SOURCE INTERLINK COMPANIES INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] Annual report under Section 13 or 15(d) of the Securities Exchange Act
of 1934. For the fiscal year ended January 31, 2002.

[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the transition period from _____________ to
______________.

Commission file number 1-13437

SOURCE INTERLINK COMPANIES, INC.
(Exact Name of Registrant as Specified in Its Charter)

MISSOURI 43-1710906
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

TWO CITY PLACE DRIVE, SUITE 380
ST. LOUIS, MISSOURI 63141
(Address of Principal Executive Offices) (Zip Code)

(314) 995-9040
(Registrant's Telephone Number, Including Area Code)

Securities registered under Section 12(b) of the Exchange Act:

Name of Each Exchange
Title of Each Class on Which Registered
------------------- ---------------------

Securities registered under Section 12(g) of the Act: COMMON STOCK $0.01 PAR
VALUE

Indicate by check mark whether the registrant: (1) 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. Yes X No

Indicate by check mark if disclosure of delinquent filers in response to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|

At March 31, 2002 the aggregate market value of the voting and non-voting stock
held by non-affiliates of Source Interlink Companies, Inc. (the "Company") was
approximately $62,634,028 based on the last sale price of the Common Stock
reported by the Nasdaq National Market on March 31, 2002. At March 31, 2002, the
Company had outstanding 18,288,679 shares of Common Stock.

TABLE OF CONTENTS

PART I

SOME OF THE INFORMATION CONTAINED IN THIS FORM 10-K CONTAINS FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE FEDERAL SECURITIES LAWS. WHEN USED IN THIS
REPORT, THE WORDS "MAY," "WILL," "BELIEVES," "ANTICIPATES," "INTENDS,"
"EXPECTS," AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING
STATEMENTS. BECAUSE SUCH FORWARD-LOOKING STATEMENTS INVOLVE CERTAIN RISKS AND
UNCERTAINTIES, OUR ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS COULD DIFFER
MATERIALLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR CONTRIBUTE
TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: (I) OUR DEPENDENCE ON THE
MARKETING AND DISTRIBUTION STRATEGIES OF PUBLISHERS AND OTHER VENDORS; (II) OUR
ABILITY TO ACCESS CHECKOUT AREA INFORMATION; (III) RISKS ASSOCIATED WITH OUR
ADVANCE PAY PROGRAM, INCLUDING PROBLEMS COLLECTING INCENTIVE PAYMENTS FROM
PUBLISHERS; (IV) DEMAND FOR OUR DISPLAY STORE FIXTURES; (V) OUR ABILITY TO
SUCCESSFULLY IMPLEMENT OUR GROWTH STRATEGY; (VI) COMPETITION; (VII) OUR ABILITY
TO EFFECTIVELY MANAGE OUR EXPANSION; (VIII) GENERAL ECONOMIC AND BUSINESS
CONDITIONS NATIONALLY, IN OUR MARKETS AND IN OUR INDUSTRY; (IX) OUR ABILITY TO
MAINTAIN ADEQUATE FINANCING ON ACCEPTABLE TERMS SUFFICIENT TO ACHIEVE OUR
BUSINESS PLAN; (X) OUR ABILITY TO SUCCESSFULLY INTEGRATE ACQUIRED COMPANIES WITH
AND INTO OUR CORPORATE ORGANIZATION, AND (XI) OUR ABILITY TO ATTRACT AND/OR
RETAIN SKILLED MANAGEMENT. INVESTORS ARE ALSO DIRECTED TO CONSIDER OTHER RISKS
AND UNCERTAINTIES DISCUSSED IN OTHER REPORTS PREVIOUSLY AND SUBSEQUENTLY FILED
BY US WITH THE SECURITIES AND EXCHANGE COMMISSION. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE
DATE HEREOF. WE UNDERTAKE NO OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS, WHICH MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF
UNANTICIPATED EVENTS.

PART I
ITEM 1. DESCRIPTION OF BUSINESS.

We are a leading provider of information and management services for retail
magazine sales to U.S. and Canadian retailers and magazine publishers. We are
also a leading manufacturer of display and store fixtures used by retailers. On
May 31, 2001, we acquired The Interlink Companies, Inc. ("Interlink") and its
operating companies, including International Periodical Distributors, Inc.
("IPD"), a distributor of magazines to bookstore chains, record stores, computer
stores and independent retailers, and David E. Young, Inc. ("Deyco"), a national
distributor to secondary wholesalers who supply magazines to independent
retailers and specialty chains. Interlink represents a new business segment,
magazine distribution. Through this strategic acquisition, we have become a
leading direct distributor of magazines to bookstore chains, computer stores and
independent retailers.

Through our information services, we provide sales data and product placement
and other related information in various user-friendly formats, including print,
CD-ROM and over the Internet. This information helps users to formulate
marketing, distribution and advertising plans and to react more quickly to
changing market conditions. Our information services cover over 10,000 magazine
titles and are provided to approximately 1,000 retail chains with approximately
80,000 stores and 400,000 checkout counters. We believe we maintain the most
comprehensive information database available for retail magazine sales and
magazine placement at checkout counters. We have expanded upon our experience
with retail magazine sales to provide similar information and services to
confectioners and vendors of general merchandise sold at checkout counters.

We assist retailers in increasing sales and incentive payment revenues by
reconfiguring and designing front-end display fixtures, supervising
installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. Historically, as part of our services, we
arranged for the manufacture of display fixtures for many of our customers.
Since January 1999, we acquired five display fixture manufacturers.
Manufacturing display fixtures in our own facilities allows us to be a
full-service provider of management services for the checkout area, or
"front-end," of a customer's store. We also can integrate the design and
manufacturing processes with our clients' merchandising strategies and better
manage the timing of display fixture delivery and installation.

The Company's segment reporting has been restructured based on the reporting of
senior management to the Chief Executive Officer. This restructuring combines
the Company's business units in a logical way that more easily identifies
business concentrations and synergies for both analysis of results and real-time
control by management. The reportable segments of the Company are in-store
services, manufacturing and magazine distribution.

We believe that we are well positioned to use our existing relationships with
retailers and vendors to cross-sell our products and services.

1

INDUSTRY OVERVIEW

In-Store Services and Manufacturing

A substantial portion of the products sold in retail stores are bought on
impulse. It is therefore important to vendors that their products be on
prominent display in those areas of a store where they will be seen by the
largest number of shoppers. There are usually two such areas in a store. One is
a dedicated area called a mainline display; the other is the checkout area which
is sometimes referred to as the front-end. The front-end is visited by virtually
every shopper in a store. Shoppers typically must wait to complete the checkout
process and are more likely to see products on display in the front-end, which
increases the likelihood that these products will be bought on impulse. Products
suited to front-end display include magazines, confections and certain general
merchandise such as razor blades, film and batteries.

Vendors of front-end products compete for favorable spaces on display fixtures,
which we refer to as "pockets". Some vendors make incentive payments to
retailers for favorable product locations. These payments may include up-front
fees to have display fixtures configured to provide for a vendor's desired
product placements, recurring placement rental fees based on the location and
size or rebate payments on a product's sales volume.

Timely delivery of information about retailer activity at the front-end,
including timing of reconfigurations, changes in display position or the
discontinuance of a vendor's products, is important to vendors of front-end
products. Timely delivery of information about price changes, special
promotions, new product introductions and other vendor plans is important to
retailers. We believe that there is an increasing demand on the part of
front-end product vendors for more frequent and detailed information on sales
and other front-end activity.

Our in-store service segment and manufacturing segment also operate in the
in-store development industry which is comprised of suppliers who offer products
and services to retailers for the build-out of their store interiors and
suppliers of products and services related to the promotion and display of
merchandise that is offered to consumer products manufacturers.

Magazine Distribution

According to industry statistics, the newsstand magazine sales industry totals
approximately $4.4 billion in retail sales.

The distribution of magazines is generally described on the following levels:

Publishers: Publishers range from large, well-financed publishers of high volume
periodicals and books to independent publishers of low circulation specialty
titles.

National Distributors: National distributors represent publishers in
distributing their products nationwide to Local Distributors, who in turn
deliver the product to a wide variety of classes of trade, including major
retail chains, superstores, computer stores, specialty retailers and independent
retailers. National distributors do not physically handle product, but rather
direct and bill product to the local distributors on behalf of their publisher
clients.

Local Distributors: Local distributors, also referred to as "Wholesalers", take
physical delivery of publications, warehouse them, deliver them to retail
outlets, service magazine displays and initiate the returns process. They are
billed by National Distributors, and, in turn, invoice the retailer. There are
currently three types of Local Distributors, or Wholesalers, within the magazine
industry:

Primary Wholesalers: Primary wholesalers generally service the stores of
national and regional retail chains including transportation outlets,
supermarkets, convenience food stores, and drug stores. This class of
trade is also commonly referred to as Traditional Retailers. Although
there are currently only four major primary wholesaler companies, they
continue to operate from several hundred local distribution points.

Secondary Wholesalers: There are hundreds of secondary wholesalers in the
United States. Secondary wholesalers generally handle special interest
magazines, and distribute to smaller retail chains and independents.
Deyco is a national distributor who primarily represents publishers to
this group of wholesalers.

2

Specialty Distributors: This is the newest class of distributors; these
are the principal suppliers to the rapidly developing "Specialty Market",
which consists of bookstores, record stores and other niche oriented
classes of trade such as crafts and hardware. This segment has recently
developed into a significant component of newsstand sales within the last
five years. While Specialty Distributors are billed by national
distributors, invoice retailers, and warehouse product, they
fundamentally differ from the primary and secondary wholesalers in other
regards. Rather than delivering product via company owned trucks and
labor, they outsource the actual delivery of product to a third party
carrier. This enables these companies to supply retail locations
throughout, and even beyond, the United States from only a handful, as
opposed to hundreds, of locations. Specialty distributors also differ in
that because they do not actually deliver the product to their retail
customers with their own labor force, they lack the capability to
physically service the fixtures within their retailers' stores. This is
generally acceptable to these types of retailers as they are able to
adequately service the display fixtures with their own in-store labor.
IPD is an example of a Specialty Distributor.

Historically, Local Distributors were comprised of a geographically specific
series of local family-owned "monopolies". In 1995, the historical structure was
disrupted when the traditional major retailers began bidding out their magazine
business to a single distribution company nationwide. This resulted in the
consolidation to create what is currently recognized as the four Primary
Wholesalers. While Secondary Wholesalers have always existed, the Primary
Wholesalers' concentration and focus upon the major Traditional retail chains
have afforded these Secondary Wholesalers new opportunities with the smaller
retailer chains and independents. In many instances Secondary wholesalers are
solicited by some of the tens of thousands of smaller retailers whose
distribution from the Primary Wholesalers has been discontinued.

In contrast, much of the Specialty Market's emergence has occurred since 1995,
and because they were able to employ the Specialty Distributors as their
preferred alternative, they are the only retail class of trade to not have been
greatly affected by the Primary Wholesalers' consolidation.

This consolidation continues to affect all other distribution channels of the
publishing industry, limiting the business prospects for distributors that
cannot provide the geographic reach or level of service required by customers.
As a result, periodical wholesaling is being transformed from a low-cost,
low-risk, local or regional industry into an industry that is more capital
intensive, more reliant on technology and in many instances national in scope.

BUSINESS SEGMENTS

Our claims submission services for magazine retailers were established over 20
years ago. Our experience in providing these services is the foundation for our
other services. Set forth below are descriptions of our services and products in
each of our segments: in-store services (26.9% of our fiscal 2002 revenues)
manufacturing (7.5% of our fiscal 2002 revenues), and magazine distribution
(65.6% of our fiscal 2002 revenues). See Note 18 in our "Notes to Consolidated
Financial Statements" for certain financial information of each of our segments.

In-Store Services

Claim Submission Program. Through our information gathering capabilities, we
assist U.S. and Canadian retailers to accurately monitor, document, claim and
collect magazine publisher incentive and pocket rental payments. Incentive
payments consist of cash rebates offered to retailers by magazine publishers
equal to a percentage of magazine sales. Pocket rental payments are made by
magazine publishers for providing a specific pocket size and location on a
display fixture. Our claim submission program relieves our retailer customers of
the substantial administrative burden of documenting their claims and we believe
increases the amount of claims they collect.

The claim submission process begins at the end of each calendar quarter. Local
distributors detail the titles and number of copies sold by our retailer clients
during that quarter. Display fixture manufacturers and our retailer clients
provide us with information about magazine pocket placements. Based on this
information, we prepare claim forms and submit the documented claims to the
appropriate national distributor. After verification of the claim, the national
distributor, on behalf of the publisher, remits to us payment for the retailer.
We then record the payment and forward it to the retailer. We charge the
retailer a negotiated percentage of the amount collected.

Retailer customers who use our traditional claim submission program include
Fleming, Southland 7-Eleven and Walgreens.

3

Advance Pay Program. As an extension of our claim submission program, we have
established our Advance Pay Program for magazine sales. Under this program, we
advance to participating retailers a negotiated fixed percentage of the total
quarterly incentive payments and pocket rental fees otherwise due the retailer.
We generally make these payments within 90 days after the end of the quarter. We
then collect the payments for our own account. This service provides the
retailer with improved cash flow and relief from the burdensome administrative
task of processing a large number of small checks from publishers. Payments
collected from publishers under the Advance Pay Program as a percentage of all
incentive payments collected from publishers grew from 32.6% during fiscal 2000
to 47.4% during fiscal 2001 to 50.4% during fiscal 2002.

Our payments to the retailer precede our collections from the publisher. In
order to make these payments to retailers, we use funds generated from
operations and funds borrowed under our revolving credit facility. We generally
assume the risk of uncollectibility of the incentive and pocket rental payments.

Customers of our Advance Pay Program include A&P, Ahold USA, Food Lion, Kmart,
Target and W.H. Smith.

ICN, PIN and Store Level Data. In response to the business communications
opportunities presented by the internet, we have developed our ICN website. The
ICN website enables subscribing magazine publishers to access information
regarding pricing, new titles, discontinued titles and display fixture
configuration changes on a chain-by-chain basis. This information is important
to publishers because discontinuation and placement of their titles on the
display fixture can have a significant impact on sales. We believe that, prior
to ICN, publishers could not react as quickly to these changes. Publishers also
can use ICN to promote special incentives and advertise and display special
editions, new publications and upcoming covers, all of which can increase their
sales. We have an agreement with Barnes & Noble, Inc. to jointly offer their
store-by-store daily sales data to magazine publishers. We also have agreements
with AC Nielsen, the world's leading market research firm, and Efficient Market
Services ("EMS"), a privately held consumer-information company, to market and
sell store-level point-of-sale data. We believe the more timely, store-by-store
information has increased the attractiveness of our ICN website to publishers.

Retailers can use ICN to order new magazine titles and take advantage of
promotions by publishers. They also can download frequently changing price
information, including Uniform Product Codes, which change often because of
price changes and new title introductions.

The ICN website is configured so that publishers cannot access the strategically
sensitive information of other publishers and retailers. Retailers and
publishers can also exchange information and conduct transactions on the
Internet site without compromising their sensitive, proprietary information.

We market to magazine publishers our database of magazine-related industry
information (referred to as "PIN") that we gather through our claims submission
program. This information assists them in formulating their publishing and
distribution strategies. PIN subscribers have access to a historical database of
sales information for publications, as well as quarterly updates. PIN can
generate reports of total sales, sales by class of trade and sales by retailer.
Each report also provides other sales related information, including returns of
unsold magazines and total sales ranking. We believe that PIN is the most
extensive database available for single-copy retail magazine sales information.

Store Level Data provides publishers with daily insight into magazine sales
performance and information regarding their own titles' performance compared to
their competitors' sales performance on a daily, weekly or issue basis store by
store.

We receive annual fees, paid quarterly or monthly, from each publisher and
general merchandiser that subscribes to ICN, PIN or Store Level Data. For a fee,
publishers may advertise and run promotions and special programs on ICN. We have
approximately 150 retailer subscribers, including Ames Department Stores,
Eckerd, Kmart, Southland 7-Eleven, W.H. Smith and Wegman's Food Markets, and
approximately 20 publishers, including Comag, Murdoch Magazines, Time
Distribution Services and Times Mirror.

Front-End Management. We help retailers to increase sales and incentive payment
revenues by reconfiguring and designing front-end display fixtures, supervising
fixture installation, selecting products and negotiating, billing and collecting
incentive payments from vendors. We also help our retailer clients to develop
specialized marketing and promotional programs, which may include, for example,
special mainline or checkout displays and cross-promotions of magazines and
products of interest to the readers of these magazines.

4

Front-End and Point-of-Purchase Displays. We design, manufacture, deliver and
dispose of custom front-end and point-of-purchase displays for both retail store
chains and product manufacturers, including Kmart, Food Lion, Kroger, Target,
Home Depot and Hershey Food Corporation. For many of our retail store accounts,
we also invoice vendors for fixture costs and coordinate the collection of
payments on these invoices. We believe that manufacturing display fixtures
increases our access to information about sales of magazines and other products
from retail checkout areas, which enhances our ability to provide PIN and ICN.

Our manufacturing process typically begins when a retail store chain requests us
to design a display for its stores. We create a computer model of the display
based on the retailer's specifications, from which a prototype is created and
presented to the retailer for its examination. We then work together with the
retailer to finalize the design of the display and negotiate a price per
display. All of our front-end display fixtures are manufactured to customer
specifications.

We design, manufacture and powder-coat each pocket, shelf and other component of
a display unit separately and then assemble these components to create the
finished display. We believe that our component-oriented manufacturing process
enables us to produce our displays more quickly and efficiently and with a
higher standard of quality than if we used a unit-oriented process.

Materials used in manufacturing our fixtures include wire, metal tubing and
paneling. At our four manufacturing locations, we cut, shape, bend and weld
wire, tubing and metal paneling and powder coat and assemble the finished
product. We use a just-in-time inventory practice. This reduces our requirements
to carry inventories of raw materials, which in turn improves our cash flow.

Manufacturing

In September 1999, we acquired Huck, a major manufacturer and supplier of custom
wood displays and fixtures to national retailers. Also, in September, we
acquired Arrowood, another manufacturer of wooden display fixtures. These
acquisitions enable us to meet demands for customized wooden display fixtures
from our major retail customers. This strategic broadening of our base business
provides access to new markets, solidifies existing relationships, and further
strengthens our leading position as the front-end one-stop shop for retailers.

Current customers for wooden store fixtures include bookstore chains, discount
stores, department stores, convenience stores, pizza delivery stores and other
niche retailers. Our fixtures are primarily made from wood veneers or laminated
wood. Other raw materials used include paints and varnishes and hardware such as
hinges, drawer slides, aluminum and other metals to support and assemble the
wood product. Our production process includes cutting, machining, assembly and
finish. Virtually all product is shipped assembled ready to place in service at
a retailer's store.

All wooden store fixtures are custom made and as such we do not manufacture
product without a customer commitment for the product. Engineering and design
teams work closely with retailers to create product to meet specific
requirements. The process includes use of computer assisted drawings ("CAD") and
"photo rendering" that allow a retailer to see an image of the product from
various angles and make changes. Once the CAD drawing is finalized, a prototype
is typically manufactured for approval prior to large scale manufacturing.
Products we make for retailers are check out counters, service desks, fitting
rooms, customized room kits, bookshelves, magazine racks and other merchandise
display fixtures.

To meet seasonal demands for product, customers will typically provide
commitments well in advance of needing the product in its stores so that enough
product is available for shipment when needed. As such, our inventory levels
increase during seasonal periods when customers are not opening or remodeling
stores, typically November through April. Inventory levels decrease during
periods when the majority of store openings and remodelings occur, typically
July through October.

Magazine Distribution

On May 31, 2001, we acquired Interlink and its operating companies, including
IPD, a distributor of magazines to the Specialty Market, including bookstore
chains, record stores, computer stores and independent retailers, and Deyco, a
national distributor to the secondary wholesalers. This established our magazine
distribution segment.

5

Through our magazine distribution segment, we distribute approximately 5,000
titles for publishers and national distributors. IPD arranges for copies of each
issue to be shipped from the supplier to our seven geographically dispersed
distribution centers, at which point the magazine copies are repackaged for
shipment by third party carriers to approximately 7,000 retail outlets. In
contrast, Deyco arranges for shipments of magazines to be made directly by the
supplier to secondary magazine wholesalers located throughout the country.

Almost all magazines are distributed on a fully returnable basis. Within a
specified period, which could be as much as 180 days, after the publisher
specified off-sale date, the retailers and secondary distributors are entitled
to return to our magazine distribution segment all unsold copies for full credit
of the price payable by such customers. Periodically, we report to our suppliers
the amount of returns received and obtain full credit of the price we paid for
such copies.

Payment for delivered copies is made by our customers under a wide variety of
terms, which may include regular payments, net payment and delayed payment. We
endeavor to match the terms of payment received from our suppliers with the
terms of payment offered to our customers, and thereby reduce our working
capital requirements.

Deyco recognizes revenue from sales to wholesalers based on the on-sale date of
each periodical, net of provisions for estimated returns. IPD recognizes revenue
at the time of shipment to the retailer customer, net of estimated returns.
Retailer customers of IPD include Barnes & Noble, B. Dalton Booksellers,
Borders, Waldenbooks, Babbages, Hastings Book, Music & Video and Tower
Magazines/MTS, Inc.

MAJOR CUSTOMERS

For fiscal 2002, two customers accounted for approximately 43% of revenues.
Barnes & Noble accounted for approximately 26% and Borders accounted for
approximately 17%. For fiscal 2001, two customers accounted for approximately
29% of revenues. Borders accounted for approximately 15% of revenues and Kmart
accounted for approximately 14% of revenues. For fiscal 2000, two customers
accounted for approximately 26% of revenues. Winn Dixie accounted for
approximately 15% of revenues and Ahold USA accounted for approximately 11% of
revenues.

MARKETING AND SALES

We market our services and display fixtures through our own direct sales force.
Our sales group consists of three divisional vice presidents and 11 regional
managers. We have integrated our marketing efforts for our traditional
information and management services with our display fixture manufacturing. We
market our services primarily through direct contact with clients and
prospective clients. We also market our services at industry trade shows and
through trade publications.

Each of our managers is assigned to a specific geographic territory and is
responsible for the preparation of quotations, program presentations and the
general development of sales, as well as maintenance of existing accounts,
within his or her territory. Our regional managers maintain frequent contact
with our clients in order to provide them with a high level of service and react
quickly to their needs.

Our magazine distribution segment is engaged in a two-pronged marketing and
sales effort. The first prong targets publishers and national distributors from
whom we acquire magazines for distribution. Our publisher services department
maintains direct contact with publishers and national distributors to secure
additional titles and a greater copy allocation of titles currently distributed.
The second prong targets retailers and distribution agents with a direct sales
force dedicated to securing new outlets for sale of magazines distributed by the
Company. The primary means of locating new retail outlets and distribution
agents is direct sales presentation, although the Company frequently attends
trade shows and industry gatherings to promote its business and make contacts
with potential customers.

COMPETITION

We face significant competition for many of our services. For example, we have a
number of direct competitors for our claims submission program, all of which are
closely-held private companies. We also compete with approximately five other
manufacturers for front-end display fixture manufacturing business. There also
are a substantial number of competitors for our

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point-of-purchase fixture business, many of which are national in scope. Any of
these competitors could also compete for our front-end display fixture business.

In addition, some of our information and management services may be performed
directly by our retailer customers or by vendors, distributors or other
information service providers. Other organizations, including ACNielsen,
Information Resources and Audit Bureau of Circulations, also collect sales data
from retail stores. While none of these organizations currently compete with us,
any one of them could do so. If any of them were to compete with us, given their
experience in collecting information and their industry reputation, they could
be a formidable competitor.

The environment in our magazine distribution segment continues to evolve. Deyco
and IPD face competition from such organizations as Curtis Circulation Company
and Time Distribution Services, each of which are divisions of national
distributors targeting the secondary market. In addition, Deyco and IPD compete
with specialty distributors such as Retail Vision and Ingram. It is possible
that our magazine distribution segment, Deyco in particular, will face increased
competition from national distributors entering the secondary market.

Our competitors also may introduce services that are perceived by our clients to
be more attractive than those we provide. In addition, many of our current and
possible competitors have substantially greater financial resources than we do.

We believe that the principal competitive factors in the retail information
industry include access to information, technological support, accuracy, system
flexibility, financial stability, customer service and reputation. In addition
to financial stability, customer service and reputation, we believe that product
quality, timeliness of delivery and, to a lesser extent, price are competitive
factors in the display fixture manufacturing business. We believe we compete
effectively with respect to each of the above factors.

Competitive pressures may result in a decrease in the number of clients we serve
and a decrease in our revenues. Either of these could materially harm our
business, financial condition and future results.

INFORMATION SYSTEMS; INTELLECTUAL PROPERTY

Software used in connection with our claims submission program and in connection
with PIN and ICN was developed specifically for our use by a combination of
in-house software engineers and outside consultants. We believe that certain
elements of these software systems are proprietary to The Source. Other portions
of these systems are licensed from the third party, MJ Systems, that helped to
design the system. We also receive systems service and upgrades under the
license.

We have filed applications with the U.S. Patent Office for patent protection for
our ICN and PIN innovations. Certain aspects of our ICN and PIN innovations also
have copyright protection.

Software used in connection with our magazine distribution program was developed
specifically for our use by a combination of in-house software engineers and
outside consultants. We believe that certain elements of these software systems
are proprietary to The Source. Other portions of these systems are licensed from
the third party, Data Processing Services, that helped to design the system. We
also receive systems service and upgrades under the license.

EMPLOYEES

As of March 31, 2002, we employed approximately 1,200 persons. Of the employees
at our Brooklyn, New York facility, 108 are represented by Local 810 of the
Steel, Metal, Alloys and Hardware Fabricators of the International Brotherhood
of Teamsters under a collective bargaining agreement expiring on September 30,
2004. Of the employees at our Philadelphia, Pennsylvania facility, 70 are
represented by Local 837 of the Teamsters Union under a collective bargaining
agreement expiring on December 31, 2005. We consider our employee relations to
be satisfactory.

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ITEM 2. DESCRIPTION OF PROPERTY.

We conduct our business from over twenty manufacturing, data processing, office
and warehouse facilities.

In addition, we have warehouse facilities in Florida and New Jersey and small
offices in Pennsylvania, Ohio, Oklahoma, California, Washington, Arkansas,
Massachusetts, Wisconsin, Alberta and Ontario. We believe our facilities are
adequate for our current level of operations and that all of our facilities are
adequately insured.

ITEM 3. LEGAL PROCEEDINGS.

We are from time to time parties to various legal proceedings arising out of our
businesses. We believe that there are no proceedings pending or threatened
against us which, if determined adversely, would have a material adverse effect
on our business, financial condition, results of operations or liquidity.

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

(a) The Annual Meeting of the Shareholders of the Company was held on November
19, 2001. Of the 18,231,299 shares entitled to vote at such meeting, 14,857,334
shares were present at the meeting in person or by proxy.

(b) The proposal to amend the Company's Article of Incorporation to change the
name of the Company to Source Interlink Companies, Inc. was approved The number
of shares voted for, against and withheld were as follows:

Each of the management nominees for director was duly elected to serve an
additional term of three years. The number of shares voted for and withheld were
as follows:

8

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Our Common Stock is quoted on the Nasdaq National Market under the symbol
"SORC." The following table sets forth, for the periods indicated, the high and
low closing sale prices for the Common Stock as reported on the Nasdaq National
Market.

As of April 22, 2002, there were approximately 124 holders of record of the
Common Stock.

We have never paid dividends on our Common Stock. The Board of Directors
presently intends to retain all of its earnings, if any, for the development of
our business for the foreseeable future. The declaration and payment of cash
dividends in the future will be at the discretion of our Board of Directors and
will depend upon a number of factors, including among others, future earnings,
operations, capital requirements, the general financial condition of the Company
and such other factors that the Board of Directors may deem relevant. Currently,
the credit agreement with Bank of America, N.A., prohibits the payment of cash
dividends or other distributions on capital stock or payments in connection with
the purchase, redemption, retirement or acquisition of capital stock.

SALES OF UNREGISTERED SHARES

In May, 2001, we issued an aggregate of 980,025 shares of our common stock to
the former shareholders of Deyco Acquisition Corporation ("DAC") in exchange for
their shares of common stock of DAC. DAC, now Source Interlink Companies, Inc.,
is the parent corporation of IPD and Deyco. Each of the DAC shareholders
represented to us in writing that he or she as acquiring the shares for
investment and agreed that the shares could not be sold or otherwise transferred
unless they were first registered under the Act except in a transaction which is
exempt from the registration requirement. The certificates for the shares bear
appropriate restrictive legends and stop-transfer instructions with respect to
such shares have been given to our transfer agent. Based upon representations
made by each of the former DAC shareholders, we believe each was an accredited
investor as defined in Regulation D promulgated under the Act. We believe that
the issuance of these shares was exempt from the registration requirements of
the Act pursuant to Section 4(2) thereof and Regulation D.

In July, 2001, we issued warrants to Richard Cohen as consideration for
consulting services. The warrants are exercisable for 20,000 shares of our
common stock at an exercise price of $5.34 per share. The warrants vested in
February of 2002 and expire on January 31, 2003. Mr. Cohen represented to us in
writing that he was acquiring the warrant for investment, and, upon exercise,
would acquire shares of our common stock for investment and agreed that neither
the warrant nor the shares could be sold or otherwise transferred unless they
were first registered under the Act except in a transaction which is exempt from
the registration requirement. The warrant bears, and the certificate for shares
issued upon exercise of the warrant will bear, appropriate restrictive legends.
A stop-transfer instruction will be placed with our transfer agent for the
shares, should Mr. Cohen exercise the warrant. Based upon representations made
by Mr. Cohen, we believe that he is an accredited investor as defined in
Regulation D. We believe that the issuance of the warrant was, and the issuance
of shares upon exercise of the warrant will be, exempt from the registration
requirements of the Act pursuant to Section 4(2) thereof and Regulation D.

9

ITEM 6. SELECTED FINANCIAL DATA

For a discussion on acquisitions and impairment that affect comparability of
results, see Notes 5 and 8 in the "Notes to the Consolidated Financial
Statements."

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

OVERVIEW

On May 31, 2001 we acquired Interlink, which has various operating companies,
including IPD, a distributor of magazines to bookstore chains, record stores,
computer stores and independent retailers, and Deyco, a national distributor to
secondary wholesalers. Interlink represents a new business segment, magazine
distribution. The Company's segment reporting has been restructured based on the
reporting of senior management to the Chief Executive Officer. This
restructuring combines the Company's business units in a logical way that more
easily identifies business concentrations and synergies for both analysis of
results and real-time control by management. The reportable segments of the
Company are in-store services, manufacturing and magazine distribution.
Formerly, the segments were services, display rack and store fixture
manufacturing and magazine distribution.

10

Magazine Distribution. We derive our revenues from distributing magazines to
major bookstore chains, independent retailers and secondary wholesalers.
Magazine distribution revenue is recognized at the time of shipment to the
retailer, net of estimated returns. We recognize magazine distribution revenue
from sales made to wholesalers based on the on-sale date of each periodical, net
of provisions for estimated returns.

Cost of revenues for magazine distribution includes the price paid for magazines
sold plus costs associated with the shipping and handling of magazines sold.

In-Store Services. We derive our revenues from in-store services from (1)
providing information and management services relating to retail magazine sales
to U.S. and Canadian retailers, magazine publishers, confectioners and vendors
of gum and general merchandise sold at checkout counters and (2) designing,
manufacturing, shipping and salvaging display fixtures used by retailers at
checkout counters as well as at other points of purchase throughout their
stores.

In-store services include configuring, designing and manufacturing front-end
display fixtures, supervising installation, and billing and collecting incentive
payments from vendors for product placement. Revenues are recognized as fixtures
are shipped.

We also earn fees in connection with the collection of incentive payments under
our Traditional Claim Submission and Advance Pay Programs. Most incentive
payment programs offer the retailer a cash rebate, equal to a percentage of the
retailer's net sales of the publisher's titles, which is payable quarterly upon
submission of a properly documented claim. Under our Traditional Claim
Submission Program, we submit claims for incentive payments on behalf of the
retailer and receive a fee based on the amounts collected. Under the Advance Pay
Program, we advance participating retailers a negotiated fixed percentage of
total quarterly incentive payments and pocket rental fees and then collect the
payments from the publishers for our own account.

Under both the Traditional Claim Submission Program and the Advance Pay Program,
revenues are recognized at the time claims for incentive payments are
substantially completed for submission to the publishers. We believe our
allowance for doubtful accounts will be adequate to satisfy losses from
uncollectible accounts receivable. Under the Advance Pay Program, the revenues
we recognize represent the difference between the amount advanced to the
retailer customer and the amount claimed against the publisher.

Cost of revenues includes the cost of labor, materials and supplies directly
used in the provision of the in-store services as well as overhead costs which
include indirect material, indirect labor, and such items as depreciation,
taxes, insurance, heat and electricity.

Manufacturing. We derive our manufacturing revenues from designing,
manufacturing and installing primarily wooden store fixtures. We generally
recognize manufacturing revenues as products are shipped to customers. When we
receive payment prior to shipment, we record the amount as a liability and
recognize the amount as revenues when products are shipped.

Cost of goods sold includes the cost of labor, materials and supplies directly
used in the completion of store fixtures as well as manufacturing overhead costs
which include indirect material, indirect labor, and such items as depreciation,
taxes, insurance, heat and electricity incurred in the manufacturing process.

See Note 18 in the "Notes to Consolidated Financial Statements" for certain
financial information on our three business segments.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent
liabilities. On an ongoing basis, management evaluates its estimates, including
those that relate to magazine sales returns, magazine purchase returns, bad
debts, intangible assets, income tax contingencies, accruals and litigation.
Management bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other

11

sources. Actual results may differ from these estimates under different
assumptions and conditions. If actual results significantly differ from
management's estimates, the Company's financial condition and results of
operations could be materially impacted.

The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements. The Company records a reduction in revenue for estimated
magazine sales returns and a reduction in cost of sales for estimated magazine
purchase returns. These estimates are based on historical sales returns,
historical purchase returns and other known factors. If the historical data the
Company uses to calculate these estimates does not properly reflect future
returns, revenue and/or cost of sales may be misstated.

The Company provides for potential uncollectible accounts receivable based on
customer specific information and historical collection experience. If market
conditions decline, actual collection experience may not meet expectations and
may result in increased bad debt expenses.

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

In assessing the recoverability of the Company's goodwill and other intangible
assets, the Company must make estimates of expected future cash flows and other
factors to determine the fair value of the respective assets. If these estimates
and their related assumptions change in the future, the Company may be required
to record impairment charges. The Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets, on
February 1, 2002 and will be required to analyze its goodwill for impairment on
an annual basis. The Company does not expect to record any impairment charges as
a result of the adoption of this statement.

Deyco's costs of sales represents 8.7% of our total cost of sales and 12.3% of
our magazine distribution segment's cost of sales. Due to the complexities of
the many combinations and permutations of thousands of magazines and hundreds of
customers and publishers as well as the fact that payment for issues sold can
take up to a year and in some cases more to be finally settled, management
accrues a cost of sales for Deyco based on estimates derived from historical
analysis of product cost as a percent of sales. The basis of this estimate is
reviewed and updated on a regular basis. The cost accrual for each month's
billing is kept segregated in the general ledger and as payments are made, they
are charged to the same account. In this way management can track over time the
amount actually paid in settlement for a particular month's sales and
continuously hone the estimate. If the historical data the Company uses to
calculate these estimates does not properly reflect actual cost of sales, cost
of sales for Deyco may be misstated.

RESULTS OF OPERATIONS

The following table sets forth, for the periods presented, information relating
to our operations expressed as a percentage of Total Revenues:

12

FISCAL 2002 COMPARED TO FISCAL 2001

Revenues

Magazine Distribution. On May 31, 2001, we acquired Interlink. Interlink's
results of operations have been included in our consolidated financial
statements since the date of acquisition. Magazine distribution accounted for
approximately 65.6% of our revenues for the year ended January 31, 2002. There
were no magazine distribution revenues in the year ended January 31, 2001.

In-Store Services. In-store services accounted for approximately 26.9% (78.1%
excluding revenues from our newly acquired magazine distribution companies) and
73.3% of our revenues for the years ended January 31, 2002 and 2001,
respectively. In-store services revenues of $63.9 million decreased only $3.3
million compared to the year ended January 31, 2001 despite the inclusion in the
prior year of approximately $4.0 million of non-recurring revenue from the sale
of software associated with our information products.

Manufacturing. Manufacturing accounted for approximately 7.5% (21.9% excluding
revenues from our newly acquired magazine distribution companies) and 26.7% of
our revenues for the year ended January 31, 2002 and 2001, respectively.
Revenues of $18.0 million in the year ended January 31, 2002 decreased $6.5
million compared to the year ended January 31, 2001 due to reduced volume in
store fixture manufacturing caused by a major customer decreasing its new store
openings compared to last year. Sales to this major customer decreased
approximately $5.8 million compared to the prior year. Significant efforts were
made to establish relationships with new customers to replace this business. One
new customer accounted for over $2.0 million in revenues.

Gross Profit

Magazine Distribution. Gross profit was $20.1 million with a gross margin of
12.9%. We did not distribute magazines during the year ended January 31, 2001.

In-Store Services. Gross profit decreased approximately $2.0 million for the
year ended January 31, 2002 compared to the prior year despite approximately
$4.0 million of non-recurring revenue in the prior year. An insignificant amount
of costs were associated with such non-recurring revenue, thus the gross margin
decreased only slightly from 39.2% to 38.0%. Excluding the non-recurring
revenue, the gross margin was approximately 33.1% for the year ended January 31,
2001. The dramatic improvement was partially due to the fixed cost components of
the cost of revenue which do not increase with increased volume. More
importantly, however, was that we were able to produce more volume with
approximately the same amount of labor dollars. We attribute this to the efforts
of our employees and to the management of our production facilities. Further, we
believe that an indiscrete portion of our gross margin is related to our
ability, which is enhanced by our information products, to attract and retain
good customers.

Manufacturing. Gross profit decreased $3.8 million compared to the year ended
January 31, 2001. The gross margin also decreased from 22.8% to 10.1% partly
because of the decrease in volume. The margins on production for new customers
tend to be low due to start-up costs such as prototype production. Additionally,
some of the new business involved numerous short production runs as well as
services beyond those traditionally provided.

Selling, General & Administrative Expense ("SG&A")

Magazine Distribution. SG&A expenses were $19.9 million or 12.8% of revenues. We
did not distribute magazines during the year ended January 31, 2001.

In-Store Services. SG&A expenses decreased from $15.6 million to $12.9 million
($10.4 million after allocation of costs to the magazine distribution segment)
primarily as a result of write-offs of receivables being approximately $2.0
million higher last year. Excluding the write-offs of receivables, SG&A as a
percentage of revenue decreased slightly from 17.1% to 16.9%.

Manufacturing. SG&A expenses increased approximately $200,000 over the prior
year. Approximately $150,000 of this increase resulted from an increase in
administrative salaries which included the addition of three employees.

13

Goodwill Impairment. Following are the events and/or changes in circumstances
that indicated that the recoverability of the carrying amount of our goodwill
should be assessed:

A valuation analysis was commissioned in preparation for adopting SFAS 142
effective February 1, 2002. The initial phases of this analysis revealed
that we had experienced significant decreases in the market value of our
subsidiaries, Interlink and Huck. Early adoption of SFAS 142 is prohibited,
however, it did serve to alert us that we have experienced a significant
decrease in the market value of our assets.

Our manufacturing segment, Huck, experienced a substantial scale back in
sales to its most significant customer resulting in a net operating loss
for the segment.

The accumulation of costs to acquire Interlink were significantly in excess
of the amounts originally expected. This was because the net liabilities
acquired far exceeded the amount originally projected. Management does not
believe that it was practicable to determine the magnitude of this excess
during due diligence. The Company is seeking recourse from the sellers of
Interlink.

Interlink experienced a significant cash flow loss and has had a history of
operating and cash flow losses.

According to SFAS 121 estimates of future cash flows shall be the best estimate
based on reasonable and supportable assumptions and projections. The weight
given to the evidence in support of the estimated cash flows should be
commensurate with the extent of which the evidence can be verified objectively.

Management's reasonable and supportable estimates of expected future cash flows
from Interlink and Huck, weighted commensurately with the extent of which the
evidence for such estimates can be verified objectively, for the purpose of
complying with SFAS 121, are less than the carrying amount of the goodwill.

Accordingly, we reduced the carrying value of the goodwill for Interlink and
Huck to fair value. Our estimate of fair value was determined by independent
appraisal using customary valuation methodologies (including discounted cash
flow and fundamental analysis). The valuation concluded that the fair values of
these segments were less than the carrying amount of the assets associated with
these segments by approximately $78.1 million.

The following table shows, by segment, the original goodwill net of accumulated
amortization, the impairment charge and the resulting goodwill at January 31,
2002 (in thousands):

Interest Expense. Interest expense for the year ended January 31, 2002 increased
$1.2 million compared to the year ended January 31, 2001 principally due to the
borrowings by the newly acquired magazine distribution companies. A significant
portion of such borrowings were used to acquire the magazine distribution
companies.

Other Income (Expense). Other expense resulting from a loss on the sale of a
security of $3.5 million and an unrealized loss on an interest rate swap
agreement of $0.7 million was offset by other income of $2.0 million resulting
from life insurance proceeds.

Income Tax Expense. The effective income tax rates for fiscal years 2002 and
2001 were 1.4% and 39.3%, respectively. The effective income tax rate for the
year ended January 31, 2002 varied significantly from the federal statutory rate
due to the non-taxable life insurance proceeds received during the period and
due to the portion of the asset impairment charge which is not deductible for
income tax purposes. The rate for the year ended January 31, 2001 varied from
the federal statutory rate

14

due to state income taxes and expenses not deductible for income tax purposes.
These non-deductible expenses include goodwill amortization, meals and
entertainment and officers' life insurance premiums.

FISCAL 2001 COMPARED TO FISCAL 2000

Revenues

In-Store Services. In-store services accounted for approximately 73.3% and 88.4%
of our revenues for the years ended January 31, 2001 and 2000, respectively.
In-store revenue of $67.2 million decreased $5.7 million compared to the year
ended January 31, 2000. Although we had approximately $4.0 million of
non-recurring revenue from the sale of software associated with our information
products, we experienced an overall decrease in sales of $9.7 million primarily
related to volume, and to a small degree, pricing. Volume was impacted by
customer postponements. Although we enjoy a significant market share which we
believe in excess of 60%, we have experienced a limited degree of pricing
pressure.

Manufacturing. In September 1999, we acquired Huck and Arrowood. Results of
operations for these companies have been included in our consolidated financial
statements since their respective dates of acquisition. Manufacturing accounted
for approximately 26.7% and 11.6% of our revenues for the years ended January
31, 2001 and 2000, respectively.

Gross Profit

In-Store Services. Gross profit decreased to $26.3 million in fiscal 2001 from
$31.3 million in fiscal 2000, a decrease of approximately of approximately $5.0
million. Included in the gross margin of fiscal 2001 is approximately $4.0
million of non-recurring revenue that had an insignificant amount of costs
associated with it. Excluding that non-recurring revenue, the gross margin
decreased from 42.8% to 39.2%, primarily as a result of lower volume and pricing
pressure experienced during the third and fourth quarters of fiscal 2001.

Manufacturing. In September 1999, we acquired Huck and Arrowood. Results of
operations for these companies have been included in our consolidated financial
statements since their respective dates of acquisition. The gross profit
increased from $2.4 million to $5.6 million.

Selling, General and Administrative Expense)

In-Store Services. SG&A expense increased $4.2 million from $11.4 million in
fiscal 2000. The majority of the increase is due to a charge of $4.1 million to
write-off accounts receivable. Excluding the charge, SG&A as a percentage of
revenues increased slightly from 15.6% in fiscal 2000 to 17.1% in fiscal 2001.

Manufacturing. SG&A expense increased $0.7 million. The increase was merely the
result of the inclusion of Huck's operating results for a full year in fiscal
2001 versus four months in fiscal 2000.

Interest Expense. Interest expense for fiscal 2001 increased $1.3 million
compared to fiscal 2000 principally due to the increase in the average balance
outstanding on our credit facility from approximately $9.6 million during the
year ended January 31, 2000 to $26.8 million for the year ended January 31,
2001.

Income Tax Expense. The effective income tax rates for fiscal years 2001 and
2000 were 39.3% and 42.8%, respectively. These rates varied from the federal
statutory rate due to state income taxes and expenses not deductible for income
tax purposes. These non-deductible expenses include goodwill amortization, meals
and entertainment and officers' life insurance premiums.

LIQUIDITY AND CAPITAL RESOURCES

Our primary cash requirements for the in-store services segment are for funding
the Advance Pay Program, for purchasing materials and the cost of labor incurred
in the provision of the in-store services. Our primary cash requirements for the
manufacturing segment are for purchasing materials and the cost of labor
incurred in the manufacturing process. Our primary cash requirements for the
magazine distribution segment are for the cost of the periodicals and for
meeting general working capital requirements. Historically, we have financed our
business activities through cash flows from operations, borrowings under
available lines of credit and through the issuance of equity securities.

15

During fiscal 2002, 2001 and 2000, we advanced approximately $81.5 million,
$84.8 million and $68.9 million, respectively, under the Advance Pay Program.
Generally, the primary source of funding the advances is our credit facility,
which is discussed below. During fiscal 2002, the Program was funded by
borrowings under the revolving credit facility and cash flows from operations.
Collections under the Advance Pay Program are used to pay down any outstanding
balance under the credit facility. Thus, the credit facility is primarily used
to manage the timing of payments and collections under the Advance Pay Program.
Growth of the Advance Pay Program will be monitored and controlled to ensure
that funding will be available either through cash provided by operations or
borrowings under our credit facility.

Net cash provided by operating activities of $14.4 million for fiscal 2002 was
primarily from the increase in accounts payable and accrued expenses and the non
cash items of depreciation and amortization, the loss on sale of the marketable
security and the asset impairment charge offset by the net loss and the increase
in accounts receivable. Net cash provided by operating activities of $8.7
million for fiscal 2001 was primarily from net income, non cash items of
depreciation and amortization and the decrease in inventories offset by the
decrease in accounts payable and accrued expenses and the increase in other
assets. Net cash used by operating activities of $16.4 million for fiscal 2000
was primarily from the increase in accounts receivable, increase in other assets
and decrease in accounts payable and accrued expenses offset by net income and
non cash items of depreciation and amortization. The average collection period
for 2002 was approximately 168 days, 129 days and 42 days for the in-store
services segment, the manufacturing segment and the magazine distribution
segment, respectively (all considered to be within an acceptable range by
management based on the nature of our business and historical experience).

Net cash used in investing activities was $13.7 million, $8.8 million and $42.1
million in fiscal year 2002, 2001 and 2000, respectively. The cash used in
fiscal year 2002 was primarily for the acquisition of the magazine distribution
companies. Net cash provided by financing activities was $1.2 million in fiscal
2002 compared to net cash used in financing activities of $0.5 million in fiscal
2001 and net cash provided by financing activities of $ $59.4 million in fiscal
2000.

At January 31, 2002, we anticipate capital expenditures during fiscal 2003 of
approximately $2.5 million of which approximately $1.5 million is allocated to
company-wide upgrades and maintenance of computers, software, and telecom
equipment and approximately $1.0 million is allocated to manufacturing plant
equipment upgrades and maintenance.

During fiscal 2003, we are undertaking the first phase of a consolidation of
company-wide administrative offices to new worldwide headquarters in Bonita
Springs, Florida. At January 31, 2002, we anticipate additional capital
expenditures relating to the move of approximately $1.8 million allocated to
furniture, leasehold improvements, computer equipment, and telecom equipment at
the new headquarters.

At January 31, 2002, our total long-term debt obligations were approximately
$57.7 million. In December 1999, we entered into an unsecured credit agreement
with Bank of America, N.A. which provides for a $46.0 million revolving credit
facility. The revolving credit facility bears interest at a rate equal to the
London Interbank Offered Rate ("LIBOR") plus a percentage ranging from 1.0% to
2.1% depending on our ratio of funded debt to earnings before interest, taxes,
depreciation and amortization (2.1% at January 31, 2002) and carries a facility
fee of 1/4 % per annum on the difference between $25 million and the average
principal amount outstanding under the loan (if less than $25 million) plus 3/8%
per annum of the difference between the maximum amount of the loan and the
greater of (i) $25 million or (ii) the average principal amount outstanding
under this loan. The availability at January 31, 2002 on the revolving credit
facility was approximately $9.9 million.

Under the Credit Agreement, we are subject to various financial and operating
covenants. These include (i) requirements that we satisfy various financial
ratios and (ii) limitations on the payment of cash dividends or other
distributions on capital stock or payments in connection with the purchase,
redemption, retirement or acquisition of capital stock.

Under the credit agreement, we are required to maintain certain financial
ratios. We were in compliance with all such ratios at January 31, 2002 other
than ratios driven by earnings before interest, taxes, depreciation and
amortization ("EBITDA"). We incurred a $3.5 million charge to EBITDA from the
loss on the sale of a security we acquired in July 2000 (the prior fiscal year).
While Bank of America did not raise the issue, we were unable to obtain
confirmation from Bank of America certifying for our auditors that the loss on
the sale of a security totaling $3.5 million is an allowable addition to net
income in the calculation of EBITDA. We believe that this amount should be an
allowable addition since Bank of America approved the investment, in writing,
and the investment has been carried on the balance sheet at its market value
since July 2000. The market value at October 31, 2001 was $63,000, at which
point, such decline in the market value of the security had not affected net
income or EBITDA. However, the actual sale of the security in January 2002
resulted in a charge to EBITDA of $3.5 million.

The existing revolving credit facility terminates on December 31, 2002. We are
currently in the process of negotiating an extension with Bank of America
including modifications to the agreement that would clearly allow the add-back
of the loss on the sale of the security for purposes of calculating EBITDA. We
have received from Bank of America a proposed term sheet for discussion purposes
which indicates that we will be required to offer collateral and possibly accept
a rate increase due to the change in the banking climate since our original loan
was negotiated. In addition to negotiating an extension with Bank of America, we
are also examining opportunities with other banks, one of which has provided a
proposed term sheet, not a commitment, which is subject to the completion of due
diligence with results satisfactory to the bank.

16

In connection with the acquisition of MYCO, Inc., we assumed MYCO's Industrial
Revenue Bonds ("IRB"). On January 30, 1995, the City of Rockford issued $4
million of its Industrial Project Revenue Bonds, Series 1995, and the proceeds
were deposited with the Amalgamated Bank of Chicago, as trustee. Bank of America
("the Bank") has issued an unsecured letter of credit for $4.1 million in
connection with the IRB with an initial expiration date of April 20, 2001. As
provided in the reimbursement agreement, the expiration date shall automatically
extend for successive additional periods of one calendar month until the
twentieth day of the thirteenth month following receipt of a notice of
non-extension from the Bank. To date, no such notice of non-extension has been
received and management does not expect such notice to be given by the Bank in
the foreseeable future. The bonds are secured by the trustee's indenture and the
$4.1 million letter of credit. The bonds bear interest at a variable weekly rate
(approximately 80% of the Treasury Rate) not to exceed 15% per annum. The bonds
mature on January 1, 2030. Fees related to the letter of credit are .75% per
annum of the outstanding bond principal plus accrued interest.

On February 22, 2001, IPD and Deyco (now our wholly-owned subsidiaries) entered
into a credit agreement with Congress Financial Corporation ("Congress"). The
credit agreement includes a $4,000,000 term loan to be repaid in 36 equal
monthly installments, as well as a revolving credit facility secured by IPD and
Deyco's accounts receivable, inventories, equipment and other intangibles.
Borrowings under the term loan portion of the credit facility bear interest at a
rate equal to 0.5% in excess of the prime rate. Borrowings under the revolving
credit portion of the facility bear interest at a rate equal to 0.25% in excess
of the prime rate. Under the credit agreement, IPD and Deyco are required to
maintain certain financial ratios. IPD and Deyco were not in compliance with all
such ratios at January 31, 2002, and received a waiver from Congress of its
right to enforce compliance. In addition, IPD, Deyco and Congress have entered
into an amendment to the credit facility that will have the effect of easing the
ability of IPD and Deyco to maintain the financial ratios.

Summarized below are our obligations and commitments to make future payments
under debt obligations and lease agreements based on obligations at January 31,
2002.

In June 1999, we purchased our facility in High Point, North Carolina for $1.8
million. We financed this purchase through available borrowings under our
revolving credit facility.

We believe that our cash flow from operations together with our revolving credit
facilities will be sufficient to fund our working capital needs and capital
expenditures for the foreseeable future.

NEW ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.

SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when

17

those assets were initially recognized. SFAS 142 requires the Company to
complete a transitional goodwill impairment test six months from the date of
adoption. The Company is also required to reassess the useful lives of other
intangible assets within the first interim quarter after adoption of SFAS 142.

The Company's previous business combinations were accounted for using the
purchase method. Amortization expense arising from goodwill that will no longer
be amortized under the provision of the new rules was approximately $5.4
million, $3.0 million and $2.7 million in fiscal year 2002, 2001 and 2000,
respectively. Other than the impact on amortization expense, the Company does
not expect the adoption of this statement will have a material impact on the
Company's financial position, results of operations or cash flows.

In October 2001, the Financial Accounting Standards Board issued SFAS 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144").
This statement addresses financial accounting and reporting for the impairment
and disposal of long-lived assets. This Statement supercedes FASB Statement 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of", and the accounting and reporting provisions of APB Opinion No.
30, "Reporting the Results of Operations - Reporting the Effect of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions", for the disposal of a segment of a business. The
provisions of SFAS 144 will be effective for fiscal years beginning after
December 15, 2001.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our primary market risks include fluctuations in interest rates and exchange
rate variability. Our debt relates primarily to credit facilities with Bank of
America, N.A. and IPD and Deyco's facility with Congress Financial Corporation.
The credit facility with Bank of America is a three-year credit agreement with
an outstanding principal balance of approximately $36.1 million as of January
31, 2002. Interest on the outstanding balance is charged based on a variable
interest rate related to LIBOR plus a margin specified in the credit agreement.
The credit facility with Congress includes a $4.0 million term loan to be repaid
in 36 equal monthly installments, as well as a revolving credit facility secured
by IPD and Deyco's accounts receivable, inventories, equipment and other
intangibles. The outstanding principal balance under the term loan at January
31, 2002 is approximately $2.8 million. The revolving credit facility had an
outstanding principal balance of approximately $11.1 million at January 31,
2002. Borrowings under the term loan portion of the credit facility bear
interest at a rate equal to 3.0% in excess of the adjusted eurodollar rate or
0.5% in excess of the prime rate. Borrowings under the revolving credit portion
of the facility bear interest at a rate equal to 2.5% in excess of the adjusted
eurodollar rate or 0.25% in excess of the prime rate. Interest on the
outstanding balances is subject to market risk in the form of fluctuations in
interest rates.

In order to better manage its exposure to interest rate risk, in February 2001
we entered into an interest rate swap agreement. The swap agreement, with a
notional amount of $15.0 million converts the floating interest rate on the Bank
of America credit facility to a fixed rate. At January 31, 2002 the fair value
of the swap is not material and is recorded in accrued expenses.

We also conduct operations in Canada. For the year ended January 31, 2002,
approximately 1.4% of our revenues were earned in Canada and collected in local
currency. In addition, we generally pay operating expenses in the corresponding
local currency and will be subject to increased risk for exchange rate
fluctuations between such local currency and the dollar. We do not conduct any
significant hedging activities.

18

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS.

The consolidated financial statements of the Company are included herein as a
separate section of this statement which begins on page F-1.

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

Not applicable.

19

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

The following table sets forth certain information concerning the directors and
executive officers of the Company:

The Board consists of seven members, each of whom serves in that capacity for a
three year term or until a successor has been elected and qualified, subject to
earlier resignation, removal or death. The number of directors comprising the
Board may be increased or decreased by resolution adopted by the affirmative
vote of a majority of the Board. Our Articles of Incorporation and By-Laws
provide for three classes of directorships serving staggered three year terms
such that one class of the directors is elected at each annual meeting of
stockholders. The terms of Messrs. Katzman, Minix and Gillis will continue until
the 2002 annual meeting of stockholders, the terms of Messrs. Franc and Teasdale
will continue until the 2003 annual meeting of stockholders and the terms of
Messrs. Aders and Flegel will continue until the 2004 annual meeting of
stockholders.

Each of the executive officers is a full-time employee of The Source.
Non-employee directors of The Source devote such time to the affairs of The
Source as is necessary and appropriate. Set forth below are descriptions of the
backgrounds of the executive officers and directors of The Source:

S. Leslie Flegel has been the Chairman of the Board of Directors and Chief
Executive Officer of The Source since its inception in March 1995. For more than
14 years prior thereto, Mr. Flegel was the principal owner and Chief Executive
Officer of Display Information Systems Company ("DISC"), a predecessor of The
Source. S. Leslie Flegel is the father of Jason S. Flegel, The Source's
Executive Vice President, Information Services. Mr. Flegel is a director of
eRoomSystem Technologies, Inc.

James R. Gillis became President of The Source in December 1998, was appointed
as a director of The Source in March 2000 and became President and Chief
Operating Officer in August 2000. Prior thereto, he served as the President and
Chief Executive Officer of Brand Manufacturing Corporation.

20

W. Brian Rodgers has served as Secretary and Chief Financial Officer since
October 1996. Prior to joining The Source, Mr. Rodgers practiced for seven years
as a Certified Public Accountant with BDO Seidman, LLP.

Jason S. Flegel has served as Executive Vice President, Information Services
since June 1996. Prior thereto, and since the Company's inception in March 1995,
he served as Vice President-- Western Region. For more than two years prior
thereto, Mr. Flegel was an owner and the Chief Financial Officer of DISC. Jason
S. Flegel is the son of S. Leslie Flegel.

Monte Weiner has served as President and Chief Executive Officer - Source
Display since August 2000. Prior thereto, Mr. Weiner served as Executive Vice
President and Chief Executive Officer - Source Display from September 1999 until
May 2000. For more than 15 years prior thereto, Mr. Weiner served as President
of TCE Corporation and Secretary and Treasurer of Brand Manufacturing
Corporation.

Frank Bishop has served the Company since 1995, most recently as Senior Vice
President, Sales. Prior to joining the Company, Mr. Bishop served as the
Director of Sales & Marketing for Triangle News Co, a wholesale distributor of
books and magazines.

John D'Aloia joined the Company as Executive Vice President, Chief Marketing
Officer in February 2002. Prior to joining the Company, Mr. D'Aloia worked for
Hearst Distribution Corporation where he held the office of Executive Vice
President for Hearst Distribution Group since 1990, and simultaneously served as
Senior Vice President of COMAG Marketing Group. Prior to that, he worked for
Time Inc. Magazine Division of AOL Time Warner for 14 years where he held a
variety of positions including New York Regional Sales Director for People
Magazine.

Robert O. Aders was appointed as a director in March 1999. He is Chairman and
Chief Executive Officer of the Advisory Board, Inc. (an international consulting
organization) and a member of the Board of Directors of Food Marketing
Institute, where he served as President and CEO from its founding in 1976 until
his retirement in 1993. Mr. Aders was the Acting Secretary of Labor in the Ford
administration, is a former advisor to the White House Office of Emergency
Preparedness and has served on the U.S. Wage and Price Commission and as a Vice
Chairman of the National Business Council for Consumer Affairs. From 1970 to
1974, Mr. Aders was Chairman of the Board of the Kroger Company, where he served
in various executive positions beginning in 1957. Mr. Aders is also a member of
the Board of Directors of Coinstar, Inc., Spar Group, Inc. and Telepanel
Systems, Inc.

Harry L. "Terry" Franc, III, has been a director of The Source since it
commenced operations in May 1995. Mr. Franc is one of the founders of Bridge
Information Systems, Inc. ("BIS"), a global provider of information services to
the securities industry and of BIS's subsidiary, Bridge Trading Company ("BTC"),
a registered broker-dealer and member of the New York Stock Exchange. Mr. Franc
has been Executive Vice President of BTC for more than 20 years and for more
than 20 years prior to 1995, served as a director and an Executive Vice
President of BIS. Mr. Franc is a member of the National Organization of
Investment Professionals. He is a director of TV House, Inc. and of the St.
Louis Community Foundation.

Aron Katzman has served as a director of The Source since it commenced
operations in May 1995. Mr. Katzman was a founder of Medicine Shoppe
International, Inc. (Nasdaq) and served on its Board of Directors until it was
purchased by Cardinal Health (NYSE) in 1994. Until its sale in May 1994, Mr.
Katzman served as the Chairman and Chief Executive Officer of Roman Company, a
manufacturer and distributor of fashion custom jewelry. Mr. Katzman is a member
of the board of directors of Foto, Inc. Presently, Mr. Katzman is Chairman and
Chief Executive Officer of Decorating Den of Missouri.

Randall S. Minix has served as a director of The Source since it commenced
operations in May 1995. As of March 1, 2001, Mr. Minix became the Chief
Financial Officer of South Atlantic Lumber Industries in Greensboro, North
Carolina. For more than five years prior thereto, Mr. Minix had been the
managing partner of Minix, Morgan & Company, L.L.P., an independent accounting
firm headquartered in Greensboro, North Carolina.

Kenneth F. Teasdale was appointed as a director of The Source in March 2000. Mr.
Teasdale has been the Chairman of Armstrong Teasdale LLP, a law firm, since 1993
and before that was Managing Partner from 1986 to 1993. He has been associated
with Armstrong Teasdale since 1964. Prior thereto, Mr. Teasdale served as
General Counsel to the Democratic Policy Committee of the United States Senate
beginning in 1962. In that position, he also served for three years as Legal
Assistant to the Majority Leader of the United States Senate. Mr. Teasdale is
Chairman of the Board of Regents for St. Louis University, Member of the Board
of Trustees for the St. Louis Science Center, member of the Board of Directors
for the United Way of Greater St. Louis, member of the Board of Trustees for St.
Louis University and member of the Board of Trustees for the St. Louis Art
Museum.

21

COMMITTEES OF THE BOARD OF DIRECTORS

The Board has established an Audit Committee, a Compensation Committee, a
Finance Committee and an Acquisition Committee. The duties and members of each
of these committees are indicated below.

o The Audit Committee is comprised of three non-employee directors, presently
Messrs. Minix, Katzman and Franc. The audit committee assists the board in
fulfilling its financial oversight responsibilities by reviewing all audit
processes and fees, the financial information that will be provided to our
stockholders and our systems of internal controls. The audit committee
shares with the board the authority and responsibility to select, evaluate
and, where appropriate, replace the independent public accountants.

o The Compensation Committee is comprised of three non-employee directors,
presently Messrs. Aders, Katzman and Minix, and has been given the
responsibility of reviewing our financial records to determine overall
compensation and benefits for executive officers and to establish and
administer the policies which govern employee salaries and benefit plans.

o The Finance Committee is comprised of two directors, Messrs. Franc and
Katzman. The Finance Committee has been given the responsibility of
monitoring our capital structure, reviewing available alternatives to
satisfy our liquidity and capital requirements and recommending the firm or
firms which will provide investment banking and financial advisory services
to us.

o The Acquisition Committee is comprised of four directors, presently Messrs.
Katzman, Aders, Franc and Minix, and has been given the responsibility of
monitoring our search for attractive acquisition opportunities, consulting
with members of management to review plans and strategies for the
achievement of our external growth objectives and recommending the firm or
firms that will serve as advisors to us in connection with the evaluation of
potential business combinations.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to
the Company during its most recent fiscal year and Form 5 and amendments
thereto, or written representations that no Form 5 is required, all executive
officers and directors of the Company timely filed with the Securities and
Exchange Commission all reports required by Section 16(a) of the Securities
Exchange Act of 1934 except that Messrs. Teasdale, Weiner, Aders and Minix
failed to timely file a Form 4, Statement of Changes in Beneficial Ownership.
All such reports have since been filed.

22

ITEM 11. EXECUTIVE COMPENSATION.

The following table summarizes information concerning cash and non-cash
compensation paid to or accrued for the benefit of the named executive officers
for all services rendered in all capacities to the Company and its predecessors.

SUMMARY COMPENSATION TABLE

- --------
(1) In fiscal 2002, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $970, $0, $981 and $0, respectively. In
fiscal 2001, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $970, $0, $381 and $0, respectively. In
fiscal 2000, the estimated incremental cost to the Company of life
insurance premiums paid on behalf of Messrs. Flegel, Gillis, Weiner, J.
Flegel and Bishop was $5,450, $2,860, $0, $381 and $0, respectively.
(2) Includes $100,000 bonus accrued in fiscal year 2000, but paid in fiscal
year 2001, which was inadvertently not included in the proxy statement
dated September 22, 2000.

23

OPTIONS GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
- --------------------------------------------------------------------------------

(1) Options were granted February 6, 2001 and are exercisable as to 100,000
shares immediately, another 100,000 shares on February 6, 2002 and the final
100,000 shares on February 6, 2003.

(2) Options were granted July 12, 2001 and vest in three equal annual
installments.

(3) Options were granted February 6, 2001 and vest 33.33% immediately, 33.33% on
August 1, 2001 and the remainder on August 1, 2002.

(4) Options were granted July 12, 2001 and vest 33.33% immediately, 33.33% on
August 1, 2002 and the remainder on August 1, 2003.

(5) Options were granted December 6, 2001 and vest in three equal annual
installments.

AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
- --------------------------------------------------------------------------------

(1) "In-the-Money" options are options whose exercise price was less than the
market price of Common Stock at January 31, 2002.

24

DIRECTOR COMPENSATION.

Under the Company's present policy, each director of the Company who is
not also an employee receives $15,000 annually payable quarterly in either cash
or shares of Common Stock valued at 90% of market on the date of grant as of the
payment date. Directors also annually receive options to purchase 10,000 shares
of Common Stock at an exercise price equal to market on the date of grant.
Directors are also entitled to be reimbursed for expenses incurred by them in
attending meetings of the Board and its committees.

EMPLOYMENT AGREEMENTS WITH NAMED EXECUTIVE OFFICERS.

In February 2001, we entered into an employment agreement with S. Leslie Flegel,
which expires January 31, 2004. Under the agreement, Mr. Flegel serves as the
Chairman of the Board and Chief Executive Officer of The Source for an initial
annual base rate of compensation (the "Base Compensation") of $425,000. For the
fiscal years beginning February 1, 2002 and February 1, 2003, the Base
Compensation shall be increased to $500,000. Mr. Flegel will also be entitled to
receive a bonus ("Annual Bonus") each year of up to 100% of his Base
Compensation for such year if certain performance goals are met. The Company
granted to Mr. Flegel options to purchase an aggregate of 300,000 shares of our
common stock (the "Option") at an exercise price of $5.00. The options vest
100,000 immediately upon the granting of the options, another 100,000 shares on
February 6, 2002 and as to 100,000 shares on February 5, 2003. In the event the
employment of Mr. Flegel with The Source is terminated for reasons other than
for cause, permanent disability or death or there occurs a significant reduction
in the position, duties or responsibilities thereof (a "Termination") following
a "Hostile Change of Control" (as defined in the employment agreement), Mr.
Flegel will be entitled to a Severance Bonus equal to the sum of (i) the
aggregate of the Base Compensation that would be earned by Mr. Flegel had he
remained in The Source's employ from the date of such termination until January
31, 2004 (the "Remaining Term") and (ii) an amount equal to the aggregate Annual
Bonus Mr. Flegel would have earned for the Remaining Term if all criteria for
payment of the Annual Bonus were achieved at maximum levels for each of the
periods within the Remaining Term. Mr. Flegel also will agree to refrain from
disclosing information confidential to The Source or engaging, directly or
indirectly, in the rendering of services competitive with those offered by The
Source during the term of his employment and for one year thereafter, without
the prior written consent of The Source and will receive $250,000 in
consideration.

In August 2000, we entered into an employment agreement with James R. Gillis,
which expires July 31, 2003 (subject to renewal). The employment agreement
provides that Mr. Gillis serves as President of The Source and receives annual
base compensation of $350,000. In addition, Mr. Gillis is entitled to receive a
guaranteed bonus of $250,000 for each of fiscal 2001, 2002 and 2003, as long as
he is an employee of The Source at the agreed upon date of payment. Mr. Gillis
may also receive a discretionary bonus of $100,000 for each of fiscal 2001, 2002
and 2003 at the discretion of the Compensation Committee of the Board of
Directors. The Company will also grant Mr. Gillis options to purchase an
aggregate of 200,000 shares of our common stock at an exercise price of $7.84.
The options shall vest as to 66,667 shares immediately upon the granting of the
options, another 66,666 shares on August 1, 2001, and as to 66,666 shares on
August 1, 2002. In the event the employment of Mr. Gillis is terminated for
reasons other than cause, permanent disability or death, Mr. Gillis will be
entitled to receive the remainder of his base salary and benefits for the
balance of the term of the agreement. Mr. Gillis agreed to refrain from
disclosing information confidential to The Source during the term of the
employment agreement and agreed not to engage, directly or indirectly, in the
rendering of services competitive with those offered by The Source during the
term of his employment and for two years thereafter.

In August 2000, we entered into an employment agreement with Monte Weiner, which
expires July 31, 2003 (subject to renewal). The employment agreement provides
that Mr. Weiner serves as President/Chief Executive Officer of Source Display
and receives annual base compensation of $300,000. Also, as an inducement to
accept employment, Mr. Weiner received a signing bonus of $100,000 upon
execution of his employment agreement. In addition, Mr. Weiner is entitled to
receive a guaranteed bonus of $150,000 for each of fiscal 2001, 2002 and 2003,
as long as he is an employee of The Source at the agreed upon date of payment.
Mr. Weiner may also receive a discretionary bonus of $100,000 for each of fiscal
2001, 2002 and 2003 at the discretion of the Compensation Committee of the Board
of Directors. The Company will also grant Mr. Weiner options to purchase an
aggregate of 200,000 shares of our common stock at an exercise price of $7.84.
The options shall vest as to 66,666 shares immediately upon the granting of the
options, another 66,666 shares on August 1, 2001, and as to 66,667 shares on
August 1, 2002. In the event the employment of Mr. Weiner is terminated for
reasons other than cause, permanent disability or death, Mr. Weiner will be
entitled to receive the remainder of his base salary and benefits for the
balance of the term of the agreement. Mr. Weiner