, and represents the maximum loss that
would be recognized at the reporting date if the counterparty failed to perform
as contracted.
 
 We have
applied hedge accounting to the interest rate swap and designated it as a cash
flow hedge in accordance with the provisions of FAS 133.The Company uses this
derivative to reduce the risk of changes in cash interest payments related to
its long-term debt.The notional balance for this interest rate swap is $210.0
million at April 30, 2008.The agreement was perfectly effective throughout the
three months ended April 30, 2008 and is expected to be effective throughout its
life.
  11.
Segment Financial Reporting
 
 The
Company’s segment reporting is based on the reporting of senior management to
the chief operating decision maker. This reporting combines the Company’s
business units in a logical way that identifies business concentrations and
synergies.Accordingly, beginning in fiscal 2009, management has restructured the
presentation of the Company’s segments to better reflect the change in
management and financial reporting of the applicable units.The Company’s
segments are heretofore presented as follows: Media, Periodical Fulfillment
Services, DVD and CD Fulfillment and Shared Services.Prior reporting periods
have been reclassified to conform to current presentation to make prior period
comparisons meaningful.
  The
Company conducts business through four reportable segments; Media, Periodical
Fulfillment Services, CD and DVD Fulfillment and Shared Services. The accounting
policies of the segments are materially the same as those described in the
Summary of Accounting Policies found in our Annual Report on Form 10-K for the
year ended January 31, 2008 filed with the SEC on April 15, 2008, as amended on
May 30, 2008.
  The Media
segment derives revenues primarily from (1) selling print advertising space in
its enthusiast publications, (2) selling enthusiast publications via newsstand
and subscription, (3) selling online advertising and lead generation services,
and (4) other revenues including licensing, barter and events.
  The
Periodical Fulfillment Services segment derives revenues from (1) selling and
distributing magazines, including domestic and foreign titles, to major
specialty and mainstream retailers and wholesalers throughout the United States
and Canada, (2) exporting domestic titles internationally to foreign wholesalers
or through domestic brokers, (3) providing return processing services for major
specialty retailers, (4) providing claim filing services related to rebates owed
retailers from publishers or their designated agent, (5) designing,
manufacturing, shipping, installation and removal of front-end display fixtures,
and (6) providing information and management services relating to retail
magazine sales to U.S. and Canadian retailers and magazine publishers and
national distributors.
  The CD
and DVD Fulfillment segment derives revenues from (1) selling and distributing
pre-recorded music, videos, video games and related products to retailers, (2)
providing product and commerce solutions to “brick-and-mortar” and e-commerce
retailers, and (3) providing consumer-direct fulfillment and vendor managed
inventory services to its customers.
  Shared
Services consist of overhead functions not allocable to the individual operating
segments.
   17
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 (unaudited)
  The
segment results are as follows:
  Three
      months ended April 30, 2008 (in thousands)
              
              Media
              
              
              Periodical
      Fulfillment
              
              
              CD
      and DVD Fulfillment
              
              
              Shared
      Services
              
              
              Eliminations
              
              
              ConsolidatedRevenues,
      net:Distribution
              
              $
              2,060
              
              
              $
              257,151
              
              
              $
              228,584
              
              
              $
              -
              
              
              $
              -
              
              
              $
              487,794Advertising
              
              
              61,633
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              61,633Circulation
              
              
              37,242
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (7,080
              )
              
              
              30,162Manufacturing
              
              
              -
              
              
              
              8,629
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              8,630Claiming
      and information
              
              
              -
              
              
              
              3,762
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,762Other
              
              
              22,380
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              22,380Total
      revenues, net
              
              
              123,315
              
              
              
              269,542
              
              
              
              228,584
              
              
              
              -
              
              
              
              (7,080
              )
              
              
              614,361Cost
      of goods sold
              
              
              33,391
              
              
              
              204,339
              
              
              
              189,572
              
              
              
              -
              
              
              
              (7,080
              )
              
              
              420,222Gross
      profit
              
              
              89,924
              
              
              
              65,203
              
              
              
              39,012
              
              
              
              -
              
              
              
              -
              
              
              
              194,139Distribution,
      circulation and fulfillment
              
              
              11,303
              
              
              
              28,888
              
              
              
              14,812
              
              
              
              -
              
              
              
              -
              
              
              
              55,003Selling,
      general and administrative expenses
              
              
              53,680
              
              
              
              23,756
              
              
              
              15,328
              
              
              
              3,868
              
              
              
              -
              
              
              
              96,632Depreciation
      and amortization
              
              
              12,143
              
              
              
              2,271
              
              
              
              2,946
              
              
              
              864
              
              
              
              -
              
              
              
              18,224Integration,
      consolidation and relocation expenses
              
              
              2,002
              
              
              
              486
              
              
              
              164
              
              
              
              55
              
              
              
              -
              
              
              
              2,707Write-off
      of capitalized acquisition costs
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,900
              
              
              
              -
              
              
              
              1,900Impairment
      of goodwill and intangible assets
              
              
              270,847
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              270,847Operating
      (loss) income
              
              $
              (260,051
              )
              
              $
              9,802
              
              
              $
              5,762
              
              
              $
              (6,687
              )
              
              $
              -
              
              
              $
              (251,174
              )Capital
      expenditures:
              
              $
              1,780
              
              
              $
              2,491
              
              
              $
              2,744
              
              
              $
              1,557
              
              
              $
              -
              
              
              $
              8,572As
      of April 30, 2008Total
      assets
              
              $
              1,089,849
              
              
              $
              437,222
              
              
              $
              491,803
              
              
              $
              89,257
              
              
              $
              -
              
              
              $
              2,108,131Goodwill,
      net
              
              $
              477,662
              
              
              $
              194,632
              
              
              $
              201,532
              
              
              $
              -
              
              
              $
              -
              
              
              $
              873,826Intangibles,
      net
              
              $
              478,253
              
              
              $
              36,136
              
              
              $
              36,245
              
              
              $
              -
              
              
              $
              -
              
              
              $
              550,634
 
  
   18
 SOURCE
INTERLINK COMPANIES, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
 (unaudited)
  Three
      months ended April 30, 2007 (in thousands)
              
              Media
              
              
              Periodical
      Fulfillment
              
              
              CD
      and DVD Fulfillment
              
              
              Shared
      Services
              
              
              Eliminations
              
              
              ConsolidatedRevenues,
      net:Distribution
              
              $
              -
              
              
              $
              233,935
              
              
              $
              230,816
              
              
              $
              -
              
              
              $
              -
              
              
              $
              464,751Manufacturing
              
              
              -
              
              
              
              7,154
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              7,154Claiming
      and information
              
              
              -
              
              
              
              3,500
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              3,500Other
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      revenues, net
              
              
              -
              
              
              
              244,589
              
              
              
              230,816
              
              
              
              -
              
              
              
              -
              
              
              
              475,405Cost
      of goods sold
              
              
              -
              
              
              
              185,036
              
              
              
              190,875
              
              
              
              -
              
              
              
              -
              
              
              
              375,911Gross
      profit
              
              
              -
              
              
              
              59,553
              
              
              
              39,941
              
              
              
              -
              
              
              
              -
              
              
              
              99,494Distribution,
      circulation and fulfillment
              
              
              -
              
              
              
              28,788
              
              
              
              7,701
              
              
              
              -
              
              
              
              -
              
              
              
              36,489Selling,
      general and administrative expenses
              
              
              -
              
              
              
              21,561
              
              
              
              21,613
              
              
              
              4,183
              
              
              
              -
              
              
              
              47,357Depreciation
      and amortization
              
              
              -
              
              
              
              2,224
              
              
              
              4,035
              
              
              
              577
              
              
              
              -
              
              
              
              6,836Operating
      income (loss)
              
              $
              -
              
              
              $
              6,980
              
              
              $
              6,592
              
              
              $
              (4,760
              )
              
              $
              -
              
              
              $
              8,812Capital
      expenditures:
              
              $
              -
              
              
              $
              1,522
              
              
              $
              1,683
              
              
              $
              822
              
              
              $
              -
              
              
              $
              4,027As
      of January 31, 2008Total
      assets
              
              $
              1,378,489
              
              
              $
              433,508
              
              
              $
              538,867
              
              
              $
              89,208
              
              
              $
              (4,067
              )
              
              $
              2,436,005Goodwill,
      net
              
              $
              673,654
              
              
              $
              194,649
              
              
              $
              201,532
              
              
              $
              -
              
              
              $
              -
              
              
              $
              1,069,835Intangibles,
      net
              
              $
              561,808
              
              
              $
              37,868
              
              
              $
              37,406
              
              
              $
              -
              
              
              $
              -
              
              
              $
              637,082
 
  13.
Subsequent Event
  In April
2008, as a result of a securities demand on our Bridge Facility by the Lenders
(see Item 1, Note 5), the Company intends to undertake an offering of Senior
Notes in reliance and in conformance with the exemptions for non-public
offerings provided by Rule 506 and Section 4(2) of the Securities Act of
1933.These notes will constitute “restricted securities” under Rule 144A of the
aforementioned Act.The provisions of Rule 144A permit limited resale of
“restricted securities” subject to mandatory holding periods, volume limitations
and other restrictions.
  The
Company intends to offer $465.0 million aggregate principal amount of Senior
Notes (the “Notes”) at an estimated cost from related fees of $13.4 million.The
interest rate on the Notes will not exceed 11.25% and the maturity shall not be
earlier than February 1, 2015. The proceeds from the issuance of the Notes will
be used to retire and refinance all indebtedness outstanding under the Bridge
Facility, dated August 1, 2007 in Note 5.
  
   19
  CAUTIONARY
STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995
  Some of
the information contained in this Quarterly Report on Form 10-Q including, but
not limited to, those contained in Item 2 of Part I “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” along with
statements in other reports filed with the Securities and Exchange Commission
(the “SEC”), external documents and oral presentations, which are not historical
facts are considered to be “forward-looking statements” within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The words “believe,” “expect,”
“anticipate,” “estimate,” “project,” and similar expressions often characterize
forward-looking statements. These statements may include, but are not limited
to, projections of collections, revenues, income or loss, cash flow, estimates
of capital expenditures, plans for future operations, products or services, and
financing needs or plans, as well as assumptions relating to these matters.
These statements are only predictions and you should not unduly rely on them.
Our actual results will differ, perhaps materially, from those anticipated in
these forward-looking statements as a result of a number of factors, including
the risks and uncertainties faced by us described below and those set forth
below under “Risk Factors” in our Annual Report for the fiscal year ended
January 31, 2008 on Form 10-K filed with the SEC on April 15, 2008, as amended
on May 30, 2008:
  ·  changes
in the retail market for CDs and DVDs;
  ·  changes
in the retail market for magazines, books and other publications;
  ·  changes
in the market for advertising expenditures;
  ·  adverse
effects to our customer base, upon whom our business depends;
  ·  disruptions in the operations of our key shipper and/or increased costs for
shipping services;
  ·  the
departure from the Company of key personnel;
  ·  changes
in print, ink, paper and fuel costs; and
  ·  changes
in consumer discretionary spending.
  The
factors listed above should not be construed as exhaustive.We believe it is
important to communicate our expectations to our investors. However, there may
be events in the future that we are not able to predict accurately or over which
we have no control. The factors listed above provide examples of risks,
uncertainties and events that may cause our actual results to differ materially
from the expectations we describe in our forward-looking statements. Before you
make an investment decision relating to our common stock, you should be aware
that the occurrence of the events described in these risk factors and those set
forth below under “Risk Factors” in our Annual Report for the fiscal year ended
January 31, 2008 filed with the SEC on April 15, 2008, as amended on May 30,
2008 could have a material adverse effect on our business, operating results and
financial condition. You should read and interpret any forward-looking statement
in conjunction with our consolidated financial statements, the notes to our
consolidated financial statements and Item 2 of Part I “Management’s Discussion
and Analysis of Financial Condition and Results of Operation.” Any
forward-looking statement speaks only as of the date on which that statement is
made. Unless required by U.S. federal securities laws, we undertake no
obligation to release publicly the results of any future revisions we may make
to forward-looking statements to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
  20
  ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
 
 We are a
premier publishing, marketing, merchandising and fulfillment company of
entertainment products including magazines, DVDs, music CDs, books and related
items, serving more than 100,000 retail locations throughout North America. We
produce print and digital content for consumers in North America through our
enthusiast media division, Source Interlink Media (“SIM”), which was acquired on
August 1, 2007.We also sell and distribute entertainment products to leading
mass merchandise retailers, grocery stores, bookstore chains, music stores, drug
stores and other specialty retailers, as well as e-commerce retailers. We offer
customers an array of value-added content and services including enthusiast
media publications and online content, category management, product procurement,
fulfillment services, claims submission, information services and in-store
display fixturing.
 
 We
directly produce and deliver magazine, Internet and home entertainment content
to consumers. With the addition of SIM, we transformed from a leading home
entertainment distributor into a significant content owner.This array of
products and services, in combination with our value added services and
geographic reach, positions us to service the needs of America’s leading
retailers and to capitalize on the rapidly changing distribution and fulfillment
landscape.
 
 We are
one of the largest independent wholesalers of DVDs and CDs in North America. We
effectively operate as an extension of our customers’ operations. Between our
fulfillment, category management and e-commerce solutions, we provide our
customers with a complete solution to maximize the sales and profitability of
their home entertainment content products.
 
 We are a
dynamic organization composed of three synergistic operating divisions. Together
they form a leading integrated media company with distinguished content and a
national distribution and merchandising platform.
   Our
Divisions
 
 Source Interlink
Media.Our SIM division is one of the largest providers of enthusiast
print and digital content in North America. SIM sells print advertising space in
its publications, sells publications through newsstands and subscriptions, sells
online advertising and lead generation services, and sells sponsorships and
tickets for events. Its properties consist of 80 publications, 94 websites and
over 100 events as of April 30, 2008. Well known print titles include Motor Trend, Hot Rod, Lowrider,
Power & Motoryacht, Surfer, Home Theater, Motorcyclist, 4 Wheel &
Offroad, and Soap Opera
Digest. SIM’s web properties include Automotive.com, Motortrend.com and
Equine.com as well as corresponding properties for most of its print
publications. SIM’s magazines have a combined circulation of approximately 9.0
million print copies per month, and its websites reach a total of over 19
million unique users who generate over 145 million page views per month. The
estimated total reach of our audience is over 75 million consumers each month.
Additionally, the reader base of our automotive portfolio is approximately 90%
male, and approximately 81% are between 18 and 54 years old.
 
 SIM is
the dominant provider of content to enthusiast communities interested in
automotive, action sports, marine, equine and home technology. SIM has the
largest portfolio of magazines in the automotive category, including six of the
top ten titles by paid circulation. These print publications are supplemented by
branded websites, consumer events, and licensed products. Automotive.com has
proven expertise in car sales lead generation, search engine marketing and
search engine optimization. This expertise coupled with a technology platform
that is increasing traffic can be monetized through advertising and lead
generation. As automakers divert marketing dollars to the Internet and as auto
dealers seek increased car sale leads, the combination of Automotive.com and our
portfolio of branded Internet sites provides a platform for strong growth in
online advertising and lead generation revenues.
 
 SIM’s
strategy of differentiated, specialized and authoritative content has
effectively positioned it to take advantage of the industry shift towards more
targeted advertising. SIM is an important source of information for readers on
their avocations. Given its niche content, SIM is less exposed to the pressures
faced by sports, news and other general interest magazines. SIM’s readers tend
to spend a significant amount of time and money on their avocations, which
results in titles that are less reliant on rate base guarantees than general
interest publications. Only six of SIM’s 80 titles have rate base guarantees.
SIM’s 15,000+ endemic advertisers rely on its titles as virtual storefronts to
directly connect with buyers and generate sales. Endemic sources comprise
approximately 85% of SIM’s print advertising revenue and provide a highly
desirable and, historically, a relatively less volatile revenue stream that
differentiates it from other content providers.
  Periodical
Fulfillment Services.Our Periodical Fulfillment Services division
provides an array of value-added services including category management, product
procurement, fulfillment and returns processing services to approximately 18,600
mainstream retail locations and 3,100 specialty retail locations. Its customers
include most of the nation’s leading magazine
  21
  retailers
including Barnes & Noble, Borders, Wal-Mart, Target, Kroger, Safeway,
Costco, Walgreens and Rite Aid, many of which have been customers for more than
10 years. The division has approximately 30% share of the single-copy magazine
distribution market and is the leading distributor in five of the nation’s top
ten advertising markets. The division also imports and exports periodicals sold
in more than 100 markets worldwide.
 
 This
group also designs and implements display fixture programs, manages rebates and
other incentive payments and accumulates data from more than 100,000 retail
locations. These services are critical to both mainstream and specialty
retailers alike as they enable clients to make more informed decisions regarding
product placement and marketing strategies.
 
 DVD / CD
Fulfillment.Our DVD / CD Fulfillment
division is the leading independent distributor of DVDs and CDs in the home
entertainment products marketplace, offering the most extensive selection of
products in the United States. It provides category management (vendor managed
inventory), procurement, fulfillment and e-commerce services to leading DVD and
CD retailers and Internet retailers, includingBarnes & Noble, Amazon.com,
Meijer, K Mart, Toys “R” Us, Circuit City and Walgreens. The DVD / CD
Fulfillment division utilizes its industry leading Stock Keeping Unit (“SKU”)
availability of approximately 360,000 CD titles and approximately 100,000 DVD
titles, approximately two-thirds of which are physically in stock in our
warehouses, as well as video games and other related products to supply a
tailored merchandise offering for its customers. Through its Consumer Direct
Fulfillment segment, the division also provides fulfillment for the majority of
domestic e-commerce sites that sell music or videos.
 
 The
Company’s business is affected by economic factors that impact the level of
disposable income available to our customers.The current economic downturn has
affected the level of consumer spending on discretionary items such as
magazines, DVDs and CDs.This reduction in discretionary spending has had a
related effect on the amount of advertising spend in our
publications.Advertising is a significant source of revenue for the Company and
is traditionally negatively affected by economic downturns in any of the
Company’s markets.Historically, our cost of sales has been made up of raw
material and packing costs with paper being the Company’s most substantial raw
material.Operating results could be adversely affected to the extent that
current economic conditions bring about significant increases in raw material
prices.In addition, related expenses have increased and will continue to do so
resulting from the impact of unprecedented rising fuel prices on our freight
costs.
 
 Overview
  Significant
events that occurred during the three months ended April 30, 2008 and 2007
include:
  Impairment
Charge
  As a
result of our fiscal year 2009 FAS 142 first quarter impairment analysis,
we determined that certain tradenames of our Media reportable segment were
impaired and consequently recorded a charge of approximately $74.3 million.This
determination was based largely on management’s projections regarding the
revenues from and profitability of tradenames acquired on August 1, 2007.The
combination of the analysis and other factors discussed below, had an
adverse impact on the anticipated future cash flows used in the impairment
analysis performed during the first quarter of fiscal year 2009.The net carrying
amount of the tradenames was $280.6 million at the end of the first quarter of
fiscal year 2009, after the impairment charge was recorded.
  22
  As a
result of our fiscal year 2009 FAS 142 annual first quarter impairment analysis,
we determined that the goodwill of four of our reporting units of our Media
reportable segment was impaired and consequently recorded an impairment charge
of $196.5 million. However, the results of the Phase I analysis indicated
significant clearance on three of the reporting units within our Media
reportable segment.This determination was based largely on management’s
projections regarding the revenues and profitability of the Media reportable
segment as well as the effects of the recent credit market changes, the
continued economic downturn and the related effects on customer discretionary
spending and print advertising. The charge was measured on the basis of
comparison of estimated fair values with corresponding book values and relates
primarily to goodwill recorded in connection with our acquisition of EM. These
fair values were determined in accordance with Company policy discussed above as
well as FAS 142 and other relevant guidance.
 
 Valuation
Allowance
  At
January 31, 2008, we had significant deferred tax assets resulting from tax
credit carryforwards, anticipated net operating losses and other deductible
temporary differences, which reduce taxable income in future periods. FAS 109
requires a valuation allowance be established when it is more likely than not
that all or a portion of deferred tax assets will not be realized and that it is
difficult to conclude that a valuation allowance is not needed when there is
negative evidence such as cumulative losses in recent years. Therefore,
cumulative losses as well as several significant first quarter 2009 developments
were considered in determining the need for this valuation allowance, including
management’s projections regarding the near-term revenues and profitability of
our segments and the continuing economic downturn and its related effects on
consumer discretionary spending.Accordingly, management assessed the short-term
realizability of the deferred tax assets based upon forecasted taxable income.
As a result of the review undertaken at April 30, 2008, the Companyconcluded that it was
appropriate to establish a valuation allowance forits net deferred tax
assets.As a result, the valuation allowance for deferred tax assets amounts to
$108.7 million at April 30,2008. In addition, the
Company expects to provide a full valuation allowance onfuture tax benefits
until its projections support reversal of some or all of the valuation
allowance.
 
  Sale
of Wood Manufacturing Division
  On April
30, 2007, we sold substantially all of the assets of our Wood Manufacturing
Division.This discontinued operation has been excluded from current and prior
year results as presented herein.See Note 7 – Discontinued
Operation.
   23
  Results
of operations
  Please
see our Annual Report on Form 10-K for the fiscal year ended January 31, 2008
and filed with the SEC on April 15, 2008, as amended on May 30, 2008, for more
information on the types of revenues and expenses included within the specific
line-items in our financial statements.
  The
Company’s segment reporting is based on the reporting of senior management to
the chief operating decision maker. This reporting combines the Company’s
business units in a logical way that identifies business concentrations and
synergies.Accordingly, beginning in fiscal 2009, management has restructured the
presentation of the Company’s segments to better reflect the change in
management and financial reporting of the applicable units.The Company’s
segments are heretofore presented as follows: Media, Periodical Fulfillment
Services, DVD and CD Fulfillment and Shared Services.Prior reporting periods
have been reclassified to conform to current presentation to make prior period
comparisons meaningful.
  THREE
MONTHS ENDED APRIL 30, 2008 AND 2007
  Media
  The
following table sets forth, for the periods presented, information relating to
our Media segment:
  Three months ended April
      30,
              
              
              Change2008
              
              
              2007
              
              
              Amount
              
              PercentRevenues,
      netDistribution
              
              $
              2,060
              
              
              $
              -
              
              
              $
              2,060
              
              NMAdvertising
              
              
              61,633
              
              
              
              -
              
              
              
              61,633
              
              NMCirculation
              
              
              37,242
              
              
              
              -
              
              
              
              37,242
              
              NMOther
              
              
              22,380
              
              
              
              -
              
              
              
              22,380
              
              NMTotal
      revenues, net
              
              
              123,315
              
              
              
              -
              
              
              
              123,315
              
              NMCost
      of goods sold
              
              
              33,391
              
              
              
              -
              
              
              
              33,391
              
              NMGross
      profit
              
              
              89,924
              
              
              
              -
              
              
              
              89,924
              
              NMDistribution,
      circulation and fulfillment
              
              
              11,303
              
              
              
              -
              
              
              
              11,303
              
              NMSelling,
      general and administrative expenses
              
              
              53,680
              
              
              
              -
              
              
              
              53,680
              
              NMDepreciation
      and amortization
              
              
              12,143
              
              
              
              -
              
              
              
              12,143
              
              NMIntegration,
      consolidation and relocation expense
              
              
              2,002
              
              
              
              -
              
              
              
              2,002
              
              NMImpairment
      of goodwill and intangible assets
              
              
              270,847
              
              
              
              -
              
              
              
              -
              
              NMOperating
      loss
              
              $
              (260,051
              )
              
              $
              -
              
              
              $
              (260,051
              )
              NMNM
      - percentage change not meaningful
 
  On August
1, 2007 we acquired EM, which created our Media operating segment.All changes in
income statement line items result from this acquisition.
   24
  Periodical
Fulfillment Services
  The
following table sets forth, for the periods presented, information relating to
our Periodical Fulfillment Services segment:
  Three months ended April
      30,
              
              
              Change2008
              
              
              2007
              
              
              Amount
              
              
              PercentRevenues,
      netDistribution
              
              $
              257,151
              
              
              $
              233,935
              
              
              $
              23,216
              
              
              
              9.9
              %Manufacturing
              
              
              8,629
              
              
              
              7,154
              
              
              
              1,475
              
              
              
              20.6
              %Rebate/information
              
              
              3,762
              
              
              
              3,500
              
              
              
              262
              
              
              
              7.5
              %Total
      revenues, net
              
              
              269,542
              
              
              
              244,589
              
              
              
              24,953
              
              
              
              10.2
              %Cost
      of goods sold
              
              
              204,339
              
              
              
              185,036
              
              
              
              19,303
              
              
              
              10.4
              %Gross
      profit
              
              
              65,203
              
              
              
              59,553
              
              
              
              5,650
              
              
              
              9.5
              %Distribution,
      circulation and fulfillment
              
              
              28,888
              
              
              
              28,788
              
              
              
              100
              
              
              
              0.3
              %Selling,
      general and administrative expenses
              
              
              23,756
              
              
              
              21,561
              
              
              
              2,195
              
              
              
              10.2
              %Depreciation
      and amortization
              
              
              2,271
              
              
              
              2,224
              
              
              
              47
              
              
              
              2.1
              %Integration
      and relocation expense
              
              
              486
              
              
              
              -
              
              
              
              486
              
              
              NMOperating
      income (loss)
              
              $
              9,802
              
              
              $
              6,980
              
              
              $
              2,822
              
              
              
              40.4
              %Key
      operating measures:Gross
      profit margin
              
              
              24.2
              %
              
              
              24.3
              %
              
              
              (0.2
              %)Operating
      income margin
              
              
              3.6
              %
              
              
              2.9
              %
              
              
              0.8
              %Distribution,
      circulation andfulfillment as a percent of revenues10.7
              %
              
              
              11.8
              %
              
              
              (1.1
              %)Selling,
      general and administrative expensesas
      a percent of revenues
              
              
              8.8
              %
              
              
              8.8
              %
              
              
              (0.0
              %)NM
      - percentage change not meaningful
 
  Revenues
increased due to the impact of a new exclusive contract with a major bookstore,
significant sales to new mainstream retailers and increased export distribution
as a result of a new exclusive export contract with a major domestic national
distributor.
  Distribution,
circulation and fulfillment as a percent of revenues decreased partially due to
synergies achieved related to our acquisition of Anderson Mid-Atlantic News, LLC
and Anderson SCN Services, LLC during fiscal 2007 as well as increased revenue
from our export distribution business that does not carry freight
costs.
  Selling,
general and administrative expenses as a percent of revenues remained consistent
with the prior year period. Selling, general and administrative expenses
increased due in part to additional information technology expense associated
with the continued integration of the operating platforms of our prior
acquisitions.
  In fiscal
2008, we incurred expenses associated with the integration of our Brainerd, MN
distribution center into our new McCook, IL distribution center.
   25
  CD
and DVD Fulfillment
  The
following table sets forth, for the periods presented, information relating to
our CD and DVD Fulfillment segment:
  Three months ended April
      30,
              
              
              Change2008
              
              
              2007
              
              
              Amount
              
              
              PercentRevenues,
      netDistribution
              
              $
              228,584
              
              
              $
              230,816
              
              
              $
              (2,232
              )
              
              
              (1.0
              %)Total
      revenues, net
              
              
              228,584
              
              
              
              230,816
              
              
              
              (2,232
              )
              
              
              (1.0
              %)Cost
      of goods sold
              
              
              189,572
              
              
              
              190,875
              
              
              
              (1,303
              )
              
              
              (0.7
              %)Gross
      profit
              
              
              39,012
              
              
              
              39,941
              
              
              
              (929
              )
              
              
              (2.3
              %)Distribution,
      circulation and fulfillment
              
              
              14,812
              
              
              
              7,701
              
              
              
              7,111
              
              
              
              92.3
              %Selling,
      general and administrative expenses
              
              
              15,328
              
              
              
              21,613
              
              
              
              (6,285
              )
              
              
              (29.1
              %)Depreciation
      and amortization
              
              
              2,946
              
              
              
              4,035
              
              
              
              (1,089
              )
              
              
              (27.0
              %)Integration
      and relocation expense
              
              
              164
              
              
              
              -
              
              
              
              164
              
              
              NMOperating
      income
              
              $
              5,762
              
              
              $
              6,592
              
              
              $
              (830
              )
              
              
              (12.6
              %)Key
      operating measures:Gross
      profit margin
              
              
              17.1
              %
              
              
              17.3
              %
              
              
              (0.2
              %)Operating
      income margin
              
              
              2.5
              %
              
              
              2.9
              %
              
              
              (0.4
              %)Distribution,
      circulation and fulfillment as a percent of revenues
              
              
              6.5
              %
              
              
              3.3
              %
              
              
              3.2
              %Selling,
      general and administrative expensesas
      a percent of revenues
              
              
              6.7
              %
              
              
              9.4
              %
              
              
              (2.7
              %)NM
      - percentage change not meaningful
 
  Revenues
remained consistent with the prior year period due in part to the addition of a
significant new customer which offset declining sales from existing
customers.
  Gross
profit margin decreased slightly primarily due the addition of a significant new
customer that carries lower gross margins.
  Distribution,
circulation and fulfillment as a percent of revenues increased due in part to
increased fuel costs versus the prior year period.
  Selling,
general and administrative expenses as a percent of revenues remained consistent
with the prior year period.
  Depreciation
and amortization decreased primarily due to decreased intangible assets as a
result of the prior year impairment.
  Operating
income decreased primarily due the factors listed above.
   26
  Shared
Services
  The
following table sets forth, for the periods presented, information relating to
our Shared Services segment:
  Three months ended April
      30,
              
              
              Change2008
              
              
              2007
              
              
              Amount
              
              
              PercentSelling,
      general and administrative expenses
              
              $
              3,868
              
              
              $
              4,183
              
              
              $
              (315
              )
              
              
              (7.5
              %)Depreciation
      and amortization
              
              
              864
              
              
              
              577
              
              
              
              287
              
              
              
              49.7
              %Merger
      and acquisition costs
              
              
              55
              
              
              
              -
              
              
              
              55
              
              
              NMWrite-off
      of capitalized acquisition costs
              
              
              1,900
              
              
              
              -
              
              
              
              1,900
              
              
              NMOperating
      loss
              
              $
              (6,687
              )
              
              $
              (4,760
              )
              
              $
              (1,927
              )
              
              
              (40.5
              %)Key
      operating measures:Selling,
      general and administrative expenses %as
      a percent of total revenues
              
              
              0.6
              %
              
              
              0.9
              %
              
              
              (0.3
              %)NM
      - percentage change not meaningful
 
  Selling,
general and administrative expenses remained consistent with the same period of
the prior year.
  During
the three months ended April 30, 2008 we wrote off $1.9 million in previously
capitalized acquisition related costs.The write-off occurred as a direct result
of management’s determination that continued capitalization of these costs was
no longer appropriate given the status of the potential
acquisition.
  Interest
Expense
  Interest
expense includes the interest and fees on our significant debt instruments and
outstanding letters of credit.Net interest expense increased to $28.9 million
from $3.6 million for the three months ended April 30, 2008 and 2007,
respectively.The increase relates to the significant increase in borrowings as a
result of our acquisition of EM.
  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 rate for the current quarter was 0.0% versus an effective tax rate
of 40.0% in the same period of the prior year. The change in effective tax rates
is due to the valuation allowance discussed above.Our effective tax rate differs
from that disclosed in our Annual Report on Form 10-K due to the full valuation
of current period tax benefits.
  27
  Liquidity
and Capital Resources
  Our
primary sources of cash include receipts from our customers and borrowings under
our credit facilities.
  Our
primary cash requirements for the Media group consist of raw materials and
salaries.
  Our
primary cash requirements for the Periodical Fulfillment Services group consist
of the cost of home entertainment products, the cost of freight and facility
expense associated with our distribution centers and the cost of raw materials,
labor, and factory overhead incurred in the production of front-end wire
displays, the cost of labor incurred in providing our claiming, design and
information services and cash advances funding our Advance Pay program.Our
Advance Pay program allows retailers to accelerate collections of their rebate
claims through payments from us in exchange for the transfer to us of the right
to collect the claim.We then collect the claims when paid by publishers for our
own account.
  Our
primary cash requirements for the CD and DVD Fulfillment group consist of the
cost of home entertainment products and the cost of freight, labor and facility
expense associated with our distribution centers.
  Our
primary cash requirements for the Shared Services group consist of salaries and
professional fees not allocated to the operating groups.
  There
have been no material changes to our contractual obligations since January 31,
2008.
  
  Operating
Cash Flow
  Net cash
used in operating activities was $12.4 million for the three months ended April
30, 2008 compared with cash provided by operating activities of $6.9 million for
the three months ended April 30, 2007.
  Operating
cash flows for the three months ended April 30, 2008 were comprised
of:
  ·
              Net
      loss of $280.8 million,
  ·
              Plus
      non-cash charges and positive changes in operating assets and liabilities
      including:
  ·      Impairment
of goodwill and intangibles of $270.8 million,
 ·      Depreciation
and amortization of $22.9 million,
 ·      Provisions
for losses on accounts receivable of $2.0 million and
 ·      Decreases
in accounts receivable of $18.9 million.
 
 ·
              Cash
      was used for:
  ·
              Increases
      in inventories of $11.3 million,
 ·
              Decreases
      in accounts payable and other liabilities of $35.2 million
    and
 ·
              Increases
      in other current and non-current assets of $1.2
  million.
  The
decrease in accounts receivable of $18.9 million relates primarily to a decrease
in accounts receivable within our DVD and CD Fulfillment group of $27.1 million
related primarily to the timing of payments received from major customers.This
increase was partially offset by an increase in accounts receivable within our
Periodical Fulfillment Services group of approximately $10.7 million related
primarily to the timing of payments received from major customers.
  The
increase in inventories of $11.3 million relates in part to the conversion of
customers to scan-based trading relationships within our Periodical Fulfillment
Services group which results in a decrease in accounts receivable and an
increase in inventories.
  The
decrease in accounts payable and other liabilities of $35.2 million relates
primarily to a decrease in accounts payable within our DVD and CD Fulfillment
group of $54.0 million related primarily to the timing of vendor payments.We
currently do not receive as favorable payment terms from DVD vendors as from CD
vendors.Therefore, as the mix shifts we experience negative working capital
consequences.Also contributing to the decrease in accounts payable and other
liabilities
   28
  were our
Media and Shared Services groups; both experienced decreases of $4.9 million and
$5.1 million, respectively.These decreases were partially offset by an increase
in accounts payable within our Periodical Fulfillment Services group of $29.1
million related primarily to better payment terms received from certain
vendors.
  Operating
cash flows for the three months ended April 30, 2007 were comprised
of:
  ·
              Net
      income of $1.8 million,
  ·
              Plus
      non-cash charges including:
  ·
              depreciation
      and amortization of $7.3 million,
 ·
              provisions
      for losses on accounts receivable of $1.1
  million
 ·
              loss
      on sale of discontinued operation of $0.5
  million
 ·
              decreases
      in accounts receivable of $5.7 million,
and
 ·
              increases
      in accounts payable and other liabilities of $7.0
  million.
  ·
              Cash
      was used for:
  ·
              increases
      in inventories of $14.3 million,
and
 ·
              increases
      in other current and non-current assets of $3.1
  million.
 
 The
decrease in accounts receivable of $5.7 million relates primarily to a decrease
in accounts receivable within our CD and DVD Fulfillment group of $18.6 million
related to the timing of customer payments, offset by an increase within our
Periodical Fulfillment Services group of $15.0 million related primarily to the
timing of customer payments and decreased expected returns during the second
quarter of fiscal 2008 versus the first quarter of fiscal 2008.
 
 The
increase in accounts payable and other liabilities of $7.0 million relates
primarily to an increase in accounts payable within our Periodical Fulfillment
Services group of $14.4 million primarily related to the timing of vendor
payments, offset by a decrease in accounts payable and other liabilities within
our CD and DVD Fulfillment group of $8.5 million primarily related to the timing
of vendor payments.
 
 The
increase in inventories of $14.3 million relates primarily to an increase in
inventories of $9.1 million related primarily to the timing of shipments and
increased consignment inventory as well as an increase within our CD and DVD
Fulfillment group of $5.7 million related primarily to the timing of purchases
and shipments.
 
 Investing
Cash Flow
  Net cash
used by investing activities was $8.4 million for the three months ended April
30, 2008 compared with cash provided by investing activities of $10.3 million
for same period last year.
  For the
three months ended April 30, 2008, cash used by investing activities consisted
primarily of $8.6 million in capital expenditures and payment of potential
acquisition costs of $1.9 million, partially offset by $2.1 million in net
collection of purchased claims.
  For the
three months April 30, 2007, cash provided by investing activities consisted
primarily of $10.0 million received from the sale of our Wood Manufacturing
group and $4.3 million received from net collections of advance pay claims,
offset by $4.0 million in capital expenditures.
 
 Financing
Cash Flow
  Outstanding
balances on our credit facility fluctuate partially due to the timing of the
retailer rebate claiming process and our Advance Pay program, the seasonality of
our front end wire and services business and the payment cycles of the CD and
DVD and magazine fulfillment businesses. Because the magazine distribution
business and Advance Pay program cash requirement usually peaks during the
middle of the fiscal quarter, the reported bank debt levels usually are the
minimum level outstanding during the quarter. Our CD and DVD Fulfillment group
has historically generated approximately 33% of its total net sales in the
fourth calendar quarter coinciding with the holiday shopping season and
therefore requires greater borrowings in the third quarter to finance the
buildup of inventory.
   29
  Payments
under our Advance Pay program generally occur just prior to our fiscal quarter
end. The related claims are not generally collected by us until 30-60 days after
the advance is made. As a result, our funding requirements peak at the time of
the initial advances and decrease over this period as the cash is collected on
the related claims.
  The front
end display fixture manufacturing and services business is seasonal because most
retailers prefer initiating new programs before the holiday shopping season
begins, which concentrates revenues in the second and third quarter. Receivables
from these programs are generally collected from all participants within 180
days. We are usually required to tender payment on the costs of these programs
(raw material and labor) within a shorter period. As a result, our funding
requirements peak in the second and third fiscal quarters when we manufacture
the fixtures, and decrease significantly in the fourth and first fiscal quarters
as the related receivable are collected and significantly less manufacturing
activity is occurring.
  Net cash
used in financing activities was $11.6 million for the three months ended April
30, 2008 versus cash used in financing activities of $2.7 million for the same
quarter last year.
  Financing
activities in the three months ended April 30, 2008 consisted primarily of a
$5.9 million in payments on notes payable and capital leases and $5.7 million in
payments of deferred purchase price liabilities within our Media
segment.
  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 under the revolving credit facility of $1.4
million, offset by borrowings under notes payable of $2.0 million.
 
 
 Debt
  For a
detailed description of the terms of our significant debt instruments, please
refer to Note 5 to our Consolidated Financial Statements.
  In
connection with our acquisition of EM, we issued three new credit facilities on
August 1, 2007.These facilities consist of a $300.0 million asset-based
revolving facility that was undrawn at April 30, 2008, an $880.0 million term
loan facility that amortizes 1.0% per year, and a $465.0 million bridge loan
that will convert to long-term financing if it is not refinanced within one year
- see Note 13 Subsequent Event relating to a securities demand on the Bridge
Facility after the date of these Consolidated Financial Statements.We expect to
pay interest on these facilities with cash flow generated from
operations.
  Off-Balance
Sheet Arrangements
  We do not
engage in transactions or arrangements with unconsolidated or other special
purpose entities as defined by Item 303(a) (4) of Regulation S-K.
   30
  ITEM
3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  Our
primary market risks include fluctuations in interest rates and exchange rate
variability.
  Our debt
primarily relates to credit facilities with Citicorp North America, Inc.See Note
5 to our Consolidated Financial Statements.
  The
revolving credit facility with Citicorp North America had no outstanding
principal balance at April 30, 2008.There were outstanding balances of $873.4
million and $465.0 million as of April 30, 2008 on our Term Loan B and Bridge
Facility, respectively.Interest on the outstanding balances is charged based on
a variable interest rate related to LIBOR (2.86% at April 30, 2008) plus a
margin of 3.25% on the Term Loan B and 5.75% on the Bridge
Facility.
  As a
result of the above, our primary market risks relate to fluctuations in interest
rates.On April 11, 2008, the Company entered into an interest rate swap
agreement with Wachovia Bank, N.A. to hedge the Company’s exposure to
fluctuations in LIBOR.The notional amount of this swap is $210.0 million.A 1.0%
increase in the prevailing interest rate on our debt at April 30, 2008 is
estimated to cause an increase of $10.0 million in interest expense for the
remainder of the year ending January 31, 2009.The swap would provide protection
against approximately $1.6 million of the above increase.
  ITEM 4.
CONTROLS AND PROCEDURES
  Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report (the
“Evaluation Date”).
  Attached
as exhibits to this Quarterly Report are certifications of our principal
executive officer and chief financial officer, which are required in accordance
with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (“Exchange
Act”). The information appearing below should be read in conjunction with the
certifications for a more complete understanding of the topics
presented.
  About
Disclosure Controls
  Disclosure
controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) of the
Exchange Act) are designed to provide assurance that the information concerning
us and our consolidated subsidiaries, which is required to be included in our
reports and statements filed or submitted under the Exchange Act, as amended,
(i) is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions required disclosure and (ii) is recorded, processed, summarized
and reported within the time periods specified in rules and forms of the
SEC.
  Limitations
on the Effectiveness of Controls
  Our
management, including our principal executive officer and chief financial
officer, do not expect that our disclosure controls and procedures will prevent
all error and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
system’s objectives will be met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty and that breakdowns
can occur because of simple error or mistake. Controls can also be circumvented
by the individual acts of some persons, by collusion of two or more people, or
by management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of
compliance with policies or procedures. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
  Scope
of the Controls Evaluation
  The
evaluation of our disclosure controls and procedures included a review of the
controls’ objectives and design, the company’s implementation of the controls
and the effect of the controls on the information generated for use in this
Quarterly Report. In the course of the controls evaluation, we sought to
identify data errors, control problems or acts of fraud and
  31
  confirm
that appropriate corrective action, including process improvements, were being
undertaken. This type of evaluation is performed on a quarterly basis so that
the conclusions of management, including the chief executive officer and the
chief financial officer, concerning the effectiveness of the controls can be
reported in our Quarterly Reports on Form 10-Q and to supplement our disclosures
made in our Annual Report on Form 10-K. Many of the components of our disclosure
controls and procedures are also evaluated on an ongoing basis by our Internal
Audit Department and by other personnel in our finance organization. The overall
goals of these various evaluation activities are to monitor our disclosure
controls and procedures, and to modify them as necessary. Our intent is to
maintain the disclosure controls and procedures as dynamic systems that change
as conditions warrant.
  Conclusions
  Based on
this evaluation, our principal executive officer and our chief financial
officer, have concluded that, subject to the limitations noted above, as of the
end of the period covered by this report, our disclosure controls and procedures
were effective to ensure that information we are required to disclose in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in SEC rules and forms and
include controls and procedures designed to ensure that information required to
be disclosed by the Company in such reports is accumulated and communicated to
the Company’s management, including the principal executive officer and the
chief financial officer, as appropriate to allow timely decisions regarding
required disclosure.
  Changes
in Internal Controls over Financial Reporting
  There
were no changes in the Company’s internal controls over financial reporting (as
defined in Rule 13a-15f of the Exchange Act) that occurred during the fiscal
quarter ended April 30, 2008 that have materially affected, or are reasonably
likely to materially affect those controls.
   32
  PART
II – OTHER INFORMATION
  ITEM 1.
LEGAL PROCEEDINGS.
  We are
party to routine legal proceedings arising out of the normal course of
business.Although it is not possible to predict with certainty the outcome of
these unresolved legal actions 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 our financial condition or results of operations.
  ITEM 1A.
RISK FACTORS.
  Refer to
our Annual Report on Form 10-K filed April 15, 2008 as amended May 30,
2008.
  ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
  Not
Applicable.
  ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.
  Not
Applicable.
  ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
  Not
Applicable.
  ITEM 5.
OTHER INFORMATION.
  Not
Applicable.
  ITEM 6.
EXHIBITS.
  See
Exhibit Index.
   33
  SIGNATURES
  Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  SOURCE
      INTERLINK COMPANIES, INC.June
      6, 2008
              By:
              /s/
      Marc FiermanMarc
      FiermanChief
      Financial Officer(principal
      financial officer)
 
   34
  EXHIBIT
INDEX
  Exhibit
      No.
              
              Description31.1*
              
              Rule
      13a-14(a)/15d-14(a) Certification of Principal Executive
      Officer.31.2*
              
              Rule
      13a-14(a)/15d-14(a) Certification of Principal Financial
      Officer.32.1*
              
              Section
      1350 Certification of Principal Executive Officer and Principal Financial
      Officer.
 
 * Filed
Herewith