SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K/A
 Amendment
No. 1





(Mark
One)


x
            Annual
      Report Under Section 13 or 15(d) of the Securities Exchange Act of
      1934




For the
fiscal year ended December 31, 2007




or




 ̈
            Transition
      Report Under Section 13 or 15(d) of the Securities Exchange Act of
      1934





COMMISSION
FILE NUMBER 000-27915





GENIUS
PRODUCTS, INC.


(Exact
name of registrant as specified in its charter)




DELAWARE
            33-0852923(State
      or Other Jurisdiction of
              Incorporation
      or Organization)
            (I.R.S.
      Employer
              Identification
      No.)3301
      EXPOSITION BLVD., SUITE 100,
              SANTA
      MONICA, CALIFORNIA
            90404(Address
      of principal executive offices)
            (Zip
      Code)





(310)
401-2200


(Registrant’s
telephone number, including area code)





Securities registered pursuant to
Section 12(b) of the Act:





None





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





COMMON
STOCK, PAR VALUE $0.0001


(Title
of Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o  No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes o  No x





Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No o





Indicate
by check mark if disclosure of delinquent filers pursuant 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-KSB or any amendment to
this Form 10-KSB. Yes o No x





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




Large
      accelerated filer   ̈
            
            Accelerated
      filer  x
            
            Non-accelerated
      filer  ̈





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes  ̈  No x





The
aggregate market value of voting stock held by non-affiliates of the registrant
was $146,169,528 as of June 30, 2007 (computed by reference to the average of
the bid and asked price of a share of the registrant’s common stock on that date
as reported by the Over the Counter Bulletin Board). For purposes of this
computation, it has been assumed that the shares beneficially held by directors
and officers of registrant were “held by affiliates”; this assumption is not to
be deemed to be an admission by such persons that they are affiliates of
registrant.





There
were 67,709,094 shares of the registrant’s common stock outstanding as of
February 29, 2008.







EXPLANATORY
NOTE
 
 During
meetings held on October 8, 2008 and November 13, 2008, the Audit Committee of
the Board of Directors of Genius Products, Inc. (the “Company”), acting on a
recommendation from the Company’s management, determined that it was necessary
to restate (i) the Company’s unaudited consolidated financial statements and
other financial information as of and for the three months ended September 30,
2006, March 31, June 30 and September 30, 2007 and March 31 and June 30, 2008,
and (ii) the audited consolidated financial statements and other financial
information of the Company and Genius Products, LLC (the “Distributor”) as of
December 31, 2006 and 2007 and for the periods then ended.
 
 The
aforementioned restatements relate to (i) an error in the application of
generally accepted accounting principles with respect to the recognition in the
Company’s financial statements of costs paid on its behalf by the Distributor
and (ii) an error in the application of generally accepted accounting principles
with respect to the accounting classification and measurement of certain
redemption rights of the holders of the Distributor’s Class W
Units.
 
 The
Company’s prior accounting methodology with respect to costs paid on its behalf
by the Distributor was based on the view that such costs should be recognized in
the Company’s financial statements to the extent of the Company’s economic
participation and ownership interest in the Distributor.  The Company
has now determined that it should recognize all such costs incurred on its
behalf by the Distributor in the Company’s financial
statements.
 
 The
Distributor’s prior accounting methodology with respect to the accounting
classification and measurement of the aforementioned redemption rights did not
properly classify and measure the Distributor’s Class W Units as redeemable
securities.  The Distributor will now recognize, as an asset, the fair
market value of such redemption rights in the Distributor’s financial
statements.  In addition, the Distributor has now recorded the
redeemable Class W Units outside of permanent equity in its financial
statements.  This accounting change in the Distributor’s financial
statements has also resulted in the need to restate the Company’s financial
statements to reflect a corresponding liability related to the aforementioned
redemption rights at the end of each of the aforementioned reporting
periods.
 
 The
impact of these restatements (i) as of and for the periods ended December 31,
2006 and December 31, 2007 and (ii) as of and for the three months ended
September 30, 2006 and March 31, June 30 and September 30, 2007, are further
discussed in Note 3 to the audited consolidated financial statements of the
Company and the Distributor included herein.
 
 This
amendment is being filed for the purpose of amending and restating Item 1 and 1A
of Part I and Item 6 and 7 of Part II and Item 15 of Part IV of the Company’s
Annual Report on Form 10-K originally filed with the Securities and Exchange
Commission on March 19, 2008, solely to the extent necessary (i) to reflect the
restatement of the Company’s audited consolidated financial statements as of and
for the periods ended December 31, 2007 and December 31, 2006, as described in
Note 3 to the audited consolidated financial statements of the Company and the
Distributor, (ii) to reflect the restatement of the Company’s unaudited
consolidated financial statements as of and for the three months ended September
30, 2006 and March 31, June 30 and September 30, 2007, (iii) to make revisions
to “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” as warranted by the restatements, (iv) to update the certifications
required by the Sarbanes-Oxley Act of 2002, and (v) to update the
exhibits.













TABLE OF CONTENTS




PagePART
      IITEM 1.
              DESCRIPTION OF BUSINESS
              1ITEM 1A.
              RISK FACTORS
              7ITEM 1B.
              UNRESOLVED STAFF COMMENTS
              10ITEM 2.
              PROPERTIES
              10ITEM 3.
              LEGAL PROCEEDINGS
              11ITEM 4.
              SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
              12PART
      IIITEM 5.
              MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
      MATTERS
              13ITEM 6.
              SELECTED FINANCIAL DATA
              16ITEM 7.
              MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
              18ITEM 7A.
              QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
              30ITEM 8.
              FINANCIAL STATEMENTS AND SUPPLEMENTARY
    DATA
              30ITEM 9.
              CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
      AND FINANCIAL DISCLOSURE
              30ITEM 9A.
              CONTROLS AND PROCEDURES
              31ITEM 9B.
              OTHER INFORMATION
              33PART
      IIIITEM 10.
              DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
      PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE
    ACT
              34ITEM 11.
              EXECUTIVE COMPENSATION
              38ITEM 12.
              SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
      MANAGEMENT AND RELATED STOCKHOLDER MATTERS
              49ITEM 13.
              CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
      DIRECTOR INDEPENDENCE
              51ITEM 14.
              PRINCIPAL ACCOUNTANTS FEES AND SERVICES
              53PART
      IVITEM 15.
              EXHIBITS, FINANCIAL STATEMENT SCHEDULES
              54EXHIBIT INDEX
              54





NOTICE ABOUT FORWARD-LOOKING
STATEMENTS




This
Annual Report on Form 10-K includes “forward-looking statements”. To the extent
that the information presented in this Annual Report discusses financial
projections, information or expectations about our business plans, results of
operations, products or markets, or otherwise makes statements about future
events, such statements are forward-looking.  Such forward-looking
statements can be identified by the use of words such as “intends”,
“anticipates”, “believes”, “estimates”, “projects”, “forecasts”, “expects”,
“plans” and “proposes”.





Although
we believe that the expectations reflected in these forward-looking statements
are based on reasonable assumptions, there are a number of risks and
uncertainties that could cause actual results to differ materially from such
forward-looking statements.  These include, among others, the
cautionary statements in the “Risk Factors” and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” sections of this
Annual Report.  These cautionary statements identify important factors
that could cause actual results to differ materially from those described in the
forward-looking statements.





When
considering forward-looking statements in this Annual Report, you should keep in
mind the cautionary statements in the “Risk Factors” and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
sections, and other sections of this Annual Report.  Except as
required by law, we do not intend to update our forward-looking statements,
whether written or oral, to reflect events or circumstances after the date of
this Annual Report.





PART
I




ITEM 1.    DESCRIPTION OF
BUSINESS





BUSINESS





Overview





Genius
Products, Inc. (the “Company” or “Management”), through our 30%-owned
subsidiary, Genius Products, LLC (the “Distributor”), is a leading independent
home entertainment products company that acquires, produces and licenses an
extensive library of motion pictures, television programming,
and  trend entertainment that is primarily sold on digital versatile
disks (“DVD”) and digitally.  The Distributor works in partnership
with major retailers to distribute widely recognized home entertainment brands
to a diversified customer base.  The remaining 70% of the Distributor
is owned by The Weinstein Company Holdings LLC (“TWC Holdings”) (which includes
a 1% percentage interest owned indirectly through its wholly-owned subsidiary,
W-G Holding Corp (“W-G Holding”)).  TWC Holdings is the parent company
of The Weinstein Company LLC (“TWC”), the largest provider of content for our
library.




Through the Distributor, for
which the Company serves as managing member, we produce and distribute a vast
and growing content library that encompasses approximately 3,550 feature films
and documentaries and 4,000hours of television
programming.  This library includes feature films and television
programming from critically acclaimed producers such as The Weinstein Company®,
for which the Distributor hasthe exclusive U.S. home video distribution
rights,and RHI
EntertainmentTM (Hallmark library).  Additional content, such
asindependent films, sports,
family, and lifestyle productions, come from partnerships with established consumer
brands:  IFC®,ESPN®, World Wrestling
Entertainment®,Classic Media,Sesame Workshop®, Discovery
KidsTM, Animal Planet and The Learning Channel (TLCTM).




The
Distributor has developed a fully integrated direct-to-retail distribution
platform that parallels the home entertainment divisions of the major Hollywood
studios.  This platform provides direct sales and marketing, inventory
management and state-of-the-art supply-chain services.  In
collaboration with leading replicators and third-party logistics and
supply-chain companies, we have rapidly scaled this network, which has helped
to facilitate our rapid
growth in revenues.




We
primarily sell to major national retailers including Wal-Mart, Blockbuster
Entertainment, Best Buy, Circuit City, Kmart, Target, Netflix, Costco, Sam’s
Club, Amazon, Barnes & Noble, Borders, Toys R Us and Columbia
House.  We co-produce programming with our branded content partners
and mitigate the impact of our production costs through minimum guarantees from
our revenue share partner, Blockbuster.  We believe that the strong
relationships we have developed with these well-known retailers and branded
content partners help promote and enhance consumer awareness of our
programs.




We
collaborate with our retail and content partners to create sales programs that
exploit their widely recognized brands and endorse related
content.  These sales programs focus on brands to provide the retailer
with solutions that simplify the retailer’s buying process, improve shelf-space
utilization, and help consumers quickly make informed purchase
decisions.  Our ability to deliver unique, innovative solutions that
improve the sales and rentals of our content has enabled us to compete
successfully and maintain strong relationships with our retail and content
partners.




Wecurrentlydistribute our libraryonDVDs,next-generationDVDs, andelectronicallyin a digital
format.We plan to continue to
expand the distribution of our theatrical and non-theatrical products through
the diverse and emerging digital distribution markets including: Video-on-Demand
(“VOD”) and Electronic Sell-Through (“EST”) on the Internet to companies such as
Amazon, Apple, MovieLink and Microsoft, Internet-based subscription VOD
customers (such as NetFlix) and direct-to-television peer-to-peer network
solutions.  Through our partnerships, we have released 128 theatrical
and non-theatrical titles since inception (including ninety titles released in
2007).  The Distributor distributes products to basic channels
distributed on cable, Direct Broadcast Satellite (“DBS”) and Internet Protocol
Television (“IPTV”), which delivers television programming to households via a
broadband connection using Internet protocols.  Further, we are
exploring kiosk-based distribution with retailers.




1


Industry
Overview





The
traditional and Internet markets for entertainment products such as DVDs and
compact discs (“CDs”) are highly competitive.  We face significant
competition with respect to the number of products currently available in the
marketplace and in securing distribution at retail outlets.  The costs
of entry into the retail and Internet markets for competitive products are low,
and there are no significant barriers to entry.





Established
companies who compete with the Distributor include major studios such as Buena
Vista (Disney), Fox (who distributes MGM and Lions Gate home entertainment
products), Paramount, Sony, Warner Bros. and Universal Studios, as well as
certain independent studios and suppliers, such as Image
Entertainment.  The Distributor’s portfolio of owned and distributed
content from The Weinstein Company®, ESPN®, World Wrestling Entertainment®,
Sesame Workshop®, Classic Media and others provides the Distributor with a high
volume of major studio quality, theatrically released feature films and
direct-to-video releases, which we believe provides the Distributor with a
strong competitive position in the marketplace.





Changes
in the distribution, sale and use of home entertainment products have created
significant business opportunities.  We believe these changes have
driven the demand for branded content, and that this demand will grow based on
several recent trends, including the following:




·
            We
      believe that owners of major consumer entertainment brands are
      increasingly recognizing the retail channel as a critical component of
      their sales growth strategy.  This is due in part to the large
      installed base of 95.3 million DVD set-top households in the U.S. as at
      year-end 2007 (according to Adams Research, Hollywood After Market January
      31, 2008 Newsletter, Vol. 14, No. 6) and the consolidation of
      retailers by national retail chains which offer exposure to a large
      population of consumers, as well as the emergence of new retailers who
      service their customer base through the
  Internet;




·
            We
      believe that national retail chains, including Wal-Mart, Best Buy and
      Target, have focused on branded content for their retail environment in
      order to improve the sales and profitability of their largest retail
      categories, including home
entertainment.




Home
entertainment is the largest sector of filmed entertainment.  In 2007
DVD units sold to consumers were 1.1 billion.  Consumer spending on
DVD purchases was $15.9 billion, a decline of 3.2% from 2006.  In
addition, consumer spending on rental transactions was $8.2 billion (2.5 billion
rental transactions, a decline of 2.2% from 2006).  Total home video
consumer spending in 2007 was $24.1 billion (all data according to Adams
Research,Hollywood After
Market January 31, 2008 Newsletter, Vol. 14, No. 6).




Management
believes that, with the end of the high definition format war, any lingering
doubts about the strong near-term future of home video will be
mitigated.  The impact should translate into reduced consumer
confusion and an increase in high definition demand.  The Distributor
plans to release titles on the Blu-Ray format in 2008.




Distribution/Supply
Chain




Direct-to-Retail
Distribution Platform




Through
the Distributor, we have relationships with and are a direct supplier to nearly
every major retailer or major wholesaler of entertainment-based
products.  These relationships provide more control over our
inventory, the ability to customize our distribution strategies for a large
number of retail locations and independence from third-party wholesalers.
Through the Distributor, we provide Vendor Managed Inventory (“VMI”) services
and contract with merchandisers to assist several of our most important retail
partners in merchandising and managing their inventory.  Through our
VMI system, we manage store level placement and replenishment of
shelves.  Our in-store displays effectively highlight and promote our
products and brands to the consumer.  We customize store-level
distribution and replenishment strategies based upon analysis of each product
relative to the retailer’s inventory plan, store traits, seasonal trends and
forecasted store traffic, as well as the buying patterns, habits and
demographics of consumers to whom the products are targeted.




2


Strong
Relationships with Key Retailers




Our
direct-to-retail distribution capabilities and independence from major film
studios enable us to work with our retail and content partners to develop
innovative programs.  We believe our retail-centric focus builds
deeper relationships and gives us the opportunity to connect major brands with
retailers and their customers, thereby increasing our level of business with our
partners.  We work with both our retail and content partners to
develop promotional plans, re-pricing strategies and volume forecasts for
catalog as well as recently released titles.  We utilize tools to
measure project effectiveness and customer feedback that enable us to develop
unique programs to improve the level of service for our partners.




Wide
Range of Diverse Retailers




Our
ability to reach a wide variety of retailers enables us to access a broad
spectrum of customer demographics through which we have attracted major brand
partners and thereby enabled us to develop a diversified portfolio of
content.  We currently distribute directly to a mixture of retailers,
including:




·
            Mass
      retail stores:  Wal-Mart, Target, Kmart, Costco and Sam’s
      Club


·
            Electronics
      stores:  Best Buy, Fry’s and Circuit
  City


·
            Bookstores:  Borders
      and Barnes & Noble


·
            Music
      retailers:  Trans World Entertainment and
  Virgin


·
            Emerging
      retailers:  Amazon.com, Netflix, iTunes, Microsoft and
      MovieLink


·
            Rental
      outlets:  Blockbuster, Hollywood Video and Movie
      Gallery


·
            Direct
      marketing companies:  QVC and Columbia
  House




We also
sell through key select wholesale distribution companies, including Ingram,
Alliance Entertainment Corp., Video Products Distributors, and Baker &
Taylor.




Content
Partnerships




Our
retail marketing and distribution expertise has attracted widely recognized
brand content partners from major competitors.  For example, we were
granted the exclusive home video distribution rights for ESPN®, which is owned
by The Walt Disney Company.  We utilize widely recognized consumer
branded content to improve customer recognition and purchase of our products,
encourage repeat purchases, and manage marketing costs (which are typically
lower for branded content than for comparable content not associated with a
brand).  Our content strategy is primarily driven by our focus on
retail partners’ requirements, which has led us to identify our four core
content categories, which we call “Content Verticals”:




·
            Theatrical/Independent
      Films (includes Independent Film Channel (IFC)® , RHI
      EntertainmentTM (Hallmark library), Tartan, The Weinstein
      Company®  and
WellspringTM)


·
            Sports
      (includes ESPN® and World Wrestling Entertainment®
  (“WWE”))


·
            Lifestyle
      (includes Animal Planet and The Learning Channel
  (TLCTM))


·
            Family/Faith
      (includes Classic Media, Discovery KidsTM, Entertainment Rights and Sesame
      Workshop®)





We
believe that the breadth of our content portfolio allows us to compete
effectively with the major studios in almost every major content
segment.




The
Distributor has released over 95 TWC theatrical titles on DVD, including the
following recent or forthcoming releases:




Released
Titles:


·
            Halloween, directed by
      Rob Zombie


·
            The Nanny Diaries,
      starring Scarlett Johansson and Laura
Linney


·
            Who’s Your Caddy?,directed by Don Michael Paul


·
            Sicko, directed by
      Michael Moore (Fahrenheit
      911)




3


·
            Planet Terror, directed
      by Robert Rodriguez and starring Josh
Brolin


·
            1408, based on a short
      story by Stephen King and starring John Cusack and Samuel L.
      Jackson




Upcoming
Titles:


·
            The Hunting Party, starring Richard Gere
      and Terrence Howard·
            Grace is Gone, starring
      John Cusack


·
            Awake, starring Hayden
      Christensen and Jessica Alba


·
            The Mist, starring
      Thomas James and Marcia Gay Hayden


·
            Control, starring Sam
      Riley and Samantha Morton


·
            Pete Seeger:  The
      Power of Song,documentary by Jim
Brown


·
            Dedication, starring
      Billy Crudup and Mandy Moore




The
following selection of content releases and upcoming releases with the
Distributor’s other major content partners demonstrates the breadth of the
Distributor’s expanding film library:




Released
      Titles:
              Partner·
              The Christmas Card,
      starring Ed Asner, John Newton and Alice Evans
              RHI
      EntertainmentTM·
              Avenging Angel,
      starring Kevin Sorbo and Cynthia Watros
              RHI
      EntertainmentTM·
              John Cena:  My
      Life
              WWE·
              Rey Mysterio:  The
      Biggest Little Man
              WWE·
              The Bronx is
      Burning
              ESPN®·
              Ultimate
      NASCAR
              ESPN®·
              Little
      People, Big World
              Discovery/TLCTM·
              Meerkat
      Manor
              Animal
      Planet·
              Flight
      27 Down
              Discovery
      KidsTM·
              Kenny
      the Shark
              Discovery
      KidsTM·
              Sesame
      Street:  Ready for School!
              Sesame
      Workshop®·
              Casper’s
      Scare School
              Classic
      MediaUpcoming
      Titles:·
              Ten Commandments,
      starring Ben Kingsley, Christian Slater, Alfred Molina and Elliott
      Gould
              Promenade
      Pictures·
              Tin Man, starring Zooey
      Deschanel, Alan Cumming, Neal McDonough and Richard
    Dreyfuss
              RHI
      EntertainmentTM·
              Hogfather, based on the
      novel by Terry Pratchett
              RHI
      EntertainmentTM·
              The Legacy of Stone Cold Steve
      Austin
              WWE®·
              The Rock:  The Most
      Electrifying Man in Sports Entertainment
              WWE®·
              Sesame
      Street:  Dinosaurs
              Sesame
      Workshop®·
              Elmo’s
      Christmas Countdown
              Sesame
      Workshop®·
              Jeff
      Corwin Experience
              Animal
      Planet·
              Gorillas
      on the Brink
              Animal
      Planet·
              LA
      Ink
              TLCTM·
              Trading
      Spaces:  The Specials
              TLCTM·
              Turok:  Son of
      Stone
              Classic
      Media·
              Pat
      the Bunny Playdates
              Classic
      Media




Proven
Management Team




Our
management team is comprised of seasoned home entertainment industry executives,
some of whom have been involved in the home entertainment distribution industry
with major Hollywood studios from its inception.  Additionally, our
senior financial professionals have sophisticated media investment banking
experience in capital markets transactions, content acquisitions and production
financing.  We have attracted experienced personnel in home
entertainment, acquisition, sales, marketing, distribution and
finance.




4


Vision
and Execution




A key
driver of our business strategy is to exploit our extensive relationships with
retailers and branded content providers to increase our share of the home video
market and other entertainment products.  Our growth strategy centers
on capitalizing from our direct-to-retail distribution platform to (i) increase
business with existing and new content partners, (ii) engage in profitable
production and licensing of new content, (iii) continue to expand into new
markets and complementary businesses including digital distribution, interactive
software (video games) and (iv) license our partners’ proprietary brands and
content.  To achieve these goals, we intend to:




Further
Penetrate Existing Retail and Content Partner Relationships




Our
retail and content partner relationships and broad distribution and marketing
capabilities offer multiple opportunities to increase business with our existing
retail and content partners.  We actively pursue these opportunities
through increasing the number of co-productions with our content partners,
extending a successful project to other divisions of our retail partners, and
fostering relationships built in one part of our retail partners’ organizations
to win business opportunities in other divisions.




Co-Produce
Content with Brand Partners




Some of
our key distribution agreements, including those with ESPN®, WWE®, Sesame
Street®,
Classic Media and RHI EntertainmentTM, provide the
opportunity to co-produce content in which we will own either a portion of or
the entire copyright, earn a distribution fee and/or share in the profits of
such content.  We anticipate that we will increase the number of
co-productions to improve gross margins and expand our owned-content
library.




Pursue
Strategic Alternatives to Take Advantage of Fixed-Cost
Infrastructure




We have
built a fully integrated distribution and marketing infrastructure to deliver
superior service to our retail and content partners.  We now plan to
take advantage of our distribution and marketing infrastructure, as well as the
expertise of our third-party supply-chain partners, to expand our home
entertainment distribution business into: (i) other geographical markets such as
Canada; (ii) the interactive software/video game distribution business, which is
complementary to our existing supply-chain, retail and content partnerships; and
(iii) licensing and marketing services for our branded content partners and
retail customers.  While our focus is on internal growth, we may
selectively pursue acquisitions that accomplish a previously identified
strategic goal where acquiring that capability is more cost-effective than
building it internally.  As an example, in April 2007, we acquired
Castalian Music (as defined in Item 7), a direct response music and video
company, from EMI.  The acquisition of Castalian Music enables us to
provide our content partners an additional consumer channel.




The
Weinstein Company Transaction





On July
21, 2006 (the “Closing Date”), the Company completed a transaction (the “TWC
Transaction”) with TWC Holdings and W-G Holding (two subsidiaries of TWC)
pursuant to which we launched the Distributor to exploit the exclusive U.S. home
video distribution rights to feature film and direct-to-video releases owned or
controlled by TWC.  On the Closing Date, the Company contributed
substantially all of its assets (except for $1 million in cash and certain
liabilities), its employees, and its existing businesses to the
Distributor.
  Thus, the
Distributor is owned 70% by TWC Holdings and W-G Holding and 30% by the
Company.  The 70% interest in the Distributor held by TWC Holdings and
W-G Holding consists of Class W Units and is redeemable, at TWC Holdings’ and
W-G Holding’s option commencing at any time from July 21, 2007  for up
to 70% of the Company’s outstanding common stock, or with TWC Holdings’ and W-G
Holding’s approval, cash.   The redemption value of the Class W
Units may not be less than $60.0 million.   The Company’s 30%
membership interest in the Distributor consists of the Distributor’s Class G
Units.
  In
addition, the Company issued an aggregate of 100 shares of its Series W
Preferred Stock to TWC Holdings and W-G Holding in connection with the TWC
Transaction.  The Series W Preferred Stock provides the holders
thereof with (i) the right to elect five of the seven directors on our
Board of Directors, of which two are currently TWC Holdings executives,
(ii) majority voting power over other actions requiring approval of our
stockholders, and (iii) the right to approve certain specified
actions.  The Series W Preferred Stock has no rights to receive
dividends and minimal liquidation value.




5




On the
Closing Date, the Company also entered into a Registration Rights Agreement with
TWC Holdings and W-G Holding pursuant to which the Company agreed to register
for resale the shares of the Company’s common stock issuable upon redemption of
Class W Units in the Distributor currently held by them.  The Company
and/or the Distributor entered into the following agreements on the Closing
Date: (i) an Amended and Restated Limited Liability Company Agreement for the
Distributor, (ii) a Video Distribution Agreement between the Distributor and TWC
(the “TWC Distribution Agreement”), (iii) a Services Agreement between the
Company and the Distributor and (iv) an Assignment and Assumption
Agreement.
  From
December 5, 2005 through the Closing Date, the Company operated under an interim
distribution agreement with TWC and recorded the results from titles we released
for TWC on our financial statements. After the Closing Date, substantially all
of the operating activities we previously conducted, as well as the results from
releasing TWC product, are reflected in the financial statements of the
Distributor.




For a
full description of the TWC Transaction, please see our Current Report on Form
8-K filed with the Securities and Exchange Commission (the “SEC”) on July 26,
2006.




Suppliers
and Compliance with Environmental Laws





We are
not aware of any environmental laws that materially affect our business or the
business of the Distributor.





Internet
Business





Consumers
who visit our website at www.geniusproducts.com can learn about us and the
Distributor’s products.  We are also creating a business-to-business
section that will allow retailers to gain access to promotional and marketing
materials.  We believe that a continued Internet presence is desirable
because it aids in consumer sales, business-to-business sales, brand exposure
and retail sales.





Corporate
Information




Genius
Products, Inc. was incorporated in the State of Nevada on January 8, 1996
under the name Salutations, Inc.  In October 1999, we changed our name
to Genius Products, Inc. to reflect our primary business of producing,
publishing, licensing and distributing audio and video products under our “Baby
Genius” brand.  In March 2005, we changed our state of
incorporation to Delaware.




Genius
Products, LLC was formed in the State of Delaware on May 10, 2005 as a
wholly-owned subsidiary of The Weinstein Company Holdings LLC, and was
originally named The Weinstein Company Funding LLC.  The company was
renamed Genius Products, LLC on July 21, 2006 in connection with the TWC
Transaction.




Our
principal executive offices are located at 2230 Broadway, Santa Monica,
California 90404, and our telephone number is (310) 453-1222.  Our
Internet address is www.geniusproducts.com.




EMPLOYEES





As of
December 31, 2007, the Company had 2 employees and the Distributor had 219
full-time employees and one part-time employee.





None of
the Distributor’s employees are represented by an organized labor
union.  We believe that the Distributor’s relationship with its
employees is good, and neither the Company nor the Distributor has experienced
an employee-related work stoppage.


INTERNET
ACCESS TO OUR SEC REPORTS


Our
Internet address is www.geniusproducts.com.  Through our website, we
make available, free of charge, the following reports as soon as reasonably
practicable after electronically filing them with, or furnishing them to, the
SEC: our Annual Reports on Form 10-K; our Quarterly Reports on
Form 10-Q; our Current Reports on Form 8-K; and amendments to those
reports.  Our Proxy Statements for our Stockholder Meetings are also
available through our website.  Our website and the information
contained therein or connected thereto are not intended to be incorporated into
this Annual Report on Form 10-K.




6


ITEM 1A.    RISK FACTORS





We
have a history of significant losses, and we may never achieve or sustain
profitability.





The
Company has incurred operating losses in all but two quarters since we commenced
operations.  As of December 31, 2007, we had an accumulated deficit of
$46.4 million.  Our net loss for the year ended December 31,
2007 was $14.9 million.  Our net loss before extraordinary gain
for the year ended December 31, 2006 was $47.0 million. Our net loss
for the year ended December 31, 2005 was $17.2 million.  Neither
we nor the Distributor may ever achieve or sustain profitability in the
future.   Our continued operating losses may have a material
adverse effect upon the value of our common stock and may jeopardize our ability
to continue our operations.




Our
business, results of operations and financial condition depend principally on
the success of
the Distributor.





In July
2006 we contributed substantially all of our assets to the Distributor in
exchange for a 30% interest in that entity.  As a result of that
transaction, our business substantially consists of acting as the managing
member of, and holding a membership interest in, the
Distributor.  Accordingly, our business results of operations and
financial condition depend almost exclusively on the successful operations of
the Distributor.  Further, in the past the Distributor has provided
and we expectthe
Distributor in the future to continue providing, funds to pay our operating
costs, including the cost of preparing and filing reports with the
SEC.  If the Distributor does not continue to provide these funds, our
overhead may increase and our net income may decline as a percentage of
revenues.





Failure to
achieve and maintain effective disclosure controls or internal controls would
have a material adverse effect on our ability to report our financial results
timely and accurately.





Effective
internal controls are necessary for us to produce reliable financial reports and
are important in our effort to prevent financial fraud. We are required to
periodically evaluate the effectiveness of the design and operation of our
internal controls. These evaluations may result in the conclusion that
enhancements, modifications or changes to our internal controls are necessary or
desirable. Company management has concluded that several material weaknesses
relating to the internal controls and related structure existed as of December
31, 2007 at both the Company and the Distributor. While Company management
evaluates the effectiveness of our internal controls on a regular basis, we
cannot provide absolute assurance that these controls will be remediated timely,
and be considered effective, nor can we give any assurance that the controls,
accounting processes, procedures and underlying assumptions will not be subject
to revision. As such, until remediated, these weaknesses could adversely affect
the accuracy or timing of future filings with the SEC and other regulatory
authorities. There are also inherent limitations on the effectiveness of
internal controls and financial reporting practices, including collusion,
management override, and failure of human judgment. Because of this, control
procedures and financial reporting practices are designed to reduce rather than
eliminate business risks. If we fail to maintain an effective system of internal
control over financial reporting or if and for so long as management or our
independent registered public accounting firm were to discover material
weaknesses in our internal control over financial reporting (or if our system of
controls and audits result in a change of practices or new information or
conclusions about our financial reporting) like the disclosed material weakness,
we may be unable to produce reliable financial reports or prevent fraud and it
could harm our financial condition and results of operations and result in loss
of investor confidence and a decline in our stock price. A discussion of these
material weaknesses and our remediation efforts can be found in Item 9A.
Controls and Procedures — Management’s Report on Internal Control Over Financial
Reporting.





If
the Distributor continues to grow at a rapid pace, it may not be able to manage
that growth effectively.





Initially
the Company, then through its transfer of assets and operations to the
Distributor in mid 2006, have each expanded operations rapidly since
inception.  Net revenues increased from $22.3 million in fiscal 2005
(for the Company), to $274.6 million in fiscal 2006 (for the Company and
Distributor combined), and to $474.1 million in fiscal 2007 (for the
Distributor). This substantial growth has placed a significant strain on
management systems and resources.  The Distributor is currently
investing in new management information systems and related technology,
increasing the number of employees in the affected areas, and improving
processes.  However, if the Distributor’s operations continue to grow
at this rate, the Distributor could experience serious operating difficulties in
these and other areas (including difficulties in hiring, training and managing
an increasing number of employees, difficulties in obtaining manufacturing
capacity to produce products, and delays in production and shipments), which
could result in a material adverse effect on the Distributor and
us.


7


The
Distributor’s business depends upon the success of its relationship with TWC and
our other key content suppliers.





A
significant amount of the Distributor’s net revenue is derived from the
distribution rights accorded to the Distributor under its distribution
agreements with TWC and other key content suppliers.  Specifically,
67% of the Distributor’s net revenue in fiscal year 2007 was derived from
TWC-controlled titles, compared to 84% in fiscal year 2006.  The
Distributor’s results of operations and financial condition depend principally
on the success of the relationships with TWC and other content
suppliers.  To grow its business, the Distributor is reliant on the
quantity and quality of theatrical and direct-to-video releases provided by TWC
and its other content partners.  The failure of the Distributor to
maintain its relationships with TWC and other key content suppliers would have a
material adverse effect on the Distributor and us.





The
motion picture industry is rapidly evolving, and recent trends have shown that
audience response to both traditional and emerging distribution channels is
volatile and difficult to predict.





The
entertainment industry in general and the motion picture industry in particular
continue to undergo significant changes, due both to shifting consumer tastes
and to technological developments.  New technologies, such as
video-on-demand and Internet distribution of films, have provided motion picture
companies with new channels through which to distribute their
films.  Accurately forecasting both the changing expectations of movie
audiences and market demand within these new channels have proven
challenging.





We cannot
accurately predict the overall effect shifting audience tastes,
technological change or the availability of alternative forms of entertainment
may have on the Distributor.  In addition to uncertainty regarding the
DVD market, there is uncertainty as to whether other developing distribution
channels and formats, including video-on-demand, Internet distribution of films
and high-definition, will attain expected levels of public acceptance or, if
such channels or formats are accepted by the public, whether the Distributor
will be successful in exploiting the business opportunities they
provide.  Moreover, to the extent that these emerging distribution
channels and formats gain popular acceptance, the demand for delivery through
DVDs may decrease.





The
Distributor faces intense competition.





The
market for entertainment products, including DVDs and CDs, is highly
competitive.  The Distributor faces significant competition from both
Hollywood studios and other independent distributors with respect to the number
of titles currently available and in securing distribution at retail
outlets.  The costs of entry into the retail and Internet markets for
competitive products are low, and there are no significant barriers to
entry.  Many of the Distributor’s competitors are larger with
established brand names, greater resources and access to established
distribution channels, and therefore may be able to adapt more quickly to
changes in customer requirements, devote greater resources to marketing and sale
of their products, generate greater brand recognition or adopt more aggressive
pricing policies than the Distributor.  As a result, the revenues,
results of operation and financial position of the Distributor may be materially
adversely affected.





The
unauthorized use of the Distributor’s intellectual property rights may reduce
revenues.





The
success of the Distributor’s business is highly dependent on the maintenance by
our content partners of intellectual property rights in the entertainment
products the Distributor distributes.  New technologies such as
peer-to-peer technology, high speed digital transmissions (including digital
distribution of theatrical films) and some features of digital video recorders
have made infringement of intellectual property in films and television
programming easier and faster and enforcement of intellectual property rights
more challenging.  Unauthorized use of intellectual property rights in
the entertainment industry generally is a significant and rapidly growing
phenomenon.  These developments may result in a loss of revenues
as a result of sales of unauthorized products.





The
loss of any major customer would harm us.




The
Distributor does not have long-term agreements with its customers, nor is it an
exclusive supplier to any of its retail customers.  If any customer
were to reduce or cancel a significant order, it would have a material adverse
effect on its business, results of operations and financial
condition.  For 2007, Wal-Mart and Blockbuster Entertainment accounted
for 34% and 20%, respectively, of the Distributor’s net revenues.  For
the period from July 22, 2006 through December 31, 2006, Wal-Mart accounted for
31%  of the Distributor’s net revenues. At December 31, 2007, Wal-Mart and
Target comprised 36% and 12% of the Distributor’s accounts receivable after
allowances, respectively, while at December 31, 2006, Wal-Mart and Best Buy
comprised 50% and 7% of the Distributor’s accounts receivable after allowances,
respectively.


Substantially
all of the Distributor’s revenues are derived from the distribution rights
accorded to the Distributor under its distribution agreements with TWC and other
key content suppliers.  Specifically, 84% of the Distributor’s net
revenue for the period from July 22, 2006 through December 31, 2006, and 67% of
the Distributor’s net revenue for fiscal 2007 were derived from its agreement
with TWC.  The Distributor’s business, operational results and
financial condition depend principally on the success of the relationships
between it and these content suppliers.




8


The
Distributor’s products are subject to returns.





The
Distributor’s products are subject to return.  While we anticipate a
certain level of returns, if product returns experienced by the Distributor are
significantly greater than anticipated, it will negatively impact the business
of the Distributor and us.  If the actual amount of customer returns
significantly exceeds historic return rates, it would have an adverse effect
upon the Distributor and our results of operations.





The
Distributor’s cash flow may not be sufficient to meet its operational
needs.





At
December 31, 2007, the Distributor had cash balances of $3.1 million, with an
additional $7.8 million of short-term and $3.3 million of long-term restricted
cash.  The $7.8 million is part of the Distributor’s short-term liquid
cash that had accumulated in a central lockbox account and can only be disbursed
weekly pursuant to the terms of the “Allocation of Accounts Receivable and
Intercreditor Agreement” entered into by and among  the Distributor,
The Weinstein Company, LLC and Société Générale dated August 10,
2007.  The $3.3 million is comprised of:  (i) $3 million in
a money market account, which is restricted pursuant to our credit facility with
Société Générale and (ii) $0.3 million in a certificate of deposit which is
securing a letter of credit on the Distributor’s Broadway lease.  The
Distributor may need or choose to obtain additional financing to fund its
activities in the future.  Funds could be raised by selling securities
or by entering into credit agreements.  The Distributor may not be
able to obtain additional funds on acceptable terms, or at all.  In
addition, the Distributor’s ability to borrow funds in excess of certain agreed
upon thresholds is subject to the approval of TWC Holdings.  If
adequate funds are not available, the Distributor may be required to curtail its
operations.





Inventory
obsolescence may adversely affect the Distributor’s business.





The
Distributor maintains a substantial investment in its DVD inventory, and if it
overestimates the demand for a particular title, it may have to destroy excess
inventory.  Further, the Distributor’s agreements with content
providers may limit its ability to sell such titles at discounted
prices.  The Distributor’s estimated allowances for obsolete or
unmarketable inventory are based upon management’s understanding of market
conditions and forecasts of future product demand, which are subject to
change.  The Distributor reviews inventory for excess or obsolete
product on a quarterly basis.  Obsolescence is determined by taking
the total inventory on hand less the 12 months projected sales.  Any
inventories in excess of 12 months are deemed 100% obsolete and a corresponding
charge for obsolescence is recorded.  Obsolescence is calculated only
on inventory for which the Distributor is responsible on a title-by-title basis,
which includes all theatrical and direct-to-video titles.





The
Distributor’s revenues and results of operations may fluctuate
significantly.





The
Distributor’s revenues and results of operations (and consequently our 30%
equity interest in the Distributor) depend significantly upon the success of the
motion pictures and television programming delivered by our content partners
that we distribute and which cannot be predicted with
certainty.  Accordingly, our revenues and results of operations may
fluctuate significantly from period to period.  The results of one
period may not be indicative of the results of any future period.  Our
revenues and results are also significantly influenced by seasonality and in
particular the all-important fourth quarter gift-giving season.  Any
quarterly fluctuations that we report in the future may not match the
expectations of market analysts and investors.  This could cause the
price of our common stock to fluctuate significantly.





Litigation
may harm our business and the Distributor or otherwise distract
management.





Substantial,
complex or extended litigation could cause us and the Distributor to incur large
expenditures and could distract management.  For example, lawsuits by
licensors, employees or stockholders could be very costly and disrupt
business.  While disputes from time to time are not uncommon, we may
not be able to resolve such disputes on terms favorable to us and the
Distributor.





Our
business would be adversely affected if the Distributor lost key members of its
executive management team.





We are
highly dependent on the efforts and performance of the Distributor’s executive
management team.  The loss of any key members of this team could
result in our inability to manage our operations effectively or to execute our
business strategy.  The failure to maintain or replace any such
individuals could have a material adverse effect on the Distributor and
us.


9


If
we cease to serve as the managing member of the Distributor, we could become
subject to the Investment Company Act of 1940.





The
Amended and Restated Limited Liability Company Agreement of the Distributor (the
“Distributor LLC Agreement”) contemplates that TWC Holdings or its designee will
become the managing member of the Distributor, instead of the Company, if we
become insolvent or bankrupt, if we violate the membership interest transfer
restrictions in the Distributor LLC Agreement or if a lender forecloses on a
security interest granted with respect to our Class G Units in the
Distributor.  If we cease to serve as the managing member of the
Distributor, then we could become subject to the Investment Company Act of 1940
(the “1940 Act”), which could have a material adverse effect on our
business.





Under the
1940 Act, a company may be deemed to be an investment company if it owns
investment securities with a value exceeding 40% of its total assets, subject to
certain exclusions.  If we ceased to serve as the managing member of
the Distributor and were deemed an investment company, we would become subject
to the requirements of the 1940 Act.  As a consequence, among other
things, we would likely incur significant expenses and could be prohibited from
engaging in our business or issuing our securities as we have in the
past.





Decreasing retail shelf space may limit sales of
the Distributor’s programming.





Revenues
and results of operations are at risk from competition from major motion picture
studios, music and game distributors, and other independent content suppliers
for limited retail shelf space.  The failure by the Distributor to
successfully compete for and procure retail shelf space for its products could
have a material adverse effect on the Distributor and us.





ITEM 1B.    UNRESOLVED STAFF
COMMENTS





None.




ITEM 2.   
PROPERTIES





On
December 31, 2007, the Distributor entered into a lease commitment (the “New
Maguire Lease”) with Maguire Properties – 3301 Exposition, LLC (“Maguire LLC”),
pursuant to which the Distributor will rent approximately 40,520 square feet of
office space in Santa Monica, California.  When complete, this
facility will be the consolidated home office of the Company and the
Distributor, housing all employees currently located at the Company’s and the
Distributor’s Santa Monica offices.





The
initial term of the New Maguire Lease is ten (10) years, commencing five (5)
months after the completion of certain tenant improvements to be constructed by
Maguire LLC (the “Occupancy Date”), which Occupancy Date is currently projected
to be in July, 2008.  The Distributor has an option to extend the term
of the New Maguire Lease for two (2) additional five (5) year terms, subject to
the satisfaction of certain conditions specified in the New Maguire
Lease.





As
security for its obligations under the New Maguire Lease, the Distributor has
delivered to Maguire LLC an irrevocable letter of credit in the amount of $1.5
million.  The aforementioned tenant improvements are being constructed
at Maguire LLC’s expense in accordance with an agreed upon space plan and
subject to certain conditions specified in the New Maguire Lease.





Also on
December 31, 2007, the Distributor and Maguire Properties, L.P. (“Maguire LP”)
amended the lease agreement, dated January 23, 2007 (the “Old Maguire
Lease”),  under which the Distributor currently rents approximately
14,000 square feet of office space located in Santa Monica,
California.  Under the amendment to the Old Maguire Lease, Maguire
L.P. agreed to waive the Distributor’s monthly rent for a period commencing on
January 1, 2008 through the Occupancy Date under the New Maguire
Lease.  The Distributor has the right to terminate the Old Maguire
Lease at any time upon five (5) business days’ prior written
notice.  The Distributor’s accounting and finance departments are
currently housed in this office space.


10


On
October 12, 2007, Castalian, LLC, a wholly owned subsidiary of the Distributor
(“Castalian”), entered into a lease agreement with 2800 OBI, LP (the “Castalian
landlord”),  under which Castalian rents approximately 6,465 square
feet of office space in Santa Monica, California.  This lease has a
three (3) year term commencing on November 23, 2007.   Castalian
also has the option to extend the lease for an additional three (3) year term
upon the expiration of the initial term.





On
January 5, 2007, the Distributor entered into a sublease agreement with The
Advantage Network, LLC, under which the Distributor subleased to The Advantage
Network, LLC its leasehold interest in a 5,603 square foot facility located in
Solana Beach, California.  This sublease is for a term commencing
February 1, 2007 and ending December 31, 2008.   Until March
2006, we used this facility as our principal executive offices pursuant to a
sublease agreement entered into in November 2003.  The November 2003
sublease is for a five-year term which commenced in January 2004, and was
assigned to the Distributor as part of the TWC Transaction.





On March
18, 2006, we entered into a five-year lease agreement for a 17,400 square foot
facility located in Santa Monica, California.  This lease was assigned
to the Distributor as part of the TWC Transaction.  This facility has
been used as our, and the Distributor’s, principal executive
offices.





On March
22, 2005, as part of the acquisition of American Vantage Media Corporation and
Wellspring Media, Inc., we assumed office space in New York and Santa Monica on
a month-to-month basis.  Effective as of April 30, 2006, we terminated
our lease for the Santa Monica space.  Effective as of the Closing
Date of the TWC Transaction, the Distributor assumed all of our rights and
obligations under the New York lease, and continues to occupy the New York
space.





On
October 15, 2004, we entered into a sublease agreement for a 1,670 square foot
facility located in Bentonville, Arkansas.  This sublease has
a five-year term and expires in October 2009.  This sublease
was assigned to the Distributor as part of the TWC Transaction.





ITEM 3.    LEGAL
PROCEEDINGS





Except as
described below, neither we nor the Distributor are a party to any legal or
administrative proceedings, other than routine litigation incidental to our
business and that of the Distributor that we do not believe, individually or in
the aggregate, would be likely to have a material adverse effect on our, or the
Distributor’s, financial condition or results of operations.





FALCON
PICTURE GROUP MATTER





On
October 3, 2005, Falcon Picture Group, LLC (“Falcon”) commenced litigation
against the Company in the Circuit Court of Cook County, Illinois, Case No.
05H16850 (the “Illinois Proceeding”), based upon allegations, among other
things, that the Company breached the terms of a license agreement between
Falcon and the Company by refusing to pay certain royalties to which Falcon
allegedly was entitled.  On or about July 2007, Falcon was granted
leave to file an amended complaint alleging further that the Company interfered
with Falcon’s current and potential business relationships.  Falcon
seeks damages resulting from the interference claim of approximately $0.4
million as well as $0.8 million relating to the claim for breach of the license
agreement.  The court’s decision to grant leave to amend is not
indicative of the merits of such amended claims as leave to amend proceedings in
the early stages of litigation are routine procedural matters.





The
Company has asserted various affirmative defenses to Falcon’s complaint,
including, among other things, that Falcon in fact breached the license
agreement by delivering defective content to the Company, double billed for
content and failed to honor provisions in the license agreement requiring Falcon
to indemnify the Company in the event of claims by third parties that the
Company did not possess the legal right to sell Falcon content.  The
Company has also asserted that the additional claims in Falcon’s amended
complaint are unfounded, and that the damages asserted by the Company pursuant
to its own claims will substantially exceed the damages sought by
Falcon.  The Company believes that the evidence will demonstrate that
there was no monetary default on its part under the license agreement insofar
as, at the time of the alleged default, Falcon was indebted to the Company for
an amount substantially in excess of the sum Falcon claims was past
due.  Accordingly, the Company has commenced litigation against Falcon
and its owner, Carl Amari, in the form of a counter claim seeking damages of
approximately $1.5 million, exclusive of any award of attorneys’ fees, costs of
suit and punitive damages to which the Company may also be entitled to
recover.  Discovery is in its final stages but a trial date has not
yet been scheduled.  The Company plans to continue to vigorously
defend against Falcon’s allegations and to pursue its counter claim against
Falcon.


11


ENTERTAINMENT
RESOURCE MATTER





In June
2007, Larry S. Hyman, as assignee for Entertainment Resource, Inc. (“ERI”),
commenced litigation against the Company in the Circuit Court of Broward County,
Florida, Case No. 06-012249 CACE 05, based upon allegations, among other things,
that the Company owes ERI for products delivered and sold to the Company by ERI
between September 2005 and January 2006.  ERI seeks an award of $0.9
million.  The Company plans to vigorously defend against ERI’s
allegations and has denied ERI’s allegations in response to their
complaint.  Among other defenses, the Company plans to provide
evidence that ERI owes to the Company approximately $1 million for products sold
and delivered by the Company to ERI, which amount should be set-off against any
amounts owing by the Company to ERI.  Discovery is in its early stages
and the action has not been scheduled for trial.




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





On
October 31, 2007, stockholders of the Company holding voting rights equivalent
to seventy percent (70%) of the outstanding shares of our common stock executed
written consents in lieu of a special meeting approving a reverse stock split of
the Company’s common stock in an exchange ratio of (i) one-for-five, (ii)
one-for-six, (iii) one-for-seven, or (iv) one-for-eight (the “Reverse Stock
Split”), with the Company’s Board of Directors retaining the discretion of
whether to implement the Reverse Stock Split and which exchange ratio to
implement.  The Company’s Board of Directors approved the proposed
Reverse Stock Split on September 28, 2007, but the Board of Directors has not
yet determined whether to implement the Reverse Stock Split or which exchange
ratio to implement.  A complete description of the proposed Reverse
Stock Split is included in the Company’s Definitive Information Statement filed
with the SEC on October 31, 2007.





Our 2007
Annual Meeting of Stockholders was held on December 5, 2007.  Of the
67,673,344 shares eligible to vote, 50,161,285 appeared by proxy and established
a quorum for the meeting.  The singular matter considered at the
annual meeting was the election of directors, with the holders of our common
stock entitled to appoint two directors and the holders of our Series W
Preferred Stock entitled to appoint five directors.  The items listed
in the table below were approved by, respectively, a majority of the common
stockholders appearing at the meeting and a majority of the Series W Preferred
stockholders appearing at the meeting.





VOTES FOR
            
            
            VOTES
              AGAINST
            
            
            VOTES
              WITHHELD
            
            
            NOT
              VOTED1.
            
            Election of Directors
      by Common StockholdersStephen
      K. Bannon
            
            
            45,401,109
            
            
            
            126,000
            
            
            
            4,634,176
            
            
            
            0Trevor
      Drinkwater
            
            
            45,526,109
            
            
            
            1,000
            
            
            
            4,634,176
            
            
            
            0




VOTES FOR
            
            
            VOTES
              AGAINST
            
            
            VOTES
              WITHHELD
            
            
            NOT
              VOTED2.
            
            Election of Directors by Series W
      Preferred StockholdersBradley
      A. Ball
            
            
            100
            
            
            
            0
            
            
            
            0
            
            
            
            0James
      G. Ellis
            
            
            100
            
            
            
            0
            
            
            
            0
            
            
            
            0Herbert
      Hardt
            
            
            100
            
            
            
            0
            
            
            
            0
            
            
            
            0Larry
      Madden
            
            
            100
            
            
            
            0
            
            
            
            0
            
            
            
            0Irwin
      Reiter
            
            
            100
            
            
            
            0
            
            
            
            0
            
            
            
            0




12


PART II




ITEM 5.    MARKET FOR COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS





Our stock
trades on the over-the-counter bulletin board (“OTCBB”) under the symbol “GNPI”.
The market represented by the OTCBB is extremely limited and the price for our
common stock quoted on the OTCBB is not necessarily a reliable indication of the
value of our common stock. The following table sets forth the high and low bid
prices for shares of our common stock for the periods noted, as reported on the
OTCBB. Quotations reflect inter-dealer prices, without retail mark-up, mark-down
or commission and may not represent actual transactions.




YEAR
            PERIOD
            
            HIGH
            
            
            LOWCalendar
      Year 2006
            First
      Quarter
            
            $
            2.35
            
            
            $
            1.62Second
      Quarter
            
            
            2.08
            
            
            
            1.55Third
      Quarter
            
            
            2.12
            
            
            
            1.63Fourth
      Quarter
            
            
            2.72
            
            
            
            1.78Calendar
      Year 2007
            First
      Quarter
            
            $
            3.30
            
            
            $
            2.53Second
      Quarter
            
            
            3.32
            
            
            
            2.63Third
      Quarter
            
            
            2.96
            
            
            
            2.30Fourth
      Quarter
            
            
            2.85
            
            
            
            1.59





Our
common stock is subject to Rules 15g-1 through 15g-9 under the Securities
Exchange Act of 1934, as amended, which impose certain sales practice
requirements on broker-dealers who sell our common stock to persons other than
established customers and “accredited investors” (generally, individuals with a
net worth in excess of $1,000,000 or an annual income exceeding $200,000
individually or $300,000 together with their spouses). For transactions covered
by this rule, a broker-dealer must make a special suitability determination for
the purchaser and have received the purchaser’s written consent to the
transaction prior to the sale.




13


Stock
Performance Graph





The
following graph compares the performance of our common stock over the five
preceding fiscal years to the weighted average performance over the same period
of the stock of companies included in the NASDAQ Composite Index and the S&P
Movies and Entertainment Index.  The graph assumes $100 was invested
at the close of trading on December 31, 2002 in our common stock and in each of
the indices and that all dividends were reinvested.  The stockholder
return shown on the graph below should not be considered indicative of future
stockholder returns, and we will not make or endorse any predictions of future
stockholder returns.








Stockholders





As of
February 29, 2008, we had 67,709,094 shares of common stock issued and
outstanding which were held by 184 stockholders of record, including the holders
that have their shares held in a depository trust in “street” name. The transfer
agent for our common stock is Interwest Transfer Company, 1981 East 4800 South,
Suite 100, Salt Lake City, Utah 84117.


14





Equity
Compensation Plans





The
following table provides information concerning our equity compensation plans as
of December 31, 2007.




(Securities in
      thousands)Number of securities
      to be issued
              Upon
      exercise of outstanding
              options,
      warrants and rights
              (a)
            
            Weighted-average
              exercise
      price of
              outstanding
              options,
      warrants
              and
      rights
              (b)
            
            Number of securities
      remaining available for future issuance under Equity
      Compensation Plans (excluding securities reflected in column
      (a))
              (c)Equity
      compensation plans approved by security holders
            28,196
            
            $
            2.06
            
            8,290Equity
      compensation plans not approved by security holders
            —
            
            
            —
            
            —Total
            28,196
            
            $
            2.06
            
            8,290





Dividend
Policy





Our Board
of Directors determines any payment of dividends. We have never declared or paid
cash dividends on our common or preferred stock. We do not expect to authorize
the payment of cash dividends on our shares of common or preferred stock in the
foreseeable future. Any future decision with respect to dividends will depend on
future earnings, operations, capital requirements and availability, restrictions
in future financing agreements and other business and financial
considerations.





Sales
of Unregistered Securities





On
March 2, 2005, we engaged in a private placement of 6,518,987 shares of our
common stock and five-year warrants to purchase 1,303,797 shares of common
stock, half at an exercise price of $2.56 per share and half at an exercise
price of $2.78 per share. The transaction closed on March 3, 2005 and we
realized gross proceeds of $10.3 million from the financing, before deducting
commissions and other expenses. We agreed to register for resale the shares of
common stock issued in the private placement and shares issuable upon exercise
of warrants. Such registration statement became effective on May 11,
2005.





On March
22, 2005, in connection with the Company’s acquisition of American Vantage
Corporation from American Vantage Companies (“AVC”), the Company issued to AVC
(i) 7,000,000 shares of the Company’s common stock valued at $2.27 per share and
(ii) warrants to purchase 1,400,000 shares of the Company’s common stock, half
at an exercise price of $2.56 per share and half at an exercise price of $2.78
per share.





In May
2005, we engaged in a private placement of 3,000,000 shares of our common stock
and five-year warrants to purchase 270,000 shares of our common stock at an
exercise price of $2.56 per share. The transaction closed on May 20, 2005,
and we realized gross proceeds of $5.25 million from the financing before
deducting commissions and other expenses.





On
December 5, 2005, we engaged in a private placement of 16,000,000 shares of
our common stock and five-year warrants to purchase 4,800,000 shares of common
stock with an exercise price of $2.40 per share. The transaction closed on
December 6, 2005 and we realized gross proceeds of $32 million from the
financing, before deducting commissions and other expenses.





On
October 4, 2005, we entered into a Note and Warrant Purchase Agreement with a
group of investors (collectively, the “Investors”).  Under the Note
and Warrant Purchase Agreement, the Investors loaned a total of $4.0 million to
the Company in exchange for (i) promissory notes in favor of the Investors with
a total principal balance of $4.0 million and (ii) five-year warrants to
purchase a total of 280,000 shares of our common stock at an exercise price of
$1.88 per share.


15


From time
to time, the Company has awarded stock options to certain individuals outside of
the Company’s stock option plans.





The
aforementioned sales of securities were not registered under the Securities Act
of 1933, as amended (the “Act”), or any state securities laws, and were sold in
private transactions exempt from registration pursuant to Section 4(2) of
the Act and Regulation D promulgated thereunder.





ITEM 6.    SELECTED FINANCIAL
DATA





You
should read the financial data set forth below in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
(included in Item 7) and our consolidated financial statements and the related
notes included in this Annual Report.





Genius
Products, Inc.




(In
      thousands), except per share data
                
                Years
      Ended December 31,2007
      *, ^
                  (Restated)
                
                
                2006
      *, ^
                  (Restated)
                
                
                2005
                
                
                2004
                
                
                2003Statement
      of Operations data:Revenues,
      net of sales returns, discounts and allowances
                
                $
                -
                
                
                $
                119,011
                
                
                $
                22,328
                
                
                $
                16,630
                
                
                $
                3,069Cost
      of revenues
                
                
                -
                
                
                
                130,870
                
                
                
                22,883
                
                
                
                13,893
                
                
                
                2,150Gross
      profit (loss)
                
                
                -
                
                
                
                (11,859
                )
                
                
                (555
                )
                
                
                2,737
                
                
                
                919Operating
      expenses (income):General
      and administrative
                
                
                5,248
                
                
                
                20,752
                
                
                
                14,747
                
                
                
                8,231
                
                
                
                3,531Restructuring
                
                
                -
                
                
                
                -
                
                
                
                2,745
                
                
                
                -
                
                
                
                -Gain
      on sale, related party
                
                
                -
                
                
                
                (63
                )
                
                
                (1,352
                )
                
                
                -
                
                
                
                -Equity
      in net loss from Distributor
                
                
                10,565
                
                
                
                7,989
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
      operating expenses
                
                
                15,813
                
                
                
                28,678
                
                
                
                16,140
                
                
                
                8,231
                
                
                
                3,531Loss
      from operations
                
                
                (15,813
                )
                
                
                (40,537
                )
                
                
                (16,695
                )
                
                
                (5,494
                )
                
                
                (2,612
                )Net
      interest income (expense)
                
                
                (797
                )
                
                
                853
                
                
                
                (465
                )
                
                
                (551
                )
                
                
                (130
                )Loss
      before provision for income taxes
                
                
                (16,610
                )
                
                
                (39,684
                )
                
                
                (17,160
                )
                
                
                (6,045
                )
                
                
                (2,742
                )Provision
      (benefit) for income taxes
                
                
                (1,730
                )
                
                
                7,304
                
                
                
                1
                
                
                
                1
                
                
                
                1Loss
      before extraordinary item
                
                
                (14,880
                )
                
                
                (46,988
                )
                
                
                (17,161
                )
                
                
                (6,046
                )
                
                
                (2,743
                )Extraordinary
      gain, net of taxes
                
                
                -
                
                
                
                54,203
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      income (loss)
                
                $
                (14,880
                )
                
                $
                7,215
                
                
                $
                (17,161
                )
                
                $
                (6,046
                )
                
                $
                (2,743
                )Basic
      and diluted earnings per common sharesLoss
      before extraordinary item
                
                $
                (0.22
                )
                
                $
                (0.77
                )
                
                $
                (0.42
                )
                
                $
                (0.25
                )
                
                $
                (0.16
                )Extraordinary
      item
                
                
                -
                
                
                
                0.89
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      income (loss)
                
                $
                (0.22
                )
                
                $
                0.12
                
                
                $
                (0.42
                )
                
                $
                (0.25
                )
                
                $
                (0.16
                )Basic
      and diluted weighted average common shares
                
                
                66,222
                
                
                
                60,949
                
                
                
                40,400
                
                
                
                23,827
                
                
                
                17,574Balance
      Sheet data:Cash
      and cash equivalents
                
                $
                1,757
                
                
                $
                3,745
                
                
                $
                30,597
                
                
                $
                1,224
                
                
                $
                941Working
      capital
                
                
                1,669
                
                
                
                3,707
                
                
                
                21,441
                
                
                
                60
                
                
                
                1,150Investment
      in Distributor
                
                
                73,002
                
                
                
                87,694
                
                
                
                -
                
                
                
                -
                
                
                
                -Total
      assets
                
                
                83,060
                
                
                
                92,326
                
                
                
                76,365
                
                
                
                12,996
                
                
                
                5,575Redeemable
      common stock
                
                
                -
                
                
                
                -
                
                
                
                414
                
                
                
                395
                
                
                
                491Deferred
      gain, related party
                
                
                -
                
                
                
                -
                
                
                
                1,212
                
                
                
                -
                
                
                
                -Total
      stockholders' equity
                
                
                65,897
                
                
                
                73,858
                
                
                
                55,188
                
                
                
                4,432
                
                
                
                2,723




^ The
aforementioned restatements relate to (i) an error in the application of
generally accepted accounting principles with respect to the recognition in the
Company’s financial statements of costs paid on its behalf by the Distributor
and (ii) an error in the application of generally accepted accounting principles
with respect to the accounting classification and measurement of certain
redemption rights of the holders of the Distributor’s Class W
Units.  See Note 3 to each of
the Company’s and the Distributor’s financial statements for further details
regarding the restatements.


16





Genius
Products LLC





(In
      thousands)
                      
                      Years
      Ended December 31,2007
      ^
                        (Restated)
                      
                      
                      
                      2006
      *Statement
      of Operations data:Revenues,
      net of sales returns, discounts and allowances
                      
                      $
                      474,087
                      
                      
                      $
                      155,591Cost
      of revenues
                      
                      
                      451,597
                      
                      
                      
                      168,044Gross
      profit (loss)
                      
                      
                      22,490
                      
                      
                      
                      (12,453
                      )Operating
      expenses:General
      and administrative
                      
                      
                      38,440
                      
                      
                      
                      7,566Total
      operating expenses
                      
                      
                      38,440
                      
                      
                      
                      7,566Loss
      from operations
                      
                      
                      (15,950
                      )
                      
                      
                      (20,019
                      )Other
      income (expense)
                      
                      
                      (2,882
                      )
                      
                      
                      309Net
      loss
                      
                      $
                      (18,832
                      )
                      
                      $
                      (19,710
                      )*
      For 2006, the financial data reflects results from July 22 through
      December 31, 2006




^ See
comment above


17


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




THE
WEINSTEIN COMPANY TRANSACTION.




On July
21, 2006 (the “Closing Date”), the Company completed a transaction (the “TWC
Transaction”) with TWC Holdings and W-G Holding (two subsidiaries of TWC)
pursuant to which we launched the Distributor to exploit the exclusive U.S. home
video distribution rights to feature film and direct-to-video releases owned or
controlled by TWC.  On the Closing Date, the Company contributed
substantially all of its assets (except for $1 million in cash and certain
liabilities), its employees, and its existing businesses to the
Distributor.
 
 Thus, the
Distributor is owned 70% by TWC Holdings and W-G Holding and 30% by the
Company.  The 70% interest in the Distributor held by TWC Holdings and
W-G Holding consists of Class W Units and is redeemable, at TWC Holdings’ and
W-G Holding’s option commencing at any time from July 21, 2007  for up
to 70% of the Company’s outstanding common stock, or with TWC Holdings’ and W-G
Holding’s approval, cash.   The redemption value of the Class W
Units may not be less than $60.0 million.  The Company’s 30% membership
interest in the Distributor consists of the Distributor’s Class G Units. (see
Equity Investment in Distributor section below).
 In
addition, the Company issued an aggregate of 100 shares of the Company’s Series
W Preferred Stock to TWC Holdings and W-G Holding in connection
with  the TWC Transaction.  The Series W Preferred Stock
provides the holders thereof with (i) the right to elect five of the seven
directors on the Company’s Board of Directors, of which two are currently TWC
executives, (ii) majority voting power over other actions requiring approval of
our stockholders, and (iii) the right to approve certain specified
actions.  The Series W Preferred Stock has no rights to receive
dividends and minimal liquidation value.
 
 On the
Closing Date, the Company entered into a Registration Rights Agreement with TWC
Holdings and W-G Holding pursuant to which we agreed to register for resale the
shares of our common stock issuable upon redemption of Class W Units in the
Distributor currently held by them.  The Company and/or the
Distributor also entered into the following agreements on the Closing Date: (i)
an Amended and Restated Limited Liability Company Agreement of the Distributor,
(ii) a Video Distribution Agreement (the “TWC Distribution Agreement”), (iii) a
Services Agreement, and (iv) an Assignment and Assumption
Agreement.
 
 From
December 5, 2005 through the Closing Date, the Company operated under an interim
distribution agreement with TWC and recorded the results from titles we released
for TWC on our consolidated financial statements. After the Closing Date,
substantially all of the operating activities we previously conducted, as well
as the results from releasing TWC product, are reflected in the financial
statements of the Distributor.
 
 For a
full description of the TWC Transaction, please see our Current Report on Form
8-K filed with the Securities and Exchange Commission (the “SEC”) on July 26,
2006.
  For the
period from July 22, 2006 through December 31, 2007 (after the Closing Date), we
accounted for our investment in the Distributor using the equity method of
accounting.  Under the equity method of accounting, only the Company’s
investment in and amounts due to and from the Distributor are included in our
consolidated balance sheet.  As a result, we recorded an asset on our
balance sheet related to our investment interest in the
Distributor.  In our statement of operations, we recorded our 30%
share of the Distributor’s loss as equity in net losses from the
Distributor.  We recorded an extraordinary gain on sale of $54.2
million, after taxes, upon consummation of the TWC Transaction based on the
difference between the fair market value of assets contributed and their net
book value, reduced for the portion of the gain associated with our retained
economic interest in the Distributor.  We entered into a master
contribution agreement related to the TWC Transaction effective December 5, 2005
and operated under an interim distribution agreement with TWC through July 21,
2006.  During that period, we recorded the results from releasing TWC
titles in our financial statements.  After the Closing Date,
substantially all of the operating activities that we previously conducted,
including releasing TWC products, are reflected in the financial statements of
the Distributor.





The
information in this Annual Report pertaining to our business operations reflects
the operations of the Company prior to the Closing Date and the operations of
the Distributor after the Closing Date.  In addition, we are
including stand-alone financial statements and footnotes of the Distributor,
which are located immediately following the footnotes for the
Company.





CRITICAL
ACCOUNTING POLICIES





NOTE:  THE FOLLOWING CRITICAL
ACCOUNTING POLICIES ARE CONSISTENTLY APPLIED BY BOTHTHE COMPANY AND THE
DISTRIBUTOR  (For further details, refer to Note 2 in the
Financial Notes and Disclosure section incorporated herein by
reference)





ALLOWANCE
FOR SALES RETURNS, PRICE PROTECTION, CUSTOMER DISCOUNTS, CUSTOMER DEDUCTIONS AND
BAD DEBTS.





We
calculate the allowance for doubtful accounts and provision for sales returns
based on management’s estimate of the amount expected to be uncollectible or
returned on specific accounts.  We provide for future returns and
price protection for releases of home video product at the time the products are
sold. We calculate an estimate of future returns of product by analyzing units
shipped, units returned and point of sale data to ascertain consumer purchases
and inventory remaining with retail to establish anticipated
returns.  Price protection is calculated on a title by title
basis.  The objective of price protection is to mitigate returns by
providing retailers with credits to ensure maximum consumer
sales.  Price protection is granted to retailers after they have
presented the company an affidavit of existing inventory.





Other
factors are taken into consideration in the calculation of future returns such
as title genre, historical returns, projections of consumer demands, box office
and other research.  We allow for future returns on non-theatrical
titles by analyzing a combination of historical returns, point of sale data and
product seasonality.


18


We
provide for customer discounts based on arrangements entered into on a
customer-by-customer basis.  We set aside reserves for bad debts and
customer deductions based on management’s estimate of the amounts expected to be
uncollectible on specific accounts.




INVENTORIES.





Inventories
consist of raw materials and finished goods, and these are valued at the lower
of cost or market.  As of January 1, 2007, the Distributor changed its
method for valuing inventory from an average cost basis to the first-in,
first-out method (“FIFO”) of valuation, which is the predominant method
used in the industry.  The Distributor does not believe that this
change in accounting method had a material effect on the Distributor's
consolidated financial statements.





We review
inventory for excess or obsolete product on a quarterly
basis.  Obsolescence is determined by taking the total inventory on
hand less the 12 months projected sales.  Any inventories in excess of
12 months are deemed 100% obsolete and a corresponding charge for obsolescence
is recorded.  Obsolescence is calculated only on inventory for which
the Distributor is responsible on a title-by-title basis, which includes all
theatrical and direct-to-video titles.





LONG-LIVED
ASSETS.


Film
Library: As of
July 21, 2006, the Company transferred all of its film library to the
Distributor.  The Distributor capitalizes the costs of production and
acquisition of film libraries. In accordance with Statement of Position (“SOP”)
00-2, “Accounting by Producers or Distributors of Films” (“SOP 00-2”), the
Distributor amortizes costs to cost of revenues, using the individual film
forecast method over a period of ten years or less.
 
 The film
library is stated at the lower of amortized cost or estimated fair
value.  The fair value of its film library is determined using
management’s future revenue and cost estimates, and the valuation of films is
reviewed on a title-by-title basis. In accordance with Statement of Financial
Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” when an event or change in circumstances
indicates that the fair value of its film is less than its unamortized cost, an
impairment loss is recognized by recording additional amortization in the amount
by which the unamortized costs exceed the estimated fair value of the film.
Estimates of future revenue involve measurement uncertainty and it is therefore
possible that reductions in the carrying value of film library may be required
as a consequence of changes in management’s future revenue
estimates.





19


Goodwill and Other Intangible
Assets: We evaluate the carrying value of goodwill as of December 31
of each year. Per the requirements of FAS 142, “Goodwill and Other Intangible
Assets,”  between annual evaluations, if events occur or circumstances
change that would more likely than not reduce the fair value of the reporting
unit below its net book value, we would book an impairment charge. Such
circumstances could include, but are not limited to: (i) a significant
adverse change in legal factors or in business climate, (ii) unanticipated
competition, or (iii) an adverse action or assessment by a regulator. When
performing the impairment review, we determine the carrying amount of each
reporting unit by assigning assets and liabilities, including the existing
goodwill, to those reporting units. A reporting unit is defined as an operating
segment or one level below an operating segment (referred to as a component). A
component of an operating segment is deemed a reporting unit if the component
constitutes a business for which discrete financial information is available,
and segment management regularly reviews the operating results of that
component.
  To
evaluate whether goodwill is impaired, we compare the fair value of the
reporting unit to which the goodwill is assigned to the reporting unit's net
book value, including goodwill. We determine the fair value of each reporting
unit using the present value of expected future cash flows for that reporting
unit. If the net book value of a reporting unit exceeds its fair value, the
amount of the impairment loss must be measured. The impairment loss would be
calculated by comparing the implied fair value of reporting unit goodwill to its
carrying amount. In calculating the implied fair value of the reporting unit
goodwill, the fair value of the reporting unit is allocated to all of the other
assets and liabilities of that unit based on their fair values. The excess of
the fair value of a reporting unit over the amount assigned to its other assets
and liabilities is the implied fair value of goodwill. An impairment loss would
be recognized when the carrying amount of goodwill exceeds its implied fair
value.  We also evaluate other intangible assets to determine whether
such assets have been impaired.
  Long-lived
assets are reviewed annually for impairment and whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. An impairment loss is recognized when the undiscounted cash flows
estimated to be generated by the asset are less than the carrying amount of the
asset.


ROYALTIES
AND PARTICIPATIONS.
  As of
July 21, 2006, the Company transferred all of its advances to the
Distributor.
 
 The
Distributor’s royalty and distribution fee advances represent fixed minimum
payments made to program suppliers for exclusive content distribution rights. A
program supplier’s share of exclusive program distribution revenues is retained
by the Distributor until the share equals the advance(s) paid to the program
supplier. Thereafter, any excess is paid to the program supplier in accordance
with contractual terms.  The Distributor records as a cost of sales an
amount equal to the program supplier’s share of the net distribution
revenues.
 
 Participation
costs due to TWC are accrued in the proportion that current year’s revenue bears
to management’s estimate of ultimate revenue.  The Distributor
amortizes the participations to cost of revenues using the individual film
forecast method. Revenue and cost forecasts are continually reviewed by
management and revised when warranted by changing
conditions.
  REVENUE
RECOGNITION.





Revenue
from the sale or licensing of films is recognized upon meeting all recognition
requirements of SOP 00-2 and Staff Accounting Bulletin (“SAB”) No. 104 Revenue
Recognition. Revenues are recorded upon the receipt of goods by the customer for
titles that are available for consumer purchase.  Costs of sales and
an allowance for returns, rebates and discounts are recorded at the time of
revenue recognition.  Revenues from revenue sharing arrangements are
recognized as follows:   (i) in the case of by title guarantees,
when the product is available for consumer rental and (ii) in the case of
revenues derived from overages (i.e., revenue sharing arrangements when the
Distributor’s agreed-upon share of consumer rentals exceeds the guarantee), one
month after receipt.  Revenues from royalties are recognized when
received.  Revenues from licensing are recognized when all required
deliverables of a title are received and accepted by the
licensee.  Revenue for shipments of titles not available for consumer
purchase are deferred and only recognized when that title is available for
consumer purchase.  Cash payments received are recorded as deferred
revenue until all the conditions of revenue recognition have been met.
 Long-term, non-interest bearing receivables are discounted to present
value.




FAIR
VALUE OF FINANCIAL INSTRUMENTS.


The
carrying amounts of cash and cash equivalents, prepaid expenses, accounts
payable, accrued expenses, and Class W Option Liability approximate the fair
value thereof.
 OFF-BALANCE
SHEET ARRANGEMENTS.





The
Company had no off-balance sheet arrangements as of fiscal year-end
2007.


20






STOCK-BASED
COMPENSATION.
 
 Under
Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based
Payment” (“SFAS 123R”), which was adopted by the Company beginning on January 1,
2006, share-based compensation cost is measured at the grant date based on the
estimated fair value of the award and is recognized as expense over the
employee's requisite service period using a modified prospective application.
The valuation provisions apply to new awards and to awards that were outstanding
on the effective date and subsequently modified or cancelled. Share-based
compensation expense is based on the grant date fair value for share-based
awards granted subsequent to January 1, 2006, and share-based awards granted
prior to, but not yet vested as of January 1, 2006.
 
 Subsequent
to the Closing Date of the TWC Transaction, the Company’s stock-based
compensation expense consists of expense associated with stock options held by
and subsequently granted to independent members of the Company’s Board of
Directors.  The stock-based compensation expense associated with the
former employees of the Company, who became employees of the Distributor as of
the Closing Date, is recorded on the books of the
Distributor.  Stock-based compensation expense is calculated using the
Black-Scholes-Merton formula as our closed-form valuation option pricing model
(the “Option Model”). The Option Model requires the use of subjective and
complex assumptions, per the requirements of FAS123R, that include: (i) the
option's expected term, (ii) the estimated future price volatility of the
underlying stock, (iii) the risk-free interest rate, (iv) the dividend yield and
(v) expected forfeiture.
 
 The
Distributor records stock-based compensation expense associated with Company
stock options held by and subsequently granted to the Distributor’s employees
(the former employees of the Company before the TWC Transaction) in accordance
with Emerging Issues Task Force EITF Issue No. 00-12, “Accounting by an Investor
for Stock-Based Compensation Granted to Employees of an Equity Method Investee”
(“EITF 00-12”).  EITF 00-12 requires that the Distributor recognize
the costs of stock-based compensation incurred by an investor on its
behalf.
 
 For a
complete discussion of the Option Model and assumptions used to calculate
stock-based compensation expense, please refer to Note 8 in the Footnotes
and Disclosures.


NOTE:  THE
FOLLOWING CRITICAL ACCOUNTING POLICIES ARE APPLIED ONLY BY THE
COMPANY





INVESTMENT
IN DISTRIBUTOR





The
amount initially recorded for our investment in the Distributor was partially
based on our fair value as determined by reference to the quoted market price of
the Company’s common stock at the close of the market on the Closing Date of the
TWC Transaction and partially based on the historical basis of the net assets
surrendered in the TWC Transaction. The carrying amount of the Company’s
investment in the Distributor is adjusted to recognize our share of the earnings
or losses of the Distributor after the TWC Transaction. Pursuant to Accounting
Principles Bulletin No. 18, we are required to periodically assess whether a
decrease in value of the investment has occurred which is other than temporary
and which should be recognized immediately, resulting in an impairment
loss.




CLASS
W OPTION LIABILITY
 
 The
Company records the Class W Option Liability at fair value in accordance
with EITF 00-6, “Accounting for Freestanding Derivative Financial Instruments
Indexed to, and Potentially Settled in, the Stock of a Consolidated Subsidiary.”The Company has utilized a
lattice valuation model to simulate future stock movements of the Company’s
Common Stock in order to determine the fair value
of the Class W Option Liability.  The assumptions used in preparing
such model include, among other things, inputs such as volatility, risk-free
interest rates, dividend yield, expected time of redemption and assessment of
counterparty risk.




INCOME
TAXES




The Company files a
consolidated corporate tax return and accounts for income taxes under SFAS No.
109, “Accounting for Income Taxes” (“SFAS No. 109”). This statement requires the
recognition of deferred tax assets and liabilities for the future consequences
of events that have been recognized in the Company’s consolidatedfinancial statements or tax returns. The measurement of the deferred
items is based on enacted tax laws. In the event the future consequences of
differences between financial reporting basis and the tax basis of the Company’s
assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an
evaluation of the probability of being able to realize the future benefits
indicated by such asset. A valuation allowance related to a deferred tax asset
is recorded when some portion or the entire deferred tax asset will not be
realized on a more likely than not basis.  Based on the Company’s
assessment of all available evidence, the Company has concluded that its
deferred tax assets are not more likely than not to be realized. This conclusion
is based primarily on our history of net operating losses, annual net operating
loss limitations under Internal Revenue Code (“IRC”) Section 382, and the need
to generate significant amounts of taxable income in future periods on a
consistent and prolonged basis in order to utilize the deferred tax
assets.  Accordingly, the Company has recorded a full valuation
allowance on its deferred tax assets and has recorded a net deferred tax
liability related to its investment in the Distributor.  The deferred
tax liability related to the Distributor is not offset against the deferred tax
assets as the reversal period for this amount is not considered to be
determinable on a more likely than not basis.


21


THE
COMPANY





The
following discussion and analysis of the financial condition and results of
operations of the Company should be read in conjunction with the financial
statements and notes thereto of the Company contained in this
report.  The discussion contains forward-looking statements that
relate to future events or the Company’s future financial performance that
involve known and unknown risks, uncertainties and other factors that may cause
the Company’s actual results, levels of activity, performance or achievements to
be materially different from those expressed or implied by the forward-looking
statements. For additional information concerning these factors, see the
information under the caption “Risk Factors” in Item 1A above.





Results
of Operations for the Company





Concurrently
with the closing of the TWC Transaction, the Company contributed to the
Distributor all of its operating business, including substantially all of its
assets.  Thus, the results of operations of the Company relate to the
operations of the Distributor.  We account for our 30% investment in
the Distributor using the equity method of accounting, pursuant to Accounting
Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for
Investments in Common Stock” (“APB No. 18”).  On our consolidated
statement of operations subsequent to the Closing Date of the TWC Transaction,
we record our 30% share of the Distributor’s profit (loss) as equity in net
earnings (loss) from Distributor, adjusted for basis differences and costs
incurred by the Distributor on behalf of the Company.   Per the
requirements of APB 18, we periodically assess whether a decrease in value of
the investment has occurred which is other than temporary and which should be
recognized immediately as an impairment loss (see Investment in Distributor
under Critical Accounting Policies above).  Under the equity method of
accounting, only our investment in and amounts due to and from the Distributor
have been included as an asset in our consolidated balance
sheet.


With the
restructuring of its business, the Company’s results of operations for the
fiscal year 2007 are not comparable to its results of operations for the fiscal
year ending December 31, 2006.  Hence, we did not present a direct
comparison of the results of operations as of December 31, 2007 with the results
for the fiscal year ended December 31, 2006.  The financial condition
discussion therefore focuses on a description of the results of the Company for
the fiscal years ended December 31, 2007 and December 31, 2006.





The
Company does not report its different product lines as segments as defined
by  SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information (“SFAS No. 131”), because we do not allocate our resources
among product lines nor do we measure performance by product line.  We
do not maintain discrete financial information regarding product
lines.  Our sales, marketing and product development efforts among our
different product lines are supported by one integrated group of
individuals.  Additionally, our warehousing costs also reflect support
of all product lines and as such cannot be segmented.


Revenues





The
Company had no revenue for the year ended December 31, 2007.  All of
the revenues are reflected in the results of operations of the
Distributor.





Costs and
expenses




Cost
of Revenues




The
Company had no costs of revenues for the year ended December 31,
2007.  All of the costs of revenues are reflected in the results of
operations of the Distributor.





Operating
Expenses





The
Company had selling, general and administrative expenses of $5.2
million for the year ended December 31, 2007.  The
selling,  general and administrative expenses reflect an allocation
of the public company costs borne by the Distributor on behalf of the
Company.
  Selling,
general and administrative expenses were $20.8 million for the year
ended December 31, 2006 and 17% of net revenues.


22


For the
year ended December 31, 2007, the Company’s 30% equity in the net loss of the
Distributor was $5.6 million.
 
 For the
163-day period from July 22 through December 31, 2006, the Company’s 30% equity
in the net loss of the Distributor was $5.9 million.
 
 Other Income and
Expense
 
 The
Company had net interest income of $0.4 million and other expense of $1.2
million for the year ended December 31, 2007.  Interest income
relates to interest earned on outstanding cash balances, as well as the interest
accrued on the two promissory notes totaling $8.0 million issued by the
Distributor to the Company on September 27, 2007 and November 1, 2007,
respectively.   Other expense of $1.2 million reflects the
re-measurement of the Class W Option Liability .
 
 The
Company had an income tax benefit of $1.7 million for the year ended
December 31, 2007.  As a result of the foregoing, the Company’s net
loss was $14.9 million for the year ended December 31, 2007.
  As of
December 31, 2007, the Company had total net operating loss carry-forwards for
federal and state income tax purposes of $62.9 million and $53.6
million, respectively, which start expiring in 2011 through
2027.  Included in our total net operating loss carryover, is
approximately $17.6 million of net operating losses we inherited as a result of
the AVMC acquisition pertaining mainly to the Wellspring
division.  The utilization of net operating loss carry-forwards may be
limited due to the ownership change under the provisions of Internal Revenue
Code Section 382 and similar state provisions.
 
 The net
increase in our valuation allowance was $1.3 million in 2007, $5.1
million in 2006, and $12.3 million in 2005.  The Company has recorded
a net deferred tax liability relating to its investment in the
Distributor.  The deferred tax liability related to the Distributor is
not offset against the deferred tax assets as the reversal period for this
amount is not considered to be determinable on a more likely than not basis.
Factors that are considered in the evaluation of the recoverability of the
deferred tax asset are continued profitability and our ability to meet our
future forecasts.  In general, any realization of our net deferred tax
asset will reduce the effective tax rate in future periods.
  On July
21, 2006, as a result of the closing of the TWC Transaction, the Company
recorded an extraordinary gain of $54.2 million after taxes.  The
extraordinary gain represents the fair value of the 70% interest in the Company
relinquished in the TWC Transaction, determined by reference to the Company’s
equity market capitalization on July 21, 2006, less the carrying amount of net
assets.
 
 The
Company had interest income of $0.1 million and other income of $0.8
million for the year ended December 31, 2006.   Other income
reflects the re-measurement of the Class W Option
Liability .  Interest income relates to interest earned on
outstanding cash balances, and interest expense was associated with notes
payable that were partially repaid in the first quarter.
  The
Company had income tax expense of $7.3 million for the fiscal year ended
December 31, 2006.
 
 As a
result of the foregoing, the net loss before extraordinary gain was $47.0
million for the year ended December 31, 2006.  Net income was
$7.2 million for the year ended December 31,
2006.


Liquidity
and Capital Resources




The
Company transferred all of its operations in fiscal 2006 to the Distributor, of
which it owned a 30% equity interest.  Net cash provided by operations
was $0.4 million during the year ended December 31, 2007.


Cash used
in investing activities of $8.0 million was attributable to the promissory notes
for two loans provided to the Distributor in the fourth quarter of
2007.  This funding was for the Distributor’s working capital
requirements.


23


Cash
provided by financing activities for the year ended December 31, 2007 was $5.7
million and is comprised of the proceeds from the exercise of warrants and
options.




At
December 31, 2007, the Company had cash balances of $1.8 million.





We may
consider additional issuance of equity and debt financing to fund future growth
opportunities. Although we believe that the Distributor’s expanded product line
offers us the opportunity for significantly improved operating results in future
quarters, no assurance can be given that we will operate on a profitable basis
in 2008, or ever, as such performance is subject to numerous variables and
uncertainties, many of which are out of our control. Although we own a 30%
equity interest in the Distributor, we only have access to the cash on the
Distributor’s balance sheet to the extent that we agree with our partner, TWC
Holdings, to make a distribution to us.  As of December 31, 2007, the
Company had no off-balance sheet arrangements.





THE
DISTRIBUTOR




The
following discussion and analysis of the financial condition and results of
operations of the Distributor should be read in conjunction with the financial
statements of the Company and notes thereto attached to this report. The
discussion contains forward-looking statements that relate to future events or
the Distributor’s future financial performance that involve known and unknown
risks, uncertainties and other factors that may cause the Distributor’s actual
results, levels of activity, performance or achievements to be materially
different from those expressed or implied by the forward-looking
statements.  For additional information concerning these factors, see
the information under the caption “Risk Factors” in Item 1A above.





Results
of Operations of the Distributor





The
discussion in this section reflects the results of operations of the Distributor
for the year ended December 31, 2007.  The TWC Transaction closed on
July 21, 2006.  After the closing of the TWC Transaction,
substantially all of the operating activities previously conducted by the
Company, including the results from releasing TWC products, were transferred to
the Distributor.  Consequently, the results of operations are
reflected in the financial statements of the Distributor.  Since the
TWC Transaction closed mid-calendar year 2006, we did not compare the results of
fiscal 2007 with those of the prior year due to the fact that the Distributor
did not have comparable period reporting financials for the fiscal year ending
December 31, 2006.  We did present, however, a quarterly comparison of
the results of operations for the three-month period ending December 31, 2007 to
the three-month period ending December 31, 2006 and to the three-month period
ending September 30, 2007.




The
Distributor does not report its different product lines as segments as defined
by SFAS No. 131 because it does not allocate its resources among product lines
nor does it measure performance by product line.  The Distributor does
not maintain discrete financial information regarding product
lines.  The Distributor’s sales, marketing and product development
efforts among its different product lines are supported by one integrated group
of individuals. Additionally, the Distributor’s warehousing costs also reflect
support of all product lines and as such cannot be segmented.





Revenues





The
Distributor generated revenue of $474.1 million, net of sales returns, discounts
and allowances of $177.3 million for the fiscal year ended December 31, 2007,
compared to $155.6 million, net of sales returns, discounts and allowances of
$72.0 million, for the period July 22 through December 31, 2006.
 
 Revenues
for the year ended December 31, 2007 were primarily composed of sales of TWC
titles, of which the top five revenue generators were:  Scary Movie 4, Hoodwinked, 1408,
DerailedandHalloween, in addition to sales of branded content, including titles such
as the Christmas Classics
Giftset, under our agreements with Classic Media, WWE®, Sesame Street®,
Arts Alliance and RHI EntertainmentTM.  For the 163 days ended December
31, 2006 the primary TWC titles generating revenues were:  Scary Movie 4, Lucky Number Slevin,
Pulse, Feastand Clerks
2, and sales of branded and proprietary ESPN® and WWE® titles on DVD.
  Consistent
with the operations of other retail product distributors, the Company
historically experienced some degree of sales seasonality.  Subsequent
to the July 21, 2006 completion of the TWC Transaction, sales seasonality is
directly reflected only in the revenues and operations of the Distributor and
indirectly for the Company’s results of operations, through its equity interest
in the Distributor.  Historically the Company observed higher sales
during the last two calendar quarters than during the first two quarters and
expect this trend to continue with the Distributor.


24


In the
past, the Company was subject to higher product returns during the first two
calendar quarters than during the last two calendar quarters. However, historic
changes in revenues may not be indicative of future trends and may not track
industry seasonality norms.


The
Distributor does not have long-term agreements with its customers, nor is it an
exclusive supplier to any of its retail customers.  If any customer
were to reduce or cancel a significant order, it would have a material adverse
effect on its business, results of operations and financial
condition.  For 2007 Wal-Mart and Blockbuster Entertainment accounted
for 34% and 20%, respectively, of the Distributor’s net revenues.  For
the period from July 22, 2006 through December 31, 2006, Wal-Mart accounted for
31% of the Distributor’s net revenues.




Costs and
expenses




Cost
of Revenues




Cost of
revenues consists primarily of the raw material and manufacturing costs of
products sold to customers, packaging and shipping costs, advertising and
marketing expenses, the amortization of the film library, participation and
intangible expenses, and royalties.  Participation expenses that
relate to the TWC Distribution Agreement are accrued in the proportion that the
current year’s revenues for a title bear to management’s estimates of the
ultimate revenues expected to be recognized for the respective
title.





The
Distributor’s total cost of revenues for the year ended December 31, 2007 were
$451.6 million, compared to $168.0 million, for the period July 22 through
December 31, 2006.  Cost of revenues is comprised of the
following:





Manufacturing
and distribution expenses were $113.8 million for 2007, or 24.0% of net revenues
compared to $54.2 million, or 34.9% of net revenues, for the period July 22
through December 31, 2006.  Manufacturing and distribution expenses
were primarily driven by the video release costs of TWC’s titles, several of
which major titles are highlighted in the discussion below of advertising and
marketing expenses.
 
 The
Distributor’s advertising and marketing expenses were $58.2 million for 2007, or
12.3% of net revenues, compared to $24.6 million, or 15.8% of net revenues, for
the period July 22 through December 31, 2006.  In fiscal 2007, these
expenses were principally due to the advertising campaigns for the video release
of TWC’s titles, including: Halloween, 1408, Planet Terror,
Death Proofand Hannibal
Rising.For period July 22 through December 31, 2006,
the advertising campaigns were for the video release of TWC’s
title:  Scary Movie
4, Lucky Number
Slevin, Pulse,
Feast and Clerks
2.  Advertising and marketing expenses are recorded in the
period in which these expenses are incurred.
 
 The
Distributor’s amortization and participation expenses were $279.6 million for
2007, or 59.0% of net revenues, compared to $89.2 million, or 57.4% of net
revenues, for the period July 22 through December 31, 2006.  These
expenses included amortization of libraries, intangibles and participation
expenses related to TWC and other licensors.  Participation expenses
for TWC in fiscal 2007 were $170.7 million, compared to $72.7 million, for the
period July 22 through December 31, 2006.




25




As a
result of the amendment to the TWC Distribution Agreement described in Item 13
below, TWC’s participation expenses in 2007 were impacted by the
following:





i)
            Historically,
      a Direct-to-Video (“DTV”) release under the TWC Distribution Agreement was
      defined as a title that was not released theatrically prior to its initial
      home video release date.  As a consequence of the
      above-mentioned amendment, this definition was amended so that a DTV
      release means any title that was not released theatrically prior to its
      initial home video release date or was released theatrically prior to its
      home video release, but whose U.S. theatrical box office revenue prior to
      its initial home video release date was less than $0.5
      million.  The classification of titles according to the revised
      definition applied both prospectively and retrospectively.  The
      effect of this change was a benefit of $0.8 million to cost of revenues in
      2007.


ii)
            Historically,
      returns processing costs were absorbed by the Distributor under the TWC
      Distribution Agreement.  Pursuant to the above-mentioned
      amendment, TWC and the Distributor agreed that TWC would absorb the cost
      of returns processing both retrospectively and
      prospectively.  The effect of this change was a benefit to the
      Distributor of $2.9 million in 2007 and an additional $1.7 million to be
      recognized in future periods.  TWC revenue and cost of sales are
      recognized upon meeting all recognition requirements of SOP
      00-2.iii)
            Under
      the TWC Distribution Agreement, the video ratio calculation is a
      measurement of the Distributor’s performance in exploiting TWC’s
      titles.  With respect to the year ending December 31, 2007, the
      measurement period is January 1 to December 31, 2007.  The
      “measured films” were those films that were theatrically released after
      November 1, 2005 and had their initial video release during the period
      October 1, 2006 through September 30, 2007.  The “annual video
      ratio” for the measurement period is calculated by dividing the total
      adjusted net contribution for all measured films by the US theatrical box
      office for all such measured films.  The result of this
      calculation was an increase in the Distributor’s fee from 5% to
      6%.  The benefit to the Distributor’s cost of sales for fiscal
      2007 was $2.9 million.  This calculation is not included in the
      SOP 00-2 calculations, as it is considered a “Performance Bonus” and the
      adjusted fee re-sets to 5% for the next fiscal year
  (2008).







Entertainment
Rights PLC, through their affiliate, Classic Media, granted the Distributor a
concession in supply chain-related costs amounting to $1.0 million for the
period ending December 31, 2007.  The resulting concession was a
benefit of $1.0 million to the Distributor’s cost of revenues.




Operating
Expenses




The
Distributor’s general and administrative expenses were $38.4 million, or 8.1% of
net revenues, for the year ended December 31, 2007, compared to $7.6 million, or
4.9% of net revenues, for the period July 22 through December 31, 2006. 
General and administrative expenses primarily relate to payroll, rent,
professional service fees, as well as warrants and options expense. The
increase of $30.8 million in general and administrative expenses in fiscal 2007
over the period July 22 through December 31, 2006 was driven by the following
factors:  (i) increased headcount from an average of 100 employees for
the 163 days ending December 31, 2006, to 219 employees for the year ending
December 31, 2007; (ii) an increase in professional service fees of $ 1.2
million; and (iii) exceptional rent expense due to the rapid expansion of the
Distributor’s business, whereby the Distributor had to lease property on a
month-to-month basis at higher than market rates, until a permanent lease could
be concluded (see Item 2).




Other Income and
Expense





The Distributor
had net interest expense of $1.8 million , or 0.4% of net revenues, compared
to net interest income of $0.3 million, or 0.2% of net revenues, for the period
July 22 through December 31, 2006. Interest income related to interest
earned on outstanding cash balances. For 2007, interest expense related to
interest on outstanding balances due to licensors, to the Company and to the
Distributor’s lender, Société Générale (under the Distributor’s Amended and
Restated Credit Agreement).  For the period July 22 through December
31, 2006, interest expense was primarily associated with notes payable that were
contributed to the Distributor upon the closing of the TWC
Transaction.  The Distributor also had other expense of $1.1 million for
the year ended December 31, 2007 compared to none for the period July 22 through
December 31, 2006. Other expense reflects an impairment to the value of the
Class W Purchased Call Option (included within deposits and
other) .
 
 As a
result of the aforementioned, the Distributor’s net loss was $18.8
million for the year ended December 31, 2007, as compared to a net loss of $19.7
million, for the period July 22 through December 31,
2006.


26


Related Party
Expenses





For the
year ended December 31, 2007, the Distributor had the following related party
expenses:  (i) participation expenses to TWC for a portion of the net
receipts from the sale of TWC DVDs of $170.4 million; (ii) accrued interest
expense on the two promissory notes to the Company of $0.2 million; and (iii)
bonuses, consulting and reimbursable expenses of $0.5 million to Bannon
Strategic Advisors.
 
 For the
period July 22 through December 31, 2006, the Distributor had the following
related party expenses:  (i) participation expenses to TWC of $70.0
million; and (ii) bonuses, consulting and reimbursable expenses of $0.6 million
to Bannon Strategic Advisors.
 Quarterly
Comparisons
 The
year-over-year quarterly comparison compares the financial results of the
Distributor, for the three months ended December 31, 2007 to the three months
ended December 31, 2006.
 
 Revenues
 
 For the
three months ended December 31, 2007, net revenue was $184.9 million as compared
to $75.5 million for the three months ended December 31, 2006, an increase of
$109.4 million, or 145%. This revenue growth was attributable to:  a
stronger slate of TWC films in the fourth quarter of 2007 compared to 2006,
including Planet Terror, 1408, Sicko, Halloween, and Nanny Diaries; revenue from
arrangements with new licensors, primarily Classic Media, WWE®, and Sesame
Street®; and additional revenue from Castalian (acquired in April
2007).
 
 Cost of
Revenues
 
 For the
three months ended December 31, 2007, cost of revenues was $188.7 million as
compared to $89.2 million for the three months ended December 31, 2006, an
increase of $99.5 million, or 112%.  The increase in cost of revenues
in the fourth quarter of 2007 was primarily due to increased marketing and
advertising costs for TWC titles, impairments taken on the film library, royalty
advances and certain intangible assets, offset by a performance bonus of $2.9
million from TWC and other favorable charges of $2.9 million, which
resulted from the TWC Distribution Agreement amendment described in Item 13
below.
 
 General
and Administrative Expenses
 
 For the
three months ended December 31, 2007, general and administrative expenses were
$8.2 million as compared to $7.3 million for the three months ended December 31,
2006, an increase of $0.9 million or 12.3%
 
 The
quarter-over-quarter comparison compares the financial results of the
Distributor for the three months ended December 31, 2007 to the three months
ended September 30, 2007.
 
 Revenues
 
 For the
three months ended December 31, 2007, net revenue was $184.9 million as compared
to $93.4 million for the three months ended September 30, 2007, an increase of
$91.5 million or 98%.  This revenue growth was attributable to
seasonality as well as: a stronger slate of TWC films in the fourth quarter
of 2007 than in the third quarter, including Planet Terror, 1408, Sicko,
Halloween, and Nanny Diaries and revenue from arrangements with new licensors,
primarily Classic Media, WWE®, and Sesame Street®; and additional revenue from
Castalian (acquired in April 2007), compared to the third quarter slate of TWC
titles (Factory Girl, The Ex, and Deathproof); and from the release of Redline
(a theatrical feature film).




27






Cost of
Revenues
 
 For the
three months ended December 31, 2007, cost of revenues was $188.7 million as
compared to $86.6 million for the three months ending September 30, 2007, an
increase of $102.1 million or 118%.  The increase in cost of revenues
in the fourth quarter of 2007 was primarily due to an increase in revenue
generated, $15.3 million of impairments taken on the film library, royalty
advances and certain intangible assets, offset by a performance bonus of $2.9
million from TWC and other favorable charges of $2.9 million, which
resulted from the TWC Agreement amendment in Item 13 below.
 
 General
and Administrative Expenses
 
 For the
three months ended December 31, 2007 general and administrative expenses were
$8.2 million compared to $10.8 million for the three months ended September 30,
2007, a decrease of $2.6 million or 24%.   The decrease in
general and administrative expenses was primarily due a reduction in stock-based
compensation expense of $1.1 million.


Liquidity and Capital Resources




At
December 31, 2007, the Distributor had cash and cash equivalents of $14.2
million, comprised of:  (i) $3.1 million of  cash balances;
(ii) $7.8 million of short-term restricted cash; and (iii) $3.3 million of
long-term restricted cash.  The $7.8 million is part of the
Distributor’s short-term liquid cash balances that had accumulated in a central
lockbox account and can only be disbursed weekly pursuant to the terms of the
“Allocation of Accounts Receivable and Intercreditor Agreement” entered into by
and among  the Distributor, The Weinstein Company, LLC and Société
Générale (“Soc Gen”) dated August 10, 2007.  The $3.3 million is
comprised of:  (a) $3.0 million in a money market account, which is
restricted pursuant to our credit facility with Société Générale and (b) $0.3
million in a certificate of deposit which is securing a letter of credit on the
Distributor’s Broadway lease.
 The
Distributor recorded depreciation expense of $0.4 million, and intangible asset
amortization (excluding film library and product amortization) expense of $6.3
million for the year ended December 31, 2007.
  On August
10, 2007, the Distributor entered into a three-year, senior secured revolving
credit facility (the “Credit Agreement”) with Société Générale (‘‘Soc Gen’’), as
lender and agent. The Credit Agreement provides for an initial commitment of $30
million and up to a total of $70 million.  On November 1, 2007, the
Distributor, Soc Gen and Alliance Leister entered into the Amended and Restated
Credit Agreement (the “Amended Credit Agreement”), which increased the total
commitment to $50 million, based on expected incremental commitments. Borrowings
under the Amended Credit Agreement are based upon a borrowing base that includes
certain of the Distributor’s accounts receivable from licensors other than TWC
and certain of the Distributor’s film rights. The Amended Credit Agreement
terminates on June 30, 2010, and may be extended to August 10, 2010, under
satisfaction of certain conditions. Voluntary prepayments and commitment
reductions are permitted at any time upon proper notice.  Borrowings
under the Amended Credit Agreement are based on LIBOR or the higher of Soc Gen’s
prime rate or the Federal Funds Rate plus 0.50% and vary depending on the
percentage of loans outstanding. The interest rate varies from 2.5% to 3.0%
above LIBOR for Eurocurrency loans and 1.5% to 2.5% above the prime rate or
Federal Funds Rate plus 0.50% for base rate loans. Quarterly commitment fees of
0.50% are due on the unused portion of the commitment.  The Amended
Credit Agreement contains operating covenants customary for facilities of this
type, including, among other things, (i) limitations on indebtedness, liens,
sales of assets, mergers, investments, dividends and redemptions, and (ii)
minimum liquidity and borrowing base coverage requirements. In the event of a
default, the interest rate on all borrowings will be increased and payment of
all borrowings may be accelerated and/or the commitments may be
terminated.  Upon the occurrence of certain events of default, all
amounts payable under the Amended Credit Agreement automatically become
immediately due and payable and the lenders’ commitments will automatically
terminate.  Borrowings outstanding under the Amended Credit Agreement
were $31 million at December 31, 2007. The maximum amount available at December
31, 2007 was $32.8 million.  The obligations of the Distributor under
the Amended Credit Agreement are guaranteed by the Company and the direct and
indirect subsidiaries of the Distributor.  Soc Gen holds a security
interest in substantially all personal property of the Company, the Distributor,
and its direct and indirect subsidiaries, other than TWC accounts receivable.
TWC continues to have a first priority security interest in accounts receivable
attributable to TWC content.
  Pursuant
to the Amended Credit Agreement, the Distributor is required, on a quarterly
basis, to provide Soc Gen with a certificate (a “Compliance Certificate”)
evidencing the Distributor’s compliance with the covenants included in the
Amended Credit Agreement.  In preparing such Compliance Certificate,
the Distributor performs an analysis of all debt covenants included in the
Amended Credit Agreement in order to ensure that the Distributor is operating
within the terms thereof.  Such an analysis was performed for the
fiscal quarter ending December 31, 2007.  Based on such analysis, the
Distributor determined that as of December 31, 2007, the Distributor was in
compliance with all such debt covenants.


28


As part
of the Amended Credit Agreement, the following agreements, among others, were
also entered into by the Distributor and Soc Gen: (i) Amendment No. 1 to
Allocation of Accounts Receivable and Intercreditor Agreement; and (ii)
Reaffirmation of Guaranty Agreement (see Item 15:  exhibits
10.66-10.69 and 10.71-10.73).  At December 31, 2007 the Distributor
had $31.0 million outstanding under the Credit Agreement.  For
complete details on the Amended Credit Agreement’s terms and obligations, see
Note 10 of the Distributor's Financial Footnotes and Disclosures and
the related exhibits.
 The
Distributor incurred $1.9 million in financing costs related to securing the
Credit Facility with Soc Gen.  Deferred financing costs are being
amortized over the term of the arrangement.  The Distributor recorded
$0.2 million in interest expense related to deferred financing costs during
fiscal year 2007.
 On
September 27, 2007, the Distributor borrowed $6.0 million from the Company and
issued a promissory note in favor of the Company in the principal amount of $6.0
million.  On November 1, 2007, the Distributor borrowed an additional
$2.0 million from the Company and issued a promissory note in favor of the
Company in the principal amount of $2.0 million.  Under each of the
aforementioned notes, interest is due on the unpaid principal balance at a
monthly rate equal to the LIBOR Rate (as defined in the notes) plus five percent
(5%) until paid.  The principal and accrued interest under the
notes was originally due and payable on demand at any time after March
31, 2008.  On March 16, 2008, the Company's Board of Directors
approved amendment to each of the aforementioned notes pursuant to which
principal and accrued interest under the notes would be due and payable on
demand at any time after January 1, 2009. In the event payment of principal or
interest due under the notes is not made when due, the outstanding principal
balance will bear interest at the rate of two percent (2%) above the interest
rate which is otherwise provided under the notes for so long as such event
continues. If the notes are not paid when due, the Distributor agreed to pay the
Company’s reasonable costs of collection, including, without limitation, all
reasonable attorneys’ fees and all reasonable expenses actually incurred by the
Company in connection with such collection efforts.  The principal
amount of the notes may be prepaid in whole or in part, provided that all
accrued interest on the amount to be prepaid is also paid at such
time.  The proceeds from the notes were used to pay amounts owed by
the Distributor to TWC under the TWC Distribution Agreement.  As of
December 31, 2007, an aggregate of $8.2 million in principal and accrued
interest expense was outstanding under the notes.  As of February 29,
2008, a further $0.1 million of accrued interest expense was outstanding under
the notes.
 Net cash
used by operations during the year ending December 31, 2007 was $33.3 million,
primarily due to increases in net accounts receivable and decreases in
remittances due to licensors.  These items are primarily attributable
to the release of TWC titles.  Accounts receivable relates to sales of
the following titles:  Halloween, Nanny Diaries, Who’s Your
Caddy?, The Last LegionandThe Hunting Party,and the
release of Classic Media, WWE®, Sesame Street®, Arts Alliance and RHI
EntertainmentTMtitles during the year ending December 31, 2007.  At December
31, 2007, Wal-Mart and Target comprised 36% and 12%, respectively, of accounts
receivable before allowances.  Accrued expenses at December 31, 2007
primarily relate to invoices received but not paid for the production of
inventory and sales and marketing expenses related to Planet Terror, 1408,Sicko, Halloween, NannyDiariesandWho’s Your Caddy?.  The remittance
to licensor primarily represents the amount owed to TWC after deducting the
related cost of revenues, marketing costs, and the Distributor’s distribution
fee from net sales of TWC titles during the year ending December 31, 2007. Under
the terms of the TWC Distribution Agreement, the Distributor is required to pay
TWC after collection of receipts, the amount of which is determined by net
revenue, which as of December 31, 2007 had not been collected. However, the
Distributor bears the risk of accounts receivable collections. Allowance for
doubtful accounts and provision for returns increased primarily as a result of
reserves for returns related to TWC titles.  In the fourth quarter of
2007, the Distributor signed a $1.0 million 5-year long-term debt obligation
with IBM related to the planned ERP implementation of SAP
software.  As of December 31, 2007, the Distributor had a
net loss of $18.8 million.
  Net cash
used in investing activities for the year ending December 31, 2007, was $4.0
million, primarily attributed to the April 1, 2007 acquisition of 100% of the
membership interest of:  (i) The Thirteen-Thirty-One LLC, the sole
member of Castalian LLC (dba Castalian Music) and (ii) Castalian DC, LLC, a
fully integrated direct response TV marketing and fulfillment service for the
music and video entertainment industry, from EMI North America for $3.7 million
in cash.  Of this acquisition cost, approximately $0.2 million was for
legal, appraisal and commission expenses.
 
 Net cash
provided in financing activities for the year ending December 31, 2007 was $32.0
million, primarily attributable to the Amended and Restated Credit Agreement
with Société Générale.
  Cash used
in investing activities for the 163 days ending December 31, 2006 was $4.6
million, resulting from operating costs incurred by the Distributor to provide
certain services to the Company.
 
 Net cash
used in financing activities for the 163 days ending December 31, 2006 was $1.3
million.
 
 At
December 31, 2006, the Distributor had cash and cash equivalents of $8.3 million
and $0.3 million in long-term restricted cash required by the Distributor’s
lease agreement for its 2230 Broadway facility.
  The
payment terms with TWC are due 45 days from the last day in the calendar month.
As needed, these terms are extended anywhere from 15 to 45 days in order to
provide flexibility and manage cash flows. The Distributor expects TWC to
continue to provide such flexibility through at least December 31,
2008.
  The
Distributor may consider additional issuances of debt financing to fund future
growth opportunities. Although we believe that the Distributor’s expanded
product line offers the opportunity for significantly improved operating results
in future quarters, no assurance can be given that we or the Distributor will
operate on a profitable basis in 2008, or ever, as such performance is subject
to numerous variables and uncertainties, many of which are out of our or the
Distributor’s control.
  29


The table
below summarizes information as of December 31, 2007 regarding certain future
minimum contractual obligations and commitments for the next five
years.





Contractual
Obligations:




($
      in thousands)2008
                
                
                2009
                
                
                2010
                
                
                2011
                
                
                2012
                
                
                Thereafter
                
                
                TotalRoyalty
      advances
                
                $
                31,209
                
                
                $
                13,285
                
                
                $
                5,250
                
                
                $
                5,500
                
                
                $
                -
                
                
                $
                -
                
                
                $
                55,244Operating
      Lease Obligations
                
                
                1,311
                
                
                
                3,085
                
                
                
                3,148
                
                
                
                2,370
                
                
                
                2,305
                
                
                
                15,648
                
                
                
                27,867Long-Term
      Debt Obligation
                
                
                313
                
                
                
                313
                
                
                
                314
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                940Purchase
      Obligations
                
                
                353
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                353Capital
      Lease Obligations
                
                
                30
                
                
                
                30
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                60Total
                
                $
                33,216
                
                
                $
                16,713
                
                
                $
                8,712
                
                
                $
                7,870
                
                
                $
                2,305
                
                
                $
                15,648
                
                
                $
                84,464




ITEM 7A.    QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK





As of
December 31, 2007, the Distributor’s cash and cash equivalents were invested
with financial institutions with investment grade credit ratings. Due to the
short duration of the Distributor’s investment portfolio and the high quality of
the Distributor’s investments, an immediate 10% change in interest rates would
not have a material effect on the fair market value of the Distributor’s
portfolio. Therefore, we would not expect the Distributor’s operating results or
cash flows to be affected to any significant degree by the effect of a sudden
change in market interest rates on the Distributor’s investment
portfolio.





Neither
we nor the distributor enter into hedging or derivative instrument
arrangements.




ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA





The
Consolidated Financial Statements of Genius Products, Inc. and Genius Products,
LLC, together with the reports thereon of Ernst & Young LLP, are
incorporated herein by reference and contain the following:




Genius
      Products, Inc.Reports
      of Ernst & Young LLP
              F-1Report
      of Singer Lewak Greenbaum & Goldstein LLP
              F-3Consolidated
      Genius Products, Inc. Balance Sheets as of December 31, 2007 and
      2006.
              F-4Consolidated
      Genius Products, Inc. Statements of Operations for the Years Ended
      December 31, 2007, 2006 and 2005.
              F-5Consolidated
      Genius Products, Inc. Statements of Stockholders’ Equity for the Years
      Ended December 31, 2007, 2006 and 2005.
              F-6Consolidated
      Genius Products, Inc. Statements of Cash Flows for the Years Ended
      December 31, 2007, 2006 and 2005.
              F-7Notes
      to Genius Products, Inc. Consolidated Financial
Statements.
              F-9Schedule
      II Valuation and Qualifying Accounts
              F-32Genius
      Products, LLCReport
      of Ernst & Young LLP
              F-34Consolidated
      Genius Products, LLC Balance Sheet as of December 31, 2007 and
      2006.
              F-35Consolidated
      Genius Products, LLC Statements of Operations for the Year Ended December
      31, 2007 and the Period from July 22 through December 31,
      2006.
              F-36Consolidated
      Genius Products, LLC Statements of Member's Deficit for the Year
      Ended December 31, 2007 and the Period from July 22 through December 31,
      2006.
              F-37Consolidated
      Genius Products, LLC Statements of Cash Flows for the Year Ended December
      31, 2007 and the Period from July 22 through December 31,
      2006.
              F-38Notes
      to Genius Products, LLC Consolidated Financial Statements.
              F-39




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





None.


30


ITEM 9A.    CONTROLS AND
PROCEDURES





Evaluation
of Disclosure Controls and Procedures





In
connection with the preparation of this Annual Report on Form 10-K, an
evaluation was carried out by the Company’s management, with the participation
of the Company’s Chief Executive Officer and Chief Financial Officer, of the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange
Act)) as of December 31, 2007. Disclosure controls and procedures are designed
to ensure that information required to be disclosed in reports filed or
submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in SEC rules and forms and that such
information is accumulated and communicated to management, including the Chief
Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosures.





During
the evaluation of disclosure controls and procedures as of December 31, 2007
conducted during the preparation of the Company and Distributor’s financial
statements to be included in this Form 10-K, several material weaknesses in
internal controls were identified.  As a result of these material
weaknesses, described more fully below, the Company’s Chief Executive Officer
and Chief Financial Officer concluded that, as of December 31, 2007, our
disclosure controls and procedures were ineffective.





In light
of the material weaknesses described below, we performed additional analyses and
other procedures to ensure that our consolidated financial statements included
in this Annual Report were prepared in accordance with generally accepted
accounting principles in the United States (“GAAP”). These measures
included, among other things, expansion of our year-end closing procedures,
including the expanded review and analysis of the accounting between the Company
and the Distributor, dedication of significant internal resources and external
consultants to scrutinize account analyses, reserve estimates, asset valuations,
proper accounting treatment for revenues and expenses and account
reconciliations at a detailed level. Notwithstanding the existence of these
material weaknesses in internal controls, the Company believes that the
consolidated financial statements in this Annual Report on Form 10-K fairly
present, in all material respects, our consolidated balance sheets as of
December 31, 2007 and 2006, and the related consolidated statements of
operations, stockholders’ equity, and cash flows for the years ended December
31, 2007, 2006 and 2005 in conformity with GAAP.





Management’s
Report on Internal Control Over Financial Reporting





Our
management, under the supervision of our Chief Executive Officer and Chief
Financial Officer, is responsible for establishing and maintaining adequate
internal control over financial reporting. Internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with GAAP.  Internal control over
financial reporting includes policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the Company, (ii) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP, and that receipts
and expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company, and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company’s assets that could have a
material effect on the financial statements.





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





Company
management conducted an assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2007 based on the criteria
established in Internal Control — Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).  Based
on this assessment, we have determined that we did not maintain effective
internal controls over financial reporting as of December 31,
2007.


31


A
material weakness is “a deficiency, or a combination of deficiencies (within the
meaning of PCAOB Auditing Standard No. 5), in internal control over financial
reporting, such that there is a reasonable possibility that a material
misstatement of the Company’s annual or interim financial statements will not be
prevented or detected on a timely basis.”





Company
management has concluded that, as of December 31, 2007, the following material
weaknesses existed at both the Company and the Distributor:





·
              Timely and
      routine financial statement close/reportingprocess
      and the entity level controls surrounding this process.

                  We were unable
      to execute a timely financial close, nor were we able to properly
      accumulate certain analyses and reconciliations in a consistent and
      accurate manner, allowing for the proper application of GAAP. In addition
      management did not adequately supervise the financial close and reporting
      process which resulted in material post-closing audit
      adjustments.  Furthermore, the Company was unable to timely and
      properly calculate its computation of its equity in the net loss of the
      Distributor.





·
              Calculation
      of expenses related to stock compensation.

                  We
      were unable to properly accumulate, analyze and compute stock compensation
      during the fiscal year as the Company and Distributor lacked the
      appropriate financial personnel to undertake this computation.  As a
      direct result of this lack of experienced personnel, material stock
      compensation post-closing audit adjustments were noted during each quarter
      and year-end
close.





·
              Formal
      processes over change management and access procedures related to our
      information technology systems.

                  We
      were unable to properly implement and maintain an effective information
      technology operating environment. In addition, we did not properly
      maintain access or program change controls related to our critical
      information technology systems including the General Ledger system and
      Order Processing/Management
    system.




Also, our
management has found additional material weaknesses specifically related to the
Distributor:





·
              Revenue
      recognition process; specifically, our controls in the areas of allocating
      and tracking Market Development Funds (“MDF”) Spending.

                  The Distributor has not fully implemented a
      formalized process and related controls to determine the appropriate
      classification of MDF related expenses.  Due to this weakness,
      there is a reasonable possibility that the Distributor could materially
      record revenue improperly or misclassify MDF related expenses in its
      statements of
operations.





·
              Licensor
      participations expense and related liabilities, and film library
      amortization.

                  The
      analyses and models utilized by the Distributor to calculate licensor
      participation expense and film library amortization and impairment
      pursuant to the provisions of SOP 00-2 "Accounting by Producers or Distributors of
      Films" utilized incorrect
      data and assumptions which resulted in material audit adjustments at each
      quarter-end and year-end
  close.





·
              Management’s
      estimation and forecasting process as it relates to our inventory
      obsolescence reserve.

                  In
      calculating the Distributor’s inventory obsolescence, management utilized
      incorrect projections which resulted in a material audit adjustment being
      recorded.




The
effectiveness of our internal control over financial reporting as of December
31, 2007 has been audited by Ernst & Young LLP, an independent registered
public accounting firm, as stated in their report which is included
herein.


32


Remediation
of Material Weaknesses in Internal Control Over Financial Reporting During
2007





A
significant number of the above noted material weaknesses were reported as of
December 31, 2006 and have remained in effect throughout fiscal year 2007. Our
management has undertaken the following actions to remediate these material
weaknesses:





·
            Engaged
      a nationally recognized accountancy firm, to establish, document and test
      our key internal controls in order for management to effectively assess
      the internal control environment and all its related
    aspects.


·
            Added
      additional accounting and financial personnel with industry experience,
      including an experienced financial executive to oversee internal controls
      and procedures and implement a formal closing
  process.


·
            Established
      formal processes and procedures including a review conducted by management
      to ensure appropriate documentation and analyses for all significant
      reserve estimates.


·
            Engaged
      the services of an independent stock administration firm to assist with
      transactions, recordkeeping and the computation of compensation expense
      related to the Company and its Distributor’s stock options, and allocated
      an individual within the organization to oversee the administration of
      stock options and performed a review of stock option grants to ensure
      accuracy of the information.


·
            Refined
      our licensor participation calculation model with a more sophisticated one
      that properly extracts data from our general ledger system, instituted
      more detailed review processes, and plan to upgrade to an enterprise
      relationship planning and budgeting system in fiscal
  2008.


·
            Implemented
      a periodic review process to assess the recoverability of amounts invested
      in specific licensor and co-production
deals.


·
            Retained
      a third party valuation firm to value specific assets including intangible
      assets such as the Distributor’s film
      library and allocated personnel to ensure that certain asset and liability
      accounts are properly reviewed and analyzed for
    realizability.


·
            Recruited
      and hired additional information technology professionals to ensure that
      the information technology operating systems are operating effectively and
      to formalize user access issues
noted.


·
            Began
      the process of sourcing an effective Customer Relationship Management
      System to increase controls and oversight over MDF costs to ensure proper
      revenue recognition and
classification.


·
            We
      will continue to strengthen our accounting and finance department through
      recruiting efforts underway to fill the Chief Accounting Officer and
      Controller positions.





Notwithstanding
the existence of these material weaknesses in internal controls, we believe that
the consolidated financial statements fairly present, in all material respects,
our consolidated balance sheets as of December 31, 2007 and 2006 and
the related consolidated statements of operations, stockholders’ equity, and
cash flows for the years ended December 31, 2007, 2006 and 2005 in
conformity with GAAP.








ITEM 9B.    OTHER
INFORMATION





None.


33


PART
III




ITEM 10.    DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE





Management





The
following table sets forth certain information with respect to each of our
directors and executive officers, and each of the executive officers of the
Distributor, as of February 29, 2008.





NAME
            AGE
            POSITIONStephen
      K. Bannon
            54
            Director,
      ChairmanTrevor
      Drinkwater
            41
            President
      and Chief Executive Officer of the Company, Chief Executive Officer of the
      Distributor, DirectorBradley
      A. Ball (1) (2) (3)
            57
            DirectorHerbert
      Hardt (1) (2) (3)
            64
            DirectorLarry
      Madden
            42
            DirectorIrwin
      Reiter
            49
            DirectorJohn
      Mueller
            45
            Executive
      Vice President and Chief Financial Officer of the Company and the
      DistributorMatthew
      Smith
            46
            President
      of the DistributorMitch
      Budin
            42
            Executive
      Vice President and General Manager of the DistributorEd
      Byrnes
            63
            Executive
      Vice President, Finance, Systems and Information Technology of the
      DistributorChristine
      Martinez
            41
            Executive
      Vice President of Corporate Strategy of the DistributorMichael
      Radiloff
            44
            Executive
      Vice President of Productions and Acquisitions of the
      DistributorRodney
      Satterwhite
            43
            Executive
      Vice President of the Distributor




(1)        
Member of
audit committee.


(2)         Member
of compensation committee.





(3)         Member
of nominating committee.





Stephen K. Bannon was
appointed as a Director and Chairman of the Board of the Company in March 2005
in connection with our acquisition of American Vantage Media Corporation
(“AVMC”).  Mr. Bannon has also served as an outside consultant to the
Company since July 20, 2006.  Mr. Bannon served as the Chief Executive
Officer of AVMC from May 2004 until our acquisition of AVMC in March
2005.  From January 2004 to April 2004, Mr. Bannon provided executive
and management services to AVMC as a consultant.  From April 2002 to
December 2003, Mr. Bannon served as Head, Strategic Advisory Services for The
Firm, a leading talent management company in the entertainment and media
industries.  Prior to that, from April 1990 to July 1998, he served as
Chief Executive Officer of Bannon & Company, Inc., an investment banking
firm specializing in the entertainment, media and communications
industries.  In July 1998 Bannon & Company Inc. was sold to
Société Générale and Mr. Bannon became head of The Media and Entertainment Group
as part of this transaction.   Mr. Bannon began his investment
banking career in 1984 with Goldman Sachs, Inc., where he worked as a Mergers
and Acquisitions Investment Banker until 1990.  Mr. Bannon was
appointed Chairman of the Board of Points International in February
2007.  Mr. Bannon has a Masters of Arts from Georgetown University and
an MBA from Harvard Business School where he graduated with
honors.  Mr. Bannon was a Naval Officer for seven years from 1976-1983
including four years of sea-duty aboard the USS Paul F. Foster
“DD964”.  Mr. Bannon was awarded the Navy Expedition Medal in 1981 for
service in the Persian Gulf during the Iranian Hostage Crisis.


34


Trevor Drinkwater has served
as a director of the Company since July 21, 2005 and has served as the Company’s
President and Chief Executive Officer since February 2005.  Mr.
Drinkwater has also served as the Chief Executive Officer of the Distributor
since the closing of the TWC Transaction on July 21, 2006  and was
President of the Distributor from July 21, 2006 through January 2,
2008.  From July 2004 to February 2005, Mr. Drinkwater served as the
Company’s Executive Vice President of DVD Sales.  Prior to that, he
served as Chief Operating Officer of Take-Two Interactive Software, Inc. from
2003-2004, Senior Vice President of Sales & Sales Operations at Warner Home
Video, Inc. from 1999-2003 and worked for The Perrier Group of America, now
known as Nestle Waters, from 1989-1999, where he started in field sales and
progressed to General Manager.





Bradley A. Ball has served as
a director since December 12, 2006.  Mr. Ball is currently Vice
President of Entertainment and Marketing for NASCAR and the NASCAR Media Group,
a position he accepted in February 2008.  Most recently Mr. Ball
served as Senior Partner at Moroch, a full-service advertising firm, where he
has served since early 2007.  Prior to that, Mr. Ball served as
President of Warner Bros.’ Domestic Theatrical Marketing
division.  While at Warner Bros., he directed all areas of film
marketing for Warner Bros.’ North American operations and the release of over 90
films, including “You’ve Got Mail,” “The Matrix” and “Harry Potter and the
Sorcerer’s Stone.”  He also served as Chairman of the Time Warner
Marketing Council, integrating all divisions of Warner Bros. in cross-divisional
marketing efforts to maximize efforts resulting from the AOL-Time Warner
merger.  Further, Mr. Ball was a key player in Warner Bros.’ first
entry into “original” IMAX content, spearheading production and corporate
sponsorship for the film “NASCAR 3D, the IMAX Experience.”  Before
joining Warner Bros., Mr. Ball worked as Senior Vice President and Chief
Marketing Officer for McDonald’s Corporation’s domestic
business.  During his tenure at McDonald’s, he directed U.S. marketing
plans for over 10,000 restaurants, 2,800 franchises and their multiple agency
system.  His contributions included being co-architect of the Disney
and McDonald’s global alliance, the Atlanta Olympics campaign, numerous Super
Bowl advertisements and the launch of McDonald’s “Did Somebody Say McDonald’s?”
branding campaign.  Mr. Ball began his career at Davis, Johnson, Mogul
and Colombatto, a Los Angeles based advertising agency where he worked his way
to partner.




Herbert Hardt has served as a
director since October 2005.  Mr. Hardt has been a principal of
Monness, Crespi, Hardt & Co., Inc. since 1980.  From 1976 to 1979,
he served as Vice President of Fidelity Management and Research
(Bermuda).  Mr. Hardt worked at Fidelity Management and Research in
Boston, first as an analyst and then as fund manager of Essex Fund and Trend
Fund from 1971-1976.  Mr. Hardt received his Bachelor of Arts with a
Concentration in Engineering and Applied Physics from Harvard College in 1965
and his Master of Business Administration from Harvard University in
1971.  He also attended graduate school in applied mathematics at the
University of Bern in Bern, Switzerland.  From 1966-1969, Mr. Hardt
served in the military with the 82nd
Airborne Division.  Mr. Hardt also serves on the board of directors of
E-Room Systems.





Larry Madden has served as a
director since July 21, 2006.  Mr. Madden has served as Executive Vice
President and Chief Financial Officer of The Weinstein Company since July
2005.  From March 2005 to June 2005, Mr. Madden served as President,
Digital Media Solutions for Loudeye Corp., a supplier of white label music
platforms and business-to-business digital media distribution
services.  During his tenure at Loudeye, he also served as Executive
Vice President and Chief Financial Officer from March 2004 to March
2005.  Prior to this, Mr. Madden served as Executive Vice President,
Chief Financial Officer and Chief Administrative Officer for EMAK Worldwide,
Inc., a Los Angeles based provider of integrated marketing services, from
November 2000 to January 2004.  He also served as Executive Vice
President and Chief Financial Officer for Atomic Pop, an online music
distribution and marketing venture, and as Senior Vice President and Chief
Financial Officer for the recorded music and publishing investments of
Wasserstein Co., Inc., an investment bank.  Earlier in his career, Mr.
Madden held executive financial roles at Def Jam Recordings and PolyGram
International.  He began his career with Ernst &
Young.


35


Irwin Reiterhas served as a
director since July 21, 2006.  Mr. Reiter has served as The Weinstein
Company’s Executive Vice President of Accounting and Financial Reporting since
October 2005.  Prior to joining The Weinstein Company, Mr. Reiter held
various positions at Miramax Films from 1989-2005, including Controller, Chief
Financial Officer and Executive Vice President of Accounting and Financial
Reporting.  During his tenure at Miramax, Mr. Reiter was responsible
for all aspects of general ledger and financial reporting as well as overseeing
the participation reporting department.  He worked on all financial
aspects of The Weinstein Company including key vendor relationships, key
licensing relationships as well as overseeing the financial reporting and
accounting department.  Prior to working for Miramax, Mr. Reiter held
the position of Manager of Financial Reporting at Tri-Star Pictures from
1985-1989.  Mr. Reiter is a CPA with an MBA in Finance from Hofstra
University.
  John Mueller has served as
the Company’s Executive Vice President and Chief Financial Officer since
February 1, 2006.  Mr. Mueller has also served as the Chief Financial
Officer of the Distributor since the closing of the TWC Transaction on July 21,
2006.  Mr. Mueller joined the Company from Jefferies & Company,
Inc., where he served as Senior Vice President of Media and Entertainment
Investment Banking in New York.  Prior to Jefferies, Mr. Mueller
worked for Credit Suisse First Boston in New York and SG Cowen in Los Angeles
advising entertainment and media companies from a broad range of sectors
including filmed entertainment, video games and Internet media.  Mr.
Mueller began his career in corporate finance at Kimberly-Clark Corporation, a
Fortune 500 consumer packaged goods company.





Matthew Smithhas served as
the Distributor’s President since January 2, 2008.  Prior to joining
the Distributor, Mr. Smith served as Senior Vice President for Media Development
& Studios for Blockbuster Inc. (“Blockbuster”) since August
2007.  Mr. Smith joined Blockbuster in 1990 and during his tenure
served in a variety of executive positions, including International Product
Director from 1998 to 2001, Vice President of Studio Relations &
International Merchandising from 2001 to 2003, Senior Vice President and General
Manager, Content from 2003 to 2005 (during which he was responsible for
Blockbuster’s studio agreements on a worldwide basis) and Senior Vice President,
General Merchandising Manager from 2005 to August 2007 (during which he was
responsible for all aspects of the merchandising of Blockbuster’s
products).  In addition, he managed DEJ Productions, the Blockbuster
entity that produced such films as Oscar® winning movies “Monster” and “Crash.”
Prior to joining Blockbuster, Mr. Smith worked in the entertainment industry
with both EMI and RCA.





Mitch Budin has served as the
Distributor’s Executive Vice President and General Manager since December 5,
2007.  Prior to that, Mr. Budin served as the Distributor’s Executive
Vice President of Sales since the closing of the TWC Transaction on July 21,
2006.  Mr. Budin also served as the Company’s Executive Vice President
of Sales from January 6, 2006 through July 20, 2006.  Mr. Budin joined
us from Dreamworks SKG, where he served as Head of Sales North America, Home
Entertainment division, for over five years.  At Dreamworks, Mr. Budin
was instrumental in developing sales and marketing strategies and launching some
of the industry’s biggest selling DVDs, including Madagascar, Gladiator, Shrek,
Shrek 2 and Shark Tale, among others.  He joined Dreamworks from
Warner Home Video, where he held a number of sales and sales management
positions during his nine-year tenure.  Budin received his BS from
Towson University.





Ed Byrneshas served as the
Distributor’s Executive Vice President, Finance, Operations, and Information
Technology since March 5, 2007.  Mr. Byrnes joined the Distributor
from Warner Bros., where during a 30-year tenure with Warner Bros. he served in
a number of senior positions in both the music and filmed entertainment groups,
most recently serving as Executive Vice President, Worldwide Finance, Systems
and IT, a position he had held since 2000.  In 1980, Mr. Byrnes was
instrumental in the creation of Warner Bros.’ International Home Entertainment
group, initially setting up the UK company, thereafter managing the EMEA region
(Europe, Middle East and Africa) and, from 1985 through 2000, serving as
International Executive Vice President and General Manager.





Christine Martinezhas served
as the Distributor’s Executive Vice President of Corporate Strategy since
December 5, 2007.  Prior to that, Ms. Martinez served as the
Distributor’s Executive Vice President and General Manager since the closing of
the TWC Transaction on July 21, 2006.  Ms. Martinez also served as the
Company’s Executive Vice President and General Manager from September 2005
through July 20, 2006.  Prior to joining us, Ms. Martinez was a Sales
and Marketing Executive at Warner Home Video from April 1996 to May
2005.  Her last executive appointment with Warner Home Video was as
Vice President, Marketing – Non Theatrical, from November 2003 until her
departure from the company.  Ms. Martinez also had a three-year tenure
in sales, from March 1993 to April 1996, with WEA Corp., a former Time Warner
division.  Ms. Martinez holds a BBA from the University of Texas at
Austin.


36


Michael Radiloffhas
served as the Distributor’s Executive Vice President of Productions and
Acquisitions since December 5, 2007.  Prior to that, Mr. Radiloff
served as the Distributor’s Executive Vice President of Marketing since the
closing of the TWC Transaction on July 21, 2006.  Mr. Radiloff also
served as the Company’s Executive Vice President of Marketing from October 2005
through July 20, 2006.  Mr. Radiloff is a senior marketing executive
with 16 years of entertainment and packaged goods marketing experience with
industry-leading companies.  He was most recently at Warner Home Video
as Vice President of Theatrical Catalog Marketing from May 2001 to September
2005 and as Director of DVD Marketing from March 2000 to April
2001.  As the person responsible for releasing Warner’s vast film
library onto DVD, Mr. Radiloff launched over 100 new DVD releases
annually.  Prior to that, he worked as a Brand Marketing Manager at
Disney Interactive and Activision.  Mr. Radiloff holds an MBA from
Stanford Graduate School of Business.





Rodney Satterwhite has served
as the Distributor’s Executive Vice President since December
2007.  Prior to that, Mr. Satterwhite served as the Distributor’s
Executive Vice President and Chief Operating Officer since the closing of the
TWC Transaction on July 21, 2006.  Prior to that, Mr. Satterwhite had
served as the Company’s Executive Vice President since November 2005, after
serving as our Executive Vice President of Operations from April 2005 to
November 2005 and our Vice President, Sales Services from July 2004 to April
2005.  Mr. Satterwhite has over 22 years of management experience in
entertainment and retail operations, merchandising and
strategy.  While at Giant Foods Inc. from October 1986 to May 1998 he
gained management experience in the areas of manufacturing, sourcing,
distribution, cost accounting, finance, merchandising and category
management.  He spent more than five years as an executive at Warner
Bros., from May 1998 to February 2004, where he was responsible for developing
category management processes as well as revamping non-traditional video markets
and rental strategies.  From February 2004 to July 2004, before
joining us, he was responsible for revamping trade marketing, sales planning and
analysis, inventory/supply and customer service as Take-Two Interactive
Software, Inc.’s Vice President of North American Sales Services.





Board
Composition and Committees





Our Board
of Directors is currently comprised of six directors and currently has three
committees: an audit committee, a compensation committee and a nominating
committee.





The audit
committee currently consists of Messrs. Hardt and Ball.  Our Board of
Directors has determined that Mr. Hardt is an audit committee financial expert
as defined under applicable rules of the SEC, and that Messrs. Hardt and Ball
are independent under the rules applicable to NASDAQ listed
companies.  The audit committee, among other things, reviews the scope
and results of the annual audit and other services provided by our independent
auditors and reviews and evaluates our accounting policies and systems of
internal controls.  Our Board of Directors has adopted a written
charter for the audit committee, which establishes operating guidelines for the
audit committee.





The
compensation committee currently consists of Messrs. Hardt and
Ball.  The compensation committee, among other things, reviews and
approves the salaries, bonuses and other compensation payable to our, and the
Distributor’s, directors, executive officers and employees and administers and
makes recommendations concerning our employee benefit plans.





The
nominating committee currently consists of Messrs. Ball and
Hardt.  The nominating committee is responsible for administering our
corporate governance systems, recommending proposed new members of our Board of
Directors, evaluating the independence of our current and prospective directors,
and reviewing the suitability of each member of our Board of Directors for
continued service.  Our Board of Directors adopted a written charter
for the nominating committee in June 2007.





It is the
nominating committee’s policy to consider candidates recommended by
stockholders.  If a stockholder wishes to submit a candidate for
nomination to our Board of Directors, the stockholder should send a written
notice to our Secretary, at 2230 Broadway, Santa Monica, California 90404, Attn:
Corporate Secretary.  It is the nominating committee’s policy to
evaluate candidates proposed by stockholders using the same criteria as for
other candidates.  The following are among the qualifications that our
nominating committee considers when evaluating and selecting candidates for
nomination to our Board of Directors:  (i) experience in business,
finance or administration; (ii) familiarity with our industry; (iii) prominence
and reputation; and (iv) whether the individual has sufficient time available to
devote to the work of the Board of Directors and one or more of its
committees.


37


In
addition, our Board of Directors expects nominees to possess certain core
competencies, some of which may include broad experience in business, finance or
administration, familiarity with national and international business matters,
and familiarity with our industry.  In addition to having one or more
of these core competencies, board member nominees are identified and considered
on the basis of knowledge, experience, integrity, diversity, leadership,
reputation and ability to understand our business.





Code
of Ethics





Our Board
of Directors has adopted an Amended and Restated Code of Ethics that applies to
all of our directors, principal executive officer, principal financial officer,
principal accounting officer and controller, as well as all other persons
performing similar functions.  A copy of such Amended and Restated
Code of Ethics has been posted on the Company’s website at www.geniusproducts.com.





Section
16(a) Beneficial Ownership Reporting Compliance





To the
Company’s knowledge, no person who, at any time during the year ended December
31, 2007, was a director, officer or beneficial owner of more than ten percent
of any class of our equity securities registered pursuant to Section 12 of the
Exchange Act failed to file on a timely basis, as disclosed in Form 3 and 4
filings, reports required by Section 16(a) of the Exchange Act during the year
ended December 31, 2007.  The foregoing is based solely upon a review
of Form 3 and 4 filings furnished to us during the year ended December 31, 2007,
and certain representations from officers and directors of the
Company.





Compensation
Committee Interlocks and Insider Participation





No member
of our compensation committee serves as a member of the Board of Directors or
compensation committee of any entity that has one or more executive officers
serving as a member of our Board of Directors or compensation
committee.





ITEM 11.    EXECUTIVE
COMPENSATION





COMPENSATION
DISCUSSION AND ANALYSIS





Compensation
program objectives and philosophy





We
maintain a group of executive compensation programs for our named executive
officers (“Named Executive Officers” or “NEOs”) and other senior level
executives.  Our executive compensation program, taken as a whole, has
several objectives.  The primary objective of our executive
compensation program is to attract, retain, motivate and develop the types of
people which we need to effectively manage our business during this period of
unprecedented growth; we seek to employ the best executive talent in our line of
business.  A second objective is to reward our executives for business
achievements and satisfaction of corporate objectives.  Finally, we
strive to align the overall executive compensation program, and therefore the
executives, with the interests of our stockholders.





In
developing our overall executive compensation program and in establishing the
pay packages for the NEOs, we strive to meet the following goals:





·
            To
      pay salaries that are competitive in our industry and our geographical
      market.


·
            To
      use, assuming that it makes sense for the Company and the Distributor,
      executive pay practices that are commonly found in companies engaged in
      the entertainment distribution
industry.


·
            To
      maintain a ‘pay for performance’ outlook, particularly in our incentive
      programs.


·
            To
      pay salaries, and award merit increases, on the basis of the individual
      executive’s performance and contributions to our
    organization.





We view
our competitors for executive talent (for compensation purposes) as the
entertainment distribution industry.


38


To attain
these goals, we have created an executive compensation program which consists of
base pay and a discretionary short-term cash bonus program.  Although
we maintain a stock option program, we did not make any grants to NEOs in
2007.  NEOs also participate in the benefit programs that we offer to
all full-time employees, and certain NEOs receive additional fringe
benefits.  The Distributor also maintains employment contracts with
certain of our NEOs, as well as with other senior executives at the
Distributor.





Our
executive compensation program rewards executives for Company and individual
performance.  Company and individual performance are strongly
considered when we grant base pay increases.  The pool of funds to be
used for our short term bonus program is decided by our principal preferred
stockholder, TWC Holdings; the Compensation Committee of our Board of Directors
(the “Compensation Committee”) approves an allocation of the bonus award among
the NEOs and other corporate executives with job titles of manager and
above.





The
role of the Compensation Committee





Our
Compensation Committee operates under a formal charter, which was adopted on
December 12, 2006 and was approved for a second time by the full Board of
Directors on December 5, 2007.  The charter provides that the
Compensation Committee shall perform the following functions regarding
compensation for the NEOs:





·
            Review
      and approve the Company’s and the Distributor’s goals relating to
      Principal Executive Officer (“PEO”)
  compensation.


·
            Evaluate
      the PEO’s performance in light of the
goals.


·
            Determine
      and approve the PEO’s compensation package based on the evaluation of the
      PEO’s performance.


·
            Make
      recommendations to the Board of Directors regarding compensation to be
      paid to the other NEOs.


·
            Approve
      any stock option award.


·
            Annually
      review, for all NEOs, annual base salary, short term bonus, long term
      incentives, employment-related agreements and special
      benefits.





Our
Compensation Committee is active; the Committee utilized the services of an
independent compensation consultant who also provided services to the
Company.  The Compensation Committee is involved in all phases of
our executive compensation program’s design and operation.





The
components of our executive compensation program





Our
executive compensation program consists of three elements:  base pay;
short term cash bonus; and grants of fair market value options in our
stock.  We use this mix of programs for a variety of
reasons:





·
            As
      a package, these types of programs are typically offered by the types of
      companies from which we would seek executive
  talent.


·
            As
      a package, these particular programs provide both a current and a long
      term incentive for the executive officers, thereby aligning the
      executives’ interests with that of our
  stockholders.


·
            These
      programs, as a package, provide the executives with short and long term
      rewards; this serves as both a retention and as a motivational device for
      the executives.





The
Distributor also provides NEOs with a package of fringe benefits on the same
basis that is provided to all full-time benefits eligible
employees.  These benefits include such items as health insurance and
group term life insurance.  We provide certain executives with an
additional benefit of an automobile allowance, which is provided for in their
employment contracts.





We
believe that the package of executive compensation programs that we offer fits
our needs well.  Our program is competitive; we are able to attract
and retain the executive talent that we need to successfully run our
business.  We do not maintain any type of non-qualified deferred
compensation program (either a defined benefit or a defined contribution
program) or a cash-based long term incentive program for
executives;  we currently do not provide our NEOs life insurance
benefits beyond what are available to our other full time
employees.  We currently believe that the long term incentive
component of our executive compensation program, which uses fair market value
stock options, provides executives with an incentive as well as putting a
portion of their compensation at risk if our share price declines; we believe
that it is necessary for the Company to grant equity instruments on an annual
basis to executives to retain and motivate them.  We do not currently
feel the need to provide additional long term incentives to our executives,
although we are examining that issue.


39


Certain
of our NEOs have formalized employment contracts with the Distributor. The
existence of a contract gives the Company, the Distributor and the NEO structure
as to the other’s expectations from the employment relationship.  We
also believe that the level of security that an employment contract provides to
the executive is an important retention tool; we feel that many of the companies
with whom we compete for executive talent offer such agreements.  We
are considering making changes to our executive compensation program, and as a
result, are not offering new employment contracts or extensions of expiring
contracts until we decide whether any changes will be made to our executive
compensation program; when that decision is made, we will then determine whether
executive employment contracts should be issued.





The
salient terms of the employment agreements for the NEOs which were in effect at
the end of 2007 are as follows:





Trevor Drinkwater, Principal
Executive Officer:  Mr. Drinkwater signed his employment
agreement on July 26, 2005, and it was amended on December 5, 2005 and July 20,
2006.  The initial agreement provided for a base pay of
$275,000.  The original agreement, which had a two year term, also
contained a grant of fair market value options to acquire 1,200,000 shares of
our stock; one half of the options were immediately exercisable and one quarter
of the options vested on the second and third anniversary of the grant date, and
the grant provided that vesting could accelerate if certain performance goals
were met.  Mr. Drinkwater also receives all of the benefits that are
made available to all of our full time employees, as well as an $800 monthly
automobile allowance.  The agreement also provides for severance pay
in certain circumstances, which will be discussed below in the “Post-employment
Payments” section.





The
December 5, 2005 amendment extended the term of the agreement to three years
from that date, and gave the Company the ability to extend the term an
additional two years.  The amendment also granted Mr. Drinkwater an
additional 1,000,000 fair market value options to purchase Company stock, which
were to vest in equal installments over five years.  Mr. Drinkwater’s
base salary starts at $425,000 annually and increases $50,000 annually, on July
21 of each year.





John
Mueller, Principal Financial Officer:  Mr. Mueller
signed his employment agreement on March 10, 2006.  The agreement
provides for an initial two year term with Company options to extend the term
for up to three additional one year terms and provides annual base pay beginning
at $250,000 and increasing by $25,000 annuallythrough the maximum five
year term.Additionally, Mr.
Mueller is guaranteed an annual bonus of $150,000, and the Company has the
discretion to pay him an additional bonus if it is warranted.  The
agreement also contains a grant of fair market value options to acquire 750,000
shares of our stock; two-thirds of the options were immediately exercisable and
one sixth of the optionsvested on January 1, 2007 and 2008,
respectively.  Mr. Mueller also receives all of the benefits that are
made available to all of our full time employees, as well as an $800 monthly
automobile allowance.  The agreement also provides for severance pay
in certain circumstances, which will be discussed below in the “Post-employment
Payments” section.





The other three NEOs, Rodney
Satterwhite, Executive Vice President of the Distributor, Christine Martinez,
Executive Vice President of Corporate Strategy of the Distributor, and Mitch
Budin, Executive Vice President and General Manager of the Distributor, do not
currently have employment agreements.





Taken as
a whole, we believe that our executive compensation program is a cost-effective
method of providing competitive pay to our NEOs.





Our
process for setting executive pay





The
Compensation Committee’s focus is to determine the compensation of the Principal
Executive Officer and to review the proposals of the Principal Executive Officer
regarding the compensation for his direct reports, which include the
NEOs.  In 2007, the Compensation Committee made the final decision on
all aspects of NEO pay.


40


Our
process for determining executive compensation has changed.  In the
past, our human resources department provided various types of pay information
to the Principal Executive Officer for his evaluation and eventual submission of
each executive’s total pay package to the Compensation Committee for its
determination.  In the fall of 2007, the Company retained Remedy
Compensation Consulting (“Remedy”) to assist both the Company and the
Compensation Committee with executive compensation issues relating to bonus
payments related to 2007 operations, 2008 base pay levels and short and long
term incentive compensation program design.  Remedy worked with our
human resources department to develop a peer group which was approved by the
Compensation Committee.  The peer group is comprised of publicly
traded companies who produce and/or distribute products related to home
entertainment.  The members of the peer group are (i) Activision,
Inc.; (ii) Dreamworks Animation SKG, Inc.; (iii) Electronic Arts, Inc.; (iv)
Lions Gate Entertainment Corporation; (v) Marvel Entertainment, Inc.; (vi)
Navarre Corporation; (vii) Playboy Enterprises, Inc.; (viii) Take Two
Interactive Software, Inc.; (ix) THQ, Inc.; (x) Time Warner, Inc.; (xi) Walt
Disney Companies; and (xii) World Wrestling Entertainment, Inc.  This
peer group was used as a basis for comparing our executive pay and Board of
Director pay programs with the market.  As will be discussed below,
Remedy provided information to both the Company and the Compensation Committee
for their review.





Our
process for determining the value of each component of executive pay functioned
in the following manner for 2007:





Base
pay:  Base compensation for all of our NEOs is provided for in
their respective employment agreements, which were in effect in 2007and the
Company has the ability to make annual increases to the base pay
level.  The employment contracts for the Principal Executive Officer
and the Principal Financial Officer contain a fixed annual base pay increase for
the contract term.  After reviewing information compiled by our
outside consultant and our human resources department, the Principal Executive
Officer makes a recommendation for executive base pay increases to the
Compensation Committee.  The Compensation Committee reviews the
information provided by the Principal Executive Officer, the outside consultant,
and makes a determination of annual base pay increases.





The
Compensation Committee has not yet determined base pay increases for all of the
NEOs.  Base pay increases for the Principal Executive Officer and the
Principal Financial Officer are provided for in their employment
contracts.  The increase for the Principal Financial Officer was
effective on January 1, 2008, and the increase for the Principal Executive
Officer will be effective on July 1, 2008.





NEO
            Annualized
              2007
      Base
            Annual
              Increase
            Annualized
              2008
      Base
            Percentage
              Increase




Trevor
      Drinkwater, Principal Executive Officer
            $475,000
            $50,000
            $525,000
            11%John
      Mueller, Principal Financial Officer
            $275,000
            $25,000
            $300,000
            9%Rodney
      Satterwhite, Executive Vice President of the Distributor
            $275,000
            $0
            $275,000
            0%Christine
      Martinez, Executive Vice President of Corporate Strategy of the
      Distributor
            $275,000
            TBD
            TBD
            TBDMitch
      Budin, Executive Vice President and General Manager of Sales of the
      Distributor
            $275,000
            TBD
            TBD
            TBD





Annual
bonus:  Other than a bonus paid to our Principal Financial
Officer, which is guaranteed under the Principal Financial Officer’s employment
contract, we did not pay any annual bonuses for 2007 corporate and personal
achievements.


41


Our
procedure for determining annual bonuses for executives for 2007 was as
follows:  our principal preferred shareholder, TWC, authorized funding
a bonus pool of a specific dollar amount to be awarded to a group of executive
employees; this amount was determined, in part, on 2007 operating
results.  This group includes the NEOs as well as managers, senior
managers, directors, executive officers, vice presidents and certain members of
the sales department.  After TWC provided the Company with the overall
amount of the bonus pool, the PEO is in the process of preparing a proposal to
the Compensation Committee regarding the allocation of the bonus pool to all
eligible employees, including the NEOs.  To make this allocation, the
Company used an internal formal bonus program in 2007.  The program
provided that if a stated EBITDA goal was satisfied, participating employees
would be entitled to a bonus; the bonus cannot exceed a maximum percentage of
their base salary,  and the bonus amount could increase or decrease
based on the percentage of the goal that was satisfied.  A threshold
goal level was established.  At target level, NEOs who did not have
bonus levels contained in their employment contracts could earn a bonus of up to
25% of their base salary; the maximum payout could not exceed 30% of base
salary.   If the threshold goal level was not attained, any
bonuses paid under the program were discretionary.  The threshold goal
was not attained in 2007, and, as a result, no bonuses were paid.  The
PEO considers other factors in making the allocation, including the particular
NEO’s base salary, competitive compensation information, the NEO’s role in the
Company, and his or her contribution to the Company’s success during
2007.





The
Principal Financial Officer has a guaranteed bonus in his employment contract;
the contract also gives the Company the right to make a discretionary additional
bonus to him.  The Compensation Committee did not make an additional
bonus award to the Principal Financial Officer as a result of 2007
operations.





As the
bonus awards are not determined based on any particular Company metric or
metrics related to financial performance, the Company does not have a policy
that would require that recipients return the bonus to the Company in the event
that a restatement of the Company’s financial statements results in a detriment
to the Company.





The
annual bonus related to 2007 operations for each NEO stated as a percentage of
base pay is as follows:





NEO
            Annualized
              2007Base
            Bonus
              Awarded
            Percentage
      of
              Annualized
      BaseTrevor
      Drinkwater, Principal Executive Officer
            $475,000
            $0
            0%John
      Mueller, Principal Financial Officer
            $275,000
            $150,000
            55%Rodney
      Satterwhite, Executive Vice President of the Distributor
            $275,000
            $0
            0%Christine
      Martinez, Executive Vice President of Corporate Strategy of the
      Distributor
            $275,000
            $0
            0%Mitch
      Budin, Executive Vice President and General Manager of the
      Distributor
            $275,000
            $0
            0%





Equity
grants:  No equity grants were made to NEOs during
2007.  Our procedure for making equity grants to NEOs is as
follows:  the Principal Executive Officer provides the Compensation
Committee with a proposal for equity grants as part of the employment contract
process.  The amount of the grant is based on various factors,
including the equity grant ranges for the position which the Company maintains,
information from our human resources department and outside
consultants.  The Compensation Committee reviews the Principal
Executive Officer’s proposal and the underlying information, and makes its
determination as to the grant.


42


We
establish the exercise price for our options in the following
manner:





For a new
hire, the Compensation Committee approves the grant and establishes the price
based on the Company’s closing price on the day of Compensation Committee
approval; however, if the executive has not yet started employment as of the
date of Compensation Committee approval, the price is set as the Company’s
closing price on the executive’s first day of work.





For a new
contract for a current executive, the Compensation Committee approves the grant
and establishes the price based on the Company’s closing price on the day of
Compensation Committee approval.





It has
not been our policy to consider amounts realized in a prior year from annual
bonuses or equity awards as a factor in determining current year equity
grants.





We do not
maintain any equity ownership guidelines for our NEOs.  We have
adopted a corporate policy which expressly prohibits any NEOs from trading in
derivative securities of our Company, short selling our securities, or
purchasing our securities on margin at any time.




Because
each of our NEOs provides unique services to us, we do not use a fixed
relationship between base pay, short term bonus and equity
awards.  When the Compensation Committee makes the final decisions
about a NEO’s total compensation package for a year, the three elements (base
pay, short term bonus and equity award) are considered both individually and as
a complete package.  We do not take into account amounts that a NEO
may have realized in a year as a result of short term bonus awards or stock
option exercises when we establish pay levels and goals for the current
year.  Overall, we believe that our total compensation program for
executives is reasonable while being competitive with market peers.





Summary
Compensation Table for 2007





The
following table shows the compensation for each of the Named Executive Officers
for 2007.




Name
      and Principal Position
                (a)
              Year
                (b)
              Salary
                ($)
                (c)
              Bonus
                ($)(1)
                (d)
              Stock
      Awards
                ($)
                (e)
              Option
      Awards
                ($)
                (f)
              Non-Equity
      Plan Incentive Compensation
                ($)
                (g)
              Non-Qualified
      Deferred Compensation Plan Earnings
                ($)
      (h)
              All
      Other Compensation
                ($)
                (i)
              Total
                ($)
                (j)Trevor
      Drinkwater,
              2007
              $450,000
              $0
              —
              $95,916
              —
              —
              $9,600
              $555,516Principal
      Executive Officer (2)
              2006
              $333,134
              $200,000
              —
              $1,836,198
              —
              —
              $26,761
              $2,396,093John
      Mueller,
              2007
              $275,000
              $150,000
              —
              $108,345
              —
              —
              $9,600
              $542,945Principal
      Financial Officer (3)
              2006
              $224,584
              $150,000
              —
              $620,462
              —
              —
              $9,600
              $1,004,646Rodney
      Satterwhite,
              2007
              $275,000
              $0
              —
              $55,732
              —
              —
              $9,600
              $340,332Executive
      Vice President (4)
              2006
              $225,213
              $70,000
              —
              $381,426
              —
              —
              $9,600
              $686,239Christine
      Martinez,
              2007
              $275,000
              $0
              —
              $7,627
              —
              —
              $8,000
              $290,627Executive
      Vice President of Corporate Strategy (5)
              2006
              $241,669
              $50,000
              —
              $339,345
              —
              —
              $0
              $631,014Mitch
      Budin,
              2007
              $275,000
              $16,250
              —
              $27,730
              —
              —
              $9,600
              $328,580Executive
      Vice President of Sales (6)
              2006
              $197,046
              $92,500
              —
              $109,245
              —
              —
              $13,100
              $411,891




43


(1)
            Discretionary
      bonuses for 2006 operations were paid in April 2007, aside from Trevor
      Drinkwater’s, which was paid in January,
2007.





(2)
            In
      2007, all other compensation consists of an $800 per month automobile
      allowance.  In 2006, all other compensation consists of an $800
      per month automobile allowance and $17,161 in relocation
      expenses.





(3)
            Bonus
      amounts were provided for in his employment agreement.  All
      other compensation consists of an $800 per month automobile
      allowance.




(4)
            All other
      compensation consists of an $800 per month automobile
  allowance.




(5)
            All
      other compensation consists of an $800 per month automobile
      allowance.




(6)
            In
      2007, bonus consists of an additional payment made to correct an error in
      the computation of the 2006 bonus described below.  All other
      compensation consists of an $800 per month automobile
      allowance.  In 2006, bonus consists of a $40,000 discretionary
      bonus and $52,500 of bonuses provided for in his employment contract; all
      other compensation consists of an $800 per month automobile allowance and
      a $3,500 bonus relating to the award of premium
  options.





Grants
of Plan-Based Awards Table




During
2007, we made no equity grants to any of our NEOs, and therefore the “Grant of
Plan Based Awards” table is not included in this report.





In past
years, we have intended to grant all of our options with an exercise price equal
to the fair market value of our common stock as of the date of grant (as further
explained below).  Outstanding equity grants that continue to vest
were granted in this manner, and it is our intent that any future grants that we
will make will also be granted with an exercise price equal to the fair market
value of our common stock as of the date of grant.





As
discussed more fully in Note 8 of the footnotes to our financial
statements for the year ending December 31, 2007, we estimate the fair value of
our service-based stock option plans using the Black-Scholes option pricing
model (the “Option Model”). The Option Model requires the use of subjective and
complex assumptions, two of which are the option's expected term and the
estimated future price volatility of the underlying stock, which estimates the
fair value of the service-based awards.  The valuation is reduced by an
estimate of stock option forfeitures.  Our estimate of expected term
in 2007 was determined based on the weighted average period of time that options
granted are expected to be outstanding considering current vesting
schedules.  Beginning in 2006, the expected volatility assumption used
in the Option Model changed from being based on historical volatility to implied
volatility based on traded options on our stock in accordance with guidance
provided in SFAS 123R and SAB 107.  The risk-free interest rate used
in the Option Model is based on the yield of U.S. Treasuries with a maturity
closest to the expected term of our stock options.  We estimated
share-based compensation expense for fiscal year 2007 using the Black-Scholes
model with the following weighted average assumptions:  risk-free
interest rate – 4.48%; expected dividend yield – 0%; expected volatility –
88.22%; expected life in years – 6.16; and expected forfeitures –
0%.





In prior
years, we have established the exercise price for our options in the following
manner:





For
      a new hire, the Compensation Committee approves the grant and establishes
      the price based on the closing price of the Company’s common stock on the
      day of Compensation Committee approval; however, if the executive has not
      yet started employment as of the date of the Compensation Committee
      approval, the price is set as the closing price of the Company’s common
      stock on the executive’s first day of work.  For a new contract
      for a current executive, the Compensation Committee approves the grant and
      establishes the price based on the closing price of the Company’s common
      stock on the day of the Compensation Committee
  approval.


We do not
currently intend to alter this procedure for future option
grants.




44


Outstanding
Equity Awards at Year End





The
following table shows the number of shares covered by exercisable and
unexercisable options held by the Named Executive Officers on December 31,
2007:




Name
      and Principal Position
              (a)
            
            Number
      of Securities Underlying Unexercised Options (#) Exercisable
              (b)
            
            
            Number
      of Securities Underlying Unexercised Options (#)
Unexercisable
              (c)
            
            
            Equity
      Incentive Plan Awards: Number of Securities Underlying Unexercised
      Unearned Options
              (d)
            
            
            Option
      Exercise Price
              ($)
              (e)
            
            Option
      Expiration Date
              (f)Trevor
      Drinkwater,
              Principal
      Executive Officer (1)
            
            
            1,200,000
              400,000
              150,000
              —
              175,000
              87,500
              87,500
            
            
            
            —
              600,000
              —
              400,000
              —
              —
              —
            
            
            
            —
              —
              —
              —
              —
              —
              —
            
            
            
            $1.65
              $1.88
              $2.00
              $2.31
              $2.00
              $3.00
              $4.00
            
            7/26/2015
              11/7/2015
              7/16/2014
              11/28/2015
              9/30/2014
              9/30/2014
              9/30/2014John
      Mueller,
              Principal
      Financial Officer (2)
            
            
            625,000
            
            
            
            125,000
            
            
            
            —
            
            
            
            $1.89
            
            3/10/2016Rodney
      Satterwhite,
              Executive
      Vice President (3)
            
            
            22,500
              187,500
              30,000
              96,000
              30,000
            
            
            
            7,500
              37,500
              —
              24,000
              45,000
            
            
            
            —
              —
              —
              —
              —
            
            
            
            $1.63
              $1.88
              $2.00
              $2.10
              $2.31
            
            10/19/2015
              11/7/2015
              7/16/2014
              6/14/2015
              11/28/2015Christine
      Martinez,
              Executive
      Vice President of Corporate Strategy (4)
            
            
            225,000
              30,000
            
            
            
            —
              45,000
            
            
            
            —
              —
            
            
            
            $1.63
              $2.31
            
            10/19/2015
              11/28/2015Mitch
      Budin,
              Executive
      Vice President of Sales (5)
            
            
            187,500
              30,000
            
            
            
            37,500
              45,000
            
            
            
            —
              —
            
            
            
            $2.00
              $2.31
            
            01/03/2016
              01/03/2016




(1)
            Mr.
      Drinkwater’s unvested options vest as follows: (a) the options which
      expire on 11/28/2015 will only vest upon the satisfaction of certain
      performance targets; (b) the options which expire on 11/7/2015 will vest
      in equal installments over the next three
years.





(2)
            Mr.
      Mueller’s unvested options vested as follows: 125,000 shares on January 1,
      2008.





(3)
            Mr.
      Satterwhite’s unvested options will vest as follows: (a) the options which
      expire on 10/19/2015 will fully vest on 12/5/2008; (b) the options which
      expire on 11/7/2015 will fully vest on 12/5/2008; (c) the options which
      expire on 6/4/2015 will fully vest on 12/5/2008; (d) the options which
      expire on 11/28/2015 will vest over five years with the vesting period
      beginning six months after the date of
grant.





(4)
            Ms.
      Martinez’s unvested options will vest in equal installments over the next
      three years.





(5)
            Mr.
      Budin’s unvested options will vest as follows: (a) the options with an
      exercise price of $2.00 will fully vest on 12/5/2008; and (b) the options
      with an exercise price of $2.31 will vest in equal installments over the
      next three years.





As we do
not maintain any programs for our NEOs that would require inclusion in the
“Pension Benefits” or the “Non-Qualified Deferred Compensation” tables, those
tables are not included in this report.


45


Post-
employment compensation





The
Distributor maintains employment arrangements with two of our Named Executive
Officers that provide for payments upon their termination of employment in
certain circumstances.  Both of the employment contracts have the
following common provisions:





A
termination for ‘cause’ occurs if the NEO has:





·
            been
      repeatedly negligent in his or her
duties;


·
            acted
      with ‘gross negligence’ or willful
misconduct;


·
            been
      dishonest or committed an act of theft, embezzlement, fraud, material
      breach of confidentiality, unauthorized disclosure or use of inside
      information, customer lists, or trade
secrets;


·
            been
      convicted or plead guilty to a felony or misdemeanor which would harm our
      reputation;


·
            materially
      breached the employment agreement;


·
            materially
      violated our company policies;


·
            engaged
      in unfair competition or taken other actions which would harm the Company
      or the Distributor;


·
            caused
      a vendor or customer to terminate any contract with us;
  or


·
            failed
      to attend Company meetings or frequently visit our offices after receiving
      written warnings from us.





A Change
in Control, which impacts the vesting of options, occurs if:





·
            There
      is a merger or consolidation in which we are not the surviving
      entity;


·
            We
      sell or dispose of all or substantially all of our
  assets;


·
            We
      dissolve or liquidate;


·
            We
      enter into a reverse merger where 40% of our voting power is transferred;
      or


·
            There
      is a change in the membership of a majority of the Board of Directors in a
      36 month period where the new directors were not nominated by the then
      current board members.





The
ability to exercise options for the NEOs is governed by the following
rules:





·
            Upon
      a termination for cause, all vested and unvested options are
      cancelled;


·
            Upon
      death or disability, vested options can be exercised for six months
      (certain options of Drinkwater and Satterwhite, all of Martinez) or until
      the options’ expiration date (certain options of Drinkwater and
      Satterwhite, all of Mueller and Budin); all unvested options are
      forfeited; and


·
            Upon
      termination for good reason, vested options can be exercised for three
      months after termination; all unvested options are
    forfeited.





As
discussed below, certain NEOs receive additional vesting in certain
circumstances.





For
purposes of the table information regarding post employment payments, we assume
the following:





·
            Accrued
      vacation is paid in all cases.  As of December 31, 2007, all
      NEOs had 15 days of accrued
vacation.


·
            The
      NEO does not have any severance benefit reduced as a result of obtaining
      employment with a new employer.


·
            For
      change in control purposes, a change in control occurred on December 31,
      2007.


·
            The
      fair market value of Company shares is $1.80, which is the ending share
      value on December 31, 2007.


·
            Termination
      of employment occurs on December 31, 2007, and the termination of
      employment for change of control purposes is not for
  cause.


·
            The
      NEO exercises all outstanding options that can be exercised immediately
      upon termination and the net profit from the exercise is paid to the NEO
      in cash.


46


The
particular terms regarding post-employment compensation for each NEO are as
follows:





Trevor Drinkwater, Principal
Executive Officer:  If Mr. Drinkwater is terminated without
cause, he receives a severance payment not to exceed eighteen months of base
pay; this payment is limited to the remaining term of his employment
agreement.  He also receives health insurance for the remaining term
of his employment agreement, with a limit of thirty six months.  He
also receives an additional twelve months of vesting on his stock
options.  In the event of a Change in Control, all unvested stock
options fully vest.





John Mueller, Principal
Financial Officer: If Mr. Mueller is terminated without cause, he
receives a severance payment not to exceed eighteen months of base pay and any
applicable annual bonus that has been awarded but not paid, based upon the
amounts specified in his employment agreement; this payment is limited to the
remaining term of his employment agreement.  He also receives an
additional eighteen months of vesting on his stock options.  In the
event of a Change in Control, all unvested stock options fully
vest.





Rodney Satterwhite,
Executive Vice President of the Distributor; Christine Martinez, Executive Vice
President of Corporate Strategy of the Distributor; Mitch Budin, Executive Vice
President of Sales of the Distributor:  None of these
individuals have employment agreements with the Distributor as of December 31,
2007.  As a result, if any of them are terminated without cause, each
of them would receive a severance payment equal to one month of base salary for
each year of service with our Company, with a maximum severance payment of three
months of base pay.





Post-Employment
Payments Table





Name
      and Principal Position
            
            Severance
      for Cause
            
            
            Severance
              Not
      for Cause
            
            
            Death,
              Disability
      or Retirement
            
            
            Change
      in
              ControlTrevor
      Drinkwater, Principal Executive Officer
            
            $
            27,404
            
            
            $
            692,244
            
            
            $
            207,404
            
            
            $
            692,244John
      Mueller, Principal Financial Officer
            
            $
            15,865
            
            
            $
            84,615
            
            
            $
            15,865
            
            
            $
            84,615Rodney
      Satterwhite, Executive Vice President
            
            $
            15,865
            
            
            $
            88,015
            
            
            $
            19,265
            
            
            $
            88,015Christine
      Martinez, Executive Vice President of Corporate Strategy
            
            $
            54,115
            
            
            $
            122,865
            
            
            $
            54,115
            
            
            $
            122,865Mitch
      Budin, Executive Vice President of Sales
            
            $
            15,865
            
            
            $
            84,615
            
            
            $
            15,865
            
            
            $
            84,615




47


Board
of Directors Compensation





The
following table sets forth the compensation paid to our non-employee directors
in 2007.





Name
              (a)
            
            Fees
      Earned or Paid in Cash
              ($)
              (b)
            
            
            Stock
      Awards
              ($)
              (c)
            
            
            Option
      Awards
              ($)
              (d)
            
            
            Non-Equity
      Incentive Plan Compensation
              ($)
              (e)
            
            
            Nonqualified
      Deferred Compensation Earnings
              ($)
              (f)
            
            
            All
      Other Compensation
              ($)
              (g)
            
            
            Total
              ($)
              (h)Stephen
      K. Bannon, Chairman
            
            $
            0
            
            
            $
            0
            
            
            $
            357,119
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            357,119Bradley
      A. Ball
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0James
      G. Ellis
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0Herbert
      Hardt
            
            $
            0
            
            
            $
            0
            
            
            $
            151,922
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            151,922Larry
      Madden
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0Irwin
      Reiter
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0
            
            
            $
            0





The
Company did not pay outside directors any cash payments for service on our Board
of Directors during 2007.  The Company did not make any type of equity
grant to any outside director for service on our Board of Directors during
2007.  We do not reimburse directors for their actual expenses
incurred for attending Board meetings.  Compensation amounts shown on
the table reflect the FAS 123R value of options used to calculate the Company’s
financial expense for 2007.   Mr. Bannon’s consulting firm
received payments from the Company during 2007 (see Item 13, Related Party
Transactions, for more details regarding these payments).





Our
Principal Executive Officer is also a member of the Board of
Directors.  He receives no additional compensation related to his
service on the Board of Directors.





Compensation
Committee Report





The
Compensation Committee has reviewed the Compensation Discussion and Analysis
included above, and has reviewed this document with members of our management
team.  Based upon the review and discussions that the Compensation
Committee had with management regarding the Compensation Discussion and
Analysis, the Compensation Committee recommended to the Board of Directors that
the Compensation Discussion and Analysis be included in our Annual
Report.





Members
of the Compensation Committee:





Herbert
Hardt


Bradley
A. Ball


48


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





The
following table sets forth certain information known to us with respect to the
beneficial ownership of our common stock and our Series W Preferred Stock by
(i) each person who is known by us to own beneficially more than 5% of our
common stock or Series W Preferred Stock, as of the most recent date for which
information is available,  (ii) each of our directors and Named
Executive Officers and the executive officers of the Distributor, as of February
29, 2008 and (iii) all of our executive officers, directors and all of the
executive officers of the Distributoras a group, as of
February 29, 2008.  Except as otherwise listed below, the address of
each person is c/o Genius Products, Inc., 2230 Broadway, Santa Monica,
California 90404. As of February 29, 2008, there were outstanding
67,709,094shares
of our common stock and 100 shares of our Series W Preferred Stock.




Shares Beneficially Owned
      (1)Name
      of Owner of Common Stock
            
            Number
            
            
            PercentBradley
      A. Ball
            
            0
            
            
            0%Stephen
      K. Bannon
            
            829,520
            (2)
            
            1.2%Mitch
      Budin
            
            217,500
            (3)
            
            *Ed
      Byrnes
            
            0
            
            
            0%Trevor
      Drinkwater
            
            2,100,000
            (4)
            
            3.1%Herbert
      Hardt
            
            419,044
            (5)
            
            *Larry
      Madden
            
            0
            
            
            0%Christine
      Martinez
            
            255,000
            (6)
            
            *John
      Mueller
            
            750,000
            (7)
            
            1.1%Michael
      Radiloff
            
            198,750
            (8)
            
            *Irwin
      Reiter
            
            0
            
            
            0%Rodney
      Satterwhite
            
            366,000
            (9)
            
            *Matthew
      Smith
            
            0
            
            
            0%All
      directors and officers as a group (13 persons)
            
            5,135,814
            (10)
            
            7.6%Bonanza
      Master Fund, Ltd.
            
            5,438,629
            (11)
            
            8.0%Janus
      Capital Management LLC
            
            7,672,100
            (12)
            
            11.3%Stephens
      Investment Management, LLC
            
            3,641,787
            (13)
            
            5.4%Wellington
      Management Company LLP
            
            8,486,730
            (14)
            
            12.5%Capital
      Research Global Investors
            
            3,450,000
            (15)
            
            5.1%Name
      of Owner of Series W Preferred Stock
            
            Number
            
            
            PercentW-G
      Holding Corp.
            
            1.42857
            (16)
            
            1.4%The
      Weinstein Company Holdings LLC
            
            98.57143
            (16)
            
            98.6%





*          
   Represents less than 1% of our common stock.





(1)
            Beneficial
      ownership is determined in accordance with the rules of the SEC and
      generally includes voting or investment power with respect to
      securities.  Shares of common stock subject to options and
      warrants currently exercisable or convertible, or exercisable or
      convertible within 60 days of February 29, 2008, are deemed outstanding
      for computing the percentage of the person holding such option or warrant
      but are not deemed outstanding for computing the percentage of any other
      person.  Except as pursuant to applicable community property
      laws, the persons named in the table have sole voting and investment power
      with respect to all shares of common stock beneficially
      owned.  The information reflected in this Item 12 is based on
      the Company’s review of the most recent SEC filings for the individuals
      and entities listed above and the Company’s internal records which is as
      of February 29, 2008 or the most recent date for which information is
      available.





(2)
            Includes
      outstanding options to purchase 829,520 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      1,000,000 shares exercisable after that
period.





(3)
            Includes
      outstanding options to purchase 217,500 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      82,500 shares exercisable after that
period.


49


(4)
            Includes
      outstanding options to purchase 2,100,000 shares exercisable within 60
      days of February 29, 2008.  Excludes outstanding options to
      purchase 1,000,000 shares exercisable after that
  period.




(5)
            Includes
      outstanding options to purchase 419,044 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      110,476 shares exercisable after that
period.





(6)
            Includes
      outstanding options to purchase 255,000 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      45,000 shares exercisable after that
period.





(7)
            Includes
      outstanding options to purchase 750,000 shares exercisable within 60 days
      of February 29, 2008.





(8)
            Includes
      outstanding options to purchase 198,750 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      101,250 shares exercisable after that
period.





(9)
            Includes
      outstanding options to purchase 366,000 shares exercisable within 60 days
      of February 29, 2008.  Excludes outstanding options to purchase
      114,000 shares exercisable after that
period.





(10)
            Includes
      outstanding options to purchase 5,135,814 shares exercisable within 60
      days of February 29, 2008.  Excludes outstanding options to
      purchase 2,453,226 shares exercisable after that
  period.





(11)
            Bonanza
      Master Fund, Ltd. is managed by Bonanza Capital, Ltd., which is managed by
      Bonanza Fund Management, Inc.  The number of shares indicated
      includes warrants to purchase 783,829 shares of common stock exercisable
      within 60 days of February 29, 2008.  The mailing address for
      Bonanza Master Fund, Ltd. is 300 Crescent Court, Suite 1740, Dallas, Texas
      75201.





(12)
            Janus
      Capital has an indirect 86.5% ownership stake in Enhanced Investment
      Technologies LLC (“INTECH”) and an indirect 30% ownership stake in
      Perkins, Wolf, McDonnell and Company, LLC (“Perkins Wolf”).  Due
      to the above ownership structure, holdings for Janus Capital, Perkins Wolf
      and INTECH are aggregated for purposes of this filing.  Janus
      Capital, Perkins Wolf and INTECH are registered investment advisers, each
      furnishing investment advice to various investment companies registered
      under Section 8 of the Investment Company Act of 1940 and to individual
      and institutional clients (collectively, the “Managed
      Portfolios”).  As a result of its role as investment adviser or
      sub-adviser to the Managed Portfolios, Janus Capital may be deemed to be
      the beneficial owner of 7,672,100 shares.    However,
      Janus Capital does not have the right to receive any dividends from, or
      the proceeds from the sale of, the securities held in the Managed
      Portfolios and disclaims any ownership associated with such
      rights.  Janus Venture Fund is an investment company registered
      under the Investment Company Act of 1940 and is one of the Managed
      Portfolios to which Janus Capital provides investment
      advice.  The mailing address for Janus Investment Fund is c/o
      Janus Capital Management, 151 Detroit Street, Denver, Colorado
      80206.





(13)
            Stephens
      Investment Management, LLC, in its capacity as investment adviser, may be
      deemed to beneficially own 3,641,787 shares which are held of record by
      clients of Stephens Investment Management, LLC.  The principal
      business address of Stephens Investment Management, LLC is One Sansome
      Street, Suite 2900, San Francisco, California
  94104.





(14)
            Wellington
      Management LLP, in its capacity as investment adviser, may be deemed to
      beneficially own 8,486,730 shares which are held of record by clients of
      Wellington Management LLP.  The principal business address of
      Wellington Management LLP is 75 State Street, Boston, Massachusetts
      02109.





(15)
            Capital
      Research Global Investors is deemed to be the beneficial owner of
      3,450,000 shares as a result of CRMC acting as investment adviser to
      various investment companies registered under Section 8 of the Investment
      Company Act of 1940.




(16)
            The
      principal business address for each of W-G Holding Corp. and The Weinstein
      Company Holdings LLC is 345 Hudson Street, 13th
      Floor, New York, New York
10014.


50


Changes
in Control





Pursuant
to the Amended and Restated Limited Liability Company Agreement of the
Distributor, The Weinstein Company Holdings LLC has the right to redeem all or a
portion of its interest in the Distributor in exchange for common stock of the
Company.  The exercise of this right by The Weinstein Company Holdings
LLC could result in a change of control of the Company.





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





Services
Agreement





The
Distributor provides certain services and pays certain direct costs, including
filing fees, registration fees and audit fees, on behalf of the Company
according to the terms of a services agreement between the Distributor and the
Company and entered into in connection with the TWC Transaction.  The
Distributor incurred a total of $4.8 million in corporate operating and payroll
related expenses on behalf of the Company during the year ended December 31,
2007 and incurred a total of $1.3 million during the 163-day period ended
December 31, 2006.




TWC
Distribution Agreement





On July
17, 2006, the Distributor entered into a distribution agreement with TWC (the
“TWC Distribution Agreement”), an affiliate of TWC Holdings and W-G Holding
Corp., holders of our Series W Preferred Stock.  Pursuant to the TWC
Distribution Agreement, TWC granted to the Distributor the right to distribute,
advertise, publicize, promote and market DVDs of motion pictures owned or
released by TWC for an initial term of approximately five years, subject to
early termination provisions described in the TWC Distribution
Agreement.  Under the TWC Distribution Agreement, after deducting
permitted amounts from gross receipts for return reserves, the Distributor’s
distribution fee and the Distributor’s reimbursable expenses, the Distributor is
required to pay to TWC a portion of the net receipts from the sale of any such
DVDs.  For the fiscal year ending of December 31, 2006, the Company
and the Distributor incurred $141.0 million of expenses related to TWC
participation fees.  For the fiscal year ending December 31, 2007, the
Distributor incurred $170.4 million of expenses related to
TWC.  For the period January 1 through February 29, 2008, the Company
and the Distributor incurred $0.7 million, in respect of such net
receipts.


On August
10, 2007, in connection with the Credit Agreement, the Distributor entered into
a letter agreement  with TWC (the “TWC Letter”) under which the
Distributor and TWC agreed to schedule payments owing to TWC by the
Distributor under the TWC Distribution Agreement.  In the TWC Letter,
TWC also agreed to waive any remedies it may have attributable to past
non-timely payments and reporting under the TWC Distribution Agreement on or
prior to August 10, 2007.





On March
4, 2008, the Distributor and TWC entered into a letter agreement memorializing
certain amendments to the TWC Distribution Agreement and the interim
distribution agreement under which the Company and TWC operated prior to the
closing of the TWC Transaction, previously agreed upon by the Distributor and
TWC.  Pursuant to such letter agreement,  effective as of
March 21 , 2006, (i) the definition of a “Direct-to-Video” title under the TWC
Distribution Agreement (and the interim distribution agreement) was revised to
mean any title that (a) was not released theatrically prior to its initial home
video release date or (b) was released theatrically prior to its home video
release, but earned U.S. theatrical box office revenue prior to its initial home
video release date of less than $0.5 million; and  (ii) TWC agreed to
absorb the cost of returns processing for all TWC titles distributed under the
TWC Distribution Agreement (and the interim distribution
agreement).  The effect of these changes was a benefit to the
Distributor, respectively, of $0.8 million to cost of revenue in 2007 and $2.9
million in 2007 (TWC revenue and cost of sales are recognized upon meeting all
recognition requirements of SOP 00-2; the full benefit of the change described
in subsection (ii) above was $4.6 million and, therefore, a further $1.7 million
will be recognized in future periods).  In addition, in the letter
agreement TWC acknowledged that, based on the Distributor’s satisfaction of
certain terms relating to the “annual video ratio” under the TWC Distribution
Agreement, the Distributor’s distribution fee for the period from January 1,
2007 through December 31, 2007 should be increased from 5% to 6%.  The
effect of this clarification was a benefit of $2.9 million to the Distributor’s
cost of sales for fiscal 2007 (also see Item 7 above for a discussion regarding
the financial statement impact of these amendments).


51


Related
Party Loans





On
September 27, 2007, the Distributor borrowed $6.0 million from the Company and
issued a promissory note in favor of the Company in the principal amount of $6.0
million.  On November 1, 2007, the Distributor borrowed an additional
$2.0 million from the Company and issued a promissory note in favor of the
Company in the principal amount of $2.0 million.  Under each of the
aforementioned notes, interest is due on the unpaid principal balance at a
monthly rate equal to the LIBOR Rate (as defined in the notes) plus five percent
(5%) until paid.  The principal and accrued interest under the notes
were originally due and payable on demand at any time after March 31,
2008.  On March 16, 2008, the Company's Board of Directors approved
amendments to each of the aforementioned notes pursuent to which principal and
accrued interest under the notes would be due and payable on demand at any time
after January 1, 2009. In the event payment of principal or interest due under
the notes is not made when due, the outstanding principal balance will bear
interest at the rate of two percent (2%) above the interest rate which is
otherwise provided under the notes for so long as such event continues. If the
notes are not paid when due, the Distributor agreed to pay the Company’s
reasonable costs of collection, including, without limitation, all reasonable
attorneys’ fees and all reasonable expenses actually incurred by the Company in
connection with such collection efforts.  The principal amount of the
notes may be prepaid in whole or in part, provided that all accrued interest on
the amount to be prepaid is also paid at such time.  The proceeds from
the notes were used to pay amounts owed by the Distributor to TWC under the TWC
Distribution Agreement.  As of December 31, 2007, an aggregate of $8.2
million in principal and accrued interest expense was outstanding under the
notes.  As of February 29, 2008, a further $0.1 million of accrued
interest expense was outstanding under the notes.





Bannon
Consulting Agreement





Stephen
K. Bannon is the chairman of the Company’s Board of Directors.  Mr.
Bannon is also a principal with Bannon Strategic Advisors, Inc. (“Bannon
Strategic Advisors”).  On July 20, 2006, the Company and Bannon
Strategic Advisors entered into a consulting agreement (the “Consulting
Agreement”), pursuant to which Bannon Strategic Advisors has provided the
Company with consulting and advisory services.  Pursuant to the
Consulting Agreement, the Company agreed to pay to Bannon Strategic Advisors a
monthly consulting fee of $0.02 million for a term of two years (i.e., an
aggregate of $0.5 million) and reimburse Mr. Bannon for expenses incurred in
connection with services provided to the Company.  The Consulting
Agreement was approved by the Board of Directors, with Mr. Bannon abstaining
from the vote.  On July 21, 2006, the rights and obligations of the
Company pursuant to the Consulting Agreement were assigned to the
Distributor.  On January 2, 2007, the Distributor paid to Bannon
Strategic Advisors a bonus of $0.2 million for services rendered in 2006, and an
additional bonus of $0.03 million on March 13, 2007.  These bonuses
were approved by the compensation committee of the Company’s Board of
Directors.  For the years ended December 31, 2006 and 2007, the
Distributor recorded $0.2 and $0.3 million, respectively for consulting fees and
$0.2 million and $0.2 million for expense reimbursements.   For
the period from January 1 through February 29, 2008, the Distributor incurred
$0.1 million of expenses for Bannon Strategic Advisors, for bonuses, consulting
fees and reimbursement of expenses pursuant to the Consulting
Agreement.
  Director
Independence





Our Board
of Directors is comprised of six individuals, two of whom (Bradley A. Ball and
Herbert Hardt) the Company has determined are independent under the rules
applicable to NASDAQ listed companies.


52


ITEM 14.    PRINCIPAL ACCOUNTING FEES AND
SERVICES





The
following table shows the fees paid or accrued by the Company for the audit and
other services provided by Ernst & Young LLP (“E&Y”), Singer Lewak
Greenbaum & Goldstein LLP (“SLGG”) and Cacciamatta Accounting
Corporation (“CAC”) for the years ended December 31
shown:




(In
      thousands)
                2007
                
                2006E&Y
                
                SLGG
                
                E&Y
                
                SLGG
                
                CACTotal
      Fees
                
                
                Total
      Fees
                
                
                Total
      Fees
                
                
                Total
      Fees
                
                
                Total
      FeesAudit
      Fees
                
                $
                3,131
                
                
                $
                138
                
                
                $
                1,950
                
                
                $
                235
                
                
                $
                -Audit
      - Related Fees
                
                
                69
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Tax
      Fees
                
                
                83
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -All
      Other Fees
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                483
                
                
                
                120Total
      Fees
                
                $
                3,283
                *
                
                $
                138
                
                
                $
                1,950
                
                
                $
                718
                
                
                $
                120*
      The disclosed total fee of $3.3 million is related to services rendered at
      both the Company and the Distributor, of which $1.4 million is
      attributable to the Company and $1.9 million is attributable to the
      Distributor.
 All Other
Fees incurred during the year ended December 31, 2006 include fees
associated with SEC filings, consents and the TWC
Transaction.





Tax
Fees





Our
principal accountants do not regularly bill us fees for tax compliance, tax
advice or tax planning.  However, during our fiscal year ended
December 31, 2007, we paid $0.08 million to Ernst &Young LLP (“E&Y”) for
their services in connection with the preparation of the U.S. Federal Income Tax
Return Form 1065 for the Distributor. No fees for tax compliance, tax advice or
tax planning were paid to E&Y in 2006.





Audit
Committee Approvals





Effective
May 6, 2003, the SEC adopted rules that require that before our auditor is
engaged by us to render any auditing or permitted non-audit related services,
the engagement must be approved by our audit committee or entered into pursuant
to pre-approved policies and procedures established by the audit committee,
provided the policies and procedures are detailed as to the particular service,
the audit committee is informed of each service, and such policies and
procedures do not include delegation of the audit committee’s responsibilities
to management.





Our audit
committee requires advance approval of all audit, audit-related, tax and other
services performed by the independent auditor. Unless the specific service has
been previously pre-approved with respect to that year, the audit committee must
approve the permitted service before the independent auditor is engaged to
perform it.


53


PART IV





ITEM 15.    EXHIBITS, FINANCIAL STATEMENT
SCHEDULES





The
financial statements and Schedule II are filed as part of this report under Item
8 – Financial Statements and Supplementary Data.





References
to “the Company” in this Exhibit index means Genius Products, Inc.




Exhibit
      No.
                                                              Description3.1
                                                              Amended
      and Restated Certificate of Incorporation (incorporated by reference from
      Exhibit 3.1 to the Company’s Form 10-Q filed on November 20,
      2006).3.2
                                                              Bylaws
      as amended (incorporated by reference from Exhibit 3.2 to the Company’s
      Form 10-KSB filed on March 31, 2005).4.1
                                                              Specimen
      Certificate for Common Stock (incorporated by reference from Exhibit 4.8
      included with the Company’s Form 10-KSB filed on April 14,
      2000).4.2
                                                              Certificate
      of Change in Stock (incorporated by reference from Exhibit 3.2.2 included
      with the Company’s Form 10-KSB filed on April 16,
2002).10.1
                                                              Employment
      Agreement with Trevor Drinkwater dated July 16, 2004 (incorporated by
      reference from Exhibit 10.1 included with the Company’s Form 10-QSB filed
      on August 16, 2004).10.2
                                                              Employment
      Agreement with Trevor Drinkwater dated July 26, 2005 (incorporated by
      reference from Exhibit 99.1 to the Company’s Form 8-K filed on July 29,
      2005).10.3
                                                              Confidential
      Settlement Agreement and Mutual Release of Claims between the Company and
      Mike Meader dated July 29, 2005 (incorporated by reference from Exhibit
      99.2 to the Company’s Form 8-K filed on July 29, 2005).10.4
                                                              Confidential
      Settlement Agreement and Mutual Release of Claims between the Company and
      Klaus Moeller dated July 28, 2005 (incorporated by reference from Exhibit
      99.4 to the Company’s Form 8-K filed on July 29, 2005).10.5
                                                              Employment
      Agreement with Christine Martinez, effective October 27, 2005
      (incorporated by reference from Exhibit 99.1 to the Company’s Form 8-K
      filed on November 1, 2005).10.6
                                                              Employment
      Agreement with Michael Radiloff, effective October 27, 2005 (incorporated
      by reference from Exhibit 99.2 to the Company’s Form 8-K filed on November
      1, 2005).10.7
                                                              Amendment
      to Employment Agreement between Genius Products, Inc. and Trevor
      Drinkwater dated December 5, 2005 (incorporated by reference from Exhibit
      99.1 to the Company’s Form 8-K filed on December 9,
  2005).10.8
                                                              Amendment
      to Employment Agreement between Genius Products, Inc. and Michael Radiloff
      dated December 5, 2005 (incorporated by reference from Exhibit 99.2 to the
      Company’s Form 8-K filed on December 9, 2005).10.9
                                                              Employment
      Agreement between Genius Products, Inc. and Rodney Satterwhite dated
      December 2, 2005 (incorporated by reference from Exhibit 99.3 to the
      Company’s Form 8-K filed on December 9, 2005).10.10
                                                              Amendment
      to Employment Agreement between Genius Products, Inc. and Rodney
      Satterwhite dated December 5, 2005 (incorporated by reference from Exhibit
      99.4 to the Company’s Form 8-K filed on December 9,
  2005).10.11
                                                              Employment
      Agreement between Genius Products, Inc. and Mitch Budin dated December 5,
      2005 (incorporated by reference from Exhibit 99.5 to the Company’s Form
      8-K filed on December 9, 2005).10.12
                                                              Amendment
      to Employment Agreement between Genius Products, Inc. and Mitch Budin
      dated December 5, 2005 (incorporated by reference from Exhibit 99.6 to the
      Company’s Form 8-K filed on December 9, 2005).10.13
                                                              Form
      of Executive Stock Payment Agreement dated as of June 2, 2003, with Klaus
      Moeller, Michael Meader, Larry Balaban. Howard Balaban and Julie Ekelund
      for stock and warrants paid in lieu of $20,000 each of 2003 salary
      (incorporated by reference from Exhibit 10.1 included with the Company’s
      Form 10-QSB filed on August 14, 2003).10.14
                                                              Amended
      and Restated 1997 Non-Qualified Stock Option Plan (incorporated by
      reference from Exhibit 10.61 included with the Company’s Form 10-KSB,
      Amendment #1, filed on April 30, 2002).10.15
                                                              Form
      of Non-Qualified Stock Option Agreement under the Amended and Restated
      1997 Stock Option Plan (incorporated by reference from Exhibit 10.16 to
      the Company’s Form 10-KSB filed on March 31,
  2005).




54
  10.16
                  Second
      Amended and Restated 2000 Non-Qualified Stock Option Plan (incorporated by
      reference from Exhibit 10.62 included with the Company’s Form 10-KSB,
      Amendment #1, filed on April 30, 2002)10.17
                  Form
      of Non-Qualified Stock Option Agreement under the Second Amended and
      Restated 2000 Non-Qualified Stock Option Plan (incorporated by reference
      from Exhibit 10.18 to the Company’s Form 10-KSB filed on March 31,
      2005).10.18
                  2003
      Stock Option Plan (incorporated by reference from Exhibit A included with
      the Company’s Proxy Statement filed on April 30, 2003).10.19
                  Form
      of Incentive Stock Option Agreement under the 2003 Stock Option Plan
      (incorporated by reference from Exhibit 10.30 included with the Company’s
      Registration Statement (No. 333-108966) on Form SB-2 filed on September
      19, 2003).10.20
                  Form
      of Non-Qualified Stock Option Agreement under the 2003 Stock Option Plan
      (incorporated by reference from Exhibit 10.31 included with the Company’s
      Registration Statement (No. 333-108966) on Form SB-2 filed on September
      19, 2003).10.21
                  2004
      Stock Incentive Plan (incorporated by reference from Appendix B included
      with the Company’s Proxy Statement filed on October 4,
    2004).10.22
                  Form
      of Notice of Stock Option Award under the 2004 Stock Incentive Plan
      (incorporated by reference from Exhibit 10.23 to the Company’s Form 10-KSB
      filed on March 31, 2005).10.23
                  Form
      of Stock Option Agreement under the 2004 Stock Incentive Plan
      (incorporated by reference from Exhibit 10.24 to the Company’s Form 10-KSB
      filed on March 31, 2005).10.24
                  Sublease
      with Citibank (West), FSB for office space in Solana Beach, California
      (incorporated by reference from Exhibit 10.30 included with the Company’s
      Form 10-KSB filed on March 30, 2004).10.25
                  Lease
      Agreement with ProCon, Inc. dated as of August 25, 2004 for office space
      in Bentonville, Arkansas (incorporated by reference from Exhibit 99.1
      included with the Company’s Form 8-K filed on November 12,
      2004).10.26**
                  License
      Agreement with Falcon Picture Group, LLC dated September 8, 2003
      (incorporated by reference from Exhibit 10.3 included with the Company’s
      Form 10-QSB filed on May 17, 2004).10.26**
                  First
      Amendment to License Agreement with Falcon Picture Group, LLC dated
      December 22, 2003 (incorporated by reference from Exhibit 10.4
      included with the Company’s Amended Form 10-QSB filed on July 13,
      2004).10.28
                  Form
      of $1 and $3 Warrants issued in conjunction with 2003 Secured Promissory
      Notes (incorporated by reference from Exhibit 10.38 included with the
      Company’s Form 10-KSB filed on March 30, 2004).10.29
                  Form
      of Warrant for purchasers in March 2004 private placement. (incorporated
      by reference from Exhibit 10.37 to the Company’s Form 10-KSB filed on
      March 31, 2005).10.30
                  Form
      of Warrant issued to Sands Brothers International Limited dated March 12,
      2004. (incorporated by reference from Exhibit 10.38 to the Company’s Form
      10-KSB filed on March 31, 2005).10.31
                  Form
      of Warrant dated March 2, 2005 (incorporated by reference from Exhibit
      99.3 to the Company’s Form 8-K filed on March 9, 2005).10.32
                  Agreement
      and Plan of Merger, dated as of March 21, 2005, by and among the Company,
      Genius Acquisition Corp., American Vantage Companies (“AVC”), and American
      Vantage Media Corporation (incorporated by reference from Exhibit 2.1 to
      the Company’s Form 8-K filed on March 25, 2005).10.33
                  Form
      of Common Stock Purchase Warrant issued to AVC (incorporated by reference
      from Exhibit 2.7 to the Company’s Form 8-K filed on March 25,
      2005).10.34
                  Form
      of Common Stock Purchase Warrant issued to various purchasers
      (incorporated by reference from Exhibit 99.3 to the Company’s Form 8-K
      filed on May 26, 2005).10.35
                  Form
      of Common Stock Purchase Warrant issued to various investors in connection
      with the Note and Warrant Purchase Agreement dated October 4, 2005
      (incorporated by reference from Exhibit 99.3 to the Company’s Form 8-K
      filed on October 11, 2005).10.36
                  Form
      of Warrant issued to various purchasers (incorporated by reference from
      Exhibit 99.3 to the Company’s Form 8-K filed on December 8,
      2005).10.37
                  Master
      Contribution Agreement by and among Genius Products, Inc., The Weinstein
      Company LLC and The Weinstein Company Holdings LLC dated as of December 5,
      2005 (incorporated by reference from Exhibit 2.1 to the Company’s Form 8-K
      filed on December 9, 2005).[Exhibits
      are omitted but will be furnished to the Commission supplementally upon
      request]
  55
 
 10.38
                Form
      of Stock Option Award Agreement with Michael J. Koss (incorporated by
      reference from Exhibit 99.2 o the Company’s Form S-8 filed on December 20,
      2005).10.39
                Form
      of Stock Option Award Agreement with Charles H. Rivkin (incorporated by
      reference from Exhibit 99.3 o the Company’s Form S-8 filed on December 20,
      2005).10.40
                Form
      of Stock Option Award Agreement with Trevor Drinkwater (incorporated by
      reference from Exhibit 99.5 o the Company’s Form S-8 filed on December 20,
      2005).10.41
                Form
      of Stock Option Award Agreement with Trevor Drinkwater (incorporated by
      reference from Exhibit 99.6 to the Company’s Form S-8 filed on December
      20, 2005).10.42
                Form
      of Stock Option Award Agreement with Shawn Howie (incorporated by
      reference from Exhibit 99.7 to the Company’s Form S-8 filed on December
      20, 2005).10.43
                Form
      of Stock Option Award Agreement with Stephen K. Bannon (incorporated by
      reference from Exhibit 99.8 to the Company’s Form S-8 filed on December
      20, 2005).
 10.44
                Form
      of Stock Option Award Agreement with Stephen K. Bannon (incorporated by
      reference from Exhibit 99.9 to the Company’s Form S-8 filed on December
      20, 2005).10.45
                Form
      of Stock Option Award Agreement with James G. Ellis (incorporated by
      reference from Exhibit 99.11 to the Company’s Form S-8 filed on December
      20, 2005).10.46
                Form
      of Stock Option Award Agreement with Robert V. Graziano (incorporated by
      reference from Exhibit 99.12 to the Company’s Form S-8 filed on December
      20, 2005).10.47
                Form
      of Stock Option Award Agreement with Herbert Hardt (incorporated by
      reference from Exhibit 99.13 to the Company’s Form S-8 filed on
      December 20, 2005).10.48
                Form
      of Stock Option Award Agreement with Mitch Budin (incorporated by
      reference from Exhibit 99.14 to the Company’s Form S-8 filed on December
      20, 2005).10.49
                Form
      of Stock Option Award Agreement with Mitch Budin (incorporated by
      reference from Exhibit 99.15 to the Company’s Form S-8 filed on December
      20, 2005).10.50
                First
      Amendment to Master Contribution Agreement by and among Genius Products,
      Inc., The Weinstein Company LLC and The Weinstein Company Holdings LLC,
      dated as of March 15, 2006 (incorporated by reference from Exhibit 2.2 to
      the Company’s Form 8-K filed on March 16, 2006).10.51
                Employment
      Agreement by and between Genius Products, Inc. and John Mueller dated
      March 10, 2006 (incorporated by reference from Exhibit 99.1 to the
      Company’s Form 8-K filed on March 16, 2006).10.52
                Settlement
      Agreement and Release of Claims entered into by Genius Products, Inc. with
      Shawn Howie dated February 7, 2006 (incorporated by reference from Exhibit
      99.1 to the Company’s Form 8-K filed on February 13,
  2006).10.53
                Lease
      Agreement with PTL Realty dated as of March 8, 2006, by and between the
      Company and Ed Silver, Co-Trustee of the Silver Trust and Tess Weinstein,
      Co-Trustee of the Weinstein Trust, d/b/a PTL Realty (incorporated by
      reference from Exhibit 10.1 to the Company’s Form 10-Q filed on May 15,
      2006).10.54
                Second
      Amendment to Master Contribution Agreement by and between the Company, The
      Weinstein Company LLC, The Weinstein Company Holdings LLC and The
      Weinstein Company Funding LLC entered into on April 26, 2006 (incorporated
      by reference from Exhibit 2.3 to the Company’s Form 8-K filed on May 2,
      2006).10.55
                Third
      Amendment to Master Contribution Agreement by and between the Company, The
      Weinstein Company LLC, The Weinstein Company Holdings LLC and The
      Weinstein Company Funding LLC entered into on May 30, 2006 (incorporated
      by reference from Exhibit 2.4 to the Company’s Form 8-K filed on June 2,
      2006).
 10.56
                Fourth
      Amendment to Master Contribution Agreement by and between the Company, The
      Weinstein Company LLC, The Weinstein Company Holdings LLC and The
      Weinstein Company Funding LLC entered into on June 28, 2006 (incorporated
      by reference from Exhibit 2.5 to the Company’s Form 8-K filed on June 29,
      2006).10.57
                Form
      of Limited Liability Company Agreement of Genius Products, LLC, dated July
      21, 2006 (incorporated by reference from Appendix C to the Company’s
      Definitive Proxy Statement filed on June 29, 2006).10.58
                Form
      of Distribution Agreement, dated July 17, 2006, by and between Genius
      Products, LLC and The Weinstein Company LLC (incorporated by reference
      from Appendix D to the Company’s Definitive Proxy Statement filed on June
      29, 2006).10.59
                Amended
      and Restated 2004 Stock Incentive Plan (incorporated by reference from
      Appendix F to the Company’s Definitive Proxy Statement filed on June 29,
      2006).10.60
                Output
      Distribution Agreement, dated July 7, 2006, by and between the Company and
      ESPN Enterprises, Inc. (incorporated by reference from Exhibit 10.1 to the
      Company’s Form 8-K/A filed on September 29, 2006).10.61
                Consulting
      Agreement, dated July 20, 2006, by and between the Company and Bannon
      Strategic Advisors, Inc. (incorporated by reference from Exhibit 10.1 to
      the Company’s Form 8-K filed on July 26, 2006).10.62
                Amendment
      No. 2 to Employment Agreement, dated July 20, 2006, by and between the
      Company and Trevor Drinkwater (incorporated by reference from Exhibit 10.2
      to the Company’s Form 8-K filed on July 26,
  2006).
   
 56
 10.63
                Registration
      Rights Agreement, dated July 21, 2006, by and between the Company and The
      Weinstein Company LLC (incorporated by reference from Exhibit 10.7 to the
      Company’s Report on Form 10-Q filed on November 20,
  2006).10.64
                Amended
      and Restated Limited Liability Company Agreement of Genius Products, LLC,
      dated as of July 21, 2006 (incorporated by reference from Exhibit 99.2 to
      the Company’s Form 8-K filed on September 19, 2007).10.65
                Letter
      Agreement, dated as of September 17, 2007, by and among the Company, the
      Distributor, The Weinstein Company Holdings LLC and W-G Holding Corp.
      (incorporated by reference from Exhibit 99.1 to the Company’s Form 8-K
      filed on September 19, 2007).10.66
                Credit
      Agreement, dated as of August 10, 2007, by and among the Distributor, as
      borrower, Société Générale, as administrative agent, collateral agent and
      L/C Issuer, the lenders party thereto and SG Americas Securities, LLC, as
      lead arranger and sole bookrunner (incorporated by reference from Exhibit
      99.1 to the Company’s Form 8-K filed on August 16,
  2007).10.67
                Allocation
      of Accounts Receivable and Intercreditor Agreement, dated as of August 10,
      2007, by and among the Distributor, The Weinstein Company LLC and Société
      Générale (incorporated by reference from Exhibit 99.2 to the Company’s
      Form 8-K filed August 16, 2007).10.68
                Guaranty
      Agreement, dated as of August 10, 2007, by the Company and each of the
      other signatories thereto, as guarantors, in favor of Société Générale
      (incorporated by reference from Exhibit 99.3 to the Company’s Form 8-K
      filed August 16, 2007).10.69
                Security
      Agreement, dated as of August 10, 2007, by and among the Distributor, the
      Company, each of the other signatories thereto and Société Générale
      (incorporated by reference from Exhibit 99.4 to the Company’s Form 8-K
      filed August 16, 2007).10.70
                Promissory
      Note, dated as of September 27, 2007, issued by the Distributor in favor
      of the Company (incorporated by reference from Exhibit 99.1 to the
      Company’s Form 8-K filed October 3, 2007)10.71
                Amended
      and Restated Credit Agreement, dated as of November 1, 2007, by and among
      the Distributor, as borrower, Société Générale, as administrative agent,
      collateral agent and L/C Issuer, the lenders party thereto, SG Americas
      Securities,
                  LLC,
      as lead arranger and sole bookrunner, and Alliance & Leicester
      Commercial Finance plc, as managing lead arranger (incorporated by
      reference from Exhibit 99.1 to the Company’s Form 8-K filed November 6,
      2007)10.72
                Amendment
      No. 1 to Allocation of Accounts Receivable and Intercreditor Agreement,
      dated as of November 1, 2007, by and among the Distributor, The Weinstein
      Company LLC and Société Générale (incorporated by reference from Exhibit
      99.2 to the Company’s Form 8-K filed November 6, 2007).10.73
                Reaffirmation
      of Guaranty Agreement, dated as of November 1, 2007, by the Company and
      each of the other signatories thereto, as guarantors, in favor of Société
      Générale (incorporated by reference from Exhibit 99.3 to the Company’s
      Form 8-K filed November 6, 2007).10.74
                Employment
      Offer Letter, dated December 28, 2007, by Matthew Smith and the
      Distributor (incorporated by reference from Exhibit 99.2 to the Company’s
      Form 8-K filed January 8, 2008)10.75
                Lantana
      Office Lease, dated December 31, 2007, by and between the Distributor and
      Maguire Properties – 3301 Exposition, LLC (incorporated by reference from
      Exhibit 99.1 to the Company’s Form 8-K filed January 8,
    2008)14.1
                Code
      of Ethics adopted February 27, 2004 (incorporated by reference from
      Exhibit 10.39 included with the Company’s Form 10-KSB filed on March 30,
      2004).23.1*
                Consent
      of Ernst & Young LLP.23.2*
                Consent
      of Singer Lewak Greenbaum & Goldstein LLP.31.1*
                Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act.31.2*
                Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act.32.1*
                Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act.32.2*
                Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act.


*       Filed
herewith.




**     Confidential
treatment has been requested with respect to certain portions of this exhibit.
Omitted portions have been filed separately with the Securities and Exchange
Commission pursuant to an application for confidential treatment.





57





SIGNATURES





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




Date:
      March 25, 2009
            
            
            
            GENIUS
      PRODUCTS, INC.,a
      Delaware corporationBy:
            
            /s/
      Trevor
      DrinkwaterTrevor
      Drinkwater,Chief
      Executive Officer




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




SIGNATURE
                      
                      TITLE
                      
                      DATE/s/ Trevor
      Drinkwater­­­­­­­­­­­
                      
                      Chief
      Executive Officer and Director
                        (Principal
      Executive Officer)
                      
                      March
      25, 2009Trevor
      Drinkwater/s/ Edward J. Byrnes
                      
                      Chief
      Financial Officer
                        (Principal
      Financial and Accounting Officer)
                      
                      March
      25, 2009Edward
      J. ByrnesChairman
      of the Board of Directors
                      
                      March
      __, 2009Alan
      Quasha/s/ Stephen K.
Bannon
                      
                      Director
                      
                      March
      25, 2009Stephen
      K. BannonDirector
                      
                      March
      __, 2009Bruce
      Bunner/s/ Herbert Hardt
                      
                      Director
                      
                      March
      25, 2009Herbert
      HardtDirector
                      
                      March
      __, 2009John
      Hecker










58




Report
of Independent Registered Public Accounting Firm
 
 To the
Stockholders and Board of Directors of Genius Products, Inc.:
 
 We have
audited the accompanying consolidated balance sheets of Genius Products, Inc.
(the ‘Company’) and subsidiaries as of December 31, 2007 and 2006, and the
related consolidated statements of operations, stockholders’ equity, and cash
flows for the years then ended. Our audits also included the financial statement
schedule listed in the Index at Item 8. These financial statements and schedule
are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements and schedule based on our
audits. The financial statements of Genius Products, Inc. and subsidiaries for
the year ended December 31, 2005, were audited by other auditors whose report
dated April 13, 2006, expressed an unqualified opinion on those
statements.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 Since the
date of completion of our audit of the accompanying financial statements and
initial issuance of our report dated March 16, 2008, as discussed in Note 14 to
the financial statements of the Company, Genius Products, LLC (the
‘Distributor’) does not expect to generate sufficient operating cash flow to
fund operating activities, thereby adversely affecting the Distributor’s results
of operations and liquidity. As the Company relies solely on the Distributor to
fund its operations and is also the guarantor of the Distributor’s credit
facility, any adverse impact on the operations and liquidity of the Distributor
could also adversely impact the Company’s results of operations and liquidity.
Note 14 describes management’s plans to address this issue.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Genius Products, Inc.
and subsidiaries at December 31, 2007 and 2006, and the consolidated results of
their operations and their cash flows for the years then ended, in conformity
with U.S. generally accepted accounting principles. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
 
 As
discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for stock-based compensation effective January
1, 2006.
 
 As
discussed in Note 3 to the consolidated financial statements, the Company has
restated its audited financial statements and other financial information as
of December 31, 2007 and 2006 and for the years then
ended.
 
 We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Genius Products, Inc.’s internal control over
financial reporting as of December 31, 2007, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated March 16, 2008
expressed an adverse opinion thereon.
 
 /s/ Ernst & Young
LLP
 
 Los
Angeles, California
 March 16,
2008,
 except
for Note 3 and Note 14, as to which the date is
 March
24, 2009
 F-1
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  The
Stockholders and Board of Directors of Genius Products, Inc.:
  We have
audited Genius Products, Inc.’s internal control over financial reporting as of
December 31, 2007, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the COSO criteria). Genius Products, Inc.’s
management is responsible for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management’s
Report on Internal Control Over Financial Reporting. Our responsibility is to
express an opinion on the company’s internal control over financial reporting
based on our audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, testing
and evaluating the design and operating effectiveness of internal control based
on the assessed risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the company’s annual or interim financial
statements will not be prevented or detected on a timely basis. The following
material weaknesses have been identified at the company including its
significant equity investee and is included in management’s assessment: a)
Timely and routine financial statement close/reporting process and the entity
level controls surrounding this process, b) Calculation of expenses related to
stock compensation, c) Formal processes over change management and access
procedures related to information technology systems, d) Revenue recognition
process; specifically, controls in the areas of allocating and tracking Market
Development Funds spending, e) Licensor participations expense and related
liabilities, and film amortization, f) Management’s estimation and forecasting
process as it relates to inventory obsolescence reserve. These material
weaknesses were considered in determining the nature, timing and extent of audit
tests applied in our audit of the December 31, 2007 consolidated financial
statements, and this report does not affect our report dated March 16, 2008, except
for Note 3 and Note 14, as to which the date is March 24 , 2009, on
those financial statements.
  In our
opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Genius Products, Inc. has
not maintained effective internal control over financial reporting as of
December 31, 2007, based on the COSO criteria.
  /s/    ERNST &
      YOUNG LLP
  Los
Angeles, California
 March 16,
2008
 
 F-2
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS
 
 
 To the
Board of Directors
 Genius
Products, Inc.
 Santa
Monica, California
 
 We have
audited the consolidated statements of operations, stockholders’ equity and cash
flows for the year ended December 31, 2005 of Genius Products, Inc. and
subsidiaries (collectively, the “Company”).  Our audit also included
the financial statement schedule of the Company, listed in Item
15(a).  These financial statements and financial statement schedule
are the responsibility of the Company’s management.  Our
responsibility is to express an opinion on these financial statements based on
our audits.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provided a reasonable basis
for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above presented
fairly, in all material respects, the results of operations of Genius Products,
Inc. and subsidiaries and their cash flows for the year ended December 31, 2005
in conformity with U.S. generally accepted accounting
principles.  Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements, taken as a whole, presents fairly in all material respects the
information set forth therein.
 
 
 /s/
SINGER LEWAK LLP
 
 
 Los
Angeles, California
 April 13,
2006
 
 F-3
  GENIUS
      PRODUCTS, INC. AND SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETS(IN
      THOUSANDS, EXCEPT SHARE AND PAR VALUE
  INFORMATION)
   December
      31, 2007
                      
                      
                      December
      31, 2006Restated
      (Note 3)
                      
                      
                      Restated
      (Note 3)ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      1,757
                      
                      
                      $
                      3,745Prepaid
      expenses and other current assets
                      
                      
                      110
                      
                      
                      
                      110Amounts
      receivable from affiliate, net
                      
                      
                      -
                      
                      
                      
                      777Total
      current assets
                      
                      
                      1,867
                      
                      
                      
                      4,632Notes
      receivable, related party, net
                      
                      
                      8,191
                      
                      
                      
                      -Investment
      in Distributor
                      
                      
                      73,002
                      
                      
                      
                      87,694Total
      assets
                      
                      $
                      83,060
                      
                      
                      $
                      92,326LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Amount
      payable to affiliate, net
                      
                      $
                      198
                      
                      
                      $
                      -Amount
      payable
                      
                      
                      -
                      
                      
                      
                      59Accrued
      expenses
                      
                      
                      -
                      
                      
                      
                      865Total
      current liabilities
                      
                      
                      198
                      
                      
                      
                      924Class
      W option liability
                      
                      
                      4,168
                      
                      
                      
                      3,016Deferred
      tax liability
                      
                      
                      12,797
                      
                      
                      
                      14,528Total
      liabilities
                      
                      
                      17,163
                      
                      
                      
                      18,468Stockholders’
      equity:Preferred
      stock, $.0001 par value; 10,000,000 shares authorized; no
      sharesoutstanding
                      
                      
                      -
                      
                      
                      
                      -Series
      W preferred stock, $.0001 par value; 100 shares authorized and
      outstanding
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, $.0001 par value; 300,000,000 shares authorized;67,709,094
      and 63,305,195 shares outstanding in 2007 and 2006,
      respectively
                      
                      
                      7
                      
                      
                      
                      6Additional
      paid-in capital
                      
                      
                      112,293
                      
                      
                      
                      105,375Accumulated
      deficit
                      
                      
                      (46,403
                      )
                      
                      
                      (31,523
                      )Total
      stockholders’ equity
                      
                      
                      65,897
                      
                      
                      
                      73,858Total
      liabilities and stockholders' equity
                      
                      $
                      83,060
                      
                      
                      $
                      92,326See
      accompanying notes.
 F-4
 GENIUS
      PRODUCTS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONS(IN
      THOUSANDS, EXCEPT PER SHARE
INFORMATION)
   Year
      Ended December 31,2007
                      
                      
                      2006Restated
      (Note 3)
                      
                      
                      Restated
      (Note 3)
                      
                      
                      2005Revenues,
      net of sales returns, discounts andallowances
      of $40,882 and $9,965
                      
                      $
                      -
                      
                      
                      $
                      119,011
                      
                      
                      $
                      22,328in
      2006 and 2005, respectivelyTotal
      cost of revenues
                      
                      
                      -
                      
                      
                      
                      130,870
                      
                      
                      
                      22,883Gross
      loss
                      
                      
                      -
                      
                      
                      
                      (11,859
                      )
                      
                      
                      (555
                      )Operating
      expenses (income):Selling,
      general and administrative
                      
                      
                      5,248
                      
                      
                      
                      20,752
                      
                      
                      
                      14,747Restructuring
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,745Gain
      on sale, related party
                      
                      
                      -
                      
                      
                      
                      (63
                      )
                      
                      
                      (1,352
                      )Equity
      in net loss from Distributor
                      
                      
                      10,565
                      
                      
                      
                      7,989
                      
                      
                      
                      -Total
      operating expenses
                      
                      
                      15,813
                      
                      
                      
                      28,678
                      
                      
                      
                      16,140Loss
      from operations
                      
                      
                      (15,813
                      )
                      
                      
                      (40,537
                      )
                      
                      
                      (16,695
                      )Other
      income (expense)
                      
                      
                      (797
                      )
                      
                      
                      853
                      
                      
                      
                      (465
                      )Loss
      before provision for income taxes
                      
                      
                      (16,610
                      )
                      
                      
                      (39,684
                      )
                      
                      
                      (17,160
                      )Provision
      (benefit) for income taxes
                      
                      
                      (1,730
                      )
                      
                      
                      7,304
                      
                      
                      
                      1Loss
      before extraordinary item
                      
                      
                      (14,880
                      )
                      
                      
                      (46,988
                      )
                      
                      
                      (17,161
                      )Extraordinary
      gain, net of taxes of $5,843 in 2006
                      
                      
                      -
                      
                      
                      
                      54,203
                      
                      
                      
                      -Net
      income (loss)
                      
                      $
                      (14,880
                      )
                      
                      $
                      7,215
                      
                      
                      $
                      (17,161
                      )Basic
      and diluted EPSLoss
      before extraordinary item
                      
                      $
                      (0.22
                      )
                      
                      $
                      (0.77
                      )
                      
                      $
                      (0.42
                      )Extraordinary
      item
                      
                      
                      -
                      
                      
                      
                      0.89
                      
                      
                      
                      -Net
      income (loss)
                      
                      $
                      (0.22
                      )
                      
                      $
                      0.12
                      
                      
                      $
                      (0.42
                      )Basic
      and diluted weighted average shares
                      
                      
                      66,221,896
                      
                      
                      
                      60,949,469
                      
                      
                      
                      40,400,112See
      accompanying notes.
  F-5
  GENIUS
      PRODUCTS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY(IN
      THOUSANDS, EXCEPT SHARE AMOUNTS)
  Accumulated
                      
                      
                      Total
                        Stockholders’Deficit
                      
                      
                      EquitySeries W Preferred Stock
                      
                      
                      Common Stock
                      
                      
                      Additional Paid-in
                      
                      
                      Restated
                      
                      
                      RestatedShares
                      
                      
                      Amount
                      
                      
                      Shares
                      
                      
                      Amount
                      
                      
                      Capital
                      
                      
                      (Note
      3)
                      
                      
                      (Note
      3)Balance,
      December 31, 2004
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      25,208,512
                      
                      
                      $
                      3
                      
                      
                      $
                      26,006
                      
                      
                      $
                      (21,577
                      )
                      
                      $
                      4,432Shares
      issued in private placement, net of offering costs
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      25,681,024
                      
                      
                      
                      2
                      
                      
                      
                      44,454
                      
                      
                      
                      -
                      
                      
                      
                      44,456Shares
      and warrants issued for the acquisition of AVM
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      7,550,301
                      
                      
                      
                      1
                      
                      
                      
                      18,807
                      
                      
                      
                      -
                      
                      
                      
                      18,808Exercise
      of warrants for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,255,315
                      
                      
                      
                      -
                      
                      
                      
                      1,277
                      
                      
                      
                      -
                      
                      
                      
                      1,277Exercise
      of options for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      157,600
                      
                      
                      
                      -
                      
                      
                      
                      192
                      
                      
                      
                      -
                      
                      
                      
                      192Issuance
      of options/warrants for services rendered
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      440
                      
                      
                      
                      -
                      
                      
                      
                      440Shares
      issued for services rendered
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      585,402
                      
                      
                      
                      -
                      
                      
                      
                      988
                      
                      
                      
                      -
                      
                      
                      
                      988Severance
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,419
                      
                      
                      
                      -
                      
                      
                      
                      1,419Warrants
      issued as debt discount
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      322
                      
                      
                      
                      -
                      
                      
                      
                      322Other
      adjustment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      15
                      
                      
                      
                      -
                      
                      
                      
                      15Net
      loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (17,161
                      )
                      
                      
                      (17,161
                      )Balance,
      December 31, 2005
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      60,438,154
                      
                      
                      $
                      6
                      
                      
                      $
                      93,920
                      
                      
                      $
                      (38,738
                      )
                      
                      $
                      55,188Exercise
      of warrants for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      649,288
                      
                      
                      
                      -
                      
                      
                      
                      840
                      
                      
                      
                      -
                      
                      
                      
                      840Cashless
      exercise of warrants
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      325,029
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Exercise
      of options for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,892,724
                      
                      
                      
                      -
                      
                      
                      
                      2,522
                      
                      
                      
                      -
                      
                      
                      
                      2,522Issuance
      of Series W Preferred Stock
                      
                      
                      100
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Share-based
      compensation
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      7,679
                      
                      
                      
                      -
                      
                      
                      
                      7,679Reclassification
      of redeemable stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      414
                      
                      
                      
                      -
                      
                      
                      
                      414Net
      income
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      7,215
                      
                      
                      
                      7,215Balance,
      December 31, 2006
                      
                      
                      100
                      
                      
                      $
                      -
                      
                      
                      
                      63,305,195
                      
                      
                      $
                      6
                      
                      
                      $
                      105,375
                      
                      
                      $
                      (31,523
                      )
                      
                      $
                      73,858Exercise
      of warrants for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      2,734,142
                      
                      
                      
                      1
                      
                      
                      
                      3,684
                      
                      
                      
                      -
                      
                      
                      
                      3,685Cashless
      exercise of warrants
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      490,928
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Exercise
      of options for cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,178,829
                      
                      
                      
                      -
                      
                      
                      
                      1,967
                      
                      
                      
                      -
                      
                      
                      
                      1,967Share-based
      compensation
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,267
                      
                      
                      
                      -
                      
                      
                      
                      1,267Net
      loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (14,880
                      )
                      
                      
                      (14,880
                      )Balance,
      December 31, 2007
                      
                      
                      100
                      
                      
                      $
                      -
                      
                      
                      
                      67,709,094
                      
                      
                      $
                      7
                      
                      
                      $
                      112,293
                      
                      
                      $
                      (46,403
                      )
                      
                      $
                      65,897
 See
accompanying notes.
 F-6
 GENIUS
      PRODUCTS, INC. AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWS(IN
      THOUSANDS)
   Year
      Ended December 31,2007
                      
                      
                      2006Restated
      (Note 3)
                      
                      
                      Restated
      (Note 3)
                      
                      
                      2005Cash
      flows from operating activities:Net
      income (loss)
                      
                      $
                      (14,880
                      )
                      
                      $
                      7,215
                      
                      
                      $
                      (17,161
                      )Adjustments
      to reconcile net income (loss) to net cash used in operating
      activitiesDepreciation
      and amortization
                      
                      
                      -
                      
                      
                      
                      116
                      
                      
                      
                      3,155Equity
      in net loss from Distributor
                      
                      
                      10,565
                      
                      
                      
                      7,331
                      
                      
                      
                      -Amortization
      of production masters and film library
                      
                      
                      -
                      
                      
                      
                      12,508
                      
                      
                      
                      -Change
      in allowance for doubtful accounts and provision for
    returns
                      
                      
                      -
                      
                      
                      
                      17,423
                      
                      
                      
                      5,545Change
      in provision for obsolete inventory
                      
                      
                      -
                      
                      
                      
                      3,922
                      
                      
                      
                      1,827Common
      stock issued for services
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      988Operating
      expenses paid by Distributor
                      
                      
                      4,828
                      
                      
                      
                      1,263
                      
                      
                      
                      -Revaluation
      of Class W option liability
                      
                      
                      1,152
                      
                      
                      
                      (767
                      )
                      
                      
                      -Extraordinary
      gain
                      
                      
                      -
                      
                      
                      
                      (60,046
                      )
                      
                      
                      -Amortization
      of warrants issued for services
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      440Stock
      compensation expense
                      
                      
                      566
                      
                      
                      
                      7,400
                      
                      
                      
                      1,418Gain
      on sale of assets to Pacific Entertainment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (1,352
                      )Interest
      expense on redeemable common stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      19Amortization
      of discount on notes payable
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      217Deferred
      tax liability
                      
                      
                      (1,731
                      )
                      
                      
                      13,148
                      
                      
                      
                      -Changes
      in assets and liabilities:Increase
      in accounts receivable
                      
                      
                      -
                      
                      
                      
                      (65,331
                      )
                      
                      
                      (1,493
                      )Increase
      in inventories
                      
                      
                      -
                      
                      
                      
                      (12,470
                      )
                      
                      
                      (3,525
                      )(Increase)
      decrease in prepaid expenses, notes receivable and
deposits
                      
                      
                      -
                      
                      
                      
                      389
                      
                      
                      
                      (81
                      )(Increase)
      decrease in related party receivable
                      
                      
                      777
                      
                      
                      
                      -
                      
                      
                      
                      -Increase
      in royalty advances
                      
                      
                      -
                      
                      
                      
                      (2,416
                      )
                      
                      
                      -Increase
      in library
                      
                      
                      -
                      
                      
                      
                      (1,456
                      )
                      
                      
                      (3,454
                      )Increase
      (decrease) in accounts payable
                      
                      
                      (59
                      )
                      
                      
                      (3,767
                      )
                      
                      
                      (4,218
                      )Increase
      (decrease) in related party payable
                      
                      
                      198
                      
                      
                      
                      -
                      
                      
                      
                      -Increase
      (decrease) in accrued expenses and other
                      
                      
                      (865
                      )
                      
                      
                      18,149
                      
                      
                      
                      1,453Increase
      (decrease) in note receivable
                      
                      
                      (191
                      )
                      
                      
                      -
                      
                      
                      
                      -Decrease
      in customer deposits
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (41
                      )Increase
      in deferred revenue
                      
                      
                      -
                      
                      
                      
                      2,494
                      
                      
                      
                      -Increase
      in remittance to licensors
                      
                      
                      -
                      
                      
                      
                      50,992
                      
                      
                      
                      -Net
      cash provided (used) in operating activities
                      
                      
                      360
                      
                      
                      
                      (3,903
                      )
                      
                      
                      (16,263
                      )Cash
      flows from investing activities:AVM
      cash, net of expenses paid in cash
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      599Proceeds
      from sale of assets to Pacific Entertainment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      250Investment
      in Distributor
                      
                      
                      -
                      
                      
                      
                      (20,329
                      )
                      
                      
                      -Long
      term note receivable with Genius Products, LLC
                      
                      
                      (8,000
                      )
                      
                      
                      -
                      
                      
                      
                      -Restricted
      cash
                      
                      
                      -
                      
                      
                      
                      (303
                      )
                      
                      
                      -Patents
      and trademarks
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (10
                      )Purchase
      of property and equipment
                      
                      
                      -
                      
                      
                      
                      (448
                      )
                      
                      
                      (272
                      )Net
      cash provided (used) in investing activities
                      
                      
                      (8,000
                      )
                      
                      
                      (21,080
                      )
                      
                      
                      567Cash
      flows from financing activities:Proceeds
      from notes payable
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      4,000Net
      borrowings (payments) on notes payable and debentures
                      
                      
                      -
                      
                      
                      
                      (5,231
                      )
                      
                      
                      (4,856
                      )Payments
      of offering costs
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (3,444
                      )Proceeds
      from exercise of options
                      
                      
                      1,967
                      
                      
                      
                      2,522
                      
                      
                      
                      192Proceeds
      from exercise of warrants
                      
                      
                      3,685
                      
                      
                      
                      840
                      
                      
                      
                      1,277Proceeds
      from issuance of common stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      47,900Net
      cash provided (used) in financing activities
                      
                      
                      5,652
                      
                      
                      
                      (1,869
                      )
                      
                      
                      45,069Net
      increase (decrease) in cash and cash equivalents
                      
                      
                      (1,988
                      )
                      
                      
                      (26,852
                      )
                      
                      
                      29,373Cash
      and cash equivalents at beginning of year
                      
                      
                      3,745
                      
                      
                      
                      30,597
                      
                      
                      
                      1,224Cash
      and cash equivalents at end of year
                      
                      $
                      1,757
                      
                      
                      $
                      3,745
                      
                      
                      $
                      30,597
 F-7
 Supplemental
      disclosure of cash flow informationWarrants
      issued for offering costs
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          1,015Issuance
      of common stock for offering costs
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          350Interest
      paid
                          
                          
                          -
                          
                          
                          
                          11
                          
                          
                          
                          1Taxes
      paid
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          1Noncash
      transactionsContribution
      of assets, liabilities and businesses to Distributor
                          
                          $
                          -
                          
                          
                          $
                          11,851
                          
                          
                          $
                          -Reclassification
      of  redeemable common stock
                          
                          
                          -
                          
                          
                          
                          414
                          
                          
                          
                          -Equity
      consideration for acquisition of AVMC
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          18,808Recording
      of Class W Option Liability
                          
                          
                          -
                          
                          
                          
                          3,016
                          
                          
                          
                          -See
      accompanying notes.
  
 F-8
 GENIUS
PRODUCTS, INC. AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007
  NOTE
1. NATURE OF BUSINESS
 
 Genius
Products, Inc. (“we”, “us”, “our” or the “Company”), through our 30%-owned
subsidiary, Genius Products, LLC (the “Distributor”), is a leading independent
home entertainment products company that acquires, produces and licenses,
through the Distributor’s multiple distribution agreements with content
partners, an extensive library of motion pictures, television programming,
and  trend entertainment on digital versatile disks (“DVD”) and
digitally.  The Distributor works in partnership with major retailers
to distribute widely recognized home entertainment brands to a diversified
customer base.  The remaining 70% of the Distributor is owned by The
Weinstein Company Holdings LLC (“TWC Holdings”) (which includes a 1% percentage
interest owned indirectly through its wholly-owned subsidiary, W-G Holding Corp
(“W-G Holding”).  TWC Holdings is the parent company of The Weinstein
Company LLC (“TWC”), the largest provider of content for the Distributor’s
library.
 
 Through
the Distributor, for which the Company serves as managing member, we produce and
distribute a vast and growing content library that encompasses approximately
3,550 feature films and documentaries and 4,000 hours of television
programming.  This library includes feature
films and television programming from critically acclaimed producers such as The
Weinstein Company®, for which the Distributor hasthe exclusive U.S. home
video distribution rights,and RHI EntertainmentTM
(Hallmark library).  Additional content, such as independent films,
sports, family, and lifestyle productions, come from partnerships with
established consumer brands:  IFC®, ESPN®, World Wrestling
Entertainment®, Classic Media, Sesame Workshop®, Discovery KidsTM, Animal Planet
and The Learning Channel (TLCTM).
 
 The
Distributor has developed a fully integrated direct-to-retail distribution
platform that parallels the home entertainment divisions of the major Hollywood
studios.  This platform provides direct sales and marketing, inventory
management and state-of-the-art supply-chain services.  In
collaboration with leading replicators and third-party logistics and
supply-chain companies, the Distributor has rapidly scaled this network, which
has helped to facilitate its rapid growth in revenues.
  The
Distributor primarily sells to major national retailers including Wal-Mart,
Blockbuster Entertainment, Best Buy, Circuit City, Kmart, Target, NetFlix,
Costco, Sam’s Club, Amazon, Borders, Toys R Us and Columbia
House.  The Distributor co-produces programming with its branded
content partners and mitigates the impact of its production costs through
minimum guarantees from its retail partners.  We believe that the
strong relationships the Distributor has developed with these well-known
retailers and branded content partners help promote the Distributor’s
programming and heighten consumer awareness of its programs.
  The
Distributor collaborates with our retail and content partners to create sales
programs that exploit their widely recognized brands and endorse related
content.  These sales programs focus on brands to provide the retailer
with solutions that simplify the retailer’s buying process, improve shelf-space
utilization and help consumers quickly make informed purchase
decisions.  The Distributor’s ability to deliver unique, innovative
solutions that improve the sales and rentals of its content has enabled it to
compete successfully and maintain strong relationships with its retail and
content partners.
  The Distributorcurrentlydistributesitslibrary on DVDs,next-generationDVD, and
electronicallyin a digital format.Weplan to continue to
expand the distribution of the Distributor’s theatrical and non-theatrical
product through the diverse emerging digital distribution markets including:
Video-on-Demand (“VOD”) and Electronic Sell-Through (“EST”) on the Internet to
companies such as Amazon, Apple, MovieLink and Microsoft, Internet-based
subscription VOD customers (such as NetFlix) and direct-to-television
peer-to-peer network solutions.  Through its partnerships, the
Distributor has released 128 theatrical and non-theatrical titles since
inception (including ninety titles released in 2007).  The Distributor
distributes products to basic channels distributed on cable, Direct Broadcast
Satellite (“DBS”) and Internet Protocol Television (“IPTV”), which delivers
television programming to households via a broadband connection using Internet
protocols.
  The
Distributor primarily focuses on four core branded content categories that we
call Content Verticals:
 
 ·
                Theatrical/Independent
      Films (includes Independent Film Channel (IFC)® , RHI
      EntertainmentTM (Hallmark library), Tartan, The Weinstein
      Company®  and
WellspringTM)
 ·
                Sports
      (includes ESPN® and World Wrestling
  Entertainment®)
 ·
                Lifestyle
      (includes Animal Planet, The Learning Channel (TLC) and
      WellspringTM)
 ·
                Family/Faith
      (includes Classic Media, Discovery KidsTM, Entertainment Rights and Sesame
      Workshop®)
 
 F-9
 
 THE
WEINSTEIN COMPANY TRANSACTION.
 On July
21, 2006 (the “Closing Date”), the Company completed a transaction (the “TWC
Transaction”) with TWC Holdings and W-G Holding (two subsidiaries of TWC)
pursuant to which we launched the Distributor to exploit the exclusive U.S. home
video distribution rights to feature film and direct-to-video releases owned or
controlled by TWC.  On the Closing Date, the Company contributed
substantially all of its assets (except for $1 million in cash and certain
liabilities), its employees, and its existing businesses to the
Distributor.
 
 Thus, the
Distributor is owned 70% by TWC Holdings and W-G Holding and 30% by the
Company.  The 70% interest in the Distributor held by TWC Holdings and
W-G Holding consists of Class W Units and is redeemable, at TWC Holdings’ and
W-G Holding’s option commencing at any time from July 21, 2007  for up
to 70% of the Company’s outstanding common stock, or with TWC Holdings’ and W-G
Holding’s approval, cash. The
redemption value of the Class W Units may not be less than $60.0 million. The
Company’s 30% membership interest in the Distributor consists of the
Distributor’s Class G Units (see Equity Investment in Distributor section
below).
 
 In
addition, the Company issued an aggregate of 100 shares of the Company’s Series
W Preferred Stock to TWC Holdings and W-G Holding in connection
with  the TWC Transaction.  The Series W Preferred Stock
provides the holders thereof with (i) the right to elect five of the seven
directors on the Company’s Board of Directors, of which two are currently TWC
executives, (ii) majority voting power over other actions requiring
approval of our stockholders, and (iii) the right to approve certain
specified actions.  The Series W Preferred Stock has no rights to
receive dividends and minimal liquidation value.
 
 On the
Closing Date, the Company entered into a Registration Rights Agreement with TWC
Holdings and W-G Holding pursuant to which we agreed to register for resale the
shares of our common stock issuable upon redemption of Class W Units in the
Distributor currently held by them.  The Company and/or the Distributor
also entered into the following agreements on the Closing Date: (i) an Amended
and Restated Limited Liability Company Agreement of the Distributor, (ii) Video
Distribution Agreement (the “TWC Distribution Agreement”), (iii) Services
Agreement, and (iv) Assignment and Assumption Agreement.
 
 From
December 5, 2005 through the Closing Date, the Company operated under an interim
distribution agreement with TWC and recorded the results from titles we released
for TWC on our consolidated financial statements. After the Closing Date,
substantially all of the operating activities we previously conducted, as well
as the results from releasing TWC product, are reflected in the financial
statements of the Distributor.
 
 For a
full description of the TWC Transaction, please see our Current Report on Form
8-K filed with the Securities and Exchange Commission (the “SEC”) on July 26,
2006.
 
 
 NOTE
2. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 RECLASSIFICATIONS
 Certain
reclassifications have been made to the 2006 consolidated financial statements
to conform to the 2007 presentation.
 
 PRINCIPLES
OF CONSOLIDATION.
 The
consolidated financial statements include the accounts of the
Company.   All significant inter-company transactions and accounts
have been eliminated in consolidation.
 
 USE OF
ESTIMATES.
 The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
 F-10
 CASH AND
CASH EQUIVALENTS.
 The
Company’s $1.8 million cash and cash equivalents represent an investment in time
deposits, certificates of deposit and money market accounts with original
maturities of three months or less.
 
 FAIR
VALUE OF FINANCIAL INSTRUMENTS.
 The
carrying amounts of cash and cash equivalents, prepaid expenses, accounts
payable, accrued expenses and Class W Option Liability approximate the fair
value thereof.
 FILM
LIBRARY AND RELATED AMORTIZATION.
 As of
July 21, 2006, the Company transferred all of its film library to the
Distributor.  Prior to the transfer, the Company capitalized the costs of
production and acquisition of film libraries. In accordance with Statement of
Position (“SOP”) 00-2, “Accounting by Producers or Distributors of Films” (“SOP
00-2”), the Company amortized such costs to cost of revenues, using the
individual film forecast method over a period of ten years or less.
 
 The film
library was stated at the lower of amortized cost or estimated fair value. 
The fair value of the film library was determined using management’s future
revenue and cost estimates, and the valuation of films were reviewed on a
title-by-title basis. In accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (“SFAS 144”), when an event or change in circumstances
indicates that the fair value of its film is less than its unamortized cost, an
impairment loss is recognized by recording additional amortization in the amount
by which the unamortized costs exceed the estimated fair value of the film.
Estimates of future revenue involve measurement uncertainty and it is therefore
possible that reductions in the carrying value of film library may be required
as a consequence of changes in management’s future revenue estimates.
 
 REVENUE
RECOGNITION.
 The
Company had no revenues in fiscal 2007 nor subsequent to the Closing Date of the
TWC Transaction (July 21, 2006).  For the approximately seven- month
period ending July 21, 2006 and for fiscal 2005, revenue from the sale or
licensing of films was recognized upon meeting all recognition requirements of
SOP 00-2 and Staff Accounting Bulletin (“SAB”) No. 104 Revenue
Recognition.  Revenues were recorded upon the receipt of goods by the
customer for titles that were available for consumer purchase.  Costs
of sales and an allowance for returns, rebates and discounts were recorded at
the time of revenue recognition.  Revenues from revenue sharing
arrangements were recognized as follows:   (i) in the case of by
title guarantees, when the product was available for consumer rental and (ii) in
the case of revenues derived from overages (i.e., revenue sharing arrangements
when the Distributor’s agreed-upon share of consumer rentals exceeds the
guarantee), one month after receipt.  Revenues from royalties were
recognized when received.  Revenues from licensing were recognized
when all required deliverables of a title were received and accepted by the
licensee.  Revenue for shipments of titles not available for consumer
purchase were deferred and only recognized when that title was available for
consumer purchase.  Cash payments received were recorded as deferred
revenue until all the conditions of revenue recognition were
met.  Long-term, non-interest bearing receivables were discounted to
present value.
 
 ALLOWANCE
FOR SALES RETURNS, PRICE PROTECTION, CUSTOMER DISCOUNTS, CUSTOMER DEDUCTIONS AND
BAD DEBTS.
 At the
Closing Date, the Company transferred all of its accounts receivable assets to
the Distributor and there were no accounts receivable balances at December 31,
2006 or December 31, 2007.
 
 For
fiscal year 2005 and for the approximately seven month period prior to the
closing of the TWC Transaction (July 21, 2006), the Company calculated the
allowance for doubtful accounts and provision for sales returns based
on  management's estimate of the amount expected to be uncollectible
or returned on specific accounts.  The Company provided for future
returns and price protection for releases of home video product at the time the
products were sold.  It calculated an estimate of future returns of
product by analyzing units shipped, units returned, and point of sale data to
ascertain consumer purchases and inventory remaining with retailers to establish
anticipated returns.  Price protection was calculated on a
title-by-title basis.  The objective of price protection was to
mitigate returns by providing retailers with credits to ensure maximum consumer
sales.  Price protection was granted to retailers after they had
presented to the Company an affidavit of inventory on hand.
 
 F-11
 CONCENTRATIONS
OF CREDIT RISK.
 As of the
Closing Date of the TWC Transaction, the Company transferred substantially all
of its assets and employees to the Distributor.  For fiscal 2005,
Wal-Mart accounted for 44% of its net revenues.  For the period from
January 1 through July 21,2006, Wal-Mart accounted for 29% of its net
revenues.
 
 Financial
instruments that potentially subject us to concentration of credit risk consist
primarily of temporary cash investments and trade receivables. The Company
restricts investment of temporary cash investments to financial institutions
with investment grade credit ratings.
  We
maintain cash and cash equivalents at one financial institution. From time to
time the balances for this account exceed the Federal Deposit Insurance
Corporation’s (“FDICs”) insured amount.  Balances on deposits at banks
in the United States are insured by the Federal Deposit Insurance Corporation up
to $100,000 per institution.  As of December 31, 2007, the uninsured
portions of these balances held at U.S. banks aggregated $1.7
million.
 
 ROYALTIES
AND PARTICIPATIONS.
 As of
July 21, 2006, the Company transferred all of its royalty and distribution fee
advances to the Distributor.
  The
Company's royalty and distribution fee advances represented fixed minimum
payments made to program suppliers for exclusive content distribution rights. A
program supplier’s share of exclusive program distribution revenues was retained
by the Company until the share equaled the advance(s) paid to the program
supplier. Thereafter, any excess was paid to the program supplier in accordance
with contractual terms.  The Company recorded as a cost of sales an
amount equal to the program supplier’s share of the net distribution
revenues.
 
 Participation
costs due to TWC were accrued in the proportion that current year’s revenue bore
to management’s estimate of ultimate revenue.  The Company amortized
the participations to cost of revenues using the individual film forecast
method. Revenue and cost forecasts were continually reviewed by management and
revised when warranted by changing conditions.
 
 ADVERTISING
AND MARKETING COSTS.
 The
Company had no advertising costs for the year ended December 31,
2007.  Advertising expense and all other costs of revenue are
reflected in the results of operations of the Distributor.
  Prior to
the closing of the TWC Transaction (July 21, 2006), the Company’s advertising
and marketing expense comprised of expenditures related to placement of products
with retailers, advertising in trade and consumer publications, product
brochures and catalogs, booklets for sales promotion, radio and television
advertising and other promotional costs. In accordance with SOP 93-7, “Reporting
on Advertising Costs”, we expense advertising costs in the period in which the
advertisement first takes place.   The advertising and promotion
expense in 2005 was composed primarily of brochures and tradeshows, as compared
to 2006 advertising and promotion expense, which is composed primarily of co-op
advertising and third-party TV and radio advertising.
  SHIPPING
EXPENSES.
 The
Company had no operations subsequent to the closing of the TWC
Transaction.  All operational costs are reflected in the financial
statements of the Distributor.
 
 Prior to
the closing of the TWC Transaction, the Company classified shipping expense in
accordance with Emerging Issues Task Force (“ETIF”) Issue 00-10, “Accounting for
Shipping and Handling Fees and Costs”, as cost of sales in the accompanying
statements of operations.
 
 STOCK-BASED
COMPENSATION.
 Under
Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based
Payment”, which was adopted by the Company beginning on January 1, 2006,
share-based compensation cost is measured at the grant date based on the
estimated fair value of the award and is recognized as expense over the
employee's requisite service period using a modified prospective application.
The valuation provisions apply to new awards and to awards that were outstanding
on the effective date and subsequently modified or cancelled. Share-based
compensation expense relates to share-based awards granted subsequent to January
1, 2006, and share-based awards granted prior to, but not yet vested as of
January 1, 2006, are based on the grant date fair value.
 
 F-12
 Subsequent
to the Closing Date of the TWC Transaction, the Company’s stock-based
compensation expense consists of expense associated with stock options held by
and subsequently granted to independent members of the Company’s Board of
Directors.  The stock-based compensation expense associated with the
former employees of the Company, who became employees of the Distributor as of
the Closing Date, are recorded on the books of the
Distributor.  Stock-based compensation expense is calculated using the
Black-Scholes Merton formula as our closed-form valuation option pricing model
(the “Option Model”). The Option Model requires the use of subjective and
complex assumptions, per the requirements of FAS123R, that include: (i) the
option's expected term, (ii) the estimated future price volatility of the
underlying stock, (iii) the risk-free interest rate, (iv) the dividend yield and
(v) expected forfeitures.
 
 The
Distributor records stock-based compensation expense associated with Company
stock options held by and subsequently granted to the Distributor’s employees
(the former employees of the Company before the TWC Transaction) in accordance
with Emerging Issues Task Force (‘EITF’) Issue No. 00-12, “Accounting by an
Investor for Stock-Based Compensation Granted to Employees of an Equity Method
Investee”, (“EITF 00-12”).  EITF 00-12 requires that the Distributor
recognize the costs of stock-based compensation incurred by an investor on its
behalf.
 
 For a
complete discussion of the Option Model and assumptions used to calculate
stock-based compensation expense, please refer to Note  8
below.
 
 INCOME
TAXES.
 The
Company files a consolidated corporate tax return and accounts for income taxes
under SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). This
statement requires the recognition of deferred tax assets and liabilities for
the future consequences of events that have been recognized in the Company’s
consolidated financial statements or tax returns. The measurement of the
deferred items is based on enacted tax laws. In the event the future
consequences of differences between financial reporting basis and the tax basis
of the Company’s assets and liabilities result in a deferred tax asset, SFAS
No. 109 requires an evaluation of the probability of being able to realize
the future benefits indicated by such asset. A valuation allowance related to a
deferred tax asset is recorded when some portion or the entire deferred tax
asset will not be realized on a more likely than not basis.  Based on
the Company’s assessment of all available evidence, the Company has concluded
that its deferred tax assets are not more likely than not to be realized. This
conclusion is based primarily on our history of net operating losses, annual net
operating loss limitations under Internal Revenue Code (“IRC”) Section 382,
and the need to generate significant amounts of taxable income in future periods
on a consistent and prolonged basis in order to utilize the deferred tax
assets.  Accordingly, the Company has recorded a full valuation
allowance on its deferred tax assets and has recorded a net deferred tax
liability related to its investment in the Distributor.  The deferred
tax liability related to the Distributor is not offset against the deferred tax
assets as the reversal period for this amount is not considered to be
determinable on a more likely than not basis.
 
 We
adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”
(“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with FASB Statement 109, “Accounting for Income Taxes”, and
prescribes a recognition threshold and measurement process for financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return.  FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.  We have no material unrecognized
tax benefits at January 1, 2007 or at December 31, 2007.
 
 BASIC AND
DILUTED INCOME (LOSS) PER COMMON SHARE.
 Basic EPS
is calculated using income available to common stockholders divided by the
weighted average of common shares outstanding during the year. Diluted EPS is
similar to Basic EPS except that the weighted average of common shares
outstanding is increased to include the number of additional common shares that
would have been outstanding if the potential dilutive common shares, such as
options and warrants, had been issued. The treasury stock method is used to
calculate dilutive shares and reduces the gross number of dilutive shares by the
number of shares purchasable from the proceeds of the options assumed to be
exercised.
 
 The
effects of the potentially dilutive securities (options and warrants that are
outstanding) were not included in the computation of diluted loss per share for
2007, 2006 and 2005, since to do so would have been anti-dilutive.
 
 F-13
 INVESTMENT
IN DISTRIBUTOR.
 At the
closing of the TWC Transaction, we contributed to the Distributor all of our
operating businesses, including substantially all of our assets, except for $1
million in cash and certain liabilities, and received a 30% equity interest in
the Distributor. The accompanying consolidated financial statements account for
the Company’s investment in the Distributor (30% membership interest represented
by the Distributor’s Class G units) using the equity method of
accounting.  On the Company’s consolidated statement of operations
subsequent to the Closing Date, the Company recorded its 30% share of the
Distributor’s profit or loss as equity in net profit or loss from the
Distributor, adjusted for non-cash basis differences (see Note 4 ) and
costs incurred by the Distributor on behalf of the Company.  Pursuant
to Accounting Principles Board Opinion No. 18, “The Equity Method of Accounting
for Investments in Common Stock”, the Company will periodically assess whether a
decrease in value of the investment has occurred (which is other than temporary)
and which should be recognized immediately, resulting in an impairment
loss.
 
 Under the
equity method of accounting, only the Company’s investment in and amounts due to
and from the Distributor have been included as an asset in its condensed
consolidated balance sheet.  The TWC Transaction represented a
non-monetary exchange of a business controlled by the Company for a
non-controlling interest in the Distributor. Accordingly, the amount recorded
for the Company’s investment in the Distributor was partially based on the
Company’s fair value as determined by reference to the quoted market prices of
the Company’s shares at the close of the market on the Closing Date and
partially based on the historical basis of the net assets surrendered in the TWC
Transaction.  On the Closing Date, we recorded a gain based on the
difference between the fair market value of assets contributed and their net
book value, reduced for the portion of the gain associated with the retained
economic interest in the Distributor.  The Distributor is treated as a
partnership for U.S. federal income tax purposes.
  CLASS
W OPTION LIABILITY
 The
Company records the Class W Option Liability at fair value in accordance
with EITF 00-6, “Accounting for Freestanding
Derivative Financial Instruments Indexed to, and Potentially Settled in, the
Stock of a Consolidated Subsidiary.”The Company has utilized a
lattice valuation model to simulate future stock movements of the Company’s
Common Stock in order to determine the fair value of the Class W Option
Liability.  The assumptions used in preparing such model include,
among other things, inputs such as volatility, risk-free interest rates,
dividend yield, expected time of redemption and assessment of counterparty
risk.
  RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS.
 In
September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements” (“SAB No. 108”). SAB No. 108 provides guidance on the consideration
of the effects of prior year misstatements in quantifying current year
misstatements for the purpose of a materiality assessment. SAB No. 108
establishes an approach that requires quantification of financial statement
errors based on the effects on each of the Company’s balance sheets and
statement of operations financial statements and the related financial statement
disclosures. The SAB permits existing public companies to record the cumulative
effect of initially applying this approach in the first year ending after
November 15, 2006 by recording the necessary correcting adjustments to the
carrying values of assets and liabilities as of the beginning of that year with
the offsetting adjustment recorded to the opening balance of retained earnings.
Additionally, the use of the cumulative effect transition method requires
detailed disclosure of the nature and amount of each individual error being
corrected through the cumulative adjustment and how and when it arose. We have
determined that there is no impact from SAB No. 108 on our consolidated balance
sheet, results of operations and cash flows.
  In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“Statement”) No. 157, Fair Value Measurements(“FAS 157”). FAS 157 establishes a single authoritative
definition of fair value, sets out a framework for measuring fair value and
expands on required disclosures about fair value measurement. Certain provisions
of FAS 157 related to financial assets and liabilities as well as other
assets and liabilities carried at fair value on a recurring basis will become
effective for the Company on January 1, 2008.  The provisions of
FAS 157 related to other nonfinancial assets and liabilities will be
effective on January 1, 2009, and will be applied prospectively. The
Company is currently evaluating the impact the provisions of FAS 157 will
have on the Company’s consolidated financial statements.
 
 In
February 2007, the FASB issued Statement No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" ("FAS 159"), which permits
entities to elect to measure many financial instruments and certain other items
at fair value. Upon adoption of FAS 159, an entity may elect the fair value
option for eligible items that exist at the adoption date. An entity will report
unrealized gains and losses on items for which the fairvalue option has been elected in earnings at each
subsequent reporting date. The fair value option (1) may be applied
instrument by instrument, with a few exceptions such as investments accounted
for by the equity method, (2) is irrevocable (unless a new election date
occurs) and (3) is applied only to entire instruments and not to portions
of instruments. FAS 159 does not affect any existing accounting literature that
requires certain assets and liabilities to be recorded at fair value nor does it
eliminate disclosure requirements included in other accounting standards. FAS
159 is effective January 1, 2008. We are currently evaluating FAS 159;
however, we do not believe it will have a material impact on our consolidated
financial condition or results of operations.
 
 F-14
 In
December 2007, the FASB issued Statement No. 160, "Non-controlling Interests in
Consolidated Financial Statements—an Amendment of Accounting Research Bulletin
No. 51" ("FAS 160"). FAS 160 establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
non-controlling interest, changes in a parent's ownership interest, and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated.  FAS 160 establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the non-controlling owners. FAS 160 is effective for fiscal years
beginning after December 15, 2008.
  NOTE
3.  RESTATEMENT OF FINANCIAL STATEMENTS OF THE COMPANY
 
 During
meetings held on October 8, 2008 and November 13, 2008, the Audit Committee of
the Board of Directors of the Company, acting on a recommendation from the
Company’s management, determined that it was necessary to restate (i) the
Company’s unaudited consolidated financial statements and other financial
information as of and for the  three months  ended September 30,
2006, March 31, June 30 and September 30, 2007 and March 31 and June 30, 2008,
and (ii) the audited consolidated financial statements and other financial
information of the Company and the Distributor as of December 31, 2006 and 2007
and for the periods then ended.
 
 The
aforementioned restatements relate to (i) an error in the application of
generally accepted accounting principles with respect to the recognition in the
Company’s financial statements of costs paid on its behalf by the Distributor
and (ii) an error in the application of generally accepted accounting principles
with respect to the accounting classification and measurement of certain
redemption rights of the holders of the Distributor’s Class W
Units.
 
 The
Company’s prior accounting methodology with respect to costs paid on its behalf
by the Distributor was based on the view that such costs should be recognized in
the Company’s financial statements to the extent of the Company’s economic
participation and ownership interest in the Distributor.  The Company
has now determined that it should recognize all such costs incurred on its
behalf by the Distributor in the Company’s financial statements.  As a
result of this change, selling, general and administrative expenses for
the twelve months ended December 31, 2007 and 2006 increased by $3.4 million and
$0.9 million, respectively.
 
 In
addition, the Company previously did not account for its obligation to deliver
shares of its Common Stock to the Distributor upon the redemption of the
aforementioned Class W Units.  The Company has now accounted for such
obligation as a written call option (the “Class W Option Liability”), by
recording the fair value of the Class W Option Liability as of July 21, 2006
(i.e., the date that the Class W Units of the Distributor were issued), and
subsequently re-measuring the fair value of the Class W Option Liability through
its Statements of Operations (in other income (expense)) at the end of every
reporting period.  As of July 21, 2006, the Class W Option Liability
was valued at $3.8 million.  Subsequently, the Company has re-measured
and recorded in its financial statements the fair value movements in the Class W
Option Liability as of December 31, 2007 and 2006.  As a result of
these re-measurements, other income for the twelve months ended December 31,
2007 decreased by $1.2 million to $0.8 million of other expense, and other
income for the twelve months ended December 31, 2006 increased by $0.8 million
to $0.9 million of other income.  In addition, the benefit for income
taxes for the twelve months ended December 31, 2007 increased by $0.1 million to
$1.7 million.
 
 F-15
 The
cumulative impact of the above-described restatement adjustments
on selling, general and administrative expenses, equity in net loss from
Distributor, other income (expense), provision (benefit) for income taxes, loss
before extraordinary item, net income (loss), net income (loss) per
share,  investment in Distributor, total assets, Class W option
liability, deferred tax liability, total liabilities, accumulated deficit and
total stockholders’ equity as of and for the years ended December 31, 2007 and
2006 are as follows:
  (In
      thousands)
                      
                      Year
      Ended December 31, 2007
                      
                      
                      Year
      Ended December 31, 2006As
      Originally Reported
                      
                      
                      RestatementAdjustments
                      
                      
                      As
      Restated
                      
                      
                      As
      Originally Reported
                      
                      
                      RestatementAdjustments
                      
                      
                      As
      RestatedSelling,
      general and administrative
                      
                      $
                      1,869
                      
                      
                      $
                      3,379
                      
                      
                      $
                      5,248
                      
                      
                      $
                      19,867
                      
                      
                      $
                      885
                      
                      
                      $
                      20,752Equity
      in net loss from Distributor
                      
                      
                      10,225
                      
                      
                      
                      340
                      
                      
                      
                      10,565
                      
                      
                      
                      7,989
                      
                      
                      
                      -
                      
                      
                      
                      7,989Other
      income (expense)
                      
                      
                      355
                      
                      
                      
                      (1,152
                      )
                      
                      
                      (797
                      )
                      
                      
                      86
                      
                      
                      
                      767
                      
                      
                      
                      853Provision
      (benefit) for income taxes
                      
                      
                      (1,614
                      )
                      
                      
                      (116
                      )
                      
                      
                      (1,730
                      )
                      
                      
                      5,797
                      
                      
                      
                      1,507
                      
                      
                      
                      7,304Loss
      before extraordinary item
                      
                      
                      (10,125
                      )
                      
                      
                      (4,755
                      )
                      
                      
                      (14,880
                      )
                      
                      
                      (45,363
                      )
                      
                      
                      (1,625
                      )
                      
                      
                      (46,988
                      )Net
      income (loss)
                      
                      
                      (10,125
                      )
                      
                      
                      (4,755
                      )
                      
                      
                      (14,880
                      )
                      
                      
                      8,840
                      
                      
                      
                      (1,625
                      )
                      
                      
                      7,215Net
      income (loss) per share
                      
                      
                      (0.15
                      )
                      
                      
                      (0.07
                      )
                      
                      
                      (0.22
                      )
                      
                      
                      0.15
                      
                      
                      
                      (0.03
                      )
                      
                      
                      0.12Investment
      in Distributor
                      
                      
                      73,823
                      
                      
                      
                      (821
                      )
                      
                      
                      73,002
                      
                      
                      
                      84,796
                      
                      
                      
                      2,898
                      
                      
                      
                      87,694Total
      assets
                      
                      
                      83,881
                      
                      
                      
                      (821
                      )
                      
                      
                      83,060
                      
                      
                      
                      89,428
                      
                      
                      
                      2,898
                      
                      
                      
                      92,326Class
      W option liability
                      
                      
                      -
                      
                      
                      
                      4,168
                      
                      
                      
                      4,168
                      
                      
                      
                      -
                      
                      
                      
                      3,016
                      
                      
                      
                      3,016Deferred
      tax liability
                      
                      
                      11,406
                      
                      
                      
                      1,391
                      
                      
                      
                      12,797
                      
                      
                      
                      13,021
                      
                      
                      
                      1,507
                      
                      
                      
                      14,528Total
      liabilities
                      
                      
                      11,604
                      
                      
                      
                      5,559
                      
                      
                      
                      17,163
                      
                      
                      
                      13,945
                      
                      
                      
                      4,523
                      
                      
                      
                      18,468Accumulated
      deficit
                      
                      
                      (40,023
                      )
                      
                      
                      (6,380
                      )
                      
                      
                      (46,403
                      )
                      
                      
                      (29,898
                      )
                      
                      
                      (1,625
                      )
                      
                      
                      (31,523
                      )Total
      stockholders' equity
                      
                      
                      72,277
                      
                      
                      
                      (6,380
                      )
                      
                      
                      65,897
                      
                      
                      
                      75,483
                      
                      
                      
                      (1,625
                      )
                      
                      
                      73,858
 
 IMPACT
OF RESTATEMENTS ON QUARTERLY FINANCIAL INFORMATION
  For
the Three and Nine Months Ended September 30, 2007 and 2006
 As
a result of recognizing all costs incurred on the Company’s behalf by the
Distributor in the Company’s financial statements, selling, general and
administrative expenses (i) for the three and nine months ended September 30,
2007 increased by $0.9 million and $2.3 million, respectively, and (ii) for the
three and nine months ended September 30, 2006 increased by $0.4 million in both
periods.
  With
respect to the fair value of the aforementioned redemption rights, the Company
re-measured and recorded in its financial statements the fair value movements in
the Class W Option Liability as of September 30, 2007 and 2006.  As a
result of these re-measurements, other income (i) for the three and nine months
ended September 30, 2007 decreased by $0.1 million to $0.03 million of other
expense, and increased by $0.3 million to $0.5 million of other income,
respectively, and (ii) for the three and nine months ended September 30, 2006
decreased by $0.3 million to $0.2 million of other expense, and $0.3 million to
$0.2 million of other expense, respectively.  In addition, the benefit
for income taxes for the nine months ended September 30, 2007 increased by $0.1
million to $0.2 million.
  F-16
  The
cumulative impact of the above-described restatement adjustments on selling,
general and administrative expenses, equity in net loss from Distributor, other
income (expense), provision (benefit) for income taxes, loss before
extraordinary items , net income (loss), net income (loss) per
share, investment in Distributor, total assets, Class W option liability,
deferred tax liability, total liabilities, accumulated deficit and total
stockholders’ equity as of and for the three and nine months ended September 30,
2007 and 2006 are as follows:
  (In
      thousands)
                    
                    Three
      Months Ended September 30, 2007 (Unaudited)
                    
                    
                    Three
      Months Ended September 30, 2006 (Unaudited)As
      Originally reported
                    
                    
                    Restatement
                      Adjustments
                    
                    
                    As
      Restated
                    
                    
                    As
      Originally reported
                    
                    
                    Restatement
                      Adjustments
                    
                    
                    As
      RestatedSelling,
      general and administrative
                    
                    $
                    448
                    
                    
                    $
                    888
                    
                    
                    $
                    1,336
                    
                    
                    $
                    4,166
                    
                    
                    $
                    422
                    
                    
                    $
                    4,588Other
      income (expense)
                    
                    
                    86
                    
                    
                    
                    (117
                    )
                    
                    
                    (31
                    )
                    
                    
                    78
                    
                    
                    
                    (263
                    )
                    
                    
                    (185
                    )Provision
      (benefit) for income taxes
                    
                    
                    104
                    
                    
                    
                    -
                    
                    
                    
                    104
                    
                    
                    
                    8,053
                    
                    
                    
                    1,507
                    
                    
                    
                    9,560Loss
      before extraordinary item
                    
                    
                    (3,476
                    )
                    
                    
                    (1,005
                    )
                    
                    
                    (4,481
                    )
                    
                    
                    (12,506
                    )
                    
                    
                    (2,192
                    )
                    
                    
                    (14,698
                    )Net
      income (loss)
                    
                    
                    (3,476
                    )
                    
                    
                    (1,005
                    )
                    
                    
                    (4,481
                    )
                    
                    
                    41,253
                    
                    
                    
                    (2,192
                    )
                    
                    
                    39,061Net
      income (loss) per share
                    
                    
                    (0.05
                    )
                    
                    
                    (.02
                    )
                    
                    
                    (0.07
                    )
                    
                    
                    0.68
                    
                    
                    
                    (0.04
                    )
                    
                    
                    0.64Investment
      in Distributor
                    
                    
                    79,391
                    
                    
                    
                    250
                    
                    
                    
                    79,641
                    
                    
                    
                    92,123
                    
                    
                    
                    3,361
                    
                    
                    
                    95,484Total
      assets
                    
                    
                    89,636
                    
                    
                    
                    250
                    
                    
                    
                    89,886
                    
                    
                    
                    94,081
                    
                    
                    
                    3,361
                    
                    
                    
                    97,442Class
      W option liability
                    
                    
                    -
                    
                    
                    
                    2,761
                    
                    
                    
                    2,761
                    
                    
                    
                    -
                    
                    
                    
                    4,046
                    
                    
                    
                    4,046Deferred
      tax liability
                    
                    
                    12,964
                    
                    
                    
                    1,371
                    
                    
                    
                    14,335
                    
                    
                    
                    14,445
                    
                    
                    
                    1,507
                    
                    
                    
                    15,952Total
      liabilities
                    
                    
                    13,986
                    
                    
                    
                    4,132
                    
                    
                    
                    18,118
                    
                    
                    
                    14,630
                    
                    
                    
                    5,553
                    
                    
                    
                    20,183Accumulated
      deficit
                    
                    
                    (37,458
                    )
                    
                    
                    (3,882
                    )
                    
                    
                    (41,340
                    )
                    
                    
                    (22,124
                    )
                    
                    
                    (2,192
                    )
                    
                    
                    (24,316
                    )Total
      stockholders' equity
                    
                    
                    75,650
                    
                    
                    
                    (3,882
                    )
                    
                    
                    71,768
                    
                    
                    
                    79,451
                    
                    
                    
                    (2,192
                    )
                    
                    
                    77,259
   (In
      thousands)
                      
                      Nine
      Months Ended September 30, 2007 (Unaudited)
                      
                      
                      Nine
      Months Ended September 30, 2006 (Unaudited)As
      Originally reported
                      
                      
                      Restatement
                        Adjustments
                      
                      
                      As
      Restated
                      
                      
                      As
      originally reported
                      
                      
                      Restatement
                        Adjustments
                      
                      
                      As
      RestatedSelling,
      general and administrative
                      
                      $
                      1,559
                      
                      
                      $
                      2,308
                      
                      
                      $
                      3,867
                      
                      
                      $
                      18,621
                      
                      
                      $
                      422
                      
                      
                      $
                      19,043Equity
      in net loss from Distributor
                      
                      
                      6,259
                      
                      
                      
                      340
                      
                      
                      
                      6,599
                      
                      
                      
                      63
                      
                      
                      
                      -
                      
                      
                      
                      63Other
      income (expense)
                      
                      
                      202
                      
                      
                      
                      255
                      
                      
                      
                      457
                      
                      
                      
                      113
                      
                      
                      
                      (263
                      )
                      
                      
                      (150
                      )Provision
      (benefit) for income taxes
                      
                      
                      (57
                      )
                      
                      
                      (136
                      )
                      
                      
                      (193
                      )
                      
                      
                      6,780
                      
                      
                      
                      1,507
                      
                      
                      
                      8,287Loss
      before extraordinary item
                      
                      
                      (7,559
                      )
                      
                      
                      (2,257
                      )
                      
                      
                      (9,816
                      )
                      
                      
                      (37,147
                      )
                      
                      
                      (2,192
                      )
                      
                      
                      (39,339
                      )Net
      income (loss)
                      
                      
                      (7,559
                      )
                      
                      
                      (2,257
                      )
                      
                      
                      (9,816
                      )
                      
                      
                      16,613
                      
                      
                      
                      (2,192
                      )
                      
                      
                      14,421Net
      income (loss) per share
                      
                      
                      (0.11
                      )
                      
                      
                      (0.04
                      )
                      
                      
                      (0.15
                      )
                      
                      
                      0.27
                      
                      
                      
                      (0.03
                      )
                      
                      
                      0.24Investment
      in Distributor
                      
                      
                      79,391
                      
                      
                      
                      250
                      
                      
                      
                      79,641
                      
                      
                      
                      92,123
                      
                      
                      
                      3,361
                      
                      
                      
                      95,484Total
      assets
                      
                      
                      89,636
                      
                      
                      
                      250
                      
                      
                      
                      89,886
                      
                      
                      
                      94,081
                      
                      
                      
                      3,361
                      
                      
                      
                      97,442Class
      W option liability
                      
                      
                      -
                      
                      
                      
                      2,761
                      
                      
                      
                      2,761
                      
                      
                      
                      -
                      
                      
                      
                      4,046
                      
                      
                      
                      4,046Deferred
      tax liability
                      
                      
                      12,964
                      
                      
                      
                      1,371
                      
                      
                      
                      14,335
                      
                      
                      
                      14,445
                      
                      
                      
                      1,507
                      
                      
                      
                      15,952Total
      liabilities
                      
                      
                      13,986
                      
                      
                      
                      4,132
                      
                      
                      
                      18,118
                      
                      
                      
                      14,630
                      
                      
                      
                      5,553
                      
                      
                      
                      20,183Accumulated
      deficit
                      
                      
                      (37,458
                      )
                      
                      
                      (3,882
                      )
                      
                      
                      (41,340
                      )
                      
                      
                      (22,124
                      )
                      
                      
                      (2,192
                      )
                      
                      
                      (24,316
                      )Total
      stockholders' equity
                      
                      
                      75,650
                      
                      
                      
                      (3,882
                      )
                      
                      
                      71,768
                      
                      
                      
                      79,451
                      
                      
                      
                      (2,192
                      )
                      
                      
                      77,259
 
 Three
and Six Months Ended March 31 and June 30, 2007
 As a
result of recognizing all costs incurred on the Company’s behalf by the
Distributor in the Company’s financial statements, selling, general and
administrative expenses for the three and six months ended March 31 and June 30,
2007 increased by $0.6 million and $1.4 million, respectively.
 
 With
respect to the fair value of the aforementioned redemption rights, the Company
re-measured and recorded in its financial statements the fair value movements in
the Class W Option Liability as of March 31 and June 30, 2007.  As a
result of these re-measurements, other income for the three months ended March
31, 2007 increased by $0.4 million to $0.4 million, and other income for the
three and six months ended June 30, 2007 increased by $0.01 million and $0.4
million to $0.07 million and $0.5 million, respectively. In addition, the
provision for income taxes for the three months ended March 31, 2007 decreased
by $0.1 million to $0.01 million and the benefit for income taxes for the six
months ended June 30, 2007 increased by $0.1 million to $0.3
million.
 F-17
  The
cumulative impact of the above-described restatement adjustments on selling,
general and administrative expenses, equity in net loss from Distributor, other
income, provision (benefit) for income taxes, net loss, net loss per share,
investment in Distributor, total assets, Class W option liability, deferred tax
liability, total liabilities, accumulated deficit and total stockholders’ equity
as of and for the three and six months ended March 31 and June 30, 2007 are as
follows:
  (In
      thousands)
                    
                    Three
      Months Ended March 31, 2007 (Unaudited)
                    
                    
                    Three
      Months Ended June 30, 2007 (Unaudited)As
      Originally reported
                    
                    
                    Restatement
                      Adjustments
                    
                    
                    As
      Restated
                    
                    
                    As
      Originally reported
                    
                    
                    Restatement
                      Adjustments
                    
                    
                    As
      RestatedSelling,
      general and administrative
                    
                    $
                    456
                    
                    
                    $
                    603
                    
                    
                    $
                    1,059
                    
                    
                    $
                    655
                    
                    
                    $
                    817
                    
                    
                    $
                    1,472Equity
      in net loss from Distributor
                    
                    
                    2,228
                    
                    
                    
                    340
                    
                    
                    
                    2,568
                    
                    
                    
                    1,021
                    
                    
                    
                    -
                    
                    
                    
                    1,021Other
      income
                    
                    
                    49
                    
                    
                    
                    367
                    
                    
                    
                    416
                    
                    
                    
                    67
                    
                    
                    
                    5
                    
                    
                    
                    72Provision
      (benefit) for income taxes
                    
                    
                    134
                    
                    
                    
                    (136
                    )
                    
                    
                    (2
                    )
                    
                    
                    (294
                    )
                    
                    
                    -
                    
                    
                    
                    (294
                    )Net
      loss
                    
                    
                    (2,769
                    )
                    
                    
                    (440
                    )
                    
                    
                    (3,209
                    )
                    
                    
                    (1,315
                    )
                    
                    
                    (812
                    )
                    
                    
                    (2,127
                    )Net
      loss per share
                    
                    
                    (0.04
                    )
                    
                    
                    (0.01
                    )
                    
                    
                    (0.05
                    )
                    
                    
                    (0.02
                    )
                    
                    
                    (0.01
                    )
                    
                    
                    (0.03
                    )Investment
      in Distributor
                    
                    
                    82,877
                    
                    
                    
                    1,955
                    
                    
                    
                    84,832
                    
                    
                    
                    82,283
                    
                    
                    
                    1,138
                    
                    
                    
                    83,421Total
      assets
                    
                    
                    89,884
                    
                    
                    
                    1,955
                    
                    
                    
                    91,839
                    
                    
                    
                    90,297
                    
                    
                    
                    1,138
                    
                    
                    
                    91,435Class
      W option liability
                    
                    
                    -
                    
                    
                    
                    2,649
                    
                    
                    
                    2,649
                    
                    
                    
                    -
                    
                    
                    
                    2,644
                    
                    
                    
                    2,644Deferred
      tax liability
                    
                    
                    13,154
                    
                    
                    
                    1,371
                    
                    
                    
                    14,525
                    
                    
                    
                    12,860
                    
                    
                    
                    1,371
                    
                    
                    
                    14,231Total
      liabilities
                    
                    
                    14,510
                    
                    
                    
                    4,020
                    
                    
                    
                    18,530
                    
                    
                    
                    13,758
                    
                    
                    
                    4,015
                    
                    
                    
                    17,773Accumulated
      deficit
                    
                    
                    (32,667
                    )
                    
                    
                    (2,065
                    )
                    
                    
                    (34,732
                    )
                    
                    
                    (33,982
                    )
                    
                    
                    (2,877
                    )
                    
                    
                    (36,859
                    )Total
      stockholders' equity
                    
                    
                    75,374
                    
                    
                    
                    (2,065
                    )
                    
                    
                    73,309
                    
                    
                    
                    76,539
                    
                    
                    
                    (2,877
                    )
                    
                    
                    73,662
 (In
      thousands)
                      
                      Six
      Months Ended June 30, 2007 (Unaudited)As
      Originally reported
                      
                      
                      Restatement
                        Adjustments
                      
                      
                      As
      RestatedSelling,
      general and administrative
                      
                      $
                      1,111
                      
                      
                      $
                      1,420
                      
                      
                      $
                      2,531Equity
      in net loss from Distributor
                      
                      
                      3,249
                      
                      
                      
                      340
                      
                      
                      
                      3,589Other
      income
                      
                      
                      117
                      
                      
                      
                      372
                      
                      
                      
                      489Benefit
      for income taxes
                      
                      
                      160
                      
                      
                      
                      136
                      
                      
                      
                      296Net
      loss
                      
                      
                      (4,083
                      )
                      
                      
                      (1,252
                      )
                      
                      
                      (5,335
                      )Net
      loss per share
                      
                      
                      (0.06
                      )
                      
                      
                      (0.02
                      )
                      
                      
                      (0.08
                      )Investment
      in Distributor
                      
                      
                      82,283
                      
                      
                      
                      1,138
                      
                      
                      
                      83,421Total
      assets
                      
                      
                      90,297
                      
                      
                      
                      1,138
                      
                      
                      
                      91,435Class
      W option liability
                      
                      
                      -
                      
                      
                      
                      2,644
                      
                      
                      
                      2,644Deferred
      tax liability
                      
                      
                      12,860
                      
                      
                      
                      1,371
                      
                      
                      
                      14,231Total
      liabilities
                      
                      
                      13,758
                      
                      
                      
                      4,015
                      
                      
                      
                      17,773Accumulated
      deficit
                      
                      
                      (33,982
                      )
                      
                      
                      (2,877
                      )
                      
                      
                      (36,859
                      )Total
      stockholders' equity
                      
                      
                      76,539
                      
                      
                      
                      (2,877
                      )
                      
                      
                      73,662
  F-18
  NOTE
4. INVESTMENT IN DISTRIBUTOR (GENIUS PRODUCTS, LLC)
 
 Summaries
of the statements of operations for the Distributor and a computation of equity
in the net loss of the Distributor for 2007 and the period from July 22, 2006
through December 31, 2006 are shown below.
  GENIUS
PRODUCTS, LLC AND SUBSIDIARIES
 SUPPLEMENTAL
CONDENSED STATEMENTS OF OPERATIONS
 (IN
THOUSANDS)
 
 Year
      Ended
                                                        December
      31, 2007
                                                        (Restated)
                                                      
                                                      
                                                      
                                                      Period
      from July 22, 2006 through December 31, 2006Revenues,
      net of sales returns, discounts and allowances of $177,324 and $71,983 in
      2007 and 2006, respectively
                                                      
                                                      $
                                                      474,087
                                                      
                                                      
                                                      $
                                                      155,591Total
      cost of revenues
                                                      
                                                      
                                                      451,597
                                                      
                                                      
                                                      
                                                      168,044Gross
      profit (loss)
                                                      
                                                      
                                                      22,490
                                                      
                                                      
                                                      
                                                      (12,453
                                                      )Total
      operating expenses
                                                      
                                                      
                                                      38,440
                                                      
                                                      
                                                      
                                                      7,566Loss
      from operations
                                                      
                                                      
                                                      (15,950
                                                      )
                                                      
                                                      
                                                      (20,019
                                                      )Other
      income (expense)
                                                      
                                                      
                                                      (2,882
                                                      )
                                                      
                                                      
                                                      309Net
      loss
                                                      
                                                      $
                                                      (18,832
                                                      )
                                                      
                                                      $
                                                      (19,710
                                                      )
   Under the
equity method of accounting, only our investment in and amounts due to and from
the Distributor have been included in our balance sheets.  Our
investment in the Distributor is adjusted each period for basis differences
between the investment and the underlying equity in the Distributor and for the
impact of certain costs incurred by the Distributor on behalf of the
Company.
  As a
result of restating the Distributor’s financial statements as described in Note
3, the net loss of the Distributor for the year ended December 31, 2007
increased by $1.1 million to $18.8 million.  This resulted in a basis
difference adjustment to our investment in the Distributor of $0.3 million (30%
of the net loss from the Distributor for the twelve months ended December 31,
2007).
 
 The table
below summarizes the basis differences between the investment and the underlying
equity in the Distributor.
 Year
      Ended
                                  December
      31, 2007
                                  Restated(Note
      3)
                                
                                
                                Period
      of July 22
                                  through
                                  December
      31, 2006Genius
      Products, Inc. 30% share of net loss from the Distributor
                                
                                $
                                5,649
                                
                                
                                $
                                5,913Adjustments
      for basis differences
                                
                                
                                4,385
                                
                                
                                
                                1,420Charge
      for stock compensation for the Distributor employees
                                
                                
                                531
                                
                                
                                
                                656Equity
      in net loss from the Distributor
                                
                                $
                                10,565
                                
                                
                                $
                                7,989
  F-19
  NOTE
5. COMMITMENTS AND CONTINGENCIES
 
 GUARANTY
OF CREDIT FACILITY.
 The
Company and the direct and indirect subsidiaries of the Distributor have
unconditionally guaranteed the obligations of the Distributor under its Amended
and Restated Credit Agreement (i.e., full and punctual payment of the
Distributor’s obligations, when and as due). Management has appropriately
assessed the likelihood of the Company’s guarantee of the Amended and Restated
Credit Agreement entered into by the Distributor and considered the provisions
of FIN 45, Guarantor’s
Accounting and Disclosure Requirements for Guarantees,noting that the
likelihood of making any payments related to this guarantee is remote and
therefore no liability is required to be recorded on the Company’s balance
sheets associated with this guarantee.
 
 LEASE
OBLIGATIONS.
 As of
December 31, 2007, we did not have any future minimum annual rental commitments
under existing non-cancelable operating leases since, at the Closing Date of the
TWC Transaction, we transferred all of our lease obligations to the
Distributor.
 
 LITIGATION.
 Except as
described below, we are not a party to any legal or administrative proceedings,
other than routine litigation incidental to our business that we do not believe,
individually or in the aggregate, would be likely to have a material adverse
effect on our financial condition or results of operations.
 
 Falcon
Picture Group Matter:
 On
October 3, 2005, Falcon Picture Group, LLC (“Falcon”) commenced litigation
against the Company in the Circuit Court of Cook County, Illinois, Case No.
05H16850 (the “Illinois Proceeding”), based upon allegations, among other
things, that the Company breached the terms of a license agreement between
Falcon and the Company by refusing to pay certain royalties to which Falcon
allegedly was entitled.  On or about July 2007, Falcon was granted
leave to file an amended complaint alleging further that the Company interfered
with Falcon’s current and potential business relationships.  Falcon
seeks damages resulting from the interference claim of approximately $0.3
million as well as $0.8 million relating to the claim for breach of the license
agreement.  The court’s decision to grant leave to amend is not
indicative of the merits of such amended claims as leave to amend proceedings in
the early stages of litigation are routine procedural matters.
 
 The
Company has asserted various affirmative defenses to Falcon’s complaint,
including, among other things, that Falcon in fact breached the license
agreement by delivering defective content to the Company, double billed for
content and failed to honor provisions in the license agreement requiring Falcon
to indemnify the Company in the event of claims by third parties that the
Company did not possess the legal right to sell Falcon content.  The
Company has also asserted that the additional claims in Falcon’s amended
complaint are unfounded, and that the damages asserted by the Company pursuant
to its own claims will substantially exceed the damages sought by
Falcon.  The Company believes that the evidence will demonstrate that
there was no monetary default on its part under the license agreement insofar
as, at the time of the alleged default, Falcon was indebted to the Company for
an amount substantially in excess of the sum Falcon claims was past
due.  Accordingly, the Company has commenced litigation against Falcon
and its owner, Carl Amari, in the form of a counter claim seeking damages of
approximately $1.5 million, exclusive of any award of attorneys’ fees, costs of
suit and punitive damages to which the Company may also be entitled to
recover.  Discovery is in its final stages but a trial date has not
yet been scheduled.  The Company plans to continue to vigorously
defend against Falcon’s allegations and to pursue its counter claim against
Falcon.
 
 Entertainment
Resource Matter:
 In June
2007, Larry S. Hyman, as assignee for Entertainment Resource, Inc. (“ERI”),
commenced litigation against the Company in the Circuit Court of Broward County,
Florida, Case No. 06-012249 CACE 05, based upon allegations, among other things,
that the Company owes ERI for products delivered and sold to the Company by ERI
between September 2005 and January 2006.  ERI seeks an award of $0.9
million.  The Company plans to vigorously defend against ERI’s
allegations and has denied ERI’s allegations in response to their
complaint.  Among other defenses, the Company plans to provide
evidence that ERI owes to the Company approximately $1 million for products sold
and delivered by the Company to ERI, which amount should be set-off against any
amounts owing by the Company to ERI.  Discovery is in its early stages
and the action has not been scheduled for trial.
 
 F-20
 NOTE
6.  RELATED PARTY TRANSACTIONS
 
 The
Company accounts for all related party transactions under SFAS No. 57, “Related
Party Disclosures”. The statement provides guidance on disclosures of
transactions between related parties, including transactions between affiliates
and principal owners. Disclosures must include (i) the nature of the
relationship involved (ii) a description of the transaction (iii) the dollar
amount of the transaction and (iv) amounts due to and from related parties. The
statement also requires an assessment of the transaction to ensure that they
have been carried out on an arms-length basis.
 
 SERVICES
AGREEMENT.
 The
Distributor provides certain services and pays certain direct costs, including
filing fees, registration fees and audit fees, on behalf of the Company
according to the terms of a services agreement between the Distributor and the
Company and entered into in connection with the TWC Transaction.  The
Distributor incurred a total of $4.8 million in corporate operating and payroll
related expenses on behalf of the Company during the year ended December 31,
2007 and incurred a total of $1.3 million during the 163-day period ended
December 31, 2006.
 
 RELATED
PARTY LOANS.
 On
September 27, 2007, the Distributor borrowed $6.0 million from the Company and
issued a promissory note in favor of the Company in the principal amount of $6.0
million.  On November 1, 2007, the Distributor borrowed an additional
$2.0 million from the Company and issued a promissory note in favor of the
Company in the principal amount of $2.0 million.  Under each of the
aforementioned notes, interest is due on the unpaid principal balance at a
monthly rate equal to the LIBOR Rate (as defined in the notes) plus five percent
(5%) until paid.  The principal and accrued interest under the notes
were originally due and payable on demand at any time after March 31,
2008.  On March 16, 2008, the Company ’s Board of Directors approved
amendments to each of (i) that certain promissory note, dated September 27,
2007, by the Distributor in favor of the Company, in the principal amount of $6
million and (ii) that certain promissory note, dated November 1, 2007, by the
Distributor in favor of the Company in the principal amount of $2 million,
pursuant to which principal and accrued interest under the notes would be due
and payable on demand at any time after January 1, 2009. In the event payment of
principal or interest due under the notes is not made when due, the outstanding
principal balance will bear interest at the rate of two percent (2%) above the
interest rate which is otherwise provided under the notes for so long as such
event continues. If the notes are not paid when due, the Distributor agreed to
pay the Company’s reasonable costs of collection, including, without limitation,
all reasonable attorneys’ fees and all reasonable expenses actually incurred by
the Company in connection with such collection efforts.  The principal
amount of the notes may be prepaid in whole or in part, provided that all
accrued interest on the amount to be prepaid is also paid at such
time.  The proceeds from the notes were used to pay amounts owed by
the Distributor to TWC under the TWC Distribution Agreement.  As of
December 31, 2007, an aggregate of $8.2 million in principal and accrued
interest expense was outstanding under the notes.
 
 BANNON
CONSULTING AGREEMENT.
 Stephen
K. Bannon is the chairman of the Company’s Board of Directors.  Mr. Bannon
is also a principal with Bannon Strategic Advisors, Inc. (“Bannon Strategic
Advisors”).  On July 20, 2006, the Company and Bannon Strategic Advisors
entered into a consulting agreement (the “Consulting Agreement”), pursuant to
which Bannon Strategic Advisors has provided the Company with consulting and
advisory services.  Pursuant to the Consulting Agreement, the Company
agreed to pay to Bannon Strategic Advisors a monthly consulting fee of $0.02
million for a term of two years (i.e., an aggregate of $0.5 million) and
reimburse Mr. Bannon for expenses incurred in connection with services provided
to the Company.  The Consulting Agreement was approved by the Board of
Directors, with Mr. Bannon abstaining from the vote.  On July 21, 2006, the
rights and obligations of the Company pursuant to the Consulting Agreement were
assigned to the Distributor.
  
 NOTE
7.  STOCKHOLDERS' EQUITY
  COMMON
STOCK.
 On March
2, 2005, we entered into a securities purchase agreement with certain
institutional investors related to the private placement of 6,518,987 shares of
our common stock, par value $0.0001 per share, and five-year warrants to
purchase 1,303,797 shares of Common Stock, half at an exercise price of $2.56
per share and half at an exercise price of $2.78 per share. The transaction
closed on March 3, 2005 and we realized gross proceeds of $10.3 million from the
financing, before deducting commissions and other expenses. We agreed to
register for resale the shares of Common Stock issued in the private placement
and shares issuable upon exercise of warrants. Such registration statement
became effective on May 11, 2005.  The Company used the proceeds from
this offering for working capital and other general corporate
purposes.  The fair value of the warrants was classified as equity in
2005 in accordance with EITF 00-19.
 
 F-21
 On March
22, 2005, in connection with the Company’s acquisition of American Vantage
Corporation from American Vantage Companies (“AVC”), the Company issued to AVC
(i) 7,000,000 shares of the Company’s common stock valued at $2.27 per share and
(ii) warrants to purchase 1,400,000 shares of the Company’s common stock, half
at an exercise price of $2.56 per share and half at an exercise price of $2.78
per share.
 
 In May
2005, we entered into a securities purchase agreement with certain institutional
investors related to the private placement of 3,000,000 shares of our common
stock and five-year warrants to purchase 270,000 shares of our common stock at
an exercise price of $2.56 per share. The transaction closed on May 20, 2005,
and we realized gross proceeds of $5.25 million from the financing before
deducting commissions and other expenses.  The Company used the
proceeds from this offering for working capital and other general corporate
purposes.  The fair value of the warrants was classified as equity in
2005 in accordance with EITF 00-19.
 
 On
December 5, 2005, we entered into a securities purchase agreement with certain
institutional investors related to the private placement of 16,000,000 shares of
our common stock, par value $0.0001 per share, and five-year warrants to
purchase 4,800,000 shares of common stock with an exercise price of $2.40 per
share. The transaction closed on December 6, 2005 and we realized gross proceeds
of $32 million from the financing, before deducting commissions and other
expenses. The proceeds from the offering will provide working capital to fund
new ventures as well as content acquisitions. The fair value of the warrants was
classified as equity in 2005 in accordance with EITF 00-19.
 
 During
2006, we issued 974,317 common shares related to the exercise of warrants (some
of which were cashless exercises) for proceeds of $0.8
million.  Additionally, we issued 1,892,724 common shares related to
the exercise of options for proceeds of $2.5 million.
  During
2007, we issued 3,225,070 common shares related to the exercise of warrants
(some of which were cashless exercises) for proceeds of $3.7
million.  Additionally, we issued 1,178,829 common shares related to
the exercise of options for proceeds of $2.0 million.
 
 OTHER
STOCK ISSUANCES.
 During
2005, we issued 585,402 shares of common stock to third-party consultants and
service providers for a total of $0.9 million.
 
 SERIES W
PREFERRED STOCK.
 In
connection with the closing of the TWC Transaction, we issued 100 shares of
Series W Preferred Stock to TWC Holdings and its first-tier subsidiary, W-G
Holding (collectively, the “TWC Holders”). The Series W Preferred Stock provides
the holders with significant rights, preferences and powers.
 
 A. Voting.
 1. General. Except as
required by our certificate of incorporation or applicable law, the holders of
Series W Preferred Stock are entitled to vote on all matters submitted to a vote
of our stockholders, voting together with the common stockholders as one
class.
 
 2. Voting Power When Threshold
Amount Held. Subject to certain limitations set forth in our Charter, the
holders of Series W Preferred Stock, in the aggregate, have voting rights equal
to the greater of (i) 100 votes; (ii) the number of votes attributable to the
number of shares of common stock that TWC Holders beneficially own or have the
right to acquire, less the number of votes attributable to the shares of common
stock which they may vote directly; and (iii) the number of votes that, together
with all other votes entitled to be directly cast by the holders of shares of
Series W Preferred Stock, entitle the holders of Series W Preferred Stock to
exercise one vote more than one-half of all votes entitled to be cast by all
holders of our capital stock.
  3. Board of Directors.
The holders of Series W Preferred Stock (voting separately as a single class)
are entitled to elect five (5) directors to our Board (the “Series W
Directors”), and to replace or remove any such Series W Directors.  So
long as the TWC Holders own or have the right to own at least 20% of our
outstanding common stock (the “Threshold Amount”), the holders of our common
stock (voting separately as a single class) are entitled to elect two (2)
directors (the “At-Large Directors”), and to replace or remove any such At-Large
Director.
 
 F-22
 4. Protective
Provisions. The holders of Series W Preferred Stock have special
protective provisions under our Charter. These protective provisions provide
that the Company may not, without the approval of the holders of at least a
majority of the Series W Preferred Stock, take certain important actions
specified in our Charter and relating to the Company’s and the Distributor’s
business.
 
 5. Vote Below Threshold
Amount. At such time as the TWC Holders and their permitted transferees
no longer beneficially own or have the right to acquire the Threshold Amount,
the voting rights of the holders of the Series W Preferred Stock described above
immediately terminate and each share of Series W Preferred Stock will entitle
the holder thereof to the number of votes represented by the number of shares of
common stock into which all Class W Units held by TWC Holders and their
permitted transferees would be converted, exchanged or redeemed pursuant to the
Amended and Restated Limited Liability Company Agreement of the Distributor,
divided by the number of shares of Series W Preferred Stock outstanding at the
record date for such vote.
 
 B. Dividend Provisions.
The Series W Preferred Stockholders are entitled to receive dividends as may be
declared from time to time by our Board of Directors.
  C. Liquidation. In the
event of the liquidation, dissolution, winding up or sale or other disposition
of all or substantially all of the assets of the Company, whether voluntary or
involuntary (“Liquidation”), the Series W Preferred Stockholders are entitled to
receive, after payment of the debts and other liabilities of Genius Products,
Inc., an amount (or assets having a fair market value) equal to $0.01 plus all
accrued but unpaid dividends up to and including the date of
Liquidation.
 
 D. Conversion. The
Series W Preferred Stock will not be convertible into any other class of stock
of the Company.
 
 NON-EMPLOYEE
WARRANTS.
 In 2005,
we granted warrants to purchase a total of 8,905,750 shares of our common stock
at exercise prices from $1.58 to $2.78 per share to individuals for services to
be rendered and in relation to a private placement.  During 2005,
warrants for 1,255,315 shares were exercised for cash.  In accordance
with EITF Issue 96-18, “Accounting for Equity Instruments That are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services,” and EITF Issue 00-18, “Accounting Recognition for Certain
Transactions Involving Equity Instruments Granted to Other Than Employees,” the
stock based compensation expense recorded in our statement of operations for the
year ended December 31, 2005 of $0.4 million reflected the proportion of
the aggregate value corresponding to the number of warrants that had vested by
that date.
  In 2006,
warrants for 649,288 shares were exercised for cash.  Additionally,
warrants for 826,796 shares were exchanged in cashless exercises for 325,029
shares.
  In 2007,
warrants for 2,734,142 shares were exercised for cash and warrants for 1,625,954
shares were exchanged in cashless exercises for 490,928 shares.
 
 A summary
of warrant activity follows:
   F-23
  WeightedWarrants
                  
                  
                  Average
                  
                  
                  AggregateOutstanding
                  
                  
                  Exercise
      Price
                  
                  
                  Intrinsic
      ValueAs
      of December 31, 2004
                  
                  
                  11,075,255
                  
                  
                  
                  1.82Granted
      in private placement
                  
                  
                  7,773,797
                  
                  
                  
                  2.47Granted
      for services rendered
                  
                  
                  1,131,953
                  
                  
                  
                  1.82Exercised
                  
                  
                  (1,255,315
                  )
                  
                  
                  1.02Canceled
                  
                  
                  (2,496,773
                  )
                  
                  
                  2.06As
      of December 31, 2005
                  
                  
                  16,228,917
                  
                  
                  
                  2.15Exercised
                  
                  
                  (1,442,863
                  )
                  
                  
                  1.47As
      of December 31, 2006
                  
                  
                  14,786,054
                  
                  
                  
                  2.21
                  
                  
                  $
                  32,663,180Exercised
                  
                  
                  (4,360,096
                  )
                  
                  
                  1.62
                  
                  
                  
                  5,794,510As
      of December 31, 2007
                  
                  
                  10,425,958
                  
                  
                  $
                  2.45
                  
                  
                  $
                  25,581,631Warrants
      exercisable,  as of December 31, 2007
                  
                  
                  10,425,958
                  
                  
                  $
                  2.45
                  
                  
                  $
                  25,581,631
  The following information applies to
warrants outstanding at December 31, 2007:
  Weighted
                  
                  
                  
                  
                  
                  WeightedAverage
                  
                  
                  Average
                  
                  
                  
                  
                  
                  AverageWarrants
                  
                  
                  Remaining
                  
                  
                  Exercise
                  
                  
                  Warrants
                  
                  
                  ExerciseOutstanding
                  
                  
                  Life
                  
                  
                  Price
                  
                  
                  Exercisable
                  
                  
                  PriceUnder
      $1.50
                  
                  
                  
                  943,757
                  
                  
                  
                  0.47
                  
                  
                  
                  $1.40
                  
                  
                  
                  943,757
                  
                  
                  
                  $1.40$1.50
      - $1.99
                  
                  
                  
                  170,723
                  
                  
                  
                  2.76
                  
                  
                  
                  1.88
                  
                  
                  
                  170,723
                  
                  
                  
                  1.88$2.00
      - $2.99
                  
                  
                  
                  7,664,478
                  
                  
                  
                  2.60
                  
                  
                  
                  2.48
                  
                  
                  
                  7,664,478
                  
                  
                  
                  2.48$3.00
      - $3.99
                  
                  
                  
                  1,647,000
                  
                  
                  
                  1.25
                  
                  
                  
                  3.00
                  
                  
                  
                  1,647,000
                  
                  
                  
                  3.0010,425,958
                  
                  
                  
                  2.19
                  
                  
                  
                  $2.45
                  
                  
                  
                  10,425,958
                  
                  
                  
                  $2.45
  NOTE
8 . STOCK-BASED COMPENSATION
 
 We have
adopted several stock option plans, all of which have been approved by our
stockholders, that authorize the granting of options to purchase shares of our
common stock subject to certain conditions. As of December 31, 2007
and  December 31, 2006, we had reserved 17.8 million and
19.3 million, respectively, of our common shares for issuance of
share-based compensation awards under our stock option plans. We did not grant
any stock options during fiscal year 2007.   As of December 31,
2006, we had granted 7,394,213 share-based compensation awards outside of our
stock option plans. Options were granted at the fair value of the shares
underlying the options at the date of the grant and generally become exercisable
over periods ranging from three to five years and expire in ten
years.
  The 2004
Stock Option Plan provides a total of 13,500,000 shares to be granted as either
incentive stock options or nonqualified stock options to our employees,
directors and consultants. The term of the awards may not be for more than ten
years (or five years in the case of incentive stock options granted to any
participant who owns stock representing more than 10% of the combined voting
power of us or any parent or subsidiary of ours).
  During
2005, we granted to our employees and directors options to purchase a total of
6,561,253 shares of our common stock under the 2004 Stock Option Plan and
options to purchase a total of 3,270,000 shares of our common stock outside any
plan, at exercise prices ranging from $1.45 to $2.31 and $1.55 to $2.31,
respectively.
  During 2006, we granted to our employees and directors options to
purchase a total of 1,992,000 shares of our common stock under the 2004 Stock
Option Plan and options to purchase 1,577,929 shares of our common stock outside
any plan, at exercise prices ranging from $1.75 to $2.45 and $1.70 to $2.31,
respectively.
 
 During
2007 and 2006, we estimated the fair value of the service-based stock options
using the Black-Scholes Merton formula as our closed-form valuation option
pricing model (the “Option Model”). The Option Model requires the use of
subjective and complex assumptions, per the requirements of FAS123R, that
include: (i) the option's expected term, (ii) the estimated future price
volatility of the underlying stock, (iii) the risk-free interest rate, (iv) the
dividend yield and (v) expected forfeiture.  The transaction concluded
with TWC on July 21, 2006 significantly altered our corporate structure thus
invalidating several of the assumptions used previously in calculating stock
option expense.
 
 F-24
 Notably,
whereas the Company had previously used the historical volatility percentage of
its stock the Option Model’s expected volatility assumption, this was no longer
valid due to the restructure of the Company as of July 21, 2006, since
historical volatility should be measured over a period commensurate with the
expected term of the option (for the Company, between 5.25 and 6.25
years).  The Company, therefore, changed from using a historical
volatility percentage based on traded options on its own stock to an historical
volatility percentage based on peer or guidance companies in its industry, the
home video distribution market.  This volatility change was confirmed
by a third-party compensation consulting firm and is in accordance with the
guidance provided in SFAS No. 123R and SAB 107 “Share-Based
Payment”.
 
 As a
result of the change in corporate structure, expected term could not be
accurately calculated based on historical experience.  Therefore, our
estimate of expected term in 2007 and 2006 for the service-based stock options
was calculated using the “shortcut method” as described in SEC Staff Accounting
Bulletin 107; i.e., expected term = ((vesting term + original contractual
term)/2) or based on the weighted average period of time that options granted
are expected to be outstanding considering current vesting
schedules.  The Company could use this short-cut method through
December 31, 2007 because it met all of the required criteria:  (i)
the stock options are granted “at-the-money”; (ii) exercisability is conditional
only on performing service through the vesting date; (iii) if an employee
terminates service prior to vesting, the employee would forfeit the share
options; (iv) if an employee terminates service after vesting, the employee
would have a limited time to exercise the share options (typically 30-90 days);
and (v) the stock options are non-transferable and non-hedgeable.  The
Company’s expected term varies from approximately 5.25 to 6.25
years.  During each quarter in fiscal 2007, we calculated volatility
for each expected “tranche” of stock options in increments of 0.25 years,
utilizing the average volatility calculations of our peer
companies.
 
 As we are
using a closed-form valuation option pricing model for these service-based stock
options, the risk-free interest rate used in the Option Model is based on the
yield of U.S. Treasury zero-coupon issues, with maturities closest to the
expected term of our stock options.  The Company has not and does not
expect to grant dividends.  Hence, the dividend yield is
0%.
 
 For
forfeiture rate, the Company rejected historical calculations due to the limited
amount of accurate historical data.  In 2007 it used the most
conservative estimate of 0% forfeiture.
 
 In 2005
the Company granted market-based options to purchase 800,000 shares that do
not vest until attaining stock price targets respectively of $4.00, $6.00, and
$8.00.  For these grants we utilize the Monte Carlo Simulation as the
stock option model to provide the most accurate fair value estimate due to the
path dependency of the options valued under the provisions of this
grant. Monte Carlo Simulation is a lattice model, which - unlike the
closed-form model – can  incorporate a range of expected volatilities.
 Monte Carlo Simulation is a generally accepted and widely practiced
technique used here to simulate future stock movements in order to determine the
fair value of these option grants.  The option fair values are
calculated by simulating, within a risk-neutral framework, many future stock
price paths. At each measurement period, the projected stock price is
compared to the predefined vesting hurdles to determine if the instrument vests.
Since the Company does not have historical exercise experience of instruments
with market conditions, we have not applied exercise behavior similar to the
service based options. Instead, we have assumed that exercise of vested options
occurs uniformly on the interval of the vesting date to the options full
contractual term of 10 years.
 
 These
valuations were performed on a multi-tranche basis considering three vesting
tranches and the weighted average volatility for these grants is calculated to
be 54.8%.
 
 The
risk-free rates have been determined based upon the interest rates for
zero-coupon U.S. Treasury bonds as of December 31, 2007.  A yield
curve has been determined based upon interpolating between the rates ranging
from 3.05% to 5.09%.
 
 Consistent
with the service-based stock option grants, both the dividend and forfeiture
rates are 0.0% for the performance-based option grants.
 
 F-25
 Total
stock-based compensation expense recognized for the years ended December 31,
2007 and 2006 was $0.6 million and $6.8 million, respectively. For the years
ended December 31, 2007 and 2006, no income tax benefit was recognized in the
statement of operations for share-based compensation arrangements.
 
 During
the years ended December 31, 2007, 2006 and 2005, we received proceeds of $2.0
million, $2.5 million and $0.2 million, respectively, related to the exercise of
options.
  For the
service-based stock options, we estimated share-based compensation expense for
fiscal years 2007 and 2006 using the Black-Scholes-Merton formula with the
following weighted average assumptions:
  Year
      Ended
                              
                              
                              Year
      Ended12/31/07
                              
                              
                              12/31/06Risk
      free interest rate
                              
                              
                              4.4
                              %
                              
                              
                              
                              4.0
                              %Expected
      dividend yield
                              
                              
                              -
                              
                              
                              
                              
                              -Expected
      volatility
                              
                              
                              71.7
                              %
                              
                              
                              
                              145.9
                              %Expected
      life (in years)
                              
                              
                              6.0
                              
                              
                              
                              
                              5.3
  A summary
of option activity follows:
  Weighted
                  
                  
                  AggregateOptions
                  
                  
                  Average
                  
                  
                  IntrinsicOutstanding
                  
                  
                  Price
                  
                  
                  ValueAs
      of December 31, 2004
                  
                  
                  11,976,494
                  
                  
                  
                  1.84Grants
                  
                  
                  9,831,253
                  
                  
                  
                  1.80Exercised
                  
                  
                  (157,600
                  )
                  
                  
                  1.14Canceled
                  
                  
                  (2,927,263
                  )
                  
                  
                  2.06As
      of December 31, 2005
                  
                  
                  18,722,884
                  
                  
                  
                  1.78Grants
                  
                  
                  3,569,929
                  
                  
                  
                  1.91Exercised
                  
                  
                  (1,892,724
                  )
                  
                  
                  1.36Canceled
                  
                  
                  (1,089,500
                  )
                  
                  
                  2.04As
      of December 31, 2006
                  
                  
                  19,310,589
                  
                  
                  
                  1.84
                  
                  
                  
                  $35,574,789Exercised
                  
                  
                  (1,178,829
                  )
                  
                  
                  1.67
                  
                  
                  
                  1,449,172Canceled
                  
                  
                  (361,719
                  )
                  
                  
                  3.26
                  
                  
                  
                  1,177,492As
      of December 31, 2007
                  
                  
                  17,770,041
                  
                  
                  
                  $1.82
                  
                  
                  
                  $32,429,785Options
      exercisable, as of December 31, 2007
                  
                  
                  14,192,320
                  
                  
                  
                  $1.78
                  
                  
                  
                  $25,314,540
  The
following information applies to options outstanding at December 31, 2007:
  Weighted
                      
                      
                      
                      
                      
                      WeightedAverage
                      
                      
                      
                      
                      
                      AverageExercise Price
                      
                      
                      
                      
                      
                      Exercise PriceOptions
                        Outstanding
                      
                      
                      Average
                        Remaining
      Life
                      
                      
                      of
      Options
                        Outstanding
                      
                      
                      Options
                        Exercisable
                      
                      
                      of
      Options
                        OutstandingUnder
      $1.50
                      
                      
                      
                      3,602,876
                      
                      
                      
                      4.90
                      
                      
                      
                      $1.05
                      
                      
                      
                      3,602,876
                      
                      
                      
                      $1.05$1.50
      - $1.99
                      
                      
                      
                      9,094,915
                      
                      
                      
                      7.19
                      
                      
                      
                      1.76
                      
                      
                      
                      6,558,694
                      
                      
                      
                      1.72$2.00
      - $2.99
                      
                      
                      
                      3,917,500
                      
                      
                      
                      7.05
                      
                      
                      
                      2.15
                      
                      
                      
                      2,876,000
                      
                      
                      
                      2.10$3.00
      - $3.99
                      
                      
                      
                      793,750
                      
                      
                      
                      6.08
                      
                      
                      
                      3.00
                      
                      
                      
                      793,750
                      
                      
                      
                      3.00$4.00
      + over
                      
                      
                      
                      361,000
                      
                      
                      
                      4.58
                      
                      
                      
                      5.07
                      
                      
                      
                      361,000
                      
                      
                      
                      5.0717,770,041
                      
                      
                      
                      6.59
                      
                      
                      
                      $1.82
                      
                      
                      
                      14,192,320
                      
                      
                      
                      $1.78
  F-26
  Pro
Forma Information Under SFAS 123 for Periods Prior to Fiscal 2006
  Prior to
January 1, 2006, we accounted for stock options under the recognition and
measurement principles of APB Opinion No. 25, “Accounting for Stock Issued
to Employees,” and related interpretations. Prior to the implementation of SFAS
No. 123R, stock-based employee compensation expense was not generally reflected
in net income, as all options granted under our plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if we had applied the fair value recognition provisions of SFAS No. 123R to
stock-based employee compensation for the year ended December 31,
2005:
  (In thousands,
      except per share amounts)Year
      Ending December 312005Net
      loss as reported
                
                $
                (17,161
                )Compensation
      cost at fair value
                
                
                (1,007
                )Pro
      forma net loss
                
                $
                (18,168
                )Basic
      and diluted net loss per shareAs
      reported
                
                $
                (0.42
                )Pro
      forma
                
                $
                (0.45
                )
 
 The pro
forma compensation cost recognized for the grant date fair value of the stock
options granted during the year ended December 31, 2005 was estimated using the
Black-Scholes model with the following weighted-average
assumptions:
  Year
      Ending December 312005Risk
      free interest rate
                
                
                3.6%Expected
      dividend yield
                
                
                —Expected
      volatility
                
                
                50%Expected
      life (in years)
                
                
                3.5
 
 NOTE
9. SEVERANCE
 
 We
reorganized our executive management team and terminated an exclusive agreement
with our financial advisor during fiscal year 2005. As a result, severance
related charges of approximately $2.7 million were recognized, of which, $1.4
million was related to non-cash compensation expense resulting from the grant of
additional vested stock options and the acceleration of certain unvested stock
options.
 
 In
February 2006, we reorganized our theatrical releasing business as part of a
decision to discontinue the use of theatrical releasing as a marketing strategy
to improve video sales.  As a result, severance related charges of
approximately $0.9 million were recognized during the 202-day period ended July
21, 2006.  As of December 31, 2006, we did not have any remaining
severance obligations related to this action.
 
 F-27
  NOTE 10. INCOMETAXES
 
 The
Company recorded a federal and state tax benefit of $1.7 million for the fiscal
year ended December 31, 2007.  The tax benefit resulted from the net
decrease in the deferred tax liability related to our investment in the
Distributor.  The Company currently has a full valuation allowance on
its deferred tax assets and has recorded a net deferred tax liability relating
to its investment in Distributor.
 
 The
following table presents the current and deferred income tax provision for
(benefit from) federal and state income taxes for the years ended December 31,
2007, 2006 and 2005:
  (In
      thousands)2007
                    Restated
                  
                  
                  2006
                    Restated (Note )
                  
                  
                  2005CurrentFederal
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -State
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1DeferredFederal
                  
                  
                  (770
                  )
                  
                  
                  6,121
                  
                  
                  
                  -State
                  
                  
                  (960
                  )
                  
                  
                  1,183
                  
                  
                  
                  -Total
                  
                  $
                  (1,730
                  )
                  
                  $
                  7,304
                  
                  
                  $
                  1
  At
December 31, 2007 and 2006, components of net deferred tax assets (liabilities)
in the accompanying balance
sheet include the following amounts of deferred taxes:
 (In
      thousands)December
      31,Deferred
      tax asset (liability)
                            
                            2007
                              (Restated)
                            
                            
                            2006
                              (Restated)NOL
      carry-forwards
                            
                            $
                            24,880
                            
                            
                            $
                            21,121Other
      reserves
                            
                            
                            1,107
                            
                            
                            
                            1,569Stock
      options
                            
                            
                            -
                            
                            
                            
                            2,384Investment
      in Distributor
                            
                            
                            (12,797
                            )
                            
                            
                            (14,926
                            )13,190
                            
                            
                            
                            10,148Less
      valuation allowance
                            
                            
                            (25,987
                            )
                            
                            
                            (24,676
                            )Net
      deferred tax asset (liability)
                            
                            $
                            (12,797
                            )
                            
                            $
                            (14,528
                            )
  Income
tax benefit (expense) differs from the amounts computed by applying the United
States federal income tax rate of 34% to
income taxes as a result of the following for the years ended December 31, 2007,
2006 and 2005:
  2007
                    (Restated)
                  
                  2006
                    (Restated)
                  
                  2005Federal
      tax on pretax income at statutory rates
                  
                  
                  34
                  %
                  
                  
                  34
                  %
                  
                  
                  34
                  %State
      tax, net of federal benefit
                  
                  
                  4
                  %
                  
                  
                  6
                  %
                  
                  
                  6
                  %Valuation
      allowance
                  
                  
                  (22
                  %)
                  
                  
                  (62
                  %)
                  
                  
                  (39
                  %)Stock
      Based Compensation
                  
                  
                  (1
                  %)
                  
                  
                  (1
                  %)
                  
                  
                  0
                  %Other
                  
                  
                  (4
                  %)
                  
                  
                  2
                  %
                  
                  
                  (1
                  %)Total
                  
                  
                  11
                  %
                  
                  
                  (19
                  %)
                  
                  
                  0
                  %
 As of
December 31, 2007, we had total net operating loss carry-forwards for federal
and state income tax purposes of $62.9 million and $51.2 million,
respectively, which start expiring in 2011 through 2027.  Included in
our total net operating loss carryover, is approximately $17.6 million of net
operating losses we inherited as a result of the AVMC acquisition pertaining
mainly to the Wellspring division.  The utilization of net operating
loss carry-forwards may be limited due to the ownership change under the
provisions of Internal Revenue Code Section 382 and similar state
provisions.
  F-28
 
 The net
increase in our valuation allowance was $1.3 million in 2007, $5.1 million in
2006, and $12.3 million in 2005.  We have provided a valuation
allowance for all of our deferred tax assets.  We will continue to
evaluate the recoverability of our deferred tax asset and the need for a
valuation allowance against such asset.  Factors that are considered
in the evaluation  of the recoverability of the deferred tax asset are
continued profitability and our ability to meet our future
forecasts.  In general, any realization of our net deferred tax asset
will reduce the effective tax rate in future periods.  The Company has
recorded a net deferred tax liability relating to its investment in the
Distributor.  The deferred tax liability related to the Distributor is
not offset against the deferred tax assets as the reversal period for this
amount is not considered to be determinable on a more likely than not
basis.
  NOTE
11.  EMPLOYEE BENEFIT PLAN
 
 We
sponsor a defined contribution plan (the “Plan”) under Section 401(k) of the
Internal Revenue Code, covering employees of the Company.  Under the
Plan, we may match contributions at the discretion of management.  For
the 202-day period ended July 21, 2006 and the year ended December 31, 2005 we
did not make any contributions to the Plan.  At the Closing, we
transferred the Plan to the Distributor and as such, there was no employee
benefit plan at December 31, 2006 and December 31, 2007 for the
Company.
  NOTE
12.  CLASS W OPTION LIABILITY
 
 The
Distributor is owned 70% by TWC Holdings and W-G Holding (collectively, the “TWC
Parties”) and 30% by the Company.  The Company’s 30% membership
interest in the Distributor consists of the Distributor’s Class G
Units.  The 70% interest in the Distributor held by the TWC Parties
consists of Class W Units.   Pursuant to the Distributor’s
Amended and Restated Limited Liability Company Agreement (the “Distributor LLC
Agreement”), at any time after July 21, 2007, the TWC Parties have the option to
redeem all or a portion of their Class W Units for either (i) shares of the
Company’s common stock or, (ii) at the option of the Distributor (and with the
consent of the TWC Parties), cash (as defined in the Distributor LLC
Agreement).  In order to exercise such redemption right, the TWC
Parties must provide to the Distributor and the Company written notice of
redemption (“Notice of Redemption”), specifying the number of Class W Units
being tendered for redemption.
 
 Upon
receipt of a Notice of Redemption, the number of Company common shares issuable
to the TWC Parties is determined by multiplying (i) the number Class W Units
being redeemed, by (ii) a fraction, the numerator of which is the number of
outstanding Company common shares as of the date of the Notice of Redemption,
and the denominator of which is the number of outstanding Company common shares
as of July 21, 2006 (the intent of this adjustment factor being that the TWC
Parties would receive no less than 70% of the Company’s common stock upon
redemption of all of the Class W Units).  Notwithstanding the
above-described computation, in the event that the trading price of the
Company’s common stock is less than $0.42 as of the date of the Notice of
Redemption, the number of common shares issuable to the TWC Parties is
determined by dividing (i) $60 million dollars (the “Floor Amount”), by (ii) the
trading price of the Company’s common stock as of the date of the Notice of
Redemption (such calculation being referred to as the “Floor
Calculation”).  In other words, if on the date of the Notice of
Redemption the trading price of the Company’s common stock is less than $0.42,
then the TWC Parties would be entitled to receive either cash or shares of the
Company’s common stock with a value of no less than the Floor Amount of $60
million.
 
 The
Company has accounted for its obligation to deliver shares of its Common Stock
to the Distributor upon the redemption of the Class W Units (including the Floor
Amount provision), as described above, as a written call option (the “Class W
Option Liability”) in accordance with EITF 00-6, “Accounting for Freestanding
Derivative Financial Instruments Indexed to, and Potentially Settled in, the
Stock of a Consolidated Subsidiary.”  The Company has utilized
a lattice valuation model to simulate future stock movements of the Company's
Common Stock in order to determine the fair value of the Class W Option
Liability.  The assumptions used in preparing such a model include, among
other things, inputs such as volatility, risk-free interest rates, dividend
yield, expected time of redemption and assessment of counterparty
risk.
  The
Company has recorded the fair value of the Class W Option Liability as of July
21, 2006 (i.e., the date that the Class W Units of the Distributor were issued
to the TWC Parties), and has subsequently re-measured the fair value of the
Class W Option Liability through its Statements of Operations (in other income
(expense)) at the end of every reporting period.  See Note 3 for a
discussion regarding the impact for such reporting periods.
 F-29
 NOTE
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
  Selected
unaudited quarterly financial data for the years ended December 31, 2007
and 2006 are summarized below.
  (In
      thousands)
                  
                  2007First
      Quarter
                    Restated
                    (Note 3)
                  
                  
                  Second
      Quarter
                    Restated
                    (Note 3)
                  
                  
                  Third
      Quarter
                    Restated
                    (Note 3)
                  
                  
                  Fourth
      Quarter
                    Restated
                    (Note 3)Net
      revenues
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -Gross
      profit (loss)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Loss
      before income taxes
                  
                  
                  (3,211
                  )
                  
                  
                  (2,421
                  )
                  
                  
                  (4,377
                  )
                  
                  
                  (6,601
                  )Net
      loss
                  
                  
                  (3,209
                  )
                  
                  
                  (2,127
                  )
                  
                  
                  (4,481
                  )
                  
                  
                  (5,063
                  )Basic
      and diluted loss per common share
                  
                  $
                  (0.05
                  )
                  
                  $
                  (0.03
                  )
                  
                  $
                  (0.07
                  )
                  
                  $
                  (0.07
                  )Basic
      and diluted weighted average common shares outstanding
                  
                  
                  64,193
                  
                  
                  
                  66,069
                  
                  
                  
                  66,952
                  
                  
                  
                  67,658
   2006First
      Quarter
                          
                          
                          Second
      Quarter
                          
                          
                          Third
      Quarter
                            Restated
                            (Note 3)
                          
                          
                          Fourth
      Quarter
                            Restated
                            (Note 3)Net
      revenues
                          
                          $
                          27,912
                          
                          
                          $
                          76,084
                          
                          
                          $
                          15,015
                          
                          
                          $
                          -Gross
      loss
                          
                          
                          (885
                          )
                          
                          
                          (10,671
                          )
                          
                          
                          (303
                          )
                          
                          
                          -Loss
      before income taxes
                          
                          
                          (6,766
                          )
                          
                          
                          (19,148
                          )
                          
                          
                          (5,139
                          )
                          
                          
                          (8,631
                          )Loss
      before extraordinary item
                          
                          
                          (6,720
                          )
                          
                          
                          (17,921
                          )
                          
                          
                          (14,699
                          )
                          
                          
                          (7,648
                          )Extraordinary
      gain
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          53,760
                          
                          
                          
                          443Net
      income (loss)
                          
                          
                          (6,720
                          )
                          
                          
                          (17,921
                          )
                          
                          
                          39,061
                          
                          
                          
                          (7,205
                          )Basic
      and diluted earnings (loss) per common share before extraordinary
      item
                          
                          $
                          (0.11
                          )
                          
                          $
                          (0.29
                          )
                          
                          $
                          (0.24
                          )
                          
                          $
                          (0.13
                          )
 Basic
      and diluted earnings (loss) per common share
                          
                          $
                          (0.11
                          )
                          
                          $
                          (0.29
                          )
                          
                          $
                          0.64
                          
                          
                          $
                          (0.12
                          )
 Basic
      and diluted weighted average common shares
    outstanding
                              
                              
                              60,446
                              
                              
                              
                              60,829
                              
                              
                              
                              61,370
                              
                              
                              
                              61,132
 In the
third quarter of 2006, an extraordinary gain was recorded upon consummation of
the TWC Transaction based on the difference between the fair market value of
assets contributed and their net book value, reduced for the portion of the gain
associated with our retained economic interest in the
Distributor.
  F-30
  GENIUS
PRODUCTS, INC AND SUBSIDIARIES
 SCHEDULE
II – Valuation and Qualifying Accounts
 Years
Ended December 31, 2005, 2006 and 2007
 (In
thousands)
  Allowances
are deducted from the assets to which they apply, except for sales returns and
allowances.
  Balance
      at
                  
                  
                  Charged
      to
                  
                  
                  Charged
      toBeginning
      of
                  
                  
                  costs
      and
                  
                  
                  Other
                  
                  
                  
                  
                  
                  
                  Balance
      at EndPeriod
                  
                  
                  expenses
                  
                  
                  Accounts
                  
                  
                  
                  Deductions
                  
                  
                  of
      PeriodYear
      ended December 31, 2005Allowance
      for:Uncollectible
      accounts
                  
                  $
                  42
                  
                  
                  $
                  361
                  
                  
                  $
                  1,310
                  
                  (a)
                  
                  $
                  (758
                  )
                  
                  $
                  956Reserve
      for potential product obsolescence
                  
                  
                  474
                  
                  
                  
                  1,827
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  2,301Reserve
      for sales returns and allowances
                  
                  
                  1,322
                  
                  
                  
                  5,184
                  
                  
                  
                  217
                  
                  (b)
                  
                  
                  (770
                  )
                  
                  
                  5,953Deferred
      tax assets
                  
                  
                  7,320
                  
                  
                  
                  12,280
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  19,600$
                  9,158
                  
                  
                  $
                  19,652
                  
                  
                  $
                  1,527
                  
                  
                  
                  $
                  (1,528
                  )
                  
                  $
                  28,810Year
      ended December 31, 2006Allowance
      for:Uncollectible
      accounts
                  
                  $
                  956
                  
                  
                  
                  721
                  
                  
                  
                  (1,238
                  )
                  (b)
                  
                  
                  (439
                  )
                  
                  
                  -Reserve
      for potential product obsolescence
                  
                  
                  2,301
                  
                  
                  
                  4,602
                  
                  
                  
                  (6,223
                  )
                  (b)
                  
                  
                  (680
                  )
                  
                  
                  -Reserve
      for sales returns and allowances
                  
                  
                  5,953
                  
                  
                  
                  40,408
                  
                  
                  
                  (23,094
                  )
                  (b)
                  
                  
                  (23,267
                  )
                  
                  
                  -Reserve
      for uncollectable advances
                  
                  
                  -
                  
                  
                  
                  2,209
                  
                  
                  
                  (2,202
                  )
                  (b)
                  
                  
                  (7
                  )
                  
                  
                  -Deferred
      tax assets
                  
                  
                  19,600
                  
                  
                  
                  (19,600
                  )
                  
                  
                  -
                  
                  (b)
                  
                  
                  -
                  
                  
                  
                  -$
                  28,810
                  
                  
                  $
                  28,340
                  
                  
                  $
                  (32,757
                  )
                  
                  
                  $
                  (24,393
                  )
                  
                  $
                  -Year
      ended December 31, 2007Allowance
      for:Uncollectible
      accounts
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  -Reserve
      for potential product obsolescence
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  -Reserve
      for sales returns and allowances
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  -Reserve
      for uncollectable advances
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  -Deferred
      tax assets
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  -
                  
                  
                  
                  -$
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  $
                  -
                  
                  
                  $
                  -
  (a)
      AVMC acquired reserve(b)
      As part of the closing of the TWC Transaction, these amounts were
      transferred to the Distributor.
  F-31
 NOTE
14.  RECENT EVENTS
 
 As a
result of a reduced slate of pictures the Distributor is to distribute on behalf
of one its major licensors and the recent economic conditions, including a
decrease in consumer confidence resulting in lower spending levels, the
Distributor has experienced a significant reduction in net revenue.  Based
on current operating results through December 31, 2008, the Distributor will
fall short of generating enough cash flow from continuing operations to timely
meet its financial commitments and obligations. In addition, the financing
historically provided by TWC will not be available to the Distributor effective
January 1, 2009.  Currently, the Distributor is carefully evaluating all
capital and operational expenditures on a go forward basis, including an
internal restructuring of its resources and overhead to decrease its operating
expenses. The Distributor is pursuing these options to alleviate any liquidity
shortfall that may arise in the future.  At this time, the Distributor is
unable to conclude if the aforementioned actions being taken, including a
potential restructuring will be successful. If the Distributor is unable
successfully to reduce its overhead costs in the near future, the Distributor’s
ability to generate sufficient cash flows to continue its operations and service
its obligations under the credit facility may be adversely affected. As the
Company relies solely on the Distributor to fund its operations and is also the
guarantor of the Distributor’s credit facility (See Note 5), any adverse impact
on the operations and liquidity of the Distributor could also adversely impact
the Company’s results of operations and liquidity. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
  F-32
  GENIUS
PRODUCTS, LLC AND SUBSIDIARIES
 
 TABLE OF
CONTENTS
 
 
 REPORT
      OF INDEPENDENT AUDITORS
                F-34GENIUS
      PRODUCTS, LLC BALANCE SHEETS AS OF DECEMBER 31, 2007
                F-35AND
      2006GENIUS
      PRODUCTS, LLC STATEMENTS OF OPERATIONS FOR THE YEAR
                F-36ENDED
      DECEMBER 31, 2007 AND THE PERIOD FROMJULY
      22, 2006 THROUGH DECEMBER 31, 2006GENIUS
      PRODUCTS, LLC STATEMENTS OF MEMBER'S DEFICIT FOR THE
                F-37YEAR
      ENDED DECEMBER 31, 2007 FOR THE PERIOD FROMJULY
      22, 2006 THROUGH DECEMBER 31, 2006GENIUS
      PRODUCTS, LLC STATEMENTS OF CASH FLOWS FOR THE YEAR
                F-38ENDED
      DECEMBER 31, 2007 FOR THE PERIOD FROMJULY
      22, 2006 THROUGH DECEMBER 31, 2006NOTES
      TO GENIUS PRODUCTS, LLC CONSOLIDATED FINANCIAL
                F-39STATEMENTS
 F-33
 
 Report
of Independent Auditors
  To
the Members of Genius Products, LLC:
  We
have audited the accompanying consolidated balance sheets of Genius Products,
LLC and subsidiaries (the ‘Distributor’) as of December 31, 2007 and 2006, and
the related consolidated statements of operations, member’s deficit, and cash
flows for the year ended December 31, 2007 and the period from July 22, 2006
through December 31, 2006. These financial statements are the responsibility of
the Distributor’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.
  We
conducted our audits in accordance with auditing standards generally accepted in
the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. We were not engaged to perform an audit of the
Distributor’s internal control over financial reporting. Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the
Distributor’s internal control over financial reporting. Accordingly, we express
no such opinion. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
  Since
the date of completion of our audit of the accompanying financial statements and
initial issuance of our report dated March 16, 2008, as discussed in Note 19,
the Distributor does not expect to generate sufficient operating cash flow to
fund operating activities, thereby adversely affecting its results of operations
and liquidity. Note 19 describes management’s plans to address this
issue.
  In
our opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Genius Products, LLC
and subsidiaries at December 31, 2007 and 2006, and the consolidated results of
their operations and their cash flows for the year ended December 31, 2007 and
the period from July 22, 2006 through December 31, 2006 in conformity with U.S.
generally accepted accounting principles.
  As
discussed in Note 3 to the consolidated financial statements, the Distributor
has restated its consolidated financial statements as of December 31, 2007 and
2006 and for the periods then ended.
  /s/ Ernst & Young
LLP
  Los
Angeles, California
 March
16, 2008,
 except
for Note 3 and Note 19, as to which the date is
 March
24 , 2009
 F-34
 GENIUS
      PRODUCTS, LLC AND SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETS(IN
      THOUSANDS)
   December
      31, 2007
                      
                      
                      December
      31, 2006Restated
      (Note 3)
                      
                      
                      Restated
      (Note 3)ASSETSCurrent
      assets:Cash
      and cash equivalents
                      
                      $
                      3,102
                      
                      
                      $
                      8,326Restricted
      cash - short term
                      
                      
                      7,765
                      
                      
                      
                      -Accounts
      receivable, net of allowance for doubtful accounts of $4,311 and
      $2,963and
      sales returns of $68,159 and $42,057
                      
                      
                      123,295
                      
                      
                      
                      97,495Inventories,
      net of reserves for obsolescence of $13,257 and $10,487
                      
                      
                      11,282
                      
                      
                      
                      7,589Prepaid
      expenses and other current assets
                      
                      
                      1,110
                      
                      
                      
                      728Total
      current assets
                      
                      
                      146,554
                      
                      
                      
                      114,138Restricted
      cash - long term
                      
                      
                      3,323
                      
                      
                      
                      309Property
      and equipment, net of accumulated depreciation of $455 and
      $103
                      
                      
                      953
                      
                      
                      
                      818Royalty
      advances, net of uncollectible advances of $5,112 and
    $3,057
                      
                      
                      31,492
                      
                      
                      
                      20,042Film
      library, net of accumulated amortization of $6,452 and
$484
                      
                      
                      14,403
                      
                      
                      
                      8,102Goodwill
                      
                      
                      87,512
                      
                      
                      
                      84,982Other
      intangible assets, net of accumulated amortization of $9,675 and
      $3,419
                      
                      
                      11,596
                      
                      
                      
                      16,172Deferred
      financing fees
                      
                      
                      1,654
                      
                      
                      
                      -Deposits
      and other
                      
                      
                      5,617
                      
                      
                      
                      4,056Total
      assets
                      
                      $
                      303,104
                      
                      
                      $
                      248,619LIABILITIES
      AND MEMBER'S DEFICITCurrent
      liabilities:Accounts
      payable
                      
                      $
                      31,477
                      
                      
                      $
                      18,704Notes
      payable
                      
                      
                      31,297
                      
                      
                      
                      213Remittance
      to TWC
                      
                      
                      78,759
                      
                      
                      
                      96,685Remittance
      to other licensors
                      
                      
                      20,000
                      
                      
                      
                      9,653Accrued
      advertising and marketing
                      
                      
                      24,515
                      
                      
                      
                      13,375Other
      accrued expenses
                      
                      
                      20,910
                      
                      
                      
                      3,295Deferred
      revenue
                      
                      
                      8,492
                      
                      
                      
                      4,986Total
      current liabilities
                      
                      
                      215,450
                      
                      
                      
                      146,911Long
      term liabilities:Notes
      payable to Genius Products, Inc.
                      
                      
                      8,191
                      
                      
                      
                      -Long
      term notes payable
                      
                      
                      627
                      
                      
                      
                      -Long
      term capital lease
                      
                      
                      30
                      
                      
                      
                      -Total
      long term liabilities
                      
                      
                      8,848
                      
                      
                      
                      -Redeemable
      Class W units
                      
                      
                      284,378
                      
                      
                      
                      401,777Total
      member's deficit
                      
                      
                      (205,572
                      )
                      
                      
                      (300,069
                      )Total
      liabilities and member's deficit
                      
                      $
                      303,104
                      
                      
                      $
                      248,619See
      accompanying notes.
  F-35
 GENIUS
      PRODUCTS, LLC AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF OPERATIONS(IN
      THOUSANDS)
  Year
      Ended
                        December
      31, 2007
                      
                      
                      Period
      from
                        July
      22, 2006Restated
      (Note 3)
                      
                      
                      through
                        December
      31, 2006Revenues,
      net of sales returns, discounts and allowances of
                      
                      $
                      474,087
                      
                      
                      $
                      155,591$177,324
      and $71,983Cost
      of revenues:Amortization
      and participation
                      
                      
                      279,563
                      
                      
                      
                      89,246Manufacturing
      and distribution
                      
                      
                      113,836
                      
                      
                      
                      54,230Advertising
      and marketing
                      
                      
                      58,198
                      
                      
                      
                      24,568Total
      cost of revenues
                      
                      
                      451,597
                      
                      
                      
                      168,044Gross
      profit (loss)
                      
                      
                      22,490
                      
                      
                      
                      (12,453
                      )Operating
      expenses:General
      and administrative
                      
                      
                      38,440
                      
                      
                      
                      7,566Total
      operating expenses
                      
                      
                      38,440
                      
                      
                      
                      7,566Loss
      from operations
                      
                      
                      (15,950
                      )
                      
                      
                      (20,019
                      )Other
      income (expense)
                      
                      
                      (2,882
                      )
                      
                      
                      309Net
      loss
                      
                      $
                      (18,832
                      )
                      
                      $
                      (19,710
                      )See
      accompanying notes.
  F-36
 
  GENIUS
      PRODUCTS, LLC AND SUBSIDIARIESSTATEMENTS
      OF MEMBER'S DEFICITFOR
      THE YEAR ENDED DECEMBER 31, 2007 AND THE PERIOD FROM JULY 22, 2006 THROUGH
      DECEMBER 31, 2006(IN
      THOUSANDS)
   Genius
      Products, Inc.Class
      G unitsContribution
      of assets, liabilities and businesses of Genius Products,
    Inc.
                      
                      $
                      117,960Class
      W purchased call option
                      
                      
                      3,783Stock
      compensation expense
                      
                      
                      938Distribution
      to members for costs incurred on behalf of Genius Products,
      Inc.
                      
                      
                      (1,263
                      )Re-measurement
      of Redeemable Class W units to redemption value
                      
                      
                      (401,777
                      )Net
      loss
                      
                      
                      (19,710
                      )Ending
      member's deficit at December 31, 2006 (restated)
                      
                      $
                      (300,069
                      )Stock
      compensation expense
                      
                      
                      757Distribution
      to members for costs incurred on behalf of Genius Products,
      Inc.
                      
                      
                      (4,827
                      )Re-measurement
      of Redeemable Class W units to redemption value
                      
                      
                      117,399Net
      loss
                      
                      
                      (18,832
                      )Ending
      member's deficit at December 31, 2007 (restated)
                      
                      $
                      (205,572
                      )See
      accompanying notes.
  F-37
 GENIUS
PRODUCTS, LLC AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (IN
THOUSANDS)
 Year
      ended
                          December
      31, 2007
                        
                        
                        Period
      from
                          July
      22, 2006Restated
      (Note 3)
                        
                        
                        through
                          December
      31, 2006Cash
      flows from operating activities:Net
      loss
                        
                        $
                        (18,832
                        )
                        
                        $
                        (19,710
                        )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                        
                        
                        354
                        
                        
                        
                        103Amortization
      of intangible assets
                        
                        
                        6,256
                        
                        
                        
                        3,419Amortization
      of film library
                        
                        
                        5,969
                        
                        
                        
                        484Amortization
      of deferred financing costs
                        
                        
                        212
                        
                        
                        
                        -Change
      in allowance for doubtful accounts and provision for
    returns
                        
                        
                        27,448
                        
                        
                        
                        20,031Change
      in provision for obsolete inventory
                        
                        
                        672
                        
                        
                        
                        4,383Loss
      on disposal of fixed assets
                        
                        
                        -
                        
                        
                        
                        63Imputed
      interest on notes receivable, related party
                        
                        
                        -
                        
                        
                        
                        (39
                        )Stock
      compensation expense
                        
                        
                        757
                        
                        
                        
                        938Interest
      expense on notes payable
                        
                        
                        191
                        
                        
                        
                        13Impairment
      of Class W purchased call option (included in deposits and
      other)
                        
                        
                        1,134
                        
                        
                        
                        -Changes
      in assets and liabilities:(Increase)
      decrease in restricted cash
                        
                        
                        (10,779
                        )
                        
                        
                        (6
                        )(Increase)
      decrease in accounts receivable
                        
                        
                        (49,647
                        )
                        
                        
                        (67,211
                        )(Increase)
      decrease in inventory
                        
                        
                        (2,693
                        )
                        
                        
                        2,034(Increase)
      decrease in prepaid expenses and deposits
                        
                        
                        (1,906
                        )
                        
                        
                        (378
                        )(Increase)
      decrease in notes receivable
                        
                        
                        86
                        
                        
                        
                        288(Increase)
      decrease in royalty advances
                        
                        
                        (14,626
                        )
                        
                        
                        (16,285
                        )(Increase)
      decrease in film library
                        
                        
                        (9,870
                        )
                        
                        
                        (1,252
                        )Increase
      (decrease) in accounts payable
                        
                        
                        7,892
                        
                        
                        
                        13,288Increase
      (decrease) in accrued expenses and other
                        
                        
                        28,212
                        
                        
                        
                        (3,912
                        )Increase
      (decrease) in deferred revenue
                        
                        
                        3,507
                        
                        
                        
                        2,229Increase
      (decrease) in remittance to TWC
                        
                        
                        (17,926
                        )
                        
                        
                        96,685Increase
      (decrease) in remittance to other licensors
                        
                        
                        10,269
                        
                        
                        
                        (41,339
                        )Net
      cash used in operating activities
                        
                        
                        (33,320
                        )
                        
                        
                        (6,174
                        )Cash
      flows from investing activities:Purchase
      of Castalian (net of working capital acquired of $527)
                        
                        
                        (3,683
                        )
                        
                        
                        -Transaction
      costs related to TWC transaction
                        
                        
                        -
                        
                        
                        
                        (4,305
                        )Purchase
      of property and equipment
                        
                        
                        (270
                        )
                        
                        
                        (261
                        )Net
      cash used in investing activities
                        
                        
                        (3,953
                        )
                        
                        
                        (4,566
                        )Cash
      flows from financing activities:Proceeds
      from Credit Facility
                        
                        
                        54,500
                        
                        
                        
                        -Repayments
      of Credit Facility
                        
                        
                        (15,757
                        )
                        
                        
                        -Deferred
      financing costs paid
                        
                        
                        (1,867
                        )
                        
                        
                        -Distribution
      to Members
                        
                        
                        (4,827
                        )
                        
                        
                        (1,263
                        )Net
      cash provided (used) in financing activities
                        
                        
                        32,049
                        
                        
                        
                        (1,263
                        )Net
      decrease in cash and equivalents
                        
                        
                        (5,224
                        )
                        
                        
                        (12,003
                        )Cash
      at beginning of period
                        
                        
                        8,326
                        
                        
                        
                        20,329Cash
      at end of period
                        
                        $
                        3,102
                        
                        
                        $
                        8,326Supplemental
      disclosure of cash flow informationInterest
      paid
                        
                        $
                        858
                        
                        
                        $
                        -Non-cash
      transactionsRedeemable
      Class W units re-measurement to redemption value
                        
                        $
                        117,399
                        
                        
                        $
                        401,777Class
      W purchased call option
                        
                        
                        -
                        
                        
                        
                        3,783See
      accompanying notes.
  F-38
 
 GENIUS
PRODUCTS, LLC AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007
 
  NOTE 1. NATURE OF
BUSINESS
 
 Genius
Products, LLC (the “Distributor”), a 30%-owned subsidiary of Genius Products,
Inc. (“we”, “us”, “our” or the “Company”), is a leading independent home
entertainment products company that acquires, produces and licenses, through the
Distributor’s multiple distribution agreements with content partners, an
extensive library of motion pictures, television programming,
and  trend entertainment on digital versatile disks (“DVD”) and
digitally.  The Distributor works in partnership with major retailers
to distribute widely recognized home entertainment brands to a diversified
customer base.  The remaining 70% of the Distributor is owned by The
Weinstein Company Holdings LLC (“TWC Holdings”), which includes a 1% percentage
interest owned indirectly through its wholly-owned subsidiary, W-G Holding Corp
(“W-G Holding”).  TWC Holdings is the parent company of The Weinstein
Company LLC (“TWC”), the largest provider of content for our
library.
 
 The
Distributor produces and distributes a vast and growing content library that
encompasses approximately 3,550 feature films and documentaries and 4,000 hours
of television programming.  This library includes feature
films and television programming from critically acclaimed producers such as The
Weinstein Company®, for which the Distributor hasthe exclusive U.S. home
video distribution rights,and RHI EntertainmentTM
(Hallmark library).  Additional content, such as independent films,
sports, family, and lifestyle productions, come from partnerships with
established consumer brands:  IFC®, ESPN®, World Wrestling
Entertainment®, Classic Media, Sesame Workshop®, Discovery KidsTM, Animal Planet
and The Learning Channel (TLCTM).
 
 The
Distributor has developed a fully integrated direct-to-retail distribution
platform that parallels the home entertainment divisions of the major Hollywood
studios.  This platform provides direct sales and marketing, inventory
management and state-of-the-art supply-chain services.  In
collaboration with leading replicators and third-party logistics and
supply-chain companies, the Distributor has rapidly scaled this network, which
has helped to facilitate its rapid growth in revenues.
  The
Distributor primarily sell to major national retailers including Wal-Mart,
Blockbuster Entertainment, Best Buy, Circuit City, Kmart, Target, NetFlix,
Costco, Sam’s Club, Amazon, Borders, Toys R Us and Columbia
House.  The Distributor co-produces programming with its branded
content partners and mitigates the impact of its production costs through
minimum guarantees from one of its retail partners, Blockbuster.  We
believe that the strong relationships the Distributor has developed with these
well-known retailers and branded content partners help promote the Distributor’s
programming and heighten consumer awareness of its programs.
  The
Distributor collaborates with its retail and content partners to create sales
programs that exploit their widely recognized brands and endorse related
content.  These sales programs focus on brands to provide the retailer
with solutions that simplify the retailer’s buying process, improve shelf-space
utilization and help consumers quickly make informed purchase
decisions.  The Distributor’s ability to deliver unique, innovative
solutions that improve the sales and rentals of its content has enabled it to
compete successfully and maintain strong relationships with its retail and
content partners.
  The Distributorcurrentlydistributesitslibrary on DVDs,next-generationDVD, and
electronicallyin a digital format.Weplan to continue to
expand the distribution of the Distributor’s theatrical and non-theatrical
product through the diverse emerging digital distribution markets including:
Video-on-Demand (“VOD”) and Electronic Sell-Through (“EST”) on the Internet to
companies such as Amazon, Apple, MovieLink and Microsoft, Internet-based
subscription VOD customers (such as NetFlix) and direct-to-television
peer-to-peer network solutions.  Through its partnerships, the
Distributor has released over 128 theatrical and non-theatrical titles since
inception (including ninety titles released in 2007).  The Distributor
distributes products to basic channels distributed on cable, Direct Broadcast
Satellite (“DBS”) and Internet Protocol Television (“IPTV”), which delivers
television programming to households via a broadband connection using Internet
protocols.
  The
Distributor primarily focuses on four core branded content categories that we
call Content Verticals:
 
 ·
                Theatrical/Independent
      Films (includes Independent Film Channel (IFC)® , RHI
      EntertainmentTM (Hallmark library), Tartan, The Weinstein
      Company®  and
WellspringTM)
 ·
                Sports
      (includes ESPN® and World Wrestling
  Entertainment®)
 ·
                Lifestyle
      (includes Animal Planet, The Learning Channel (TLC) and
      WellspringTM)
 ·
                Family/Faith
      (includes Classic Media, Discovery KidsTM, Entertainment Rights and Sesame
      Workshop®)
 
 F-39
 THE
WEINSTEIN COMPANY TRANSACTION.
 On July
21, 2006 (the “Closing Date”), we completed a transaction (the “TWC
Transaction”) with TWC Holdings and its subsidiaries, TWC and W-G Holding,
pursuant to which the Company and TWC Holdings launched the Distributor to
exploit the U.S. home video distribution rights to feature film and
direct-to-video releases owned or controlled by TWC.  In connection
with the TWC Transaction, the Company contributed substantially all of its
assets (except for approximately $1.0 million in cash and certain liabilities),
its employees, and its existing businesses to the Distributor, in exchange for a
30% interest in the Distributor. The remaining 70% interest in the Distributor
held by TWC Holdings and W-G Holding consists of Class W Units and became
redeemable at their option commencing on July 21, 2007 for approximately 70% of
our outstanding common stock, or with their approval,
cash. The
redemption value of the Class W units may not be less than $60.0 million. The
Company’s 30% membership interest in the Distributor consists of the
Distributor’s Class G Units.
 
 In
addition, the Company issued an aggregate of 100 shares of its Series W
Preferred Stock to TWC Holdings and W-G Holding in connection with the TWC
Transaction.  The Series W Preferred Stock provides the holders
thereof with (i) the right to elect five of the seven directors on our Board of
Directors, of which two are currently TWC Holdings executives, (ii) majority
voting power over other actions requiring approval of our stockholders, and
(iii) the right to approve certain specified actions.  The Series W
Preferred Stock has no rights to receive dividends and minimal liquidation
value.
 
 On the
Closing Date, the Company entered into a Registration Rights Agreement with TWC
Holdings and W-G Holding pursuant to which we agreed to register for resale the
shares of our common stock issuable upon redemption of Class W Units in the
Distributor currently held by them.  The Company and/or the Distributor
also entered into the following agreements on the Closing Date: (i) an Amended
and Restated Limited Liability Company Agreement of the Distributor, (ii) a
Video Distribution Agreement (the “TWC Distribution Agreement”), (iii) a
Services Agreement, and (iv) an Assignment and Assumption
Agreement.
 
 After the
Closing Date, substantially all of the operating activities previously conducted
by Genius Products, Inc., as well as the results from releasing TWC product, are
reflected in the financial statements of the Distributor.
 
 For a
full description of the TWC Transaction, please see our Current Report on Form
8-K filed with the Securities and Exchange Commission (the “SEC”) on July 26,
2006.
 
 The total
basis of the Distributor’s contributed assets and liabilities as of the closing
date of the TWC Transaction was allocated to the estimated fair value of assets
acquired and liabilities assumed as set forth in the following
table:
  (In
      thousands)Cash
                  
                  $
                  20,329Accounts
      receivable, net
                  
                  
                  50,315Film
      library
                  
                  
                  11,090Inventory
                  
                  
                  14,006Other
      assets
                  
                  
                  3,144Intangible
      assets
                  
                  
                  19,591Liabilities
      assumed
                  
                  
                  (81,192
                  )Goodwill
                  
                  
                  80,677Total
      consideration
                  
                  $
                  117,960
  
 F-40
 The
consideration and final goodwill were calculated as follows:
  (In
      thousands)Total
      Genius Products, Inc shares outstanding as of July 21,
2006
                  
                  
                  61,005Closing
      share price at July 21, 2006
                  
                  $
                  1.95Equity
      market capitalization
                  
                  
                  118,960Less
      cash retained at Genius Products, Inc.
                  
                  
                  (1,000
                  )Total
      consideration
                  
                  
                  117,960Genius
      Products, Inc. - net book value at July 21, 2006
                  
                  
                  18,692Less
      cash retained at Genius Products, Inc.
                  
                  
                  (1,000
                  )Adjusted
      net book value
                  
                  
                  17,692Total
      consideration in excess of net book value
                  
                  
                  100,268Amounts
      allocated to identifiable intangible assets
                  
                  
                  (19,591
                  )Amounts
      allocated to goodwill
                  
                  
                  80,677Capitalized
      transaction costs
                  
                  
                  4,305Goodwill
      at December 31, 2006
                  
                  $
                  84,982
  NOTE
2.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 PRINCIPLES
OF CONSOLIDATION.
 The
consolidated financial statements of the Distributor include the accounts of the
Distributor and its controlled subsidiaries after the elimination of
intercompany accounts and transactions. The Distributor’s consolidated financial
statements include (i) the Distributor’s wholly owned subsidiary American
Vantage Media, LLC (“AVM”), (ii) Wellspring Media, LLC (“Wellspring Media”), a
wholly owned subsidiary of AVM and (iii) Castalian DC, LLC, Castalian LLC (dba
Castalian Music), The Thirteen-Thirty-One LLC, Abacus Media L.L.C. and Marathon
Media, LLC, direct and indirect wholly-owned subsidiaries of the Distributor
(collectively, “Castalian”). AVM and Wellspring Media were acquired on
March 21, 2005 and Castalian was acquired on April 1,
2007.  Abacus Media L.L.C. and Marathon Media, LLC were merged with
and into Castalian LLC on August 29, 2007, with Castalian LLC
surviving.  In addition, American Vantage/Hypnotic, Inc. and
Wellspring Productions, LLC, each a wholly-owned subsidiary of Wellspring Media,
are each inactive.
 
 USE OF
ESTIMATES.
 The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
 CASH AND
CASH EQUIVALENTS.
 Cash
equivalents include investments in time deposits, certificates of deposit and
money market accounts with original maturities of three months or
less.  At December 31, 2007, the Distributor had cash balances of $3.1
million.  See “Restricted Cash” below.
 
 F-41
 RESTRICTED
CASH.
 The
Distributor had restricted cash of $7.8 million (current asset) and $3.3 million
(long-term) at December 31, 2007.  The $7.8 million is part of the
Distributor’s short-term liquid cash that had accumulated in a central lockbox
account and can only be disbursed weekly pursuant to the terms of the
“Allocation of Accounts Receivable and Intercreditor Agreement” entered into by
and among  the Distributor, The Weinstein Company, LLC and Société
Générale dated August 10, 2007.The $3.3 million is comprised of:  (i)
$3 million in a money market account that is restricted pursuant to the
Distributor’s credit facility with Société Générale and (ii) $0.3 million in a
certificate of deposit, which certificate of deposit secures a letter of credit
on the Distributor’s 2230 Broadway lease.   At December 31, 2006,
the Distributor had $0.3 million in restricted cash which represented the cash
invested in certificates of deposit to collateralize a letter of credit issued
to the landlord as security for the Distributor’s obligations under the lease
for its 2230 Broadway office.
 
 FAIR
VALUE OF FINANCIAL INSTRUMENTS.
 The
carrying amounts of cash and cash equivalents, accounts receivable, prepaid
expenses, accounts payable and accrued expenses approximate the fair value
thereof.
 
 INVENTORIES.
 The
Distributor’s inventories consist of raw materials and finished goods, and these
are valued at the lower of cost or market. As of January 1, 2007, the
Distributor changed its method for valuing inventory from an average cost basis
to the first-in, first-out (“FIFO”) method of valuation, which is the
predominant method used in the industry.  The Distributor does not
believe that this change in accounting method had a material effect on the
Distributor's consolidated financial statements.
 
 The
Distributor reviews inventory for excess or obsolete product on a quarterly
basis.  Obsolescence is determined by taking the total inventory on
hand less 12 months projected sales.  Any inventories in excess of 12
months are deemed 100% obsolete and a corresponding charge for obsolescence is
recorded.  Obsolescence is calculated only on inventory for which the
Distributor is responsible on a title-by-title basis, which includes all
theatrical and direct-to-video titles.
 
 LONG-LIVED
ASSETS.
 Property and Equipment:Property and equipment purchases are recorded at cost and are depreciated
and amortized over the estimated useful lives of the assets (three to seven
years generally) using the straight-line method.
 
 The
Distributor periodically reviews and evaluates the recoverability of property
and equipment. In accordance with Statement of Financial Accounting Standards
(“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, if it is determined that the carrying amount of the assets exceeds the
fair value, a reduction in the carrying amount is recorded.
 
 Film Library:The
Distributor capitalizes the costs of production and acquisition of film
libraries. In accordance with Statement of Position (“SOP”) 00-2, “Accounting by
Producers or Distributors of Films” (“SOP 00-2”), the Distributor amortizes such
costs to cost of revenues, using the individual film forecast method over a
period of ten years or less.
 
 The Film
Library is stated at the lower of amortized cost or estimated fair value. 
The fair value of its film library is determined using management’s future
revenue and cost estimates, and the valuation of films is reviewed on a
title-by-title basis. In accordance with Statement of Financial Accounting
Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets”, when an event or change in circumstances indicates that the
fair value of its film is less than its unamortized cost, an impairment loss is
recognized by recording additional amortization in the amount by which the
unamortized costs exceed the estimated fair value of the film. Estimates of
future revenue involve measurement uncertainty and it is therefore possible that
reductions in the carrying value of film library may be required as a
consequence of changes in management’s future revenue estimates.
 
 F-42
 Goodwill and Other
Intangibles:  The Distributor has adopted the provisions of
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
Intangible Assets” (“SFAS No. 142”). Under SFAS No. 142, the Distributor is
required to test goodwill for impairment at least annually. The Distributor
evaluates the carrying value of goodwill as of December 31 of each year and
between annual evaluations if events occur or circumstances change that would
more likely than not reduce the fair value of the reporting unit below its
carrying amount. Such circumstances could include, but are not limited to:
(i) a significant adverse change in legal factors or in business climate,
(ii) unanticipated competition, or (iii) an adverse action or
assessment by a regulator. In performing the impairment review, the Distributor
determines the carrying amount of each reporting unit by assigning assets and
liabilities, including the existing goodwill, to those reporting units. A
reporting unit is defined as an operating segment or one level below an
operating segment (referred to as a component). A component of an operating
segment is deemed a reporting unit if the component constitutes a business for
which discrete financial information is available and segment management
regularly reviews the operating results of that component. The Distributor has
identified one reporting unit.  To evaluate whether goodwill is
impaired, the Distributor compares the fair value of the reporting unit to the
reporting unit’s net book value, including goodwill. The Distributor determines
the fair value of its reporting unit using the present value of its expected
future cash flows. If the net book value plus the value of outstanding debt of
the reporting unit exceeds its fair value, then the amount of the impairment
loss must be measured. The impairment loss would be calculated by comparing the
implied fair value of the reporting unit to its net book value plus the value of
debt outstanding. In calculating the implied fair value of the reporting unit’s
goodwill, the fair value of the reporting unit is allocated to all of the other
assets and liabilities of that unit based on their fair values. The excess of
the fair value of a reporting unit over the amount assigned to its other assets
and liabilities is the implied fair value of goodwill. An impairment loss would
be recognized when the carrying amount of goodwill exceeds its implied fair
value. The Distributor conducted an impairment review as of December 31,
2007. Based on the analysis performed the Distributor determined that the fair
value of its reporting unit’s goodwill exceeded its carrying amount, and,
therefore, there was no indication of an impairment loss.  The
Distributor also evaluates other intangible assets to determine whether such
assets have been impaired.  As a result of its 2007 review, the
Distributor recognized an impairment loss of $2.2 million with respect to its
distribution rights agreement assets.
 
 REVENUE
RECOGNITION.
 Revenue
from the sale or licensing of films is recognized upon meeting all recognition
requirements of SOP 00-2 and Staff Accounting Bulletin (“SAB”) No. 104 "Revenue
Recognition".  Revenues are recorded upon the receipt of goods by the
customer for titles that are available for consumer purchase.  Costs
of sales and an allowance for returns, rebates and discounts are recorded at the
time of revenue recognition.  Revenues from revenue sharing
arrangements are recognized as follows:   (i) in the case of by
title guarantees, when the product is available for consumer rental and (ii) in
the case of revenues derived from overages (i.e., revenue sharing arrangements
when the Distributor’s agreed-upon share of consumer rentals exceeds the
guarantee), one month after receipt.  Revenues from royalties are
recognized when received.  Revenues from licensing are recognized when
all required deliverables of a title are received and accepted by the
licensee.  Revenue for shipments of titles not available for consumer
purchase are deferred and only recognized when that title is available for
consumer purchase.  Cash payments received are recorded as deferred
revenue until all the conditions of revenue recognition have been
met.  Long-term, non-interest bearing receivables are discounted to
present value.
 
 ALLOWANCE
FOR SALES RETURNS, PRICE PROTECTION, CUSTOMER DISCOUNTS, CUSTOMER DEDUCTIONS AND
BAD DEBTS.
 The
Distributor has continued the accounting policies historically followed by the
Company with respect to allowances for sales returns, price protection, and the
aforementioned items.
 
 The
Distributor’s allowance for doubtful accounts and provision for sales returns
includes management's estimate of the amount expected to be uncollectible or
returned on specific accounts.  The Distributor provides for future
returns and price protection for releases of home video product at the time the
products are sold.  The Distributor calculates an estimate of future
returns of product by analyzing units shipped, units returned, and point of sale
data to ascertain consumer purchases and inventory remaining with retail to
establish anticipated returns.  Price protection is calculated on a
title-by-title basis.  The objective of price protection is to
mitigate returns by providing retailers with credits to ensure maximum consumer
sales.  Price protection is granted to retailers after they have
presented to the Distributor an affidavit of existing inventory.
 
 Other
factors are taken into consideration in the calculation of future returns such
as title genre, historical returns, projections of consumer demand, box office
and other research.  The Distributor allows for future returns on
non-theatrical titles by analyzing a combination of historical returns, point of
sale data and product seasonality.
 
 F-43
 The
Distributor provides for customer discounts based on arrangements entered into
on a customer-by-customer basis.  It sets aside reserves for bad debts
and customer deductions based on management’s estimate of the amounts expected
to be uncollectible on specific accounts.
 
 CONCENTRATIONS
OF CREDIT RISK.
 The
Distributor does not have long-term agreements with its customers, nor is it an
exclusive supplier to any of its retail customers.  If any customer
were to reduce or cancel a significant order, it would have a material adverse
effect on its business, results of operations and financial
condition.  For 2007, Wal-Mart and Blockbuster Entertainment accounted
for 34% and 20%, respectively, of the Distributor’s net revenues.  For
the period from July 22, 2006 through December 31, 2006, Wal-Mart accounted for
31% of the Distributor’s net revenues. At December 31, 2007, Wal-Mart and Target
comprised 36% and 12% of the Distributor’s accounts receivable after allowances,
respectively, while at December 31, 2006, Wal-Mart and Best Buy comprised 50%
and 7% of the Distributor’s accounts receivable after allowances,
respectively.
 
 Substantially
all of the Distributor’s revenues are derived from the distribution rights
accorded to the Distributor under its distribution agreements with TWC and other
key content suppliers.  Specifically, 67% of the Distributor’s net
revenue for fiscal 2007,  and 84% of the Distributor’s net revenue for
the period from July 22, 2006 through December 31, 2006 were derived from its
agreement with TWC.  The Distributor’s business, operational results
and financial condition depend principally on the success of the relationships
between it and these content suppliers.
 
 Financial
instruments that potentially subject the Distributor to concentration of credit
risk consist primarily of temporary cash investments and trade receivables. The
Distributor restricts investment of temporary cash investments to financial
institutions with investment grade credit ratings. The Distributor provides
credit in the normal course of business to customers located throughout the
United States. The Distributor performs ongoing credit evaluations of its
customers, generally does not require collateral and maintains allowances for
potential credit losses which, when realized, have been within the range of
management’s expectations.
 
 The
Distributor maintains cash and cash equivalents at several financial
institutions. From time to time the balances for these accounts exceed the
Federal Deposit Insurance Corporation’s (“FDICs”) insured
amount.  Balances on deposits at banks in the United States are
insured by the Federal Deposit Insurance Corporation up to $100,000 per
institution.  As of December 31, 2007, the uninsured portions of these
balances held at U.S. banks aggregated 19.6 million.
 
 ROYALTIES
AND PARTICIPATIONS
 
 The
Distributor’s royalty and distribution fee advances represent fixed minimum
payments made to program suppliers for exclusive content distribution rights. A
program supplier’s share of exclusive program distribution revenues is retained
by the Distributor until the share equals the advance(s) paid to the
program supplier. Thereafter, any excess is paid to the program supplier in
accordance with contractual terms.  The Distributor records as a cost
of sales an amount equal to the program supplier’s share of the net distribution
revenues.
 
 Participation
costs due to TWC are accrued in the proportion that current year’s revenue bears
to management’s estimate of ultimate revenue.  The Distributor
amortizes the participations to cost of revenues using the individual film
forecast method. Revenue and cost forecasts are continually reviewed by
management and revised when warranted by changing conditions.
 
 ADVERTISING
AND MARKETING COSTS.
 The
Distributor’s advertising expense comprises expenditures related to placement of
its products with retailers, advertising in trade and consumer publications,
product brochures and catalogs, booklets for sales promotion, radio and
television advertising and other promotional costs.  In accordance
with SOP 93-7, “Reporting on Advertising Costs”, the Distributor expenses
advertising costs in the period in which the advertisement first
airs.  For the year ended December 31, 2007, advertising and promotion
expense was $58.2 million and for the 163-day period ended December 31, 2006,
was $24.6 million.
 
 SHIPPING
EXPENSES.
 In
accordance with Emerging Issues Task Force (“EITF”) Issue 00-10, “Accounting for
Shipping and Handling Fees and Costs,” the Distributor classifies amounts
related to shipping as cost of revenue in the accompanying statements of
operations.
 
 F-44
 STOCK-BASED
COMPENSATION.
 The
Distributor records stock-based compensation expense associated with Company
stock options held by and subsequently granted to the Distributor’s employees
(the former employees of the Company before the TWC Transaction) in accordance
with Emerging Issues Task Force (‘EITF’) Issue No. 00-12, “Accounting by an
Investor for Stock-Based Compensation Granted to Employees of an Equity Method
Investee”, (“EITF 00-12”).  EITF 00-12 requires that the Distributor
recognize the costs of stock-based compensation incurred by an investor on its
behalf.
 
 RECLASSIFICATIONS
 Certain
reclassifications have been made to the 2006 consolidated financial statements
to conform to the 2007 presentation.
 
 INCOME
TAXES.
 The
Distributor is taxed as a partnership for Federal and state income tax
purposes.  As such, no provision for income taxes has been recorded
since the liability for such taxes is that of each of the individual members
rather than the Distributor. The Distributor's income tax returns are subject to
examination by the Federal and state taxing authorities, and changes, if any,
could adjust the individual income tax of the members.
 
 RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS.
 In
September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements” (“SAB No. 108”). SAB No. 108 provides guidance on the consideration
of the effects of prior year misstatements in quantifying current year
misstatements for the purpose of a materiality assessment. SAB No. 108
establishes an approach that requires quantification of financial statement
errors based on the effects on each of the Company’s balance sheets and
statement of operations financial statements and the related financial statement
disclosures. The SAB permits existing public companies to record the cumulative
effect of initially applying this approach in the first year ending after
November 15, 2006 by recording the necessary correcting adjustments to the
carrying values of assets and liabilities as of the beginning of that year with
the offsetting adjustment recorded to the opening balance of retained earnings.
Additionally, the use of the cumulative effect transition method requires
detailed disclosure of the nature and amount of each individual error being
corrected through the cumulative adjustment and how and when it arose. We have
determined that there is no impact from the adoption of SAB No. 108 on our
consolidated balance sheet, results of operations and cash
flows.
  In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“Statement”) No. 157, Fair Value Measurements(“FAS 157”). FAS 157 establishes a single authoritative
definition of fair value, sets out a framework for measuring fair value and
expands on required disclosures about fair value measurement. Certain provisions
of FAS 157 related to financial assets and liabilities as well as other
assets and liabilities carried at fair value on a recurring basis will become
effective for the Company on January 1, 2008. These provisions of
FAS 157 are not expected to have any impact on the Company’s consolidated
financial statements. The provisions of FAS 157 related to other
nonfinancial assets and liabilities will be effective on January 1, 2009,
and will be applied prospectively. The Company is currently evaluating the
impact the provisions of FAS 157 will have on the Company’s consolidated
financial statements as it relates to other nonfinancial assets and
liabilities.
 
 In
February 2007, the FASB issued Statement No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" ("FAS 159"), which permits
entities to elect to measure many financial instruments and certain other items
at fair value. Upon adoption of FAS 159, an entity may elect the fair value
option for eligible items that exist at the adoption date. An entity will report
unrealized gains and losses on items for which the fair value option has been
elected in earnings at each subsequent reporting date. The fair value option
(1) may be applied instrument by instrument, with a few exceptions such as
investments accounted for by the equity method, (2) is irrevocable (unless
a new election date occurs) and (3) is applied only to entire instruments
and not to portions of instruments. FAS 159 does not affect any existing
accounting literature that requires certain assets and liabilities to be
recorded at fair value nor does it eliminate disclosure requirements included in
other accounting standards. FAS 159 is effective as of January 1, 2008. We
are currently evaluating FAS 159; however, we do not believe it will have a
material impact on our consolidated financial condition or results of
operations.
  In
December 2007, the FASB issued Statement No. 160, "Non-controlling Interests in
Consolidated Financial Statements—an amendment of Accounting Research Bulletin
No. 51" ("FAS 160"). FAS 160 establishes accounting and reporting standards for
ownership interests in subsidiaries held by parties other than the parent, the
amount of consolidated net income attributable to the parent and to the
non-controlling interest, changes in a parent's ownership interest, and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated.  FAS 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the non-controlling owners. FAS 160 is effective for fiscal years
beginning after December 15, 2008.  We have not yet determined the
impact that FAS 160 will have on our consolidated financial
statements.
 
 F-45
  NOTE
3.   RESTATEMENT OF FINANCIAL STATEMENTS OF THE
DISTRIBUTOR
 
 During
meetings held on October 8, 2008 and November 13, 2008, the Audit Committee of
the Board of Directors of the Company, acting on a recommendation from the
Company’s management, determined that it was necessary to restate (i) the
Company’s unaudited consolidated financial statements and other financial
information as of and for the  three months  ended September 30,
2006, March 31, June 30 and September 30, 2007 and March 31 and June 30, 2008,
and (ii) the audited consolidated financial statements and other financial
information of the Company and the Distributor as of December 31, 2006 and 2007
and the periods then ended (See Note 3 of the Company’s financial statements for
the impact of these restatements thereon).
 
 The
aforementioned restatements to the Distributor’s financial statements relate to
an error in the application of generally accepted accounting principles with
respect to the accounting classification and measurement of certain redemption
rights of the holders of the Distributor’s Class W Units.
 
 The
Distributor’s prior accounting methodology with respect to the accounting
classification and measurement of the aforementioned redemption rights did not
properly classify and measure the Distributor’s Class W Units as redeemable
securities.  The Distributor has now recorded the cash redemption
value of the Class W Units outside of permanent equity in its financial
statements.  Subsequent changes to the cash redemption value of such
units has resulted in increase or decrease, as applicable, to the Redeemable
Class W Units amount, with a corresponding increase or decrease, as applicable,
in member’s deficit, which now consists of only the value of the Distributor’s
Class G Units.  As of July 21, 2006 (the issuance date of the
Distributor’s Class W Units), the value of the Redeemable Class W Units was
recorded at $277.6 million.
 
 The
Distributor also previously did not account for its right to receive shares of
the Company’s Common Stock upon the redemption of the aforementioned Class W
Units.  The Distributor has now recognized, as an asset, the fair
market value relating to its right to obtain shares of the Company’s Common
Stock to affect the Class W Unit redemption in the Distributor’s financial
statements as a Class W Purchased Call Option (included in deposits and
other).  As of July 21, 2006, this Class W Purchased Call Option was
valued at $3.8 million and is carried at cost within deposits and
other.  Any impairments of the Class W Purchased Call Option have been
reflected in the Distributor’s Statements of Operations (in other income
(expense)).
 
 As of
December 31, 2006, the cash redemption value of the Redeemable Class W Units
amount increased by $124.2 million, to $401.8 million (resulting in a deficit
balance in the Class G Units member’s equity of $300.1 million as of December
31, 2006), and as of December 31, 2007, the cash redemption value of the
Redeemable Class W Units amount decreased by $117.4 million, to $284.4 million
(resulting in a deficit balance in the Class G Units member’s equity of $205.6
million as of December 31, 2007).
 
 The
Distributor recorded an impairment of $1.1 million to the Class W Purchased Call
Option asset (included in deposits and other) as of December 31, 2007 (with a
corresponding increase to the Distributor’s other expense for the twelve months
ended December 31, 2007 of $1.1 million, as compared to December 31,
2006).
 The
cumulative impact of the above-described restatement adjustments on other income
(expense), net loss, Class W Purchased Call Option (included in deposits and
other), total assets, Redeemable Class W Units, and member’s equity (deficit) as
of and for the year ended December 31, 2007, and the period from July 22, 2006
through December 31, 2006, are as follows:
 Period
      from July 22, 2006 through(In
      thousands except per share amounts)
                          
                          Year
      Ended December 31, 2007
                          
                          
                          December
      31, 2006As
      Originally Reported
                          
                          
                          Restatement
                            Adjustments
                          
                          
                          As
      Restated
                          
                          
                          As
      Originally Reported
                          
                          Restatement
                            Adjustments
                          
                          
                          As
      RestatedOther
      income (expense)
                          
                          $
                          (1,748
                          )
                          
                          $
                          (1,134
                          )
                          
                          $
                          (2,882
                          )
                          
                          $
                          309
                          
                          
                          $
                          -
                          
                          
                          $
                          309Net
      loss
                          
                          
                          (17,698
                          )
                          
                          
                          (1,134
                          )
                          
                          
                          (18,832
                          )
                          
                          
                          (19,710
                          )
                          
                          
                          -
                          
                          
                          
                          (19,710
                          )Deposits
      and other
                          
                          
                          2,968
                          
                          
                          
                          2,649
                          
                          
                          
                          5,617
                          
                          
                          $
                          273
                          
                          
                          $
                          3,783
                          
                          
                          
                          4,056Total
      assets
                          
                          
                          300,455
                          
                          
                          
                          2,649
                          
                          
                          
                          303,104
                          
                          
                          
                          244,836
                          
                          
                          
                          3,783
                          
                          
                          
                          248,619Redeemable
      Class W Units
                          
                          
                          -
                          
                          
                          
                          284,378
                          
                          
                          
                          284,378
                          
                          
                          
                          -
                          
                          
                          
                          401,777
                          
                          
                          
                          401,777Member's
      equity (deficit)
                          
                          
                          76,157
                          
                          
                          
                          (281,729
                          )
                          
                          
                          (205,572
                          )
                          
                          
                          97,925
                          
                          
                          
                          (397,994
                          )
                          
                          
                          (300,069
                          )
 F-46
  NOTE
4. INVENTORY
  Inventories
consist of raw materials and finished goods and are valued at the lower of cost
or market.
  (In
      thousands)
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006Raw
      materials
                  
                  $
                  1,245
                  
                  
                  $
                  1,377Finished
      goods
                  
                  
                  23,294
                  
                  
                  
                  16,69924,539
                  
                  
                  
                  18,076Less
      allowance for obsolescence
                  
                  
                  (13,257
                  )
                  
                  
                  (10,487
                  )Inventories,
      net
                  
                  $
                  11,282
                  
                  
                  $
                  7,589
   NOTE
5. PROPERTY AND EQUIPMENT
  Property
and equipment purchases are recorded at cost and are depreciated and amortized
over the estimated useful lives of the assets (three to seven years generally)
using the straight-line method.
  (In
      thousands)
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006
                  
                  Useful
      livesComputers
      and equipment
                  
                  $
                  1,301
                  
                  
                  $
                  919
                  
                  3-5
      yearsFurniture
      and fixtures
                  
                  
                  107
                  
                  
                  
                  2
                  
                  3-7
      years1,408
                  
                  
                  
                  921Less
      accumulated depreciation and amortization
                  
                  
                  (455
                  )
                  
                  
                  (103
                  )Property
      and equipment, net
                  
                  $
                  953
                  
                  
                  $
                  818
  Depreciation
expense for the year ended December 31, 2007 and the 163 days ended December 31,
2006 was $0.3 million and $0.1 million, respectively.
 
 NOTE
6. ACCRUED EXPENSES
  The
components of other accrued expenses at December 31, 2007 and 2006 are as
follows:
  (In
      thousands)
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006Accrued
      operating expenses
                  
                  $
                  18,666
                  
                  
                  $
                  1,440Accrued
      payroll and related items
                  
                  
                  1,925
                  
                  
                  
                  1,042Accrued
      bonus
                  
                  
                  300
                  
                  
                  
                  696Due
      to related party
                  
                  
                  19
                  
                  
                  
                  117Total
      accrued expenses
                  
                  $
                  20,910
                  
                  
                  $
                  3,295
 
 F-47
 NOTE
7. FILM LIBRARY
  Following
are the components of the Distributor’s film library:
  Years
      Ended December 31,(In
      thousands)
                  
                  2007
                  
                  
                  2006Co-Productions
      - In process
                  
                  $
                  10,337
                  
                  
                  $
                  590Co-Productions
      - Released
                  
                  
                  2,588
                  
                  
                  
                  66Film
      Library
                  
                  
                  7,930
                  
                  
                  
                  7,930Gross
      Co-Productions and Film Library
                  
                  
                  20,855
                  
                  
                  
                  8,586Accumulated
      Amortization
                  
                  
                  (6,452
                  )
                  
                  
                  (484
                  )Total
      film library and co-productions
                  
                  $
                  14,403
                  
                  
                  $
                  8,102
  The
Distributor’s film library consists of the costs incurred related to third party
co-production arrangements and the Wellspring library.  The
Distributor expects to fully amortize its unamortized costs related to released
co-productions within two years.  The Distributor expects amortization
of its film library and in-release productions to be $0.6 million in
2008.  The Wellspring library, which  was acquired on March
21, 2005, is being amortized over a ten year period using the film forecast
method.  Based on the results of an impairment analysis completed by
the Distributor during the fourth quarter of 2007, it was determined that the
Wellspring library was impaired.  An impairment charge of $4.3 million
was recorded by the Distributor, resulting in a remaining unamortized balance of
$2.2 million as of December 31, 2007.
  NOTE
8.  CASTALIAN ACQUISITION
  On April
1, 2007, the Distributor acquired, from EMI North America, all of the membership
interest of (i) The Thirteen-Thirty-One LLC, the sole member of Castalian Music
L.L.C. (which, in turn, is the sole member of each of Abacus Media L.L.C. and
Marathon Media, LLC) and (ii) Castalian DC, LLC, a fully integrated direct
response TV marketing and fulfillment service for the music and video
entertainment industry, from EMI North America.  The Distributor paid
$3.7 million in cash, of which approximately $0.2 million represented
acquisition costs for legal, appraisal, and commission expenses.  The
transaction has been accounted for as a purchase in the second quarter of
2007.
  The
Distributor’s consolidated financial statements include the results of
operations for Castalian and its subsidiaries from the date of acquisition
through December 31, 2007.  Pro forma information is not presented
herein as the amounts are not significant to the results of the
Distributor.
  NOTE
9.  OTHER INTANGIBLE ASSETS
 
 Intangible
assets were recorded in connection with the TWC transaction and are amortized
over the estimated lives of the assets using the straight line
method.
  (In
      thousands)
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006
                  
                  Useful
      LivesCustomer
      relationships
                  
                  
                  8,125
                  
                  
                  
                  6,625
                  
                  2.5
      - 7.5 yearsDistribution
      agreements
                  
                  
                  11,309
                  
                  
                  
                  11,129
                  
                  1 -
      6 years19,434
                  
                  
                  
                  17,754Less
      related accumulated amortization
                  
                  
                  (7,838
                  )
                  
                  
                  (1,582
                  )Other
      intangible assets, net
                  
                  $
                  11,596
                  
                  
                  $
                  16,172
 Amortization
expense for the year ended December 31, 2007 was $6.3 million and  for
the 163 days ended December 31, 2006 was $3.4 million.  Other intangible
assets recorded in connection with the TWC Transaction amounting to $1.8 million
were fully amortized as of December 31, 2006.
  F-48
 Expected
amortization expense for intangible assets on our December 31, 2007
consolidated balance sheet for each of the next five years is as
follows:
  (In
      thousands)2008
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2011
                  
                  
                  2012
                  
                  
                  ThereafterCustomer
      relationships
                  
                  
                  1,483
                  
                  
                  
                  1,333
                  
                  
                  
                  883
                  
                  
                  
                  883
                  
                  
                  
                  883
                  
                  
                  
                  1,019Distribution
      agreements
                  
                  
                  1,916
                  
                  
                  
                  1,372
                  
                  
                  
                  1,125
                  
                  
                  
                  699
                  
                  
                  
                  0
                  
                  
                  
                  0
  NOTE
10.  SEVERANCE
 
 In 2007 the Distributor reorganized its
sales organization, which included downsizing its Wellspring, New York sales
office and  closing its Del Mar office.  As a result of these
actions, the Distributor incurred severance payments in the amount of $0.4
million for 11 employees.  These actions were substantially completed
by December 31, 2007, except for the final severance payments accrued but not
yet paid to four employees of the New York office.
 
 NOTE
11. COMMITMENTS AND CONTINGENCIES
  The
Distributor leases certain facilities and computer equipment under
non-cancelable operating leases described below.
 
 FACILITY
LEASES.
 On
December 31, 2007, the Distributor entered into a lease agreement (the “New
Maguire Lease”) with Maguire Properties – 3301 Exposition, LLC (“Maguire LLC”),
pursuant to which the Distributor will rent approximately 40,520 square feet of
office space in Santa Monica, California.  When complete, this
facility will be the consolidated home office of the Company and the Distributor
housing all employees currently located at the Company’s and the Distributor’s
Santa Monica offices.
 
 The
initial term of the New Maguire Lease is ten (10) years, commencing five (5)
months after the completion of certain tenant improvements to be constructed by
Maguire LLC (the “Occupancy Date”), which Occupancy Date is currently projected
to be in July, 2008.  The Distributor has an option to extend the term
of the New Maguire Lease for two (2) additional five (5) year terms, subject to
the satisfaction of certain conditions specified in the New Maguire
Lease.
 
 As
security for its obligations under the New Maguire Lease, the Distributor has
delivered to Maguire LLC an irrevocable letter of credit in the amount of $1.5
million.  The aforementioned tenant improvements are being constructed
at Maguire LLC’s expense in accordance with an agreed upon space plan and
subject to certain conditions specified in the New Maguire Lease.
 
 Also on
December 31, 2007, the Distributor and Maguire Properties, L.P. (“Maguire LP”)
amended the lease agreement, dated January 23, 2007 (the “Old Maguire
Lease”),  under which the Distributor currently rents approximately
14,000 square feet of office space located in Santa Monica,
California.  Under the amendment to the Old Maguire Lease, Maguire
L.P. agreed to waive the Distributor’s monthly rent for a period commencing on
January 1, 2008 through the Occupancy Date under the New Maguire
Lease.  The Distributor has the right to terminate the Old Maguire
Lease at any time upon five (5) business days’ prior written
notice.  The Distributor’s accounting and finance departments are
currently housed in this office space.
 
 On
October 12, 2007, Castalian, LLC, a wholly owned subsidiary of the Distributor
(“Castalian”), entered into a lease agreement with 2800 OBI, LP, (the “Castalian
landlord”) under which Castalian rents approximately 6,465 square feet of office
space in Santa Monica, California.  This lease has a three (3) year
term commencing on November 23, 2007.   Castalian also has the
option to extend the lease for an additional three (3) year term upon the
expiration of the initial term.
 
 On
January 5, 2007, the Distributor entered into a sublease agreement with The
Advantage Network, LLC, under which the Distributor subleased to The Advantage
Network, LLC its leasehold interest in a 5,603 square foot facility located in
Solana Beach, California.  This sublease is for a term commencing
February 1, 2007 and ending December 31, 2008.   Until March
2006, we used this facility as our principal executive offices pursuant to a
sublease agreement entered into in November 2003.  The November 2003
sublease is for a five-year term which commenced in January 2004, and was
assigned to the Distributor as part of the TWC Transaction.
 
 F-49
 On March
18, 2006, we entered into a lease agreement for a 17,400 square foot facility
located in Santa Monica, California.  This lease was assigned to the
Distributor as part of the TWC Transaction.  This facility has been
used as our, and the Distributor’s, principal executive offices.  This
lease is for a five-year term which commenced in March 2006.  On
January 5, 2007, the Distributor entered into a sublease agreement with The
Advantage Network, LLC, under which the Distributor subleased to The Advantage
Network, LLC its leasehold interest in a 5,603 square foot facility located in
Solana Beach, California.  This sublease is for a term commencing
February 1, 2007 and ending December 31, 2008.
 
 On March
22, 2005, as part of the acquisition of American Vantage Media Corporation and
Wellspring Media, Inc., we assumed office space in New York and Santa Monica on
a month-to-month basis.  Effective as of April 30, 2006, we terminated
our lease for the Santa Monica space .  Effective as of the Closing
Date of the TWC Transaction, the Distributor assumed all of our rights and
obligations under the New York lease.
 
 On
October 15, 2004, we entered into a sublease agreement for a 1,670 square foot
facility located in Bentonville, Arkansas.  This sublease has a term
of five (5) years and expires in October 2009.  This sublease was
assigned to the Distributor as part of the TWC Transaction.
 
 CREDIT
FACILITY.
 On August
10, 2007, the Distributor entered into a three-year, senior secured revolving
credit facility (the “Credit Agreement”) with Société Générale (‘‘Soc Gen’’), as
lender and agent. The Credit Agreement provides for an initial commitment of $30
million and up to a total of $70 million.  On November 1, 2007, the
Distributor, Soc Gen and Alliance Leister entered into the Amended and Restated
Credit Agreement (the “Amended Credit Agreement”), which increased the total
commitment to $50 million, based on expected incremental commitments. Borrowings
under the Amended Credit Agreement are based upon a borrowing base that includes
certain of the Distributor’s accounts receivable from licensors other than TWC
and certain of the Distributor’s film rights. The Amended Credit Agreement
terminates on June 30, 2010, and may be extended to August 10, 2010, under
satisfaction of certain conditions. Voluntary prepayments and commitment
reductions are permitted at any time upon proper notice.  Borrowings
under the Amended Credit Agreement are based on LIBOR or the higher of Soc Gen’s
prime rate or the Federal Funds Rate plus 0.50% and vary depending on the
percentage of loans outstanding. The interest rate varies from 2.5% to 3.0%
above LIBOR for Eurocurrency loans and 1.5% to 2.5% above the prime rate or
Federal Funds Rate plus 0.50% for base rate loans. Quarterly commitment fees of
0.50% are due on the unused portion of the commitment.  The Amended
Credit Agreement contains operating covenants customary for facilities of this
type, including, among other things, (i) limitations on indebtedness, liens,
sales of assets, mergers, investments, dividends and redemptions, and (ii)
minimum liquidity and borrowing base coverage requirements. In the event of a
default, the interest rate on all borrowings will be increased and payment of
all borrowings may be accelerated and/or the commitments may be
terminated.  Upon the occurrence of certain events of default, all
amounts payable under the Amended Credit Agreement automatically become
immediately due and payable and the lenders’ commitments will automatically
terminate.  Borrowings outstanding under the Amended Credit Agreement
were $31 million at December 31, 2007. The maximum amount available at December
31, 2007 was $32.8 million.  The obligations of the Distributor under
the Amended Credit Agreement are guaranteed by the Company and the direct and
indirect subsidiaries of the Distributor.  Soc Gen holds a security
interest in substantially all personal property of the Company, the Distributor,
and its direct and indirect subsidiaries, other than TWC accounts receivable.
TWC continues to have a first priority security interest in accounts receivable
attributable to TWC content.
 
 Pursuant
to the Amended Credit Agreement, the Distributor is required, on a quarterly
basis, to provide Soc Gen with a certificate (a “Compliance Certificate”)
evidencing the Distributor’s compliance with the covenants included in the
Amended Credit Agreement.  In preparing such Compliance Certificate,
the Distributor performs an analysis of all debt covenants included in the
Amended Credit Agreement in order to ensure that the Distributor is operating
within the terms thereof.  Such an analysis was performed for the
fiscal quarter ending December 31, 2007.  Based on such analysis, the
Distributor determined that as of December 31, 2007, the Distributor was in
compliance with all such debt covenants.
 
 As part
of the Amended Credit Agreement, the following agreements, among others, were
also entered into by the Distributor and Soc Gen: (i) Amendment No. 1 to
Allocation of Accounts Receivable and Intercreditor Agreement; and (ii)
Reaffirmation of Guaranty Agreement (see Item 15:  exhibits
10.77-10.80 and 10.82-10.84).  At December 31, 2007 the Distributor
had $31.0 million outstanding under the Credit
Agreement.
 
 The
Distributor incurred $1.9 million in financing costs related to securing the
Credit Facility with Soc Gen.  Deferred financing costs are being
amortized over the term of the arrangement.  The Distributor recorded
$0.2 million in interest expense related to deferred financing costs during the
year ended December 31, 2007.
 
 LITIGATION.
 The
Distributor is not a party to any legal or administrative proceedings, other
than routine litigation incidental to the Distributor’s business that we do not
believe, individually or in the aggregate, would not be likely to have a
material adverse effect on the Distributor’s financial condition or results of
operations.
 
 F-50
 EMPLOYMENT
AGREEMENTS.
 As of
December 31, 2007, the Distributor was a party to employment agreements with
Trevor Drinkwater, the Company’s President and Chief Executive Officer, and John
Mueller, the Company’s Executive Vice President and Chief Financial
Officer.
 
 Mr.
Drinkwater’s employment agreement was originally entered into on July 26, 2005,
and was amended on December 5, 2005 and July 20, 2006.  The term of
Mr. Drinkwater’s agreement will expire on December 5, 2008, with a Company
option to extend the term for an additional two year term.  Mr.
Drinkwater’s base salary under his employment agreement is $0.4 million
annually, subject to annual review by the Company’s Compensation
Committee.  Pursuant to Mr. Drinkwater’s employment agreement, Mr.
Drinkwater has been granted fair market value options to acquire an aggregate of
2,100,000 shares of the Company’s common stock.
 
 Mr.
Mueller’s employment agreement was entered into on March 10, 2006 and expired on
March 10, 2008.  Mr. Mueller’s agreement provides for an annual base
pay beginning at $0.2 million and increasing by $25,000 annually through the end
of the term.  Additionally, Mr. Mueller is guaranteed an annual bonus
of $150,000, and the Company has the discretion to pay him an additional bonus
if it is warranted.  The agreement also contained a grant of fair
market value options to acquire 750,000 shares of our stock.
 
 FUTURE MINIMUM CONTRACTUAL OBLIGATIONS.
 
 As of
December 31, 2007, future minimum annual commitments are as
follows:
  ($
      in thousands)2008
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2011
                    
                    
                    2012
                    
                    
                    Thereafter
                    
                    
                    TotalRoyalty
      advances
                    
                    $
                    31,209
                    
                    
                    $
                    13,285
                    
                    
                    $
                    5,250
                    
                    
                    $
                    5,500
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    55,244Operating
      Lease Obligations
                    
                    
                    1,311
                    
                    
                    
                    3,085
                    
                    
                    
                    3,148
                    
                    
                    
                    2,370
                    
                    
                    
                    2,305
                    
                    
                    
                    15,648
                    
                    
                    
                    27,867Long-Term
      Debt Obligation
                    
                    
                    313
                    
                    
                    
                    313
                    
                    
                    
                    314
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    940Purchase
      Obligations
                    
                    
                    353
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    353Capital
      Lease Obligations
                    
                    
                    30
                    
                    
                    
                    30
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    60Total
                    
                    $
                    33,216
                    
                    
                    $
                    16,713
                    
                    
                    $
                    8,712
                    
                    
                    $
                    7,870
                    
                    
                    $
                    2,305
                    
                    
                    $
                    15,648
                    
                    
                    $
                    84,464
 
 NOTE
12.  RELATED PARTY TRANSACTIONS
 
 The
Distributor accounts for all related party transactions under SFAS No. 57,
“Related Party Disclosures”. The statement provides guidance on disclosures of
transactions between related parties, including transactions between affiliates
and principal owners. Disclosures must include:  (i) the nature of the
relationship involved (ii) a description of the transaction (iii) the dollar
amount of the transaction and (iv) amounts due to and from related
parties.  The statement also requires an assessment of the transaction
to ensure that they have been carried out on an arms-length basis.
 
 SERVICES
AGREEMENT.
 The
Distributor provides certain services and pays certain direct costs, including
filing fees, registration fees and audit fees, on behalf of the Company
according to the terms of a services agreement between the Distributor and the
Company and entered into in connection with the TWC Transaction.  The
Distributor incurred a total of $4.8 million in corporate operating and payroll
related expenses on behalf of the Company during the year ended December 31,
2007 and incurred a total of $1.3 million during the 163-day period ended
December 31, 2006.  Such amounts were reflected as a distribution to
members in the accompanying financial statements.
 
 TWC
DISTRIBUTION AGREEMENT
 On July
17, 2006, the Distributor entered into a distribution agreement with TWC (the
“TWC Distribution Agreement”), an affiliate of TWC Holdings and W-G Holding
Corp., holders of our Series W Preferred Stock.  Pursuant to the TWC
Distribution Agreement, TWC granted to the Distributor the right to distribute,
advertise, publicize, promote and market DVDs of motion pictures owned or
released by TWC for an initial term of approximately five years, subject to
early termination provisions described in the TWC Distribution
Agreement.  Under the TWC Distribution Agreement, after deducting
permitted amounts from gross receipts for return reserves, the Distributor’s
distribution fee and the Distributor’s reimbursable expenses, the Distributor is
required to pay to TWC a portion of the net receipts from the sale of any such
DVDs.  For the year ended December 31, 2007, the Distributor incurred
$170.4 million of expenses related to TWC. For the year ended December 31, 2006,
the Distributor incurred $70.0 million of expenses related to TWC participation
fees.
 
 F-51
 On August
10, 2007, in connection with the Credit Agreement, the Distributor entered into
a letter agreement  with TWC (the “TWC Letter”) under which the
Distributor and TWC agreed to schedule payments owing to TWC by the
Distributor under the TWC Distribution Agreement.  In the TWC Letter,
TWC also agreed to waive any remedies it may have attributable to past
non-timely payments and reporting under the TWC Distribution Agreement on or
prior to August 10, 2007.
 
 On March
4, 2008, the Distributor and TWC entered into a letter agreement memorializing
certain amendments to the TWC Distribution Agreement and the interim
distribution agreement under which the Company and TWC operated prior to the
closing of the TWC Transaction, previously agreed upon by the Distributor and
TWC in 2007.  Pursuant to such letter agreement,  effective
as of March 21 , 2006, (i) the definition of a “Direct-to-Video” title under the
TWC Distribution Agreement (and the interim distribution agreement) was revised
to mean any title that (a) was not released theatrically prior to its initial
home video release date or (b) was released theatrically prior to its home video
release, but earned U.S. theatrical box office revenue prior to its initial home
video release date of less than $0.5 million; and  (ii) TWC agreed to
absorb the cost of returns processing for all TWC titles distributed under the
TWC Distribution Agreement (and the interim distribution
agreement).  The effect of these changes was a benefit to the
Distributor, respectively, of $0.8 million to cost of revenue in 2007 and $2.9
million in 2007 (TWC revenue and cost of sales are recognized upon meeting all
recognition requirements of SOP 00-2; the full benefit of the change described
in subsection (ii) above was $4.6 million and, therefore, a further $1.7 million
will be recognized in future periods).  In addition, in the letter
agreement TWC acknowledged that, based on the Distributor’s satisfaction of
certain terms relating to the “annual video ratio” under the TWC Distribution
Agreement, the Distributor’s distribution fee for the period from January 1,
2007 through December 31, 2007 should be increased from 5% to 6%.  The
effect of this clarification was a benefit of $2.9 million to the Distributor’s
cost of sales for fiscal 2007.
  The
payment terms with TWC are due 45 days from the last day in the calendar
month.  As needed, these terms are extended anywhere from 15 to 45 days in
order to provide flexibility and manage cash flows.  The Distributor
expects TWC to continue to provide such flexibility through at least December
31, 2008.
  BANNON
CONSULTING AGREEMENT.
 As part
of the TWC transaction, the Distributor was assigned the Bannon Consulting
Agreement as of July 21, 2006.  On January 2, 2007, the Distributor
paid to Bannon Strategic Advisors a bonus of $0.2 million for services rendered
in 2006, and an additional bonus of $0.03 million on March 13,
2007.  These bonuses were approved by the compensation committee of
the Company’s Board of Directors. For the periods ended December 31, 2006
and 2007, the Distributor recorded $0.2 million and $0.3 million, respectively
for consulting fees and $0.2 million and $0.2 million for expense
reimbursements.
  
 
 NOTE
13. NOTES PAYABLE TO RELATED PARTY (RELATED PARTY LOANS)
 
 On
September 27, 2007, the Distributor borrowed $6.0 million from the Company and
issued a promissory note in favor of the Company in the principal amount of $6.0
million.  On November 1, 2007, the Distributor borrowed an additional
$2.0 million from the Company and issued a promissory note in favor of the
Company in the principal amount of $2.0 million.  Under each of the
aforementioned notes, interest is due on the unpaid principal balance at a
monthly rate equal to the LIBOR Rate (as defined in the notes) plus five percent
(5%) until paid.  The principal and accrued interest under the
notes were originally due and payable on demand at any time after March 31,
2008. On March 16, 2008, the Company's Board of Directors approved amendments to
each of (i) that certain promissory note, dated September 27, 2007, by the
Distributor in favor of the Company; in the principal amount of $6 million and
(ii) that certain promissory note, dated November 1, 2007, by the Distributor in
favor of the Company in the principal amount of $2 million, pursuant
to which principal amount of $2 million, pursuant to which principal
and accrued interest under the notes would be due and payable on demand at any
time after January 1, 2009.  In the event payment of principal or
interest due under the notes is not made when due, the outstanding principal
balance will bear interest at the rate of two percent (2%) above the interest
rate which is otherwise provided under the notes for so long as such event
continues. If the notes are not paid when due, the Distributor agreed to pay the
Company’s reasonable costs of collection, including, without limitation, all
reasonable attorneys’ fees and all reasonable expenses actually incurred by the
Company in connection with such collection efforts.  The principal
amount of the notes may be prepaid in whole or in part, provided that all
accrued interest on the amount to be prepaid is also paid at such
time.  The proceeds from the notes were used to pay amounts owed by
the Distributor to TWC under the TWC Distribution Agreement.  As of
December 31, 2007, an aggregate of $8.2 million in principal and accrued
interest expense was outstanding under the notes.
  F-52
 
 NOTE
14. REMITTANCE DUE TO LICENSOR AND DEFERRED
REVENUE
  The
Distributor records as net revenues the amount it receives from sales of TWC and
the licensor’s home video products (net of reserves and allowances), deducts its
distribution fee, costs of goods sold (including manufacturing expenses) and
certain marketing expenses, and remits the balance to TWC and the other
licensors.   The remittance to licensors at December 31, 2007
primarily related to amounts owed to TWC from sales of TWC's titles, of which
the top 5 were: 1408,
Halloween, Death Proof, Planet TerrorandThe Nanny
Diaries. The remittance to licensors at December 31, 2006
primarily related to amounts owed to TWC from sales of TWC's titles,Scary Movie, Lucky Number Slevin,
Feast, Clerks 2andPulse that were released on DVD during the period from July 22, 2006
through December 31, 2006.  The payment terms with TWC are due 45 days from
the last day in the calendar month.
 
 At
December 31, 2007, the Distributor reported $8.5 million in deferred revenue,
comprised of:  (i) $5.3 million associated  with shipments
at the end of the fourth quarter that consisted of titles not available for
consumers’ purchase; (ii) $1.8 million associated with outstanding advances from
Columbia House that have not been recouped; and (iii) $1.4 million of
outstanding advances from EMI for consignment sales.  The major titles
comprising this deferred revenue were The Hunting
PartyandSolstice.As of December 31,
2006, the Distributor reported $5.0 million of deferred revenue, comprised of
The Protector and Seven
Swords.
 
 NOTE
15.  STOCK-BASED COMPENSATION
 
 Subsequent
to the Closing Date of the TWC Transaction, stock-based compensation expense
associated with the former employees of the Company, who became employees of the
Distributor as of the Closing Date, are recorded by the
Distributor.
 
 During
2007 and 2006, the Distributor estimated the fair value of the service-based
stock options issued to its employees by the Company using the Black-Scholes
Merton formula as our closed-form valuation option pricing model (the “Option
Model”). The Option Model requires the use of subjective and complex
assumptions, per the requirements of FAS123R, that include: (i) the option's
expected term, (ii) the estimated future price volatility of the underlying
stock, (iii) the risk-free interest rate, (iv) the dividend yield and (v)
expected forfeiture.
 
 Historical
volatility should be measured over a period commensurate with the expected term
of the option (for the Company, between 5.25 and 6.25 years).  Due to
the restructuring of the Company as of July 21, 2006, using the historical
volatility percentage of its stock as the Option Model’s expected volatility
assumption was no longer valid.  The Distributor, therefore, changed
from using an historical volatility percentage based on traded options on its
own stock to an historical volatility percentage based on peer or guidance
companies in its industry, the home video distribution market.  This
volatility change was confirmed by a third-party compensation consulting firm
and is in accordance with the guidance provided in SFAS No. 123R and SAB 107
“Share-Based Payment”.
 
 As a
result of the change in corporate structure, expected term could not be
accurately calculated based on historical experience.  Therefore, the
estimate of expected term in 2007 and 2006 for the service-based stock options
was calculated using the “shortcut method” as described in SEC Staff Accounting
Bulletin 107; i.e., expected term = ((vesting term + original contractual
term)/2) or based on the weighted average period of time that options granted
are expected to be outstanding considering current vesting
schedules.  The Distributor could use this short-cut method through
December 31, 2007 because it met all of the required criteria:  (i)
the stock options are granted “at-the-money”; (ii) exercisability is conditional
only on performing service through the vesting date; (iii) if an employee
terminates service prior to vesting, the employee would forfeit the share
options; (iv) if an employee terminates service after vesting, the employee
would have a limited time to exercise the share options (typically 30-90 days);
and (v) the stock options are non-transferable and non-hedgeable.  The
Distributor’s expected term varies from approximately 5.25 to 6.25
years.  During each quarter in 2007, the Distributor calculated
volatility for each expected “tranche” of stock options in increments of 0.25
years, utilizing the average volatility calculations of peer
companies.
 
 F-53
 As the
Distributor is using a closed-form valuation option pricing model for these
service-based stock options, the risk-free interest rate used in the Option
Model is based on the yield of U.S. Treasury zero-coupon issues, with maturities
closest to the expected term of our stock options.  The Distributor
has not and does not expect to grant dividends.  Hence, the dividend
yield is 0%.
 
 For
forfeiture rate, the Distributor rejected historical calculations due to the
limited amount of accurate historical data.  In 2007 it used the most
conservative estimate of 0% forfeiture.
 
 The
Company granted market-based options to an employee of the Distributor to
purchase 400,000 shares that do not vest until attaining Company stock price
targets respectively of $4.00, $6.00, and $8.00.  For this grant, the
Distributor utilizes the Monte Carlo Simulation as the stock option model to
provide the most accurate fair value estimate due to the path dependency of the
options valued under the provisions of this grant.  Monte Carlo
Simulation is a lattice model, which - unlike the closed-form model –
can  incorporate a range of expected volatilities.  Monte
Carlo Simulation is a generally accepted and widely practiced technique used
here to simulate future stock movements in order to determine the fair value of
these option grants.  The option fair values are calculated by
simulating, within a risk-neutral framework, many future stock price
paths.   At each measurement period, the projected stock price is
compared to the predefined vesting hurdles to determine if the instrument vests.
Since the Distributor does not have historical exercise experience of
instruments with market conditions, the Distributor has not applied exercise
behavior similar to the service based options. Instead, the Distributor has
assumed that exercise of vested options occurs uniformly on the interval of the
vesting date to the options full contractual term of 10 years.
 
 This
valuation was performed on a multi-tranche basis considering three vesting
tranches and the weighted average volatility for these grants is calculated to
be 49.4%.
 
 The
risk-free rates have been determined based upon the interest rates for
zero-coupon U.S. Treasury bonds as of December 31, 2007.  A yield
curve has been determined based upon interpolating between the rates ranging
from 3.45% to 4.96%.
 
 Total
stock-based compensation expense recognized for the market-based options under
the Monte Carlo Simulation for the periods ended December 31, 2007 and 2006 was
approximately $0.03 million and $0.2 million, respectively. Stock-based
compensation expense recognized for the service-based options using the
Black-Scholes Merton formula for the years ended December 31, 2007 and 2006 was
approximately $0.7 million and $0.7 million.  For the years ended
December 31, 2007 and 2006, no income tax benefit was recognized in the
statement of operations for share-based compensation arrangements.
 
 For the
service-based stock options, the Distributor estimated share-based compensation
expense for the year ended December 31, 2007 and the 163 day period ended
December 31, 2006 using the Black-Scholes-Merton formula with the following
weighted average assumptions:
 
 2007
                        
                        
                        2006Risk
      free interest rate
                        
                        
                        4.3
                        %
                        
                        
                        
                        4.0
                        %Expected
      dividend yield
                        
                        
                        -
                        
                        
                        
                        
                        -Expected
      volatility
                        
                        
                        49.4
                        %
                        
                        
                        
                        145.9
                        %Expected
      life (in years)
                        
                        
                        6.0
                        
                        
                        
                        
                        5.3
 
 NOTE
16.  MEMBER’S DEFICIT AND REDEEMABLE CLASS W UNITS
 
 UNITS OF
THE DISTRIBUTOR.
 There are
61,005,126 Class G Units and 142,345,294 Class W Units of the Distributor issued
and outstanding. The terms and conditions of the Class G Units and Class W Units
are governed by the Amended and Restated Limited Liability Company Agreement of
the Distributor dated July 21, 2006, as amended (the “Distributor LLC
Agreement”).
 
 F-54
 Under the
Distributor LLC Agreement, the Company is obligated to contribute to the
Distributor, as an additional capital contribution (or loan to the Distributor
in the case of debt), the net proceeds received from any issuances by the
Company of stock or securities convertible into or exchangeable for common
stock, or upon the exercise, conversion or exchange of any convertible
securities, or the sale of its property, incurrence of indebtedness,
recapitalization or refinancing, or from any other capital raising
transaction.  However, the consideration received by the Company from
the exercise of options, warrants or other convertible securities issued and
outstanding as of July 21, 2006 (or any property acquired solely with such
consideration) is not required to be contributed to the
Distributor.
 
 Under the
Distributor LLC Agreement, no holder of Class G Units or Class W Units will be
entitled to demand or receive a return of any capital contributions or otherwise
withdraw from the Distributor without the consent of all members.
 
 Under the
Distributor LLC Agreement, if either the Distributor, TWC Holdings or certain
affiliates of TWC Holdings pays, discharges or otherwise satisfies or assumes
any liability or obligation for which it is entitled to indemnification from the
Company pursuant to the Master Contribution Agreement dated December 5, 2005, as
amended, the Distributor will redeem from the Company (without any further
payment to the Company) a number of Class G Units, and issue to the holders of
Class W Units (without any further payment by such holders) a number of
additional Class W Units based on a formula set forth in the Distributor LLC
Agreement (an “Indemnification Issuance”).
 
 REPURCHASE
OF CLASS W UNITS.
 Under the
Distributor LLC Agreement, if, at any time prior to December 31,
2009:
 
 (i) TWC
terminates the Distribution Agreement between TWC and the Distributor (the “TWC
Distribution Agreement”) because the “Annual Video Ratio” is less than 60% or
the “Semi-Annual Video Ratio” is less than 60% (as such terms are defined in the
TWC Distribution Agreement) and the Annual Video Ratio or Semi-Annual Video
Ratio, as applicable, giving rise to such termination is more than 50%, (as
calculated pursuant to the terms of the TWC Distribution
Agreement).  TWC must exercise this right within 90 days following the
calculation of the Annual or Semi-Annual Video Ratio, after which time it
forfeits the right to terminate the Agreement until the next measurement period
(refer to TWC Distribution Agreement); or
 
 (ii) TWC
enters bankruptcy and does not (i) continue to substantially perform its
obligations under the TWC Distribution Agreement, or (ii) provide for TWC’s
obligations being assumed under the TWC Distribution Agreement by or through a
successor, affiliate or other person; then, in either such case, the Distributor
may repurchase from TWC Holdings and its first-tier subsidiary, W-G Holding
Corp., a portion of the Class W Units owned by them as provided in the table
below. The purchase price to be paid will be an amount equal to 75% of the cash
amount that TWC Holdings and W-G Holding Corp. would receive upon redemption of
tendered units as described below under “Redemption Rights of Class W Units”,
where the number of tendered units is equal to the number of Class W Units to be
repurchased. The portion of Class W Units subject to the repurchase right during
any calendar year will be determined as follows:
 
 Year
      of Term
                Portion
      of Units
                  Subject
      to Repurchase1/1/06
      - 12/31/06
                60%1/1/07
      - 12/31/07
                30%1/1/08
      - 12/31/08
                20%1/1/09
      - 12/31/09
                10%
  If at any
time prior to December 31, 2009, TWC terminates the TWC Distribution Agreement
for the reasons described above and the Annual Video Ratio or Semi-Annual Video
Ratio, as applicable, giving rise to such termination is less than 50% (as
calculated pursuant to the terms of the TWC Distribution Agreement), then the
Distributor will have no right to repurchase any portion of the Class W Units
then held by TWC Holdings or W-G Holding Corp.
 
 F-55
 REDEMPTION
RIGHTS OF CLASS W UNITS.
 The
Distributor is owned 70% by TWC Holdings, Weinstein GP Holdings LLC and W-G
Holding (collectively, the “TWC Parties”) and 30% by the Company.  The
Company’s 30% membership interest in the Distributor consists of the
Distributor’s Class G Units.  The 70% interest in the Distributor held
by the TWC Parties consists of Class W Units.   Pursuant to the
Distributor LLC Agreement, at any time after July 21, 2007, the TWC Parties have
the option to redeem all or a portion of their Class W Units for either (i)
shares of the Company’s common stock or, (ii) at the option of the Distributor
(and with the consent of the TWC Parties), cash.  In order to exercise
such redemption right, the TWC Parties must provide to the Distributor and the
Company written notice of redemption (“Notice of Redemption”), specifying the
number of Class W Units being tendered for redemption.
 
 Upon
receipt of a Notice of Redemption, the number of Company common shares issuable
to the TWC Parties is determined by multiplying (i) the number Class W Units
being redeemed, by (ii) a fraction, the numerator of which is the number of
outstanding Company common shares as of the date of the Notice of Redemption,
and the denominator of which is the number of outstanding Company common shares
as of July 21, 2006 (the intent of this adjustment factor being that the TWC
Parties would receive no less than 70% of the Company’s common stock upon
redemption of all of the Class W Units).  Notwithstanding the
above-described computation, in the event that the trading price of the
Company’s common stock is less than $0.42 as of the date of the Notice of
Redemption, the number of common shares issuable to the TWC Parties is
determined by dividing (i) $60 million dollars, by (ii) the trading price of the
Company’s common stock as of the date of the Notice of Redemption (such
calculation being referred to as the “Floor Calculation”).  In other
words, if on the date of the Notice of Redemption the trading price of the
Company’s common stock is less than $0.42, then the TWC Parties would be
entitled to receive either cash or shares of the Company’s common stock with a
value of no less than the Floor Amount of $60 million.
 
 In lieu
of delivering Company common shares to the TWC Parties, the Distributor (with
the consent of the TWC Parties) may elect to pay to the TWC Parties a cash
amount equivalent to the value of the common shares otherwise issuable upon
delivery of a Notice of Redemption.  Any such election would be made
by the Board of Directors of the Company, in its capacity as managing member of
the Distributor, which consists of five members elected by the TWC
Parties.
 
 All Class
W Units redeemed by the Distributor would be transferred to the Company and
converted into Class G units.
 The
Distributor accounts for the Class W Units in accordance with Emerging Issues
Task Force (“EITF”) Topic No. D-98, “Classification and Measurement of
Redeemable Securities” (“EITF D-98”) because the TWC Parties’ exercise of these
redemption rights is outside the control of the Distributor.  As of
July 21, 2006 (the issuance date of the Distributor’s Redeemable Class W Units),
the value of the Redeemable Class W Units was recorded at $277.6
million.  Accordingly, the Distributor has determined the cash
redemption value of the Redeemable Class W Units as of December 31, 2007 and
2006  by multiplying (i) the number of shares of the Company’s common
stock that would be issuable to the TWC Parties upon a redemption for shares
(157,987,886 shares and 147,712,122 shares, respectively), by (ii) the fair
market value of one share of Company common stock as of December 31, 2007 and
2006 ($1.80 and $2.72, respectively).  As of December 31, 2007 and
2006, the cash redemption value of the Redeemable Class W Units was $284.4
million and $401.8 million , respectively.
 
 F-56
 LIMITATION
ON AUTHORITY OF MANAGING MEMBER.
 The
Company is the managing member of the Distributor. However, the Company’s
authority to operate the business and affairs of the Distributor is subject to
certain limitations. For so long as TWC Holdings, W-G Holding Corp. and their
transferees beneficially own units comprising at least 20% of the outstanding
units of the Distributor, the managing member is not permitted to take certain
actions on behalf of the Distributor (directly or through a subsidiary) without
the prior approval of TWC Holdings, including without limitation the following:
(i) creating or assuming any indebtedness or liability, or providing any
indirect financial assistance, or assuming any mortgage, charge or other
encumbrance on any property of the Distributor; (ii) selling, leasing,
exchanging or disposing of, by any means, property or assets of the Distributor
having a value in excess of $0.1 million; (iii) entering into or effecting any
conversion, consolidation or merger involving the Distributor; (iv) taking any
action to liquidate or dissolve the Distributor; (v) entering into, amending or
waiving any contract with a member or with any party that is not at arm’s
length; (vi) engaging, removing or replacing the Distributor’s independent
auditors; (vii) guaranteeing the liabilities or debts of any other person than a
subsidiary of the Distributor; (viii) requiring any guarantee from any member;
(ix) declaring or making any distribution, including any distribution in-kind of
securities or other non-cash assets; (x) issuing or granting any Class G Units,
Class W Units or any other units, membership interests or economic interests in
the Distributor (other than as provided in the Distributor LLC Agreement); (xi)
utilizing sub-distributors, or licensees, or outsourcing any functions relating
to the Distributor’s performance under the Distribution Agreement; (xii)
appointing or removing the Distributor’s Chief Executive Officer, Chief
Operating Officer, Chief Financial Officer, or any other executive level officer
or employee, or any other employee whose compensation is in excess of $0.2
million per year; (xiii) approving the annual or quarterly budget for the
Distributor, or varying more than 10% from the amount budgeted for any
particular line item therein; (xiv) engaging in any debt or equity financing,
refinancing, recapitalization or other capital raising transaction; (xv)
approving or entering into any contracts, agreements, understandings or
arrangements outside the ordinary course or providing for payments by or to the
Distributor or obligations in excess of $0.1 million per year; (xvi) commencing
or settling any litigation; (xvii) licensing any item of product outside the
ordinary course or on terms other than fair market value; (xviii) approving or
adopting any material employee compensation plan or arrangement; (xix) creating
any subsidiary or taking any of the actions described above with respect to any
subsidiary. In addition, the Distributor generally must follow tax positions on
its tax returns advocated by TWC Holdings.
 
 ALLOCATION
OF PROFITS AND LOSSES.
 Profits
and losses are allocated to the partners based upon their relative ownership of
the Distributor.
 
 NOTE
17.  EMPLOYEE BENEFIT PLAN
 
 The
Distributor sponsors a defined contribution plan (the “Plan”) under Section
401(k) of the Internal Revenue Code, covering employees of the
Distributor.  Under the Plan, the Distributor may match contributions
at the discretion of management.  For the year ended December 31, 2007
and the 163-day period ended December 31, 2006, the Distributor did not make any
contributions to the Plan.
   F-57
 NOTE
18. VALUATION AND QUALIFYING ACCOUNTS
  Allowances
are deducted from the assets to which they apply, except for sales returns and
allowances.
  (In
      thousands)
                
                Balance
      at
                
                
                Charged
      toBeginning
      of
                
                
                costs
      and
                
                
                
                
                
                Balance
      at EndPeriod
      (a)
                
                
                expenses
                
                
                Deductions
                
                
                of
      PeriodPeriod
      from July 22, 2006 through December 31, 2006Uncollectible
      accounts
                
                $
                1,238
                
                
                $
                2,205
                
                
                $
                (480
                )
                
                $
                2,963Reserve
      for inventory obsolescence
                
                
                6,223
                
                
                
                6,266
                
                
                
                (2,002
                )
                
                
                10,487Reserve
      for sales returns and allowances
                
                
                23,094
                
                
                
                52,851
                
                
                
                (33,888
                )
                
                
                42,057Reserve
      for uncollectable advances
                
                
                2,202
                
                
                
                855
                
                
                
                -
                
                
                
                3,057$
                32,757
                
                
                $
                62,177
                
                
                $
                (36,370
                )
                
                $
                58,564Year
      ended December 31, 2007Uncollectible
      accounts
                
                $
                2,963
                
                
                $
                1,445
                
                
                $
                (97
                )
                
                $
                4,311Reserve
      for inventory obsolescence
                
                
                10,487
                
                
                
                3,335
                
                
                
                (565
                )
                
                
                13,257Reserve
      for sales returns and allowances
                
                
                42,057
                
                
                
                156,610
                
                
                
                (130,508
                )
                
                
                68,159Reserve
      for uncollectable advances
                
                
                3,057
                
                
                
                6,761
                
                
                
                (4,706
                )
                
                
                5,112$
                58,564
                
                
                $
                168,151
                
                
                $
                (135,876
                )
                
                $
                90,839
  (a)
      The beginning of the period is July 22, 2006 when the balances for these
      allowances were transferred from Genius Products, Inc. to Genius Products,
      LLC.
  NOTE
19. RECENT EVENTS
 
 As a
result of a reduced slate of pictures The Distributor is to distribute on behalf
of one of its major licensors and the recent economic conditions, including a
decrease in consumer confidence resulting in lower spending levels, the
Distributor has experienced a significant reduction in net revenue.  Based
on current operating results through December 31, 2008, the Distributor will
fall short of generating enough cash flow from continuing operations to timely
meet its financial commitments and obligations. In addition, the financing
historically provided by TWC will not be available to the Distributor effective
January 1, 2009.  Currently, the Distributor is carefully evaluating all
capital and operational expenditures on a go forward basis, including an
internal restructuring of the its resources and overhead to decrease its
operating expenses. The Distributor is pursuing these options to alleviate any
liquidity shortfall that may arise in the future.  At this time, the
Distributor is unable to conclude if the aforementioned actions the Distributor
is taking including a potential restructuring will be successful. If the
Distributor is unable to successfully reduce its overhead costs in the near
future, the Distributor’s ability to generate sufficient cash flows to continue
its operations and service its obligations under the credit facility (See Note
5) may be adversely affected. The financial statements do not include any
adjustments that might result from the outcome of this
uncertainty.
 
 F-58