UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-Q





(Mark
One)




x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
quarterly period ended September 30, 2008




o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934




For the
transition period from  
to




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)
            (IRS
      Employer
              Identification
      No.)




3301
EXPOSITION BLVD., SUITE 100


SANTA
MONICA, CA 90404


(Address
of principal executive offices)




(310)
401-2200


(Registrant's
telephone number, including area code)





(Former
name, former address and former fiscal year,


if
changed since last report)




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act 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 ý    No  
 ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer, “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
accelerated filer o              Accelerated
filer x              Non-accelerated
filer o              Smaller
reporting company o




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




There
were 67,609,094 shares outstanding of the issuer's Common Stock as of March 9,
2009.














GENIUS
PRODUCTS, INC. AND SUBSIDIARIES


FORM
10-Q


FOR
THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008




INDEX






PAGEPART I
            FINANCIAL INFORMATIONItem 1
            Financial
      Statements
            4Condensed
      consolidated Balance Sheets at September 30, 2008 (unaudited) and December
      31, 2007
            4Condensed
      consolidated Statements of Operations for the Three Months Ended September
      30, 2008  and 2007 (unaudited), and for the Nine Months Ended
      September 30, 2008 and 2007 (unaudited)
            5Condensed
      consolidated Statements of Cash Flows for the Nine Months Ended September
      30, 2008  and 2007 (unaudited)
            6Notes
      to Condensed consolidated Financial Statements (unaudited)
            7Item 2
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            22Item 3
            Quantitative
      and Qualitative Disclosures About Market Risk
            30Item 4
            Controls
      and Procedures
            30PART II
            OTHER INFORMATIONItem 1
            Legal
      Proceedings
            31Item 1A
            Risk
      Factors
            32Item 2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            32Item 3
            Defaults
      Upon Senior Securities
            32Item 4
            Submission
      of Matters to a Vote of Security Holders
            32Item 5
            Other
      Information
            32Item 6
            Exhibits
            33SIGNATURES
            34




2


NOTICE ABOUT FORWARD-LOOKING STATEMENTS




This
Quarterly Report on Form 10-Q includes “forward-looking statements”. To the
extent that the information presented in this Quarterly 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 Quarterly
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 Quarterly 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 Quarterly 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 Quarterly
Report.























3


PART
I - FINANCIAL INFORMATION




ITEM 1. FINANCIAL
STATEMENTS


GENIUS
      PRODUCTS, INC. AND SUBSIDIARIESCONDENSED
      CONSOLIDATED BALANCE SHEETS(IN
      THOUSANDS, EXCEPT SHARE AND PAR VALUE INFORMATION)September
      30,
                            
                            
                            December
      31,2008
                            
                            
                            2007(Unaudited)
                            
                            
                            (Restated)ASSETSCurrent
      assets:Cash
      and cash equivalents
                            
                            $
                            1,840
                            
                            
                            $
                            1,757Prepaid
      expenses and other current assets
                            
                            
                            -
                            
                            
                            
                            110Notes
      Receivable from Distributor
                            
                            
                            8,691
                            
                            
                            
                            -Total
      current assets
                            
                            
                            10,531
                            
                            
                            
                            1,867Notes
      Receivable from Distributor
                            
                            
                            -
                            
                            
                            
                            8,191Investment
      in Distributor
                            
                            
                            4,287
                            
                            
                            
                            73,002Total
      assets
                            
                            $
                            14,818
                            
                            
                            $
                            83,060LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accrued
      Expenses
                            
                            
                            7
                            
                            
                            
                            -Accounts
      payable to Distributor, net
                            
                            
                            305
                            
                            
                            
                            198Total
      current liabilities
                            
                            
                            312
                            
                            
                            
                            198Class
      W Option Liability
                            
                            
                            2,253
                            
                            
                            
                            4,168Deferred
      tax liability
                            
                            
                            -
                            
                            
                            
                            12,797Total
      liabilities
                            
                            
                            2,565
                            
                            
                            
                            17,163Commitments
      and contingenciesStockholders'
      equity:Preferred
      stock, $.0001 par value; 10,000,000 shares authorized; no shares
      outstanding
                            
                            
                            -
                            
                            
                            
                            -Series
      W preferred stock, $.0001 par value; 100 shares authorized and
      outstanding
                            
                            
                            -
                            
                            
                            
                            -Common
      stock, $.0001 par value; 300,000,000 shares authorized;67,609,094
      and 67,709,094 shares outstanding, respectively
                            
                            
                            7
                            
                            
                            
                            7Additional
      paid-in capital
                            
                            
                            110,533
                            
                            
                            
                            112,293Accumulated
      deficit
                            
                            
                            (98,287
                            )
                            
                            
                            (46,403
                            )Total
      stockholders' equity
                            
                            
                            12,253
                            
                            
                            
                            65,897Total
      liabilities and stockholders' equity
                            
                            $
                            14,818
                            
                            
                            $
                            83,060See
      accompanying notes to condensed unaudited interim financial
      statements.


4


GENIUS
PRODUCTS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (IN
THOUSANDS, EXCEPT PER SHARE INFORMATION)
 (UNAUDITED)
  Three
      Months Ended
                                                                                                            September
      30,
                                                                                                          
                                                                                                          
                                                                                                          Nine Months
      Ended
                                                                                                            September
      30,2008
                                                                                                          
                                                                                                          
                                                                                                          2007
                                                                                                            Restated(Note
      3)
                                                                                                          
                                                                                                          
                                                                                                          2008
                                                                                                          
                                                                                                          
                                                                                                          2007
                                                                                                            Restated(Note
      3)Operating
      expenses:Impairment
      of investment in Distributor
                                                                                                          
                                                                                                          $
                                                                                                          1,121
                                                                                                          
                                                                                                          
                                                                                                          $
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          $
                                                                                                          36,033
                                                                                                          
                                                                                                          
                                                                                                          $
                                                                                                          -Selling,
      general and administrative
                                                                                                          
                                                                                                          
                                                                                                          1,229
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          1,336
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          3,868
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          3,867Equity
      in net loss from Distributor
                                                                                                          
                                                                                                          
                                                                                                          13,784
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          3,010
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          27,417
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          6,599Total
      operating expenses
                                                                                                          
                                                                                                          
                                                                                                          16,134
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          4,346
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          67,318
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          10,466Loss
      from operations
                                                                                                          
                                                                                                          
                                                                                                          (16,134
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (4,346
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (67,318
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (10,466
                                                                                                          )Interest
      and other income, net
                                                                                                          
                                                                                                          
                                                                                                          806
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          (31
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          2,297
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          457Loss
      before provision for income taxes
                                                                                                          
                                                                                                          
                                                                                                          (15,328
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (4,377
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (65,021
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          (10,009
                                                                                                          )Benefit
      (Provision) for income taxes
                                                                                                          
                                                                                                          
                                                                                                          -
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          (104
                                                                                                          )
                                                                                                          
                                                                                                          
                                                                                                          12,797
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          193Net
      loss
                                                                                                          
                                                                                                          $
                                                                                                          (15,328
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (4,481
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (52,224
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (9,816
                                                                                                          )Basic
      and diluted EPSNet
      loss per share
                                                                                                          
                                                                                                          $
                                                                                                          (0.23
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (0.07
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (0.77
                                                                                                          )
                                                                                                          
                                                                                                          $
                                                                                                          (0.15
                                                                                                          )Basic
      and diluted weighted average shares
                                                                                                          
                                                                                                          
                                                                                                          67,609,094
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          66,951,924
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          67,655,809
                                                                                                          
                                                                                                          
                                                                                                          
                                                                                                          65,738,041


See
accompanying notes to condensed unaudited interim financial
statements.












5




GENIUS
PRODUCTS, INC. AND SUBSIDIARIES
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (IN
THOUSANDS)
 (UNAUDITED)




Nine
      Months Ended
                                                September
      30,2008
                                              
                                              
                                              2007Restated(Note
      3)Cash
      flows from operating activitiesNet
      loss
                                              
                                              $
                                              (52,224
                                              )
                                              
                                              $
                                              (9,816
                                              )Adjustments to reconcile net loss
      to net cash provided byoperating
      activitiesImpairment
      of investment in Distributor
                                              
                                              
                                              36,033
                                              
                                              
                                              
                                              -Equity
      in net loss from Distributor
                                              
                                              
                                              27,417
                                              
                                              
                                              
                                              6,599Operating
      expenses paid by Distributor
                                              
                                              
                                              3,489
                                              
                                              
                                              
                                              3,192Stock
      compensation expense
                                              
                                              
                                              312
                                              
                                              
                                              
                                              654Deferred
      tax benefit
                                              
                                              
                                              (12,797
                                              )
                                              
                                              
                                              (193
                                              )Revaluation
      of Class W option liability
                                              
                                              
                                              (1,915
                                              )
                                              
                                              
                                              (255
                                              )Changes
      in assets and liabilities:(Increase)
      decrease in prepaid expenses, notes receivable and
deposits
                                              
                                              
                                              110
                                              
                                              
                                              
                                              (91
                                              )Decrease
      in accounts payable
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (59
                                              )Decrease
      in Distributor payable
                                              
                                              
                                              (393
                                              )
                                              
                                              
                                              -Increase
      in accrued expenses
                                              
                                              
                                              7
                                              
                                              
                                              
                                              157Net
      cash provided by operating activities
                                              
                                              
                                              39
                                              
                                              
                                              
                                              188Cash
      flows from investing activities:Short-term
      note receivable from related party
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (6,000
                                              )Net
      cash used in investing activities
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (6,000
                                              )Cash
      flows from financing activities:Proceeds
      from exercise of options
                                              
                                              
                                              44
                                              
                                              
                                              
                                              1,595Proceeds
      from exercise of warrants
                                              
                                              
                                              -
                                              
                                              
                                              
                                              3,634Net
      cash provided by financing activities
                                              
                                              
                                              44
                                              
                                              
                                              
                                              5,229Net
      increase (decrease) in cash and cash equivalents
                                              
                                              
                                              83
                                              
                                              
                                              
                                              (583
                                              )Cash
      and cash equivalents at beginning of period
                                              
                                              
                                              1,757
                                              
                                              
                                              
                                              3,745Cash
      and cash equivalents at end of period
                                              
                                              $
                                              1,840
                                              
                                              
                                              $
                                              3,162


See
accompanying notes to condensed unaudited interim financial
statements.




6





GENIUS
PRODUCTS, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


(UNAUDITED)




NOTE
1.  NATURE OF BUSINESS





The
financial statements and related footnote disclosures reflect the results of
operations of the Company and the Distributor, as applicable, as of and for the
periods ended September 30, 2008 and 2007.  The financial statements
and related footnote disclosures do not reflect the impact of any events that
have occurred since September 30, 2008, which events are more particularly
described in Note 11 to the Company’s financial statements and in the Company’s
Current Report on Form 8-K filed with the Securities and Exchange Commission on
February 24, 2009.





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”), and a 14% percentage interest owned indirectly through its
indirect wholly-owned subsidiary, Weinstein GP Holdings LLC (“Weinstein GP
Holdings”)).  TWC Holdings is the subsidiary 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 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:  ESPN®, World Wrestling Entertainment®,
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.We believe
that the strong relationships the Distributor has developed with these
well-known retailers as well as with the Distributor’s 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
Distributor currently distributes its library on DVDs, next-generation
DVD, and electronically in a digital format.We plan 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 176 theatrical and non-theatrical titles since
inception.  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.




7


The
Distributor primarily focuses on four core branded content categories that we
call Content Verticals:





·
                Theatrical/Independent
      Films (includes RHI EntertainmentTM (Hallmark library), The
      Weinstein Company®  and WellspringTM)·
                Sports
      (includes ESPN® and World Wrestling
  Entertainment®)


·
                Lifestyle
      (includes Animal Planet, The Learning Channel (TLCTM) and
      WellspringTM)·
                Family/Faith
      (includes Discovery KidsTM, and Sesame
Workshop®)





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.





On April
22, 2008, TWC Holdings transferred an approximate 15% percentage interest in the
Distributor to its indirect wholly-owned subsidiary Weinstein GP
Holdings.  Thus, the Distributor is owned 70% by TWC Holdings,
Weinstein GP Holdings and W-G Holding and 30% by the Company.  The 70%
interest in the Distributor held by TWC Holdings, Weinstein GP 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 not
less than 70% of the Company’s outstanding common stock, or with TWC Holdings’,
Weinstein GP 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 Note 5 below).





In
addition, on the Closing Date 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.  On April 22, 2008, W-G Holding
transferred to TWC Holdings all of its Series W Preferred Stock, so that
effective on such date TWC Holdings owns all of the issued and outstanding
shares of the Company’s Series W Preferred Stock.  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.





RECENT
RESTRUCTURING TRANSACTIONS


Since
September 30, 2008, the Company and the Distributor have been parties to certain
restructuring transactions more particularly described in Note 11.





NOTE
2.   BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES




BASIS
OF PRESENTATION





The
accompanying interim consolidated financial statements are unaudited, but in the
opinion of management, reflect all adjustments necessary for a fair presentation
of the results for the periods indicated.  The results of operations for
any interim period are not necessarily indicative of results for the full year.
 The accompanying financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the year
ended December 31, 2007.





As more
fully described in Note 11 (under the heading “Recent Events Relating to
Liquidity and Capital Resources”), the Distributor is not in compliance with the
terms, conditions and covenants of the Amended Credit Agreement and has
experienced a significant reduction in net revenue and
liquidity.  Management plans with respect to these matters is also
described in Note 11.  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 6), 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.


8





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.





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.





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 5) 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
from the Distributor have been included as an asset in the Company’s 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
Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements(“FAS 157”), which the Company adopted beginning on January 1,
2008.  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.





STOCK-BASED
COMPENSATION


Under
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.





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.


9





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 9 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 historically recorded a full
valuation allowance on its deferred tax assets and had recorded a net deferred
tax liability related to its investment in the Distributor.  The
deferred tax liability related to the Distributor was not offset against the
deferred tax assets as the reversal period for this amount was not considered to
be determinable on a more likely than not basis.  In the nine month
period ended September 30, 2008, the tax basis of our investment in Distributor
exceeded the amount for financial reporting purposes.  Accordingly,
the entire deferred tax liability was reversed.





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
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.  We have no material unrecognized
tax benefits at September 30, 2008.





BASIC AND
DILUTED LOSS PER COMMON SHARE


Basic
earnings per share (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
the periods presented since to do so would have been anti-dilutive.





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.


10





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 increased by
$0.9 million and $2.3 million for the three and nine months ended September 30,
2007, 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 September 30, 2007.  As a result of these
re-measurements, other income for the three months ended September 30, 2007
decreased by $0.1 million to $0.03 million of other expense, and other income
for the nine months ended September 30, 2007 increased by $0.3 million to $0.5
million.





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 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 nine months ended September 30, 2007 are as follows:





Three
      Months Ended September 30, 2007 (Unaudited)
                      
                      
                      Nine
      Months Ended September 30, 2007 (Unaudited)(In
      thousands)
                      
                      As
      Originally
                        Reported
                      
                      
                      Restatement
                        Adjustments
                      
                      
                      As
      Restated
                      
                      
                      As
      Originally
                        Reported
                      
                      
                      Restatement
                        Adjustments
                      
                      
                      As
      RestatedSelling,
      general and administrative
                      
                      $
                      448
                      
                      
                      $
                      888
                      
                      
                      $
                      1,336
                      
                      
                      $
                      1,559
                      
                      
                      $
                      2,308
                      
                      
                      $
                      3,867Equity
      in net loss from distributor
                      
                      
                      3,010
                      
                      
                      
                      -
                      
                      
                      
                      3,010
                      
                      
                      
                      6,259
                      
                      
                      
                      340
                      
                      
                      
                      6,599Other
      income (expense)
                      
                      
                      86
                      
                      
                      
                      (117
                      )
                      
                      
                      (31
                      )
                      
                      
                      202
                      
                      
                      
                      255
                      
                      
                      
                      457Provision
      (benefit) for income taxes
                      
                      
                      104
                      
                      
                      
                      -
                      
                      
                      
                      104
                      
                      
                      
                      (57
                      )
                      
                      
                      (136
                      )
                      
                      
                      (193
                      )Loss
      before extraordinary item
                      
                      
                      (3,476
                      )
                      
                      
                      (1,005
                      )
                      
                      
                      (4,481
                      )
                      
                      
                      (7,559
                      )
                      
                      
                      (2,257
                      )
                      
                      
                      (9,816
                      )Net
      loss
                      
                      
                      (3,476
                      )
                      
                      
                      (1,005
                      )
                      
                      
                      (4,481
                      )
                      
                      
                      (7,559
                      )
                      
                      
                      (2,257
                      )
                      
                      
                      (9,816
                      )Net
      loss per share
                      
                      
                      (0.05
                      )
                      
                      
                      (0.02
                      )
                      
                      
                      (0.07
                      )
                      
                      
                      (0.11
                      )
                      
                      
                      (0.04
                      )
                      
                      
                      (0.15
                      )Investment
      in Distributor
                      
                      
                      79,391
                      
                      
                      
                      250
                      
                      
                      
                      79,641
                      
                      
                      
                      79,391
                      
                      
                      
                      250
                      
                      
                      
                      79,641Total
      assets
                      
                      
                      89,636
                      
                      
                      
                      250
                      
                      
                      
                      89,886
                      
                      
                      
                      89,636
                      
                      
                      
                      250
                      
                      
                      
                      89,886Class
      W option liability
                      
                      
                      -
                      
                      
                      
                      2,761
                      
                      
                      
                      2,761
                      
                      
                      
                      -
                      
                      
                      
                      2,761
                      
                      
                      
                      2,761Deferred
      tax liability
                      
                      
                      12,964
                      
                      
                      
                      1,371
                      
                      
                      
                      14,335
                      
                      
                      
                      12,964
                      
                      
                      
                      1,371
                      
                      
                      
                      14,335Total
      liabilities
                      
                      
                      13,986
                      
                      
                      
                      4,132
                      
                      
                      
                      18,118
                      
                      
                      
                      13,986
                      
                      
                      
                      4,132
                      
                      
                      
                      18,118Accumulated
      deficit
                      
                      
                      (37,458
                      )
                      
                      
                      (3,882
                      )
                      
                      
                      (41,340
                      )
                      
                      
                      (37,458
                      )
                      
                      
                      (3,882
                      )
                      
                      
                      (41,340
                      )Total
      stockholders' equity
                      
                      
                      75,650
                      
                      
                      
                      (3,882
                      )
                      
                      
                      71,768
                      
                      
                      
                      75,650
                      
                      
                      
                      (3,882
                      )
                      
                      
                      71,768





RESTATEMENT
OF FINANCIAL STATEMENTS OF THE DISTRIBUTOR


The
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 permanent equity in its financial
statements.  Subsequent changes to the cash redemption value of such
units have 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 Class W Units was recorded at
$277.6 million.





11


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
September 30, 2007, the cash redemption value of the Redeemable Class W Units
increased by $166.2 million, to $443.8 million (resulting in a deficit balance
in the Class G Units member’s deficit of $350.2 million as of September 30,
2007).





The
Distributor recorded an impairment of $1.1 million to the Class W Purchased Call
Option (included in deposits and other) asset in the nine months ended September
30, 2007 (with a corresponding increase to the Distributor’s other expense for
the nine months ended September 30, 2007 of $1.1 million).





The
cumulative impact of the above-described restatement adjustments on other
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 three and nine months ended September 30, 2007 are as
follows:





Three
      Months Ended September 30, 2007 (Unaudited)
                                      
                                      
                                      Nine
      Months Ended September 30, 2007 (Unaudited)As
      Originally
                                        Reported
                                      
                                      
                                      Restatement
      Adjustments
                                      
                                      
                                      As
      Restated
                                      
                                      
                                      As
      Originally Reported
                                      
                                      
                                      Restatement
                                        Adjustments
                                      
                                      
                                      As
      RestatedOther
      expense
                                      
                                      $
                                      (1,226
                                      )
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      (1,226
                                      )
                                      
                                      $
                                      (1,753
                                      )
                                      
                                      $
                                      (1,134
                                      )
                                      
                                      $
                                      (2,887
                                      )Net
      loss
                                      
                                      
                                      (5,179
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (5,179
                                      )
                                      
                                      
                                      (5,465
                                      )
                                      
                                      
                                      (1,134
                                      )
                                      
                                      
                                      (6,599
                                      )Deposits
      and other
                                      
                                      
                                      228
                                      
                                      
                                      
                                      2,649
                                      
                                      
                                      
                                      2,877
                                      
                                      
                                      
                                      228
                                      
                                      
                                      
                                      2,649
                                      
                                      
                                      
                                      2,877Total
      assets
                                      
                                      
                                      336,557
                                      
                                      
                                      
                                      2,649
                                      
                                      
                                      
                                      339,206
                                      
                                      
                                      
                                      336,557
                                      
                                      
                                      
                                      2,649
                                      
                                      
                                      
                                      339,206Redeemable
      Class W Units
                                      
                                      
                                      -
                                      
                                      
                                      
                                      443,812
                                      
                                      
                                      
                                      443,812
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      443,812
                                      
                                      
                                      
                                      443,812Member's
      equity (deficit)
                                      
                                      
                                      90,992
                                      
                                      
                                      
                                      (441,163
                                      )
                                      
                                      
                                      (350,171
                                      )
                                      
                                      
                                      90,992
                                      
                                      
                                      
                                      (441,163
                                      )
                                      
                                      
                                      (350,171
                                      )





NOTE
4.  FAIR VALUE MEASUREMENTS





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. The Company
adopted on January 1, 2008, 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.  The provisions of FAS 157
related to other non-financial 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 non-financial
assets and liabilities.





The
Company adopted the provisions of FAS 157 as of January 1, 2008, to account for
the Class W Option Liability.  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’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.  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) $60.0 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 $60.0
million.





The Class
W Option Liability recorded at fair value in the Company’s balance sheet as of
September 30, 2008 is categorized based upon the level of judgment associated
with the inputs used to measure its fair value.  Hierarchical levels
defined by FAS 157 are directly related to the amount of subjectivity associated
with the inputs to the fair valuation of the Class W Option Liability, which is
as follows:





Level 1 –
inputs are un-adjusted quoted prices in active markets for identical assets or
liabilities at the measurement date;


Level 2 –
inputs other than Level 1 inputs that are either directly or indirectly
observable; and


Level 3 –
unobservable inputs developed using estimates and assumptions developed by
management, which reflect those that a market participant would
use.


12





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, which the Company has classified as unobservable, Level 3
inputs.  The Company has determined the fair value of the Class W
Option Liability as of September 30, 2008 to be $2.3 million resulting in an
increase to other income of $0.7 million for the three months ended September
30, 2008 (as compared to June 30, 2008), and an increase of $1.9 million for the
nine months ended September 30, 2008 (as compared to December 31, 2007). The
following table summarizes our fair value measurements using significant Level 3
inputs, and changes therein, for the three and nine months ended September 30,
2008:





Three
      Months Ended
                          
                          
                          Nine
      Months EndedSeptember 30, 2008
                          
                          
                          September 30, 2008Class
      W Option Liability:Balance
      at beginning of period
                          
                          $
                          2,920
                          
                          
                          $
                          4,168Re-measurement
      of Class W Option Liability
                          
                          
                          (667
                          )
                          
                          
                          (1,915
                          )Balance
      at September 30, 2008
                          
                          $
                          2,253
                          
                          
                          $
                          2,253





In
addition, in February 2007, the FASB issued FAS No. 159, “The Fair
Value Option for Financial Assets and Financial Liabilities-including an
amendment of FASB Statement No. 115” (“FAS 159”), which the Company
adopted as of January 1, 2008.  FAS 159 expands the use of fair value
accounting but does not affect existing standards that require assets or
liabilities to be carried at fair value. Under FAS 159, a company may elect to
use fair value to measure certain financial assets and liabilities and any
changes in fair value are recognized in earnings.  The Company did not
elect the fair value option upon adoption of FAS 159.





NOTE
5.  INVESTMENT IN DISTRIBUTOR (GENIUS PRODUCTS, LLC)





Summaries
of the statements of operations, balance sheet, statements of cash flows, and
the computations of the Company’s equity in net loss of the Distributor are
shown below.




GENIUS
PRODUCTS, LLC


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(IN
THOUSANDS)


(UNAUDITED)





Three
      Months Ended
                                        
                                        
                                        Nine Months
      EndedSeptember
      30, 2008
                                        
                                        
                                        September
      30, 2007
                                          Restated(Note
      3)
                                        
                                        
                                        September
      30, 2008
                                        
                                        
                                        September
      30, 2007
                                          Restated(Note
      3)Revenues, net of sales, returns,
      discounts and allowances of $31,562 and $42,081 for the threemonths ended September 30, 2008
      and 2007, respectively, and $112,318 and $106,163 for the ninemonths ended September 30, 2008
      and 2007, respectively
                                        
                                        $
                                        77,241
                                        
                                        
                                        $
                                        93,413
                                        
                                        
                                        $
                                        250,089
                                        
                                        
                                        $
                                        289,183Total
      cost of revenues
                                        
                                        
                                        (111,581
                                        )
                                        
                                        
                                        (86,601
                                        )
                                        
                                        
                                        (289,273
                                        )
                                        
                                        
                                        (262,647
                                        )Gross
      profit (loss)
                                        
                                        
                                        (34,340
                                        )
                                        
                                        
                                        6,812
                                        
                                        
                                        
                                        (39,184
                                        )
                                        
                                        
                                        26,536Total
      operating expenses
                                        
                                        
                                        (4,370
                                        )
                                        
                                        
                                        (10,765
                                        )
                                        
                                        
                                        (27,602
                                        )
                                        
                                        
                                        (30,248
                                        )Impairment
      charge
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (18,906
                                        )
                                        
                                        
                                        -Loss
      from operations
                                        
                                        
                                        (38,710
                                        )
                                        
                                        
                                        (3,953
                                        )
                                        
                                        
                                        (85,692
                                        )
                                        
                                        
                                        (3,712
                                        )Other
      expense
                                        
                                        
                                        (3,340
                                        )
                                        
                                        
                                        (1,226
                                        )
                                        
                                        
                                        (4,127
                                        )
                                        
                                        
                                        (2,887
                                        )Net
      loss
                                        
                                        $
                                        (42,050
                                        )
                                        
                                        $
                                        (5,179
                                        )
                                        
                                        $
                                        (89,819
                                        )
                                        
                                        $
                                        (6,599
                                        )





13






GENIUS
PRODUCTS, LLC
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (IN
THOUSANDS)


September
      30, 2008
                                                                              (Unaudited)
                                                                          
                                                                          
                                                                          December
      31,
                                                                            2007
                                                                            (Restated)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                                                          
                                                                          $
                                                                          3,987
                                                                          
                                                                          
                                                                          $
                                                                          3,102Restricted
      cash - short term
                                                                          
                                                                          
                                                                          2,959
                                                                          
                                                                          
                                                                          
                                                                          7,765Accounts receivable, net of
      allowance for doubtful accounts of $3,263 and $4,311and sales returns of $41,947 and
      $68,159
                                                                          
                                                                          
                                                                          57,887
                                                                          
                                                                          
                                                                          
                                                                          123,295Inventories,
      net of reserves for obsolescence of $12,676 and $13,257
                                                                          
                                                                          
                                                                          12,109
                                                                          
                                                                          
                                                                          
                                                                          11,282Prepaid
      expenses and other current assets
                                                                          
                                                                          
                                                                          747
                                                                          
                                                                          
                                                                          
                                                                          1,110Total
      current assets
                                                                          
                                                                          
                                                                          77,689
                                                                          
                                                                          
                                                                          
                                                                          146,554Restricted
      cash - long term
                                                                          
                                                                          
                                                                          3,187
                                                                          
                                                                          
                                                                          
                                                                          3,323Property
      and equipment, net of accumulated depreciation of $775 and
      $455
                                                                          
                                                                          
                                                                          6,712
                                                                          
                                                                          
                                                                          
                                                                          953Royalty
      advances, net of uncollectible advances of $34,055 and
    $5,112
                                                                          
                                                                          
                                                                          11,503
                                                                          
                                                                          
                                                                          
                                                                          31,492Film
      library, net of accumulated amortization of $16,853 and
    $6,452
                                                                          
                                                                          
                                                                          3,503
                                                                          
                                                                          
                                                                          
                                                                          14,403Goodwill
                                                                          
                                                                          
                                                                          68,606
                                                                          
                                                                          
                                                                          
                                                                          87,512Other
      intangible assets, net of accumulated amortization of $14,178 and
      $9,675
                                                                          
                                                                          
                                                                          5,287
                                                                          
                                                                          
                                                                          
                                                                          11,596Deferred
      financing fees
                                                                          
                                                                          
                                                                          1,158
                                                                          
                                                                          
                                                                          
                                                                          1,654Deposits
      and other
                                                                          
                                                                          
                                                                          3,413
                                                                          
                                                                          
                                                                          
                                                                          5,617Total
      assets
                                                                          
                                                                          $
                                                                          181,058
                                                                          
                                                                          
                                                                          $
                                                                          303,104LIABILITIES
      AND MEMBER'S DEFICITCurrent
      liabilities:Accounts
      payable
                                                                          
                                                                          $
                                                                          16,089
                                                                          
                                                                          
                                                                          $
                                                                          31,477Notes
      payable
                                                                          
                                                                          
                                                                          17,924
                                                                          
                                                                          
                                                                          
                                                                          31,297Notes
      payable to Genius Products, Inc.
                                                                          
                                                                          
                                                                          8,691
                                                                          
                                                                          
                                                                          
                                                                          -Remittance
      to TWC
                                                                          
                                                                          
                                                                          89,029
                                                                          
                                                                          
                                                                          
                                                                          78,759Remittance
      to other licensors
                                                                          
                                                                          
                                                                          28,407
                                                                          
                                                                          
                                                                          
                                                                          20,000Accrued
      advertising and marketing
                                                                          
                                                                          
                                                                          13,294
                                                                          
                                                                          
                                                                          
                                                                          24,515Other
      accrued expenses
                                                                          
                                                                          
                                                                          12,429
                                                                          
                                                                          
                                                                          
                                                                          20,910Deferred
      revenue
                                                                          
                                                                          
                                                                          9,860
                                                                          
                                                                          
                                                                          
                                                                          8,492Total
      current liabilities
                                                                          
                                                                          
                                                                          195,723
                                                                          
                                                                          
                                                                          
                                                                          215,450Long
      term liabilities:Notes
      payable to Genius Products, Inc.
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          8,191Long
      term notes payable
                                                                          
                                                                          
                                                                          1,449
                                                                          
                                                                          
                                                                          
                                                                          627Long
      term capital lease
                                                                          
                                                                          
                                                                          15
                                                                          
                                                                          
                                                                          
                                                                          30Total
      long term liabilities
                                                                          
                                                                          
                                                                          1,464
                                                                          
                                                                          
                                                                          
                                                                          8,848Redeemable
      Class W Units
                                                                          
                                                                          
                                                                          60,000
                                                                          
                                                                          
                                                                          
                                                                          284,378Total
      member's deficit
                                                                          
                                                                          
                                                                          (76,129
                                                                          )
                                                                          
                                                                          
                                                                          (205,572
                                                                          )Total
      liabilities and member's deficit
                                                                          
                                                                          $
                                                                          181,058
                                                                          
                                                                          
                                                                          $
                                                                          303,104




14






GENIUS
PRODUCTS, LLC AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (IN
THOUSANDS)





Nine
      Months Ended September 30,2008
                                      
                                      
                                      2007
                                        (Restated)Cash
      flows from operating activities:Net
      loss
                                      
                                      $
                                      (89,819
                                      )
                                      
                                      $
                                      (6,599
                                      )Adjustments
      to reconcile net loss to net cash provided (used) in operating
      activities:Depreciation
      and amortization
                                      
                                      
                                      320
                                      
                                      
                                      
                                      255Amortization
      of intangible assets
                                      
                                      
                                      6,309
                                      
                                      
                                      
                                      3,065Amortization
      of film library
                                      
                                      
                                      12,234
                                      
                                      
                                      
                                      916Amortization
      of deferred financing costs
                                      
                                      
                                      496
                                      
                                      
                                      
                                      64Change
      in allowance for doubtful accounts and provision for
    returns
                                      
                                      
                                      (27,260
                                      )
                                      
                                      
                                      6,160Change
      in provision for obsolete inventory
                                      
                                      
                                      (581
                                      )
                                      
                                      
                                      (644
                                      )Stock
      compensation expense
                                      
                                      
                                      (1,627
                                      )
                                      
                                      
                                      1,843Interest
      expense on notes payable
                                      
                                      
                                      500
                                      
                                      
                                      
                                      7Impairment
      of goodwill
                                      
                                      
                                      18,906
                                      
                                      
                                      
                                      -Impairment
      of Class W purchased call option
                                      
                                      
                                      -
                                      
                                      
                                      
                                      1,134Changes
      in assets and liabilities:(Increase)
      decrease in restricted cash
                                      
                                      
                                      4,942
                                      
                                      
                                      
                                      (8,370
                                      )(Increase)
      decrease in accounts receivable
                                      
                                      
                                      94,420
                                      
                                      
                                      
                                      (47,740
                                      )(Increase)
      decrease in inventory
                                      
                                      
                                      (246
                                      )
                                      
                                      
                                      (11,234
                                      )(Increase)
      decrease in prepaid expenses and deposits
                                      
                                      
                                      4,530
                                      
                                      
                                      
                                      (64
                                      )(Increase)
      decrease in notes receivable
                                      
                                      
                                      -
                                      
                                      
                                      
                                      86(Increase)
      decrease in royalty advances
                                      
                                      
                                      29,389
                                      
                                      
                                      
                                      (17,022
                                      )(Increase)
      decrease in film library
                                      
                                      
                                      2,399
                                      
                                      
                                      
                                      (9,075
                                      )Increase
      (decrease) in accounts payable
                                      
                                      
                                      (12,751
                                      )
                                      
                                      
                                      15,310Increase
      (decrease) in accrued expenses and other
                                      
                                      
                                      (19,960
                                      )
                                      
                                      
                                      6,972Increase
      (decrease) in deferred revenue
                                      
                                      
                                      1,368
                                      
                                      
                                      
                                      53,683Increase
      (decrease) in remittance to TWC
                                      
                                      
                                      10,270
                                      
                                      
                                      
                                      (30,541
                                      )Increase
      (decrease) in remittance to other licensors
                                      
                                      
                                      (10,916
                                      )
                                      
                                      
                                      11,158Net
      cash provided by (used in) operating activities
                                      
                                      
                                      22,923
                                      
                                      
                                      
                                      (30,636
                                      )Cash
      flows from investing activities:Purchase
      of Castalian (net of working capital acquired of $527)
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (3,683
                                      )Purchase
      of property and equipment
                                      
                                      
                                      (6,079
                                      )
                                      
                                      
                                      (228
                                      )Net
      cash used in investing activities
                                      
                                      
                                      (6,079
                                      )
                                      
                                      
                                      (3,911
                                      )Cash
      flows from financing activities:Proceeds
      from Credit Facility
                                      
                                      
                                      26,927
                                      
                                      
                                      
                                      36,000Repayments
      of Credit Facility
                                      
                                      
                                      (39,368
                                      )
                                      
                                      
                                      (213
                                      )Repayments
      of long term capital lease
                                      
                                      
                                      (29
                                      )
                                      
                                      
                                      -Deferred
      Financing Costs Paid
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,463
                                      )Distribution
      to Members
                                      
                                      
                                      (3,489
                                      )
                                      
                                      
                                      (3,311
                                      )Net
      cash provided by (used in) financing activities
                                      
                                      
                                      (15,959
                                      )
                                      
                                      
                                      31,013Net
      increase (decrease) in cash and equivalents
                                      
                                      
                                      885
                                      
                                      
                                      
                                      (3,534
                                      )Cash
      at beginning of period
                                      
                                      
                                      3,102
                                      
                                      
                                      
                                      8,326Cash
      at end of period
                                      
                                      $
                                      3,987
                                      
                                      
                                      $
                                      4,792Non-cash
      transactions
                                        Redeemable
      Class W units re-measurement to redemption value
                                      
                                      $
                                      224,378
                                      
                                      
                                      $
                                      23,400See
      accompanying notes to condensed unaudited interim financial
      statements.


15





Our
equity in net loss of the Distributor is adjusted each period for non-cash 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.





With
respect to the nine months ended September 30, 2007, and as a result of
restating the Distributor’s financial statements as described in Note 3, the net
loss for the nine months ended September 30, 2007 increased by $1.1 million to
$6.6 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 nine months ended September 30, 2007).





With
respect to the nine months ended September 30, 2008, the Distributor performed
an interim review of its goodwill and intangible assets due to the current
economic market conditions in accordance with FAS 142, “Goodwill and Other Intangible
Assets” and FAS 144, “Accounting for the Impairment of
Disposal of Long Lived Assets.” The Distributor believes it is more than
likely that the carrying value of the Distributor’s goodwill and intangible
assets exceed their fair value as of September 30, 2008.  Based on the
Distributor’s impairment review, the Distributor recorded an impairment charge
of $18.9 million against its goodwill and an impairment charge of $1.8 million
against its intangible assets as of September 30, 2008.  In light of
the continued adverse economic conditions in the marketplace, the Distributor
will continue to monitor its goodwill and intangible assets for possible future
impairment.  The aforementioned impairments of the Distributor’s
goodwill and intangible assets resulted in a basis difference adjustment to the
Company’s investment in the Distributor of $6.2 million (which is 30% of the net
loss from the Distributor for the nine months ended September 30,
2008).





Nine
      Months Ended September 30,2008
                                      
                                      
                                      2007
                                        Restated(Note
      3)Genius
      Products, Inc. 30% share of net loss from the Distributor
                                      
                                      $
                                      26,946
                                      
                                      
                                      $
                                      1,979Adjustments
      for basis differences
                                      
                                      
                                      1,759
                                      
                                      
                                      
                                      3,330(Benefit)/Expense
      for stock compensation for Distributor employees
                                      
                                      
                                      (1,139
                                      )
                                      
                                      
                                      1,290Genius
      Products, Inc. 30% share of interest on the Distributor's notes
      payable
                                      
                                      
                                      (149
                                      )
                                      
                                      
                                      -Equity
      in net loss from Distributor
                                      
                                      $
                                      27,418
                                      
                                      
                                      $
                                      6,599




NOTE
6.  CONTINGENCIES





GUARANTY
OF 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 provided 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 Leicester 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.  The Amended Credit Agreement terminates on
September 30, 2010, and may be extended to August 10, 2010, under satisfaction
of certain conditions.  Borrowings outstanding under the Amended
Credit Agreement were $16.9 million at September 30, 2008. The maximum amount
available at September 30, 2008 was $20.6 million.  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.  See Note 11 for a description
of recent events related to the Distributor’s compliance with the terms and
conditions of the Amended Credit Agreement.





The
Company and the direct and indirect subsidiaries of the Distributor have
unconditionally guaranteed the obligations of the Distributor under the Amended
Credit Agreement (i.e., full and punctual payment of the Distributor’s
obligations, when and as due).  Management has assessed the Company’s
potential obligations under this guarantee 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 has not
recorded a liability on the Company’s balance sheets associated with this
guarantee.





16


LITIGATION


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





We have
disclosed in prior reports filed with the Securities and Exchange Commission a
complaint filed against the Company in the Circuit Court of Cook County,
Illinois by Falcon Picture Group, LLC (“Falcon”), and the related counterclaim
filed by the Company against Falcon and its owner, Carl Amari. There have been
no material developments in these matters. For a complete description of the
facts and circumstances surrounding this litigation, please see the disclosure
in our Annual Report on Form 10-K/A for the year ended December 31, 2007 under
Part I, Item 3., “Legal Proceedings”, which is incorporated herein by
reference.





Entertainment Resource
Matter





We have
disclosed in prior reports filed with the Securities and Exchange Commission a
complaint filed against the Company in the Circuit Court of Broward County,
Florida, Case No. 06-012249 CACE 05, by Larry S. Hyman, as assignee for
Entertainment Resource, Inc. (“ERI”).  There have been no material
developments in this matter.  For a complete description of the facts
and circumstances surrounding the ERI litigation, please see the disclosure in
our Annual Report on Form 10-K/A for the year ended December 31, 2007 under Part
I, Item 3., “Legal Proceedings”, which is incorporated herein by
reference.





NOTE
7.  NOTES RECEIVABLE FROM RELATED PARTY





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.  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 September 30, 2008, an aggregate of $8.7 million in
principal and accrued interest expense was outstanding under the
notes.





Payments
to TWC pursuant to the TWC Distribution Agreement are due 45 days from the last
day in the calendar month.   Through December 31, 2008, these
terms were extended by TWC anywhere from 15 to 45 days in order to provide
flexibility and manage cash flows.  As of January 1, 2009 and in connection
with the restructuring transactions described in Note 11, the TWC Distribution
Agreement was amended and restated and TWC and the Distributor agreed to a
schedule of payment for all amounts owed by the Distributor to TWC, which
schedules governs the payments going forward.





NOTE
8.  STOCKHOLDERS' EQUITY




COMMON
STOCK


During
the nine months ended September 30, 2008, we issued 50,000 common shares related
to the exercise of stock options for proceeds of $0.04 million.  In
addition, the Company retired 150,000 shares of its common stock in the second
quarter.  No warrants were exercised during the nine months ended
September 30, 2008.





During
the nine months ended September 30, 2007, we issued 3,189,320 common shares
related to the exercise of warrants (some of which were cashless exercises) for
proceeds of $3.6 million. Additionally, during the nine months ended September
30, 2007, we issued 993,829 common shares related to the exercise of options for
proceeds of $1.6 million.





17


A summary
of warrant activity follows:





Warrants
                                Outstanding
                              
                              
                              Weighted
                                  Average
                                  Exercise
                                Price
                              
                              Aggregate
                                Intrinsic
                                ValueDecember
      31, 2007
                              
                              
                              10,425,958
                              
                              
                              $
                              2.45Cancelled
                              
                              
                              (943,757
                              )September
      30, 2008
                              
                              
                              9,482,201
                              
                              
                              $
                              2.56
                              
                              
                              $
                              -Warrants
      exercisable, September 30, 2008
                              
                              
                              9,482,201
                              
                              
                              $
                              2.56
                              
                              
                              $
                              -




The
following information applies to warrants outstanding at September 30,
2008:





Warrants
                  Outstanding
                
                
                Average
                  Remaining
      Life
                
                
                Weighted
                  Average
                  Exercise
      Price of
                  Warrants
                  Outstanding
                
                
                Warrants
                  Exercisable
                
                
                Weighted
                  Average
                  Exercise
      Price of
                  Warrants
                  ExercisableUnder
      $1.50
                
                
                
                -
                
                
                
                -$1.50
      - $1.99
                
                
                
                170,722
                
                
                
                2.01
                
                
                
                1.88
                
                
                
                170,722
                
                
                
                1.88$2.00
      - $2.99
                
                
                
                7,664,479
                
                
                
                1.84
                
                
                
                2.48
                
                
                
                7,664,479
                
                
                
                2.48$3.00
      - $3.99
                
                
                
                1,647,000
                
                
                
                0.50
                
                
                
                3.00
                
                
                
                1,647,000
                
                
                
                3.009,482,201
                
                
                
                1.61
                
                
                $
                2.56
                
                
                
                9,482,201
                
                
                $
                2.56





NOTE
9.  STOCK-BASED COMPENSATION





The
following table summarizes the activity for outstanding options for the nine
months ended September 30, 2008:





Options
                                    Outstanding
                                  
                                  
                                  Weighted
                                    Average
                                    Exercise
                                    Price
                                  
                                  
                                  Aggregate
                                    Intrinsic
                                    ValueDecember
      31, 2007
                                  
                                  
                                  17,770,041
                                  
                                  
                                  $
                                  1.82Exercised
                                  
                                  
                                  (50,000
                                  )
                                  
                                  
                                  0.89Canceled
                                  
                                  
                                  (1,045,000
                                  )
                                  
                                  
                                  2.14September
      30, 2008
                                  
                                  
                                  16,675,041
                                  
                                  
                                  $
                                  1.81
                                  
                                  
                                  $
                                  -Options
      exercisable, September 30, 2008
                                  
                                  
                                  14,489,356
                                  
                                  
                                  $
                                  1.77
                                  
                                  
                                  $
                                  -




The
following table summarizes additional information regarding outstanding and
exercisable stock options as of September 30, 2008:





Options
                                  Outstanding
                                
                                
                                Average
                                    Remaining
      Life
                                
                                
                                Options
                                  Outstanding
                                
                                
                                Options
                                  Exercisable
                                
                                
                                Options
                                  ExercisableUnder
      $1.50
                                
                                
                                
                                1,900,752
                                
                                
                                
                                3.32
                                
                                
                                $
                                0.67
                                
                                
                                
                                1,900,752
                                
                                
                                $
                                0.67$1.50
      - $1.99
                                
                                
                                
                                10,161,039
                                
                                
                                
                                6.34
                                
                                
                                
                                1.72
                                
                                
                                
                                8,902,854
                                
                                
                                
                                1.70$2.00
      - $2.99
                                
                                
                                
                                3,633,500
                                
                                
                                
                                6.50
                                
                                
                                
                                2.16
                                
                                
                                
                                2,706,000
                                
                                
                                
                                2.11$3.00
      - $3.99
                                
                                
                                
                                706,250
                                
                                
                                
                                6.00
                                
                                
                                
                                3.00
                                
                                
                                
                                706,250
                                
                                
                                
                                3.00$4.00
      + over
                                
                                
                                
                                273,500
                                
                                
                                
                                5.10
                                
                                
                                
                                5.42
                                
                                
                                
                                273,500
                                
                                
                                
                                5.4216,675,041
                                
                                
                                
                                5.99
                                
                                
                                $
                                1.81
                                
                                
                                
                                14,489,356
                                
                                
                                $
                                1.77




For the
service-based stock options, the Distributor estimated share-based compensation
expense for the three and nine months ended September 30, 2008 and 2007 using
the Black-Scholes-Merton formula with the following weighted average
assumptions:


18





Three Months Ended
                        September 30,
      2008
                      
                      
                      Nine Months Ended
                        September 30,
      2008Risk
      free interest rate
                      
                      
                      3.6%
                      
                      
                      
                      3.6%Expected
      dividend yield
                      
                      
                      -
                      
                      
                      
                      -Expected
      volatility
                      
                      
                      73.9%
                      
                      
                      
                      73.8%Expected
      life (in years)
                      
                      
                      6.0
                      
                      
                      
                      6.0




For
market-based options, the Company 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.  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 54.46%.  The risk-free rates have
been determined based upon the interest rates for zero-coupon U.S. Treasury
bonds as of September 30, 2008.  A yield curve has been determined
based upon interpolating between the rates ranging from 1.02% to
3.85%.  Consistent with the service-based stock option grants, the
dividend rate is 0.0% for the performance-based option grants.





Total
share-based compensation expense recognized by the Company for the three and
nine months ended September 30, 2008 was $0.1 million and $0.2 million versus
compensation expense of $0.1 million and $0.7 for the three and nine months
ended September 30, 2007.  No income tax benefit was recognized in the
statement of operations for share-based compensation arrangements for the
Company.





In
relation to options issued by the Company to employees of the Distributor, the
Distributor recorded a share-based compensation benefit of $0.01 million and
$1.6 million for the three and nine months ended September 30, 2008 versus an
expense of $0.5 million and $1.8 million for the three and nine months ended
September 30, 2007.




NOTE
10.  INCOME TAXES





The
Company recorded a federal and state tax benefit of $12.8 million for the nine
months ended September 30, 2008.  The tax benefit resulted from the
reversal of the deferred tax liability related to our investment in the
Distributor primarily due to the impairment recorded.





NOTE
11.  SUBSEQUENT EVENTS





PURCHASE
AND SALE AGREEMENT


On
January 1, 2009 (the “Quadrant Transaction Closing Date”), the Company, the
Distributor, TWC Holdings, Weinstein GP Holdings, W-G Holding (collectively, W-G
Holding, TWC Holdings and Weinstein GP Holdings being referred to herein as the
“TWC Parties”), Quadrant Management, Inc. (“Quadrant”) and GNPR Investments LLC,
an affiliate of Quadrant (“GNPR Investments”), entered into a Purchase and Sale
Agreement (the “Purchase Agreement”) in connection with the restructuring of the
Distributor’s distribution relationship with TWC and the sale by the TWC Parties
of substantially all of their respective shares and ownership interests in the
Company and the Distributor (the “Quadrant Transaction”).





Pursuant
to the Purchase Agreement and effective as of the Quadrant Transaction Closing
Date, the Distributor and TWC agreed to settle all monetary obligations owing to
TWC by the Distributor on an accrued basis for all distribution activity through
September 30, 2008 pursuant to the Distribution Agreement between the
Distributor and TWC (as amended, the “TWC Distribution
Agreement”).  In connection with such settlement, (i) the Distributor
issued to TWC a promissory note in the principal amount of $20 million (the “TWC
Note”), which is payable on January 1, 2011 and accrues interest at a rate of 5%
per annum, (ii) the Distributor agreed to pay to TWC up to an additional $43.3
million,  from the Quadrant Transaction Closing Date through February
2010, subject to the satisfaction by TWC of certain conditions set forth in the
Purchase Agreement and (iii) the Distributor agreed to pay to TWC a further
amount to the extent the estimate of amounts payable from October through and
including December 2008 is less than the actual amounts determined to be payable
for such period, based on the monthly accounting statements for such periods and
subject to audit by TWC (to the extent such estimate exceeds the actual amounts
determined to be payable for such period, such excess may be offset by the
Distributor against future amounts owed to TWC). Subject to the Distributor’s
satisfaction of the aforementioned payment obligations, all remaining amounts
owed by the Distributor to TWC through December 31, 2008 shall be reduced to
zero and shall be extinguished.





19


Also
pursuant to the Purchase Agreement and effective as of the Quadrant Transaction
Closing Date, (i) the TWC Parties sold to GNPR Investments an aggregate of
122,010,252 Class W Units of the Distributor (representing a 60% ownership
interest in the Distributor) and the TWC Note for $20 million, and (ii) the TWC
Parties sold to the Company an aggregate of 100 shares of the Company’s Series W
Preferred Stock (representing 100% of the issued and outstanding shares of such
Series W Preferred Stock).  Immediately following the Quadrant
Transaction Closing Date, the TWC Parties collectively retained 20,335,042 Class
W Units of the Distributor, representing a 10% ownership interest in the
Distributor; provided that in connection with such sale, the TWC Parties
transferred to the applicable purchaser all of its rights to assert any
management, control or voting rights over the Distributor.





In
consideration for the sale of the Series W Preferred Stock, the Company issued
to TWC Holdings two warrants (the “TWC Warrants”) entitling TWC Holdings to
purchase in the aggregate 27,043,636 shares of the Company’s common stock
(representing 10% of the fully-diluted shares of the Company immediately
following the Quadrant Transaction Closing Date).  The first of the
TWC Warrants has a term of six (6) years, entitles TWC Holdings to purchase, for
an exercise price of $0.0001 per share, up to 13,521,818 shares of the Company’s
common stock and becomes exercisable in twelve (12) equal monthly installments
commencing on January 1, 2010.  The second of the TWC Warrants has a
term of seven (7) years, entitles TWC Holdings to purchase, for an exercise
price of $0.0001 per share, up to 13,521,818 shares of the Company’s common
stock and becomes exercisable in twelve (12) equal monthly installments
commencing on January 1, 2011.  The vesting of shares under each of
the TWC Warrants is conditioned on the effectiveness of the amended and restated
TWC Distribution Agreement and TWC continuing to be in the principal business of
producing, distributing, licensing and acquiring theatrical motion pictures,
with unvested shares subject to forfeiture in the event that TWC terminates such
agreement or ceases to engage in such business activities.





AMENDED
TWC DISTRIBUTION AGREEMENT


Pursuant
to the Purchase Agreement and effective as of the Quadrant Transaction Closing
Date, the Distributor and TWC entered into an Amended and Restated Distribution
Agreement (the “Amended TWC Distribution Agreement”), amending and restating the
TWC Distribution Agreement.  The Amended TWC Distribution Agreement
provides for, among other things, (i) the grant to the Distributor of the
exclusive right, in the United States and its territories, to distribute,
design, manufacture, advertise, publicize, promote and market TWC-owned or
controlled motion picture titles, with TWC retaining digital distribution rights
to such titles; (ii) a term expiring on December 31, 2010, subject to extension
by mutual consent until December 31, 2011; (iii) an increase in the distribution
fee payable to the Distributor for theatrical titles released on home video
after January 1, 2009; (iv) the elimination of all performance-based adjustments
to the distribution fee payable to the Distributor (i.e., adjustments based on
the level of home video sales of a title as compared to theatrical box office
performance); (v) the addition of provisions requiring that all Distributor home
video inventory created on or after October 1, 2008 and unsold at the end of the
term be purchased by TWC at Distributor’s cost, with all inventory created prior
to such date and unsold at the end of the term to be delivered to TWC at no
cost; (vi) the pre-approval by TWC of the outsourcing (and the Distributor’s
right to recoup outsourced costs) of certain distribution services; (vii) an
increase in the Distributor’s permissible returns reserve; (viii) the
elimination of provisions requiring the Distributor to maintain dedicated staff
for the distribution of TWC product; (ix) the elimination of provisions
requiring the Distributor to present content acquisition opportunities to TWC
before the Distributor engages in such opportunities; (x) additional rights of
the Distributor to recoup the costs of all approved third party manufacturing,
distribution and marketing expenses, including all supply-chain expenses; (xi)
the addition of potential incentive payments to TWC if certain distribution fees
are earned by the Distributor from January 1, 2009 through December 31, 2010,
subject to certain terms and conditions; (xii) the ability of the Distributor to
cross-collateralize and recoup up to $7.5 million of unrecouped distribution and
marketing expenses each month (up to $10 million for the period from October 1,
2009 through March 31, 2010), subject to certain terms and conditions; (xiii)
the requirement to deliver to TWC monthly accounting statements within forty
(40) days after the end of each month; (xiv) the elimination of provisions
allowing TWC to terminate the agreement based on performance levels of the
Distributor, such that TWC retains the right to terminate the Amended TWC
Distribution Agreement only upon material default, an insolvency event or
certain change of control events; (xv) the elimination of TWC’s right and/or
obligation to “buy back” the distribution rights granted to the Distributor,
with all such distribution rights terminating on expiration or termination of
the term; (xvi) the elimination of “most favored nation” clauses in favor of
TWC, except with respect only to distribution fees payable to the
Distributor.





EXCHANGE
AGREEMENT AND OTHER QUADRANT TRANSACTION DOCUMENTS





Exchange
Agreement


Pursuant
to the Purchase Agreement, the Company, GNPR Investments and the TWC Parties
entered into an Exchange Agreement (the “Exchange Agreement”), pursuant to which
GNPR Investments and the TWC Parties agreed, subject to obtaining all necessary
approvals from the Company’s Board of Directors and stockholders, to transfer to
the Company all of their respective Class W Units of the Distributor in exchange
for shares of a newly created Series A Interim Convertible Preferred Stock of
the Company, which Series A Convertible Preferred Stock would entitle (i) GNPR
Investments to convert their preferred shares into shares of the Company’s
common stock representing 60% of all issued and outstanding common shares and
(ii) the TWC Parties to convert their preferred shares into shares of the
Company’s common stock representing 10% of all issued and outstanding common
shares.  The transactions contemplated by the Exchange Agreement were
consummated effective as of January 15, 2009, and, as a result, effective as of
such date, the Distributor became a wholly-owned subsidiary of the
Company.





20


Amendment
to Distributor LLC Agreement


Pursuant
to the Purchase Agreement, the parties agreed to amend and restate the
Distributor’s Amended and Restated Limited Liability Company Agreement upon the
consummation of, and to reflect, the transactions contemplated in the Exchange
Agreement, subject to obtaining any necessary Company Board of Directors and/or
stockholder approvals in connection with such amendments.





Amendment
to Credit Agreement


In
connection with the Quadrant Transaction and effective as of December 31, 2008,
the Distributor entered into a Limited Consent and Amendment No. 3 to Amended
and Restated Credit Agreement (the “Credit Agreement Amendment”) with Société
Générale, as administrative agent, collateral agent and L/C Issuer, the lenders
party thereto, and Alliance & Leicester Commercial Finance plc
(collectively, the “Lenders”).  The Credit Agreement Amendment amends
the existing Amended and Restated Credit Agreement, dated as of November 1, 2007
(as amended, the “Credit Agreement”).





Pursuant
to the Credit Agreement Amendment, among other things, (i) the Lenders consented
to the Quadrant Transaction, (ii) the maturity date of the credit facility was
set at August 31, 2009; (iii) the total commitment of the revolving credit
facility is subject to reduction from $37.5 million to $30 million on March 31,
2009,  and to $25 million on June 30, 2009; (iv) the percentage of
receivables that count towards establishing the Distributor’s borrowing base is
reduced over time from 80% currently to 65% as of June 30, 2009 and thereafter;
(v) the interest rate for each LIBOR Loan and Base Rate Loan (each as defined in
the Credit Agreement Amendment) are increased to set amounts of 4% and 3%,
respectively; and (vi)  additional financial covenants of the
Distributor are added, requiring the Distributor to maintain certain minimum
Borrowing Base Percentages and OIBDA (each as defined in the Credit Agreement
Amendment).





Other
Transaction Agreements


Pursuant
to the Purchase Agreement, the Company also entered into a Stockholder Rights
Agreement with TWC Holdings and GNPR Investments, pursuant to which (i) GNPR
Investments granted to TWC Holdings the right to participate, on a pro rata
basis, in a proposed bona fide sale or transfer by GNPR Investments of any
equity securities of the Company; (ii) TWC Holdings and GNPR Investments agreed
to vote for any proposed acquisition of the Company approved by the Company’s
Board of Directors and a majority of its common stockholders; and (iii) TWC
Holdings granted to the Company a right of first refusal with respect to any
proposed sale by TWC Holdings of any of its equity securities of the Company
(with such right of first refusal transferring to GNPR Investments if the
Company declines to exercise such right), in each case subject to limited
exceptions.





In
addition, the Company also entered into a Registration Rights Agreement with TWC
Holdings and GNPR Investments, pursuant to which the Company agreed to register
for resale the shares of Company common stock issuable (i) upon conversion of
the Series A Interim Convertible Preferred Stock that was issued to TWC Holdings
and GNPR Investments upon the consummation of the transactions contemplated by
the Exchange Agreement and/or (ii) upon the exercise of the TWC
Warrants.  Pursuant to the Registration Rights Agreement, the Company
agreed to file an initial registration statement with the Securities and
Exchange Commission no later than the forty-fifth (45th) day
after the Quadrant Transaction Closing Date.





Pursuant
to the Purchase Agreement and effective as of the Closing Date, each of (i) that
certain Master Contribution Agreement, dated as of December 5, 2005, by and
among the Company, TWC Holdings and TWC and (ii) that certain Registration
Rights Agreement, dated on or about July 21, 2006, between the Company and TWC,
were terminated in their entirety.





QUADRANT
SERVICES AGREEMENT


On
January 2, 2009, the Special Committee of the Board of Directors of the Company,
on behalf of the Company, entered into a letter agreement (the “Restructuring
Services Agreement”) with Quadrant, pursuant to which the Company agreed to pay
to Quadrant $4 million in cash (by no later than January 2, 2009) in
consideration for restructuring services provided by Quadrant since September
2008, including, among other services, securing $20 million in debt financing
for the Company and the Distributor, negotiating the restructuring of the
Distributor’s payment obligations to TWC and negotiating and obtaining Société
Générale’s consent to the Quadrant Transaction.





NOTE AND
WARRANT PURCHASE AGREEMENT


On
February 17, 2009, the Company and the Distributor entered into a Note and
Warrant Purchase Agreement (the “Note and Warrant Purchase Agreement”) with
certain institutional investors (the “Investors”), pursuant to which, among
other things, (i) the Distributor issued to the Investors promissory notes with
an aggregate principal balance of $5 million (the “Investor Notes”) and (ii) the
Company  issued to the Investors five-year warrants to purchase
an aggregate of up to 1,109,073,910 shares of the Company’s Common Stock at an
exercise price of $0.0001 per share (the “Investor
Warrants”).  Pursuant to the terms of the Note and Warrant Purchase
Agreement, the Company and the Distributor may engage in subsequent
closings and issue an aggregate of up to $9.5 million of Investor Notes and an
aggregate of up to 1,984,587,356 Investor Warrants.


21





The
principal amounts of the Investor Notes are due and payable on December 31, 2010
and accrue interest at a rate of 5% per annum as of February 17,
2009.  At the Distributor’s option and provided that the expiration
date of the Amended TWC Distribution Agreement is extended to no earlier than
December 31, 2011, the maturity date of the Investor Notes may be extended until
December 31, 2011, in which case the Investor Notes shall accrue interest at a
rate of 10% per annum for such extension period.  Repayment of all of
the Investor Notes is subordinated to amounts owed by the Distributor to Société
Générale.





The
Investor Warrants are mandatorily exercisable at such time that the Company has
sufficient authorized Common Stock to allow for the exercise of the Investor
Warrants and the conversion of the Company’s Series A Interim Convertible
Preferred Stock.




The
Company is obligated to register for resale the shares of Common Stock issuable
upon exercise of the Investor Warrants on a registration statement to be filed
within forty-five (45) days after the closing of the Note and Warrant Purchase
Agreement; provided that if the Company takes material steps toward terminating
the registration of its Common Stock under the Exchange Act by May 30, 2009, the
obligation to file the registration statement will be delayed for one
year.





The
Company intends to use the proceeds of the Investor Notes to repay existing
indebtedness or for other general corporate purposes.





RECENT
EVENTS RELATING TO LIQUIDITY AND CAPITAL RESOURCES


As a
result of the recent economic conditions (including a decrease in consumer
confidence resulting in lower spending levels) and a reduced slate of
pictures, the Distributor has experienced a significant reduction in net
revenues and liquidity issues.  In addition, the Distributor is
currently not in compliance with certain terms, conditions and covenants of the
Amended Credit Agreement, and also is in a dispute with TWC relating to payments
under the TWC Distribution Agreement.  Based on current operating results,
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. Further, the Distributor is also in discussions
with its lender and TWC to cure and/or resolve such instances of non-compliance
and disputes.  The Distributor is pursuing these options to alleviate
the liquidity shortfall position that it currently finds itself in.  At
this time, the Distributor is unable to conclude if the aforementioned actions
being taken will be successful. If the Distributor is unable to cure such
instances of non-compliance under the Amended Credit Agreement, the
Distributor’s lender could, among other remedies, cease to extend future loans
to the Distributor, accelerate any amounts owed by the Distributor under the
Amended Credit Agreement and/or foreclose on its security interest in the
Distributor’s assets.  If the Distributor is unable to successfully
resolve its disputes with TWC, TWC could seek to terminate the TWC Distribution
Agreement.  In either such case and/or 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 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 6), 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.








ITEM 2.
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS




Management’s
discussion and analysis of financial condition and results of operation of the
Company and the Distributor, as applicable, as of and for the periods ended
September 30, 2008 and 2007are based upon events and circumstances as of
September 30, 2008 and do not reflect the impact of any events that occurred
since September 30, 2008, which events are more particularly described under the
heading “Subsequent Events” and in the Company’s Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 24,
2009.





The
following discussion of our financial condition and results of operations should
be read in conjunction with the financial statements and notes thereto contained
in this report. The discussion contains forward-looking statements that relate
to future events or our future financial performance that involve known and
unknown risks, uncertainties and other factors that may cause our 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 Part I, Item 1A in our Amendment No. 1 to Annual
Report on Form 10-K/A for the year ended December 31, 2007 filed on March 25,
2009.





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”), and a 14% percentage interest owned indirectly through its
indirect wholly-owned subsidiary, Weinstein GP Holdings LLC (“Weinstein GP
Holdings”)).  TWC Holdings is the subsidiary company of The Weinstein
Company LLC (“TWC”), the largest provider of content for the Distributor’s
library.





22


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 has the 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:  ESPN®, World Wrestling
Entertainment®, 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.  We
believe that the strong relationships the Distributor has developed with these
well-known retailers as well as with the Distributor’s 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
Distributor currently distributes its library on DVDs, next-generation DVD, and
electronically in a digital format.  We plan 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 176
theatrical and non-theatrical titles since inception.  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 RHI EntertainmentTM (Hallmark library), The
      Weinstein Company®  and
WellspringTM)


·
            Sports
      (includes ESPN® and World Wrestling
  Entertainment®)


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


·
            Family/Faith
      (includes Discovery KidsTM, and Sesame
Workshop®)




The
Distributor maintains in perpetuity distribution rights for TWC content released
during the term of the TWC Distribution Agreement, subject to certain buy-back
rights of the TWC content by TWC.





Under the
TWC Distribution Agreement, TWC granted a license to the Distributor to
manufacture, promote and sell in the U.S. and its territories and possessions,
through December 31, 2010 (or December 31, 2013 if TWC extends the term), DVDs,
videocassettes and other forms of pre-recorded home video of feature films and
direct-to-video releases which TWC has the right to distribute on home video.
These releases include films produced by TWC as well as films which TWC acquires
or obtains the right to distribute on home video. The TWC Distribution Agreement
provides that the Distributor will earn a fee on sales of these home video
products, depending on the level of these sales compared to theatrical box
office revenues for the same films. The Distributor collects the proceeds from
sales of home video products and remits these proceeds to TWC, minus the
Distributor’s distribution fee, cost of goods sold (including manufacturing
expenses) and certain marketing expenses.  The TWC Distribution
Agreement was substantially amended on January 1, 2009 in connection with the
Quadrant Transaction (see Note 11 of the condensed unaudited interim financial
statements).





23


CRITICAL
ACCOUNTING POLICIES





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.





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 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 the Company’s
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
Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements(“FAS 157”), which the Company adopted beginning on January 1,
2008.  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.





STOCK-BASED
COMPENSATION


Under
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.





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.





24


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 historically 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 was not offset against the
deferred tax assets as the reversal period for this amount was not considered to
be determinable on a more likely than not basis.  In the current
period, the tax basis of our investment in Distributor surpassed the amount for
financial reporting purposes.  Accordingly, the entire deferred tax
liability was reversed.





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
de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition.  We have no material unrecognized
tax benefits or exposure at September 30, 2008.








RESULTS
OF OPERATIONS OF GENIUS PRODUCTS, INC.





All of
the operations of the Company relate to the activity 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, 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 No. 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.  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
sheets.





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 three and nine months ended September 30, 2008
and the three and nine months ended September 30, 2007.  All of the
revenue is reflected in the results of operations of the Distributor. The
Distributor generated net revenue of $77.2 million net of sales returns,
discounts and allowances of $31.5 million for the three months ended September
30, 2008 versus net revenue of $93.4 million net of sales returns, discounts and
allowances of $42.1 million for the three  months ended September 30,
2007.  The Distributor generated net revenue of $250.1 million net of
sales returns, discounts and allowances of $112.3 million for the nine months
ended September 30, 2008 versus net revenue of $289.2 million net of sales
returns, discounts and allowances of $106.2 million for the nine months ended
September 30, 2007.





The
Distributor’s net revenue attributable to TWC titles for the three and nine
months ended September 30, 2008 were $47.6 million and $156.7 million,
respectively, a decrease of $3.4 million (or 6.7%) and $36.2 million (or 18.8%),
respectively, as compared to the three and nine months ended September 30,
2007.  The quality of the U.S. box office performance for the TWC
titles is one of the principal factors that contribute to changes in revenues
attributable to TWC titles.  TWC titles released during the three and
nine months ended September 30, 2008 included, among others, Superhero, Rogue, The Promotion, Pulse 2, Blueberry Knights, Tortoise, Thai Chi Master, Last
Winter, and Where in
the World is Osama Bin Laden?,The Mist and The Great
Debaters.  These titles represented approximately 55% of the
Distributor’s third quarter net revenue.  The U.S. box office revenues
generated by all TWC titles released during the three and nine months ended
September 30, 2008 declined by 7% and 20%, respectively, as compared to the
three and nine months ended September 30 2007. We also experienced a higher rate
of returns due to the weaker slate of releases.





25


Net
revenue from non-TWC titles for the three and nine months ended September 30,
2008 were $29.6 million and $93.4 million, respectively, a decrease of $12.8
million (or 30.2%) and $2.9 million (or 3.0%), respectively, as compared to the
three and nine months ended September 30, 2007.  The decrease in net
revenues for the three and nine months ended September 30, 2008 was primarily
due to a reduced slate of holiday-themed titles released in the third quarter of
2008, as compared to the third quarter of 2007.





Cost
of Revenues




The
Company did not have any costs of revenues for the three and nine months ended
September 30, 2008 or for the three months and nine months ended September 30,
2007.  All of the costs of revenues are reflected in the results of
operations of the Distributor.





Costs of
revenues for the Distributor consist primarily of raw material and manufacturing
costs of products sold to customers, packaging and shipping costs, advertising
and marketing, amortization of the film library, and participations and
royalties. Participation expenses related to TWC’s distribution agreement are
calculated based on SOP 00-2 whereby such costs of revenues are amortized using
the film forecast method over a period of two years.





The
Distributor’s costs of revenues were $111.6 and $289.3 million for the three and
nine months ended September 30, 2008, respectively, as compared to $86.6 million
and $262.6 million for the three and nine months ended September 30, 2007,
respectively.  The primary factor for the $25 million (or 28.9%) and
$26.7 million (or 10.2%) increase in costs of revenues for the three and nine
months ended September 30, 2008, respectively, was an increase in participation
expenses related to TWC and non-TWC titles which resulted from, among other
things, product mix.  In addition, amortization of intangibles and
film library increased by $8.1 million or 578.6% for the three months ended
September 30, 2008, as compared to the three months ended September 30,
2007.  This increase resulted from a $5.7 million impairment charge
related to certain co-production titles, an increase of $3.0 million in
amortization of film library based on an evaluation of fair value and
re-alignment of company resources, offset by a decrease of $0.6 million in
amortization of intangibles due to the write off of certain intangible assets
which were deemed to be impaired in previous quarters of
2008.  Amortization of intangibles and film library increased by $15.5
million or 534.5% for the nine months ended September 30, 2008, as compared to
the nine months ended September 30, 2007.  This increase resulted from
an impairment charge of $7.1 million related to certain co-production
titles.  In addition, the Distributor increased the amortization of
the film library by $4.2 million based on re-alignment of company resources, and
recognized an impairment of intangible assets of $4.2 million based on an
evaluation of the fair market value of the related assets.





The
increase in costs of revenues for the three and nine months ended September 30,
2008, as compared to the three and nine months ended September 30, 2007, was
partially offset by a reduction in product costs and supply chain costs of $4.2
million and $4.5 million, respectively, and a reduction in marketing and
advertising costs of $5.1 million and $12.1 million,
respectively.  The reduction in such costs was primarily driven by the
Distributor’s reduced revenues, efficiencies in managing costs and the
implementation of strict budgetary controls.





Operating
Expenses




The
Company had selling, general and administrative expenses of $1.2 million and
$3.9 million for the three and nine months ended September 30, 2008,
respectively, as compared to $1.3 million and $3.9 million for the three and
nine months ended September 30, 2007, respectively.





The
Company’s 30% equity in the net loss of the Distributor was $13.8 and $27.4
million for the three and nine months ended September 30, 2008 as compared to
$3.0 million and $6.6 million for the three and nine months ended September 30,
2007.  Included within the Company’s 30% equity in the net loss of the
Distributor for the nine months ended September 30, 2008 was $6.2 million
resulting from the Distributor recording an impairment of its goodwill and
intangible assets.





An
independent financial and strategic advisory firm engaged by the Company
determined the fair value of the Distributor as of September 30, 2008, which
resulted in the Company recording a further impairment charge of $1.1 million
for the three months ended September 30, 2008, and $36.0 million for the nine
months ended September 30, 2008 as the Company concluded that an other than
temporary decline had occurred in the fair value of the Distributor as of
September 30, 2008.





Other Income and
Expense





The
Company had other income of $0.8 million and $2.3 million for the three and nine
months ended September 30, 2008, respectively, versus other expense of $0.03
million and other income of $0.5 million for the three and nine months ended
September 30, 2007, respectively.  Other income reflects the
re-measurement of the Class W Option Liability.  The Company also had
interest income of $0.1 million and $0.4 million for the three and nine months
ended September 30, 2008 versus $0.09 million and $0.2 million for the three and
nine months ended September 30, 2007.





26


LIQUIDITY
AND CAPITAL RESOURCES




At
September 30, 2008, the Company had cash balances of $1.8 million and the
Distributor had cash and restricted cash balances of $10.1 million.  The
restricted cash balances are associated with (i) required minimum cash balances
pursuant to the Amended Credit Agreement, (ii) certain bank accounts that are
subject to semi-monthly disbursements to the Distributor and other parties under
a waterfall of funds prescribed by the Amended Credit Agreement, and (iii) an
office lease security deposit.





The
Distributor has limited access to additional capital and has used its maximum
availability under its current credit facility which was $20.6 million as of
September 30, 2008.  In the event that non-TWC revenue increase, resulting
in increased non-TWC receivables, the Distributor’s availability will increase
under its current credit facility.  Notwithstanding, near term cash
needs are met through support from TWC. Payments to TWC under the TWC
Distribution Agreement 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.





As a
result of the recent economic conditions (including a decrease in consumer
confidence resulting in lower spending levels) and a reduced slate of pictures,
the Distributor has experienced a significant reduction in net revenues and
liquidity issues.  In addition, the Distributor is currently not in
compliance with certain terms, conditions and covenants of the Amended Credit
Agreement, and also is in a dispute with TWC relating to payments under the TWC
Distribution Agreement.  Based on current operating results, 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. Further, the Distributor is also in
discussions with its lender and TWC to cure and/or resolve such instances of
non-compliance and disputes.  The Distributor is pursuing these
options to alleviate the liquidity shortfall position that it currently finds
itself in.  At this time, the Distributor is unable to conclude if the
aforementioned actions being taken will be successful. If the Distributor is
unable to cure such instances of non-compliance under the Amended Credit
Agreement, the Distributor’s lender could, among other remedies, cease to extend
future loans to the Distributor, accelerate any amounts owed by the Distributor
under the Amended Credit Agreement and/or foreclose on its security interest in
the Distributor’s assets.  If the Distributor is unable to
successfully resolve its disputes with TWC, TWC could seek to terminate the TWC
Distribution Agreement.  In either such case and/or 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 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, any
adverse impact on the operations and liquidity of the Distributor could also
adversely impact the Company’s results of operations and liquidity.








SUBSEQUENT
EVENTS





PURCHASE
AND SALE AGREEMENT


On
January 1, 2009 (the “Quadrant Transaction Closing Date”), the Company, the
Distributor, TWC Holdings, Weinstein GP Holdings, W-G Holding (collectively, W-G
Holding, TWC Holdings and Weinstein GP Holdings being referred to herein as the
“TWC Parties”), Quadrant Management, Inc. (“Quadrant”) and GNPR Investments LLC,
an affiliate of Quadrant (“GNPR Investments”), entered into a Purchase and Sale
Agreement (the “Purchase Agreement”) in connection with the restructuring of the
Distributor’s distribution relationship with TWC and the sale by the TWC Parties
of substantially all of their respective shares and ownership interests in the
Company and the Distributor (the “Quadrant Transaction”).





Pursuant
to the Purchase Agreement and effective as of the Quadrant Transaction Closing
Date, the Distributor and TWC agreed to settle all monetary obligations owing to
TWC by the Distributor on an accrued basis for all distribution activity through
September 30, 2008 pursuant to the Distribution Agreement between the
Distributor and TWC (as amended, the “TWC Distribution
Agreement”).  In connection with such settlement, (i) the Distributor
issued to TWC a promissory note in the principal amount of $20 million (the “TWC
Note”), which is payable on January 1, 2011 and accrues interest at a rate of 5%
per annum, (ii) the Distributor agreed to pay to TWC up to an additional $43.3
million,  from the Quadrant Transaction Closing Date through February
2010, subject to the satisfaction by TWC of certain conditions set forth in the
Purchase Agreement and (iii) the Distributor agreed to pay to TWC a further
amount to the extent the estimate of amounts payable from October through and
including December 2008 is less than the actual amounts determined to be payable
for such period, based on the monthly accounting statements for such periods and
subject to audit by TWC (to the extent such estimate exceeds the actual amounts
determined to be payable for such period, such excess may be offset by the
Distributor against future amounts owed to TWC). Subject to the Distributor’s
satisfaction of the aforementioned payment obligations, all remaining amounts
owed by the Distributor to TWC through December 31, 2008 shall be reduced to
zero and shall be extinguished.




27





Also
pursuant to the Purchase Agreement and effective as of the Quadrant Transaction
Closing Date, (i) the TWC Parties sold to GNPR Investments an aggregate of
122,010,252 Class W Units of the Distributor (representing a 60% ownership
interest in the Distributor) and the TWC Note for $20 million, and (ii) the TWC
Parties sold to the Company an aggregate of 100 shares of the Company’s Series W
Preferred Stock (representing 100% of the issued and outstanding shares of such
Series W Preferred Stock).  Immediately following the Quadrant
Transaction Closing Date, the TWC Parties collectively retained 20,335,042 Class
W Units of the Distributor, representing a 10% ownership interest in the
Distributor; provided that in connection with such sale, the TWC Parties
transferred to the applicable purchaser all of its rights to assert any
management, control or voting rights over the Distributor.





In
consideration for the sale of the Series W Preferred Stock, the Company issued
to TWC Holdings two warrants (the “TWC Warrants”) entitling TWC Holdings to
purchase in the aggregate 27,043,636 shares of the Company’s common stock
(representing 10% of the fully-diluted shares of the Company immediately
following the Quadrant Transaction Closing Date).  The first of the
TWC Warrants has a term of six (6) years, entitles TWC Holdings to purchase, for
an exercise price of $0.0001 per share, up to 13,521,818 shares of the Company’s
common stock and becomes exercisable in twelve (12) equal monthly installments
commencing on January 1, 2010.  The second of the TWC Warrants has a
term of seven (7) years, entitles TWC Holdings to purchase, for an exercise
price of $0.0001 per share, up to 13,521,818 shares of the Company’s common
stock and becomes exercisable in twelve (12) equal monthly installments
commencing on January 1, 2011.  The vesting of shares under each of
the TWC Warrants is conditioned on the effectiveness of the amended and restated
TWC Distribution Agreement and TWC continuing to be in the principal business of
producing, distributing, licensing and acquiring theatrical motion pictures,
with unvested shares subject to forfeiture in the event that TWC terminates such
agreement or ceases to engage in such business activities.





AMENDED
TWC DISTRIBUTION AGREEMENT


Pursuant
to the Purchase Agreement and effective as of the Quadrant Transaction Closing
Date, the Distributor and TWC entered into an Amended and Restated Distribution
Agreement (the “Amended TWC Distribution Agreement”), amending and restating the
TWC Distribution Agreement.  The Amended TWC Distribution Agreement
provides for, among other things, (i) the grant to the Distributor of the
exclusive right, in the United States and its territories, to distribute,
design, manufacture, advertise, publicize, promote and market TWC-owned or
controlled motion picture titles, with TWC retaining digital distribution rights
to such titles; (ii) a term expiring on December 31, 2010, subject to extension
by mutual consent until December 31, 2011; (iii) an increase in the distribution
fee payable to the Distributor for theatrical titles released on home video
after January 1, 2009; (iv) the elimination of all performance-based adjustments
to the distribution fee payable to the Distributor (i.e., adjustments based on
the level of home video sales of a title as compared to theatrical box office
performance); (v) the addition of provisions requiring that all Distributor home
video inventory created on or after October 1, 2008 and unsold at the end of the
term be purchased by TWC at Distributor’s cost, with all inventory created prior
to such date and unsold at the end of the term to be delivered to TWC at no
cost; (vi) the pre-approval by TWC of the outsourcing (and the Distributor’s
right to recoup outsourced costs) of certain distribution services; (vii) an
increase in the Distributor’s permissible returns reserve; (viii) the
elimination of provisions requiring the Distributor to maintain dedicated staff
for the distribution of TWC product; (ix) the elimination of provisions
requiring the Distributor to present content acquisition opportunities to TWC
before the Distributor engages in such opportunities; (x) additional rights of
the Distributor to recoup the costs of all approved third party manufacturing,
distribution and marketing expenses, including all supply-chain expenses; (xi)
the addition of potential incentive payments to TWC if certain distribution fees
are earned by the Distributor from January 1, 2009 through December 31, 2010,
subject to certain terms and conditions; (xii) the ability of the Distributor to
cross-collateralize and recoup up to $7.5 million of unrecouped distribution and
marketing expenses each month (up to $10 million for the period from October 1,
2009 through March 31, 2010), subject to certain terms and conditions; (xiii)
the requirement to deliver to TWC monthly accounting statements within forty
(40) days after the end of each month; (xiv) the elimination of provisions
allowing TWC to terminate the agreement based on performance levels of the
Distributor, such that TWC retains the right to terminate the Amended TWC
Distribution Agreement only upon material default, an insolvency event or
certain change of control events; (xv) the elimination of TWC’s right and/or
obligation to “buy back” the distribution rights granted to the Distributor,
with all such distribution rights terminating on expiration or termination of
the term; (xvi) the elimination of “most favored nation” clauses in favor of
TWC, except with respect only to distribution fees payable to the
Distributor.





EXCHANGE
AGREEMENT AND OTHER QUADRANT TRANSACTION DOCUMENTS





Exchange
Agreement


Pursuant
to the Purchase Agreement, the Company, GNPR Investments and the TWC Parties
entered into an Exchange Agreement (the “Exchange Agreement”), pursuant to which
GNPR Investments and the TWC Parties agreed, subject to obtaining all necessary
approvals from the Company’s Board of Directors and stockholders, to transfer to
the Company all of their respective Class W Units of the Distributor in exchange
for shares of a newly created Series A Interim Convertible Preferred Stock of
the Company, which Series A Convertible Preferred Stock would entitle (i) GNPR
Investments to convert their preferred shares into shares of the Company’s
common stock representing 60% of all issued and outstanding common shares and
(ii) the TWC Parties to convert their preferred shares into shares of the
Company’s common stock representing 10% of all issued and outstanding common
shares.  The transactions contemplated by the Exchange Agreement were
consummated effective as of January 15, 2009, and, as a result, effective as of
such date, the Distributor became a wholly-owned subsidiary of the
Company.





28


Amendment
to Distributor LLC Agreement


Pursuant
to the Purchase Agreement, the parties agreed to amend and restate the
Distributor’s Amended and Restated Limited Liability Company Agreement upon the
consummation of, and to reflect, the transactions contemplated in the Exchange
Agreement, subject to obtaining any necessary Company Board of Directors and/or
stockholder approvals in connection with such amendments.





Amendment
to Credit Agreement


In
connection with the Quadrant Transaction and effective as of December 31, 2008,
the Distributor entered into a Limited Consent and Amendment No. 3 to Amended
and Restated Credit Agreement (the “Credit Agreement Amendment”) with Société
Générale, as administrative agent, collateral agent and L/C Issuer, the lenders
party thereto, and Alliance & Leicester Commercial Finance plc
(collectively, the “Lenders”).  The Credit Agreement Amendment amends
the existing Amended and Restated Credit Agreement, dated as of November 1, 2007
(as amended, the “Credit Agreement”).





Pursuant
to the Credit Agreement Amendment, among other things, (i) the Lenders consented
to the Quadrant Transaction, (ii) the maturity date of the credit facility was
set at August 31, 2009; (iii) the total commitment of the revolving credit
facility is subject to reduction from $37.5 million to $30 million on March 31,
2009,  and to $25 million on June 30, 2009; (iv) the percentage of
receivables that count towards establishing the Distributor’s borrowing base is
reduced over time from 80% currently to 65% as of June 30, 2009 and thereafter;
(v) the interest rate for each LIBOR Loan and Base Rate Loan (each as defined in
the Credit Agreement Amendment) are increased to set amounts of 4% and 3%,
respectively; and (vi)  additional financial covenants of the
Distributor are added, requiring the Distributor to maintain certain minimum
Borrowing Base Percentages and OIBDA (each as defined in the Credit Agreement
Amendment).





Other
Transaction Agreements


Pursuant
to the Purchase Agreement, the Company also entered into a Stockholder Rights
Agreement with TWC Holdings and GNPR Investments, pursuant to which (i) GNPR
Investments granted to TWC Holdings the right to participate, on a pro rata
basis, in a proposed bona fide sale or transfer by GNPR Investments of any
equity securities of the Company; (ii) TWC Holdings and GNPR Investments agreed
to vote for any proposed acquisition of the Company approved by the Company’s
Board of Directors and a majority of its common stockholders; and (iii) TWC
Holdings granted to the Company a right of first refusal with respect to any
proposed sale by TWC Holdings of any of its equity securities of the Company
(with such right of first refusal transferring to GNPR Investments if the
Company declines to exercise such right), in each case subject to limited
exceptions.





In
addition, the Company also entered into a Registration Rights Agreement with TWC
Holdings and GNPR Investments, pursuant to which the Company agreed to register
for resale the shares of Company common stock issuable (i) upon conversion of
the Series A Interim Convertible Preferred Stock that was issued to TWC Holdings
and GNPR Investments upon the consummation of the transactions contemplated by
the Exchange Agreement and/or (ii) upon the exercise of the TWC
Warrants.  Pursuant to the Registration Rights Agreement, the Company
agreed to file an initial registration statement with the Securities and
Exchange Commission no later than the forty-fifth (45th) day
after the Quadrant Transaction Closing Date.





Pursuant
to the Purchase Agreement and effective as of the Closing Date, each of (i) that
certain Master Contribution Agreement, dated as of December 5, 2005, by and
among the Company, TWC Holdings and TWC and (ii) that certain Registration
Rights Agreement, dated on or about July 21, 2006, between the Company and TWC,
were terminated in their entirety.





QUADRANT
SERVICES AGREEMENT


On
January 2, 2009, the Special Committee of the Board of Directors of the Company,
on behalf of the Company, entered into a letter agreement (the “Restructuring
Services Agreement”) with Quadrant, pursuant to which the Company agreed to pay
to Quadrant $4 million in cash (by no later than January 2, 2009) in
consideration for restructuring services provided by Quadrant since September
2008, including, among other services, securing $20 million in debt financing
for the Company and the Distributor, negotiating the restructuring of the
Distributor’s payment obligations to TWC and negotiating and obtaining Société
Générale’s consent to the Quadrant Transaction.





NOTE AND
WARRANT PURCHASE AGREEMENT


On
February 17, 2009, the Company and the Distributor entered into a Note and
Warrant Purchase Agreement (the “Note and Warrant Purchase Agreement”) with
certain institutional investors (the “Investors”), pursuant to which, among
other things, (i) the Distributor issued to the Investors promissory notes with
an aggregate principal balance of $5 million (the “Investor Notes”) and (ii) the
Company  issued to the Investors five-year warrants to purchase an
aggregate of up to 1,109,073,910 shares of the Company’s Common Stock at an
exercise price of $0.0001 per share (the “Investor
Warrants”).  Pursuant to the terms of the Note and Warrant Purchase
Agreement, the Company and the Distributor may engage in subsequent closings and
issue an aggregate of up to $9.5 million of Investor Notes and an aggregate of
up to 1,984,587,356 Investor Warrants.





29


The
principal amounts of the Investor Notes are due and payable on December 31, 2010
and accrue interest at a rate of 5% per annum as of February 17,
2009.  At the Distributor’s option and provided that the expiration
date of the Amended TWC Distribution Agreement is extended to no earlier than
December 31, 2011, the maturity date of the Investor Notes may be extended until
December 31, 2011, in which case the Investor Notes shall accrue interest at a
rate of 10% per annum for such extension period.  Repayment of all of
the Investor Notes is subordinated to amounts owed by the Distributor to Société
Générale.





The
Investor Warrants are mandatorily exercisable at such time that the Company has
sufficient authorized Common Stock to allow for the exercise of the Investor
Warrants and the conversion of the Company’s Series A Interim Convertible
Preferred Stock.




The
Company is obligated to register for resale the shares of Common Stock issuable
upon exercise of the Investor Warrants on a registration statement to be filed
within forty-five (45) days after the closing of the Note and Warrant Purchase
Agreement; provided that if the Company takes material steps toward terminating
the registration of its Common Stock under the Exchange Act by May 30, 2009, the
obligation to file the registration statement will be delayed for one
year.





The
Company intends to use the proceeds of the Investor Notes to repay existing
indebtedness or for other general corporate purposes.








ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK




As of
September 30, 2008, 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 4.  CONTROLS AND
PROCEDURES





Disclosure
Controls and Procedures





We
maintain disclosure controls and procedures that 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.





As of the
end of the period covered by this report, we carried out an evaluation, under
the supervision and with the participation of our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures.  Based on the foregoing
evaluation, and in light of the material weaknesses in internal controls
described below, our Chief Executive Officer and our Chief Financial Officer
concluded that as of the end of the period covered by this report our disclosure
controls and procedures were not effective in timely alerting them to material
information to be included in our reports files or submitted under the Exchange
Act.





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 Quarterly Report were prepared in accordance with generally accepted
accounting principles in the United States (“GAAP”). These measures
included, among other things, expansion of our quarter-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.





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.”


30





Company
management has concluded that, as of September 30, 2008, the following material
weaknesses existed at both the Company and the Distributor:





·
              Timely and
      routine financial statement close/reporting process 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 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.
                
                Management did not adequately supervise the
      accumulation, analysis, and computation of stock compensation during the
      quarter as the Company and Distributor lacked the appropriate financial
      personnel to undertake this
computation.
  ·
              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
adjustments.





·
            Management’s
      estimation and forecasting process as it relates to inventory obsolescence
      reserve, and sales returns and price protection reserves.
              
              In
      calculating the Distributor’s reserves, management utilized incorrect
      projections which resulted in material adjustments being
      recorded.




The
Company will continue its efforts to strengthen its accounting and finance
departments and aggressively pursue remediation of all material
weaknesses.  The Company filled the position of Chief Accounting
Officer in the second quarter of 2008.





Changes
in Internal Control over Financial Reporting





Other
than as described above, there were no changes in our internal control over
financial reporting that occurred during our most recent fiscal quarter that
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.








PART
II - OTHER INFORMATION





ITEM 1.
            LEGAL
      PROCEEDINGS





FALCON
PICTURE GROUP MATTER





We have
disclosed in prior reports filed with the Securities and Exchange Commission a
complaint filed against the Company in the Circuit Court of Cook County,
Illinois by Falcon Picture Group, LLC (“Falcon”), and the related counterclaim
filed by the Company against Falcon and its owner, Carl Amari. There have been
no material developments in these matters. For a complete description of the
facts and circumstances surrounding this litigation, please see the disclosure
in our Annual Report on Form 10-K/A for the year ended December 31, 2007 under
Part I, Item 3., “Legal Proceedings”, which is incorporated herein by
reference.





31


ENTERTAINMENT
RESOURCE MATTER





We have
disclosed in prior reports filed with the Securities and Exchange Commission a
complaint filed against the Company in the Circuit Court of Broward County,
Florida, Case No. 06-012249 CACE 05, by Larry S. Hyman, as assignee for
Entertainment Resource, Inc. (“ERI”).  There have been no material
developments in this matter.  For a complete description of the facts
and circumstances surrounding the ERI litigation, please see the disclosure in
our Annual Report on Form 10-K/A for the year ended December 31, 2007 under Part
I, Item 3., “Legal Proceedings”, which is incorporated herein by
reference.





ITEM
      1A.
            RISK
      FACTORS





As a
result of the recent economic conditions (including a decrease in consumer
confidence resulting in lower spending levels) and a reduced slate of pictures,
the Distributor has experienced a significant reduction in net revenues and
liquidity issues.  In addition, the Distributor is currently not in
compliance with certain terms, conditions and covenants of the Amended Credit
Agreement, and also is in a dispute with TWC relating to payments under the TWC
Distribution Agreement.  Based on current operating results, 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. Further, the Distributor is also in discussions
with its lender and TWC to cure and/or resolve such instances of non-compliance
and disputes.  The Distributor is pursuing these options to alleviate
the liquidity shortfall position that it currently finds itself in.  At
this time, the Distributor is unable to conclude if the aforementioned actions
being taken will be successful. If the Distributor is unable to cure such
instances of non-compliance under the Amended Credit Agreement, the
Distributor’s lender could, among other remedies, cease to extend future loans
to the Distributor, accelerate any amounts owed by the Distributor under the
Amended Credit Agreement and/or foreclose on its security interest in the
Distributor’s assets.  If the Distributor is unable to successfully
resolve its disputes with TWC, TWC could seek to terminate the TWC Distribution
Agreement.  In either such case and/or 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 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, any adverse impact on the
operations and liquidity of the Distributor could also adversely impact the
Company’s results of operations and liquidity.




Except
for the risk factors discussed above, there are no other material changes from
the risk factors previously disclosed in our Annual Report on Form 10-K/A
for the year ended December 31, 2007.





ITEM
      2.
              UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





None.





ITEM
      3.
            DEFAULTS
      UPON SENIOR SECURITIES





None.





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





None.





ITEM
      5.
            OTHER
      INFORMATION





None.





32


ITEM
      6.
            EXHIBITS





3.1
              Amended
      and Restated Certificate of Incorporation of the Registrant (Incorporated
      by reference to Exhibit 3.1 to the Registrant’s Quarterly Report on Form
      10-Q filed with the Securities and Exchange Commission on November 20,
      2006).





3.2
              Certificate
      of Designation of Series A Interim Convertible Preferred Stock of Genius
      Products, Inc., filed with the Delaware Secretary of State on January 14,
      2009 (Incorporated by reference to Exhibit 3.1 to the Registrant’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      February 24, 2009).





3.3
              First
      Amendment to Certificate of Designation of Series A Interim Convertible
      Preferred Stock of Genius Products, Inc., filed with the Delaware
      Secretary of State on February 13, 2009 (Incorporated by reference to
      Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on February 24,
  2009).





3.4
              Amended
      Bylaws of the Registrant (Incorporated by reference to Exhibit 3.2 to the
      Registrant’s Annual Report on Form 10-KSB filed with the Securities and
      Exchange Commission on March 31,
2005).





4.1
              Specimen
      Certificate for Common Stock (Incorporated by reference to Exhibit 4.8 to
      the Registrant’s Annual Report on Form 10-KSB filed with the Securities
      and Exchange Commission on April 14,
2000).





31.1
            Certification
      of Chief Executive Officer pursuant to Section 302(a) of the
      Sarbanes-Oxley Act.*





31.2
            Certification
      of Chief Financial Officer pursuant to Section 302(a) 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.

















33


SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





GENIUS
      PRODUCTS, INC.,a
      Delaware corporationDated:    March
      30, 2009
                By:
      /s/ Trevor
      DrinkwaterTrevor DrinkwaterPresident and Chief Executive
    Officer(Principal Executive Officer)Dated:  March
      30, 2009
                By:
      /s/ Edward J.
      ByrnesEdward J. ByrnesChief Financial Officer(Principal Financial and Accounting
      Officer)














34